By Jason Snell
May 2, 2017 3:53 PM PT
Last updated July 30, 2020
Q2 2017 call transcript: Apple’s answers to analyst’s questions
Note: This story has not been updated since 2020.
Here’s a transcript of what I always consider the most interesting part of the Apple financial call, the question-and-answer session between a few analysts and Apple executives. Qualcomm lawsuits, lack of growth in China, the future of Apple in India, and the effect of news coverage of future iPhones are all covered…
Katie Huberty, Morgan Stanley: My first question is for Luca, around gross margins. How were you able to expand gross margins sequentially and guide rather seasonally for the June quarter in light of what’s going on in the memory market? And maybe if you can comment in particular whether the hold back of payments to Qualcomm is benefiting you at all on gross margins year on year? And also, whether your contracts around commodity prices is likely to hit gross margins by more in the back half of this calendar year.
Luca Maestri, Apple CFO: Thank you, Katie. A lot of questions. Let me take it one by one. Let me start with the performance for the March quarter, which we were very happy with. As you said, we were up 40 basis points sequentially and this is in spite of the fact as you know that we lose leverage as we go from the December quarter to the March quarter, foreign-exchange headwind on a sequential basis 100 basis points. Obviously that was also a negative and as you said we started to experience some level of cost pressure on the memory side particularly on on and on NAND and DRAM. To offset that and actually do better than that, we had very good cost performance on other commodities. And the fact that our services mix increases as we go through the year, that is, of course, also helping. Given the profile of our gross margin for services. But that answers the question around Q2.
LM: As we move into the June quarter, as you know, we tend to have some level of gross margin compression as we go from the March quarter to the June quarter. Again the majority of that comes from the sequential loss of leverage. We also have a different mix of products as we move into that into the June quarter and the cost pressures on memory will will remain. We expect to offset, partially, these impacts with other cost efficiencies. And again with the mix shift towards towards services. The impact on NAND and DRAM will continue to be there and we expect it to be there. You know, we don’t guide past the June quarter but we expect it to be there for the time for the time being.
On Qualcomm, I just want to make it very very clear that we are accruing. We do not expect to be paid more than what we are accruing right now. So we didn’t get any benefit in our P&L, in our margins, during the March quarter and we’re not getting any benefit during the June quarter either.
Huberty: Thank you, and just a follow up for for Tim: As you noted in your remarks the iPhone 7 Plus demand is selling incredibly well and this is a product that was pretty severely supply constrained in the December quarter. And I just wonder whether there are any lessons learned as you go forward into future product launches around how you manage the timing of announcing a product when there are supply constraints, and how you might work with the supply chain differently around ramping some of these components that have particular difficulties around the yields early on.
Tim Cook, Apple CEO: Katie, one of the things that we did not get right was the mix between the iPhone 7 and the iPhone 7 Plus. It wound up, the demand was much stronger to the 7 Plus than we had predicted and so it took us a little while to adjust all the way back through the supply chain and to bring iPhone 7 Plus into balance, which occurred early this past quarter. What do we learn from it? Every time we go through a launch we learn something, and you can bet that we’re brushing up our models and we’ll apply everything we learn to the next time.
Shannon Cross, Cross Research: Tim, can you talk a bit about what’s going on in China and give us some more more color, especially as you’re going into the year and then and obviously won’t talk about the next product launch but just, are there any shifts in demand with greater China down 14 percent? Was it all iPhone or a mix.
TC: We saw it in Q2 the performance that, combined with Q1, in the form in the first half of the year was much better than what we experienced in the second half of last year. And if you look at what was driving that, iPhone 7 Plus… we sold the highest number of Plus models in the first half than ever before. Compared to 6S Plus or compared to the 6 Plus. Also the Mac business did extremely well. Mac revenue growth was up 20 percent in China, and we had extremely strong services growth during the quarter in China.
As I’d mentioned in the in my comments, our retail and online stores did well overall and in China they grew by 21 percent, which is an acceleration from what we had seen in the previous quarter. And traffic, which for us is incredibly important in the retail stores, because we do a lot more than sell, traffic was up 27 percent year on year and now seven of our top 10 highest traffic stores in the world are in greater China. And so that’s the set of things that sort of went in our direction so to speak. On the flip side, currency devalued by 5 percent. And so that’s not an insignificant headwind, and our performance continued to be weak in Hong Kong, which has been hit a bit harder as the tourism market continues to slump. Also, where the iPhone 7 Plus did well, we didn’t perform as well on some of the previous generation iPhones, so that’s sort of the set of things on the plus and minus side.
