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For tech giant, games become big deal

Microsoft's results show off the success of Xbox. Delays in Office and Vista cut into profit.

January 26, 2007|Dawn C. Chmielewski | Times Staff Writer

Microsoft Corp. passed a milestone Thursday in its quest to shake its image as a stodgy software company: It generated more revenue from video games than computer server programs in its fiscal second quarter.

Otherwise, the Redmond, Wash.-based company had an unusually tough time. Delays in the consumer release of its Windows Vista operating system and Office productivity suite, which are due out Tuesday, dragged profit down 28% from the year-earlier period to $2.63 billion, or 26 cents a share.

Revenue reached $12.54 billion, up a meager 6%. That was the weakest growth in the year-end quarter in at least a decade, said analyst Allan B. Krans of Technology Business Research.

But Microsoft's core operations remain strong, he said. "Much of Microsoft's success during the next two years will be tied to the updated versions of [Windows] and Office," he said.

Even as Wall Street waited for Microsoft's next generation of core products to begin contributing to its growth, investors were cheered by the success of the game and entertainment division. Revenue there soared 76% to $3 billion, surpassing for the first time one of Microsoft's old-line businesses: the server and tools operation, which contributed $2.6 billion.

Microsoft said consumers bought more Xbox 360 game consoles in December than Sony PlayStation 3 and Nintendo Wii systems combined. Game revenue was further buoyed by robust sales of "Gears of War," an exclusive title from Microsoft Game Studio that sold more than 2.7 million copies in eight weeks.

At the start of the decade, Microsoft's only hardware products were keyboards and computer mice, and many investors were skeptical of its multibillion-dollar bet on game consoles.

But during the recent holiday season, Microsoft cemented its firm position in the game market, said Wedbush Morgan analyst Michael Pachter. The success is boosting Microsoft's image as well as its revenue.

"The stereotypical image of Microsoft is that nerdy guy in the Apple ads," Pachter said. Now, "Microsoft is somewhere between the cool, hip kid and the fat, nerdy guy."

The game division is unlikely to repeat its strong performance in coming quarters. Microsoft Chief Financial Officer Chris Liddell warned that sales were likely to slow in the second half of the year. Cowen & Co. analyst Walter Pritchard said that probably meant that competing game systems from Sony and Nintendo, which were in short supply during the holidays, were finally reaching stores and cutting into Xbox sales.

The game division also isn't helping Microsoft's earnings, as its older businesses do. The unit lost $290 million, compared with the server division's operating profit of $1 billion.

"This is a company that places big bets," said Peter Moore, Microsoft's vice president of interactive entertainment. "It's going to cost a few billion dollars, but here we go."

Microsoft's effort to catch up with Google Inc. is also proving costly. The Internet unit, which spent heavily to develop search and advertising technology, swung to a $155-million loss.

The company deferred $1.64 billion in revenue and $1.13 billion in earnings to account for coupons for free or discounted copies of Vista it gave out to encourage holiday shoppers to buy personal computers. Microsoft won't book that revenue until Vista ships and consumers redeem their coupons.

Without the deferral of revenue from Vista and Office, which Microsoft began selling to corporations in November, sales would have been $14.2 billion -- representing 20% growth.

Microsoft shares lost 64 cents to close at $30.45 then gained 55 cents to $31 after hours.

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dawn.chmielewski@latimes.com

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