AAPL 3Q12 Estimate

Revenue: $41.3 billion (AAPL guidance: $34.0 billion/Consensus: $37.4 billion) 

• I expect iPad and iPhone to represent approximately 75% of Apple’s quarterly revenue.  

GM: 45.5% (AAPL guidance: 41.5%/Consensus: 43.3%)

• Apple’s margin jumped to 47.4% last quarter, from 40.5% in 2011. Weaker iPhone sales should serve as a headwind for sequential quarterly GM expansion in 3Q12, although attractive component pricing will continue to provide support for yoy improvement (Apple reported 41.7% margin in 3Q11). 

EPS: $12.30 (AAPL guidance: $8.68/Consensus: $10.34) 

• I expect Apple to report 58% yoy EPS growth. 

Product Unit Sales and Commentary

Macs: 4.7 million (19% yoy growth)

• I expect Mac shipments to show continued strong yoy growth following updates to the laptop lineup at WWDC. Pent-up demand and early back-to-school purchases should help offset MacBook Pro with Retina display shortages.

iPad: 21.3 million (130% yoy growth)

• Apple will report record iPad sales for 3Q12. My iPad estimate assumes approximately 1.8 million iPads sold per week (including iPad 2 sales), which compares to the approximate 1.2 million weekly run rate during the last holiday quarter. Management commentary regarding continued iPad supply/demand imbalance bodes well for record iPad sales. Anecdotally, iPad 2 sales in education and business appear robust following the price cut, while lower component and manufacturing pricing should help to limit margin compression.

iPod: 6.6 million (13% yoy decline)

iPhone: 29.5 million (45% yoy growth)

• My estimate reflects an average 2.5 million weekly iPhone sales run rate. At the end of 2Q12, Apple reported 8.6 million iPhones in the channel inventory, a sequential increase of 2.6 million units. Backing out the inventory build, Apple reported an average 2.7 million weekly sales run rate last quarter. With supply/demand in balance and rumors of the new iPhone building, I expect the weekly sales run rate to decline into the fall.

When Apple releases earnings on July 24, iPad and iPhone sales, along with reported margin, will represent investor’s primary focal points. Apple’s prior commentary foreshadows a strong iPad quarter, surpassing the 15.3 million units sold in 1Q12. Any iPad sales number solidly above 17-19 million units will be looked at positively by the Street. With iPhone supply/demand having been in equilibrium for some time, Apple will not benefit from any significant inventory build this quarter, although carrier and country distribution expansion will result in solid yoy growth. Sell-side iPhone sales estimates have been set at somewhat realistic levels and one should not be surprised with sales between 25-30 million units, although iPhone sales estimates become somewhat irrelevant as we get closer to the new iPhone launch.

Microsoft’s Interesting Week

 
With WWDC winding down in San Francisco and chatter concerning next week’s Google I/O picking up, few would have expected this week to be dominated by Microsoft news. Late Monday evening, after the East Coast had largely gone to sleep, at an event that was oddly so secretive that the press was not made aware of the venue until a few hours prior to start time, Microsoft announced its revamped Surface tablet and I felt somewhat duped. A team of executives got on stage in Los Angeles and put on a scripted show, only I was led to think it was reality. Microsoft faces an uphill battle and while consumers are now talking about the company and Surface, I have little confidence that Microsoft’s ultimate destiny was altered this week.
 
 
Surface Event Lacked Direction and Message, but Microsoft Accomplished Goal
 
At Apple’s iPad unveiling in 2010, Steve carefully crafted his sales pitch to show why the iPad should exist and be worthy of consumer’s precious dollars (pundits still questioned iPad’s purpose for the weeks, months, and years following the event). On Monday, Microsoft lacked a similar sales pitch, instead relying on teleprompters, and hobbling through failed demos, in an attempt to show that the lights were still on in Redmond. Microsoft’s event actually reminded me of HP’s TouchPad event in early 2011, where HP showed a general lack of direction and enthusiasm for the device. Reading off of teleprompters can really kill the passion. It has been four days since the Surface was unveiled, and with more questions than answers, I think Microsoft’s primary goal was accomplished; being mentioned in tablet (and phone) discussions between WWDC and Google I/O.
 
The Big Question
 
The Surface discussion can be reduced to one question:  Is the Surface a proof of concept device meant to spur OEMs into action or is the Surface a sign that Microsoft is entering the tablet hardware space in response to changing market dynamics? It is easier for one to assume that Microsoft intends for OEMs to remain in the game, announcing the Surface as a means to drum up support and give OEMs confidence that there is interest for devices running Windows. However, if MSFT is looking to change strategies and develop the entire Surface device alone, I will give Steve Ballmer a pat on the back as that is one daunting move given the sheer difficulty in manufacturing desirable hardware.
 
