Microsoft (MSFT) reported another solid quarter after the market close on Thursday, ending a fiscal year that has given long-term shareholders much to be optimistic about.
In the fourth quarter, constant currency revenues increased 10% (adjusted for the Windows 10 revenue deferrals). Excluding revenues from LinkedIn (LNKD, Financial), which was not part of Microsoft in the year-ago period, revenues increased 5% (comparable to the full year growth rate).
Top-line growth in the quarter was driven by two segments: Productivity & Business Processes (up high single digits excluding the contribution from LinkedIn) and Intelligent Cloud (+12%).
In Productivity & Business Processes, the shift to SaaS continues. Office Commercial revenues were up 6%, with Office 365 Commercial revenues up 44% (Office 365 outpaced the legacy licensing business for the first time). The increase in revenues continued to exceed the increase in paid seats (by 13 points in the quarter), pointing to successful efforts in selling higher value offerings to customers. Office Consumer revenues increased 13%, with subscriber growth of 17%. Finally, Dynamics revenues were up 9%, with Dynamics 365 up 75% year over year.
In Intelligent Cloud, breakneck growth continued at Azure. Revenues nearly doubled from the year-ago period, with the growth rate accelerating from the third quarter. Microsoft exited the quarter with commercial cloud run rate revenues of $18.9 billion – up 56% year over year. Back in 2015, management set a goal for commercial cloud run rate revenues of $20 billion by 2018; based on current results, they will likely eclipse that mark next quarter. As Azure, Office 365 and Dynamics 365 continue to scale, we’re seeing material improvements further down the P&L as well: over the past year, commercial cloud gross margins increased 1,000 basis points.
In More Personal Computing, revenues fell 1% in the quarter due to lower phone revenues (Ballmer’s parting “gift” to shareholders). Elsewhere in MPC, the numbers looked fine, with Windows OEM revenues growing year over year and Search ad revenues climbing double digits. Xbox Live ended the quarter with 53 million monthly active users, helping drive a 4% increase in gaming.
For the full year, cash from operations at Microsoft was just shy of $40 billion. Free cash flow was north of $30 billion, or $4 per share (I should note that this is before making an adjustment for “normalized” M&A). Despite the large LinkedIn acquisition, the company’s fortress balance sheet remains intact with net cash of more than $50 billion at quarter end (roughly $7 per share).
Microsoft spent nearly $12 billion on share repurchases in fiscal 2017; as a result, the number of diluted shares declined by more than 2%. By my math, adjusted EPS increased by roughly 10% (this excludes the significant tax benefit from prior years’ losses in Microsoft’s phone business).
Heading into fiscal 2018, all signs point to another strong year at Microsoft. When you look at the stock price, there has clearly been a lot of love in the past few years for this former “dinosaur.”
Unfortunately, recognition comes with higher expectations. While I continue to own shares, I won't be buying more near current levels. At the same time, when it comes to trimming the position, I’m trying to be sensible and patient. It’s not every day that you find a business with top-notch management and huge addressable markets to go after. With Microsoft, I think you get both of those in spades.
Disclosure: Long Microsoft.
