A Good Solid Quarter: Takeaways from Apple’s Fiscal Q3 2014 Earnings

For the quarter that was (fiscal Q3):

– Three pleasant surprises (Greater China, overall company gross margin, Mac), and iPad continues to “disappoint”.

– Although iPad turned in very weak, retrograde results (-9% YOY unit growth, -8% revenue growth), iPhone, as the workhorse product bringing in about half of Apple’s revenue, “did what it needed to do” amidst increasing anticipation/clamor (and resulting sales pauses) for iPhone 6 (13% YOY unit growth, 9% revenue growth), and Mac turned in a very strong quarter (18% YOY unit growth, 13% revenue growth) thanks to the “$100 cheaper” MacBook Air, according to management.

– And it’s not necessarily that iPad is “weak” (of course, it is on a year-over-year basis) so much as it is “slow” in some markets. While Apple doesn’t appear entirely certain as to why that is, it’s not like the competition is eating Apple’s proverbial lunch, considering Apple’s stronghold in education (85% share of what I presume is the US market), and near-100% presence in enterprise (though in terms of market penetration, it’s one-third the ubiquity of PCs by percentage at around 20% vs. ~60%). Also of note – iPad growing 51% in China, 45% in India, 64% in the Middle East. And Apple is looking at accelerating iPad growth via the enterprise, with the IBM partnership being a key element on this initiative.

– I don’t think Cook and Maestri were nearly as surprised as they said they claimed to be by the 140-ish basis point gross margin beat over the 38% top-end guidance (which itself incorporates some unknown headwind from net iPhone, iPad and Mac ESP deferral – my guess is an impact of around 50 basis points). I suspect operating margin trends may have provided an indirect advance clue – we’ll see if there’s any potential validity to that when the 10-Q is released.

– Greater China (China Mobile in particular?) “saved” Apple’s quarter, with a 28% YOY revenue boost (a delta of nearly $1.3B) where all other revenue geographies, including the Retail segment, grew at either 1% or 6% YOY, curiously enough. But is there a “double-edged sword” element at play here? I’m no expert, but I do wonder if Greater China, with the occasional saber-rattling and protectionist-sounding rumors from time to time, is a region where Apple, at the very least, tries to manage its opportunity (and government relations) as carefully as possible.

For the quarter in progress (fiscal Q4):

– Revenue guidance seemed all right, and gross margin guidance of 37-38% (which I’m thinking most analysts believe to be conservative) is highly impressive on a year-over-year comparison basis considering that there’s guidance to margin improvement even though iPhone 6 is almost certainly a full-redesign-type product. Makes you wonder about the potential margin benefits to the iPhone 6’s immediate successor in fiscal 2016, but maybe that’s thinking a bit too far ahead.

(Does the gross margin guidance also hint at 16GB starting capacities for a new iPhone for the sixth generation in a row? I sure hope not.)

– In case you had any lingering doubt, iPhone 6 (or some new category that will allow top-end revenue guidance of $40B vs. $37.47B in the year-ago quarter…so yeah, it’s iPhone 6) is about as certain as is possible. Maestri in reply to Katy Huberty regarding gross margin (emphasis mine): “Again, the mix is the normal mix that we see as we continue to move through the product cycle…and obviously in Q4 we’ve got some transition costs because we’re expecting a very busy fall, we’re very excited about what we’ve got in the pipeline…”

– The $37B-40B revenue guide (a $3B band vs. the “usual” $2B) appears to be Oppenheimer’s and now Maestri’s way of accounting for the inherently greater uncertainty associated with product transitions (note range guidance for Q4 2013). Maybe I’m wrong, but for this quarter, looks like Apple’s ability to get to the high end of revenue guidance or better is limited only by how many iPhone 6 models it can produce and sell before the end of fiscal Q4.

– How will Wall Street react to Apple’s operating expenses guide of $4.75-$4.85B, which based on the midpoint is about $350M than in any prior quarter in fiscal 2014? My wild guess is this is driven mostly by increased R&D spending, though without any other information that’s only conjecture at this point. Whether this is something analysts point out over the next few days, closer to earnings, or throughout the quarter, who knows. Unfortunately, no analyst asked about the higher OpEx guide, and no explanation was given. It will be a significant hindrance to profitability, and will make it considerably more difficult to meet the current analyst consensus EPS of $1.34.

Overall, not an amazing quarter (aside from the very impressive gross margin), but quite a bit better than “not bad”, even with iPad sales declining year-over-year. Apple’s hanging in there just fine as the iPhone Everyone’s Been Waiting For (and maybe one or two other new product categories) appears on schedule for a worldwide launch in, say, two months’ time.



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