‘All of these tools are now available, the sophistication of how people can deploy these models across various business processes where there is data and where there is tuning of these models is also getting more widespread, even at systems integrators and other developers [that] are there to help enterprises,’ says Microsoft CEO Satya Nadella.

Microsoft Chairman and CEO Satya Nadella said systems integrators are now adopting tools for fine-tuning artificial intelligence models, a sign of the growing maturity of the AI market.

During the Redmond, Wash.-based vendor’s latest quarterly earnings call, held Thursday for the third fiscal quarter ended March 31, Nadella told an analyst that more tools in the marketplace are helping with AI model deployment and data preparation, including Microsoft tools such as Fabric, PostgreSQL and Cosmos.

“All of these tools are now available, the sophistication of how people can deploy these models across various business processes where there is data and where there is tuning of these models is also getting more widespread, even at systems integrators and other developers [that] are there to help enterprises,” Nadella said. “All that is maturing.”

[RELATED: Microsoft Copilot For Security Is Generally Available, Adding AI To Cyber Fight]

Microsoft Third-Quarter Earnings

Microsoft has more than 400,000 partners, including systems integrators, resellers, MSPs and other partner types, worldwide, according to the vendor.

Along with Microsoft data preparation tools, the vendor views its Copilot, Copilot Studio and AI connector products to various business systems as a way to to bring AI to marketers, salespeople and other operational workers in the way that it has brought generative AI to programmers through GitHub Copilot.

“Think of it as we’re creating GitHub Copilot-like scenarios for every business system,” he said.

Still, AI’s days are still early, with Nadella envisioning “a couple of orders of magnitude of improvements in our … models before we can sort of have more sophisticated, open-ended consumer scenarios.”

Nadella’s comments on systems integrators followed a theme on the call of providing evidence of AI’s continued adoption and assuring analysts that Microsoft has a handle on the capital expenditures needed to meet the moment.

AI Customer Appetite

On the Thursday earnings call, Nadella laid out Microsoft’s history of not only creating innovative technology, but helping customers adopt it.

He compared worker adoption of Copilots and AI to the adoption of other new technologies as they popped up, including email, Excel and Teams.

Workers use new technology “in the context of business processes. … in the context of sales enablement, customer service, revenue ops, supply chain,” he said. He called Microsoft “underappreciated” for how it has built “tools to make progress on business processes.”

With Copilot, “we have the ability to essentially bridge the work and the work artifacts inside of these knowledge worker tools with the workflow and the business process and the business process data. … We now get to bridge that between the business applications and knowledge worker tools more horizontally,” Nadella said.

This has fueled the importance of partnering and creating interoperability with vendors including ServiceNow, SAP and Salesforce, Nadella said. “We are building a Copilot which also happens to be an orchestrator of all these other copilots, which to us appear as extensions,” he said.

Customers have been shifting AI spending from traditional IT spend into other areas of the business given the improvements AI can provide to customer service departments, sales, marketing, “anywhere there’s operations,” the CEO said.

“We’re seeing it even in the horizontal use of Copilot today,” he said. “Every day, people are discovering new workflows that they can optimize. … The PC when it became standard issue in early ’90s, that’s the closest analogy I can come up with.”

Microsoft CFO Amy Hood added that AI spending has come from business executives other than CIOs such as customer service and marketing heads. “That will be important as we think about the opportunity ahead,” she said.

Although AI adoption will take time, Nadella still categorized the emerging technology as having a “faster diffusion, faster rate of adoption than anything we’ve seen in the past—as evidenced even by Copilot, right? It’s faster than any suite we have sold in the past.”

AI has even inspired culture and process change within companies, he said. “At the end of the day, companies will have to take a process, simplify the process, automate the process and apply the solution,” he said. “That requires not just technology, but in fact companies to go do the hard work of culturally changing how they adopt technology to drive that operating leverage. … We know that this is not just about technology, it’s about being able to have the methodology that goes with it.”

