Microsoft Reports PC Trouble, Cloud Growth, SMB ‘Deal Moderation’

“In this environment, it is more critical than ever to continue to invest in our strategic growth markets such as cloud, security, Teams, Dynamics 365 and LinkedIn, where we have opportunities to continue to gain share as we provide problem-solving innovations to our customers,” Microsoft CFO Amy Hood said.

Microsoft Chief Financial Officer Amy Hood said Tuesday that the tech giant continued to see “deal moderation” in Microsoft 365 plans aimed at smaller businesses, which tend to be deals with partners attached.

Hood’s comments during the Redmond, Wash.-based vendor’s quarterly earnings call Tuesday suggested that the “partner transition work” that ate into some lines of revenue during Microsoft’s previous fiscal quarter was still at work during the most recent quarter ended Sept. 30 – Microsoft’s first quarter of fiscal year 2023.

“We did see continued impact there [with small and midsize customers] in Q1, although it was not different than what we saw, frankly, in Q4,” Hood said on the call.

[RELATED: Microsoft ‘Partner Transition’ Eats Into SMB, Office 365, Windows Businesses]

She continued: “Where we in fact saw … new deal moderation – I referred to that, frankly, in Q4 as well – it tended to be in … the smaller end of the market, small to midsize companies. And it also tended to be through partner[s], which we had talked about before.”

How Did Microsoft Do In Q1?

Still, Hood noted a lot of work during the quarter came by partners and Microsoft sales and customer success teams optimizing customer Azure and cloud workloads as Azure growth continues to decelerate.

On workload optimization, “we saw that across all segments,” Hood said. “If there was one segment where I may have seen it a bit more, I would say, in the small or midsize segment of the market. That tends to be more through partner[s]. We rely on partners to help customers do those same optimizations and prepare workloads.”

She continued: “If you step back and say, ‘This is how you drive ultimate share gains and build customer loyalty and help customers grow’ – I think that needs to be the focus of our teams inside the company and also the partners that we rely on to help customers do that as well.”

Microsoft also saw healthy Microsoft 365 (M365) renewals and upsells to E5 licenses, Hood said. She did not specify whether partners played a strong role there.

“We had on-time renewals that were, frankly, better in Q1 based on explorations than we‘d seen a year ago,” she said. “So deals are both getting done and, I think, getting done on time. They’re getting done within a discount range that we feel good about, that‘s consistent. And we saw good upsell to E5.”

Some of the selling difficulty came in Microsoft E3 licenses for customers, a less expensive license type than E5 but one that has received “new value” from Microsoft, Hood said.

“This is a place where there is some macro impact,” she said. “But there‘s also, I think, a better job we can do in our E3 SKU [stock keeping unit] … we added a lot of value to that SKU in Q4 in terms of security and auto-patching for Windows. It’s a great value in the same way E5 is. We land E5 really well. We‘ve got some work to do on landing E3. So there is some macro – seems pretty consistent, frankly, more than inconsistent with what we saw. And there is some execution that I think, frankly, we can get better at as well.”

Microsoft Cloud Growth

Despite the deal moderation, Microsoft Cloud revenue was $25.7 billion, up 31 percent year over year, according to Microsoft. Total revenue for the quarter was $50.1 billion, an increase of 16 percent year over year.

Microsoft’s “productivity and business processes” segment – which includes Office Commercial, Office Consumer, LinkedIn and Dynamics – brought in $16.5 billion in revenue during the quarter, up 15 percent year over year.

Microsoft did not break out dollar amounts for revenue of specific segments within productivity and business processes. But the vendor did report that the Office Consumer business segment grew 11 percent in constant currency, with M365 subscriptions growing 13 percent to 61.3 million subscribers, Hood said.

“Demand for security, compliance and voice value in Microsoft 365 drove strong E5 momentum again this quarter,” Hood.

Office Commercial products and cloud services revenue grew 13 percent, with Office 365 Commercial revenue’s 17 percent growth year over year driving Office Commercial’s success. Hood called the Office Commercial revenue “better than expected” and Office 365 Commercial revenue “slightly better than expected.”

For Microsoft’s “intelligent cloud” segment, the vendor saw $20.3 billion in revenue during the quarter, an increase of 26 percent year over year. Azure and other cloud services revenue grew 42 percent year over year, driving the 28 percent year-over-year increase Microsoft saw in its greater server products and cloud services revenue.

Azure and other cloud services came in lower than expected, Hood said, because of “the continued moderation in Azure consumption growth as we help customers optimize current workloads while they prioritize new workloads.”

Azure still had “a very large growth rate, with growth across all segments and with growth across all geos [geographies]. That was … generally in line with where we expected,” Hood said.

Another factor that ate into Azure’s margins was high energy costs, Hood said. In fact, greater-than-expected energy costs will cost Microsoft more than $800 million for the fiscal year.

During Hood’s guidance for next quarter, she also said that she expects Azure to still grow but to decelerate, with expected revenue growth sequentially lower by five points in constant currency.

Windows Commercial products and cloud services revenue increased 15 percent year over year, according to Microsoft.

PC Market Weakness

Meanwhile, Microsoft saw demand for PCs weaken last quarter,

Microsoft’s “more personal computing” segment – which includes revenue from Windows Commercial, Windows OEMs, Xbox, search and news advertising – posted $13.3 billion during the quarter, up 3 percent in constant currency.

Factoring in foreign exchange rates, the segment “decreased slightly,” according to Microsoft.

Microsoft did not break out dollar amounts for the segments within “more personal computing.” Windows OEM revenue decreased by 15 percent year over year – 20 percent excluding the Windows 11 deferral last year.

Windows Commercial products and cloud services revenue increased 15 percent year over year, according to Microsoft.

Devices revenue increased 8 percent year over year, according to Microsoft.

Q2 Guidance

During the call, Hood gave guidance for how she thinks Microsoft will perform next quarter.

She said the productivity and business processes business should grow 11 to 13 percent to revenue between $16.6 billion and $16.9 billion.

Intelligent cloud should grow 22 to 24 percent to revenue between $21.25 billion and $21.5 billion.

She expects the “more personal computing” segment to bring in between $14.5 billion and $14.9 billion. Windows OEM revenue is expected to decline nearly 40 percent. Devices revenue should decline by about 30 percent.

However, “our outlook has many of the trends we saw at the end of Q1 continue into Q2,” Hood said. “In our consumer business, materially weaker PC demand from September will continue and impact both Windows OEM and Surface device results – even as the Windows install base and usage grows.”

For the fiscal year, Hood expects double digit revenue and operating income growth, with 20 percent growth in Microsoft’s commercial business driven by Microsoft Cloud.

“In this environment, it is more critical than ever to continue to invest in our strategic growth markets such as cloud, security, Teams, Dynamics 365 and LinkedIn, where we have opportunities to continue to gain share as we provide problem-solving innovations to our customers,” Hood said.

She continued: “While we continue to help our customers do more with less, we will do the same internally. And you should expect to see our operating expense growth moderate materially through the year while we focus on growing productivity of the significant headcount investments we‘ve made over the last year.”

Speaking of employee count, Hood said that total headcount growth next quarter “sequentially should be minimal.” The company reportedly laid off fewer than 1,000 employees in various departments and worldwide earlier this month.

Microsoft’s stock traded at about $234 a share in after hours Tusday, a decrease of about 7 percent compared to the market close.