On this Industry Focus episode, Fool analysts Dylan Lewis and Sean O'Reilly dig into Apple's (NASDAQ: AAPL) record-setting quarter, explain why the market shouldn't have been surprised, and figure out what segments fueled the company's great top- and bottom-line growth.

A full transcript follows the video.


Sean O'Reilly: Grizzly ghouls from every tomb are closing in to seal your doom, on this tech edition of Industry Focus.

Greetings, Fools! I am Sean O'Reilly here from Alexandria, Virginia. I guess Apple's earnings didn't spook investors too much, but I'm joined today by the always-scary Dylan Lewis. How's it going, man?

Dylan Lewis: Doing all right. Nice to be here on Halloween in the office. I have a pretty fun day planned.

O'Reilly: Yeah. Before we dive into Apple's earnings -- which were not spooky in the least -- very anxious to hear what your costume is, because you're not dressed up because we've got the show and everything.

Lewis: Yeah. We're filming so I didn't want to come in and then get undressed and then redressed. It was going to be a whole to-do. After we do the podcast, I will be changing into my Samuel Adams.

O'Reilly: Oh, look at you! Mr. Patriot.

Lewis: Brewer patriot.

O'Reilly: You're just doing this because you're from Boston.

Lewis: Yeah. It's near and dear to my heart. What about you?

O'Reilly: I'm currently dressed as my evil twin. I'm probably going to trip you when we walk out of here.

Lewis: Oh, God. How do I know which Sean I'm doing the podcast with?

O'Reilly: I don't know. I was thinking about it and I thought I probably should have gotten a curly mustache or something.

Lewis: That would have been pretty funny.

O'Reilly: I know. Like, "Ah! I'm evil Sean."

Lewis: You see people walking around the office today. What's your favorite costume so far?

O'Reilly: Obviously, Johnnie Weathersby as Master Chief from Halo.

Lewis: Nice.

O'Reilly: Obviously.

Lewis: I liked healthcare analyst Kristine Harjes as the Banksy Stencil. She's the one throwing the flowers.

O'Reilly: Yeah. That's pretty good.

Lewis: That's very creative.

O'Reilly: No, the amount of creativity that we witness in this office every Halloween is awesome.

Lewis: I'm looking forward to watching the walk-off later today.

O'Reilly: It's going to be wonderful.

Lewis: Yeah.

O'Reilly: There's going to be music and all that stuff. By the way, can I get a "well-done" for nailing Vincent Price there?

Lewis: That was pretty good.

O'Reilly: I was a little nervous. I was like, "Oh, geez. How did he do this?'

Lewis: I need to watch that music video a couple times today.

O'Reilly: Everybody does. It's going to blow up on YouTube. Without further ado, Tim Cook's gearing up to have a good Halloween. He has enough money to hand out iPhones to every kid that comes up to his house.

Lewis: Yeah.

O'Reilly: How was the quarter?

Lewis: Pretty good. They reported earlier this week. Revenue came in at $51.5 billion, earnings at $1.96 per share. Estimates were $50.9 billion for revenue and $1.87 per share in earnings.

O'Reilly: Apple is notorious for undershooting on the guidance, though, correct?

Lewis: Yeah. I think "Underpromise, overdeliver" is what you want out of a company.

O'Reilly: For sure.

Lewis: This is 22% year-over-year revenue growth, and one of the interesting things to watch here is we saw a very nice report last quarter and the stock dipped.

O'Reilly: Right. It was, what, revenue or guidance? I can't remember.

Lewis: Something that was related to iPhone sales and some of it was related to guidance, but I think it's important to revisit what we said last quarter with this report and the guidance that they provided. Keep that in mind as we move forward with the company. If you remember, analysts' expectations were about $51 billion for revenue and they had issued guidance of $49-$51 billion.

So people were disappointed that the upper limit on that guidance was what analysts were going to be expecting. There's that margin of error where, if they were to miss, then they're going to miss at what they were expecting. You have a little bit of sell-off there. This is something that I point out last time we did the show, and I relistened to last quarter's review...

O'Reilly: Did we sound good?

