Apple Inc ($AAPL) Q3 2021 Earnings Call

Good day and welcome to the Apple Q3 FY2021 Earnings Conference Call. Today's call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Tejas Gala, Director, Investor Relations and Corporate Finance. Please go ahead.

Thank you. Good afternoon and thank you for joining us. Speaking first today is Apple CEO Tim Cook and he'll be followed by CFO Luca Maestri. After that, we'll open the call to questions from analysts. Please note that some of the information you'll hear during our discussion today will consist of forward-looking statements, including, without limitation, those regarding revenue, gross margin, operating expenses, other income and expenses, taxes, capital allocation, and future business outlook, including the potential impact of COVID-19 on the company's business and results of operations. These statements involve risks and uncertainties that may cause actual results or trends to differ materially from our forecast. For more information, please refer to the risk factors discussed in Apple's most recently filed annual report on Form 10-K and the Form 8-K filed with the SEC today along with the associated press release. Apple assumes no obligation to update any forward-looking statements or information, which speak as of their respective dates. I'd like to now turn the call over to Tim for introductory remarks.

Thank you, Tim. Good afternoon, everyone. We're very pleased to report record June quarter financial results, which reflect the importance of our products and services in our customers' lives and our strong underlying operating performance. Our revenue reached a June quarter record of 81.4 billion, an increase of nearly 22 billion or 36% from a year ago. We grew double digits in each of our product categories with an all-time record for services and June quarter records for iPhone, Mac, and wearables, home, and accessories. We also set new June quarter records in every geographic segment with very strong double-digit growth in each one of them. Products revenue was a June quarter record of 63.9 billion, up 37% over a year ago. This level of sales performance, combined with the unmatched loyalty of our customers, drove our installed base of active devices to a new all-time record. Our services set an all-time revenue record of 17.5 billion, up 33% over a year ago with June quarter records in each geographic segment. Company gross margin was 43.3%, up 80 basis points from last quarter, driven by cost savings and a higher mix of services, partially offset by seasonal loss of leverage. Products gross margin was 36%, down 10 basis points sequentially as seasonal loss of leverage was almost entirely offset by cost savings. Services gross margin was 69.8%, down 30 basis points sequentially, mainly due to a different mix. Net income of 21.7 billion, diluted earnings per share of $1.30, and operating cash flow of 21.1 billion were all June quarter records by a wide margin. Let me get into more detail for each of our revenue categories.

iPhone revenue set a June quarter record of 39.6 billion, growing 50% year over year and exceeding our own expectations as the iPhone 12 family continued to be in very high demand. Performance was consistently strong across the world, and we grew very strong double digits in each geographic segment, setting June quarter records in most markets we track. Our active installed base of iPhones reached a new all-time high thanks to the exceptional loyalty of our customer base and the strength of our ecosystem. In the US, the latest survey of consumers from 451 Research indicates iPhone customer satisfaction of 97% for the iPhone 12 family. Turning to services, as I mentioned, we reached an all-time revenue record of 17.5 billion with all-time records for cloud services, music, video, advertising, and payment services and June quarter records for the App Store and Apple Care. Our newer service offerings, Apple TV Plus, Apple Arcade, Apple News Plus, Apple Card, Apple Fitness Plus, as well as the Apple One bundle, continue to scale across users, content, and features and are contributing to overall services growth. The key drivers for our services business all continue to move in the right direction. First, our installed base of devices reached an all-time high across each geographic segment. Second, the number of both transacting and paid accounts on our digital content stores reached a new all-time high during the June quarter in each geographic segment, and paid accounts increased double digits. Third, paid subscriptions continue to show strong growth. We now have more than 700 million paid subscriptions across the services on our platform, which is up more than 150 million from last year and nearly four times the number of paid subscriptions we had only four years ago. And finally, we're adding new services that we think our customers will love while also continuing to improve the breadth and quality of our current services offerings. For example, during WWDC in June, we previewed our new iCloud Plus and Apple Wallet features, which we believe will create a more secure and differentiated customer experience.

