Thursday, October 26, 2006

Q1 Earnings

Well, here we are in the lead up to the earnings call tonight. You can almost taste the fear and hear the dull hum as thousands of long-term MSFT shareholders look to the sky and repeat the same mantra: "Please don't f#*kup again". Meanwhile, the market is registering its confidence in the management team by taking the stock slightly lower [currently] in an otherwise flat to slightly positive market.

Now for the not-so-well-kept secret: the earnings tonight don't really matter. Sure, a major miss would be negative, buts odds of that happening are slim. A minor miss, unfortunately, is not without precedents over the past 2 years and so again, is unlikely to tank the stock. On the other side, a major upside surprise is also unlikely. That leaves the odds on bet the usual meet or beat by a penny or two - well, at least after you add back the inevitable "one-time" charges that typify all post 00 MSFT earnings calls. One outlier to this analysis is how investors may react to another lukewarm report from MSFT given the very strong results already reported by GOOG, AAPL and even IBM (on the earnings side). If investors do that compare, we're done. So, what is important? GUIDANCE. In particular, the outlook for the year but also for Q2. Unfortunately, we now know the latter is going to be severely impacted by the coupon program - so they've already dug themselves a nice big hole to try and get out of there. Focus will also be on the emerging businesses, especially Xbox 360 which appears to be struggling of late. MSN's progress in search-related advertising is going to be important - and likely underwhelming (although I will say their search engine is much improved and worth giving another try). Luckily, BusSol has been nicely hidden under Office, so I suspect there won't be too many details on that underperforming train wreck. Finally, analysts might just be looking for a final, unqualified date on MSFT's two biggest cash cows - Windows and Office. Are these guys sticklers for details or what? More after the call - unless I'm too busy crying in my beer...

Post close:

Revenue $10.81B vs $10.75B consensus. EPS given as $.35 versus $.31 consensus, much stronger than expected - unclear yet whether that's apples to apples. Taking a quick look at the financials, operating expenses continue to outpace sales (Hint Steve: that isn't going to lead to earnings acceleration). Client posted weak revenue growth of 4% vs comparable '05 Q (as was somewhat expected) and even weaker income (+3%). Server continued to prove why they're the only group currently earning their pay, posting a 17% growth rate on revenue and 36% gain in income. Great job! Online Services continued to show what a mess it is, posting weaker revenue (-4%) and managing to lose even more money doing it (-$136M vs last year's $68M profit). The Business Division managed a 4% revenue growth rate as well, but was effectively flat on income (more signs that BusSol still isn't executing?). Entertainment came in at up 70% on revenue and decreased its YOY loss from -$173M to -$96M. Unearned revenue up $185M. Buybacks on the Q of $7.683B. Stock initially off more than $.67 in AH, but recovering currently to -$.11. More after the conference call...

Post Conference Call:

Phew! No huge surprises. The stronger EPS result mentioned above, seems to have been due to shifting some planned marketing expenses to Q2 and beyond. That makes more sense, since revenue growth was in-line and expenses were hotter than that. Advertising growth of 5% and lower search revenues (I kid you not), were the brutal results that I had anticipated and posted about. With GOOG seeing 70-90% growth in this segment, let's not even bother belaboring how bad that result is. Luckily (?), MSFT's comically bad performance to date in this regard has set expectations at a very low level, so that one can probably slide. Dynamics notched a 19% YOY increase in billings. That's better than the advertising result, but still shows no acceleration in growth and is insufficient to take major share -especially when segment competitors like are growing at 2-3X that. Xbox 360 unit sales now stand at 6M life to date. Unclear whether that puts them in position to make their target of 10M units by year-end. The general tone seemed to more reserved than one might expect heading into the biggest season of the year for that particular product - but I might be reading something that isn't there. The post CC Q&A, as expected, was dominated with questions about the coupon program and the Q2 downward revisions. The answers generally seemed to be forthcoming, and I don't think analysts walked away with any new concerns following their "advance" warning a whole two days ago. Net net, it could have been a lot worse. The market, at least in AH, seems to agree, with the stock now marginally green at $28.41 (+$.06). We'll have to see what the full session tomorrow brings...


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