Microsoft(MSFT) Second Quarter Analysis

Microsoft (MSFT) announced its second quarter earnings after the close of markets today. From the press releases, it appears as though Microsoft missed the revenue numbers but beat the so called consensus number by one cent. The one cent gain came from some tax benefits obtained in this specific quarter. In other words, Microsoft met the analyst estimates for this quarter.

The stock responded by trading higher in the after hours trading. The analysts have generally been bullish about this stock for this year with the anticipated launch of Windows Vista and Office 12 later this year. The company had also warned higher product launch expenses in its last yearly report to diminish the earnings this fiscal year.

Let us dive down into the balance sheets to see if one should be optimistic about this stock and how the company performed under the hood.

The operating income margin fell in this quarter compared to the last one. It fell to ~38 cents a share from 41.5 cents a share. R&D expenses increased from 1515 million to 1591 million an increase of 5% quarter over quarter. The cost of revenues also increased quarter over quarter by 83%. While part of this is attributable to the XBox 360 launch, not all the expenses are attributable to this. The operating income for the first six months of the year declined by 2% year over year. This was primarily because of the increased expenditure ( 22% year over year) in sales and marketing division. The increase in revenue was primarily driven by higher PC shipments and increase in server revenue.

Let us look at each of the segments to see how Microsoft did. We also will take a look at the impact from the 7 billion stock buy back on stock dilution.

First MSN search. MSN revenues declined year over year. Three factors contributed to the decline. The first one is the decline from internet connection revenue. The second one is the increase in headcount costs. The third factor is the ramp up to the new search hasn't been as fast as expected and the growth in search revenue hasn't been as good. ( although the traffic increased through the new MSN search. ) MSN profit declined by 55% year over year.

The MBS revenue increased year over year and finally the division turned a profit of ten million dollars. The revenue growth in MBS is increasing steadily.

The Microsoft Office family of products increased revenue by 5% year over year. The operating earnings increased at a lesser rate of 2%.

The windows server division is the current star in the company. The server division increased in revenue by 14% and the operating margins increased by 16% compared to the prior year.

The windows client revenue increased by 8% year over year but the profit margins increased by only 4%.

The mobile and embedded devices division also turned in profit for the time making up for some of the losses in home and entertainment and MSN.

In the home and entertainment division, the revenue increased by about 180 million dollars compared to the previous year's quarter. Although the revenues increased by 180 million dollars, the expenses increased faster than revenue. Microsoft's 10Q states that expenses will continue to climb faster than revenue in the coming quarters.

Microsoft spent 7.6 billion in the quarter buying back 283 million shares. However the total number of shares outstanding declined by 138 million. The rest of the money went to stem dilution in the number of shares through insider selling. The stock holder equity fell by about three billion dollars year over year though the number of outstanding shares declined by about three hundred million year over year. Investment income also increased by 40% year over year for the first six months of the year.

Overall, the positive was the increase in microsoft's revenues year over year. MBS and Mobile Devices division also turned a profit for the first time which is a good sign. Given the rate of stock buy back and the expected increase in cost in the Home and Entertainment division, it is likely that Microsoft will continue see the pattern in the growth of operating income in the next two-three quarters.

The balance sheet may have no bearing on stock performance as several analysts have rated the stock a buy. Stock performance is also based on investor psychology. If more money flows into the tech sector, Microsoft stock could be a beneficiary.