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My investing philosophy mostly centers around the Value discipline and GARP- Growth at a Reasonable Price. This blog includes commentary on market conditions as well as fundamental analysis of specific companies. Graduated from Rhodes College with a degree in Business with concentration in Finance & Marketing. Currently working on obtaining the CFA designation. Previously worked in Mortgage Trading for a major bank. Use MS Excel extensively for developing investment models, notably valuation models based on DCF methods.

Thursday, October 28, 2010

Warranty Expense Crimps Apple's Margins in 4Q10

Apple Inc (nasd:AAPL) reported a 36.9% gross margin for Q4 2010 which ended in September. This caused worry among investors especially since management stated on the earnings conference call that the decline was due to higher cost structure of iPad and iPhone and the exceptional value it is delivering to consumers. However, a considerable portion of the decline was due to warranty expense which there was no mention on the call.

At the time Apple recognizes revenue for the sale of a product, it also records its estimate warranty expense in costs. It is just an estimate, thus actual warranty costs may vary. When there is an actual warranty cost incurred, it is not recorded to expenses on the income statement since Apple already accounted for warranty expense at the time of sale. Instead, actual cost incurred are recorded as reduction to the warranty expense reserve.

Apple’s warranty accruals had been averaging around 1% of revenue for the first three quarters of FY10, or roughly ~$150M. In Q4, warranty accruals ballooned to $457M, or 2.3% of revenue.

If estimated warranty expense had remained constant in absolute dollar terms ($150M), GM would have been 38.4% vs 36.9%. If If estimated warranty expense had remained constant in as a percentage of revenue (1%), GM would have been 130bps higher at 38.2%.

The silver lining is often estimates of warranty costs are overly conservative resulting in much smaller accruals going forward. This could potentially happen with Apple if actual costs incurred fail to materialize, Apple would make much smaller accruals going forward, hence boosting gross margins. 

Monday, January 25, 2010

FA Estimates for Apple (AAPL) Q1 2010

Apple Inc. (nasd:AAPL)- Apple reports Q1 2010 results after the bell today, January 25th.

Below are my expected numbers:

Tailwinds Q1 2010:
1) Improving economic environment and consumer spending.
2) New iMacs released in October.
3) iPhone expansion into China, Korea, and additional carriers in current markets.
4) iPhone 3GS channel fill due to supply constraints in Q4.
5) Strengthening international demand for Macs, iPhones, and iPods.
6) iPhone “halo effect” benefiting Mac demand.
7) USD weakening should lift ASPs from sales abroad.
8) iPod sales mix shifting towards touch models should lift iPod ASP.

Headwinds Q1 2010:
1) Unavailability of higher priced iMac models in December.
2) GM pressure for shipping costs from iMac refresh.
3) Higher provision for warranty expense stemming from defective 27’ iMac units.
4) iPod product life cycle maturing, potential market nearing saturation, and cannibalization of iPhone/iPod touch demand.
5) Competition from low-price notebooks and netbooks resulting in MacBooks appearing to be much more expensive.

On balance, tailwinds were much more stronger than headwinds that Apple faced in Q1 2010. Thus, Apple should report an extremely strong quarter.

Disclosure: Long AAPL

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