Yesterday Microsoft held their annual Financial Analyst Meeting for 2008 and while you can view the full video and (nearly unreadable) transcripts of the presentations, it was mostly predictable fare. However, there were a few newsworthy nuggets::
"One last thing I wanted to also talk about is an extension of our Facebook relationship where we are extending it to Search and Page Search. We will be providing an API to Facebook where they will create a rich search experience, including a Web search for the Facebook users. And that’s something that they will launch in the fall, working with us, and it’ll carry both our Web results as well as our Page Search advertising."
We still have the possibility of doing a search transaction, which we think makes some economic sense. If I had a worry it’s the parallel paths continue, and about the time Yahoo decides that search deal makes sense for them is probably about the time that we have committed to our own plan so much that it may no longer make sense for us."
Microsoft Corp. today announced first quarter revenue of $10.81 billion for the period ended September 30, 2006, an 11% increase over the same quarter of the prior year. Operating income for the quarter was $4.47 billion, an 11% increase compared with $4.05 billion in the prior year period. Net income and diluted earnings per share for the first quarter were $3.48 billion and $0.35 per share. For the same quarter of the previous year, net income and diluted earnings per share were $3.14 billion and $0.29, including a $0.02 per share charge for certain legal charges.
This neatly exceeded the analyst consensus of earnings of $0.31 per share on revenue estimates ranging from $9.74 billion to $10.75 billion. The big star was once again Server and Tools, most particularly SQL Server. You know, the software business is so good, maybe Microsoft should consider getting out of consumer electronics?
But, of course, the analyst mantra this time around was that “it’s not the earnings, it’s the outlook,” and here’s what Microsoft had to say:
Microsoft management offers the following guidance for the fiscal second quarter ending December 31, 2006:
- Revenue is expected to be in the range of $11.8 billion to $12.4 billion, which reflects approximately $1.5 billion of revenue deferrals that will be captured in the fiscal third quarter as noted below.
- Operating income is expected to be in the range of $2.9 billion to $3.1 billion, which reflects approximately $1.5 billion of deferrals noted below.
- Diluted earnings per share are expected to be $0.22 to $0.24, which includes an $0.11 per share impact for deferrals noted below.
Note: The guidance above includes the impact of an approximately $1.5 billion of revenue deferral from the second to the third quarter, primarily related to the technology guarantee programs announced on October 24, 2006 for Windows Vista and the 2007 Microsoft Office system.
Management offers the following guidance for the full fiscal year ending June 30, 2007:
- Revenue is expected to be in the range of $50.0 billion to $50.9 billion.
- Operating income is expected to be in the range of $19.1 billion to $19.5 billion.
- Diluted earnings per share are expected to be in the range of $1.43 to $1.46.
There don’t appear to be any big surprise there, but, pundits, start your engines!
Update: Some related notes:
Below are some selected highlights from yesterday’s Microsoft Financial Analyst Meeting 2006. As I mentioned previously, the list of speakers with copies of their presentations, and transcripts and/or Webcast replays are available here. (Bink.nu also has some candid snaps of the speakers.)
Steve Ballmer, Chief Executive Officer
Microsoft Chief Executive Officer Steve Ballmer said Thursday that his company must be able to operate successfully in multiple markets — a phenomenon he calls being “multi-core” — for the company to continue to grow well into the future.
Although Microsoft is best known for its desktop OS and software business, the company has managed also to carve out a successful business in server software, making it a two-core company, Ballmer said at Microsoft’s annual Financial Analyst Meeting in Redmond, Washington.
But as Microsoft moves ahead, the company is fighting a war on several fronts, and Ballmer hopes it will develop more core businesses with its entertainment and online services strategies.
“There really is a Sony that lives inside of us,” he said. “There’s an aspiring Google or Yahoo that lives inside of us.”
“You have to confront the question: Is it OK to get into some area of endeavor when you’re not first?” he said. “It’s always best in our business to be first. We want to be first. But are you prepared to get in and innovate and try to get growth in areas where you’re not first in the market. As investors, you have to understand that we think that’s important.”
And on a theme dear to the analysts’ hearts – Ballmer: Vista delays won’t be repeated.
Kevin Johnson, Co-President, Platforms & Services Division
Microsoft expects sales in its popular Windows division to grow 8 to 10 percent in the coming fiscal year, a senior executive said Thursday.
The No. 1 computer software maker expects sales of between $14.3 billion and $14.5 in its Windows operating system division in its current fiscal year, Kevin Johnson, co-president of Microsoft’s platforms and services division, said during the company’s annual financial analyst meeting being held at its headquarters in Redmond, Wash.
Since that’s the projected unit growth rate in PCs, Microsoft’s Windows client revenue is merely matching units. I guess that’s good news since it has lagged unit growth recently and presumably a match is the best they expect from the upselling and antipiracy initiatives:
Vista, with its multiple versions, has “something for everyone,” Johnson said, but Microsoft plans in particular to promote the purchase of its higher-end, or “premium” versions to consumers. Traditionally, higher-end versions do better among business customers than home users. “There is an opportunity for us to grow the premium mix,” he said.
Premium versions of Vista include Windows Vista Home Premium and Windows Vista Ultimate.
Microsoft also is investing in ways to encourage customers in emerging markets to purchase genuine copies of Windows Vista as part of an overall campaign to prevent people from using counterfeit or pirated versions of Windows, Johnson said.
