Update: Microsoft has record Q2, misses revenue estimates

Company says growth due to strong Server and Tools business, SQL Server

Microsoft Corp. on Thursday reported the highest quarterly revenue in company history for its fiscal 2006 second quarter on the strength of its Windows OS and a series of highly anticipated product releases. Still, the company fell slightly shy of analysts' revenue expectations.

Microsoft reported revenue of US$11.84 billion, a year-over-year gain of 9 percent that was just short of the $11.96 billion consensus revenue forecast from analysts polled by Thomson Financial. Last year for the same time period, Microsoft reported revenue of $10.82 billion.

Net income for the quarter increased 5 percent to $3.65 billion, or $0.34 per share. Excluding a tax benefit, pro forma earnings per share came in at $0.33, meeting the consensus estimate of analysts polled by Thomson Financial.

Microsoft attributed the growth to its core Server and Tools business, home to its Windows OS, which continued to do well in a strong PC market. The unit itself grew its revenue 14 percent year over year.

The availability of a host of highly anticipated products in the quarter, including the Xbox 360 game console, as well as SQL Server 2005, Visual Studio 2005 and Microsoft Dynamics CRM 3.0 software, also gave financials a boost, Microsoft said. SQL Server in particular experienced strong growth, with a revenue gain of 20 percent over the same time period last year.

Analysts from several investment banks, including J.P. Morgan Chase & Co. and Goldman Sachs & Co., had lowered their expectations for Microsoft's quarter last week. Analysts were concerned that Microsoft's inability to meet high demand for the Xbox 360, which was released Nov. 22 in the U.S., would affect its second-quarter revenue. After Intel Corp. last week blamed lower-than-expected shipments of desktop computers for missing its own quarterly estimates, analysts believed the same problem might affect Microsoft's revenue as well.

While that was not the case, Chief Accounting Officer Scott DiValerio acknowledged on a conference call Thursday that Xbox consoles shipped during the quarter were "lower than we expected due to component shortage." In the second quarter, Microsoft shipped a total of 1.5 million units of the Xbox 360 -- 900,000 in North America, 500,000 in Europe, the Middle East and Africa, and 100,000 in Japan, he said.

DiValerio added that Microsoft's problems in producing enough Xbox 360s to meet demand are a thing of the past. "We believe this is a short-term manufacturing challenge," he said.

Microsoft late last year announced a third manufacturer, Celestica Inc., to produce Xbox 360 consoles. Celestica will join Wistron Corp. and Flextronics Corp. in manufacturing the consoles next month, said Chris Liddell, Microsoft's chief financial officer. Microsoft is confident it will meet current and future demand for the Xbox and is still on track to ship its expected total of 4.5 million to 5.5 million Xbox consoles by June, the end of its fiscal year, he said.

Looking ahead, Microsoft expects revenue for fiscal 2006 to be in the range of $44 billion to $44.5 billion, with revenue for its third quarter ended March 31 coming in between $10.9 billion and $11.2 billion. It expects all of its business units except for MSN to experience growth for both the full year and the third quarter. The Server and Tools groups will continue to chug along strongly with expected growth for fiscal 2006 of 16 percent to 17 percent year over year, Liddell said. MSN growth for both the year and the quarter is expected to be flat, he said.

Though MSN continues to be a financial nonstarter, Microsoft is expecting that to change as it ramps the business up significantly. To help give the unit a shot in the arm, Microsoft is accelerating its development of adCenter, a new system for selling advertising within its search results, Liddell said.

AdCenter is Microsoft's answer to Google Inc.'s explosive success selling advertising linked to searches. Microsoft hopes to boost both the advertising revenue and the image of MSN Search, which now is ranked third behind the Google and Yahoo Inc. search engines in terms of visitors.

AdCenter is currently in trial deployments in several countries, including Singapore, France and the U.S., with the full launch expected by June. The company plans to hire 1,000 more employees before the end of the fiscal year to provide customer service for advertisers that use the new service, Liddell said. Microsoft also plans to roll out adCenter in more countries over the course of the year.

MSN also oversees Microsoft's "Live" hosted services business, which the company continues to promote as it adds new Web-based services to its portfolio. On Thursday, Microsoft also publicly announced a new research center, Live Labs, exclusively devoted to quickly developing and deploying new Web-based services and technologies.

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