18 January 2011

AAPL: Income Statement Analysis for the December 2010 Quarter

Apple (NASDAQ: AAPL) earned $6.43 per diluted share on a GAAP basis in the December-ending first quarter of fiscal 2011, up an astonishing 75 percent from $3.67 in the same three months of 2009.

This post examines Apple's Income Statement for the quarter. 

The results were overshadowed to some extent by the announcement CEO Steve Jobs, the leader of the Apple cult, would take a third medical leave of absence.

Reported earnings were $1.63 per share (34 percent) greater than Apple's guidance of $4.80.  Please note we did not issue our normal "look-ahead" estimates because detailed projections are available from the many professional and amateur analysts that follow Apple's every move.  (Andy Zaky's Bullish Cross is one excellent example.)

The principal sources for this income statement analysis were the earnings announcement, the accompanying data sheet, and the ensuing 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, brand-building marketing, and secrecy.

A soaring stock price has elevated Apple's market value to almost $320 billion, on a fully diluted basis, making Apple the second-most valuable U.S. company.  Only Exxon Mobil (NYSE: XOM) is worth more.

In fiscal 2010, which ended in September, Apple earned $14.0 billion ($15.15 per diluted share) on sales of $65.2 billion.  Earnings in fiscal 2009 were $8.2 billion ($9.08 per share) on sales of $42.9 billion.

Apple 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.

The "A4" computer chips that run the iPad, iPhone, 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.

In February 2011, Apple will start selling an iPhone 4 compatible with Verizon Wireless's CDMA network.  iPhones in the U.S. have heretofore been marketed in conjunction with AT&T (NYSE: T), which operates a GSM network.

Apple products are sold online and through the company's chic retail stores.  Digital content is made available through the iTunes Store®, as well as Mac, iPhone and iPad Apps stores.  The Mac App store opened in January 2011.

The amazing success of the iPhone (nearly 90 million sold to date), now being repeated with the iPad (13.8 million sold in 9 months), has fundamentally redefined the market for mobile computing devices.  Numerous companies envious of Apple's rich profits are attempting to develop attractive alternatives.  Mobile devices that run Android, an open source operating system supported by Google (NASDAQ: GOOG) are already selling well.  In addition, Research in Motion (NASDAQ: RIMM) has improved its Blackberry product line, Microsoft (NASDAQ: MSFT) has enhanced Windows Phone, and Nokia (NYSE: NOK) has a series of capable products.

In something of a halo effect, Apple's triumphs with its "i" products have also increased sales of Macintosh desktops and laptops.  These devices have expanded their share of the U.S. personal computer market to almost 10 percent.

Please click here to see a 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, Revenue of $26.7 billion in the latest quarter far surpassed Apple's $23.0 billion guidance.  Macs, iPads, and iPhones sold in numbers greater than the company expected.

The reported amount, a record high for Apple by a wide margin, was 70.5 percent greater than Revenue of $15.7 billion in the December 2009 quarter.

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

Macintosh Dec 2010Dec 2009% Change
 Units (m)4.1343.36223.0%
 ASP ($)$1,313 $1,324 -0.8%
 Revenue ($B)$5.43 $4.45 22.0%
 Units (m)7.331--
 ASP ($)$629 --
 Revenue ($B)$4.61 --
 Units (m)16.2358.73785.8%
 ASP ($)$645 $638 1.0%
 Revenue ($B)$10.47 $5.58 87.7%
 Units (m)19.44620.97-7.3%
 ASP ($)$176 $162 8.9%
 Revenue ($B)$3.43 $3.39 1.0%
Other *    
 Revenue ($B)$2.81 $2.26 24.1%
TotalRevenue ($B)$26.74 $15.68 70.5%
* 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)Dec 2010Dec 2009% Change
Americas$9.22 $6.09 51.3%
Europe$7.26 $5.02 44.4%
Japan$1.43 $0.78 83.0%
Asia Pacific$4.99 $1.81 175.1%
Retail$3.85 $1.97 95.2%
Total$26.74 $15.68 70.5%

The Cost of Goods Sold of $16.4 billion in the December quarter was 61.5 percent of Revenue, which translates into a Gross Margin of 38.5 percent.  The margin contracted 240 basis points from 40.9 percent in the December 2009 quarter. 

Although down, the Gross Margin still surpassed the company's 36 percent guidance (announced during the conference call on 18 October).  The Gross Margin exceeded Apple's expectations because commodity and some other product costs were lower than budgeted.  In addition, better-than-expected Revenue had a positive effect on the margin.

Research and Development and Sales, General, and Administrative expenses in the latest quarter summed to $2.47 billion, only 6.3 percent higher than the company's $2.325 billion guidance for these Operating Expenses. 

R&D spending increased 44 percent, from $398 million to $575 million.  R&D fell, however, from 2.5 percent of Revenue to 2.2 percent.

SG&A rose from $1.3 billion to $1.9 billion, an 47 percent increase.  As a percentage of revenue, SG&A edged down from 8.2 percent of Revenue to 7.1 percent.

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

Operating Income, calculated by subtracting the various operating expenses discussed above from revenue, was $7.8 billion, 66 percent greater than last year's $4.7 billion.  If the quarter had turned out as implied by the Apple's guidance, Operating Income would have been roughly $6.0 billion.

Net interest and other non-operating items produced income of $136 million. This figure, roughly twice as much as expected, benefited from currency exchange rates.

The 24.6-percent effective income tax rate was significantly less burdensome than the previous December's 29.0-percent rate.  The latest tax rate was also less than the 25.5-percent rate included in the company's guidance.  Apple says that the lower-than-expected rate was due to the retroactive extension of the R&D tax credit in the U.S.

Bottom-line Net Income rose by 78 percent to $6.0 billion ($6.43 per diluted share), compared to (restated) earnings in the year-earlier quarter of $3.378 billion ($3.67 per share). 

Apple's guidance was to expect earnings of around $4.80 per share, which the company handily exceeded.

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

The company sold 23 percent more Macintoshs and 86 percent more iPhones during the holiday quarter.   Amazingly, Apple stated it "could have sold even more iPhones if we had been able to supply them."  Not to be left behind, Mac unit sales grew at a pace far more robust than the overall personal computer market.

The iPad, in its third quarter, brought in Revenue of $4.6 billion.  iPod unit sales were lower, but the average selling price expanded.  Apple's earnings also benefited from a falling tax rate, due both to a one-time benefit and international sales outpacing those in the U.S.

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

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