Investors weren't quite sure how to digest Apple's (NASDAQ: AAPL) latest digits initially, as shares were rather volatile in after-hours trading last night. They jumped on the headline beats, but dropped precipitously on concerns around margin guidance. Revenue came in at US$37.5 billion, which translated into net income of US$7.5 billion, or US$8.26 per share.
Shares opened slightly higher this morning, as concerns have eased. Here's what Apple investors need to know.
"It's going to be an iPad Christmas" (unless you want a Retina Mini)
iPhone sales were rock solid at 33.8 million, well ahead of investor expectations. Investors already knew that Apple had 9 million in the bag from its iPhone launch weekend, and the iPhone 5s was severely constrained for the nine days or so it was available during the quarter. Supply is still limited and Apple exited the quarter with a "significant backlog," but production continues to ramp each week.
There were about 1.8 million iPhones in transit at the time, which were included in channel inventory but were on their way directly to customers. iPhone channel inventory was at the low end of Apple's target range, showing it's still having trouble keeping up with demand.
iPad units were a little light at 14.1 million, but that's somewhat expected with the refresh that took place this month. While the iPhone gets included in and boosts the September quarter to a small degree, the iPad does not. Tim Cook is so confident in the new iPad lineup that he predicts that "it's going to be an iPad Christmas."
More challenging will be Apple's ability to satisfy demand for the new Retina iPad Mini. Apple knows how many it will be able to make, but the company won't know demand until it begins shipping. Cook said it's "unclear" if Apple will have enough, which is really just a modest way of saying they won't.
Free comes at a cost
Apple made plenty of headlines last week when it announced that it was making OS X Mavericks and iWork free from here on out for new customers. Well, just like your mother used to tell you, "There's no such thing as a free lunch."
Due to free future software upgrades (especially for iOS), Apple has always deferred a portion of revenue from device sales. With the company giving more away now, these deferrals are increasing. For iOS devices, Apple is now deferring US$15 to US$25 per unit, which is an increase of around US$5, which is then recognised over the subsequent two years. For Macs, we're talking about US$20 to US$40 in deferrals, an increase of US$20, which is recognised over four years.
The net result of these is that Apple expects a sequential increase in deferred revenue of US$900 million in the December quarter. This is also affecting Apple's gross margin guidance, which had initially disappointed investors. Backing out these deferrals, analysts were actually impressed with the guidance. Investors apparently were too, since shares immediately jumped upon this revelation.
Some analysts are estimating the negative impact of this deferral at around 150 to 160 basis points. My estimates come out a little bit more conservative.
| Revenue guidance | US$56.5 billion |
| Gross margin guidance (%) | 37% |
| Gross margin guidance (US$) | US$20.9 billion |
| Revenue guidance ex-deferrals | US$57.4 billion |
| Gross margin guidance ex-deferrals (%) | 37.98% |
| Gross margin guidance ex-deferrals ($) | US$21.8 billion |
| Difference | 98 basis points |
Source: Apple and author's calculations. Guidance midpoints used.
Analysts may only be adding the US$900 million to the gross margin line, which would result in 160 basis points of additional margin. However, CFO Peter Oppenheimer said this should be included in both the revenue and gross profit line items, and that the deferrals are a dollar-for-dollar reduction, which is how I arrived at my figures above.
Apple to Icahn: It's not me, it's you
Despite Carl Icahn's call for a US$150 billion repurchase program, Apple slowed the rate of its share buybacks this quarter. During the June quarter, Apple repurchased $16 billion in shares. In the September quarter, that figure declined to US$4.9 billion. Retiring about 10.4 million shares puts Apple's average price paid around US$472.
Remember that US$12 billion of the June quarter repurchases was made through an accelerated repurchase program, with only US$4 billion in open market purchases. All US$4.9 billion of this quarter's buybacks were open market, so in this sense there was an increase in regular activity while the accelerated program took advantage of low prices earlier in the year.
That means that in fiscal 2013, Apple bought back US$22.9 billion of stock, or over a third of the US$60 billion total authorisation that's good through the end of calendar 2015.
Icahn thinks Apple is undervalued, and Apple clearly agreed wholeheartedly during the June quarter as shares traded as low as US$390. From here on out, Apple plans to be "thoughtful and deliberate" with changes to its capital return program, and ultimately appreciates input from investors — be it Icahn or David Einhorn. Any changes will be announced in early 2014.
Greater China is bouncing back
Instead of giving out Greater China revenue including retail this quarter, Tim Cook provided the figure for the full fiscal year, which was US$27 billion. That puts fiscal fourth quarter Greater China revenue including retail at US$6 billion, a sequential increase of 22%. The sequential drop in Greater China revenue in the previous quarter to US$4.9 billion was a little disconcerting, so it's good to see sales in the Middle Kingdom start to rebound despite Apple's high-end pricing strategy with the iPhone.
Source: Conference calls.
China was included in the first wave of iPhone launch countries this year for the first time ever, which helped. The same will be true for the iPad Air when it launches this week. With the eagerly anticipated China Mobile deal expected in November to coincide with the carrier's TD-LTE network rollout, the Greater China business should continue higher into next quarter. After that, the Chinese New Year and associated holiday shopping season will subsequently boost fiscal second quarter results.
It's the time of the season
The September quarter is typically a transitional one for Apple, particularly with its recent product cycle shift where it launches its most meaningful products in the fall. Apple just closed out a great fiscal year, and continued to tease at new product categories (and new markets) coming next year.
Following a year of investor pessimism, it's time to be optimistic again.
