Analysis: Apple June Quarter Earnings Call - Keeping it Real

APPLE (AAPL) STOCK PRICE: 
Jan. 20 = $78.20 
July 20  = $152.91

Remember all of the platitudes about Apple being doomed since they are a consumer-centric company selling high end products in the worst economic cycle in decades?

Well, it was the mighty consumer that enabled the company to (once again) report its highest non-holiday quarter (in terms of revenue and earnings) in Apple’s history. 

More on that in a minute. But first, some numbers.

In terms of GAAP, Apple generated $8.34B in sales in the June quarter, a 12% increase over last year’s June quarter, which is incredible considering the economic shift between last June and now.  

No less, this growth did not come at a cost of margins and profitability.  Instead, the company generated net income of $1.23B, or $1.35/share, on gross margins of 36.3%, which was 300 basis points better than they guided; so much for sacrificing margin to entice customers to buy. 

More impressive is when you add in the full impact of iPhone revenue via the non-GAAP model that Apple now provides transparency on (it backs out the impact of subscription model accounting - i.e., two-year ratable revenue recognition). 

Here, the sales mushroom to $9.7B and net income to $1.9B, a bump of $1.4B and $700M, respectively. 

Oh, and cash, Apple has LOTS of it.  They are now sitting on a “sick” $31.1B pile of it, an increase of $2.3B from the prior quarter.

Yowza!  So, how did they do it?  Well, that’s a story worth analyzing a bit, as it provides a framework for making sense of the durability of the company's performance over the next handful of quarters.

The Mac Business

Incredibly, the company has outgrown the market now for a staggering 18 of the last 19 quarters, and in the June quarter, they were up 4% versus 3-5% contraction for the industry (a 7-9 point outpacing of the market). 

They did this by selling 2.6 million Macs, setting a new June quarter record.  Clearly, this was aided by accelerated sales after the launch of new MacBooks in the June quarter, but interestingly, whereas institutional business, education and pro segments were down, the consumer segment was up. 

Credit Apple’s execution here in taking down the average sales price of their products to remain compelling to cash strapped consumers – without sacrificing margins.

By contrast, the competition continues its assault on high volume, low margin, undifferentiated offerings, which predictably, has played into Apple’s hands.

The upside scenario in the Mac segment is that as K-12, higher ed and pro segments rebound, the company could see significant upside to this part of their business, further aided by federal stimulus inflows into the education segments, which in this quarter, had no impact (good or bad) for the company.

The counter is that now that the company has refreshed both its desktop and notebook lines, some of the call to action is muted in the coming quarter. 

iPod, iPod touch and iPhone

First off, this was the first time that I heard the company refer to the iPod, iPod touch and iPhone product lines as “Pocket" products. 

My gut is that this is a precursor to the segmentation (and hardware/software matrix) that they will announce when they come out with the larger form-factor tablet device that is (expected) in the October time-frame (see my post on the iTablet here).

The bottom line is that the descent of the iPod is in full force (10.2M units sold, down 4%) versus the ascent of both the iPod touch (numbers not presented, but up 130%) and the iPhone, but this is more a product of the maturation of the market than Apple losing any market share (they have 70%+ of the MP3 player market).

By contrast, the iPhone sold 5.2M handsets in the quarter, nominally aided by the presence of a $99 3G after the June 19 launch of the 3GS (which sold 1M  units in the first three days following its release). 

I have written too much on the phenomenal success of the iPhone platform so the only things of note here are that the company:

1. Has a dearth of 3GS supply, which suggests that they have achieved the right balance between low-end 3G buyers and high-end 3GS buyers.  And unlike the Apple of years past, one gets the sense that the company has a good handle on its supply chain/demand planning.
2. Is seeing growing interest from the enterprise in terms of iPhone 3.0 OS and iPhone 3GS due in part to hardware encryption and improved security. They are doing particularly good with small businesses and large orgs that allow people to purchase phones for personal use. In fact, 20% of the Fortune 100 have purchased 10,000 units each, with some orgs having purchased more than 25,000 units. This data, coupled with a highest overall satisfaction rating among business customers (according to JD Power), and being approved for purchase by over 300 higher ed institutions, leaves them confident that they are still at the tip of the iceberg of this market.

