A few weeks ago, CNBC contributor Herb Greenberg argued on national television that Apple (NASDAQ:AAPL) should stop offering quarterly guidance due to the fact that Apple’s management is far too conservative to be helpful. While it’s obvious to most analysts that conservatism has very little to do with whether a company’s guidance is helpful -- consistency is the far more relevant issue -- Herb Greenberg is about to learn why a careful analysis of Apple’s guidance is important in more ways than one.
First of all, good guidance analysis is almost always helpful to investor-analysts who have consistently outperformed Wall Street in accurately predicting Apple’s quarterly earnings. Yet, every so often, Apple’s guidance can also shed light on something very significant beyond the company’s earnings. Take Apple’s recently reported fiscal Q2, for example. In the conference call, Apple’s CFO Peter Oppenheimer, stated very briefly among several other statements, “We expect OpEx [operating expenses] to be about $2.5 billion, including about $255 million related to stock-based compensation expense.”
To most people, this may seem to be a relatively benign and largely mundane statement. Something Herb Greenberg might find to be unimportant or trivial. Yet, to those with a more keen eye, Peter Oppenheimer might as well have just said, “Despite what you might hear on Wall Street, we expect the iPhone 5 to be released in late June or early July as planned.”
For everyone living under a rock for the past month, the next generation iPhone’s release date – whether it’s called the iPhone 5, iPhone 4S or something else entirely – has been wrought with speculation and rumor. Most on Wall Street now expect the iPhone 5 to be delayed for at least three months from its customary release date in late June to some time in early September. Everyone from chip analysts to overseas component suppliers to Apple analysts to journalists who “know people that know people who are familiar with the situation” have all generally agreed that the iPhone 5 is delayed.
Yet, the rumor mill is evolving so quickly it’s difficult to tell exactly what to believe. The most recent rumor suggests that the new iPhone is not only delayed for three months, but that it’s going to be merely “evolutionary” rather than “revolutionary.” A few analysts have come out over the past week and concluded that the iPhone 5 has been delayed until sometime in 2012 and that instead Apple will be releasing an iPhone 4S with minor upgrades -- much like the 3GS -- after a three month delay in September. The iPhone 5 – according to the rumor mill – is the name for the device that supposedly runs on the faster LTE network.
According to Jefferies & Co. analyst Peter Misek,
the likelihood of the iPhone 5 launch in September including LTE [Long-Term Evolution] is now remote. According to our industry checks, the device should be called iPhone 4S and will include minor cosmetic changes, better cameras, A5 dual-core processors, and HSPA+ support.
Further confirming this research from Jefferies & Co., Keith Bachman of BMO Capital concluded in a note to clients on Monday that “poor battery life” is to blame for Apple delaying the iPhone 5 -- an iPhone without LTE or 4G network -- until next year and that investors should expected a refresh of the iPhone 4 with minor changes that are “more evolutionary than revolutionary.”
Alright, so what do we know? First, the new iPhone – whatever it’s called – is delayed until September and it’s going to look exactly like the old iPhone 4. It’s basically just going to be an iPhone 4 on steroids. This, according to Wall Street speculation. Speculation that is supposedly so solid that chances of it being wrong are considered “remote.” Right.
Historically speaking, nearly every year there are countless theories advanced as to what the new iPhone will be and what it will not be. Almost every year there is rampant speculation that the iPhone is delayed for a few months. Though I must say that this year there seems to be a widely accepted consensus that the next generation iPhone is delayed until September. After all, how can Apple come out with a new iPhone two months after finally releasing the White iPhone 4? It would seem counter-intuitive for Apple to release the White iPhone at the eve of a new roll-out. I must concede that this argument is in fact very compelling.
Yet, the best ally to investors when it comes to Apple has been and always will be common sense. While Apple may or may not decide to release a revolutionary new design for the iPhone this year, common sense dictates that there’s very little chance that Apple will both delay the release of the device and make only minor changes. It’s either one or the other. If Apple is going to be releasing an iPhone 4S with merely evolutionary changes this year, it’s coming out in June. Here’s why.
First, this is Apple we’re talking about. Remember the company operating under the helm of the most demanding perfectionist? A company as competent in execution as Apple is not going to allow the iPhone to be delayed when we’re talking about minor changes to the device. If there’s going to be a delay, then it’s because Apple is working on revolutionary changes. Apple is a company with $65 billion sitting at its disposal. If it wants the device out in June, it’s coming out in June.
