MSFT Microsoft 10-Q 2026-09-30 section summaries

Microsoft (MSFT) — Q1 FY2027

Three months ended September 30, 2026; dollar amounts in USD. Comparisons are with Q1 FY2026 unless stated otherwise.

Consolidated results

Revenue grew 18.8%, led by service and other revenue (+25.7%), while product revenue declined 8.1%. Gross profit increased, but gross margin eased to about 67.8% from 69.0%; operating margin rose to about 49.7% from 48.9%. Net income also benefited from a favorable swing in non-operating results: Microsoft reported $272M of net gains from OpenAI investments, compared with $4.1B of net losses in the prior-year quarter. The prior-year quarter included $3.660B of other expense; current-quarter other income was approximately $38M, inferred from operating income and pretax income.

Segments and revenue categories

The September 2026 reporting change combines applications and agents, the multimodal system, and Azure infrastructure in Agents and Infra; prior periods were recast. Microsoft allocates certain AI infrastructure and training costs across segments. U.S. revenue was $49.459B versus $40.077B; revenue from other countries was $42.820B versus $37.596B.

Cash flow and capital returns

Stock-based compensation expense was $3.134B versus $2.983B. Under the $60.0B repurchase authorization, $37.7B remained at quarter-end; repurchases under the program were $2.925B versus $3.955B. Capital investment expanded alongside infrastructure: net property and equipment rose to $346.844B from $313.076B, and depreciation expense increased to $11.1B from $7.1B.

Balance sheet and obligations

Net intangible assets comprised marketing-related assets of $11.617B, technology-based assets of $4.102B, customer-related assets of $1.527B, and contract-based assets of $0.505B. Implied tangible common equity was $333.112B. Debt repayments were $4.850B during the quarter. Total debt carrying value comprised $4.391B current and $31.090B long-term; face value was $41.269B and estimated fair value, including current debt, was $29.3B.

Lease liabilities were $70.973B for finance leases and $27.477B for operating leases. Undiscounted payments were $95.246B for finance leases and $33.012B for operating leases. Particularly significant, $364.6B of additional leases, primarily for datacenters, had not yet commenced; they are expected to start between FY2027 and FY2034, run 1–20 years, and some depend on contractual conditions being met. This represents substantial future infrastructure commitments and capacity and execution exposure.

Other material exposures and outlook

Microsoft disclosed an approximately 24% as-converted equity interest in OpenAI, $13.0B in total funding commitments ($12.0B funded), and $10.0B of Q1 revenue from commercial arrangements, including revenue-sharing payments. Receivables from OpenAI were $7.2B, up from $6.0B at June 30. Microsoft uses the HLBV method for equity-method income or loss because liquidation rights and priorities differ from its ownership percentage. The relationship is a significant commercial opportunity as well as a source of counterparty and earnings volatility.

Remaining performance obligations were $683B, including $677B in commercial business, with a weighted-average commercial duration of about 2.3 years. Microsoft expects to recognize approximately 30% of total and commercial obligations over the next 12 months. Unearned revenue was $69.563B, down from $75.712B at the start of the quarter.

Debt investments had $60.687B adjusted cost basis and $58.894B recorded fair value at quarter-end. Unrealized losses increased to $1.934B from $1.274B, primarily due to interest-rate changes; $1.324B related to securities in continuous loss positions for at least 12 months. Management did not consider the remaining losses impairments. Equity investments totaled $29.178B at fair value; net recognized equity-investment losses were $5M versus $582M in Q1 FY2026.

The effective tax rate rose to 20% from 19%. Unrecognized tax benefits and other income-tax liabilities were $30.6B. The IRS is seeking $28.9B plus penalties and interest, primarily over proposed 2004–2013 transfer-pricing adjustments; Microsoft disputes the adjustments and plans to contest them. Accrued legal liabilities were $582M, with approximately $400M of additional adverse outcomes considered reasonably possible. The interim accountant review identified no material modifications needed for GAAP conformity; it was not an audit opinion.

Q1 FY2027 results

Revenue grew 19%, while cost of revenue rose 24%, reflecting investment in cloud infrastructure. Operating expenses increased 6%: R&D rose 11% to $9.047B from $8.146B, sales and marketing was essentially flat at $5.716B versus $5.717B, and G&A increased 4% to $1.881B from $1.806B. R&D spending reflected compute capacity and talent; total headcount declined 2%.

GAAP earnings growth was amplified by the comparison with prior-year OpenAI investment losses. Other income included a $272M net gain on OpenAI investments in Q1 FY2027 versus a $4.1B net loss in Q1 FY2026. Excluding those investment effects, adjusted net income grew 18%, compared with 32% GAAP growth. Interest expense rose to $870M from $698M, primarily due to higher finance-lease interest, partly offset by long-term debt maturities. Recognized investment losses were $46M versus $572M; derivative results were a $42M loss versus a $1.579B gain.

Reportable segments

Prior-year segment results are recast to Microsoft’s FY2027 reporting structure.

Agents and Infra revenue increased 25%, led by Azure, whose revenue grew 48%, up $10.8B, with demand across workloads. Microsoft Cloud revenue rose 30% to $63.9B, while its gross margin percentage declined to 66% as sales mix shifted toward Azure; Azure product-level margin improvements partly offset the mix effect. Microsoft 365 cloud revenue increased 17%, up $4.1B, driven by higher revenue per user, premium-seat upsell—including Copilot, E5 and E7—and usage-based services, especially GitHub Copilot. Commercial seats grew 5%; consumer cloud revenue rose 17% and subscribers increased 7%. Industry solutions cloud revenue grew 10%. Productivity and server licensing revenue fell 3% (down $271M), as transactional purchasing lapped prior-year product launches. Segment cost of revenue rose 35% to $23.887B from $17.701B, and operating expenses rose 10% to $12.350B from $11.253B.

Devices and Consumer revenue declined 3%, while operating income increased 2%. Windows OEM and devices revenue fell 22% (down $1.0B), reflecting the prior-year Windows 10 end-of-support demand benefit, channel inventory drawdowns and softer PC demand. Search and advertising revenue excluding traffic acquisition costs increased 12%; total search and advertising revenue rose 10% (up $612M). Xbox content and services revenue declined 2%, and Xbox hardware revenue fell 14% on lower console volumes. Segment cost of revenue decreased 8% to $5.833B from $6.342B; operating expenses declined 3% to $4.294B from $4.416B.

Cash flows, liquidity and capital allocation

Higher customer receipts and lower income-tax payments primarily drove the increase in operating cash flow, partly offset by higher supplier payments. Investing outflows increased with $20.0B more in property-and-equipment additions and $6.7B more cash used in other investing, partly offset by $19.1B more cash from net investment purchases, sales and maturities. Financing outflows primarily reflected a $4.9B increase in debt repayments.

Cash, cash equivalents and short-term investments totaled $64.5B at September 30, 2026, down from $76.8B at June 30, 2026; equity and other investments were $37.8B, up from $36.3B. Microsoft said liquidity, operating cash flow and capital-market access should cover operating needs and commitments for at least the next 12 months and thereafter for the foreseeable future. It repurchased 6M shares for $2.9B, versus 8M shares for $4.0B a year earlier; $37.7B remained under its $60B authorization. Dividends declared were $7.3B, versus $6.8B.

Outlook, risks and other disclosures

Commercial remaining performance obligations rose 73% to $677B, indicating substantial contracted future commercial revenue. Unearned revenue totaled $69.563B, including $30.299B scheduled for recognition in the December 2026 quarter and $22.202B in the March 2027 quarter. Microsoft expects continued cloud and AI infrastructure investment, including datacenters, computer systems and AI training. Execution depends on access to permitted datacenter land, reliable energy, networking supplies, servers and GPUs, with limited qualified suppliers for some device components. Competition, changing customer preferences, macroeconomic and geopolitical uncertainty, and trade restrictions and tariffs could also affect demand, costs and supply chains.

The effective tax rate was 20%, versus 19%, primarily due to lower stock-based-compensation tax benefits and changes in the geographic mix of earnings and tax expense. The IRS is auditing tax years 2014–2017. For 2004–2013, it proposed transfer-pricing adjustments of $28.9B plus penalties and interest; Microsoft disputes the adjustments and intends to contest them, and management believes its tax-contingency allowances are adequate.

