Beyond Binary

While its crystal ball is no clearer than anyone else's, Microsoft Chief Financial Officer Chris Liddell told financial analysts the company is committed to faring better than the overall IT industry, whatever the economy brings.

The company, in its quarterly earnings report, lowered its growth outlook for the year, but not as much as some had feared. It is now forecasting at least a mild recession, as opposed the economic growth it once saw coming in the second half of its fiscal year.

At the same time, Liddell, in a call with analysts following the earnings report, pointed out that the company may yet see double-digit growth in revenue and per-share earnings for the year.

"We feel extremely good about our relative competitive position," Liddell said.

Microsoft also addressed last quarter's shortfall in the company's Windows Client unit, which posted revenue growth four percentage points lower than the forecast, even though PC unit sales were in line with what the company had projected.

Bill Koefoed, general manager of investor relations, told analysts the issue was that the mix of sales was far from what it had predicted, with traditional PC sales significantly slower, while low-end "netbooks" accounted for a larger share of the market.

On the Xbox front, Microsoft said it sold 2.2 million Xbox 360s as retailers boosted inventory ahead of the holiday season.

Update at 2:50 p.m. PDT

Liddell is talking about Microsoft's approach to the recession, which is to focus on the cost savings it can offer to customers, watch its own costs, and invest for the future.

The company expects to spend less than it had planned in several areas including hiring, marketing, and on the build-out of its data centers. Cuts are also planned in areas like travel and vendor expenses.

Microsoft on Thursday reported first-quarter earnings that narrowly topped estimates, while saying that it expects the holiday season results to be slightly lower than analysts were projecting.

The company lowered its estimates of both PC and server growth by a couple of percentage points, but said it continues to see relatively healthy enterprise demand.

"There are indications out there that business is fairly strong, but there is also concern about what could happen," Chief Accounting Officer Frank Brod told CNET News.

For the quarter that ended September 30, the software maker said it earned $6 billion, or 48 cents per share, on revenue of $15.06 billion. The company had been expected to post per-share earnings of 47 cents per share, on revenue of $14.78 billion, according to Thomson Reuters.

"In spite of all that is going on we had a fairly good quarter," Brod said.

Looking ahead, Microsoft projected December quarterly earnings of 51 cents to 53 cents per share, with revenue in the range of $17.3 billion to $17.8 billion. Microsoft had been expected to post per-share earnings of 55 cents, on revenue of $17.96 billion, according to Thomson Reuters.

Brod also said the company had not seen a big drop-off in long-term contracts. "Our renewal rate on annuity contracts was at our historic levels so we were pleased to see that as well," Brod said.

Microsoft shares inched higher in after-hours trading, changing hands recently at 22.68, up 36 cents or more than 1 percent. That came on top of a 3 percent gain in regular trading.

The company is tempering its hiring plans, but he reiterated no plans for a full-on freeze in new hiring.

"We may see some pauses in select groups," Brod said. "Overall, we will still have growth, although it probably won't be as robust as we talked about just a few months ago."

Brod said that while the company is trying to keep expense growth in check, it also is trying to use the downturn as a chance to build new businesses. He noted that Microsoft invested heavily after the dot-com bust in its Server and Tools business and that unit now generates billions in sales.

"Current business certainly is influenced by current economic conditions but our future growth is influenced on how we currently choose to invest."

He said that the company's acquisition strategy has not really changed and reiterated that the company has no active talks with Yahoo.

As for the individual business units, it was a mixed bag. Among the bright spots was Microsoft's money-losing online unit, which turned in better-than-expected online advertising sales growth of 15 percent.

"We were pleased," Brod said.

Profits in the Windows unit were down year-over-year, despite slight growth in the unit's sales. The company's business division and server and tools unit posted a combined 19 percent sales growth, with double-digit profit growth as well..

The company is shaving its forecast for PC sales, now expecting the holiday quarter will be up 8 percent to 12 percent, as compared to a prior forecast of 12 percent to 15 percent.

"We are still seeing the market growing," Brod said. "That's still close to double digit growth."

Microsoft's server forecast is also coming down a few percentage points, Brod said.

SANTA CLARA, Calif.--Microsoft CEO Steve Ballmer said his company may be the only one with a chance to rival Google in search over the long term, but acknowledged that it will take several more years and a whole lot of money.

Microsoft CEO Steve Ballmer

"It's going to take us a while," he said, during a speech at the Churchill Club. "We've got a lot to do."

