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Microsoft’s 1QFY14 Earnings: Back On Track

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By: Larry Darrell
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Microsoft Corporation’s (MSFT) earnings for the last quarter of its 2013 fiscal year (FY13) had left investors deeply unsatisfied, and its stock price had dropped more than 11% subsequent to the announcement. Its results had been in keeping with recent trends however – Microsoft had missed revenue expectations in four out of the five preceding quarters as well.

Investors had many reasons to turn bearish on the company – the Microsoft management had announced a large write-down of its Surface inventory, which had added to worries arising from the overall slowing demand for PCs, the company’s marginal presence in the smartphone and tablet markets, and skepticism on its restructuring initiatives and devices and services strategy.

This quarter (1QFY14), however, Microsoft beat analyst expectations due to strong growth in its enterprise segment, and commendable performance in its consumer segments. Investors rushed to snap up the stock, which pushed the share-price up 6%.

Microsoft reported revenues of $18.5 billion for the first quarter of FY14, higher 15.7% over the same period of the preceding year. The announcement exceeded analyst expectations by $700 million. The company’s per share earnings (63 cents) were also 19% higher over the comparable period of last year, and beat analyst expectations by nine cents.

Its reported margins were also higher than consensus estimates, even though gross margins were lower compared to the same period of the earlier year.

The company has also lowered its guidance for gross and operating margins to 65.6% and 29.4% respectively for the second quarter.

All segments, except Devices and Consumer Licensing, posted improved earnings over the corresponding quarter last year.

Growth in the consumer segment came from Microsoft’s Office 365, Skype and SkyDrive services, among others. Contrary to analysts’ expectations after the last earnings announcement, the PC market actually fared quite well, but in the business segment alone. Revenues from original equipment manufacturers – a major contributor to the devices and consumer segment – fell only 7%, even though analysts had expected a decline of at least 15%. Revenues in the consumer segment from sales of Microsoft Office were also lower, with cloud-based Office 365 cannibalizing its market share.

The consumer hardware segment, however, saw revenues grow by $401 million during the quarter, owing to greater sales of the Microsoft Surface tablet as the device gains traction. Meanwhile, 13% higher advertisement revenues drove growth in the ‘other’ accounting head.

The Commercial segment, on the other hand, posted considerable growth from cloud services, with Office 365 and Azure growing more than 100%. Revenues from server products grew 12%, while SQL products experienced double-digit growth in revenues. All in all, the segment is Microsoft’s strongest revenue driver and is expected to continue growing.

Guidance

In what seems to be a shift in strategy, Microsoft has provided detailed guidance for its upcoming quarter. The company expects business as usual in the Devices and Consumer segment, with the enterprise market for PCs showing stability even as the consumer PC market remains volatile. Hardware revenues are expected to grow 35-45%, with the Surface gaining traction among tablet users and the upcoming launch of the Xbox One gaming console coinciding with the holiday season.

The Commercial segment is expected to maintain its current growth momentum into the second quarter.

Conclusion

Microsoft has delivered strong results for the quarter, along with expectations of better growth in the second quarter. The results also hint at initial successes achieved from the implementation of the company’s new strategy for devices and services, which were delineated in the last major restructuring plan announced by outgoing CEO Steve Ballmer.

Microsoft’s enterprise segment has reported strong growth and accelerating adoption of cloud services. In the consumer segment, PC demand has been weak, but less than analysts feared; meanwhile, Microsoft has gained traction in the tablet market. Following its acquisition of Nokia, Microsoft also expects to increase its share in the smartphone market to 15% by 2018.

The company’s guidance hints at good days ahead, with a lot depending on the new CEO.

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