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Summary

  • After Apple's earnings conference call on Wednesday, the stock popped 7.9% after hours.
  • Financial performance was strong, with revenue up 4.6% y/y and EPS up 15%, led by iPhone sales of 43.7 million units, above analysts' expectations.
  • Apple also announced an expanded capital return program and 7 for 1 stock split.
  • Although no new products were announced, Cook directly confirmed that they are in the works, and we could see them previewed as early WWDC in June.

Following Apple's (NASDAQ:AAPL) fiscal 2014 Q2 conference call on Wednesday, Apple shares popped 7.9% after hours. The earnings report was full of appealing news for investors: strong financial performance, increased share repurchases, and an unusual 7 for 1 stock split. Tim Cook even intimated that new products that Apple is working on are getting closer to public debut.

Returning to Growth

The best news on the revenue front was the outstanding sales performance of iPhone, with unit sales of 43.7 million for 17% y/y growth. This completely blew past professional analyst estimates of 37.9 units, as tabulated by Philip Elmer-Dewitt. Apple management attributed much of the iPhone strength to double digit sales growth in China and emerging markets.

I also consider the exclusivity afforded by the A7 64 bit processor, basically the fastest in a smartphone, to have been important in maintaining sales momentum from the Holiday season. Higher than expected iPhone sales helped push Apple's revenue to $45.646 billion, a y/y increase of 4.6% as well as graced Apple with a gross margin of 39.3%.

I've long pushed for a much higher R&D budget both in absolute terms and as a percentage of revenue as a way to ensure a steady stream of new products. This quarter R&D grew to $1.422 billion (up 27% y/y) to 3.12% of revenue. Even with this greater investment in future new products, Apple's EPS of $11.62 was up 15%.

Mac sales were also strong at 4.14 million units, up 5% y/y, bucking the overall decline in the PC market of -4.4% reported by IDC for calendar Q1. The new Mac Pro continues to be back ordered many weeks.

iPad sales turned out to be the not so bright spot in the revenue picture with unit sales of 16.35 million. The sales decline was more apparent than real, since much of the decline compared to last year's sales of 19.48 million units was due to channel inventory reduction. Even taking this into account, it still represented a roughly 3% decline in sell through compared to last year.

Since Intel reported that they had shipped 5 million tablet processors in Q1, this could be the start of Intel's impact on iPad sales. Here, the iPad may be running into a perceived value problem. The A7 in a smartphone is spectacular, but in the iPad it just barely keeps up with Bay Trail. I always felt that iPad deserved to have a quad core processor rather than the dual core A7. Consumers faced with quad core Bay Trail tablets which also offer 64 bit processing may feel the same way.

Returning Capital

Apple also increased its capital return program to $130 billion with about $90 billion committed to share repurchases and the balance intended for dividends. Apple intends to increase its debt level by an unspecified amount to offset the cost of the capital returns.

I've never been a big fan of the capital return program, as I much prefer that Apple use the money to improve its competitiveness, but Apple seems at a loss about how to do this. It has avoided large acquisitions, wisely, I think, given the history of Google and Motorola.

Apple spends enormous amounts on capital equipment ($3.37 billion in the last quarter) but that hardly seems to put a dent in its cash pile. At the end of the quarter Apple had $150.6 billion in cash and marketable securities.

Lacking anything really compelling to spend the money on, the best use for it is as a cushion while lowering the prices for its products, a sort of capital return to consumers. Lowering gross margin has not been popular with investors, but I think it's key to growing revenue and market share without compromising the quality of Apple's products. Here, I admit to some Apple developer bias. I naturally want Apple products in the hands of as many consumers as possible, if that can be done without compromising the quality of Apple's products.

Splitting the Stock

During the dot com bubble days of 1999, stock splits could get the markets excited for a while, but there was usually no real impact to the equivalent price of the stock. Apple's 7 for 1 split may actually have a net positive impact by making Apple affordable to small investors and thereby increase slightly the market for Apple shares.

Other than that, there isn't much point. Dividends per share will decrease proportionately, since the total amount allocated for dividends remains the same.

Drawing Back the Curtain

Cook didn't have much to say about future new products, only that they weren't quite ready to "draw back the curtain." But it sure sounded like we're getting close to that time. In previous articles I've discussed my expectations for a new iPhone, iWatch, Apple TV, and a lower cost (sub-$1000) MacBook Air. For many of these products, previewing them at WWDC would make sense in order to allow developers time to begin working on apps designed specifically for these new products.

For instance, an iOS based iWatch that was open to developers would really need to be previewed in order for developers to get started on apps in time for a 2014 Holiday season launch. The same goes for a fully iOS enabled Apple TV or the ARM equipped MacBook Air I have speculated about. If these things really are coming in the Fall, then developers need to start working on them by WWDC in June.

So I think it's very possible that we could see these things for the first time at WWDC, making it one of the most important conferences in years both for developers and investors. Conversely, if Apple chooses to keep developers in the dark until the very last moment, then Apple investors could be in for another long summer of second guessing of Apple by industry pundits and a slow erosion of Apple's share price. Let's hope Apple chooses to draw back the curtain.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.