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Microsoft (NASDAQ: MSFT)
Q1 2025 Earnings Call
Oct 30, 2024, 5:30 p.m. ET
Quick Overview of Earnings Call Contents
- Introduction and Financial Highlights
- Interactive Q&A Session
- Meet the Participants
Opening Remarks
Operator
Welcome to Microsoft’s first-quarter fiscal year 2025 earnings call. Please note that this call is being recorded. I’ll now introduce your host, Brett Iversen, Vice President of Investor Relations. Brett, please proceed.
Brett Iversen — Vice President, Investor Relations
Good afternoon and thank you for joining us today. Alongside me are Satya Nadella, Chairman and Chief Executive Officer; Amy Hood, Chief Financial Officer; Alice Jolla, Chief Accounting Officer; and Keith Dolliver, Corporate Secretary and Deputy General Counsel. You can find our earnings press release and a financial summary slide deck on the Microsoft Investor Relations website. This deck is meant to accompany today’s comments and shows key differences between GAAP and non-GAAP financial measures. We have updated some figures to reflect changes to our segments from August 2024.
For detailed insights, including information on FY ’23 and FY ’24 recast segment revenue and operating income, please refer to the financial statements on our website. We will also provide more detailed outlook slides later. Please remember that non-GAAP measures should complement, not replace GAAP financial performance metrics.
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We will clarify additional items to enhance understanding of our quarterly performance and the influence of these items on our financial results. All growth comparisons discussed today are relative to last year’s figures unless stated otherwise. When available, we will also provide growth rates in constant currency to show our core business performance without foreign exchange impact.
The prepared remarks will be uploaded to our website right after the call, which is also being webcast live. Any questions posed during the live call will be included in the transcript and any future recordings. You can catch the replay and see the transcript on the Microsoft Investor Relations website.
During this call, we will discuss forward-looking statements based on our current expectations and assumptions, which are subject to various risks and uncertainties. Actual results may differ significantly due to factors outlined in our earnings press release, comments during this call, and in our SEC filings. We do not promise to update any forward-looking statements.
Now, I’ll hand over the call to Satya.
Satya Nadella — Chair and Chief Executive Officer
Thank you, Brett. We’re off to a strong start for fiscal year 2025, supported by the ongoing growth of Microsoft Cloud, which brought in revenue of $38.9 billion, up 22%. The shift towards AI is transforming work and helping customers to achieve new growth and efficiency. Our AI business is projected to exceed a $10 billion annual revenue run rate by next quarter, making it the fastest in our history to reach this milestone.
Let’s highlight key achievements in our infrastructure. Azure gained market share this quarter, driven by robust cloud migration. Azure Arc now serves over 39,000 customers in various sectors, a year-over-year growth of more than 80%.
We operate data centers in over 60 regions globally and recently announced new investments in Brazil, Italy, Mexico, and Sweden to meet long-term demand. Our latest Cobalt 100 VMs are favored by companies like Databricks and Snowflake, offering up to 50% better price performance compared to prior models. Additionally, we are enhancing our AI infrastructure across the board to optimize for the growing demand in AI workloads.
We provide an extensive range of AI accelerators, including our Maia 100 along with advanced GPUs from AMD and NVIDIA. Notably, we are the first cloud provider to implement NVIDIA’s Blackwell system with GB200-powered AI servers. Our collaboration with OpenAI continues to yield positive results, enhancing our unique IP and driving revenue growth.
Furthermore, with Azure AI, we are developing a comprehensive application platform that allows customers to create their own AI tools. Usage of Azure OpenAI has more than doubled in the past six months, as both new digital startups and established firms adopt our technology. For instance, GE Aerospace has leveraged Azure OpenAI to develop a digital assistant servicing their 52,000 employees, processing over 500,000 internal queries in just three months.
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Microsoft’s AI Innovations Drive Business Transformation and Growth
Microsoft continues to push the boundaries of artificial intelligence with its latest updates, which show significant growth in various sectors. Here’s a look at the exciting developments across its platforms.
