Apple’s 3rd Quarter, In Depth

Shares of Apple Inc. (AAPL) were up 2.90% or $7.31 (after hours) post stellar third quarter 2010 results, which blew past the bullish Zacks Consensus Estimate. The upbeat quarter results were fueled by strong iPhone sales, record Mac sales, increased iPad sales and success of new product launches.

Strong results are attributable to the thriving demand for the company’s iPhone and Mac, as unit shipments remain robust. AAPL has been taking share in the PC market. Increased Mac shipments prove that cannibalization from the iPad has been limited so far.

The outlook for the Mac, iPad and iPhone 4 remains extremely strong, backed by demand in both the domestic and international markets although there could be near-term supply chain constraints for the iPhone 4.

Research firm IDC said that 66% of current iPhone 4 owners were delaying their iPhone 4 upgrades due to an ongoing antenna issue. Although the issue could impact near-term results, in the longer term we expect the iPhone 4 to be a growth driver.

The third-quarter results did not include iPhone 4 sales as the device was launched on June 24. Nevertheless, we anticipate that the company will report stronger results in fiscal 2010, attributable to a potential increase in iPad and iPhone 4 volumes, boosting Apple’s revenues and earnings.

Although AT&T Inc. (T) remains the exclusive U.S. carrier for Apple, the company has been adding multiple carriers to sell its products in other countries. Apple is expected to come up with a CDMA handset for Verizon (VZ) in January 2011, which is expected to further boost iPhone sales.


Earnings in the quarter were a record at $3.51 per share, beating the Zacks Consensus Estimate of $3.08 by 43 cents per share and surpassing the company’s own guidance of $2.28 to $2.39 per share. Earnings shot up 74.6% from $2.01 per share reported in the year-ago period. Net income soared to $3.25 billion in the quarter, a substantial growth of 78% from $1.83 billion in the year-ago period.


Strong earnings were due to record sales in the quarter, which leaped 61.3% year over year to $15.70 billion. The quarter generated highest quarterly revenues in the company’s history. The mammoth revenue growth was driven by an increased momentum in Mac shipments and strong iPhone sales, in addition to better-than-expected sales of iPad.

Geographically, Apple’s revenues increased year over year in every region as the company entered into major markets including Japan, Australia, the U.K., France and Germany. International sales accounted for 52% of the total revenue in the quarter. Year over year, revenues from America, Europe, Japan and Asia-Pacific grew 39%, 66%, 63% and 160%, respectively.

Operating Performance

Gross margins fell to 39.1%, a 180 basis points decrease year over year and a 260 basis-point decline from the previous quarter due to the increase in iPad launch cost, a strong U.S. dollar, portable Mac transition and the higher cost structure of the iPhone 4. However, it was 310 basis points above management’s expectation.

The company is benefiting from a positive mix shift to the higher-margin Mac and iPhone business, aided by recent product upgrades. Additionally, customers continue to shift to the iPod Touch, which is another positive influence on margins. Operating margin in the quarter was 27.0%, flat compared with the year-ago period.

Apple’s balance sheet remains strong. Cash and investments were $45.8 billion at the end of quarter versus $41.7 billion in the previous quarter. The company generated cash flow of $4.8 billion during the quarter versus $2.3 billion in the previous quarter.

Product Highlights

Macintosh – Apple shipped a record 3.47 million Macintosh computers in the quarter, representing a 33% year-over-year increase in units shipped, attributable to a double digit growth for Macs in each of its geographic segments led by a greater demand for iMac and the updated MacBook Pro line.

Macs grew 73% year over year in Asia-Pacific, 144% in China, 184% in Korea, 59% in Spain and doubled in Hong Kong, management said. This resulted in double-digit growth in both desktop and portable platforms that beat expectations.

Year over year, Apple’s desktop computer sales climbed 18% on a unit basis and 15% in revenues while portable MacBook computers escalated 40% on a unit basis and 41% in revenues. In comparison, the overall market for PCs grew 22% year over year during the June quarter, based on the latest forecast published by IDC.

Retail Stores – Retail revenues in the quarter were a record $2.58 billion, up 73% from the year-ago period. Retail stores sold 677,000 Macs in the quarter compared with 492,000 Macs in the year-ago quarter, an increase of 38%. Half of the Macs were sold to new customers.

