Microsoft MSFT FY2026 10-K: $115.9B Capex, Azure Up 41%, Free Cash Flow Fell Again
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The Hook
Microsoft $MSFT filed its fiscal 2026 annual report on July 29, and the most important number in it is not on the income statement. It is one sentence at the end of the lease note: "As of June 30, 2026, we had additional leases, primarily for datacenters, that had not yet commenced of $329.1 billion."
Microsoft's revenue for the whole of fiscal 2026 was $331.8 billion. So the company has signed datacenter leases equal to 99 percent of a full year of revenue, for capacity that has not been delivered, is not on the balance sheet, and does not appear in the $115.9 billion capital expenditure line everyone quotes. Those leases commence between fiscal 2027 and fiscal 2033. Add them to the leases already running and Microsoft's total committed lease payments come to $443.5 billion, against $88.5 billion of lease liabilities actually recorded on the balance sheet.
The point-in-time number is not even the story. Microsoft has printed that same sentence in each of its last three filings with a different figure in it every time: $155.1 billion at December 31, 2025, $196.6 billion at March 31, 2026, and $329.1 billion at June 30, 2026. It more than doubled in six months, and the largest single step, $132.5 billion, came in the final quarter of the fiscal year.
Company Snapshot
Microsoft is the world's largest enterprise software company, now organized around three segments: Productivity and Business Processes (Microsoft 365, LinkedIn, Dynamics), Intelligent Cloud (Azure, server products, enterprise services), and More Personal Computing (Windows, XBOX, Search advertising). This analysis covers the Form 10-K for the fiscal year ended June 30, 2026, filed July 29, 2026, accession 0001193125-26-323660. Every figure below is taken from that filing unless attributed otherwise. The fiscal 2025 comparatives in the filing match fiscal 2025 as originally reported, so nothing here is a restatement artifact.
The Financial Story
Start with the number that made the headlines. Net income rose 31.3 percent to $133.7 billion while operating income rose 20.8 percent. That 10-point gap looks like a company converting growth into profit faster than it is producing it, which would be remarkable. It is not what happened, and Microsoft says so itself.
The entire gap sits in one line: other income (expense), net, which swung from negative $4.9 billion in fiscal 2025 to positive $10.7 billion in fiscal 2026, a $15.6 billion move. Of that, $11.3 billion is Microsoft's stake in OpenAI: $6.5 billion of net gains this year against $4.8 billion of net losses last year. The filing is explicit that the fiscal 2026 gains "primarily relate to the dilution gain from the OpenAI Recapitalization" - an accounting remeasurement of Microsoft's ownership percentage, not cash and not operations. Microsoft now publishes a non-GAAP adjusted net income that strips it out. On that basis, profit grew 22 percent, not 31 percent, and adjusted diluted EPS was $17.28 rather than the reported $17.95. Note the direction of last year's adjustment: fiscal 2025 adjusted EPS of $14.13 was higher than the $13.64 reported, because the OpenAI mark was a loss then. Strip both years and the story is simple - adjusted profit up 22 percent against operating income up 20.8 percent. There is no mystery outperformance.
| Metric | FY2024 | FY2025 | FY2026 | YoY |
|---|---|---|---|---|
| Revenue | $245.1B | $281.7B | $331.8B | +17.8% |
| Operating income | $109.4B | $128.5B | $155.2B | +20.8% |
| Net income (reported) | $88.1B | $101.8B | $133.7B | +31.3% |
| Adjusted net income (ex-OpenAI) | $89.3B | $105.5B | $128.8B | +22.1% |
| Diluted EPS (reported) | $11.80 | $13.64 | $17.95 | +31.6% |
| Adjusted diluted EPS (ex-OpenAI) | $11.95 | $14.13 | $17.28 | +22.3% |
The operating leverage underneath is real but narrower than it looks. Operating margin expanded from 45.6 percent to 46.8 percent, and it did so entirely below the gross line: operating expenses grew 7 percent while revenue grew 18 percent. Gross margin percentage actually fell, from 68.8 percent to 67.9 percent. In Intelligent Cloud, the segment carrying the company, the compression is severe - revenue grew 30 percent to $137.8 billion while cost of revenue grew 44 percent to $57.9 billion, taking segment gross margin from 62.2 percent to 58.0 percent, a 4.2 point drop in a single year. Azure grew 41 percent and Microsoft Cloud revenue reached $214.4 billion, up 27 percent. But every incremental Azure dollar is arriving with more cost attached than the last one. Management is explicit about the cause: "continued investments in AI infrastructure and growing AI product usage." Two of the 18 points of revenue growth, incidentally, were foreign currency.
More Personal Computing is the part nobody is watching. Segment revenue declined 1 percent to $54.1 billion, with XBOX down 7 percent and XBOX hardware down 29 percent. Operating expenses in the segment rose on "impairment and other related expenses in our XBOX business." Search advertising was the offset, up 9 percent.
Now the cash. Operating cash flow rose $46.8 billion to $182.9 billion, up 34 percent - and free cash flow went down. Capital expenditures were $115.9 billion, up 79.6 percent and equal to 34.9 percent of revenue. Free cash flow came to $67.0 billion, a second consecutive annual decline from the fiscal 2024 peak of $74.1 billion, on revenue that has grown from $245 billion to $332 billion over the same stretch. Capex is not the whole picture either: Microsoft added another $24.6 billion of datacenter capacity through finance leases, which never touch the capex line, taking the true infrastructure add to $140.6 billion, or 42.4 percent of revenue. And $26.7 billion of property purchases were still sitting unpaid in accounts payable at year end, against $6.9 billion a year earlier - so even the $115.9 billion understates what was committed during the year.
| Cash and infrastructure | FY2024 | FY2025 | FY2026 |
|---|---|---|---|
| Operating cash flow | $118.5B | $136.2B | $182.9B |
| Capital expenditures | $44.5B | $64.6B | $115.9B |
| Free cash flow | $74.1B | $71.6B | $67.0B |
| Finance-lease datacenter additions | $11.6B | $20.5B | $24.6B |
| Total infrastructure added | $56.1B | $85.1B | $140.6B |
| Depreciation expense | $15.2B | $22.0B | $34.3B |
The tax line quietly confirms where the money went. Total tax expense rose 47.7 percent to $32.2 billion, but that is a book number. Split it and the picture inverts: current U.S. federal tax fell from $14.1 billion to $2.5 billion, an 82 percent collapse, while deferred taxes swung from a $7.1 billion benefit to a $14.4 billion expense. That is what immediate tax deduction of a $115.9 billion capital program looks like. Microsoft's cash tax bill fell in the year its pre-tax income rose $42.3 billion, which is a large part of why operating cash flow grew faster than profit. The deferral does not vanish; it reverses as the assets depreciate.
That depreciation is still ahead of the company. Depreciation expense has gone $15.2 billion, $22.0 billion, $34.3 billion over three years, and the asset base it runs against is now younger than it was: accumulated depreciation is 27.5 percent of gross property and equipment, down from 31.4 percent a year ago. Gross property and equipment reached $431.8 billion, with servers, network equipment and software alone at $215.9 billion, up from $132.8 billion. Property and equipment is now 41 percent of Microsoft's total assets, against 33 percent a year ago. This is no longer an asset-light software company on the balance sheet.
Here is the part the bearish version of this story misses. Microsoft's commitments run both directions, and both are off the income statement. On the obligation side, total contractual obligations are $743.8 billion, of which $241.9 billion falls due in fiscal 2027, plus $194.1 billion of purchase commitments "primarily related to datacenters" and $34.6 billion of construction commitments. On the revenue side, commercial remaining performance obligation - contracted revenue not yet recognized - rose 84 percent to $678 billion, with total company RPO at $684 billion and a weighted average duration of about 2.3 years. Roughly 30 percent converts within twelve months. Those two numbers, $743.8 billion committed out and $684 billion contracted in, are nearly the same size. The build is not speculative in the way "capex is exploding" coverage implies. It is matched, on paper, by signed customer contracts.
Valuation - What It Is Worth as a Normal Business
Microsoft closed at $390.54 on July 29, 2026 for a market capitalization of about $2.90 trillion, after a roughly 9 percent post-earnings move (stockanalysis.com). Even after that jump the stock sits 29.7 percent below its 52-week high of $555.45 and only 11.8 percent above the 52-week low of $349.20. The market has been re-rating this business downward all year. Analyst consensus is Strong Buy with an average target of $555.77 across 56 analysts (S&P Global via stockanalysis.com).
