The full text is here! Apple calls would be ‘confident’: Double-digit growth could have been if it wasn’t for a stronger dollar

After the US stock market closed on October 27, technology giant Apple released its financial results for the third quarter of 2022.

The financial report shows that in the third quarter of the new iPhone release, Apple’s overall revenue and profit growth were stronger than Wall Street expected: the third quarter revenue was $90.1 billion, an increase of 8.1% year-on-year; net profit was $20.7 billion, a year-on-year increase 0.8%; iPhone sales were slightly lower than expected, growing nearly 10%, Mac computers and wearables and accessories revenue soared and far exceeded expectations, while iPad sales and services were weaker.

After the earnings release, Apple management held a conference call with Apple CEO Tim Cook, CFO Luca Maestri and Investor Relations (Senior) Director Tejas Gala Meeting and answering analyst questions.

Cook mentioned the impact of the exchange rate, arguing that if it weren’t for the strengthening of the dollar, Apple’s third-quarter revenue would have grown by double digits. He says:

There were more than 600 basis points of foreign exchange headwinds in the quarter. So that’s a big (impact). Without FX headwinds, we could have grown by double digits.

But Chief Financial Officer Luca Maestri also said that despite foreign currency headwinds, Apple’s performance in emerging markets is very strong, and the performance of commodities is also quite favorable for it. These negative effects can thus be protected against.

Cook also mentioned the supply constraints of the new generation of iPhone products, the iPhone 14 Pro and 14 Pro Max, but overall, Cook remains confident in Apple’s performance prospects, and he also mentioned wearables revenue for the quarter 10 % increase. Cook believes that two-thirds of the Apple Watch customers Apple sells have not owned the product before, so the potential for new customer growth is endless, which is very positive for Apple’s performance prospects.

The following is the transcript of the Q&A session of the conference call:

Supply constraints of the iPhone 14 Pro series still exceed expectations

Shannon Cross, Credit Suisse: Can you share your thoughts on this generation of iPhones? On the positive side, you have raised prices; on the negative side, investors are concerned that higher prices will affect demand. So I’m curious, what do you think about iPhone demand and how you think it’s going to evolve. I know that the macro environment has great uncertainty.

Tim Cook: iPhone revenue rose 10% in the third quarter to $42.6 billion. Customer demand was strong and better than we expected. But that’s also on top of a 39% increase in iPhone revenue in fiscal 2021, so it’s hard-won. So we are very satisfied. As for the new products, it’s too early to talk about sales of the iPhone 14, 14 Pro and Pro Max. But supply of the iPhone 14 Pro and 14 Pro Max was constrained from the start and remains constrained to this day. So we are working very hard to meet the demand. It’s hard to tell until we can actually meet the demand, but we’re working hard to make it happen.

We are very pleased with the strong performance of iPhone last quarter. We have three of the top four smartphones in the US and UK. In addition, iPhone sales also occupy the top three in urban areas in China, the top six in Australia, the top five in Germany, and the top two in Japan. . Consumer satisfaction with the iPhone remains very, very high at 98%. So on the whole, we feel very satisfied with the performance of the third quarter.

Strong U.S. dollar hampers business but protects against FX headwinds

Shannon Cross: Can you talk about the changes in growth margins?

Luca Maestri: In the third quarter, our gross margin came in at 42.3%, and as you mentioned, that was set with foreign currency headwinds. On a month-on-month basis, foreign exchange headwinds were 70 basis points compared to 170 basis points year-over-year. Basically, all the currencies in the world have depreciated against the dollar. But we still now expect a gross margin of 42.5% to 43.5% for the next quarter. Clearly, a strong dollar is making us difficult on many fronts. Our pricing in emerging markets is tougher, and translating these revenues into dollars has also been impacted. But on the positive side, commodities are doing pretty well for us. So we believe we can defend against the negative impact of FX headwinds. I think the guidance we provide reflects that. Of course, this also takes into account foreign exchange and a certain degree of inflationary pressures. I think this is a good result.

The iPad and Mac performed very differently this quarter

Morgan Stanley’s Erik Woodring: There was a big difference between iPads and Macs in the quarter. But from a supply perspective, both are relatively constrained. Can you elaborate on some of the important factors that contributed the most to this difference, and whether those factors will reverse or normalize after the fourth quarter?