In September 2026, Microsoft realigned its segment reporting for FY2027: Agents and Infra combines applications and agents, its multi-model system and Azure infrastructure; Devices and Consumer groups key consumer offerings. Microsoft also updated related metric definitions, including adding Industry solutions cloud and paid GitHub seats to commercial seat growth. The company described its long-term OpenAI partnership, including investment, revenue-sharing payments and rights to OpenAI intellectual property for product integration.

Market risk

Microsoft is exposed to foreign-exchange, interest-rate, credit-spread, and equity-price risk. It uses derivatives to manage these exposures, but they do not eliminate the potential effect of market movements on consolidated results. Principal currency exposures include the euro, yen, pound sterling, Canadian dollar, and Australian dollar. Its fixed-income portfolio is primarily investment-grade and diversified; Microsoft manages average maturity and credit exposures relative to broad-based indices.

At September 30, hypothetical sensitivity analysis that included associated derivatives showed the following potential effects:

These sensitivities are hypothetical measures of market risk, not forecasts of actual results.

As of September 30, 2026, Microsoft’s CEO and CFO concluded that its disclosure controls and procedures were effective. During the quarter, no changes in internal control over financial reporting materially affected, or were reasonably likely to materially affect, those controls. This section reports no financial results or other material business developments.

Microsoft — Risk Factors

Microsoft’s central risk is whether it can convert rapidly growing investment in cloud and AI into durable returns while managing intense competition, infrastructure constraints, cybersecurity threats, and evolving regulation. Much of this spending precedes revenue, and the costs and customer demand required to earn an adequate return remain uncertain.

Competition, investment, and execution

Microsoft competes with large technology companies and specialized entrants across fast-changing markets. Low-cost or free offerings, open-source software, ad-funded services, hyperscalers, and frontier AI providers can pressure prices and sales, while requiring higher research, development, marketing, and sales spending. Competitors’ platform and marketplace rules may also constrain distribution. Microsoft’s expansion into proprietary hardware, infrastructure, and AI models adds execution and cost risks, including potential conflict with OEM partners.

Returns on substantial cloud and AI investment depend on customer adoption and continued Azure use, effective monetization, and pricing that covers the costs of developing, training, deploying, and supporting these services. Customers could slow or reduce workloads, or move them to competitors, on-premises, or local deployments. Demand is difficult to forecast: excess or misaligned capacity could leave infrastructure underused and require impairment, while insufficient capacity could delay service and constrain growth. High model-training and inference, component, and energy costs—or competitive price declines and commoditization—could weaken margins.

Microsoft also relies on third-party technology and strategic relationships, including its long-term OpenAI partnership. Changes in partners’ priorities, access, contracts, or capacity allocations—or limitations in Microsoft’s visibility into third-party models’ design, training data, security, and behavior—could undermine expected benefits and demand. Product adoption, retention, reliability, developer participation, and successful execution of product and organizational changes are essential; costs may precede or exceed resulting revenue. Hardware, R&D, marketing, acquisitions, and other strategic investments may not deliver expected commercial or financial returns. Acquisitions and alliances can also create integration, retention, legal, regulatory, and management challenges; underperformance may lead to goodwill or intangible-asset impairment.

Cybersecurity, privacy, and AI safety

Microsoft reports that cyber actors, including nation-state groups, have gained unauthorized access to its systems and data and to those of customers, partners, and suppliers. Threats exploit vulnerabilities, unpatched or end-of-support equipment, social engineering, vendors, open-source components, and other supply-chain routes; attackers increasingly use AI. Incidents can remain undetected, spread across interconnected systems, and take substantial time to assess and remediate. Potential consequences include service outages, data loss or misuse, ransomware, product delays, remediation costs, reputational damage, and legal or regulatory exposure.

AI creates additional attack surfaces. Models and autonomous agents may be manipulated, compromised, or behave unpredictably, potentially amplifying malicious activity. Products may contain defects or vulnerabilities, including in AI-generated code; attackers may exploit zero-days before patches are installed, while Microsoft may have limited visibility into customer-managed systems. Legacy customer environments can limit adoption of modern security standards. Continual investment in secure development, defenses, updates, and customer tools may reduce margins. Security failures could prompt claims, customer remedies, delayed purchases, or switching, and contractual liability limits may not always protect Microsoft.