Lewis: Yeah, we sounded great. We talked about the fact that the last three quarters they'd beaten guidance on revenue and gross margins every single quarter.

O'Reilly: Right. Who cares?

Lewis: They're providing conservative guidance and I think it's something to keep in mind as we look forward.

O'Reilly: What stood out? What was interesting in this report?

Lewis: I think one of the coolest stats I saw was Apple's revenue growth in dollars, $51 billion per year, was more than the full-year revenue of almost 90% of Fortune 500 companies.

O'Reilly: Woo!

Lewis: The incremental revenue that they got... more than most huge companies.

O'Reilly: There's 193 countries on planet Earth, give or take. I'm curious how many people's GDPs that beats.

Lewis: Yeah. We talked about that...

O'Reilly: That's several dozen at least. One of the other things I noticed: Apple's not very acquisitive in terms of giant companies. They made 15 smaller acquisitions. It's just software stuff, right?

Lewis: Yeah. They like to buy up small people and just...

O'Reilly: With IP that they want?

Lewis: Yeah, and just integrate into products. They noted in the conference call that the company completed 125 acquisitions in 2015. Two to watch are Metaio, which is an augmented reality solutions provider.

O'Reilly: Hold on. They're going to "augment" my reality?

Lewis: I don't know about your reality. I think all of our realities. Don't be so selfish. They're dipping their foot in VR a little bit. I've seen some stuff that they've done recently where it's tied to a U2 experience -- why wouldn't it be -- Apple loves U2. They're doing this thing called The Experience Bus, which is an immersive VR, U2 concert experience. It's one of those cool, novelty things that they're doing right now.

I don't know what the more full-fledged version of Apple's VR attempt looks like, but that's what we've seen so far. You can expect to hear a little bit more about some of the fruits from that Metaio acquisition down the road. Another one to highlight what they're doing is Mapsense, which is visual data analytics and mapping out.

That's probably just strengthening their Apple Maps offering. That's where a lot of these acquisitions have lied; strengthening products that they're already offering or dipping their toe in new markets.

O'Reilly: Talk to me about revenue for phones and all that.

Lewis: People love looking at this ASP number. The easy way to juice revenue, given that 70% of their revenue comes from iPhone sales, is for them to sell more iPhones or to sell them at a higher price point. ASPs for the quarter were $670, which was up $67 year over year.

O'Reilly: It is always staggering to me how they're able to charge a premium product for something that is so stinking commoditized on planet Earth. It's staggering. They've been able to maintain this phone. It actually doesn't have a faster processer than the Android, but, here, have one.

Lewis: If you're thinking about it from a philosophical standpoint, it's like you're using the phone as an access point to your messaging and the web. So their ecosystem is that sticky; people love it. I guess they've nailed product design and user interface so well that they're able to command that high price point.

O'Reilly: We'll probably touch on this a little bit more later on, but one of the reasons this quarter was so good to them was because of iPhone sales in China.

Lewis: Doing very well.

O'Reilly: We can touch on it a little later, I just wanted to throw that out there.

Lewis: We can tease that and then get back into it in a little bit.

O'Reilly: Yeah. Stay tuned, ladies and gentlemen. What did the CFO have to say?

Lewis: It's interesting to get some color, especially because they're an international company. With all the huge multinationals, something that everyone is facing is really difficult FX. I think one of the most interesting quotes from the conference call and a testament to what their growth could have been in a different macroeconomic environment was from Luca Maestri, the CFO.

He said, "We achieve these outstanding results despite severe, and persisting weakness in foreign exchange rates around the world that have affected all of our geographic segments. This makes our year over year growth rates even more remarkable. In a constant currency, our growth over the fourth quarter would have been 800 basis points higher."

O'Reilly: 8%?

Lewis: Yeah.

O'Reilly: Oh my gosh!

Lewis: That's insane.

O'Reilly: A company the size of Apple almost needs their own trading floor to deal with all this currency and bonds and stuff. They have $170 billion in treasuries; they almost need their own investment bank or something.

Lewis: Yeah. They started getting into some of the hedging philosophy a little bit on the conference call.

