Anyone who would continue to frame the consumer PC market in 1980s terms, as a continuance of the old war between Microsoft and Apple, would be sorely disappointed by this morning's earnings news from Microsoft. The measured candor that continues to emerge from CFO Chris Liddell suggests that Macintosh and iPhone are not even on the company's radar at the moment, and that his real battle is against a tougher and more menacing foe: Vista.
As of yesterday, it was officially okay for Microsoft to pronounce Vista part of its past, to "un-support" it from a marketing standpoint (though certainly not from a service standpoint). Steering Microsoft clear of the perfect storm -- the effects of the global recession, coupled with the peak in negative attitude toward Vista -- means putting Vista behind it, placing it in the adversarial role normally characterized by someone who looks a lot more like Justin Long than John Hodgman.
If Microsoft had continued on its unprecedented downward slope, as it was forced to report on last July, analysts might have concluded the company was in a recession of its own -- a kind of corollary of the "two consecutive quarters of decline" rule normally applied to the country's economic state. But the slope was not so down this time, and literally all the credit was bestowed upon the company's newest, bravest warrior, Windows 7.
"To put the quarter results into perspective, Q1 represented the highest number of Windows licenses sold in one quarter, ever," pronounced Investor Relations GM Bill Koefoed, "and September was the highest single month of Windows unit sales ever. In summary, it was a very solid quarter for the Windows division; and with Windows 7, we have a great product for the recovering PC market."
During the low point of the economic crisis, what kept the PC market from collapsing altogether was the ability to shift its product mix towards netbooks -- the lowest-priced segment, but certainly the lowest-margin end of the business as well. As Microsoft CFO Chris Liddell reported, netbooks went from 0 to 12% of the overall consumer PC market in just one year's time. During that same year, Windows was able to find itself installed on 90% of those systems.
"Find itself" is actually a very accurate phrase, because this wasn't really what Microsoft intended, and it actually became something of a real problem. At a time when the company needed to tout Service Pack 2 as the life saver for Vista, the netbook surge presented consumers with the single biggest confirmation of Vista's inadequacy to date: the presence of Windows XP, not Vista, on nearly all of those netbooks.
"People are clearly willing to pay for having Windows on their netbooks, so that's the first and most important fundamental," Liddell told a Deutsche Bank analyst this morning. "Then in terms of Windows 7 reaction, clearly [we've] yet to see, but early indications in terms of the OEM builds that we're having, and the mix that they're putting in terms of Windows 7, is encouraging...in terms of their expectations of the number of people who are going to want to see a Windows 7 on their netbook as opposed to an XP. In terms of the ASP [average selling price], clearly it's almost twice on Windows 7 what it would be on XP, or a significant premium...So it's going to be beneficial, but I think it's more important symbolically from our point of view that people see value in Windows 7 and are willing to pay for it. Netbooks, even though they've grown fast, are still a relatively small component of the overall demand, so it's not going to have a massive financial impact, but it'll certainly help in terms of ASP comparisons year-over-year, if we get the sort of good attach of Windows 7 that we're starting to see in the early days."
As it did during Vista's premiere, Microsoft has opted to defer about $1.5 billion of revenue from pre-orders of Windows 7 from OEMs and retail customers, until the following quarter. Still, the activity surrounding Win7 in this past quarter indicated that the period of time in which customers were deferring their operating system investments had clearly ceased. Operating income from its client division, now called the "Windows and Windows Live" division (reflecting the realignment of online software around the core product, and away from online services like Bing), dropped only marginally on an annual basis to $2.81 billion, on revenue just 3.3% lower at $3.98 billion. With Server & Tools and Entertainment & Devices income slightly higher on the year on revenue that was basically flat, the company was able to sustain a huge hit from the declining value of its stock awards -- essentially a $2.2 billion write-down.
So total income was down about 25.3% annually to $4.48 billion -- not good, but not unexpected in the wake of last quarter. And besides a little bit of credit given to the success of Halo 3 on the Xbox 360 game platform, Windows 7 enthusiasm was credited for keeping income from business operations stable.
"What I think we're seeing is the robustness of the concept of a PC," Liddell told an RBC Capital analyst this morning. "Even through an economic reset, it's something that people want to spend money on, and I think that gives us confidence in the sort of long-term trend, the long-term ability to have good, potentially double-digit growth in PC demand. That's clearly helped by the fact that we've got new form factors, Windows 7 helps clearly. You're just seeing a general positive trend on a long-term basis [for] a reset."
The next battlefield for Microsoft will be getting Vista off of business desktops and notebooks. Toward that end, the cards could finally be stacked in Windows 7's favor, for reasons Liddell alluded to today. Existing business PCs can be perceived as slow, for either of two reasons: If they're five years old or more, they're probably single-core. And if they're newer than that, they're probably stuck with Vista. Either way, they're slow, and that perception may play into business' decision to make a PC investment during calendar year 2010.
At least maybe. "The big variable in my mind is business PCs," stated CFO Liddell candidly. "That's been a significant negative, that's decreased double-digits over most of the last few quarters, and it's dragged down the numbers. That can't continue forever. Eventually those PCs wear out and have to be replaced, so the big variable in terms of rebound is going to be the strength and speed of the business PC refresh cycle. We hope and expect that to be next year...We're probably still relatively cautious, but when you start to see a rebound in that, plus what you're seeing in the consumer side, we feel pretty good about what we see demand's going to look like in the next calendar year."
Liddell did let something slip a bit when he said that revenue for the Business Division should recover in the near term when business spending in general recovers, "combined with the impact of Office 2010." That's a product whose release window even now is the entire next year, but Liddell's framework seems to put O10 someplace closer to late second-quarter, early third-quarter.