18 October 2010

AAPL: Income Statement Analysis for the September 2010 Quarter

Apple (NASDAQ: AAPL) earned $4.64 per diluted share in fiscal 2010's fourth quarter, which ended on 25 September.  Earnings per share were nearly 70 percent more than the $2.77 Apple made in the same quarter of 2009.

This post examines Apple's Income Statement for the latest quarter.  We did not issue "look-ahead" estimates because well-researched projections are available from a host of analysts.

The principal sources for this income statement analysis were the earnings announcement, the accompanying data sheet, and the conference call with analysts (transcript made available by Seeking Alpha).

In a second article, we will report Apple's scores as measured by the GCFR financial gauges.  The follow-up post will also provide the latest figures for the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

Before getting into the details, we will take a step back to introduce the subject of today's analysis.

Apple Inc. has been recognized by Fortune as the world's most admired company for the last three years.  It is known for elegant product design, innovation, customer loyalty, secrecy, and the cult-like status afforded CEO (and savior) Steve Jobs.

It sells Macintosh® desktop and laptop computers, iPhone™ portable devices, iPad tablet computers, iPod® music and video players, operating system software (including OS X and iOS), software applications and Apps, digital entertainment, and various accessories.

Apple sold 7.5 million iPads in the six months after the product's launch date on 3 April 2010.

News reports indicate that Apple in 2011 will start selling iPhones that will work on Verizon's (NYSE: VZ) network.  iPhones in the U.S. have always been marketed in conjunction with AT&T (NYSE: T).

The "A4" computer chips that run the iPhone, iPad, and some other products are based on the low-power ARM architecture, but the design was customized by Apple.  Samsung (SEO: 005930) manufactures these chips.

Apple's products are sold online and through the company's chic retail stores.  Digital content is made available through the iTunes Store®, as well as iPhone and iPad Apps stores.

For fiscal 2009, which ended one year ago, Apple earned $8.2 billion on sales of $42.9 billion.  The comparable figures for fiscal 2008 were earnings of $6.1 billion and sales of $37.5 billion.

A soaring stock price has elevated Apple's market value towards $300 billion, making Apple the second-most valuable U.S. company.

In the first quarter of fiscal 2010, Apple revised how it accounts for sales of the iPhone (and the less important Apple TV).  This change, which complies with the latest standards issued by the Financial Accounting Standards Board, enables Apple to recognize "substantially all" iPhone and Apple TV Revenue in the period that sales to consumers took place.  Apple had been required to recognize Revenue from these products over each product's two-year estimated economic life.  The "subscription accounting" method resulted in substantial amounts of deferred Revenue and costs. Apple, when it made the change, restated earlier results to conform to current accounting principles. 

Please click here to see a full-sized, normalized depiction of the actual results for the just-concluded quarter, as well as the restated quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

As has often been the case recently, Apple's Revenue of $20.3 billion far surpassed Apple's $18.0 billion guidance.  The reported amount, a record high Revenue figure for Apple, was 67 percent greater than Revenue of $12.2 billion in the September 2009 quarter.

The following table lists Apple's Revenue by product category.

Sept 2010Sept 2009% Change

Units (m)3.8853.05327.3%

ASP ($)$1254$1304-3.8%

Revenue ($B)$4.870$3.98022.4%

Units (m)4.188--

ASP ($)$667--

Revenue ($B)$2.792--

Units (m)14.1027.36791.4%

ASP ($)$626$625-

Revenue ($B)$8.822$4.60691.5%

Units (m)9.05110.177-11.1%

ASP ($)$163$1545.8%

Revenue ($B)$1.477$1.563-5.5%
Other *

Revenue ($B)$2.382$2.05815.7%

TotalRevenue ($B)$20.343$12.20766.7%
* Other = "Other Music Related Products and Services" (e.g., the iTunes Store), "Peripherals and Other Hardware," and "Software, Service and Other Sales."

All Apple operating segments experienced torrid Revenue growth. 

Revenue ($B)Sept 2010Sept 2009% Change
Asia Pacific$2.732$1.061158%

The Cost of Goods Sold was 63.1 percent of Revenue in the September quarter, which translates into a Gross Margin of 36.9 percent.  The margin contracted nearly 5 percent (a hefty 490 basis points) from 41.8 percent in the September 2009 quarter. 

Although down, the Gross Margin still surpassed the company's 35 percent guidance (made during July's conference call).  Apple now says that

"About two-thirds of [190 basis point better-than-expected Gross Margin] was driven by lower commodity and other costs, and the remainder was mostly attributable to a better-than-planned mix of iPhone sales."

Research and Development and Sales, General, and Administrative expenses in the latest quarter summed to $2.065 billion, only 3.2 percent higher than the company's $2 billion guidance for these Operating Expenses.  Because Revenue soared, R&D fell from 2.9 to 2.4 percent of Revenue, and SG&A dropped from 8.7 percent of Revenue to 7.7 percent.

The quarter did not include any separately identified "Other" operating expenses, such as restructuring charges or asset impairments.

Subtracting the various operating expenses from Revenue yields Operating Income of $5.447 billion, which was 48 percent more than $3.684 billion in the September 2009 quarter.   If the quarter had played out as implied by the Apple's July guidance, we figure that Operating Income would have been about $4.3 billion.

Net interest and other non-operating items produced income of $14 million. This figure was less than expected, but the difference is trivial when compared to the company's bottom line.

The 21.1-percent effective income tax rate was significantly less burdensome than the previous September's 32.1-percent rate.  The company's guidance was for the rate to equal 26.5 percent.  Apple says that the lower-than-expected rate was due to a greater proportion of earnings realized overseas and some one-time tax benefits.

Bottom-line Net Income rose by 70 percent to $4.31 billion ($4.64 per diluted share), compared to (restated) earnings in the year-earlier quarter of $2.532 billion ($2.77 per share). 

Apple's guidance suggested earnings of around $3.44 per share in the September 2010 quarter.

In summary, Apple had another exceptional quarter.  The top and bottom lines of the Income Statement have continued to grow at year-on-year rates rarely seen at a large company.  Both figures, Revenue and Net Income, were records for Apple.

The company sold 27 percent more Macs and 91 percent more iPhones.   The iPad, in its second quarter, brought in Revenue of nearly $2.8 billion.   iPod unit sales were lower, but the average selling price expanded.  Apple's earnings also benefited from a falling tax rate, as international sales outpaced those in the U.S.

Full disclosure: No position in AAPL at time of writing.

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