[Article Publication Date: January 27, 2019]
But First, A Quick "Q&A"
This FQ1 2019 is pretty much a "disaster", right?
Yes, no matter what the cause was. Because Apple was forced to issue a can't-sugarcoat-it earnings warning for the first time in...forever (fine, 2002). We're not talking about how this holiday quarter compares to others, nor are we looking at the numbers in a vacuum (in said vacuum, this is a fiscal quarter any number of Fortune 100 companies would love to have).
This is about expectations. Expectations of investors and analysts. Expectations, quite justified, that Apple was going to continue to grow (for the December quarter, anyway), on a year-over-year revenue/profit basis. Which were set, of course, by Apple management when it issued FQ1 guidance after a quite-good FQ4 2018.
So the problem has at least two dimensions. One, Apple didn't grow, it's going to do the opposite. Two, management was blindsided by the extent Apple was impacted in FQ1 - having to lower the expectations bar from $91B midpoint down to $84B.
So how about management's credibility now?
In terms of investor relations/financials, it's taken a huge hit. That multi-multi-year streak of reporting actual results within guidance or better? Snapped, and Luca Maestri can't be happy about it.
Not like my opinion is worth much, but this is the kind of blunder that brings, for instance, the notion of the Apple Board conducting or actual being subject to a shakeup of some kind from "never, ever happening" to "a distant non-zero possibility".
Wall Street pros and the better-informed investors (from small to very large) know, however, that Apple's financial guidance modus operandi - always be conservative - hasn't changed since the Steve Jobs CEO era, and if anything, management will double down to make sure that a guidance miss (at least, one of this severity) won't happen again - at least for another decade or so. Unless you're a jaded, cynical Apple Bear, I think it at least reasonable to say that Apple is "allowed" to make a major guidance mistake...as long as it's not more than "once in a great while". Whether you call it accumulated goodwill or a well-built guidance rep over the years, it's a heavy blow to both, but nothing that will shatter investor confidence yet.
What about Apple's "credibility" (strength) as a company?
That, that probably isn't impacted - much - yet. Sure, there are a few (or more, heh) bloggers, pundits, etc. will do their unfortunate worst - tie in Apple's FQ1 struggles into their narratives about their favorite hobby horses - overpriced iPhone X, HomePod/AirPower failure to launch, "faulty" MacBook Pro keyboard (even though that particular problem doesn't seem to afflict the newest Mac laptops now), etc.
Sure, the company's not perfect, but Apple's products are the best they've ever been, and margins - well, if you've been paying attention, you know the true story on relative value per dollar.
Apple the products/services/software provider's "credibility" is subject to erosion over time if their business model becomes imperiled. As of right now, it's far too early to say that suddenly, whatever strategies, products and initiatives that brought Apple to its current well-north-of-$200B annual revenue level just aren't working. Because some of them, such as Services, are still working. Really well. And aside from iPhone, growth was to be found in other geographies and in other business lines for FQ1.
There's the $200B-plus, plus part too, for the time being. Things seem dire to the casual observer, but Apple's really quite new to ultra-high revenue in corporate lifetime terms. It's spent a grand total of four fiscal years at the $100B-$200B weight class, and an entire four other years (y'know, the last four) at the $200B+ plateau, with its highest fiscal year rev number, $265.6B, being about quadruple the number from FY10 ($65.2B), the Infamous Antennagate Year. Of course, Apple also had that FY16 revenue hiccup (a $215.6B "comedown" from the $233.7B FY15 iPhone 6/Plus Mania Year), but the long-term trends to date have been pretty decent overall, I'd say.
That somewhat longwinded contextual aside...aside, at this point? Yes, sustained downtrend/peer underperformance would definitely have an impact on Apple's "company credibility", but that's along a spectrum, not some slider/switch with only two positions.
IBM, for instance, has been mired in financial downtrend for several years - yet, it doesn't seem all that "doomed" in general, partly because
(2) its overall financial picture is parsecs from from HTC levels of awful (Big Blue is still managing over $10B non-GAAP profit per year) once you adjust for its one-time charge due to U.S. corporate tax reform.
IBM hasn't been an exciting growth story for years, and it's not going anywhere - know what I mean?
Bottom line - should we be "worried" by Apple's earnings warning?
