Apple Plays the Conservative Card Despite Record Quarter

Amidst the iPhone 3G euphoria surrounding Apple (AAPL) these days are the bread-and-butter Computer and iPod business lines. Today, those less-hyped money machines were in the spotlight as the Cupertino Computer underdog posted an impressive and record breaking quarter.

Results coming across the wires placed Apple with $1.19/share in profits from $7.46Billion in revenue. Considering the street was averaged in at $1.07/share and $7.36Billion across the top line, those numbers represent a dramatic earnings beat. On the sales side, the company sold a whisker-shy of 2.5Million Mac computers, over 11Million iPods and over 700Thousand iPhones--all figures above or right at Wall St. predicted levels.

The problem with Apple, as always, is the conservative guidance game the company plays with analysts and investors. The Street had earnings for next quarter pegged at $1.24 on Revenue over $8.3Billion, pretty ambitious but certainly achievable as the popular Back To School computer shopping season is in full force, as well as the successful launch of the iPhone 3G. Apple's story for next quarter was incredibly conservative with earnings of about $1.00 on revenue of $7.8Billion.

Considering 3 months ago at this time Apple was saying the just-ended quarter would yield profits around $1.00, which they have now beat by 20%, one would think the analyst community would get used to the (as some have coined) "sand-bagging". Not so, Apple shares took an after hours tumble of $15/share after the results were posted.

With the company having such an extraordinary growth trajectory, why the conservative guidance? Well for one, reeling in expectations is a gigantic undertaking when dealing with a company of Apple's substance, style and mystique. The company shroud of secrecy with new products, product refreshes, and partnerships adds to that mystique and as the general public feels the excitement of new Apple products, or Apple success, so too does the Wall St. community.

From time to time, these expectations have to be brought back to reality. The current quarter saw Apple deliver 44% year over year revenue growth and 30% year over year profit growth.

Expectations for next quarter currently expect growth of about 35% revenue and 23% profit. By creating a situation where expectations curb themselves into the 30%-20% zone, Apple will be poised to once again play the old "under-promise and over-deliver" poker hand.

Given that it's the popular back-to-school shopping season, Apple has year after year gone further and further with its iPod giveaways tied to new Mac purchases. This year was the biggest yet, as the company is including iPod Touch devices with the promotion. These giveaways aren't cheap and can put pressure on margins. However, last year at the time the company was also doing its "biggest back to school promotion ever" and somehow seemed to land on its feet and blow away analyst profit expectations.

The bottom line here is that once again Investors have a chance to pick up Apple at a discount. Considering with this most recent report, the company has earned $5.12/share over the last 12 months and is looking ahead to growth rates of about 30%+ for the next 12 months. This sets a P/E at current after hours levels of 30. Perhaps that can be considered high but with a Price to Earnings Growth ratio under 1 and growth continuing in the Mac and iPhone segments of Apple's business the future does seem bright, even if current economic turbulences keep Apple from all time share price highs.

In the $150s, and looking out 1 to 2 years, it's a steal, plain and simple.

Disclosure: Author is long AAPL

Comments

[Mr Bill:]

two observations: 1. my projection of the next quarter would involve a risk assessment using my best estimates for each product modified by an evaluation of the probability of the occurrence of negative events.
2. As long as Apple's progress estimate for the next quarter is lower than average projection by the analysts the tort lawyers can look for company's to sue following a sudden market downturn.
By the way: a very good article Chris.

2008 Jul 21 10:15 PM

[Kontra:]

When one is risk modeling AAPL for the near future, it's also informative to go back to 2005 and explore how Apple risk modeled its iPhone product despite some serious odds, as I explained in:

iPhone: The bet Steve Jobs didn’t decline
counternotions.com/200.../

2008 Jul 21 11:28 PM

[rwoodsie:]

I think the key is the new product releases Jobs point to over the next several months.
1. What existing Market is apple targeting to grab Market Share with a breakthrough inovation.
2. Are the new products relatedto the iphone and ipod. Apple inovations include adding software and internet connectivity to products and partnering as a team with developers.
3. Will the product releases be on time for BACK TO SCHOOL.
rwoodsie

2008 Jul 22 12:14 AM

[hardmanb:]

Don't have a lot to say...Chris pretty much said it all.

But, I think Apple has something big up its sleeve...

2008 Jul 22 12:29 AM

[MichaelComeau:]

Here's a quick summary of some of the analyst comments that have come out so far:

Apple analyst comments

2008 Jul 22 12:49 AM

[sf94127:]

Panic selling and hedge funds who can only make money by inducing panic selling. This has nothing to do with AAPL fundamentals or future opportunity. This is truly disgusting.

2008 Jul 22 02:18 AM

[jmmx:]

DAMN!

Why is it that no one at the conference called asked them how many 3G iPhones had been sold to date - the first 10 days??? THAT would have been an interesting data point.

25 million Apps downloaded! 25 MILLION apps!! Phenomenal !!!!!!!

2008 Jul 22 02:38 AM

[Will Ritter:]

Reading the transcripts, it seems to me that the analysts were overly focused on margin related items and of course, Jobs' health. Ironically, one of the factors to negatively impact gross margins is the success of the 3g iphone launch. Notice the breakdown of revenue and expense recognition timing in Peter Oppenheimer's answer to Jeff Fidacaro of Merrill Lynch during the quarterly conference call:

"Sure. We incur our OpEx in engineering, sales, and marketing related to the iPhone currently, while recognizing the revenue over -- and product costs over a two-year period of time. And we do have launch expenses for the iPhone 3G that are built into the September quarter and that’s provided for in the $1.27 billion guidance that I gave you."

Transcript is here:

seekingalpha.com/artic...

2008 Jul 22 03:07 AM

[Will Ritter:]

Along the lines of my post above, we might want to keep in mind that for every million iphones sold, Apple could be recognizing an additional .19 per share in earnings. How many 3g iphones might they sell this quarter? They don't need to sell many to make up for the .24 reduction in guidance:

The .19 was estimated by the following equation and assumptions:

1 million iphones x 170 profit = 170 million profit / 899 million shares = .19 per share, per million iphones.

2008 Jul 22 03:25 AM

[Zoltan L. K...:]

It's amazing, how stubbornly analyst and some journalist try to pull AAPL into the usual and by professionals (like Warren Buffet) heavily criticized quarterly earnings game. Of course, AAPL is giving a conservative guess on the MARKET, after all it utilizes in the first line innovation and leadership. Those analysts did not predict the development of AAPL in the last 5 years, especially since 2003, very well, and most speculation about new products was wrong and way off the needs of the market. Maybe the cautious attitude of AAPL regarding market developments helped them to build up those marketing capabilities, the market learned to know very well. Dutiful number crunching is no replacement for strategic thinking.

2008 Jul 22 03:34 AM