We did perform about where I thought we would. I thought it would be similar to the previous quarter, and it was. What I now believe is that we’ll improve a bit more during this current quarter. Not back to growth, but improve, but make more progress. And you know we continue to believe that there is an enormous opportunity there. And in the scheme of things are our business is pretty large there.
Cross: Thoughts on cash usage? You increased your program but you still have I think 160 billion of net cash and obviously continue to generate cash, so I’m curious as to, given some of the commentary that’s come out the administration which I think most companies were expecting some sort of return. How do you generally think about what you need to run the business from a cash perspective, how you think about your balance sheet, from a strength perspective, as we look forward to what hopefully will come through.
LM: Shannon, you know how we run our capital return program we’ve been pretty consistent during the last five years. Essentially for the last five years the way we’ve run the company is essentially to return our free cash flow to our investors. That’s what we’ve done with the program until now. And you know the expansion of the program that we’ve announced today goes in the same direction. Right? We know how much we need to invest in that business. We will never underinvest in the business. We are in a very fortunate position that we generate cash beyond the needs that we have and given the current capital structure that we have, we decided that until now we return about 100 percent of the free cash flow to investors. It is difficult for us to speculate about what might or might not happen. The program that we’re announcing today reflects the current tax legislation in this country and there’s a lot that still needs to happen there and we’ll see. Obviously we will reassess our situation if things change.
Rod Hall, J.P. Morgan: I wanted to start off just going back to the 165 million subscriptions and ask Tim or Luca if you could comment on the unique number of users there and I think you had made a comment, Tim, in your prepared remarks that the average revenue per user is up or maybe that was you Luca? But if you guys could just talk about you know any more color around that average revenue per user it would be interesting to us.
LM: We don’t disclose into this number of subscriptions of course. We’re just giving you that the total count of subscriptions that are out there. Of course there are several customers that subscribe to more than one of our services. There is some level of overlap but the total number of subscribers is very, very large. Obviously, less than 165 million. But it’s very good for us to see the breadth of subscriptions that we offer and that customers are interested in. It’s a large number. And if you remember, we quoted the same number a quarter ago and we talked about 150 million. So when you think about a sequential increase of 15 million subscriptions from the December quarter to the March quarter, it really gives you a sense for the momentum that we have on our content stores. It’s quite impressive to have 15 million subscriptions in 90 days. As we look at the dynamics that are happening on our content stores and particularly on the App Store, which is the largest, we see fairly consistently two things: We see that the number of paying accounts is growing a lot, and I mentioned the increase in number of paying accounts that we’ve had during these last 90 days is the largest that we’ve ever had. So there’s a very large number of people coming into the ecosystem, experiencing the ecosystem which is obviously improving all the time in quality and quantity, and then start paying and transacting on our stores. And that number is growing very very, strongly strong double digits.
What we’re also seeing as we look at the people that start paying on our stores, we see a pretty common trend over time, and we keep track of that across cohorts of customers, that as people come into the ecosystem and start paying on the ecosystem, we see a spending profile that is very similar around the world. People start at a certain level and then they tend to spend more over time. And so obviously the combination of people spending more over time and having more people that are now actually spending on the stores, contributes to this 40 percent growth that Tim mentioned for the App Store on a year over year basis.
Hall: Tim, I wanted to just ask… The services revenue keeps growing and of course the profit contribution from that is growing. And we’ve also at the same time I think seen you maybe a little more aggressive than Apple has been historically in pricing certain—key technologies lets call them, that maybe you want to penetrate the market with? And I just wonder if you could just comment a little bit on your strategy there in terms of the usage of that extra profit contribution from that services business. You know, how you intend to apply it to the rest of the business. Thank you.
TC: Rod, the way that we think about pricing is, we come up with a price that we think is a good value for the product that we’re delivering. And we do that on the hardware side as well as on the services side. And so that’s how we think about it. We’re really not thinking about taking profits from one to subsidize the other or vice versa.
