When Apple reports earnings in January for its first fiscal quarter of 2009, the investment community could be greeted with the mother of all earnings blow-outs. The analyst consensus estimates have gotten so absurdly bearish, that Apple might beat revenue expectations by as much as $1.210 billion dollars—and that’s with a mild contraction in iPod sales! I can’t remember the last time any company beat revenue expectations by a full $1.2 billion, but I can only imagine how the stock price would react on such a beat. Almost as impressive is the 36.1% beat on analyst EPS estimates that I am confident Apple will achieve.
The analysts are currently modeling for Apple to earn $1.44 in EPS on $10.080 billion in revenue. By contrast, I’m looking for Apple to earn closer to $1.96 in EPS on $11.29 billion in revenue. That would mark the largest revenue beat by any company I’ve ever seen, and will generally be an all out fantasy-like decimation of analyst consensus estimates. Depending on where the stock price is at the time of earnings, where the consensus and whisper numbers stand going into the results, and the market’s current sentiment on equities, I wouldn’t be surprised to see a 20 point move in the stock price. This is a once in a blue moon type of earnings situation that will likely be far more surprising than Google’s results last April.
The general bearishness surrounding Apple’s fiscal Q1 is largely due to the uncertainty regarding the degree of contraction in consumer spending for the months of November and December. The analysts, who have already been overly bearish on the stock as it is (which has lead to Apple beating iPhone estimates by 72% in Q4), have seriously gone too far this quarter with their earnings estimates. It has gotten to the point of irrational bearish exuberance, that the estimates no longer reflect even a scintilla of financial reality. The analysts have been consistently wrong in predicting Apple’s earnings results and this time they’re going to get their “hats handed to them” as the expression goes.
Even on in extremely bearish scenario where iPods unit sales and iPod revenue see significant contraction, and where Macintosh sales see flat sequential growth despite its recent refresh across its line of notebook computers, Apple will still beat revenue expectations by nearly half a billion dollars—that’s on a pretty bearish scenario. The three tables below outline my preliminary GAAP and adjusted non-GAAP based earnings estimates for Q1 2009 along with the breakdown of the revenue and YoY growth rate estimates. It’s important to note that this is merely my preliminary outlook for the quarter rather than final estimates based on NPD, Gartner, IMEI and IDC data. I will provide my final earnings estimates a week or so before earnings are actually released.
Right away, investors should notice the dramatic difference between my estimates for Apple’s real earnings (non-GAAP) and my estimates for the worthless GAAP-based earnings that will likely mask nearly 80.6% of Apple’s “real-world” income and over 34% of its revenue. I have said it before, and will say it again: I have to question any accounting measure that requires a company to report less than half of its actual income. The stock price obviously does not reflect Apple’s actual earnings results since the trailing P/E ratio is based on GAAP EPS. Apple’s GAAP-Based P/E ratio is either on par or significantly lower than other similarly situated tech companies and its non-GAAP P/E ratio is significantly lower than those companies—a counter-argument for the naysayers who irrationally believe these estimates are actually baked into the stock price.
Furthermore, investors should notice the possible staggering growth rates on Apple’s Non-GAAP based adjusted earnings. I’m expecting adjusted EPS to grow 59.5%, adjusted revenue to grow 40.9% and operating income to grow 61.7% driven by sales of 8 million iPhones on the quarter. Yet, investors should view these non-GAAP earnings estimates as an indication of how Apple’s real business is doing rather than gauging how the market will react to those numbers. The market has decided to largely ignore the financial impact of the iPhone and will probably continue to do so until Apple’s GAAP-based results are driven by recognized iPhone revenue. At some point in 2010, the iPhone will be the largest contributor to Apple’s GAAP based earnings, even surpassing revenue from Macintosh sales—it already does this on a non-GAAP basis. The table below compares my GAAP-based earnings estimates with Apple’s guidance and analyst consensus estimates.
As indicated in the table above, I’m expecting Apple to beat revenue expectations by a full $1.2 billion and EPS expectations by 36.1%. The analysts have really dropped the ball in drawing their Q1 2009 estimates as they’ve either failed to realize, or contemplate in their estimates, that Apple’s guidance is far more conservative than usual. Apple has clearly shifted the gradation of conservatism built into its earnings guidance to a more dramatic degree than in previous quarters.