Tim Cook: Mac sales this quarter were the best in our company history, thanks to the release of the MacBook Air with the M2. During the second quarter of this year, our factories were barely ramping up for most of the time. So next we have a backlog of orders. We were able to fill all the demand in the quarter to fill the Mac sales channel. As a result, Mac had an incredibly strong quarter. But the iPad is doing the opposite. Compared to a year ago, we launched a new iPad in September and an iPad in October. Another thing to keep in mind is that the iPad Pro just launched just before the start of the quarter a year ago, so this is our first full quarter of iPad Pro releases. So the iPad quarter a year ago was exceptionally strong. That’s why iPad revenue declined in the third quarter.

Ben Bollin, Cleveland Research: You guys recently made some price adjustments on Apple Music, TV+ and One bundle. I’m curious how you balance consumer price and cost and the associated follow-up.

Tim Cook: Yes, on Monday we announced price increases for Apple Music, Apple TV+ and the corresponding Apple One bundle, which is a combination of both products. There are two different scenarios here: For Apple Music, the licensing cost has increased. So we paid more for the software. The benefit of this is that the singers will also earn more money from the songs they stream.

Then there’s Apple TV+, and when we first priced it, we had very few TV shows. We were in the beginning stages. We’re very focused on original shows, so at the beginning we only had four or five shows and the pricing was low. But we have more content now, and more content is coming out every month. Therefore, we have increased the price to match the service value. The Apple One bundle is just an amalgamation of the price changes for these two services.

Wearables revenue surges, Apple Watch a major contributor

Jefferies’ Kyle McNealy: I’m wondering, what drove your wearables and this strong quarter? Is it due to the high add-on rate of the iPhone, or is it a new product launched this quarter, or is it because of the relaxation of the epidemic restrictions, consumers are now more willing to come to the store to try it on?

Tim Cook: Yes. Our wearables revenue grew 10%, and we’re very pleased with that. By all accounts, the Apple Watch is a major contributor. In particular, Apple’s new product lineup, including the Apple Watch Ultra, Apple Watch Series 8, and SE, has helped a lot. So far this quarter, Ultra’s supply remains constrained. So we’re trying to meet the demand and bring these products to customers. We also released the AirPods Pro in September, which received positive reviews for noise cancellation and sound quality.

In other respects, obviously, foreign exchange is a negative factor that affects wearables, home devices and accessories, just as it affects our other products and services. Another thing I want to mention is that two-thirds of the Apple Watch customers we sell have not owned this product before. So we’re still selling to new customers most of the time, which is very, very good for our performance outlook.

FX headwinds impact growth that should have hit double digits

Jim Suva, Citigroup: I wonder if your service side is more susceptible to FX than product. Our family owns products like Apple One and TV+, and we usually pay annually, but when we go to the store to buy watches and iPads, prices adjust faster. So, could it be that service growth is more impacted by the exchange rate and then we see growth reaccelerating, or am I reading too much into the exchange rate impact, and there may be differences between services and products?

Luca Maestri: You are right. Obviously, the impact of foreign exchange on our business depends on the geographic mix in which the business is located. The impact of foreign exchange on services and products may vary slightly. So if we measure our services business in constant currency, our growth will be in the double digits. We are already very satisfied with this.

We saw some weakness in some areas of digital advertising, and games in the App Store were affected. But we’re very pleased with the behavior of our customers participating in the service, and obviously our user base is growing, which is a positive and a good foundation for the business to continue going forward.

We’ve seen more trading accounts and paid accounts, and they’re both growing at double-digit rates. Paid accounts are growing faster than trading accounts, so the penetration of paid accounts is increasing. Our subscription business is very good, we currently have 900 million paid subscribers on the platform, and that number is growing rapidly, doubling in three years. So all these dynamics are the parts that are really interesting to us because we believe the underlying drivers of service growth are stable, the FX headwinds are only temporary, and the fundamentals are very good.

Evercore’s Amit Daryanani: Given the macro concerns, there’s been a lot of focus on what’s going to change in iPhone demand. What advantages do you think current iPhone channel inventory will have compared to historical inventory? Do you think channel inventory will be optimal by the end of December? Because based on the current lead time data, iPhone revenue appears to be driven more by supply than demand. So any information on channel inventory would be helpful.

Tim Cook: Yes. In September, our iPhone inventory was below our target range, which in itself is quite unusual for this quarter. We started ramping up production and demand is still very strong. But from past experience, I don’t think it’s abnormal.

