Microsoft Corporation (MSFT) Q1 FY2026 Earnings Call Transcript

Date: October 29, 2025 | Source: Motley Fool (fool.com) full conference call transcript

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Jonathan Neilson (Corporate VP, Investor Relations): Good afternoon, and thank you for joining us today. On the call with me are Satya Nadella, Chairman and Chief Executive Officer, Amy E. Hood, Chief Financial Officer, Alice Jolla, Chief Accounting Officer, and Keith Dolliver. On the Microsoft Corporation Investor Relations website, we will provide our earnings press release and financial summary slide deck. It is intended to supplement our prepared remarks and provides the reconciliation of differences between GAAP and non-GAAP financial measures. On this call, we will discuss certain non-GAAP items. 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. Today's call is being recorded. During this call, we will be making forward-looking statements. With that, I'll turn the call over to Satya.

Satya Nadella (Chairman and CEO): 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 grew 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.

And 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. We continue to benefit mutually from each other's growth across multiple dimensions. Already, we have roughly 10x'd our investment, and OpenAI has contracted an incremental $250 billion of Azure services. Our revenue share, exclusive rights, and API exclusivity for Azure until AGI or through 2030. And we have extended the model and product IP rights through 2032.

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 two gigawatts alone. We have deployed the world's first large-scale cluster of NVIDIA GB300s. We are building a fungible 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. 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.

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 enterprises 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. We are excited by the performance of our new MAI models for text, voice, and image generation, which debuted among the top in the industry leaderboards. Our Phi family of SLMs has now been downloaded over 60 million times, up 3x year over year. Our new Microsoft Agent Framework helps developers orchestrate multi-agent systems with compliance, observability, and deep integration out of the box.

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. Just nine months since release, tens of millions of users across Microsoft 365's customer base are already using chat. Adoption is accelerating rapidly, growing 50% quarter over quarter. This quarter, we also introduced agent mode, which turns single prompts into expert-quality Word documents, Excel spreadsheets, PowerPoint presentations.

Customers are also building agents for their mission-critical business processes using tools like Copilot Studio. The overall number of agent users doubled quarter over quarter. All up, more than 90% of the Fortune 500 now use Microsoft 365 Copilot. 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.

When it comes to coding, GitHub Copilot is the most popular AI pair programmer now with over 26 million users. 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. Over 500 million pull requests were merged over the past year. Just yesterday at GitHub Universe, we introduced AgentHQ, the organizing layer for all coding agents.

We're building a similar system in security with over three dozen agents in Copilot integrated across Entra, Defender, Purview, and Intune. 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 our ambient listening tech to date.

Finally, when it comes to AI consumer experiences, every Windows 11 PC now is an AI PC. Daily users of our Copilot consumer app increased nearly 50% quarter over quarter. We also are creating a great consumer subscription offer with Microsoft 365 Premium. In gaming, we expanded our reach across every endpoint. We launched critically acclaimed games like Keeper, Ninja Gaiden 4, and Outer Worlds 2, reaching 155 million monthly active users of Minecraft, an all-time high, and set a new record for overall content and services revenue for the quarter. In closing, our planet-scale cloud and AI factory, together with copilots across high-value domains, is driving broad diffusion and real-world impact. With that, let me turn it over to Amy.

Amy E. Hood (CFO): 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. 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. This quarter, revenue was $77.7 billion, up 17% in constant currency. Gross margin dollars increased 16% in constant currency, while operating income increased 22% in constant currency. Earnings per share was $4.13, an increase of 21% in constant currency when adjusted for the impact of our investments in OpenAI.

Company gross margin percentage was 69%, down slightly year over year, driven by investments in AI, partially offset by ongoing efficiency gains, particularly in Azure and Microsoft 365 commercial cloud. Operating expenses increased 4% in constant currency. Operating margins increased year over year to 49% and were ahead of expectations. Adjusted for the impact from our investments in OpenAI, other income and expense was $401 million. 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. The remaining spend was for long-lived assets, including $11.1 billion of finance leases that are primarily for large data center sites. Cash paid for PP&E was $19.4 billion.

Cash flow from operations was $45.1 billion, up 32%, driven by strong cloud billings and collections. Free cash flow increased 33% to $25.7 billion. 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, driven by Azure commitments from OpenAI as well as continued growth in the number of $100 million plus contracts. These results do not include any impact from the incremental $250 billion Azure commitments from OpenAI announced yesterday. Commercial RPO increased to $392 billion, up 51% year over year. The balance has nearly doubled over the past two years. Microsoft Cloud revenue was $49.1 billion, ahead of expectations, and grew 25% in constant currency. Microsoft Cloud gross margin percentage was slightly better than expected at 68%.

