Microsoft Earnings: Revenues Increase As Microsoft Consolidates Phones Division Revenues

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Microsoft (NASDAQ:MSFT) announced its earnings for Q2 FY15 on January 26th. (Fiscal years end with June)  The company posted a 8% year-over-year growth in revenues to $26.47 billion, which also includes $2.3 billion revenues from Nokia’s phone division. In our pre-earnings note, we noted that hardware sales and cloud services would boost revenues. While the devices and consumer hardware revenue increased by 40.5% to $6.28 billion due to phone sales, Microsoft reported 114% growth in commercial cloud services, which includes Office 365, the Microsoft Azure platform, and Dynamics CRM. The annualized revenue run rate of commercial cloud stands at $5.5 billion. Below, we review Microsoft’s Q2 FY 15 results by segment.

See our complete analysis of Microsoft here

Hardware Sales Flatlined

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In our earnings note published earlier, we stated that the device sales will drive revenue growth for Microsoft in Q2. Microsoft’s hardware revenues were buoyed by growth in Surface Pro 3 sales and Xbox-One shipments. While Surface revenues grew by 24% year over year to $1.1 billion, the company sold 6.6 million Xbox console units.  Despite, the increase in Surface sales, revenue for hardware devices declined to $3.997 billion or 11% from $4.47 billion.

Phone Division Boosts Revenues

Nokia acquired Nokia Devices and services (NDS) unit in the fourth quarter of fiscal year 2014. During the quarter, Microsoft sold 10.5 million Lumia phones and over 39 million non-Lumia phones, which translated into $2.28 billion sales and $331 million in gross profits. Going ahead, we expect this division to do well, and Microsoft to report higher sales. However, since the company is focusing on selling Lumia at lower price points, and in emerging markets, we expect revenues to be lower and profitability to decline.  ((For more on this read Microsoft-Nokia Launches Cheap Lumia Phones For Price Sensitive  Consumers)) However, restructuring and the integration NDS impacted margins, and the company incurred costs of $243 million.

Windows OS Licensing – A mixed bag

While Microsoft reported that its consumer Windows licensing revenues declined by 13% while Windows Commercial volume licensing revenue grew by 3%, partly due to end of support for Windows XP. As the one-time benefit of the Windows XP end-of-life PC refresh cycle tailed off, revenues from Windows consumer licensing declined to pre-Windows XP end of support levels. Since both its existing and new OEM partners are bringing to market an expanded set of device offerings at more competitive price points, Windows OEM non-Pro revenue declined 13%. [1] However, Windows volume licensing revenue increased by 3%, with annuity revenue growth partially offset by declining transactional revenue. Going forward, as the company gears to launch Windows 10 in April this year. We will write more on this topic soon.

Office 365 Subscriber Base Grows

While Office 365 revenue grew by 150% or $97 million, Office consumer products and services revenue declined 12% due to the ongoing transition to Office 365. Office 365 Home and Personal subscriber base grew by 2.1 million sequentially to 9.2 million subscribers at present. However, commercial Office declined by 1% as transactional revenue was impacted by the continued transition to Office 365. As the subscription model sets in, revenues for this division are expected to grow, and become more recurring and predictable going forward.

Server & Cloud Witness Another Quarter Of Strong Adoption

Microsoft’s Windows Server division is one of the fastest growing divisions of Microsoft. During Q2 FY15, server products and services revenue grew by 9%, driven primarily by double-digit growth in Microsoft SQL Server. Furthermore, adoption of the cloud-based Azure platform also increased, and cloud revenue run rate exceeded $5.5 billion. 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 did report some encouraging signs as online advertising revenue grew  10% or $110 million, due to a 23% increase in search revenues as Bing’s US search market share rose 19.7% during the quarter. Furthermore, search advertising revenue improved due to increased revenue per search resulting from ongoing improvements in ad products and higher search volumes. This increase was offset in part by a 9% reduction in display advertising revenue, due to declines on both portal traffic and monetization. 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 $44.46 price estimate for Microsoft, which is approximately 5.42% below the current market price.

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Notes:
  1. Read more about it here []