Microsoft Corporation (MSFT - Free Report) reported fourth-quarter fiscal 2018 earnings of $1.13 per share, beating the Zacks Consensus Estimate by six cents. The figure increased 6.6% on a year-over-year basis.

Revenues of $30.09 billion increased 17.5% from the year-ago quarter (up 13% in constant currency or cc). Further, the figure exceeded the Zacks Consensus Estimate of $29.21 billion.

Commercial bookings surged 18% (same at cc). Commercial unearned revenues were $28.99 billion, up 21% year over year at cc. Commercial revenue annuity mix was 89%, up 3 points year over year, driven by an increased mix of cloud offerings.

Commercial cloud revenues were $6.9 billion, up 53% year over year (50% at cc), reflecting solid growth in the United States, Western Europe and the United Kingdom.

Shares were up 3.2% in pre-market trading. Microsoft shares have returned 22.1% year to date, outperforming the 20% rally of the industry.

Azure, Office 365 & Dynamics Drive Growth

Productivity & Business Processes includes the Office and Dynamics CRM businesses. Revenues increased 13.1% (up 10% at cc) on a year-over-year basis to $9.67 billion.

The Commercial business (products + Office 365 & related cloud services) revenues were up 10% from year-ago level (up 8% at cc). Office 365 commercial revenues grew 38% (35% at cc), driven by strong installed base growth and average revenues per user (ARPU) expansion, primarily due to customer migration to premium workloads in E3 and E5. Office 365 Commercial seat grew 29% on a year-over-year basis.

Microsoft Corporation Revenue (TTM)

Microsoft Corporation Revenue (TTM) | Microsoft Corporation Quote

The Consumer business revenues advanced 8% (up 6% at cc) year over year in the quarter. Office 365 consumer subscribers are now at 31.4 million, up from 30.6 million at the end of the previous quarter. Office 365 commercial now has more than 135 million monthly active users.

Dynamics business grew 11% (8% at cc). Dynamics 365 revenues soared 61% (56% at cc).

LinkedIn revenues surged 37.2% from the year-ago quarter (34% at cc) to $1.46 billion. LinkedIn sessions were up more than 41%, reflecting acceleration in engagement. Mobile sessions were up more than 55% from the year-ago quarter.

Intelligent Cloud includes server as well as enterprise products and services. The segment reported revenues of $9.61 billion, up 22.8% (20% at cc) year over year.

Server product and cloud services revenues went up 26% year over year (up 24% at cc). The high point was Azure's revenues, which soared 85% at cc on a year-over-year basis.

Data center expansion continues with Azure, now in 54 regions globally. The company added almost 500 new capabilities throughout the last fiscal, with focus on new workloads like Internet-of-Things (IoT) and Edge AI.

Notably, customer demand for cloud-to-edge solutions — Azure Stack and Azure Sphere — have been strong since their availability.

Azure’s clientele continues to expand, with Walmart (WMT - Free Report) being the latest to chose the cloud platform.

On-premise server products revenues increased 8% (up 6% at cc), driven by customer demand for hybrid solutions as well as premium server versions.

Enterprise Mobility install base grew 55% year over year to more than 82 million.

Moreover, enterprise service revenues increased 8% (7% at cc) in the reported quarter, due to growth in premier support services and Microsoft consulting services.

More Personal Computing comprises mainly the Windows, Gaming, Devices and Search businesses. Revenues were up 17.1% (16% at CC) year over year to $10.81 billion. Excluding phone business, revenues grew 3%.

Windows OEM pro revenues increased 14% on a year-over-year basis. Windows OEM revenues increased 7% (same at cc). Moreover, windows commercial products and cloud services revenues increased 23% on a year-over-year basis (19% at cc), driven by higher volume of multi-year agreements and favorable revenue mix.

Gaming revenues jumped 39% (38% at cc), driven by robust performance from Xbox software and services (up 35% at cc), primarily due to third-party title strength. Xbox Live monthly active users were up 8% to 57 million active users.

Surface revenues surged 25% (21% at cc) from the year-ago quarter, driven by strong performance of the latest editions.

Search advertising revenues, excluding traffic acquisition costs (TAC) revenues, grew 17% (16% at cc) as both search volume and revenues per search (RPS) improved.

Operating Results

Microsoft’s gross margin of 68% expanded 1 point from the year-ago quarter, primarily owing to growth in Productivity & Business Process segment, partially offset by weak Intelligent Cloud.

