Microsoft (NASDAQ:MSFT) reported first-quarter financial results on Wednesday. This transcript is brought to you by Benzinga APIs.
Full TranscriptOPERATORGreetings and welcome to the Microsoft Fiscal Year 2027 First Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode.
A question-and-answer session will follow the formal presentation. If anyone should require operator assistance, please press star zero on your telephone keypad.
As a reminder, this conference is being recorded. Jonathan Nielsen (Vice President of Investor Relations)Good afternoon and thank you for joining us today.
On the call Satya Nadella, Chairman and Chief Executive Officer, Amy Hood, Chief Financial Officer, Alice Joller, Chief Accounting Officer, and Brian Defoe, Deputy General Counsel and Corporate Secretary. More detailed Outlook slides will be available on the Microsoft Investor Relations website when we provide Outlook commentary on today’s call.
On this call we will discuss certain non-GAAP items. The non-GAAP financial measures provided should not be considered 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. We will also provide growth rates in constant currency when available, as a framework for assessing how underlying business performed excluding the effect of foreign currency rate valuations.
Where growth rates are in constant currency, we will refer to the growth rate only. We’ll post our prepared remarks to our website immediately following the call until the complete transcript is available.
Today’s call is being webcast live and recorded. 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.
Satya Nadella (Chairman and Chief Executive Officer)Thank you very much, Jonathan. It was a fast start to our fiscal year.
Microsoft Cloud revenue surpassed $63 billion with growth accelerating to 30% year over year. We are focused on three things: designing AI to empower people, ensuring every organization has sovereignty over its own learning, and building trust with controls that ensure agent safety and security.
Now let’s talk about how we are making progress on those goals as we build a new tech stack, starting with Copilot. We announced our biggest update to Copilot to date this quarter, bringing together chat, cowork, autopilot, and code into one unified experience.
It’s one product experience across commercial and consumer and comes with all of Office built in. We think of Copilot as the new OS for work.
Automated tasks have nearly doubled since July. Daily users are up nearly 50% quarter over quarter and over 5x year over year.
User satisfaction improved nearly 20% quarter over quarter to another all-time high. And 90% of Copilot queries use Auto Mode, which dynamically routes tasks across models, optimizing for quality, speed, and cost.
These improvements are translating into larger purchases. And just last week, Volkswagen announced plans to deploy Copilot to more than 330,000 employees, one of the largest deployments to date in Europe.
We’re also seeing strong momentum with E7, which brings together Copilot, E5, Entra, and Agent 365. Thousands of customers in every industry have purchased the suite to date, including Amadeus, BlackRock, Fiserv, New South Wales Health Department, and Zeiss.
The subscription brings increasingly capable everyday intelligence to every user, typically IT-funded, consolidating frontier advances for everyone across the organization, and as agents take on higher-value work, consumption opens up business-funded demand with spending tied directly to the value these agents deliver. The number of Copilot customers actively consuming credits through usage-based billing grew over 75% over the quarter.
When it comes to software development, all major coding agents have shown up to work on GitHub. Agent-generated PRs have increased 6x over the past six months, and agents now open more than a third of all PRs on the platform.
We are very hard at work on reliability as agentic activity on GitHub. At Universe this morning, we shared how we are expanding capacity and rebuilding the core Git architecture.
It delivers frontier-level quality up to 40% faster and at up to 77% lower cost. Credit consumption from agentic features on GitHub has more than doubled since usage-based billing went into effect, and we’re also helping developers secure their code and turn AI-generated code into high-quality software.
In the business application space, we are extending this vision of Copilot as the new OS for work, bringing the business logic and capabilities of Dynamics 365 directly into Copilot and helping every organization stand up their own infinite SaaS factory. This quarter, we introduced new Copilot skills across Dynamics 365, which enable customers to access CRM and ERP capabilities directly in the flow of work.
In recruiting, more than 10 million members use our LinkedIn AI-powered job search daily, and 25,000 customers are using our AgentIQ hiring solutions. In healthcare, we automated million patient encounters this quarter, up 70% year over year, helping clinicians spend less time on administrative work and more time with patients.
Ten providers, including Advocate Health, Mass General Brigham, Mercy, Intermountain Health, and others, have used our solutions to document over 1 million encounters each since the beginning of the calendar year. And in science, our teams are working with customers to use Discovery to accelerate scientific process.
Underneath our first-party agentic experiences is a common platform. It starts with Foundry, which is becoming an increasingly important driver of our growth.
Foundry helps organizations build learning loops grounded in their business context and deploy agents safely at scale. We now have over 120,000 Foundry customers, with revenue more than tripling year over year.
