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Apple's $37.5 billion quarter: What the analysts are saying - updated

October 29, 2013: 7:04 AM ET

Despite the report of lower earnings -- the third in a row -- a light at the end of the tunnel.

After-market trading. Chart: Think or Swim

After-hours trading. Chart: Think or Swim

FORTUNE -- Once they wrapped their minds around the impact of deferred revenue on next quarter's gross margins, analysts came away from Monday's earnings report feeling mostly positive about Apple's (AAPL) prospects for 2014. A half dozen even raised their price targets.

Excerpts from the analysts' notes we've seen so far. More as they come in.

Glen Yeung, Citi: More Concentrated Launch Drives Sept / Dec Strength; We Still See March Downside Risk. "While not wildly so, Apple's guidance was better than consensus on all major fronts (including GM when adjusting for deferred revenues), satiating investor appetite for a beat... Our position has been (and continues to be) that Apple is a trading-oriented stock as high-end smartphone growth slows. What we failed to understand is the range in which Apple shares would trade around product launches and the impact of an activist investor. Our new target reflects these effects." Neutral. Raised price target to $530 from $430.

Mark Moskowitz, J.P. Morgan: Upward Mobility in Consensus Estimates Gets a Boost. "We recommend investors take advantage of any near-term weakness in shares of Overweight-rated Apple. Results and outlook were better than expected. The gross margin outlook could be a source of debate for some investors who had sought more upside due to higher mix of iPhone. Apple's gross margin outlook adjusts for increasing level of deferred revenue, Fx, and higher cost structures on new products in iPhone, iPad, and Mac line ups. In our view, most of these headwinds stand to be temporary, and therefore, should not overshadow the increasing momentum in Apple's top-line at a time when other companies are hitting rough patches." Overweight. Raised price target to $600 from $545. 

Bill Shope, Goldman Sachs: Estimates continue to rebound, as should the stock. "Apple reported upside to its preannounced results with revenues of $37.47 billion slightly ahead of our estimate of $37.10 billion and consensus of $36.84 billion. Meanwhile, EPS of $8.26 was well ahead of our forecast and consensus of $7.93. The outlook was solidly above expectations, particularly after adjusting for a change in deferred revenue accounting... Net-net, our numbers are going up, and we expect consensus to trend upward as well." Buy. $620.   

Toni Sacconaghi, Bernstein: Solid Guidance for Dec, but March Still a Worry. "Apple's FY Q4 results were slightly above consensus expectations and consistent with Apple's prior statement that results would be "near the high end of guidance." iPhone channel build (3.3M units) was higher than we expected, pointing to weaker sell through, but otherwise the quarter was generally clean. December quarter guidance was solid, particularly adjusting for an accounting change involving deferred revenues. Outperform. $600.  

Edward Parker, Lazard: Good results, as expected. "Headline numbers largely hit the mark against improving sentiment. As noted last month, the iPhone 5S is being received well and should arrest the negative top line revision trend seen over the past year. Gross margin outlook for December was below expectation, but is resulting from increased software deferral accounting and is not indicative of pressure on or structural change to the profit model. Apple's EM prospects and concerns of slowing growth are unlikely to be resolved soon, but December looks bright with continued iPhone strength and a badly needed rebound in iPad, with both top and bottom line growth poised to re-accelerate into calendar 2014. Buy. Raised price target to $610 from $570.

Ittai Kidron, Oppenheimer: A Good Base Into December. "Apple delivered better than expected Sept. results and a solid outlook that should support the shares near term. The key question now is whether the current strong new product interest can be sustained into the next calendar year. On that front we have a positive bias as we see potential for some 4S and 5C driven international expansion and the ability to add China Mobile as a partner. We're a bit more cautious on iPad competition given Apple's pricing strategy, although market expansion should still drive good YoY growth. Mgm't also indicated that any changes to its capital return program would come only in early CY14, which should keep investors engaged on that front." Outperform. $560.

Maynard Um, Wells Fargo: Deferral Changes Provide Margin Buffer For Future Cycles. "Our bullish thesis predicated on gross margin improvement still holds as December quarter gross margin guidance (36.5-37.5%) would have been 160bps higher at the midpoint when adjusting for the change in deferred revenue recognition (effectively, guidance could have been around 38-39%). Based on historical iPhone "s" cycles, we believe this could still prove to be conservative and believe the March quarter should continue to improve, all else equal on mix. Interestingly, the accounting change also modestly helps the gross margin story into the iPhone 6 cycle (which we have not been as bullish on gross margin) and even more so the iPhone 6s cycle (presuming Apple stays true to cycles) as the compounding of the amortized revenue should provide a larger gross margin tailwind (up to 80bps) going forward." Outperform. Valuation range raised to $536 - $581 from $525 - $575.

