Live from the Microsoft Q2 earnings conference

The lack of guidance in Microsoft's accelerated earnings report this morning triggered a selloff in stocks on the NASDAQ and NYSE exchanges, and there are indications that the company has suspended trades.

8:57am PT: Call wraps up.

8:57am PT: Jeffries: Slowing buyback to preserve capital, sellers haven't reset expectations, and yet you're adding search jobs?

Ballmer: "I don't think we have anything to say about Yahoo." Advantages that may be done through a search partnership. "I know Carol Bartz from the Autodesk days," maybe a partnership is possible, looking forward to discussion.

Liddell: Clearly if we see an opportunity to buy businesses, one or two per month, we'll take it.

Ballmer: "We've only bought one thing ever over a million-five...We're not big M&A doers in general. Even small M&As get tougher because people don't know how to value their businesses today."

8:55am PT: RBC Capital Markets: To Ballmer, when do you think the Board will take action to review portfolio, divest of certain assets or technologies?

Ballmer: "I like our portfolio. The Board likes our portfolio."

8:54am PT: Deutsche Bank: Consumer vs. transactional vs. annuity breakout of businesses?

Liddell: Annuity was good in first and second quarter. One of the strengths of the business model is the insulation of the annuity business. Non-annuity business strength, remainder actually grew. Results are still lower than expectations, "but we grew revenue 2% [annually] in one of the worst environments we've ever seen."

Resigning rates inside enterprises were in line with historic rates. Very big H2 from a building perspective, opportunity to put more money back in the bank. Stronger historically, will provide cushion in six to 12 months.

Ballmer: We're realizing now contracts that we signed two to three years ago. But renewals may not be at the same dollar value as when the contracts expire. Net income, it takes longer [to realize that decline]. So the ripple-through to annuity will likely happen.

Annuity base changes quarter-to-quarter thanks to Xbox, but varies between 30-40% of revenue.

8:51am PT: J.P. Morgan: Talking about the declining environment, resetting expenses to reflect this, but new guidance for op-ex up meaningfully year-over-year, even adjusting for Q3 2008 charge. No one likes to see anyone get laid off, net 2-3,000 out of 91,000. Are you really resetting expenses to reflect what's out there?

Liddell: Half the year is already gone.

JPM: But your operating expenses are still up, if you exclude the fine.

Liddell: What I describe it as, is a change in the momentum of our expense base going forward. Expenses decline over 18 months instead of over the next few months.

Previous call, said MS would take initiatives over the next quarter. Things did get worse, and we did do more, [as promised]. Yea, we'd all like to take things out instantaneously, but we can't do that as quick as we'd like.

8:48am PT: Credit Suisse: GAAP Op-ex guidance?

Liddell: Several tens of millions, but less than $100 million, depending on the individual circumstances of layoffs.

Oppenheimer: To Liddell, only talking about $1.5 billion of costs coming out, why not take this opportunity to buy back the best investment there is, at least from your perspective?

Liddell: Over the long term, remain committed to buyback activity. Will we continue to be a net buyer of our shares? Absolutely. Outstanding opportunities over the medium-term to buy some of the companies we've looked at? Yes, I do. Opportunities go up, but we're not talking about getting out of buyback activity.

Ballmer: Once tendered for shares at $25 because they looked super-cheap. It's hard to know what the market's going to do in terms of asset values.

8:46am PT: Bank of America: To Ballmer, about headcount reduction, consumer spending and business spending contracting sharply. Headcount leaves operating expenses high. Is MS factoring in a rebound in 12, 15 months, accounting for a possible economic rebound? Or will cost structure be revisited at that time?

Ballmer: "We're not used to down markets." PC market down, "Eight percent is vast for something that's grown a lot...We're simply dealing with unprecedented ground. Our model is not for quick rebound. The economy shrinks, and then it doesn't rebound. It builds from a lower base." (You can hear Ballmer's arms moving in the air at this point.) "So no, we're not expecting a bounce."

"If the economy stays down and then builds slowly, we'll stay at the expense base that Chris talked about...Our basic thing is, things go down and could stay down...one year? Two years? You could see lower total profit percent margins, and that's certainly possible."

8:43am PT: Goldman Sachs: PC growth rate vs. Microsoft growth rate: Delta was 8%, is that reasonable going forward? MS has a sense of "inventory noise."

Ballmer: "I don't think you can pick a magic number. The dynamics shift fairly quickly. My guess is, wherever businesses will reset, that'll be more quickly than where consumers reset. Consumers will reset more volatile...I think unfortunately we're going to see more dynamism in that number."

