SEATTLE (Reuters) - Sales of Microsoft Corp's Windows software fell short of outsized expectations, rekindling fears that the spread of mobile gadgets will erode its main PC-focused business.
Microsoft surprised Wall Street with a better-than-expected profit, helped by resurgent corporate spending after the belt-tightening of past years. But its shares stayed flat as investors expressed concern about the weakness of overall computer sales amid a faltering U.S. recovery.
The world's largest software maker, whose Windows operating system runs on 90 percent of the world's computers, is heavily dependent on PC sales, which grew only 3 percent in the quarter. Now it is starting to feel the heat from investors eyeing the phenomenal take-up of Apple Inc's iPad.
"Outstanding numbers when you take a first look at it, but when you delve into them, Windows missed expectations by $300 million," said Brendan Barnicle, analyst at Pacific Crest Securities.
Sales of smartphones and tablets are expected to grow much more quickly than PCs over the next few years, posing a threat to Microsoft's key market.
With the migration to mobile devices from desktop computers expected to accelerate, Apple overtook Microsoft to become the largest U.S. technology company by market value last May.
But some analysts argued that fears of tablets and other hot-selling gadgets replacing PCs were overblown -- at least for now.
"We've gotten over 300 million Windows 7 licenses sold. I mean, PCs are not disappearing. Put that into perspective with 7 million tablets sold last quarter from Apple," said BGC Financial's Colin Gillis.
"Clearly there are disruptions in the landscape, but some of the negative viewpoints are overblown."
Though Microsoft faces longer-term challenges in the PC arena, its other core product, its suite of office applications, generates strong cash flow.
Sales of its Office application rose 24 percent, indicating that U.S. businesses are starting to spend more on technology after the recession.
But consumers are proving less resilient. U.S. initial jobless claims surged in the latest week to their highest since October, indicating that any recovery in consumer spending will come only in fits and starts.
Unearned revenue -- a measure of the strength of the business in Microsoft's pipeline -- fell 9.5 percent to $13.4 billion.
Microsoft's shares were down slightly in after-hours trading, after rising as much as 2 percent briefly on the Nasdaq after the earnings were posted on the company's website before the market closed.
They are down about 3 percent over the past 12 months.
It reported fiscal second-quarter profit of $6.63 billion, or 77 cents per share, compared with $6.66 billion, or 74 cents per share, a year earlier. The per share figure was higher due to a reduction in shares outstanding from last year.
Year-ago profit was boosted by a one-time deferral of revenue from the launch of its Windows 7 operating system.
Wall Street was expecting 68 cents per share profit, according to Thomson Reuters I/B/E/S.
Sales rose 5 percent to $19.95 billion, helped by strong sales of its Kinect hands-free gaming system, handily beating analysts' average estimate of $19.15 billion.
"Kinect represents the most legitimate opportunity we have seen for the Xbox to drive some profit. I do think there is a meaningful catalyst there," said Motley Fool senior analyst Tim Beyers. "The Windows phone looks good. I do think that Windows Phone 7 is proving to be an interesting alternative to the Blackberry.
"I guess the nut of it is, Microsoft is starting to do something better and they are not tripping on themselves, and that counts for something."
Editing by Edwin Chan and by Phil Berlowitz