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

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.

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Chris Umiastowski

Chris was a sell side financial analyst covering the tech sector for over 10 years. He left the industry to enjoy a change in lifestyle as an entrepreneur, consultant, and technology writer.

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Reader comments

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


Great story Chris. Keep up the good work.

Re: "Let’s see how they do once the next product cycle kicks in ..."

Agree. There's going to be another "big bang" of iPhone / iPad / Mac / iPod releases later this year. Not sure if that's the optimal year-round strategy, but at least the updates will be ready for sale in the holiday quarter.

Re: "... and into 2014 when we may see products that none of us even know about yet."

Yeah. Mac updates are relatively OS X release-independent. Apple releases new models whenever they're ready (and only after Intel's CPU updates are ready.)

But iPhone and iPad updates may be locked into the post-WWDC half of the year. To give developers a few post-WWDC months to update their apps to use new iOS features. In plenty of time for the holiday season. Which leaves the first half of the year open for other product releases. Like maybe Apple's future television products.

Apple TV, as it is now, is updated completely independently of WWDC. And if there is any other television hardware in Apple's pipeline, that hardware would also be on a schedule independent of WWDC.

Furthermore, the Apple TV interface is an app running on top of a stripped down version of iOS, so it might not even need the latest iOS features immediately. And I'm still not convinced that Apple will open up Apple TV to any and all random app developers. Just networks and other content providers. (And maybe one or two game developers at first, just to see if they can figure out how to get past the dreaded 10-foot interface.)

All of which means that releasing new television-related hardware and/or major software updates to that hardware could comfortably happen in the first half of the year. Or, as you say, for other products that we haven't even read rumors about. It certainly seems like Apple has cleared their 2014 Q1 and Q2 schedule.

I too don't like this product glut all in one quarter with almost nothing else the rest of the year. I'm speaking as a consumer though. I like some things being new in the spring. I need a new Mac and want to go back to retina on the iPad. Both of these releasing this fall requires a much larger expenditure all at once, not counting Christmas gifts for the family. I would like to see something moved to spring or summer refresh schedule.

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Thanks for the overview Chris. You always cover Apple and Blackberry exceptionally well from a financial standpoint and as an analyst and investor, you know your stuff. I really hope this puts an end to the Apple is doomed talk. It seems like we've been hearing for almost a year and yet quarter after quarter they deliver big. I think that the biggest point of all of this they are one the downhill slope of a product cycle for all of their mobile products and they are still turning tens of billions in profit. I don't know many companies that can compare to that. Pay attention Wall Street!

Like some other posters, I hope this year-long sabbatical that Apple has taken doesn't become the norm. They need to have product launches and updates spread out across the entire year instead of one BIG bang right before the Christmas season, imho. That schedule seemed to have worked out very well during the Jobs era, kept Apple at the top of everyone's mind, and kept the Apple stores packed all year long, with extra lineups now & then. With the current schedule, all of that has gone away and even traffic at those Apple stores has slowed noticeably with nothing new to look at but the latest cases.

Apple is still feeding off of the past. They have an incredibly loyal user base (and rightfully so) that re-ups at each product cycle. Its a nice rosy picture here but the future is far from determined. The one point not mentioned above is market share and apple's is deteriorating. If Apple fails to launch compelling new products their slow decline will continue. Right now, I'm still not convinced and an Iphone 5S sure isn't going to be the answer to where the growth is going to come from.

Even General Motors and Walmart have higher P/Es than Apple. Its difficult to fathom that the market considers GM/WMT to have better growth potential than AAPL, but I've long since given up on value based investing. Its all about emotions.

Chris Umiastowski: "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."

What makes those facts even more incredible is that Apple achieved that by selling an "aging" iPhone 5 (from September 2012), and 2 and 3 year old iPhones (4 and 4S). And that was done while brand new Android phones like the Samsung Galaxy 4S and HTC One were supposedly "killing" the iPhone.

What this incredible situation points to is that people who initially bought Android phones in droves a couple of years ago, were less than fully satisfied with their purchase, and were switching over to the iPhone more recently. This has been supported by charts showing sales of Android phones leveling off, while sales of iPhone continue to rise.

Great article. Obviously, news about Apple's imminent demise has been greatly exaggerated. Anyone has a take on Macs sales dipping yet an increase against the backdrop of slumping PC sales?