Liddell: Netbooks may help gain in attach rate, but the bigger shift will be to emerging markets. Expect revenue in Client to be in line with growth rate in traditional PC market, "all the other plusses and minuses will cancel themselves out." Shrank 7-10% in the past quarter, revenue in Client was down 8%, in that range. Same overall trend in the back half.

8:40am PT: Ballmer: PC market is strongest in emerging markets, weakest in business PCs because businesses will simply extend their refresh cycles. "Unfortunately, we're in tough winds, even relative to that mix."

Liddell: We saw a quite different shape in the quarter, December unusually weak. Most companies saw this start to set in, in late November. True for PC market and for business overall.

8:38am PT: Morgan Stanley: Buyback, is the slowing of that activity related to capital preservation, or opportunity to be more aggressive in M&A? High-level thoughts for PC market, piracy, growth in back half of the year?

Liddell: Capital preservation in this environment is more important than it's ever been. Acquisitions, the opportunity to buy other companies "has never been better relative to their price." But given that, the market hasn't lowered its expectations about prices, so Microsoft will still acquire small- to medium-sized business, but activity there relatively low in the next quarter or two.

[feed was cut, stand by]

8:36am PT: UBS: Laying off 5,000, are they all Microsoft employees or are there also outside contractors? Including cash severance charges in op-ex guidance for '09?

Liddell: Outside contractors not included in that number, so other reductions there could be in proportion.

Ballmer: "We may eliminate up to 5,000 jobs, but we're also adding a few thousand jobs. We're talking here primarily about operating expense headcount, as opposed to cost of goods, which varies in its own criteria."

UBS: So you'll cut more outside contractors?

Liddell: External contractors are measured in terms of dollar expenditures, maybe up to 15%.

Cash severance charge not included in operating expenses. Depends on the final number they'll discuss with Stiffel [Nicolaus].

8:34am PT: Q&A session begins.

Citigroup: If fiscal '09 guidance holds, four years in a row of operating margin decline. Is Microsoft moving quick enough to realign?

Liddell: $600 million of costs taken out of Q2 more, $1.5 billion for the year, that's a reaction just in December. Actions were fast and appropriate. Would agree with the margin comment, "but the mix of our business is changing significantly as well." Taking the right degree of action in reducing the cost base.

Ballmer: With our margin structure, we're going to be far more volatile on the upside and the downside with fluxuations in revenue. We have a much larger fixed cost chunk [than a typical manufacturing company]. When revenue is weaker, margin percentages will decline.

Liddell: Travel expenses and vendor costs, taking out 15%, which is broadly the right level given the reset of the economy.

8:31am PT: Office, unit volumes up year-over-year 14%.

Product pipeline, innovation, excited about that. Good market reaction to Windows Azure, Office 14 "in the next year or so." Windows Server 2008 R2 "builds on the strength of Windows Server," no timeline given. "Phenomenal new products to come."

"We'll continue to invest strongly in R&D...at the same time, we are prioritizing, we are focusing on the most important stuff as we continue to move forward."

"The size of this economic dislocation is unprecedented...There is no stopping the forward march of Microsoft. The pause that the economy is imposing on our industry will just be that."

8:29am PT: Three things to focus in on: 1) Innovation. 2) Market share. "Even in a market that is suffering, share increases drive revenue growth." 3) Efficiency, effective resource prioritization and allocation.

"We are long-term...remain incredibly positive. Microsoft, the technology industry, the opportunity for innovation. How can we prioritize, get the same amount of work done for less? We're continuing in an exercise of looking at work processes, driving for efficiency, prioritizing a number of our investments."

Cost base has grown over the past few years, and while Microsoft doesn't want to put the brakes on in '10...it may have to put the brakes on.

Will hire about 1,000 in the search area.

Market share, "we have some great opportunity." Xbox 360, 5 million Windows Mobile units, search volume up significantly. Server & Tools reflects market share improvements in Windows Server, SQL Server. Will continue to invest in Web servers, technical computing, as the company moves forward.

Client, sold north of 50 million units of Windows, another big chunk "was used but not paid for," maybe lost a few points of share as Apple Macs sold 2.5 million in the same period. Great plans for Windows 7 going forward, people will re-evaluate the Mac premium, as reviewers have started to note. Netbooks, from 0% to 80% and climbing.

8:25am PT: Steve Ballmer, CEO: "We're certainly in the midst of a once-in-a-lifetime set of economic conditions...The perspective I would bring is not one of recession. Rather, the economy is resetting to a lower level of consumer spending, based on the lower level of leverage in the economy." Foreclosures not helping. Reduction of business' capital expenditures, a 50% chunk of which is I.T. Neither consumer nor business side of economy is immune to these conditions.

