Microsoft Earnings: More of the Same

When Microsoft issued its latest quarterly earnings last week, analysts were eager to see how sales of the Xbox 360 impacted the software giant's results. The answer: Not much. Indeed, a quick look over Microsoft's earnings statement for the quarter ending December 31, 2005 reveals that Microsoft's cash cows--Windows, Office, and its server offerings--continue to be responsible for most of the company's earnings. Meanwhile, newer and highly visible initiatives like MSN and Xbox continue to hemorrhage cash.

In Microsoft's second quarter for fiscal 2006, the company posted net income of $4.66 billion, a 2 percent decline from the same quarter a year earlier; the company blamed the slight downturn on expenses related its high-profile Xbox 360 and SQL Server 2005 launch events. Revenues, however, reached record levels: Microsoft posted $11.84 billion in revenues for the quarter.

The software giant was quick to credit some familiar businesses for its earnings. "The growth in our core businesses was healthy during the quarter driven by strength in Server and Tools and the success of our Windows Client products in a robust PC market," Microsoft chief financial officer (CFO) Chris Liddell reported. "The quarter also marked the beginning of an important product cycle for Microsoft with the launches of Xbox 360 [and] SQL Server 2005 ... which were extremely successful and well received by our customers."

It's unclear how successful Xbox 360 is. Though the highly-desired product was arguably the number one item on holiday 2005 wish lists, few consumers were actually able to find Xbox 360 consoles throughout the holiday. As part of an earnings conference call, Microsoft reported that it had sold just 1.5 million Xbox 360 consoles in North America by the end of 2005, far fewer than the 3 million units the company had originally projected. Microsoft blames parts shortages for its woes, and reports that it has added a third Xbox 360 manufacturer to meet demand. Meanwhile, the division responsible for the Xbox lost $293 million in the quarter.

On the other hand, Microsoft's traditional businesses are still reaping huge profits. Indeed, the business units responsible for Windows, Office, and the server products generated over $5.8 billion in operating income. Microsoft's net income was lower than that figure because many other parts of the company lost money.

So why is this situation a problem? The markets for its Windows client and Office solutions are mature at best, and both products' biggest competitors are prior versions of the software. The only way for Microsoft to grow these markets is to keep existing users upgrading and find new markets for its software. The company has been looking into emerging markets in third world countries and places like the Far East, where software piracy still runs rampant. It's still unclear whether upcoming launches of Windows Vista and Office 12--both due in late 2006--will provide sales boosts to what are increasingly saturated markets.

Of course, a company with Microsoft's financial resources and continued financial successes can afford to peddle unsuccessful products for years at a time. If any of these new initiatives--such as living room-based computing, Web search, video games, digital media, or mobile computing--takes off, the software giant may discover its next cash cow. For now, however, it's business as usual. And business is good.