Microsoft announced quarterly revenues of $12.9 billion, a decline of just over 14 percent from the same period a year ago. Adjusted revenue, which accounts for $1.5 billion in deferred Windows 7 receipts put the quarter at $14.4 billion, just 4 percent down vs. a year ago. Profits were also down. Online services (where Bing is housed) had revenues of $490 million and a $480 million loss vs revenues of $520 million and losses of $321 million a year go.

The conference call is going to start in a few minutes but the company’s slides highlight strong Windows (7) and Xbox demand. PC growth was up 2 percent compared with a year ago but up in the “mid teens” vs. the previous quarter. There have been concerns that the movement of the consumer market to lower-cost PCs and netbooks is going to hurt Microsoft over the long term.

The company also highlights that Bing “market share in US up every month” and “US search revenue up mid-single digits.” For the rest of the year Microsoft predicted growth in Online Services but said that entertainment and devices would be flat.

Microsoft is a hugely profitable company with tons of cash and it will continue to be a force in the markets it competes in. However it faces more competition and greater vulnerability in some of its core markets than in the past. And in the strategic area of mobile it’s not been able to match competitors with its offerings. Windows 6.5 has received tepid reviews at best in contrast to Android, which now has as much or more buzz in the market than every competitor save the iPhone.

Failure by Microsoft to improve its Mobile OS and better compete against the iPhone, RIM and Android will put the company at a long-term strategic disadvantage.

Here’s an interview between the Wall Street Journal and Microsoft CEO Steve Ballmer in which he says, as one might expect, many positive and optimistic things about Microsoft’s competitive position and the future.

Appropriately top Microsoft executives, coming off  the “worst year ever” for the company, are sharing some of the pain. As PaidContent reports, the top executives at the company took a compensation hit based on the sales and revenue declines. Here are some of the numbers:

• CEO Steve Ballmer $1.265 million vs. $1.34 million a year ago
• CFO Chris Liddell: $3.5 million vs. $4.8 million
• COO Kevin Turner: $5.4 million vs. $8.6 million
• Entertainment and Devices President Robbie Bach: $6.2 million vs. $8.3 million

The snark impulse is pretty strong and I’m trying not to write something very sarcastic about struggling to get by on $3.5 million — but I won’t.

This is appropriate action for the company at a time of underperformance. If you really want to dig into these salary figures you can read the SEC filing (page 16).

eBay has announced they have hired Dr. Eric Brill as their vice president of research and applied science to lead up eBay’s research labs team. Prior, Dr. Brill was General Manager of adCenter Labs at Microsoft and before that, he Director and Principal Researcher and head of the Text Mining, Search and Navigation Group at Microsoft Research.

Microsoft has quietly pulled his bio page but Google still has a cached version.

“Search is all about predictions, highly educated guesses about what people really mean when they type in a word like Diesel or a phrase like ‘red, white and blue’,” said Mark Carges, eBay’s CTO and SVP of Marketplaces Product. “Eric’s expertise in natural language processing and data mining is a huge asset as we continue to improve our ability to determine customer intent and get the right products in front of the right buyer at exactly the right moment.”

Ten days ago, we reported that Antonio Gulli left Ask.com after 4 years heading up their technology team in the European R&D center. Gulli announced his new plans are to continue in search, but switch ships and work for Microsoft Bing.

Gulli said he will be “leading all the engineering development for UX and verticals in Europe,” focusing on Microsoft Bing’s search technology and user interface. He will be working at Microsoft’s London site of STC Europe nearby Carnaby Street.

What I found most interesting about his announcement post was that he, in not so many words, explained that he now has the resources needed to make a difference in search. The way I read it was that he felt that at Ask.com, he didn’t have enough resources to accomplish his goals. Gulli said that at Microsoft “you get the resources to experiment with it.”"Search is all about continuous improvements and evolutions, isn’t it?” Gulli added.

Congrats on the new job Antonio, it seems like you will be happy at Microsoft.

