In this week's Technology Industry Focus, Sean O'Reilly and Dylan Lewis go over the numbers -- revenues, currency impacts, earnings per share, gross margins -- and Wall Street's reaction to them. Also, one huge project Amazon's been working on that's finally ready to start rolling in profits, and one number that analysts had to read between the lines to find from Apple's call.
A full transcript follows the video.
This podcast was recorded on Jan. 29, 2016.
Sean O'Reilly: Amazon was solidly profitable, but it wasn't good enough for the Street. All that and more on this tech edition of Industry Focus.
Greetings, Fools! Sean O'Reilly here at Fool headquarters in Alexandria, Virginia. It is Friday, January 29th, 2016, and joining me to chat about several depressing earnings reports is my write-in candidate for president this November, Mr. Dylan Lewis. What's up, man?
Dylan Lewis: Oh, I like that.
O'Reilly: I was sitting there, looking around, like, "I don't like any of these... I'm going to write in Dylan! He'll be the only guy that gets one vote."
Dylan Lewis: For our listeners, Sean was very proud of the intro that he came up with today.
O'Reilly: I thought it was funny.
Lewis: I thought it was pretty good. I'm flattered that you would vote for me over Mickey Mouse. That's the de facto write-in candidate, right?
O'Reilly: Doesn't Mickey Mouse get, like, 10,000 votes every time?
Lewis: He gets enough.
O'Reilly: The Mouse gets enough? I don't know. I'm thinking about doing something wacky this November. Anyways. Dylan, before we dive into some rather sad earnings reports, I mentioned our resolutions write-ups -- which can be found on resolutions.fool.com -- on the show with Vince on Tuesday. I wanted to see if you'd be willing to give our listeners just a little bit of a taste of what you wrote about.
Lewis: Yeah. So, as the single-without-child guy...
O'Reilly: Bohemian that lives in Columbia Heights, D.C.
Lewis: ... in the group of editor-analysts at fool.com, I didn't have something heartwarming like a wedding or--
O'Reilly: A child.
Lewis: ... saving for a child or anything like that. Mine were all very selfish and focused on me.
O'Reilly: Are you putting more money in your 401(k)?
O'Reilly: Just saying (laughs).
Lewis: One of them was up my 401(k) percentage. I went from 9% to 12%, which I took care of already.
O'Reilly: Ooh, good.
Lewis: Yeah. Well, beyond the Fool's generous match policy. And then, I have an old 401(k) from a previous employer, I'm looking to roll that over.
O'Reilly: It has like $800 in it or something?
Lewis: Yeah, it's small, it's a couple hundred bucks. But the expense ratios on some of the funds that it's broken out into are just... not stomachable. So I need to move that over. Then, lastly, tuck away some money in my Roth that I've been neglecting for a year or two.
Lewis: So, I will take care of those. I will say I have one tech-related resolution...
O'Reilly: What?! Hold on, hello.
Lewis: ... this is the tech show. I currently do not own any FANG stocks. That's Facebook, Amazon, Netflix, or Google.
O'Reilly: Well, a bunch of them are down, except for Facebook, right now. So...
Lewis: Yeah. And one of my reasons for not having owned them is I really struggled with the valuations. I cover tech, I should be able to stomach those kinds of valuations. But one of my resolutions is to buy one of those...
O'Reilly: A tech stock.
Lewis: So, maybe that will be a show to come in the future -- which one I choose and why I choose it.
O'Reilly: Which FANG. All right, cool. All right, so diving in. We're going to do Apple first?
Lewis: All right. Let's do Apple first.
O'Reilly: Sound good? How did they do? Big numbers.
Lewis: Big numbers. Revenue came in at $75.8 billion, within guidance but below analyst estimates.
O'Reilly: Dylan, say it with a little bit of respect. 75... I'm just kidding. It's fine.
Lewis: Earnings clocked in at $3.28 per share, beating analyst expectations of $3.23 per share. Obviously, the third big number that most people are looking at when it comes to Apple's earnings are iPhone sales.
O'Reilly: It's really the only number.
Lewis: Yeah, given that it's two-thirds of their revenue base. IPhone sales were 74.8 million units for the quarter, which was up 300,000 units over the previous year.
O'Reilly: That's not a lot. I mean, I'm not looking at a percentage, but that's not a lot (laughs).
