While Microsoft's (MSFT) fiscal second-quarter earnings beat estimates, Wall Street supposedly expected more from AI-driven revenue streams. Brent Bracelin, Piper Sandler Equity Research Analyst on Cloud, joins Yahoo Finance Live to discuss the outlook for future revenues as generative AI turns roughly one-year-old in its adoption by tech giants.

"I think we're in a classic case here where we saw earnings reports out of the vast majority of the cloud 100 challenge that would suggest during Q3 things started to stabilize," Bracelin says. "In Q4, Microsoft is really the big, first cloud company to report, and they're showing stabilization, maybe a little bit more softness on the cloud Azure optimization side more than offset by AI. Microsoft is unique in that they have material AI tailwinds."

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Editor's note: This article was written by Luke Carberry Mogan.

Video Transcript

- Microsoft reported strong growth in cloud driven by high demand for AI services. But its softer than anticipated guidance for revenue growth seems to be giving investors pause. Joining us now, we've got Brent Bracelin, who is the Piper Sandler equity research analyst for the Cloud Sector. Brent, always a pleasure to get some of your insights here. First, I just want to summarize the quarter that was. And ultimately, the lofty expectations for AI and the show-me story really showing up strong here for both of these companies that we're tracking this morning, Google, Alphabet, and Microsoft as well as investors are certainly expecting more here.

BRENT BRACELIN: Yeah. I mean, I think it's important to put things into perspective. Generative AI is one-year-old. We're one year into this new AI cycle of Microsoft. They disclosed their business actually doubled sequentially. It's now a $4.4 billion run rate business in year one. Remind you, Azure, which we're talking about Azure. Investors were all excited by Azure, it took a decade for Azure to get to 10 billion. At Microsoft AI, it's at 4.4 billion in one year. So things are happening very fast.

I think that it is year one. I can't wait to see what year two, year three, and year four bring for Microsoft AI. But it also is important to put into perspective the 10% stock move ahead of earnings year-to-date in Microsoft and the 60% move in Microsoft over the last year. So yes, expectations are high. Maybe people always want more AI because it's exciting and it's new. But I'll remind you and put things into perspective, that $4.4 billion number is a big number in essentially what is essentially the first year of rollout.

- Yeah. Well, Brent, put that further into context for us. You Mentioned that there's still lots of questions about what year two is going to look like. What are your expectations for year two. And then also, tagging on to that, there has been at least some chatter here from the Street this morning that maybe some of the strength that we saw driven by AI in the Azure business, maybe that is clouding or masking the slowing core Azure base. Is there any truth to that?

BRENT BRACELIN: Absolutely. I think we're in a classic case here where we saw earnings reports out of the vast majority of the cloud 100, that would suggest during Q3, things started to stabilize. In Q4, Microsoft's really the big first cloud company report. And they're showing stabilization maybe a little bit more softness on the cloud optimization, Azure optimization side more than offset by AI.

Microsoft is unique in that they have material AI tailwinds. Other cloud companies might not benefit as much as Microsoft and insulate in them. But classic casework, investors think that things will get better, fundamentals aren't necessarily rebounding yet across the group. So I think it's a little early to call it a fundamental call. I think expectations are fundamentals will improve at some point. Just no evidence that it's happening now. Microsoft has the benefit of AI that's helping insulate their business for sure.

- We've been watching a wave of tech layoffs to begin the year here, Brent. And reallocation of human resources at a lot of these companies. How does this kind of position these companies for the next iteration of growth? And then ultimately, what is the impact on their business as well?

BRENT BRACELIN: I think the reality for these cloud companies. And even the reality for Microsoft is investments in AI are going to cost dollars. And you have to offset those dollars with efficiency. And it's not just Microsoft. It's going to be investing in AI. Every company is going to be investing in AI. And so I think there's just a greater focus on, as we think about this next cycle, it's not just about accelerating growth. You need to accelerate growth and improve margins. Unfortunately, that's going to be tied to some cost optimization, internal efforts. Both on vendors as well as employees. So it's a bit of a new reality. You have to do both. You can't just accelerate top line and not drive profitability as well.