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JANUARY 28, 2005
By Jay Greene Microsoft's Golden Halo Gleams Anew Second-quarter results defied naysayers and the outfit's own expectations, thanks to server software, PCs, and hit game Halo 2.
Fiscal 2005 was supposed to be one of the slowest growth periods in Microsoft's history. Analysts, and even the company, were projecting revenue gains of just 6% at the start of the fiscal year in July. But the fiscal second quarter ended Dec. 30 featured better-than-expected PC sales, big corporate spending on servers, and huge sales for the blockbuster video game Halo 2. Taken together, all that puts Microsoft (MSFT ) in a position to achieve growth approaching 9% for the fiscal year, which ends June 30. By all accounts, it was a strong quarter. The software giant's quarterly earnings jumped 123%, to $3.5 billion, on sales of $10.8 billion, a 7% gain. Microsoft had expected sales of $10.3 billion to $10.5 billion for the quarter. "You have to nitpick pretty hard to find flaws," says Sanford C. Bernstein & Co. analyst Charles DiBona. The engine behind much of Microsoft's growth in recent quarters has been its server software business. "Our server business has a track record like the Patriots in the playoffs," said John Connors, Microsoft chief financial officer, in a conference call with Wall Street analysts. UNEXPECTED GAINS. Certainly, server software sales were strong once again. Revenue in the category jumped 18%, to $2.5 billion. While industrywide server shipments climbed about 15% during the quarter, by Microsoft's estimates, Windows server shipments grew 19%. And sales of its SQL Server database software, which the company expected to slow a bit in advance of the release of a new version later this year, has shown no signs of abating. But it was the unexpected that helped push Microsoft's results past analyst expectations. Start with PC sales. The company estimates that PC shipments climbed 12% during the quarter, not the 7% to 9% it had been expecting. That nudged revenue in Microsoft's PC operating system business up 5%, to $3.2 billion. What's more, Microsoft sold 6.3 million copies of Halo 2. That put its Home & Entertainment division in the black for the first time, with an $84 million profit. The group's sales hit $1.4 billion, up 11%. "We've shifted gears from being a neophyte and startup to a company that is very seasoned in the industry," says Peter Moore, worldwide marketing and publishing vice-president for Microsoft's Xbox video-game machine. "SALTED AWAY." The better-than-expected numbers, coupled with continued improvements Microsoft now anticipates, has the giant bumping up its guidance for the fiscal year. It says sales should hit $39.8 billion to $40 billion. That's up from its first-quarter guidance of $38.9 billion to $39.2 billion. Microsoft expects fiscal-year operating income in the range of $16.5 billion to $16.7 billion. For the current, fiscal third quarter, Microsoft is guiding to operating income from $4.1 billion to $4.2 billion on sales of $9.7 billion to $9.8 billion. Investors will want to see signs that Microsoft can sustain the solid numbers in order to boost the stock, which has traded flat for several months. One place to look might be unearned revenue -- money it has taken in on long-term contracts that hasn't yet been counted as sales -- which hit $8 billion in the quarter. That money will eventually find its way into results, boosting sales in Microsoft's Office, server-software, and Windows franchises. "That's a lot of revenue that has been salted away," Bernstein's DiBona says. Connors, who will leave Microsoft to join a Seattle-area venture-capital firm in the next two months, ended his last conference call with a zinger for those who might doubt the company's performance going forward. Even from afar, Connors said, "I will enjoy seeing the skeptics proved wrong, as Microsoft always does." The fiscal second-quarter results suggest that he may indeed have some gloating ahead.  Greene is BusinessWeek's Seattle bureau chief
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