Apple Q4: China growth, Cook slams Surface, iPad mini margins

The Cupertino technology giant's fourth quarter earnings are out. On the call, Apple executives discussed China, retail stores, iPad mini profit margins, and Tim Cook even took time to slam Microsoft's latest tablet incarnation.
Written by Zack Whittaker, Contributor

Apple missed its fourth quarter forecasts, but the technology giant remains steady and on track.

Its shares were halted to report its latest earnings report, but started to dip in after hours trading, even falling below the $600 a share mark for moment or two.

Read more: Apple earnings: misses estimates, slashes guidance | Techmeme | Apple statement

But on the following earnings call, investors appeared concerned for the firm's upcoming first quarter.

Here are the numbers you need to know in a nutshell:

  • Revenue was $36 billion, a 78 percent increase on Q4 2011. Analysts expected $35.8 billion.
  • Profit was $8.2 billion, a 80 percent increase on Q4 2011.
  • Earnings per share stood at $8.67. Analysts expected at least $8.75 a share.
  • Cash balance currently stands at $121.3 billion, an increase of two-thirds from last year's $81.6 billion.

Looking at Apple's sales based on the same quarter a year ago, sales across the firm's iPhone, iPad and Mac businesses were up, but fell short in the iPod department. While that's the number some will focus on, the focus is on Apple's iPad sector.

Apple chief financial officer Peter Oppenheimer said on the call that Apple's "record" revenue was spurred on by iPhone and iPad sales. Based on the iPad sales, it was the iPhone that truly carried the quarter, while the iPad tagged along behind.

All in all, Q4 was good but it doesn't compare to what's ahead. Traditionally Q1 is where the real money is to be made, but Apple hinted that the next quarter may not yield the good results it hopes for.

Apple forecasts Q1 revenue of about $52 billion, or $11.75 a share, but analysts expected just shy of $55 billion, or $15.45 a share. When Apple announced this week at the iPad mini launch that it had only managed to sell its 100 millionth iPad -- a huge feat on the grand scale -- it fell short of analysts' expectations. It's hoped that iPad mini sales will help the overall iPad figure pick up towards and during the Christmas sales period.

To put it simply, Apple's Q1 -- where the firm traditionally blows all earlier results out of the water -- looks weak.

Apple chief executive Tim Cook was also on the earnings call, held at 5:00 p.m. ET.

A lot of the start was tooting their own flutes when it came to deployments across car manufacturers and news agencies and the like, name-dropping wherever possible for maximum investor impact. But the Q&A was the time for analysts' to strike and attempt to catch the executives out. (Historically, this never works, but it's a fun game to play nonetheless.)

Some of the highlights of the call:

iPad mini gross margin 'significantly low'

In December, Apple will see the first earnings per share decline in its history. Apple also expects 36 percent gross margin, which is very low for the company.

Oppenheimer said: "Never before have we introduced so many new form factors, and all have higher costs, and therefore Apple has lower gross margins." The reason why the gross margins are "significantly below" the company's average is because of the "sheer number of new products in a short space of time."

Apple has already lowered iPhone 4 and 4S price to counter-balance this and noted smartphone subsidies from carriers in a bid to help drive down the price of the iPhone.

Regarding the iPad mini, which was announced this week, the margin is "way below the company average." On the call, Oppenheimer said the iPad mini has "substantially lowered product margins than Apple's margins as a whole."

However, the high anticipated volume of new products will generate "vast new revenue" for Apple. The technology giant's financial chief noted that Apple was working to "improve manufacturing and efficiencies to drive down costs." 

Tim Cook chimed in, adding that Apple was, "unwilling to cut corners on delivering the best customer experience in the world." The company continues to "invest in excellence" and will always be the driving force behind Apple." He added that Apple will also focus on "long term decisions" rather than making short, snappy and potentially harful moves. 

"We are confident in our decisions," Cook said. 

In a nutshell, this means Apple might be unwilling to cut corners on their products, but they apparently are willing to cut margins in places. 

Piper Jaffray analyst Gene Munster questioned whether or not Apple will pass the margins onto customers. Cook rebuffed his "hypothetical" question and believes it "made great choices." Cook added: "Our customary practice is to just guide for current quarter. We don't want to talk about what we might do post-that." 

Microsoft Surface, Windows 8, and the competition

Cook hasn't played with the Surface yet, he admitted. He probably wasn't asked, considering Microsoft only in the past few days lifted the embargo on Windows RT and Surface reviews.

Cook was slow to talk at first, clearly picking his words carefully. Huffing and puffing, breathing heavily, and pausing for a moment, he proceeded to slam Microsoft's tablet offering.

Apple CEO on Surface: "I suppose you could design a car that flies and floats, but it wouldn't do all of those things very well."

He said Surface is a "compromised and confusing product." He added that Microsoft has made a "hard trade-off," and followed with: "I suppose you could design a car that flies and floats, but it wouldn't do all of those things very well." But isn't that the point of the Surface, that it flies and floats -- or in words palatable to ordinary people, it works at home and at work seamlessly. 

Cook couldn't deny that Microsoft's Surface existed. One analyst asked about the enterprise penetration regarding the ongoing "bring-your-own-device" (BYOD) trend among business customers.

