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Microsoft 3Q Profits Double, But Sales Disappoint

A big drop in legal expenses helped Microsoft's profits nearly double in the third quarter, but revenue inched up just 5% to $9.62 billion.

Microsoft's profits nearly doubled during the third quarter ended March 31 on lower legal expenses and strong sales of server software and its Xbox video game, but revenue inched up just 5%--short of investors' expectations--as sales of Windows and Office grew only modestly.

The world's largest software company earned $2.56 billion for the quarter, or 23 cents per share, compared with $1.32 billion, or 12 cents per share, during the comparable quarter one year ago. Microsoft's revenue was $9.62 billion, up 4.9%, compared with analysts' expectations of $9.83 billion, according to a survey by Thomson Financial.

A reduction in legal expenses helped lift profits. Microsoft spent $768 million, or 5 cents per share, to cover legal claims, including a settlement with Gateway Inc. Last year, the company spent $2.53 billion, or 17 cents per share, on legal charges, including antitrust settlements with Sun Microsystems and the European Union.

But the top line last quarter was squeezed as sales of Microsoft's largest products, Windows and Office, grew slowly. Each generated more than $2 billion in profits during the quarter. Yet Windows revenue was up just 2.2%, and Office sales grew at about 2.5%. The slow growth was partly caused by PC sales that grew less than 5%, weaker than Microsoft had expected, corporate VP and controller Scott Di Valerio said in a conference call with analysts Thursday. Server hardware sales also grew more slowly than projected. Meanwhile, revenue in Microsoft's MSN Internet unit declined 4.6% as consumers continued to abandon dial-up Net access. "There have been mixed results in the technology industry recently," Di Valerio said.

But sales in Microsoft's home and entertainment division, which includes its Xbox console, and sales of servers and tools, including the SQL Server database and Exchange E-mail software, both grew nearly 12%. "SQL and Exchange are firing on all cylinders," Di Valerio said.

For the fourth quarter, which ends June 30, Microsoft said it expects between $10.1 billion and $10.2 billion in revenue, or growth of 9% to 10% year over year. Di Valerio projected that Windows client revenue would rise by 8% to 9% during the quarter, and its servers and tools business would post a 16% to 17% increase. Microsoft also provided its first guidance for the 2006 fiscal year, which begins July 1. The company said it expects revenue of between $43.3 billion and $44.1 billion for the year.

Earlier this week, Microsoft said it hired as its CFO Chris Liddell, formerly CFO at International Paper Co. Former Microsoft CFO John Connors left the company in March to join Seattle venture-capital firm Ignition Partners.

Shares of Microsoft (Nasdaq-MSFT) closed Thursday down 54 cents, or 2.2%, at $24.45.

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