RBC Capital Markets Software Equity Analyst Rishi Jaluria joins Yahoo Finance Live to break down Microsoft's fourth-quarter earnings, Microsoft Azure, and Windows OEM.

Video Transcript

SEANA SMITH: Let's take a look at Microsoft. Look at that, shares off 2% right now, despite beating on both the top and bottom lines. Here to break this down, we want to bring in Rishi Jaluria, RBC Capital Markets software equity analyst. Rishi, it's great to see you. So that software cloud revenue really seems to be weighing on shares. What's your takeaway from the results that we're getting this afternoon?

RISHI JALURIA: Yeah, and always great to be back here. Look, I think that's-- you're absolutely right. That's what's driving things down a little bit. There were worries heading into the quarter on PC weakness and stuff. But really, especially in earnings, this name is driven by the cloud number, and very specifically, Azure. And look, Azure came maybe about a point light of where the company had guided last quarter. And so I think people are looking at that. People are looking at commercial bookings and kind of expecting things to slow down further from here.

Now, the tone on this name could turn on a dime if they provide guidance that talks about better Azure growth for next quarter. But right now, because Azure was a little bit light, I think that's what's driving the stock down in the aftermarket in spite of the top line and bottom line beats.

DAVE BRIGGS: And what's your read into how much the PC sales impacted earnings?

RISHI JALURIA: Yeah, I think that was probably where the gross margins were a little light, was because of the weak PC sales because, remember, with PC sales, Windows OEM is a big driver. That's a very high gross margin item. So with weak PC sales-- and we've all seen the data pointing to it, that's probably what drove the miss on the gross margins.

Now, I think it was really encouraging that their operating margins were kind of in line at a good place. And again, we got the EPS beat we wanted. But because gross margins were a little light, I think that's directly attributable to the Windows OEM.

SEANA SMITH: When you take a look at this demand for the cloud computing business really starting to taper, I mentioned the fact that Azure here, cloud services revenue, growth of 35% compared to 40% growth in the previous quarter. What do you think Microsoft needs to do in order to maybe get back some of the momentum, or will we maybe never see that 40% to 50% growth that we had become accustomed to?

RISHI JALURIA: Yeah, I don't want to say never. But I think the fact of the matter is, we are heading into, whether we want to call it a recession or not, we're heading into a softer or tighter macro environment, right, where you're going to hear this on the call. You hear this from all the software vendors. There's just more layers of approval to making buying decisions. Azure, remember, is primarily on a consumption model. And consumption models are where the slowdown is going to show up first, right, rather than your typical kind of seat-based subscription model.

So I think because the macro is deteriorating, I think that is going to continue to weigh on Azure numbers going forward. I also think as we kind of get visibility into an economic recovery, we're going to see Azure maybe even reaccelerate coming out of that. So I don't want to say that 40% type growth number is off the table, right? And Azure still grew 42% constant currency, right? Like, remember, we've got to consider the foreign currency headwinds here. So 42% is still pretty healthy growth. I just don't want to see that number continue to decelerate too much.

DAVE BRIGGS: To that point, how much does the strength of the dollar impact the report today?

RISHI JALURIA: Yeah, it was about a 5% headwind to growth, right, which was kind of in line with how they talked about-- with the name. It's not surprising. The US dollar is going to continue to get stronger, especially if you look at what's going on in the macro picture in Europe, in the UK, in Australia and Japan.

So I think currency will continue to be a weight on everything. I think the good news, though, is investors by now have gotten conditioned to look at everything on a constant currency basis, right? Strip out the impact of a strong dollar, or maybe in the future, a weak dollar. And look at what is going on with the underlying business.

SEANA SMITH: Rishi, when you take a look at the revenue from sales of Windows licenses dropping 15% year over year, worse than that outlook that we initially got from Microsoft, what do you make of the significance of that drop?

RISHI JALURIA: Yeah I mean, look, to me, the big significance is just, it's a matter of the weak PC demand, right? And that's not a surprise. Part of it is, remember, you had strong device demand as a result of COVID and the initial outlay of work from home. At some point, we knew that was going to fade. So I think we're starting to see the impact of that, as well as just tightening of IT budgets.

There's also the impact of even though we're at full employment, we know headcount growth is definitely starting to slow down if we look at the public job postings data, especially at tech companies, not to mention there are some with actual layoffs going on. So I think that's what's contributing to that and why we're seeing weak PC data. And it flows through to the Windows OEM business. And again, that just hits on the gross margin side.

But ultimately, the strength of Microsoft is, I think, really going to be driven by the cloud computing. And so as long as Azure continues to put up good numbers, as long as Office continues to put up good numbers, I think this name can hold in well.

DAVE BRIGGS: What do you want to hear? What's the one thing you're looking forward to hearing about more on the call?

RISHI JALURIA: Yeah, to me, the one thing I want to point to or what I want to hear is they-- continued strength in Azure, right? Because that's where all the fears are, is that Azure, on this consumption model, is going to slow down further from here. If [INAUDIBLE] get on the call and talk about Azure being more resilient than people expect and give a guidance that starts at the 4 handle for Azure for next quarter on a constant currency basis, I think that would make me very happy. If I were an investor, I think I would be very pleased with that.

SEANA SMITH: Rishi, taking a look at the performance so far this year, Microsoft off 26%, comparing that to the S&P, which is off between 19% and 20%. What's it going to take to turn it around? Because like you said before, the macroeconomic headwinds here is proving very challenging, not only for Microsoft, but obviously, for a number of its competitors as well.

RISHI JALURIA: Yeah, and you bring up a great point, which is, we actually think-- and this is one of the reasons Microsoft is one of our top picks to be defensive in this environment-- is we think Microsoft can actually consolidate budgets, right? There's going to be a lot of point solution vendors, be it on the productivity side or in security, where Microsoft can really consolidate budget and actually emerge stronger coming out of the recession than they've been right now.

But in terms of what it takes, I think two things need to happen. Number one, investors need to gain confidence that numbers aren't going any lower, which is obviously a tricky balancing act. And I think number two is interest rates are still impacting everything in software, and really, everything in tech. And so when we get to a point where interest rates kind of plateau, and we know interest rates are going to keep going up 50, 7,500 bips, I think that could be really when Microsoft starts to work.

DAVE BRIGGS: All right, good stuff. We'll have to leave it there. Rishi Jaluria, appreciate you being here. Thank you.