The Oppenheimer Code, Fiscal Q1 2014, Part 2: The North Star – or Starting Point? – of Management Guidance (Advance TL;DR warning)

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NOTE:  In case you’d like to refer back, click here for Part 1 of the current, fiscal Q1 2014 edition of my Oppenheimer Code home gamer earnings preview series.

My Oppenheimer Code posts for the prior two fiscal quarters are now collected in the Earnings Previews + Archive section.

I know it can seem a bit esoteric, so I’ve written up a new Q&A about my thought process behind Part 2 of the Oppenheimer Code series (working with management guidance) if you’re new/confused/want to check it out.  Just open a new window or tab, or simply read on to get to the post itself.  ADVANCE WARNING:  It’s a longer read, even by my long-winded standards.

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What kind of December quarter does Apple have in store for Wall Street?  According to Oppenheimer, revenues of $55B-$58B.

After some intense wild-guess-type analysis 😀 , I’ll assume for this post that Apple will (at minimum) report near the high end of guidance, and once again pick a revenue number a half billion dollars away from top-end guidance.

But first, the actual results from the year-ago quarter, fiscal Q1 2013 (NOTE:  I abbreviate “iTunes/Software/Services” as “iTunes/software” to save on space):

REVENUES revs units ASP
iPhone 30660000000 47789000 641.5702358
iPad 10674000000 22860000 466.9291339
Mac 5519000000 4061000 1359.024871
iPod 2143000000 12679000 169.0196388
iTunes/software 3687000000
Accessories 1829000000
Total revs 54512000000

Now, just like the last two times, we “force-fit” the six revenue categories to my thought exercise revenue target of $57.5B.  The point isn’t to be all that precise even by home gamer standards, just to think of a general framework of YOY product category revenue trends.  Here’s my humble take on this:

Projections Within Apple Guidance Parameters

REVENUES revs units ASP
iPhone 32007500000 54250000 590
iPad 11708750000 24650000 475
Mac 6028750000 4550000 1325
iPod 1416000000 8850000 160
iTunes/software 4332225000
Accessories 2011900000
0 YOY iPhone 13.52%
YOY iPad 7.83%
Total revs 57505125000 YOY Mac 12.04%
YOY iPod -30.20%
YOY iTunes/SW 17.50%
YOY accessories 10.00%

$57.505B.  Close enough.

I’ve now added YOY (revenue growth) percentages for iTunes/software and Accessories, which is new for this part of my earnings preview.  Those two revenue categories are getting too big to ignore – I expect Accessories to permanently “outperform” the iPod category going forward, and it’s looking like the iTunes/software category is well on pace to overtake the Mac business line!

Now for some quick, non-expert commentary on each revenue category, starting with iPhone.

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iPhone – A Case of the Holiday Blahs

Not seeing any China Mobile iPhones in that guidance?  Neither am I.  Since they’re not selling until at least January 17, that leaves us with a “base case”.  And not a particularly great one, management seems to be saying.

For purposes of this post I’ve assumed an ASP of $590 (a small increase from last quarter, but a drop of about 8% from the year-ago quarter). While you may think differently and end up much closer to the mark than my “assumed” ASP (which, as I’ve mentioned before, isn’t exactly ASP, but close enough)***, I believe iPhone will run into ASP “headwinds” in the December quarter.  I’m guessing that the (apparent) popularity of the high-ASP mix 5S will likely boost iPhone from the record low ASP of around $577 that was just set, but increased deferrals (of $10 a unit or so) will reduce the impact. And considering management’s comments about the popularity of iPhone 4, the former $0 subsidized/lowest-priced iPhone, the generally far superior 4S (with built-in Siri, better camera, and the added “bonus” of being the last Dock Connector iPhone) could be a much more compelling offer for price-conscious consumers.

Could ASP be higher than $590-ish?  It’s possible.  Just one thing, though – an ASP roughly equal to the year-ago ASP is an over 8% increase from my assumption.  And given the constraints of guidance, units would of course have to decrease, with growth dropping to well below 10% YOY.  Given everything we know about iPhone historical growth, to say nothing of the initial popularity of the iPhone 5S, single-digit percentage growth YOY just doesn’t make sense even when you factor in the imposing business physics of maintaining growth from a massive year-ago unit volume of 47.789M iPhones.  After all, if Apple was reaching the limits of top-end smartphone growth, initial sales wouldn’t have increased by at least 50% over the year-ago launch weekend.  You can’t simply wave that away by saying “well, that’s because China was added as a launch country”.