Expanding Azure AI Support and Capabilities
This quarter, Microsoft has launched support for OpenAI’s latest model family, o1. Additionally, the company is introducing industry-specific models through Azure AI, focusing on multimodal models in medical imaging. By integrating these innovations, Microsoft aims to enhance the developer workflow via GitHub models, providing users with access to a comprehensive model catalog directly within their development tools. This is part of Azure AI’s strategy to streamline data and analytics services.
As the adoption of AI-powered applications accelerates, usage of Azure Cosmos DB and Azure SQL DB hyperscale has surged among major clients like Air India, Novo Nordisk, Telefonica, Toyota Motor North America, and Uniper. With Microsoft Fabric, an AI-driven platform, companies such as Chanel, EY, KPMG, Swissair, and Syndigo can consolidate their data across multiple clouds. Currently, over 16,000 organizations are paid customers of Microsoft Fabric, including over 70% of the Fortune 500.
GitHub Copilot’s Transformational Impact on Software Development
GitHub Copilot is revolutionizing software development practices. In the last quarter, the number of enterprise customers utilizing Copilot rose by 55%, with companies like AMD and Flutter Entertainment customizing it to fit their own needs. Microsoft is also unveiling advanced AI code generation, allowing Copilot to seamlessly interact throughout the developer process. The introduction of GitHub Copilot Workspace supports developers from project inception to coding, all through natural language.
Another innovative feature, Copilot Autofix, assists developers in fixing code vulnerabilities at a pace over three times faster than traditional methods, benefiting companies like Asurion and Auto Group. To further its commitment to open-source development, Microsoft has expanded the number of models accessible via GitHub Copilot. The recently launched GitHub Spark is designed to empower a new wave of developers by enabling app creation using natural language, while generative AI has also been integrated into the Power Platform, helping users cut costs and save development time.
Power Platform and Microsoft 365 Copilot Usage Surge
Nearly 600,000 organizations have tapped into AI features within the Power Platform, reflecting a fourfold increase year-over-year. Citizen developers at ZF exemplify this expansion, having created applications simply by describing their needs in plain language. Recent advancements in Power Automate allow customers to apply AI for more efficient workflow management.
Last month, Microsoft unveiled the latest enhancements to Microsoft 365 Copilot, unifying web, work, and Pages into an innovative design framework intended for knowledge work. This new “Pages” feature is meant to facilitate idea generation and collaboration with AI support. Moreover, Copilot’s response times have improved twofold while response quality has seen almost a 300% increase, so daily users of the platform more than doubled in the last quarter.
Companies across industries are recognizing the value of Microsoft 365 Copilot. Vodafone plans to roll out the tool to 68,000 employees based on trials that revealed an average time-saving of three hours per employee, while UBS will deploy 50,000 licenses in what represents one of the largest financial services agreements to date. Today, nearly 70% of Fortune 500 companies have adopted Microsoft 365 Copilot, with a notable uptick in additional seat purchases.
Dynamics 365 and AI-Driven Business Processes
Microsoft Dynamics 365 is witnessing a shift towards AI-centric business applications as organizations, including Evron, Heineken, and Lexmark, choose its services over competitors. The monthly active users of Copilot in the Dynamics 365 portfolio have risen over 60% quarter-over-quarter. The introduction of 10 new out-of-the-box autonomous agents in Dynamics 365 aims to expedite tasks such as sales lead qualification and supplier tracking.
One year after its launch, DAX Copilot’s usage has expanded to document 1.3 million physician-patient encounters each month across more than 500 healthcare organizations. New features also automate tasks beyond simple note-taking, such as generating referrals and diagnostic evidence. The demand for Microsoft Teams remains robust, with nearly 75% of enterprise customers opting for Premium, Phone, or Rooms packages.
Focusing on Security in the Digital Age
Security continues to be a top priority at Microsoft. Through its Secure Future Initiative, the company has committed resources equivalent to 34,000 full-time engineers to address security concerns effectively. New and improved methodologies are being put in place to ensure the protection of identities, networks, and systems. Organizations like Clifford Chance, Intesa Sanpaolo, and Shell are leveraging Security Copilot to streamline their SecOps tasks with greater efficiency.
