Ballmer Provides Grim Outlook as Economy 'resets'

Speaking to financial analysts on the heels of Microsoft's announcement of layoffs and a disappointing second quarter, CEO Steve Ballmer referred to current economic conditions as an entire recalibration that means the economy likely won't return to its previous prosperity.

"As things go down, they reset," Ballmer said on a conference call Thursday. "The economy shrinks and then it doesn't rebound, it rebuilds from a lower base. We're not expecting a bounce."

Ballmer also predicted it could take a year or two for the economy to improve, and that Microsoft is prepared to keep its priorities tight and its costs conservative for the long term.

Microsoft announced its fiscal 2009 second-quarter earnings before markets opened on Thursday instead of waiting for markets to close, as the company typically does. In addition to a quarter in which net income fell 11 percent year-over-year, the company also announced it would lay off 5,000 employees.

However, on the conference call, Ballmer said the company would also add a few thousand jobs, particularly in areas of strategic investment, such as search. "Even as we take out 5,000 jobs, we'll be adding a few thousand jobs as in areas like search, where we see an incredible opportunity to do good work," he said.

Ballmer tried gamely to focus on the positives of the business, while being realistic about the current economic crisis.

"Certainly the size and scope of this economic dislocation is unprecedented," he said. "It may delay some technology adoption in the technology industry at large. But I don't think there's anything stopping the forward march of our industry and Microsoft. The pause in our economy is imposing but will certainly be just that -- it's a pause."

Among the bright spots for Microsoft in an overall disappointing quarter were double-digit growth in revenue from its Office SharePoint and Communications Server products, as well as its Microsoft CRM (customer relationship management) enterprise software. Microsoft's Server and Tools business also had its 26th straight quarter of double-digit growth. And Microsoft's online advertising revenue, long a weak spot for the company, grew 7 percent, although growth in Microsoft's Online Services Business (OSB) was flat overall.

Microsoft's Entertainment and Devices business also was bolstered in the quarter by holiday purchases of its Xbox 360 console, with a record 6 million sold in the quarter, said Microsoft Chief Financial Officer Chris Liddell. However, he warned that there could be a fall-off in sales if consumer spending continues to be down.

Despite these high points, both Ballmer and Liddell overall painted a grim picture. Liddell reiterated Microsoft's earlier announcement that the market is too volatile for the company to accurately forecast its earnings for the remainder of the fiscal year, which ends June 30.

Liddell did, however, provide some key market drivers that would indicate how Microsoft's financial performance might be in the next two quarters.

The biggest problem for Microsoft's business is the forecast for PC sales, which touches several parts of its business, including its Windows client, Server and Tools and Microsoft Business Division revenues, Liddell said.

Microsoft had expected 10 percent to 12 percent growth in the PC market but instead the market was flat, which is why Microsoft's client business did so poorly in the second quarter, Liddell said. "It weakened much more quickly and severely than expected," he said.

Microsoft's Windows client revenue fell 8 percent in the quarter, as PC sales slumped and buyers turned to low-cost netbooks.

Outlook for Microsoft's OSB going forward also will be bleak as "advertising spending will likely remain weak until the economy starts turning," Liddell noted.

Still, Microsoft has a strong annuity-revenue business that will keep some parts of its business "somewhat insulated from macro trends," he said.

Annuity revenue is any revenue that is recurring, such as from ongoing subscriptions or long-term contracts. Companies can count on such revenue and factor it into financial outlooks ahead of time.

Gartner analyst Neil MacDonald also cited Microsoft's annuity business as something that could shield the company from the economic damage other technology companies may still experience.

"Microsoft has a better model, at least with the mix of consumer and business revenue and mix of annuity and nonannuity revenue, than the typical company would," he said.

Microsoft's second-quarter results also show again how dependent the company is on revenue from its Windows client business for the overall financial health of the company. To offset this, MacDonald suggested Microsoft find a way to base more of its Windows business on an annuity model going forward.

"Today you buy Windows one time on a nonannuity revenue stream -- it's highly volatile," he noted.

On top of its financial woes, financial analysts questioned Microsoft's credibility on Thursday, with some noting the company should have preannounced earnings as soon as it knew it was going to miss expectations rather than wait until Thursday to break the news.

Not surprisingly, Microsoft stock was down nearly 10 percent following the call, trading around US$17.45 after opening the day at $18.02 and reaching $19.38 before a post-call sell-off.

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