Revenue increased primarily due to strong sales of the Xbox 360 console, Kinect for Xbox 360, the 2010 Microsoft Office system, and Server and Tools products, offset in part by lower sales of Windows 7. Revenue also increased due to the $305 million Office Deferral during the three months ended March 31, 2010. Changes in foreign currency exchange rates had an insignificant impact on revenue.
Operating income increased reflecting an increase in revenue, offset in part by higher operating expenses. Key changes in operating expenses were:
• Cost of revenue increased $1.1 billion or 41%, due to increased volumes of Xbox 360 consoles and Kinect sensors sold and higher costs associated with our online offerings, including traffic acquisition costs and royalty costs relating to Xbox LIVE digital content sold, as well as due to higher expenses from providing Enterprise Services.
• Sales and marketing expenses increased $190 million or 6%, primarily reflecting increased advertising and marketing of the Xbox 360 platform, Windows Phone, and Windows and Windows Live, and higher headcount-related expenses.
• Research and development expenses increased $49 million or 2%, due mainly to higher headcount-related expenses.
Diluted earnings per share increased reflecting higher revenue, repurchases of common stock, and a partial settlement with the U.S. Internal Revenue Service ("I.R.S."), which added $0.05 to our diluted earnings per share, offset in part by higher operating expenses.