Apple Inc. (AAPL) F3Q 2013 Earnings Conference Call July 23, 2013 5:00 PM ET
Nancy Paxton - Senior Director, Investor Relations
Tim Cook - Chief Executive Officer
Peter Oppenheimer - SVP, Chief Financial Officer
Katy Huberty - Morgan Stanley
Bill Shope - Goldman Sachs
Antonio Sacconaghi - Sanford C. Bernstein
Ben Reitzes - Barclays Capital
Gene Munster - Piper Jaffray
Shannon Cross - Cross Research
Steve Milunovich - UBS Securities
Keith Bachman - Bank of Montreal
Tavis McCourt - Raymond James
Please standby, we are about to begin. Good day, everyone, and welcome to this Apple Incorporated Third Quarter Fiscal Year 2013 Earnings Release 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 Nancy Paxton, Senior Director of Investor Relations. Please go ahead, ma’am.
Thank you. Good afternoon, and thanks to everyone for joining us. Speaking first today is Apple’s CFO, Peter Oppenheimer and he will be joined by CEO, Tim Cook; and Treasurer, Gary Wipfler for the Q&A session with 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 revenues, gross margins, operating expenses, other income and expense, stock-based compensation expense, taxes, future products and capital allocation plans. Actual results or trends could differ materially from our forecast.
For more information, please refer to the risk factors discussed in Apple’s Form 10-K for 2012, the Form 10-Q for the second quarter of the 2013 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 now like to turn the call over to Peter Oppenheimer for introductory remarks.
Thank you, Nancy. We are pleased to report the results of our third fiscal quarter. We established a new June quarter record for iPhone sales driving Apple’s strongest June quarter revenue ever.
Revenue for the quarter was $35.3 billion, up $300 million or 1% from the year ago quarter, and at the high end of our guidance range. Gross margin was 36.9% also at the high end of our guidance range, and operating margin was $9.2 billion representing 26% of revenue. Net income was $6.9 billion translating to the diluted earnings per share of $7.47. Channel inventories declined sequentially by $1 billion during the June quarter this year meaning that sell-through was $36.3 billion. In contrast, channel inventory increased $700 million from the beginning to the end of the June quarter last year meaning that sell-through was $34.3 billion in that quarter. As such, our June quarter sell-through increased by $2 billion, or 6% year-over-year ahead of our 1% [selling and] [ph] revenue growth.
As for the details of the quarter, I’d like to begin with iPhone. We sold 31.2 million iPhones compared to 26 million in the year ago quarter, an increase of 5.2 million, or 20%. We had a sequential decrease of about 600,000 iPhones in channel inventory in the June quarter translating to iPhone sell-through of about 31.8 million units. iPhone sales were ahead of our expectations and we were particularly pleased with very strong year-over-year growth in iPhone sales in a number of both developed and emerging markets including the U.S., UK, Japan, Brazil, Russia, India, Thailand and Singapore. iPhone 5 remains by far the most popular iPhone but we were also happy with sales of iPhone 4 and 4s. We exited the quarter with about 11 million units of total iPhones in channel inventory and ended within our target range of 4 to 6 weeks of iPhone channel inventory.
iPhone unit sales in the U.S. increased 51% compared to the year ago quarter and based on research recently published by comScore, iPhone once again achieved the number one spot in the U.S. smartphone market for the three months period ended in May with over 39% share. iPhone sales were also very strong in Japan growing [66%] [ph] year-over-year. iPhone is the top selling smartphone in Japan based on the latest published quarterly data from IDC and Apple is the number one or number two selling smartphone manufacturer in most markets IDC tracks including North America, Western Europe, Russia, Turkey, Australia, Hong Kong, Thailand, Malaysia and Singapore.
The most recently published study by Kantar measured at 93% loyalty rate among iPhone owners significantly higher than our competitors. And iPhone continues to lead in terms of customer experience. Not only has iPhone earned the top spot in customer satisfaction from J.D. Power and Associates, an unprecedented nine consecutive times it has also received the top customer satisfaction ranking in a number of surveys including the recent Quality Insights survey of smartphone customers in South Korea. iPhone also continues to be the smartphone of choice for business. Given the security and stability of iOS, enterprise and government customers around the world continue to deploy iPhone on their network in ways that go far beyond personal productivity.
Companies have built tens of thousands of custom apps to improve every aspect of their business. Global companies including American Airlines, Cisco, General Electric, Roche and SAP have deployed more than 25,000 iPhones each across their organizations. U.S. government organizations such NASA’s Jet Propulsion Lab, the National Oceanic and Atmospheric Administration, the ATF and the National Geospatial-Intelligence Agency are supporting and managing thousands of iPhones on their networks and continue to create both customer facing and internal iOS apps.
