Apple (AAPL): A Look at Management's Guidance

This purpose of this post is to provide some historical data points as a more detailed analysis will be forthcoming in a future write-up. 

The tables below depict Apple's quarterly guidance versus actual results. The tables begin at 2Q13 when Apple began to start providing "real" guidance opposed to low-ball figures that it always exceeded by a wide margin. That guidance reflected the absolute minimum results that management was essentially 100% certain it would achieve. The revised guidance dropped the EPS forecast and added ranges for expected revenue, gross margin, and operating expenses. Most significant change- accuracy. 

Apple exceeded the high-point of its revenue guidance only 4 times (or 33%) for the 12 quarters spanning FY16-FY18. The margin was no higher than 1.5% and roughly averaged 1%. Revenue was on the high-end of guidance for 6, or half of the quarters FY16-FY18, and twice below the midpoint.

FY15 was different story as performance in China and the iPhone 6/6+ surprised everyone. Revenue for 1Q15 exceeded guidance by 12%, yet that margin shrank in the ensuing 3 periods with each period's forecast more accurate than the previous one. Perhaps Apple overshot for 1Q16-2Q16 as it was close to missing revenue entirely. Those have been the only two quarters revenue has come in on the low-end of the forecasted range. Last quarter (1Q19) was the only time Apple failed to reach the low-point of sales guidance. 

In short, it's quite likely that Apple's revenue will be above the midpoint of its guidance, but  exceeding the high-point is not a given. 

Revenue guidance is typically a $2B or $3B range, the latter is common for December quarters. Just twice has Apple given a $4B range, which occurred in the last two quarters. The first time, Apple missed by a mile. What does that portend for the results of this quarter   given the revenue is range is $4B again? Does the embarrassment of huge miss last quarter alter management's psychology, or rather its confidence in the outlook provided to investors?  The natural reaction is more conservative guidance- numbers certain to achieve. However, Apple can't be too conservative and low-ball guidance since it will freak the market and the stock will get crushed. 

Take a look at the $59B-$55B revenue guidance Apple provided for this quarter, 2Q19. If we assume guidance is based on management's desire to give numbers low enough it is certain to reach AND also high enough not to shock investors-  wide range of $4B allows it to do both.

What are management's actual expectations? Is Apple really expecting revenue to come in on the low-end between $55B - $57B? But also tacked on and extra $2B to the range making the high end $59B so guidance would not look weak?

Or, does Apple actually expect revenue on the high-end of $58B - $59B but expanded the range down to $55B on the low-end to limit the possibility that it misses revenue guidance entirely? Perhaps a mixture of both, adding $1B to the top and bottom of the range?

I am inclined to believe that Apple is targeting the high-end for 2Q19. The Street expects the same as consensus stands above the midpoint at ~$57.5B. I am expecting 2Q19 revenue to top $58B. While still a 5% Y/Y decline similar to 1Q19, iPad and Mac will benefit from easier Y/Y compares coupled with channel fill from the introduction of new iPad and iMac models.    

  

UPDATE- Apple (AAPL): Number of Shares Sold Short Explodes

In the last Financial Alchemist report, I wrote about the massive increase in the number of AAPL shares sold short according the 2/28/19 report. I speculated that it had to be a single entity, likely a hedge fund that was at the center of such a large change in short interest. However, what did not occur to me was the possibility that this was linked to Apple's accelerated share repurchase program. This involves an investment bank essentially going short the stock as part of the process. Kudos to genius Daniel Tello at AAPL Model for pointing this out.

The ASR process:

1. Apple enters into an ASR agreement with an investment bank and pays full cash amount upfront.
2. The bank borrows AAPL shares from portfolios of its brokerage clients and/or other brokerage houses, using the cash from Apple as collateral. The investment bank is now effectively SHORT.
3. The investment bank delivers Apple the borrowed shares, equal to 85% of the payment, and outstanding shares are reduced immediately.
4. The investment bank goes out to the open market and buys AAPL shares to cover its short position returning shares that it borrowed. 
5. When the ASR is complete, the bank settles with Apple the net remaining shares owed, further reducing outstanding shares. 

We should expect to see a significant reduction in Apple's share count when it reports 2Q19 results. The effect on EPS is less known since the share count used in the calculation is a weighted average of outstanding shares over the quarter. However, it will be quite lower, and the ASR does not reflect the shares Apple might be buying back on its own using a 10b-5 plan.

