Digesting Apple's Pie... and Tablet

A certain Cupertino company, best known for selling a few computers, music players and telephones, had all of Wall St. in a frenzy yesterday as it announced quarterly earnings for the December quarter. A Christmas quarter that was wildly expected to be the most profitable in history for Cupertino based Apple Inc. (AAPL).

Expectations were inching up until analysts had settled on Income of around $2.10/share and Revenue of about $12Billion. Apple's reported numbers came in at Income of $3.67/share and Revenue of $15.7Billion, and that's where the confusion began. Just at a glance it seems something isn't right or analysts had spent too much time in the sun. Exchanges halted the stock in after-hours trading yesterday as Apple officially changed its accounting presentation to remove the controversial "subscription model" for iPhone and AppleTV sales.

With subscription accounting, due to the nature of free software upgrades, Apple has had to account for iPhone and AppleTV sales over a two year time frame, breaking up all related Revenue and Costs and lumped the rest in a deferred item on the balance sheet that caused analysts headaches and long hours at the calculators. When Wall St. still struggled to properly value this cash-generating machine Apple provided non-deferred numbers alongside the official GAAP figures. It also petitioned the standards boards to get rid of the subscription requirement.

In September 2009, the company got its wish and is now able to report Revenue and Earnings with minimal "subscription" effects (A nominal estimate representing the value of future software upgrades, which for Apple represents $25/iPhone and $10/AppleTV). The company decided that starting its new fiscal year was the prudent time to put this practice into place and the Wall Streeters were certainly caught off guard. When Apple stock resumed trading the price activity was very mixed until finally settling into a minimal after hours gain.

So that's the logistics of accounting, but what about the quarter? Apple certainly had its pie and is enjoying every bite. A record quarter in terms of profitability and Revenue starts off another successful year for the electronics maker.

Revenue: $15.68Billion vs $11.88Billion year over year.
Earnings: $3.38Billion or $3.67/share vs $2.26Billion or $2.50/share year over year

Mac Computer sales were a record at 3.36 Million units, besting the previous mark by 300,000, highlighted by the recent introduction of the new iMac desktop line.

iPod sales came in at 21 Million units, down slightly but well expected by the company as this market matures. The silver lining in the iPod numbers is the 55% growth rate in iPod Touch sales, bringing up the Average Selling Price of the business unit.

iPhone (which by definition is also an iPod) sales grew by 100% to 8.7 Million units, a quarterly shipment record, which should be noted was below the 9 Million unit consensus estimates. Some iPhone sales targets were even higher but increased competition in the space and a muted start in China is likely to blame for the shortfall. Another point to consider is the inventory channel, of which Apple is said to be one of the most efficient in the space. The company addressed this on the their conference call by re-iterating that its inventory channel is counted in a more conservative manner than competitors. The real kicker, the Average Selling Price of iPhone is $620!

It's usually the guidance game that is important to analysts and investors when Apple issues quarterly reports, however, during this announcement all eyes were and are awaiting what the company will showcase at its media event on Wednesday. Apple executives throughout much of the conference call almost gave the impression of toying with analysts, while likely secretly passing notes back and forth along the lines of "wait till they get a look at iPad"; or whatever the Tablet eventually is crowned.

The usual Apple hype machine is reaching fever pitch again and is strikingly reminiscent of the time just prior to the MacWorld keynote speech in 2007 when Steve Jobs unveiled the first iPhone to the world. News tidbits are flying out from several sources that Mr. Jobs claims the Tablet is the most important thing he's ever done, and in his customary quote on the quarterly press release he re-iterates that this week includes a new product release the company is very excited about. COO Tim Cook stoked the fires further on the conference call when asked about new product opportunities: "I don't want to take away your joy and surprise", referring to the planned Wednesday event. When Tim Cook, Apple's guru of manufacturing, retail and supply chain managment says "joy and surprise" there must be something special about this new device.

For one thing, Apple certainly have mastered the art of getting people interested and getting them in the room to have the conversation. Will the tablet be the be-all end-all of casual computing? A device to be left on the coffee table, used by anyone to control just about any media and anything electronic in their homes? Lots of questions remain and should be answered by the time Steve relents his magic wand by walking off that stage Wednesday. One thing is clear as day, and that's Apple's ability to cash in on their design prowess and excitement generation. The company took in a tidy sum last quarter, generating only about $5.8Billion in cash!

Disclosure: Author is long AAPL