Additional Comments on Microsoft’s Q2 2014 Earnings Report

Three other topics included in Microsoft’s Q2 2014 Earnings Report (http://www NULL.microsoft NULL.com/Investor/Events/Presentations/2014/ERFY14Q2 NULL.aspx?eventid=138992) may benefit from comments. The three of interest to me are the quarter’s Cost of Goods Sold (COGS), sales of Windows Phone licenses to OEMs, and sales of commercial cloud products.

COGS

Chris Suh noted a substantial, 46%, increase in COGS for the quarter. This topic comes up elsewhere in this presentation and impacts on margin considerations for the business. I think Microsoft is uniquely capable of absorbing this increase, with subdued impact on the broad product margin discussion for the overall business.

The COGS jump can be directly attributed to the Device and Consumer Hardware (D&C Hardware) business. Q2 2014 saw the commercial release of the new XboxOne and Surface 2 products. But the strength of traditionally much higher margin businesses (approaching the 83% “Nirvana” number, Amy Hood mentions early in the presentation); specifically, the combination of satisfactory growth in their Commercial Licensing Business (7%, year over year, but SQL Server business grew over 25% over the same time period), and rapid growth in the “Commercial Other” segment, which includes Azure, Office 365 and Dynamics CRM (doubling year over year, albeit with substantially smaller impact on the bottom line), will, in my opinion, pay for a lot of this front-end hardware hit to COGS.

Windows Phone Sales to Oems

Windows Phone Sales to OEMs are included in the Devices and Consumer Licensing (DCL) business segment section of Microsoft’s Earnings Release FY14 Q2 (http://www NULL.microsoft NULL.com/investor/EarningsAndFinancials/Earnings/PressReleaseAndWebcast/FY14/Q2/default NULL.aspx). Year over year, revenues from this segment were down 6%, from $5.703 Billion to $5.384 Billion. Chris Suh commented on this number noting the revenue decline reflected prevalent ” . . . PC and device market trends . . . “. I need to note, while Chris Suh specifically mentioned a 3% decline in Windows sales to OEMs, he doesn’t mention the specifics about the decline in sales of Windows Phone to OEMs. At the start of her forward looking comments, Amy Hood, CFO remarked about Nokia: “All guidance here assumes no impact from Nokia.”

But I think the drop in sales of Windows Phone licenses to OEMs, perhaps, correlates to Nokia’s announcement, a day in advance of this earnings report of a 29% drop in handset sales. In my opinion this drop is attributable to much more competition at the high end of the smart phone market. A quick look at Samsung’s report for the same calendar quarter reveals a 9% drop in year over year sales for its IM/Mobile business segment (http://www NULL.samsung NULL.com/us/aboutsamsung/ir/ireventpresentations/earningsrelease/downloads/2012/20140124_conference_eng NULL.pdf).

In fact, I think the Google Moto G, together with a robust effort by Lenovo to become a major manufacturer in this product category, has resulted in a broad drop in market share for each of the traditional major players in the market. It will be very interesting to study Apple’s report for the same calendar period. I would attribute any subdued forward looking comments about iPhone sales, once again, to these two new developments in the high end smart phone market.

Commercial Cloud Products

Microsoft reported Q2 2014 sales of $1.78 Billion, which amounts to a year over year 28% increase, in its sales of “Commercial Other” product segment offers, including Office 365, Azure and Dynamics CRM. In contrast, Google reported $1.23 Billion in “Other” (I presume this segment includes Google Apps) revenue for the 3 months ending September 30, 2013 (http://investor NULL.google NULL.com/pdf/2013Q3_google_earnings_data NULL.pdf), and Amazon appears (I find it very difficult to breakout the actual cumulative sales figure for Amazon AWS for the quarter) to have reported $1.011 Billion in “Other” sales (which includes AWS) for the calendar quarter ending September 30, 2013 (http://phx NULL.corporate-ir NULL.net/phoenix NULL.zhtml?c=97664&p=irol-newsArticle&ID=1868092&highlight=).

I leave it to the reader to draw conclusions from the above figures as to the comparative rank of each of these companies in the broad cloud computing services category. Certainly, anyone reviewing the statistics must at least acknowledge Microsoft’s ascendance to one of the leadership positions in this category in a very short period of time.

It’s important to note Microsoft’s report of a substantial 24% drop in consumer licensing for its Office products elsewhere in the quarterly report. Chris Suh provides further detail on this number, estimating 16% of the total as directly attributable to consumers abandoning on premise Office for Office 365, consumer. The next few quarters will provide important indication of how the ongoing erosion of this product segment is progressing.

Ira Michael Blonder (https://plus NULL.google NULL.com/108970003169613491972/posts?tab=XX?rel=author)

© IMB Enterprises, Inc. & Ira Michael Blonder, 2014 All Rights Reserved

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