Apple's Boring Quarter Still Produced A Beat

Jul.23.14 | About: Apple Inc. (AAPL)

Summary

Apple reported earnings that beat consensus analyst estimates; basic EPS of $1.29 versus estimates of $1.23.

Apple drove bottom line performance due to higher than expected gross margins.

This was driven by iPhone becoming a larger percentage of the sales mix.

The quarterly earnings conference doesn’t offer meaningful guidance; investors should turn their attention to the next quarterly earnings conference.

Apple (NASDAQ:AAPL) declined by .58% in the after hour session. The report wasn't exactly a disaster, but analysts were certainly hoping for revenue to be at the top end of the guidance range which didn't exactly happen. Revenue expectations were closer to $38 billion, but Apple came in at $37.43 billion. What we got was a report that was driven by bottom line expansion, which primarily came as a result of a larger mix of iPhone versus iPad. The iPad is notoriously known to have smaller gross margins, which is why bottom line performance was able to come in ahead of consensus.

Reviewing key facts from earnings

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Source: Apple

There were further declines in the iPad category, which were offset by iPhone sales ramp. Gross profit was well ahead of the guidance range for the present quarter. If anything, Apple overestimated the demand for the iPad, and underestimated demand for the iPhone, and Mac. This is why Apple missed the high-end of revenue, and reported well above its own gross profit target.

Looking over key performance indicators, iPad demand continued to trend lower, even as iPhone grew unit volume by 13% year-over-year. To be more specific, refurbished iPhone 4S models were mostly responsible for the drag on revenue. Capturing consumers in the emerging markets with older generation iPhone's is responsible for the 4% differential in unit volume growth versus revenue growth.

Apple provided key guidance metrics in the most recent earnings conference:

  • revenue between $37 billion and $40 billion
  • gross margin between 37 percent and 38 percent
  • operating expenses between $4.75 billion and $4.85 billion
  • other income/(expense) of $250 million
  • tax rate of 26.1 percent

Below, I create a forecast using the guidance figures.

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Source: AlexLeAnders

I estimate Apple will report revenue at the upper end of the range ($40 billion), gross profit of 38%, and operating expenses at $4.85 billion. I think the company will report EPS of $1.33 for the next quarter, which puts me one cent below consensus EPS estimates of $1.34.

However, basing it purely on the guidance range is kind of foolhardy. Apple will most likely report another quarter in which iPhone sales will become a larger percentage of the mix, as softness in demand hit tablets on aggregate in the past quarter.

Tim Cook goes onto explain:

iPad sales met our expectations but we realized they didn't meet many of yours. Our sales were gated in-part by a reduction in channel inventory and in-part by market softness in certain parts of the world. For example IDC's latest estimate indicates a 5% overall decline in the U.S. tablet market, as well as a decline in the Western European tablet market in the June quarter.

Softness in iPad demand is most likely coming from larger form factor smartphone devices in the 5.5 inch variation, which is why Apple is rumored to release a smartphone with a larger screen, paired with a $100 price differential from the 4.7 inch model. The difference in screen size, and the incremental cost of sapphire displays shouldn't damage gross margins, and in a more detailed analysis, I conclude that if iPhone sales become a larger percentage of total volume Apple's gross profit will improve, driving bottom line earnings expansion.

Going forward, Apple will most likely trigger a modest beat on consensus earnings in Q4, as the company is setting us up for the expectation of better gross margins, paired with modest tablet deceleration. Admittedly, I think there's some pent-up demand going into the holiday season, and an unexpected beat will occur in Q1 FY 2015. Until then, I think earnings will continue to gauge organic demand for iPhone.

Bottom line

I continue to reiterate my calendar year 2014 price target of $101.28. I think Apple remains a buy, but I don't think this quarter offered very meaningful insight. Instead I think investors should turn their attention to Q4 FY 2014 earnings as the guidance coming from that conference call will give investors a better idea on Apple's long-term growth potential as it will indicate what Apple expects out of the upcoming shopping season.

Darren Chervitz, of the Jacob Internet Fund (which owns Apple), states: "This is the most meaningless quarter in recent Apple history ... and even the guidance, which isn't particularly strong, is really meaningless as well, because who cares that the iPhone is going to be delayed."

I echo the sentiment of Darren. Best of luck to you investors, and traders. I'll be answering questions in the comments section.

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