Monday Note

On Monday last week we hear Steve Jobs is taking another medical leave of absence and, on Tuesday, we get a look at Apple’s numbers for Q1 2011 (which is actually the last quarter of 2010).

Brian Hall provides this crisp summary:

• Sales: $26.74 billion, up 70.5% year over year
• Profits: $6 billion, up 77.7%
• EPS: $6.43, up 75.2%
• iPhone: 16.24 million units, up 85.8%
• iPad: 7.33 million units, compared with Wall St. consensus of 6.15 million
• Mac: 4.13 million units, up 23%
• iPod: 19.45 million units, down 7.3%
• iPod touch: More than 50% of total iPod sales
• Gross margin: 38.5%, compared with guidance of 36%
• Revenue guidance for Q2: $22 billion
• EPS guidance for Q2: $4.90
• Gross margin guidance: 38.5%
• Apple stores: $12 million average revenue per store, up 69% from Q4
• Cash and marketable securities: $59.7 billion, up from $51 billion in Q4.

MacWorld put together a more detailed but still digestible review that includes a history of quarterly profits since 2007, as well as units and revenue numbers by product line. Very well done.

For the official word from the mother ship, we have Seeking Alpha’s transcript of the earnings call where Tim Cook, Apple’s COO, and Peter Oppenheimer, CFO, read prepared remarks and answer carefully choreographed questions from analysts.

And if you’re ready for some long form reading, we have SEC filings. For the quarter just ended, there’s the Form 10-Q (55 pages). For the entire fiscal year 2010 ending last September, Form 10-K (116 pages…).

You don’t have to read them all–or at all, it’s an acquired taste–but if you decide to indulge, take a moment to feast your legal eyes on the faux handwringing in the Risk Factors section (a.k.a CYA Central). Then head for the good stuff, the Management’s Discussion and Analysis section starting on page 28 in the 10-K, and page 20 in the 10-Q. Company execs use the MD&A to walk us through the key elements of the business.

From that sea of words and numbers, I’ll extract three trains of thoughts.

First, the significance of the iPad business.

14.8M iPads were shipped in just nine months. This in a previously marginalized or verticalized category: Tablets. By comparison, the first iPhone didn’t reach 10M until it was a year old.

Looking at quarterly iPad unit sales:

• 3.3M units for the launch quarter ending in June
• 4.3M for the following three months
• 7.3M units for the period just reported.

At last year’s D9 conference Steve Ballmer dismissed the iPad as “just another PC”. (This is standard Microsoft decorum. In 2007, he scoffed at the iPhone.) Well, then, if the iPad must be counted as a PC, it just captured 7% of the global PC market last quarter.

This explains why Acer and Asus, leading netbook makers, are rushing tablets to the market and why Lenovo, another PC titan, is starting a mobile division. All in all, 80 tablets were announced at CES a few weeks ago. The iPad is about to get some serious competition but, based on the 7.3 million units shipped last quarter, most forecasters feel confident in predicting 30 million iPads or more for the year.

Deloitte, the large accounting and consulting firm, now calls 2011 The Year Of The Tablet. They, and other market research firms, don’t agree with Ballmer. They put the iPad in a new category: Media tablets, and they see Apple’s share as somewhere between 87.5% (where do they find that .5%?) and 90% of the market. (I’m not sure the media tablet moniker will stick. These devices already let you do much more than “consume” media.)

Last quarter’s iPad revenue, $4.6B, is almost as large as the Mac’s $5.4B… and this is after only nine months while the Mac will soon be 27 years old. (For another Monday Note: the Mac business, growing by 22% last year, versus 14% for the entire PC industry, with a closer look at the MacBook Air’s impact, present and future.)

The 10-Q also gives us revenue-per-unit:

• $629 for each iPad
• $649 per iPhone

(Company execs quote ASPs of $600 and $625 in the call transcript but they’re probably excluding ancillary services and accessories.)

The iPad’s lower ASP may seem counterintuitive, but recall the iPad’s introduction last January when the $499 base price took everyone by surprise. Pre-launch speculation pegged it somewhere between $800 and $1,000. It felt like a turning point, it looked like Apple wanted to remove price as an excuse for not buying, that they wanted to occupy as much terrain as quickly as possible. And they did, with a barrage of ads that started soon after the launch and are still going on.

This was followed by two more aggressive price moves, the $99 Apple TV and, more important, the $999 MacBook Air.

Apple’s overall Gross Margin has declined from 39.4% last year to 38.5% last quarter, but that’s better than the 36% level the company had predicted in October. In other words, the more assertive prices seem to have worked: Revenue grew 70% year-to-year without harming profits, which grew by 77%.

(Again, we’ll leave the iPhone’s $649 ASP for another Monday Note, probably around the time of the Mobile World Congress, next month in Barcelona. If we are to believe Apple Insider, Apple has become the world’s largest mobile phone manufacturer — by revenue. As Apple execs “neglected” to brag about beating the incumbent, we’ll wait for Nokia’s quarterly numbers coming out in a few days, January 27th.)

The second point: The Apple Stores.

In FY 2010, revenue across all Apple Stores was $9.8B. This is 15% of Apple’s total sales, with 317 stores open at the end of the reporting period, 44 more than the year before.

But I want to know the revenue per employee. Obligingly, the 10-K mentions 26,500 “full-time equivalent” employees by the end of FY 2010. A simple division yields $370K per employee. There were significantly fewer employees at the beginning of the year so we can safely assume a full-time employee brings in about $400K/year, a ratio that must be the envy of the entire retail industry.

While I’m at it, I also want to get an idea of the Gross Margin for Apple’s retail business. I have a French peasant view of the world: Forget the revenue numbers, its the Gross Margin that really matters, those are the dollars that feed you. We know the operating profit–the 10-K says it was $2.4B, 24%–but what about the Gross Margin?

It’s moderately complicated. If this isn’t your cup of numbers, please skip to the result.

We know Apple’s overall Gross Margin, 39.4% last year; we have numbers for indirect sales and retail, $55.4B and $9.8B respectively. How do we extract retail’s GM? We’re facing one linear equation with two unknowns: the GM for indirect (non-retail) sales and the GM for retail sales. Weighted by their respective sales volumes, they compound to the known 39.4% total Gross Margin number.

I use a simple trick: I assume two components for the retail GM. First I apply a “standard” retail discount. For this exercise, I use 30%. Once I’ve done that, the discounted number becomes of the same nature as indirect sales. The second margin component of the retail GM is therefore equal to the (unknown) indirect GM.
Having “fixed” one variable, the retail discount, we now have one linear equation with one unknown, the indirect Gross Margin, x:

Retail Sales * (30% + 70% * x) + Indirect Sales * x = Total Sales * 39.4%

or, with actual sales numbers, in billions:

9.8 * (30% + 70% * x) + 55.4 * x = 65.2 * 39.4%

Now, copy the line above and paste it into WolframAlpha:

and you’re done:

Isn’t this fun?

The result: 36.5% GM for Apple’s indirect $55.4B sales and, after compounding the assumed 30% retail discount, we arrive at an approximate 56% GM for Apple’s retail stores.
(No warranties expressed or implied.)

Thus, each Apple Store employee can dine on 56% of $400K. That’s $224K. Probably enough to pay salaries, rent and HVAC…and leave change for the shareholders.

That was last year. In the quarter just reported, Apple’s retail business grew 95% year-to-year to $3.9B. Using Apple’s historic seasonality (4xQ1 for the full year; 5xQ4 for the following year) we can project at least $16B for Apple retail in FY 2011.

That’s 16% of the $100B revenue number Apple could approach this year…

Much has been said about the Apple Store as a sterling example of everything that can go right in retail: record sales volume per square foot, traffic numbers, profitability, aesthetics (more at Apple’s architecture firm: Bohlin Cywinski Jackson), and customer service.

Most important, the Apple Store proves Apple’s ability to execute on a global scale.

Which leads me to my last point: The Silence of the Lambs. Wall Street Analysts.

If you go back to the earnings call transcript, there’s a conspicuous absence. There’s no mention of Steve Jobs.

The supposedly aggressive Wall Street analysts didn’t ask a single question about Steve’s medical leave of absence, its nature, duration, Apple’s contingency plans. How come?

The answer in a single word: Access.

A few years ago I asked a journalist friend about a sycophantically fellatious piece that a colleague of his had written for a respected business daily. The writer had followed a key software executive as he toured the company’s R&D offices around the world. In dulcet, reverent tones, the journalist reported how the missus dominicus spread the gospel, blessed projects, and occasionally, but rightfully, disciplined errant local chieftains.

‘How come?’, I asked. ‘This isn’t reporting, this is simply disgorging the party line!’

His response: ‘It’s all about access. This is a huge company that’s an important source of news, great fodder for the paper and its journos. It’s a quid pro quo. In order to get access to the top execs, to get the juicy tidbits, sometimes you have to strap the kneepads on…’

Before its earnings call, a company decides which analysts will be allowed to ask questions. The opportunity comes with an understanding. If you don’t do your part, your conference call line will never open again, you’ll have lost access.

And we can’t blame Apple: All companies do it. At least the ones that bestow enough prestige.

Nonetheless, I don’t buy the criticism of Apple’s decision to keep a tight lid on Jobs’ medical condition. In the first place, no less than ex-SEC commissioner Arthur Levitt believes Apple has met its legal disclosure obligations.

Further, Apple’s behavior is consistent. Critics might find it unpleasant, but they shouldn’t be surprised. Fault-finders would lead a happier and more productive life if they recognized that this is the way it was, is, and always will be.

Speaking of which, of modus operandi, one of Steve’s signal achievements is the management team and culture he’s installed since he took the reins in 1997 and engineered Apple 2.0. The vision, the panache, the demanding aesthetics, the (more than) occasional swish of his rhetoric rapier could obscure the fact that he’s built one of the best–perhaps the best–business machines this industry has ever seen, run by a uniquely competent and cohesive management team.

But yes, there is only one Steve. We all hope to see him soon on stage or driving around Palo Alto. (Don’t ask about the license plate.)

—JLG@mondaynote.com

PS: Thanks to John Gruber, I found this advertising executive’s insightful homage to Jobs and Apple, saying things like:

‘Yeah, it’s just some metal, plastic and silicon. And, yes, Apple makes a lot of money. But those two observations miss completely the point of Apple. It’s about inspiration, hope and an embrace of the future and humanity’s place within it.’

The full text is here.

—-

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