Eight days before Windows 8's big launch, Microsoft served up expected, dismal news about its successor, in the wake of disastrous third-quarter PC shipments. They sapped Windows division revenue and profit, keeping to a recent trend. There was never a question of negative impact, merely how bad — as Wall Street analysts expected overall company revenues to decline. The question everyone should ask: Can Q4 be any better than this?
For fiscal first quarter 2013, ended September 30, Microsoft revenue fell 8 percent to $16.1 billion, year over year. Operating income: $5.31 billion, down 26 percent. Net income: $4.47 billion. Earning per share fell 22 percent to 53 cents. The results are impacted by a $1.36 billion, or 13 cents-a-share, deferral related to Windows 8 and Office 2013 launches.
Without the deferral, Microsoft would have reported $17.4 billion revenue (flat year over year); $6.7 billion operating income (down 7 percent); and 65 cents earnings per share (down 4 percent).
Average analyst consensus was $16.42 billion revenue and 56 cents earnings per share, for the quarter. Revenue estimates ranged from $16 billion to $16.87 billion, with estimated year-over-year decline of 5.5 percent. Microsoft announced results after the bell.
"While enterprise revenue continued to grow and we managed our expenses, the slowdown in PC demand ahead of the Windows 8 launch resulted in a decline in operating income", Peter Klein, Microsoft chief financial officer, says. "Multi-year licensing revenue grew double-digits across Windows, Server & Tools, and Microsoft Business Division products as businesses commit to our technology roadmap".
In a stunning turnabout and indication just how weak is the PC market, Microsoft's Server & Tools division generated more revenue and income — a first — than Windows & Windows Live. When including the deferral, Windows division revenue fell by 33 percent, income by 50 percent.
For more than a year, the PC market demonstrated consistent resistance to growth. But third quarter, which usually gets back-to-school buying lift, delivered steep declines. Global PC shipments fell 8.6 percent year over year, according to IDC, shockingly surpassing the minus 3.8 percent forecast. Gartner puts the decline at 8.3 percent. The United State is in free fall, with shipments down 13.8 percent by Gartner's reckoning and 12.4 percent according to IDC. For the better part of a year, analysts excused declining PC shipments as market anticipation for Windows 8. But the slowdown during back-to-school buying season foreshadows weakness ahead.
"The third quarter has historically been driven by back-to-school sales, but US PC shipments did not increase, not even sequentially, from the second quarter of 2012", Mikako Kitagawa, Gartner principal analyst, says. "There was great hope through the first half that 2012 would prove to be a rebound year for the PC market", Craig Stice, IHS senior principal analyst, says. "Now three quarters through the year, the usual boost from the back-to-school season appears to be a bust".
He adds: "Optimism has vanished and turned to doubt, and the industry is now training its sights on 2013 to deliver the hoped-for rebound. All this is setting the PC market up for its first annual decline since the dot-com bust year of 2001".
The PC market slowdown hit Windows harder but still sapped Office.
Q1 2013 Revenue by Division
Windows & Windows Live: $3.24 billion, down 33 percent from $4.87 billion a year earlier.Server & Tools: $4.55 billion, up 8 percent from $4.22 billion a year earlier.Business: $5.5 billion, down 2 percent from $5.64 billion a year earlier.Online Services Business: $697 million, up 9 percent from $641 million a year earlier.Entertainment & Devices: $1.95 billion, down 1 percent from $1.97 billion a year earlier.
Q1 2013 Income by Division
Windows & Windows Live: $1.65 billion, down 50 percent from $3.27 billion a year earlier.Server & Tools: $1.75 billion, up 12 percent from $1.57 billion a year earlier.Business: $3.65 billion, down 2 percent from $3.7 billion a year earlier.Online Services Business: Loss of $364 million, up 29 percent from $514 million loss a year earlier.Entertainment & Devices: $19 million, down 94 percent from $340 million a year earlier.
