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Why Is Microsoft (MSFT) Up 6.8% Since Last Earnings Report?

Zacks Equity Research

A month has gone by since the last earnings report for Microsoft (MSFT). Shares have added about 6.8% 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 catalysts.

Microsoft Q1 Earnings, Revenues Top Estimates, Up Y/Y

Microsoft reported first-quarter fiscal 2020 non-GAAP earnings of $1.38 per share, which beat the Zacks Consensus Estimate of $1.25 per share. The figure also surged 21% on a year-over-year basis (up 25% in constant currency or cc).

Revenues of $33.055 billion improved 14% from the year-ago quarter (up 15% in constant currency or cc). Further, the figure surpassed the Zacks Consensus Estimate of $32.233 billion.

Robust execution and better-than-expected demand from customers for hybrid cloud offerings drove the quarterly results. Moreover, strong Commercial business positively impacted top and bottom line.

Commercial bookings increased 30% (35% at cc), primarily due to robust renewal implementation and increase in the Azure contracts. Commercial unearned revenues were $31.1 billion, up 16% year over year at cc. Commercial revenue annuity mix was 91%, flat year over year.

Commercial cloud revenues were $11.6 billion, surging 36% year over year (39% at cc).

Segmental Details

Productivity & Business Processes includes the Office and Dynamics CRM businesses. Revenues increased 13% (up 15% at cc) on a year-over-year basis to $11.1 billion.

The Commercial business (products + Office 365 & related cloud services) revenues were up 13% from the year-ago level (up 15% at cc). Office 365 commercial revenues climbed 25% (28% at cc), driven by strong installed base growth and average revenues per user (ARPU) expansion. Office 365 Commercial seat improved 21% on a year-over-year basis.

Office Consumer products and cloud services revenues increased 5% (up 6% at cc). Office 365 Consumer subscribers came in at 35.6 million during the reported quarter.

Dynamics business grew 14% (up 16% at cc). Dynamics 365 revenues surged 41% (44% at cc). Dynamics adoption is improving with companies like H&M selecting the application to digitize critical business processes.

LinkedIn revenues advanced 25% from the year-ago quarter (up 26% at cc). LinkedIn sessions were up 22%, reflecting acceleration in engagement.

Microsoft is benefiting from growing user base of different applications like Microsoft 365 and Teams. Both solutions continue to witness strong adoption.

Intelligent Cloud includes server, and enterprise products and services. The segment reported revenues of $10.8 billion, up 27% (up 29% at cc) year over year.

Server product and cloud services revenues rallied 30% year over year (up 33% at cc). The high point was Azure's revenues, which surged 59% year over year (up 63% at cc).

The company added many new capabilities to Azure, with focus on existing workloads like security and new workloads like IoT and Edge AI.

On-premise server products revenues increased 12% (up 14% at cc), driven by customer demand for hybrid solutions, premium server versions and GitHub inclusion. Further, robust demand from end of support for SQL and Windows server 2008 were positives.

Further, enterprise mobility installed base revenues improved 36% to more than $120 million seats.

Moreover, enterprise service revenues increased 7% (up 8% at cc) in the reported quarter, on account of growth in premier support services.

More Personal Computing primarily comprises Windows, Gaming, Devices and Search businesses. Revenues were up 4% (up 5% at cc) year over year to $11.1 billion.

Windows OEM pro revenues increased 19% on a year-over-year basis, primarily due to better-than-expected Windows 10 demand and growth in Windows 7 end of support. Moreover, inventory levels ended the reported quarter above the normal range.

However, Windows OEM non-Pro revenues declined 7% year over year, primarily owing to weakness in the entry-level category. Nevertheless, windows commercial products and cloud services revenues increased 26% year over year (up 29% at cc), on the back of higher customer adoption of the company’s premium offerings and multi-year agreement that led to higher mix of revenue recognition.

Gaming revenues declined 7% (6% at cc), due to lower-than-expected sales volume from console.

Xbox content and services revenues remained flat (up 1% at cc) year over year.

The company is consistently integrating cloud capabilities of Azure into its gaming segment, which is facilitating it in enhancing gaming strategies and improving content.

Surface revenues decreased 4% (up 2% at cc) from the year-ago quarter, thanks to transition of product lifecycle.

Search advertising revenues, excluding traffic acquisition costs (TAC), grew 11% (up 13% at cc) on account of Bing rate growth.

Operating Results

Microsoft’s gross margin of 69% expanded 300 bps on a year over year, driven by higher cloud margins and favorable sales mix.

Productivity & Business Process gross margin increased 2 points year over year primarily due to improvements in LinkedIn and Office 365 margin expansion, which more than offset unfavorable cloud mix.

Moreover, Intelligent Cloud segment gross margin was up marginally year over year, due to favorable mix of cloud offering offset by material improvement in Azure gross margin.

More Personal Computing gross margin increased 4 points year over year on account of favorable sales mix.

Commercial cloud gross margin was 66%, up 4 percentage points year over year, due to improvement in Azure gross margin.

Operating expenses of $10 billion were up almost 8% from the year-ago quarter (up 9% at cc) on the back of higher investments in cloud and AI engineering, LinkedIn and GitHub.

Operating margin expanded 400 bps on a year-over-year basis to 38%.

Productivity & Business Process operating income grew 23% (up 27% at cc). Intelligent Cloud operating income surged 33% (up 38% at cc). More Personal Computing operating income rallied 28% (up 31% at cc).

Balance Sheet & Free Cash Flow

Microsoft ended with cash and short-term investments balance of $136.6 billion, up from $133.8 billion from the previous quarter. Long-term debt (including current portion) came in at 69.5 billion compared with $72.2 billion from the previous quarter.

Operating cash flow during the reported quarter came in at $13.8 billion compared with $16.1 billion reported in the previous quarter. Free cash flow during the quarter came in at $10.4 billion, down from $12 billion reported in the prior quarter.

In the reported quarter, the company returned $7.9 billion to shareholders in the form of share repurchases and dividends.

Guidance

For second-quarter fiscal 2020, Productivity and Business Processes revenues are anticipated between $11.3 billion and $11.5 billion, driven by double-digit growth in Dynamics, Office commercial and LinkedIn.

Intelligent Cloud revenues (including GitHub) are anticipated between $11.25 billion and $11.45 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 $12.6 billion and $13 billion. The company expects OEM revenues to grow sequentially backed by robust commercial demand. Surface revenue is anticipated to improve slightly year over year due to launch of the latest Surface Pro and Surface laptop device. Search advertising revenues, excluding TAC is expected to be in line on a sequential basis.

Gaming revenue is anticipated to be down year over year, thanks to declining console sales.

Management expects COGS between $12.45 billion and $12.65 billion, and operating expenses between $10.8 billion and $10.9 billion.

For fiscal 2020, management expects operating expenses to increase 11-12% on a year-over-year basis.

How Have Estimates Been Moving Since Then?

In the past month, investors have witnessed an upward trend in estimates revision.

VGM Scores

Currently, Microsoft has an average Growth Score of C, however its Momentum Score is doing a bit better with a B. Charting a somewhat similar path, the stock was allocated a grade of C on the value side, putting it in the middle 20% for this investment strategy.

Overall, the stock has an aggregate VGM Score of C. 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. It comes with little surprise Microsoft has a Zacks Rank #2 (Buy). We expect an above average return from the stock in the next few months.



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