Microsoft's plan for the future is still costing it profit today.
The company that once dominated the computer industry is making the transition to a world where software lives on many devices, all managed online in the cloud. As Microsoft makes that shift, its commercial division -- which sells its Windows operating system and Office productivity apps to businesses -- continues to take a hit.
Microsoft on Thursday reported fiscal third-quarter results that exceeded analysts' estimates. But it also said sales in its cash cow commercial division grew only 5 percent, and overall profit fell 12 percent year over year. Sales growth in the division declined steadily in the past 12 months. The company said current quarter growth of its commercial division would have been 2 percentage points higher if not for currency fluctuations.
The decline in commercial revenue has investors worried about Microsoft's ability to shift direction. The company was slow to move into the cloud and holds a negligible share of the mobile market.
Microsoft CEO Satya Nadella and his team are increasingly asking corporate customers to think of Office and Windows software not as products you buy or software that comes pre-installed on a PC, but as services that live online and persist over time. Microsoft hopes it can make money by convincing customers to pay annual subscriptions to products like cloud storage and Office 365, rather than buy software licenses they update occasionally. Many companies that sell to business, including Oracle and Symantec, have already made that shift. Microsoft's cloud businesses currently account for only about 5 percent of total revenue.
"Transitioning our customers to the cloud is a critical element to our ongoing transformation," Amy Hood, Microsoft's chief financial officer, said on a conference call with investors Thursday.
But that change in business model means Microsoft has been forfeiting short-term profit to gain a foothold in what it considers the future of software in a world where applications like Word and Excel move across your desktop to your tablet and smartphone. The end result last quarter was substantial drops in both consumer and commercial sales of Windows and Office software.
Microsoft's commercial cloud businesses grew 106 percent from this time a year ago. The division is now on track to pull in more than $6.3 billion annually. On the consumer side, subscriptions for Office 365 Home and Personal increased to more than 12.4 million, up 35 percent from this time a year ago.
For the three months ended March 31, the company said profit was $5 billion, or 62 cents a share, compared with $5.7 billion, or 68 cents a share, a year ago. Sales were $21.7 billion, up 6 percent from $20.4 billion a year ago.
That beats the average estimate of analysts surveyed by Thomson Reuters, which forecast earnings of 51 cents a share for the period and $21.1 billion in sales.
Microsoft is also being dragged down by a strong US dollar, which makes its products more expensive for international customers, and declining PC sales. Research firm IDC expects PC shipments to fall 4.9 percent to this year.
Nokia, Surface still on the rise
Though not as integral to profit as its commercial business, Microsoft's devices and consumer division -- which includes sales of its Xbox game console, Nokia smartphones and Surface tablets -- continues to grow, albeit at a slower pace.
Last quarter, sales of Microsoft's Nokia Lumia smartphones grew 18 percent year over year to 8.6 million units, yet that represents a drop from the all-time high of 10.5 million units in the fiscal second quarter where sales surpassed the $2 billion mark. Windows Phone revenue was down 16 percent from this time a year ago.
Revenue of the Surface tablet division rose 44 percent, to $713 million, from a year ago thanks to Surface Pro 3 sales. Overall, the company's devices and consumer division increased 8 percent from a year ago to $9 billion.
Update at 2:45 p.m. PT: Added additional details.