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January 21, 2009

Apple Comes Through

I have to admit a sense of great relief following Apple's December quarter earnings. The numbers were great and guidance for the March quarter was much better than feared. A lot of stocks I like, including Apple, are really struggling and it makes me question my analysis. In this case, I got it right and that increases my confidence in other stocks as well.

What follows immediately is live commentary I posted on Real Money.com prior to and during the company's conference call on Wednesday after the close. If you click "continue reading" you will find a more formal summary of the quarter and the call. Apple shares should re-emerge as market leaders on rallies thanks to this quarter.

1/21/2009 4:40 PM EST
December Q looks like a clean beat. Macs in line. iPods way ahead and flat with last year. Gotta be the touch. iPhone at 4.363 is a little light.

But is all about guidance. $7.6-8.0 billion revenue and EPS of 90-$1.00. Both of those are below consensus but not nearly as low as many feared. This is good news and is why the stock is trading over $91 as I type.

More after I fill in my spreadsheet.

1/21/2009 4:59 PM EST
With help from my updated spreadsheet...

December quarter is excellent. A clean beat. Revs higher, gross margin way above guidance. I thought this could happen given favorable input costs but very solid ASPs on Macs and iPods also helped. Desktop units light but laptop units better than expected. Apple made its Mac units without giving on price in a brutal environment when everyone else cut prices. Shows the power of the brand. iPod units were a blowout but just up tiny yoy. ASP for iPod is flat. Given speculation on strong touch sales they must also have had good luck with shuffles. iPhone units could have been better but my spreadsheet got the revenue close which gives me more confidence in future predictions.

Om March quarter guidance. Using midpoint on revenue guidance, similar qoq trends from last year on operating expenses, and lifting interest income very slightly form December quarter, I back into gross margin guidance of 30%. there is no regular pattern of qoq gross margin but this will be viewed as conservative.

That last point is what matters. If you assume rev guidance is conservative and give them a boost in gross margins to 32% you are at or above current consensus. In other words, guidance in Apple terms is good. Thus the stock is up another $8-10 bucks as the call is about to start.

1/21/2009 5:21 PM EST
Guidance assumes 32.5% gross margin and a huge step down in interest income. Should have figured that given short-term interest rates. Also, some of gross margin upside comes from a catch up from prior periods. Maybe 100 basis points?

I still believe my comment that in Apple terms guidance is in line with street estimates and a lot better than the whisper or feared.

The rest of my comments will be in my earnings summary.

Formal Summary of Quarter

Apple reported excellent December quarter earnings. Revenues and EPS easily beat estimates. Revenues were $10.17 billion and EPS were $1.78 compared to estimates for $9.74 billion and $1.39.

Mac unit sales were in line at 2.5 million with desktops light and laptops better than expected. ASPs held steady despite worries about the weak consumer spending environment.

iPod sales were much beet than expected at 22.7 million vs. estimates of 18.6 million. ASPs were steady. Nanos and the touch were singled out on the conference call. ASPs held steady. US iPod sales were down about 3%. International sales were up. The last week of the quarter saw a buying surge on a worldwide basis.

iPhone units of 4.3 million were at the low end of expectations. There was some inventory drawdown so shipments for the March quarter could get a boost as pipeline fills. But Apple remains publicly worried about demand given the economy and high price points for Smartphones.

The balance sheet looks great with $31 per share in cash after a big quarter for cash flow. Inventories look under control and within expectations for phones and Macs. For phones inventories are tricky because this is the first quarter with so many countries and so many channel partners.

Gross margins were 400 basis points ahead of expectations. One half of the upside came form component costs. The rest was evenly split between lower expenses for things like transportation and warranties and from what I think might be a one-time boost due to prior period adjustments. I may have misunderstood this last comment.

The big positive for the shares was guidance. Guidance of $7.6-8.0 billion in revenue and 90 cents to $1.00 in EPS is below consensus but not too far below. Apple normally guides conservatively and beats so in Apple terms this guidance is in line with consensus. Consensus had been coming down steadily and there was great fear guidance would fall way short. Guidance assumes a drop in gross margins sequentially and a big drop in interest income reflecting the unusually low interest rate environment on the short end of the yield curve.

This quarter and guidance should seriously relax investors. The valuation adjusted for a cash balance that is now generating a lot less interest income looks very good. Operating EPS seems set to be at least $4.00 and cash should end over $35 per share. AT recent lows around $75 that would leave the core P-E multiple at just 10 times. Quite reasonable given the still low market share in PCs and cellphones.

Apple also was once again very tightly and well managed. This should help to allay concerns about Steve Jobs health. Someone asked about Jobs health on the call but no new information was provided.

Finally, adjusting for the fact that Apple recognizes iPhone revenue over eight quarters, had they reported like RIMM or Motorola or Nokia, revenues would have been $11.8 billion and EPS would have been $2.55. That means that at a 4-5 million iPhone run rate Apple's earnings power is over $10 per share.

Posted by Steve Birenberg at January 21, 2009 05:02 PM in AAPL