Tuesday, October 18, 2011

Spaceship Apple Comes Down To Earth

Apple's September results were below most expectations. The $28.27 billion in revenue represented a $300 million sequential decline and a comparatively languid 39% year-over-year gain. On earnings per share, the 52% year-over-year rise to $7.05 was far below the 96.2% rate of eps growth realized over the first nine months of the fiscal year.
The Good News In The September Quarter
Mac Unit Sales: If there's good news to be found in the September quarter results it's the 26% growth in Mac unit sales against a global PC market with diminished prospects for continuing growth. In addition to strong unit sales growth, revenue from Mac sales rose 29%. 
Asia-Pacific: The Asia-Pacific region (exclusive of Japan) turned in a 139% increase in revenue. Although the September quarter's pace of revenue growth was below the rates of growth in the region realized in the previous two fiscal quarters (down from 247% growth in the June quarter), China is Apple's most important growth market at this point in time. Asia-Pacific's $6.53 billion revenue contribution represented 23.1% of Apple's total revenue in the period.
Apple's December Quarter Guidance: Management has guided to revenue of $37 billion or 38.4% revenue growth and eps of $9.30 or growth of 44.6% over the December quarter one year before. But keep in mind December quarter 2011 (FQ1 2012) includes an additional shipping week that occurs once ever six years to better align fiscal quarters with calendar quarters. The unusual 14th week is the week immediately after Christmas. Absent the additional shipping week, guidance would have been more conservative and it moves a high revenue week away from the following quarter. 
The Not-So-Good News In The September Quarter
Retail Stores: Despite a 25% increase in Mac unit sales at the stores in the September quarter and the first fiscal quarter in which the retail stores sold over 1 million Macs, overall store revenue rose only 1%. Apple ended the quarter with 357 stores open for business and new stores were opened in the fiscal period. This 1% revenue rise includes the revenue activity of new stores opened within the past year. Retail store traffic and revenue growth remain heavily influenced by seasonal factors and Apple product refresh cycles. 
iPhone Sales: Management stated during the conference call with analysts that September unit sales were materially impacted by a drop-off in demand ahead of the release of  the new iPhone 4S handset. iPhone unit sales growth remains heavily dependent on the company's product refresh cycle. The 16% sequential drop in unit sales is in light of surging global smartphone demand and the meager 21% year-over-year gain in unit sales is against a prior-year period in which Apple ended the quarter with constrained supplies of the then latest handset. Although Apple reported outsized unit sales growth for the iPhone of 142% in the June quarter, both Asia-Pacific and the Verizon agreement were big factors in that gain. 

iPad Sales: iPad unit sales growth was below most expectations.  More than half of the reported 20% sequential unit sales growth to 11.123 million units was due to an increase in channel supply. But for reasons known only to management at this time, Apple kept channel inventory below 4 to 6 weeks of supply ahead of the holiday quarter. Even though the September quarter results were below expectations, the product line delivered 166% year-over-year unit sales gains. 
Currently there isn't an established global market for tablet products. Of all of Apple's current product offerings, the Apple iPad represents the best proxy for measuring the economic spread of the underlying eco-system for the company's iOS-based devices.
Spaceship Apple Comes Down To Earth
Apple's September quarter results were below most expectations and the quarter's results may signal the recent era of frenetic rates of revenue and earnings growth has come to an end. Sustaining 45% to 55% revenue growth in FY 2012 is not an easy task for a $100+ billion company. I do expect the company to sustain revenue growth within that range. 
Don't Blame Apple: For those us with high expectations for the September quarter, Apple's results were a disappointment. But Apple is not immune from macro economic influences and consumer willingness to postpone purchases in favor of waiting for much-anticipated new product releases. I've been the owner of an iPhone 4S handset for less than 72 hours and I will say the new iPhone was worth the wait. 
My Mea Culpa: Referencing my own high expectations, I feel like a soccer goalie who guessed wrong on the direction of a kick during a penalty shoot-out and in front of a global audience. 
My estimates are based in part on recent historical trends and are influenced by expectations of the company's expansion into new regions. My analysis also indicated greater strength in the underlying eco-system than what was revealed in the September quarter results. I overestimated the strength of the underlying eco-system to sustain product sales and underestimated the consumer sales sensitivity to anticipated new products. The September quarter outcome was counter to the trends I identified over the most recent four fiscal quarters. This quarter's data will assist me in not making these same mistakes again. 
On the numbers, I expected Apple to more aggressively fill the global channel with supplies of iPads ahead of the holiday season and I expected continued strong adoption of the original iPhone 4 in recently added regions, other regions in which the iPhone 4S will not be available for several more weeks or a few months and among customers of recently added carriers. It was the Asia-Pacific region that delivered the biggest surprise on Mac unit sales. 
The quarter's results indicate Apple's rates of revenue and earnings growth, even as a $100+ billion global enterprise, remain highly dependent on product refresh cycles and customer anticipation of new and refreshed products. The iPad 2 is an excellent product and the iPad delivered 166% unit sales growth year-over-year in the September quarter.  But even the iPad's year-over-year unit sales growth will not push the rate of revenue growth for the company as a whole beyond the 45% to 55% rate of growth I now forecast for the current fiscal year. The iPad, the iPhone and continued good news from the Mac will sustain revenue growth within my targeted range. 

Spaceship Apple has come down to earth. Let's see how fast it travels with management's feet planted firmly on the ground. 

Robert Paul Leitao

Disclosure: The author is long Apple shares.