Lewis: Yeah. You're not used to seeing increases...
O'Reilly: Hundreds of thousands. What?
Lewis: Increases of less than a million, right? And I think that was probably part of the problem, really. I just mentioned it's two-thirds of their revenue base.
O'Reilly: Three hundred thousand is an apartment complex in China. Like... (laughs)
Lewis: (laughs) Yeah.
O'Reilly: What is this?
Lewis: A city, even. So, despite guidance that they'd laid out in the previous quarter that had said there would be segment growth, obviously, investors were a little worried coming into the report. There have been some bearish signals from Apple suppliers, notably Taiwan Semiconductor, which is something we talked about before on the show, little while back. So, a lot of people worried about iPhone growth and what general revenue growth would look like. Those concerns are obviously somewhat valid. The company did demonstrate growth, which you like to see, it was not up to the Street's expectations, which is why you see some of the dip you've seen in the market recently.
O'Reilly: But, Dylan, they beat on earnings-per-share estimates!
Lewis: Yeah, that's kind of perennially the Apple problem, is, they lay out really solid guidance that at least shows some sort of growth, except for this upcoming quarter, which is something we can get into, but the Street always wants more.
O'Reilly: OK. They already own America, how are they doing internationally?
Lewis: On a constant currency basis, Apple would have reported 8% year-over-year growth, which would have amounted to an extra $5 billion on the top line.
O'Reilly: That would have been nice, right? So, obviously, currencies -- didn't Cook talk about that on the call? Like, "We don't know what's going on, but the world's crazy right now with these currencies." (laughs)
Lewis: Yeah, he touched on it. He was like, "There's just a lot of crazy stuff going on!" That was basically the gist of it (laughs).
O'Reilly: Did you see last night that Japan's going negative with their interest rates?
Lewis: Yeah, my roommate was talking about that!
O'Reilly: They're actually charging you to -- anyways. Sorry to interrupt. Go on.
Lewis: No problem. So, instead, due to the strong dollar, the company and investors had to settle for just a 2% bump. So, you think that's 6 percentage points difference that they face due to headwinds. Looking at China, obviously one of the big markets for them, in fiscal Q4 2015, they experienced year-over-year growth of 99%, which is staggering. This quarter year-over-year growth of 14%. That is a -- I mean, it's still growth.
O'Reilly: Yeah. It's not white-hot or on fire or anything like that.
Lewis: But it's definitely a "pump the brakes a little bit" on that segment. Similarly, emerging markets' 65% growth in fiscal Q4 2015 and this most recent quarter 11% growth.
O'Reilly: Everybody's worried about China, hard landings, all this stuff right now. Cook's still bullish on them, right? He's optimistic?
Lewis: Yeah. The general tone that you got from the conference call was, we're going to continue our rollout plans. I think they have the aim... I think there's something like 28 stores in China right now...
O'Reilly: That's it?
Lewis: ... and they're looking to get to something like 40 in the next year or two. None of this has affected those plans. They're still going to run through with that. But the foreign stuff is a legitimate concern. Two-thirds of Apple's revenue comes from outside the U.S. at this point. So the strong dollar, while it's fantastic for them buying components and things like that, does make it tough to operate in some of these foreign markets.
O'Reilly: Long term, though, that is a pendulum that'll probably swing the other way eventually, I would think.
Lewis: You have to think. We're not really in the business of macroeconomics.
O'Reilly: Protocols and George Soros-y-type stuff.
Lewis: And I think one of the things that's always preached is, you can't predict which way currencies are going to move or what's going to happen on the more global scale, but the companies that are operating well have great products and satisfied customers are going to continue to operate in that way. I think that's what we're seeing here with Apple. That said, they have had to make some regional price adjustments.
O'Reilly: Up or down? (laughs)
Lewis: Up, to counter some of the currency issues and devaluations. So, Luca Maestri, the CFO, I think some of his comments during the conference call had alluded to the fact that they've made some moves, but it's possible there could be a ceiling at some point. There's a trade-off when you raise prices that you're diminishing demand. So, I think they know that inflection point is somewhere off in the distance.
O'Reilly: Because you're willing to pay $100, $150 or whatever above a comparable Samsung for an iPhone, but once you start getting above that, it's like, yeah...
