Microsoft (MSFT) Q2 2026 earnings review
Cloud Crosses $50B, But OpenAI Obscures the Real Picture
Microsoft delivered a strong quarter with revenue up 17% to $81.3B, exceeding expectations. Microsoft Cloud crossed $50B for the first time. However, the headline 60% GAAP earnings growth is misleading—driven entirely by a $7.6B gain from OpenAI investments. Adjusted EPS grew 24%. The real story: Azure grew 38% CC (stable but not accelerating), M365 Copilot reached 15 million paid seats (up 160% YoY), and the company is investing heavily ($37.5B CapEx) to meet demand that still exceeds supply. Gaming was the weak spot with a 9% revenue decline and impairment charges.
🐂 Bull Case
M365 Copilot reached 15 million paid seats, up 160% YoY, with daily active users up 10x. GitHub Copilot has 4.7 million paid subscribers (+75% YoY). Fabric crossed $2B annual run rate (+60% YoY). AI is no longer experimental—it's driving real revenue across the portfolio.
Commercial RPO reached $625B. Even excluding OpenAI (45% of total), the remaining ~$350B grew 28% YoY—larger and more diversified than most peers. This provides strong revenue visibility for years ahead.
🐻 Bear Case
45% of the $625B RPO is from OpenAI alone. Analysts repeatedly questioned the durability of this relationship and the ability of 'AI natives' to fulfill long-term commitments. Management defended the partnership but acknowledged concentration exists.
Azure grew 38% CC—down from 39% last quarter. Despite $37.5B in Q2 CapEx alone, management admits demand still exceeds supply. Amy Hood acknowledged that if all GPUs went to Azure, growth 'would have been over 40%,' but first-party apps and R&D get priority.
⚖️ Verdict: 🟢
Moderately Bullish. Solid execution with AI monetization accelerating across products. The OpenAI concentration is a real risk, but the ex-OpenAI backlog is still enormous and growing. Azure's 38% growth is impressive at this scale, even if not accelerating. The strategic positioning across the AI stack remains unmatched.
Key Themes
M365 Copilot Reaching Enterprise Scale
M365 Copilot had its largest quarter of seat additions, reaching 15 million paid seats (up 160% YoY). Daily active users increased 10x YoY. Critically, larger deployments are accelerating: customers with over 35,000 seats tripled YoY, including Fiserv, ING, Westpac, and Publicis (95,000 seats). Average conversations per user doubled YoY, indicating genuine productivity value rather than trial usage.
OpenAI Concentration Creates Portfolio Vulnerability
Approximately 45% of the $625B commercial RPO is from OpenAI. While management emphasized the remaining $350B is diversified and grew 28%, the single-customer concentration is unprecedented. The new recapitalization means Microsoft now records gains/losses based on OpenAI's balance sheet changes—creating earnings volatility. This quarter's $7.6B gain could easily reverse.
Infrastructure Investment Driving Capacity Expansion
Microsoft added nearly 1 gigawatt of capacity this quarter alone. The Maya 200 accelerator came online with 30%+ improved TCO versus latest-generation hardware. Cobalt 200 CPU delivers 50% higher performance than the first-generation chip. Management is building a 'fungible fleet' across NVIDIA, AMD, and first-party silicon to optimize cost and supply across multiple hardware generations.
GitHub Copilot Becoming Developer Standard
GitHub Copilot reached 4.7 million paid subscribers, up 75% YoY. Copilot Pro Plus subscriptions for individual developers increased 77% quarter-over-quarter. Siemens adopted the full GitHub platform for 30,000+ developers. GitHub AgentHQ is positioning the platform as the organizing layer for all coding agents (OpenAI, Anthropic, Google, Cognition, xAI). The new Copilot SDK allows developers to embed the runtime directly into applications.
Microsoft Fabric Emerging as Data Foundation
Fabric's annual revenue run rate crossed $2B, with revenue up 60% YoY. The platform now has over 31,000 customers. Fabric is becoming the unified data layer for AI applications, combining real-time analytics, data engineering, and AI workloads. Management positioned Fabric alongside Azure AI Foundry as the 'IQ layer' powering agentic applications.
