Limited demand impact, guidance boosts confidence (Apple FY2023Q1 earnings call)

On the morning of February 3, 2023 Beijing time, Apple (AAPL.O) released its Q1 2023 financial report (ending in December 2022) after the US stock market closed.

I. Core Q1 Data vs Market Expectations Snapshot:

1. Revenue: Apple's Q1 revenue was USD 117.2 billion, YoY-5.5%, which is lower than the market's expectations (-3.35% miss).

2. Gross profit margin: The Q1 gross profit margin was 43%, YoY-0.8pct, which is lower than the market's expectations (+0.1pct meet).

3. FY2023 Q2 guidance:

(1) Revenue: The YoY performance is similar to FY2023 Q1, and due to the extra week in FY2023 Q1, the actual income of FY2023 Q2 will increase year on year.

(2) Gross profit margin: 43.5%~44.5%.

For more detailed financial reports, please refer to Dolphin Analyst's comments "Apple: The Thunder Clinging to It Finally Comes Out."

II. Highlights of Performance Meeting:

1. YoY revenue growth rate decrease: It is limited by the strong US dollar, supply interruptions, and weak macroeconomic environment.

2. It is expected that FY2023 Q2 revenue will be similar to FY2023 Q1 (Q1 has one more week, so Q2 actually increases year on year), and the gross profit margin will be 43.5%-44.5%.

3. At the end of FY2023 Q1, iPhone channel inventory was below the target level.

4. Supply has now returned to normal.

5. Artificial intelligence will fully penetrate Apple's products and services.

6. In the future, it will continue to increase its development efforts in the Indian market.

7. If consumer demand is weak, Mac and wearable devices will be affected the most, and the iPhone will be affected the least.

III. Original Text of Performance Meeting:

3.1 Management Speech

1. Overview:

In Q1 2023, Apple's revenue was RMB 117.154 billion, setting a historical record for revenue in markets such as Canada, Indonesia, Mexico, Turkey, Vietnam, Brazil, and India.

Affected by the following three factors, revenue in this quarter fell by 5% year on year:

1. The headwind of exchange rates caused by the strong US dollar, which was negatively affected by nearly 800 basis points of exchange rates. Excluding exchange rate factors, most of the markets in operation achieved year-on-year growth.

2. The epidemic caused the supply of iPhone 14 Pro and iPhone 14 Pro Max to be much lower than planned, and delivery time far exceeded expectations. Currently, production and supply have returned to normal.

3. Macroeconomic challenges, such as inflation, Eastern European wars, and the pandemic.

2. Segmented Business

[1] Hardware

(1) iPhone

Revenue of $65.78 billion, a YoY decrease of 8%, flat YoY excluding exchange rate factors.

Users are very satisfied with the innovation of the camera, battery life, health and safety features. The iPhone 14 series breaks through users' imagination of intelligent smartphones.

(2) Mac

Revenue of $7.7 billion, in line with company expectations. Compared with the same period last year, in addition to the successful launch of the redesigned M1 chip MacBook Pro last year, this year is also facing the adverse macroeconomic environment and forex headwinds.

However, the company is still confident in the long-term development of Mac. In January, it launched the M2 Pro and M2 Max chip MacBook Pro. The M2 Pro and M2 Max chips achieve unprecedented high-performance performance with less energy and not only benefit the environment, but also give the new MacBook Pro the longest battery life in history. In addition, the Mac Mini driven by M2 was launched to improve productivity for all types of users.

(3) iPad

Revenue of $9.4 billion, a YoY increase of 30%, driven by supply constraints.

The versatility of the new series of products has been praised by users. The M2 chip iPad Pro and iPad 10 are equipped with Liquid Retina displays, bringing stunning visual experiences.

(4) Wearable devices, home products, and accessories

Revenue of $13.482 billion, a YoY decrease of 8% due to challenging macro environments and forex headwinds.

