MICROSOFT CORP Q1 2026 earnings call

Good afternoon and thank you for joining us today. On the call with me are Satya Nadella, Chairman and Chief Executive Officer, Amy Hood, Chief Financial Officer, Alice Jolla, Chief Accounting Officer, and Keith Dolliver, Corporate Secretary and Deputy General Counsel. On the Microsoft Investor Relations website, we will provide an earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks and provide the reconciliation of differences between GAAP and non-GAAP financial measures. More detailed Outlook slides will be available on the Microsoft Investor Relations website. On this call, we will discuss certain non-GAAP items. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP.

They are included as additional clarifying items to aid investors in further understanding the company's first quarter performance, in addition to the impact these items and events have on the financial results. All growth comparisons we make on the call today relate to the corresponding period of last year unless otherwise noted. We will also provide growth rates in constant currency, when available, as a framework for assessing how our underlying business performed, excluding the effect of foreign currency rate fluctuations. Where growth rates are the same in constant currency, we will refer to the growth rate only. We will post our prepared remarks to our website. Today's call is being recorded. If you ask a question, it will be included in our live transmission, in the transcript, and in any future use of the recording.

You can replay the call and view the transcript on the Microsoft Investor Relations website. During this call, we will be making forward-looking statements, which are predictions, projections, or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made in this conference call, and in the risk factor section of our Form 10-K, Forms 10-Q, and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statements. With that, I'll turn the call over to Satya.

Thank you, Jonathan. It was a very strong start to our fiscal year. Microsoft Cloud revenue surpassed $49 billion, up 26% year-over-year, and our commercial RPO increased over 50% to nearly $400 billion with a weighted average duration of only two years. We are seeing increasing demand and diffusion of our AI platform and family of Copilots, which is fueling our investments across both capital and talent. When it comes to infrastructure, we're building a planet-scale cloud and an AI factory, maximizing tokens per dollar per watt while supporting the sovereignty needs of customers and countries. We're innovating rapidly across the family of Copilots, spanning the high-value domains of information work, coding, security, science, health, and consumer.

As you saw yesterday, we closed a new definitive agreement with OpenAI, marking the next chapter in what is one of the most successful partnerships and investments our industry has ever seen. This is a great milestone for both companies, and we continue to benefit mutually from each other's growth across multiple dimensions. Already, we have roughly 10x our investment. OpenAI has contracted an incremental $250 billion of Azure services. Our rev share, exclusive IP rights, and API exclusivity for Azure continue until AGI or through 2030, and we have extended the model and product IP rights through 2032. We are also energized to innovate and pursue AI advancements with both talent and compute investments that have real-world impact. With that, let's turn to our momentum across our AI platform and Copilots, as well as with agents.

We have the most expansive data center fleet for the AI era, and we are adding capacity at an unprecedented scale. We will increase our total AI capacity by over 80% this year and roughly double our total data center footprint over the next two years, reflecting the demand signals we see. Just this quarter, we announced the world's most powerful AI data center, Fairwater in Wisconsin, which will go online next year and scale to 2 GW alone. We have deployed the world's first large-scale cluster of NVIDIA GB300s. We are building a fungible, global fleet that's being continuously modernized and spans all stages of the AI lifecycle, from pre-training to post-training to synthetic data generation and inference. It also goes beyond Gen AI workloads to recommendation engines, databases, and streaming. We're optimizing this fleet across silicon, systems, and software to maximize performance and efficiency.

It's this combination of fungibility and continuous optimization that allows us to deliver the best ROI and TCO for us and our customers. For example, during the quarter, we increased the token throughput for GPT-4.1 and GPT-5, two of the most widely used models, by over 30% per GPU. We also have the most comprehensive digital sovereignty platform. Azure customers in 33 countries are now developing their own cloud and AI capabilities within their borders to meet local data residency requirements. In Germany, for example, OpenAI and SAP will rely on Azure to deliver new AI solutions to the public sector. On top of this infrastructure, we're building Azure AI Foundry to help customers build their own AI apps and agents. We have 80,000 customers, including 80% of the Fortune 500.

We offer developers and enterprise access to over 11,000 models, more than any other vendor, including, as of this quarter, OpenAI's GPT-5, as well as xAI's Grok 4. For example, Ralph Lauren used Foundry to build a conversational shopping experience in its app, enabling customers to describe what they're looking for and get personalized recommendations. Open Evidence used Foundry to create its AI-powered clinical assistant, which surfaces relevant medical information to physicians and helps streamline charting. When it comes to our first-party models, we're excited by the performance of our new MAI models for text, voice, and image generation, which debuted among the top in the industry leaderboards. We continue to make great progress with our Phi family of SLMs, which now have been downloaded over 60 million times, up 3x YoY.

