Apple (AAPL) reported a top-and bottom-line beat after the bell on Thursday, with its fiscal 2020 third-quarter earnings.
On the top line, revenues of $59.685 billion (+10.9% YoY) -- with 54.7% of total sales coming from outside the U.S. -- crushed expectations of $52.2387 billion. Notably, revenue took a 300 basis point hit due to foreign exchange, a dynamic that could speak to a coming tailwind as the dollar contuse to weaken. On the bottom line, earnings per share of $2.58 (+18.3% YoY) exceeded the $2.05 per share consensus.
"Apple's record June quarter was driven by double-digit growth in both Products and Services and growth in each of our geographic segments," said CEO Tim Cook. "In uncertain times, this performance is a testament to the important role our products play in our customers' lives and to Apple's relentless innovation. This is a challenging moment for our communities, and, from Apple's new $100 million Racial Equity and Justice Initiative to a new commitment to be carbon neutral by 2030, we're living the principle that what we make and do should create opportunity and leave the world better than we found it."
"Our June quarter performance was strong evidence of Apple's ability to innovate and execute during challenging times," added CFO Luca Maestri. "The record business results drove our active installed base of devices to an all-time high in all of our geographic segments and all major product categories. We grew EPS by 18 percent and generated operating cash flow of $16.3 billion during the quarter, a June quarter record for both metrics."
Before digging into the release, we also want to note that Apple's Board of Directors approved a four-for-one stock split. As a result, shareholders of record at the close of business on Aug. 24, will own four shares for every one held on the record date, and trading will begin on a split-adjusted basis on Aug. 31. Importantly, while we applaud the move as it serves to make shares more accessible, without the need to deal in fractional shares, we remind members that this does not result in any change to the intrinsic value of shares as members will simply own four times the amount of shares, priced at a quarter of the price per share. We should also note we see no issue in owning fractional shares, especially for higher priced stocks such as those of Alphabet (GOOGL) and Amazon (AMZN) .
Higher 'Margins' of Services
On the margin front, services gross margins came in at 67.2% (+310bps YoY), while products gross margins came in at 29.7% (-70bps YoY). As we've noted previously, comparing these two segments makes it clear why we have been, and continue to be, so intensely focused on the services side of the business. In addition to the associated recurring revenue stream that demands a higher multiple given its increased visibility (i.e., it makes it easier to reliably forecast future earnings), growth in this higher margin business provides for overall margins to expand.
With this, we can see that while services accounted for 22.0% of total sales, the strong segment margins result in services accounting for 39.0% of gross income.
Combined, overall gross margins of 38.0% were right in line with consensus coming into the print.
Similar to the prior quarter, management refrained from providing revenue and margin guidance, bu, did provide less formal expectations for the September quarter.
"On iPhone, we expect to see recent performance continue for our current product lineup, including the strong customer response for iPhone SE," Maestri said. "In addition, as you know, last year, we started selling new iPhones in late September. This year, we project supply to be available a few weeks later. We expect the rest of our products categories to have strong year-over-year performance."
As for Services, Maestri stated, "we expect the September quarter to have the same trends that we have observed during the June quarter, except for Apple Care, where during the September quarter a year ago, we expanded our distribution significantly. As a consequence, we expect a difficult comp for Apple Care, also considering the Covid-related point-of-sale closures this year."
Gross margin commentary was limited, except to note that as a result of the tends noted above, the company will have a different sales mix than in prior years. Operating expenses are expected to be between $9.8 billion and $9.9 billion, largely in line with expectations.
As for capital return, Apple returned over $21 billion to shareholders during the quarter, with $3.7 billion coming via dividends and equivalents and the remainder coming from a combination of open market repurchases and an accelerated share repurchase program.
Looking ahead, Apple's board of directors has declared an $0.82 per share common stock dividend, payable on Aug. 13 to shareholders of record as of the close of business on Aug. 10,.
Additionally, on the call, Maestri reaffirmed the company's commitment to being net-cash neutral over time. On that note, the company ended the quarter with $194 billion in cash plus marketable securities and total debt of $113 billion, resulting in a net cash position of $81 billion at the end of the quarter.