Wearables, home, and accessories grew 36% year over year to 8.8 billion, setting new June quarter revenue records in every geographic segment. We continue to improve and expand our product offerings in this category. This quarter, we began shipping our new Apple TV 4K with a redesigned Siri remote and our brand new AirTags, and the customer response to both products has been very strong. In addition to its outstanding sales performance globally, Apple Watch continues to extend its reach with nearly 75% of the customers purchasing Apple Watch during the quarter being new to the product. For Mac, despite supply constraints, we set a June quarter record of 8.2 billion, up 16% over last year with June quarter revenue records in most markets we track around the world. It is remarkable that the last four quarters for Mac have been its best four quarters ever. This exceptional level of sales success has been driven by the very enthusiastic customer response to our new Macs powered by the M1 chip, which we most recently brought to our newly redesigned iMac. iPad performance was also strong with revenue of 7.4 billion, up 12% in spite of significant supply constraints. During the quarter, we also started shipping our new iPad Pro powered by the M1 chip, and customer response has been outstanding. Both iPad and Mac have taken computing to the next level, and when you combine their performance over the last 12 months, they're now the size of a Fortune 50 business. Thanks to the best product lineups we've ever had, very high levels of customer satisfaction, and a loyal growing installed base. In fact, around half of the customers purchasing Mac and iPad during the quarter were new to that product. And in most recent surveys of US consumers from 451 research, customer satisfaction was 92% for Mac and 95% for iPad.

In enterprise, our customers are excited about the superior performance, battery life, and security that the new M1 Macs bring. MassMutual, for example, is offering M1 MacBook Pro to all of its employees and equipping all conference rooms with M1 Mac minis in preparation for return to work. And with its incredible performance and affordable entry price, the MacBook Air with M1 is gaining rapid adoption among many leading enterprise organizations. Italgas, Italy's largest natural gas company, which will soon be using its extensive network to distribute renewable gases, is replacing every employee's Windows laptop with the new MacBook Air powered by Apple's M1 chip to bring the latest technology to its workforce. And Grab, Southeast Asia's leading super app that provides transportation, food delivery, and digital payment services, is adding M1 MacBook Air to its company-wide M1 Mac deployment.

Let me now turn to our cash position. We ended the quarter with 194 billion in cash plus marketable securities. We retired 3 billion of term debt and increased commercial paper by 3 billion, leaving us with total debt of 122 billion. As a result, net cash was 72 billion at the end of the quarter. As our business continued to perform at a very high level, we were also able to return 29 billion to shareholders during the June quarter. This included 3.8 billion in dividends and equivalents and 17.5 billion through open market repurchases of 136 million Apple shares. We also began a 5 billion dollars accelerated share repurchase program in May, resulting in the initial delivery and retirement of 32 million shares.

As we move ahead into the September quarter, I'd like to review our outlook, which includes the types of forward-looking information that Tejas referred to at the beginning of the call. Given the continued uncertainty around the world in the near term, we're not providing revenue guidance, but we are sharing some directional insights, assuming that the COVID-related impacts to our business do not worsen from what we are projecting today for the current quarter. We expect very strong double-digit year-over-year revenue growth during the September quarter. We expect revenue growth to be lower than our June quarter year-over-year growth of 36% for three reasons. First, we expect the foreign exchange impact on our year-over-year growth rate to be three points less favorable than it was during the June quarter. Second, we expect our services growth rate to return to a more typical level. The growth rate during the June quarter benefited from a favorable compare as certain services were significantly impacted by the COVID lockdowns a year ago. And third, we expect supply constraints during the September quarter to be greater than what we experienced during the June quarter. The constraints will primarily impact iPhone and iPad. We expect gross margin to be between 41.5% and 42.5%. We expect OpEx to be between 11.3 and 11.5 billion dollars. We expect OINE to be around zero, excluding any potential impact from the mark-to-market of minority investments, and our tax rate to be around 16%. Finally, today our board of directors has declared a cash dividend of 22 cents per share of common stock, payable on August 12, 2021 to shareholders of record as of August 9, 2021. With that, let's open the call to questions.

Thank you, Luca. We ask that you limit yourself to two questions. Operator, may we have the first question, please?

Thank you. Our first question from Kate from comes from Katy Huberty from Morgan Stanley. Please go ahead.

Hello, Katy. Your line is open. Please check your mute function. Hearing no response, we'll take our next question from Chris Caso with Raymond James.

Yes, thank you. Good morning. Just dig into the commentary on guidance a little bit. You know, just starting with the fact that last year, obviously, there was a later launch of iPhone than we've typically seen in other years. Could you talk us through that and perhaps some of the other products, what may be different as compared to last year?

