Microsoft (MSFT) – Earnings Review – January 31, 2024
Demand
Microsoft beat revenue estimates by 1.8% and beat its guidance by 1.5%. Its 12.9% 3-year revenue compounded annual growth rate (CAGR) compares to 14.9% last quarter and 13.9% 2 quarters ago. It also beat its 26.5% Y/Y constant currency (CC) growth guide by 150 basis points (bps; 1 bps = 0.01%). Azure’s overall 30% Y/Y growth was roughly 200 bps better than expectations as well. That’s its fastest Azure growth rate in 4 quarters.
Please note that organic growth ex-Activision Blizzard M&A was about 13.8% Y/Y.
Source: Brad Freeman – SEC Filings, Company Presentations, and Company Press Releases
Margins
Microsoft beat EBIT estimates by 3.3% and beat its EBIT guide by 4.6%. It also beat $2.77 GAAP earnings per share (EPS) estimates by $0.16. Activision added 11 percentage points to Microsoft’s Y/Y operating expense (OpEx) growth. OpEx growth was 14% Y/Y and would’ve been 3% Y/Y ex-M&A. This means Activision is somewhat of a margin drag considering the smaller benefit to revenue. EBIT margin would have been 44.3% ex-Activision.
A few other notes to call out about margins this quarter:
- A delay in payment to a vendor led lowered capital expenditures (CapEx) during the quarter. This helped cash flow margins.
- Margin expansion was bolstered by an $800 million severance charge taken in fiscal Q2 2023. This made Y/Y comps easier.
Source: Brad Freeman – SEC Filings, Company Presentations, and Company Press Releases
Balance Sheet
- Roughly $81 billion in cash & equivalents.
- $72 billion in debt.
- Dividends rose 10% Y/Y.
- It repurchased another $4 billion in stock and saw very modest share count shrinkage Y/Y.
Next Quarter Guidance
- Its $60.5 billion revenue guide missed estimates by 0.8%.
- Its $25.95 billion EBIT guide beat estimates by 5.3%.
- Guided to stable 28% Y/Y constant currency Azure growth. Last quarter, it told us to expect 26.5% Y/Y constant currency Azure growth for this quarter and the next two. This was a raise.
Other items in the guide include continued healthy commercial bookings growth and a material rise in Q/Q CapEx due to the aforementioned payment delay. LinkedIn growth should be roughly 9% Y/Y.
It also guided to full year EBIT margin expanding 100-200 bps Y/Y. This compares to estimates of roughly flat Y/Y EBIT margins. Strong.
Call & Release Highlights
Key Demand Metrics:
- Commercial bookings and demand were better than expected thanks to long term Azure contract strength. Commercial bookings rose by 17% Y/Y (9% constant currency).
- Current remaining performance obligations (cRPO) rose 17% Y/Y to $222 billion. Robust cRPO growth is a great sign for strong forward looking demand.
- Cosmos Database (DB) enjoyed 42% Y/Y growth in data transactions thanks, in part, to the 50% efficiency gains it delivers.
- Office Commercial Products & Cloud Services revenue rose 15% Y/Y while Office Consumer Products & Cloud Services saw 5% Y/Y growth. Microsoft 365 now has 78.4 million consumer subscriptions, which rose 15.8% Y/Y. Commercial 365 seats rose 9% Y/Y to cross 400 million.
- Windows revenue rose 9% Y/Y; devices revenue fell 9% Y/Y; Xbox content and services revenue rose 61% Y/Y (6% Y/Y ex-Activision).
Key Margin Metrics:
- Cloud gross margin was flat Y/Y. It was up 100 bps excluding the impact of a change in accounting estimate for useful life of assets in the Y/Y period. This made comps more difficult. Microsoft cloud gross margin was 72% vs. 73% Q/Q & 72% Y/Y. EBIT margin for intelligent cloud expanded by an impressive 580 bps Y/Y. That made some jaws drop… including mine.
- Productive and Business Processes gross margin expanded a bit Y/Y while OpEx fell 5% Y/Y. Again, this was helped by easier comps related to the severance charge in the Y/Y period.
- Personal Computing gross margin improved materially Y/Y while OpEx rose 38% Y/Y, but fell 10% Y/Y ex-Activision. EBIT margin improved 200 bps Y/Y for the segment.
GenerativeAI Approach:
Microsoft has taken arguably the most aggressive and direct approach to monetizing generative AI. It’s not just using it to make existing products better; it’s bundling all of the new utility into new subscriptions and software upsells via its “Copilot” offering. Copilot was first integrated into Microsoft GitHub, but is quickly making its way to the rest of the product suite.
Incredibly, Generative AI added a full 600 bps to Azure’s growth for the quarter vs. 300 bps Q/Q. This is not a pipe dream. This is not theoretical. GenAI is making a large financial impact right now for an already massive company.
Copilot is not a one-size-fits-all add-on… and far from it. Copilot Studio allows customers to tailor and customize industry-specific needs to make the “work companion” even more relevant to their own productivity.
Azure:
Azure had another remarkably strong quarter. It’s outgrowing its second best competitor in Google Cloud despite having a far larger revenue base. I’m sure AWS’s growth rate will be well below 30% Y/Y as well. Azure AI customers rose by roughly 50% Y/Y; its advantage in cost of model training and inference stands out in today’s competitive environment. It offers access to a bevy of large language models (LLMs) including Meta’s, OpenAI’s, Cohere’s and its own. Satya walked through a long list of large clients like Walmart using Azure AI. In total, 50% of the Fortune 500 use this service today.
Azure is enjoying a “more frequent” pace of large deals flowing in. Imperatively, the “period of massive optimization of cloud workloads has ended” per CEO Satya Nadella. Less optimizing means more demand for new workloads. This is not only good news for Azure, but basically all companies reliant on cloud-based revenue growth.
GitHub & Developers:
GitHub is Microsoft’s end-to-end development and operations (DevOps) product with tools such as source code repositories. It competes directly with GitLab. GitHub revenue accelerated beyond 40% Y/Y thanks to vast Copilot adoption. Specifically, GitHub Copilot subscribers rose 30% Q/Q to reach 1.3 million.
Power Platform, Windows and the Future of Work:
- Dynamics 365 “took more market share.” 365 users with Copilot reportedly complete basic tasks 29% faster than non-users.
- Usage of cloud delivered Windows rose 50% Y/Y; Windows 11 commercial deployments doubled Y/Y.
- LinkedIn has over 1 billion members vs. 985 million Q/Q; profile skills rose 80% Y/Y as engagement remains strong. Advertising demand was “about as expected.”
- 230,000 customers are now using its suite of AI tools on the Power Platform specifically.
Gaming:
- The Activision Blizzard deal closed during the quarter and vastly propped up Y/Y personal compute growth metrics.
- With Activision, it now has 200 million gaming monthly active users (MAUs) with the inorganic infusion helping gaming hours streamed rise by 44% Y/Y.
- Importantly, on the call, CFO Amy Hood told us that personal computing demand is “stabilizing.”
Take
I feel like I can copy the “take” section from each previous review and paste it here. The same is true every single quarter: Microsoft is a best-in-class performer, operator and now stakeholder in the world of Generative AI. This company performs every single quarter with little drama regardless of the macro backdrop or exogenous headwinds. Satya Nadella is a superstar and this quarter simply provides more evidence. Congrats to shareholders on what I view as a very positive print. Enough said.
