Apple (NASDAQ:AAPL) announced its fiscal Q3 2014 results on July 22, reporting a reasonably strong set of numbers that beat market expectation on earnings, although revenues were slightly lower than anticipated. The results were driven by the iPhone, which saw demand grow for all three models, and by the Mac, which saw double digits sales growth despite a shrinking personal computer market. However, iPad sales continued to disappoint, owing to weaker demand in developed markets. Quarterly revenues grew by around 6% to around $37.40 billion, while quarterly net income grew by around 12% to $7.7 billion.  Earnings per share jumped by around 20% year-over-year, aided by recent share repurchases, while gross margins expanded to around 39.4% from around 36.9% a year ago, owing to lower costs and possibly due to a higher share of iPhones in the company’s sales mix. Here is a brief look at some of the key trends that drove Apple’s performance for the quarter.
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iPhone Sells Well Across Price Points And In Emerging Markets
The iPhone remains Apple’s most important product by far, accounting for close to half of the company’s value, according to our estimates. For this quarter, Apple shipped about 35 million iPhones, representing a 12.7% jump over the same quarter a year ago, although revenue growth was slightly lower at around 9% possibly due to a greater mix of lower-end handsets. ((Q3 2014 Unaudited Summary Data, Apple, July 2014)) Business remained healthy in emerging markets such as Brazil, Russia, India and China, where iPhone shipments grew by around 55% year-over-year. China turned out to be particularly strong market, with overall revenues (from all products) growing by roughly 28% year-over-year and iPhone sales growing twice as fast as the broader Chinese smartphone market. However, sales in Japan, which had been one of the iPhone’s fastest growing markets in recent quarters, were impacted by an increase in value added taxes (VAT) and some changes to the regulatory environment for mobile carriers. ((Apple’s (AAPL) CEO Tim Cook on Q3 2014 Results – Earnings Call Transcript, Seeking Alpha, July 2014))
Key growth drivers in the Chinese market include China Mobile’s progressive deployment of LTE into new cities. As 4G penetration improves (it currently stands at just over 1% for China Mobile’s subscriber base), high-end vendors such as Apple could see a better uptake for their handsets.  Additionally, Apple could see pent-up demand for the upcoming version of the iPhone, which is rumored to have a larger screen. Thus far, Apple has been absent from the large-screen smartphone space, and it’s likely that some high-end customers have been flocking to premium large-screen Android phones. However, with the possible introduction of a large-screen iPhone, Apple should be able to grab high-end market share from players such as Samsung that have counted on big screen sizes as a distinguishing factor.
Two Encouraging iPhone Trends
Apart from the stronger shipments, we observed two encouraging trends within the iPhone business. Firstly, Apple’s mid-tier iPhone 5C appears to be gaining some traction. While all three iPhone models recorded year-over-year sales growth, Apple noted that the 5C saw the highest percentage growth when compared to last year’s mid-tier model. Although it’s safe to assume that the high-end 5S still remains the company’s largest volume driver, we believe that a more well-rounded demand mix for Apple’s handsets is a positive sign, given the increasing differentiation that smartphone customers are seeking. We estimate that Apple’s mid-tier models (the 5C in this case) could be almost as lucrative as its higher-end offerings, considering their legacy components and lower manufacturing costs.
Secondly, Apple seems to be less dependent on the subsidy model of carriers who discount the upfront price that customers pay for smartphones. The company estimates that fewer than 25% of iPhones currently sold were tied to a traditional subsidy plan, marking a significant decline from 2 years ago. This is an encouraging development, since it points to the fact that more customers (many of whom are likely to be in emerging markets where subsidies are not prevalent) are willing to pay the high upfront price of an iPhone rather than have a carrier subsidize it for them. Some carriers, such as T-Mobile, have done away with subsidy plans altogether, while other large carriers including AT&T are experimenting with their own subsidy-free plans that save customers a certain amount off their monthly bills if they purchase their own device.
iPad Sales Are Slowing, But Enterprise Market Could Offer Some Respite
Apple’s iPad shipments declined by about 9% year-over-year to around 13.3 million units, marking the second straight quarter of year-over-year declines. The lower shipments were due to weaker demand in mature tablet markets such as the U.S., which offset some double-digit percentage growth recorded in markets such as China, the Middle East and India. Additionally, the company’s move to reduce iPad channel inventory by around 500,000 units from Q2 2014 levels also contributed to a decline in shipments. While the overall growth in the tablet market has been slowing, with IDC forecasting that tablet shipments for the year will rise by just about 12.1% compared to a growth rate of around 51.8% during 2013, Apple seems to be more severely impacted due to its higher price points and exposure to developed markets where tablet penetration is high (see Why iPad Sales Growth Has Been Slowing). However, Apple has been seeking to increase its exposure to the enterprise space in order to drive sales growth. Although the iPad already has a market share of over 70% in the U.S. commercial market, the penetration levels of tablets are still low at around 20%. The recent deal with IBM (NYSE:IBM) puts Apple in an ideal position to extend its lead in the enterprise tablet market, given that IBM will be selling Apple devices to enterprises, in addition to developing industry-specific apps and solutions for iOS.
Mac Sales Surge, Defying The Shrinking PC Market
The Mac saw particularly strong sales through the last quarter, with shipments growing by around 18% year-over-year to around 4.4 million units, despite the shrinking PC market. Apple notes that Macs have gained global market share for 32 out of the last 33 quarters. The results were primarily driven by strong sales of the Macbook Air, which recently got a price cut along with a bump in specifications. While sales to the U.S. expanded by double digits, driven by the education buying season, shipments in China were robust, growing by around 39% compared to the broader Chinese PC market which was projected to have shrunk by about 5% during the period. Although the Mac isn’t as big a driver of Apple’s value as its iDevices businesses, it remains an important component of the company’s overall ecosystem.Notes:
- Apple Reports Third Quarter Results, Apple, July 2014 [↩]
- China Telecom, China Unicom Get 4G FDD-LTE test licences in 16 cities-CCTV Weibo, Reuters, June 2014 [↩]