Apple Inc. (AAPL) F2Q 2014 Earnings Conference Call April 23, 2014 5:00 PM ET
Nancy Paxton –Senior Director-Investor Relations
Timothy D. Cook – Chief Executive Officer
Luca Maestri – Vice President of Finance and Corporate Controller
Katy Huberty – Morgan Stanley & Co. LLC
Bill C. Shope – Goldman Sachs & Co.
Toni Sacconaghi – Sanford Bernstein
Steven M. Milunovich – UBS Securities LLC
Shannon S. Cross – Cross Research LLC
Gene Munster – Piper Jaffray
Good day, everyone, and welcome to the Apple Incorporated Second Quarter Fiscal Year 2014 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 today. Speaking first today are Apple CEO, Tim Cook, and Vice President and Corporate Controller, Luca Maestri, and they will be joined by CFO, Peter Oppenheimer for the Q&A session with the analysts.
Please note that some of the information you’ll hear during our discussion today will consists of forward-looking statements, including without limitation, those regarding revenue, 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 2013, the Form 10-Q for the first quarter of fiscal 2014, 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 Tim for introductory remarks.
Timothy D. Cook
Thanks, Nancy. Good afternoon, everyone. We have a lot to share with you over the next hour, and I’d like to start right away with the very strong results we’re reporting for the March quarter.
We generated $45.6 billion in revenue, which was ahead of our expectations and represents a new March quarter record, and is our strongest non-holiday quarter ever. Our underlying business performance was even stronger than our reported results imply. When you take into account changes in channel inventory this year versus last year and foreign exchange had wins that we faced in several of our international markets. Setting foreign exchange and inventory changes aside, our underlying growth rate would have been close to double digits.
These strong revenue results combined with our best gross margin percentage since September of 2012 resulted in earnings per share growth of 15%, which is our highest earnings growth rate in the last six quarters. iPhone was key in driving our stronger-than-expected results. We sold almost 44 million iPhones, setting a new March quarter record. These stronger results were broad-based both from a product point of view with demand for each of our three iPhone stronger than its predecessor and from a geographic standpoint.
We gained smartphone share in many developed and emerging markets including the U.S., the UK, Japan, Canada, Germany, France, Vietnam and Greater China, just to mention a few. In fact, we established a new all-time record for total iPhone sales in the BRIC countries.
iTunes software and services revenue continue to grow at a double-digit rate, thanks to an incredible ecosystem and our very large, loyal and engaged customer base. With its strong momentum in growing profitability, iTunes is a very important driver of our business not only here in the United States, but around the world. We now have an almost 800 million iTunes accounts, most of these with credit cards. This is a staggering number.
We continue to gain share in the personal computer market as well. We defied industry trends again by growing while the market contracted. Our bold decision to make OS X free has resulted in the largest ever percentage of the Mac installed base running on the latest version of the operating system just months after its release.
iPad sales came in at the high end of our expectations, but we realized they were below analyst estimates, and I would like to proactively address, why we think there was a difference. We believe almost all of the difference can be explained by two factors. First, in the March quarter last year, we significantly increased iPad channel inventory, while this year we significantly reduced it. Luca will go into more detail about this later.
Second, we ended the December quarter last year with a substantial backlog with iPad mini that was subsequently shipped in the March quarter, whereas we ended the December quarter this year near supply demand balance. We continue to believe that the tablet market will surpass the PC market in size within the next few years and we believe that Apple will be a major beneficiary of this trend.
When we look at our company performance on a geographic basis, we’re especially proud of our very strong results in Greater China, where we established an all time quarterly revenue record of almost $10 billion including the results from our retail stores. And in Japan, where revenue was up 26% in spite of the foreign exchange headwinds and where our smartphone market share reached an incredible 55%.
We are continuing to invest in our retail stores and since our last call, we had opened our first stores in Brazil and Turkey and we now have retail stores in 15 countries around the world. I’m looking forward to welcoming our new retail and online leader, Angela Ahrendts, who will be joining Apple’s Executive Team next week. Stepping back, we are now just passed the halfway mark for fiscal 2014.
Our strong March quarter results bring us to total revenues of over $103 billion for the first six months of the year and earnings per share growth close to double-digits. We estimate that over the last six months, we’ve added over $60 million new registered users of our four product categories. Additionally, over two-third’s of people registering an iPad in the last six months, were new to iPad, while over half of the people registering iPhones were new to iPhone.