Products with total sales of $46.529 billion blew past expectations of $38.862 billion.
Looking to other sub-sections, iPhone sales came in at $26.418 billion, well ahead of expectations of $22.201 billion "with customer demand improving as the quarter progressed."
Speaking to the intra-quarter dynamic, Maestri commented that demand was aided by "the very successful launch of iPhone SE and economic stimulus packages." As reminder, the iPhone SE is a lower priced model that serves to increase the company's addressable market opportunity, especially in key emerging growth markets such as India, where a $1,000 phone is simply out of budget for most consumers.
Total iPad sales of $6.582 billion came in above expectations of $4.854 billion. Mac sales of $7.079 billion were also above the $6.028 billion consensus. On the call, Maestri added "Both Mac and iPad are extremely relevant products in the new working and learning environments, and the most recent surveys of consumers from 451 Research measured customer satisfaction at 96% for Mac and 97% for iPad. Around half of the customers purchasing Mac and iPad during the quarter were new to that product, and as a result, the active installed base for both products reached a new all-time high."
In Wearables, Home and Accessories sales of $6.45 billion also beat expectations of $5.979 billion. Speaking to the sustained demand for the Apple Watch, Maestri commented that "over 75% of the customers purchasing Apple Watch during the quarter new to the product."
As we've noted previously, while growth rates are one part of the equation, the total installed base is what will ultimately speak to the company's addressable market on the services side of the business. As a result, we once again reiterate that the installed base is a much more important metric to us as long-term "own, don't trade" investors, rather than the number of devices sold in any given quarter.
Speaking to positive intra-quarter trends and growing installed base, Maestri noted on the call, "Lockdowns and point-of-sale closures were widespread during April and impacted our performance, but we saw demand for all products improve significantly in May and June. As a result of our strong performance and the unmatched loyalty of our customers, our installed base of active devices reached an all-time high in all of our geographic segments and all major product categories."
That said, the one metric we still want to see broken is the life time value of a customer, a metric that we believe will make it even more clear as to why the installed base is one of, if not the most important metrics on the hardware side of the business. We didn't get it this time but we continue to be on the look for it and remind investors of how strongly the stock was able to re-rate higher once the Services gross margin results were broken out.
Services sales of $13.156 billion breezed past expectations of $12.131 billion. On the call, Maestri noted that customer engagement within the Apple ecosystem "continues to grow at a fast pace" adding that "the number of both transacting and paid accounts on our digital content stores reached a new all-time high during the June quarter, with paid accounts increasing double digits in each of our geographic segments. In aggregate, paid subscriptions grew more than 35 million sequentially, and we now have over 550 million paid subscriptions across the services on our platform, up 130 million from a year ago."
As a result of the sustained growth in subscription momentum, management reiterated its confidence in reaching 600 million paid subscriptions before the end of calendar 2020.
The Bottom Line
All in, as bullish as we are on the long-term prospects of Apple (still of course being of the "own, don't trade" mindset), we must admit that even we were surprised to see just how strongly the company was able to perform across all categories given the macroeconomic backdrop, especially considering the premium pricing of its products (though the SE was certainly a valuable addition to the lineup) and dollar-related headwinds (which are now easing).
We believe these results speak not only to the increased importance of consumer computing products more broadly given the remote work environment we find ourselves in, but also Apple's incredibly fierce customer loyalty -- a less tangible, but absolutely crucial factor of our investment thesis -- and management's time and again proven ability to navigate the harshest of operating environments, be it a trade war with a key country in the supply chain or a global pandemic the likes of which has not been seen in over a century.
Apple has proven its ability to execute, has a lower priced iPhone now available, is working to increase the company's total addressable market especially in key emerging growth markets, and is still growing a record installed base that provides a growing outlet through which the company can sell subscription revenues and Apps. All this taken together, we are increasing our price target to $450, representing ~30x FY2021 earnings. While this may represent a premium to historic valuations we believe the market has finally come around to and will continue to hold our view that the company is deserving of a more software like multiple in general given the growth in Services and will continue to place a premium on those companies in strong financial standing that are able to perform in the harshest environments while continuing to return significant cash to shareholders.