Microsoft's cloud contracts outgrow its revenue as equipment spending doubles

Microsoft (Nasdaq: MSFT) reported revenue of $92.3 billion for the quarter ended September 30, an increase of 19%, and said its commercial remaining performance obligation rose 73% to $677 billion, according to its results release dated October 28.

What happened

Operating income was $45.9 billion, up 21%, and net income was $36.6 billion, up 32% on a GAAP basis, the company said. Diluted earnings per share were $4.92 on a GAAP basis.

Remaining performance obligation is the value of contracts that customers have signed but that the company has not yet recognized as revenue. Microsoft said the commercial figure grew 73% to $677 billion, nearly four times the 19% growth in total revenue (the two measures cover different things, so the comparison shows only that contracted value grew faster than recognized revenue).

Microsoft Cloud revenue was $63.9 billion, up 30% (31% in constant currency). Chief Financial Officer Amy Hood said in the release that the company had "a strong start to the fiscal year with Microsoft Cloud revenue of $63.9 billion". Azure revenue increased 48%; the release's revenue table shows $33,165 million for the quarter against $22,384 million a year earlier.

Microsoft changed its segment names for its 2027 fiscal year. The segment that holds its cloud business, Agents and Infra, had revenue of $76.8 billion, up 25%. Devices and Consumer had revenue of $15.5 billion, down 3%, with Windows OEM and Devices revenue down 22% and search and advertising revenue excluding traffic acquisition costs up 12%.

Why it matters

The cash flow statement in the release shows additions to property and equipment of $39,367 million in the quarter, against $19,394 million in the same quarter a year earlier. That is an increase of 103.0% (computed), or about twice the prior-year amount.

Net cash from operations was $58,000 million, against $45,057 million, an increase of 28.7% (computed). Subtracting additions to property and equipment from net cash from operations leaves $18,633 million for the quarter against $25,663 million a year earlier (computed; this is not a measure the company reports in the release).

The gap between GAAP and non-GAAP profit growth comes from Microsoft's investments in OpenAI. The release's reconciliation shows the effect of those investments added $207 million to GAAP net income in the quarter, compared with a $3,086 million reduction a year earlier. Excluding that effect, net income was $36,422 million, up 18% from $30,833 million.

The commercial backlog and the spending are separate figures, and the release does not link one to the other. Microsoft's release does not give a capital expenditure total that matches the cash flow line, which counts additions to property and equipment.

What to watch

The release said Microsoft would provide forward-looking guidance in connection with its earnings announcement, and the details were on the company's earnings call and webcast, which are listed on the same investor relations page. The next quarterly results will cover the three months ending December 31.

If additions to property and equipment stay near the level of the September quarter, the line would continue to absorb a large share of operating cash flow, as it did in the quarter reported here. Cash flow and spending can change from quarter to quarter.