26 May 2008

MSFT: Look Ahead to June 2008 Results

Our analysis of Microsoft's March 2008 quarter found that the Overall Gauge score increased 6 points to a very good 58 out of 100 points. This result, the highest since June 2006, was boosted by a 20-point score, of 25 possible, on the Growth gauge and 15 points each on the Profitability and Value gauges.

We cautioned that one-time events during the quarter, such as legal settlements, tax rate changes, and gains on derivatives, had a significant effect on earnings.

Microsoft Corp. (MSFT), the gigantic developer of operating system and application software, also sells video game consoles, music players, and computer peripherals. Microsoft is determined to be a major player in the online advertising business, in direct competition with Google Inc. (GOOG); however, its proposed $40+ billion acquisition of Yahoo! Inc. (YHOO) was unsuccessful.

The price of Microsoft shares lost ground in early February when the Yahoo! bid became public. The share price didn't fully bounce back after the offer was withdrawn in May, perhaps because Carl Icahn soon began to push Yahoo to revive take-over talks.

Microsoft will reports its results for the quarter and fiscal year ending 30 June 2008 on 17 July. In anticipation of this report, we've modeled Microsoft's Income Statement for the June quarter. The intent of this exercise was to produce a baseline for identifying any deviations, positive or negative, in the actual data. GCFR estimates are derived from trends in the company's historical financial results and guidance provided by company management.

Management guidance for the June 2008 quarter was included in the press release reporting the results of Microsoft's March quarter.

The company forecast that Revenue in the June quarter would be in the range of $15.5 to $15.8 billion. The mid-point, $15.65 billion, which is the figure we will use, is 17.0 percent higher than Revenue in the June 2007 quarter. On a year-over-year basis (i.e., trailing four quarters compared to the four previous quarters), Microsoft's Revenue growth would be 18 percent if sales in the June quarter match the guidance.

Microsoft's Gross Margin is typically around 80 percent (!). In the year-earlier quarter, the margin was unusually low at 75.8 percent because the company recorded a $1 billion charge to repair faulty Xbox games. We're going to be assume normal conditions apply and set our Gross Margin expectations for the June 2008 quarter at 82 percent. This ratio translates into a Cost of Goods Sold of (1 - 0.82) * $15.65 billion, or $2.8 billion.

Given where Microsoft is in its product development cycle, it's not surprising that R&D expenses, as a percentage of Revenue, have edged down a couple of percentage points towards 13 percent. However, there was an uptick in the March quarter. We will assume 13.5 percent, or $2.1 billion, for R&D expenses in the June quarter.

SG&A expenses are more volatile, but they have recently been about 30 percent of Revenue. The costs of the Yahoo bid could push SG&A expenses even higher. At 30 percent, June's SG&A expenses would equate to 0.30 * $15.65 billion = $4.7 billion.

These estimates yield an estimated Operating Income of $6.0 billion, right in the middle of the $5.8 to $6.2 billion range indicated in Microsoft's guidance.

Investment and interest income has recently been between $300 and $400 million per quarter. We'll assume net Non-operating income of $350 million. This would lead to Pre-Tax Income of almost $6.4 billion.

We'll also assume an income tax rate of 30 percent, which leads to a Net Income value just under $4.5 billion ($0.47/share). This matches the company's guidance of $0.45 to $0.48 per diluted share. Net income was $3.0 billion ($0.31/share) in the year-earlier quarter.

Please note that the tabular format below, which we use for all analyses, can and often does differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.


June 2008
June 2007
Op expenses

CGS (2817)

R&D (2113)

SG&A (4695)

Other 0
Operating Income
Other income


Interest, etc.
Pretax income

Income tax

Net Income

Shares outstanding


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