10 September 2009

MSFT: Look Ahead to September 2009 Quarterly Results

The GCFR Overall gauge of Microsoft (NASDAQ: MSFT) slipped from 69 of the 100 possible points to 61 in the three months that ended 30 June 2009.  This period was the fourth quarter of the company's fiscal 2009. 

Our income statement, financial gauge, and gauge update analyses explained in some detail how the score was attained.

Microsoft's Revenue in the June quarter was 17 percent less than in the same period last year, primarily because fewer personal computers were purchased by economically challenged consumers and businesses.  In addition, an increasing proportion of the new computers were netbooks, which result in less Revenue per device. (Most netbooks run an older, low-priced version of Windows, and some run Linux.)

Earnings in the June quarter fell from $0.46 to $0.34 per share.

The problems were not confined to the most recent quarter.  Fiscal 2009's total Revenue was less than that of fiscal 2008, an unprecedented decline for Microsoft.  Earnings per share for the year fell from $1.87 to $1.62.

We have now modeled Microsoft's Income Statement for the quarter that will end on 30 September 2009.  The intent of this exercise was to produce a baseline for identifying deviations, positive or negative, in the actual data that the company will announce on 22 October.  GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

First, we present some background information.

A high-tech Goliath, Microsoft is best known for operating system and application software, but the company also sells video game consoles, music players, and computer peripherals.

Microsoft is now gearing up for the launch of Windows 7 on 22 October 2009, which will replace the disappointing Windows Vista.  A "starter edition" of Windows 7 is being developed for netbooks. 

Many are wondering if the new operating system will trigger a new cycle of computer sales.

Microsoft will also release in October an upgrade to Windows Mobile for smartphones.  This program has to compete with Google's Android (free) and Nokia's Symbian (becoming open source) and with Apple's (NASDAQ: AAPL) iPhone and Research in Motion's (NASDAQ: RIMM) Blackberry

The company is also experimenting with cloud computing.  This initiative will include a limited web version of its Office applications.

The launch of the Bing search engine in May 2009 was the latest Microsoft effort to increase its revenue from online advertising.  The $100 million being spent to promote Bing is having some success, but Microsoft still has a long way to go to threaten Google (NASDAQ: GOOG)ComScore, Inc. (NASDAQ: SCOR) data of U.S. searches in July 2009 indicated that Google performed 64.7 percent, Yahoo! Inc. (NASDAQ: YHOO) conducted 19.3 percent, and Microsoft sites (Bing) were used for 8.9 percent of searches.  In June, the comparable figure for Microsoft was 8.4 percent.

On 29 July, after months of false starts, Microsoft and Yahoo jointly announced a 10-year partnership agreement that will result in Bing becoming "the exclusive algorithmic search and paid search platform for Yahoo! sites."  The U.S. is reviewing the antitrust implications of this agreement.

Certainly, Microsoft is no stranger to antitrust authorities.  Federal oversight of Microsoft's 2002 antitrust settlement was extended last April for 18 months.  In Europe, Microsoft has been charged with unfairly bundling its Internet Explorer web browser with Windows.  On the other hand, Microsoft was recently cleared of antitrust allegations in Russia related to Windows XP.

Now, we are ready to look ahead.

The press release reporting Microsoft's results from the June period did not include Revenue or Earnings guidance for the new fiscal year.  The company only provided guidance for operating costs:

Microsoft is providing operating expense guidance of $26.6 billion to $27.0 billion, for the full year ending June 30, 2010.

Some comments on the company's expectations for the September quarter and the rest of fiscal 2010 were made during the conference call following the earnings release -- click here for the Seeking Alpha transcript.

Revenue in the September 2009 quarter will be determined by many factors.

In the March and June 2009 quarters, shipments of personal computers increased sequentially, but were lower relative to the same periods in 2008.  We suspect this pattern will continue through the September quarter.

The October release of Windows 7 will cause customers to delay discretionary operating system upgrades.   Microsoft previously indicated that recognition of more than $1 billion in Windows 7 Revenue will be deferred from the September quarter to the December quarter.

Seasonality is another, albeit minor, concern.  In the previous five fiscal years, Revenue in the September quarter averaged about 3 percent less than Revenue in the preceding June quarter.

Given all of the above, we have settled on $12.8 billion as our target for Microsoft's Revenue in the September 2009 quarter.  This figure is 15 percent less than Revenue in the September 2008 quarter.  It is also 2.3 percent less than Revenue in June.

Microsoft typically achieves a lucrative Gross Margin of approximately 80 percent.  Because of the weak sales environment and the growing proportion of netbooks, our specific Gross Margin target for the current quarter is 79 percent.  This ratio translates into a Cost of Goods Sold of (1 - 0.79) * $12.8 billion, or $2.7 billion. 

The company's guidance for Operating Expenses in fiscal 2010 is about $26.8 billion, give or take $200 million.  This figure covers R&D expenses and SG&A expenses.  (We group Sales & Marketing and General & Administrative into one category, but Microsoft reports them separately.)  Given the actual figures for these expenses in the previous fiscal year, we estimate that the values for September quarter will be $2.3 billion for R&D and $4.4 billion for SG&A.

The Revenue and expense estimates above would result in Operating Income of $3.4 billion for the September 2009 quarter.  This figure is 43 percent below Operating Income in the September 2008 quarter.

We assume, with little certainty, net non-operating income (e.g., interest) of about $100 million. We'll also assume an income tax rate of 26 percent.  These values would lead to Net Income of $2.6 billion ($0.29/share).  This is 41 percent below Net income in the year-earlier quarter.

Please click here to see a full-sized, normalized depiction of the projected results next to Microsoft's quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

Full disclosure: Long MSFT at time of writing.

1 comment:

  1. interesting. CGS probably includes the retail packaging costs, manual printing, and costs of CDs to carry the softwares!

    The company is mostly R&D. all the programming is R&D. ha ha

    $12.9BN in revue for a Qtr is HUGE. I am suspicious! Ridiculous!