MICROSOFT CORP Q2 2026 earnings call

Good afternoon, and thank you for joining us today. On the call with me are Satya Nadella, Chairman and Chief Executive Officer, Amy Hood, Chief Financial Officer, Alice Jolla, Chief Accounting Officer, and Keith Dolliver, Corporate Secretary and Deputy General Counsel. On the Microsoft Investor Relations website, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provides the reconciliation of differences between GAAP and non-GAAP financial measures. More detailed outlook slides will be available on the Microsoft Investor Relations website when we provide outlook commentary on today's call. On this call, we will discuss certain non-GAAP items. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP.

They are included as additional clarifying items to aid investors in further understanding the company's second quarter performance, in addition to the impact these items and events have on the financial results. All growth comparisons we make on the call today relate to the corresponding period of last year, unless otherwise noted. We will also provide growth rates in constant currency when available, as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. Where growth rates are the same in constant currency, we will refer to the growth rate only. We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript, and in any future use of the recording.

You can replay the call and view the transcript on the Microsoft Investor Relations website. During this call, we will be making forward-looking statements, which are predictions, projections, or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call, and in the Risk Factors section of our Form 10-K, Forms 10-Q, and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. With that, I'll turn the call over to Satya.

Thank you very much, Jonathan. This quarter, the Microsoft Cloud surpassed $50 billion in revenue for the first time, up 26% year-over-year, reflecting the strength of our platform and accelerating demand. We are in the beginning phases of AI diffusion and its broad GDP impact. Our TAM will grow substantially across every layer of the tech stack as this diffusion accelerates and spreads. In fact, even in this early innings, we have built an AI business that is larger than some of our biggest franchises that took decades to build. Today, I'll focus my remarks across the three layers of our stack: cloud and token factory, AI and platform, and high-value agentic experiences. When it comes to our cloud and token factory, the key to long-term competitiveness is shaping our infrastructure to support new high-scale workloads.

We are building this infrastructure out for the heterogeneous and distributed nature of these workloads, ensuring the right fit with the geographic and segment-specific needs for all customers, including the long tail. The key metric we are optimizing for is tokens per watt per dollar, which comes down to increasing utilization and decreasing TCO using silicon systems and software. A good example of this is the 50% increase in throughput we were able to achieve in one of our highest volume workloads, OpenAI inferencing, powering our copilots. Another example was the unlocking of new capabilities and efficiencies for our Fairwater data centers. In this instance, we connected both Atlanta and Wisconsin site through an AI WAN to build a first-of-its-kind AI super factory. Fairwater's two-story design and liquid cooling allow us to run higher GPU densities and thereby improve both performance and latencies for high-scale training.

All up, we added nearly 1 GW of total capacity this quarter alone. At the silicon layer, we have NVIDIA and AMD and our own Maia chips, delivering the best all-up fleet performance, cost, and supply across multiple generations of hardware. Earlier this week, we brought online our Maia 200 accelerator. Maia 200 delivers 10+ petaflops at FP4 precision with over 30% improved TCO compared to the latest generation hardware in our fleet. We will be scaling this, starting with inferencing and synthetic data gen for our super intelligence team, as well as doing inferencing for Copilot and Foundry. And given AI workloads are not just about AI accelerators, but also consume large amounts of compute, we are pleased with the progress we are making on the CPU side as well.

Cobalt 200 is another big leap forward, delivering over 50% higher performance compared to our first custom-built processor for cloud-native workloads. Sovereignty is increasingly top of mind for customers, and we are expanding our solutions and global footprint to match. We announced DC investments in seven countries this quarter alone, supporting local data residency needs. We offer the most comprehensive set of sovereignty solutions across public, private, and national partner clouds, so customers can choose the right approach for each workload with the local control they require. Next, I want to talk about the agent platform. Like in every platform shift, all software is being rewritten. A new app platform is being born.

You can think of agents as the new apps, and to build, deploy, and manage agents, customers will need a model catalog, tuning services, harness for orchestration, services for context engineering, AI safety, management, observability, and security. It starts with having broad model choice. Our customers expect to use multiple models as part of any workload that they can fine-tune and optimize based on cost, latency, and performance requirements. We offer the broadest selection of models of any hyperscaler. This quarter, we added support for GPT-5 too, as well as Claude 4.5. Already, over 1,500 customers have used both Anthropic and OpenAI models on Foundry. We are seeing increasing demand for region-specific models, including Mistral and Cohere, as more customers look for sovereign AI choices.

