Recapping Apple’s Ionospheric Earnings

Of course you’re all familiar with Apple’s ridiculous, bona fide blowout-type numbers. Let’s see if my post can, albeit from a humble home gamer’s viewpoint, provide a somewhat different take on the quarter that was and the implied promise of those that follow.

“Seventy Four Point Six Billion Dollars”

Apple’s $11B more than analysts were expecting as of around three months ago result was impaired by ForEx, but also net deferrals.

Regarding ForEx – per Maestri (about 23:45 into the earnings podcast/call), “our revenue growth during Q1 would have been 4 percentage points higher on a constant currency basis”. As helpfully reminded by longtime amateur AAPL analyst Daniel Tello of deagol’s AAPL model, that means Apple’s massive, but inherently incomplete currency hedging program (due to economic feasibility considerations) was unable to mitigate roughly $2.3B ($57.594 x .04) of revenue impact.

Net ESP deferral (the only source of deferred revenue/gross margin that can be roughly estimated) played a significantly larger role than anticipated. With nearly 74.47M iPhones, 21.4M iPads, and 5.52M Macs sold, there was, at minimum, about $1.65B in gross deferred revenue based on software upgrade rights alone. Given that ESP per-unit deferral range is actually “between $15-25” for iPhones and iPads alike (the logical average being $20 deferred per unit), however, that number may be closer to $2.1B. In other words, nearly equal to ForEx impact. Account for estimated amortization, and Apple’s perhaps-Sarbanes-Oxley-driven deferral “probably” ended up reducing revenue – and GAAP-reported gross margin – by an additional one billion dollars.

Meaning that Apple, in non-GAAP (read: more accurate) measures, actually crested $75 billion in revenue this holiday quarter, even if you give Apple zero credit for ForEx factors and discount my estimated net deferral by half. If you’re an optimist? Then Apple could have rung up about $78 billion in sales. I lack the words to describe that kind of quarter by a tech company.

“39.9%” Gross Margin

Apple did not quantify the impact of foreign exchange on FQ1 gross margin – probably quite intentionally. 39.9% is a consensus-beating number, and there’s little need or desire by Maestri and the Finance team to give additional information to competitors. However, in my humble opinion, it’s more than reasonable to assume that ForEx reduced gross margin by at least 50 basis points, considering that the 5% estimated revenue growth impact due to ForEx in FQ2 2015 is said to result in 100 basis points of gross margin impact. If you accept my assumption that $1B in combined revenue/gross margin was net-deferred due to software upgrade rights alone, that’s an additional 80 basis points worth of gross margin impact in the December quarter.

In other words, “true” gross margin was around 40.7%, and if not for ForEx headwinds, was “actually” north of 41%, perhaps as high as 41.5%. The significance of this is more subtle, but worth keeping in the back of one’s mind as we progress from FQ2 2015 through FY 2016.

Why? Let’s go back to the first full quarter of iPhone 5 availability – which is not far from the time Apple’s gross margins “hit rock bottom”:

gm-q1-2015

Being a redesign, iPhone 5 had a higher cost structure than the 4S before it, and it showed. Additionally, the newly-launched iPad mini, the smallest (and lowest-margin?) of the iPads, was proving quite popular and corporate-average-margin-dilutive. iPhone 4 remained popular, also “pressuring” gross margins. These were among the factors that saw Apple’s gross margin continue its multi-quarter drop, from 38.63% in FQ1 2013 to a 5-or-so-year low of 36.5%.

FY 2015 is shaping up to be quite different. iPad ASP continues to fall (slightly), but so do unit sales year over year. iPhone is dominating revenue mix, and, due to iPhone 6/Plus’s massive sales, is driving down the cost curve at record velocity. iPhone 6/Plus momentum, as easily seen in record average selling prices, strongly hints at higher average “new iPhone mix” throughout FY 2015.

