Microsoft Financials

Most of you probably don’t know that Microsoft’s year end is June 30. This year’s results are more important than usual, because Microsoft has been under huge pressures for the last two years. The 2008 results didn’t show much of this, but this year’s results could be disastrous for the company.

Acer introduced the first Netbook late in 2007, and while it used Linux as an OS, it didn’t have an immediate effect on Microsoft’s results. Only half of the 2008 fiscal year was affected, but only in a limited way, as Netbooks started to grow as a segment. Also while the 2008 fiscal year was the start of the current recession, it wasn’t until Microsoft’s 2009 fiscal year that the effects were really felt, as illustrated from this image on Wikipedia:

Glyn Moody covered this in an excellent article titled Microsoft’s Pyrrhic Victory in the Netbook War, chronicling how Microsoft went from zero OS share in the Netbook market to 70%, but paid a price in profit margins, and sales. Let’s take a look at some numbers from Microsoft financial filings with the Securities and Exchange Commission. Every United States Corporation is required to follow certain regulations, especially publicly held corporations. This allows prospective stock holders to evaluate the company’s finances, so that they can make an informed investment decision. The accuracy of SEC filings are sworn to by the management of the company in question, and incidents of deliberate misstatements are exceptionally rare. These numbers are accurate, and certified as accurate by Microsoft’s accountants. Whatever Microsoft may be, they aren’t Enron. Microsoft’s SEC filings can be found here if you wish to check my numbers.

Operating Income (Most people call this sales)
2005 – 39,788,000,000
2006 – 44,282,000,000
2007 – 51,122,000,000
2008 – 60,420,000,000
09Q1 – 15,061,000,000 – projected yearly total – 60,244,000,000
09Q2 – 31,690,000,000 – projected yearly total – 63,380,000,000
09Q3 – 45,338,000,000 – projected yearly total – 60,450,000,000
2009 – ??,???,???,???

We can see from the yearly reports, and the reports for the first 3 quarters of 2009 that Microsoft’s historical yearly sales increases are not likely to be repeated this year, unless the fourth quarter has fantastic results. But Microsoft’s fourth quarter is not aligned with the traditional heavy sales seasons for personal computers, which are the back to school season (August) and the Christmas season (November and December). While some early shipments to stores may occur in June, most would occur in July for August sale (keeping inventory on the shelf in times of constricted credit is difficult), and of course the Christmas cycle is in the middle of Microsoft’s fiscal year, and is reflected by the 09Q2 sales bulge. Microsoft’s last fiscal quarter is a consumer spending dead zone, but when you look at the 2008 10K and the 2008 3rd quarter 10Q it shows unexpected strengths:

08Q3 – 44,583,000,000 – projected yearly total – 59,444,000,000
2008 – 60,420,000,000

So Microsoft billed a Billion more than the 3rd Quarter results would have lead us to expect, probably from B2B sales. Will they be able to do that this year? If they do, then Microsoft may beat their 2008 sales. We won’t know until we see the 10K, which has historically been released near the end of July.

Operating Income isn’t the only measure of a company’s health. If your personal expenses are higher than your income, you are in trouble. Company’s are no different. Net Income is what you have left after expenses, let’s look at that:

Net Income
2005 – 12,544,000,000
2006 – 12,599,000,000
2007 – 14,065,000,000
2008 – 17,681,000,000
09Q1 – 4,373,000,000 – projected yearly total – 17,492,000,000
09Q2 – 8,547,000,000 – projected yearly total – 17,094,000,000
09Q3 – 11,524,000,000 – projected yearly total – 15,365,000,000

Again, a comparison of 2008 yearly and 083Q is in order:

08Q3 – 13,384,000,000 – projected yearly total – 17,845,000,000
2008 – 17,681,000,000

So income for the full year was very closed to estimated income based on 3rd Quarter income. The 2008 Fourth Quarter $1 Billion sales bulge, did not results in a corresponding bulge in Net Income for the year. But that may be covered under another part of the report, “Total Operating Expenses.”

Total Operating Expenses is the fun one for you personally. New Guitar, go to a concert or movie, watch the Stanley Cup finals on your wide screen TV (and I’d like to once more call for a renaming of the Detroit Red Wings to the Detroit Dead Things considering their horrible play in the finals this year). It’s also a lot of things that aren’t fun, but necessary, such as rent, taxes, power, water, cable, etc. Corporate expenses are mostly the boring things, like rent. They also include travel which can be interesting. I’ve been in every major city in the USA, seen the Vietnam Wall Memorial, the Alamo, the Mississippi River, Mount Saint Helens, stayed at the Doral (if you golf, you’ll know what it is) and spent a good bit of time in 5 Star Hotels. The same sort of travel happens at every corporation, including Microsoft, but it’s a small portion of the totals (where your trip to Bermuda may be a major expense). Microsoft’s call to cut travel expenses, while it’s an important part of leadership, really won’t have a huge affect on the bottom line.