Prototyping
 
The lack of available Surface devices for journalists to play with (unattended) and horrid onstage demos leads to me think that the Surface is very far from a shippable state. While working prototypes are common place in Silicon Valley, it is incorrect to assume mass production is only a few short months away as the task of figuring out how to turn a prototype into a mass-produced product at a particular price point (not discussed by Microsoft) by a specific deadline (also not discussed by Microsoft) may end up being just as difficult as building the original prototype.
 
Hardware Delicacy
 
Tablet hardware is tricky.  From my initial iPad 2 review:   “After a few minutes of using iPad 2, I found myself forgetting that I was using iPad 2. My entire thought process was given to the app that I was using.  While iPad looks and feels amazing, the iPad dissolves away when in use, exactly how Apple planned it. Remove the intermediary and let users interact directly with innovation.  I don’t care what is or isn’t inside iPad 2, as long as iPad 2 has the ability to run the highest quality apps possible.”  After 15 months, I am unsure if the iPad’s software or hardware is more intriguing. Apple, a company built on the seamless integration of software and hardware, spent years mastering the art of making iPads. Does Microsoft, a company built on software, have the capabilities of designing and producing an intriguing tablet offering in a few months? While some point to Xbox and Zune as examples of Microsoft’s hardware success, the world is now a different place with substantially higher barriers of entry for hardware makers. HP, a company built on hardware, was forced to manufacture the TouchPad with parts deemed unworthy of the iPad since Apple had procured all available resources through long-term contracts.  Meanwhile, PC OEMs are seeing their sales decline as their designs are falling flat with changing consumer preferences.  I enjoy iPad because the hardware melts away.  Is Microsoft capable of beating Windows OEMs and produce tablet hardware that is truly revolutionary, but still let app interaction resonate? Daunting would be an understatement.
 
Expectations
 
Microsoft faces an uphill battle with tablets, regardless if they intend OEMs to help out or they go it alone. The most likely scenario is that Microsoft will try to have one’s cake and eat it too; bring the Surface to market while keeping OEMs in the loop about broadening the Windows mobile platform. Microsoft will likely face an increasing number of manufacturing difficulties leading to certain things being left out, or altered, in order to stay near competitive prices.  I would look at HP TouchPad and RIMM PlayBook hardware and price points as goals that Microsoft will try to meet, let alone beat (the TouchPad and PlayBook failed in the marketplace). I expect subpar Surface hardware, wrong price points, and limited distribution to become major headwinds for Microsoft. In order to beat iPad 2’s $399 price point, the Surface needs to come in at least $100 lower given Apple’s superior brand – a price I don’t think Microsoft will be able to meet without reporting huge losses. Instead, Microsoft will talk up the increased functionality of Surface (to validate a higher price) and the message will go in one ear and out the other as consumers realize laptops already fill that spot of the market. The Surface’s software, which many have continued to give praise for, will probably be up to Microsoft’s standards, however hardware limitations may spoil the treat, and as the iPad demonstrates (along with every other tablet), hardware cannot be ignored, regardless of how great the software is. Microsoft faces an uphill battle. Arriving at the baseball game in the 4th inning can make winning the game somewhat of a challenge.

Siri's Been Busy

"Customers love [Siri]. It’s one of the most popular features of our most popular phone. But there’s more that it can do. And we have a lot of people working on this. And I think you’ll be really pleased with some of the things that you’ll see in the coming months…we’ve got some cool ideas about what Siri can do...[w]e’re doubling down on it.” - Tim Cook at D10

13 Days later:

Siri introduces WWDC 

Siri learns sports

Siri learns restaurants

Siri learns movies

Siri learns how to launch apps

Siri learns more languages

Siri learns how to tweet

Siri learns how to Facebook

Siri learns how to help you on your iPad

Siri learns on how to accompany you in your car

Siri’s been busy. 

AAPL 2Q12 Estimate

Revenue: $40.6 billion (AAPL guidance: $32.5 billion/Consensus: $36.0 billion) 

• I expect iPad and iPhone to represent approximately 75% of Apple’s quarterly revenue.  

GM: 42.9%  (AAPL guidance: 42%/Consensus: 42.7%)

• Apple’s margin jumped to 44.7% last quarter, from 40.5% in 2011. Continued strong iPhone sales should benefit overall GM in 2Q12,  with attractive component pricing providing additional support. 

EPS: $11.45  (AAPL guidance: $8.50/Consensus: $9.81) 

• I expect Apple to report 79% yoy EPS growth, which is slightly less than the 83% yoy EPS growth observed in 2011.

