Apple(NASDAQ: AAPL)has been on a tear since reporting earnings earlier this month. In this episode of Industry Focus: Tech, Motley Fool analyst Dylan Lewis and senior tech specialist Evan Niu take a dive into the earnings report.
Tune in to find out what had the market so excited. Learn how many of its own records Apple broke this quarter, what the big numbers looked like, what the fastest-growing segments are and how they're poised to keep growing, and how the Trump administration might affect Apple in the next few years, and much more.
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A full transcript follows the video.
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This podcast was recorded on Feb. 3, 2017.
Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It'sFriday, Feb. 3,and we're breaking downApple'searnings release. I'm your host, Dylan Lewis,and I'm joined on Skype by Fool.comsenior tech specialist Evan Niu. Evan,how are you doing?
Evan Niu: Prettygood, about to go on vacation.
Lewis: About togo on vacation. I doubt that you could possibly bedoing as well as Apple is doingthis week, though.
Niu: [laughs] That's true.
Lewis: It'snot too often that you see the world's largest company spike6% after earnings.
Niu: Yeah. Thenumbers they put up,I mean, I was pretty impressed. I wasn't really expecting them to blow it out like this, and beat their own guidance by $400 million.
Lewis: Yeah. We always do the Apple earnings show,it's one of my favorites to do. But after several in a row where we've been like, "Yeah,we know that growth is slow or even declining, but just be patient,we think it's going to be OK,"it will be nice to do a show wherewe can talk about them andhave a bit of a rosier outlook on things, andmaybe reaffirmsome of the confidence that the Streetshould have in the business. In a lot of ways,it's still a fantastic company. Why don't we start out with a big numbers here?Revenue came in at $78.3 billion, which beat estimates of $77.3 billion. Also beat the company's guidance,like you said, by a couple hundred million. Earnings per share came in at $3.36 for the quarter, whichalso beat estimates of $3.22. So, for the first time since fiscal Q1 of last year, the company posted year-over-yearrevenue growth.
Niu: Yeah.I think that's one of the big stories. 2016 was so tough on themin terms of storylines and sentiment, because, yeah,first year ever of showing negative growth, and everyone is kind of gloomy about it. Then,they come back and say, "Westill have it in us, we can still set records,we can still push all these different parts of the business to these completely record levels,"including the Mac, which is crazy, because the Mac hasbeen around for 40 years, and they're stillcontinuing to grow it and push up higher.
Lewis: And they've beenworking against so many headwindsfor such a long time in that year. Youlook at the strong dollar having a pretty sizable impact onthe money they make overseas,and also the selling price of devices overseas. Youlook at the elongating of the upgrade cycle,particularly with some of the wireless carriersmoving away from a subsidy model, andgetting people off of that two-year upgrade.
So,there are just a lot of things pushing against what would normally cause people to be buying phones, or would beallowing them to recognize more in revenue and earnings here in the U.S. So,it's nice to see them bring it back up this quarter. Why don't we hopright into the iPhone segment? This is really where they're making most of their money.
Niu: Yeah. They sold another record of 78.3 million. The last three consecutive quarters, they put up negative growth. So, theyput an end to that trend. Of course,this creates another tough comparison for next year, raises the bar for a year from now. But, personally,I wasn't that impressed with the iPhone 7as a product.
Lewis: Do you own it?
Niu: No. It'sthe first time in eight years that I haven't upgraded my phone.[laughs]
Lewis: I don't ownthe iPhone 7 either, so don't feel bad.[laughs]
Niu: But, literallyevery year I've been upgrading, this is the first time I'm not,because I just didn't think it was that compelling. But,obviously the market really does. Part of it is that the 7 Plus is really the hot seller this quarter.Apple even acknowledged thatthey did a poor job predicting demand. They allocated less than they should have to the 7 Plus production. There'snot really a killer feature in the iPhone this year. Arguably, the biggest thing is the dual camera systemthat is specifically for the 7 Plus. So,it seems like a lot of people are picking that bigger phone. I think it costs $120 extra now. You can see it in the numbers. They put up really strong results here.
