Analysis: Apple's best-ever quarter is no disappointment

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Reality intrudes

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 Copyright 2008, GCSF Incorporated. For a free trial to MWJ, visit]

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