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Originally published January 28, 2010 at 1:31 PM | Page modified January 29, 2010 at 7:31 AM

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Microsoft beats forecasts in latest quarterly report

Driven by strong sales of its new operating system Windows 7 during the holidays, Microsoft blew past forecasts in its quarterly earnings reported Thursday.

Seattle Times technology reporter

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Microsoft is all about Windows again.

Driven by strong sales of its new operating system, Windows 7, Microsoft blew past expectations to record double-digit sales and profit gains in its latest quarterly earnings report Thursday.

Profit in the quarter, the second of Microsoft's fiscal 2010, surged to $6.66 billion, or 74 cents a share, up 60 percent from the same quarter in fiscal 2009. Analysts had expected 59 cents a share.

Thanks to consumer demand for Windows, sales reached $19.02 billion during the quarter, which ended Dec. 31, a 14 percent increase from $16.63 billion in the same quarter in fiscal 2009.

"They're really blowout results in a way," said Sid Parakh, analyst at McAdams Wright Ragen. "It's a very clean and massive beat" of what Wall Street was forecasting.

The results were a positive contrast to last January, when Microsoft said it was eliminating 5,000 positions in its first-ever major layoffs. The company cut 800 more positions in the fall. It added a few jobs as well, but head count fell by 5,300, or 8 percent. As of Dec. 31, Microsoft had 88,214 workers worldwide and 39,637 in the Puget Sound area.

It was also clear Microsoft had learned from the mistakes of Vista, the slower-selling previous operating system, and recaptured some of its old sizzle with the new system. Sales have broken previous Windows records, with 60 million copies sold during the quarter.

"The consumer market for PCs and Windows 7 PCs has been very strong, particularly in emerging markets," said new Chief Financial Officer Peter Klein, who described demand as "exceptional."

"That's really driven the upside for us, both in terms of revenue and profits as we maintain our cost-control efforts for the last year."

It's not clear when business spending will pick up and the corporate market — a linchpin of Microsoft's business — will upgrade their computers to Windows 7, Klein said.

The quarter's sales results include $1.71 billion of deferred revenue from the Windows 7 upgrade program and presales of the operating system to computer makers before the software launched in October. Adjusted for that revenue, second-quarter sales were $17.31 billion, or 60 cents per share.

Sales in the Windows division grew 70 percent to $6.9 billion, including the deferred revenue, and operating income nearly doubled to $5.39 billion. The consumer PC market grew 15 to 17 percent year over year.

The fresh face of Windows helped balance out other, sagging divisions, including the Microsoft Business, Server and Tools, and Online Services divisions.

The Server and Tools division, which released Windows Server 2008 R2 during the quarter, brought in $3.84 billion in sales, a 2 percent increase from the same quarter a year ago. Operating income rose at a faster pace, 8.4 percent, to $1.49 billion.

The server market remains weak, the company said, but the division will start selling Windows Azure, its new cloud-computing platform, in February.

The Microsoft Business Division, which makes Office software, saw sales slide 3 percent to $4.75 billion. Operating income fell 0.4 percent to $3.01 billion. The unit is working on Office 2010, a new version scheduled to start selling in June. Consumer purchases of Office rose 12 percent, but sales in this division have fallen behind the sales rate of computers.

The Online Services Division, which developed Microsoft's search engine Bing, saw a drop in online advertising as sales came in at $581 million, a 5 percent decrease from fiscal 2009. The division lost more money, $466 million, compared with $320 million a year ago.

While Bing has been gaining share in the search-engine market, it remains a small player. Its 10 percent share compares with Google's 65 percent. Microsoft hopes an imminent search partnership with Yahoo will win regulatory approval, which would make Bing a stronger secondary player.

Sales in the Entertainment and Devices division, which makes the Xbox video-game console, fell 11 percent to $2.9 billion. Microsoft sold 5.3 million Xboxes during the quarter, a 13 percent year-over-year drop. Operating income rose 188 percent to $375 million, however, thanks to a better handle on Xbox production costs, which widens Microsoft's overall profit margin slightly.

The division also is making money from Xbox Live, an online gaming service that has grown by 35 percent to 23 million subscribers. Xbox owners are buying an average 8.8 games per console.

Later this year, Microsoft plans to start selling Project Natal, a gesture sensor that can replace the handheld controller in some games.

Overall, the company is keeping a tight rein on cost controls, with operating costs expected to stay at $26 billion to $26.5 billion in fiscal 2010. Some expenses did rise during the quarter, including $290 million in legal expenses and $59 million in severance costs.

On Dec. 31, Microsoft had $36.1 billion in cash and short-term investments, compared with $31.4 billion six months earlier.

Thursday was Klein's first earnings call as chief financial officer. He was promoted after former CFO Chris Liddell resigned in December and joined General Motors as that company's CFO.

Microsoft released results after the markets closed. Its stock fell 51 cents to $29.16 in regular trading. Shares climbed as high as $30.17 in after-hours trading then dropped to $29.10.

Sharon Pian Chan: 206-464-2958 or schan@seattletimes.com

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