COP: Income Statement Analysis for the June 2009 Quarter

ConocoPhillips (NYSE: COP) earned $0.87 per share during the three months that ended on 30 June 2009, down from $3.50 in last year's second quarter. 

This post examines the Income Statement for the quarter and compares it to our "look-ahead" estimates.  Our target for Conoco's Net Income in the latest quarter was $0.89 per share.

Our principal sources were the earnings announcement and the conference call transcript at Seeking Alpha.  Some background information about ConocoPhillips and the business environment in which it is currently operating can be found in the look-ahead.

In a second article, we will report Conoco's scores as measured by the GCFR Financial Gauges. The follow-up post will also provide the latest figures for the financial metrics we use to analyze Cash Management, Growth, Profitability and Value.


Please click here to see a full-sized, normalized depiction of the actual and projected results for the just-concluded quarter, as well as the 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.






Revenue was 50 percent less than in the June 2008 quarter, but it was 15.3 percent greater than in the March 2009 quarter.  Our prediction was miraculously close: we were off by only 0.3 percent.  After considering energy prices and refining margins, we estimated that quarterly Revenue would rise 15 percent from the first to the second quarter of 2009.

To illustrate how much energy prices changed from the second quarter of 2008 to the second quarter of 2009, we have extracted the following data from the Industry Prices (Platt's) section of Conoco's earnings report.

	2Q-2008	2Q2009
WTI spot	$123.98/barrel	$59.54/barrel
Brent dated	$121.38/barrel	$58.79/barrel
Henry Hub gas	$10.94/mmbtu	$3.51/mmbtu

Despite the much lower Revenue than last year, reported production in the quarter, on a barrel-of-oil equivalent basis, was about 6.5 percent higher than in the second quarter of 2008.  Conoco attributed the increase

"to new developments in the United Kingdom, Russia, Canada, Norway, China and Vietnam, which more than offset the impact of base field declines. Production also increased due to the impacts of royalties and production sharing contracts, as well as improved well performance and less unplanned downtime."

Of the various costs and expenses reported by Conoco, we group "Purchased crude oil, natural gas and products" and "Production and operating expenses" and call the combination Cost of Goods Sold.  In the June quarter, CGS was 76.7 percent of Revenue.  Therefore, the company achieved a Gross Margin of 23.3 percent.  The Gross Margin was 23.9 percent in June 2008, so the recent quarter was slightly less profitable by this measure.  However, the Gross Margin fell significantly short of our 26-percent estimate, probably because realized refining margins were down so much.  We thought the Gross Margin would be closer to its 27.4 percent value in the first quarter of 2009.

Depreciation expenses were 6.6 percent of Revenue.  We had predicted 6.5 percent.

Exploration costs were substantially less than the $325 million we had assumed based on the company's guidance.  Perhaps, we misinterpreted the guidance, but the difference is trivial small compared to Conoco's $35 billion revenue.

We lump non-income taxes together with Sales, General, and Administrative expenses.  In the June quarter, the combination accounted for 11.8 percent of Revenue, compared to our estimate of 12 percent. 

Other operating expenses (i.e., impairments, accretion on discounted liabilities, and foreign currency changes), in the aggregate, were only $17 million, compared to our $200 million placeholder for this entry.  One interesting thing to note is that currency changes produced a gain of $142 million.  In the March 2009 quarter, currency changes were responsible for a loss of $131 million, which means there was a swing to the upside of $273 million between the first two quarters of 2009.

A second item of interest is that the Conoco recorded a $51 million impairment charge after some assets in Ecuador were expropriated.


Operating Income, by the way we define it, was 82 percent less than in the June 2008 quarter.  The lower-than-expected Gross Margin was responsible for Operating Income being 31 percent below our estimate.

Equity in the earnings of affiliates doubled our estimate and made up for most of the Operating Income shortfall.   Other income and interest expenses were 19 percent below our estimate.

The 44.8-percent effective income tax rate was not much more than our 44 percent prediction.

Rolling up all of the above, we see that Net Income was 76 percent less than the year-earlier value.  However, Net Income was only 3 percent ($0.02 per share) less than our estimate.



