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Friday, October 22, 2004 - Page updated at 04:34 P.M.
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Microsoft profit up 11 percent

By Brier Dudley
Seattle Times technology reporter

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Microsoft made almost $3 billion in profit in the past quarter, but it was Google that captured investors' fancy yesterday.

The current and former Wall Street darlings reported their earnings after the stock market closed yesterday, and the reception showed how much investors favor a hot new thing over a reliable old-timer.

Microsoft beat its forecast and analyst expectations with a profit of $2.9 billion, up 11 percent from the previous year. Sales in the quarter, the first in the company's fiscal year, reached $9.19 billion, up 12 percent.

Chief Financial Officer John Connors said every business division is strong, and the company likely has more orders booked than any commercial software maker in the world. But analysts focused on a $150 million drop in long-term contracts and moderate expectations for the current quarter.

Microsoft stock fell 46 cents in after-hours trading to $28.10, and analysts don't expect it to rise above $30 anytime soon.

Google, meanwhile, had a profit of $52 million on sales of $806 million, a 50 percent sales increase.

The unconventional company gave no guidance about future earnings, but investors didn't care. They pushed Google's stock up $12 to $161.30 in late trading.

Goldman Sachs analyst Rick Sherlund, whose company handled Microsoft's initial public offering in 1986, saw Google's results on television as he listened to Microsoft report its earnings.

"I was thinking, 'Well, I remember when they were growing 50 percent a year,' " he said wistfully.

Sherlund and other analysts were expecting Microsoft to have a strong quarter, but they were taken aback when the company reported a few glitches.

Sales from long-term contracts fell by around $400 million; analysts had expected around a $250 million decline.

Investors were also disappointed that Microsoft also expects sales to grow only about 1 percent to 2 percent in the quarter ending Dec. 31, he said.

"The good news is offset by a couple of other issues that will generate a big controversy, when in fact people were thinking this would be all good news," Sherlund said.

During yesterday's earnings conference call, CFO Connors tried persuading analysts not to dwell too much on the unearned revenue from long-term contracts.

"I do believe investors have become overly focused on unearned revenue and have missed the bigger picture," he said.

Brendan Barnicle, an analyst at Pacific Crest Securities in Portland, said the company may be getting frustrated that its stock isn't responding to its positive earnings news.

"They were trying to defend their business more than I've heard them in the past," he said. "They have had some of the best results in technology yet the stock has traded completely sideways for the past six months. It's been a huge frustration for a lot of people."

Microsoft also raised its sales outlook for the rest of its fiscal year, in part because its Xbox games are on a selling frenzy.

Among the highlights are 1.5 million orders already placed for "Halo 2," an action game going on sale Nov. 9 for around $50.

"Most any other company, if they had that type of success with 'Halo 2,' their stock would be screaming because it would be a huge growth opportunity," Barnicle said.

Connors said Xbox and other new businesses "should continue to drive growth for the long term."

Home and entertainment product sales grew 9 percent, MSN sales were up 10 percent, business solutions sales were up 9 percent and mobile and embedded device software sales grew 30 percent.

But most of the company's growth during the quarter still came from its core PC, server and productivity software products.

Connors said the company expects PC sales to grow 8 percent to 10 percent through the fiscal year, with business PC sales outpacing sales to consumers.

Server software sales were especially strong, up 19 percent in the quarter, and contributed to the higher forecast for fiscal 2005.

The company expects sales of $38.9 billion to $39.2 billion for the year, up from an earlier forecast of $38.4 billion to $38.8 billion.

Operating income for the year is expected to be $16.4 billion to $16.7 billion, and earnings per share are expected to be $1.07 to $1.09.

For the current quarter, the company expects to earn 28 cents a share on sales of $10.3 billion to $10.5 billion and operating income of $4.2 billion to $4.3 billion.

Microsoft also beat analyst expectations on an earnings-per-share basis. The company made 27 cents a share, or 32 cents if you don't count stock-compensation expenses of 5 cents a share. Analysts polled by Thomson Financial expected 30 cents, not including the stock cost.

But investors still view Microsoft as entering a slower-growth phase.

"From a Microsoft investor perspective, after-hours you see Google popping and you see Microsoft trading down, that might frustrate investors somewhat," said analyst Jonathan Rudy at Standard & Poor's in New York.

"One is young and in a high-growth phase and the other is much bigger, in a more modest-growth phase," said Drew Brosseau at SG Cowen Securities in Boston. "They're very different investments."

Brier Dudley: 206-515-5687 or bdudley@seattletimes.com

Copyright © 2004 The Seattle Times Company

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