Microsoft profit beats Street, shares rise

SEATTLE Thu Oct 28, 2010 7:08pm EDT

1 of 6. Microsoft CEO Steve Ballmer is seen after the Windows Phone 7 launch in New York, October 11, 2010.

Credit: Reuters/Jessica Rinaldi

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SEATTLE (Reuters) - Microsoft Corp beat Wall Street expectations with a 51 percent jump in quarterly profit, as higher sales of its flagship Windows and Office software knocked down fears Apple's iPad would take a bite out its main business.

Its shares, down 14 percent so far this year, rose 3 percent in after-hours trading. Despite doubling its sales and profit in the last eight years, Microsoft's stock has largely remained at the same level, as investors worry about its ability to dominate new markets or adapt to new ways of computing.

The increase in the latest quarter's profit was helped by the launch of the latest blockbuster Halo video game, but exaggerated by the deferral of some revenue in the year-ago quarter relating to the launch of its Windows 7 operating system, and was flattered by comparison to last year, when the economy was only just emerging from the downturn.

Microsoft's Windows 7 has now sold a record-breaking 240 million copies in one year and its Office suite of applications, launched this spring, is off to a strong start.

"The reports of the death of Windows and Office are premature -- the company is still a cash flow machine," said Colin Gillis, an analyst at BGC Financial. "People are buying about $10 billion worth of Windows and Office this quarter. The twin engines of Microsoft are still firing."

Between them, the Windows and Office units accounted for more than 60 percent of sales and more than 80 percent of profit, factoring out nonoperating

losses.

ONLINE LOSSES

Microsoft's online services division, which contains the Bing search engine and MSN portal, was the weakest point in the company's quarter, reporting a 17 percent wider loss of $560 million. The unit, which is investing heavily in an attempt to catch up with search advertising leader Google Inc and now powers Yahoo Inc Web searches, has lost $6 billion in the last five years.

"I hate to nit-pick too much, but we'd always like to see the online services business do even more than it does," said Andrew Miedler, an analyst at Edward Jones, pointing out that revenue growth at the unit was slow, despite a recovery in ad spending.

"We'd like to see even more great things out of the online division because Microsoft needs another pillar down the road, and online ads is a market that's big enough."

The company had not seen any adverse effect on sales of computers running Windows due to Apple Inc's popular iPad tablet device, which is close to selling 8 million units, said Chief Financial Officer Peter Klein.

"We haven't seen that at all," said Klein. "Analysts who have done research on it, largely think this (the tablet market) is additive to PC markets as opposed to instead of PCs."

BEATS THE STREET

The world's largest software company posted a fiscal first-quarter profit of $5.4 billion, or 62 cents per share, up from $3.6 billion, or 40 cents per share, in the year-ago quarter.

That beat Wall Street's average forecast of 55 cents per share, according to Thomson Reuters I/B/E/S.

Sales rose 25 percent to $16.2 billion, ahead of analysts' $15.8 billion average forecast.

Klein said companies were continuing to buy new computers, maintaining the recovery in tech spending, but consumers were not so strong.

"We feel very good about the business refresh," said Klein. "On the consumer side, it probably was a little bit less than people had anticipated, but it was still growth."

In the latest quarter, Microsoft's Office unit was the biggest engine, contributing $3.4 billion of profit. The Windows unit was the next most profitable with $3.3 billion.

The server and tools unit, which sells the software and services behind internet-based computing and data storage -- so-called "cloud computing" -- contributed $1.6 billion in profit.

Microsoft's entertainment and devices unit, which sells the popular Xbox and less successful phone software, reported $382 million in profit, helped by Halo game sales. Figures from this unit are expected to improve this quarter, as Microsoft's new phone software and its Kinect motion-controller for Xbox go on sale in the United States next month.

As it accepts that it will likely not recapture its go-go growth of the 1990s, Microsoft has recently adopted a keen focus on cost control and profit margins. It cut 5,800 jobs last year and recently told its remaining 89,000 employees they will have to contribute to their healthcare costs for the first time in 2013.

"The company is sticking to its new-found religion on expenses," said Kim Caughey Forrest, senior analyst at Fort Pitt Capital. "It used to be" 'Let's throw everything at it and not care how much it costs.' That's great if you're growing gangbusters, but now we're seeing growth with margins and that's what we want to see as investors."

Microsoft stuck to its forecast of $26.9 billion to $27.3 billion in operating expenses this fiscal year.

(Additional reporting by Liana Baker in New York and Alexei Oreskovic in San Francisco; editing by Richard Chang and Andre Grenon)

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