Xbox One, holiday sales drive Microsoft to record revenue

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Strong holiday revenue drove Microsoft to easily outpace Wall Street analyst estimates, although Windows revenue shrank due to a contracting PC market.

Microsoft reported net income of $6.56 billion, or 78 cents per share, on revenue of $24.5 billion for the second fiscal quarter of 2014. Microsoft's net income grew 2.8 percent from a year ago, while revenue increased 14.3 percent during the same period. Analysts polled by Yahoo Finance expected Microsoft to report earnings of 68 cents per share on revenue of $23..4 billion.

“Our Commercial segment continues to outpace the overall market, and our Devices and Consumer segment had a great holiday quarter,” said Steve Ballmer, chief executive officer at Microsoft, in what could be his last earnings report for the company.“The investments we are making in devices and services that deliver high-value experiences to our customers, and the work we are doing with our partners, are driving strong results and positioning us well for long-term growth.”

"As I look back on the quarter, I'm pleased with the results," said Amy Hood, Microsoft's chief financial officer, during a conference call Thursday afternoon with analysts. Microsoft's results exceeded the company's own revenue expectations, she said. 

Xbox One FTW

From a business standpoint, the winner was Microsoft's Devices and Consumer Hardware business, riding the Xbox One launch to $4.7 billion of revenue, a whopping 68.4 percent increase in revenue from the $2.8 billion Microsoft reported a year ago. Microsoft said it sold 7.4 million Xbox console units into the retail channel, including 3.9 million Xbox One consoles and 3.5 million Xbox 360 consoles.

The other big winner? The Surface tablet, which more than doubled its revenue from $400 million a quarter ago to $893 million in sales for the December quarter. Units and revenue both more than doubled during the quarter, Hood said.

However, the cost of the Surface revenue  was $932 million, meaning that Microsoft is still losing money on the tablet. And the $1.9 billion overall increase in the D&C Hardware business was offset by a $2.3 billion increase in cost of revenue. Nevertheless, Hood was positive about the division's future, and specifically the Surface.

"We feel good about the success we have made over the last two quarters," and look forward to further success, she said.

Even Bing saw ad sales climb 34 percent, as Microsoft's search share now stands at 18.2 percent.

Other Microsoft divisions didn't fare nearly as well. Devices and Consumer Licensing, which includes Windows OEM revenue, dipped slightly to $5.38 billion. Windows OEM revenue dipped 3 percent. Windows OEM Pro revenue, Microsoft said, increased 12 percent, although non-Pro revenue decreased by 20 percent. Microsoft blamed a drop in the PC market for the shortfall, and did not immediately point to any signs of recovery, as Intel and AMD did. During the call, however, Hood said that business PCs has seen three consecutive quarters of growth and that consumer PCs had exceeded expectations, but were still soft.

Microsoft also saw Office Consumer revenue drop 24 percent as consumers switched to Office 365, Microsoft said, presumably deferring revenue from a single large, one-time purchase to smaller amounts paid out to Microsoft on an annual basis. (Microsoft attributed 16 percentage points of the decline to the shift.)  About 15 percent of all consumer Office licenses came from Office 365, Hood said. 

Windows Phone revenue, however, increased by an undisclosed amount. Earlier on Thursday, Nokia reported a significant drop in phone revenue, the last quarter before its devices business is acquired by Microsoft.

Microsoft's Commercial Licensing business also saw a modest increase of 8 percent in revenue to $10.1 billion. Microsoft attributed the growth to server, volume licensing, and Office licenses, offset in part by the transition of customers to the commercial version of Office 365. Volume Windows licensing grew by 10 percent, Hood said, some of which she attributed to enterprises switching from Windows XP to a more modern Windows OS, either Windows 7 or Windows 8. 

Looking forward, Hood said, Microsoft says it sees a continuation of the trends that drove its second quarter: continued growth in the Xbox One, with an expected hit, Titanfall, on the horizon; flat business PC growth, with "headwinds" in the consumer PC space; and seasonal slowness in the commercial business, she said.

Updated at 4:27 PM with comments from Microsoft's earnings call. This story has been clarified to add more details about the PC market, as Microsoft sees it.

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