Microsoft reports $19 billion quarter, lifted by $1.71 billion deferral

A year after global recession sapped Microsoft sales and the company announced its first-ever massive layoffs, real signs of recovery can be seen. The holiday quarter was as good to Microsoft as could be expected, given how much sales are dependent on large businesses -- the majority of which are still tightfisted with IT spending or are renewing licenses for fewer seats because of layoffs.

"We reported record revenue and record profits," Peter Klein, Microsoft's new CFO, asserted during a conference call this afternoon. He praised consumer sales, particularly for Windows 7 PCs. But Klein warned that "we have not seen a return of enterprise spending growth."

The quarter's results are a bit complicated. Because of technology discount upgrade guarantees for Windows 7, Microsoft carried forward $1.71 billion from previous quarters. Still, even without the deferred revenue, Windows 7 had a great holiday sales quarter.

For fiscal 2010 second quarter, Microsoft reported revenue of $19.02 billion, for a 14 percent year-over-year increase. Operating income: $8.51 billion, up 43 percent. Net income: $6.66 billion, or 74 cents a share. Net income rose by 60 percent and earnings per share by 57 percent year over year. However, Microsoft reported these results including the aforementioned carryover. Without it, Microsoft revenue would have been $17.31 billion or 60 cents a share.

For about a year, Microsoft provided no guidance to Wall Street analysts, so there is none for fiscal Q2. Analysts average consensus was $17.9 billion and 59 cents earnings per share. Revenue estimates ranged from $15.91 billion to $19.18 billion.

Q2 2010 Revenue by Division

• Windows & Windows Live: $6.9 billion, up 70 percent from $4.06 billion a year earlier.
• Server & Tools: $3.8 billion, up 2 percent from $3.76 billion a year earlier.
• Business: $4.75 billion, down 3 percent from $4.88 billion a year earlier.
• Online Services Business: $581 million, down 5 percent from $609 million a year earlier.
• Entertainment & Devices: $2.9 billion, down 11 percent from $3.26 billion a year earlier.

Big question for this quarter: What about Windows 7? The answer is surprisingly complex. Fiscal first quarter was Microsoft's best sales period ever for Windows license sales -- the majority to OEMs stocking the channel for holiday 2009. Would Microsoft sustain the momentum in fiscal Q2? Apparently it did. In a statement, Microsoft CFO Kevin Turner, called fiscal Q2 another "record quarter for Windows units." The company claims more than 60 million Windows license shipments through end of the quarter.

The really good news came about two weeks ago from Gartner and IDC, which reported that PC sales were much stronger than expected during fourth calendar quarter (which corresponds to Microsoft's fiscal second). Better still: Mac market share dropped dramatically, as sales for several PC manufacturers surged.

Worldwide PC shipments rose 15.2 percent year over year, according to IDC, and 22.1 percent, according to Gartner. IDC put US PC shipments up 24 percent year over year and Gartner 26.5 percent. After years of market share gains, Apple dramatically dropped, presumably with Windows 7 sapping Mac sales momentum. Gartner put Apple's US share at 7.5 percent, down from 8.8 percent in fiscal Q4 2009 and 7.7 percent in fiscal Q1 2009. Both analyst firms ranked Apple fifth in US market share, a one-rank decline below Toshiba. While Mac shipments grew a respectable 31 percent, according to IDC, HP shipments grew by 45.1 percent and Toshiba by a stunning 71.5 percent.

Q2 2010 Income by Division

• Windows & Windows Live: $5.4 billion, up 99 percent from $2.7 billion a year earlier.
• Server & Tools: $1.5 billion, up 8 percent from $1.38 billion a year earlier.
• Business: $3.01 billion, flat with $3.02 billion a year earlier.
• Online Services Business: Loss of $466 million, down 46 percent from $320 million loss a year earlier.
• Entertainment & Devices: $375 million, up 188 percent from $130 million loss a year earlier.

Segment by Segment Results

Microsoft reports revenue and earnings results for five divisons: Windows & Windows Live, Server & Tools, Business, Online Services and Entertainment & Devices.

Windows & Windows Live. Revenue rose 70 percent year over year and income by 99 percent, bolster by $1.71 billion carried over from earlier quarters, as part of Microsoft's upgrade guarantee program. The division derives about 80 percent of its revenue from license sales to PC OEMs. OEM revenue increased by $2.3 billion or 72 percent when including recognized deferred revenue. Without it, OEM revenue grow by a more modest 21 percent, or by $664 million. Microsoft estimates worldwide PC shipments grew 15 percent to 17 percent during fiscal Q2.

Server & Tools. The division is most insulated against economic maladies, because 50 percent of revenues comes from contractual volume-licensing agreements -- that's a decline of 5 percent from fiscal first quarter. Because of corporate layoffs, Microsoft is seeing customers renewing license contracts at lower levels. The division's revenue grew just 2 percent year over year, while operating income grew by 8 percent.

Business. Next to Windows, Microsoft's other cash cow division reported revenue declines of 3 percent and flat income (really slightly down) year over year. Consumer revenue increased $95 million, or 12 percent, which Microsoft largely credited to increased PC sales. However, commercial Office 2007 sales declined, which isn't surprising. Microsoft is beta testing Office 2010, which launches within about six months.

Online Services Business. The division's loss widened, with ad sales in decline -- starkly contrasting with results from Google, which reported solid earnings for the same quarter. The majority of the Online Services division's sales come from advertising, which fell 2 percent, or $11 million, year over year to $516 million.

Entertainment & Devices. Xbox 360 and console game sales declined by $295 million, or 12 percent, year over year. Microsoft shipped 6.2 million consoles during the quarter.