07 July 2007

MSFT: Looking Ahead to 2Q Results

In the first quarter of this calendar year, Microsoft (MSFT) launched the consumer version of its Vista operating system. This event resulted in quarterly revenues surging 32 percent over the value attained in the period ending March 2006. Quarterly net income increased an impressive 65 percent, although the increase was a tepid 3 percent when assessed on a year-over-year basis, which is our usual practice.

Our Overall Gauge for Microsoft bounced up after the first quarter results. We reported the score to be a solid, but unspectacular, 48 points at the time. With our latest tweaks to gauges, the score would have been a slightly more encouraging 51 points.

Microsoft shares, after years of stagnant performance, moved up nicely in anticipation of the release and a massive stock buyback. The shares retreated somewhat after Steve Ballmer threw cold water on the most optimistic expectations, but the shares were subsequently carried back up toward their January highs when the overall market rallied.

More recently, when the company announced that they would set aside $1 billion to repair faulty Xbox games, the shares fell a dramatic -- scratch that -- the shares fell a minuscule $0.02. Tuppence. What does that say?

Microsoft will announce on 19 July their results for the quarter and fiscal year that ended on 30 June 2007. We're looking forward to this announcement because the results could make the shares look quite attractive. When the previous quarter's results were published, Microsoft provided guidance that revenues in the June quarter would be between $13.1 and 13.4 billion. We were surprised to see them guide revenue estimates so much below the $14.4 billion of revenue amassed in the March quarter. Evidently, the new product launch leads to a spike in sales that quickly ebbs. Perhaps, this is a low bar for the company to get over?

On the assumption that Microsoft knows their business better than we do, we'll assume $13.3 billion of revenue in the quarter that ended on 30 June.

Microsoft's Gross Margin is typically 80+ percent (!). If we set the target at 82 percent, the cost of goods sold in the recent quarter were $2.4 billion. R&D expenses are usually around 15 percent of revenue, but we're going to assume one percentage point less, or 14 percent, given where they are in the product release cycle. Therefore, we see R&D expenses of around $1.86 billion. SG&A expenses were probably around 30 percent of revenue, or $4.0 billion, if the historic pattern remained valid. These assumptions place operating expenses at about the same level as last year, which might be somewhat optimistic.

If we ignore the special charge due to the faulty Xbox's, the estimates above would translate into an operating income of about $5.05 billion.

The reduction in Microsoft's cash hoard due to share repurchases undoubtedly cut into interest income, but this might have been partially compensated for rising interest rates. For convenience, we'll assume net interest income was $400 million.

We'll also assume an income tax rate of 31 percent, which leads to a net income value of $3.763 billion ($0.38/share), less the special charges. Net income was $2.83 billion in the year-earlier quarter.

Op expenses




Op income
Other income


Interest, etc.400377
Pretax income
Income tax
Net income


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