O'Reilly: What did they say? I'm curious.

Lewis: Honestly, a lot of that stuff is way over my head. I'll stick to the stocks and talk about it that way. It's something that they provide some color to if you want some reassurance there, but the reality is: This is a macroeconomic factor that's going to impact almost every multinational company.

O'Reilly: This is going to keep going. Yeah.

Lewis: For them to keep posting these kind of results in spite of that is fantastic, I think.

O'Reilly: The stock was up modestly. I think it was up 2% after hours when the earnings first came out and you mentioned that it was up 5% since then.

Lewis: Over the last couple of days, yeah.

O'Reilly: I assume that forward guidance was decent?

Lewis: It was pretty solid. Revenue expected to be somewhere in the neighborhood of $75.5 billion to $77.5 billion. That's compared to fiscal year Q1 2015 of $74.6 billion.

O'Reilly: Gross margins of 39%-40%. Good Lord. I'm looking at the note here. Before we sign off, did Tim Cook say anything interesting?

Lewis: Yeah. There were a couple things he got into that we could talk about a little bit more, specific to certain segments, but I think something that was reassuring to analysts on the call...

O'Reilly: He's raising prices, isn't he?

Lewis: He alluded to the fact that he expected growth in the iPhone segment. One of the analysts had drilled him on that and said, "Is this something that we're going to see because of units, or see because of ASPs? What will be driving that?" He said, "It's going to be both."

O'Reilly: Awesome.

Lewis: We should expect that ASP trend to continue to go up and strong unit growth as well.

O'Reilly: Cool. Before we move on, I wanted to point our listeners to a newly redesigned focus.fool.com. There, you'll discover a special offer to join The Motley Fool's Stock Advisor newsletter for all Industry Focus listeners. All loyal IF listeners have access to a special discount on Stock Advisor that works out to $129 for a full two-year subscription. Just go to focus.fool.com to take advantage of this offer. Once again, that's focus.fool.com.

The other trick to Apple that we don't talk about a lot is their enterprise segment. What do they talk about in the quarter?

Lewis: I love this quote from Tim Cook. "The enterprise business segment is not to be underestimated. I doubt how many people knew that we had a $25 billion enterprise business that we quietly built in not too many years."

O'Reilly: Surprise!

Lewis: Right? Yeah. This is the first time that I've seen that they've put a value on it. I looked back at the last three quarterly reports -- basically an entire fiscal year -- and all mentions of it were specific to initiatives that they had undergone with IBM or other partners or some of the things that they're doing in the space. Nothing had said, "This is what it is."

O'Reilly: Just for our listeners that may not know what Apple's enterprise business does -- or me -- they're clearly not doing what AWS does at Amazon for storing data for companies. What are they doing?

Lewis: It's basically like a more mobile-friendly solution for a lot of these major businesses. It's just enabling the workforce to be a bit more flexible with the platforms that they're working on. I think one of the big struggles right now, everything that's specific to enterprise generally has to do with iPad, iPhone, or Mac, the three major hardware segments for them. I think one of the limitations that Tim Cook has talked about in past quarterly calls is having the right productivity solutions in place to support what people need to be doing on their devices.

I think one of the things we're seeing -- and maybe this is in response to and trying to catalyze their enterprise segment -- is the iPad Pro, which will launch in November, and some of the functionality that we're seeing with that and the iPencil and making it a more robust offering so it's not this "Netflix Watching Device." It's something that you could work on comfortably whether it's design work, maybe some Excel work.

I've seen some solutions that are more Bloomberg-oriented. You're clearly getting into a much more niche audience with that kind of stuff. They've also talked about some of their strategic partnerships with Cisco... some of the stuff they've been doing with IBM; it looks like they're scatter-shooting here a bit and getting the products out there a little more.

O'Reilly: Moving on to the story of the day, which was their performance in China. Everyone is macroeconomically talking about the slowdowns in China and all this stuff. Apple probably has a different opinion.

Lewis: Yeah. They don't seem fazed by it at all.

O'Reilly: Their middle-class consumer market is the population of the United States. That's going for them. What was it? 65% year-over-year growth in emerging markets? What was it in China?

