Microsoft (MSFT) FY24 Q4 Earnings Review(Apr-Jun 2024)

The software and cloud services giant Microsoft (MSFT) dropped its FY24 Q4 earnings report (April to June 2024) after the bell on July 30. Growth rates across all three segments slowed compared to the previous quarter, with the closely-watched Azure business growth falling short of market consensus. The stock tanked as much as 7.5% in after-hours trading.

Microsoft (MSFT) FY24 Q4 Financial Results Release

• Revenues: $64.73B (YoY +15%)
• Diluted EPS: $2.95 (YoY +9.7%)
• Operating income: $27.9B (YoY +15%)
• Net income: $22B (YoY +10%)
• Operating cash flow: $37.2B (YoY +29%)
• Azure: YoY +29%

Growth rates across Microsoft’s three main segments decelerated compared to the previous quarter. The most significant revenue contributor (44%), “Intelligent Cloud,” remained the primary growth driver, jumping 19% YoY to $28.52B, slightly below analyst expectations of $28.68B. The “Productivity and Business Processes” segment reported $20.32B, up 11% YoY, beating market expectations of $20.13B. The previously underperforming “More Personal Computing” segment also climbed 14% YoY to $15.9B, surpassing the market consensus of $15.49B.

Microsoft’s remaining performance obligation (RPO) grew by 20% YoY, with 40% set to be recognized within the next twelve months. Additionally, 9% of the company’s 13% growth in operating expenses stemmed from the Activision Blizzard acquisition, indicating active integration of new assets while expanding operations.

Intelligent Cloud Segment

Microsoft Cloud (including Azure and Office productivity software) sales surged 21% to $36.8B, beating market expectations. Gross margin dipped to 69% from 72% YoY. Microsoft emphasized that Azure operational improvements and AI infrastructure scaling drive profit margin expansion. Commercial bookings jumped 17%, primarily fueled by large, long-term Azure contracts.

While robust growth in Azure services propelled the “Intelligent Cloud” segment, performance fell short of expectations. Azure revenue growth improved to 29% YoY from 26% in the same period last year but lagged the previous quarter’s 31% and market expectations of 30%. This marks the first time Azure has missed market expectations since 2022. Excluding currency fluctuations, Azure revenue growth hit 30%, at the lower end of previous guidance, below the previous quarter and analyst expectations of 31%, and falling short of the buy-side consensus of 32%.

Productivity and Business Processes Segment

The “Productivity and Business Processes” segment was primarily driven by Office 365 (+13% YoY). Microsoft 365 consumer subscriptions grew 14% to 82.5 million, with related revenue up 3% YoY. Growth in business applications, such as Dynamics (+16% YoY) and LinkedIn (+10% YoY), remained stable.

More Personal Computing Segment

Microsoft’s Windows licensing business grew 4% YoY as the PC market rebounded. However, hardware like Surface laptops declined 11% despite the launch of the new Copilot+ PC. Gaming revenue soared 44% due to the Activision Blizzard acquisition (48 percentage points attributed to the acquisition), with software sales jumping 61% (58 percentage points from the acquisition). Xbox console sales dropped 31% YoY. Notably, search and advertising revenue climbed 19% YoY, marking the fastest growth over two years.

Microsoft (MSFT) FY24 Q4 Earnings Call

Microsoft CEO Satya Nadella emphasized two key strategies: First, synchronize innovation efforts in products and infrastructure to capture all growth opportunities. Second, closely observe customer demand signals to effectively manage the cost structure and maintain long-term sustainable operational efficiency.

Azure AI

Azure AI’s performance was impressive, with customer numbers surpassing 60,000 and growing over 60% YoY. Customers using Model as a Service saw over 100% YoY growth. Notably, nearly 50% of Azure AI customers also use Microsoft’s data and analytics tools, highlighting product line synergies. Azure AI demand still far outstrips supply capacity, with consumption-based billing in the overall Azure business continuing to outpace growth.

Microsoft is aggressively expanding its global data center footprint, viewed as a crucial strategy for building long-term operational assets. The company has successfully deployed its in-house AI chip, Azure Maia, in cloud services, showcasing technological innovation prowess. These initiatives have driven continued growth in data center business revenue and positioned Azure as the preferred public cloud platform for large applications like SAP and Oracle.

Microsoft views generative AI as a healthy SaaS (Software as a Service) business, driving the adoption of other Azure services and demonstrating strong profitability. The company anticipates potential future growth in AI business while reducing capital expenditure, with some expenses (like GPUs) being flexible based on demand.

However, the company noted softening non-AI-related Azure demand in some European regions.

Copilot

GitHub Copilot achieved significant success, with over 77,000 organizations adopting it, growing 180% YoY. Notably, GitHub Copilot revenue accounted for 40% of GitHub’s total revenue growth this year, indicating that AI-driven development tools are becoming a significant growth engine.

Microsoft 365 Copilot user growth has been explosive, with paid customers increasing over 60% QoQ and daily active users nearly doubling from the previous quarter. Microsoft plans to add intelligent agent abilities to enhance Copilot’s capabilities further. In healthcare, institutions using Microsoft AI to generate medical reports grew over 200% YoY, showcasing AI’s vast potential in professional domains.

Web-based Copilot chatbot usage has grown 150% since the beginning of the year, while Bing search and Edge browser market share continue to climb.

Other Business Performance

Microsoft’s AI data platform, Microsoft Fabric, performed exceptionally well, with over 14,000 paid customers, growing 20% YoY.

In operating systems, Windows 11 active devices grew 50% YoY.

The security business also shined, with over 1.2 million customers and Defender for Cloud surpassing $1 billion in revenue over the past twelve months.

E5 plans and Copilot adoption primarily drove Office 365 growth. Dynamics 365 accounts for 90% of the business, indicating cloud version popularity. Power Platform’s monthly active users reached 48 million, up 40% YoY. Teams usage continues to climb, with Teams Premium seats growing by over 3 million, up 400% YoY.

Social media platform LinkedIn saw video content uploads increase 34% YoY, with Premium memberships growing 51% over the past year.

In gaming, monthly active users exceeded 500 million, with Microsoft focusing on developing software, services, and transaction revenue, aiming to transform it into a software subscription model.

Forecast for Q1 FY25

Revenue guidance for next quarter is set at $63.8B to $64.8B, representing a YoY growth of approximately 13.8%.

• “Productivity and Business Processes” is estimated at $20.3B to $20.6B (YoY growth of 10%-11%)
• “Intelligent Cloud” is projected at $28.6B to $28.9B (YoY growth of 18%-20%)
• “More Personal Computing” is expected to land between $14.9B and $15.3B (YoY growth of 9%-12%)

Review and Analysis

Strengths and Opportunities:

• Microsoft’s increased CAPEX creates a cost advantage in AI computing
• Office 365 continues to strengthen its market moat
• Microsoft 365 Copilot sees strong customer adoption
• Copilot integration with PCs may stimulate new demand in Q4
• Generative AI drives rapid growth in cloud service demand
• Dynamics, Bing, Edge, and other products gradually increase market share

Weaknesses and Threats:

• Office product line’s high market penetration may lead to slowing long-term growth
• PC market demand recovery shows signs of deceleration
• Changing AI competitive landscape: OpenAI’s technical lead may be narrowing
• The long-term development strategy for the gaming business remains unclear

This quarter’s earnings report shows a slight slowdown in overall revenue growth. This is partly due to the volatility in the gaming business following the Activision Blizzard (ATVI) acquisition. Excluding the gaming business, Microsoft’s revenue growth deceleration remains within expected ranges, explained by the business logic of diminishing growth as company size increases.

Azure

Azure (Microsoft’s cloud service) remains the primary beneficiary of Generative AI, maintaining strong growth rates. Over the past two quarters, Azure has reversed its declining growth trend, primarily due to AI contributions. This is attributed to enterprise IT departments adopting AI services notably faster than general employees.

Microsoft states that Azure has yet to reach its true growth potential due to supply constraints, with complete market demand satisfaction potentially not occurring until the first half of next year. However, as OpenAI’s model capabilities face challenges, Microsoft’s growth momentum in this area may be affected.

Microsoft 365 Copilot

Microsoft 365 Copilot’s initial scale remains small. Although Microsoft reports positive signs in adoption rates, it may take one to two years of incubation before it significantly boosts Office business revenue. In reality, this service might slow the deceleration of Office 365 business growth over the next two years, with the best-case scenario being a slight acceleration.

Windows

Windows business YoY growth aligns closely with the overall PC market growth. The strong growth effects of the previous two quarters have passed, and the back-to-school market performance was underwhelming. However, the Q4 holiday season could bring a turnaround, especially with the gradual launch of Copilot+PC, potentially reinvigorating the Windows business.

Gaming

Even after incorporating ATVI, the gaming business’s estimated revenue this quarter is $5 billion, still less than 10% of Microsoft’s total revenue. While Microsoft has determined a general direction, they haven’t found a successful approach yet. In the near future, Microsoft’s gaming business may maintain its current adequacy without achieving definitive success.

Search and Advertising

The growth rate in search and news advertising revenue was a pleasant surprise this quarter. Compared to Google, Microsoft’s performance this quarter was particularly impressive. This result necessitates a reassessment of the overall advertising market condition, with a clearer picture potentially emerging after Meta’s earnings report.

AI Capital Expenditure

Regarding concerns about potential over-investment in AI CAPEX, Microsoft’s earnings results mirror Google’s. Generative AI currently shows strong demand in the application and cloud service sectors, allowing tech giants to invest confidently. While it takes time to convert demand into effective monetization, these companies have the capacity to wait. The view that AI infrastructure CAPEX shouldn’t be increased due to short-term ineffective monetization is considered short-sighted.

Conclusion

Microsoft’s earnings report demonstrates the company’s strong industry position in productivity software and cloud services. Even with a high market share, Microsoft maintains a solid growth trajectory. At this stage, large-scale investment in AI CAPEX appears to be the correct strategy, likely to yield positive benefits for Microsoft in the coming quarters.

However, Microsoft faces challenges, particularly as its most significant competitive advantage in AI cloud services—OpenAI’s technological lead—begins to face challenges. Beyond hoping for OpenAI to develop more powerful new models, it’s crucial for Microsoft to establish competitiveness beyond model advantages.

Despite some potential risks, Microsoft’s performance remains robust, especially in AI and cloud services. There’s no need for excessive concern about the capital market misinterpreting the company’s AI investment strategy, as these investments will likely bring considerable returns in the medium to long term.