Apple Hits All Time High On Services, ASPs, Stellar Guidance

When we wrote our preview of AAPL earnings, we said they could be a trade-off between iPhone sales on one hand, and the company service revenues as well as broader revenue picture, and sure enough that’s precisely what happened.

In the third fiscal quarter, Apple sold 41.3MM iPhones, up from 41.0MM a year ago, but missing analyst estimates of 41.6MM, with disappointing unit sales for iPads and Macs as well, but because it beat on the bottom and top line, reporting Q3 EPS of $2.34, vs Exp. $2.18 on revenue of $53.3BN, up 17% Y/Y and also beating expectations of $52.4BN, while providing Q4 revenue guidance that was well above analyst estimates, the stock jumped over 3% after hours.

As some had expected, Apple product sales missed on every metric:

  • Q3 iPhone sales 41.3MM, vs Exp. 41.6MM
  • Q3 iPad sales 11.6MM, vs Exp. 11.7MM
  • Q3 Mac sales 3.7MM, vs Exp. 4.3MM, the lowest since Q3 2010

A clearer breakdown of iPhone sales in Q3, shows that after peaking in 2015, Apple may have hit a bit of a peak (via Jon Erlichman):

  • Q3 2018: 41.3 million
  • Q3 2017: 41.0 million
  • Q3 2016: 40.4 million
  • Q3 2015: 47.5 million
  • Q3 2014: 35.2 million
  • Q3 2013: 31.2 million
  • Q3 2012: 26.0 million
  • Q3 2011: 20.3 million
  • Q3 2010: 8.4 million
  • Q3 2009: 5.2 million
  • Q3 2008: 717 thousand

And yet, despite stagnant iPhone growth, the following breakdown of Q1 revenue shows that the company has been more than able to offset the topline growth:

  • Q3 2018: $53.3 billion
  • Q3 2017: $45.4 billion
  • Q3 2016: $42.4 billion
  • Q3 2015: $49.6 billion
  • Q3 2014: $37.4 billion
  • Q3 2013: $35.3 billion
  • Q3 2012: $35 billion
  • Q3 2011: $28.6 billion
  • Q3 2010: $15.7 billion
  • Q3 2009: $9.7 billion
  • Q3 2008: $7.6 billion

But even more important than Apple’s Q3 earnings was Apple’s Q4 forecast for the next quarter, in which Apple sees revenue between $60 and $62Bn, above consensus estimates of $59.4BN, on margins of 38.0-38.5%, vs est of 38.2%. According to Bloomberg, “this looks like a bet on a new iPhone” to wit:

The larger income seems to indicate that the company is expecting to include some sales of the next-generation iPhones in the fourth quarter. Apple is preparing a major new iPhone launch with three models: an update to the iPhone X design, a giant new iPhone that looks like a bigger iPhone X, and an iPhone 8 replacement that looks like an iPhone X but still includes an LCD screen. It will, however, have facial recognition, which could help sell the phones.

One key driver for the strong revenue despite iPhone sales miss, is that ASPs came well above expectations, at $724 vs the $699 expected, resulting in 20% revenue growth. Meanwhile, gross profit margin came in exactly as expected, at 53.3%. As shown in the chart below, the average iPhone price remained above $700 for the 3rd straight quarter.

As Bloomberg notes, here’s a snapshot of how important the increasing iPhone sale prices are to the company:

If the average iPhone sale price was the same as it was at this point in 2017, Apple’s total revenue would have increased 6.5 percent in the fiscal third quarter. Instead the company’s revenue rose more than 17%.

Indeed, despite softer iPhone sales, the company’s solid revenue beat suggests that Apple is increasingly leveraging average selling prices and other revenue streams. And to this point, Apple once again announced blockbuster service revenues of $9.5BN which includes the App Store and Apple Music, beating Wall Street expectations of $9.2BN.

That is 31% growth from $7.3 billion in the year-ago quarter and 4% quarter over quarter growth. As RBC noted earlier, Apple is increasingly becoming a service company, and as the following chart shows, Service revenue is now growing far above iPhones.

The full forecast in a nutshell:

  • revenue between $60 billion and $62 billion
  • gross margin between 38 percent and 38.5 percent
  • operating expenses between $7.95 billion and $8.05 billion
  • other income/(expense) of $300 million
  • tax rate of approximately 15 percent before discrete items

Notable is that the company also returned almost $25 billion to investors through its capital return program during the quarter, including $20 billion in share repurchases, just shy of the Q2 record of $22.8 billion.

One potential blemish: as Bloomberg notes, behind the numbers in the quarter, Apple’s cost of goods sold rose faster than revenue, meaning that gross margin dollars, which increased 16.77% didn’t expand as quickly as the top line.

Some analysts had predicted declining costs of components such as memory chips would help out Apple’s costs. Doesn’t look like that’s kicking in yet. Perhaps they were working through inventory?

Commenting on the result, CEO Tim Cook said “we’re thrilled to report Apple’s best June quarter ever, and our fourth consecutive quarter of double-digit revenue growth. Our Q3 results were driven by continued strong sales of iPhone, Services and Wearables, and we are very excited about the products and services in our pipeline.”

CFO Luca Maestri also chimed in, saying that “our strong business performance drove revenue growth in each of our geographic segments, net income of $11.5 billion, and operating cash flow of $14.5 billion. We returned almost $25 billion to investors through our capital return program during the quarter, including $20 billion in share repurchases.”

So with all that said, here are the results in chart format:

Apple Net Income grew 32% Y/Y, EPS rose by 39.2% even as iPhone sales barely rose 0.7%

Product sales: The market was expecting a very modest increase in iPhone sales and yet the company failed to deliver, as iPhone sales came in at 41.3mm, below the 41.6mm expected, and just above the 41.0 mm sold last quarter. iPad sales were 11.6mm, also below the 11.7mm expected, while Apple sold 3.6 million Macs, far below the 4.3 million expected, adn the lowest since Q2 2010.

Service Revenue: a revenue category that is rapidly becoming as important as iPhone sales, soared 31% Y/Y to $9.55BN, the highest on record, and beating all Wall Street estimates.

Regional breakdown: More good news here: sales grew Y/Y in every region around the globe. In better news, Greater China posted solid 19.3% Y/Y. U.S revenues increased year over year by 20.4%, while the rest of the Asia Pacific increased by 16% year over year, and Europe also saw a solid 13.7% increase .

Finally, as a result of tax reform, for the second consecutive quarter, Apple’s cash hoard dropped, from $285BN in Q1, to $267BN in Q2, to $243.7BN as of June 30, as Apple used cash on hand to buyback stocks and fund dividends, instead of issuing more debt.

Net cash also declined, and was the lowest since Sept 2014 as it no longer has tax incentives to hoard cash offshore

Putting it all together, shareholders were happy to forgive the miss in iphone sales, and are clearly enjoying the company’s stellar forecast, and have sent the stock 3% higher, to fresh all time highs, and that much closer to $1 trillion.

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