A closer look at Microsoft Q1 2014 Results

Microsoft delivered record first quarter revenue. This holiday, the company will see competitive opening price points on tablets and laptops, such as the Dell Inspiron 15 for less than $300 and will also see exciting mobile devices from six inch phones to 10 inch tablets, many with Microsoft Office.

In the six inch category, Microsoft is incredibly excited by the Nokia Lumia 1520 tablet announced this past Tuesday. For eight inch tablets, Toshiba, Dell, Lenovo will have devices available for less than $300 and for 10 inch tablets; the company of course likes the Nokia Lumia 2520 with LTE.

Total revenue was up 7% to $18.6 billion and came in at about $700 million better than the company’s expectations. Without the impact of foreign exchange, revenue would have been $200 million or one percentage point better.

Annuity revenue was particularly strong and grew 11%, driven by commercial performance. Cost of goods sold increased 23%, which was in line with the company’s expectation of over 20% growth. This increase was primarily due to service cost and also higher depreciation related to the CapEx investments Microsoft made this quarter for cloud services strategy. As a result, gross margin grew 3% to $13.5 billion, reflecting the changing mix of revenue.

In R&D, Microsoft is continuing to focus its resources while accelerating cadence. Operating income and earnings per share, both declined 3% to $6.4 billion and $0.63, respectively. Unearned revenue grew a healthy 14% to $20.1 billion and the company’s contracted not billed balance grew to over $21 billion, driven by commercial strength.

Microsoft’s inventory balance sequentially increased by $675 million, mostly due to build the Xbox 360 and Xbox One. Ahead of holiday selling season, Xbox represents over half of the company’s inventory balance.

Inventory for Surface products declined sequentially even as the company built levels ahead of this week Surface 2 and Surface Pro 2 launches. This quarter, Microsoft announced a 22% increase in its quarterly dividend to 28% and also announced $40 billion share repurchase program. The company returned $3.8 billion of cash to shareholders, high quarterly amount since the second quarter of fiscal 2011.

Performance of each Reporting Segments:

Microsoft’s devices and consumer licensing segment is comprised principally of Windows OEM, consumer office and Windows Phone, including related patent licensing. Windows OEM business performed better than expected, declining 7% versus the company’s expectation of a mid-teens decline.

The management believes it is seeing stabilization in business PCs, which grew again this quarter and drove Pro revenue growth of 6%. The company also saw better than expected performance in the consumer part of business.

Non-Pro revenue declined 22%, but with several points better than expected. Excluding the impact of China, which continues to have a different dynamics than other emerging markets, non-Pro revenue declined 17%.

Moving to Devices and Consumer other. As a reminder, this segment includes the online marketplaces, advertising, Xbox Studio, Office 365 Home Premium and other consumer products and services. This quarter revenue growth in this segment was driven by both an increase in advertising revenue and also volumes in online marketplaces.

Search advertising revenue grew 47% driven by continued revenue per search improvements and query volume growth. Bing has now grown its share of search queries in the U.S. to 18%. Gross margin declined slightly due to higher royalty costs and also infrastructure cost growth as the company expanded geographic footprint of its services.

Moving to Commercial Business. With all up commercial revenue across both on-premise and cloud services grew 10% this quarter. Notably even as the company invests for growth, it saw gross margin expansion in commercial cloud business.

Across commercial portfolio, the company saw healthy renewal, a continued shift to premium products and strong adoption of its cloud services. Microsoft’s enterprise cloud strategy is resonating with customers and server product revenue grew 12%. SQL Server revenue grew double-digit with SQL Server Premium revenue growing over 30%.

Office products also remained strong and grew 11%. Within this, SharePoint, Exchange and Lync collectively grew double-digits with Lync growing nearly 30%. Helping to drive this demand for Server and Office product is deployment of hybrid cloud solution. This quarter, revenue for the company’s commercial cloud services grew over 100% as services such as Office 365, innovative Azure services for comprehensive cloud solution.

Revenue in the Commercial Licensing segment grew 7% and in Commercial Other segment, revenue grew 28% to $1.6 billion. As a reminder, Corporate and Other is where Microsoft consolidates adjustments for tech guarantees, pre-sales and the like. In the comparable quarter of last year, the company had aggregate deferrals of $1.4 billion for Windows and Office and this quarter deferred $113 million, primarily related to Windows 8.1 pre-sale.

