Tuesday, July 24, 2012

June Quarter Results: Apple's Melancholy Moment

On Tuesday, Apple reported underwhelming results for the three-month period ended June 30, 2012. For the quarter, Apple reported revenue of $35.023 billion and earnings of $9.32 per share, representing 22.58% revenue growth and eps growth of 19.57%. The fiscal quarter's outcome, against expectations of much stronger growth, represents Apple's melancholy moment and a slow-growth period in a six-quarter era of exceptional growth that began with the first quarter of the current fiscal year. 
Guidance and The Economy
For the current quarter, management offered conservative guidance of $34 billion in revenue and $7.65 in earnings per share. In the June quarter, all of Apple's major product lines, including the iPhone and the iPad, had unit sales results that were impacted by a challenging global economy, particularly in Europe. The iPhone's uninspiring 28% unit sales growth was also influenced by consumer expectations of a pending refresh of the product line. 
Apple's quarterly results represent a static snapshot of a fast-moving company. As much as the June quarter results were a disappointment, the outcome reveals both challenges and opportunities in the fiscal quarters ahead. 
Gross Margin
In the first six months of the current fiscal year, revenue growth zoomed forward at a 66% pace and earnings per share rose 104%. Apple's average gross margin during the six-month period was 45.9%. In the June quarter, gross margin dropped to 42.8% due to the impact of currency fluctuations, the lower price on the iPad 2 and a change in model mix on iPhone sales. Apple's gross margin moving forward may remain closer to the June quarter's outcome rather than return to the very high gross margin reported in the first two quarters of this fiscal year. Moderation in gross margin will move the rate of earnings per share growth closer to the rate of revenue growth in future quarters. 
In the first six months of the current fiscal year, the iPhone represented 55% of Apple's revenue total and the popular iPhone 4S delivered very attractive gross margin. In the June quarter the iPhone represented just over 46% of revenue.  The iPhone's smaller percentage contribution to the quarter's revenue total and the lower price on the iPad 2 lead to a sequential drop in gross margin from 47.37% to 42.8%. Although the successor to the iPhone 4S will generate industry leading gross margin, the change in the company's overall revenue mix and anticipated higher costs for the new flagship handset will influence gross margin throughout Apple's next fiscal year. 
Operating Expenses
Operating expenses, inclusive of stock-based compensation, remained under 10% of revenue in the June quarter. Operating expense discipline continues to positively impact the percentage of revenue that flows to the company's net income line. In the June quarter, about one-third of revenue flowed to the operating income line and about one-quarter of every revenue dollar landed on the net income line.
The iPhone Product Cycle
Throughout the conference call with analysts, management repeatedly mentioned the impact of consumer expectations of an imminent iPhone product line refresh on unit sales in the quarter. Consumers will, by the millions, postpone or delay iPhone purchases and iPhone handset upgrades in favor of waiting on the release of new models.
There are a number of factors that determine or influence the release dates for new iPhone handsets. These factors include production capacity, component supplies, planned releases of iOS updates and contracts with iPhone carriers. None of these factors are changed by consumer expectations for the release of a new iPhone.
At this time, all points lead to a fiscal first quarter (fourth calendar quarter) release of the successor to the iPhone 4S. The iPhone 4S will remain the company's flagship iPhone handset for about 12 full months. Very high rates of revenue growth will be realized in the first two quarters of next fiscal year due to the release of a new flagship iPhone and the expected lower prices on the iPhone 4 and iPhone 4S models. Between now and the release of a new iPhone handset, overall revenue growth will be held in moderation even with a strong September quarter for the Mac and iPad product lines. 
A Look At Apple's Global Numbers
Apple manages its business on a geographic basis.  The table below details Apple's revenue results by region with sequential and year-over-year performance comparisons. Revenue is in millions of dollars:



FQ3 2012
FQ3 2011
FQ2 2011







Due to a number of factors including the fact that the new iPad was not available for sale on China's mainland during the June quarter, revenue growth in the Asia-Pacific region decelerated to 24.56% from the 83.45% growth rate in the first six months of the current fiscal year. Asia-Pacific has recently been Apple's fastest growing revenue region and the dramatic slowdown in the rate of revenue growth in the region had the biggest single impact on Apple's June quarter revenue performance. The Asia-Pacific region will return to a much faster rate of growth in the September quarter due primarily to the release of the new iPad on China's mainland.

The release of the new iPhone handset and an eventual agreement with China Mobile to become an authorized iPhone carrier will deliver in the first two quarters of next fiscal year rates of revenue growth in the Asia-Pacific region that are similar to the rates of revenue growth realized in the region during the first half of the current fiscal year.

It's no secret Europe is experiencing economic challenges that took years to develop and will take years to resolve. For at least the next four fiscal quarters, Europe's rate of revenue growth will be below Apple's average rate of revenue growth for the company as a whole.  In the June quarter Europe represented about 24% of Apple's recognized revenue total. Slower growth in Europe will hamper the company's overall rates of growth. Revenue growth in Europe came in at 16%.

The continuing popularity of the iPhone product line in the United States and strong education channel sales of the iPad line of products delivered 26% revenue growth in Apple's largest revenue region. Although iPhone unit sales in the Americas were down sequentially, the iPhone displayed competitive strength as the iPhone 4S approaches the end of its one-year reign as Apple's flagship smartphone product.

Apple had its highest education sector performance in the company's history in the quarter and education channel sales assisted in boosting Mac unit sales to a slight 2% year-over-year gain against a backdrop of a global PC industry in economic decline.  The Mac's unit sales performance in the quarter was impacted by a shortage of Retina displays for the MacBook Pro line. Management expects the display shortage to be resolved in August.

The table below details Apple's unit sales performance in the June quarter by product line with sequential and year-over-year unit sales comparisons. Units are in thousands:




FQ3 2012
FQ3 2011
FQ2 2011





Moving Froward
No matter's Apple's "melancholy moment" in the June quarter, I expect the share price to reach $700 by early November in response to the release of a new flagship iPhone, a rebound in the rate of revenue growth in the Asia-Pacific region in the September quarter due to the release of the iPad on China's mainland and expectations for a strong  iPad performance in the holiday quarter. I also anticipate a strong MacBook Pro performance during the September quarter's back-to-school season.
The June quarter's outcome doesn't diminish Apple's growth prospects over the next four to six quarters. However, the quarter's performance highlights conditions and circumstances that will moderate growth in certain quarters each fiscal year. Moderate rates of growth will be the norm in quarters that do not include major refreshes of the iPhone or iPad product lines.
I expect strong share price performances from component makers Broadcom (BRCM), Cirrus Logic (CRUS) and Qualcomm (QCOM) through the March quarter of next year and the completion of the global rollout of the next flagship iPhone model. I also expect the availability of the iPhone 4 at a lower post-subsidy price to boost overall iPhone unit sales next fiscal year.
Robert Paul Leitao
Disclosure: The author is long Apple, Broadcom, Cirrus Logic and Qualcomm