Apple’s Uncharacteristically Sloppy Execution

by: FP Trading Desk posted on: July 23, 2008 | about stocks: AAPL    
  • Font Size:
  • Print

On Monday, Apple (AAPL) reported a strong Q3 that again topped analyst estimates, but its forecast missed estimates. Along with activation and other service issues for the new 3G iPhone and concerns over Steve Jobs’ health, the weak forecast has led to shares falling 11% in after-hours trading to about $149. This is the first time Apple has looked sloppy.

For Q4, Apple expects revenue of $7.8 billion and EPS of $1 versus analyst estimates of $1.24 EPS on revenue of $8.3 billion. Gross margin is expected to decrease from 34.8% in Q3 to about 31.5%. A new accounting system for the 3G iPhone, “future product transition” and the impact of back-to-school promotions are behind this sequential decline.

In the first weekend after the 3G iPhone launched on July 11, Apple sold 1 million 3G iPhones, with many stores reporting stockouts. This compares with sales of 6.4 million first-generation iPhones in the first year of their release, adding 717,000 from Q3. By all indications, the 3G iPhone will do better, although the inventory shortfall will prevent them from doing as well as the company could have. In my opinion, this is another sloppy situation. Apple has released the 3G iPhone in so many markets, including numerous international markets, without working out the supply-side details - inventory, logistics, tracking, supply chain - very uncharacteristic lack of attention to operational details.

According to iSuppli, Apple is spending $174.33 on components plus $50 in IP royalties per unit while the unsubsidized price is $399/$499 for the 8GB/16GB device. That gives a 44% and 50% margin for each 8GB and 16GB 3G iPhone sold, respectively, although AT&T is selling the phone at a $200 discount against 2-year service contracts. Without an AT&T (T) contract or subsidy, AT&T is selling the iPhone at $599 for the 8GB model and $699 for 16GB. That would imply a gross margin of 62% for the 8GB model and 64% for the 16GB model (at an additional cost of $23 for the 16GB chip). Apple gets an estimated $300 per iPhone in subsidy from AT&T. Overall; the margin numbers across the board look quite healthy.

However, Q4 sales will not be significantly affected by this high margin or by high iPhone sales due to the new accounting method in which iPhone revenue is going to be distributed over two years. This deferred revenue stance will make future revenues predictable, although both current revenue and EPS will be lower.

As for Q3, revenue was up 38% y-o-y to $7.46 billion, driven by 43% growth in Mac revenue. Net income was $1.07 billion, or $1.19 per diluted share, versus $818 million, or $0.92 per diluted share in Q3 2007. Analysts estimated EPS of $1.08 on revenue of $7.36 billion.

Apple generated $1.33 billion in cash during the quarter, ending with a $20.8 billion reserve. Operating expenses were $1.21 billion and gross margin was 34.8%, down from 36.9% last year.

Apple shipped 2.5 million Macs, which accounted for 61% of revenue. The updated iMac helped drive 49% growth in desktop sales, while portable sales were up 37% due to demand for the MacBook Air as well as MacBooks and MacBook Pros. For the second quarter, Gartner and IDC placed Apple in the No.3 spot in the U.S. market, behind HP (HPQ) and Dell (DELL). IDC says Apple has 7.8% share, sharing the spot with Acer, while Gartner puts the figure at 8.5%. Either way, Apple is becoming a force in the U.S. computer market, something that HP and Dell, as well as Microsoft (MSFT) would need to battle in the years to come.

Music products and services accounted for 33% of revenue. Apple sold 11 million iPods in the quarter, up 12% y-o-y and 4% q-o-q, driven by sales of iPod Shuffle and iPod Touch. However, due to lower ASPs courtesy of price reductions, iPod revenue grew just 7%.

International revenue accounted for 42% of revenue. Revenue from Europe grew 43% and from Japan 40%. Asia-Pacific had y-o-y growth of 53% in the Mac business. Apple opened its first store in Australia, and last weekend its first store in Beijing opened. In Q4, the company is planning to open stores in Switzerland and Germany.

There has not yet been any hint from Apple about how it will use its $278 million acquisition of microprocessor design company PA Semiconductor. We have to wait also to see how Apple plans to use its $20.8 billion cash reserve. There is no lack of ambition in the ever-hungry Jobs, but perhaps he ought to acknowledge that he needs help in dealing with the growing pains of his beloved company from people who don’t shy away from the dirty details of operations.

Chart for Apple Inc. (<a href='http://seekingalpha.com/symbol/aapl' title='More opinion and analysis of AAPL'>AAPL</a>)

Disclosure: None

This article has 11 comments! Add yours below...
FP Trading Desk

FP Trading Desk

About this author:
Become a Contributor Submit an Article

This article has 11 comments:

