Microsoft Corporation (MSFT) reported first quarter 2010 earnings that beat the Zacks Consensus Estimate by 8 cents. Revenue beat the consensus by 4.9%.
Revenue
Revenue of $12.9 billion was down 1.4% sequentially and 14.2% year over year. This excludes $1.47 billion in deferred revenue related to the Windows 7 Upgrade Option as well as initial sales of Windows 7 to OEMs and retailers. Consumer demand drove increases in Windows and Xbox products, but this was offset by sluggish business spending. Foreign exchange had a $233 million impact on revenue in the last quarter.
Approximately 35% of total revenue came from annuity, 30% from OEM, 25% from licenses and 10% from other business. Management estimates that the PC market was up mid-teens from the Jun 2009 quarter, with approximately 12% of the total market consisting of net books.
Revenue by Segment
Management renamed the Client segment, which is now being referred to as the Windows and Windows Live segment. This segment generated 20% of first quarter revenue, declining 15.7% sequentially and 37.9% year over year. The decline was related to PC market dynamics, where the mix is changing in favor of consumer-type computing devices. These lower-priced devices are having a negative impact on Windows attach rates.
The Server & Tools segment at 27% now contributes the largest revenue share. Segment revenue was down 2.2% sequentially and flat (up 0.8%) compared to the year-ago quarter. The company continued to see strong attach rates of the Windows Server, SQL Server and System Center, which resulted in a smaller decline than was originally anticipated for the x86 hardware market.
The Online Services business, or online advertising, which generated 4% of revenue, continued its steady decline, with strong double-digit revenue decline on both sequential and year-over-year bases. Revenue was impacted by lower advertising rates, although page views increased, according to management. Bing market share appears to be inching upward.
The Microsoft Business Division generated 34% of first quarter revenue, down 3.5% sequentially and 11.0% year over year. Segment revenue was impacted by slower consumer and enterprise spending, as well as the negative impact of currency.
Entertainment & Devices generated 15%, up 59% sequentially and 4.2% year over year. Although price cuts and declining console sales had a negative impact, total gaming revenue was up strongly. The company benefited from the large global installed base of 34 million units and popular titles such as the Halo 3 ODST. Xbox Live also witnessed strong growth.
Operating Results
The pro forma gross margin for the quarter was 78.0%, down 225 basis points (bps) sequentially and 399 bps year over year, as higher search distribution and online costs were partially offset by lower Xbox 360 console costs and service and support costs.
However, operating expenses of $5.6 billion was down $890 million sequentially. The operating margin was 34.7%, up 395 bps sequentially from 30.7% recorded in the previous quarter. It was down 514 bps from the year-ago quarter. The sequential increase was the result of reduction in headcount and vendor-related costs, with R&D, S&M and particularly, G&A declining as a percentage of sales. This was partially offset by the lower gross margin. The decline from the year-ago quarter was due to relatively lower sales.
Operating margin by segment is as follows: Windows 55.8%, Server & Tools 37.4%, Online Services -98.0%, Microsoft Business Division 65% and Entertainment & Devices 16.5%. The sequential declines in the Windows and Servers segment margins were more than offset by increases in the other segments. However, Servers and Entertainment & Devices were the only segments generating margin growth on a year-over-year basis.
The company generated a pro forma net income of $3.6 billion, or 27.7% net income margin compared to $3.1 billion, or 23.6% in the previous quarter and $4.4 billion, or 29.0% in the year-ago quarter. GAAP EPS was 40 cents in the last quarter, compared to 34 cents in the June 2009 quarter and 48 cents in the Sept. quarter of last year. There were no special items in the last quarter, other than the deferred revenue, which would have added 12 cents to the EPS.
Balance Sheet
Inventories were up over 60%, due to the Win7 launch. Inventory turns 9.9x. Days sales outstanding (DSOs) went down from 78 to around 61. The company ended with cash and short term investments balance of $36.7 billion, up $5.3 billion during the quarter. In the last quarter, the company generated $6.1 billion in cash from operations, spent $1.5 billion share repurchases, $1.1 billion on dividends and $435 million on capital assets.
Guidance
Management provided revenue guidance for fiscal 2010, which is expected to be in the range of $26.2 billion to $26.5 billion.
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