The company opened seven new stores, including four in the U.S., two in Australia and one in Canada, totaling to 293 stores opened by the end of June. With an average of 287 stores opened during the June quarter, average revenues per store were $9 million compared with $5.9 million in the year-ago quarter.

The company hosted a record 60.5 million visitors in stores during the quarter compared with 38.6 million visitors in the year-ago quarter, an increase of 57%. AAPL plans to open 24 stores in the fourth quarter, including new stores in Paris, Shanghai, London and Spain.

iPods – AAPL sold 9.41 million iPods during the quarter, representing a 8% unit decline from the year-ago quarter. However, the iPod Touch did extremely well in the quarter, growing 48% in revenues year over year, resulting in an increase of iPod revenues by 4% year over year.

The continued mix shift toward iPod Touch resulted in an overall iPod ASP increase of 12%. iPod unit shipments fell 8% year over year due to the cannibalization from iPod Tough.

According to NPD data, Apple’s share of MP3 players in the U.S. was over 70% in the month of June, and iPod was the top-selling MP3 player. The company continues to gain share year over year in most international markets such as Australia, the U.K., Canada and Japan based on the latest data published by GFK.

iTunes – The iTunes store delivered a strong quarter with sales of $1 billion growing 25% year over year due to strong sales of music, video and apps. Apple’s app store continues to be an unparalleled success with more than 225,000 apps (including more than 11,000 apps for iPad) and well over 5 billion downloads to date by iPhone, iPod Touch and iPad users in 90 countries.

iPhones – The iPhone continues to be a major success for AAPL due to its strength in overseas markets, particularly Asia, Europe and Japan. Overall iPhone unit sales were 8.4 million during the quarter, representing a 61% unit growth over the year-ago quarter. This includes over 1.7 million iPhone 4 sales in the initial five countries where it was launched.

According to IDC, the overall smartphone market grew 38% in the June quarter, almost half of the Apple’s 61% growth. In our opinion, the new iPhone 4 will be another milestone achievement for the AAPL, enabling it to continue on the growth path.

The value of iPhones sold during the quarter was $5 billion, resulting in an average selling price (ASP) of about $595. During the quarter, the company sold 100 million iOS devices, which will further drive iPhone sales. The company has iPhone distribution agreements with 154 carriers in 88 countries. Revenues from iPhone handset sales, accessory sales and carrier payments summed up to $5.33 billion compared with $3.06 billion in the year-ago quarter, an increase of 74%.

iPads – The third quarter 2010 represented the first full quarter when the company began shipping iPads in 10 countries. Sales of iPad were in line with expectations at 3.27 million. Recognized revenues from sales of iPad and iPad accessories during the quarter totaled 1.27 billion. The value of iPads sold alone was $2.1 billion in the quarter, resulting in an ASP of about $640.

The company plans to launch iPad in nine additional countries on July 23. A market research firm, iSuppli, raised its outlook for Apple’s iPad sales to 12.9 million units from 7.1 million in 2010. The research firm expects Apple to sell 36.5 million iPads in 2011 and 50.4 million in 2012.


For the fourth quarter of fiscal 2010, AAPL expects revenues to be approximately $18.0 billion, up 47.5% from the year-ago quarter and 14.6% sequentially. The revenue outlook is above the Street expectation of $17 billion, an unusually optimistic forecast as Apple generally gives a conservative outlook. Earnings are expected to be approximately $3.44 per share compared with $1.82 in the year-ago quarter. The Zacks Consensus Estimate for the fourth quarter was at $3.81 at the time the company reported results.

The company expects gross margin of 35.0%, reflecting approximately $40 million related to stock-based compensation expense. Gross margin is expected to decline sequentially due to a higher mix of iPhone 4 and iPad sales and the $175 million revenue deferral impact of the iPhone 4 case offer for the September quarter, which will be recognized in the December quarter.

Operating expenses are expected to be about $2 billion, while Other Income and expenses are projected to be about $50 million. The tax rate is estimated to be about 26.5% from previous 27%.

Apple has a short-term Zacks #1 Rank (Strong Buy) and a longer-term Outperform recommendation.

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