Apple Retail Stores

I would, however, flag Apple retail as the “potential fly in the ointment” bucket, inasmuch as while the company still shows that over 50% of the Mac buyers in Apple stores are first time Mac buyers, and they saw an uptick of store visitors to 38.6M from 31.7M last year (up 22%), same store sales (versus the prior year) were down $5.9M (versus $6.8M), a drop of 13.2%.  

This is the one clear asymmetry in their numbers, and in retail land (my first career was in retail real estate asset management), when same store sales drop, it is often an early warning sign that new stores are cannibalizing old ones, and the macro business is approaching a ceiling. 

Plus, the shrinkage is a deviation from all of the aforementioned growth numbers in the macro business. 

Finally, and purely anecdotal, is the fact that Apple’s former head of retail now works for Microsoft spearheading their (likely disastrous) foray into retail.  

Know this.  Retail real estate guys rarely jump off of gravy trains. They are either pushed or see the opportunity for real growth as behind them.

In any event, this is one to watch.

Other notes of interest:

1.    There was no cameo appearance by Steve Jobs in the call, and no one asked where he was, which is both a credit to Apple's performance and perception management (i.e., perception is that the company is in good hands in terms of operational performance).

2.    Over 8 billion songs have now been downloaded from iTunes store. By contrast, 1.5 billion apps have been downloaded from App Store in about a year. Not a one-to-one comparison, since many of the app downloads are free, but gives some relativistic view into the potency of Apple’s media and platform strategy.

3.    Snow Leopard is coming sometime in the next quarter, and as noted in past posts, it is being priced as a $29 upgrade from Leopard, which I believe is tied somehow to unannounced functionality in the tablet and/or new ways that Apple will better bridge the distinctions between MacOS and iPhoneOS computing models; the implication being that we (Apple) want/hope/need everyone to upgrade to take advantage of something unannounced, and are pricing the upgrade accordingly.

4.    Tim Cook sidestepped questions about an Apple tablet/netbook device.  One of the questions asked by analysts was whether Apple had plans or saw a market for netbooks. Cook's answer was a tell; namely, that the company saw no viable $399-499 type of offering that would meet its goals, reminding the audience that Apple isn’t about maximizing units (whither Nokia, Dell, etc.) but rather, on delivering ease of use, value and innovation, suggesting that the netbook buyer was replacing a full featured notebook with something underpowered, cramped, small display, etc.  When asked by a different analyst if Apple saw a market for such devices at ANY price, Cook punted.  Translation: a $700-900 device solving a different problem than a shrunken down notebook, and presumably offering more than a bigger screen version of an iPod touch is coming soon. I can hardly wait.

5.    App Store differentiation. The question came up whether Apple could keep ahead of the competition, which is now building its own app store concepts and platform plays, and Cook basically noted Apple App Store's 65K apps versus 1-5K for Android, RIM, Palm and Nokia, respectively.  All true, and the company has knocked the ball out of the park, and back again, which I blogged about here, but there has been serious developer backlash about a race to the bottom and Apple’s capricious, non-transparent approach to its developer constituency, so I would flag the health/happiness of the developer ecosystem as a category to watch over the coming quarter. The key challenge for the competition is to come up with the "desktop publishing differentiator" that changes the equation from a simple law of numbers to a metrics of success discussion (i.e., we are solving a different problem, and supporting the ecosystem accordingly). Yeah, I know.  That as easy as "just add water," but the game is no longer about trying to meet Apple punch for punch. It's about changing the rules (again).

6.    iPhone in China. The word I have heard is that a deal is finally done, and we will see a stripped down iPhone in China later this year.  Cook went so far as to say that it is Apple’s goal to have the iPhone in China within a year.  I will leave the analysis on units and dollars to others.

Netting it out: Apple continues to be the sexiest company in tech by balancing a brilliant, gusty vision with a boring focus on the basics: strategic planning, execution, innovation, value, ease of use, diversity and leverage.  And it has its (traditionally) two best quarters of the year upcoming.  Wishing you owned this puppy at $78.20 when the sky looked like it was falling?  

UPDATE 1: Chris Albrecht of NewTeeVee asks What the Heck is Going on with Apple TV, noting that Apple didn't evening mention the "hobby" in the earnings call, and analysts didn't ask.  I know that I forgot, even though there is no way that I believe that Apple is doing little/nothing with the product.

