Microsoft Corporation (MSFT) Q2 FY2026 Earnings Call Transcript

Date: January 28, 2026 | Source: Motley Fool (fool.com) full conference call transcript

---

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 Hood, Chief Financial Officer; Alice Jolla, Chief Accounting Officer; and Keith Dolliver, Corporate Secretary and Deputy General Counsel. On the Microsoft Corporation Investor Relations website, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call 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 webcast live and 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 very much, Jonathan. This quarter, the Microsoft Cloud surpassed $50 billion in revenue for the first time, up 26% year over year, reflecting the strength of our platform and accelerating demand. We are in the beginning phases of AI diffusion and its broad GDP impact. TAM will grow substantially across every layer of the tech stack as this diffusion accelerates and spreads. In fact, even in this early innings, we have built an AI business that is larger than some of our biggest franchises that took decades to build. Today, I'll focus my remarks across the three layers of our stack: Cloud and Token Factory, the agent platform, and high-value agentic experiences.

When it comes to our cloud and token factory, the key to long-term competitiveness is shaping our infrastructure to support new high-scale workloads. The key metric we are optimizing for is tokens per watt per dollar, which comes down to increasing utilization and decreasing TCO using silicon, systems, and software. A good example of this is the 50% increase in throughput we were able to achieve in one of our highest volume workloads, OpenAI inferencing, powering our copilots. We connected both Atlanta and Wisconsin sites through an AI WAN to build a first-of-kind AI super factory. Fairwater's two-story design and liquid cooling allow us to run higher GPU density. All up, we added nearly one gigawatt of total capacity this quarter alone.

At the silicon layer, we have NVIDIA and AMD and our own Maya chips delivering the best all-up fleet performance, cost, and supply across multiple generations of hardware. Earlier this week, we brought online our Maya 200 accelerator. Maya 200 delivers 10+ flops at FP4 precision with over 30% improved TCO compared to the latest generation hardware in our fleet. We will be scaling this starting with inferencing and synthetic data gen for our superintelligence team as well as doing inferencing for Copilot and Foundry. On the CPU side, Cobalt 200 is another big leap forward, delivering over 50% higher performance compared to our first custom-built processor for cloud-native workloads. We announced DC investments in seven countries this quarter alone supporting local data residency needs.

Next, I want to talk about the agent platform. Like in every platform shift, all software is being rewritten. You can think of agents as the new apps. It starts with having broad model choice. We offer the broadest selection of models of any hyperscaler. This quarter, we added support for GPT-5.0.2 as well as Claude 4.5. Already over 1,500 customers have used both Anthropic and OpenAI models on Foundry. Two years since it became broadly available, Fabric's annual revenue run rate is now over $2 billion with over 31,000 customers, and it continues to be the fastest-growing analytics platform on the market with revenue up 60% year over year. All up, the number of customers spending $1 million plus per quarter on Foundry grew nearly 80%, and over 250 customers are on track to process over 1 trillion tokens on Foundry this year.

As agents proliferate, every customer will need new ways to deploy, manage, and protect them. This quarter, we introduced Agent 365, which makes it easy for organizations to extend their existing governance, identity, security, and management to agents. We are the first provider to offer this type of agent control plane across clouds. Now let's turn to the high-value agentic experiences we are building. AI experiences are intent-driven and are beginning to work at task scope. In consumer, Copilot experiences span chat, news, feed, search, creation, browsing, shopping, and integrations into the operating system, and it's gaining momentum. Daily users of our Copilot app increased nearly 3x year over year.

With Microsoft 365 Copilot, we are focused on organization-wide productivity. WorkIQ takes the data underneath Microsoft 365 and creates the most valuable stateful agent for every organization. Microsoft 365 Copilot's accuracy powered by WorkIQ is unmatched, delivering faster and more accurate work-grounded results than competition. This has driven record usage intensity with the average number of conversations per user doubling year over year. Microsoft 365 Copilot is becoming a true daily habit with daily active users increasing 10x year over year. All up, it was a record quarter for Microsoft 365 Copilot seat adds, up over 160% year over year. We now have 15 million paid Microsoft 365 Copilot seats, and the number of customers with over 35,000 seats tripled year over year. Publicis alone purchased over 95,000 seats for nearly all its employees.

In coding, we are seeing strong growth across all paid GitHub Copilot. Copilot Pro Plus subs for individual devs increased 77% quarter over quarter, and all up now, we have 4.7 million paid Copilot subscribers, up 75% year over year. GitHub AgentHQ is the organizing layer for all coding agents. In security, we added a dozen new and updated security Copilot agents across Defender, Entra, Intune, and Purview. 24 billion Copilot interactions were audited by Purview this quarter, up 9x year over year. In health care, Dragon Copilot is the leader in its category, helping over 100,000 medical providers automate their workflows. All up, we helped document 21 million patient encounters this quarter, up 3x year over year.