Those with BT broadband in the UK have noticed that the Yahoo/BT portal at bt.yahoo.com has a new search technology provider. You would guess that if Yahoo would replace their own search technology, it would be in exchange for Bing, in light of the recent news about the Bing & Yahoo deal. You would be wrong to think that because Google is now powering the search technology Yahoo/BT portal.

Here is a screen capture of the search box that now says, “Powered by Google,” taken from ConnectedInternet.co.uk, which tipped us to this:

I know the Yahoo and Microsoft deal has not been signed off on yet, but you have to admit, this is a bit comical?

On an annual basis the University of Michigan puts out the American Customer Satisfaction Index (ACSI) E-Business report, sponsored and administered by Foresee Results. Among the things the index examines is consumer satisfaction with search engines.

The survey asks a representative sample of consumers to rate their experiences with portals and search engines according to several criteria, which produces an overall score on a 100 point scale. Google is again on top in search with a score of 86, identical to last year. The survey is supposed to be predictive of future consumer behavior, as the associated report argues:

[The ACSI] is a predictor of future success on both the micro and macro level. Google’s huge 10 point jump in satisfaction from 2007 to 2008 preceded a 7% increase in search market share from 2008 to 2009. Satisfaction with Yahoo, on the other hand, dropped 2.5% from 2007 to 2008, preceding a 17.5% decrease in search market share and a 5% drop in portal market share.

When the 2007 results saw Yahoo jump ahead of Google for the first time since the inception of the e-business survey I asked about this asserted relationship between the survey and market share:

The satisfaction data clearly don’t correlate with search market share. I asked [Foresee Results CEO Larry] Freed in this context why people should care and pay attention to the ACSI. Freed was confident that “search market share reflects past behavior. But the ACSI is predictive of future consumer behavior.” He said that historically it has been a very accurate gauge of future consumer behavior in other industries. He added that Google’s decline was a second dip in a row after a smaller decline last year.

Considered over the course of almost a decade of satisfaction rankings, the survey results would indeed appear predictive of market share (for Google), though the 2007 satisfaction win did not correctly predict corresponding market-share gains for Yahoo in 2007-2008.

Source: ACSI/Foresee Results (2009)

According to the survey, conducted before Bing, Google has a significant lead over its competitors, which has widened since 2007.

These overall results line up with a recent search loyalty report from comScore showing Google users as the most loyal.

It’s somewhat disappointing that we’ll have to wait an entire year to see what the ACSI has to say about Bing, because it would give us another opportunity to test the accuracy of the index as a predictor of future behavior.

According to comScore Bing now has an 8.9 percent share of the search market, up from 8 percent in May, before the launch. A year from now, when the next report comes out, we’ll know generally whether Bing is a success. For now, here’s what the ACSI report commentary has to say about Bing and its prospects:

[I]t seems unlikely that customers will actually leave Google in enough numbers to allow Bing to seriously challenge Google’s market dominance, given Google’s extremely high customer satisfaction. People are happy with Google, so why would they switch? They might switch if Bing is better, and that’s a tall order considering Google is the second- highest scoring ACSI service-sector company, behind Newegg.com. Bing has been called a search engine war “game changer,” but Google’s game will be very hard to change at this point. If anyone can do it, it’s the combined resources and market share of Yahoo and MSN.

The central “takeaway” from the report would seem to be that it’s not simply “habit” driving Google usage — people are actually “satisfied.”

One thing Microsoft and Yahoo were touting as a major advantage to them teaming up, is that their search scale will grow tremendously. The benefit of the search scale, or search volume query, growing is that Microsoft and Yahoo will have more data to analyze and use in order to compete against Google.

