First off, investors expecting even a little transparency around the performance of Skype will be disappointed. Despite being managed internally as a separate division, Skype’s results will not be individually disclosed in MSFT’s financials. Most of Skype’s results were folded in to the Entertainment and Devices Division (“EDD”) and the goodwill from the purchase apportioned between EDD and Microsoft Business Division.
Overall Microsoft’s revenue rose 5% to $20.88 billion while operating income fell 2% to $7.99 billion. Results for the individual divisions were as follows.
|(In millions)|| Three Months Ended|
|Six Months Ended|
|Windows & Windows Live Division||4,709||4,988||9,541||9,694|
|Server and Tools||4,775||4,291||9,026||8,154|
|Online Services Division||798||729||1,456||1,292|
|Microsoft Business Division||6,265||5,890||11,855||11,063|
|Entertainment and Devices Division||4,237||3,728||6,205||5,507|
|Unallocated and other||101||327||174||438||Consolidated||20,885||19,953||38,257||36,148|
|Operating Income (Loss)||6,360|
|Windows & Windows Live Division||2,825||3,148||6,044||3,271|
|Server and Tools||2,003||1,723||3,608||(1,121|
|Online Services Division||(455||(557||(968||7,321|
|Microsoft Business Division||4,137||3,865||7,811||1,088|
|Entertainment and Devices Division||530||706||888||(1,638|
(Source: MSFT 10-Q)
Most significant is that the eternal money pit known as Online Services is starting to improve. Operating margins are now -57%, up from -75% for the same quarter last year and up from the regular -100% margins in years before. The main drivers in the improved performance were increased Bing search share (something MSFT can control) and higher advertising rates (outside of MSFT control).
There continues to be mixed news about how the HDD shortage affected the PC industry. Microsoft explicitly blamed the shortage for the decline in revenue along with some other factors. However, in the Intel conference call management stated that they believed the impact of the HDD shortage on end sales to consumers and businesses was negligible and that anyone who wanted to buy a PC could get one. We tend to side with Intel’s view on this and believe that the tablet market (humorously referred to by Microsoft as “competing form factors”) is indeed putting a dent in PC sales. Also, the depressed economy in the Eurozone certainly isn’t helping sales either.
Microsoft’s core businesses continue to do well with strength in Servers & Tools and Entertainment and Devices Division (“EDD”) offsetting declines in the Windows franchise. We believe PC sales will continue to be soft and the dynamic that we are seeing this quarter will continue.
EDD continues to be a bright spot with continuing strong sales of Xbox, Xbox LIVE subscriptions, Kinect, and the rollout of Nokia handsets running Windows. Revenue was up sharply but operating income fell as expenses related to Skype and increased royalty payments weighed on the bottom line results.
Microsoft provided the following slide summarizing their outlook for the rest of 2012.
(Source: MSFT quarterly presentation)
Microsoft’s stock continues to suffer from the “Ballmer discount” and despite a solid business the stock continues to meander between $25 and $30. We will continue to hold MSFT in the Buffett-Munger portfolio as we believe the attractiveness of MSFT’s business outweighs the poor quality of management at the executive level.
Disclosure: Long MSFT, INTC
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