Windows revenue falls 13%, share of sales drops to 23%

Weak sales of Windows last quarter dropped the operating system division to its second-lowest share of Microsoft’s total revenue since the third quarter of 2009, the period just before the launch of Windows 7.

The Windows and Windows Live group posted sales of $4.1 billion during the three months ending June 30, a drop of 12.5% from the same period the year before.

Revenue was reduced by the $540 million that Microsoft deferred to cover the upgrade deal it kicked off last month that offers buyers of new Windows 7 PCs a $14.99 upgrade to Windows 8.

Even minus that deduction, the Windows division would still have posted a downturn compared to the second quarter of 2011. In that case, the revenue decline would have been a much smaller 1.2%.

As it has for several quarters, Microsoft blamed poor PC sales for the weak Windows numbers.

The company estimated that global PC sales were flat for the quarter, with business system sales up 1% but sales to consumers down 2%. Those numbers were in sync with estimates by research firms IDC and Gartner, which said earlier this month that global sales were down 0.1%, in part because consumers have diverted spending to tablets and smartphones, particularly Apple’s iPad and handsets powered by Google’s Android.

One analyst saw that as a good thing.

“Over the last 10 years, they have weaned themselves off the operating system and [become] a very different kind of company. Microsoft is a commercial software company, not an OS company. And I see that as a positive,” said Patrick Moorhead, principal analyst at Moor Insights & Strategy.

Peter Klein, Microsoft CFO, argued that Windows 8 would give eventually give the Windows division a boost, but said not to expect great things next quarter unless PC sales suddenly shoot up.

“Excluding the impact of the deferrals associated with the Windows Upgrade Offer and pre-sales [of Windows to OEMs], we expect Windows revenue to slightly trail the PC market for the quarter,” said Klein during the company’s earnings call with Wall Street analysts Thursday.

The portion of the firm’s total revenue of $18.1 billion generated by Windows was just 23%, the lowest figure since the fourth quarter of 2011, when the division accounted for 22.7% of all sales. The smallest percentage of revenue booked by Windows in the last four years was 20.3% in the third quarter of 2009, the three-month stretch that preceded the launch of the popular Windows 7.

A year ago, Windows accounted for 27.3% of all Microsoft revenue.

The third quarter’s numbers for Windows will be even bleaker because of additional revenue deferments that Microsoft will take related to the Windows Upgrade Offer.

“In the first quarter [of our fiscal year] we expect to defer $1 billion to $1.2 billion related to the Windows Upgrade Offer and presales of Windows 8 to OEMs prior to general availability,” said Klein yesterday.

Microsoft will account for that deferred revenue and the $540 million for last quarter, during the first quarter of 2013.

The upgrade program, which Microsoft announced June 1, lets buyers of new PCs powered by Windows 7 to purchase an upgrade to Windows 8 Pro for $14.99 when the new operating system goes on sale Oct. 26. The deal covers PCs bought between June 2, 2012 and Jan. 31, 2013. Customers must download and pay for the upgrade by the end of February 2013.

The other money-making divisions of Microsoft — Business, which handles the Office suite, and Server and Tools — both beat Windows in sales last quarter. The Business group generated $6.3 billion while Server and Tools did $5.1 billion.

The Business division accounted for 34.8% of all revenue; Server and Tools produced 28.2%.

Moorhead pointed out while Windows isn’t the revenue driver it once was, that puts Microsoft in a better spot than many think.

“We have all this industry talk about Windows 8…. Windows 8 is important, but this is a world with essentially free operating systems in tablets and phones. Over the next two years, tablets will encroach on the notebook space, so [the decline in importance of Windows] has put Microsoft in a much better position over the last five years or so.”

Moorhead’s scenario allows Microsoft’s prime engine, Office, to become even more important, and profitable. “Office will be everywhere, on the iPad, cloud-based, on phones,” he said, noting that as Windows’ position relative to revenue continues to shrink — “I see that percentage coming down even more dramatically,” he added — Microsoft won’t hesitate to put Office on devices powered by rivals’ operating systems.

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