Surface sales sag and Windows Phones fade, as Microsoft's hardware business takes a hit

As the company reports "negligible revenue from phones," its huge Nokia investment fades into nothing.

Four little words from Microsoft CFO Amy Hood describe the tragic state of Microsoft's mobile experiment: "negligible revenue from phones."

Phone sales for the current quarter were bad, falling $730 million from the same period a year ago, Microsoft executives said Thursday during the company's second-quarter earnings call. But they can't fall much further: Hood was referring to a forecast of the current quarter ending in June, when sales of all Microsoft-branded phones will apparently trickle off into oblivion.

Microsoft also said it suffered lower-than-expected sales of Surface Pro products, with an overall drop of 26 percent in Surface revenue. Third-party hardware partners appear to be doing better, however: Microsoft said that sales of its Windows 10 Pro operating systems grew by 10 percent, as more PC vendors were able to sell premium PCs that used Microsoft's more advanced operating system.

Why this matters: Microsoft's hardware woes contrast sharply with the welfare of the company as a whole, as Microsoft's cloud services bolstered the bottom line. Microsoft reported profits of $4.8 billion on $22.1 billion in revenue, up 28 percent and 8 percent, respectively, from a year ago. "I'm proud of the progress we've made," said Satya Nadella, chief executive of Microsoft. While the company has repeatedly insisted Windows Phone isn't dead, however, the slow fade of its own phones doesn't help the platform's prospects.

Down go Windows phones, and Surface too

The Windows phone woes come as no surprise, given that sales of Microsoft's devices have spiraled ever downward quarter after quarter. Microsoft's market share in the mobile phone market is in the single digits within the United States and struggles overseas, as customers jump ship for Android and iOS. Microsoft essentially paid $7.17 billion for a Nokia phone business that went nowhere.

Microsoft also seemed to put meager effort into its most recent update for Windows phones, the Windows 10 Mobile Creators Update, which lacked major features.

Third-party partners like HP are still free to continue making phones, and Microsoft does continue to support the operating system with patches and upgrades within its Insider program. Some have speculated that Microsoft may finalize its plans to bring the entire Windows 10 ecosystem onto one common code base, making a "phone" a PC that can be carried in your hand. For now, however, Hood's words appear to be one of the nails in the coffin of the Windows phone.

An unexpected surprise was how Microsoft's Surface tablets fared. Microsoft's Surface revenue fell to its lowest point in the last five quarters, with just $831 million in total revenue. Part of that might be attributed to seasonality, as Microsoft reported a high-water-mark for Surface revenue, $1.3 billion, during the fourth calendar quarter of 2016. Microsoft attributed the drop to competition to what it called "product end-of-lifecycle dynamics."

The company didn't explain this term, but most likely it means that customers are turning away from Microsoft's aging selection. Microsoft hasn't refreshed the Surface Pro series since Oct. 2015, when it launched the Surface Pro 4 and Surface Book. Next week, Microsoft is expected to launch a new device, possibly branded as a Surface, for the education market. Most speculate it will be a rugged, clamshell device, running the rumored Windows 10 Cloud OS.

Microsoft didn't say much about its Xbox business, simply noting that gaming revenue came in at $1.9 billion. Xbox Live subscribers rose from 46 million a year ago to 52 million.

Microsoft's HoloLens made a surprise appearance. Nadella reminded analysts that the one-year anniversary of broad HoloLens availability had just concluded, and that Microsoft now had 150 HoloLens-specific apps within its Store. Nadella clearly still feels Microsoft hardware has a role in the company's future: "Surface Pro, Book, Hub, Studio, HoloLens are all creating new markets for the Windows ecosystem and pushing differentiation with new natural user capabilities: ink, vision, voice, touch, and mixed reality," he said. Interestingly, he didn't include Windows Phone in that list.

Microsoft's cloud services, though, continue to carry the company forward. Microsoft's revenue for its Intelligent Cloud segment, which includes Azure, climbed by 11 percent to $6.8 billion. Office also continues to be a key driver: Office consumer licenses jumped 15 percent, with the number of subscribers growing to 26.2 million. Office commercial products were up 7 percent.

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Mark Hachman

PC World (US online)
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