MSFT Stock | Microsoft Corporation Q3 2026 Earnings Call

Thank you, Satia, and good afternoon, everyone. We delivered results that exceeded expectations across revenue, operating income, and earnings per share driven by strong demand and execution. As Satia shared, our AI business annual revenue run rate surpassed $37 billion this quarter, growing 123% year-over-year. And we're accelerating our pace of innovation as we execute against the expansive opportunity ahead. This quarter, revenue was $82.9 billion, up 18% and 15% in constant currency. Gross margin dollars increased 16% and 13% in constant currency, while operating income increased 20% and 16% in constant currency. Earnings per share was $4.27, an increase of 21% and 18% in constant currency. When adjusted for the impact from our investment in OpenAI, FX was roughly in line with guidance at the total company level. Company gross margin percentage was 68%, down year-over-year driven by continued investment in AI infrastructure and growing AI product usage. The impact from these investments was partially offset by ongoing efficiency gains particularly in Azure and M365 commercial cloud. Operating expenses increased 9% and 8% in constant currency driven by continued investment in AI, including R&D compute capacity, talent, and data to support product development across the portfolio. This quarter, growth was impacted by a low prior-year comparable, particularly in sales and marketing and G&A expenses - operating margins increased slightly year-over-year to 46% over revenue and margin performance shows disciplined execution across segments: total headcount declined, capex increased to $31.9 billion for semiconductors mainly GPUs CPUs operating income rose across divisions driven by scale efficiencies However demand signals remain Supply-limited especially Azure pacing ahead The remainder reflects capital allocation priorities within Compute layers adjusted accordingly for quarter-over-quarter seasonality variance Due to increased customer activity Several forward-looking indicators Also importantly Property Plant Equipment Investments signifying long-term cloud business durability While Operating Performance remains paramount toward sustaining Growth & Returns Leveraging Unique market dynamics. Capital expenditures were $31.9 billion, down sequentially due to the normal variability from cloud infrastructure build-outs and the timing of delivery of finance leases. This quarter, roughly two-thirds of our capex was for short-lived assets, primarily GPUs and CPUs. The remaining spend was for long-lived assets that will support monetization over the next 15 years and beyond. This quarter, total finance leases were $4.7 billion and were primarily for large data center sites, and cash paid for PP&E was $30.9 billion, roughly in line with capital expenditures, as the impact from finance leases was partially offset by differences between the receipt of goods and payment. Cash flow from operations was $46.7 billion, up 26% driven by strong cloud billings and collections, partially offset by an increase in operating lease payments. And free cash flow was $15.8 billion, reflecting higher capital expenditures. And finally, we returned $10.2 billion to shareholders through dividends and share repurchases. Now to our commercial results. Commercial bookings grew 7% when excluding the impact from OpenAI, driven by consistent execution in our core annuity sales motions. Bookings decreased 4% and 6% in constant currency when including Azure commitments from OpenAI. Commercial remaining performance obligation grew 26% in line with historic seasonality when excluding OpenAI. RPO increased to $627 billion and was up 99% year-over-year with a weighted average duration of approximately two and a half years when including OpenAI. Roughly 25% will be recognized in revenue in the next 12 months, up 39% year-over-year, with the remaining portion recognized beyond the next 12 months increasing 138%. Microsoft Cloud revenue is $54.5 billion and grew 29% to 25% in constant currency, reflecting strong demand across the Azure platform and our first-party AI applications and services. Microsoft Cloud gross margin percentage was slightly better than expected at 66%, and down year-over-year due to continued investments in AI, partially offset by the ongoing efficiency gains noted earlier. Now to our segment results. Revenue from Productivity and Business Processes was $35 billion and grew 17% and 13% in constant currency. M365 Commercial Cloud revenue increased 19% and 15% in constant currency, ahead of expectations. Strong execution and improving product quality drove accelerating M365 Copilot seat adds this quarter, with paid seats now over 20 million. ARPU growth was again led by both E5 and M365 Copilot, and paid M365 commercial seats grew 6% year-over-year with installed base expansion across all customer segments, though primarily in our small and medium business and frontline worker offerings. M365 Commercial