Microsoft (MSFT, Financial) reported results for the fourth quarter of fiscal 2020 on Wednesday.
It was another quarter of double-digit growth, with revenues up 13% to $38.0 billion (+15% on a constant-currency basis). Operating income grew at a slower pace than revenues in the quarter, with EBIT margins contracting by roughly 150 basis points. Adjusted for the costs related to the closure of Microsoft Store retail locations, EBIT margins would have declined 40 basis points. As CFO Amy Hood noted on the call, this outcome partly reflects weakness in small and medium sized businesses (SMB's) that were adversely impacted by the pandemic, as well as short-term investments to benefit customers (for example, offering free trials to enable clients to quickly adapt to remote work).
Net income ($11.2 billion) and diluted earnings per share ($1.46) both increased high-single digits in the fourth quarter on an adjusted basis (excluding the $2.6 billion net income tax benefit in fiscal 2019, but including the $450 million charge for the retail store closures). For the full year, diluted earnings per share (EPS) was $5.8, an increase of more than 20% from the result in fiscal 2019. As shown below, the pace of EPS growth has accelerated meaningfully in the past few years.
Five years ago, Microsoft set a target for run rate commercial cloud revenues of $20 billion by the end of 2018. They achieved that goal ahead of schedule and have kept charging ahead ever since: run rate commercial cloud revenues are now $57 billion. Amazingly, on that sizable base, they still managed to grow commercial cloud by 30% in the fourth quarter (+32% in constant currencies). In addition to significant revenue growth, the commercial cloud business continues to see benefit from economies of scale and increasing adoption of premium services, with gross margins up 100 basis points to 66% in the quarter and commercial cloud gross profit dollars up by one-third to $9.44 billion.
Digging into the segment results, Productivity and Business Processes revenues increased by 13% in fiscal 2020 to $46.4 billion. Customer growth continued for Office 365 Commercial (15% paid seat growth, which does not include the free trials offered to support customers as they quickly adapted to remote work), with higher average revenue per user (ARPU) from continued mix shift to E5 leading to 22% constant currency revenue growth in the quarter. Office 365 Consumer continues to grow as well, with 42.7 million subscribers at year-end (up 23%).
Dynamics reported another strong quarter with revenues up 15% in constant currencies and Dynamics 365 growth of 40%. Finally, LinkedIn revenues increased 10% despite headwinds from a weak job market, with another quarter of record engagement among its more than 700 million global members (up 10% year-over-year).
In addition to 13% revenue growth, Productivity and Business Processes operating margins expanded by 100 basis points in fiscal 2020 to 40.4%; as a result, segment operating income increased by 15% for the year to $18.7 billion, up 65% over the past three years.
Revenues in the Intelligent Cloud segment increased 32% to $48.4 billion, led by another year of strong growth from Azure. Analysts at Goldman Sachs estimate that Azure revenues are now roughly $25 billion a year, or roughly 15% of Microsoft's total annual sales. In addition to outsized revenue growth, Intelligent Cloud segment margins expanded by more than 200 basis points in fiscal 2020, resulting in operating income growth of 32%, to $18.3 billion.
In More Personal Computing (MPC), revenues increased 24% to $48.3 billion with strength across MPC in the fourth quarter as the business benefited from work, learn, and play from home. Notably, CEO Satya Nadella called it a "breakthrough quarter for Gaming," with revenues up 64% year-over-year. As noted on the call, there are nearly 100 million Xbox Live players around the world (for context, Xbox Live had 65 million monthly active users a year ago).
In fiscal 2020, cash flow from operations were $60.7 billion, up 16% year-over-year. After accounting for $19 billion in capital expenditures (inclusive of capital leases), the company generated roughly $42 billion of free cash flow for the year, or $5.40 per share. As shown below, despite significant growth in capital expenditures - they more than tripled over the past five years - free cash flow per share has roughly doubled over the same period.
Microsoft returned the vast majority of its free cash flow to owners in fiscal 2020, through $23 billion in share repurchases and $15 billion in dividends. At year-end, Microsoft held $137 billion in cash and short-term investments, or $73 billion net of all outstanding debt (roughly $10 per share of net cash). Considering the strength of the business and the fact that they’re now generating more than $10 billion of free cash flow a quarter, the balance sheet positioning remains incredibly conservative. That has been the case for many years at Microsoft (and many of their large cap tech peers), which leads me to believe it's unlikely to change anytime soon.
Conclusion
I'll close with a comment from Nadella:
"We are expanding our opportunity and investing across the full modern technology stack. Over the next decade technology spending as a percentage of GDP is projected to double and we are well-positioned to participate in that growth by innovating and defining the key technologies that empower every person and every organization on the planet to build more of their own tech intensity."
With Nadella at the helm, I'm confident that the company will continue to capitalize on the huge opportunities that lie ahead of them. There's a bright future ahead at Microsoft.
Disclosure: Long Microsoft
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