It is wonderful to add tens of millions of first time Apple product users, especially considering the strong halo effect, we’ve seen over and over again in our history. Customers who have a great experience with their first Apple products, often become loyal and happy owners of the multiple Apple products overtime.
As always, I’d like to thank our talented employees who make these results possible through their creativity and passion they bring to their work everyday. And I’d like to thank our hundreds of millions of customers for their loyalty and enthusiasm and for continually inspiring us to surprise and delight them.
In addition to our quarterly results, we are also announcing an update to our capital return program today, and I’d like to share a few thoughts about our guiding principles for capital allocation and our conclusion on the changes we are making for this year. Apple has created tremendous value for shareholders by developing great products that enrich people’s lives and that will always be our top priority and driving force.
We’ll continue to innovate by investing in research and development and capitalizing on our strengths in hardware, software and services. We’ll keep investing in our supply chains promote scale and efficiencies, expanding our global presence by building retail stores, investing in marketing and distribution and extending our reach into new markets.
We are expanding Apple’s products and services into new categories and we are not going to under invest in this business. We are also investing through acquisitions and we’ve acquired 24 companies in the past 18 months. To invest organically and to make acquisition strategically, we need to maintain financial flexibility. With this framework in mind, Apple’s Board and management team, will do capital allocation regularly and we solicit input on our program from a broad base of shareholders.
We very much appreciate all of the input that so many of our shareholders have provided us on how the best to deploy our cash. We’ve continued to seek investor input going forward and we’ll update you on our conclusions around this time each year.
This regular process allows us to continually evaluate return of capital in light of the most current information available and it enables us to be thoughtful about the size, mix and pace of the program. We continue to be in the fortunate position of being able to return significant capital to shareholders. We started doing so two years ago when we announced our first program of $45 billion and we more than doubled the program last April to $100 billion.
Today, we are announcing that we are increasing the size of our program once again with an addition of over $30 billion for a total program size of over $130 billion. The size and pace of our program is unprecedented and we still expect to complete it by December of 2015 as we announced last year.
We think very deliberately about how much and in which way to return cash to our shareholders. We decided to continue to allocate the vast majority of the incremental capital return to share repurchases because we believe our current stock price does not reflect the full value of the company. The size of the share back increases the signal of the Board and the management team’s strong confidence in the future of Apple.
We also understand the importance of the dividend to many of our investors and we are increasing it for the second time in less than two years. We believe this is a meaningful increase for those shareholders who value income and we are planning for annual dividend increases going forward.
Now, I would like to turn the call over to Luca for the details of our quarterly results as well as more information about our capital return program.
Thank you Tim and good afternoon everyone. As Tim said revenue for the March quarter was $45.6 billion, up $2 billion or 5% from a year ago and above our guidance range. Sales in each of our major product categories were at the high end of our expectations or better and the vast majority of the revenue upside came from strong sales of iPhone.
Gross margin was 39.3%, also above our guidance range and operating margin was $15.6 billion, representing 29.8% of revenue. Net income was $10.2 billion translating to diluted earnings per share of $11.62.
For details by product, I’d like to start with iPhone. We sold 43.7 million iPhones which was a March quarter record. That’s an increase of 6.3 million iPhones over last year that represents 17% growth. The addition of China Mobile coupled with great response to our more affordably priced iPhone 4S led to an all time quarterly record for iPhone sales in Greater China. We look forward to broadening our relationship with China Mobile as they expand points of sale and continue to build out their 4G network.
In Japan, iPhone sales were up over 50% year-over-year resulting in significant market share gains, as Tim mentioned we’ll try strong growth and share gains in many other major developed markets based on IDCs latest estimates for the March quarter.
iPhone also continued to perform exceptionally well in many developing markets. In Greater China, Brazil, Indonesia, Poland and Turkey. iPhone sales grew by strong double-digits year-over-year, and in India and Vietnam sales more than doubled.
We exited the quarter with 15.4 million total iPhones in channel inventory, which represents a sequential increase of about 100,000 from the December quarter and left us within our target range of four to six weeks.
In the enterprise market progressive organizations are leading the charge to replace legacy devices and systems, and are using iPhone and iOS to drive innovation at their companies. Deutsche Bank has nearly 20,000 iPhones running on its network and has created 40 internal apps that extend the capabilities of its mobile workforce.
