Microsoft Continues To Show Resilience

| About: Microsoft Corporation (MSFT)

On Thursday evening, Microsoft (NASDAQ:MSFT) announced its earnings for the last quarter. The company beat the estimates in earnings but failed to beat them in revenue. Microsoft earned 72 cents per share in the last quarter as opposed to the 68 cents expected by the analysts. Furthermore, the company generated $20.49 billion in revenue whereas the analysts were looking for $20.68 billion.

Successful Quarter

Microsoft's quarterly profit rose by 19% and its revenue rose by 23% in the last quarter even though PC sales aren't doing that well and Microsoft hasn't gained any significant market share in the mobile devices industry, which includes smartphones and tablets. Apart from Windows, Microsoft benefited greatly from its Office and Xbox Live products. Xbox Live posted a growth of 46% whereas Xbox and Kinect grew by 56% in the quarter.

Microsoft acknowledged that it would develop a new version of Windows 8, which will be called "Blue." This new version of Windows 8 will be based on the feedback received from the customers who use Windows 8. This is very important for the company because Microsoft has always enjoyed a bad reputation among consumers because it tended to ignore customer feedback about its products unless the feedback was in overwhelmingly high numbers and related to a bug that hurt the functioning of Windows. This may be the first time in a long time when Microsoft will improve one of its major products based on customer feedback. When consumers see that their voice is being heard by a company that sells a product they use, they are more likely to recommend the product to their friends and family because they feel like their feedback adds a personal touch to the products.

When Microsoft signs multi-year licensing contracts with clients, it realizes the revenues on a year-by-year basis, which means that some of the revenues will be deferred. In the Windows division, all of the growth was attributable to deferred revenues that came from people who upgraded their computers from older versions of Windows to Windows 8. Excluding this figure, Windows division's revenue was flat compared with the last quarter. This is not very bad in a PC market that continues to decline in double-digits but it's a dangerous spot to be if the PC market doesn't turnaround anytime soon.

Excluding one-time items and deferred revenues, Microsoft's revenue was up by 8%, operating income was up by 5%, earnings per share was up by 8% and unearned revenue was up by 13%. Normally, the single-digit growth might appear to be sluggish; however, considering the slowdown of the PC industry, it is fair to say that Microsoft has been holding on tightly.

Outlook Is Encouraging

For the next quarter, Microsoft expects to see strong results with its tablet whereas the weakness in the PC industry is expected to continue on. In the Server and Tools division, Microsoft expects to see another quarter of double-digit growth. In the Business Division, the company expects licensing revenue to increase at a rate slightly above 10% in addition to the $780 million of revenue that was previously deferred and will be recognized during the quarter. In online advertisement, the company expects to see revenue growth of 10-15% in the next quarter. Finally, in the Entertainment and Devices Division (which includes Xbox, Skype and Windows Phone) the expected growth rate is between 14-%16%.

Windows Phone was covered very briefly during the earnings call. In Microsoft's 10Q report it says that Windows Phone's revenue increased in the last quarter by $259 million without giving further details. Besides that, Microsoft affirmed that it expects Windows Phone to continue to grow and gain market share. It would be really nice to know more about Windows Phone's performance. For example, I am sure Microsoft has access to the number of Windows Phone devices sold. This was one of the things that disappointed me about Microsoft's earnings release.

Microsoft's Cash Piles On, Debt Shrinks

In the quarter, Microsoft added a nice sum to its pile of cash. In the last quarter, the company had $6.02 billion in cash and $62.30 billion in short-term investments, totaling $68.32 billion in cash and cash equivalents. By the end of this quarter, the company's total cash position is $5.24 billion whereas its short-term investments total $69.24 billion. As a result, Microsoft's cash and cash equivalents balance totals $74.48 billion, representing a growth of $5.24 billion. During the same quarter, Microsoft's total debt fell from $14.18 billion to $11.95 billion. Hopefully Microsoft will put some of this money into good use, such as heavily marketing Windows Phone 8 products. The company will use about 23 cents per share for dividends, which represents 32% of its quarterly income.

Final Thoughts

Microsoft is transforming from a desktop software company to multi-platform and multi-media company. Historically, Microsoft was worried about building software or operating systems that would run on a desktop, and that was it. Now, the company has to build software and offer services that can integrate a computer with a smartphone, a tablet with a gaming system, a car's sync system with a laptop and so on. Things are far more complex and Microsoft's transformation reflects that. Because Microsoft is such a large company with so many components and business units, it is such a challenge to manage the process. So far, the company has been doing a nice job.

One thing the company could do better is on the marketing side. Despite all the efforts and investments, Windows Phone is not gaining market share fast enough. Companies like Samsung and HTC hardly make any money on their Windows Phone devices and Nokia (NYSE:NOK) wants to conserve its cash reserves to survive. This is why it is very important for Microsoft to do the heavy lifting when it comes to marketing Windows Phone 8. Microsoft has more than enough money to get the job done.

In the next year, every division of Microsoft is expected to grow by 10%-15%, which is impressive in a highly competitive environment given the state of the European economy and PC industry. Once the European economy picks up and the demand for PCs returns back to "normal" levels, Microsoft will see some great results. If the PC market never returns to its glory days, then Microsoft will have to work extra hard to make sure that as many Windows tablets and smartphones as possible are being sold. For the time being, Microsoft's results were very encouraging.

Disclosure: I am long MSFT, NOK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.