Three Apple Fears That Were Blown Out of Proportion
When Apple (AAPL) reported its earnings this quarter (conference call transcript), alarm bells rang out over:
1. Steve Jobs' health.
2. Apple's guidance of a buck next quarter.
3. Decreased gross margins.
Turns out these concerns were much ado about nothing.
1. Steve Jobs did not have the dreaded adenocarcinoma of the pancreas, the disease that kills most of its victims. He said that in a very public forum at the Stanford University 2005 Commencement speech. For those interested, google Steve Jobs Stanford Commencement. It was a very moving speech describing in detail the ordeal he went through before learning that he had a rare but completely curable tumor. The tumor was resected, it's gone, end of story. Reporters and analysts that were speculating on Jobs' coming demise and then criticized him for not going public were wrong on both accounts.
2. Apple always gives low guidance. But, anyway, from now on, reported earnings will have little to no meaning because they do not include quarter iPhone profits (see Unlocking iPhone Profits here). 
As Apple rolls out its new iPhone globally, and successfully, its reported earnings in no way reflect real income. Because of an idiosyncrasy in accounting rules, Apple is forced to report its iPhones sales at a turtle's pace over a 24 month period. Now, make no mistake, Apple booked the profits as received in the bank; it's only the actual accounting (and eventual tax payments, a nice benefit) that get dragged out. Expect next quarter reported earnings to be 30 to 50% below true income. Future reported earnings will be completely unhelpful. Guidance, from now on, should be a big YAWN. For the real story, investors must look to the growing bonanza in operating cash flow. That cash flow, already gigantic, will pop next quarter. Apple, by law, cannot give you the real figures of iPhone earnings but instead must defer them (isn't it foolish). You, as an investor, must "unlock" your own iPhone profits.
3. Gross margins slipped a tad but did anyone notice SGA costs? Those slipped as a percentage of gross income by 150 basis points. SGA% went from 13.7% to 12.2%. Unfortunately, analysts aren't handed that number; nobody noticed. That's a nice decline. The decline indicates Apple can do a great sales job for less. Another key number that went unnoticed was R&D costs. R&D went up from 207 to 292 million this quarter. That's the future and something Apple doesn't want to scrimp on. This quarter Apple spent 85 million more on R&D than last year's quarter. That's 41% more, a sign that good things are going to be in store for Apple. I don't think that larger R&D budget went to pay higher commodity or energy costs; rather that went to fund creative people developing the next tech breakthrough.
So, breath easy, Apple investors. The boss is healthy and well. Reported earnings, and certainly guidance, don't give the real meat of what happened in the quarter; look instead at cash flow. Computer and iPhone earnings are going wild; you can tell the Mac story from the earnings but not the iPhone. Don't get preoccupied with tiny changes in gross margins; look instead at the sheer volume of sales, remarkable execution, and investment in the future.
Disclosure: Long AAPL
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This article has 15 comments:
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mrtaxx
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47 Comments
My Website
Jul 28 05:36 AMBravo and cudos to the writer who understands that Apples earnings for the iPhone are not reflected in earnings, most analysts and writers don't get this. The earnings report reported in April where Apple reported $1.16 would have been $1.45 if iPhone sales would have been included.
Apple is the most innovative and admired USA company and its earnings hopefully will be reflected in years to come.
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tom1234
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174 Comments
Jul 28 06:29 AM-
tuskagee
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58 Comments
Jul 28 07:12 AM-
Apple Fan
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1 Comment
Jul 28 08:04 AM-
taojones
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41 Comments
Jul 28 09:07 AMand unfortunately the new phone is under the same accounting rules because apple is delivering upgrades for free over the life of the contract length and the law states that until the "whole value " is actually delivered the sale can not be considered "complete" but as was astutely pointed out apple will have use of the cash right away and save gobs on the taxes and the bottom line will grow and grow steadily over the next 5 years regardless of small setbacks in sales. Good news to investors like me if the bearish pundits don't panic the market as they have been doing. this routine unnerving of investors should be as illegal as crying fire in a crowded theater
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PK de C'ville
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98 Comments
Jul 28 09:55 AM"with the new iPhone (3G), those revenues and profits will be reported for the current quarter."
Fail.
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mollytjm
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332 Comments
Jul 28 09:55 AMApple has a lot in the pipeline...it's first name is innovation (one reason they took Computer out of the Apple name) and multiple revenue streams will continue to grow...in 70 countries! i'm not a day trader. in the long run, APPL is a great investment. hopefully, the market will get use to manipulators and bashers of a company (and stock) that has no debt, huge piles of $, unequalled innovation, unequalled store profit, unequalled tech support and products. this huge moat, getting larger all the time, will bring more value investors. and it should.
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brewer
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422 Comments
Jul 28 11:01 AM-
Neil Anderson
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136 Comments
My Website
Jul 28 03:34 PM:)
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Tom B
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1771 Comments
Jul 28 03:35 PM-
User 233726
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2 Comments
Jul 28 03:59 PMYou may be right on iphone, but if you are then they will have to pay for updates like the ipod touch.
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Constable Odo
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44 Comments
Jul 28 07:06 PMHmm. Oh, I keep forgetting that the better Apple does, the more the stock price goes down. Oh, well, that's just the proverbial dark before the dawn. That's because Apple's stock is going to go up and up and up and the next thing we know it will be sitting at $300 a share, the same way it was going to do in March 2008. I'm going to take a nap now. Wake me when it hits $300. No, wake me when it hits $170 again.
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herbnerho
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5 Comments
Jul 29 05:45 AM-
Jon T
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330 Comments
Jul 29 09:43 AMThe over arching truth is that there is activity to contain the Apple success story.
There are a lot, in fact a HUGE number of businesses and people who do not want to see the Apple freight train run them over.
It is going to run them over, but in the meantime expect negative talk at every opportunity.
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Tom B
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1771 Comments
Jul 29 01:34 PMMany of these businesses had plenty of time to prepare. Why did it take over 15 years for someone (Apple) to invent a smartphone worthy of the moniker? Surely Palm had the technical expertise to deliver one-- and didn't. MSFT had all the money in the world to throw at the problem-- and didn't arrive at a satisfactory solution, either.