Microsoft sees drop in phone revenue as Nadella pledges more efficiency for entry-level smartphones

Microsoft (NASDAQ: MSFT) suffered its worst quarterly loss in the second quarter thanks in large part to its $7.5 billion writedown of its purchase of Nokia's (NYSE:NOK) devices and services business. Yet Microsoft CEO Satya Nadella said the software firm remains committed to smartphones and the broader mobile market as it prepares to unveil Windows 10, its newest operating system. He said that Microsoft would in particular focus on being more efficient in the entry-level smartphone market.

Microsoft posted a net loss in its fiscal fourth quarter, which ended June 30, of  $3.2 billion, and revenue dipped 5.1 percent to $22.2 billion. Analysts on average had expected sales of $22 billion, according to data compiled by Bloomberg.  

Microsoft was hit with a $7.5 billion non-cash impairment charge related to assets associated with the acquisition of the Nokia hardware business, in addition to a restructuring charge of $780 million. There was also a charge of $160 million related to the previously announced integration and restructuring plan, adding up to $8.44 billion in total.

Earlier this month, Microsoft said it would cut 7,800 jobs, mainly in the phone business, an acknowledgement of its struggle to gain traction. In the last quarter, Microsoft said that its phone hardware revenue fell 38 percent year-over-year to $1.23 billion.

That happened despite Microsoft seeing an uptick in Lumia Windows Phone smartphone sales to 8.4 million units, up more than 10 percent from the year-ago period. However, revenue fell because of a decline in average selling prices, since Microsoft was selling more low-end phones. Microsoft also said that it sold 19.4 million non-Lumia mobile phones, down year-over-year, as the market for feature phones continues to shrink.

Nadella has said Microsoft will focus on building smartphones for three main categories: for business users, entry-level phones for value phone buyers and flagship phones for "Windows fans." Nadella has also said Microsoft will release "premium" phones this year. Yet the company is going to scale back the number of phone models it sells.

On the company's earnings conference call, Microsoft CFO Amy Hood said that with the recently announced changes in the phone business, "there will be significant revenue declines year-over-year in the phone segment each quarter. With the proactive measures we've taken to reduce our cost structure, overall losses will also decline for the fiscal year. We would expect the majority of that improvement in the second half of the year once the restructuring efforts are materially complete."

Nadella said Microsoft is now thinking about Windows 10, which is designed to will run every Windows 10 device from phones to PCs to its HoloLens augmented reality headset, in a more holistic way.

"We clearly are going to have premium first-party portfolio, and you've seen some of the numbers, some of the progress we have made in Surface," Nadella said on the call, according to a Seeking Alpha transcript. "I feel that we have a formula there that I would like to apply more broadly in terms of growing, just delivering innovation, growing our own economic return for it, stimulating demand, creating categories. All of that is what I want to do broadly. And it applies to phones, it applies to Surface hardware, it applies to HoloLens, and that's how I view it."

Nadella said he thinks Microsoft's "participation in the phone segment by itself with Windows phones and Lumia phones being there is important, and that's why we picked the three areas where we have differentiation and we want to focus on it." He said flagship phones will be coming for Windows 10 and that is "actually a segment we don't today have good devices, and we hope to change that with Windows 10."

Nadella said Microsoft has "good traction" in the business segment. "This is business customers who are actually buying phone devices, which is basically a radio with essentially a smartphone to be able to deploy their line-of-business applications," he said. "That's where we have pretty unparalleled value, which is we have Visual Studio Online and some of the tools I talked about, so you can generate these apps at a low cost of ownership, manage them, secure them, and deploy them to our phone endpoints, and then of course, management and security. So that's a place where we want to continue to focus."

In the "value" segment, Microsoft is going to be "much more efficient" than it has been, Nadella said. "We clearly have some value to add there because of the uniqueness of Office and Skype and our services," he added. "But at the same time, I think we want to be smart about how many of these phones do we want to generate, how many, which price points we want to participate. That's where you will see the most significant operational changes from how we operated last year to the coming year."

Separately, Microsoft said that Panos Panay, the corporate vice president in charge of Microsoft's Surface tablet, will be taking on more responsibilities following the departure of Stephen Elop, who had been Microsoft's devices chief. Panay will be in charge of engineering for all Microsoft premium devices, including Surface, Windows phones, the Xbox gaming console, the Surface Hub conferencing system, Microsoft fitness Band and HoloLens.

A Microsoft spokesperson confirmed to ZDNet that Panay "will be taking over (engineering for) premium devices." Panay is under Terry Myerson, who is leading a new team at Microsoft called the Windows and Devices Group.

For more:
- see this release
- see this Seeking Alpha transcript
- see this WSJ article (sub. req.)
- see this Bloomberg article
- see this Reuters article
- see this The Verge article
- see this ZDNet article
- see this Windows Central article

Special Report: Wireless in the second quarter of 2015

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