Apple: ChatGPT will be integrated by the end of the year (FY24Q3 conference call minutes)

Apple (AAPL.O) Beijing time August 2, 2024, early morning, released the 2024 third quarter financial report after the US stock market (as of June 2024).

The following is the summary of Apple's 2024 third quarter financial report conference call. For the interpretation of the financial report, please refer to " Apple: The Pillar of the US Stock Market Holds Firm "

I. $Apple(AAPL.US) Financial Report Highlights:

II. Detailed Content of Apple's Financial Report Conference Call

2.1. Key Points from Executive Statements:

1) Operational Highlights:

① Important Releases and Innovations:

• Apple Intelligence: Launched at the global developer conference, based on years of AI and machine learning innovation, transforming the way users interact with technology, emphasizing privacy and security.
• Integration of ChatGPT: Integrated ChatGPT into the experience of iPhone, Mac, and iPad, expanding users' knowledge base.
• Apple Vision Pro: Launched in more countries, allowing users to customize workspaces, watch movies, and explore the world through Vision Pro.

② Product and Service Performance:

• iPhone: Introduced the iPhone 15 series and teased the iOS 18 update, including a redesign of the Photos app and new personalization options.
• Mac: The MacBook Air with M3 chip has been popular among students and creatives, and Macs with Apple Silicon have become the best personal computers for AI.
• iPad: Introduced the all-new iPad Air and iPad Pro, video editors and musicians can utilize AI features in Final Cut Pro and Logic Pro.
• Wearables, Home, and Accessories: Revenue slightly declined, Apple Watch offers AI features such as irregular heart rhythm notifications, walking stability, crash detection, and fall detection.
• Services business set a revenue record of $24.2 billion, with a record high number of paid subscriptions
• Apple TV+: Launched multiple new series and movies, receiving numerous award nominations and wins.
• Introduced new features, including hiking in U.S. national parks on Apple Maps and a new experience on Apple Fitness+.

③ Retail:

• Opened the first store in Malaysia, continuing expansion in emerging markets.
• Apple Vision Pro Demo: Global teams shared the magic of Apple Vision Pro through demonstrations to attract customers.

2) Financial Highlights:

① 2024Q4 Guidance:

• Foreign Exchange Impact: Expected to continue to have an adverse effect, with a negative impact of approximately 1.5 percentage points year-on-year.
• Revenue Growth: Expected total revenue growth in September quarter to be similar to June quarter. Services revenue expected to grow at a double-digit rate, similar to the previous three quarters of this fiscal year.
• Gross Margin: Expected to be between 45.5% and 46.5%.
• Operating Expenses: Expected to be between $14.2 billion and $14.4 billion.
• Other Income and Expenses (OI&E): Expected to be approximately -$50 million, excluding the potential impact of fair value adjustments of minority equity investments.
• Tax Rate: Expected to be approximately 16.5%.

② Equity Related:

• Returned over $32 billion during the quarter, including $3.9 billion in dividends and equivalents, repurchased 139 million Apple shares on the open market, totaling $26 billion.
• Announced a cash dividend of $0.25 per common share, payable on August 15, 2024.

2.2, Analyst Q&A

Q: Can you share your views on the current iPhone replacement cycle and how many old iPhone users you think may upgrade? How much potential demand could this bring in the new iPhone release cycle?

A: This quarter, our user install base reached a new high, which we are pleased about. iPhone achieved growth at constant rates, especially with iPhone 15 performing better than iPhone 14 during the same period after release. As for the upgrade rate, it is currently difficult to estimate accurately, but Apple's smart technology will bring high value to users, which could be a strong reason for users to upgrade.

Q: Could you further discuss the dynamics of the Chinese market? Despite a 6% year-on-year decline in sales this quarter, it only decreased by 3% at constant currency, which is still an improvement after the price reduction of iPhones in the previous quarter. Please share your overall view of the Chinese market, evaluate the impact of promotional activities on sales this quarter, and the sustainability of this improvement. Additionally, has this market performance affected any adjustments to your future China market strategy?

