Ruminations on Apple Q1, 2010 Earnings Call and Investor "Dead Zones"

By Mark Sigal
January 26, 2010

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"Ah. Yes. Don't you see how clear it is? Not only can you see the future, you can ..."

"...I can change it." - from the 'The Dead Zone'

They still don't get it. You know, the folks who saw Apple as a consumer-dependent, overpriced house of cards that was destined to collapse when the economic downturn hit.

The same ones who dismissed the iPhone, couldn't make heads or tails of the iPod touch, never "got" the platform play or the importance of the App Store, let alone parse through the earnings impact of Apple's subscription-based accounting relative to its mobile peers (RIM, Nokia, et al).

And don't even get me started on how totally these same folks are dazedly staring into space as they contemplate Wednesday's Apple Tablet announcement, and how it feeds the next leg of Apple's growth, while throwing a lifeline to print media.

blind-person.jpgListening to Apple's earnings call yesterday, then the chatter across a number of technology, investing and Apple-focused sites, and finally, watching the stock go up, down and sideways, I am reminded that when you are working from the wrong narrative, faulty storylines are destined to emerge.

Worse yet, when you are attempting to tidily bucket the gravitational force of emergent ecosystems using simplistic and dated logic about markets, makers, consumers and value chains, you can't possibly hope to see the full picture.

This leads some to under-factor the impact and durability of the new market innovation, such as seeing Apple in terms of old Windows v. Macintosh paradigms, with the outcome pre-ordained (Apple has to ultimately lose, doesn't it?).

Others, view the company purely as a widget maker with stylistic marketing and over-priced, high-end products, a growth story destined to reach rapid maturity, then stagnation, decay and finally, demise (the law of averages suggests that not everything Apple does will succeed, right?).

Finally, others see the company as only as strong as its weakest link (how long can iPhone grow before it's game over?).

The End (to End) Game: Apple's Platform Vision

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But what the Apple naysayers still don't get is that not only can Apple and Steve Jobs see the future, but they are committed to changing it by reworking the communications, computing and media landscape with the digital consumer at the center of the equation.

No less, Apple is doing so with a coherent vision, clear tactics and an execution-oriented culture, something yesterday's earnings further bear out.

Ironically, the same company that is dubbed evil by some, too proprietary by others and too pricey by still others is actually winning in the market by democratizing the relationship between consumers and media, application & communication providers.

They are doing this by virtue of unbundling entire industries (e.g., mobile, music, apps), with the net effect of bringing down consumer cost, while enabling consumers to buy ala carte (if they desire to do so).

Only Apple is providing an end-to-end platform that yields consumers surplus access to application and media libraries, where artificial or logistical scarcity once existed, all the while giving application builders and media creators a guaranteed path to distribution, reach and monetization. It's a WIN-WIN-WIN proposition for BigCos, Upstarts and Consumers. That's the simple reason why the strategy is working.

When the Apple Tablet is announced on Wednesday, I believe that the premise will be one unified platform (derived from iPhone) that supports best-of-breed application creation (and soon advertising and media unit creation), inclusive of developer tools, marketplace and retail presence/support for mobile, desktop, on-the-go and in the living room.

Moreover, I am guessing that a significant reboot of Apple TV is imminent, as it represents a natural piggyback on top of the media-centricity of the Apple Tablet, and Apple is all about leverage.

After all, this is Steve Jobs' legacy on the line, his final act, so to speak, and that understanding frames why Wednesday's Applet Tablet announcement should not be seen as simply iPhone redux or Netbook on steroids, but rather as the signature moment on a truly epic career. I expect the product to deliver no less.

Apple Delivers All-Time Highest Revenue and Profit

Saccharin sentiments or not, numbers don't lie, and Apple delivered (once again) mega-dollars and massive profits, a truth that is best anchored by Steve Job's quote in the earnings release, "If you annualize our quarterly revenue, it's surprising that Apple is now a $50+ billion company."

In fact, the math is stunningly strong (almost) anyway you slice it, with the Company posting record revenue of $15.68 billion (representing 32% growth over the previous December quarter), a net quarterly profit of $3.38 billion (50% higher year-over-year, and $850M higher than the previous quarterly record), and generating an additional $5.8 billion in cash during the quarter. That means that the Company is now sitting on a $40 billion hoard of cash (or cash equivalents).

Apple did this with gross margins was 40.9 percent, up from 37.9 percent in the year-ago quarter. So much for the consumer squeeze.

