Microsoft Corporation (MSFT)
Q2 2009 Earnings Call Transcript
January 22, 2009 11:00 a.m. ET

Executives

Bill Koefoed – General Manager, Investor Relations
Steve Ballmer – Chief Executive Officer
Chris Liddell – SVP & Chief Financial Officer
Frank Brod – Chief Accounting Officer
John Seethoff -- Deputy General Counsel.

Analysts

Brent Thill – Citigroup
Heather Bellini – UBS
Adam Holt – Morgan Stanley
Sarah Friar – Goldman Sachs
Kash Rangan – Bank of America.
Philip Winslow – Credit Suisse
Brad Reback – Oppenheimer & Co
John Difucci – JP Morgan
Todd Raker – Deutsche Bank
Robert Breza – RBC Capital Markets
Katherine Egbert – Jefferies & Co

Presentation

Operator

Welcome to the Microsoft fiscal year 2009 second quarter earnings call. Today’s call is being recorded. If you have any objections, you may disconnect at this time. I would now like to turn the call over to Mr. Bill Koefoed, General Manager Investor Relations. Sir, you may begin.

Bill Koefoed – General Manager, Investor Relations

Thank you, operator, and thanks everyone for joining us a little earlier than normal today for Microsoft’s second quarter 2009 earnings conference call. We decided to align the timing of the earnings release this quarter with the cost management initiatives that we announced this morning. We will talk further about these initiatives later on the call. I am delighted today to be joined by Steve Ballmer, our Chief Executive Officer, as well as Chris Liddell, Senior Vice President and Chief Financial Officer; Frank Brod, Corporate Vice President and Chief Accounting Officer; and John Seethoff, Deputy General Counsel. The format for today’s call will be as follows. Chris will summarize some of the key takeaways for the quarter, as well as address the announcement we made this morning. I’ll then provide details around our second quarter results and then hand it back to Chris for a more detailed discussion of our business outlook, and then Steve will make some comments. After that, we’ll take some questions.

Please be aware that we filed our Form 10-Q today in conjunction with our earnings release. We have also posted our quarterly financial summary slide deck, which is intended to follow the flow of our prepared remarks, as well as provide a reconciliation of differences between GAAP and non-GAAP financial measures that we will talk about today. You can find these documents on the Investor Relations website at www.microsoft.com/msft. Today’s call will be webcast live and recorded. Please be aware that if you decide to ask a question, it will be included in both our live transmission as well as any future use of the recording. A replay of the call will be available at the Microsoft Investor Relations web site through the close of business on January 22, 2010. This conference call report is protected by copyright law and international treaties. Unauthorized reproduction or distribution of this report or any portion of it without the express permission of Microsoft may result in civil and criminal penalties.

We will be making statements during this call that are forward-looking. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially because of factors discussed in today’s earnings press release, in the comments made during this conference call, and in the risk factors section of our Form 10-Q, our most recent Form 10-K, and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statements.

And now, I’ll return the call over to Chris.

Chris Liddell – Chief Financial Officer

Thanks, Bill, and again thanks to all of you for accommodating our timing changes. Our second-quarter results reflect a difficult environment as the global economy continued to deteriorate beyond our expectations, particularly during the month of December. Despite this economic backdrop, we were able to grow revenue and utilize accelerated cost reductions to offset the majority of the impact of the revenue shortfall on operating income. On a segment basis, our client business, being the most severely impacted by the softening economy, declining 8% due to the significant weakness in the traditional PC market sales, partially offset by the rapid growth of netbooks. Revenue from Microsoft business division and Server and Tools divisions grew a combined $500 million or 7% driven by healthy demand from enterprise customers while the transactional aspects of these businesses were impacted by lower PC and server hardware unit sales. Our online services business revenue was flat, although online advertising revenue was up 7% in a tough environment. And entertainment and devices division delivered revenue above the high end of our guidance driven by a record number of consumers purchasing Xbox 360 consoles during the holiday season.

Against the backdrop of a deteriorating economy, we are focused on the need for fiscal discipline and on executing in the areas we can control by managing expenses while delivering on the next wave of our product pipeline. During the second quarter, as the economic outlook continued to slow, we accelerated our expense reduction plan. These actions allowed us to deliver operating expenses in the second quarter $600 million below our October forecast. However, today we have also announced steps we will take to further manage our cost structure. These steps include a reduction in headcount related costs, including plans to reduce up to 5,000 positions in the areas of research and development, marketing, sales, finance, legal, human resources and IT over the next 18 months, of which 1,400 are effective today. There will be no pay raises next fiscal year.

We have plans to significantly reduce our vendor and contingent staff expenses. We’ll also be looking for reductions in marketing expenses, reduced capital expenditure and facility costs, as well as tighter discretionary spending, including significantly reduced travel related expenses. The cumulative result of these actions taken during the quarter and those announced today will result in operating expense savings of $1.5 billion and capital expenditure savings of $700 million lower in this fiscal year ‘09 than assumed in our July guidance. Lastly, we plan to manage operating expenses broadly flat in the fiscal year ‘10 and capital expenditure to be lower year-over-year. While we are managing our expenses tightly, we continue investing in key strategic opportunities which will fuel the future growth of the company. We have a strong product pipeline and are bringing to market a number of significant product releases over the next two calendar years.

With those high level themes, I will turn the call over to Bill for more details on the second quarter.

Bill Koefoed

Thanks Chris. I will discuss top line financial and business momentum points followed by revenue performance for each of the business units. Then I’ll review the rest of the income statement. All growth comparisons relate to the comparable quarter of last year unless otherwise noted. Revenue grew 2% to $16.6 billion, which was below our low end guidance as the economic environment weakened further than we expected, particularly in the month of December. Our mix of product billings was approximately 30% from OEMs, 25% from multi-year licensing agreements, 20% from license only sales, and the balance from our other businesses. Despite the broad economic weakness, the annuity portion of our volume licensing business remains healthy and increased one percentage point in our billing mix. Enterprise agreements renewal rates were in line with historical trends.