Microsoft News Tracker

Microsoft beat Wall Street expectations today when it announced its fiscal 3Q07 results:

Microsoft Corp. today announced revenue of $14.40 billion for the quarter ended March 31, 2007, a 32% increase over the same period of the prior year. This revenue drove record profits with operating income of $6.59 billion and net income of $4.93 billion. Diluted earnings per share for the quarter grew 72% to $0.50, and included $0.02 in tax benefits and $0.01 in legal charges.

These results reflect $1.67 billion of revenue and operating income, $1.14 billion of net income and $0.12 of diluted earnings per share that were previously deferred primarily related to the technology guarantee programs for Windows Vista™ and the 2007 Microsoft® Office release.

The good news was clearly driven by Vista and Office, but Microsoft oddly provided none of the usual commentary in the 10-Q report so it is hard to really get insight into the numbers. In any case, below are the segment breakouts with some brief commentary. Last quarter I indicated the effect of adding back in the deferred Vista and Office revenue mentioned above – correspondingly, I mention below the results for 3Q with the deferred revenue subtracted.

Client:

Subtract the $1.1 billion of Client revenue that was deferred last quarter and you still get a 33% increase which is substantially above estimates of PC unit sales growth, so it looks like the Vista upsell is producing results. Microsoft gave no indication of units sold however, so it is hard to tell for sure. Also note that unlike XP, Microsoft is not deferring any Vista revenue and income to later years.

Business (mostly Office):

Subtract the $0.5 billion of Office revenue that was deferred and you get a 20% increase which is substantially better than past quarters. Once again, without an indication of units sold it’s hard to determine exactly what is going on.

Entertainment and Devices (mostly Xbox and an occasional Zune):

It looks like the competition cut into Xbox 360 sales which while bad news for revenue, is good for income in this perennially losing business.

Online Services:

As always lately, Online is in the tank with no sign of a life preserver.

Server and Tools:

Server and Tools may be slowing its torrid pace a bit, but there are some big products coming out in the next year.

Bottom Line:

Microsoft reported that there was $1.1 billion in net income deferred last quarter for Vista and Office 2007, but gave no break out. Subtracting that out would give Client and Business in aggregate 35% income growth which is certainly healthy, but again hard to gauge without unit sales numbers.

If it seems that I am harping on that aspect, the reason is that the 3rd quarter performance could be due to either or both of a temporary bulge in Vista and Office sales in their otherwise mature markets or an increase in per unit revenue and income. The amount attributable to each would indicate how sustainable this performance really is. The Microsoft management outlook for 2008 (first link above) is considerably milder (11-12% over 2007) than these results, so my belief is that the 3Q07 performance was mostly a one time shipment bulge.

Update: Some of the segment discussion that used to be in the 10-Q appeared in the slide deck for the earnings conference call. It was a shipment bulge and while Client “premium share” grew to 71% from 53%, that was claimed to have added only a percentage point to OEM revenue.

Press release:

Microsoft Corp. today unveiled the first publicly available test version of the next edition of Windows Server, code-named “Longhorn.” The release allows people to evaluate the increased control, flexibility and protection built into Microsoft Windows Server “Longhorn” Beta 3, available for download today at http://www.microsoft.com/getbeta3. The final version of Windows Server “Longhorn” is on track for release to manufacturing in the second half of 2007.
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The newest version of Microsoft’s Web server, Internet Information Services (IIS) 7.0, also provides a more secure, extensible platform for efficiently managing and reliably hosting Web applications and services. Microsoft is today announcing the availability of the IIS7 Go Live license, which will allow customers to host Web applications and .NET 3.0 Web services on Windows Server “Longhorn” Beta 3 in live production environments.
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The Beta 3 release of Windows Server “Longhorn” marks the beginning of the second wave of innovation to be delivered by Microsoft over the next year. Following on the heels of the successful launch of Windows Vista™ and the 2007 Office system are Windows Server “Longhorn” and the next versions of Visual Studio®, code-named “Orcas,” and Microsoft SQL Server™, code-named “Katmai.” These products will provide organizations with an advanced development and Web platform as well as streamlined data management and analysis, enabling infrastructure optimization.

There’s more on new features in Beta 3 by following the link, but I didn’t spot any surprises although there have certainly been enhancements. David Lowe at the Windows Server Division weblog has more details on how Beta 3 will be widely distributed plus some new information resources including the Windows Server Code Name “Longhorn” Technical Library, a Reviewer’s Guide, and some free e-learning clinics.

From this week’s SAPPHIRE conference comes the latest on Microsoft’s Duet partnership with SAP:

April 24, 2007 — SAP AG (NYSE: SAP) and Microsoft Corp. (NYSE: MSFT) today announced that they have deepened their relationship and extended their product road map for Duet™ software for Microsoft® Office and SAP, a solution that allows information workers to interact with select SAP business processes and data through Microsoft Office applications. The companies will jointly enhance Duet with additional business scenarios, platform capabilities and development tools. The upcoming version, Duet 2.0, is planned for the end of 2008 and Duet 3.0 is planned to be released soon after the next generation of SAP® Business Suite applications and Microsoft Office software, including Microsoft Office SharePoint® Server. This announcement from SAP and Microsoft underscores the companies’ continued investment in shaping the future of Duet to ensure that it benefits their joint customers.
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Following are some new features customers can expect in Duet 2.0 and Duet 3.0:

• Enhanced and new business scenario support for sales and supply chain management, and other business scenarios — extended capabilities will allow sales professionals to manage sales leads and opportunities within SAP® Customer Relationship Management (SAP CRM) from Microsoft Office. Additionally, supply chain managers will have new capabilities for purchasing and legal contract management. There will also be support for selected governance, risk and compliance scenarios.