Secondly, Apple was embarrassed last year with the iPhone 4 missing prototype debacle. Don’t be surprised if Steve Jobs significantly increased efforts to return Apple to the days of secrecy. Remember the days when Steve Jobs would end his presentation with “One more thing…” and release a product that the public was genuinely surprised to see? This rumor mill of a delayed iPhone all began because Apple didn’t make mention of the iPhone in its invitation to the World Wide Developer’s Conference set for this June. It seems like a perfect stage for Steve Job to once again surprise us all with “one more thing…”
By the way, just because Apple didn’t make mention of the iPhone in its invitations for the WWDC doesn’t mean the iPhone is definitively delayed. There were instances in the past where Apple has held two separate events in June -- one to introduce the iPhone and another for the WWDC.
Thirdly, if the changes to the device are merely evolutionary, then a roll-out of the more advanced 4S shortly after the White iPhone 4 would make a lot more sense. The White iPhone 4 would merely become the lower end version of iPhone 4 / iPhone 4S family of devices. New White iPhone 4 customers won’t feel as bad about buying the device ahead of the new iPhone 4S than they would if Apple introduced a whole new revolutionary design. Especially if Apple decides to make the new iPhone 4S available only in black for a short period of time. There would be a sense of exclusivity with the White iPhone 4 despite the advances to the new iPhone 4S.
Either way, if it’s not a whole new design and Apple plans on continuing selling the White iPhone 4 alongside the iPhone 4S -- much like they do now with the iPhone 3GS -- Apple won’t be seen as somehow screwing over new White iPhone 4 customers.
Finally, and most importantly, Apple significantly increased its guidance for operating expenses this quarter. The only time we see Apple do this is when it expects heavy traffic to its retail segment or ahead of a big product launch like the iPhone. For example, during the holiday shopping season where store traffic is at its peak -- October through December -- Apple dramatically increases its temporary and part time employment.
Higher employee hours leads to higher selling, general and administrative expenses (SG&A), which in turn leads to a higher OpEx (operating expenses) guidance on the quarter. Apple almost always guides for an aggressive OpEx number ahead of the holiday shopping season. The only other time Apple puts forth such aggressive OpEx guidance is ahead of a major product launch like the iPhone.
Over the past two quarters, Apple offered OpEx guidance of $2.325 billion for fiscal Q1 ($2.471 billion actual) and $2.350 billion for fiscal Q2 ($2.344 billion actual). Yet, while Apple only reported $2.344 billion in operating expenses this past quarter, management all of a sudden decides to up their OpEx guidance to $2.5 billion out of the blue? That is quite a significant jump in operating expenses. There is traditionally nothing particularly special about Apple’s fiscal Q3 in terms of store traffic that would necessitate higher SG&A expenses -- especially if no iPhone launch is expected during the quarter.
What’s most revealing about the $2.5 billion guidance is the fact that Apple has underestimated its actual expenses in 13 out of the last 15 quarters. Even as recently as fiscal Q1, Apple missed its OpEx guidance by $146 million. What this suggests is that Apple’s $2.5 billion guidance is a lot more aggressive and telling than it may appear. Here’s why.
Given Apple’s past history of underestimating its expenses, coupled with guidance that is $150 million higher than what it actually reported last quarter, indicates that Apple is “reaching” to get ahead of some major expense. Apple will probably report closer to $2.6 billion in operating expenses as a result of some major product launch for which Apple will be preparing. Notice the reason Apple has to “reach” is because they can’t just come out with a $2.7 billion OpEx guidance. That would all but confirm a June launch for the iPhone. Thus, the $2.5 billion number is subtle enough that most analysts will simply brush over the number without a second look, but telling enough to those paying close attention
If that isn’t convincing enough, consider this. In what is generally considered one of Apple’s seasonally slowest quarters of the year, Apple’s management just offered the most aggressive OpEx guidance in the company’s history. Notice this huge increase in Q3 guidance is also more or less very consistent with the historical trend. We saw the exact same pattern take place in 2010. Apple offered the same exact guidance of $1.64 billion in fiscal Q1 and fiscal Q2 of 2010, and then increased its OpEx guidance by 11.6% to $1.83 billion for fiscal Q3 ahead of the iPhone 4 launch.
Now, most of the expenses associated with the actual launch of the iPhone take place in Apple’s fiscal Q4. But it’s been the general pattern that Apple increases its SG&A ahead of an iPhone launch that usually kicks-off in the closing days of fiscal Q3. Expect to see the new iPhone in customer hands this July.
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Disclosure: I am long AAPL.