Microsoft’s AI Opportunity Is An Azure Opportunity

When asked by an analyst about customer demand for Azure, Nadella called the cloud offering “a share taker” and a “port of call for pretty much anybody who is doing any AI project.”

“That’s sort of been a significant help for us in terms of acquiring even new customers,” he said.

He said that the Azure AI Search information retrieval platform for developers building AI apps has become “one of the fastest-growing services for us.”

“We are seeing adjacent services in Azure that get attached to AI,” he said. “I would say migration to Azure as well. So this is not just all an AI story. We’re also looking at customers. … There’s always an optimization cycle. But there’s also, as people optimize, they spend money on new project starts, which will grow, and then they’ll optimize.”

On the call, Hood teased at even more work ahead moving businesses from on-premises to cloud technology. “Some of that—which I know isn’t as exciting, talking about all the AI projects—this is still really foundational work to allow companies to take advantage of the cost savings,” she said. “And the total TCO is still really good.”

Microsoft seeing customer spend in cloud fluctuate over time isn’t a negative, Hood said. It’s part of optimizing technology spend. “You want to run your workloads as efficiently as you possibly can,” she said. “It’s critical to customers being able to grow and get value out of that. … For us, it is just about a healthy cycle at the customer account level.”

Nadella shared some data to illustrate continued growth in Microsoft cloud offerings:

• The Azure Arc hybrid and multi-cloud management product now has 33,000 customers, more than double year over year.
• The number of $100 million-plus Azure deals increased more than 80 percent year over year.
• The number of $10 million-plus Azure deals more than doubled year over year.

And to show that the AI hype hasn’t taken away from growth in the Microsoft Teams collaboration application, Nadella shared this data:

• Microsoft surpassed 1 million Teams Rooms for the first time.
• Teams Phone now has more than 20 million public switched telephone network users.
• That number is an increase of nearly 30 percent year over year.

Nadella’s Security Pledge

Analysts on the call had no questions about negative headlines around the security of Microsoft’s products.

But Nadella used some of his opening remarks to emphasize the importance of cybersecurity to the vendor. He pointed to Microsoft’s Secure Future Initiative and the general availability of Copilot for Security—an AI tool informed by 78 trillion daily security signals and providing actionable insight to cybersecurity professionals—as indicators of how seriously the vendor approaches customer resistance to cyberthreats.

“Security underpins every layer of the tech stack, and it’s our No. 1 priority,” Nadella said.. “We are doubling down on this very important work putting security above all else—before all other features and investments. … We remain committed to sharing our learnings, tools and innovation with customers.”

Microsoft Third Quarter In Detail

Microsoft brought in $61.9 billion for the quarter, an increase of 17 percent year over year, which “exceeded expectations,” Hood said.

Commercial bookings grew 31 percent ignoring foreign exchange, she said, “significantly ahead of expectations, driven by Azure commitments with an increase in average deal size and deal length, as well as strong execution across our core annuity sales motions.”

Operating income grew 23 percent year over year to $27.6 billion. Net income grew 20 percent year over year to $21.9 billion.

Microsoft Cloud brought in $35.1 billion in revenue during the quarter, up 23 percent year over year, “ahead of expectations,” Hood said. Gross margin percentage increased slightly “even with the impact of scaling our AI infrastructure.”

Microsoft’s productivity and business processes segment—which includes Office 365, Teams, Viva and Copilot for Microsoft 365—brought in $19.6 billion in revenue during the quarter, up 11 percent year over year ignoring foreign exchange.

Within this segment, Office Commercial products and cloud services grew 12 percent year over year. This division includes Office 365, Viva, Copilot for M365 and Teams.

Office 365 Commercial revenue grew 15 percent. Hood said that “suite strength contributed to ARPU [average revenue per user] expansion for our Office Commercial business, although new business growth continued to moderate for stand-alone products sold outside the Microsoft 365 suite.”

She added that O365 Commercial growth came from “healthy renewal execution, ARPU growth from continued E5 momentum and early Copilot for Microsoft 365 progress,” areas where services-led Microsoft partners play a role.

