Using Apple's Crystal Ball For Q4

| About: Apple Inc. (AAPL)

Summary

Facts from Apple's Q3 numbers.

Q4 projections based on history and other factors.

The disappearance of Apple "surprise".

Since Apple's (NASDAQ:AAPL) last earnings announcement on 7/26, Seeking Alpha readers have had many articles to read each and every day on the merits or shortcomings of this well-known company. Whether the articles are written with a well-loathed or well-revered slant is what makes this website so great. You get both.

But, it's a lot to absorb. With less than a week to go before the next earnings announcement (as of this writing), SA readers have had significantly fewer articles to paw through when compared to the previous two quarters. Since the last earnings announcement on 7/26, 163 articles have been published with Apple as one of the tags. The previous quarter was at 200 (earnings announcement to earnings announcement). So I ask, are we all tiring of this back and forth banter?

As I've stated before, I try to rely on facts and numbers to formulate my own opinion. Over the past few quarters, I have presented an in-depth look into the guidance numbers presented at each of Apple's earnings announcements, comparing them to the actual to determine where the patterns and problems might show up. This article is an ongoing continuation of that analysis.

Apple's Crystal Ball, a.k.a. Guidance, only gives us factors that we must formulate to come up with the all important earnings per share. If we make assumptions regarding outstanding share count, they give us just enough information to come up with a number. But there's history in those guidance numbers. History to learn from. That is why I dig deeper to ascertain. First, let's review the Q3 results related to guidance and a few side notes that may be pertinent as we review the Q4 guidance and my expectations later in this article.

Q3 Results - Revenue

For fiscal Q3, ending 6/25/16, Apple's revenue came in at $42.358 billion. This number was down 14.6% from a year ago but was within the range of guidance provided for this quarter ($41.0-43.0 billion) back in April's announcement. Now, my research only goes back to Apple's Q1 of 2009, but over those last 31 quarters, Apple has never "missed" on revenue guidance. The revenue has never been below its low guidance. Not once in 31 straight quarters. The closest it ever came to being below its guidance was Q1 of this year, when the guidance was a mere $382 million dollars over the guidance. It bears repeating, not once in 31 straight quarters.

Q3 Results - Gross Margin

Apple's Q3 gross margin fell just north of the guided range at 38.02%. This is the 11th quarter of the past 14 quarters where the high-end guidance was beat. The guided range was between 37.5% and 38.0%. Even more spectacular, like revenue, actual gross margin has never missed on the low side of guidance.

Q3 Results - Expenses

During this 14-quarter timeframe since reinstating guidance for expenses, Apple results have never exceeded the high-end of the guided range. Instead, the actual hover around the low-end of guidance, averaging just 0.11% over low guidance. Q3 numbers tightened this average even closer, coming in at just 0.02% over its low-end guidance. The actual expense number was $6.001 billion.

Q3 Results - Other Income

Other income came in at $364 million for the quarter. This was 21.3% or $64 million higher than the guidance number of $300 million. The average OI for the last 14 quarters now stands at $296.4 million.

Q3 Results - Tax Rate

The tax rate for Q2 was 25.53%, just 0.13% higher than the guided rate of 25.5%. The average for the first three quarters of this fiscal year is 25.48%. The people in Apple's tax department have this down to a science.

Q3 Results - Share count

As pointed out in previous articles, there are three share counts Apple reports in its 10-Q. The header of the 10-Q includes the share count at the time it completes (internally) its 10-Q. This number was reported as of 7/15/16 and was 5,477,425,000. This was down 88,992,000 (1.6%) from the previous quarter, which is slightly more than the average post-split quarterly drop of 1.3%. The share count used to determine earnings per share, which is a weighted average (see Note 1 of the 10-Q's notes to condensed consolidated financial statements (unaudited)) fell 1.24% (68,105,000 shares) to 5,472,781,000 (fully diluted). The third share count reported by Apple is the one used to determine shareholder's equity as of the close of the quarter. This was reported as 5,393,165,000, down 1.56% from the previous quarter, a drop of 85,281,000 shares. As one would expect with a company known for its share buybacks, this marks the 4th year in a row that there was a decline in share counts.

Q3 Results - EPS

Apple's Q3 guidance with all of its permutations averaged an expected earnings per share of $1.36. It came in at $1.42 per share with the street calling it a $0.04 beat. Based on the various extrapolations of its guidance, the range could have been between $1.30 and $1.43.

Examining The Trends, Projections for Q4 Report Next Week

With revenue, gross margin and expense guidance pretty much always on the money, the tax rate guidance on a three quarter roll, and other income providing less than a nickel of EPS (<2.5%), you would think that the guidance numbers can be pretty much taken at face value. But that's where Apple gets interesting. With major share buybacks ongoing, and a historical propensity for surprise, analyzing the trends can provide insight into the future of Apple's earnings.

Revenue - Q3 analysis and Q4 projection

The analysis provided in last quarter's article (here) projected the range of revenue to be $42.49 billion, a mere 0.3% over the actual. For the 14 quarters since returning to a guided revenue range, actual revenue has averaged 7.151% over the low-end of guidance. This is down from last quarter's 13-quarter average of 7.447%. However, the last four quarters have averaged just 2.5% over the low guidance and just 1.8% under the high end of guidance.

For the fourth quarter, Apple has guided revenue to be between $45.5 and $47.5 billion. I am sticking with the four-quarter average and projecting revenue to be 2.5% over low guidance or $46.638 billion.

