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Microsoft Beat on Earnings Because Its Phone Business Is Finally Dead

Overall, Microsoft's (NASDAQ: MSFT) earnings report last night was pretty solid, beating consensus estimates for both top- and bottom-line results. Office 365 consumer subscribers climbed to 27 million, Azure revenue nearly doubled, and the software giant's commercial cloud annualized revenue run rate now exceeds $18.9 billion.

There were some soft spots, like revenue guidance coming in slightly below analyst forecasts. One item in particular was a mixed bag: the phone business.

Image source: Getty Images.

Burying the dead

Microsoft's struggles in the smartphone market over the past decade are well-documented, and the acquisition of Nokia's handset business didn't help. The company has been winding down its phone operations over the past two years, with the process finally being completed last month at the end of its fiscal 2017. Here's an excerpt from the last 10-Q in April:

Phone Hardware Restructuring 

In June 2015, management approved a plan to restructure our phone business to better focus and align resources (the "Phone Hardware Restructuring Plan"), under which we eliminated approximately 7,400 positions in fiscal year 2016. 

In fiscal year 2015, we incurred restructuring charges of $780 million under the Phone Hardware Restructuring Plan, including severance expenses and other reorganization costs. In fiscal year 2016, we reversed $21 million of previously estimated restructuring charges related to contract termination costs. The actions associated with the Phone Hardware Restructuring Plan were substantially complete as of June 30, 2016, and are expected to be completed by the end of fiscal year 2017. 

2016 Restructuring 

In the fourth quarter of fiscal year 2016, management approved restructuring plans that would result in job eliminations, primarily across our smartphone hardware business and global sales. In addition to the elimination of 1,850 positions that were announced in May 2016, approximately 2,850 roles globally will be reduced during fiscal year 2017 as an extension of the earlier plan. These actions are expected to be completed by the end of the current fiscal year.

With this process complete, Microsoft was finally able to deduct losses from prior years associated with the phone business that were not deductible in the years that the losses were incurred.

Specifically, we're talking about a $18 billion tax benefit that Microsoft was able to recognize last quarter, which put its effective tax rate at a negative 17% on a GAAP basis (negative 6% on a non-GAAP basis). Excluding this tax gain, Microsoft's GAAP tax rate would have been 19% during the quarter. The gain boosted earnings per share by a full $0.23; without that benefit, Microsoft would have posted $0.60 in earnings per share, a penny worse than what analysts were modeling for.

Yep. MS' GM Investor relations Chris Suh just said to me there's effectively no revenue in the phone segment, at this point.

— Mary Jo Foley (@maryjofoley)

Microsoft phone revenue is already pretty much nonexistent at this point. Phone revenue fell $361 million last quarter relative to a year ago, and the company discontinued Windows Phone support earlier this month (it still supports Windows 10 Mobile as the spiritual successor).

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Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Evan Niu, CFA has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.