Amy Hood
Executive Vice President and Chief Financial Officer at Microsoft
Thank you, Satya, and good afternoon, everyone. This quarter, revenue was $65.6 billion, up 16%, and earnings per share was $3.30, an increase of 10%. With strong execution by our sales teams and partners, we delivered a solid start to our fiscal year with double-digit top and bottom line growth. We also saw continued share gains across many of our businesses. In our commercial business, increased demand and growth in long-term commitments to our Microsoft Cloud platform drove our results.
Commercial bookings were ahead of expectations and increased 30% and 23% in constant currency. Results were driven by strong execution across our core annuity sales motions and growth in the number of $10 million-plus contracts for both Azure and Microsoft 365. Additionally, we also saw an increase in the number of $100 million-plus contracts for Azure. Commercial remaining performance obligation increased 22% and 21% in constant currency to $259 billion. Roughly 40% will be recognized in revenue the next 12 months, up 17% year-over-year. The remaining portion, recognized beyond the next 12 months, increased 27%. And this quarter, our annuity mix increased to 98%.
In addition to commercial results that were in line with expectations, we also saw some benefit from in-period revenue recognition across Microsoft 365 commercial, Azure, and our on-premises server business. At a company level, Activision contributed a net impact of approximately three points to revenue growth, with a two-point drag on operating income growth and had a negative $0.05 impact to earnings per share.
A reminder that this net impact includes adjusting for the movement of Activision content from our prior relationship as a third-party partner to first-party and includes $911 million from purchase accounting adjustments, integration, and transaction-related costs. FX did not have a significant impact on our results and was roughly in line with expectations on total company revenue, revenue, segment-level COGS, and operating expense growth.
Microsoft Cloud revenue was $38.9 billion and grew 22%, roughly in line with expectations. Microsoft Cloud gross margin percentage decreased two points year-over-year to 71%. This was slightly better than expected due to improvement in Azure. Although, the gross margin percentage decrease year-over-year continues to be driven by scaling our AI infrastructure.
Company gross margin dollars increased 13% and 14% in constant currency, and gross margin percentage was 69%, down two points year-over-year, driven by the lower Microsoft Cloud gross margin noted earlier as well as the impact from purchase accounting adjustments, integration and transaction-related costs from the Activision acquisition.
Operating expenses increased 12%, lower than expected due to our focus on cost efficiencies and ongoing prioritization work. Operating expense growth included nine points from the Activision acquisition. At a total company level, headcount at the end of September was 8% higher than a year ago. Excluding the growth of the Activision acquisition, headcount was 2% higher. Operating income increased 14% and operating margins were 47%, down one point year-over-year.
Excluding the net impact from the Activision acquisition, operating margins were up one point as we continue to drive efficiencies across our businesses as we invest in AI infrastructure and capabilities. Now to our segment results. Revenue from Productivity and Business Processes was $28.3 billion and grew 12% and 13% in constant currency, ahead of expectations, driven by better-than-expected results across all businesses. M365 commercial cloud revenue increased 15% and 16% in constant currency with business trends that were as expected.
The better-than-expected result was due to a small benefit from the in-period revenue recognition noted earlier. ARPU growth was primarily driven by E5 as well as M365 Copilot. Paid M365 commercial seats grew 8% year-over-year with installed base expansion across all customer segments. Seat growth was driven by our small and medium business frontline worker offerings. M365 commercial cloud revenue represents nearly 90% of total M365 commercial products and cloud services.
M365 commercial products revenue increased 2% and 3% in constant currency, ahead of expectations, primarily due to the benefit from in-period revenue recognition noted earlier. M365 consumer products and cloud services revenue increased 5% and 6% in constant currency. M365 consumer cloud revenue increased 6% and 7% in constant currency, with continued momentum in M365 consumer subscriptions, which grew 10% to $84.4 million. M365 consumer cloud revenue represents 85% of total M365 consumer products and cloud services.
LinkedIn revenue increased 10% and 9% in constant currency, slightly ahead of expectations with growth across all lines of business. Dynamics revenue grew 14%, driven by Dynamics 365, which grew 18% and 19% in constant currency with continued growth across all workloads and continued share gains. As a reminder, Dynamics 365 represents about 90% of total Dynamics revenue.
Segment gross margin dollars increased 11% and 12% in constant currency, and gross margin percentage decreased slightly year-over-year, driven by scaling our AI infrastructure. Operating expenses increased 2% and operating income increased 16%. Next, the Intelligent Cloud segment. Revenue was $24.1 billion, increasing 20% and 21% in constant currency, in line with expectations. Azure and other cloud services revenue grew 33% and 34% in constant currency, with healthy consumption trends that were in line with expectations.
