Updated from 9:04 a.m. EDT

Microsoft ( MSFT) shares bounced Friday, a day after the software behemoth beat analyst estimates with a 17% increase in fiscal third-quarter revenue and offered typically conservative guidance for fiscal 2005.

Shares of Microsoft were recently up $1.60, or 6.2%, at $27.55.

Encouraged by the third-quarter report, several analysts raised their estimates for the rest of the year and reiterated buy ratings, although Microsoft's fiscal 2005 guidance was mixed, with revenue short of estimates but earnings exceeding them.

"We reiterate our outperform rating on MSFT shares and believe that the next three to six months present a buying opportunity ahead of what we believe are three major catalysts," Piper Jaffray analyst Gene Munster wrote in a note Friday. He cited a likely dividend increase in July, an improvement in deferred revenue and anticipation of the next release of Windows, due out in 2006.

"Long term, we expect investor anxiety related to Microsoft's growth potential will ease as the company delivers on fiscal 2005 targets," Munster added. (Piper has not done banking with Microsoft.)

Meanwhile, a smaller-than-expected decline in the closely watched deferred revenue line -- a measure of subscription sales -- also boosted investor confidence. "This is music to the ears of investors who have been concerned about the decline in unearned revenue over the past few quarters," wrote Friedman Billings Ramsey analyst David Hilal, who has an outperform rating on Microsoft. (His firm hasn't done banking with Microsoft.)

Unearned, or deferred, revenue fell about $326 million to $7.53 billion from $7.85 billion at the end of December. That was a smaller decline than the $500 million drop expected by analysts.

Previously, analysts expressed concern that a dearth of new products in coming years and competition from Linux are discouraging business customers from renewing their subscriptions. Microsoft expects the third-quarter decline in deferred revenue to be offset by an equally or slightly greater increase in the just-started fourth quarter, CFO John Connors said in a post-close conference call.

Taking into account the lower-than-expected unearned revenue decline, Microsoft's total bookings, or sales, in the quarter beat expectations by as much as $700 million, or 10% of consensus estimates, analysts noted.

Raising the Bar, Slightly

Under generally accepted accounting principles, Redmond, Wash.-based Microsoft earned $1.32 billion, or 12 cents a share, in the third quarter, which includes a stock-based compensation charge of 5 cents a share and legal charges of 17 cents a share. The legal charges include $1.89 billion related to Microsoft's historic settlement with archrival Sun Microsystems ( SUNW) and a fine imposed by the European Union in its antitrust case.

A year ago, Microsoft posted third-quarter net income of $2.14 billion, or 20 cents a share, which includes stock-based compensation charges of 6 cents a share.

Excluding charges, Microsoft earned pro forma net income of 34 cents a share in the third quarter. That handily beat the consensus estimate gathered by Thomson First Call of 29 cents a share and the company's target range of 28 cents to 29 cents a share for the third quarter ended in March.

Third-quarter revenue rose 17% to $9.18 billion from $7.84 billion a year earlier, but declined 9.6% from a record $10.15 billion in the previous quarter. That exceeded the consensus estimate of $8.66 billion for the third quarter and the company's targeted range of $8.6 billion to $8.7 billion.

"We had a fantastic quarter," Connors said. "We expect improvement we saw in corporate spending to continue for the remainder of the fiscal year. Businesses seem more willing to invest in IT products."

Looking ahead at the fiscal fourth quarter, Microsoft expects to earn 28 cents a share, excluding a 5-cents-a-share stock compensation charge, on revenue of $8.9 billion to $9.0 billion. Analyst estimates called for fourth-quarter earnings of 27 cents a share on revenue of $8.88 billion.

The company also provided its outlook for fiscal 2005, beginning in July, for the first time. Microsoft said it expects to earn $1.31 to $1.33 a share, excluding stock compensation of 15 cents a share, on revenue ranging from $37.8 billion to $38.2 billion in 2005. That represents a modest 4% revenue jump year over year and falls short of the consensus estimate calling for revenue growth of 7.4% in 2005 to $38.51 billion. But the company's earnings guidance exceeds analysts' estimates for EPS growth of 6.7% to $1.28 a share.

Microsoft is known for giving extremely conservative guidance. In a question-and-answer session on the earnings call, SG Cowen analyst Drew Brosseau noted that a year ago, Microsoft's guidance for the current Fiscal year 2004 was about 10% short of the revenue Microsoft now expects to deliver and about 15% short on earnings.

But Connors cautioned that the big difference from a year ago is that PC and server hardware has rebounded and foreign exchange rates proved to be more beneficial than the company expected.

PC Spending Rebound

Microsoft enjoyed an $800 million benefit from foreign currency exchanges in the first nine months of fiscal 2004 -- including $350 million in the third quarter -- and that benefit is likely to shrink next year.

In the third quarter, Microsoft estimated PC shipments grew 14% -- higher than its 10% expectation -- and server hardware grew 17%, with lower growth in Japan and Latin America.

"The first half of the year was really a consumer story in the PC business," Microsoft spokesman Curt Anderson said in an interview before the conference call. "It appears the second half of the year is going to be more of a business story," while admitting it will be hard to beat the PC growth in fiscal 2004.

Microsoft is forecasting PC shipments grow 10% in the fourth quarter and in the mid-to-upper single digits in fiscal 2005.

Another reason Microsoft faces tough comparisons in 2005 relates to the company's subscription sales. Microsoft's sales received a $1.1 billion boost in 2004 from subscription sales spurred by a special promotion two years ago, which won't be repeated; consequently, many of those customers are not expected to renew their subscriptions.

Finally, Xbox sales are declining year over year, in part due to a recent price cut on consoles, which is typical late in the video game console cycle.

Still, the company will deliver on the bottom line by keeping expenses flat in 2005 compared to 2004, Anderson said.

Elsewhere on the balance sheet, Microsoft's gigantic cash hoard reached $56.4 billion, with $4.97 billion in cash generated from operations during the third quarter. Connors remained mum on the company's plans for its cash but said he will give more details at its analyst day July 29. Options include paying a higher dividend and buying back more cash.

On the income statement, Microsoft's Client, Information Worker, and Server and Tools businesses posted a combined 17% growth from a year ago. Microsoft Server and Tools posted the largest percentage increase in sales, at 19% year over year to $2.18 billion. That was driven in part by adoption of the Windows Server 2003 operating system, with new licenses growing 31%, Microsoft said.

Buoyed by its launch of Office 2003 in October, Microsoft's Information Worker segment registered year-over-year sales growth of 18%, to $2.74 billion.

Worldwide retail license sales of Office 2003 are double those of its predecessor, Office XP, over its first five months and sales of Office to hardware manufacturers grew by 35% year over year, according to Microsoft.

Microsoft's Client business, largely made up of Windows operating system sales, posted nearly 16% growth year over year. MSN posted another profitable quarter on 16% year-over-year revenue growth, to $591 million. Microsoft's Home and Entertainment division, including the Xbox video game business, showed a 17% increase in sales to $530 million, but Microsoft loses money on every console sold.

The one weak spot was Microsoft's Business Solutions unit, a miniscule part of Microsoft's overall business that includes applications for small and medium-sized businesses. Business Solutions sales revenue climbed a tiny $6 million, or 4%, year over year to $153 million, representing less than 2% of total sales. "We aren't having very good U.S. execution," Connors acknowledged. Efforts to change that should bear fruit in fiscal 2005.