Apple: It’s a Matter of What, Where and Why

For the fiscal quarter ended Saturday, December 28th, Apple will report record revenue and earnings per share. There’s no disputing the popularity of Apple’s iPhone and iPad product lines. As of today Wall Street analysts are expecting revenue of $57.31 billion and earnings per share of $14.05. This is in contrast to revenue of $54.51 billion and eps of $13.81 in the prior-year quarter. 

As the founder of the Braeburn Group, I am currently collecting December quarter estimates from our global network of independent analysts. Although management has guided to revenue in the quarter of $55 billion to $58 billion, the independents by and large are expecting a revenue performance above the upper threshold of guidance. I will be publishing the Braeburn Group Estimate Index for the quarter on Sunday, January 5th. 

However, Apple’s quarterly results are merely a static snapshot of a fast-moving enterprise object. More than a purveyor of independent device lines, Apple has become a customer relationship continuum with a global platform of inter-related products and services. 

Among the factors influencing near-term results are management’s decision to increase the amounts of device sales revenue deferred for recognition in future periods, the pace of the company’s geographic expansion and the seasonal nature of the company’s product refresh cycles. Apple’s growth is best viewed not by quarters but by fiscal years. In today’s article I will look at Apple’s growth across a variety of measures and metrics. 

Apple: It’s A Matter of What, Where and Why

The graph below illustrates Apple’s FY2013 revenue mix by product line. In the fiscal year ended in September, over 72% of the company’s reported revenue was derived from the iPhone and iPad product lines. While this concentration of revenue in two product lines for a company that reported over $170 billion in revenue might on the surface seem alarming, the concentration of revenue is emblematic of Apple’s dynamic product mix and the changing nature of the digital device markets. 

The graph below illustrates Apple’s revenue growth by product line in fiscal years 2012 and 2013. In FY2013 the rates of revenue growth in year-over-year comparisons were impacted by the release of the lower-cost iPad mini and slowing rates of growth in the high-end smartphone market. While the average selling price (ASP) for the iPhone fell from $629 in FY2012 to $607 in FY2013, the average selling price for the iPad fell from $531 to $450. 

Moving into FY2014, the reported ASP for the iPhone will be impacted as much by the recent change in deferred revenue on each iPhone sold as any other factor. Apple’s apparent ability to meet demand for the iPhone 5s more quickly than for any new iPhone release in the past will assist in stabilizing reported revenue per unit sold. 

The Retina display iPad mini, at a higher per unit price than the original, will buttress the iPad’s ASP this fiscal year. In FY2014, there will be a stronger correlation between the rates of unit sales growth and revenue growth than in the slower-growth FY2013 that ended in September.

Apple's Competent June Quarter

In the first six months of Apple's current fiscal year, the device maker realized revenue growth of 66.35% and earnings per share growth of 104.03%. The successful release of the iPhone 4S and the addition of new carriers such as Sprint pushed recognized revenue from iPhone sales up nearly 107% in the six-month period and represented 55% of the company's revenue total.

On July 24th, Apple will release results for the fiscal quarter ended June 30th. While I don't expect the pace of revenue and earnings growth in the June quarter to match the rates of growth realized in the first six months of the fiscal year, I do expect Apple to report strong growth in what I am calling "Apple's Competent June Quarter."

For the quarter, I expect revenue growth of 41.37% to $40.391 billion and eps growth of 53.40% to $11.95 per share. In the June quarter I expect the Apple iPad line to have delivered the largest percentage of year-over-year revenue growth among Apple's major device lines while the iPhone will deliver the biggest revenue growth numbers. Combined, I expect the iPhone and iPad to deliver 75% of the quarter's recognized revenue total. 

The chart below illustrates my anticipated revenue mix by product line:

Apple's Monster Quarter - The Sequel

Last fall I dubbed Apple's December quarter "The Monster Quarter". The company's December quarter performance lived up to the name. In the 14-week period ended December 31, 2011, Apple reported recognized revenue growth of 73.27% to $46.333 billion and eps growth of 115.71% to $13.87. 

