Microsoft Sales, Profit Top Estimates on Cloud; Azure Slows

Dina Bass (Bloomberg) -- Microsoft Corp.’s sales and profit got a boost from demand for Azure cloud-computing programs and internet-based versions of Office productivity software, lifting results above analysts’ expectations.

Profit in the first quarter, which ended Sept. 30, rose to $10.7 billion, or $1.38 a share, compared with the $1.24 per-share average estimate of analysts polled by Bloomberg. Revenue rose 14% to $33.1 billion, the Redmond, Washington-based company said Wednesday in a statement, better than the $32.2 billion average prediction.

Chief Executive Officer Satya Nadella has spent the past five years building up Microsoft’s cloud business, which lets customers avoid having to buy and run their own hardware and applications. Revenue from Azure cloud services rose 59% in the recent period, slowing from a 64% gain in the previous period and 73% for the quarter before that. As that growth decelerates, the company is working to improve margins and rack up a steady stream of large deals for Azure, which competes with Amazon.com Inc.’s web-services division. Sales of the subscription-based Office 365 for corporate customers, Microsoft’s other major cloud business, jumped 25%.

“They’ve made the migration from core enterprise software to this cloud focus,” said Daniel Morgan, senior portfolio manager at Synovus Trust Co. “You look at cloud, at expanding margins, at the corporate move to Windows 10, and at least the PC market was better than expected in the quarter.”

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Microsoft shares were little changed in extended trading following the report, after closing at $137.24 in regular New York trading. The stock gained 3.8% in the quarter, while the Standard & Poor’s 500 Index rose 1.2%.

The company’s shares have jumped this year on optimism about the cloud business. The stock is also being helped by some investors’ belief that Microsoft is a safer bet as U.S. and European regulators sharpen their scrutiny of other large technology firms, including Google, Amazon and Facebook Inc. Microsoft’s market capitalization rose above $1 trillion briefly in April and returned to that level in June. Apple Inc. overtook Microsoft as the most valuable publicly traded U.S. company earlier this month.

In the latest period, Microsoft said commercial cloud revenue rose 36% to $11.6 billion. Margins widened by 4 points to 66%, “driven by material improvement in Azure gross margin,” the company said in a slide deck posted on its website. Microsoft doesn’t break out Azure revenue separately or comment on whether that business is profitable.

Commercial cloud profitability will continue to improve in the coming quarter and the current fiscal year, Microsoft Chief Financial Officer Amy Hood said in an interview. Still, over time, as the lower-margin Azure becomes a larger piece of that business, “you will see more pressure on that number,” she said.

The company will keep spending to construct data centers to keep up with strong customer interest in Azure, she said. “With the type of demand signal we have, we will continue to build.”

Hood told analysts on a conference call that the company expects another strong quarter in the period that ends Dec. 31. Here are her forecasts:

Keith Weiss, an analyst at Morgan Stanley, expects commercial cloud sales of $48 billion for the 12 months that end June 30, rising to $79 billion in fiscal 2022. He also expects continued improvement in margins as increasing use of Microsoft’s cloud data centers allows the company to run the services more efficiently.

“They’re doing a good job with the move to the cloud,” Synovus’s Morgan said. “Of all the old smokestack tech companies -- you look at IBM, you look at Oracle -- of all those companies, Microsoft is the one that has done a really good job.”

Sales of Windows to PC makers rose 9%. Surface revenue declined 4%, in part because the company introduced new models for the holiday season after the end of the first quarter. LinkedIn revenue grew 25% and gaming revenue fell 7%.

Microsoft still gets more than 15% of its sales from Windows, and that business remains heavily dependent on the cycle of companies replacing PCs. In the September quarter, global shipments of personal computers increased 1.1%, Gartner said earlier this month, fueled by businesses upgrading to the latest Windows operating system. Microsoft is ending support for Windows 7, which was released in 2009, in January, meaning companies need to upgrade to Windows 10 if they want to continue to receive updates and service on their systems.

The older software’s expiration is also helping boost sales of the company’s Microsoft 365 bundle, which includes Windows and Office cloud software such as Word, Excel and Teams, Microsoft’s rival to Slack Technologies Inc.’s product.