Microsoft News Tracker

As always, it’s not nice to fool Wall Street and Microsoft shares are getting pummeled this morning as a result. It wasn’t so much that 3Q earnings were bad, as that they were at the lower end of what Wall Street expected. And it wasn’t so much the 3Q earnings, as it was the guidance for FY 2007. Jay Greene at BusinessWeek Online elucidates in Microsoft’s strange spending splurge:

Just when Microsoft investors were getting used to the company’s combination of slowing growth and expanding margins, they got a jolt on Apr. 27. The software giant released quarterly results that were largely in line with expectations. But projections for the fiscal year, which begins July 1, were another story.

Microsoft, under Chief Executive Steve Ballmer, will spend about $2 billion more in fiscal 2007 than Wall Street was expecting. “We decided to aggressively invest in a number of areas, and they do add up,” Microsoft Chief Financial Officer Chris Liddell said on a conference call.

Among those areas: speeding up production of the Xbox 360 game console, pumping money into the company’s fledgling Windows Live service that delivers software applications over the Web, and increasing the pace of acquisitions.
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The sticking point, though, is that those types of investments were already factored into analysts’ models. Many were left scratching their heads, wondering how Microsoft’s new investments could add up to so much more than they calculated. “It sounds like you’re building a Google or a Yahoo inside the company,” Goldman Sachs & Co. analyst Rick Sherlund told Liddell on the call, referring to Web services, one of the areas targeted for added spending.

Liddell says the company isn’t hiding anything. “I don’t think there’s a Trojan Horse there that we don’t want to talk about, sitting below the surface,” he replied.
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Analysts were disappointed by the lack of information. “Where is the money going? There wasn’t an answer,” says Charles DiBona, a Sanford C. Bernstein & Co. analyst. “It’s going into a black hole as far as anyone knows.”

It’s an interesting puzzle for the analysts, I’m sure, but models (both Microsoft’s and the analysts’) can be wrong and we’ve touched previously on the fact that in the ad-supported online services game it takes big money (in the form of people, hardware, and bricks and mortar) to make big money, so some large expenditures are going to have to be on Microsoft’s menu if they want to play.

As for the Xbox 360, it certainly is a glaring hole in Microsoft’s wallet. In 3Q, Home and Entertainment (mostly Xbox 360) had 39% of the revenue of Server and Tools, but swallowed up 49% of the S&T profits. Although it is undoubtedly too soon, one wonders exactly when the shareholders are going to get impatient for the Xbox 360 to turn the corner. To soothe potential grumblers, Microsoft’s John Porcaro reports that Business is fine, thanks for asking:

• This quarter, we shipped 1.7 million Xbox 360 consoles, bringing our cumulative sales to date to 3.2 million consoles with 1.8 million in North America, 1.1 million in Europe and 300,000 in the rest of the world.
• According to NPD, our life-to-date attach for software and peripherals in the U.S. through March was 4.5 and 3.0 per console respectively – higher than any other gaming console at this point in the lifecycle.
• Despite a relatively small installed base, three of the top 10 selling video games in the US in March were for the Xbox 360 platform.
• Attach rates on the Xbox Live service remain strong, with more than half of all Xbox 360 consoles sold connected to the service either via Silver or Gold tier memberships.
• Because of our increased optimism and strong console shipments in Q3, we are tightening our previously announced fiscal year shipment guidance of 4.5 to 5.5 million consoles to 5.0 to 5.5 million consoles.

There’s more on the list – I just grabbed the biggies. However, while there is a whiff of largesse in the offing, the proof will be when cash starts flowing in, not out. Everyone knows the “razor and blades” analogy, but they want to be sure the customers haven’t decided to grow beards.

Finally, since the demand for cash is high, I expect there will be renewed interest in milking more cash out of the Office (aka Information Worker) and Client segments. I discussed last week how there appears to be a concerted effort to expand income from Vista by reducing piracy and raising the price per PC sold, and we just saw a new piracy reduction initiative for Office. Perhaps there will be a concerted effort to upsell Office 2007 too.

In the end, the ultimate source of Wall Street’s discomfort seems to be Microsoft acting like a growth stock. From Jay Greene’s article referenced above:

What’s behind the angst? At least part of the reason is that investors had decided to view Microsoft as a value play rather than a growth stock. So they were willing to accept slowing growth in exchange for fattening margins and rising shares. But the investment binge will curtail margin expansion at least into mid-2007.

It’s interesting to see Microsoft again making some big bets, but are they still capable of cashing them in?

Update: More analyst quotes here and here.

Update 2: A couple of commentaries: Microsoft Lost in Space and Dinosaurs like Microsoft don’t run with bulls. Ouch! On a more positive note, see Is Microsoft Preparing a Big Attack?

The headline is Microsoft 3Q Income Misses Wall Street Expectations; Software Company Offers Tepid 4Q Forecast, but as usual, the most interesting part of a Microsoft earnings statement for me is the breakout of the results by business segment. The quarterly segment numbers are reproduced below and here are some observations augmented by the 10-Q explanations:

Cash cows:

Client income from all the variants of Windows XP was up only 5.9% although revenue was up 8.5% which, while better than last quarter when it was up only 4% on a similar revenue gain, isn’t what you want to see in a software product, particularly when the underlying PC sales are estimated to have increased by 12-13%. There was "10% growth in OEM revenue driven by 16% growth in OEM license units from increased PC unit shipments, partially offset by a $31 million or 6% decrease in revenue from commercial and retail licensing of Windows operating systems" as even more customers moved to acquiring licenses with new hardware.  How does a 16% unit growth only result in a 10% revenue gain? It’s the product mix trending toward cheaper versions including Media Center editions cutting into XP Professional sales. Income was also down due to Vista related expenses.

