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Golden Delicious

by Mark W. Hibben

Apple's Fiscal Third Quarter Exceeds Even My Expectations

For the past few quarters, I've been chiding financial analysts for their overly conservative predictions of Apple financial performance, but this quarter I think they can be forgiven for once again falling short.  Apple's performance was simply amazing.  Where other well run technology companies congratulate themselves for 20-30% year-over-year revenue gain, Apple has managed y/y revenue gains of greater than 80% for two consecutive quarters.  In what should have been a humdrum quarter without major holidays or new product announcements to drive sales, Apple set all-time records for quarterly revenue and earnings of US$28.57 B and US$7.31 B respectively.  Even more spectacular was the y/y growth of unit sales of iPhone and iPad, 142% and 183% respectively.  How Apple managed these feats is the subject of today's Tech Chat.

Fiscal Q3 2011 % Change Q3 2010 % Change Q2 2011 Apple Guidance at Q2 '11 Blogger Consensus Apple 2.0 The Street, Thomson Financial
Revenue (US$B) 28.57 82.0% 15.8% 23 26.69 24.92
Earnings (US$B) 7.31 124.9% 22.0%      
EPS (US$/diluted share) 7.79 121.9% 21.7% 5.03 6.72 5.8
Gross Margin (%) 41.7 6.6% 0.7%      
Mac Unit Sales (M) 3.95 13.8% 5.1%      
iPhone Unit Sales (M) 20.34 142.1% 9.1%      
iPad Unit Sales (M) 9.25 182.9% 97.2%      
iPod Unit Sales (M) 7.54 -19.9% -16.4%      

Outflanking the Competition

Rather than just slug it out in the developed (and crowded) markets of North America and Europe, Apple has mounted a flanking maneuver in the War for Mobile Internet Supremacy (WMIS) by going big in South America, the Middle East, and Asia.  The revenue breakdown by geographic segment that Apple provides in their 10-Q indicates this strategy:

Fiscal Q3 2011 Revenue US$ B % Change Q3 2010 Revenue Fiscal Q3 2011 Op. Income US$ B % Change Q3 2010 Operating Income
Americas 10.126 62.61% 3.596 80.07%
Europe 7.098 70.63% 3.107 90.50%
Japan 1.510 65.93% 0.735 88.46%
Asia-Pacific 6.332 246.96% 2.782 230.80%
Retail 3.505 35.96% 0.828 39.63%


All segments except retail (Apple owned stores) have shown explosive growth.  In the Americas and Europe, this has been fueled by growth in Mexico, South America and the Middle East, and in Asia this has been fueled by China.  The Retail segment, which includes all Apple stores regardless of geography, has grown the slowest, but this is to be expected, since the stores are as much about brand awareness as driving retail sales. 

As Tim Cook, Apple COO, finally admitted in the conference call with financial analysts on 7/19/11, Apple does indeed care about market share, and emerging markets are where Apple plans to grab share.  For those markets, Apple's low power iOS devices such as iPhone and iPad are superbly positioned to be not merely digital accessories but the principal computing resources for individuals and households.  According to Cook, Apple is just "scratching the surface" in emerging markets such as China. 

Another vital market in which Apple appears to be outflanking the competition is in enterprise adoption.  Here, the information from Apple management is very sketchy.  According to them, more than 90% of the Fortune 500 are testing or deploying iPhone, but they've been saying that for the past few quarters.  No actual breakdown of sales has been made available.  The best evidence for Apple's success in this arena comes from the declining fortunes of Research in Motion (RIM), whose Blackberries were de rigueur for the corporate elite for years.  While other tech companies are growing, RIM suffered a sequential revenue  decline of 12 % and a year over year earnings decline of 10% in their most recent fiscal Q1 2012 quarter, reported in June.  While Microsoft's Win7 Phones continue to languish, and Android is too undisciplined for the corporate world, Apple's iOS offers a reasonable alternative to Blackberry.  The very controlled environment of iOS should offer security assurances to corporate IT managers while the success of Apple iOS products in general will be attractive to executives longing to trade in their dumpy old Torches for new iPhones.  The erosion of RIM's market share will only accelerate in the quarters ahead, and only Apple stands to gain from this. 

iOS Device Population Update

In addition to the specific unit shipment numbers Apple provides every quarter, Apple also provided a total number for iOS devices shipped of 222 M through the end of the June quarter (Apple Fiscal Q3 2011).  Combined with their quarterly shipment data, these summary numbers provide a way to back out the number of iPod Touch shipments (which Apple doesn't break out separately from iPods), and thereby arrive at an estimate of the current worldwide population of iOS devices.  Assuming a phased replacement rate, which never exceeds 10%, I estimate the current worldwide population of iOS devices to be 208 M, with 61.14 iPod Touch, 118.2 M iPhones, and 28.73 M iPads.  This is in contrast to the Android device population of 128 M I estimated for Google Q2 2011 Financial Results.  As the Android and iOS population chart (next panel) shows, Android is very gradually closing the gap between iOS and Android worldwide device population.

If Google can maintain the activation rate of 550k/day they reported at their recent conference call, then Android population will jump considerably next quarter.  Cook was even asked about the Android 550k/day activation rate at the Apple conference call and evinced the same puzzlement I experienced.  Cook was also unsure just what the number means.  Based on Apple's most recent quarter iOS device shipments, Apple shipped an average of 335K iOS devices/day, whereas I estimate an average Android activation rate of 392K/day for the recent Google Fiscal Q2 2011 (also ending in June) based on the total Google-reported number of Android activations of 135 M.