This much is clear from the shift in the conservative language in Apple’s Q1 guidance. In the past, whenever the issue of Apple’s conservatism was brought up in a conference call, Oppenheimer would repeatedly stick to the same guidance language of offering estimates that he has “reasonable confidence in achieving.” In Apple’s fiscal Q3 2008 Conference Call, for example, Keith Bachman’s asked a question regarding Apple’s conservatism in its guidance, and Oppenheimer responded by saying, “Keith, we gave you guidance that we have reasonable confidence in achieving.” In the fiscal Q1 2008 conference call, we saw the same exact type of language from Oppenheimer. In response to a question from Kathryn Huberty regarding revenue guidance, Oppenheimer responded by saying, “We provide you guidance that we have reasonable confidence in achieving.” In the fiscal Q4 2007 conference call, Oppenheimer responded in similar fashion to a guidance question by Andrew Neff of the late Bear Stearns by saying, “Andy, I give you guidance each quarter that we believe we have a reasonable chance of achieving.”
Yet, in Apple’s Q4 2008 conference call, Oppenheimer was repeatedly quoted in saying that Apple is being “prudent,” rather than simply offering guidance that it has “reasonable confidence in achieving.” For example, in Oppenheimer’s opening statement, he noted that “Our [management's] visibility is low and our forecasting is challenging and as a result, we are going to be prudent in predicting the December quarter.” Notice how Oppenheimer didn’t say the business itself would necessarily be challenging, but rather that the forecasting itself is challenging; thus necessitating a more “prudent” stance on the guidance issue. Because visibility is low, Oppenheimer is giving guidance that is far below what will likely happen in the quarter – Oppenheimer wants to make sure that Apple handedly beats its forecast in even a worst-case scenario. And given that Apple is known to be far more conservative than others in the industry, this outlook obviously gives new meaning to the term ultra-conservative.
Yet, the analysts are either failing to see this nuanced shift in Apple’s guidance strategy, are simply ignoring the nuance altogether, or understand the nuance but are deliberately offering unrealistic estimates for some hidden reason (I choose not to speculate). What I do know is that Apple offered “prudent” revenue guidance of $10 billion for Q1, and yet the consensus estimates stand at only $10.08 billion. This guidance-consensus issue should tell investors that the consensus estimates, as currently stated, are simply too low. Even under a bearish scenario where several segments of Apple’s business contract in Q1, Apple would still likely report close to $10.5 billion—nearly half a billion above consensus and still a blow-out by all measure. And though the $10 billion revenue guidance is at the upper end of Apple’s range of $9-10 billion, Apple has generally beaten the higher end of its range by a significant degree—see Q1 2007 where Apple beat the upper end of its revenue and EPS guidance by $1 billion and $0.41 respectively. Under normal circumstances where there is less uncertainty, I would have expected Apple to offer guidance of about $10.3 billion—such guidance would contemplate significant contraction in iPod sales. Thus, from a certain perspective, the analyst consensus can be viewed as being below Apple’s normal conservatism.
Q1 2009 iPod Sales Estimates
Much of the uncertainty regarding Apple’s fiscal Q1 is mostly due to questions about how the iPod will perform in this questionable holiday shopping season. I am currently modeling for a mild YoY contraction in iPod unit sales as I look for Apple to sell about 22 million iPods down from the 22.121 million Apple sold in the year ago period—that’s a 1% contraction. Yet, for iPod revenue, I expect Apple to report about $3.74 billion down about 6.4% from the $3.997 billion it reported in Q1 2007. At the current moment, it is difficult to determine how the iPod will perform until we get solid NPD data for months of October, November and December. Recent weekly NPD data on third-party retailers selling the iPod can be interpreted to suggest some mild contraction in iPod sales. Yet, I am very cautious to use such data because the vast majority of Apple’s iPod sales come from Apple’s own online and retail stores, which have generally fared a lot better than retail chains such as Best Buy—weekly NPD data doesn’t cover Apple’s own retail and on-line stores.