Lewis: Yeah. AndI think you really see that when you look at average selling price. That grew to $695in the most recent quarter,up from $619 in the previous quarter. And a lot of that is the 7 Plus model, andconsumers clearly voting for the better camera,and being willing to pony up a little bit more dough for it.
Niu: And/orextra storage, because those things shoot 4K video,and you need a lot of storage to store all that.
Lewis: Yeah.absolutely. So, if you put those two numberstogether, the units and average selling price,you get roughly $54.5 billion in revenue. So,right now, we're looking at the iPhone segment making up about70% of revenue for Apple for this quarter. Higher thanit's been in the past, but not necessarily surprising,because the iPhone segment was so massively popularand so successful this quarter.
Niu: Yeah. They were so supply constrained theentire quarter. They acknowledged that they didn't meet supply demand balance until January. So, they were pretty short oninventory throughout the entire quarter. To still be able to hit these numberseven with constraints and,arguably, not a super strong feature set --I was kind of blown away, honestly.Lewis: I think we all were. One of the segmentsthat is gaining more and moreattention from analysts andthe market in general isApple's services segment. This is the iTunes Store, the App Store, Apple Pay, Apple Music, TV App Store, etc. Services, this time, came in at $7.2 billion, which is roughly 9% of revenue. But,perhaps more impressively, it was up 18% year over year. It seems like the company and the Street are both giving this a little bit more emphasis as time goes on.
Niu: Yeah. Andthat was a quarterly record,one of those records they set this quarter. If you look at it nowon a trailing 12-month basis, Services has now crossed $25 billion, in terms of thesize of the business. So this is a huge business already. Here's the crazy thing -- they'revery ambitiously saying they're hoping to double the services business within four years. That's saying, "Wethink we can make a $50 billionbusiness by 2020." Which ispretty ambitious. As far as how they'll get there,they highlighted a couple things. First of all, now, there are150 million paid subscriptions that are beingautomatically billed,recurring subscriptions. That includes Apple's services as well as third-party services. Butthat's the total number that is being billed through iTunes and the App Store right now. That's a pretty big number. They do expect that to keep growing. That's a pretty big base of regular subscriptions of various types ofservices that they sell. Transaction volumes are going up, theinstalled base is growing. There's really all these different aspects of it. Theyeven mentioned, this is kind of surprising, thisiCloud storage business isgrowing quite a bit. I would never have thought it would be a growth driver. But,basically, all these different aspects are really putting up good growth, and combined, they're really bullish about this going forward. It's a pretty ambitious goal there.
Lewis: Yeah. Looking at the inputs of whatmakes up that services revenue,there's momentum on both sides. Not only is theinstalled base is getting larger -- so, thenumber of people that are actually somehow transactingwith the services segment --they indicated in the call that that'sincreasing in the strong double digits. Also, the ARPU (average revenue per user) for each paying customer is increasing inthe double digits. So it's not that one side of that equation is really crushing it and the other one is stagnating. Both sides are performing well. And I think that's what you want to see.
Niu: Yeah. Andthey also had mentioned the music business,which had been declining for quite some time, formany years. Before Apple got into thestreaming side, when it was all the downloadbusiness for music, as people shift toward streaming, that business was shrinking. Now, we'reback to this inflection point where music is growing again. If you include both download and streaming -- so bothiTunes plus Apple Music --if you combine them,the music business as a whole is now growing again. That's always nice to see, particularly as the shift towardstreaming continues, more and more people arewilling to pay. The industry itselfreally likes the shift to paid streaming versus ad-supported streaming. AndApple is a big proponent in that transition. That's also another good sign. They are really helping the music industrygrow as a whole, as well as their cut of the whole music business growing again.
Lewis: Andyou have to like that, considering that they are,what some people might argue,kind of a late entrant into streaming music. You already hadSpotifywith tens of millions of people using it,and you might have wondered what adoption might have looked like for Apple Music and the streaming service. Butresults seem to be pretty good so far. Another area that I think we should spend a little bit of time focusing on here issome of the international results,specifically China. I know that four out of Apple's fivegeographic operating segments set fresh highs -- all but Greater China. But, China is really seen asa huge market opportunity in addition to India, for Apple. Do you want to put a little color out as to what they said in the call?