Despite the decline in revenue, the company still has a positive outlook on the development prospects of this category of products. A few weeks ago, the new generation of HomePod was released, which provides users with superior audio experience and reliable security through advanced computational audio. Specifically, its voice recognition function can send smoke warnings to users, which will be launched in late spring. Apple Watch 8 and Apple Watch Ultra are also widely praised and loved by users.

[2] Software

(1) Safety and health

In terms of safety, one of the highlights is the emergency satellite rescue function of the iPhone 14 series, which was launched in the US and Canada in November and in France, Germany, Ireland, and the United Kingdom in December.

(2) App

Freeform App was released in December, allowing users to create and collaborate anytime, anywhere, and has received wide acclaim.

(3) Subscription Services

As part of the growing install base, there are now over 2 billion active devices, double that of 7 years ago. The service business generated revenue of $20.8 billion, better than expected. Among them, App Store subscriptions achieved double-digit revenue growth, and cloud and payment categories received the highest revenue in history. Currently, Apple has over 935 million paid users. (4) Apple TV+

Apple has started a 10-year-long partnership with Major League Soccer (MLS) and will broadcast MLS matches on its Apple TV+ from 2023. Yesterday, the company launched MLS Season Tickets, which will broadcast MLS regular-season and playoffs to fans in 100+ countries.

Hits such as Shrinking, Slow Horses, and Truth Be Told have captured many viewers, and Ted Lasso will return in the spring, with a series of popular movies coming soon.

(5) Apple Fitness+

New content has been added to Apple Fitness+, including kickboxing, a new sleep meditation program, and 7 new workout programs, bringing the total number of fitness and meditation categories to 3500+. In addition, a new album "Renaissance" from Beyoncé and Time to Walk 5 will also be available.

(6) Apple Business Connect

Apple has launched Business Connect to help small businesses grow and connect with users. It provides practical tools for all businesses to establish better contact with customers and manage the way more than 1 billion users browse and use products and services every day. Businesses of different sizes can now customize key information for users through applications such as Apple Maps, Messages, Wallet, and Siri.

(7) Retail

1. The Apple Store Online celebrates its 25th anniversary.

2. The new Apple Pacific Centre retail store opened in Vancouver and the Apple American Dream opened in New Jersey.

(8) Privacy and Security

Apple provides users with three new tools to protect their most sensitive data: iMessage contact key verification, security keys for Apple IDs, and advanced data protection for Apple IDs.

(9) Sustainable Development

1. Environment: The latest version of the Mac Mini and MacBook Pro uses 100% recyclable aluminum for the casing, and recyclable rare earth elements are used in all magnets. For the first time, 100% recycled gold is used in the electroplating of multiple printed circuit boards in the HomePod.

2. Black History Month: Apple has launched the Black Unity Collection, including the special edition Apple Watch Black Unity Loop Sport strap, a new watch face, and iPhone wallpapers, to show their support. In addition, it will deepen the support for five organizations through the Racial Equity and Justice Initiative (REJI), which are committed to unlocking creative potential and revitalizing black and brown skin communities through technology.

3. Other: Since the implementation of the donation plan 11 years ago, over $880 million has been donated to humanitarian work, disaster relief, children's education and more. Over the past 16 years, through cooperation with the Red Cross, Apple's supported grants have helped more than 11 million people receive the care and support they need.

3. Performance guidance

(1) Revenue

Given the global economic instability in the short term, specific revenue guidance will not be provided.

1. Business as a whole: Performance is similar to FY2023Q1 on a year-on-year basis, and since FY2023Q1 is one week longer, revenue in FY2023Q2 will increase year-on-year in substance; however, negative foreign exchange impact of 5% is expected.

2. Business segments:

• Services: Although challenged by macroeconomic weakness in advertising and mobile games, revenue is expected to grow year-on-year.

• iPhone: Compared with the same period of 1Q23, it accelerated towards improvement.

• Mac and iPad: Affected by macroeconomic challenges, revenue is expected to decline year-on-year in double digits.

