Microsoft Reports Strong Earnings Off Windows 7 Sales

Microsoft reported increased revenues for the second fiscal quarter of 2010, as Windows 7 continued to sell well among consumers. Despite increased cash flow, however, Microsoft executives reported no growth in the enterprise software market, and certain company segments such as Microsoft Business Division saw their revenues dip year over year. Analysts have suggested that Microsoft's success in 2010 and beyond would depend on a broader tech refresh among businesses and consumers.

Microsoft reported revenues of $19.02 billion for the second fiscal quarter of 2010, representing a 14 percent increase from the same quarter a year ago, when a massive recession battered the earnings of both the company and much of the tech industry. The company attributed much of that rise to sales of Windows 7, its new operating system launched Oct. 22.

Microsoft issued a statement ahead of its Jan. 28 earnings call stating that some 60 million Windows 7 licenses had so far been sold. Revenues for its Windows & Windows Live Division climbed year over year from $4.06 billion to $6.9 billion.

The company reported net income of $6.66 billion, operating income of $8.51 billion and diluted earnings per share of $0.74, representing respective increases of 60 percent, 43 percent and 57 percent year over year. However, some of its divisions also saw their revenue fall, with Microsoft Business Division reporting a year-over-year decline from $4.88 billion to $4.74 billion, and its Entertainment and Devices Division tumbling from $3.25 billion to $2.9 billion.

During a Jan. 28 earnings call, Microsoft Chief Financial Officer Peter Klein suggested that the uptick in revenues was due largely to "strong consumer demand for Windows 7 and PCs." However, he noted, "We have not seen a return to enterprise software growth."

Bill Koefoed, Microsoft's general manager of Investor Relations, also suggested on the call that "we have not seen a return to enterprise growth." Within a business-spending context, he added, "conditions from last quarter remain unchanged" with "weak business PC sales" despite strength in the consumer segment.

Microsoft had found itself battered by the global recession, reporting a 17 percent year-over-year revenue decline for the fourth fiscal quarter of 2009 and a 14 percent decline for the first fiscal quarter of 2010. However, Microsoft executives and Wall Street analysts seemed somewhat satisfied at the time with the latter number, as it was stronger than earlier estimates.

In a statement before the Oct. 23 earnings call announcing the numbers for the first fiscal quarter of 2010, former Microsoft Chief Financial Officer Chris Liddell suggested that the company had "maintained our cost discipline, which allowed us to drive strong earnings performance despite continued tough overall economic conditions."

Part of that cost discipline involved cutting 5,000 employees through the course of 2009.

That quarter, Microsoft also reported that it would defer $1.47 billion in revenue due to the Windows 7 Upgrade Option program and sales of Windows 7 to OEMs and retailers before the operating system's Oct. 22 launch date. Had those figures been incorporated into Microsoft's overall tally, they would have raised Microsoft's overall quarterly revenues to $14.39 billion, for a year-over-year decline of a comparatively softer 4 percent.

Instead, that income found its way onto the balance sheet for the most recent quarter, ended Dec. 31, 2009, where deferred revenue grew from $1.47 billion to $1.71 billion.

Liddell had cautioned during the Oct. 23 earnings call that "Windows division revenue will be in line with overall PC growth." He also suggested that hesitation among CIOs could lead to a more gradual tech refresh for both the enterprise and SMBs (small to medium-sized businesses) into the years beyond 2010. With that in mind, Microsoft was staying "reasonably cautious" about the rate of adoption for Windows 7, despite some apparently good early reviews of the operating system.

Around the time of that earnings announcement, a number of analysts suggested that a business-oriented tech refresh could start in earnest sometime in 2010.

"It looks like the Win7 inspired upgrade cycle can start in late 2010 and run through early 2013," Katherine Egbert, an analyst with Jefferies & Co., wrote in an Oct. 12 report. "We expect new hardware purchases to precede the software upgrades by about 6 months."

According to research firm Net Applications, some 92.21 percent of PCs currently run Windows, followed by 5.11 percent using the Mac OS, 1.02 percent using Linux and 0.53 percent relying on Java ME. Of those PCs running Windows, some 67.77 percent continue to run the nearly decade-old Windows XP, while 17.87 percent run Windows Vista and 5.71 percent use Windows 7.

Microsoft still expects a broad-based enterprise and SMB refresh to take place, despite the current flatness in business software growth.

"We expect the tech refresh to begin this calendar year," Klein said during the earnings call, with sales increasing "gradually over a couple of years."