Microsoft (MSFT) FY25 Q1 Earnings Review (Jul-Sep 2024)

Productivity tech giant Microsoft (MSFT) reported its FY25 Q1 earnings (first quarter of fiscal year 2025) after the closing bell on October 30, beating Wall Street expectations on revenue and earnings. However, with the closely-watched Azure cloud business showing decelerating growth, shares dropped approximately -3.6% in after-hours trading.

Microsoft (MSFT) FY25 Q1 Financial Results

• Revenues: $65.6B (YoY +16%)
  • Productivity and Business Processes: $28.3B (YoY +12%)
  • Intelligent Cloud: $24.1B (YoY +20%)
  • More Personal Computing: $13.2B (YoY +17%)
• EPS: $3.3 (YoY +10%)
• Azure: YoY +33% (QoQ -1ppt)

Microsoft (MSFT) announced a business reorganization on August 21, 2024, primarily to provide investors with greater transparency into its growing cloud infrastructure operations. The Productivity and Business Processes segment was expanded to incorporate certain operations previously under Intelligent Cloud and More Personal Computing. Simultaneously, Azure operations were adjusted, with specific services removed and search advertising revenue partially integrated. Microsoft also updated its financial guidance, raising the outlook for Productivity and Business Processes while lowering expectations for Intelligent Cloud and More Personal Computing while maintaining overall revenue guidance.

Segment Performance

All three segments achieved double-digit year-over-year growth. Productivity and Business Processes, the largest segment (43% of revenue), reached $28.32B, growing 12% YoY and beating market expectations of $27.9B. The Azure-centric Intelligent Cloud segment saw revenue increase 20% YoY to $24.09B, slightly exceeding analyst expectations of $24.04B. More Personal Computing grew 17% YoY to $13.18B, surpassing the market consensus of $12.56B.

Intelligent Cloud maintained its position as the fastest-growing segment, driven by robust Azure growth. Azure revenue growth accelerated to 33% YoY from 31% in the prior year, though slightly below the previous quarter’s 34%, roughly in line with market expectations of 32.8%. In constant currency terms, Azure revenue growth was 34%, marginally lower than the previous quarter’s 35%, slightly outperforming the updated August guidance (33%) and meeting the buy-side consensus of 34%.

The Productivity and Business Processes segment was primarily driven by Microsoft 365 Commercial Cloud subscription services, which grew 15% YoY, mainly benefiting from strong SMB demand and pricing effects that elevated ARPU. Microsoft 365 Consumer subscriptions increased 10% to 84.4M, with related revenue up 6%. Business applications like Dynamics (up 10%) and LinkedIn (up 18%) maintained steady growth trajectories.

More Personal Computing saw improvement amid PC market recovery, with Windows licensing and devices up 2% YoY. While Windows licensing revenue increased, Surface hardware continued to decline. Gaming revenue surged 43% due to the Activision Blizzard acquisition (contributing 43 percentage points), with Xbox content and services up 61% (acquisition contributing 53 percentage points), though Xbox hardware sales declined 29%. Search and advertising revenue accelerated by 18%, marking its fastest growth in nearly a year.

Financial Performance

Microsoft Cloud product sales grew 22% to $38.9B, with gross margin at 71%, down approximately 2 percentage points YoY, primarily impacted by AI infrastructure scaling investments. Commercial bookings demonstrated robust growth of 30%, driven by large-scale, long-term Azure commitments.

Company-wide gross margin declined two percentage points to 69%, while operating margin decreased one percentage point to 47%, reflecting significant investment pressure but still exceeding analyst expectations. Operating cash flow reached $34.2B, with capital expenditures (including finance leases) of approximately $20B, substantially higher than the year-ago period’s $11.2B and the previous quarter’s $19B. PP&E cash expenditure totaled roughly $14.9B, primarily allocated to cloud and AI capacity expansion, with about half dedicated to long-term assets.

Microsoft (MSFT) FY25 Q1 Earnings Call

Microsoft is actively pioneering the AI era, with CEO Satya Nadella emphasizing how AI-driven digital transformation revolutionizes every role, function, and workflow. Microsoft is expanding market opportunities and attracting new customers, helping them leverage Microsoft’s AI platforms and tools to drive new growth and enhance operational leverage.

Azure and Cloud

• Azure continues gaining market share with ongoing customer migrations from competing cloud services
• Azure AI platform enabling customer development of AI agents
• AI demand contributed 2% to Azure growth, with compute capacity remaining constrained
• Overall, cloud services gross margin declined due to AI infrastructure investments, though Azure-specific margins improved
• Custom Cobalt 100 CPU gaining customer adoption, offering a 50% better price-performance ratio

AI Infrastructure and Strategy

• Data center expansion and power supply facing constraints, expected improvement in H1 next year
• AI inference demand is projected to rapidly reach a multi-billion dollar scale
• GPU allocation is prioritized for inference over training workloads
• Copilot positioned as key AI interface, including future automated agents

