Microsoft Q4 FY19: Why is Azure 'slowing' and Windows growing?

There's more going on with Microsoft's Azure and Windows businesses than a cursory look at the company's latest earnings might indicate.

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Credit: Microsoft

Microsoft posted another strong quarter with its fourth-quarter fiscal 2019 period, with expected strong performances from its cloud services, its on-premises server products, Surface unit, and even Windows. Some who are looking deeper into Microsoft's earnings are wondering whether Microsoft's Azure business is slowing because it is now "only" up 64 percent, year-over-year, but steadily down, sequentially. And some are asking whether the Windows Pro business can keep going strong after the Windows 7-to-10 migrations taper off.

Microsoft's revenue for the fourth quarter was $33.7 billion, and operating income $12.4 billion. Microsoft is still not breaking out Azure numbers when it reports performance of its "commercial cloud" -- an amalgamation of Azure, Office 365, Dynamics 365 and some LinkedIn commercial business. 

Microsoft's overall commercial cloud business was strong in Q4 FY19, coming in at $11 billion. Microsoft watchers continue to believe the lion's share of the commercial cloud business comes from Office 365 Commercial. Office 365 Commercial revenues were up 31 percent this quarter due to a combination of growth in seats and higher average revenue per user (which means continued demand for O365 E3, more Office 365 E5 and interest in Microsoft's recently announced Security and Compliance SKUs).

Mike Spencer, General Manager of Investor Relations, said the lower Azure growth percentage is because of the law of large numbers, meaning the bigger Azure gets as an overall business, the slower it's likely to grow, percentage-wise. (He also said it's growing at 68 percent if you look at the constant currency numbers, not 64%.) Additionally, he noted that the Enterprise Mobility + Security service on Azure is growing more moderately so that its trajectory now looks more like Office 365.

It's a different story on the Azure margins side, where things are improving noticeably, thanks to more significant, multi-year contracts that Microsoft's been signing of late, officials said.

"We are continuing to get scale and find efficiencies in the business," Spencer said when asked about margins. He said Microsoft had gotten a handle on how its data centers are structured; its customer support; and the overall scale in the business. These days, Azure deals are more about partnerships than looking for price cuts (though, of course, customers are still price-sensitive), he said.

Windows revenues were up to seven percent year-over-year because of strong growth in Windows OEM and commercial this quarter. Windows OEM Pro revenue, in particular, was up 18 percent due to "strong momentum in advance of Windows 7 end of support," Microsoft officials said in their earnings statements. (Microsoft's on-premises server business has also experienced similar positive effects of the end-of-support dates for Windows Server 2008/R2 and SQL Server 2008/R2.)

This quarter is the first time I've seen Microsoft officially cite Jan. 14, 2020, end of support deadline for Windows 7 as a reason for Windows growth, though Spencer told me this had been the case for the last few quarters. When I asked during earnings calls in previous quarters, Microsoft officials downplayed the effect of the end-of-life of Windows 7 on Windows revenues. Microsoft expects the end-of-life of Windows 7 to continue to have a long-tail positive impact in the next quarter and beyond, officials are now saying.

Other reasons for Windows commercial (not the weaker consumer) growth this quarter also included "an increase of multi-year agreements that carry higher in-quarter revenue recognition," according to its 8-K, plus strong commercial PC growth and four percent increased inventory levels ahead of anticipated tariffs and the end of a chip-supply issue which affected PC makers, officials said. Microsoft officials said a decrease in patent licensing had some negative effect on the Windows business but didn't elaborate on why IP licensing revenues declined.

Microsoft's gaming business had a lackluster quarter with console sales continuing to decline, and Surface clocked in at $1.3 billion, which was good given no new products were launched in Q4. Microsoft CEO Satya Nadella said the company considers gaming a growth workload on Azure and it's moving full-steam ahead toward its xCloud cross-platform game streaming service.