Well, you know, as I explained, first of all, you know, we are expecting to grow very strong double-digits. You know, that's I think, Chris, the starting point here. We expect, you know, this very strong level of growth that we've experienced during the course of the year to continue into the September quarter. We said that, you know, the growth rate is going to be below 36% and I've listed three factors. The first factor is that the dollar continues to be favorable on a year-over-year basis in the sense that it's weakened against most currencies on a year-over-year basis, but that benefit is going to be about three points less in the September quarter than what we've experienced during the June quarter because the dollar strengthened against most currencies in recent weeks. Second, I mentioned that the services growth rate that we've experienced in the June quarter, 33%, that's significantly higher than what we've had in recent history. And that was due to the fact that there were a couple of services categories, namely our advertising business and AppleCare that were significantly impacted a year ago because of the COVID lockdowns and therefore they had a relatively easy compare in the June quarter. And so, we don't expect that to continue into the September quarter. And so, we expect still significant growth in services, but not to the level that we've seen in June. And then I mentioned that the supply constraints that we've seen in the June quarter will be higher during the September quarter. Back in, you know, when we talked here 3 months ago, we said that we were expecting supply constraints for the June quarter between 3 and 4 billion dollars to affect primarily iPad and Mac. We were able to mitigate some of those constraints during the June quarter and so, we came in at a number that was slightly below the low end of that range that we had quoted at the beginning of the quarter, but we expect that number to be higher for the September quarter. And so, when you put that all together, again, very strong double-digit growth for September with these caveats that I just mentioned.

And thank you. If I could follow up with regard to the supply constraints, and do you expect those supply constraints to persist through the December quarter as well? You know, what effect will that have on the holiday selling season? And then in conjunction with that, what additional costs are you absorbing because of these supply constraints? Is that having an effect on gross margins or just product costs in general as you, you know, perhaps pay a little more to get more supply?

And Chris, on the cost side, as I mentioned during my comments, our results for gross margins for the June quarter, 43.3%, we really saw some really nice cost savings during the quarter. And I think you've seen that, you know, we provided guidance of 41 and 1/2 to 42 and 1/2 for September, which is obviously a level that we are very pleased with.

Thank you, Chris. Can we have the next question, please?

Thank you. We'll take our next question from Jim Suva with Citigroup Investment Research. Please go ahead.

Thank you very much and congratulations to you and your global team for great during a challenging time. Tim and Luca, I just have one question and either of you or both of you could figure out who's best to answer it, but we look at a world of pretty unprecedented, whether it be COVID, the Delta variant, China floods, supply chain components. Just wondering for your like R&D and innovation, is it being materially impacted by that such where a normal cadence is unfair or is it kind of happening during a slow time of year where you're able to empower people to work remotely and still have the typical innovations and product launches that you've had historically in the past?

Thanks, Tim. Can we have the next question, please?

Thank you. We'll take our next question from Shannon Cross with Cross Research.

Thank you very much. Tim, I'm curious what have you learned from this iPhone cycle regarding customer preferences and pricing and maybe subscriptions and that, and if there's a difference if you could talk about it on a geographic basis. Thanks.

Okay. And maybe if you can talk a bit about China, up 58%, you know, where are you seeing the growth? What are you hearing from customers there? How sustainable is the strength?

Wait, was the 85% China or overall?

Right. Great. Thank you so much.

Yeah, thanks, Shannon. Can we have the next question, please?

Thank you. We'll take our next question from Amit Daryanani with Evercore. Please go ahead.

Thanks a lot for taking my question. I have two as well. I guess first for Luca, I was hoping you could maybe talk a little bit more about the gross margins and maybe the expectations you laid out for September. I think sequentially it implies it's down 100 basis points or so, so maybe just talk about what are the puts and takes, that would be helpful because I think historically September tends to be a flattish, maybe even up a little bit gross margin number.

Yeah, I think it's important to go back to the Q3 results, right? It's 43.3%. And one of the things that I mentioned is that in addition to getting really good cost savings on a sequential basis, we also had a very high mix of services as part of the total. And particularly with advertising doing really, really well because of the rebound that we saw from the COVID lockdowns a year ago. And so as we move forward sequentially, we do expect a different mix, and so that drives the guidance that we provided, which again, as you know, it's significantly higher than just a year ago, for example, a year ago we were at 38.2%, so almost 400 basis points of expansion on a year-over-year basis, right? And so I think it's important to take that into account. Just a different mix.

Got it. No, absolutely. Listen, I don't think anyone expected gross margins to be north of 40 this quickly for you folks, so that is impressive. If I could follow up on services and, you know, I know you called out the 33% growth this quarter as a bit of an aberration to compare to easy year, but you know, if you look at your services growth rate over the last four quarters, let's just say, what do you think is enabling this growth? Is it you are able to have a higher ARPU, more monetization of your installed base, or is your installed base growing? I'm curious which one's bigger, and then over time, how do you think those two components stack up for you?

