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Wireless Infrastructure Newsletter

Devices weigh on both Apple and Microsoft July 23 2014

iPhone and iPad sales disappoint Wall Street and Nokia hits its parent's profits, but both firms thrive in enterprise

By Caroline Gabriel

Perhaps this is the shape of the future. Rivals Apple and Microsoft reported solid quarterly results, but handsets were not the star in either, while hopes of future growth were focused heavily on enterprise services. Reinforcing the idea that Microsoft's decision to enter the smartphone business with the Nokia acquisition was a miracle of bad timing, it seems that companies must look beyond the competitive and saturating cellphone space for their growth.

For Apple, iPhone and iPad sales were strong by most firm's standards, but disappointed Wall Street. As reports mount up about the vendor making record orders for next generation iPhones from its suppliers, the slump in sales of the current models, as users anticipate the new offerings, may be more marked than usual. CEO Tim Cook said there were new products which "we can't wait to introduce", but gave no details. CFO Luca Maestri commented: "We're seeing some purchase delays and we've reflected that in our guidance. It happens. We have to live with that."

Despite hopes for the 'iPhone 6' and other rumored launches like the iWatch, the most discussed source of hope for future growth was the new and important enterprise alliance with IBM, which could ensure that Apple retains its market lead over Android in that segment for the long term, and gains some of the cloud-based services it lacks.

Enterprise cloud was the shining star of Microsoft's quarter too, though CEO Satya Nadella will be well aware of the threat from the IBM/Apple tie-up in vertical sectors. Cloud and corporate software drove the software business to exceed expectations, helped by surprising buoyancy in the business PC space, which also helped Intel's quarter. Revenue from Office 365 and the Azure cloud platform doubled year-on-year and were hailed as "pillars of strength" by CFO Amy Hood. She added that commercial cloud products now have an annual run rate of $4.4bn.

Meanwhile, as Daniel Ives of FBR Capital Markets put it, "Nokia continues to be the black cloud over Microsoft". The former Finnish business accounted for nearly $2bn in revenue in the quarter, but also for a $692m operating loss. Nadella says the phone unit is on track to break even on an operating basis in 2016, a long path for a business which already looked non-strategic to its owner only weeks after its purchase was completed.

So the pattern is clear, despite the huge differences between the two firms - by contrast with the high hopes for business and cloud offerings, device sales are not exciting investors.

Apple's fiscal third quarter, which ended in mid-June, saw revenue below analyst expectations, at $37.4bn, rather than the anticipated $38bn, but up 6% year-on-year. Net income was up 12% to $7.7bn and earnings per share were five cents above forecasts, at $1.28. The company sold 35.2m iPhones in the period, up from 31.2m a year earlier, but this was below Wall Street hopes of 35.78m. Likewise, the iPad came in 1.16m units below expectations at 13.3m, down from 14.6m in the year-ago quarter. The iTunes, software and services segment was up from $4.1bn last year to $4.48bn in revenue, but again, below analyst predictions of $4.53bn.

The iPad is a particular concern, as it is now Apple's second largest source of revenue. Cook said sales hit internal targets, but admitted they were below Wall Street expectations. The tablet remains the market leader but is being squeezed by a host of Android models in many price brackets, as well as alternative 'post-PC' form factors such as Chromebooks. It tends to have a longer upgrade cycle than the handset's typical two years, and rarely attracts operator subsidies. More than half of iPads are sold to first-time tablet buyers, a very different pattern from the iPhone, which depends heavily on the upgrade market.

Amid all these factors, the iPad posted its second quarter in a row of declining year-on-year sales, shifting 13.3m units. Cook blamed weakness in the critical US market, on which Apple is always somewhat over-reliant, and a reduction in channel inventory. However, he said on the analyst call: "We're very bullish about the future of the tablet market, and we're confident we can continue to bring innovation to this category through software, hardware, and services." He said there was strong growth in the BRIC economies and in education, and expects the IBM deal to help too.

Overall, almost 60% of sales now come from outside the US. Chinese iPad sales rose by 51% year-on-year, and iPhone shipments by 48%, though despite the distribution deal with China Mobile, Apple remains in fourth place in smartphones in the country. iPad sales were also up 45% in India. "China, honestly, was surprising to us," Cook said. "We thought it would be strong, but it went well past what we thought."

