Microsoft Beats by a Penny - Analyst Blog

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Microsoft Corporation's ( MSFT ) fiscal second-quarter earnings of 76 cents beat the Zacks Consensus Estimate by a penny.

Revenue

Revenue of $21.46 billion was up 34.0% sequentially and 2.7% from last year, in line with our estimates. All except the Entertainment & Devices segment grew both sequentially and from the year-ago quarter. Entertainment & Devices were down year over year.

Segment Specifics

The Windows and Windows Live Segment generated 27% of Microsoft's quarterly revenue, up 81.3% sequentially and 24.2% year over year. Microsoft stated that over 60 million Windows 8 licenses were sold to date and more than 60% of enterprise desktops had migrated to Windows 7. OEM revenue outdid x86 demand according to Microsoft, reflecting underlying demand in the channel.

Non-OEM revenue grew 40%, driven by Windows 8, the Surface tablet and volume licensing deals (up double-digits). Similar to past quarters, the x86 section of the market saw emerging markets doing better than developed markets and business PCs better than consumer PCs. Microsoft attributed part of the softness on the consumer side to the stronger-than-expected demand for touch devices.

The Microsoft Business Division , which generated 27% of revenue, grew 3.4% sequentially while declining 9.4% from last year. The business side grew 4%, of which multi-year licensing grew 10%. However, the consumer side impacted segment performance, as tablet cannibalization of x86-based PCs outdid the impact of growing attach rates. Microsoft stated that revenue from other products, such as SharePoint, Exchange and Lync increased double-digits.

The Server & Tools segment, at 24% of total revenue, was up 13.9% sequentially and 8.7% year over year. Microsoft's multi-year licensing revenue grew more than 17% year over year, with SQL server up 16% and System Center around 18%. Overall trends indicate continuing strength in the enterprise. Virtualization and cloud computing are proving to be very beneficial for Microsoft's S&T business.

Microsoft generated 18% of revenue from the Entertainment & Devices segment, up 93.8% sequentially and down 11.0% year over year. The holiday season was the main reason for the sequential increase, video game deferrals impacted the year-over-year comparison.

Xbox remains the leading console at 5.9 million units with the Halo 4 gaming franchise (launched in Nov 2012) achieving best-seller status. Microsoft also stated that Xbox Live members touched 40 million.

Windows Phone sales were 4X the level reached in the year-ago quarter.

Skype, acquired from eBay Inc ( EBAY ) in 2010 had minutes touching 138 billion, up 59% from last year.

The Online Services business, or online advertising, generated 4% of revenue, up 24.7% sequentially and 10.8% year over year. Microsoft is investing in technology and innovation and it is this work that is improving user experience and helping Bing take some share in the U.S. The revenue per search (RPS) continued to improve in the last quarter.

Operating Results

Microsoft's gross margin of 73.5% dropped 49 basis points (bps) sequentially and increased 47 bps year over year. The gross margin is closely related to the mix, since margins on hardware and software products differ widely. Therefore, the increase in Entertainment & Devices revenue (mostly hardware) hurt the sequential comparison, despite growth in other segments.

Operating expenses of $7.99 billion were up 22.4% sequentially and 10.2% year over year. The operating margin of 36.2% expanded 306 bps sequentially although shrinking 206 bps from last year. All expenses increased sequentially as a percentage of sales, with R&D (up 196 bps) and S&M (up 170 bps) being the most significant.

The operating margin by segment was as follows-Windows 56.0% (a sequential increase of 531 bps), Microsoft Business Division 62.6% (down 362 bps), Server & Tools 40.9% (up 250 bps) and Entertainment & Devices 15.8% (up 1,482 bps). The Online Services business continues to generate a loss, although narrower than in the past.

The company generated a pro forma net income of $6.38 billion, or 29.7% net income margin compared to $4.47 billion, or 27.9% in the previous quarter and $6.62 billion, or 31.7% in the year-ago quarter.

Balance Sheet

Inventories were up 2.3%, which lowered inventory turns from 10.3X to 13.7X. Days sales outstanding (DSOs) went to 61, down from around 56 at the end of the Sep 2012 quarter.

Microsoft ended with a cash and short term investments balance of $68.3 billion, up $1.67 billion during the quarter. The net cash position was around $54.12 billion, down from $54.69 at the beginning of the quarter. In the last quarter, the company generated $4.78 billion in cash flow from operations, spent $1.66 billion on share repurchases, $1.93 billion on dividends, $311 million on acquisitions and $930 million on capital assets.

Guidance

Microsoft maintained its 2013 opex expectations of a 6% increase to $30.3 to 30.9 billion. The tax rate for the year is expected to be 17-20% (previous 19-21%) and capital expenses around $3.5 billion (unchanged).

Key Takeaways

Microsoft had a more or less regular quarter, with revenue coming in somewhat better than normal seasonality. The many new products across segments, strength in the cloud computing segment and share gains in search combined to generate the encouraging results. Its leadership position in the gaming segment and Halo 4 also had a positive impact.

Microsoft said that demand for its new touch-based devices was well in excess of supply, which contributed to the weakness in consumer sales. Additionally, competition from popular platforms by Apple ( AAPL ), Samsung and others makes growth in the mobile segment difficult.

While the search business is growing steadily, Microsoft is still way behind market leader Google ( GOOG ). Google has had phenomenal success in the mobile segment and its position here is practically unshakeable. Microsoft's focus on mobile hardware is therefore very important. In the meantime, the cannibalization of its core x86 market remains an overhang on the shares. 

Microsoft shares currently carry a Zacks Rank #4 (Sell).



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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Business , Stocks

Referenced Stocks: AAPL , EBAY , GOOG , MSFT

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