Apple's Monster Quarter - The Sequel
Today I am calling the company's March quarter "Apple's Monster Quarter - The Sequel." For the 13-week period ended March 31, 2012, I am estimating reported revenue of $44.028 billion and earnings per share of $13.15, representing anticipated revenue growth of 78.49% and eps growth of 105.47%. 

The chart below illustrates my estimated revenue mix for the March quarter. I expect the Apple iPad and iPhone to represent 77% of the reported revenue in the quarter and for the iPhone to be the primary product in determining the quarter's revenue growth, gross margin and eps outcome for the period.

Apple: March Quarter Expectations After Record FQ1 Results

On Tuesday Apple announced record quarterly revenue of $46.333 billion and record eps of $13.87 in the December quarter. The 73.2% rise in revenue and 115.7% rise in earnings per share were fueled by strong domestic demand for iPhones, iPads and Macintosh personal computers and by gross margin in the quarter of 44.7%.

In announcing the company's FQ1 results for the 14-week period, Apple offered revenue guidance of $32.5 billion for the 13-week quarter ending March 31, 2012 and earnings guidance of $8.50 per share. Management's guidance suggests revenue growth of 31.75% and eps growth of 32.8%. Once again, Apple's guidance will be proven decidedly conservative. 

December Quarter Revenue Growth Recap

Apple's 73.2% revenue growth in the December quarter was aided by a 14-week fiscal period encompassing the immediate post-Christmas shopping week and extraordinary revenue growth in Apple's Americas region, exclusive of the company's retail stores. The Americas delivered 92% revenue growth to $17.714 billion, representing 38.2% of total reported revenue on strong sales of the Apple iPhone 4S. 

Despite the well publicized economic problems in Europe, the region turned in a strong revenue growth rate of 55% for the quarter. Apple's Asia-Pacific region, absent the release of the iPhone 4S through an authorized carrier on China's mainland, turned in a respectable 54% revenue growth rate. The Asia-Pacific region will be the catalyst for robust revenue and earnings growth in the March quarter.

On To The March Quarter

In a recent article titled Where Apple Makes Its Money, I suggested the Asia-Pacific region will surpass Europe as Apple's second biggest revenue region this fiscal year. In FY2011, China was the only country outside the US to deliver more than 10% of Apple's reported revenue total. The release of the iPhone 4S on China's mainland in the March quarter will generate greater than 100% revenue growth in the Asia-Pacific region in this three-month period. 

The Apple iPhone

In the December quarter Apple defied skeptics who questioned the company's ability to ramp iPhone supply to meet demand. In the holiday quarter iPhone unit sales rose 128% to 37.044 million units and handset sales revenue, inclusive of accessories and related products, rose 133% to $24.417 billion or 52.7% of the company's total reported revenue. In the March quarter, the rate of iPhone unit sales growth may again reach triple digits due to the China iPhone 4S rollout and the company's proven ability to meet demand for product. At the end of the December quarter, the iPhone's global channel supply of about 6 million units represented less than three weeks of December quarter sales and was well below the targeted range of 4 to 6 weeks of supply. 

In addition to the expected strong iPhone sell-through in the March quarter, Apple can add millions of units to channel supply before the end of the period and in support of the continuing global roll out of the iPhone 4S handset. For the March quarter, I'm targeting iPhone unit sales of 36 million units. 

The Apple iPad

In FQ1, Apple sold 15.434 million iPad units and sell-through was slightly higher than reported sales. This represented 111% unit sales growth even as consumer expectations for a product line refresh to occur in the March quarter continue to grow. During the conference call with analysts following Tuesday's earnings release, management mentioned the iPad's fast adoption in the education market. With the prospect of the iPad 3's release in the March quarter and the chance the iPad 2 will remain a shipping product, Apple could deliver in the area of 200% iPad unit sales growth in this fiscal period. Education channel sales will be an iPad unit sales growth catalyst in the upcoming June quarter.

