Microsoft posted strong results with the highlight coming from Azure and the Intelligent Cloud segment. Azure accelerated by 100 basis points on a constant currency basis, meanwhile, Google Cloud decelerated 549 basis points as reported on the same evening.
Azure reported growth of 28% YoY compared to 27% last quarter. Meanwhile, Google Cloud reported growth of 22.5% compared to 28% last quarter. This is important because GCP had finally passed Azure growth quarter, only to fumble in a fairly dramatic deceleration this quarter.
The company reported a fiscal Q1 growth rate of 12.8% for revenue of $56.5 billion versus 8.8% growth expected on revenue of $54.6 billion. Microsoft beat by almost $2 billion. This flowed through to the bottom line, which was also a sizable beat at $2.99 EPS reported compared to $2.65 EPS expected.
Microsoft’s guide for next quarter came in above expectations for 15.5% revenue growth compared to 11% expected. For next quarter, analysts were expecting revenue of $58.6 billion whereas management is guiding for $60.9 billion for a raise of $2.3 billion. The company is clearly seeing the early effects of AI revenue; however, the Activision acquisition is also contributing.
Of the roughly $2B beat this quarter, $850M of the beat is coming from the Intelligent Cloud segment. This segment reported $24.3 billion in revenue for growth of 19% on a CC basis. This is an acceleration from 17% on a CC basis last quarter. Per the CFO, “Higher-than-expected AI consumption contributed to revenue growth in Azure.” Later, the CFO stated something along the same lines in regard to Azure’s beat being AI-driven: “While the trends from prior quarter continued, growth was ahead of expectations, primarily driven by increased GPU capacity and better-than-expected GPU utilization of our AI services as well as slightly higher-than-expected growth in our per-user business,”
Personal Computing also came in better than expected by $1 billion at 3% growth YoY, which beat guidance of (-4.7%). For next quarter, the guide is 13.6% growth which is a considerable rebound from the many declining quarters this segment has been reporting. This is partly due to the Activision acquisition, which will contribute to gaming growth of mid to high 40%.
Although Microsoft guided Azure growth to decelerate 1-2pts for the December quarter and then to be “stable” throughout FY24, analysts were digging to find out if conservatism was baked into the guide, and how much room there is for potential upside in Azure based on new workload starts, mostly driven by AI workloads. In addition to this, optimizations were peaking in H2 of last fiscal year, and so that is technically a tailwind as Microsoft laps those quarters in H2 of this fiscal year.
Although Azure tends to grab the headlines, the margins were also impressive. We detail this and more below.
Revenue and EPS:
As stated, the company beat on the top line and bottom line.
- Microsoft reported a fiscal Q1 growth rate of 12.8% for revenue of $56.5 billion versus 8.8% growth expected on revenue of $54.6 billion.
- This flowed through to the bottom line, which was also a sizable beat at $2.99 EPS reported compared to $2.65 EPS expected.
- Guidance was also strong at 15.5% revenue growth compared to 11% expected. For next quarter, analysts were expecting revenue of $58.6 billion whereas management is guiding for $60.9 billion for a raise of $2.3 billion.
Segment Revenue:
- Productivity and Business Processes revenue increased to $18.6B (up 13% YoY) which is an acceleration of 300 basis points from last quarter.
- Intelligent Cloud revenue increased to $24.3B (19% YoY) above guidance of $23.45B or 15.5% YoY and was driven by strength in Azure and other cloud services. This is up from 15% last quarter.
- More Personal Computing was $13.7B and above guidance of $12.5B – $12.9B, driven by strength in Gaming and Windows, partially offset by a 22% YoY decline in Devices revenue growth
Guidance on Segment Revenue:
- Productivity and Business expected to decelerate by 150 basis points at the midpoint for growth of 11% to 12% YoY.
- Intelligent Cloud revenue is expected to decelerate 150 basis points at the midpoint for growth of 17.5%
undefinedundefined - More Personal Computing is expected to show revenue of $16.5B – $16.9B representing 13.6% growth. Gaming is especially expected to be strong next quarter due to Activision, however, devices are still weak.
Margins:
This is where the report really shined.
Regarding gross margins, the company has done a good job of improving gross margins with 71.2% for the current quarter, up 200 basis points YoY. Microsoft Cloud gross margins increased by 200bps Y/Y when excluding the impact of useful lives. There was discussion on the earnings call that there is room for improvement in Cloud GMs as MSFT continues to benefit from the investments in its cloud infrastructure.
Microsoft is showing strong operating margin leverage with 47.6% in the current quarter, up from 43.2% last quarter along with strong operating margin expansion in Intelligent Cloud with 48.4% in the current quarter up from 43.9% last quarter. This flowed through to record net profit of $22.3 billion, up from $20.1 billion in the previous quarter.
There may be more room for operating margin expansion in Intelligent Cloud as the company continues to stay disciplined with OpEx with implementing the AI transition with Azure. Although MSFT maintained FY24 operating margins to be flat Y/Y, there is potential upside to operating margins on better-than-expected integration of the Activision acquisition and Microsoft’s continued efforts to improve Azure and Microsoft 365 gross margins.