The company said that, in its fiscal fourth quarter, it expects to bring in between $37bn and $40bn in revenue, which fell slightly short of Wall Street estimates of $40.44bn. But the critical quarter will be the next one, when the new iPhone should make its debut in time for the holidays. Anticipation of a large-screened version is rising along with consensus that Apple will need to do something dramatic this time, to fend off Android competition in key markets. The latest results emphasize the company's critical reliance on its handset, which accounts for about 70% of total profit and contributed over $91bn in revenue last year.

"Apple's fortunes are tied to the iPhone," Michael Binger of Gradient Investments told Bloomberg. With the smartphone market becoming crowded and low-margin, that may not be a comfortable position for the company in the years ahead.

At Microsoft, results generally beat estimates, but profit was hit hard by the acquisition of Nokia's devices unit. In its fiscal fourth quarter, the company reported net income of $4.61bn, or 55 cents a share, including adjustments related to Nokia. Without Nokia-related items and taxes, the figure would have been 66 cents. Wall Street had anticipated 60 cents with the Nokia items and 64 cents without, indicating that the acquisition has had a far bigger negative impact on earnings than expected. Nadella recently announced 12,500 cuts to the former Nokia workforce in a broad refocusing of Microsoft, to focus heavily on the cloud and to de-emphasize most devices, and even Windows itself.

Nadella built on those announcements during the earnings call, emphasizing enterprise and cloud achievements and promising that the three main Windows versions - Windows 8, RT and Phone - would converge into one. "We are galvanized around our core as a productivity and platform company for the mobile-first and cloud-first world, and we are driving growth with disciplined decisions, bold innovation, and focused execution," he said in his statement. "I'm proud that our aggressive move to the cloud is paying off."

Microsoft decimates Nokia division July 18 2014

Under CEO Nadella's reorganization, 18,000 jobs will go, 12,500 former Nokia employees, as role of devices is squeezed

By Caroline Gabriel

Given the tone of Microsoft CEO Satya Nadella's recent manifesto about the future of Microsoft, which was clearly cool about the acquisition of Nokia's devices business, it came as no surprise that, as the company confirmed one of the biggest programs of layoffs in its history, the handset division was the chief casualty.

Microsoft may be increasingly multiplatform with its cloud applications and mobile enterprise tools - the heart of Nadella's strategy - but it still wants to offer an end-to-end, Windows-based solution for the substantial base of enterprises which trust that approach. Nadella may know that 'Windows everywhere' is no longer a viable strategy, but that doesn't mean Microsoft will not still push its own OS as a superior option, enhancing it and reducing its licensing fees. So the mobile devices strategy, after flirting with Android, will now be refocused entirely on Windows Phone.

Here, Microsoft will pursue a 'bottom-up' approach, seeking to make WP8 a serious competitor to Android on low end devices and attract OEMs in that space, and investing in its hubs in Brazil and Vietnam.

That will involve the axing of the Nokia X Android line, despite recent upgrades to it post-acquisition, and also Nokia's elderly Series 40 platform, which gained its second wind in the past couple of years by powering the Asha range of 'smart featurephones'. The shift to Windows Phone-only does remove confusion for OEMs, and sees Microsoft doing what it should have done all along - optimizing its smartphone OS for the segments where there is still significant growth, in emerging markets where the Nokia brand is still strong.

It is almost certainly too late for Microsoft to gain mass market share for Windows Phone, despite its attractions and differentiated experience, at this stage, and a bolder Nadella might just have killed it - as surely he will one day. After all, if he was serious about being a high volume smartphone maker, he would have stuck with Android and Nokia X. So soon after the acquisition of Nokia, however, it would have angered shareholders to make a complete U-turn, effectively telling them Microsoft had wasted its money. So, like Google with Motorola, Microsoft will hang on for now and seek to extract the jewels from its purchase, such as R&D inputs to Xbox and Surface, its more important hardware activities.

And Android activity will not be dead of course - Microsoft is increasingly releasing business and consumer productivity apps, and web services, for Android and iOS ahead of its own operating systems.

The change of emphasis in devices will cost 12,500 former Nokia employees their jobs, in a total cull of 18,000 staff (14% of the workforce) across Microsoft, designed to meet Nadella's objectives of streamlining and reducing time to market. A memo from Stephen Elop, former Nokia CEO and now head of a much-reduced Microsoft devices kingdom, said that the cellphone unit will now target two markets - "future high end Lumia products" and "more affordable devices". R&D for both lines will be driven out of Finland, from the former Nokia centers in Salo and Tampere.

