MSFT Microsoft Corporation

By Jay Greene 

Microsoft Corp. remains a distant second to Amazon.com Inc. in cloud computing, but the software giant's latest quarterly results suggest that it is effectively managing the transition from selling software licenses to selling on-demand computing services.

In its fiscal fourth quarter, sales of the Redmond, Wash., company's Azure cloud computing service more than doubled, offsetting a decline in the segment that includes its flagship Windows operating system and its struggling mobile-phone business.

The strength of Microsoft's cloud business surprised investors. The company beat expectations for both sales and profit, which spurred a 4% rise in Microsoft's shares in after-hours trading.

Microsoft has proved especially adept at selling its cloud services to existing customers, taking advantage of longstanding relationships with companies that have run its software in their own data centers.

"They are effectively getting their customers to transition to the cloud, " Stifel Nicolaus & Co. analyst Brad Reback said.

Microsoft's transition to the cloud comes with an important cost: eroded margins. When the company relied on software licenses sold to companies every few years, it registered fat profits. But margins on cloud services, which are sold by subscription, are slimmer.

For the quarter, gross margins slid 14% to $12.64 billion.

Microsoft Chief Financial Officer Amy Hood expected margins to decline slightly in the next year as well, she said in an interview.

Chief Executive Satya Nadella in his two years on the job has orchestrated the shift. In the process, he has pulled Microsoft back from its mobile-phone investments championed by his predecessor Steve Ballmer.

In May, Microsoft further dismantled the acquisition of Nokia Corp.'s handset business, contributing to a $1.1 billion charge in the quarter. Ms. Hood said the charge "reflects all of our judgments today" about the business.

Microsoft's decision to roll back the phone business -- along with a continuing decline in sales of personal computers that run its Windows operating system -- led the company to post its first decline in annual revenue since 2009. Sales fell 8.8% to $85.32 billion in fiscal 2016.

For the year, revenue from the reporting segment that includes Windows and mobile phones fell 6.3% to $40.46 billion. For the fourth quarter, sales in that segment fell to $8.9 billion, a decline of 3.7% year over year (2% in constant currency), even as revenue from sales of Windows to computer makers rose 11%.

The decline in annual revenue didn't trouble investors.

"It's really important to focus on what's growing and what's falling," Mr. Reback said. "Everything that matters grew and grew at a good clip."

The biggest gains came in the segment that includes the Azure cloud computing services. There, revenue amounted to $6.71 billion, a rise of 6.6%, or 9.6% in constant currency. Notably, revenue for Azure alone grew 102% (108% in constant currency) year over year.

The other big gain came in the segment that includes Microsoft's Office productivity tools as well as its Dynamics business programs. That segment posted sales of $6.97 billion, a year-over-year gain of 4.6%, or 7.6% in constant currency. Revenue from commercial sales of the cloud-based Office 365 jumped 54%.

Ms. Hood said that with some investments in cloud infrastructure in the rear-view mirror, she expected Microsoft to begin reaping economies of scale.

"We have invested heavily to build [market] share, expand geographically and ensure world-class support and reliability for our commercial customers," she said. "Going forward, we expect those investments to provide benefits of scale. We also anticipate our cloud capital expenditure growth curve will slow."

Microsoft posted $3.12 billion in fourth-quarter net income, or 39 cents a share, compared with a loss of $3.2 billion, or 40 cents a share, a year ago. The year-earlier results included $8.4 billion in charges related to the company's mobile-phone operation.

Excluding the impact of revenue deferrals and restructuring charges, adjusted earnings rose to 69 cents from 62 cents a year earlier. Revenue slid 7.1% to $20.61 billion and was $22.64 billion on an adjusted basis.

Analysts surveyed by Thomson Reuters had expected Microsoft to report adjusted earnings per share of 58 cents and sales of $22.1 billion.

Write to Jay Greene at Jay.Greene@wsj.com

(END) Dow Jones Newswires

July 20, 2016 02:49 ET (06:49 GMT)

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