Microsoft earnings meet expectations as Windows sales dip

Microsoft posted earnings today meeting analyst expectations, as a decline in its Windows business was offset by big sales gains in its gaming and server divisions.

The company posted revenue of $20.89 billion for its fiscal second quarter that ended December 31, a 5 percent jump from the year-ago period. Operating income fell 2 percent to $7.99 billion. Earnings per share came in at 78 cents. Analysts had expected Microsoft to post $20.9 billion in revenue and earnings per share of 76 cents, according to Thomson Reuters.

"We delivered solid financial results, even as we prepare for a launch year that will accelerate many of our key products and services," Microsoft Chief Executive Officer Steve Ballmer said in a statement.

Microsoft announced results after the U.S. stock markets closed. In after-hours trading, company shares climbed almost 3 percent to $28.88.

Microsoft's Windows business, long the engine for its financial empire, slumped in the quarter, in large part the result of flooding in Thailand that led to a shortage of hard drives and slowed overall PC sales. Those challenges came on top of an already slowing PC business.

What's more, Microsoft Chief Financial Officer Peter Klein said in a conference call with analysts that the impact of the Thai floods will hit third-quarter results as well.

"We...expect the hard-disk drive shortage to continue to challenge the PC market through at least the next quarter," Klein said.

Klein also cast a bit more cold water on the current quarter, noting that the company's red-hot game console business should produce results a bit "softer than we previously expected." Despite selling 8.2 million Xbox game consoles in the quarter, a 25 percent jump from the year-ago period, sales were slower than Microsoft expected in December. Overall, console sales were down for the holiday period. Microsoft's gains came largely as it took share from rivals.

But slower overall sales led to larger-than-expected Xbox inventories for retailers. That should result in lower-than-expected sales for the console. Klein now expects revenue in its Entertainment & Device Division to grow in the "high single-digits" for the fiscal third quarter and in the "mid-teens" for the full fiscal year.

In the most recent quarter, sales in the Windows & Windows Live division fell 6 percent to $4.7 billion. Operating income for the division slid 11 percent to $2.9 billion. The company noted that it has sold more than 525 million Windows 7 licenses since the product launched more than two years ago.

Sales of Windows to businesses actually gained during the quarter, climbed 2 percent as companies refresh their PCs for employees. Consumer sales brought the group's overall revenue down, primarily as once-popular Netbook computers faded. Those lightweight but underpowered laptops accounted for 8 percent of all PC sales a year ago, but only 2 percent in the previous quarter.

Countering that Windows division slide, the software giant's Server & Tools group posted solid gains with double-digit sales growth from Windows Server and SQL Server premium editions, and a more than 20 percent sales jump in its System Center software. Sales in the group climbed 11 percent to $4.8 billion, while operating income grew 16 percent to $2 billion.

Microsoft's Xbox business continued to outpace rivals during the period, generating big sales during the holiday. Sales in the company's Entertainment & Devices Division grew 15 percent to $4.24 billion in the quarter. Operating income in the group, though, fell 20 percent to $528 million, the result of increased royalty costs, the company noted in its 10-Q filing with the Securities and Exchange Commission.

Microsoft said that the Xbox 360 installed base now approaches 66 million consoles and 18 million Kinect sensors. The company's Xbox Live service has 40 million members worldwide, up 33 percent from the year-ago period.

Microsoft's largest group in terms of revenue, the Microsoft Business Division, posted modest gains as sales of Office 2010 continue to chug along. Sales for the group grew 3 percent to $6.28 billion in the quarter, while operating income increased almost 2 percent to $4.2 billion.

The company noted that nearly 200 million licenses of Office 2010 have been sold since the product debuted 18 months ago. What's more, revenue for Exchange and SharePoint posted double-digit growth and sales from Lync and Dynamics CRM each climbed more than 30 percent.

Microsoft's Online Services Division, home to its Bing search engine, continues to hemorrhage cash, even as it grows modestly. The group posted an operating loss of $458 million, narrowed 18 percent from the year-ago period. Sales climbed 10 percent to $784 million.

"Overall, this was not as bad as we think investors had come to expect," Nomura analyst Rick Sherlund wrote in a note to investors after results were released.

Updated at 4 p.m. PT additional details from the conference call with analysts and analysis.