Microsoft reports revenue and earnings results for five divisons: Windows & Windows Live, Server & Tools, Business, Online Services and Entertainment & Devices. Results presented here include the deferral.
Windows & Windows Live. Weaker than-expected PC demand hurt the division during fiscal first quarter. Revenue fell by 33 percent and income by a stunning 50 percent. Still, volume-license sales, which represent about 25 percent of the total, rose by double-digits, helping to insulate against PC market malaise.
According to Microsoft's 10-Q filing: "Windows Division revenue decreased from the prior year, due mainly to the deferral of $783 million of revenue related to Windows 8 Pre-Sales and $384 million of revenue related to the Windows Upgrade Offer. Windows Division revenue was also negatively impacted by a decline in the PC market, decreased inventory levels within distribution channels as OEMs and retailers began to prepare for the Windows 8 launch, and continued higher relative growth in emerging markets, where average selling prices are lower than developed markets".
Even when removing the deferral and presales, division revenue fell by 9 percent year over year.
Typically Microsoft sees some falloff in Windows license sales ahead of a new version launch, but third quarter was unusually severe. "Retailers were conservative in placing orders as they responded to weak back-to-school sales", Kitagawa observes. "By the end of September, retailers were focused on clearing out inventory in advance of the Windows 8 launch later this month".
One reason; Manufacturers will roll out new design concepts, including convertibles and slates, supporting Windows 8, giving all parties even more reason to make store shelves as bare as possible ahead of October 26.
Looking ahead, Microsoft CEO Steve Ballmer is optimistic: "The launch of Windows 8 is the beginning of a new era at Microsoft". To that end, Windows 8 presales are up 40 percent compared to its predecessor.
Server & Tools. The division was Microsoft's star performer and foreshadows much positive about the overall server software strategy. The division is insulated against economic maladies, because about 50 percent of revenues come from contractual volume-licensing agreements, which sales increased by 19 percent.
Revenue rose about 8 percent year over year and operating income by 12 percent. The division's rise above Windows & Windows Live is a dramatic turnabout. Even when removing the deferral and Windows 8 presales, revenue was still $141 million more.
According to the 10-Q: "Product revenue increased $215 million or 6 percent, driven primarily by growth in SQL Server, System Center, and Developer Tools, reflecting continued adoption of the Windows platform. Enterprise Services revenue grew $121 million or 13 percent, due to growth in both Premier product support and consulting services".
Business. Revenue and income both fell 2 percent year over year. Like Server & Tools, Business division is largely insulated against sluggish PC sales. Sixty percent of revenue comes from annuity licensing to businesses. Multi-year licensing revenues rose by 8 percent.
According to the 10-Q: "MBD revenue decreased, mainly reflecting $189 million of revenue deferred primarily related to the Office Deferral, offset in part by overall increased sales of the 2010 Microsoft Office system. Business revenue increased $142 million or 3 percent, primarily reflecting growth in multi-year volume licensing revenue and a 6% increase in Microsoft Dynamics revenue. Consumer revenue decreased $275 million or 25% driven by the Office Deferral and a decline in the PC market".
Online Services Business. Revenue rose by 9 percent and the operating loss decreased by 26 percent. Online advertising revenue grew by 15 percent, or $83 million, to $655 million — growing largely from search.
Entertainment & Devices. Revenue fell by 1 percent, but operating income decreased by 94 percent year over year. Microsoft shipped 1.7 million Xboxes during the quarter, down from 2.3 million a year earlier. According to the 10-Q: "EDD revenue decreased slightly, mostly due to lower Xbox 360 platform revenue, offset in part by Skype and Windows Phone revenue. Xbox 360 platform revenue decreased $418 million or 24 percent, due mainly to lower volumes of consoles sold and lower video game revenue, offset in part by higher Xbox LIVE revenue".
Xbox Live memberships rose by 15 percent. Skype users made 120 billion minutes of calls, up 58 percent.