(AAPL) Apple’s Earnings Beat Examined In Depth

Apple Inc. (AAPL) reported stellar fourth quarter 2010 results with highest quarterly revenues and earnings in the company’s history, which blew past the bullish Zacks Consensus Estimate. The upbeat quarter results were fueled by strong iPhone sales, record Mac sales Incorporatedreased iPad sales and success of new product launches.

Strong results are attributable to the thriving demand for the company’s iPhone and Mac, as unit shipments remain robust. Despite upbeat results, shares fell in after-hours trading by 6.13% or $19.50 to $298.50 as investors remained cautious on lower-than-expected iPad shipment and weaker gross margins.

However, the outlook for the Mac, iPad and iPhone 4 remains extremely strong, backed by demand in the domestic and international markets, boosting Apple’s revenues and earnings.

Earnings

Earnings in the quarter were a record at $4.64 per share, beating the Zacks Consensus Estimate of $4.05 by 59 cents, posting a positive surprise of 14.6% and surpassing the company’s own guidance of $3.44 per share. Earnings shot up 67.5% from $2.77 per share reported in the year-ago quarter. Net income soared to $4.31 billion in the quarter, a substantial growth of 70.1% from $2.53 billion in the year-ago quarter.

Revenues

Strong earnings were attributable to record sales in the quarter, which leaped 66.7% year over year to $20.34 billion. Revenues beat the Zacks Consensus Estimate of $19.02 billion. The mammoth revenue growth was driven by an increased momentum in Mac shipments and strong iPhone and iPad sales. International sales accounted for 57.0% of the total revenue in the quarter.

Operating Performance

Gross margins fell to 36.9%, a 490 basis points decrease year over year. However, it was 190 basis points above management’s expectation. Margins declined due to increase in sales of low-margin iPads, partially offset by a mix shift to the higher-margin Mac and iPhone business. Operating margin in the quarter was 26.8%, down from 30.2% in the year-ago quarter.

Apple’s balance sheet remains strong. Cash and investments were $51.0 billion at the end of quarter versus $45.8 billion in the previous quarter. The company generated cash flow of $5.7 billion during the quarter versus $4.8 billion in the previous quarter.

Full Year 2010 Results

Apple ended fiscal 2010 with earnings of $15.15 per share, up 66.9% from $9.08 per share reported in 2009. Revenues in 2010 soared 52.0% year over year to $65.23 billion. In fiscal 2010, Apple generated five times the revenues and more than 10 times the earnings from fiscal 2005, management pointed out.

The tremendous growth was driven by product upgrades and increased Mac sales of over $13.6 million in fiscal 2010, a 31% growth from 2009 level. Apple benefited from the launch of iPhone 4 in June that resulted in a sale of 40 million units of iPhones (all generations) in fiscal 2010, an increase of 93% year over year as well as the launch of iPad in April that sold nearly 7.5 million units to date.

Apple also introduced new features to iOS and iTunes. Apple unveiled new Apple TV for just $99 that will stream rented HD movies and television shows for 99 cents in rentals. Apple sold 250,000 units of its updated Apple TV since the device went on sale in June 2010. We also remain positive on the launch of its new iAd, a mobile computing platform in July 2010. The new iAd should give Apple a foothold in the emerging mobile search market.

Product Highlights

Macintosh – Apple shipped a record 3.89 million Macintosh computers in the reported quarter, representing a 27.0% year-over-year increase in units shipped, attributable to a double-digit growth for Macs in each of its geographic segments.

This growth was driven by a greater demand for the updated iMac and the continued popularity of MacBook Pro line. Macs grew 56.0% year over year in Asia Pacific and 49.0% in Japan. This resulted in a double-digit growth in both desktop and portable platforms. In comparison, the overall market for PCs grew 11.0% year over year during the September quarter, based on the latest forecast published by IDC.

Retail Stores — Retail revenues in the quarter were a record $3.57 billion, up 75% from the year-ago quarter. The retail stores sold 874,000 Macs in the quarter compared with 670,000 Macs in the year-ago quarter, an increase of 30%. Half of the Macs were sold to new customers.

The company opened 24 new stores, of which 16 were international stores in Beijing, Paris, Shanghai, London and Spain. AAPL also opened four stores in China and one store each in Barcelona and Madrid. At quarter end, AAPL had 317 stores worldwide, with 84 stores located outside the U.S.

With an average of 301 stores opened during the September quarter, average revenues per store were $11.8 million compared with $7.8 million in the year-ago quarter. The company hosted a record 74.5 million visitors in stores during the quarter compared with 45.9 million visitors in the year-ago quarter, an increase of 62%. AAPL plans to open 40 to 50 stores in fiscal 2011 quarter, of which 50% will be internationally located.

iPods – AAPL sold 9.05 million iPods during the quarter, representing a 10.8% unit decline from the year-ago quarter and also came below 9.6 million units expected by analysts. According to NPD data, Apple’s share of MP3 players in the U.S. was over 70% in the month of September, and iPod was the top-selling MP3 player.