Office (aka Information Worker) was basically flat as usual and actually down in income due to increased expenses, some due to Office 2007.

Server and Tools retains its position as up and coming heifer of the herd with a %16.4 income gain exceeding %14.4 revenue growth driven by Windows Server and SQL Server.

The Calves:

All of the smaller segments were in the red this quarter which has to be bad news for Microsoft Business Solutions, MSN, and Mobile and Embedded since they all were in the black last quarter and for the latter two since they were in the black for the same quarter last year.  Explanations: MBS did lose less than last year and had sales expenses; MSN continues to lose ISP subscribers and has increased expenses related to the development and rollout of adCenter and Windows Live; and Mobile had increased revenue but increased costs due to development and marketing.

Finally, as expected, the Xbox 360 provided Home and Entertainment a big jolt in revenue and a big loss. As usual, there is a prediction of "a positive margin over the Xbox 360 console lifecycle."

Odd notes:

You may wonder how you get a %16.8 increase in quarterly income when none of the segments were that high. It’s in the "reconciling amounts" which include a variety of corporate level items. Legal settlements and stock-based compensation expenses were reduced from the year ago quarter by nearly $700M. Also, if you look at the 10-Q’s separate explanations of segment results, the numbers there have some of the reconciling amounts folded in. I have stuck with the ones in the 10-Q overall segment rollup.

After the recent reorganization, the seven segments no longer correspond to Microsoft’s structure and I expect change is coming: "We previously announced a plan to reorganize the company into three operating divisions – Microsoft Platform Products and Services Division, Microsoft Business Division, and Microsoft Entertainment and Devices Division. We expect to complete any changes in internal financial management and reporting as a result of the reorganization by the beginning of fiscal year 2007. The impact on reporting segments, if any, will be reflected at the time. In the interim, we continue to organize, manage, and report the business through the seven segments." It’ll be too bad if the numbers get rolled up to that level and much more opaque. 

Aside from the AssetMetrix acquisition, there was a variety of other news from the Microsoft Management Summit 2006. At one point Microsoft had planned to build a product called System Center that combined its management software icons, System Management Server (SMS) and Microsoft Operations Manager (MOM) but has given that up in the face of customer resistance and “now plans to use System Center as a brand, covering a half dozen different products.”

Here’s the rundown:

The new System Center offerings released and announced over the past year are:

• System Center Data Protection Manager 2006

• System Center Capacity Planner 2006

• System Center Reporting Manager 2006
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MOM V3 will become Microsoft System Center Operations Manager 2007, while SMS V4 will become Microsoft System Center Configuration Manager 2007.

and there’s a new service desk product planned:

We also announced our investment in a new product for the service-desk market, to be delivered toward the end of 2007. This is a very significant announcement as with this product, codenamed Service Desk, we are providing two key components that will form the foundation for the entire System Center family: 1) A workflow engine that will provide the basis for how we automate IT processes, and 2) the implementation of the SDM-based Configuration Management Database (CMDB), which will be the foundation of our asset and change management capability.

Underlying all this is a new administrative scripting language called Windows PowerShell:

We announced the delivery schedule for Windows PowerShell, formerly known as MONAD. Windows PowerShell is a powerful administrative command shell and scripting environment. It will be available as a no-charge Web download in the second half of this year. Also, we announced that the next version of Microsoft Exchange, which will be the first Microsoft application to deliver new automation capability based on PowerShell, will officially be named Microsoft Exchange Server 2007. In addition, System Center Operations Manager 2007 is building a solution based on PowerShell. The Exchange Management Shell in Exchange Server 2007 is based on PowerShell and will save IT administrators valuable hours by allowing routine and repetitive tasks to be automated through a scriptable command line shell.

In addition, Exchange Server 2007, which is due end of 2006 or early 2007, will include the Exchange Management Console – a graphical console also built entirely on top of MMC 3.0 and PowerShell that will increase administrative productivity through simplified navigation and new filtering capabilities for managing the messaging environment.

The above is apparently the first announcement of the formal name for the next version of Exchange, heretofore called Exchange 12. You can download RC1 of PowerShell via the links at this post on the Monad Technology Blog.

As we mentioned on Monday, the buzz is building in preparation for E3, a major gaming conference coming up on May 10 where among other juicy news, Sony is expected to reveal more PS3 details:

Sparking one last round of rumors and excitement among gamers before a big convention in Los Angeles, an independent PlayStation magazine said it had the final word Wednesday on pricing for Sony’s PS3 console.

The machine will cost $399, contain a 60 gigabyte hard drive and will go on sale in the first half of November, according to PSM. The PS3 was originally scheduled for release in Spring 2006.

A Sony spokeswoman said earlier this month that no further details on pricing or launch would become available until May 8 at a press event ahead of the E3 game industry trade show.

That’s rather less than indicated by earlier comments from a Sony executive. Whatever the price though, Sony has high hopes for the PS3:

Sony expects its upcoming PlayStation 3 console to be out of the starting gate more quickly than Microsoft’s Xbox 360, it said today.

The company, which recently pushed back the launch of its console to November, said it expects sales during the first four to five months after launch to be about 6 million units.

Microsoft, which launched the Xbox 360 in November last year, expects sales to hit between 4.5 million units and 5.5 million during about the first seven months.

Frankly, that doesn’t seem like a whole lot quicker uptake considering that the PS2 dominates today’s game console market.