Cloud Services Boosted Microsoft’s Revenue

Commercial cloud annualized revenue run rate exceeded $14 billion during Q2 FY17

Technology giant Microsoft Corp. (NASDAQ: MSFT) announced its Q2 FY17 financial results on January 26th, 2017.

Headquartered in Redmond, Washington, Microsoft develops, licenses, and supports a range of software products and services. The Company also designs and sells hardware, and delivers online advertising to customers. Microsoft operates in four segments: Productivity and Business Processes, Intelligent Cloud, More Personal Computing, and Corporate and Other.

The Company’s products include operating systems for computers, servers and server applications for distributed computing; desktop and server management tools; and software development tools. It also offers cloud-based solutions that provide customers with software, services, and content over the Internet by way of shared computing resources located in centralized data centers. Its cloud-based computing services include Bing, Microsoft Azure, Microsoft Dynamics CRM Online, Microsoft Office 365, OneDrive, Skype, Xbox Live, and Yammer. It also provides consulting and product & solution support services as well as trains and certifies system integrators and developers. Microsoft has offices in over 100 countries. Read more about Microsoft’s financial results below.

Q2 FY17 financial highlights

During Q2 FY17, Microsoft continued to steadily pivot away from its legacy software business, getting a year-end boost from sales in cloud services and its recent purchase of LinkedIn. The technology giant’s revenue grew 1% to $24.1 billion versus $23.8 billion in the year ago same period. Growth was mainly driven by the strength of its cloud business, which brought in $6.86 billion in revenue during the reporting quarter. Revenue from its major cloud offering, Azure, grew 93% Y-o-Y even as its commercial cloud annualized run rate surpassed $14 billion. Growth in cloud revenue is seen as a key indicator of Microsoft’s progress as the Company transitions away from its legacy businesses under CEO Satya Nadella, who completes three years with the company in February 2017. Nadella target is to hit a $20 billion annualized run rate for the cloud business by 2018.

Similar to its rivals Cisco Systems Inc. (NASDAQ: CSCO) and Oracle Corp. (NYSE: ORCL), Microsoft is focusing on reinventing itself as a business technology services Company. CEO Satya Nadella is channeling all efforts to steer Microsoft from a PC software maker to a company that sells business technology services, cloud-based services, and subscription products. Although the cloud is driving Microsoft’s results, it only accounts for a small part of the Company’s overall business, while PC software still accounts for a hefty chunk of Microsoft’s top-line. Microsoft is faced with the challenge of scaling up its cloud and subscription businesses at a faster clip than the slowdown of its legacy operations.

During Q2 FY17, Microsoft’s gross margin grew 2% to $14.2 billion, while gross margin percentage grew 0.4 points to 58.9%. Operating income grew 3% to $6.2 billion. GAAP net income grew 4% to $5.2 billion, while diluted EPS grew 6% to $0.66 during the reporting quarter.

Segmental highlights

Microsoft’s Productivity and Business Processes segment revenue grew 10% (up 12% in constant currency) to $7.38 billion during Q2 FY17, driven by Office 365 and LinkedIn, offset by the negative impact of foreign currency. LinkedIn, whose acquisition was completed on December 08th, 2016, contributed 3% of growth and brought in $228 in revenue.

Gross margin dollars grew 5% Y-o-Y (up 6% in constant currency), with LinkedIn contributing 2% to gross margin dollar growth. This segment’s operating expenses grew 13% Y-o-Y (up 14% in constant currency), with operating income declining 1% (up 1% in constant currency).

Microsoft’s Intelligent Cloud segment revenue grew 8% to $6.38 billion (up 10% in constant currency) during Q2 FY17. Growth was driven by server products and cloud services, offset by a decline in Enterprise Services revenue and the negative impact from foreign currency. During the reporting quarter, this segment’s gross margin dollars grew 2% (up 4% in constant currency) due to improved Azure gross margin. However, operating expenses grew 12% (up 13% in constant currency) due to investments in cloud engineering, sales capacity, and developer engagement. Operating income declined 7% (down 4% in constant currency).

Microsoft’s More Personal Computing segment revenue declined 5% (down 4% in constant currency) to $11.82 billion during Q2 FY17, due to phone, Xbox consoles and the impact from foreign currency, offset by growth in Windows and search. During the reporting quarter, this segment’s gross margin dollars grew 3% (up 5% in constant currency) driven by growth in Windows and search, offset by decline in phone. Operating expenses fell 12% (down 12% in constant currency) due to lower phone expenses, one-time legal settlement and Surface launch-related marketing spend. As a result, operating income jumped 33% (up 37% in constant currency).

Other highlights

Returns to shareholders: During Q2 FY17, Microsoft returned $6.5 billion to shareholders in share repurchases and $3 billion in dividends.

Deal closures: Microsoft completed its acquisition of LinkedIn Corp. (NYSE: LNKD) and the sale of its entry-level feature phone business in Q2 FY17. After the closure of the LinkedIn deal, Microsoft will report LinkedIn results under its Productivity and Business Processes segment. During Q2 FY17, the results of LinkedIn including amortization of acquired intangible assets, contributed revenue of $228 million, operating loss of $(201) million, net loss $(100) million, and diluted EPS of $(0.01).

Job cuts: Microsoft expects to announce 700 job cuts as part of its previously announced plan to cut 2,850 jobs by June 2017. The cuts will not be concentrated in any particular area, but are part of an effort to update skills across the Company. Microsoft had more than 114,000 employees as of June 30th, 2016, and has more than 1,000 open positions that it is seeking to fill.

The Company is in the midst of a year-long transition to a cloud model, where it sells software as subscription services, rather than licensing it for installation on computers owned by its customers. During this transition, Microsoft has laid off more than 25,000 workers, mostly from the smartphone business it gained in its 2013 acquisition of Nokia.

Acquisition of deep learning startup Maluuba: On January 13th, 2017, Microsoft announced that it has agreed to acquire Maluuba, a Montreal-based Company with one of the world’s most advanced deep learning research labs for natural language understanding. Maluuba’s expertise in deep learning and reinforcement learning for question-answering and decision-making systems will help Microsoft advance its strategy to make artificial intelligence accessible and valuable to consumers, businesses and developers.

Guidance for Q3 FY17

Going forward, Microsoft is projecting revenue of $7.65 billion to $7.85 billion in Q3 FY17, with Intelligent Cloud expected to bring in $6.45 billion to $6.65 billion. LinkedIn is expected to bring in $0.95 billion in revenue during the quarter.

Stock Performance

Microsoft’s stock stood at $65.78, gaining 2.35%, at the close on Friday, January 27th, 2017, having vacillated between an intraday high of $65.91 and a low of $64.89 during the session. The stock’s trading volume was at 44,374,298 for the day. The Company’s market cap was at $511.46 billion as of Friday’s close.

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