Microsoft Corporation

Greetings, and welcome to the Microsoft Fiscal Year 2026 Third 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. It is now my pleasure to introduce Jonathan Nielsen, Vice President of Investor Relations. Please go ahead.

Good afternoon, and thank you for joining us today. On the call with me are Satya Nadella, Chairman and Chief Executive Officer, Amy Hood, Chief Financial Officer, Alice Jolla, Chief Accounting Officer, and Brian Defoe, Deputy General Counsel and Corporate Secretary. On the Microsoft Investor Relations website, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provides the reconciliation of differences between GAAP and non-GAAP financial measures. 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 as 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 third quarter performance in addition to the impact these items and events have on the financial results. All growth comparisons we make on the call today relate to the corresponding period of last year unless otherwise noted. We will also provide growth rates in constant currency when available as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. Where growth rates are the same in constant currency, we will refer to the growth rate only. We will 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. If you ask a question, it will be included in our live transmission, in the transcript, and in any future use of the recording. 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. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call, and in the risk factor section of our Form 10-K, Forms 10-Q, and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that, I'll turn the call over to Satya.

Thank you very much, Jonathan. It was a record third quarter powered by the continued strength of Microsoft Cloud, which exceeded $54 billion in revenue, up 29% year over year. Our AI business surpassed $37 billion ARR, up 123%. We are at the beginning of one of the most consequential platform shifts that will change the entire tech stack as agents proliferate and become the dominant workload. This will drive time expansion and change the value creation equation across the entire economy. To capture this opportunity, we are executing against two priorities. First, we are building the world's leading cloud and AI infrastructure for agentic computing error. Second, we are building high-value agentic systems across core domains such as productivity, coding, and security. These two layers reinforce each other and we are focused on driving competitive value and differentiation for customers across each so that they can eval max their outcomes. Today, I'll focus my remarks on both priorities starting with infrastructure. We're optimizing every layer of the tech stack from DC design to silicon to system software, the model architecture, as well as its optimization. This is translating into operational gains. We have reduced dock-to-live times for new GPUs in our biggest regions by nearly 20% since the beginning of the year. Our Fairwater data center in Wisconsin came online earlier this month, six weeks ahead of schedule, allowing us to recognize revenue earlier. And we delivered a 40% improvement in inference throughput for our most used models across Copilot, driven by our software and hardware optimization work. All up, we added another gigawatt of capacity this quarter and remain on track to double our overall footprint in just two years. We're moving aggressively to add capacity aligned to our demand signals we see, and we've announced new data center investments across four continents. We also continue to modernize our fleet with our first-party innovation alongside the latest from NVIDIA and AMD. Across our fleet, millions of servers are powered by our custom networking, security, and virtualization silicon, including Azure Boost, as well as our first-party CPUs and accelerators. Our Maya 200 AI accelerator, which offers over 30% improved tokens per dollar compared to the latest silicon in our fleet, is now live in our Iowa and Arizona data centers. Our Cobalt server CPU is deployed in nearly half of our DC regions, running workloads at scale for customers like Databricks, Siemens, and Snowflake. As our largest customers scale their AI deployments, they're increasingly leveraging other services across our platform and choosing to run those workloads on Cobalt. And we are expanding Cobalt supply significantly to meet this demand. The next layer up from infrastructure is the agent app platform. It starts with model choice. We offer the broadest selection of models of any hyperscaler so customers can choose the right model for the right workload across OpenAI, Anthropic, Open Source, and more. Over 10,000 customers have used more than one model on Foundry. 5,000 have used Open Source models, and the number who have used Anthropic and OpenAI models increased 2x quarter over quarter. For example, Bear is using multiple models in Foundry to create its own in-house agent platform with more than 20,000 active monthly users. All up, over 300 customers are on track to process over 1 trillion tokens on Foundry this year, accelerating 30% quarter over quarter. We also remain focused on our first-party model work to differentiate our high-value co-pilots and agents and reduce cogs. We introduced MAI Transcribe 1, a state-of-the-art speech-to-text model, and MAI Image 2, one of the top image generation models in the world. These models are already powering first-party scenarios like image generation in Bing and PowerPoint, and we're working towards having Transcribe 1 power transcription in co-pilot and Teams. Early signals show 67% increase in GPU efficiency with Transcribe 1 and up to 260% increase in Image 2. We also brought MAI models to commercial customers like Shutterstock and WPP for the first time through Foundry. And we are innovating on OpenAI IP to drive product evals and lower COGs. Two recent examples of what we've done with multi-step retrieval with WorkIQ and Copilot and how reasoning adapts to intent complexity in researcher with much reduced latency and increased accuracy. The next layer up. It's all about enterprise data and context across Fabric, Foundry, Microsoft 365, and our security graph. We are building a unified IQ layer for organizational intelligence. Thousands of enterprises already are accessing context across these IQ layers. And as AI usage grows, so does the context layer, creating a flywheel that continuously improves the grounding, relevance, and effectiveness of every agent they use and build, making our IQ layers an unmatched context engine for organizational intelligence. More broadly, our database business accelerated quarter over quarter. Cosmos DB alone saw 50% year-over-year revenue growth driven by AI app workloads. We now have 35,000 paid Fabric customers up 60% year-over-year. And all of the amount of data in Fabric One Lake data lake increased nearly 4x year-over-year. Over 15,000 customers now use both Foundry and Fabric up 60% year over year as enterprises connect agents to real-time operational, analytical, and unstructured data that Fabric brings together. And we're very excited about the continued progress with Foundry agent