If you missed Apple's (AAPL) earnings report on Tuesday and woke up Wednesday morning to see the stock down $20 or more, you would be stunned. It was an ugly report, and you cannot argue that point. Apple missed on both the top and bottom line as well as several other metrics. But how bad was it, and what does this mean going forward? Let's take a look. Here are the overall numbers first.
| Category | My Prediction | Street Prediction | Actual |
| Mac Sales | 4.7 million | 4.0-4.5 million | 4.89 million |
| Ipod Sales | 7.5 million | 7.2-7.7 million | 6.62 million |
| Iphone Sales | 19 million | 18-23 million | 17.07 million |
| Ipad Sales | 13 million | 12 million | 11.12 million |
| Revenues | $31.5 billion | $29.5 billion | $28.27 billion |
| EPS | $8.33 | $7.30 | $7.05 |
| Gross Margins | 38.50% | N/A | 40.25% |
| Operating Margins | 31.00% | N/A | 30.81% |
| Profit Margins | 24.50% | N/A | 23.43% |
Now you can say that in certain cases my estimates may have been a little high, and yes, some of them were at or above the highest estimates on the street. By why wouldn't I be so positive? Apple has crushed numbers numerous times before, so why not expect another blowout? Now, I knew that margins would be a little lower than most expect, as this is Apple's lowest margin quarter of the year, primarily due to strong educational discounts. And I thought that IPhone sales could miss if enough people were waiting for the new IPhone. But I didn't think the numbers would be that bad.
See the Full AAPL Earnings Call Transcript
Unfortunately, they were. Now, I'll give Apple credit for great Mac sales, which may have been one of the drivers to the higher-than-expected gross margins. The fact that people didn't buy as many iPhones isn't the surprise here. It's the two other numbers. From reports I was getting in September, iPod sales were down less than expected in the first two months of the quarter. Either that report was wrong, or September was a really bad month for iPod sales. The iPad number was also extremely disappointing. There's no "waiting for iPad 3" excuse here because Apple hasn't announced that new product yet. We can give them a slight pass on the iPhone number since we expect it to bounce back this quarter. And from the company's guidance for the next quarter, which was ahead of current street estimates, I expect that revenue and EPS will bounce back, and in a big way.
So how do these numbers compare with past quarters? Let's take a look at some financial metrics over the past two years. We'll look at margins first.
| Profitability | 4Q 2009 | 1Q 2010 | 2Q 2010 | 3Q 2010 |
| Gross Margin | 36.62% | 40.88% | 41.67% | 39.08% |
| Operating Margin | 22.22% | 30.13% | 29.48% | 26.97% |
| Profit Margin | 16.87% | 21.54% | 22.77% | 20.72% |
| Return on Assets | 3.26% | 6.27% | 5.54% | 5.34% |
| Return on Equity | 6.20% | 10.62% | 8.18% | 7.89% |
| Profitability | 4Q 2010 | 1Q 2011 | 2Q 2011 | 3Q 2011 | 4Q 2011 |
| Gross Margin | 36.93% | 38.51% | 41.42% | 41.73% | 40.25% |
| Operating Margin | 26.78% | 29.27% | 31.92% | 32.83% | 30.81% |
| Profit Margin | 21.18% | 22.45% | 24.27% | 25.58% | 23.43% |
| Return on Assets | 6.16% | 7.42% | 6.59% | 7.25% | 5.94% |
| Return on Equity | 9.48% | 11.72% | 10.31% | 11.17% | 9.08% |
The year-over-year numbers for this quarter did improve like we expected, although I would have liked to see a little bit more on the operating margin number, and a lot more on the profit margin number. The culprit on the profit margin might have been the effective tax rate. In last year's quarter, the effective tax rate was 21.11%, while this year it was 24.66%. That will certainly take a bite out of your bottom line. As a side note, if Apple's tax rate was the same as last year's, the profit margin would have been 24.53%, right where I was projecting.