Moreover, Microsoft is focused on securing AI deployments, with Defender identifying over 750,000 GenAI app instances and Purview auditing compliance for more than 1 billion Copilot interactions.
LinkedIn’s Continued Member Growth and Engagement
Turning to Microsoft’s consumer segments, LinkedIn’s member base is growing steadily, particularly in markets such as India and Brazil, where growth rates are in double digits. With engagement levels hitting records, Microsoft is enhancing the platform with new features that facilitate connections, services, and knowledge-sharing among its 1 billion members. Its investments in video formats further assert LinkedIn’s leadership in B2B advertising, illustrated by an uptick in weekly immersive video views.
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LinkedIn Sees Video Growth and Microsoft Reports Strong Financials
LinkedIn’s video viewership has surged, climbing 36% year-over-year and sixfold quarter-over-quarter. The platform’s AI-driven tools are changing the landscape for sales, learning, and hiring. In sales, new AI features help team members perform at peak levels, leading to increased profitability.
Innovations in Learning and Hiring
Recently, LinkedIn announced enhancements to its coaching experience that include personalized career development plans. The platform’s first AI-driven hiring assistant is designed to expedite the recruiting process, resulting in a 44% higher acceptance rate for candidates reached through AI messaging compared to traditional methods. This tool is part of LinkedIn’s ongoing strategy to capture more market share in hiring.
Advancements in Search, Advertising, and Gaming
The introduction of Copilot represents an early step toward developing an AI companion for users. This new experience features design improvements, enhanced speed, and fluency, while also incorporating advanced capabilities such as voice and vision. Copilot’s ability to see what users see facilitates a conversational browsing experience.
In the gaming sector, Microsoft’s acquisition of Activision Blizzard King, finalized a year ago, aims to foster long-term growth through higher-margin content and services. The company has diversified gaming access, setting new records for monthly active users and revenue from Game Pass subscriptions.
Record-Breaking Launches and Future Outlook
The recent launch of “Black Ops 6” not only became the biggest release in the Call of Duty franchise but also resulted in a significant increase in unit sales on PlayStation and Steam, up over 60% year-over-year. This demonstrates Microsoft’s commitment to adapting to gamer preferences by allowing access across multiple devices.
In three weeks, Microsoft will host its Ignite Conference, where the company plans to unveil additional strategies centered on how AI can support growth across various business sectors.
Financial Highlights from Amy Hood
Amy E. Hood — Executive Vice President, Chief Financial Officer
Thank you, Satya, and good afternoon everyone. This quarter, Microsoft achieved revenues of $65.6 billion, reflecting a 16% increase and earnings per share of $3.30, up by 10%. Strong performance from sales teams and partners contributed to the positive start for our fiscal year, marked by double-digit growth.
Microsoft witnessed gains in many sectors, particularly in commercial business, where demand for Microsoft Cloud services surged. Commercial bookings exceeded forecasts, rising 30%, with a 23% increase in constant currency. This robust performance was driven by successful execution in securing high-value contracts, especially for Azure and Microsoft 365.
Key Insights on Commercial Growth
The number of $100 million-plus contracts for Azure also rose significantly, contributing to an overall 22% increase in commercial remaining performance obligations, which reached $259 billion. In addition, nearly 40% of this amount is expected to be recognized as revenue within the next 12 months, reflecting a 17% increase year-over-year.
Overall, Microsoft’s investment in long-term contracts is showing solid results. This quarter, the annuity mix reached 98%, indicating a strong reliance on subscription-based revenue streams across many business segments.
Review of Segment Performance
Revenue from Productivity and Business Processes reached $28.3 billion, an increase of 12%. The growth was attributed to robust performance across M365, with commercial cloud revenue increasing 15%. The demand for premium E5 licenses and M365 Copilot drove revenue per user higher.
M365 consumer subscriptions grew to 84.4 million, demonstrating strong demand in the consumer segment, while LinkedIn revenue increased by 10%, aided by a diverse range of business services. Dynamics revenue saw a 14% growth, thanks to a continued uptick in Dynamics 365 across various markets.
