Thursday, January 24, 2008

Q2 FY08 Earnings


Stakes heading into MSFT's report are about as high as I can remember. The punishment for companies who disappoint this earnings season has been swift and severe - just ask INTC or AAPL holders. Additionally, you have markets that are on the edge of the abyss. At the lows yesterday, the Nasdaq notched the 20% decline that signals a bear market - and the Dow and S&P weren't far behind. Luckily, buyers waded in and the subsequent rally managed to turn it into a reversal day. But signs increasingly point to the demise of the bull market that began back in 2002.

For its part, MSFT has held up amazingly well during this market meltdown. Although significantly off its recent highs, it's substantially above the $28.60 or so level it would be at had it just performed like usual (i.e. at or below the index). The risk, of course, is that we'll end up there shortly if the market takes exception to anything said tonight. Alternatively, if MSFT impresses, maybe we rally a buck and give the rest of tech at least a short term boost as well.

As a reminder, consensus is as follows:

  • Revenue: $15.95B
  • EPS: .46
See more background here:
The most important figure - guidance for the year - was:

  • Revenue: $58.8B-$59.7B
  • EPS: $1.78-$1.81
If MSFT backs away from that at all, we're done. Q3 compares are also going to be ugly given the benefit realized last year from the deferred Windows and Office revenue. As per usual, if the market likes the report and guidance overall, then what is primarily an accounting/timing issue will be given a pass. Otherwise, we'll see headline after headline tomorrow about "slowing growth". FWIW, Goldman is banging the drum and getting "conviction" about MSFT again ahead of earnings. They called it right last time, although their conviction was short-lived - more like an infatuation. So let's see if [newer] analyst Sarah Friar can make it 2:2, following Rick Sherlund's disastrous 0:30 record previously.

I'll be back after earnings to update this post. Meanwhile, you can check out the recent Motley Fool bull versus bear debate on MSFT, or join me in scratching your head over this development.


Very strong. Looks to be a beat of consensus and whisper numbers on both the top and bottom lines, along with raised guidance for the full year:

  • Revenue: $16.37B
  • EPS: .50
Guidance for the year:

  • Revenue: $59.9B-$60.5B
  • EPS: $1.85-$1.88

Stock is up $1.50 to $34.75 currently in AH. Back with more commentary after the cc.
Conference Call and 10Q analysis:
  • 15% growth overall (net of technology guarantee impact)
  • $4.1B in buybacks during the Q (leaving $8.7B remaining on the previously approved $36.2B)
  • Online advertising growth of 38% (26% excluding AQNT)
  • Online expenses grew even faster though
  • E&D managed its third ever quarterly profit and first back to back one (now just $5.4B to go before breakeven)
  • Cost of revenue dropped from 29% to 22% during the Q (yielding 21% vs 23% YOY half way through the fiscal)
  • Result: operating margins increased 4% to 40%
  • SharePoint grew 50% during the Q, as did Office Communication Server 
  • Dynamics customer billings up 26%
  • 427M Windows Live ids from 352M last year
  • 22nd consecutive quarter of double-digit revenue growth for Server & Tools (very impressive)
  • Over 60% of sales from users and regions outside of the US (emerging markets up nearly 30%, non-US mature up 20%)
  • Unearned revenue down sequentially, but up YOY ($12.178B vs $11.861B) and $500M more than forecast
  • R&D up 15% on the Q to $1.885B from $1.637B, but down a point as a percentage of revenue (and no, I'm no clearer on the value received for money spent)
  • Cash + short term investment down to $21.1B from $23.4B
  • Expect PC growth for the year to be 11-13% now (up 1% from previous)
  • Diluted shares outstanding decreased to 9.503B from 9.942B
  • Total stockholder's equity up $3.33B to $34.431B
  • Not immune to global economic factors, but haven't seen any negative spillover from a weakened US economy (yet)
  • Currently under audit by the IRS for tax years 2000-2006? (I must have missed this one previously)
Short version: strong results, increased guidance, generally upbeat tone, and no really embarrassing items for analysts to question. Good job! Yes, online continues to be a sinkhole for cash. But everyone is used to that by now, and at least the top line result is semi-respectable. Yes, there's still no color on actual large scale Vista deployments. But at least client revenue and unearned remains solid. Bottom line, if last report was sufficient to get some investors to take another look at MSFT, then this one should attract others and perhaps reduce doubts that last time was merely a fluke. 
Stock now up $1.59 to $34.84 in AH. We'll see what happens tomorrow in the regular session.
Mini has a good selection of the post earnings reviews that I normally provide here. So I won't bother duplicating that, although I'll offer one more just because I like the title:

