MSFT — Q3 2026 Financial Report Analysis

A clean quarter with no OpenAI noise: EPS $4.27 either way, Azure still +40%, and capital spending now 37% of revenue

Microsoft's fiscal 2026 third quarter covers the three months to 31 March 2026. The 10-Q was filed on 29 April 2026.

After two quarters in which Microsoft's reported earnings were dominated by its OpenAI stake — a $4.1 billion loss in the September quarter, a $10.0 billion gain in the December quarter — this one is almost free of it. Net losses from the OpenAI investments were $19 million, effectively nil. As a result reported diluted EPS and Microsoft's own adjusted EPS are the same number to the cent: $4.27, up 23% and 21% respectively (the small difference in growth rates is because the prior-year quarter still carried a $583 million OpenAI drag).

That makes this the most readable of the three fiscal-2026 quarters filed so far, and what it shows is a business growing revenue 18% while its gross margin — the share of revenue left after the direct cost of delivering the product — falls by more than a full percentage point.

The numbers

Nine-month figures (to 31 March 2026): revenue $241.8 billion (+18%), operating income $114.6 billion (+22%), reported EPS $13.14 (+32%), adjusted EPS $12.54 (+22%). The 10-point gap between reported and adjusted nine-month EPS growth is the December-quarter OpenAI recapitalisation gain, worth $0.60 of EPS across the year to date.

Azure and other cloud services — Microsoft's consumption-based cloud and AI business — grew 40%, reaccelerating from 39% in the December quarter. Commercial remaining performance obligation (RPO), the contracted revenue Microsoft has sold but not yet recognised, was $627 billion, up 99%, with a weighted average duration of about 2.5 years and roughly 25% expected to be recognised within twelve months.

Currency did about three points of the work

Before reading the growth rates as operational performance: the filing states that revenue, gross margin and operating income each included a favourable foreign currency impact of 3%, 3% and 4% respectively, with cost of revenue carrying a 2% unfavourable impact. Constant currency — holding exchange rates fixed so only volume and price show through — puts underlying revenue growth nearer 15% than the reported 18%, and underlying operating income growth nearer 16% than 20%.

The effect is uneven by segment. Productivity and Business Processes had the largest currency benefit of the three: revenue +4%, gross margin +5%, operating income +7% from currency alone. Its reported 21% operating income growth is therefore closer to 14% on an underlying basis — a material distinction that the headline segment table does not show.

Segments

Intelligent Cloud grew 30% — its fastest of the three quarters — on server products and cloud services up $7.8 billion or 32%. But its cost of revenue rose 47%, and for the first time the gap is wide enough that segment operating income growth (24%) fell well short of revenue growth (30%). The filing names the cause directly: "investments in AI infrastructure to support growing customer demand and increased GitHub Copilot usage." Server products revenue itself increased only "slightly," held back by "renewals with lower in-period revenue recognition from the mix of contracts and continued customer shift to cloud" — the legacy licence business is being cannibalised by the cloud business, as intended, but it means the segment's growth is now almost entirely one product line.

Productivity and Business Processes grew 17%, with Microsoft 365 Commercial cloud revenue up 19% on revenue per user (E5 and Copilot) against paid seat growth of just 6%. Microsoft 365 Commercial products revenue — the on-premises licence portion — grew only 1%, down from 17% two quarters ago, confirming that the transactional licence tailwind from Office 2024 purchasing has run out. Consumer was the standout line: Microsoft 365 Consumer cloud revenue +33% on both price and 7% subscriber growth.

More Personal Computing shrank 1%, though operating income rose 4% because cost of revenue fell 10% on lower hardware sales — a mix effect, not an efficiency gain. Two specifics stand out. Gaming fell 7%, with Xbox hardware down 33% and Xbox content and services down 5%, and the segment again absorbed unquantified "impairment and other related expenses in our Gaming business." And Windows OEM revenue grew for a reason worth flagging: "OEM partners continue to build inventory due to increasing memory pricing." That is PC makers stockpiling ahead of component cost inflation, not end-user demand — the same category of borrowed revenue as the Windows 10 end-of-support pull-forward two quarters earlier, and it reverses the same way.

The capital spending problem is now arithmetic, not narrative

Capital spending was $30,876 million in the quarter, up 84%, equal to 37% of revenue (it was 24% a year ago). Operating cash flow was $46,679 million, up 26%.

Cash left after capital spending — operating cash flow minus additions to property and equipment — was $15.8 billion, down from $20.3 billion a year ago, a 22% decline in a quarter when operating income grew 20%. Across the nine months, capital spending reached $80.1 billion against $47.5 billion a year earlier.

This is the central tension in the filing. Microsoft's income statement is improving (operating margin up 0.7 points) while its cash conversion is deteriorating, because the AI buildout is being capitalised onto the balance sheet faster than it is being depreciated through the income statement. That depreciation is coming: the assets bought in the last three quarters have barely begun to run through cost of revenue. Microsoft Cloud gross margin has already moved 68% → 67% → 66% across the three quarters, with the company naming the same cause each time.

One offsetting note on costs: total company headcount declined year on year, and operating expenses rose 9% — less than revenue — so the operating-expense line is not the pressure point. The pressure is entirely in cost of revenue, which rose 22% against 18% revenue growth.

Takeaway: With the OpenAI accounting noise absent, the underlying trend is legible and it is a margin story, not a growth story. Azure grew 40% and Intelligent Cloud 30%, but Intelligent Cloud's cost of revenue grew 47%, total gross margin fell 1.1 points, Microsoft Cloud gross margin fell to 66%, and cash after capital spending dropped 22% year on year to $15.8 billion. Roughly three points of the 18% revenue growth was currency. Microsoft is buying its cloud growth with $30.9 billion a quarter of infrastructure whose depreciation cost is still mostly ahead of it.

What to watch next

The 10-Q gives no numeric guidance — Microsoft provides that on its earnings call — but it does state its own expectation of direction: "the investments we are making in cloud and AI infrastructure and devices will continue to increase our operating costs and may decrease our operating margins."

Specific things to carry into the fourth quarter (which ends 30 June 2026 and is seasonally Microsoft's largest, "driven by a higher volume of multi-year contracts executed during the period"):

1. Microsoft Cloud gross margin. 68% → 67% → 66% is a consistent one-point-a-quarter decline with a consistent stated cause. Whether it stabilises around 65-66% or keeps sliding is the single most important number for the next few quarters.
2. Cash after capital spending. $25.7bn → $5.9bn → $15.8bn across the three quarters, versus $19.3bn → $6.5bn → $20.3bn a year earlier. The year-on-year comparison has now been negative for two consecutive quarters.
3. Whether the Windows inventory build reverses. OEM partners buying ahead of memory price rises inflates current revenue at the cost of future quarters, exactly as the Windows 10 deadline did in the September quarter.
4. The OpenAI relationship, extended again in April 2026. The filing notes Microsoft "will continue to receive revenue-sharing payments" under the extended partnership — different language from the earlier reciprocal-revenue-sharing description, and worth watching for what it means for both the equity-method line and Azure's reported growth.

Our own read: the operating business is healthy and the quarter is better than the two before it precisely because nothing unusual happened in it. But the trajectory across all three fiscal-2026 quarters filed so far is consistent — revenue growth flat at 17-18% reported and roughly 15% in constant currency, gross margin down every quarter, capital spending up to 37% of revenue, and cash after capex falling year on year. None of that is deterioration in demand; it is the cost of meeting it. The question the fourth quarter and fiscal 2027 will answer is whether AI revenue scales into the fixed cost base fast enough to stop the margin slide, or whether this is the new steady state.

Source: Microsoft Corporation Form 10-Q for the quarterly period ended 31 March 2026, filed with the US Securities and Exchange Commission on 29 April 2026 (accession number 0001193125-26-191507). All figures are as reported by the company; percentage changes, margin percentages and cash-after-capex figures are calculated from those figures.