As Microsoft readies Q2 earnings report, non-financial questions swirl

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Microsoft will detail its second quarter financial performance on Thursday, but it’s not clear whether the company will take the opportunity to also clear up some of the uncertainty over key products and corporate changes.

Take Windows. In recent months, there has been speculation about the future direction of the OS, after the mixed reception for Windows 8 and its 8.1 update. It’s not clear whether Microsoft will try to further fine tune the OS with an 8.2 update or instead focus on its next major version, which outsiders refer to informally as Windows 9. Although Microsoft addressed some of the main Windows 8 complaints in 8.1, the update has suffered from a series of bugs of varying severity since its release in mid-October.

Another open question around the OS is whether Microsoft will in the long run retain both Windows Phone and Windows RT—the Windows 8 version for ARM devices—or merge their code bases into a single mobile OS.

While speculation over the future direction of Windows gathers steam, many companies that still have XP on most or some of their PCs fret over the end of its support in April. “There are plenty of frustrated CIOs holding the bag on instances of XP they can’t get rid of for valid reasons, now fuming at the cost of dealing with its obsolescence. All of this as Ballmer leaves the building,” said Forrester Research analyst David Johnson via email, referring to CEO Steve Ballmer’s plan to retire this year.

Then there is the much anticipated version of Office for non-Windows tablets, which executives have said is in the works but hasn’t yet materialized. There is a lot of interest among iPad users in particular to have a full, native version of Office for the Apple tablet.

Other issues

And as Microsoft boosts its efforts to build its own hardware, the Surface 2 tablet hit another rough patch recently due to a faulty firmware upgrade, the latest in a series of mishaps affecting the Surface family, which is key to the company’s ambitions to significantly expand its device business.

Surface Pro 2 Robert Cardin

Microsoft put out a firmware patch for Surface Pro 2 in the past week, but the company has suffered some missteps with its tablet lineup.

At the end of its fiscal year in mid-2013, Microsoft took a $900 million charge due to the anemic sales of the Surface RT models, and that first generation of Surface tablets got a lukewarm reception in the market in general. The Surface 2 models have been better received.

In corporate matters, it’s not clear at what stage of completion the major reorganization Steve Ballmer unveiled in July is. Dubbed One Microsoft, it’s intended to make the company operate more cohesively by eliminating in-fighting among the different product teams.

As part of the restructuring, Microsoft dissolved its five business units—the Business Division, which housed Office; Server & Tools, which included SQL Server and System Center; the Windows Division; Online Services, which included Bing; and Entertainment and Devices, whose main product was the Xbox console. It replaced them with four engineering groups organized by function, around OSes, applications, cloud computing and devices, and by centralized groups for marketing, business development, strategy and research, finance, human resources, legal and operations.

After the reorganization, Microsoft also introduced a new format for breaking down its quarterly financial results that some critics feel makes it harder to pinpoint how key products like Windows and Office are doing in terms of sales. That new format made its debut in the first quarter earnings report.

Who leads Microsoft

Probably the biggest open question of them all is who will replace Ballmer, who said about five months ago that he would retire at some point before the end of August of this year. Early speculation after Ballmer’s bombshell announcement was that Microsoft’s board would appoint his replacement sooner rather than later, as pundits bet that the new CEO would be in place prior to the first quarter earnings report in October. When that didn’t happen, rumors arose that Ballmer’s successor would be named before 2013 closed. Wrong again.

Microsoft CEO Steve Ballmer

Microsoft continues to look for a replacement for Steve Ballmer, who announced his retirement last year.

As the search continues, there have been reports that some possible candidates have taken themselves out of the running, concerned that Ballmer and co-founder and Chairman Bill Gates would exert too much influence. All along the guessing game has continued in the media, becoming a sideshow Microsoft could do without, especially the initial flurry of speculation over whether Ballmer decided to retire or was pressured to leave.

Clearly it hasn’t been easy finding qualified candidates with the required skillset and experience to lead Microsoft, which has a very broad and varied family of products, ranging from the Xbox gaming console to high-end server software for businesses, and which faces complicated business and corporate challenges, including the integration of Nokia’s smartphone business once that massive acquisition closes. Microsoft is also navigating a tricky shift from being a provider of desktop and on-premises server software to becoming a provider of hardware devices and cloud computing services.

Recently, Alan Mulally, Ford’s CEO, considered a front-runner candidate, stated that he would stay put leading the car company.

Forrester’s Johnson said he expects Microsoft on Thursday to position lagging Windows 8.x sales as solid and on track with internal targets, and to report good results from the server and cloud computing product lines.

He also thinks Microsoft will drop “teasers designed to incite interest at what to expect with Windows 9” as well as an update on the CEO search process.

Microsoft’s outlook

The consensus expectation from Wall Street analysts polled by Thomson Financial is for Microsoft to report revenue of $23.68 billion and earnings per share of 68 cents. Last year, second quarter revenue was $21.46 billion and EPS was 76 cents.

In a research note published Tuesday, Morgan Stanley analysts wrote that Microsoft’s “top-line should be good, but at a cost to margins.” They said a solid launch of the new Xbox One gaming console and “some momentum” around Surface 2 tablets could result in Microsoft topping Morgan Stanley’s $23.7 billion revenue expectation.

The analysts expect Microsoft to report Surface sales of 1.4 million units, up from an estimated 900,000 last quarter, driven by the Surface 2 rollout, although they point out that still puts the Microsoft product at below 5 percent of the overall tablet market. But despite sales of about 3 million Xbox One units, Morgan Stanley sees margin pressure in the devices market segment overall, affecting Microsoft negatively.

“Looking ahead, waning expectations around potential impacts of a new CEO, execution risk around Nokia and near-term model disruptions stemming from business model changes leave us on the sidelines,” the analysts wrote.

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