Highlights:


  • Macintosh Business: Apple sold 3.36 million Macintosh® computers during the quarter, representing a 33 percent unit increase over the year-ago quarter (beating consensus estimates by over 300K units, and besting industry averages by almost double). In particular, K-12 and higher-ed in the US was up 16% year over and year, which represents the best growth rate the Company has experienced in this segment since before the recession. Of equal note, in response to a question by Piper Jaffray analyst, Gene Munster, is the fact that Apple COO, Tim Cook, noted that he saw no mitigating factor that suggests this type of growth (for the Mac) can't continue.

  • iPhone (Sales): The Company sold 8.7M iPhones in the quarter, representing 100 percent unit growth over the year-ago quarter (but below analyst estimates of 9.1M units). For the first time, Apple revealed that the average sales price (ASP) for iPhone is $620, and also noted that their growth rate compares favorably to the 35% growth rate of the overall smart phone segment. Moreover, Apple CFO Peter Oppenheimer stated that enterprise demand for iPhone is increasing, specifically noting that "Business customers have ranked iPhone the Number 1 smart phone in the J.D. Power customer satisfaction survey for the second year in a row." He added that 70% of the Fortune 200 is currently deploying or piloting iPhone (a doubling since iPhone 3GS debuted a year ago), and that the enterprise is a core focus for Apple, although in my opinion, Oppenheimer was fuzzy on the details relative to specific apps and strategies designed to drive market penetration and/or any halo effect for the Mac.

  • iPhone (AT&T Exclusivity): Is it ending? Well, Apple gave a wet kiss to AT&T, calling them a great partner, and emphatically stating that AT&T has a detailed plan to fix performance issues in the few cities where there are known issues, a plan which Apple has seen and believes in. More to the point, though, they sidestepped the exclusivity question, noting that the addition of iPhone carriers in markets leads to incremental sales gains, which is another way of saying that while more is better, it may not be world-beating better, since the trade-off for sacrificing exclusivity is lower subsidies, and likely, lower margins. The most likely outcome, in my opinion, is the Apple Tablet launching with multiple domestic carriers, and only then, an end to AT&T's exclusivity with iPhone.

  • iPhone (Global Distribution): Apple now has iPhone distribution in 86 countries (and added 17 new carriers during the quarter, including China Unicom, although Cook soft-pedaled regarding expectations for China). Finally, Cook conveyed high confidence relative to channel inventory management, always comforting in such a high volume, rapid-growth segment.

  • iPod Business: Apple sold 21 million iPods during the quarter, representing an eight percent unit decline from the year-ago quarter. This was in line with expectations, a trend that should only increase, as the traditional iPod segment is very mature, but which also represents a category being leapfrogged by the iPod touch. In fact, a 55% gain in iPod touch sales, and their materially higher ASP (relative to traditional iPods) meant that revenue actually grew for the entire device category.

  • iTunes and App Store: Apple continues to strengthen its position with iTunes as the deepest library of music, video, and apps, with an 11M song library, over 8,000 films and an App Store model that has delivered over 100K applications, and more than 3 billion application downloads to date.

  • Apple Retail: Apple Retail remains strong, with same store sales of $7.1M versus $7M in the year ago quarter. Same store sales is an important indicator of the effectiveness of a bricks and mortal retail strategy, and along those lines, a record 680,000 Macs sold at Apple Stores (half of which were to first-time Mac buyers), with 50.9 million visitors in the quarter, compared to 46.7 million in the year ago quarter.

It's worth noting that this quarter's earnings (and Apple earnings moving forward) were favorably impacted by the Company's adoption of new FASB accounting standards that allow Apple to move away from subscription-based accounting (on iPhone and Apple TV) and recognize both income and reflect the majority of product costs on iPhone and Apple TV at the time of purchase (versus ratably over each product's estimated economic life).

As such, about half of the impact of the upward surge in revenue and profits came from the company's adoption of the new accounting standards, which I had previously blogged about HERE.

The balance of the surge was a by-product of superior execution of the business.

In tandem, the Company retrospectively adopted the new accounting principles as if the new accounting principles had been applied in all prior periods since the launch of iPhone and Apple TV in fiscal 2007 (through fiscal 2009), an approach that should provide analysts and investors the most comparable and useful financial information from which to evaluate the underlying performance of the Company's business.

Stay tuned for Wednesday's announcement.

Related Posts:


  1. Holy Sh-t! Apple's Halo Effect

  2. Apple Accounting Change: Why it Matters

  3. Rebooting the Book: One Apple iPad Tablet at a Time

  4. Built-to-Thrive - The Standard Bearers: Apple, Google, Amazon

  5. Android's 'Inevitability' and the Missing Leg


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