Monday, February 6, 2012

Apple: Rising Revenue, Falling Costs Per Revenue Dollar

For the 14-week period ended December 31, 2011, Apple reported record revenue in the fiscal quarter of $46.333 billion representing a 73% year-over-year gain. The company also reported a 115.7% rise in earnings per share to $13.87. No one can dispute the success of the company's popular products. But Apple's extraordinary eps growth in the December quarter and eps growth over the past two fiscal years was influenced by more than revenue growth alone. The company's focus on cost discipline is generating earnings growth at a much faster pace than the underlying rate of growth in revenue. 

Apple's Net Income Per Revenue Dollar
The graph below illustrates the rising percentage of reported revenue that has flowed to the net income line over the most recent nine fiscal quarters. In the December quarter 27.90% of reported revenue flowed to the net income line. This does not include the beneficial impact on net income from interest and other returns on the company's holdings in cash and marketable securities. The value of those assets totaled $97.6 billion at the end of the December quarter. 

Apple's Expenses Per Revenue Dollar
Over the most recent nine fiscal quarters, the percentage of reported revenue consumed by expenses has fallen from a high of 79.60% in the 3rd quarter of FY2010 to a low of 72.10% in the recent 1st quarter of FY2012. The graph below illustrates the percentage of revenue consumed by cost of sales (the inverse of gross margin), operating expenses and taxes.

Operating Expenses As A Percentage of Revenue
While the costs of manufacturing the company's products is the largest expense each quarter and will vary as a percentage of revenue due to product refresh cycles and the often higher costs per unit on newly released products, the company's ability to drive down operating expenses as a percentage of revenue has been particularly impressive. The graph below illustrates the rates of revenue growth and operating expenses (OpEx) over the most recent nine fiscal quarters. Because operating expenses have both fixed and variable cost components, the faster the rate of revenue growth in a quarter, the more pronounced the difference in the rates of growth between revenue and operating expenses. 
In a December article titled Where Apple Makes Its Money, I detailed the company's revenue sources by geographic region and the operating expenses assigned to those regions in fiscal years 2011 and 2010. The graph below illustrates the falling percentage of revenue consumed by operating expenses as the company's global sales footprint continues to expand. From a high of 12.2% of revenue consumed by operating expenses in FQ2 2010 to a low of 7.26% in FQ1 2012, Apple continues to drive down the percent of revenue consumed by this major cost component. 

Apple's Expense Components Compared
The graph below illustrates the percentage of total expenses represented by the three major expense components. Apple's tax expense will vary based on the company's operating income and the geographic region in which the revenue is sourced. The initial release of the iPhone 4S in the United States during the December quarter with limited release in other geographic regions increased the average tax liability in the quarter to 25.25% of pre-tax income. US corporate tax rates tend to be higher than the tax rates in Apple's other geographic regions. 

A Note On Gross Margin
Apple reported 44.7% gross margin in the December quarter. This high margin was influenced by the popularity of the iPhone 4S handset which came to market during the quarter without a form factor change from the iPhone 4. Gross margin will vary each quarter based on product refresh cycles and manufacturing economies of scale. I expect gross margin to remain comparatively high through the quarters in which the iPhone 4S handset is the company's flagship smartphone product. 
The popularity of Apple's digital products is fueling strong rates of revenue growth. Coupled with high gross margin and a focus on cost discipline, strong rates of revenue growth are delivering extraordinary rates of growth in earnings per share. For example, in the December quarter, revenue rose 73% while earnings per share rose 115.7%. I expect the rate of growth in earnings per share to far outstrip the rate of growth in revenue through FY2012 that ends in late September.
Robert Paul Leitao
Disclosure: The author is long Apple shares