Apple’s Uncharacteristically Sloppy Execution

Apple (AAPL) reported a strong Q3 yesterday that again topped analyst estimates, but its forecast missed estimates. Along with activation and other service issues for the new 3G iPhone and concerns over Steve Jobs’ health, the weak forecast has led to shares falling 11% in after-hours trading to about $149. This is the first time Apple has looked sloppy.

For Q4, Apple expects revenue of $7.8 billion and EPS of $1 versus analyst estimates of $1.24 EPS on revenue of $8.3 billion. Gross margin is expected to decrease from 34.8% in Q3 to about 31.5%. A new accounting system for the 3G iPhone, “future product transition” and the impact of back-to-school promotions are behind this sequential decline.

In the first weekend after launching the 3G iPhone on July 11, Apple sold 1 million 3G iPhones, with many stores reporting stockouts. This compares with sales of 6.4 million first-generation iPhones in the first year of their release, adding 717,000 from Q3. By all indications, the 3G iPhone will do better, although the inventory shortfall will prevent them from doing as well as they could have. This is another situation that feels sloppy to me. Apple has released the 3G iPhone in so many markets, including numerous international markets, without working out the supply-side details – inventory, logistics, tracking, supply chain – very uncharacteristic lack of attention to operational details.

According to iSuppli, Apple is spending $174.33 on components plus $50 in IP royalties per unit while the unsubsidized price is $399/$499 for the 8GB/16GB device. That gives a 44% and 50% margin for each 8GB and 16GB 3G iPhone sold, respectively, although AT&T is selling the phone at a $200 discount against 2-year service contracts. Without an AT&T contract or subsidy, AT&T is selling the iPhone at $599 for the 8GB model and $699 for 16GB. That would imply a gross margin of 62% for the 8GB model and 64% for the 16GB model (at an additional cost of $23 for the 16GB chip). Apple gets an estimated $300 per iPhone in subsidy from AT&T. All in all, the margin numbers across the board look quite healthy.

However, Q4 sales will not be significantly affected by this high margin or by high iPhone sales due to the new accounting method in which iPhone revenue is going to be distributed over two years. This deferred revenue stance will make future revenues predictable, but both current revenue and EPS lower.

As for Q3, revenue was up 38% y-o-y to $7.46 billion, driven by 43% growth in Mac revenue. Net income was $1.07 billion, or $1.19 per diluted share, versus $818 million, or $.92 per diluted share in Q3 2007. Analysts estimated EPS of $1.08 on revenue of $7.36 billion.

Apple generated $1.33 billion in cash during the quarter, ending with a $20.8 billion reserve. Operating expenses were $1.21 billion and gross margin was 34.8%, down from 36.9% last year.

Apple shipped 2.5 million Macs which accounted for 61% of revenue. The updated iMac helped drive 49% growth in desktop sales while portable sales were up 37% due to demand for the MacBook Air as well as MacBooks and MacBook Pros. Gartner and IDC placed Apple in the No.3 spot in the US market, behind HP and Dell, for the second quarter. IDC says Apple has 7.8% share, sharing the spot with Acer, while Gartner puts the figure at 8.5%. Either way, Apple is becoming a force in the US computer market, something that HP and Dell, as well as Microsoft would need to battle in the years to come.

Music products and services accounted for 33% of revenue. Apple sold 11 million iPods in the quarter, up 12% y-o-y and 4% q-o-q, driven by sales of iPod Shuffle and iPod Touch. However, due to lower ASPs courtesy of price reductions, iPod revenue grew just 7%.

International revenue accounted for 42% of revenue. Revenue from Europe grew 43% and from Japan 40%. Asia-Pacific had y-o-y growth of 53% in the Mac business. Apple opened its first store in Australia and last weekend its first store in Beijing, and the company is planning to open stores in Switzerland and Germany in Q4.

There has not yet been any hint from Apple about how it will use its $278 million acquisition of microprocessor design company PA Semi. We have to wait also to see how Apple plans to use its $20.8 billion cash reserve. There is no lack of ambition in the ever-hungry Jobs, but perhaps he ought to acknowledge that he needs help in dealing with the growing pains of his beloved company from people who don’t shy away from the dirty details of operations.