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Microsoft Pri0

Welcome to Microsoft Pri0: That's Microspeak for top priority, and that's the news and observations you'll find here from Seattle Times technology reporter Matt Day.

October 29, 2010 at 10:12 AM

The big picture take on Microsoft Q1 earnings

This story ran in Friday’s Seattle Times.

Powered by its core strengths in Windows and Office, Microsoft delivered a strong quarter to a Wall Street that has grown increasingly doubtful about the company’s prospects.

Businesses are upgrading their PCs, driving sales of new software, particularly Windows 7. Office 2010, which launched in June, had a strong start in its first full quarter on the market.

It all came together to produce record sales of $16.2 billion in the first quarter of Microsoft’s fiscal 2011, the company reported Thursday.

Net profit was $5.4 billion, or 62 cents a share. Analysts had expected 55 cents a share.

The profit increase was 51 percent compared with the same quarter a year ago, when Microsoft saw $3.6 billion, or 40 cents a share. (Accounting for $1.5 billion in deferred revenue from a Windows 7 upgrade program a year ago, profit grew 16 percent.)

The $16.2 billion in sales represented a 25 percent increase from $12.9 billion a year earlier. Analysts were looking for sales to come in at $15.8 billion. (Accounting for the deferred revenue, sales grew 13 percent.).

Chief Financial Officer Peter Klein, speaking in a conference call with analysts and reporters, called the results “excellent” and said they “reflect the ongoing strength and breadth of our product portfolio.”

Wall Street agreed, sort of. Microsoft’s stock closed at $26.28 Thursday, before the company reported financial results, then rose a little more than 3 percent, to $27.19, in after-hours trading.

“I think it’s a really good quarter. Much better than expected,” said Sid Parakh, analyst at McAdams Wright Ragen in Seattle. “I would characterize it as its strength in the core business. It’s certainly good to see that.”

Even Sarah Friar, a Goldman Sachs analyst who recently downgraded Microsoft stock to “neutral” from “buy,” called it a “solid quarter.”

“If you look at where the strength came, strength came from Windows and Office,” she said.

She does, however, still have reservations about Microsoft’s long-term prospects. “The PC side we didn’t think would be weak this quarter,” she said. “The longer-term structural challenges they still don’t have an answer on,” specifically about tablets.

Among some analysts, the tablet has become a potential boil on the PC. They believe Apple’s iPad as a device could eat into PC sales and Microsoft software.

On the conference call, Microsoft said it does not see a “material shift” to tablets. “We are confident that tablets will expand the PC market,” Klein said.

Friar said that’s a view “I don’t agree with at all.”

For the next nine months at least, Microsoft expects business customers to keep churning through PC upgrades, which would continue to drive Windows and Office sales.

Microsoft also pointed to record bookings as an indicator that customers are committing to Microsoft products for multiple years.

Looking to the long term, the company started highlighting its future in cloud computing for the first time, talking up adoption of its cloud-computing platform Azure and the work on building and selling cloud versions of Office.

While Azure is not generating significant revenue, Microsoft believes this will become a major source of sales over the next 10 years.

Sales in almost all its divisions increased in the first quarter, while the Online Services division, home of Bing, MSN and online advertising sales, continued to lose money. Here is the breakdown by divisions:

Windows division. Sales jumped 66 percent to $4.8 billion, and operating income jumped 124 percent to $3.3 billion. Microsoft said it has sold 240 million copies of Windows 7 since the new operating system came out in October 2009.

Business division (Office and SharePoint). With the launch of Office 2010 in June, sales rose 14 percent to $5.1 billion and operating income increased 20 percent to $3.4 billion. The company announced this month a test version of Office 365, a cloud version of Office, Exchange, SharePoint and Lync.

Server and Tools division (SQL, Windows Server and Azure). Sales increased 12 percent to $4 billion and operating income rose 32 percent to $1.6 billion. The number of subscriptions to Azure has grown 40 percent since the fourth quarter of fiscal 2010. Microsoft said developers have built 20,000 applications that run on Azure.

Online Services division (Bing and MSN). Sales rose 8 percent to $527 million and the operating loss widened 17 percent to $560 million. Microsoft worked on implementing its search partnership with Yahoo during the quarter, which added $74 million to cost of sales. The division also spent $61 million more on research and development, a result of “headcount-related expenses.” As part of an agreement, Microsoft is hiring Yahoo engineers. Bing is now running Yahoo’s searches, and this week said the two companies had completed the transition of paid search advertising to Microsoft’s ad platform.

Entertainment and Devices division (Xbox and Windows Phone). Sales rose 27 percent to $1.8 billion, while operating income grew 47 percent to $382 million. The new Xbox game “Halo Reach” has seen $350 million in sales since it launched in September. Microsoft sold 2.8 million Xbox 360 consoles during the quarter, compared with 2.1 million in the first quarter of fiscal 2010. Next week Microsoft will begin selling Kinect, a motion sensor for the Xbox that allows gamers to play without a handheld controller. The company is also launching Windows Phone 7 for the holidays, a redesigned smartphone to compete with Apple and Google. The phone will start selling in the U.S. on Nov. 8.

The company generated a record $8 billion in cash during the quarter, bringing its total cash and cash-equivalent balance to $44.2 billion.

Microsoft returned $5.4 billion to investors through dividends and repurchasing shares.

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