Productivity & Business Process gross margin remained flat due to improvements in Office 365 and LinkedIn, offset by an increased mix of cloud offerings.

Moreover, Intelligent Cloud segment gross margin also remained unchanged, owing to higher mix of cloud offerings, partially mitigated by solid improvement in Azure's gross margin.

More Personal Computing gross margin expanded year over year, driven by robust performance from Surface.

Commercial cloud gross margin was 58%, up 6 points year over year, due to improvement across Azure, Office 365 and Dynamics 365.

Operating expenses of $10 billion were up 9% (up 8% at cc) from the year-ago quarter, due to higher investments in commercial sales capacity, cloud engineering and LinkedIn.

Operating margin expanded 300 bps on a year-over-year basis to 30.9%.

Productivity & Business Process operating income grew 19.9% (up 13% at cc). Intelligent Cloud operating income jumped 34% (up 30% at cc). More Personal Computing operating income surged 37.8% (up 32% at cc).

LinkedIn operating income, excluding amortization of intangible assets, were $196 million as compared with $18 million reported in the year-ago quarter.

Balance Sheet & Free Cash Flow

Microsoft ended with cash and short-term investments balance of $133.8 billion, down $4.7 billion from the previous quarter.

Free cash flow decreased 15% year over year to $7.4 billion, primarily reflecting higher capital expenditures related to the cloud business.

The company returned $5.3 billion to shareholders in the form of share repurchases and dividends in fiscal 2018. Microsoft bought back shares worth $2.1 billion in the reported quarter.

Guidance

For fiscal 2019, Microsoft expects no impact from foreign exchange on revenues. However, volatility in foreign exchange is expected to hurt cost of goods sold (COGS) and operating expense growth by 1 point.

Productivity and Business Processes is expected to grow double-digits, driven by Office 365, Dynamics 365 and LinkedIn.

Customer demand for Microsoft’s hybrid offerings is expected to drive high-teens growth in server products and cloud services. For Azure, management expects an increasing mix of IaaS and PaaS consumption-based revenues.

Moreover, Microsoft expects growth rate in OEM Pro and Windows commercial businesses to slow down.

Further, the rate of improvement in Commercial cloud gross margin may moderate relative to fiscal 2018 as revenue mix continues to shift to Azure's IaaS and PaaS consumption-based services.

Operating expenses for fiscal 2019 are expected to grow 7%, driven by continuing investments in commercial cloud, LinkedIn, gaming and AI.

Nevertheless, Microsoft expects operating margin to increase slightly on a year-over-year basis.

For the first quarter of fiscal 2019, commercial unearned revenues are expected to decrease almost 10% sequentially, while commercial cloud gross margin is expected to improve slightly.

Productivity and Business Processes revenues are expected between $9.25 billion and $9.45 billion, driven by double-digit growth in Office Commercial and Dynamics.

Intelligent Cloud revenues are expected between $8.15 billion and $8.35 billion. Azure's revenue growth is likely to reflect continued strength in the IaaS and PaaS consumption-based services, and a moderating rate of growth in per-user services.

More Personal Computing revenues are expected between $9.95 billion and $10.25 billion. OEM Pro revenues are expected to grow in line with the commercial PC market. Surface revenues are expected to grow at a similar rate achieved in the year-ago quarter.

Search ex-TAC is expected to grow in mid-teens, while Gaming is also likely to grow mid-teens.

Management expects COGS between $9.5 billion and $9.7 billion and operating expenses between $9.2 billion and $9.3 billion.

Conclusion

Microsoft is benefiting from growing user base of its different applications like Office 365 commercial, Outlook mobile and Teams. Windows 10 is now active on more than 700 million devices, with continued deployments across enterprises. Moreover, Azure’s expanding customer base is a key catalyst.

Microsoft’s gaming segment is performing well, primarily driven by a combination of Xbox Live, Game Pass subscriptions and Mixer, which are driving user engagement.

Further, acquisitions like PlayFab and GitHub (pending) expand Microsoft’s total addressable market (TAM) and penetration.

Additionally, the company’s expanding partner base is a key catalyst.

However, projections of a moderating growth rate in commercial cloud gross margin, and OEM Pro and Windows commercial businesses is a headwind.

Zacks Rank & Stocks to Consider

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

Adobe Systems (ADBE - Free Report) and Verint Systems (VRNT - Free Report) are stocks worth considering in the same sector. Both stocks sport a Zacks Rank #1 (Strong Buy). 

Long-term earnings growth rate for Adobe and Verint is currently pegged at 16.2% and 10%, respectively.