Microsoft (MSFT) reported better-than-expected results for its fiscal third quarter of 2022.

• On the top line, total revenue of $49.4 billion (up 18% year over year) exceeded the consensus estimate on FactSet of $49.02 billion. 

• Gross margins of 68.4% were slightly ahead of the 68.2% expectation and operating margins of 41.3% were slightly ahead of the 40.8% estimate. 

• On the bottom line, Microsoft earnings per share of $2.22 (an increase of 9% year over year) exceeded estimates of $2.19.

Productivity and business processes

• Revenue of $15.79 billion (up 19% year over year in constant currency) edged estimates of $15.75 billion and operating income of $7.18 billion (a gain of 23%) edged estimates of $7.13 billion. (Constant currencies help strip out fluctuations in foreign currency to provide a clearer financial picture)

• Within the segment, office commercial products and cloud services revenue increased 14% year over year in constant currency. 

• Office consumer products and cloud services revenue grew 12% year over year in constant currency and the number of Microsoft 365 Consumer subscribers increased by roughly 2 million quarter over quarter to 58.4 million. 

• Dynamics products and cloud services revenue grew 25% year over year in constant currency. 

• LinkedIn, which has been a beneficiary of a strong labor market, saw its revenues increase 35% year over year constant currency with sessions up 22% with record engagement.

Intelligent cloud

• Revenue of $19.05 billion (a jump of 29% year over year constant currency) exceeded estimates of $18.89 billion, and operating income of $8.28 billion (up 33% year over year constant currency) was higher than expectations of $7.95 billion.

• The single most important line item in this segment, and perhaps the entire company, is revenue growth for Azure and other cloud services. Investors were hoping to see a slight acceleration from the 46% constant currency growth rate last quarter. What did Microsoft do? 49%. 

More personal computing

• Revenue in this segment was $14.52 billion (a rise of 13% year over year constant currency), beating estimates of about $14.3 billion, while operating income of $4.9 billion (up 10% year over year constant currency) was in line with estimates. 

• Window OEM revenue growth increased 11% year over year, thanks to continued strength in the commercial personal computer market, which has higher revenue per license. 

• Windows commercial products and cloud services revenue grew 19% year over year in constant currency,

• In Gaming, total revenue increased 8% in constant currency. Xbox content and services revenue increased 6%, while Xbox hardware sales grew 16% in constant currency. 

• Search and news advertising revenue excluding traffic acquisition costs (TAC) increased 25% year over year in constant currency.

Guidance

As always, management provided its outlook for the next quarter during the conference call.

Segment revenue guidance was as follows:

• Productivity and business processes: $16.65 billion to $16.9 billion, which at a midpoint of $16.78 billion is higher than estimates of $16.68 billion. 

• Intelligent cloud: $21.1 billion to $21.35 billion relative to consensus estimates of $20.8 billion. Management expects Azure revenue growth to be lower sequentially by roughly 2 percentage points.

• More personal computing: $14.65 billion to $14.95 billion, which at a midpoint of $14.8 billion was a slight miss against estimates of $14.95 billion. Management expects gaming revenues to decline in the mid-to-high single digits due to lower engagement hours year over year and constrained console supply. These comments — along with the weaker-than-expected forecast from Texas Instruments after the bell tonight — could hurt shares of Advance Micro Devices (AMD) tomorrow.  

Adding that all up, we get a total revenue guide of $52.4 billion to $53.2 billion, which at a midpoint of $52.8 billion is slightly higher than estimates of $52.75 billion. 

Factored into guidance is a $110 million impact to revenue from the ongoing war in Ukraine. Also, the current impact of the lockdowns in China is reflected in guidance, though an extended shutdown into May would negatively impact this outlook. In addition, management expects another quarter of operating margin expansion. 

Capital allocation and cash flow

• Microsoft returned $12.4 billion to shareholders in the quarter, with $7.8 billion from buybacks and $4.6 billion in dividends. 

• The company is still generating a ton of cash. Free cash flow of $20 billion (up 17% year over year) topped estimates of $17.7 billion and operating cash flow of $25.4 billion (up 14%) exceeded estimates of $23.68 billion. 

• Capital expenditures including assets acquired under finance leases were $6.3 billion. This was slightly more than the $5.9 billion expected but the spending is necessary to support Microsoft’s growth in its cloud offerings. 

Bottom line

It was a strong quarter from Microsoft, with a beat on nearly every single line. Management’s forecast for the next quarter was also better than expected, even after factoring in all the market’s biggest uncertainties, like how much revenue will be lost due to the war in Ukraine and the China Covid-19 lockdowns. 

The software maker will be a great test for the ever-declining market this morning: if a high-quality stock like MSFT— which is already down more than 20% from its high — can’t catch a bid after reporting an excellent quarter and solid outlook, we might be in for more market troubles ahead.