Original URL: http://www.theregister.co.uk/2011/04/24/apple_looks_in_better_shape_than_it_is/

Behind Apple's record sales are signs of desperation

Hailstorm of lawsuits hints at vulnerability

By Wireless Watch

Posted in Financial News, 24th April 2011 08:00 GMT

As we went to press with this story, Apple had just reported its first quarter results and Nokia was about to. For both arch-rivals, the quarter will not be indicative of longer term trends. For Apple, there has been disruption to its supply chain, while Nokia's future will be hard to judge until it launches its new WP7 devices.

Until then, Nokia remains in a state of limbo, and its quarter will reflect that in no uncertain terms. Nokia may be suffering the downward swing of the handset pendulum at the moment, but Apple itself is hovering precariously at the top of the curve. Its own fears that it could start to slide downwards are only reinforced by its hailstorm of legal actions against its challengers, which have even now extended to its key supplier Samsung. And as Google's own results indicated the company has only just begun in the mobile market, there is a bigger cloud on Apple's horizon – whether the cloud itself will be its undoing in mobile.

Apple's quarter

Apple's quarter beat records as usual, but did not convince that the firm is more than a one-trick pony in mobile. It is a pretty pedigree pony to be sure, with the iPhone booming on increased US distribution, thanks to Verizon, and international reach. The handset sold 18.65m units in the quarter, up 113 per cent on the year-ago period. However, Apple – like all of its rivals – needs to expand beyond the smartphone segment as even the high end starts to commoditise, a process that the large Android ecosystem is better equipped to handle. And the iPad, though dominant in the nascent tablet category, is not yet proving that the category itself is a winner, or will be more than a niche form factor in the wave of new, cloud-focused products that will appear over the next few years.

The iPad sold 4.69m tablets, fewer than the 6.1m predicted by analysts or the 7.3m of the holiday quarter. It remains to be seen whether this is a short-term supply issue or an indicator of limited demand for the form factor. CFO Peter Oppenheimer said Apple sold "every iPad 2 we could make", suggesting Apple is experiencing parts shortages, though Apple officially said the earthquake was not having a "material impact" and that it was ramping up iPad 2 production. "The iPad has the mother of all backlogs," said acting CEO Tim Cook.

Overall, Apple's revenue rose 83 per cent year-on-year to $24.67bn, though the figure was 8 per cent lower than the holiday quarter of 2010. Net profit leapt by 95 per cent to $5.99bn or $6.40 a share, which was flat on Q410. Gross margin slipped slightly, from 41.7 per cent a year ago to 41.4 per cent. Analyst consensus forecasts had looked for revenues of $23.34bn and earnings of $5.36 a share. A strong sign for Apple was that international sales were up to 59 per cent of the total, addressing its historic over-reliance on north America in the mobile business.

But for the current quarter, Apple forecast profit and sales below analysts' predictions, at $5.03 a share on revenues of $23bn, (though it traditionally issues conservative guidance). Gross margin will be down to 38 per cent this quarter, the firm said.

Apple sues Samsung

The note of caution surrounding even these strong results is clear, and an even stronger signal of Apple's new vulnerability is heard in its frantic round of litigation. Samsung is the latest iPhone challenger to feel the heat, despite the close relationship between the two firms; the Korean vendor supplies memory, processors and touchscreens to Apple, which is its second biggest customer. However, Apple has filed suit alleging that the Galaxy handsets and tablets infringe iPhone/iPad patents and their trademarked appearance.

In targeting the rise of Android, Apple is picking off the vendors whose products are eating most seriously into its installed base and the mystique of its mobile platform. Samsung joins HTC and Motorola, though the iPhone maker is yet to attack Google itself. Apple also has a complex series of tit-for-tat lawsuits ongoing with Nokia, covering a wide range of patents.

The actions indicate Apple's increasing sense of vulnerability and its determination to slow down the progress of Android, and perhaps stop Nokia in its smartphone tracks altogether. Each lawsuit focuses on slightly different areas, with the Samsung actions concentrating on patents that relate to the use of hand gestures on the touchscreens. They also allege copying of the colors and rectangular shape of the Apple products. The complaint, filed on 15 April in federal court in Oakland, California, says the Galaxy products were deliberately designed to copy Apple's gadgets.

Specifically, it cites seven patents related to the way the devices understand gestures, including selecting, scrolling, pinching and zooming, plus three patents on the design, including the flat black face. Samsung also is accused of copying onscreen icons and trademarks for certain icons, including green boxes with phones or a sunflower for photos. Apple also claims the packaging is copied.

