Devices weigh on both Apple and Microsoft

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

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.”

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