08 September 2007

MSFT: Looking ahead to Sept. results

Cash-rich, debt-free Microsoft (MSFT) has been affected only mildly by the current housing/mortgage-induced market turmoil. Microsoft shares are down only a dollar from their price on 30 June. The shares might even have benefited from a flight to quality. The company setting aside $1 billion to repair faulty Xbox games had minimal effect.

The beginning of this calendar year -- it was the third quarter of fiscal 2007 for Microsoft -- saw the launch 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. The revenue increase was not as dramatic in June quarter: 13 percent compared to the year-earlier value.

When we evaluated Microsoft after the results from June became available, our Overall Gauge read 46 out of 100 possible points. This score was down from an encouraging 51 points after March. The small drop-off reflected the fact that there was nothing particularly surprising about the March quarter and that Microsoft shares had already moved up, albeit modestly.

In October, Microsoft will announce their results for the quarter ending on 30 September 2007. When the results from June were publicized, Microsoft provided some guidance about what they expect in the current quarter and the fiscal year that will end in June 2008.

The company forecast that revenue in the September quarter would range between $12.4 and $12.6 billion. This would seem to be a fairly conservative estimate, as it is less than the June quarter, much less than the March quarter, and about the same as the December 2006 quarter. However, September quarters are historically weak, and the mid-point of the forecast is about 15 percent greater than the revenue of the September 2006 quarter.

Microsoft's Gross Margin is typically over 80 percent (!). If we set the target for the current quarter at 83 percent, the Cost of Goods Sold will be 0.17 * $12.5 billion, or $2.125 billion. R&D expenses have recently been 14 to 15 percent of revenue. We're going to assume the lower number because the trend has been down. Therefore, we expect R&D expenses of around $1.75 billion. SG&A expenses are typically around 30 percent of revenue, which would equate to 0.30 * $12.5 billion = $3.75 billion, for September quarter. Note that we're assuming that any special charges due to faulty Xboxs were fully expensed in the June 2007 quarter.

The estimates above would translate into an Operating Income of about $4.875 billion. The is a little below the $5.0 to $5.2 billion range forecast by Microsoft, but we're not aware of any reason to expect below-normal costs. We would not be surprised at all to see Revenue come in higher than the company forecast, which would push up operating income

The reduction in Microsoft's cash hoard due to share repurchases undoubtedly cut into interest income. We'll assume net interest income was $350 million.

We'll also assume an income tax rate of 30 percent, which leads to a Net income value of $3.658 billion ($0.38/share). Net income was $3.478 billion in the year-earlier quarter.

Sept 2007
Sept 2006
12500 10811
Op expenses

CGS (2125) (1696)

R&D (1750) (1786)

SG&A (3750) (2855)

Other 0 0
Op income
4875 4474
Other income

Investments 0 0

Interest, etc. 350 567
Pretax income
5225 5041
Income tax
(1568) (1563)
Net income
3658 3478

0.38/sh 0.35/sh

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