Shares of Microsoft (MSFT 104.88, -1.50, -1.41%) are trading lower this morning after
the company reported Q2 results and provided its Q3 outlook during its earnings
call. Specifically, it posted EPS of $1.10 vs. the $1.09 consensus, on
revenue growth of 12% to $32.47 bln vs. the $32.53 bln consensus. During the
earnings call, it guided for Q3 revenue of $29.4-$30.1 bln, in-line with the
$29.8 bln consensus.
On the surface, its results look relatively solid, especially when compared against other prominent tech companies like Intel (INTC), Juniper (JNPR), and Texas Instruments (TXN). In contrast to those companies, each of which provided downside guidance, MSFT issued quarterly results and forward guidance that was essentially in-line with expectations.
Still, the stock is down today, due to a couple issues -- both of which are growth related.
Growth May Be Harder to Come By
First, MSFT has a recent history of comfortably outperforming quarterly expectations. To put that into context, over the past six quarters, its average EPS beat has been about $0.10. During this span, it has also exceeded analysts' revenue forecasts by a good margin. This quarter, however, MSFT edged out the earnings consensus by a mere penny ($1.10 vs. $1.09) and revenue actually came up a bit short of expectations at $32.47 bln (+12% yr/yr). With MSFT failing to impress the market with another easy beat this time around might suggest that the "low hanging fruit" has already been picked, and growth won't be as easy to come by.
Additionally, investors are also focusing on MSFT's growth in its cloud services business, as the company continues to take aim at Amazon (AMZN) and its burgeoning Amazon Web Services segment. (On a side note, AMZN is set to report earnings after the close tonight). Over the past few years, MSFT has been transitioning towards a cloud services and subscription-based company as growth in its traditional PC Windows-based products erodes. This evolution is most evident in through the successful launch of Azure in 2010.
For some quick background, Azure is a collection of cloud computing services that enables for the building, testing, deployment and management of applications and data through Microsoft-managed data centers. It supports both open-source and proprietary software from MSFT and other companies. Instead of building on-premise server centers, or leasing physical servers, Azure's billing structure is based on resource consumption.
Azure's growth has been robust, driven by a combination of new customer adds and expanding usage from existing customers. On the topic of new customer acquisitions, MSFT recently secured a few more high-profile wins, including Wallgreens Boots Alliance (WBA), Albertsons, Kroger's (KR), and The Gap (GPS).
The company doesn't provide much in the way of specific financial data for its Azure business, but, it did state that Azure revenue grew by 76% yr/yr in the quarter. That is quite healthy growth from last year, but it was flat on a sequential basis, which is what is causing much of the disappointment today. Furthermore, it is a deceleration from the year ago quarter when Azure revenue surged by 98%.
Additionally, in its revenue guidance for Q3, it did break it down by its primary product categories. For Intelligent Cloud, in which Azure is included, it guided for revenue of $9.15-$9.35 bln, representing a sequential decrease for Q2's $9.4 bln. Combine this with the downbeat forecasts from infrastructure companies like JNPR, and a clearer picture emerges regarding MSFT's most important growth driver in Azure.
Surface & LinkedIn Help to Offset PC Related Weakness
The holiday season turned out to be a solid one for MSFT as its
Surface tablets and laptops saw a 39% jump in sales. On top of that, LinkedIn
revenue jumped by 29% with user engagement reaching record levels once again.
This helped to offset a 5% dip in revenue from Windows licensing, which the
company attributed to unfavorable timing for the supply of processors to PC
OEMs. The 5% drop represents its worst performance for the segment in over two
On the topic of computer chips, the various cuts in guidance from semiconductor and memory makers (MU, SSNLF, INTC, TXN) doesn't bode well for MSFT's Personal Computing segment, which still represents around 40% of its total revenue. Not surprisingly, the company is forecasting modest yr/yr growth of about 6% in Q3 for this business.
Key Takeaways: All in all, it wasn't a bad quarter for MSFT. EPS grew by a solid 15%, cash flow from operations was up 13%, and it generated $5.2 bln in free cash flow. Demand still held up fairly well at +12%, as its cloud services -- driven by Azure -- led the way and helped to offset weaker areas, including Windows OEM. But, in the aftermath of the reduced outlooks from various chip makers, investors are now concerned that one of MSFT's primary growth catalysts (Azure) has topped out in terms of its growth rate. While MSFT doesn't provide details regarding Azure's revenue base, analysts estimate it to be around $2.5-$2.8 bln. At that size, growth rates will naturally decelerate. However, when taken together with the cautious outlooks from other tech leaders, looking at its Q3 guidance for its Intelligent Cloud segment as a whole, and factoring in the slowdown in its PC/Windows business. Investors are left feeling less enthusiastic about its growth prospects.