Falling PC Sales Hurt Microsoft Earnings, But Office 2010 Is Still Cranking

steve ballmer
Microsoft CEO Steve Ballmer

Microsoft reported earnings for the March quarter (Q3 of its 2011 fiscal year) this afternoon, and they were OK but not spectacular.Investors were expecting more of a blowout, and have sent the stock down about 1.5% after hours.

Revenue was $16.43 billion, slightly ahead of consensus estimates of $16.19 billion.

EPS of $0.61 came in ahead of expectations of $0.56. But as investor Doug Kass pointed out on Twitter, Microsoft got a one-time tax benefit of $0.05 per share, and had some income from investments (as it always does). Sub those out, and the company actually missed EPS estimates by a couple cents.

Windows sales were down about 4% — in line with a PC unit sales drop of more than 3%. Some investors were expecting Microsoft to buck the PC sales trend like Intel did, but Intel’s numbers didn’t entirely reflect a decline in netbook sales. Microsoft says that netbooks are off 40% from last year.

Microsoft also said that expenses would be up 3% to 5% in its next fiscal year, which starts on July 1. That’s probably because of a planned compensation increase that Microsoft explained to employees earlier this month. But that’s a lot smaller increase than operating expenses at some competitors — Google, for instance, announced opex expansion of 10% on its last earnings call.

The Business Division (Office) continued to show the spectacular growth it’s seen in the last two quarters, rising almost 21%. That’s thanks mainly to the release of Office 2010 and related products last spring.

Kinect continued to do great things for the Xbox — Entertainment & Devices revenue was up 60% from last year to $1.94B. But margins are still a lot slimmer here than in the company’s core businesses — operating income was only $225 million.

The Online business continues to be a dog — once again, the division’s operating LOSS (-$726m) was greater than its REVENUE ($648m). Microsoft investor relations head Bill Koefoed confirmed that revenue per search is down, as Yahoo CEO Carol Bartz said on Yahoo’s last earnings call, as advertisers are bidding less than the companies expected for keywords on the companies’ combined search sites.

But the losses continue to be relatively affordable when the rest of the company is growing and accumulating cash.

And yes, the company’s cash hoard continues to grow — it’s now over $50 billion. That’s up from $41 billion last quarter.

The numbers:

Revenue: $16.43B (+13%) vs $16.19B consensus

EPS: $0.61 vs $0.56 consensus.

Net income: $5.23B

Windows: Revenue $4.45B (-4% — about in line with PC sales), operating income $2.76B

Business (mostly Office+Exchange+SharePoint): Revenue $5.25B (+24%), op income $4.31B

Server & Tools: Revenue $4.10B (+11%), op income $1.15B

Entertainment & Devices (Xbox+mobile): Revenue $1.94B (+60% — Kinect!), op income $225m

Online: Revenue $648m (+14%), operating LOSS of $-726 million.

CASH and short-term investments: $50.15 billion.

Here’s the live coverage of the company’s earnings call.

(A quick aside: like most companies, Microsoft doesn’t usually reveal a lot of new information on its earnings calls, but today’s call was really light. The company dodged nearly every single question from analysts.)

5:30 ET:  Here we go. They’re on time today — usually it starts a few minutes late.

CFO Peter Klein is leading the call. Commercial side saw “strong multiyear licensing commitments by enterprises” and “robust transaction sales” to small and mid-size businesses.

Translation: consumers may be shying away from some types of PC, but we’re going crazy in the business market. Office 2010 now, Office 365 (cloud service) coming out soon.

Enterprise deployment of Windows 7 has more than doubled over last six months. (NOT 12 months as I originally mistyped. Sorry!)

But consumer PC sales are down.

5:35: Revenue per search is down on the Bing+Yahoo search thing. They’re working with Yahoo to figure out what the heck is going on.

5:36: Investor relations head Bill Koefoed is going into more detail on business segments now.

Fourth consecutive quarter of 10%+ revenue growth, 6th consecutive quarter of 10%+ EPS growth.

Operating cash flow a record $8.67B. That’s insane. Cash flow year to date has surpassed $21B, an increase of $2.6B from last year. (Note, Microsoft is talking about its fiscal year, which started July 1, 2010.)

Business PC growth up 9%. Consumer PC down 8%. That includes a 40% decline in netbooks, plus “stronger competition” for consumer spending (think iPad).

5:38. Adjusting for the Windows launch, revenue was in line with PC market. Strength in emerging markets has helped offset weakness in the US and developed markets.

350 million units at launch, but 75% of PC installed base is still running older OSs.

Percentage of enterprises running Windows 7 has doubled over last 6 months.

5:40: Business Division revenue was up 13% if you eliminate one-time effect of one-time deferral for Office 2010 upgrade plan.

“Transactional” revenue up 28% — higher PC shipments, higher attach among small businesses.