The Macintosh

The Mac's unit sales performance exemplifies the "Apple product mutual halo effect." Record Apple retail store traffic following the release of the iPhone 4S in October assisted in boosting December quarter Mac unit sales 26% to 5.198 million units. In the Asia-Pacific region Mac unit sales rose 58%. I expect March quarter Mac unit sales of about 4.7 million. Both the Asia-Pacific region and the Apple retail segment will be unit sales growth leaders in this three-month period. 

For The March Quarter

My preliminary March quarter revenue estimate stands at $41 billion, representing anticipated revenue growth of 66% and an earnings per share growth rate of about 80% to $11.50. Apple's guidance for the quarter of $32.5 billion in revenue and eps of $8.50 is consistently conservative. I currently expect Apple to beat guidance by $3 per share.

On The Fiscal Year

For the fiscal year ending in late September, I now expect revenue exceeding $175 billion and earnings per exceeding $50. FY2013 is on track to be a more than one-quarter trillion dollar revenue year. Over the next two weeks I will be updating my current 12-month price target of $640. I expect the updated price target to land in the vicinity of $700 per share. 

Apple's Earnings Quality

Apple's gross margin in the December quarter reached 44.7% and net income reached nearly 28.2% of revenue.  I expect gross margin and the percentage of revenue that flows to the net income line to remain high through the March and June fiscal quarters due to the continuing global roll out of the iPhone 4S handset. For as long as revenue growth rates remain greater than 50%, the percentage of revenue consumed by operating expenses will continue to decline. In the December quarter operating expenses came in at $3.363 billion or just above 7.25% of reported revenue. The declining percentage of revenue consumed by operating expenses contributed to the very strong net income growth in the quarter and will contribute to extraordinarily high net income growth rates this fiscal year. 

Robert Paul Leitao

Disclosure: The author is long Apple shares

The Apple Analyst Sandbag Factor

Each fiscal quarter Apple 2.0's Philip Elmer-DeWitt provides an index of quarterly estimates that include numbers from a select group of bloggers and numbers from Wall Street pros. For the September quarter, the differences in the estimates from the bloggers and the pros have the widest divergence since the quarterly indexes began. This quarter the gap is so pronounced it might best be described as a chasm. Revenue estimates range from a high of $37.19 billion from Mark Beauch of the AAPL Independent Analysts group to a low of $26.36 billion from Morgan Stanley's Kathryn Hubert. On earnings per share, the estimates range from a high of $10.01 put forward by this author to a low of $6.30 also from Kathryn Huberty. 

The table below lists the average revenue and eps estimates from the 16 bloggers and the 28 pros who submitted revenue and eps numbers. 

The Apple Analyst Sandbag Factor

There's more to the difference in the average eps estimates from the two groups than the difference in revenue estimates. This difference is what I call "The Apple Analyst Sandbag Factor."

The purpose of this exercise is to remove differences in the revenue estimates from the numbers submitted by the individual analysts and compare each analyst's eps outcome to their respective revenue estimate, using Apple's June quarter results as a constant in the review. The outcome of the analysis indicates the Wall Street analysts are forecasting a significant deterioration in Apple's net income and eps performance per revenue dollar based on their own revenue and eps numbers. This anticipated deterioration in net income and eps performance represents the "Sandbag Factor."

The chart below lists the September quarter estimates from the analysts. The content is courtesy of Apple 2.0 and is from the article titled, Wall Street Still Doesn't Understand Apple published on October 11, 2011. The analysts are ranked by revenue estimate. The bloggers are highlighted in green and the Wall Street pros are highlighted in blue.

Why Apple's FQ4 Earnings Will Approach $10 Per Share

There's no other company on the planet that excites the imagination of its product users as much as Apple. In developing revenue and earnings estimates for the company, I am guided by one overarching principle:

Apple doesn't sell products. Apple crafts customer relationships and those relationships sell Apple products. 

Understanding Apple's Pathways To Success
Understanding Apple's pathways to success requires more than an effort at counting the number of individual products that might be sold. It necessitates understanding the company's eco-systems and what motivates enterprises and consumers to invest in the purchase of Apple-branded products. 