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Microsoft Earnings Report Highlights Strong Growth Across Segments
Dynamics 365 remains a major contributor for Microsoft, accounting for about 90% of total Dynamics revenue. The segment’s gross margin dollars saw an increase of 11%, while it climbed 12% when adjusted for constant currency. However, the gross margin percentage experienced a slight year-over-year decline due to the scaling of our AI infrastructure. Operating expenses rose by 2%, resulting in a 16% increase in operating income.
Next, we look at the Intelligent Cloud segment. Revenue reached $24.1 billion, reflecting a growth of 20% and 21% in constant currency, aligning with forecasts. Revenue from Azure and other cloud services experienced a robust increase of 33% and 34%, respectively, in constant currency, driven by strong consumption trends.
Azure’s growth included approximately 12 points from AI services, similar to last quarter. Demand continues to surpass our existing capacity. Non-AI growth trends were consistent with expectations across all regions, as clients shifted to Azure for modernization. However, non-AI contributions to Azure growth saw a slight sequential decline of roughly 1 point.
In the on-premises server business, revenue dipped by 1%. This was influenced by lower-than-expected transactional purchases before the Windows Server 2025 launch, coupled with decreased license sales in multi-cloud setups. This decline was mostly balanced out by earlier noted in-period revenue recognition benefits. Revenue from enterprise and partner services also decreased by 1%, remaining relatively constant in constant currency. Gross margin dollars for this segment increased by 15%, although gross margin percentage dropped by 3 points year-over-year due to AI infrastructure scaling.
Operating expenses in this area rose by 8%, while operating income saw an 18% growth. Turning to More Personal Computing, this segment generated $13.2 billion in revenue, marking a 17% increase, largely attributed to a net positive impact of 15 points from the Activision acquisition. The results exceeded expectations, mainly due to successful initiatives in Gaming and Search.
Windows OEM and Devices revenue grew by 2% year-over-year, benefiting from better-than-expected outcomes in the Windows OEM market, though challenges in the commercial devices segment affected overall performance. Excluding traffic acquisition costs, Search and news advertising revenue surged by 18% and 19% in constant currency, driven by effective execution and increased rates alongside healthy volume growth for Edge and Bing. Gaming revenue soared by 43% and 44% in constant currency, with 43 points of net impact stemming from the Activision acquisition.
Performance outpaced expectations in both first- and third-party content and console sales. Xbox content and services revenue jumped by 61%, with a notable 53-point net impact from the acquisition. Segment gross margin dollars rose by 16% and 17% in constant currency, demonstrating 12 points of net impact from Activision. Despite robust margin improvement, operating expenses surged by 49%, primarily due to the acquisition, resulting in a 4% decrease in operating income.
Regarding total company results, capital expenditures, including finance leases, totaled $20 billion, meeting expectations. Cash spent for property, plant, and equipment amounted to $14.9 billion. Nearly half of our cloud and AI-related expenditures are on long-lived assets aimed at monetization in the long term. The other portion mainly supports server requirements based on customer demand. Cash flow from operations increased by 12% to $34.2 billion, propelled by strong cloud billing and collections, despite higher payments to suppliers, employees, and taxes.
Free cash flow fell by 7% year-over-year to $19.3 billion, reflecting increased capital spending for cloud and AI initiatives. In this quarter, other income expense was negative $283 million, better than anticipated, due to foreign currency remeasurement and net investment gains. Losses on investments accounted for under the equity method were in line with expectations, and the effective tax rate was around 19%.
Finally, Microsoft returned $9 billion to shareholders through dividends and stock repurchase programs. Looking ahead to Q2, barring specific notes, we anticipate currency fluctuations to boost total and segment revenue growth by less than 1 point, without significantly affecting cost of goods sold or operating expenses.
The trends observed in Q1 are expected to persist into Q2. Customer demand for our unique solutions is likely to drive another quarter of solid growth. In commercial bookings, we forecast a robust growth driven by ongoing long-term commitments to our platform and strong performance in core annuity sales. It’s worth noting that larger Azure contracts can lead to increased volatility in quarterly booking growth rates due to their unpredictable timing. Microsoft Cloud’s gross margin percentage is projected to be around 70%, down year-over-year as a result of scaling AI infrastructure.
