AAPL’s 2Q10 earnings: a raft of records, followed by an aftermarket fall

the report

After the close last night on Wall Street, AAPL reported its 4Q10 (the fiscal year for AAPL ends on September 30) results.  At $20.4 billion, quarterly revenue was a record high, as were net profit, at $4.31 billion, and eps, at $4.64.  The company also had record unit sales of Macs, iPhones and iPads.  AAPL guided to December quarter eps of $4.80.

Despite the stellar numbers, AAPL’s stock fell by about 6% in aftermarket trading.   This same fate befell the shares of IBM and VMW, both of which also reported above consensus results after the bell.  So this weakness may simply be the reaction of short-term traders whose plan has been to “sell on the news”–no matter what the news was.  In AAPL’s case, there are one, maybe two, sore points with investors, though–iPad sales and the tax rate.


AAPL sold 3.9 million Macs during the quarter.  That was 440,000 more than in the previous record quarter (3Q10) and a 27% gain vs. the year-ago period.  This compares favorably with the overall PC industry, which grew by 11% vs. 2009.

iPod units fell by about 11% year over year, to 9.1 million.  Hardware revenue fell by only 5.5%, however, as consumers continued to gravitate toward higher-priced models.  Throw in the iTunes store and sales of accessories, and revenues in this very mature segment and revenues were up 5% vs. the comparable quarter of 2009.

With iPhone4 available for the full quarter, iPhone units were up a stunning 91% year over year, compared with a 64% global advance by the smartphone category.  Despite the huge gain, AAPL was capacity-constrained during the quarter and thinks it could have sold more iPhones if it could have manufactured them.

In its second quarter of existence, iPad sold 4.188 million units vs. 3.27 million in its inaugural three months.  Manufacturing capacity, now reportedly at 2 million+ units monthly, appears to have caught up with demand in the major markets where the tablet was launched.  AAPL ended the quarter with an extra 500,000 units in channel inventory.  My guess is that AAPL has about 1.2 million iPad units in stock.  The company’s only comments are that supply and demand are in balance in the markets where iPad is available so far; and that inventories are 3-4 weeks supply, below the 4-6 weeks it would prefer.

The Apple Stores continue to expand rapidly.  At $3.57 billion, up 75% year over year, store revenues were a record.  Sales of Macs totaled 874,000 (another record), half of which went to customers who had never owned a Mac before.

AAPL ended the quarter with no debt and $51 billion in cash.

The fourth-quarter tax rate was 21%, about 5 percentage points below company guidance and about 3.5 percentage points below the full-year rate.  This is partly because sales were stronger than expected in low tax-rate jurisdictions outside the US, partly due to year-end adjustments between what the company estimated (and recorded in its quarterly income statements) its tax liability would be and what it actually turned out to owe.

why is the market upset?

After all, sales of the iPhone4 were at least a couple of million units better than the consensus had expected.  Macs were strong, as well.

The main issue is the iPad, I think.  After all the hype about the device and recent stories by industry experts attributing at least a portion (maybe even most) of the current weakness in consumer PC sales in the US and Europe to cannibalization from the AAPL tablet, expectations were very high.   Investors thought they’d hear that the company was still struggling to meet demand and it had sold about 5 million units in the quarter.  What they heard instead was that inventories were starting to accumulate and that sales were a bit under 4.2 million.

Yes, the “shortfall” in units sold was more than made up for by iPhone strength.  But the iPad market has been transformed in analysts’ minds from one where they can imagine boundless growth for a long time to one where available information forces them to think demand is 1.5-2 million units a month.  To some degree, the “dream” is punctured.

The tax rate is also a potential issue, for me anyway.   The actual 21% meant after-tax income was about 7% higher than it would have been under the 26% rate AAPL had guided to.  But operations were very strong on a pre-tax basis.  And I don’t think today’s Wall Street pays more than fleeting attention to the tax rate in any event.

should it be?

I don’t think so.

