Microsoft delivered a strong performance in FY26 Q1, exceeding market expectations driven by robust demand for cloud and AI services.
Here is the summary of key highlights:
1. Overall Financial Performance: Above Expectations
- Revenue: Reached 77.7 billion USD, up 18% year-over-year. This exceeded the market expectation of 75.3 billion USD.
- Net Income: Stood at 27.7 billion USD.
- Operating Income: Grew by 24% to 38 billion USD.
- Earnings Per Share (EPS): Adjusted EPS was 4.13 USD, a 23% increase year-over-year, beating the market estimate of 3.66 USD.
- OpenAI Investment Impact: Net income was negatively impacted by a 3.1 billion USD loss related to the investment in OpenAI.
2. Core Business Segment Performance
All business segments saw growth, with Intelligent Cloud being the standout performer:
- Intelligent Cloud:
- Revenue increased 28% to 30.9 billion USD.
- Azure Performance: Revenue for Azure and other cloud services accelerated to 40% growth (39% in constant currency), primarily fueled by demand for AI infrastructure and services.
- Productivity and Business Processes:
- Revenue grew by 17%, driven mainly by Microsoft 365 Commercial Cloud. The adoption of Copilot contributed to higher revenue-per-user growth.
- More Personal Computing:
- Revenue grew by 4%. Search and news advertising revenue increased by 15%.
- Gaming Slump: While content and services saw growth, Xbox hardware revenue plummeted by 29%, leading to an overall 2% decline in gaming revenue. Windows OEM revenue grew by 6%.
3. AI Investment and Capital Expenditure (Capex)
Microsoft is in a phase of aggressive AI infrastructure expansion:
- Surge in Capital Expenditure: Capex reached a record 34.9 billion USD this quarter, a 74% increase year-over-year. Approximately half of this was allocated to short-term assets like GPUs and CPUs to meet cloud and AI demand.
- Explosion in Commercial Bookings: Commercial bookings grew by 112% year-over-year, largely attributed to OpenAI’s significant commitments to Azure.
- Supply Constraints: Management indicated that cloud computing power is currently in a state of “demand exceeding supply,” with these constraints expected to persist beyond June 2026.
4. Future Outlook and Management Commentary
- Capacity Expansion: CEO Satya Nadella announced plans to increase AI capacity by over 80% this fiscal year and double the scale of data centers over the next two years.
- Market Reaction: Despite the better-than-expected financial data, Microsoft’s stock price experienced a slight decline following the announcement. This was due to investor concerns regarding massive AI spending and supply chain issues that prevent capacity from meeting demand.
Summary: Microsoft’s FY26 Q1 was a powerful quarter, proving that its aggressive AI strategy is translating into tangible financial results, such as the 40% growth in Azure and the doubling of bookings. However, the company faces immense pressure from capital expenditures and production capacity bottlenecks.
Here is the Income Statement for Microsoft based on the provided 10-Q filing for the quarter ended September 30, 2025, including the year-over-year (YoY) growth analysis.
Microsoft Corporation Income Statements (Unaudited)
Quarter Ended September 30 (In millions, except per share amounts)
| Item | 2025 | 2024 | YoY Growth |
| Total revenue | 77,673 | 65,585 | 18.4% |
| Product | 15,922 | 15,272 | 4.3% |
| Service and other | 61,751 | 50,313 | 22.7% |
| Total cost of revenue | 24,043 | 20,099 | 19.6% |
| Gross margin | 53,630 | 45,486 | 17.9% |
| Operating expenses | |||
| Research and development | 8,146 | 7,544 | 8.0% |
| Sales and marketing | 5,717 | 5,717 | 0.0% |
| General and administrative | 1,806 | 1,673 | 8.0% |
| Operating income | 37,961 | 30,552 | 24.2% |
| Other expense, net | (3,660) | (283) | 1,193.3% |
| Income before income taxes | 34,301 | 30,269 | 13.3% |
| Provision for income taxes | 6,554 | 5,602 | 17.0% |
| Net income | 27,747 | 24,667 | 12.5% |
| Earnings per share | |||
| Basic | 3.73 | 3.32 | 12.3% |
| Diluted | 3.72 | 3.30 | 12.7% |
Key Observations
- Revenue Momentum:Total revenue grew 18.4%, primarily driven by a 22.7% increase in Service and other revenue. This reflects the continued scaling of Microsoft Cloud (including Azure) and AI-integrated services.
- Operational Efficiency:Operating income grew 24.2%, outstripping revenue growth. This was achieved by keeping Sales and Marketing expenses flat YoY while continuing to invest in R&D and Cloud/AI infrastructure.
- OpenAI Investment Impact:Other expense, net increased significantly due to a 4.1 billion loss from the investment in OpenAI (primarily the equity method investment). On a non-GAAP basis (excluding these losses), net income growth would have been 22% as noted in the MD&A section.
