Microsoft Corporation (MSFT) Q1 2026 Earnings Call Transcript

Access earnings results, analyst expectations, report, slides, earnings call, and transcript.

Overview

The earnings call reveals strong financial performance with significant growth in free cash flow, commercial bookings, and cloud services revenue. Despite a decline in gaming revenue and cloud gross margin, the company maintains optimistic guidance for FY '26 with a focus on AI and cloud. The Q&A session addressed concerns about risks and investments, with management expressing confidence in their strategic positioning. The positive aspects, such as AI-driven growth and strategic partnerships, outweigh the negatives, suggesting a positive stock price movement.

Key Financial Performance

Microsoft Cloud revenue $49 billion, up 26% year-over-year. The increase is attributed to growing demand and diffusion of AI platform and Copilots.

Commercial RPO Nearly $400 billion, up over 50% year-over-year. Growth driven by increased demand for AI and cloud services.

Revenue $77.7 billion, up 18% year-over-year. Growth driven by strong performance across cloud and AI services.

Gross margin percentage 69%, down slightly year-over-year. Decline due to investments in AI infrastructure and growing usage of AI product features.

Operating income Increased 24% year-over-year. Growth driven by strong performance in high-margin businesses and efficiency gains.

Earnings per share (EPS) $4.13, up 23% year-over-year. Growth driven by strong cloud billings and collections.

Capital expenditures $34.9 billion, driven by growing demand for cloud and AI offerings, including GPUs and CPUs.

Free cash flow $25.7 billion, up 33% year-over-year. Growth driven by strong cloud billings and collections.

Commercial bookings Increased 112% year-over-year. Growth driven by Azure commitments from OpenAI and large contracts for Azure and M365.

Microsoft Cloud gross margin percentage 68%, down year-over-year. Decline due to investments in AI infrastructure.

Productivity and Business Processes revenue $33 billion, up 17% year-over-year. Growth driven by M365 Commercial Cloud and Dynamics 365.

Azure and other Cloud services revenue Grew 40% year-over-year. Growth driven by demand for core infrastructure and AI services.

LinkedIn revenue Increased 10% year-over-year. Growth driven by Marketing Solutions.

Dynamics 365 revenue Increased 18% year-over-year. Growth driven by growth across all workloads.

Windows OEM and Devices revenue Increased 6% year-over-year. Growth driven by demand ahead of Windows 10 end of support.

Search and news advertising revenue ex TAC Increased 16% year-over-year. Growth driven by volume and third-party partnerships.

Gaming revenue Decreased 2% year-over-year. Decline due to strong prior year comparable.

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Operating Highlights

Microsoft Cloud Revenue: Surpassed $49 billion, up 26% year-over-year, driven by increasing demand for AI platform and Copilots.

AI Data Center Expansion: Announced the world's most powerful AI data center, Fairwater in Wisconsin, scaling to 2 gigawatts.

Copilot Features: 900 million monthly active users across products, with 150 million monthly active users for first-party Copilots.

GitHub Copilot: Now has over 26 million users, driving record usage with over 500 million pull requests merged in the past year.

Gaming Innovations: Launched critically acclaimed games and expanded Xbox Ally, reaching 155 million monthly active users.

OpenAI Partnership: Closed a new definitive agreement with OpenAI, including $250 billion in Azure service commitments.

Azure AI Services: Revenue grew 40%, driven by demand from largest customers and AI workloads.

Microsoft 365 Copilot Adoption: Adopted by over 90% of the Fortune 500, with significant seat purchases by major enterprises like PwC and Lloyds Banking Group.

Efficiency Gains: Achieved ongoing efficiency gains in Azure and M365 Commercial Cloud, partially offsetting AI investments.

Token Throughput Optimization: Increased token throughput for GPT-4.1 and GPT-5 by over 30% per GPU.

Cloud Infrastructure Investments: Capital expenditures reached $34.9 billion, with significant investments in GPUs and CPUs to meet AI demand.

AI Talent and Compute Investments: Increased investments in AI talent and compute to support product development and innovation.

Digital Sovereignty Platform: Expanded Azure's digital sovereignty platform to 33 countries, enabling local cloud and AI capabilities.

Consumer AI Experiences: Introduced AI features in Windows 11, Edge, and Bing, driving increased user engagement and market share.

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Risk or Challenges

AI Infrastructure Investments: Significant investments in AI infrastructure, including GPUs and CPUs, are driving costs higher. This could impact operating margins and profitability in the short term.

Capacity Constraints: Azure is expected to remain capacity constrained through at least the end of the fiscal year, which could limit revenue growth despite strong demand.

Regulatory and Compliance Risks: The need to meet local data residency and sovereignty requirements in 33 countries adds complexity and potential compliance risks.

Economic Uncertainty: Weakness in the hiring market is impacting LinkedIn's Talent Solutions business, reflecting broader economic uncertainties.

Supply Chain Challenges: The company faces challenges in bringing AI capacity online quickly enough to meet demand, which could delay revenue realization.

Competitive Pressures: The rapid adoption of AI and cloud services by competitors could erode Microsoft's market share if it fails to maintain its leadership position.