A: Overall sales in Greater China declined by 6.5% year-on-year, but at constant currency, the decline was less than 3%, indicating that over half of the decline is related to currency fluctuations. This is an improvement compared to the first half of the fiscal year, and we are satisfied with this accelerating trend. Particularly in Greater China, iPhone's install base and the number of upgrade users in mainland China reached new highs, with Kantar's survey showing iPhone ranking in the top three mobile models in urban areas in ChinaIn addition, the performance of the 15 series has exceeded that of the 14 series since its release.

We also focus on the purchasing behavior of new customers towards our products. In mainland China, the majority of buyers of Mac, iPad, and the vast majority of buyers of Watch are first-time buyers. iPad has resumed growth in Greater China and globally. We remain confident in the long-term opportunities in the Chinese market. Although we cannot predict every step of the development, we maintain an optimistic outlook on the long-term prospects.

Q: After the introduction or announcement of Apple's smart technology, what is your view on its potential impact on the service business? Do you think this technology will drive the development of the service business or provide additional value? Will users potentially need to purchase more storage space and other products as a result? How do you see this technology as a catalyst for driving service business growth in the next year?

A: We introduced the initial version of Apple's smart technology to developers this week, with some features available since Monday. This will undoubtedly help developers take their apps to the next level. Currently, we are taking a crucial first step by releasing the beta version and eagerly look forward to seeing developers leverage this technology to create amazing results.

Q: Regarding gross margin, facing rising component prices and changes in product mix, could you share how you have been managing these factors consistently? Also, what are your views on the impact of the current component market on profit margins?

A: The company's overall gross margin is 46.3%, a decrease of 0.3 percentage points from the previous quarter, mainly due to changes in the product mix. This quarter, we launched important products such as the iPad, but the growth of the service business and cost savings offset this impact. Despite the pressure from foreign exchange, our profit margin has significantly improved compared to the same period last year.

For the September quarter, we expect the gross margin to be between 45.5% and 46.5%, in line with the guidance from the previous quarter. We anticipate slight changes in the product mix, with the minimization of the impact from foreign exchange from a quarter-over-quarter perspective, but a significant impact from a year-over-year perspective. In terms of commodity prices, memory prices have risen, but prices of other commodities continue to decline. Overall, we believe we are in a favorable position. It is well known that such a gross margin is very high for us.

Q: Has there been any change in demand for the iPhone 15 Pro and Pro Max since WWDC, which may indicate consumer demand for Apple smartphones?

A: We just announced system and silicon-level requirements in June, so our time is very limited this quarter. Therefore, it is too early to discuss this issue now.

Q: Can you talk about the upgrade potential in the coming years, expectations for the U.S. promotional environment, especially considering the importance of device sales during the upgrade cycle to channel partners such as wireless carriers, and the retail support that may be provided during peak smartphone upgrade periods?

A: We are excited about Apple's smart technology, which is a strong driver for upgrades. As for promotional strategies, they should be decided by the carriers. I expect this to be a very important upgrade moment

Q: Regarding the dynamics of Apple AI, consumers are clearly excited about the potential benefits it may bring. Do you think all Apple intelligent functions will be launched simultaneously, or will they be phased out? If phased out, will this affect consumers' decisions to purchase the new generation of iPhone?

A: As we mentioned in June, this week we have started rolling out some Apple AI features to developers, not all at once. Within this year, we will continue to release other features, including language support beyond American English, and some other functionalities. ChatGPT will also be integrated by the end of the year. So, indeed, it will be phased out.

Q: Your service business has shown very strong growth for several consecutive quarters, and it seems to have accelerated recently. Can you explain how much of this double-digit growth is due to the increase in the installed base, improved ARPU, or better user monetization? How do you view the future trend of this growth combination?

A: The growth of our service business is driven by multiple factors. Firstly, the growth of the installed base is crucial as we have more customers using our ecosystem and services. We observe a continuous increase in customer engagement with our ecosystem, with the number of active accounts increasing every quarter, and both free and paid services usage on the rise. The growth of paid accounts and platform subscriptions is double-digit, a trend that has been ongoing for several quarters.