Venture Capitalist Ann Winblad, who was moderating the talk with Ballmer, noted that when Ballmer addressed the club in 2006, he said search was a five-year battle.

"It's a five-year task," he said, with a smile. "It's a long-term task."

To succeed, he said, the company will have to find a way to fundamentally change the experience and the economics of search. "You have to redefine the category," Ballmer said. "We've taken some steps in that direction."

"You don't really brute force your way into any market," he said. (I looked around, but I didn't see anyone choke on their water over that one.)

On the antitrust front, Winblad asked Ballmer if he had any advice for Google's executives. "I'd probably keep that advice to myself," he said.

He also stayed silent on several other topics, such as a question about "Red Dog," the company's rumored competitor to Amazon's EC2. He did promise Microsoft would have much more to say in six weeks at the company's Professional Developer Conference in Los Angeles.

He did say that Red Dog and other cloud computing efforts are key to winning the battle for developers, particularly Web developers.

"I think at the end of the day, cloud computing will be dictated by the interests and the degree to which you capture the imagination of developers," Ballmer said.

On other topics:

The Seinfeld-Gates ads: "It was a two-week campaign but man did it get people talking for more than two weeks," Ballmer said.

The phone business: In five to ten years, Ballmer said all of the one billion cell phones sold a year will be smartphones. He said that means that software and hardware are likely to separate, at least in the mass market. He said of the players in that area--Windows Mobile, Symbian, Linux mobile and Android--Microsoft's is the most mature.

He said RIM and Apple may have nice and profitable businesses, but they are likely to be niches. "We're kind of battling for the big part," Ballmer said. "That doesn't mean Apple and RIM wont make lots of money."

On Windows-related headaches: "Every version of Windows statistically... gets better than versions before," he said. "I'm not saying that we are there yet."

With Vista, Ballmer said Microsoft made a choice, right or wrong, to change some things that caused compatibility issues in the name of security.

He said that it would be easier if Microsoft was trying to build a fixed-function device rather than an open, general-purpose platform. Still, he said, the goal is a system that everyone likes. "Every day we've got 5,000 people...that come to work just focused on that single challenge."

Updated 10 a.m. PDT, with more details on spending plans

REDMOND, Wash.--In trying to explain Microsoft's continued decision to spend in its money-losing online services business, CEO Steve Ballmer likened it to a game of high-stakes poker.

"We are going to have to ante up in a significant way to even be in this game," he said.

Ballmer: Online investments a fraction of operating income.

(Credit: Ina Fried/CNET News)

But, he said, as both advertising and content move online, the opportunity is huge.

"There's at least a trillion dollars just in media, communications, and advertising, not all of which we can capture," Ballmer said.

(It seems every time Microsoft talks about the opportunity, it grows, even if Microsoft's market share doesn't.)

In any case, Ballmer made the familiar case that the scale of the opportunity for a company of Microsoft's size is too big to ignore.

The money that Microsoft is spending, he said, is a few hundred million dollars in losses each year, but amounts to around 5 percent of the company's overall operating income.

"Some say it's too expensive," Ballmer said. "It's a relatively small percentage investment from an overall Microsoft standpoint, in order to have a real opportunity at significant acceleration of our market value. I think it is a very good risk return."

Ballmer did say that the investment will have to continue until Microsoft gets more scale, which he said he could not put a time frame on.

Of note, one slide Ballmer showed pointed to an investment of 5 percent to 10 percent of operating income until the company has a more significant share of the market.

Ballmer's comments came at the start of Microsoft's financial analysts meeting, which runs all day here.

Originally, Ballmer said, he wasn't planning to give the online pitch, but said recent organizational changes (i.e. the departure of online business head Kevin Johnson) forced him into duty.

But, he said, the company thought it was important that "whoever gives this presentation was actually still going to be here in three weeks."

Update: Ballmer went into detail of where that online spending is going. He talked about how Microsoft's costs to maintain its search index have to be nearly as high as Google, despite the fact that Microsoft has a lower volume of searches.

Microsoft also has to spend more in other areas than Google, by virtue of its No. 2 position. Marketing was one area, he said, where Microsoft will have to outspend the market leader. "Google doesn't have to. We do," Ballmer said.

Ballmer also said that the on-again, off-again talks with Yahoo are in the "off-again" stage.