service and how customers can now build durable stateful agents that run across time boundaries, orchestrate tools and models, and close the loop with evals and improvement over long-running workflows. Beyond Fabric and Foundry, we're also helping knowledge workers build agents with tools like Copilot Studio. Nearly 90% of the Fortune 500 now have active agents built with our low-code, no-code tools, and we're seeing fast growth of our Copilot credit consumptive offer up nearly 2x quarter over quarter as customers increasingly extend Copilot with custom agents tailored to their workflows. finally with agent 365 we offer a control plane that extends companies existing governance identity security and management frameworks to agents tens of thousands of companies are already managing tens of millions of agents in agent 365 and we expect this momentum to grow significantly as agents will increasingly need tools for identity governance security and more Now, let me turn to the high-value agentic systems we ourselves are building on this platform. We are evolving our family of co-pilot from synchronous assistance to async co-workers that can execute long-running tasks across key domains. In knowledge work, it was another record quarter for Microsoft 365 co-pilot seat ads, which increased 250 percent year-over-year, representing our fastest growth since launch. Quarter over quarter, we continue to see acceleration and now have over 20 million Microsoft 365 Copilot paid seats. The number of customers with over 50,000 seats quadrupled year over year, and Accenture now has over 740,000 seats, our largest Copilot win to date. And Bayer, Johnson & Johnson, Mercedes, and Roche all committed to 90,000 or more seats. Co-pilot is uniquely valuable at work where nearly every task depends on organizational context. WorkIQ grounds co-pilot responses in the full context of an organization, including people, roles, documents, and communications, all within the company's security boundary. The system of work behind WorkIQ alone now spans more than 17 exabytes of data growing 35 percent year-over-year. The liquidity and freshness of that data matters. with billions of emails, documents, chats, hundreds of millions of Teams meetings, and millions of SharePoint sites added each day. And that context is getting even richer as co-pilot adoption grows, co-pilot and agent conversations and artifacts that create feedback into WorkIQ, making it even more context-rich. We continue to increase the pace of feature innovation across Microsoft 365 Copilot, introducing over 625 updates over the past year, up 50%. In Microsoft 365 Copilot, you now have access in chat to multiple models by default with intelligent auto routing. In agents with critique and counsel, you can use multiple models together to generate optimal responses. As of last week, agent mode is now default experience across Copilot in Word, Excel, and PowerPoint. And with co-work, you now have a new way to delegate and complete work using Copilot. All this innovation is driving record usage intensity across Copilot. We have seen a surge in usage of our first-party agents with monthly active usage up 6x year-to-date. Co-pilot queries per user were up nearly 20 percent quarter over quarter. To put this momentum in perspective, weekly engagement is now at the same level as Outlook, as more and more users make co-pilot a habit. When it comes to biz apps, we are seeing a new pattern emerge as customers shift from traditional seat model to seats plus consumption. The customer service category is at the forefront of this transformation as nearly 60% of our service customers are already purchasing usage-based credits. For example, HSBC uses pre-built agents with Dynamics 365 to manage customer inquiries across products, markets, regulatory requirements, reducing issue resolution time by over 30%. And our agentic products in LinkedIn talent solutions, which help hires automate time-consuming tasks like sourcing, screening, and drafting messages, have already surpassed a $450 million annualized revenue run rate. When it comes to developers, GitHub itself is seeing unprecedented growth driven by proliferation of agentic coding, and we are hard at work to scale and meet this demand. We see this even with GitHub Copilot. Nearly 140,000 organizations now use GitHub Copilot and enterprise subscribers have nearly tripled year over year. The majority of users leverage multiple models. We're also seeing rapid adoption of GitHub Copilot CLI with usage nearly doubling month over month. And earlier this week, we announced our move to usage-based pricing model for GitHub Copilot as we align pricing to actual usage and costs. When it comes to security, the physics of cybersecurity has changed as AI compresses the window between vulnerability and exploitation. To help mitigate risk immediately, we sim-ship defender protections when updates for AI-discovered vulnerabilities are released. And we are on course to productize new multi-moral AI-driven scanning harness as well. Already, the number of security co-pilot customers increased 2x year over year. Our data security triage agents alone handled over 2 million unique alerts this quarter, and we are helping customers secure their AI deployments as well. 35 billion co-pilot interactions have been audited by Purview to date, up 7x year over year. Finally, when it comes to our consumer business, we're doing the foundational work required to win back fans and strengthen engagement across Windows, Xbox, Bing, and Edge. In the near term, we are focused on fundamentals, prioritizing quality and serving our core users better. You see this in the work underway across our consumer products. With Windows, we recently announced performance improvements for lower memory devices, streamlined the Windows Update experience, and brought back focus to core features and fundamentals that matter most to our customers. You also see this in Xbox where the team is recommitting to our core fans and players and shaping the future of play. Last week's Game Pass changes are one example of how we are staying responsive to customer feedback. Monthly active Windows devices surpassed 1.6 billion, and over time, Windows value will extend to deliver unmetered intelligence at the edge. Our edge browser has taken share for 20 consecutive quarters, and Bing monthly active users reached one billion for the first time. LinkedIn has 1.3 billion members, and we are seeing increased depth of conversation and it's the leading B2B sales and advertising channel for large and small businesses. We set new records for monthly Xbox active users in the quarter, as well as game streaming hours. And in Microsoft 365 Consumer, we now have nearly 95 million subscribers, and early signals show increasing satisfaction as we make agent mode the default. Across everything I've talked about, we're also hard at work changing the way we work. Our North Star remains the same, delivering customer value with highest quality and top-class innovation, and this is what gives me confidence in our ability to shape the next phase of growth for our company and our customers. With that, let me turn it over to Amy to walk through our financial results and outlook.

