Microsoft: What is constraining the growth of Azure? (1Q25 Conference Call Summary)
The following is the summary of the Q1 2025 earnings conference call for $Microsoft(MSFT.US) . For the financial report interpretation, please refer to Microsoft: AI only shows “spending” but not “returns” .
I. Core Financial Report Information Review:
II. Detailed Content of the Earnings Call
2.1 Key Information from Executives:
- Business Progress
① Overall Performance: Revenue for the quarter was $65.6 billion, an increase of 16%, with earnings per share of $3.30, up 10%. AI business is expected to exceed $10 billion in revenue next quarter.
② Copilot Business:
- The number of Copilot Enterprise customers increased by 55% quarter-over-quarter.
- There are 100,000 organizations using Copilot Studio, more than doubling quarter-over-quarter;
- Over 500 healthcare institutions have purchased DAX Copilot, recording over 1.3 million patient-provider interactions.
- The monthly active users of Copilot in the CRM and ERP product suite increased by over 60% quarter-over-quarter.
- Launched GitHub Spark, allowing anyone to build applications using natural language.
- The response speed of Microsoft 365 Copilot has improved by 2 times, and the response quality has improved by nearly 3 times. The number of daily users of Microsoft 365 Copilot has more than doubled quarter-over-quarter.
③ Power Platform Business:
Over 600,000 organizations are using AI features in Power Platform, a fourfold increase year-over-year.
④ Azure Business:
- Revenue from Azure and other cloud services increased by 33% year-over-year (34% at constant currency).
- The company now has over 60,000 Azure AI customers, a nearly 60% year-over-year increase; and over 39,000 Arc customers, an increase of over 80% year-over-year.
- Added the latest GPUs from AMD and NVIDIA, as well as the company's own first-party accelerator Maia 100.
- Over 60 global data centers, Cobalt 100 VMs perform excellently, advancing AI infrastructure construction.
- Microsoft Fabric: Currently has over 16,000 paying customers, including over 70% of Fortune 500 companies.
⑤ Productivity and Business Processes:
1.Server Products and Cloud Services:
Overall year-on-year growth of 20% (21% growth in constant currency), Azure and other cloud services growth met expectations, while on-premises server business revenue declined, and enterprise and partner services business remained relatively stable.
2. Office Commercial Products and Cloud Services:
M365 commercial cloud revenue grew by 15% (16% growth in constant currency), with increases in paid seats and ARPU, M365 commercial product revenue grew, and M365 consumer product and cloud service revenue increased.
3. LinkedIn Social Networking Services:
Revenue grew by 10% (9% growth in constant currency), membership growth accelerated, video format performed strongly, AI tools supported business development, and recruitment business market share expanded.
4. Dynamics Business:
Year-on-year growth of 14%, Dynamics 365 grew by 18% (19% growth in constant currency), Dynamics 365 accounts for about 90% of total Dynamics revenue, with growth across all workloads and expanded market share.
5. Department Financial Status: Department gross margin increased by 11% (12% growth in constant currency), operating expenses grew by 2%, and operating income increased by 16%.
⑥ Personal Computing Business:
1.Windows Operating System:
OEM and device revenue grew by 2% year-on-year, Windows OEM performed well due to market structure changes, and device business was impacted by commercial execution challenges, falling below expectations.
The new Copilot+ PC series offers top-notch AI capabilities, performance, and value, winning new customers.
2. Devices and Gaming Business:
Search and news advertising business growth exceeded expectations, gaming revenue grew by 43% (44% growth in constant currency), Xbox content and services revenue grew by 61%, hardware revenue was impacted, Game Pass performed excellently this quarter, and the release of "Call of Duty: Black Ops 6" achieved outstanding results.
⑦ Security Business:
- Invested 34,000 full-time engineers to handle the highest priority security tasks.
- Customers have used Defender to discover and protect over 750,000 GenAI application instances; and have audited over 1 billion Copilot interactions using Purview to fulfill their compliance obligations ⑧ Consumer Business:
- LinkedIn: Weekly immersive video views increased sixfold month-over-month, with total video views on LinkedIn growing 36% year-over-year.
