Microsoft beats estimates, reports 35 percent profit jump

Business spending on technology is back, but it's going to be a slow wade back into the water rather than a swan dive.

The hesitant return of the economy was evident in Microsoft's fiscal third-quarter earnings report Thursday.

While the Redmond software company performed well during the quarter, beating analyst estimates and driving profit up 35 percent over last year, it did not see a surge of businesses buying new computers and software.

Corporations have begun upgrading their software and hardware, Chief Financial Officer Peter Klein said in a conference call with analysts, but "the business spend and sales cycle remains challenged."

"Enterprise spending is still just beginning to turn," said Sarah Friar, an analyst with Goldman Sachs. "This report doesn't have you pounding your chest that the enterprise is back."

Overall, Microsoft performed ably in the third quarter of fiscal 2010, coming in at 45 cents earnings a share, 3 cents higher than what analysts had forecast. Its profit of $4.01 billion was above the $2.98 billion, or 33 cents a share, recorded in the same quarter in fiscal 2009.

On the revenue side, a year ago Microsoft reported the first quarterly drop in sales in the company's history. A year later, the company's sales hit a record high, driven by its new operating system Windows 7. Sales grew 6 percent to $14.5 billion, up from $13.65 billion last year.

Accounting for deferred sales related to Office 2010's technology guarantee, sales for the quarter were $14.81 billion, an increase of 8 percent from last year.

The technology guarantee gives shoppers who buy Microsoft Office now an automatic upgrade to the next version.

"I am pleased by our continuing performance this quarter," Klein said on the conference call. "We have a very exciting pipeline of new products to come, and we continue to deliver strong results."

Windows 7, which started selling in October, is now on 10 percent of PCs worldwide. "Strong demand for Windows 7 is a primary contributor to our performance," Klein said.

Sid Parakh, an analyst at McAdams Wright Ragen, summed it up: "Generally speaking, it all seems to be going OK for them."

Shares, however, were down in after-hours trading after closing at $31.39, up 6 cents for the regular trading day Thursday. The stock has been trading near a 52-week high recently.

"I can't control primarily hedge-fund buying," Bill Koefoed, general manager for Microsoft investor relations, said of the aftermarket trading. "The stock's run up quite a lot over the last couple weeks. We're going to focus on what we can control, which is revenue, operating expenses and great products."

Despite the profitable quarter, Microsoft's growth paled in comparison to Apple's report earlier this week, which showed a quarterly profit increase of 90 percent — to $3.07 billion — on sales of $13.5 billion.

Here's a rundown of performance by business divisions:

• Windows and Windows Live. Sales rose 28 percent to $4.42 billion from $3.45 billion. Operating income grew 35 percent to $3.06 billion from $2.27 billion. Windows sales rose slightly faster than the PC market. PC sales to consumers increased 30 percent while sales to businesses increased by about 14 percent.

The division was responsible for $3.06 billion of the company's overall $5.17 billion in operating income.

• Servers and Tools (SQL, Azure). Sales were up 3 percent to $3.58 billion from $3.49 billion. Operating income was also up 3 percent to $1.26 billion from $1.22 billion. This division launched Microsoft's new cloud computing service, Azure, in the third quarter.

• Online Services Division (Bing, MSN). Sales were up 12 percent to $566 million from $507 million. The division's operating loss widened 73 percent to $713 million from $411 million.

Online advertising sales grew 19 percent, driven by search ads, which outpaced the market, the company reported. Bing's share of search traffic is now up to 12 percent since it launched 10 months ago, but still far behind Google's 65 percent, according to research firm comScore.

The division also spent $140 million in general and administrative expenses to bring together the Microsoft and Yahoo search partnership.

• Business Division (Office). Sales were down 6 percent to $4.24 billion from $4.51 billion. Operating income fell 5 percent to $2.62 billion from $2.76 billion. The majority of sales in this division comes from Office software, and executives say many companies are pausing before the next version Office 2010 begins selling on May 12.

• Entertainment and Devices (Xbox, Windows Phones, Zune). Sales were up 2 percent to $1.67 billion from $1.63 billion. Operating income was $165 million in the quarter compared with an operating loss of $41 million a year ago.

Xbox 360 console sales fell 12 percent, which the company said was in line with the overall market. The attach rate — how many games were sold per console — was 8.8.

The company paid out $3.1 billion in dividends to shareholders and through stock buy backs. The company increased its cash and short-term investments to $39.7 billion.

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