Steve Milanovich, UBS: Tim, could you comment on the opportunity in wearables? The watch some people consider disappointing, had what seems to be a very good quarter. And ironically the competition almost seems to be fading in that part of the market right now the AirPods of course are doing well. Do you see wearables, a) expanding over time into a broader product line and b) increasingly being independent of the iPhone longer term?
TC: We have seen the watch as, you know, a really key product category for us since before we launched it. And we took our time to get it right. And we’ve made it even better with the Series 2 offering. And we’re really proud of the growth of the business. You know, Watch units more than doubled in six of our top 10 markets, which is phenomenal growth particularly in a non-holiday quarter. And so we couldn’t be more satisfied with it. As some people are doing, when you begin to combine the watch revenues with the revenues for AirPods, and as you know is the first full quarter of shipments for AirPods, it’s still very much in the ramping mode and we’re not even coming close to satisfying the demand. And then add the Beats products that a group of our customers really enjoy as well. And look on the trailing 12 months—this is not a forecast—that business was was well into the Fortune 500. And so as I look at that, that’s pretty fast to come that far. You know the watch hasn’t been out very long and AirPods have been out there for three, four months. And so we feel really great about it. Where does it go? I wouldn’t want to comment on that. But we do have a really great pipeline here.
And I think in terms of competition falling out and so forth. The watch area is really hard. It in essence from an engineering point of view is similar to a phone in terms of the intricacies and so forth. And so I’m not very surprised that some people are falling out of it, but we’re very committed to it and believe that it’s already a big business and believe over time it will be even larger.
Milanovich: You mentioned the 451 Research survey. They did have a couple of findings that were kind of interesting. One is a nine-year low in iPhone purchase intent, and that might just be where you are in the cycle, and the other was a declining retention rate in the US toward 80 percent. Any comment on either of those and whether you’re concerned?
TC: I only glanced at it. And so I haven’t had time to study it but in general what we are seeing, we’re seeing what we believe to be a pause in purchases on iPhone which we believe are due to the earlier and much more frequent reports about future iPhones. And so that part is clearly going on, and it could be what’s behind the data. I don’t know. But but we are seeing that, in full transparency.
Toni Sacconaghi, Bernstein: Tim, I’m wondering if you can comment on your recent decision and the rationale for withholding royalty payments to Qualcomm. And really specifically, I wonder what you believe is the risk that Qualcomm could have a detrimental response such as withholding modem chip sales or potentially even getting an injunction on iPhones in select geographies around the world. And I’d like to understand your perspective on whether either those are real risks to any degree. And why would Apple potentially take on those risks, you know, just in advance of what will arguably be your most significant and largest product launch in history?
TC: Anyone that has a standards-essential patent has a responsibility to offer it to everyone that would like it under what are called FRAND terms. FRAND stands for “fair reasonable and nondiscriminatory” terms. That’s both the price and the business terms. Qualcomm has not made such an offer to Apple. And so I don’t believe anyone is going to decide to enjoin the iPhone based on that. I think that there’s plenty of case law around that subject, but we shall see.
In terms of why we’re withholding royalties. You can’t pay something when there’s a dispute about the amount. You don’t know how much to pay. And so, you know, they think we owe some amount we think we owe a different amount. And there hasn’t been a meeting of the minds there, and so at this point we need the courts to decide that. Unless we are able to over time settle between us on some amount. But right now we are depending upon the courts to do that. And so that is the thinking. The reason that we’re pursuing this is that Qualcomm’s trying to charge Apple a percentage of the total iPhone value, and they do some really great work around standards essential patents.
But it’s one small part of what an iPhone is. It has nothing to do with the display or the Touch ID or a gazillion other innovations that Apple has done. And so we don’t think that’s right. And so we’re taking a principled stand on it, and we strongly believe we’re in the right. I’m sure they believe that they are. And that’s what courts are for and we’ll let it go with that.
