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Apple: 1 Billion Paid Subscriptions
As iPhone sales moderate, Services surge and China bounces back
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It’s already been a few weeks since Apple (AAPL) reported its Q3 FY23 earnings (Apple ends its fiscal year in September).
We’ve got the key details on the world’s biggest company. The Apple-as-a-Service story continues to play out as subscriptions hit a new milestone.
Today at a glance:
Apple’s Q3 FY23.
Recent business highlights.
Key quotes from the earnings call.
What to watch looking forward.
Last week, we discussed the portfolio moves of big money managers in Q2 2023. That included the stock portfolio at Berkshire Hathaway, managed by Warren Buffett. Apple, the stock du jour, made 51% of Uncle Warren’s portfolio at the end of June, by far the largest position in the portfolio.
What type of investor are you?
Some like predictable businesses, like Warren Buffett.
Others chase the next big thing, like Cathie Wood.
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What combination are you? We’ll help you find out!
1. Apple Q3 FY23
Here is the bird’s-eye view of the income statement.
Revenue declined by 1% Y/Y to $82 billion (in line with expectations).
Products (74% of overall revenue) fell -4% Y/Y to $61 billion.
📱 iPhone (48% of total revenue) declined -2% Y/Y to $40 billion.
💻 Mac (8% of total) declined -7% Y/Y to $7 billion.
🖊 iPad (7% of total) dropped -20% Y/Y to $6 billion.
⌚️ Wearables (10% of total) grew +2% Y/Y to $8 billion.
Services (26% of overall revenue) grew +8% Y/Y to $21 billion.
It includes the App Store, Apple Music, Apple Pay, AppleCare, Apple TV+, Apple Arcade, Apple Fitness+, iCloud+, and more. They also include that juicy annual payment from Google to remain the default search engine on Apple devices.
While hardware revenue follows the ebb and flow of new product releases, the Services segment has been growing consistently in the past few years. The charts below show the steady rise of Services, reaching a record 26% of revenue.
Gross margin was 45% (+1pp Y/Y).
Operating margin was 28% (+0pp Y/Y).
EPS (earnings per share) grew +5% to $1.26 (a $0.07 beat).
Operating cash flow was $26 billion (32% margin, +4pp Y/Y).
Cash, cash equivalent, and marketable securities: $167 billion.
Total debt: $109 billion.
Q4 FY23 Guidance (September quarter):
CFO Luca Maestri provided the following directional insights:
Apple expects its year-over-year revenue growth for Q4 FY23 to match Q3 FY23's decline of 1%. This indicates a small slowdown. Why? The company predicts a currency-related headwind of 2 percentage points in Q4. This is half of the 4 percentage point headwind they factored in for Q3. In constant currency terms, this would mean a 2 percentage point slowdown.
Management expects iPhone and Services to accelerate, partially boosted by the less unfavorable foreign exchange rates.
Mac and iPad are expected to decline double digits year-over-year because of tough comparisons. Why? Last year saw a surge in demand after a factory shutdown. Plus, there are broader economic challenges.
So what to make of all this?
The strong dollar adversely impacted the recent performance. A 4 percentage point hit from currency exchange meant revenue effectively grew by 3% when you factor that out. This matches Apple's own predictions.
Apple saw growth in active devices. The installed base of active iPhones reached an all-time high thanks to a June quarter record for switchers.
iPhone revenue grew Y/Y on a constant currency basis, albeit slightly. Management highlighted record sales in India and other emerging markets.
The 20% drop in iPad sales? Largely because the iPad Air came out this time last year.
Wearable, home, and accessories met expectations, with a 6% growth in constant currency, driven by Apple Watch and Watch Ultra. Notably, two out of every three Apple Watch buyers were first-time buyers.
Services reached a new all-time revenue record of $21.2 billion, growing +8% Y/Y, an acceleration (and up double-digit in constant currency).
Services accounted for 41% of Apple’s gross profit (+2pp Y/Y). If you are a regular reader of this newsletter, you know the story by now. Services, which are digital products, have a higher gross margin profile than hardware products. As a result, they make a larger share of gross profit. The Apple-as-a-Service thesis continues to play out. Services are slowly making a larger share of the revenue, resulting in a gradual improvement in the margin profile of the business. Analysts predict that, in the future, Apple's profit growth will outpace its revenue growth. To put the $21.2 billion in services revenue into perspective—it was more than the combined revenues of Netflix, Mastercard, Spotify, Activision Blizzard, and Peloton. We could even throw in Dropbox, but you get the point.
Is the business sustainable?
Analysts expect operating cash flow to increase steadily in the coming years (in the high single-digit). Apple generated $113 billion in cash from its operations in the past 12 months and $26 billion in the June quarter alone.
The company is returning most of its cash to shareholders. To illustrate, Apple continues to use the majority of its cash generated from operations toward stock buyback ($18 billion) and, to a lesser extent, toward dividends ($4 billion). As a result, the EPS (+5% Y/Y) grew faster than the net income (+2% Y/Y).
2. Recent business highlights
💳 Apple Savings
In a partnership with Goldman Sachs, Apple's high-yield Apple Card Savings account has gathered $10 billion in deposits since its debut in April, boasting an impressive 4.15% APY. When you think that this occurred in just a few months, it speaks to the power of Apple’s ecosystem. By way of comparison, SoFi, a fintech veteran of 12 years, reported $12.7 billion in deposits for the same quarter.
We discussed SoFi and other Fintech innovators earlier this week.
A staggering 97% of account holders are rerouting their Daily Cash rewards into this savings platform. This Apple Card offers cash back perks of 1% across all purchases, 2% via Apple Pay, and 3% with specific merchants. It's devoid of fees, mandatory minimum deposits, or balance prerequisites. Plus, users can conveniently manage everything via the Wallet app, which provides a comprehensive view of savings and accrued interest.
📱 Peak smartphone?
There's chatter among industry analysts about whether we've reached the zenith of the smartphone era. Market intelligence from the likes of Gartner or IDC paints a consistent picture: smartphone sales to consumers were at their pinnacle between 2017 and 2019. Since then, there's been a consistent downturn, despite a brief rebound post-pandemic.
For Apple to grow its iPhone segment in a receding market, the focus pivots to converting brand switchers and increasing the ASP (average selling price). Emerging markets, India in particular, could also boost the numbers.
With users postponing smartphone upgrades, Apple may look more towards integrating multiple products and expanding services to sustain its growth curve.
🇨🇳 Apple and China
A standout in the report was Apple's June-quarter record for Greater China, witnessing a year-over-year jump from -3% to +8%. This equates to a double-digit growth in consistent currency.
Tim Cook explained:
“Switchers were a very key part of our iPhone results for the quarter.[…] We set a record in Greater China, in particular, and it was at the heart of our results there.”
Data from Counterpoint Research reveals a 4% dip in China's overall smartphone sales year-over-year, marking the lowest Q2 sales since 2014. Yet Apple is evidently expanding its market presence in this waning environment, claiming 17% of smartphone sales and closely tailing market leader, Vivo.
Additionally, management emphasized the record Wearables sales during the June quarter, underscoring the brand's deep-rooted engagement in a pivotal market. Multi-product adoption should lead to higher Services revenue.
3. Key quotes from the earnings call
In February 2023, Apple disclosed a 2 billion active devices install base, good for a 150 million increase or +8% Y/Y. While we didn’t get an exact number since then, stellar retention and brand switchers fuel this growth.
CFO Lucas Maestri stated:
“Our installed base reached an all-time high across all geographic segments, driven by a June quarter record for iPhone switchers and high new-to rates in Mac, iPad and Watch, coupled with very high levels of customer satisfaction and loyalty.”
A 98% customer satisfaction rate for the iPhone 14 in the US, according to 451 Research, underscores Apple's unwavering brand loyalty. Despite the noise around Apple’s lack of hardware innovation, more people have switched to Apple products and are very happy with their decision.
In reference to Mac, the CFO pointed out:
“Almost half of Mac buyers during the quarter were new to the product.”
As iPhone switchers hit a new high for the June quarter, it’s interesting to see the success bleed into other categories. It’s no secret that the iPhone's success brings customers to the entire Apple ecosystem, from Mac to iPad to Apple Watch.