In summary, the historic decline in energy prices led ConocoPhillips from last year's peak took a big bite out of Conoco's Revenue.  However, the Revenue figure for the quarter came close to matching our estimate.  We were a disappointed the Gross Margin wasn't at least a couple percentage points higher, but the difference was made up for by items such as currency gain and equity in the earnings of affiliates.  Net income was just two cents per share shy of our estimate. 




Full disclosure: Long COP at time of writing

TDW: Income Statement Analysis for the June 2009 Quarter

Tidewater (NYSE: TDW) earned $0.86 per share in the first quarter of fiscal 2010, which ended 30 June 2009, down from $1.64 in the same quarter of last year.  If a $48.6 million charge related to the seizure of Tidewater vessels in Venezuela is excluded, and no other changes are made, earnings were $1.80 per share.

This post examines the Income Statement for the quarter and compares its entries to our "look-ahead" estimates.  Our target for Tidewater's Net Income in the latest quarter was $1.81 per share.

In a second article, we will report Tidewater's scores as measured by the GCFR Financial Gauges. The follow-up post will also provide the latest figures for the financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

Our principal sources were the earnings announcement and the 10-Q for the quarter.  Some background information about Tidewater and the business environment in which it is currently operating can be found in the look-ahead.


Please click here to see a full-sized, normalized depiction of the actual and projected results for the just-concluded quarter, as well as the 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.




Revenue in the June quarter was 4.0 percent less than in the year-earlier period.  We had assumed that Revenue would be unchanged.

More than 87 percent of Tidewater's Revenue in the quarter was attributed to vessels operating outside the U.S.  Revenue from these international vessels slipped only one percent when compared to the June 2008 quarter.  Revenue from U.S.-based vessels, on the other hand, fell by 39 percent.  Other Marine Revenues increased 38 percent, but this is a relatively small part of Tidewater's business.

The utilization rate for the international fleet was 73 percent (down 3.4 percent from last year) and only 39 percent (down 14 percent) for the U.S. based vessels. 

Of the various costs and expenses reported by Tidewater, we group "Vessel operating costs" and "Costs of other marine revenues" and call the combination Cost of Goods Sold.  In the June quarter, CGS was 51.5 percent of Revenue.  Therefore, the company achieved a Gross Margin of 48.5 percent.  The Gross Margin was only 45 percent in June 2008, so the recent quarter was substantially more profitable by this measure.  However, the Gross Margin fell short of our 51-percent estimate.

Vessel operating costs were down a substantial 13 percent, but the Costs of the other marine revenue were up 41 percent.

Depreciation expenses were $2 million less than our $34 million estimate.  The actual expense was 9.7 percent of Revenue, whereas we expected 10 percent.

Sales, General, and Administrative expenses were also $2 million less than our projection.  At 10.5 percent of Revenue, these expenses were nearly the same as our 10.6 percent target.

As mentioned above, the recent quarter included a $48.6 million operating charge related to the seizure of Tidewater vessels and other assets in Venezuela by Petroleos de Venezuela, S.A.  The bulk of the charge, $44.8 million, reflects the uncertainty in whether and when PDVSA will pay Tidewater for services provided previously.  The remaining $3.75 million of the charge writes down the net book value of the seized assets. 

Without this charge Operating Income, as we define it, would have been $92 million, or 5.8 percent greater than the amount in the June 2008 quarter.  Operating Income excluding the charge fell short of our estimate by about 10 percent, primarily because of the lower Revenue.

Income from Asset Sales, which Tidewater treats as an operating item, was about $13 million, or $8 million more than our $5 million estimate. Tidewater sold "14 anchor handling towing supply vessels, 10 platform supply vessels and two crewboats."

Miscellaneous non-operating income was only about $1 million more than the value we predicted. 

The effective Income Tax Rate in the quarter was 28.4 percent, far above the 17.5 percent guidance.  Tidewater reported that the increase in the tax rate was related to the Venezuela charge.  [If the charge were excluded, the tax rate would have been 15.9 percent.

