Apple Tumbles On Soft Guidance, iPhone Sales Miss; End Of iPhone Unit Sales Data

Update: AAPL shares were already tumbling after hours on weak guidance and iPhone sales miss, when during the earnings call the stock was rocked lower when the company shocked investors with news that said it would stop providing unit sales numbers for iPhone, iPad and Mac.

While CFO Lucas Maestri “explained” on the earnings call that unit sales do not represent clear indication of a performance of the company and are less relevant, investors clearly disagreed and punished the stock, sending it back under the much discussed $1 trillion market cap.

Commenting on the Apple stopping unit sales, analyst Gene Munster said: "I was shocked, but it makes sense. Apple wants investors to focus less on iPhone units, and more on the overall Apple business (including iPhone) as a service. It's going to take a few quarters for Apple to win investor confidence in this new way of analyzing the Apple story."

The bigger risk for Apple is that it now relies exclusively on raising prices at a time when the global economy is said to be within 1-2 years of a recession. Meanwhile, if a big part of value is growing the ecosystem and services, the poor unit growth (and implied share loss) should be a harbinger of slowing service growth.

As another analyst notes, "Seems they are making a huge mistake taking ASP up so much.  Sure it is like doing a few lines of blow over the short term.  Feels great.  But can only do it so long.  Really is amazing their only real innovation has been to take up ASP, but some big warning signs underneath what optically looks good over short term."

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With Apple the last remaining hope to bring back some enthusiasm for the flagging FAANG/growth sector - and perhaps overall market - investors were focused on three key things that Apple would report in its earnings report today: i) whether the average selling price of its iPhone would remain above $700 (and continue rising), indicating continued demand for its top-end products; ii) whether Apple services would remain a source of continued strong growth even as iPhone unit sales appear to have plateaued in recent quarters, and iii) most importantly, Apple's guidance for the all important holiday quarter will be to gauge the success of the new iPhones and especially the lower-priced XR model.

With that in mind, here's what Apple reported moments ago.

In the fourth fiscal quarter, Apple sold 46.9MM iPhones, well below analyst estimates of 48.4MM with iPad unit sales of 9.8 million also missing expectations, even as it beat on the bottom and top line, reporting Q3 EPS of $2.91, vs Exp. $2.78 on revenue of $62.9BN, and also beating expectations of $61.44BN. More good news from Tim Cook: the average selling price of its iPhones soared to $793, up from $618 a year ago, and smashing analyst expectations of $729.

But the main reason why the stock is sliding in after hours trading is that Apple's holiday quarter guidance was somewhat soft, at $89BN-$93BN, with the midpoint below the analyst estimate of $92.74BN.

A summary of key metrics from the fourth fiscal quarter:

  • Q4 EPS: 2.91BN, beating Exp. $2.78
  • Revenue: $62.9BN, beating Exp. $61.44 billion
  • iPhone sales: 46.9 million, missing Exp. 48.4 million
  • iPad sales: 9.8 million, missing Exp. 10.5 million, and down from 10.3 million a year ago
  • Mac sales: 5.3 million, beating Exp. 4.9 million, and down from 5.4 million a year ago
  • iPhone ASP: $793, up from $618, smashing Exp. $729
  • Guidance for holiday quarter revenue: $89-$93billion, with the midline below Wall Street estimates of $92.74 billion

Of the above, the last items most important according to Morgan Stanley analyst Katie Huberty, who said that: "Guidance will be the most important driver of investor sentiment as it provides the first read on iPhone XR demand." And judging by the market's reaction, the company's guidance could have been better.

Looking at the income statement, net income grew 32% Y/Y, EPS rose by 40.6% even as iPhone sales were effectively flat at 0.4%.

Just like last quarter, the key driver for the strong revenue growth despite iPhone sales miss, is that ASPs came well above expectations, at $793 vs the $729 expected, and up from $618 a year ago. Meanwhile, gross profit margin came in slightly below expectations, at 38.2%, up 0.7% Y/Y but below the 38.3% expected. As shown in the chart below, the average iPhone price remained above $700 for the 4th straight quarter.