Total Operating Expenses are extremely important. If you can increase your Operating Income, and reduce your Total Operating Expenses, your Net Income increases, giving you more freedom of action, to spend money on further R&D, asset purchases, pay dividends, etc.

Total Operating Expenses:
2005 – 25,227,000,000
2006 – 27,810,000,000
2007 – 32,598,000,000
2008 – 37,928,000,000
09Q1 – 9,062,000,000 – projected yearly total – 36,248,000,000
09Q2 – 19,752,000,000 – projected yearly total – 39,504,000,000
09Q3 – 28,962,000,000 – projected yearly total – 38,616,000,000

Looking at the numbers so far, what do we see?

Operating Income is probably flat, unless there is a large increase or decrease in Quarter 4
2008 – 60,420,000,000
09Q3 – 45,338,000,000 – projected yearly total – 60,450,000,000

Net Income appears set to drop, again unless something unexpected happened in Quarter 4
2008 – 17,681,000,000
09Q3 – 11,524,000,000 – projected yearly total – 15,365,000,000

Total Operating Expenses appear set to rise slightly, again dependent on Quarter 4
2008 – 37,928,000,000
09Q3 – 28,962,000,000 – projected yearly total – 38,616,000,000

So what does all this mean, if anything? It’s an extremely simplified method of looking at Microsoft the company, and attempting to determine it’s state of corporate health, in a time where Microsoft is under huge pressures as documented above. Projected Operating Income is flat for the first time in the company’s history. Net Income is projected to drop by over $2 Billion dollars. Total Operating Expenses are projected to rise by $700 Million, despite various belt tightening exercises, including the phasing out of many products, the layoffs that have affected 5000 workers so far, and may be expanded to affect more (while hiring continues in India).

Remember, these are projections, and they are almost certainly wrong. Even wrong projections are useful, they give a general guidance on where a corporation may be. If the corporation beats the projections, then their stock becomes more valuable. If the corporation doesn’t beat the projections, then their stock becomes less valuable.

Stock price has a huge affect on corporate capabilities. If your stock is work $200.00 per share, and you have 1 Billion issued shares, you can issue a million shares to use in a $200,000,000.00 acquisition. If your stock is worth $20,00 per share, you’d have to issue 10 million shares to fund that acquisition. One scenario dilutes your shares by 0.1%, the other dilutes your shares by 1%, or 10 times the dilution factor.

Another thing to consider is that a very few big investors control Microsoft’s stock price. The big institutional investors (pension funds, mutual funds, etc) control the price of the stock, and they base their price targets for the stock on the same SEC reports that I’ve been quoting. With Microsoft’s Net Income being so high, you would think that Microsoft stock might be worth more. The big institutional investors don’t think so, and even Bill Gates, with his huge holding in Microsoft stock can’t do anything about it.

Let’s take another look at those numbers, but with a more sceptical view of the 4th Quarter

Operating Income assuming incomes drops by half in 4th quarter
2008 – 60,420,000,000
09Q3 – 45,338,000,000 – projected yearly total – 60,450,000,000
2009 – 52,894,000,000 – 7.5 Billion Drop year over year

Net Income drops due to drop in Operating Income
2008 – 17,681,000,000
09Q3 – 11,524,000,000 – projected yearly total – 15,365,000,000
2009 – 15,031,000,000 – 2.5 Billion Drop year over year

Total Operating Expenses assuming a 5% drop through cost savings
2008 – 37,928,000,000
09Q3 – 28,962,000,000 – projected yearly total – 38,616,000,000
2009 – 36,685,000,000 – projected 5% drop through cost savings

So we can see that even a devastating 4th Quarter (sales dropping by half is devastating in anyone’s book) isn’t enough to cause Microsoft to have a terrible year (note that I adjusted taxes downward to reflect the drop in income), though it could limit Microsoft’s options moving forward.

The problem is that the news out of Redmond is very disturbing. Microsoft seems to be cutting far more products than I would expect them to based on any numbers I can come up with. Of course there’s the online moneypit, which since the launch of Bing may have gotten a lot deeper. There’s also one time costs involved with terminating employees, which could push up 4th Quarter costs higher than I think.

