Microsoft: Earnings OK, but Future Is Hazy

Adding to what has already been a crowded and busy earnings week, Microsoft (MSFT) announced its 3rd quarter results to the waiting market on Thursday. In most categories, the results were sufficiently positive to meet or exceed expectations. Guidance for the quarter ending in June was mixed.

Net income for Q3 came in at $4.4b or 47 cents a share on revenue of $14.45 billion. Last year, for the same period, Microsoft earned 50 cents a share, but that number was inflated thanks to onetime gains resulting from coupon programs that were aimed at addressing concerns caused by Vista and Office 2007 shipping delays. Taking into account the onetime benefits, the year to year results were very similar.

For the current quarter, the consensus expectation among analysts was earnings of 44 cents a share on revenue of $14.5 billion. The actual was enough to beat between one forecast and fall just short on the other.

Getting deeper into the numbers, operating income was $3.1b on the quarter, down from $4.2b last year.

By segment:

• The Entertainment and Devices division (which is home to the Xbox platform) continued to show growth. The unit posted a small operating profit ($89m) but boasted revenue of $1.57b (compared to $936m last year). The result was enough to push the division ahead of its revenue target. In total units, console sales beat 1.3 million on the quarter to reach 19 million total.
• The Online Services business, which includes the MSN properties, posted revenue of $843m, up from $603. Despite the increase, the group's operating loss actually grew to $228m from a loss of $171m.
• Client revenue, which includes PC operating systems XP and Vista, was $4.02b this quarter. That result pales compared to the $5.27b generated last year but the decrease was expected. Last year, for the same quarter, Microsoft recognized $1.64b in deferred revenue resulting from its guarantee program leading up to Vista’s launch. Operating income for the division was $3.1 billion this quarter.
• Server and Tools revenue for the quarter was $3.25b and operating income for the division was $1.1b, both up from year ago tallies.

In other relevant numbers, Microsoft spent $2b on research in the quarter and closed with total cash, equivalents and short term investments totaling $26.3b.

THE FUTURE: Guidance and Yahoo

Looking ahead, two things remain in view but a little out of focus: Microsoft’s pending takeover attempt of Yahoo (YHOO) and the company’s forward guidance for the June quarter.

For the quarter ending June 30th, Microsoft is projecting revenue in the range of $15.5 to $15.8 billion with operating income in the range of $5.8b to $6.2b. Earnings are expected to fall in the range of 45 cents to 48 cents a share.

In the analysts' call, CFO Chris Liddell broke the projections out further by giving detail for the various business units. For Q4, the growth expectations are 7 to 11% for the Client group, 18% to 20% for Server and Tools, 37-41% for the Online Services, 15-16% for the business division and a sizable 32-34% growth projection for Entertainment and Devices.

For the fiscal year ending, which also ends June 30th, the company expects revenue in a range of $66.9 to $68 billion and operating income of $26.7 to $27.4 billion. Earnings are expected to fall in a range between $2.13 and $2.19 a share.

Regarding Yahoo, Microsoft’s self imposed deadline for action expires this weekend. During the analyst call, CFO Liddel didn’t tip off what is planned but he reiterated the party line: he and Microsoft believe the current offer is “extremely generous,” he said. Yahoo’s recent earnings didn’t sway them. Regarding claims that the bid undervalues the company, he said (as expected) that Microsoft sees “the opposite.”

If Microsoft chooses to escalate the current offer to hostile, earlier reports have confirmed that Microsoft is prepared to nominate a slate of directors for a proxy fight. The list, reportedly, has 10 names and three alternates. Among the candidates are John Chapple, former CEO of Nextel Partners, Edward Meyer, former CEO of Grey Global Group, Jaynie Studenmund, the former COO of Overture and Vanessa Wittman, former CFO of Adelphia Communications.

Even with such a list in place, it is by no means certain that a hostile takeover effort will proceed. Earlier in the day, Steve Ballmer said from Milan that Microsoft is “prepared to move forward alone without Yahoo.”

As previously speculated, Microsoft’s own shareholders may be a determining factor. The graphic repeated from the above linked article shows Microsoft’s five largest institutional investors (who hold 14.84 percent of the company) are also among Yahoo’s top seven shareholders.

Reports coming from Bloomberg and other sources suggest there is increasing sentiment that members of this group believe Microsoft’s stock is being restrained by deal risk and not reaching levels otherwise supported by the company’s underlying fundamentals. At the same time, a extended fight risks weakening their holdings in both companies. Absent a quick buyout, the theories speculate, the shareholders may begin asserting pressure to walk away.

By Monday, how Microsoft and Yahoo intend to proceed should be clearer.

Comments

[iJah420]

What about ZUNE sales figures? Is Zune No longer a division of MSFT?

iJah420 would like to know.

[ezduzit]

they are trying to find the person who sold them the name zune and give him a raise. another forward thinking msft move.