Net Income was 47.5 percent less than in the June 2008 quarter.  However, excluding the Venezuela charge, earnings would have been up 10 percent and would have matched our expectation.  Greater-than-expected income from asset sales made up for weaknesses in other areas.


In summary, Tidewater's Revenue in the first quarter of fiscal 2010 was approximately 4 percent less than we anticipated.  The decrease was due, for the most part, to a significant decline in demand for U.S. vessels, which is a relatively small part of Tidewater's business.

The company did a good job keeping operating costs under control, as seen in the Gross Margin increase.  The Revenue decline kept the Gross Margin from increasing as much as we expected.

Unfortunately, these generally good results were obscured by the asset expropriation that led to an operating charge of almost $50 million.





Full disclosure: Long TDW at time of writing.

WPI: Income Statement Analysis for the June 2009 Quarter

Watson Pharmaceuticals, Inc. (NYSE: WPI) earned $0.46 per share during the three months that ended on 30 June 2009, down from $0.51 in last year's second quarter. 

This post examines the Income Statement for the quarter and compares it to our "look-ahead" estimates.  Our target for Watson's Net Income in the latest quarter was $0.53 per share.

Our principal sources were the earnings announcement and the conference call transcript at Seeking Alpha.  Some background information about Watson and the business environment in which it is currently operating can be found in the look-ahead.

In a second article, we will report Watson's scores as measured by the GCFR Financial Gauges. The follow-up post will also provide the latest figures for the financial metrics we use to analyze Cash Management, Growth, Profitability and Value.


Please click here to see a full-sized, normalized depiction of the actual and projected results for the just-concluded quarter, as well as the 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.

Watson's Revenue in the quarter was 8.9 percent more than in the year-earlier quarter.  Our target, which was based on the company's prior guidance that total Revenue in 2009 would be approximately $2.65 billion, proved to be too low by 2.5 percent.

Revenue at the business segment associated with generic drugs increased 6.5 percent relative to last year's second quarter.  Revenue directly tied to generic drug sales rose 14.4 percent, with newly launched products providing a boost.

The smaller Distribution segment did even better with Revenue advancing 26 percent.  Revenue fell 2.3 percent at the business segment responsible for branded pharmaceuticals; however, the company is optimistic about two new branded products launched during the second quarter.


The Cost of Goods Sold was 58.0 percent of Revenue, which translates into a Gross Margin of 42.0 percent.  On this measure, Watson matched our expectation exactly.  We assumed the margin would equal the 42 percent of Revenue achieved in the first quarter.

The charge for Depreciation and Amortization in the quarter also matched our expectation.  Now halfway through the year, management's earlier guidance to expect an $88 million Amortization expense in 2009 appears to be accurate.

Research and Development expenses were about 5 percent less than our $45 million target.  The reported figures for the first two quarters of 2009 are modestly below what one would expect given the company's forecast of 2009 R and D expenses between $180 million and $190 million.

Sales, General, and Administrative costs exceeded our target by 11 percent. Watson reported that they incurred additional costs when launching the RAPAFLO® (silodosin) and Gelnique (oxybutynin chloride) products and in taking steps to acquire Arrow Group.  Watson increased its guidance range for these expenses in 2009 to $480-$500 million, from $420-$430 million.

The March 2009 quarter included an $18 million charge to SG and A related to a legal settlement with Elan (NYSE: ELN).

Operating Income, as we define it, was down 7.4 percent from the amount in the June 2008 quarter.  Despite better-than-anticipated Revenue, Operating Income fell short of our prediction by 4.5 percent.  The deficiency was primarily due to new product and acquisition-related expenses.

Non-Operating items were almost immaterial, as expected.

Our target for the Income Tax Rate was 35 percent, and the actual rate was a surprisingly high 41.5 percent.  Watson attributed the higher rate to non-deductible expenses related to the pending Arrow Group acquisition.

Net Income was 12.1 percent less than the result of the year-earlier quarter, and it was 14.5 percent less than our prediction.   The shortfall was the result of the higher SG and A expenses and the higher provision for income taxes.


In summary, Revenue in the second quarter rose at a healthier rate than we expected, and the Gross Margin hit our target.  However, non-recurring product and acquisition expense negatively affected earnings.





