Apple Inc. (AAPL)
Q3 2014 Earnings Conference Call
July 22, 2014 05:00 AM ET
Nancy Paxton - Senior Director of Investor Relations
Tim Cook - CEO
Luca Maestri - SVP and CFO
Katy Huberty - Morgan Stanley
Bill Shope - Goldman Sachs
Toni Sacconaghi - Sanford Bernstein
Steve Milunovich - UBS
Kulbinder Garcha - Credit Suisse
Ben Reitzes - Barclays
Ben Schachter - Macquarie
Good day, everyone, and welcome to the Apple Incorporated Third 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.
Thank you. Good afternoon, and thanks everyone for joining us today. Speaking first is Apple CEO, Tim Cook; and he will be followed by CFO, Luca Maestri, and then we'll open the call for questions from 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 revenue, gross margins, operating expenses, other income and expense, taxes, future products.
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 two quarters 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.
Thanks, Nancy. Good afternoon, everyone. It’s been a very busy and exciting time at Apple and I'd like to review some of the highlights of our June quarter. We hosted our best ever Worldwide Developer’s Conference last month with over 20 million people from around the world watching our keynote session, which is the a record. We've had overwhelming response from customers and developers to the new features we previewed in OS X Yosemite and iOS 8. Yosemite has been redesigned with a fresh look and powerful new apps and iOS 8 is the biggest release since the launch of the App Store. With powerful continuity features, these upcoming releases will allow Macs and iOS devices to work together in even smarter ways.
Customers can start on activity like writing an email on one device and pass it to another, picking up where they left off without missing a beat. They will even be able to make and receive iPhone calls on their Mac with just a click. These are features that only Apple can deliver. With iOS 8, we have opened over 4000 APIs providing more flexibility and opportunity for developers than ever before. iOS 8 provides developers with amazing new frameworks, enables wide use of Touch ID to securely authenticate users within apps and lets developers further customize the user experience with major extensibility features such as third-party keyboards.
We have also introduced Swift, an innovative new programming language for both iOS and OS X. Swift is the result of the latest research on programming languages, combined with decades of experience within building Apple platforms. It makes writing code interactive and fun, eliminates entire classes of unsafe code and generates apps that run lightning fast. It's easy to learn, allowing even more people to dream big and create whole new categories of apps. We believe our new OS releases, combined with Swift will result in a huge leap forward for the Apple ecosystem and we can’t wait to what developers will create with Yosemite, iOS 8 and Swift.
When we introduced iOS 7 years ago, it was a revolutionary operating system for iPhone. Over the years we've extended it to the iPod family with iPod Touch and later to a tablet form factor with iPad. An explosion of apps, accessories and services for these devices has created an incredibly vibrant ecosystem. We’re extending iOS in even more dimensions as customers around the world make iPhones and iPads an essential part of their lives, at home, at school, at work and on the go. We’re putting a huge effort into delivering the best experience to our customers wherever they use iOS. That includes a safe and intuitive user interface for driving, called CarPlay, which is being integrated by 29 major car brands including Audi, BMW, Ford, General Motors, Honda, Hyundai, Mercedes, Toyota and Volvo; and after-market systems like Pioneer and Alpine.
We’ve created a new tool for developers called HealthKit, which allows health and fitness apps work to together and empowers customers to choose what health data they share. We're taking the first steps in this area in collaboration with the Mayo clinic, whose new apps can automatically receive data from a blood pressure app, for example and share it with a physician, or a nutrition app can inform fitness apps how many calories are being consumed each day. Our ARM health app will provide an easy to read dashboard of all health and fitness data.
We're enabling new ways to control light and doors and thermostats and other connected devices around the house using Siri with the HomeKit feature of iOS 8. And in the Enterprise, we are including new security, productivity and device management features in iOS 8. We forged a relationship with IBM to deliver a new class of mobile business solutions to enterprise customers around the world. We are working together to provide companies access to the power of Big Data analytics, right on every employee's iPhone or iPad. Using Swift, we will collaborate to bring over 100 Mobile First apps to enterprise clients, each addressing a specific industry need or opportunity.
This is a radical step for Enterprise and opens up a large market opportunity for Apple but more importantly, it’s great for productivity and creativity of our enterprise customers. From the pocket to the car, to the workplace, home and gym, we have a very large vision of what iOS can be and we're incredibly excited about our plans.
Turning to our financial results, today we are reporting record June quarter revenue, thanks to the very strong performance of iPhone, Mac and the continued growth of revenue from the Apple ecosystem. Our teams executed brilliantly during the quarter with earnings per share up 20% year-over-year, our highest growth rate in seven quarters.
We sold over 35 million iPhones, setting a new third quarter record. We generated healthy growth in our entry priced, mid-tier and lead iPhone categories. I'm especially happy about our progress in the BRIC countries, where iPhone sales were up a very strong 55% year-over-year.
