January 25, 2013

Microsoft Fiscal Q2 2013 Earnings - Is a Walk as Good as a Hit?


More accurately, is a walk as good as a single? If you are in a baseball game, the answer of course would be yes. From an earnings perspective a single is more a sign of successful survival than achievement and a walk is more a sign of barely hanging on. Microsoft hit a double on its enterprise numbers and well, it managed a walk on the consumer front.

With the holiday quarter now behind us, Microsoft's earnings for this key quarter - the highlights of which we'll provide shortly - clearly reflect that Microsoft remains first and foremost an enterprise vendor, and only secondarily a consumer player. This suggests that efforts to get those floodgates that support Apple and Samsung - smartphones and tablets - to open for Microsoft continue to fail for the most part. We can give Microsoft an A grade for trying, but the test results still show a C as the result on the consumer front.

Framing this issue, as we'll see, is that Microsoft's successful consumer products (think Xbox) underwhelmed during the holiday quarter. And while the holiday quarter is entirely meaningless for Microsoft's massive enterprise businesses, it is critical to its consumer business. The group did not manage a hit in the quarter - we're feeling charitable so we'll say it managed a walk. The less charitable among us might view it as a strikeout.

That said, Microsoft managed to record revenue for the quarter of $21.5 billion - up from $20.9 billion a year ago. It had operating income of $7.77 billion, and net income of $6.4 billion, a decline from last year's $6.6 billion. EPS came in for the quarter at $0.76 per share compared to last year's $0.78 per share.

Consensus analyst estimates had been $21.5 billion in revenue and an EPS of $0.75 per share, so Microsoft managed to meet expectations on revenue and beat EPS estimates. Taking the actual revenue results a bit further, Microsoft pulled in $21.46 billion in, but consensus estimates were $21.53 billion, so it was in truth a slight miss on the revenue side, albeit a "rounding error" miss.

CEO Steve Ballmer was not on the earnings call, but he did issue the following statement: “Our big, bold ambition to reimagine Windows as well as launch Surface and Windows Phone 8 has sparked growing enthusiasm with our customers and unprecedented opportunity and creativity with our partners and developers. With new Windows devices, including Surface Pro, and the new Office on the horizon, we’ll continue to drive excitement for the Windows ecosystem and deliver our software through devices and services people love and businesses need.”

Perception vs. Reality

That statement, however, doesn't really reflect the reality that Ballmer continues to whiff on the consumer side. It also suggests that revenue might have been higher for the quarter on the enterprise side if the new version of Office weren't on the immediate horizon - which no doubt kept many businesses large and small from buying. The results overall underscore the kind of CEO Ballmer really is, which we detailed when Steven Sinofsky left Microsoft.

Peter Klein, Microsoft's CFO, managed the earnings call. He did underscore that Microsoft has sold over 60 million Windows 8 licenses to date and that the company's Windows division managed to post revenue of $5.9 billion, a 24 percent increase from the prior year's quarter. Klein noted that this represents an adjustment for net deferral of revenue for the company's Windows Upgrade Offer and the recognition of the previously deferred revenue from Windows 8 Pre-sales - without this adjustment (which reflects Windows 8 sales offers prior to Windows 8 becoming officially available) Windows Division revenue increased only 11 percent for the second quarter, though that is still a solid number.

The company's key enterprise Server and Tools group delivered $5.2 billion in revenue, up nine percent from the previous year's quarter. The star of the show here was double-digit percentage revenue growth in Microsoft's SQL Server and System Center platforms.

The Business Division posted $5.69 billion of revenue, a 10 percent decrease from the prior year period (as we noted above, no doubt due to likely buyers awaiting the next release of Office). Taking into account an adjustment for the impact of the company's Office Upgrade Offer and Pre-sales (same as noted for Windows 8 above), the Business Division's revenue increased three percent for the second quarter. Revenue from Microsoft’s productivity server offerings (collectively including Lync, SharePoint, and Exchange) continued double-digit percentage growth.

The Online Services Division reported revenue of $869 million, an 11 percent increase from the prior year period, and online advertising revenue grew 15 percent, which was driven by an increase in revenue per search. Nevertheless, the group as a whole continues to be a drop in the revenue bucket and a far cry from delivering the level of performance Microsoft needs from it.

Finally, we come to the Entertainment and Devices Division, which managed to deliver revenue of $3.8 billion. But - let's make it an upper case BUT - this represents a huge consumer-side decrease of 11 percent from the prior year period. Yet another adjustment, this one reflecting Video Game Deferral, leaves the division with only a two percent decrease in revenue.  Microsoft noted that Xbox continues to be the top-selling console in the United States - but this looks to us a hollow victory.

That these consumer-side decreases occurred during the peak quarter for consumer buying suggests that Microsoft has yet to crack the code here. Once again, we believe that this falls directly on Ballmer, who continues to be a great enterprise CEO but, in our opinion, a CEO not suitable for today's consumer marketplace. Some of our concern here is directly reflected by the lack of Surface RT tablet sales, which as we've previously noted we believe has been due to a significant failure in sell-through strategy.

During the quarter, of course, Microsoft and its partners launched Windows Phone 8 with a broad array of carriers and devices. The company did not break out details of these sales, nor did we expect it to. However, Klein did note that Microsoft and its partners sold four times as many Windows Phone devices in the last quarter as they did a year earlier. That isn't saying much, however, since sales were entirely negligible in 2011.

To summarize, Microsoft continues to reflect a great deal of enterprise strength and - regardless of all its efforts to date to tell a consumer story - significant consumer-side weakness. We need to highlight this issue specifically because it is absolutely fundamental to why Microsoft's stock continues to languish. It was in the range of $27 per share 10 years ago. It was in the range of $27 per share yesterday. It's in the range of $27 per share today.

It remains a huge disappointment. A stagnant stock says it all about…well, we know who.




Edited by Brooke Neuman



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Microsoft    Apple    Tablet
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