Beyond AI, we continue to invest in all our core franchises. When it comes to cloud migrations, our new SQL Server has over 2x the IaaS adoption of the previous version. In security, we now have 1.6 million security customers, including over a million who use four or more of our workloads. Windows reached a big milestone: 1 billion Windows 11 users, up over 45% year over year. In gaming, we saw record PC players and paid streaming hours on Xbox. In closing, we feel very good about how we are delivering for customers today and building the full stack to capture the opportunity ahead. With that, let me turn it over to Amy.

Amy Hood (CFO): Thank you, Satya, and good afternoon, everyone. With growing demand for our offerings and focused execution by our sales teams, we again exceeded expectations across revenue, operating income, and earnings per share while investing to fuel long-term growth. This quarter, revenue was $81.3 billion, up 17% in constant currency. Gross margin dollars increased 16% in constant currency, while operating income increased 21% in constant currency. Earnings per share was $4.14, an increase of 24% in constant currency when adjusted for the impact from our investment in OpenAI.

Company gross margin percentage was 68%, down slightly year over year, primarily driven by continued investments in AI infrastructure and growing AI product usage, partially offset by ongoing efficiency gains. Operating expenses increased 5% in constant currency, driven by R&D investments in compute capacity and AI talent as well as impairment charges in our gaming business. Operating margins increased year over year to 47%, ahead of expectations. As a result of OpenAI's recapitalization, we now record gains or losses based on our share of the change in their net assets. Therefore, we recorded a gain which drove other income and expense to $10 billion in our GAAP results. When adjusted for the OpenAI impact, other income and expense was slightly negative and lower than expected driven by net losses on investments.

Capital expenditures were $37.5 billion in this quarter, roughly two-thirds of our CapEx on short-lived assets, primarily GPUs and CPUs. Our customer demand continues to exceed our supply. This quarter, total finance leases were $6.7 billion and were primarily for large data center sites. Cash paid for PP&E was $29.9 billion. Cash flow from operations was $35.8 billion, up 60% driven by strong cloud billings and collections. Free cash flow was $5.9 billion and decreased sequentially, reflecting the higher cash capital expenditures from a lower mix of finance leases. Finally, we returned $12.7 billion to shareholders through dividends and share repurchases, an increase of 32% year over year.

Now to our commercial results. Commercial bookings increased 23% in constant currency, driven by the previously large Azure commitment from OpenAI, reflects multiyear demand needs as well as the previously announced Anthropic commitment from November, and healthy growth across our core annuity sales motions. Commercial remaining performance obligation increased to $625 billion, up 11% year over year with a weighted average duration of approximately two and a half years. Approximately 45% of our commercial RPO balance is from OpenAI. The significant remaining balance grew 28% and reflects ongoing broad customer demand across the portfolio.

Microsoft Cloud revenue was $51.5 billion, grew 26% in constant currency. Microsoft Cloud gross margin percentage was slightly better than expected at 67% and down year over year due to continued investments in AI. Now to our segment results. Revenue from productivity and business processes was $34.1 billion and grew 16% in constant currency. Microsoft 365 commercial cloud revenue increased 17% in constant currency with consistent execution in the core business and increasing contribution from strong Copilot results. Paid Microsoft 365 commercial seats grew 6% year over year to over 450 million. LinkedIn revenue increased 11% in constant currency. Dynamics 365 revenue increased 19% in constant currency. Segment operating margins increased year over year to 60%.

Next, intelligent cloud segment. Revenue was $32.9 billion and grew 29% in constant currency. In Azure and other cloud services, revenue grew 39% in constant currency, slightly ahead of expectations with ongoing efficiency gains across our fungible fleet. Demand continues to exceed available supply. In our on-premises server business, revenue increased 21% in constant currency ahead of expectations driven by demand for our hybrid solutions including a benefit from the launch of SQL Server 2025. Operating margins were 42%, down slightly year over year.

Now to more personal computing. Revenue was $14.3 billion and declined 3%. Windows OEM and devices revenue increased 1%. Search and news advertising revenue ex-TAC increased 10% in constant currency, slightly below expectations. And in gaming, revenue decreased 9% in constant currency. Xbox content and services revenue decreased 5% in constant currency and was below expectations driven by first-party content with impact across the platform. Segment operating margins were relatively unchanged year over year at 27%.

Now moving to our Q3 outlook. Based on current rates, we expect FX to increase total revenue growth by three points. Starting with the total company, we expect revenue of $80.65 billion to $81.75 billion, or growth of 15% to 17%. We expect COGS of $26.65 billion to $26.85 billion, growth of 22% to 23%, and operating expense of $17.8 billion to $17.9 billion. Operating margins should be down slightly year over year. We expect our adjusted Q3 effective tax rate to be approximately 19%. Next, we expect capital expenditures to decrease on a sequential basis due to normal variability from cloud infrastructure build-outs and the timing of delivery of finance leases. Microsoft Cloud gross margin percentage should be roughly 65%, down year over year driven by continued investments in AI.

In productivity and business processes, we expect revenue of $34.25 billion to $34.55 billion, or growth of 14% to 15%. In intelligent cloud, we expect revenue of $34.1 billion to $34.4 billion, or growth of 27% to 29%. In Azure, we expect Q3 revenue growth to be between 37% and 38% in constant currency. Demand continues to exceed supply. In more personal computing, we expect revenue of $12.3 billion to $12.8 billion.

