Apple's Monster Quarter And The Pending Share Price Advance

Apple is unique among America's mega caps due to the company's ongoing rates of revenue and earnings growth. From $108.25 billion in revenue reported in the fiscal year ended in September, Apple will surpass $170 billion in revenue this fiscal year and reach over one-quarter trillion dollars in revenue in FY2013. At a current market cap of $375 billion, the shares trade at about 14.5 times trailing twelve month earnings of $27.68 per share and at about 8.75 times my projected FY2012 earnings of $46 per share.

Because of the company's frenetic rates of revenue and earnings growth, Apple is in an equity class all its own. Apple will deliver a third consecutive fiscal year of revenue growth above 50% and eps growth above 60%. This fiscal year's strong performance begins with what I call "Apple's monster quarter."

Apple's Monster Quarter

Apple's first fiscal quarter of FY2012 will be fourteen weeks in length. It stretches from September 25, 2011 to December 31, 2011. The additional week in the quarter will encompass the immediate post-Christmas period. The quarter also includes the initial release of the iPhone 4S in the United States and other launch countries. The additional shipping week, the new Sprint agreement for the iPhone and pent-up demand for the recently refreshed smartphone handset will deliver revenue growth greater that 60% in the quarter and eps growth exceeding 80%. 

AAPL's Discount To Current And Future Growth
The chart below illustrates how much the rate of Apple's share price appreciation has fallen behind the rate of earnings growth over the past four quarters. Despite the 82.7% growth in earnings per share in FY2011, at Apple's closing price of $403.33 on Friday, December 23rd, the share price has risen only 24.64% year-over-year. The dates selected for the charts in this article represent the first trading day of the month following the release of quarterly earnings and the closing price on Friday, December 23, 2011.

Apple's Ghost Of Christmas Yet To Come

In the famous novel by Charles Dickens, Ebenezer Scrooge is visited on the night before Christmas by Ghosts of Christmas Past, Present and Yet To Come. The story, which has endured many popular adaptations, ends with the conversion of a miserly and miserable man to a gentleman who carries with him the hopeful and generous spirit of Christmas to the end of his years.

I have followed Apple since the release of the original Macintosh in early 1984. I have witnessed and written about the tragedies and triumphs of the company's past, its present and Apple's potential for growth in the years yet to come. Today I see a storied enterprise with a colorful past befitting its own novel, yet an enterprise that maintains a youthful, almost playful approach to the product strategies that will yield success in those years yet to come.

Apple's Ghost of Christmas Past

I remember a time when the word "beleaguered" had become a de facto prefix to the company's corporate name. The company that many consider the first modern tech industry IPO and the company that claims to have ignited the personal computer revolution became stodgy and stubborn like the character in the Charles Dickens novel.

In the mid-1990's Apple didn't lose its leadership in the PC market because Windows PCs were better. Apple lost its leadership because the CEO at the time bet on the brand name rather than innovation to deliver revenue and margins. The Performa line of Macintosh computers nearly drove the company to oblivion.

It was a twist of fate and a combination of products for content creation and content consumption that reversed Apple's fortunes. The return of Steve Jobs, the nimble and diminutive iPod, the iTunes music store and a revamped line of personal computers sparked one of the great corporate revival stories of the past one hundred years. It was innovative thinking that started Apple and it's the continued spirit of innovation that recently delivered the company's first $100 billion fiscal year.

Although Apple has invested heavily in building global brand awareness, innovation is delivering record revenue and earnings, not the brand name. Apple has learned from its ghosts of the past.

Apple's Ghost of Christmas Present

For the holiday season of 2011, Apple released a compelling line of new smartphones and the company is a global leader in the emerging market for tablet-style products. This quarter Apple will generate revenue of over $40 billion and earnings of more than $11 per share.

Apple Competes With Device Makers, Not Operating Systems
Contrary to popular opinion, Android handset makers compete more with one another than they compete with Apple. Apple's biggest challenges are maintaining the pace of product innovation and meeting demand with supply when refreshed products are initially released.

Absent innovation Apple can not sustain strong rates of revenue and earnings growth. Only in the absence of adequate supplies of newly released Apple products can competitors establish or sustain a lucrative foothold in any of  the company's primary product markets.

Where Apple Makes Its Money

In the past ten years Apple has transitioned from being primarily a personal computer maker with annual revenue of just over $5 billion to a global enterprise with literally twenty times the revenue, retail store locations around the world and four major product lines including the popular iPhone line of smartphones. Today I'm taking a look at where the company now makes its money. Over 60% of Apple's revenue is currently sourced from the sales of products and services outside the United States.

