Microsoft Fiscal Q4 2024 Earnings: Capex Surges QoQ; Azure Remains Durable

Posted on August 1, 2024June 30, 2026 by io-fund

The reason that AI semiconductors were deep in the green is because Microsoft announced strong QoQ increase to its capex for AI infrastructure. Microsoft’s capex increased 36% sequentially and 78% YoY to $19 billion in Q4. Capex was $14 billion last quarter, where it grew 22% sequentially.

Full year 2024 capex was up 75% YoY to $55.7 billion, yet this quarter’s run rate suggests we could see up to $80 billion in capex in FY2025. Notably, management is guiding for a further YoY increase in capex in FY’25. We’ve covered the importance of Big Tech’s capex for our AI stocks in an analysis here.an analysis here.

With Azure AI forming a larger percentage of Azure’s growth and Azure customers growing 60% YoY, there seems to be no slowdown in sight for capex growth, a positive for the AI data center stocks in our portfolio which saw strong rallies following the report.

Copilot is also showing very strong growth, with Copilot accounting for over 40% of GitHub’s revenue growth this year and is already a larger business than all of GitHub when Microsoft acquired it, with Microsoft being optimistic about seeing similar adoption trends in Copilot for Microsoft 365.

This quarter, Microsoft beat on both the top and bottom lines with margins above guided levels. The stock was initially brought down by a headline miss as Azure growth of 29% and 30% YoY on a CC basis came in at the lower-end of its guidance range due to some softness in Europe during the last month of the quarter and continues to be impacted by capacity constraints.

However, while management guided for a slight deceleration in Azure growth in Q1’25, with growth of 28% to 29% in CC (vs 30% this quarter), they expect an acceleration in H2’25 as their capital investments increase AI capacity.

Microsoft Fiscal Q4 Financials:

Revenue and EPS:

Fiscal Q4 revenue grew by 15% and 16% in CC YoY to $64.7 billion. It beat expectations by $260 million, driven by a 19% increase in Intelligent Cloud revenue and the Activision acquisition that contributed 3% to revenue growth. Azure growth was 29% (30% in constant currency), which came in at the lower end of their guidance range but was consistent with Q3 when adjusting for the leap year. Azure growth included 8 points from AI services, up from 7 points last quarter, and demand continues to remain higher than available capacity.

The company guided for Azure growth of 28% to 29% percent in constant currency next quarter. Management expects Q4 consumption trends to persist through the first half of FY’25 with an acceleration in the second half as AI capacity increases.

For next quarter, management guided to $64.3 billion at the midpoint, which is below analyst estimates of $65.30 billion
GAAP EPS of $2.95 beat estimates by $0.02, representing YoY growth of 10%. Non-GAAP EPS of $2.95 beat estimates by $0.01.

Segment Revenue:

Productivity and Business revenue was $20.3 billion, up 11% YoY, driven by 13% growth in Office 365 Commercial. Growth came in 140 bps ahead of the midpoint of the guided range.
Intelligent Cloud revenue was $28.5B, up 19% YoY, driven by Azure and other cloud services revenue growth of 29%. Growth came in in-line with the midpoint of the guided range.
More Personal Computing revenue was $15.9 billion, up 14% YoY. Windows revenue increased 7% with OEM revenue growth of 4% and Commercial products and cloud services revenue growth of 11%, while devices revenue decreased (11%). Xbox content and services revenue increased 61% YoY driven by 58% of net impact from the Activision acquisition. Growth came in 320 bps ahead of the midpoint of the guided range.

Guidance on Segment Revenue:

Productivity and Business revenue guided to $20.45 billion at midpoint for growth of 9.2% to 10.8% YoY. This would be a QoQ deceleration of 100 bps in growth rate, at the midpoint.
Intelligent Cloud revenue was guided to $28.75 billion at midpoint for growth of 17.9% to 19.1% YoY. This is a deceleration of 50 bps in growth rate, at the midpoint.
More Personal Computing revenue was guided to $15.1 billion at midpoint for growth of 9% to 12% YoY. This is a deceleration of 350 bps in growth rate, at the midpoint.

Margins:

Margins topped management’s guide in gross margin, operating margin and net margin but fell across the board YoY. However, excluding the impact of an accounting estimate for useful lives, gross and operating margins would have been slightly up YoY. Operating margin for Q4 was 43.1%, 80 bps above guidance, and a 10 bps decrease YoY, helped by operating leverage and offset by the Activision acquisition.

Microsoft’s More Personal Computing segment experienced the largest QoQ operating margin decline, down 639 bp QoQ to 30.9% due to impact from the Activision acquisition.

Full year operating margins were up 287 bps, ahead of management’s guidance for 100 to 200 bps. However, management continues to expect operating margins to be down 1% in FY2025 due to increased expenses related to cloud and AI.

Gross margin of 69.6% was down from 70.1% in the year ago quarter. The guide for next quarter is 68.8%.
Operating margin was 43.1%, down from 43.2% in the year-ago quarter. Operating margin is guided for 45.1% next quarter.
Net margin was 34%, down from 35.74% in the year-ago quarter. Net margin is guided to improve to 35.7% next quarter.
Productivity and Business operating margin was 49.9%, down 191 bp QoQ but expanding 42 bp YoY.
Intelligent Cloud operating margin was 45.09%, down 175 bp QoQ but expanding 120 bp YoY
More Personal Computing operating margin was 30.9%, down 639 bp QoQ due to impact from the Activision acquisition

Cash and Debt:

Operating cash flow was $37.19 billion, up 29% YoY driven by strong cloud billings and collections.

Free cash flow was $23.3 billion, up 18% YoY reflecting higher capital expenditures to support cloud and AI offerings.

Microsoft returned $9.78 billion to shareholders in the form of dividends and share repurchases.

For Q4 2024, the company has $51.63 billion total debt, with $75.54 billion in cash and short-term investments compared to $65.44 billion in total debt and $80.02 billion in cash and short-term investments in the previous quarter. The company repaid $13.1 billion of debt in the recent quarter.

Key Metrics:

Bookings increased 17% YoY and 19% on a constant currency basis. This was significantly above expectations and driven by growth in the number of $10M+ and $100M+ contracts for Azure and Microsoft 365. This compares to 29% growth (31% on CC basis) in Bookings last quarter and compares to a -2% decrease (-1% on CC basis) in Bookings in the year ago quarter.

Commercial RPO grew by 20% YoY to $269 billion. This compares to 20% growth last quarter and 19% YoY growth in the year ago quarter.

Azure AI customers totaled more than 60,000, implying customer growth rate of nearly 60% YoY and up over 13% vs Q2’24 with average customer spend continuing to grow. The number of Azure AI customers using data and analytics tools also grew nearly 50% YoY.

The next-gen analytics platform, Microsoft Fabric, has over 14,000 paid customers, up 20% QoQ.

Azure Arc, a tool that allows organizations to manage resources not hosted on Azure, has 36,000 customers, up 90% YoY and 9% QoQ.

GitHub now has an annual revenue run rate of $2B with GitHub Copilot accounting for over 40% of GitHub’s revenue growth this year and is already a larger business by itself than all of GitHub at acquisition. GitHub Copilot has been adopted by over 77,000 companies, up 180% YoY.

Power Platform, a collection of low-code development tools, saw MAUs rise 40% YoY to 48 million. 480,000 organizations have also used the AI-powered capabilities in Power Platform, up 45% QoQ.

In its second full quarter of availability, Copilot for Microsoft 365 continues to gain traction as the number of people using Copilot daily at work nearly doubled QoQ. Copilot customers increased 60% QoQ and the number of customers with over 10,000 seats more than doubled QoQ. Copilot Studio, a low-code tool for creating and maintaining copilots, saw a 70% QoQ increase in organizations using it to 50,000.

Earnings Call:

Azure AI Growth as a Leading Indicator of Capex Investment:

Microsoft stated capex was $19 billion this quarter compared to $7.8 billion in the year ago quarter, up 77.6% YoY. This compares to $14 billion in the previous quarter, up 35.7% sequentially. For FY’24, capex was $55.7B, up 74.6% YoY. Furthermore, Microsoft is guiding for a YoY increase in capex in FY’25.

Given this significant spending, analysts are questioning whether monetization is going to match the level of investment.

Question:

Keith Weiss (Analyst)

“Is CapEx still an appropriate leading indicator for cloud growth? Or does the shift in gross margin profile change that equation? Or said another way, maybe can you give us a little bit more help in understanding the timing between the CapEx investments and the yield on those investments?”

Answer:

Satya and Amy (Management)

Satya noted “So I would say – and obviously, the Azure AI growth, that's the first place we look at. That then drives bulk of the CapEx spend, basically, that's the demand signal because you got to remember, even in the capital spend, there is land and there is data center build, but 60-plus percent is the kit, that only will be bought for inferencing and everything else if there is demand signal, right?”the Azure AI growth, that's the first place we look at. That then drives bulk of the CapEx spend, basically, that's the demand signal because you got to remember, even in the capital spend, there is land and there is data center build, but 60-plus percent is the kit, that only will be bought for inferencing and everything else if there is demand signal, right?”

Amy further noted “[…] roughly half of FY2024's total capital expense as well as half of Q4's expense, it's really on land and build and finance leases, and those things really will be monetized over 15 years and beyond… they're incredibly flexible because we've built a consistent architecture”.half of FY2024's total capital expense as well as half of Q4's expense, it's really on land and build and finance leases, and those things really will be monetized over 15 years and beyond… they're incredibly flexible because we've built a consistent architecture”.

Given the flexibility of the underlying infrastructure that comprises half of current capex spend, Microsoft feels comfortable investing in land and data centers ahead of demand though only outfits them with infrastructure kits based on observed customer demand with the KPI being Azure AI growth.

In a further answer, management noted that they can adjust capex investment with little impact on revenue growth.

Amy noted “the pace at which we fill those builds with CPUs or GPUs will be demand-driven. And so if we see differences in demand signal, we can throttle that investment on the CPU side,…the same thing on the GPU side. And so you're right that you could see relatively consistent revenue patterns and yet see these inconsistencies and capital spend quarter-to-quarter.”if we see differences in demand signal, we can throttle that investment on the CPU side,…the same thing on the GPU side. And so you're right that you could see relatively consistent revenue patterns and yet see these inconsistencies and capital spend quarter-to-quarter.”

Factors Driving Soft Q4 Azure Growth Expected to Persist

Analysts noted that Azure growth of 30% YoY came in at the lower end of their provided range of 30% to 31%, which was driven by persistent capacity constraints and modest softness in Europe. They asked management to elaborate on that and how they factored that into Q1’25 guidance.

Answer:

Amy (Management)

“The distinguishing between being at the higher end or at the lower end, really was some softness we saw in a few European geos on non-AI consumption really made the difference in that number. And we've assumed that going forward into H1 inclusive of my guide 28% to 29% going forward. And then let me separate which was your larger point, which is what are the other factors you see ongoing. Number one, you're right, capacity constraints, particularly on AI and Azure will remain in Q4 and will remain in H1.”

Broader Applications of Copilot

With GitHub Copilot already accounting for 40% of GitHub’s revenue growth this year and pushing it to an annual revenue run rate of $2 billion, analysts are questioning if there is potential for it to drive similar growth for non-developers too.

Question:

Mark Murphy (Analyst)

“With a couple of quarters of Copilot for M365 availability under your belt now, how are you assessing the capability of Copilots to replicate the productivity gains that they've created for developers, which seem to be very high and to do something similar for the broader population of knowledge workers?”

Answer:

Satya (Management)

“So we think of this as really a new design system for knowledge and frontline work to drive productivity, which would be very akin to what has happened in software engineering. So when you think about marketing or finance or sales or customer service, we will effectively replicate what you just said, which is the type of productivity we've seen in developers, will come to all of these functions as they think about their work, workflow and workout effect, all being driven by Copilots.”

Management noted that they aim to extend the productivity benefits seen with GitHub Copilot to a broader population of knowledge workers through M365 Copilot.

Valuation

Microsoft could see about 10% to 15% upside from here, at which time, it will be trading at a forward PE where the stock has met resistance two times prior.

The same is true on the sales valuation where the stock is trading at a forward PS of 11 to where a PS of 12 or 13 mark its absolute maximum valuation. There’s some room left but not a lot to work with.