Before the earnings announcement, analysts were estimating that AAPL could earn a bit over $18 in the 2011 fiscal year.  That number will probably rise to $19 as the factor the strength of Macs and the iPhone into their numbers.  At $300 a share, that would mean AAPL is trading at under 16x prospective earnings, with over 30% earnings growth in prospect.

Yes, maybe the iPad and iPod results, plus the increasing importance of foreign markets, mean that AAPL products don’t all have immunity from economic weakness in the US and Europe.  Yes, maybe thinking about AAPL’s earnings has lost some of the element of boundless upside.  But, as I’ve pointed out elsewhere, AAPL sports nothing like the 35x-50x PE multiple that a growth stock usually carries.  In anything other than the panic conditions of late 2008 and early 2009, the very low multiple limits any downside, I think.

the tablet war: dispatches from the front lines

In the past week or so, there have been two significant developments in the story of the development of the PC tablet:

–one is the outpouring of reports, both from the blogosphere and in newspapers, that the iPad is cannibalizing the notebook.

–the other is that AAPL has made up with ADBE, sort of.


the iPad

The many blogger stories about cannibalization seem to have been generated as the result of a well-marketed brokerage research reports by analysts covering AAPL at UBS and Barclays Capital.  The Financial Times recently had a more comprehensive comment in its Lex column.

Clearly, something is happening.  But I’m not sure the cannibalization numbers add up or that the overall story makes any sense.

We know from INTC that the back to school season has been weaker than had been expected as late as early July.  Last minute processor order cancellations/deferrals were big enough for INTC to make a downward revision to revenues on August 27th, pointing to “weaker than expected demand for consumer PCs in mature markets.”  This quantified the weakness that Taiwanese IT firms and US laptop makers like DELL had been talking about in the prior weeks.

In its press release, INTC revises its September quarter sales down by about $600 million, or 5%.  If we assume 5% is a good proxy for the unit demand shortfall (since the sectors showing weakness are less expensive computers, the 5% probably understates the unit decline), then the reduction in units to be sold in the Us and Europe (mature markets) is about 5 million.  That figure probably exceeds AAPL’s production, and worldwide sales, of the iPad during July-September.

Also, the laptop sales shortfall is reported to be predominantly in the netbook end of the market.  I suspect this is because low-end “regular” laptops have come down in price and now mimicked the features of netbooks.  As a result, for several quarters the latter’s unit sales have been flattish in a rising market.  Besides, I can’t imagine anyone who has used a netbook or an iPad would think they were close substitutes for one another.  You might just as easily argue that smartphones are cannibalizing PCs.

F or what it’s worth, my guess is that the slowdown in consumer PC sales in the US and Europe is a slowdown-in-the-economy phenomenon, not a cannibalization one.

Nevertheless, there is extremely high interest in tablets, even though most of those intending to buy one don’t really know what they are or where they fit in among their digital devices.  According to a Forrester blog post from last Friday 2.5 million US online consumers already own an iPad and 7.4 million more intend to buy one.  An additional 20 million say they’re going to buy a tablet of some sort–not necessarily an iPad–over the next 12 months.  (This 27 million total surpasses the number of Americans intending to buy an e-reader, the next most desired device, by about a third).

The one characteristic of tablets that should jump out for investors is that none will have INTC microprocessors and most will likely have linux-based software, not MSFT’s.

This explosion of interest, and the resulting scramble by AAPL to increase production capacity and by other manufacturers to get their tablet devices into the market, may explain the apparent urgency behind INTC’s moves to acquire McAfee and Infineon’s cellphone chip business.


Last Thursday, AAPL posted a release on its website about “App Store Review Guidelines.”   It seems innocuous…but it isn’t.  Back when the iPad was being introduced, AAPL said the device wouldn’t support Adobe Flash.  Why?  Steve Jobs eventually wrote his thoughts in an open letter.  Although AAPL and ADBE have a long relationship, he wrote, but Flash is unreliable, poor performing, and not secure.  The world has passed ADBE by, as well.  Ouch!

