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Microsoft (MSFT) Beats on Q1 Earnings, Azure Aids Top Line

Microsoft CorporationMSFT reported first-quarter fiscal 2019 earnings of $1.14 per share, which beat the Zacks Consensus Estimate by 18 cents. The figure jumped 35.7% on a year-over-year basis.

Revenues of $29.08 billion increased 18.5% from the year-ago quarter (up 18% in constant currency or cc). Further, the figure exceeded the Zacks Consensus Estimate of $27.73 billion.

Commercial bookings increased 15% (16% at cc). Commercial unearned revenues were $27.3 billion, up 21% year over year at cc. Commercial revenue annuity mix was 90%, up 1 point year over year.

Commercial cloud revenues were $8.5 billion, up 47% year over year (46% at cc), reflecting solid growth in the United States, Western Europe and the United Kingdom.

Shares were up 3.2% in pre-market trading . Microsoft shares have returned 19.6% year to date, substantially outperforming the 14% rally of the industry .

Azure, Office 365 & Dynamics Drive Growth

Productivity & Business Processes includes the Office and Dynamics CRM businesses. Revenues increased 18.6% (up 18% at cc) on a year-over-year basis to $9.77 billion.

The Commercial business (products + Office 365 & related cloud services) revenues were up 17% from the year-ago level (up 16% at cc). Office 365 commercial revenues grew 36% (35% at cc), driven by strong installed base growth and average revenues per user (ARPU) expansion. Office 365 Commercial seat grew 29% on a year-over-year basis.

The Consumer business revenues advanced 16% (up 17% at cc) year over year in the quarter. Office 365 consumer subscribers are now at 32.5 million, up from 31.4 million at the end of the last reported quarter.

Microsoft Corporation Price, Consensus and EPS Surprise

Microsoft Corporation Price, Consensus and EPS Surprise | Microsoft Corporation Quote

Dynamics business grew 20% (same at cc). Dynamics 365 revenues soared 51% (49% at cc). Dynamics adoption is improving, with companies like H&M selecting the application to digitize its critical business processes. The newly launched Dynamics 365 AI is expected to drive growth. Moreover, Dynamics 365 Mixed Reality is already gaining rapid traction and has been selected by the likes of Chevron and ZF Group.

LinkedIn revenues surged 33% from the year-ago quarter (same at cc) to $1.46 billion. LinkedIn sessions were up 34%, reflecting acceleration in engagement.

Microsoft is benefiting from growing user base of its different applications like Microsoft 365 and Teams. Both solutions continue to gain strong adoption. Microsoft 365 has been chosen by the likes of Eli Lilly and Company in recent times. Microsoft Teams is now used by roughly 329,000 organizations, including 87 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 infused 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.

Moreover, Microsoft is well-poised to gain on strong growth in no-code app building and business analytics in the cloud, driven by the company's investments in Power BI, Power Apps and Flow. The Open Data Initiative, which is a partnership between Microsoft, Adobe ADBE and SAP SE SAP , is further expected to strengthen the company's dominant position further.

Intelligent Cloud includes server as well as enterprise products and services. The segment reported revenues of $8.57 billion, up 23.8% (same at cc) year over year.

Server product and cloud services revenues rallied 28% year over year (up 28% at cc). The high point was Azure's revenues, which soared 76% at cc on a year-over-year basis.

The company added almost 100 new capabilities to Azure in the last quarter, 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, Anheuser-Busch In Bev and Mastercard MA selecting the cloud platform.

On-premise server products revenues increased 10% (up 9% at cc), driven by customer demand for hybrid solutions as well as premium server versions.

Moreover, enterprise service revenues increased 6% (same at cc) in the reported quarter, owing to growth in premier support services and Microsoft consulting services.

More Personal Computing comprises mainly the Windows, Gaming, Devices and Search businesses. Revenues were up 14.6% (same at cc) year over year to $10.75 billion.

