Microsoft (MSFT) Q1 Earnings Top, Azure Drives Top Line

Microsoft MSFT reported first-quarter fiscal 2021 non-GAAP earnings of $1.82 per share, which beat the Zacks Consensus Estimate by 18.95%. The bottom line also surged 32% on a year-over-year basis (up 30% at constant currency or cc).

Revenues of $37.153 billion improved 12% from the year-ago quarter (up 12% at cc). Further, the top line surpassed the Zacks Consensus Estimate by 4.15%.

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 climbed 23% year over year (up 18% at cc), courtesy of consistent sales execution, and growth in big, long-term Azure contracts. Commercial remaining performance obligation came in at $107 billion, up 24% year over year (up 23% at cc). Commercial revenue annuity mix was 93%, increasing 2% year over year, driven by ongoing shift to cloud infrastructure.

Commercial cloud revenues were $15.2 billion, up 31% year over year.

Microsoft Corporation Price, Consensus and EPS Surprise

Microsoft Corporation Price, Consensus and EPS Surprise

Microsoft Corporation price-consensus-eps-surprise-chart | Microsoft Corporation Quote

Segmental Details

Productivity & Business Processes segment, which includes the Office and Dynamics CRM businesses, contributed 33% to total revenues. Revenues increased 11% (up 11% at cc) on a year-over-year basis to $12.32 billion.

Office Commercial products and cloud services revenues increased 9% (up 9% at cc) on a year-over-year basis backed by growth in Office 365 commercial revenues, which climbed 21% (up 20% at cc). The upside was driven by strong installed base growth and average revenues per user (ARPU) expansion. However, sluggishness in transactional licensing affected performance.

E5 revenue growth was driven by strength in advanced security, compliance, and voice components.

Office 365 Commercial seats improved 15%, driven by momentum in free trial conversions, growth across small and medium sized businesses and first-line worker offerings, and improving mix from Microsoft 365. Notably, Office 365 commercial accounted for more than 70% of existing Office Commercial paid installed base.

Office Consumer products and cloud services revenues improved 13% (up 13% at cc), driven by growth in Microsoft 365 subscription revenues and better than expected uptake of Office 2019. Microsoft 365 Consumer subscribers came in at 45.3 million, compared with 42.7 million reported in the prior quarter. The figure was up 27% year over year, driven by coronavirus crisis-led increased demand courtesy of work-from-home wave.

Notably, PricewaterhouseCoopers, Morgan Stanley, and Prudential Financial Insurance have selected Microsoft 365 E5, powered by differentiated security, compliance, voice, and analytics capabilities.

Dynamics business improved 19% (up 18% at cc). Dynamics 365 revenues surged 38% (37% at cc). Dynamics adoption is improving with companies like Walgreens Boots Alliance WBA, Chipotle, American Electric Power AEP, Ingram Micro, FedEx FDX, Cleveland Clinic and St. Luke’s Health Network, leveraging the application to securely digitize critical business processes.

LinkedIn revenues advanced 16% from the year-ago quarter (up 16% at cc). The better-than-expected performance was driven by growth in Marketing 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 noted that Microsoft Teams has daily active user base of 115 million.

Increasing popularity of the company's products is expected to instill confidence in the stock. Notably, shares of the company have returned 35.2% in the year-to-date period compared with the industry’s rally of 29.6%.

Microsoft currently carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Integration of Teams with Microsoft’s various inhouse offerings including PowerPoint presentations, SharePoint, Stream, Dynamics 365 makes it a winner as it makes collaboration easy and engaging, while simultaneously driving outcomes and saving time.

The company is also witnessing significant demand for Windows 10 PCs with Windows 10 monthly active devices up double digits on a year-over-year basis across commercial, consumer, and education verticals.

Intelligent Cloud segment, which includes server, and enterprise products and services, contributed 35% to total revenues. The segment reported revenues of $12.99 billion, up 20% (up 19% at cc) year over year.

Server product and cloud services revenues rallied 22% year over year (up 21% at cc). The high point was Azure's revenues, which surged 48% year over year (up 47% at cc), driven by robust growth in consumption-based business.

On-premise server products revenues declined 1%, on continued transactional weakness.

Further, enterprise mobility installed base revenues improved 27% to more than 152 million seats.

Enterprise service revenues improved 6% (up 5% at cc) in the reported quarter, on account of growth in Premier Support Services.

More Personal Computing segment, which primarily comprises Windows, Gaming, Devices and Search businesses, contributed 32% to total revenues. Revenues were up 6% (up 6% at cc) year over year to $11.85 billion, driven by work-from-home, web-based learning and online gaming trends.

