iPhone sale slowed down, iPad and Services impressed

Highlights from the press release and earning call

  • iPhone sale down by 17% YoY. Mac had a great quarter with a YoY increase of 21%. Mac had a 5% revenue decline compared to last year
  • Half of the Mac customers during the quarter were new to Mac and the active installed base of Macs reached a new all-time high
  • 75% of the Watch customers never owned a Watch before
  • Apple Pay transaction volume more than doubled year-over-year and on track to reach 10 billion transactions this calendar year. Apple Pay is now available in 30 markets and will be live in 40 markets by the end of the year. New York’s MTA system will begin their rollout in early summer.
  • 390 million paid subscriptions at the end of March, an increase of 30 million in the last quarter alone.
  • “As we mentioned in January, we’ve been working on an initiative to make it simple to trade in our — trade in a phone in our store, finance the purchase over time and get help transferring data from the old phone to the new phone. As part of this initiative, we rolled out new trade-in and financing programs in the U.S., China, the U.K., Spain, Italy and Australia. The results had been striking. Across our stores, we had an all-time record response to our trade-in programs and with more than 4 times the trade-in volume of our March quarter a year ago.”
  • All-time services revenue records in four of our five geographic segments. Services accounted for 20% of March quarter revenue and about one-third of gross profit dollars.
  • “In fact, the number of paid third-party subscriptions increased by over 40% compared to last year in each of our geographic segments. And across all third-party subscription apps, the largest accounted for only 0.3% of our total Services revenue.”
  • Wearables business grew close to 50%
  • Total cash, plus marketable securities: $225 billion. Total Debt: $113 billion
  • App Store search ad business: up around 70% over the previous year and expanding into new geographies
  • An additional $75 billion for share repurchases is authorized

Note: In the following chart, Other Products refers to Wearables, Home and Accessories . I tried to update the historical figures as much as possible, but there might be some discrepancies to the latest ones.

Revenue in Q2 2019 is down by 5% YoY

iPhones and Mac disappoint while the other segments impress year over year

iPhone and Mac’s makeup of Apple’s total revenue continued to decline. Services and Wearables/Home/Accessories become increasingly more significant

Revenue from Greater China as % of the total revenue continues to slide while Americas’ share went up this quarter

Both Gross and Net Margin decline year over year

QuarterGrossMarginNetMarginR&D/RevSG&A/Rev
Q2 201439.32%22.40%3.12%6.42%
Q2 201540.78%23.39%3.31%5.96%
Q2 201639.40%20.80%4.97%6.77%
Q2 201738.93%20.85%5.25%7.03%
Q2 201838.31%22.61%5.53%6.79%
Q2 201937.61%19.93%6.81%7.68%

Dividend growth decreased compared to last year

My thoughts

Though revenue went down compared to last year, it’s not that bad in my opinion. It is almost on the same level as Q2 2015 when iPhones made up 70% of the total revenue. Services, iPad and Wearables seem to be able to make up, at least for now, some of the lost revenue from iPhones. The continued drop of Gross Margin is concerning and so is the almost 3% decline in net margin.

As customers prefer keeping and using their phones longer and Apple is losing ground in China, a major market for the iPhones, I think the iPhone share in the revenue pie will become smaller while Services will be more important to the company’s health. Tim Cook wasted no time on emphasizing that this is the best quarter for Services as it made up 20% of the total revenue and 1/3 of the total gross profit. Much time was spent on a whole range of services. I look forward to seeing the remaining two quarters of the year and the first of the next year after many services announced last month debut.

I actually prefer the trade-in initiative to lowering the prices as the initiative will likely not dilute the brand value as much as price cuts, especially for a luxury brand such as Apple. It’s promising to see the response to the new trade-in program.

While it’s interesting to see a significant growth in the App Store search ad, I am concerned about what it would do the image of a privacy-focused brand such as Apple. Ads and privacy don’t actually go hand-in-hand.

Disclaimer: I owned Apple stocks. This post is a practice exercise and stems from my curiosity. It’s not intended to be investment advice or anything of the sort. I am not that good lol.

Sources:

https://www.apple.com/newsroom/pdfs/Q2%20FY19%20Consolidated%20Financial%20Statements.pdf

https://investor.apple.com/investor-relations/financial-information/dividend-history/default.aspx

https://seekingalpha.com/article/4258275-apple-inc-aapl-ceo-tim-cook-q2-2019-results-earnings-call-transcript?part=single

Apple’s strategic switch

Disclaimer: I do own a few Apple stocks, but it’s nothing major and this post is just to share my observation of Apple. As a fan of business strategy, I have been a fan of the company and interested in how it performs amid the concerns after the letter to shareholders on 2nd January 2019.