On the less-positive but still worth reading side, Henry Blodget drills into the online numbers further:

For its part, the stock opened strongly ($34.90) but has given back much of that gain currently ($33.54). Volume is very high (already surpassed average daily volume).

Thursday, January 10, 2008

And then there was one...

Jeff Raikes retires from MSFT.

My initial reaction - "Wow!". Didn't see this one coming. Gates, Ballmer, and Raikes have effectively been the top echelon of the company for as long as I can remember. With Gates having already announced his retirement this year, and now Raikes as well, that leaves just Ballmer from the original troika.

The [external] choice for Raikes' replacement seems to have the right pedigree. There is also a fairly decent transition period - so hopefully no balls get dropped in the process. But Raikes did a solid job with Office and was widely seen as the leading candidate to succeed Ballmer. So combine that with some other recent high level departures, and I don't think the market is going to respond positively to the news tomorrow.

Some coverage:


Update: Made some additions/deletions.

Update #2 (1/11/08): Additional coverage that caught my eye:

As someone who has been calling for leadership change for some time, I guess I'm overall happy to see it possibly occurring in earnest. But if it is (and the departure of Gates and Raikes make it unique regardless), it's almost inevitable that there will be those you didn't want to lose along the way - and ones that don't go who should. Let's hope both are minimized. It would also be nice if these announcements weren't landing so close to earnings and dribbling out piecemeal, with reports of still more departures to come. As this level, as reported, these things don't normally come as a surprise, at least for Ballmer. So make the announcements - all of them - and let employees and the market move on. That way it sounds like planned change, not musical chairs at the top or - worse - abandon ship.

Wednesday, January 09, 2008

Gates kills it at CES - literally

So Bill Gates had his final CES keynote as a full-time MSFT employee (and likely his last ever). Anyone who has attended a Gates presentation knows that they're long on repetition and short on excitement. In fact, they're normally real groaners. But apparently some were hoping for a miracle despite that well-established track record. And given that the consumer market is red-hot right now, and MSFT - being perpetually slow to respond - has finally even acknowledged that it needs to do a better job there (earmarking $300M more for advertising), it would have been nice to see Gates and MSFT do more. But alas, it wasn't to be. In fact, the best part imo was the video - which shows a self-deprecating side of MSFT that I think few external watchers appreciate exists.

Still, the media reviews are surprisingly scathing. Which suggests to me that others besides myself are tiring of MSFT constantly promising innovation but delivering precious little of it, and are no longer afraid to say so. Some examples:


In an era when the vanguard of technology is creating smart devices for entertainment and communications, Bill Gates, the outgoing chairman of Microsoft, had little that was interesting or innovative to show off in his last annual keynote at CES in Las Vegas on Sunday.


But the biggest problem for CES isn't the competition, it's internal. And you only need to look as far as Microsoft to see what's wrong. Despite headlining the event, Microsoft didn't make a single major announcement last night, let alone acknowledge that some of its biggest announcements from last year--Windows Vista, new Media Center Extenders, or an IPTV-based Xbox 360--have yet to materialize or have any real positive impact on the market if they have. 

And for crying out loud, start talking to Steve Jobs. That the most influential consumer electronics company in the world isn't at CES is a crime.


