Microsoft (NASDAQ:MSFT) disappointed investors when it announced results for the quarter ending December 31, 2014. Due to a combination of factors, they punished the stock, which fell 9 percent immediately after the earnings call.
Earnings for the fourth quarter were down about 10 percent. Slower-than-expected results in corporate technology, where sales rose by less than 5 percent from a year earlier, was a contributing factor. Also, Microsoft said that revenue growth for the next two quarters would be slower than expected, partly due to the effect of a stronger dollar. Finally, and unsurprisingly, PC sales were not strong.
One bright spot: CEO Satya Nadella is trying to steer the company away from its reliance on the PC market and to emphasize cloud computing. This bet may be starting to bear fruit as the company’s cloud business threw off more than $1.3 B in revenue in the final quarter of the year.
- Summary numbers: Revenues of $26.35 billion, net earnings of $5.86 billion, and earnings per share (EPS) of $0.71.
- Gross margins narrowed from 71.33% to 67.32% compared to the same quarter last year, operating (EBITDA) margins now 35.77% from 37.58%.
- Ability to declare a higher earnings number? Change in operating cash flow of -1.65% compared to same quarter last year was better than change in earnings.
- Narrowing of operating margins contributed to decline in earnings.
- Earnings per Share growth exceeded earnings growth
The table below shows the preliminary results and recent trends for key metrics such as revenues and net income growth:
|Relevant Numbers (Quarterly)|
|Revenue Growth (%YOY)||14.34||-0.34||17.84||25.26||7.61|
|Earnings Growth (%YOY)||2.84||-6.52||-7.11||-13.42||-10.6|
|Net Margin (%)||26.77||27.78||19.75||19.58||22.24|
|Return on Equity (%)||31.46||26.25||20.82||20.18||25.76|
|Return on Assets (%)||17.73||14.62||11.23||10.62||13.61|
Market Share Versus Profits
Companies sometimes focus on market share at the expense of profits or earnings growth.
Compared to the same quarter last year, MSFT-US’s change in revenue of 7.61% surpassed its change in earnings, which was -10.60%. This suggests perhaps that MSFT-US’s focus is on market share at the expense of bottom line earnings. However, this change in revenue is better than its peer average, pointing to perhaps some longer lasting success at wrestling market share from its competitors and helping Capital Cube look past its weaker earnings performance this period. Also, for comparison purposes, revenues changed by 13.69% and earnings by 29.14% in the quarter ended September 30, 2014.
Earnings Growth Analysis
The company’s year-on-year decline in earnings was influenced by a weakening in gross margins from 71.33% to 67.32% as well as issues with cost controls. As a result, operating margins (EBITDA margins) went from 37.58% to 35.77% in this time frame. For comparison, gross margins were 70.48% and EBITDA margins were 36.21% in the quarter ending September 30, 2014.
Gross Margin Trend
Companies sometimes sacrifice improvements in revenues and margins in order to extend friendlier terms to customers and vendors. We probe for such activity by comparing the changes in gross margins with any changes in working capital. If the gross margins improved without a worsening of working capital, it is possible that the company’s performance is a result of truly delivering in the marketplace and not simply an accounting prop-up using the balance sheet.
MSFT-US’s decline in gross margins were offset by some improvements on the balance sheet. The management of working capital, for example, shows progress. The company’s working capital days have fallen to 235.96 days from 256.26 days for the same period last year. This leads us to conclude that the gross margin decline is not altogether bad.
Cash Versus Earnings – Sustainable Performance?
MSFT-US’s year-on-year change in operating cash flow of -1.65% is better than its change in earnings. This suggests that the company might have been able to declare a higher earnings number. The change in operating cash flow is better than the average of the results announced to date by its peer group.
The company’s decline in earnings has been influenced by the following factors: (1) Decline in operating margins (EBIT margins) from 32.43% to 30.00% and (2) one-time items that contributed to a decrease in pretax margins from 32.16% to 29.78%.
EPS Growth Versus Earnings Growth
MSFT-US’s change in earnings per share of -8.97% compared to the same quarter last year is better than its change in earnings of -10.60%. At the same time, this change in earnings is less than the peer average among the results announced by its peer group, suggesting that the company is losing ground in generating profits from its competitors.