The Ever-Changing World Of Apple

On Saturday, December 27th, Apple’s first quarter of FY2015 drew to a close. While management has guided to revenue of between $63.5 billion and $66.5 billion in the period, the current Wall Street revenue consensus estimate of $66.46 billion is already pushing against the upper threshold of management’s revenue guidance range. 

Apple’s Global Expansion

Apple manages its business on a geographic basis. The graph below illustrates the regional revenue mix for the fiscal year ended in late September. 

Although in aggregate revenue rose a fairly modest 6.95% in the fiscal year, revenue growth by region varied widely with Greater China and Japan again delivering the fastest rates of growth. The graph below illustrates Apple’s revenue growth rates by region for the fiscal year.

Both Greater China and Japan delivered double-digit revenue growth rates in the period while Europe delivered revenue growth at a rate greater than the aggregate rate of growth for the company as a whole. The Americas region, Apple's largest revenue region, realized revenue growth of 3.95% in the fiscal year with negative growth in the Rest of Asia Pacific region.

Changes In Regional Revenue Reporting

Concurrent with the start of the December quarter (FQ1 2015), Apple is eliminating Retail as an independent revenue region. Results for the retail stores will be incorporated in the revenue totals for the geographic region in which the stores are located. For the year, Apple reported 437 retail stores of which 40% were located outside the United States. On a national basis with retail store revenue geographically assigned, the United States represented 37.7% of revenue and China represented 16.8% of revenue in FY2014. Japan may become a third national region to contribute 10% or more of Apple’s reported revenue. 

FY2015: Apple's Big Adventure

On Friday, November 28th, Apple’s share price closed the month’s trading at $118.93, up 9.9% from the opening price on November 3rd and up nearly 10.5% from the opening price on September 29th, the first trading day of the fiscal year. 

Recent analyst revenue upgrades and price target revisions have provided support for the share price. The current Wall Street consensus revenue estimate for the December quarter is $66.23 billion compared to management’s revenue guidance for the quarter of between $63.5 billion and $66.5 billion. However, the current revenue consensus estimate for FY2015 remains a decidedly conservative $210.68 billion and for FY2016 the revenue consensus estimate is a surprisingly low $223.02 billion.

In contrast, my revenue models suggest Apple may reach one-quarter trillion dollars in revenue in FY2016 following a revenue performance this fiscal year of $225 billion.

On November 19th Morgan Stanley’s Katy Huberty raised her firm’s price target from $115 to $126. She stated investors underestimate demand for the Apple Watch and is forecasting 30 million Apple Watches will be sold in CY2015. She also believes institutions remain underweighted in Apple shares. In my view, increasing institutional demand for shares will buoy the share price during the first six months of the current fiscal year.

On November 25th Aaron Rakers at Stifel Nicolaus raised his Apple price target to $130 from $115. On the same day Brian Blair reiterated his firm’s view iPhone unit sales will range between 72 million and 75 million in the December quarter. Although the share price may not go higher in a straight line, I expect a continuing series of analyst estimate revisions over the next several weeks to support the share price into Apple’s December quarter earnings release in late January. 

Looking Back

Although unit sales expectations for Apple’s iPhone 6 handsets are moving higher with strong evidence of a big market share shift in the high-end smartphone market from competitors to Apple, most analysts remain cautious on their FY2015 revenue and earnings per share estimates. 

The graph below illustrates Apple’s revenue mix for the fiscal year ended in September. In the 12-month period, the iPhone represented just over 55% of reported revenue. Combined, the iPhone and iPad lines represented over 72% of revenue in the period.

Apple’s Magical Mystery Year

On October 20, 2014, Apple announced results for the fiscal quarter ended September 27, 2014 and for the fiscal year that ended the same day. For the fiscal year, Apple’s revenue rose about 7% to $182.795 billion while earnings per share rose about 13.6% to $6.45 due to year-over-year growth in net income and the ongoing $90 billion share repurchase program.

For the fiscal year, Apple set records for revenue and earnings per share. Although net income rose about 6.7% year-over-year to $39.51 billion, the current high water mark for net income was set in FY2012 at $41.733 billion on outsized gross margin. However, Apple may come within striking distance of a new net income record in FY2015 as we watch the fiscal year unfold.

The Trend Is Again Apple’s Friend

The graph below illustrates Apple’s net income on a quarterly basis and the corresponding percentage of revenue that flowed to the net income over the most recent twenty fiscal quarters. 

After a peak of 29.66% of revenue flowing to the net income line in FQ2 2012, Apple’s net income as a percentage of revenue has begun to gradually recover from the nadir of 19.53% set in FQ3 2013.