The better than expected result was due to the small benefit from in-period revenue recognition noted earlier. Azure growth included roughly 12 points from AI services, similar to last quarter. Demand continues to be higher than our available capacity. Non-AI growth trends were also in line with expectations in total and across regions as customers continued to migrate and modernize on the Azure platform. The non-AI point contribution to Azure growth was sequentially lower by approximately one point.
In our on-premises server business, revenue decreased 1%. Lower than expected transactional purchasing ahead of the Windows Server 2025 launch as well as lower purchasing of licenses running a multi-cloud environment was mostly offset by the benefit from in-period revenue recognition noted earlier.
Enterprise and partner services revenue decreased 1% and was relatively unchanged in constant currency. Segment gross margin gross margin dollars increased 15%, and percentage decreased three points year-over-year, driven by scaling our AI infrastructure. Operating expenses increased 8% and operating income grew 18%. Now to More Personal Computing. Revenue of $13.2 billion increasing 17%, with 15 points of net impact from the Activision acquisition. Results were above expectations, driven by gaming and search.
Windows OEM and devices revenue increased 2% year-over-year as better than expected results in Windows OEM due to mix shift to higher monetizing markets was partially offset by the lower than expected results in devices due to execution challenges in the commercial segment. Search and news advertising revenue ex TAC increased 18% and 19% in constant currency, ahead of expectations, primarily due to continued execution improvement. We saw rate expansion in addition to healthy volume growth in both Edge and Bing.
And in gaming, revenue increased 43% and 44% in constant currency with 43 points of net impact from the Activision acquisition. Results were ahead of expectations, driven by stronger than expected performance in both first and third-party content as well as consoles. Xbox content services revenue increased 61% with 53 points of net impact from the Activision acquisition. Segment gross margin dollars increased 16% and 17% in constant currency with 12 points of net impact from the Activision acquisition.
Gross margin percentage was relatively unchanged year-over-year. Our strong execution on margin improvement in gaming and search offset by sales mix shift to those businesses. Operating expenses increased 49% with 51 points from the Activision acquisition. Operating income decreased 4%. Now, back to total company results. Capital expenditures, including finance leases, were $20 billion, in line with expectations, and cash paid for PP&E was $14.9 billion.
Roughly half of our cloud and AI-related spend continues to be for long-lived assets that will support monetization over the next 15 years and beyond. The remaining cloud and AI spend is primarily for servers, both CPUs and GPUs, to serve customers based on demand signals. Cash flow from operations was $34.2 billion, up 12%, driven by strong cloud billings and collections, partially offset by higher supplier employee and tax payments. Free cash flow was $19.3 billion, down 7% year-over-year, reflecting higher capital expenditures to support our cloud and AI offerings.
This quarter, other income expense was negative $283 million, significantly more favorable than anticipated due to foreign currency remeasurement and net gains on investments. Our losses on investments accounted for under the equity method were as expected. Our effective tax rate was approximately 19%. And finally, we returned $9 billion to shareholders through dividends and share repurchases.
Now, moving to our Q2 outlook, which unless specifically noted otherwise, is on a U.S. dollar basis. First, FX. With the weaker U.S. dollar and assuming current rates remain stable, we expect FX to increase total revenue and segment level revenue growth by less than one point. We expect FX to have no meaningful impact to COGS or operating expense growth.
Our outlook has many of the trends we saw in Q1 continue through Q2. Customer demand for our differentiated solutions should drive another quarter of strong growth. In commercial bookings, we expect strong growth on a growing expiry bas,e driven by increased long-term commitments to our platform and strong execution across core annuity sales motions. As a reminder, larger long-term Azure contracts, which are more unpredictable in their timing, can drive increased quarterly volatility in our bookings growth rate.
Microsoft Cloud gross margin percentage should be roughly 70%, down year-over-year, driven by the impact of scaling our AI infrastructure. We expect capital expenditures to increase on a sequential basis, given our cloud and AI demand signals. As I said last quarter, we will stay aligned and, if needed, adjust to the demand signals we see. As a reminder, there can be quarterly spend variability from cloud infrastructure build-outs and the timing of delivery of finance leases.
