Why Apple is set to hit record numbers. Again.

Apple just finished reporting its fiscal Q4 2013 results, which ended in September. Overall it was a very solid quarter, with just under $38 billion in revenue, gross margin of 37% and earnings per share of $8.26 (fully diluted). Was it a record quarter? We have to keep in mind that Apple’s Q1 (December) is the big one every year, driven by holiday sales. But as far as comparable Q4 periods, this was a record setting quarter for iPhone sales, with 33.8 million units sold. They also tied last year’s Q4 shipments for the iPad (though no records were set on the Mac). So what does it all mean?

Earnings-wise, $8.26 is a solid performance in EPS, but it’s slightly lower than last year’s Q4, when earnings were $8.67. Why? Because gross margin was higher last year - 40% versus only 37% this year. It just so happens that the iPad Mini started shipping the very next quarter, and it’s well understood that this product had a negative effect on gross margin. When a company makes a shift in its product portfolio like this, we’ve got to ride it out, and by next quarter we’ll have a better idea of how earnings growth is shaping up. The company did guide to revenue of $55-58 billion for the holiday quarter, which would be ahead of last year’s $54.5 billion. I won’t dive deep into the accounting, but the implied growth is actually about a billion dollars better than it looks because of how Apple accounts for software now that Mavericks and iWork are free (pesky accounting rules!)

Judging from Apple’s guidance, it still seems like they will generate less earnings in the holiday season despite producing record sales. Again, the culprit is gross margin. Apple is always quick to point out that higher revenue usually produce higher gross margin. So analysts are bothered by the fact that management doesn’t expect the huge holiday revenue numbers to correlate into higher gross margin. In fact, guidance for margin in Q1 is flat with the Q4 they just posted. How can that be?

One possibility is the new lineup of iPhone 5s, iPad Air and the new Retina iPad mini. Unless Apple is sandbagging on guidance, it’s only natural to conclude that these brand new products come with higher bill of materials, which Apple will have to work hard to reduce over the next couple of quarters to help margins. But it’s a bit more complicated than this. Because of the accounting changes I mentioned above, about $900 million in revenue (relating to software, and usually very high margin) is being deferred. So absent that deferral, gross margin would be forecast to climb to similar levels as last year. With the stock dropping in reaction to this whole situation, I think the market is doing its typical overreaction.

At the end of the day Wall Street is obsessed with quarterly reporting and analysts are in an industry that is designed to respond to minutia. I prefer to look at the business performance with a long term horizon in mind. Apple has just finished refreshing the bulk of its portfolio with some pretty impressive, industry leading specs.

This will translate into record sales for the holiday period, and we’ve got a pretty clear message from Tim Cook about confidence on future product and service offerings into 2014.

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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There are 8 comments. Add yours.

Derrick4Real says:

Hey Chris, Why are their gross margins not rising and isn't that a point of mild concern? Is it just more expensive parts? Shouldn't they be getting cheaper not more expensive? They are selling more the same amount of ipads but making less money.

Aside from a China Mobile, deal where do you see growth in profits coming from?

Hypothetical: You're made Apple CEO, what would you do to raise not just sales numbers but over all profit in macs, ipad, and iphones and or maybe a new product. Thanks.

Rene Ritchie says:

The way I understand it, they're selling products that are more expensive to produce for less markup than before. That puts pressure on margins from both ends. iPad Air will no doubt be more expensive to make than the iPad 4, but the price will be the same. iPad mini will be sold for less than before.

Should the focus be on margins? Wall Street seems to think so. I still think Wall Street doesn't understand Apple.

Derrick4Real says:

Weird, i'd think the air would be cheaper or the same at least as i don't see much different other than new chip and thinner granted, i haven't paid much attention to that device..

Wall Street is concerned about profit growth rates. Good margins seem merely a way to get more profit. They are concerned because they pay a certain prices for the stock based on it's earnings. If the earnings drop it's not as valuable and they are wasting money. The margin is only a concern if you can't maintain your profit growth rate. I don't care that much if your margin goes down if you earn 12% more profit this quarter than you did last quarter. But if margins go down and you make profit doesn't keep growing at that same rate i'm going take notice.

But wall street is about investing in profitable stocks not caring about Apple. And a stock is profitable if it has consistent profits like a profit growth like apple has had in the past or high dividend yields or just super big profit. I think Apple fans simply don't get what investors care about and it's not Apple. They just want consistent profits. All they care is what direction the stock is going. And if Apple's profits grow consistently the stock will go up & it's a safe investment and the investor get's consistent profits. If the Apple's profits stagnate or are inconsistent or fall well then they aren't making profits, they are overpaying, they sell, the stock drops and you rebuy at a level where you can justify the price. Or they move to something with better earnings growth rates. Wall Street is playing an accounting game. They don't really care about the particulars of the product.

Another thing it's also not uncommon for Apple to sell of after they announce earnings and people buy back later and ride it back up.

7Anthony says:

Why do you comment if you haven't paid attention?

Derrick4Real says:

You're comment is misguided and lends nothing to the conversation. I've paid close attention to Apple and I have a very good idea of what does and doesn't make the stock move up or down.

If your "you haven't paid attention" comment is a reference to mine saying "I haven't paid much attention to that device." Well I comment because this is an article about Apple's financials & Apple as a whole and that includes all Apple products. The movement of apple's stock is based on much more than just the ipad air. Second, I say i haven't paid "much" attention. I did not say I haven't paid any attention. Also when i said that I meant that I'm not looking to buy an ipad so i haven't gone to the charts and matched up the particular differences between the ipad 4 and ipad air, to determine if it is worth an buying or upgrading just for a 64 bit processor, camera, wifi bands and thinner? I don't need to know that to comment on the stock, it's earnings, it's earnings growth rate, why it does and doesn't sell off after earnings. And i know what was said in the earnings report.

pookyjoralyn says:

Apple's overall revenues is down for the third consecutive quarter (don't get me wrong, it's on BBC), even explosive iPhone growth doesn't make up for the loss.

cransmi says:

Actually, Apple's revenues are not down this quarter, or in fact any quarter in recent memory. You likely mean that 'earnings' or 'net income' are down the last three quarters. The basic reason is that gross margins are significantly lower than last year. The biggest impact here is the iPad mini with several other small factors such as component costs, a slew of new products with high manufacturing costs, and other factors like foreign currency influences. Much slower revenue growth coupled with lower margins have led to have 3 quarter of negative earnings growth. Next quarter, with the anniversary of the iPad mini, earnings are expected to return to positive growth.

AdamChew says:

When they compare revenue BBC should look at the first quarter '13 they will find that 4th quarter '13 beats that. I don't have to remind them what the first quarter means to Apple.

As for BBC I don't trust their reporting on Apple.