Apple: A lackluster next quarter (FY23Q4 conference call)

Apple (AAPL.O) released its fiscal fourth-quarter earnings report for 2023 (ending in September 2023) after the US stock market closed on November 3, 2023. The key points from the conference call are as follows:

1. Incremental information from the conference call of $Apple.US:

1) Performance expectations for the next quarter: The company expects total revenue for the next quarter to be similar to last year. Absolute iPhone revenue is expected to increase year-on-year, while the year-on-year performance of Mac is expected to accelerate significantly compared to the September quarter. Revenue performance for iPad, wearables, home, and accessories is expected to decline significantly compared to the September quarter. For services, average revenue is expected to grow at a strong double-digit rate similar to the September quarter. The gross margin is expected to be between 45% and 46%.

2) Indian market: We achieved a historic revenue record in India, with very strong double-digit growth.

2. Original transcript of the Apple conference call:

2.1 Management statement

1) Business segment discussion

iPhone: iPhone revenue reached $43.8 billion, a 3% increase compared to the same period last year, setting a new record for the September quarter. This fall, we are excited to introduce the iPhone 15 series. The all-new iPhone 15 and iPhone 15 Plus feature stunning designs, powerful cameras, and intuitive dynamic islands. Our iPhone 15 Pro series is supported by the industry-leading A17 Pro, featuring a beautiful, durable, and robust titanium design and the best iPhone camera system ever, including a 5x telephoto lens on the iPhone 15 Pro Max. Consumers love the entire iPhone 15 series and the reviews have been very positive.

Mac: Mac revenue was $7.6 billion, a record-breaking quarter-on-quarter decline of 34% compared to the same period last year. This is due to challenging market conditions and the difficulties of comparing with the supply disruptions and subsequent demand recovery we experienced a year ago. Earlier this week, we were thrilled to introduce the next generation of Apple Silicon, including our incredible M3 chip series: M3, M3 Pro, and M3 Max. We continue to innovate at an amazing pace, making our industry-leading personal computer product line even better. The all-new MacBook Pro series brings our most advanced technology to professional users, while the world's best-selling all-in-one iMac becomes faster and more powerful. And according to the latest data from Student Monitor, nearly two-thirds of college students choose Mac. We are extremely excited about the future.

iPad: The revenue for the September quarter was $6.4 billion. iPad has set the gold standard for tablets, and the seamless integration of our hardware and software brings an iPad experience that our competitors cannot match. iPad is also our most versatile product. In classrooms around the world, it helps educators bring lessons to life while providing students with a window to the world around them. In artist studios, design studios, and anywhere else where creative thinking comes together, iPad accelerates the creative process, helping users take their ideas further than ever before.

Wearables, Home, and Accessories: Revenue in the wearables, home, and accessories category was $9.3 billion. Apple Watch has become an indispensable part of our lives, and this is our best Apple Watch series ever. With Apple Watch Series 9 and Apple Watch Ultra 2, we provide people with more tools to stay safe and live a healthy, active life.

With the new double-tap gesture, users can easily control Apple Watch Series 9 and Apple Watch Ultra 2 with just one hand, without touching the display. It feels like magic.

Our latest Apple Watch series also includes our first carbon-neutral product, a significant achievement of innovation and determination.

Services revenue reached a historic record of $22.3 billion, a 16% YoY growth. We set historic revenue records in the App Store, advertising, AppleCare, iCloud, payment services, and video, and set a September quarter revenue record in Apple Music. Whether subscribers are reading headlines on Apple News+ when they wake up, doing morning workouts on Fitness+, enjoying the rhythm through Apple Music on their way to work or school, or relaxing with Apple Arcade at the end of the day, we offer a variety of services to enrich their day. Apple TV+ continues to delight customers with new and returning shows like "The Morning Show," "Lessons in Chemistry," and "Monarch." We are telling impactful stories that inspire imagination and ignite the soul. Producing impactful films is also at the core of Apple TV+, and we are thrilled to have produced Martin Scorsese's "Flower Moon," a breathtaking film that premiered in theaters worldwide last month. We are proud to say that since its launch four years ago, Apple TV+ has received nearly 1,600 award nominations and nearly 400 awards. We have also provided unprecedented live sports experiences for subscribers through the MLS Season Pass. We are very satisfied with the progress of our partnership with the Major League Soccer in its first year. The number of MLS season ticket subscriptions has exceeded our expectations, and we are pleased to continue this momentum next year.

