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Free Windows 7 Upgrades Hurt Microsoft Profits

SEATTLE — Microsoft's income fell 18 percent in the last quarter, largely because it deferred revenue to let summertime PC buyers get free upgrades to Windows 7.

The upgrade program, which let people buy PCs with Windows Vista and later install Windows 7 for free, meant that Microsoft counted only half of its Windows sales in the period. It will report the rest as customers upgrade to the new system through January 2010, when the offer expires.

Investors looked past that accounting decision, noting that if it had counted its deferred Windows revenue, Microsoft's earnings would have increased 8 percent from last year with the help of big cost cuts. Microsoft shares jumped $1.99, 7.5 percent, to $28.58 in morning trading, hitting a 52-week high.

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PC shipments edged up in the July-September period after falling all year, but the industry remains far weaker than even a year ago. Consumers and corporations have cut back on buying computers, servers and other technology during the recession, damaging Microsoft. The software maker resorted to its first wide-scale layoffs, announced in January, and saw annual revenue fall from the prior year for the first time since the company went public in 1986.

In the last quarter, consumers helped boost PC shipments by buying more inexpensive laptops and small "netbooks." Those machines are less profitable for Microsoft, though, because they run lower-end versions of Windows.

Analysts now think many businesses will start buying new computers and other technology again in the middle of 2010. Microsoft has been cautious about predicting the PC industry's turnaround, but others, especially Intel Corp., have indicated they expect things to improve faster, in the current quarter.

Microsoft said Friday its earnings dropped to $3.6 billion, or 40 cents per share, but that was much higher the analysts' estimate of 32 cents per share in a Thomson Reuters survey. In the same period last year Microsoft earned $4.4 billion, 48 cents per share.

Revenue sank 14 percent to $12.9 billion. If Microsoft had counted all the Windows sales, it would have posted a 4 percent drop in revenue, to $14.4 billion.

A big reason that Microsoft's earnings would have increased if not for the deferrals, even as revenue fell, is that the company's layoffs and other expense cuts are paying off. Its operating expenses were more than $600 million lower in the last quarter than in the same period last year.

Microsoft also told analysts its expenses in the current fiscal year, which ends in June, could be as much as $400 million lower than previously expected.

The company, based in Redmond, Wash., also lifted its earnings per share by resuming purchases of its own stock after a six-month pause, spending $1.45 billion in the quarter.

Revenue and profit declined in Microsoft's biggest division, the group that makes Office, Sharepoint and other business programs. Microsoft's head of investor relations, Bill Koefoed, said layoffs at companies that buy Microsoft's software reduced the number of licenses sold.

Koefoed also said online advertising revenue was flat. Even with a positive reception for Bing, Microsoft's revamped search engine, the online business widened its loss in the quarter.