Microsoft Earnings: 3 Big Takeaways - InformationWeek

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7/23/2014
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Microsoft Earnings: 3 Big Takeaways

Microsoft's cloud business is booming, but devices and consumer mindshare remain problems.

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Microsoft on Tuesday announced strong but slightly mixed earnings for its fiscal Q4, which ended June 30. The company's cloud businesses continued to blossom, with revenue expanding almost 150% to an annualized run rate of more than $4.4 billion. But its device efforts -- particularly the Nokia acquisition, which closed during the quarter -- continue to pose challenges.

Overall, the company's revenue reached $23.4 billion, a year-over-year increase of almost 18%. That exceeded the expectations of Wall Street analysts, who forecast closer to $23 billion. With net income of $4.6 billion, or 55 cents per share, Microsoft came in below profit estimates, however. Analysts had expected per-share earnings closer to 60 cents. In the year-ago quarter, the company's net income was $4.9 billion.

Given that CEO Satya Nadella's just-launched restructuring plan involves the biggest round of layoffs in company history, he faces pressure to accelerate the strong spots while quickly addressing weaknesses. Is Microsoft on the right track heading into its fiscal 2015? Here are three essential takeaways.

1. Microsoft's cloud services are growing rapidly.
Nadella's strategy relies heavily on personalized productivity experiences that follow users via the cloud from one device to the next. On the enterprise side, these services -- which include Office 365, Azure, Exchange Online, SharePoint Online, Dynamics CRM, Lync Online, and Intune -- drove terrific business during the quarter, and, as mentioned, are now on pace for more than $4.4 billion annually. Consumers are embracing Microsoft's cloud services as well. During the quarter, the company benefited from not only Office for iPad, but also Office 365 Personal, a new low-cost option. It also aggressively bundled OneDrive storage with Office 365 plans. Thanks to these efforts, Office 365 Home and Personal subscribers now total more 5.6 million, up from 4.4 million in the previous quarter.

[Say goodbye to the old days. Microsoft Shows Tech 'Monopolies' Don't Last.]

2. Device sales are still a black hole of profit.
Nadella said Tuesday that his "mobile-first, cloud-first" mantra goes beyond mere devices, and is more about the digital experiences mentioned above. That's probably a wise way to spin his strategy, given that Microsoft's first-party device efforts are still hurting. Nokia, for example, added $2 billion in revenue to Microsoft's books, but still posted such poor margins that Microsoft ended up with lower overall profit. Similarly, the company conceded it took a charge when it decided not to release a new Surface form factor, presumably the much-rumored Surface Mini. On the bright side, company execs said the Surface Pro 3 is outselling previous models. It was released late in the quarter, however, and had only a minimal impact on the quarter's overall numbers.

During Tuesday's earnings call, Nadella spoke with an awareness of these challenges, and stressed that devices will have a smaller role in his strategies than they did in predecessor Steve Ballmer's. He talked about inventing new device types that highlight Microsoft services and set an example for partners and about responsibly building the Windows Phone businesses via a scaled-down Nokia. Microsoft said demand had been relatively decent for low-cost, low-margin Lumia smartphones, and that it plans to attack the higher end of the market with upcoming devices.

3. Windows posted a decent quarter, but long-term prospects are still unclear.
Microsoft's Windows cash cow has looked vulnerable over the last year, as PC sales have slid and Windows 8 and 8.1 have flopped. But in the most recent quarter, Windows OEM revenue increased 3%, boosted by an 11% surge in Windows OEM Pro revenue. Microsoft conceded that the uptick was tied at least in part to business upgrades prompted by Windows XP's end-of-service deadline. This makes it unclear how much of the growth is sustainable. Moreover, consumer Windows revenue is falling.

Nadella offered two points of optimism for the long term. He noted that free and low-cost OEM licenses are helping device partners bring sub-$200 Windows laptops and tablets to the market, which should help Microsoft's consumer market share. He also said the next version of Windows would scale across all device types, replacing Windows 8.1, Windows RT, and Windows Phone with a single, unified OS. He didn't go into much detail, but with Windows 8.1 considered a bust, the next version needs bold changes.

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Michael Endler joined InformationWeek as an associate editor in 2012. He previously worked in talent representation in the entertainment industry, as a freelance copywriter and photojournalist, and as a teacher. Michael earned a BA in English from Stanford University in 2005 ... View Full Bio

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Lorna Garey
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Lorna Garey,
User Rank: Author
7/29/2014 | 9:41:01 AM
Re: The device dilemma
Well, let's look:
Market Share of Windows 7 Windows 7 50.55%
Market Share of Windows XP Windows XP 25.31%
Market Share of Windows 8.1 Windows 8.1 6.61%
Market Share of Windows 8 Windows 8 5.93%
Market Share of Mac OS X 10.9 Mac OS X 10.9 3.95%

That's per: http://www.netmarketshare.com/operating-system-market-share.aspx?qprid=10&qpcustomd=0

So, let's say Mac OS grows by 20% this quarter. 20% of 4% is .8% So it's still less than 5%. 
Charlie Babcock
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Charlie Babcock,
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7/23/2014 | 7:34:08 PM
Microsoft is a server company
This is the first quarter where it's been made clear that Microsoft is no longer a consumer device company. It's a server company, able to sell consumer services from cloud data centers. It has two sources of server strength: the enterprise data center and the Azure cloud.
Michael Endler
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Michael Endler,
User Rank: Author
7/23/2014 | 5:34:08 PM
Re: No surprise
It's true that hardware margins aren't as high as software margins, as a general rule. But Apple still achieves pretty extraordinary profit. So too, since it was brought up in some of the comments, does Cisco.

