The earnings announcement this afternoon from Apple (AAPL) clearly was the most important earnings release for the company in many years. Since the last earnings announcement in January 2013, questions have swirled and the stock has been battered. Concerns about slowing growth, falling gross margins, future product releases, and a lack of clear plans for returning additional cash to shareholders have taken their toll on the stock. Prior to its last earnings report, Apple shares traded for over $515 a share. One glance at the chart below provides all you need to know about the direction the stock has taken since the last report:
Trading at slightly over $400 a share today, Apple has seen a roughly 20% decline over the last 3 months which has wiped out close to $100B in the market capitalization for the company. The earnings, guidance, and updated plans for returning cash to shareholders announced today will play a pivotal role in where the stock goes next. Continue reading for key figures from today's earnings release and a quick take on how you should interpret these figures.
All actual results shown below come directly from the current Apple earnings release as well as prior quarterly releases. Estimates are taken from the Fortune magazine survey of 44 analysts covering Apple. The survey showing the estimates can be found here, and the various data points are in the tables and analysis below reflecting the "Institutional consensus" estimates. The actual summary table of estimates provided in the Forbes article linked to above is shown here:
APPLE Q2 2013 RESULTS
Revenue & Earnings -
There is no argument that the rate of growth for Apple is slowing. The question heading into this earnings report centered around the scale of the slowdown and whether it was transitory in nature. See the below table for the results and comparisons:
Revenue & Earnings Summary: revenue continued to grow year over year, albeit at a much slower pace than a year ago. Earnings saw a year over year decline. Both of these metrics must be taken in the context of the company having no new product releases, which for Apple leads to pent up demand as users await the next version of the iPhone and iPad. Apple has achieved a revenue run rate, whereby simply sustaining or having minimal future growth, would arguably show the company to be significantly undervalued. This valuation argument is in the context of what happens to the gross margin % for the company, which is shown below.
Gross Margin -
This quarter Apple faced the headwinds of increased competition with a lack of major product refresh cycles, in addition to the iPad mini, and its lower gross margin % becoming a bigger share of total iPad shipments. The time of Apple having a quarterly gross margin % north of 45% has probably sailed into the sunset. However, starting at such a high gross margin compared to competitors in the industry, Apple can sacrifice margin as needed with the introduction of lower margin products like the iPad mini and still maintain gross margin % levels that are industry leading. See the below table for the results and comparisons:
Gross Margin Summary: As expected, gross margins saw a precipitous decline from the prior year as well as a sequential decline from the prior quarter. Gross margin for the quarter was also below the midpoint of guidance provided by the company and the consensus estimates. Again, the positive for Apple is that they have set the expectations for their pricing as a premium product company and have garnered a significant user base willing to pay that premium. They are not starting off as an entry-level provider of smartphones and tablets with paltry gross margins. They are the king of the industry. The company has achieved this level of success while, in some manner, gouging consumers when you consider they previously saw close to 50% gross margins. There is ample room for Apple to continue to price their products aggressively as needed, at the expense of diluting gross margins. At the same time, the company can either work to reduce input costs to offset this dilution, or continue innovating to provide features that can only be found in Apple products. This would in turn enable them to continue to command premium pricing. In the worst case scenario, Apple could see gross margins crater to 25%, yet if the company still manages to grow revenues to over $200B in FY 2014 as consensus estimates reflect, this will still deliver $50B in total gross margin annually. Any way you view gross margins, the high level of gross margin the company is starting from allows it to plot a strategic course to maximize profits through growth or through premium pricing.
Unit Shipments -
The same headwinds impacting revenue growth rates are felt in the volume of unit shipments for the key iPhone product line. The iPad product is actually benefiting on a year over year basis from the introduction of the iPad mini. The Mac product line continues to be relatively steady as she goes, even in the face of secular declines across the personal computer market. See the below table for the results and comparisons:
Unit Shipment Summary: The table above really says all you need to know with regards to unit shipments. In what may come as somewhat of a surprise, both the iPhone and iPad unit shipments exceeded the consensus analyst estimates. The key question going forward will center around the future product releases. Will Apple introduce a larger screen iPhone or simply update the iPhone 5? Will the company head into the trenches with the introduction of a low cost iPhone to compete with lower end Android phones especially in emerging markets? Finally, has the iPad mini created a permanent mix shift within the iPad product line? If so, does the company intend to embrace this or continue to innovate in an attempt to push consumers back to the larger and more profitable iPad?
Cash and Cash Flow -
The total cash balance and cash generated from operations is one area where Apple continues to leave competitors in the dust. Cash on the balance sheet jumped to a new record high and operating cash flow continued at a level that gives the company the ability to grow their cash balance while paying a significant dividend and repurchasing shares. See the below table for the results and comparisons:
Cash and Cash Flow Summary: What can you say other than Apple is a money printing machine that Ben Bernanke probably would love to have at his disposal. An important takeaway from these results is that Apple can continue to generate meaningful cash from operations even in a period of declining margins and sequential declines in revenue with no new products released to provide any type of catalyst. This is a competitive advantage that cannot be matched. Those arguing for Apple to meaningfully increase the amount of cash being returned to shareholders should reflect on what happened the last time Apple made a move to return cash to shareholders. The sugar high that surrounded the initial reaction to Apple instituting a dividend quickly faded. The reality is that there are no guarantees what the stock will do, even if Apple does deploy more cash in a perceived shareholder friendly way.
Guidance And Dividend Update
The company provided guidance for the upcoming quarter that in likelihood will be seen as somewhat disappointing. The midpoint guidance for revenue in Q3 is $34.5B. However, the key item to focus on from a guidance standpoint is the outlook for gross margins. In this regard, the midpoint in the gross margin guidance range for the upcoming quarter is 36.5%. This should be interpreted as a positive considering there are still no confirmed product updates currently anticipated debuting in the following quarter. Said another way, Apple does not see much further dilution to gross margin % in a quarter where there are no real catalysts from a product release standpoint.
Many in the investment and analyst community alike have been pining for Apple to make a major move with regard to its roughly $150B cash hoard. Here, the company seems to be offering a big tip of the hat to these investors, as the company will be raising their quarterly dividend by 15%. The company has also committed to returning $100B in cash to shareholders through 2015 and repurchasing $60B worth of stock.
I believe many will look back at this earnings report as confirmation that the pessimism surrounding the company reached a crescendo that was not supported by the reality shown by the company's financial performance. Ultimately, Apple showed with their earnings today that the company can still deliver incredible levels of profitability and cash flow generation without the added benefit of any new products to generate excitement. Hopefully the financial results today and the outlook provided will reset investor expectations for Apple. Those who were calling for Apple to hit a $1,000 a share and have a trillion dollar market cap less than a year ago were just as silly as those who believe Apple should trade at a level approaching just two times the amount of cash the company sits on. This company has entered a maturation stage, and wise investors trading without emotion can find ample opportunity to profit from Apple at the price levels seen today.