$AAPL FQ4 2016 Home Game Earnings Preview + FQ1 2017 Look-Ahead: The Most Enviable Down Year Ever Leaves Observers on Edge for What Follows

“If only fiscal 2015 had never happened. At least, in the order in which it did.”

Wha?! An absurd thing to say, right? When you consider how far too many observers perceive Apple (not in the most rational manner), perhaps not. Here Apple’s actual fiscal results + 2016-estimated, alongside a…“temporal shift”, let’s say:

They add up the same, but not from a stock market/valuation perspective.

I mean, sure, the pretend chart on the right (swapping 2016 and 2015’s revenues as a quick example) would probably have been better from a trend perspective. Wall Street may have liked it better. But business waits for no one. Apple doesn’t regret how fiscal 2015 turned out one bit, I’m quite sure — “regardless” of the “disappointment” fiscal 2016 has been.

The demand was there for iPhone 6 (oh, was it ever), especially in Greater China, so Apple struck while the aluminium stamps were hot and harvested the fruits of utterly astonishing-for-a-company-this-size growth (in both fiscal and installed base gains), just before the macroeconomic jitters of 2016 (and really, 2015 too) caught up to it.

And, well, as you can see in the chart above. A revenue number almost certainly well into the $210B stratosphere, probably around 17% better than FY 2014 with hurricane-force foreign exchange headwinds. A net income number of at least $45B, on the pessimistic end of expectations, which, yes, is still second-best in corporate history, 14% better than far-less-ForEx-impaired FY 2014 and around 8% better than the previous second-best profit year, Apple’s banner fiscal 2012 (fueled largely by iPhone 4S sales). If it weren’t for caveman-esque, context-absent notions of “negative growth bad” (though it is Apple Inc. we’re talkin’ here)…FY 2016 wouldn’t really look “as bad”.

Still, growth worries persist, not without legitimacy. And, yes, the burden of proof that growth will resume weighs at least somewhat on the subject company, after a 15-year streak of continued annual revenue growth (starting from $5.36B in revenues and $25M in net loss in FY 2001) comes to an end.

With all that said: Hello and welcome to my 14th consecutive (no, really!) home game AAPL earnings preview, where I try to understand the world’s most (formerly, heh) consequential and (not so much lately, heh) profitable tech company just that little bit better.

In just two disclaimer-reminder paragraphs, we’ll be back to what I usually do: (1) check guidance and analyst expectations for the to-be-reported quarter; (2) throw a horseshoe toss for FQ4 2016 with some humble home game commentary on major revenue categories; and (3) wrap up this TL;DR bonanza hardly anyone reads with a quick note on the quarter of most interest — the one Apple’s about to give guidance on. Which, in this case, is the massive, yet massively “mysterious”, holiday/December quarter, otherwise known as “FQ1 2017”.

(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 humble home gamer in his corner of the Web trying to understand Apple and tech a 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”. Performing your own due diligence is an absolute must.)

Something that I think bears repeating once again: There’s a gulf of difference between Apple disappointing Wall Street and Apple actually beginning to show signs of failure in an objective sense, whatever any hyperventilating members of the analyst/media/blogger class might tell you. Still, even the most ardent Apple bulls should (in my opinion) agree that a sudden patch of negative growth is one worth keeping in mind — and doing additional research about — to check against the ol’ investment/trading thesis.

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Apple’s FQ4 2016 Guidance, Plus the Formalistic-But-Somewhat-Meaningless “Stating of the Analyst Consensus for To-Be-Reported FQ4 2016” [as of October 21, 2016]

Here’s the FQ4 guidance from Apple:

• revenue between $45.5 billion and $47.5 billion
• gross margin between 37.5 percent and 38 percent
• operating expenses between $6.05 billion and $6.15 billion
• other income/(expense) of $350 million
• tax rate of 25.5 percent

The tail end of iPhone 6 momentum, a decent burst of iPhone 6s-generation sales, Apple Watch (having launched around April 2015) and, yes, “all-time Mac sales” (because the lineup wasn’t so old then) all contributed to an imposing year-ago compare of $51.5B revs and 39.9% gross margin.

