What to Expect When Microsoft Reports Earnings

Microsoft (NASDAQ: MSFT  ) is set to report its second-quarter earnings after market close on Jan. 23. A corporate reorganization last year split the company into two main segments: devices and consumer, which includes all hardware and consumer software, and commercial, which is responsible for enterprise software and services. As the company shifts its focus to devices and services, the next CEO, expected to be announced within the next few months, will have the dual tasks of maintaining Microsoft's dominance in its core markets while pushing the company into the cloud. Here's what to look for in Microsoft's earnings report.

What analysts are expecting
Analysts are expecting revenue for the quarter to grow significantly, with the average estimate of $23.68 billion up 10.4% from the same quarter last year. The release of the Xbox One, as well as updated versions of the Surface tablet, should give a boost to device revenue, while continued growth of Office 365 Home Premium should help offset sluggish Windows sales due to a weak PC market. Microsoft's commercial business is a source of strength for the company, with 10% year-over-year growth reported last quarter, and rapid expansion the cloud business should help drive significant growth in the second quarter as well.

Earnings are expected to decline, with the average analyst estimate of $0.68 per share down from $0.76 per share in the same period last year. Last quarter, Microsoft beat earnings estimates by nearly 15%, and another beat could be in the cards if analysts are being too pessimistic.

What to look for
There are a few key pieces of data to look for when Microsoft reports its earnings. The first is revenue from Windows licenses, a number that fell on the consumer side last quarter. While consumer Windows revenue may continue to decline, with many consumers opting for tablets instead of low-end laptops, the enterprise business may get a boost from the end of Windows XP support, set to occur in April of this year.

I suggested in my earnings preview for Intel (NASDAQ: INTC  ) that the end of Windows XP support could drive enterprise customers to upgrade PCs, giving a boost to Intel's desktop chip business, and this seems to have been the case. Intel reported growth in its PC chip business, with CEO Brian Krzanich citing the XP transition, as well as strong demand for high-end parts from gamers, as the main drivers.

Office 365 is another important business for Microsoft, and continued growth on both the consumer and enterprise sides is a signal that free products from Google and others are still no match for Microsoft's productivity suite. In October, Microsoft announced that Office 365 Home Premium had reached 2 million subscribers, doubling in less than six months. Microsoft is shifting Office into a recurring revenue business model, instead of trying to sell new versions of the software every few years, and the success of Office 365 is an indication that the strategy is working.

The cloud is another area where Microsoft has been pushing hard. Last quarter, commercial cloud revenue rose by 103% year-over-year, with the company's Azure cloud infrastructure offering many of the same features as Amazon's Web Services, while also being used to deliver Microsoft services like Office 365, Skype, and SkyDrive. Azure has plenty of potential for Microsoft, from being used to run portions of games for the Xbox One, like EA's upcoming Titanfall, to allowing developers using the company's Visual Studio product to host code, track changes, collaborate with team members, and edit code directly in the browser. Microsoft may have shown up late to the cloud party, but it's quickly making up for lost time.

The bottom line
Microsoft's commercial business has always been strong, and that trend should continue in the second quarter. Continued growth in the company's cloud business, as well as services like Office 365, should help commercial revenue rise in the double-digits year-over-year. On the consumer side, the Xbox One and Surface tablet should give the device business a boost, offsetting any weakness in the consumer Windows segment. Analysts may be too pessimistic on earnings, so don't be surprised if Microsoft beats estimates significantly.

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