Microsoft (NASDAQ:MSFT) announced its earnings for Q2 FY14 on January 23. The company posted a strong 14% year-over-year growth in revenues to $24.51 billion and 3% year-over-year growth in net income to $6.55 billion, buoyed by growth in hardware sales. In our pre-earnings article, we noted that the Windows OS division would be negatively impacted due to weak PC shipment number for Q4 CY13. Microsoft felt the heat from declining PC sales as its Windows original equipment manufacturing revenues declined by 3% year over year. Additionally, weak consumer demand also affected the sales of Windows Office. However, its cloud initiatives continued to deliver growth in the quarter. Below, we review Microsoft’s Q2 FY 14 results by segment.
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In our earnings note published earlier, we stated that the device product launch will drive revenue growth for Microsoft in Q2. Microsoft’s hardware revenues were buoyed by growth in Surface sales and Xbox-One shipments. While Surface revenues more than doubled, increasing to $893 million from $400 million in Q1, the company sold 7.4 million Xbox console units, which led to $1.2 billion in Xbox Platform revenue, up 54%. As a result, revenue for hardware devices was up $1.9 billion or 68% to $4.7 billion.
Licensing Revenue Declines
The company reported that its consumer licensing revenues, which includes Windows original equipment manufacturer (OEM) and consumer office, declined by 6% to $5.38 billion. While weak PC sales affected Windows OEM revenues, the shift to new subscription model also impacted revenues due to the changes in the timing of revenue recognition.
During the earnings announcement, Windows OEM revenue declined $109 million or 3% due to continued softness in the consumer PC market. Furthermore, Consumer Office revenue declined $473 million or 25%. This was partially offset by OEM Pro, which was up 12%. In addition, Microsoft reported that Office 365 now has over 3.5 million subscribers, and that revenue from this Cloud offering in the quarter more than doubled year to year. 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 Q2 FY14, revenue from commercial segment, which includes servers, commercial office licensing and cloud platform, grew 10% to $12.66 billion driven by higher SQL server sales and adoption of the 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 11%, 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.
Online Service Division (OSD)
The Online Services Division division did report some encouraging signs as online advertising revenue grew 6% due to a 34% increase in search revenues as Bing’s US search market share rose 18.2% during the quarter. Furthermore, search advertising revenue improved due to increased revenue per search resulting from ongoing improvements in ad products and higher search volume. 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 are in the process of updating our Microsoft model. At present, we have $42 price estimate for Microsoft, which is approximately 15% above the current market price.