Stuart Jeffrey, Nomura: Solid Near Term, but Growth Elusive. "Apple's Q4 results offered few surprises after the recent positive pre- announcement. Apple is giving away the OS and key applications for new iOS and OS X devices, worth $5 to $20 per device. This boosts deferred revenue by $900m sequentially, theoretically a 160bp gross margin headwind. However, when adjusted for seasonality, we estimate that the like-for-like impact is around 87bp. The net result is a further cut to our 2014E gross margin estimates." Neutral. Raised price target to $519 from $513.  

Anil Doradla, William Blair: Solid iPhone Sales, Gross Margin Stabilization, and Healthy Channel Inventory Bode Well Into the Holiday Season. "Apple delivered a solid quarter, with the two most important products—iPhone and iPad—delivering sales upside. More importantly, gross margin improved after five- straight sequential declines, and the company provided a stable gross margin outlook despite several new product launches. Deferred revenue from iOS and MacBook products is expected to increase by $900 million sequentially (up on both a per-unit basis and due to higher-unit sales), which limited gross margin guidance by roughly 100 basis points." Outperform. 

Timothy Arcuri, Cowen: Like Mavericks, a big wave in '14. "After a set-up year in '13 (poor margin iPhone 5 launched into very immature LTE mkt), we believe '14 shapes up to be very strong for three reasons: 1) overall share of served markets should grow as LTE penetration (where AAPL share is higher) expands (we estimate >70% of iPhone user base even in US is still 3S/4/4S); 2) iPad sees a long-awaited upgrade cycle given first real hardware refresh since pdct intro'd; and 3) new category creation using software and 64bit as the beachhead (potential larger screen iPad, TV, a potentially larger screen iPhone 6, wearables, a purpose built low-cost phone (potential for 2015)). Capacity for more capital return seems constrained barring, for example, another big debt deal." Outperform. Raised price target to $590 from $550.

Andy Perkins, Societe Generale: Handsets return to growth. "For us the key to the quarter is the improvement in the handset numbers. In the 2013 March quarter, handset unit growth dropped to 7% and margins have been falling since the beginning of 2012. Reversing these trends is vital for the company. Additionally, without the new deferred revenues, we think it likely that we would have seen expansion in gross margins in the December quarter yoy. We still think the 5s is a real success and that volumes could be very large for the final quarter of the cal. year." Buy. $575. 

Kulbinder Garcha, Credit Suisse: iPhone Solid; Follow-Through Uncertain. "Amidst a solid earnings release, GM guidance was the fly in the ointment with an expected range of 36.5% to 37.5%, light of both CS and consensus expectations despite higher than expected revenue. A change in the recognition of deferred SW revenue creates a headwind in the December quarter, though a portion of the expected $900mn sequential uptick is due to typical seasonality and therefore is not all incremental." Neutral. $525. 

Rob Cihra, Evercore: Back on Top of its Game. "ASP gets help from stronger 5s vs. 5c mix, where we see 5s cycling catalyzed by 2yr anniversary of the 4S's step-function uptake. While 5c still needs to prove itself, we think its GM profile provides latitude and like the move to make midrange step-down a different iPhone not just an older iPhone, setting up new multi-SKU road-mapping we still think Apple can use to broaden markets. This remains key, since we est Apple's WW iPhone installed base exited the Sep-qtr ~267mil, with replacements accounting for ~57% of the mix but tracking to 79% of our FY14E model." Overweight. $630.

Peter Misek, Jefferies: Results Solid; Light GM Guidance Due to Accounting Changes. "Three sources of GM pressure but we believe two are temporary/one-time. 1) Accounting change. Due to the decision to offer free Mac OS, iWorks, and iLife software, Apple is deferring up to $5 per iPhone/iPad and $20 per Mac with an overall impact of $900M to CQ4 (we estimate that half of this is due to units sold prior to CQ3 and is a one- time catch-up charge). The deferred revenues will be recognized over the next 2-4 years. We estimate only a 40bp impact per Q after CQ4 with general improvement over time. 2) Apple chose 5s units over margins. Apple's strong CQ4 rev guidance implies a substantial ramp in iPhone 5s sales. Our checks indicate that the fingerprint sensor yields were ~30% at the beginning of the quarter and will likely be ~40% overall for CQ4. With the increased production, we estimate that this yield issue is hurting CQ4 GM by ~75bp but should be much less of a factor in CQ1. 3) Lower Other Software revenues due to free software upgrades. We did not fully factor in the GM hit from the free Mac OS, iWorks, and iLife software. While we est they are <1% of revs but are ~90% GM and therefore trim our FY15 GM from 39.3% to 38.5% due to the change." Buy. $600.