Lewis: Yeah, the brand cachet they have only offers so much pricing elasticity.
O'Reilly: They're not quite Tiffany. Someday. So, we keep mentioning the conference call. What was your best takeaway or tidbit for our listeners from the conference call?
Lewis: I really honed in on the gross margins. The reason I think this is such an awesome thing from the conference call is, something I was talking about is, you can look at financial statements, and you can make numbers look very pretty in a table. Without context or framing for why things are doing certain things, it's very easy to just say, "OK, that was great" and check it off. And so, during the rundown, running through all the numbers, Luca Maestri highlighted the company's 40.1% gross margin for the quarter, which is actually up from the previous quarter's 39.9%. That's not really...
O'Reilly: 0.2%? (laughs)
Lewis: ... a 20 basis-point bump, but that's not really the whole story. In December, Samsung paid Apple $548 million to settle a long-standing patent dispute between the two companies.
O'Reilly: Naughty, naughty Samsung.
Lewis: And this is actually something we also talked about, maybe in late December or something on the podcast. So, that baked into the topline number that that gross margin is based on--
O'Reilly: So, really, it didn't grow.
Lewis: More of an operational metric, and this is something Maestri has talked about after being pressed on it from one of the analysts that covers Apple, that $550 million figure contributed something like a 40 basis-point change in gross margins. So, the more accurate gross margin number on a products side is closer to 39.7%. And that's actually down both sequentially and year-over-year. So, you know, anytime you see that 40% gross margin, that's pretty gaudy, right?
Lewis: That's something Apple's going to play up. That's not a sustainable number here, and I think, when you look at what they've guided for for the next quarter, it's somewhere between 39-39.5%, that just reinforces the fact that that's closer to where the real number is. So, I love that, particularly just because it showed how great getting into the weeds on the conference call can be and how valuable it can be for investors.
O'Reilly: Given Apple's bank account of $150-180 billion, do you think they bothered cashing the $548 million check?
Lewis: I think they did.
O'Reilly: You think?
O'Reilly: Maybe played a game with it? (laughs)
Lewis: I think those cash reserves were somewhere in the neighborhood of $213 billion, and 93% of that is held overseas at the moment.
O'Reilly: Oh my gosh. My point is, a $548 million check is like you and me getting a $50 bill.
Lewis: Yeah, it's a drop in the bucket, but they'll happily take it, especially if it boosts margins.
O'Reilly: Last but not least before we get an outlook, what's up with the Watch? Did they sell anymore? Did they sell 10 more Watches?
Lewis: This is the struggle. There's not a lot of info on the Apple Watch.
O'Reilly: So, they're being coy about it still.
Lewis: Yeah, and with the iPhone line, they give average selling price, which is a metric people watch very carefully, and they give units. So, you can say, "OK, this is what the revenue contribution is," it's very easy. But they don't really do that aside from segment reportings, so, looking at like, the services, things like that. So, all we really got on Apple Watch is, "As we expected, we set a new quarterly record for Apple Watch sales, with especially strong sales in the month of December."
O'Reilly: It seems like the Apple Watch is... I'm far less bullish on the Watch than I was or am currently on AWS, but it seems like Apple's AWS. Like, they're going to be coy about it until it's big.
Lewis: That could be. I think that's got to be the strategy for tech firms. We've seen several companies do that at this point.
O'Reilly: So, how is it, looking going forward? We're well into 2016 now, what's up?
Lewis: Yeah. We talked about this on the walk down to the studio, at a $750 billion valuation--
O'Reilly: They're going to make it to a trillion, Dylan. Don't say it.
Lewis: You know, like, they were a couple months ago, there's only really so much room to grow. Now, they're back somewhere in the neighborhood of $500 billion, $550 billion.
O'Reilly: So they have to sell cars.
Lewis: (laughs) So there's a little bit more growth available to them. I think the crazy growth story that we've seen over the last three, four years, is not going to be the story moving forward. That said, some of the customer satisfaction numbers they pointed to, it was like 97% customer satisfaction for a lot of their products, in the conference call, from all these different various research firms. I think that's very telling. Like we talked about, these macroeconomic factors that are impacting emerging markets, it's going to persist for a while, but it's going to be short-lived, I think. And you have to love a company that has the devout following and nice dividend kicker that Apple does. I don't think they're going anywhere in that respect. So, I still like them. I own them, so maybe I'm a little bit biased here. But I don't have any real reason to worry. Any thoughts?