As cloud services scale, Microsoft processes more personal data, increasing exposure to improper disclosure or misuse by employees or third parties. Government requests, differing privacy rules, data-location expectations, and cross-border requirements may constrain operations or increase costs. Content, advertising, professional, marketplace, and gaming platforms also face risks from impersonation, harmful or illegal content, and misuse of protected information. AI outputs may be inaccurate, biased, offensive, or harmful, or disclose sensitive information or take unintended actions. Failures in safety, moderation, child protection, or responsible AI could prompt controversy, litigation, regulatory action, and loss of user trust amid divergent global requirements.

Infrastructure, supply, and resilience

Meeting cloud and AI demand requires costly expansion of datacenters, servers, GPUs, networking, storage, and power. Execution depends on obtaining land, permits, skilled labor, equipment, and reliable, affordable energy. Grid limits, connection delays, outages, rising electricity costs, water and environmental requirements, zoning, permitting, and community opposition may delay or restrict capacity. Shortages and long lead times for semiconductors, networking, power, and cooling equipment—compounded by competition for suppliers, tariffs, trade disruption, or geopolitical events—could delay deployments or force unfavorable purchasing commitments. Supply disruptions and excess, obsolete, or price-reduced inventory may also raise costs, including for Xbox and Surface.

Datacenter, connectivity, power, server, or third-party-provider failures—and defects in complex products—could degrade services, delay releases, trigger claims or regulatory action, and harm sales and reputation. Catastrophes, pandemics, conflict, cyberattacks, and other infrastructure failures could disrupt operations and supply chains. Greater reliance on cloud services raises the consequences of prolonged outages; Microsoft also identifies seismic exposure affecting headquarters, significant R&D, and other essential operations.

Regulation, litigation, and tax

Evolving and inconsistent U.S. and international rules may require costly operational or product changes or expose Microsoft to penalties, litigation, and restrictions. Areas of focus include competition and digital markets, AI (including the EU AI Act and U.S. state requirements), privacy and data transfers, cybersecurity, trade controls and AI export restrictions, and datacenter energy, water, siting, and environmental standards. AI’s resource demands may also increase costs and challenge Microsoft’s goals to become carbon negative, water positive, and zero waste by 2030.

AI offerings, product releases, transactions, warranties, employment practices, and regulation may give rise to claims, damages, or injunctive relief. Government contracts are exposed to audits, changing compliance expectations, funding changes, termination rights, and possible suspension or debarment. Microsoft’s tax expense could rise through legal changes, disputed positions, or shifts in the geographic mix of operating income. The IRS has proposed adjustments primarily concerning intercompany transfer pricing for tax years 2004–2013, seeking $28.9 billion in additional tax, plus penalties and interest; resolution could materially affect results in the period settled. OECD global-minimum-tax proposals and other tax disputes or agreement expirations add uncertainty.

Other business and financial exposures

Protecting intellectual property globally is difficult. Unauthorized source-code disclosure could weaken trade-secret protection, aid competitors, and increase security risks. AI training, inference, and outputs have prompted infringement claims; potential consequences include damages, indemnification, less favorable licensing or data-access terms, and product redesign or withdrawal. Microsoft has paid significant sums to settle claims and acquire rights.

Economic downturns, inflation, interest and foreign-exchange movements, and uncertain IT spending cycles may reduce or delay demand. Distributor, OEM, or retailer distress could disrupt channels; weaker customer finances could increase doubtful-account allowances and write-offs. Market, credit, liquidity, or interest-rate declines could reduce investment-portfolio fair values and result in impairment charges.

Geopolitical instability, sanctions, tariffs, export controls, protectionism, and local-sourcing requirements may raise costs, interrupt supply, restrict market access, or constrain public-sector sales. International operations also face currency, political, regulatory, and staffing challenges; hedging covers only part of currency exposure. Competition for skilled employees, limits on talent mobility, employment-law changes, and increased unionization may raise costs or impede execution. Across these risks, damage to Microsoft’s products, security, privacy, public-policy positions, or responsible-AI reputation could weaken trust among customers, partners, employees, and regulators.

Trading Arrangements

During the three months ended September 30, 2026, no officers or directors adopted, modified, or terminated a Rule 10b5-1 or non-Rule 10b5-1 trading arrangement. This section reports no financial results, business developments, or other material changes.