Beyond models in Foundry, we are providing everything developers need to design, customize, and manage AI applications and agents at scale. Our new Microsoft Agent Framework helps developers orchestrate multi-agent systems with compliance, observability, and deep integration out of the box. For example, KPMG used the framework to modernize the audit process, connecting agents to internal data with enterprise-grade governance and observability. These kinds of real production-scale AI deployments are driving Azure's overall growth, and once again, this quarter, Azure took share. Now let's turn to applications and agents we ourselves are building on this platform. We now have 900 million monthly active users of our AI features across our products. Our first-party family of Copilots now has surpassed 150 million monthly active users across information work, coding, security, science, health, and consumer. When it comes to information work, we continue to innovate with Microsoft 365 Copilot.

Copilot is becoming the UI for the Agentic AI experience. We have integrated chat and Agentic workflows into everyday tools like Outlook, Word, Excel, PowerPoint, and Teams. Just nine months since release, tens of millions of users across the Microsoft 365 customer base are already using chat. Adoption is accelerating rapidly, growing 50% quarter-over-quarter, and we continue to see usage intensity increase. This quarter, we also introduced Agent Mode, which turns single prompts into expert-quality Word documents, Excel spreadsheets, PowerPoint presentations, and then iterates to deliver the final product, much like Agent Mode in coding tools today. We're thrilled by the early response, including third-party benchmarks that rank it best in class. Beyond individual productivity, Copilot is multiplayer with Teams Mode announced this week.

You can now invite colleagues into a Copilot conversation, and our collaborative agents like Facilitator and Project Manager prep meeting agendas, take notes, capture decisions, and kick off group tasks. We are seeing a growing Copilot agent ecosystem with top ISVs like Adobe, Asana, Jira, LexisNexis, SAP, ServiceNow, Snowflake, and Workday all building their own agents that connect to Copilot. Customers are also building agents for their mission-critical business processes and workflows using tools like Copilot Studio and integrating them into Copilot. The overall number of agent users doubled quarter-over-quarter, and just yesterday, we announced App Builder, a new Copilot agent that lets anyone create and deploy task-specific apps and agents in minutes grounded in Microsoft 365 context. All this innovation is driving our momentum. Customers continue to adopt Microsoft 365 Copilot at a faster rate than any other new Microsoft 365 suite.

All up, more than 90% of the Fortune 500 now use Microsoft 365 Copilot. Accenture, Bristol-Myers Squibb, EY Global, and the U.K.'s Tax and Payment and Customs Authority all purchased over 15,000 seats this quarter. Lloyd’s Banking Group has deployed 30,000 seats, saving each employee an average of 46 minutes daily. A large majority of our enterprise customers continue to come back to purchase more seats. Our partner, PwC, alone added 155,000 seats this quarter and now has over 200,000 deployed across its global operations. In just six months, PwC employees interacted with Microsoft 365 Copilot over 30 million times, and they credit this agentic transformation with saving millions of hours in employee productivity. When it comes to coding, GitHub Copilot is the most popular AI pair programmer now with over 26 million users.

For example, tens of thousands of developers at AMD use GitHub Copilot, accepting hundreds of thousands of lines of code suggestions each month and crediting it with saving months of development time. All up, GitHub is now home to over 180 million developers, and the platform is growing at the fastest rate in its history, adding a developer every second. 80% of new developers on GitHub start with Copilot within the first week. Overall, the rise of AI coding agents is driving record usage with over 500 million pull requests merged over the past year. Just yesterday at GitHub Universe, we introduced Agent HQ. GitHub Copilot and Agent HQ are the organizing layer for all coding agents, extending the GitHub primitives like PRs, issues, and actions to coding agents from OpenAI, Anthropic, Google, Cognition, xAI, as well as OSS and in-house models.

GitHub now provides a single mission control to launch, manage, and review these agents, each operating from its own branch with built-in controls, observability, and governance. We're building a similar system in security with over three dozen agents in Copilot integrated across Entra, Defender, Purview, and Intune. For example, with our phishing triage agent in Defender, studies show that analysts can be up to 6.5 times more efficient in detecting malicious mails. In health, Dragon Copilot helps providers automate critical workflows. This quarter alone, we helped document over 17 million patient encounters, up nearly 5x year-over-year. More than 650 healthcare organizations have purchased our ambient listening tech to date, including University of Michigan Health, where over 1,000 physicians are actively using it. Finally, when it comes to AI consumer experiences, we are excited about all the progress Copilot is making, starting with Windows.

Every Windows 11 PC now is an AI PC. Two weeks ago, we introduced new ways to speak naturally to your computer, including a Copilot wake word. With Vision, Copilot sees what you see on your screen, and you can have a real-time conversation about it. With Action, it takes real action on your behalf, interacting with both web and desktop apps. In Edge, we are introducing first-of-its-kind AI features to automate multi-step workflows within the browser and help you pick up right where you left off. Edge now has taken share for 18 consecutive quarters. In Bing, our overview pages now include embedded conversational capabilities. We took share again in search. Daily users of our Copilot consumer app increased nearly 50% quarter-over-quarter. Among many updates we made last week is Groups, which turns Copilot for the first time into a shared experience.

Thank you, Satya, and good afternoon, everyone. First, as you heard from Satya, we were pleased to announce the next phase of our partnership with OpenAI yesterday. They continue to choose Microsoft to power their workloads, and together, we remain committed to driving innovation that meets real-world needs. Our Q1 results were not impacted by the deal signed this week. Now, on to the quarter. We delivered a strong start to our fiscal year, exceeding expectations across revenue, operating income, and earnings per share. We also saw continued share gains across many of our businesses, demonstrating our leadership position in key markets. This quarter, revenue was $77.7 billion, up 18% and 17% in constant currency. Gross margin dollars increased 18% and 16% in constant currency, while operating income increased 24% and 22% in constant currency.

Earnings per share was $4.13, an increase of 23% and 21% in constant currency when adjusted for the impact of our investments in OpenAI. FX impact was roughly in line with guidance. Company gross margin percentage was 69%, down slightly year-over-year, driven by investments in AI, including the impact of scaling our AI infrastructure and the growing usage of our AI product features. This was partially offset by ongoing efficiency gains, particularly in Azure and M365 commercial cloud. Operating expenses increased 5% and 4% in constant currency, driven by investments in cloud and AI engineering, including compute capacity and AI talent to support product development across the portfolio. Operating margins increased year-over-year to 49% and were ahead of expectations with stronger than anticipated results in high-margin businesses this quarter.

When adjusted for the impact from our investments in OpenAI, other income and expense was $401 million, as interest income more than offset interest expense, which includes the interest payments related to data center finance leases. Capital expenditures were $34.9 billion, driven by growing demand for our cloud and AI offerings. This quarter, roughly half of our spend was on short-lived assets, primarily GPUs and CPUs, to support increasing Azure platform demand, growing first-party apps and AI solutions, accelerating R&D by our product teams, as well as continued replacement for end-of-life server and networking equipment. The remaining spend was for long-lived assets that will support monetization for the next 15 years and beyond, including $11.1 billion of finance leases that are primarily for large data center sites. Cash paid for PP&E was $19.4 billion.

As a reminder, the difference between total CapEx and cash paid for PP&E is primarily due to finance leases, as well as the normal timing of goods received but not yet paid. Cash flow from operations was $45.1 billion, up 32%, driven by strong cloud billings and collections, partially offset by higher supplier payments. Free cash flow increased 33% to $25.7 billion, with minimal impact from a sequential increase in CapEx, given the higher mix of finance leases. Finally, we returned $10.7 billion to shareholders through dividends and share repurchases. Now to our commercial results. Commercial bookings increased 112% and 111% in constant currency and were significantly ahead of expectations, driven by Azure commitments from OpenAI, as well as continued growth in the number of $100 million+ contracts for both Azure and M365.

These results do not include any impact from the incremental $250 billion Azure commitments from OpenAI announced yesterday. Commercial remaining performance obligation increased to $392 billion and was up 51% year-over-year. The balance has nearly doubled over the past two years. Even with this growth, our weighted average duration has been relatively stable at approximately two years. Microsoft Cloud revenue was $49.1 billion ahead of expectations and grew 26% and 25% in constant currency. Microsoft Cloud gross margin percentage was slightly better than expected at 68% and down year-over-year due to the investments in AI that were partially offset by ongoing efficiency gains, as noted earlier. Now to segment results. Revenue from Productivity and Business Processes was $33 billion and grew 17% and 14% in constant currency.

M365 commercial cloud revenue increased 17% and 15% in constant currency, with one point of benefit from end-period revenue recognition. year-over-year growth was driven by both ARPU and seats, with ARPU growth again led by E5 and M365 Copilot. Paid M365 commercial seats grew 6% year-over-year, with installed base expansion across all customer segments, though primarily in our small and medium businesses and frontline worker offerings. M365 commercial products revenue increased 17% and 14% in constant currency ahead of expectations due to higher than expected Office 2024 transactional purchasing. M365 consumer cloud revenue increased 26% and 25% in constant currency, again driven by ARPU growth. M365 consumer subscriptions grew 7% to over 90 million. LinkedIn revenue increased 10% and 9% in constant currency, driven by marketing solutions. The talent solutions business was impacted by continued weakness in the hiring market.

Dynamics 365 revenue increased 18% and 16% in constant currency, with continued growth across all workloads. Segment gross margin dollars increased 19% and 16% in constant currency, and gross margin percentage increased, driven by efficiency gains in M365 commercial cloud that were partially offset by investments in AI, including the impact of growing usage in M365 Copilot chat. Operating expenses increased 6% and 5% in constant currency, and operating income increased 24% and 20% in constant currency. Operating margins increased three points year-over-year to 62%, driven by the higher gross margin noted earlier, as well as improved operating leverage. Next, the Intelligent Cloud segment. Revenue was $30.9 billion and grew 28% and 27% in constant currency. In Azure and other cloud services, where we continue to see accelerating demand, revenue grew 40% and 39% in constant currency.

Results were ahead of expectations, driven by better than expected growth in our core infrastructure business, primarily from our largest customers. Azure AI services revenue was generally in line with expectations, and this quarter, demand again exceeded supply across workloads, even as we brought more capacity online. In our on-premise server business, revenue increased 1% and was relatively unchanged in constant currency. Results were ahead of expectations, driven by transactional purchasing of Windows Server 2025. Segment gross margin dollars increased 20% and 19% in constant currency, and gross margin percentage decreased year-over-year, driven by investments in AI that were partially offset by efficiency gains in Azure. Operating expenses increased 4% and operating income grew 27%. Operating margins were 43%, down only slightly year-over-year, as increased investments in AI were mostly offset by improved operating leverage. Now to More Personal Computing.

Revenue was $13.8 billion and grew 4%. Windows OEM and devices revenue increased 6% year-over-year, significantly ahead of expectations, driven by strong demand ahead of Windows 10 end of support, as well as a benefit from inventory levels that remain elevated. Search and news advertising revenue ex-TAC increased 16% and 15% in constant currency, driven by growth in volume, as well as a continued benefit from third-party partnerships that was better than expected. In gaming, revenue decreased 2% and 3% in constant currency. Against a strong prior year comparable, Xbox content and services revenue increased 1% and was relatively unchanged in constant currency, driven by better than expected performance from third-party content. Segment gross margin dollars increased 11% and 10% in constant currency, and gross margin percentage increased year-over-year, driven by sales mix shift to higher margin businesses.

Operating expenses increased 4% and 3% in constant currency, and operating income increased 18% and 16% in constant currency. Operating margins increased three points year-over-year to 30%, driven by the higher gross margin noted earlier. Now, moving to our Q2 outlook, which, unless specifically noted otherwise, is on a U.S. dollar basis. Based on current rates, we expect FX to increase total revenue growth by two points. Within the segments, we expect FX to increase revenue growth by two points in Productivity and Business Processes and Intelligent Cloud, and one point in More Personal Computing. We expect FX to increase COGS and operating expense growth by one point. Starting with the total company, we expect revenue of $79.5 billion-$80.6 billion, or growth of 14%-16%. We expect COGS of $26.35 billion-$26.55 billion

or growth of 21%-22%, and operating expense of $17.3 billion-$17.4 billion, or growth of 7%-8%. Operating margins should be relatively flat year-over-year and down sequentially, aligned with historic seasonality. Now, other income and expense. The combination of OpenAI's conversion to a public benefit corp and the ongoing nature of our partnership will result in increased volatility. Therefore, going forward, we'll provide our outlook excluding any impact from our investments in OpenAI. On that basis, in Q2, other income and expense is estimated to be roughly $100 million, as interest income will more than offset interest expense. We expect our Q2 effective tax rate to be approximately 19%. Next, capital expenditures. With accelerating demand and a growing RPO balance, we're increasing our spend on GPUs and CPUs.

Therefore, total spend will increase sequentially, and we now expect the FY 2026 growth rate to be higher than FY 2025. As a reminder, there can be quarterly spend variability from cloud infrastructure buildouts and the timing of delivery of finance leases. Next, our commercial business. In commercial bookings, we expect healthy growth in the core business on a low expiry base, when adjusted for the OpenAI contracts in the prior year. We expect commercial bookings will be positively impacted by the significant OpenAI commitments announced yesterday. As a reminder, larger long-term Azure contracts, which are more unpredictable in their timing, drive increased quarterly volatility in our bookings growth rate. Microsoft Cloud gross margin percentage should be roughly 66%, down year-over-year, driven by the continued investments in AI, as well as the mix shift to Azure. Now to segment guidance.

Thanks, Amy. We'll now move over to Q&A. Out of respect for others on the call, we request that participants please only ask one question. Operator, can you please repeat your instructions?