Microsoft prepares for a mild recession, nothing worse

In another indication that the American information technology industry is better suited to riding out the economic storm than other sectors, Microsoft's forecast for the rest of this year is for slightly slower growth.

Prior to the on-shore strike of an approaching hurricane, you're likely to hear many meteorologists use the phrase, "I'm not a fortune teller," as a way of downplaying expectations about the confidence one may have in their predictions. Over the last week of quarterly earnings reports, the keyphrase uttered almost invariably has been, "We're not economists."

"We're not economic forecasters, and there is a high degree of uncertainty in outlook based on the state of the economy," stated Microsoft CFO Chris Liddell at the start of yesterday afternoon's first fiscal quarter conference call (our thanks to Seeking Alpha for the transcript). This was his way of preparing financial analysts for possible downticks in the company's guidance.

But later, Microsoft gave analysts an unusual shock: While it reset its end-of-year forecast to take into account the possibility of a mild recession on the one hand, and a sustained recession on the other (which makes sense), the company says it's expecting single-digit growth in spending in the enterprise segment...the same segment whose spending last September appeared to have tanked for almost everyone else.

"Even in this environment of softening demand, recent third party research continues to call for growth in overall technology spending, with the enterprise software portion of the spending expected to be up in the high single-digit range," Liddell told analysts.

So for the company's second fiscal quarter -- the final calendar quarter -- Microsoft projects revenues to increase annually by 6% to 9%, which is only slightly milder than the typical holiday season boost an ordinary company may receive on an average year. To give you a sense of scale with respect to Microsoft, however, revenues for the quarter just ended were just over $15 billion, a 9.4% gain over the previous year's fiscal Q1. Now, thanks in large part to the Xbox 360, last year's holiday quarter saw a 30% revenue spike over 2006.

In the last quarter, Microsoft earned the smallest tick under $6 billion. For the next quarter, it expects to earn between $6.1 and $6.4 billion -- about a 4% gain. Now, due to some serious expenses incurred in 2006, last year's fiscal first quarter saw a dramatic 86.6% surge in operating income.

Slower growth is the phrase that describes Microsoft's outlook -- not a recession for the company, even if there's one in the economy. Leading the way for revenue, it believes, will be its Server and Tools division, whose revenue growth it still forecasts as high as 17%, while client operating system revenue could grow as much as 10%. Believe it or not, the company expects its growth rate in online services to be as high as 13% for the quarter, exceeding the growth rate in OS clients -- something that's been historically very difficult for Microsoft to pull off.

How will it pull this off? Liddell said the company intends to implement a cost cutting program that could save the company as much as a half-billion dollars in operating expenses over the coming year. If you're thinking "layoffs," in Microsoft's case, these cost savings have more to do with not hiring.

"This saving can be categorized as follows. Lower headcount related costs as we review the hiring plans, making adjustments to our headcount growth. Lower marketing expenses as we're adjusting our spending plans to correspond to our updated economic outlook. Lower CapEx spend on data centers and other general savings including travel expenses and vendor services. These savings will progressively layer in, translating to economic savings particularly later this year and carrying forward into the next fiscal year as well," stated the CFO.

Later, an analyst pressed Liddell for some hard figures, citing 15% as the company's current rate of headcount growth (at 91,000 employees). "I don't see any scenario where we'll grow by that much this year, by 15%," he responded. "So it would certainly be less than that, and it will be less than what we expect them to grow...coming into the year. What we've done is...we have gone right across the company, every division and looked at areas where we can...have lower priority spending taken out."

Microsoft sold 2.2 million Xbox 360 consoles in the last quarter, a 20% gain over the previous year, due no doubt to the recent worldwide price drop. But revenue in the Entertainment and Devices division declined 6% over the previous year, pretty much as expected -- also due to the price drop -- and the company says it could fall another 5% next quarter.

Structural changes as a means of saving operating expenses, Liddell told one analyst, may be a matter for future fiscal years, as the company is positioning itself for simply turning down the expenditure faucet this year.

"I think we're making the right balance of taking cost out in the short term, but still investing for the future," he said. "As we start to put our forecasts for how we see the environment in fiscal year '10, '11 and so forth, then we have to start making some decisions about more structural change on the expense side as opposed to saving what we have already budgeted for this year."