Product Development Costs: High costs associated with developing and scaling AI products like Copilot and GitHub Copilot could pressure margins.

Customer Shift to Cloud: Ongoing customer migration to cloud offerings could negatively impact on-premises server business revenue.

Gaming Revenue Decline: Gaming revenue is declining, particularly in Xbox content and services, which could impact overall revenue diversification.

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Guidance & Outlook

AI Capacity Expansion: Microsoft plans to increase its total AI capacity by over 80% this year and double its total data center footprint over the next two years to meet growing demand.

Azure Revenue Growth: Azure revenue is expected to grow approximately 37% in constant currency in Q2 FY26, with demand significantly ahead of available capacity.

Microsoft Cloud Revenue: Microsoft Cloud revenue is projected to grow 14% to 16% in Q2 FY26, driven by strong demand for AI and cloud services.

Capital Expenditures: Capital expenditures are expected to increase sequentially in FY26, with a higher growth rate than FY25, primarily driven by investments in GPUs, CPUs, and cloud infrastructure.

Microsoft 365 Commercial Cloud: Revenue growth for Microsoft 365 Commercial Cloud is expected to be between 13% and 14% in constant currency in Q2 FY26, driven by ARPU growth from E5 and M365 Copilot.

LinkedIn Revenue: LinkedIn revenue is expected to grow approximately 10% in Q2 FY26.

Dynamics 365 Revenue: Revenue growth for Dynamics 365 is projected to be in the mid- to high teens in Q2 FY26.

Search and News Advertising: Search and news advertising revenue is expected to grow in the low double digits in Q2 FY26, driven by volume and revenue per search across Edge and Bing.

Gaming Revenue: Xbox content and services revenue is expected to decline in the low to mid-single digits in Q2 FY26, impacted by strong prior year comparables.

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Shareholder Return Plan

Dividends paid: $10.7 billion returned to shareholders through dividends and share repurchases.

Share repurchase: $10.7 billion returned to shareholders through dividends and share repurchases.

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Key Q&A

Q:What is Microsoft's perspective on AGI and its potential impact on their market positioning?

A:Satya Nadella explained that Microsoft feels confident about their positioning and the new agreement with OpenAI. He emphasized the concept of 'jagged intelligence' in AI systems, where capabilities may excel in specific tasks but not uniformly. Microsoft is focusing on building systems like M365 Copilot and GitHub Agent HQ to smooth out these jagged edges and create value for customers. Nadella stated that AGI, as defined in their contract, is not expected to be achieved soon, but advances in AI models can still drive significant value.

Q:What is Microsoft's response to concerns about concentration risk in their bookings growth?

A:Amy Hood clarified that Microsoft's $400 billion RPO balance is spread across numerous products and customers of all sizes. She emphasized that these contracts are being consumed in relatively short order, indicating real-world value creation. Hood also highlighted that OpenAI is a part of this balance, contributing to leading systems that benefit other customers.

Q:How confident is Microsoft in monetizing their AI investments and avoiding overbuilding for demand?

A:Amy Hood explained that Microsoft's $400 billion RPO balance and short-lived assets like GPUs and CPUs are aligned with contract durations, reducing risk. She noted that demand is increasing across multiple areas, and Microsoft is investing in modernization and high-quality service delivery. Satya Nadella added that Microsoft's focus on efficient, fungible fleets and high-value agent systems in domains like information work, coding, and security gives them confidence in their investments.

Q:What is the nature of the $4.1 billion investment in OpenAI reported in other income?

A:Amy Hood clarified that the $4.1 billion reflects Microsoft's share of OpenAI's losses under the equity method and is not related to the new agreement with OpenAI.

Q:How does Microsoft evaluate the ability of AI-native companies to fulfill large contractual commitments?

A:Satya Nadella emphasized the importance of building fungible assets that can serve both third-party and first-party needs. He noted that while digital natives are early adopters, enterprise adoption is just beginning, which will balance the customer base over time. Amy Hood added that Microsoft's flexible fleet and lead times for contract delivery help mitigate concentration risks.

Q:What is the revenue impact of Azure's capacity constraints, and how does Microsoft mitigate this risk?

A:Amy Hood acknowledged that Azure bears most of the revenue impact from capacity constraints, as resources are prioritized for M365 Copilot, security features, and GitHub momentum. She noted that Microsoft is working to mitigate these constraints and ensure capacity for product teams and AI talent, but it is challenging to quantify the exact revenue impact.

Q:How does Microsoft approach decisions on accepting or declining large AI-related contracts?

A:Satya Nadella explained that Microsoft evaluates contracts based on their alignment with the company's long-term goals, including fleet fungibility, margin profiles, and the balance between first-party and third-party needs. He emphasized that Microsoft prioritizes contracts that fit their strategic objectives and feels confident about their decision-making process.

Q:Review of Unclear Management Responses

A:Management avoided directly addressing the question from Kash Rangan about whether another hyperscaler took business from Microsoft. Satya Nadella provided a general explanation of Microsoft's decision-making process for contracts but did not directly confirm or deny the claim.

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Earnings Word Cloud

The most frequently occurring keywords in this quarter's earning call

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