Microsoft Profit, Sales Beat as Cloud Demand Persists

Dina Bass (Bloomberg) -- Microsoft Corp.’s quarterly sales beat analysts’ projections by more than $1 billion, fueled by persistent demand from corporate customers seeking to shift computing tasks to cloud-based systems.

Revenue in the period ended Dec. 31 rose 14% to $36.9 billion, marking the software maker’s 10th straight quarter of double-digit sales growth. Analysts on average had predicted $35.7 billion. Fiscal second-quarter profit was $11.6 billion, or $1.51 a share, Microsoft said Wednesday in a statement. That compared with the $1.32 per-share estimate of analysts polled by Bloomberg. Shares rose 4% in late trading.

Chief Executive Officer Satya Nadella has been trying to narrow the gap in cloud infrastructure with market leader Amazon.com Inc., in both technical capabilities and the caliber of customer it can attract for its Azure products and services. Microsoft’s recent wins include a massive contract with the Pentagon, for which it beat out front-runner Amazon, and a cloud deal with accounting giant KPMG LLP. Microsoft is also pulling in more revenue from Office 365, with companies such as KPMG and Ikea upgrading to the internet-based productivity software. Azure revenue in the recent period rose 62% and Office 365 sales to businesses increased 27%.

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“The cloud business is on fire,” said Hari Srinivasan, senior research analyst and technology portfolio manager at Neuberger Berman Group, which manages more than $340 billion including Microsoft shares. “More importantly, it’s also growing in profitability. As the business scales, the profitability increases. That’s what we are banking on.”

Shares of the Redmond, Washington-based company rose as high as $176.20 in extended trading after the report. They closed at $168.04, an all-time high. The stock gained 13% in the December quarter, outpacing the 8.5% increase in the Standard & Poor’s 500 Index.

The company’s targets for third-quarter revenue by unit were slightly better than analysts’ estimates, except in one division: In a nod to the possible impact of the spreading coronavirus in China, Chief Financial Officer Amy Hood gave a wider-than-usual forecast range for the More Personal Computing unit, because some of the biggest PC makers and parts suppliers are based in China. If the virus hurts the construction and sale of PCs, that would constrain demand for Microsoft’s Windows operating system software. As for Microsoft’s own workers, Hood said the company has asked employees in China to work from home and is canceling non-essential business travel in and to the area.

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In the second quarter, commercial cloud revenue, a combination of Azure, Office 365 and other business-cloud programs, rose 39% to $12.5 billion, Microsoft said in slides posted on its website. Gross margin for that business widened 5 points from a year earlier to 67%, “driven primarily by material improvement in Azure gross margin,” the company said.

Hood said Microsoft’s operating expenses will rise by less than previously forecast this fiscal year, and the company will increase capital spending to build cloud data centers in the current quarter. Because of improved cloud profitability and the lower forecast for operating expenses, the company said operating margins for the fiscal year ending June 30 are likely to increase by 2%.

As more large companies move computing tasks into the cloud, Microsoft is gaining customers among a group that has historically purchased its software and is already comfortable with the sales and support it provides. A Goldman Sachs Group Inc. survey of 100 information-technology executives released this month showed 56 respondents are using Azure for cloud infrastructure and 66 plan to in three years’ time. Amazon Web Services still dwarfs Azure in terms of revenue, according to analyst reports.

Azure’s second-quarter revenue growth rate accelerated from the 59% gain posted in the first fiscal quarter. New customers added to bookings, a measure of future revenue, while usage of Azure services from existing customers boosted revenue in the period, Hood said in an interview.

“The Azure growth number is all about usage,” Hood said. “We had good signings of agreements in the quarter and that contributed to bookings, and we had a good underlying consumption quarter.”

Microsoft doesn’t disclose a number for total Azure revenue, while Amazon does break out sales for AWS. The e-commerce giant, which reports earnings Thursday, is projected to post $9.89 billion in AWS sales for the fourth quarter.

In October, the U.S. Defense Department awarded Microsoft the so-called JEDI contract to modernize the Pentagon’s computing infrastructure. Amazon had been widely seen as the front-runner for the $10 billion contract, and has since filed suit in the U.S. Court of Federal Claims, alleging that the Defense Department failed to fairly judge its bid because U.S. President Donald Trump viewed Amazon CEO Jeff Bezos as his “political enemy.” Amazon has asked a court to temporarily block Microsoft from working on the contract until the lawsuit is resolved.

Between the legal challenge and the length of the contract, JEDI is unlikely to materially add to revenue in the short term. Still, Microsoft’s win is seen as a boost to the company’s reputation among other potential cloud customers.

“It does serve as further validation of Azure’s capabilities, which could accelerate Azure’s share gains going forward,” said Nick Yako, an analyst at Cowen & Co., in a research note.

Sales of Windows, the operating system that runs most of the world’s personal computers, have been improving as the overall PC market stabilized in the past few quarters and customers upgraded to new versions before Microsoft ended support for the decade-old Windows 7 this month. Annual PC sales rose in 2019 for the first time in eight years, according to market research firm IDC. In the three months ended in December, global PC unit sales climbed 4.8% to reach the highest quarterly shipment volume in five years, IDC said.

More details on Microsoft’s divisions in the second quarter: