Microsoft (MSFT Quick QuoteMSFT - Free Report) reported second-quarter fiscal 2024 earnings of $2.93 per share, which beat the Zacks Consensus Estimate by 6.16% and improved 33.2% on a year-over-year basis. At constant currency (cc), earnings increased 23% year over year.

Revenues of $62.02 billion increased 17.6% year over year and beat the Zacks Consensus Estimate by 1.6%. At cc, revenues grew 16% year over year.

In commercial business, the company witnessed strong demand for Microsoft Cloud offerings, including artificial intelligence (AI) services, which drove better-than-expected growth in large and long-term Azure contracts. Microsoft 365 suite strength contributed to ARPU expansion for Office Commercial business, while new business growth continued to be moderated for standalone products sold outside the Microsoft 365 suite.

Commercial bookings increased 17% and 9% at constant currency, ahead of expectations, primarily driven by strength in long-term Azure contracts and strong execution across core annuity sales motions.

Commercial remaining performance obligation increased 17% (16% at cc) to $222 billion. Roughly 45% will be recognized in revenues in the next 12 months, up 15% year over year. The remaining portion, which will be recognized beyond the next 12 months, increased 19%.

Microsoft Cloud revenues were $33.7 billion, up 24% (up 22% at cc) year over year, driven by strong execution by sales teams and partners.

In the consumer business, the personal computer (PC) and advertising markets were generally in line with the company’s expectations. PC market volumes continued to stabilize at pre-pandemic levels. The gaming console market was a bit smaller.

Microsoft completed the acquisition of Activision Blizzard on Oct 13, 2023.

Segmental Details

The Productivity & Business Processes segment, which includes the Office and Dynamics CRM businesses, contributed 31% to total revenues. Revenues increased 13% (up 12% at cc) on a year-over-year basis to $19.2 billion, primarily driven by better-than-expected results in LinkedIn, and beat the consensus mark by 1.42%.

Office commercial products and cloud services revenues grew 15% (up 13% at cc). Office 365 commercial revenues increased 17% (up 16% at cc). This rise continues to be driven by healthy renewal execution and ARPU growth as E5 momentum remains strong.

Paid Office 365 commercial seats grew 9% year over year to more than 400 million with installed base expansion across all customer segments. Seat growth was driven by small and medium business and frontline worker offerings, with continued impact from the growth trends in new standalone businesses.

Office commercial licensing declined 17% year over year (down 18% at cc), which was in line with the continued customer shift to cloud offerings.

Office Consumer products and cloud services revenues increased 5% (up 4% at cc). Microsoft 365 Consumer subscribers grew to 78.4 million in the reported quarter, up 16% year over year.

LinkedIn revenues increased 9% (8% at cc), ahead of expectations, driven by slightly better-than-expected performance across all businesses. In the Talent Solutions business, bookings growth was impacted by a weaker hiring environment in key verticals.

Dynamics products and cloud services revenues grew 21% (up 19% at cc) because of Dynamics 365, which increased 27% (up 24% at cc) with continued growth across all workloads.

Bookings growth was negatively impacted by weaker new business, primarily in Dynamics 365 ERP and CRM workloads.

The Intelligent Cloud segment, including server and enterprise products and services, contributed 41.7% to total revenues. The segment reported revenues of $25.9 billion, which increased 20% year over year (up 19% at cc) and beat the consensus mark by 2.38%.

Server products and cloud services revenues increased 22% (up 20% at cc), driven by Azure and other cloud services revenue growth of 30% (up 28% at cc), including roughly 6 points from AI services.

Azure offers the top performance for AI training and inference and the most diverse selection of AI accelerators, including the latest from AMD and NVIDIA, as well as the company’s first-party silicon, Azure Maia.

Microsoft witnessed solid adoption of Azure AI, which now has a clientele of more than 53,000 customers. Over one-third of customers are new to Azure over the past 12 months.

The company’s new models-as-a-service offering makes it easy for developers to use LLMs from partners like Cohere, Meta Platform (META Quick QuoteMETA - Free Report) and Mistral on Azure without having to manage underlying infrastructure.

Meta and Microsoft seek to provide an open approach to AI development, which benefits companies by enabling innovation, collaboration and transparency. They have been working together for more than a decade on various AI initiatives, such as PyTorch, the partnership on AI and the metaverse.

In the fiscal second quarter, the company added support for OpenAI’s latest models, including GPT-4 Turbo, GPT-4 with Vision, Dall-E 3, as well as fine-tuning. Over half of the Fortune 500 use Azure OpenAI today, including Ally Financial, Coca-Cola and Rockwell Automation.

Walmart (WMT Quick QuoteWMT - Free Report) is using Azure OpenAI Service, along with its own proprietary data and models, to streamline more than 50,000 associates’ work and transform customers’ digital shopping experience.

Vodafone (VOD Quick QuoteVOD - Free Report) will invest $1.5 billion in cloud and AI services over the next 10 years as it works to transform the digital experience of more than 300 million customers worldwide.

MSFT is integrating the power of AI across the entire data stack. Microsoft Intelligent Data Platform brings together operational databases, analytics, governance and AI to help organizations simplify and consolidate their data estate.

Cosmos DB is the go-to database to build AI-powered apps at any scale, powering workloads for companies in every industry, from AXA and Coles to Mitsubishi and TomTom. Cosmos DB data transactions increased 42% year over year.

Microsoft Fabric is also gaining momentum in unifying compute, storage and governance into one end-to-end analytical solution, with an all-inclusive business model.

In the fiscal second quarter, the company made Microsoft Fabric generally available, helping customers like Milliman and PwC. Data stored in Fabric’s multi-cloud data lake, OneLake, increased 46% quarter over quarter.

On the developer side, GitHub revenues increased more than 40% year over year, driven by all-up platform growth and the adoption of GitHub Copilot, the world’s most widely deployed AI developer tool. Microsoft now has more than 1.3 million paid GitHub Copilot subscribers, up 30% quarter over quarter.

More than 50,000 organizations use GitHub Copilot Business to supercharge the productivity of their developers, from digital natives like Etsy and HelloFresh to leading enterprises like Autodesk, Dell Technologies and Goldman Sachs. Accenture alone will roll out GitHub Copilot to 50,000 of its developers this year.

More than 230,000 organizations have already used AI capabilities in Power Platform, up more than 80% quarter over quarter. With Copilot Studio, organizations can tailor Copilot for Microsoft 365 or create their own custom copilots. It has already been used by more than 10,000 organizations, including An Post, Holland America and PG&E.

In Sales, Copilot has helped sellers at more than 30,000 organizations, including Lumen Technologies and Schneider Electric, to enrich their customer interactions using data from Dynamics 365 or Salesforce.

In healthcare, DAX Copilot is being used by more than 100 healthcare systems, including Lifespan, UNC Health and UPMC, to increase physician productivity and reduce burnout.

Copilot in Windows is already available on more than 75 million Windows 10 and Windows 11 PCs.

The company’s Unified Security Operations Platform brings together its SIEM Microsoft Sentinel, XDR Microsoft Defender and Copilot for Security to help teams manage an increasingly complex security landscape.

More than one million customers, including over 700,000 who use four or more of Microsoft’s security products, like Arrow Electronics, DXC Technology, Freeport-McMoRan, Insight Enterprises, JB Hunt and The Mosaic Company.

In per-user business, the enterprise mobility and security installed base grew 11% to more than 268 million seats. In the on-premises server business, revenues increased 3% (up 2% at cc), primarily driven by better-than-expected demand related to Windows Server 2012 end of support.

Enterprise Services revenues increased 1%, driven by growth in Enterprise Support Services and Industry Solutions.

More Personal Computing segment, which primarily comprises Windows, Gaming, Devices and Search businesses, contributed 27.2% to total revenues. Revenues increased 19% year over year (up 18% at cc) to $16.9 billion and beat the Zacks Consensus Estimate by 0.76%. The growth included 15 points of net impact from the Activision acquisition.

Windows OEM revenues increased 11% year over year, ahead of expectations, driven by slightly better performance in higher monetizing consumer markets.

Windows Commercial products and cloud services revenues grew 9% (up 7% at cc) due to lower in-period revenue recognition from the mix of contracts. Devices revenues decreased 9% (down 10% at cc).

Usage of cloud-delivered Windows increased more than 50% year over year. Windows 11 commercial deployments increased 2X year over year as companies like HPE and Petrobas rolled out the operating system to employees.

Search and news advertising revenues, excluding traffic acquisition costs, increased 8% (up 7% at cc), driven by higher search volume offset by the negative impact of a third-party partnership.

Gaming revenues grew 49% (up 48% at cc), with 44 points of net impact from the Activision acquisition. Total Gaming revenues were in line with expectations as stronger-than-expected performance from Activision was offset by the weaker-than-expected console market.

Xbox content and services revenues increased 60% (up 61% at cc), driven by 55 points of net impact from the Activision acquisition. Xbox hardware revenues increased 3% (up 1% at cc).

Operating Results

Gross profit increased 20.2% year over year to $42.3 billion. The gross margin expanded 150 basis points (bps) to 68.4% on a year-over-year basis. Microsoft Cloud’s gross margin percentage was 72%, relatively unchanged year over year.

Operating expenses rose 3.4% year over year to $15.3 billion, with 11 points from the Activision acquisition. The Activision impact includes $550 million from purchase accounting adjustments, integration and transaction-related costs.

Operating income of $27 billion increased 33% and 25% on a non-GAAP basis (up 23% at cc). The operating margin expanded 490 bps on a year-over-year basis to 43.6%.

Productivity & Business Process operating income rose 25.8% to $10.28 billion, beating the Zacks Consensus Estimate by 7.6%.

Intelligent Cloud operating income increased 39.9% to $12.46 billion, beating the consensus mark by 10.48%.    

More Personal Computing’s operating income increased 29.1% to $4.28 billion, which missed the consensus mark by 16.82%. 

Balance Sheet & Cash Flow

As of Dec 31, 2023, Microsoft had total cash, cash equivalents and short-term investments balance of $81.01 billion compared with $143.9 billion as of Sep 30, 2023.

As of Dec 31, 2023, long-term debt (including the current portion) was $47.1 billion compared with $67.7 billion as of Sep 30, 2023.

Operating cash flow during the reported quarter was $18.9 billion compared with $30.5 billion in the previous quarter. Free cash flow during the quarter was $9.1 billion, up 86% year over year.

In the reported quarter, the company returned $8.4 billion to shareholders in the form of share repurchases ($4 billion) and dividends payouts ($5.57 billion).

Guidance

For the fiscal third quarter, Microsoft expects the cost of revenues between $18.6 billion and $18.8 billion and operating expenses to grow in the $15.8-$15.9 billion range. Other income and expenses are expected to be roughly $(600) million.

The company expects revenue growth in the productivity and business processes segment between $19.3 billion and $19.6 billion.

MSFT expects Office 365 Commercial revenue growth to be roughly 15% at cc. Office Commercial products revenues are expected to decline in the low 20s.

In Office Consumer products and cloud services, Microsoft expects revenue growth in the mid-to-high single digits. For LinkedIn, the company expects revenue growth in the mid-to-high single digits. In Dynamics, Microsoft expects revenue growth in the mid-teens.

For Intelligent Cloud, Microsoft anticipates revenues between $26 billion and $26.3 billion.

In Azure, Microsoft expects revenue growth at cc to remain stable in the fiscal second quarter. In Enterprise Services, revenues are expected to decline 10%. The company expects Server revenue growth in the mid-to-high single digits.

For More Personal Computing, the company projects revenues between $14.7 billion and $15.1 billion. It expects Windows OEM revenues to remain relatively flat year over year.

In Gaming, this Zacks Rank #3 (Hold) company expects revenue growth in the low 40s. This includes roughly 45 points of net impact from the Activision acquisition. You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here.

Microsoft expects Xbox content and services revenue growth in the mid to high 50s, driven by roughly 50 points of net impact from the Activision acquisition.