• Expansion of Duet to support unstructured processes, information and team collaboration through embracing Microsoft Office SharePoint Server, Microsoft’s business productivity platform. The combination of SAP Business Suite and Microsoft Office SharePoint Server streamline the way people do business by truly connecting people, process and information.

• Enhanced Duet tools and infrastructure interwoven with Microsoft Office SharePoint Server, so customers and partners can customize existing scenarios and create new ones. New scenario templates and development tools allow organizations to adapt existing Duet scenarios and build new scenarios that meet their evolving business needs.

For more information on Duet, visit http://www.Duet.com.

Duet still rates as one of the sparse crop of “corporate alliances” that actually produced substantial product, but there are some sour notes in the harmony since Microsoft persists in competing with SAP’s core business with their Dynamics line which has its own Office connector. For now at least, the companies are papering over the cracks:

The Duet partnership had appeared somewhat strained last month when Microsoft unveiled plans to come out with Dynamics Client for Office and SharePoint, a new product to more tightly integrate its own rival Dynamics business applications with Office and its SharePoint Web portal. Microsoft, which has tended to focus more on small to midsize users, also promised to compete more aggressively in the enterprise applications space against both market leader SAP and number-two player Oracle Corp.

Microsoft executives positioned the Dynamics Client, due out in May, as “a superset” to what Microsoft and SAP currently offer with Duet. For instance, unlike Duet 1.0, the Dynamics Client will provide Microsoft’s customers and partners with access rights to information and processes managed by Dynamics so they can customize and build their own Office business applications.
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During Tuesday’s press conference, SAP and Microsoft executives were keen to stress their ongoing commitment to Duet and limit their likely competitive clashes. The two vendors remain “good friends,” according to SAP CEO Henning Kagermann. “Every so often we’ll meet in the market and will act as fair competitors,” Apotheker added.

It will be interesting to see how well that works out.

When the first reports surfaced last week that a number of big name IT companies (including Microsoft) had participated in widespread kickbacks on US government contracts, it wasn’t clear to me exactly how Microsoft was allegedly involved. Today, the details are a little clearer in Lorraine Woellert’s report at Business Week. First the big picture:

With some big players already named in lawsuits alleging a widespread kickback scheme, the information technology industry will see further scrutiny as federal prosecutors pursue additional charges in coming weeks. Last week, the Justice Dept. filed civil charges against Hewlett-Packard (HPQ), Sun Microsystems (SUNW), Accenture (ACN), and Accenture subsidiary Proquire as part of a two-year investigation involving potentially billions of dollars in government procurement projects.

The Justice Dept. unsealed complaints Apr. 19 in U.S. District Court for the Eastern District of Arkansas in Little Rock, charging the four companies with fraud and conspiracy in their attempts to win lucrative government contracts. Prosecutors also made public six whistleblower lawsuits that had been filed under seal in September, 2004, by former Accenture employee Norman Rille and Neal Roberts, a onetime partner with Deloitte & Touche who has investigated alliances between technology vendors.

The lawsuits accuse at least a dozen technology vendors of operating rebate and commission programs, referral systems, and strategic alliances that they kept secret from the government agencies that bought their systems or followed their advice. The practice has been going on in some cases for a decade, the lawsuits claim. The Justice Dept. is seeking treble damages plus civil penalties.

There are more details in the article, but the problem is with the payment of referral fees which aren’t uncommon or illegal in many business situations, but have to be disclosed on government contracts. The way the fees were so visibly institutionalized at these companies indicates to me at least that they didn’t understand what trouble they were getting themselves into with the government. Where’s a lawyer when you need one?

As for Microsoft:

According to court documents, the original six civil cases Rille and Roberts filed will proceed against Cisco Systems (CSCO), Electronic Data Systems (EDS), SAP (SAP), Lockheed Martin (LMT), Oracle (ORCL), American Management Systems, CACI International (CAI), SeeBeyond Technology, and Dell (DELL). At least five other defendants remain cloaked under court seal, including one identified in court documents as a wholly owned subsidiary of IBM (IBM).

Boeing (BA), Raytheon (RTN), Microsoft (MSFT), SAIC (SAI), and Exostar were named in the original complaints, but the court, at the urging of prosecutors, dismissed them from the cases last week. The lawsuits themselves describe a network of relationships that reads like a Who’s Who of the nation’s biggest IT companies. Based on documents and information he received while a senior manager at Accenture, Rille claims in one of the original lawsuits, “all the major systems-integration consultants and technology vendors were and are engaged in the same kickback scheme and associated conspiracies.”

So Microsoft isn’t on the hook right now, but they and a number of other big names still seem to have a significant risk. I wonder if it will rate a footnote in tomorrow’s quarterly report?