Microsoft’s Nadella Posts Cloud Gains in Third Quarter

Microsoft Corp. (MSFT)’s push into cloud computing, which is accelerating under new Chief Executive Officer Satya Nadella, is paying off.

Net income in the fiscal third quarter was $5.66 billion, or 68 cents a share, Redmond, Washington-based Microsoft said yesterday in a statement. That topped the average analyst estimate of 63 cents, according to data compiled by Bloomberg. Sales were $20.4 billion, matching projections.

Nadella, who took the helm two months ago, is leading a shift to focus on selling devices and software delivered over the Internet, both for Microsoft’s own Windows operating system and rival programs. Rising sales of Web-based tools, such as Office software and Azure cloud services, are helping the largest software maker grapple with shrinking personal-computer demand and a failure to gain ground in tablets and phones.

Related: Cloud Spending by Companies Outpaces Predictions

“All the cloud stuff is starting to actually materialize,” said Sid Parakh, an analyst at McAdams Wright Ragen in Seattle, who suggests holding the shares. “There’s tangible evidence of progress on that front, and that’s encouraging.”

Microsoft rose less than 1 percent to $39.91 at the close in New York. The stock climbed 9.6 percent last quarter, compared with a 1.3 percent increase in the Standard & Poor’s 500 Index.

Photographer: David Paul Morris/Bloomberg

Microsoft Corp. Chief Executive Officer Satya Nadella. Close

Microsoft Corp. Chief Executive Officer Satya Nadella.

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Photographer: David Paul Morris/Bloomberg

Microsoft Corp. Chief Executive Officer Satya Nadella.

Cloud Gains

Sales from Office 365, the cloud-based subscription version of Microsoft’s productivity programs, more than doubled in the quarter that ended March 31, as did revenue from Azure, the company said.

Microsoft beat profit estimates by saving money on the costs of running cloud services, as well as marketing, said Chief Financial Officer Amy Hood. Gross margin in the Commercial Other segment, largely cloud products, increased 80 percent.

“It’s an ongoing effort,” she said in an interview. “We meet monthly to go through this data and we set bars and raise them.” The consumer version of Office 365 gained 1 million subscribers during the quarter, Hood said.

Since replacing Steve Ballmer on Feb. 4, Nadella has rearranged his leadership team, making changes in areas like marketing, Xbox and hardware, and business development.

Nadella’s Changes

He has also overseen the release of a cloud version of Office for Apple Inc.’s iPad, and he pledged Microsoft’s attention to developing quality versions of its programs for rival operating systems -- a departure from the company’s past approach.

“What you can expect from Microsoft is courage in the face of reality,” Nadella said on a conference call yesterday, borrowing a quote from philosopher Friedrich Nietzsche.

The company has cut the price to free on versions of Windows for phones and small tablets, seeking to juice demand for handheld devices that run the program in a market now dominated by Apple and Google Inc.’s Android software. Microsoft will bolster its smartphone offerings through the acquisition of Nokia Oyj’s device and services business for $7.5 billion, a deal that the companies expect to close today.

“I look forward to being able to do the real work” on Nokia, Hood said. “Planning is just that.”

Third-quarter sales from devices and consumer hardware, including Xbox and Surface devices, rose to $1.97 billion, compared with an average analyst prediction of $1.95 billion, according to data compiled by Bloomberg First Word.

Microsoft said it sold 2 million Xbox devices -- including 1.2 million of the new Xbox One -- to retailers in the quarter.

Windows Licenses

Devices and consumer licensing revenue, including copies of Windows sold to PC makers, increased to $4.38 billion, compared with the $4.2 billion average analyst estimate. Other revenue from devices and consumer businesses, such as the Bing search engine and video games, came in at $1.95 billion, compared with a $1.81 billion projection.

In the Commercial Licensing unit, revenue from software like server programs and corporate versions of Windows and Office rose to $10.3 billion. Analysts on average had predicted $10.5 billion. Other commercial revenue, which includes cloud software like Azure and Office 365, was $1.9 billion, compared with an estimate of $1.82 billion.

Unearned revenue, which comes from sales of multiyear deals that will be recognized in the future, was $19.5 billion for the quarter, compared with the $18.6 billion average analyst projection, according to data compiled by Bloomberg.

Licensing Sales

In the current period, which ends in June, revenue from devices and consumer hardware will be $1.3 billion to $1.5 billion, Hood said on the call. Fourth-quarter devices and consumer licensing sales are forecast to be $4.1 billion to $4.3 billion, while revenue from other devices and consumer businesses will be about $1.9 billion. Fourth-quarter forecasts don’t include the effects of the Nokia acquisition.

“Nokia and mobile continue to be the biggest concern for investors and challenge for Nadella and Microsoft,” said Daniel Ives, an analyst at FBR Capital Markets & Co., who rates the shares the equivalent of a hold. “This remains the main variable.”

Total quarterly commercial sales will be $13.1 billion to $13.3 billion, Hood said. Revenue in the other commercial category is forecast to be $2.1 billion, meaning commercial license revenue is estimated at $11 billion to $11.2 billion.

For many investors, financial results have taken a back seat for now to Nadella’s strategy and plans, Ives said. PC shipment declines are getting smaller, which is also helping to ease the pressure. Still, the new CEO must figure out a way to restore Microsoft to prominence in the parts of the technology market that matter most now.

Corporate Demand

About 90 percent of the world’s PCs run on Microsoft Windows. Global PC shipments declined 1.7 percent in the March quarter, researcher Gartner Inc. said earlier this month. That’s a smaller drop than in the previous quarter, when shipments fell 6.9 percent.

In the Windows business, the company saw some strength in corporate demand with business customers as the primary driver of an increase in Windows licenses to PC makers, Hood said. There is still “some softness” in consumer PC demand, though that area is stabilizing in developed markets, she said.

“This all helps Microsoft’s cause, but it doesn’t change the story that it continues to be a very tough PC environment,” Ives said. “For them to show sustainable growth of anything above single digits will be very difficult unless they find growth in cloud, mobile and tablets.”

Windows Marketing

Separately, Microsoft said it hired Tony Prophet, a former Hewlett-Packard Co. executive, to oversee Windows marketing. The addition was reported earlier yesterday by ZDNet.

In last year’s third quarter, net income was $6.06 billion, or 72 cents a share, on revenue of $20.5 billion. The year-earlier period included $1.66 billion in revenue recognized from prior quarters and a $733 million fine from the European Commission.

Microsoft adopted a new financial reporting structure for the current fiscal year, organizing divisions around consumer, commercial and cloud sales instead of the company’s traditional products. That followed Ballmer’s July reorganization, which shuffled executives, staff and products into new groups to focus on a strategy of devices and services rather than just software.

To contact the reporter on this story: Dina Bass in Seattle at dbass2@bloomberg.net

To contact the editors responsible for this story: Pui-Wing Tam at ptam13@bloomberg.net Jillian Ward, Mark Beech

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