Yet, one thing investors should keep in mind when assessing Q1 iPod estimates is the fact that iPod unit sales have never contracted on a YoY basis. Even in its recently reported fiscal Q4, Apple reported an 8.4% YoY rise in iPod unit sales despite the fact that GDP contracted by 0.3% for the quarter. This tends to indicate that the iPod is far more resilient than economists, journalists and analysts lead on. Throughout each quarter in 2008, countless analysts have modeled for the total collapse in iPod sales which never materialized. Kathryn Huberty, for example, estimated that iPod sales would fall by 24.1% on a YoY basis in Q2 when she modeled for sales of only 8.5 million iPod (down from the 10.55 billion iPods Apple sold in 2007). Yet, she wasn’t alone in forecasting contraction as Scott Craig, Mike Abramsky, Ben Reitzes, Richard Gardner, Shaw Wu and others forecasted negative growth as well. As a matter of fact, only Gene Munster and myself (along with other blogger-analysts) were forecasting flat to mild growth on the quarter. Apple reported sales of 10.644 million iPods in Q2, which was not only positive on the year, but was way above Huberty’s estimates and quite above other analysts as well. What this should tell investors is that this wouldn’t be the first time analysts are modeling for severe contraction in iPod sales and that forecasting negative sales growth shouldn’t be considered lightly.
As a matter of fact, it wouldn’t be entirely unreasonable to forecast slight growth in iPod sales due to the fact that the iPod demonstrated 8.4% growth in a quarter where GDP and employment contracted. In a bull case, where the iPod is far more resilient than expected, I can see iPod unit sales grow at 4.4% to 23.1 million units in Q1 up from the 22.121 million sold in the year ago period. Remember, the idea that iPod sales will see major headwinds in a recession is only theoretical as we have yet to see how the iPod performs in a true recession. Though economists have been ringing the recession bell for all of 2008, we haven’t seen GDP contraction until recently. If the iPod continues its current trend of growth into Q1, iPod sales will indeed grow past 23 million units.
Yet, a bear case can also be made where the iPod sees major contraction. As I said, it’s impossible to tell how the iPod will perform in a major contraction since we have no history on the subject. The iPod thus far appears to be far more resilient than previously thought by analysts, yet the December quarter will be very telling on how Apple will perform in a recession. Thus, under a bear case, some analysts have iPod sales contracting some 14% on YoY basis. While I tend disagree with the assessment given the iPod’s organic growth rate, despite the obvious slowdown in consumer spending, it is important to lay out how a bear case compares to the consensus. In a bear case, where iPods contract 14% from 22.121 million units to 19 million units, Apple would still report about $10.460 billion in revenue which is still well above the $10 billion consensus. What this should tell investors is that the analysts are simply too bearish on Q1.
I think analysts are overlooking one very important point regarding the iPod. And that is the fact that the iPod is still showing organic growth despite the flat GDP seen in 2008. It’s simply a matter of offsetting the natural growth rate of the iPod from any negative effects of a slowdown. It’s a question of whether the contraction in consumer spending will be so deep that it will offset the expansion of the iPod’s new customer base. Given how well the iPod has performed in the face of a slower 2008, I simply don’t see a big enough of an offset to warrant modeling for such dramatic negative growth for the iPod.
Q1 2009 Macintosh Sales Estimates
As with the iPod, there is a lot of concern about whether Mac sales can continue to grow despite the premiums customers pay for Apple’s notebook and desktop computers in a slowing environment. I find most of those concerns to be with only minimal merit due to the bottom line. And the bottom line here is, Mac sales have accelerated, not just grown, but accelerated in 2008. Apple experienced much larger Mac sales growth rates in 2008, than it did in 2007 despite the law of large numbers, and despite the substantial slowdown in the economy. Moreover, Apple’s management mentioned on the Q4 conference call that Mac sales saw an upsurge in sales once the new notebooks were released in October. Not only does this upsurge in sales in October benefit Q1, but it also indicates that Q4 sales were, to some degree, misleading. Apple sold about 2.6 million Macs in Q4 growing at a pace of 20.7%. While this growth rate was lower than in previous quarters in 2008, this slowdown was largely due to a number of factors not owing entirely to the economy.
First, it’s difficult to tell just how much of an impact the product transition in Apple’s notebooks had on Q4′s sales. If Apple happened to update its line of notebooks in late August, rather than in October, Mac sales could have easily been 100-200 thousand units higher than what they were in Q4. In the opening statement of Apple’s conference call, Oppenheimer noted, “Although Mac sales grew faster than the market, we believe Mac growth was impacted by purchase delays based on speculation about the new launch of our portables and budgetary constraints affecting education institution purchases. We are unsure how the economy may have affected Mac sales in the quarter.”
