Crystal Ball

Companies in turnaround often plead to investors for time to let the changes they’re planning take root. Sometimes, as is appearing to be the case with Yahoo, time ticks on with little sign of improvement. Other times, as with HP, recovery is slow and meager.

Microsoft’s turnaround under Satya Nadella is a species unto itself. Only five months into his tenure as Microsoft’s CEO, the company is showing both signs of pain and of improvement. The company’s earnings report for the fiscal year ended June 30 provides more evidence of both.

Microsoft’s stock initially slipped in after hours trading Tuesday when it reported that its earnings of 55 cents a share missed analyst estimates by five cents a share. Everyone was bracing for the $7 billion Nokia acquisition to take a toll, but not that big a toll.

Soon enough, Microsoft’s stock was trading up nearly 2 percent as investors had a chance to digest more metrics. Notably, commercial revenue rose 11 percent in the quarter, driven by server products like Azure and SQL Server. Revenue from cloud services grew 147 percent.

That growth is coming without a corresponding increase in costs: Microsoft said commercial gross margins grew by 10 percent in the quarter. Not only is Microsoft showing an ability to grow revenue in cloud computing, it’s doing so while benefiting from economies of scale.

Microsoft’s commercial business has been much healthier in recent years than its more visible consumer offerings, but there were surprisingly encouraging here as well. Revenue from Windows OEM grew 3 percent. Office consumer revenue rose 21 percent thanks to a 1 million unit increase in Office 365 subscriptions. Bing search revenue rose 40% as Microsoft’s share of the US search market increased to 19.2 percent.

If these improvements continue, Nadella will be credited with an impressive turnaround at Microsoft. But much of these initiatives have been in the work for years, under Steve Ballmer, particularly in the commercial division and the dogged determination to stick with Bing in the era of Google.

That doesn’t mean Nadella doesn’t have a difficult challenge ahead. The last quarter’s strength in Windows revenue has more to do with an upswing in the replacement cycle of PC software than anything else. PC sales may be stabilizing after losing market share to tablets, but there still aren’t strong indications that anything more than weak growth can be expected in this core area of Microsoft.

Nokia also remains a big challenge. Microsoft can’t benefit from the dwindling sales of feature phones in an era where cheap smartphones are spreading around the world. Nokia’s operations may help Microsoft’s mobile OS claw out a larger share of the market for smartphones, but not before a lot of job cuts come. Analysts are expecting Nokia to remain a drag on earnings for the next year at least.

That means reading Microsoft’s earnings today involves a bit of crystal-ball gazing into the mid-term future. What will Microsoft look like once the pain and transformation begins to finally pass? Microsoft bulls are looking at the spotty areas of growth and finding reasons for encouragement.

Ballmer may have laid the foundation for a Microsoft turnaround (while also doing plenty in his tenure to muck things up at the company), but it’s up to Nadella to manage the transition. Microsoft still has many chances to keep mucking up its future. From the indications in today’s earnings, the opportunity for a true turnaround is its own to lose.