Thank you, Satya, and good afternoon, everyone. We deliver results that exceeded expectations across revenue, operating income, and earnings per share, driven by strong demand and execution. As Satya 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. And 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%. Total company headcount declined year over year as we focus on building high-performing teams that operate with pace and agility. When adjusted for the impact from our investments in OpenAI, other income and expense was $961 million. Favorability was driven by gains on investments that were partially offset by losses on foreign currency remeasurement. 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. And 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 payments. 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. The remaining portion recognized beyond the next 12 months increased 138%. Microsoft Cloud revenue is $54.5 billion and grew 29% and 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 co-pilot seat ads this quarter with paid seats now over 20 million. ARPU growth was again led by both E5 and M365 co-pilot 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 at 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 co-pilot 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 XTAC 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 mixed 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 U.S. 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. And 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 opening AI, 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 that takes effect on June 1st of this year. Now to segment guidance. In productivity and business processes, we expect revenue of 37 to 37.3 billion US dollars 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 co-pilot momentum we saw in Q3, we expect net paid seat ads 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 end 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 U.S. dollars, 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-premise 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 US dollars. 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 and the 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 cost. 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 at stack 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 year 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 U.S. dollars, or growth of 13 to 15 percent, 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 U.S. dollars or growth of 22 to 23 percent, including roughly $350 million from the retirement program. an operating expense of 19.3 to 19.4 billion U.S. dollars, or 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 platforms. 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 in-app 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 at 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, Jonathan.

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. Operator, can you please repeat your instructions?

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. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. And our first question comes from the line of Keith Weiss with Morgan Stanley. Please proceed.