Katy Huberty, Morgan Stanley: Revenue Growth Trajectory Surprising to the Upside. Our CY2014 revenue and FCF estimates move higher while EPS remains unchanged due to deferral of gross profit dollars on the back of free software updates. The stronger revenue growth inflection, bullish management tone, and improving like-for-like gross margins are all bullish, in our view... Whereas two quarters ago Apple CEO, Tim Cook, set the tone by acknowledging Apple had not delivered on everyone's expectations, yesterday's call focused on confidence in the future including a strong holiday season. Management continues to highlight innovation both in current and new product categories, examples of which could include iWatch and iTV. Overweight. Raises price target to $585 from $540. 

Gene Munster, Piper Jaffray: Business Stabilized; Expect Return To Earnings Growth In CY14. "Results were largely as expected given the late quarter guidance update post the iPhone 5S launch. More importantly, the company guided Dec-13 revenue to $55-58 billion and gross margins to the midpoint of 37.5% excluding the unexpected change in deferred revenue policy. The revenue mid-point was ahead of our expectation and the adjusted gross margin was in-line. The overall trends in the business have stabilized, and we expect earnings to be essentially flat y/y in Dec-13 and up 8% in Mar-14, marking the first earnings growth quarter in 5 quarters. We are modeling revenue growth to go from 5% in CY13 to 8% in CY14, and EPS growth to go from down 10% to up 15%. Our model does not reflect new product categories (likely TV & Watch) that were hinted to again on the earnings call." Overweight. $640.

Amit Daryanani, RBC Capital: Healthy Print and Guide Given The Change In Deferrals. "AAPL reported a strong Sept-qtr and guided Dec-qtr revenues ahead of expectations. The one (perceived) negative was Dec-qtr gross-margin of 36.5-37.5%, we note that reflects 160bps headwind due to deferrals. Fundamentally, we believe AAPL is executing impressively and we see more catalysts: i. China mobile deal, ii. iPad/iPad mini launches, iii. potential increase capital allocation." Outperform. Raised price target to $590 from $550. 

Avi Silver, CLSA: Gross margin conundrum. "Even after the various explanations on the call, we are still surprised that the gross margin outlook is not better. Apple discussed the $900m impact from deferred revenue growing based on an increase in software deferral per device along with increased volume in the Dec-Q. As the volume growth is well understood, we isolate this and focus only on the software deferral increase per device, which reflects more free software from Apple (iWork, iLife, Mavericks). Based on our math, the impact should be $491m (Figure 2) or 80bps, which would have brought the gross margin range to 37.3-38.3% vs the 36.5-37.5% actual guidance." Outperform. Raised price target to $613 from $590. 

Chris Whitmore, Deutsche Bank: Product cycles kicking into gear. "We expect strong holiday demand for Apple's new product lineup and suspect its guidance will prove conservative. Furthermore, Apple remains very confident in its product pipeline heading into CY14. Specifically, we see multiple catalysts to support growth over the next 12-18 months including iPhone 6, expansion with China Mobile and further geographic expansion. In addition, Apple pointed to expanding into new product areas (Apple TV and/or wearables) which should alleviate innovation concerns. Buy. $575. 

Walter Piecyk, BTIG: Apple Takes Another Step Towards Its Return to Growth. "Inventories of iPhones rose by 3.7 million units in the quarter, which was the largest increase ever.  The company claims that 1.8 million phones were "in transit" and not available for sale.  However, there is no context for this in transit reference to compare that to prior quarters.  The company claimed that iPhone inventories are below their target of 4-6 weeks which is positive and clearly implies a strong expectation for the December quarter... Share repurchase of $4.9 billion was lower than the $7.5 billion we expected and much lower than the $16.0 billion last quarter.  As a result, the reported EPS was $0.09 lower than it would have been if they bought more stock.  Remember that last quarter $0.12 of the $0.22 EPS upside the company reported was a result of that massive $16 billion buy back during the quarter." Buy. $540. 

Brian White, Cantor Fitzgerald: Apple Delivers a Strong 4Q Print, Looks Forward to a Year of Innovation in FY:14. "Tonight, Apple reported strong 4Q:FY13 results and offered up a healthy 1Q:FY14 outlook. At first, there were concerns on the call regarding the margin outlook; however, the gross margin outlook is skewed by increased deferred revenues and margins actually would be higher than our projections when excluding this impact. Given a strong quarterly performance, a bottom in the profit cycle based on our model, our expectation of a year of innovation in FY:14, and Carl Icahn getting louder around the need for increased cash distribution, we believe Apple has upside to our $777 price target." Buy. $777.