Analysts have been very concerned about the potential for sales cannibalization for the iPad, so of course, Cook was asked about it again at the latest conference call.  He did admit some cannibalization of Mac laptop sales, but according to the latest iOS sales numbers, that's not really where the cannibalization is occurring.  Starting at the beginning of 2011, I estimate that iPod Touch sales have fallen dramatically, from a total of 6.4 M for the last calendar quarter of 2010 to 1.13 M for the calendar Q1 2011 and 0.945 M for calendar Q2 2011.  Probably, iPhone and iPad are dividing the lost  iPod Touch sales between them, in some unknown ratio.  This only makes sense.  iPod Touch and iPad are functionally the same devices, except that the iPad has a much more usable display and a higher price tag. 

Whereas, a 32 GB iPhone 4 sells for the same price as a 32 GB iPod Touch.  iPod Touch has the misfortune to significantly overlap two very popular products (iPhone 4 and iPad 2) that do not themselves overlap.  iPod Touch may not be long for this world. The sole advantage for Apple of iPod Touch is that it provides some diversification of what is otherwise a very narrowly focused mobile device product line.  I have in the past urged a broadening of Apple's mobile product line, and mobile product diversification was even the topic of one analyst's question.  Cook's response was to point out that Apple also sells the iPhone 3Gs, at only US$49.  Selling old obsolete products from leftover inventories isn't normally what is meant by product diversification.  When automobile manufacturers want to address the low end of their market, they don't merely sell previous year's models at a discount.  Instead, they specifically design low cost "economy cars" to appeal to consumers who want low cost transportation.  There certainly is a market for low cost communications and computing devices, a market that Nokia currently dominates.  Ceding this market without a fight may not be a good strategy in the WMIS. 

iPhone 5

Apple management made it very clear that they expect a sequential revenue and earnings impact in fiscal Q4 (July-September) due to a product refresh in the "Fall".  There is only one product that is big enough to do that and that is due for a refresh: iPhone.  So I expect iPhone 5 to arrive in September, just in time for the holiday season and not too late for back to school as well.  On the next panel is my summary of expected iPhone 5 features.

iPhone 5 Feature Type Specifications Comments
Processor Apple A5 dual core ARM processor Unifies feature set with iPad 2.
Screen 960x640 Holdover of iP4 "Retina Display".
Position Sensors Gyro, Accelerometer, Compass, GPS Basically the same as iP4.
Front Camera Facetime VGA capable Basically the same as iP4.
Rear Camera 8 Mpixel still, 720p/30fps video record, LED flash Upgraded still capability.
Antenna designs External frame, larger gaps Continuation of iP4 approach but with larger insulating gaps between the cellular and WiFi antennas to minimize "finger bridging" effects.  See iPhone 4 Fiasco for a discussion of this.
Video Output 1080p video mirroring, 720p movie output via Digital AV adapter through HDMI cable, also video out through Airplay Essentially the same capability as iPad 2.  Movie output resolution is limited by the source material.  Home screen is an inset of the full 1080p video output for video mirroring.
Back cover Plastic composite Apple ditches the too fragile "Gorilla glass" in favor of fiberglass reinforced ABS in your choice of white or black.
Front cover Glass White or black frame.
Networks GSM and CDMA Verizon and AT&T get their new iP5 models simultaneously.

Fiscal Q4 2011 Projections

I've decided it's time for me to put my money where my mouth is, prediction wise, and provide a projection of Apple financial performance for the fourth quarter.  My prognostications are summarized below:

Fiscal Q4 2011 Fiscal Q3 2011 % Change from Fiscal Q3 2011 Fiscal Q4 2010 % Change from Fiscal Q4 2010
Revenue (US$B) 30.76 28.57 7.7% 20.34 51.2%
Earnings (US$B) 7.42 7.31 1.5% 4.31 72.3%
Mac Unit Sales (M) 4.10 3.95 3.8% 3.89 5.5%
iPhone Unit Sales (M) 20.40 20.34 0.3% 14.10 44.7%
iPad Unit Sales (M) 12.00 9.25 29.7% 4.19 186.5%
iPod Unit Sales (M) 6.70 7.54 -11.1% 9.05 -26.0%


Here, I'm assuming that Apple have learned their lesson from the introduction of the iPad 2 and are not rushing iPhone 5 to market with inadequate channel inventory.  Therefore, I expect the impact of iPhone 5 to be a pause in the explosive sales growth of the iPhone rather than an actual decline in sales.  On the other hand, I expect Apple to continue to ramp up iPad 2 production in order to finally sate demand, so that sales of iPad 2 grow significantly, and channel inventory finally reaches desired levels.  iPad unit sales are expected to afford continuation of Apple's revenue growth momentum, but with sequential growth in earnings nearly flat due to the iPad's lower margins.  Year over year revenue and earnings growth will be quite good, though not so spectacular as in previous quarters. 

  • 1.
    Golden Apple
  • 2.
    Out- Flanking
  • 3.
    iOS Pop. Update
  • 4.
    Touch Declines
  • 5.
    iPhone 5
  • 6.
    iP5 Features
  • 7.
    Apple's Q4
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