Full disclosure: No position in WPI at the time of writing.

AAPL: Gross Margin Exposition

The Financial Alchemist recently explained why Apple's Gross Margin should be a healthy 36 to 38 percent in the current quarter, significantly above management's guidance.

He adds:

iPhone contributes an equal amount to EPS as does the Mac segment, and will surpass Mac's EPS contribution in the quarters going forward.

BP: Income Statement Analysis for the June 2009 Quarter

BP (NYSE: BP) earned a profit of $1.39/ADR in the three months that ended 30 June 2009, down from $2.98 in last year's second quarter.

This post examines the Income Statement for the quarter and compares its entries to our "look-ahead" estimates.  Our target for Net Income in the second quarter was $0.80.  We were not alone in underestimating BP's second quarter earnings by a wide margin.

In a second article, we will report BP's scores as measured by the GCFR Financial Gauges. The follow-up post will also provide the latest figures for the financial metrics we use to analyze Cash Management, Growth, Profitability and Value.


Please click here to see a full-sized, normalized depiction of the actual and projected results for the just-concluded quarter, as well as the 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.






BP prepares its financial statements in accordance with International Financial Reporting Standards (IFRS), as adopted for use by the European Union.  Reports prior to 2006 complied with UK Generally Accepted Accounting Principles. 

Second-quarter Revenue (i.e., Sales and Other Operating Revenues) was 15.8 percent more than in the March 2009 quarter, but Revenue was 49.6 percent less than in last year's second quarter.  Revenue exceeded our estimate by 9.6 percent.
 
Reported production in the quarter, on a barrel-of-oil equivalent basis, was 4 percent higher than in the second quarter of 2008. BP attributed the increase to "the continued ramp-up of production from major projects that started up in 2008 and the first half of 2009."

Revenue from the Refining and Marketing business was up almost $9 billion from last quarter, but it was still only half of last year's figure when oil prices were peaking.

"overall refining availability rose 5.3 percentage points versus the same period last year, to 93.6 per cent, its highest level since the first quarter of 2005."

BP's Cost of Goods Sold (CGS) -- which we define to be Purchases, Production and Manufacturing Expenses, and Production and Similar Taxes -- was 77.9 percent of Revenue.  This equates to a Gross Margin of 22.1 percent, which is significantly more profitable than our 20.0 percent prediction.  The Gross Margin in the year-earlier quarter was 19.8 percent.

Depreciation (including Depletion and Amortization) was 12.4 percent more than our $2.75 billion estimate. 

Exploration costs in the second quarter were almost double our $175 million estimate.  The exploration expense was the highest it has been in a quarter since 2006.  Of the total expense, two-thirds was related to the company's U.S. operations

Sales, General, and Administrative (SG&A) expenses, which BP calls Distribution and Administration Expenses.  These expenses were 6 percent below our $3.5 billion prediction.

Other Operating income and expenses is our catchall category.  Items of this sort are erratic and, as far as we can tell, unpredictable from quarter to quarter.  In the second quarter, the Other category consisted of a $154 million "Fair value gain ...  on embedded derivatives."


Operating Income, as we define it, was $5.5 billion, 56 percent less than last year's $12.5 billion gain.  However, Operating Income was nearly 55 percent more than our prediction.  Much better-than-expected Revenue and Gross Margin were the main reasons the actual results exceeded our prediction.

The quarterly results benefited from a $522 million gain on the sale of a business, less impairment charges of $154 million.  Net interest expense greater than last year, but quite a bit less than we anticipated.

The income tax rate was 41.1 percent. Our estimate was 40 percent. 

After-tax earnings from jointly controlled entities and associates added $1 billion.  We expected $500 million.

The bottom-line result was Net Income of $4.385 billion ($1.39/ADR), which was 53 percent less than earnings in the year-earlier quarter.  Our estimate was much too pessimistic.


Although Revenue, Operating Income, and Net Income dropped significantly, they all did much better than we had thought likely.  Production was up, and the Gross Margin was the highest it has been since 2005. 


