Update: Microsoft revenue declines 17% in fiscal Q4

Microsoft revenue declined 17% and net income declined 29% year over year in the company's fiscal 2009 fourth quarter due to continued weakness in global sales of PCs and hardware servers, the company reported Thursday.

Revenue of $13.1 billion and earnings per share (EPS) of 34 cents slightly missed analysts' forecasts for the quarter that ended June 30. Quarterly earnings were affected by a 2-cent reduction due to $276 million in deferred revenue related to Microsoft's Windows 7 Upgrade Option program announced June 25, Microsoft said. Thomson Reuters analysts were expecting revenue of $14.37 billion and earnings per share of 36 cents for the quarter.

Operating income for the quarter was $3.99 billion, a decline of 30% year over year, and net income was $3.05 billion, a decline of 29% year over year.

Analysts were expecting revenue to be deferred to the December quarter, or later, because of the Windows 7 upgrade program, which allows people to purchase PCs now with the right to upgrade to Windows 7 when it becomes available. Microsoft can't report that Windows 7 revenue until the upgrade occurs, which will be at least after the software's Oct. 22 availability date.

However, analysts still largely expected Microsoft to meet or even slightly beat consensus estimates for the quarter despite the deferred revenue.

They also thought that Gartner's outlook for the PC market, released last week, would reflect positively on Microsoft's fourth-quarter results. Gartner had expected a 10% year-over-year decline in PC unit shipments for the second calendar quarter, but ended up estimating a 5% decline instead. However, Gartner's PC shipment predictions still could bode well for Microsoft when Windows 7 is released in October.

Microsoft's results also were affected by $193 million in legal charges, $108 million of impairments to investments and $40 million of additional severance charges related to a previously announced severance plan, the company said.

Revenue for the full fiscal year that ended June 30 was $58.44 billion, a 3% decline from the prior year. Operating income was $20.36 billion for the year, a decline of 9%, while net income was $14.57 billion, a decline of 18%. Diluted EPS for the year was $1.62, a decline of 13% from the previous year.

On a positive note, Microsoft said it took $750 million out of its operational costs for the quarter as it continued to enact cost-cutting measures to navigate the challenging economic environment. In January, Microsoft announced its first-ever layoffs as part of these measures, and also cut back on traveling expenses and contracts with short-term employees.

On a conference call Thursday, Microsoft CFO Chris Liddell acknowledged that Microsoft's fourth-quarter results were disappointing, but given how the company executed during the recession — in particular by taking costs out of the business — it is in a good position to meet the economic challenges it expects to face in at least the first two quarters of its fiscal 2010.

“In my mind, we are a stronger company than we were a year ago,” he said. “However, the economy continues to be challenging and we need to lift our game to another level in 2010.”

One segment of Microsoft's business that is usually strong but declined for the first time since the company began breaking out financial results by segment was its server and tools business, which includes Windows Server, Exchange Server and other software used to run corporate networks. That revenue decline was slight, though — from $1.37 billion last year to $1.35 billion this year — and Liddell said Windows Server units were up for the quarter after falling the previous two quarters.

Revenue from Microsoft's core Windows client business, which is still taking a hit from netbooks and the worldwide decline in PC sales, was down 29% year over year, to $3.12 billion. That business should pick up with the release of Windows 7 in October, Liddell said, and the company once again will defer revenue — from $1.1 billion to $1.3 billion — from Windows 7 in the first quarter of fiscal 2010 to the second quarter, when the OS is released.

For the full fiscal year, Microsoft expects Windows client revenue to be in line with the total PC market, but could see Windows license revenue growing faster than PC shipments by the end of the fiscal year, he added.

Indeed, Microsoft's fourth-quarter results come as the company is poised for a major wave of product launches, which should give it a boost in the coming year, said Directions on Microsoft analyst Matt Rosoff.

In addition to Windows 7 and Windows Server 2008 R2 in October, Microsoft is planning the next release of its Office suite — which alongside Windows is a key revenue-driver — in the first half of next year.

Despite an expected uptick on the horizon, there was still some troubling news in Microsoft's results. Unearned revenue was down year over year, from $15.3 billion last year to $14.28 billion in the fourth quarter, which Rosoff said may indicate that renewal rates for the three-year enterprise contracts that ended during the quarter were lower than expected.

Unearned revenue includes, among other things, revenue from Microsoft's volume-licensing programs. These enterprise contracts provide a predictable annuity revenue for Microsoft and are how many of its large customers purchase its software, including its Windows and Office products. “The fact that it's down is not great news,” Rosoff said.

During a conference call earlier Thursday, Microsoft told analysts there is a discrepancy between the end of its fiscal year on June 30 and the end of its sales cycle on July 3, and that many companies wait until the last minute to renew sales contracts. Taking that into account, unearned revenue was flat and enterprise renewals were on par with traditional rates, Rosoff said.

However, he noted, it's also likely that some customers decided that their software infrastructure is good enough for now, and chose not to renew their contracts.