Siemens have 30,000 iPhones on its network and has deployed over 50 internal apps for field service teams, sales associates and corporate executives for solution that are only possible with iOS and iPhone. We are really happy with the continued growth and strength of the Apple ecosystem.
Total revenue from iTunes software and services was $4.6 billion, an increase of 11% year-over-year at an all time quarterly record. Our iTunes stores generated record billings of $5.2 billion in the March quarter, up 24% year-over-year driven by very strong growth in App Store sales. These iTunes billings translated to quarterly iTunes revenue of over $2.6 billion, up 9% from the year ago quarter, and also a new all-time record.
Software and services revenue was over $1.9 billion, up 14% from a year ago. App Store momentum is incredibly strong as cumulative app downloads at 70 billion, 87% of iOS devices are now running iOS 7 and our highly engaged users are a great audience for developers.
According to App Annie, the App Store generated 85% more global revenue than Google Play in the March quarter despite the differences in unit market share between iOS and Android devices.
Now, I’d like to talk about the Mac. We saw 4.1 million Macs compared to just under 4 million in the year ago quarter. Thanks to strong performance from MacBook Pro and MacBook Air and Macs have now gained global market share for 31 of the last 32 quarters. Response to Mavericks has been great, and we are very proud of the fact that so many of our Mac customers are taking advantage of the most advanced and secured experience possible. We ended the quarter with Mac channel inventory slightly below our four to five week target range.
Turning to iPad, we saw 16.4 million units. As Tim explained earlier, our iPad results and the comparison to the March quarter last year were heavily influenced by channel inventory changes. Specifically, this year we saw 16.4 million iPads into our channels and sold through almost 17.5 million reducing our channel inventory by 1.1 million units.
Last year we sold over 19.4 million iPads into our channels and sold through 18 million and therefore increased channel inventory by 1.4 million units. As a result, the year-over-year sell through decline was only 3% compared to the sell in decline of 16%. We exit the March quarter with 5.1 million units of iPad channel inventory, which left us within our target range of four to six weeks.
In a February survey, ChangeWave measured a 98% customer satisfaction rate for both iPad Air and iPad Mini with Retina display. And also found that among people planning to purchase a tablet within 90 days two-thirds plan to buy an iPad. iPad continues to allow companies around the world to reimagine the way they use technology to drive efficiency and improve employee satisfaction. Thousands of iPads are used at FedEx everyday. In an industry where efficiency is critical FedEx pilots and maintenance crews around the world use iPad to transform operational processes and save the company millions of dollars.
Eli Lilly has deployed over 20,000 iPads and 50 internal apps as part of a laptop replacement program that dramatically increased the productivity and capabilities of its employees.
The U.S. Department of Veterans Affairs is on its way to deploying iPads to 11,000 providers to transform the way doctors and patients interact. As part of this initiative, a suite of applications is being developed to allow quick access to real-time secure medical information. In education, according to the latest data published by IDC, iPad has over 95% share of the U.S. education tablet market as teachers and students increasingly benefit from the growing range of engaging iBooks, textbooks and solutions that are helping to transform the education experience.
Let me now turn to our cash position. We ended the quarter with $150.6 billion in cash plus marketable securities, a sequential decline of $8.3 billion. Our domestic cash was $18.4 billion at the end of the March quarter, a sequential decline of $16 billion and $132.2 billion or 88% of our total cash was offshore. Cash flow from operations was very strong at $13.5 billion for the quarter.
In total, we executed almost $21 billion worth of capital return activities during the March quarter. First, we launched our third accelerated share repurchase program in late January through which we will acquire an additional $12 billion of Apple stock. We received an initial delivery of 19.2 million shares under this ASR and we received a balance of shares due when the program concludes by December of this year.
Second, we paid $2.7 billion in dividends in February. And finally, we spent $6 billion on open market purchases of 11.4 million shares throughout the March quarter. At the end of March, we also settled our second ASR program, which was launched in April of last year, resulting in the retirement of an additional 1.1 million shares.
I would like now to go into more detail about the expansion of our capital return program that we’re announcing today. Let me start by summarizing the progress that we’ve made on the program we updated a year ago. By the end of March 2014, we’ve already taken action of $46 billion of the current $60 billion share repurchase authorization, over 75% of the program with seven quarters remaining to its completion.
