Microsoft

Although Microsoft may have seen the worst of the economic woes, CFO Christopher Liddell said he expects business to be tough for the remainder of 2009.

"The economy continues to be challenging and we need to lift our game," Liddell said during a conference call with analysts, following the company's reporting of lower-than-expected quarterly revenue.

Liddell said the company doesn't expect to see things pick up significantly in the coming quarters. "Neither, in the short term, do we expect them to worsen," he said.

Microsoft did not give a specific earnings or sales forecast for the current quarter, which runs through the end of September.

"There are some signs that we have at least seen the worst," Liddell said. He said that the company saw several businesses stabilize, when compared to the prior quarter. Liddell noted that it saw unit increases in both Windows and Windows Server for the first time in a year, though revenue has continued to slide, with Netbooks making up 11 percent of PC units.

Search revenue was flat compared to last year, despite the launch of Bing.com during the quarter, Microsoft said. However, the company said it has seen a double digit increase in unique users.

On the PC side, Liddell said there is an opportunity for improvement next year, both from possible higher PC sales in general, and perhaps from business PC growth starting to outpace consumer PC growth. This year, consumer PC spending has been stronger than business, resulting in lower average selling prices for Windows--a trend exacerbated by the growth of Netbooks, for which Microsoft typically gets even less revenue.

As for the server unit, the company could see better sales next year, but he said corporate technology purchases will have to pick up for that to happen.

"Macro conditions are going to continue to trump everything," Liddell said. "IT spending is the key."

Liddell noted that several analysts are predicting that server spending may have reached bottom, but will stay in the same range for the next couple of quarters.

"That's internally consistent with the way we see things as well," he said.

Asked about Google's Chrome OS announcement, Liddell struck largely the same tone that Bill Gates did in his interview with CNET News.

"We've been fighting the free OS...for some time," Liddell said. While people do want to surf the Web, he said most people also want to run applications. "We don't see that significantly changing just because of Chrome OS coming out," Liddell said.

Microsoft on Thursday reported weaker-than-expected quarterly revenue and again declined to offer a forecast for the current quarter.

The software maker reported that for the three months ended June 30, the company earned $3.05 billion, or 34 cents per share, on revenue of $13.1 billion. However, those results included legal and other charges, as well as the deferral of revenue related to a Windows 7 upgrade program. In total, those charges cut into per-share earnings by 4 cents.

Analysts had expected per-share earnings of 36 cents, according to First Call. However the revenue figure was notably weaker than the $14.37 billion that analysts expected, even accounting for the Windows revenue deferral.

"Our business continued to be negatively impacted by weakness in the global PC and server markets," said Chris Liddell, chief financial officer at Microsoft. "In light of that environment, it was an excellent achievement to deliver over $750 million of operational savings compared to the prior year quarter."

Investors were not pleased. In after-hours trading, Microsoft's stock dropped 7 percent, or $1.90, to $23.66.

In a series of PowerPoint slides released along with its report, the company said the enterprise business remained relatively healthy, but hardware sales were weak. PC sales, in particular dropped 5 percent to 7 percent.

On the cost front, it said it reduced expenses by $800 million more than the low-end of its plans. It also recorded $108 million of "impairments" related to a drop in value for some investments.

Although there were some blogs and Twitter posts to the contrary, a Microsoft representative said the company isn't announcing any new job cuts. It did discuss in its earnings report its previously announced program to cut up to 5,000 jobs.

Microsoft didn't give a sales or earnings forecast when it reported its last quarterly numbers in April. It did say it was seeing economic pressures that were both "broad and deep"--the worst in the company's 30-year history.

The results come just as the company wrapped up development of Windows 7, which was officially finalized on Wednesday and is due to go on sale October 22.

Here's a look at the how each business unit did, by the numbers.

After reporting its first-ever quarter in which sales dropped from the year-earlier period, Microsoft had more distressing news for investors.

In an earnings call with financial analysts, Microsoft Chief Financial Officer Chris Liddell warned that things continue to look tough in the global economy, describing the conditions as the worst in the company's 30-year history.

