It has been about a month since the last earnings report for Microsoft (MSFT). Shares have lost about 2.3% 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 Q3 Earnings & Revenues Beat Estimates

Microsoft delivered third-quarter fiscal 2019 earnings of $1.14 per share, which beat the Zacks Consensus Estimate of $1.00 per share. The figure surged 20% on a year-over-year basis.

Revenues of $30.57 billion increased 14% from the year-ago quarter (up 16% in constant currency or cc). The figure also surpassed the Zacks Consensus Estimate of $29.78 billion.

Robust execution and better-than-expected demand from customers for hybrid cloud offerings drove the quarterly results.

Commercial bookings increased 30% (34% at cc). Commercial unearned revenues were $25.1 billion, up 20% year over year at cc. Commercial revenue annuity mix was 90%, up 1 percentage point year over year.

Commercial cloud revenues were $9.6 billion, surging 41% year over year (43% at cc), reflecting solid growth in the United States, Western Europe, the U.K. and Germany.

Segmental Details

Productivity & Business Processes includes the Office and Dynamics CRM businesses. Revenues increased 14% (up 15% at cc) on a year-over-year basis to $10.2 billion.

The Commercial business (products + Office 365 & related cloud services) revenues were up 12% from the year-ago level (up 14% at cc). Office 365 commercial revenues grew 30% (31% at cc), driven by strong installed base growth and average revenues per user (ARPU) expansion. Office 365 Commercial seat grew 27% 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 34.2 million during the reported quarter.

Dynamics business grew 13% (up 15% at cc). Dynamics 365 revenues soared 43% (44% at cc). Dynamics adoption is improving, with companies like H&M selecting the application to digitize its critical business processes.

LinkedIn revenues surged 27% from the year-ago quarter (up 29% at cc). LinkedIn sessions were up 24%, 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 National Bank of Canada, BNP Paribas, Refinitiv — a joint venture between Thomson Reuters and Blackrock in recent times. Microsoft Teams is now utilized by more than 150 organizations having over 10,000 active users, including 91 of the Fortune 100.

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.

Intelligent Cloud includes server, and enterprise products and services. The segment reported revenues of $9.7 billion, up 22% (up 24% at cc) year over year.

Server product and cloud services revenues rallied 27% year over year (up 29% at cc). The high point was Azure’s revenues, which soared 73% year over year (up 75% 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 had rolled out its HoloLens 2 mixed-reality (MR) headsets and demonstrated use cases at the MWC 2019. The other major takeaways from the event include the roll out of Azure Kinect and Azure Spatial Anchors.

On-premise server products revenues increased 7% (up 9% at cc), driven by customer demand for hybrid solutions, premium server versions and GitHub inclusion.

Further, enterprise mobility installed base revenues increased 53% to more than $100 million seats.

Moreover, enterprise service revenues increased 4% (up 5% at cc) in the reported quarter, due to growth in premier support services and Microsoft consulting services.

More Personal Computing primarily comprises Windows, Gaming, Devices and Search businesses. Revenues were up 8% (up 9% at cc) year over year to $10.7 billion.

Windows OEM pro revenues increased 5% on a year-over-year basis, primarily due to better-than-expected chip supply and strong commercial demand. However, Windows OEM non-Pro revenues decreased 1% year over year. Nevertheless, windows commercial products and cloud services revenues increased 18% year over year (up 20% at cc), on the back of higher customer adoption of the company’s premium offerings. Windows 10 deployments across new and existing devices remained robust during the reported quarter.

Gaming revenues jumped 5% (7% at cc), driven by robust performance from Xbox software and services (up 15% at cc) due to third-party title strength. Xbox live monthly active users came in at $63 million, up 7% year over year.

Recently, the company introduced Game Stack with an aim to provide developers with a comprehensive platform, enabling them to design, test, publish and monetize on engaging games.

As part of Game Stack, the 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 21% (up 25% at cc) from the year-ago quarter, driven by strong performance of the latest editions. Further, robust growth across consumer and commercial aided the year-over-year increase.

Microsoft expanded its Surface family just before holiday shopping season by introducing Surface Laptop 2, Surface Pro 6 and Surface Studio 2 devices and smart Surface Headphones.

Additionally, bundling new Surface devices sales with Office 365 is a smart move and is anticipated to bolster Office 365 adoption. The holiday deals along with these initiatives are in sync with the company’s attempt to take on Apple which dominates the market with Macbook Pro and Macbook Air.

Search advertising revenues, excluding traffic acquisition costs (TAC), grew 12% (up 14% at cc) as both search volume and revenues per search (RPS) improved. Further, higher Bing rate growth was a catalyst.

Operating Results

Microsoft’s gross margin of 66.7% expanded 130 bps on a year over year, driven by higher cloud margins.

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 decreased marginally year over year, due to favorable mix of clod offering offset by material improvement in Azure gross margin.

More Personal Computing gross margin increased year over year owing to favorable sales mix.

Commercial cloud gross margin was 63%, up 5 percentage points year over year, due to improvement in Azure gross margin.

Operating expenses of $10.06 billion were up almost 9% from the year-ago quarter on the back of higher investments in cloud engineering, LinkedIn and GitHub.

Productivity & Business Process operating expenses increased 4% (up 6% at cc) on account of aggressive investments in LinkedIn and cloud engineering.

Intelligent Cloud operating expenses increased 22% (up 23% at cc), driven by on-going investments in cloud, AI engineering, GitHub and commercial sales capacity expansion initiatives.

More Personal Computing operating expenses increased 1% (up 2% at cc).

Operating margin expanded 290 bps on a year-over-year basis to 33.8%.

Productivity & Business Process operating income grew 28% (up 30% at cc). Intelligent Cloud operating income surged 21% (up 23% at cc). More Personal Computing operating income rallied 25% (up 28% at cc).

Balance Sheet & Free Cash Flow

Microsoft ended with cash and short-term investments balance of $131.6 billion, up from $127.7 billion from the previous quarter. Long-term debt (including current portion) came in at 73.1 billion compared with $73.2 billion from the previous quarter.

Operating cash flow during the reported quarter came in at $13.5 billion. Free cash flow during the quarter came in at $10.95 billion, down from $5.2 billion reported in the previous quarter.

In the reported quarter, the company returned $7.4 billion to shareholders in the form of share repurchases and dividends.

Guidance

For the fourth quarter of fiscal 2019, commercial unearned revenues are expected to increase 36-37% sequentially, while commercial cloud gross margin is expected to improve at a moderate pace.

Productivity and Business Processes revenues are expected between $10.55 billion and $10.75 billion, driven by double-digit growth in Dynamics. Office commercial revenues are anticipated to be slightly down sequentially due to growth in Office 365 which will partially be offset by the consumer PC market headwinds.

Intelligent Cloud revenues (including GitHub) are expected between $10.85 billion and $11.05 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 $10.8 billion and $11.1 billion, with a shift in revenue mix to Surface and gaming businesses.

Gaming revenue is anticipated to be down year over year, owing to unfavorable hardware trends.

Management expects COGS between $10.65 billion and $10.85 billion, and operating expenses between $10.7 billion and $10.8 billion.

For fiscal 2020, management expects operating margin to increase slightly 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.

VGM Scores

Currently, Microsoft has a nice Growth Score of B, though it is lagging a lot on the Momentum Score front with a D. Charting a somewhat similar path, the stock was allocated a grade of C on the value side, putting it in the middle 20% for this investment strategy.

Overall, the stock has an aggregate VGM Score of C. If you aren’t focused on one strategy, this score is the one you should be interested in.

Outlook

Estimates have been broadly 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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