Good question. But it's probably not the question I'd ask.
OK "genius", so what's the "right" question?
I still don't claim any expertise in this subject matter - but I'll humbly suggest a better question: "What's [a way to set] a reasonable benchmark for FY19?" Such a benchmark won't, and can't, provide anything definitive, but it has the enduring advantage of favoring numbers over narratives. It gives us something to refer to, to compare against. And I'll throw out a scenario or two before this article is through.
In one well-worn disclaimer paragraph, we’ll be back to the familiar format:
(1) check guidance and analyst expectations for the to-be-reported quarter;
(2) take a entertainment-purposes-only look at FQ1 2019 with some quick, humble home game commentary on major revenue categories (revenues are all we have to go on now that units are no longer reported); and
(3) wrap up this 5+ year continuing series with a quick note on the quarter of most interest — the in-progress FQ2 2019, which is justifiably causing investors all kinds of anxiety.
(IMPORTANT NOTE: Please refer to this About + Disclaimer message from my old blog. You won’t ever find actionable investing/trading advice here, just a bunch of paragraphs from a hobbyist blogger in my cozy corner of the Web trying to understand Apple/financials/tech a little bit better. As you know, no one has any clue what AAPL stock will do from day to day, quarter to quarter, year to year, even if earnings “seem good enough” [FQ1 2019 sidenote: And if they're not...?]. Performing your own due diligence is an absolute must.)
Apple’s FQ1 2019 Guidance, Then and Now, Plus Wall Street’s Take(s)
>>> Part One: Apple’s Guidance, Before and After
In early November, Apple guided as follows:
• revenue between $89 billion and $93 billion
• gross margin between 38 percent and 38.5 percent
• operating expenses between $8.7 billion and $8.8 billion
• other income/(expense) of $300 million
• tax rate of approximately 16.5 percent before discrete items
Over $90B based on mid-point guidance was not to be, however. On January 2, Tim Cook issued the following revised guidance:
• revenue of approximately $84 billion
• gross margin of approximately 38 percent
• operating expenses of approximately $8.7 billion
• other income/(expense) of approximately $550 million
• tax rate of approximately 16.5 percent before discrete items
What "should have been" 3% YOY rev growth under the original, inaccurate guide (midpoint) instead turned into a YOY rev decline of about 5%. Gross margin, however, is not being projected to be particularly affected - call it 20-30 basis points from the November midpoint.
It's been covered enough, so I won't spend too many words on Cook's cited reasons for the revenue shortfall. Probably best to focus most on the quantitative aspects of his investor letter, and this one is key:
"most of our revenue shortfall to our guidance, and over 100 percent of our year-over-year worldwide revenue decline, occurred in Greater China across iPhone, Mac and iPad"
You've got $7B worth of "revenue shortfall versus guidance" measuring from the midpoint, and you've got around $4.3B worth of actual YOY revenue decline under the revised guidance vs. FQ1 2018 actual.
So, the Greater China rev geo was, on its own, responsible for more than $4.3B of Apple's unexpected underperformance for FQ1 2019. What "most" means isn't clear, but why don't we "set" the YOY rev geo decline at $5B in advance of Apple's Jan. 29 earnings release? We'll return to this later.
Also of note - Tim Cook was careful to mention that iPhone, Mac, and iPad all contributed to the Greater China rev decline. Thus, if you "believe him", then it wasn't solely an "iPhone problem", it was a broader-based Apple hardware demand challenge for the quarter in that rev geo.
Cook also wanted to make very clear that Greater China's installed base was not showing any signs of erosion: "Our results in China include a new record for Services revenue, and our installed base of devices grew over the last year."
Finally, aside from some iPhone macro concerns and a vague reference to "other emerging markets" helping contribute to Apple's revenue decline, Cook noted that Services, Other Products, Mac, and iPad all saw YOY revenue growth for FQ1 2019. The revenue categories have been reclassified, however, so we do need to spend some amount of time on the new accounting standard. Long story short - it caused Services to "receive" modest "contributions" from across Apple's hardware product lines.