It's a combination of multiple factors, right? Obviously, the fact that our installed base continues to grow and it sets new all-time highs all the time obviously gives us a larger opportunity all the time. And second, we have more and more people that are engaged in our ecosystem, both transacting for free, which is a very large number, and people that are willing to pay for some of the services. And that percentage of people that are paying for our services continues to grow nicely. I mentioned it grew double digits again this quarter, so that obviously helps on the revenue side. And of course, we continue to increase both the quality and the quantity of the services. As you know, during the last few years we've launched a lot of new services from Apple TV Plus to Fitness Plus, Apple Arcade, News Plus, and of course, the Apple Card. And so these are businesses that we are scaling right now, and so all that additional revenue helps, and I think it flows through our growth rates. As you said, during the last four quarters, we're well into the mid-20s, right? So I think it's obviously very nice for us to see.

Perfect. Thank you.

Thanks, Amit. Can we have the next question, please?

Thank you. We'll hear next from Katy Huberty with Morgan Stanley. Please go ahead.

Thank you. Good afternoon. Can you hear me okay?

Yes, we can.

Okay, good. So, first question, there's a debate in the market around how much Apple benefited from the pandemic given increased spending areas like Mac and App Store, but of course, you've mentioned over the past several quarters that there are other areas that were limited by the pandemic and store closures and less foot traffic. When you net out all the puts and takes, was your business helped or was it hindered by the pandemic?

Well, of course, you know, Katy, we don't have the crystal ball that tells us exactly how these different variables impacted our business. We do know that on the positive side of the ledger, obviously, especially during the periods of extreme lockdowns, digital services did very well because entertainment options were limited, and so obviously our digital services did really, really well. Obviously, with more people working from home, more people studying from home, we know that iPad and Mac demand was very, very strong. On the other side, we had certain services like advertising because of the reduced economic activity, AppleCare because our stores were closed, they were affected negatively. And certain products like the iPhone or the watch, that are maybe more complex types of sales because of the complexity of the transaction, they were also affected because so many points of sale were closed all around the world, not only our stores, but also our partner stores, right? Difficult for us to gauge because we've been constrained for quite a long period of time. And the reality is that maybe the new normal after we exit COVID may be different from the past. For example, maybe there's going to be hybrid models around work, for example. And so, it's difficult to tell you on a net basis what that is. Clearly, and this is very fluid because it tends to change over time. I can certainly tell you that we're all looking forward to a COVID-free world. I think that would be very good for us and for our customers, as well.

And just to follow up on iPhone specifically, if you look historically after a really strong product cycle, which you've experienced this year with iPhone 12, iPhone revenues come under pressure because the upgrade rate slows, the mix often shifts to the lower end of the portfolio. Is it fair to assume a similar trend will play out over the next year or not?

That's great color. Thank you.

Thanks, Katie. Can we have the next question, please?

Thank you. We'll take our next question from Harsh Kumar with Piper Sandler.

Yeah, hey guys. First of all, congratulations. Fantastic execution. It's resulted in consistency for your results. Tim, this is actually perfect timing for this question. You talked about your installed base of a billion odd units. I was curious if you could help us understand how old that installed base is. And the reason that I'm asking this question is we're clearly seeing people upgrade to 5G phones. And if that's the case and that continues, that could be a larger force than most other forces for your revenues to continue to grow as people migrate to the 5G family of phones. So, I was curious if you could shed light on how the upgrades are happening and then also how old that base is.

Fair enough. For my follow-up, Apple's probably one of the largest semiconductor companies in the world. How does Apple determine what's strategic and something that Apple wants to make itself versus non-strategic? And also, I was curious, you know, there's a lot of, well, it's public news now that ARM is getting acquired by Nvidia. And I was curious how Apple views that. Is that something that's beneficial to Apple or not meaningful or negative?

Thank you. Thanks for the question.

Thank you. Can we have the next question, please?

Absolutely. We'll take our next question from Chris Sanker with Cowen and Company. Please go ahead.

Yeah, hi. Thanks for taking my question and congrats on the strong results. First one for Luca, you mentioned services growth should normalize in the September quarter. And I understand the last few quarters services business was strong, driven by work from home, etc. So, what is the normalized growth rate for the services business as folks return back to the office in this post-COVID world? And then I had a follow-up.

Well, I think, you know, you can go back several quarters and try to do a bit of an average, and that's what we would be talking about. Of course, there's always a bit of variability around results, right? But certainly, we haven't done 33% in years. And so, that was a bit of an anomaly. And again, I explained it's around a couple of the businesses that had a relatively easy compare during the June quarter. So, but you know, our services growth has been for many, many quarters strong double digits. And we feel confident around that level.

