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April 27, 2006

Microsoft disappoints with 3Q results

Posted by David Hunter at 8:25 PM ET.

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. 



Three Months Ended
March 31

(millions) % change 2006 2005

Client %8.5 $3,168 $2,919
Server and Tools 14.4 2,657 2,323
Information Worker 2.8 3,110 3,026
Microsoft Business Solutions 20.9 214 177
MSN 0.0 623 623
Mobile and Embedded Devices 41.3 89 63
Home and Entertainment 84.8 1,037 561
Reconciling amounts - 2 (72)


Total revenue %13.3 $10,900 $9,620

Operating Income / (Loss)

Three Months Ended
March 31

(millions) % change 2006 2005

Client %5.9 $2,458 2,322
Server and Tools 16.4 882 758
Information Worker (1.2) 2,257 2,285
Microsoft Business Solutions - (20) (31)
MSN (110.0) (13) 130
Mobile and Embedded Devices (950.0) (17) 2
Home and Entertainment - (433) (186)
Reconciling amounts - (1,226) (1,951)


Total Operating Income %16.8 $3,888 $3,329

Filed under Financial, General Business, Microsoft

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4 Responses to “Microsoft disappoints with 3Q results”

  1. Microsoft 3Q earnings angst on Wall Street -- Microsoft News Tracker Says:

    [...] 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. [...]

  2. Microsoft employee reaction to the 3Q earnings report -- Microsoft News Tracker Says:

    [...] Scot Hillis at Reuters observes that Microsoft’s disappointing 3Q earnings report is causing turmoil that extends beyond Wall Street in Microsoft profit miss may be latest blow to morale: Microsoft Corp.’s share price may not be the only casualty of the software powerhouse’s surprise earnings miss. [...]

  3. Outlook for next week’s Microsoft earnings report -- Microsoft News Tracker Says:

    [...] Also as I mentioned after the 3Q report, this appears to be the last quarter in which the results will be broken out in the glory of full 7 segment detail. Next FY looks to be just Microsoft Platform Products and Services Division, Microsoft Business Division, and Microsoft Entertainment and Devices Division which will blur some of the more interesting results. Filed under Xbox, General Business, Financial, Microsoft   [Permalink] [...]

  4. Changes in Microsoft’s financial reporting -- Microsoft News Tracker Says:

    [...] If you campare with the previous 7 segment breakout, it is much as expected except that shifting Exchange server turned out to be a win-win: lod=sing it lifted Server and Tools and gaining it lifted the Microsoft Business Division (formerly Information Worker and MBS). Filed under Office, Servers, Exchange, Xbox, MBS, General Business, Financial, Microsoft, Argo, Zune   [Permalink] [...]

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