Analysis: Apple's best-ever quarter is no disappointment
Let’s get one thing correct right from the start: Apple’s results for the first quarter of fiscal year 2008 are no kind of “disappointment,” nor could anyone rationally call the company’s guidance for the second fiscal quarter anything but “positive.” Once again, Apple posted its best quarter ever in terms of iPod and Macintosh unit sales, in addition to posting record revenue and record profitability. Apple has never sold more products in a single quarter throughout its 31-year history.
While the March 2008 quarter should have seasonally lower sales that everyone expected (people buy lots of iPods to put under Christmas trees, not in Easter baskets, or Ostara baskets if that’s your thing), Apple’s projections for the quarter are still an impressive 29 percent higher than in the year-ago period. We suspect that this week, there are CEOs who would sacrifice children to get 29-percent year-over-year growth.
So how in the name of Phil Schiller did this narrative about “disappointing” results, or “warning” about future results get started? For that, turn no further than CNBC, the 24-hour business cable news channel owned and operated by NBC Universal with input and news from News Corporation (via its recent acquisition of Dow Jones, the parent company of the Wall Street Journal). CNBC is to stock traders what chocolate is to Augustus Gloop—they just can’t get enough of the channel’s obsession with everything to do with the stock market.
On Tuesday, that was not the best choice of obsessions, as worldwide markets tanked amid fears of a recession in the U.S. economy. CNBC was desperate to find “signs of strength” immediately after the end of an otherwise gloomy day.
At 4:00 p.m. EST, just after the markets closed, CNBC anchor Melissa Francis started the post-market coverage by noting “signs of strength,” and the surprise 0.75-percent rate cut by the U.S. Federal Reserve, and then said, “Now, attention switches to tech. Apple and Texas Instruments [are] scheduled to post earnings after the bell today. What they say could dictate the mood of the market tomorrow.”
CNBC’s first post-trading report from the floor of the New York Stock Exchange came from reporter Bob Pisani. In case Francis’s attempt to pin the market’s hopes on Apple were too subtle for you, here’s how Pisani ended his live report:
Still waiting for those Apple numbers. If we get a good number from Apple, and — [unintelligible, sounds like “off print,” but apparently means “if not,”] to the downside, the bears will have an argument that we’ve still got some ways to go. But Melissa, this may not be the bottom, but at least we’re in the process now, we can argue, of putting in some kind of bottom.
In other words, a good number from Apple will make it much easier for Wall Street to pretend that everything is going to be fine, but a bad number reinforces the view that the economy is in trouble. The hopes for the next trading day, according to CNBC’s first four minutes after the close of trading, were all on Apple.
Good is bad
Apple put its results on the newswire half an hour later, at 4:30 p.m. EST, just a few minutes before the permanent press release went live on Apple’s own Web site. When it happened, CNBC went live to its Silicon Valley bureau chief, Jim Goldman, who blogged last week that “this time, the company’s numbers will be followed more closely than ever before.”
Why? Worries about a recession, concerns over a lackluster holiday shopping season, insecurity about how the company’s products are selling. And there are questions about whether consumers will reach deep to pay for Apple’s pricey products even as they worry about whether they’ll have a job this quarter or next, leaving some head-scratching over Apple’s precipitous decline these last few weeks. Are you kidding me?
Apple reports earnings next Tuesday, and while the shorts and naysayers continue to beat the uncertainty drum, the company is probably sitting prettier than any other big name in big name tech nowadays. We can harp on recession worries, though Steve Jobs himself tells me that it’s a non-issue for his company…
Further, he scoffed at my suggestion that Apple is pricing itself out of competition with high-priced Macs, the iPhone and Apple’s iPods since all have seen noticeable price drops and the company, for the first time in its history, offers a broad array of products with a broad range of price tags. It’s a good and fair point.
Goldman’s blog entry is well worth reading in its entirety as he goes on to defend Apple’s value, but there it is once again—the narrative that the business press will not abandon, no matter how many times its proven incorrect and laughable, that Apple makes “pricey” or “high-priced” products that Joe and Jane Six-Pack can’t afford when the going gets tough, that Apple is some kind of boutique or luxury brand that doesn’t deliver solid performance for the price of its products.
The press has had to hide this narrative for several years because Apple is doing well, and they all love their iPods and iPhones, but they think they’re “luxuries” that ordinary people shouldn’t consider in hard times. (Apparently, during a recession, only the wealthy are entitled to convenient ways to listen to music or watch videos.) But it’s always there, waiting to burst through one day at the slightest sign of trouble. Tuesday was that day. CNBC probably thought it was being fair by saying, in essence, that if “pricey” Apple was still doing well, the economy must be in decent shape after all. On a broader scale, the cluelessness was just staggering.
