21 March 2009

MSFT: Look Ahead to March 2009 Quarterly Results

The GCFR Overall gauge of Microsoft (NASDAQ: MSFT) increased to 68 of the 100 possible points -- up a healthy 9 points -- in the December 2008 quarter.  The full evaluation that led to this score was explained fully in this analysis report.

The recent change to our analytical methods bumped up the Overall score to 71 points.

In the December quarter, Revenue disappointed as a substantial deceleration of personal computer sales growth, coupled with a greater proportion of low-cost netbook PCs, led to decreased sales of Microsoft Windows.   This period also included a $400 million loss on derivatives and a $350 million loss on "foreign currency remeasurements."  These factors contributed to Net Income in the quarter falling 11.3 percent less than last year's value.

These results explain the significant drop in the Growth gauge.  However, a plunge in Microsoft's share price produced a sharp rise in the Value gauge, which more than compensated for the weaker operating performance.  The soaring Value gauge, therefore, explains the increase in the Overall score.

To look ahead, we have modeled Microsoft's Income Statement for the March 2009 quarter, which is the third quarter of the fiscal year.  The intent of this exercise was to produce a baseline for identifying any deviations, positive or negative, in the actual data that Microsoft will announce on, or about, 23 April 2009.  GCFR estimates are derived from trends in the historical financial results and guidance provided by company management. 

Microsoft Corp., best known for operating system and application software, also sells video game consoles, music players, and computer peripherals.  In recent years, Microsoft has increased its role in the online advertising business, in direct competition with Google Inc. (NASDAQ: GOOG)

In early 2008, Microsoft offered $40+ billion to acquire Yahoo! Inc. (NASDAQ: YHOO).  The bid was withdrawn in May when Yahoo's management resisted.  There have been, ever since, numerous reports that Microsoft remains interested in acquiring Yahoo's search business or partnering with it.  Just days ago Microsoft CEO Steve Ballmer made comments confirming his interest in Yahoo.

In September, Microsoft joined the elite ranks of non-financial entities with AAA bond ratings, which is the highest S&P grade.  After Microsoft's board authorized as much as $6 billion worth of debt, the company established a program allowing issuance of $2 billion of short-term commercial paper.  Microsoft also opened a $2 billion revolving credit facility.

Microsoft also authorized its second $40 billion share repurchase program in September 2008, and the company increased its quarterly dividend by 18 percent.

In the press release reporting the results from the December period, Microsoft discontinued its previous practice of providing quantitative guidance for Revenue and Earnings Per Share in future quarters of the fiscal year.  The company attributed this decision to "the volatility of market conditions going forward."  Management did indicate that operating expenses in the fiscal year ending 30 June 2009 will be approximately $27.5 billion.

Microsoft's Revenue in the March 2009 quarter will be adversely affected by the weak global economy.  Gartner warned that 11.9 percent fewer personal computers will be sold in 2009 than 2008, with mini "netbooks " that aren't especially lucrative for Microsoft the only bright spot.   Tech Trader Daily reported that Morgan Stanley analyst Adam Holt forecast that PC units will decline by 11 percent in 2009 and that the average price of Windows sold to manufacturers will fall 15 percent.

It is important to remember that Microsoft's diverse businesses give it some protection for the drop off in computer sales.

Yahoo Finance indicates that 25 analysts expect Microsoft's Revenue in the March quarter to vary between $13.66 billion and $14.56 billion.  The lower figure is 5.5 percent below Revenue in the March 2008 quarter.  The higher figure would be an increase of 0.7 percent.

Given this sketchy information, we are, with much uncertainty, setting a $13.85 billion target for Microsoft's Revenue in the March 2009 quarter.  This figure is 4.2 percent below Revenue in the year-earlier quarters.

Microsoft typically achieves a Gross Margin of 80 percent, give or take a few percentage points.  We expect the margin to be towards the lower end of the range, if not below it, given the weaker sales environment and the lower profitability of software for inexpensive computers.  Our specific target is for a Gross Margin of 76 percent.  (Microsoft's Gross Margin has exceeded 76 percent in 85 of the last 98 quarters, as best we can determine.)  This ratio translates into a Cost of Goods Sold of (1 - 0.76) * $13.85 billion, or $3.3 billion. 

The company's guidance for Operating Expenses in fiscal 2009 of $27.5 billion covers R&D expenses and SG&A expenses.  (Microsoft breaks the latter category into Sales & Marketing and General & Administrative.)  Given the actual figures for these expenses in the first half, we estimate that the values for the March quarter will be about $2.4 billion for R&D and $4.8 billion forSG&A.

The estimates above would result in Operating Income of $3.38 billion for the current quarter.  This figure is 23.4 percent below Operating Income in the March 2008 quarter.

We assume Investment and interest income will be about $300 million.  This would lead to Pre-Tax Income just below $3.7 billion.

We'll also assume an income tax rate of 26 percent, which leads to a Net Income value of $2.72 billion ($0.31/share).  This is 38 percent below Net income in the year-earlier quarter.

Our Net Income prediction is quite a bit below the consensus estimate reported on Yahoo Finance.  This is probably because of Revenue and Gross Margin estimates were conservative.

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.


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