Cook reiterated much of what he said during the iPad mini presentation. "We now have almost all of the Fortune 500 testing or deploying the iPad. With recent announcements [hinting at the Surface and Windows RT] iPad penetration will only grow. We're now pushing for the Global 500, and have seen a 80 percent penetration rate with the iPhone and iPad."

Retail stores visitation increased by 22 percent

Oppenheimer explained that a greater European and China expansion in retail store space was important for the company. Apple this year opened a store in Sweden and Hong Kong -- another store in Chinese territory -- a key market for Apple to crack.

All in all, out of the 190 stores, 140 stores are outside the United States. In all, 94 million people visited Apple retail stores around the world during the fourth quarter, or 19,000 visitors per store per week, versus 77.5 million a year ago. That's an increase in visitation of 22 percent in one year, which by any retail store is a tremendous feat.

China is "15 percent of Apple"

Cook noted that China was a keen interest for Apple to keep up to date with.

He said revenue was up 26 percent year on year in China. Breaking down the numbers for the region, he said Mac revenue was up 44 percent, iPad was up by 45 percent in Greater China, and the iPhone was up by 38 percent.

"All in all, it was a fantastic quarter" in China, he confirmed. For the fiscal year, revenue was $23.8 billion, up $10 billion year-on-year, or up 78 percent.

China represents 15 percent of Apple's revenue.

To show how important it is for Apple to crack into the Chinese market, Cook confirmed that the world's largest country by population represents around 15 percent of Apple's revenue for the fiscal year.

He also confirmed that the iPhone 5 will arrive in China during the December quarter. "Yes, we project that it will," Cook said.

He also said that the firm will continue to invest in retail stores there -- and has recently opened a Hong Kong store. He wants to expand distribution with channel partners in the country, describing the region as an "extremely exciting market."

iPhone 5 "backlogged"

Cook said the iPhone 5 demand is extremely robust, and the company was in a "significant state of backlog" in trying to ship out as many devices as it can. Production is clearly stalling or not high enough to meet consumer demand, suggesting supply chain issues.

However, "output has improved significantly." Cook said he was pleased with the overall progress and most of all pleased with volume ramp.

In regards to the next quarter, the crucial holiday season first quarter, he says: "We think we will have an incredible holiday season." Considering the firm sells more iPhones than iPads, iPods and Macs put together for the fourth quarter, and that Apple's iPhone business generates more in revenue than Microsoft does as an entire company according to the last December quarter, Apple will be fine so long as the iPhone continues to do well.

Check that, Tim: "We will never make a 7-inch tablet"

Of course, because the 7.9-inch iPad mini is absolutely not a 7-inch tablet.

On the call, Cook said Apple would "never make a 7-inch tablet [because] we don't think they're good products." The analyst asking the question about the screen size of the iPad mini was referencing what Steve Jobs said many years ago, dismissing the idea of a more petite tablet altogether.

"The iPad mini not a compromised product like the 'other' products." -- Cook.

Adding to the mix, Cook threw his weight behind the iPad versus the PC market. "We're very confident that the tablet market will surpass the PC market." Given the size of the PC market, it's an "enormous opportunity" for the company.

"We do think that the iPad and iPad mini will be extremely attractive offerings in lieu of a PC. We will focus on the future of the iPad, and we are confident with what we have in the pipeline."

It goes almost without saying, and was reiterated a number of times on the earnings call, that Apple doesn't comment on anything relating to its roadmap -- not even to its investors. To be fair, with the number of leaks in the run-up to the iPhone 5 and the following iPad mini announcement, it probably couldn't do that much damage.

Cannibalization of the iPad

There has been much concern that the iPad mini will "cannibalize" sales of the other, larger iPads, where by the smaller tablet eats into the firm's other line of products.

"We only have a new products, not old products," Cook said. Firmly putting the point down, he said: "We're not worried about cannibalization  of our own products. It's better that it's us rather than one of our competitors."

He noted the PC market and how the iPad will chip into that, a market that's dipping quarter-on-quarter. He noted that there are 80-90 million PCs shipped per quarter, and around 300 million PCs bought every year. "We think they would be better off buying an iPad...," he said, adding quickly, "or a Mac," seemingly forgetting that the post-PC evolution was far from completed.

"Instead of focusing on cannibalization of ourselves, we see it as an enormous opportunity for us."

Apple television? "Or not."

That's pretty much all Tim Cook said about the Apple television, the so-called rumored 50-plus-inch display designed fro the television. In replying to an analyst asking about the "living room strategy" and "whether or not" Apple would be willing to discuss it, Cook simply said: "Or not."

There wasn't even a hint at a television, but did mention Apple TV, the set-top box that plugs into existing television sets and connects to iTunes and other Apple devices around the house.

He said there were 1.3 million Apple TV sales, up 100 percent year-on-year. He said in total there were 5 million Apple TV sales for the full fiscal year, almost double on 2011. However, he noted that it was a "small" portion of Apple's business and remains a "beloved hobby." 

The only potential... maybe... possible hint that there may be something in it for the future, Cook noted that he believed there was "something more there" for the living room strategy, and will "continue to pull the strings to see what's next."

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