Apple Inc.’s (AAPL) first-quarter of 2010 earnings, margins and revenues were much better than expected. The results were a record in the company’s history and surpassed expectations on all fronts. Apple’s share price rose 2.69% and closed at $203.07 and increased 1% after hours. AAPL posted impressive results fueled by strong Mac and iPhone sales. We believe the company will continue to post solid results due to continued resurgence of its Mac computer line, increased sale of iPods and continued growth in iPhone sales.
Earnings in the quarter were $3.67 per share, beating the Zacks Consensus Estimate of $2.08 by $1.59 and surpassing the company’s own guidance of $1.70 to $1.78 per share. The earnings increased 46.8% from $2.50 per share reported in the year-ago period.
Strong earnings were due to higher sales in the quarter, which increased 32% to $15.68 billion, representing the highest revenue growth in the company’s history. The tremendous revenue growth was driven by increased Mac shipments and strong iPhone sales as the company rolled it out in new international markets such as China via China Unicom Honk Kong Ltd. (CHU).
Apple’s revenue increased in every region, including the U.S. and Europe. International sales accounted for 58% of total revenue in the quarter as the company entered major markets including Japan, Australia, the U.K., France and Germany.
Apple is due to unveil the Apple Tablet on Jan 27, which will drive the fortunes of the company. We continue to believe that AAPL will outperform its peers, given its strong iPhone sales and new product launches.
Operating Performance
The company is currently benefiting from a positive mix shift to the higher-margin iPhones/iPod business from its traditional MP3 players, as a result of which gross margins grew to 40.9%, a 300 basis point increase year over year. The company also benefited from the ramp-up of new products. We expect AAPL to post higher margins as a result of higher sales and the continued mix shift in the next several quarters.
Operating margin for the quarter was 30.1%, the highest in the company’s history and better than the company’s expectation. This was due to higher than anticipated revenue and gross margin.
Apple’s balance sheet remains strong. Cash and investments were $39.8 billion at the end of the quarter versus $34.0 billion in the previous quarter. AAPL generated cash flow of $5.8 billion during the quarter versus $3.1 billion generated in the previous quarter.
Accounting Issues
Management also noted that a decision by the FASB last September regarding subscription accounting principles is likely to require the company to recognize the contribution from iPhone and Apple TV in the period of sale rather than over the product’s estimated life. The new accounting principles will be adopted on retrospective basis. Consequently, the financial results of each quarter from fiscal 2007 through fiscal 2009 have been revised. Thus the company filed an amended 10-K for 2009 to reflect the retrospective application of the new principles to prior years. Under the new accounting rules, the company will not provide any non-GAAP financial metrics.
Quarterly Highlights
Macintosh –– AAPL shipped a record 3.36 million Macintosh computers in the quarter, representing 33% unit increase year over year due to the increased demand for the new Macbook and iMac introduced in October, which contributed to 70% year-over-year growth in desktop sales. In comparison, the overall market for PCs grew 17% year-over-year during the December quarter, based on the latest forecast published by IDC. The retail stores sold a record 689,000 Macs in the quarter compared to 515,000 Macs in the year-ago quarter. Mac portable sales increased 18% year-over-year on strong sales of Macbook Pro, which is a very significant gain.
iPods –– AAPL sold 21 million iPods during the quarter, representing an 8% unit decline from the year-ago quarter. However, the iPod Touch did extremely well in the quarter, growing 55% year over year, resulting in an overall iPod ASP increase of 9% and revenue growth of 1% in the quarter. According to NPD, Apple’s share of MP3 players in the U.S. was over 70% in the month of December, and iPod was the top-selling MP3 player. The company continues to gain share year-over-year in most international markets.
iTunes –– The iTunes store delivered a record quarter with strong sales of music, video and apps. The iTunes store features 11 million songs, while the app store continues to be an unparalleled success with more than 3 billion downloads to date by iPhone and iPod touch users in 77 countries. iPhones –– The iPhone continues to be a major success for AAPL.
iPhone unit sales were 8.7 million during the quarter, representing 100% unit growth over the year-ago quarter. The value of iPhones sold during the quarter was over $4.5 billion, resulting in an ASP of about $620. The company added 17 new carriers in the quarter.
Guidance
For the second quarter of fiscal 2010, AAPL expects revenue in the range of $11.0 billion to $11.4 billion, up 23% from the year-ago period. Earnings are expected in the range of $2.06 to $2.18 per share compared to $1.79 in the year-ago quarter boosted by the new accounting principles. The company traditionally gives extremely conservative guidance.
Gross margin is expected to be about 39.0%. Operating expenses are expected to be about $1.46 billion, while Other Income and expenses are expected to be about $30 million, reflective of the short-term interest rate environment. The tax rate is expected to be about 29%.
We expect the company to report stronger results in fiscal 2010. While AAPL has various positive attributes, we believe that the company’s strong growth has already been priced into its shares, although momentum could drive the shares slightly higher. Thus, we advise stockholders to hold the shares. We have a long-term Neutral rating on AAPL.
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