Additionally, we have introduced many new services in recent years such as Apple Pay, Apple TV+, Apple Arcade, and Fitness+, providing customers with more opportunities to interact with our ecosystem. We are also continuously enhancing the quality of services and the richness of content, such as ongoing investments in TV+ and Apple Arcade, launching new shows and games.

Although the comparison base is higher compared to the same period last year, making growth more challenging, this quarter we achieved a 14% growth, exceeding our initial expectations for the quarter.

Q: You announced Apple Intelligence and established a partnership with OpenAI, with potentially more to come in the future. How should investors understand the profit models of these collaborations? Partners are clearly making capital investments while leveraging our platform to reach our large user base. In the long term, do you think the growth of Apple Intelligence services or these partner relationships will ultimately become a greater growth driver?

A: My view on Apple Intelligence is that it involves on-device processing and private cloud computing, which are often closely related to personal contexts. As for World Knowledge, we are initially planning to integrate with ChatGPT, focusing on providing world knowledge. Regarding the monetization model, I cannot disclose the details of the commercial agreements as they are confidential. However, I believe both aspects are crucial, as people need both intelligent processing on devices and access to world knowledge.

Q: Looking back at 2023, our product gross margin increased by an average of 150 basis points per year. Since 2024, the gross margin has remained relatively flat year-on-year. Apart from ongoing foreign exchange headwinds, are there any other temporary or structural headwinds that may limit further growth in our strong gross margin?**

A: The fluctuation of foreign exchange rates is beyond our control. Although we try to hedge, it does affect our gross margin, especially when the US dollar is strong. The product mix also affects the gross margin because different products have different gross profit profiles. Changes in market acceptance can lead to fluctuations in gross margin. For example, the recent launch of the iPad may impact the product mix.

We always prioritize gross profit in US dollars, and the gross margin is usually adjusted accordingly. The conditions of commodity markets also have a significant impact as they are cyclical, and we will observe how this evolves over time.

Q: Regarding the increase in silicon content in AI edge devices and the rising commodity costs you mentioned, how should we consider the gross margin of these new AI devices?

A: In terms of gross margin, we usually only provide guidance for the current quarter. The guidance for this quarter is 45.5% to 46.5%, which is consistent with our report for the June quarter. We will evaluate on a quarterly basis and update the report as needed.

Q: Do these advanced features of Apple require more hardware upgrades than currently?

A: Running Apple's intelligence involves requirements for systems and chips. The iPhone 15 Pro and Pro Max can run Apple's intelligence, and future products will also support it. For Mac and iPad, the M-series chips introduced in 2020 already meet these requirements. So, each device has its specific system and chip requirements.

Q: We have noticed that many other consumer discretionary and luxury brands have also mentioned the sluggishness of the Chinese market. You mentioned that half of the decline is related to foreign exchange. I want to know if the other half of the decline is more related to the macroeconomic situation in China, or do you think it may be a specific situation for Apple, related to domestic competition?

A: Certainly, the competition in the Chinese market is very fierce, as I mentioned earlier and remains so. The macroeconomic situation in China has been reported in the media, and although I am not an expert in this area, I can say that we see the market improving.

Q: Regarding Apple's intelligence, although it is still early, you mentioned that developers are just starting to experience it. What kind of innovations do you think developers can make with this technology in the existing categories of apps in the App Store? Is it an upgraded version of existing apps, or is it more suitable for certain types of apps, such as games or creative apps? How do you view this possibility?

A: We have considered the deployment of Apple's intelligence in all the apps you use daily, from notes, emails to messages, etc. We have thought deeply about how it can naturally integrate into these apps, excite users, and increase usage. Developers will also extensively do this in their apps. We are excited about the initial version launched this week and look forward to seeing developers' creativity.

