Microsoft just flipped a $10 billion accounting win from its OpenAI investment restructuring, but investors aren't buying the good news. The software giant's shares tumbled 5% after hours Wednesday despite beating earnings expectations, as Azure cloud growth decelerated to 39% and a bombshell disclosure revealed that OpenAI now represents 45% of Microsoft's entire commercial backlog. The Q2 results expose the double-edged sword of Microsoft's AI bet: a massive paper gain today, but growing dependency on whether OpenAI can deliver on its $250 billion cloud commitment.
Microsoft just posted a fiscal second quarter that perfectly captures the AI era's contradictions: record-breaking commitments paired with nagging doubts about execution.
The Redmond giant delivered $81.27 billion in revenue for the quarter ending December 31, beating the $80.27 billion consensus and marking 16.7% year-over-year growth. Adjusted earnings hit $4.14 per share, topping expectations of $3.97. But the stock dropped 5% in extended trading as investors fixated on what's slowing down rather than what's speeding up.
The headline number that moved markets? Azure and other cloud services grew 39%, down a tick from 40% in the prior quarter. Analysts had expected somewhere between 38.9% and 39.4%, so Microsoft technically delivered. But in the high-stakes game of cloud infrastructure, even meeting expectations feels like losing ground when you're racing against Amazon Web Services and scrambling to monetize billions in AI investments.
Then there's the OpenAI situation, which is where things get interesting. Microsoft reported $9.97 billion in other income this quarter, a dramatic swing from $2.29 billion in other expenses a year ago. The source? A dilution gain triggered when OpenAI completed its restructuring in October, converting its for-profit arm into a public-benefit corporation. Microsoft's ownership stake decreased, and accounting rules forced the company to book a massive paper gain.
Net income ballooned to $38.46 billion, or $5.16 per share, compared to $24.11 billion a year earlier. Strip out the OpenAI impact and you get those adjusted earnings of $4.14 per share. The company's gross margin, meanwhile, narrowed to just over 68%, the thinnest it's been in three years as AI infrastructure costs pile up.
But here's the disclosure that has analysts buzzing: Microsoft's commercial remaining performance obligation, essentially future contracted revenue, hit $625 billion at year end, up 110%. OpenAI's $250 billion cloud commitment during the quarter drove that surge. The kicker? OpenAI now represents 45% of that entire backlog.
"The backlog is really good, but the disclosure that OpenAI is 45% of their backlog, it goes back to the situation where, Can OpenAI achieve these financial goals to pay Oracle, Microsoft and many of the providers," Jefferies analyst Brent Thill told CNBC's Closing Bell Overtime. It's a polite way of asking: What happens if OpenAI can't deliver?
Commercial bookings growth, which tracks quarterly activity rather than long-term commitments, surged to 230% from 112% in the fiscal first quarter. That's the OpenAI effect in action, though it also raises the stakes on execution.
Breaking down the segments, Microsoft's Intelligent Cloud unit delivered $32.91 billion in revenue, up nearly 29% and above the $32.40 billion StreetAccount consensus. The Productivity and Business Processing segment, home to Office, Dynamics, and LinkedIn, contributed $34.12 billion, up 16% and ahead of the $33.48 billion estimate.
The More Personal Computing segment stumbled, posting $14.25 billion in revenue, down 3% and missing the $14.38 billion consensus. Gartner reported PC shipments rose 9.3% in the quarter as Windows 10 support ended in October, but Microsoft couldn't capture that momentum. Xbox content and services revenue fell 5%, continuing the gaming unit's identity crisis that former Xbox executive Mike Ybarra called "confusing" in a since-deleted X post.
The infrastructure arms race continues unabated. Microsoft's capital expenditures and finance leases hit $37.5 billion in the quarter, up 66% and well above the $34.31 billion Visible Alpha consensus. Like Amazon, Microsoft is building data centers packed with specialized chips for running generative AI models, while also leasing capacity from CoreWeave and Nebius.
Microsoft made moves during the quarter to shore up revenue. The company announced price increases for commercial Office subscriptions starting in July, while Anthropic revealed plans to buy $30 billion in cloud services and contract up to a gigawatt of additional computing capacity.
The stock has fallen roughly 11% over the past three months while the S&P 500 gained 1%. Investors are grappling with whether generative AI represents a growth catalyst or a threat to Microsoft's traditional software margins. The Q2 results don't resolve that debate, they intensify it.
CEO Satya Nadella and CFO Amy Hood will face analyst questions about the OpenAI concentration risk and Azure's trajectory during their 5:30 p.m. ET earnings call. The $10 billion accounting gain is nice, but Wall Street wants to know if Microsoft can convert its massive AI investments into sustainable margin expansion without betting the farm on one partner's success.
Microsoft's Q2 earnings reveal a company at an inflection point, balancing a massive near-term accounting windfall against mounting questions about its AI strategy's sustainability. The $10 billion dilution gain from OpenAI's restructuring is real money on paper, but the disclosure that OpenAI represents 45% of Microsoft's commercial backlog creates a new kind of risk: What happens if the ChatGPT maker can't fulfill its $250 billion commitment? Meanwhile, Azure's deceleration to 39% growth, capital spending racing ahead at $37.5 billion per quarter, and shrinking gross margins paint a picture of a company spending heavily to maintain its position in the AI infrastructure wars. The market's 5% after-hours sell-off suggests investors aren't convinced the payoff is worth the concentration risk.