And just this past quarter iOS 6 was granted FIPS 140-2 validation by the U.S. federal government and approval by the U.S. Department of Defense to connect to their networks. Combining sales to business, government and education customers, iPhone holds a 62.5% share of the U.S. commercial market based on the latest quarterly data published by IDC.
Turning to iPad we sold 14.6 million iPads during the quarter compared to 17 million in the year ago quarter. The tough year-over-year comparison was driven by both the significant channel inventory increase and the first full quarter of the availability of the third generation iPad in the year ago quarter. We built 1.2 million units of iPad channel inventory in the June quarter last year whereas we reduced channel inventory by 700,000 units in the June quarter this year.
Factoring in this 1.9 million unit channel inventory swing, iPad unit sell-through was down 3% year-over-year. We exited the quarter with about 4.1 million units of iPad channel inventory within our target range of 4 to 6 weeks.
Customers continue to love their iPads, for the second consecutive time in the two year history of a survey, iPad ranked number one in the 2013 U.S. tablet satisfaction survey by J.D. Power and Associates and again in its latest study published today [Chitika] [ph] reported that iPad accounted for 84.3% share of tablet web usage by customers in the U.S. and Canada, its highest level this year.
In every major industry around the world companies are developing, deploying and supporting apps for iPad. Government organizations as well as global enterprise companies across diverse fields including automotive, insurance, energy services and healthcare are using iPad and custom apps to create unique meaningful experiences for their employees, partners, and customers. The USDA’s National Agricultural Statistics Service has deployed thousands of iPads to in-person interviewers resulting in higher response rates and decreased cost. And companies including Eli Lilly, Novartis, Cathay Life, Roche, and SAP have deployed over 20,000 iPads each across their organizations.
Turning to Mac, we are pleased with sales of 3.8 million Macs, which is a 7% decline from the year ago quarter, but higher than our expectations. IDC estimates that the global personal computer market contracted by 11% during the June quarter, indicating that Macs gained share. In June, we introduced two new versions of MacBook Air and customer response has been great. Wired magazine described the new 13-inch MacBook Air as nearly flawless citing its phenomenal battery life, processing performance, feather-light chassis, and super-fast WiFi. Additionally, last month, we provided a sneak-peek at our next generation Mac Pro engineered around the workstation graphics with dual GPUs, PCI Express-based flash storage, high-performance Thunderbolt 2, next generation Xeon processors, ultra-fast memory and support for 4-K video. The new state-of-the-art Mac Pro will be assembled in the U.S. and will be available later this year.
We were excited to release to developer preview of OS X Mavericks last month. More than 200 new features, OS - with more than 200 new features, OS X Mavericks brings Maps and iBooks to the Mac, introduces Finder Tags and Tabs, enhances multi-display support for power users, delivers new core technologies for breakthrough power efficiency and performance, and includes an all-new version of Safari. OS X Mavericks will be available to customers in the fall. We ended the quarter with just below our 4 to 5 week target range of Mac channel inventory.
Our U.S. education institution business had a great quarter generating its highest quarterly revenue ever. The results were fueled by all-time record quarterly iPad sales of 1.1 million units in addition to strong June quarter Mac sales. The state of Maine’s Learning Technology Initiative, which provides the state’s little school and high school students and teachers with personal computing solutions allowed individual school districts to choose which products to purchase rather than standardized on a single statewide solution. We are very proud that an estimated 94% of the 69,000 total units selected this year were Apple products. And we are extremely pleased to have received the Los Angeles School Board of Education’s unanimous approval to begin the first phase of a massive rollout of iPads to students across the district starting this fall. The district is the second largest in the United States and plans to equip every one of its 660,000 students with a tablet by 2014.
We continue to be very pleased with the growth and the strength of the Apple ecosystem. With the broadest geographic reach and depth of content in the industry, our iTunes Stores generated record billings of $4.3 billion in the June quarter culminating in our best months and best week ever for App Store billings at the very end of the quarter. The quarter’s iTunes billings translated to quarterly revenue of $2.4 billion, up 29% from the year ago quarter with strong growth in revenue in both content and apps. The continued strong iTunes sales combined with other software and service revenue resulted in total quarterly revenue of $4 billion from iTunes software and services. We added some great new video content to iTunes and Apple TV.
Last month we announced HBO GO and WatchESPN are now available directly on Apple TV joining programming from Hulu Plus, Netflix’s streaming catalog, live sports from MLB, NBA and NHL as well as Internet content from Vimeo, YouTube and Flickr. Sky News, Crunchyroll and Qello are offering live news, sports and current TV programming. Apple TV users can now choose from a broad selection of programming including over 60,000 movies and over 230,000 TV episodes as well as the world’s largest collection of music on the iTunes Store.
iTunes users have downloaded more than 1 billion TV episodes and 390 million movies from iTunes to-date, and they are purchasing over 800,000 TV episodes and over 350,000 movies per day. We recently celebrated the five year anniversary of our amazing app store. Our developers have now created more than 900,000 iOS apps including 375,000 apps made for iPad. The popularity of these apps remains incredibly strong.
