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Apple's Bumpy Road Ahead

Tue, 24 Jul 2012

Growth is likely to keep slowing at Apple until the firm releases its next-generation iPhone, but the long-term future of the tech giant remains bright, says Morningstar's Michael Holt.

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Video Transcript

Jeremy Glaser: For Morningstar, I am Jeremy Glaser.

"Apple" and "disappointing" are not two words we've seen in the same sentence together very often, but this quarter came in a little bit light. I am here with our analyst Michael Holt to take a look and get his take.

Mike, thanks for joining me.

Michael Holt: Thanks for having me.

Glaser: So, let's take a look at this quarter. Did it meet your expectations? What surprised you?

Holt: I think it definitely was a little lighter than we were expecting, specifically on the iPhone unit shipments, but you've got to take this with a grain of salt, because expectations got ahead of themselves with this quarter. We know that this is the third quarter since the iPhone has been released. We know that we are expecting a pullback. We just didn't know the exact magnitude. And we expect more of the same next quarter. It's going to be another wait-and-see quarter before we get another product launch that will drive things forward.

Glaser: So Apple may have failed to meet those lofty expectations, and certainly as you mentioned, the phone was the core of that. What's happened with the iPhone? How important is that to Apple right now?

Holt: The iPhone is still the most important device for Apple. Even in this quarter, we were light on iPhone units, but we actually exceeded my expectations on iPad units, but because of the gross margin differences between those devices--the iPad is a lower gross margin [product] than the iPhone--that's not enough to turn things around on the bottom line.

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Glaser: So even with being in a couple of different categories, they can't make up that difference. When would you expect iPhone sales to take off again? Will the iPhone 5 really help reignite, or is this the start of a long decline as Android takes a bigger share?

Holt: We don't think this is a secular decline. This is really just the calm before the storm when the iPhone 5 will come out, but we're still one more quarter away from that. So, there is some time we have to wait.

And I think one of the important things to realize is consumers ... in general are just becoming more attuned to the product-release cycles. Many more people are aware that there is a phone coming out in the back half of this year then there would have been last year at this time.

Glaser: So is this lull giving an opportunity for some of those competitors--Nokia is obviously pushing Windows phone pretty heavily and with a lot of new Android devices--for people to maybe look across that fence and to think about switching? Does that pose a competitive threat?

Holt: I think the competitors, Samsung, HTC, even Nokia, they're starting to put out much more compelling devices, and when they have releases in the last couple of months and the iPhone hasn't been refreshed in nine months, then you start to see that it's looking a little bit more stale than it has in the past. So, it's a much bigger opportunity for [rivals] to come in and convert people who are going into the smartphone world for the first time into their ecosystems.

Glaser: Now, looking at the Mac business, obviously, it's not as big a part of the company as it was, but they did refresh the notebook line. Has that had any impact yet or would you expect that to have any impact on the long-term earnings of the company?

Holt: It is too early to see it, and you actually didn't see great year-over-year growth, but that really is tied to exactly what you were just referring to. Last year, they refreshed it in February. This year they refreshed it just last month. So, we're not going to see the impact of that new Mac product line until the next quarter.

Glaser: How about profitability? Anything surprising there?

Holt: Earnings per share were down, but more importantly, the gross margin was down a little bit more than we were expecting. This is due to two things: It's the iPhone and iPad both having different product mix shifts. So, it's the mix shift with iPads growing faster than iPhones and then it's also within those segments, the lower-price devices. So, more specifically, the iPad 2 at $399, that's been actually a pretty strong seller. It is not the best seller, but you're seeing a shift towards that lower price point, and that affects the gross profit.

Glaser: So, if this quarter was a little bit bumpy, it looks like next quarter is going to be more of the same?

Holt: Definitely. We think that until you get the next product release, you're in for more moderate results from Apple, but that doesn't change our long-term perspective on the Apple story and the stock.

So, we really see, if there is a pullback in this quarter or next quarter, that could be an opportunity for investors. Our long-term outlook is based on the fact that they are pulling new customers into their platform and they are locking them in with the content and services that they are providing. And that outlook is the same.

Glaser: Mike, thanks for your take today.

Holt: Thanks.

Glaser: For Morningstar, I'm Jeremy Glaser.

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