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April 28, 2008

Microsoft 3Q08 earnings underwhelm

Posted by David Hunter at 1:38 PM ET.

Shareholders were justifiably nervous after the first good news called out in the 3Q08 Microsoft earnings report was that the nearly profitless sinkhole of Entertainment and Devices grew revenues by 68%. That such a diversion was necessary was because the milk yields of Microsoft’s leading cash cows, Windows and Office, dropped in a still mostly unexplained manner.

Below are the segment breakouts with some brief commentary based on the 10-Q.

Client:

(millions) % change 3Q08 3Q07

Revenue %(24) $4,025 $5,274
Operating Income (26) 3,097 4,204

The big hit here is the $1.14 billion of deferred revenue that got tacked on in 3Q07, but even removing that, revenues were down over last year despite OEM sales (which account for 80% of unit sales) being up 5% and the "premium mix" being up as well. Estimated PC sales growth was 8-9% and theories ranging from piracy to Apple/Linux competition to Microsoft shifting revenue to next quarter have been offered for the shortfall.

Business (mostly Office):

(millions) % change 3Q08 3Q07

Revenue %(2) $4,745 $4,827
Operating Income (8) 3,138 3,399

Subtracting the $500M deferred revenue booked in 3Q07 makes this look much better apparently due to strong Office revenue growth from businesses, but consumer revenue was actually down. R&D expenses were up 19% driven by headcount expenses and headcount itself was up 7%, presumably not to add bells and whistles to the traditional Office product.

Server and Tools:

(millions) % change 3Q08 3Q07

Revenue %18 $3,255 $2,748
Operating Income 20 1,092 911

Another sterling quarter for Server and Tools who launched major new products.

Entertainment and Devices (mostly Xbox):

(millions) % change 3Q08 3Q07

Revenue %68 $1,576 $936
Operating Income - 89 (324)

The good news is that E&D made money in 3Q. The bad news is that it didn’t make much, but then it never does. R&D expense was up 26% and sales and marketing expenses were up 29%.

Online Services:

(millions) % change 3Q08 3Q07

Revenue %40 $843 $603
Operating Income %(33) (228) (171)

Online advertising revenue grew 39% ($175M) to $619 million including aQuantive’s $47 million. aQuantive also added $97 million in agency revenue. So where did it all go? There was a large write-off from the acquisition of aQuantive plus increases in general expenses for infrastructure, "online content expenses," and headcount. One item that caught my eye was "a $24 million in-process research and development write-off." The Online Services Business (OSB) doesn’t seem to be going anywhere fast. The question, of course, is whether it would go any faster with the addition of Yahoo.

Corporate Level Activity (overhead and legal): 

(millions) % change 3Q08 3Q07

Corporate level results %(94) $(2,779) $(1,430)

The big ticket item here was an increase of $1.2 billion in legal expenses including the EU fine.

Bottom Line:

Out of Microsoft’s three cash cows (Windows Client, Office, and Servers) only Servers delivered in accustomed fashion. Entertainment and Devices is all sound and fury signifying nothing, while Online Services is treading water waiting for a Yahoo life preserver



Filed under Acquisitions, Financial, General Business, Microsoft, Yahoo

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One Response to “Microsoft 3Q08 earnings underwhelm”

  1. Microsoft 4Q08 earnings strong but fail to impress Wall Street | Microsoft News Tracker Says:

    [...] at the segments, the good news was that compared to the very odd 3Q, Microsoft’s cash cows got back to churning up the butter while the bad news was that the [...]

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