"Instead of pursuing independent product development, Samsung has chosen to slavishly copy Apple's innovative technology, distinctive user interfaces, and elegant and distinctive product and packaging design, in violation of Apple's valuable intellectual property rights," the complaint reads.

"What's of concern is that you can see the strategic relationship between Samsung and Apple getting worse of late," Kim Young Chan, an analyst at Shinhan Investment in Korea told Bloomberg. "As Samsung pushes ahead with its handset and tablet business, Apple is trying to keep Samsung in check."

Steve Dowling, a spokesman for Apple, commented: "It's no coincidence that Samsung's latest products look a lot like the iPhone and iPad, from the shape of the hardware to the user interface and even the packaging. This kind of blatant copying is wrong, and we need to protect Apple's intellectual property when companies steal our ideas.

"Samsung will respond actively to this legal action taken against us through appropriate legal measures to protect our intellectual property," was the official statement from the Korean firm, but the country's Yonhap news agency quoted executives saying that, in fact, it was Apple which violated Samsung IPR. One commented: "Apple is one of our key buyers of semiconductors and display panels. However, we have no choice but respond strongly this time."

In fact, Apple was Samsung's second largest customer in 2010, accounting for 4 per cent of its total revenue of $142bn. Apple may have been trying to reduce its dependence on the firm, for instance by reducing Samsung's design and manufacturing input to its A4/A5 processors, but it will not be able to avoid it, given the shortages of touchscreens and memory chips and the problems already seen in tablet parts.

Apple suffers reverse in ITC

The courts may take years to decide on the merits of the case, and how far a rectangular shape really can be patented, but the rising tide of lawsuits in smartphones shows the level of competition, and Apple's sense that its day in the sun is over. Filing suit over elements like shape and color smacks of desperation, as do some of the patents cited in Apple's separate battles with HTC, Motorola and Nokia. A key decision went against Apple in the US International Trade Commission this week, with a judge ruling for HTC and Nokia. The vendors are accusing the iPhone maker of "dredging up" ageing patents in its determination to stop rivals in their tracks.

A lawyer at the ITC has said that Nokia and HTC did not infringe Apple patents, a recommendation which is highly likely to be adopted by the full body when it reaches its final verdict in early August. Apple has been seeking to block imports of both Nokia and HTC smartphones to the US, as part of broader legal battles with the Finnish giant, and a wider attack on the Android community – also involving Motorola and now Samsung. This case is only one of several against Nokia. Last month, the ITC ruled against Apple in a separate complaint against Nokia.

The HTC ruling is particularly important because it is likely to have implications for the whole Android base. Apple claims the Taiwanese vendor infringes five patents that are vital for "seamless integration of hardware and software". Some, related to signal processing and interprocess communications, date from the early 1990s and "were, at best, a very narrow distinction" from the inventions of others, HTC lawyer Robert Van Nest told ITC judge. "HTC is a smartphone innovator and pioneer in the smartphone sphere. They were there long before Apple," he said. "The fundamental differences from the Apple patents represent choices made by HTC and Google."

One of the signal processing patents involved in the HTC suit is also cited in a complaint against Nokia, and this was spun off from the wider ITC suit against the Finns, which should be decided by 24 June. Nokia lawyer Pat Flinn, of Alston & Bird, accused Apple of "dredging up patents" when it was approached for royalties by mobile pioneers like Ericsson and Nokia itself, according to Bloomberg. "Advances in technology have made the patent moot," Flinn said of the signal processing IPR.

HTC and Nokia have their own countersuits against Apple and Nokia has also sued over fundamental wireless patents for which it claims the iPhone maker does not pay royalties, even though most of the handset industry does. HTC's counterclaims will be heard from 9 May.

The importance of patents

Legal ups and downs generally end up having limited impact on actual product sales, but patents are increasingly vital to building a power base in the mobile market. This is something Google understands, and has prompted it to become the stalking horse bidder for Nortel's huge IPR portfolio.

Here, it was expected to come up against Apple too, but in fact RIM may emerge as the counter-bidder. It is reported to be preparing a rival bid for Nortel's huge store of patents. The BlackBerry maker was said to be interested in the assets when Nortel was first being broken up in the bankruptcy court, and could see the patents both as a new revenue stream and a way to increase its fighting power against Android and Apple. Under the rules of the court, a second bidder would have to offer Nortel at least $929m and subsequent bids would have to be at least $5m more.

