It's a lull in the product cycle and we know it, but Apple's doing fine

Let’s see how Apple does once the next product cycle kicks in, and into 2014 when we may see products that none of us even know about yet.

The results of fiscal Q3 are in, and Apple stock is actually up almost 4% in after hours trading. All this really tells us, of course, is that Wall Street is reasonably happy with the news. The Street expected an overall worse combination of Q3 results and Q4 guidance. So what does it all mean?

First, we need to keep in mind that Apple is in an unusual period where it hasn’t launched any new significant products for a while. In particular, there have not been any significant new products since the iPad Mini launch in October 2012 and just prior to that, the iPhone 5 in September 2012. So Apple is now deep into a product lull and we all realize this is bound to change by the time the holidays roll around.

Now, let’s look at the key numbers for the quarter. Revenue was $35.3 billion, just a hair above Street estimates of $35.2 billion. Gross margin was 36.9%, towards the high end of guidance and pretty much spot on the 37% analyst estimates. Earnings per share (EPS) were $7.47 while Wall Street expected $7.34, so the quarter was a slight beat overall.

iPhone sales were up 20% year over year, and up a whopping 51% in the USA.

The highlight of the quarter was iPhone shipments. Analysts pegged Apple to ship 26 million iPhones this quarter and they ended up selling more than this at 31.2 million. That’s means iPhone sales were up 20% year over year, and up a whopping 51% in the USA versus the year ago quarter. That’s absolutely incredible.

In contrast to this, iPad shipments were quite a bit lighter than estimates. Analysts thought Apple would sell over 18 million iPads, but they sold only 14.6 million. Tim Cook explained this by reminding everyone that last year’s quarter saw the launch of the 3rd generation iPad and a corresponding inventory build. This year there was no new iPad, and inventory was depleted by distributors. When you factor in the inventory changes, Apple sold about 3% fewer iPads to end customers. That’s not bad for a company that didn’t ship a new model within the period, but considering how young the tablet market is I admit I’m a bit disappointed.

The media is focusing entirely on iPhone strength in the quarter. Why?

The media is focusing entirely on iPhone strength in the quarter. Why? Because if you look at the strength of Samsung on the back of the Galaxy S3 and Galaxy S4 products, the major concern on Wall Street was that Apple’s iPhone sales would suffer. So it’s nice to see that iPhone was in fact the only real source of positive surprise in the quarter.

What nobody is really talking about, and what I think is a good indication of how management thinks about Apple’s future, is OPEX (operating expenses). A company that sees itself facing a significant revenue decline will typically look to cut expenses. Apple is not doing this at all. This quarter they spent a combined total of $3.82 billion on R&D (research and development) and SG&A (selling, general, and administrative). This was the operating expense level Apple deemed appropriate during a quarter where sales were $35 billion. But look at the Christmas quarter just six months ago. Apple generated over $54 billion and operating expenses were pretty much the same at $3.85 billion. By the way, operating expenses have been steadily climbing for the last couple of years, which tells me Apple has been gearing up for continued growth. Sure, they could be wrong. Companies usually only cut spending after they realize they were wrong. But I don’t think we’ve seen the last of Apple innovation. Far from it.

Apple has trailing 12 month EPS (earnings per share) of over $40 now, and the stock price trades at $435 in the after market. So it’s priced at only 11x trailing earnings, and this ignores the huge amount of cash Apple carriers. This kind of valuation combined with incredible balance sheet strength and a dividend yield of 2.8% seems pretty attractive to me. It’s been painful to watch the stock slide down from $700, but I’m not terribly worried.

Let’s see how Apple does once the next product cycle kicks in, and into 2014 when we may see products that none of us even know about yet.