We continue to invest in our first-party models, which are optimized to address the highest value customer scenarios, such as productivity, coding, and security. As part of Foundry, we also give customers the ability to customize and fine-tune models. Increasingly, customers want to be able to capture the tacit knowledge they possess inside of model weights as their core IP. This is probably the most important sovereign consideration for firms as AI diffuses more broadly across our GDP, and every firm needs to protect their enterprise value. For agents to be effective, they need to be grounded in enterprise data and knowledge. That means connecting their agents to systems of record and operational data, analytical data, as well as semi-structured and unstructured productivity and communications data. And this is what we are doing with our Unified IQ layer, spanning Fabric, Foundry, and data powering Microsoft 365.

In the world of context engineering, Foundry Knowledge and Fabric are gaining momentum. Foundry Knowledge delivers better context with automated source routing and advanced agentic retrieval while respecting user permissions. Fabric brings together end-to-end operational, real-time, and analytical data. Two years since it became broadly available, Fabric's annual revenue run rate is now over $2 billion, with over 31,000 customers, and it continues to be the fastest-growing analytics platform on the market, with revenue up 60% year-over-year. All up, the number of customers spending $1 million plus per quarter on Foundry grew nearly 80%, driven by strong growth in every industry. Over 250 customers are on track to process over 1 trillion tokens on Foundry this year. There are many great examples of customers using all of this capability on Foundry to build their own agentic systems.

Alaska Airlines is creating natural language flight search, BMW is speeding up design cycles, Land O'Lakes is enabling precision farming for co-op members, and SymphonyAI is addressing bottlenecks in the CPG industry. And of course, Foundry remains a powerful on-ramp for the entire cloud. The vast majority of Foundry customers use additional Azure solutions like developer services, app services, databases as they scale. Beyond Fabric and Foundry, we are also addressing agent building by knowledge workers with Copilot Studio and Agent Builder. Over 80% of the Fortune 500 have active agents built using these low-code, no-code tools. As agents proliferate, every customer will need new ways to deploy, manage, and protect them. We believe this creates a major new category and significant growth opportunity for us.

This quarter, we introduced Agent 365, which makes it easy for organizations to extend their existing governance, identity, security, and management to agents. That means the same controls they already use across Microsoft 365 and Azure now extend to agents they build and deploy on our cloud or any other cloud. And partners like Adobe, Databricks, Genspark, Glean, NVIDIA, SAP, ServiceNow, and Workday are already integrating Agent 365. We are the first provider to offer this type of agent control plane across clouds. Now, let's turn to the high-value agentic experiences we are building. AI experiences are intent-driven and are beginning to work at task scope. We are entering an age of macro delegation and micro steering across domains. Intelligence using multiple models is built into multiple form factors.

You see this in chat, in new agent inbox apps, coworker scaffoldings, agent workflows embedded in applications and IDEs that are used every day, or even in our command line with file system access and skills. That's the approach we are taking with our first-party family of Copilot spanning key domains. In consumer, for example, Copilot experiences span chat, news, feed, search, creation, browsing, shopping, and integrations into the operating system, and it's gaining momentum. Daily users of our Copilot app increased nearly 3x year-over-year, and with Copilot Checkout, we have partnered with PayPal, Shopify, and Stripe so customers can make purchases directly within the app.... With Microsoft 365 Copilot, we are focused on organization-wide productivity. Work IQ takes the data underneath Microsoft 365 and creates the most valuable stateful agent for every organization.

It delivers powerful reasoning capabilities over people, their roles, their artifacts, their communications, and their history and memory, all within an organization's security boundary. Microsoft 365 Copilot's accuracy and latency, powered by Work IQ, is unmatched, delivering faster and more accurate work-grounded results than competition. We have seen our biggest quarter-over-quarter improvement in response quality to date. This has driven record usage intensity, with average number of conversations per user doubling year-over-year. Microsoft 365 Copilot also is becoming true daily habit, with daily active users increasing 10x year-over-year. We are also seeing strong momentum with Researcher Agent, which supports both OpenAI and Claude, as well as agent mode in Excel, PowerPoint, and Word. All up, it was a record quarter for Microsoft 365 Copilot seat adds, up over 160% year-over-year.