"We remain more cautious than most about the state of the world economy," Liddell said. "Economic pressures are broad and deep."

His comments are in contrast to statements by executives at EMC and Intel, who held out hope that the worst could be behind them.

Liddell noted that emerging markets, which had been outpacing mature markets for many quarters, actually did worse in the quarter just ended, with demand down as much as 20 percent.

On the PC side, Microsoft noted that the overall single-digit decline in unit shipments was thanks only to Netbooks, which now make up 10 percent of total PC sales. Sales of traditional non-Netbook computers were down 15 percent to 17 percent, compared with a year ago, Liddell said.

One area of strength for Microsoft was the fact that the company's business customers continued to renew long-term licensing deals.

Although Microsoft was hiring even as it laid off workers, the software maker ended the quarter with 800 fewer employees than it had when it started the quarter.

Liddell didn't give a specific forecast for the current quarter.

"We expect the overall spending environment to remain difficult," he said. The company did say it is cutting its expectations for its operating expenses, now saying it may cut up to $2.5 billion from its initial cost forecast, reflecting a further $1 billion in expense reductions. It also is cutting $200 million from its January estimates for capital expenses.

Liddell was also cautious when looking further out. He said that the company expects macroeconomic conditions to remain "challenging" through the rest of the calendar year. For "calendar year 2010, there is some potential for market conditions to improve, but it is clearly too soon to call," Liddell said.

As analysts predicted it might, Microsoft on Thursday reported the company's first ever year-over-year sales decline for the quarter ended March 31.

The software maker said fiscal third-quarter sales totaled $13.65 billion, down 6 percent compared with $14.45 billion in the same quarter a year ago. Its per-share earnings were 33 cents per share, although that included severance and investment impairment charges that reduced earnings by 6 cents per share.

Analysts had been projecting sales of $14.15 billion and per-share earnings of 39 cents, down from 47 cents a year ago, according to Reuters Estimates.

Microsoft had said in January that the crystal ball for the company was cloudy and at the time announced its first companywide layoffs, with plans to chop 5,000 jobs over an 18-month period.

"While market conditions remained weak during the quarter, I was pleased with the organization's ability to offset revenue pressures with the swift implementation of cost-savings initiatives," Microsoft Chief Financial Officer Chris Liddell said in a statement.

The company noted that software sales to large businesses were stable during the quarter, but that weakness in server and PC sales hit its Windows, server and Office units.

Whereas Intel and EMC have been somewhat optimistic that things may have reached bottom last quarter, Microsoft's comments were less hopeful.

"We expect the weakness to continue through at least the next quarter," Liddell said.

The company didn't have much to say on several closely watched topics. The company did not give a specific sales or earnings outlook for the coming quarter, instead only noting what it expects as far as its operating expenses.

As for Windows 7, Microsoft just noted that it "remains on track for a fiscal year 2010 launch." That's even less specific than its usual comment, which is that it should ship within three years from general availability of Windows Vista, meaning by January. The software maker has been pushing to have Windows 7 out in time to be on PCs by this year's holiday season, with recent indications that the company is still aiming for that goal.

Shares closed Thursday at $18.92, up 14 cents. In after-hours trading, investors sent Microsoft shares higher. The stock was trading recently at $19.85, up 93 cents, or nearly 5 percent.

The PowerPoint slides that Microsoft put out to accompany its earnings report offered a few more nuggets. The company saw its online advertising revenue decline 16 percent, causing that unit to fall below what analysts were expecting.

PC unit sales were down 7 percent to 9 percent during the quarter, but the industry's revenue dropped more than that as Netbooks continued to make up a larger slice of sales--a trend that hurts both the PC makers and Microsoft. Microsoft sold 1.7 million Xbox 360s during the quarter, up 30 percent from a year ago and helping push that unit back into the red.

Here's a look at how each of Microsoft's individual units did during the quarter, in terms of both revenue and operating income.

How bad is the tech slump?