Yesterday, Apple announced their Q1 earnings. A few notable points from their announcement and earning call:

  • Apple no longer reports units sold across their business segments
  • Overall, Apple recorded $84.3 billion, down 5% year over year
  • Products gross margin was 34.3% and Services gross margin was 62.8%.
  • iPhone revenue dropped by 15% year over year
  • Services revenue in Q1 was $10.9 billion, a 19% YoY increase. Service revenue grew from $8 billion in calendar 2010 to $41 billion in calendar 2018, allegedly on pace to reach $50 billion in 2020
  • Mac revenue was up 9% while iPad revenue was up 17%
  • Wearables, home and accessories revenue grew by 33% to $1.8 billion
  • There are 50 million paid Apple Music subscribers, up from 40 million reported in June 2018
  • Apple reported a base of 900 million installed iPhones, out of 1.4 billion active devices in total from Apple
  • There are 360 million paid subscriptions across Services portfolio, an increase of 120 million versus a year ago.
  • This quarter saw 1.8 billion transactions through Apple Pay, twice the volume recorded in the same quarter a year ago
  • In Germany, there are more Apple Pay activations in one week than for Android in one year
  • “Revenue from cloud services continues to grow rapidly with year-over-year revenue up over 40% in the December quarter. And readership of Apple News set a new record with over 85 million monthly active users in the three countries where we’ve launched the United States, the U.K., and Australia”.
  • Ending Q1 2019, Apple cash stands at $244 billion while net cash is at $130 billion

I am a big believer in the notion that business models need to be adapted to the changes in the business environment. No business model could be effective while staying still over the years, especially in the fast-changing world that we live in today. Apple should be no exception and from the numbers reported, it seems to me that they are making changes.  

For years, the bulk of Apple’s business has come from hardware which is differentiated by its exclusive software, especially in the case of iPhone. iPhone revenue has made up approximately 60% of Apple’s turnover. However, the luxury smartphone market has reached the maturation point. iPhone unit sale growth has been either minimal or flat for quarters. Greater China market, which makes up 20% of their iPhone revenue, has boasted challenges to Apple, particularly in 2018. Their iOS isn’t as appealing to Chinese users as it is to users in other parts of the world while competitors such as Huawei and Xiaomi offer alternatives with more or less same features at a lower price. The macroeconomic conditions in China and the trade war aren’t helpful either.

The growth in iPhone revenue has come largely from the price hike which lengthens the upgrade cycle and puts a limit on how much Apple can reach out to potential users. Not everyone can afford those pricey phones. Lowering the prices isn’t the solution. Firstly, Apple is a luxury brand. Lowering prices may leave significant damages to its brand power. Secondly, cheaper phones will require substantial changes to its operations, including supply chain, distribution and Sales & Marketing.

All the signs point to the fact that too much dependence on iPhone is no longer sustainable for Apple moving forward. Enter Services.

Services has been a bright spot amid concerns over iPhone revenue for the past 2 or 3 years, growing at a 20% annual clip. Put that in perspective, their Services revenue this quarter alone is $10.9 billion, almost equal to Netflix’s revenue in 3 quarters in 2018 while Facebook Q3 revenue was about $13 billion. Instead of making money from devices, Apple is betting on users keeping devices longer and paying consistently and more for services. And why not? If the users tend to hold on to devices longer, it makes sense to generate more money from their activities. Plus, margin from Services is substantially higher than that of Products.

And they have been doing a good job. Apple Pay transactions reached 1.8 billion this quarter, 100% YoY increase. Revenue from cloud went up by 40%. The number of paid subscriptions grew by 50% year over year and Apple Music has added 10 million users, reaching the 50 million mark and achieving a 25% growth, since June 2018.

As of June 2017, developers earned $70 billion from App store since its launch in 2008. As of January 2019, the figure went up to $120 billion. Moreover, we are about to see their investment in original content as their streaming service is reportedly going to be live this April.

In summary, Apple seems to be heading to the right direction strategically in my opinion, given the changes in the environment they are operating in. I think the following guidance in the next few quarters will continuously be lower than analyst expectations as the reduction in iPhone revenue may not be sufficiently offset by the growth in Services yet. There is a chance that Apple won’t have the same revenue level as they had at the peak of iPhone-dominated era.

Nonetheless, I think the company is far from the demise alleged by some after a letter to shareholders on 2nd January 2019. They generated $84 billion in revenue and almost $20 billion in net income in 90 days! Instead, the change to be a Services company may be better for the company’s health.