Microsoft Also Needs Cleaning Up

Microsoft’s (MSFT) woes continued this quarter as was evident from their Q2 results announced yesterday.

Q2 revenue of $16.6 billion recorded annual growth of only 1% and sequential growth of 10%. The market was looking for revenue of $17.1 billion. EPS of $0.47 was also 2 cents shy of the market’s expectations. EPS dropped one cent sequentially and 6% over the year. This was also the fourth consecutive year of margin decline for the company.

By segment, Clients Division revenue declined 8% over the year, primarily due to softness in PC sales. Revenue from Microsoft Business Division and Server and Tools divisions grew 7% driven by demand from enterprise customers. Microsoft’s entry into the hypervisor arena seems to be yielding good results. Their Online Services business revenue was flat, although online advertising revenue grew 7%, while the Entertainment and Devices division grew over 3%, driven by record sales of Xbox 360 consoles.

The company’s commitment to cost-effective flexible data centers in the quarter was evident in the preview of the cloud-based services platform, Windows Azure. The Azure services platform hosted in Microsoft data centers provides an operating system and a set of developer services that can be used to build/enhance cloud applications.

Microsoft is expecting revenues and earnings to decline further in the first half of the year. This is despite their announcement of 5,000 job cuts in addition to lay-offs of contract employees.

To get back on track, they are focusing on three key areas. First, innovation with products such as Windows Azure, Office 14 and Windows 7. Second, market share, which they have been improving through Xbox sales and the hypervisor market. And third, efficiency and effective resource prioritization through rightsizing and careful evaluation of all investments.

Microsoft did annual revenue of $60.4 billion in 2008, and has over $15 billion in free cash flow. They need to start acquiring some futuristic businesses. Here is a shopping list I had identified earlier. In particular, they need to beef up their SaaS portfolio, as well as their Vertical Search portfolio, if they want to defend against Google’s increasing dominance and take apiece of the online pie.

On the negative side, Vista is the best thing that ever happened to Apple, so Microsoft is extremely vulnerable in its core franchise.

The stock fell 12% and closed at $17.11, a 5-year record low.