We have also opened new stores in South Korea, China, and the UK, and expanded the Apple Store online to Vietnam and Chile. We opened another store in China this week. In September, I joined our team on the day of the Apple Fifth Avenue event, and the energy and excitement at that time were incredible. Every time we connect with our customers, we are reminded of why we do what we do. From the simple joy of creating and sharing memories to life-saving features like satellite emergency assistance, we are enriching people's lives in big and small ways. Whether we are working hard to protect user privacy, ensuring that everyone can use the technology made by Apple, or creating a more inclusive workplace, we are determined to be guided by our values.

Our environmental work is a great example of how our work aligns with our values. Throughout Apple, our actions are guided by a simple premise: the best products in the world should be the best products for the world. We have made environmental work a core focus of our innovation because we feel a responsibility to make the world better than we found it, and because we know that climate change cannot be stopped unless everyone stands up and contributes their part.

Our first carbon-neutral product represents an important milestone, and we will go further. We plan to make every product in our lineup carbon neutral by the end of this century. We are not alone in this effort. Our more than 300 suppliers have committed to using 100% clean energy in Apple production by 2030.

1. Financial Analysis

Revenue for the September quarter was $89.5 billion, down less than 1% from last year.

Foreign exchange had a negative impact of over 2 percentage points, and on a constant currency basis, our total revenue and revenue in each geographic region grew year over year. We set a record for the September quarter in the Americas and saw strong performance in emerging markets, with double-digit growth in iPhone and services. Product revenue was $67.2 billion, down 5% from last year, as the comparison on Mac and iPad was particularly challenging, which I will discuss in more detail later. Meanwhile, driven by strong momentum in emerging markets, iPhone achieved its highest September quarter performance in history.

Our services revenue set a record of $22.3 billion, with a year-over-year growth of 16% and an accelerated growth rate compared to the June quarter.

The company's gross margin reached a record for the September quarter at 45.2%, an increase of 70 basis points from the previous quarter, primarily due to leverage and favorable mix, partially offset by foreign exchange. Product gross margin was 36.6%, an increase of 120 basis points from the previous quarter, also driven by leverage and mix, but partially offset by foreign exchange.

Due to the different structure, the service gross margin was 70.9%, up 40 basis points from the previous quarter. Operating expenses were $13.5 billion, at the lower end of our guidance range, a 2% increase YoY. Net profit was $23 billion, with diluted earnings per share of $1.46, a 13% increase from last year, setting a quarterly record for September. Operating cash flow was strong at $21.6 billion.

Revenue details

iPhone revenue was $43.8 billion, a 3% increase YoY, setting a new quarterly record for September. We performed strongly in multiple markets, including reaching historic highs in India, as well as setting records in Canada, Latin America, the Middle East, and South Asia in the September quarter.

Mac revenue was $7.6 billion, a 34% decrease YoY. Last year, we experienced supply disruptions due to factory closures in the June quarter, but were able to meet pent-up demand in the September quarter.

iPad generated $6.4 billion in revenue, a 10% decrease YoY. Similar to Mac, these results reflect the challenging comparison to the supply disruptions in the June quarter a year ago and the subsequent pent-up demand in the September quarter. iPad continues to attract a large number of new customers, with over half of the customers purchasing iPad this quarter being new to the product.

Wearables, Home, and Accessories revenue in the United States was $9.3 billion, a 3% decrease YoY, with a customer satisfaction rate of 98%. We set a September quarter record in Europe and saw strong performance in several emerging markets globally. Apple Watch continues to expand its reach, with nearly two-thirds of customers purchasing Apple Watch this quarter being new to the product. Most recently, customer satisfaction for the US services industry reached 97% for the quarter. We set a new revenue record of $22.3 billion, a 16% increase YoY. We are pleased to see growth in all categories and every geographic region, a direct result of the strength of our ecosystem.