The company continues to gain shares year over year in most international markets such as Australia, the U.K., Canada and Japan based on the latest data published by GFK. In September, Apple refreshed the iPod Touch, redesigned iPod Shuffle and iPod Nano. We expect the new refreshed iPod line to deliver incremental revenues in the December quarter.

iTunes — The iTunes store delivered a strong quarter with sales of $1 billion. In September, AAPL launched iTunes 10, with new features such as AirPlay wireless music playback and Ping for iTunes users in 23 countries.

iPhones – The iPhone continues to be a major success for AAPL, given its strength in overseas markets, particularly Asia, Europe and Japan. Overall, iPhone unit sales were 14.1 million during the quarter, representing 91% unit growth over the year-ago quarter.

The year-over-year increase was attributable to robust iPhone 4 sales. The quarter represented the first full quarter of iPhone 4 sales, which hit the market in late June. According to IDC, the overall smartphone market grew 64% in the September quarter. In our opinion, the new iPhone 4 will be another milestone achievement for AAPL, allowing it to continue on the growth path.

The value of iPhones sold during the quarter was $8.6 billion, resulting in an average selling price (ASP) of about $610. The company released iPhones in China via China Unicom (CHU) at the end of the fourth quarter, which will further drive iPhone sales.

The company has iPhone distribution agreements with 166 carriers in 89 countries. Revenues from iPhone handset sales, accessory sales and carrier payments summed up to $8.82 billion compared with $4.61 billion in the year-ago quarter, a significant increase of 92%.

Although iPhone faces tough competition from Research in Motion’s (RIMM) BlackBerry devices and Google Inc.’s (GOOG) Android-based handsets, management pointed out that the sale of iPhones beat RIMM’s 12.1 million Blackberry’s sold in their most recent quarter. AAPL criticized Google’s Android as a “fragmented” operating system. Moreover, the company said that Google is activating 200,000 devices a day with 90,000 apps in the Android app store while Apple is activating 275,000 devices a day, with 300,000 apps in the App Store.

iPads– Sales of iPad were 4.2 million in the quarter, up from previous quarter sale of 3.27 million units. However, sales fell slightly short of analysts’ expectation of 5 million units in the quarter due to supply chain constraints. Since the launch of iPad in 26 countries, management highlighted that over 65% of the Fortune 100 companies such as Procter & Gamble (PG), Lowe’s Co. (LOW), NBC Universal and Novartis AG (NVS) have deployed iPad.

Recognized revenues from sales of iPad and iPad accessories during the quarter totaled $2.8 billion. The value of iPads sold alone was $2.7 billion in the quarter or 13% of total revenue, resulting in an ASP of about $645. Apple plans to expand its distribution of iPad in international markets via Wal-Mart (WMT), Target (TGT), Best Buy (BBY), Verizon Wireless — a venture between Verizon Communications (VZ) andVodafone Group Plc (VOD) and AT&T (T) stores.

Apple’s app store continues to be an unparalleled success with more than 200,000 registered iOS developers Incorporatedluding over 65,000 game and entertainment titles and over 30,000 apps designed for iPad. During the quarter, AAPL released iOS 4.1. In November, AAPL plans to release iOS 4.2 for iPad that includes new features such as AirPrint. Management discarded the smaller tablets made by rivals Incorporatedluding those by Samsung and Dell Inc. (DELL).

A market research firm, iSuppli, raised its outlook for Apple’s iPad sales to 13.8 million units from 12.9 million in 2010. The research firm expects Apple to sell 43.7 million units, up from previous expectation of 36.5 million in 2011. For 2012, the firm’s new forecast is 63.3 million, up from 50.4 million previously expected.

Guidance

For the first quarter of fiscal 2011, AAPL expects revenues to be approximately $23.0 billion, up 46.5% from the year-ago quarter and 13.3% sequentially. The revenue outlook is above Wall Street expectations. Earnings are expected to be approximately $4.80 per share compared with $3.67 in the year-ago quarter. The Zacks Consensus Estimate for the first quarter was at $5.03 at the time the company reported results.

The company expects gross margins of 36.0%, reflecting approximately $52 million related to stock-based compensation expense. Operating expenses are expected to be $2.33 billion Incorporatedluding about $250 million related to stock-based compensation, while Other Income and expenses are projected to be about $65 million. The tax rate is estimated to be about 25.5%.

Apple currently has a short-term Zacks #1 Rank (Strong Buy) and a longer-term Neutral recommendation.

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