Conclusion

Microsoft’s report shows continued growth in all the right areas and supports our large allocation to AI data center stocks. Ultimately, we closed Microsoft following our July quarterly webinar where we expressed valuation concerns. Pausing Microsoft in our I/O Fund portfolio is likely to be short-lived as we see the company as a clear winner in AI, with AI driving an increasing amount of Azure’s growth and with Azure continuing to be capacity constrained. We’ve also been quite vocal that enterprise is where the growth in AI will come from, and Microsoft is unique among the FAANGs for its leading position with enterprise customers. We continue to see Microsoft as a quality company, yet we are rolling the dice to see if we can get a lower entry.

Richard Chu, Equity Analyst at I/O Fund, contributed to this analysis

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Microsoft Fiscal Q4 2024 Earnings: Capex Surges QoQ; Azure Remains Durable

Posted on August 1, 2024June 30, 2026 by io-fund

The reason that AI semiconductors were deep in the green today is because Microsoft announced strong QoQ increase to its capex for AI infrastructure. Microsoft’s capex increased 36% sequentially and 78% YoY to $19 billion in Q4. Capex was $14 billion last quarter, where it grew 22% sequentially.

Microsoft Fiscal Q4 Financials:

Revenue and EPS:

For next quarter, management guided to $64.3 billion at the midpoint, which is below analyst estimates of $65.30 billion
GAAP EPS of $2.95 beat estimates by $0.02, representing YoY growth of 10%. Non-GAAP EPS of $2.95 beat estimates by $0.01.

Segment Revenue:

Productivity and Business revenue was $20.3 billion, up 11% YoY, driven by 13% growth in Office 365 Commercial. Growth came in 140 bps ahead of the midpoint of the guided range.
Intelligent Cloud revenue was $28.5B, up 19% YoY, driven by Azure and other cloud services revenue growth of 29%. Growth came in in-line with the midpoint of the guided range.
More Personal Computing revenue was $15.9 billion, up 14% YoY. Windows revenue increased 7% with OEM revenue growth of 4% and Commercial products and cloud services revenue growth of 11%, while devices revenue decreased (11%). Xbox content and services revenue increased 61% YoY driven by 58% of net impact from the Activision acquisition. Growth came in 320 bps ahead of the midpoint of the guided range.

Guidance on Segment Revenue:

Productivity and Business revenue guided to $20.45 billion at midpoint for growth of 9.2% to 10.8% YoY. This would be a QoQ deceleration of 100 bps in growth rate, at the midpoint.
Intelligent Cloud revenue was guided to $28.75 billion at midpoint for growth of 17.9% to 19.1% YoY. This is a deceleration of 50 bps in growth rate, at the midpoint.
More Personal Computing revenue was guided to $15.1 billion at midpoint for growth of 9% to 12% YoY. This is a deceleration of 350 bps in growth rate, at the midpoint.

Margins:

Microsoft’s More Personal Computing segment experienced the largest QoQ operating margin decline, down 639 bp QoQ to 30.9% due to impact from the Activision acquisition.

Gross margin of 69.6% was down from 70.1% in the year ago quarter. The guide for next quarter is 68.8%.
Operating margin was 43.1%, down from 43.2% in the year-ago quarter. Operating margin is guided for 45.1% next quarter.
Net margin was 34%, down from 35.74% in the year-ago quarter. Net margin is guided to improve to 35.7% next quarter.
Productivity and Business operating margin was 49.9%, down 191 bp QoQ but expanding 42 bp YoY.
Intelligent Cloud operating margin was 45.09%, down 175 bp QoQ but expanding 120 bp YoY
More Personal Computing operating margin was 30.9%, down 639 bp QoQ due to impact from the Activision acquisition

Cash and Debt:

Operating cash flow was $37.19 billion, up 29% YoY driven by strong cloud billings and collections.

Free cash flow was $23.3 billion, up 18% YoY reflecting higher capital expenditures to support cloud and AI offerings.

Microsoft returned $9.78 billion to shareholders in the form of dividends and share repurchases.

Key Metrics:

Commercial RPO grew by 20% YoY to $269 billion. This compares to 20% growth last quarter and 19% YoY growth in the year ago quarter.

The next-gen analytics platform, Microsoft Fabric, has over 14,000 paid customers, up 20% QoQ.

Azure Arc, a tool that allows organizations to manage resources not hosted on Azure, has 36,000 customers, up 90% YoY and 9% QoQ.

Power Platform, a collection of low-code development tools, saw MAUs rise 40% YoY to 48 million. 480,000 organizations have also used the AI-powered capabilities in Power Platform, up 45% QoQ.

Earnings Call:

Azure AI Growth as a Leading Indicator of Capex Investment:

Given this significant spending, analysts are questioning whether monetization is going to match the level of investment.

Question:

Keith Weiss (Analyst)

Answer:

Satya and Amy (Management)

In a further answer, management noted that they can adjust capex investment with little impact on revenue growth.

Factors Driving Soft Q4 Azure Growth Expected to Persist

Answer:

Amy (Management)

Broader Applications of Copilot

Question:

Mark Murphy (Analyst)

Answer:

Satya (Management)

Management noted that they aim to extend the productivity benefits seen with GitHub Copilot to a broader population of knowledge workers through M365 Copilot.

Valuation

Microsoft could see about 10% to 15% upside from here, at which time, it will be trading at a forward PE where the stock has met resistance two times prior.

Conclusion

Microsoft’s report shows continued growth in all the right areas and supports our large allocation to AI data center stocks. Ultimately, we closed Microsoft earlier this month following our July quarterly webinar where we expressed valuation concerns. Pausing Microsoft in our portfolio is likely to be short-lived as we see the company as a clear winner in AI, with AI driving an increasing amount of Azure’s growth and with Azure continuing to be capacity constrained. We’ve also been quite vocal that enterprise is where the growth in AI will come from, and Microsoft is unique among the FAANGs for its leading position with enterprise customers. We continue to see Microsoft as a quality company, yet we are rolling the dice to see if we can get a lower entry.

Richard Chu, Equity Analyst at I/O Fund, contributed to this analysis

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Cloudflare Q2 Earnings Preview: With Bated Breath for FY Outlook

Posted on August 1, 2024June 30, 2026 by io-fund

Cloudflare will report its results on August 1st. Management guided revenue in the range of $393.5 million to $394.5 million, representing YoY growth of 27.7% at the midpoint. Despite the Q1 revenue beat of 1.4%, management did not raise the FY guidance due to the mixed macroeconomic environment and geopolitical uncertainty. They remained cautious and said that the short term is uncertain, and the long term is bright.

Cloudflare is at an advantage as the company has visibility into many industries and had rightly given early warning of the slowdown in 2022. They reassured investors in the last earnings call during the Q&A that the level of concern is not the same as in Q1 2022 but remains prudent.

We see pockets of weakness (Tesla, for example, continues to face the effects of high interest rates), yet we will need to look to more commentary from Cloudflare to understand if the situation has grown worse or better as it’s not clear from our vantage point what spooked the CEO last quarter.

Revenue

The analysts expect Q2 revenue to grow 27.9% YoY to $394.5 million. Revenue growth will decelerate from 30.5% YoY to $378.6 million in Q1. It will further decelerate to 26.1% YoY growth in Q3 and 25.9% in Q4 and then accelerate to 26.2% growth in Q1 FY 2025. This is actually quite strong for best-of-breed cloud as many >40% revenue growth cloud companies have dipped <20% in recent years.

Margins

The Q1 gross margin improved 180 bps YoY and 50 bps sequentially to 77.5%. The adjusted gross margin improved 170 bps YoY and 60 bps sequentially to 79.5%. This was higher than the management’s long-term target of 75% to 77%.

The operating margin was (-14.4%) compared to (-16.3%) in the same period last year and (-11.8%) in the previous quarter. The adjusted operating margin improved 450 bps YoY and 20 bps sequentially to 11.2%. The operating expenses as a percentage of revenue were reduced by 300 bps YoY due to the focus on higher productivity and greater efficiency in the operations. Sales and marketing expenses as a percentage of revenue reduced by 100 bps, R&D expenses reduced by 200 bps and general & administrative expenses reduced by 100 bps YoY. The adjusted operating margin guide for the next quarter is 9%, up 240 bps YoY and down 220 bps sequentially.

The net loss was (-$35.5) million or (-$0.10) per share compared to (-$38.1) million or (-$0.12) per share in the same period last year. The adjusted net income was $58.2 million or $0.16 per share compared to $27.2 million or $0.08 per share in the same period last year and beat estimates by 22.6%. The guide for the next quarter is $0.14.

The analysts expect adjusted EPS to grow 40.7% YoY to $0.14 in Q2 and decline by (-6.3%) YoY to $0.15 in Q3.

Cash Flow and Balance Sheet

Q1 operating cash flow was $73.6 million or 19% of revenue compared to $36.41 million or 13% of revenue in the same period last year.
Free cash flow was $35.6 million or 9% of revenue compared to $13.9 million or 5% of revenue in the same period last year as it benefited from an uptick in collections on accounts receivable. Network capex was 8% in the recent quarter. Management expects network capex to be 10% to 12% of revenue in 2024, including the rollout of GPU capacity to every location.
The company has cash and available-for-sale securities of $1.72 billion and debt of $1.28 billion compared to $1.67 billion and $1.28 billion in the December quarter.

Key Metrics

RPO

RPO increased 8% QoQ and 40% YoY to $1.343 billion. This is an acceleration from growth of 37% YoY in the previous quarter.

Billings

The company’s primary focus is on RPO as a more comprehensive measure of its business. We track billings since they are reported for other cybersecurity stocks. Billings grew by 24% YoY and declined by (-7%) sequentially to $387.6 million and a deceleration from 28% YoY growth and 15% sequentially in the previous quarter.

DBNRR

The dollar-based net retention rate was 115% in Q1, flat QoQ but down from 117% in the year-ago quarter. Management expects the decelerating trend to stabilize around the current levels.

Customers

Customers with greater than $100,000 annualized revenue grew by 33% YoY to 2,878. The number of customers has been trending higher sequentially even though the growth decelerated from 35% in the previous quarter.

Matthew Prince, CEO and co-founder, said in the earnings call, “We added 122 new large customers, those that pay us more than $100,000 per year, and now have 2,878 large customers, up 33% year-over-year. Revenue contribution from our large customers during the quarter increased to 67%, up from 62% in the first quarter last year. Digging into our largest customers, we added a record number of net new customers year-over-year spending more than $100,000, $500,000 and $1 million on an annualized basis. We are successfully moving upmarket and becoming a larger and more strategic vendor to more and more of our customers.”

Paying customers grew by 17% YoY to 197,138 and have been growing at a similar rate in the last three quarters.

Cloudflare is reporting 2 million developers on their Workers platform. This is up from “more than a million” in a press release in November of 2023 and is up from 450K developers in May of 2022 per a corporate blog. Per the opening remarks: “The last few months were incredible for the entire workers' ecosystem. First, we crossed over 2 million active developers building applications on Cloudflare Workers. Second, in April, we GA-ed a number of key products like DY, our serverless SQL database; hyperdrive, which makes any traditional database perform like it's globally distributed; and Workers AI, which allows developers to run and tune AI models across our global network.”

Other key points to watch

FY Outlook

Cloudflare has good visibility in various industries since the company is a leading CDN player. Management has been cautious due to macroeconomic uncertainty and geopolitical tension, maintaining the FY 2024 guide of $1.648 billion to $1.652 billion, representing a YoY growth of 27.3% at the midpoint. However, the market expected a rise in the FY 2024 guide, particularly after the strong Q1.

Matthew Prince said in the earnings call, “I feel extremely confident and clear in the long-term opportunity that Cloudflare has in front of us. In the short-term, however, my crystal ball is less clear. We see a lot of signals based on our privileged position running a good chunk of the Internet. Even without that visibility, if you've been watching the news at all, it's clear that the near-term outlook for the world is uncertain, increasing tensions in the Middle East, no end in sight from the Russia-Ukraine war and potential signs of instability in Asia. It's not at all certain on anything we see that things will get worse, but we do know from even recent history that macro factors can impact short-term sales trends.”

During the Q&A, Matthew Prince clarified that they didn’t see a clear signal of a slowdown that they saw in 2022. He described the crystal ball as cloudy. “We see things that worry us, but we also see things that give us some level of optimism. And so, I think describing the crystal ball as cloudy is the right thing.”

Customer wins

The management highlighted strong customer wins during the Q1 earnings. Some of the notable include:

“The National Cyber Security Centre, the UK's technical authority for cyber threats, signed a three-year contract with Cloudflare to deliver its protective domain name service. PDNS protects over 1,400 UK organizations in central government, local government, healthcare and emergency services from malware and cyber threats.”

“A leading technology company expanded their relationship with Cloudflare, signing a three-year, $40 million pool of funds contract, $8.5 million of which are expansion.”

“A large international energy company signed a five-year, $4.5 million contract. This new customer is going all-in with Cloudflare's SASE platform with 6,000 Zero Trust seats along with CASB, DLP, browser isolation, Magic WAN and Magic Firewall.”

Network capex

The company has been efficiently managing capex despite the GPU rollout and benefitting from the uniqueness of its platform to onboard new workloads. Management mentioned that they don’t need capex like the hyperscalers. Matthew Prince highlighted in the earnings call that they sell more high-margin products like Zero Trust and SASE that require lesser capex. They also made the right decision to reserve space, sensing the AI opportunity. The company now only needs to plug the GPU cards into the servers, freeing up the capex to invest in other areas. Also, they note that the inference tasks do not require cutting-edge GPUs that are in short demand, so the company has more flexibility in choosing between different GPU vendors.

Network capex was 8% of the total revenue in Q1 and has been at the same level in the last three quarters. Management expects network capex to be 10% to 12% of revenue in 2024, including the rollout of GPU capacity to every location.

Valuation

The company trades at a P/S ratio of 18.9 and a forward P/S ratio of 16. The average P/S ratio since the company’s listing in September 2019 is 33. We continue to monitor the 20x forward P/S level that ‘best-of-breed’ cloud stocks struggle to maintain, particularly when the macroeconomic conditions worsen.

Conclusion

The company sits in an enviable position for AI inference at the Edge. The developer growth of Workers to 2 million was the highlight in the last earnings report. We continue to monitor the key metrics and the outlook for the year. We liked the management’s response on network capex as it shows they have a strategy. It’s showing up today with cash flows remaining at an acceptable percentage of revenue – although, notably, we want to stay neutral here regarding what the network capex reports in the future and continue to scrutinize cash flow margins.

Royston Roche, Equity Analyst at the I/O Fund, contributed to this article.

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Palantir’s Stock Is Priced For Perfection

Posted on July 22, 2024June 30, 2026 by io-fund

This article was originally published on Forbes on Jul 18, 2024,05:46pm EDTForbes Forbes on Jul 18, 2024,05:46pm EDT

We are no strangers to Palantir’s story, saying as far back as September 2020 prior to Palantir’s public offering that the “commercial sector is the growth story” for the company as it expands beyond government clientele. Heading into 2024, Palantir was exhibiting “multiple signs of acceleration” stemming from strong growth in its US commercial segment, driven by AIP, Palantir’s Artificial Intelligence Platform that lets customers lever Palantir’s AI and ML tools and harness the power of the latest large language models (LLMs) within Foundry and Gotham.

AIP and US commercial growth are still the main storyline for Palantir investors to watch moving through 2024, given the two are the pr imary growth drivers this year. A closer look in Q1 reveals that momentum is not slowing down for AIP, and US commercial revenue growth remains intact. Government revenue also bucked its trend of decelerating growth throughout 2023, rebounding from under 11% YoY growth in Q4 to 16% YoY growth in Q1.

However, Palantir’s management shed light on some potential hiccups in AIP’s sales cycle, which we outline below. Meanwhile, the market is pricing in a perfect story this year, which puts pressure on the stock to execute.

US Commercial Business Remains Strong

Palantir’s US commercial segment remained strong in Q1, with AIP driving strong customer growth as revenue growth accelerated on a sequential basis. Management continued to drill home AIP’s momentum in the quarter by saying: “US commercial business continues to see unprecedented demand driven by momentum from AIP.”

Palantir reported $150 million in US commercial revenue in Q1, an increase of 40% YoY.

Source: I/O Fund

US commercial revenue rose 40% YoY and 14% QoQ to $150 million in Q1, accelerating 100 bp on a QoQ basis. While this was technically a deceleration from 70% YoY growth last quarter, that came against an extremely weak comp, with the QoQ growth acceleration more reflective of Q1’s strength.

Management explained that the segment is “where we're seeing the greatest transformation. While Q1 is seasonally our slowest quarter, AIP adoption by new and existing customers helped drive notable growth in customer acquisition and revenue in our US commercial business.”

Palantir added 41 net new US commercial customers in Q1, an increase of 69% YoY and 19% QoQ.

Source: I/O Fund

Palantir added 41 net new customers in the segment, an increase of 69% YoY and 19% QoQ. This accelerated from 55% YoY growth in Q4. We also saw customer additions broaden beyond the US this quarter – the commercial segment (including international) reported total net new adds of 52. As a whole, commercial customer count rose 53% YoY and 14% QoQ to 427 customers.

This means that the commercial segment, driven by US commercial, once again dominated net new adds in the quarter. US commercial contributed 41 (and commercial 52) of Palantir’s 57 net new additions, or ~72%, compared to more than 90% of net new adds last quarter; the entire segment still contributed more than 90% of net new adds with international growth.

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AIP Interest Remains High

As has been the case since its launch just over a year ago, Palantir is continuing to witness elevated interest and high demand for AIP, and is offering developers a free trial to explore and build on AIP, but it is limited in user size and Ontology quantity.

Management said that “continued interest in AIP is loud and clear,” and shared an update on AIP bootcamp progress, saying that they have sustained the “high volume of bootcamps with over 915 organizations participating to date to meet inbound demand.” Palantir had completed 560 bootcamps across 465 organizations by February, tacking on an additional 450 organizations in just the past five months. Palantir did not share an updated bootcamp total.

Palantir also said that AIP was aiding in customer conversion and expansion, aligning with trends observed earlier in the year, where management said AIP bootcamps were “quickly converting to paying customers” or expanding existing customers’ contracts. US commercial deals rose 94% YoY to 136, and total contract value (TCV) increased 131% YoY in Q1 to $286 million. Overall, commercial TCV bookings increased 187% YoY to $505 million, with the US driving more than half of that.

In addition, Palantir said that it is “seeing substantial deal cycle compression. As one example, a leading utility company signed a seven-figure deal just five days after completing a bootcamp. Another customer immediately signed a paid engagement after just one day of their multi-day bootcamp and then converted to a seven-figure deal three weeks later.” We have seen Palantir’s quarterly deals accelerate following AIP’s launch, but we have also seen a larger proportion of deals on the smaller end, between $1 million and $5 million.

Palantir signed 87 deals in Q1, of which 27 were >$5 million and 15 of which were >$10 million.

Source: I/O Fund

Questions In Converting Customer Interest to Contracts

Despite the optimism and reiteration on elevated interest in AIP, CEO Alex Karp shared one key shortfall that the company has – which is difficulties in selling AIP.

Karp explained that Palantir is “at the way early days of figuring out how to actually get customers to buy our product. We are good at educating customers on what is the art of the possible, and then some portion of those customers buy it. So, I expect as we get better and better at that, our numbers will increase. But it is really early days. It's not — we're not flawlessly executing on our sales motion.”

While this could be viewed as a positive given the high interest in AIP, implying that Palantir is not closing as many deals as it potentially could, the market is pricing in perfection this year, and essentially looking for a beat and raise in every quarter this year. Having a sales model where management is still figuring out how to market and sell AIP to interested customers while the market wants acceleration sets the stage for a potential shortfall if Palantir cannot meet these elevated expectations.

International Headwinds Persist

Palantir is also facing some headwinds internationally, primarily in its European business.

International commercial revenue grew 16% YoY, but declined (3%) QoQ to $149 million, “as a result of continued headwinds in Europe and the revenue catch-up in Q4 that we noted last quarter.”

Management further clarified that they “do have headwinds in Europe, 16% of our business in Europe. Europe is gliding towards zero percent GDP growth over the next couple of years. That is a problem for us. There is no easy remedy for that.” Shifting into a low or no GDP growth environment may continue to pressure customer deal expansion and present headwinds to larger deal sizes if budget scrutiny persists.

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Market Pricing Palantir’s Stock for Perfection

With Q1’s beat in store and US commercial still strong, the market is looking ahead for a strong year – essentially pricing in beat and raises each quarter this year, though Palantir’s extended valuation for barely 20% YoY growth enhances downside risk to shares given the international headwinds and the noted friction in its sales process.

Palantir reported $634 million in revenue in Q1, and guided fiscal Q2 revenue between $649 million to $653 million, an increase of 22.1% YoY at midpoint. For FY24, management guided revenue of $2.677 billion to $2.689 billion, up 20.6% YoY, with US commercial revenue of $665 million, for at least 45% YoY growth.

This translates to $1.285 billion in revenue in 1H, and $1.398 billion in revenue in 2H. However, analysts are expecting Palantir to generate $1.414 billion in 2H, with FY24 revenue estimates ranging from $2.68 billion on the low end to $2.80 billion on the high end. That’s about 4.4% higher than Palantir’s guide, suggesting analysts are expecting business momentum to accelerate each quarter with a beat and raise, and increased FY24 guidance.

Palantir’s valuation leaves little to no room for error here, trading at elevated levels compared to AI-exposed large-cap enterprise software stocks with similar top-line growth and bottom-line margins. For example, Palantir’s stock trades at more than 24x forward sales, versus less than 14x forward sales for ServiceNow, which has been reporting revenue growth of >24% the last three quarters, versus 17% to 21% for Palantir.

Other ‘best-of-breed’ software stocks trade at lower multiples, despite having stronger top-line growth rates than Palantir – CrowdStrike has pulled back to below 21x sales after hovering at 24x. Snowflake and Cloudflare trade at 12.9x and 16.3x forward sales, respectively. Since the start of 2023, best-of-breed software has repeatedly struggled to achieve or maintain a valuation above 24x sales, with most rerating back to the 16x level.

While investors can argue that Palantir deserves an ‘AI premium’ from its product suite, investors will still have to value it as a mature company rather than a hypergrowth SaaS, as it’s no longer in that basket. This is the most expensive Palantir has been on a top-line valuation since November 2021, with revenue growth nearly 30 percentage points slower.

Palantir trades at more than 24x forward sales, a premium to best-of-breed software peers.

Source: YChartsYCharts

Down the line, Palantir trades at nearly 89x forward earnings (non-GAAP), again at its most expensive level in more than a year, with adjusted EPS expected to grow 32% YoY to $0.33. ServiceNow trades below 55x forward earnings for 25% EPS growth, while CrowdStrike trades similarly to Palantir at 85x forward earnings. Snowflake and Cloudflare, both not profitable on a GAAP basis, trade far above 100x forward adjusted earnings.

If Palantir’s adjusted EPS growth does slow to <20% as currently estimated by analysts, its premium multiple risks rerating lower.

Palantir trades at nearly 89x forward adjusted earnings, again at its most expensive level in more than a year.

Source: YChartsYCharts

In terms of cash flow, Palantir trades at more than 100x operating and free cash flow multiples, with an operating cash flow margin of 20% and an adjusted FCF margin of 23% in Q1. ServiceNow trades at less than half of Palantir’s multiples, despite having a superior margin profile, at a 52% OCF margin and 47% FCF margin. CrowdStrike trades at 67x OCF with a 42% margin, while Snowflake trades below 49x OCF with a 43% margin.

Source: YChartsYCharts

Across the board, Palantir trades at elevated valuation multiples, whether it be on the top-line, bottom-line, or on cash flows, not only relative to peers, but also relative to itself, trading at its highest levels or near its highest levels of the past twelve months.

Conclusion

Palantir continues to exhibit strong momentum in its US commercial segment, with Q1 results reflective of this with sequential growth accelerating alongside customer count. While AIP demand remains elevated and a core driver of Palantir’s growth, management highlighted a pitfall in that there is friction in selling the product, a key risk to watch moving forward as the market is looking for nothing short of perfection through the end of fiscal 2024.

Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.

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Cloudflare Q1: H2 Deceleration to 26.5%, CEO Spooked by Macro

Posted on May 3, 2024June 30, 2026 by io-fund

Cloudflare reported a razor-thin beat in Q1, with revenues increasing 30.5% YoY to $378.6 million, marginally ahead of the company’s guide for $373 million by $5.6 million. The guide next quarter is for $394 million at the midpoint. Analysts were expecting $393.5 million. The stock is selling off because although Cloudflare beat for two quarters, management is not raising full year guidance.

If you do the math, the current guide implies a growth rate in the second half of 26.5%. The growth rate for H1 was:

Q1 actual of $373M
Q2 guide for $394M
H1 of $767M compared to H1 revenue last year of $598.7 for H1 2024 growth of 28.1%
H2 will be revenue of $883M compared to H2 revenue last year of $698M for H2 2024 growth of 26.5%. Notably, H1 2023 had higher comps (53% both qtrs) than H2 2023 (47% and 41%) so that doesn’t help explain the deceleration, in fact, it would make the decel stand out more.

The interesting part is that Cloudflare’s key metrics are not throwing any major flags as to what is causing the deceleration. Paying customers accelerated by 20 basis points from 17% to 17.2%. Customers above $100K were up 33.5% compared to 35% in the prior quarter. RPO increased 8% QoQ from $1.245 billion to $1.343 billion for growth of 40% YoY. This is an acceleration from growth of 37% YoY in the previous quarter.

When asked why management didn’t raise full year guidance, the answer was macro concerns. Essentially, what this earnings report is communicating is that Cloudflare is quite strong, but the macro environment is not, per signals Cloudflare is seeing from their vantage point as a company that has visibility into many industries.

Revenue and EPS:

Management said Q1’s results were “fueled by a record number of net-new customers year-over-year spending more than $100,000, $500,000, and $1 million with Cloudflare on an annualized basis.”

Although adjusted EPS increased 100% to $0.16 and beat estimates by 23%, Cloudflare struggled to make improvements down the line on a GAAP basis, with GAAP operating loss widening YoY and GAAP net loss showing little improvement. Cloudflare has stubbornly high SBC expense, at $69.7 million in Q1. This is about 18.4% of revenue, meaning that Cloudflare’s path to GAAP profitability will rely on continual improvements in gross profit growth and minimizing SBC growth.

For Q1, Cloudflare reported revenue of $378.6 million, increasing 30% YoY and beating estimates by 1.4%.
Adjusted EPS of $0.16 increased by 100% YoY, and beat estimates by 23.1%. GAAP EPS was ($0.10), an increase of 16.6% YoY.
For Q2, Cloudflare guided revenue of $393.5 million to $394.5 million, representing YoY growth of 27.7%.
For Q2, Cloudflare guided adjusted EPS to be $0.14, a slight sequential decline but a YoY increase of 40%.
For FY24, Cloudflare maintained its revenue guidance for $1.648 to $1.652 billion, for YoY growth of 27.3%. Management increased its adjusted EPS forecast by $0.02, now seeing full-year adjusted EPS of $0.60 to $0.61.

Margins:

A higher mix of Zero Trust and SASE revenue contributes to the gross margin expansion. Zero Trust and SASE are discussed in more detail here.

A closer look at Cloudflare’s report shows that as revenues increased $88 million YoY, operating expenses increased $81 million, more than offsetting improvements in gross margin. However, Cloudflare reported a one-time sales & marketing compensation expense of $15 million, which was likely the primary reason for a ~41.6% YoY increase in sales & marketing spend. Stripping out this one-time expense would see GAAP operating loss improve by nearly $8 million YoY, from ($47.3 million) in Q1 of last year to ($39.5 million), instead of slipping deeper into the red at ($54.6 million).

GAAP gross margin in Q1 was 77.5% for profit of $293.6 million, a 180 bp YoY and 50 bp QoQ expansion.
Adjusted gross margin was 79.5%, a 170 bp YoY and 60 bp QoQ expansion for $301.1 million.
GAAP operating margin was (14.4%), a 190 bp YoY improvement but a 260 bp QoQ contraction from (11.8%) in Q4 2023 for operating losses of (-$54.6) million. As stated, stock-based compensation is $69.7 million which drags down GAAP profits into the red.
Adjusted operating margin was 11.2%, a 450 bp YoY and 20 bp QoQ expansion for adjusted operating income of $42.4 million.
GAAP net margin was (9.4%), a 370 bp YoY improvement but a 170 bp QoQ contraction to ($35.5) million.
Adjusted net margin was 15.4%, a 500 bp YoY and 80 bp QoQ improvement for $58.2 million.
For Q2, based on management’s guidance, adjusted operating margin is expected to be ~9%, a 220 bp QoQ contraction. They expect FY adjusted operating margin of 9.8%.

Cash and Debt:

Free cash flow decelerated from 14% last quarter to 9% this quarter for a total of $35.6 million. Operating cash flow of $73.6 million had a margin of 19.4% down from 24% last quarter. On a YoY basis, Cloudflare is trending up on cash flows but the market is sensitive right now on this line item. Despite the QoQ deceleration, the CFO stated on the call that cash would increase in H2: “We expect free cash flow to be relatively consistent with operating profit for the full year 2024 with the first half lower and the second half higher compared with operating profit.”

Network capex is expected was 8% this quarter and is expected to be 10% to 12% for FY2024, which is in line with prior comments, yet will be up from FY2023 by 200 basis points, at the midpoint.

Essentially, the 10,000-foot view is that Cloudflare is competing with hyperscalers who have very large capex budgets. The concern is that Cloudflare may not be able to keep up — where will the cash come from to build a larger footprint given the cash flow margins are fairly thin with $1.7 billion on the balance sheet although net cash is $432 million when you consider the $1.28B in debt.

The CFO pointed out why capex should remain reasonable: “We were at 8% to 9% of revenue with network CapEx in the first quarter. We said the year will be close in the range of 10 to 12, and this includes the rollout of GPU capacity pretty much to every server and every location we have.”

The CEO said something similar later in the call – that capex will remain reasonable as a percentage of revenue: “If we have to — we — so it may be that we — on a just pure dollars basis, end up spending more on GPUs. But as a percentage of revenue, we feel very comfortable that we can service these applications very well at the percentage of revenues that it is in our forecast going forward.”But as a percentage of revenue, we feel very comfortable that we can service these applications very well at the percentage of revenues that it is in our forecast going forward.” There was additional discussion from the CEO on the call quoted below.

Operating cash flow was $73.6 million in Q1, or 19% of revenue, compared to $85.4 million or 24% of revenue in Q4.
Free cash flow was $35.6 million, or 9% of revenue, compared to $50.7 million or 14% of revenue in Q4.
Cash and equivalents totaled $1.72 billion.
Debt totaled $1.28 billion.

Key Metrics:

RPO increased 8% QoQ from $1.245 billion to $1.343 billion for growth of 40% YoY. This is an acceleration from growth of 37% YoY in the previous quarter.

DBNRR was 115% in Q1, flat QoQ but down from 117% in the year ago quarter.

Customers with ARR of >$100K grew 33.5% YoY to 2,878. This customer cohort accounted for 67% of revenue in Q1, compared to 66% in Q4 and 62% a year ago.
This is down from last quarter with 35% YoY growth.
This is down from the year ago quarter with 40% YoY growth.
Paying customers of 197,138 accelerated both YoY and QoQ
This is up 20 basis points from 17% growth last quarter
This is up from 13% growth in the year ago quarter

Earnings Call:

The earnings call can be boiled down into two key discussions. The first was on capex, which was a very important discussion for the longer-term thesis of AI inference at the Edge and the Workers Platform, which we discussed here.

The second important discussion was analysts grilling management on why they didn’t raise guidance for the back half of the year. The brief answer is macro reasons, but the discussion addresses the primary reason the stock is down after hours.

Network Capex:

Today, for this report, network capex is not an issue. However, we did recently note that Super Micro has a fundamental problem where the company must raise cash to grow. Investors should pencil-in that Cloudflare could be in a similar issue someday. The management team is pulling a lot of levers to make sure this isn’t a serious concern, and ultimately if they can time their need to scale to when cash is cheap, then all will be well.

Here is what management said regarding why their approach is different from the hefty cash approach the hyperscalers take.

Answer
Matthew Prince (Executives)

[…] the thing which is really magical about Cloudflare's business, which is really elegant is that it all fits together so well. So for instance, as we sell more of our Zero Trust and SASE products, those are extremely high-margin products, and they don't require a significant additional amount of CapEx. That then frees up our ability to invest that CapEx in other areas, including in the AI space.

[…] That means that as we deploy CapEx, it's literally not shipping an entire server to support AI, but shipping just the GPU cards that go into existing servers that are in the field. That reduces the amount of CapEx that has to be deployed. And again, it works because it is all running on 1 unified network. The fact that every server across Cloudflare's entire platform is capable of performing any function that we need. That has allowed us an enormous amount of flexibility in how we can deploy things and has helped us.

[…] But in the average hyperscaler, if they're getting maybe 20% utilization out of a CPU or GPU resources that they've deployed, we can often be many times that in terms of the utilization where in CPUs we're seeing almost 80% utilization. So that efficiency allows us to get more out of every CapEx dollar. Finally, I would say that inference is different than training. And so you need different resources for that. You don't mean necessarily the most cutting-edge GPUs in order to do inference tasks. And so that has meant that we haven't had to chase down what is a — GPUs that have limited quantity. It's also meant that we can be much smarter about picking and choosing between different GPU vendors and matching workloads to whoever it is that can provide the best service. And I think over time, that gives us a significant advantage over people who are just trying to rent 1 particular type of GPU or rent that and let their customers figure out how to be as efficient as possible.

–End Quote

Workers Platform:

As we likely face some turbulence in the near-term (defined as next couple quarters) due to cloud valuations being quite high, it’s important to remember the medium-term thesis (next 1-2 years). When asked what was special about the Workers Platform, the CEO stated the following, some of which we described in detail in the October deep dive.

Answer
Matthew Prince (Executive)

In terms of why, what is it about Cloudflare that's unique? I think there are sort of 3 things that stand out to me about it. The first is just the performance of Cloudflare Workers AI because we are distributed around the world and today, over 150 locations globally, as we serve customers that serve a global audience, we can just give them a much better experience in having to ship all of your code back to some central location.

The second is that we can actually be significantly more cost effective. If you're using one of the big hyperscale cloud in order to do any sort of AI task, it's up to you to manage efficiency. You have to make sure that you're getting the most out of the GPU that you're renting whereas what we do is much more of a serverless AI model where you only pay for the task that you actually run. So especially in a lot of the start-ups, they're finding that they can just get significant better efficiency, significant better cost if they use our platform in order to deliver that AI experience. And then the third thing is that because we got it distributed globally and because of the fact that we have such a rich ecosystem that we've built, where you can get a AI experience that's allowing people to actually fine-tune their models […] We can actually correspond all of the local and regional differences all around the world. That's something that you don't get anywhere else.

—End Quote

Macro Concerns:

The tone on this particular call was that macro is providing early signals of a H2 slowdown. This was not your typical “oh, macro is hard to predict” discussion. When they discussed the H2 slowdown, it was not Cloudflare specific at all, rather that Cloudflare would have better visibility than other companies due to where they sit in terms of the internet.

This was a sample of the opening remarks:

“In the short term, however, my crystal ball is less clear. We see a lot of signals based on our privileged position running a good chunk of the Internet […] The short term is uncertain, the long term is bright, and so in the medium term, we're going to keep our hands firmly on the levers of our business […]”

Here’s an additional glimpse into the tone on the call, at times:

Question
Jonathan Ho (Analysts)

Excellent. And just a quick follow-up. Is there something specific in the macro that's maybe causing you a little bit of pause? Anything that you can sort of point to in terms of that additional concern on the outlook.

Answer
Matthew Prince (Executives)

I think that we we get a lot of signal based on where we sit on the Internet. And what I would say right now is that it's not any one thing pointing in any one clear direction. But there's a lot of noise pointing in a number of different directions that give us, I think, reason to be cautious and I think that, that is in our very nature is always taking as much signal being data-driven and making sure that we're making investments in a responsible way. And so I think the obvious thing is the geopolitical uncertainty around the world. That absolutely causes changes in buying behavior. On the other hand, some of that — those changes in buying behavior have been positive for us as we're seeing, especially in our government business, pick up because of that uncertainty.

So there are puts and takes that are out there. What we want to do is just make sure that we are being prudent and responsible and thoughtful as we make investments and as we think through how to handle the responsibility that we have with investors capital and that they've trusted us with.

–End Quote

Additional discussions on macro had a similar tone, such as this one from the CEO: “We can make investments and we can think through what that future looks like in part because we just get much more signal than I think the average enterprise SaaS company gets. And I think that, that has served us well. And I think we try not to be surprising in any way. And so as we see — I would say that there is certainly an uptick in uncertainty and sort of potential downside this quarter over last quarter.”I would say that there is certainly an uptick in uncertainty and sort of potential downside this quarter over last quarter.”

Here is more along those lines: “I think my level of concern is not at the same level that it was in Q1 of 2022, but it is definitely heightened over a lot of what we've seen in more recent quarters.”

However, one analyst didn’t let them off the hook so easily, and so to really drive home the tone of the call, I’m quoting in full one of the last questions where the analyst pushed for management to be crystal clear.

Question
Alex Henderson (Analysts)

So if nothing is really spooking you here, I'm still struggling with the guidance and the outlook for the back half of the year. You've given guidance that — or commentary that you're seeing significant strengthening of your pipeline, you're saying you're duration stable. You're seeing solid closure rates. You're adding more sales capacity, you're winning large customer deals at an accelerating rate. You’re spending more on hiring people and productivity in your sales force is significantly improving. Yet your guidance implies with the first quarter beat and the second quarter are above the Street, the back half is much more conservative. So I guess the question is, is that a function of specific weakness in a particular geography or due to political issues? Or is it just trying to feather in more opportunity for the sales organization to be realigned as Mark comes on and drives things because ultimately, it sounds like the mechanics imply an acceleration, not a deceleration.

Answer
Matthew Prince (Executives)

Yes. Alex, I'll start and then Thomas can give a little bit more color. I would push back on your initial statement, which was that nothing spooks me, a lot spooks me right now. So just because just — and I want to make it clear, we are in a much more uncertain environment and the signal that we're seeing is that uncertainty is up. In addition to that, I think you're correct that whenever you have a sales leadership change, there is risk that comes with it. And so there's a bit of that. But the primary factor here is that as we look at the signals in the overall macro economy, it is — it feels like a much more — it feels like there's much more reason to worry in Q1 than there was in Q4. But that doesn't mean that it was the same, just sound the alarm bells that we were seeing back in Q1 of 2022.

–End Quote

Conclusion:

Cloudflare’s valuation at 18x forward sales is hovering at the 20x forward PS level that ‘best-of-breed’ cloud stocks struggle to maintain. If macro does weaken, cloud stocks will get slammed for their thin FCF margins (far majority have negative FCF) and lack of GAAP profitability. Remember, I’m simply the messenger here. The reality is that cloud gets hit hard. We trimmed the position over the past quarter or so because cloud simply doesn’t sustain well at certain valuations. Had we not already trimmed Cloudflare, we would be doing so today – primarily based on valuation, secondly due to this management team being better than most at giving investors a heads-up when something is off. Meaning, management stated their crystal ball was “cloudy,” but in reality, if you’re listening, they’re being crystal clear.

With that said, Cloudflare is one of our favorite choices for the medium-term. The company sits in an enviable position for AI inference at the Edge. The key metrics are strong incl an acceleration in RPO, and I suspect that won’t be the case with most cloud peers this quarter. The developer growth on Workers to 2M is fire. I liked management’s response on network capex as it shows they have a strategy, and it’s showing up today with cash flows remaining at an acceptable percentage of revenue – although, notably, we do want to stay neutral here in terms of what the network capex reports in the future and also continue to scrutinize cash flow margins.

Recommended Reading:

Microsoft Fiscal Q3 2024 Earnings: 80% YoY Increase in Capex; Azure AI is Hitting Capacity

Posted on April 26, 2024June 30, 2026 by io-fund

Highlights this quarter include Azure’s growth of 31% up from 30% and 28% on CC basis last quarter. Of this, 7 points was from AI compared to 6 points from AI last quarter. The reason that Azure did not see more QoQ growth from AI is due to capacity constraints. In other words, Microsoft has higher demand than they have GPU supply. This is leading Microsoft to grow its capex 80% YoY from $7.8 billion in the year ago quarter to $14 billion this quarter. On a fiscal year basis, capex will grow 50% this year, and what this quarter proves, is that this high growth rate on already high capex spend is only accelerating.

Beyond Azure, management’s focus was on Copilot, which are tools that are not capacity constrained. There were many impressive statistics on Copilot that we share with you below. In addition to Copilot, Microsoft emphasized that security is their number one priority – “over anything else” – which was a good reminder for investors given AI takes up the majority of the time on the call. There were also some initial AI-powered PC stats from this ER that we share below, as well.

Microsoft has a knack for in-line reports. However, bookings and RPO were exceptionally strong this quarter. We detail this and more below.

Microsoft Fiscal Q3 Financials:

Revenue and EPS:

Fiscal Q3 revenue of $61.85 billion beat expectations by $960 million, driven by a 21% increase in Intelligent Cloud revenue and a 17% increase in More Personal Computing revenue. Azure growth was 31%, marking a continuation of the acceleration we’ve seen since the June quarter. Of this, AI drove 7 points. Per the CFO: “Azure and other cloud services revenue grew 31% ahead of expectations, while our AI services contributed 7 points of growth as expected.”

The company guided for Azure growth of 30% to 31% percent next quarter, which represents a management guide of flat growth QoQ.

Revenue and EPS:

Revenue of $61.85 billion beat estimates by 1.7%, representing YoY growth of 17% but a QoQ decrease of 0.3%.
For next quarter, management guided to $64 billion, which is under analyst estimates of $64.6 billion and lower mainly due to the rising US dollar.
GAAP EPS of $2.94 beat estimates by $0.11, representing YoY growth of 20%. Non-GAAP EPS of $2.94 beat estimates by $0.10.

Segment Revenue:

Productivity and Business revenue was $19.6 billion, up 12% YoY, driven by 15% growth in Office 365 Commercial. Growth came in 100 bp ahead of the midpoint of the guided range.
Intelligent Cloud revenue was $26.7B, up 21% YoY, driven by strong demand for server products and cloud services revenue from Azure and other cloud services revenue growth of 31%. This was a 260 bp acceleration from last quarter.
More Personal Computing revenue was $15.6 billion, up 17% YoY. Windows revenue increased 11% with OEM revenue growth of 11%, while devices revenue decreased (17%).

Guidance on Segment Revenue:

Productivity and Business revenue guided to $20.05 billion at midpoint for growth of 8.7% to 10.4% YoY. This would be a deceleration of 145 bps in growth rate, at the midpoint.
Intelligent Cloud revenue was guided to $28.55 billion at midpoint for growth of 18.3% to 19.6% YoY. This is a deceleration of 205 bps in growth rate, at the midpoint.
More Personal Computing revenue was guided to $15.4 billion at midpoint for growth of 9.4% to 12.2% YoY. This would be a deceleration from 17% growth on CC basis this quarter.

Margins:

Margins were strong across the board, topping management’s guide in gross margin, operating margin and net margin. Operating margin for Q3 was 45%, 210 bp above guidance, and a 270 bp increase YoY.

We’ve previously discussed how there may be room for continued operating margin expansion in Intelligent Cloud, but in this report, it was Microsoft’s More Personal Computing segment that experienced strong operating margin expansion, up 610 bp QoQ to 31.6% as the company shifted the sales mix to higher margin businesses.

One of the more bullish comments on the call was the CFO guiding full year operating margin to be up 2 points for FY2024. There was a note it would be down 1 point for FY2025 due to higher capex. Overall, Microsoft has done an excellent job maintaining margin strength.

Gross margin of 70.1% was up from 69.5% in the year ago quarter. The guide for next quarter is approximately 69.2%.
Operating margin was 45%, up from 42.3% in the year-ago quarter. Operating margin is guided for 42.3% next quarter.
Net margin was 35.5%, up from 34.6% in the year-ago quarter. Net margin is guided to decelerate to 33.6%, implying a decrease QoQ.
Productivity and Business operating margin was 51.8%, down 160 bp QoQ but expanding 250 bp YoY.
Intelligent Cloud operating margin was 46.9%, down 120 bp QoQ but expanding 400 bp YoY due to strength in Azure.
More Personal Computing operating margin was 31.6%, up 610 bp QoQ due to a sales mix shift to higher margin businesses.

Cash and Debt:

Operating cash flow was $31.9 billion, up 31% YoY driven by strong cloud billings and collections.

Free cash flow was $21 billion, up 18% YoY reflecting higher capital expenditures to support cloud and AI offerings.

Microsoft returned $8.4 billion to shareholders with $5.6 billion in dividends and $2.8B in share repurchases.

For Q3 2024, the company has $65.44 billion total debt, with $80.02 billion in cash and short-term investments.

Key Metrics:

Bookings increased 29% YoY and 31% on a constant currency basis. This was driven by strength in large, long-term Azure contracts and “strong execution across our core annuity sales motions.” This compares to 17% growth (9% on CC basis) in Bookings last quarter and compares to 11% growth (12% on CC basis) in Bookings in the year ago quarter. This is the highest quarter for bookings since fiscal year 2022.

Commercial RPO grew by 20% YoY to $235 billion. This compares to 17.5% growth last quarter and 26% YoY growth in the year ago quarter.

Last quarter, it was stated that “more than half of the Fortune 500 are using Azure OpenAI Services” and this was updated to “more than 65% of the Fortune 500 now use Azure OpenAI services.” Last quarter, it was stated that “Azure AI customers totaled more than 53,000, with one-third of these being new customers over the past twelve months. This implies customer growth rate of approximately 50% YoY.” This quarter, it was updated to: “The number of $100 million-plus Azure deals increased over 80% year-over-year, while the number of $10 million-plus deals more than doubled.” These aren’t exactly apples-to-apples but seems to imply the trend is up.

According to the opening remarks, over half of Azure AI customers use their data and analytics tools. The next-gen analytics platform, Microsoft Fabric, has over 11,000 paid customers.

Beyond AI, Microsoft stated cloud migrations contributed to Azure growth, as well. Azure Arc has 33,000 customer up 200% YoY as legacy workloads from Oracle and SAP are migrated to Azure.

GitHub commentary certainly showed impressive growth with paying subscribers at 1.8 million, up from 1.3 million last quarter for growth of 35% QoQ up from 30% QoQ. Revenue accelerated 45% YoY and it was stated that “more than 90% of the Fortune 100 are now GitHub customers.”

Copilot for Microsoft 365 was available for its first full quarter with 30,000 organization using Copilot Studio. The low code, no-code Power Platform is being used by “over 330,000 organizations, including over half of Fortune 100 have used AI-powered capabilities in Power Platform, and Power Apps now has over 25 million monthly active users, up over 40% year-over-year.”

There was an important update on CoPilot for Windows provided, which is that it’s now available in 225 million Windows 10 and Windows 11 PCs and is “up 2X quarter-over-quarter.” The company also teased an upcoming event: “And there's much more to come in just a few weeks, we'll hold a special event to talk about our AI vision across Windows and devices.”

Earnings Call:

Well, I won’t be shy about the fact that our firm has been particularly keen to hear capex commentary from this week’s earnings reports. Microsoft’s report was as bullish as it could be on that point.

Capex:

Microsoft stated capex was $14 billion this quarter compared to $7.8 billion in the year ago quarter, up 80% YoY. This compares to $11 billion in the previous quarter, up a whopping 27.2% sequentially.

The way analysts are thinking of this is up 50% YoY on a run rate for this current fiscal year ending in June with whispers this could get to $100 billion.

Keith Weiss (Analysts)

congratulations on the fantastic quarter. a lot of excitement in the marketplace around generative AI and the potential of these technologies. But there's also a lot of investment going on behind them. It looks like Microsoft is on track to ramp CapEx over 50% year-on-year this year to over $50 billion. And there's media speculation of more spending ahead with some reports talking about like $100 billion data center. So obviously, investments are coming well ahead of the revenue contribution. It looks like Microsoft is on track to ramp CapEx over 50% year-on-year this year to over $50 billion. And there's media speculation of more spending ahead with some reports talking about like $100 billion data center. So obviously, investments are coming well ahead of the revenue contribution.

But what I was hoping for is that you could give us some color on how use as the management team, try to quantify the potential opportunities that underlie these investments because they are getting very big. And maybe if you could give us some hint on whether there's any truth to the potential of like $100 billion data center out there.And maybe if you could give us some hint on whether there's any truth to the potential of like $100 billion data center out there.

There was not a direct answer other than the following tone – but the overall message is key to the I/O Fund’s portfolio allocation, and thus, the question in this case reveals more than the answer in terms of what institutions are expecting: “So this is not the quarter. I realize in the news, it's a lot more in the quarter nowadays. But if you look at it, we have been doing what is essentially capital allocation to be a leader in AI for multiple years now, and we plan to sort of essentially keep taking that forward.”

AI Demand Exceeds Capacity

According to the CFO’s opening remarks: “We expect capital expenditures to increase materially on a sequential basis driven by cloud and AI infrastructure investments. As a reminder, there can be normal quarterly spend variability in the timing of our cloud infrastructure build-outs and the timing of finance leases. We continue to bring capacity online as we scale our AI investments with growing demand. Currently, near-term AI demand is a bit higher than our available capacity.” Currently, near-term AI demand is a bit higher than our available capacity.” It was also stated that growth in Azure next quarter “will be driven by our Azure consumption business and continued contribution from AI with some impact from the AI capacity availability noted earlierwith some impact from the AI capacity availability noted earlier.

This later led to an important part of the Q&A that helps spell out why Microsoft must increase capex, and how they expect it to flow-through to Azure. Commentary that Azure is hitting capacity due to demand is very bullish for the outlook on GPUs and ASICs this year.

Question
Karl Keirstead (Analysts)

Satya and Amy, congrats on these outstanding Azure results. I'd love to hone in a little bit on the 7-point lift to Azure growth from AI, outstanding number, but it's leveling off a little bit from 6 points in December. I'm wondering if you could unpack that a little bit. To what extent did the capacity issues that you Amy highlighted on the call, impact that number. Is there any seasonality? I wouldn't think so or any other factor that can swing around that number that you'd advise us to keep in mind?

Answer
Amy Hood (Executives)

[…] it is how much capacity we have in play and how much capacity that we have to sell on the inferencing side, in particular. And so that is partially why you see the capital investment in the shape that is, is because right this minute, we do have demand that exceeds our supply by a bit. So it is fair to say that, that could have been an impact on the number for the quarter and it does impact a little bit the number in Q4.it is how much capacity we have in play and how much capacity that we have to sell on the inferencing side, in particular. And so that is partially why you see the capital investment in the shape that is, is because right this minute, we do have demand that exceeds our supply by a bit. So it is fair to say that, that could have been an impact on the number for the quarter and it does impact a little bit the number in Q4.

Security #1 Priority:

I wanted to pull out this quote from the opening remarks as it was a particularly strong statement in terms of how Microsoft thinks of their security products moving forward. It seemed as if this means security is an even bigger priority than AI (although the capex increase communicates otherwise):

“Security underpins every layer of the tech stack and it's our #1 priority. We launched our Secure Future initiative last fall for this reason, bringing together every part of the company to advance cybersecurity protection and we are doubling down on this very important work, putting security about all else before all other features and investmentsSecurity underpins every layer of the tech stack and it's our #1 priority. We launched our Secure Future initiative last fall for this reason, bringing together every part of the company to advance cybersecurity protection and we are doubling down on this very important work, putting security about all else before all other features and investments.”

Conclusion:

For our purposes, Microsoft’s report confirms we are on the right track for 2024 in terms of how we have structured our portfolio for the AI data center (reference the webinar highlights here). Microsoft’s report signals the trend is clearly up for AI in the years to come – both for Microsoft and the many other AI data center stocks we own. We are pleased to have this stock in our portfolio and our goal is to continue to add at key levels. There is no question in my mind that Microsoft will remain in the Mag 7 over the next decade, alongside Nvidia. The only remaining questions are when do we buy and how much. If we are lucky, we will get it lower in the near-term to hold for the long-term.

Recommended Reading:

Microsoft Fiscal Q3 2024 Earnings: 80% YoY Increase in Capex; Azure AI is Hitting Capacity

Posted on April 26, 2024June 30, 2026 by io-fund

Notably, Microsoft’s report, Tesla report with 130% increase in H100 equivalents, and Meta’s earnings report supports what we discussed in our recent Quarterly Kickoff webinar on capex and AI spend. To understand critical points on how we have structured our AI portfolio, view the Quarterly Kickoff webinar here. Per the webinar, Microsoft’s report was a vote of confidence we are positioned well.

Microsoft has a knack for in-line reports. However, bookings and RPO were exceptionally strong this quarter. We detail this and more below.

Microsoft Fiscal Q3 Financials:

Revenue and EPS:

The company guided for Azure growth of 30% to 31% percent next quarter, which represents a management guide of flat growth QoQ.

Revenue and EPS:

Revenue of $61.85 billion beat estimates by 1.7%, representing YoY growth of 17% but a QoQ decrease of 0.3%.
For next quarter, management guided to $64 billion, which is below analyst estimates of $64.6 billion and lower mainly due to the rising US dollar.
GAAP EPS of $2.94 beat estimates by $0.11, representing YoY growth of 20%. Non-GAAP EPS of $2.94 beat estimates by $0.10.

Segment Revenue:

Productivity and Business revenue was $19.6 billion, up 12% YoY, driven by 15% growth in Office 365 Commercial. Growth came in 100 bp ahead of the midpoint of the guided range.
Intelligent Cloud revenue was $26.7B, up 21% YoY, driven by strong demand for server products and cloud services revenue from Azure and other cloud services revenue growth of 31%. This was a 260 bp acceleration from last quarter.
More Personal Computing revenue was $15.6 billion, up 17% YoY. Windows revenue increased 11% with OEM revenue growth of 11%, while devices revenue decreased (17%).

Guidance on Segment Revenue:

Productivity and Business revenue guided to $20.05 billion at midpoint for growth of 8.7% to 10.4% YoY. This would be a deceleration of 145 bps in growth rate, at the midpoint.
Intelligent Cloud revenue was guided to $28.55 billion at midpoint for growth of 18.3% to 19.6% YoY. This is a deceleration of 205 bps in growth rate, at the midpoint.
More Personal Computing revenue was guided to $15.4 billion at midpoint for growth of 9.4% to 12.2% YoY. This would be a deceleration from 17% growth on CC basis this quarter.

Margins:

Margins were strong across the board, topping management’s guide in gross margin, operating margin and net margin. Operating margin for Q3 was 45%, 210 bp above guidance, and a 270 bp increase YoY.

Gross margin of 70.1% was up from 69.5% in the year ago quarter. The guide for next quarter is approximately 69.2%.
Operating margin was 45%, up from 42.3% in the year-ago quarter. Operating margin is guided for 42.3% next quarter.
Net margin was 35.5%, up from 34.6% in the year-ago quarter. Net margin is guided to decelerate to 33.6%, implying a decrease QoQ.
Productivity and Business operating margin was 51.8%, down 160 bp QoQ but expanding 250 bp YoY.
Intelligent Cloud operating margin was 46.9%, down 120 bp QoQ but expanding 400 bp YoY due to strength in Azure.
More Personal Computing operating margin was 31.6%, up 610 bp QoQ due to a sales mix shift to higher margin businesses.

Cash and Debt:

Operating cash flow was $31.9 billion, up 31% YoY driven by strong cloud billings and collections.

Free cash flow was $21 billion, up 18% YoY reflecting higher capital expenditures to support cloud and AI offerings.

Microsoft returned $8.4 billion to shareholders with $5.6 billion in dividends and $2.8B in share repurchases.

For Q3 2024, the company has $65.44 billion total debt, with $80.02 billion in cash and short-term investments.

Key Metrics:

Commercial RPO grew by 20% YoY to $235 billion. This compares to 17.5% growth last quarter and 26% YoY growth in the year ago quarter.

According to the opening remarks, over half of Azure AI customers use their data and analytics tools. The next-gen analytics platform, Microsoft Fabric, has over 11,000 paid customers.

Beyond AI, Microsoft stated cloud migrations contributed to Azure growth, as well. Azure Arc has 33,000 customer up 200% YoY as legacy workloads from Oracle and SAP are migrated to Azure.

Earnings Call:

Capex:

The way analysts are thinking of this is up 50% YoY on a run rate for this current fiscal year ending in June with whispers this could get to $100 billion.

Keith Weiss (Analysts)

AI Demand Exceeds Capacity

Question
Karl Keirstead (Analysts)

Answer
Amy Hood (Executives)

Security #1 Priority:

Conclusion:

For our purposes, Microsoft’s report confirms we are on the right track for 2024 in terms of how we have structured our portfolio for the AI data center (reference the webinar here). Microsoft’s report signals the trend is clearly up for AI in the years to come – both for Microsoft and the many other AI data center stocks we own. We are pleased to have this stock in our portfolio and our goal is to continue to add at key levels. There is no question in my mind that Microsoft will remain in the Mag 7 over the next decade, alongside Nvidia. The only remaining questions are when do we buy and how much. If we are lucky, we will get it lower in the near-term to hold for the long-term.

Recommended Reading:

Cybersecurity Stocks: CrowdStrike Soars While Palo Alto And Zscaler Fall

Posted on March 10, 2024June 30, 2026 by io-fund

This article was originally published on Forbes on Mar 7, 2024,08:19pm ESTForbes Forbes on Mar 7, 2024,08:19pm EST

This year has led to a split landscape for cybersecurity stocks, with two of cybersecurity leaders up more than 20% YTD while others are negative YTD. In the past, we’ve discussed the resiliency of the cybersecurity trend being that it’s one of the highest costs that enterprises face at 12% of IT budgets on average. The cost of cybercrime continues to rise, and is estimated to reach $10.3 trillion by 2025 and $13.8 trillion by 2028. AI and automation are playing an increasingly large role in the industry, with 560,000 new pieces of malware detected every day. Software systems cannot keep up with this, and AI is already assisting human teams in identifying which threats require more analysis.

Source: Data by YCharts

Despite the strength of the trend, we are seeing mixed results across cybersecurity leaders. Palo Alto cut its billings and revenue forecast in a shift to a “platformization” approach. Zscaler fell despite beating on the top and bottom line as it pointed to a rather sharp deceleration in calculated billings. In contrast, CrowdStrike rose nearly 11% after it beat estimates with another record in net new ARR, and guided fiscal Q1 marginally ahead of consensus. Adding to CrowdStrike’s strength, Fortinet has rallied double-digits year-to-date despite signaling that growth is slowing, with revenue and billings set to decelerate sharply this year.

However, if we zoom out, it’s quite clear what the strongest cybersecurity stock has been with CrowdStrike’s 1-year returns of 162% well ahead of its peers. The analysis below looks at why some are starting the year exceptionally strong, while others are not in the leading cloud vertical of cybersecurity.

Source: Data by YCharts

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Fortinet: Growth Is Slowing

Although Fortinet reported solid improvement in operating income and EPS for fiscal 2024, revenue growth and billings growth is slowing considerably. Revenue increased 10.2% YoY to $1.42 billion in the quarter, a 570 bp deceleration from 16% growth in Q4. Fortinet had initially guided for billings to decline YoY to $1.63 billion at midpoint, but it handily beat its guide as it reported 8.5% growth with billings of $1.89 billion. This was a 280 bps acceleration from 5.7% billings growth in Q3, but a far cry from the 30% range seen through 2021 and 2022, with growth decelerating swiftly through 2023.

Source: I/O Fund

Q4’s billings were driven by signing 13 deals above >$10M generating $232M in billings (up 177% YoY). However, the Q4 beat was short lived with Q1’s guide pointing to a (5%) YoY decline in billings to $1.43 billion at the midpoint. Growth is expected to be minimal for the full year, with Fortinet pointing to $6.4 billion to $6.6 billion in billings, or growth of 0% to 3%.

This would represent a significant slowdown in billings growth over the past two years, from 33.8% in 2022 to 14.4% in 2023 to the low-single digit range for 2024. Revenue growth is decelerating rather rapidly as a result, with Fortinet’s $5.76 billion guide for the full year pointing to growth in the high single digit range from $5.31 billion in 2023. Consensus estimates were at $5.94 billion for 11.9% growth, but that has since been revised lower to $5.79 billion for 9.1% growth.

Product revenue has declined for two consecutive quarters, in part due to tough comps in late 2022. Management explained that product revenue “will continue to be impacted by project and product digestion in 2024,” though the “selling environment should improve in the second half of 2024 and into 2025.”

Source: I/O Fund

Services revenue growth has slowed to under 25%, the lowest level since early 2022. Given services’ share at nearly 66% of revenue in Q4, a prolonged deceleration would bode negatively for revenue growth moving forward. There were positives emerging in SecOps, which grew 44%, and SSE element of SASE, which management added also witnessed more than 40% growth in the quarter.

Palo Alto: Billings and Revenue Forecasts Cut in Platformization Approach

Palo Alto shares plunged over (28%) after its fiscal Q2 earnings report when management cut its billings and revenue forecast for the full year. We had informed our readers in the analysis “The Strongest Cybersecurity Stocks in Q3” in December following Palo Alto’s weak billings in Q1 that this was “amplifying concerns that revenue and billings growth is decelerating.”

Palo Alto also unveiled a stronger push for “platformization” among its three platforms to drive vendor consolidation, saying that it intends to make “significant additional investments” in this strategy as it will be “a major area of focus for us as we move forward.”

Revenue in fiscal Q2 increased 19% YoY to $1.98 billion, a 1 percentage point deceleration from 20% in Q1. Palo Alto cut its full year revenue guide by $0.2 billion to $7.95 billion to $8.0 billion, for growth of 15% to 16% YoY, and also cut its billings forecast by ~5%. Palo Alto is now seeing billings at $10.1 to $10.2 billion, for growth of 10% to 11% YoY, down from its prior view for $10.7 to $10.8 billion due to impacts in its federal government business. This implies a further deceleration over the next two quarters, potentially to revenue growth in the low teens.

However, next-gen offerings continued to see strong demand and growth: networking security SASE ARR increased more than 50% YoY for the fifth consecutive quarter, while Next-Gen Security (NGS) ARR rose 50% YoY to $3.49 billion. Palo Alto also saw the highest number of deals signed for XSIAM (Extended security intelligence and automation management) in the quarter.

Source: I/O Fund

Palo Alto is taking a more aggressive approach to “platformizing” its offerings as customer LTV increases exponentially per platform added. It sees the near-term headwinds to revenue and billings growth as merely a blip in its long-term target to reach $15 billion in NGS ARR by 2030, up from its guided $3.95 to $4 billion in 2024. Revenue growth is expected to remain pressured through FY24 and begin inflecting higher through the end of FY25 (12 to 18 months), as the headwinds of this approach begin to fade.

Source: Investor Relations

While this exponential increase in customer long-term value alone can support this strategy shift, peer Fortinet also highlighted other positives around this approach: “Consolidation allows security solutions to share data and communicate with each other, reducing complexity, improving security effectiveness, easing the need for skilled labor, and lowering the total cost of ownership. Consolidation drove our SecOps business to 44% growth, with strong growth from EDR, SIEM, email security, and NDR.”

Zscaler: Calculated Billings to Decline Sequentially

Zscaler beat on the top and bottom line, and marginally boosted its full year revenue and calculated billings forecast. Despite the beat and raise, Zscaler guided for a (7%) sequential decline in calculated billings for Q3, suggesting further deceleration in this key metric to the low-20% range.

Revenue increased 35% YoY to $525 million, a slight deceleration from 40% growth in Q1; Zscaler guided for 28% YoY growth in Q3 to $535 million at midpoint. As a result, Zscaler marginally boosted its full year revenue outlook to $2.118 to $2.122 billion, up approximately 1% from its prior view for $2.09 to $2.10 billion.

Zscaler tightened its billings growth outlook to $2.55 to $2.57 billion, at the upper end of its prior forecast for $2.52 to $2.56 billion. This correlates to 25% to 26% YoY growth. We had said in December following Q1’s release that the fact Zscaler “did not raise its full-year billings outlook as it tends to do” suggested that ‘billings growth will decelerate through the remainder of the fiscal year.” This is currently what is playing out – calculated billings increased 34% in Q1, decelerating to 27% in Q2. Q3’s forecast for a (7%) QoQ decline implies calculated billings of $584 million, or a further deceleration to just 21% growth.

Source: I/O Fund

GAAP profitability remains elusive, unlike peers CrowdStrike and Palo Alto, who have both recorded quarters with GAAP operating and net profitability. Zscaler has been making inroads on the GAAP profitability front, with GAAP operating margin just above (9%) and GAAP net margin at (6.7%) for the past two quarters. However, until Zscaler can meaningfully reduce operating expenses, currently at approximately 87% of revenues, GAAP profitability will continue to remain elusive should growth decelerate.

Interestingly, Zscaler commented that it believes it is “still operating in a challenging macroenvironment and customers continue to scrutinize large deals,” and that its 2024 outlook balances its “business optimism with ongoing macroeconomic uncertainties and sales leadership changes.”

CrowdStrike: Shares Fly With Record Net New ARR, Robust RPO, Margin Strength

CrowdStrike reported a new record for net new ARR in Q4, far surpassing the record it set in the previous quarter, as GAAP margins continued to strengthen. For FY25, CrowdStrike’s guide was marginally above consensus, yet the market is clearly pleased with this continued expansion in operating and net margins. The turnaround on net new ARR is notable, yet the turnaround on GAAP profitability is what is most impressive compared to its cloud peers, especially considering the far majority of cloud stocks are years away from GAAP profitability (if they ever get there). We covered the earnings report in-depth for our premium members here.

Net new ARR accelerated significantly in the quarter to 27% growth, which is a 14-point acceleration from 13% growth in Q3. This is up from 2% growth for net new ARR in the year ago quarter. The turnaround in this particular key metric is notable, especially compared to other cloud stocks whose key metrics are decelerating. ARR increased 34% to $3.44 billion, which was down 1 percent from 35% growth last quarter.

CrowdStrike’s management stated that the company continues “to aggressively invest in our innovation engine and flank the company to achieve its vision of reaching $10 billion in ARR over the next 5 to 7 years.” That would imply about 200% growth in 5-7 years. The growth of deals with total value exceeding $1 million accelerated to “over 30%” this quarter for 250 customers.

Source: I/O Fund

Margins strengthened across the board – driven by four quarters of GAAP gross margin at 75% and GAAP subscription margin at 78%, both up from the prior year. To further illustrate CrowdStrike’s margin expansion, GAAP operating income was $30 million this quarter compared to (-$61.5) million in the year ago quarter. This is up from $3.2 million last quarter. For the full year, CrowdStrike nearly broke even from operations, reporting just a ($2 million) loss from operations, or a (0%) margin, an 800 bp improvement from FY23. CrowdStrike also reported its first full year with GAAP net profitability, reporting a 2.9% net margin, compared to an (8.2%) margin in FY23.

CrowdStrike echoed Zscaler with its macro commentary, saying that it believes the “current macro environment remains stable and consistent with prior quarters,” as it expects “continued deal scrutiny throughout this coming year.” Management added that its fiscal Q1 and FY25 guidance “assumes a consistent, challenging macro backdrop.”

Conclusion

The 1-year performance across cybersecurity leaders is quite variable, ranging from an impressive 161% to a mere 17%. This makes it well worth our time to monitor the metrics driving performance in this sector. Billings growth will be important to continue to track, as some hints of weakness last quarter spilled over into reduced forecasts from Palo Alto and Fortinet. Revenue deceleration will also be a key metric to watch given the decelerations guided from Palo Alto and Fortinet. Most importantly, these key metrics can provide clues as to which companies will be strongest moving into the rest of 2024 and beyond.

If you own Cybersecurity stocks or are looking to own these stocks, consider joining us for our next broad market webinar. Every Thursday at 4:30 pm Eastern, the I/O Fund team holds a webinar for premium members to discuss how to navigate the broad market, manage risk, as well as revealing our various long-term game plans regarding stock entries and exits. We offer trade alerts plus an automated hedging signal. The I/O Fund team is one of the only audited portfolios available to individual investors. Learn more here.

Recommended Reading:

Palantir Stock Surges From Artificial Intelligence Platform

Posted on February 20, 2024June 30, 2026 by io-fund

This article was originally published on Forbes on Feb 15, 2024,04:51 pm ESTForbes Forbes on Feb 15, 2024,04:51 pm EST

Palantir’s Q4 earnings confirmed an acceleration in its US commercial business as it closed out its first GAAP profitable year. Shares are reflecting the optimism surrounding Palantir’s commercial segment and bottom line expansion, with shares up more than 47% YTD and nearly 280% since the start of 2023.

We noted in our stock newsletter in December that Palantir was “exhibiting multiple signs of acceleration heading into 2024 with an improved fundamental backdrop driven by increasing AI demand. Palantir’s Artificial Intelligence Platform (AIP) is driving a significant acceleration in its US commercial business, while underlying metrics and the bottom line are rapidly improving.”

Revenue acceleration stemming from the commercial business is the major story for Palantir through 2024 and into 2025, with revenue growth poised to accelerate from 17% last year to 20% this year and nearly 21% in 2025.

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Strong Acceleration in US Commercial Is Driving Growth

In a deep dive at the time of Palantir’s direct listing, our firm said in 2020 that the “commercial sector is the growth story.” Palantir’s public offering was seen as a way to facilitate attracting and acquiring commercial clients before AI brought a wave of competition. The fruits of Palantir’s labor are beginning to pay off, with a newfound rapid acceleration in its US commercial business after AIP’s launch in Q2 was met with “unprecedented” demand. At its core, Palantir’s AIP is a comprehensive AI solution that lets customers lever Palantir’s AI and machine learning tools and harness the power of the latest large language models (LLMs) within Foundry and Gotham. Customers can deploy LLMs on their own private networks using their own private data, maximizing data security and improving efficiency by helping reduce data transfer and storage costs.

Although its US commercial segment accounts for less than 25% of quarterly revenue — it just surpassed a $500 million annual run rate in Q4 — it is now becoming the dominant factor behind the strong business momentum Palantir has seen over the past few quarters.

US commercial revenue rose 70% YoY to $131 million, a 37 percentage point acceleration from Q3 and a 58 percentage point acceleration from the year ago quarter. For the full year, US commercial revenue rose at more than double Palantir’s growth rate, increasing 36% YoY to $457 million.

The graph below illustrates just how strong the recent quarter was:

Source: PALANTIR

This acceleration in the US over the past two quarters is driving global commercial revenue higher. Palantir’s global commercial revenue accelerated by 22 percentage points, from 10% growth in Q2 to 32% in Q4. The segment topped a $1.1 billion annual run rate last quarter, up from a $920 million run rate two quarters ago.

Source: PALANTIR

While the revenue acceleration was the main headline for the US commercial business, a closer look reveals that the segment also drove more than 90% of Palantir’s customer additions with very strong underlying metrics.

Palantir reported 55% YoY and 22% QoQ growth in US commercial customer count to 221 in the quarter, as customer growth continues to accelerate. Over the past two quarters, Palantir has added 60 net new US commercial customers with 40 customers added in Q4 alone. This is more than 3X higher than the previous period of just 18 net new US commercial customers from Q4 2022 to Q2 2023.

Source: PALANTIR

Global commercial customers increased 44% YoY and 14% QoQ to 375 customers – representing 45 net new customer additions in the quarter. This means the US commercial segment drove more than 90% of Palantir’s net new customer additions in Q4. That compares to below 63% of net new customer additions in Q3 and just 20% in Q2.

This growth was “meaningfully driven by AIP” with Palantir saying that “demand is off the charts” for its new product. AIP is “propelling growth both through new customer acquisitions and expansions with existing customers,” with evidence of AIP bootcamps “helping to significantly compress sales cycles and accelerate the rate of new customer acquisition.”

Palantir had set a goal in October to hit 500 AIP bootcamps to drive top of funnel growth, and it has already surpassed that target, completing 560 bootcamps in just four months.

CRO Ryan Taylor commented on how this translates through to growth in the US commercial segment, with “70% year-over-year growth in revenue in Q4, 55% growth in customer count year-over-year, and a 107% growth in TCV closed on an adjusted basis […] Either it's — first, it's bootcamps that are quickly converting to paying customers or its expansion of existing customers or it's customers where maybe we've been engaged for a while and introduction of AIP, that whole process has been accelerated. We're seeing that across the board, and yet at the same time, we barely touched that addressable market.”