On a financially precarious day, stock professionals were glued to CNBC’s coverage as if they were politicians watching election returns. When Goldman gave the first take on Apple’s results at 4:30 p.m. EST, he was creating the narrative, live and in real time:
All right, Melissa. We are digging through these numbers. They’re coming out on a headline basis, but right now, at first blush, it looks like a very good report from Apple Inc. The company, on the top line, reporting $9.6 billion, way ahead of the Street, and I should also tell you that that beats—or actually, meets the “whisper number” of $9.6 billion. The Street was at $9.465 billion.
The EPS number that we’re looking at here is $1.76; we’ll confirm that that number is solid. The Street was at $1.62.
But the reasons that [Apple] shares may be in the midst of a pretty significant 10-percent sell-off right there, that you see there on the screen, that the company is warning on its second quarter results, and that comes as a significant surprise. There was a lot of optimism that Apple would at least meet Wall Street expectations for its fiscal second quarter, but indeed, it appears to be warning. We’ll get the exact numbers on what Apple is expecting here in just a few moments.
But let me dig a little deeper here, because the Mac number was substantially better than anyone had anticipated: 2.391 million Macs on the quarter. The Street was at 2.2 million. I’m going to read through here really quickly so I can get to the guidance. The company is looking now at—hold on one second here, let me just get through here—the company is looking at $6.8 billion and earnings of 94 cents for its next quarter. The Street was at $6.96 billion; Piper Jaffray, for one, was at over $7 billion, and the EPS number was $1.08.
So if you look at where the company is guiding vs. what the expectations are, this is substantially lower than what Wall Street had anticipated, and certainly not the jolt of confidence that tech investors were indeed looking for. Let me get you an iPod number as well: the company [says] 22.1 million iPods, again, well below the 24.7 [million] the Street was anticipating. An iPhone number: 2.315 [million], and that’s actually ahead of where the Street was, but only slightly [at] 2.26 million iPhones sold on the quarter.
So we’re going to dig a little deeper into these numbers, and this is going to make for one heck of an interesting conference call, which begins at 5:00 p.m. EST. Let me remind you that I will be live-blogging that call, but there are a number of questions. I should remind you that Apple always tends to sandbag Wall Street when it comes to guidance, but “sandbagging” in terms of Apple usually means “slightly below or meeting Wall Street guidance,” as opposed to raising guidance or providing numbers that are significantly higher than what Wall Street anticipated. Numbers like this? They’re going to cause a tremor, big-time. Back to you.
At 4:40 p.m. EST, 20 minutes before Apple’s conference call would start, Goldman was back on CNBC talking about Apple’s results, continuing to create the narrative that something was “wrong” with Apple’s second quarter projections:
When you look at this, you know, the real question is “when is ‘best’ not good enough?” Apple is characterizing its past quarter as the best quarter in the company’s history, but that is so last quarter when you’re talking about guidance for the upcoming quarter that just does not meet expectations. Again, Apple beating the street by 14 cents per share, a buck seventy-six vs. the $1.62 that the Street anticipated, but look at the share price now! Down $18 a share from the close. You’re talking about almost $14 billion in market cap[italization] that Apple is essentially giving back in a heartbeat. The guidance [is] 94 cents [per share], the Street was at $1.08. Revenue [guidance is] $6.8 billion when the Street was closer to US7 billion, and many on the Street [were] over $7 billion.
The real surprise here? Apple missing its iPod number during the holiday shopping quarter. If they were going to miss, most people thought maybe it would be on the Mac side, or even iPhones, but to miss on the iPod number is a big surprise: 22 million instead of the 24.7 million that the Street anticipated, and—wow. When you see a stock that’s already been down 25 percent over just the past three weeks, giving back more than 10 percent now just because of these earnings, you gotta wonder whether this sends a message to the rest of tech. We’ll check the rest of the sector through today and certainly into tomorrow, but again, this is just not the news that weary tech investors were hoping for—some kind of optimism from certainly the biggest name in the sector.
At that point, anchor Melissa Francis asked, “But Jim, you mentioned before, I mean, Apple is notorious for sandbagging when it comes to their future guidance. Is there any chance that’s the case here? People are obviously taking this news not very well.” Goldman responded:
I think it’s a really good point. I think there is the risk that Apple is sandbagging once again. But given the current climate, with all the uncertainty around technology, you’d think that Apple would sort of err on the side of what’s more of a “reality” expectation, if you will, not sort of sandbagging as much as the company has in the past. Even if Apple is sandbagging, in the past, when the company’s done that, it has sort of met expectations or been slightly below expectations. This is 14 cents below what the Street anticipated, so clearly, if they’re sandbagging, it’s much more significant than we’ve seen from the company in the past.
