Microsoft Profits Up 5% On Xbox, Database Sales

The company set a quarterly revenue record, but fell short of its forecast, and operating income fell reflecting higher expenses associated with new product launches.

Aaron Ricadela, Contributor

January 26, 2006

3 Min Read

Microsoft posted a 5% gain in profits and the highest quarterly sales in its history, in the midst of a series of high-profile product launches the company is counting on to revive its underperforming stock.

The world's largest software company on Thursday reported that revenue for its second quarter ended Dec. 31 rose 9% to $11.84 billion--a quarterly record for the company, but still short of its forecast of $11.9 billion to $12 billion in sales. Net income rose 5% to $3.65 billion, or 34 cents per share. Sales of Microsoft's new SQL Server 2005 database software and Xbox 360 video game console boosted results. But operating income fell 2% to $4.66 billion, reflecting higher sales, marketing, and development expenses associated with the new product launches.

Shares of Microsoft (Nasdaq--MSFT) rose during after-hours trading following the report. The shares closed regular trading Thursday up 10 cents, or 0.38%, at $26.50. Microsoft shares have underperformed the major stock indices for the past three years. And a 7% rise in the shares' price since the company's last earnings report in October trails an 8% increase in the S&P Information Technology index.

During a conference call with analysts Thursday, Microsoft chief financial officer Chris Liddell called the company's servers and tools division a "highlight" of the second quarter. Sales of SQL Server increased more than 20%, outpacing the overall database market, and adoption of the new product has been faster than the company expected, he said. The launch of the Xbox 360 console during the quarter also lifted sales. The releases are part of a string of more than a dozen new products Microsoft plans to ship before the end of this year. During the second half of the calendar year, Microsoft plans to release Windows Vista, the next version of its flagship PC operating system, and a new version of its cash-cow Office suite.

But questions remain about the company's ability to capitalize on PC sales growth, meet demand for the Xbox, and build its Internet businesses. Liddell said PC unit sales grew between 11% and 13% during Microsoft's second quarter, and the company expects 12% to 14% growth during the fiscal year which ends in June. The positive estimate follows Intel's report last week of soft PC demand. But faster growth in emerging markets than in the United States, Europe, and Japan, and stronger sales of lower-priced home versions of Windows compared with business versions mean Microsoft has collected less money on the software bundled with each machine. This week, Microsoft said it would release additional source code for its Windows server operating system to comply with an antitrust ruling by the European Union.

Component shortages have constrained Microsoft's ability to deliver enough Xbox consoles to meet demand; the company shipped 2.5 million units to retailers during the quarter, compared with its previous forecast of 2.75 million to 3 million units.

And revenue from Microsoft's MSN division was little changed from a year ago. Microsoft's test versions of new Internet ad-serving software it's developing are having "a dampening effect on revenue from search," said Liddell.

Microsoft is counting on new releases of its Internet products for growth. On Wednesday, Microsoft said it's formed a "live labs" applied research group to speed new Internet technologies to market. The group, headed by Microsoft technical fellow Gary Flake, will prototype and release emerging technologies in areas including multimedia Web searching, machine learning, distributed computing, and data mining, the company said.

Microsoft on Thursday also provided financial guidance for the rest of its fiscal year. For the third quarter ending March 31, Microsoft forecast revenue of $10.9 billion to $11.2 billion, and operating income of $4.5 billion to $4.6 billion. For the fiscal year ending June 30, the company said it would post operating income of $17.9 billion to $18.3 billion, on $44 billion to $44.5 billion in sales.

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