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Apple Earnings: A Record Quarter With Mediocre Guidance

By Evan Niu, CFA - Updated Feb 2, 2018 at 3:26PM

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And a dash of iPhone X demand fears.

Apple (AAPL 1.62%) had a rather happy holiday season. The company just reported fiscal first-quarter earnings results, and the tech titan was able to set a handful of all-time records, including total revenue and earnings per share. This year, Apple had 13 weeks in its December quarter, compared to 14 weeks a year ago. That's important context for the results, one that Apple pointed out repeatedly during the subsequent conference call.

Revenue in the quarter was a whopping $88.3 billion, topping the high end of Apple's guidance. Gross margin was 38.4%, near the high end of guidance, and the company posted net income of $20 billion, or $3.89 per share. Two years ago, Apple announced its active installed base (devices, not users) had reached 1 billion. This figure has grown 30% since then and now stands at 1.3 billion.

iPhone X splashing in water

Image source: Apple.

How iPhone performed

In terms of unit sales, Apple sold 77.3 million iPhones, which is actually a 1% decline from a year ago. Before you let that decline disappoint you too much, keep in mind the 13-week context I mentioned earlier, as well as the fact that iPhone X didn't ship until early November. When Apple launched the iPhone 7 and 7 Plus last year, it did so in September, meaning the 2016 flagships were available for the full quarter last time around, whereas this time many customers waited for the iPhone X.

Even though units were down modestly, iPhone revenue jumped 13% to $61.6 billion, as average selling prices (ASPs) posted a significant (and expected) sequential uptick to $796. With iPhone X starting at $999 and iPhone 8 and 8 Plus getting $50 and $30 price bumps, respectively, investors knew ASP growth was in store.

Chart showing iPhone ASP spiking last quarter

Data source: SEC filings. Chart by author. Calendar quarters shown.

The company also sold 13.2 million iPads and 5.1 million Macs. Other products, which includes Apple Watch results, saw revenue jump 36% to $5.5 billion. Always coy with Apple Watch figures, all CEO Tim Cook would say was that units and revenue both grew over 50% for the smartwatch.

Steady progress toward services goal

Services put up another strong quarter, with sales growing 18% to $8.5 billion. On a trailing-12-month basis, this is now a $31.2 billion business, up 22% from a year ago when Apple publicly set a goal of doubling that business over four years. The App Store continues to drive growth, as the growing installed base continues to buy more digital content. That includes paid subscriptions, of which there are now 240 million.

Chart showing paid subscriptions rising over time

Data source: Apple earnings calls. Chart by author. Calendar quarters shown.

Unfortunately, Apple did not give any updates as to how many paid subscribers Apple Music now has. The last update was 30 million at the end of September. With as important as Apple Music is to the services business, as well as the forthcoming launch of HomePod, investors deserve an official update.

Cash and taxes

Following the tax reform that recently passed, Apple is preparing to cut a $38 billion check to the U.S. government, but it will also have greater access to its foreign reserves. Apple has already been accruing expected tax liability on foreign earnings, so the company didn't have to recognize an unexpected one-time charge (like other companies).

Apple now has a mind-boggling $285 billion in gross cash, of which $269 billion is held abroad. After backing out $110 billion in term debt and $12 billion in commercial paper, net cash is approximately $163 billion. Oddly, CFO Luca Maestri articulated that over time, Apple wants to bring its net cash position to zero, where total cash and total debt are roughly equal.

Front view of iPhone X

Image source: Apple.

Maestri did not elaborate on how much foreign cash Apple will be bringing home, or when it will do so. The company is still looking at the logistics -- no small task since we're talking about a massive amount of money to move.

Apple will provide more detail regarding its capital allocation strategy when it reports March-quarter results in April or May and also gives investors an update on its capital return program. Apple repurchased $10.1 billion in shares last quarter, including $5.1 billion in open market purchases and a fresh $5 billion accelerated share repurchase (ASR) program.

About those iPhone X demand fears

Now, the bad news. There has been concern recently regarding iPhone X demand. While Cook noted iPhone X has been the best-selling model every week since launch, there are some potential clues that demand is worse than expected.

For starters, management confirmed that the company reached supply-demand balance in December, which is suspiciously fast. Some analysts had initially predicted that Apple wouldn't achieve supply-demand balance until the second half of 2018. For reference, it took Apple two quarters to reach supply-demand balance with the iPhone 7 Plus during the last product cycle, but iPhone X achieved it in about a month.

Of course, Apple has been ramping iPhone X production incredibly fast after resolving manufacturing bottlenecks, and strong supply is half the battle. But if iPhone X demand was as robust as many investors and analysts had hoped, shouldn't the company have sold more units with that sufficient supply?

Furthermore, guidance for the March quarter came in below consensus. Apple expects revenue to be in the range of $60 billion to $62 billion, whereas the Street was modeling for $65.4 billion in sales. It's hard to reconcile all of these data points with the hope of "supercycle" demand. Maybe the market for $1,000 phones is simply smaller than Apple realized.

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