Product Unit Sales and Commentary

Macs: 4.3 million (14% yoy growth)

• With no Mac updates during the quarter, I expect Mac shipments to show continued yoy growth, albeit at a slower pace than 1Q12. iPad cannibalization is also picking up as consumers bypass Macs for lower-priced iPads. 

iPad: 12.0 million (155% yoy growth)

• Apple sold three million new iPads during opening weekend (includes pre-orders that shipped for the 12 days leading up to the March 16 launch, but not iPad 2 sales).  My iPad estimate is primarily based on weekly sales run rates, using Apple’s new iPad opening weekend sales as a benchmark between slower iPad sales in January and February and the supply/demand imbalance at the end of March. Unlike last year’s iPad launch, Apple seemed to have a better handle with new iPad supply, as online shipment waits did not reach 2011 levels, even with a more extensive international rollout. My estimate assumes approximately 6 million new iPads sold during the last 3.5 weeks of March and an additional 6 million iPads sold in January, February, and the beginning of March. 

iPod: 6.8 million (25% yoy decline)

• Representing only 2.7% of estimated 2Q12 revenue, the iPod is a footnote. 

iPhone: 36.4 million (95% yoy growth)

• My estimate reflects an average 2.2 million weekly sales run rate and the addition of approximately 6 to 8 million iPhones into the distribution channel (approaching Apple’s desired 4 to 6 week range). For some perspective, Apple saw a 1.6 million weekly iPhone sales run rate during 2Q11 (pre-iPhone 4S).  My 2Q12 estimate assumes 38% yoy growth in the weekly run rate, which I think is reasonable given  the iPhone 4S and increased iPhone penetration at newer carriers (including Verizon and Sprint) and countries (China). 

When Apple releases earnings on April 24, many will look at iPad and iPhone sales as an indicator for continued strong consumer demand. I suspect Apple may be allowed some breathing room on iPad sales given the supply/demand imbalance and trickiness surrounding a new product launch. Meanwhile, iPhone lacked any significant interferences during the quarter, with results dependent on demand, and to a lesser extent, the number of units added into the distribution channel. 

Thoughts on the new iPad

Software and Hardware

Why has iPad been so successful?  Intriguing software?  Gorgeous hardware?  After using iPad 2 for a year, my connection with the device has been formed by the seamless interaction between software and hardware.  The iPad form factor seemingly disappears as I interact with iOS apps. Meanwhile, iPad competitors have focused on only one aspect of the software & hardware duplex; either shipping okay software (“okay” can be an overstatement) with mediocre hardware, or okay hardware (again, I am being generous) with buggy software. The new iPad’s improved hardware features, along with new apps, combine to form a package that can appear to be “magical” to the user. 

Motorola RAZR Syndrome

One of the bigger risks Apple faces is the “Motorola RAZR Syndrome”, or reliance on your current success at the detriment of your future success.  After three generations of iPads, it is clear that Apple understands its biggest competitor is Apple. The new iPad’s biggest competition will come from iPad 2, while the original iPad was iPad’s 2 biggest competitor. Even though the original iPad sold well, Apple continued to push the envelope with iPad 2, and now the same can be said with the new iPad. Cameras, a Retina display, faster guts, amazing software, improved battery life, and 4G LTE, all at the same $499 entry-level price point.  

iPad 2 Price Drop  

Although Apple devoted only a brief minute to iPad 2’s new $399 price, consumers will give the $100 price drop much more attention.  For many, price remains king.  While $399 is still a lot of money, consumers are starting to compare iPad to regular laptops, in which the $399 price tag doesn’t look nearly as steep. Similar to the iPhone 3GS and iPhone 4 being bought by former feature phone owners, the iPad 2 will continue to sell well as laptop owners look at iPad for the first time. 

More iPads in the Wild?

Up to now the iPad had been looked at as largely an “inside the home” device, confined to the living or play room.  With the original iPad not having any cameras, using an iPad at a social event, such as a family occasion, picnic, or concert, was questionable.  Apple’s new video and picture software (and improved cameras) will give people a greater incentive to bring iPad to different gatherings and events.  While iPad is still no where near as convenient to transport as iPhone, it is easier to transport than any other computing device.  As more iPads find their way into the wild, a whole new marketing realm will kick in.  While advertisements can be effective, seeing friends or family enjoy their iPad outside the confines of their home represents a brand new marketing angle. 

Jony Ive and New Product Form Factors 

The new iPad’s form factor has subtle differences from iPad 2 (the minor variances might even be hard for a normal consumer to see or feel). While Apple’s SVP of Industrial Design, Jony Ive, is intimately involved in any form factor change, no matter how minuscule, my gut tells me we might see some interesting new form factors for most, if not all, of Apple’s product lines over the next year. I think this is what Tim Cook hinted at at the end of the new iPad’s unveiling when he said, “Across the year, you’re going to see a lot more of this kind of innovation. We are just getting started.” What is the point of changing form factors that seemingly don’t need to be fixed?  How much can you change a phone or tablet form factor? Apple doesn’t settle. New product form designs will focus on greater functionality and feasibility, all while keeping design at the forefront. Dimension barriers will be dismantled. A new round of product design and manufacturing innovation is on the horizon and Jony is guiding the ship.