Engaging customers via bootcamps to then translating that engagement into new customer deals or expanded deals sets the foundation for sustained revenue growth at a higher rate, more so if it can drive its net retention rate higher.

A Note on Net Retention Rate

Palantir reported a company-wide NRR of 108% in Q4, but noted that it “does not yet fully capture the acceleration in our US commercial business” since customers acquired over the last twelve months are not reflected in the calculation. A majority of the net new customer additions have come in the last two quarters, suggesting US commercial NRR will be higher than 108% come the end of FY24 when this customer cohort is reflected. For context, Palantir reported an NRR of 150% at the end of FY21 in US commercial, but that likely fell significantly when growth slowed to a crawl at the end of FY22.

If AIP can continue to drive a high level of customer acquisition and expansion through FY24, this can help drive and maintain the revenue acceleration we’re seeing in the segment through FY25 and into FY26.

Valuation Remains a Risk Despite Strong Improvement in Fundamentals

Fundamentally, Palantir has seen major improvements throughout FY23, as it became the company’s first GAAP profitable year.

Gross margin has expanded consistently throughout the year, rising 300 bp YoY from 79% to 82% in Q4. GAAP operating margin shifted positive and expanded in each quarter in 2023, rising from (4%) in Q4 2022 to 11% last quarter.

Net income growth has been particularly strong, with Palantir generating nearly $210 million in net income during the year, compared to nearly ($374 million) in 2022. Cash flow generation has improved substantially, with operating and free cash flow both more than doubling QoQ in Q4 to over $300 million. Palantir ended the year with a 32% OCF margin and a 33% adjusted FCF margin.

Source: YCHARTS

While the fundamentals are certainly supporting an increase in Palantir’s share price, the AI hype may be overshooting the near-term potential for returns at this level. What’s striking is that investors are paying prices last seen when the market set a major top in November 2021, meanwhile the 2021 growth story is decoupled from management’s long-term 30% revenue growth target.

In early 2021, Palantir’s management expected to reach $4 billion in revenue by 2025 as they expected more than 30% annual revenue growth each year for the next five years, or through 2026. Palantir exceeded this target with 34% growth in 2021, but a macro-inflicted deceleration in late 2022 and early 2023 has practically nullified its ability to reach that $4 billion target after posting 24% growth in 2022 and just 17% in 2023. Current analyst estimates point to nearly 21% growth to $3.22 billion in revenue in 2025, meaning Palantir is one year off track – it’s projected to reach the $4 billion milestone in 2026, one year later than expected.

To reach $4 billion by the end of 2025, Palantir would need to record 35% growth this year and next, about 15 percentage points above estimates for both years. While AIP is aiding strong acceleration in the US commercial segment, it’s unlikely to drive revenues to that target. As a result, shares may be pricing in perfection for AIP and AI-related stock performance.

Source: YCHARTS

Prior to Q4’s earnings, Palantir was trading near its average P/S ratio of 18x, but the strong rally has now taken shares to over 26x P/S and 20x forward P/S – this is the highest level since late 2021 yet growth has slowed. On a cash flow basis, shares are trading at around 60x 2024’s projected $800 million to $1 billion in adjusted FCF.

Palantir’s shares are no longer cheap. It’s the third most expensive enterprise software stock on a forward P/S basis, behind Cloudflare and Snowflake, despite having the slowest forward revenue growth rate by more than 700 basis points, at 20% compared to 27% to 30% for the other two. This valuation may open up the door for downside throughout the year as it leaves no room for error, considering its lower revenue growth rate compared to peers; in addition, any dampening to growth stock sentiment from higher-for-longer rates with cut expectations being pushed back further in the year also presents a potential headwind for shares.

Conclusion

Enterprises are showing elevated interest in Palantir’s Artificial Intelligence Platform, which is translating to new customer additions. AIP’s early success in the US commercial segment drove Palantir’s new customer additions in Q4. US commercial revenue is accelerating significantly, reaching 70% YoY growth in Q4 from 33% in the prior quarter.

Management’s commentary about how Palantir is engaging and converting customers via bootcamps sets a foundation for a sustained acceleration thanks to a rapid customer acquisition cycle. However, the size of the US commercial business at less than 25% of quarterly revenues means that the AI-related acceleration may not be enough to sustain the stock’s current valuation.

I/O Fund Equity Analyst Damien Robbins contributed to this analysis.

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AI Driving Acceleration For Big 3 Cloud Stocks

Posted on February 13, 2024June 30, 2026 by io-fund

This article was originally published on Forbes on Forbes Forbes on Feb 8, 2024,07:01pm EST

Big Tech’s participation in the market’s push to all-time highs is becoming increasingly narrow, with Nvidia, Meta, Microsoft and Amazon serving as the primary contributors to 2024’s rally. Though Alphabet fell more than 7% on somewhat disappointing Google ad revenue, Alphabet’s Google Cloud, Microsoft’s Azure, and Amazon’s AWS shined as generative AI products drove an acceleration in cloud revenue growth in the recent quarter.

Source: Trading View

The Big Three’s cloud segments are crucial to business performance on both the top and bottom lines: Azure sits as Microsoft’s fastest growing segment (excluding Xbox’s more than 40 percentage point impact from Activision in Q2), AWS is driving a lion’s share of Amazon’s operating income, while Google Cloud is now generating more than 10% of revenue as Alphabet’s fastest growing segment while expanding its operating margin.

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Microsoft’s Azure

Azure witnessed the strongest AI contribution by far, as Microsoft works to extend its lead as the first major tech player to monetize enterprise and consumer AI subscriptions at scale. Azure also is powering a handful of the largest LLMs and AI assistants on the market, from OpenAI’s ChatGPT to Meta’s Llama and Llama 2 to Microsoft’s own Bing Copilot.

We highlighted in October in our free newsletter that AI would help drive a ‘noticeable acceleration’ for Microsoft’s revenue this year, and that’s exactly what we’re seeing: revenue growth accelerated from 8.3% YoY in fiscal Q4 2023 (calendar Q2) to 17.7% YoY in fiscal Q2 2024 (calendar Q4).

Azure growth was 30% in fiscal Q2, a 200 bp QoQ acceleration driven by strong demand for consumption-based services. Yet AI’s impact was quite notable: Microsoft said the 30% growth rate for Azure included “6 points from our AI services.”

Source: Microsoft

This 6 point contribution is impressive, given that AI services contributed 3 points to growth last quarter and 1 point in fiscal Q4 — a significant ramp considering the scale that this growth is attached to, with Azure’s revenue at a $74 billion run rate. This AI-related growth has helped Azure’s growth re-accelerate after seeing decelerating growth for five straight quarters.

Azure’s AI customer growth has also been rapid, and Microsoft is seeing an increase in larger commitments for Azure. Microsoft reported that Azure AI customers totaled more than 53,000 last quarter, with one-third of these new customers over the past twelve months. That implies customer growth rate of approximately 50% YoY, given that Microsoft added nearly 18,000 customers through 2023. More than half of the Fortune 500 are using Azure OpenAI Services, highlighting the strength of Microsoft’s AI offerings.

For Azure specifically, management said on the earnings call that “customers continue to choose Azure to simplify and accelerate their cloud migrations. Overall, we are seeing larger and more strategic Azure deals with an increase in the number of $1 billion-plus Azure commitments.” An increase in customer count and an increase in deal size are foundations for sustainable long-term growth and supportive of further acceleration in the coming quarters.

Amazon’s AWS

Q4 was a busy quarter for Amazon as it rolled out many new features, capabilities and hardware designed to capture generative AI demand, with AWS showing a hint of accelerated growth. AWS finally accelerated in Q4 for the first time in 2 yearsQ4 for the first time in 2 years, with Amazon reporting 13.2% growth in Q4, up just over 1 point from Q3’s 12%. AWS is now quickly approaching a $100 billion annual run rate, delivering $24.2 billion in revenue in Q4 and $90.8 billion in revenue for 2023.

What’s more important is that AWS’ operating leverage has improved over the last two quarters, with operating income growing at 3x the rate of revenue in Q4.

Source: Amazon

AWS’ operating income increased 39% YoY on a constant currency basis in Q4, with operating margin increasing 530bp YoY to 29.6%. For the full year, AWS’ operating margin was 27.1%, down 140bp YoY as operating leverage decreased in the first half of the year as growth decelerated from the 20% range to the 12% range.

AWS remains Amazon’s primary generator of operating income (67% of Amazon’s total operating income in 2023), a trend that can strengthen with AI driving accelerated customer and revenue growth and decreased costs. CEO Andy Jassy explained that AWS “added more than $1.1 billion an incremental quarter-over-quarter revenue, which on an FX neutral basis is more than any other cloud provider as far as we can tell.”

AWS’ existing customers “are renewing larger commitments over longer periods and migrations are growing,” and “while cost optimization continued to attenuate larger new deals also accelerated.” That includes recent agreements with Nvidia to be the first CSP to deploy the GH200 Grace Hopper Superchips with multi-node NVLink technology, and with Salesforce to deepen AI and data integrations between the two.

Bedrock is already witnessing strong adoption, with management seeing “many thousands of customers using the service after just a few months” as AWS continues to add “new models from Anthropic, Cohere, Meta with Llama2, Stability AI and our own Amazon Titan family of LLMs.”

Although AWS’ quarterly growth rates look paltry compared to Azure’s 30% and Google Cloud in the high-20% range, it is still showing all the ingredients for a sustained AI-driven acceleration.

Google Cloud

Google Cloud revenue accelerated four points from 22% in Q3 to 26% in Q4, topping $9 billion for the first time, helped by an increasing contribution from AI. Q4’s $9.2 billion in revenue implies that Google Cloud is just crossing above a $36 billion annual run rate, less than half of Azure’s run rate and 60% below AWS’ $90 billion run rate.

Google Cloud’s operating margin in Q4 came in at 9% compared to 3% in the previous quarter and (0.2%) in Q4 last year. Margins are naturally worse than AWS and Azure as Google Cloud does not benefit from the same efficiencies at scale; however, it is positive to see strong QoQ and YoY improvement in operating margin as it bodes well for future performance at a larger revenue scale.

Source: Alphabet

This acceleration in Q4 also helped narrow the gap to 4 percentage points with Azure, compared to 7 percentage points in the previous quarter. Google Cloud had previously topped Azure’s growth rates in late 2022 and the first half of 2023 before a rather swift deceleration in Q3. What’s crucial here over the next few quarters is Google Cloud continuing to close this growth rate gap with Azure, and possibly surpass Azure once more — it should be theoretically easier to realize higher growth rates at a smaller scale, more so when leveraging AI.

Like AWS and Azure, Google Cloud is seeing strong momentum with AI products. Management said that the “strong demand we are seeing for our vertically integrated AI portfolio is creating new opportunities for Google Cloud across every product area,” while its generative AI portfolio helped win and expand deals. CEO Sundar Pichai said that “greater than 70% of gen AI unicorns are using Google Cloud,” and customers including Anthropic and Mistral AI are building and serving LLMs on Google Cloud’s AI Hypercomputer, which combines Google’s “TPUs and GPUs, AI software and Multislice and Multi-host technology to provide performance and cost advantages for training and serving models.”

Google Cloud led the charge in monetizing AI via subscriptions with Duet AI for $30/month, and management noted that customers are “increasingly choosing Duet AI” to “boost productivity and improve their operations.” Duet AI will soon incorporate Google’s Gemini, its multi-modal family of LLMs developed to challenge OpenAI’s GPT-4. Google Cloud is “intensely focused on bringing the benefits of Gemini” to its cloud customers, and the rollout of the top iteration, Gemini Ultra, at a $20/month subscription could help Google gain share away from OpenAI and thus Azure while increasing revenue.

Conclusion

Big Tech’s cloud units reported strong growth in calendar Q4, with AI helping drive a noticeable acceleration for Azure while AWS and Google Cloud touted strong contributions from generative AI products. The trio all possess the necessary ingredients for sustained accelerations or maintained growth at higher levels: increased customer migrations, larger and longer duration contracts, monetization opportunities within the suite via subscriptions, and improvements in productivity and cost reductions for cloud customers.

I/O Fund Equity Analyst Damien Robbins contributed to this analysis.

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