The Abridged Maestri Code, Fiscal Q4 2014 Part 2/2 – Notes on OpEx, Margins, and Guidance

So! I’m recalibrating the Maestri Code to save some on time, energy and TL;DR as the earnings release is less than 24 hours away.

In the abridged version (which might be a permanent thing, assuming I can work up the energy/motivation to do this a seventh consecutive time considering the modest audience this “feature” musters each quarter), we’ll go over the former Parts 3-5…yes, all at once. Let’s see how consolidating operating expenses, operating margin (ex-Retail), gross margin and a quick note on analyst expectations goes. 😀 [Author’s Note: It ended up being a tidy 1100-ish words, a decently concise read!]

Shall we get started?


Operating Expenses Update

Escalator’s back in service – but the stairs are…uh…out the window.

And the reason? R&D spending, which is increasing each and every fiscal quarter in 2014 (so far) at the fastest clip yet. Fiscal Q3 R&D spending, at $1.603B, was fully $273M higher than fiscal Q1 ($1.33B).

With Maestri’s guidance of OpEx at $4.75B-$4.85B, Apple’s disproven the fiscal year stair-step theory of OpEx spending at least for now. Wouldn’t surprise me in the least if Apple Watch R&D spending is showing up in a big way as the “early 2015” launch approaches. In case you were wondering – no, it doesn’t look like stock-based compensation expense is, or will, be a significant driver of OpEx – it really is just good old-fashioned investing in shipping, soon-to-be-shipping, and may-never-be-shipped products. The “downside” – this “spike” in OpEx will continue pressuring profits.

Will OpEx level off once Apple Watch is released? Or is this the start of a trend? A quick chart, and off we go to margins.

aapl-opex-q42014


Margin Checkup

Operating Margins

op-marginq4-2014

Return of the 140-data-point 2-axis chart – now with 150 data points! 😀 But if you’ve seen this before, it’s not too hard to get caught up.

Quick notes per revenue geography (again, Retail isn’t included in this discussion):

Japan bounced back above the just-plain-ridiculous 50% operating margin level. Yes, it’s still down year-over-year (from 52.81%), but let’s see if the new iPhones and iPads have any impact – the iPhone 6 sales pause effect undoubtedly affected all geographies to some degree. Next to the Americas it was the slowest-growing rev geography (by revenue).

Speaking of, the Americas geography continued its operating margin uptrend in fiscal Q3, the clear #2 “profit center” – no bad thing considering it’s still the #1 geography by revenue by a considerable margin. Rev growth was very slow, but operating margins picked up about 350 basis points YOY to 39.22% – strong work, iPhone 5S, I’d say.

Greater China experienced solid revenue growth of about 28%, and Apple can probably thank China Mobile subscribers for a large portion of that. Interestingly operating margin fell sequentially – though it was up big YOY, from 31.03% to about 36.6%. Did I mention the Q4 year-ago operating margin compare was 30.87%, by the way? Well, I guess I have now. 🙂

Europe may surprise – it’s had Americas-like recovery in operating margin (maybe even a bit stronger) since Q3 2013. Another big move YOY, from 32.18% to a very solid 37.28% for this year’s fiscal Q3. Though Europe might seem to have the more fragile economy at the moment compared to other regions, rev growth was actually pretty OK YOY, at around 6%. FYI – the Q4 year-ago operating margin compare is about 34%. But as mentioned earlier, OpEx will be a significant profitability headwind.

Rest of Asia Pacific remains a laggard in all respects lately, except YOY rev growth (about 6% from Q3 2013 to Q3 2014). On the other hand, operating margin, though volatile, is still generally steady – having held above 33% since Q2 2013. It’s the smallest rev geography, but full of emerging markets – let’s see what happens in the quarters that follow.

Gross Margin

gm-est-q4-2014

I’m guessing a gross margin beat of 70 basis points over top-end guidance – so 38.7% vs. Maestri’s top-end guidance of 38%. On the one hand, I’m guesstimating over guidance. On the other hand, Apple’s beaten GM guidance in the past three quarters. Not much to say, other than margins appear to have stabilized (iPhone cost curve expertise and slowing iPad growth help that way, and it’s not like 36% GM is low), and that iPhone 6’s potential to tip the revenue mix further in favor of iPhones promises to make for a very interesting fiscal 2015.


Analyst Expectations for Fiscal Q4 2014, Q1 2015

As far as the just-ended quarter, analysts (as polled by Yahoo! Finance, roughly equivalent to Thomson First Call) seem pretty darn optimistic – on average, they’re gravitating towards the very top of revenue guidance ($39.85B vs. top-end guidance of $40B). The consensus EPS is $1.31 – “implied” top-end EPS is about $1.32, as I estimated in Part 1. Not much “room for error” – then again, I’m not sure Maestri could have done much more to moderate expectations.

The storylines seem simple enough – how quickly did Apple move iPhone 6/Plus units and ramp production? How much did the iPhone 6 sales pause impact the first 10 or so weeks of iPhone sales? And “how badly” did iPad trail off while awaiting the yearly refresh?

Amusingly, aside from iPad concerns, analysts may largely look past this quarter assuming gross margins turn out to be “good enough” (whatever that means).

That would be because Q1 2015, of course, is Apple’s main event. iPhone 6 is finally here, and if wait times are any indication, it remains popular and in limited supply. So, if it’s “just a question of iPhone supply“, how will Maestri guide? The other big unknown, of course, is iPad.

All in all, similar storylines, but a very different product posture. This quarter, China Mobile subscribers get in as close to the ground floor as is possible, ready to buy their share of iPhone 6/Plusses (which is what they’ve really been waiting for all this time). We’ll see if Tim Cook provides any additional commentary on his nonspecific “record orders” announcement regarding iPhone’s China launch.

iPad refresh is go – just a question of whether it’s enough to get the iPad line to at least single-digit YOY unit growth.

Analysts aren’t holding much back even considering the scale of the company. They’re expecting big things out of those bigger iPhones, and are collectively projecting revs of about $63.5B (about 10% growth vs. ~$57.6B in Q1 2014) and EPS of $2.40 vs. $2.07 in the year-ago quarter, almost 16% growth. Considering the expectations and Apple’s own hype, including from last Thursday’s event? I’d say these expectations are very fair. It will help that Apple’s diluted share count will probably be around 5.95B shares vs. around 6.3B, a reduction of ~5.5%…though this is unlikely to repeat itself for future compares, given current stock price trends and buyback levels.

A potential assist, however modest – a full quarter’s worth of Beats revenue, and a holiday quarter at that. You might not really see it, since it’ll probably be incorporated into Accessories for the most part, but every tenth of a percent of revenue growth helps. 😉

That wraps up my home game AAPL earnings preview for the 6th straight quarter. Hope you enjoyed it!

Now it’s time to see how Apple’s most wonderful time of the year unfolds.

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