An often irreverent look at this week's other news related to Microsoft's blockbuster earnings announcement, including no news about Microsoft's next CEO, an educated guess about actual Surface sales in Q4, questions around the health of the Surface business, a strong start for Xbox One,as a bellwether for Microsoft's transition to services, Microsoft's business offerings continue to dominate earnings, and looking for a few trends in a sea of numbers.
This week: Microsoft earnings
Yes, yes, I know you're just dying to know my opinions about the real news sweeping the tech industry this week—Apple might finally adopt slightly bigger iPhone screens and lead the industry to a new product category that it absolutely invented yet again or whatever—but this time, it's all about Microsoft's blockbuster earnings announcement from the fourth calendar quarter of 2013. So if you haven't, be sure to check out Microsoft Reports Record Quarterly Revenues of $24.52 Billion for the roundup. (Also, I'm going to use the term Q4 to describe this quarter, since that's how us humans think of it. But it was Microsoft's second fiscal quarter. You're welcome.)
No CEO for you!
The press was warned ahead of Microsoft's quarterly earnings conference call that the firm would not be announcing a new CEO or discussing that issue in any way. My take on this is that Microsoft had a lot of really good news to discuss this week around the success of its transition to a devices and services firm, and it didn't want any CEO news, even a tidbit, to dominate the headlines instead. Naturally, the mainstream press complied with such understanding headlines as "Microsoft profit beats forecasts, no word on new CEO" and "Microsoft tops Q2 earnings expectations, still no new CEO." Classy.
How many Surface tablets did Microsoft sell?
One of the things I was most curious about was how well Microsoft's fledgling Surface business did in Q4. In its earnings announcement, the firm noted that Surface revenues more than doubled sequentially, from Q3 to Q4, from $400 million to $893 million. That sounds positive ... but it's vague. It also led to some closet analysis from bloggers and individuals with an Internet connect around such esoteric topics of average selling price (ASP) and so on. So, we need to do some math. With lots of assumptions.
Let's do the math
In a post-earnings conference call I'll be referencing repeatedly, Microsoft said that "most" of the Surface devices it sold were running Windows RT, meaning Surface RT (ASP ~$300) and Surface 2 (ASP ~$450). But some were Pro/Pro 2 devices (ASP ~$800). And of course we need to account for accessories, especially the keyboard covers, since most Surface customers probably got one of those as well, and "Surface" includes those hardware accessories too. If "most" equals about two-thirds, we can assume the following: One Surface RT sale, One Surface 2 with cover sale, and one Surface Pro/Pro 2 with cover sale represent each three "Surface sales." So the ASP there is $300 (Surface RT) + $450 + 100 (Surface 2 with cover) + $800 + $100 (Pro/Pro 2 with cover) divided by 3, or ... wait for it... $583. And when you divide $893 million divided by $583, you get about $1.5 million units. Is 1.5 million units good? Apple sold over 14 million iPads in the non-holiday Q3, and in the year-ago holiday quarter it sold almost 23 million units. So ... it's kind of hard to argue that is any good, no.
OK, but how healthy is the Surface business?
Of course, one might argue that Apple trundled along with 5 percent or less of the PC market for a good 20 years there, and its Mac business is highly profitable. Could Microsoft be heading towards a similar place? Perhaps, but it didn't happen in Q4. I'm seeing a lot of bloggers using another term they obviously don't understand—"cost of revenue"—to explain to their readers why the Surface business is still a big loser. So where does that come from? As it turns out, the source is a Microsoft filing with the Securities and Exchanges Commission, in which the term "cost of revenue" appears fully 50 times. If I understand the argument, the "cost of revenue" of Surface--$932 million in Q4—is so big that it clearly dwarfs Surface revenues, and thus Surface lost about $39 million in Q4. And ... that may be accurate, and could be a reflection, roughly, of what we might call the "net income" for the business in the quarter. To be fair, a $39 million loss is a rounding error for a company like Microsoft in some ways, and of course it's a new business. So is it a step in the right direction (or "continued progress," as Microsoft puts it)? Yes. But let's just say that they have a ways to go and leave it at that.
Strong start for Xbox One
We already knew that Microsoft sold over 3 million Xbox One video game consoles by the end of 2013, but the firm added some addition numbers to but things in perspective. Through the end of 2013, it delivered 3.9 million Xbox One consoles into the channel—meaning to distributors and retail stores—so it really was delivering on its promise to make them as fast it could. Given that you couldn't find an Xbox One in December, it's safe to say that they really did sell every Xbox One they delivered to stores. And that a bunch of those remaining 900,000 units were no doubt sold this month too. But the other interesting figure is 7.4 million, which is the total number of Xbox consoles sold in Q4. This means that Microsoft also sold 3.5 million Xbox 360 consoles (into the channel) in Q4 and probably sold about 3 million of them to actual customers. That is not shabby at all.
Office 365 as a bellwether for Microsoft's transition from software to services
One year ago, Microsoft launched the new version of Office 365, a compelling set of office productivity services—and subscription-based desktop software—for both consumers and businesses. Since Office is Microsoft's biggest business, it makes sense to view this transition—from traditional Office software to Office as a set of services—as a bellwether of sorts for the wider strategy change that is sweeping Microsoft. So how is Office doing? Microsoft said that it now has over 3.5 million Office 365 Home Premium subscribers, which seems ... pretty good? But one of the side effects of the change from software to services is that profits and revenues will fall too, and the firm reported that consumer Office revenue was down 24 percent year over year, with 16 percent of that due entirely to Office 365 Home Premium. The upside here is that switching customers to a more predictable and consistent revenue model is good overall. And if you doubted my assertion that Office 365 Home Premium is a tremendous deal for consumers, these numbers sort of prove that. Microsoft is making less off you on Office.
Microsoft's business offerings continue to dominate
Not surprisingly, it was Microsoft's business offerings that really carried the day in the quarter. Again. Server revenues were up 12 percent. Office business revenues were up 10 percent, with Office 365 for business seats more than doubling year over year. SQL Server and System Center grew double digits. Azure grew triple digits. So how big is this stuff for Microsoft? Full $12.6 billion in revenues can be attributed to business licensing and "other"; that half of Microsoft's total revenues for the quarter. But when you look at gross margins, it's even more dramatic: The business stuff accounted for $10.4 billion of a total of $16.2 billion; that's two-thirds of Microsoft.
Looking for trends
Finally, it's interesting to look at Microsoft's various business units and see whether there are any trends. For example, Windows was once Microsoft's biggest business, and it had fallen to number three behind Office and Server before Microsoft changed the way it accounts for these products. Looking over Microsoft's business segment history, which dates back only to FQ1 2013 (which is really mid-2012), I see the following. Commercial licensing is king, at $9 billion or so per quarter with a $1 billion bump in the holiday quarter. (I guess there are a lot of SQL Server licenses sitting under Christmas trees for some reason.) But Devices and consumer licensing is number two and fairly consistent at $4.3 billion per quarter with a $1 billion bump in the holiday quarter. Number three is Devices and Consume Hardware, with roughly $1 billion per quarter but a huge bump in the holiday quarter ($2.8 billion a year ago and $4.7 billion this past quarter). So... Microsoft says it's a devices and services company and it pretty much is. But two interesting bits. One, the firm is more services than devices, and by a wide margin. And, go figure, the (consumers) devices are show early signs of taking off, especially from a revenues perspective. (Margins, not so much.)
But Wait, There's More
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