Friday, 25 October 2013

A closer look at Microsoft Q1 2014 Results

Microsoft delivered record first quarter revenue. This holiday, the company will see competitive opening price points on tablets and laptops, such as the Dell Inspiron 15 for less than $300 and will also see exciting mobile devices from six inch phones to 10 inch tablets, many with Microsoft Office.

In the six inch category, Microsoft is incredibly excited by the Nokia Lumia 1520 tablet announced this past Tuesday. For eight inch tablets, Toshiba, Dell, Lenovo will have devices available for less than $300 and for 10 inch tablets; the company of course likes the Nokia Lumia 2520 with LTE.

Total revenue was up 7% to $18.6 billion and came in at about $700 million better than the company’s expectations. Without the impact of foreign exchange, revenue would have been $200 million or one percentage point better.

Annuity revenue was particularly strong and grew 11%, driven by commercial performance. Cost of goods sold increased 23%, which was in line with the company’s expectation of over 20% growth. This increase was primarily due to service cost and also higher depreciation related to the CapEx investments Microsoft made this quarter for cloud services strategy. As a result, gross margin grew 3% to $13.5 billion, reflecting the changing mix of revenue.

In R&D, Microsoft is continuing to focus its resources while accelerating cadence. Operating income and earnings per share, both declined 3% to $6.4 billion and $0.63, respectively. Unearned revenue grew a healthy 14% to $20.1 billion and the company’s contracted not billed balance grew to over $21 billion, driven by commercial strength.

Microsoft’s inventory balance sequentially increased by $675 million, mostly due to build the Xbox 360 and Xbox One. Ahead of holiday selling season, Xbox represents over half of the company’s inventory balance.

Inventory for Surface products declined sequentially even as the company built levels ahead of this week Surface 2 and Surface Pro 2 launches. This quarter, Microsoft announced a 22% increase in its quarterly dividend to 28% and also announced $40 billion share repurchase program. The company returned $3.8 billion of cash to shareholders, high quarterly amount since the second quarter of fiscal 2011.

Performance of each Reporting Segments:

Microsoft’s devices and consumer licensing segment is comprised principally of Windows OEM, consumer office and Windows Phone, including related patent licensing. Windows OEM business performed better than expected, declining 7% versus the company’s expectation of a mid-teens decline.

The management believes it is seeing stabilization in business PCs, which grew again this quarter and drove Pro revenue growth of 6%. The company also saw better than expected performance in the consumer part of business.

Non-Pro revenue declined 22%, but with several points better than expected. Excluding the impact of China, which continues to have a different dynamics than other emerging markets, non-Pro revenue declined 17%.

Moving to Devices and Consumer other. As a reminder, this segment includes the online marketplaces, advertising, Xbox Studio, Office 365 Home Premium and other consumer products and services. This quarter revenue growth in this segment was driven by both an increase in advertising revenue and also volumes in online marketplaces.

Search advertising revenue grew 47% driven by continued revenue per search improvements and query volume growth. Bing has now grown its share of search queries in the U.S. to 18%. Gross margin declined slightly due to higher royalty costs and also infrastructure cost growth as the company expanded geographic footprint of its services.

Moving to Commercial Business. With all up commercial revenue across both on-premise and cloud services grew 10% this quarter. Notably even as the company invests for growth, it saw gross margin expansion in commercial cloud business.

Across commercial portfolio, the company saw healthy renewal, a continued shift to premium products and strong adoption of its cloud services. Microsoft’s enterprise cloud strategy is resonating with customers and server product revenue grew 12%. SQL Server revenue grew double-digit with SQL Server Premium revenue growing over 30%.

Office products also remained strong and grew 11%. Within this, SharePoint, Exchange and Lync collectively grew double-digits with Lync growing nearly 30%. Helping to drive this demand for Server and Office product is deployment of hybrid cloud solution. This quarter, revenue for the company’s commercial cloud services grew over 100% as services such as Office 365, innovative Azure services for comprehensive cloud solution.

Revenue in the Commercial Licensing segment grew 7% and in Commercial Other segment, revenue grew 28% to $1.6 billion. As a reminder, Corporate and Other is where Microsoft consolidates adjustments for tech guarantees, pre-sales and the like. In the comparable quarter of last year, the company had aggregate deferrals of $1.4 billion for Windows and Office and this quarter deferred $113 million, primarily related to Windows 8.1 pre-sale.

Future Outlook

Devices and Consumer

In Licensing, Microsoft expects revenue to be $5.2 billion to $5.4 billion. This range reflects similar dynamics to what the company saw in the first quarter. As noted earlier, the company expects the business PC market to be stable; however, the consumer PC market is subject to more volatility.

In Hardware, the company expects revenue to grow 35% to 45% to $3.8 billion to $4.1 billion, reflecting the expanded Surface line up and the much anticipated Xbox One launch. The 10 percentage point range reflects variability in device unit volumes. In the consumer hardware business, such variability is not uncommon, especially during launches and the holiday season.

In Devices and Consumer Other, the company expects revenue to be $1.7 billion to $1.8 billion. Search revenue should continue to grow reflecting improved revenue per search and query volume. As a reminder, in Q2 of the prior year, Microsoft launched Halo 4, which contributed $380 million of revenue to this segment.


The company expects revenue to grow 9% to 11%, in line with the first quarter.

In Commercial Licensing, Microsoft expects revenue to be $10.7 billion to $10.9 billion, with similar dynamics to what it saw in the first quarter. This includes healthy renewals and strong annuity revenue growth from volume licensing with Software Assurance.

In Commercial Other, the company expects revenue to be $1.7 billion to $1.9 billion, reflecting ongoing momentum in its commercial cloud business and enterprise services. As CIOs increasingly look to capitalize on the opportunities of cloud computing, the management is confident they will continue to look to Microsoft for their IT solutions.

Cost of Revenue

Moving on to cost of revenue, the company expects it to be $7.9 billion to $8.3 billion next quarter. This range primarily relates to the unit variability assumed in hardware revenue.

Operating Expenses

Microsoft expects OpEx to grow 6% to 8%, to $8.5 billion to $8.6 billion. The company also reaffirms its full-year guidance of $31.3 billion to $31.9 billion. The company continues to invest in innovative experiences for its customers while remaining focused on expenses.

Microsoft still expects full year capital expenditures to be about $6.5 billion, even though the company only spent $1.2 billion in the first quarter. Given the nature of the investments, there is variability from quarter-to-quarter due to company’s success based approach as well as the timing of delivery and completion.

The company expects its tax rate for the full year to be between 18% and 20%, depending on its geographical mix of earnings. When adjusting for tech guarantees and product deferrals, Microsoft expects unearned revenue to be roughly in line with historical trends.

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