- Profitability:Net income rose to 27.7 billion, representing a 12.5% increase despite the significant non-operating losses mentioned above.
According to the analysis of Microsoft’s Q1 FY2026 financial results, revenue from Azure and other cloud services grew significantly by 40% (39% in constant currency). The primary drivers for this surge in Azure revenue are as follows:
1. Surge in AI-Related Demand
The most significant driver is the “runaway” growth in demand for artificial intelligence infrastructure. Enterprise customers are increasingly leveraging Microsoft’s cloud services to host and train AI models. Management described this as a period of “massive AI-related investment and demand,” emphasizing their focus on building “planet-scale cloud and AI factories” to meet this unprecedented market need.
2. Massive Commitments and Partnership with OpenAI
The growth of Azure is inextricably linked to OpenAI. During this quarter, commercial bookings saw a staggering 112% increase, which financial analysts explicitly attributed to Azure service commitments made by OpenAI. This highlights how strategic partnerships are directly translating into substantial financial growth.
3. Broad Portfolio and Workload Expansion
Beyond AI, growth was bolstered by demand for Microsoft’s comprehensive portfolio of services. Reports indicate that Azure’s expansion is broad-based, occurring “across all workloads.” This shows that traditional cloud services and emerging AI services are scaling simultaneously.
4. Supply-Constrained Market Conditions
Current revenue growth is actually being tempered by supply limits. Management noted that customer demand currently exceeds Microsoft’s available supply, particularly regarding AI compute capacity. This intense demand drove Microsoft to raise its capital expenditure (Capex) to a record $34.9 billion to procure GPUs and expand data centers, further confirming the high market demand for Azure services.
Based on Microsoft’s Q1 FY2026 financial data, here is the English analysis regarding OpenAI’s Commercial Bookings:
1. Explosive Growth in Commercial Bookings
During the first quarter of fiscal year 2026, Microsoft reported a staggering 112% increase in commercial bookings (111% in constant currency). This growth figure significantly outperformed Wall Street’s expectations and represents a structural shift in the company’s contract pipeline.
2. Primary Driver: OpenAI Commitments
The earnings report and management commentary explicitly stated that this surge was “primarily driven by Azure commitments from OpenAI.”
- Binding Agreements: This indicates that OpenAI has signed legally binding contracts to purchase massive amounts of Azure cloud computing power over a defined period.
- RPO Growth: These commitments directly contributed to Microsoft’s Remaining Performance Obligation (RPO)—the total value of contracted work not yet billed—which surged to $392 billion this quarter, a 51% year-over-year increase.
3. Critical Context: Data Excludes the Latest Mega-Deal
It is important to note that the reported 112% growth does not include the massive new agreement announced on October 28, 2025 (as that occurred after the Q1 closing date of September 30).
- The New $250 Billion Pact: This subsequent deal involves OpenAI committing to an incremental $250 billion in Azure services over the coming years.
- Implication: The 112% growth seen in Q1 was merely the momentum before this record-breaking expansion, highlighting the rapid and continuous scaling of the partnership.
4. Financial Dualism: Bookings vs. Investment Losses
While OpenAI’s commitments provide a long-term revenue “moat” for Azure, the immediate financial relationship is a “double-edged sword” on Microsoft’s income statement:
- Future Revenue (Pros): The massive bookings guarantee a steady, high-volume income stream for Azure infrastructure for years to come.
- Current Net Income Impact (Cons): Under equity accounting, Microsoft recorded a $3.1 billion reduction in net income this quarter due to its share of OpenAI’s losses.
- OpenAI’s Burn Rate: Given Microsoft’s ~27% equity stake, this suggests OpenAI’s quarterly losses may have reached approximately $11.5 billion as it aggressively invests in model training and R&D.
Based on Microsoft’s Q1 FY2026 financial data, Operating Income grew by 24%, outpacing Revenue growth of 18%. This outperformance was driven by effective operational expense management and a strategic shift toward higher-margin product mixes.
1. Significant Operating Leverage
Operating leverage was the primary driver of profit growth exceeding revenue growth. While revenue surged by 18%, operating expenses increased by only 5%.
- Expense Control: Microsoft successfully expanded its top line without a proportional increase in marketing or administrative costs.
- Focused Investment: The modest 5% increase in expenses was largely directed toward cloud and AI engineering (infrastructure and talent). Because this investment grew significantly slower than revenue, it generated strong leverage that expanded the overall operating margin.
2. Structural Profitability Improvement in “More Personal Computing” (MPC)
The disparity between profit and revenue growth was most prominent in the MPC segment.
- Financial Performance: Segment revenue grew by only 4%, but operating income jumped by 18%.
