Thursday, April 27, 2006

Microsoft Q3 earnings

We analyzed Microsoft's 2nd quarter earnings where it missed consensus revenue estimates. We also looked at Microsoft's legal problems with the EU. Let us look at Microsoft's Q3 earnings and see how things are looking now.

In the earnings report released today, Microsoft failed to meet the profit and revenue estimates for the year. In addition, Microsoft guided down the revenue forecasts for the coming quarter and FY07. The expenses for FY07 are expected to be couple of billions higher than anticapted by the analysts. So let us take a look at what is going on.

The total number of shares outstanding declined on 24th of April to 10,201,202,877. This declined from 10.303 billion shares from the 31st of March. This is better news for the investors.

Let us look at three basic components of the earnings report. The income statement, cash flow statement and balance sheet.

First the operating earning margins excluding investment income. The operating income is 35.5 cents for every dollar. This is a slight improvement from the 34.6 cents for every dollar. This is good news but the investment income declined for the quarter as cash and other short term investments declined this year compared to the past year. The share holders equity also declined this year compared to the prior year as more cash was deployed to buy back shares. Year over year the number of shares declined by about 300 million shares.

Let us take a look at cash flow statements next. The cash flow statements indicate large amount of cash being deployed to buy back shares. In the time period, 12 billion dollars were spent in buying back stocks.

The company makes majority of its money from windows client and office. Although the server and tools division is growing briskly, the division is not as profitable as the other two divisions. Meanwhile, the other four divisions turned into the red in this quarter. The CFO Liddell commented that the expenses will increase significantly in the coming fiscal year. The launching of new products will definitely increase the marketing expenses and the new products probably wont add to the bottom line immediately. The cost of doing business is also likely increase as the labor costs increase year over year. The senior management is planning to heavily increase spending on software services and windows life platform without really having established a solid beach head. There is also low employee morale.

The company faces numerous challenges and its inability to attract top engineering talent could prove to be problematic as it tries to make foray into the search area.

The company is expected to earn $1.39 in FY07. If one backs out $3=00/share, the P/E for 2007 is around 15. This is somewhat cheap. However, tech companies are not valued for their cash but earnings growth. Massive spending doesnt equal massive market share. Microsoft was consistently losing about a billion dollars a year on MSN in the late nineties, just putting the same figure on that business in in 21st century is not going to excite anyone.

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