O'Reilly: No, that's it. If anybody wants to check it out -- what's the title of that Daniel Sparks piece? It's slipping my mind. He compares them to McDonald's.
Lewis: Oh, yeah, I know the one you're talking about.
Lewis: If you email us and you want it, we'll find the link and send it to you guys.
O'Reilly: Yeah, or just google Motley Fool Daniel Sparks and look for it. Basically, he compares the valuation of Apple to McDonald's, and it's, like, the world's premier tech firm, and it's valued at like 40% less on a P/E basis than McDonald's or something. McDonald's has a P/E of like 20, and they're not growing.
Lewis: Yeah. You look at it, they're at 10 right now on P/E? Something like that?
Lewis: So, it's extremely reasonably valued.
O'Reilly: Is that backing out the cash or not? (laughs)
Lewis: I don't know.
O'Reilly: Anyways. That's fine. All right, before we move on to Amazon, I wanted to point our listeners to the newly redesigned focus.fool.com. There, you'll discover a special offer to join The Motley Fool's Stock Advisor newsletter to start your year off Foolishly. 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.
And now, we're talking Amazon earnings. Should we switch seats?
Lewis: Yeah, proverbially. But not literally.
Lewis: Yeah, because, remember last time we did that...
O'Reilly: Austin is going to get mad.
Lewis: Austin won't be thrilled, because it messed up all his camera shots. So, I'll take host lead here. What do things look like for the quarter, Sean?
O'Reilly: I liked it, but Wall Street did not. I think it was down after hours last night by 12%-13%. It's down 8% right now, but it's still higher than it was three months ago, so whatever. Anyways, net sales for the fourth quarter increased 22% to $35.7 billion, and that's, of course, up from $29 billion in the fourth quarter of 2014. So, I mean, that's a 26% increase. Operating income for the fourth quarter increased 88% to $1.1 billion, compared with operating income of $591 million in Q4 2015. Net income for the quarter came in at $1 per share exactly, which, I don't know, it's kind of weird. I wondered, like, if they could make...
Lewis: A little too round.
O'Reilly: A little too round. What are you doing, Jeff Bezos? Wall Street was expecting $1.55 per share, hence the huge miss that anybody that goes to the Internet today will see as being cited. But in the same period last year for the quarter earned $0.45. So this is not...
Lewis: Yeah. This is a company that's new to profitability.
O'Reilly: Yeah, this is what, only their eight quarter of showing gap profits for years?
Lewis: Yeah, if I had said two years ago, "Amazon's going to miss a positive net income estimate by $0.06," you'd be like, "What?"
O'Reilly: "What? Amazon? They're going to have a gap profit? I'm going to buy the stock!" For the full year -- these full-year numbers are awesome. Operating cash flow, which everybody talks about Amazon's cash flow, so that's why I'm highlighting it.
Lewis: And that's really the number to look at.
O'Reilly: Right, yeah. Heck, gap profits were like... they're a joke for anybody but particularly for Amazon. Anyways. Operating cash flow increased 74% to $11.9 billion for the trailing 12 months, compared with $6.8 billion as of Dec. 31st, 2014. Free cash flow for the full year was $7.3 billion, up from $1.9 billion last year. Even taking out the least principle payments, all the machinery and that good stuff, it still came in at $4.7 billion. So, they're throwing off billions of dollars in free cash, and God knows Jeff Bezos is going to keep spending it on new initiatives, on drones and stuff. But that's fine. Anyways.
Lewis: One of the more interesting notes that I saw when I read through the conference call, someone was pressing them a little bit about some of their logistics efforts and those sides of the business...
O'Reilly: Did you see the photo I took of the Amazon truck?
Lewis: Yeah. And, they were saying, "Is this something that's intended to supplant your current infrastructure and the outside businesses that you work with and rely on?" And they said, "No. I mean, we want to do this so that we can handle extra capacity during particularly busy times." And I think having this kind of money enables the company...
O'Reilly: Did he wink at the end when he said that?
Lewis: Yeah, like, "Just kidding!" (laughs) No, that seems to be the plan. And having this kind of free cash flow available allows for those kinds of investments.
