Microsoft Corporation's
(
MSFT
) fourth quarter earnings topped the Zacks Consensus Estimate
although revenues were just short. Non-GAAP earnings including
revenue deferrals related to the Windows 8 upgrade of $540 million
and excluding goodwill impairment of $6.2 billion resulted in
earnings of 74 cents, which exceeded the Zacks Consensus by 11
cents, or 17.5%.
Revenue
Revenue excluding deferrals of $18.05 billion was up 3.7%
sequentially and 4.0% from last year, exceeding estimates by 0.4%.
All except the Windows segment contributed to the increases in the
last quarter, although Server & Tools and Entertainment &
Devices were particularly strong. The softness in Windows was not
surprising, since customers were expected to delay purchases ahead
of the Windows 8 launch.
Segment Specifics
The
Windows
and Windows Live Segment generated 23% of Microsoft's quarterly
revenue, down 10.4% sequentially and 12.6% year over year.
Management stated that the promo upgrade offer for qualifying
Windows 7 PCs pushed out $540 million in revenues. Management
estimates that total PC unit growth was flat, with business PCs
increasing 1% and consumer PCs declining 2%.
Enterprise was again very strong and Windows 7 is now in 50% of
desktops, up from 40% at the end of the last quarter. Management
also stated that volume licensing again grew double-digits.
Microsoft attributed the softness in consumer to PC market issues
in developed countries, as offset by higher attach rates.
There was no alleviation in pressure from tablets, particularly
Apple's
(
AAPL
) iPad. However, attach rates declined 1% on an overall basis,
helping the decline in OEM sales.
The
Microsoft Business Division
, which generated 35% of revenue, grew 8.2% sequentially and 7.0%
from last year. Deployment of Office 2010 continued to gain
momentum, with the annuity side of the business remaining the major
driver of the increase from last year (up roughly 12%), helped by
increase in transaction-based sales of around 2%. Microsoft stated
that other products such as SharePoint, Exchange and Lync remained
strong.
Microsoft's success with CRM could give
Salesforce.com
(
CRM
) something to worry about. In the last quarter, Dynamics CRM grew
over 25%, with customers touching 36,000 and users touching 2.7
million. The acquisition of Yammer closed, with the best-in-class
enterprise social networking expected to boost its cloud
offerings.
The
Server & Tools
segment, at 28% of total revenue, was up 11.4% sequentially and
12.7% year over year. Microsoft's multi-year licensing revenue grew
more than 20% year over year, with SQL server up 20% and SQL
premium up over 30%. Windows Server Premium grew double-digits and
System Center around 20%.
Microsoft also remains optimistic about Azure. Overall trends
indicate continuing strength in the enterprise (enterprise services
were also up 15%). Virtualization and cloud computing are proving
to be very beneficial for Microsoft's S&T business.
Microsoft generated 10% of revenue from the
Entertainment & Devices
segment, up 10.1% sequentially and 19.4% year over year. The
segment is finally showing signs of sustainable improvement.
Despite the market weakness that contributed to the 39% decline
in Xbox units, Microsoft increased market share during the quarter
from 42% to 47%. It also added new partners to Xbox LIVE, where
memberships grew 15%. The newly introduced SmartGlass will help
connect phones, PCs and tablets to Xbox, which is expected to
attract more users to the platform.
Windows Phone units increased more than 50% sequentially, with
apps on the platform touching 100,000. Microsoft also said that
Windows Phone 8 was around the corner.
Skype, acquired from
eBay Inc
(
EBAY
) in 2010 had minutes touching 115 billion, up 50% from last
year.
The
Online Services
business, or online advertising, generated 4% of revenue, up 4.0%
sequentially and 8.1% year over year. We think that 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. (up 120 basis points year over year).
The partnership with
Yahoo Inc
(
YHOO
) remains on track, with increasing ROI for advertisers. But
monetization remains below expectations. The company wrote down
goodwill on the aQuantive acquisition in the last quarter.
Operating Results
Microsoft's gross margin of 76.9% dropped 35 basis points (bps)
sequentially and 170 bps year over year. The gross margin is
closely related to the mix, since margins on hardware and software
products differ widely.
The significant decline from the year-ago quarter was mainly on
account of payments made to
Nokia
(
NOK
) with respect to joint strategic initiatives, the inclusion of
Skype and higher headcount expenses. The search agreement
with Yahoo also remains, raising online services and traffic
acquisition costs.
Operating expenses of $7.51 billion were down 6.1% sequentially
and up 0.3% year over year. The operating margin of 35.4% dropped
126 bps sequentially and 18 bps from last year. S&M expenses
increased 132 bps sequentially as a percentage of sales, with both
R&D and G&A declining. However, lower S&M and G&A
offset higher R&D in the year-ago quarter.
The operating margin by segment was as follows-Windows 57.8% (a
sequential decline of 601 bps), Microsoft Business Division 65.2%
(up 33 bps), Server & Tools 41.1% (up 313 bps) and
Entertainment & Devices -14.8% (down 61 bps). The Online
Services business continues to generate a loss.
The company generated a pro forma net income (excluding
deferrals and goodwill impairment) of $5.7 billion, or 31.6% net
income margin compared to $5.1 billion, or 29.3% in the previous
quarter and $5.9 billion, or 33.8% in the year-ago quarter.
Including goodwill impairment charges, the GAAP EPS was a loss of 6
cents compared to income of 60 cents in the March 2012 quarter and
69 cents in the June quarter of 2011.
Balance Sheet
Inventories were down 19.5%, which raised inventory turns from
11.2X to 14.6X. Days sales outstanding (DSOs) went to 80, up from
57 at the end of the March quarter.
Microsoft ended with a cash and short term investments balance
of $63.0 billion, up $3.5 billion during the quarter. The net cash
position was around $6.23 a share, up from $5.67 a share at the
beginning of the quarter. In the last quarter, the company
generated $7.67 billion in cash flow from operations, spent $1.03
billion on share repurchases, $1.68 billion on dividends, $526
million on acquisitions and $622 million on capital assets.
Guidance
Microsoft maintained its 2013 opex expectations of a 6% increase
to $30.3 to 30.9 billion.
Key Takeaways
Microsoft had a more or less regular quarter, with Windows
revenue impacted by purchase deferrals and S&T and Business
Division seeing good growth. Windows Phone numbers are encouraging,
although the growth is off a small base. However, it is significant
that the company was able to grow share in the gaming segment,
considering the condition of the market and we think the platform
approach here is the way to go.
Of course, we recognize the danger of tablets that are still
largely based on iOS or Android, since these devices are eating
into its netbook sales. We expect this phenomenon to continue
because of the popularity that iOS and Android-based devices have
already encountered. We think this will take time to overcome and
we therefore have a long term Neutral recommendation on the
stock.
We expect the jump in Windows 8 to be tempered by dynamics in
the PC market and therefore think the shares will not gain much. We
have a Zacks Rank of #3 on the shares, which implies a Hold
recommendation in the short-term (1-3 months).
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