Microsoft Corporation MSFT reported second-quarter fiscal 2017 earnings (adjusted for Windows 10 deferrals and currency effect) of 83 cents per share, which comfortably surpassed the Zacks Consensus Estimate of 79 cents. Earnings per share (EPS) increased 9.2% on both year-over-year and sequential basis. Revenues (adjusted for Windows 10 deferrals) of $26.07 billion increased 16.7% sequentially and inched up 2.2% from the year-ago quarter (up 4% in constant currency or CC). Further, it exceeded the Zacks Consensus Estimate of $21.54 billion. Encouragingly, annuity-based revenue continued to grow indicating that the user base continues to migrate to the cloud. We note that strong cloud growth has helped Microsoft to outperform the Zacks Computer Software industry in the last six-months. While the company has gained 14.8%, the industry has returned 8.2% over the same period. Commercial cloud annualized revenue run rate now exceeds $14 billion, and Microsoft remains on track to achieve its goal of $20 billion in fiscal 2018. Segment Details Productivity & Business Processes includes the Office and Dynamics CRM businesses. Revenues increased 10.9% sequentially and 10.3% (up 12% CC) on a year-over-year basis to $7.38 billion. The Commercial business (products + Office 365 & related cloud services) revenue was up 5% from year-ago level (up 7% CC). Office 365 commercial revenue grew 47% (up 49% CC). Office 365 saw commercial seat growth of 37% from the year-ago quarter. During the quarter, the company launched Microsoft Teams, a new chat-based workspace for Office 365. The company also noted that the integration of SharePoint with PowerApps and Microsoft Flow has improved adoption as evident from the fact that almost half a million people are now using these apps (PowerApps or Microsoft Flow) after just eight weeks of availability. Based on the improving features and capabilities of Office 365, the company is winning customers like Willis Towers Watson, TD Bank, AXA, Partners Healthcare, University of Pittsburgh Medical Center and AstraZeneca AZN across the financial services and healthcare markets. The Consumer business revenue grew 22% (21% CC) year over year in the quarter. Office 365 consumer subscriptions are now at 24.9 million, up from 24 million in the previous quarter. Dynamics and cloud services revenue jumped 7% (9% CC). Management noted that more than 80% of new Dynamics enterprise customers are choosing Dynamics 365. Dynamics 365 paid seats more than doubled in the reported quarter. Intelligent Cloud includes server, and enterprise products and services. The segment reported revenues of $6.86 billion, which was up 7.5% sequentially and 8.2% (up 10% in CC) year over year. Server product and cloud services revenue went up 12% year over year (up 14% CC). Annuity revenue grew double digits. The high point was Azure revenue, which soared 95% at CC year over year, with Azure compute usage doubling in the reported quarter. We believe that Microsoft’s strategy of expanding its offerings to the open source community will further drive cloud adoption. During the quarter, the company joined the Linux Foundation and announced a new Azure partnership with Open AI. Enterprise Service revenue decreased 4% (down 2% CC) in the reported quarter. More Personal Computing comprises mainly the Windows, Gaming, Devices and Search businesses revenues surged 27.2% sequentially but slipped 5.2% (1% CC) year over year to $11.82 billion. Windows OEM pro revenue increased 6% year over year, while non pro-revenue increased 5%. Windows commercial products and cloud services revenue increased 5% on a year-over-year basis (up 6% in CC) backed by annuity revenue. Management stated that enterprise and education deployments increased 52% in the quarter as Windows 10 was selected by the likes of Accenture, Broward County School District and United Healthcare Group. Microsoft expects strong Windows 10 adoption to continue based on partnerships with Dell, HP, Lenovo and Acer. The company’s collaboration with chip-makers Intel ( INTC Quick Quote INTC - Free Report) and Qualcomm QCOM to develop next-generation Window-based PCs is expected to further drive growth in the long run. Gaming revenue dipped 1% in CC. Xbox Live monthly active users were up 17% to 55 million. The company witnessed more than 26 billion hours of gameplay on Windows 10 PCs and tablets. Surface revenue decreased 2.3% from the year-ago quarter but surged 42.7% sequentially to $1.32 billion. Search excluding traffic acquisition costs (TAC) revenue grew 10% (11% CC) as both search volume and revenue per search (RPS) improved. Operating Results Microsoft’s gross margin of 58.9% contracted 270 basis points (bps) sequentially but expanded 40 bps from the year-ago quarter. In dollar-terms, gross profit increased 12.5% sequentially and 1.9% year over year to $14.19 billion. The growth in gross profit dollars by segment was as follows: Productivity up 2% CC (increased mix of cloud offerings and investments in cloud were drivers), Intelligent Cloud 4% CC (again a result of increased mix of cloud offerings) and More Personal Computing 1% CC (search and Windows OEM were drivers neutralized by phones and Xbox). Operating expenses (excluding Impairment, integration, and restructuring costs) of $8.01 billion were up 8.5% sequentially and 1.4% from the year-ago quarter. However, as percentage of revenues, operating expenses decreased 280 bps sequentially but increased 10 bps on a year-over-year basis. As a result, operating margin expanded 10 bps sequentially and 30 bps on a year-over-year basis to 25.6%. The operating margin by segment was as follows: Productivity 44.1% (down 280 bps sequentially and 510 bps year over year); Intelligent Cloud 35% (up 270 bps sequentially but down 550 bps year over year) and More Personal Computing 21.1% (up 40 bps sequentially and 610 bps year over year). Balance Sheet Microsoft ended with cash and short term investments balance of $136.9 billion, up $23.69 billion during the quarter. The net cash position was around $62.24 billion ($7.90 a share), up from $59.55 billion ($7.58 a share) at the beginning of the quarter. Microsoft returned $6.5 billion to shareholders in the form of share repurchases and dividends in the reported quarter. Acquisitions and Divestitures Microsoft completed the acquisition of LinkedIn on Dec 8, 2016. Financial results from the acquired business are reported in the Productivity and Business Processes segment. LinkedIn contributed revenues of $228 million in the quarter but hurt EPS by a penny. The company completed the sale of its feature phone business in Nov, 2016. Guidance Management expects foreign exchange to remain a headwind for the rest of 2017. The company now expects currency to impact revenues by 1% in the third-quarter and 2% in the fourth quarter. Microsoft expects commercial cloud services to continue to drive annuity growth, on the back of expanding installed base, growing consumption and higher number of renewals. Management forecasts commercial unearned revenue of $20.2 to $20.4 billion, in line with historical seasonality. For the third quarter, Microsoft expects Productivity & Business Process revenues of $7.65–$7.85 billion (2% impact from currency), Intelligent Cloud revenues of $6.45–$6.65 billion (2% impact from currency) and More Personal Computing revenue of around $9.05–$9.35 billion (1% impact from currency). LinkedIn is expected to contribute revenues of almost $950 million in the quarter. Microsoft expects COGS of $8.35–$8.45 billion and operating expenses of $8.5–$8.6 billion. Management said that fiscal 2017 operating expenses would be $33.1–$33.3 billion (up from $31.1–$31.4 billion) as investments in strategic growth opportunities continue. Capital expenditure is anticipated to grow sequentially. However, for fiscal 2017 management expects capital expenditure to grow at a lower rate than 2016. Zacks Rank Microsoft currently carries a Zacks Rank #2 (Buy). You can see . the complete list of today’s Zacks #1 (Strong Buy) Rank stocks here The Best Place to Start Your Stock Search
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