We foresee an increase in capital expenditures in response to cloud and AI demand signals. As previously stated, we will remain aligned and adjust to emerging demand trends as necessary. For segment guidance, let’s start with Productivity and Business Processes.
We are the leading force in knowledge-based copilots and agents in the enterprise sector, focused on maintaining our market share in productivity solutions. We anticipate revenue growth in the Productivity and Business Processes sector to fall between 10% and 11% in constant currency, translating to USD 28.7 billion to USD 29 billion. M365 commercial cloud revenue is expected to rise by approximately 14% in constant currency, with moderating seat growth across customer segments and increased average revenue per unit (ARPU) through E5 and M365 Copilot. Revenue growth for the second half of the fiscal year is anticipated to be stable compared to Q2.
Growth in M365 Copilot seats is continuing, and we expect this revenue to grow steadily over time. Regarding M365 commercial products, we foresee a slight decline in revenue in the low single digits. It’s important to remember that M365 commercial products comprise on-premise components, which can lead to variability in our quarterly revenue based primarily on in-period revenue recognition influenced by contract mixes. M365 consumer cloud revenue is anticipated to grow in the mid-single digits, driven by subscriptions.
For LinkedIn, we project revenue growth of about 10% fueled by broad-based growth across all business areas. In Dynamics 365, we predict revenue growth in the mid- to high teens, driven by ongoing advancements across all workloads. Moving on to Intelligent Cloud, our goal of helping customers innovate and grow with cloud and AI solutions continues to fuel revenue growth in Azure.
Therefore, we foresee revenue in the Intelligent Cloud segment to grow between 18% and 20% in constant currency or USD 25.55 billion to USD 25.85 billion. Azure’s revenue growth is forecasted to be 31% to 32% in constant currency, supported by continued demand for our service portfolio. We expect consumption growth to remain stable compared to Q1, with expectations to add more sequential dollars to Azure than any other segment.
Microsoft’s recent quarter shows solid progress, particularly in AI services. Despite capacity issues and shifts in project timelines, the company anticipates sustained growth in Azure as investments ramp up to meet soaring demand.
Anticipating Azure Growth Amid Capacity Challenges
In this upcoming quarter, Microsoft expects AI service contributions to remain consistent, despite ongoing capacity restrictions. Azure is projected to experience an acceleration in growth during the second half of the year, thanks to strategic capital investments aimed at increasing AI capacity. Regarding the on-premises server sector, the company predicts a revenue contraction in the low to mid-single digits, compared to a previous period that enjoyed a boost from purchases made before the Windows Server 2012 end-of-support deadline. In the Enterprise and partner services segment, revenue growth is expected to be in the low single digits.
Focus on High-Margin Opportunities in More Personal Computing
Microsoft continues to prioritize high-margin prospects within its consumer businesses. The company projects More Personal Computing revenue between USD 13.85 billion and USD 14.25 billion, benefiting from improved gross and operating margins. However, Windows OEM and device revenues are expected to decline in the low to mid-single digits. Growth in the Windows OEM sector is anticipated to align with the PC market but will likely be offset by a drop in device sales. Search and news advertising revenue, excluding TAC, is expected to see growth in the high teens.
Gaming Revenue Forecast Shows Challenges
In the gaming sector, Microsoft predicts a high single-digit revenue decline primarily due to hardware sales. Although Xbox content and services revenue is expected to remain flat, the recent launch of Call of Duty led to an unprecedented increase in Game Pass subscriptions on launch day. The game’s availability on Game Pass and the requirement of an online connection for play will influence how revenue is recognized over time.
Cost Management and Strategic Investments Remain a Priority
Looking at company guidance, Microsoft anticipates COGS growth between 11% and 13%, amounting to approximately USD 21.9 billion to USD 22.1 billion. Operating expenses are projected to increase around 7%, totaling USD 16.4 billion to USD 16.5 billion. This trajectory suggests another quarter of operating margin expansion.