Dissecting Apple's (AAPL) Consensus Estimates for FY19

As depicted in the graphs below,  Apple's revenue and EPS consensus estimates have come way down.  The first sharp drop occurred in the beginning of January when Apple warned it would not meet guidance and issued a revised revenue forecast that was $7B lower than its initial guidance. The stock bottomed around $142, and gradually rose through the rest of January to the mid $150's- even as consensus estimates were still falling. After Apple reported Q1 results at the end of January, estimates took another leg down, but Apple's stock price jumped to over $170. Apple's stock price has anticipated decreases to consensus estimates as analyst revisions have lagged stock price movements. Apple's stock began its decline when it reported Q4 results at the beginning of November. Apple issued weak guidance and announced it would no longer report unit sales. The stock took a steep dive, but estimates only decreased slightly. And while estimates have dropped significantly in recent weeks, Apple's stock has rallied. This suggests that the bad news has been priced in, and that the market expects revisions to stabilize or perhaps even rise.

The table below highlights what appears to be a disconnect between revenue and EPS estimates. Revenues are expected to fall mid-low single-digits, but EPS is forecasted to decrease much more, as much as double-digit declines for Q2 and Q3. If we assume that Apple repurchases 125M shares each quarter, then net income based on those share counts coupled with consensus EPS estimates points to even a much larger Y/Y decline in net income. Those net income levels imply 300-plus basis point drop in net margin. Does this make sense? 

As we saw in Q1, sales dropped 4.5%, but EPS rose 7.5% due to two factors. 1) EPS benefited from a lower share count. 2) Net income only fell 0.5% due to a lower tax rate boosting net margin by 100 basis points.  Thus, with Apple expected to buyback considerable amount of stock, one would expect EPS to perform better than revenue as seen in Q1. However, upon closer analysis the forecasted relationship between sales and EPS appear to be reasonable. 

There are 3 factors or headwinds that could offset the benefit of a lower share count. 1) Lower revenue causes a loss of operating leverage as fixed costs are spread over a smaller revenue base resulting in margin compression. Gross margins are pressured by depreciation expense that is independent of sales volume. Aside from depreciation, there are other fixed costs that affect gross margins. 2) Operating margins are affected by the levels of SG&A and R&D expense which are relatively fixed. R&D has been rising at a much faster pace than revenue for several years. With an expected smaller revenue base, these expenses will compress operating margins if they are at levels equal to or higher than last year's. 3) Higher tax rates will compress net margins thus negatively impacting net income. Apple is guiding to a tax rate of 17% for Q2 vs. 14.5% for the year-ago quarter. Apple's tax rates for Q3 and Q4 last year were 13.3% and 14%, respectively. If 17% is the norm for the remainder of FY19, then net margin will be negatively impacted.

Investors should keep an eye on the trends affecting these 3 factors- gross margins, operating expenses, and tax rates as they will be the primary drivers behind net margins which drives net income. Since EPS is net income divided by the share count, net income should be the primary focus since it can be safely assumed the share count will fall. We just don't have much visibility for what net income will do.

FA Estimates for Apple (AAPL) Q1 2010

Apple Inc. (nasd:AAPL)- Apple reports Q1 2010 results after the bell today, January 25th.

Below are my expected numbers:

Tailwinds Q1 2010:

1) Improving economic environment and consumer spending.

2) New iMacs released in October.

3) iPhone expansion into China, Korea, and additional carriers in current markets.

4) iPhone 3GS channel fill due to supply constraints in Q4.

5) Strengthening international demand for Macs, iPhones, and iPods.

6) iPhone “halo effect” benefiting Mac demand.

7) USD weakening should lift ASPs from sales abroad.

8) iPod sales mix shifting towards touch models should lift iPod ASP.

Headwinds Q1 2010:

1) Unavailability of higher priced iMac models in December.

2) GM pressure for shipping costs from iMac refresh.

3) Higher provision for warranty expense stemming from defective 27’ iMac units.

4) iPod product life cycle maturing, potential market nearing saturation, and cannibalization of iPhone/iPod touch demand.

5) Competition from low-price notebooks and netbooks resulting in MacBooks appearing to be much more expensive.

On balance, tailwinds were much more stronger than headwinds that Apple faced in Q1 2010. Thus, Apple should report an extremely strong quarter.

Disclosure: Long AAPL

Apple Inc (AAPL): Q4 2009 Estimates

Apple (nasd:AAPL) reports its Q4 2009 results on Monday, October 19th. I am expecting revenue to increase 19% (Y/Y) to $9.374B and EPS to increase 25% to $1.57.  I expect gross margin to rise sequentially to 36.7% from 36.3% reported in Q3.

