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Apple’s Results Foretell Sunnier Environment Will Return
It's rare that I write about Apple missing a quarter. For the twenty years I've been following the company, I now count three times results have come in below expectations. As I peeled back the layers of the results along with the company's guidance, the big picture became more clear. Even though Apple's business is being negatively impacted by the supply chain and the macro, the company is maintaining innovation excellence with its core products, optionality with potential new products (AR and auto) and most importantly a loyal, engaged and growing customer base. All signs suggest sunnier days will return for Apple.

Key Takeaways

The 3% miss was from supply chain, macro, and FX headwinds
Revenue guidance for March revenue was inline with expectations when factoring in FX and ahead of expectations on gross margin.
What's most important in assessing quarterly results on the long term is customer engagement. Apple's installed base of active devices and subscriptions is evidence that the fly wheel is as strong as ever.

The miss

For the December quarter, overall revenue was down 6% y/y, compared to up 8% last September. This translated to both a revenue and earnings miss of 3%, despite the company warning investors in November that the quarter would be negatively impacted by supply constraints for the iPhone Pro lineup. Tim Cook commented that the bulk of the macro slowdown was felt in the Mac and Wearables segments, which combined account for just over 20% of revenue. Mac revenue was down 29% y/y and wearables revenue was down 8%. The iPhone (56% of revenue in December) did well considering the production shutdowns, declining 8% y/y and flat on a constant currency basis.


The guide was favorable

Officially, Apple does not give guidance, but rather “directional insights” that are effectively guidance. Revenue for the March quarter is expected to decline by about 5%, which is below the consensus expectations of down 1%. That said, the FX headwind is stronger than many had anticipated, and backing out that headwind would suggest revenue on a constant currency basis will be flat, which is fractionally better than the Street’s outlook. The reason for the flattish expected growth is related to Services (negatively impacted by the macro, digital ads, and mobile gaming) along with the Mac and iPad, which are both expected to decline double digits y/y from the macro. In total, about 40% of Apple’s business is feeling the economic pressure in March.

The good news is the iPhone (50% plus of revenue) is expected to see an acceleration in growth compared to December when the segment was down 8% y/y. My sense is the iPhone finishes the March quarter flat to down 2%, better than the overall revenue which will likely be down 5%. Importantly the iPhone segment’s headwinds are temporary given any iPhone that is not upgraded in the near term will likely be in the long term.

The biggest takeaway from the guidance was that gross margin for March is expected to be between 43.5% and 44.5%, higher than the 43% just reported in December and the 39% average over the past four years. That’s especially surprising given revenue is declining. Typically when revenue is declining, margins are declining at a greater rate. CFO Luca Maestri attributed the margin outlook to seasonal leverage and a favorable product mix. I’ll add another likely factor that was not mentioned, Apple’s strength in negotiations with component suppliers. This dynamic has enabled the company to expand gross margins by around 500bps over the past year despite rising industry component costs. That is a competitive advantage that will yield benefits beyond the March quarter.


Apple's flywheel franchise is intact

The customer engagement formula has been working for Apple for the past 20 years. Its starts with making world class hardware. Buy one Apple product, fall in love, buy another product, add a service, upgrade and repeat.

This flywheel has led Apple’s active device installed base to now reach 2B, up 8% y/y and doubling over the past seven years. The growth in the base today is coming from markets like India and Brazil, both Android stronghold markets that give Apple plenty of room to grow in the coming years.

Pulled through the active device installed base are paid subscriptions. Apple reported that they now have more than 935m paid subs signed up through the App Store. That number is up more than 150 million in the past year and is 4x greater than five years ago. For context, that 150m is about equal to the total number of Amazon Prime subscriptions.


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