Apple reported its  Q3 FY19 result. The company’s fiscal calendar runs from October to September. Historically, Q3 of its fiscal year rarely has extreme deviations from normal Apple cyclic trends, but a lot of eyes were on this quarter’s earnings because there were numerous pending headwinds: US-China trade war, lack of 5G hardware and foreign exchange.

iPhone Revenue Contribution Below 50% since Q3 2012:

iPhone shipments declined year-on-year (YoY) for the third successive quarter. As a result of this iPhone revenue contribution reached below the 50% level for the first time since Q3 2012. This has impacted its overall operating margin, which reached its lowest level since the start of the decade. However, strong services revenues and wearable growth partially offset the decline in iPhone sales. Apple’s buyback programs and other marketing are dampening growing holding periods. However, the lack of 5G over upcoming quarters may again increase holding periods.

Offsetting the iPhone losses were these gains:

• Wearables and home products up 48% or US$1.8 billion
• Services up 13% or US$1.3 billion
• Mac sales up 11% or US$562 million
• iPad sales up 8% or US$389 million

Greater China Improves, but iPhone Sales Remains Challenging for Apple

Apple continues to face challenges in China in terms of iPhone sales although there have been short-term reprieves in sales due to price cuts, trade-in programs, and offers. However, competitive pressures remain with the growing local smartphone players.

The services segment continues to grow but faces challenges from apps of home-grown giants like Baidu, Alibaba, and Tencent.  In Greater China, except for the App Store, it has been difficult for Apple to monetize services and implement stickiness for the Apple ecosystem. In fact, Apple services grew in double-digits only due to the strong growth of the App Store in China.

The US-China trade war had a direct and indirect impact on Apple in China. The indirect impact was in the form adding some nationalistic purchases which benefitted Huawei’s performance. A saturated market like China is now a zero-sum game, and hence, the growth of Huawei meant that it has likely impacted Apple’s share in China. The direct impact of US-China trade war is that Apple has already started looking at alternatives to drive its production into China alternatives such as Vietnam and India. These changes take a long time to implement, and CEO Tim Cook hinted that reports of manufacturing changes were overblown. In reference to a potential boycott of Apple products, Cook responded with, “I see no signs of a boycott at all. None.”

Americas region grows to 47% of Apple’s regional revenue mix:

Strength of the iPhone XR, wearables, and services helped the region grow 2% to 47% of Apple’s revenue. Rest of APAC saw the largest growth at 13%, followed by Japan at 6%. All regions saw positive year-over-year revenue growth if accounting for greater exchange rate headwinds this year. In all, 15 of the top 20 markets had positive trends—a good sign for Apple. In terms of iPhone performance, this was the third consecutive quarter of a decline in Apple iPhone shipments. To ramp up sales, Apple implemented price cuts for the iPhone XR in India and China. In India, its shipments grew 19% YoY but one of the key points to note here is that during the similar period in earlier years its iPhone 6 contributed 2/5^th of the shipments and this year after the iPhone XR price cut, the iPhone XR became the best selling model for Apple in India contributing half of the shipments. These trends suggest that if Apple gets the pricing right in emerging markets, there is a pent-up demand for iPhones.

5G iPhone:

The recent acquisition of Intel’s smartphone modem business highlights Apple’s in-house ambitions for key components. This is Apple’s largest acquisition of staff, and it is much more than improving know-how or its patent pool. Cook clearly stated the acquisition will help Apple expedite rollouts and that Apple clearly wants to own and control the technology behind its products.

No surprise, Apple deflected any comments regarding a 5G iPhone as it never comments on future products. Cook did give some hints that new apps are coming via AR Kit and Reality Kit, which will likely take full advantage of 5G.

Many Android vendors will be on their second (or third) generation 5G smartphone before Apple launches its first. We expect Apple to get more aggressive with its older portfolio—something we have already seen in the US where the iPhone 7 is being transitioned into the prepaid heavyweight at a retail price of us$49. This will help Apple maintain its growing installed base.

Apple Trade-in Program Ramps:

Apple has been growing its retail and partner trade-in programs and announced a “trade-in as a percentage of sales was significant.” This will help Apple to combat growing holding periods. Apple Care also hit all-time highs during the quarter as Apple continues to grow its partners of carriers, resellers, and repair.

Services Continue to Outperform, Wearables Outperformed:

Services now contribute to more than 1/5^th of overall Apple revenue. Apple services grew 13% year-over-year. Apple Pay reached revenues of US$1 billion per month as it has grown to 47 markets. The company has high hopes for its new services, including Apple Card, Apple TV+, and Apple Arcade.

Mac and iPad sales outperformed the overall PC and tablet markets. B2B sales have helped both see 11% and 8% growth, respectively. Apple has a nice corporate brag that 90 out of the top 100 US banks use Apple products.

In terms of wearables, Apple Watch set a new June quarter revenue record with over 50% growth. 75% of the customers buying Apple Watch purchased it for the first time ever during the quarter.

Apple has given solid guidance for the next quarter with revenue expectations between US$61 billion to US$64 billion and gross margin between 37.5% and 38.5%. A lot will depend on the initial response to the new iPhones and performance in regions like China and Europe. We estimate that services will continue to deliver strong performance, especially with the launch of new services, including Apple Card, Apple TV+, and Apple Arcade. Amid the slowdown in China and likely launch of 5G capable iPhone in 2020, Apple will have also have to concentrate its efforts on emerging markets.