Microsoft’s Nokia Purchase Weighs on Fourth-Quarter Results

Jul 23, 2014 4:14 pm ET

(Updates with shares in fifth paragraph.)

July 23 (Bloomberg) -- Microsoft Corp.’s purchase of Nokia Oyj’s mobile business dragged down fiscal fourth-quarter profit, even as the software maker benefits from improving corporate demand for computers and software delivered over the Web.

Nokia’s operations, which Microsoft bought for 5.44 billion euros ($7.33 billion) in April, contributed to a 7.1 percent decline in net income to $4.61 billion, or 55 cents a share, for the period that ended June 30, the company said in a statement yesterday. That missed analysts’ average projection for profit of 60 cents a share, according to estimates compiled by Bloomberg. Excluding Nokia-related items and taxes, the profit was 66 cents, beating the average prediction for 64 cents.

Chief Executive Officer Satya Nadella, who took over in February, is struggling to reduce costs, with 12,500 of the 18,000 job cuts announced last week related to Nokia. While Microsoft’s main software business topped estimates, the company has made little headway in delivering popular smartphones and tablets.

“Nokia continues to be the black cloud over Microsoft,” said Daniel Ives, an analyst at FBR Capital Markets & Co. who has the equivalent of a buy rating on the stock. “This is the first quarter before the cost cuts. That’s why Nadella took the ax out.”

The shares of Redmond, Washington-based Microsoft were little changed at $44.87 at the close in New York. The stock climbed 1.7 percent last quarter, compared with a 4.7 percent increase in the Standard & Poor’s 500 Index.

Nokia Challenge

The Nokia numbers underscore the challenges facing Nadella and his lieutenants as they seek to halt the decline of the handset business and turn it into an asset that can aid Microsoft’s mobile efforts.

“Satya has taken a number of exciting steps both to reposition the company and to energize it,” Microsoft Chief Financial Officer Amy Hood said in an interview.

Nadella will cut more costs and prioritize core areas, he said on a conference call yesterday. He also pledged to make the money-losing Bing search engine profitable by fiscal 2016. Nadella said MSN websites, retail stores and hardware production are now considered supporting efforts, where costs will be watched carefully. Hood said Microsoft’s new phone unit, formerly the Nokia handset business, is on track to break even on an operating basis in 2016 as well.

Microsoft plans to cut operating costs for the current fiscal year to $34.2 billion to $34.6 billion, Hood said.

Cloud, Enterprise

At the same time, cloud and enterprise software performed well, with revenue doubling for the Web-based versions of Office and Microsoft’s Azure cloud-based service for hosting applications. Commercial cloud products now have an annual run- rate of $4.4 billion, Hood said. Corporate demand for personal computers helped shore up sales of Office and Windows to businesses, with companies signing multiyear licensing deals.

“Cloud looked strong -- core PC seemed to get an uplift from improving PC demand,” Ives said. “Office 365 and Azure continue to be pillars of strength. I would call this in-line results.”

Unearned revenue, which comes from sales of multiyear deals that will be recognized in the future, was $25.2 billion for the quarter, compared with the $24.5 billion average analyst projection, according to data compiled by Bloomberg.

Restructuring Efforts

In addition to a plan to cut a total of 18,000 jobs as the company integrates Nokia, Nadella has discontinued unpromising products and placed more emphasis on cloud-computing software delivered via the Web. The restructuring will result in $1.1 billion to $1.6 billion in charges in the current fiscal year, according to Microsoft.

“The company as a whole is galvanized around Satya’s strategy,” Hood said.

Microsoft is also seeing signs of improvement in the PC market, which drives sales of Windows and Office software. PC shipments declined 1.7 percent in the second quarter, a smaller drop than estimated as businesses upgraded their equipment. Demand in the U.S., Europe and Canada also helped to make up for a drop in Asia, researcher IDC said earlier this month.

Intel Corp. also released results last week that topped analysts’ projections. Microsoft’s Hood said the company is seeing similar trends to those reported by Intel.

“The strength in the enterprise and the comments on the (PC) refresh would seem to bode well for Microsoft continuing to have uptake with enterprise sales,” said Michael Shinnick, a fund manager at South Bend, Indiana-based Wasatch Advisors Inc., which has $19 billion under management.