On Friday, August 16th, Apple's (
) share price closed above $500 for the first time since January.
The recent announcement by Carl Icahn of his investment in Apple,
the completion of the first big phase of the planned $60 billion
share repurchase program and better than expected iPhone sales in
the June quarter have combined to catapult the share price off the
52-week low of $385.10 set back in April.
From the all-time high of $705.07 reached last September to the
52-week low set in April to the closing price of $502.33 on Friday,
Apple's share price has gyrated wildly over the past twelve
Within weeks Apple will announce its fall product refreshes for
the iPhone and iPad lines. Rumors and speculation about the
company's forthcoming new products are again receiving broad press
coverage. The product news will come at the tail end of Apple's
most challenging fiscal year in recent history.
In late October, Apple is likely to report negative net income
growth for the fiscal year ending in September and a fourth
consecutive quarter of tepid revenue growth. The deterioration in
Apple's year-over-year profitability is due in part to the outsized
revenue and earnings growth rates achieved in the prior fiscal
year. In FY2012, Apple's revenue rose 44.58% and earnings per share
rose 59.60%. In the first three quarters of the current fiscal
year, Apple's revenue growth rate was 10.7%. Net income, a better
metric than earnings per share as Apple repurchases tens of
millions of shares, is down 11.89% year-over-year.
Apple's Challenging Metric Conversion
In today's article I am publishing a series of graphs that detail
the recent deterioration in a select set of financial performance
metrics and mention the challenges Apple faces as management
strives to return the company to strong rates of revenue and
Apple's Revenue Growth Rates
The graph below illustrates Apple's revenue growth and revenue
growth rates over the most recent fifteen fiscal quarters.
(click to enlarge)
Although the company has eked out revenue growth of 10.7% in the
first nine months of the current fiscal year, due in part to a
roughly $1 billion sequential drop in channel supply value in the
recent June quarter, the reported revenue growth rate in the period
was 0.86%. Apple is now experiencing its slowest rate of revenue
growth in years and the revenue growth rate so far this fiscal year
is below the 14.4% revenue growth rate realized in
Apple's Earnings Per Share Performance
The graph below illustrates Apple's earnings per share and eps
growth rates by quarter since FQ1 2010.
(click to enlarge)
In the first three quarters of the current fiscal year, Apple has
reported negative earnings per share growth. Over this nine-month
period eps has fallen 11.61% year-over-year to $31.36. The recent
negative eps growth is despite fewer shares outstanding in the
recent March and June quarters. In the June quarter, Apple's $7.47
eps performance fell below the $7.79 per share earned two years
prior in FQ3 2011.
Apple's Net Income Per Revenue Dollar
Causing much of the drop in earnings per share this fiscal year
is a dramatic falloff in the percentage of recognized revenue
reaching the net income line. The graph below illustrates the net
income per revenue dollar trend over the most recent fifteen fiscal
From a high of 29.66% of revenue reaching the net income line in
FQ2 2012 to a low of 19.53% in the recent June quarter, net income
has been trending down on a year-over-year basis since the June
quarter of FY2012.
Expenses Per Revenue Dollar
The graph below illustrates Apple's expenses per revenue dollar.
In the recent March and June quarters, expenses per revenue dollar
reached levels last seen three years ago in FY2010. The recent
deterioration in net income per revenue dollar and the
corresponding rise in expenses per revenue dollar are due in large
part to slowing rates of revenue growth.
(click to enlarge)
Apple's biggest expense component is Cost of Sales. Cost of
Sales represents the direct costs of revenue and is the inverse of
gross margin. As Cost of Sales rise as a percentage of reported net
sales, gross margin is reduced. The graph below illustrates Apple's
gross margin performance on a quarterly basis since FQ1 2010.
Apple's reported gross margin of 36.87% in the recent June quarter
is the lowest gross margin outcome in the fifteen quarters measured
in the graph.
There are many factors that have adversely impacted Apple's
gross margin this fiscal year including the extraordinary $1.551
billion warranty set-aside recognized in the March quarter. The
factors also include but are not limited to the release of the
lower-priced iPad mini last November, the year-over-year drop in
Mac unit sales over the most recent nine months and the higher
costs of producing the iPhone 5 handset versus the costs of
producing the iPhone 4S handset one year ago.
Turning It All Around
Returning to faster rates of revenue growth, reversing the
decline in net income growth and delivering a higher percentage of
revenue to the net income line won't be easy. But it can be
accomplished is a series of forward-looking steps.
The Impact of the iPad mini
While iPad unit sales rose 28.64% in the first nine months of
the current fiscal year, corresponding revenue growth was a scant
8.32%. As Apple moves past the first anniversary of the iPad mini's
release in early November, the revenue growth rate from the product
line will rise in tandem with the rate of growth in unit sales.
A 1.9 million unit shift in channel supply year-over-year drove
reported iPad unit sales down 14.23% in the recent June quarter.
There have been no updates to the iPad line in over nine months.
Consumers will pay for Apple innovation. Consumers will not pay for
Apple products viewed as stale. Apple chose to forego a spring
update to the iPad line and the outcome is plain to see in the
line's June quarter unit sales and revenue performances.
Keeping to an annual iPad line refresh will diminish unit sales
growth. A more frequent refresh schedule need not include a change
of form factor but an upgrade to components. While the engineering
challenges involved in delivering an iPad mini with the so-called
Retina display have taken time, refreshes of the iPad line need to
be more frequent.
iPads 3 & 4 are viewed as transitional product designs. The
first Retina display iPad was released in March 2012 in the iPad 3.
