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A man shows a photograph he took on his iPhone of an Apple store in Beijing June 6, 2012. (DAVID GRAY/REUTERS)
A man shows a photograph he took on his iPhone of an Apple store in Beijing June 6, 2012. (DAVID GRAY/REUTERS)

Behind the numbers: Why Apple missed the mark Add to ...

A rare earnings disappointment for Apple Inc. dealt a blow to investor sentiment already weakened by an intensifying financial crisis in southern Europe.

Markets are likely to focus on the shortfall in Apple’s profit margins Wednesday as an indication of Apple’s future growth.

Gross profit margins for Apple declined almost 5 percentage points to 42.8 during the quarter, well below expectations. Management projected margins to fall to 38.5 per cent in the current quarter.

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Technology stocks have historically been extremely sensitive to changes in gross margins. Falling profitability often signifies declining market share and pricing power. In Apple’s case, average selling price (ASP) for iPhone and iPad declined 3.5 per cent during the most recent quarter. Analysts expect this trend to continue until new products are released.

Samsung is the most likely beneficiary of the slowdown in Apple sales. Now the largest smartphone manufacturer in the world, Samsung is gaining market share with its recently released Galaxy III device.

The regional breakdown of Apple revenues provided a number of clues regarding the health of the global economy. CEO Tim Cook made specific reference to soft sales from the resource-focused economies of Canada, Brazil and Australia, a trend that potentially signifies slower commodity demand from emerging markets. Apple revenues from Europe declined 6 per cent as economic volatility continues to depress sales.

Apple management announced they were content with revenue growth in China, although quarter-over-quarter sales dropped 28 per cent. Mr. Cook said that a large inventory adjustment was responsible for the decline.

Apple results highlighted the company’s dependence on iPhone sales. Sales of iPad were more than two million units ahead of expectations but this was not enough to compensate for the shortfall in iPhone revenues.

Earnings guidance for the current quarter reflected continued weak demand. However, the famously secretive management team hinted at a fall 2012 release of the iPhone 5. Rumours about the new iPhone were cited by many analysts as a major detractor from current iPhone sales, as consumers delay purchases until the new product is released.

Apple has been a reliable source of positive earnings surprises for investors in recent years. Management has earned a reputation for “sandbagging” the market, guiding analysts to project profits that the company can easily exceed. Investors are likely to view this quarter’s disappointment more critically as a result.

Markets reacted negatively to the earnings report, sending the stock lower by more than five per cent in after hours trading. This weakness however, may prove temporary. The release of the new iPhone is likely to release pent up demand, restoring profit growth to higher levels.

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