Gaming Segment Under Pressure
Gaming revenue declined 9% CC, with Xbox content and services down 6% CC—below expectations. The segment took impairment charges that elevated operating expenses. Hardware continues to decline. Management cited weak first-party content performance. While Game Pass and PC gaming remain bright spots, the segment is clearly struggling post-Activision integration.
Agent Platform Emerging as New Category
Microsoft introduced Agent 365 for governance, identity, security, and management of AI agents—positioning it as a 'control plane' that extends existing Microsoft 365 and Azure controls to agents built on any cloud. Partners including Adobe, Databricks, SAP, ServiceNow, and Workday are already integrating. Over 80% of Fortune 500 have active agents built using Copilot Studio and AgentBuilder. This represents a potential new monetization layer.
Capacity Constraints Limiting Azure Growth
Management explicitly stated that Azure revenue 'could be higher' if more capacity were allocated there, versus being prioritized for first-party apps (M365 Copilot, GitHub) and R&D. Amy Hood acknowledged that if all GPUs went to Azure, growth would have exceeded 40%. This strategic choice constrains reported Azure growth and raises questions about how much demand is being left unserved.
AI Margins Improving with Scale
Microsoft Cloud gross margin was 67%, down YoY due to AI infrastructure investments but slightly better than expected. Management emphasized that GPU margins improve over their useful life as software optimizations compound. The fungible fleet strategy—rotating in new silicon while extracting efficiency from aging hardware—is designed to improve margins over time. Maya 200 delivering 30%+ better TCO suggests the efficiency thesis is working.
Healthcare AI Scaling Rapidly
Dragon Copilot helped document 21 million patient encounters this quarter, up 3x YoY. Over 100,000 medical providers now use the service. Mount Sinai Health is expanding from a pilot to system-wide deployment. Healthcare represents a high-value vertical where AI productivity gains translate directly to billable time and patient capacity.
Other KPIs
Up 60% YoY, driven by strong cloud billings and collections. This strong cash generation funds the massive CapEx program while maintaining shareholder returns. Free cash flow was $5.9 billion after $29.9B in cash CapEx—down sequentially due to lower finance lease mix.
Down slightly YoY as AI infrastructure investments offset operating leverage. This compares to 42.5% in Q1 FY26 and 42.5% in Q2 FY25. The segment is absorbing the bulk of AI CapEx while maintaining margin stability—a positive sign for AI unit economics at scale.
Up 32% YoY, consisting of dividends and share repurchases. Despite $37.5B in CapEx, the company continues returning substantial capital. Buybacks totaled $7.4B in the quarter. This signals confidence in free cash flow sustainability even during peak investment phase.
Guidance
Decelerating slightly. Implies 15-17% YoY growth versus 17% in Q2. This is a sequential revenue decline (Q2 was $81.3B), reflecting normal seasonality and Windows OEM weakness. FX provides a 3-point tailwind. Operating margins expected to be down slightly YoY.
Stable. Essentially flat with Q2's 38% CC growth. Management noted demand continues to exceed supply. Quarterly variability depends on timing of capacity delivery and revenue recognition mix. The guidance implies Azure will maintain its growth plateau rather than accelerate further despite massive CapEx.
Decelerating from 14% CC in Q2. Growth on a large base ($30B+ quarterly revenue) with E5 and Copilot driving ARPU expansion. The deceleration is modest and expected given the installed base scale (450+ million paid seats).
Reversing from +1% in Q2. The Windows 10 end-of-support benefit is normalizing, and elevated inventory levels need to work down. Memory price increases add uncertainty. This is a temporary headwind that should stabilize by Q4.
Upgraded from 'relatively unchanged.' Higher revenue from Windows OEM and commercial on-prem businesses (which carry higher margins) plus disciplined investment are driving the improvement. This is notable given the massive AI investment cycle.
Q2's $37.5B was unusually high. Normal variability in cloud infrastructure build-outs and finance lease timing will bring Q3 lower. Mix of short-lived assets (GPUs/CPUs) expected to remain similar to Q2. The investment thesis remains intact—just lumpy timing.