The Maestri Code, Fiscal Q1 2015 Part 1/2 (Guidance/Revenue Mix): The Main Event

The recently-ended December quarter (fiscal Q1 2015) was probably a good one for Apple Inc.

Just how good?

My not-quite-as-TL;DR-as-before AAPL earnings preview series begins for the seventh (!!) consecutive quarter. If you’ve been following along here or there, we’ll be off to a running start – er, by home gamer standards. If you need some background on my thought process, just refer to last quarter’s Part 1 or the archives.

As with last quarter, let’s begin the somewhat abridged Maestri Code with management guidance, revenue mix commentary, and my “just for fun” home game estimate.

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Running the Ranges

Apple issued the following guidance for fiscal Q1 2015:

• revenue between $63.5 billion and $66.5 billion
• gross margin between 37.5 percent and 38.5 percent
• operating expenses between $5.4 billion and $5.5 billion
• other income/(expense) of $325 million
• tax rate of 26.5 percent

That results in a net income guidance range of about $13.7B-$15.1B, versus $13.1B actual net income in the year-ago quarter. So unless Apple had a mysteriously lousy holiday season (Maestri hasn’t stopped the sandbagging of his predecessor, far as I can tell), it seems all-but-certain that profit will grow year-over-year for the fifth “consecutive” quarter. (Fiscal Q1 2014 rang in $6 million less in profit compared to Q1 2013 due to the impact of increased per-unit revenue/gross margin deferrals.) It’s just a question of how much growth there was.

As usual, we just have to solve for shares to get to EPS. There were about 5.97B diluted shares (share-weighted basis) as of the end of the September quarter.

In fiscal Q4, Apple repurchased about 141M shares, with 116M of them repurchased in August (2014 10-K, page 22). For what I guess are GAAP purposes, somewhere between 1/3 or 2/3 of the impact (depending on exact time of repurchase) will not be factored in until fiscal Q1. Let’s just say around half of the total, or 70M, were net-retired, leaving another 70M shares to be counted as retired in fiscal Q1 2015.

Did Apple do some additional open market purchases in the December quarter? They have all of fiscal 2014, so why stop now? My wild guess, Apple purchased at least $8B worth (matching fiscal Q4’s total), especially if management had conviction that Apple’s product pipeline and results would mean the market bidding up the stock price. And that new August 2014 ASR, for $9B (2014 10-K, page 69), isn’t fully tapped – assuming an average share price of around $100, seems Apple could still buy another $3B worth of shares, though we won’t know how many additional shares were delivered for a little while yet.

I’m wild-guessing $10B in share repurchases in the first third of the December quarter, along with 70M “carryover” shares from the prior quarter. Guess the average share price at $105…carry the 2…apply share-weighting…say 130M shares were retired for diluted share count purposes. Leaving an estimated 5.84B diluted shares outstanding, excluding the unknown impact of share creep due to RSUs and the like.

True, at this market cap, being off by “a few billion dollars” actually has a fairly nominal effect on EPS. Still, I think it’s good practice to keep track of the buybacks – Apple may well continue them indefinitely.

Put it all together and “implied EPS range” is around $2.35-2.58. That compares to $2.07 in the year-ago quarter and current analyst expectations of $2.54 (22% EPS growth) per Yahoo! Finance.

Analyst average near the potential guidance top-end? I’m pretty sure I’ve seen this before. You think Apple’s finance team isn’t fully aware of what the analysts are thinking?

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Revenue Mix Thought Exercise and “Bonus” Q4 Estimate (Very, VERY Emphatic Air Quotes, Unless I’m Right on Target that is)

OK, here we go. The highest revenue quarter Apple will turn in for at least a year (or, for at most a year, if you’re an AAPL bull). No pressure on this wild guess/thought exercise.

So, after probably not nearly enough consideration…and certainly not enough in the way of qualifications…I’m predicting (big surprise) a revenue beat of…about $2.4B.

Go big and go home (in utter embarrassment due to hilarious overestimation of the quarter)? I have between now and earnings to worry about that and change my mind. 😀 (If I do, you’ll know.)

Meanwhile, let’s look at actual results from the prior year for the necessary context.

Actual results from fiscal Q1 2014 (NOTE:  I abbreviate “iTunes/Software/Services” as “iTunes/software” to save on space):

REVENUES	revs	units	“ASP”
iPhone	$32.498B	51.025M	636.90
iPad	$11.468B	26.035M	440.48
Mac	$6.395B	4.837M	1322.10
iPod	$973M	6.049M	160.85
iTunes/software	$4.397B
Accessories	$1.863B
Total revs	$57.594B

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Now, per usual, the “fun part”. 😀

“If Apple reaches this revenue level, how did it get there?” Here’s my humble take on this, and yes, your opinion may vary – considerably, and quite justifiably (YOY category growth percentages in terms of units):

Revenue “Estimate”:

REVENUES	revs	units	“ASP”
iPhone	$43.84B	64.75M	677
iPad	$10.75B	25.0M	430
Mac	$6.76B	5.5M	1230
iPod	$412M	2.5M	150
iTunes/software	$4.925B
Accessories	$2.250B
		YOY iPhone	26.9%
		YOY iPad	-4.0%
Total revs	$68.9B	YOY Mac	13.7%
		YOY iPod	-58.7%
		YOY iTunes/SW	12%
		YOY Accessories	20.8%

Now for some quick, exceedingly oversimplified humble home gamer commentary on each revenue category, starting with iPhone and working our way down the revenue categories to Accessories. Well, with one exception.

