Microsoft Reports Soaring Azure Revenue In Q3, But CEO Nadella Says That Surface 'Fell Short'

Microsoft said Thursday that sales surged in Azure, Dynamics 365 and other cloud categories during its fiscal third quarter, ended March 31, while the company also saw a number of positive signs in its personal computing segment.

But the company's Surface line of devices wasn't one of those bright spots.

Microsoft reported that revenue for Surface—which includes the Surface Pro 4 and Surface Book—plunged 26 percent during its fiscal Q3. Sales of Surface products were $831 million in the quarter, down from $1.11 billion a year earlier.

[Related: Microsoft Touts Cloud Revenue Growth, Looks Ahead To LinkedIn Opportunities]

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"This quarter our Surface results fell short of expectations," Microsoft CEO Satya Nadella said during the company's earnings call. Nadella cited increased price competition as a key reason for the sluggish results.

However, the slowdown also comes after Microsoft passed on updating the Surface Pro line of 2-in-1 tablets in 2016—the Surface Pro 4 came out in the fall of 2015—and offered only a minor update for the Surface Book detachable laptop.

The drop in Surface product sales and the absence of phone revenue—the company unloaded its phone business in November—fueled a 7 percent decrease in revenue for Microsoft's personal computing segment during the fiscal third quarter. That segment, which is Microsoft's largest business, came in at $8.8 billion in the quarter.

The drop came despite good news from other parts of the personal computing segment, including in Windows OEM revenue (up 5 percent), Windows commercial products and cloud services revenue (up 6 percent) and gaming revenue (up 4 percent).

Overall for Microsoft's fiscal third quarter, revenue climbed 8 percent to $22.09 billion, up from $20.53 billion during the same period a year earlier.

Microsoft reported net income of $4.80 billion, or 61 cents per share, for its fiscal Q3. That's compared to $3.76 billion, or 47 cents per share, in the year-ago quarter.

The growth was driven by a strong showing for the vendor's intelligent cloud offerings and an even stronger showing for Microsoft's productivity and business processes segment. That segment saw revenue growth of 22 percent during the fiscal third quarter, to $8 billion.

Office 365 revenue grew 45 percent as subscribers reached 26.2 million in the quarter, while Dynamics 365 revenue surged 81 percent.

"On Dynamics 365, we are at the very, very beginning phase of the transition of Dynamics from primarily being on-premise to now being a very modern, modular, SaaS service," Nadella said during the earnings call. "The Dynamics 365 momentum is picking up … That's definitely going to be true in the quarters to come and the years to come."

Meanwhile, LinkedIn contributed revenue of $975 million during Q3 to the productivity and business processes segment. The LinkedIn acquisition closed on Dec. 8, making this the first time that Microsoft has been able to count a full quarter of LinkedIn financial results.

For the intelligent cloud segment, Microsoft generated a revenue increase of 11 percent during its fiscal Q3, to $6.8 billion.

Azure revenue rose 93 percent—and server products licensed on-premise grew 6 percent—leading to revenue growth of 15 percent in the server products and cloud services segment during the quarter. However, that was offset somewhat by a 1 percent drop in enterprise services revenue, Microsoft reported.

On the growth of Azure, "the driver of a lot of it is net new" demand such as Internet of Things workloads, Nadella said during the earnings call. "IoT was not a workload on the old server world."