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Originally published Friday, January 28, 2005 at 12:00 AM

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Earnings: Microsoft has a record quarter

Listening to Microsoft's earnings report yesterday was like watching Michael Jordan play basketball at the height of his career. Another record quarter, another...

Seattle Times technology reporter

Listening to Microsoft's earnings report yesterday was like watching Michael Jordan play basketball at the height of his career.

Another record quarter, another $3 billion in the coffers, another day at the office.

For the quarter ending Dec. 31, the company reported $10.8 billion in sales, a 6.5 percent increase from the previous year, while profit more than doubled to $3.46 billion, or 32 cents a share after factoring in stock-compensation expenses. It beat Wall Street estimates by 3 cents a share and its own by 4 cents. In addition, the company raised its outlook for the rest of its 2005 fiscal year, which ends June 30.

The company attributed the growth to strong server sales, hot video-game products and a generally strong market for technology around the world.

Analysts said the stock may rally a bit on the news, but they don't expect it to break $30 for perhaps another year, when the next wave of core products reaches the market. Shares closed at $26.11 yesterday, up 10 cents, before the earnings were reported. It rose to $26.57 in extended trading.

"We have to discern the enthusiasm over 7 percent growth versus 30 to 50 percent growth we had seen 10 years ago," said Rick Sherlund, an analyst at Goldman Sachs in New York. "We're excited that they did better than expectations, but to put it in context, it's not the kind of growth that was driving this stock so robustly in earlier years."

Chief Financial Officer John Connors, in what's likely to be his last report for the company, called it "good results pretty much across the board." He is leaving Microsoft to become a venture capitalist.

Connors said the company benefited from positive economic trends and corporate technology spending.

"Corporate profits worldwide are pretty darn healthy and worldwide GDP growth is pretty decent," he said.

In raising its outlook for fiscal 2005, Microsoft expects sales of $39.8 billion to $40 billion, which would represent an 8 to 9 percent increase over fiscal 2004. That's also up from the company's estimate made in October of $38.9 billion to $39.2 billion.


Operating income is expected to be $16.5 billion to $16.7 billion, and earnings per share are expected to be $1.09 to $1.11, up from earlier estimates of $1.07 to $1.09.

Microsoft also distributed $32.6 billion in a special $3 per share dividend during the quarter, but it still had $34.5 billion in cash as of Dec. 31.

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Cash flow during the quarter was $3.6 billion.

"From a cash-flow valuation perspective, the stock should be trading in the low 30s," said Jonathan Rudy, a Standard & Poors analyst in New York.

"Aggressive tech investors aren't going to be too crazy about it, but it was a really good quarter across the board," Rudy said. "It's just so tough for Microsoft — the law of large numbers is really working against them. For them what is really solid growth, nearing a $40 billion run rate ... you're not going to see the 20, 25 percent growth out of Microsoft anymore."

Highlights of the quarter included an 18 percent increase in server sales, despite the ongoing threat of competitors such as Linux. It was the server group's 10th consecutive quarter of double-digit growth.

"The world is buying a heck of a lot of servers," Connors said.


Boosted in part by the release of the Xbox game "Halo 2" in November, the home and entertainment division posted its first quarterly profit, $84 million.

So far 6.3 million copies of "Halo 2" have been sold at around $50 apiece since its November introduction. The game also helped boost sales of the Xbox console to 19.9 million units, a goal the company didn't expect to reach until June.

Peter Moore, Xbox vice president, called it a "phenomenal turnaround quarter." He said the Halo franchise has become a mass-market phenomenon that the company can build upon for years.

But the company warned that the game profits are temporary. It's spending to develop the next version of the console, Xbox 2, which Sherlund believes will go on sale in October. Microsoft still expects the division to start posting regular profits in its 2007 fiscal year.

Connors said PC sales were stronger than the company expected, growing 12 percent rather than 7 percent to 9 percent. Windows division profit was $2.5 billion, up from $2.1 billion during the same period last year.

Office and other "information worker" products declined 3 percent compared with the previous year, when the company launched the Office 2003 line.

"Can't complain too much. I think it was a real solid quarter," said analyst Al Davis at McAdams Wright Ragen in Seattle.

Davis expects the stock to climb today. But will it break $30?

"I don't know," he said. "Our target's $31 and the stock's been lagging for three years now."

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

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