Microsoft: A Reality Check for Tech

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And consumers are gravitating to low-price netbooks that bring in much less revenue for Microsoft and PC makers than traditional laptops do. Even after factoring out $276 million in Windows revenue Microsoft has deferred for a promotion on Windows 7, sales in its client division fell 22%. The Windows group profits were down 33%.

Sales in Microsoft's business division, which includes its cash cow Office software, fell 13%, to $4.56 billion. Sales of server software and development tools to companies were down 6%, to $3.5 billion, as shipments of server computers tumbled 24% in the quarter, according to Microsoft. And revenues in the division that includes the Xbox game console declined 25%, to $1.2 billion.

For its full 2009 fiscal year, Microsoft reported $58.44 billion in revenues, down 3.3% from the 2008 level, while net income of $14.57 billion was down 17.6%.

Some of Microsoft's problems are endemic to its business of selling software to corporations and small businesses, and therefore less indicative of the overall tech sector's health. Apple was buoyed by strong demand for consumer Macintosh computers and iPhones. And Intel cited strong PC sales in China and other emerging markets. But Chinese sales don't help Microsoft as much, since many PC users there run pirated versions of Windows that Microsoft doesn't get paid for.

Hopes Are Pinned on Windows 7

There are signs of brighter days for Microsoft ahead. The launch of Windows 7 in October is expected to spur a wave of PC buying, and Microsoft plans to deliver a new version of its Office productivity software next year. A July survey of 80 chief information officers by Pacific Crest Securities found that 56% plan to upgrade their machines to run Windows 7 as soon as it's available. On July 22, Microsoft released Windows 7's final code to PC makers, indicating the product is on track.

"It's this temporary pause in demand, which will snap back," says Citigroup's Thill. "No one should be looking at Microsoft and investing for one quarter." Microsoft shares have risen 31.5% in 2009, and the stock could be "a great play in the recovery of the overall IT and PC industry," he says. "On a one-year horizon, the stock's still worth $28."

Microsoft has also received favorable early reviews for its Bing search engine and picked up market share of U.S. search queries in June, as it tries to pry away some of Google's (GOOG) share of the search-related Internet advertising market.

Microsoft plans to hold its annual meeting with financial analysts July 30 in Redmond, Wash. Analysts will be looking for any hint of what to expect in coming quarters in the absence of financial guidance from the company during the recession.

Some analysts are heartened that Microsoft has kept expenses down—it forecast lower operating expenses for fiscal 2010 than it had previously told Wall Street to expect. But Liddell said the company hasn't been able to cut costs fast enough to keep pace with falling demand.

Microsoft's disappointing quarter quashed hopes for a fast tech turnaround. Now the question is whether Windows 7 can inject optimism back into the sector.

Ricadela is a writer for BusinessWeek in Silicon Valley.

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