Our installed base of active devices, which exceeds 2 billion, continues to grow at a healthy pace, laying a solid foundation for the expansion of our ecosystem in the future. We continue to see increasing customer engagement with our services. Both transaction accounts and paid accounts grew by double digits YoY, reaching all-time highs. Additionally, our paid subscriptions have shown strong growth.

The number of paid subscriptions for various services on our platform has exceeded 1 billion, nearly double what it was three years ago. Finally, we continue to enhance the breadth and quality of our current services, from exciting new content on Apple TV+ and Apple Arcade to additional storage layers on iCloud. We believe our customers will love these new products.

Speaking of enterprise, we are pleased to see both developed and emerging market business customers expanding their deployment of Apple products and technologies to drive business innovation and employee satisfaction. Starbucks continues to invest in Apple technology to bring the best experience to its customers and employees, including equipping tens of thousands of iPads in all retail stores to help streamline order management. Operations and Training.

In addition, Starbucks recently upgraded over 10,000 Macs to the latest M2-powered MacBook Air for all store managers, enabling them to excel in their work and increase productivity. In Indonesia, popular tech company GoTo offers Macs as an option for employees to have the best tools to enhance work efficiency.

Cash Position and Capital Return Plan: At the end of this quarter, we have over $162 billion in cash and marketable securities. We added $2 billion in commercial paper, bringing our total debt to $111 billion.

Therefore, as of the end of this quarter, net cash is $51 billion, and we maintain our goal of achieving net cash neutrality over time.

This quarter, we returned nearly $25 billion to shareholders, including $3.8 billion in dividends and equivalents, and $15.5 billion through the repurchase of 85 million Apple shares on the open market.

We also initiated a $5 billion accelerated share repurchase program in August, ultimately delivering and retiring 22 million shares. Looking back at the 2023 fiscal year, our annual revenue was $383 billion.

Although it decreased by 3% compared to the previous year, we still achieved growth when calculated at a fixed exchange rate despite the volatile and uneven macroeconomic environment.

As this year has passed, our year-over-year revenue performance has improved in each quarter, as has our earnings per share performance, as we achieved double-digit EPS growth in the September quarter.

We are particularly pleased with our performance in emerging markets, with record-high revenue in the 2023 fiscal year and double-digit growth when calculated at a fixed exchange rate.

We are expanding our direct business in these markets, from new Apple retail stores in India to online stores in Vietnam and Chile. We will continue to work with partners to provide extensive affordability programs so that we can best serve our customers.

4) Performance Outlook

The additional week of revenue added approximately 7 percentage points to total revenue for this quarter. Despite the reduction in weeks this year, we expect total company revenue for the December quarter to be similar to last year.

We expect absolute growth in iPhone revenue compared to the previous year.

We also anticipate growth in the economy after last year's supply disruptions and the normalization of the additional week.

We expect significant acceleration in Mac's year-over-year performance compared to the September quarter.

We anticipate a significant decline in year-over-year revenue performance for iPad and wearables, home, and accessories compared to the September quarter due to different product release timings. For iPad, we launched the new iPad Pro and 10th generation iPad a year ago in the December quarter.

In the wearables category, we benefited from the release of the second-generation AirPods Pro, Watch SE, and the first Watch Ultra throughout the entire December quarter last year. For our services business, we expect average revenue to grow at a strong double-digit rate similar to the September quarter.

We expect gross margin to be between 45% and 46%.

We expect operating expenses to be between $14.4 billion and $14.6 billion.

We expect OI&E to be approximately negative $200 million, excluding any potential impact from the valuation of minority equity investments, and our tax rate to be around 16%.

Finally, today our board of directors announced a cash dividend of $0.24 per share of common stock payable on November 16, 2023 to shareholders of record as of November 13, 2023.

2.2 Q&A Analyst Questions

Q: Regarding iPhone storage and demand versus iCloud. With the growth in storage demand, have you seen a shift towards higher-capacity iPhone models? Or do consumers mostly opt for the same way due to increased usage of iCloud+? What are the strategic and financial considerations and trade-offs when considering the shift towards higher storage models and iCloud penetration?