- Lower Costs (Hardware Decline): The segment’s cost of revenue decreased by 3%. This was primarily due to a decline in lower-margin hardware sales, specifically a 29% drop in Xbox console sales.
- High-Margin Growth (Sales Mix Shift): Concurrently, higher-margin businesses saw growth, such as a 15% increase in Search and News Advertising revenue. This shift away from low-margin hardware toward high-margin digital services significantly bolstered the segment’s gross margin and profitability.
3. Efficiency Gains in Microsoft Cloud
Despite a 20% increase in the cost of revenue—driven by the massive build-out of AI infrastructure which caused a slight dip in overall gross margin percentage—Microsoft mitigated these pressures through efficiency gains.
- Azure and Microsoft 365 Efficiency: Continuous optimization within Azure and the Microsoft 365 commercial cloud helped offset the high depreciation and energy costs associated with scaling AI infrastructure.
Summary
Microsoft’s ability to deliver 24% profit growth on 18% revenue growth stems from strict control over operating expenses (limited to a 5% increase) and a successful business mix adjustment. By reducing reliance on low-margin hardware and achieving high-efficiency monetization in cloud and advertising, the company realized superior bottom-line results.
Here is the Balance Sheet for Microsoft based on the provided 10-Q filing, comparing the quarter ended September 30, 2025, to the fiscal year-end on June 30, 2025.
Microsoft Corporation Balance Sheets (Unaudited)
(In millions)
| Item | Sep 30, 2025 | Jun 30, 2025 | Change |
| Assets | |||
| Cash and cash equivalents | 28,849 | 30,242 | -4.6% |
| Short-term investments | 73,163 | 64,323 | 13.7% |
| Total cash, cash equivalents, and short-term investments | 102,012 | 94,565 | 7.9% |
| Accounts receivable, net | 52,894 | 69,905 | -24.3% |
| Inventories | 1,130 | 938 | 20.5% |
| Other current assets | 33,030 | 25,723 | 28.4% |
| Total current assets | 189,066 | 191,131 | -1.1% |
| Property and equipment, net | 230,861 | 204,966 | 12.6% |
| Operating lease right-of-use assets | 24,791 | 24,823 | -0.1% |
| Equity and other investments | 11,465 | 15,405 | -25.6% |
| Goodwill | 119,497 | 119,509 | 0.0% |
| Intangible assets, net | 21,236 | 22,604 | -6.1% |
| Other long-term assets | 39,435 | 40,565 | -2.8% |
| Total assets | 636,351 | 619,003 | 2.8% |
| Liabilities and Stockholders’ Equity | |||
| Accounts payable | 32,580 | 27,724 | 17.5% |
| Current portion of long-term debt | 7,832 | 2,999 | 161.2% |
| Accrued compensation | 9,201 | 13,709 | -32.9% |
| Short-term income taxes | 3,655 | 7,211 | -49.3% |
| Short-term unearned revenue | 58,987 | 64,555 | -8.6% |
| Other current liabilities | 22,741 | 25,020 | -9.1% |
| Total current liabilities | 134,996 | 141,218 | -4.4% |
| Long-term debt | 35,376 | 40,152 | -11.9% |
| Long-term income taxes | 26,569 | 25,986 | 2.2% |
| Long-term unearned revenue | 2,546 | 2,710 | -6.1% |
| Deferred income taxes | 2,852 | 2,835 | 0.6% |
| Operating lease liabilities | 17,348 | 17,437 | -0.5% |
| Other long-term liabilities | 53,588 | 45,186 | 18.6% |
| Total liabilities | 273,275 | 275,524 | -0.8% |
| Stockholders’ equity | |||
| Common stock and paid-in capital | 110,964 | 109,095 | 1.7% |
| Retained earnings | 254,873 | 237,731 | 7.2% |
| Accumulated other comprehensive loss | (2,761) | (3,347) | -17.5% |
| Total stockholders’ equity | 363,076 | 343,479 | 5.7% |
| Total liabilities and stockholders’ equity | 636,351 | 619,003 | 2.8% |
Key Balance Sheet Trends
- Massive Infrastructure Investment:Property and equipment (net) increased by 25.9 billion (12.6%) in just three months. This aligns with the company’s strategy to expand datacenter capacity for AI and Cloud services.
- Liquid Liquidity:Total cash and short-term investments reached 102 billion. The 13.7% jump in short-term investments indicates a shift of cash into interest-bearing marketable securities.
- OpenAI Valuation:Equity and other investments dropped by 25.6% (roughly 3.9 billion). This is primarily tied to the recognized losses from the OpenAI equity method investment mentioned in the income statement.
- Debt Management:While total long-term debt (including current portion) remained relatively stable, 4.8 billion shifted from long-term to current, reflecting upcoming maturities within the next 12 months.