Microsoft Earnings: Windows Licensing And Cloud Power Revenues

by: Trefis

Microsoft (NASDAQ:MSFT) announced its earnings for Q3 FY14 on April 24. The company posted a good 8% year-over-year growth in revenues to $20.4 billion. In our pre-earnings note, we noted that cloud services would boost revenues. The company reported 101% growth in commercial cloud services, which includes commercial Office 365 (growth of over 100%) and Microsoft Azure platform (growth of 150%). We also anticipated that Windows OS license sales would grow during the quarter despite weak PC shipments for Q1 CY14. Microsoft was able to buck the declining PC sales trend as its Windows original equipment manufacturing (OEM) revenues grew by 4% year-over-year driven by strong 19% growth in Windows OEM Pro revenue. Below we review Microsoft's Q3 FY 14 results by segment.

Hardware Sales Bolster Revenues

In our earnings note published earlier, we stated that device sales will drive revenue growth for Microsoft in Q3. Microsoft's hardware revenues were buoyed by growth in Surface sales and Xbox One shipments. While Surface revenues grew by 50% year-over-year to $500 million, the company sold 2 million Xbox console units compared to 1.3 million in Q3 FY13. As a result, revenue for hardware devices was up $571 million or 41% to $1.97 billion.

Windows Licensing Revenue Grows

The company reported that its consumer licensing revenues, which includes Windows original equipment manufacturer (OEM) and consumer office, grew by 1% to $4.38 billion. In spite of weak PC sales, its Windows OEM revenues grew by 4%, reflecting a 19% increase in OEM Pro revenue. Windows volume licensing also had a solid 11% year-over-year growth in revenues, partly due to end of support for Windows XP.

Office 365 Powers Windows Office Division

Consumer Office revenue grew 15%, mainly due to higher volume of licenses sold. However, commercial Office and Commercial Office 365 revenue also grew by 6% during the quarter. In addition, Microsoft reported that Office 365 now has more than 4.4 million subscribers and that revenue from this cloud offering in the quarter more than doubled year to year. As the subscription model sets in revenues for this division is expected to grow and become more recurring and predictable going forward.

Server And Cloud Witness Another Quarter Of Strong Adoption

Microsoft's Windows Server division is one of the fastest growing divisions for Microsoft. During Q3 FY14, revenue from the commercial segment, which includes servers, commercial office licensing and cloud platform, grew 7% to $12.23 billion, driven by higher SQL server sales and adoption of the cloud based Azure platform. While its server product grew by 8% year-over-year to $313 million, due to double digit (15%) growth in SQL servers, its Azure cloud offering clocked in triple digit (150%) growth in revenues. We're encouraged by the continual growth that this division posted, and it is becoming an important driver for Microsoft's value.

Online Service Division (OSD)

The online services division did report some encouraging signs as online advertising revenue grew 16% or $144 million due to a 38% increase in search revenues as Bing's US search market share rose 18.6% during the quarter. Furthermore, search advertising revenue improved due to increased revenue per search resulting from ongoing improvements in ad products and higher search volume. We forecast Bing's global market share to increase steadily throughout our forecast period but any surprises to the upside are not expected to increase the company's value substantially.

We are in the process of updating our Microsoft model. At present, we have a $41 price estimate for Microsoft, which is approximately 3.4% above the current market price.

Disclosure: No positions.