McAdams Wright Ragen analyst Sid Parakh maintains a Hold rating for Microsoft Corporation (NASDAQ:MSFT) as the company announces its second quarter results.


Microsoft’s second quarter results

Microsoft Corporation (NASDAQ:MSFT)’s Q2 EPS of $0.78 exceeded our $0.69 forecast; aided by lower operating expenses ($8.3 billion vs. guidance of $8.5-$8.6 billion) and a lower tax rate (16.8% vs. guidance of 19%). Both combined equate to an uplift of ~$0.05. Revenue of $24.5 billion was notably above our $23.8 billion forecast. Despite the strong revenue and EPS performance, we note that cash generation metrics continue to weaken, reflecting the inherently lower margin profile of new revenue dollars. On a trailing 12-month basis, while revenues improved 7.6%, cash flow from operations actually declined 7.7% during that timeframe.

Hardware drives revenue upside

Higher XBOX unit sales and a (more than) doubling of Surface units and revenues sequentially were the primary factors behind Microsoft Corporation (NASDAQ:MSFT)’s Q2 sales beat. All other segments performed in line or better than forecast. In the Windows business, consumer trends remained weak (-20% year-on-year) but were partially offset by strength in enterprise-oriented versions (+12% y-y). Worthy of note is a 107% y-y increase in commercial cloud (Azure, Office 365) revenues and a 34% y-y uptick in search ad sales. Windows Phone sales also grew 50% y-y on higher patent-licensing and Phone license sales. Microsoft’s consumer-facing Office subscription offering Office 365 Home Premium now has 3.5 million subscribers (two million in Q1).

Commercial trends remain strong

Microsoft Corporation (NASDAQ:MSFT) continued to see strength in each of its enterprise focused businesses and experienced strong growth in its annuity business—unearned revenues increased 12.1% y-y while contracted but not billed balances increased $2 billion sequentially to >$23 billion. Like before, such strength continues to indicate customer interest in Microsoft’s long-term product roadmap.

Estimate changes with no change to price target

Our FY14 revenue and EPS forecast is now $84.9 billion and $2.74 (formerly $85.9 billion/$2.68). For FY15, we project revenues and EPS of $90 billion  and $2.90 (vs. prior $91.2 billion/$2.87). Our price target stays at $39 (13.4x our FY15 EPS forecast of $2.90).