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Apple Misses 4Q Estimates

Zacks Equity Research

Apple Inc. (AAPL) reported sluggish fourth quarter 2012 results, with earnings of $8.67 per share missing the Zacks Consensus Estimate by approximately 18 cents.

Earnings soared 23.0% from $7.05 per share earned in the year-ago quarter and were also ahead of Apple’s conservative guidance of $7.65. The year-over-year growth was driven by higher revenue in the quarter. Apple’s fourth-quarter miss was primarily due to lower-than-expected iPad sales.

Quarter Details

Total revenue was up 27% year over year to $35.97 billion and beat the company’s forecast of $34.00 billion. However, revenue fell shy of the Zacks Consensus Estimate of $36.22 billion. The year-over-year upside in revenue was primarily driven by strong iPhone sales in the quarter.

iPhone unit sales surged 58.0% year over year to 26.9 million. Revenue shot up 56.0% year over year to $17.13 billion in the quarter. However, iPad was the major disappointment in the quarter as unit sales increased only a modest 26.0% year over year to 14.03 million, much below expectations. iPad revenues, however, were up 9.0% year over year to $14.04 billion in the quarter.

Apple shipped 4.92 million Macintosh computers in the reported quarter, up 1.0% annually. Revenue climbed 6.0% year over year to $6.62 billion, primarily driven by strong portable sales (up 17.0%), which fully offset sluggish sales of desktops (down 26%).

iPod unit and sales continued to decline in the quarter. Apple sold 5.34 million iPods (down 19.0% year over year) and earned $820.0 million (down 26% year over year) in the quarter. Revenue from music related products and services (iTunes store, App Store, iBookstore in addition to sales of iPod services and accessories) improved 37.0% year over year to $2.30 billion.

Retail revenues in the quarter increased 18.0% year over year to $4.2 billion, primarily attributable to higher iPhone and iPad sales. During the quarter, Apple opened 18 new retail stores. At quarter end, Apple operated 390 stores worldwide.

Gross profit jumped 26.5% year over year to $14.40 billion in the fourth quarter. Gross margin expanded 40 basis points (bps) year over year to 40.0%, well above management’s forecast of 38.5%, driven by lower commodity and other product costs as well as favourable foreign exchange.

Operating expenses spiked 29.5% year over year to $3.42 billion, slightly lower than management’s expectation of $3.5 billion. Operating expenses, as a percentage of revenue, expanded 20 bps annually to 9.6% due to a sharp rise in research & development expense (up 20 bps), partially offset by lower selling, general & administrative expense (down 10 bps) in the fourth quarter.

Operating profit increased 25.6% year over year to $10.94 million. Operating margin decreased 40 bps annually to 30.4%, reflecting strong growth in operating expenses.

Net income increased 24.2% year over year to $8.22 billion in the quarter.

Apple’s balance sheet remains strong with cash and investments of $121.3 billion at the end of the quarter compared with $117.2 billion in the previous quarter.

First Quarter Guidance

For the first quarter of fiscal 2013, Apple expects revenues of approximately $52.0 billion. Earnings are projected at approximately $11.75 per share. Apple expects gross margin to be 36%, reflecting stock-based compensation expense of approximately $90.0 million.

Operating expenses are estimated to be $4.05 billion, including about $485.0 million in stock-based compensation. The tax rate is estimated to be about 26.0%.

Our Take

We believe that Apple remains the biggest growth story over the long term based on its superior product pipeline, Apps, iCloud and loyal customer base. Apple is also well positioned to gain from international expansion going forward, in our view.

Moreover, the recent shareholder friendly moves such as dividend payment and share buyback are expected to drive the stock going forward.

However, Apple continues to face increasing competition from Google’s (GOOG) Android based products manufactured by Asian handset and tablet makers like Samsung and HTC. Although Apple has been trying to block the sale of products from these companies all over the world, its efforts have not been entirely successful.

The company has lost significant battles against Motorola (now owned by Google) and HTC lately. Its success rate against ally-turned-foe Samsung is also mixed.

We believe that Samsung will continue to grab market share, particularly in the developing countries such as China, based on its diversified product portfolio that caters to every income group. Apple’s ability to spur the popularity of its products in developing nations, where pricing is often an important consideration, will go a long way in deciding the company’s future growth, in our view.

Moreover, increasing product related costs may hurt profitability going forward.

We maintain our Neutral recommendation over the long term (6-12 months). Currently, Apple has a Zacks #3 Rank, which implies a Hold rating in the near term.

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