Even sales at Microsoft appear to be headed downward. If projections hold, Microsoft on Thursday will report a year-over-year drop in quarterly revenue, a first for the software maker.

The company has come close to flat-lining before, most notably in mid-2000 as the dot-com boom came to an end. Even then, though, it managed to post a slight increase in revenue.

Microsoft is forecast to report quarterly revenue of $14.15 billion for its fiscal third quarter, according to Reuters Estimates, down from $14.45 billion in the same quarter a year earlier. Per-share earnings are pegged to come in at 39 cents, down from 47 cents a year ago.

In addition to paying attention to Microsoft's overall numbers, folks will be closely watching what Microsoft has to say about the PC market. While Intel surprised some last week by suggesting the PC market had hit bottom, AMD's chief executive said Tuesday that such a prediction is premature.

"I don't know how anybody can say we've hit bottom, considering the macroeconomic outlook," CEO Dirk Meyer said during the AMD earnings conference call Tuesday afternoon.

Even when the economy does bottom out, Microsoft has said it is not expecting sales will quickly return to where they were in recent years. CEO Steve Ballmer has repeatedly characterized the current woes as a "reset" of the economy, rather than a temporary dip. When things do pick up, Microsoft said in January, expect slow growth.

There will be other items to watch for during Microsoft's earnings report.

Some think Microsoft might also finally bite the bullet and admit that it is trying to get Windows 7 out this year, as opposed to just by January. The software maker has had a largely positive response to the beta version and is expected to come out with a near-final "release candidate" version in the coming weeks.

In general, new operating systems aren't necessarily the biggest driver of new PC sales, but computer makers are holding out some hope that an early release of Windows 7, combined with continued good reviews, could help the holiday season perhaps be somewhat better than it might otherwise have been. For Microsoft, the release of Windows 7 offers the opportunity to move past Windows Vista, a product that has had a decidedly mixed reputation in the marketplace.

The earnings call will also provide an opportunity to hear not just what Microsoft says about its quarterly results, but also a chance to learn if it is seeing any signs of weakness among customers renewing long-term corporate licensing deals.

Also of note will be what, if anything, Microsoft says about discussions with Yahoo on a search deal. The two sides have reportedly been having some face-to-face talks in recent days and weeks. However, the two sides have done plenty of talking without reaching an accord.

On Yahoo's earnings conference call on Tuesday, CEO Carol Bartz also pointed to search as an important core area for Yahoo, but she wouldn't rule out the possibility of relying on another company's search technology plugged into Yahoo's infrastructure. Microsoft, meanwhile, has been testing the next version of its search product, code-named Kumo.

Further job cuts are also a possibility. One analyst said this week that he anticipates Microsoft will go beyond its previously announced cuts. However, I'd note that Microsoft's January plans called for up to 5,000 jobs to be cut over an 18-month period and it made only about a third of those cuts right away.

Although Microsoft is cutting jobs, the software maker apparently isn't axing any major products as part of its cost-cutting moves.

On a conference call with analysts Thursday, though, CEO Steve Ballmer defended the company's decision to stick by all of its businesses, even as it looks to cut up to 5,000 jobs.

"I like our portfolio," Ballmer said on the conference call. "The board likes our portfolio," he said, before moving on to the next question.

But should they be so pleased?

Microsoft itself acknowledged on the call that it does not have the leading position in several of its emerging businesses. The company makes the bulk of its money from Windows and Office. It also has a server software business that is profitable and fast-growing.

However, the software maker has struggled to attain profitability in its entertainment unit, its cell phone software unit remains small, and its online efforts continue to lose significant money.

Thus far, Microsoft has announced plans to cut only one product, its Windows Live OneCare security service. Even that one will be replaced by a new, free product code-named Morro.

The company apparently isn't cutting any entire products as part of the new cost cuts either, though it did say it would try to better prioritize its investments.

Microsoft's decision not to pare its efforts more significantly--and cut more jobs--clearly disappointed some analysts who were anticipating the software maker to make deeper cuts.