We also had a record June quarter for Mac sales, with growth of 18% year-over-year in a market that is shrinking by 2% according to IDC’s latest estimate. Demand has been very strong for our portables in particular and we've have had a great customer response to the new higher performance, lower priced MacBook Air. It was another strong performance for the App Store and the other services contributing to the thriving Apple ecosystem.
In fact for the first nine months of this fiscal year, the line item that we call iTunes software and services has been the fastest growing part of our business. iTunes billings grew 25% year-over-year in the June quarter and reached an all-time quarterly high, thanks to the very strong results from the App Store. We're continuing to invest in our incredible ecosystem, which is a huge asset for Apple and a very important differentiator of our customer experience. iPad sales met our expectations but we realized they didn’t meet many of yours. Our sales were gated in-part by a reduction in channel inventory and in-part by market softness in certain parts of the world. For example IDC’s latest estimate indicates a 5% overall decline in the U.S. tablet market, as well as a decline in the Western European tablet market in the June quarter.
But what’s most important to us is that customers are enjoying their iPads and using them heavily. In a survey conducted in May by ChangeWave, iPad Air registered a 98% customer satisfaction rate, while iPad Mini with retina display received an astonishing 100% customer satisfaction rate. The survey also found that among people planning to purchase a tablet within 90 days, 63% plan to buy an iPad and our own data indicates that more than half of customers purchasing an iPad are buying their very first iPad.
Another recent study by Custora found that iPad accounts for 80% of all U.S. tablet based e-commerce purchases. We're very bullish about the future of the tablet market and we're confident that we can continue to bring significant innovation to this category through hardware, software and services. We think our partnership with IBM, providing a new generation of mobile enterprise applications, designed with iPad’s legendary ease of use and backed by IBM’s cloud services and Data analytics will be one such catalyst for future iPad growth.
Looking ahead, we are very excited about our agreement to purchase Beats Electronics and Beats Music. We think its part of Apple’s DNA and we think the addition of Beats team will be great for music lovers. Beats provides Apple with a fantastic subscription music service, access to rare talent and a fast growing line up of products that we can build upon. Not counting Beats, we've completed 29 acquisitions since the beginning of fiscal year 2013 including five since the end of the March quarter and we have brought some incredible technology and more importantly some incredible talent into Apple in the process. We are hard at work and investing heavily on exciting opportunities across our business and we have an incredible pipeline of new products and services that we can’t wait to show you.
With that I would like to turn the call over to Luca to discuss our Q3 results in more detail.
Thank you, Tim and good afternoon everyone. We set a new June quarter record for revenue at $37.4 billion, up $2.1 billion or 6% year-over-year. This result was towards the high end of our guidance range, despite a reduction in channel inventory for both iPhone and iPad. The revenue growth was driven by strong sales of iPhones and Macs, as well as the continued great performance of iTunes softwares and services. Gross margin was 39.4%, above our guidance range and operating margin was $10.3 billion, representing 27.5% of revenue. Net income was $7.7 billion, translating to diluted earnings per share of $1.28, a 20% year-over-year increase.
For details by product, I'd like to start with iPhone. We sold 35.2 million iPhones, an increase of 4 million over last year, representing 13% growth. As Tim mentioned, iPhone sales grew well across all three of our entry-price, mid-tier and lead product categories.
In the U.S., iPhone accounts for 41.9% of the smartphone subscriber base according to the latest data from ComScore, up from 41.3% in the previous measurement period. Also based on the latest survey by ChangeWave, iPhone earned a 97% customer satisfaction rate and among responders planning purchase a smartphone within 90 days, 50% planned to purchase an iPhone, up from 42% in the March quarter and 44% a year ago.
iPhone sales were at the high end of our expectations, despite new product rumors that we believe resulted in purchase delay. In addition, tax increases and the regulatory environment in Japan affected smartphone sales in what has been one of iPhone’s fastest growing markets in recent quarters. Considering these factors, the performance of iPhone was even more impressive in the June quarter and it boosts our confidence for the future. We reduced iPhone channel inventory by about 150,000 from the end of the March quarter, leaving us within our target range of four to six weeks.
Apple continues to innovate through hardware, software and services to make iPhone the best smartphone for business. Today, companies have equipped millions of employees with iPhones and they are seeing tremendous benefits in productivity, employee satisfaction and profitability. For instance medical device leader Medtronic has developed over 175 internal iOS apps for over 16,500 iPhones used by its employees to facilitate sales, improve productivity and ensure that essential marketing materials are up to date. Throughout the global offices of Nestle, the largest food company in the world, over 25,000 iPhones are accessing corporate networks, improving communication and connecting employees to critical internal resources. And at NASA over 26,000 iPhones are in use by scientists, flight crew members, technicians and researchers.
