Quick Thoughts: AMZN and MSFT – Seattle Takes its Turn Beating Consensus

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–          AMZN beat on the top line with 23%+ sales growth, with in line EPS muted by increased technology and content expenses. Investors were spooked by guidance for a 2Q loss.

–          As usual, AMZN divulged little detail, but Bezos has been busy recently, increasing the price for Prime, launching Fire TV, signing a big content deal with HBO, and announcing Prime Pantry.

–          MSFT delivered modest beats on both top and bottom lines – without a one-time sales recognition issue last year, growth would have been a healthy 8%+.

–          Cloud revenues (Azure, Office 365, Dynamics) more than doubled, commercial Windows grew double digits on the XP sunset, and Consumer and Devices rose a healthy 12%.

After Silicon Valley stalwarts Apple and Facebook delivered big blow outs last night, the Pacific Northwest division of the tech league took its turn today, with both Amazon and Microsoft delivering better than expected results. Amazon’s strong revenues were delivered with typically spare detail and a bitter bit of guidance on June quarter margins that spooked investors who had initially bid the stock up after hours. Seattle neighbor Microsoft was also a bit shy on detailed operational data, frustrating analysts already coping with the comprehensive reorganization of the previous reporting segments. However, despite their shared secretive approach to reporting, both companies are doing the right things to stay at the forefront of the ongoing TMT paradigm shift, with strong results to show for it.

Amazon’s 23% YoY sales growth was a strong reversal from the slight disappointment of 20% growth in the previous quarter, returning the top line to a stable and strong trajectory of growth. Operating margins, almost always a surprise one or another with Amazon, were a disappointment after Amazon pushed substantial new technology and content expenses through the income statement without prior warning. These expenses are likely to get larger in the next quarter given AMZN just announced an exclusive and almost certainly expensive deal for HBO second run content this week, which is likely to play through results in coming quarters. Amazon is doubling down on its Prime video streaming service with these aggressive investments in content and the launch of the Fire TV set-top box. Management revealed that Prime viewing has tripled YoY, of course without giving away ANY indication of the actual magnitude. I suspect that Amazon’s Technology and Content Opex, which also includes funding for AWS, but it would be nice if management would give us a bit more to go on.

Though margins are still narrow and guidance for next quarter is for a disheartening loss, AMZN is starting to care about profitability as it experiments with new offerings to test consumer price elasticity. The new Prime Pantry service allow Prime members, who will soon pay $99 annually, to purchase packaged non-perishables like toilet paper, canned food and beverages, garbage bags, etc. with a shipment cost of $5.99 per box. Prime Pantry customers will have a box with a capacity of 4 cubic feet or 45lbs and Amazon will display how much room customers have in their boxes as they shop online. Some of these items originally qualified under free Prime 2-day shipping, but a closer look at Amazon’s site now shows Prime eligible Tide laundry detergent selling at a significant enough mark-up to Prime Pantry to justify the $5.99 cost. It’s not yet clear if this service will result in margin accretion if goods are offered at a discount to subsidize the shipping cost. Still, I think Bezos and Company are making the right moves and the recent price increase in Prime should be able to better address growing costs. Also with e-commerce penetration still in the high single digits, Amazon has runway to continue deliver double digit topline growth.

Moving on to Microsoft, it was Satya Nadella’s first earnings call and in an eloquent opening remark, he laid out his vision for the company in the medium to long term and also promised investors to remain engaged in investor calls going forward. Though revenue growth appears flat YoY, the $20.4B would have been a healthy 8% excluding revenue recognition adjustments for deferred revenue in the year ago quarter. The $20.4B was a modest beat on $20.36B expected and EPS came in at $0.68 versus the $0.63 consensus, likely driven by growing adoption of Microsoft’s high margin Office 365.

Microsoft’s recent shift to new reporting segments throws a wrench in analyzing the growth of Windows and Office products. Portions of Windows revenue for instance are now captured in both the “Devices & Consumer” and “Commercial” segments. Copies of Windows that ship with PCs are allocated to the former, while enterprise level Windows licenses not tied to hardware are allocated in the latter. Both saw lift from the Windows XP sunset with Windows OEM Pro revenue up 19% and Commercial licenses up 11%. While some third party firms tracking OS penetration still project significant XP adoption in excess of 20%, Microsoft claims ~90% of enterprise desktops now run on Windows 7 or Windows 8. Office 365 is also allocated in a similarly confusing way with Mister Softy disclosing it now has 4.4M home subscriptions and only providing growth guidance for Office 365 growth on the commercial side. While Microsoft is not giving the goods on consumer Office 365 growth, it seems pretty certain to be robust in the wake of the long awaited decision to offer versions for iOS and Android, a significant boon to the huge base of users on those platforms – who will have to sign up for paid subscriptions in order to use it.

Aside from Windows non-Pro OEM revenue down 15% and yet to be disclosed Windows Phone numbers (the Nokia acquisition closes tomorrow), just about every product in Microsoft’s stable saw respectable growth. Surface was up over 50% to a revenue level of $494M with a growing mix of Surface 2 and Pros sold implying unit sales below the 1M mark. XBox sold 2M consoles and was up 45% in revenue. The commercial businesses also fared well, up 7% overall, with Azure’s 150%+ growth overshadowing the tepid 3% commercial licensing growth

So far, so good for Mr. Nadella. With his first quarter under his belt, and presiding over a dramatically reconfigured organization, Microsoft’s new CEO appears pointed in the right direction. His mantra of “Mobile First, Cloud First” is just right given the sea changes in the industry and Microsoft’s position in it. Perhaps the haters will have to find another company to hate.

For our full research notes, please visit our published research site.

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