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Originally published Friday, January 26, 2007 at 12:00 AM

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Microsoft sees strong growth; Xbox scores big

Even though new versions of its two flagship software products weren't available for the holiday shopping season, Microsoft's Xbox 360 game...

Seattle Times technology reporter

Even though new versions of its two flagship software products weren't available for the holiday shopping season, Microsoft's Xbox 360 game console was. And people bought it in droves, helping the company beat its own financial projections.

The giant posted revenue Thursday of $12.54 billion for its fiscal second quarter ended Dec. 31.

That was 6 percent growth over the previous year, a deceptively low figure attributable to accounting for an incentive program aimed at stimulating PC sales during the holidays.

Executives claimed success for Microsoft's program to give PC buyers a discounted or free upgrade from Windows XP and Office 2003 to Windows Vista and Office 2007, whose broad release is Tuesday. It caused the company to defer $1.6 billion of revenue to this quarter, the third in Microsoft's fiscal 2007.

Without that deferral, revenue growth in the second quarter would have been 20 percent.

"That's impressive growth for any company, let alone one of our size," Chief Financial Officer Chris Liddell boasted on a conference call with reporters and financial analysts.

Profit fell 28 percent for the quarter from the year-ago period, again due to the upgrade program, to $2.63 billion, or 26 cents a share. However, both figures surpassed the company's guidance issued in October.

Andy Miedler, an Edward Jones analyst with a buy rating on Microsoft stock, said he was impressed by the strength across the board — after adjusting for the revenue deferrals.

Microsoft's server and tools business unit had its 18th consecutive quarter of double-digit revenue growth, coming in at 17 percent.

The entertainment and devices division, responsible for selling 10.4 million Xboxes by year's end, added $1.27 billion in revenue for a 76 percent growth rate.

"Every quarter there's a unit that's up, a unit that's down, but to have everything doing well is a good time for the company," Miedler said.

The stock fell about 2.1 percent, along with the broader market Thursday, but gained 55 cents in heavy after-hours trading to finish at $31.

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A soft spot lingers in Microsoft's online-services business, which battles the likes of Google and Yahoo!. The unit saw 5 percent revenue growth, including 20 percent growth in ad revenue overall.

But the contribution of search advertising — the source of Google's billions — to that growth was only "modest," the company said, and third-party statistics have shown Google's lead in Internet search widening in recent months.

"Although we're still forecasting growth in search queries and page views, our plans now include a more measured rate of growth for the balance of the year," Liddell said.

Philip Durrell, a senior analyst with The Motley Fool, said he isn't expecting Microsoft's online business to be a big contributor soon, despite the company's significant investment.

"They're not winning any search battles," said Durrell, who owns Microsoft shares. "That jumped out. My expectation of Microsoft is these new product launches [Vista, Office and Windows Server later in 2007] are going to be the main thing driving growth over the 2008 and 2009 fiscal years."

For the rest of the current fiscal year, Microsoft increased its guidance slightly.

It also lowered its expectations for Xbox 360 sales during the next six months. By the end of June, the company had aimed for a total of 13 million to 15 million consoles, but now expects to reach 12 million.

The Xbox 360 was a winner during the holiday season, as new rivals Sony PlayStation 3 and Nintendo Wii dealt with shortages. The Microsoft video game "Gears of War" was also a strong seller.

"With that strong momentum, we're making tradeoffs and choices in managing the Xbox business to achieve our target of profitability in fiscal year '08," Liddell said.

Microsoft aims to shed more light on its strategy Feb. 15 when Liddell and CEO Steve Ballmer will brief analysts in New York City.

The company will give its first estimate for the 2008 fiscal year when it reports current quarter revenues in about three months.

Benjamin J. Romano: 206-464-2149 or bromano@seattletimes.com

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