The Oppenheimer Effect: Conservative Guidance, Stellar Earnings from Apple

Apple (AAPL) and CFO Peter Oppenheimer have a history of being conservative with their guidance. Listen to a conference call, or read a transcript and you’ll hear repeated remarks about forecasts the company can “confidently meet.” It’s like a lawyer that won’t ask a question in court without first knowing the answer; similarly Apple seems incapable of making a projection without being sure it will come true.

The history tracks back quarter after quarter. In summer 2007, when Apple issued third quarter guidance, it forecast dramatically decreased margins and profits as a consequence of a then ambiguous product launch. It was going to be costly, it said. Earnings as a result, it told analysts, could be as low as 65 cents a share; well below the trend line. When the actual numbers came in, Apple reported $1.01/share. Last quarter, the first of their fiscal 2008 was more of the same. Conservative guidance from Q4 ’07 was trumped with record results but then the next round of forward guidance was received like a doomsday projection.

By now one would think the markets would be used to it. It’s an obvious enough pattern: first Apple gives conservative guidance about future earnings. The economy, a product shift, a parts shortage…something, warrants more caution. Next, the numbers come: conservative projections are blown away by stellar earnings that probably shouldn’t have been a surprise. Then, lest expectations get too lofty, the upside of the stellar earnings is tempered with another round of conservative guidance. It’s the Apple M.O., the “Oppenheimer effect”: Apple’s way of under promising, over delivering then under promising again.

Wednesday, on cue, Apple announced another round of earnings that followed the script. Already, the company had reset expectations to a forecast for Q2 profits of 94c/share, 13 cents less than analysts’ prior expectations of $1.09/share. Apple had also projected revenue would be short at $6.8b versus analyst consensus of $6.99b.

Now the numbers are out. Steve Jobs was “delighted” with the result. Peter Oppenheimer said “We’re thrilled.” And surprise, surprise, the numbers exceeded original expectations and then some.

BY THE NUMBERS

• Apple earned $1.05 billion or $1.16 a share on revenue of $7.51 billion. Both revenues and earnings easily beat Apple’s prior projections. They also showed substantial improvement over last year’s result of $770m net profit (87 cents/share) on revenue of $5.26 billion. Overall, it was Apple’s best March quarter in history.

• Within the computer segment, Apple had a very successful quarter. The company shipped 2,289,000 Macs. Total units represents a 51% increase in volume and 54% increase in revenue over the same period last year. The growth rate was the company’s highest ever. Also notable within the category, portables were up 61%.
• In the iPod subset of the music category, as expected, sequential growth was has slowed. Apple sold 10.64 million iPods – a gain of 1% in total units sold and (courtesy of pricier products like the iPod touch) revenue was up 8%.
• In actual music sales, iTunes officially surpassed Wal-Mart (WMT) (according to NPD) to become the largest music retailer in the US. The store had more than 50 million customers and 85% of the market for downloaded music.
• For iPhones, which are being closely watched in light of Apple’s projections to sell more than 10 million units, quarterly sales were 1,703,000. Total revenue recognized for the phone, accessories and payments from partners amounted to $378m. Deferred revenue, which includes a sum of monies related to both iPhones and Apple TV units was $1.93b, up from $1.44b in December.
• Within the retail category, Apple was up 74% year over year. Apple stores sold 458k Macs and returned an average store revenue of $7.1m (a 48% increase from the $4.8m reported a year ago). Operating profits at the stores were up nearly double to $334. Approximately 45 new stores will open in 2008. About half of these will be likely be outside the US. The new international outlets will include the first Apple stores in China, Australia and Switzerland.
• Other important financials: Cash flows generated from operations equaled $4 billion. The cash balance at the end of the quarter was $19.4b. Gross Margin was 32.9 percent, off from 35.1 percent a year ago but still slightly ahead of Apple’s projected result.

Beyond the figures, which by any measure were mostly all positive, Apple shareholders have some other things to be satisfied with and look forward to too.

For starters there’s the iPhone. Not only is it doing well, but it also appears poised to do even better. Since the beta software development kit was announced on March 6th, more than 200k developers have signed up and downloaded the kit. More than 1/3 of the Fortune 500 is represented. Some impressive software is likely on the way.

In addition to upcoming applications, Apple expressed almost certain confidence that it will make good on its projection to sell 10 million iPhones this year. They key to that success, they say, is international expansion. (Considering 3G is almost essential for parts of Europe and Asia, Apple’s confidence is a sign a second generation phone is highly likely by June, or July).

Another positive appears to be component parts. Pricing for DRAM and Nand Flash hit low levels in March, “historically low” according to the analysts call. This favorable pricing is expected to continue and should help margins in the present quarter.

As for new products and all the gossip and rumor about iPhone shortages, analysts did their best to get insights. Apple held to the line and kept silent. Nothing was revealed about what’s in the pipeline, nor did Apple add much color regarding inventory shortfalls for the iPhone other than to admit that demand was high.

Looking ahead: Last quarter in the earnings call Peter Oppenheimer was crystal clear. He told analysts, “[Apple is] giving very strong guidance. We are very confident we will achieve it.” And guess what, that’s exactly what they did. This second quarter, the wording isn’t much different. In forward guidance for Q3, Apple is projecting revenue of $7.2b and earnings of about $1.00. Those numbers seem a little low, and it’s likely they will be.

Comments

[Rob Dupea]

When you consider how many linear projections populate the pages of analyses churned out everyday, Apple's refusal to use exponential math doesn't seem so conservative.

Nothing hyperbolic about it, if you grasp the parable.

[KenC]

Oppenheimer did not say $1.00. He said, "about one dollar". Emphasis on "about". He also guided to 33% gross margin. In a response to a Bear Stearns analysts, he said, "do the math".

So, let's do the math. Apple guided to $7.2B in revs. That's 96% of this quarter's $7.5B. GM was 32.9% this quarter and Apple guided to 33% next quarter, essentially the same. In other words, there's no reason why a quick and dirty calculation can't just extrapolate eps from revs, since GM is virtually the same. 96% of last quarter's eps of $1.16, gives us $1.11. Note, Oppenheimer did not say there would be any unusual charges that would make operating margins different, so there's no reason why we can't use this GM proxy. So, if you do the math, Oppenheimer guided to $7.2B in revs and 33% GM and $1.11 eps, a touch above estimates.

Further, he noted that no iPhone revs would be counted between March 6th and end of June when iPhone software ver2 would be released. That's a minimum $100M hit. Since the analysts' $7.2B revenue estimate did not include this $100M hit, then in fact, Apple guided $100M better, and another penny on eps, better.

[Mr. A]

KenC, no, Apple did not 'guide to $7.2B in revs'. Listen again to the concall. Oppenheimer said 'about $7.2B in revenue', emphasis on 'about'.

[KenC]

Uhm, okay, I heard it. You do know what sig figs are, right? Significant figures? He said "about $7.2B". I guess he could have meant $7.15B or $7.24B, but you know, I don't really care, because of sig figs, I know the level of precision is to the $50M.

[ramankandola]

Salesforce.com is giving Macs to all employees. Yup, all 4000 of us; we are going to be one of the largest enterprise software Mac shops around. As the leases come up for the Dells, IT is replacing with Macs.

And why, you ask, Security! The resources it takes to defend against all the stuff the baddies throw at a PC, it’s just cheaper/easier to pay a few bucks more for a Mac and not have any of those issues.

With the Google Apps integration, and moving to the Mac, we will be free of the clutches of the Redmond Beast!

You really couldn’t ask for a much better endorsement of your value to the forward-looking enterprise than being officially adopted by Salesforce.com, could you now?

[Zach Bass]

It's all about managing investor expectations, which manages stock price. Apple must employ a conservative strategy in order to quell the volatility that would ensue due to their secretive nature.

Personally, I believe their strategy and execution of the strategy is brilliant. And like a good dog, investors follow Apple's lead, with the intended consequence of providing unconditional viral marketing.

-zach bass
www.zachbass.com

[Brewer]

Great article. You would think that people would know this already, but they clearly don't get it yet. Then again, this is the first successful profit where folks are not just taking profits and waiting for the next major rumor. Even after the incredible, totally unforseen iPhone announcement, the stock was back down to previous levels within a week of the announcement. (Then it ramps all of the rest of last year.)

Apple will inherit the PC market from the inept folks at MSFT. Wether MS bails on the boneheaded Yahoo! deal or ends up paying dearly for it, both are bad news. No purchase and they continue to be dogged by critics (only now it's sticking). MS already HAS an internet division, it's called MSN. The Yahoo! buyout is only more smoke and mirrors.

MSFT has been a legendary cash cow (in the 90's at least, it's been rather pathetic in this entire decade, drawing to a close.) Sure, they pay dividends, but so does your local bank, and that is insured. They have many projects losing money, while the OS (key to the monopoly) is at a total dead end. Office still doesn't allow basic features such as the ability to collaborate in real time (as Google docs already excels at (no pun intended)).

This is all without the iPhone, the most incredible device ever invented, or the iPod, the most successful, cultural phenomenon I have ever seen. I'm long on Apple, if you hadn't guess already. :-)