Microsoft Q2 Earnings Beat Estimates as Cloud and AI Drive Results

Microsoft MSFT reported second-quarter fiscal 2026 earnings of $4.14 per share on a non-GAAP basis (excluding OpenAI investment impacts), which beat the Zacks Consensus Estimate by 6.7% and increased 24% on a year-over-year basis and 21% in constant currency (cc).

Revenues of $81.3 billion increased 17% year over year and beat the Zacks Consensus Estimate by 1.3%. At cc, revenues grew 15% year over year, showcasing strong demand for cloud and AI offerings. 

Commercial bookings surged 230% (228% in cc), significantly exceeding projections. This exceptional growth reflected substantial Azure commitments alongside continued expansion in large contracts exceeding $100 million for both Azure and Microsoft 365. The commercial remaining performance obligation reached $625 billion, marking 110% year-over-year growth, with the balance nearly tripling over a two-year period.

Microsoft Cloud revenues totaled $51.5 billion, crossing the $50 billion quarterly threshold for the first time and growing 26% year over year (24% in cc). The Microsoft Cloud gross margin percentage was 67%, declining slightly from the prior year due to ongoing AI infrastructure investments, partially offset by efficiency improvements.

Following the earnings announcement, Microsoft shares lost 7% in extended trading despite beating revenue and earnings estimates. Investor concern centered on guidance indicating continued high capital expenditure requirements and the company's acknowledgment of remaining capacity-constrained through at least the fiscal year-end.

Microsoft Corporation Price, Consensus and EPS Surprise

Microsoft Corporation price-consensus-eps-surprise-chart | Microsoft Corporation Quote

Segment Performance

The Productivity & Business Processes segment generated $34.1 billion in revenues, representing 42% of total revenues. The segment grew 16% year over year (14% in cc), driven by strong performance in Microsoft 365 commercial products and cloud services alongside Microsoft 365 consumer offerings.

Microsoft 365 commercial cloud revenues increased 17% (14% in cc). Growth stemmed from both average revenue per user expansion and seat additions, with ARPU increases again led by E5 subscriptions and Microsoft 365 Copilot adoption.

Microsoft 365 commercial paid seats grew 6% year over year, with installed base expansion occurring across all customer segments, though concentrated primarily in small and medium business offerings and frontline worker categories.

Microsoft 365 consumer cloud revenues jumped 29% (27% in cc), propelled by ARPU growth. Microsoft 365 consumer subscriptions expanded to more than 90 million users.

LinkedIn revenues advanced 11% (10% in cc), with Marketing Solutions driving growth. The Talent Solutions business faced ongoing headwinds from persistent weakness in hiring markets.

Dynamics 365 revenues rose 19% (17% in cc), demonstrating continued expansion across all workloads within the business applications portfolio.

Segment gross margin dollars totaled $28.0 billion, up 17.3% year over year. Gross margin percentage reached 82.1%, improving from the prior-year period. These gains were driven by efficiency improvements in Microsoft 365 Commercial cloud that partially offset AI investments, including impacts from growing Microsoft 365 Copilot usage. Operating expenses totaled $7.4 billion, rising 6.1% year over year. Operating income reached $20.6 billion, expanding substantially. Operating margin improved to 60.4%, up from the prior-year period.

The Intelligent Cloud segment contributed $32.9 billion in revenues, accounting for 40.5% of total revenues. The segment reported 29% growth year over year (28% in cc), powered by Azure and on-premises server business performance.

Azure and other cloud services revenues surged 39% (38% in cc), significantly exceeding expectations. This acceleration resulted from continued strong growth in the core infrastructure business, primarily from the company's largest enterprise customers. Azure AI services revenues performed generally in line with internal projections.

The on-premises server business generated modest revenue growth of 1% (relatively unchanged in cc), performing ahead of expectations primarily due to transactional purchasing activity around Windows Server 2025 releases.

Segment gross margin dollars totaled $19.3 billion, up 19.8% year over year. Gross margin percentage reached 58.8%, declining from the prior-year period due to AI infrastructure investments that were partially offset by efficiency improvements in Azure operations. Operating expenses totaled $5.5 billion, up 3.4% year over year. Operating income reached $13.9 billion, growing substantially. Operating margin was 42.2%, declining only slightly year over year as increased AI investments were largely offset by improved operational leverage.

The More Personal Computing segment generated $14.3 billion in revenues, representing 17.6% of total revenues. Revenues decreased 3% year over year, impacted primarily by gaming segment performance.

Windows OEM and Devices revenues increased 1% year over year (relatively unchanged in cc). This performance reflected some benefit from elevated inventory levels that remained in the channel.

Search and news advertising revenues excluding traffic acquisition costs increased 10% (9% in cc), driven by volume growth and continued benefits from third-party partnerships.
Gaming revenues decreased 5% (6% in cc). Xbox content and services revenues declined 5% (6% in cc), falling below expectations due to weaker first-party content performance with impacts felt across the platform.

Segment gross margin dollars totaled $7.9 billion, increasing 1.6% year over year. Gross margin percentage reached 55.8%, improving from the prior-year period, driven by business mix shifts toward higher-margin offerings. Operating expenses totaled $4.1 billion, rising 6.0% year over year. Operating income reached $3.8 billion, declining slightly from the prior year. Operating margin was 26.7%, down from the prior-year period.