>>> Part Two: Tracking Wall Street's Expectations
In late October (shortly before the FQ4 2018 earnings release), Wall Street was feeling relatively bullish about Apple's FQ1 2019, with a consensus of almost exactly $93B in holiday-quarter revenue (though, as is often the case with FQ1s, the low-to-high estimate range spanned over $15B).
Predictably, Apple's very specific revised guidance means the consensus is now a rounding error from $84B. Here's the latest according to Yahoo! Finance, which sources its analyst estimate data from Refinitv - basically a recent spin-off of Thomson Reuters "Financial & Risk" division:
Since Apple "gave away" its lousy FQ1 2019 result, it's the other consensus data points that are of most interest. We'll take a look at the "March quarter" (FQ2 2019) consensus ($59.3B, calling for a 3% revence decline YOY) near the end of this article.
Next, my “entertainment purposes only” estimates for FQ1 2019. There's a lot less guesswork, given Apple's earnings-warning-driven disclosures (linked above, some parts tabulated below).
The AAPL Tree “So, How Dour Could FY19 Really Get From Here?” Not-Really-A-Horseshoe-Toss for Apple’s FQ1 2019 Numbers
• $84B revenue guidance; 38% GM; $8.7B OpEx; OI&E $550M; 16.5% tax rate ex-discrete items (I'm just going with a 16.5% tax rate).
• Services revenue for FQ1 2019 = $10.8B;
• "Wearables" (mostly Apple Watch + AirPods) up "almost 50 percent year-over-year"
• not-iPhone revenue up almost 19% YOY (translation: iPhone revenue down about 15-16%)
• iPad revenue had "double-digit revenue growth" YOY
• Mac revenue did grow YOY
The Reclassification of "Modest" Amounts of iPhone, iPad, Mac and Other Products Revenue as Services Revenue:
The link can be found here, but to make it easier, I'm just uploading a screen capture of the one-page chart:
Here were my takeaways from the chart (yours may differ, and with good reason):
1) Of course, no aggregate change in reported revenue resulted. It was an accounting change that reallocated deferred "Service-type value" from Apple's hardware devices to Services. Which sounds logical enough - it's just that the timing, particularly against the backdrop of an earnings warning, makes it more difficult to compare apples to apples.
2) Services received very consistent quarterly boosts to its revenue total as reclassified - about $2.56B in reallocation in all. Maybe it's not quite a proper explanation, but Services has not been a seasonal line item for Apple (because the installed base of users isn't "seasonal"), and nothing about the reclassification changes that trend.
3) iPhone "contributed" the great majority of Services' "newfound" revenue in FY18 - around 70% for the full year. iPad was next at slightly over 15% of the reallocated revenue total, followed by Mac at just over 10%, with a very nominal contribution (not quite 2%) from then-named Other Products.
4) Apple was apparently only obligated to reclassify revenue going back one fiscal year, which adds uncertainty to whatever "adjusted" compares would have been in FY17 and prior. *sighs*
5) Speaking of compares, the new revenue category numbers (one hopes the revenue geography numbers remain about the same, but we won't know for a while yet) are as follows under the new Services revenue accounting method:
FQ1 2018 iPhone: $61.1B (about 75 basis points lower than before)
FQ1 2018 iPad: $5.75B (about 1.8% lower than before)
FQ1 2018 Mac: $6.82B (about 1% lower than before)
FQ1 2018 Services: $9.13B (about 7.8% higher than before)
FQ1 2018 Other Products: $5.48B (a mere 15 basis points lower than before)
With that in mind, here's how I filled in the rest of the blanks for FQ1 2019:
(NOTE: W/H/A is convenient shorthand for the Artist Formerly Known as "Other Products" - it's now been renamed Wearables/Home/Accessories)
In case you were wondering, assuming a similar tax rate for FQ1 2018 (didn't happen, but just as a sidenote), Apple's net income would have been down about 12% from the prior year (GAAP basis: down slightly over 1%). A decent part of that non-GAAP decline, however, is attributable to what has for the past several years been an annual "stair-stepping" in OpEx, which for FQ1 2019 is guided to be up almost $1.1B (14%) year-on-year.