Excellent. Thank you guys for taking the question, and congratulations on another really solid quarter. Those Microsoft 365 Copilot numbers are super impressive, and I think way ahead of most people's expectations. I wanted to ask a broader question on demand. We've been talking about strong demand for a while. We see it in our CIO surveys, and you guys definitely express it in what you're seeing in your business. Maybe in the short term, Amy, you could talk to us about how that demand translates into commercial bookings and how that might be changing. You mentioned different contracting cycles between seats and consumption that may impact that. And then we also have to think about renewal basis. And then longer term, and maybe this opens it up to Satya. what is supporting this demand over time? Or said another way, who's paying for all of this? Because while we see excitement for Microsoft in our CIO survey, like our overall IT spending expectations aren't increasing and GDP growth isn't really increasing. So at some point, like how does this get paid for? And you start to see the indications of where those dollars are going to come from. Thank you.

You want to start?

Why don't I start with the first half of your question, Pete? 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. It's the expiration base or maybe large multi-year Azure commitments to get signed. And that stuff has always had some volatility to it. But I think if you take a step back, which is I think the broader question you're asking, and obviously I'll let Satya answer, 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 And when I think about that model, I start to think about it as a licensed business plus a consumption business. And really applying far more broadly than I think... People have thought about that. 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. It may not all flow through bookings in the same way. You'll just bill for usage. If that usage has great value to customers, and I'll 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 sort of 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.

Yeah, I think Amy captured it. I think the basic transformation of, say, any per-user business of ours, whether it's productivity, coding, security, will become a per-user and usage business. That's the best way to think about it. It's obviously already happening with coding. That's where you see it already perhaps at scale. Some of the business model changes even we made this quarter. speak to that. But it also speaks, I think, to this intensity of usage, right? Because where is these dollars going to come from? At the end of the day, it'll go to come from some eval and outcome that a business has where these agents that are working on behalf of users or with users has created value. And so that's sort of where it starts, whether it's customer service, whether it's individual productivity, team productivity, a business process. Some cost per is either decreasing because of the use of agents or some revenue is increasing because of agents, because it was able to compress these workflows. And that's what you broadly start seeing, right? Even when people talk about co-pilot, it's obviously they use chat, chat with reasoning, they use co-work, they use agent mode. inside a Word, Excel, PowerPoint, but it's all being done in the context of some task trajectory. And so when they start seeing that that task trajectory is compressing the workflow, improving revenue, decreasing costs, that is what's driving usage. So it may not be, by the way, pure seat coverage type of motions like in the past. This is more about getting intense users and intense usage, and that's what we're focused on.

And, Keith, maybe just to take a quick second, just a big thank you to you. It's been a real privilege to work with you over many, many quarters. And just to say we've really appreciated your coverage over this time, and congratulations. I think this is our last earnings quarter.

Thank you so much, Keith, and it's just been fantastic with you. Thanks, Keith. Thank you so much.

Thank you. Operator, next question, please.

The next question comes from the line of Carl Kirsten with UBS. Please proceed.

Okay, great. Thank you. Maybe, Amy, could you elaborate a little bit on the CapEx guidance you just provided? Obviously, it requires a fairly material pickup in CapEx in the second half of the calendar year, maybe to the tune of $120 billion. I'm just curious, your confidence in working through the physical component constraints to hit that number? Does it involve the greater use of partners? And how are you thinking about allocating that increased capacity between third party and first party? Do you have a general framework you'd advise us to keep in mind? Thank you.

Sure. Thanks. Thanks, Carl. 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 and 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, you know, start to support even better the demand signals we've been seeing. Trying to get some help on part of that being price. I think that just helps give you a sense on volumes. And obviously, it leads 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, you know, we talked a little bit about what you were seeing in Azure, you know, looking for 39 to 40 in constant currency, and 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 co-pilot 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 FY20, 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 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.

Okay. Terrific. Thank you.

Thanks, Carl. Operator, next question, please.

The next question comes from the line of Brent Thill with Jefferies. Please proceed.

Thanks, Amy. One of the big pushbacks we all get is that AI is going to be really expensive and Yet you, Google, and Amazon are showing higher margins tonight as you report. What are investors missing, and why is AI a potential better margin for the industry over time?

