BETA
This is a BETA experience. You may opt-out by clicking here

More From Forbes

Edit Story

Apple's Rocket Fuel Explained

This article is more than 10 years old.
 

Apple (NASDAQ:AAPL) is the Houdini of investments. Whenever skeptics think it’s trapped, it surprises with sensational escape acts. Apple defied critics with profits that were 20% above consensus, forcing even the detractors to ratchet up forecasts for this perpetual performer. In the past two weeks, Apple’s stock dropped 15% from its highs only to rebound to $620 today. Such volatility is commonplace with the push and pull of critics  faced off against the zealots. Clearly, no one knows what the future holds, but post-earnings the optimists won.

Quarter Surprises -- China & iPad

The company reported performance that could be considered magical with annualized gains in each product. Going forward, the company guided above expectations for the current quarter (June). Apple has delivered on a consistent upward trajectory since 2007 when it introduced the iPhone.

Bears assumed that shortfalls of the iPhone at Verizon (NYSE:VZ) and AT&T (NYSE:T) hinted to an Apple earnings miss, but they were blindsided by Apple's 75% sequential growth in China. Slowness in the US was an anomaly in the global picture as U.S. carriers try to wrestle market power from Apple to ensure negotiating room and price competition. To counter Apple’s iOS dominance, U.S. carriers pushed rival operating systems from Microsoft’s WindowsPhone (NASDAQ:MSFT) and Google’s Android (NASDAQ:GOOG). Despite marketing efforts by rivals, Apple sold almost the same number of iPhones in the March quarter as it did in the holiday quarter (35 million in March vs. 37 million in December), a remarkable feat given difficult compares with the Christmas season.  

China's sales of $8 billion in the quarter were 20% of total revenues, up from 15% of revenues the prior quarter.  Continued supply constraints in China indicate a healthy pipeline. So, with the momentum, Apple seems poised to race past rivals throughout the end of the year. 

Production Edge

Apple manages to make fluid changes to production, allowing it to vary output by product and feature despite  its gargantuan size. Apple is noted for  control over its supply chain and expertise in operations engineering. The computer giant uses many common elements across its products, and then leverages its huge scale in negotiations with chip suppliers, pitting them against each other to capture the carrot. And do they jump. Multiple suppliers vie for each component and push innovation, and the diversity lowers risk for Apple. The computer company keeps around 4-6 weeks of demand in the supply channel and consistently meets its own goals.

Apple gains an edge by controlling integration  too, outright owning some assembly lines on factory floor. It has the flexibility to make last-minute changes to capacity, a luxury most competitors lack. As a non-consequential side benefit, it blocks rivals from using its idle production facilities when they face their own supply constraints. Apple said it will spend $5 billion in capex in the second half, up from $3 billion in the first half and pulling ahead of the pack of competitors.

Apple does not hesitate to spend aggressively at the last minute to meet fickle demand and frequently locks out competitors. For example, it bought all the air cargo capacity during the holiday season for $400 million to meet unanticipated demand (see BusinessWeek story). Its ingenious production control is a hat tip to Tim Cook who built the supply chain over a decade.

New iOS Products

The surprise in the quarter was the uptick in iPad demand, which could continue into the current quarter (June) with an expected  50% change, eclipsing the growth rate for iPhone in the same three month period.  IPads may deliver $10 billion in revenues in the June quarter, driven by surprise in corporate demand.  Apple traditionally focused on the consumer market, but enterprise market is clamoring for the goods too.  For example, airline pilots use iPads in the cockpit to look up details once only in technical documents. The iPad is supply-constrained in Asia and Europe.

The very success of the iPad could weigh in on gross margins in the June quarter. The iPads have ASPs of around $550, maybe $100 below the iPhone. And, the iPad is a new product so gross margins are below the company average . The shift toward iPads could depress gross margins to 42% for the June quarter versus the 47% reported in March. 

New products on the drawing board could offer new paths to growth. The computer giant could be planning a dive into the television industry with a giant iPhone-like large screen TV.  The so-called iTV would offer a new kind of user interface, including Siri, the artificial servant to take commands for finding shows. The iOS platform would allow interoperability among all the digital devices – phones, tablets, TVs and PCs.  

Stores and Clouds

In the earnings call, management  noted the the fast ramp of  the Stores, iTunes and  the iCloud, which competitors are scrambling to duplicate. Surprisingly, there were 125 million iCloud users at the end of March quarter. The iCloud could be a stealth contributor of profits and product stickiness.

China and Spain 

Momentum could come from China as US carriers continue to try to temper Apple’s success and the European recession dampens demand in most countries. The one bright spot in Europe is Spain where demand is very strong. Apple supplies to 160 different countries around the globe so growth has different paces. Management said it is trying to better understand the wants of the skyrocketing middle class in China as well as other emerging nations.

Outlook

Though management offered conservative guidance for the current quarter (ends in June), it has a  practice of setting the bar low and beating it by a mile. As such, June revenues could be comparable to March at $40 billion rather than the $34 billion from guidance. Profits may be down quarter-to-quarter to about $10-11 per share as the iPad ramps.