Regarding other income and expenses, a loss of around $1.5 billion is expected, largely as a result of the anticipated loss from OpenAI. Microsoft’s investments in OpenAI are crucial for developing its AI business, helping position the company as a leader in this expanding field. The effective tax rate for Q2 is estimated to be around 19%.
Looking Ahead: Emphasizing Long-Term Growth
In summary, Microsoft remains focused on strategic investments that support long-term value for shareholders. The AI business is projected to surpass a remarkable $10 billion annual revenue run rate by Q2, marking a record pace for the company. Even with constraints, Microsoft is committed to maintaining its leadership across the Microsoft Cloud while also managing costs effectively.
Now, let’s move to the Q&A session. Brett, over to you.
Questions & Answers:
Operator
[Operator instructions] Our first question comes from Keith Weiss at Morgan Stanley. Please proceed.
Keith Weiss — Analyst
Thank you for taking my questions and congratulations on a strong quarter. Satya, the rapid development and opportunities in generative AI seem to be creating an exciting time for the software industry.
However, I have two related questions concerning constraints: first, what internal limitations exist for Microsoft in funding future foundational models, especially given the substantial projected costs? Secondly, what external constraints might affect your ability to build out the necessary capacity in a sustainable manner? I’m keen to understand your perspective on both aspects.
Satya Nadella — Chair and Chief Executive Officer
Thanks, Keith. Let’s address your first question about investment constraints. Our capital outlay for training will be influenced by the monetization and demand we see for inference in upcoming models. Similar to past strategies, our investments in training will align with projected demand. In terms of external factors, we do face limitations, particularly as recent demand spikes have outpaced our current capabilities. Building new data centers and ensuring power availability are significant challenges we encounter in fulfilling demand.
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Microsoft Financial Outlook: A Look at Azure’s Future Growth
Keith Weiss — Analyst
Things are becoming more long lead. However, I am optimistic that by the second half of this fiscal year, supply and demand will align better.
Brett Iversen — Vice President, Investor Relations
Thank you, Keith. Operator, please take the next question.
Operator
The next question comes from Brent Thill of Jefferies.
Brent Thill — Analyst
Thanks, Amy. I’m glad to hear about the expected rebound in Azure’s growth in the latter half. However, I noticed Q1 growth was 34%, but it dropped to the low 30s for Q2. Besides the tough comparison, are there other factors affecting this forecast for Q2?
Amy E. Hood — Executive Vice President, Chief Financial Officer
Thank you, Brent. This is an important question. In Q1, the 34% growth was slightly above our guidance of 33%, largely because of certain revenue recognition advantages. If we look ahead, we expect some deceleration, mainly due to delays in AI supply expected to come online. However, the core consumption growth remains stable from Q1 to Q2. I am confident that as we receive more AI supply in the second half, we can better balance supply and demand, which is why we project an acceleration then. It’s also crucial to remember that AI workloads require both GPU and CPU capabilities, which will contribute to this anticipated growth.
Brent Thill — Analyst
Thanks.
Brett Iversen — Vice President, Investor Relations
Thanks, Brant. Operator, please take the next question.
Operator
The next question comes from Mark Moerdler of Bernstein.
Mark Moerdler — Analyst
Thank you for taking my question. Congratulations on the quarter! Investors are concerned about capital expenditures. Half of our investments are tied to facilities with long lifespans, but the other half is for other components. Can you provide insights into your capex growth? Will it align with or slightly lag cloud revenue growth? What is the expected timeline? Will we have sufficient facilities operational by next year?
Amy E. Hood — Executive Vice President, Chief Financial Officer
Thanks, Mark. To understand our current situation, it helps to reflect on our cloud transition over the past decade. Initially, we needed to build our infrastructure to meet demand. Now, we are expanding globally, so our strategy is parallel rather than sequential. As long as we see sustained demand growth, we anticipate that the pace of capex growth will slow compared to revenue growth. Over time, they will move closer together. The timing of our investments will largely depend on market adoption rates. Some of our spending is directed toward establishing new training infrastructure, meaning not all will show up in cost-of-goods-sold (COGS), while some will apply to operating expenses. However, this approach should keep capex and revenue growth balanced, similar to our previous cycles.
