No Monday Note last week: I was in The Country of Sin, enjoying pleasures such as TGV trips across a landscape of old villages, Romanesque churches, Rhône vineyards — and a couple of nuclear power plants. All this without our friendly TSA.
Back in the Valley, Apple just released their latest quarterly numbers. They weren’t as good as expected, a fact that launched a broadside of comments ranging from shameless pageview whoring (I’m looking at you, Henry) to calm but worried (see Richard Gaywood’s analysis).
As I’ll attempt to explain below, Apple’s latest quarterly performance is unusual. But, stepping back a bit, the company’s numbers are nonetheless phenomenal.
Net sales, growing 23%, are more than three times larger than Amazon’s — and Apple’s net income is more than 1,000 times larger, $8.8B vs. a tiny $7M for the Seattle giant, whose shares went up after disclosing its earnings release anyway.
Turning to Google, Apple sales of $35B are more than three times Google’s $11.3B (including Motorola, for the first time), with net income numbers in a similar ratio at $8.8B and $2.8B respectively.
Ending comparisons with Microsoft, its revenue grew 4% to $18B, about half of Apple’s and, for the first time, the company posted a net loss of $492M, due to the huge $6.2B aQuantive write off, a one time event. Excluding that number, Microsoft net income would have been about $5.5B, two thirds of Apple’s. iPhone revenue at $16B for the quarter, approaches Microsoft’s number for the entire company, iPad, at $9B is about half.
For in-depth coverage of Apple’s Q3 FY 2012, you can turn to Philip Ellmer-DeWitt’s Apple 2.0 or Horace Dediu’s Asymco — possibly the best source of fine-grained industry analysis. I can also recommend Daring Fireball for John Gruber’s lapidary comments and carefully chosen links, and Brian Hall’s Smartphone Wars — vigorous commentary and insights, occasionally couched in NSFW language. Of course, you can always wade through Apple’s 10-Q SEC filing, if you have the time and inclination. Of particular interest is Section 2 MD&A, Management Discussion and Analysis, starting on page 21.
Out of this torrent of information and argument, I suggest we look at three numbers.
First, the 3% “Miss”, Wall Street’s term for failing to hit the revenue bull’s eye. I’m not referring to the guessing games played by Wall Street analysts, both the pros and the so-called amateurs. In the past, the amateurs have done a consistently better job of forecasting revenue, gross margin, profit, unit volumes, but this time, the pros won. Although almost everyone substantially overestimated Apple’s numbers, the pros weren’t nearly as optimistic as the amateurs.”
Instead of measuring Apple’s performance against the predictions of the traders and observers, we can recall what the company itself told us to expect. About a month into each quarter, management provides an official but non-committal estimate of the quarter’s revenue. This guidance is a delicate dance: You want to be cautious, you want to sandbag a little, but not so much that your numbers aren’t taken seriously. Unavoidably, a lot of second-guessing ensues.
Apple has consistently beaten its own guidance, by 19% on average over the past three years, and as much as 35% in Q1 2010. But in this past quarter, Apple “achieved” a historic low: Actual revenue came in at only 3% above the guidance number. Richard Gaywood provides a helpful graphic in his TUAW piece:
Apple management offered explanations during the conference call following the earnings release: The economy in Europe isn’t doing so well, “rumors” about the iPhone 5 have slowed sales of iPhone 4s… These might very well be the causes of the lackluster performance, but one has to wonder: Weren’t these issues known two months ago when the guidance number was announced? Apple is praised for its superbly managed supply chain, its global distribution network, its attention to detail. How is it possible that it didn’t see that the European economy was already cooling? How could management not have heard the steady murmur about an upcoming iPhone?
Put another way: What did you know and when did you know it? And, if you didn’t know, why didn’t you?
There is a possible alternative explanation: Samsung is making more substantial inroads than expected, as their impressive quarterly numbers just released would attest: 50.5M smartphones shipped, almost twice as many as Apple’s 26M.
Sharp-eyed readers may protest the comparison: Samsung reports the number of devices “shipped” while Apple reports units “sold”. But even if we allow for unsold inventory, Samsung’s performance is impressive. (And, as circumstantial evidence, I noticed an unusually heavy amount of advertising for the Galaxy S III during my recent overseas trip.)
Samsung’s strong showing will almost certainly continue — so how will Apple react? A new product? Price moves? Both? In the conference call, Tim Cook assured his audience that Apple won’t create a “price umbrella” for competitors, that it won’t insist on premium price tags and thus leave small-margin money on the table.
Which leads us to the second number: Gross Margin guidance for the current quarter, ending September 30th, is 38.5%, down from 42.8% for the quarter that just ended. In consultant-speak, that’s an evaporation of 430 basis points (hundredths of percent) in just one quarter — and we’re already one month into it with no visible change in the product lineup other than the full availability of newer MacBooks (Air, Pro, Retina), and no evidence of heavy-handed discounting.
During the conference call, a Morgan Stanley analyst noted that Apple hadn’t shown Gross Margin numbers below 40% for the past two years. Would Apple care to comment?
We expect most of this decline to be primarily driven by a fall transition and to a much lesser extent, the impact of the stronger U.S. dollar.
The entire Gross Margin drop of about $34B of sales (the latest guidance) amounts to $1.5B, a sum that will shift in less than two months, and probably less than one as any momentous announcement is unlikely before Labor Day (the first Monday of September for our overseas readers). This could portend a strong price move in the “fall transition”. To put the $1.5B shift in perspective, imagine Apple dropping its “usual” Gross Margin by $100 per device (new or existing); this means 15M lower-margins devices in the three weeks of September after Labor Day. Or perhaps Apple’s CFO is sandbagging the guidance once again.
The third curious number is the most perplexing: While the entire company grew by 23% compared to the same quarter last year, Apple Store revenue grew by only 17% — and this in spite of adding 47 stores over the year, for a total of 372. Why would Apple’s much vaunted retail channel grow more slowly than the company? The weak Euro economy can’t be the explanation, there are relatively less Apple Stores there. The same can be said for “rumors” of newer devices, they impact all channels and not just company stores.
We’ll see if this last quarter was simply a manifestation of a natural “granularity” of its business (as opposed to the unnatural smoothing of quarter after quarter numbers favored by Wall Street), or if the company is entering a new chapter of the smartphone wars and, if this is the case, how it will change tactics.