- Gross margin of 71.2% was up from 69.2% in the year ago quarter. The guide is for 68% next quarter.
- Overall operating margin was 47.6%, expanding 470bps YoY and 440bps QoQ. The guide is for 42.4% next quarter. The guide for next fiscal year is for operating margin to be flat YoY.
- Net margin of 39.4% will help cement Microsoft as the leading FAAMG in terms of GAAP profit margin again. The guide was for 33.5% next quarter.
- Productivity and Business operating margin was 53.6%, expanding 310bps YoY and 410bps QoQ due to strength in Office 365.
- Intelligent Cloud operating margin was 48.4%, expanding 430bps YoY and 460bps QoQ due to strength in Azure and other cloud services. This was the best Intelligent Cloud operating margin in six years.
- More Personal Computing operating margin was 37.9%, expanding 620bps YoY and 420bps QoQ due to strength in Gaming and Windows, offset by weakness in Devices
Cash Flows:
Operating cash flow of $30.6 billion was up 32% year-over-year due to strong cloud billings and collections. This represents an operating cash flow margin of 54%.
Free cash flow was up 22% year-over-year for $20.7 billion. This compares to the June quarter with 12% YoY growth.
Key Metrics:
Commercial bookings increased 14% and 17% in constant currency in line with expectations, primarily driven by strong execution across our core annuity sales motions with continued growth in the number $10 million-plus contracts for both Azure and Microsoft 365.
GitHub CoPilot is growing rapidly with over 1 million paid copilot users across 37,000 organizations, which is up 40% QoQ. According to Microsoft, GitHub CoPilot increases developer productivity by up to 55%.
CoPilot 365 is one of the more crucial growth trajectories to watch as we move into calendar year 2024. This integrates an AI assistant for Microsoft Office and becomes available Nov 1st.
Azure Open AI Services has been adopted by 18,000 organizations, which allows companies to use OpenAI’s APIs for new development purposes. Ultimately, OpenAI creates more business for Azure even if a startup or company is not directly an Azure customer.
AzureArc is helping Microsoft to expand the meaning of hybrid and multi-cloud, to also include running apps across on-prem, edge and multi-cloud environments. This key metric grew 140% year-over-year.
Earnings Call:
The Microsoft management team is very polished so most questions are answered with fairly uneventful replies, at times. However, one analyst did get more color on future operating margin. The concern is that opex came in so low, where does Microsoft go from here?
Primarily, the CFO believes margins will be flat/stable due to: “improvements we're making in Azure and even Microsoft 365 gross margins, even in the core of the commercial cloud. It speaks to the pace at which we're delivering AI revenue with the increasing cost expense and capital investment ahead with the demand we see.”
And then, another analyst went right for the question on everyone’s minds, which is — can Microsoft sustain double-digit growth? Here is the transcript, which as you can see, the management team is fairly vague. But if you read between the lines, they’re using the word stability a lot, and that would imply no notable acceleration, but more importantly, no notable deceleration either. This could change if AI continues to show up in various segments (Office 365, Search, Security, etc)
“Question – Brent Thill: Thanks. Amy, good to see the 12% growth. Many investors are asking, can you sustain double-digit growth, especially with a stronger AI boost coming in the next several quarters?
Amy Hood: I think, looking at our – as I said, Q1 was a strong start to the year. Q2 certainly implies that we've talked about stability for Azure into the second half of the year looking at the – and in line with what we're seeing for Q2. And so I think we feel good about our ability to execute. But more importantly, our ability to continue to take share.”
Later, the CFO explained that by guiding for stable Azure growth, that Microsoft is overcoming optimization headwinds due to new AI workloads. The puts and takes lead to stable growth, and there was an underlying tone that this will ultimately set Microsoft apart: “And at the scale we're talking about being able to have stability in our Azure business does mean that we will have a lot of new workload starts. And primarily, we're expecting those to come from AI workloads, but AI workloads don't just use our AI services. They use data services and they use other things. And so that combination I think looking on a competitive basis, we feel good about our execution, we feel good about taking share, and we feel good about consistent trends. And so I feel good about that guide and what it says about where we are on share.”
If I were to wrap up the call in one word, it would be “leverage.” This was probably the most important statement on the call in terms on why the company may fare better than its peers in a recession (or excuse me, during extended periods of optimization):
“In addition, what Satya mentioned earlier in a question, and I just want to take every chance to reiterate it, if you have a consistent infrastructure from the platform all the way up through its layers, that every capital dollar we spend, if we optimize revenue against it, we will have great leverage. Because wherever demand shows up in the layers, whether it's at the SaaS layer, whether it's at the infrastructure lower, whether it's for training workloads, we're able to quickly put our infrastructure to work generating revenue.”
Conclusion:
At one point, Microsoft was left out of the FAANG acronym. This earnings season, and probably a few more in the near future, will place this profitable powerhouse at the front of the Big Tech train. This company is not messing around when it comes to the one unique advantage it has over its peers, which is simply this: enterprises.
Recommended Reading: