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Microsoft beats cloud drum as revenues remain solid but flat

Office 365, Azure, and yes, even Bing to lead the way, Nadella assures us

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Microsoft reported flat revenues and shrinking profits for the third quarter of its fiscal 2014, but that was still better news than the analysts were expecting to hear.

On average, the Wall Street wizards polled by Yahoo! Finance were betting Redmond would take in revenues of $20.39bn for the three months ending March 31, with earnings per share of $0.63. It actually did slightly better than that, clocking sales of $20.40bn and earnings of $0.68 per diluted share.

The bad news is that with revenues barely budging from the year-ago quarter, Microsoft's earnings per share were still down 6 per cent, as was its net income for the period, which fell to $5.66bn.

It's no secret, however, that the overall shape of the PC market is as lousy as it's ever been, and Microsoft remains a distant also-ran in the smartphone and tablet markets, behind both Apple and the Android horde. Little wonder, then, that new CEO Satya Nadella would try to credit the fact that Microsoft's earnings slump wasn't worse to its recent gains in the cloud.

"This quarter's results demonstrate the strength of our business, as well as the opportunities we see in a mobile-first, cloud-first world," Nadella said in a canned statement. "We are making good progress in our consumer services like Bing and Office 365 Home, and our commercial customers continue to embrace our cloud solutions."

Such sentiments are sure to raise a few eyebrows among longtime Redmond-watchers. The profitability of the Windows Azure cloud business has always been difficult to assess, but the Bing division has been a money pit since its inception – at least, it was until Microsoft's new reporting structure lumped it in with enterprise services and other, better-performing units.

Still, the Commercial Other subdivision – new home to Bing and Redmond's business-oriented cloud services – did show solid growth in the quarter. Its revenues were up 31 per cent from the year-ago period to $1.90bn, while its gross margins were $475m – an 80 per cent increase, year-on-year.

In a call with financial analysts, Microsoft CFO Amy Hood said that Azure revenues had grown over 150 per cent, driven both by new customers and increased use by existing ones. Similarly, revenues from business subscriptions to Office 365 grew by more than 100 per cent.

Weathering the storm

In fact, none of Microsoft's five new reporting segments saw its revenues shrink, market conditions be damned.

The Devices and Consumer Licensing unit, which covers Windows Phone and Windows and Office sales to consumers, still struggled. Its revenues and gross margins were both essentially flat, at $4.38bn and $3.90bn, respectively.

But software sales to enterprises fared slightly better. Commercial Licensing revenues were up 3.4 per cent to $10.32bn, and the unit's gross margins gained 3.8 per cent, to $9.43bn.

Revenues for the Devices and Consumer Hardware division – which covers Surface and Xbox but nothing from Nokia's Devices and Services unit, which doesn't officially become part of Microsoft until Friday – were $1.97bn, up 41 per cent from the year-ago quarter. Surface sales, in particular, grew 50 per cent to $500m.

There was a bit of difficulty there, though. Microsoft said its cost of revenue was up 24 per cent for the quarter, largely due to the expense of building all those Surface slabs and Xboxes. As a result, gross margins for the Devices and Consumer Hardware unit were down 34 per cent from the previous year's quarter, to $258m.

That leaves the Devices and Consumer Other division, a hodge-podge category that includes such things as Office 365 Home Premium subscriptions, app sales from the Windows Store and Windows Phone Store, revenue from Microsoft's retail stores, ad sales, and a few other odds and ends. Revenues for this group for the quarter were $1.95bn, an 18 per cent increase, and gross margins were up 26 per cent to $541m.

In fact, if it weren't for the $127m in revenues lost by a sixth reporting segment, Corporate and Other – a catchall line-item that includes various corporate expenses and revenue reshufflings related to software upgrade offers – you could even say Microsoft had a strong quarter. Its businesses appear to be firing on all cylinders, and Nadella says he's focused on making it a more agile company that's focused on growth.

But nobody's cheering yet. If anything, Wall Street seemed cautiously optimistic, sending Microsoft shares up around 2.6 per cent in after-hours trading. ®

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