Products revenue increased 1% and decreased 3% in constant currency, down sequentially as Office 2024 transactional purchasing trends continued to normalize as expected. M365 Consumer Cloud revenue increased 33% and 29% in constant currency, again driven by ARPU growth. M365 consumer subscriptions grew 7%. LinkedIn revenue increased 12% and 9% in constant currency with growth across all lines of business. Dynamics 365 revenue increased 22% and 17% in constant currency with continued share gains and growth across all workloads. Bookings growth was impacted by weaker renewals as customers balanced spend between the traditional per-seat and the emerging seats-plus-consumption model. Segment gross margin dollars increased 18% and 13% in constant currency, and gross margin percentage increased slightly, again driven by efficiency gains in M365 Commercial Cloud that were partially offset by continued investments in AI, including the impact of growing adoption and usage of Copilot against a low prior-year comparable. Operating expenses increased 11% and 9% in constant currency, driven by the shared R&D AI investments mentioned earlier as well as higher Copilot advertising spend. Operating income increased 21% and 14% in constant currency, and operating margins increased year-over-year to 60%. Next, the Intelligent Cloud segment revenue was $34.7 billion and grew 30% and 28% in constant currency. In Azure and Other Cloud Services, revenue grew 40% and 39% in constant currency against a prior year that included accelerating growth. Results were ahead of expectations as we delivered capacity earlier in the quarter, enabling increased consumption across both AI and non-AI services. Strong customer demand across workloads, customer segments, and geographic regions continues to exceed available capacity. In our on-premises server business, revenue increased slightly and decreased 3% in constant currency with ongoing customer shift to cloud offerings. Segment gross margin dollars increased 19% and 18% in constant currency. Gross margin percentage decreased year-over-year driven by continued AI investment and increased GitHub Copilot usage, partially offset by ongoing efficiency gains in Azure. Operating expenses increased 9% and 7% in constant currency, driven by the shared R&D AI investment noted earlier. Operating income grew 24% and 23% in constant currency, and operating margins were 40%. Now to More Personal Computing: revenue was $13.2 billion and declined 1% and 3% in constant currency. Windows OEM and Devices revenue decreased 2% and 3% in constant currency. Windows OEM increased slightly and was ahead of expectations as OEM and channel partners continued to build inventory given increasing memory prices. Search advertising revenue (ex-TAC) increased 12% and 9% in constant currency with growth driven by higher volume and revenue per search across Edge and Bing. And in Gaming, revenue decreased 7% and 9% in constant currency. Xbox content and services revenue decreased 5% and 7% in constant currency against a prior-year comparable that benefited from strong first-party content performance. Segment gross margin dollars increased 6% and 4% in constant currency, and gross margin percentage increased year-over-year driven by sales mix shift to higher-margin businesses against a low prior-year comparable. Operating expenses increased 7% and 6% in constant currency, driven by impairment and other related expenses in our gaming business, as well as continued investments in shared R&D mentioned earlier that benefits the entire portfolio. Operating income increased 4% and 1% in constant currency, and operating margins increased year-over-year to 28%. Now moving to our Q4 outlook, which unless specifically noted otherwise is on a US dollar basis. Based on current rates, we expect FX to increase revenue growth by roughly one point in Productivity and Business Processes and More Personal Computing, with no meaningful impact to Intelligent Cloud. Overall impact to total revenue is expected to be less than one point. FX should increase COGS growth by roughly one point, with no impact to operating expense growth. Starting with our commercial business: in commercial bookings, when adjusted for the impact from OpenAI, we expect healthy growth on a growing expiry base with consistent execution in our core annuity sales motions against a significant prior-year comparable. Microsoft Cloud gross margin percentage should be roughly 64%, down year-over-year driven by continued investments in AI and increased GitHub Copilot usage. Just this week, we announced a business model transition in GitHub Copilot that will align pricing with usage and value, taking effect on June 1st of this year. Now to segment guidance: in Productivity and Business Processes, we expect revenue of $37.0 to $37.3 billion, or growth of 12% to 13%. In M365 Commercial Cloud, on an adjusted basis, we expect revenue growth to be between 15% and 16% in constant currency. When normalized for the