Microsoft (NASDAQ:MSFT) announced its earnings for Q1 FY14 on October 24th. The company posted a strong 16% y-o-y growth in revenues to $18.53 billion and 17% y-o-y growth in net income to $5.24 billion. This marks the first quarter Microsoft reported its results broken into five segments grouped into two categories: Devices & Consumer and Commercial.
In our pre-earnings article, we noted that the Windows OS division would be negatively impacted due to weak PC shipment number for Q3 CY13. Microsoft felt the heat from declining PC sales as its Windows original equipment manufacturing revenues declined by 7% y-o-y. Additionally, weak consumer demand also affected the sales of Windows Office. However, Microsoft’s cloud initiatives continued to deliver growth in the quarter. Below, we review Microsoft’s Q4 FY 13 results by segment.
Hardware Sales To Bolster Revenues In Q2 FY14
In our earnings note published earlier, we stated that device and new product launch will be central to revenue growth for Microsoft in the future. The company projects that its hardware revenues will increase by 35%- 45% to $3.8 billion to $4.1 billion in Q2, reflecting the expanded Surface line up and the much anticipated Xbox One launch.
Microsoft Office Division
During Q1 FY14, Microsoft’s revenues from its business division grew by 5% to $5.99 billion. While weak PC sales affected Office’s consumer revenues that declined by 23%, the shift to new subscription model also impacted revenues due to the changes in the timing of revenue recognition. During the earnings announcement, Microsoft reported that cloud based Office 365 now has over two million subscribers. As subscription model sets in revenues for this division is expected to grow, and become more recurring and predictable going forward.
Microsoft’s Windows Server division is the second largest business unit making up over 20% of its total value. It is also one of the fastest growing divisions of Microsoft. During Q1 FY14, revenue from server and tools grew 11% to $5.05billion driven by higher SQL server sales and adoption of cloud based Azure platform. Many customers of Microsoft depend on SQL servers for mission critical and business intelligence needs, specifically in the big data analytics domain. As a result, Microsoft’ SQL server revenue grew by 30% outpacing the server market. Additionally, its Azure cloud offering clocked in triple digit growth in revenues. We’re encouraged by the continual growth that this division posted, and it is becoming an important driver for Microsoft’s value.
Windows OS Division
Windows Operating System is Microsoft’s third largest division and makes up 13% of its stock value by our estimates. During Q1 FY14, Microsoft’s revenues from its Windows division declined by 5%. For Q3 CY13, IDC reported a 8% y-o-y decline in PC shipments and OEM revenues declined in line with the PC market.  However, Microsoft launched Windows 8.1, an updated version of Windows 8, in this quarter. We expect the updated version would fare better in the market than Windows 8. We, therefore, estimate that OEM revenue for Microsoft will decline at a slower rate in the remainder of 2013. Additionally, we expect PC sales to stabilize in the coming quarters and if Microsoft can continue to maintain its market share, it could be a catalyst for the company’s stock price.
Online Service Division (OSD)
The Online Services Division continued to negatively impact Microsoft’s overall profitability posting an operating loss of $321 million. However, this division did report some encouraging signs as online advertising revenue grew 13% due to a 47% increase in search revenues as Bing’s US search market share rose 18% during the quarter. We forecast Bing’s global market share to increase steadily throughout our forecast period but any surprises to the upside are not expected to increase the company’s value substantially.
We have $42 price estimate for Microsoft, which is approximately 25% above the current market price.Notes:
- Gartner and IDC: PC shipments continued to slide in Q3, but the worst may be over, October 9 2013, www.engadget.com [↩]