And finally, the Pièce de résistance:  


The big question is how, in 2008, have we come to a point that Microsoft is so bereft of new ideas and innovation that what was once the most important keynote speech of the year turned out to be a complete dog? It’s not for a lack of good people, there are many in Microsoft doing a great job, and there’s even some good technology and products being created (Silverlight and Windows Live Maps being two examples) and to those people I say don’t take this personally, it’s not personal, it’s just that if people don’t have anything interesting to say, they’re better off not getting on stage and making us yawn. I’ll be in San Francisco for the Steve Jobs keynote at Macworld next week and I doubt that I’ll be writing a similar post.

"How" indeed. Current leadership should really reflect on that -  especially in light of the massive R&D spend relative to virtually everyone else (especially AAPL) - and make substantive changes. Will they? Of course not. They'll simply deny it's true - call it the "Vista defense".

Reviewing the rest of the MSFT-related CES coverage, I found this article the most interesting:

Primarily because of this excerpt from Gates, which encapsulates most of the reasons I continued holding MSFT:

Gates: Remember, it's all about software. So why are we talking about those companies? There are very few companies that understand software. The phone is becoming about software, the TV experience is becoming about software. Our bet goes back to the founding of the company--that software is going to be at the center (of things). It really is coming true.


I think the core of who we are and what we do (is) believing in a platform. We're better positioned than anyone. Do we have to continue to work on our advertising scale and our search and some usability things in our music products? You bet. But that all comes off the core of being a company with the best research group, by far, of any software company, and a breadth of talent that everyone is envious of.

What a shame that they've done such a poor job of executing to be the leader in realizing that vision. Instead, they lost focus, decided to be lazy, played defense, tried to solve every problem from a PC-centric perspective rather than a platform-agnostic software one, and vainly tried to hold back the internet. So now others - in particular AAPL, GOOG, and even Adobe - are realizing this original vision for them. Can this situation be turned around? With a lot of hard work and tough choices, I think so. But I don't see how you get there with a leadership team that begins from a position of near-total denial. Just ask an iPhone user who they think "understands software" better - AAPL, on their first attempt, or MSFT after nearly a decade of mobile involvement? Or maybe the problem isn't "understanding software", but more importantly understanding what people need to accomplish from it, and then maximizing the resulting "experience" for those paying the freight? Oh, and delivering on your commitments doesn't hurt either. Just a thought.

Off-topic - but related timing-wise (and therefore worth covering in this post) - is MSFT's decision to acquire Fast Search for a whopping $1.23B. I'm still scratching my head on this one. The market hated it - there's nothing like announcing a new $1.23B acquisition and immediately losing $5B in marketcap on the news. Apparently, the market initially saw it as [more] good money going after bad in the so far hopelessly losing battle against GOOG for consumer search/advertising share. That seems to be wrong, with the deal being more of a SharePoint/enterprise play. Thank god! Market reaction today suggests that maybe folks are now getting that. Still, when you the read history of Fast - suspended trading, accounting restatements, executive resignations, charges that a Director sold the company an external organization at an inflated price (pocketing the windfall), the heretofore dominant shareholder demanding removal of board members, Directors being sought for tax evasion by the Norwegian equivalent of the IRS, etc. - you really have to wonder "wtf was MSFT thinking?". Oh, and did I mention it's unprofitable? Doesn't MSFT already have too many of those?

Now, maybe Fast has some killer technology and/or people that would be worth this otherwise ridiculous premium for such a troubled company. Even then, you have to question how come MSFT R&D, which has some of the industry acknowledged superstars in Search (and has been focused on it for several years now), wasn't light years ahead of some struggling player from Norway. Quite frankly, the whole thing smacks of a defensive move by MSFT to either play catch up (which, as above, shouldn't require going external), or to ensure that a failing company with some good technology didn't fall into the hands of ORCL, IBM or perhaps GOOG. Neither option seems like an especially great use of $1.2B of our cash, unless we see R&D come down by say an equivalent amount? Yeah, didn't think so.