Full disclosure:  Long BP at time of writing

MSFT: Financial Gauge Scores for the June 2009 Quarter

In an earlier post, we examined Microsoft's (NASDAQ: MSFT) Income Statement for the June quarter and compared the figures to our "look-ahead" estimates.  Earnings fell from $0.46 per share to $0.34 in this fourth quarter of Microsoft's fiscal year 2009.

We have since mined the financial statements in Microsoft's earnings announcement to update the metrics we use to assess Cash Management, Growth, Profitability and Value.  This post reports on these metrics and the Financial Gauge scores.

If necessary, we will update the analysis results after Microsoft files its 10-K report for the year with more detailed information.

In summary, Microsoft's latest GCFR gauge scores are as follows:

• Cash Management: 21 of 25 (up from 16 in March)
  
• Growth: 1 of 25 (down from 5)
• Profitability: 12 of 25 (down from 13)
• Value: 18 of 25 (down from 25)

• Overall: 61 of 100 (down from 69)

The current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary.

Cash Management	Jun 2009	Mar 2009	Jun 2008	5-Yr Avg
Current Ratio	1.8	1.7	1.4	2.1
LTD/Equity	9.5%	0.0%	0.0%	0.0%
Debt/CFO (years)	0.3	0.1	0.0	0.0
Inventory/CGS (days)	25.6	21.0	33.2	39.2
Finished Goods/Inventory	N/A	0.6	0.5	0.7
Days of Sales Outstanding (days)	77.4	56.8	75.3	60.3
Working Capital/Invested Capital	161%	124%	106%	254%
Cash Conversion Cycle Time (days)	-10.0	-20.2	-7.5	-1.0
Gauge Score (0 to 25)	21	16	14	17

In its first bond offering, Microsoft sold debt securities worth $3.75 billion in May 2009.  Since the company has over $31 billion in Cash and Short-term investments on its Balance Sheet, and since Cash Flow from Operations averaged $4.76 billion per quarter in fiscal 2009, the debt is not especially significant.  Microsoft has, however, exercised a means of raising larger amounts of cash should management, for example, decide to pursue a large acquisition.

Microsoft joined the elite ranks of non-financial entities with AAA rating bond ratings, which is the highest S&P grade, last September. 

We're curious if there is an issue involving Accounts Receivable, which is reflected in the Days of Sales Outstanding metric.  Shorted periods are preferred because it indicates the company is getting paid faster.  The increase shown in the table above got our attention, but the bigger concern might be that the Allowance for Doubtful Receivables spiked unprecedentedly in the last quarter from $242 million to $451 million.  Is a big customer slowing payments?

Growth	Jun 2009	Mar 2009	Jun 2008	5-Yr Avg
Revenue growth	-3.3%	5.6%	18.2%	10.8%
Revenue/Assets	77.6%	87.6%	88.9%	71.1%
Operating Profit growth	13.7%	18.0%	21.8%	15.8%
CFO growth	-11.9%	-12.1%	21.4%	9.0%
Net Income growth	-17.6%	-3.6%	25.7%	8.8%
Gauge Score (0 to 25)	1	5	22	16

Revenue, CFO, and Net Income growth rates compare the last four quarters to the four previous quarters.
The Operating Profit rate is the annualized rate of growth in Operating Profit after Taxes over the last 16 quarters.

The 3.3-percent drop in Revenue during the last four quarters was the first time Microsoft's Revenue fell from one fiscal year to the next.

Fiscal 2009 was also the first year since 2002 in which Net Income declined. 

Profitability	Jun 2009	Mar 2009	Jun 2008	5-Yr Avg
Operating Expenses/Revenue	64.6%	63.5%	63.1%	63.5%
ROIC	115%	132%	163%	139%
Free Cash Flow/Invested Capital	120%	127%	182%	163%
Accrual Ratio	14.5%	7.2%	0.9%	-8.3%
Gauge Score (0 to 25)	12	13	12	17

The Operating Expense ratio above was negatively affected by the lower margins on software for inexpensive netbooks and the decline in Revenue.  However, Microsoft's cost-cutting actions announced at the beginning of the year have gained traction and should help reduce the expense ratio in the future.