Remember, prior year YOY unit growth in iPhone (adjusted) could have been as high as 39% on a like-for-like basis.  It ended up being 29% on an inherently skewed 14-week-to-13-week compare.  So if Apple managed 29% “uncorrected” YOY unit growth for disappointing iPhone 5, about 20% YOY unit growth for the entire FY ’13, and around 20% YOY unit growth during the iPhone 5S/5C launch quarter, can you seriously imagine the YOY iPhone growth rate for the December quarter being much lower than 15%…at all?  With Greater China benefiting iPhone numbers for the entire quarter?

One last note before moving onto iPad units and revenues.  I’m “ignoring” any “impact” from China Mobile right now due to complete and utter lack of information.  There was likely some degree of “sales freeze” on account of the China Mobile buzz, then announcement, but it would be mostly attributed, in my humble opinion, to those existing China Mobile subscribers intending to buy a new iPhone to use with horrifically slow EDGE speeds on China Mobile’s non-3G network, knowing that they have to somehow get a TD-LTE model to have any hope of future TD-LTE or TD-SCDMA access.  Sounds like a very select group, doesn’t it?

To this day, we still have no real idea how many iPhone-using subscribers are plodding along on China Mobile’s EDGE network – yes, there’s the 15M iPhone subs in March 2012 number, but there hasn’t been anything definitive-sounding or sourced to a named executive at China Mobile since then.  Also, it’s impossible to determine the mix of iPhones, which surely include used as well as new units.  Basically, it’s just more trouble than it’s worth to even attempt to quantify “lost sales” when almost every iPhone used by a China Mobile subscriber until January 17 won’t be able to access data on China Mobile’s 3G or 4G network.  The “lousy” 13.5% YOY unit growth assumption should more than account for that sales headwind.

iPad – Not Much of an iPad Christmas

First, the good news.  With iPad mini retina models selling for $70 more than their prior-year “equivalents”, the top-end model selling for $829, and the top-end iPad Air selling for $929 (which, by the way, is the only iPad Air model with a significant wait time to ship in China – 3-5 business days as of today), it’s very hard to see ASP lower than the $467 in the year-ago quarter.  Also, management seemed more than confident in a year-over-year unit increase in iPad – otherwise Tim Cook would never have said “it’s going to be an iPad Christmas”.

Now, the “bad” news – management guidance really won’t allow for significant YOY unit growth (as you know, the higher the ASP, the lower units have to be), and as it so happened, the new iPads (both Air and mini retina) had significant supply constraints for much of the December quarter.  While the supply situation for iPad mini retina cleared up far more quickly than for the first iPad mini, the mini retina launched over a week later in November than the first mini, leaving less time to ramp up.  And as bizarre as it sounds, there’s a chance that the iPad mini retina everyone was breathlessly anticipating (which ended up being a better iPad than anyone expected) could be “less popular” than its fuzzy-screened predecessor (at least in terms of iPad mix) due to the $70 price increase across the board, the presence of competent, full-HD-res lower-priced tablets with 7″ screens, and maybe even iPad Air itself (hey, iPad Air really is a thin and light tablet).  Yep, Tim Cook’s nebulous remarks about knowing iPad mini retina supply but not what demand would be like may have carried an actual clue about anticipated demand.

All that aside – including the China Mobile TD-LTE iPad booster rocket that may be awaiting ignition in future quarters – is around 8% iPad YOY unit growth really the best Apple can do for the all-important holiday quarter? Well, that’s what guidance is suggesting to my admittedly untrained eyes – if iPhone grew any more slowly, we’d be approaching ludicrous territory. And yet, unit growth slowing to Mac-like levels, where the Mac is turning 30, and iPad isn’t even 4?  I’ll take a closer look at this when I draw up my home game estimates for the quarter.

Mac – An Uptick in Truck Sales?

Depends on who you ask.  These are US-only estimates, but Gartner sees quite the surge from the year-ago quarter, a tremendous (for PCs, anyway) 28.5% YOY unit increase to 2.168M Mac shipments in the December quarter.  That’s huge, even if you think the delayed all-new iMac could’ve boosted the year-ago numbers.  IDC, on the other hand, sees a YOY unit drop of over 5%.

You’re not the only one thinking at least one of these companies could be a bit off the mark?  What a surprise! 😛  Well, for now I’ve decided to more or less split the difference between the two estimates.  While a YOY growth rate of about 12% (with a slight decrease in ASP) could well be too high, especially when you extrapolate to the rest of the world (Europe’s consumers may still be retrenching, China’s consumers aren’t really into PCs at all) there is a case to be made for growth.  The MacBook line is solid overall, with the ultra-long-battery-life (though “aging”) MacBook Airs as volume leaders.  And refreshed iMacs actually shipped in volume this December quarter, taking advantage of last year’s soft iMac compare.  As a side benefit, higher Mac sales makes for slightly more conservative iPhone and iPad numbers – and Oppenheimer is nothing if not conservative.

iPod – Wait, iPod Used to Be Relevant?

