Apple Inc.’s (AAPL) second-quarter of 2010 results (both earnings and revenue) beat the bullish Zacks Consensus Estimates, fueled by strong iPhone sales (which more than doubled in the quarter due to strong international demand), increased Mac sales, success of its new product launch, increased consumer spending and a rebound in PC shipments.
Overall, Apple’s earnings performance has been way above the Zacks Consensus expectations. The shares rose 7.0% ($17.09) after hours to close at $261.68, an all-time high.
Apple said that the second quarter was the “best non-holiday quarter ever” in the company’s history and exceeded the company’s own expectations. We believe the company will continue to post solid results due to the continued resurgence of its Mac computer line, increased sale of iPods and continued growth in iPhone sales.
Further, we believe that the iPad is expected to be the strongest growth driver for Apple, moving forward. The second-quarter results did not include iPad sales, as the device did not launch until after the period officially ended.
We expect the company to report stronger results in fiscal 2010 due to a potential increase in iPad volume boosting Apple’s revenue and earnings. Moreover, Apple has several new products in the pipeline this year and is expected to launch a fourth generation of the iPhone this June.
Earnings
Earnings in the quarter reached a record at $3.33 per share, beating the Zacks Consensus Estimate of $2.43 by 90 cents and surpassing the company’s own guidance of $2.06 to $2.18 per share. The earnings increased 86.0% from $1.79 per share reported in the year-ago period. Net income soared to $3.07 billion in the quarter from $1.62 billion in the year-ago period.
Under the subscription accounting principles, Apple is now recognizing the contribution from the iPhone and Apple TV in the period of sale rather than over the product’s estimated life. Under the company’s new accounting principles, there will be no deferred revenue.
Revenue
Strong earnings were due to higher sales in the quarter, which increased 48.6% to $13.50 billion, beating the Zacks Consensus Estimate of $12.0 billion. The tremendous revenue growth was driven by increased momentum in Mac shipments and strong iPhone sales.
Apple’s revenue increased year over year in every region as the company entered into major markets including Japan, Australia, the U.K., France and Germany. The company also added new mobile carriers to sell its products in additional countries. International sales accounted for 58% of the total revenue in the quarter.
Operating Performance
The company is currently benefiting from cost reductions in prior quarters and a positive mix shift to the higher-margin iPhones. As a result, gross margins grew to 41.7% — a 180 basis point increase year over year and 270 basis points above management’s expectation.
Operating margin for the quarter was 29.5%, compared to 25.6% in the year-ago period. This was due to higher-than-anticipated revenue and gross margin as well as increased cost reduction.
Apple’s balance sheet remains strong. Cash and investments were $41.7 billion at the end of quarter versus $39.8 billion in the previous quarter. AAPL generated cash flow of $2.3 billion during the quarter versus $5.8 billion in the previous quarter (which included the 2009 holiday season).
Quarterly Highlights
Macintosh –– AAPL shipped a record 2.94 million Macintosh computers in the quarter, representing a 33% year over year increase in units shipped due to the increased demand for Macs in each of its geographic segments. This resulted in double-digit growth in both desktop and portable platforms. Apple’s desktop computer sales rose 40% year over year on a unit basis, while portable MacBook computers increased 28%.
By comparison, the overall market for PCs grew 24% year over year during the March quarter, based on the latest forecast published by IDC. Apple updated its MacBook Pro line by using NVIDIA Corp.’s (NVDA) graphics that will further help grow Mac sales.
Retail Stores –– Retail revenue in the quarter was $1.68 billion, up 21.7% from the year-ago period. The retail stores sold 606,000 Macs in the quarter compared to 438,000 Macs in the year-ago quarter, an increase of 38%. Half of the Macs were sold to new customers. The company opened two new stores in the U.K. and one store in Germany , totaling to 286 stores opened by the end of March. With an average of 284 stores opened during the March quarter, average revenue per store was $5.9 million compared to $5.5 million in the year-ago quarter.
iPods –– AAPL sold 10.9 million iPods during the quarter, representing a 1% unit decline from the year-ago quarter. However, the iPod Touch did extremely well in the quarter, growing 63% year over year, resulting in an overall iPod revenue increase of 12%, the strongest iPod revenue growth rate in the last two years.
According to NPD, Apple’s share of MP3 players in the U.S. was over 70% in the month of March, and iPod was the top-selling MP3 player. The company continues to gain share year over year in most international markets such as Australia, the U.K., Canada and Japan based on the latest data published by GFK.
iTunes –– The iTunes store delivered a record quarter with sales of $1.1 billion due to strong sales of music, video and apps. The iTunes store features 12 million songs, while the app store continues to be an unparalleled success with more than 185,000 apps and well over 4 billion downloads to date by iPhone and iPod Touch users in 90 countries. Apple has also launched the iBook store with over 3,500 new apps designed for iPad, which will further drive success in the coming quarters.
iPhones –– The iPhone continues to be a major success for AAPL due to its strength in overseas markets, particularly Europe and Asia, where sales rose 400%. Apple said that the revenue from China, Taiwan and Hong Kong grew 200% year over year to $1.3 billion. The company plans to open two Shanghai stores this summer and have 25 locations in China by the end of 2011.
Overall iPhone unit sales were 8.75 million during the quarter, representing 131% unit growth over the year-ago quarter and the highest the company’s history. The increase was driven by strong international demand for the smartphone as well as addition of new carriers in key overseas markets.
According to IDC, the overall Smart Phone market was expected to grow just 41% in the March quarter. The value of iPhones sold during the quarter was $5.3 billion, resulting in an ASP of about $600. Apple recently released the iPhone OS4 (beta release) and SDK which will further drive iPhone sales. Although AT&T Inc. (T) remains the exclusive U.S. carrier for Apple, the company has been adding new mobile carriers to sell its products in other countries such as Vodafone (VOD) in the U.K. The company has iPhone distribution agreements with 151 carriers in 88 countries.
Guidance
For the third quarter of fiscal 2010, AAPL expects revenue in the range of $13.0 billion to $13.4 billion, up 36% from the year-ago period of $9.7 billion but down 2.3% sequentially. Earnings are expected to be in the range of $2.28 to $2.39 per share compared to $2.01 in the year-ago quarter. However, we should note that the company traditionally gives extremely conservative guidance.
Apple has strong fundamentals and long-term growth potential and thus the Zacks Consensus Estimate for the third quarter is at $2.65, above the company’s guidance. Revenue is expected to be in the $13 billion to $13.4 billion range.
The company expects gross margin of 36.0%, down from 41.7% reported in the March quarter, driven by the increase in iPad launch cost. Operating expenses are expected to be about $1.83 billion, while Other Income and expenses are expected to be about $45 million. The tax rate is expected to be about 27%.
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