Microsoft leans less on Windows

As Windows faltered, Office stepped in and rescued Microsoft.

Word, Excel, PowerPoint and business software may not be as sexy as an Apple iPad, but the old reliables helped save the day in the company's latest quarterly financial report, with growth of 21 percent to $5.3 billion in sales.

The new Xbox Kinect also came on strong, with sales growth of 60 percent.

Overall, sales in the quarter — the third of fiscal 2011 — rose 13 percent to $16.4 billion, slightly more than the $16.2 billion analysts had forecast. Last year, sales were $14.5 billion.

Profit reached $5.2 billion, an increase of 31 percent from $4 billion last year. It reflected a one-time, $461 million tax benefit related to a settlement with the Internal Revenue Service involving an audit covering 2004 to 2006. Without the benefit, profit increased 19 percent.

Earnings per share was 61 cents, including 5 cents from the tax benefit. Analysts had expected 56 cents. Last year, the company reported 45 cents per share.

Analysts and observers have long demanded that Microsoft stop leaning on the one-legged stool that is Windows and build other billion-dollar businesses.

Microsoft showed Thursday that Office and enterprise products, as well as the Xbox video-game system, have grown into powerhouses of their own. Even the server software business held its own, with 11 percent growth.

"If you exclude, or if you leave out the PC business, most everything else looked pretty good," said Sid Parakh, analyst for McAdams Wright Ragen in Seattle.

Still, it's hard to get around the fact that Windows sales fell short of expectations, a setback Microsoft blamed on a "mixed PC market," as Microsoft Chief Financial Officer Peter Klein described it. That market declined 1 to 3 percent during the quarter, while sales of Windows to consumers fell 8 percent.

The Windows landscape was not all dark. Corporate spending has returned, and companies are upgrading their PCs to Windows 7, with growth of 9 percent among business customers. Emerging markets are also buying a lot more computers.

But in developed markets such as the U.S., analysts say it's clear the iPad is suppressing consumer sales of Windows PCs.

Microsoft itself acknowledge netbook sales have fallen 40 percent, and analysts say it's a category where sales have been affected by tablet growth.

"The biggest overhang on the stock is they're losing share to tablets and they don't have an answer to that," said Yun Kim, analysts at Gleacher and Co. in New York. "They're trying to survive in a new era where it's a post-PC era.

Kim said that tide could turn when Microsoft announces its road map for the next version of Windows, one that would run on tablet devices.

Microsoft is more equivocal on the impact tablets are having on PC sales.

"It's a lot of factors," said Todd Setcavage, director of investor relations. "You look at netbooks — they declined 40 percent; the broader consumer markets — it's pretty clear there's a lot of things going on."

Klein said to expect more of the same from the PC market in the fourth quarter.

Meanwhile, he expressed satisfaction with the overall results. "We again delivered solid financial results reflecting strong business and consumer demand for our products and services," he told analysts in a conference call.

"Despite a mixed PC environment, the breadth and depth of our portfolio drove another quarter of double-digit revenue and earnings-per-share growth," he said.

Microsoft's profit for the quarter, which ended March 31, fell behind Apple. For the first time, Apple's quarterly profit surpassed Microsoft, clocking in at nearly $6 billion.

Microsoft's results surprised some analysts who had expected stronger numbers, especially after Intel reported strong earnings that defied the decline in PC sales.

The financial report hinted at how much Microsoft will spend on pay raises announced last week — up to $1.1 billion to $1.3 billion more on compensation. Setcavage said an equivalent 3 to 5 percent rise in estimated operating expenses for fiscal 2012 includes the raises.

Microsoft stock closed at $26.71 Thursday, up 1.3 percent. It later fell 1.5 percent in after-hours trading to $26.32. The quarterly report came after the market closed the regular trading day.

Here is how each Microsoft division performed during the quarter.

Windows and Windows Live. This team has historically been the powerhouse behind Microsoft's growth, but not this quarter. Sales fell 4 percent to $4.4 billion. Microsoft said Windows sales are directly tied to the health of the PC market, which contracted in the last quarter.

Windows sales were also expected not to perform as well as last year because Windows 7 launched in fall 2009.

Operating income in the group fell 10 percent to $2.8 billion.

"We have to remember that Windows is also one of their most profitable businesses, so the earnings drag that it has is much more than most other businesses," Parakh said.

Microsoft launched a cloud service for Windows called Windows Intune during the quarter.

Microsoft Business. Sales for the division, which makes the Office software suite, rose 21 percent from a year ago to $5.3 billion, and operating income grew 25 percent to $3.2 billion. Including an Office 2010 upgrade-guarantee program, sales in the group rose 13 percent.

Microsoft executives said business customers are buying Office while adding more software the group makes, including collaboration software SharePoint and customer-relationship-management software Dynamics. Microsoft began selling a cloud version of Dynamics during the quarter.

The third quarter included the newly launched Lync, Microsoft's unified communications software that can replace a corporate phone system. Sales of Lync grew 30 percent.

Server and Tools. The business, which makes server software, saw sales increase 11 percent to $4.1 billion and operating income rise 12 percent to $1.4 billion. Unlike the Windows group's sales, which Microsoft said tracked the health of the PC market, the Server and Tools group is performing better than the overall server market.

Entertainment and Devices. The division, which makes Xbox, Kinect and Windows Phone, saw sales increase 60 percent to $1.9 billion. Operating income rose 50 percent to $225 million. During the quarter, the group sold 2.4 million Kinect motion sensors and 2.7 million Xbox 360 video-game consoles. Last year, Microsoft sold 1.5 million consoles in the quarter.

The company did not provide any numbers on sales of Windows Phone 7.

Online Services. The division, which works on Bing and MSN, had a sales increase of 14 percent to $648 million, but the division continues to lose money with an operating loss of $726 million. The loss widened 2 percent from last year. Bing's market share has grown to 14 percent of search traffic, Microsoft said.

Microsoft said the Bing-Yahoo partnership is not hitting sales expectations, specifically on revenue per share.

To increase sales, the two companies plan to focus on improving the integration of the two search engines in the United States and Canada before working on bringing the two together in other countries.

Sharon Pian Chan: 206-464-2958 or schan@seattletimes.com