Entertainment and devices help Microsoft post more stellar gains

Despite widespread complaints about Windows Vista's performance, it finally turned out to be one of the main drivers behind a stellar quarter for Microsoft. Entertainment turned a page too, but MSN remains the wayward child.

Driven by the new Vista operating system, Microsoft Office 2007, and holiday sales of Xbox consoles and games, Microsoft's revenues soared to $16 billion for the second quarter of the fiscal year, an all-time record.

In a conference call with financial analysts late yesterday afternoon, Microsoft officials pointed to double-digit growth for the company's business division, including SharePoint Portal Server and the Office Communications Server (OCS); and for the server and tools division in anticipation of the release of new server products such as Windows Server 2008 and Microsoft's server virtualization technology, Hyper-V.

"The results for the quarter were outstanding," declared Chris Liddell, Microsoft's senior VP and CFO. "Besides just the sheer size and pace of growth, the broadth was notable as we saw strength across all customer segments, divisions, channels and geographies."

Sales outside the US account for a slight majority of Microsoft's sales, at 60%, according to Liddell. Sales growth was also stronger in other parts of the world, amounting to 30% in "emerging markets" for the first half of the year and 20% in "non-US mature markets," he said.

But Microsoft is also witnessing "significant [sales] improvement in the US, and also in Japan," maintained Colleen Healy, general manager of investor relations.

During the holiday quarter, Xbox 360 sales exceeded those of Sony's PS3 by one million consoles, Liddell said. While he also compared Xbox 360 sales to Nintendo's Wii, he did so only from a "closed wallet" perspective, which includes not just consoles but also games and accessories.

From that perspective, consumers spent 27% more on Xbox 360 than on the Wii, and twice as much as on the PS3, he said.

Second quarter sales were also buttressed by the release of products such as new Zune devices, Microsoft Dynamic CRM, and Visual Studio 2008, the officials suggested.

Sales figures don't tell the whole financial story, though. Profitability is even more important. Microsoft's online services division -- which includes MSN -- is still losing money.

Despite second quarter revenues of $863 million, online services showed an operating loss of $245 million on Microsoft's balance sheet.

By contrast, Microsoft's entertainment and devices division -- which includes the Xbox, Xbox 360, and Zune -- displayed an operating profit of $357 million on revenues of $3.07 billion.

Yet during a Q&A session at the end of the analyst call, one analyst honed in on the future profitability of the entertainment and devices division.

"The entertainment and devices division is much more than the Xbox," Liddell responded. "There's obviously a music player in there, Windows Media Center, and various other parts of it as well. So there's other dynamics (that) are going to play in terms of our investment in the future."

In addition, Xbox customers are now buying an average of seven games per console, according to the Microsoft CFO.

"Now, people on average are spending more in terms of the software and accessories than they are on the underlying console itself. So that model of selling the console as a way of generating future revenue is really paying off," Liddell said.