Next, segment guidance, starting with Productivity and Business Processes. We are the market leader when it comes to knowledge-based Copilots and agents in the enterprise space, and we are focused on continuing to gain share across our productivity solutions. Therefore, we expect revenue in Productivity and Business Processes to grow between 10% and 11% in constant currency or $28.7 billion to $29 billion. M365 commercial cloud revenue growth should be approximately 14% in constant currency with moderating seat growth across customer segments and ARPU growth through E5 and M365 Copilot.
For H2, we expect revenue growth to remain relatively stable compared to Q2. We continue to see growth in M365 Copilot seats, and we expect the related revenue to continue to grow gradually over time. For M365 commercial products, we expect revenue to decline in the low single-digits. As a reminder, M365 commercial products include on-premises components of M365 suites. So our quarterly revenue growth can have variability primarily from in-period revenue recognition depending on the mix of contracts.
M365 Consumer Cloud revenue growth should be in the mid-single digits driven by M365 subscriptions. For LinkedIn, we expect revenue growth of approximately 10%, driven by continued growth across all businesses. And in Dynamics 365, we expect revenue growth to be in the mid- to high teens, driven by continued growth across all workloads.
Next, Intelligent Cloud. Helping our customers transform and grow with innovative cloud and AI solutions is driving continued growth in Azure. Therefore, we expect revenue in Intelligent Cloud to grow between 18% and 20% in constant currency or USD25.55 billion to USD25.85 billion. Revenue will continue to be driven by Azure, which, as a reminder, can have quarterly variability primarily from in-period revenue recognition depending on the mix of contracts.
In Azure, we expect Q2 revenue growth to be 31% to 32% in constant currency, driven by strong demand for our portfolio of services. We expect consumption growth to be stable compared to Q1, and we expect to add more sequential dollars to Azure than any other quarter in history. We expect the contribution from AI services to be similar to last quarter given the continued capacity constraints. as well as some capacity that shifted out of Q2. And in H2, we still expect Azure growth to accelerate from H1 as our capital investments create an increase in available AI capacity to serve more of the growing demand.
And in our on-premises server business, we expect revenue to decline in the low to mid-single-digits on a prior year comparable that benefited from purchasing ahead of Windows Server 2012 and support. And in Enterprise and Partner Services, we expect revenue growth to be in the low single digits.
Now to more Personal Computing. We continue to make decisions to prioritize strategic higher-margin opportunities within each of our consumer businesses. Our outlook reflects the improvement in gross and operating margins from this prioritization work across gaming, search and devices. We expect revenue in more Personal Computing to be USD13.85 billion to USD14.25 billion.
Windows OEM and devices revenue should decline in the low to mid-single digits. We expect Windows OEM revenue growth in line with the PC market to be more than offset by a decline in devices as the trends from Q1 continue. Search and news advertising ex TAC revenue growth should be in the high teens with continued growth in both volume and revenue per search. This will be higher than overall search and news advertising revenue growth, which we expect to be in the high single-digits.
And in gaming, we expect revenue to decline in the high single digits due to hardware. We expect Xbox content and services revenue growth to be relatively flat. We're excited about last week's launch of Call of Duty, where we saw the most Game Pass subscriber adds we've ever seen on the launch day. There are two things about the launch that are different than the Call of Duty launch a year ago, where revenue was mostly recognized in the quarter of purchase.
First, the game is available on Game Pass. So for players who play through Game Pass, the subscription revenue is recognized over time. Second, the game requires an online connection to play. So even for players who purchase the stand-alone game, revenue recognition will also occur ratably over time. Now back to company guidance. We expect COGS to grow between 11% and 13% in constant currency or to be between 21.9 billion to $22.1 billion and operating expense to grow approximately 7% in constant currency or to be between $16.4 billion and $16.5 billion.
This should result in another quarter of operating margin expansion. Other income and expense is expected to be roughly negative $1.5 billion, primarily driven by our share of the expected loss from OpenAI, which is accounted for under the equity method. As a reminder, we do not recognize mark-to-market gains or losses on equity method investments.
As you heard from Satya, our strategic partnership and investment in OpenAI has been pivotal in building and scaling our AI business and positioning us as the leader in the AI platform wave. And lastly, we expect our Q2 effective tax rate to be approximately 19%. In closing, we remain focused on strategically investing in the long-term opportunities that we believe drive shareholder value. Monetization from these investments continues to grow, and we're excited that only 2.5 years in, our AI business is on track to surpass $10 billion of annual revenue run rate in Q2. This will be the fastest business in our history to reach this milestone. We are committed to growing this leadership position across our entire Microsoft Cloud, while maintaining our disciplined focus on cost management and prioritization across every team.
With that, let's go to Q&A, Brett.
