News Column

Microsoft Results Disappoint as Surface, Windows 8, PCs Slump

July 20, 2013
microsoft, sales, results

Microsoft missed big in the fourth-quarter earnings it reported Thursday -- hit especially hard on the sales side by the slumping PC market and on the profit side by a write-down in the inventory of Surface RT tablets.

Also a factor was Microsoft's shift in how it sells some of its products, most notably Office. The company is moving away from selling traditional software licenses, where people pay a licensing fee upfront, toward a subscription model, where people pay in installments over time.

For the quarter ended June 30, Microsoft posted revenue of $19.9 billion with earnings per share of 59 cents on profit of $4.97 billion. Those figures reflect a $900 million write-down of Surface RT inventory related to a price-reduction offer for those devices.

Adjusted for that write-down, Microsoft says earnings per share would be 66 cents.

That still would have fallen short of analysts' expectations of $20.7 billion in quarterly revenue and earnings per share of 75 cents.

All of these trends -- the PC sales decline; Microsoft's shift toward subscription fees and cloud-based services; and lukewarm demand for Windows 8 in general and the Surface tablet in particular -- have "been building up for some time," said David Cearley, an analyst with research firm Gartner.

"Some of it seems to have come to a head" in the fourth quarter, he said.

For the fiscal year, Microsoft also fell short of analysts' estimates, posting revenue of $77.85 billion, profit of $21.86 billion and earnings per share of $2.58.

Analysts had expected revenue of $78.69 billion and earnings per share of $2.75.

Microsoft shares took a hit after the earnings report came out, trading after hours Thursday at $33.21, down $2.23, or about 6.3 percent.

Up from last year

Still, the fourth quarter and fiscal year results were up from last year's.

In the fourth quarter of last year, Microsoft posted revenue of $18.06 billion, net loss of $492 million, and loss per share of 6 cents.

Those figures reflected some unusual events such as a write-down of the 2007 acquisition of online ad company aQuantive and deferred revenue from a Windows 8 upgrade offer.

Adjusting for those items, Microsoft had fourth-quarter 2012 revenue and earnings per share of $18.6 billion and 73 cents.

For the full year 2012, the company posted revenue of $73.7 billion and earnings per share of $2 on profit of $16.98 billion. (Those figures include the aQuantive write-down and deferred Windows 8 upgrade offer revenue.)

Continuing trends

"In many ways, our fourth-quarter trends continued many of the trends we've seen earlier this year," Amy Hood, Microsoft's chief financial officer, said during a conference call with analysts Thursday afternoon.

One such trend is the continued decline in PC shipments, which several research firms said dropped 11 percent in the second quarter from a year ago.

Hood, who became CFO in May, also acknowledged the difficulties Microsoft is facing in what some call the "post-PC era" and what Microsoft likes to refer to as the "PC-plus era."

"We are working to transition the business into this modern era of computing," Hood said. "Given the complexity of the ecosystem, this journey will take time."

Hood touted some of the company's accomplishments, including a record $22.4 billion in unearned revenue -- basically, money corporations have committed to Microsoft via multiyear licenses.

"Have to do better"

But, she said, "We know we have to do better," adding that the massive company reorganization announced last week was one way, designed to make the company more efficient and quicker.

One surprise for some analysts came from the Surface RT write-down.

Surface RT is the version of Microsoft's own branded tablet that runs a "lite" version of Windows 8. It does not run Windows desktop apps nor is it backward compatible. (The Surface Pro is the version that runs "full" Windows 8 and is backward compatible.)

Earlier this week, Microsoft announced it was cutting the price of the Surface RT by $150. The 32 GB tablet is now selling for $349, while the 64 GB one goes for $449. The clickable keyboard cover is sold separately.

Unsold Surface RTs

Those Surface RT tablets related to the write-down will still be available for sale. The write-down reflects only the price reduction that Microsoft is taking on each of them, as well as inventory adjustments in parts and accessories.

"I was certainly surprised at the amount of the writedown," said Sid Parakh, an analyst with investment firm McAdams Wright Ragen.

"It's probably indicative of how much of a shortfall there may have been in Surface RT sales relative to their expectations," said Parakh, who thinks there are "certainly probably a few million" Surface RT units sitting unsold.

Brian Hall, Microsoft's general manager of Surface marketing, declined to say how many such Surface RT units there are.

He did say in an interview Thursday that the "aggressive price cut (was) to accelerate the adoption of Surface."

"People who use Surface RT really like it," he said, but "it's going to take a significant number to compete" with the millions of existing iPad users.

Research firm IDC estimated Microsoft shipped 900,000 Surface tablets -- most of those Surface Pros -- in the first quarter of this year. That compares with 19.5 million iPads shipped by Apple.

Hall said there are no plans to cut the price of the Surface Pro and that Microsoft intends to continue producing Surface RTs and to work on Windows RT.

Breakdown by division

Here's how the divisions did:

--Windows (Windows, Internet Explorer, Surface): Revenue of $4.41 billion for the quarter, up from $4.15?billion this quarter last year.

Its full-year revenue was $19.24 billion, up from $18.4 billion last year.

Those figures include recognition of deferred revenue from last year's Windows 8 upgrade offer. Excluding that, Windows revenue decreased 6 percent for the quarter and 1 percent for the full year.

Revenue from consumer PCs declined more than 20 percent in the fourth quarter, while business PCs showed a modest growth.

"So the offset (from business PC sales) was not as beneficial as it might have been," said Parakh of McAdams Wright Ragen.

--Business (Office, SharePoint, Lync, Dynamics, Yammer): Revenue of $7.21?billion, up 14 percent from $6.32 billion last year.

Adjusting for the recognition of previously deferred revenue related to the Office upgrade offer, revenue increased 2 percent for the fourth quarter.

Its full-year revenue was $24.7 billion, up 3 percent.

Consumer revenue declined 27 percent, driven by the decline in PC sales, as well as the transition from traditional Office to the subscription model of Office 365.

Though Office 365 continued its fast growth, on pace to become a $1.5 billion business, in the short term there's a decline in revenue since people pay less up front for subscriptions than for a one-time license.

"Whatever growth they saw on the subscription side probably came at the expense of the licensing side," Parakh said.

Still, "In a way, your business model is getting stronger because a subscription customer is more valuable in the long run than a license-only customer," he said.

--Server & Tools (Windows Server, SQL Server, System Center, Azure): $5.5?billion, up 9 percent from $5.05 billion last year.

The increase was due largely to double-digit growth in SQL Server and System Center.

Its revenue for the full year was $20.28 billion, up 9 percent from $18.53 billion last year.

--Entertainment & Devices (Xbox, Kinect, Windows Phone, Skype): $1.92 billion, up about 8 percent from $1.78 billion last year.

Xbox Live membership revenue grew nearly 20 percent in the quarter. For the full year, revenue was $10.17 billion, up 6 percent from $9.6 billion last year.

--Online Services (Bing, MSN): $804 million, up about 9 percent from $735 million fourth quarter last year.

Its $3.2 billion revenue for the full year was up 12 percent from last year's $2.87 billion.

Online Services was the only division that posted an operating loss for the year. The operating loss was $1.28?billion, 84 percent narrower than last year's loss of $8.13 billion

Overall, said Gartner's Cearley, Microsoft has "been working over a long period of time to try to address this post-PC market. ... The strategy they have in place, I think, is a good and appropriate one to ultimately address the challenges."

Janet I. Tu: 206-464-2272 or jtu@seattletimes.com.

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