Two other problems.  Flash is designed for PCs and uses a lot of processing power and battery life.  Also, if you could download Flash onto your iPad you could use services like Hulu and bypass the AAPL apps store.

AAPL went a step further, too.  ADBE had developed a cross-platform compiler, that is, a software program that’s something like a translation device.  It converts a Flash-created app into one in a programming language that AAPL found acceptable.  But AAPL said developers couldn’t use the ADBE compiler, either.  The result was that many app developers had to hire two staffs, one to develop specifically for AAPL, another to develop for the rest of the world.

Last week’s press release is AAPL’s capitulation on app development.  AAPL still won’t allow any Flash code to be downloaded into the iPad, but it will accept programs that have been cross compiled from Flash in to an Apple-approved language.

Why did AAPL give in?  Some people say it was ADBE’s appeal to the government anti-trust authorities.  Maybe.  But I think the real issue is the stunningly fast development of the tablet market.  After all, the iPad is a limited device.  It’s been crafted to avoid any cannibalization of the iPhone (remember–if we look at profits, AAPL is a cellphone maker with a couple of lucrative sidelines, like MP3 players and computers).  Users are funneled to its app store to get  content to use.  If AAPL could get developers to write code that would be very expensive to adapt for most other tablet devices, its first-to-market advantage would be that much more overwhelming.

It’s this last thing that the bland note linked above is raising the white flag to.  To me, it’s a signal that AAPL sees competition coming for the iPad faster than it had thought.  This isn’t 100% bad for the company.  Its dominance of the tablet market will likely be less complete, but the market will likely be very much larger than it had dreamed.  It wasn’t that long ago (March or April) that analysts laughed at AAPL for arranging for production capacity of 1 million units a month.  It’s now churning out twice that and still scrambling to expand fast enough to keep up with demand.

Intel acquiring McAfee

the announcement

Last Thursday INTC issued a press release and held a web news conference announcing that it had reached an agreement with the board of directors and top management of McAfee to acquire MFE for $48 per share in cash.  This would be a total of about $7.7 billion, or $6.8 billion after subtracting the cash MFE has on its balance sheet.

Assuming regulatory and shareholder approval, the merger could be completed before the end of this year.  Presumably, the two firms are aiming to have this happen, to save the effort and expense of producing a superfluous, pre-merger set of audited accounts.  Senior management of MFE have agreed to stay on at INTC for an unspecified period of time–probably at least a couple of years–operating as a more or less autonomous unit and reporting to one of INTC’s division heads.

the numbers

MFE rose almost 60% on the news, to $47 a share.  INTC fell about 3%.  To me, this looks like ordinary risk arbitrage activity, making a statement that no other bidder is going to emerge (I can’t imagine who would) and that the deal will face no real obstacles to completion.

Over the past five years, cash generation at MFE has been growing at about a 15% annual pace and now stands at a what I estimate to be a touch over $3 a share annually.  There are enough unusual non-cash expenses charged against operations that net income is only about 40% of that.  But because earnings are so unreflective of cash flow, I think they shouldn’t be the standard used in evaluating whether the acquisition makes financial sense.

MFE has no debt and about $2 a share in working capital, a quarter of that in cash.  Net of cash, the acquisition cost is $46 a share.

INTC says that, ex unusual items, MFE will be accretive to INTC earnings immediately.  This is at least in part due to the fact that MFE’s profits will replace interest income on the cash deposits INTC will use to pay for the MFE shares.  At today’s rates, that income has to be very close to zero, so being accretive right away isn’t saying much.

Let’s assume I’m correct that current MFE cash generation is about $3 a share and is growing at a 10% annual rate (given competition in the internet security business, that may be high).  Let’s also say that the appropriate rate to discount MFE’s future cash flows back into the present is 5% (that’s probably too low, but its halfway between the zero INTC is earning on its cash and the 10% it would cost the company to issue new stock).  On these assumptions, it takes MFE about ten years to pay for itself.