prior-year comparable that benefited from two points of in-period revenue recognition, and on a reported basis, we expect revenue growth to be between 13% and 14% in constant currency. Building on the Copilot momentum we saw in Q3, we expect net paid seat adds to increase sequentially, which will drive continued ARPU growth. M365 Commercial Products revenue should grow in the mid-single digits against a prior year that benefited from higher-than-expected Office 2024 transactional purchasing. As a reminder, M365 Commercial Products includes components that can be variable due to in-period revenue recognition dynamics. M365 Consumer Cloud revenue growth should be in the low 20% range, down sequentially as we start to lap the benefit from last year's price increase. Growth will again be driven by ARPU and an increase in subscription volume. For LinkedIn, we expect revenue growth of approximately 10%. And in Dynamics 365, we expect revenue growth to be in the low double digits, down sequentially with impact from a strong prior-year comparable and the bookings trends noted earlier. For Intelligent Cloud, we expect revenue of $37.95 to $38.25 billion, or growth of 27% to 28%. In Azure, we continue to focus on accelerating the delivery of capacity and increasing fleet efficiencies, and therefore we expect Q4 revenue growth to be between 39% and 40% in constant currency against a strong prior-year comparable that included accelerating growth. Broad and growing customer demand continues to exceed supply, and we continue to balance the incoming supply we can allocate here against our other high-ROI priorities: first-party applications, R&D, and end-of-life server replacement. As a reminder, year-over-year Azure growth rates can vary quarter to quarter based on capacity timing and contract mix. In our on-premises server business, we expect revenue to decline in the mid-single digits with ongoing customer shift to cloud offerings. In More Personal Computing, we are lapping strong prior-year comparables, navigating complex PC market dynamics impacted by memory prices, and refocusing on delivering quality and value to consumers. Therefore, we expect revenue to be $11.75 to $12.25 billion. Windows OEM revenue should decline in the high teens, with roughly six points of impact from a prior-year comparable that benefited from Windows 10 end-of-support, six points from inventory levels that we expect to come down for the quarter, and six points from a lower PC market as prices increase due to memory costs. The range of potential outcomes remains wider than normal. Therefore, Windows OEM and Devices revenue should decline in the mid-to-high teens. Search advertising revenue (ex-TAC) growth should be in the high single digits, driven by revenue per search and volume with continued share gains across Bing and Edge. And in Xbox content and services, we expect revenue to decline in the low teens, reflecting a prior comparable that benefited from strong first-party content as well as the recent price changes for Xbox Game Pass as we focus on delivering more value to gamers. Hardware revenue should decline year-over-year. Therefore, at the total company level, revenue should be between $86.7 and $87.8 billion, or growth of 13% to 15%, with accelerating commercial growth partially offset by our consumer business. Our Q4 outlook for COGS and operating expenses includes roughly $900 million in one-time costs for the recently announced voluntary retirement program. Therefore, we expect COGS of $29.4 to $29.6 billion, or growth of 22% to 23%, including roughly $350 million from the retirement program, and operating expense of $19.3 to $19.4 billion, a growth of approximately 7%, including roughly $550 million from the retirement program. Even as we invested through the year in additional capacity to serve the growing AI platform, apps, and services demand, and inclusive of these one-time costs, we expect full-year FY26 operating margins to be up about one point year-over-year, excluding any impact from our investments in OpenAI. Other income and expense is expected to be roughly negative $100 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 adjusted Q4 effective tax rate to be approximately 19%. Next, capital expenditures. We expect capex spend to increase to over $40 billion as we continue to bring more capacity online. The sequential increase includes roughly $5 billion from higher component pricing as well as the impact from finance leases, which add variability given the full value is recorded in the period of lease commencement. And we expect the mix of short-lived assets to remain similar to Q3. For calendar year 2026, we expect to invest roughly $190 billion in capital expenditures, which includes approximately $25 billion from the impact of higher component pricing. We remain confident in the return on these investments given higher demand signals and increasing product usage as well as the efficiencies we're already driving across the platform. Even with