Azure OpenAI directly benefited in the last quarter with big advances in OpenAI models, and when you couple this with our model choice built into Foundry, customers are able to build solutions optimizing across quality, cost, performance. In fact, the number of customers building agentic solutions with multiple models increased 5x year over year, and revenue from open-source models on Foundry increased 10x.
We also continue to make rapid progress with our first-party models. Our goal is to advance the cost-to-outcome frontier, which means delivering capabilities comparable to leading models within three to six months of their release at a fraction of the training cost, thereby allowing us to transfer those cost benefits to customers, and you see this in our products today.
MAI Transcribe is the most accurate and cheapest transcription model in the world, supporting Dragon Copilot’s multilingual workflow. MAI Code Flash had 3 million users in GitHub Copilot last month alone, helping developers get more out of their AI credits.
Microsoft Decision One is our new model for structured decision making, outperforming both LLMs and other decision models in latency and quality. And we recently completed pre-training MAI Base 2, which outperforms other open-weight models we tested with 4 to 12 times greater training compute efficiency.
This base model will be used in upcoming MAI models across Thinking, Code, and Cyber. Beyond models, we are making the harness behind our own Copilot experiences available to customers in Foundry.
Another critical layer is data. We now have 44,000 paid Fabric customers, up more than 50% year over year.
We are bringing Foundry and Fabric closer together so you can build your own agents right next to data. Over 19,000 customers now use Foundry and Fabric as enterprises connect and operate agents over real-time operational, analytical, and unstructured data.
PostgreSQL growth accelerated for the fourth consecutive quarter, and the number of PostgreSQL customers also using Foundry accelerated to 90% year over year. We also have one of the most important databases for any enterprise, which is the knowledge underneath Microsoft 365, spanning people, their relationships, documents, emails, meetings, chats, projects, and other artifacts.
Nearly 60,000 customers are accessing context across Microsoft IQ, up 25% quarter over quarter. As enterprises deploy more agents, they also need to govern them at scale.
With Agent 365, we provide a platform for AI observability, enabling customers to manage, secure, and optimize the performance and cost of their agents. Over 50 million agents are now in the registry, up over 30% quarter over quarter.
And finally, as agents gain greater access to enterprise data and systems, security becomes even more critical. Last week, we expanded Perception with new capabilities to help customers secure and contain agentic insiders, including expanded agent discovery across local and cloud environments, dynamic permissions that enforce least-privileged access for each task, and continuous risk assessment.
We also introduced teams of Guardian agents that continuously monitor agent activity to help prevent unsafe actions before they occur. More broadly, we are helping customers secure and govern AI use across the enterprise.
6 billion agent activities to date, up 5 quarter over quarter. Underlying everything I’ve talked about so far is our infrastructure.
We are building against a growing book of business with a fungible fleet that allows us to dynamically allocate capacity to the highest-value opportunities across Compute, Data, Foundry, and Copilot. At the same time, we continue to get more from the infrastructure we already have by optimizing across the data center design, silicon, systems, software, and models.
For example, we increased the throughput for Copilot workloads by over 50% quarter over quarter. We continue to scale our fleet with the latest innovations from NVIDIA and AMD alongside our own Maia systems.
We have docked our first NVIDIA Rubin GPUs and are very excited about it. 7 times more tokens per watt across the AI experiences in Teams and Copilot, and Maia 300 will drive further gains, delivering 40% more tokens per watt compared to the leading GPU-based systems.
Our growth extends beyond GPUs. We continue to see strong adoption of our cloud-native Cobalt CPUs, improving price-performance for general-purpose workloads.
Finally, let me turn to Devices and Consumer. In Windows, we are executing on our vision to bring hybrid intelligence to every desk and every home, making every PC the secure agent box.
As more capable models run locally, we see an opportunity to make it more intelligent, unmetered. With these new devices, you can run last year’s frontier models on your laptop and last quarter’s model at your desk.
We are bringing together Windows and Agent 365 so agents can work with secure boundaries on-device. We introduced Microsoft Execution Containers, a policy-driven execution layer that governs and contains agents across Windows and other platforms, integrated with Agent 365 for governance and observability.
In Search and Advertising, Bing and Edge once again took share. 4 billion members, with time spent viewing content in the feed up 15% year over year.
And finally in Gaming, we remain focused on building great games and reaching players wherever they choose to play—across console, PC, mobile, and cloud. We enter the holiday season with one of our strongest first- and third-party lineups in years, including Modern Warfare 4, which we launched last week to the best reviews for a Call of Duty game in more than a decade, and Grand Theft Auto 6, which is coming to Xbox next month.
In closing, based on the demand we see, the strength of our products, and the efficiency we are driving across the stack, I’ve never been more confident in the long-term returns for our investments. Amy Hood (Chief Financial Officer)Thank you, Satya, and good afternoon, everyone.
