(AAPL) Apple Struggles in Fourth Quarter

Apple Inc.’s (AAPL) earnings juggernaut hit a road block, after the iPhone maker missed the Zacks Consensus Estimates in the fourth quarter of 2011. Apple earned $7.05 in the reported quarter, lagging the Zacks Consensus Estimate of $7.31. Apple shares declined approximately 7.0% in after hours trading.

Earnings per share (EPS) shot up 52.0% from $4.64 reported in the year-ago quarter and were ahead of Apple’s conservative guidance of $5.50. The year-over-year growth was driven by higher revenue in the quarter. However, revenue fell shy of the Zacks Consensus Estimate of $29.51 billion.

Apple’s fourth-quarter miss was primarily due to lower iPhone sales, which reflects that consumers deferred their purchase based on the rumors surrounding the release of iPhone 5. This negatively impacted the sequential growth, which declined (16.0%) for the first time since the release of iPhone 4. The year-over-year growth was also modest compared with 142.0% growth in the third quarter and 113.0% upside in the second quarter of 2011.

Operating Performance

Gross margin expanded 340 basis points (bps) year over year to 40.3%, well above management’s forecast of 38.0%. Operating margin increased to 30.8% from 26.8% recorded in the year-ago quarter. The significant margin expansion was due to lower component and other costs. Total operating expenses increased 29.3% year over year to $2.67 billion (down 80 bps to 9.4% as a percentage of revenue).

Net income stood at $6.6 billion in the quarter, reflecting a remarkable growth of 53.7% from $4.31 billion in the year-ago quarter.


Total revenue in the quarter surged 39.0% year over year to $28.27 billion and beat the company’s forecast of $25.00 billion. The year-over-year upside was driven by strong growth in iPad (up 166.0% year over year), iPhone (up 21.0% year over year) and Macintosh (up 26.0% year over year) sales.

Product Highlights

Macintosh: Apple shipped 4.89 million Macintosh computers in the reported quarter, representing a 14.0% year-over-year increase, attributable to strong demand for Macs across all geographic regions, particularly in the Asia-Pacific region, which grew 61.0% year over year. The growth in sales was driven primarily by strong MacBook Air and MacBook Pro sales.

Moreover, customer response to the newly launched Mac OS X Lion has been overwhelming with more than 6 million downloads during the September quarter.

Retail Stores: Retail revenues in the quarter were a record $3.6 billion, up 1.0% from the year-ago quarter, primarily attributable to increased Macintosh and iPad sales, but were largely offset by lower iPhone sales arising from tough year-over-year comparisons. The retail stores sold 1.1 million Macs in the quarter compared with 874,000 in the year-ago quarter, an increase of 25.0%. During the quarter, Apple opened 30 new retail stores, 21 of which were outside United States. At quarter end, Apple had 357 stores worldwide.

iPods: Apple sold 6.6 million iPods during the quarter, representing a unit decline of 27.0% from the year-ago quarter. According to MPD data, Apple’s share of MP3 players in the U.S. was over 70% in the month of September, and iPod was the highest-selling MP3 player based on the latest data published by GFK. iPod touch sales remained strong, accounting for over 50% of all iPods sold during the quarter.

iPhone: iPhone unit sales were 17.1 million during the quarter, representing a year-over-year growth of 21.0%. Revenues from iPhone handset sales, accessory sales and carrier payments totaled $11.0 billion, up 24.0% from $8.8 billion in the year-ago quarter.

Apple finally released the new iPhone 4S (not 5 as the market expected) in October, and sold 4 million units in the first three days. Apple added Sprint Nextel Corp. (S) and KDDI as new carriers and thus brought the number of carriers to 230 in 105 countries.

iPads: Total iPad units sold in the quarter were 11.1 million, up from 4.2 million sold in the prior-year quarter. During the quarter, Apple launched iPad 2 in two additional countries. The tablet device is currently available in 90 countries.  Recognized revenues from iPad and iPad accessories during the quarter totaled $6.9 billion.

Apple’s app store continues to top the charts with more than 500,000 apps and over 18 billion downloads till date.

Balance Sheet

Apple’s balance sheet remains strong. Cash and investments were $81.6 billion at the end of the quarter compared with $76.1 billion in the previous quarter. The company generated $10.5 billion in free cash flow during the quarter versus $11.1 billion in the previous quarter.

First Quarter Guidance

For the first quarter of fiscal 2012, Apple expects revenues to be approximately $37.0 billion. Earnings are projected at approximately $9.30 per share. The Zacks Consensus Estimate was pegged at $8.98 per share at the time the company reported its fourth quarter results.

Apple expects gross margin of 40.0%, reflecting stock-based compensation expense of approximately $60.0 million. Operating expenses are estimated to be $3.25 billion, including about $350.0 million in stock-based compensation, while other income and expenses are anticipated at around $85.0 million. The tax rate is estimated to be about 24.25%.

Our Take

Apple has outperformed the broader market over the last 12 months. Apple shares have surged 28.2% year to date compared to a 3.7% decline in S&P 500. We believe the massive after hour decline reflects the high expectation levels on Apple. This was the first earnings call for the new management under CEO Tim Cook and it may apparently seem that the company has lost the “Midas touch” of its late CEO Steve Jobs.

We believe the new management will be under the scanner following the miss. We also believe comparisons with Mr. Jobs’ innovative acumen will be drawn regularly, which will weigh heavily on the company’s new board in the near term. We expect the dismal fourth quarter result to remain an overhang on the stock going forward.

We believe Apple’s growth is excessively dependent on the performance of iPhone and iPad, which contributed approximately 63.0% of total revenue growth in the quarter. However, Apple’s iOS has been facing significant competition from Google Inc.’s (GOOG) Android mobile operating system over the last few quarters.

Apple’s primary smartphone and tablet markets are crowded with the likes of Research In Motion Ltd. (RIMM), Hewlett-Packard Co. (HPQ), Dell Inc. (DELL), Cisco Systems Inc. (CSCO), Samsung, Toshiba and Acer, which are gaining popularity in several international markets. So far, Apple has managed to maintain its dominant position in both the markets. However, we believe that increasing pricing pressure, particularly in the growing Asia-Pacific market, will hurt margins going forward.

Moreover, Apple has also taken the patent litigation route against handset and tablet makers to sustain its leadership position. Apple has been targeting Android-based smartphone makers, especially Samsung and has temporarily stalled its growth in Europe and Australia through patent liti

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