Stronger than expected Windows sales contribute to Microsoft's solid Q2 FY20

While all eyes are on Microsoft's cloud performance, Windows' contribution to Microsoft's second fiscal quarter was stronger than expected.
Written by Mary Jo Foley, Senior Contributing Editor

While Microsoft and Wall Street only want to talk about the company's cloud sales and margins, Windows was no slouch when it came to Microsoft's Q2 FY20 results. Microsoft's "More Personal Computing" business segment -- which includes Windows, Surface, Bing/advertising gaming and Microsoft 365 -- contributing $13.2 billion of the company's $36.9 billion for the quarter.

Commercial cloud, the Microsoft-devised bucket which includes Office 365, Azure, Dynamics 365 and some LinkedIn revenues, contributed $12.5 billion in the second quarter. With gross margins of 67 percent for the quarter, this is the category on which Microsoft wants everyone to focus.

Windows' growth this quarter was above officials' expectations. Windows Pro OEM revenue growth was 27 percent compared to the comparable year-ago quarter. Non-Pro (consumer) revenue growth was four percent, the first time it had been in the black for the past year. And Surface revenue was $1.98 billion for the quarter.

Officials attributed Windows' strong results to a few things: Resolution of an Intel chip-supply issue which plagued the company in Q2 FY19 (and beyond), as well as strong demand for Windows 10, given anticipation of Windows 7's end of free support, which happened in January this year. An unnamed OEM partner also pre-purchased Windows 10 licenses in anticipation of trade/tariff issues likewise contributed to the strong non-OEM growth.

Given Q2 FY20 revenues covered the period between October 2019 and December 2019 -- and Windows 7 support didn't end until January, 2020 -- there still could be more positive impact on Windows revenues during Microsoft's Q3 FY20. In addition, revenues Microsoft will be earning from selling companies Extended Security Updates (ESUs) for Windows 7 haven't yet really started contributing to revenues, a company representative told me, even though Microsoft began offering ESU coverage as of April 1, 2019.

During the analyst call following the release of Q2 results, Chief Financial Officer Amy Hood said that OEM Pro revenues contribute 40 percent of overall Windows revenues. OEM Non-Pro revenues add another 20 percent and Windows Commercial products and cloud services an additional 30 percent. (Commercial Products and Cloud Services is where Microsoft 365 revenues, among other products/services, fall.)

In Q2, an increase in Microsoft 365 agreements, "which carry higher in-quarter revenue recognition," played into More Personal Computing's solid performance. Making the business unit's numbers even more impressive was the fact that gaming revenue -- also counted in this segment -- was down 21 percent compared to the comparable quarter. Xbox content and services revenue was down 11 percent in Q2 because of a high prior year comparable influenced by a "third-party title," which many believe to be Fortnite.

Hood warned that the More Personal Computing segment could face a tougher Q3 FY20. She attributed this to uncertainties around public health in China (where Microsoft makes its hardware), as well as unspecified "execution challenges" in the consumer segment for Surface. Update: I asked for elaboration on what those challenges are/were, but a spokesperson said the company had nothing further to say on the matter.

Hood and CEO Nadella emphasized that Microsoft's Azure business is seeing more impact from higher-margin platform-as-a-service type offerings, a trend which should continue and grow in the coming months. New PaaS workloads like Azure Synapse Analytics, Cosmos DB and Azure Arc are coming on board, and Microsoft 365 is becoming a big contributor to Microsoft's cloud business, she said. Microsoft's xCloud game-streaming service also is hosted on Azure.

Microsoft still does not break out Azure sales separately, but some analysts have estimated that Azure is contributing roughly $4 billion in revenues per quarter. 

Editorial standards