Microsoft Continues to See Impact of Transition to Cloud

Microsoft's move to be the key provider of software and solutions to the mobile-first, cloud-first world pays off as the company transitions.

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Microsoft reported revenue of $26.5 billion for the second quarter of its 2015 fiscal year, driven largely by momentum in cloud and devices.

Microsoft's commercial cloud revenue grew 114 percent, driven by Office 365, Azure and Dynamic CRM Online, and is now on an annualized revenue run rate of $5.5 billion. This is the sixth consecutive quarter in which Microsoft's commercial cloud revenue has seen triple-digit growth.

"This quarter's results show the product and business transformation underway at Microsoft," said Microsoft CEO Satya Nadella during the company's earnings call on Jan. 26. "We saw success in a number of our strategic areas, including cloud adoption, redefining and revitalizing the Windows ecosystem, and improving economics in our hardware portfolio."

Microsoft is in the midst of a transformation to become the productivity and platform company for the mobile-first and cloud-first world, Nadella said. In essence, the company is moving from selling packaged software to selling services via subscription.

"Our commercial cloud services delivered triple-digit revenue growth for the sixth consecutive quarter," said Amy Hood, executive vice president and chief financial officer of Microsoft, on the earnings call. "Office 365 continues to be a priority for CIOs, as both existing and new customers move to the cloud. This transition accelerated, with 45 percent of our renewal seats in Office moving to the cloud this quarter. We are seeing great growth in revenue from premium Azure services, driven by both an increasing customer base and expansion in the number of services that those customers deploy. Within Dynamics CRM Online, customer growth accelerated and revenue nearly doubled."

Operating income and earnings per share for the quarter were $7.8 billion and 71 cents, respectively, meeting Wall Street EPS expectations.

"Microsoft is continuing to transform, executing against our strategic priorities and extending our cloud leadership," Nadella said in a statement. "We are taking bold steps forward across our business, and specifically with Windows 10, to deliver new experiences, new categories, and new opportunities to our customers."

Microsoft's Devices and Consumer revenue grew 8 percent to $12.9 billion. The Microsoft Surface group reported revenue of $1.1 billion, up 24 percent, driven by Surface Pro 3 and accessories. This is the first quarter Microsoft has earned $1 billion from Surface sales.

Phone Hardware revenue was $2.3 billion for the quarter, with 10.5 million Lumia units sold, driven by growth in affordable smartphones. That represents a 30 percent increase in the number of units sold over the same period last year. However, overall phone revenues were down 61 percent due to costs related to bringing the Nokia handset business into the Microsoft fold.

Windows OEM revenue dropped 13 percent from the same time a year ago. Revenue was impacted by the business PC market and Windows Pro mix returning to pre-Windows XP end-of-support levels and by new lower-priced licenses for devices sold to academic customers.

Other highlights include that Office 365 Home and Personal subscribers increased to over 9.2 million, up 30 percent sequentially over the prior quarter. Search advertising revenue grew 23 percent, with Bing U.S. market share at 19.7 percent, up 150 basis points over the prior year. And Xbox console sales totaled 6.6 million units, with strong holiday season performance.

"Navigating a transitional state with relatively minimal disruption to earnings is no small feat," said Merv Adrian, a Gartner analyst. "And delivering forward-looking products, well-designed to replace some of the revenue they will give up in the move to cloud-based pricing models and sometimes lower-cost products—as in the phone business—is also challenging. But they seem to have a clear vision and crisp execution on both fronts."

Meanwhile, commercial revenue grew 5 percent to $13.3 billion. Office Commercial products and services revenue declined 1 percent. Transactional revenue was impacted by the continued transition to Office 365 and declines in commercial PCs following the XP refresh cycle.

Server products and services revenue grew 9 percent, with double-digit growth of SQL Server and System Center. And Windows volume licensing revenue increased by 3 percent, with annuity revenue growth partially offset by declining transactional revenue.

"We again saw enthusiasm and demand around our cloud offerings like Office 365, Dynamics CRM Online and Azure, as well as Surface Pro 3," said Kevin Turner, chief operating officer at Microsoft, in a statement. "Our sales engagement worldwide continues to focus on helping customers and partners transition to the cloud and navigate the shifting product mix related to our services and solutions."

Moreover, "The steady growth of platforms to deliver what they do best—software to make people productive—is a longer term play," Adrian said. "But giving up Windows OS client revenue to create the platforms for delivery of newer software people will willingly pay for seems well-designed to regain Microsoft's mojo with developers, who above all want the biggest market to sell their offerings to. And in the enterprise, managing the transition to a well-governed environment that spans distributed BYOD employees' devices is worth paying for, and I believe enterprises will."