Not only that, Maestri guided gross margin on the high end to 39.5% for FQ2 – fully aware that actual quarterly gross margin has matched or exceeded guidance since FQ4 2013. That’s a strong hint that gross margins will not have a “bottoming phase” as seen in FY 2013 and FY 2010, when the iPhone 4 launched. Given the 130+ basis point gross margin beat in FQ1 2015, it’s possible that FQ2 2015 will bring a sequential increase.

In other words, gross margin trends, particularly if ForEx headwinds weaken, are looking quite positive in iPhone’s redesign year – before the historically gross-margin-friendly S generation cycle.

The “Resurgent” iPhone

No one doubted that “the iPhone everyone really wanted” would sell “well” given enough supply. It’s just the extent that shocked most everyone. Record ASP, not far from $700. 46% YOY unit growth from an already-lofty 51M units in year-ago quarter, with strong interest in the US (44% unit growth), and massive interest from Greater China (read: China Mobile subscribers) driving segment revenue growth of 70% year-on-year.

Speaking of growth markets, Apple cited BRIC countries iPhone growth of 97% – a not-so-subtle hint that India is also a strong performer, relatively modest revenue contribution notwithstanding.

But it can’t last, right? Not this growth pace. Well, one would think that Apple’s iPhone 6 cycle will follow iPhone 5 and 5S in a general sense – a surge of initial interest, then slowing YOY growth rates through the third full quarter of availability as seasonality and “new iPhone anticipation” kick in. The 46% unit growth rate has a “one-time” feel to it. And there’s a “common sense” in thinking “stronger-than-average” interest in iPhone 6/Plus will come at the expense of the presumptive iPhone 6S.

There’s just one thing. Tim Cook did absolutely nothing to dampen expectations for iPhone 6. Instead, he cited record numbers of new-to-iPhone customers and Android switchers, while pointing out the 15% or less upgrade rate amongst the iPhone installed base. He also noted that supply/demand balance was only reached in January, meaning channel fill will be a tailwind for iPhone sales. And only a small fraction of China Mobile’s 806M customers (330M+ of whom are 3G/4G customers) have iPhones, with 4G coverage continuing to expand.

Granted, there’s no need to preemptively lower expectations for an unannounced product – so the question of whether the iPhone 6 generation represents a “sales nova” will probably have to wait until around late January next year. But returning to the present, given the strong FQ1 start, is 30-35% really that unrealistic a FY 2015 unit growth rate?

A quick sidenote on the “Apple is too dependent on iPhone” storyline. Apple was once an Apple II-dominated company. Then, a Mac-dominated company. And later, an iPod-dominated company. In each case, Apple moved on to the next big thing, which is currently far larger than MP3 players and PCs ever were. (Never mind wearables for now.)

Of course, Boeing’s revenue derives chiefly from aerospace (mostly, commercial aircraft). BMW, from automobiles. Costco, from “buy in bulk” sales to members. Are we suddenly to believe that a company’s core competence is now its worst liability by virtue of it being a core competence? Maybe if the world moves on. But it hasn’t yet, and the smartphone market continues to grow – subsidy or otherwise.

iPad in “Decline”

Tim Cook made it very clear to Wall Street not to expect anything “different” out of iPad this year. Meaning, growth rates between -10% and -20% sound quite reasonable.

On the other hand, Tim remains bullish on iPad “in the long arc of time”, and according to Francisco Jeronimo of IDC, Samsung Electronics (which sells at least 10 distinct models of tablets in the US) shipped 11 million tablets in CQ4 2014 – essentially 10M less than Apple in the same time period.

Also worth noting – Apple had multiple ways of enhancing the iPad lineup for Fall 2014. Higher entry-level capacities, an A8 chip in the iPad mini 3, reducing the $130 cellular radio premium after all these years or even dropping Wi-Fi only. It deliberately chose not to. In other words, Apple seems perfectly content to think of iPad in multi-year terms and remain patient, because it still leads the field in general-purpose tablet computing.

