Cars That Fly *And* Float: Explaining Apple’s Q4 And Beyond

Apple’s Q4 2012 results were mixed. As usual, reading Twitter, you’d think this was the end of the world. Nevermind that Amazon managed to post a loss on $13.8 billion in sales today — Apple only made $8.2 billion in profit. “Ahhhh!!!!! What is wrong with Apple?!!!” “This would have never have happened under Steve!”

That’s right, such a profit wouldn’t have happened under Steve. In fact, it never did. Jobs’ best quarter in terms of profit was just over $7 billion — and actually, that’s when Tim Cook was interim CEO last year.

But had you read TechCrunch in July, after Apple’s last “miss”, you would have been prepared. As we noted at the time:

Apple missed this past quarter, but the true shock could come if they miss next quarter as well. The guidance Apple gave indicates they’re thinking small (well, for them — it’s all relative, remember) as they prepare for a “fall transition”. Apple may well hit/beat their numbers next quarter, or they may not. Regardless, they’ll likely be fairly depressed again. But that’s only because everything is aligning for a mega Q1 holiday quarter. Again.

That’s exactly what we saw. Apple beat Wall Street revenue estimates, but missed in profit and earnings-per-share. Fairly depressed. Mixed. And yes, it’s largely because Apple has aligned their product might behind Q1. Think about this stat that Cook rattled off during the earnings call today: the products that Apple has released in the past six weeks are expected to make up 80 percent of sales in the coming quarter.

iPhone 5. 4th generation iPad. iPad mini. 13-inch retina MacBook Pro. New iMacs. New iPods. Etc.

The chamber will be out of bullets.

That’s why Apple is projecting revenue of $52 billion next quarter. It would be their biggest quarter ever — topping even last year’s monster Q1, which saw revenues hit $46 billion and blew Wall Street away. While Apple has missed Wall Street’s numbers here and there, they don’t miss their own. They’re clearly aiming for sales greater than $52 billion.

Still, some are disappointed that the next massive quarter will only be $6 billion higher than last year. And others can’t understand how Apple could miss on some of the numbers this past quarter. But it’s actually pretty easy to understand if you just stop. Think. And read between the lines.

The most important product in Apple’s arsenal is still by far the iPhone. Apple’s numbers basically live or die by these sales. Some people may have been disappointed that Apple’s numbers were up only slightly sequentially since the iPhone 5 came out last month, but it was actually only one sale for nine days in the quarter before it closed. Still, those nine days probably helped boost revenues just over last quarter. That in turn may have helped Apple get by revenue estimates. The iPhone 5 will fuel Apple’s next quarter past $50 billion.

The iPad situation was not nearly as good this past quarter. Apple actually sold fewer iPads sequentially. Cook noted that Apple expected this decline. But why? It is a pretty new product after all.

The first reason is K-12 sales. Those typically happen in the June quarter, not the September quarter. Clearly, they matter a lot to the iPad already. The second reason is that the June quarter was the first full quarter during with the new iPad (the third-generation) was on sale. That clearly boosted the numbers, and they fell back from there. And this may have also been related to the rumors of a new product — which of course ended up being the iPad mini.

Cook didn’t dwell on this factor nearly as much as his did last quarter for depressed iPhone sales (leading up to the iPhone 5), but he still mentioned that he believed it had an impact. Given that Apple just released not only the iPad mini, but the fourth-generation iPad as well, that will not be an issue next quarter, clearly.

Mac sales were good, but they simply don’t matter as much to Apple’s bottom line. It’s iPhone first, iPad second, Mac third.

Meanwhile, the iPod fell below a $1 billion business — both software and iTunes are now bigger when it comes to Apple’s revenues. In other words, Apple has lost one of the main “legs” of their table, as Jobs used to describe it.

So yes, Apple’s numbers were depressed this past quarter due to the biggest batch of product refreshes that Apple has ever done — the “fall transition, they’ve spoken about in the past — the seasonality of the iPad, and minimal impact of the iPhone 5.

More interesting is going forward. Again, people are upset about the $52 billion in revenue being put out there — which on one hand, is insane, but on the other, the EPS of $11.75 is far less than some were hoping for. Why is that?

Three things. Two major. One minor.

First, the minor. Last year, Apple’s Q1 was 14 weeks long. Usually, financial quarters are 13 weeks long, so this was an anomaly, which they noted at the time. This year, the same quarter will have the standard 13 weeks. Apple CFO Peter Oppenheimer made a point of saying this about a half dozen times on the call. Apple wants to make it clear that this extra week of sales do matter and analysts should set expectations (lower) accordingly.

One major reason for concern going forward is Apple’s margins. This past quarter, Apple was able to maintain a higher-than-expected 40 percent gross margin. Next quarter, they’re projecting 36 percent margins. That’s a significant decline.

So why will that drop take place? Two words.

iPad. Mini.

During the call, Oppenheimer noted that the iPad mini had a “gross margin is significantly below corporate average”. In other words, if the average is around 40 percent for Apple the past several quarters, iPad mini is in the 30s. (Or maybe lower though I’d guess not much lower.)

There has been a lot of questions the past few days as to why Apple would sell the iPad mini starting at $329 instead of say $299 or even $249, to get closer to the prices at which competitors are selling their smaller tablets. This is the reason. Apple is already dipping into uncomfortable margin territory for them.

And even at $329, Apple clearly expects to sell a lot of iPad minis this holiday season, thus lowering the overall margin.

The other major reason for Apple’s lower guidance is the iPhone 5 supply chain. Cook noted a few times that demand for the device remains huge and Apple cannot yet meet it. While he says conditions are improving, he would not commit to Apple being able to meet demand by the end of Q1. That means less iPhones sold than would otherwise be possible. That means less revenue.

The iPad mini will be the true wild card for Q1. If it does sell really well, Apple’s revenues could shoot through the roof again. But profit won’t raise as quickly due to the margin. This is important to remember.

It’s also interesting to note that the average selling price of the iPad fell significantly last quarter. Oppenheimer explained this is because the $399 iPad 2 continues to sell well. I’ve personally wondered why Apple is keeping the iPad 2 on the market with the fourth generation iPad and iPad mini now out there (and the third-generation iPad being removed). Apparently, this is why: it’s selling really well. That also suggests the $329 iPad mini is going to sell really well.

People want the iPad, but many seem to want it at the cheaper price points. It’s not like the iPhone which is subsidized down to $199 with the carriers paying Apple the full price directly.

Apple clearly also believes the iPad mini will cannibalize some of the larger iPad market. But Cook says they’re fine with that, as long as they’re the ones doing it. Still, the effect that will have on the margin is what will have Wall Street worried. The iPad is already a lower margin product than the iPhone. The iPad mini is lower still.

That’s why some people are disappointed with a $36 billion quarter that could lead to a $50 billion quarter next quarter. Apple has set a very high bar. And until they get a completely new product out there with a very high margin, they’ll continue to fly closer and closer to the sun. To a lesser extent, they will continue to reduce production costs, thus bolstering margins. But can they do it fast enough?

As for the just-unleashed Microsoft Surface tablet hurting iPad sales, Cook had this to say, “I suppose you could design a car that flies and floats. But I don’t think it would do all of those things very well.”

[image: flickr/creative location]