What We Learned About the AI Threat From Q1 Software Earnings

It’s been a tough nine months for software stocks. Some say they face an existential crisis, as market participants worry about artificial intelligence upending long-held, profitable business models. Morningstar analysts say there are emerging winners and losers, but for now, first-quarter earnings results appear to have alleviated concerns about immediate threats, even as outlook risks remain.

Early in the AI stock boom, software companies rose along with much of the rally. But late last year, with the capabilities of the technology exploding, investors began to worry that it would undercut many of the competitive advantages held by legacy software companies. Amid fears of the “SaaSpocalypse,” software stocks from Salesforce to Thomson Reuters suffered big declines.

But the first quarter of 2026 provided a measure of relief. Throughout Morningstar analysts’ coverage, many companies reported small but growing revenue from AI products. Software companies, including cybersecurity company Palo Alto Networks PANW, say they are continuing to invest heavily in building AI capabilities, but a potential hurdle is that costs are rising. Meanwhile, clients are also focusing on AI-integrated products. At the same time, there are signs that, amid the unknowns of what AI will mean for software platforms in the future, some clients are seeking shorter contracts.

We asked three Morningstar analysts who cover software stocks about first-quarter earnings. Among the questions:

• What was the overall takeaway on the AI impact among your companies?
• What companies stood out as good or bad results around AI?
• What are companies saying about AI revenues and costs?
• What are they hearing from clients?

According to senior equity analyst Dan Romanoff, the broad takeaway is that “contrary to popular belief, software is still not dead.”

In addition to Romanoff—who covers Microsoft MSFT, Salesforce CRM, ServiceNow NOW, and others—we checked in with senior equity analyst Malik Ahmed Khan—whose coverage includes Alphabet GOOG, Zscaler ZS, and Palo Alto Networks PANW—and analyst Luke Yang—who covers IT services and software companies, such as IBM IBM, Oracle ORCL, and Snowflake SNOW. Here’s what the trio had to say.

Malik Ahmed Khan

What was the overall takeaway among your companies?

Cyber spending is strong. We are seeing a divergence between AI beneficiaries and AI losers. Small firms are getting squeezed while larger ones benefit from vendor consolidation. AI is driving consolidation.

Any particular standout stories, good or bad?

Agentic is driving security demand in both endpoint, network (firewalls), cloud (increased workloads), and identity (agentic identity). Okta OKTA was a clear beneficiary of this trend (identity), as was Fortinet FTNT.

What are companies saying about AI revenues? Are they materializing? Are they additive or simply reflecting a shift in the mix?

AI revs are scaling. We have some disclosures, such as Zscaler calling out north of $100 million in security AI annual recurring revenue. ARR for Palo Alto’s XSIAM (its AI-driven security operations platform) is at $600 million, growing more than 100% year over year. We are also seeing strong adoption of AI Runtime security, which will hit more than $100 million in ARR in the next couple of quarters.

We are also seeing bookings increase for hardware and software firewalls, driven by AI data center demand. Firewall bookings were up 19%, accelerating from 11% last quarter.

What are companies saying about AI costs, such as higher compute fees and rising hardware/memory costs?

There’s some pressure on companies like Cloudflare NET and Zscaler as they ramp up infrastructure spending and flow it through their income statements via depreciation. Other than that, we are seeing margin expansions slow as firms spend more on AI. Over time, we expect margin expansion to get turbocharged as firms basically replace labor with tokens.

What are they hearing from clients? Are they looking to shorten contract terms, building on AI-related exit ramps? What about client budgets, where they may be ramping up their IT spending on AI vs SaaS products?

Clients are moving ahead with AI spending. The token budgets being stressed are real. Unlike with prior technologies, this tech is expensive on arrival, so budgeting is tough, as you have to cut elsewhere to find these dollars.

Software firms are also being told by the market that they’re all dead. So to prove otherwise, they have to spend big on AI, which boosts AI lab revenues and improves adoption of AI tools by other software vendors.

Dan Romanoff

What was your overall takeaway?