Paid O365 Commercial sales grew 8 percent year over year, Hood said. The installed base expanded across all customer segments and seats grew in frontline worker and small and midsize business offerings, although SMB growth—a market heavily serviced by partners— “continued to moderate.”

The vendor’s commercial remaining performance obligation (RPO) increased 21 percent ignoring foreign exchange to $235 billion.

Office Consumer products and cloud services revenue grew 4 percent. Microsoft 365 Consumer subscribers hit 80.8 million, up 14 percent. This division includes Copilot Pro subscriptions. Dynamics products and cloud services revenue grew 17 percent year over year ignoring foreign exchange. Dynamics 365 revenue grew 22 percent.

Hood called the Dynamics growth “ahead of expectations … with continued growth across all workloads and better-than-expected new business—although bookings growth remains moderated.”

Microsoft’s “intelligent cloud” business segment brought in $26.7 billion in the quarter, an increase of 21 percent year over year. This segment includes public, private and hybrid server products and cloud services, including Azure. Hood highlighted “better-than-expected results across all businesses.”

Within intelligent cloud, server products and cloud services revenue increased 24 percent year over year. Azure and other cloud services revenue increased 31 percent. “Our AI services contributed seven points of growth, as expected,” Hood said.

The vendor’s Enterprise Mobility and Security per-user business saw the installed base grow 10 percent to more than 274 million seats, Hood said, “with continued impact from the growth trends in new stand-alone business.”

The on-premises server business saw revenue increase 6 percent, “ahead of expectations” thanks to “better-than-expected renewal strength, particularly for contracts with higher in-period revenue recognition,” she said. The vendor’s enterprise and partner services revenue decreased 9 percent year over year.

Microsoft’s “more personal computing” (MPC) segment brought in $15.6 billion, up 17 percent year over year. This segment includes Windows, Windows OEM licensing, Surface, HoloLens, PC accessories, gaming and search engine revenue.

Within the MPC segment, Windows revenue grew 11 percent year over year, according to Microsoft. Windows OEM revenue increased the same amount, with Hood saying “PC market demand was slightly better than we expected.”

Windows Commercial products and cloud services revenue grew 12 percent ignoring foreign exchange. Hood said this was “below expectations” and credited the disappointing number to “growth trends in new stand-alone business … as well as lower in-period revenue recognition from the mix of contracts.”

Devices revenue fell 16 percent ignoring foreign exchange, according to Microsoft. “Surface demand was slightly lower than expected,” Hood added. Microsoft saw $21 billion in free cash flow, up 18 percent year over year.

Microsoft’s stock traded at about $416 a share after hours Thursday, up about 6 percent from market open.

Microsoft Fourth-Quarter Guidance

The PBP segment should grow revenue between 9 and 11 percent ignoring foreign exchange—$19.9 billion to $20.2 billion. O365 revenue growth should be about 14 percent. Dynamics revenue should increase in the low to midteens, with “continued bookings growth moderation,” Hood said.

The on-premises business’ revenue should decline in the mid to high teens. Office Consumer revenue should grow in the low to mid single digits, Hood said.

The intelligent cloud business segment should grow between 19 percent and 20 percent ignoring foreign exchange—$28.4 billion to $28.7 billion. Azure should grow between 30 percent and 31 percent, with the possibility of results “similar to our stronger-than-expected Q3 results,” she said.

“Growth will be driven by our Azure consumption business and continued contribution from AI. with some impact from the AI capacity availability noted earlier,” Hood said.

The on-premises server business should grow low to mid single digits with “continued hybrid demand,” Hood said. She expects enterprise and partner services revenue to decline in the mid to high single digits.

In the MPC business segment, Microsoft expects revenue to grow between 10 percent and 13 percent ignoring foreign exchange—$15.2 billion to $15.6 billion. Windows OEM should grow low to mid single digits, with “PC market unit volumes … at pre-pandemic levels,” she said.

Windows Commercial products and cloud services should grow mid single digits. Devices revenue should decline in the midteens.