As usual, we’ll "overview" Apple's five revenue categories: iPhone, iPad, Mac, Services, and Wearables/Home/Accessories, which is just the "old" Other Products by a different name, if I remember right. Since it's all about revenues now, I decided to change things up a bit, and provide bar charts to display YOY revenue growth and/or decline over the past several years. (It's in "Old GAAP" for consistency's sake, because "new GAAP" data is unavailable before FY18.)
iPhone - Almost $52B Never Looked So Glum
Slowing growth until iPhone 5s; the iPhone 6 Revenue Explosion; the iPhone 6s Hangover; the stabilizing period of FY17; and then, the eye-popping $700+ iPhone ASP year, fueling impressive growth considering Apple's immense scale.
Now, a -15% or so "red bar" will join the chart party at far right. Will the iPhone shortfall be "mostly contained" to Greater China, or will demand malaise expand beyond that region plus various emerging markets? Since we just don't know, I'd prefer to wait on FQ2 guidance for clues, versus "rely" on supply chain rumors that just happened to be "right" this time around.
Note what I didn't say. I may happen to think Apple will survive this latest business challenge, but I'm hardly calling for a return to iPhone revenue growth anytime this fiscal year. It's probably safe to assume iPhone revenues will be down easily 10% or more at least until the next product cycle, absent signs of recovering iPhone demand in Greater China in the meantime.
"Is Apple to blame", because its iPhones have the price points they do? Such a question relies on a faulty premise, because Apple's never claimed to be anything other than a premium hardware manufacturer. Lower price points would always help, but realistically,
• Apple wouldn't sell an iPhone Xs for $200 less per SKU at this point (margin percentage is similar or worse than the historical average, anyway),
• and the basic result would be basically the same regardless - weakening demand means less units sold. The only difference is the amount of revenue lost per unit.
Next up - iPad.
iPad - A Semi-Opposite of iPhone, Including in FQ1 2019
iPhone revenue may be down 15% or so YOY, but iPad is up at least 10% according to Cook. It might be up over 15% - depends on how you think Apple Watch Series 4 and its supporting cast fared, and how strong Mac was in the December quarter. Of course, it helps that
• Apple has a very nice lineup of iPads across the price spectrum with quality redesigns at the top end (we...shall not speak of iPad mini 4), and
• well, just look at all of those red bars, making for easier compares should iPad revenue ever recover...which it appears to be doing.
iPad's hypergrowth period (fun fact! It was basically just one year) clearly couldn't last (in retrospect) - smartphones are the undisputed volume leader, and traditional-ish laptops plus a side of desktops don't appear to be going anywhere, increasing contention amongst the various devices for consumers' money. Just because iPad won't be seeing $10B holiday quarters anytime soon, though, doesn't mean iPad is no longer a decent business for Apple. The revenue declines seem to have halted for now, with iPad having turned in an $18.4B fiscal 2018 ("new GAAP" basis).
Is (close to) $20B for FY19 too ambitious a goal? I don't claim to have the answer, but I can leave you with an interesting statistic: iPad hasn't had a "December quarter" of 10%+ revenue growth under "old GAAP" since FQ1 2013.
Next, a quick look at Mac.
Mac - An Overall Positive Revenue Story Looks to Continue (For Now)
Macs have been around longer than any Apple hardware product line, so many of these mature-industry-looking YOY growth/decline numbers aren't very surprising.
Cook mentioned Mac had positive YOY revenue growth for the December quarter. True, it's almost certainly the lowest positive growth rate of Apple's "bright spot" revenue categories given the "fixed points" included with Apple's $84B guidance. Still, it's not bad for a lineup with allegedly lousy laptop keyboards, "no innovation" in the MacBook Air, everything's still too pricey, etc.
Good ol' Mac remains a much-needed tailwind for Apple, however modest, and a decent sign that Mac will be at least steady for the fiscal year in progress. As Cook mentioned, MacBook Air was constrained for the quarter, while iMac hasn't seen a refresh in over 13 months in the case of iMac Pro, and over 18 months for the consumer-grade iMacs (which are due for a redesign, with the form factor dating back to late 2012). I doubt the prosumer Mac mini relaunch could overcome the negative impact of "stale" iMacs on shelves. 😁
Two other reasons to be cautiously optimistic on Mac for 2019: A new modular Mac is supposedly very close at hand, with a new Apple (5K+, I'd assume) monitor to pair with it.
And with that, we move on to Apple's most vibrant business lines: Services, and then Wearables/Home/Accessories.
