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Microsoft’s 2Q17: cloud growth slows, Windows surprising, Surface resilient

Peter Bright
In its second quarter of its 2017 financial year, Microsoft posted revenue of $24.1 billion, up 1 percent year on year, with operating income of $6.0 billion, up 3 percent, net income of $5.0 billion, up 4 percent, and earnings per share of $0.62, up 6 percent.
As ever, Microsoft also offered alternative figures that book Windows 10 revenue up front instead of amortized over several years, and which hold exchange rates constant to remove the impact of rate fluctuations year-on-year (which gives some indication of year-to-year changes in actual sales transactions, if not of money in the bank). Using that regime for both this year and last, revenue was up 4 percent at $26.1 billion, operating income was up 8 percent at $8.2 billion, net income up was up 10 percent at $6.5 billion, end earnings per share were up 13 percent at $0.83.
Microsoft's LinkedIn acquisition completed on December 8, 2016, with the company saying that this small contribution added $228 million in revenue, and losses of $201 million, $100 million, and $0.01, to operating income, net income, and earnings per share, respectively.
Microsoft currently has three reporting segments: Productivity and Business Processes (covering Office, Exchange, SharePoint, Skype, and Dynamics), Intelligent Cloud (including Azure, Windows Server, SQL Server, Visual Studio, and Enterprise Services), and More Personal Computing (covering Windows, hardware, and Xbox, as well as search and advertising).
The cloud business continues to be strong, with the company claiming a $14 billion annualized run rate, compared to $13 billion in the previous quarter and $12.1 billion the quarter before that. More unexpected, Windows OEM revenue was up 5 percent, suggesting some strengthening of the PC market, and Surface revenue was down only 2 percent, showing surprising resilience in spite of a lack of major hardware updates. The PC doesn't appear to be dead just yet, and Surface seems to be carving out a solid niche for itself in the PC industry.
Productivity and Business Processes revenue was up 10 percent to $7.4 billion, with strong performances all round: commercial Office revenue was up 5 percent, consumer Office revenue was up 22 percent, and Dynamics revenue was up 7 percent. The number of commercial Office 365 seats continues to grow strongly, up 37 percent year-on-year, and consumer adoption of Office 365 is also continuing, with 24.9 million subscribers. There are 65 million monthly active users of Office for iOS and Android, more than twice the number of last year.
In spite of the revenue increases, operating income for the division fell 1 percent to $3.3 billion. The company attributed this wholly to the LinkedIn purchase: operating expenses were up 14 percent as a result of Microsoft buying the professional social network, and this caused operating income to drop 6 percent.
Intelligent Cloud revenue was up 8 percent to $6.86 billion. SErver products and cloud services revenue was up 12 percent, thanks to double digits growth in subscriptions, and Azure revenue was up 93 percent. Not for the first time, compute usage on Azure was described as more than doubling year on year. Enterprise Services revenue dropped, however, by 4 percent, due to a decline in custom support agreements for Windows Server 2003.
This shift in revenue from Enterprise Services to cloud services saw gross margin go up by 2 percent. Operating expenses, however, grew by 12 percent, attributed to investments in cloud engineering, sales capacity, and developer outreach. Overall, operating income for the division was down 7 percent, to $2.4 billion.
More Personal Computing held the surprises. Revenue overall was down 5 percent to $11.8 billion. This overall fall was because of the collapse of phone revenue (down 81 percent year on year) and Xbox price cuts and lower sales. But there were many gains: Windows OEM revenue was up 6 percent for Pro SKUs and 5 percent for non-Pro SKUs. This is driven by sales of Windows preinstalls on PCs; Microsoft said the product mix was skewing towards more expensive SKUs, and that growth outperformed the PC market. Enterprise Windows subscriptions and related revenue were also up, by 5 percent. Although overall gaming revenue was down 3 percent, Xbox software and subscription revenue was up 18 percent, with Microsoft reaching $1 billion of transactions in the busy Christmas quarter. Xbox Live monthly active users also hit a record high of 55 million, representing 15 percent growth.
As bad as the phone situation is, Microsoft's other foray into hardware, Surface, seems to be doing rather better. Revenue was down ever so slightly, falling 2 percent to $1.3 billion. That's a 2 percent fall even though the Surface Pro 4 was not refreshed at all, and the Surface Book saw only a minor upgrade with the introduction of the high price Performance Base. The rollout of the Performance Base was also very narrow, with sales substantially limited to US markets. Microsoft did introduce one all new piece of hardware in the quarter, the Surface Studio, but again, this was a US-only release, and availability during 2016 was severely limited. The lack of updates didn't appear to discourage buyers, and gross margin went up 6 percent due to a shift in purchases from the Surface 3 to Surface Pro 4 and Surface Book.
Search revenue also continued its steady growth, up 10 percent due to a greater number of searches, with each search yielding more revenue.
Operating income for the division rose 33 percent to $2.5 billion. The growth in Windows and search improved gross margin dollars by 3 percent, and operating expenses dropped 12 percent. Compared to a year ago, phone expenses and Surface marketing expenses were both down, and this quarter last year also included a one-time legal settlement.
Microsoft’s 2Q17: cloud growth slows, Windows surprising, Surface resilient Reviewed by Chidinma C Amadi on 3:54 PM Rating: 5

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