Revenue growth will be driven by strength in the iPhone, iTunes, and software segments. Mac units sales will be up (Y/Y), but Mac ASPs will be down resulting in slightly lower Mac revenue (Y/Y). iPod revenue will be down 10% due to lower unit volume and ASPs.

Earnings growth will be driven by the higher sales mix of high-margin products such as iPhones and software.

Disclosure: Long AAPL

Apple's FY09 EPS Estimate Too Low

Apple Inc (nasd: AAPL)- Apple’s FY09 EPS estimate continues to be revised downward and now stands at a $5.08, a level Apple should easily exceed. The consensus FY09 estimate represents a 5.2% decline from FY08 $5.36 EPS, although revenues are forecasted to increase 11.8%, or $3.8B to $36.3B. Thus, analysts are expecting significant margin compression. Specifically, the consensus estimates for EPS and revenue imply net margin will be 12.8% in FY09, a decline of 2.1% from 14.9% recorded in FY08.

It’s not that I don’t believe the recession will take a major toll on Apple, it will. Instead of achieving 35%-40% earnings growth likely to occur in a normal economy, Apple’s EPS should increase at least 5%-10% in FY09. Due to deferred revenue recognition and upward margin pressure, it’s very unlikely Apple’s earnings will decline, certainly not to the 20%-30% magnitude some analysts predict.

I believe there are two major factors being ignored with respect to FY09 estimates that suggest higher earnings. First, there are multiple factors in play that argue against margin deterioration. This includes lower product and overhead costs, and a more favorable sales mix towards high margin products. iPod revenue (as percentage of total sales) will be much lower in FY09 which is significant since iPod has the lowest margins. iPhone and software have the highest margins and will contribute a much larger portion of Apple’s total revenue.

Second, Apple will recognize a sizable amount of deferred revenue associated with high margin segments, such as iPhone and AppleCare. Also, Apple’s $25B cash position will produce a decent amount of income. Thus, without even having to make a single sale, Apple should still produce $2.67/share in incremental after-tax income.

Assuming 19M iPhone unit sales, incremental taxed EPS for iPhone segment would be $2.99/share. Combining deferred revenue, interest income, and iPhone sales; I estimate incremental EPS will be $4.04. Apple would only have to earn $1.04/share in its other segments to meet the FY09 consensus.





According to Yahoo Finance, the lowest estimate for FY09 is $3.70 (High- $6.00). I have been seeing many estimates being revised down to the mid-to-low $4 range. In my opinion, these estimates are ridiculously low. Canaccord Adams puts FY09 EPS @ $3.70 (31% decline) with an $80 price target and Morgan Stanley’s FY09 estimate is $4.37 (18.5% decline) with price target of $95.

PROFIT MARGIN OUTLOOK:
I recently did a detailed analysis of Apple’s profit margin outlook and concluded that FY09 gross margin expectations are too low. I highlight some of my main points below.

-Favorable Cost Environment:
All of the factors listed below should lead to lower costs, hence higher margins. At the least, provide margin stability by eliminating upward pressure on costs. Considering most of FY08 was marked by a commodity bubble and $100-plus crude, FY09 should be a much more favorable cost environment.

1) Raw Material / Component Prices
2) Energy- Transportation / Overhead
3) Occupancy / Labor (stable)
4) Marketing
5) Scale Benefits & Shared Costs

-Margin Expansion From Increased iPhone Revenue:
The primary driver for higher margins for FY09 is iPhone revenue. The iPhone generates substantially higher margins than the Mac and iPod segments. Due to the subscription accounting whereby iPhone sales are recognized over 8 quarters, the margin effects were minor for FY08 since only $1.84 Billion of iPhone revenue was recognized. This equates to roughly 5.7% of Apple’s total FY08 revenue.

Most analysts and myself included, expect iPhone revenue to come in above $7B for FY09. Not only will the iPhone supply more than 20% of Apple’s total sales (FY09), the subsidy payment agreement of the new 3G model translates into even higher margins compared to the legacy iPhone. I calculated that the gross margin of the new 3G model was 55% in 4Q08.

If Apple recognized iPhone revenue in the period sold, instead of deferring, 4Q08 gross margin would have been 39% compared to GAAP 34.7%, net margin would have been 20.9% vs. 14.4%, and EPS $2.69 vs. $1.26. As deferred revenue continues to pile up on the balance sheet, the portion recognized in current quarterly revenue will continue to increase each quarter.