My analysis relies heavily on the company's historical growth trends and an evaluation of the phenomena that occur when appealing and abundant content is made readily available for smartly designed devices. These products are offered to customers who have established a relationship with Apple through iTunes, through visits to the company's retail stores or have a long-standing relationship with the company through the use of Apple's popular Macintosh line of personal computers. 

Below are my estimates for the company's September quarter and an overview of the elements that underly the assumption Apple's FQ4 earnings will approach $10 per share:

	Revenue Segment		Units FQ4 ’11	Units FQ4 ’10	Unit Growth	FQ4 Revenue
	Macintosh		4,500,000	3,885,000	15.83%	5,737,500,000
	iPhone		26,500,000	14,102,000	87.92%	17,225,000,000
	iPod		7,250,000	9,051,000	-19.90%	1,268,750,000
	iPad		14,500,000	4,188,000	246.23%	9,425,000,000
	Peripherals					620,000,000
	Software, Services					800,000,000
	Other Music					1,625,000,000
	Revenue Total					36,701,250,000
	Cost of Sales		58.20%			-21,360,127,500
	Gross Margin		41.80%			15,341,122,500
	Operating Expenses		8.79%			-3,225,000,000
	Operating Income					12,116,122,500
	Other Income					200,000,000
	Income Before Taxes					12,316,122,500
	Provision For Taxes		23.50%			-2,894,000,000
	Net Income					9,422,122,500
	Earnings Per Share		(Based on 940.825 million shares)			10.01

The AAPL Independent Analysts FQ4 Estimate Index

On October 18th Apple will announce results for the company's 4th fiscal quarter ended September 24th. To gauge expectations for the quarter, we asked members of the AAPL Independent Analysts group on Linkedin and members of the Apple Finance Board who have participated in prior quarterly indexes to submit estimates of the company's 4th fiscal quarter performance. 

Among the fourteen individuals who submitted estimates for this September quarter index are well known independent analysts Horace Dediu and Daniel Tello, returning analysts Navin Nagrani and Patrick Smellie and newcomers Michael Cranston and Martin Epstein. Collectively these individuals represent a cross section of the AAPL independent analyst community and come from various professional backgrounds and career interests. 

On average index participants anticipate the following September quarter unit sales results:

	Macs	4,677,500			20.40% YOY Rise
	iPhones	23,765,071			68.52% YOY Rise
	iPods	7,158,857			20.91% YOY Decline
	iPads	13,624,214			225.32% YOY Rise

Notes on the Unit Sales Numbers:

Mac sales: Over the first nine months of FY 2011, Macintosh unit sales rose 21.1%. The index average is inline with the recent unit sales trend and reflects confidence in Mac sales during the recent back-to-school season.

iPhone sales: The index average reflects expectations of a slower rate of growth in iPhone unit sales in the 4th quarter due to the release of the iPhone 5 in the holiday quarter. During the first nine months of the fiscal year iPhone unit sales rose 113%. 

iPod sales: The Apple iPod remains in a state of steady unit sales decline. The iOS-based Apple iPod touch remains the biggest revenue generator among the available iPod models. Apple's decision this year to offer $100 in iTunes content to students purchasing a new Mac versus a free iPod touch will influence iPod unit sales results in the quarter. 

iPad sales: The index average suggests anticipation of strong iPad unit sales in the September quarter as Apple strived to resolve the challenge of constrained product supplies. Index participants expect a rise in unit sales of 225% over the prior-year period. 

Apple's PEG Ratio Signals Share Price Gains Ahead

On Friday, Apple (AAPL) closed New York trading at 343.26, up $7.59 on the day and up  $16.91 or 5.2% on the week. Although the week's share price advance was impressive, Apple remains significantly under valued based on the company's current rates of revenue and earnings growth. In the first six months of the current fiscal year Apple's revenue has risen 76.2% and earnings per share has gained 83.2%. In contrast, since the first trading of Apple's current fiscal year on September 27, 2010, the share price has responded with only a 17.9% gain.