AI Products and Services

• GitHub Copilot enterprise users up 55% QoQ
• Microsoft 365 Copilot gaining enterprise validation with gradual adoption expansion
• AI emerging as primary enterprise application interface
• OpenAI investment continuing to yield positive returns:
  • OpenAI valuation experiencing rapid growth
  • Revenue growth through OpenAI IP rights
  • Azure OpenAI service usage doubled in six months

Microsoft 365 and Productivity Tools

• Teams usage maintaining historic highs, with 75% of enterprise customers purchasing additional features
• Microsoft 365 ARPU growth driven by E5 plans and Copilot
• Commercial cloud version penetration at 90%
• Consumer cloud version penetration at 85%
• Copilot expected to drive significant Microsoft 365 revenue contribution
• Bing search engine and Microsoft Edge browser gaining market share
• Gaming business achieving record monthly active users

Outlook for FY25 Q2

Next quarter revenue guidance of $68.1B-$69.1B implies 10.6% YoY growth, with Productivity and Business Processes projected at $28.7B-$29.0B (up 12% YoY), Intelligent Cloud at $25.55B-$25.85B (up 19% YoY), and More Personal Computing expected to decline to $13.85B-$14.25B (down 4% YoY).

Azure revenue growth is projected at 31-32% in constant currency, indicating further deceleration, though the CFO reaffirmed that Azure growth will accelerate in H2 FY2025 as supply capacity expands. Additionally, Microsoft will continue AI infrastructure investments based on demand evolution, with next quarter’s capital expenditure expected to exceed this quarter’s $20B. Notably, the CFO indicated that Microsoft’s “other income and expense” line item would show approximately $1.5B in losses next quarter, primarily due to Microsoft’s share of expected OpenAI losses.

Review and Analysis

Microsoft has demonstrated impressive stability over recent quarters. While market concerns about the next quarter’s outlook exist, these worries may be overstated from a strategic perspective. The 16% overall revenue growth reflects a crucial reality: Microsoft is undergoing structural transformation rather than facing fundamental operational challenges.

Microsoft’s decision to combine Windows OS revenue with Surface hardware revenue represents a step back in terms of transparency. However, this change might signal a broader strategic pivot: Microsoft is redefining its role in personal computing, evolving from a pure software company toward hardware-software integration.

Cloud Services

In the public cloud market, Azure’s slight deceleration needs to be understood within a broader strategic context: this is a marathon, not a sprint. Notably, Azure’s growth moderation stems from supply constraints rather than demand issues. This phenomenon reveals a deeper strategic consideration: computing power has become the new oil in the AI era, and controlling compute capacity equates to controlling the digital economy’s lifeblood.

Microsoft 365 Commercial’s stable growth and Copilot’s gradual contribution demonstrate Microsoft’s business model innovation capabilities in the AI era. This represents more than simple product layering – a comprehensive ecosystem strategy deeply embedding AI capabilities into users’ daily workflows. The debate over whether AI should exist as a Copilot or Agent is fundamentally a question of technical maturity evolution rather than strategic choice.

AI

Compared to Google’s TPU and Amazon’s Trainium & Inferentia, Microsoft is currently the most affected by NVIDIA supply conditions among the three major public cloud providers in terms of revenue and gross margin impact. Microsoft’s heavy reliance on NVIDIA reflects a larger strategic question: whether to invest heavily in developing proprietary AI chips, making chip strategy development a key indicator to watch.

Microsoft’s relationship with OpenAI is subtly transforming from a single-between to a diversified portfolio approach. This transition reflects a fundamental reality in the AI domain: no single player can maintain perpetual technological advantage. Microsoft’s comprehensive betting across major AI models represents a prudent risk diversification strategy.

Microsoft’s decision to increase capital expenditure should be viewed as a positive signal. In the AI era, infrastructure investment parallels 19th-century railroad construction – whoever builds the most robust infrastructure network will secure a competitive advantage in future competition. While capital expenditure growth currently exceeds revenue growth, considering rapid AI computing demand growth, this represents the most appropriate capital deployment strategy.

Conclusion

Microsoft’s current performance should be evaluated from a broader perspective: the company is transitioning from a traditional software company to an AI-era tech giant. Some fluctuations during this process are inevitable, but these short-term variations shouldn’t be over-interpreted as long as the direction remains correct. Microsoft’s core competitiveness lies in ecosystem completeness and business model innovation capability, advantages that may become more pronounced in the AI era. Current revenue growth remains healthy, and while future capital expenditure amortization pressure may emerge, overall profitability is expected to maintain robust levels.

Strengths and Opportunities

1. Microsoft 365 Copilot showing very positive customer adoption
2. Microsoft Dynamics, Bing, and Microsoft Edge products gaining market share
3. AI demand in cloud services maintains rapid growth

Weaknesses and Threats

1. OpenAI model positive effects significantly diminished
2. AI computing costs slightly higher than competitors, and current computing capacity is insufficient to realize full growth potential
3. PC market demand is yet to show a strong recovery
4. Office overall market penetration is already high, long-term growth rate inevitably moderating
5. The gaming business’s long-term strategy remains unclear