Future Outlook

Devices and Consumer

In Licensing, Microsoft expects revenue to be $5.2 billion to $5.4 billion. This range reflects similar dynamics to what the company saw in the first quarter. As noted earlier, the company expects the business PC market to be stable; however, the consumer PC market is subject to more volatility.

In Hardware, the company expects revenue to grow 35% to 45% to $3.8 billion to $4.1 billion, reflecting the expanded Surface line up and the much anticipated Xbox One launch. The 10 percentage point range reflects variability in device unit volumes. In the consumer hardware business, such variability is not uncommon, especially during launches and the holiday season.

In Devices and Consumer Other, the company expects revenue to be $1.7 billion to $1.8 billion. Search revenue should continue to grow reflecting improved revenue per search and query volume. As a reminder, in Q2 of the prior year, Microsoft launched Halo 4, which contributed $380 million of revenue to this segment.

Commercial

The company expects revenue to grow 9% to 11%, in line with the first quarter.

In Commercial Licensing, Microsoft expects revenue to be $10.7 billion to $10.9 billion, with similar dynamics to what it saw in the first quarter. This includes healthy renewals and strong annuity revenue growth from volume licensing with Software Assurance.

In Commercial Other, the company expects revenue to be $1.7 billion to $1.9 billion, reflecting ongoing momentum in its commercial cloud business and enterprise services. As CIOs increasingly look to capitalize on the opportunities of cloud computing, the management is confident they will continue to look to Microsoft for their IT solutions.

Cost of Revenue

Moving on to cost of revenue, the company expects it to be $7.9 billion to $8.3 billion next quarter. This range primarily relates to the unit variability assumed in hardware revenue.

Operating Expenses

Microsoft expects OpEx to grow 6% to 8%, to $8.5 billion to $8.6 billion. The company also reaffirms its full-year guidance of $31.3 billion to $31.9 billion. The company continues to invest in innovative experiences for its customers while remaining focused on expenses.

Microsoft still expects full year capital expenditures to be about $6.5 billion, even though the company only spent $1.2 billion in the first quarter. Given the nature of the investments, there is variability from quarter-to-quarter due to company’s success based approach as well as the timing of delivery and completion.

The company expects its tax rate for the full year to be between 18% and 20%, depending on its geographical mix of earnings. When adjusting for tech guarantees and product deferrals, Microsoft expects unearned revenue to be roughly in line with historical trends.

Dell's Savior: Enterprise Solutions Group

Dell Inc. (DELL) world’s third-largest personal computer maker and Silver Lake Management LLC have secured enough votes for approval of their proposed $24.9 billion leveraged buyout.

After Corporate Raider, Carl Icahn dropped his opposition to the deal, opposing for almost seven months, Michael Dell seems to have won more than half of the battle. The voting results will be disclosed at September 12th meeting at Dell’s Round Rock, Texas, headquarters. Previously three attempts were made to hold this meeting, but were adjourned as CEO Michael Dell and Silver Lake were falling short of the votes they needed to secure this approval. 

The present proposal stands at $13.75 a share, plus a 13% special dividend and guaranteed payment of the company’s third-quarter dividend.

 Let's take a quick look at Dell's performance in the recent quarter, and also a look at their Enterprise Solutions Group or ESG, which they've been successful in.

Also check out Dell Inc.: Things You Ought To Know

Q1 2014 highlights:

· Delivered revenue of $14.1 billion, down 2%; the Enterprise Solution Services and Software Business was up 12% to $5.5 billion.

· Announced and closed the acquisition of Enstratius which improves their end-to-end solutions capabilities by enabling customers to more effectively manage and integrate their cloud environments.

·         Gross margin was $2.9 billion at $20.6 of revenue which was down 40 basis points sequentially when adjusting for last quarter's vendor settlements.

· SG&A increased 4% and as a percentage of revenue increased 20 basis points sequentially to 14.2%.

· R&D spending increased 33% and as a percent of revenue increased 10 basis points sequentially to 2.2%. Of note there were almost $90 million in expenses related to the pending go private transaction that were excluded from their non-GAAP results.