UPDATE 2: China Unicom in 3-Year iPhone Sales Deal, Reuters reports.  China Unicom Ltd. (CHU) has reached an agreement with Apple Inc. (AAPL) to be the sole supplier of the iPhone in China for three years, the Shanghai Securities News reported Tuesday, citing unnamed sources. The mainland's second-largest mobile operator by users after China Mobile Ltd. (CHL) will guarantee total iPhone sales of at least CNY5 billion by buying 1 million to 2 million phones from Apple annually, the report said. China Unicom could begin selling the iPhone in China around late September, the paper said.

Related Posts:

1. Apple, the 'Boomer' Tablet and the Matrix (O'Reilly Radar guest post)
2. Is the iPhone Platform Destined to Disrupt the Packaged Software Industry? (GigaOM guest post)
3. iPhones, App Stores and Ecosystems 
4. Analysis: Apple WWDC Keynote - Punishing the Wizard, Part Two 
5. Built-to-Thrive - The Standard Bearers: Apple, Google, Amazon 

Comments

[retail vs auctions vs classifiedsq]

I think apple shows a constant stock price. It is very useful to share holders.

[Chris R]

See what happens when you make something people actually want. People buy it.

Are you paying attention GM and Chrysler?

[Ronk]

it is nice to hear some good financial news once in a while.

Now if only I didn't have to use go through AT&T to use it.

[Mark Sigal]

@Chris R, this one is so fundamental, that you/we almost miss the obviousness of it. Crappiest economy in decades, yet customers make a flight to quality. Bold this one and underscore it, as it says a lot about consumers and the way they think, and also underscores why there is Apple and everyone else (in a different bucket).

@Ronk, agreed. Hopefully, everyone gets the Apple virus and focuses on thrilling customers, building compelling products and operating with fiscal discipline.

[mark]

Agree with all your excellent points. But did want to add two thoughts:
1) The Apple Store retail slowdown could indicate that the Best Buy and Wal-mart Mac & iPhone deals are doing well. And/or the ongoing shift to online sales is also true for Apple; places like MacMall have had the largest discounts. It would be interesting to see that data.
2) As distribution becomes less important, the Apple Store may be as important as an ongoing support and customer relationship channel (and for marketing as a such). I bought my MBP from Amazon, but rely on the local Apple Stores for first-level support. Note the increasing One-on-One consultations.
3) And even though revenue growth for the Store has slowed to just 2%, 1%, and 4% year-over-year during this recession, the division still has never recorded a single quarter of negative growth in 7 years of y-o-y data. Not sure there are any other retailers that can say that.

[Mark Sigal]

@mark, all of that may be true wrt Apple Store, but to the extent it is a core/expensive part of their strategy, and visitors were up materially while revenue was down, it's a concern, although next quarter numbers should provide some visibility into whether an aberration or a trend.

Re the consultation aspect, I agree wholeheartedly, huge value there.

As to the historical data and relativity to the rest of retail, Apple is in class by itself, and I am not one to find faults in generally great execution, but I wouldn't be an honest source if did not flag a reverse indicator that I have seen in past life.

Thanks again for the great thoughts.

Mark

[cheap fioricet]

Apple is doing great, IPhone takes the phone industry by storm..

[laureanoar]

compared windows international working suggest

[Michael Alletts]

Apple's virtual non-mention of iTunes music downloads is telling - for the number one seller of music on the planet, why not trumpet that fact, unless of course they don't care because it's all about selling iPods not songs.

[Mark Sigal]

I think that you are right, but I would frame it a bit by saying that my sense is that iTunes is a low margin business for Apple where they don't do a lot of work but also don't secure high margins.

I think the Apple narrative is pretty consistently about touting high margins. Hence, you showcase the iTunes song download numbers but not the dollars.

[Jr.]

Dont you people surf the net? Hackintosh tell you something?
Its the big boom theses last years.
For 299$ CA, you can get a netbook or eaven a regular notebook, download os x on anny torrent website and your in business with a mini macbook, oh! yes, do not forget the touchscreen kit for 89$ CA. Mini touchscreen macbook for less than 400$, sounds great no? well believe it coz it is true, just google it.
And you's wunder why apple is slowing down or still stable...
I would never spend 2000$ CA for a 1g ram c/w 160g hdd macbook, when I can get the same as I mentionned above, for less than 400$ CA.