Apple: Fiscal Q4 2011 All Over Again

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 |  About: Apple Inc. (AAPL), Includes: S, T, VZ
by: Bill Maurer

After the bell on Tuesday, Apple (NASDAQ:AAPL) reported its much anticipated fiscal third quarter results. I previewed the report yesterday. Unfortunately, we saw a similar result to fiscal Q4 of 2011, where iPhone sales were very sluggish in anticipation of the new phone launch. Apple reported numbers that widely missed Street expectations. As I noted yesterday, the professional analysts were much more skeptical going into this report, and they turned out to be less wrong than the independent analysts, who really got this one wrong. Apple's stock dropped in after-hours, but this might be a great opportunity to get into the name. Let's look at the numbers.

Product Results:

The following table shows Apple's unit sales by product in Q3 over the past four years, with the reported change over last year's period.

Q3 Unit Sales 2009 2010 2011 2012 Change
Mac 2.6m 3.47m 3.95m 4.0m 2%
iPod 10.2m 9.41m 7.54m 6.8m (10%)
iPhone 5.2m 8.4m 20.34m 26.0m 28%
iPad N/A 3.27m 9.25m 17.0m 84%
Click to enlarge

Let's begin with the Mac numbers. I noted that the Mac refresh (update to new versions) occurred late in the quarter, so apparently it was too late to catch up on lost sales earlier in the quarter. I was expecting a bit more in terms of Mac sales, but I'm guessing that we'll see those sales recover in fiscal Q4 and the holiday fiscal Q1. iPod sales didn't decline as much as I was expecting, but for now, that product line is essentially dead.

In terms of the iPhone, 26 million units is a disappointment. There is no other way to describe it. Most analysts on the Street were expecting 28 to 30 million, and I was above that at 31.5 million. Remember, fiscal Q2 saw more than 35 million units sold, so I was expecting a 10% decline. Investors were expecting a little pullback in sales, but were hoping strong China sales would help offset US losses. I guess it didn't happen. We had heard quarter over quarter declines from Verizon (NYSE:VZ) and AT&T (NYSE:T) in terms of iPhone activations over the past few days. However, the numbers from those two carriers weren't too terrible, and didn't point to this much of a disappointment. As a point of reference, Sprint (NYSE:S) will report its numbers this Thursday. After this data today, I'm guessing the results will be shaky.

iPad sales came in at a strong 17 million units, which was about 3% below my forecast. However, I was actually fairly conservative, as I had heard many out there expecting 18 to 20 million units or more for the quarter. But remember, the iPad only went on sale in China in the last week or so. That is a huge market, so that's why sales weren't as tremendous as some had hoped. Expect fiscal Q4 to be very strong as China sales will count then.

Overall Results:

Overall, Apple reported revenues of $35 billion, which compares to last year's $28.6 billion. However, that number was well below the $37.18 billion that analysts were expecting. It was also tremendously below the $41.5 billion that the average independent analyst was predicting. I'm glad I wasn't the one that predicted more than $46.4 billion in revenues.

In terms of earnings per share, Apple reported $9.32, which was above last year's $7.79, but well below the $10.36 the Street was expecting. The independents were also expecting about $12.31, which was close to fiscal Q2's $12.30.

Apple did increase two of its three primary margins over the prior year quarter, but net profit margins actually declined, as seen from the table below.

Q3 Margins 2009 2010 2011 2012
Gross 40.92% 39.08% 41.73% 42.81%
Operating 27.04% 26.97% 32.83% 33.04%
Profit 18.78% 20.72% 25.58% 25.19%
Click to enlarge

Obviously, not selling close to 30 million iPhones really did in the margin numbers, cause even 30 million in iPhones probably would have gotten gross margins to 44%-45%. That had a significant impact on the other margin numbers as well.

Apple improved its gross margins because the cost of sales only increased by 20.3%, compared to the 22.58% increase in revenues. That helped gross margin dollars increase by 25.77%, which resulted in a 108 basis point increase in gross margins.