Thanks, Brent. 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. 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 at 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, you know, when you go through that, you also then start to focus on the efficiency work. 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 that, and this really dates back to the question that Keith asked in the beginning, which is 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, Brent. All right, the next question, please.

The next question comes from the line of Mark Mordler with Bernstein Research. Please proceed.

Thank you very much for taking my question, and congratulations on the quarter you delivered and the rate of growth and some of the commentary you've made on guidance, et cetera. I'd like to drill in a little bit. is on this whole question of the CapEx and the spending that you're making. Obviously, the commercial cloud is growing fast. Azure is growing fast. AI is growing even faster within your overall business. But there's a bit of a disconnect that makes investors a bit nervous between how fast they're seeing CapEx growing and how fast they're seeing revenue growing. So can you give some color about how the timing works out or how much needs to be spent on replacement of equipment or first party in order to build that confidence that as we look toward this strong spending on CapEx, that the core business will continue to be very, very healthy? and that the margins will be good. Thank you.

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 guy to 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-ish 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 on certainly and 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, are we 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, 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, in, in GitHub, right, where you see revenue growth rates and usage consumption models result in acceleration in the top line. And then, you know, in general, I think you'll continue to see that, right? And so when you think about, you know, spending that amount of capital, putting it into production, seeing some delay before it turns into revenue ready, having the book of business, you know, 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 co-pilot. 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.

I mean, let me just add one point here, which is I think at some level, one of the things that we have learned even in the last, whatever, two years or so in AI and also built more conviction and confidence on is, Where is the TAM and the category economics of the TAM? And so this, I mean, it's fascinating that here we are in 2026 and the most exciting things are plugins in Word or Excel or CLIs in coding. And so when you see that, that means we have a structural position in knowledge work, coding, security, which are the big TAMs. And then you couple that with the right business model, which is what Amy was referencing multiple times, which is user plus usage. And then you take even the book of business we have. That sort of is the through line of And if anything, we want to make sure we are getting the capex to get the capacity in time for those increases in usage, which I think is going to be very, very key. And you've got to remember the model capabilities are exponential. So, you know, if you think about even agent mode in Excel, it sort of kind of didn't work until it started working. And that's just because the model showed up. And so you have to be ready for those opportunities.

That's extremely helpful. I really do appreciate it. And again, congratulate on the quarter.

Thanks, Mark. Operator, next question, please.

The next question comes from the line of Gabriella Borgs with Goldman Sachs. Please proceed.

Hi, good afternoon. Thank you. Sasha, I would love to hear some of your reflections on Copilot, given the technical and commercial milestones that Microsoft has hit just in the last three months. So maybe share with us a little on your learnings from co-pilot adoption today. What do you think is working? What's not working? How is that now informing your E7 strategy and the co-pilot, co-work strategy? Thanks so much.

Thank you for the question. So I think the way to perhaps think about even co-pilot is, the Microsoft 365 Copilot and knowledge work, in some sense, this pattern, we've learned a lot, as I said, even from coding. But if you sort of focus it on M365 Copilot, the first thing is to think about even the form factor and the shape of the product and how it's evolved, right? So there's chat, chat now with reasoning over work IQ. So that's sort of one form factor. Then there is all the agents like researcher and analyst that you use within chat, or even custom agents that our customers are building. And then on top of that, you now have this edit mode, right? So if you think about a typical trajectory or a session in Copilot, it starts with chat, you ask some questions, you get some insights, you ask it to even generate an artifact, you open that artifact in Word, Excel, PowerPoint, you further refine it. So in other words, you continue the conversation. And then, of course, we now have even a complete new form factor where you essentially delegate the task, right? So you're not even interactively working, but you're delegating the task with co-work. So these are all the various form factors. And one of the most interesting things to keep in mind is the usage of this. Is it the same level as Outlook? So this is not even to the previous question. Are people using it, finding it useful? I mean, this is like a daily habit of intense usage, right? The other thing that is important when you think about what makes these form factors useful is intelligence, and the intelligence is a function of two things. It's an intelligence of having multiple models coupled to context. That's the meetings, the documents, the emails, the teams, all of that SharePoint data, all of that rich data. by the way, constantly updated, right? So this is not some static database. It's the most important database in any company that is constantly changing every second. So that's the context, the models brought together with a harness that's multi-model. This is essentially the same thing we do in GitHub, whether we do it in M365, we do this in security, which is our goal is to decouple the harness from the model's and then have the context richness show through because customers are going to use multiple models. In fact, if you look at Critique or Council, that's a great example, or Rubber Duck and GitHub Copilot. These are good examples of why you want to, or even in Excel, you know, I generate using Opus and I check with Codex. That's the type of things that you want users to have access to. And so that's really the, and then coupled that with the business model of user usage plus user pricing, I feel like that's what's happening and we're seeing that all play out.