On the filing's numbers: 21.8 times reported diluted EPS, 22.6 times adjusted EPS, 8.7 times revenue, and about 15.1 times EV/EBITDA using an enterprise value of roughly $2.93 trillion (market cap plus $40.3 billion of debt and $66.6 billion of finance-lease liabilities, less $76.8 billion of cash and short-term investments). Free cash flow yield is 2.31 percent - which is the number that explains the de-rating better than any other. You are paying 43 times free cash flow for a business whose free cash flow has fallen for two straight years.
A scenario discounted cash flow makes the sensitivity explicit. The only assumption that matters is when capital intensity normalizes. All three cases model five years explicitly and then a terminal value, using an operating cash flow margin near the recent range and capex as a declining share of revenue.
| Scenario | Revenue CAGR | Capex, % of revenue by FY2031 | WACC | Terminal growth | Implied value per share |
|---|---|---|---|---|---|
| Bear | ~7.5% | 27% (intensity never normalizes) | 9.0% | 2.5% | ~$210 |
| Base | ~11% | 22% (normalizes by FY2030) | 8.5% | 3.0% | ~$365 |
| Bull | ~14% | 18% (build completes, Azure margin recovers) | 8.0% | 3.5% | ~$600 |
Implied value under stated assumptions. Not a price target and not investment advice.
The base case lands about 7 percent below today's price, which is a fair reading of a market that neither believes the bear case nor pays for the bull. Cross-checking against peers on forward earnings as of late July 2026 - Oracle near 15.9 times, Alphabet near 22.3 times, Amazon near 29.3 times, Apple near 31.4 times (financecharts.com, gurufocus.com, valueinvesting.io) - Microsoft's 22.6 times adjusted earnings prices it as a mature compounder rather than an AI winner. Applying Alphabet's multiple gives roughly $385; Amazon's gives roughly $506. The consensus $556 target requires something close to the bull case: the capex cycle ending and Azure gross margin recovering at the same time.
Risks
The filing names the risk in plain language, and it is the one that matters: "Overestimation of demand or misalignment of capacity investments may result in underutilization of infrastructure and may lead to impairment of assets on our balance sheet." Microsoft also concedes the investments "are being made at significant scale and on an accelerated timeline" and "are in advance of fully developed revenue streams." With $329.1 billion of leases yet to commence and a finance-lease book with a 13-year weighted average term, the commitment horizon is far longer than the customer contract duration of 2.3 years. Power availability, permitting, community opposition and component supply are each called out as capacity constraints.
Two more. The IRS is seeking $28.9 billion in additional tax plus penalties and interest on transfer pricing for tax years 2004 to 2013, which Microsoft is contesting; long-term accrued income taxes on the balance sheet stand at $28.6 billion. And the OpenAI relationship now cuts both ways on the income statement - a $6.5 billion gain this year was a $4.8 billion loss last year on an equity-method position whose carrying value is a small fraction of the swings it produces. Microsoft's total equity-method investments doubled to $12.0 billion.
The Bottom Line
Fiscal 2026 was a very good operating year that the income statement overstates and the cash flow statement complicates. Adjusted profit grew 22 percent, in line with operating income - the 31 percent headline is an OpenAI remeasurement Microsoft itself removes. Meanwhile free cash flow has now fallen two years running, gross margin is compressing where the growth is, and the real infrastructure commitment is $329.1 billion larger than the balance sheet shows. What holds it together is an $678 billion contracted backlog that grew 84 percent. Watch three things next year: whether Intelligent Cloud gross margin stops falling, whether free cash flow turns back up as capex intensity peaks, and whether the leases that commence in fiscal 2027 arrive with the customers already signed for them.
Every figure in this analysis came out of Microsoft's SEC filings via the RoboSystems SEC Shared Repository - structured XBRL data for every public company that files. Run your own: robosystems.ai/pricing. New customers get 50% off your first month with code ROBO50.
This is not investment advice and contains no price targets. Filing data: Microsoft Corporation Form 10-K, fiscal year ended June 30, 2026, accession 0001193125-26-323660. Market data as of July 29, 2026.