Got it. Got it. And then just to follow up with Tim or Luca, I think Tim, you mentioned in your prepared comments that in September quarter, there's going to be greater impact on supply constraints on the iPhone and iPad. So, I'm kind of curious, you know, this is the first time I heard you talk about component shortages impacting the iPhone. Can you be more specific? Is it display drivers or what exactly is the choke point on the supply?

On silicon. Thanks, Tim.

Thanks, Chris. Thank you. Next question, please.

Thank you. We'll hear our next question from David Voyt with UBS.

Great. Thank you guys for the question. So, maybe just a point of clarification. So, based on the data and the comments about upgraders and switchers being strong as well as emerging markets that were relatively strong in the quarter. What does that specific set of data points strength mean for the iPhone portfolio? And I guess my question around that is, you know, when you think about switchers and price points, I think last year you launched the SE2 to really address maybe some of the lower price point markets like the emerging markets. So, does that mean thinking about the portfolio going forward, there's less of a need for a lower price product going forward and that, you know, the current portfolio and the new cycle going forward would be more high-end in nature as we currently have today? And then I have a follow-up.

No, no, that's helpful. I appreciate that, Tim. So, does that mean sort of the emerging market buyer that wants to get into the iPhone, you know, is looking for a device that has 5G capability as well? You know, obviously we're early innings in a lot of markets or how do we think about that, you know, over the intermediate to longer term in terms of consumer preference for 5G in those markets if available from an infrastructure perspective?

Great. Thank you very much.

Thank you. Can we have the next question, please?

Thank you. We'll take our next question from Ben Boldin with Cleveland Research Company.

Good evening, everyone. Thanks for taking the question. I wanted to start, Luca or Tim, could you walk us through a little bit about how you think Apple One bundles are influencing the trajectory of services and the economics? And then a second part on services, I'm curious how you think IDFA is developing and influencing the trajectory of the advertising business within services.

Thank you. Can we have the next question, please?

Thank you. We'll take our next question from Wamsi Mohan with Bank of America.

Yes, thank you. I have two as well. To begin with Luca, you noted significant product revenue deleverage but yet your product gross margins were roughly flat. You noted cost savings. Can you maybe talk about whether these are tactical in nature or more structural like vertical integration that'll continue to drive benefits to product gross margins. And on services side you noted several times about the strength in app growth which is obviously very high margin contributor, but the sequential trajectory on services margins was flat. So, what were some of the offsets there? And I have a follow-up for Tim.

Yeah. On the product side, I talked about cost savings. Tim mentioned that, you know, maybe on the freight side we're seeing some level of cost pressure that is a bit out of the norm at this point in the cycle. For everything else, for all the major commodities and components, we continue to see a very typical cycle where we are getting good cost savings on a sequential basis. And so far it's been very good as you can tell from the absolute level of gross margins because on the product side, we're up more than 600 basis points on a year-over-year basis. So, it feels something that we've been able to accomplish and we're able to maintain at least in the near term. Nothing that was abnormal during the quarter or one-off in nature. It was pretty structural. On the services side, again, up a lot on a year-over-year basis. So, the baseline has gone up a lot. The sequential decline, as you said, it was very, very small. And as I mentioned several times in the past, we have a very large services portfolio with very different margin profiles in our services. And so even a slight change in mix can drive some sequential differences. And this was the case this quarter. Just a different mix. I mentioned, for example, that Apple Care has rebounded. And so the relative success of our services in the marketplace can drive some slight changes in gross margins. Again, step back for a second, 69.8% gross margin. We're very, very, very happy with where we are with the services margin trajectory.

Okay, thanks, Luca. And Tim, there is increasing regulatory focus in China in particular on some of the Chinese companies. It's not a direct impact on Apple, but how should investors handicap the indirect impact given some of these companies are pretty large contributors to Apple's App Store revenues. And also, are you seeing any impact at all from these? And is the limiting of the usage of some of these apps influencing how people are either interacting with your devices or is there any other ancillary impact that you're seeing?

Thanks, Tim. Thank you, Wamsi. A replay of today's call will be available for two weeks on Apple Podcasts as a webcast on apple.com/investor and via telephone. The numbers for the telephone replay are 888-203-1112 or 719-457-0820. Please enter confirmation code 976-6068. These replays will be available by approximately 5:00 p.m. Pacific Time today. Members of the press with additional questions can contact Josh Rosenstock at 408-862-1142. Financial analysts can contact me with additional questions at 669-227-2402. Thank you again for joining us.

Thank you. That does conclude today's conference. Thank you for your participation.