Last week, Microsoft (MSFT, Financial) reported results for the second quarter of fiscal 2021.
Yet again, the company reported double-digit growth across the board, with revenue up 15% to $43.1 billion (constant currencies), operating income up 26% to $17.9 billion, and earnings per share up 31% to $2.03 per share. All three of Microsoft's segments reported double-digit revenue growth in the quarter, with Intelligent Cloud leading the way (up 22% to $14.6 billion).
The outsized growth in operating income resulted in 400 basis points of margin expansion to 42% (adjusted for the impact of an accounting change and temporary Covid-related benefits, margins expanded by roughly 100 basis points). As shown below, Microsoft's operating profit margins have increased considerably over the past several years, with the 42% margins reported in the first half of this fiscal year more than 1,000 basis points higher than in fiscal 2017.
When Microsoft first outlined the long-term opportunity in the commercial cloud businesses, its objective was to reach $20 billion in run rate revenue by the end of fiscal 2018. That goal was achieved well ahead of schedule and it has been charging ahead ever since: run rate commercial cloud revenue in the second quarter was north of $66 billion. Amazingly, despite comping off a larger and larger base, commercial cloud revenue increased 34% year over year in the second quarter (compared to 30% growth for the entirety of fiscal 2020).
Looking at the segment results, Productivity & Business Processes revenue increased by 11% (in constant currencies) to $13.4 billion due to continued growth from Office, Dynamics and LinkedIn. Strong customer additions continued for Office 365 Commercial (15% paid seat growth), with average revenue per user tailwinds from mix shift to higher value offerings resulting in 20% year-over-year revenue growth. The consumer side of the business continues to grow as well, with the addition of more than 10 million Microsoft 365 subscribers in the past 12 months (up 28% year over year to 47.5 million subscribers at quarter end).
Strength in Dynamics continued with high-teens year-over-year revenue growth attributable to 37% growth from Dynamics 365. As CEO Satya Nadella noted on the conference call, "We are taking share as companies in every industry turn to new business applications to grow."
LinkedIn revenue and sessions increased by 22% and 30%, respectively, marking another quarter of record engagement (sessions) among the platforms 740 million members. On top of 11% revenue growth, Productivity & Business Processes operating margins expanded by 250 basis points, resulting in 17% growth in segment operating income to $6.2 billion.
Intelligent Cloud growth was led by another strong quarter from Azure (up 48%). As shown below, Azure's top-line growth has held in the 50% range each of the past three quarters despite being measured against a large base of business (run rate revenues of roughly $30 billion).
In addition to outsized revenue growth, Intelligent Cloud segment margins expanded by more than 600 basis points (with a material benefit from the useful life accounting change mentioned earlier), resulting in a 41% year-over-year increase in operating income to $6.5 billion.
In More Personal Computing, revenue increased 13% to $15.1 billion as the segment continues to benefit from work, learn and play from home. Most notably, Gaming revenue increased 50% year over year due to a combination of 38% growth in Xbox content and services revenues, as well as 86% growth in hardware from new console sales ("The launch of Series X and Series S were the most successful in our history, with the most devices ever sold in the launch month"). In addition, Windows, Surface and Search each reported single-digit growth in the quarter, contributing to the strong results in MPC.
Excluding discrete tax items, cash flow from operations and free cash flow increased 33% and 41% in the quarter (with the latter exceeding $7 billion). The company returned $10 billion to owners between repurchases and dividends, up 18% from the year-ago period.
At the end of the quarter, cash and short-term investments on the balance sheet totaled $132 billion, or $72 billion net of all outstanding debt ($9 per share of net cash). As I've noted many times in years past, the balance sheet positioning at Microsoft – and its mega-cap tech peers - remains overly conservative. Simply put, these companies are all but certain to continue generating tens of billions of dollars in free cash flow every year – a number that is likely to grow meaningfully over time (as CFO Amy Hood noted on the call, revenue and operating income are both expected to increase double digits this year).
Given that reality, why keep $70 billion in net cash in the corporate coffers, particularly if the ability to complete large-scale M&A feels somewhat constrained in today's regulatory environment? Personally, I think the answer is that their approach is overly cautious and suboptimal. That said, while I feel the need to stand on my soap box from time to time, the other reality is that this is a secondary concern, particularly as the company's value continues to climb (and to be fair, they have improved the pace of capital returns in recent years); even a special dividend of $50 billion is not that meaningful in light of a market cap that is approaching $2 trillion.
Conclusion
I'll close with part of Nadella's prepared remarks on the call, which speaks to the strength of Microsoft's recent results, as well as the long-term opportunities on the horizon:
"We are witnessing the dawn of a second wave of digital transformation, sweeping every company and every industry. Digital capability is key to both resilience and growth. It's no longer enough to just adopt technology; businesses need to build their own technology to compete and grow. Microsoft is powering this shift with the world's largest and most comprehensive cloud platform… We've always led in hybrid computing and we are accelerating our innovation to meet customers where they are… I'm energized by our increasing momentum and the expanding opportunity fueled by the structural change brought about by the rapid adoption of digital technology. We are investing to meet these needs in the coming decade and I'm optimistic about what's ahead."
Disclosure: Long Microsoft.
Read more here:
- Netflix: A Stellar Year
- Union Pacific: Solid Results in a Tough Year
- Match Group: Full Steam Ahead Into 2021
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