Microsoft's cloud business Azure showed disappointing growth of 31%, falling below Wall Street's expectations of 31.8%, causing shares to drop 4.5% in after-hours trading.
The company faces pressure from Chinese competitors like DeepSeek, which claims to produce AI technologies at lower costs, raising fears of a potential price war.
Microsoft's capital expenditure hit $22.6 billion, exceeding analysts' estimates of $20.95 billion, as the company continues heavy investment in AI infrastructure.
CEO Satya Nadella reported that AI models are showing 10 times better performance for the price as Microsoft optimizes its algorithms.
Microsoft has added DeepSeek's AI model to its Azure offerings, with AI contributing 13 percentage points to Azure's growth in Q2, up from 12 points in the previous quarter.
Total revenue rose 12% to $69.6 billion, beating analysts' expectations of $68.78 billion, despite cloud division challenges.
Commercial bookings grew by 67%, primarily driven by large new Azure contracts with OpenAI, according to Microsoft VP Brett Iversen.
Microsoft's stock gained about 8% over the past year, lagging behind Alphabet's 29% and Amazon's 50% growth.
The Intelligent Cloud unit, which includes Azure, reached revenue of $25.54 billion but missed expectations of $25.76 billion.
Despite missing some targets, Microsoft reported a profit of $3.23 per share, exceeding the expected $3.11 per share.