Now to segment results. Revenue from productivity and business processes was $33 billion and grew 14% in constant currency. Microsoft 365 commercial cloud revenue increased 15% in constant currency. Paid Microsoft 365 commercial seats grew 6% year over year. LinkedIn revenue increased 9% in constant currency. Dynamics 365 revenue increased 16% in constant currency. Segment operating margins increased three points year over year to 62%. Next, the intelligent cloud segment. Revenue was $30.9 billion and grew 27% in constant currency. In Azure and other cloud services, revenue grew 39% in constant currency, ahead of expectations. 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. Operating margins were 43%, down only slightly year over year.

Now more personal computing. Revenue was $13.8 billion and grew 4%. Windows OEM and devices revenue increased 6% year over year, ahead of expectations. Search and news advertising revenue ex-TAC increased 15%. In gaming, revenue decreased 3% in constant currency against a strong prior year comparable. Xbox content and services revenue increased 1%. Segment operating income increased 16% in constant currency.

Now moving to our Q2 outlook. Based on current rates, we expect FX to increase total revenue growth by two points. Starting with the total company, we expect revenue of $79.5 billion to $80.6 billion, or growth of 14% to 16%. We expect COGS of $25.6 billion to $25.8 billion, and operating expense of $17.6 billion to $17.7 billion. Operating margins should be down slightly year over year. We expect our adjusted Q2 effective tax rate to be approximately 19%. Next, we expect capital expenditures to increase sequentially due to timing of cloud infrastructure build-outs and the delivery of finance leases. Microsoft Cloud gross margin percentage should be roughly 66%, down year over year, driven by continued investments in AI.

In productivity and business processes, we expect revenue of $33.3 billion to $33.6 billion, or growth of 15% to 16%. In intelligent cloud, we expect revenue of $31.7 billion to $32 billion, or growth of 27% to 29%. In Azure, we expect Q2 revenue growth to be between 38% and 39% in constant currency. As a reminder, demand continues to exceed supply. In more personal computing, we expect revenue of $14.3 billion to $14.7 billion.

In closing, we delivered a strong start to the year and remain focused on meeting the demand signals we're seeing with disciplined investment across the entire stack. With that, let's go to Q&A.

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Questions & Answers

Keith Weiss (Morgan Stanley): Microsoft Cloud revenue growing well, commercial bookings up triple digits, and that's obviously a big result. One of the things that keeps coming up is the capacity constraint. Can you help us understand the magnitude of capacity you have coming online over the next couple of quarters and how that translates into revenue?

Amy Hood (CFO): We are capacity constrained today. As we think about the fiscal year, demand has continued to exceed our ability to supply across workloads, and we expect to be capacity constrained through at least the end of the fiscal year. We're allocating capacity across our own first-party apps, R&D, and Azure, and we're working to bring on supply as quickly as we can. The guidance we gave for Azure growth in Q2 reflects what we can deliver given the capacity coming online, not the underlying demand.

Brent Thill (Jefferies): On the OpenAI partnership and the $250 billion incremental commitment, can you help us think about the mechanics and the durability of that relationship?

Satya Nadella (Chairman and CEO): This is one of the most successful partnerships our industry has seen. We have exclusive rights to Azure for OpenAI's workloads through AGI or 2030, extended model and product IP rights through 2032, and OpenAI has contracted an incremental $250 billion of Azure services. We both benefit mutually from each other's growth, and the demand signals are strong across our entire business.

Mark Moerdler (Bernstein): How do investors get comfortable that the significant CapEx, much of it AI-centric, will generate sufficient revenue over the useful life of the hardware?

Amy Hood (CFO): A lot of the capital we're spending today, and a lot of the GPUs we're buying, are already contracted for most of their useful life. On the GPU contracts, including for some of our largest customers, those are sold for the entire useful life of the GPU. And as you go through the useful life, you actually get more and more efficient at delivery, so margins improve with time.

Karl Keirstead (UBS): Azure demand clearly exceeds supply. Can you frame the magnitude of capacity additions in the coming quarters?

Amy Hood (CFO): We're working as hard as we can to add capacity as quickly as we can. We're adding capacity globally, a lot of it in the United States, and we need to make sure we've got power, land, and facilities available, then put GPUs and CPUs in them as quickly as we can. It's not really about any specific locations — those are multiyear delivery timelines. We just need to get it done everywhere we're currently building.

Jonathan Neilson (VP, IR): Thanks everyone for joining us today. We look forward to speaking with you soon.