Gaming: This quarter set a new record for monthly active users. Game Pass achieved new records for total revenue and average revenue per subscriber in the first quarter. The release day of "Call of Duty 6" set a record for the increase in Game Pass subscribers. Sales on PlayStation and Steam also grew by over 60% year-over-year.
- Financial Performance
Overall Overview:
Revenue Side:
- Revenue: This quarter's revenue was $65.6 billion, an increase of 16%.
- Earnings per Share: Earnings per share were $3.30, an increase of 10%.
Expense Side:
Operating costs increased by 12% year-over-year, below expectations, with 9 percentage points coming from the Activision Blizzard acquisition.
Profit Side:
- Operating profit increased by 14% year-over-year, profit margin at 47%, a year-over-year decrease of 1%, with profit margin rising by 1% excluding the impact of Activision Blizzard.
Cash Flow and Capital Expenditure:
- Capital expenditure was $20 billion, in line with expectations, with cash paid for P, P, and E at $14.9 billion.
- Operating cash flow was $34.2 billion, increasing by 12%, with free cash flow at $19.3 billion, decreasing by 7%.
- This quarter, other income and expenses were negative $283 million.
- Returned $9 billion to shareholders through dividends and stock buybacks.
- Order volume exceeded expectations, growing 30% year-over-year (23% growth at constant exchange rates).
- Commercial remaining performance obligations increased by 22% (21% growth at constant exchange rates), reaching $259 billion. Approximately 40% of revenue will be recognized in the next 12 months, a year-over-year increase of 17%. The remaining portion (to be recognized after the next 12 months) grew by 27%. This quarter, the annuity portfolio increased to 98%.
- Effective tax rate of 19%.
- Second Quarter Outlook.
- Foreign Exchange: It is expected that foreign exchange will not have a significant impact on revenue, COGS, or operating expense growth.
- Gross Margin: Microsoft's cloud gross margin is expected to be around 70%, with a year-over-year decline in gross margin due to the expansion of AI infrastructure.
- Capital Expenditure: Capital expenditure is expected to continue to increase.
- Productivity and Business Areas:
- Revenue: Revenue is expected to grow by 10% (11% growth at constant exchange rates), amounting to $28.7 billion to $29 billion.
- M365 commercial cloud revenue is expected to grow by approximately 14% (at constant exchange rates), with related revenue expected to continue to gradually increase over time
- M365 Commercial Products: Expected revenue will decline in low single digits.
- LinkedIn: Expected revenue growth of approximately 10%.
- Dynamics 365: Expected revenue growth will reach mid-to-high levels driven by continued growth across all workloads.
- Intelligent Cloud:
- Revenue: Expected revenue for Intelligent Cloud will grow by 18% (20% growth at constant currency), reaching between $25.55 billion and $25.85 billion. Revenue will continue to be driven by Azure, which may experience quarterly fluctuations primarily due to revenue recognition during the period.
- Azure: Expected revenue growth for the second quarter will reach 31% (32% growth at constant currency).
- Enterprise and Partner Services: Expected revenue growth will remain in low single digits.
- On-Premises Server Business: Expected revenue will decline in low to mid-single digits.
- More Personal Computing:
- Revenue: Expected revenue will be between $13.85 billion and $14.25 billion.
- Windows OEM and device revenue is expected to decline to low single digits.
- Search and news advertising ex-TAC revenue is expected to be in high single digits.
- Gaming: Expected revenue will decline at a high single-digit rate due to hardware issues, while Xbox content and services revenue growth is expected to remain relatively stable.
- Company Guidance:
- COGS is expected to grow by 11% (13% growth at constant currency), reaching between $21.9 billion and $22.1 billion.
- Operating expenses are expected to grow by approximately 7%, reaching between $16.4 billion and $16.5 billion.
- Other income and expenses are expected to be approximately negative $1.5 billion, primarily due to anticipated losses from OpenAI.
- Expected effective tax rate for the second quarter is 19%.
2.2 Q&A Analyst Q&A
Q: What are Microsoft's internal and external constraints on investment in generative AI innovation?
A: Capital expenditure for training is constrained by monetization of inference and will determine the pace of investment based on demand signals and factors such as Moore's Law; externally, there are issues in the short term with data center construction and power supply, as some demand is affected by third-party suppliers, but it is expected that supply-demand matching will improve in the second half of the year.
Q: Azure's Q1 growth was 34%, and Q2 guidance has been lowered to just over 30%. Besides the year-over-year difficulty, are there other factors contributing to the expected slowdown?
A: The part of Q1 growth that exceeded expectations was due to revenue recognition benefits. The slowdown in Q2 guidance is mainly due to delays in some supplies (such as delays in AI supply rollout), but fundamental consumption growth remains stable, and supply-demand matching is expected to improve after supply increases in the second half of the year, while emphasizing the importance of GPUs and CPUs for AI workload operations.
Q: Will the trend of capital expenditure growth return to traditional patterns? What are the timelines and the situation for facilities coming online next year? A: Similar to the cloud transformation ten years ago, construction will be demand-driven. As demand grows, capital expenditure growth will slow down, while revenue growth will accelerate, gradually narrowing the gap between the two. The specific speed depends on the adoption rate, with some capital expenditure allocated to building the next-generation training infrastructure, which will not all be reflected in the cost of sales.
Q: How does Microsoft manage the capital expenditure demands brought by helping OpenAI scale and its impact on other revenues?
A: The cooperation between the two parties is mutually beneficial. Microsoft's investment in OpenAI has been successful, collaborating in areas such as infrastructure, model innovation, and product innovation, and will continue to deepen in the future. The investment capital is to meet the needs of OpenAI and other customers. Regarding the impact on other revenues, the equity method is used for accounting, bearing losses according to the investment ratio, with a loss cap equal to the total investment (mentioned this quarter as $13 billion).
Q: What is Microsoft's profit model during the inference phase and related products and applications?
A: The company has generated revenue from its inference business, such as products like GitHub Copilot and M365 Copilot, and does not participate in GPU sales for non-enterprise needs, resulting in high revenue quality. The current $10 billion revenue (including inference and applications) will drive the next round of training investments, and the investment and profit cycle is already underway.
Q: What are the specific circumstances of Azure supply constraints and their impact on Q2 growth?
A: Supply delays are mainly due to third-party delivery delays, primarily affecting the second half of the year (especially Q3), including complete end-to-end deliveries such as suites. Q2 consumption is flat with Q1, with differences mainly arising from revenue recognition gains in Q1 and supply delays in Q2.
Q: What is the product evolution thinking from Copilot to intelligent agents?
A: The company has built Copilot, Copilot Studio, intelligent agents, and autonomous intelligent systems. Copilot serves as the user interface layer for AI, which can be extended through Copilot Studio to connect with other systems to build intelligent agents and autonomous intelligent agents that collaborate with each other, while Azure provides underlying system services that customers can use to build their own applications.
Q: What is the data performance after the reclassification of Copilot? And what is Microsoft's AI strategy for consumers and enterprises?
A: The commercial Copilot is experiencing strong growth, with high adoption rates among Fortune 500 companies and increased buybacks. The transformation it brings is not only at the tool level but also in changing work methods. On the consumer side, revenue growth from search, news, and advertising businesses has exceeded the market, and businesses like LinkedIn, gaming, and Windows will also benefit from AI investments. The prospects for Copilot + PCs are broad, and Microsoft's overall investment strategy will benefit all businesses. The seat growth in M365 commercial business mainly comes from frontline employees and small businesses, which has lowered the average revenue per user (RPU), but in the future, Copilot will have a positive impact on RPU
Risk Disclosure and Statement of This Article: Dolphin Investment Research Disclaimer and General Disclosure
