Compare-Aware, Part One of Maybe Two: Notes on That Apple and the 14-Week FQ1 2017 Revenue Growth Situation

Since John Gruber and Jason Snell (both citing Jeff Johnson) recently brought this to the attention of the mainstream Apple-following community - a community who I will presumptuously presume is not largely made up of actively involved/engaged stock market participants (since that takes commitment and time not everyone has, after all) — I might as well share my rusty two cents on the matter.

The point raised by Jeff Johnson— Apple’s FQ1 2017 was 14 weeks vs. the usual 13, and very few tech blogs, financial press outlets, etc. noted this. Therefore, Apple did not return to growth on a like-for-like, arithmetic-week-average basis, contrary to the prevailing reportage.

Spoiler Alert! I agree on both points (oh, and for the record, li’l ol me mentioned the 14 week FQ1 multiple times). However, “it doesn’t matter”, on two levels. Read on to find out why.

While Perfectly Understandable, an (Arguably) Irrelevant Yardstick Is Being Used

Strong (though of course, quite polite) words? Well, while I’m no good at it, I have been a market participant (e.g. AAPL trader/investor) for a number of years now. And for what little it’s worth, I’ve blogged Apple earnings 15 fiscal quarters in a row. So I can say with fair confidence that the 14th week did not go ignored by the major benchmark-setters for each Apple financial quarter.

Who are these people? If you’ll forgive my self-quotation: “Wall Street…analysts the financial press relies on for, in particular, consensus estimates for corporate earnings and such.”

“Independent” types don’t tend to agree with Wall Street analysts very often — that’s been well-documented on Philip Elmer-DeWitt’s Apple 2.0 then Apple 3.0 sites — but the fact remains, they’re the professionals. They do this for a living.

They, like me, listen in to conference calls, but unlike me, the pros have performance standards set by their employers (in theory), use their firm’s resources to run their own surveys and channel checks, and actually get to ask Tim Cook and Luca Maestri questions during said conference calls (and also those analyst meetings with Apple you hear about now and then).

Suffice it to say, these benchmark-setters knew that the 14th week was coming, as it does every 5–6 calendar years. And they were most certainly listening when Luca Maestri reminded everyone that a 14-week fiscal quarter was nigh. Which he did during the FQ4 2016 conference call in late October 2016.

The Consensus Yardstick, Not Pure-Arithmetic, Was the One Against Which Apple’s FQ1 2017 Was (Probably) Judged (Based on AAPL Share Price Post-Earnings)

Here’s where Wall Street analysts were at before FQ4 2016 results were announced (based on the Yahoo!/Altaba Finance consensus ostensibly sourced from Thomson Reuters):

As of around October 22, 2016, analysts were thinking Apple would bring in $74.65B in revenue for FQ1 2017, down almost $1.3B from the year-ago quarter.

Apple caused a change in consensus thinking by its strong one-quarter-forward guidance (i.e., for FQ1 2017) during the FQ4 2016 earnings release. How so? Apple guided the Street to a revenue range between $76–78B for the holiday quarter. Among the positives cited during the conference call were strong iPhone 7 Plus demand, strong demand for Watch (Series 2), and Apple’s current growth star, the high-margin Services business segment.

For those who quite understandably don’t follow this stuff, Apple’s known to guide next-quarter financial results with heaps of conservatism. In other words, it aims to NEVER, EVER guide a revenue range above its actual results. This is an actual unbroken streak dating back to at least 2004 which Tim Cook touted when wishing former CFO Peter Oppenheimer farewell in April 2014, and an impressive “sandbag streak” which Maestri has continued since then.

Long story short, analysts believed Apple’s guidance, and given the upside surprise, moved up their FQ1 2017 estimates up by around $2.7B to around $77.37B (the top third of guided revenue range) as of late January 2017.

It’s not (necessarily) growth on a per-week basis — a bit more on this later. But the point was, analysts got more optimistic for the holiday quarter, even though Wall Street “optimism” would not catch up in AAPL’s share price until shortly before earnings. 😂

So with expectations moved (up) to around $77.4B for the December quarter, what did Apple proceed to do?

Report actual GAAP revenues of $78.4B, as in around one billion dollars higher than the higher bar set by Wall Street. Another upside surprise.

And the stock price…as it sometimes does…followed suit.

I could end the post here, really. Look, you don’t have to like it (I would understand!), and Wall Street valuations, post-earnings stock reactions, etc. don’t always make a lot of sense. Remember when AAPL was $55, vs. the $130 or so today? Regardless, in this case, things played out fairly logically for Wall Street. The relevant yardstick wasn’t “arithmetic”, per-holiday-week growth, but Apple beating Wall Street analyst expectations for FQ1 at least twice.

Better-than-expected numbers led to above-average market sentiment — at least by Apple Inc.’s below-market-average valuation standards.

