Tuesday, July 22, 2008

Panicky Investors: "OMG! Apple is teh DOOMED!"

It may just be another great opportunity to pick up some AAPL.

Apple just reported their 2008 third fiscal quarter results. Overall it was another insanely great quarter. This was the best June quarter for Apple in terms of both revenue and earnings, and represents the best quarter of all time for Mac sales. Revenues were up 38 percent to $7.46 billion and profits were up 31% to $1.07 billion or $1.19 per share. The analyst consensus estimates were for earnings of $1.08 per share which Apple handily beat by 10%. Sales in Apple's own retail stores increased 58%. Apple added $1.33 billion to their cash position to end the quarter with $20.8 billion in cash and no debt.

Apple shipped 2,496,000 Macintosh computers in the June quarter for an increase of 41% over the year ago quarter. Apple has been able to significanly increase unit sales, revenues, and market share for its lucrative and high margin computer business due to a combination of factors including the huge amount of user dissatisfaction with Windows Vista, the 'halo' effect from their other products, and gaining acceptance of MacOS as an operating system. The Gartner group now ranks Apple as the number three US PC vendor with 8.5 percent market share. Not only did Apple increase sales by the largest percentage of the major manufacturers, they also increased sales by more units than HP. With only 8.5% market share, Apple has significant room to grow in this area. I believe that a good deal of Apple's growth both in revenues and profits going forward will come from Macintosh sales.

Apple sold 11,011,000 iPods this quarter which represents unit growth of 12% and revenue growth of seven percent. The average selling price of iPods has been declining due to the sales of a much larger amount of inexpensive shuffles, especially after a recent price cut. Due to the already high market share Apple enjoys in the MP3 player business (as high as 70% in some countries), I do not see this area of business as a significant growth driver. I believe that iPod sales will show some growth, but will eventually start trending toward being flat especially due to decreased demand for iPods from owners of iPhones.

There are quite a few accounting items which actually make iPhone sales, revenue, and earnings seem lower than they are. Apple shipped 717,000 first generation iPhones during the June quarter. This number is significant because of the fact that in early May the stock of the first generation was pretty well sold out and not replaced due to the pending release of the 3G model. Therefore, no iPhones could be sold for more than half the quarter. Also, the revenue for all first generation iPhones sold after March 6th (the date the 2.0 software was announced) was booked on July 11th when the 2.0 software and the 3G iPhone was released. Therefore, all iPhone revenue and earnings in the June quarter is for iPhones sold prior to March 6th. Additionally, due to accounting rules, since Apple is making new features and software available for the iPhones available at no additional cost, they account for the revenues and earnings on a subscription based model over 24 months. Therefore, an iPhone sold in a particular quarter would only add 12.5% of its total revenue and earnings to that quarter's results.

Response to the iPhone 3G was described by Apple management as "stunning." The phone sold one million units within 3 days of release. This is contrasted to the 74 days it took to sell the first million original iPhones or the nearly two years to sell the first million iPods. I personally wouldn't be surprised if Apple sells 10 million of the iPhone 3G before the end of calendar year 2008. Apple is currently having trouble keeping up with the incredible amount of demand for the new phone, but they say their production ramp is going well. Apple will launch the iPhone 3G in an additional 20 countries on August 22nd bringing the total to over 40, and plans on having it available in more than 70 countries before the end of 2008. The App store is also doing extremely well, and adds significantly to the value of the iPhone and iPod Touch. There are currently over 900 applications available from the App store and users have already completed over 25 million downloads of programs. Apple recieves 30% of all revenue from application sales, while the remaining 70% is passed on to the developers. The iPhone currently enjoys a 28% share of the smartphone market which leaves plenty of room for growth, especially as the smartphone market grows to a larger percentage of the cell phone market as a whole.

There was some talk in the call about a "product transition" which will lower gross margins to the 30 percent level for the 2009 fiscal year. The explanation that Peter Oppenheimer gave for this is that Apple is
"delivering state-of-the-art products at price points that our competitors can’t match, which has resulted in market share gains in each of our products. We plan to continue this strategy and to deliver great value to our customers while making a reasonable margin but not a margin so high as to leave an umbrella for our competitors.

In addition, and one of the investments that we make is to introduce new products that initially cost more because they deliver an entirely new level of value to the customer. Then we ride the cost curves down with value engineering and volume manufacturing, leaving us far ahead of our competitors."

While I won't speculate on what the product introduction will be, I believe that the temporarilary lower margins will be well worth it due to higher overall profits and market share. From management's comments on the call, it definitely seemed that this new product transition will be released in the current quarter ending in September. This release, depending on how it is received could easily push the stock well over $200 per share.

The only thing in the whole conference call which gave me some pause were the concerns about Steve Jobs' health. Apple had previously stated that he is on antibiotics for a 'common bug'. Today in the call, management stated that Steve loves Apple and has no plans on leaving and that his health is a "private matter." On a deeply personal level, I wish Steve the best of health. As one of the people I look up to most, his genius in so many fields is unequalled and his innovative vision is unsurpassed. The world would be a much less interesting place if it were not for Steve's many contributions. He truly did put a dent in the universe, and I am sure he is not done yet.

Apple is currently down about 10% to under $150 in the after-hours trading on this great quarter's results. I view this as a good buying opportunity for long term investors especially if we see some good pullbacks. I believe that the institutions, funds, etc are going to use this as an opportunity to get in before it really runs up. I am reiterating my price target of $200 before the end of January, 2009 which I made in my blog post AAPL's on sale... when Apple was trading at 135.60. I really don't know what more you would want than a company growing profits by over 30% in this market environment which is best in class, with tons of innovative products, no debt, and nearly $21 billion in cash. Even if hard times are ahead, this is a company that has the resources to weather the storm. Apple's future looks very bright to me and I will be holding tight through this short term volatility.

Full Disclosure: I have been long AAPL continuously since August 4th, 2004.

Apple Reports Record Third Quarter Results

Revenue Up 38 Percent Year-Over-Year
Mac Sales Reach All-Time High

CUPERTINO, California—July 21, 2008—Apple® today announced financial results for its fiscal 2008 third quarter ended June 28, 2008. The Company posted revenue of $7.46 billion and net quarterly profit of $1.07 billion, or $1.19 per diluted share. These results compare to revenue of $5.41 billion and net quarterly profit of $818 million, or $.92 per diluted share, in the year-ago quarter. Gross margin was 34.8 percent, down from 36.9 percent in the year-ago quarter. International sales accounted for 42 percent of the quarter’s revenue.

Apple shipped 2,496,000 Macintosh® computers during the quarter, representing 41 percent unit growth and 43 percent revenue growth over the year-ago quarter. The Company sold 11,011,000 iPods during the quarter, representing 12 percent unit growth and seven percent revenue growth over the year-ago quarter. Quarterly iPhone™ units sold were 717,000 compared to 270,000 in the year-ago-quarter.

“We’re proud to report the best June quarter for both revenue and earnings in Apple’s history,” said Steve Jobs, Apple’s CEO. “We set a new record for Mac sales, we think we have a real winner with our new iPhone 3G, and we’re busy finishing several more wonderful new products to launch in the coming months.”

“We’re extremely pleased with the growth of our business and the generation of almost $5.4 billion in cash in the first three quarters of fiscal 2008,” said Peter Oppenheimer, Apple’s CFO. “Looking ahead to the fourth quarter of fiscal 2008, we expect revenue of about $7.8 billion and earnings per diluted share of about $1.00.”

1 comment:

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