The Oppenheimer Code, Fiscal Q2 2014, Part 2: Stay Within the Lines – Forecasting Apple’s Revenue Mix + Quick Earnings Estimate

Welcome to Apple’s post-holiday “hangover quarter”, also known as the March quarter.

 

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Oppenheimer, with only months to go before he begins transitioning the CFO role to current Apple VP/Finance and Corporate Controller Luca Maestri, put Wall Street on edge in late January with guided revenues of $42-$44B.  Not long before the fiscal Q1 2014 results were released, analysts were expecting…about $2B higher than that.

But I’ll get back to analyst expectations later in my home game earnings preview series (hopefully – there’s a lot of typing between here and there). For now, I’ll be looking at a potential revenue number within guidance, and from there taking a second leap of logic by forecasting a revenue mix, fit to that number.

Things will differ some from previous quarters – this will form the basis for my humble home game estimate, absent an unusual event like a guidance-related 8-K filing from Apple. I’ll put the rest of my home game numbers at the end of this post.

On to the intense wild-guess-type analysis. If there’s one thing Oppenheimer has been most known for throughout his tenure as Apple CFO, it’s conservative guidance. And even under the still-fairly-new range guidance methodology, Apple still shows a strong unwillingness to overpromise. Result? All actual revenue numbers since fiscal Q2 2013 have been at the upper range of the guidance range, or slightly beyond.  Which is why I’ll assume, again, that Apple will report revenues of about $43.5B – a half billion dollars shy of top-end guidance.

But first, the actual results from the year-ago quarter, fiscal Q2 2013 (NOTE:  I abbreviate “iTunes/Software/Services” as “iTunes/software” to save on space):

REVENUES revs units ASP
iPhone $22.955B 37.430M 613.28
iPad $8.746B 19.477M 449.04
Mac $5.447B 3.952M 1378.28
iPod $962M 5.633M 170.87
iTunes/software $4.114B
Accessories $1.379B
Total revs $43.603B

Once again, we “force-fit” the six revenue categories to my thought exercise-ish revenue target of $43.5B.  “If Apple reaches this revenue level, how did it get there?” Here’s my humble take on this, and yes, of course, your opinion may vary – considerably:

Projections Within Apple Guidance Parameters

REVENUES revs units ASP
iPhone $22.320B 36M 620
iPad $8.918B 20.5M 435
Mac $5.629B 3.95M 1425
iPod $560M 3.5M 160
iTunes/software $4.628B
Accessories $1.448B
YOY iPhone -3.82%
YOY iPad 5.25%
Total revs $43.502B YOY Mac -0.05%
YOY iPod -37.83%
YOY iTunes/SW 12.50%
YOY Accessories 5.00%

$43.502B.  I think that’s close enough.

Now for some home gamer commentary on each revenue category, starting with iPhone.

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iPhone – Year-Over-Year Unit Decline? Is This Really Happening?!

The most “ominous” words from Oppenheimer in the last conference call? In my opinion, “we expect the value of the underlying sellthrough to grow year-over-year”.

Now, it’s true that I’m just a humble home gamer. Had I a better ear, more concentration, etc., certain sellthrough data would be fairly easy to break out. With iPhones – track changes in channel inventory, adjust GAAP sell-in accordingly, and there you go.

There’s just one problem – for whatever reason, it’s just not that easy for me to do, at least on a look-back basis. The quarterly/annual data is dense, but it’s written and easily referred to on demand. Sellthrough information is only spoken of, and somewhat selectively – plus, if you don’t regularly update your podcasts, you’re left with transcripts (which Morningstar does a great job of transcribing and maintaining, by the way).

Bit of a detour/”complaint” about Apple needing to be clearer about sellthrough there, yes, but the main point I wanted to make is as follows:  Sellthrough is the measure of actual sales in a quarter, but GAAP sell-in is what Wall Street and market participants seems to focus on most – since it’s what we see, written and easily referred to in the earnings release, 10-Qs/10-Ks and the dozens of articles, analyst notes and blog posts that cite sell-in numbers and always seem to emphasize “slowing iPhone growth”.