However, Directions on Microsoft analyst Matt Rosoff said he wasn't at all surprised that Microsoft didn't take an ax to more products. The longtime Microsoft watcher said that, as long as Ballmer is CEO, Microsoft is unlikely to pull back from any of its investments in areas such as search, mobile phones, or entertainment.

"That's their modus operandi and it looks like they are going to keep expanding," Rosoff said.

Technology Business Research analyst Allan Krans said that it's just not in Microsoft's nature to give up on a big bet.

Up to this point, Microosft experienced large success in nearly all of its endeavors, Krans said in an e-mail interview. That has provided Microsoft with both the cash it has needed for new businesses, as well as incentive to keep trying.

"Search and Zune are two examples of Microsoft going against extremely well-entrenched leaders in Google and Apple, failing to make any significant headway, and still refusing to give up," Krans said. "IBM is on the opposite end of the spectrum, deciding to exit both the PC and printing business once it became clear that HP would be the market leader. "

Ballmer who often cites the server unit as an example of what can come from such investment, though that effort was closer to Microsoft's core business than some of its more recent pushes.

One of the biggest bets that shows no sign of slowing down is Microsoft's online effort, particularly in search.

"They look at that as a huge opportunity that they missed and they don't want to leave it to one company--Google," Rosoff said.

Rosoff said that even accepting that premise, he sees some areas to cut. One example he cited was all of the Web content Microsoft creates for MSN.

"I think some of their MSN assets, though profitable today, are not a good fit, long term," Rosoff said. "To have a network of content sites just doesn't seem like a core Microsoft businesses today."

Krans said he doesn't expect any big product changes, even online where Microsoft loses money.

"Losses represent less than 10 percent of operating profit for 2008, which Microsoft sees as the price of admission to what could become a substantial market," he said.

As for the scale of the job cuts, it was less than some analysts had been projecting and far less than those seen at other big-name firms. The Seattle Times' Brier Dudley summed it up well.

"Today's cuts aren't a radical transformation of Microsoft," he wrote. "It's a little inpatient liposuction, so the company will fit into the smaller pants it has to wear for a while."

Note: Rosoff is a contributor to the CNET blog network.

After posting disappointing earnings and disclosing plans to lay off 5,000 workers, Microsoft held a call with financial analysts. Here's our minute-by-minute coverage of the call, in reverse chronological order.

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8:56 a.m. PST: Call has ended.

8:55 a.m. PST: Ballmer on Yahoo: "I don't think we have anything to say about Yahoo." He said the company has been quite public that it remains interested in a search deal. On Yahoo's new CEO: "I know Carol Bartz...(I'm) glad to see her at the helm of Yahoo." Ballmer said he's happy to have discussions when it is appropriate.

8:53 a.m. PST: Microsoft is seeing some limits to volatility in its revenue because of its long-term contracts with businesses, which account for 30 percent to 40 percent of sales. However, Ballmer noted that if companies have fewer employees, even as they renew contracts, the value of new deals may be lower, eventually hurting annuity revenue.

8:46 a.m. PST: Liddell notes that over the medium term, he expects better opportunities to buy small and midsize companies, but he said merger activity may actually be slower over the next quarter or so as companies haven't fully adjusted to their lower valuations.

8:44 a.m. PST: Ballmer said he is not planning on a quick rebound when the economy does improve, with the cuts made based on that. He said he is assuming that the economy will eventually build slowly on a new, lower base. "I'm not expecting a bounce."

8:38 a.m. PST: Microsoft makes its highest margins and gets the most per-unit revenue on business PCs, then traditional home PCs, then Netbooks, then emerging markets (where piracy rates are high and prices are lower). Demand, though, is the reverse, with emerging markets being the strongest, followed by Netbooks, with traditional consumer PCs and business computers both weak.

8:36 a.m. PST: The company plans to spend less on share buybacks.

8:33 a.m. PST: Microsoft is reducing contractors at a greater percentage level than full-time staff, Liddell said. Contractor spending could be cut by "up to 15 percent."

