Microsoft's Non-AI Cloud Business Surges, Driving Strong Datacenter Growth and Profits

Microsoft has delivered solid financial results for the third quarter of its fiscal year 2025, particularly in its cloud business. For the quarter ending in March, the company reported revenues of $70.1 billion, marking a 13.3% increase year on year and a slight sequential rise. Operating income climbed by 16% to $32 billion, also showing a 4.7% sequential improvement. While Microsoft's on-premises datacenter business, which includes Windows Server and its extensions, continues to face pressure, the company is seeing a strong shift toward cloud computing for various enterprise workloads unrelated to AI. The Intelligent Cloud group, encompassing both the Windows Server stack and Azure, saw significant growth with $26.75 billion in sales, up 20.8% year on year. Operating income for this segment increased by 16.6% to $11.1 billion, representing 41.5% of its revenues. Despite the substantial investment in datacenter infrastructure, Microsoft’s cloud operations remain highly profitable. The Productivity and Business Processes group, which includes Office 365, Dynamics 365, and LinkedIn, performed exceptionally well, generating $29.94 billion in sales, a 10.4% year-on-year increase, and $17.38 billion in operating income, up 14.8%. This segment, known for its high margins and profitability, accounted for 58% of its revenues. Microsoft’s broader cloud offerings, collectively known as Microsoft Cloud, saw revenues surge by 20.1% to $42.45 billion, with gross profits rising by 15.1% to $29.29 billion, representing 69% of revenues. Azure, a significant contributor to this success, is estimated to have driven $16.58 billion in sales, up 33% from the previous year, and accounted for 62% of Intelligent Cloud revenues. The estimated operating income for Azure stood at $6.88 billion, or 41.5% of its revenues. To gauge the "real" systems business, which includes systems-level hardware and software along with tech support, our analysis suggests that this segment generated $18.74 billion, up 25.4%, with an operating income of $7.77 billion, a 21% increase. This growth underscores the effectiveness of Microsoft’s strategy in leveraging its strong software portfolio to drive cloud adoption. CEO Satya Nadella provided insights into the AI landscape during the earnings call. He highlighted that model capabilities are doubling in performance every six months, thanks to advancements in multiple areas, including datacenter design, hardware, silicon, systems software, and model optimization. These improvements are aimed at reducing costs and enhancing performance. Nadella noted that Microsoft has achieved a 20% reduction in dock-to-lead times for new GPUs, a 30% increase in AI performance per unit of power across its blended fleet, and more than a 50% reduction in the cost per token. In the quarter, Microsoft processed over 100 trillion tokens, a 5X increase compared to the same period last year. March was particularly noteworthy, with a record 50 trillion tokens processed. While it's challenging to discern the exact distribution, OpenAI’s training and API customers, Microsoft’s Copilot users, and enterprise customers training their own models on Microsoft infrastructure are likely major contributors to this growth. Industry insiders commend Microsoft’s strategic focus on optimizing and scaling its infrastructure, positioning it well to capture the growing demand for cloud and AI services. The company’s ability to integrate its robust software portfolio with advanced cloud capabilities demonstrates its leadership in the tech sector. As Azure continues to scale and improve, Microsoft is poised to maintain its competitive edge and drive further innovation in the industry. Microsoft, with its strong financial position and continuous investment in cutting-edge technology, remains a formidable player in both the cloud and AI markets. The company’s efforts to enhance efficiency and performance while reducing costs are crucial factors in its ongoing success and potential to capitalize on emerging market trends.