That’s a long time.  So the rationale for the acquisition can’t be that MFE stock is really cheap.

INTC’s reasoning

Continue reading

INTC’s June 2010 quarter: stellar performance with more on the way

the quarter

I listened to the INTC 2Q2010 conference call last night.  The three-month period established a whole raft of new operating performance records.  Earnings per share came in at $.51 vs the analysts’ consensus of $.43.  Six-months’ eps was $.94, with the seasonally stronger second half just beginning.  $2 a share for the year, a number I would have thought six months ago would be impossible for the company to reach, now looks achievable.  from the way the usually cautious company management is talking, next year could be 20% better.

The most important message from the INTC quarter to Wall Street is, I think, that corporations are in the early stage of what could be a significant capital spending boom–implying they see their profits starting to accelerate.  In particular, the US, a laggard to date, is beginning to perk up.

the details

1.  Revenues were unusually strong, at $10.8 billion.  This is up 5% quarter on quarter at a time when typical seasonality would have called for a 2% revenue drop.

All regions of the world were unexpectedly strong.

Consumer notebook sales remained brisk, but the real boost to the quarter came from business customers.  Several aspects to this:

–companies are starting to adopt Windows 7 and are replacing their wretchedly old PC stock as they do so

–firms are also feeling good enough about their prospects that they are buying more powerful, higher-end (read: more profitable for INTC) products

–the server mix is also improving both because companies have more cash to upgrade and because the internet data center business (growing 170% yoy) is booming.

2.  INTC has increasingly good control of costs.  Gross margin was a record 67% in the quarter, which was about four percentage points better than in the first three months of the year.  Virtually all of the increase came from lower-cost manufacturing.  Only one point came from the effect of higher sales.  INTC sees no reason for the margin to contract from this level any time soon.

3.  Customer inventories are low.  The Iceland volcano, sovereign credit worries in the EU and the consequent decline of the euro caused Europe-oriented OEMs and distributors to run down stocks.  End demand from big businesses is unaffected, however.  Distributors are busily reconfiguring machines–less memory, less sophisticated graphics–to try to keep consumer price points from moving up too much.  At some point, presumably during the second half, customers will likely bring stocks up to normal levels, creating extra demand for INTC chips.

the second half–and beyond

1.  Customer reviews of INTC’s next family of chips, named Sandy Bridge, have been the most favorable in some time.  As a result, INTC is accelerating Sandy Bridge’s introduction–suggesting INTC believes corporate demand will continue to be strong for at the very least the next year.

2.  The Atom chip is plateauing, although the introduction of dual core Atoms spurred 16% quarter on quarter growth in June.  The next market for this chip is likely imbedded devices, like Google TV, DVD players and set-top boxes.


Unlike AAPL, which never saw a netbook it didn’t hate, INTC appears very relaxed about the introduction of tablets.  The company thinks that the netbook was a much bigger threat to cannibalize notebooks.  Given that the category proved additive to the overall mobile business, it expects the same to be true for tablets.  At this point, it’s hard to know whether INTC will have that much presence in the tablet category, but there are at least 30 Atom-configured tablets being displayed at trade shows.


At potentially 10x next year’s eps, and yielding 3%, the stock looks cheap to me (I don’t own it, though).   My sense is that the Wall Street consensus thinks 2010 is a cyclical peak for INTC’s earnings.  My guess is that the peak, if there is going to be a significant high point followed by a sharp decline, isn’t until 2012.

Sales to corporations are going much, much better than the company thought several months ago.  This is a positive statement, not only about business confidence, but also about how firms have raised their forecasts of their own revenue and profit prospects for this year and next.

INTC is boosting its estimate of its tax rate for 2010 from 31% to 32%, since it now anticipates a greater proportion of its business than it earlier expected will come from high tax-rate areas (read: the US).  I think this is a very bullish sign for Wall Street that most analysts will probably overlook.

