Believe it or not, we are almost two-thirds through the third quarter of 2012. For Apple (AAPL), that means the fiscal fourth quarter is about 65% complete. As Apple's stock continues to all-time highs, investor expectations for this company get higher and higher. Twice in the past four quarters, Apple has produced quarterly results below analyst expectations as consumers have held back on iPhone purchases while waiting for a new version to come out. The current expectation is for the new version of the iPhone to be released in mid to late September, and that will have a huge impact on how fiscal Q4 will turn out. Will Apple miss earnings estimates again? Here's a mini-preview of what to look for as Apple's fiscal year ends.
Past Results / Current Expectations:
In the following table, I will provide the key headline numbers for the past two fiscal fourth quarters. I'll go into a more in depth discussion of the individual products later on.
Obviously, 2011's fiscal fourth quarter, despite missing analyst expectations, saw a fair amount of growth. To be fair, Apple beat its own expectations for the quarter.
Current analyst expectations call for Apple to report $34.84 billion in revenues, which would represent 23.2% growth from the prior year period. Apple guided to $34 billion in revenues for the quarter. On an earnings per share front, analysts are expecting $8.40, which would represent 19% growth. Apple guided to earnings per share of $7.65.
In the next few sections, I'll discuss the themes regarding each individual product category.
iPod:
We all know that iPod sales are declining. The first three fiscal quarters of this year have seen unit sales down between 10 and 21 percent. If you estimate that sales will decline 15 percent this quarter, you're looking at unit sales of about 5.6 million, down about a million. Fortunately, the revenue hit on that should only be about $150 to $175 million. Also, iPod sales will only account for roughly 3% of the total, so the decline won't have a major impact on the results.
Macs:
This quarter is expected to be a strong quarter for Mac sales, off of the mid to late June Mac refresh. Because the refresh occurred so late in the quarter, Mac sales in the fiscal third quarter were just 4.0 million, an increase of just two percent over the prior year period. We've also seen Dell (DELL) and Hewlett Packard (HPQ) report very weak quarters. Is this a sign of the entire computer industry, or is Apple taking away market share? I'd tend to side with the latter.
Now that the new units, including the MacBook Pro with Retina Display have had a full selling quarter, we should see a strong sales number. Last year's period saw nearly 4.9 million units sold, so that will be a tough number to blow out. While I could see Mac sales breaking 5 million units in the quarter, I don't see a huge increase towards the 5.5 million or 6.0 million unit level. If Mac sales can break the 5 million unit level, they should be able to offset the revenue loss from the decrease in iPod sales.
iPad:
Apple launched the new iPad in March, late in the second fiscal quarter. The fiscal third quarter was a very strong selling quarter, and Apple sold 17 million iPads.
Now, we know that sales in the United States and other countries that have had the product available for several months now will see a decrease in sales. But there is an offset. Apple was not able to sell the iPad in China until early to mid July, so those sales should be fairly strong this quarter.
In last year's period, Apple sold over 11.1 million iPads, so we will see an increase in the year over year sales. The question is, to what extent. If sales in China can offset lost sales in other countries, we could see another quarter of 17 million iPad sales. However, it probably would be a bit more realistic to expect 15-16 million at this point.
iPhone:
You can make the case that every Apple quarter is dependent on the iPhone, but this one is slightly different. This quarter is dependent on whether or not Apple releases the new version of the phone during the quarter. Current estimates say a release on or about September 20th is likely, but we'll find out at Apple's media event coming up in the next few weeks. But since the iPhone also is a very high margin product for Apple, it is a very important factor in this quarter's results.
Current estimates are for about 23 million iPhones to be sold in the quarter, but most of those estimates do not have the new phone being released until October. If Apple were to release the new phone during the quarter, the consensus among analysts will probably rise by about 5 million. So basically, you are going from the low to mid 20 million range, to mid to high 20 million range.
Yes, that is quite an important difference. 5 million iPhones account for about $3.2 billion in revenue. Plus, like I said, they are a high margin product, so 5 million iPhones could literally increase gross margins for the quarter by a full percentage point or two. That's huge.
Just to throw out some numbers, let's assume that Apple sells about what I've been discussing so far: 5.6 million iPods, 5 million Macs, and 15 million iPads. If Apple sells 21 million iPhones, you are looking at a quarter with about $32 billion in revenues (rough estimate). Now, put the iPhone number at 26 million, and you've got roughly $35.25 billion in revenues. Remember, current analyst estimates are for $34.84 billion.
If Apple does release the phone for a late September launch, it will be interesting to see how analysts change their estimates. The thought process is that Apple could sell about 8 million iPhones in the roughly 10 days the iPhone would be on sale in Q4. Right now, I'm comfortable with the current estimate, but if the revenue estimate rises to say $37 billion or $38 billion by the time Apple actually reports the quarter, I might start to worry a little. On the flip side, if Apple doesn't launch the phone during the quarter, I believe that analysts will probably take down their estimates for this quarter, which probably means they will increase their estimates for fiscal Q1.
Margin Discussion:
Now we know that Apple's results will be heavily dependent on how many iPhones the company can sell, and that also has a huge impact on margins. Since Apple's gross margins on the iPhone have ranged between 49% and 58% in the past, you would think that the more iPhones the company sells the better. That is true to a point, but there's a more important factor involved. It's the percentage of sales related to iPhone and related products as a percentage of the whole that really matters. Look at the following table, comparing the percentage of dollar sales the iPhone represented in the quarter, compared to Apple's gross margin in that quarter, over the last year.
