(AAPL) Apple Reports Record First Quarter Earnings

Apple Inc. (AAPL) reported stellar first quarter 2011 results with better-than-expected quarterly revenues and earnings, which flew past the bullish Zacks Consensus Estimate. The upbeat quarter results were fueled by strong iPhone sales, record Mac sales and increased iPad sales, as unit shipments remain robust.

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

Given upbeat results, Apple shares rose in after-hours trading by 1.25% or $4.25 to $344.90.

Earnings

The quarter’s earnings reached a record $6.43 per share, beating the Zacks Consensus Estimate of $5.38, posting a positive surprise of 19.5% and surpassing its own guidance of $4.80 per share. Earnings shot up 75.5% from $3.67 per share reported in the year-ago quarter. Net income soared to $6.00 billion in the quarter, reflecting a substantial growth of 77.7% from $3.38 billion in the year-ago quarter.

Revenues

Strong earnings were attributable to record sales in the quarter, which leaped 70.5% year over year to $26.74 billion. Revenues beat the Zacks Consensus Estimate of $24.30 billion and its own forecast of $23.00 billion. The mammoth revenue growth was driven by increased momentum in Mac shipments and booming iPhone and iPad business. International sales accounted for 62.0% of the total revenue in the quarter.

Operating Performance

Gross margin fell 240 basis points year over year to 38.5%. However, it was 250 basis points above management’s expectation. Operating margin in the quarter was 29.3%, down from 30.1% in the year-ago quarter.

Apple’s balance sheet remains strong. Cash and investments were $59.7 billion at the end of the quarter versus $51.0 billion in the previous quarter. The company generated cash flow of $9.8 billion during the quarter versus $5.7 billion in the previous quarter.

Product Highlights

Macintosh: Apple shipped 4.13 million Macintosh computers in the reported quarter, representing a 23.0% year-over-year increase, attributable to strong demand for Macs in each of its geographic segments. Over 50% growth was seen in both the Asia-Pacific and Japan. This resulted in a double-digit growth in both desktop and portable platforms. Apple opened the Mac App Store on January 6, which will further drive Mac sales. Greater demand for the new MacBook Air (launched in October) and the growing popularity of MacBook Pro line will further drive growth. In comparison, the overall market for PCs grew 3.0% year over year during the December quarter, based on the latest forecast published by IDC.

Retail Stores: Retail revenues in the quarter were a record $3.85 billion, up 95% from the year-ago quarter due to increased Mac and iPad sales. The retail stores sold 851,000 Macs in the quarter compared with 689,000 in the year-ago quarter, indicating an increase of 24%. Half of the Macs sold through retail stores in the quarter were to new customers. International Retail Store sales were strong in the quarter, particularly in China. The company opened 6 new stores in the quarter. At quarter end, Apple had 323 stores worldwide, with 87 stores located outside the U.S.

The iTunes store also delivered a strong quarter with sales of $1.1 billion. With an average of 321 stores opened during the December quarter, average revenues per store were $12.0 million compared with $7.1 million in the year-ago quarter. The company saw a record 75.7 million visitors in stores during the quarter compared with 50.9 million visitors in the year-ago quarter, an increase of 49%. Apple plans to open 40 to 50 stores in 2011, of which 50% will be located internationally.

iPods: Apple sold 19.45 million iPods during the quarter, representing a 7.0% unit decline from the year-ago quarter. Sale of iPods surpassed analysts’ expectation of 6 million units. According to NPD data, Apple’s share of MP3 players in the U.S. was over 70% in the month of December, and iPod was the top-selling MP3 player based on the latest data published by GFK. iPod touch sales continued to be strong and grew 27.0 year over year, accounting for over 50% of all iPods sold during the quarter.

iPhones: The iPhone continues to be a major success for Apple, given its strength in overseas markets, particularly Asia, Europe and Japan. Overall, iPhone unit sales were 16.2 million during the quarter, representing 86% unit growth over the year-ago quarter. Sales in the both the Asia-Pacific region and Japan doubled over the year. According to IDC, the overall smartphone market grew 70% in the December quarter.

The company had iPhone distribution agreements with 185 carriers in 90 countries at quarter end. Apple announced that Verizon Wireless, a venture between Verizon Communications (VZ) and Vodafone Group Plc (VOD), will offer iPhone 4 to its more than 93 million customers as of February 10, which will help Apple come out of its exclusive deal with AT&T (T). In our opinion, the Verizon deal will be another milestone achievement for Apple, allowing it to continue on the growth path.

The value of iPhones sold during the quarter was over $10.1 billion, resulting in an average selling price (ASP) of about $625. Revenues from iPhone handset sales, accessory sales and carrier payments summed up to $10.47 billion compared with $5.58 billion in the year-ago quarter, a significant increase of 88.0%.

iPads: Total iPad units sold in the quarter were 7.3 million, up from previous quarter’s sale of 3.0 million units. iPad is currently available in 46 countries. Management highlighted that over 80%, up from 65% in the September quarter of the Fortune 100 companies such as JPMorgan Chase (JPM), Wells Fargo (WFC) and DuPont (DFT) among others, have already deployed iPad. Recognized revenues from sales of iPad and iPad accessories during the quarter totaled $4.61 billion. The value of iPads sold alone was $4.4 billion in the quarter, resulting in an ASP of about $600.

Apple’s app store continues to see unparalleled success with more than 300,000 apps and over 9 billion downloads to date. In November, Apple released iOS 4.2 for iPad that includes new features such as multitasking, folders, unified inbox, Game Center, AirPlay and AirPrint.

Second QuarterGuidance

For the second quarter of fiscal 2011, Apple expects revenues to be approximately $22.0 billion. Earnings are expected to be approximately $4.90 per share. The revenue and earnings outlook is above the Zacks Consensus Estimates of $20.7 billion and $4.45 per share, respectively at the time the company reported first quarter results.

The company expects gross margins of 38.5%, reflecting approximately $50 million related to stock-based compensation expense. Operating expenses are expected to be $2.35 billion, including about $250 million related to stock-based compensation, while Other Income and expenses are projected to be about $50 million. The tax rate is estimated to be about 25.5%.

Recommendation

We believe that the addition of Verizon Wireless for its iPhone and iPad distribution will help Apple reach new heights. We expect Apple to come out with new products and refresh its old products that will be distributed via its new carrier – Verizon, helping it double its customer base in the upcoming months.

Although analysts’ estimates were up in the run-up to the first quarter earnings release based on the new Verizon deal, Apple’s competitive battle against Research in Motion’s (RIMM) BlackBerry devices and Google Inc.’s (GOOG) Android-based handsets will continue. iPad will also compete with a host of low priced tablets slated for debut this year. Moreover, there could be supply constraints as Apple launches the iPhone with Verizon. This is Apple’s biggest challenge at the moment.

The company’s CEO Steve Jobs announced that he has taken his second medical leave of absence in over two years to focus on his health issues. During his absence, Tim Cook, the company’s COO, will look after its day-to-day operations. We remain apprehensive for the time being.

If Apple continues to deliver impressive results, investor concerns relating to Jobs’ leave will gradually subside. We advise investors to hold the stock and wait for a favorable entry point. Apple currently has a short-term Zacks #3 Rank (Hold) and a longer-term Neutral recommendation.

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