Niu: Yeah. Like youmentioned, more quarterly recordsin terms of all the other geographical segments, which, again,it's all these little things that are contributingto this overall overperformance. For example,Japan grew 20%. Japan is not a huge market for them,but just the fact that they can still put out meaningful growth numbers ...Europe was pretty much flat. But, Greater China, it has bounced back quite a bit sequentially. In the third quarter, sales were something like $8.7 [billion] to $9 billion. So, to really bounce back to $16 billion, it's shy of their all-time record, which was set a year or two ago, around $18 billion, but it is bouncing back on asequential basis. I think there are still lingering concernsabout the smartphone market in China,because it's getting really competitivewith all these low-cost Chinese vendorsreally proliferating and flooding the market with these cheap choices. You can see in their numbers that they've hadtrouble in the past year ascompetition intensifies on the ground. But I still think thatChina is a very big, promising business. It's probably going to be a tough place to compete. But it's a great market. They're still growing,they still have to expand the retail footprint. There's still room to run.
Lewis: Yeah. With lower-priced entrantscoming into the market, Apple's brand cachet is only going to give it so much pricing power. But, you have to think there's still some room to run there. Speaking of theirinternational segments, I think it might make sense to check in on their cash hoard a little bit. As of their recent report, Apple is sitting on $246 billion in cash. Because they do so much businessoutside of the U.S. and because of certain current tax regulations, $230 billion of that total, or roughly 94%, is held outside the U.S.Morgan Stanleyanalyst KatyHubertyasked [CEO] Tim Cook on the call aboutwhat the company might be thinking with the current administration,and the possibility of repatriating some of that cash. I think that was a question a lot of people wanted an answer to.
Niu: Yeah. That'sone of the big things that the Trump administration is pushing, is this tax reform,including a potential repatriation holiday. If they could bring back a lot of that cash,there are certainly a couple things they could do with it. Cook didn't really givea lot of clear guidance on what he's thinking. But, you could buy some companies. Hekeep saying that Apple is open toreally big acquisitions if they fit,if they make sense, all these things. But he's basically not concerned about pricing anymore. You could buy some companies, you could invest in the U.S.,you could potentially bring production back. Obviously, that's another big thing that Trump is pushing.
Another thing I wouldactually like to see is strengthen the balance sheet. The whole reason they have the $70 billion-plus in debt is because it'salways been a way to avoid the repatriation taxes. So, if they canrepatriate at appealing rates,it might also make sense to pay down some of that debt,because that way, you can avoid some of the interest expense, and it strengthens your balance sheet a little. Not thatthe balance sheet is weak, by any stretch of the imagination. It all nets out in the end. But,logistically, it would be nice to bring that money back, pay down some debt. Because, if this is a one-time deal that they canbring back a ton of money,I would expect them to keepgenerating ridiculous amounts of cash overseas, and then they would want to raise more debt, again,to be able to tap that,in the same way they have been doing, but if they could pay down that debt, that basically gives themeven more time to keep pursuing the same strategy. Andif they're taking advantage of a one-time tax holiday,I think that would make sense, from a corporate finance standpoint.
Lewis: Yeah. Even with $70 billion in debt, wherethey had to repatriate a lot of that cash that's heldoverseas, they still have quite a bit to work with. I think on the call, Hubertyspecifically asked about what merger and acquisition activityto expect,or if they might continue to invest in original content and programmingthat would make the Apple ecosystem seem a little bit more appealing. I think because she led with that questionand had some specific examples of where cash might go, Cook'sresponse followed along with that. But,I was hoping we might get some colorabout an increase in the dividend, or anupdate on what the company was thinking with share repurchasewhere they'd have that extra capital on hand. But,nothing there at the moment. Cook wasnotoriously cagey, as always, in his response.
