Last week, Apple published its Q2 earnings for 2020, and to the surprise of some, recorded 1% growth year-on-year, despite a COVID-19 pandemic which has forced all of Apple's stores to close at some point during the last three months. Apple recorded quarterly earnings of $58.3 billion, up 1% from a year ago.
In Apple's press release, CEO Tim Cook said that he was "proud to report that Apple grew for the quarter, driven by an all-time record in Services and a quarterly record for Wearables." Given Apple's usually meteoric financial performance, 1% growth doesn't sound like much, but given current global circumstances, it's actually pretty impressive. So how did Apple manage to sustain growth in Q2? How did Apple secure record retail revenue over 3 months, despite being forced to close all of its stores? How important are services now, and what does the future hold? We caught up with Above Avalon's Neil Cybart to dig deeper into Q2.
Cybart founded Above Avalon in 2014, and is a full-time Apple analyst who measures the company from "both a Wall Street and Silicon Valley perspective." Cybart has been cited by massive outlets including WIRED, Financial Times, The New York Times, and The Wall Street Journal and consistently ranks amongst the most accurate Apple financial analysts, ranking as the most accurate Apple financial analyst in two of the previous three quarters, including this one.
Back in January
Back in January, Apple recorded $91.8 billion in revenue, a record-setting first quarter. Those bumper earnings were driven by iPhone, Wearables, and services. As per usual, Apple released guidance for 2Q2020 as follows:
- Revenue between $63.0 billion and $67.0 billion
- gross margin between 38.0 percent and 39.0 percent
- operating expenses between $9.6 billion and $9.7 billion
- other income/(expense) of $250 million
- tax rate of approximately 16.5 percent
Just a couple of hours later, Tim Cook announced on Apple's earnings call that it was closing its Qingdao Apple store as the COVID-19 pandemic began to take hold in the country. By January 30, it had closed two more stores, and, on February 1, Apple shut down its entire China operation out of "an abundance of caution." Next, Italy's 17 retail stores were closed, and soon, all of Apple's stores outside of Greater China had shut their doors. As of today, only stores in China, Korea, Austria, and Australia have reopened.
Amidst all of this, Apple advised that it would not meet its Q2 earnings guidance on February 17 citing constrained iPhone supply and the impact of reduced demand in China. Apple, of course, was yet to close any more stores at this point, and at the time noted that demand outside China remained strong.
To be expected
All of this is to say that we expected Apple to endure something of a downturn in Q2. Only the extent of that impact was up for debate.
"I wasn't too surprised with Apple's 2Q results as the numbers were close to my expectations." said Cybart, My expectations were that the numbers were going to only be partially impacted from the pandemic and that's exactly what happened."
Apple's resilience through Q2 can seemingly be attributed to a few different factors. One notable aspect is that these earnings really only reflect a few weeks of stay-at-home orders, quarantines, and store closures. "Apple reported a very strong January," says Cybart, reflecting Tim Cook's own sentiment during Thursday's earnings call. Speaking to Shannon Cross, Cook noted that in China, Apple was "having a really good January" before seeing a steep decline in demand in February. As stores began to reopen, Cook said that Apple saw an improvement in March and had seen further improvement in April.
"You look at the rest of the world; We were doing great in January, the first five weeks of the quarter," said Cook, "and we do believe that we were headed toward to sort of the top end of our expectations that we had talked to you about on the last call."
Apple managed to record a new record in Retail Revenue in Q2, despite losing all of its in-person retail at some point this year.
"Prior to the pandemic, Apple had been seeing momentum with its direct distribution channel" notes Cybart. "Accordingly, a strong January and February on the sales front, combined with customers going online to purchase products in March, allowed Apple to see a sales record regarding its direct channel."
Without a pandemic to contend with, Apple may well have been pushing towards its previous revenue guidance of between $63B and $67B. In terms of the impact of the pandemic, it seems clear that a very strong January and a return to form later in the quarter have helped Apple tremendously. In fact, Apple managed to record a new record in Retail Revenue in Q2, despite losing all of its in-person retail at some point this year.
Once, Apple was a computer company. Then, it was a phone company. Apple's former head of retail, Angela Ahrendts, once told Apple retail staff; "when iPhone catches a cold, all of Apple gets sick." That philosophy no longer rings true. The headlines in Apple's most recent earnings reports have been wearables and services. On the whole, it seems that people are keeping their phones for longer, perhaps upgrading once every 3-4 years, where once they might have upgraded every year. Conversely, wearables like Apple Watch, AirPods, and Apple's Beats lineup have become a mainstay in Apple's revenue streams. In fact, Cybart believes that wearables will take center stage for Apple in the future.
Wearables are crucial to Apple's future as they represent a paradigm shift in computing.
"Wearables are crucial to Apple's future as they represent a paradigm shift in computing," he says. "My expectation is that wearables will become Apple's primary revenue growth driver in absolute terms. We saw an early preview of this dynamic in 1Q20 when wearables were Apple's top revenue growth driver."
In Q1, Apple recorded all-time records for both Services and Wearables. In Q2, Apple again broke its Services record and had a quarterly record for Wearables. Cybart notes that, not only has Apple's Services "become a large, recurring stream of revenue," but it also has high margins.
Apple has successfully detached the success of its business model from hardware and is now seeing more and more growth driven by its services like Apple Music, Apple Arcade, Apple TV+, and Apple News+.
In an unusual, but not surprising move, Apple did not provide any official guidance for Q3. During the call, Tim Cook noted "the lack of visibility and uncertainty in the near-term." His enduring message, however, was that Apple had a "high degree of confidence in the enduring strength of our business" and a "profoundly durable and resilient" supply chain. With that being said, Apple noted that it expects iPhone and wearables performance to worsen in Q3, but Mac and iPad are expected to improve. So what can we make of this?
"Apple is very good at providing financial clues as to things like how wearables are doing. The same thing took place with Apple's 3Q20 "guidance", says Cybart. He says that Apple's clues are enough "for an analyst with a strong earnings model to arrive at reasonably accurate estimates." The only unknown quantity is the health crisis, which could change the situation on the ground at any time.
It seems clear that Apple expects its Mac and iPad lineups to benefit from more people settling into work-from-home orders and distance learning.
Whilst Apple won't be struggling for cash anytime soon, Cybart did suggest that Apple's Q3 report "will likely end up being weaker than 2Q20 from a growth perspective."
In my view, Apple's ecosystem will weather the pandemic just fine.
"In my view, Apple's ecosystem will weather the pandemic just fine. However, there will be near-term speed bumps and issues" Cybart concludes, "for example, near-term financial results will continue to be messy and lumpy. Certain ways of life may change going forward. However, there will continue to be the same level of need for Apple tools."
Cybart believes that looking ahead to Q3, it will be important to keep an eye on how stay-at-home orders and quarantines around the world are developing, as well as how many retail stores Apple is able to reopen.
Certainly not unscathed, Apple likely lost out on around $10 billion in revenue in Q2, and Cybart notes that Apple "has been impacted in a big way by the pandemic." However, he also thinks that "those who may have thought that Apple would be in major trouble because of the pandemic have likely had a change of mind."