It has been about a month since the last earnings report for Microsoft (MSFT). Shares have added about 5.9% in that time frame, outperforming the S&P 500.
Will the recent positive trend continue leading up to its next earnings release, or is Microsoft due for a pullback? Before we dive into how investors and analysts have reacted as of late, let’s take a quick look at its most recent earnings report in order to get a better handle on the important drivers.
Microsoft Q4 Earnings Beat Estimates, Azure Strength Drives Top Line
Microsoft reported fourth-quarter fiscal 2020 non-GAAP earnings of $1.46 per share, which beat the Zacks Consensus Estimate by 5.8%. The bottom line also surged 7% on a year-over-year basis (up 9% at constant currency or cc).
Revenues of $38.03 billion improved 13% from the year-ago quarter (up 15% at cc). Further, the top line surpassed the Zacks Consensus Estimate by 3.95%.
Robust execution and better-than-expected demand from customers for commercial cloud offerings drove the quarterly results. Solid uptick in Teams on the back of coronavirus-led work-from-home, stay-at-home, telehealth and online learning wave, remained noteworthy.
Moreover, strong Commercial business positively impacted earnings and revenues. Commercial bookings increased 12% year over year (12% at cc), courtesy of robust renewal implementation and growth in big, long-term Azure contracts. Commercial remaining performance obligation came in at $107 billion, up 23% year over year at cc. Commercial revenue annuity mix was 94%, increasing 4% year over year, driven by ongoing shift to cloud infrastructure.
Commercial cloud revenues were $14.3 billion, surging 30% year over year (up 32% at cc).
Segmental Details
Productivity & Business Processes segment, which includes the Office and Dynamics CRM businesses, contributed 30.9% to total revenues. Revenues increased 6% (up 8% at cc) on a year-over-year basis to $11.75 billion.
Office Commercial business (products + Microsoft 365 & related cloud services) revenues were up 5% from the year-ago level (up 7% at cc). Office 365 commercial revenues climbed 19% (22% at cc), driven by strong installed base growth and average revenues per user (ARPU) expansion. Office 365 Commercial seats improved 15%, driven by improving mix from Microsoft 365.
Office Commercial products revenues declined 34% on a year-over-year basis reflecting ongoing customer shift to cloud-based offerings compared with multi-year on-premises agreements. Also, sluggishness in transactional licensing, across small and medium businesses affected performance.
Office Consumer products and cloud services revenues increased 6% (up 7% at cc), driven by growth in Office 365 subscription revenue. However, “transactional weakness” limited growth. Office 365 Consumer subscribers came in at 42.7 million, up from 39.6 million reported in the prior quarter, benefiting from the coronavirus crisis-led increased demand courtesy of work-from-home wave.
Dynamics business improved 13% (up 15% at cc). Dynamics 365 revenues surged 38% (40% at cc). Dynamics adoption is improving with companies like Walgreens Boots Alliance, Chipotle, BNY Mellon, FedEx, selecting the application to securely digitize critical business processes.
LinkedIn revenues advanced 10% from the year-ago quarter (up 11% at cc), driven by 27% growth in LinkedIn sessions. LinkedIn usage was up with professionals watching more amount of LinkedIn Learning content. However, coronavirus crisis-induced weakness in job market significantly affected bookings in Talent Solutions business.
Microsoft is gaining from expanding user base of different applications including Microsoft 365 E5 and Teams. Both solutions continue to witness record adoption. The uptick can be attributed to coronavirus-led work-from-home, stay-at-home, telehealth and online learning wave. Notably, the company did not provide daily active user base of Microsoft Teams, which came in at 75 million in the prior quarter.
Nevertheless, management noted that “69 organizations now have more than 100,000 users of Teams, and over 1800 organizations have more than 10,000 users of Teams.”
The company is also witnessing significant demand for Windows 10 PCs, with minutes spent in Windows 10 marking an increase of more than 55% year over year.
Intelligent Cloud segment, which includes server, and enterprise products and services, contributed 35.2% to total revenues. The segment reported revenues of $13.37 billion, up 17% (up 19% at cc) year over year.
Server product and cloud services revenues rallied 19% year over year (up 21% at cc). The high point was Azure’s revenues, which surged 47% year over year (up 50% at cc), driven by robust growth in consumption-based business.
On-premise server products revenues remained flat (up 1% at cc). The better-than-expected performance was driven by solid renewal execution, and ongoing uptake of hybrid solutions and premium server versions.
Further, enterprise mobility installed base revenues improved 26% to more than 147 million seats.
Enterprise service revenues remained flat (up 2% at cc) in the reported quarter, on account of growth in Premier Support Services. However, delays in consulting limited growth.
More Personal Computing segment, which primarily comprises Windows, Gaming, Devices and Search businesses, contributed 33.9% to total revenues. Revenues were up 14% (up 16% at cc) year over year to $12.91 billion, driven by work-from-home, web-based learning and online gaming trends.
Windows revenues increased 6% courtesy of growth in Windows Commercial and Windows OEM. Windows commercial products and cloud services revenues increased 9% year over year (up 11% at cc), on the back of higher customer adoption of Microsoft 365 offerings and robust improvement in advanced security solutions. However, sluggishness in transactional licensing limited growth.
