Apple Earnings Preview: It's All About The iPhone

| About: Apple Inc. (AAPL)

On Tuesday, Apple (NASDAQ:AAPL) will released its much anticipated 1st quarter earnings results after the bell. It's expected to be a monster, with the potential for the company to eclipse $40 billion in revenues for the first time (and $30 billion for that matter), as well as $10 in earnings per share. Apple's quarter is all about the iPhone, which should account for about half of its revenues this quarter. Now we must remember that this quarter is an extra week, so that will slightly impact comparisons to last year's quarter.

Before I get into my prediction for this quarter's report, here is what Apple did in the prior year's period.

Category Value
Revenues $26.74 Billion
EPS $6.43
Gross Margin 38.51%
Operating Margin 29.27%
Profit Margin 22.45%
iPhones Sold 16.235 million
iPads Sold 7.331 million
iPods Sold 19.446 million
Macs Sold 4.134 million

Now here are what analysts think, as of time of writing of this article (Sunday morning). According to Yahoo! Finance's estimates page, analysts expect revenues to be $38.76 billion, and the range is from $35.3 billion to $41.8 billion. Earnings per share are expected to be $10.07, with a range of $8.88 to $11.45. Remember, when Apple provided their own guidance for the quarter, they projected $37 billion in revenues and $9.30 in EPS.

Here are my overall predictions, which I will break down afterwards:

  • Revenues of $40.71 billion.
  • EPS of $10.76.

So how do I get to my quarterly numbers? Well, here is the chart of my predictions for individual product sales. The average price I'm estimating is for sales of the product and related accessories and items. For the iPod, sales of what Apple classifies as "other music" on its statements are included in the average price.

Product Units Price Sales
iPhone 30.85 million $655 $20.21 billion
iPad 11.9 million $625 $7.44 billion
iPod 15.6 million $300 $4.68 billion
Mac 5.12 million $1,325 $6.78 billion

That gives us a total of roughly $39.11 billion. I'm also expecting other revenues of $1.6 billion. These will come from what Apple classifies as "hardware, peripherals, software, service and other sales".
That gives us the total revenue number of $40.71 billion.

Now we know that the iPhone will dominate, and that is a big key to this quarter. With that average selling price, every 3 million iPhones equates to about $2 billion in revenues. So, the difference between say 29 million and 32 million iPhones is huge in terms of the overall revenue number. Now, some may question my iPad number, but I'm being a little conservative. I think that Amazon's (NASDAQ:AMZN) Kindle Fire will have some of an impact on the iPad, although it's not a killer. While the price points are a bit different, Amazon selling say 3 to 5 million Kindles will take away some iPad sales, even if only a couple hundred thousand. We know that Research in Motion's (RIMM) Playbook is not doing well, so that is not even factored into my number. RIMM sold 150,000 Playbook's in its latest quarter, while Apple sells almost a million iPads per week.

Now that we have some top line numbers, we need to translate them down the income statement. Here are Apple's margins in the past six fiscal quarters.

Margins 3Q 2010 4Q 2010 1Q 2011 2Q 2011 3Q 2011 4Q 2011
Gross 39.08% 36.93% 38.51% 41.42% 41.73% 40.25%
Operating 26.97% 26.78% 29.27% 31.92% 32.83% 30.81%
Profit 20.72% 21.18% 22.45% 24.27% 25.58% 23.43%

Apple did say in its recent 10-K that it did not expect margins to remain at such high levels as it continues to deliver innovative products, but that is just conservatism and those are statements that they must provide. The iPhone is a higher margin product, and with it representing about half of sales this quarter, we would expect margins to be elevated. You might expect margins to be higher than all of these quarters, but I'm not sure that they will be. Apple's margins have been a little lower in quarters when it has released the iPhone, so I won't put my expectations above the moon. Here are my predictions for their quarterly margins:
  • Gross Margins of 41.6%.
  • Operating Margins of 32.5%.
  • Profit Margins of 24.9%.

Now, using that profit margin number, we get a net income number of approximately $10.136 billion. Since Apple is not currently buying back stock, its share count increases each quarter as options are granted and such. My estimate is for about 942.33 million shares outstanding at the end of the quarter. That gives us $10.76 in EPS.

Now, I wouldn't have a complete preview if I didn't also give an estimate for next quarter, which is Apple's fiscal second quarter. I'm estimating that Apple will provide the following guidance: $33 billion in revenues and $8.25 in EPS. Next quarter will be good for Apple, and will show decent growth over the prior period in 2011. However, it's not a holiday quarter, so the quarter over quarter numbers will be down, and that's expected. Could we see Apple launch a new iPad in the first quarter? It's possible, although if they do, it will probably be later in the quarter. Apple could potentially launch one to rival Amazon's Kindle Fire, however I don't think they will. Apple is focused on premium products, and I think that they will remain there. For now, Apple's main driver is the iPhone, which accounts for 40-50% of revenues, depending on the quarter. If Research in Motion continues to struggle financially, it will only help Apple going forward.

So the big question I'll be asked is of course, what does the stock do afterwards. Well, I'm positive on the name in the long term, but we know that doesn't have much impact on after-earnings trading. Generally, I use the following table below, with $425 as my pivot price. Anything below $425 going into earnings sets up positive in my opinion (with a good report of course), but I think you have to be a little cautious above that level. If Apple goes into earnings below $410, I think you have to be extremely positive, but if it goes in above $440, I think you need to be very cautious.

Price Up Down
$400 100% 0%
$405 90% 10%
$410 80% 20%
$415 70% 30%
$420 60% 40%
$425 50% 50%
$430 40% 60%
$435 30% 70%
$440 20% 80%
$445 10% 90%
$450 0% 100%

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL over the next 72 hours.