Viewed from a certain angle, Apple’s first-quarter earnings were pretty good. After all, they were up in nearly every category: iPads brought in $6.7 billion, up 17 percent year over year — the first time in a long time that Apple has posted double-digit gains in tablet sales. Mac sales, spurred by the release of the new MacBook Air, were $7.4 billion, up by 9 percent year over year. The Apple Watch and other wearables brought in a record $7.3 billion, enough revenue to make wearables alone “a Fortune 200 company,” as CEO Tim Cook noted on Apple’s earnings call. And its services division was up 19 percent compared to last year, bringing in $10.9 billion.
But this is Apple, a company that is still best described as a phone manufacturer that also sells computers and tablets — 61 percent of its first-quarter revenue came from iPhone sales. And it was iPhone sales that slumped badly in the first quarter, down 15 percent year over year, bringing in just $52 billion. The company had prepared investors for a hard landing in a historic letter earlier this month, but Apple’s overall revenue still fell by 4.5 percent year over year to $84.3 billion, the first time in a decade the company has seen its revenue decline during the December sales period. It didn’t offer investors a tremendously optimistic outlook for the next quarter either, projecting total revenues of between $55 billion and $59 billion, which means that even if it hits the high end of that projection, it will be under the $61.1 billion Apple made in the same quarter last year.
Tim Cook and CFO Luca Maestri addressed the soft iPhone sales, blaming macroeconomic trends (i.e., China’s slumping economy), fewer upgrades than anticipated, and a strong U.S. dollar for driving up the price of the iPhone overseas. But what they really wanted to talk about — and what they did talk about at length — was services.
To rewind a bit, it’s been clear for years that iPhone sales are stalling out, after years of double-digit growth. This was driven home during Apple’s last earnings report, when Maestri announced that the company would no longer report how many units Apple sold of its products, and would instead just share the company’s overall revenue and its gross margins. It was a clear sign to investors that Apple did not expect its iPhones sales to bring good news moving forward, and that it wanted to shift the focus elsewhere.
So Apple is now trying to get investors and analysts to pay attention to the rapidly increasing amount of money brought in by services, which encompasses everything from Apple Music subscriptions to the fees Apple collects when people use Apple Pay. Apple’s goal is $50 billion in annual services income by 2020, and it appears the company is well on its way to hitting that goal.
Instead of sharing how many iPhones or iPads it sold last quarter, Apple revealed its gross margins — or how much revenue it brought in, minus the cost of selling goods. For all Apple’s hardware sales, the gross margins were 34.3 percent — a healthy number that nearly any other hardware company would be ecstatic to share. And the gross margin for services was 62.8 percent, up by over 10 percent compared to last year. Investors like high-margin businesses — you spend a little to make a lot.
Apple also took pains to point out that its services revenue is diversified — its biggest service revenue driver made up just 30 percent of its total service revenue. In other words, the company is attempting with services to avoid the bind that it currently finds itself in, with its fortunes tied to one product alone. It’s clear that Apple has a strategic vision and is executing on it, but what’s less clear is whether services revenue can grow quickly enough to make up for slumping hardware sales, especially as Apple faces stiffer-than-expected headwinds globally.
As for investors and analysts, Apple’s new metric of sharing gross margins — and taking special care to call out its extraordinarily high gross margins on services — seems a bit confusing. Unlike the straightforward metric of how many iPhones Apple has sold in a given quarter, gross margins are harder tea leaves to read. When pressed by an analyst on whether its gross margins might see some volatility, Maestri had to admit the answer was yes. If Apple is chasing service revenue where margins may be lower — say, trying to get people to sign up for the original video content offerings the company is producing in partnership with Oprah — that gross margin number will fall, even if Apple is bringing in more service dollars overall. It’s a weird number to try to soothe investors with, because its rise and fall won’t be as closely tied to Apple’s overall financial performance as just how many iPhones it sells each quarter and at what average price.
But this is Apple in the era after the iPhone boom. The numbers will be a bit more difficult to read. If it really plans to become a full-on services company, investors will likely want to know not just how much money it’s bringing in, or what its gross margins are, but how many paying subscribers Apple has, what the churn rate is for those subscription services, and how much it costs Apple to acquire a subscribing customer. As of right now, it doesn’t seem like Apple will be sharing that information. (To be fair, neither do a lot of companies that make their money off services — Netflix notoriously doesn’t share much more than how many subscribers it has.)
Still, this is Apple, a company with $130 billion of cash on hand that sells the most popular smartphone in the world. Even with weak iPhone revenue and a pessimistic projection for the next quarter, Apple’s shares were up in after hours trading. But compared to the crystal-clear plan Apple provided to investors just a few years ago — sell more and more millions of phones at very high margins to a very loyal audience — it’s now much harder to see exactly what the future holds for Apple.
