Windows 7 Drives Record Profit For Microsoft

Better-than-expected growth in Microsoft's consumer business, and strong Windows 7 demand, helped the software giant break a string of disappointing quarterly results.

For Microsoft's fiscal second quarter ended December 31, revenue jumped 14 percent to just over $19 billion and profit rose 60 percent to $6.6 billion. Earnings per share leapt 57 percent to 74 cents, far outpacing Wall Street analysts' expectation of 59 cents per share.

In Microsoft's earnings call, newly anointed CFO Peter Klein, who took over last month for the departed Chris Liddell, said Microsoft sold roughly 60 million Windows 7 licenses during the first half of its fiscal 2010 year. Consumer SKUs such as Windows 7 Home Premium helped drive a 35 percent year-on-year increase in Windows licensing revenue during Q2, according to Klein.

"It was an exceptional quarter for the Windows division," Klein said in the call.

Netbooks, which have been the bane of Microsoft's existence because of their propensity to eat away at Microsoft's Windows Client division revenue, are starting to look like less of a threat. Klein estimated that netbooks currently account for about 11 percent of the PC market, a number that is roughly flat year on year.

Microsoft is trying to become more consumer oriented and the Q2 results suggest it has made some progress in this area. But Microsoft, of course, has traditionally made most of its money from business customers, and its outlook in this regard is decidedly less rosy. Klein admitted that enterprise spending still hasn't seen any kind of meaningful uptick that would indicate a recovery is imminent.

The server hardware market was stronger than expected during the quarter, and customer adoption of Windows Server 2008 R2, as well as Microsoft's virtualization and management offerings, continued to grow during the quarter, Klein said. But the Microsoft Business Division saw revenue drop 3 percent due to the weak IT spending environment. And annuity licensing revenue, which Microsoft derives from volume licensing agreements, was also flat year-on-year.

Klein said Enterprise Agreement sales cycles are starting to lengthen and that overall, Microsoft's unearned revenue, much of which comes from volume licensing, was down slightly for the year, he said.

This is important because annuity licensing has acted as a cushion for Microsoft's revenue in the past. Last July, Bob Muglia, president of Microsoft's Server and Tools division, acknowledged this in a meeting with financial analysts.

"What you have in essence is a shock absorber to the business," Muglia told financial analysts last July.

Elsewhere, Microsoft's Entertainment and Devices division saw revenue fall 11 percent, and Online Services division revenue dropped 5 percent, including a 2 percent drop in online advertising. Microsoft was quick to point out that Bing has gained market share in each of the 7 months since its launch, but has been impacted by declining display advertising rates in international markets.

While it's no doubt encouraging to Microsoft executives to see the Windows cash cow back on its feet, the questions about its enterprise business have probably stifled any champagne cork popping in Redmond. With Microsoft set to launch Windows Azure as a paid service next week, all eyes will be on the Server and Tools division in next quarter's earnings call.
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