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Apple: The Bad Year Ends – Apple Inc. (NASDAQ: AAPL)

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Execution is Killer App

People talk about it, but generally don't understand it, or acknowledge it once it has happened. You may have the best plan in the world, but if you can't execute it, what does it mean? The last four quarters have shown Tim Cook and Apple (AAPL) performing as never before. Management earns their absurd allowance for how to cope with bad times, not good times. Let me tell you a story about bad times.

Once upon a time, there was a Cupertino kingdom with a cash cannon called the iPhone. But several years ago, the cash cannon was in trouble. Carrier "subsidies" (actually a 2-year low interest rate loan) disappeared and the upgrade cycles became longer. On top of that, much of iPhone's future growth was predicated on the growing Chinese consumer market, and it stopped the trade war.

The long-term plan was to leverage Apple's high customer satisfaction, iPhone & # 39; s popularity, and its legendary installed base to feed new revenue streams from services and new wearables products. But it is a long-term plan, and the cannon went low on powder.

In FY 2018, Apple saved its economy with a one-time pull with the price increase on the iPhone X. The devices were down, but who cares when EPS is up 30% YoY?

Entered FY 2019 in October last year, Apple was facing tough computers from the blowout 2018, but still faces dwindling devices and no price increase to save them. When the trade war killed their China numbers on top of that, and also Europe and Japan flag, Apple had its first guidance miss this year last December quarter. Only by Apple standards is this true, but the iPhone XS / R was flops.

So Apple had to start pulling levers.

  • Take advantage of the iPhone's high resale value, and try to get people back to a 2-year upgrade cycle with a built-in program and monthly interest-free payments.
  • Invest heavily in services, utilizing their billion user-installed base.
  • Continue to grow your base by having a low price point on each product line.
  • Accelerates buybacks to mask some of the YoY negative EPS growth.
  • Keep everyone focused on services with the March Services event, long before the services were launched.

This is how the story looks on a chart:

Two things to note here. Only when the lever pull began could they cause the negative columns to begin to shrink. The second is this, Apple has been making since they announced they would not turn down their guidance in December:

 Chart Data by YCharts

That's the execution. So the bad year has ended with a startling surprise. Net income was only 3.1% lower than on a very tough comp, and EPS increased by 3.7% on a less tough comp due to all repurchases that occurred in the intervening 12 months. I thought they had a good shot for $ 2.99, but they blew past it for $ 3.03

But the best part is that they managed to do that with the iPhone not having a very good quarter:

iPad has been very accelerating since the introduction of iPad Pro and pencil. That giant outfit is Airpods and Watch. And of course, services continue to pop like a weed. In total, wearables and services, two businesses that barely existed for Apple just a few years ago, accounted for nearly 30% of net sales in the quarter.

Breathe it in for a moment. iPhone sales were 9.2% lower than the previous year, but total sales increased by 1.8% in the quarter. In the previous quarter, iPhone was down 11.8% this year, but overall revenue increased by 1.0%. This is not just the iPhone company anymore.

Lever: Pricing

Apple has utilized this in two ways. First, since iPhones were unlocked at the end of transport contracts, it also unlocked the very high resale they have. Since then, smart consumers have put their two-year-old iPhones on eBay to fund the upgrade. Apple has always had a trade-in program, but they always paid far less than the eBay price, and they never emphasized it in either the online or retail Apple Stores.

But it changed last Christmas when the iPhone XS / R numbers came in slowly internally. They looked up exchange values, more on older phones, and promoted it more in stores. With the 2019 iPhones, they took it a step by adding two years of 0% interest and putting it all front and center. Here's what greets you when you buy an iPhone 11 from the Apple Store:

The first number you see is $ 16.62. That doesn't sound like much, does it? But it is for a replacement of a two year old iPhone X. A more relevant trade in would be the two year old iPhone 8. With that, the monthly payment is $ 19.95 per month. (Not) coincidentally, the carriers charged you $ 20 a month in the old "grant days". Apple is trying to get everyone back to thinking that way. Many even speculate that the phone will move to a subscription.

Apple reported that they have doubled the exchange volume YoY (I believe on a device basis), so it seems everyone is working as they please.

The other way Apple takes advantage of pricing is by having an input model for each major product line. Mac has long had the $ 799 Mac Mini. iPad has $ 329 base model. If the normally reliable Ming Chi Kuo is right, it will be a $ 399 iPhone SE2 this spring. These lines are likely to receive less frequent updates than their more expensive siblings, but they create a low price point to enter Apple walls.

Liver: Services

My sister, the bank strategist: What kind of multiple do you think services get?

Meg: They have 64% gross margins. What diversity does it get?

There are two aspects to this, a real and a perception. The real part is that Apple services have been showing double-digit YoY growth for some time now, and they have huge margins. The perception is that people haven't failed to notice it, and Apple is happy to continue to remind them. Here's how they headlined their 4th quarter press release:

Services receive top billing over the record EPS.

Besides, the service provided in March was a bit of a weird animal. It's very uncommon for Apple to announce something so early before launch, but they did it because they needed to distract people from the ugliness of some of these lists above. Remember that it was just over a month before they reported the March quarter, the worst in some time. The event unveiled a future where revenue for services could continue to grow by double digits each year, and Apple wanted to make sure everyone saw that before they saw the March quarter.