To achieve this goal, Microsoft is “putting more feet on the street” and is providing more training for channel partners, especially in emerging markets such as China, to help sell genuine copies of Windows, he said.
Johnson also reiterated that Vista development continues on schedule although his caveat that it wouldn’t ship before it was ready inexplicably depressed investors since it’s clear that there’s no windfall there.
Bob Muglia, Senior Vice President, Server & Tools Business
Muglia went off on a Linux tangent for some reason, but I guess he’s entitled – his business is an earnings growth superstar even if it gets no buzz.
Jeff Raikes, President, Business Division
Jeff had some interesting things to say about competitors. He referred to OpenOffice and IBM WorkSpace as efforts to “clone our old technological” capabilities. Whoa.
But it’s “good enough,” Jeff, as are old versions of Office and there’s the rub. Raikes also predicted a less than scintillating 7% CAGR for his business over the next few years.
Robbie Bach, President, Entertainment & Devices Division
No surprise that Microsoft game, device unit sees loss in ’07, The big surprise is that they plan to make money in 2008.
Microsoft said investments for its new “Zune” media player and another year of losses at its Xbox game unit will continue to weigh on the entertainment and devices unit’s earnings this year. The division posted a loss last year.
The entertainment and devices division encompasses much of Microsoft’s consumer-oriented products, such as Windows-based smartphones, the Xbox 360 game console and its upcoming “Zune” media player, but it has not been a consistent earnings driver.
“Fiscal ’07 will be a loss. We think that turns to profit in 08,” Robbie Bach, president of Microsoft’s entertainment and devices division, said at Microsoft’s annual analyst meeting.
As for Zune:
The software giant said it will invest “hundreds of millions” of dollars to develop and market Zune, due to hit the market later this year.
Bach encouraged investors to be patient and not expect an immediate return on its outlay for the device.
“It is something that is going to take time,” said Bach. “This is not a six-month-investment time horizon,” he said, adding that it may take three, four or five years to succeed.
Zune’s differentiating feature from Apple’s iPod will be built-in Internet connections that allows users of the devices to connect with their friends and other music fans.
On the Xbox 360:
Though competitors Sony and Nintendo are slated to launch rival game consoles this fall, a Microsoft executive predicts his company’s next-generation game machine should have a 10 million unit lead by the end of this year.
Microsoft’s next-generation Xbox 360, which launched last year, starts at $299, and Bach said he sees no price changes through the holiday season.
That presumably lays to rest the persistent rumors that there will be an Xbox 360 price cut when Sony ships the PS3. Microsoft also touted Windows Mobile based phones as gaining share from Research in Motions’ Blackberry. There’s more on Bach’s presentation here including:
When asked whether Microsoft was abandoning its PlaysforSure digital-media-connectivity initiative in favor of developing its own end-to-end Zune solution, Bach said Microsoft is planning to continue to back PlaysforSure.
“PlaysforSure continues as it is today,” he said. In fact, the Zune team “will work with the same (PlaysforSure) interfaces,” Bach said.
He likened the PlaysforSure/Zune paradigm to the PC/Xbox console one. The two teams will continue to work in parallel, with the hope that the two different environments ultimately will work together, Bach said.
What else could he say?
Ray Ozzie, Chief Software Architect
Ozzie’s presentation was described as “visionary” and “a high-level, theoretical look” which I take to mean that there were a lot of glazed eyes among the financial crowd. On a slightly more down-to-earth note – Web services to aid, not kill, software:
Web services, delivered alongside classic software, will complement rather than replace the existing software industry, Microsoft Corp.’s chief technologist said on Thursday.
Chief Software Architect Ray Ozzie told investors and reporters attending the annual financial analyst meeting at Microsoft’s headquarters that the company is looking to convert its existing software franchises into Web-delivered services.
“The overall services opportunity is largely additive, increasing revenue opportunities for both our existing software licensing model as well as our services business model,” Ozzie said.
Microsoft’s strategy is to connect a wide range of devices onto various networks to allow consumers to enjoy the same information and entertainment not only on their computers but also via mobile phones, televisions and gaming systems.
In response to a question, Ozzie declined to say how much revenue per user could come from new Web services or how these might compare to license revenue streams from Windows and Office software that generate the bulk of Microsoft revenue.
Yusuf Mehdi, Microsoft’s Chief Advertising strategist
Kevin Turner, Chief Operating Officer
Turner delivered some bromides.
Craig Mundie, Chief Research & Strategy Officer
Microsoft shows off cell phone-PC prototype. It’s called FonePlus and is intended for emerging markets and rivals Nicholas Negroponte’s “$100 PC” as we have mentioned previously. It’s merely a research project but drew disproportionate press interest.
Chris Liddell, Senior Vice President & Chief Financial Officer
Chief Financial Officer Chris Liddell said Microsoft was in “high investment mode” and very acquisitive over the past year, spending $649 million to buy 23 companies. He said it acquired four companies in July.
But its acquisition spending is still dwarfed by the billions it plows into research and development every year and Liddell said it was unlikely that will change.
And Microsoft executives underscored that they are contemplating no change of strategy that would lead to a major acquisition anytime soon. It has spent less than $30 million per company, on average, on its buying streak over the past year.
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.
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.
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?