Although the ROIC and FCF/IC ratios are still impressive, their significant declines in the last year should be considered.

Value	Jun 2009	Mar 2009	Jun 2008	5-Yr Avg
P/E	14.6	10.3	14.6	19.6
P/E vs. S&P 500 P/E	0.7	0.6	0.8	1.2
PEG	1.1	0.6	0.7	0.6
Price/Revenue	3.6	2.7	4.3	5.6
Enterprise Value/Cash Flow (EV/CFO)	9.8	7.3	10.8	12.7
Gauge Score (0 to 25)	18	25	19	15

Microsoft's stock price rebounded 29 percent during the April-June quarter, from $18.37 to $23.77, and this, coupled with the last quarter's weak results, ended Microsoft's time with a perfect 25-point Value gauge score. Nevertheless, 18 points is still a very good result.

These ratios for Microsoft can be compared with other companies in the Application Software industry.

Overall	Jun 2009	Mar 2009	Jun 2008	5-Yr Avg
Gauge Score (0 to 100)	61	69	65	64

We will conclude with one more ratio.  At the end of June, Microsoft's Market Value was about $212 billion.  Cash Flow from Operations in fiscal 2009, a challenging year for the company, was $19 billion.  Therefore, the Price/Cash Flow ratio was about 11.  The inverse of this number indicates that each dollar to purchase a share of Microsoft returns 9 cents in annual cash flow. 



Full disclosure: Long MSFT at time of writing.

PEP: Gauge Scores for the June 2009 Quarter

In an earlier post, we examined PepsiCo's (NYSE: PEP) Income Statement for the 12 weeks that ended 13 June 2009 and compared the figures to our "look-ahead" estimates.  PepsiCo's GAAP earnings increased from $1.05 to $1.06 per diluted share in this second quarter of the fiscal year. 

We have since mined the financial statements in PepsiCo's 10-Q for the quarter to update the metrics we use to assess Cash Management, Growth, Profitability and Value.  This post reports on these metrics and the Financial Gauge scores.


In summary, PepsiCo's latest GCFR gauge scores are as follows:

• Cash Management: 12 of 25 (down from 13 in March)
  
• Growth: 1 of 25 (unchanged)
• Profitability: 11 of 25 (unchanged)
• Value: 14 of 25 (down from 16)

• Overall: 44 of 100 (down from 48)

The current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary.

Cash Management	Jun 2009	Mar 2009	Jun 2008	5-Yr Avg
Current Ratio	1.3	1.4	1.4	1.3
LTD/Equity	58.6%	76.5%	36.3%	25.6%
Debt/CFO (years)	1.4	1.5	0.9	0.8
Inventory/CGS (days)	53.5	45.7	51.4	44.9
Finished Goods/Inventory	41.5%	42.6%	45.3%	46.3%
Days of Sales Outstanding (days)	46.2	39.8	44.9	40.5
Working Capital/Invested Capital	14.9%	14.9%	16.1%	12.3%
Cash Conversion Cycle Time (days)	-43.5	-48.5	-41.0	-54.0
Gauge Score (0 to 25)	12	13	13	9

PepsiCo's capital structure has become much more leveraged over the last few years.  Long-term debt expanded from $3 billion in September 2007 to over $9 billion earlier this year.  The debt has been used for acquisitions and share repurchases.   However, in the last three months PepsiCo trimmed $1 billion of debt from the total, bringing it down to $8.2 billion.  This action is reflected in the recent decrease in the Long-term debt to Equity ratio (from 76.5 percent to 58.6 percent) and, to a less extent, in the Debt to Cash Flow from Operations ratio.

Inventory changes, which can signal improving or worsening business conditions, increased substantially in the second quarter.  We would ordinarily consider the rise to be worrisome, but a check of the record indicates that PepsiCo always builds up inventory in the second quarter to meet the rising demand for cool beverages and snack in the warm summer.  The decrease in the ratio of finished goods in the inventory is consistent with this view.  The company has bought commodities in anticipation of future sales; output does not appear to be piling up unsold.

The increase in Days of Sales Outstanding is also typical for the June quarter.  It probably reflects expected seasonal sales growth.  We will keep an eye on this metric to make sure it is not indicating easier payment terms (to stimulate slack demand).