But We’ll Continue Anyway — Factors Impacting FQ1 GAAP Revenues and More Importantly, Seeing the Full-Year FY2017 Forest From the FQ1 2017 Trees

>>> Factors Impacting FQ1 GAAP Revenue

$78.4B comes with more asterisks than meets the eye — you’d need to have picked up on items mentioned during Apple’s conference call, which not all of the Apple earnings coverage did. Three items are readily quantifiable:

• Foreign exchange: The strong dollar (and correspondingly weaker basket of foreign currencies where Apple does business) hurt Apple’s revenue growth by 100 basis points (one percent) year-on-year, or about $760M. It’s a problem that’s been getting worse with time, even now — Maestri mentioned that the US dollar, since mid-2014, has appreciated a whopping 25% “against the basket of currencies where we do business”. And since Apple does well over half of its business internationally (in fiscal 2016, international sales were 65% of Apple’s revenue total!), the dollar’s relative strength makes it near-impossible for even Apple’s world-class hedging programs to make up the difference. Add in demand-dampening price hikes required to protect Apple’s margins given tanking foreign currency values, and a 100-basis-point revenue headwind due to ForEx really doesn’t seem that bad.
• Samsung Settlement: FQ1 2016 revenue was benefited by a one-time $548M patent infringement jury award payment.
• Apple had a ~700,000 unit channel inventory drawdown for iPad due to what Tim Cook termed an “undercall” of iPad demand. At iPad’s FQ1 2017 ASP of $423, that was an estimated $295M hit to GAAP revenue.

Add those in, and would be “as if” Apple’s FQ1 revenue was just about $80B versus $75.9B in FQ1 2016.

No, it’s not the “$81.7B” you’d expect on a “flat-growth, pure arithmetic” scale (which assumes that every week in FQ1 is equal within that quarter). But it’s not far from it, either.

Aside from that — none of this is really that important to Wall Street in the context of revenue growth throughout the entire 2017 fiscal year.

>>> FY17 Forest vs. FQ1 2017 Trees — Apple’s True Financial Test

Why? Because Wall Street is expecting Apple to grow revenues year-on-year, no asterisks, for the whole of 53-week fiscal 2017 vs. 52-week fiscal 2016.

A brief “proof” follows.

Yes, Apple’s December quarters bring in more revenue, on average, than any other quarter. Here’s what their average-per-week revenue contribution to the annual total has been the past two years, and is projected to be (more or less) for the fiscal 2017 in progress.

Don’t mind the mess — the key takeaway is in the right-most column. In FY15, an average week in that December quarter contributed 2.46% of Apple’s total FY15 revenue. That metric was a whopping 2.71% for FY16. If FY17 goes more or less the way Wall Street expects, that metric will be the same percentage value as FY15.

So, let’s just say that a typical December quarter week contributes 2.5% of Apple revenue per week. Without revenue seasonality that number should be 100/52 = ~1.92%. Therefore, in approximate terms, said “holiday week” would carry almost 60 basis points more revenue weight than an average week in the rest of the fiscal year (lately).

Want to be even more “harsh”? Compound this greater-revenue-weight week by assuming the 53rd revenue week is purely additive. So, assuming flat revenue on a 52-week to 52-week basis, the 53rd week would add 53/52 = 1.92% revenue to the fiscal year’s results.

But the 53rd week is a special holiday week. So, let’s add that 60 basis points right back in.

Therefore, we would “reasonably” (?) expect Apple, in a 53-week fiscal year of flat-growth-per-week year to year, to have a baseline fiscal year growth of around 2.5%.

Uh oh, nailbiter time?

I hate to burst anyone’s bearish bubble, but 2.5% revenue growth for FY17 is actually safely below what Wall Street expects from Apple.

As denoted (but not precisely expressed) in my quick-and-dirty chart above, Wall Street, as of February 6, 2017, expects fiscal year revenue growth of around 5.6%:

You might also notice in the above chart that “curiosity” I tweeted about a few months ago:

Apple encountering less daunting FQ2 and FQ3 compares with better (iPhone 7-series, Watch Series 2) and anticipated fresher (iPad Pro 12.9 + Mini, iMac and/or other Macs) product? Carryover demand of iPhone 7 Plus, Series 2 and AirPods for at least FQ2? Whatever the case, analysts are looking at 13-week FQ2 ‘17 and FQ3 ‘17 year-on-year growth rates (at 4.7% and 7.6%, respectively) to be higher than the 3.3% non-adjusted growth rate in FQ1 2017.

If you were to assume analysts treated Apple’s 53rd fiscal week as a supercharged 250-basis-point-of-total-annual-revenue anomaly, that still nets out to a “like for like”, true-arithmetic-average, 300 or so basis point revenue growth expectation from the professional analyst community in FY 2017.

Since it’s out there and readily trackable, let’s see if Apple can, at least this one fiscal year, manage revenue growth to around $227.7B. The analyst consensus currently believes Apple can meet that target.

And for the “sake” of Apple Inc. share prices and the continuity of the current Board of Directors (which includes a certain Tim Cook), it’s in Apple’s best interests to deliver.

To its credit, Apple already passed Wall Street’s first quarterly exam of FY17 with flying colors. And if it continues to do so, don’t be surprised if Wall Street dynamically increases the degree of difficulty by raising the FY17 revenue target before the year is through.[1]

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[1] The reverse is also true (analysts downgrade Apple’s stock rating and typically price targets and forward estimates along with it), but the current sentiment is what passes for “bullish”. Should Apple underperform between FQ2-FQ4 2017, we can cross that bridge then.