Microsoft (MSFT) rose to dominate the computer industry by recognizing that the future lay in software, rather than hardware. As we discussed in our last report (FAT124), the industry is now beginning to evolve away from desktop software to software hosted on central networks, known as clouds.

Microsoft must therefore ensure that they are a part of the industry’s evolution, even if they no longer lead it. On this front, they have now moved to catch up through the release of an initial version of their own cloud platform Azure. Azure is currently available as a test version, the feedback from which will shape the final product.

This is an important development for Microsoft. There is a general view that the next generation of companies (Google specifically) are chipping away at their dominance. For a company such as Microsoft, whose major growth phase is behind it, maintaining industry position is vital. The launch of Azure is a key weapon in this battle, and serves as a reminder that Microsoft is still a serious force in the industry.

Turning to the latest result, for the three months to 30 September 2008, Microsoft’s sales of $15.06 billion were up 9 percent on the $13.76 billion for the same period last year. This was ahead of both market expectations and management’s previous guidance. The bottom line growth was a touch more sedate though, with net income up just 1.6% to $4.3 billion.

The table below shows the company’s key September quarter earnings data for each division.

The Client division’s revenue growth fell short of management’s previous guidance of 6% growth, expanding by just 2% to $4.2 billion. A primary impact to the division has been the growth of netbooks, which are essentially small laptops designed for web browsing. Netbooks have limited software requirements and Microsoft’s revenue related to the products is typically half that which they would ordinarily receive.

Server and Tools continued the division’s impressive track record of double-digit growth, with revenue up 17% to $3.4 billion. Various new software releases supported the division’s growth during the quarter, including SQL Server 2008. In addition, demand for the division’s consulting and support services remained strong.

Entertainment and Devices’ revenue decline was expected given that the previous period benefited from the launch of Halo 3. However, the weakness was milder than management had anticipated due to stronger sales of the company’s Xbox 360 games console. Microsoft sold an impressive 2.2 million units during the period, which outstripped Sony’s competing Playstation 3 product by around 100,000 units.

Moreover, the Entertainment and Devices division overcame lower sales to expand profitability. An increase in membership of the company’s Xbox Live internet service was the driving force. Xbox live membership has doubled in the last two years to over 14 million. Since there are very little costs associated to each new membership, a large percentage of the additional revenue flows to the bottom line.

Although the quarter was reasonably robust overall, management did state that demand began to soften towards the end of the period. Certainly, computer and software expenditure is swiftly dropped from the corporate shopping list in a recessionary environment.

Management have recognized this and reduced their guidance for the full year to 30 June 2009. Expectations are for sales of $64.9 billion to $66.4 billion, compared to (previously revised) guidance of $67.3 billion to $68.1 billion. Management also plan to shave around $500 million from their cost base in the months ahead.

As shown on the charts, Microsoft has remained under pressure since slipping back below $30 in February. As evident on the daily chart, prices are nearing significant support in the region of $20, which represents the major lows of 2000 and 2002.

In our opinion, the reaction of the stock to tests of the $20 level will be a key determinant of direction for the coming months. A rebound would point to a continuation of consolidation within the broad range of prices that has dominated trade for the past nine years. However, a break and hold below $20 is likely to see a further deterioration in price.

Microsoft will remain held in the Fat Prophets Portfolio.

Fat Prophets provide independent, unbiased, and transparent financial markets advice to investors around the world. Fat Prophets have an absolute passion and dedication to making your investments as FAT as possible. Our record speaks for itself. To join the weekly Fat Free newsletter click here.

To take a look at two current buy recommendations by the analysts at Fat Prophets click here and to see a sample report click here.