On the other hand, on the eve of July quarter earnings results, the analyst consensus tabulated by Yahoo! Finance (yes, I know how increasingly irrelevant it’s getting, but the consensus has remained available and relevant as ever) was about $45.8B.

Turns out, Apple had an upside surprise in store. So as of Oct. 21, analysts are aiming about one billion and change higher, at $46.89B (EPS of $1.65 vs. year-ago $1.96). Funny what management guidance will make people do, eh? 😉

Considering that ForEx conditions remain rather brutal, and that Apple just went through a major product change with iPhone 7 (even though the outer casing doesn’t seem all that different at first look), projected margins still look pretty good, and Apple looks as confident as ever in its business model. Wall Street agreed, with AAPL now back above $115 per share, a level not seen since sometime last December.

And now, we move on to my “entertainment purposes only” complete wild guess for FQ4, with quick “commentary” on the major revenue categories.

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The AAPL Tree “Mav Just Got Half-Lucky Last Time” Horseshoe Toss for Apple’s Reported FQ4 2016 Numbers

I recalibrated rather well last FQ3 by my standards, I’m happy to say. Sets myself up decently well to puzzle out FQ4, and also shows you, dear reader, that I’m not a complete waste of your time. 😂

For FQ3, I guessed revenues of $42.32B and net income of $7.69B. Apple reported revenues at $42.358B (0.1% error) and net income of $7.796B (1.4% error). I figured iPhone wouldn’t fare too badly, relatively speaking, and guessed 40.7M iPhones, actual GAAP number 40.399M (0.74% error). I had, I dunno, “some weird feeling” that iPad was going to have a bit of a recovery quarter, so I guessed a unit sales number of 10.2M, which seemed to be in the opposite, overbullish direction of the consensus. Actual GAAP unit sales, 9.95M (2.5% error), when several were thinking 9M units or less (read: a lot of professional analysts).

Oh, I was off on more than one aspect of the horseshoe toss, don’t you worry. iPhone ASP was about $22 lower than I thought (to be fair, there was partly due to that huge channel inventory correction thing of greater magnitude than anyone expected, likely driven by Apple’s long-infamous conservatism in inventory management). iPad ASP at $490 was way higher than I’d anticipated (I guessed $422 on the conservative side —far too conservative), making iPad Pro 9.7 a new storyline worth following. I lowballed the Services growth rate at 10% vs. 19% actual (much too conservative), etc. Still, all in all, not bad for a home gamer.

So, here’s my exceedingly humble guess for FQ4 2016, and a “sense” of my overall “thinking” follows.

We’ll start with iPhone and end with Services. (Watch and Other Products will be “discussed” simultaneously, since Watch isn’t reported separately.)

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iPhone

Last 11 fiscal quarters of year-over-year unit growth/decline, GAAP sell-in reporting basis (FQ1 2014 — FQ3 2016): 7%, 17%, 13%, 16%, 46%, 40%, 35%, 22%, 0.42%, -16%, -15%

Part I: Intro, Tackling Sellthrough, Units

“Negative 2% unit growth for FQ4, more or less? You’re out of your mind, bro.”

My “thinking” (somewhat bullish by my reckoning, but that’s what makes it fun!) is as follows, starting with the two key management statements.

1) Tim Cook specifically said at the beginning of the FQ3 conference call that the sellthrough compare would turn out better for FQ4 2016 than FQ3.

2) FQ3 sellthrough for iPhone was “over 4 million units” better than the GAAP number, according to Luca Maestri, so on a sellthrough basis, iPhone units were down “about 8%”.

That leaves a much lower starting channel inventory for FQ4. By way of a dash of context, channel inventory was reduced by 600,000 iPhone units in FQ3 2015, though that was a function of continued strong demand reducing Apple’s inventory buffer.

So, to run the math quickly. FQ3 2015 sellthrough was 48.1M units, 600k better than the 47.5M GAAP number. Apple sold 40.4M iPhones in the “year-after” quarter, but the sellthrough number was at least 44.4M iPhones, which represents a 7.7% year-on-year decline.