And in this home gamer’s non-expert opinion, it’s tough to see GAAP unit sales growing year-over-year this quarter. Despite Apple having had what I recall to be a continuous record of YOY iPhone unit growth (sell-in basis) up to this point.

That would be a big change – from 7% YOY growth as of the March 2013 quarter – and not a positively received one. Yet not surprising – Oppenheimer’s sellthrough comment is an indirect, yet clear signal as to the value of GAAP sell-in-based revenue, as reflected in guidance. Don’t expect that to grow much, if at all.

Aside from the quarterly revenue “ceiling”, why do I think iPhone YOY unit growth ends in the March quarter? Well, let’s look at iPhone “average selling price”.

Despite increased deferrals, Apple rang in an “ASP”*** of $637 compared to the year-ago quarter. Considering the $5 in extra deferrals; currency headwinds (which means less US dollar revenues); and the conventional wisdom that smartphone ASP, as with consumer tech prices, should trend downward over time, iPhone ASP was essentially static year-to-year. Higher ASP points to a higher mix of iPhone 5S sales. Indeed, Tim mentioned customers’ preference for the 5S during the last conference call. While the upcoming quarter could always surprise (remember the popularity of iPhone 4 in fiscal 2013?), it seems ASP can only decline so much, particularly when you consider that China Mobile started selling the iPhone 5S and 5C in January, and the 5S is apparently more popular worldwide (and for good reason).

Higher ASP, lower units for a given revenue. Sure, total revenue could surprise to the upside, but Oppenheimer’s “restrictive” range methodology and the lack of 8-K filing as of time of posting don’t seem to leave much room for that possibility.

I ended up with an ASP of $620 and a YOY unit decline of close to 4%. Even if you assume that ASP will decline as it did in Q2 2013, and adjust downward to about $608 (due to the higher deferral), that still won’t reverse the trend, assuming the same total iPhone revenue.

So, about total iPhone revenue. Am I being too bearish here, and too bullish on iPad and/or Mac?

iPad – Growth Up in the Air – or Up TO the Lower-Priced iPad Lineup?

Moving on to iPad, the continual post-PC unit sales enigma.

iPad Air and mini retina both looked incredibly compelling, with pricing mostly well north of $450. iPad mini retina pricing topped out at $829. iPad Air, $929.

And what happened in fiscal Q1? “ASP” of $440 – about a $20 drop per unit from the year-ago quarter accounting for higher deferrals. Don’t forget, in holiday 2012, the top-end iPad cost $829 and the starting-at-$329 iPad mini stole the show.

Translation? The $299+ iPad mini and/or $399+ iPad 2 were very popular this holiday season. In this case, the consumer voted for lower-priced iOS product. And as the iPad Air and mini retina “age” with a massively improved 4th-generation iPad taking the iPad 2’s place and $399/$529 price points as of mid-March, is that general trend likely to change?

I’m thinking no, which is why I’ve estimated iPad ASP to fall a bit sequentially, to $435. Could ASP fall further? I suppose, but ASP was never lower than $436 (prior deferral system) set in fiscal Q3 2013, and iPad Air/mini retina are the most compelling high-end iPads to date, so they should have some staying power.

Now what about iPad unit growth? From 65% in the year-ago quarter to just over 5% for the current March quarter? Really?!

Given the guidance – yes, really. YOY iPad unit growth (GAAP sell-in basis) was “just” 14% in the prior quarter, indicative of slowing growth at least for now. (We’ll see if the arrival of TD-LTE iPads on China Mobile moves the needle much over the next year or so.)

Is it possible that iPad or Mac are doing considerably worse than my home game estimates, such that my iPhone estimates are too low? Well, I’ll get to Mac in a moment, but bear in mind that for all of iPad’s importance to Apple, it’s generally accounted for less than 20% of Apple’s quarterly revenues lately. So even if iPad, as a newer product line, is selling around 10% fewer units than I’ve estimated, the general theme of iPhone growth grinding to a halt doesn’t really change.