(2) Profit and other

1. Gross margin: 43.5%~44.5%.

2. Total operating expenses: $13.7~13.9 billion.

3. Operating profit: about negative $100 million (excluding any potential impacts from minority investments calculated at market price and a 16% tax rate)

(3) Dividends

A cash dividend of $0.23 per share of common stock will be paid to shareholders registered as of February 13, 2023 on February 16, 2023.

3.2 Q&A session

1. Business as a whole

Q: Reasons for the high gross margin guidance of 43.5%-44.5% for FY2023Q2, and expectations for negative foreign exchange impact

A: Benefiting from seasonal and product service portfolio advantages, gross margin for FY2023Q1 was as high as 43%. In this quarter, the impact of exchange rates on the company's gross margin was about 110 basis points compared to the previous quarter and 300 basis points year-on-year. Clearly, exchange rates have changed greatly in the past 12 months.

In FY2023Q2, the adjustment of product service portfolio and the improvement of cost architecture in components and other aspects will drive the increase of profit margin, with the prospect of 43.5%~44.5%. The exchange rate still has a negative impact of about 50 basis points compared to the previous quarter, but the situation is improving. The US dollar has depreciated in the past few weeks, and it is hoped that the situation will continue to improve this fiscal year. The company is also actively seeking solutions to offset the negative impact of foreign exchange.

Q: How do you view the problem of supply interruption, and how do you manage the supply chain to avoid disruption caused by incidental factors?

A: Supply chain disruptions existed from early November to most of December, but have now resumed normality.

Regarding the future of the supply chain, Apple's product production is spread worldwide, and zero components are supplied from many locations. The five iPhone assembly plants are located in three countries, and we will continue to optimize and adjust the supply chain. Due to the impact of the pandemic and silicon material shortages, the past three years have been quite difficult, but overall, the adaptability of the company's suppliers has been very good. At present, the supply situation this quarter is relatively normal.

Q: The impact of adjustments to China's New Year and pandemic policies on consumption, the main types of products purchased by Chinese consumers, and the company's current market position in China.

A: The Greater China market in FY2023Q1 decreased by 7%, but with fixed exchange rates, it still achieved growth in times of tight supply. In addition, epidemic prevention and control in various parts of China also affected demand this quarter. After adjusting the prevention and control policies in December, there was a significant change in retail store traffic and demand compared to November.

I won't discuss the situation in January too much, but I have included it in the performance guidance. Overall, the change in January compared to December was greater than the change in December compared to November.

Q: The actual and target market share of China and India.

A: Despite these headwinds, business in the Indian market still achieved double-digit growth.

India is a key market of focus for the company, with a very positive outlook for development there. The company will push its retail and manufacturing business in India. In retail, Apple's first store in India is about to open, while in manufacturing, it will continue to drive the export of products such as the iPhone. In the future, the company will continue to increase its investment in the Indian market and will apply the experience of scaling in China several years ago to the development of the Indian market.

There is no specific market share data yet, but overall, although supply constraints exist, the company's market share in various parts of the world increased last quarter, and there should not be much difference in market share between China and India.

Q: How low consumer demand in a poor macroeconomic environment will impact different products?

A: Macs and wearable devices will be most affected, while iPhones will be least affected.

2. iPhone

Q: The number of active device installations exceeded 2 billion, setting a new record. Can you provide the installed base for the end of 2022 and explain the differences in the demographic or monetization aspects between new and old user groups?

A: The number of installations exceeded 2 billion, setting a historical record across all regions and major product categories, which is a widespread fundamental change.

With a year-on-year increase of over 150 million, double-digit growth was achieved in emerging markets such as India and Brazil, which is a good sign.

Q: What is the current level of iPhone channel inventory?

A: The limited supply of the iPhone 14 Pro and iPhone 14 Pro Max means that it was below target levels at the end of FY2023Q1. However, stock was also below target levels last year for the same reason, hopefully providing insight into the company's January situation. Q: Will consumers choose cheaper iPhones or upgrade due to severe shortage of high-end models in November and December?