these additional investments and continued efforts to bring GPU, CPU, and storage capacity online faster, we expect to remain constrained at least through 2026. Despite these constraints and the continued need to balance incoming supply, we expect Azure growth to show modest acceleration in the second half of the calendar year compared with the first half. Now, I'd like to share some closing thoughts as we look to next fiscal year. First, we continue to evolve how we operate to increase our pace and agility, and therefore we expect headcount will decrease year-over-year. Operating expense growth will be in the mid-to-high single digits, reflecting ongoing investments in R&D inclusive of AI investment in compute, data, and talent to accelerate product innovation. Next, as a reminder, we will lap strong prior-year comparables impacted by Windows 10 end-of-support, elevated OEM inventory levels, as well as increased Office and server transactional purchasing. And finally, we remain focused on delivering a platform that enables customers to build and run AI solutions and on driving innovation in our first-party AI applications and services. And therefore, we expect another year of double-digit revenue and operating income growth in FY27. In closing, we are committed to delivering innovation that helps customers create new business value as we enter the final quarter of our fiscal year. With that, let's go to Q&A.

Why don't I start with the first half of your question, Keith, around how do some of these models impact bookings? And I think it's really important. You're right, we have the normal cyclical things that happen with bookings—the expiration base or maybe large multi-year Azure commitments that get signed—and that stuff has always had some volatility to it. But I think if you take a step back, which is the broader question you're asking, and obviously I'll let Satia talk to it too, you're really thinking through as we go through using a model that's been historically thought of as a per-seat business. And suddenly, if you think about getting work done and being more productive, it's thinking about being a seat or a worker plus an agent. And when I think about that model, I start to think about it as a licensed business plus a consumption business, and really applying it far more broadly than I think people have thought about that. And so it starts to mean that over time, bookings will actually also look a little different. It'll still have that per-seat license logic, but it'll also have a meter just like you see in Azure. And it may not all flow through bookings in the same way. You'll just bill for usage, and if that usage has great value to customers—and I'll let Satia talk a little bit about this—then you'll keep spinning and still keep using those agents if they're adding direct value or growth to your business. And so I think it's probably healthy to start to think about that transition in a broader way. While you may not see it in the short term in bookings, I think if I were to frame how to think about the opportunity, I would probably think about it more in that light.

Sure. Thanks, Karl. No, I actually feel quite good about our ability to work through the physical sort of limitations. I think of the industrial logic of the supply chain to be able to put that—both, you know, some of that as we've talked about is getting capacity online, but a lot of that is far more short-term in nature, being able to get CPUs, GPUs, storage put in place to be able to start to support even better the demand signals we've been seeing. I tried to give some help on part of that being price. I think that just helps give you a sense on volumes. And obviously it leans more to short-term assets when you see that type of impact of price on the number. I would also say, in terms of a sense of allocation, you should assume—we talked a little bit about what you were seeing in Azure: looking for 39% to 40% in constant currency in Q4 means that we're able to use some efficiencies to make sure we're able to meet demand as we can best do that in a balanced way across Azure, our Copilot usage which I think you've seen in Q3 has really been on a different trajectory than we saw it up to this point. That applies across coding, it applies across productivity, and I have some confidence it's also going to apply across security. Then if you think about talking about some acceleration into what I would call the first half of FY27, the second half of the calendar year, it means we're getting some insights into our abilities to increasingly put pressure on efficiencies, being able to speed up the deliveries into our data centers and make that what I would call revenue ready as quickly as we can. So, I would expect that the pressure between first-party usage and being able to meet Azure demand will persist, as I said, but we're doing our best to be able to get things in as quickly as we can, and hence the capex number that we see in the second half of the year.