· Operating income was $590 million or 4.2% of revenue and non-GAAP tax rate of 28.7% is driven by a greater portion of their business and higher tax jurisdictions during the quarter.

· Earnings per share were $0.21 declining 51%, cash used in operations in the quarter was $39 million as the first quarter is typically a seasonal low for cash flow.

· On a trailing 12 month basis, cash flow from operations was $3.4 billion down 31%. Cash investments balance ended at $13.2 billion and they repaid approximately $2 billion in debt during the quarter.

Highlights of Enterprise Solutions Group or ESG:

· This business includes Servers, Networking, Storage and ESG related peripherals. Dell continue to see strong growth in ESG of 10% on revenue of $3.1 billion and operating income of $136 million or 4.4% of revenue. Within ESG, Server, Networking and Enterprise Peripheral Business delivered revenue of $2.7 billion which equates to 14% growth.

· It was driven by strong growth in hyper-scale data center servers, in this stage Dell servers power Four of the Top Five Search Engines and 75% of the top Social Media Sites worldwide.

· Networking Business increased 24%.

· Dell storage revenue was down 10% to $424 million, and is focused on continuing to more effectively position the right solutions based on customer needs and optimizing its selling motion to improve revenue momentum.

· The great example of this was a win with Statoil Norway as Dell’s global capabilities and convert solution displays legacy vendors in each of the traditional product sets.

· The services business includes a broad range of IT and business services including support and deployment services and infrastructure, Cloud, Security Services applications and Business Software Services, this business was up 2% to 2.1 billion.

· Paying for this business increased 370 million or 17.6% of revenue up 16.3% of revenue in the first quarter of the last year.

Dell’s software business includes systems management, security software solutions and information management. This business delivered revenue of 295 million and an operating loss of 85 million for the quarter. Consistent with prior communication and business plan, it remains confident that the Quest acquisition will be accretive in the first quarter of fiscal year '15 as it invests to grow the business. Michael Dell added, ‘We are enhancing our software capabilities and increasing our investment in this business with additional sales capacity in R&D’.

Dell Inc.: Things You Ought To Know

Dell is unique and unencumbered by a legacy of older technology and their solutions were born in the microprocessor age and this gives them the ability to build scale-out solutions that are based on standard architectures. And this focus is helping them to allow their customers to transform in a very agile way and an affordable way and build powerful solutions that can drive organizations forward.

Dell also operates in 180 countries around the world. It has mission critical support in those 180 countries. So who are we talking about, who are the customers of Dell? Well, it's 98% of the Fortune 500 companies out there; over 10 million small businesses rely on Dell, hundreds of thousands of students and teachers in hundreds of thousands of classrooms. This is a significant customer of Dell.

A great example is newly announced product in China, PowerEdge T20 server. It's ideal for small businesses combining large internal storage and performance capability in a very small quiet chassis, it's part of Dell’s 12th generation of PowerEdge server lines. Dell has been doing this for quite some time and is now on 12th generation and is gaining share in the Server sector for sure. Dell now has number one share in North America, number one share in China, number one share in Asia-Pacific and Japan and is approaching number one share worldwide.

Now, what's very interesting you see happening in the data center is the rise of kind of the software defined data center where the server is increasingly becoming the center of the data center as Storage, Networking, Security and other things that go on in the data center are essentially becoming applications that are running inside virtual machines and that makes Dell's leadership in the server sector, all the more important.

Michael Dell said, ‘We are working to dramatically expand our capabilities across the other areas like networking and storage’. This week, Dell introduced their most advanced networking switch, S6000, it consumes 50% less power and doubles the density. It's an ideal switch for a highly virtualized environment and Dell has great standalone offerings at networking and storage and servers, the real innovation comes when you combine all of these together.

‘This convergence when you add new technologies like flash memory combine with this whole idea of highly virtualized environment builds a very modern agile data center with high levels of efficiency and that's a major, major focus for us’, said Michael Dell.

So, Dell is launching a large scale initiative to localize its offerings for the Chinese markets, bringing its system's management, security, information management solutions. So, customers can really take advantage of these and one of the examples is one of their latest converged platforms, Vertex product which combines storage, networking and servers all in one very small and a very affordable package.

