Microsoft Earnings Fall Sharply Ahead of Windows 7 Launch

Microsoft felt the effects of the global recession, including declines in the PC and server markets, as its earnings declined 17 percent from the same quarter in 2008. Although Microsoft came in below Wall Street Estimates with $13.10 billion in quarterly revenue, it can look forward to a possible earnings bump later in 2009 with the release of Windows 7 and Windows Server 2008.

Microsoft took a hit to it earnings during its fourth financial quarter of 2009, reporting a 17 percent decline in year-over-year revenue. Overall, Microsoft earned $13.10 billion for the quarter, coming in more than $1 billion below Wall Street estimates.

Although Microsoft hit several technical milestones during the quarter, including the rollout of the Windows 7 and Windows Server 2008 release candidates, it will not see revenue on those products until later in the year. The deferring of revenue related to the Windows 7 Upgrade Option program, announced on June 25, dragged down earnings per share by 2 cents.

"Our business continued to be negatively impacted by weakness in the global PC and server markets," Chris Liddell, Microsoft's chief financial officer, said in a statement before the July 23 earnings call. "In light of that environment, it was an excellent achievement to deliver over $750 million of operational savings compared to the prior year quarter."

During the earnings call, Liddell re-emphasized that the quarter had been "difficult but encouraging."

"I do feel better about our relative performance," Liddell added. "We actually executed much better across all aspects of our business." He also noted that the company had seen signs of overall economic improvement: "We have begun to see sequential stabilization in some our key businesses. ... I'm very pleased with the way in which we are responding to the environment."

Heading into the call, earnings for the current quarter were estimated at 36 cents a share on revenues of $14.37 billion, representing a year-over-year drop of 9.3 percent. For the same quarter in 2008, Microsoft earned 47 cents a share on $15.84 billion in revenue. Earlier in the year, Microsoft posted its first-ever quarterly revenue decline, with a handful of its business units showing significant drops in revenue.

Overall for the fiscal year ended June 30, Microsoft reported revenue of $58.44 billion, down 3 percent from the prior year.

Even as its revenues decline, Microsoft is in the midst of readjusting its corporate strategy in the face of a rapidly changing IT paradigm. Whereas in previous years the company could rely on its desktop dominance to ensure revenues and profitability, the increased prevalence of cloud-based platforms and applications such as Google Apps obviously has the Redmond, Wash., company somewhat concerned that its model could become outdated.
To combat that, Microsoft has readjusted its strategy to embrace the cloud, particularly with regard to Office 2010, which it will offer as a free online service to subscribers of Microsoft Live. However, the online versions of Word, Excel, OneNote and PowerPoint will be somewhat more stripped down from the full versions. Microsoft will also offer a hosted subscription service and on-premises versions of Office 2010 for those SMBs (small- to medium-sized businesses) and enterprise not willing to move into the cloud in one shot.

Microsoft will also potentially be facing a new Web-based operating system, Google Chrome OS, scheduled for release in the second half of 2010. Although designed to run on less-powerful mininotebooks, known popularly as "netbooks," the prospect of an operating system released by one of Microsoft's prime Web competitors had a number of media outlets prematurely predicting Redmond's imminent demise.

However, Microsoft seems to have put on a public face of dismissing Chrome OS, with Microsoft CEO Steve Ballmer claiming during his July 14 keynote address at Microsoft's Worldwide Partner Conference that Google's operating system was "highly interesting" but would be unable to meet users' needs for both full online and offline capability.

Microsoft's response to Google's shot across its bows may be to commercialize its own research into a browser-based OS, a project code-named Gazelle.

But in the short term, Microsoft will be depending on Windows 7-which has proven to be a pre-sales bestseller on online shopping sites such as Amazon-to be a monster hit. Roughly a third of Microsoft's historical income has come from its operating-system sales. In order to encourage a rapid worldwide rollout, Microsoft has instituted sweeping price cuts and discounts for the operating system. In the case of consumers buying retail copies of Windows 7, the strategy thus far has seemed a success.

The looming question, though, is whether SMBs (small and midsized businesses) and the enterprise will be willing to leave the bunkers in which they've spent most of the current recession and begin spending to upgrade their systems. A recent survey of 1,000 companies by ScriptLogic suggested that six out of 10 companies will avoid purchasing Windows 7 at the time of its debut, although 34 percent also said they will have the operating system online by December 2010.

Despite weakness in sales of business PCs, and overall lower IT budgets for businesses, Microsoft CEO Steve Ballmer is betting that SMBs and the enterprise are in desperate need of a tech refresh.

Speaking during a Q&A session following his Worldwide Partner Conference speech, Ballmer said, "Even if you take the assumption that [the economy] won't turn around for a long period of time, every minute of every day we're building up a pent-up demand for IT."