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Microsoft Quarterly Earnings: By the Numbers


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Microsoft Layoffs
AP file/Eric RisbergMicrosoft CEO Satya Nadella
Microsoft (MSFT) sales soared 25 percent in the last quarter, largely from cloud computing. But sales of the Xbox, tablets, and Nokia smartphones also contributed to the strong performance, which handily beat Wall Street expectations as the company maintained profit margins.

Microsoft's business of selling cloud services to other businesses -- in which companies store their data run their major software on remote Microsoft servers -- doubled, and is now the primary focus of the company, according to the new CEO Satya Nadella.

This earnings release follows the earnings announcements from the following peers of Microsoft: Adobe Systems (ADBE), Oracle Corporation (ORCL), International Business Machines (IBM), Google (GOOG), Apple (AAPL), Nokia (NOK) and Yahoo! (YHOO).

Microsoft stood out from peers IBM and SAP who recently reported negative earnings results after strong warnings about operating profits while they move into cloud-related businesses, which generally yields lower margins than technology companies are used to.

  • Summary numbers: Revenues of $23.201 billion, Net Earnings of $4.540 billion and Earnings per Share (EPS) of $0.54.
  • Revenue rose, helped by outstanding performance in the cloud segment and the phone business it bought from Nokia, beating analysts' estimates.
  • Gross margins narrowed to 70.5 percent from 77.5 percent from same period last year.
  • At the same time, Microsoft reported gross margin improvements in its cloud business, despite the cost of building and operating new data centers.
  • Performance focus was more on revenue than the bottom-line: increase of revenue of 25.3 percent vs. decline in earnings of -13.4 percent from same period last year.
  • Ability to declare a higher earnings number? Rise in operating cash flow of 1.8 percent versus same period last year--better than change in earnings.

The table below shows the preliminary results and recent trends for key metrics such as revenues and net income (See complete table at the end of this report):

Q3 2013 Q4 2013 Q1 2014 Q2 2014 Q3 2014
Revenue Growth (YOY) 15.9% 14.3% -0.3% 17.8% 25.3%
Earnings Growth (YOY) 17.4% 2.8% -6.5% -7.1% -13.4%
Net Margin 28.3% 26.8% 27.8% 19.7% 19.6%
EPS $0.62 $0.78 $0.68 $0.55 $0.54
Return on Equity 26.1% 31.5% 26.2% 20.8% 20.2%
Return on Assets 14.7% 17.7% 14.6% 11.2% 10.6%

Market Share Versus Profits

Investors should look at revenue growth to understand a company's ability to grow its market share, and earnings growth to look at the company's ability to generate profits, because companies sometimes focus on growing their top-line-(sales or revenues) more than their bottom-line-(earnings or net income).

Microsoft's change in revenue compared to the same period last year of 25.3 percent is better than its change in earnings which was -13.4 percent - suggesting perhaps that the company's focus is on sales and revenue at the expense of profits. However, this revenue improvement beat the announced results thus far by its technology peer group - pointing to some likely market share gains and helping us to overlook the weaker earnings performance this period. (In comparison to the second quarter, revenues declined by 0.7 percent and earnings declined by 1.6 percent.)

Earnings Growth Analysis

Microsoft's lower earnings compared to the same period last year has been influenced by the following factors: (1) Narrowing of company-wide gross margins from 77.5 percent to 70.5 percent and (2) issues with cost controls. As a result, operating margins (EBITDA margins) went from 39.3 percent to 36.3 percent in the past three months. In the second quarter, by comparison, gross margins were 74.9 percent and EBITDA margins 35.6 percent.

Cash Versus Earnings

In order to determine if a company's performance is sustainable, Capital Cube lifts the veil behind a company's cash versus earnings numbers.

Companies often post earnings numbers that are influenced by non-cash activities. One way to gauge the quality of the reported earnings number is to compare the growth in earnings to the growth in operating cash flows. Microsoft's rise in operating cash flow for the same period this year of 1.8 percent is better than its change in earnings, which suggests that the company might have been able to declare a higher earnings number. But, this increase in operating cash flow is less than average among the declared results thus far in its peer group, cautioning us about its performance versus its peers in the future.

One-time charges

Microsoft had a one-time charge of $1.1 billlion related to announced layoffs, mostly from the integration of Nokia. This charge is largely what caused profits to slip to 54 cents a share compared to 62 cents a share in the year ago quarter.

EPS Growth Versus Earnings Growth

Microsoft's year-on-year change in Earnings per Share (EPS) of -12.9 percent is better than its change in earnings of -13.4 percent. Despite its strong performance in its cloud and device business segments noted above, this loss in earnings is worse than the average of its peer group who have reported earnings thus far, suggesting that the company may be losing some ground in generating profits for some of its business segments compared to its peers.