Management By Geographic Region
According to the company's regulatory filings, Apple "manages its business primarily on a geographic basis." The company's geographic segments consist of the Americas, Europe, Japan, Asia-Pacific and Retail. For Apple's current fiscal year (FY2012) ending in September, I estimate revenue growth of 57% to $170 billion. This is following the 66% revenue rise to $108.249 billion that occurred last fiscal year. The company's strong rates of revenue growth are fueled in part by continuing international expansion.

The US and China: Apple's Revenue Leaders
When Apple retail store sales are assigned to the countries of sales origin, Apple's FY2011 revenue from US sales comes in at  $41.812 billion. This represents 38.6% of the fiscal year's total. I expect the US to deliver about 37% of reported revenue in FY2012 on revenue growth of at least 50% in the region. As early as FY2013, non-US revenue sources may deliver 67% or two-thirds of the company's top line number. China is the only country outside of the US to deliver over 10% of recognized revenue in FY2011. China's $12.472 billion in revenue represented 11.52% of the company's $108.249 billion total.

In fiscal years 2011 and 2010, revenue growth in the Asia-Pacific segment exceeded 150% and in FY2011 Asia-Pacific delivered almost 21% of the company's recognized revenue. In FY2012, I expect the Asia-Pacific region, inclusive of China, to surpass Europe in revenue generation and become Apple's second largest geographic revenue segment.

The pie chart below illustrates each geographic segment's percentage contribution to Apple's revenue in FY2011. The numbers include retail store sales as a separate geographic segment as formally reported by Apple:

Apple's $170 Billion Fiscal Year

On September 25th, Apple entered its current fiscal year with the strongest product line in the company's storied history. In a recent article titled Apple's 25% Solution, I provided an overview of Apple's extraordinary FY 2011 revenue and earnings growth performance, including the nearly 25% of recognized revenue that flowed to the net income line. Today I'm publishing my preliminary revenue and earnings per share estimates for FY 2012. For the current fiscal year ending next September, I anticipate 57% revenue growth to $170 billion and earnings per share growth of 66.2% to $46. 

In FY 2012, Apple will surpass HP in revenue to become the nation's largest technology company and maintain its position as the most highly valued enterprise in the industry measured by market capitalization.

The graph below illustrates the percentage of revenue I anticipate each of Apple's major product lines will contribute to the $170 billion recognized revenue total.

The Apple iPhone As The Principal Growth Catalyst

Before I delve into an overview of the anticipated unit sales and revenue performance for each of Apple's major product lines, mention needs to be made of the Apple iPhone as the company's growth catalyst. In FY 2012 I anticipate the popular smartphone line will represent 50% of Apple's recognized revenue and about 62% of the expected 57% rise in revenue. Almost 75% of Apple's projected FY 2012 recognized revenue will be derived from iOS-based products including the Apple iPhone, the Apple iPad and the iPod touch. Each of those products have been brought to market within the past five years. 

The Apple iPhone alone will deliver over $85 billion in revenue in FY 2012 or an amount equal to at least 130% of the company's FY 2010 recognized revenue total.

Understanding Apple's Rates Of Growth

Apple's 21st Century Renaissance
Since the start of the new millennium, Apple has become among the nation's most highly valued enterprises measured by market cap, the world's largest distributor of music, a major global retailer and the biggest mobile device maker when ranked by revenue. Apple's rates of growth over the past six years have been so strong, in FY 2011 revenue surpassed $100 billion. By the end of the company's FY 2013 in September of that year, revenue will surpass $200 billion. This article is intended to assist readers in understanding Apple's recent and near-term rates of revenue and earnings growth.

Apple's Frenetic Rates of Growth

In the six fiscal years since FY 2005, Apple's annual revenue rose 677% to FY 2011's $108.249 billion. During this six-year period earnings per share rose an astonishing 1,686% to FY 2011's $27.68. 

To put the current rates of growth in perspective, in each quarter of FY 2011, revenue exceeded the company's total revenue of $24.578 billion FY 2007.  Earnings per share in FY 2011 reached the combined eps totals for fiscal years 2006 through 2009 with over $5 per share to spare.

Beyond doubt, Apple is an extraordinary success story of the early 21st Century. It was only ten years ago the first iPods came to market and it's been less than five years since the iPhone was initially announced. While understanding Apple's success seems simple when viewing six-year growth charts, over the past few years Apple's success story has become more complex.

Apple's Recent Quarterly Rates of Growth

Apple's frenetic rates of growth have become as challenging to understand as they are to accurately forecast. Graphs of the company's quarterly revenue and eps performance over the most recent eight fiscal quarters are posted below to illustrate the changes in Apple's quarterly revenue and earnings growth cycle:

Apple's 25% Solution

Make no mistake: Apple is primarily a hardware device maker. From beginning to end and at every spot in between, the company is focused on the sales of hardware devices and the development of high margins on products sold. The nearly 25% of recognized revenue that flowed to the net income line in FY 2011 is what I call "Apple's 25% solution." It's Apple's formula  for consistent earnings growth and management's solution to the complex questions that surround strategic product decisions. 

iTunes, The Apple Retail Stores and Other Services

Although Apple is the world's largest distributor of recorded music, a major distributor of software through the app stores and a global retailer with 357 Apple store locations as of the end of the September quarter, these ventures are designed to boost device sales and provide competitive advantages in the company's device markets. 

iTunes, the Apple retail stores and other software and service ventures are constituent to device sales, they support high gross margins and efforts to differentiate the company's product in the competitive global marketplace. They have no other primary or secondary purpose. Apple has no major ventures or areas of operation that could be considered ancillary to the sales of hardware devices.

Apple's Revenue Growth is a Function of Device Sales Only

The graph below illustrates Apple's sources of revenue in the fiscal year ended September 24, 2011. Almost 90% of recognized revenue was sourced from hardware device sales. Sales of iOS-based devices (iPhone, iPad and iPod touch) represented close to two-thirds of the $108.249 billion in revenue generated during the twelve-month period. Revenue generated through iTunes and sales of software products such as Mac OS X, 10.7 represented just over 10% of revenue and this revenue is exclusively tied to the company's device sales efforts. 

Apple's Unrelenting Mac Attack On The PC Market

In Apple's most recent fiscal year ended in September, the company's Macintosh line of personal computers generated revenue of $21.783 billion, representing 20.12% of Apple's $108.249 billion in reported revenue. The Mac's $4.304 billion gain in revenue during the fiscal year represented 10% of Apple's $43 billion in revenue growth. 

Although the $21.783 billion in revenue generated from Mac sales in FY 2011 represented only 20.12% of the company's revenue total, it exceeded Apple's total reported revenue of $19.315 billion in FY 2006, just five years before. In FY 2011, revenue generated from Mac sales exceeded the revenue generated from iPad sales by $1.425 billion. 

Apple's Unrelenting Mac Attack On The PC Market

The graphs and table data in this article illustrate and delineate Apple's unrelenting Mac attack on the PC market. For over five consecutive years the rate of growth in Mac unit sales has exceeded the rate of unit sales growth for the PC industry as a whole. In only one quarter of the most recent twelve fiscal quarters has Apple experienced a year-over-year unit sales decline. In FY 2011 Macintosh unit sales rose about 22.5% to 16.735 million units following a 31% rise in unit sales in FY 2010. 

In the current quarter ending in December, Macintosh unit sales may reach 5 million units for the first time in the company's history, breaking the unit sales record of 4.894 million units sold in the recent September quarter. 

Apple Price Target: $640 Per Share

Today I am posting my 12-month price target for Apple of $640 per share. This target price forecasts a 63% advance in the share price within twelve months and tracks slightly below my anticipated 66% growth in earnings per share in Apple's current fiscal year. 

Apple's Share Price Today

Apple closed trading on Friday, October 21st, at $392.87. At that price the shares traded at 14.19 times trailing 12-month earnings of $27.68 per share. The lowly price-earnings multiple stands in stark contrast to the company's 66% revenue growth in the fiscal year ended last month and the corresponding 82.7% growth in earnings per share. At the end of the fiscal year, Apple had cash and marketable securities of $81.57 billion or almost $87 in cash standing behind each outstanding share. The company's cash per share provides a strong foundation for share price appreciation at a rate in tandem with the anticipated rate of growth in earnings per share.

Apple's languid September quarter revenue growth of 39% and eps growth of 52% reversed the recent upward momentum in the share price.  While the quarter's outcome was indicative of Apple's revenue growth challenges in fiscal quarters immediately preceding the annual iPhone product refresh, it was not indicative of anticipated average rates of revenue and earnings growth in the four fiscal quarters immediately ahead.

The Cyclical Nature of Apple's Revenue and Earnings Growth

Each of Apple's four fiscal quarters have strong seasonal or product cycle influences on their respective revenue and earnings growth outcomes. For example, the current fiscal quarter (FQ1 2012) includes a fourteenth shipping week that occurs once every six years and encompasses the immediate post-Christmas shopping week. The quarter will also realize above average rates of revenue and earnings growth due to the release of the iPhone 4S early in the quarter. While FQ4 2011 was negatively impacted by the pending iPhone model refresh, the current quarter will benefit from the release of the new iPhone handset. 

