Microsoft Corporation MSFT delivered second-quarter fiscal 2019 earnings of $1.10 per share, which beat the Zacks Consensus Estimate by a penny. The figure jumped 14.6% on a year-over-year basis.
Revenues of $32.47 billion increased 12% from the year-ago quarter (up 13% in constant currency or cc). The figure was almost in line with the Zacks Consensus Estimate of $32.45 billion.
Robust execution and better-than-expected demand from customers for hybrid cloud offerings drove the quarterly results.
Commercial bookings increased 18% (22% at cc). Commercial unearned revenues were $25.32 billion, up 19.6% year over year at cc. Commercial revenue annuity mix was 89%, up 3 percentage point year over year.
Commercial cloud revenues were $9 billion, surging 48% year over year (47% at cc), reflecting solid growth in the United States, Western Europe and the U.K.
Shares were up 3.3%, yesterday. In fact, shares of Microsoft have returned 8.7% year over year, outperforming the 7.9% rally of the industry.
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Segmental Details
Productivity & Business Processes includes the Office and Dynamics CRM businesses. Revenues increased 13% (up 13% at cc) on a year-over-year basis to $10.1 billion.
The Commercial business (products + Office 365 & related cloud services) revenues were up 11% from the year-ago level (up 11% at cc). Office 365 commercial revenues grew 34% (33% at cc), driven by strong installed base growth and average revenues per user (ARPU) expansion. Office 365 Commercial seat grew 27% on a year-over-year basis.
Office Consumer products and cloud services revenue increased 1% (up 2% at cc). Office 365 Consumer subscribers came in at 33.3 million during the reported quarter.
Dynamics business grew 17% (same at cc). Dynamics 365 revenues soared 51% (50% at cc). Dynamics adoption is improving, with companies like H&M selecting the application to digitize its critical business processes.
LinkedIn revenues surged 29% from the year-ago quarter (up 30% at cc). LinkedIn sessions were up 30%, reflecting acceleration in engagement.
Microsoft is benefiting from growing user base of its different applications like Microsoft 365 and Teams. Both solutions continue to witness strong adoption. Microsoft 365 has been chosen by the likes of Neiman Marcus to Brooks Running to global biopharmaceutical leader, Sanofi in recent times. Microsoft Teams is now used by roughly 420,000 organizations, including 89 of the Fortune 100.
More importantly, Microsoft is adding features on a regular basis to these applications. Apart from strengthening cybersecurity features of Microsoft 365, the company integrated new AI-driven features, including automated slide design, Cortana reminders, enhanced search experiences and real-time meeting transcription, among others.
In Microsoft Teams, the company is adding automated translation support for meetings, shift scheduling for firstline workers, and new industry-specific offerings for healthcare and small businesses.
Intelligent Cloud includes server as well as enterprise products and services. The segment reported revenues of $9.4 billion, up 20% (up 21% at cc) year over year.
Server product and cloud services revenues rallied 24% year over year (same at cc). The high point was Azure's revenues, which soared 76% at cc on a year-over-year basis.
The company added more than 100 new capabilities to Azure, with focus on existing workloads like security and new workloads like Internet of Things (IoT) and Edge AI. Azure’s clientele continues to expand with Volkswagen, Starbucks, WalgreensAnheuser-Busch In Bev and Mastercard MA selecting the cloud platform.
Microsoft and LG Electronics inked a deal at CES 2019. Per the agreement, Microsoft’s Azure cloud platform and robust AI capabilities will be utilized by LG to enhance its self-driving software. The new partnership adds to Azure’s growing clout.
On-premise server products revenues increased 3% (up 4% at cc), driven by customer demand for hybrid solutions, premium server versions and GitHub inclusion.
Further, enterprise mobility installed base revenues increased 57% to more than $94 million seats.
Moreover, enterprise service revenues increased 6% (up 7% at cc) in the reported quarter, due to growth in premier support services and Microsoft consulting services.
More Personal Computing primarily comprises Windows, Gaming, Devices and Search businesses. Revenues were up 7% (same at cc) year over year to $13 billion.
Windows OEM pro revenues decreased 2% on a year-over-year basis. Windows OEM non-Pro revenues decreased 11% year over year. However, windows commercial products and cloud services revenues increased 13% year over year (up 14% at cc), driven by higher customer adoption of the company’s premium offerings. Windows 10 deployments across new and existing devices remained robust during the reported quarter.
Gaming revenues jumped 8% (9% at cc), driven by robust performance from Xbox software and services (up 32% at cc) due to third-party title strength.