A: We started producing the 256GB version with the iPhone Pro Max, so we will see a different mix this year if you want it. Other than that, no significant changes.

Q: As a separate follow-up, I was just wondering if you could talk about the market conditions for notebooks and desktops. Any insights on the timing of the M3 MacBook Pro versus the earlier M2 this year?

A: With our existing product lineup and the comparison issue we didn't have in Q1, we expect significant acceleration in the Mac area in Q1. Just to reiterate the performance in the prior quarter, in the June quarter of last year, our factories were shut down for several weeks. The pent-up demand from that resulted in a record September quarter. So, not only a record, but a substantial record. Clearly, we're now comparing to that situation in '23.

So, I wouldn't take the -34% as representative of the underlying business performance.

Q: Can you help us describe what the demand environment looks like in China? How is the response to iPhone 15? Similar to the previous question. How would you describe the mix in China domestically as you go through the current product cycle?

A: If you look at our performance in Greater China this quarter, you'll see that our revenue performance was -2%. But one thing to keep in mind here is that the FX impact was close to 6 percentage points.

So, our growth is on a constant currency basis. Underneath that, if you look at the different categories, iPhone actually set a September quarter record in mainland China. The main drag was the mix of Mac and iPad. Services also grew this quarter. Mac and iPad also faced the same issue as the company did, which was the factory shutdown issue in Q3 '22, which then got resolved in Q4 '22. In addition, we also have the top four selling smartphones in Chinese cities.

Q: When we shift to a more inflationary component pricing environment, how do we consider this impact, or how do you consider the shift from a clearly favorable situation in component pricing at the product level over the past few quarters to a more inflationary environment?

A: As you can see from our fourth quarter performance and first quarter guidance, we have clearly experienced very strong gross margin levels. 45.2% is a record level for the September quarter, and the first quarter guidance is obviously strong, ranging from 45% to 46%.

Our gross margin is influenced by various factors. The commodity environment is one of them, and the environment has been favorable in recent quarters. But equally important is the product mix we sell, and clearly, the growth of services is favorable for us. This contributes to the gross margin of our company.

On the other hand, given the strength of the US dollar, foreign exchange has been a drag on several quarters. We do not provide guidance beyond the December quarter, which is important for us as it marks the beginning of many product cycles.

Therefore, we feel very good about the coming year, very confident, and I think the gross margin guidance reflects that.

Q: Does your December quarter revenue guidance take into account any supply constraints? If so, is there any way to quantify how much supply will limit your December quarter revenue performance? Should we expect an increase in capital intensity or similar capital intensity? If so, what are some of the more notable moving parts we should consider?

A: Today, our iPhone 15 Pro and iPhone 15 Pro Max are still supply-constrained. We are working very hard to get the products into the hands of all the customers who have ordered. We will achieve supply-demand balance by the end of this quarter, so the guidance reflects that.

Our main areas of investment are in the tools and equipment for manufacturing facilities, investments in data centers, and our own facilities, including company facilities and retail stores.

Therefore, for our investments in factory tools and data centers, we tend to adopt some kind of hybrid model, sharing some investments with partners and suppliers.

So maybe that's why you sometimes see some changes. But over the past few years, we have made all the necessary investments. Clearly, we plan to make all the investments we deem necessary and appropriate to continue innovating.

Q: First, I would like to understand the current and future situation of your partners in the United States. What do you expect? Second, is the mix of products and services in the first quarter a key driver for the overall gross margin guidance, for example, in the December quarter? Or is there anything else? I know you mentioned there are many moving parts, but is this the main driver of the increase in profit margin?

A: For US carriers and the overall US enterprise, it is indeed too early to judge the iPhone cycle now, especially considering the constraints on Pro and Pro Max, which have often performed well in these products. Now it's too early to judge the upgrade rate and switch rate.

In terms of profitability, if I understand your question correctly about the guidance for the December quarter, please keep in mind that December is typically a very busy quarter for our product business due to the holiday season.

Therefore, the service gross margin has some impact on the overall company, but it is not as significant as in other quarters throughout the year.

