iPhone sales boom but iPad disappoints Wall Street

CEO Tim Cook takes shot at Microsoft's Surface tablet, calls it 'compromised, confusing'

Apple on Thursday announced record revenue on the back of booming iPhone sales, but for the second quarter in a row iPad sales came up short of Wall Street's expectations.

The forecast for the holidays also looks less profitable, the company acknowledged, what with its aggressive roll-out pace -- new iPods, new iPhone, new iPads -- one small, one larger -- new MacBook Pro and new iMacs in the last six weeks.

In an earnings call Thursday, Apple executives said the company sold 26.9 million iPhones in the third quarter, a 58% increase and above analyst predictions of between 24 and 25 million.

Apple sold 14 million iPads, up 26% but well under the 18.5 million Wall Street had anticipated.

"Apple has settled into a rapid, but not insane, rate of growth," said Ezra Gottheil, analyst with Technology Business Research. "They're growing the Mac, they're retaining their position in tablets and seem to be taking all the market in smartphones that they want. I don't see a problem with that."

Apple's total revenue of $36 billion was a record for the third quarter, and a 27% jump over the same period in 2011. Unlike last quarter, revenue came in slightly above Wall Street's expectations.

Net profit was $8.2 billion, up 24.2% from 2011, which was not up to the Street's consensus.

"[But] the investment community tends to get 'wrapped around the axle' on tertiary details and fails to [remember] the 'big picture' ... [that] demand for Apple products is much greater than current supply," said Brian Marshall of the ISI Group in a note to clients after the earnings call.

Peter Oppenheimer, Apple's CFO, and CEO Tim Cook took turns explaining the numbers for the third and fourth quarters.

"We are dedicated to making the very best products in the world and we think about the smallest of details, and we are unwilling to cut corners in delivering the best customer experience to the world," said Cook about the leaner profits.

"What Tim was saying is that Apple is a premium product company, and that their margins, once very, very, very high, are now just very, very high," Gottheil interpreted.

The winner of the quarter's battle for revenue supremacy was the iPhone, which accounted for 47.6% of all sales. That was slightly more than the iPhone's contribution last quarter, but also the second in a row where the smartphone's portion was less than half of all sales.

The quarter was the first to include iPhone 5 sales, the larger model that went on sale Sept. 21. Even now, Apple struggles to meet demand: The iPhone remains where it landed just shortly after launch, backordered three to four weeks.

More than once Cook declined to forecast when iPhone supply and demand would reach a balance, saying only that the latter was "extremely robust" and that production output had "improved significantly" since early October.

The iPad missed Wall Street's estimates by a large margin, selling 24% fewer units than predicted. But analysts knew bad news was brewing: On Tuesday Cook said that Apple had sold its one-hundred millionth iPad two weeks earlier. Analysts did the arithmetic and quickly backed off earlier projections.

But even off the Street's forecast as it was, the quarter was the third-best ever for the iPad, with the 14 million coming in under only the previous quarter's record of 17 million and the 2011 fourth quarter's of 15.4 million.

The iPad's $7.5 billion in sales dropped the tablet's contribution to the Apple's total revenue from 26.2% in the second quarter to 20.9% in the most recent.

Cook defended iPad sales, saying that the 14 million was above the company's own prognostications and that Apple had stuffed the pipeline the quarter before with over 1 million additional tablets.

But he also admitted that the rampant rumors of an impending smaller iPad, which Apple unveiled this week as the iPad Mini, made consumers pause.

"It's clear that customers delayed purchases of tablets due to new product rumors and this intensified in August and September," Cook said. "Some of that was anticipated and some of it I wish wouldn't occur. But it did occur."

The holidays will be a test for Apple, with the Mini's smaller size taking it into uncharted waters. Some analysts see it as Apple's toughest sell in years because buyers may balk at the $329 price when other similar-sized tablets from Amazon and Google cost $199 or less.

Oppenheimer pre-empted questions about the Mini's price when he answered an analysts question with what sounded like a script. As he talked he used the word "aggressive" twice to describe the $329 price tag.

"All these new products, and the iPad Mini too, obviously, are at their most expensive point [to make]," said Gottheil. "Apple's saying they packed a lot more stuff in the new products, and were aggressive on the iPad Mini. I believe it."

