New Draft 2026-10-29 11:10:20

Original author: Li Hailun

Original editor: Xu Qingyang

Original source: Tencent Tech

Microsoft's latest quarterly earnings report has provided a set of hard data for the debate over returns on AI investment.

On October 28 local time in the United States, Microsoft announced results for the first quarter of fiscal year 2027 (corresponding to the third quarter of calendar year 2026), covering the period ended September 30. Revenue, operating income, and earnings per share all exceeded market expectations, with Azure becoming the most prominent growth engine of the quarter.

The earnings report showed that Microsoft's first-quarter revenue was $92.3 billion, up 19% from $77.7 billion in the same period last year, beating the analyst consensus of approximately $90.7 billion; operating income was $45.9 billion, up 21% year over year; net income was $36.6 billion, up 32% year over year, with diluted earnings per share of $4.92, up 32% year over year.

Excluding the impact of OpenAI investment gains and losses, net income on a Non-GAAP basis was $36.422 billion, up 18% year over year; adjusted diluted earnings per share were $4.89, up 18% year over year, beating analysts' expectation of approximately $4.73.

In the same period last year, Microsoft's investment in OpenAI generated a net loss of approximately $3.1 billion, while the first quarter of fiscal year 2027 generated a net gain of $207 million. The change in investment gains and losses between the two periods inflated the year-over-year growth rate of Microsoft's net income for the quarter.

In the first quarter, Microsoft disclosed Azure's quarterly dollar revenue for the first time. Azure revenue reached $33.17 billion, up 48% year over year, exceeding analyst expectations. Capital expenditures were $45.2 billion, below the company's previously guided expectation of more than $50 billion.

Against the backdrop of continuously expanding AI infrastructure investment, the market has been asking when these investments will translate into revenue. Microsoft's first-quarter cloud business provided a positive signal, but cash flow is still declining, and the Windows and devices business also contracted significantly. Meanwhile, Microsoft has just offered voluntary severance packages to approximately 60,000 employees.

Microsoft's stock closed at $531.01 the day before the earnings release, down 0.06% for the day. After the earnings announcement, the stock rose as much as 5% in after-hours trading. As of October 28, Microsoft's stock had risen approximately 9.8% year to date.

Azure Continues to Accelerate

Microsoft disclosed Azure's quarterly dollar revenue for the first time in the first quarter, providing the market with a more direct basis for comparing the business scale of different cloud providers.

Azure's first-quarter revenue was $33.17 billion, an increase of approximately $10.781 billion from $22.384 billion in the same period last year. On a constant-currency basis, Azure revenue grew 48% year over year, up from 43% in the previous quarter, above Microsoft's prior guidance of 44% to 45% growth, and also beating analysts' expectation of approximately 44%.

This marks another quarter of growth for Microsoft's cloud business. In the previous quarter, Azure revenue grew 43%. Microsoft has repeatedly said that customer demand for cloud and AI services exceeds available computing capacity. Azure's continued acceleration suggests that newly added computing capacity is translating into higher cloud service revenue.

Microsoft's newly created Agents and Infra business segment reported first-quarter revenue of $76.8 billion, up 25% year over year. This segment includes Azure, Microsoft 365 cloud services, productivity software, and server licensing, and is currently Microsoft's largest revenue source. During the same period, Microsoft Cloud revenue reached $63.9 billion, up 30% year over year, or 31% on a constant-currency basis.

Contract backlog continued to grow. Microsoft's commercial remaining performance obligation (RPO) reached $677 billion, up 73% year over year. This amount comes from contracts that have been signed but not yet recognized as revenue, reflecting future revenue backlog, but it does not equal revenue that can be realized in the short term. Contract fulfillment periods vary, and the timing of revenue recognition also differs.

Microsoft previously disclosed that excluding OpenAI, commercial RPO grew 25% year over year; the sequential increase in RPO in the previous quarter also came entirely from customers other than frontier model companies.

Microsoft Chief Financial Officer Amy Hood said the company had a strong start to the new fiscal year, with Microsoft Cloud growth accelerating and revenue, operating income, and earnings per share all exceeding expectations.

AI computing demand is an important driver of Azure's growth. Microsoft continues to expand data centers to provide enterprises with the infrastructure needed for model training, inference, and cloud-based AI services. For some time, insufficient computing supply has limited the growth of some cloud services; as more infrastructure comes online, Microsoft is gaining more capacity to meet customer demand.

However, Azure's 48% growth does not mean that all of Microsoft's AI investments have entered the payback period. Cloud revenue also includes traditional cloud computing and other services, and growth rates alone cannot isolate the specific revenue contributed by generative AI. For Microsoft, the next step is not only to continue expanding its cloud business but also to prove that newly added computing capacity can generate revenue and profits commensurate with the investment.

Copilot Commercialization Continues to Advance

Microsoft is selling AI services through two paths: one is providing Azure computing power to enterprises, and the other is embedding AI features into existing software such as Microsoft 365.

In the first quarter, Microsoft 365 Commercial Cloud revenue grew 17%, or 18% on a constant-currency basis; Microsoft 365 Consumer Cloud revenue grew 17% year over year, and industry solutions cloud revenue grew 10%.

These businesses, together with Azure, constitute the revenue sources from Microsoft's enterprise customers, but commercial cloud revenue growth does not fully equal Copilot revenue growth. Microsoft did not separately disclose Copilot's revenue scale in this earnings report.

However, Microsoft is advancing AI from a Q&A tool into actual workflows.