Overall though, the trend is still likely to continue higher. I know that some may point out that return on assets and equity missed by a bit, but so did net income. These numbers will also improve when, and if, Apple decides to slow the growth of its asset base. One note of caution, as a few people have pointed out, the release of the iPhone this quarter may have a slight negative impact on margins this quarter, as it has when Apple has released the iPhone in past quarters. I still expect improvement in the year-over-year numbers, but don't expect the moon just quite yet. Especially after this quarter. Let's look at some other numbers.
| Activity | 4Q 2009 | 1Q 2010 | 2Q 2010 | 3Q 2010 | 4Q 2010 | 1Q 2011 | 2Q 2011 | 3Q 2011 | 4Q 2011 |
| Receivables Turnover | 3.26 | 4.86 | 4.52 | 4.96 | 4.54 | 4.64 | 4.17 | 4.80 | 4.93 |
| Inventory Turnover | 14.98 | 17.99 | 12.97 | 12.11 | 12.88 | 16.99 | 15.92 | 18.31 | 20.29 |
| Asset Turnover | 0.19 | 0.29 | 0.24 | 0.26 | 0.29 | 0.33 | 0.27 | 0.28 | 0.25 |
The receivables and inventory turnover numbers improved because Apple's inventory and accounts receivable balances declined this quarter. Apple's accounts receivable balance was down 12% quarter over quarter, and was about 3% below last year's fourth-quarter number as well. Apple is getting paid in a timely manner, although I would have expected these numbers to rise a little as sales have jumped year over year. I'm not worried about Apple's declining asset turnover ratio, as it just means net income isn't rising as quick as assets. Like the instance from above, this number will improve when Apple's asset base growth slows down. Finally, let's look at some balance sheet metrics and numbers.
| Liquidity/Coverage | 4Q 2009 | 1Q 2010 | 2Q 2010 | 3Q 2010 |
| Current Ratio | 1.88 | 2.55 | 2.64 | 2.31 |
| Quick Ratio | 1.39 | 2.13 | 2.13 | 1.78 |
| Working Capital | $17.0B | $20.2B | $20.1B | $20.4B |
| Debt Ratio | 48.32% | 33.67% | 31.04% | 33.39% |
| Liquidity/Coverage | 4Q 2010 | 1Q 2011 | 2Q 2011 | 3Q 2011 | 4Q 2011 |
| Current Ratio | 2.01 | 1.85 | 1.93 | 1.75 | 1.61 |
| Quick Ratio | 1.50 | 1.39 | 1.44 | 1.28 | 1.12 |
| Working Capital | $21.0B | $20.1B | $22.7B | $20.0B | $17.0B |
| Debt Ratio | 36.43% | 36.98% | 35.22% | 35.05% | 34.16% |
Apple's numbers are coming down, but I wouldn't worry just yet. It was a bad quarter so next quarter will most likely show improvement. The curious case is the working capital number. Apple's current assets number came down by about $1.9 billion in the quarter, and we saw declines in cash and equivalents ($2.276 billion), short-term investments ($167 million), accounts receivable ($733 million), and inventory ($113 million). The inventory number is most likely though due to fewer iPhone 4's being produced in anticipation of the 4S, so I wouldn't worry there. And it also seems like Apple bought some more "long-term investments", so that's where some of the cash went. Apple's debt ratio (liabilities to assets) improved again so I'm not worried that some of its shorter term metrics come down. Again, with current assets at $45 billion and current liabilities at $28 billion, if they increase at the same numerical value the current ratio will come down. It's a simple matter of math. Same goes for the quick ratio.
So what's my overall opinion? Well, it wasn't a good quarter. But, I'm giving Apple a pass on this one. For now. It appears that people stopped buying iPhones this quarter in anticipation of the new release. According to Apple's guidance, the company should make up the lost revenue and income in the next quarter. So I'll let the company prove that over the next few months. The stock had a nice pullback today on the news, but my recommendation for picking up shares is still about $375, so I'd wait for it to go a little lower. Apple's numbers weren't great, and it will need to pick it up or Tim Cook will have some serious questions to answer next time around. Every company has one bad quarter eventually, so I guess we shouldn't be too surprised here. This just better not be the start of a trend, or one of the greatest companies of our time will be under a lot of fire.
