Microsoft Q1 2011 by the numbers: Beats consensus but not Apple

[Editor's Note: This was a live document from about 4:36 p.m. EDT to 5:50 p.m. Refresh page for updates.]

Microsoft started fiscal 2011, which first quarter closed on September 30, ahead of analyst consensus. Slower PC shipment growth didn't take the spark out of Windows revenues, and Office 2010 delivered during its first full quarter of license sales. Microsoft announced earnings after the bell, setting a record executives won't be touting: Revenues fell below Apple, by more than $4 billion, yet another sign that the aging Office-Windows-Windows Server applications stack is declining in relevance before cloud-connected mobile devices.

Microsoft revenue rose 25 percent to $16.2 billion, year over year. Operating income: $7.12 billion, up 59 percent. Net income: $5.41 billion, or 62 cents a share. Net income rose by 51 percent and earnings per share by 55 percent year over year. However, Microsoft stated growth rates when counting a $1.47 billion deferral related to Windows 7's launch. Without the deferral, revenue grew by 13 percent, operating income by 20 percent, net income by 16 percent and earnings per share by 19 percent.

For more than 18 months, Microsoft has provided no guidance to Wall Street analysts, in a move that is highly unusual for so large and so successful a public company. As such, Wall Street analysts had to rely solely on their wits to call the quarter. Average consensus was $15.8 billion revenue and 55 cents earnings per share. Revenue estimates ranged from $15.32 billion to $16.18 billion. So Microsoft topped the Street.

Fiscal 2011 Challenges

By comparison, Apple reported $20.34 billion in revenue during the same quarter. However, and not surprisingly, Microsoft's net income beat Apple's net income of $4.3 billion by about $1.1 billion. Microsoft's greater net income isn't surprising, given how much richer margins are for software than hardware. Apple generates most of its sales from hardware (and bundled software and services), while Microsoft largely licenses software.

In April and June posts, I asserted that with the new revenue stream opened up by iPad Apple revenue could pass Microsoft as early as second calendar quarter. Apple fell short by about $340,000. However, for third calendar quarter Apple easily whizzed past Microsoft, in a gesture that is as much symbolic as financially relevant. Apple has better adapted to the new mobile paradigm than has Microsoft -- and not just with iPhone. In just two quarters, iPad generated nearly $5 billion in new revenue for Apple. Combined, during third calendar quarter, iPad and iPhone accounted for 57 percent of total revenues. Apple is among the companies successfully selling a full stack of integrated hardware, software and services -- an approach Microsoft has taken for Xbox and Zune but not PCs or connected devices, like smartphones and tablets.

Microsoft's major revenue streams today are pretty much what they were a decade ago: Office and Windows, with Windows Server making successive gains over many quarters. By comparison, in 2000, the Mac was Apple's major revenue stream. Since 2001, Apple came to dominate the markets for music players, digital music sales and mobile applications stores, also wildly succeeding with smartphones and media tablets. Microsoft's challenge, as it embarks into fiscal 2011, will be the successful expansion or extension of its push into cloud services, mobile operating systems, search and supporting services and desktop and mobile gaming. The point: Apple has reinvented its business and profited, while Microsoft has not.

Q1 2011 Revenue by Division

• Windows & Windows Live: $4.76 billion, up 66 percent from $2.88 billion a year earlier (13 percent growth when adding deferral).
• Server & Tools: $3.96 billion, up 12 percent from $3.5 billion a year earlier.
• Business: $5.126 billion, up 14 percent from $4.5 billion a year earlier.
• Online Services Business: $527 million, up 8 percent from $487 million a year earlier.
• Entertainment & Devices: $1.8 billion, up 27 percent from $1.4 billion a year earlier.

Microsoft's most immediate challenge remains mobile, where upstarts like Apple and Google body slammed Windows Mobile into fifth place in global smartphone market share, according to Gartner. One week ago, Gartner forecast that, by 2014, mobility would be a trillion-dollar business. Among handsets, smartphones will play the most important role. For businesses, Gartner predicts that by 2015, IT management will no longer define corporate mobile strategy.

