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Apple's 1Q Mixed, Shares Plunge

Zacks Equity Research

Apple Inc. (AAPL) reported earnings of $13.81 per share that beat the Zacks Consensus Estimate by approximately 37 cents in the first quarter of 2013. However, shares plunged 9.8% ($50.52) in after hours trading on the heels of lower-than-expected iPhone shipments in the quarter.


Total revenue was up 17.7% year over year and 51.6% sequentially to $54.51 billion and beat the company’s forecast of $52.00 billion. However, revenues fell shy of the Zacks Consensus Estimate of $54.80 billion for the third consecutive quarter.

Apple made some changes in its reporting structure to provide greater transparency. iPhone, iPad, iPod and Macintosh sales are exclusive of related service and accessory revenue. The company also established a new operating segment, Greater China that includes Mainland China, Hong Kong and Taiwan.

Although iPhone unit sales surged 29.0% year over year and 78% from the previous quarter to 47.79 million, it was significantly lower than expectations. Revenues shot up 28.0% from the year-ago quarter and 84.2% from the previous quarter to $30.66 billion in the quarter.

Apple experienced strong iPhone sales in most of its markets. The company launched iPhone 5 in China, South Korea and 50 additional countries in the first quarter.  In Greater China, iPhone sales more than doubled on a year-over-year basis.

iPhone growth continues to be driven by strong adoption from a number of U.S. government agencies as well as companies around the world. This healthy adoption rate is particularly beneficial for Apple as the iPhone continues to face significant competition from Google’s (GOOG) Android based smartphones from Korean handset maker Samsung.

iPad growth was strong as unit sales jumped 48.0% year over year and 63% sequentially to 22.86 million. iPad revenues were up 21.7% year over year and 49.6% quarter over quarter to $10.67 billion in the quarter.

During the quarter, Apple launched iPad mini and iPad 4, which received overwhelming response. Global companies such as Barclays Plc, Nomura Securities and Bank of Beijing continued to deploy iPad, which further drove growth in the quarter.

Apple shipped 4.06 million Macintosh in the reported quarter, down 22.0% from the year-ago quarter and 18.0% on a sequential basis. Revenues plunged 16.4% year over year and 16.6% quarter over quarter to $5.52 billion.

iPod units and sales on a year-over-year basis continued to decline in the quarter. Apple sold 12.68 million iPods (down 18.0% year over year) and earned $2.14 billion (down 15.2% year over year) in the quarter. On a sequential basis, iPod unit shipment and revenues jumped 161.3% and 131.0%, respectively.

Revenues from iTunes/ Software/ Services improved 22.1% year over year and 5.5% sequentially to $3.69 billion. Accessories surged 24.6% from the year-ago quarter and 45.7% from the previous quarter to $1.83 billion.

Retail revenues in the quarter increased 5.3% year over year and 52.3% sequentially to $6.44 billion. During the quarter, Apple opened 11 new retail stores, including 4 in Greater China. At quarter end, Apple operated 401 stores worldwide, of which 150 are located outside the U.S.

Region wise, Greater China reported strongest growth, with revenues surging 67.4% year over year and 25.9% sequentially in the reported quarter. The launch of iPhone 5 was the primary reason behind this strong growth. Rest of Asia-Pacific and Japan grew 10.4% and 25.2% year over year, respectively. Americas grew 14.8% year over year while Europe increased 10.7% from the year-ago quarter.


Gross profit increased a modest 1.7% year over year and 46.2% sequentially to $21.06 billion in the first quarter. However, gross margin contracted 610 basis points (bps) year over year to 38.6%, but remained slightly above management’s forecast of 38.5%. On a sequential basis, gross margin declined 140 bps in the quarter.

In the first quarter of 2013, Apple started allocating certain manufacturing cost and variances including cost related to product tuning and manufacturing process equipment to operating segments. Earlier, these were included in corporate expenses.

Operating expenses spiked 14.5% year over year to $3.85 billion lower than management’s expectation of $4.05 billion. Operating expenses, as a percentage of revenues, declined 20 bps year over year and 250 bps from the previous quarter to 7.1%.  The improvement was due to lower selling, general & administrative expense (down 40 bps year over year and 190 bps sequentially) in the first quarter.

Operating profit decreased 1.0% year over year but increased 57.3% sequentially to $17.21 million. Operating margin decreased 580 bps from the year-ago quarter to 31.6%, reflecting lower gross margin base. On a sequential basis, operating margin improved 120 bps to 31.6% owing to significantly lower operating expenses.

Net income remained flat on a year-over-year basis but jumped 59.0% sequentially to $13.08 billion. Earnings per share (EPS) also remained flat year over year but surged 59.3% sequentially to $13.81 in the reported quarter.

Balance Sheet and Cash Flow

Apple’s balance sheet remains strong with cash and investments of $137.1 billion at the end of the first quarter compared with $121.3 billion in the previous quarter. Cash flow from operating activities was $23.4 billion in the reported quarter.

Second Quarter Guidance

For second quarter 2013, Apple forecasts revenues to be in the range of $41.0 billion to $43.0 billion (approximately 5.0% to 10.0% year-over-year growth). Gross margin is expected to be in the range of 37.5% to 38.5%, while operating expenses are projected to be within $3.8 to $3.9 billion range. Other income/ (expense) are forecasted to be $350.0 million while the tax rate is likely to be 26%.

Our Take

Apple’s after hour sell-off primarily reflects excessively high investor expectation as well as declining confidence in its ability to sustain supernormal growth rate. Nonetheless, we believe that Apple’s three consecutive revenue misses reflect fundamental challenges it currently faces in the market.

Of late, Apple has been criticized for lack of innovation in its product pipeline. Although Apple continues to update its devices frequently and has launched new products on a regular basis, these have not been successful enough to boost investor confidence. Moreover, the problems with voice application Siri and failed initiative with Apple Maps also did not go well with investors as well as customers.

Additionally, Apple continues to face significant competition from Samsung not only in the U.S. but also in Greater China. We believe that Samsung’s diversified portfolio that caters to almost every income segment will continue to hurt Apple’s market share, particularly in Greater China where pricing is often an important consideration.

Moreover, Finnish handset maker Nokia (NOK) is refocusing on the smartphone segment through its Lumia range of mobiles. Nokia still has a significant customer base in the Asia-Pacific markets. Another smartphone maker, Research In Motion’s (RIMM) upcoming BlackBerry 10 also poses significant threat in the near term.

Nevertheless, we believe that Apple’s growth story is based on its Apps, iCloud and loyal customer base. Apple is also well positioned to gain from international expansion going forward. Moreover, the recent shareholder friendly moves such as dividend payment and share buyback are expected to drive the stock going forward.

Currently, Apple has a Zacks Rank #3 (Hold).

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