News.com interviewed Google’s chief economist, Hal Varian on this topic. Varian called that logic “bogus,” saying that search scale does little, on a statistical base, to help improve search quality. Varian explained why in three points:

1. Statistically, Varian said, that there is a “small statistical point that the accuracy with which you can measure things as they go up is the square root of the sample size.” Meaning, statistically, more data at this level, doesn’t really change how you measure things.
2. Queries at all search engines are growing approximately 40 percent a year. So there is a huge increase in search scale, even without this deal.
3. When Google tests quality and other factors, they do so on 1 percent or 0.5 percent, that is all they need to measure on. So Microsoft or Yahoo can increase that sample percentage size to 2 percent, if they like, and get similar data back.

These are extremely interesting points that I personally did not think about, but indeed make a lot of sense. If you think about it, Microsoft has about 5% share (approximating) and Yahoo has about 20% search share. Microsoft grew tremendously with this, but if Varian is right, then that growth is not as significant, in terms of quality, as Microsoft wants us all to believe.

Yesterday Microsoft and French advertising holding company Publicis Groupe announced that the latter was buying agency Razorfish. Razorfish came to Microsoft as part of the $6 billion aQuantive deal, the largest acquisition in Redmond’s history.

As part of the deal Publicis will give Microsoft 6.5 million shares, amounting to a roughly 3 percent stake in the holding company. The total value of the deal is estimated at $530 million. Just over half of that will be in cash. According to a statement by Publicis CEO Maurice Levy, “Once this acquisition is complete, about a quarter of our revenue will come from digital communication…”

In an earlier, parallel move, Publicis also bought Performics from Google almost exactly a year ago. Performics was part of the DoubleClick transaction.

According to the Wall Street Journal:

As part of the pact, Publicis has entered a “strategic alliance” with Microsoft, which includes a five-year media-buying relationship. In return for buying a certain amount of display and search advertising on Microsoft properties, Publicis will receive better ad rates.

Publicis also has similar sounding deal with Google, though there don’t appear to be any ad-buying quotas or favorable pricing as part of that relationship.

The Microsoft-Publicis deal includes paid search. One question is: how will this deal affect Yahoo’s role selling “premium search” on behalf of both Microsoft and itself? Publicis’ advertisers are all the kind that fall into the “premium” category.

First to pounce on the SEC 8-K filing by Yahoo was PaidContent, which provides an extensive bulleted list of many of the deal terms not revealed last week during the frenzy of conference calls and articles that followed the official announcement of the Microsoft-Yahoo search deal. CNET also writes about selected aspects of the deal contained in the filing, specifically an “escape clause” (termination) for Yahoo (see below). And the AP has a short piece on how the deal terms require Microsoft to hire at least 400 Yahoo employees.

Here are some verbatim excerpts from the SEC filing:

Negotiation and Execution of the Definitive Agreements

Pursuant to the terms of the Letter Agreement, the parties will negotiate and execute the Definitive Agreements as soon as practicable but in any event by October 27, 2009 (the “Negotiation Period”). If the Definitive Agreements are not executed during the Negotiation Period, the parties will submit any disputes regarding the final terms of the Definitive Agreements to an arbitration panel.

Conditions to Commencement and Termination Prior to Commencement

Prior to the Commencement Date, the Letter Agreement and Definitive Agreements may be terminated only by (a) mutual consent, (b) if a breach renders a condition incapable of being satisfied by the Termination Date (as defined below), or (c) if the conditions to commencement have not been satisfied by July 29, 2010 (the “Termination Date”); provided that Yahoo!, in its sole discretion, has the right to extend the Termination Date by six (6) months if the required antitrust approvals have not yet been obtained.

Search and Advertising Services and Sales Agreement

For a period of ten (10) years beginning on the Commencement Date (the “Term”), Microsoft will be Yahoo!’s exclusive technology provider for algorithmic and paid search services and Microsoft will provide contextual advertising to Yahoo! on a non-exclusive basis. Yahoo! will be the exclusive worldwide relationship sales force for Yahoo!’s and Microsoft’s premium search advertisers.