According to Apple’s management, those who are in the best position to gauge this sort of thing, the rampant speculation surrounding the notebook refresh had an impact on Q4 Mac sales as consumers delayed purchases by opting to buy the new notebooks in October. It was widely believed that Apple would be coming out with new Macs since mid-September, and one would have to be a dolt to buy a Mac notebook when a complete revision was right around the corner—this is basic common sense. Tim Cook harped on this point when noting, “As you know, there were rampant rumors and lots of press reports about a potential portable transition and we saw some slowing towards particularly the final weeks of September and the initial weeks of October. However, once announcing last week, we saw a considerable rebound in sales and we are very, very optimistic about those results.”
Secondly, Apple also noted in its conference call that there was a marked slowdown in K-12 spending due to local and state budge constrains, which had an impact of about 75,000 units according to Tim Cook who said, “Mac unit sales would have been 75,000 units higher and so this was a big issue for the quarter from a Mac perspective.” This is a crucial point to grasp when forecasting Mac sales for Q1. Because while Q4 is generally driven by K-12 spending and the back to school shopping season, Q1 sales are generally driven by the holiday shopping season. Thus, the impact on Mac sales from this discernible slowdown in K-12 spending will have a much lower impact on overall sales in Q1 as Apple’s dependence on education related purchases ease.
Thus, what we see in Q4 is that sales could have been anywhere from 200 thousand to 300 thousand units higher if it weren’t for the product transition and the noted k-12 budged constrains. Investors should view this information in two ways. First, that Q4 Mac sales are somewhat misleading in interpreting the health of Apple’s computer operations; and secondly, that Q1 sales could be markedly higher than they were in Q4. Last year, Apple saw a 7.2% sequential rise (155,000 units) between Q4 and Q1 and that was without a full notebook transition in the month of October. As a matter of fact, the last time Apple came out with completely revamped notebooks was in March of 2006 where Apple saw screaming growth rates as a result. Thus, though Apple saw a sequential rise in sales in Q1 2008, it did so without the help of a new product transition.
Obviously, it is difficult to tell how much of an impact the economy might have on Mac sales in Q1, but what we do know is that sales saw a noticeable rebound in the month of October due to the product transition. Based on this data, I am modeling for sales of 2.8 million Macs for the January quarter. This would mark a 7.2% sequential rise in sales in Q1 matching close to the same sequential rise seen in Q1 2008. I am basing my estimate on: (1) the benefit of the Mac refresh offsetting the negative impact from the economy, (2) Apple’s lower dependence on K-12 spending in Q1, and (3) the noticeable rebound in sales that even conservative Apple mentioned that it saw in the month of October.
Yet, it’s important to recognize a bull and bear case when thinking about Mac sales. A bear case would see the economy having a much larger impact on Mac sales with little to no offset from the product transition leading to sales of only 2.65 million Macs. A bull case, on the other hand, would see Mac sales surging on the new product transition and helped by Apple’s lower dependence on K-12 spending in Q1. In a bullish scenario, I would not be surprised to see sales fly past 2.9 million units.
The Key to Q1 2009 Results is Understanding Apple’s “Prudence”
On a final note, I think it’s crucial that investors not underestimate just how “prudent” Apple is being with its guidance. There has never been a time over the past three years where the analyst consensus stood below Apple’s forecast. At $10 billion, the revenue consensus could very well be below what Apple expects to earn in the quarter, and what Apple would have guided for if not for the uncertainty. Moreover, the $10 billion consensus estimate is actually in line with Apple’s prudent guidance! I cannot stress enough how ludicrous it is for any analyst to have an estimate that is in-line with anything that Apple says. Any analyst who forecasts such a result is simply begging to be embarrassed when Apple reports earnings. Yet, the entire community of analysts as a whole, share in this overt bearish delusion that Apple is going to report in-line with its, not just conservative, but prudent outlook. Here’s what Steve Jobs had to say regarding just how prudent is prudent:
“Well, there’s a lot of prudence in there but it’s also October and October has always been a little bit of a foggy month for us. You know, we are always biting our nails, wondering whether we ordered too many iPods or this or that for the holiday quarter because sales often don’t really take off until November some time. So the months of October and April are our slowest during the year and we think we are doing the right things. We think we know what the results may be but October and April are foggy months for us in terms of predicting the whole quarter but there’s a lot of prudence built in.”