Like last quarter, iPhone unit sales year over year was essentially flat, but now that the flagship iPhone costs between $1000 and $1450, they make up for this in revenue. That's a 29% year over year jump for Apple in the quarter.

As expected, Tim Cook was euphoric as usual:

“We’re thrilled to report another record-breaking quarter that caps a tremendous fiscal 2018, the year in which we shipped our 2 billionth iOS device, celebrated the 10th anniversary of the App Store and achieved the strongest revenue and earnings in Apple’s history,” Cook said. “We enter the holiday season with our strongest lineup of products and services ever.”

However, digging through the data revealed several red flags. First, going back to the point about peak iPhone sales which emerged first last quarter, Q4 iPhone sales were nearly the same as the fourth quarter last year despite the new flagship iPhone not launching until the holiday quarter. That, according to Bloomberg, means unit sales are flat despite there being new flagship iPhones this year and not last year. "That could be concerning to investors as well." Meanwhile both iPad and Mac sales continues to decline, perhaps as a result of the company's recent price hikes.

As flagged above, despite flat unit sales, the continued rise in ASPs resulted in a nearly 29% increase in iPhone revenues Y/Y, the highest in three years.

Looking ahead, look for much of the same next quarter: revenues making up for slowing unit sales growth. This fourth quarter only includes about a week of iPhone XS and XS Max sales, so we'll get the full picture when they report Q1 2019 either in late January or early February. It'll be the same for the Macs and iPads too, in all likelihood, which earlier this week got nice price jumps too.

Another red flag: Apple's latest revenue prediction would represent growth of "only" 3% year over year, ending a streak of five-straight quarters of double digit percentage gains and is lower than analysts estimates which called for an expansion of 5%.

Other observations: Apple's "Other Products" category - which includes the Apple Watch and AirPods - blew it out of the water with $4.2 billion in revenue, growing 13% from Q3 and 31% year over year, suggesting that the new Apple Watch may be enjoying a bit of a renaissance (although it is unlikely that products like the HomePod helped much).

Apple's Service revenue jumped again, but was just shy of $10 billion, or $9.981BN to be exact, up from $9.548BN last quarter, and up 27% Y/Y (growth slowed from last quarter's 30.8%)

As Bloomberg analyst John Butler notes, services "is getting bigger and becoming a more important contributor to revenue. Strong services growth helps cushion the volatility in iPhone sales. My concern is that services won't continue to grow 30% quarter in, quarter out."

In talking about services, Cook mentioned that year over year services growth would have been even higher (29%) if you exclude a one time accounting adjustment that happened in the year ago quarter. There was also a lawsuit related adjustment to services last quarter. Here's Apple's explanation:

Services net sales in the third quarter of 2018 included a favorable one-time item of $236 million in connection with the final resolution of various lawsuits. Services net sales in the fourth quarter of 2017 included a favorable one-time adjustment of $640 million due to a change in estimate based on the availability of additional supporting information.

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Looking at the regional breakdown, there was more good news here, as sales grew Y/Y in every region around the globe. Greater China posted solid 16.4% Y/Y growth, offsetting fears of a decline in China due to tariffs or nationalistic retaliation. U.S revenues increased year over year by 19.1%, while the rest of the Asia Pacific increased by 21.9% year over year, and Europe also saw a solid 18.2% increase. Curiously, the biggest jump in Revenue came in Japan, where sales rose 33% Y/Y.

As a result of tax reform, for the fourth consecutive quarter, Apple's cash hoard dropped, from $285BN in Q1, to $267BN in Q2, to $243.7BN as of June 30 to $237.1BN in Q4, 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.

And while Tim Cook was delighted over another record quarter and said he couldn't be more bullish about Apple's future, the market does not share his sentiment, with the stock down over 4% after hours and near session lows, on concerns about "peak iPhones" and soggy guidance.