Google clearly needs to strengthen its relatively weak IPR power, compared to that of key rivals and litigants, such as Apple, Microsoft and Nokia. Therefore it is likely to raise its price in order to secure the patents and could easily outrun RIM. The Canadian firm may, though, bid as part of a group, which according to Bloomberg's unnamed sources could contain other technology vendors and even other handset makers.

Ownership of patents is vital to being a real power player in wireless, where licensing of IPR still relies primarily on bilateral tit-for-tat agreements rather than pools or the "reasonable and non-discriminatory" principles of other standards. Even firms that rarely go to court aggressively over their patents, like Microsoft, know that their IPR mountains protect them – and their handset partners – from many lawsuits.

RIM could gain backing from other firms which have an interest in limiting the power of Google over the mobile industry. The patents collection represents one of the largest ever to come to market as a single portfolio and covers many key technology areas, especially those used in LTE, such as MIMO.

Google just starting in mobile

A relatively small IPR position is only one of the signs that Google is a newcomer to the mobile game, but that makes it all the more worrying for Apple; it still has a lot of growth to achieve, while Apple may be peaking already. At its results announcement, Google talked up its huge mobile potential even as it delivered first quarter results that disappointed because of the firm's galloping costs. CFO Patrick Pichette said the company "tripped" into a $1bn mobile business without massive effort, leaving the audience to imagine what could be achieved once Google really started to try. Jeff Huber - SVP of commercial and local services under Google's recently announced new management structure – said mobile search had increased by more than 500 per cent in the past two years, while 350,000 Android devices were being activated a day. More than three billion Android Market apps have been installed to date.

For the first quarter, Google saw earnings up 17 per cent year-on-year to $2.3bn but its shares dropped by 5 per cent, because costs grew more quickly than revenues. The latter were up 27 per cent to $8.6bn, with paid-for clicks on adverts a key driver. Operating expenses were a third of revenue, the highest proportion since 2007, and some investors are concerned at the trend, since Google plans to add a further 6,200 staff to its 23,300-strong workforce this year, the highest number in its history. Many will be focused on expansion areas like mobility, with new CEO Larry Page putting emerging technologies at the heart of his strategy. The co-founder took over the top job this month from Eric Schmidt, who stays on as chairman.

Pichette justified these rising expenses, saying: "It's clear that our past investments have been crucial to our success today - which is why we continue to invest for the long term ... We just happen to have great opportunities to fuel. Why not carpe diem now? It's there to take."

He hastened to add that Google was committed to financial discipline and all investments were regularly reviewed against productivity measures. As of 31 March, the firm had cash reserves of $36.7bn and it is expected to make further acquisitions in the key areas of mobility and social networking this year.

The next fight will be in the cloud

All this could leave Apple in a weakened position, especially if it does not move more aggressively to embrace the cloud/browser trend, which may eventually start to eclipse the apps business where it succeeds so well. Apple has made only halfhearted moves in this direction, and has been outsmarted by firms like Amazon so far. We remain unconvinced of the chances for the new breed of cloud-focused operating systems – webOS, Chrome OS, Microsoft Jupiter and MeeGo – but they do indicate where the tide of mobile web behavior is flowing, and Apple is notably absent.

Hewlett-Packard, for instance, is pushing webOS as a full cloud platform, providing a low power, browser-based system that can run in every imaginable connected gadget and, where required, coexist with full OSs like Windows. And HP is now reported to be preparing a music and movie store for its upcoming TouchPad webOS tablet, with a heavy emphasis on streaming and cloud storage. HP is likely to focus on multiscreen content rather than mobile-specific items. This is in line with its webOS strategy, which looks to run the system in all kinds of devices. HP's store will support a mixture of downloaded and cloud content, according to a presentation leaked to the PreCentral site for Palm enthusiasts.

As HP and Amazon leap ahead with such platforms, Apple is left in the unusual position, when it comes to content and user experience, of being behind the curve. It may call the iPad a "post-PC" product, but it still depends on a PC or Mac to sync information. iOS devices need a PC link to update the OS, move content, back-up and restore, and activate the gadgets. Only Apple TV 2 provides a fully streamed, self-activating platform. That may point to changes that will also reach the iPhone and iPad, along with streamed content and web services for iTunes and App Store. But Apple is moving too slowly, and all the lawsuits in the world will not make up for a misstep when it comes to jumping on the mobile cloud bandwagon.

Copyright © 2011, Wireless Watch

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