Growth	Jun 2009	Mar 2009	Jun 2008	5-Yr Avg
Revenue growth	2.5%	6.7%	14.0%	9.0%
Revenue/Assets	116.0%	122.1%	121.7%	114.5%
Operating Profit growth	10.1%	10.0%	11.1%	5.6%
CFO growth	-11.4%	-9.0%	12.4%	10.3%
Net Income growth	-12.9%	-10.0%	-1.9%	6.6%
Gauge Score (0 to 25)	1	1	14	11

Revenue, CFO, and Net Income growth rates compare the last four quarters to the four previous quarters.
The Operating Profit rate is the annualized rate of growth in Operating Profit after Taxes over the last 16 quarters.

Revenue is growing at a slower rate, but Cash Flow and Net Income are faring even worse.  Operating profit, which excludes special charges and non-operating items, and which we average over a longer time period, is showing more staying power.

The strengthening of the dollar has steepened declines caused by the weak economy and restructuring activities.   

Special factors, most notably a "discretionary" $1 billion pension plan contribution, have affected PepsiCo's results. 

Profitability	Jun 2009	Mar 2009	Jun 2008	5-Yr Avg
Operating Expenses/Revenue	83.6%	83.7%	81.8%	81.7%
ROIC	25.5%	26.4%	29.4%	29.3%
Free Cash Flow/Invested Capital	19.7%	19.2%	23.7%	24.4%
Accrual Ratio	7.1%	6.1%	2.9%	4.5%
Gauge Score (0 to 25)	11	11	12	13

Operating Expenses as a percentage of Revenue have crept up (with the price of agricultural commodities) and have negatively effected earnings and cash flow returns on capital.  Nevertheless, these returns are remain admirable.

The recent increase in the Accrual Ratio, which can suggest diminished earnings quality, indicates that less the company's Net Income is due to Cash Flow from Operations (CFO).  However, this change seems to be more an artifact of the pension plan contribution than anything more worrisome.

Value	Jun 2009	Mar 2009	Jun 2008	5-Yr Avg
P/E	16.9	15.8	17.5	20.3
P/E vs. S&P 500 P/E	0.8	0.8	1.0	1.2
PEG	1.7	1.6	1.6	1.7
Price/Revenue	2.0	1.9	2.5	2.9
Enterprise Value/Cash Flow (EV/CFO)	14.6	14.2	15.0	16.4
Gauge Score (0 to 25)	14	16	10	5

The value metrics came under pressure as PepsiCo's stock price increased from $51.48 to $54.96 during months of April, May, and June.  However, several of these metrics, which can be compared with other companies in the Processed & Packaged Goods industry, remain modestly attractive relative to historic norms.

Overall	Jun 2009	Mar 2009	Jun 2008	5-Yr Avg
Gauge Score (0 to 100)	44	48	47	37

PepsiCo's gauge scores are treading water.  Yet, we remain optimistic about the company.  The dollar will become less of a drag on results, organic growth will resume when the economy recovers, Productivity for Growth cost-cutting measures will have long-term benefits, as will recent acquisitions.  Sales of Gatorade might even begin to grow again after a difficult period!

A major unknown is the outcome of PepsiCo's April 2009 offer to buy the shares it does not already own in Pepsi Bottling Group, Inc. (NYSE: PBG) and PepsiAmericas, Inc., (NYSE: PAS). 


Full disclosure: Long PEP at time of writing.

MSFT: Income Statement Analysis for the June 2009 Quarter

Microsoft Corp. (NASDAQ: MSFT) earned $0.34 per share in the three months that ended on 30 June 2009, down from $0.46 in the same quarter last year.  The April-to-June period is the fourth quarter of the Microsoft's fiscal year. 

This post examines the Income Statement for the quarter and compares its entries to our "look-ahead" estimates.  Our Net Income estimate almost exactly matched the reported amount ($3.045 billion vs. $3.014 billion).   We attribute this result to dumb luck.  We show below that our estimates for Revenue and many of the expense items were not nearly so accurate.