At present I believe that it’s virtually impossible for Microsoft to run a loss this year. I also believe that the final Net Income numbers will have many corporate executives drooling with envy. The problem is 2010. At present we don’t even know if we’ll have an economy in 2010. Assuming that the projected “recovery” really happens this fall, what form will it take? Will it be a jobless recovery? If it is, Microsoft is one of the companies who is likeliest to suffer. Businesses won’t replace hardware, the primary driver for OS and Office sales, and will look to Free (as in speech) Software to handle more functions where they might have used a Microsoft solution before. Consumers will attempt a variety of life extension routines on existing computers, which won’t include installing Windows 7. A lot of units are going to end up being converted to run Linux as viruses continue to run rampant through the Windows ecosystem, especially “average user” computers. Gamers of course will continue running Windows.

So I’m going to go out on a limb – these are my projections for Fiscal Year 2010 at Microsoft

Operating Income assuming incomes drops by half in 4th quarter
2008 – 60,420,000,000
2009 – 52,894,000,000 – 7.5 Billion Drop year over year
2010 – 47,604,000,000 – 5.0 Billion Drop projected

Net Income drops due to drop in Operating Income
2008 – 17,681,000,000
2009 – 15,031,000,000 – 2.5 Billion Drop year over year
2010 – 12,804,000,000 – 2.2 Billion Drop projected

Total Operating Expenses assuming a 5% drop through cost savings
2008 – 37,928,000,000
2009 – 36,685,000,000 – projected 5% drop through cost savings
2010 – 34,000,000,000 – 2.6 Billion Drop projected

My base assumption is that Microsoft’s sales will drop by 10% due to the global financial crisis, the pressure on the high end of the market by Apple, and the pressure on the low end of the market by Linux. From that I adjusted taxes down, other income (interest) down, and projected a 7% cost saving through further layoffs, product retirements, and other cost reduction strategies. You end up with a company that is still insanely profitable by most standards, however my assumptions are fairly conservative in many ways.

But all of this depends on what Microsoft’s 10K for the entire 2009 Fiscal Year says. It could be better than I’ve projected, or worse. If it’s worse, Microsoft’s could go into a downward spiral as management tries to increase sales and control costs at the same time, a recipe for disaster.

And of course all of this affects the stock price. I’m going to cover that more fully in a later post.

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4 thoughts on “Microsoft Financials

  1. not bad, but not accurate, and small profit from netbooks for windows is better than no profits for Netbooks for Linux. I dont know what you were trying to point out, but if it was that MS is doing badly the figures you post tell a different story.A few typo's and errors, but you spent 20 hours on it, so you know where they are.Nice try at FUD, and I wonder what type of life you have to spend 20 hours or even 1 hour doing something like that. The hatred runs deep in your padwin.

  2. This blog seems like a thoughtful pice, and yet the first comment is by a Microsoft troll mocking the author as a "padwin", meaning a young Jedi in training, a joke from Star Wars. The Microsoft troll accuses the author of attempting to engage in FUD (Fear, Uncertainty and Doubt).It appears that Microsoft is paying astroturfers to critic pro-Linux or anti-Microsoft posts, much the same way that the Church of Scientology does. Evidence brought out in sworn deposition testimony document Microsoft's formal practice of skewing ostensibly neutral panels, and that practice is now extended, apparently, to comments on pro-Linux or anti-Microsoft posts. Here is a quote from Microsoft employee James Plamondon's widely-publicized panel-stacking memo, in which he advocates deceiving public discussion panels by stacking the supposedly neutral panels with Microsoft staffers:"A stacked panel, on the other hand, is like a stacked deck: it is packed with people who, on the face of things, should be neutral, but who are in fact strong supporters of our [Microsoft's] technology:"A copy of that memo is available here on Groklaw:http://www.groklaw.net/article.php?story=20071023002351958 One of the key practices of these Microsoft astroturfers is to post anonymously, so that their financial ties to Microsoft cannot be traced. I now make it the habit of posting my real name on all of my public forum posts, and I challenge the 1st poster on this blog to do the same. My name is Christian Einfeldt, and I live and work in San Francisco, where I am a self-employed tort lawyer. I am very googleable. I challenge the 1st poster here to do the same.

  3. The hatred runs deep in your padwin.Don't you mean 'Padawan'. Sheesh. The longer I do this, the lower the grade of trolls I draw.It appears that Microsoft is paying astroturfers to critic pro-Linux or anti-Microsoft posts, much the same way that the Church of Scientology does.Christian,It doesn't appear. They are. I've been monitoring blogs and websites for a future article on astro-turfing. The trends I've been documenting are damning.Still, thanks for dropping in, and coming to my defence. I always appreciate that.Just curious – what do you intend to write about at Digital Tipping Point?

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