Q: You did not list all product categories in your speech. From what you said, I understand that for the next quarter, the performance of the service business is good, the impact of foreign exchange is easing, and you seem to be saying that product revenue is expected to be flat compared to the same period last year before the release of new products. I want to know in this expectation, what are the positive and negative factors, especially how Apple's intelligence may play a role in stimulating demand.

A: We expect the company's total revenue to achieve similar growth as reported before, roughly a 5% increase, although we anticipate facing headwinds from foreign exchange, impacting around 150 basis points. The growth in services business will also remain in double digits, comparable to the growth rate in the first three quarters of this year.

We haven't detailed other categories, but based on the information we provided, you can make some calculations. It should be noted that Mac introduced new products last year, especially the 15-inch MacBook Air, which will affect this year's base for comparison. Similarly, iPad saw a 24% growth in the June quarter, benefiting from the launch of iPad Air and iPad Pro. These factors are crucial when considering sequential growth.

Q: Can we expect most of the features announced at WWDC to appear in iOS 18? Or are some features likely to be delayed until next year's iOS 19?

A: Our goal is to release the Apple Smart in American English in the fall as planned, and gradually increase support for more features and language regions over the next year. We are progressing according to this timeline.

Q: With strong growth in the services business, will the changes in compliance with DMA rules affect us?

A: We made adjustments to the European App Store in March, and developers have responded positively to these changes. We are in discussions with the European Commission to ensure full compliance with DMA rules, although it is still in the early stages. Currently, both the services business and the App Store are performing well. For reference, the App Store's revenue in the EU accounts for approximately 7% of our total revenue.

Q: You mentioned that Apple Smart also faces regulatory issues in specific regions. You talked about the phased rollout and timeline in your plans, how do you consider the complexity of the regulatory process, especially in the EU and China? Have you already included regulatory factors in your promotion schedule? How should we consider the timing including regulatory factors?

A: We are actively communicating with the mentioned regulatory bodies. Our goal is to progress quickly because we always want to introduce new features to users as soon as possible. Before we can make commitments and set timelines, we need to first understand the regulatory requirements. Our interaction with these agencies is very proactive.

Q: You mentioned an acceleration in revenue sequential growth. Can you break down which product categories are driving this growth? Because in the previous quarters, these categories lagged in revenue. What factors are starting to drive their sequential growth?

A: When we look at wearable devices, home, and accessories categories, we must remember the significant pressure from new product releases. Our product line from last year, including the second-generation AirPods Pro, Watch SE, and the first Watch Ultra, has provided us with a sustained advantage. Nevertheless, from a macro perspective, over the past 12 months, this part of the business has actually grown to nearly $40 billion, double what it was five years ago.

Q: You mentioned that our R&D investment has already hit a new high in the June quarter before the launch of Apple Smart. Will the introduction of these new features lead to further increases in R&D or operating expenses (OpEx) and capital expenditures (CapEx), especially in cloud computing capabilities?At the same time, given that these services are new to consumers, can we predict the usage of the services?

A: Our research and development expenses have been increasing. Over the years, we have been investing in artificial intelligence and machine learning, reallocating certain technical resources to focus on these areas. The growth in these investments is reflected in our annual figures.

As for capital expenditures, we have adopted a mixed strategy, involving both internal projects and collaborations with external partners, with the latter's capital expenditures reflected in their businesses. It can be expected that we will continue to increase our annual investments in this area.

Q: The free cash flow profit margin in the first 9 months has significantly improved. Considering the product mix for this year, can you explain which changes in the service mix or cost control measures have led to the structural growth of the overall business's free cash flow profit margin?

A: It's great that you've noticed the significant improvement in our free cash flow profit margin. This includes the increased capital return to shareholders this quarter, setting a new record. This is due to several factors: firstly, revenue growth, which has driven the expansion of our gross margin over the past few years, thereby improving operating cash flow. Secondly, regarding capital expenditures, we have adopted a mixed model, with some investments reflected on our balance sheet, while other investments are made in the form of payments for usage. We are committed to efficient operations and value capital efficiency.

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