Cloud Growth Will Be The Focus When Microsoft Reports Q2 FY16 Earnings

For a detailed analysis of Microsoft stock post earnings check our Microsoft Earnings Report- Q2 2016

  • Software giant Microsoft will report Q2 FY 16 on 28th January 2016 after markets close.
  • Most analysts expect the company to report healthy growth numbers, powered in part by healthy Windows 10 adoption.
  • Most eyes will be on Microsoft's cloud growth.

Software company Microsoft (NASDAQ:MSFT) will report second quarter fiscal 2016 earnings on 28 January 2016. Wall Street consensus is for the company to report EPS of $0.71, a 7.8% Y/Y decline compared to EPS for the previous year’s comparable quarter. The decline in Microsoft’s EPS can be chalked up to the fact that the company is mostly giving away Windows 10 for free. As more people abandon their older Windows operating systems for Windows 10, Microsoft foregoes Windows licensing fees. Wall Street expects Microsoft to report revenue of $25.26B.

Meanwhile, there is an earnings whisper that Microsoft might report EPS of $0.75, or $0.04 better than expectations.

Investors will no doubt focus strongly on Microsoft’s cloud growth to check how well the company is moving with its transition from a seller of on-premise software to a cloud subscription company. Microsoft offered a broad guidance for Q2 FY 16 as follows:

  • Intelligent Cloud (Azure, Enterprise Services, and Server Products) to report revenue of $6.2B-$6.3B, a 5%-6.8% sequential growth compared to the $5.9B posted by the segment during Q1 FY 16. Although Microsoft does not divulge its Azure revenue numbers, the company said that Azure revenue grew in triple digits during the last quarter. Microsoft said that its hybrid cloud approach was a key driver in the company’s server licensing business and was driving rapid growth in the cloud.
  • Microsoft did not offer specific revenue guidance for its Commercial Cloud revenue, but said that it expects unearned revenue for the segment to be in the range of $19.5B-$19.7B. Microsoft reported a 70% Y/Y growth in Commercial Cloud revenue during the last quarter to a $8.2B annual revenue run rate, compared to $8.0B during the previous quarter. Microsoft’s said that its Commercial Cloud gross margins were improving in tandem with the revenue due to increasing scale and efficiency. Microsoft recently announced that it will give away $1B in cloud services either for free or at discounted rates to about 70k non-profits and startups over the next three years. But with cloud usage rates still in the single digits, Microsoft will simply be giving away idle bandwidth and this should not have any major impact on cloud revenue or margins in the coming quarters. If anything, the move by Microsoft should help to introduce tens of thousands of SMBs to its cloud services, especially Office 365. Microsoft remains on track to hit $20B in Commercial Cloud revenue by FY 18, and this will be one of the most closely watched cloud metrics during the company’s upcoming earnings call.

Investors should note that Microsoft might start going easy on its cloud investments after years of heavy cloud cap-ex, which should have a positive impact on the company’s margins and earnings. During the last quarter alone, Microsoft spent $1.5B on its data centers to support demand-driven cloud growth. This led to an operating loss of $280M by the segment. During last quarter’s earnings release, Microsoft lowered its projection of operating expenses for the full year by ~$2B.

Microsoft expects its More Personal Computing (Windows devices including Surface, Xbox and Bing) to report revenue of $12B-$12.4B, compared to $9.4B during the previous quarter. Investors should note that Microsoft has moved to make Windows 10 the only OS across all its devices. New CPUs from Intel (NASDAQ:INTC), AMD (NASDAQ:AMD), and Qualcomm (NASDAQ:QCOM) will only support Windows 10. Additionally, Facebook’s newly unveiled Oculus Rift will only support the new OS. The rapid growth of Microsoft’s devices segment should therefore have a positive impact on Windows 10 growth.

Bing Search Surges

Investors should note that Bing Search finally became profitable during the last quarter. Search contributed more than $1B to Microsoft’s top line during the last quarter, with Bing revenue ex-TAC(Traffic Acquisition Costs) up a healthy 29% Y/Y, implying that Bing Search is growing revenue at a much faster clip than its bigger rival, Google Search. Interestingly, Microsoft said that close to 20% of Bing Search revenue was driven by Windows 10 devices. Rapid growth by Windows 10 should therefore continue powering growth in Bing Search.

Investor Takeaway

It’s all systems go as Microsoft heads into the earnings season. All indications are that the company is likely to perform well on most fronts, particularly in the cloud segment. Microsoft shares made strong double-digits gains after the company’s last earnings call. The effect might be muted this time due to the ongoing turmoil in the markets, but MSFT shares remain a good investment over the long haul.

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