The AAPL “Discount”

After growing EPS by 48%, reducing ttm EPS by around 15%, and increasing net cash reserves by $22B in a single quarter, Apple shareholders were rewarded with a one-day stock price increase of…5.6%.

Surely options play a role, but the reaction in the wake of this massive earnings surprise was relatively muted (if typical in terms of post-earnings percentage upside). AAPL is the market-cap leader, which automatically makes it something of a special case. Nevertheless, its current (ttm) multiple in the mid-15s comfortably trails the S&P 500 (close to 19), the NASDAQ (26) and the $480B+ revenue, not-exactly-growth stock known as Wal-Mart (close to 18).

On the other hand, ex-AAPL S&P 500 technology earnings growth rate has never exceeded 10% since at least CQ1 2012, according to Factset. And while Apple’s domestic cash reserves are “somewhat low” (at $20B vs. $158B internationally), Apple remains more than willing to grow dividend payouts and buyback shares indefinitely (having repurchased $45B in stock in FY 2014 alone).

It’s also hard to find anything particularly troublesome on the weekly chart other than a relatively controlled consolidation/downtrend phase from last November.

The bullish investor might say that all things considered, it seems that Apple’s forecasted diminished future is baked into the stock much more than the reality of the present and the strong guidance of the near-term. Assuming that Apple continues to show solid growth throughout the remainder of FY 2015, and the markets don’t go to heck in a handbasket, do bears have the consensus – or contrarian – view that AAPL has already met its market cap ceiling? I’m not qualified to render investment/trading advice of any kind – but that doesn’t mean I lack an opinion on the matter.

The World’s #1 Technology Company

Samsung just reported revenues of 52.73 trillion won for the December quarter. Earlier in the year that would have been around $52B USD. Today, just over $48.1B USD. In either case, Apple’s seasonality-fueled quarter bested Samsung’s by well over $20B – and unless Samsung manages to reverse its current downtrend, Apple looks poised to out-revenue Samsung for two quarters in a row. It now appears likely that Apple will out-revenue Samsung for calendar year 2015 and take over as the world’s largest technology company by sales.

And with a first-half FY 2015 revenue total of $129B based on the top-end of management guidance, it’s quite clear that Apple is well on the way past $200B in total FY 2015 revenues. Wall Street now expects $220B in sales (22% YOY growth) just as iPhone 6S presumably launches.

It’s understandable if you think Apple is in the middle of an outlier fiscal year, with considerably less growth a distinct possibility for FY 2016. And yet, management has made little attempt to manage expectations (other than for iPad), and ForEx-impaired top-end revenue guidance of $55B (ahead of analysts’ pre-earnings expectations) is already setting the Wall Street consensus on a path to once again exceed guidance before late April rolls around. There is no way Maestri has failed to account for this, or the continued spillover effects. Words of caution should be easy to detect and must be watched for – but around the corner they are not.

Sure, Apple is playing in a world marketplace filled with the keenest competition yet, with companies like Xiaomi or Lenovo “threatening” Apple as they grow smartphone shipment volumes from lower price points. But this isn’t the Apple of 1996, or 2007, or 2010. It’s now pushing into territory never before reached by any technology company in history, never mind that new all-time quarterly net income record. It’s playing in a space large enough for multiple winners, while bringing in customers who have never owned Apple products before. Competitors are still scrambling to fit 64-bit, biometric security and an integrated payment platform together, while Apple took care of the first two over a year ago, and has already signed up more financial institutions and card networks onto its industry-standard-compatible NFC platform than any other competitor – before any international expansion of Apple Pay.

Oh, and it’ll soon start selling multi-thousand dollar gold watches to an installed base of iPhone 5+ users numbering in the many tens of millions.

Back in December 2012, Tim Cook advised Brian Williams – and the world – “don’t bet against us”.

Does anyone care to take that bet now?

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