Since returning to net income growth in the March quarter, Apple’s share price has risen from a split-adjusted price of $74.96 on April 23rd immediately prior to the release of March quarter results to $105.22 on Friday, October 24th. This 40% rise in the share price in six months correlates to the market’s anticipation of rising net income and rising earnings per share amplified by the ongoing share repurchase program.

The graphs below depict Apple’s revenue and earnings per share performances over the most recent twenty fiscal quarters. 

Apple’s Revenue Growth

Apple’s revenue growth rates have moderated since the torrid rates of growth experienced in fiscal years 2010 through 2012. From a high of 66% revenue growth in FY2011, which included the first full fiscal year of iPad unit sales, to about 7% revenue growth in the fiscal year ended in late September, Apple’s revenue growth rates sharply declined over the two most recent fiscal years. FY2014’s revenue growth rate performance represents Apple’s slowest rate of revenue growth in over a decade. However, the revenue growth rate in the recent September quarter of 12.4% to $42.123 billion represents a reversal of that recent revenue growth rate trend.

For the December quarter (FQ1 2015) Apple is guiding to revenue of between $63.5 billion to $66.5 billion. This represents an expected revenue growth rate of between 10.25% and 15.5% in the period. To put Apple’s revenue guidance for the December quarter in perspective, Apple’s revenue total for all of FY2010 was $65.225 billion. 

Apple Looks East, Looks West For Growth

Over the past few years much of Apple’s revenue growth has been fueled by the expansion of the number of iPhone carriers outside the Untied States. In the first nine months of the current fiscal year, Apple’s revenue moved higher by 5.42% to $140.672 billion. During this time, revenue in Apple’s Americas region rose by only 0.38% to $48.985 billion while revenue rose in the Greater China region by 22.27% to $24.068 billion and in Japan by 13.38% to $11.475 billion. 

The chart below details Apple’s regional revenue mix for the first nine months of the fiscal year that ends on Saturday, September 27th.

During this nine-month period, Greater China and Japan combined to deliver just over 25% of reported revenue while the Americas region represented just over one-third of Apple’s revenue total. 

The graph below illustrates Apple’s revenue growth rates by region over this nine-month period. While Europe’s 5.07% revenue growth was close to the aggregate revenue growth rate of 5.42%, the Rest of Asia Pacific region had a negative revenue growth in the period. Apple’s Retail revenue segment, separate from the revenue activity in the regions in which the stores are located, delivered a 3.64% rate of growth. 

No matter the four-quarter slide in net income that ended in the December quarter (FQ1 2014), Apple has continued to deliver year-over-year revenue growth. The chart below illustrates Apple’s revenue on a quarterly basis, segmented by region, since FQ1 2011.

Apple’s Success Is In The Sensational And The Subtle

On Friday, August 29th, Apple’s share price ended the month’s trading at an all-time closing high of $102.50 after setting an all-time trading high of $102.90 earlier in the day’s session. For the month of August, the share price rose about 8% from the opening price of $94.90 on August 1, 2014. Since Apple announced the return to profit growth following the close of trading on April 23, 2014, the share price has risen about 37%. 

At Friday’s closing price, the company’s market capitalization stands at about $614 billion dollars. Because of the ongoing $90 billion share repurchase program and despite the recent all-time highs, the company’s market cap remains below the record levels set in late September 2012 and institutional ownership remains at a curiously low 62% of outstanding shares. 

No matter the dramatic rise in the share price over the past four months, opportunities remain for long-term shareholders to be richly rewarded over the next several quarters. 

Apple’s September 9th Event

There’s no shortage of rumors and speculation concerning what products and services Apple will choose to announce at the upcoming September 9th event. There’s very little doubt Apple will announce the next iteration of the company’s popular line of smartphones and expectations are high Apple will also announce its foray into mobile payments as well as new services to complement the much-anticipated iWatch line of accessories. 

Various reports from component suppliers suggest Apple will produce record numbers of iPhones, with larger screen sizes, to accommodate what is predicted to be unprecedented demand for the new handsets and demand on a scale that may prove to be high even by lofty iPhone standards. But the fact of the matter is it would actually be worrisome if demand for the new iPhone handsets didn’t break all previous records by a proverbial country mile. 

Apple’s Dependence On iOS Devices

The graph below illustrates Apple’s reliance on the iPhone and iPad product lines for revenue and revenue growth. Since the June quarter (FQ3) of FY2011, the iPhone and iPad lines have contributed at least 60% of Apple’s reported revenue. In seven of the most recent fifteen quarters, the iPhone and iPad lines have contributed at least 70% of Apple’s reported revenue total.