Recently, the company announced a discount of $50 on select Xbox One S and Xbox One X variants for a limited time period. However, Xbox hardware revenues declined year over year given “the holiday launch of the Xbox One X a year ago.”
Surface revenues increased 39% (up 41% at cc) from the year-ago quarter, driven by strong performance of the latest editions. Further, robust growth across consumer and commercial aided the year-over-year increase.
Microsoft expanded its Surface family just before holiday shopping season by introducing Surface Laptop 2, Surface Pro 6 and Surface Studio 2 devices and smart Surface Headphones.
Additionally, bundling new Surface devices sales with Office 365 is a smart move and is anticipated to bolster Office 365 adoption. The holiday deals along with these initiatives are in sync with the company’s attempt to take on Apple (AAPL) which dominates the market with Macbook Pro and Macbook Air.
Search advertising revenues, excluding traffic acquisition costs (TAC), grew 14% (same at cc) as both search volume and revenues per search (RPS) improved.
Operating Results
Microsoft’s gross margin of 61.7% remained flat year over year, as higher cloud margins were fully offset by unfavorable sales mix.
Productivity & Business Process gross margin declined slightly as unfavorable cloud mix offset LinkedIn and Office 365 margin expansion. Moreover, Intelligent Cloud segment gross margin remained flat year over year, driven by solid improvement in Azure's gross margin.
More Personal Computing gross margin also contracted year over year owing to unfavorable sales mix.
Commercial cloud gross margin was 62%, up 5 percentage points year over year, due to improvement in Azure gross margin.
Operating expenses of $9.78 billion were up almost 7% from the year-ago quarter owing to higher investments in commercial sales capacity, cloud engineering and LinkedIn.
Productivity & Business Process operating expenses increased 3% (up 4% at cc) om account of aggressive investments in LinkedIn, cloud engineering and commercial sales capacity to support top-line growth.
Intelligent Cloud operating expenses increased 26% (same at cc), owing to on-going investments in cloud, AI engineering and commercial sales capacity expansion initiatives.
More Personal Computing operating expenses declined 4% year over year.
Operating margin expanded 160 bps on a year-over-year basis to 31.6%.
Productivity & Business Process operating income grew 20% (up 19% at cc). Intelligent Cloud operating income surged 16% (up 15% at cc). More Personal Computing operating income rallied 18% (up 19% at cc).
Balance Sheet & Free Cash Flow
Microsoft ended with cash and short-term investments balance of $127.7 billion, down $133.8 billion from the previous quarter. Long-term debt (including current portion) came in at 73.2 billion.
Operating cash flow during the reported quarter came in at $8.9 billion. Free cash flow during the quarter came in at $5.2 billion, down from $10.1 billion reported in the previous quarter.
In the reported quarter, the company returned $9.6 billion to shareholders in the form of share repurchases and dividends.
Guidance
For the third quarter of fiscal 2019, commercial unearned revenues are expected to decline 2-3%, sequentially, while commercial cloud gross margin is expected to improve at a moderate pace.
Productivity and Business Processes revenues are expected between $9.9 billion and $10.10 billion, driven by double-digit growth in Office commercial and Dynamics. Office is expected to be in the low-single digits due to growth in Office 365 which will partially be offset by the consumer PC market headwinds.
Intelligent Cloud revenues (including GitHub) are expected between $9.15 billion and $9.35 billion. Azure's revenue growth is likely to reflect continued strength in the consumption and per-user based services.
More Personal Computing revenues are expected between $10.35 billion and $10.65 billion, with a shift in revenue mix to Surface and gaming businesses.
Gaming revenue growth rate is anticipated to be moderate in the current quarter.
Management expects COGS between $10.35 billion and $10.55 billion, and operating expenses between $10.10 billion and $10.20 billion.
For fiscal 2019, operating expenses are expected to grow roughly 8%, driven by continuing investments in GitHub, commercial cloud, LinkedIn, gaming and AI.
Nevertheless, management expects operating margin to increase slightly on a year-over-year basis.
Microsoft expects the GitHub deal to be minimally dilutive to fiscal 2019 and 2020 earnings per share on a non-GAAP basis and accretive to fiscal 2020 operating income on a non-GAAP basis.
Zacks Rank
Microsoft currently carries a Zacks Rank #3 (Hold).
Some better-ranked stocks in the broader technology space are Mellanox Technologies, Ltd. MLNX and salesforce.com, inc. CRM, both sporting a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
Mellanox and salesforce anticipates long-term earnings growth rate at 19% and 24.2%, respectively.
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