Apple Forecast Shortfall Shows Cost of Year-End Product Rush

Oct. 25 (Bloomberg) -- Saturna Capital Senior Analyst Paul Meeks and Music Analytics Senior Advisor John Rudolph discuss Apple's coming radio service. They speak with Nicole Lapin on Bloomberg Television's "Bloomberg West." (Source: Bloomberg)

Apple Inc. (AAPL) traded industry-leading margins for a revamped product line in time for the holiday shopping season, a sign of the rising costs of rivalry with Samsung Electronics Co. (005930), Microsoft Corp. (MSFT) and Amazon.com Inc. (AMZN)

The trade-off was outlined yesterday when Apple said profit in the current quarter will be about $11.75 a share on sales of $52 billion. That compares with $15.49 a share on sales of $55.1 billion predicted by analysts surveyed by Bloomberg. Gross profit margin, the proportion of sales left after deducting production costs, will fall to about 36 percent, the lowest level in more than four years, Apple said.

Read: Samsung Record Profit Beats Estimates as Galaxy Sales Surge

Apple Chief Executive Officer Tim Cook has introduced a new iPhone and iPad, while updating the iPod and Mac computer lines. The overhaul stands to give Apple products an advantage against new phones and tablets from competing electronics makers, such as Samsung, which today reported record third-quarter profit on demand for its Galaxy smartphones. It also means rising production costs and narrower profit margins.

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“They are going to have a big holiday quarter, a big March quarter, and then you have to wonder after that,” said Shaw Wu, an analyst at Sterne Agee & Leach Inc. “They could be doing this to address competition.”

Photographer: Noah Berger/Bloomberg

Tim Cook, chief executive officer of Apple Inc., holds an iPad Mini during an event in San Jose, California. Close

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Photographer: Noah Berger/Bloomberg

Tim Cook, chief executive officer of Apple Inc., holds an iPad Mini during an event in San Jose, California.

Apple fell 0.9 percent to $604 at the close in New York. The shares have slumped 14 percent since reaching a record the week iPhone 5 went on sale, related partly to the company’s struggle to keep with with demand.

Costs Increasing

Profit last quarter rose to $8.67 a share, shy of the $8.75 projected by analysts. While revenue rose 27 percent to $36 billion, operating expenses rose 29 percent to $3.46 billion, a sign Apple spent more to refresh its entire product line ahead. Research and development costs rose 40 percent.

Apple has traditionally given a conservative financial outlook that falls short of analysts predictions, though heading into last year’s holiday shopping period it exceeded expectations.

“We’ve never introduced so many new form factors at once,” Apple Chief Financial Officer Peter Oppenheimer said on a conference call with analysts.

When a technology company introduces a new product, it typically encounters higher costs for components and equipment that can squeeze profit margins. For instance, Oppenheimer said the iPad mini has “significantly lower” profit margins than Apple’s overall level. He said costs would come down over time. Apple’s gross profit margin, the proportion of sales left after deducting production costs, was 40 percent last quarter, the lowest level since Apple’s first quarter of 2011.

No Corner-Cutting

“Clearly there are supply-chain costs and startup costs that are impacting gross margin, which is ultimately driving down the earnings,” said Shannon Cross, a Livingston, New Jersey-based analyst for Cross Research. “Is this a one-time incremental cost or is this a change to the business?”

Cook, who took over for Apple co-founder Steve Jobs last year, said the costs are necessary to make products that customers want to buy.

“We’re unwilling to cut corners to deliver the best customer experience in the world,” Cook said on the call. “We are managing the company for the long run.”

Investors will be on the lookout for an evidence that higher costs persist, said Andy Hargreaves, an analyst at Pacific Crest Securities LLC.

‘Compromised’ Surface

“The bigger concern would be if it’s just getting more expensive for them to build products,” Hargreaves said.

Apple also sold fewer iPads last quarter than some analysts predicted as consumers held off purchases before the release of the iPad mini. Pre-orders for the smaller tablet started today. The company sold 14 million iPads, compared with 15.3 million projected by analysts surveyed by Bloomberg.

Amazon released a new line of Kindle tablets in September, ramping up competition by offering a range of models priced from $159 to $599. The base 7-inch Kindle Fire HD, which sells for $130 less than the iPad Mini and has better screen resolution, saw its sales triple from a week earlier after Apple unveiled the iPad mini on Oct. 23, said Drew Herdener, an Amazon spokesman.

The reason for Apple’s dash: It’s grappling with accelerating competition in the very mobile markets it pioneered, including from Microsoft, which today begins selling a tablet it calls Surface.

Asked about Microsoft’s new tablet, Cook said it’s a “compromised” and “confusing” product because it tries to blend the functionality of a laptop and tablet. Customers prefer one or the other, Cook said.

Desktops, Laptops

Apple sold 26.9 million iPhones during the period, more than the 26.3 million predicted by analysts in a Bloomberg survey. Analysts had lowered iPad predictions earlier this week after Cook, during the unveiling of the new iPad, said the company had sold 100 million iPads to date -- an indication that some quarterly projections were too high.

Apple has said the new iPhone, which went on sale last month and sports a bigger screen and works with speedier wireless networks, will be available in about 100 countries by the end of the year. The smaller iPad goes on sale Nov. 2.

In the fourth quarter, back-to-school shopping helped push Mac sales to 4.9 million, matching the 4.9 million predicted by analysts. The lineup of desktops and laptops has been gaining share as demand wanes for competing personal computers, according to research firm Gartner Inc. Microsoft this week releases its own tablet, the Surface.

Apple sold 5.3 million iPods (IOD), compared with the 5.8 million predicted by analysts.

To contact the reporter on this story: Adam Satariano in San Francisco at asatariano1@bloomberg.net

To contact the editor responsible for this story: Tom Giles at tgiles5@bloomberg.net

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