By Aaron Tilley 

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (January 30, 2020).

Microsoft Corp.'s cloud business is continuing to serve as a source of strong profits even as the company spends heavily to expand its offerings and acquire new customers.

The Redmond, Wash., software giant Wednesday posted stronger fiscal second-quarter earnings on record sales, driven by growth in its cloud-computing offerings. Gross margins for the commercial cloud business, which includes Azure computing services and Office 365 applications, grew to 67%. And while margins for the business rose for a fourth-consecutive quarter, executives told analysts on a conference call that percentage should continue to rise this year.

Revenue from the commercial cloud business grew 39% to $12.5 billion, which Chief Executive Satya Nadella said reflected the company's ability to sell a broader set of cloud products, including cloud infrastructure as well as cloud-based productivity applications.

Microsoft said improving gross margins is indicative of the huge opportunity in the cloud business.

"If we can continue to capture the revenue growth, continue to meet customer needs and scenarios, pick and thoughtfully invest in industry level solutions to grow those things, I worry less about the mechanics of the [gross margin]," said finance chief Amy Hood on a conference call.

Shares in Microsoft steadily climbed following the earnings report, where it posted record revenue and soundly beat analysts' quarterly financial expectations, and recently traded up 4.4% after hours. The company's stock has gained 63% over the past 12 months, roughly doubling the rise in the tech-heavy Nasdaq Composite Index.

"I think their vision across infrastructure, productivity and applications is starting to resonate with customers," said Alex Zukin, an analyst at RBC Capital Markets.

Improved margins are surprising as Microsoft has spent heavily to fuel cloud growth and narrow the gap between it and Amazon, which still has a dominant market share in the business world-wide.

The battle between the two firms remains heated as Amazon has contested the Pentagon's October award of a massive cloud-computing contract to Microsoft. The deal is valued at up to $10 billion over the next decade, the Pentagon has said.

Overall Microsoft's quarterly revenue rose 14% to $36.9 billion. Earnings rose to $1.51 a share, up from $1.08 a share for the same period last year. Analysts surveyed by FactSet had expected earnings per share of $1.32.

For the fiscal third quarter Microsoft guided revenue to rise between 12% to 14% from a year earlier to $34.1 billion to $34.9 billion, as analysts polled by FactSet expected $34.11 billion. Ms. Hood said the wider guidance for one of its segments reflected uncertainty related to the spread of coronavirus in China.

Azure sales increased 62% in the second quarter from a year ago, a steeper increase than the first quarter.

Brad Reback, an analyst at Stifel, Nicolaus & Co., expects that Azure will be Microsoft's single biggest revenue contributor in the next two to three years.

Microsoft's intelligent cloud segment, which includes its Azure cloud services, had sales of $11.87 billion, up 27% from the year-ago period and exceeding analysts' expectations of $11.4 billion, according to FactSet.

Microsoft's productivity and business process division, which includes LinkedIn and commercial subscriptions to the Office 365 product suite, had $11.83 billion in sales, up 17% from the same quarter a year ago. Analysts were expecting sales of $11.43 billion for the quarter.

The division that includes the legacy Windows personal computer operating software business, the Xbox gaming business and Surface hardware also surprised Wall Street as the company had forecast for sales to be down as much as 3% from the second quarter last year. Instead, sales rose 1.7% to $13.21 billion, helped by stronger Windows operating system installs as well as commercial products and cloud services.

"We don't think we'll see sustainable growth with Windows, but we also don't think a cliff is coming," Jonathan Neilson, a finance director with Microsoft's investor relations team. "The underlying demand is there."

Microsoft this month ended support of its Windows 7 software. That deadline helped drive PC sales in recent months as customers such as large enterprises bought devices featuring the newer Windows 10 operating system.

Revenue from its Surface hardware such as tablets and laptops came in lower than expected, rising roughly 6% from the previous year. Microsoft has been working to expand the line of Surface products and signaled it would continue such investments.

Another point of weakness was the performance of Microsoft's videogame unit. Games revenue fell 21% from a year earlier, even though the company owns several development studios, while Xbox content and services revenue fell 11%.

The decline was expected, in part, as Microsoft prepares to launch its next-generation gaming console this year, the Xbox Series X. Microsoft's chief competitor in the console-gaming space, Sony Corp., is also expected to launch a new console in 2020.

Sarah E. Needleman contributed to this article.

Write to Aaron Tilley at aaron.tilley@wsj.com

 

(END) Dow Jones Newswires

January 30, 2020 02:47 ET (07:47 GMT)

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