Apple's (AAPL) fiscal third quarter earnings detailed why the company needed to do its deal with IBM (IBM), as it builds out its tablet business, in hopes of capturing significant amounts of the enterprise market.
The company sold 13.28 million iPads this quarter, on its way to earning $1.28 a share on $37.4 billion in revenue. Gross margins came in at 39.4%, helping the company beat the bottom line, but the top line miss (analysts were expecting $38.03 billion) is due in part to exceptionally weak iPad sales, a fact CEO Tim Cook noted on the call.
"iPad sales met our expectations but we realized they didn’t meet many of yours," Cook said on the call, noting the company saw a reduction in channel inventory, as well as "market softness in certain parts of the world," most notably a 5% decline in the U.S. market per research firm IDC, and a decline in the Western European tablet market in the June quarter.
For the current quarter, the company sees revenue in a range of $37 billion to $40 billion, below consensus of $40.6 billion. Gross margin is seen in a range of 37% to 38%.
Cantor Fitzgerald analyst Brian White, who has a $123 price target noted that the overall iPad market is still weak, though there are bright spots around the world. "During the call, Apple called out strong year-over-year iPad sales growth in developing markets," White wrote in the note. "For example, Middle East was up 64%, China was up 51%, and India was up 45%."
Though Cook tried to put a positive spin on it, saying that usage is more important than sales, citing data from ChangeWave (iPad Air had a 98% customer satisfaction rate, and iPad Mini with retina display had a 100% customer satisfaction rate), his comments later in the call about the deal with IBM are encouraging, as the iPad moves into enterprise.
He noted that penetration in business is low, at 20%, according to IDC, compared to 60% for notebooks, and was one of the reasons why Apple teamed up with IBM.
"And so we think that there is a substantial upside in business," Cook said on the call. "And this was one of the thinkings behind the partnership with IBM that we announced last week. We think that the core thing that unleashes this is a better go to market, which IBM clearly brings to the table, but even more importantly apps that are written with Mobile First in mind. Not all but many of the enterprises apps that have been written for iPad have been essentially ports from a desktop arrangement and haven’t taken full advantage of mobile."
The tablet market is still expected to surpass the PC market, with Gartner expecting 350 million tablets sold in 2018, compared to 315 million PCs currently. Apple still believes that the tablet market will continue to surpass the PC market, but the IBM deal will speed that adoption up, particularly in the enterprise, as Apple readies new products for later this year and next year.
The iPad average selling price during the quarter was $443, relatively stable from last quarter, indicating the mix continues to be stable, in terms of iPad minis and the larger, iPad Air, but it's up to Apple and IBM to show that the market is really going to be as big as Apple thinks it is. "We still feel the category as a whole is in its early days and that there's significant innovation to the iPad and we plan on doing that," Cook said on the call.
Apple noted that governments are deploying thousands of iPads across the world, and the company has 85% of education tablet market domestically, so there is precedent for Apple to bump up the tablet business in markets outside of the consumer. It's just going to take IBM's help to reach the end goal.