With the strong work delivered in H1 to prioritize investment in key growth areas and the favorable impact from a higher mix of revenue in our Windows OEM and commercial on-prem businesses, we now expect FY26 operating margins to be up slightly. In closing, we delivered strong top-line growth in H1 and are investing across every layer of the stack. With that, let's go to Q&A.

---

Questions & Answers

Keith Weiss (Morgan Stanley): I'm looking at a Microsoft print where earnings is growing 24% year on year, a spectacular result. But I'm looking at after-hours trading, the stock is still down. One of the core issues weighing on investors is CapEx growing faster than expected, and maybe Azure growing a little bit slower than expected. How should we think about the ROI on this CapEx spend?

Amy Hood (CFO): I think the first thing is that there's a very direct correlation investors are drawing between CapEx spend and an Azure revenue number. We've tried to talk more specifically about all the places that the CapEx spend, especially the short-lived CapEx across CPU and GPU, will show up. Sometimes it's probably better to think about the Azure guidance we give as an allocated capacity guide about what we can deliver in Azure revenue. The first thing we're solving for is the increased usage in sales and the accelerating pace of Microsoft 365 Copilot as well as GitHub Copilot, our first-party apps. Then we make sure we're investing in the long-term nature of R&D and product innovation. The remainder goes towards serving the Azure capacity that continues to grow in demand. If I had taken the GPUs that just came online in Q1 and Q2 and allocated them all to Azure, the KPI would have been over 40.

Satya Nadella (Chairman and CEO): As an investor, when you think about our capital and the GM profile of our portfolio, you should think about Azure, but you should also think about Microsoft 365 Copilot, GitHub Copilot, Dragon Copilot, Security Copilot. All of those have a GM profile and a lifetime value. We don't want to maximize just one business. We want to be able to allocate capacity, while we're sort of supply constrained, in a way that allows us to essentially build the best LTV portfolio.

Mark Moerdler (Bernstein): You capitalize servers over six years, but the average duration of your RPO is two and a half years, up from two years last quarter. How do investors get comfortable that you'll capture sufficient revenue over the six-year useful life to deliver solid gross profit dollars growth?

Amy Hood (CFO): The majority of the capital that we're spending today, and a lot of the GPUs that 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, so there's not the risk to which you may be referring. As you go through the useful life, you actually get more and more efficient at delivery, so margins improve with time.

Satya Nadella (Chairman and CEO): In addition to what Amy mentioned — that it's already contracted for the useful life — we also use software to continuously run even the latest models on the fleet that is aging. We constantly age the fleet; each year you ride the Moore's Law curve, you add, you use software, and then you optimize across all of it.

Brent Thill (Jefferies): On 45% of the backlog being related to OpenAI, there's obviously concern about the durability and exposure. Could you talk through your perspective on what both you and Satya are seeing?

Amy Hood (CFO): The first thing to focus on is the reason we talked about that number: because 55%, or roughly $350 billion, is related to the breadth of our portfolio — a breadth of customers across solutions, across Azure, across industries, across geographies. That is a significant RPO balance, larger than most peers, more diversified than most peers, and we have super high confidence in it. That portion alone grew 28%, which is really impressive work on the breadth as well as the adoption curve. And then on OpenAI, listen, it's a great partnership. We continue to be their provider of scale. We sit under one of the most successful businesses ever built and we continue to feel quite good about that.

Karl Keirstead (UBS): Regardless of how you allocate the capacity between first party and third party, can you comment qualitatively on the amount of capacity that's coming online? The one gigawatt added in December was extraordinary.

Amy Hood (CFO): We're working as hard as we can to add capacity as quickly as we can. You've mentioned specific sites like Atlanta or Wisconsin; those are multiyear deliveries, so I wouldn't focus necessarily on specific locations. The real thing we've got to do is adding capacity globally, a lot of it in the United States. We'll continue to add both long-lived infrastructure and put GPUs and CPUs in them as quickly as we can. We need to get it done in every location where we're currently in a build.

Mark Murphy (JPMorgan): The Maya 200 accelerator for inference looked quite remarkable, especially in comparison to TPUs and Trainium and Blackwell. Could you put that accomplishment in perspective in terms of how much of a core competency silicon might become?

Satya Nadella (Chairman and CEO): We've been at this in a variety of different forms for a long, long time in terms of building our own silicon. We're very, very thrilled about the progress with Maya 200, especially when we think about running GPT-5.0.2 and the performance we're able to get at FP4. When you have a new shape of workload, you can start innovating end to end between the model and the silicon. The way to think about it is we want a fleet at any given point in time to have access to the best TCO. It's not a one-generation game. We're excited about Maya, we're excited about Cobalt, we're excited about our DPU. We have a lot of systems capability, and because we can vertically integrate doesn't mean we just only vertically integrate. We want to have the flexibility.

Jonathan Neilson (VP, IR): Operator, we have time for one last question. Thank you everyone for joining. We look forward to speaking with you soon.