Why Microsoft was punished for a very profitable quarter

Analysts read the writing on the wall about Microsoft's future, despite impressive surges in Office and Xbox revenue

Last Thursday, Microsoft reported its quarterly earnings, and Wall Street was so impressed it took the stock down 5 percent by mid-day on Friday.

You probably know the big news: Apple turned a bigger profit than Microsoft last quarter; Windows sales are down 4.4 percent compared to last year; Office turned a very healthy $5.25 billion profit; and Entertainment, pulled and prodded by the Kinect, rose an astonishing 60 percent in revenue over last year.

Here are some of the details that you may have missed.

Windows Phone 7 was nowhere to be seen. Aside from a very brief nod in the conference call -- acknowledging the de facto takeover of Nokia and the 13,000 apps currently being offered to all 10 Windows Phone 7 app buyers -- nary a syllable was spent on Microsoft's most portable program. We still have no idea how many copies of Windows Phone 7 have been activated, how many apps have been sold, or when the cut-and-paste NoDo update will go out to everybody, including Omnia 7 and Samsung Focus owners. Not a breath about the 4,000 layoffs at Nokia escaped either.

Office 2010 numbers drew hosannas and sighs of relief, with consumer purchases largely credited with driving up sales by 21 percent vs. the same quarter last year. I attribute Office's popularity with consumers to the simple fact that so many new PCs now ship with the 30-day trial of Office 2010, and a large number of consumers buy licenses directly from Microsoft, cutting out the middleman -- excellent marketing.

The general uptake of Office 2010 in the enterprise is said to be fivefold greater compared to the analogous time in Office 2007's history. Personally, I attribute that to the Ribbon: Companies were loathe to upgrade from Office 2003 to 2007, especially when Office 2007 first rolled out, because of the learning hump incurred by the Ribbon. With Office 2010, resistance isn't as high because, four years later, many Office users are inured to the Ribbon. IT departments figure Microsoft isn't going to bring back menus, so they may as well switch. I also give a begrudging nod to the re-appearance of the File menu in Office 2010, which lessens the Ribbon sting a bit.

Microsoft also made a great deal of hay out of the 60 percent rise in Xbox and Kinect sales -- a remarkably good development and testament to the popularity of the Kinect. (I remain convinced that Kinect, and similar input devices from other companies, will revolutionize the much-beleaguered "user experience.") But the analyses tend to gloss over one important fact: Xbox/Kinect profits account for less than 5 percent of Microsoft's total profits. It's not quite a rounding error, but not a whole lot more.

The Windows client numbers give me pause. I talked about the discrepancy between Microsoft's Windows 7 licensing figures and Gartner's PC sales figures last week. In that article I came to the conclusion that roughly 35 to 40 percent of all new PCs ship without Windows 7. In the earnings report, Windows sales were down 4.4 percent compared to last year, while total PC sales are estimated (by Gartner) to be down about 1.1 percent. That's a considerable gap -- one that makes me wonder if more than 40 percent of all new PCs ship without Windows 7. Staggering.

This isn't an iPad-induced gap, by the way. It's a discrepancy between a small decline in PC sales and a much larger decline in Windows 7 revenue. Of course, Microsoft doesn't release enough information to come up with definitive statistics. But a gap like that has to make you wonder.

The number that really grabs me: Bing is absolutely gushing red ink. At the current rate, Bing will lose $3 billion this year. Microsoft's buying market share -- trying to build up its search numbers -- and paying a stunning price. The deal with Yahoo isn't generating the kind of return everyone was expecting. Bing's inching up in U.S. market share, but going absolutely nowhere internationally. Henry Blodget at Business Insider rubs the numbers together and comes to the conclusion that Microsoft is paying $5.5 billion this year to generate $3 billion in online revenue.

All is not doom and gloom. The Server and Tools division is going strong, with $4.1 billion in quarterly revenue -- almost as much as Windows client. Microsoft hired a net 684 new employees in the quarter, for a total of 89,403. There are new products coming down the pike, with Office 365 out now in beta/preview form, Windows 8 and Windows 8 server milestones leaking like concurrent sieves -- still widely anticipated around fall of next year -- and Office 15 sitting somewhere in the wings for anticipated delivery in 2013.

Microsoft's clearly generating cash faster than it can spend it, but the downturn in Windows 7 sales doesn't bode well. We may be seeing another sign of an inflection point on the way to the post-PC era.

This story, "Why Microsoft was punished for a very profitable quarter," was originally published at InfoWorld.com. Get the first word on what the important tech news really means with the InfoWorld Tech Watch blog. For the latest developments in business technology news, follow InfoWorld.com on Twitter.

Copyright © 2011 IDG Communications, Inc.

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