Microsoft's magic hurts: Nadella signals 'tough choices' on the way

CEO sugar-coats the medicine for Nokia phone biz

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There’s nothing like sweetening the bad news medicine, and that’s what Microsoft’s tried with its latest internal staff memo.

It wasn't until the penultimate para of Satya Nadella’s saccharine, 20-paragraph ramble about magical things that Microsoft's CEO delivered the bad-tasting medicine.

“Tough choices” are coming in Microsoft’s impending fiscal year.

“We will need to innovate in new areas, execute against our plans, make some tough choices in areas where things are not working and solve hard problems in ways that drive customer value,” Nadella said.

Microsoft’s chief didn’t elaborate on what those tough choices will be, but all eyes must surely fall on Microsoft’s Windows Phone and Nadella's Nokia inheritance from Steve Ballmer.

Microsoft starts its new fiscal year on July 1 and reports the previous 12 months in the middle of next month.

June and July are an important watershed in the Microsoft calendar, marking the end of the old fiscal year and beginning of the new. It’s the time when budgets are set and when restructurings take place to deliver goals for the coming 12 months. As such, there’s already been blood-letting in the run up to the new year: long-timers Kirill Tatarinov and Eric Rudder are off, along with ex-politico and chief ads attack dog Mark Penn on June 17.

Also exiting the business is ex-Nokia-CEO-turned-executive-vice-president devices group Stephen Elop. He had run the phone hardware division since April 2014.

He joins 18,000 who Nadella has pink-slipped since becoming Microsoft CEO.

Many of those 18,000 jobs cuts have fallen, meanwhile, on Nokia staffers. The omens are particularly ominous for Windows Phone and Nokia.

In April, Microsoft told Wall Street at the end of the third quarter that things are going so badly with phone hardware it may cut its losses and write off the $7.2bn mobile and devices business acquisition – an act that would extract a Mosasaurus-sized chunk from earnings.

Here’s what Microsoft said about how bad it's got with the phone hardware unit, deep, deep, deep down in its Q3 10K filing with the SEC:

In the third quarter of fiscal year 2015, Phone Hardware did not meet its sales volume and revenue goals, and the mix of units sold had lower margins than planned. We are currently beginning our annual budgeting and planning process. We use the targets, resource allocations, and strategic decisions made in this process as the inputs for the associated cash flows and valuations in our annual impairment test.

Given its recent performance, the Phone Hardware reporting unit is at an elevated risk of impairment. Declines in expected future cash flows, reduction in future unit volume growth rates, or an increase in the risk-adjusted discount rate used to estimate the fair value of the Phone Hardware reporting unit may result in a determination that an impairment adjustment is required, resulting in a potentially material charge to earnings.

Phone hardware made $1.4bn in the third quarter but making and selling phones cost Microsoft $1.4bn. The phone hardware unit made $4m in losses on gross margin. Microsoft's sales are lagging even those of Windows Phone partners: 8.6 million Lumias (Nokia) moved versus 24.7 million non-Lumias sold.

But even this pales. To give you an idea of just how few Windows phones are shipping – that's both Microsoft and non-Microsoft handsets – 255 million Android phones were moved in the same time frame as Microsoft’s third quarter, according to IDC. ®

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