AI Platform and Technology Advancements

Microsoft continued expanding its AI infrastructure and platform capabilities throughout the second quarter. Azure AI Foundry now serves a customer base exceeding 80,000 organizations, including 80% of Fortune 500 companies, with access to over 11,000 models from various providers.

The company now counts 900 million monthly active users of AI features across its products, with over 150 million monthly active users of first-party Copilots. More than 90% of Fortune 500 organizations now utilize Microsoft 365 Copilot, with major enterprise customers deploying tens of thousands of seats.

Partners like Adobe ADBE, Databricks, Genspark, Glean, NVIDIA NVDA, SAP SAP, ServiceNow, and Workday are already integrating Agent 365.

Microsoft Fabric revenues grew 60%, outpacing other data and analytics platforms in the industry, with the customer base expanding to 28,000 paid subscribers. In database services, SQL Database hyperscale revenues increased nearly 75%, while Cosmos DB grew 50%.

Financial Performance

Gross profit reached $55.3 billion, up 15.6% year over year. The gross margin contracted to 68% from the prior year, driven by AI infrastructure investments and growing AI product usage, partially offset by ongoing efficiency gains in Azure and Microsoft 365 Commercial cloud operations.

Operating expenses increased 5% (4% in cc), driven by investments in cloud and AI engineering, including compute capacity expansion and AI talent acquisition to support product development across the portfolio. Operating margins improved year over year to 47% and exceeded internal projections, supported by stronger-than-anticipated results in high-margin businesses.

Productivity & Business Process operating income rose 22% to $20.6 billion. Intelligent Cloud operating income increased 27.8% to $13.9 billion. More Personal Computing’s operating income reached $3.8 billion, down 2.9% year over year.

Capital Expenditure and Infrastructure

Capital expenditures totaled $29.9 billion in the fiscal second quarter. Microsoft expects capital expenditure to decrease sequentially in the fiscal third quarter due to normal variability from cloud infrastructure buildouts and the timing of delivery of finance leases. The company anticipates the mix of short-lived assets to remain similar to second-quarter levels as it works to close the gap between demand and available supply.

As of Dec. 31, 2025, Microsoft maintained total cash, cash equivalents and short-term investments of $89.5 billion compared with $102.1 billion as of Sept. 30, 2025.

Long-term debt (including current portion) was $40.3 billion as of Dec. 31, 2025, compared with $43.2 billion as of Sept. 30, 2025.

Cash flow from operations totaled $35.8 billion. Microsoft returned $12.7 billion to shareholders through dividends and share repurchases during the fiscal second quarter, representing a 32% increase year over year.

OpenAI Partnership

The fiscal second quarter reflected net gains from investments in OpenAI totaling $7.6 billion, which increased net income and diluted earnings per share by $7.6 billion and $1.02, respectively. This contrasted with the second quarter of fiscal 2025, when net losses from OpenAI investments decreased net income and diluted earnings per share by $939 million and 12 cents, respectively.

These OpenAI-related impacts create volatility in reported GAAP results, leading the company to provide non-GAAP measures excluding these effects to help investors better understand operational performance. Management emphasized it would provide a future outlook, excluding any impact from OpenAI investments.

Q3 FY26 Outlook

For the third quarter of fiscal 2026, this Zacks Rank #2 (Buy) company expects total company revenues between $80.65 billion and $81.75 billion, suggesting growth of approximately 15% to 17%. The company anticipates that operating margins will be down slightly year over year. You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here.

The Productivity and Business Processes segment is expected to generate revenues between $34.25 billion and $34.55 billion, indicating growth of 14% to 15%. Within this segment, Microsoft 365 commercial cloud revenue growth is projected to be 14-15% in cc, with ARPU growth again driven by E5 and Microsoft 365 Copilot. LinkedIn revenues are expected to grow approximately 10%, while Dynamics 365 revenue growth should reach the mid-to-high teens percentage range.

For the Intelligent Cloud segment, revenues are projected between $32.65 billion and $32.95 billion, suggesting growth of approximately 27% to 28%. Azure and other cloud services revenue growth is expected to reach approximately 37% to 38% in cc, as demand continues to significantly exceed available capacity. The company now expects to remain capacity-constrained through at least fiscal year-end, with demand exceeding current infrastructure buildout, resulting in lost revenue opportunities for Azure.

For the More Personal Computing segment, revenues are expected in the range of $13.95 billion to $14.45 billion. Windows OEM revenues are expected to decline in the low to mid-single digits, despite continued momentum from Windows 10 end of support, as growth rates will be impacted by elevated inventory levels at OEMs expected to decline through the quarter. In gaming, Xbox content and services revenues are expected to decline in the low to mid-single digits.

The company now expects fiscal 2026 operating margins to rise slightly for the full year, aided by first-half investment prioritization and favorable impacts from revenue mix shifts in Windows OEM and commercial on-premises businesses.

With 900 million monthly active users of AI features and more than 150 million monthly active Copilot users, Microsoft has established significant scale in AI adoption. The challenge ahead involves balancing infrastructure capacity expansion with profitable growth while maintaining leadership positions across productivity software, cloud infrastructure, and emerging AI platforms.

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