Thank you very much. Thanks, Gabriela. Operator, next question, please.

The next question comes from the line of Kirk Matern with Evercore ISI. Please proceed.

Yes, thanks very much, and thanks for taking the question. Amy, I was wondering, could you just talk a little bit about the change in the OpenAI agreement? If there's anything we should be aware of from a modeling perspective or from a financial perspective that would change today versus where we were maybe a couple weeks ago? And then, I guess, Satya, for you, it seems like an opportunity for you guys to continue to diversify from a model perspective. Any other takeaways we should be thinking in terms of where you guys landed with OpenAI and this new framework? Thanks.

Yeah, maybe I'll start. Overall, we feel good about our partnership with OpenAI. I'm always very, very focused on any partnership and ensuring that there's a win-win construct at all times. I mean, that's how you can remain good partners. In this case, it starts with, quite frankly, IP. Amy referenced this. We have a frontier model. royalty-free with all the IP rights that we will have access to all the way to 32, and we fully plan to exploit it. And there are examples I talked about in even my remarks earlier, and we're thankful for that, and that's sort of one part of the agreement. The second part, of course, is them as a customer of ours. They're a large customer of ours, not just on the AI accelerator side, but also on all the other compute side. And so we want to serve them well. And then, of course, we have our equity. And so overall, I think the construct, as they have grown and we have grown, and our customers also have different expectations in terms of their model diversity. So, therefore, we have all evolved the partnership, but I feel very good about where we are.

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, that Safiya pointed out, the IP, thinking about that as royalty-free with the elimination of our rep share to them.

Thank you all. Thanks, Kirk. Operator, we have time for one last question.

And the last question will come from the line of Rishi Jaluria with RBC Capital Markets. Please proceed.

Oh, wonderful. Hi, Seta. Hey, Amy. Thanks so much for squeezing me in. I wanted to go back to the discussion we've been having today on seat-based models and consumption and maybe kind of the philosophy for how this changes over time. Look in complete agreement with what you're seeing out there and totally makes sense. Maybe I want to drill into, you know, you announced E7, which will come out. That is predominantly seat-based with some consumption components. So you're doubling down on that seat element. And it seems increasingly customers still want the predictability of seek-based models, as we've seen with all the kind of usage issues that companies have run into as AI has kind of gone out of control. Can you maybe understand how to bring all these pieces together, you know, how to maintain predictability within the customer base while increasingly growing consumption? And maybe, you know, if we were to fast forward three, five years in the future, how should we be thinking about what that mix of consumption versus traditional seed-based looks like? Thanks so much.

Yeah, I mean, at a high level, and maybe we should add to it, but I think you said it, which is customers want predictability, especially for budgets and procurement. And the seed-based pricing is just entitlements to some consumption right. And so that's, I think, the way to think about it, which is there is some base usage rights that get bundled in or packaged into seats. It's a convenient way for people to buy some essentially consumption packs that happen to be assigned to seats or agents. And then beyond a certain level, there's overages that go into pure consumption. And even there, if you have commitments, long-term commitments to consumption, you get discounting that is appropriate with it. So I feel like that's the direction of travel. And then the other thing you mentioned is How is this going to change? From a customer perspective, they're going to evaluate it by evals. Where are they seeing the value of tokens? As simple as that. So where they see the outcome, the eval and the token, whether it's improving revenue, improving efficiency, and that's what will refine. Like when we talk about IT budgets, IT budgets are going to have to be reshaped by a combination of business outcomes, making their way into IT budgets and maybe reallocation from other line items on the income statement like OPEX.

Thanks, Rishi. That wraps up the Q&A portion of today's earnings call. Thank you for joining us today, and we look forward to speaking with all of you soon.

Thank you. Thank you.

This concludes today's conference. You may disconnect your lines at this time and enjoy the rest of your day.