Microsoft Sees Profit Slide Despite Enterprise Boost

Microsoft’s transformation of its Windows empire is reaping some success for Redmond, but its latest financials show the company still not firing on all cylinders.

For its second quarter ended 31 December, 2012, Microsoft posted operating income, net income and diluted earnings per share of $7.77 billion (£4.9bn), $6.38 billion (£4bn) and $0.76 (£0.48) per share respectively. The gains were led by a boost in Windows sales and overall enterprise business, the company said.

Microsoft also announced quarterly revenue of $21.46 billion (£13.6bn), a 5 percent increase compared with the same quarter during the prior year.

Profit Slide

However it seems that net income was down 4 percent for the quarter. This is because Microsoft posted net income of $6.38 billion (£4bn) for its second fiscal quarter of 2013, down from the same period in FY 2012 when it posted net income of $6.62 billion (£4.2bn).

The Windows division posted revenue of $5.88 billion (£3.7bn), a 24 percent increase from the prior year period. Microsoft said it has sold more than 60 million Windows 8 licenses to date. Windows was Microsoft’s biggest revenue generator for the quarter, surpassing the Microsoft Business Division at $5.69 billion (£3.5bn) and the Server & Tools unit at $5.19 billion (£3.3bn).

This quarter marks the first that the new Windows 8 operating system has entered the market. The new operating system, which is intended to “reimagine” and enliven the Windows platform with touch capability and a host of other new features, hit the market on 26 October, giving the software giant more than two months of sales of the new OS.

“Our big, bold ambition to reimagine Windows as well as launch Surface and Windows Phone 8 has sparked growing enthusiasm with our customers and unprecedented opportunity and creativity with our partners and developers,” Steve Ballmer, Microsoft’s CEO, said in a statement. “With new Windows devices, including Surface Pro, and the new Office on the horizon, we’ll continue to drive excitement for the Windows ecosystem and deliver our software through devices and services people love and businesses need.”

Also during the quarter, Microsoft released its Surface RT tablet computer, which was well-received at opening day events at the company’s stores around the country. However, indications are that Surface sales have been lukewarm. Its newest Surface tablet model, the Surface Windows 8 Pro, will be available for purchase on 9 February, 2013, in the United States and Canada at all Microsoft retail stores, microsoftstore.com, Staples and Best Buy in the US, as well as from a number of locations in Canada.

Expected Disappointment

“I’d call Microsoft’s results disappointing but not particularly surprising,” said Charles King, principal analyst at Pund-IT. “There’s been chatter for a couple of weeks about weak sales of Windows 8-based PCs and laptops during the holidays.”

A drop in sales often occurs just before a company refreshes a major product, and both Office and Xbox appeared to suffer such a falloff, said King.

“The most disturbing thing about the call was the company’s decision not to provide details about Surface sales,” he said. “That would be a bad sign in any case but is doubly so when it pertains to a product designed to establish Microsoft as a name player in the hot tablet market.”

Industry analyst Rob Enderle of the Enderle Group advised to take a wait and see approach on Microsoft’s Windows 8 progress.

“There was a shortage of Windows 8 hardware last quarter largely due to vendors getting their touch-screen orders in too late,” Enderle said. “I think it likely that was a big reason [Steven] Sinofsky was let go. Still this was actually better than I expected given they are about to release a new version of Office as well as suggesting their sustaining revenue from long-term contracts and online services may be reaching old IBM levels, making them far more predictable even in the face of adversity.”

He added, “Folks pay those contracts regardless of economic conditions or product cycles, which was the old IBM model. It really slows growth but also makes revenue and profit damn near immovable objects so makes the company incredibly stable and predictable. We’ll know better by the end of the year.”

Enterprise Success

“We saw strong growth in our enterprise business driven by multi-year commitments to the Microsoft platform, which positions us well for long-term growth,” said Peter Klein, chief financial officer at Microsoft, in a statement. “Multi-year licensing revenue grew double digits across Windows, Server & Tools, and the Microsoft Business Division.”

Microsoft’s Server & Tools business reported $5.19 billion (£3.3bn) of revenue, a 9 percent increase from the prior year period, driven by double-digit percentage revenue growth in SQL Server and System Center.

“We see strong momentum in our enterprise business. With the launch of SQL Server 2012 and Windows Server 2012, we continue to see healthy growth in our data platform and infrastructure businesses and win share from our competitors,” said Kevin Turner, chief operating officer at Microsoft, in a statement. “With the coming launch of the new Office, we will provide a cloud-enabled suite of products that will deliver unparalleled productivity and flexibility.”

The Microsoft Business Division posted $5.69 billion (£3.5bn) of revenue, a 10 percent drop from the prior year period. Revenue from Microsoft’s productivity server offerings – collectively including Lync, SharePoint, and Exchange – continued double-digit percentage growth.

“The success of the company’s enterprise products group isn’t particularly surprising,” King told eWEEK. “Microsoft has benefited hugely from businesses continuing migration to x86-based server and appliance solutions, a situation that’s likely to continue for some time. But I expect that the market and analysts will be watching closely in 2013 to see if the company’s data centre success mirrors any corresponding boost in sales of Windows 8 PCs, Ultrabooks, tablets and phones to businesses.”

Other Divisions

The Online Services division reported revenue of $869 million (£551m), an 11 percent increase from the prior year period. Online advertising revenue grew 15 percent driven by an increase in revenue per search.

The Entertainment and Devices division posted revenue of $3.77 billion (£2.4bn), a decrease of 11 percent from the prior year period. Xbox continues to be the top-selling console in the United States. During the quarter, Microsoft launched Windows Phone 8 with a broad array of carriers and devices.

“Valuation held at near current levels because they met on the top line and exceeded modest estimates on the bottom line,” Enderle said. “Supply issues are mostly resolved for Windows 8 but the first quarter is typically very slow, and corporate purchases outside of enterprise contracts, which have them built in for both Office 2013 and Windows 8, aren’t likely to move significantly until the second half of the year. However, year over year numbers, particularly starting in calendar Q2, should tell us whether Windows 8 really has legs.”

Meanwhile, Al Hilwa, an analyst with IDC, said he thought Microsoft’s earnings results were good.

“I think Microsoft is executing on a long-term transition, and they are aware it is not going to happen in one quarter,” Hilwa said. “I think the design of Windows 8 deliberately attempts to trade off quick migration versus long-term building of a new portfolio of touch apps.”

Moreover, “The issue I have for developers is that they have two platforms they are promoting with Windows Phone and Windows 8, and it may be fragmenting developers who are also distracted by opportunities on other platforms,” he said.

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