Some people do like the deal:


Forrester Research analyst Ken Poore called the buyout "a big deal." In an interview, Poore said Microsoft's search strategy has been weak, leaving the software maker trailing behind not only big players like Fast, but also Oracle and IBM, who have been investing in the technology in recent years.

"By going out and acquiring Fast, in my opinion, they've kind of leapfrogged" IBM and Oracle, Poore said.


The acquisition will give Microsoft an immediate strong presence in the market for corporate search software thanks to Fast's high-end roster of clients, including Merrill Lynch (ML), Disney (DIS), Best Buy, Pfizer (PFE), and Dell (DELL). The Norwegian company's chief rivals in the estimated $4.8 billion business include Google (GOOG), IBM (IBM), Britain's Autonomy, Oracle (ORCL), and SAP (SAP). Fast was on track to book $200 million in 2008 sales—about 20% higher than in 2007—and Microsoft's direct-sales and reseller network can expand that, UBS (UBS) analyst Heather Bellini wrote in a note to clients.

The latter includes MSFT perma-bull Brendan Barnicle, a vice-president and senior research analyst at Pacific Crest Securities:

"Buying Fast will cost Microsoft less than three weeks' worth of free cash flow, and could provide better returns on the company's $21.6 billion cash pile than stock buybacks and dividends...Microsoft has tried everything in the world with its cash," Barnicle says, "and nothing has really worked for the stock."

Um, Brendan, is that meant to encourage shareholders given that the company isn't profitable? Sorta like "buying the shares of a losing company is a better investment that buying shares of MSFT"? Er, okay. Also, isn't that because the one thing they haven't done with our cash is use it to make smart, accretive acquisitions in areas that they actually know something about and can execute best-in-class in?

Also pumping the deal was top-rated Goldman Analyst Sara Friar:

The acquisition of FAST bolsters Microsoft's positioning in the enterprise search market. We view this acquisition as a necessary next step to help Microsoft shore up its defenses against Google in the enterprise. Microsoft's strength is that it owns the entire back-end infrastructure and hence data in the enterprise, which may be more difficult for Google to access. We also believe that this acquisition highlights an increased focus on inorganic growth.

Hmm.."shore up its defenses" in the enterprise? Isn't that what MSFT's massive annual R&D spend is meant to do - at a minimum? And an "increased focus on inorganic growth"? So basically Ballmer is throwing in the towel on his largely failed "big bets" strategy and adopting ORCL's approach instead? The same one he initially denigrated, but which has subsequently shown far better returns than his own? Well, if true, that might actually be a good thing - though Fast seems an unlikely candidate for achieving success on that tact. Finally, Sara forgot to mention that Goldman acted as advisor to MSFT in the deal. But I'm sure that didn't influence her coverage <wink>

Bottom line, this was likely Gates' last keynote at CES - and that's a good thing. Listening to Bill reminds me of some old-school news anchors or politicians. They're smart, capable, etc. but just seem out-of-step and staid. Sorta like recent interviews I watched with former NBC anchor Tom Brokaw and current CNN anchor Anderson Cooper. Cooper came across as hip, fresh, and real; Brokaw did not. The company needs a new chief spokesperson. This time, one that's capable of getting people fired up about the company's new and exciting offerings (assuming they can fix what's wrong there and deliver those).  And please don't tell me that's Robbie Bach, whose CES presentation sounded more like he was doing his performance review and trying to justify his job. It also isn't Ozzie, sadly. So who? And wrt the Fast acquisition, let's just say that for shareholders at least, that's yet another questionable "show me" investment versus any kind of obvious home run.


Update: Under the heading "be careful what you wish for". Okay, so maybe there's a limit to how "real" you want your main spokesperson to be after all:

The discussion here provides some more background on his thoughts wrt Vista, mistakes made, and what I hope he meant.