Microsoft (MSFT) Surpasses Q2 Earnings & Revenues, Up Y/Y

Microsoft Corp. (NASDAQ:MSFT) deliveredsecond-quarter fiscal 2018 earnings of 96 cents per share, which beat the Zacks Consensus Estimate by 10 cents. The figure rallied 20% on a year-over-year basis.

Revenues of $28.92 billion increased almost 12% from the year-ago quarter (up 11% in constant currency or cc). Further, the figure marginally exceeded the Zacks Consensus Estimate of $28.35 billion. Revenues were positively impacted primarily due to strategic growth investments in cloud business and Artificial Intelligence (“AI”) alongwith robust sales implementation. LinkedIn (NYSE:LNKD) contributed 4 points of revenue growth.

Microsoft stated that better-than-expected performance in large markets like France, the United States and Western Europe drove top-line growth.

Commercial unearned revenues were $20.2 billion, up 18.1% year over year and marginally higher than Microsoft’s expectation, primarily owingto strong customer commitments to Azure and FX benefit.

Annuity mix was 86%, while commercial bookings grew 7% (4% at cc). New Commercial cloud business revenues were approximately $5.3 billion, growing 56% year over year.

Shares were up around 2.5%, yesterday. Microsoft has returned 50.4% year over year, substantially outperforming the 39.2% rally of the industry.

Azure, Office 365 and Dynamics 365 Drives Growth

Productivity & Business Processes include the Office and Dynamics CRM businesses. Revenues jumped 25% (up 24% at cc) on a year-over-year basis to $9 billion. The increase was primarily owingto LinkedIn revenuesstepping up, which contributed 15 points of growth.

The Commercial business (products + Office 365 & related cloud services) revenues were up 10% from year-ago level (up 10% cc). Office 365 commercial revenues grew 41% (41% at cc) driven by strong installed base growth and average revenues per user (ARPU) expansion.

Office 365 adoption remained strong during the quarter. Office 365 Commercial seat grew 30% during the quarter in line with the expectation.

The Consumer business revenues advanced 12% (11% at cc) year over year in the quarter, on the back ofOffice 365 recurring subscription revenuesand growth in its subscriber base. Office 365 consumer subscribers are now at 29.2 million, up from 28 million in the previous quarter.

Dynamics business grew 10% (9% at cc). Dynamics 365 revenues soared 67% (68% at cc).

LinkedIn contributed revenues of $1.3 billion, better than management’s guidance of $1.2 billion. LinkedIn sessions were up more than 20% for the fifth consecutive quarter.

Moreover, user engagement, customer acquisition, renewals, and upsell performance during the quarter remained strong.

Intelligent Cloud includes server and enterprise products and services. The segment reported revenues of $7.8 billion, up 15% driven by strong performance in hybrid cloud.

Server product and cloud services revenues went up 18% year over year (same at cc). The high point was Azure revenues, which soared 98% at ccon a year-over-year basis. Microsoft noted that Azure premium revenues grew triple digits for the 14th consecutive quarter.

Adoption remains strong as evident from growing customer base. Azure has been selected by the likes of United Technologies (NYSE:UTX) and Columbia Sportswear.

Data center expansion continues with Azure now in 42 regions globally, more than any other cloud provider.

Enterprise service revenues grew 5% (3% at cc) in the reported quarter, owingto growth in Premier Support Services and Microsoft Consulting Services. However, declines in custom support agreements related to Windows 2003 remains a headwind.

More Personal Computing comprises mainly the Windows, Gaming, Devices and Search businesses. Revenues were up 2% year over year to $12.2 billion. Excluding phone business, revenues grew 4% (same at cc).

Windows OEM revenues increased 4% (same at cc). Windows OEM pro revenues increased 11% (same at cc) on a year-over-year basis, ahead of the overall commercial PC market. Moreover, windows commercial products and cloud services revenues decreased 4% on a year-over-year basis (5% at cc) mainly due to the impact of large deals in the previous year.

During the quarter, the company unveiled Surface LTE and a new generation of Windows 10 PCs from its OEM partners.

Recently, the company also acquired PlayFab, which assists 700 million and more gamers with above 1,200 games from companies like Disney, Rovio and Atari. The acquisition will help Microsoft to extend investments in Azure to provide a world-class cloud platform for the gaming industry.

Gaming revenues increased 8% (same at cc), primarily driven by hardware revenue growth of 14% (13% at cc), with the launch Xbox One X. Strength in Xbox software and services revenues(up 4%) also supported the segmental growth. Xbox Live monthly active users were up 7% to 59 million active users.

