Microsoft Corporation Had a Fantastic Quarter
Shares of Microsoft opened about 4% higher the day after the company reported solid earnings, with double-digit revenue growth in both its consumer and commercial segments. The launch of the Xbox One, as well as the sequential doubling of Surface sales, led to significant growth in the hardware division, while the commercial segment outpaced enterprise IT spend by winning market share. With the announcement of the company's next CEO coming soon, current CEO, Steve Ballmer, can leave on a high note.
A look at the results
Total revenue in the quarter rose 11% to $24.5 billion, with an impressive flat gross margin, given the launch of the Xbox One, which carries a very low gross margin, during the quarter. GAAP EPS rose by 3%, while non-GAAP EPS fell by 4%, reflecting items like pre-sales and deferred revenue in fiscal 2013.
Devices and consumer revenue rose by 13% to $11.91 billion. Windows OEM licensing revenue fell by 3%, a significant improvement compared to last quarter, which was driven by strong demand for Pro versions of Windows. While Office consumer revenue was down 24%, 16% of this decline was attributed to the shift to Office 365 Home Premium, Microsoft's subscription-based Office suite. This means that Office revenue, excluding this impact, outperformed the consumer PC market as a whole. Office 365 Home Premium now has 3.5 million subscribers, up from about 2 million just a few months ago.
Revenue from the Surface tablet more than doubled compared to last quarter, rising to $893 million, as the second generation of devices has resonated more with consumers than the first generation. Microsoft has sold 3.9 million Xbox One consoles in the retail channel, with the console beating out the PlayStation 4 in the U.S. market in December.
Things look even better on the commercial side. Windows volume licensing revenue rose 10%, reflecting the continued dominance of Windows in the enterprise. SQL server, Microsoft's entry into the database market, grew by double-digits while continuing to gain market share, with the premium version growing by more than 25%. Revenue from Office commercial rose by 10%, with the number of Office 365 seats more than doubling.
The cloud was particularly strong for Microsoft. Contained in the "commercial other" segment, which accounted for just $1.78 billion of revenue in the quarter, Microsoft's cloud business is small, but growing fast. Commercial cloud services revenue grew by 107% in the quarter, with the number of Azure customers and Dynamics CRM seats more than doubling. The cloud has the potential to be a very big business for Microsoft in the future, and the strong growth is encouraging.
Growing market share
While the consumer PC market remains weak, Microsoft is diversified enough that growth in other areas can make up for it. The fact that Microsoft is gaining market share with its various commercial products is a testament to how much enterprise customers rely on Microsoft, even with plenty of alternatives available.
One example is Hyper-V, Microsoft's virtualization solution. The leader in this space is VMware with a 57% market share, but this is down from a 65% market share in 2008. This loss has been Microsoft's gain, with Hyper-V now accounting for 28% of the virtualization market, up from 20% in 2008. Hyper-V gained five points of market share year-over-year for Microsoft in the second quarter, and this trend doesn't seem to be slowing down.
Microsoft has the advantage that, for enterprise customers already using Microsoft's other products, it makes sense to choose Hyper-V over the competition. In fact, Microsoft's System Center customers receive Hyper-V virtualization at no cost, and with System Center revenue growing in the double-digits during the second quarter, Microsoft's position in the virtualization market is only getting stronger. This is a big problem for VMware going forward, as battling Microsoft in the enterprise segment is likely a losing proposition.
On the consumer side, there's reason to be hopeful that the Windows licensing business can be boosted by the influx of Windows 8 tablets and convertibles, made possible by Intel's low-power Atom processors. During the recent conference call after Intel's earnings report, the company stated that more than 70 2-in-1 devices, offering both a tablet and laptop experience, would be available going into the back-to-school season this year. While it's not clear how many of these will be Windows devices, a majority will likely run Windows 8 instead of Android, which could help make up for weak consumer PC sales, helping Microsoft gain share in the tablet market.
The bottom line
Microsoft reported solid earnings, with the commercial segment especially strong. Any threats to Microsoft's dominance in enterprise have yet to have any serious impact, as both Windows and Office continue to grow. On the consumer side, adoption of Office 365 suggests that consumers are still willing to pay for Office, even with free alternatives available, and that bodes well for one of Microsoft's biggest cash cows. While Microsoft continually faces an almost innumerable number of threats, the company has done well fending them off, maintaining its dominance and hefty margins, plus proving that Microsoft is far from becoming irrelevant.
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The article Microsoft Corporation Had a Fantastic Quarter originally appeared on Fool.com.Timothy Green owns shares of Microsoft. The Motley Fool recommends Intel and VMware. The Motley Fool owns shares of Intel, Microsoft, and VMware. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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