So the next area for Dell is Connect and Connect addresses this enormous growth in mobility and they see enormous number of new devices from smartphones to tablets to wearable computing to all sorts of sensors, capturing and pooling data and creating data. And addressing this concept of mobility from the device through to the data center and to the cloud and they increasingly live in what is absolutely a multi-device world.

It seems like nobody has one or two devices anymore; now we all have many, many devices and the PC is certainly evolving. Dell has the desktop PC, the virtual PC, have a tablet PC, notebooks and workstations and many different types.

Dell announced in China the most recent addition to their Latitude family, the 7000, 5000 and 3000 ultrabooks for their business in China and are brining leading security, manageability, reliability, touch display to these products at a very affordable price point.

Dell is also moving aggressively into commercial tablets. Dell’s Latitude 10 runs Windows 8, runs Microsoft Office and it docks to become a fully configured high-performance workstation. Now there are hundreds and millions of PCs sold every year, the installed base of PC is about 1.5 billion and overwhelmingly in offices across the city in Beijing and across other cities around the world, PCs are still integral to how business gets done.

New capabilities building around Big Data Analytics and Cloud Data Integration:

You don't just want Big Data, you want big results from your Big Data and you're going to hear about capabilities that Dell has to help you do this. You're also going to hear about vertical solutions that Dell has been building like their healthcare cloud.

Today, Dell has built about a $1 billion IT security business, helping its customers secure and protect. They have embedded solutions at the device level like secure BIOS and data encryption and has whole capability around detecting and protecting, so dealing with malware, intrusion detection and prevention, next generation firewalls of all sizes including carrier grade, next generation firewalls, secure socket layer VPN solutions and email security.

Mr. Dell said, ‘Today we see about 50 billion security events per day and we're protecting tens of trillions of dollars of assets for the largest banks, financial services firms, e-commerce firms that are transacting online and we'd be building our team, our talent, our infrastructure, our production capacity, our supply chain to make Dell a true partner for customers in China and across the region’.

Out of the 110,000 people at Dell, over 40,000 of them are in Asia-Pacific and Japan and four manufacturing centers; Chennai, Panang, Xiamen and just last June a few months ago, inaugurated and opened newest factory in Chengdu.

Michael Dell concluded by saying that Across Transform, Connect, Inform and Protect, our focus is really on harnessing the disruptive forces that you face and bringing those as an advantage for your organization.

Carl Icahn's recent exploits

The recent news of Mr. Carl Icahn placing his big bet on Apple Inc. was something we couldn’t afford to miss, and while we sit tight thinking that any day Mr. Icahn may send out a tweet about firing one of the key personnel of Apple, I personally feel that this time, it’s going to take time for the Investor Activist, as he likes to call himself, to turn Apple management’s world upside down. The only reason I believe for the delay is because he is presently busy in giving Michael Dell, CEO of Dell Inc. a tough time.

Michael Dell did not foresee Carl Icahn’s arrival, not even in his weirdest dreams and I bet at this point in time, he wished he had a crystal ball. Now if I were to take a firm like Dell private, it would definitely create a buzz, and on top of it, if I were to underpay my stockholders for every share they owned, I would definitely be expecting a Carl-o-storm.

So what could possibly be driving Mr. Icahn to always be upping his game? While many people would conveniently say that he is money driven, I’d beg to differ. I feel that he wants to be known today the same he used to be in the past, a Corporate Raider (can be one of the few names). That’s the only thing he has been doing, a thing which he is undoubtedly good at. He might have no doubt started off as being money driven, but I feel he is now more pleasure driven, for lack of a better word.

He would always want to be remembered as a nightmare for the company executives who sit on huge salaries, great bonuses and are unable to deliver value to their shareholders. Who knows, he may even retire after his Apple gig, but I seriously wouldn’t want that. I would love to see what he can get delivered from the already delivering Google Inc., or even Microsoft; in case he intends to retire in his late 80’s.

Since only Carl Icahn can tell what’s up his sleeve and on his mind, there’s no point in brainstorming or wasting time, predicting his next move. I suggest let’s just sit back and enjoy our drinks because the Master is in no hurry.