Apple 12-Month Price Target

There were a number of challenges revealed in Apple's September quarter results I will address later in this column. Those challenges are amplified by a slow-growth global economy and increasing competition in the smartphone device market. Based on Apple's FY 2011 performance, anticipated global growth in iPad sales and the successful launch of the iPhone 4S, I've established a 12-month price target of $640 per share. 

This 12-month price target of $640 anticipates FY 2012 revenue growth of 55% and eps growth of 66%. It also anticipates a price-earnings multiple of no more than 14 times forecast FY 2012 earnings of $46 per share. 

Apple's Share Price Performance

The chart and table data below illustrate and detail Apple's share price performance over the most recent twenty months. It includes the share price as of Friday, October 21, 2011 and the closing share price on the first trading day of the month following the release of earnings dating back to February 1, 2010.

Spaceship Apple Comes Down To Earth

Apple's September results were below most expectations. The $28.27 billion in revenue represented a $300 million sequential decline and a comparatively languid 39% year-over-year gain. On earnings per share, the 52% year-over-year rise to $7.05 was far below the 96.2% rate of eps growth realized over the first nine months of the fiscal year.

The Good News In The September Quarter

Mac Unit Sales: If there's good news to be found in the September quarter results it's the 26% growth in Mac unit sales against a global PC market with diminished prospects for continuing growth. In addition to strong unit sales growth, revenue from Mac sales rose 29%. 

Asia-Pacific: The Asia-Pacific region (exclusive of Japan) turned in a 139% increase in revenue. Although the September quarter's pace of revenue growth was below the rates of growth in the region realized in the previous two fiscal quarters (down from 247% growth in the June quarter), China is Apple's most important growth market at this point in time. Asia-Pacific's $6.53 billion revenue contribution represented 23.1% of Apple's total revenue in the period.

Apple's December Quarter Guidance: Management has guided to revenue of $37 billion or 38.4% revenue growth and eps of $9.30 or growth of 44.6% over the December quarter one year before. But keep in mind December quarter 2011 (FQ1 2012) includes an additional shipping week that occurs once ever six years to better align fiscal quarters with calendar quarters. The unusual 14th week is the week immediately after Christmas. Absent the additional shipping week, guidance would have been more conservative and it moves a high revenue week away from the following quarter. 

The Not-So-Good News In The September Quarter

Retail Stores: Despite a 25% increase in Mac unit sales at the stores in the September quarter and the first fiscal quarter in which the retail stores sold over 1 million Macs, overall store revenue rose only 1%. Apple ended the quarter with 357 stores open for business and new stores were opened in the fiscal period. This 1% revenue rise includes the revenue activity of new stores opened within the past year. Retail store traffic and revenue growth remain heavily influenced by seasonal factors and Apple product refresh cycles. 

iPhone Sales: Management stated during the conference call with analysts that September unit sales were materially impacted by a drop-off in demand ahead of the release of  the new iPhone 4S handset. iPhone unit sales growth remains heavily dependent on the company's product refresh cycle. The 16% sequential drop in unit sales is in light of surging global smartphone demand and the meager 21% year-over-year gain in unit sales is against a prior-year period in which Apple ended the quarter with constrained supplies of the then latest handset. Although Apple reported outsized unit sales growth for the iPhone of 142% in the June quarter, both Asia-Pacific and the Verizon agreement were big factors in that gain. 

The Apple Analyst Sandbag Factor

Each fiscal quarter Apple 2.0's Philip Elmer-DeWitt provides an index of quarterly estimates that include numbers from a select group of bloggers and numbers from Wall Street pros. For the September quarter, the differences in the estimates from the bloggers and the pros have the widest divergence since the quarterly indexes began. This quarter the gap is so pronounced it might best be described as a chasm. Revenue estimates range from a high of $37.19 billion from Mark Beauch of the AAPL Independent Analysts group to a low of $26.36 billion from Morgan Stanley's Kathryn Hubert. On earnings per share, the estimates range from a high of $10.01 put forward by this author to a low of $6.30 also from Kathryn Huberty. 

The table below lists the average revenue and eps estimates from the 16 bloggers and the 28 pros who submitted revenue and eps numbers. 

The Apple Analyst Sandbag Factor

There's more to the difference in the average eps estimates from the two groups than the difference in revenue estimates. This difference is what I call "The Apple Analyst Sandbag Factor."