The services provided by Microsoft under the Search Agreement will be provided on all web sites, applications and other online digital properties owned or operated by or on behalf of (a) Yahoo!, Yahoo! subsidiaries and Yahoo! joint venture relationships, as well as on software applications developed or distributed by Yahoo! or Yahoo! subsidiaries that provide access to or enable algorithmic search services or paid search services (“Yahoo! Properties”) and (b) Yahoo! Syndication Partners (as defined below), as well as software applications developed or distributed by Yahoo!’s Syndication Partners that provide access to or enable algorithmic search services or paid search services from Yahoo! (“Syndication Properties”). “Syndication Partner” means a third party with whom Yahoo! has contracted to provide algorithmic search services or paid search services.

Subject to certain specified restrictions, Yahoo! will have full flexibility with respect to the user experience, content and look and feel on all of its web pages, and will also be entitled to use the paid search services and algorithmic search services for non-internet search queries with minimal restriction . . .

Microsoft’s mapping services and mobile search services. Yahoo! may implement each of the mapping services and the mobile search services on a non-exclusive or an exclusive basis. Yahoo! also has the option to work with Microsoft to implement the services on other platforms. If Yahoo! elects to receive services for other platforms, it must receive such services on an exclusive basis.

Revenue Share Payments and Other Payments

During the first five years of the Term, Yahoo! will be entitled to receive 88% of the net revenues generated from Microsoft’s services on Yahoo! Properties (the “Revenue Share Rate”). Yahoo! will also be entitled to receive its share (at the Revenue Share Rate) of the net revenues generated on Syndication Properties after the Syndication Partner’s share of net revenues is deducted. For new Syndication Properties during the Term, and for all Syndication Properties after the first five years of the Term, Yahoo! will receive its share (at the Revenue Share Rate) of the net revenues generated from Microsoft’s services on Syndication Properties after the Syndication Partner’s share of net revenues and certain Microsoft costs are deducted.

On the fifth anniversary of the Commencement Date, Microsoft will have the option to terminate Yahoo!’s sales exclusivity for premium search advertisers. If Microsoft exercises its option, the Revenue Share Rate will increase to 93% for the remainder of the Term, unless Yahoo! exercises its option to retain its sales exclusivity, in which case the Revenue Share Rate would be reduced to 83% for the remainder of the Term. If Microsoft does not exercise such option, the Revenue Share Rate will be 90% for the remainder of the Term.

Microsoft will also pay Yahoo! a payment of $50 million annually during the first three (3) years of the Search Agreement. Yahoo! may use these payments to partially cover transition and implementation costs not otherwise covered under the Search Agreement.

Termination Provisions

Yahoo! may terminate the Search Agreement if the trailing 12-month average of the RPS in the United States (the “U.S. RPS”) of Yahoo! and Microsoft’s combined queries falls below a specified percentage of Google Inc.’s (“Google”) estimated RPS measured on a comparable basis or if the combined Yahoo! and Microsoft query market share in the United States falls below a specified percentage; (d) on the fifth anniversary of the Search Agreement, and any time thereafter, Yahoo! has the right to terminate the Search Agreement if the trailing 12-month average of Yahoo!’s U.S. RPS is less than a specified percentage of Google’s estimated RPS; or (e) subject to exceptions, either party may terminate if a law, regulation or order would have a significant, adverse impact on a primary aspect of such party’s intended benefit of the Search Agreement.

Transition and Implementation Plan

Microsoft will hire not less than 400 Yahoo! employees (the “Transferred Employees”) and will offer the Transferred Employees market competitive compensation packages. In addition, Yahoo! and Microsoft will mutually agree on a retention plan to be paid for by Microsoft to assist in retaining the Transferred Employees and an additional 150 Yahoo! employees to be mutually agreed upon between Microsoft and Yahoo! to assist with providing the transition services.

The deal seems broader than the “web, image and video” search scope we heard before. Yahoo can terminate the deal if certain targets aren’t meet surrounding revenue per search, benchmarked to Google. At the five year mark the parties can change who runs “premium sales.” The rev share percentages change accordingly.

