Apple Fires All Cylinders in 2Q

Apple Inc. (AAPL) continued its bullish run with better-than-expected second quarter fiscal 2011 results. Apple breezed past the Zacks Consensus Estimate of $5.34 by $1.06 (19.9%) in the quarter. The results were fueled by strong iPhone sales, record Mac sales and increased iPad sales, as unit shipments remained robust.

The outlook for Mac, iPad and iPhone 4 remains extremely strong, backed by demand in domestic and international markets, boding well for Apple’s revenues and earnings.

Piggybacking on the results, Apple shares rose in after-hours trading by 3.10% or $10.61 to $353.02.

Operating Performance

Apple reported earnings of $6.40 per share, well ahead of its conservative guidance of $4.90. Earnings shot up 92.2% from $3.33 per share reported in the year-ago quarter.

Net income soared to $5.98 billion in the quarter, reflecting a remarkable 94.8% growth from $3.07 billion in the year-ago quarter.

Gross margin fell 30 basis points (bps) year over year to 41.4%, due to a higher mix of aggressively priced iPad sales. However, it was 290 bps above management’s expectation. Operating margin was 31.9%, up from 29.5% in the year-ago quarter.

Revenues

Strong earnings were attributable to the quarter’s record sales, which leaped 82.7% year over year to $24.67 billion. Revenues beat the Zacks Consensus Estimate of $23.11 billion and Apple’s own forecast of $22.00 billion. The strong revenue growth was driven by increased momentum in Mac shipments and booming business by iPhone and iPad. International sales accounted for 59.0% of the total revenue in the quarter.

Product Highlights

Macintosh: Apple shipped 3.76 million Macintosh computers in the reported quarter, representing a 27.8% year-over-year increase, attributable to strong demand for Macs across all geographic segments. In the Asia Pacific region, Mac sales grew 76.0% year over year. The growth in Mac sales was driven primarily by strong sales of MacBook Air, which was updated in the December quarter, as well as robust sales of MacBook Pro, updated in the March quarter. Apple outperformed the personal computer (PC) market for the 28th consecutive quarter, which according to research group IDC, declined 1.1% for the quarter ended March 31, 2011.

Retail Stores: Retail revenues in the quarter were a record $3.19 billion, up 90% from the year-ago quarter, courtesy increased Mac and iPad sales. The retail stores sold 797,000 Macs in the quarter compared to 606,000 in the year-ago quarter, an increase of 31.5%. Half of the Macs sold through retail stores in the quarter were to new customers. International Retail Store sales were strong, with average international store volume exceeding average U.S. store volume. At quarter end, Apple had 323 stores worldwide, with 87 stores located outside the U.S.

The iTunes store also delivered a strong quarter with sales of $1.4 billion, driven by record revenue from music, video, iOS apps and books. During the quarter, iBookstore began offering a full catalog of 17,000 ebooks from Random House. The iBookstore now includes ebooks from more than 2,500 publishers in over 20 categories, and customers have already downloaded over 100 million copies.

iPods: Apple sold 9.0 million iPods during the quarter, representing a 17.4% unit decline from the year-ago quarter. According to NPD data, Apple’s share of MP3 players in the U.S. was over 70% in the month of March, and iPod was the top-selling MP3 player based on the latest data published by GFK. iPod touch sales remained strong, accounting for over 50% of all iPods sold during the quarter.

iPhones: The iPhone continues to be a star performer for Apple, with double-digit growth in both the Americas and the Asia-Pacific regions. Overall, iPhone unit sales were 18.6 million during the quarter, representing 111.0% growth over the year-ago quarter. According to IDC, the overall smartphone market grew 74% in the March quarter.

Revenues from iPhone handset sales, accessory sales and carrier payments summed up to $12.3 billion compared with $5.45 billion in the year-ago quarter, a significant increase of 125.6%.

The company had iPhone distribution agreements with 186 carriers in 90 countries at quarter end. During the quarter, Verizon Wireless, a venture between Verizon Communications (VZ) and Vodafone Group Plc (VOD), started offering the iPhone 4 in the U.S., ending the exclusive agreement that Apple had with AT&T (T).

iPads: Total iPad units sold in the quarter were 4.7 million, up from 4.6 million sold in the previous quarter. Apple launched iPad 2 in the U.S on March 11 and in 25 additional markets on March 25. iPad is currently available in 59 countries. Recognized revenues from sales of iPad and iPad accessories during the quarter totaled $2.8 billion.

Management highlighted that over 75% of the Fortune 500 companies, such as Automatic Data Processing Inc. (ADP), Walt Disney (DIS) and Estee Lauder Companies Inc. (EL), are already using iPad.

Apple’s app store continues to top the charts with more than 350,000 apps and over 10 billion downloads till date. Last month, Apple announced a new subscription service available to all publishers of content-based apps, including magazines, newspapers, video and music. We believe the new subscription service will drive further revenue growth going forward.

Balance Sheet

Apple’s balance sheet remains strong. Cash and investments were $65.8 billion at the end of the quarter versus $59.7 billion in the previous quarter. The company generated cash flow of $6.2 billion during the quarter versus $9.8 billion in the previous quarter.

Third Quarter Guidance

For the third quarter of fiscal 2011, Apple expects revenues of approximately $23.0 billion. Earnings are projected at approximately $5.03 per share. The Zacks Consensus Estimate was pegged at $4.45 per share at the time the company reported second quarter results.

Apple expects gross margins of 38.0%, reflecting approximately $55 million related to stock-based compensation expense. Operating expenses are expected to be $2.5 billion, including about $255 million related to stock-based compensation, while Other Income and expenses are projected at around $70 million. The tax rate is estimated to be about 25.0%.

Our Take

We maintain our Outperform rating over the long term (6–12 months). We believe Apple is well positioned to achieve strong top-line growth over the long term, based on product innovation.

Apple is scheduled to launch its new operating system Lion by June this year and update the iPhone again by September.

Apple is also expected to discuss the future of iOS in the upcoming “Worldwide Developers Conference” (WWDC) event. The new iOS version is expected to include cloud-based features, such as a “media locker” where users can store their music, video and books.

We believe the upgraded iOS (name and release timing yet to be confirmed) is absolutely necessary for Apple to compete against Google Inc.’s (GOOG) Android-based mobile operating system.

We also believe Apple’s foray into the cloud computing market will boost its results. In February 2011, Apple announced that it is preparing to open a $1.0 billion data center in North Carolina, to support iTunes and MobileMe services.

However, we believe Apple will have a tough battle in the cloud computing market, where Amazon Inc.’s (AMZN) Web services holds a dominant position. Recently, Amazon launched its cloud-based service that allows users to store music, photos and videos and access them any time and from any computer.

We believe Apple has a number of near-term headwinds. Notably, supply chain problems related to the iPad and iPhone, aggravated by the natural disaster in Japan, could upset the Apple cart. The company is also facing a number of legal hurdles against companies including Nokia Inc. (NOK), Eastman Kodak (EK), Taiwanese handset maker HTC and most recently Samsung Electronics Co. (SSNLF).

ESTEE LAUDER (EL): Free Stock Analysis Report

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