Q3 results: 3D pricing, EGOT timing, and underestimating demand

I’m still the boss, kid. I’ve been covering Apple financial results and earnings calls for a very long time, dating back to my time at Macworld when Steve Jobs would occasionally parachute into earnings calls presided over by, among other people, Tim Cook! This week’s earnings call was Cook’s 90th and final installment, and that’s probably the most notable thing about it. Even the fact that it was a record third quarter isn’t that notable. It’s more notable when Apple doesn’t set a quarterly record, especially given economic changes and inflation. Still, as always, the results and the earnings call provided a few things I thought were worth pointing out. And so, powered by my second cup of tea while I’m on a summer trip to visit family (that was a late-night flight!), here are some thoughts about financial things. It’s not a chip shortage, it’s demand Apple is having supply-constraint problems. Maybe you’ve noticed the lack of new Mac minis and Mac studios? The Mac is the hardest-hit product line when it comes to supply, but Cook said the iPhone has also been affected, and anticipates constraints on the iPad as well. This isn’t the whole story, of course, but it is part of it—and a part that Apple wants to crow about. Apple is limited in how many Macs, iPhones, and iPads it can sell because they are all powered by systems-on-chips that are coming off of chipmaker Taiwan Semiconductor’s most advanced production nodes. Here’s how Cook put it: The root cause of it is not a regular supply issue. It’s a demand forecast issue, to be candid, where the iPhone and the Mac are both doing remarkably better than we thought they would do. And we had high expectations, so it wasn’t that our expectations were low, but as you can see from iPhone’s growth being 22% and Mac’s growth at 29%… these are extraordinary numbers and the supply chain just has less flexibility in it than normal. So we’ve been pulling supply ahead, and at some point there’s a limit to that. And so we’ve got a quarter that we’re going to be scrambling on the supply side, essentially. This isn’t a partner or supplier issue. This issue is an incredibly strong… iPhone and Mac product cycle that has really yielded a demand beyond our expectation. You can’t argue with the strong iPhone and Mac sales figures, and Apple specifically called out the MacBook Pro and the MacBook Neo, which Cook said “has been especially popular” and suggested that the company is still struggling to make them fast enough. It’s admirable (and sensible) that Cook isn’t pointing fingers at anyone but customers who want Apple products, but the key phrase in his statement is “the supply chain just has less flexibility in it than normal.” This is an acknowledgement that while in the past, Apple might have been able to boost chip production from its partners, today the chip industry is maxed out thanks to the wild building of chips for AI applications. Still, I do take Cook at his word: Even in a normal world, there’s only so much TSMC could do to rapidly respond to a dramatic increase in chip orders from Apple. I’m sure Apple is kicking itself for not anticipating stronger demand, especially given how tight the whole industry has gotten. And Cook’s suggestion that Apple is going to be “scrambling on the supply side” because the impact will “increase significantly” (and Cook really emphasized that word!) suggests that this may get worse before it gets better. Oh yeah, and this isn’t just about cutting-edge SOCs. It goes for memory too. According to Cook, the price Apple pays for memory just keeps going up, and the offsetting Apple has been able to do by using existing inventory is going to be less effective as supplies run out. As an aside, Cook also alluded to reports that Apple has tried to get the U.S. government to authorize purchase of RAM from some forbidden Chinese chipmakers, which has aroused political ire. “Obviously if there were more suppliers, that would be good, and it would help us on the supply side and perhaps the pricing side.” How does Apple increase prices? One of the analysts on the earnings call asked a question about Apple’s recent price increases, which was a great opportunity for Cook to explain Apple’s pricing philosophy. It started out pretty normal, with Cook pointing out the price increases were done “reluctantly” and only because it’s “a hundred-year flood on the memory pricing.” But then it got more philosophical: In terms of our philosophy on dollars or percentages, we look at units, revenue, and margin, and then come to a business judgment as to how to handle that. And so it’s not a mathematical formula that gets us to a specific result or just looking at one dimension of that. We look at all three dimensions and think about it over the long term instead of a 90-day clock. Hopefully that helps. Yep, that helps, Tim. Three-dimensional pricing. Imagine pricing as a cube, and you’ll finally see the Matrix. Soft Services stories Services revenue, while up year-over-year, was (shockingly?) not up sequentially for the first time in more than three years. Apple laid most of the blame at various foreign-exchange rate “headwinds,” but CFO Kevan Parekh also tried to blame the softness on a few other factors: Theatrical gross from “F1: The Movie” last year “Headwinds in mobile gaming” Changes to the App Store business model worldwide, mostly driven by regulation The U.S. court order allowing developers to link out of Apple’s payment model without penalty It felt like a real stretch, and more of an opportunity to complain about the App Store being regulated and litigated. But I will admit that a softening in mobile gaming, which obviously drives a lot of App Store revenue, is an interesting data point. And it’s more interesting that Apple felt it was worth sharing. But, Parekh went on to say, “Despite this, the App Store did set a June quarter revenue record.” So… maybe not the reason for the softness after all? Apple is an EGOT Did you know that Steven Spielberg just won a Grammy award, which made him an EGOT? Winning an Emmy, Grammy, Oscar, and Tony is a pretty rare accomplishment that any individual should be proud of. But did you know that large corporations are also keeping score? It’s true. “It was wonderful to see Apple TV earn the industry’s top honors, adding Tony Awards this year to its Emmy, Grammy, and Oscar wins,” Cook said Thursday. “We reached that milestone faster than any streamer in history.” I wonder which marketing person at Apple had the job of figuring out how quickly every other streamer became an EGOT. Also, thanks to cancelled series “Schmigadoon” for the Tony. Maybe do everyone a solid and bring it back? This was Tim Through the earnings call, financial analysts showed their softer side by thanking Cook for all his years of service and revenue generation. Cook made a point of thanking them all individually before answering their questions, which I thought was a nice, and human, touch. He also made a final farewell statement designed to warm Wall Street hearts: Thank you to all of you, from our shareholders, particularly our long-term shareholders who have put their trust in us for so many years, to the analysts who have followed our company so closely. As you know, this will be my final earnings call, and John will lead these calls going forward. The transition is going seamlessly, and I am beyond excited for John to step into his new role and lead Apple into its next era. He is truly one of a kind and there is no better person to take the helm of the company. Oh! The new guy! I didn’t even mention it, but John Ternus was on the call the entire time, and didn’t say a peep. At least, not until Wamsi Mohan of Bank of America decided to devote one of his two questions to him. He threw him a softball about how the competitive landscape is changing overall. Ternus did not pick up the ball. “Well, thank you for asking,” Ternus said, rousing from his call-long slumber. “I guess I would just reiterate what Tim said, there is so much opportunity for us with everything that’s happening in this space, and we’re just really focused on our plans and very excited about it.” Deferring to the big guy and not letting Wamsi Mohan bait you into stealing Cook’s moment. That’s future CEO thinking right there, pal. If you appreciate articles like this one, support us by becoming a Six Colors subscriber. Subscribers get access to an exclusive podcast, members-only stories, and a special community.