Zacks_Analysts' Blog : Earnings Preview: Microsoft Corp. - Analyst Blog

Microsoft Corp. (MSFT) is scheduled to announce its second quarter fiscal 2012 results on January 19, 2012, and we notice downward movements in analyst estimates.

Prior-Quarter Synopsis

Microsoft reported an in-line first quarter, as the enterprise refresh largely offset consumer softness in the quarter. Revenue was flat sequentially and up 7.3% year over year, aided by the Entertainment & Devices segment, with the Windows segment also contributing. However, all the other segments were down sequentially.

Gross margin was 78.3%, down 39 basis points sequentially and 236 bps year over year. Higher royalty costs due to higher transactional sales on Xbox Live and an unfavorable mix hurt margins in the last quarter.

The overall performance in the quarter continued to be impacted by the weak consumer PC market.

Management Guidance

Though management did not provide any specific revenue and margin guidance, it raised the fiscal 2012 operating expense projection to $28.6–$29.2 billion due to additional costs related to Skype.

(A detailed discussion of the earnings results is available here: Microsoft's Q1 is Unexciting)

Agreement of Analysts

There have been a significant number of revisions over the past 30 days. During this period, 9 analysts made downward revisions for the second quarter and fiscal 2012, with no one moving in the positive direction.

The analysts believe that a lackluster PC market and weak consumer sales in mature markets will likely weaken Windows revenue growth in the coming quarters. They expect the consumer segment to continue to be impacted by the increasing popularity of tablet devices like the iPad. Additionally, the analysts believe that the floods in Thailand have disrupted the PC supply chain more than expected, leading to HDD (hard disk drive) shortages.

The analysts also expect gross margins to contract as the revenue contribution of lower-margin businesses increases. They believe that Microsoft’s Windows business continues to be pressured by tablets and is becoming a smaller portion of overall computing revenues.

However, analysts remain encouraged by the strong demand for Xbox sales, indicating that the Entertainment & Devices segment will perform well in the coming quarter. Similar to recent quarters, they expect continued robust sales of Xbox/Kinect to offset weaker consumer PC sales.

Magnitude of Estimate Revisions

In the last 30 days, the Zacks Consensus Estimate dropped a penny to 76 cents for the second quarter and 2 cents to $2.72 for fiscal 2012.

Over the 90-day period, the Zacks Consensus Estimate plunged 8 cents for the second quarter and 13 cents for fiscal 2012.

The floods in Thailand have been causing disruptions in the production of hard disk drives since October 2011, and has started to negatively affect the PC supply chain (and IT hardware in general). The market research firm Gartner stated that the worldwide PC shipments declined 1.4% from the fourth quarter of 2010, in line with its earlier forecast of a 1% decline for the fourth quarter of 2011. The negative impact of the shortage in HDDs)is expected to persist in the near term and lower PC shipment growth during 2012. This is the primary reason for the reduction in estimates.

However, longer term, we believe that Microsoft will be a major beneficiary of cloud computing adoption. Moreover, new product cycles will drive growth going forward.

Our Recommendation

We believe Microsoft remains one of the best positioned software vendors, given its wide range of products, strength in emerging markets, continued technology deployment at data centers and growth in cloud computing.

The persistent weakness in consumer PC demand, slowdown in IT spending, and impact of the Thai floods on hard drive supply indicate weak second quarter results. Additionally, Microsoft has a significant exposure to Europe, so the economic slowdown in the region will definitely have an impact on its results. Hence, we do not expect Microsoft to report a very strong quarter.

However, Windows 8, which is expected to be released in 2012 and supports both the x86 and ARM chip architectures could be the next big catalyst for Microsoft. We believe that the availability of Windows applications on a tablet form factor could make the Windows 8 tablet a formidable alternative to iPad and Android tablets.

The slowdown in the global consumer PC market and the disruptions caused by Thai floods has pushed the Zacks Rank on Microsoft shares to #4, which translates into a short-term Sell recommendation.