I sympathize with Mel's indicated point about double standards; it's almost like people expect healthy hardware margins to be definitionally short-lived, whereas software margins are seen as potentially eternal. I can see why that bias exists in the abstract, since it's easier to move quickly and adapt as a software-reliant company than it is as one that also relies on hardware. But if anyone has earned some respect in this regard, it's Apple. I still remember when everyone thought Apple was a short-lived "anomaly" during the height of the recession, when its stock price was half what the post-split price is now. Says something about what analysts know. Maybe Android's huge installed base will lead to future glory as users in emerging markets upgrade, but I can tell you right now, in the present-tense, all that market share doesn't mean squat compared to the real dollars and real user-investment iOS is achieving.


That said, I think Microsoft's problem is more complicated than "no one wants their stuff." That might have been, by and large, the case when Windows 8 and Windows Phone 8 both debuted. I used each OSes extensively, and speaking as objectively as I can, neither was nearly as satisfying as OS X or iOS. Windows 8.1 and Windows Phone 8.1 are better, however. I still prefer the Apple OSes, but I don't think Microsoft's UI is a reason to avoid the platform anymore. I once would have had trouble recommending Windows 8 devices to people, especially if I was talking to someone willing to shell out for an Apple product. But the newest Lumias and the Surface Pro 3 have legitimate merit. I don't think they beat Apple's products, per se, but Microsoft has closed some gaps, from a functional standpoint. From a PR standpoint, however, is another matter-- which is probably why Microsoft will ditch the "Windows 8.x" branding and move to "Windows 9" - or perhaps even just "Windows," to reflect the multi-form factor, rapid-release model Microsoft is going for - early next year.
Lorna Garey
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Lorna Garey,
User Rank: Author
7/23/2014 | 12:48:57 PM
Re: The device dilemma
I'd argue that WinMobile failed mainly because Microsoft under Ballmer was hideously late to the mobile game, and the ecosystem is served by Android and iOS. 

As to no one wanting MS desktop products, apparently, businesses and consumers didn't get that memo. Take a look at the latest desktop OS numbers:

http://www.netmarketshare.com/operating-system-market-share.aspx?qprid=10&qpcustomd=0

As of June, all versions of OS X owned about 8%, Linux 1.74%. The rest is Windows.

Moreover, Android is doing just fine. It's even with iOS in the US and well ahead globally. I don't hear many uh-ohs coming from Google.
Lorna Garey
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Lorna Garey,
User Rank: Author
7/23/2014 | 12:06:39 PM
Re: No surprise
I didn't say anything about huge software margins being OK (more on that in a bit). But to start, saying "no one wants their products" is patently incorrect. Surface may not be for everyone, but my college-age daughter bought one (with her own money) and likes it a lot. I've talked with business people whose companies support the devices, and they find them of good quality and suitable for work.There's a huge market globally for lower-end and midrange smartphones. Not everyone is an Apple fan.

And, frankly, in terms of huge margins, we're a market-driven economy. No one "deserves" any given profit margin by right. A company is in business to make as much profit as the market will bear. If Microsoft or Cisco or Apple can get people to pay X dollars for a product, hard or soft, that's exactly what they should be charging. "Fairness" has exactly nothing to do with it.
Shane M. O'Neill
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Shane M. O'Neill,
User Rank: Author
7/23/2014 | 11:43:13 AM
The device dilemma
Some good takeaways here to think about. Very surprised to hear that Nadella & Co "plan to attack the higher end of the [phone] market with upcoming devices." Why would Microsoft keep trying to push that boulder uphill? To say nothing of "inventing new device types that highlight Microoft services." Microsoft is not cut out to invent new devices. They've proven that it's not in their DNA. Cloud services and software are where Microsoft clearly excels. I agree with @Lorna that Microsoft should stay in the hardware game as long as it's not actively hurting the company. But if they keep treating devices as an afterthought, the hurt will come soon enough.
Lorna Garey
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Lorna Garey,
User Rank: Author
7/23/2014 | 11:14:04 AM
No surprise
Hardware margins are always thin -- seems like the point is the linkage and driving adoption of your OSes and software. Oh, and your cloud services. As long as MS isn't actively losing money on phones and tablets I can't see the downside to being in the hardware game.
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