Even though Apple sold more iPhones in fiscal Q1 (37 million) versus fiscal Q2 (35 million), fiscal Q1 was a holiday quarter, so there were a lot more sales in terms of iPads, Macs, etc. In fiscal Q2, Apple sold less units of the phone, but a higher percentage of its sales came from that device, so gross margins were extremely high. Thus, in the latest quarter, when iPhone sales were low, the gross margin dropped. Generally speaking, the same can be said for operating margins and net profit margins as well.
So what should investors take away from this? Well, if Apple tries to diversify its product lines more, meaning less sales of iPhones as a total, margins could come down. In the next section, I talk about the possibility that Apple will launch a mini iPad in fiscal Q1. Since the regular iPad had gross margins of 23% to 32%, more iPad sales as a percentage of the total could take down margins a little.
Looking forward to fiscal Q1:
It will be a very interesting holiday quarter this year. Not only have we seen new versions of Research in Motion's (RIMM) PlayBook come out, but it also appears that Amazon (AMZN) is close to launching the new Kindle Fire in September as well.
But the two main competitors I'm looking at are Google (GOOG) and Microsoft (MSFT). Microsoft is launching Windows 8 over the next couple of months. That means that Microsoft will have the new operating system out for computers, laptops, and the like, but also, its Surface tablet that it is launching. Also, new versions of Windows phones are expected in October as well. For Google, they have launched their Nexus tablet, and the hope is that a successful Nexus launch will show the greatness of the Android system, thus boosting Android phone sales as well. The debates will rage on about the true competition from Microsoft's and Google's launches, but competition is competition. If someone buys a Surface or a Nexus, they just might not buy an iPad.
So what will Apple do? Well, it appears that Apple is on its way to launching a new mini iPad, and that will provide the next leg of growth in this ever competitive space. It appears that Apple will launch the mini iPad sometime in October, as they really don't want to launch it at the same time as the iPhone, their marquee device. The mini is expected to have a display of less than eight inches, compared to the 9.7 inch display of the current model. If Apple does launch this product in October, it will have two immensely popular products out for the key holiday season. It will also keep Apple's name in the headlines, and a mini iPad could surely take the Windows 8 launch off the front pages.
Fiscal Q1 will be a monster holiday quarter for Apple, and the amount of iPhones sold will depend on the launch date. But it will be a great holiday quarter for Apple. The one caution to remember is that last year's period was 14 weeks, and this one will only be 13 I believe. That might not seem like much, but Apple averaged over $3.3 billion in revenues per week in last year's period, so remember that when truly trying to compare results for the periods.
Currently, for fiscal Q1, analysts are expecting $54.84 billion in revenues and $15.32 in earnings per share. Now, when it comes to margins, you might think that Apple might have a new high in gross (and perhaps operating and profit) margins because it is going to sell a record number of iPhones. That is very well possible. But remember, as I described above, it also has to do with the percentage of sales coming from the iPhone. If Apple does release an iPad mini, and sells a ton of Macs and iPads in the quarter, gross margins might not be as high as some think, only because the percentage of sales coming from the iPhone might not be as high, despite the number of units sold.
Potential Trade Ideas:
Yes, if you think Apple is going to do well, going long the stock is the best idea, even though we are only about $12 off the 52-week and all-time high. Now, if you believe in the theory that Apple will pull back when it launches the new iPhone, as it has done a few times in the past, you might want to wait to enter the name, or add to your current position. A drop into the $625 to $650 range could happen, and that seems like a decent opportunity to get in.
Since I always get asked for potential options trades for Apple, I'll throw one in. We don't know yet the official date for Apple's next earnings release, so I would not gamble on the October expiration options at this point. I'll go with November ones, giving you a few extra weeks. My trade recommendation would be to buy the $500 calls (currently for around $167) and to sell the $720 calls (currently around $17). This trade allows you to be effectively long 100 shares of Apple, for just $150 per call, or $15,000 total. That's a fraction of the more than $66,000 it would take you to own 100 actual shares of Apple. If Apple stays above $650 by expiration, you can profit all the way up to $720, at which point your gains are capped. Your maximum profit is about $70, or $7,000 per contract, which would be a return of roughly 47% on the trade by November. If Apple goes above $720, you are forced to sell at $720, but you can exercise your calls and buy at $500.
Conclusion:
Yes, fiscal Q4 for Apple is going to be heavily dependent on when the new version of the iPhone is launched. But there are plenty of other intriguing storylines for the quarter. Is Apple really stealing away a lot of market share from the other computer names, and will it sell well more than 5 million Macs? Will the introduction of the new iPad in China help offset the natural slowdown in iPad sales elsewhere. How about Google's Nexus, where does that play in?
Going forward, Apple will face increased competition. Microsoft has Windows 8 coming out soon, and Google is trying to bolster its presence in both the tablet and mobile space. Apple could launch a mini iPad to retain it's dominance in this area of the market, but that could cost it in terms of overall margins. The iPhone has so much impact on both overall results and margins, so moving away from it as the heavily relied on device could change how Apple's overall financials will look going forward.
Right now, expectations for Apple's quarter are fair, and they will likely change dependent on when the iPhone is released. But I don't think it's a negative if it isn't released in September. Most consumers seem to be waiting for this phone, so an October launch won't be the worst thing. It just would mean Apple has a huge fiscal Q1, a quarter like no other. For long-term investors, Apple can still be bought here. For those looking for just a trade, you may want to wait for a pull back. Apple is in a great position right now, and if you don't believe that, just go back and read my previous Apple article.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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