Our results exceeded expectations across revenue, operating income, and earnings per share driven by strong demand across the Microsoft cloud. 3 billion, up 19%.
Gross margin dollars increased 17% and gross margin percentage was 68%. Operating income increased 21% and 22% in constant currency.
When adjusted for the impact per our investment in OpenAI, NFX was roughly in line with guidance. Operating expenses increased 6% driven by continued investments in R&D, compute capacity, and talent.
Operating margins increased slightly year over year to 50% driven by strong revenue growth, platform efficiency gains, and focused investments across our portfolio, partially offset by sales mix shift to Azure. 2 billion as some third-party capacity deliveries we expected in Q1 were delayed.
Roughly three-quarters of our CapEx was for short-lived assets, primarily CPUs and GPUs, including higher memory and storage costs, as we continue to invest in the infrastructure required for our customers to build and scale AI applications. The remaining spend was for long-lived assets.
4 billion. 6 billion reflecting higher capital expenditures.
2 billion to shareholders through dividends and share repurchases. Now to our segment results reported under the updated segment structure announced in September.
8 billion and grew 25%, reflecting strength across the connected layers of our platform. Commercial remaining performance obligation grew 73% to $677 billion, with a smaller sequential decline relative to historical seasonality due to the large Azure commitment this quarter.
3 years, and roughly 30% will be recognized in revenue in the next 12 months, up 29% year over year. The remaining portion recognized beyond the next 12 months increased 98%.
Now to Microsoft Cloud. 9 billion and growth accelerated to 30% and 31% in constant currency, with sequential dollars added nearly doubling year over year, reflecting strong demand across Azure and M365 Commercial Cloud.
Foundry revenue more than tripled year over year, with upside driven by efficiency gains across our GPU fleet that allowed us to allocate additional capacity to customers, as well as higher revenue per token that we benefited from in the quarter across our CPU fleet. Engineering work enabled us to identify and monetize underutilized capacity this quarter, helping us serve more of the growing demand with our existing capacity.
M365 Commercial Cloud revenue increased 18% and 19% in constant currency when adjusted for the prior-year comparable that benefited from one point of in-period revenue recognition. On a reported basis, revenue growth was 17% and 18% in constant currency.
Results were ahead of expectations driven by stronger GitHub Copilot adoption and usage, partially offset by weaker sales execution in our M365 E3 and standalone SKUs. Year over year, growth was driven by both ARPU and seats.
ARPU growth was led by our premium seat-based offerings, including M365 Copilot, E5, and E7, which has already reached millions of paid seats, with additional contribution from usage-based offerings, primarily GitHub Copilot and Copilot. Revenue growth accelerated quarter over quarter with continued adoption across M365, GitHub, and security.
Growth was driven by install base expansion across all customer segments, though primarily in our SMB and frontline worker offerings. M365 consumer cloud revenue increased 17% and 16% in constant currency, down sequentially as we begin to lap the benefit from the price increase in the prior year.
Industry Solutions Cloud revenue increased 10% with growth in Dynamics 365 and LinkedIn Talent Solutions, though booking trends continued to moderate. Frontier and Support Services revenue increased 4% and 5% in constant currency, driven by Support.
Microsoft Cloud gross margin percentage declined year over year to 66%, driven by sales mix shift to Azure, partially offset by product-level margin improvements, primarily in Azure. For this segment, gross margin dollars increased 20% and 21% in constant currency.
Operating expenses increased 10%, driven by the R&D investments noted earlier. Now to Devices and Consumer.
5 billion and declined 3%. Search and advertising revenue ex-TAC increased 12% and was ahead of expectations, driven by higher volume and rate across LinkedIn, Edge, and Bing.
Xbox revenue decreased 2%, and Xbox content and services revenue decreased 2% and 1% in constant currency, driven by declines in third-party content and Xbox Game Pass, partially offset by growth in first-party content. Windows OEM revenue was below expectations and decreased 27% and 28% in constant currency, driven by the Windows 10 end-of-support demand in the prior year, inventory drawdowns by OEM and channel partners, and weaker PC market demand.
Inventory levels remain elevated. Operating income increased 2% and 3% in constant currency, and operating margins increased year over year to 35%, driven by lower amortization of intangible assets from the Activision acquisition, partially offset by the impact from a lower mix of Windows OEM revenue.
S. dollar basis.
Based on current rates, we expect FX to have no meaningful impact on total revenue, COGS, or operating expense growth, or on revenue growth in either segment. 7 billion, or growth of 24% to 25%.
Timing related to significant Azure commitments like these will result in material volatility in bookings, making quarterly growth rates less indicative of underlying sales execution. In Azure, we expect revenue growth of 49% to 50% in constant currency, with continued efficiency gains across our CPU and GPU fleet helping to offset some 3P GPU-as-a-Service contracts that have been delayed to H2.