-Other Margin Drivers:
There are several other factors that could aid profitability this year. First, software revenue, which has huge margins, will be much higher in FY09. Apple is releasing new iWork and iLife editions, and it’s expected to release Mac OSX 10.6 “Snow Leopard” this year. MobileMe also carries high margins, yet even though revenue won’t be much, the yr/yr incremental will be sizable. Second, Apple will incur and recognize more of its high margin AppleCare revenue.

Looking at operational expenses, such as SG&A and R&D, these items should fall on a percentage basis (of total sales) due to leverage effects if sales continue to increase as expected. Looking at the table one can see the trend in declining operating expense and rising profit margins.



The other side of the margin equation is selling price. Margin compression can still occur even while costs are decreasing if selling prices drop more. Apple’s brand is unique and it products command premium prices. Apple’s products are highly differentiated which eliminates price competition. I don’t expect Apple to make drastic price reductions. I recently explained why Macs sell at premium ASPs.

SALES OUTLOOK:
The Street is expecting sales to increase 11.8%, or $3.8B to $36.3B (FY09) vs. $32.5B (FY08). By default, Apple’s sales will increase $3.5B from recognizing 4.85B in current deferred revenue. Apple will also take in around $400 million from iPhone carrier payments and $650 million in investment income. Thus, even with out making a single sale in FY09, Apple will still post nearly $6B in revenue.

Total FY09 iPhone revenue will likely increase by at least $5B, implying Apple’s other revenue is expected to decline if consensus sales growth is $4B. Most analysts expect iPod revenue to drop significantly, coupled with either a slight increase/decrease in Mac sales. I see iPod unit sales declining 25%-30%, but iPod revenue only dropping 15%-20% due to the shift towards the higher ASP touch model.

-iPhone:
According to my estimates, Apple will report iPhone FY09 sales of $7.0B, $3.1B originating from new sales, and 3.9B from recognition of deferred revenue and carrier payments. This assumes Apple sells 19M units. With 56% gross margins, iPhone will contribute $2.99 in EPS. Hence, all other segments only need to earn $2.09/shr to meet the Street’s estimate.

I estimate only 60 cents of $5.36 FY08 EPS is associated with iPhone, which leaves $4.76 from all other segments. This means FY09 non-iPhone EPS could decline 55% or $2.67 to $2.09 and match the $5.08 consensus if iPhone can pull in $2.99/share.

-Mac:
With new MacBooks released in Q1, and new desktops expected in Q2/Q3, FY09 Mac sales should continue to grow despite the weak economy. MacBook hasn’t seen a redesign since being released in 2006. This has provided little reason to replace/upgrade. Looking at unit sales growth, it is evident that the product line had become very tired and in need of a refresh as growth began to lag desktops. There are probably 5M MacBooks that may be replaced in the coming year.

Mac revenue has grown roughly 40% for the past two years, and under favorable economic conditions, I would expect growth to continue if not exceed that pace. Given the harsh economic conditions, I expect single-digit unit growth for FY09.

-Pod:
Unit sales will probably see a sharp decline in FY09 due to the economic landscape and product saturation. The iPod touch model will be popular causing unit sales to exceed forecasts. In addition, the touch will boost ASPs, which will soften the decline in dollar sales.

-Music & Software/Services:
Music segment revenue increased 34% to $3.34B in FY08. Music sales will continue to demonstrate strong growth due to the direct placement of the iTunes music store on the iPhone and iPod touch allowing purchases/downloads in seconds over cellular and Wi-Fi network connections. The iTunes App store could add up to one billion in additional sales this year.

Software sales could get a billion dollar boost from iWork ’09, iLife ’09, Snow Leopard, and MobileMe plus other titles. Typically software delivers high profit margins, thus these software introductions should offer margin support.

CONCLUSION:
When considering the amount of high margin deferred revenue and interest income Apple will recognize this year coupled with multiple drivers lending margin support, it’s unlikely Apple’s earnings will fall in FY09. Apple won’t earn $7 to $8 in EPS possible in a favorable economic climate, but EPS won’t decline as analysts predict.

Apple already has $2.67 in incremental EPS in the bag. Including my estimates for new iPhone sales, the incremental EPS effect is $4.04. Considering SG&A and R&D expense, I estimate that EPS from deferred revenue recognition, interest income, and iPhone sales will be $3.43. Adding Mac, iPod, and all other segments, EPS will easily top the $5.08 concensus.

Disclosure: Long AAPL