Mark Moerdler — Analyst
Thank you, that clarification is very helpful.
Brett Iversen — Vice President, Investor Relations
Thanks, Mark. Operator, please take the next question.
Operator
The next question comes from Karl Keirstead of UBS.
Karl Keirstead — Analyst
Thank you. Instead of numbers, I want to address the relationship between Microsoft and OpenAI. There has been a lot of media coverage recently, and I’d love to hear how you view that partnership. There are hints that Microsoft might want to diversify its offerings. Can you explain how you see this relationship evolving and how it impacts capital expenditures?
Satya Nadella — Chair and Chief Executive Officer
Thank you, Karl. Our partnership with OpenAI has been immensely rewarding for both parties. Microsoft was an early investor, backing one of today’s highest-valued private companies when we invested several years ago. This collaboration has resulted in significant advancements for both OpenAI and Microsoft. Our approach is to provide world-class infrastructure for OpenAI’s innovations and, in turn, incorporate their breakthroughs into our products, like GitHub Copilot and Microsoft 365 Copilot. We maintain a robust and ongoing dialogue with OpenAI to ensure mutual growth and continued collaboration.
Amy E. Hood — Executive Vice President, Chief Financial Officer
To address your concerns about capex, we are proud to support OpenAI’s scaling needs while also serving our broader customer base. This necessity drives our ongoing investment to ensure that we meet the high demand from a wide range of clients, not just OpenAI. That’s why we’ve committed considerable capital in recent quarters, as it is essential for our collective growth and Azure platform expansion.
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Microsoft’s Continued Investment in AI: Insights from Recent Earnings Call
Substantial Growth in AI Investments
Microsoft’s leadership emphasizes the importance of meeting customer needs without the challenge of balancing competing demands. They focus on providing value for clients and recognize the necessity of adapting quickly to fulfill those needs. The company is committed to working diligently to enhance service delivery.
Investment Strategies Under the Equity Method
In discussing income impacts, executives provided clarity about their accounting approach. Microsoft operates under the equity method, meaning the company accounts for its share of losses each quarter. These losses are limited by their total investment, which was reported at $13 billion for the quarter. This investment strategy plays a crucial role, and while the equity losses are a consideration, they do not dominate the management focus.
Rapid Growth in AI Revenue
When asked about the investment cycle in AI, Microsoft CEO Satya Nadella highlighted that the company isn’t merely waiting for revenue from AI’s inference phase. The business is positioned to be the fastest to reach $10 billion, generating income primarily from inference-driven services. Interestingly, Microsoft does not focus on selling raw GPUs for model training, as demand is primarily coming from enterprise applications and internal products like GitHub Copilot and M365 Copilot. This approach reflects high-quality revenue generation in a competitive landscape.
Continuous Investment Fuels Future Growth
Amy E. Hood, Executive Vice President and CFO, added that current revenue contributes to future training cycles. The momentum created through past investments lays the groundwork for ongoing growth, illustrating a cycle where today’s investments foster tomorrow’s profitability.
Impact of Supply Chain on Azure
Delving into Azure’s supply challenges in Q2, Amy Hood explained that these challenges are not merely about components. The delays stem from third-party suppliers that have pushed back their delivery timelines. These supply constraints primarily affect the second half of the year. Thus, the impact on Azure’s growth may be slight but notable.
Evolution of AI Product Offerings
Analysts expressed interest in the evolution of Microsoft’s AI offerings from Copilot to more advanced agent systems. Satya Nadella described a spectrum that includes Copilots, Copilot Studio, and autonomous agents. This spectrum outlines how user interfaces (UIs) for AI evolve from basic assistance to more capable systems that can operate independently under certain circumstances, although they may still require human oversight.
As Microsoft continues to innovate in AI, executives underscore their commitment to meeting customer needs efficiently while navigating supply chain complexities. The ongoing journey of AI development represents a strategic focus for future growth within the company.