Niu: Yeah. He didn't really give a lot away there. Theyusually update their capital return program every April. So,next quarter, we will get some insight. They did buy back $11 billion in shares this quarter. Which partially helps juice the earnings-per-share number, which is another record,because they are able to retire so many shares.They retired something like 62 million shares last quarter. That's really highly accretiveto that earnings-per-share figure,even though net income was actually down slightly relative to a year ago,in part because offoreign exchange headwinds and things of that nature. So,right now, they are up to about $144 billion incumulative repurchases, and the current authorization is $175 billion. Sothey still have plenty of room. They only have one more quarterbefore they update it again. ButI would expect them to give another update and increase it again in a couple months,because this businesscreates so much cashthat they literally have no idea what to do with it.[laughs] I mean,think about how much money they have given back,and the fact that they still have more money now than they've ever had before. So, it's like, they'retrying to give this cash back at this ridiculous rate,but they generate so much of it that it still adds on a net basis to their total cash position, even after giving back so much over the years. It's mind-boggling.
Lewis: Andthat's with them continuing to invest in the future, as well. You hear aboutsome of the different projects that they may or may not be funding, and some of theinitiatives they might be pushing. It'snot like they're sitting on their heels here. They'recertainly throwing money into seeing where tech might be going. It's just that,with this type of money available to them, you can only do so much of it with reinvesting in the business and with R&D. I mean,that's the beauty of having a cash cow business like that.
Niu: It's just insane how much they make.
Lewis: One of the things that I was happiest about, and I thinkmaybe this is one of the things that also pushed the stock upas much as it did after the report, was,looking forward, management guided that revenue should come in somewhere between $51.5 billion and $53.5 billionfor the next quarter. And this would be a 1.7% to 5.7% increase over where they were a year ago.I think the reason you have to be really psyched about this as an investor is, they're showing growth year over year in a quarter that isn't fiscal Q1, where they are typically doing blockbuster salesbecause of the holidays. So, it seems like we are not only back to growth this quarter, but going to at least continuemoderate growth for the next couple quarters, if all things hold.
Niu: Yeah. Andanother thing that's pretty impressiveabout the guidance for this coming quarter, the current quarter, is they'realso leaving some room for some gross margin upside,in terms of the guidance. The last quarter, there was 38.5 [percent], and their current guidance is 38-39 [percent]. What'smost impressive about that is,most of the time, when you're coming off the big fourth-quarterholiday season,you lose some operating leverage, so you're margins usually come down slightly because of the seasonality. Forrevenue to be coming down from seasonal factors to this 51.5-53.5 level and still being able to potentiallyput up a sequential increase in gross margin, that's pretty strong.I think the biggest factorthat's contributing to volatilityis all the currency stuff. But,if they could increase gross margin on a sequential basisafter losing leverage,it's pretty good. That's impressive.
Lewis: Yeah. Strong business, firing on allcylinders. Nice to see them back in a growth phase. Anything else that really came out to you in the report, Evan?
Niu: No. It was just really broad-based. They just hit these numbers, smalllittle records, but all across the business. As an investor myself, it'spretty encouraging. There is this perception that Appleis at the end of the road, they'rerunning out of ideas, they're peaking. And they're just like, "Hey, no,we can still squeeze out these gains if we really push and hit on all these sides of the business."
Lewis: And that's working with atop-of-the-line smartphonethat really isn't all that different than theprevious versions. I mean, this wasn't acrazy update to form factor,aside from, maybe, getting rid of the headphone jack and updating the camera. The phone still resembles what people expect of the iPhone. So, youthink about what that might mean, were they to makesome really serious updates in functionality, or do something radical withfuture versions of the phone.I think you have to like what that would do for the business.
Niu: Yeah.I thought it was the least impressive update in years. But, here we go.[laughs]
Lewis:Clearly 70 billion people disagree with you. [laughs]
Well,listeners, that does it for this episode of Industry Focus. If you have any questions, or just want to reach out and say "Hey,"shoot us an email at email@example.com, or you can tweet us @MFIndustryFocus. If you're looking for more of our stuff, subscribe on iTunes, or check out The Fool's family of shows at fool.com/podcasts. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. For Evan Niu, I'm Dylan Lewis, thanks for listening and Fool on!
Dylan Lewis owns shares of Apple. Evan Niu, CFA owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool has a disclosure policy.