On September 25, Microsoft announced the new Copilot product architecture, integrating Home, Code, and Autopilot into a single product system. Home focuses on daily conversation and work collaboration, Code is used for developing applications and automating workflows, and Autopilot is positioned as an agent capable of continuously and autonomously executing tasks.

Users can process documents, spreadsheets, and presentations in Copilot, and can also have AI participate in programming, data analysis, and multi-step tasks. Compared with traditional chat tools, the goal of these products is not just to answer questions but to further complete work.

Microsoft Chairman and CEO Satya Nadella said in the earnings statement that Microsoft is providing customers with greater capabilities, more choices, more control, and cost efficiency across the entire technology stack. He also emphasized that helping enterprises build and own their own intelligence, and winning customer trust through the safety and reliability of agents, are important elements in driving AI adoption.

Windows and Xbox Drag on Performance

Of course, not all of Microsoft's businesses are growing.

The newly created Devices and Consumer segment reported first-quarter revenue of $15.5 billion, down 3% year over year. Among this, Windows OEM and devices revenue fell 22%, and Xbox content and services revenue fell 2%.

By comparison, search and advertising revenue (excluding traffic acquisition costs) grew 12%, becoming the main growth source for this segment. Microsoft continues to add AI features to Bing and Edge, and the advertising business remains in growth, but this performance is not enough to offset the decline in Windows OEM and devices revenue.

The decline in Windows OEM and devices revenue is related to PC market demand, component costs, and a high comparison base in the same period last year. Rising memory and storage costs pushed up prices for some devices, while the same period last year was near the end of Windows 10 support, and enterprise replacement demand also raised the comparison base. Microsoft had previously expected Windows OEM and devices revenue to decline by a high single-digit to nearly 20% year over year in fiscal year 2027.

The decline in Xbox content and services revenue was smaller, but the gaming business is still in a period of adjustment. Microsoft had previously carried out layoffs in the Xbox division and closed some game studios. First-quarter Xbox content and services revenue fell 2%, indicating that this business has not yet returned to full growth.

The strong growth of the cloud business has temporarily masked the weakness in some of Microsoft's traditional businesses. As AI becomes one of the company's most important investment directions, whether Microsoft can keep its other businesses stable will also affect overall profit and cash flow performance.

Capital Expenditures of $45.2 Billion, Cash Flow Still Under Pressure

The other side of AI business growth is continuously expanding infrastructure investment.

Microsoft's first-quarter capital expenditures and finance lease costs totaled $45.2 billion, up approximately 30% from $34.9 billion in the same period last year, but below the company's previously guided expectation of more than $50 billion.

Microsoft Vice President of Investor Relations Jonathan Neilson explained on the earnings call that some third-party computing infrastructure originally scheduled for delivery in the first quarter was delayed, causing quarterly spending to fall below expectations, but the company's overall investment plan has not changed as a result.

Capital expenditures below expectations do not mean Microsoft has begun to scale back AI investment. Microsoft previously expected capital expenditures of approximately $175 billion in calendar year 2026.

This figure is below the previous expectation of approximately $190 billion, mainly related to a change in the accounting classification of data center leases: Microsoft extended the estimated useful life of data centers and office buildings from 15 years to 25 years, and more future data center leases will shift from finance leases to operating leases.

Because finance leases are included in capital expenditure statistics while operating leases are not included under the same measure, this adjustment will lower the book capital expenditure forecast, but it does not mean the company has correspondingly reduced its actual infrastructure investment plans.

Microsoft previously explained that the adjustment to useful lives has a limited impact on current operating income and mainly affects future depreciation timing and the statistical treatment of capital expenditures. Therefore, judging whether Microsoft has truly slowed AI investment cannot rely solely on comparing capital expenditure figures; it also requires considering lease structure, actual cash spending, and computing capacity delivery.

Microsoft's operating cash flow for the quarter reached $58 billion, compared with $45.057 billion in the same period last year. Calculated as operating cash flow minus cash expenditures on fixed assets, free cash flow was approximately $18.633 billion, down approximately 27% from the same period last year, but still above analysts' expectation of approximately $8.5 billion.

This indicates that Microsoft still has the ability to support part of its infrastructure investment through cash generated from operations. However, capital expenditure growth is significantly faster than revenue growth, and whether future data centers can maintain high utilization rates after coming online and whether computing demand can continue to grow will directly affect the returns on these assets.

Microsoft previously expected to remain free cash flow positive for the full fiscal year 2027, with operating margin declining by less than 1 percentage point year over year.

Silicon Valley's Largest "Voluntary" Layoff

Two days before the earnings release, Microsoft announced voluntary severance packages for approximately 60,000 employees. This is equivalent to about 27% of the company's 223,000 employees as of the end of June and is Microsoft's largest voluntary departure program to date by coverage.

The program covers some teams in the United States, Canada, the United Kingdom, and India, and eligible employees at internal job levels 70 and below can apply. Participating departments include Copilot, Windows, Xbox, Finance, Human Resources, and others, but not all teams are included. Employees need to decide whether to accept by early December and are expected to leave by the end of the year.

Microsoft Chief Human Resources Officer Amy Coleman said in an internal memo that the program aims to provide more choices for employees considering leaving the company while helping relevant organizations adapt to changes in business needs.

Microsoft previously launched a voluntary retirement program for senior employees in spring 2026, with approximately 8,750 employees eligible, of whom more than 30% accepted the plan. For this broader program, Microsoft expects the acceptance rate to be significantly lower than that of the previous retirement plan.

What is special about this program is that it is not only aimed at employees close to retirement age or with long tenures. Some middle and senior managers may also be eligible,