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Ina Fried

Staff Writer, CNET

Citing strength in both the business and consumer markets, Microsoft on Thursday reported better-than-expected quarterly sales–and profits that doubled those of a year ago.

For the three months ended Dec. 31, the company earned $3.46 billion, or 32 cents per share, on revenue of $10.82 billion. That compares with earnings of $1.55 billion, or 14 cents per share, on revenue of $10.15 billion in the same quarter a year ago.

In October, Microsoft forecast revenue for the December quarter of $10.3 billion to $10.5 billion and per-share earnings of 28 cents a share. Analysts had been expecting a bit more in revenue, with the consensus average being $10.554 billion, according to First Call.

“Our record revenue came from across-the-board strength in both our business and consumer segments,” outgoing financial chief John Connors said in a statement. Connors also noted that the company’s Home and Entertainment unit, which includes Xbox, delivered its first profitable quarter. All told, Microsoft’s emerging businesses saw a $700 million improvement over last year’s losses.

For the current quarter, Microsoft said it expects revenue in the range of $9.7 billion to $9.8 billion, just ahead of current analyst expectations, with per-share earnings expected to be 27 cents or 28 cents.

Microsoft also hiked its expectations for the full fiscal year, which runs through June. The company now expects revenue between $39.8 billion and $40 billion, with per-share earnings in the range of $1.09 to $1.11. Previously, the company had been calling for revenue between $38.9 billion and $39.2 billion, with per-share earnings of $1.07 to $1.09.

The earnings report sent Microsoft shares modestly higher in after-hours trading, to $26.47 on the Island ECN. The stock closed regular trading at $26.11, up 10 cents, or less than half of 1 percent.

All of Microsoft’s seven business units saw an improvement in the bottom line. In many cases, however, better results stemmed from stock-based compensation charges in the year-ago quarter. Most units saw sales rise as well. The Information Worker unit, which includes Office, was the only unit whose sales dropped, while revenue in the Microsoft Business Solutions unit was roughly flat.

The company’s balance of unearned revenue–seen as a predictor of future sales–rose slightly from the prior quarter, to $7.97 billion from $7.78 billion.

The company’s cash balance dropped significantly following the company’s one-time $3-per-share payout. Microsoft ended the quarter with $34.5 billion in cash and short-term investments, down from $64.4 billion three months earlier.

Microsoft said that during the three-month period, the company repurchased 23.6 million shares of its stock for a total of $655 million, a lower level than repurchases in the year-earlier period, when the company bought back 30.5 million shares for $830 million. The company announced plans to step up the rate at which it repurchases shares, though for the past two quarters it has bought back less stock than in the comparable year-earlier periods.

As for the individual business units:

• The client unit, which includes desktop and notebook versions of Windows, saw sales rise to $3.22 billion from $3.05 billion. Operating income was $2.53 billion, up from $2.10 billion a year earlier.

• The server and tools unit saw sales jump to $2.43 billion from $2.15 billion, with operating income at $913 million, compared with a loss of $209 million in the year ago period.

• The unit that includes Office saw sales dip from a year ago, to $2.78 billion from $2.86 billion. However, operating income increased to $2.03 billion from $1.83 billion a year ago. Microsoft attributed the sales drop to the fact that the year-ago quarter benefitted from initial sales of the just-launched Office 2003 product.

• The Microsoft Business Solutions unit had sales of $211 million, up from $210 million. Losses were narrowed to $29 million from $139 million a year ago.

• MSN continued to show profits, earning $130 million this quarter on revenue of $588 million. A year ago MSN had a loss of $95 million on revenue of $546 million. The company noted a 17 percent rise in online advertising and forecast continued growth in online advertising sales and subscription revenue from MSN’s premium services.

• Microsoft’s mobile and embedded devices unit, which includes software for handhelds and cell phones, posted a narrow $4 million loss, compared with the $110 million loss a year ago. Revenue increased to $91 million from $63 million a year ago.

• Buoyed by strong Xbox sales, The Home and Entertainment unit posted an $84 million profit on revenue of $1.41 billion. A year ago, the unit saw losses of $397 million on sales of $1.27 billion.

Microsoft did not break out results for the division between hardware and software, but the quarter included the release of the Microsoft-published Xbox game “Halo 2,” which has sold 6.4 million copies to date.

“Game sales were definitely the big driver, but we’ve also done some really good work on reducing console costs,” said Maroof Haque, Xbox business manager for Microsoft.

As Microsoft has nothing remotely like “Halo 2” on the horizon, the end-of-year profit should be considered an anomaly, Haque said. “We’re not expecting profitability on a sustained basis,” he said. “We’re focusing on investment for sustained profitability long-term.”

Microsoft hiked its forecast for Xbox sales and subscribers to the Xbox Live online service. The company now expects that by the end of June it will have sold 21 million to 22 million Xboxes since the product debuted, up from an earlier forecast of less than 20 million. By the same point, it expects to have 1.6 million to 1.8 million Xbox live subscribers, up from a prior prediction of 1.5 million subscribers.

Microsoft is widely expected to release a new version of the Xbox late this year, although Connors declined during the conference call to reveal a date for Xbox 2. Haque said the route to profitability could be faster for the next Xbox.

“We’ve definitely learned a lot from this generation, as far as the partnerships we’ve made, the efficiencies we’ve built,” he said. “We’re going to be taking that key learning into the future.”

CNET’s David Becker contribute to this report.