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Microsoft bets on AI to drive next wave of cloud, revenues

While Microsoft revenues grew slightly in its second fiscal quarter, the company's cloud revenues continue to stall as users become more conservative with their IT spending.

While Microsoft reported a slowdown in cloud revenues in its second fiscal quarter, Microsoft CEO Satya Nadella expressed optimism about a rebound that will be driven by the heavy infusion of AI in core products, including Azure and Office.

Addressing financial analysts in its quarterly meeting, Nadella added that Microsoft 365 and Azure are rapidly evolving into an "AI-first platform" that will make users more productive and offer more opportunities to be creative with both existing and new applications.

"The next major wave of computing is being born as we turn our AI models into new computing platforms," he said during the investor call Tuesday. "This is an important time for Microsoft to work with customers to help realize more value from IT investments, as well as build long-term loyalty with them while aligning our cost structure with revenue growth."

Despite the slowdown, Microsoft did manage to eke out a small gain in overall revenue for its second fiscal quarter.

Satya NadellaSatya Nadella, Microsoft CEO

The company reported a 2% gain in revenue, to $52.75 compared with $51.72 billion, while net income dropped to $16.43 billion compared with $17.4 billion in the year-ago quarter. Microsoft cloud revenue was $27.1 billion, up 22% year over year, according to Satya Nadella, Microsoft's CEO, in remarks made to financial analysts.

Azure growth slowed to 31%, barely beating analysts' consensus of 30.8%. The cloud platform grew at 35% in the quarter ended Dec. 31. Server products and cloud services grew by 20%, driven largely by Azure and other cloud services, which increased by 31%.

Explaining the slowdown in parts of the company's cloud business, Nadella said organizations became cautious in the latter half of 2022 given the challenges imposed by the pandemic and inflationary pressure.

Just as we saw customers accelerate their digital spend during the pandemic, we are now seeing them taking time to optimize that spend. Those organizations are also exercising caution given the macro economic uncertainty.
Satya NadellaMicrosoft, CEO

"Just as we saw customers accelerate their digital spend during the pandemic, we are now seeing them taking time to optimize that spend," Nadella said. "Those organizations are also exercising caution, given the macroeconomic uncertainty."

One analyst shared that optimism, saying businesses will start spending more liberally on cloud services later in the year.

"The slowdown will be temporary. I believe it is reflective of the austerity in the market right now," said Dan Newman, principal analyst at Futurum Research and CEO of Broadsuite Media Group. "Their cloud performance for the quarter represents pretty decent growth in a market that is generally considered to be horrible right now."

AI to drive growth

Newman added that the company's recent investments in ChatGPT will help serve as an accelerator for Microsoft's cloud sales going forward.

"Users are looking for ways to get more out of the technology investments they have made," Newman said. "The fundamental inclusion of AI in more offerings will add value and also give [Microsoft] more pricing power."

Backing up its ambitions to create AI-first core platforms, Microsoft earlier this week made perhaps its boldest move to date in the technology. The company invested another $10 billion in OpenAI, makers of ChatGPT. Microsoft plans to use the AI-based technology as a way to "democratize AI as a new technology platform."

OpenAI has worked closely with Microsoft's Azure. As far back as 2019, Microsoft made its first investment in the AI startup, investing $1 billion. As part of that deal, Microsoft became the exclusive provider of cloud computing services to OpenAI.

Microsoft intends to integrate ChatGPT across its product line in hopes of competing against a wide range of rivals, including Amazon and Google in the cloud and a host of web-based application developers. The generative AI tool will also integrate into Microsoft's Bing search engine, where it would take on the virtually uncontested market leader, Google.

Cloud momentum slows, hardware declines

What dampened that optimism was the forward-looking statements about the shorter-term prospects for Azure cloud growth. Amy Hood, Microsoft's CFO, said she expects growth of the cloud platform to slow another four to five percentage points from its 35% growth in the December 2022 quarter. This drove down Microsoft's stock price in late-afternoon trading.

The company's Windows OEM and hardware businesses continued their downward spiral. Its Windows OEM revenue decreased some 39%, as demand for desktop and laptop PCs continue to wane.

Revenues from devices, such as the Surface tablets and desktops, also decreased 39%.

In the midst of all this activity, Microsoft continues its battles with the Federal Trade Commission (FTC) and the European Commission to win approval of its proposed $69 billion acquisition of video game giant Activision Blizzard. Hood told analysts she was confident they could close the deal by the end of 2023, pending FTC approval.

Microsoft reported taking a $1.2 billion charge in connection with its decision to lay off 10,000 employees last week, in addition to costs associated with revising its hardware lineup.

As Editor At Large with TechTarget's News Group, Ed Scannell is responsible for writing and reporting breaking news, news analysis and features focused on technology issues and trends affecting corporate IT professionals.

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