Services - Still Superb
Based on Cook's $10.8B Services number for FQ1 2019, the next green bar to appear on the chart will be a solid one - 18% growth. Also of note - because Services was the beneficiary of increased revenue throughout FY18, it stands to reason that "new GAAP" would have similarly increased Services revenue totals for the entire time period covered by the above chart (if Apple had been required to reconcile farther back in time).
Hence, my "theory" that under "new GAAP", Services growth percentages would all be lower (shorter green bars) than they were under "old GAAP".
But I digress. As Cook since reminded the general public in one CNBC interview or another, Services isn't seasonal, because its overall health is tied to the installed base of primarily Apple hardware device owners (yes, mostly iPhone owners).
So as long as Apple's total installed base continues to increase (+100M year-on-year as of FQ1 2019, per Cook), Services should remain vibrant. Of course, the combined challenge and opportunity is to engage/retain existing users as well, and, for lack of better term, increase "ARPU" ("average revenue per user", more of a celco metric but still useful here) over time.
Whether it's encouraging a better App Store experience, improving iCloud/Music services or adding new ones over time (Netflix-esque original content, health, etc.), the proverbial winds still appear to be at Apple's back as it approaches its goal to essentially make Services a $50B/year business unit by (end of) (FY) 2020. Of course, the new accounting standard makes hitting this goal easier than it was previously.
Don't forget, we get Services-level gross margin data for the very first time in just a few short days!
We'll wrap up the revenue category section of this article with Apple's current growth leader (by percentage), Wearables/Home/Accessories.
Wearables/Home/Accessories - a.k.a. "Mostly Apple Watch and Apparently Still First-Gen AirPods"
The overall trend, fueled by Apple Watch, has been obviously fantastic. And while the revenue base is still small -
Wait. That's actually quite the misstatement. It's true that Other Products was the smallest of Apple's five revenue categories to end FY 2018, but not by much. It rang in $17.4B in annual sales to iPad's $18.4B ("new GAAP" basis).
Note also W/H/A's recent trajectory. Seven consecutive quarters of YOY growth, and the last five have seen revenue growth exceeding 30%. FQ1 2019 actually stands a chance of extending that 30%+ YOY growth streak to six quarters.
Put another way, W/H/A, at present pace, has a fairly decent shot of ending FY19 as a $20B+ annual business - and somehow, fairly-old AirPods are still contributing to revenue growth! Just imagine what Apple Watch Series 5, new AirPods, maybe a new health product, and especially an AirPower mat 😉 could do to bring W/H/A to that impressive revenue plateau.
Finally, we conclude with a few thoughts on FQ2 2019...the March quarter that's got everyone on edge.
FQ2 2019 Quick Look - Not (Really) a Question of Direction, But of Degree?
Reposting that Refinitv/Yahoo! Finance analyst consensus screenshot for convenience:
This is a pretty easy one - is a consensus of 3% revenue decline for FQ2 2019...too optimistic?
Here's where Apple's revised guidance helps provide something of a base case, if nothing else.
Here's Apple's FQ2 2018 10-K (only useful for rev geo information, please note):
And we'll recap some of the revised guidance for quick reference:
• Apple's revised guidance is for about -5% YOY revenue growth in FQ1 2019
• $4.3B worth of actual YOY revenue decline under the revised guidance vs. FQ1 2018 actual.
• Greater China rev geo, itself, responsible for more than $4.3B of Apple's unexpected underperformance for FQ1 2019. ASSUMPTION: $5B
• ASSUMPTION: At $5B in YOY revenue decline, that puts Greater China's revenue growth at about -28% YOY for FQ1 2019.
• iPhone line revenue down about 15% YOY FQ1 2019
• rest-of-Apple-business up about 19% YOY for FQ1 2019
>>> To What Extent Will Greater China Weigh on Results?
Seems like a good place to start.
Zooming out, Greater China didn't have a significantly larger share of Apple revenue moving from FQ1 2018 to FQ2 2018 - in both cases, revenue share was about 20%. This was also the case in 1H FY17, interestingly enough.
