I Wanted an Excuse to Bail on Microsoft. Then Earnings Landed.
I've been in the shares for a long time, and they've been good to me. So should I take profits and run, or is this report a reason to stick around?
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Really? Did Microsoft (MSFT) really disappoint? The stock is down a couple of percentage points overnight. Alphabet (GOOGL) is up roughly 8%. I am long both. It might have been nice to take a victory lap and write about Alphabet's quarter. That would do nothing though to help the readers who may be trying to figure out if Microsoft has a problem or if they should act on Microsoft. That said, we'll cover Microsoft's quarter and their guidance in this piece and discern for ourselves what matters. Let us proceed.
The Quarter
MSFT's fiscal first quarter, which ended Sept. 30, posted an adjusted earnings per share of $4.13 (unadjusted revenue of $3.72) on revenue of $77.673 billion. The top-line print beat Wall Street by more than 2.25 billion, while the adjusted bottom-line number absolutely crushed expectations. That revenue print was also good enough for year-over-year growth of 18.4%. This was in line with the kind of growth Microsoft has posted for the two prior quarters.
The C-Suite
- Chairman and CEO Satya Nadella commented in the press release, "Our planet-scale cloud and AI factory, together with Copilots across high value domains, is driving broad diffusion and real-world impact. It's why we continue to increase our investments in AI across both capital and talent to meet the massive opportunity ahead."
- CFO Amy Hood also commented, "We delivered a strong start to the fiscal year, exceeding expectations across revenue, operating income, and earnings per share. Continued strength in the Microsoft Cloud reflects the growing customer demand for our differentiated platform."
Operations
With a revenue print of $77.673 billion (+18.4%), services drove revenue of $61.751 billion (+22.7%), while products generated sales of $15.922 billion (+4.3). The cost of that revenue landed at $24.043 billion, leaving an unadjusted gross profit of $53.63 billion (+17.9%) as gross margin remained flat from a year ago at 69.1%. GAAP operating expenses increased 4.9% to $15.669 billion, leaving an uadjusted operating income of $37.961 billion (+24.3%) as operating margin improved from 46.4% to 48.9%.
After accounting for interest, other income, expenses and taxes, unadjusted net income hit the tape at $27.747 billion (+12.5%). That works out to $3.72 per fully diluted share, up from $3.30 for the year-ago period. Interestingly, the adjustment of $0.41 per share that brings the adjusted EPS up to $4.13 was attributed to impacts from the firm's investment in OpenAI. It was that investment that led to a 3% rally in the stock earlier this week that has largely unwound overnight.
Segment Performance
- Productivity and Business Processes generated revenue of $33.02 billion (+16.6%), producing an operating income of $13.391 billion (+23.6%) as segment operating margin improved from 58.3% to 61.8%.
Business lines sales growth: Microsoft 365 was up 26%, Dynamics 365 up 18%, and LinkedIn up 10%. Copilot applications surpassed 150 million monthly active users, up more than 50% in three months.
- Intelligent Cloud generated revenue of $30.897 billion (+28.3%), producing an operating income of $20.407 billion (+27.5%) as segment operating margin dropped slightly from 43.6% to 43.3%. Azure sales growth printed at 40% or 39% in constant currency. CFO Amy Hood commented that demand for Azure during the quarter exceeded the firm's ability to meet that demand.
- More Personal Computing generated revenue of $13.756 billion (+4.4%), producing an operating income of $4.163 billion (+17.8%) as segment operating margin improved from 26.8% to 30.3%. Business lines sales growth Search & Advertising +16%, Windows OEM +6%, Xbox +1%.
Guidance
During the call, management guided the current quarter toward revenue of $79.5 billion to $80.6 billion, putting the midpoint at $80.05 billion, which is a little on the light side. Consensus view had been for something between $80.1 billion and $80.4 billion. This would be good for annual growth of roughly 15% and accounts for at least part of the overnight pressure on the stock.
Interestingly, CFO Amy Hood broke out segment guidance during the call, which she does every quarter. The company is expecting both the Productivity & Business Processes and Intelligent Cloud segments to outperform the street's expectations. It's the More Personal Computing segment that produced guidance well below what Wall Street has been looking for.
Fundamentals
For the period reported, Microsoft generated operating cash flow of $45.057 billion (+32%). Out of that number came capital spending of $19.394 billion (+30%), which left free cash flow of $25.663 billion (+33%). Out of that number, it repurchased $5.65 billion in common stock for the corporate treasury and paid out cash dividends of $6.169 billion to shareholders.
Looking at the balance sheet, Microsoft ended the quarter with a cash position of $103.012 billion and inventories of $1.13 billion. That puts current assets at $189.066 billion. Current liabilities add up to $134.996 billion including $7.832 billion in shorter-term debt and unearned revenue of $58.987 billion, which we know is not a true financial obligation, but rather one of goods or services. At the headline, this puts the current ratio at 1.40, which is fine. Adjusted for those unearned revenues, that ratio rises to 2.49, which is simply outstanding.
Total assets amount to $636.351 billion, including $140.733 billion in goodwill and other intangibles. At 22% of total assets, this would not be considered outlandish. Total liabilities less equity comes to $273.275 billion. This does include longer term debt of $35.376 billion, which is something that the firm could take care of out of pocket several times over if necessary.
My Take
I was kind of looking for an excuse to take my profits in Microsoft and go home. I've been long the shares for a very long time, and they've been good to me. The stock is still up 34% over six months after a slow start to the year. I have reduced over time, but after seeing this quarter, this guidance, these cash flows and this balance sheet, I see absolutely no reason to exit Microsoft now. Satya Nadella still has MSFT humming along on "almost" all cylinders. Microsoft's operations are an excellent example of what elite-level corporate execution looks like.
Readers will see that shares of MSFT had broken out from the above Closing Pennant pattern to the upside ahead of earnings. Now, there is a little bit of give-back. The indicators, inclusive of the daily Moving Average Convergence Divergence are still set up bullishly. These real tests, should the weakness persist, will come at the 21-day exponential moving average (currently $539) for the swing crowd and the 50-day simple moving average (currently $514) for the professionals.
My feeling is that if the swing traders crack, I would like to add to my long position in between those two lines. My target price is still $638. However, there could be trouble lurking. Readers need to know that should this selloff persist, Closing Pennant is going to start looking like a Double Top pattern of bearish reversal...
See what I did there? The pattern is underdeveloped, but the possibility is there. Until next time, rock on, my friends, rock on.
At the time of publication, Guilfoyle was long GOOGL, MSFT equity.