A: It's difficult to estimate the situation of regaining customers due to unpredictable consumer behavior and time required for obtaining business data.

The company has made the best forecast for the new quarter, and iPhone production has returned to the expected level. If it weren't for the supply shortage, iPhone revenue would have grown this quarter.

Q: Comparison between Pro and non-Pro models

A: iPhone 14 Pro and Pro Max performed very well before supply chain problems emerged. It's difficult to provide specific demand figures. There are many reasons for high demand, mainly driven by product innovation.

The company is very satisfied with the products released in September and is happy to be in the phase of shipping based on demand.

Q: Is a higher ASP sustainable in a difficult macro environment?

A: We do not estimate whether the transition to a higher ASP is sustainable.

iPhone has become an indispensable part of people's lives, including information such as communication, health, smart homes, banks, and many people's payment tools. Therefore, people are willing to do their best to buy the best products they can afford.

3. Services

Q: Artificial intelligence strategy for service business

A: Artificial intelligence is a key focus of the company.

Artificial intelligence can enrich users' lives and empower ECG, which was released last fall with collision detection, fall detection, and electrocardiogram functions, saving many lives.

We see enormous potential in the field of artificial intelligence, which can almost affect everything the company does. This is a cross-sectional technology, not a longitudinal technology, so it will affect all of Apple's products and services.

Q: Is the growth of service business due to an increase in installed base or an increase in ARPU? How do you view the development of installed base and ARPU?

A: 1) The installed base is the engine of service business growth, and the company has found that growth rates in emerging markets are very fast.

1. Customer engagement in the ecosystem continues to increase. For example, both active and paid accounts have seen growth rates of more than double digits.

2. The company will continually improve service quality and launch new services. For example, Apple Pay has gone from being promoted in the United States to being in 70+ markets and serving millions of merchants, and payment services continue to innovate and reach new heights.

Q: Assuming going back to the time when chip prices were higher, and the prices of company products increased, has an estimate been made of the price elasticity?

A: An estimate has been made, but it may differ from the results obtained by financial analysts from a cost perspective.

In addition, the company is TSMC's largest customer in Arizona.

Q: The growth rate of paid accounts in the service business and its comparison with the installed base.

A: The installed base has doubled over the past seven years. The proportion of paid accounts in developed markets and emerging markets tends to increase. In addition, the company has added many new service projects on its platform, such as providing multiple payment methods in many countries, making services more accessible. With the passage of time, the number of paid accounts will increase.

Q: FY2023Q1 growth drivers for service business

A: Mainly due to increased user engagement, which in turn drives up paid subscriptions.

In this quarter, cloud services, payment services, and Apple Music performed strongly, with many subcategories reaching new highs, surpassing the company's expectations at the beginning of the quarter. According to fixed exchange rates, the service business still achieved double-digit growth under the high base of 24% from last year. We believe that the growth of the service business is sustainable.

4. Mac

Q: Expectations for Mac shipments in light of declining PC industry shipments

A: The industry is under pressure in the short term, but has great long-term market potential. Currently, the company has a low market share and the advantage of high-performance chips, which puts it in a favorable position.

No estimates are made for Mac shipments.

Dolphin's Apple historical article retrospective:

Earnings Season

February 3, 2023, earnings review: "Apple: The Thunderbolt That Was Finally Unleashed"

October 28, 2022, phone conference: "Apple: No Boom During the Peak, Tough Times for the Moneymaker (FY2022Q4 Conference Call)"

October 28, 2022, earnings review: "Apple: The Only Giant Standing, But for How Long?"

July 29, 2022, phone conference: "With Only the iPhone Business Covering Its Shame, How Will the Management Respond? (Apple Conference Call)"

July 29, 2022, earnings review: "The Slightly Rising iPhone, Unexpectedly Becomes Apple's Last Piece of 'Clothing'"

April 29, 2022, phone conference: "Apple Presents Weak Guidance Due to Various Factors (Summary of Conference Call)"

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