Windows and Office cash cows take a hit in Microsoft's first quarter

A day after Microsoft launched Windows 7, its first quarter 2010 results are in. And both Windows and Office -- Microsoft's biggest cash cows -- took a hit.

For the quarter, which ended on September 30, Microsoft's net income was down 18 percent, to $3.57 billion, and revenues down 14 percent, to $12.92 billion -- both compared to the first quarter earnings for fiscal 2009.

Because Microsoft beat analysts' expectations for earnings-per-share and Microsoft has continued to prove it can cut costs, the company's stock price was up this morning. And because of strong pre-orders for Windows 7 (which didn't go on sale at retail until October 22, which is during Microsoft's next quarter), Microsoft's press release is highlighting "the strong consumer demand for Windows," even though the Windows division's revenues were down to $3.98 $2.62 billion from $4.28 billion from the comparable quarter a year ago.

Microsoft said the first quarter of 2010 was the biggest quarter for Windows sales ever. But the numbers aren't reflecting that fact, primarily because of $1.5 billion worth of deferrals from programs it offered PC makers to convince customers to keep buying Vista PCs prior to the launch of Windows 7. Company officials also attributed the lower Windows earnings to more sales of netbooks and a decline in premium editions of Windows sold to business customers. Here's what the company wrote in its 10-Q report, released on October 23:

"Windows Division revenue decreased primarily as a result of the deferral of approximately $1.5 billion of revenue related to the Windows 7 Upgrade Option and sales of Windows 7 to OEMs and retailers before general availability in the second quarter of fiscal year 2010. Including revenue and units associated with the Windows 7 Deferral, OEM revenue decreased $207 million or 6%, while OEM license units increased 6%. The decline in OEM revenue reflected the 8 percentage point decrease in the OEM premium mix to 63%, primarily driven by growth of licenses related to sales of netbook PCs, a decline in premium editions sold to business customers, and changes in geographic mix. Based on our estimates, total worldwide PC shipments from all sources grew approximately 0% to 2% through growth in both emerging and developed markets."

Things weren't quite as bad for the Microsoft Business Division, which sells Office and Microsoft's Dynamics ERP/CRM products. But sales were still down, even though the Office 2010 release is still quite a number of months away. (It is expected to ship in mid-2010.) The company attributed the revenue decrease to a decline in licenses sold for Office 2007 and to a shift to lower-priced products among consumers. The particulars, again, from the 10Q:

"MBD revenue decreased reflecting decreased consumer and business revenue, and included an unfavorable impact from foreign currency exchange rates of $88 million or two percentage points. Consumer revenue decreased $390 million or 34%, primarily as a result of pricing promotions in the first quarter of fiscal year 2009 that drove increased licensing in that period, a shift to lower-priced products, and a decline in licensing the 2007 Microsoft Office system. Business revenue decreased $161 million or 4%, primarily reflecting a decline in licensing the 2007 Microsoft Office system to transactional business customers and a 6% decrease in Microsoft Dynamics revenue, offset in part by growth in multi-year volume licensing agreement revenue. The growth in multi-year volume licensing agreement revenue primarily reflects recognition of deferred revenue from previously signed agreements."

Microsoft's Entertainment and Devices division's revenues were flat for the quarter. EDD is responsible for Xbox, PC games, Zunes, keyboards/mice and other hardware, and Windows Mobile sales. EDD revenue was flat, with growth in Xbox 360 and games offsetting decreased revenue from other parts of the business. From the 10Q:

"Non-gaming revenue decreased $98 million or 14%, primarily reflecting decreased sales of PC hardware products, Zune digital music and entertainment devices and services, and embedded device platforms. Foreign currency exchange rates accounted for a $35 million or two percentage point decrease in revenue."

Microsoft's online services unit continued to lose money, and the Server division's revenues were relatively flat for the quarter.

This quarter reflects changes by Microsoft in its reporting structure, with Windows Live now part of the Windows client unit, and mobile services moved to Entertainment and Devices.