We saw accelerating seat growth quarter-over-quarter, and now have 15 million paid Microsoft 365 Copilot seats and multiples more enterprise chat users. We are seeing larger commercial deployments. The number of customers with over 35,000 seats tripled year-over-year. Fiserv, ING, NASA, University of Kentucky, University of Manchester, US Department of Interior, and Westpac all purchased over 35,000 seats. Publicis alone purchased over 95,000 seats for nearly all its employees. We are also taking share in Dynamics 365 with built-in agents across the entire suite. A great example of this is how Visa is turning customer conversations data into knowledge articles with our Customer Knowledge Management Agent in Dynamics, and how Sandvik is using our Sales Qualification Agent to automate lead qualification across tens and thousands of potential customers. In coding, we are seeing strong growth across all paid GitHub Copilot.

Thank you, Satya, and good afternoon, everyone. With growing demand for our offerings and focused execution by our sales teams, we again exceeded expectations across revenue, operating income, and earnings per share while investing to fuel long-term growth. This quarter, revenue was $81.3 billion, up 17% and 15% in constant currency. Gross margin dollars increased 16% and 14% in constant currency, while operating income increased 21% and 19% in constant currency. Earnings per share was $4.14, an increase of 24% and 21% in constant currency when adjusted for the impact from our investment in OpenAI. FX increased reported results slightly less than expected, particularly in Intelligent Cloud revenue.

Company gross margin percentage was 68%, down slightly year-over-year, primarily driven by continued investments in AI infrastructure and growing AI product usage that was partially offset by ongoing efficiency gains, particularly in Azure and M365 Commercial Cloud, as well as sales mix shift to higher margin businesses. Operating expenses increased 5% and 4% in constant currency, driven by R&D investments in compute capacity and AI talent, as well as impairment charges in our gaming business. Operating margins increased year-over-year to 47% ahead of expectations. As a reminder, we still account for our investment in OpenAI under the equity method, and as a result of OpenAI's recapitalization, we now record gains or losses based on our share of the change in their net assets on their balance sheet, as opposed to our share of their operating profit or losses from their income statement.

Therefore, we recorded a gain which drove other income and expense to $10 billion in our GAAP results. When adjusted for the OpenAI impact, other income and expense was slightly negative and lower than expected, driven by net losses on investments. Capital expenditures were $37.5 billion, and this quarter, roughly two-thirds of our CapEx was on short-lived assets, primarily GPUs and CPUs. Our customer demand continues to exceed our supply. Therefore, we must balance the need to have our incoming supply better meet growing Azure demand with expanding first-party AI usage across services like M365 Copilot and GitHub Copilot, increasing allocations to R&D teams to accelerate product innovation, and continued replacement of end-of-life server and networking equipment. The remaining spend was for long-lived assets that will support monetization for the next 15 years and beyond.

This quarter, total finance leases were $6.7 billion and were primarily for large data center sites, and cash paid for PP&E was $29.9 billion. Cash flow from operations was $35.8 billion, up 60%, driven by strong cloud billings and collections. Free cash flow was $5.9 billion and decreased sequentially, reflecting the higher cash capital expenditures from a lower mix of finance leases. Finally, we returned $12.7 billion to shareholders through dividend and share repurchases, an increase of 32% year-over-year. Now to our commercial results.

Commercial bookings increased 230% and 228% in constant currency, driven by the previously announced large Azure commitment from OpenAI that reflects multiyear demand needs, as well as the previously announced Anthropic commitment from November and healthy growth across our core annuity sales motions. Commercial remaining performance obligation, which continues to be reported net of reserves, increased to $625 billion and was up 110% year-over-year, with a weighted average duration of approximately 2.5 years. Roughly 25% will be recognized in revenue in the next twelve months, up 39% year-over-year. The remaining portion, recognized beyond the next twelve months, increased 156%. Approximately 45% of our commercial RPO balance is from OpenAI.

The significant remaining balance grew 28% and reflects ongoing broad customer demand across the portfolio. Microsoft Cloud revenue was $51.5 billion and grew 26% and 24% in constant currency. Microsoft Cloud gross margin percentage was slightly better than expected at 67% and down year over year due to continued investments in AI that were partially offset by ongoing efficiency gains noted earlier. Now to our segment results. Revenue from Productivity and Business Processes was $34.1 billion and grew 16% and 14% in constant currency. M365 Commercial Cloud revenue increased 17% and 14% in constant currency, with consistent execution in the core business and increasing contribution from strong Copilot results.

