09 December 2007

MSFT: Look Ahead to December 2007 Results

Microsoft's (MSFT) earnings and revenue grew substantially in the quarter that ended on 30 September 2007. MSFT shares surged from about $30 before the quarterly report in late October to $37 in the first days of November. The share price fell back in subsequent days, but the price is still above the earlier trading range.

Microsoft's Revenue in the September 2007 quarter was an amazing 27.3 percent greater than in the year-earlier quarter, on brisk sales of the new Halo 3 video game, Windows and Office. A win-win combination of higher Revenue and lower Sales, General, and Administrative (SG&A) expenses resulted in Operating Income more than 21 percent above our forecast value.

Our Overall Gauge for Microsoft moved up to a very good 55 out of 100 possible points after we analyzed September's results.

Today's higher stock price will serve as headwind slowing further increases in the Overall Gauge. Or, will the results from the December quarter overpower the friction and propel the scores higher? We think so.

When the results from September 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 December 2007 quarter (the second of fiscal 2008) would be in the range of $15.6 to $16.1 billion. The mid-point, $15.85 billion, which is the figure we will use, is a healthy 26 percent above the $12.5 billion of the December 2006 quarter. This value would also lead to year-over-year revenue growth of 25 percent. These growth rates are rare for a large company and haven't been seen at Microsoft since the dot-com boom.

Microsoft's Gross Margin is typically over 80 percent (!). If we set the target for the current quarter at 82 percent, the Cost of Goods Sold will be 0.18 * $15.85 billion, or $2.85 billion. R&D expenses, as a percentage of revenue, have been declining from about 15 percent of revenue to under 14 percent. We will assume 14 percent for the December quarter. Therefore, we expect R&D expenses of around $2.2 billion. SG&A expenses are more volatile, but they are typically around 30 percent of revenue. This would equate to 0.30 * $15.85 billion = $4.76 billion, for December quarter.

The estimates above would translate into an Operating Income of about $6.02 billion, which is consistent (not coincidentally) with the $5.9 to $6.1 billion range forecast by Microsoft.

The reduction in Microsoft's cash hoard due to share repurchases undoubtedly cut into investment and interest income. We'll assume net other income of $300 million.

We'll also assume an income tax rate of 30 percent, which leads to a Net income value of $4.4 billion ($0.47/share). This is a little above the company's guidance of $0.44 to $0.46 per diluted share. We may have underestimated the income tax rate, or Microsoft might be setting the bar a little lower than they think they can achieve. Net income was $2.626 billion ($0.26/share) in the year-earlier quarter.

Dec 2007
Dec 2006
15850 12542
Op expenses

CGS (2853) (3620)

R&D (2219) (1637)

SG&A (4755) (3813)

Other 0 0
Operating Income
6023 3472
Other income

Investments 0 0

Interest, etc. 300 333
Pretax income
6323 3805
Income tax
(1897) (1179)
Net Income
4426 2626

0.47/sh 0.26/sh

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