As I listened to financial analysts grumble about how Microsoft continues to pour its hard-earned software profits back into its online services effort, I couldn't help but think that maybe Microsoft is on to something.

Wouldn't newspaper industry analysts have had the same grumbles if the Gannetts and Knight Ridders of the world had poured a huge chunk of their profits into online ventures a decade ago at a time when their ad revenues were still enjoying healthy growth? And wouldn't they now say such a move, if well done, would have been brilliant?

Newspapers have traditionally been funded by things like classified advertising in areas like real estate, help wanted, and car sales. Had one of the newspaper companies seen the online threat and said, "We need to own those categories online," perhaps they would be in better shape. Instead, they are faced trying to reinvent themselves at a time when their revenue is in sharp decline.

Of course, it's not a direct parallel. There's an argument to be made that, while newspapers were inevitably going to lose revenue to online sources, Microsoft could steer clear of advertising by focusing on business software.

But if the biggest long-term threat to Windows and Office is free rivals and Web-based services, shouldn't Microsoft be using a significant fraction of its profits to develop its online advertising capacity?

A long-term battle between Microsoft and Google is shaping up. The question is whose economic engine will be stronger. Google is funding its legions of data centers and armies of engineers via online advertising, while Microsoft is using Windows.

Importantly, after reporting weak Windows results in April, Microsoft saw that unit post healthy and better-than-expected 15 percent growth for the most recent quarter.

Obviously, Microsoft needs to execute better on the Web. Pouring money into online ventures is only good if it produces returns. To date, Microsoft has not seen the kind of gains it will need to have to make it pay off. Some newspaper companies did, for example, build online job sites and auto sites and just weren't able to grab enough money to replace the ad dollars being lost. It's not enough to see the threat and try. To prove the grumblers wrong, Microsoft will have to do more than throw money online. It will have to win.

Microsoft is hoping to get advertisers to think beyond search.

In an e-mail sent to reporters and analysts on Thursday, Microsoft's Brian McAndrews said the company is working on a new technology that will better measure the indirect role that online ads play in leading to a sale, a field known as "conversion attribution." McAndrews, who was chief executive of Aquantive when Microsoft bought it for $6 billion last year, said Microsoft has a new product that will enable advertising that is better at "giving credit where credit is due."

McAndrews, who heads Microsoft's advertising tools business, also predicted "significant growth" for online video advertising and said in-game advertising will "also begin to make meaningful in-roads," saying that there are now seven-figure deals in that space as well as better metrics to make them pay off.

"That said, we're not discounting the importance of search as it continues to drive a lion's share of digital advertising budgets," McAndrews said.

McAndrews has been sending out annual e-mails to reporters for several years, though this is his first since joining Microsoft.

Microsoft landed another ad-serving deal on Tuesday, announcing it will be the exclusive third-party provider of contextual and paid search ads for the Wall Street Journal online and several other Dow Jones-owned sites.

The move is the latest in a string of deals, following Microsoft's expanded ad-serving deal with Facebook in October. In December, Microsoft announced a deal with Viacom that it valued at $500 million, though it didn't provide specific details on how it came to that figure. Last month, Microsoft signed a deal with another financial information company, Edgar Online.

In addition to WSJ.com, the latest deal also covers Marketwatch.com, Barrons.com, and AllThingsD.com. Contextual ads from Microsoft should start appearing on Dow Jones sites next month.

Unlike the Viacom and Edgar Online deals, which use the Atlas technology acquired as part of Microsoft's $6 billion Aquantive purchase, the Dow Jones deal is using Microsoft's homegrown AdCenter product. Microsoft is replacing two smaller firms that Dow Jones had been using--Pulse360, for contextual ads, and Business.com, for paid search.

Gordon McLeod, president of The Wall Street Journal Digital Network, said in a statement that the deal should boost the company's ad revenue. "Microsoft's state-of-the-art advertising platform will enable us to dramatically improve our revenues from this key sector, and we look forward to working together."

Meanwhile, Microsoft said the move will bring a further 20 million unique visitors to Microsoft's ad network.

"This deal is a significant win for Microsoft for two key reasons," Microsoft senior VP Brian McAndrews said in a statement. "First, it makes the extended Microsoft advertising network the premier destination for advertisers interested in reaching financially minded users, as it complements our offering in this vertical through MSN Money and other syndication partners. Second, this deal is a strong indicator that we're gaining significant traction with our advertising platform."