Lewis: 99% year over year.

O'Reilly: Oh my gosh!

Lewis: That's $12.5 billion. Insane. The iPhone 6 was the number one selling smartphone in mainland China last quarter, iPhone 6 Plus was the number three selling smartphone.

O'Reilly: Wow.

Lewis: Obviously, U.S., and Europe, their luxury brands there enjoy a certain branch cache. I thinks that's even truer of the Chinese market. I think that's why they've enjoyed so much success and why they'll continue to enjoy it. You think about how big their footprint is there and it's tiny compared to the addressable market.

O'Reilly: I visited China in 2009 and the thing that struck me was the dominance of American brands there. Pizza Hut was a luxury restaurant. It was amazing. You had a LeBron James cutout in McDonald's. To see Apple as this premium brand there, perhaps more so than here, you need to slap yourself. What was the statistic in China? Sixty-nine percent of the people that purchased an iPad, it was the first tablet they've ever owned.

Of course, if you're going to try out a tablet, I'd definitely want this experience. The iPad is a sure bet -- 40% of the people that bought the iPad have never owned an Apple product.

Lewis: Yeah.

O'Reilly: That sounds weird to me.

Lewis: Usually, you don't think of the iPad as the intro product for them.

O'Reilly: Right. I think it would be a phone or a computer.

Lewis: Yeah. It's just another way for them to get people into their ecosystem.

O'Reilly: Right. I'm also particularly curious, because we've done many shows about how coy Apple has been regarding the watch. Did they say anything?

Lewis: It was another struggle for clarity... the watch. This is something we talked about with the last earnings call and how they'd been cagey. They talked about their other business segments, but they didn't break out specifically what the watch contributed to that.

O'Reilly: Apple Watch accounted for more than 100% of the year-over-year growth in net sales of other products. This is the same stuff they pulled last quarter. Other products and "We're satisfied with the growth. It's met our internal projections."

Lewis: Yeah.

O'Reilly: Can you add any more color here?

Lewis: We're lucky because some other tech outlets have been very good about digging through the data and helping us out. VentureBeat's Chris O'Brien ran through the 10Q and plugged some great info for us. As you mentioned, the 100% year-over-year growth in the "other products" segment -- a little math here -- if other products grew from roughly $8.4 billion in 2014 to just over $10 billion in 2015; that's being driven by 100% growth in the watch specifically.

That ballparks that Apple sold about 1.7 billion watches. When you factor in the fact that it was only available for less than half a year you annualize that out and say that this is at least a $3.5 billion segment for them if you were to look at a whole year. I think one of the other things that you have to find pretty encouraging about the Apple Watch is, last time we talked they said, "June was stronger than May or April."

This was something that a lot of people were worried about; that sales were declining and weakening, rather than strengthening, as the product was available for a longer period of time. It ended the quarter stronger than it began at last quarter, and they said in this conference call, that it was up sequentially. So you're seeing growth on growth, which is great. The problem is that we don't have much more insight than that.

O'Reilly: No, we don't. Unbelievable. I really can't wait for three to four months from now to find out how the watch performs during the holiday season. How many stockings is this device going to be in?

Lewis: It's the perfect size.

O'Reilly: For sure. It is perfect! Yeah, perfect stocking stuffer, ladies and gentlemen. Dylan, thanks for your thoughts. Let's go get some pizza and we'll look at some crazy costumes.

Lewis: Sounds great.

O'Reilly: Awesome. If you are a loyal listener and have questions or comments, we would love to hear from you. Just email us at IndustryFocus@Fool.com. Again, that's IndustryFocus@Fool.com. As always, people on this program may have interests in the stocks that they talk about, and The Motley Fool may have formal recommendations for or against those stocks. So don't buy or sell anything based solely on what you hear on this program. For Dylan Lewis, I'm Sean O'Reilly. Thanks for listening, and Fool on!

Dylan Lewis has no position in any stocks mentioned. Sean O'Reilly has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon.com, Apple, and Netflix. The Motley Fool recommends Cisco Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.