So if Apple's Greater China market, to oversimplify, "is down the same amount (by percentage)" as it looks to be in FQ1 2019, it'll have the same relative effect on overall revenue. Same numerical amount, different story, but that would presume near-disaster for the rev geo - an accelerated revenue decline to 38% YOY if you assumed $5B in YOY revenue loss, and around a 35% YOY drop if you assumed $4.5B.
Let's assume a "base case" of all revenue geographies basically repeating their performance or lack thereof for a second consecutive FQ. That means Greater China, by itself, would result in 6% total corporate revenue decline for FQ2 2019.
Uh oh. (?)
Of course, it's not that simple. Greater China over-contributed to Apple's revenue decline; however, Apple did have revenue growth in other product/service lines and other markets. And it almost certainly will on a revenue category level for FQ2, to counterbalance near-inevitable iPhone weakness.
>>> The Potential "Benefit" of iPhone Revenue Seasonality?
But wait! If the total Apple revenue decline is 5% YOY for FQ1 2019, why is Wall Street at -3% (about $1.8B in YOY decline) for FQ2? Let's see if we can't get a half-decent clue or two.
iPhone revenue fell slightly over 38% sequentially (almost the same under "old" and "new" GAAP accounting) from FQ1 2018 to FQ2 2018. From $61.1B (almost 70% of total revenue) to $37.6B, or about 61% of total revenue.
For that same period in 1H FY18, Services revenue grew sequentially, from $9.13B to $9.85B (new GAAP). Its share of Apple revenue increased from 10.3% to 16.1% in the March quarter.
For FQ1 2019, Services has been guided to 12.9% of total Apple revenue. And expect Services to continue growing its slice of the revenue pie until a serious sea change.
If you assume a reasonable-ish growth rate of around 14% for FQ2 2019, then you have Services YOY revenue growth of $1.4B, on its own, counterbalancing March quarter iPhone YOY revenue decline of $5.8B, assuming the same ~15%downtrend as in FQ1 (it might be a bit better, it might be much worse, but we'll have to see). Yes, that means 7.2% YOY revenue decline assuming none of iPad, Mac or W/H/A grew in the quarter.
But W/H/A almost certainly did. Assume 25% YOY growth, and the decline is stemmed by almost $1B, to negative 5.5% revenue growth.
What if iPad had a positive FQ2 as well? iPad will have itself the best revenue result since FQ2 2015, if you don't count FQ1 2016 - and iPad line revenues, for FQ1 2019, could get fairly close to that $7.1B number. Apply the 30% sequential seasonality drop-off we've seen the past two FQ1-to-FQ2 transitions, and you end up with an FQ2 2019 iPad revenue growth number of around $740M. That further moderates our "base case" FQ2 revenue decline by another 120 basis points - to around -4.3% revenue growth...
...before Mac. (Math check: $1.4B + $1B + $740M - $5.8B = net -$2.66B revenue shortfall before accounting for Mac)
Hmm. Almost $900M short under this set of assumptions.
Mac is a bigger business than iPad, but not by much, and it certainly doesn't have the same growth potential...right?
OK, let's get "optimistic" for a moment and assign Services and W/H/A revenue growth rates similar to FQ1 2019 (estimated). 18% Services growth increases the iPhone "counterbalance" by around $400M, or 65 basis points worth of FQ2 2018's revenue result. And 32% W/H/A growth adds around $275M in incremental revenue - adding another 45 basis points worth of counterbalance.
That means, under the "optimistic" scenario, in which iPhone revenue decline does not worsen on a percentage basis sequentially, that Mac would need to chip in around a quarter-billion USD worth of YOY revenue growth for the consensus to be accurate. It could be very, very close. Or the iPhone revenue wildcard could make an overwhelming difference to the "upside" or downside.
Finally, speaking of the pro analyst "consensus" - it's not close to a consensus on a revenue polling basis. Estimates somehow run from a gloomy -10% YOY growth all the way up to...um...+5% YOY growth. For the in-progress March quarter.
Needless to say, the stage is set for a very interesting and closely-watched FQ2 guide this Tuesday.
This concludes my 23rd (yes, really!) consecutive Apple Inc. quarterly earnings preview. Hope it helped your thought process on the company's financials, and it sure would be great if you felt it worthy of a weekend/evenings-eve share, like or retweet!
See you all online for the Jan. 29 earnings event!