Turning to iPad, we sold 15.3 million units, compared to 14.6 million in the June quarter last year. iPad sales grew overall in the developing markets with particularly strong year-over-year growth in the Middle-East, where iPad sales were up 64%, in China where they grew 51%, and in India, where they were up 45%. This growth was more than offset by lower sales in more mature markets. We reduced iPad channel inventory by 500,000 from the end of the March quarter, which lets us within our target range of four to six weeks.
In the Enterprise, global companies are using iPad to improve customer service, boost work and productivity and enhance critical processes. iPad continues to be the standard for teams across the airline industry. Qantas Airlines has over 15,000 iPads deployed to pilots as well as cabin, customer service and ground crews to enhance key processes across the daily operations and governments are deploying thousands of iPads worldwide. One of the largest examples is Sweden, where over 100,000 iPads are being used by local government offices across the country.
In education, iPad remains the tablet of choice with 85% share of the U.S. education tablet market according to the latest published estimate from IDC. We’ve now sold 13 million iPads to education customers globally. We’re bringing teachers and students great new tools to build an experience educational count into an iPad. As of this month, teachers using the free iTunes U app can create, edit and manage entire courses that are on iPad for the first time and students can discover new ways to collaborate, including the ability to start class discussions and ask questions right from their iPad.
Next, I'd like to talk about the Mac. We sold 4.4 million Macs, compared to under 3.8 million in the year ago quarter, an increase of 18% year-over-year and a new June quarter record. The increase was driven by portables, thanks to very strong growth of MacBook Air. We achieved strong double digit Mac growth across many countries, including the U.S. Canada, Mexico, the UK, Germany, France, Australia, China, India and the Middle-East. This growth is particularly impressive, given the contraction of the overall PC market. Macs have now gained global market share for 32 of the last 33 quarters.
Macs performed well in the U.S. education buying season with double-digit growth in the K to 12 market, driven primarily by large deployments of MacBook Air. The Shawnee Mission School District in Kansas chose Apple to provide an entire solution that will equip every teacher with a MacBook Air and an iPad Air, every high school student with a MacBook Air and every middle school and elementary student with an iPad. The Rowan-Salisbury School System in North Carolina is deploying thousands of MacBook Airs to students and teachers in grades 9 to 12 as part of the district's digital learning initiatives.
We ended the quarter with Mac channel inventory slightly below our four to five week target range. The Apple ecosystem continues to grow and thrive. Total revenue from iTunes software and services was $4.5 billion, an increase of 12% year-over-year. Our iTunes stores generated all time record billings of $5.4 billion in the June quarter, up 25% year-over-year, driven by very strong growth in App Store sales. These items billings translated to quarterly iTunes revenue of almost $2.6 billion, up 8% from the year ago quarter. Software and services revenue was $1.9 billion, up 19% from a year ago.
App Store momentum remains very strong and cumulative app downloads has topped 75 billion. We continue be amazed by our vibrant and diverse developer community and we are extremely proud that our developers have now earned over 20 billion for sales of their apps through the App Store, nearly half of which have been earned in the past 12 months. This number truly stands out among our competition as our developers continue to benefit from the broad reach and powerful design of the App Store, coupled with Apple’s large, loyal and very engaged customer base.
Let me now turn to our cash position. We ended the quarter with $164.5 billion in cash plus marketable securities, a sequential increase of $13.9 billion. Our domestic cash was $26.8 billion at the end of the June quarter, a sequential increase of $8.3 billion and $137.7 billion or 84% of our total cash was offshore. Cash flow from operations was $10.3 billion.
We executed another very successful debt offering in April, issuing a total of 12 billion in notes across 3, 5, 7, 10 and 30 year maturities. In addition, during the quarter, we entered the commercial paper market for the first time with $2 billion in short-term obligations outstanding as of the end of June. We also continued to execute our shareholder return program with $8.3 billion of capital returned to inventors during the June quarter. We spent $5 billion to repurchase 59 million Apple shares to open market transactions. We paid almost $2.9 billion in dividends and equivalents and utilized over $400 million to net share settle vesting employee RSUs.
We've now taken action on over $74 billion of our $130 billion capital return program, including $51 billion in share repurchases with six quarters remaining to its completion. And finally our Board has declared a dividend of $0.47 per common share payable on August 14, 2014 to shareholders of record as of record as of August 11, 2014.
Now as we move ahead into September 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 $37 billion and $40 billion, compared to $37.5 billion in the year ago quarter. We expect gross margin to between 37% and 38%. We expect OpEx to be between $4.75 billion and $4.85 billion. We expect OI&E to be about $250 million and we expect the tax rate to be about 26.1%. Finally, we expect the Beats transaction to close this quarter and we expect the acquisition to be accreted to our earnings in our fiscal 2015.
With that, let me open the call to questions.
Thank you, Luca. And we ask that you limit yourself to one question and one follow-up please. Operator, may we have the first question.
Source : https://finance.yahoo.com/news/apples-aapl-ceo-tim-cook-022603749.html