8:31 a.m. PST: On to questions and answers. The first questioner notes that Microsoft's margins have declined in recent years and wonders if Microsoft has cut expenses quick enough. CFO Chris Liddell noted that the company cut $600 million in expenses during the course of last quarter and now has plans to take out $1.5 billion worth.

8:30 a.m. PST: "We've certainly got our work cut out for us," Ballmer said, noting that several of Microsoft's businesses don't have leading positions. "We are prioritizing, we are focusing on the most important stuff."

8:28 a.m. PST: Office 14 "will be out in the next year or so," Ballmer said.

8:25 a.m. PST: Ballmer: "We're certainly in the midst of a once-in-a-lifetime" economic condition. "Consumers cannot refinance their homes, (and they) don't have discretionary money to buy second and third PC. (On the business side), we certainly see a reduction in capital expenditures. Neither the consumer nor the business side of the technology industry is immune to these economic conditions."

Ballmer said he is still bullish long-term on technology but that now is certainly the time to look at the company's investments to see which should be prioritized. Microsoft will thus cut jobs but will also add jobs in key areas, such as search.

"We'll take out (and) put back in, but in aggregate, (we'll) take out expenses," Ballmer said.

8:22 a.m. PST: The Xbox unit, though strong for the last six months, could also weaken as consumer spending slows, Liddell said. "The economy has clearly deteriorated more than we expected."

8:20 a.m. PST: In online advertising, Liddell said the company expects "monetization rates across the industry to continue to weaken."

8:18 a.m. PST: Liddell: No overall guidance. The PC market is "likely to remain weak," with Netbooks continuing to grow as traditional PCs decline.

8:16 a.m. PST: Operating expenses were 6.8 billion, $600 million less than expected, as the company scaled back on marketing, contractors, and hiring.

8:15 a.m. PST: As for the 7 percent growth in online advertising, here's how it broke down. Search revenue grew in double digits, but display ad growth was lower, amid a weaker ad market.

8:12 a.m. PST: Earnings for Microsoft's server and tools unit was up 15 percent for the quarter, despite a declining server hardware market.

8:10 a.m. PST: Sales of traditional PCs was down roughly 10 percent during the quarter, partly offset by Netbook growth. Sales of Microsoft's premium operating systems declined by double digits as a result of the Netbook trend.

8:06 a.m. PST: Online advertising was up 7 percent in a tough environment.

8:05 a.m. PST: "Our second-quarter results reflect the difficult environment," Liddell said. December was particularly weak.

8:04 a.m. PST: Chief Financial Officer Chris Liddell will kick things off, then Ballmer will add his comments.

8:00 a.m. PST: Hold music is playing. We just got the 2-minute warning.

7:53 a.m. PST: Ahead of the call, Microsoft shares are trading at $17.72, down $1.66, or about 8.6 percent.

From: Steve Ballmer
Sent: Thursday, January 22, 2009 6:07 AM
Subject: Realigning Resources and Reducing Costs

In response to the realities of a deteriorating economy, we're taking important steps to realign Microsoft's business. I want to tell you about what we're doing and why.

Today we announced second quarter revenue of $16.6 billion. This number is an increase of just 2 percent compared with the second quarter of last year and it is approximately $900 million below our earlier expectations.

The fact that we are growing at all during the worst recession in two generations reflects our strong business fundamentals and is a testament to your hard work. Our products provide great value to our customers. Our financial position is solid. We have made long-term investments that continue to pay off.

But it is also clear that we are not immune to the effects of the economy. Consumers and businesses have reined in spending, which is affecting PC shipments and IT expenditures.

Our response to this environment must combine a commitment to long-term investments in innovation with prompt action to reduce our costs.

During the second quarter we started down the right path. As the economy deteriorated, we acted quickly. As a result, we reduced operating expenses during the quarter by $600 million. I appreciate the agility you have shown in enabling us to achieve this result.

Now we need to do more. We must make adjustments to ensure that our investments are tightly aligned with current and future revenue opportunities. The current environment requires that we continue to increase our efficiency.