But…how to get from -7.7% sellthrough to -2% GAAP? Unavoidable leaps must be taken, but at least we can support them with a modicum of logic.

Let’s see if the sellthrough number for FQ4 2015 is of any help. Apple increased channel inventory by “less than” 2 million units for the 6s launch, understandably so considering the extremely short sales window for that FQ4 (one week less than normal). So, subtract, say, 1.7M or so units from the GAAP number, and sellthrough was…hm…46.3M iPhones for the year-ago quarter.

So…uh…did I actually just horseshoe-toss an iPhone sellthrough increase? It’s impossible to say, because I have no idea if Apple will be able to increase channel inventory in support of the iPhone 7 launch. In any case, when all is said and done, starting channel inventory is already quite low, and unit sales are ultimately determined by demand (and production) at the end of the day. Since I think we can assume Apple’s good at making iPhones in mass volumes by now, no matter what certain supply chain rumors might say about Jet Black finish issues or “lack of dual camera assemblies” and so on.

About that demand for the iPhone 7 series, slightly over one month post-launch:

• a quick spot check of non-Jet Black 7 Regular models on apple.com promises delivery by Wednesday (Oct. 26)
• for 7 Plus non-Jet Black, it’s 3–4 weeks
• in China (thanks Google Translate!), it’s pretty much the same for “boring colors” of iPhone 7 Plus, and mostly in stock for non-Jet Black 7 Regulars, so I guess Apple is doomed or something
• in Japan, basically the same story, except non-Jet Black 7 Regulars appear to indicate Apple Store availability by Monday, Oct. 24 (local time in Japan).

All told…looks like demand remains solid, potentially indicating it wasn’t a “flash in the pan” either at launch, or when FQ4 ended on Sep. 24, 2016. So I’ll stick with my 47.25M iPhone unit sales guess, perhaps “counting on” continued strength in the iPhone SE, which, aside from being an actual new-and-improved small iPhone, also launched at the beginning of FQ3 2016, meaning it was still fairly early in the sales curve through September.

Next, a quick guess on ASP.

Part II: ASP

Did iPhone SE impact iPhone ASP? Of course it did.

But so did the 4-million-plus channel inventory drawdown, which, per Maestri, targeted mainly the high end of the iPhone line. In context, a drop in iPhone ASP sequentially from $642 to around $595 for FQ3 2016 actually isn’t that bad.

Well, ALMOST present; sorry, I’m in Low Power Mode 😄. Think of $595 as about the same height as the FQ2 2014 bar.

Now that the inventory levels are probably plenty low enough for Apple’s taste, there shouldn’t be any real GAAP “distortions” now that the $649+ and $769+ iPhone 7 models, which appear to be pretty popular, enter the revenue mix. Additionally, Apple launched iPhone 7/Plus on Sep. 16, in 29 countries (give or take a couple for mis-counting), versus 12 for the 6S-series — and, there were the “usual” nine selling days in FQ4 2016 for iPhone, versus only two for the year-ago quarter. (See also: My iPhone units guess, and, “if 7 Plus was going to be parts-constrained from the beginning, why launch in 29 countries at once like the 7 Regular?”)

So, I’ll keep it simple(r) to save a bit on words. ASP in FQ4 2015 was a lofty $670. Before FQ3 2016, the lowest ASP in the iPhone 6-and-later sales period was $642. If anything, my wild guess of $625 iPhone ASP, adjusting for SE, might be a bit low, unless SE and the new-midrange 6s units are really tearin’ it up in the marketplace…in which case, units will surprise a lot of people. But I’m not gonna call that by any means — let’s just see what’s reported next Tuesday.

Next up, iPad.

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iPad

Last 11 fiscal quarters of year-over-year unit growth/decline: 14%, -16%, -8%, -13%, -18%, -23%, -18%, -20%, -25%, -19%, -9%.

Two things. iPad units “declined by noticeably less”. Second, iPad revenue FINALLY grew year-on-year, thanks to the astonishing influence of iPad Pro 9.7 driving sequential ASP from about $430 to $490.

No, iPad still can’t be considered a “growth” business by any metric, not until we see a consistent pattern of revenue growth quarters at the absolute minimum. However, there is now some “hope” that iPad can “hold the line” somewhere above $4B per quarter, at least between holiday quarters, when iPads tend to be most positively affected by seasonality. (Just for fun, the FQ1 GAAP number for iPad units was 16.1M.) Of course, if iPad Pros are on an annual update cadence, that would certainly help.

I don’t really have much to say about FQ4 — I think iPad’s YOY unit drop will again be “less bad” because of iPad Pro 9.7’s clear uptake by customers (enterprise in particular?), since iPad Pro 9.7 (and iPad Pro at all, for that matter), simply did not exist in the year-ago quarter. Against those tailwinds is iPad Air 2, which is rather close to becoming the next iPad 2…well, depending on what Apple decides to do with the “consumer full-size iPad form factor” in the coming days or weeks.

So, let’s talk about the future real quick. Will iPad Pro 12.9 be updated this holiday season? It certainly seems like iPad mini’s due for an update to the A9…will they really call it “iPad mini 5”, or is it time for a redesign, which iPad mini has never had? Meanwhile, iPad mini 4 becoming the new budget iPad mini wouldn’t be the worst thing ever, either. iPad Pro 9.7 should soldier on just fine until at least Spring 2017, leaving…

…yes…

…iPad Air 2. If I had to guess, I’d say Apple wants to keep a “consumer-level” full-size iPad around at $399, but who knows? Here’s hoping that doesn’t become iPad Air 2, which is now 2 years old.

Now, we move onto what will soon be Apple’s second-or-third most interesting product line of the moment: Mac.

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Mac

Last 11 fiscal quarters of year-over-year unit growth/decline: 19%, 5%, 13%, 21%, 14%, 10%, 9%, 3%, -4%, -12%, -11%

With little to say, you’re in luck — I’ll keep this very brief.

Macs are super-old, excepting the retina MacBook 12. iMacs are about a year old. The retina MBPs, something around 520 days old. MacBook Air, around 600 days old. It gets worse, but those are the products that really matter. (Sorry, Mac mini and Mac Pro owners, Mac Pro owners in particular. Hope Apple has something for you soon.)

ASP really doesn’t matter as much when attempting to “forecast” an essentially assured year-on-year unit drop. So, I decided to be a little “bold” for entertainment purposes, and assume a -24% unit growth rate…which, given how some Wall Street analysts are, may actually be in the middle of those estimates. Heh.

Anyway, why a “sequential acceleration” in unit growth decline when it was only 11% last quarter? Here’s where I don my tinfoil hat, with some indirect support from FQ3. Apple, in order to aggressively manage channel inventory plus, incidentally, “low-key” its GAAP numbers a bit, could drain the channel of old iMacs and really old rMBPs and MacBook Airs to make way for whatever may be announced on October 27. -10–15% unit growth on a GAAP basis was already pretty likely. Add to that Apple’s traditional 4–5 week supply of Mac channel inventory, and there’s room to sellthrough quite a bit more units than were produced in the quarter (unless people are really, really big on custom configurations, and can actually tell if their MacBook was assembled weeks versus days ago 😂).

Again, somewhat like iPhone, -24% units may be too bold to the downside. But it’s no fun to play it too safe each quarter, so there you have it!

Speaking of downside, over the coming year we’ll see whether Apple’s newest Macs can hold up against the continued inexorable downtrend in PC unit growth.

We now move to Apple Watch and Other Products.

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Watch and Other Products

Series 1 and 2 and the ceramic Edition seem quite well-received — but that’s mostly a story for next quarter.

Still, Series 1 and 2 did launch with the same nine selling days remaining in FQ4 2016, and in an iPhone 7-rivaling 27 countries (including China). Obviously, in terms of points of sale, iPhone wins and it’s not even close.

All the same, it’s not hard to imagine Apple, with a bit less engineering to do for Series 1 and 2 (form factor not entirely new, though plenty of welcome changes), selling a substantial number of Watches in that “burst sales” interval through the sales channels it does have so far. And if Watch “does well enough”, those points of sale will expand, quickly.

What’s it all mean in unit sales, though? I don’t have a clue, and not like Apple will say. Maybe a little under 2M units total, combining residual sales of the old Apple Watch? Perhaps $375 is too high of an ASP assumption (prices start from $269/299 for Series 1 and $369/399 for Series 2, up to the $1249/1299 Series 2 Edition), but really, this is just part of the exercise to get a total Other Products number, which Apple does report.

Series 1 and 2 look like some very nice updates, and as a bonus, watchOS 3 appears to have made it so even the first-gen Apple Watch is no longer a slowpoke. 12-month sales cycle growth in Watch is most certainly expected — let’s see if Other Products significantly outperforms its current revenue record of about $4.35B. Which, conveniently, is the year-ago holiday quarter number.

So, about “everything else” in Other Products. Basically comprised of accessories, from the A8-equipped Apple TV set-top boxes to Beats, Lightning cables, spare Lightning adapters for 3.5mm headphone plugs, cases for iPhone and iPad, AirPods (well, for the holidays), replacements for lost AirPods, and so on and so forth.

I used two approaches. The first is looking at YOY comparisons. Two years ago, Other Products was about $1.9B. So I figure the category, even assuming Beats headphones haven’t been selling super-well, should be at least stable when you consider the installed base of iPhone 6 and up consumers, plus Apple TV A8, which didn’t exist until late last year. Then, look sequentially. Other Products was about $2.22B in FQ3. Against any “sales decay” in “stale” product such as Watch and aging 4th-gen Apple TV, there’s also burst sales from Apple Watch, and accessories sales activity related to the launch of iPhone 7 and 7 Plus. That’s how the ol’ Mental Blender™ arrived at around $2.56B, roughly between FQ3 2016 and FQ4 2015’s numbers.

Next, Services and a quick look at the quarter everyone’s been waiting for.

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Services

Last 11 fiscal quarters of year-over-year unit growth: 19%, 11%, 12%, 8%, 9%, 9%, 12%, 10%, 26%, 20%, 19%

I’ll keep this really to-the-point.

Services is more a function of installed base (and new service additions) than seasonality. Apple’s installed base, so far anyway, is growing, and loyal. And since it’s still growing, and Apple Music is relatively new, we’re not at that potentially uncomfortable point where “same-user revenue growth” (kinda sorta like “same-store sales”) is front-and-center in the eyes of analysts.

Nope, Services is Apple’s shining light for FY 2016, and Tim Cook already made that Babe Ruth-like call that it would be a Fortune 100 company in the next year. So, that revenue category’s all set for the next little while, I’d say.

Apple Music doing well. Apple adding to the installed base with iPhone 6s, 6 and SE throughout the year (with a side of iPad and maybe Mac). Lots of new users in China buying apps, content and services. Given all this, it’s quite easy to see Apple make another “$5B-to-$6B” year-on-year jump in Services, so I’m embracing that trend and guessing a roughly 20% jump in revenues for FQ4.

No real comment on buybacks or gross margins (other than, you bet management is confident if they guide gross margin within a 50-basis-point band in an iPhone transition quarter), so we’ll wrap up with a “sneak peek” at FQ1 2017.

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“Apple’s Greatest Test” — the $75B-ish-Scale FQ1 2017

At least, that’s what Apple bulls are hoping for…maybe a little bit better than that.

Analysts polled by Yahoo! Finance, as of the date of this posting, expect Apple to have a holiday season ending on a very…flat note. Though there’s some variance in the estimates (lay off the eggnog for a bit longer, $86.99B analyst), the 32 pros polled are calling for a $74.65B December quarter, representing -1.6% growth from the year-ago quarter. It’s basically the same number as Q1 2015’s, iPhone 6-fueled $74.599B result.

For FY 2017, the consensus hasn’t moved much more than a billion and a half, meaning their FY 2017 estimated year-on-year growth rate has moved from around 4% to 4.6% (or $225.66B, still about 6.5% from Apple’s FY 2015 revenue peak).

But here’s the thing. December quarters set the tone. And since the powerhouse player in iPhone 7/Plus and the just-getting-started Watch Series 1 and 2 will feature prominently in that quarter (as aided by new Macs and Services revenue), along with presumptive iPad Pro 12.9 and mini refreshes, maybe an Apple TV update too…

…how exactly will a negative growth FQ1 2017 suddenly make way for decent-growth quarters for the rest of the fiscal year? It’s tough to see iPhone SE, iPad Pro 9.7 and Services carrying the weight on their own, if everything else is weighing Apple financials down.

And, no, I don’t think AirPods would help much, either.

So, we’ll conclude by flash-overviewing the five revenue categories, bearing in mind the “$1.2B shortfall” analyst consensus projects year-on-year.

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iPhone: Maybe analysts both think units will be up and ASP will be down? Yes, with FQ1 2016’s number being a staggering $690, lower ASP year-on-year is not a tough call. So, let’s pretend analysts see 5% unit growth (~78.5M units) and 7% ASP decline (~$642). No, I didn’t know the result beforehand — that’s essentially a year-on-year revenue decline of $1.2B! Adjust as needed depending on how effusive or dismissive you think analysts will be for “iPhone 6SE’s” prospects, heh.

iPad: Revenues were down 21% year-on-year in FQ1 2016, but with the FQ3 result and iPad Pro 9.7 clearly gaining some traction, it’s possible that iPad could have a revenue-growth holiday quarter in the works. Obviously, FQ4 will provide an important, if indirect, clue, as will what is or isn’t announced in the “hello again” event just two days after the earnings release. For fun, I’ll set the revenue growth dial at “exactly zero” — the direction it turns is heavily dependent upon what iPads Apple has on offer by next month.

Mac: It’s long past time for new Macs. But…is consumer demand still there given “the long, slow decline of the PC”? It partly depends upon the kind of case Apple can make for, primarily, the redesigned MacBook Pro retina 13/15s…or whatever replaces those two mainline models. And what of the popular, if aging, MacBook Air? iMac could help too, of course. Just so there’s a placeholder opinion, plus because reasons of conservatism to counter any raging fanboy bullishness, I’ll “dock” Apple half a billion dollars year-on-year for this one (-7% revenue growth), even as I think revenue growth is possible “in the right conditions”. It wouldn’t be entirely bad news if Mac sales convert to iPad sales instead, but a net loss in revenue for the replacement is a near-certainty.

Services: Fortune 100 company? Fortune 100 company. How big is that? $28B. $6.5-ish B or $7B for the holiday quarter? Let’s use “installed base theory” plus conservatism, and presume Services revenue will get a bit better from FQ1 to FQ4. So, let’s say $6.6B (about 9% growth), or around $550M in year-on-year growth, basically “cancelling out” any “lost revenue” from Mac.

Finally, Other Products: Apple Watch pretty much has to be a growth star, otherwise the smartwatch market may never really be what we thought it was. But what will that sales curve look like? Your guess is as good as anyone else’s. Following that, there’s the March of the W1-enabled Headphones/Earbuds, from the oh-so-easy-to-pair AirPods to Apple’s Beats business. And provided iPhone 7s and Plusses “are popular enough”, that will also positively influence that revenue category. Still, $4.35B is a high number. And Apple “would need” year-on-year growth of around 27% in Other Product for this overall revenue scenario to end up with…exactly the same revenue as the year-ago quarter.

Oh, and I forgot to tell everyone, so I’ll tell you now — it’s actually a 14-week holiday quarter versus the typical 13 weeks.

So analysts are actually either 5–7% more bearish than it initially appears, or they’re hedging their bets something fierce until Apple gives them the…let’s call it “courage” to bring that FQ1 number to perhaps more reasonable territory, especially in light of their whole-year-growth estimate. Hmmm.

This concludes my 14th Apple Inc. earnings preview, until then. Hope you didn’t mind reading, and it sure would be great if you felt it worthy of a weekend/evenings-eve share, like or retweet! It promises to be an action-packed week ahead, and I hope to see you all then!