"Many mobile business systems will exploit contextual cloud services hosted by others," Nick Jones, Gartner distinguished analyst, said in a statement. "It will also be a major commercial battleground with powerful vendors such as Nokia, Google, and Apple striving to own the consumer's context. Context will also be bound up with social relationships and social networks, illustrated today by services such as location-tagged posts to Facebook and Twitter."

From that perspective, Microsoft's approach to Windows Phone 7, which emphasizes social and business and personal lifestyle contexts, is fresh and forward-looking. Microsoft also is investing heavily in cloud services. Mobile and the cloud are among the major topics being discussed at Microsoft's 2011 developer conference, which convened this morning for two days.

Q1 2011 Income by Division

• Windows & Windows Live: $3.32 billion, up 124 percent from $1.5 billion a year earlier (20 percent growth when adding deferral).
• Server & Tools: $1.63 billion, up 32 percent from $1.24 billion a year earlier.
• Business: $3.39 billion, up 20 percent from $2.83 billion a year earlier.
• Online Services Business: Loss of $560 million, up 17 percent from $477 million loss a year earlier.
• Entertainment & Devices: $382 million, up 47 percent from $260 million a year earlier.

Segment by Segment Results

Microsoft reports revenue and earnings results for five divisons: Windows & Windows Live, Server & Tools, Business, Online Services and Entertainment & Devices.

Windows & Windows Live. Microsoft revealed that OEM licensing now accounts for 75 percent of revenues, down from the longstanding 80 percent threshold. The 5-percent shift reflects a licensing change Microsoft implemented with Windows Vista and continues with version 7: Businesses must adopt Software Assurance annuity licensing to obtain licenses for Windows Enterprise Edition. The change is hugely significant. Microsoft long ago shifted about 40 percent of Office license revenue to annuity licensing and about 50 percent for Windows Server.

Software Assurance customers pay upfront for upgrades, in yearly installments, which helps smooth out Microsoft revenues, insulating sales from changing market conditions. When customers buy software on new PCs, Microsoft is more susceptible to slow downs in computer sales. Two weeks ago, Gartner and IDC released calendar third-quarter preliminary PC shipment data that foreshadowed weaker-than-expected Windows license shipments. But Windows licenses rose above slower sales, buoyed in part by annuity license sales.

IDC put year-over-year global PC shipment growth at about 11 percent, or nearly 3 percent below forecasts. Gartner gave a more tepid growth figure of 7.6 percent, rather than the forecast 12.7 percent. Microsoft projected PC shipment growth to be between 9 percent and 11 percent for third calendar quarter. Still, even with slower PC shipments, Windows OEM licenses sold surprisingly well, up 93 percent -- $1.8 billion -- year over year. Microsoft said that PC shipments to emerging markets grew three times that of emerging markets.

Server & Tools. The division is most insulated against economic maladies, because about 50 percent of revenues come from contractual volume-licensing agreements; annuity revenue grew by 15 percent year over year. Product revenue grew 12 percent, or $343 million, buoyed by Windows Server, SQL Server and Enterprise Client-Access License sales. Because of corporate layoffs, Microsoft has seen customers renewing license contracts at lower levels. However, IT spending is up. Microsoft estimated that server hardware shipments grew in the mid teens, year over year. Azure subscriptions increased 40 percent sequentially; there is no year-over-year comparison.

Business. Microsoft's other cash cow division reversed several quarters of year-over-year declines, buoyed by Office 2010's release. Consumer sales also reversed a weak sales trend, with revenue growing 26 percent, or $216 million, on strength of Office 2010. More broadly, the division's revenue grew 14 percent.

Online Services Business. The division's loss lessed, buoyed by ad sales increases. Online advertising revenue rose 13 percent, or by $55 million, to $473 million. However, cost of revenue increased by $74 million, largely related to Microsoft's agreement to provide Yahoo with search services.

Entertainment & Devices. Microsoft shipped 2.8 million Xbox consoles during the quarter, up 38 percent, from 2.1 million a year earlier. Halo Reach generated $350 million revenue.

{Editor's Note: Correction to Online Services net income.]