As part of the process of adjustments, we will eliminate up to 5,000 positions in R&D, marketing, sales, finance, LCA, HR, and IT over the next 18 months, of which 1,400 will occur today. We'll also open new positions to support key investment areas during this same period of time. Our net headcount in these functions will decline by 2,000 to 3,000 over the next 18 months. In addition, our workforce in support, consulting, operations, billing, manufacturing, and data center operations will continue to change in direct response to customer needs.

Our leaders all have specific goals to manage costs prudently and thoughtfully. They have the flexibility to adjust the size of their teams so they are appropriately matched to revenue potential, to add headcount where they need to increase investments in order to ensure future success, and to drive efficiency.

To increase efficiency, we're taking a series of aggressive steps. We'll cut travel expenditures 20 percent and make significant reductions in spending on vendors and contingent staff. We've scaled back Puget Sound campus expansion and reduced marketing budgets. We'll also reduce costs by eliminating merit increases for FY10 that would have taken effect in September of this calendar year.

Each of these steps will be difficult. Our priority remains doing right by our customers and our employees. For employees who are directly affected, I know this will be a difficult time for you and I want to assure you that we will provide help and support during this transition. We have established an outplacement center in the Puget Sound region and we'll provide outplacement services in many other locations to help you find new jobs. Some of you may find jobs internally. For those who don't, we will also offer severance pay and other benefits.

The decision to eliminate jobs is a very difficult one. Our people are the foundation of everything we have achieved and we place the highest value on the commitment and hard work that you have dedicated to building this company. But we believe these job eliminations are crucial to our ability to adjust the company's cost structure so that we have the resources to drive future profitable growth. I encourage you to attend tomorrow's Town Hall at 9am PST in Cafe 34 or watch the Webcast.

While this is the most challenging economic climate we have ever faced, I want to reiterate my confidence in the strength of our competitive position and soundness of our approach.

With these changes in place, I feel confident that we will have the resources we need to continue to invest in long-term computing trends that offer the greatest opportunity to deliver value to our customers and shareholders, benefit to society, and growth for Microsoft.

With our approach to investing for the long term and managing our expenses, I know Microsoft will emerge an even stronger industry leader than it is today.

Thank you for your continued commitment and hard work.

Steve

With the PC market tanking along with the rest of the economy, Microsoft is seen as unlikely to be able to live up to the financial forecast it issued in October.

The company is set to release its quarterly earnings after the markets close on Thursday.

In a further sign of just how rough the economy is, Microsoft is also expected to announce shortly its plans for a significant, companywide layoffs. Although Microsoft has cut jobs in a particular unit or location in the past, it has managed to navigate through all past downturns without having to resort to such broad job cuts.

But as CEO Steve Ballmer told CNET News earlier this month, this is no ordinary downturn.

"The fact of the matter is, this is not a downturn, this is a bit of a reset," he said in an interview at the Consumer Electronics Show in Las Vegas. "Those are quite different and we're trying to really suss through what we think that means for us."

There has been much speculation over just what that "sussing" will result in, with expectations ranging from no full-time job cuts to one report that suggested the software maker could trim as many as 17,000 workers from its 95,000-strong payroll. More recently, analysts and others have suggested Microsoft might cut several thousand workers, but stop short of layoffs that would add up to double digits.

Fears were heightened this week as Microsoft workers found themselves unable to access an online tool, known as Headtrax, that provides a company organizational chart. An error message said that the tool was unavailable but scheduled to be operational by Friday.

As for the financial results themselves, Microsoft had projected in October that it would manage per-share earnings of 51 cents to 53 cents per share, with revenue in the range of $17.3 billion to $17.8 billion.

Analysts are now forecasting results more along the lines of $17.1 billion, with per-share earnings of 49 cents, according to Thomson Reuters.

For the current quarter, which stretches through March, analysts are projecting earnings of 48 cents per share, although estimates vary from 42 cents to 52 cents, again according to Thomson Reuters. Revenue for the period is pegged at $15.1 billion.