Therefore, I believe the main driving factors for the guidance we provided are the cost improvement and portfolio improvement in our product business, partially offset by foreign exchange, which continues to be a drag and increases year by year.

Q: The growth rate of the service industry has seen a significant acceleration. Can you talk about what is driving this acceleration? Are there any products that have made meaningful progress in a certain way?

A: Our performance in the cross-border sector has been very strong this quarter, as we have seen significant growth both in terms of geography and product categories. I mentioned the records in terms of geography. In terms of categories, literally, we have set records in every major category. We have set records in the App Store, advertising, cloud, video, Apple Care, and payments, and also set a record in music for the September quarter.

So it's hard to pick out one in particular because they are all doing well. And then we really step back and think about why our services business is performing well, and it's because our customer base continues to grow at a very good pace, and the engagement in our ecosystem continues to increase.

We keep adding content and features. We added a lot of content on TV+, new games on Apple Arcade, and new features and storage plans on iCloud.

So it's a combination of all these factors, and the engagement in the ecosystem is improving, so it benefits every service category.

Q: I have a question about Vision Pro. I believe it should be more widely launched at some point in 2024 (early this year). I'm curious, how do you think the release and consumer education of this product or new category differ from what you have done with other products like AirPods or Apple Watch? And perhaps what are the themes that stand out among the developers who are able to use it in the developer lab? What feedback have you received from them?

A: We have set up developer labs in different regions of the world so that they can have hands-on experience and develop applications. I have been fortunate enough to see some of them, and there are some really amazing things happening.

So everything looks good. Therefore, we intentionally launched it in our stores so that we can really focus a lot of attention on the last mile of it. We will provide demos in the stores, which will be a very different process from the usual "take and go" process.

**Q: Many companies are trying to develop generative artificial intelligence. I'm curious about your efforts in this area. I'm sure you already have Vision Pro. But I'm curious if you can let us know how some of these efforts can be monetized through the generation of artificial intelligence?

A: If you narrow it down and look at the work we've done in artificial intelligence and machine learning and how we use it, we see artificial intelligence and machine learning as foundational technologies that are almost part of every product we release.

Just recently, when we released iOS 17, it had features like personal voice and real-time voice mail. Artificial intelligence is at the core of these features. And then you can go all the way to the life-saving features on the Apple Watch and iPhone, such as fall detection, collision detection, and electrocardiogram on the watch. Without artificial intelligence, these would not be possible.

So, if you will, we don't label them as such. We label them as what the consumer benefits are, but the underlying technologies behind them are artificial intelligence and machine learning.

In terms of generating artificial intelligence, we are obviously working on it. I won't go into detail about what it is because, as you know, we don't really do that. But you can bet that we are investing, and we are investing quite a bit of money.

We will do it in a responsible way. Over time, you will see products with these technologies at their core continue to evolve.

Q: Is the shift to in-house chips economically advantageous for Apple? Or is it a strategic move where you just need to own it and it is crucial for the consumer experience of your products, or perhaps there is a path back to chip suppliers at some point?

A: It does allow us to build products that we couldn't build otherwise. As you know, we like to own the primary technologies behind the products we sell. And silicon is at the core of the primary technologies, you could say.

So no, I don't think we're going back. I'm happier today than I was yesterday, or last week, because we've completed the transition and I see the benefits of it every day.

Q: How do you view Apple's positioning and the opportunity to continue gaining market share, especially in China? From a demand perspective, how linear is China?

A: In the September quarter, we set an iPhone record - a revenue record in China - and we're very proud of that. We're clearly growing. The market forecasts I see would lead to a contraction in the market. We gained share last quarter, and we're very proud of that. I don't know what will happen every quarter, obviously, we just give some color on the current quarter. But in the long run, I think China is an extremely important market, and I'm very optimistic about it.

Q: Can you talk about how you view these relationships and the potential need for Apple to take some possible measures to mitigate some risks, considering some scrutiny on some of these search partners?

A: We won't get into our business relationships on the call. I think they're important, and the decisions we make are in the best interest of the users, or what we believe is in the best interest of the users. That's what we've done in the past, and that's how we operate going forward. Q: When you look to the future, have most major steps in terms of features and cost reduction (such as the transition to Mac chips) been completed? Or is there still more room for profit expansion?