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iPhone – A Question of Supply, If Only Just This Once

Last 5 Quarters of YOY Unit Growth (Fiscal Q4 2013 – Q4 2014): 26%, 7%, 17%, 13%, 16%

A product launches in 2007. Seven years later it has a bit of a growth renaissance “in spite of” its maturing market, business physics of selling almost 170M units in FY 2014, etc.

Hey, when you have a smartphone opportunity this large, and with China Mobile subscribers finally getting access to the iPhones they always wanted (y’know, the ones with the bigger screens) and with impressively-growing 4G signal coverage to match – it can happen! Even if it’s more of a one-time occurrence. Even if you’re pigeonholed in the media as being “trapped” in the “premium” space. 😛

This is an “unusual” situation for Apple/iPhone in that –

(1) no one serious (that I’m aware of, anyway) thinks iPhone’s about to stop growing this year (look at the analyst consensus and ask yourself what’s likely driving that growth projection)

(2) no one has any idea just how big this iPhone 6/Plus demand wave is

(3) no one really knows Apple’s production capacity, much less target

(4) “everyone” thinks the iPhone unit number will impress (and that Apple could have sold more, considering the time it’s taken for iPhone 6/Plus to reach supply/demand balance), and

(5) probably “most people” (including yours truly) don’t think this surge in demand can possibly last longer-term (meaning this will be an outlier quarter of sorts “in the arc of time” as Tim Cook is fond of saying)

So, where to begin? Fortunately, iPhone is Apple’s biggest seller and it’s not even close. Mac, iTunes/SW/Services and Accessories revenue growth trends should be “predictable” (relative to iPhone, anyway). Also – for better or for worse – the presumption is that iPad isn’t poised to have a particularly stellar holiday season. My wild guess is it won’t grow units at all year over year.

Oversimplifying? But of course! Yet the benefit is clarity. So, mindful of all that, we can focus on iPhone units and ASP in light of management guidance.

Let’s just start at the high end of guided revenues. Why? As you may remember, the analyst consensus (as per Yahoo! Finance, if I transcribed correctly) was $63.5B in revs for fiscal Q1.

That turned out to be the low end of Maestri’s guidance. So analysts currently expecting $66.77B in revs is fair and not at all surprising. (UPDATE: Hold the iPhone. That was a few days ago or so. As of Jan. 19, the analyst revenue consensus is apparently…uh…$750M over management top-end guidance (at $67.28B). That’s…not too common lately.)

Let’s assume the rest of my estimates ex-iPhone are decently close to actual. They collectively contribute just over $25.5B to Apple’s December quarter.

That “leaves” about $41B in revenue for iPhone. Assuming an ASP of $677 (estimated to be up about $40 YOY due to iPhone 6 popularity and ASP tailwinds/higher ASP mix thanks to the $749-and-up iPhone 6 Plus line, it may actually turn out to be conservative), that’s about 60.56M units. Representing close to 18.7% YOY unit growth from the year-ago quarter.

…Sounds a bit “low” considering this incredible response to iPhone 6/Plus, doesn’t it? There’s a non-analytical angle to this as well. There’s just no way Apple would guide as high as it did without holding an ace or two up its corporate sleeve, particularly when citing foreign exchange headwinds.

I happen to think Apple will beat on guided revenue range – just as it did last quarter. 27% YOY unit growth sounds a bit lofty in the abstract, given the enormous base of “upscale” smartphones from which Apple is building. But given the circumstances (which includes Apple reducing channel inventory in preparation of the Fall 2014 iPhone lineup) – it also looks quite possible, even though iPhone 6/Plus momentum may well “trail off” to some extent as we approach the likely (and already talked-about) iPhone 6S launch.

The other possibility – unit growth is more modest, but ASP is higher. Still another possibility: ASP and unit sales volumes are just off the charts. In which case – well…I’m not sure anyone is prepared for those numbers. Or maybe I’m being too conservative just because $70B in a single quarter is a ridiculously galactic revenue number that no tech company in the history of the Earth has ever achieved.

Anyway, we’ll know how well I tossed the proverbial horseshoe in less than two weeks.

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iPad – So, What About This iPad Christmas?

Last 5 Quarters of YOY Unit Growth (Fiscal Q4 2013 – Q4 2014): 0%, 14%, -16%, -9%, -13%

On the one hand, we have a trend (you’re already quite familiar with some of the narratives). Three consecutive quarters of negative iPad growth. And really, overall tablet growth has been slowing – sharply.

On the other hand, Tim Cook remains as generally bullish on iPad as ever, sales decline/plateau aside. iPad mini (3) and iPad Air (2) finally have Touch ID, along with Apple Pay for in-app purchases. Overall value proposition is up, and iPad Air/iPad mini 1/2 prices are down. We’re also getting to the point where a replacement cycle effect may be in play.

Does that translate to unit growth for the December quarter? My home game projection is no, though the slowdown should be stemmed on account of the fresh slate of iPads. But really, with only recently “established” product cadences and seasonality and iPad still not even five years old yet? It’s anyone’s guess.

“Momentum” from iPad this quarter may be a sign of a 2015 turnaround/stabilization as Apple, in partnership with IBM, attempts to push iPad in the enterprise. Meanwhile, as it enters its “mid-life crisis” rather early, iPad weakness in non-holiday quarters is being counter-balanced by a surprising source – good old Mac.

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Mac – Respect the Truck

Last 5 Quarters of YOY Unit Growth (Fiscal Q4 2013 – Q4 2014): -7%, 19%, 5%, 18%, 21%

Which product line grew the fastest by percent unit growth in Fiscal 2014? That’s right…the oldest. 16% for Mac, and 13% for iPhone. Sure, iPhone is much higher-volume. But that venerable “truck” line, 30 years on, is showing no signs of fading away. Especially considering how IDC estimated the entire PC market to have -2.1% growth in calendar 2014. (Apple is estimated to have taken a positively gigantic 6.4% of this shrinking-but-308M unit market, by the way.)

Both Gartner and IDC are quite bullish on Mac in calendar Q4. IDC projects YOY unit growth of nearly 19% worldwide, with Apple having re-gained the #5 top-selling vendor spot. Gartner only focuses on the US, having ASUS in the #5 worldwide PC vendor spot, but does estimate 11.5% YOY US unit growth from Mac in calendar Q4.

Yes, only the Mac mini (refresh) and iMac 5K (new) launched recently. Meaning the other products “continued to age”, particularly non-Retina iMacs and those Mac Pros we’ve heard very little about since launch. On the other hand, Macs aren’t that seasonal. And for fiscal Q1, the “average age” of the MacBook Pro refresh was 110 days, with the MacBook Air at around 200 days. Meaning that core Mac products are more mid-to-late-cycle than hopelessly stale.

I think ASP is more usefully compared sequentially than YOY in this particular case, so I’m guessing an ASP bump of around $30 based on iMac 5K pricing starting at $2499.

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Intermission: A quick word about Apple’s Defunct Growth Engine, iPod…

Once-Mighty iPod is Basically a Rounding Error. And So We’re Just “Marking Time” Until Apple Watch.

Moving on! 😀

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iTunes/Software/Services – Slowing, but Steady

Last 5 Quarters of YOY Revenue Growth (Fiscal Q4 2013 – Q4 2014): 22%, 19%, 11%, 12%, 8%

Reminder: This revenue category is now called “Services”.

Over time some slowing of revenue growth in this category seems “expected”. Long-time customers within the (net-growing, if healthy) installed base won’t necessarily buy (that much) more software, apps, and media (and AppleCare) year over year – so the more likely source of growth is customers new(er) to the Apple platform.

With the new iPads and especially new iPhones, Apple will certainly get its fair share of new customers to help in this regard. Meanwhile, it could be some time until either Apple’s enterprise initiative or Apple Pay (which will certainly benefit from international expansion) will make much of a dent in this ~$20B run-rate revenue category. For now I’m guessing a growth rate of about 12%.

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Accessories – Now Called “Other Products”!

Last 5 Quarters of YOY Revenue Growth (Fiscal Q4 2013 – Q4 2014): 5%, 2%, 3%, 12%, 13%

If Beats Electronics (acquired by Apple in August) is a over-$1B-run-rate company – and presumably still growing – you’d expect it to contribute meaningfully to this now-renamed product category (year-ago Accessories revenue was $1.863B), particularly if you assume that a key music accessory (read: audio products such as headphones) have an iPod-like holiday seasonality effect. That’s why I’m assuming an “anomalous” YOY growth rate of about 21% for the holiday quarter.

“Other Products” is due to get much more interesting this year thanks to the addition of Apple Watch, which, unless it sells in rather “small” quantities, will invariably cause this category to experience higher-than-recent growth. How much higher? It’ll be fun to see.

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“Bonus”: My Home Game Estimates for Fiscal Q1 2015

Finally, my estimates for the quarter:

$68.9B revs (~19.6% YOY growth)

64.75M iPhones
25M iPads
5.5M Macs
2.5M iPods

$4.925B iTunes/software/services revenue
$2.25B Accessories revenue

39.2% GM
$5.475B OpEx
26.5% tax rate
$15.97B net income (~22% YOY growth)

$2.74 EPS based on estimated 5.84B shares outstanding (share-weighted basis, 32% EPS growth)

Next up, should I get to all of it – a checkup on OpEx, an update on gross margin/operating margin, and a look at analyst expectations for fiscal Q1 and in-progress fiscal Q2.