Microsoft Knuckles Down for Hard Times

[Editors Note: Because of today's stunning early earnings announcement and news of layoffs, I will blog on the now and future first. My usual "by the numbers" look at Microsoft earnings will come later in the day.]

The first layoffs come today, 1,400 employees, with Microsoft planning to cut as many as 5,000 over 18 months. Cuts will come in the areas of finance, human resources, IT, legal, research and development, and sales. But the layoffs are not necessarily as severe as they might appear.

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During a conference call this morning, Microsoft CEO Steve Ballmer said that the layoffs will come in areas where Microsoft must make hard decisions. "Now is the time to ask critically which investments should be prioritized." He emphasized that Microsoft "will add thousands of jobs in areas like search."

Later, Steve reiterated that while Microsoft will lay off some people, others will be hired. How I read between the lines: Some people may be moved from one position to another, without there necessarily being a lost employee.

Anonymous Microsoft employee blogger Mini-Microsoft described the 1,400 layoffs as a "drop in the bucket." He's right about that. Microsoft employed about 96,000 people before the layoffs. I would describe the layoffs as more of a bloodletting for Wall Street's benefit, particularly in context of Steve's statements about hiring more people in some areas.

The layoffs do not include Microsoft contractors, whose numbers could be even higher, Chris Liddell, Microsoft's CFO, indicated in response to an analyst question.

Microsoft has frozen pay raises, in conjunction with today's cost-cutting measures. Microsoft expects the measures to reduce operating expenses by $1.5 billion and, for fiscal 2009, capital expenditures by about $700 million. Other measures include curbing stock repurchases to preserve capital.

Steve described the current economic crisis as a "once in a lifetime" event. He said this is no recession, but, rather, the economy is "relocating." Later he emphasized that the "economic dislocation is unprecedented."

Sluggish sales in October and November literally stalled in December, when Microsoft saw a dramatic change. "The economy has clearly deteriorated more than we expected," Chris said.

Coming into the quarter, analysts closely watched PC sales as a measure of Microsoft's quarterly results. Last week, I cautioned that slowing PC sales didn't have to be bad for Microsoft. That's still my assessment, which I will further explain based on actual results in a later post today.

For now, some quick and important numbers: Microsoft's Client business revenue declined 8 percent year over year during fiscal second quarter, which was the same as the holiday fourth quarter. The revenue decline is significant, considering holiday sales typically lift revenue.

"We're not used to down markets. Eight percent is vast for something that traditionally has grown a lot," Steve told financial analysts late this morning. Microsoft had forecast that worldwide PC shipments would grow 10 percent to 12 percent during the quarter, when they instead were flat.

But revenue declines just weren't about slowing PC shipments. Microsoft also took a hit from increased sales of consumer Windows versions, which was spurred in part by increasing netbook sales. Steve said that consumer sales and those to emerging markets showed some resilience, but were "weakest in business PCs."

Microsoft "sold north of 50 million units of Windows" during the quarter, Steve said. But he conceded that Windows PCs lost "a few points" of share to Macs. Yesterday, Apple announced recorded fourth calendar quarter earnings.

Microsoft didn't offer guidance for the remainder of fiscal 2009, which ends June 30. That's unprecedented and shows how volatile the company perceives the economic crisis to be. During his opening comments on today's conference call, Steve explained how with capital markets essentially frozen, the economic recovery will be market changing.

As such, later, in describing Microsoft's plans and limited guidance given today, Steve said: "Our model is not for a quick rebound. The economy shrinks and builds from a lower base respectively."

Layoffs and other cost-cutting measures could have been more severe if not for annuity licensing, which varies from 30 percent to 40 percent of revenue, depending on the quarter. For some divisions, the percentage is much higher. Example: business, where annuity licensing accounts for 55 percent of revenue, making the division's revenue "somewhat insulated from IT trends," Chris told financial analysts.

The question: What about licensing contract renewals? Chris said that Microsoft expects a typically "big second half from a billing perspective," which means there is much money on the line. For now, volume-licensing renewals are typical, meaning no decrease.

But there's a problem, which Steve surprisingly volunteered to explain. In the United States, many companies have been laying off employees and instituting their own cost-cutting measures. "Even if they're renewing their contracts, they're not renewing at the same level." That means less revenue for Microsoft off the same contracts. Steve said the reductions would "ripple through the annuity business."

[Please send your tips or rumors to watchtips at live.com].

Related Posts:

• Steve Ballmer's Memo on Microsoft Layoffs, Microsoft Watch, Jan. 22, 2009
• Quick Take: Microsoft Earnings, Layoffs, Microsoft Watch, Jan. 22, 2009
• What 2008 PC Sales Mean to 2009, Microsoft Watch, Jan. 15, 2009
• How Much Microsoft Tax Do You Pay?, Microsoft Watch, Jan. 12, 2009
• Can Microsoft Sell Value in Tough Times?, Microsoft Watch, Jan. 12, 2009
• When Mini Speaks Layoffs, I Believe, Microsoft Watch, Dec. 22, 2008
• Vista: Now Microsoft Can Blame the Economy, Microsoft Watch, Dec. 10, 2008
• What Happens If Microsoft Warns?, Microsoft Watch, Dec. 8, 2008