Revenue for the three months to March 31 was $9.62bn, up 5% on the same period last year. Microsoft had expected $9.7bn to $9.8bn, and analysts, on average, had been predicting revenue to come in at the high end of that guidance.

Net income was $2.56bn, and $0.23 per share, compared to $1.32bn and $0.12 per share a year ago. The profit was boosted by lower legal fees, which ate up $0.17 per share in Q3 2004, but only $0.05 in the latest quarter.

The slight revenue miss was primarily due to unfavorable exchange rate movements… and a greater than expected decline in commercial and retail licensing for the client business, said Curt Anderson, general manager of investor relations at Microsoft.

The Client business was up 2%, not as much as Microsoft had hoped. A 7% increase in revenue from PC makers, which saw a 10% increase in Windows unit shipments, was tempered by an 18% decline in retail and commercial sales.

This is primarily attributable to a decline in Upgrade Advantage revenue and customers’ continued preference to upgrade the operating system through the OEM channel when they replace PCs, rather than through an annuity contract, Anderson said.

The decline in commercial and retail licensing revenue was a little steeper than expected, Anderson said. He added that it he thinks it is relatively normal at this point in a product’s lifecycle leading into a new OS release

Smoothing out its Windows licensing revenue over long release cycles is an ongoing challenge for Microsoft. Longhorn, the codename for the next Windows client, is expected to ship in time for the late 2006 holiday season.

We’re hopeful than annuity licensing for the client will start to turn around as customers get more clarity around the Longhorn product and its launch date, Anderson said.

The OEM business, where large PC makers negotiate for volume discounts, accounts for about 80% of Windows sales, and Anderson said that in the third quarter the mix of OEM versus retail had shifted towards OEM.

The mix of operating systems being bought via PC makers leant towards the cheaper Home Edition of Windows XP. Sales of Professional Edition made up 49% of the sales, down from 50%.

That was in a large part because small and medium sized business volume was up, and they tend to buy more Home Edition than enterprise users would, Anderson said.

While the Client side was disappointing, Microsoft said its server software sales were impressive, up 12% at $2.45bn. SQL Server revenue was up 15% and Exchange server revenue was up 20%, the company said.

Our read is that IT and corporate spending were healthy during the quarter, corporate controller Scott Di Valerio said. We had very strong SQL and Exchange business in Q3 and we expect that to continue on in Q4. We also expect the Windows server business to grow in line with overall hardware market.

The Information Worker segment, which includes Office, grew at 2% year on year to $2.77bn. Microsoft Business Solutions grew at 3% to $185m. MSN was down 5% at $564m, on lower internet access subscriptions. The small but fast growing mobile business was up 31% at $80m.