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Microsoft (MSFT -6%) is trading lower after reporting Q2 (Dec) results last night. The software giant posted a solid double-digit EPS beat. Revenue rose 12% yr/yr to $69.63 bln, which was above analyst expectations. However, the Q3 (Mar) revenue guidance was a bit light of expectations. Also, its Intelligent Cloud (IC) segment was a bit below prior guidance and its closely-watched Azure number was at the low end of guidance.

• Let's start with Azure, which grew +31% CC (constant currency), marking it at the low end of its +31-32% CC prior guidance. MSFT noted that Azure AI results were better than expected. However, there were some challenges on the non-AI side with some indirect customers that MSFT reaches thru partners and indirect sales. MSFT expects Q3 Azure revenue growth to be +31-32% CC. The Azure AI side is seeing good demand but MSFT expects ongoing impacts through H2 on the non-AI side as it works to address execution challenges.
• In terms of the broader IC segment shortfall, Azure appears to have played a role. However, MSFT also said that FX was a bigger headwind than expected. Also, Azure non-AI services, on-prem server, and Enterprise and Partner services were slightly lower than expected, partially offset by better-than-expected results in Azure AI services. Azure also can have quarterly variability from in-period revenue recognition depending on the mix of contracts.
• The company made what we thought was a notable comment on the call. It expects Azure AI to be capacity constrained in Q3, however, by the end of FY25, MSFT expects it should be roughly in-line with near-term demand given its significant capital investments. We have heard a lot from MSFT in recent quarters about how its AI capacity constraints have held back results, so it will be interesting to see how they perform without being constrained.
• Its two other segments, Productivity and Business Processes and More Personal Computing both performed better with sales coming in ahead of prior guidance.
• When asked about DeepSeek's impact on AI spend, MSFT said that DeepSeek has had some real innovations. Also, it noted that what's happening with AI is no different than what was happening with the regular compute cycle. When token prices fall, inference computing prices fall, that means people can consume more, and there will be more apps written. For a hyperscaler and PC platform provider like MSFT, the company believes this is all good news.

Overall, the DecQ results were a bit of a letdown. Microsoft typically outperforms guidance in all three segments each quarter. However, coming up a bit light in IC and with Azure on the low end, that has spooked investors a bit. We think the market may be overdoing the concern a bit. Had Azure's Q3 guidance dipped into the 20's percent range, we would be more worried, but guidance is +31-32% CC. Also, the weakness is more on the non-AI side which is less troublesome, in our view. We look forward to Amazon's AWS performance next week.