ARPU growth was again led by E5 and M365 Copilot, and paid M365 commercial seats grew 6% year-over-year to over 450 million, with installed base expansion across all customer segments, though primarily in our small and medium business and frontline worker offerings. M365 Commercial Products revenue increased 13% and 10% in constant currency ahead of expectations due to higher-than-expected Office 2024 transactional purchasing. M365 Consumer Cloud revenue increased 29% and 27% in constant currency, again driven by ARPU growth…. M365 consumer subscriptions grew 6%. LinkedIn revenue increased 11% and 10% in constant currency, driven by marketing solutions. Dynamics 365 revenue increased 19% and 17% in constant currency, with continued growth across all workloads.

Segment gross margin dollars increased 17% and 15% in constant currency, and gross margin percentage increased, again, driven by efficiency gains at M365 Commercial Cloud that were partially offset by continued investments in AI, including the impact of growing Copilot usage. Operating expenses increased 6% and 5% in constant currency, and operating income increased 22% and 19% in constant currency. Operating margins increased year-over-year to 60%, driven by improved operating leverage, as well as the higher gross margins noted earlier. Next, the Intelligent Cloud segment. Revenue was $32.9 billion and grew 29% and 28% in constant currency.

In Azure and other cloud services, revenue grew 39% and 38% in constant currency, slightly ahead of expectations, with ongoing efficiency gains across our fungible fleet, enabling us to reallocate some capacity to Azure that was monetized in the quarter. As mentioned earlier, we continued to see strong demand across workloads, customer segments, and geographic regions, and demand continues to exceed available supply. In our on-premises server business, revenue increased 2% and 1% in constant currency, ahead of expectations, driven by demand for our hybrid solutions, including a benefit from the launch of SQL Server 2025, as well as higher transactional purchasing ahead of memory price increases. Segment gross margin dollars increased 20% and 19% in constant currency. Gross margin percentage decreased year-over-year, driven by continued investments in AI and sales mix shift to Azure, partially offset by efficiency gains in Azure.

Operating expenses increased 3% and 2% in constant currency, and operating income grew 28% and 27% in constant currency. Operating margins were 42%, down slightly year-over-year, as increased investments in AI were mostly offset by improved operating leverage. Now to More Personal Computing. Revenue was $14.3 billion and declined 3%. Windows OEM and devices revenue increased 1% and was relatively unchanged in constant currency. Windows OEM grew 5% with strong execution, as well as a continued benefit from Windows 10 end of support. Results were ahead of expectations as inventory levels remained elevated, with increased purchasing ahead of memory price increases. Search and news advertising revenue, ex TAC, increased 10% and 9% in constant currency, slightly below expectations, driven by some execution challenges. As expected, the sequential growth rate moderated as the benefit from third-party partnerships normalized.

In gaming, revenue decreased 9% and 10% in constant currency. Xbox content and services revenue decreased 5% and 6% in constant currency and was below expectations, driven by first-party content with impact across the platform. Segment gross margin dollars increased 2% and 1% in constant currency, and gross margin percentage increased year-over-year, driven by sales mix shift to higher margin businesses. Operating expenses increased 6% and 5% in constant currency, driven by the impairment charges in our gaming business noted earlier, as well as R&D investments in compute capacity and AI talent. Operating income decreased 3% and 4% in constant currency, and operating margins were relatively unchanged year-over-year at 27%, as higher operating expenses were mostly offset by higher gross margins. Now, moving to our Q3 outlook, which, unless specifically noted otherwise, is on a US dollar basis.

Based on current rates, we expect FX to increase total revenue growth by three points. Within the segments, we expect FX to increase revenue growth by four points in Productivity and Business Processes and two points in Intelligent Cloud and More Personal Computing. We expect FX to increase COGS and operating expense growth by two points. As a reminder, this impact is due to the exchange rates a year ago. Starting with the total company, we expect revenue of $80.65 billion-$81.75 billion, or growth of 15%-17%, with continued strong growth across our commercial businesses, partially offset by our consumer businesses.

Thanks, Amy. We'll now move over to Q&A. Out of respect for others on the call, we request that participants please only ask one question. Operator, can you please repeat your instructions?