The iPad 4 was released last fall. Consumers are waiting on a
slimmer, lighter 9.7" iPad model. To boost the product line's
revenue growth rates, refreshes in both the spring and fall are
needed. The tablet market is not without fierce competition and
Apple must address the perception of consumers the product line
becomes stale six months out from each new product release.
Consumers do want a Retina display iPad mini and few will settle
for anything less. The sooner Apple delivers what consumers want in
the iPad mini, the sooner unit sales growth will reignite.
The Apple iPhone
The iPhone 5 suffered from engineering complexities that
constrained supplies at last year's launch. Additionally, the
change in form factor and the change in dock connector increased
costs per unit sold.
Speculation about a new, lower-cost iPhone 5 series handset in a
polycarbonate enclosure suggests Apple is working to reduce
manufacturing costs and manufacturing complexities in the pending
product line refresh.
Removing from sale all handsets with the legacy 30-pin dock
connector (iPhone 4 & 4S) and adopting the 4" display across
all models will provide for uniformity on all new handsets and
benefit economies of scale throughout the product line.
Cost of Sales include not only the incremental costs of each
additional handset sold, but also fixed costs such as the
amortization of manufacturing equipment. The more units sold and
the more easily each unit can be manufactured, the higher the
reported gross margin. Not all cost components represent cash out
the door in the quarter the devices are sold. Apple's next flagship
handset in the current iPhone 5 enclosure will deliver higher gross
margin than its predecessor if Apple can deliver ample supplies of
the product at launch and maintain ample supplies through the peak
As of this writing there's rampant speculation Apple is
including a fingerprint sensor for added device security in the
pending flagship iPhone refresh. Conspicuous innovation will drive
unit sales much more than over attention to a device's enclosure.
Apple views design as an art form and no one can dispute the
company's global leadership in product design. Superior design,
conspicuous innovation and easing the complexities of product
manufacturing will deliver strong rates of unit sales growth and
more attractive performance metrics such as higher gross margin
beginning this fall.
Apple's outsized gross margin in the first half of last fiscal
year was driven in part by the economies of scale achieved with
unit volume of two iPhone 4 series handsets in the market.
Innovation and product updates have costs, but economies of scale
achieved with high demand for new and innovative products can and
will deliver more satisfactory performance metrics. Management has
been walking down gross margin expectations for the past few
quarters. Although Apple will not reach the gross margin
performances achieved in the first two quarters of FY2012, Apple
can improve on the gross margin outcome realized in the first three
quarters of the current fiscal year.
Apple's Macintosh line is not immune to the economic decline of
the global PC industry. To combat the industry's negative revenue
and unit sales growth, Apple must continue to bring new and
innovative products to market. At Apple's WWDC event in June, the
company announced a radically reengineered Mac Pro line that will
debut before the end of the calendar year. While views on the new
Mac Pro line are mixed with many professionals decrying the loss of
expandability, there's no disputing the fact Apple can and will
continue to bring innovative products to market.
In the December quarter, Mac unit sales fell 22% due in part to
manufacturing delays in the new line of iMacs. Today the iMac line
has yet to be refreshed with the latest Intel chipsets released in
late spring. In June, Apple refreshed only the MacBook Air line of
portable PCs. The MacBook Pro line will be updated to Intel's
Haswell chipsets at a later date. The sooner Apple delivers the new
Mac Pro and processor updates to the MacBook Pro and iMac lines,
the better the company can fight the declining unit sales
It's All About The Eco-System
Next fiscal year iTunes billings will surpass $20 billion. Much
of that revenue will be passed through to developers and content
providers and not be recognized as revenue on Apple's quarterly
financial statements. But iTunes billings reveals the size and
scope of Apple's app and content sales economy.
Next fiscal year the entire iTunes/Software/Services segment
will deliver greater than $20 billion in recognized revenue and may
represent 10% or more of Apple's reported revenue total.
Over 90% of iOS device owners are currently running iOS 6. Apple
will achieve a similar level of adoption with iOS 7 while providing
developers with the most robust mobile platform on the planet. With
all new iPhones running nothing less than the iPhone 5's A6 SOC and
the new flagship iPhone running the new A7 SOC, every new iPhone
sold will easily handle the latest apps while very high iOS 7
adoption will provide for a uniform platform for eco-system growth
Next fiscal year the iTunes/Software/Services segment may come
close to matching the revenue generated by the entire Macintosh
line and may deliver five times the revenue of the fading iPod
line. Boosting unit sales of all device lines will boost Apple's
post-purchase revenue growth from sales of apps, software, content
iTunes/Software/Services is currently Apple's fastest growing
revenue segment and is essential to the company's long-term
success. Content drives unit sales as much as unit sales drives the
company's overall growth. Increasing the flow of revenue through
Apple's expansive global eco-system is justification for management
to reduce device manufacturing complexities, moderate gross margin
in favor of unit sales and deliver to developers the highest number
of users possible running the latest version of iOS on the latest A
As the founder of the Braeburn Group, I am in contact with
members of our global network of independent Apple analysts
throughout the day. In general, our members are cautiously
optimistic about Apple's forthcoming fall product refreshes and
management's ability to return the company to strong and
sustainable rates of revenue and net income growth. Although the
road ahead may not be an easy path to travel, Apple's management
can deliver strong revenue growth coupled with moderately higher
gross margin next fiscal year.
Apple's massive share repurchase program will buttress the share
price and amplify the impact of rising net income on earnings per
share. However, to move the share price well beyond Friday's
closing price and capture new all-time highs, management must meet
the challenge of reversing the decline in key performance metrics.
For shareholders, Apple's metric conversion must begin this
The author is long Apple shares
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