At least they've invested a lot here, about a billion dollars a quarter on top, which of course has thinned margin. Apple has traditionally had a surprisingly low R&D item in its reports, but it has changed over the last couple of years:

March 2017 quarter = 100

Over 9 quarters, R&D spending was up over 50%, even if you can see that it is tailor made now that much of the infrastructure is in place.

Regardless, at a very high price, they perform well here and continue to gain momentum.

Liver: The Cash. My God, the Cash

For many years as Apple's box office grew, people asked what it was for. People and companies save money for a rainy day, and since last fall it has rained as hard in Cupertino as it has done in a while. Apple is using its money strategically to distract from some of the ugly YoY numbers we saw above.

Back in May, Horace Dediu from Asymco updated his most useful Apple Chart ever. It is a bit outdated now 5 months later, but it is a great framing of our discussion.


It's an amazing information-rich chart, so spend some time with it if you like that kind of thing. But I want you to focus on the red line, cash net debt. The cash return program started in 2012 where you see the red line start to deviate from the blue line, generated cash. Previously, Apple had zero debt.

Because most of the cash was technically in Apple's Irish subsidiary, the cheapest way for Apple to return cash was to take out debt, at rates directly above the US Treasury, to return to shareholders while the cash heap in Ireland continued to grow . As you can see, the red line went pretty straight for several years.

In 2018, they moved the cash to the United States with the tax bill and began to return it much more aggressively, as you see the red line dip. There are two more reported quarters after this chart, and the red line is now below $ 98 billion, the first time the red line has dipped below $ 100 billion since 2011.

So Apple has spent its money tactically, and the The biggest way is the big light gray cliff at the top of the chart – buybacks. You can see how it is accelerating, and the net effect is to make YoY EPS numbers better than YoY net income.


Apple had an unusual miss of their guidance last December, but I will not trust it to happen again. Let's look at the ugly chart from above, but add to their high and low guidance:

Lo scenario assumes net 50M stock reduction of weighted average number. Hi guess net 70 M.

The December quarter is the coolest in terms of iPhone and total revenue. Cook talked quite optimistically about the Phase One trade and reduced tensions, but he pointed out that the optimistic Hi scenario was based on it. In any case, if they hit it, it will be $ 4.70 EPS against $ 4.18 last year.

The Big Risk: China and the Trade War

No one has more exposure to trade war risk than Apple, which sees both supply and demand risk with China. Of course, almost all of their products are made there, and the December tolls would hit them hard if implemented.

But much of their near-term growth scenario had been assumed by the Chinese consumer, and they are taking the hardest hit in all this. Perhaps Apple's strongest execution was in China this year, fighting headwinds, but turned a -16% yoY growth to a -2% growth rate this quarter.

However, this has the potential to be ugly for Apple. It can jeopardize both their supply chain and also lose a tremendous source of future growth. Cook has been happy with Chinese leadership for a decade now, and with Trump since entering office. So far they have managed to escape the worst, but it can not last.


  • Apple completed 3 billion Apple Pay transactions in the quarter, more than PayPal (PYPL).
  • Wearables now generate more annual revenues than two-thirds of the Fortune 500.
  • They come close to half a billion paid subscriptions. That was 330 million just a year ago.
  • Apple returned $ 21 billion to shareholders at a net cost of $ 4.3 billion in net cash. They borrowed $ 7 billion for the first time since 2017.
  • Apple had $ 1.1 billion in foreign currency headwinds this quarter. Without it: China was a bit up; revenues up 3.6% versus 1.8%; gross profit up 5.5% versus 1%; EBT up 4.9%, compared to down 1.8%; net income up 4.7% versus down 3.1% and EPS of $ 3.27 instead of $ 3.03.

Conclusions: The new Apple is the same Apple

FY 2020 has begun, and 2019 iPhones appear to be a little more popular than their predecessors, but not especially if you look at the guide. The 2020 iPhone will be the first 5G iPhone, and most analysts are looking for this model to be a major iPhone comeback. I'm less convinced that 5G will be a must-have feature in a year, but I seem to be in the minority on that one.

Regardless, iPhones, 2019 and 2020, there seems to be wearables and services ready to continue the rocket rise. We have not yet reached the point where their growth is replacing the iPhones, but when the iPhone is gone for almost 10% years and Apple can still show revenue growth, we are looking at a new Apple.

But it's still the same Apple. Apple creates one product: customer satisfaction, which always stays well at 90% for all product lines. Increasingly, there are several ways to buy it, and some more attractive ways to pay, but they all constitute the same thing, and it's the same thing they sold when they only had Apple] [

I remain a huge Apple bull in the long run, though I think you'll probably be able to get it cheaper than it is now. Always buy at the dip; there always comes one. If you go back and read my WWDC coverage, what you see is a company that has a complete technical stack – hardware, software, services – that their customers love and their competitors can't match. No one is better prepared for the future, no matter what it brings.

Someday, something will replace the touch screen smartphone as people's most important device. Apple probably doesn't want the first one, but they want it that everyone else stops copying.

Disclosure: I am / we are a long time AAPL. I wrote this article myself, and it expresses my own opinions. I do not receive compensation for it (other than Seeking Alpha). I have no business relationship with any company mentioned in this article.

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