AAPL FQ2 2017 Earnings - 10 Key Takeaways & Projection Variances

After the close of trading on May 2, AAPL reported its results for its 2nd fiscal quarter of 2017 (ending April 1, 2017). Soon thereafter, AAPL hosted its normal analyst call to discuss its earnings as well as provide its annual update to its capital return program - the April earnings call has been the time where AAPL has chosen to update its shareholder return program, which includes changes to its dividends and authorized share repurchases.

Here are 10 Key Takeaways from AAPL's FQ2-17 Earnings Call

• 'Services' is a beast. Services revenue again topped $7 billion at $7.041 billion, a bit short of the holiday quarter (FQ1-17), where it hit $7.244 billion. It was also the first time that Services was the second largest revenue contributor of AAPL's 5 product segments. In his opening remarks, Cook reiterated the fact that the Services business is "well on its way to being the size of a Fortune 100 company." Just for reference, on the last Fortune 500 list, number 100 was Northwestern Mutual with annual revenue of $28.111 billion. This implies AAPL's expectation that its Services business will meet or exceed an average quarterly revenue run-rate of a bit north of $7 billion, which it just did in both FQ1 & FQ2.
  
  This is significant because it shows the underlying strength and engagement of AAPL's ecosystem and installed base. As a reminder, Services revenue encompasses AAPL's share of paid downloads & in-app purchases from its App Store, digital content revenue from iTunes, AAPL Music subscriptions, iCloud storage subscriptions, ApplePay residual revenue, AppleCare, and licensing of its Made for iPhone (MFI) technology provided to 3rd party peripheral makers.  More than anything, this revenue stream is particularly critical to AAPL because much of it is annuitant in-nature AND it has a very high profit margin (e.g., the revenue from paid App Store downloads is booked on a 'net revenue' basis with little-to-no attributable cost). The strong Services revenue undoubtedly contributed to AAPL coming in at the very high-end of its gross margin guidance (38.9%).  
   
• The App Store is Stronger than Ever: In its prepared remarks, AAPL indicated that App Store revenue grew 40% year over year to an all-time quarterly high AND the number of developers offering apps for sale on the App Store was up 26% over last year. It's a bit difficult to correlate App Store revenue to AAPL's Services revenue as AAPL only retains a percentage of sales (in most cases - 30%). However, it is safe to assume that the App Store is a huge driver of the Services revenue segment, regardless of the revenue retention rate.
  
  Additionally, AAPL indicated that 'paid subscriptions for our own [AAPL's] services and the third-party content offered on our stores' now exceed 165 million. That is a crapload of subscriptions and that momentum should continue to carry the Services segment to new highs. AAPL restated its ambition to double the size of the Services revenue segment by 2020.
   
• That is a lot of iMessages: AAPL indicated that during the Super Bowl this past February, people were sending 380,000 iMessages per second - more than double the number of messages sent during the previous Super Bowl. It's all about ecosystem - AAPL iPhone users don't pay to use the iMessage service, but it certainly is a huge benefit to staying on the platform as iMessage is not licensed out.
   
• Enterprise Penetration Continues to Grow: AAPL pointed out that its enterprise partnerships are really starting to scale, in-particular its partnership with SAP. SAP recently released the SAP Cloud Platform SDK for iOS at the end of March, and over 3 million SAP developers now with access to the tools needed to develop more powerful native iOS apps for enterprise. Additionally, IBM Mobile First iOS apps have been deployed on 3,300 client engagements. One specific company it pointed out was Capital One, where AAPL has helped empower the consumer banking experience by providing Capital One Associates with 40 native iOS applications running on nearly 30,000 iPhones and iPads. I believe a couple years back, Cook indicated that AAPL's enterprise business (not counting BYOD) had a $25 billion annual run-rate - I wonder what it is now?
   
• AAPL Watch - The Most Successful 'Disappointment' Ever: AAPL mentioned that AAPL Watch sales 'nearly doubled' year-over-year in the quarter, after what was also a very strong holiday quarter for the product - one might expect a post-holiday sales fatigue. One of the analysts even pointed out that many of the original competitors competing in the smartwatch space are either dropping out or re-evaluating it. Cook re-emphasized AAPL's dedication to the product and how difficult it is to curate the right experience on the wrist, thus leading to dwindling competition.
   
• AAPL Has a Huge Wearables Presence: AAPL categorizes its wearables (AAPL Watch, AirPods, & Beats headphones) into its 'Other Products' segment. It was interesting that when asked about AAPL's presence in wearables, Cook mentioned the following for the trailing 12 months: "...when we combine Apple Watch, AirPods, and Beats headphones, our revenue from wearable products in the last four quarters was the size of a Fortune 500 company". That's only going to grow considering the AirPods ($159 a pop) have only had very limited shipments due to heavy supply constraint.
   
• AAPL Pay Adoption Rolling Along: AAPL Pay may not have jumped out of the gates, but mainstream adoption (including my own) continues to increase with additional merchants supporting the technology. AAPL indicated that AAPL Pay transaction volume was up 450% over the past 12 months and it continues to roll out the service in more countries. In Japan alone, where AAPL Pay became available this past October, transit customers are already completing nearly 20 million transactions per month. AAPL Pay is not about the revenue stream as I believe it creates very little, but it is about additional touch-points of user engagement within the ever-sticky AAPL ecosystem.
   
• Retail is not dead everywhere: While headlines in retail suggest that the industry is facing its dooms-day scenario, AAPL continues on its aggressive retail brick-and-mortar expansion plans. It now has 495 retail stores worldwide, and just opened its first ever store in Dubai in late-April. Clearly, AAPL is not seeing the physical retail trends that is forcing others to shutter stores at a record pace.
   
• One-Quarter of a TRILLION Dollars of Cash: AAPL reported total cash of $256.8 billion in cash exiting FQ2 - a sequential increase of $10.8 billion. Of that $256.8 billion, about 93% of it (or $239 billion) was held overseas. It did raise another $11 billion of debt during the quarter bringing its total debt to ~$98.5 billion. Even so, netting out the debt still leaves AAPL with a massive pile of $160 billion of cash. If congress can ever get a tax reform bill passed with a reasonable repatriation rate, AAPL will undoubtedly be a huge beneficiary. 
   
• Huge Returns to Shareholders: Shareholders have not only seen large returns in share price appreciation, but they have also been the beneficiaries of $211.2 billion of AAPL's capital return program, which includes $60.2 billion of cash dividends and $151 billion of share repurchases. AAPL indicated that the Board has authorized an increase in the dividend by 10.5% to $0.63 per common share, and authorized another $35 billion of share repurchases. The capital return program has been extended by a year, and total returns at the end should be $300 billion with the majority of that coming in the form of share repurchases. The aggressive share repurchases signal that Management still believes AAPL's shares are undervalued. If you look at its multiple even at near-record highs, it's hard to argue with that.

Source: Seeking Alpha

So How Did I Do on My Projections?

Pretty well, actually.

• I missed the iPhone number, which effectively made me miss on revenue. I was a bit over on ASP as well.
• On total revenue, I only missed by $617 million, which is a 1.2% variance - not bad.
• Additionally, I was extremely close on gross margin (38.8% projection vs. 38.9% actual), and therefore my EPS number was under by $.04 ($2.10 actual v. $2.06 projection).

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