Less than a year after Microsoft entered the tablet computer market with the Surface, the cracks are starting to show.
The software giant yesterday booked a big write-off to its Surface RT business after it slashed tablet prices this week to stimulate demand.
Its quarterly earnings results also showed that Windows 8, an operating system designed to bridge the divide between PCs and tablets, has been so poorly received that it contributed to a revenue drop for its operating system software unit.
The missteps with both products disappointed Wall St and shares plunged nearly 7 per cent to US$33.10 in after-hours trading.
The write-down for expected losses on the Surface RT tablet amounted to US$900 million ($1.1 billion). Even without it, Microsoft's results would have fallen short of expectations.
The results came a week after the company announced a reorganisation to turn it into a "devices and services" company less reliant on providing software for personal computers.
The earnings miss raised new questions as to whether the transition will succeed.
"It doesn't inspire a lot of confidence," said Nomura Securities analyst Rick Sherlund.
"You're in the hardware business now, and shortly after entering it you have a big write-down. That's embarrassing."
Windows 8 and the Surface tablet are Microsoft's big bets on the tablet computer market as PC sales continue to decline.
Research firms IDC and Gartner said last week that global PC shipments fell 11 per cent in the April-June quarter, the fifth consecutive quarterly decrease.
Acknowledging the company's difficulties with the change, Microsoft chief financial officer Amy Hood told investors on a conference call that "this journey will take time".
"We know we have to do better," Hood said. "We are confident we are moving in the right direction."
Microsoft cut the price of Surface RT from US$499 to US$349 on Monday.
It began selling Surface tablets in October, and shipped about a million tablets in the first three months of this year, according to research firm IDC.
The shipments gave Microsoft a meagre 2 per cent share of the tablet market. Apple remained the leader with 39.1 per cent, followed by Samsung Electronics, AsusTek Computer, Amazon.com and Acer.
Microsoft's revenue from its flagship Windows operating system was down 6 per cent in the recent quarter.
Users have not responded well to Microsoft's latest operating system, Windows 8, and the results reflect the poor reception.
IDC has said the new operating system is contributing to the longest slump in the history of personal computer sales.
An analyst with Pacific Crest Securities, Brendan Barnicle, said the entire PC market was undergoing a shift, especially as device makers increasingly developed their own operating systems, as Apple and Google have done for their tablets and personal computers.
In a sign that Microsoft is adjusting, the company said it expected to derive 65 per cent of Windows revenue from third-party computer manufacturers in the July-September quarter, down from 75 per cent a year ago.
Revenue and profitability improved in Microsoft's other lines of business, including enterprise software, servers and tools, the Xbox video game division and the Bing search unit, but those results also fell short of analysts' forecasts.
Net income in the April-June quarter came to US$4.97 billion, or US59c a share, reversing a US$492 million loss a year ago when it wrote down almost the entire value of its 2007 purchase of online ad service aQuantive.