Apple Outperforms Expectations on Strong iPhone SE Sales

By Markets Fool.com

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Apple (NASDAQ: AAPL) reported earnings for the third quarter of fiscal 2016 on Tuesday, July 26, after the market close. Investors reacted with optimism to the news, sending shares of the iPhone maker up by nearly 7% in after-hours trading. Let's look at the recent earnings announcement from Apple and see what it means for investors in the company going forward.

The key numbers

The smartphone industry is maturing, and the iPhone 6 was a booming success for Apple in 2015, which makes year-over-year comparisons quite challenging in 2016. In this context, management guidance was for a decline of approximately 15% in revenue during the third quarter, and sales figures came in ahead of those forecasts.

Revenue was $42.4 billion during the third quarter, a 14.5% decline versus the same quarter last year, but Apple still outperformed expectations of $42.1 billion among Wall Street analysts following the company. Earnings per share of $1.42 also outperformed analysts' expectations for $1.38 per share.

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Forward-looking guidance can be even more important than revenue during the past quarter, and that number was also encouraging. For the fourth quarter of fiscal 2016, the company expects revenue of between $45.5 billion and $47.5 billion. Those figures compare favorably with the average analyst estimate of $45.7billion.

Apple CEO Tim Cook said in the press release that the business outperformed management expectations and that demand for the iPhone SE looks quite promising. In his own words: "We are pleased to report third-quarter results that reflect stronger customer demand and business performance than we anticipated at the start of the quarter. We had a very successful launch of iPhone SE, and we're thrilled by customers' and developers' response to software and services we previewed at WWDC in June."

The iPhone accounted for nearly 57% of total revenue during the quarter, so this segment is of utmost importance in terms of overall company-level financial performance. Apple sold 40.4 million iPhone units during the third quarter. That was a 15% annual decline, but it still beat analysts' expectations for 40.02 million units.

What this means for investors

Investors shouldn't put too much attention on Wall Street forecasts when analyzing a business. Looking at a company with a long-term perspective is a far smarter and more productive approach to investing decisions. Nevertheless, when trying to understand the market's reaction to the earnings announcement, it's important to keep in mind that revenue came in ahead of expectations, even if sales declined year over year.

Strong performance from the iPhone SE is quite encouraging. The iPhone SE has a comparatively low starting price of $399 without a two-year contract, considerably cheaper than the $649 starting price for the iPhone 6s. Because of a big sales contribution from the iPhone SE during the quarter, the average selling price in the iPhone segment declined from $662 in the third quarter of 2015 to $595.

Still, the impact on profit margins wasn't too big: Gross profit margin was 38% of revenue last quarter, compared with 39.7% in the year-ago period. This performance indicates that management is doing a sound job of offering a more competitively priced product while still producing healthy profitability for investors, alleviating concerns about the possibility of a big decline in earnings from shrinking margins.

The iPhone SE is particularly targeted at attracting new clients to the sticky Apple ecosystem. Not only is the device selling better than expected, but the negative impact on profitability is also quite modest, and this is arguably the main positive in the recently released earnings report.

Another major plus in the report is vigorous growth in the services division, which includes revenue from the iTunes Store, the App Store, Apple Pay, Apple Care, and other services. Revenue in this business grew 19% year over year, reaching almost $6 billion during the quarter. The services segment is now the second largest segment behind the iPhone, representing 14% of total Apple revenue.

iPhone sales tend to fluctuate substantially from quarter to quarter, making Apple's financial performance hard to predict. On the other hand, services tend to be recurrent and more stable, so a growing contribution from the services segment in the overall revenue mix will make performance more stable in the future.

Expectations were admittedly low for Apple leading up to the report, but the company still managed to beat a low bar on the back of strong performance from the iPhone SE and the services business. This news has positive implications going forward, so it's no wonder Apple stock was rising steeply after the announcement.

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Andrs Cardenal owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.