Microsoft Earnings Preview: Revenues To Improve As Cloud Services And Hardware Sales Gain Traction

Microsoft (NASDAQ:MSFT) is set to announce its Q3 FY 2017 earnings on Thursday, April 27th. ^[1] (Fiscal years end with June.) The company continues to implement its “mobile first, cloud first” strategy, which led to 2% growth in its revenues in Q2 2017. The company continues to develop an ecosystem of cross-device applications and value-added services around its hardware and software. This has resulted in good growth for its Office, Server, Operating System and hardware divisions in the first half of the fiscal year. During this earnings announcement, we will continue to monitor the company’s growth in cloud services, and expect it to report growth across its verticals. Furthermore, we will continue to monitor the progress of the revenue growth from productivity (Office), operating systems divisions and hardware sales.

See our complete analysis of Microsoft here

Productivity Revenues Improve As Office 365 And Dynamic CRM Gain Traction

Microsoft’s Office division makes up 35% of our price estimate for Microsoft’s stock. In Q2 2017, Microsoft reported that its Office commercial products and cloud services revenue grew 5% (up 7% in constant currency), driven by Office 365 commercial revenue growth of 47% (up 49% in constant currency). Monthly active users of Office 365 commercial now number over 85 million, up more than 37% year over year, while the Office 365 consumer subscriber base grew to 24.9 million, resulting in 8% growth in Office consumer and cloud services revenue.

While we expect that the transition from Microsoft’s perpetual license model for Office transitions to a subscription-based structure will negatively impact revenues over the short term, Microsoft will be able to monetize Office 365 over the extended period of usage, as users tend to use software over a longer period of time. Therefore, we expect that Microsoft will report increases in both subscribers and the revenue run rate for Office 365. As a result, Office productivity revenue is expected to increase for Q3 FY17.

The Microsoft Dynamics family includes six products. Microsoft’s Dynamics Cloud services continue to report increased adoption, as Microsoft’s clients continue to adopt the CRM and ERP services. While Microsoft chooses not to disclose its Dynamics revenue allocation between CRM and ERP, we expect Dynamics software to report growth for Q3 FY17 (Q1 CY2017).

Server Products To Report Growth Once Again

Microsoft’s Windows Server division, for the past few quarters, has been one of the fastest-growing divisions of Microsoft and contributes over 32.6% to Trefis’s estimated valuation. During fiscal Q2, the intelligent cloud segment (Azure, Server products, and enterprise services) delivered $6.86 billion in revenues, year-over-year growth of 8% (10% in constant currency). While server products and cloud services revenue grew by 12% (14% in constant currency), driven by growth in Microsoft SQL Server, adoption of the cloud-based Azure platform resulted in 93% growth (95% in constant currency) in its revenues. As a result of these products, the company’s Cloud revenue run rate exceeded $14 billion. Furthermore, as Microsoft is significantly ramping its Azure platform to boost its Cloud revenues through IaaS and PaaS solutions, revenues for Azure are expected to grow in the quarter. The popularity of Cloud and Big Data analytics is also fueling growth for Microsoft’s SQL Server as it is witnessing excellent adoption among developers. We expect that these trends persisted in fiscal Q3, and revenue growth for intelligent cloud will be in the double digits once more.

Windows OS Sales To Improve In The Quarter

The Windows Operating System (OS) is Microsoft’s third-largest division and makes up around 10% of its value, per our estimates. Microsoft still generates most of its revenues and cash from the sale of perpetual licenses for the Windows operating system.

In fiscal Q2, Microsoft reported that its Windows OEM non-Pro licensing revenues grew by 5% and its OEM Pro revenue grew by 6%. Despite the slowdown in PC hardware sales, the company was able to buck this trend as license sales grew due to improvements in both the commercial PC market and the mix of premium devices. As both its existing and new OEM partners are bringing to market an expanded set of device offerings at lower price points for the Windows 10 offering, we expect sales to pick up in Q3 and the ensuing quarters.

Hardware Launches Bolster Personal Computing Division

Microsoft acquired Nokia’s Hardware phone division in 2014. Since the acquisition, it has ramped down the production of handsets as the division was not able to make headway in the smartphone market. As a result, revenues from phone division have declined by over 90% in 2016. However, Microsoft’s personal computing division has done exceptionally well in 2016, largely due to the launch of its Surface devices.

The company announced the launch of new hardware in November 2016 and is expected to announce a host of new Surface products in May this year. However, shipment numbers for Surface devices will shed some light on the popularity of these devices among developers and creatives, the targeted segment of users.

In this earnings announcement, we will continue to monitor the growth in revenues for Surface devices. We also believe that the company is nearly done with phasing out its phone hardware, and that revenue for the devices segment will report growth in Q3.

We currently have a $65 price estimate for Microsoft, which is in line with the current market price.

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