O'Reilly: And to your point, the Amazon truck that I took a photo of and showed around the office, it was there on a Sunday, which, the postal service isn't running, and they still want to get me my diapers for my son. And I know they were using it, because I was talking to Buck Hartzell upstairs, I think, and he noticed there were lots of Amazon trucks running around, just playing catch-up during the holidays. So, as of now, that's true. Prime memberships, everybody's favorite service, increased 51% in 2015.
O'Reilly: That actually includes 47% growth in the U.S., so it's actually slightly better overseas. That's crazy, though!
Lewis: I don't know exactly what the stat is off the top of my head, but I think Prime members spend like threefold what standard members do.
O'Reilly: Yeah. They spend over $1,000 a year on average. AWS, everybody's favorite cloud computing business that stores all my photos of the last two years of my son -- I actually think I just got the count. I have like 30GB of photos and videos.
O'Reilly: It's bad.
Lewis: And how old is your son?
O'Reilly: He's two! Extrapolate this, I'm going to be to a terabyte by his 10th birthday.
Lewis: And plus, I mean, you get the first out of the way now. There's some interesting stuff there. But, he's going to be doing chorus concerts, baseball games...
O'Reilly: It's going to be bad, bad.
Lewis: There's going to be a lot of video in the next couple years.
O'Reilly: So, thank you, Amazon, for storing my son's life. That accounted for $2.4 billion of the sales, in the fourth quarter, and it finished the year at $7.9 billion of total revenues. So, that's like 8% of the revenues, because they're just over $100, I think. For the quarter. Anyways. I'm going to skip forward to this chart I have later in the notes.
Lewis: Sean titled this, in our outline, "More on AWS -- That is One Pretty Chart."
O'Reilly: AWS's operating margin, I don't even know what AWS' costs are. It's just a bunch of servers in a room. Stop me?
Lewis: It's a lot of physical infrastructure they had to set up. I mean, the services that power those cost some money.
O'Reilly: And a bunch of programmers, I assume. Anyways, it looks like the gross margin was about 7.5% back in Q2 2014, so flash-forward a year and a half, it is a 45-degree angle straight up, Q4 2015 AWS gross margin was just under 30%. They built out all that infrastructure, they got the customers coming in, and it's just all icing on the cake.
Lewis: I think the thing you have to love about those kinds of margins is, it's such a scaleable business.
O'Reilly: It's going to get even better. It's awesome.
Lewis: It's crazy, how easy it is for them to roll it out and increase that customer base.
O'Reilly: I first heard about this, that hedge fund manager, he's retired now, but Stanley Druckenmiller, he was George Soros' general, or chief trigger puller or whatever you want to call him in 90s. I saw him give an interview on CNBC, and he was talking about how much he loves Jeff Bezos and Amazon. He's like, "Listen, Bezos is a serial monopolist, AWS is killing it, it's so scaleable and everything." And I didn't quite get what he was talking about then, because, honestly, this was like two years ago, this was the first time I'd heard of AWS, and then you see it, it's like, "Oh my gosh, they're going to kill everybody!" They're beating Microsoft at all this cloud storage stuff, it's a big deal.
Lewis: Yeah, they tag themselves as the best in the biz.
O'Reilly: Proof's in the pudding.
Lewis: Wall Street was disappointed, some of the headline figures that a lot of people tend to fixate on these quick briefs were disappointing. Sounds like things were pretty good. What is the outlook like for the company over the next year or two?
O'Reilly: They were pretty conservative with their outlook. They guided for revenues in the first quarter of about $29-31 billion, I mean, obviously, the fourth quarter is always way bigger because of Christmas and all that. But they were pretty conservative. None of the analysis that I read seemed to imply that Wall Street was disappointed with the forward guidance, they were just mad that they missed on gap earnings, and that was it. But the trends that I'm seeing, and the absolute dollar numbers, are awesome.
Lewis: So, maybe the lesson here is, as a company is newly profitable, there is going to be some volatility in what that profitability looks like, particularly if it's a high-growth company that takes a lot of moonshot projects on.
O'Reilly: Exactly, yeah. So, I like what's going on. Anyways.
If you're a loyal listener and have questions or comments, we would love to hear from you. Just email us [email protected] Again, that's [email protected] As always, people on this program may have interests in the stocks 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!