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Why Is Microsoft (MSFT) Down 0.2% Since Last Earnings Report?

Zacks Equity Research

It has been about a month since the last earnings report for Microsoft (MSFT). Shares have lost about 0.2% in that time frame, outperforming the S&P 500.

Will the recent negative trend continue leading up to its next earnings release, or is Microsoft due for a breakout? 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 & Revenues Beats Estimates, Up Y/Y

Microsoft delivered fourth-quarter fiscal 2019 non-GAAP earnings of $1.37 per share, which beat the Zacks Consensus Estimate of $1.21 per share. The figure surged 21% on a year-over-year basis (up 24% in constant currency or cc).

Revenues of $33.72 billion increased 12% from the year-ago quarter (up 14% in constant currency or cc). The figure also surpassed the Zacks Consensus Estimate of $32.73 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 22% (25% at cc), primarily due to robust renewal implementation and increase in the Azure contracts.Commercial unearned revenues were $34.1 billion, up 16% year over year at cc. Commercial revenue annuity mix was 90%, flat year over year.

Commercial cloud revenues were $11 billion, surging 39% year over year (42% at cc).

Segmental Details

Productivity & Business Processes includes the Office and Dynamics CRM businesses. Revenues increased 14% (up 17% at cc) on a year-over-year basis to $11 billion.

The Commercial business (products + Office 365 & related cloud services) revenues were up 14% from the year-ago level (up 16% at cc). Office 365 commercial revenues grew 31% (34% at cc), driven by strong installed base growth and average revenues per user (ARPU) expansion. Office 365 Commercial seat improved 23% on a year-over-year basis.

Office Consumer products and cloud services revenues increased 8% (up 10% at cc). Office 365 Consumer subscribers came in at 34.8 million during the reported quarter.

Dynamics business grew 12% (up 15% at cc). Dynamics 365 revenues surged 45% (48% at cc). Dynamics adoption is improving with companies like H&M selecting the application to digitize its critical business processes.

LinkedIn revenues advanced 25% from the year-ago quarter (up 28% at cc). LinkedIn sessions were up 22%, reflecting acceleration in engagement.

Microsoft is benefiting from growing user base of its different applications like Microsoft 365 and Teams. Both solutions continue to witness strong adoption. Microsoft 365 has been chosen by the likes of L'Oreal, Walgreens, BASF, CenturyLink and KPMG in recent times

The company recently also announced a slew of partner updates and enhancements to its Teams, Azure and Dynamics 365. Management remains elated that Teams registered daily active user count of 13 million and weekly active users of around 19 million.

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. The features are anticipated to aid Microsoft in upping the game against Splunk, Cisco’s Webex Teams, among others, in collaborative platforms domain.

Moreover, Microsoft updated Dynamics 365 Nonprofit Accelerator, announced two latest integrations for Dynamics 365 pertaining to financial services and automotive sectors. The enhancements are likely to favor adoption of Dynamics 365, which remains a positive.

Intelligent Cloud includes server, and enterprise products and services. The segment reported revenues of $11.4 billion, up 192% (up 21% at cc) year over year.

Server product and cloud services revenues rallied 22% year over year (up 24% at cc). The high point was Azure's revenues, which soared 64% year over year (up 68% 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. Microsoft and AT&T Inc.’s business segment, AT&T Communications, recently announced multi-year technology collaboration.

Under this new strategic alliance, the companies will accelerate innovation and apply cutting-edge technologies that include 5G, cloud and AI to transform every aspect of work and life.

Microsoft also announced availability of Azure Kinect DK (or developer kit), which was unveiled around February, at Mobile World Congress (MWC), held in Barcelona. With Azure Kinect DK, Microsoft is raising its stakes against cloud rivals Amazon's Amazon Web Services (AWS), Alphabet’s Google cloud platform, among others.

Further, Microsoft and Sony recently signed a memorandum of understanding (MoU). Per the deal, the companies will explore the utility of Azure cloud computing capabilities to provide immersive gaming experience to the end user.

On-premise server products revenues increased 5% (up 7% 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 increased 413% to more than $1160 million seats.

Moreover, enterprise service revenues increased 4% (up 6% 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 6% at cc) year over year to $11.3 billion.

Windows OEM pro revenues increased 18% 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 quarter above the normal range.

However, Windows OEM non-Pro revenues decreased 8% year over year, primarily owing to weakness in the entry-level category. Nevertheless, windows commercial products and cloud services revenues increased 13% year over year (up 16% 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 10% (8% at cc) and came in at $2.1 billion, due to lower-than-expected sales volume from console and “monetization across third party titles.”

Xbox software and services revenues declined 3% (down 1% at cc) year over year. Xbox hardware revenues slumped 48% (down 47% at cc) year over year.

