Microsoft Profits Climb, Despite Flat Windows Sales

Microsoft's own second quarter was a good one; the company reported total sales of nearly $70 billion ($69.94B). Operating and net income stood at $27.16B and $23.15B, up 13 percent and 23 percent over the same period in 2010. Interestingly enough, the company's major growth areas were in the combined Entertainment / Mobile division where strong Kinect uptake and a successful Windows Phone 7 launch pushed revenue to $1.49B, up 30 percent over 2010. The company is often portrayed as an Office + Windows behemoth whose other projects lose money. While it's true that those two areas generate the vast majority of company revenue, the 'Other' column isn't a unilateral loss.

The one area where Microsoft lost money, in fact, was Windows. The Windows/Windows Live division reported revenues of $4.74B, down one percent quarter-on-quarter and $19.02B for the year (down two percent). This is partly a result of accounting maneuvers--Microsoft pre-recognized revenue for Windows 7 prior to launching the product--had they not done so, estimated growth would've been in the 2-4 percent range. The company reports that businesses continue to convert to Windows 7, with business system sales up eight percent, partially offsetting a two percent decline in consumer sales.

Investors continue to be wary over whether or not Microsoft can effectively transition to tablets. "All eyes are on Windows and how they are ultimately going to extend this franchise in the future, as the PC business continues to lose share to the tablets," said Josh Olson , technology analyst at money manager Edward Jones. " Microsoft is really a show-me story in terms of its ability to extend its core flagship products to these new growth platforms."

The company also posted strong Office sales, though Office 365 is a work in progress and has yet to fulfill the promises Microsoft has made for it. The company believes its entertainment division will drive further gains in the next 12 months, thanks to the combination of strong Xbox sales and increased adoption of Windows Phone 7. The software giant's much-publicized deal with Nokia could add impetus to that last point, provided consumers respond to additional Nokia phones as positively as the company hopes.

Over the longer term, Microsoft's Windows profits will partly hinge on whether or not Windows 8 is able to address the concerns of that market. That said, current analyst concerns that Windows 7 revenue is being eaten by tablet sales are incorrect. For now, the tablet market simply isn't big enough to chew into total PC sales in significant numbers. This is particularly true considering that there are segments (think small business and enterprise) where the overwhelming majority of workers are going to be buying desktops and laptops, even if the company does deploy a small number of tablets.

If Windows 8 proves unable to meet the needs of this emerging market, Microsoft may have a genuine revenue problem to deal with. For now, it's a bit premature to borrow trouble.