The purpose of this exercise is to remove differences in the revenue estimates from the numbers submitted by the individual analysts and compare each analyst's eps outcome to their respective revenue estimate, using Apple's June quarter results as a constant in the review. The outcome of the analysis indicates the Wall Street analysts are forecasting a significant deterioration in Apple's net income and eps performance per revenue dollar based on their own revenue and eps numbers. This anticipated deterioration in net income and eps performance represents the "Sandbag Factor."

The chart below lists the September quarter estimates from the analysts. The content is courtesy of Apple 2.0 and is from the article titled, Wall Street Still Doesn't Understand Apple published on October 11, 2011. The analysts are ranked by revenue estimate. The bloggers are highlighted in green and the Wall Street pros are highlighted in blue.

Why Apple's FQ4 Earnings Will Approach $10 Per Share

There's no other company on the planet that excites the imagination of its product users as much as Apple. In developing revenue and earnings estimates for the company, I am guided by one overarching principle:

Apple doesn't sell products. Apple crafts customer relationships and those relationships sell Apple products. 

Understanding Apple's Pathways To Success
Understanding Apple's pathways to success requires more than an effort at counting the number of individual products that might be sold. It necessitates understanding the company's eco-systems and what motivates enterprises and consumers to invest in the purchase of Apple-branded products. 

My analysis relies heavily on the company's historical growth trends and an evaluation of the phenomena that occur when appealing and abundant content is made readily available for smartly designed devices. These products are offered to customers who have established a relationship with Apple through iTunes, through visits to the company's retail stores or have a long-standing relationship with the company through the use of Apple's popular Macintosh line of personal computers. 

Below are my estimates for the company's September quarter and an overview of the elements that underly the assumption Apple's FQ4 earnings will approach $10 per share:

	Revenue Segment		Units FQ4 ’11	Units FQ4 ’10	Unit Growth	FQ4 Revenue
	Macintosh		4,500,000	3,885,000	15.83%	5,737,500,000
	iPhone		26,500,000	14,102,000	87.92%	17,225,000,000
	iPod		7,250,000	9,051,000	-19.90%	1,268,750,000
	iPad		14,500,000	4,188,000	246.23%	9,425,000,000
	Peripherals					620,000,000
	Software, Services					800,000,000
	Other Music					1,625,000,000
	Revenue Total					36,701,250,000
	Cost of Sales		58.20%			-21,360,127,500
	Gross Margin		41.80%			15,341,122,500
	Operating Expenses		8.79%			-3,225,000,000
	Operating Income					12,116,122,500
	Other Income					200,000,000
	Income Before Taxes					12,316,122,500
	Provision For Taxes		23.50%			-2,894,000,000
	Net Income					9,422,122,500
	Earnings Per Share		(Based on 940.825 million shares)			10.01

The AAPL Independent Analysts FQ4 Estimate Index

On October 18th Apple will announce results for the company's 4th fiscal quarter ended September 24th. To gauge expectations for the quarter, we asked members of the AAPL Independent Analysts group on Linkedin and members of the Apple Finance Board who have participated in prior quarterly indexes to submit estimates of the company's 4th fiscal quarter performance. 

Among the fourteen individuals who submitted estimates for this September quarter index are well known independent analysts Horace Dediu and Daniel Tello, returning analysts Navin Nagrani and Patrick Smellie and newcomers Michael Cranston and Martin Epstein. Collectively these individuals represent a cross section of the AAPL independent analyst community and come from various professional backgrounds and career interests. 

On average index participants anticipate the following September quarter unit sales results:

	Macs	4,677,500			20.40% YOY Rise
	iPhones	23,765,071			68.52% YOY Rise
	iPods	7,158,857			20.91% YOY Decline
	iPads	13,624,214			225.32% YOY Rise

Notes on the Unit Sales Numbers:

Mac sales: Over the first nine months of FY 2011, Macintosh unit sales rose 21.1%. The index average is inline with the recent unit sales trend and reflects confidence in Mac sales during the recent back-to-school season.

iPhone sales: The index average reflects expectations of a slower rate of growth in iPhone unit sales in the 4th quarter due to the release of the iPhone 5 in the holiday quarter. During the first nine months of the fiscal year iPhone unit sales rose 113%. 

iPod sales: The Apple iPod remains in a state of steady unit sales decline. The iOS-based Apple iPod touch remains the biggest revenue generator among the available iPod models. Apple's decision this year to offer $100 in iTunes content to students purchasing a new Mac versus a free iPod touch will influence iPod unit sales results in the quarter. 

iPad sales: The index average suggests anticipation of strong iPad unit sales in the September quarter as Apple strived to resolve the challenge of constrained product supplies. Index participants expect a rise in unit sales of 225% over the prior-year period.