Thanks, Brent. I think we've been talking about where this AI business of ours has been in the cycle compared to even the cycle we saw with the cloud, which now seems very long ago, and how margins were actually better and they've remained better in our AI business versus where we saw in the cloud transition looking back. And so I do feel like what we've been really focused on is making sure that the business models reflect how these applications are both getting built and the value that they're bringing. And so when you think about that type of value, it tends to be captured more in consumption and usage-based pricing models. And I think that's something that's probably been a little underappreciated as we look in terms of margins going forward. I also think it's been important to us to make sure we leverage the IP we have. The IP we get from our partnerships is obviously free to us for a long time. So we're able to take that and apply it and to benefit our margins in a healthy way. You've also seen us work hard on the first-party hardware stack, being able to make sure we can take margins out of the infrastructure as well. And then, of course, just the efficiency work. We've really been in an accelerated phase, as you know, of trying to get as much capacity as we can get into production. But when you go through that, you also then start to focus on the efficiency work—and that's efficiency work on the hardware side as well as efficiency work on the software side to be able to deliver these types of margins. I do believe that one of the real focuses that we've got to all have is—and this really dates back to the question that Keith asked in the beginning—that when you move to usage-based models, you have to make sure you're delivering incredibly high value to customers. So what we need to do is make sure the focus starts with customer usage that creates value. If that creates value and positive output, then the TAM expansion here and the ROI will be very good.

Thanks, Mark. Let me maybe start with Azure, which given its size and its growth rates where we've talked about acceleration from where we are—which is the guide at 39% to 40% into a bigger number in the second half of the calendar year. When you start to see that type of growth rate on the size of the business we have, the amount of spend being done on short-term assets—which is really the thing that correlates with revenue, as opposed to the third of that number that's going into 15-year assets or some lumpy timing from lease contracts that can kind of get confusing—you know, I think in so many ways, this just reminds us of the last cycle. And when the TAM is so expansive and when shortages are generally, I think, growing seems to be the sentiment between supply and demand, it just gives you a lot of confidence in the ROI, certainly starting with the platform side. Then what you're really asking is whether, as we see these usage-plus-consumption models emerge at the app and services layer, we are starting to see the benefits of that. And I think, you know, if you look past the last quarter, I think we saw some acceleration which I felt good about in the M365 Commercial Cloud number this quarter—we're guiding for that to be better again in Q4. I think that's where you're starting to see it, right? I think the thing that investors have been asking, and Mark, you're asking about, is when we'll start to see that show up in revenue growth. And I think that's the first place you point to. We can also point to it and I think you'll start to see it in GitHub, right? Where you see revenue growth rates and usage consumption models result in acceleration in the top line. And then, in general, I think you continue to see that. And so when you think about spending that amount of capital, putting it into production, seeing some delay before it turns into revenue ready, having the book of business—I think it's over $600 billion of revenue that we still need to deliver, and that's before we're starting to see the acceleration in seats that we're seeing on Copilot. I do feel very good about frankly that number, and our real focus will be how much of that we can pull in as fast as we can. I just want to be transparent that when you have revenue that's sitting there that can be grown faster or efficiencies, the focus needs to be on doing that and landing this capex as quickly as we can and converting it to revenue as quickly as we can.

Yeah, I think the only maybe two things to keep in mind, I would say, is having the revenue share exist through 2030 and the predictability of that is a real positive for us. And then, as you point out and Satia pointed out, the IP thinking about that as royalty-free with the elimination of our revenue share to them.

Thank you.