What you need to know from Mi­crosoft’s $26 bln 2Q

Financial Mirror (Cyprus) - - FRONT PAGE - By Alex Wil­helm,

Mi­crosoft re­ported its fis­cal sec­ond-quar­ter fi­nan­cial per­for­mance on Tues­day, laid out its forecasts for its fu­ture per­for­mance and took ques­tions from a num­ber of an­a­lyst. It was a flurry of data, so let’s take a mo­ment and dig through the big points that mat­ter.

THE BIG­GER PIC­TURE

Mi­crosoft met the Street’s fi­nan­cial ex­pec­ta­tions: The company’s $26.5 bln in rev­enue and $0.71 in earn­ings per share were in-line. Its profit de­clined from the year-ago pe­riod, but that was ex­pected due to prior one-time ben­e­fits, and the cur­rent fis­cally dele­te­ri­ous im­pact of the company’s phone as­sets that didn’t ex­ist in the year-ago quar­ter.

The company is down more than 4% in after-hours trad­ing, drift­ing down fur­ther as time has passed. The company’s earn­ings call, which can some­times re­as­sure in­vestors, did not. That’s likely due to the fact that Mi­crosoft in­di­cated on the call that it now ex­pects to grow a mere 4 or 5% dur­ing its cur­rent fis­cal year.

What is driv­ing that limp growth? The company cited that it ex­pects 4 points of rev­enue drag due to for­eign-ex­chan­g­ere­lated is­sues alone mov­ing for­ward. That, cou­pled with macro con­di­tions that are weak in some mar­kets, in­clud­ing Ja­pan, and the prior im­pact of the XP end-of-life bump that has ended, are caus­ing Mi­crosoft’s top-line ex­pan­sion to slow.

So was it all bad? Not at all. Mi­crosoft’s hard­ware had a good quar­ter.

HARD­WARE

Hard­ware had what was gen­er­ally its best quar­ter for Mi­crosoft yet - Sur­face had record rev­enue, and a record num­ber of Lu­mia Win­dows Phone hand­sets shipped. Phone rev­enue fell on a se­quen­tial quar­ter ba­sis to $2.3 bln from $2.6 bln. Sur­face rev­enue grew on a se­quen­tial ba­sis to $1.1 bln, from just over $900 mln the pre­ced­ing quar­ter. But those growth rates on a se­quen­tial quar­ter ba­sis are only large, and they in­clude the tra­di­tional cal­en­dar fourth-

so quar­ter sales bump. I say that to put a touch of cau­tion into your men­tal model go­ing for­ward.

Mi­crosoft noted on its call that the Sur­face Pro 3 is cur­rently out­selling its pre­de­ces­sor, the Sur­face Pro 2, by a fac­tor of 3 to 1. The company also shared that it has yanked $1 bln in cost out of phone, as promised. That should lower short-term earn­ings pres­sure from the group. The company promised more sav­ings in time.

Xbox man­aged to get 6.6 mln con­soles out, down from the year-ago quar­ter, and Mi­crosoft didn’t break down how many Xbox One de­vices were sold in that fig­ure. The company did note that the Xbox One was the best­selling con­sole in the United States dur­ing the hol­i­days.

CLOUD

Con­sumer Of­fice 365 rev­enues, search ad­ver­tis­ing rev­enue, and com­mer­cial cloud all had de­cent quarters.

Con­sumer Of­fice 365 picked up 2.2 mln net new sub­scribers, putting it at 9.2 mln at the end of the quar­ter. Sim­ple math: 9.2 mln x $10 per month x 12 months = $1.1 bln in re­cur­ring SaaS rev­enue, not ac­count­ing for ac­count churn or pos­i­tive or neg­a­tive dol­lar churn.

Com­mer­cial cloud rev­enue notched what Mi­crosoft de­scribed on the call as its sixth con­sec­u­tive quar­ter of three­fig­ure growth, mean­ing that ev­ery quar­ter in the last six has seen that rev­enue cat­e­gory more than dou­ble from its year-ago to­tal. The law of large num­bers will make the streak an in­creas­ingly dif­fi­cult chal­lenge.

Com­mer­cial cloud rev­enue is now on a $5.5 bln run rate, up $1.1 bln in two quarters. That, stacked with the bln from Con­sumer Of­fice 365, makes Mi­crosoft’s cloud top-line a nearly $7 bln business for the company, de­pend­ing greatly on how you mea­sure, of course.

Fi­nally in the cloud cat­e­gory, Bing grew rev­enues 23% from the year prior.

WIN­DOWS

its

ad­ver­tis­ing

Win­dows had a dif­fi­cult quar­ter, due in part to the fact that its year-ago pe­riod had a num­ber of sweet­en­ers and lucky boosts. Win­dows XP lost support, and some Win­dows 8 rev­enues that had been ac­creted and stored be­came ma­te­rial. Try and beat that with­out help.

Mi­crosoft noted that it now has more than 2 mln peo­ple test­ing its Win­dows 10 op­er­at­ing sys­tem, up from 1.7 mln just five days ago. In re­sponse to a ques­tion con­cern­ing how cheaper and free ver­sions of Win­dows will be mon­e­tised, Mi­crosoft CEO Satya Nadella ex­plained on the company’s call that it would de­pend on a mix of ser­vices rev­enue, and sales - the Win­dows Store, Bing, Xbox Live, and so forth.

The company also noted that it al­lowed for lower rev­enue per Win­dows li­cense for low-cost de­vices on pur­pose. This had the ef­fect, ac­cord­ing to CFO Amy Hood, of driv­ing “mean­ing­ful plat­form growth.”

More de­vices sold now means more de­vices that will up­grade to Win­dows 10 for free, thus cre­at­ing a bet­ter user pool for de­vel­op­ers to sell into.

Mi­crosoft noted that it ex­pects the forex is­sues it is deal­ing with, stem­ming from the strength­en­ing dol­lar, and the macroe­co­nomic drag that it is ex­pe­ri­enc­ing will per­sist for the rest of its fis­cal year. That im­plies that other multi­na­tional tech­nol­ogy firms could see clipped growth rates in dol­lars, if not unit terms, this year, ei­ther fis­cal or cal­en­dar.

Sum­ming all the above, the company’s cloud push is still putting points on the board, as are its hard­ware projects. So the “de­vices and ser­vices” bit is still in play. But with limited growth pro­jected, a sea­sonal down­turn in de­vice sales likely in the cur­rent quar­ter, and fall­ing “trans­ac­tional” Of­fice rev­enues which are bet­ter off­set in the long-term by re­cur­ring SaaS Of­fice fees, Mi­crosoft will have to bust hump to meet street ex­pec­ta­tions for the next few quarters.

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