The graph below delineates the revenue performance of the iPhone and iPad lines over the most recent fifteen quarters. Against a backdrop of 5.42% aggregate revenue growth in the first three quarters of the current fiscal year, iPhone revenue rose 9.12% to $78.313 billion while iPad revenue fell 3.21% to $24.967 billion. Combined, the two product lines delivered $103.280 billion or 73.42% of the $140.672 billion in reported revenue in the nine-month period. As Apple determines the best path forward for growth in iPad unit sales, the iPhone line is and will remain Apple’s primary revenue growth driver.

Apple's Game Of Inches

On Friday, July 25, 2014, Apple’s share price reached a 52-week closing high of $97.67. This was also the highest split-adjusted closing price since September 24, 2012 and within range of the all-time high closing price of $100.30 set on September 19, 2012.

From the closing high of 100.30 on September 19, 2012 to the closing share price nadir of $55.79 on April 19, 2013 to Friday’s closing price of $97.67, it’s been a startling roller coaster ride for Apple’s long-term shareholders. It’s simply a matter of time before Apple’s share price vaults above its previous all-time closing high and begins an ongoing series of new records.

Despite the share price volatility of the past two years, Apple’s growth moving forward will be best seen in sublime advances of technologies and less in sharp spikes and slides in revenue and earnings growth rates that have characterized the past four years of the company’s financial performance.

Apple is engaged in a game of inches and has entered an era that will again reward long-term shareholders for their conviction, patience and grit. 

Apple’s Return To Glory

While much attention has been placed on Apple’s recent 7-for-1 stock split, the share price rise from the closing price on the first day of post-split trading on June 9, 2014 of $93.70 to Friday's closing price represents a share price gain of 4.24%.

However, the share price rise from the closing price immediately prior to the release of March quarter results on April 23, 2014 has been 30.29%. Apple’s return to organic net growth income growth has delivered extraordinary share price gains in just over three months. Apple has now concluded two consecutive quarters of net income growth following a four-quarter slide in underlying profitability. 

The graph below illustrates the company’s net income performance over the most recent nineteen fiscal quarters. Rising net income is and will remain the primary catalyst for Apple’s share price appreciation.

Apple's Latent Rates Of Revenue Growth

For the fiscal year ending in late September, Apple is on track to deliver reported revenue of over $182 billion versus reported revenue in the prior fiscal year of $170.91 billion. In dollar terms, revenue growth in the range of $12 billion appears more impressive than the underlying revenue growth rate of between 6% and 7%. However, there are factors at work which will lead to faster rates of revenue growth in the new fiscal year beginning this fall. I will delve into a few of these factors in this article. 

Apple’s Revenue Mix

The graph below illustrates Apple’s revenue mix for the first half of the fiscal year ending in September.

For the six-month period ended in June, the iPhone and iPad lines represented 75.20% of Apple’s reported revenue total of $103.24 billion. While Apple’s aggregate revenue rose 5.22%, the combined iPhone and iPad lines delivered revenue growth of 6.31%, the Mac line realized 8.64% revenue growth year-over-year and the combined iTunes/Software/Services & Accessories segments achieved revenue growth of 11.29%. The iPod line, in contrast, experienced a 53.82% decline in revenue. The iPod line’s revenue decline in the six-month period was $1.671 billion. iPod line revenue fell from $3.105 billion in the first six months of FY2013 to $1.434 billion in the first half of FY2014. 

Apple’s Unit Sales Growth Rates By Product Line

The graph below illustrates the unit sales growth of Apple’s major product lines from FQ1 2011 through FQ2 2014. While there has been obvious moderation in the unit sales growth rates of the iPhone and iPad lines over this time, iPod unit sales have been in decline throughout the fourteen-quarter period.

Product Line ASPs

The graph below illustrates the average selling prices for each of Apple’s major product lines over the same fourteen-quarter period. Although the introduction of the iPad mini in late 2012 (FQ1 2013) reduced the average selling price of iPads, Apple has been able to keep the ASPs on iPhones and Macintosh PCs consistently high even as unit sales growth rates have moderated over the past several quarters.

It was recently announced iPads and iPhones will again be sold through Costco. Walmart, in a high-profile move, has reduced the prices on iPhone 5 series handsets sold through the bricks and mortar stores when accompanied by a two-year contract. Apple is expanding the domestic sales reach of its current iPhone and iPad models ahead of the expected fall product refresh cycle. 

Apple's Global Picture In 1,500 Words

In the first half of Apple’s current fiscal year, revenue rose 5.22% to $103.24 billion dollars. This is the first time Apple’s revenue surpassed $100 billion in a six-month period and is emblematic of the fact the company’s operations are truly global in scope.

