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Hits and Misses in Mircrosoft's Results

Updated on January 27, 2015

Microsoft (MSFT:Nasdaq) reported earnings after the close that met expectations on the bottom line and slightly beat on the top line. Fiscal 2Q earnings were 71 cents a share, with revenue of $26.5 billion vs the $26.3 billion consensus. Earnings included 6 cents of unfavorable items: 2 cents from restructuring/integration and 4 cents from an IRS tax adjustment. Plus, there was a 1 cent hit from currency translation.

The highlights were better growth in devices and consumer (48% of total revenue), led by the company’s cloud business, offset by weaker-than-expected commercial results (PCs, with the end of the Windows XP support refresh cycle) and uneven results in geographic regions, mainly in China and Japan. The U.S. outperformed and Europe was in line.

Currency also impacted bookings, which were flat y/y. The company indicated that it will complete its existing $40 billion share repurchase program by the end of 2016. In 2Q, the company returned $4.5 billion in buybacks and dividends. Devices and consumer came in at $12.9 billion and up 8% y/y vs. the $12.8 billion consensus. Surface revenue rose 24% y/y to $1.1 billion. Subscribers for Office 365 Home and Personal -- its cloud offering -- rose 30% y/y and increased to more than 9.2 million, Xbox console sales posted 6.6 million units and phone hardware revenues came in ahead at $2.3 billion, with 10.5 million Lumia units sold.

The big offset was that Windows OEM Pro revenue, which fell 13% with the scale out of Windows XP support. Plus, commercial revenue came in shy of expectations at $13.3 billion, which was up 5% y/y but below the 8% y/y expectations. Within this segment, cloud was the clear highlight, expanding 114% y/y driven by Office 365, Azure and Dynamic CRM Online and is now on an annualized revenue run rate of $5.5 billion. Server products and services grew 9% and Windows volume licensing revenue grew 3%, but was also below the 5% expectations. The Office Commercial products fell 1% as the company continues to shift towards cloud and, again, because of the end of XP support and the refresh cycle. Expenses rose 1%to $8.3 billion, slightly better, mainly due to spending on new strategic initiatives.

Management lowered guidance due to the negative currency translation and the difficult comparisons driven by the XP refresh seen last year. Plus, the company now expects to see revenue declines in China, Russia and Japan.

So, there were puts and takes to the quarter. The clear highlight being the transition to cloud, which has seen impressive growth both in consumer and commercial. But the weakness in PCs, driven by the tough comparisons from last year’s XP refresh cycle and the uneven results internationally, will weigh on shares tomorrow, especially after the 30% gains in shares posted in the last year.

I like the transition the company is undergoing and believe in the long-term story. I am inclined to buy with the stock trading at 15x and with more than $11 per share in cash on its balance sheet, which the company will use to do more M&A and to continue to invest in the growth part of its business.

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