Microsoft Tops Estimates Across Its Business But Signals Near-Term Capacity Challenges

On Thursday, Microsoft Corporation MSFT issued its third quarter earnings report.

Year to date, Microsoft shares are 10% up, behind its tech rivals, Google parent Alphabet GOOGGOOGL and Amazon.com Inc AMZN that are 15% and 22% up, respectively, with the three locked in a battle to show who can offer the most comprehensive AI solutions. 

This week, Microsoft got a pleasant boost from the beverage giant, The Coca Cola Company KO who agreed to infuse Microsoft’s  Azure cloud services and developing AI technology across its business and network.

Third quarter results surpassed estimates.

For the quarter ended on March 31st, revenue rose 17% YoY to $61.86 billion, surpassing LSEG’s estimate of $60.80 billion.

Net income amounted to $21.94 billion or $2.94 per share and also surpassed LSEG’s estimate of $2.82 per share.

Overall commercial cloud revenue came in at $35.1 billion, surpassing Wall Street’s guidance for $33.93 billion. Intelligent Cloud segment brought in $26.71 billion as sales rose about 21% with Microsoft’s Azure cloud alone growing 31%. AI services contributed 7 percentage points of growth to its Azure and other cloud services revenue, rising from second quarter’s 6 percentage points and first quarter’s 3 percentage points. 

Capital expenditures jumped 79% to $14 billion. Microsoft has been investing heavily to secure Nvidia Corporation NVDA graphics processing units it needs to develop and train AI models. But even with all that investment, Microsoft has a shortage of data center infrastructure, specifically for deploying artificial intelligence models. CFO Amy Hood noted that AI demand could outstrip available capacity in the near-term. Microsoft is certainly not the only AI vendor with this challenge as Nvidia is facing the same issue. Fueled by the AI boom, Nvidia reported its revenue more than tripled over consecutive quarters. Microsoft, being one of its customers, is simply now feeling the stress Nvidia has been facing for a while due to insatiable AI demand. Only a month ago, Microsoft and Nvidia deepened their longstanding collaboration by announcing major integrations to accelerate the development of generative AI for enterprises.

More Personal Computing revenue rose 18% YoY to $15.58, surpassing StreetAccount consensus of $15.08 billion.  It was driven by 11% growth in Windows OEM sales to PC manufacturers, along with 62% growth in sales of Xbox content and services, with 61% being attributable to the net impact of Microsoft's October acquisition of Activision Blizzard.

PC demand was slightly better than expected during the quarter and consequently, sales of Windows licenses to device makers rose 11%. 

The Productivity and Business Processes unit that hosts Office software and LinkedIn, among others, reported a revenue rise of 12% as sales amounted to $19.57 billion. This is first full quarter of the Copilot-add-on sales, on which Microsoft invested billions to develop. 

Fourth quarter guidance was not as impressive.

Microsoft guided for revenue from $63.5 billion to $64.5 billion in the current quarter. Hood guided for a material rise in capital expenditures due to cloud infrastructure both in the current quarter and in the new fiscal year that will kick off on July 1st.

The boost from Coca Cola.

This week, Microsoft revealed it entered into a five-year, $1.1 billion agreement with Coca Cola. The Coca-Cola Company  will use Microsoft’s tech expertise to accelerate system-wide AI transformation across its global business and network of independent bottlers.

AI is key to Microsoft’s prospects, which means its cloud business is running the show.

Growing faster than any other of its businesses, the Azure brings in revenue of tens of billions of dollars every quarter. Together with AI services that go within its package, Cloud is also Microsoft’s biggest tool in its rivalry against Amazon and its Amazon Web Services. But, Amazon and Microsoft are certainly not the only ones battling for the AI throne as this is still just the beginning of that story and a an entirely new era in the making.

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