Customer demand continues to exceed available supply, and looking beyond Q2, year-over-year growth will continue to reflect the timing and scale of engineering efficiencies delivered in the quarter and new capacity adds, as well as a strong prior-year comparable that included accelerating growth in the second half. We expect continued momentum across our premium per-seat offerings and usage-based offerings, along with some improvement in execution across E3 and our standalone SKUs.
Growth will be driven primarily by ARPU, with additional contribution from seats, and we continue to expect revenue growth to accelerate through the year. M365 consumer cloud revenue should grow in the low teens, down sequentially as the price impact noted earlier.
Quarterly growth can vary materially based on contract mix, product launch timing, and other transactional purchasing trends. In Industry Solutions Cloud, we expect revenue growth to be in the mid- to high-single digits, with continued impact from the bookings trends noted earlier.
In Frontier and Support Services, we expect revenue to grow in the low- to mid-single digits. 4 billion.
Search and advertising revenue ex-TAC growth should be in the low double digits, driven by consistent trends in rate and volume, with overall search and advertising revenue expected to grow at a similar rate. With content launch patterns through the year, we expect growth to be the strongest in the second quarter, with some deceleration in Q3 and further moderation in Q4.
Hardware revenue in Q2 should decline year over year. Windows OEM and Devices revenue should decline in the mid-30s.
Growth will continue to be impacted by elevated inventory levels, PC market demand, and a prior-year comparable that benefited from Windows 10 end of support. We expect these trends to continue through the rest of the fiscal year.
1 billion, or growth of 18% to 19%. 6 billion, or growth of 9% driven by continued investment in R&D, compute capacity, and talent.
Operating margins should be down slightly year over year, including any impact from our investments in OpenAI. Other income and expense is expected to be roughly negative $300 million, as interest income will be more than offset by interest expense, which includes the interest payments related to data center finance leases, and we expect our Q2 effective tax rate to be approximately 20%.
Next, capital expenditures. In Q2 we expect CapEx spend will be over $50 billion.
Therefore for the calendar year, spend approximately $170 billion. Due to the 3P capacity delays noted earlier, in the second half of the fiscal year we currently expect CapEx spend to accelerate, primarily from CPUs inclusive of higher memory and storage costs and GPUs, as well as the 3P capacity deliveries that shifted to H2.
Given our strong business performance, we expect to remain free cash flow positive in FY27. To complement cash generated by the business and preserve financial flexibility, we will access additional sources of funding when we believe it is attractive to do so.
In closing, we are off to a strong start to FY27 with accelerated growth across the Microsoft cloud. Product improvements along with efficiency gains across our data center infrastructure and our first-party apps and agents are increasing the value and improving the outcomes we deliver to our customers.
Delivering that value to our customers positions us for durable long-term growth. With that, let’s go to Q&A.
Jonathan Nielsen (Vice President of Investor Relations)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. OPERATORThank you.
Ladies and gentlemen, if you would like to ask a question, please press star one on your telephone keypad and a confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue.
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Adam Wood (Analyst at Morgan Stanley)Hi. Thanks so much.
Satya Nadella (Chairman and Chief Executive Officer)Thanks for the question, Adam. I’d say all of the above, but I think the way we’re coming at this is we have one pool and we want to get the pool to be as efficient and fungible.
That’s sort of the place where, if I think about all of the physics of how we’re building out the data centers, all of the operational rigor with which we can bring up the capacity, and then of course how we run the workloads that are optimized on that infrastructure. And once you do that, then it’s just a function of how we allocate it by looking at the demand signal.
Copilot, stateful database. Underneath it is work IQ that gets used in Foundry, which is where people will build, let’s say, a multi-agent system for supply chain that spans both unstructured and structured.
Of course it uses a Postgres database in Azure. And then, by the way, all the agentic work is registered in the Agent 365 and Perception manages the security of it.
To us at least, we look at all of this as the same infrastructure. Of course we report to you in a variety of different products, but your core question of where is the margin going to come from, where is the leverage going to come from—it’s not going to come from any one, it’s going to come from every one of them, and it compounds when we work them across.
Amy Hood (Chief Financial Officer)And Adam, I’m sorry if we missed the front half of your question. Adam Wood (Analyst at Morgan Stanley)Yeah, absolutely.
Jonathan Nielsen (Vice President of Investor Relations)Thank you, operator. OPERATORThe next question comes from the line of Carl Kirsted with UBS.
Carl Kirsted (Analyst at UBS)Okay, thank you. Amy and Satya, I’m wondering if you could unpack what I thought was one of the key metrics from this call, and that is the guidance for Azure growth of 49% to 50% constant currency in December.
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