Sacconaghi: Thank you. I was wondering if you if I could just follow up a little bit on iPhone demand. If I try and adjust for the drawdown in inventory and the extra week last quarter, I think sequentially iPhones declined about 27 percent if I make those adjustments. And that’s actually quite a bit lower than the normal seasonality we would see from Q1 and Q2, which is typically closer to 20 percent. I understand your comments around China but your comparison was 40 points easier this quarter relative to last quarter and the growth rate improved only marginally, I think when you adjust for the extra week. And then you made a final comment around “a pause” on iPhones. So I’m wondering if you could maybe elaborate on what’s the below-sequential, at least by my calculation, growth rate in Q2 attributable to a pause. And can you characterize what you think upgrade rates are doing perhaps broadly by geography, to help us better understand what might be happening or whether there are competitive dynamics that that also are at play here that again might be contributing to that pause and that sequential decline that I referenced. Thank you.
TC: Lot of questions there. Let me give you some color as I see it. In this quarter, we reduced channel inventory by 1.2 million units. And so if you look on a year-over-year basis, which is primarily what we look at from a unit point of view because it would have the seasonality embedded in that, we grew sell-through on a year-over-year basis. Last quarter, I’m sure other folks remember, was a 14-week quarter. So you sort of have to adjust the rates last quarter to get out what the underlying sell-through growth was. And so I think that when you do that you’re going to find that actually the year over year performance is similar, between the quarters.
In terms of upgraders, we saw the largest absolute number of upgraders ever in any six-month period in the first half of this year. First half of this fiscal year, to precise. And we saw the largest absolute number of switchers outside of Greater China in the same period that we’ve ever seen. And so in four of the five operating segments, as I think Luca mentioned in his comments, we had very good growth and it was really propelled by the demand for iPhone 7 Plus which is growing incredibly fast around the world. And so that’s kind of the color I would add there and hopefully some of that is useful for you.
Simona Jankowski, Goldman Sachs: Last year you had a 4 million unit channel inventory reduction for the iPhone in the June quarter. So just curious what you’re expecting for this year. Jus so we have an apples to apples comparison if we think about your guidance.
LM: As you know, Simona, we do not provide guidance around units and around channel inventory reduction. But our goal is always to have the right amount of weeks of inventory in the channel. And if you look at our history over the last several years, we have fairly consistently reduced channel inventory in the June quarter, so I think it’s a fair expectation to have.
Jankowski: Tim, you’ve been excited about the India market for some time and have made strides in establishing a retail manufacturing and R&D presence there. So just curious, as you look at the market and the rollout of 4G there, is it reasonable for us to assume that Apple can sell something on the order of 10 to 20 million iPhones there next year and then grow from there.
TC: Yeah, we make it a point not to forecast by geo. We just provide a current quarter forecast. But as hopefully you’ve seen, as we began to give you more information about India we’ve been investing quite a bit. We have a ton of energy going into the country on a number of fronts, and it is the third largest smartphone market in the world today behind China and the United States. And so we believe, particularly now that a 4G infrastructure is going in the country and it’s continuing to be expanded, that there is a huge opportunity for Apple there. And so that’s that, and the demographics of the country is why we’re putting so much energy there.
Jim Suva, Citigroup: Thank you very much and congratulations on returning to growth consistently. That’s great. I believe, Tim, in your prepared comments, you mentioned India was growing double digits, which is great. But I believe if you look at geographic information, India is really under-penetrated from an Apple reception perceptive. But yet they have LTE, you have the iPhone SE, the lower priced iPhone. You think that, say, this next 12-18 months is going to be a turning point, or is it more you need to work with the government to have Apple own stores or production there, or what’s it really going to take to get India going along, because we think it’s really a great opportunity.
TC: Well we think it’s a great opportunity too. And so we’re we’re bringing all the things that we’ve brought to bear in other markets that we’ve eventually done well in. That’s from channel to stores to our ecosystem and so forth. Phil was just over there opening a developer’s center last quarter. So there are a ton of things going on there, and we agree that we are under-penetrated there. Our growth rates are are good—really good by most people’s expectations, maybe not mine as much. And so we’re putting a lot of energy in, just like we have in other geo’s that eventually wound up producing more and more. And so I’m very excited about it. The 4G network investment really began rolling in in a significant way toward the last quarter of last year, as you know. But they are moving fast, they’re moving at a speed that I have not seen, in any other country in the world, once they were started. And it is truly impressive.
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