It was!  One holiday quarter it even accounted for the majority of Apple’s revenue!   Remember when?

Well…not anymore.  These days we guess a YOY unit growth decline in the double digits and call it a day.

A bit dismissive, perhaps, but the fact is iPod is an increasing non-factor in Apple’s financials, even during the seasonality-boosted December quarter.  iPod will probably be the smallest of Apple’s revenue categories by a considerable margin.  I applied a YOY unit decline of around 30% (revenue impact of about $700M) because the YOY decline the prior two quarters exceeded 30%.  Also, you didn’t see any truly new or refreshed iPods this year, did you?  Just not a lot of thinking that needs to be done for this category these days.  So, time to move on – as even Apple largely has.

iTunes/Software/Services – The True Fourth Leg of Apple’s “Business Chair”

Of course, iPod and iTunes go hand and hand, and for all the (often legitimate) complaining about iTunes bloatware and Mac/App Store user-unfriendliness, Apple’s digital strategy has been doing quite well, growing steadily as iOS hardware revenues likely exceed 75% of Apple’s total revenue for the December quarter.

I’m making a small adjustment this time around.  As you know, Apple is now giving away a bunch of extra software for free with the purchase of any new Mac or iOS device.  That includes OS X (Mavericks), the Mac iWork suite, iPhoto for iOS, Garageband for iOS, and “iOS iWork” – up to nine new apps in all, depending on the consumer.

Not only does the free software manifest itself as increased deferrals to Mac ($20 extra) and iOS devices (say, $10 extra?), it’s also revenue that Apple has willingly left on the table.  Of course, Apple still sells Final Cut Pro X and other software for a price, and there’s a massive amount of paid apps and digital media for sale across iTunes and the Apple App Stores.  So I’m just adjusting iTunes/software YOY growth from 20% to 17.5% while we await new data.

Accessories – Apple’s Lesser-Known $5+ Billion a Year (and Still Growing) Business

Finally, accessories.  Designer iOS device cases, Lightning cables, adapters, Apple TVs (you know, the $99 one), alarm clocks, Hue light bulbs, printers, premium headphones, Sharp 4K monitors 😀 , you name it. Collectively, they will probably outsell the entire iPod line this holiday quarter – and absent a somehow revitalized iPod line, for several December quarters into the future.

Because Accessories is a fairly new revenue category – as is iTunes/software – we only have about a year’s worth of YOY data for reference.  The data points (revenue growth numbers) are:  25% (fiscal Q1 2013), 15% (fiscal Q2), -4% (fiscal Q3), and 5% (fiscal Q4).

This is a tricky one.  It’s bad enough that there’s only four data points – there’s no discernible micro-trend whatsoever. One quarter actually had negative growth.  Yet, the holiday quarter would seem to be the perfect time for shoppers to spend most heavily on accessories as gifts and gift compliments (the same way iPod has such a predictable seasonality).

Given the lack of data, I simply adjusted my “default” YOY revenue growth rate from 20% to 10% for this quarter to “account for” the slower two quarters.  If this proves conservative, it acts as a slight (~$200M) “check” against being too cautious on the other revenue categories.

So, there you have it, humbly submitted for your review (and comment, if you like!).  If Apple reports revenues of around $57.5B, that was my wild guess as to how it got there and what the general trends were for the quarter. But it sure seems unlikely for Apple to have put up such “modest” growth in iPhone and iPad – even with those increased deferrals – doesn’t it?

My actual humble home gamer’s estimates, which as you might guess are a little higher 😛 , will be posted at the conclusion of this quarter’s Oppenheimer Code series (probably).

Next up:  The quarterly check-up on Apple’s OpEx and gross margin, most likely in separate posts as before.

*** Reposted from last quarter:  ASP isn’t quite true average selling price due to deferred revenue.  But since the vast majority of the product’s price is recognized at the time of sale (and refining ASP to account for deferrals, amortization, etc. is basically impossible), the simple division of revs by units is “good enough” for home gamer purposes.  If you want full details, you can check out Oppenheimer’s iCloud revenue deferral here (pages 4-5 of the presentation section) and any Apple 10-Q filing.  Note that AppleCare revenue is part of iTunes/software category revenues (note c, page 27 of the Apple Q3 2013 10-Q filing).

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