Lucas Maestri noted:
“We set June quarter records in both Europe and Greater China and continue to see strong performance across our emerging markets driven by iPhone.”
CEO Tim Cook expanded on India:
“We did exceptionally well in emerging markets last quarter and even better on a constant currency basis. […] We did hit a June quarter revenue record in India, and we grew strong double digits. We also opened our first 2 retail stores during the quarter. […] It's the second largest smartphone market in the world […] so we ought to be doing really well there. And where I'm really pleased with our growth there, […] we still have a very, very modest and low share in the smartphone market. And so I think that it's a huge opportunity for us.”
Cook celebrated their record:
“We set an all-time revenue record in Services driven by more than $1 billion paid subscriptions.”
This was good for an 18% growth year-over-year and 3% sequentially (faster than the overall Services revenue). Unfortunately, there is no breakdown of these paid subscriptions.
Tim Cook highlighted the new record:
“We set an all-time revenue record for total services and in a number of categories, including video, AppleCare, cloud and payment services.“
On Apple TV+:
“In the few years since its launch, Apple TV+ has earned more than 1,500 nominations and 370 wins. That includes the 54 Emmy Award nominations across 13 titles that Apple TV+ received last month.”
Highlighting their MLS partnership, Cook added:
“Soccer legend Lionel Messi made his debut with Major League Soccer last month, and fans all over the world tuned in with MLS Season Pass. We are excited about our MLS partnership, and we're thrilled to see Messi suiting up with Inter Miami.”
On Apple Music, Cook hinted at new features that could streamline access to live music. The ticketing industry is ripe for disruption, so it will be interesting to watch:
“Apple Music launched new discovery features celebrating live music, including venue guides in Apple Maps and set lists from tours of major artists. These new features and others join a lineup of updates coming later this year to make Services more powerful, more useful and more fun than ever.”
Multi-product adoption remains a potential tailwind for Services:
“Customers that own more than one device are typically more engaged in our ecosystem. And so obviously, they tend to also spend more on the Services front.”
Lastly, management highlighted a June quarter record for advertising, though the specifics remain under wraps. This category is likely to gain prominence moving forward.
4. What to watch looking forward
🤖 AI and Services
Compared to its Big Tech peers, Apple has been somewhat reserved in its AI communication. However, this silence shouldn't be mistaken for inactivity.
Tim Cook explained:
“We view AI and machine learning as core fundamental technologies that are integral to virtually every product that we build. [..] We've been doing research across a wide range of AI technologies, including generative AI for years. […] As you know, we tend to announce things as they come to market, and that's our MO, and I'd like to stick to that.”
This last point is critical. Unlike Google, which previewed its Bard and the Search Generative Experience (SGE) ahead of their release, Apple remains tight-lipped, opting to surprise the market.
Apple is reportedly developing its own AI chatbot, similar to OpenAI's ChatGPT and Google's Bard, according to Bloomberg. Codenamed "Ajax," Apple is purportedly trialing an internal tool dubbed "Apple GPT." Despite trailing in the AI race, Apple has its eyes set on a significant AI reveal next year.
Apple Vision Pro
Apple has slashed its 2024 production target for the Apple Vision Pro headset from one million units to 400,000 due to complex manufacturing challenges, according to the Financial Times. The intricate EyeSight feature and low yields from the 4K micro-OLED displays are major contributors to the setback. This has also delayed plans for a second-generation model. Apple's manufacturing partner, Luxshare, experienced a stock drop following the news. The Vision Pro's initial launch is set for the US early next year.
As explained in previous articles, the iPhone's monumental success wasn't achieved overnight; multiple iterations paved its ascent to prominence. It will likely take years (and obviously a lower price point) for Apple Vision to reach mass appeal.
As always with Apple, there is more to the story than initially meets the eye, with the headlines too often focused on iPhone revenue. From its record-breaking growth in Services to its rebound in China to its potential foray into AI, the tech giant remains a compelling story of resilience and evolution.
That’s it for today!
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Author's Note (Bertrand here 👋🏼): The views and opinions expressed in this newsletter are solely my own and should not be considered financial advice or any other organization's views.