Last week in a post titled AAPL: The Coiled Spring I compared the median price targets for three popular equities: Amazon, Apple and Netflix and the share prices for each of these companies. Apple is trading at a price-earnings multiple of 16.35 times trailing 12-month earnings of $20.99 per share and at only 76.3% of the median Wall Street price target of $450 per share. In comparison, both Amazon and Netflix are trading at much higher price earnings multiples and at or near their respective median price targets.

Apple's PEG Ratio: More Share Price Gains Ahead

For today's post I asked Jeff Fosberg of the Apple Finance Board to adapt his popular "coiled spring" graphic to reflect not the price-earnings multiples of the above-referenced companies but the PEG ratios of the companies at Friday's closing prices. 

Simply defined, the PEG ratio represents the price-earnings multiple divided by earnings per share growth. The lower the PEG ratio, the lower the current valuation relative to rates of earnings growth. Apple's current PEG ratio is 0.63 versus 2.92 for Amazon and 1.98 for Netflix. Compared to high-flying stocks such as Amazon and Netflix, Apple is bargain priced and the company's current PEG ratio signals more share price gains ahead. Because Amazon, Apple and Netflix operate in different product and service markets, the PEG ratio is a more effective way to compare and contrast the current market valuations of the three popular equities than a comparison of price-earnings multiples alone. This comparison accentuates the deep discount to growth at which Apple currently trades.  

The AFB AAPL FQ3 Unit Sales Estimate Index

The Apple Finance Board (AFB) is home to many AAPL traders, investors and Apple product enthusiasts. Among the members of the AFB are well know independent analysts Daniel Tello (deagol), Horace Dediu (aysmco), Turley Muller and Andy Zaky. I serve as the moderator of the AFB under the DawnTreader moniker. 

The AFB AAPL FQ3 Unit Sales Estimates

Each fiscal quarter active members of the AFB are polled for their estimates of Apple's quarterly performance based on product unit sales and financial outcome. Yesterday I posted the revenue and earnings estimates of AFB members participating in the index for the three-month period ended in late June (Apple's FQ3 2011). Today I am posting the unit sales estimates that underpin the anticipated financial results. 

On average the 30 active AFB members participating in the June quarter index estimate Apple will report the following unit sales results by product line. Unit sales numbers are in thousands:

AFB Member AAPL FQ3 Unit Sales Estimate Averages:

Macs	4,330		(24.7% Unit Sales Rise)
iPods	8,335		(11.4% Unit Sales Decline)
iPhones	17,602		(110% Unit Sales Rise)
iPads	8,325		(155% Unit Sales Rise)

Notes On The Numbers:

Macintosh Unit Sales: In the first six months of the current fiscal year (September and March quarters) Macintosh unit sales have risen 25.2%. The AFB member average estimate for Mac unit sales in the June quarter is consistent with the recent unit sales growth trend. 

iPod Unit Sales: iPod unit sales have continued to decline. In the first six months of the current fiscal year iPod unit sales fell more than 10%. The mass adoption of smartphones such as the Apple iPhone with iPod functionality have reduced demand for single-use digital music players. The iPod touch, an iOS-based device, is now the largest unit sales component of the Apple iPod line. 

iPhone Unit Sales: In the March quarter iPhone unit sales rose 113% inclusive of the 155% domestic unit sales growth rate influenced by the release of the Apple iPhone on the Verizon network. In the first six months of the current fiscal year iPhone unit sales rose 99.5%. The average estimate of AFB members suggests the March quarter unit sales growth trend will continue in the June quarter.

Last year Apple significantly reduced iPhone unit shipments in the June quarter ahead of the  release of the iPhone 4, leading to favorable conditions for year-over-year unit sales gains in the June quarter this year. 

iPad Unit Sales: The June quarter is the first quarter in which prior-year iPad unit sales are available. Apple's ability to have met demand for the iPad 2 in the June quarter will have a significant impact of the quarter's unit sales results that will be released later this month.

For more information on Apple product unit sales results please see my article published on May 8th titled Apple: Ten Quarters of Product Unit Sales.

Robert Paul Leitao

Disclosure: The author is long AAPL shares