Apple Earnings Call Nuggets: Margin Recovery and Competitive Landscape

Apple (NASDAQ:AAPL) recently reported its second quarter earnings and discussed the following topics in its earnings conference call.

Margin Recovery

Kathryn Huberty – Morgan Stanley: Peter, given gross margin did come in at the low end of guidance this quarter and you’re looking for another downtick in June, can you just rank for us the biggest factors that are limiting the margin recovery, and as I assume, costs are coming down with the new product? And then I have a follow-up.

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Peter Oppenheimer – SVP and CFO: Sure. In the March quarter, our gross margin was 37.5%. It was at the low end of our range. We had a few items that on balance resulted in us reporting at the low-end. They included mix, in particular selling more iPads than we had planned, including getting iPad mini into our four to six-week channel inventory range. Some changes in our service policies that required us to make provisions from prior quarter sales, and we have some unfavorable adjustments. As I look forward to the June quarter, we’re guiding gross margin to be down between 50 and 150 basis points sequentially. We see two factors impacting the gross margin sequentially. First, and the largest of the two, is the loss of leverage on sequentially lower revenue, and second, a different product mix. We expect both of these headwinds to be partially offset by better cost in the quarter.

Kathryn Huberty – Morgan Stanley: Tim, question for you on China. Growth did slow in that market to single digit this quarter. Curious of your perspective as to whether Apple’s hitting a wall, given you don’t have the largest carrier formally selling your products? And then just any thoughts around the stickiness of customers in China, given you don’t have an iTunes Store there, and data shows that they download fewer apps than in developed countries? Thanks.

Tim Cook – CEO: We actually had our best quarter ever in Greater China. It was a record for us. The revenue came in at $8.8 billion. That includes our retail stores that are in that region. That’s up 11% year-on-year, again, that includes our retail stores that are in that region, which is the same as our – same as the Apple is growing. The highlights for the quarter in China were that iPads grew 138% year-on-year and we set new records for sell-through for iPhone and iPad during the quarter. There were some significant year-over-year timing differences with regard to channel inventory relative to iPhone that affected the compare year-over-year. In particular, in the year-ago quarter, we increased iPhone channel inventories globally by 2.6 million. As you probably recall, 1.6 million of the 2.6 million occurred in Greater China to support the launces that were in the March quarter of last year. So, if you look at revenue on a sell-through basis, Greater China revenue was actually up approximately 18%. And so, it’s a bit better than it first looked. As I’ve said in the year-ago quarter, we launched the iPhone 4S with China Unicom in January and we launched China Telecom in March. This year the iPhone 5 launched in December. And so, it’s a very different set of dynamics on a year-on-year basis. Going forward, we still see significant opportunity in China. It’s a great market. We have 11 stores there. We expect to double those in less than two years. We have added about 8,000 iPhone point-of-sales in the indirect channel to about 19,000 today, and we obviously have a plan to add more and further grow our distribution. This number is, obviously, too low currently. We’re also innovating in our online – with our online store there and adding different functionality to the store. China has an unusually large number of potential first time smartphone buyers, and that’s not lost on us. We’ve seen a significant interest in iPhone 4 there, and have recently made it even more affordable to make it even more attractive to those first-time buyers. So, we’re hopeful that that will help iPhone sales in the future.

Competitive Landscape

Bill Shope – Goldman Sachs: Tim, you mentioned several factors that were compressing growth in gross margins in recent quarters and this year, but can you comment a bit more on the competitive landscape in 2013 versus 2012? How has it surprised you and what do you think the Company needs to reinvigorate your share gains across your key product categories?

Tim Cook – CEO: Bill, I think the smartphone market has always been competitive. The names have been changed. The names of competitors have change. In the beginning, RIM was sort of the very – the strongest player, because the smartphone as you know really got going in the enterprise area. And of course today, our top competitor from a hardware point of view would be Samsung and married to Google on the operating system side. They are obviously tough competitors, but we feel that we have the best products by far, and we are continuing to invest in innovative products and feel really, really confident about our product pipeline in both hardware, software and also services. We have the best ecosystem by far, and we’re just going to keep augmenting it and making it better and better, and that shows up in both our loyalty ratings and our customer sat. And so, I feel very good about our competitive position.

Bill Shope – Goldman Sachs: One more question if I may. Can you comment on how you are thinking about the pace of your buyback program, and what factors are you going to consider to determine purchase timing over the next few years?

Peter Oppenheimer – SVP and CFO: Bill, it’s Peter, I’ll take that. We’re going to begin buying shares under the authorization beginning this month. We expect to utilize the remaining $58 billion under the authorization by the end of calendar year 2015, which spans 32 months from now. We expect to use accelerated share repurchase programs and to buy in the open market.

A Closer Look: Apple Earnings Cheat Sheet>>