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Microsoft (MSFT) Q2 Earnings Beat, Azure & Gaming Aid Top Line

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Microsoft (MSFT - Free Report) reported second-quarter fiscal 2021 non-GAAP earnings of $2.03 per share, which beat the Zacks Consensus Estimate by 23.8%. The bottom line also surged 34% on a year-over-year basis (up 31% at constant currency or cc).

Revenues of $43.076 billion improved 17% from the year-ago quarter (up 15% at cc). Further, the top line surpassed the Zacks Consensus Estimate by 7.36%.

Shares of the company are up more than 2% in the pre-market trading on Jan 27 following encouraging results.

Robust execution and better-than-expected demand trends across industries, and improving uptake of 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 on digital transformation wave positively impacted earnings and revenues. Commercial bookings climbed 19% year over year (up 11% at cc), courtesy of consistent sales execution, and growth in Azure contracts and Microsoft 365 momentum. Commercial remaining performance obligation amounted to $112 billion, up 24% year over year (up 22% at cc). Commercial revenue annuity mix was 93%, increasing 4% year over year, driven by ongoing shift to cloud infrastructure.

Commercial cloud revenues were $16.7 billion, up 34% (up 32% at cc) 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 29% to total revenues. Revenues increased 13% (up 11% at cc) on a year-over-year basis to $13.353 billion.

Office Commercial products and cloud services revenues climbed 11% (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 can be attributed to strong installed base growth and average revenues per user (ARPU) expansion.

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.

Office Consumer products and cloud services revenues improved 7% (up 6% at cc), driven by growth in Microsoft 365 subscription revenues. Microsoft 365 Consumer subscribers totaled 47.5 million, compared with 45.3 million reported in the prior quarter. The figure was up 28% year over year, driven by coronavirus crisis-led increased demand courtesy of work-from-home wave.

Notably, AT&T (T - Free Report) , Amgen (AMGN - Free Report) , Daimler, GSK, and IKEA have selected Microsoft 365 E5, powered by differentiated security, compliance, voice, and analytics capabilities.

Dynamics products and cloud services business improved 21% (up 18% at cc). Dynamics 365 revenues surged 39% (37% at cc). Dynamics adoption is improving with companies like Walgreens Boots Alliance (WBA - Free Report) , Chipotle, American Electric Power, Ingram Micro, FedEx, Cleveland Clinic and St. Luke’s Health Network, leveraging the application to securely digitize critical business processes.

LinkedIn revenues advanced 23% from the year-ago quarter (up 22% at cc). The better-than-expected performance was driven by advertising demand 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 60 million on mobile alone. Also, 117 organizations have more than 100,000 users of Teams, and over 2,700 organizations have over 10,000 deployments of Teams.

Increasing popularity of the company's products is expected to instill confidence in the stock. Notably, shares of the company have returned 40.4% in the past year compared with the industry’s rally of 33.7%.

Microsoft currently carries a Zacks Rank #3 (Hold). 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.

Intelligent Cloud segment, which includes server, and enterprise products and services, contributed 32% to total revenues. The segment reported revenues of $14.601 billion, up 23% (up 22% at cc) year over year.

Server product and cloud services revenues rallied 26% year over year (up 24% at cc). The high point was Azure's revenues, which surged 50% year over year (up 48% at cc), driven by robust growth in consumption-based business and recovery across industries.

On-premise server products revenues improved 4% (up 3% at cc), on strong annuity performance driven by continued demand for hybrid and premium offerings.

Further, enterprise mobility installed base revenues improved 29% to more than 163 million seats.

Enterprise service revenues improved 5% (up 4% 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 39% to total revenues. Revenues were up 14% (up 13% at cc) year over year to $15.122 billion, driven by work-from-home, web-based learning and online gaming trends.

Windows commercial products and cloud services revenues increased 10% year over year (up 8% at cc), on the back of higher customer adoption of Microsoft 365 offerings and robust improvement in advanced security solutions.

Windows OEM revenues increased 1% (up 1% at cc) on a year-over-year basis.

Windows OEM non-Pro revenues advanced 24%, on robust consumer PC demand driven by remote working and online learning wave.

However, Windows OEM Pro revenue declined 9%.

Search advertising revenues, excluding traffic acquisition costs (TAC), improved 2% (up 1% at cc) on improving advertising market.

Surface revenues improved 3% (up 1% at cc) from the year-ago quarter to $2.045 billion.

Gaming revenues increased a whopping 51% (up 50% at cc) driven by increased engagement led by stay-at-home wave. Revenues from Xbox hardware grew 86%, driven by the new console launch, and gains from lower price promotions on the company’s prior-generation consoles. Moreover, Xbox content and services revenues increased 40% year over year (up 38% at cc), driven by solid growth in Xbox Game Pass subscriber base, third-party transactions and first-party titles.

Operating Results

Non-GAAP gross margin increased 18% (up 16% in cc) to $28.88 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 67% expanded 200 basis points (bps) on a year-over-year basis, on change in accounting estimate.

Commercial cloud gross margin was 71%, up 400 bps year over year, driven by sales mix shift to Azure, increasing customer utilization of the company’s productivity and collaboration solutions, and momentum in strategic investments.

Operating margin expanded 400 bps on a year-over-year basis to 42%.

Productivity & Business Process operating income grew 19% (up 17% at cc) to $6.18 billion. Intelligent Cloud operating income surged 43% (up 41% at cc) to $6.49 billion.

More Personal Computing operating income rallied 11% (up 9% at cc) to $5.22 billion. Gross margin (as a percentage of segment income) contracted 200 bps on a year-over-year basis, as sales mix moved to Gaming.

Balance Sheet & Free Cash Flow

As of Dec 31, 2020, Microsoft had total cash, cash equivalents, and short-term investments balance of $137.98 billion, compared with $131.97 billion as of Sep 30, 2020. As of Dec 31, 2020, long-term debt (including current portion) was $60.52 billion compared with $63.55 billion as of Sep 30, 2020.

Operating cash flow during the reported quarter was $12.5 billion compared with $19.3 billion in the previous quarter. Free cash flow during the quarter was $8.5 billion, compared with $14.4 billion in the prior quarter.

In the reported quarter, the company returned $10 billion to shareholders in the form of share repurchases and dividends.


For third-quarter fiscal 2021, Productivity and Business Processes revenues are anticipated between $13.35 billion and $13.6 billion.

Strong upsell opportunity for Microsoft E5 and momentum in Office 365 is expected to drive growth in Office commercial. However, on-premises business is anticipated to decline in the mid to high-teens range, on account of the ongoing customer shift to Office 365, despite projected improvement in transactional business.

Office consumer revenues are expected to gain from continued growth in Microsoft 365 subscription revenues.

LinkedIn revenue growth is anticipated to be driven by continued strong engagement on the platform. Revenues from Dynamics are projected to gain from continued Dynamics 365 momentum.

Intelligent Cloud revenues are anticipated between $14.7 billion and $14.95 billion. Azure's revenue growth is likely to reflect continued strength in the consumption-based services. Further, gains from Microsoft 365 suite momentum is expected to boost growth in per-user business. Also, on-premises server business is projected to grow in the low to mid-single digits range driven by continued demand for hybrid and premium offerings.

However, in Enterprise Services business, management expects revenues to be in line, on a sequential basis.

More Personal Computing revenues are expected between $12.3 billion and $12.7 billion. In Windows commercial products and cloud services business, growth is anticipated in the low to mid-teens driven by solid momentum in Microsoft 365 and advanced security solutions. The company expects overall Windows OEM revenues to grow in the low-single digits range.

Surface revenues are anticipated to improve in the mid to high-teens range on a year-over-year basis. Search advertising revenues, excluding TAC, are anticipated to grow on improving advertising market.

Gaming revenues are anticipated to be up 40% year over year on solid demand of the next generation Xbox Series X and S consoles. Xbox content and services revenue are projected to grow in the mid-20% range. 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 $13.1 billion and $13.3 billion, and operating expenses in the range of $11.9 billion to $12 billion.

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