The iPad's ASP (average sales price) also dropped, noted Gottheil, to $535, down from $570 the quarter before, indicating that consumers were selecting lower-priced iPads, or more likely, buying more of the $399 iPad 2.

A year ago, before Apple decided to sell the older iPad at a discount when it introduced the new iPad in March, the iPad ASP was $617.

The iPad Mini will probably eat into the ASP, too. "There will be some cannibalization," predicted Gottheil of buyers deciding for the Mini rather than the larger, pricier iPad. He estimated that the cannibalization rate would run between 20% and 25%, meaning out of every ten consumers who decide to buy an iPad, between two and three will choose the Mini.

"We've learned over the years not to worry about cannibalization of our own products," said Cook. "It's much better for us to do that than somebody else to do it. And the far, far bigger opportunity here are the 80 million to 90 million PCs that are being sold per quarter. I think a great number of those people would be much better off buying an iPad or a Mac, and so that's a much bigger opportunity for Apple."

Like the iPhone, the Mac line also exceeded analyst predictions, posting sales of 4.9 million units -- under 1 million desktops, almost 4 million notebooks -- for a minuscule combined growth rate of under 1%. It was the third quarter running that Mac sales growth was in the single digits.

Revenue for the Mac line was up 6% year-over-year.

"The good news was that notebooks' ASP had a big jump, and was the highest it's been since the first quarter of 2009," said Gottheil. The $1,356 ASP for Apple laptops in the quarter was up 9% over the previous period.

"That was all from the higher-priced Retina 15-in. MacBook Pro," Gottheil said, referring to the high-resolution laptop Apple started selling in June that starts at $2,199.

This week, Apple introduced a 13-in. MacBook Pro with a Retina-style screen that begins at $1,699, $500 more than the corresponding model minus the high-resolution display.

The Mac's growth year-over-year, while tiny -- just 0.6% -- was better than the computer industry average by a mile. Global personal computer sales in the third quarter were down between 8% and 9%, according to Gartner and IDC, which released their estimates two weeks ago.

But there's trouble ahead for the Mac, namely the iMac, which Apple refreshed this week. The problem: It won't have any to sell until next month, and the largest model won't be available until December.

"We'll be constrained for the full quarter in a significant way," Cook said of iMac supplies during the crucial fourth quarter. "There will be a short amount of time during the quarter to manufacture and ramp those, and I expect the demand to be robust."

Gottheil suspected that screen availability was the reason why the new iMacs won't ship for weeks. "Certainly something challenged them about the new iMacs," he said.

But he backed Apple's decision to unveil the new desktop computers this week rather than wait until enough were in the channel. "This was a gigantic roll-out this week ... they usually roll out one category at a time, but they had more to say about the iMacs than what would fit in a press release."

Gottheil thought it was better that Apple announced the new iMacs, even without any to sell, or without a way for customers to pre-order them, in the hope that that would pacify customers, "lock" them in to the iMac before they decided on a Windows all-in-one.

"But Apple's not been feeling any love for their desktops," Gottheil said.

Cook also used the earnings call, as he has a habit of doing, to ding the competition.

When asked about Microsoft's Surface RT tablet, which went on sale late Thursday in New York City's Times Square and will be available in about 60 stores in the U.S. and Canada on Friday morning, Cook admitted he hadn't touched one yet. But that didn't stop him from disparaging Microsoft's first-ever tablet.

"[From] what we're reading ... it's a fairly compromised, confusing product," Cook said of the $499 Windows RT tablet. "So I think one of the toughest things you do ... is to make hard trade-offs and decide what a product should be. I suppose you could design a car that flies and floats, but I don't think it would do all of those things very well."

Six months ago, and long before Microsoft took the wraps off the Surface, Cook had said something similar, calling tablet-keyboard combinations and so-called "hybrids" a cross between "a toaster and a refrigerator."

In after hours trading late Thursday, Apple shares were down $7.29, a loss of around 1.2%.

Gregg Keizer covers Microsoft, security issues, Apple, Web browsers and general technology breaking news for Computerworld. Follow Gregg on Twitter at @gkeizer, or subscribe to Gregg's RSS feed . His e-mail address is gkeizer@ix.netcom.com.

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