25 April 2008

MSFT: Financial Analysis through March 2008

We have analyzed Microsoft's 10-Q financial statements for the quarter that ended on 31 March 2008. The company submitted the 10-Q to the SEC on the same day they announced their results publicly, which is something we really appreciate. Early access to a full set of financial statements and notes is a boon to analysts.

Microsoft Corp. (MSFT), the gigantic developer of operating system and application software, also sells video game consoles, music players, and computer peripherals. The company is also determined to become a major player in the online advertising business, putting it in direct competition with Google (GOOG). The pursuit of this objective is why Microsoft is currently engaged in an increasingly testy battle to acquire Yahoo (YHOO). Last year, Microsoft paid $6 billion for the aQuantive advertising network, and they spent $240 million to acquire a 1.6 percent stake in Facebook.

Our earlier financial analysis of Microsoft's results from the fourth quarter of calendar year 2007 produced an Overall Gauge score of 55 points. This figure, a very good outcome, was boosted by a perfect 25-point score on the Growth gauge and an excellent 21-point Profitability gauge score.

Now, with the available data from the March 2008 quarter, which was the third quarter of Microsoft's fiscal year, our gauges display the following scores:

Before we examine each gauge, let's compare the latest Income Statement to our expectations, which were based on both on company guidance and trend analysis.


($M)

March 2008
(actual)
March 2008
(predicted)
March 2007
(actual)
Revenue
14454
14450
14398
Op expenses





CGS (2514)
(2890)
(2140)

R&D (2035)
(1878)
(1750)

SG&A (5496)
(4046)
(3919)

Other (0)
0
0
Operating Income
4409
5635
6589
Other income





Investments
0
0
0

Interest, etc.
401
325
382
Pretax income

4810
5960
6971
Income tax

(422)
(1788)
(2045)
Net Income
4388
4172
4926


$0.47/sh
$0.44/sh
0.26/sh
Shares outstanding

9428
9500
9862


Revenue in the recent quarter was just slightly above the midpoint of the $14.3 to $14.6 billion range forecast by the company in January. The Revenue increase over the year-earlier quarter was 0.4 percent. Sales in the March 2007 quarter were boosted by the long-delayed release of the Vista operating system and Office 2007. Year-over-year Revenue growth has now slowed to 17 percent.

We conservatively expected the Gross Margin to equal 80 percent of Revenue, and the actual value was 82.6 percent. In other words, the Cost of Goods Sold was only 17.4 percent of Revenue.

Research and Development expenses were 14.1 percent of Revenue, compared to our 13 percent estimate. Microsoft attributed rising R&D costs to increased numbers of personnel earning higher salaries. Sales, General, and Administrative expenses were 38 percent of Revenue, a shocking 10 percent above the 28 percent estimate. SG&A expenses were extraordinarily high in the March 2008 quarter because Microsoft incurred $1.5 billion of charges associated with a fine payable to the European Commission.

The better-than-expected Gross Margin was outweighed by the higher-than-expected R&D and SG&A costs. Operating Income was 21.8 percent below the forecast value and well below the company's guidance that Operating Income would be between $5.6 to $5.7 billion.

Non-operating income was $76 million more than expected as a result of "higher net gains on equity, interest rate, and commodity derivatives." The Income Tax Rate of 9 percent was well below the predicted 30 percent because various tax matters were resolved. These two Non-operating factors overcame the below-forecast Operating Income and enabled Net Income to exceed the prediction by 5.2 percent. Net Income was 11 percent below the super quarter of March 2007.


Cash Management. This gauge decreased from 12 points in December to 10 points now.


March
2008
3 mos.
ago
12 mos.
ago
Current Ratio1.5
1.7
2.0
LTD/Equity
0%
0%0%
Debt/CFO
0 yrs
0 yrs
0 yrs
Inventory/CGS
N/A
N/A N/A
Finished Goods/Inventory
N/A
N/A N/A
Days of Sales Outstanding (DSO)57.7 days
67.8 days
56.2 days
Working Capital/Market Capitalization 5.4%
4.6%
7.7%
Cash Conversion Cycle Time-10.8 days
-5.8 days
18.0 days

Microsoft has no debt. Current liabilities are up to reflect taxes due. We don't analyze Inventory at Microsoft because they are more of a Services business than a Manufacturing business.


Growth. This gauge decreased from a perfect 25 points in December to 20 points now.


March
2008
3 mos.
ago
12 mos.
ago
Revenue growth16.9%
25.7%
16.2%
Revenue/Assets 81.9%
86.0%
77.6%
CFO growth
31.5%
58.7%
10.4%
Net Income growth 18.5%
42.4%
2.9%
Growth rates are trailing four quarters compared to four previous quarters.

While the growth rates are all commendable, it is also clear that the rate of growth has slowed from the previous quarter.


Profitability. This gauge decreased from 19 points in December to 15 points.


March
2008
3 mos.
ago
12 mos.
ago
Operating Expenses/Revenue 64.1%
60.3%62.8%
ROIC 60.0%
59.5%46.5%
FCF/Equity
51.0%
57.1%41.4%
Accrual Ratio
-3.5%
-5.1%-18.1%

Operating expenses are edging up, but we haven't separated from one-time from recurring costs. The increasing Accrual Ratio tells us that less of the company's Net Income is due to Cash Flow from Operations (CFO), and, therefore, more is due to changes in non-operational Balance Sheet accruals.


Value. Microsoft's stock price decreased from $35.60 to $28.38 over the course of the quarter. The Value gauge, based on the latter price, surged to 15 points from 6 points three months ago.


March
2008
3 mos.
ago
12 mos.
ago
P/E 16.3
20.0
19.8
P/E to S&P 500 average P/E 99%
112%125%
Price/Revenue 4.6
5.8
5.5
Enterprise Value/Cash Flow (EV/CFO)
11.0
14.314.8
The average P/E for the Software industry is 28.3, and the average Price/Sales is 5.4.


Microsoft's share price declined after it made the $40 billion offer for Yahoo, in anticipation of future earnings dilution. It's more or less trading at a market multiple and delivering much more growth.


While the Growth and Profitability gauges each gave up a few points from December's stellar highs, they are still at very good levels. The Value gauge has now joined the party, pushing the Overall gauge score up to 58 points. The last time the Overall gauge score was this high was June 2006. However, this positive story has to be balanced with a caution that quarterly earnings were driven by one-time factors such as legal settlements, tax rate changes, and gains on derivatives.

1 comment:

  1. Overall score should be 60 and not 58.

    ReplyDelete