Windows OEM pro revenues increased 8% on a year-over-year basis. Windows OEM revenues increased 3% (same at cc). Moreover, windows commercial products and cloud services revenues increased 12% year over year (same at cc), driven by higher volume of multi-year agreements.

Gaming revenues jumped 44% (45% at cc), driven by robust performance from Xbox software and services (up 36% at cc) due to third-party title strength. Xbox hardware revenues jumped 94% (96% at cc).

Surface revenues increased 14% (same at cc) from the year-ago quarter, driven by strong performance of the latest editions - Surface Book 2 and Surface Go.

Search advertising revenues, excluding traffic acquisition costs (TAC), grew 17% (same at cc) as both search volume and revenues per search (RPS) improved.

Operating Results

Microsoft's gross margin of 66% contracted slightly from the year-ago quarter, due to 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 increased year over year, driven by solid improvement in Azure's gross margin.

More Personal Computing gross margin also contracted year over year due to unfavorable sales mix.

Commercial cloud gross margin was 62%, up 4 percentage points year over year, owing to improvement in Azure gross margin.

Operating expenses of $9.22 billion were up almost 8% (up 8% at cc) from the year-ago quarter due to higher investments in commercial sales capacity, cloud engineering and LinkedIn.

Productivity & Business Process operating expenses increased 7% (up 8% at cc) due to aggressive investments in LinkedIn, cloud engineering and commercial sales capacity to support top-line growth.

Intelligent Cloud operating expenses increased 19% (up 20% at cc), driven by on-going investments in cloud, AI engineering and commercial sales capacity expansion initiatives.

More Personal Computing operating expenses declined 1% year over year.

Operating margin expanded 280 bps on a year-over-year basis to 34.2%.

Productivity & Business Process operating income grew 29.1% (up 27% at cc). Intelligent Cloud operating income soared 37.2% (up 30% at cc). More Personal Computing operating income rallied 22.5% (up 32% at cc).

LinkedIn operating income, excluding amortization of intangible assets, were $196 million compared with $18 million reported in the year-ago quarter.

Balance Sheet & Free Cash Flow

Microsoft ended with cash and short-term investments balance of $133.8 billion, down $4.7 billion from the previous quarter.

Free cash flow decreased 2% year over year to $10.1 billion but increased from $7.4 billion reported in the previous quarter.

In the reported quarter, the company returned $6.1 billion to shareholders in the form of share repurchases and dividends.

Guidance

For fiscal 2019, Microsoft expects foreign exchange to negatively impact revenues by 1 point. Moreover, volatility in foreign exchange is expected to hurt cost of goods sold (COGS) and operating expense growth by almost 1 point.

Microsoft expects Dynamics to deliver revenues of more than $2.5 billion in fiscal 2019. Half of that is expected to come from Dynamics 365.

Operating expenses for fiscal 2019 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.

For the second quarter of fiscal 2019, commercial unearned revenues are expected to grow 19% year over year, while commercial cloud gross margin is expected to improve at a moderate pace.

Productivity and Business Processes revenues are expected between $9.95 billion and $10.15 billion, driven by double-digit growth in Office commercial and Dynamics. Office is expected to see continued momentum in new subscriber growth.

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 as well as per-user based services.

More Personal Computing revenues are expected between $12.8 billion and $13.2 billion. OEM Pro revenues are expected to grow in line with the commercial PC market. Surface revenues are expected to grow faster benefiting from recently launched devices, including Surface Pro 6 and Surface Laptop 2.

Gaming revenue growth rate is expected to be moderate in the current quarter.

Management expects COGS between $12.2 billion and $12.4 billion and operating expenses between $9.8 billion and $9.9 billion.

Moreover, capital expenditures are expected to grow on a year-over-year basis but remain almost flat sequentially.

Zacks Rank

Microsoft currently sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today's Zacks #1 Rank stocks here .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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