Office 2010 is travelling with Windows 7. Office 2010 deployment is 5x faster than Office 2007. Businesses are also attaching SharePoint, Exchange, and Lync, all grew double digits.

Lync grew 30%. (Shipments? Revenue? Not clear.)

In case you’re not familiar, Lync is Microsoft’s instant messaging, presence, and voice-over-IP product for companies. It competes most directly against Cisco’s offerings — so Microsoft is benefiting as Cisco flails about.

40,000 customers are trying Dynamics CRM Online — the company’s Salesforce.com competitor.

5:43: Server & Tools grew 11%, faster than server hardware market.

Multiyear licenses up 11%, services revenue up 12%. “Strong enterprise agreement renewals of Windows Server this quarter.” (EAs are the long-term licence agreements signed by the company’s largest customers.)

5:45: Online ad revenue up 17%. Bing’s market share was 13.9% at end of quarter. “We feel great about the pace of innovation and customer satisfaction.”

“However” — monetization of Bing-Yahoo deal is taking longer than expected. They’ve delayed international rollout to focus on improving revenue per search in the US.

5:46: Now onto Entertainment & Devices. Kinect sold 2.4m during the quarter. Shipped 2.7m Xbox 360s, a new record for the quarter — more than 1m higher than previous record.

Windows Phone. Good reviews. Customer sat is above 90%. Nokia alliance. More than 13k apps, and greater developer interest post-Nokia announcement.

But no talk of sales numbers.

5:48: COGS up 41% this quarter, for three reasons:

1. Kinect and Xbox.

2. Enterprise services

3. Online traffic acquisition, mainly because of Yahoo.

Taxes: got a $461m one-time benefit thanks to an agreement with the IRS to settle an audit between 2004 and 2006

Purchased $827m of stock. This year, returned $13.9B through buybacks and dividends, up 33% from previous year.

5:49: CFO Klein is back.

Expectations for next quarter.

PC market: business growth outpace consumer, emerging markets outpace developed markets. So overall revenue will increase in line with PC shipments.

Business Division growth will moderate as Office 2010 anniversary.

S&T: 50% revenue from multiyear licensing, 30% from one-time sales, 20% from services. Multiyear and services will grow <10%, and one-time sales in line with server hardware sales.

Online: ad revenue perform in line with overall online ad market.

Operating expenses: no change.

5:52: Now, FY’12. Business PC refresh cycle will continue through the fiscal year, with similar trends — businesses buying faster than consumers, and emerging markets faster than developed markets.

Search business: we expect to see revenue per search improve. (We’ll see…)

Expect FY’12 op ex to grow 3% to 5%. Based on that growth rate, expect $28.0 to $28.6B expenses. Capex about $2.5B for FY’12.

Now it’s Q&A time.

Q. Gross margin lower than we expected during the quarter, why? FY’12 — do you expect revenue to outpace expense growth?

A. Biggest reason for margin pressure was Xbox growth. Enterprise services and online TAC also contributed (mainly Yahoo).

We don’t give revenue guidance. (They used to, but stopped during the downturn in early 2009 and have never resumed.)

Q. Share buybacks, any more info there? What are you thinking there?

A. We’ve had a good track record, will keep doing it. (Nothing specific.)

Q. Reconcile on PC market — why were you different from Intel?

A. Intel had some unique factors. (See this post for more.)

Q. What’s Business Division growth going to look like after Office 2010 anniversary. Will it slow down?

A. It’s not just Office apps, but also SharePoint, Exchange, Dynamics, Lync, long-term sustainable growth. Office 365 will also help.

Q. What about the new leadership in Server & Tools — Satya Nadella.

A. Background in both cloud services (Bing) and offline, so perfect to lead it.

Q. Can you straighten the record on the Nokia partnership? What’s the impact on COGS?

A. Perfect opportunity for both of us to build compelling, vibrant goods. We are each making investments together.

Wow, Microsoft didn’t even TRY to answer that one.

Q. Can you say anything else about why Online will get better?

A. Revenue per search has to get better. Laser-focused on getting that RPS up. High leverage and margins going forward.

Q. How will services and Office 365 affect COGS?

A. Has driven an increase in multiyear licensing commitments. Having a clear story, partner that can help them transition, has been a driver in conversations with customers. Increased revenue and operating profit opportunity for us, they do have a lower gross margin, but the revenue increase more than makes up for it.

Q. Seems like organic Office growth rate is 8% to 10%. Will it go up or down next year? What do you see with enterprise IT?

A. We’re bullish on enterprise IT, customers like our products. “High-priority area for CIOs.”

Q. When will next Xbox launch? Have you talked about it internally?

A. We’re focused on Xbox 360 and Kinect right now.

Final statement: Financial Analyst Meeting will be held in conjunction with developer conference in Anaheim on Sept. 13. It will supplement developer conference. This is a first.