Surface revenues increased 1% (flat at cc) from the year-ago quarter primarily due to higher sales of the new Surface Laptop, Pro with LTE and the new Surface Book 2 in both the commercial and consumer segments.

Search excluding traffic acquisition costs (TAC) revenues grew 15% (same at cc) as both search volume and revenues per search (RPS) improved.

Operating Results

Microsoft’s gross margin came in at 62%, flat year over year, primarily owing to favorable revenues mix along with commercial cloud margin improvement. LinkedIn contributed almost 5 points of gross margin growth.

Commercial cloud gross margin was 55%, up 7 points year over year.

Operating expenses of $9.2 billion were up 14% from the year-ago quarter. FX added 1 point of growth to operating expenses. LinkedIn contributed 10 points of growth, including $154 million of amortization of acquired intangible expense.

As a result, operating margin contracted 60 bps on a year-over-year basis to 30%. LinkedIn contribution had minimal effect on operating margin. Excluding the cost of amortization of acquired intangibles, LinkedIn contributed $111 million to operating income.

Balance Sheet

Microsoft ended with cash and short-term investments balance of $142.8 billion, up $138.5 billion from the previous quarter. Total debt amounted to $89.26 billion. The company returned $5 billion to shareholders in the form of share repurchases and dividends in the reported quarter.

Guidance

For third-quarter fiscal 2018, Microsoft expects foreign exchange to increase revenues growth by 2 points, COGS growth by 1 point and operating expenses growth also by 1 point.

The company anticipates that solid renewal and increasing customer demand for Microsoft’s hybrid cloud services and new cloud solutions like Microsoft 365 will continue to drive commercial business growth.

Management expects dollar volume of EA expirations to return to growth in the third quarter, which will positively impact commercial bookings. Microsoft anticipates commercial unearned revenues to decline 2-3%, sequentially.

Microsoft expects commercial cloud gross margin to improve on a year-over-year basis, backed by Azure margin improvement.

Productivity and Business Processes revenues are expected between $8.6 billion and $8.8 billion. Office 365 commercial and consumer growth will continue in the upcoming quarter, with growth rates consistent with second quarter. Dynamics revenues areexpected to grow double digit, driven by the ongoing shift to Dynamics 365. LinkedIn revenues are projected to be $1.2 billion, growing above 20%.

Intelligent Cloud revenues are projected between $7.55 billion and $7.75 billion, with another quarter of double-digit revenue growth across server products and cloud services. Management expects Enterprise Services revenue growth to be similar to last quarter, driven by Premier Support Services mitigatingdeclines in custom support agreements.

More Personal Computing revenues are anticipated between $9.1 billion and $9.4 billion. Windows OEM revenues should track roughly in-line with the overall PC market. Specifically, OEM Pro revenue growth should be more aligned to the commercial PC market.

Surface revenues expected to be up on a year-over-year basis, as the transition to the new Surface Pro, Surface Laptop and Surface Book 2 continues. However, the same is projected to decline sequentially. Management expects double-digit revenues growth in search ex-TAC, reflecting continued strong performance in both rate and volume.

Gaming revenues are anticipated to grow due to the launch of the Xbox One console and consistenthealthy growth of software and services revenue. Higher mix of Gaming hardware revenues will significantly impact both segment and the company’s gross margin percentages.

Microsoft expects COGS between $9 billion and $9.2 billion, in the normal range for a holiday quarter with new device launches and including 1 point of FX headwind.

Management projects operating expenses of $9.1 billion-$9.2 billion, which includes 1 point of FX headwind.

For the fiscal year 2018, Microsoft expects FX to increase revenue, COGS and operating expense growth at the company level by 1 point. Gross margin is expected to be flat year over year. Management now expects operating expense growth, including LinkedIn, to be between $36.4 billion and$36.7 billion.

Management now anticipatesoperating margin, including LinkedIn, to be slightly up year over year. Excluding LinkedIn the company expects operating margin to improve by more than a point.

Zacks Rank

Microsoft currently carriesa Zacks Rank #3 (Hold).

Some better-ranked stocks in the broader technology sector include Applied Materials, Inc. (NASDAQ:AMAT) , NVIDIA Corporation (NASDAQ:NVDA) and Vishay Intertechnology, Inc. (NYSE:VSH) , all carrying a Zacks Rank #2(Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The long-term earnings growth rate for Applied Materials, NVIDIA and Vishay are projected at 12.7%, 10.3 and 20.6% respectively.

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