The “So What” in Apple’s Earnings
On Tuesday, July 31st, Apple announced its 3Q18 financial results, an event that drove even more attention than usual given the headwind that some companies faced during this earnings cycle. In particular, analysts were trying to measure the health level of the whole smartphone industry based on what Apple reported for the iPhone.
Apple sold 41.3 million iPhones, slightly lower than expected but certainly a strong performance considering this is usually a softer quarter for Apple given the expected September launch cycle. The numbers look even better when one takes into account that Apple decreased inventory by 3.5 million units which means that sales to end users ended up at 44.8 million units. The iPhone X remained the most popular model driving ASP to $724. As markets saturate ASP growth is a much more positive signal than sales not only for the immediate impact on revenue but most importantly as a driver for further revenue growth coming from the latest technologies integrated into the hardware and the services they enable.
iPad had almost a reverse trend to the iPhone with stronger sales and weaker revenue. This reflects the state of the portfolio quite well, as the most recent iPad model has a lower price tag and the iPad Pro, which drives higher ASP is due for an update in the next couple of months. The expected update on the iPad Pro line is certainly stalling prospective buyers who would rather wait for the new models or see if they can take advantage of a price drop on the current ones. This point might also be true of enterprises as we did not hear Apple talk specifically about iPad uptake in this segment as they have done many times in the past.
It is also interesting to note the different installed base story for the iPhone and the iPad. The iPhone user base is more defined in number, but it is improving in capability as users in the base are upgrading to newer devices. With iPad, however, we are still in a growing phase of the installed base as Apple pointed out that 50% of iPad buyers in the quarter were new to the product.
On the Mac side, this is the first time in a very long time that Macs underperformed compared to the overall PC market. Cook linked the year over year decline to the different launch cycle, and it will be interesting to see the impact of the upgraded MacBook Pro next quarter. While rumor points to more Macs to come the back to school window is gone, and all will rest on the holiday quarter.
The Shining Stars: Wearables and Services
Wearables (Apple Watch, AirPods and Beats) had a great quarter, with revenue up over 60% year-over-year and growth accelerating quarter-over-quarter. Wearables produced over $10 billion in revenue over the past four quarters. While Apple Watch sales were reported to have grown by 40%, it is AirPods that in my view have been the clear dark horse of the category. Tim Cook compared AirPods to the iPod, and I could not agree more when you consider the appeal the product has. Like the iPod. AirPods transcend gender, income, age and tech savviness to deliver a clear value-add by doing what they are meant to do most straightforwardly.
The long-term opportunity that wearables offer is that they pave the way for whatever Apple is planning around AR and glasses. A loyal base of Watch + AirPods users will offer a great addressable market for glasses.
Paid subscriptions across Apple Services have now passed 300 million, an increase of more than 60% in the past year alone. For Apple Music specifically, paid subscriptions have now passed 43 million. There were two areas that Apple highlighted either directly or when prompted. One was the mention of the doubling in news articles read during the quarter. This datapoint bodes well for an upcoming paid news service as it proves that engagement is growing.
When asked about the deal Apple signed with Oprah, Tim Cook did not hold back his excitement about the collaboration and referred to original content being developed. With the limited ability that Apple TV has had to convince people they needed it for its apps and as a single sign-on portal for all our content, Apple is left with no choice than to differentiate through content. If you are skeptical about why Apple would enter this space consider the low level of penetration of Apple TV, you forget the many screens this content will be viewed on when you consider iPhones and iPads. I struggle to see Apple embarking on the very expensive endeavor of creating original content to limit viewing to Apple TV.
There was not much mention of the HomePod during the call other than an implication by an analyst that Apple is losing the home. Cook’s answer, reflected not only why Apple might not be worried but also why Apple has not been as aggressive in the home as some might want. The bottom line for Cook is that owning the home is not enough but owing the pocket (with the iPhone) is key, and of course Apple has done that, which grants them access to the home and beyond.
One data point during the call referred to Siri, and that was the number of requests put forward to the Apple’s digital assistant. An impressive number but one that does not really give us much visibility in the growing level of engagement and, most of all, satisfaction.
The Bigger Picture
Apple Pay has been growing steadily over the past few quarters but for Apple to be able to say that transactions were higher than PayPal Mobile and Square was certainly good this time around. Even more rewarding, I am sure, is being able to announce that CVS and 7-Eleven will add Apple Pay. CVS, in particular, must feel like a victory as CVS had originally opposed Apple Pay in favor of its own payment method called CVS Pay.
While politics was not an explicit topic on the call, Tim Cook did address a question about tariffs by wishing for calmer heads as tariffs always impact consumers. While calmer heads are certainly welcome, I find it useful to point out that in the past the impact of new tariffs on phones, in particular, has been shortlived. My proof points are South Korea and their increase in tax of a few years ago and Russia where there was a crackdown on import duties earlier in the 2010-2012 time frame. In both occasions, prices grew, and the market slowed down for a few quarters before picking back up.
Absent on the call were references to AI and Cloud, key areas for Apple’s big ecosystem competitors: Google, Microsoft, and Amazon. While these two are not key business drivers for Apple, not in the way where there is a direct revenue target associated with them, they are crucial ingredients of products and services, and I believe Apple should start to mention them more often in the role they play in empowering successful services and experiences.