The Oppenheimer Code, Fiscal Q2 2014, Part 4: Revenue Geography Lessons (or Hints, Anyway) + Gross Margin Update

I think I know what some of the 50-60 of you1 may be thinking after reading the post title and likely groaning at the 120th bad pun I’ve inflicted tried.

“Man, I just knew that home gamer AAPL blogger was gonna make a terrible pun based on revenue geography.”

No? Tsk. You’re missing out on a primary mission of this blog, which is to challenge the boundaries of kindergarten-level fundamentals and bad jokes –

Y’know, let’s just move onto the recently expanded margin discussion 😉

As you might have seen last quarter, this part of the earnings preview now includes a surface-level look at the operating margins of Apple’s five revenue geographies (of which Retail doesn’t really belong, for reasons I set out back then). Good news on the TL;DR front once again – since this quarter’s post is also more of a continuation/update, it’ll be a much quicker read. (Though if you’re a first-time reader or “need” a refresher, you can always read last quarter’s post on your own time if desired.)

First, some humble home game discussion on operating margin, which we’ll keep to the five revenue geographies (not Retail) for simplicity’s sake. If you want to skip ahead to the gross margin chart or commentary, it’s near the end of the post.

Here’s the updated chart of Apple’s operating margins per revenue geography (the line chart) with segment revenue “in the background” as a stacked column chart. (It’s probably best you open this in a new window.)

aaplopmargin-toq12014

I’ve charted operating margin geography results from fiscal Q1 2011 onward (which is far back as they go for Greater China), and included segment revenue (same color, just “faded”) for context. Again, apologies if this looks dense – but since there’s 65 primary data points, it kind of just is.2

All right.  Now that you’ve had a chance to look things over (the primary focus being the line chart), any takeaways from this data? Again, nothing definitive, and there’s many ways to approach a data set. But here’s some “obvious” takeaways:

– Japan’s operating margin decreased significantly, but it remains still head and shoulders above all other geographies. Quite the Apple stronghold/profit center. Japan was the second-highest-performing geography by GAAP revenue, up about 11% YOY (with the revenue reported being affected by currency headwinds). It seemed a bit “anomalous” for margin to fall slightly (about 160 basis points), given Tim Cook’s remark that iPhone sellthrough increased 40% on a unit basis YOY. But given management’s obvious enthusiasm about the Japan results from last quarter’s conference call, I’ll just keep an eye on it for now. I imagine most companies would be just fine with a regional operating margin of 48%. 😀

– The other “lagging” geography is the Americas, which also saw a 1% YOY sales decline. Of which a big contributor must surely be the US cellular carriers. Tim Cook’s comment on restrictive upgrade policies has merit – in the holiday quarter, only T-Mobile saw a year-over-year increase in smartphone sales/activations. AT&T, Verizon and Sprint all posted YOY declines, and in AT&T and Verizon’s cases, they didn’t seem too concerned. Nothing wrong with saving on subsidy costs, I guess, when you consider their customer bases versus the competition. One quick point – even though the Americas “underperformed” sequentially, it’s not really an operating margin decline when looking from Q1 2013 on. And Q1 2014 operating margin (36.15%) was still slightly higher than Q3 2013 (35.68%). We’ll see about the March quarter soon.

– Europe, Greater China, Rest of Asia Pacific? Seem to like their iPhone 5ses very much. I’m no economist but I’ve been hearing the Europe economy isn’t exactly on a growth tear, which may explain the more muted operating margin bounce. Interestingly, “Rest of Asia Pacific” had a substantial sequential and YOY boost in operating margin, despite a YOY revenue decline of about 9% (of which iPhone’s first-stage launch in China may have been a significant factor – maybe even the singular factor).

– Speaking of Apple’s addition of China as a first-stage launch country for iPhones – well, the chart pretty much says it all.  Will China Mobile keep the high-margin-mix momentum going?

– Since Greater China is such an important revenue geography, I’ll take a little time to discuss the seeming dissonance in YOY trending between revs (up over 29%,) and operating margin (down 175 basis points). It’s just my home gamer’s take, but Apple’s investing heavily in Greater China, and OpEx is obviously a part of that investment. There’s also the impact of margin mix and deferrals – and on a sell-through basis, Apple saw a 64% YOY increase in iPads (margin-dilutive), greatly outpacing iPhone, plus a 28% YOY increase in Macs per Tim Cook (and Macs carry the heftiest increase in deferrals at $20 more per unit).

To wrap up, some quick thoughts on gross margin.

aapl-gm-q22014edition

– For now, it looks like gross margins hit ‘rock bottom” in the June 2013 quarter.

– Why are GMs steadier now? My guess, a planned consequence of Apple’s deliberate, yet poorly communicated margin strategy. In my view, this mostly involved a combination of (a) higher cost-structure (and presumably higher-value for same price) iPhones, and (b) then-outpacing iPad unit growth, which don’t have carrier subsidies to boost margins, and which are deliberately priced to be more accessible to consumers relative to more general-purpose-computing Macs.

– iPhone and iPad may not be growing much YOY – so far anyway. And if iPhone and iPad have “similar” growth rates into the future, we probably won’t be seeing anything like Late 2010 – Early 2013 GM variations again. I’d also argue that Apple has evolved with the times and learned a few skills to preserve margin. It’s getting better at megascale and product ramp, as well as driving down the cost curve – thus a return to the prior trend of Q2 gross margin being higher than the Q1 gross margin despite reduced revenue leverage.

– Speaking of which, as you know, Oppenheimer guided gross margins in the range of 37%-38%. Interesting, considering that the higher deferrals didn’t kick in until the December quarter. Assuming essentially flat key product growth YOY (iPhone, iPad, Mac), Apple’s March quarter is disadvantaged by roughly $400M in higher deferrals versus fiscal Q2 2013.  EDIT: If you add that increased deferred revenue (which is also accounted for as 100% gross margin) back into guidance, that results in a gross margin impact of around 50 basis points.

– Just a couple of the themes I’ll be tracking until the June quarter – whether iPhone and thus gross margins will suffer as the next iPhone that everyone’s really been waiting for approaches, and to what extent China Mobile “helps” (with the “transitional” iPhone 5S) or even “hurts” gross margins in the next several weeks (with the launch of the TD-LTE iPad line).

Next up, to conclude the fourth (!) quarterly installment of the for-now-still-called-Oppenheimer Code series: The Wall Street expectations game. 

____________________________________________

1 My thanks for stopping by and making my blog a slowly more-visited home on the Web!  Comments, feedback, follows, retweets, etc. are always welcome!

2 I’ve had some time to look this format over and I’m still decently happy with overall readability, though feel free to chime in if you have suggestions or comments.

 

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