According to the company’s SEC filings, Apple manages its business on a geographic basis. The chart below illustrates the company’s regional revenue mix in the first six months of the fiscal year. 

For the six-month period ended March 29, 2014, nearly 56% of reported revenue was sourced from the company’s traditional strongholds in North America and Europe. Combined, Greater China and Japan delivered 26.19% of reported revenue versus 22.57% of revenue sourced from Europe alone. Currently, the United States and China are the only two countries that deliver 10% or more of Apple’s revenue. Japan is quickly closing the gap and may soon gain entry to this exclusive group of nations.

Apple’s Revenue Growth Rates By Region

The graph below illustrates the rates of growth in each of the company’s regional segments in the first half of the current fiscal year. 

In the six-month period, Greater China delivered revenue growth at a 20.54% rate followed by Japan with a 17.59% growth rate. Europe lagged the aggregate growth rate of 5.22% with a 4.57% revenue growth performance and revenue in the Americas region was virtually static with a 0.04% revenue growth rate. In fact, year-over-year in the Americas region, revenue rose by only $15 million. 

Apple’s Newfound Glory

On Wednesday, April 23rd, Apple triumphantly surprised the market with a return to net income growth in the March quarter following a four-quarter cycle of declining profitability. Although Apple did not set a record for March quarter net income, the company delivered record March quarter revenue and an impressive 22.40% of revenue to the net income line.

The graph below illustrates Apple’s net income performance and the percentage of revenue that has flowed to the net income line over the most recent eighteen quarters. 

On revenue of $45.646 billion, $10.223 billion flowed to the net income line. This was the fifth-highest net income performance in the company’s history and second-highest March quarter net income performance, eclipsed only by the results in the March quarter of FY2012. 

Stock Split and Expanded Share repurchase Program

With the release of March quarter results Apple also announced a 7-for-1 stock split. The likelihood Apple will be added to the Dow Jones Industrial Average (DJIA) after the completion of the stock split in early June added fuel to the immediate post-earnings share price rally. Following the release of the company’s March quarter numbers and accompanying announcements, the share price jumped from a closing price on Wednesday of $524.75 to end the trading week at $571.94. With a current market cap of over one-half trillion dollars, rising revenue, rising quarterly dividends and anticipated fiscal year revenue of over $180 billion, the addition of Apple to the well-known index is viewed as a near certainty after completion of the 7-for-1 stock split.

Apple is increasing its share repurchase program from $60 billion to $90 billion with all purchases to be completed by the end of calendar year 2015. As of the close of the March quarter, Apple had utilized $45.9 billion of the previously authorized $60 billion for repurchases.

The graph below illustrates the dramatic drop in the company’s reported fully diluted share count over the past several quarters.

Management also announced with the March quarter results the company would be returning to the debt table to borrow against the company’s massive overseas holdings of cash and marketable securities. Although Apple reports a US tax expense on all foreign-sourced earnings not permanently dedicated for use outside the US, the payments are not due until the funds are repatriated. As of March 29, 2014, Apple has $19.471 billion in deferred tax liabilities on the balance sheet and $17.0 billion in previously acquired debt for share repurchases.

Apple Is Walking Up The Down Staircase

Over the past eight fiscal years Apple’s revenue has risen 1,127% from $13.931 billion in FY2005 to $170.910 billion in FY2013. Over this same eight-year period, Apple’s earnings per share has risen 2,457% from $1.55 to $39.63. The graphs below illustrate the story.

Since the migration of Apple’s Macintosh line of personal computers to Intel microprocessors in 2005 through the release of the iPhone and iPad product lines, Apple’s revenue growth performance has been phenomenal. From a peak revenue growth rate of 66% in FY2011 to a low of 9.2% revenue growth in the fiscal year ended in September, the company’s revenue growth performance over the past eight years places Apple among the highest revenue generating enterprises on the planet. Apple has become a global economic empire with roughly two-thirds of annual revenue generated outside the United States.

Despite a 10.3% drop in earnings per share in Apple’s most recent fiscal year, the company’s fast rate of revenue growth over the past eight years combined with high gross margin have propelled earnings per share on an annual basis to greater than 25 times the company’s FY2005 results.

Apple’s Revenue and Earnings Growth Performances Today

Following 66% revenue growth in FY2011 and 45% revenue growth in FY2012, Apple’s rate of revenue growth decelerated dramatically to just over a 9% rate last fiscal year. In the first quarter of FY2014 ended in December, Apple’s revenue growth rate continued to decelerate to a 5.7% pace. Management’s March quarter guidance suggests slow to no revenue growth in the quarter ended March 29, 2014. 