Contrary to popular belief, software is still not dead. Enterprise software spending seems steady. Of my 16 companies that have reported so far, 14 have beaten their top/bottom lines for the quarter, one was in line, and one missed—and it only guides to annuals and is not widely covered. Guidance is either in line with expectations or raised for the year based on upside.

Margins continue to increase as a result of internal efficiencies brought about by AI. Most companies are aggressively buying back stock. Salesforce bought back $27 billion worth of stock—roughly 103 million shares in the quarter.

Any particular standout stories?

For my communications companies, Five9 FIVN and Twilio TWLO ripped on earnings. This quarter, RingCentral RNG was down 5%, but they had their pop in February. For several quarters, this group has been the worst-performing software category, per our quarterly pulse, but I suspect it will be the best-performing one next quarter.

Atlassian TEAM produced a massive quarter. They have a product (the data center version) that is sunsetting, and customers are buying ahead of its end of life. The SaaS version was strong in the quarter; bundling helped. Customers who are using Atlassian’s AI features are accelerating seats. The firm also announced a restructuring, which is welcome, since its margins are a little substandard vs. its large(ish) peers.

What are companies saying about AI revenues?

AI revenues are growing materially. For anybody who discloses it (ServiceNow, Adobe, ADBE, and Salesforce all do), growth is easily over 100% year over year. They are hovering at around 5% of revenue at this point and growing rapidly. Salesforce’s Agentforce AI ARR, for example, was $1.2 billion this quarter, up 205% year over year.

What are companies saying about AI costs?

Nothing yet, but gross margins are trending up for software companies, so, thus far, they are serving up AI in a profitable way. Microsoft is an exception because of Azure, where depreciation is pressuring gross margins a little, which is being offset by operating efficiency gains, so operating margin is stable or even trending up a little.

What are they hearing from clients? I’ve seen reports of companies saying clients are looking to shorten contract terms, building on AI-related exit ramps. What about client budgets (ramping up their IT spending on AI vs SaaS products, for example?

Big deals are healthy for everybody. Duration has generally been stable or up slightly. Management teams say that the IT budget for software is relatively fixed in the near term, but the added AI spending is coming from headcount costs (as in AI makes employees more efficient, so lower headcount additions free up some budget).

Luke Yang

What was your overall takeaway?

Demand for AI cloud infrastructure is extraordinarily strong. I don’t cover Nebius NBIS, but their CEO said during the earnings call that four or more customers are competing for each GPU. The dynamics are similar at CoreWeave and IREN.

Enterprise software is also seeing strong momentum, especially on the infrastructure layer. Workday’s AI revenue crossed $500 million. Snowflake also saw huge revenue growth acceleration. I believe there are several other infrastructure software names posting positive results, like Datadog and Ahmed’s cyber names.

Any particular standouts?

A good standout: Snowflake shares surged 36% after they delivered quarterly revenue growth of 34%, 700 bps higher than guidance. We see very strong AI attachment across the board. The post-earnings rally is pricing in Snowflake’s status as a key AI data infrastructure.

A bad standout: Intuit INTU shares sold off 20% after earnings. TurboTax revenue missed guidance, and management attributed it to the reduction in the overall number of tax filers this tax season. I think the market reaction also highlights that investors are still concerned about AI’s threat to TurboTax as frontier AI labs start to provide tax filing services.

What are companies saying about AI revenues?

AI revenue is scaling fast, but the base is also small. For enterprise software companies like Workday WDAY, I’d think it’s more of a shift in the mix, since overall revenue growth is in line, but for AI infrastructure like neoclouds/Snowflake, AI revenue is additive.

What are companies saying about AI costs?

I’ve only heard very brief mentions about AI costs, and I think most software companies are confident to absorb the margin dilution through operating leverage/efficiency improvement. Overall, I wouldn’t say that’s a major concern for the companies I follow.

What are they hearing from clients?

I don’t think the enterprise spending environment has changed materially. IT services companies’ results were generally in line. Client spending is still impacted by macro/geopolitical uncertainty. Many CIOs are also in wait-and-see mode to make sure the AI tech stacks they are building align with their companies’ long-term growth.