  •  
    guliamo
    Jul 23 06:56 AM
    My Website
    Analysts reaction to Apples reports was to lower the stocks' price by as much as 10% during beginning of trading.. So what happened that made Apple close at a mere -2.5%?
    I think a lot of private investors gobbled up the discount stock awaiting the rebound back to $200.
    I totally believe Apple will return to and break the $200 mark. Everything about the company looks great and recession or not, one just has to pop into the Apple store on 5th avenue NY and see the complete mayhem of shoppers cramming in endless lines to get the new AirBook.. have you seen it, by the way?
    I definitely want to own stock in a company that produces that kind of machine.
  •  
    KellyOKeefe
    Jul 23 07:21 AM
    It's absurd to say Apple's "forecast missed estimates". Forecasts neither achieve or miss estimates, they ARE estimates. It is accurate to say that Apple's estimates are less optimistic than their investors. This isn't failed execution – this is careful execution. Isn't it better to under promise and over deliver than to do the opposite? Given the tragic disappointment of companies like Bear Stearns that ride their own, wild optimism to disaster, I think we should rally around this company. I have certainly taken the opportunity to increase my holdings.
  •  
    Fedman
    Jul 23 08:08 AM
    What is absurd to me is all this focus on speculation as opposed to fact. Apple gave great earnings and said that they are guiding lower due to back to school sale incentives. It is clear that they are at the critical mass point where a gain in market share is more important that a gain in profit, for the long term of the company.

    We can all take away from the conference call what we will, but I came away with the feeling that Apple was entering a new era where they could be the dominant force in several key market places that would ensure them a long lasting bright future.

    All the issues of Steve's health, how they account for iphone sales, etc are really for traders. For an investor, do you agree that they should focus on market share or one quarter's profit? I think the pricing of the new Iphone convinced them that there is tremendous market share that is price sensitive and they're going for it. I, as an investor, am pleased.
  •  
    mrtaxx
    Jul 23 08:14 AM
    My Website
    Apple had stellar results along with the Jobs in a bad economy, NO cancer by NYT article today possibly helped Apples recovery yesterday. NYT apparently leaked the info on NO cancer. Apple added $1.5B in cash for a total of almost 21B. With these earnings results the stock should have never gone down and should of went up substantially. Forget about the guidance, Apple always guides lower and were in a recession. With a recession why didn't analysts lower estimates instead of raising them, manipulation?

    Almost daily banks report billions in losses and their stocks go up. Rimm missed and its stock went up right after earnings. Apple had stellar earnings & the stock went down, manipulation at its finest. Today Costco reported they will miss, even good companies are missing but Apple didn't. Apple beats in a terrible economy and the stock takes a hit, this is ridiculous and pure manipulation. Where is the SEC? Oh, their giving Fannie and Fredie a free shorting ride, how about the other stocks, manipulation at its best.

    Apple is the best tech stock and they prove it each quarter, hang in there Apple will reward long term holders.
  •  
    ezduzit
    Jul 23 08:37 AM
    an idle comment about apple's "growing pains" is quite a stretch. every company and the usa government should have such pains.

    and as far as a comparison between bank america and apple, one is run as a real company and the other has taken as much liberty as possible by using the government as its partner. apple doesn't need a bailout or a government guarantee to make a deal.
  •  
    zoltan
    kovacs
    Jul 23 10:22 AM
    AAPL's new "accounting method" is deferring sales and earnings for two years. Analysts simply don't get it: these earnings are real and have to be added to the publicized flow of income and to the estimates. Since the flow of income from the iPhone is growing percentually, the absolute incremenal numbers will be "significant"... Some people covered themselves with AAPL shares on the cheap and we all got rid of some weak hands again.
  •  
    peter02l
    Jul 23 10:28 AM
    "In the first weekend after the 3G iPhone launched on July 11, Apple sold 1 million 3G iPhones, with many stores reporting stockouts. This compares with sales of 6.4 million first-generation iPhones in the first year of their release, ..."

    How can you compare one weekend of sales with one year's worth, and then you sound disappointed, calling this a sloppy execution? Let's have an example of another phone company with a similar product release that executed well.
  •  
    mollytjm
    Jul 23 11:06 AM
    Apple said that even they were blown away by demand for the 3G iPhone. Pent up demand was hard to estimate. but they are restocking at regular intervals now. they've been in the 'phone game' for a little more than a year and they already have a better product than anyone and it (and macbook air) are winning awards all over the place. Apple will get a smoother distribution system and do THAT better than anyone. Financially responsible and secure company with LOTS of $$, innovation. And, the Chinese are coming!! Great stock for investors.
  •  
    tom1234
    Jul 23 11:26 AM
    when the market is not rewarding aapl excellant report with the additional announcement of delayed anounced profits which says the report is (in a good way) sandbaged how can you not find a better value--if you buy value there is no debt with delayed profit announcements ---plus new products and still lines for the iphone in the NJ market --what am i missing --is this not by any standards a good investment--aapl is very transparent with not hidden wright downs --no further to be announced bad loans --it offers multi products -not a one trick pony and a subtle replacement of windows --said another way a take down of microsoft--did i miss the movie
  •  
    mollytjm
    Jul 23 11:33 AM
    tom1234... right! all this negative stuff is obviously from day traders, not from value investors, who DO recognize a great company.

    and while everyone notices the lines for the iphone and the jammed stores, the lines of app developers are just as long and not noticed. remember the days when almost no one developed for Apple? now they can't wait which will make all Mac/Apple products even richer, along with it's investors.
  •  
    FPPC
    Jul 23 12:13 PM
    Hey, isn't it about time Apple considered a dividend (even a special dividend) for all the investors that have stuck with it? Share some of that cash hoard.
Loading...
Symbols:
Authors:
Quick Links:

ETFs In Focus

  • Long Ideas

  • Short Ideas

  • Cramer's Picks