Updated from April 28

With sales of Windows slowing a bit,


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sales in the third quarter were lighter than expected. But the company's in-line revenue guidance for the fourth quarter and next fiscal year soothed investors.

In early Friday trading, the shares were recently up 38 cents, or 1.6%, to $24.83.

Including charges of 9 cents a share for stock-based compensation and legal expenses, the company earned $2.56 billion, or 23 cents a share, in the third quarter, which is about what analysts expected on that basis. A year ago, Microsoft earned $1.3 billion, or 12 cents a diluted share.

Revenue was $9.62 billion, up 5% year over year, but below expectations of $9.8 billion. Excluding charges, the company earned 32 cents a share, equal to the First Call consensus.

Colleen Healy, senior director of the company's investor relations group, said in an interview that more than half the top-line miss was caused by some slippage of the euro vs. the dollar in January and subsequent months. Microsoft had planned on a stronger euro, which gives U.S.-based companies a boost, when it made its forecast, she said.

But sales of Windows decelerated somewhat, she said, as customers began thinking of upgrading to Longhorn, the next version of the operating system, which is scheduled for availability in late 2006.

Microsoft's Client group, responsible for sales of the desktop versions of Windows, posted revenue of $2.98 billion, up 2.2% year over year, but a bit below the company's own expectations.

The Home and Entertainment group, responsible for sales of the popular Xbox and gaming software, grew sales by nearly 12% to $593 million, but, as expected, posted an operating loss of $154 million.

The other standout was the Server and Tools group, which sells Microsoft's SQL Server database, Exchange and server-based version of the operating system. Revenue for the group was up 11.6% to $2.45 billion, and operating income increased by one-third to $824 million.

But Microsoft Business Solutions, which is supposed to compete with enterprise software from companies like


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grew by an anemic 3.4% and lost $54 million, $2 million more than it lost a year ago.

For the fourth quarter, the company expects revenue to range from $10.1 billion to $10.2 billion, roughly in line with analysts polled by Thomson First Call. On a GAAP basis, earnings will be about 27 cents or 28 cents a diluted share. Wall Street was expecting 27 cents on the same basis.

For the full year ending June 30, 2006, revenue is expected to be in the range of $43.3 billion and $44.1 billion, and diluted earnings per share are expected to be between $1.26 and $1.30, including stock-based compensation expense. Wall Street was expecting $40 billion in revenue and EPS of $1.26.

Commenting on the results, Loomis Sayles analyst Tony Ursillo noted that demand for software appeared to soften in late March. The slowdown was strong enough to force a number of misses by other software companies in the quarter. Microsoft's guidance, however, was a welcome development. "I'm a bit surprised the revenue guidance for next year is so strong," Ursillo said. Loomis Sayles has a long position in Microsoft.

Microsoft's earnings announcement came as the tech-heavy


sank close to 1900, its lowest level in six months. The market was looking to Microsoft, widely seen as a technology bellwether, to give the sector a lift when regular trading resumes Friday.

Not that Microsoft doesn't need a lift. The giant software maker's stock hasn't provided much of a return for some time. In the last two years, for example, the stock has appreciated by 8%, while the Nasdaq as a whole has grown by nearly four times that amount.