A: In terms of products, as you know, when we introduce new products, their cost structure is often higher than the products they replace. This happens because we are always adding new technologies and features, and then we study the cost curve of the product over its lifecycle, and over time, we often gain benefits. The guidance we provided for December reflects all of this.

One of the things we have done well in the past few years is to provide more affordable solutions to our customers in the form of installment plans, trade-in options, and low-cost financing. The purpose of doing this is to lower the affordability threshold for our customers so that they can purchase our top-tier products. This is an important factor in our profit margin expansion.

You know, we don't provide guidance or color for the current quarter because there are many different variables that can affect gross margin. But obviously, we are very pleased with the trajectory of 2023 and the guidance we provided for the beginning of the 24 fiscal year. We need some of that because obviously, the foreign exchange environment has been challenging and a bit of a drag for us. But net-net, we are very pleased with where we are.

Q: When you look at the growth opportunities in India, how do you view these hardware segments? How do you view ASP compared to other regions? Is there a way to compare or contrast the growth momentum in India with that of China (about ten years ago), while the share growth in that region has also seen a similar situation?

A: We achieved a historic revenue record in India. We achieved very strong double-digit growth. It is an incredible market for us and a major focus for us.

Our share in a large market is very low.

So it looks like there is a lot of room there. Average selling prices, I haven't looked at recently, but I'm sure they are lower than the global average. But that doesn't bother us at all. In terms of similarities, I would say every country has its own journey, and I don't want to play the comparison game, but we see an extraordinary market, a lot of people entering the middle class, distribution is getting better, and there are a lot of positive aspects. As you know, we have opened 2 retail stores there. They are performing better than we expected. It's still early, but they have had a good start. I'm very pleased with the progress so far.

Q: I also wanted to ask about the supply chain situation. Where is your top priority - are you prioritizing diversification of the supply chain? How do you view Apple's global supply chain? Specifically, what are your thoughts on further investment in the United States?

A: Our supply chain is truly global, so we invest all over the world, including the United States. We are very focused on advanced manufacturing in the United States and have undertaken many different projects there, whether it's our joint venture with Corning in glass, Face ID modules, or semiconductors. Q: Can you provide some insights into the normalization of the supply chain this year, given the lockdown measures in China due to the COVID-19 pandemic? What are the advantages this year?

A: The additional week is a 7-point revenue boost. Last year, we did experience supply disruptions for our iPhones, particularly for the 14 Pro and Pro Max models in the December quarter. When we normalize for these two factors, as I mentioned on the call, we still expect growth for the iPhone.

So, when you consider the loss of that additional week and compare it to the supply disruptions that we hope will not recur this year, we still expect growth for the iPhone.

Q: Can you shed some light on the key components or driving factors behind the increase in innovation spending? Is it the Apple chips? Is it new products like Vision Pro or content supporting new services?

A: There are some things that I can't talk about, such as Vision Pro. That's artificial intelligence and machine learning. It's our chip investments that we're making and the transition for the Mac and other chips. That's all of those things. But I think you'll find that R&D spending overall looks very competitive compared to other spending.

Q: What other metrics do you think you can provide to help investors understand how Apple measures and enhances customer lifetime value, especially when we see many users entering the ecosystem with relatively lower-priced or refurbished devices? So, while you're building your ecosystem, how do you view increasing customer lifetime value in the long run?

A: Some of the metrics that I mentioned earlier are obviously the installed base of active devices that we focus on. We see - we want to make sure that we retain the customers that we get, so we have good visibility into that, and we're very focused on the behavior of the installed base, both by product and by geography. And then we look at the engagement within the ecosystem on a daily basis.

That's why we pay a lot of attention to things like transaction accounts, paid accounts, and so forth. We want to see if over time, we really can move customers from free to paid. That's obviously very, very important to us.

So, we track all of these things. That's - and what we do, because I think it's important, is over time, as we add new services, as we understand behavior in different markets and so forth. I think the progress that we've made in services has been remarkable over the last 12 months. We completed $85 billion, which is the scale of the Fortune 50, and much larger than a few years ago.

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