Microsoft earnings CEO Steve BallmerMicrosoft (MSFT), the world's largest software company, said Thursday its fiscal third-quarter net income shot up 35% from last year, buoyed by the most recent release of its Windows operating system.

Net income for the third quarter ended March 31 was $4 billion, or 45 cents per share, up from $3 billion, or 33 cents per share last year. Revenue for the quarter was $14.5 billion, up 6% from $13.6 billion for the year-ago period.

That beat analysts expectations, which on average called for earnings of 42 cents per share on $14.4 billion in revenue, according to a Thomson/Reuters survey. Looking forward, the company said it expects operating expenses of $26.1 billion for the full year ending June 30, 2010.

Microsoft was widely expected to benefit from a rebound in PC sales as well as the October release of its Windows 7 operating system. A recent study from market research firm IDC found that first-quarter PC sales jumped 20% from last year. Similarly, early indications suggested Windows 7 sales were strong -- in fact, the its first weekend they were up 234% over first-weekend sales of Windows Vista.

Signs of Increased IT Spending

"Windows 7 continues to be a growth engine, but we also saw strong growth in other area like Bing search, Xbox LIVE and our emerging cloud services," said CFO Peter Klein, in a prepared statement.

Microsoft execs hinted that they've seen broad signs of an economic recovery in increased IT spending, but much of the company's growth during the quarter was generated by the Windows division. Windows-related revenue grew to $4.42 billion, up 28% percent from $3.45 billion last year.

Another area where Microsoft said it has seen signs of beefed up spending is in online advertising. "The outlook for online advertising appears to be improving and we expend the trend to continue," said CFO Peter Klein on the earnings conference call.

Struggling in Mobile OS Competition

The numbers don't necessarily reflect a dramatic improvement, though. Revenue for the online services segment grew to $566 million, up 12% from $507 million last year.

Although Microsoft has long enjoyed a dominant market position for PC operating systems, it's struggling to maintain its 15% market share for mobile-phone operating systems, according to market research firm comScore. And after investing heavily in its Bing search engine, Microsoft has made little progress in taking market share from search giant Google (GOOG).

"The shares are seeming attractive from a valuation perspective, but I have a hard time getting behind this stock given that Microsoft is generally a loser in every segment it competes in," says Curtis Shauger, an analyst with Caris & Co. "It's minor, and its glacial, but over the long-term, I struggle with it as an investor. The company is losing share in servers, browsers and databases. Basically, the only two segments where it's holding or growing its market share is search and video games, and it's unclear how sustainable that is."

Indeed, despite the strong earnings, investors clearly expected better, and pushed the shares down in after market trading by about $1.40 to $30, or 3.5% lower, in after-hours trading.

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