The graph above illustrates Apple’s decelerating revenue growth rates on a quarterly basis since the second quarter of FY2012. 

In all four quarters of FY2013, Apple realized negative earnings per share growth. However, the ongoing $60 billion share repurchase program pushed the earnings per share growth rate in the recent December quarter (FQ1 2014) to a positive 5% growth rate despite a slight decline in net income year-over-year. Based on management’s March quarter revenue guidance, earnings per share in the quarter may again turn negative despite the unprecedented share repurchase plan now in place. 

Apple: Net Income Growth Is The Name Of The Game

Apple is a global empire with revenue results that place it among the top publicly-traded enterprises on the planet. Apple is also among the largest dividend payers in the world and management is dedicated to returning more than $100 billion in capital to shareholders over a four-year period through a combination of dividend payments and share repurchases. Apple’s brand value is arguably the highest in the world and the company’s balance sheet reflects over $140 billion in cash and equivalents net of debt despite the ongoing capital return program. 

No matter these superlatives, Apple is challenged to reverse a decline in profitability. The company is in the midst of a multi-quarter decline in net income and a cycle of lower net income per revenue dollar even as revenue rises modestly year-over-year.

Apple: Net Income Growth Is The Name Of The Game

For Apple’s first quarter of FY2014 ended December 28, 2013, management reported revenue growth of 5.7% to $57.594 billion. In the same 91-day period net income fell year-over-year by $6 million to $13.072 billion and represented 22.70% of reported revenue, below the 23.99% of net income per revenue dollar earned the year before.

This FQ1 2014 performance came on the heels of the company’s FY2013 results in which Apple’s reported revenue rose 9.2% to $170.91 billion and net income fell 11.25% to $37.037 billion. Based on Apple’s March quarter revenue guidance, which suggests the possibility of a decline in revenue year-over-year, net income in the current quarter may fall below not only last year’s results, net income is likely to come in well below the results of two years ago. 

Apple’s Net Income By Quarter

The graph below illustrates Apple’s net income has been in decline on a year-over-year basis since the March quarter (FQ2) of FY2013. Although in FQ1 2013 the company managed a meager rise in net income of $14 million, in the recent December quarter (FQ1 2014), Apple’s net income was $6 million below the results in the prior-year period and only $8 million above the results of two years ago. 

While Apple’s reported revenue has continued to rise, the company’s net income per revenue dollar has continued to fall. In the December quarter, net income represented 22.70% of revenue versus 23.99% in the prior-year quarter and 28.20% of revenue in the December quarter two years ago.

Apple: Management Needs To Vision Tomorrow More Than Explain Today

On Monday, January 27th, Apple announced results for the company’s December quarter (FQ1 2014). The company reported year-over-year revenue growth of $5.65% to $57.594 billion and earnings per share of $14.50 versus $13.81 in the prior-year quarter. Net income at $13.072 billion was lower than the results in FQ1 2013 by $6 million. Earnings per share rose 5.0% due to 45.765 million fewer shares in the fully diluted share count. 

The Demise of the iPod Line

Contributing to Apple’s unimpressive revenue growth rate in the December quarter was a 54.60% year-over-year decline in iPod revenue on a 52.29% decline in unit sales. The iPod touch, which represents greater than 50% of the product line’s revenue, was last updated in September 2012. iPod sales have been subsumed by the popular iPhone line with iPod capabilities and there is declining consumer demand for specific-use digital music players. Year-over-year, iPod revenue fell by $1.17 billion dollars.

The Resurgent Macintosh

In the midst of Apple’s 30th anniversary Macintosh celebration, the product line turned in a strong 19.11% unit growth rate against a soft prior-year comparison. The 4.837 million units sold was the fourth highest quarterly unit sales total in the product line’s history and the highest unit sales performance in two years. For the quarter, the Macintosh delivered 11.10% of Apple’s reported revenue. 

Apple’s Reliance on the iPhone and iPad

No matter the strong Macintosh unit sales numbers for the quarter, Apple’s reliance on the iPhone and iPad lines for growth continued to rise in the December quarter. The graph below illustrates the fact that 76.34% of reported revenue in the quarter was sourced from iPhone and iPad sales.

iPhone and iPad Unit Sales Growth

On a combined basis, iPhone and iPad unit sales rose 9.07% in the December quarter and combined revenue rose 6.37% net of the impact of the increase in deferred revenue per unit sold.The graph below illustrates the combined unit sales for the iPhone and iPad lines over the most recent seventeen fiscal quarters. Among the challenges for Apple is the fact iPhone and iPad unit sales growth rates have begun to slow dramatically.