Heralding a general retrenchment in the cellphone business, Motorola Inc. (NYSE: MOT) pre-announced disappointing quarterly results this morning, leading to the biggest drop in the handset maker's stock in almost five years.

While the Schaumburg, Ill.-based company said sales volume was strong, at 66 million units shipped in the quarter, average sales prices and margins were obviously sharply down. After gaining market share in 2006 with the slim, stylish RAZR phone, Motorola saw its sales slide to between $11.6 billion and $11.8 billion, below the company's earlier predictions of as much as $11.8 to $12.1 billion and below consensus analyst estimates. The launch of the KRZR phone, expected to build on RAZR's momentum by selling 6 million units in the quarter, has been a disappointment, while some analysts are now referring to a "collapse" in handset margins as manufacturers slash prices to win market share, particularly in fast-growing Third-World markets such as India and China. (See KRZR Burn.)

“We are very disappointed with our fourth-quarter financial performance,” said Ed Zander, Motorola's chairman and CEO, in a statement, “but we remain committed to the strategic direction and long-term financial targets we discussed at our annual analysts meeting in July 2006."

The disappointing report from Motorola, which opens the earnings season for cellphone manufacturers, had a ripple effect across the industry as handset makers from Nokia Corp. (NYSE: NOK) to Samsung Corp. to Ericsson AB (Nasdaq: ERIC) (part owner of the Sony Ericsson Mobile Communications joint venture, the fourth-largest cellphone manufacturer in the world) saw their shares decline.

Industry observers say a price war has developed over the last 12 months in a business that hit the 1 billion mark in worldwide handset sales in 2006. As developing economies in Asia, with their huge populations of cellphone users, become the most important battleground for handset makers, some companies are selling devices at $50 or less. Nokia CEO Olli-Pekka Kallasvuo said in October that average selling prices for his company's handsets had fallen 9 percent, to 93 euros ($121.70) in the third quarter.

The price war has tipped the delicate balance between margins and market share, according to Daryl Armstrong, wireless telecom equipment analyst at Citigroup .

"If [Motorola] felt the need to reduce pricing to the point of sharp margin contraction in what should be the seasonally strongest period of the year, what are the prospects for the seasonally weak [first quarter] of '07?" Armstrong wrote in a research note this morning. Citigroup has downgraded its rating on Motorola's stock from "Buy" to "Hold."

Motorola shares were down 8.18 percent on the NYSE as of 11:14 a.m. Eastern time.

— Richard Martin, Senior Editor, Unstrung