The high end products - which presumably will, one day, converge with, or replace, Windows RT - will be delivered "in alignment with major milestones ahead from both the Windows team and the Applications and Services Group", which likely means a new version of WP and Office early next year.

At the low end, handset design will focus on "driving Lumia volume in the areas where we are already successful today in order to make the market for Windows Phone", which suggests a concentration of the pared-down resources on Nokia's traditional strongholds such as India, but also on South America via Brazil. Microsoft has new manufacturing hubs in Vietnam and Brazil but will reduce engineering in Beijing and San Diego, though both sites will continue to have "supporting roles", the Chinese team in developing affordable devices in Beijing and the California group in specific US requirements. Two more Nokia centers in Finland, Espoo and Lund, will still operate and will focus on application development, Elop said. Microsoft will shut down the Nokia plant in Hungary, which employs about 1,800 people.

Nadella steers Microsoft away from 'devices and services' July 16 2014

Major job cuts loom, including in former Nokia business, as CEO puts cloud first, and chases new productivity

By Caroline Gabriel

Microsoft CEO Satya Nadella has issued a manifesto for his company's future, clearly indicating a shift away from devices - a move which is likely to be underscored by upcoming job cuts.

The missive - a 3,000-word email to employees, but also made public - raised alarm bells for the former Nokia business, and those will soon become louder. Microsoft is expected to make swingeing job cuts within the next few weeks, which are likely to hit the handsets activity hard, and just to rub salt in the wound of bad timing, Nomura analysts also expect the firm to take a charge of at least $1bn "to mitigate the risk of the Nokia acquisition" - finalized, of course, less than three months ago.

Not that Nadella is suggesting axing hardware like Surface or Xbox, but we can expect a slowdown in any new moves to expand the mobile range, especially the Nokia family. The document places the cloud platform Azure - which Nadella formerly headed up - at the heart of the company, and in a pointed strike at his forerunner, Nadella writes: "While the devices and services description was helpful in starting our transformation, we now need to hone in on our unique strategy."

Nadella wants Microsoft to become the "productivity and platform company for the mobile-first and cloud-first world", he writes - and by productivity, he looks "beyond solely producing something to include empowering people with new insights". He argues that people are "swimming in a growing sea of devices, apps, data and social networks" and need applications and gadgets that can make sense of that, for instance by dividing work and personal data intelligently.

However, under all this vision there are plenty of old Microsoft favorites being dusted off for the new era. We might have hoped Nadella would be bold enough to turn his back on hardware altogether, given the limited success of Surface and the conflicts with OEM partners. But he insists that Surface Pro 3 "is the world's best productivity tablet" and that "we will build first-party hardware to stimulate more demand for the entire Windows ecosystem".

This is, however, a shift away from older Microsoft claims that it would take significant tablet and handset market share over time. Instead, like Google with Nexus, it is focusing on making new markets, stimulating interest and showing what can be done, and then stepping back for OEMs to ramp up the volume.

Nadella wants to stop talking about individual devices, or even about mobile, and to create 'experiences' which are common across all kinds of screens, gadgets and connections. "While today many people define mobile by devices, Microsoft defines it by experiences," he says. "We're really in the infant stages of the mobile-first world. In the next few years we will see many more new categories evolve and experiences emerge that span a variety of devices of all screen sizes."

The CEO acknowledges that achieving his goals will need "fundamental cultural changes", including management and organizational shake-up, which will prompt groans in many quarters, given what a short time has elapsed since Ballmer's last big restructuring. One of the critical aims of the latest shake-up will be to address criticisms, from the Microsoft board as well as many customers and partners, that development times are too slow for the rapidly changing needs of enterprises, consumers and the mobile world. "Every team across Microsoft must find ways to simplify and move faster, more efficiently," Nadella writes. "We will increase the fluidity of information and ideas by taking actions to flatten the organization and develop leaner business processes."

Flatter structures and streamlined processes usually mean significant layoffs too, and Microsoft's stock leapt to $42.47 on Tuesday morning on Wall Street anticipation of these efficiency drives.

The uptick was prompted by a research note from Nomura's Rick Sherlund, which predicted "bold moves and organizational changes" as well as increasing his earnings forecast from $45 to $50 for the fiscal year. He expects Microsoft to take a $1bn-plus charge related to changes in strategy following the Nokia acquisition - probably connected to major cuts to the 25,000 workforce that came with that transaction.

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