Microsoft Q1 2023 Earnings: CEO Nadella ‘Very Pleased’ With Early AI Rush

Microsoft already has tens of thousands of users and 40 percent of the Fortune 100 in the copilot early access program, the vendor revealed Tuesday.

With Microsoft 365 Copilot set to become generally available Nov. 1, Microsoft already has tens of thousands of users and 40 percent of the Fortune 100 in the copilot early access program—including KPMG, Mayo Clinic and Visa—executives revealed Tuesday during the vendor’s quarterly earnings call.

And although Microsoft CFO Amy Hood expects related M365 Copilot revenue “to grow gradually over time,” the revenue opportunity from AI is already here, with 28 percent growth year over year in Azure and other cloud services during the quarter “including roughly three points from AI services.”

Microsoft Chairman and CEO Satya Nadella told listeners on the Tuesday call, which included results for the Redmond, Wash.-based vendor’s first quarter of its fiscal year ended Sept. 30, that “customers tell us that once they use copilot, they can’t imagine work without it.”

[RELATED: Microsoft Reveals Copilot, AI Features Across Windows, Bing, Edge; New Surface Devices Launched]

Microsoft First-Quarter 2023 Results

“For something completely new to have this level of usage already and this level of excitement is something we’re very, very pleased with,” Nadella said later on the call.

The CEO’s observations are good news for solution providers that have invested time and resources into preparing customers for generative AI, improving their own operations through AI and looking for ways to bring in more revenue through the technology.

Microsoft reported total revenue of $56.5 billion for the quarter, up 12 percent year over year ignoring foreign exchange, according to the vendor.

Hood credited sales teams for their “consistent execution” and said partners “drove a strong start to the fiscal year.”

Microsoft stock traded at about $344 a share after hours Tuesday, up about 4 percent.

GenAI Lessons From Cloud

As the GenAI race heats up—with rivals including Google, IBM and Salesforce—Microsoft has a technical advantage through its “full-stack approach,” Nadella told listeners.

“Whether it’s ChatGPT or Bing Chat or all our copilots, all share the same model,” Nadella said. “So in some sense, one of the things that we do have is very high leverage of the one model. … And that advantage sort of trickles down all the way to both utilization internally, utilization of third parties. And also, over time, you can see that sort of stack optimization all the way to the silicon.”

He also took a lesson from building Microsoft’s cloud business, promising a “very disciplined” and “concentrated” tech stack and capital spending approach.

“The lesson learned from the cloud side is this: We’re not running a conglomerate of different businesses,” Nadella said. “It’s all one tech stack up and down Microsoft’s portfolio. And that I think is going to be very important because that discipline, given what the spend will look like for the AI transition, any business that’s not disciplined about their capital spend accruing across all their businesses could run into trouble.”

Microsoft GenAI users aren’t just using Microsoft models, he said. Users are training on open-source and proprietary models and fine-tuning them.

The vendor has more than 60 data center regions worldwide and “the best AI infrastructure for both training and inference,” Nadella said on the call. “We also have our AI services deployed in more regions than any other cloud provider.”

Hood said that “when it comes to our ability to leverage the infrastructure that we’re building out, we don’t really have a preference in terms of how people are utilizing that infrastructure.”

“It gives us a good opportunity to see quick conversion into revenue,” she said.

“If you have a consistent infrastructure, from the platform all the way up through its layers, then every capital dollar we spend, if we optimize revenue against it, we will have great leverage because wherever demand shows up in the layers, whether it’s at the SaaS layer, whether it’s at the infrastructure layer, whether it’s for training workloads, we’re able to quickly put our infrastructure to work generating revenue,” she said.

Nadella told listeners that early copilot users are leveraging the GenAI tool across applications including Word, Excel, PowerPoint, Outlook and Teams.

Copilot is deploying across organizations and in different functions, with workers in sales and finance seeing productivity gains that developers saw when using Microsoft’s GitHub Copilot paired programmer tool, Nadella said.

He shared some early copilot numbers on the call, including:

*More than 1 million paid GitHub Copilot users

*More than 37,000 organizations subscribed to GitHub Copilot for Business, up 40 percent quarter over quarter with significant traction outside the U.S.

*More than 126,000 organizations have used Copilot in Power Platform to date

*More than 15,000 organizations using Sales Copilot

“With copilots, we’re making the age of AI real for people and businesses everywhere,” Nadella said. “We are rapidly infusing AI across every layer of the tech stack and for every role of business process to drive productivity gains for our customers.”