On a related note, there’s an opinion piece in the Wall Street Journal that argues these terms give Redmond a bigger win than Yahoo in Microsoft CEO Steve Ballmer’s “win-win” scenario but that, in the larger scheme of things, Google may have already won the game:

The deal is a clear win for Microsoft and a qualified win for Yahoo. The big question is whether it makes any difference in the only contest that really matters, which is the one with Google. The risk for both Microsoft and Yahoo is that the contest is already over. Second place won’t really matter, especially as the competition shifts to Microsoft’s home turf: operating systems.

Related coverage:

• It’s Finally Official, Microsoft & Yahoo Make A Deal, Yahoo Gives Up On Search
• Live Blogging The MSFT – YHOO Search Press Conference
• Microsoft-Yahoo Deals 2008 & 2009, Side-By-Side
• A Search Eulogy For Yahoo
• Micro-Hoo Details: Q&A With Mehdi & Schneider
• The Microsoft-Yahoo Search Deal, In Simple Terms

During the Yahoo-Microsoft conference call with CEOs Bartz and Ballmer and subsequent discussion with Microsoft’s Yusuf Mehdi and Yahoo’s Hilary Schneider we heard repeatedly that although the two engines would share a single index and Microsoft would incorporate elements of Yahoo Search (e.g., Search Monkey) into Bing, Yahoo would continue to be different and vital in search.

Freed from the cost ($425 million reportedly) and ongoing demands of the back end, it would “innovate” around the interface and search user experience.

Many people in the industry were skeptical and  shrugged it off as something akin to wishful thinking or putting a brave face on Yahoo’s exit from the search business. (Danny wrote “A Search Eulogy for Yahoo” thereafter.) But Prabhakar Raghavan, in charge of Yahoo Labs, discussed on Friday, how the company might incorporate Twitter and real-time search into Yahoo results. He again made the case that Yahoo would continue to innovate and present a compelling search user experience.

“In terms of satisfying user intent, the hard work and in some sense the bigger growth opportunities for differentiation are not the back-end of crawling and indexing, but really surfacing and assembling content the right way to satisfy user intent,” he said.

Real Time search is an increasingly popular online activity where Yahoo’s approach to search could provide a compelling user experience, Raghavan said.

It’s theoretically possible but one of the practical challenges will be recruiting and retaining top search talent, as the NY Times points out:

Yahoo will lose some of its most talented engineers to Microsoft and as many as 400 employees through layoffs. The deal also undercuts years of investment around search technology. By selling the technological crown jewels, the company may lose some of its high-tech credibility among employees and others in Silicon Valley, as well as among customers.

Investors, who had been expected to cheer the deal, punished Yahoo for the terms of the transaction. On Thursday, the day the deal was announced, Yahoo’s stock declined roughly 12 percent — although it has largely recovered since then. Financial analysts and investors saw the deal terms as something of a fire sale. According to the Times article:

Microsoft offered $46 billion to buy all of Yahoo. Analysts estimate that the new deal — involving what many people saw as Yahoo’s most important asset — is worth only around $4 billion to $5 billion.

The deal was largely motivated by Ballmer’s persistence and Yahoo’s inability to compete with Google and Microsoft in search at the required levels of investment. There was also lots of additional pressure coming from the market. All of these things, among a couple of others, perhaps made the deal inevitable.

The deal isn’t done until regulators in the US and EU approve it. That process is not, as they say, a “slam dunk.” But let’s assume that it does go through. Yahoo can’t simply ignore search. It will still be forced by the market to pay attention to search volumes and monetization (RPS).

To that end, Yahoo will in fact need to invest in the user experience to maintain its position. If it doesn’t it will lose share to Google or Bing. If that starts happening Bartz and Yahoo will be under intense pressure. So the notion of “innovating around the user experience” isn’t simply an aspiration for Yahoo, it’s a necessity.