After releasing first-quarter 2019 financial results today, Apple CEO Tim Cook and CFO Luca Maestri hosted their quarterly live question-and-answer session for financial analysts. We covered the session live, with updates below in chronological order as the call proceeded.
Today’s Q&A comes after Apple disclosed mixed results for the quarter, including a 15 percent iPhone revenue decline offsetting 19 percent growth across all of the company’s other categories. Sales in the Americas were up modestly year-over-year from $35.193 billion to $36.94 billion, with slight Asia Pacific growth from $6.928 billion to $6.853 billion. Sales for Europe, Greater China, and Japan were each down, at least modestly.
Tim Cook: Prepared remarks
Cook opened the call by discussing the company’s unexpected shortfall, which he reiterated was based primarily on revenue issues in Greater China — where iPhone, iPad, and Mac sales were all down — as well as a lower number of iPhone upgrades elsewhere in the world. Apple continues to believe it has a bright future in China, Cook said, and he thinks that message has been lost. There are 2.5 million app developers there, with increasing sales of wearables, and two-thirds of customers are new to the Apple products they’re buying. Overall, he noted, full-year sales in China grew slightly.
iPhone XR, XS, and XS Max are the company’s best-ever iPhones, Cook said, and customers are hanging onto their devices longer, which in part explains a 15 percent iPhone revenue shortfall. But there are other factors. Foreign exchange has made Apple’s products more expensive in many parts of the world. Subsidies have become less common and weaker in scope, and promotional activities have been restricted. The battery replacement program, he said, was “the right thing to do for our customers,” but it had an impact. Even so, Apple’s total installed base has grown from 1.3 billion to 1.4 billion over the last year.
Putting iPhone aside, Cook said that the company experienced 19 percent overall growth across other categories, including strong growth of services. Apple had its highest music revenue ever, with over 50 million paid subscribers to Apple Music. Apple Pay had 1.8 billion transactions in the quarter, with increasing adoption of the technology among U.S. retailers and foreign countries — now 27 markets around the world.
Cloud services are generating 40 percent more revenue, and there are over 85 million Apple News readers in the three territories where it’s supported. It’s now the most-read news source in the United States and, as recently discovered, coming soon in bilingual form to Canada.
Mac revenue was the highest ever, up 9 percent, due to new Retina MacBook Air and pro-caliber Mac mini. iPad revenue was up 17 percent, thanks to the new iPad Pro. The combined Wearables, Home, and Accessories category also grew, largely thanks to strong sales of Apple Watch and AirPods, with the wearables part seeing nearly 50 percent growth on its own.
Also important, Cook said, are advances in health technologies, and embedding of machine learning power within Apple’s custom chips. iPhones can now recognize patterns, learn from experience, and make decisions while keeping personal information private. Apple is also trying to raise awareness of iPhone trade-in opportunities, believing that old devices retain high residual value and represent a strong “subsidy” to encourage new device purchases.
Luca Maestri: Prepared remarks
Apple CFO Luca Maestri noted that, starting this quarter, Apple is beginning to report separate gross margins for products in aggregate — 34.3 percent — and services, which were 62.8 percent. Wearables alone are now almost the size of a Fortune 200 company.
The company is still on track for its previously stated goal of doubling services revenue by 2020. There are now over 360 million paid subscriptions, up 120 million over a year ago, with an estimate of over 500 million subscriptions by 2020.
After the iPhone trade-in campaign, which has been very heavily promoted across Apple’s website, the company more than doubled the number of trade-ins over last year, Maestri said. He also noted a variety of successes Apple customers have experienced across various initiatives and customers, including health, construction, and manufacturing.
Maestri expects that foreign exchange rates and a more uncertain macroeconomic environment, especially in emerging markets, will push Apple’s numbers down next quarter.
Services growth actually decelerated over recent quarters — why was that? Will services be a lower-growth segment in 2019 than 2018? Maestri says that Apple set an ambitious target for doubling the size of its business from 2016 to 2020, and is on track to meet it. Growth is coming from installed base — now at 1.4 billion active devices — and little from revenue changes. But more users are paying for more than one service now, more services are being offered globally, the App Store is growing, and there are more payment systems accepted around the world. Subscriptions are growing well above the services average, too. New services will be launched going forward.
Even so, foreign exchange plays a role: U.S. dollar value is going up, and Apple doesn’t reprice for foreign markets. Also, there’s a temporary slowdown in Chinese approval of apps, impacting revenue. And there’s been some deceleration in AppleCare adoption.
There’s a perception that you priced the iPhones too high. What have you learned? Cook says that the iPhone XS in the U.S. was priced the same as the iPhone X a year ago, and XS Max was $100 more, with the XR right in the middle of the iPhone 8 and iPhone 8 Plus — “a pretty small difference in the United States.” But the foreign exchange made that difference amplified in international markets, particularly emerging markets. In some locations, Apple is absorbing part or all of the foreign currency move compared to last year, to get close or on the local price from a year ago.
“Yes, I do think the price is a factor. Part of it is the (foreign exchange) piece, but secondly, in some markets … the subsidy is probably the bigger of the issues in the developed markets.” Cook says the company has a number of things in the works to address the subsidy issue.
Can you comment on iPhone average selling price on a year-over-year basis? Maestri says that the different timing of launches was predicted to impact year-over-year compares, and Apple knew it would create a difficult compare — all he says is that in line with expectations, iPhone XR is the most popular model, followed by XS Max, and XS. (In other words, Apple isn’t commenting on the average selling price, but it must have been down.)
Your forecasts suggest the deepest iPhone decline in history — are you being conservative or do you think it’s getting worse macroeconomically? We had been good when it comes to forecasting an accurate range until last quarter, Maestri says, and on channel inventory Apple typically increases in Q1 and decreases in Q2; this will be similar this year. iPhone performance in Q1 was down, and the key factors Tim mentioned in Q1 will be continuing in Q2.
In September, Apple’s Lisa Jackson said Apple needs to design products to last as long as possible. Why shouldn’t Apple be extending product life cycles going forward, isn’t that an objective? Cook says Apple designs them to last as long as possible, and the cycle has extended, leading to fewer upgrades than expected. Where it goes in the future, I don’t know, Cook said, but Apple wants to make great, high-quality products for users.
How do you view the opportunity on video? Cook says there are huge changes in customer behavior, and there will be a breakdown of the cable bundle that will take place at a much faster pace this year, which Apple will participate in via Apple TV, AirPlay 2 with third-party TVs, and third-party video subscriptions, which people will buy in multiple. Apple will also offer original content, which it’s not ready to discuss beyond saying that it has a multi-year deal with Oprah and other key people it has great confidence in.
Providing free services for Apple devices — how does the (revenue/cost recognition) math work on that? Apple estimates the value of the “free” services, Maps, Siri, and iCloud, and has come up with a total value that gets deferred and amortized over the time the services are delivered. Previously, it was part of the products’ value. Now it’s being reclassified as services revenue. And the cost for those services is reclassified.
As previously explained, the first driver is a growing installed base, with 100 million new devices in the last 12 months alone, and customers wanting to pay for services rather than just getting free ones. Making it easy for customers to buy the services helps, too. Apple Music, Apple Pay, and App Store ads for developers are what are being offered now, but there will be new services to announce in the future.