We have acted aggressively and opportunistically and have delivered on our intention to return capital to shareholders at a fast pace. Including dividends and net-share-settlements, we’ve taken action on $66 billion of total $100 billion program announced last year.
Today we’ve taken additional steps that will increase the overall size of the program from $100 billion to over $130 billion within the same timeframe of December 2015 as before. There are two elements to the expansion of the program. First, we’re increasing the size of our share repurchase authorization from $60 billion to $90 billion. We are very confident in Apple’s future, and we believe our current stock price does not reflect the full value of the Company. That’s why the vast majority of our capital program continues to be allocated to share repurchases. We will also continue to net-share-settle, restricted stock units and expect to utilize about $1 billion of cash annually for that purpose.
Second, our Board has declared a dividend of $3.29 per common share payable on May 15, 2014 to shareholders of record as of May 12, 2014. That represents an increase of about 8% in our quarterly dividend. We understand the importance of dividend increases to many of our investors, and we’re increasing the dividend for the second time in less than two years. We are planning for continued annual increases and we’re very proud that Apple is one of the largest dividend payers in the world, with annual payments of $11 billion.
All our capital return activities must be funded by domestic cash which as I mentioned was about $18 billion as we exited the March quarter, and down from $39 billion in the quarter that we paid our first dividend. We would maintain sufficient domestic liquidity to grow the business and execute capital expenditures and acquisitions. Thanks to Apple’s strong growth in international expansion in recent years. We have built substantial offshore cash balances to repatriate our fall in cash on the current U.S. tax law, we will incur significant cash tax consequences and we don’t believe this would be in the best interest of our shareholders.
We continue to advocate for comprehensive corporate tax reform and streamlining the tax code which we believe would be of great benefit to the U.S. economy. To execute our updated capital return program in a tax efficient manner and leverage our very strong balance sheet, we intend to access the debt markets again. We plan to be active in both the domestic and international bond markets during 2014 for an amount of term debt financing similar to what we issued in 2015, with a break down between markets currencies and tenures to be determined over the course of the year and subject to prevailing conditions in each market.
We have also prepared ourselves to access the commercial paper market given the substantial short term liquidity and flexibility that this channel can provide.
Now, as we move ahead into the June quarter, I’d 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 $36 billion and $38 billion compared to $35.3 billion in the year ago quarter. We expect gross margins to be between 37% and 38%.
We expect OpEx to be between $4.4 billion and $4.5 billion. We are continuing to invest heavily in R&D for current revenue generating categories as well as future products and services. We expect OI&E to be about $200 million and we expect the tax rate to be about 26.1%.
And now, I’d like to turn it back to Tim.
Timothy D. Cook
Thanks Luca. In addition to the changes to our capital return program today. We are also announcing a seven-for-one split of Apple common stock which will occur in June of this year. We are taking this action to make Apple stock more accessible to a larger number of investors. Each shareholder of record at the close of business on June the 2nd, 2014 will receive six additional shares for every outstanding share held on the record day and trading will begin on a split-adjusted basis on June the 9th, 2014.
Finally, before we start the Q&A, I would like to take a minute to talk about my dear friend and colleague Peter Oppenheimer. As you know, Peter will be transitioning from the CFO role in June. Peter has been Apple’s CFO for 10 years and the list of his accomplishments is immense. Apple is now more than 20 times the size it was when Peter became our CFO and his expertise, leadership and incredibly hard work had been instrumental to the company’s success. I’d like to thank him very publicly for his contributions to Apple, from the very bottom of my heart and wish him all the best in his approaching retirement at the end of September.
And I’d also like to recognize him that he has never missed guidance in the 10 years as CFO which must be an all-time record for CFOs. We’re really happy and fortunate to have someone with Luca’s talent on Board to replace Peter. He has over 25 years of experience, building and leading finance teams in global companies and has an exceptionally broad international background, which you might be able to detect from his accent. He’s been managing most of Apple’s financial functions since coming on Board last year and has done an outstanding job. I’m looking forward to working with Luca even closer as Apple’s next CFO.
With that, I’d like to open the call for questions.
Thank you, Tim. We’d like to ask that you limit yourself to one question and one follow-up please. Operator, may we have the first question.
Earnings Call Part 2: