TMTPOST -- Microsoft Corporation expects its cloud business will further slow down in spite of hefty artificial intelligence (AI) bills following a quarter that saw huge spending failed to accelerated the cloud segment.

Credit：Microsoft

Microsoft’s top and bottom line for its second fiscal quarter ended December 31 beat Wall Street expectation. Revenue rose 12% year-over-year (YoY) to $69.63 billion, compared with expected $68.92 billion. That was the slowest growth rate since the middle of 2023 and cooled from a 16% YoY increase for the previous quarter. Diluted earnings per share (EPS) for the December quarter stood at $3.23, maintaining a 10% growth rate. Analysts expected EPS to be $3.10.

However, the cloud business, which is currently most evidently benefiting from generative AI applications, missed Wall Street anticipation. Revenue from Microsoft’s commercial cloud climbed 21% YoY to $40.09 billion from October to December after a 22% YoY rise in the previous quarter. Analysts projected the segment recorded $41.1 billion of revenue. Microsoft Intelligent Cloud, which also includes the core cloud platform Azure, saw revenue gained $19% YoY to $25.5 billion, shy of Wall Street estimates of $25.8 billion.  

The miss on revenue and slowdown made Microsoft more difficult in justifying its heavy investments in AI are necessary when Chinese upstart DeepSeek’s low-cost AI models are going viral rapidly. Capital expenditure,  including assets acquired under finance leases, surged 96.5% to $22.6 billion for the December quarter following a 78.6% YoY increase in CapEx three months earlier.  

Microsoft Chief Financial Officer (CFO) Amy Hood said part of the cloud revenue miss had to do with demand outpacing its available capacity for cloud services and that non-AI cloud services were lower than expected because it’s working to “balance driving near-term non-AI consumption with AI growth.”

“Azure growth included 13 (percentage) points from AI services, which grew 157% YoY, and was ahead of expectations, even as demand continued to be higher than our available (data center) capacity,” Hood told analysts on an earnings call. “Growth in our non-AI services was slightly lower than expected due to go to market execution challenges, particularly with our customers that we primarily reach through our scale motions.”  

Hood said that the data center capacity constraints should lift, or capacity should meet customers’ need, by the end of the current fiscal year.

Microsoft issued weak guidance for the current quarter, suggesting its key cloud business Azure would continue to slow down even thought it promised a rebund for the unit in the second half of its fiscal year. It anticipated revenue to between $67.7 billion and %68.7 billion, versus analysts’ forecast of $69.78 billion. Revenue from Intelligent Cloud is expected to grow between 19% and 20% in constant currency, or $25.9 billion to $26.2 billion, after a 19% YoY increase for the December quarter. Azure revenue growth for the third fiscal quarter is projected to between 31% and 32%, not much faster than that in the last quarter of 2024. Revenue from Azure and other cloud services gain 31% YoY from October to December, down from a 33% YoY increase for the preceding three months.  

Hood said Microsoft expected quarterly spend in the third and fourth fiscal quarters to remain at similar levels as that in the second quarter. In the fiscal 2026 year, the company expected to continue investing against strong demand signals, including customer contracted backlog it need to deliver against, across the entirety of our Microsoft Cloud, but the growth rate would be lower than the fiscal 2025 year.

"The second-half re-acceleration story for Azure is not playing out," Barclays analyst Raimo Lenschow said. "The company overly focused on AI workloads at the expense of core Azure. It will take time to fix this, which means the Azure growth acceleration the market had been hoping for has to wait for a little longer."

Many analysts are still optimistic on Microsoft. Goldman Sachs analyst Kash Rangan called the company “well-positioned” to continue benefiting from AI adoption and among the “most compelling investment opportunities” in the industry. “While investors wanted a more pronounced 2H (acceleration) from Azure, we continue to believe [Microsoft] is the predominant software AI winner,” Jefferies analyst Brent Thill wrote in a notes.