Mac – Mac Truck (er, Mac Pro) Should Help Apple’s Revenue – But By How Much?

Could be just me, but I think my home gamer’s thoughts on iPhone and iPad are at least somewhat reasonable. Still, have I estimated the Mac business to be more robust than it should be?

Gartner and IDC see negative Mac unit shipment growth in the US, at -3.8% and -7% respectively.

I’m thinking Mac unit sales will be just about the same as the year-ago quarter, at minimum, due to ample supply of iMac (which Apple still had trouble ramping in the year-ago quarter), and the arrival of Mac Pro, which has a substantial back-order situation (4-6 week ship times as of time of posting), but curiously, with no supply chain constraint/product ramp issue chatter that I know of. This leads me to believe that Mac Pro is just plain popular, and despite being necessarily niche, will contribute to the March quarter’s Mac unit sales.

And I haven’t even mentioned ASP yet.

At $2999 and $3999 – before adding any number of pricey options which can collectively exceed the price of the base configurations! – Mac Pro sales will have an outsize impact on average selling price, which is currently in the $1300s.

I think my Mac Pro ASP estimate of $3999 (the base 6-core config) isn’t too out there, considering.

If Apple sold 100k Mac Pros this quarter – remember, the previous Mac Pro lacks Thunderbolt and has a chassis dating back to the Power Mac G5 – what impact would that have on ASP, assuming a rest-of-Mac unit sales of 3.85M units and ASP of $1300?

ASP would rise to almost $1370. 2.5% of total Macs raising total Mac ASP by about 5% all by themselves. Yep, Mac Pro packs a punch in more ways than one.

For this quarter, I estimate ASP to rise from the year-ago $1378 to about $1425 – so, about the same as the prior example when accounting for the $20 increased deferral. And since an incremental Mac Pro sale could be worth three “regular” Macs of revenue – or more – it’s not hard to see even zero Mac growth still resulting in Mac revenue growth (my estimate – around 3%). Hey, every $100 million counts. 😀

Let’s assume I’m too bullish on Mac. Unit sales decline 7% worldwide, and ASP is static despite Mac Pro. Does that change the narrative on iPhone? Again, no. Assuming the same iPhone ASP and $43.5B in total quarterly revenue, iPhone growth would still be negative – a decline of around 1%.

iPod – Barely Worth Mentioning

But because of…er…tradition, I will anyway, until Apple no longer breaks out an iPod line in its financials.

Speaking of which, I wonder when Apple will have a line item for wearables?

A negative growth projection of a little over 35%, and we’re done.

iTunes/Software/Services – Apple’s Hidden and “Slightly Hampered” $15B+ Ecosystem Booster

For the quarter, I’m assuming a YOY revenue growth rate of about 12.5%. I’m attempting to adjust for Apple’s free software initiative and slower iOS unit growth, although this category did see a 19% YOY increase in the prior quarter. Apple continues to add new users, who continue to spend on media, apps and services, so I don’t think the megatrend will decelerate too much in the March quarter.

Accessories – Meaningful, Highly Unpredictable

As mentioned last quarter, Accessories revenue growth is tough to predict. I suspect part of the reason is that many of the accessories sold are non-Apple products. For fiscal Q1 2013, growth was 25%. The following year, just 2%. For now, I’m just going with a 5% growth rate.

My Home Game Estimates for Fiscal Q2 2014

Finally, my estimates for the quarter:

$43.502B revs

36M iPhones

20.5M iPads

3.95M Macs

3.5M iPods

$4.628B iTunes/SW/services revenue

$1.448B Accessories revenue

38% GM

$4.3B OpEx

26.5% tax rate

$9.136B net income

884M projected shares (share-weighted basis)

$10.34 EPS

 

Next up, should I get there – a checkup on OpEx, an update on gross margin/operating margin, and a look at analyst expectations for the March quarter and in-progress June quarter.

*** Note:  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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