Goldman did indeed live-blog the call, and twice he pointed out that the reaction in after-market trading, where Apple’s shares had fallen precipitously, seemed without basis in fact. Near the end, he said, in boldface type, “Just my two cents so far: I have heard nothing on this call that would suggest anything that warrants this kind of after-market sell-off.” When the call was over, Goldman wrote:
I look forward to getting your comments about all this. Is the market overreacting to softer than expected guidance? Are there clouds over the horizon?
Doesn’t seem to be the case. I’m interested to cull the analyst reaction to all this and see whether today’s news leads to a Wall Street downgrade parade. Seems to me, Apple still looks solid and that shares are oversold. The metrics still seem solid.
I think everyone was stunned when these numbers came out. Now we have to wait for Wall Street to follow through; see what the experts have to say for themselves. But on first blush, nothing jumped out at me as a red flag warning, or that Apple was waving the white flag in any way. Should be interesting to see whether today’s sell-off was merely momentum follow-through from the craziness we saw during the regular trading day. Longer term, I heard nothing on the call that changes my opinion that I posted here last Friday—nothing.
But the damage was already done, of course: Goldman’s network had told viewers at least twice in the half-hour before the announcement that Apple’s numbers would set the tone for Wednesday’s trading. Goldman himself told them—incorrectly—that Apple had “warned” about its second quarter projections. On Wall Street, a “warning” means that a company now knows that its revenues or profits will not meet previous guidance or would be substantially below Wall Street expectations—but Apple’s guidance was not unusually lower than Street estimates, and Apple had previously issued no second quarter guidance, so there was nothing to correct.
There was no warning.
Just 10 minutes later, Goldman said that Apple “missed” its iPod number, but this was also entirely false. Apple did not release projections for iPod sales in the December quarter, or any other quarter in recent memory. The number was, again, the estimates of Wall Street analysts who are only guessing based on previous seasonal trends, overall economic trends, surveys of some retail stores, and a feel for the overall consumer electronics market.
In fact, Apple sold more iPods than in the year-ago quarter, but also saw average selling prices go up 14 percent (from about $163 per iPod to about $181 per iPod) due to the success of the new high-end iPod Touch model. They were more expensive, perhaps slowing some unit sales but making up for it in revenue. During the conference call, Apple’s No. 2 man, Tim Cook, said that the iPod sales met the company’s internal expectations. Apple did not miss its internal iPod number, and no external iPod number was published.
Goldman implied that Apple’s “characterization” of its results as the company’s best quarter ever was somehow misleading, when it is indisputably true. He said that Apple’s guidance did not meet “expectations,” without pointing out adequately that Wall Street expectations for Apple’s guidance are always, always higher than Apple’s own guidance. For the December 2007 quarter, Apple said to expect sales of $9.2 billion and earnings of $1.42 per share, well below the actual results of $9.6 billion and $1.76 in earnings per share.
By repeatedly using the term sandbagging, Goldman and Francis are implying that Apple is engaged in some kind of trickery to fool investors, when Peter Oppenheimer revealed several quarters ago that Apple issues guidance that the company is “relatively certain it can meet.” Apple’s guidance is not the center of an expectations interval, much less the high end of that: it’s the low end, and has been for years, and Apple has not been hiding this for some time. Apple gets punished so badly in the stock market any time it doesn’t meet its own guidance that, out of a surplus of sanity that’s clearly not about to affect Wall Street, the company simply stopped issuing guidance that it wasn’t nearly certain it could meet. The estimates of financial analysts are always higher, because they’re projecting actual results, not lower boundaries. Goldman acted as if he knew this but implied that any discrepancy was Apple’s fault.
Best of all, in the “how do these people get on the teevee” sense of the word best, when Francis specifically asked Goldman about Apple’s habit of issuing guidance lower than what Wall Street firms would issue, Goldman essentially said that because the market was so volatile, it just wasn’t fair of Apple to continue guiding to results it knew it could meet.
Tech investors were “weary” and wanted a “jolt of confidence” from Apple, so after Goldman has misrepresented the company’s second quarter guidance as a “warning” that did not exist, he insisted that the only decent thing for Apple to do would be to issue higher guidance. It didn’t matter to Goldman if Apple was not “reasonably certain” it would make those higher numbers: it might, and Apple somehow owed it to The Market At Large as reassurance needed to undo CNBC’s own incredibly ill-considered reporting.
So what really happened?
Apple posted its best-ever quarterly results for the first fiscal quarter of 2008. That included record sales of Macintosh computers (2,319,000 units, up 7 percent sequentially and 44 percent year-over-year), record iPod unit sales (22,121,000 units, up 5 percent year-over-year and 117 percent sequentially as a stunning example of the holiday seasonal market for iPods), and record revenues ($9.608 billion, up 55 percent sequentially and 35 percent year-over-year).