Unfortunately, Apple's operating margins only increased by 21 basis points. That was due to R&D expenses rising 39.49% and Selling and General expenses rising 32.9%, rates much faster than the rise in revenues and gross profit. Overall, those two operating categories cost 9.77% of revenues, compared to 8.9% in the prior year period.

Apple did report other income of $288 million, compared to $172 million in the prior year period. However, Apple's effective tax rate was 25.6%, compared to 23.48% in last year's quarter. Thus, the rise in net income was just 20.74%, below the 22.58% increase in sales. That is evident in the 39 basis point decline in net profit margins.

In terms of both revenues and earnings, Apple beat its own guidance of $34 billion and $8.68, but this was the smallest beat we have seen in quite a while.

Balance Sheet and Dividend Update:

Apple continued to strengthen its balance sheet in the quarter. The table below shows some key financials, dollars in millions. The four years are at the end of Q3, and I provided last quarter's (Q2) numbers for comparison as well, with the current quarter in bold.

Key Financials 2009 2010 2011 2012 Q2 2012
Cash & Investments $31,121 $45,839 $76,156 $117,221 $110,176
Working Capital $18,509 $20,421 $20,039 $18,883 $18,676
Current Ratio 2.11 2.31 1.75 1.57 1.58
Debt Ratio 46.22% 33.39% 35.05% 31.40% 32.09%
Click to enlarge

Apple increased its cash and investments pile by another $7 billion. Working capital increased slightly, so the current ratio was basically flat. The debt (liabilities to assets) ratio improved a bit.

Apple declared its dividend with this report, something investors were waiting for. The $2.65 dividend is payable on August 16, 2012, to stockholders of record as of the close of business on August 13, 2012.

Guidance:

Apple's guidance for fiscal Q4 was a bit more than I was expecting in terms of revenues. Apple, which is always known for its conservative guidance, said it expects revenues of $34 billion in Q4. That compares to last year's $28.27 billion. Yes, it is below the current Street expectations of $38 billion, but we knew that was coming.

In terms of earnings per share, Apple guided to $7.65 for fiscal Q4, which compares to last year's $7.05. Again, analysts were well above that, currently expecting $10.22.

Apple's guidance was a bit higher than I was expecting for revenues, so I'm beginning to wonder if Apple may launch the iPhone 5 towards the middle or end of September, within Q4. Prior to this quarter, Apple's revenue guidance usually was about 15-20% below where they actually reported, meaning a $34 billion guide could equate to $40 billion when they actually reported. That's why I was a little above $40 billion for fiscal Q3, since Apple guided to $34 billion for this quarter.

Conclusion / Apple Trading Update:

Unfortunately, the iPhone slowdown everyone was expecting did occur. However, it was much more than most had expected. The late quarterly Mac refresh led to sales being basically flat over the prior year period. Apple's inability to sell the iPad in China until mid-July also took a toll on iPad sales.

In after-hours trading, Apple was down about 5%, or $32, to $570. Wednesday is shaping up to be a bad day for the markets, at the moment, given Apple's market dominance.

However, one must realize that the slowdown in sales for this quarter means sales will be made up in future quarters. If consumers really held back purchases of the iPhone as they wait for new one, it means that the iPhone 5 is going to be a blockbuster. The only question will be is the phone released in fiscal Q4 of 2012 or fiscal Q1 of 2013.

As for the stock, there are a few ways to play it. Long term investors should take advantage of this decline, as the average analyst price target is still around $725, implying more than 20% upside from here. Apple shares will rebound, so picking up shares on the cheap is advised. The second way to play it, should Apple open Wednesday around $570, would be to sell puts at that strike or maybe say the $550-$560 range for November expiration. You will collect a nice premium, which you will pocket completely if Apple goes higher and the options aren't exercised. If they are exercised, you'll be forced to buy Apple, but you'll probably get it for roughly $525 or so.

But as the saying goes, today's news was just "déjà vu all over again."

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