In a second article, we will report Microsoft's scores as measured by the GCFR Financial Gauges.  The follow-up post will also provide the latest figures for the financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

Some background information about Microsoft and the business environment in which it is currently operating can be found in our look-ahead.


Please click here to see a full-sized, normalized depiction of the actual and projected results for the just-concluded quarter, as well as the 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.






Revenue was 17 percent less than in the year-earlier quarter, and it was 12.7 percent less than in the March 2009 quarter.  Since we had estimated that Revenue would decline by 5.3 percent, the actual figure fell far, far short of our expectations. 

Each of Microsoft's reporting business segments experienced a Revenue decline in the June quarter,  

"... primarily [due to] weakness in the global PC market and the unfavorable economic environment."

The two segments where Revenue fell the most were Client, down 28.7 percent, and Entertainment and Devices division, down 25 percent.  Fewer Xbox consoles were sold, and the price per console fell.

Microsoft estimated:

"total worldwide PC shipments from all sources declined approximately 5% to 7%."

In formulating our Revenue estimate, we had assumed that the decline in Microsoft's total Revenue would be somewhat less severe than the fall in worldwide PC shipments.  In fact, the decline was much more harsh.  It seems pretty clear that a growing proportion of the computers sold were netbooks for which Microsoft receives much less Revenue.

In fiscal 2009, total Revenue was 3.3 percent less than in 2008.  This is the first time Microsoft's Revenue in one fiscal year was less than in the previous year.


The Cost of Goods Sold in the quarter was 19.7 percent of Revenue, which translates into a Gross Margin percent.  Because our target for the Gross Margin was 78 percent, Microsoft did a couple of points of better than the 80.3 percent we anticipated.

Research and Development expenses were 7.3 percent less than our $2.4 billion estimate.  One reason for the lower R&D expenses was that Microsoft was able to capitalize $105 million of certain Windows 7 software development costs. However, because Revenue in the quarter was so weak, R&D expenses were higher as a percentage of Revenue, 17 percent vs. 16 percent, than we anticipated.

Sales, General, and Administrative expenses were a substantial 9.3 percent below our estimate.  These expenses increased from 30.8 percent of Revenue to 32.5 percent.  The recent quarter included $193 million of legal costs.

The quarter included a special operating charge of $40 million for employee severance costs associated with the cost-cutting actions announced earlier.  We had budgeted $300 million for this item.

Operating Income was 30 percent less than in the June 2008 quarter.  However, Operating Income was only 7.3 percent weaker than our projection because operating expenses were also much less.

The Client division's quarterly Operating Income was down 33 percent from June 2008 to June 2009.

Non-operating investment income and interest summed to $155 million, which was substantially better than in recent quarters.  For one thing, we didn't count on the $100 million of gains on derivatives and "foreign currency remeasurements."  We had expected a net expense of $200 million for non-operating items.

The Income Tax Rate was 26.5 percent, which matched the predicted 26.5 percent.


Net Income of $3.0 billion ($0.34/share) was 25 percent below last June's value, but it was eerily close to our prediction.

Chris Liddell, chief financial officer at Microsoft, said it plainly:

    “Our business continued to be negatively impacted by weakness in the global PC and server markets.”

The weakness is most clearly seen in the top-line Revenue figure, which fell by an unprecedented amount.  However, the "resource management" cost-cutting measures announced at the beginning of the year have already gained traction. "Headcount-related expenses" were 6 percent less in the June 2009 quarter than in the same period last year.

[Microsoft is] "eliminating up to 5,000 positions in research and development, marketing, sales, finance, legal, human resources, and information technology by June 30, 2010.")

Despite significant challenges,

• The fall in IT spending (especially by businesses),
• The increasing popularity of netbooks,
• Competition from open source software, and even
• Cloud computing.

Microsoft still managed to earn $3.0 billion in the quarter, and the net Cash Flow from Operations was $3.8 billion.

On the day before the earnings announcement, Microsoft announced that Windows 7 and Windows Server 2008 R2 "were released to manufacturing" and will become available to the public on 22 October 2009.


Full disclosure: Long MSFT at time of writing.