Microsoft Q2 Earnings: Still Winning While Windows Loses

Microsoft had, by all accounts, a successful second quarter. Its $19.9B in revenue was a Q2 record and net income of $6.63B fell just short of the $6.66B from a year ago.

The biggest earners for Microsoft were not the usual suspects (Sorry, the online services group didn’t miraculously start making money). It was the business and gaming grouping that exceeded expectations and came up huge for Redmond.

Microsoft’s Entertainment and Devices division grew revenue by a whopping 55 percent year over year, fueled by the 8 million Kinect/Xbox units sold since Kinect’s release in November. The Business division saw a 24 percent revenue increase year over year, led by surprisingly strong sales of Office 2010, Microsoft Dynamics and SharePoint.

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But what about Windows? You know, that shining star, cash cow operating system we all know and love? Well, it stagnated in Q2, and analysts conclude that the steady rise of tablet PCs, led by the iPad, is to blame.

Microsoft’s accounting methods for Windows revenue in Q2 are a bit complicated. Microsoft is factoring in revenue of $1.71 billion that had been deferred to account for the free upgrades Microsoft gave customers who bought Vista in the months before Windows 7 debuted in Oct. 2009. The company also accounted for inflated revenue caused by a Windows 7 pre-launch spike that took place in Q1 2010.

When the spike and the deferred revenue are accounted for, Windows revenue fell 30 percent year over year. When the spike and deferred income revenues are ignored, Microsoft said, Windows’ revenues of $5.05 billion is a 3 percent year-over-year increase.

Told you it was complicated. Nevertheless, Windows is starting to feel the effects of the tablet PC movement, as overall PC sales growth has started to slow, according to Gartner and IDC, and Windows growth and PC sales growth are one in the same.

During Microsoft’s earnings call yesterday, CFO Peter Klein admitted that there has been “a little bit of a drag on the consumer side” of Windows sales, particularly on netbooks, because of a rise in ultra-portables and tablets like the iPad and the Android-based Samsung Galaxy.

Microsoft’s ace in the hole once again is the enterprise, as sales of business PCs were up this quarter, counteracting the dips in consumer sales.

So Microsoft proved it can have a great quarter without Windows leading the charge. But was it a one-hit wonder? The enterprise PC refresh cycle will carry on for awhile, making Microsoft and its partners lots of money. But as tablets transfix consumers and eat into laptop and netbook sales, Windows revenues are likely to languish. And Microsoft is stubbornly delaying a true iPad tablet competitor until the next version of Windows arrives in 2012, which will be designed to work with lower-powered chips and run on tablets.

Despite Q2’s solid earnings, two big questions loom: How long will Office and SharePoint sales surprise analysts and Microsoft execs by “exceeding expectations”? And can Kinect keep coming to the rescue once the novelty of the gesture-based gaming technology wears off?

The Kinect and Office gains were of the moment, and can’t save Windows every time. Windows needs to save itself. Getting the OS on tablets long before late 2012 is a good start.

Shane O’Neill covers Microsoft, Windows, Operating Systems, Productivity Apps and Online Services for CIO.com. Follow Shane on Twitter @smoneill. Follow everything from CIO.com on Twitter @CIOonline. Email Shane at soneill@cxo.com.