Windows OEM revenues improved 7% on a year-over-year basis, primarily due to improved supply in April.
Windows OEM non-Pro revenue advanced 34%, on robust consumer demand driven by remote working and online learning wave, and gains from improved supply scenario in April “from unfulfilled fiscal third quarter demand.”
However, Windows OEM Pro revenue declined 4%, owing to coronavirus crisis-induced slowdown in small and medium businesses in May and June, which more than offset gains from improving supply in April.
Search advertising revenues, excluding traffic acquisition costs (TAC), declined 18% (down 17% at cc). Reduced spend on advertising by industries severely impacted by coronavirus-induced economic crisis led to the decline.
Surface revenues improved 28% (up 30% at cc) from the year-ago quarter to $1.72 billion, driven by remote work and online learning-led demand increase, and strength across consumer and commercial segments.
Gaming revenue increased 64% (up 66% at cc) driven by increased engagement led by stay-at-home wave. Xbox content and services revenue increased 65% (up 68% at cc) year over year, driven by solid growth in Xbox Game Pass subscriber base, third-party transactions and Minecraft. Notably, Minecraft recorded a new high of nearly 132 million monthly active users during the reported quarter.
Operating Results
Non-GAAP gross margin increased 10% (12% in cc) to $25.7 billion, driven by revenue growth in Intelligent Cloud and More Personal Computing. Non-GAAP gross margin (in percentage terms) of 68% contracted 200 basis points (bps) on a year-over-year basis, driven by unfavorable sales mix.
Commercial cloud gross margin was 66%, up 1 percentage point year over year. This can be attributed to improvement in Azure gross margin.
Operating expenses surged 13%, including $450 million charge pertaining to re-alignment of digital strategy involving closer of Microsoft Store brick-and-mortar stores.
Operating margin contracted 200 bps on a year-over-year basis to 35%.
Productivity & Business Process operating income declined 9% (down 5% at cc) to $3.97 billion. Intelligent Cloud operating income surged 19% (up 22% at cc) to $5.34 billion. More Personal Computing operating income rallied 15% (up 19% at cc) to $4.09 billion.
Balance Sheet & Free Cash Flow
As of Jun 30, 2020, Microsoft had total cash, cash equivalents, and short-term investments balance of $136.53 billion, compared with $137.63 billion as of Mar 31, 2020. As of Jun 30, 2020, long-term debt (including current portion) was $63.33 billion compared with $66.61 billion as of Mar 31, 2020.
Operating cash flow during the reported quarter came in at $18.7 billion compared with $17.5 billion reported in the previous quarter, owing to solid cloud billings and collections. Free cash flow during the quarter was $13.9 billion, compared with $13.7 billion reported in the prior quarter.
In the reported quarter, the company returned $8.9 billion to shareholders in the form of share repurchases and dividends.
Guidance
For first-quarter fiscal 2021, Productivity and Business Processes revenues are anticipated between $11.65 billion and $11.9 billion, backed by low-double-digit growth in Dynamics and mid-single-digit revenue growth in LinkedIn. Weak job market and lower spend on advertising are likely to weigh on LinkedIn and Search revenues.
Strong upsell opportunity for Microsoft E5 and momentum in Office 365 is expected to drive growth in Office commercial. However, decline of 30% in on-premises business, owing to sluggishness in transactional business across small and medium businesses is anticipated to affect growth.
Office consumer revenues are expected to remain unchanged on a year-over-year basis as growth in subscription-based offerings offset the decline in transactional business.
Intelligent Cloud revenues are anticipated between $12.55 billion and $12.8 billion. Azure’s revenue growth is likely to reflect continued strength in the consumption-based services. Solid momentum in Microsoft 365 suite is expected to drive growth. However, increasing size of the installed base is anticipated to limit growth.
More Personal Computing revenues are expected between $10.95 billion and $11.35 billion. The company anticipates OEM revenues to decline in low teens owing to weakness across small and medium businesses. Windows commercial products and cloud services revenues are expected to grow in “healthy double-digits” driven by solid Microsoft 365 momentum and advanced security solutions. Surface revenues are anticipated to increase in the “mid-teens” year over year. Search advertising revenues, excluding TAC, are anticipated to decline “in the low 20% range.”
Gaming revenues are anticipated to be up in the high-teens year over year on momentum in user engagement.
Management expects COGS between $10.75 billion and $10.95 billion, and operating expenses in the range of $10.7 billion to $10.8 billion.
How Have Estimates Been Moving Since Then?
In the past month, investors have witnessed an upward trend in estimates review.
VGM Scores
At this time, Microsoft has a strong Growth Score of A, though it is lagging a bit on the Momentum Score front with a B. However, the stock was allocated a grade of D on the value side, putting it in the bottom 40% for this investment strategy.
Overall, the stock has an aggregate VGM Score of B. If you aren’t focused on one strategy, this score is the one you should be interested in.
Outlook
Estimates have been trending upward for the stock, and the magnitude of these revisions looks promising. Notably, Microsoft has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.
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