Brian Marshall, ISI Research: Easy Math since 2 x 300 = $600. "We believe strong iPhone 5s/5c uptake despite relatively modest hardware upgrades reinforces our view of the "stickiness" of AAPL's ecosystem. In addition, we are seeing AAPL taking advantage of its tight integration with a much stronger focus on adoption of its applications this year. In particular, we believe AAPL's recent announcement to offer for free (value of ~$45 on iOS) its popular productivity/creativity software suites (e.g., iWork consisting of Pages, Numbers, Keynote and iLife consisting of iPhoto, iMovie, GarageBand, etc.) have gone largely underappreciated. In our view, this, along with ongoing improvements to AAPL's cloud services should help AAPL retain ecosystem dominance." Strong buy. $600.

Aaron Rakers, Stifel Nicholas: China Growth Remains in Focus. "Lacking a Significant Snapback? Apple reported Greater China revenue at $5.733B, +6% yr/yr and +31% seq. While return to growth is positive, we believe investors should continue to question Apple's relative underperformance in this key Geo over the past two quarters." Buy. Raised target price to $600 from $540. 

Charlie Wolf, Needham: Apple reports Q4 nominally above guidance, Raising our 2014 estimate. "The most positive news coming out of Apple's conference call was the company's heightened confidence that it could grow iPhone sales at the three price points currently characterizing the lineup. Contrary to the misplaced hopes of the investment community, Apple has no intention to build market share through downscale pricing. The company believes it can drive the demand curve to the right—a view we share—by solidifying its position as the aspirational brand and ecosystem in the smartphone industry. We do not anticipate a breakout of growth. But it should be steady as more households enter the middle class in emerging markets. Buy. $595.

Colin Gillis, BCG. Waiting for China Mobile. "Haiku: Upside catalysts, are dwindling for Apple, as news hits the tape. Apple posted upside September quarter results and issued strong December quarter holiday guidance that was above consensus expectations. With the product refresh complete for the year, in our opinion, and the holiday December quarter guidance issued, we see upside catalysts for shares of Apple dwindling. We note that Apple has changed its guidance practice to land in or near its guidance range, so we do not see material upside to Apple's December quarter results. The one remaining catalyst we see is adding China mobile-the world's largest carrier with over 700 million subscribers- to the list of carriers that sell the iPhone." Buy. $550. 

Steven Milunovich, UBS: iPhone strong, iPad soft. "Shipment of 33.8mn iPhones beat our 31mn estimate and was up 26% YoY. The backlog on 5s is significant though Cook said he is confident supply will ramp. Little was said about 5c demand, likely because it has been mediocre." Neutral. $540... The Dec quarter guide of 36.5-37.5% seemed light, but Apple said that there would be a $900mn increase in deferred revenue ($5 or 33% on iPhone/iPad) to account for the increased free software with iOS device sales. We think the right way to think about this is that of the $900mn additional deferral about $400mn is related to unit growth that would have occurred anyway and about $500mn to this increase in deferred revenue per unit. So the gross margin hit is half a point or a bit more." Neutral. $540. 

Stephen Turner, Hillard Lyons: Solid Fiscal Fourth Quarter Results; Deferrals Soften our FQ1'14 View. "Apple generated record FQ4 operating cash flow of $9.9 billion, and free cash flow of $7.9 billion. Net cash & investments totaled $129.8 billion or ~$143 per share. Share count was reduced by 15 million q/q, as the company returned $7.7 billion to shareholders during the quarter." Buy. Raised price target to $580 from $545.  

Jack Narcotta, TBR: Apple's cachet with customers will provide som protection from Android OEMs, but revenue growth will be hindered into 2Q 2014. "It is clear with Apple's 3Q13 earnings report that the company's phenomenal annual revenue growth rates, even for quarters in which the company launches a new iPhone, are a thing of the past. Pricing pressures applied by Android OEMs such as Samsung, Sony, Lenovo, Huawei, combined with continued weakness in the global PC market reducing iMac sales and shipments, are forcing Apple to rely on the strength of brand to protect its customer base in developed markets, and utilize lower-priced older models of iPhones and iPads to expand into emerging markets." Link.

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About This Author
Philip Elmer-Dewitt
Philip Elmer-DeWitt
Editor, Apple 2.0, Fortune

Philip Elmer-DeWitt has been following Apple since 1982, first for Time Magazine, and now on the Web for Fortune.com.

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