At Microsoft’s upcoming Ignite conference, the vendor promises to introduce more than 100 new products and capabilities and “ talk a lot more about all of the use cases and where’s the value and give more prescriptive guidance on how people can deploy,” Nadella said.

As for Microsoft’s Azure OpenAI Services AI, more than 18,000 organizations now leverage the offering, including some brand-new Azure customers, he said.

Other Product Updates

Nadella shared other user statistics for various Microsoft products on Tuesday’s call.

Those numbers include:

*21,000 Azure Arc customers, up 140 percent year over year

*More than 16,000 customers actively using Microsoft Fabric, including more than 50 percent of the Fortune 500

*More than 73 percent of the Fortune 1000 use three or more Microsoft data solutions

*Four times the number of developers using GitHub since Microsoft bought the code repository five years ago

*Dynamics 365 “took share for the 10th consecutive quarter”

*20 million monthly active users, up 40 percent year over year, for Power Apps

*Microsoft Sentinel now has more than 25,000 customers with revenue surpassing a $1 billion annual run rate

The Microsoft CEO also shared some data around the Teams collaboration application:

*More than 320 million monthly active Teams users

*More than 10,000 paid customers for Teams Premium

*Nine consecutive quarters of triple-digit revenue growth for Teams Rooms

*More than 2,000 apps in the Teams store

*Collaborative apps from Adobe, Atlassian and Workday each exceeded 1 million monthly active users on Teams

Nadella also disclosed that the Dall-E 3 AI image generator has created more than 1.8 billion images.

Azure Sees AI Benefit

Azure saw expected “optimization trends” similar to the prior quarter, Hood said on the call. But “higher-than-expected AI consumption contributed to revenue growth in Azure.”

Multiple analysts on Tuesday’s call asked Nadella and Hood about Microsoft spending to meet AI demand and what AI means for Azure.

Nadella said that Azure growth has come from more cloud migrations, with partnerships including Microsoft’s deeper relationship with database and cloud vendor Oracle enabling more cloud moves.

“Once we announced that the Oracle databases are going to be available on Azure, we saw a bunch of unlock from new customers who have significant Oracle estates that have not yet moved to the cloud because they needed to rendezvous with the rest of the app estate in one single cloud,” Nadella said. “And so we’re really excited about that.”

He said that when customers start new workloads, they like to optimize them before starting new ones, characterizing Azure as lapping “some of those optimization cycles that were fairly extreme perhaps in the second half of our fiscal year.”

Hood added that this is not new behavior for customers. “That is a pattern that has been a fundamental part of having customers both make new room for new workload adoption and and continue to build new capabilities,” she said. “I think that impact remains through the rest of the year.”

Hood said that even with spending to meet AI demand, “we still feel confident we can deliver consistent operating margins to last year.”

As for Microsoft sustaining double-digit growth, Hood said Microsoft “feels good about our ability to execute, but more importantly, our ability to continue to take share.”

“It speaks to the pace at which we’re delivering AI revenue with the increasing success and capital investment ahead, with the demand we see,” she said. “We’re really focused on making sure that every dollar we put and commit is back to the priorities we talked about, which is commercial cloud leadership and leading the AI wave.”

Productivity App Growth

Analysts asked about how Microsoft continues to see good growth in its 365 suites of productivity apps—a big business for a lot of Microsoft solution providers.

Hood said that customers are responding “to the broadening nature of what Microsoft 365 means.”

“It’s more applicable to more people,” she said. “And so I think many people have thought, ‘Oh my goodness, you know, you’ve got a lot of customers already.’ And we look and say, how many people when you expand what Microsoft 365 means whether it’s security, or it means analytics or it means Teams. … It applies to more types of workers and, frankly, the value is such—especially on the small-business front— where it’s to the point where people feel like it’s a great way to spend.”

Microsoft First-Quarter 2023 In Detail

Microsoft Cloud brought in $31.8 billion, up 23 percent year over year, according to the vendor.

Operating income was $26.9 billion, up 24 percent year over year. Net income was $22.3 billion, up 26 percent year over year ignoring foreign exchange.

Commercial bookings growth during the quarter came from “strong execution across our core annuity sales motions, with continued growth in the number of $10 million-plus contracts for both Azure and Microsoft 365,” Hood said.

Commercial remaining performance obligation (RPO) increased 18 percent to $212 billion, Hood said. About 45 percent of that will become revenue in the next 12 months, up 13 percent year over year. Microsoft saw a 20 percent increase year over year to the remaining portion recognized as revenue after the next 12 months.

With mass layoffs conducted by the vendor earlier this year, Hood said that Microsoft head count at the end of September was 7 percent lower than a year ago.

