Apple (AAPL) reported a fantastic fiscal second-quarter after the closing bell on Thursday. Shares in after-hours trading did give about half of the regular session’s 4.5% gain as the conference call got underway and management called out a greater revenue headwind due to supply constraints. However, we believe the underlying fundamentals to be as strong as ever. 

Companywide Q2 results

Record March quarter revenue rose 9% year-over-year to $97.28 billion, breezing past expectations of $93.91 billion. Earnings of $1.52 per share, also a March quarter record, came in ahead of the $1.42 per share consensus. Additionally, with the help better-than-expected gross margin performance, operating income of $29.98 billion outpaced expectations of $27.94 billion. Gross margin was 43.75% versus the 43.1% expected.

Taking a look at cash flows, operating cash flow of $ 28.2 billion outpaced expectations of $27.1 billion. After backing out payments of about $2.5 billion for the acquisition of property, plant and equipment, free cash flow of roughly $25.7 billion edged out the $25.2 billion expected. As a result of the strong cash generation, Apple ended the quarter with $193 billion in cash and marketable securities on the balance sheet and a $73 billion net cash position after backing out $120 billion of debt.

We always pay close attention to Apple’s cash flow for two reasons.

• First, as is the case with all companies, comparing it to net income can tell us the quality of earnings. Higher quality earnings have more actual cash backing them. In Apple’s case, free cash flow exceeds net income, indicating very high quality.

• Second, Apple has a policy of being “net cash neutral over time,” meaning that ultimately, if the cash isn’t used for acquisitions or organic growth investments, it makes its way back to us, the shareholders, in the from of buybacks and dividends.

To this point, Apple returned nearly $27 billion to shareholders in the reported quarter via dividends and buybacks. Along with this earnings release, we got a 5% dividend increase and news of a newly authorized $90 billion share repurchase program.

Q2 Segment Results

Breaking down the headline results a step further, Services sales rose 17% to $19.82 billion came up a bit short versus the $19.91 billion consensus, though they do represent an all-time record; while Products revenue of $77.46 billion came in well ahead of the $73.99 billion consensus.

Taking a look at margin performance, Services gross margin came in at 72.6% while Products gross margin came in at 36.4%, demonstrating once again why growth in the Services segment is such a huge factor for earnings growth over time – not to mention the support it provides the valuation multiple placed on those earnings due to the recurring nature of Services sales.

• Digging into the Services segment, management called out that it was a record quarter for the App Store, Music, Cloud Services and Apple Care, as well as a March quarter record for video, advertising and payment services. Furthermore, engagement continues to grow with the team calling out that “transacting accounts, paid accounts and accounts with paid subscriptions all reached all-time highs during the March quarter in every geographic segment.” As of the end of the quarter, Apple had over 825 million paid subscriptions across its services offerings, a greater than 165 million increase versus a year ago.

Breaking the down the results within the Products segment, device sales were as follows:

• iPhone: $50.57 billion versus $48.72 billion expected

• iPad: $7.65 billion versus $7.14 billion expected

• Mac: $10.44 billion versus $9.1 billion expected

• Wearables, Home and Accessories: $8.81 billion versus $9 billion expected

Apple’s installed base of active devices once again reached an all-time high in all product categories and geographies. As members know, we always keep an eye out for this commentary on the call as the installed base is the outlet through which Apple can sell its service subscriptions and buildout its ecosystem.

• On the call, management highlighted growth in all product categories with the exception of iPad which remained “significant supply constrained throughout the quarter.” As a result, the sales hit a March quarter record for the iPhone, Mac, and in Wearables, Home and Accessories. Notably, the Wearables, Home and Accessories business has doubled over the past three years and is the size of a Fortune 100 business. Regarding the Watch, management also called out that over two-thirds of buyers in the quarter were new to the product.

Guidance

As has been the case since the start of the Covid pandemic, management refrained from providing quantitative guidance, instead opting to provide some “directional insights” based on an assumption that Covid-related impacts do not worsen.

On sales, management commented that they expect Covid-related supply constraints and industrywide silicon shortages to impact the company’s ability to meet demand. The impact is expected to hold back sales by $4 billion to $8 billion in the quarter, “substantially larger” than the impact management saw in the March quarter. Foreign exchange is expected to present a nearly 3 percentage point headwind to the annual growth rate and management reminded investors that they paused all sales during the March quarter in Russia, after that country invaded Ukraine.

• Services revenue will also be impacted by some of the noted headwinds, though management still expects double digit growth, albeit at a slower pace than we saw this quarter. The Street is looking for 15.7% growth in the upcoming quarter, below the 17% increase reported in the March quarter. So the Services guide appears to be roughly in line with expectations.

• Gross margin is expected to come in at 42% to 43%, a tad light versus the 43.3% consensus. Other expenses are expected to be about $100 million, operating expenses are forecast to be between $12.7 billion and $12.9 billion and the tax rate is expected to be around 16%.

Bottom line

All in, a very strong quarter from Apple that once again demonstrates the incredible ability of management — led by Tim Cook, one of the greatest CEOs of all time — to navigate just about anything the world throws at them; be it a once in a century pandemic or the most strained geopolitical environment Europe has seen since World War II. 

While the Street was looking for a little bit more out of the Services segment, it nonetheless reported record revenue. Products sales saw a March-quarter record. We also got a 5% dividend increase, a $90 billion buyback authorization, a $73 billion net cash position on the balance sheet and another record setting installed base. 

Shares are trading down on a macro-headwind that's affecting the stock market as a whole. Given the stellar track record of management, we would not hesitate to buy more shares as the price comes down. At some point in the future, buyers will come back to this name again, and we want to have a strong (low) cost basis when that happens.