Windows revenues decreased 1% owing to decline in Windows OEM, which partially offset growth in Windows Commercial. Windows commercial products and cloud services revenues increased 13% year over year (up 12% 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 decreased 5% on a year-over-year basis.

Windows OEM non-Pro revenue advanced 31%, on robust consumer PC demand driven by remote working and online learning wave.

However, Windows OEM Pro revenue declined 22%, owing to lower commercial demand.

Search advertising revenues, excluding traffic acquisition costs (TAC), declined 10% (down 11% at cc). Reduced spend on advertising by industries severely impacted by coronavirus-induced economic crisis led to the decline.

Surface revenues surged 37% (up 36% at cc) from the year-ago quarter to $1.55 billion, driven by PC market demand triggered by remote work and online learning-led demand increase, and gains from product launch timing.

Gaming revenues increased 22% (up 21% at cc) driven by increased engagement led by stay-at-home wave. Xbox content and services revenues increased 30% year over year, driven by solid growth in Xbox Game Pass subscriber base, third-party transactions and first-party titles. However, revenues from Xbox hardware declined 27%, owing to a decrease in volume of consoles sold ahead of new console launches.

Operating Results

Non-GAAP gross margin increased 15% (up 15% in cc) to $26.2 billion. This can be attributed to revenue growth across Productivity & Business Processes, Intelligent Cloud and More Personal Computing segments. Non-GAAP gross margin (in percentage terms) of 70% expanded 200 basis points (bps) on a year-over-year basis, on change in accounting estimate.

Commercial cloud gross margin was 71%, up 500 bps year over year.

Operating margin expanded 400 bps on a year-over-year basis to 43%.

Productivity & Business Process operating income grew 19% to $5.71 billion. Intelligent Cloud operating income surged 39% (up 38% at cc) to $5.42 billion. More Personal Computing operating income rallied 18% to $4.75 billion.

Balance Sheet & Free Cash Flow

As of Sep 30, 2020, Microsoft had total cash, cash equivalents, and short-term investments balance of $137.98 billion, compared with $136.53 billion as of Jun 30, 2020. As of Sep 30, 2020, long-term debt (including current portion) was $63.55 billion compared with $63.33 billion as of Jun 30, 2020.

Operating cash flow during the reported quarter was $19.3 billion compared with $18.7 billion in the previous quarter. Free cash flow during the quarter was $14.4 billion, compared with $13.9 billion reported in the prior quarter.

In the reported quarter, the company returned $9.5 billion to shareholders in the form of share repurchases and dividends.


For second-quarter fiscal 2021, Productivity and Business Processes revenues are anticipated between $12.75 billion and $13 billion,

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 and the ongoing customer shift to Office 365, is anticipated to affect growth.

Office consumer revenues are expected to grow in the mid-single digits on a year-over-year basis.

LinkedIn revenue growth is expected to be driven by recovery in advertising market and continued strong engagement on the platform. Revenues from Dynamics are projected to gain from continued Dynamics 365 momentum.

Intelligent Cloud revenues are anticipated between $13.55 billion and $13.8 billion. Azure's revenue growth is likely to reflect continued strength in the consumption-based services. However, increasing size of the enterprise mobility installed base is anticipated to limit growth in per-user business. Also, on-premises server business is anticipated to decline in low single digits as demand for hybrid and premium offerings gets impacted by continued transactional weakness.

However, in Enterprise Services business, management expects revenues to be up in low single digits.

More Personal Computing revenues are expected between $13.2 billion and $13.6 billion. In Windows commercial products and cloud services business, annuity billings are expected to witness “healthy” growth driven by solid momentum in advanced security solutions.

The company expects overall revenues from Windows to decline in the high single digit range. OEM business is anticipated to witness strong growth in OEM non-Pro. However, OEM Pro business is anticipated to be affected by the lower commercial demand.

Surface revenues are anticipated to remain flat on a year-over-year basis. Search advertising revenues, excluding TAC, are anticipated to decline “the mid to high-single digit range.”

Gaming revenues are anticipated to be up in the high 20% range year over year on solid demand following the launch of next generation Xbox Series X and S consoles, which in turn, are projected to boost hardware revenue growth of approximately 40%. Increasing investments on enhancing life-time value of the new console platforms, is anticipated to negatively impact gross margin. Xbox content and services revenue are projected to grow in the low 20% range, on strong engagement and continued uptick in GamePass subscribers. Management noted that the outlook does not include contribution from ZeniMax, which is expected to close in the second half of fiscal 2021.

Management expects COGS between $13.75 billion and $13.95 billion, and operating expenses in the range of $11.4-$11.5 billion.

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