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Microsoft’s Copilot: A Game Changer in AI for Business Growth
Microsoft is making significant strides with its Copilot technology, integrating it into various services to enhance productivity. This involves establishing a user interface layer, bolstered by the Copilot Studio and its autonomous agents. The company’s strategy centers around delivering a comprehensive system that leverages these advancements effectively.
Moreover, Microsoft is enhancing its core infrastructure by offering underlying system services through Azure. Users have access to a robust framework, enabling them to develop AI applications akin to what has been achieved with the Copilot technology. This flexibility allows businesses to utilize Microsoft’s AI platform to create tailored solutions.
Raimo Lenschow — Analyst
OK. Perfect. Very clear.
Brett Iversen — Vice President, Investor Relations
Thanks, Raimo. Operator, we have time for one last question.
Operator
The last question comes from Rishi Jaluria with RBC. Please proceed.
Rishi Jaluria — Analyst
Thank you. Hi, Satya. Hi, Amy.
I want to discuss Copilot’s numbers and the recategorization. It seemed softer in the past than expected, but perhaps the current quarter reflects some improvements. Can you provide more insight on this? Additionally, how should we view your AI strategy for consumers versus enterprises, especially with Moustafa now involved?
Satya Nadella — Chair and Chief Executive Officer
On your first point, Rishi, we are very optimistic about the growth of our commercial Copilot. As mentioned, it is experiencing the fastest adoption rate of any suite in M365 history, surpassing earlier transitions such as E3 or E5. The penetration rate among Fortune 500 companies and their increasing demand for additional seats indicate strong momentum.
Furthermore, we are committed to ensuring that Copilot functions as a systemic solution. This means integrating security controls, deployment strategies, skills training, and effective change management. It’s not merely a tool; it’s a transformation in the way people work. This change is comparable to the dramatic impact of personal computer adoption in the 1990s, particularly seen in business processes like forecasting. Overall, we are pleased with our progress and penetration levels.
Looking at the consumer side, our strategy capitalizes on our investments in commercial segments. Notably, our revenue in search, news, and ads is outpacing market growth, indicating a vibrant consumer sector contributing over $10 billion that might sometimes be overlooked. We are confident about leveraging AI innovations, especially within LinkedIn, as it directly benefits our consumer demographic.
We recently introduced features on LinkedIn that cater to both consumers and recruiters, affirming our belief that AI investments will yield returns through its continuous innovation across all platforms, including gaming and Windows. The integration of Copilot and PCs is pivotal as we aim to unify AI technology to revitalize the PC as a central hub for AI-driven operations.
Our strategy emphasizes a unified corporate entity. By investing once, we enable benefits across all our product categories, a core philosophy driving our approach.
Amy E. Hood — Executive Vice President, Chief Financial Officer
To add on Rishi’s question, it seems there’s some confusion about the visibility of Copilot’s progress in our results. You’re already seeing the impact in our M365 commercial segment, where growth has primarily stemmed from increasing seats at lower average revenue per user (ARPU) rates, predominantly from frontline workers and small businesses. This factor may obscure some of the potential growth from E5, which, along with Copilot, continues to contribute positively.
As we move forward, watch for enhanced ARPU in M365 commercial, and expect to see the effects of Copilot engagement reflected in our performance metrics.
Rishi Jaluria — Analyst
Thank you very much.
Brett Iversen — Vice President, Investor Relations
Thank you, Rishi. That concludes the Q&A segment of today’s earnings call. We appreciate your participation and look forward to connecting again soon.
Operator
[Operator signoff]
Call Participants:
Brett Iversen — Vice President, Investor Relations
Satya Nadella — Chair and Chief Executive Officer
Amy E. Hood — Executive Vice President, Chief Financial Officer
Keith Weiss — Analyst
Brent Thill — Analyst
Amy Hood — Executive Vice President, Chief Financial Officer
Mark Moerdler — Analyst
Karl Keirstead — Analyst
Kash Rangan — Analyst
Mark Murphy — Analyst
Raimo Lenschow — Analyst
Rishi Jaluria — Analyst
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