However, Xbox live monthly active users came in at $65 million, up 14% year over year.

Recently, Microsoft made a slew of announcements at the E3 2019. The company showcased a plethora of new games, comprising 11 world premieres and 14 from Xbox Game Studios as part of Xbox Briefing.

Moreover, the company upped the ante in console gaming with Project Scarlett which is scheduled for a holiday 2020 release. The upcoming console is equipped with AMD processor, “high bandwidth GDDR6 memory” and a robust solid state drive (SSD). Project Scarlett is aimed at making gaming more immersive.

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

Further, with Microsoft’s Game Stack, developers can access Microsoft’s cloud computing platform Azure, and game development tools including PlayFab, Visual Studio, DirectX, Xbox Live, Havok and App Center. Notably, the company anticipates developers to choose Azure as the preferred cloud partner, although it is not a compulsion.

Surface revenues increased 14% (up 17% at cc) from the year-ago quarter, driven by strong performance of the latest editions. Further, robust growth across commercial, especially in United States, Japan, and Canada aided the year-over-year increase.

Microsoft recently also announced its plan to introduce Surface Go tablet. The new Surface Go features a 10-inch screen and weighs 1.15 pounds, lighter than its prevailing Surface counterparts. The latest series is equipped with Intel’s processor and graphic chips.

Additionally, bundling new Surface devices sales with Office 365 is a smart move and is anticipated to bolster Office 365 adoption. The move is in sync with the company’s attempt to take on Apple’s budget iPads,and Alphabet’s lower-priced Chromebook.

Search advertising revenues, excluding traffic acquisition costs (TAC), grew 9% (up 10% at cc) as both search volume and revenues per search (RPS) improved.

Operating Results

Micosoft’s gross margin of 69% expanded 200 bps on a year over year, driven by higher cloud margins and favorable sales mix. Notably, gross margin includes 6 percentage point expansion primarily driven by Azure.

Productivity & Business Process gross margin increased 1 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 flat year over year, due to favorable mix of cloud offering offset by material improvement in Azure gross margin.

More Personal Computing gross margin increased 2 points year over year on account of favorable sales mix.

Commercial cloud gross margin was 65%, up 6 percentage points year over year, due to improvement in Azure gross margin.

Operating expenses of $10.9 billion were up almost 9% from the year-ago quarter on the back of higher investments in cloud and AI engineering, LinkedIn and GitHub.

Productivity & Business Process operating expenses increased 8% (up 9% at cc) on account of aggressive investments in LinkedIn and cloud engineering.

Intelligent Cloud operating expenses increased 23% (up 24% at cc), driven by on-going investments in cloud, AI engineering, GitHub and commercial sales capacity expansion initiatives.

More Personal Computing operating expenses decreased 2% (down 1% at cc).

Operating margin expanded 200 bps on a year-over-year basis to 37%.

Productivity & Business Process operating income grew 25% (up 31% at cc). Intelligent Cloud operating income surged 15% (up 19% at cc). More Personal Computing operating income rallied 18% (up 22% at cc).

Balance Sheet & Free Cash Flow

Microsoft ended with cash and short-term investments balance of $133.8 billion, up from $131.6 billion from the previous quarter. Long-term debt (including current portion) came in at 72.2 billion compared with $73.1 billion from the previous quarter.

Operating cash flow during the reported quarter came in at $16.1 billion compared with $13.5 billion reported in the previous quarter. Free cash flow during the quarter came in at $12 billion, up from $10.95 billion reported in the previous quarter.

In the reported quarter, the company returned $7.7 billion to shareholders in the form of share repurchases and dividends.

Fiscal 2019 Highlights

Microsoft reported fiscal 2019 revenues of $125.8 billion increased 14% year over year. Non-GAAP earnings came in at $4.75 per share, which surged 22% on a year over year.

Guidance

For the first quarter of fiscal 2020, commercial unearned revenues are expected to increase 11-12% year over year, while commercial cloud gross margin is expected to improve at a moderate pace, sequentially.

Productivity and Business Processes revenues are expected between $10.7 billion and $10.9 billion, driven by double-digit growth in Dynamics, Office commercial and LinkedIn.

Intelligent Cloud revenues (including GitHub) are anticipated between $10.3 billion and $10.5 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 $10.7 billion and $11 billion. The company expects OEM revenues to grow sequentially owing to robust commercial demand. Surface revenue is anticipated to decline marginally year over year due to transitions in product lifecycle. 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, owing to unfavorable hardware trends and declining console sales.

Management expects COGS between $10.55 billion and $10.75 billion, and operating expenses between $10.1 billion and $10.2 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 fresh estimates. The consensus estimate has shifted 5% due to these changes.

VGM Scores

At this time, Microsoft has a great 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. 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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