Strong cloud, weak PCs, and accounting rules give Microsoft a flat 3Q 2014

Microsoft logoКMicrosoft posted its financial results for the third quarter of its 2014 financial year, corresponding to the first quarter of the 2014 calendar year. Revenue was essentially flat, down less than one percent, at $20.4 billion. Operating income was down 8 percent at $6.97 billion, and earnings per share were down 6 percent at $0.68. Unless otherwise stated, all comparisons are with the third quarter of the company's 2013 financial year.

Devices and Consumer (D&C) Licensing revenue was up 0.7 percent at $4.38 billion, though gross margin was down 0.6 percent at $3.91 billion. Windows OEM revenue was overall up 4 percent, with Windows OEM Pro revenue up by a substantial 19 percent, reflecting increased sales of business PCs (stimulated in part by Windows XP's end-of-life) and greater penetration of Windows Pro in small and medium businesses. However, this strong Pro performance was substantially offset by Windows OEM non-Pro revenue, which was down 15 percent. Office Consumer revenue was also up, growing by 15 percent, with increased sales in Japan ahead a tax increase that Microsoft called out for special attention.

This reporting division also includes Windows Phone and related patent licensing. Microsoft didn't offer any specific information about its performance this quarter, but the year-to-date numbers (up $440 million in the first six months, but up only $429 million in the first nine months) indicate a $11 million deterioration in its quarterly performance, year-on-year.

D&C Hardware revenue was up 41 percent at $1.97 billion, with gross margin down 34 percent at $0.39 billion. This was driven by sales of the expensive-to-build Xbox One. In total, 2 million Xboxes were sold in the quarter, 1.2 million of which were Xbox Ones.

Surface revenue increased by more than fifty percent to $494 million, but still loss-making, with cost of revenue of $539 million. This suggests a worsening of the business as compared to the previous quarter. In the previous three months, Microsoft lost $40 million on sales of $890 million. This three months they lost $45 million on lower sales.

D&C Other revenue was up 18 percent at $1.95 billion. Gross margin was also up, rising 26 percent to $0.54 billion. This was driven by an increase in advertising revenue and subscription revenue. Online advertising was up $0.14 billion/16 percent. Search advertising revenue was up 38 percent, though display advertising was down 24 percent. Subscription revenue was $98 million. This was driven by the growth of Office 365 Home (or "Home Premium" as it was known at the time), which now has 4.4 million subscribers, up almost 1 million compared to the previous quarter.

Commercial Licensing revenue was up 3 percent to $10.32 billion, with gross margin up 4 percent to $9.43 billion. This was driven primarily by increased server product revenue, up 10 percent, and Office revenue, up 6 percent, offset somewhat by the migration to cloud services. Lync, SharePoint, and Exchange all experienced double digit growth, with SQL Server growing by more than 15 percent. Windows volume license revenue was up 11 percent, and Microsoft estimates that now 90 percent of enterprise desktops are using Windows 7 or 8.

Commercial Other revenue was up 31 percent to $1.90 billion, with gross margin up 80 percent to $0.48 billion. Most of this growth was driven by cloud services, which were up 101 percent/$0.37 billion; most of this was Office 365 revenue, up by more than 100 percent. Azure revenue was also up by more than 150 percent. Enterprise Services revenue was up 8 percent/$0.09 billion.

With revenue across all the product groups up, it's a little surprising that overall revenue was down. The difference comes from Microsoft's final reporting bucket: Corporate and Other. This section is used to account for revenue deferrals that are tied to pre-sales, bundling, and upgrade offers. In the 2013 financial year, this bucket showed revenue of $1.65 billion and gross margin of $1.60 billion. This year, the revenue is $-0.13 billion, and the gross margin is $-0.15 billion. This negative revenue arises from the earlier recognition of revenue tied to products that were only delivered in the most recent quarter.

Microsoft's purchase of Nokia closes tomorrow, with the company saying that this was some four months later than it originally expected. Nokia's results will be included within the D&C Hardware segment, and next quarter's results will include the impact of the acquisition. The company is offering no specific guidance, but says that it expects annual "cost synergies" of $600 million within 18 months of the close.

Nokia aside, the company did offer guidance for next quarter. On the Devices & Consumer side, revenue will be broadly similar for Licensing ($4.1-4.3 billion) and Other ($1.9 billion). Hardware will see lower revenue ($1.3-1.5 billion) as the quarter is traditionally slow for hardware sales.

On the Commercial side, reasonable growth is predicted, with Licensing estimated at $11-11.2 billion, and Other at $2.1 billion.

Source: Ars Technica

Tags: Microsoft, report

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