Tuesday, April 24, 2012

Apple's March Quarter Results: The Good, The Bad and The Irrelevant

On April 24th, Apple announced results for the company's 2nd fiscal quarter ended March 31, 2012. For the quarter Apple reported revenue of $39.186 billion and earnings of $12.30 per fully diluted share. These results represent year-over-year revenue growth of 58.9% and eps growth of 92.2%. 
Apple's results for the March quarter exceeded Wall Street estimates by a country mile and in after hours trading the shares retraced recently lost ground and closed the session above $600.
Apple has transformed from being the maker of individual product lines to a purveyor of an integrated device and services eco-system. The March quarter results demonstrate the company's growing global dominance of the both the smartphone and emerging tablet device markets while extending Apple's leadership in offering a broadening array of content for these devices. 
I've titled this article Apple's March Quarter Results: The Good, The Bad and The Irrelevant. I'd like to take each of these qualifiers in turn.
The Good
In the March quarter Apple sold 35.064 million iPhones, representing an 88% year-over-year increase in units sold. The iPhone gained market share among subscribers at  Verizon and AT&T despite the sequential decline in domestic iPhone sales. 
In the March quarter, Apple shipped 11.798 million iPads, representing 151% year-over-year unit sales growth. 
Apple's Asia-Pacific Region delivered 114% revenue growth based on strong demand for the popular iPhone 4S handset with ongoing product demand.
The revenue segment inclusive of iTunes delivered 32% revenue growth to $2.151 billion and the revenue total exceeded revenue from iPod sales by 78%, signaling while the iPod line continues its decline, Apple's revenue generated from content sales and services for iOS-based devices continues to rise. 

The Bad
Apple's iPhone sales in the quarter of just over 35 million handsets were boosted by a 2.6 million unit increase to global channel supply. While the channel supply expansion was warranted by sales volume, the prospects for strong year-over-year iPhone unit sales growth in the June quarter have been diminished. 
The iPhone 4S will have delivered its best quarter in the December quarter. This is not an issue of that fiscal quarter's 14-week length. It's an issue of slowing overall growth in the global smartphone market and the introduction of the current flagship handset early in that quarter with considerable pent-up demand.
The Mac line produced an uninspiring 2% year-over-year revenue gain on an increase in unit sales of 7%. The Mac line had a challenging prior-year comparison and the pace of growth in the overall PC market has slowed to a crawl, due in part to the success of the Apple iPad. But Apple's desktop and portable personal computers are in need of a major product refresh.
iPad unit sales in the quarter were impacted by a further reduction in product channel supply. Apple did not have sufficient quantities of the new iPad available to meet consumer demand. The new iPad will be Apple's revenue and earnings growth catalyst in the June quarter. The iPhone's year-over-year growth rate in the June quarter will be below the March quarter's 88% performance and Apple's ability to reach supply/demand equilibrium in the June quarter on the iPad will be essential for sustained strong revenue growth in the period. Apple reduced iPad channel supply to 2 million units, indicating three hundred thousand more units were sold through than the company reported as sales in the quarter. 
Gross margin is likely to diminish moving forward from the March quarter's impressive 47.37% rate. The iPhone represented 57.9% of revenue in the March quarter and that very high percentage of revenue from the iPhone line may not be seen again or seen again soon. The successor to the iPhone 4S is expected to be delivered in a new form factor and the product mix on the iPad will include lower-priced iPad 2s. Gross margin will diminish to a more sustainable rate starting in the June quarter. 
Questions were raised during today's conference call with analysts as to whether or not Qualcomm can provide sufficient quantities of chips for the next iteration of the iPhone. Production delays of any kind on the successor to the iPhone 4S will be problematic for Apple. 
The Irrelevant
Concerns earlier this week about the number of iPhones that were activated on the Verizon network and Tuesday morning's release of AT&T's iPhone activation number contributed to a share price tail spin. These numbers are now irrelevant. By the March quarter of next year, two-thirds or more of Apple's revenue will be sourced outside the United States. The Asia-Pacific region surpassed Europe in revenue generation in the March quarter and Apple's biggest markets for potential revenue growth are now outside the United States.
Android is irrelevant to Apple's sustained rates of growth. Most Android smartphone handsets are sold in price tiers that do not compete with the iPhone. The iPad is the undisputed leader in tablet-style products. The iPad owns the market and Android competitors at this time are not up to the fight.
Apple's biggest competitors are time and the pace of the company's own innovation. 
I maintain a $790 price target on the shares. 

Robert Paul Leitao
Disclosure: The author is long Apple and Qualcomm shares