Nokia write-down leads Microsoft to record $3.2B loss on $22.2B revenue

We knew that Microsoft’s quarter was going to be a rough one after it announced a $7.6 billion write-down of the Devices and Services division it purchased from Nokia last year, and so it has come to pass: on revenue of $22.2 billion, the company had a gross margin of $14.7 billion, an operating loss of $2.05 billion, a net after-tax loss of $3.20 billion, and a $0.40 loss per share.

This was driven by a $7.5 billion goodwill and asset impairment charge from Nokia Devices and Services, coupled with a new $0.78 billion restructuring charge, and a further $0.16 billion cost for integration and previously announced restructuring. In total, the company booked $8.4 billion of losses in the quarter.

This loss eclipses the $0.49 billion loss in that fourth quarter of its 2012 fiscal year that was driven largely by the $6.2 billion write-down of the aQuantive advertising firm.

But even absent that massive hit, the quarter wasn’t a good one. That $22.2 billion of revenue is down 5 percent on the same quarter last year, and excluding the one-off Nokia charges, operating income was $6.39 billion, down 3 percent year on year. The company’s Device and Consumer segment was down sharply, as sales of non-volume-licensed Windows and Office continued their fall on the back of a weak PC market: Windows license revenue from OEM preinstalls was down 22 percent, and consumer sales of Office were down 42 percent. Windows Phone revenue was down an even sharper 68 percent, due to a decrease in royalty payments, though sales of Lumia hardware were up more than 10 percent to 8.4 million, compared to 7.5 million in the same quarter a year ago.

There were some glimmers of hope. The Surface range appears to be credibly carving out a decent niche for itself. Revenue for the quarter was $0.89 billion, up 117 percent year on year, and for the full 2015 financial year, revenue was $3.6 billion, up 65 percent. For a narrow product line-up—no conventional desktops, laptops, or all-in-ones, just a pair of slightly quirky hybrids—this is an encouraging performance. Xbox sales were up more than 30 percent, to 1.4 million in the quarter.

Consumer-oriented Office 365 subscriptions are also up substantially. There are now 15.2 million consumer subscribers to Office 365, with nearly 3 million of those added in the most recent quarter, and nearly 10 million added for the whole 2015 fiscal year. The real question for this business will be renewal rates. Many Windows devices come bundled with 1 year subscriptions to Office 365. Will those subscribers renew at the end of that year, or abandon the service?

On the commercial, volume licensed side, Windows revenue was down 8 percent and Office revenue was down 18 percent. Even server products, normally strong performers, were flat year on year; while annuity (subscription) revenue was up, this was offset by a decline in transactional (non-subscription) revenue. As a whole, licensing was down 7 percent.

But for Microsoft, the cloud itself is the silver lining. The “Commercial Other” segment, which includes non-consumer cloud services and consulting services, grew 36 percent. Cloud services were up 88 percent, with an annualized run rate now of over $8 billion. Azure revenue was up “triple digits” year on year, and Dynamics CRM Online’s install base has grown by almost two and a half times.

Across Microsoft’s business, the continued strength of the dollar exacerbated the declines; in constant dollars, revenue would have been down only 2 percent, not the 5 percent it actually fell.

The large charge due to Nokia was bad news. While Lumia sales grew, they were clearly expected to do much better. Given the product mix—the continued lack of high-end phones, for example—10 percent growth year-on-year doesn’t seem terrible. With large gaps in the product line-up caused by product cancellations, there’s certainly no reason for the growth to have been higher. The scaled back plans should yield a better product range, though it’s not clear at this point if they’ll do anything to move the sales needle.

That write-down, however, was a costly one-off. The continued malaise in the PC market isn’t, and the declines there are outpacing the growth seen from cloud services. That’s the real story of the quarter, and indeed, the whole fiscal year. Windows XP’s end-of-life did cause a brief uptick in Windows revenue, and it’s possible that the release of Windows 10 will do the same. If nothing else, Windows 10 should appeal more to businesses than Windows 8 and 8.1 ever did. PCs aren’t going away, and they’re certainly not unimportant. But they are lasting longer than ever, and as such are going to generate less revenue. This is Microsoft’s long-term challenge, and nothing on the horizon is going to make it any easier.