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Microsoft: You're not out of love with cloud, you're just 'optimizing' it for a bit

Q2 results include modest revenue increase, steep consumer and net income decrease

Microsoft has posted modest growth for the quarter ended December 31, 2022, with its consumer-centric products recording marked revenue dips.

Quarterly revenue of $52.7 billion was a two percent year on year increase, and produced $16.4 billion of GAAP net income – a 12 point drop.

Nasty numbers from Satya Nadella's software-slingers included a 39 percent decline in Windows-related revenue paid by PC manufacturers, a 34 percent drop in device revenue, a 12 percent fall in Xbox content and services revenue, and a two percent drop in revenue from Office Consumer products and cloud services (although had exchange rates not changed the business would have posted three percent growth in that segment). The cost of acquiring search and advertising revenue rose ten percent.

Server products and cloud services revenue increased 20 percent, with Azure and other cloud services revenue growing by 31 percent. Office Commercial products and cloud services revenue increased seven percent, and Dynamics did very well, posting 13 percent growth.

But on the earnings call, execs warned of slowing growth for Azure and associated products – from 35 percent to four or five points lower.

CEO Nadella had a theory for that looming slowdown.

Core Azure is being transformed

"Just as we saw customers accelerate their digital spend during the pandemic, we are now seeing them optimize that spend," he told investors.

"Also, organizations are exercising caution given the macroeconomic uncertainty," he added, before offering the observation that customers might be holding back because "the next major wave of computing is being born as we turn the world's most advanced AI models into a new computing platform."

Financial analysts on the call asked several questions about what "optimizing" cloud usage means. Nadella said "they are looking to back some savings on some workloads" and once they've done that, they'll start on new cloudy projects.

The CEO said Microsoft Teams has already shown increased post-pandemic usage, and expressed excitement for the imminent debut of Teams Premium that will shift some existing Teams features into a new and more expensive pricing tier and presumably grow revenue.

Nadella emphasized, as he did in Microsoft's previous results announcement, that securing customer loyalty is on the agenda. Or as he put it, "helping them realize more value from their tech spend and building long-term loyalty and share position."

He also spoke of "internally aligning our own cost structure with our revenue growth" – a nod to the recent sacking of 10,000 staff.

Some of the software leviathan's costs are incurred rebuilding Azure for AI.

Nadella said "the core of Azure or what is considered cloud computing fundamentally changes in its nature and how compute storage and network come together."

"That's, in some sense, under the radar, if you will. For the last three and a half years, four years, we have been working very, very hard to build both the training supercomputers and now, of course, the inference infrastructure. Because once you use AI inside of your applications, it goes from just being training-heavy to inference."

"Core Azure itself is being transformed," he said.

Once Azure is ready to deliver the AI customers want, cloudy growth will resume as customers take the savings from their optimizations and do more Azure. Microsoft will be well positioned to cash in on appreciative customers as they start adopting AI, Nadella hypothesized.

Nadella and CFO Amy Hood both acknowledged that macroeconomic conditions aren't brilliant, and that Redmond's consumer businesses suffered as a result.

"Windows OEM and devices will see continued declines as the PC market returns to pre-pandemic levels," Hood told investors. "And LinkedIn and search will be impacted as ad market spending remains a bit cautious."

But execs on the earnings call were bullish overall, suggesting that Microsoft's recent cost-cutting will leave its finances in fine shape, pointing out that Office365 is a profit-making machine – the Productivity and Business Processes segment produced $8.2 billion of operating income on $17 billion revenue – and that economic conditions are bound to improve.

If they don't, well, Microsoft's balance sheet for the quarter detailed $99.5 billion – yes, billion – in cash, cash equivalents, and short-term investments. That's a reasonably comfortable buffer for even the rainiest day – although it's down $5 billion over six months, for unspecified reasons. ®

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