8:23am PT: "The economy has clearly deteriorated more than we expected." Fiscal '09 operating expenses $27.4 billion. Maintain broadly flat into fiscal '10.

EPS tax rate 26.5% for the year, income negatively affected by negative market movements. Stock repurchases over the long term, but that activity will slow in H2 '09.

8:22am PT: Server hardware market is expected to decline over H2, so annuity licensing (in WS2K8) may grow faster than IT spending, but still be pressured by contracting market.

Advertising market will continue to worsen. Hit from the impact of foreign currency in H2.

Entertainment and devices dependent upon consumer spending, but a shrinking environment will likely trigger console revenue declines. Attach rates will moderate, software and peripheral revenue will follow that trend.

8:21am PT: Chris Liddell on business outlook, guidance: "Clearly the volatility in the macroeconomic climate creates uncertainty for the rest of the fiscal year."

Macroeconomic variables prevent the company from providing quantitative guidance.

PC market is the driver for client revenue, and will remain weak up through H2 2009. Netbooks will help save the day. But as the economy slows, inventories will contract. Client revenue will perform in line with traditional PC market (expect more declines).

Business revenue will be impacted by decline in non-netbook PC sales. See the same general alignment, which may include declines in H2. SharePoint, Unified Communications may help offset declines.

8:18am PT: Cost of goods sold is higher, but operating expense growth rate is significantly slowed. Operating income was only $174 million below guidance despite $712 million in revenue below guidance.

Effective tax rate for the quarter 26%, one-half-point lower than guidance.

Earnings per share 47¢, decline of 7%.

8:16am PT: Business Division revenue +1%, business revenue +7% due to Office, SharePoint, client access license. Non-annuity revenue declined due to small business, consumer segments, -23%. SharePoint, Office Communications Server, CRM grew at double-digit rates. Final versions of Exchange Online, SharePoint Online delivered. Promise to deliver Office experiences through the browser.

Xbox 360 sales +41% worldwide, outselling PS3 two-to-one. Software attach rate is 8.1 : 1. Xbox Experience received extremely well. Increases appeal, durability of the platform. Xbox Live membership +70%.

8:14am PT: Netbook attach rates exceeding 80%, meaning four out of every five netbooks sold have Windows pre-installed. (Unsaid, a lot of those are XP.)

Windows 7 public beta "great reviews to date." Remain positive about client product pipeline.

Server & Tools +13%, 26th consecutive quarter of double-digit growth. SQL Server 2008 and Hyper-V drivers, plus System Center administrative tools. Growing faster than the hardware market.

Support services for deploying Microsoft software +16%.

Windows Server 2008 R2 will add live migration, further enhancing that offering. Windows Azure hosted in Microsoft data centers, premiered at PDC 2008. Reiteration of Azure features.

Online services $866 million revenue, flat. Advertising revenue +17%. Healthy growth in traffic, with page view and query searches up year-over-year. Partnerships with Dell and Sun Microsystems.

8:11am PT: Bill Koefeod: Windows Client revenue declined 8% to $4.0 billion. Overview of PC market: PC market was flat year-over-year, short of 10-12% growth forecast. Traditional PCs declined 10% in business, consumer segments, offset by netbook growth. OEM bookings declined 1%.

The decline in PC sales drove double-digit declines in consumer and premium SKUs.

8:10am PT: Revenue +2% to $16.6 billion, lower than expected. 30% OEMs, 25% licensing, 20% from license-only sales, balance from other businesses. Annuity-based business +1%. Enterprise renewal rates in line with historical trends.

8:09am PT: Significant number of product releases over the next two calendar years.

8:09am PT: Promise to manage expenses more thoroughly going forward, accelerated expense reduction program. Cost reductions of $600 million above expectations.

Reiteration of all the departments in which Ballmer earlier mentioned headcount cutbacks.

Cumulative results: $1.5 billion operating expense savings by July 2009 as a result of headcount cutbacks. There will by July guidance, apparently, later on this call.

8:07am PT: Chris Liddell, CFO: "Our second quarter results reflect a difficult environment..." Wasn't able to offset the sharp decline in PC market sales, but the rapid growth of netbooks compensated. Online services revenue was flat, Entertainment & Devices record numbers thanks to record Xbox 360 sales.

8:04am PT: Boilerplate warnings have begun.

8:00am PT: Certainly more by accident than design this morning, the lead-in music to CEO Steve Ballmer's morning conference was a song whose lyrics are, "Take a look at me now...There's just an empty space..."

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