Every underperforming schoolboy knows that lowering parental expectations in advance can take some gloom out of the most downbeat report. Learning a lesson from 12-year-old underachievers everywhere, Apple had already warned investors at the start of the year that sales for the recent December-ending quarter would be roughly $84 billion, and not the $89-93 billion that everyone hoped. Shares fell at the time, but they were up nearly 5% when the Nasdaq opened today as markets dwelt on the bright side. (See iPhone Upset Leads to Apple Crumble.)
The big tick on the report card was a 19% year-on-year increase in service revenues, to around $10.9 billion. Like certain other companies that have grown fat off gadget sales, Apple Inc. (Nasdaq: AAPL) is shifting focus to apps, games, movies and music -- all of which promise a continuous stream of revenues -- as smartphone users put device upgrades on hold. The move is paying off: Services look far more profitable than hardware, generating a gross margin of 63% in the quarter, compared with one of 34% at the hardware business. Apple is firmly on track for a doubling in annual service revenues between 2016 and 2020, says Luca Maestri, its chief financial officer. That would pull in a whopping $48.6 billion in sales. (See Apple Really Is in Trouble This Time and Apple Delivers Post-Holiday Turkey, Lowers Revenue Guidance.)
Unfortunately, the news on the iPhone side was at least as bad as analysts were expecting. A 15% drop in iPhone revenues, to about $52.3 billion, dragged overall sales down 5%, to $84.3 billion. While Apple has started to cheekily hide details of iPhone shipments, Jefferies analyst Timothy O'Shea reckons they declined 18% compared with the year-earlier quarter -- a drop that would mean Apple sold about 63.4 million iPhones. "Apple now sits on millions of extra iPhones that will need to be sold at deep discounts to clear the channel," said O'Shea in a research note. "We estimate this alone could drive 100bps [basis points, or 1 percentage point] of gross margin contraction."
Tim Cook, Apple's CEO, seemed to acknowledge that Apple has overpriced iPhones in some countries, although he blamed the exorbitant fees on foreign-exchange movements outside Apple's immediate control. "What we have done in January and in some locations and some products is essentially absorbed part or all of the foreign currency move as compared to last year and therefore got close or perhaps right on the local price from a year ago," he said during Apple's earnings call, according to a Seeking Alpha transcript. "So, yes, I do think that price is a factor."
China is another black mark. Revenues there were down by $4.8 billion compared with the year-earlier quarter, Cook told analysts, to just $13.2 billion, as Apple shifted fewer iPhones, Macs and iPads. Have trade tensions between the US and China hurt performance? O'Shea certainly thinks so, arguing that a US backlash in the country is "driving consumers to opt for domestic brands like Huawei over the iPhone." Tensions look set to remain high for the foreseeable future, he writes, after the US Department of Justice filed criminal charges against Huawei Technologies Co. Ltd. this week. (See Huawei Hits Out at DoJ Amid Global Backlash.)
Apple still managed to report a 7.5% increase in earnings per share, to $4.18, and generated about $26.7 billion in operating cash flow. It currently sits on net cash reserves of about $130 billion, enough to snap up a handful of smaller services companies or splash out on a major strategic acquisition. Even after today's increase, Apple's share price is about 30% lower than at the start of October, and O'Shea does not foresee any big catalyst for device upgrades before the arrival of 5G. "That is more of a 2020 or 2021 story," he says. Diversification looks more important than ever.
— Iain Morris, International Editor, Light Reading