Microsoft First Quarter By Segment

Looking at each segment within Microsoft, the productivity and business processes segment brought in $18.6 billion during the quarter, up 12 percent year over year ignoring foreign exchange.

This was “driven by better-than-expected results in Office 365 Commercial and LinkedIn,” Hood said.

Within the PBP segment, Office Commercial products and cloud services revenue grew 14 percent year over year. Office 365 Commercial revenue grew 17 percent, “slightly better than expected, with a bit more in pre-revenue recognition, while billings remained relatively in line with expectations,” Hood said.

She cited healthy renewal execution, average revenue per user (ARPU) growth and “strong” E5 momentum as driving growth within O365 Commercial.

“Paid Office 365 commercial seats grew 10 percent year over year with installed base expansion across all customer segments,” she said. “Seat growth was again driven by our small and medium business and frontline worker offerings.”

Office Commercial licensing fell 17 percent due to “continued customer shift to cloud offerings,” she said.

Office Consumer products and cloud services revenue grew 4 percent year over year. Microsoft 365 Consumer subscribers reached 76.7 million, up 18 percent year over year.

Dynamics products and cloud services revenue grew 21 percent year over year. Dynamics 365 revenue grew 26 percent year over year.

In the “intelligent cloud” segment, revenue for the quarter was $24.3 billion, up 19 percent year over year “with better-than-expected results across all businesses,” Hood said.

Server products and cloud services revenue grew 21 percent. Azure and other cloud services revenue grew 28 percent year over year.

In particular, increased GPU capacity, better-than-expected GPU utilization of Microsoft AI services and slightly higher-than-expected growth in the per-user business drove the growth, Hood said.

In that per-user business, the Enterprise Mobility and Security install base grew 11 percent year over year to more than 259 million seats.

The on-premises server business revenue grew 2 percent year over year “driven primarily by demand in advance of Windows Server 2012 end of support,” Hood said.

Enterprise and partner services revenue increased 1 percent, “ahead of expectations, driven by better-than-expected performance in enterprise support services,” she said.

In the “more personal computing” segment—which includes Microsoft devices, Windows, Xbox search and news advertising—revenue was $13.7 billion for the quarter, up 2 percent year over year ignoring foreign exchange.

Device revenue fell by 22 percent year over year, “ahead of expectations due to stronger execution and the commercial segment,” Hood said.

Windows revenue increased 5 percent. Windows OEM revenue grew 4 percent, “driven by stronger-than-expected consumer channel inventory builds and stabilizing PC market demand … particularly in commercial,” Hood said.

“Market unit volumes are returning to pre-pandemic levels,” she said.

Windows Commercial products and cloud services revenue grew 8 percent, according to the vendor. This was “driven by demand for Microsoft 365 E5,” Hood said.

Microsoft’s capital expenditures for the quarter was $11.2 billion, which went toward cloud demand support, “including investments to scale our AI infrastructure,” Hood said.

Cash flow from operations was $30.6 billion, up 32 percent year over year. Free cash flow was $20.7 billion, up 22 percent year over year, she said.

Microsoft Second-Quarter Outlook

Microsoft predicts flat bookings growth next quarter. The vendor’s “cloud gross margin percentage will be up roughly 1 point, primarily driven by improvement in Azure and Office 365, “partially offset by the impact of scaling our AI infrastructure to meet growing demand,” Hood said.

Capital expenditures will grow because of cloud and AI infrastructure investments, Hood said.

She predicts the PBP business will grow between 11 percent and 12 percent, or $18.8 billion and $19.1 billion. O365 revenue should grow about 16 percent, she said.

On-premises business revenue should fall “in the mid to high teens,” she said. Office Consumer revenue should grow in “the mid single digits, driven by Microsoft 365 subscriptions.” Dynamics should grow in the high teens.

She expects the intelligent cloud segment to grow between 17 percent and 18 percent, resulting in $25.1 billion to $25.4 billion, driven by Azure.

Azure revenue growth should be 26 percent or 27 percent, “with an increasing contribution from AI.”

Hood expects “continued moderation in seat growth rates given the size of the installed base” for Microsoft 365, with momentum still benefiting the per-user business.

For the second half of the year, Azure revenue should “remain roughly stable compared to Q2,” she said.

She expects the “more personal computing” segment to bring in $16.5 billion to $16.9 billion. Windows OEM revenue should grow in the mid to high single digits. PC market unit volumes should “look roughly similar to Q1,” she said.

Device revenue should fall in the mid teens “as we continue to focus on our higher-margin premium products,” she said. Windows Commercial products and cloud services should grow in the low to mid teens, she said.