Gross Margin - Q3 analysis and Q4 Projection

Based on the historic data, Apple's gross margin factor was anticipated to be 2.4% over the low-end guidance of 37.5%, or 38.4%. This was a shade over Apple's high guidance of 38.0%. The Q3 actual came in a fraction over the high-end guidance at 38.02% and 0.38% below my projections. Apple has repeated its Q3 guidance for Q4 with a guided a range of 37.5% to 38.0%. The last time two consecutive quarters came in at or below 38.02 was back in Q4 of 2013. As mentioned above, with the propensity of beating gross margin on the high side, I am going to project off of the high-side guidance and go with the 14-quarter average of 0.97% over high guidance. This puts my gross margin projection at 38.37%

Operating Expenses - Q3 analysis and Q4 projections

Coming into Q3 and going back as far as the beginning of 2013, when Apple reformatted its guidance by providing a high and low range of expenses, the actual operating expenses had not exceeded the high guidance. That trend continued with the release of the Q3 numbers with OpEx just a fraction over the low-end of guidance at $6.001 billion. Would there be any reason to expect a change? I still doubt it as well. Last quarter, I expected the expenses to be 0.98% off the high guidance of $6.1 billion or $6.04 billion. For Q4, Apple has increased its range of OpEx, increasing both the high and low-end by $50 million. Based on a 14-quarter average of -0.86% off the high guidance, I project the Q4 number to be $6.097 billion.

Other Income - Q3 analysis and Q4 projections

This continues to be a parameter that fluctuates wildly. During the last 14 quarters, other income has ranged from a low of $113 million to a high of $439 million. Guidance has been in a range from $200-400 million. Last quarter saw the actual number come in 21.3% higher than guidance. Compare that to the previous quarter where other income came in 52.3% lower than guidance and you see the erratic nature of this parameter. But, when averaging a number of quarters (14 to be consistent), the average other income comes in at $277.14 million against guidance of $296.43 million.

Apple's projection for this quarter is $350 million. This is equal to the average for the last five quarters so I will go with this number as a new trend. Remember, in the bigger picture, other income plays a small role in determining EPS. In fact, it averages just 2.7% of total profit over the last 14 quarters.

Tax Rate - Q3 analysis and Q4 projections

The Q3 tax rate of 25.53% was only 0.03% over the guidance. This is almost perfectly in line with the average tax rate this fiscal year where Apple has "suffered" an average rate of 25.48%. Apple has again guided the tax rate to be 25.5% as it has in the previous two quarters. Last year, at this time the average tax rate was 26.4% for the previous three quarters. So, it's obvious that something has changed. For that reason, I will go with the guided number of 25.5% for Q4 as it seems like the bucking the short-term trend would be smarter than applying the long-term trend's numbers.

Share count - Q3 analysis and Q4 projections

As stated in previous articles, this is one factor where there is no guidance. So in order to develop a refined estimate on earnings, we have to review the trends and changes that Apple's financial engineering team comes up with. To that end, Apple's shareholders have benefited through the stock buybacks. Since Q3 of 2014, when the 7:1 split came into play, Apple has seen an 9.57% decline in weighted average shares used to calculate earnings per share. This is an average just over 1.0% per quarter. As the actual share count was already down to 5,388,433,000 on 7/15/16, I believe this quarter could see the weighted average share count fall to 5,380,000,000 for Q4.

Q4 expected numbers

So we have the numbers. I've summarized Apple's guidance and my projection of the numbers in the chart below to determine where earnings should fall. The EPS projected using Apple's guidance numbers reflects the use of Q3's weighted average share count.

Parameter

Q3 Projection

Q3 Actual

Q4 Guidance

Q4 Projection

Revenue

$42.49 Billion

$42.358 Billion

$45.5-47.5 Billion

$46.638 Billion

Gross Margin

38.40%

38.02%

37.5-38.0%

38.37%

Expenses

$6.04 Billion

$6.001 Billion

$6.05-6.15 Billion

$6.097 Billion

Other Income

$276 Million

$364 Million

$350 Million

$350 million

Tax Rate

25.5%

25.53%

25.5%

25.5%

Share count

5,470,000,000

5,472,781,000

No Guidance

5,380,000,000

EPS

$1.45

$1.42

$1.51-1.66

$1.68

Click to enlarge

The Surprise Factor

Anyone who has followed Apple over the years is well aware of some of the surprises found during the earnings announcement calls. Beginning with Q1 of 2009, for 14 straight quarters, earnings surpassed guidance by greater than 14% each quarter. In fact, the average "surprise" over this period was 41.51%.

Since then, 17 quarters are in the books. The average surprise over these 17 quarters, just 6.7%. But, the last four quarters have averaged...wait for it.....no surprise. None, Nada, Zip. Goose egg. This is probably the most telling factor in the aging and maturing of Apple as a company. The thrill is gone......nothing to see here, move along. I will continue to monitor this for future quarters to see if this is truly a trend or a fluke but for now, I will leave my projected earnings per share alone at $1.68 per diluted share.

Potential Effect on Stock Price

The day before Apple's last earnings announcement, the stock closed at $96.67. A week before this next earnings announcement the stock closed at $117.47, producing a sizeable $20.80 gain for the quarter. I'll admit that I didn't see that coming based on a quarter matching the lowest quarterly EPS in two years. The previous trailing 12 months earnings were $8.99 putting the P/E on 4/26/16 at 9.3. The P/E on 10/18/16 is up to 13.72. Projected earnings of $1.68 per share would put the TTM earnings at $8.28 and put the P/E at 14.19. It's my opinion that Apple will need to hint of a huge Q1 to drive the price over a 15 multiple. I think it is more likely that the stock settles in the $110-115 range while it waits for the next big thing from Apple.

Of course, the elephant in the room is the outcome of November 8th....and an uncertainty that could push the course of the market in one direction or another, making this solid dividend payer a favorite port in a storm. As John Huston Finley put it, "Maturity is the capacity to endure uncertainty". We shall see.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I occasionally use Apple stock as part of a covered call writing position. I do not own any stock or calls at this time.