(MSFT) Microsoft Third Quarter 2010 Earnings Scorecard

Last month, Microsoft Corporation (MSFT) reported third quarter 2010 earnings that exceeded analyst expectations. While some analysts continue to hold reservations, forward estimate revisions indicate a more positive outlook for Microsoft.

Third Quarter Highlights

The earnings beat was attributable to operating costs, which proved more flexible than expected, declining slightly on a sequential basis.

Revenue came in more or less as expected, although seasonality drove a sequential decline across all segments. The increase from the comparable prior-year quarter was driven by stronger consumer and enterprise demand for its newly-launched Windows 7 operating systems (OS). Microsoft benefited from stronger spending by small and medium sized consumer OEMs, as well as some early enterprise demand that could herald a stronger year ahead.

The inline revenues and cost control enabled Microsoft to generate record cash flow of over $7 billion Incorporatedreasing the net cash per share to $4.10.

Microsoft also guided to lower expenses for the fiscal year to end in June 2010.

Agreement of Analysts

We see a notable number of estimate revisions over the past 30 days among the 27 analysts covering the stock.

A total of 11 and 14 analysts raised estimates for the June and September quarters of 2010, respectively. Twenty five analysts raised their estimates for fiscal 2010 and 24 for fiscal 2011.

Moreover, while 5 analysts lowered their estimates for the upcoming quarter and 1 for the following quarter, there were no downward revisions for either fiscal 2010 or fiscal 2011.

The last 7 days saw no changes, indicating that the revisions were in response to the company’s earnings announcement and the guidance provided at the time.

Magnitude of Estimate Revisions

Despite the large number of analysts revising estimates over the past 30 days, the Zacks Consensus Estimate edged up a penny each for the June and September quarters, while it was up a more pronounced 4 cents for fiscal 2010. The revision for the year is mostly a reflection of the better-than-expected results in the last completed quarter, while the estimate revision for June looks more like a fine tuning.

Additionally, the smaller magnitude of revisions for the next two quarters indicates that analysts expect a gradual recovery for Microsoft rather than a quick turnaround. This may be traced to the large percentage of revenue generated under annuity contracts (that lend stability to revenue) rather than a pure licensing model.

The Zacks Consensus Estimate for fiscal 2011 is up 10 cents, which is very encouraging. Therefore, the analysts clearly expect adoption of Windows 7 OS to be strong, despite the fact that Google Inc.’s (GOOG) Chrome OS will hit the market later this year.

Stays Outperform

Our positive sentiments are validated and strengthened by analysts’ optimism regarding Windows 7 for enterprise and consumer PCs and Office 2007, as well as Microsoft’s strong cash flow, its history of returning cash to investors and cheap valuation. The mobile strategy has not really been hailed yet, and we will take a wait and see approach to that. Of course, we are positive about the Kin twins and the new Windows 7 mobile OS.

Overall, we believe the risk/reward ratio is in favor of Microsoft at present. We therefore have an Outperform rating on the stock.

Zacks Investment Research

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