Gross Margin and Efficiency Trend

Companies sometimes offer easier terms to customers and vendors even at the cost of improvements in revenues and margins. Capital Cube checks this out by comparing the changes in gross margins with any changes in working capital. If the gross margins improved without working capital sliding, the company's performance might be a result of truly delivering in the marketplace, and not simply a gimmick using the balance sheet.

Microsoft's lower gross margins are offset by some improvements on the balance sheet side - working capital management shows progress. The company's working capital days have dropped to 267.4 days from 316.8 days for the same period last year, and suggest that the overall company-wide gross margin decline is not altogether bad.

Supporting Data

The table below shows the preliminary results along with the recent trend for revenues, net income and other relevant metrics:
Q3 2013 Q4 2013 Q1 2014 Q2 2014 Q3 2014
Revenue Growth (YOY) 15.9% 14.3% -0.3% 17.8% 25.3%
Peer Average Revenue Growth (YOY) -0.9% -1.7% -0.5% 4.4% 1.8%
Earnings Growth (YOY) 17.4% 2.8% -6.5% -7.1% -13.4%
Peer Average Earnings Growth (YOY) 6.7% 1.4% -2.0% 14.0% 0.6%
Operating Cash Flow Growth (YOY) -4.0% -10.3% 12.7% 15.9% -21.2%
Peer Average Operating Cash Flow Growth (YOY) 5.9% -18.3% -9.5% 11.3% -9.8%
Gross Margin 77.5% 71.3% 77.0% 74.9% 70.5%
Peer Average Gross Margin 70.5% 66.7% 72.7% 71.7% 70.1%
EBITDA Margin 39.3% 37.6% 40.2% 35.6% 36.3%
Peer Average EBITDA Margin 27.0% 28.9% 27.4% 28.8% 22.7%
Net Margin 28.3% 26.8% 27.8% 19.7% 19.6%
Peer Average Net Margin 20.0% 22.5% 23.1% 20.2% 18.9%
EPS $0.62 $0.78 $0.68 $0.55 $0.54
Peer Average EPS $0.55 $0.67 $0.62 $0.82 $0.51
Return on Equity 26.1% 31.5% 26.2% 20.8% 20.2%
Peer Average Return on Equity 17.1% 19.5% 19.6% 17.9% 19.3%
Return on Assets 14.7% 17.7% 14.6% 11.2% 10.6%
Peer Average Return on Assets 10.9% 12.2% 9.8% 11.5% 10.2%

Company Profile

Microsoft Corp. develops and markets software, services and hardware that deliver new opportunities, greater convenience and enhanced value to people's lives. The company's products include operating systems for computing devices, servers, phones, and other intelligent devices; server applications for distributed computing environments; productivity applications; business solution applications; desktop and server management tools; software development tools; video games; and online advertising. It also designs and sells hardware devices including surface rt and surface pro, the Xbox 360 gaming and entertainment console, Kinect for Xbox 360, Xbox 360 accessories, and Microsoft pc accessories. The company operates its business through two segments: Devices and Consumer and Commercial. The Devices and Consumer segments develop, market, and support products and services designed to entertain and connect people, increase personal productivity, help people simplify tasks and make more informed decisions online, and help advertisers connect with audiences. Its Devices and Consumer segments are: D&C licensing comprise of windows, including all original equipment manufacturer licensing and other non-volume licensing and academic volume licensing of the windows operating system and related software; non-volume licensing of Microsoft office, comprising the core office product set, for consumers; windows phone, including related patent licensing; and certain other patent licensing revenue; D&C hardware comprise of Xbox gaming and entertainment consoles and accessories, second-party and third-party video game royalties, and Xbox live subscriptions; surface; and Microsoft pc accessories; and D&C other, comprise of resale, including windows store, Xbox live transactions, and windows phone store; search advertising; display advertising; subscription, comprising office 365 home and office 365 personal; studios, comprising first-party video games; its retail stores; and certain other consumer products and services not included in the categories above. The Commercial segments develop, market, and support software and services designed to increase individual, team, and organizational productivity and efficiency, including simplifying everyday tasks through seamless operations across the user's hardware and software. Its Commercial segments are: Commercial licensing comprise of server products, including windows server, microsoft sql server, visual studio, and system center; windows embedded; volume licensing of the windows operating system, excluding academic; microsoft office for business, including office, exchange, sharepoint, and lync; client access licenses, which provide access rights to certain server products; microsoft dynamics business solutions, excluding dynamics crm online; and skype; and Commercial Other comprise of enterprise services, including premier support services and microsoft consulting services; cloud services, comprising office 365, excluding office 365 home and office 365 personal, other microsoft office online offerings, dynamics crm online, and microsoft azure; and certain other commercial products and online services not included in the categories above. Microsoft was founded by William Henry Gates III in 1975 and is headquartered in Redmond, Washington.

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