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VOL. 126 | NO. 20 | Monday, January 31, 2011

Microsoft 2Q Earnings Edge Down on Slow PC Sales

JESSICA MINTZ | AP Technology Writer

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SEATTLE (AP)Microsoft Corp.'s net income for the latest quarter fell slightly from a year ago but the software giant still beat Wall Street's expectations despite the weak personal computer market.

Sales of Office 2010 to businesses buoyed the results, as did the popularity of Kinect, Microsoft's new motion-sensing controller for the Xbox 360 video game system.

The results for October through December leaked online more than an hour before they should have been released, prompting a temporary spike in trading before the markets closed. After investors had time to digest the full report, however, it became clear that a solid quarter isn't enough to give the company's shares more than a temporary lift. Companies carefully time the release of key financial information to comply with complex Securities and Exchanges Commission rules.

Much of Microsoft's business depends on selling copies of the Windows operating system and Office desktop software, both of which are tied to the health of the personal computer market.

Revenue in the Windows division plunged 30 percent to $5.1 billion. Microsoft launched Windows 7 in the same quarter of 2009, making for a tough comparison. Meanwhile, in the 2010 quarter, worldwide personal computer shipments only grew about 3 percent as Apple Inc.'s iPad and the promise of more tablet devices to come made consumers think twice about what kind of device to buy.

Sid Parakh, an analyst for McAdams Wright Ragen, said Microsoft's revenue was weighed down by the rising share of sales coming from emerging markets where prices are lower.

The division that sells Office software and other programs, however, saw revenue rise 24 percent to $6 billion. Companies that put off buying new technology during the worst of the recession are more willing now to upgrade their systems. Microsoft said the division's revenue from businesses rose 18 percent while revenue from consumers jumped 49 percent, both because of sales of Office 2010.

On the consumer side, Microsoft may have increased Office sales with its strategy of installing a free but limited version of Office 2010 on new computers and making it easy to pay to upgrade, instead of making people buy a boxed copy.

Strength in the entertainment and devices division, which is responsible for Xbox 360, also helped make up for weak Windows sales. Microsoft had already said it sold 8 million Kinect controllers, which helped push revenue for the segment up 55 percent to $3.7 billion.

Parakh said revenue in that division was higher than expected, indicating that people weren't just buying Kinects – they were getting Xbox consoles and games at a faster clip than predicted. Microsoft said in a conference call that it expects revenue in that division to rise 50 percent in the current quarter as the Kinect craze continues.

In all, Microsoft's revenue edged up 5 percent to $20 billion, topping analysts' expectations for $19.2 billion in revenue.

Net income was $6.63 billion, compared with $6.66 billion in the same period last year.

Thanks to stock buybacks, its net income rose to 77 cents per share, from 74 cents. Analysts surveyed by FactSet were expecting net income of 68 cents per share for the fiscal second quarter.

Microsoft still needs to prove to investors that it is heading in the right direction in areas where it currently trails the market leaders.

Thursday's report included a wider loss in the online division, which is mostly made up of online advertising. Google Inc., which makes almost all of its money from online advertising, saw its earnings in the same period rise 29 percent to $2.5 billion.

Devices running a new smart phone system, Windows Phone 7, went on sale during the quarter. Microsoft said it sold two million licenses to phone hardware makers, but did not say how many Windows phones were sold.

The software maker rushed out its earnings report a few minutes early, just before the markets closed for the day, after its shares spiked to more than $29 per share in heavy trading about 15 minutes before the closing bell. They dropped back to close at $28.87, a gain of 9 cents for the day, and they slipped 16 cents to $28.71 in extended trading.

"Hey, you beat, but your core business, where most of your profitability comes from, is lagging," is what Parakh said investors are probably thinking. "If you take the miss on the Windows business and put in the context of what people said for many years – that Windows is basically going to go away at some point – people are probably putting those two things together and saying, this is just the beginning. Tablets are just going to completely eat into PC sales."

Sandeep Aggarwal, an analyst for Caris & Co., noted that this was the third quarter in a row where investors have been unmoved by Microsoft's better-than-expected results. That's because they're focused on the competition Microsoft faces from the iPad, iPhone and Android, Google's software for phones and tablets.

"Earnings can provide some support, but it's really success in the mobile and tablet markets which will create more excitement among investors," Aggarwal said.

More than an hour before Microsoft issued its report, a company called Selerity sent the information to institutional investor customers and a partner site called StockTwits. Selerity uses search technology to scoop up information, including data from earnings reports.

In an interview, Selerity CEO Ryan Terpstra said the company found the report early because Microsoft uses a similar Web address for earnings information every quarter.

Terpstra said Selerity analysts verified that the information was on Microsoft's public site before it published the results.

In a statement, Microsoft's general manager of investor relations called what Selerity found "a preproduction draft of our earnings release." Microsoft posted its official numbers ahead of schedule after consulting with Nasdaq and is reviewing its procedures to avoid a repeat.

This has happened before to other companies, including The Walt Disney Co. last year. A reporter accessed its quarterly report by guessing the Web address Disney would use, based on the pattern used in past quarters.

Copyright 2011 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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