Amit Daryanani: I think for the past few quarters, you guys have been talking about digital advertising. Are there any metrics that give us an idea of ​​how big the business is or what are you focusing on? Do you think Apple can build a massive advertising business without sacrificing consumer privacy?

Tim Cook: First of all, we care about privacy, so we don’t do anything that deviates from it. We believe privacy is a fundamental human right, and that’s how we look at privacy. Our specific advertising business is small relative to other companies. But we didn’t publish the exact number, but it’s obviously not huge.

Provide employee benefits and foreign exchange hedging to relieve pressure

Harsh Kumar, Piper Sandler: A lot of large-cap companies are suffering, so we appreciate your solid performance. I want to ask you about inflationary pressures and labor issues in the U.S. and globally. Maybe talk a little bit about what Apple can do to alleviate these problems? In this regard, foreign exchange is becoming a rather significant headwind. I’m curious if there is anything that can be done to alleviate this.

Tim Cook: On the people side, we’re focused on taking care of our teams, giving them the best benefits and the best pay so they can do the best jobs of their lives. That’s what we focus on on the team side.

In terms of inflation, there is clearly wage inflation, and there is inflation in logistics as well, and it has not returned to pre-pandemic levels by any means. Some silicon components also have inflationary pressures, and that’s not all that we’re seeing, but it provides some of the inflationary pressures that we’re seeing. This has been taken into account in the gross margin guidance we have given.

Luca Maestri: Foreign exchange is obviously a very important factor in our performance, affecting our revenue and gross margin. With the dollar very strong, we hedged our exposure. We try to hedge FX in as many places in the world as possible.

There may be some very small currencies that we don’t hedge because the cost is too high, or the market doesn’t exist. But in general, we tend to hedge because that provides stability to our margin. Obviously this protection diminishes over time as we need to buy new contracts after the contract expires. But this is the main tool we use to offset some of the FX pressure.

Of course, when we launch new products, we pay special attention to the situation in the foreign exchange market. In some cases, customers in international markets need to face price increases, but US customers do not. I have to say, one of the things we appreciate most this quarter is that despite a very strong dollar and a tough FX environment, we had very strong performances in many international markets, especially some very large emerging markets. Even in dollar terms, we had very strong double-digit growth in places like India, Indonesia, Mexico, Vietnam, and many places where we did very well. Clearly, these places have even higher growth rates in local currency.

It’s important for us to see how these markets are performing in local currency, as it gives us a better understanding of how customers are responding to our products, engagement with our ecosystem, and brand strength in general.

No revenue guidance, free cash flow still very strong

Harsh Kumar: You expect the next quarter to be slower compared to the current quarter, with revenue growth of about 8% year-over-year in the third quarter. Should I assume that this 8% number will gradually decline from the fourth quarter onwards?

Luca Maestri: Our revenue will start to decelerate from September, the year-on-year growth in the third quarter is 8%, so the next growth will be less than 8%. We don’t provide guidance, for reasons we’ve explained, there’s a lot of uncertainty. We’ll see how this quarter progresses.

Krish Sankar, Cowen & Company: Given the valuations and adjustments of some public and private companies, does that change your thought process about being cash-neutral (that is, maximizing the benefits of cash)? In other words, would you be more aggressive in making acquisitions, or would you find it more attractive to hold more cash for interest income than your previous investment goals?

Tim Cook: Throughout fiscal 2022, we’re making an average of one acquisition per month. We’re always looking for markets: what will create synergies, what will provide the intellectual property or talent we need, preferably both. So we’re always looking for acquisitions of all sizes.

Luca Maestri: In terms of cash allocation, we obviously like a long-term capital return plan. We’ve done that and have repurchased over $550 billion in stock at an average buyback price of $47, which has been very successful. We still have net cash. We’ve always said that we want to be cash-neutral at some point. Our cash generation has been very, very strong over the past few years, especially last year. As I mentioned, we had free cash flow of $111 billion, up 20% year over year. Therefore, we will use these funds for investors.

Krish Sankar: Regarding the outlook for the next quarter, I would like to ask if the extra week in this quarter will not help to offset some of the foreign exchange impact, or in other words, if it is a 13-week quarter, the foreign exchange brings 10 percentage points Will the negative impact be greater?

Luca Maestri: No, I don’t think so. Since the foreign exchange impact is presented as a percentage, 13 weeks or 14 weeks is not much different.