Every single metric for Apple’s sales was up both sequentially and year-over-year, with the sole exception of desktop Mac sales: at 1,342,000 units for the December quarter compared to 1,347,000 in the September 2007 quarter, they were statistically flat (down by less than 0.5 percent), but were up a brisk 38 percent year-over-year, thanks to strong customer demand for the new iMac (Mid 2007) models.
Apple will not sell 22 million iPods in the March 2008 quarter, and everyone knows it, but Apple is still projecting revenue that’s up 29 percent year-over-year, and earnings per share of 94 cents that would be up 8 percent year-over-year—and that’s with Apple’s notoriously conservative guidance. It may be closer to 10 percent, and if the U.S. really is entering a recession, Wall Street will dance for joy at 10 percent year-over-year earnings growth.
But the big story Wednesday, thanks in large part to the live CNBC narrative, is that Apple is somehow “pessimistic” about the next quarter (in the words of a CNet News headline that the article text simply does not support). The Associated Press said that Apple’s guidance “spooks” investors.
These narratives are important because they have real consequences. When Apple is doing well on Wall Street, investors let the company work in relative peace, giving Apple the time to develop products like the iPhone, Leopard, and the MacBook Air. When revenues are seen as tighter, Wall Street wants instant answers—more profitability now, no luxurious development times, no gambling on new markets like iPhone or Apple TV. The executives spend more time explaining to analysts that the company is doing just fine, and investors remain jittery and generate news stories that drive down sales.
You very probably remember someone telling you, a decade ago, that he would not be purchasing Macs or other Apple products because he’d heard the company was about to go bankrupt. Apple did have a cash crunch and some accounting fixes to undertake in 1996, but by the time most of those stories were circulating, those problems were fixed. The only remaining problem was low sales, driven in large part by near-daily stories that Apple was a bad risk for investors and customers alike. (Even with Apple’s stock price falling dramatically on Tuesday, it’s worth pointing out that just over 10 years ago, on December 23, 1997, Apple’s stock closed at a current split-adjusted price of $3.23 per share.)
Apple’s stock has already taken a beating this month—no surprise since the idea of short-term trading around Steve Jobs’ Macworld Expo keynote got a fair amount of attention, likely introducing volatility into the market. Even without the “Keynote Index Fund,” investors were speculating in December that Apple would introduce something spectacular in January. Most investors later figured out that this rarely happens, and the stock price naturally fell.
Now, thanks to CNBC and other constructors of inaccurate narratives, Apple is facing a beating on Wall Street for “missing” guidance that it didn’t issue, for meeting its unpublished iPod sales figures but not meeting the guesswork of Wall Street analysts, and for issuing the same kind of guidance it has issued for years when CNBC’s correspondents insist it’s just not fair of Apple to not inflate its guidance when people who watch CNBC are jittery.
Analyst estimates are more than darts thrown at a target. The analysts perform diligent work to track down sales estimates, survey retail channels, gauge economic trends, and more. Yet in the end, they’re guessing at Apple’s sales based on past trends and what information Apple executives have released. Apple, on the other hand, knows what products are in the pipeline, what stores are opening, what pricing actions it plans to take, and what it anticipates both costs and revenues to be. Whether Apple’s public estimate is the exact number that the company expects to post or the low end of a probability window, Apple’s information is far, far more accurate than the analysts.
And yet, throughout the company’s history, Wall Street insists on acting as if its own navel-gazing is infallible. Companies that accurately meet their own guidance are ignored unless they also meet the projections of analysts who work without anything remotely resembling the same kind of accurate information. In statements Tuesday on a conference call—information that has to be truthful under SEC guidelines—Apple’s Tim Cook said today that the company sold just as many iPods as it expected to sell in the December 2007 quarter. People working with less information in tiny windowless rooms got the number wrong. They can’t tell you why Apple should have sold 2 million more iPods—just that they thought Apple would. They were wrong.
In a sane world, Wall Street would demand that those analysts explain why they overestimated Apple’s sales. In the world we have, Wall Street punishes Apple for not creating the analysts’ fantasy, amplified by CNBC’s irresponsible mischaracterization of the plain facts that Apple released Tuesday. If Apple’s stock takes another beating for reasons that appear to puzzle commentators, you’ll know that they haven’t looked at the tape of Tuesday’s Closing Bell program on CNBC. That’s where the “Apple disappointed Wall Street” narrative was created—right before their eyes, live, in real time.
[Adapted with permission from the January 23 issue of MWJ, published by MacJournals.com. Copyright 2008, GCSF Incorporated. For a free trial to MWJ, visit www.macjournals.com.]