AAPL vs. GOOG: battle of the titans (II)

Judging by their stock charts, Wall Street has pretty much conceded the battle to AAPL.  In fact, there isn’t much doubt at all.  Since the ipo of GOOG in 2004, AAPL is up about 12x.  GOOG is up 4x–and that includes a big jump after an unusual, and less than successful, ipo in which GOOG tried to market itself directly to investors, cutting out Wall Street investment banks.

Yes, the S&P is just about flat over that span, so both are big winners.  And, yes, AAPL is starting from a low base in 2004, a point when some questioned its survival.  But the big separation between the two names has come between the beginning of 2007 and now, a time period when AAPL tripled and GOOG has been flat.

AAPL has also pulled significantly ahead in simple balance sheet metrics like working capital or accumulated cash holdings.  The balance sheet number read as follows:



cash                  $8.0 bill.                           $15.8 bill.                  $7.8 bill.

wc                      $8.3 bill.                           $17.9 bill.                  $9.6 bill.


cash                  $11.9 bill.                          $24.8 bill.                $12.9 bill.

wc                     $9.4 bill.                            $20.2 bill.                 $10.8 bill.

At first glance, it looks like AAPL is pulling away from GOOG, but not opening up an insurmountable gap.  But AAPL has recently begun to divide its marketable securities into those with a life of a year or less and those with more.  The latter, $15 billion at 12/09, although cash-like, are listed as non-current assets.  Adjusting the figures, AAPL’s cash is up by $27.9 billion over the past three years, or 3.5x the cash generation of GOOG.  The main driver of this surge is the phenomenal success of the iPhone.

In addition, AAPL has set up a business, iAd, to sell iPhone ads through the apps downloaded from its store, a move calculated to fence GOOG out of the mobile ad business.  Ironically, however, the FTC has citied iAd plus AOL’s purchase of mobile ad specialist Quattro Wireless as reasons of giving the anti-trust green light to GOOG’s proposed purchase of AdMob, a Quattro rival.

The are are other signs as well, that the contest may not be so one-sided from now on.  According to the Financial Times, sales of smartphones using GOOG’s Android operating system were higher than those of the iPhone in the US market for the first three months of 2010, taking 26.6% of the market vs. 22.1% for AAPL.  Android phones were about 10% of the worldwide market over the March quarter vs. 1.6% during the year-ago period.  The gains come 40% from MSFT, the rest from everyone else.

Since the start of the year, GOOG has released version 2.1 of Android (Eclair), which increases the speed of phone apps significantly.  This week it announced version 2.2 (Froyo), which gives the operating system another big overhaul.  The following upgrade, Gingerbread, has a name and a potential release date of late this year, but no version number and few details.

Chrome os netbooks, at  one time scheduled for release during the second half of this year, appear to have dropped off the radar screen.  After the surprisingly strong sales of the iPad, they seem to have been replaced by a bevy of android-based tablets that are claimed to be hitting the market in time for the year-end holidays.

Suppose, then, that the next year or two show a reversal of trend, in which GOOG products gain market share over their AAPL counterparts?

Will this mean a significant increase in the growth rate of GOOG’s profits vs. what it is presently showing?  Only time will tell, but my guess is that it won’t.  Success of Android phones and Android tablets will allow GOOG to take its business into the mobile arena, but I think this will only erosion of revenue and profit expansion that Wall Street seems to now sense in the company.  That’s probably worth a few points of price earnings multiple expansion, however.

On the other hand, GOOG success would also have the potential to stop the momentum of the AAPL earnings freight train that is currently barreling down the tracks at an extraordinarily rapid clip.  As is the case with any growth stock, a slowing in growth from the pace the market expects has two negative effects on the stock.  It lowers the stock price by the extent to which earnings fall short of Wall Street expectations.  And it causes the price earnings multiple to contract.  This happens both as investors project forward a new, lower rate of profit advance, and as the open-ended “dream” that the stock will always surprise on the upside becomes tarnished.

For me, this means that, as stocks, AAPL has much more to lose than GOOG has to gain from Android success.

Tis is a situation to monitor closely.