Cumulative app downloads have surpassed 50 billion and app developers have made over $11 billion for their sales through the App Store half of which was earned in the last four quarters. Our vibrant ecosystem continues to drive tremendous user engagement with our devices and services and we now have over 320 million iPod accounts and 240 million Game Center accounts and our customers have sent almost 900 billion iMessages, uploaded over a 125 billion photos and received over 8 trillion push notifications. And thanks to the stability and security and popularity of the iOS platform, the iOS devices continue to have a strong lead over Android in the enterprise.
In its most recently published quarterly enterprise device activations report, the technology is found that among its corporate clients iPhone 5 was by far the most frequently updated device of any kind and iPad’s represent 88% of all tablet activations. We’re continuing to invest in software and services to make the ecosystem and user experience even richer. This fall we will release a beta version of iWork for iCloud bringing pages, numbers and keynotes to the web. With iWork for iCloud users will be able to create great looking letters, reports and flyers, generate complex yet beautiful spreadsheets and develop and deliver beautiful presentations with powerful graphics and special effects all from within a web browser.
And we’re extremely excited about the fall launch of iOS 7 with its stunning new user interface and many great new features including control center, AirDrop and iTunes Radio, smarter multi-tasking and enhancements to notification center, photos, Safari and Siri.
I would now like to turn to the Apple retail stores, revenue for the quarter was 4.1 billion approximately equal to the year ago quarter. The stores experienced strong growth in iPhone sales and have been most successful MacBook Air launch to-date.
We opened six new stores across five countries during the quarter and end of the quarter with a total of 408 stores including a 156 outside of United States. We expect over nine new stores in the September quarter getting us to a total of 27 new store openings in fiscal 13. We also relocated four stores in the June quarter that had outgrown their former space and we expect to complete and total of 23 such relocations in fiscal ’13. With an average of 405 stores opened in the June average revenue per store was 10.1 million compared to 11.1 million in the year ago quarter.
Retail segment income was 667 million; we hosted 84 million visitors to our stores during the quarter this translates to 16,000 visitors per store per week. Operating expenses were 3.8 billion and included 488 million in stock based compensation expense. OI&E was 234 million and the tax rate for the quarter was 26.9%. And turning to our cash we ended the quarter with a 146.6 billion in cash plus short term and long term marketable securities compared to a 144.7 billion at the end of the March quarter, a sequential increase of 1.9 billion. A 106 billion of our total cash was offshored at the end of the June quarter and cash flow from operations with 7.8 billion. In early April we concluded the 1.95 billion accelerated share repurchase program that we initiated in December quarter resulted in cumulative retirement of over 4 million shares of Apple stock under that program.
In late April we executed a very successful debt offering issuing 17 billion of debt across 3, 5, 10 and 30 year maturities. We paid 2.8 billion in dividends in the quarter and we also utilized a total of 16 billion in cash on share repurchase activity through a combination of a new accelerated share repurchase program and open market purchases. 12 billion of the 16 billion was utilized under a new ASR program initiated with two financial institutions in April.
An initial delivery of 23.5 million shares was made under this program with the final number of shares delivered in average price per share to be determined at the conclusion of the program, based on the volume weighted average purchase price of Apple’s stock over the program period, which will conclude in fiscal ‘14. In addition to the new ASR, we executed 4 billion of open market share repurchases, resulting in the retirement of 9 million additional shares. Our Board of Directors has declared a dividend of $3.05 per common share payable on August 15, 2013, the shareholders of record as of the close of business on August 12, 2013.
Now, as we move ahead into the March quarter, I would like to review our outlook, which includes the types of forward-looking information that Nancy referred to at the beginning of the call. We expect revenue to be between $34 billion and $37 billion compared to $36 billion in the year ago quarter. We expect gross margin to be between 36% and 37% reflecting approximately $90 billion related to stock-based compensation expense. We expect OpEx to be between $3.9 billion and $3.95 billion, including about $495 million related to stock-based compensation. We expect OI&E to be about $200 million and we expect the tax rate to be about 26.5%.
In closing, we are pleased with our record June quarter iPhone sales, the strong growth in revenue from iTunes software and services, and the continued enhancement and popularity of our tremendously vibrant ecosystem. We are very excited about the upcoming releases of the stunning new iOS 7 in OS X Mavericks, and we are very hard at work on some amazing new products that we will introduce in the fall in across 2014.
And with that, I’d like to open the call to questions.
Thank you, Peter. And we ask that you limit yourself to one question and one follow-up. Operator, may we have the first question please?
Earnings Call Part 2: