2 Unexpected Drivers for Apple Earnings

Apple (AAPL -0.31%) reported stellar earnings this quarter, which sent the stock to new all-time highs.

In this segment from Industry Focus: Tech, analyst Dylan Lewis is joined by senior tech specialist Evan Niu to discuss two of the company's less-popular segments that saw incredible growth: services and iPads. Find out how Apple is seeing such a huge uptick in iPads, which many people had written off as irrelevant; how big services is for Apple's bottom line, and how it compared to companies like Facebook; why services is such an exciting segment for Apple to grow; and more.

A full transcript follows the video.

This video was recorded on Aug. 4, 2017.

Dylan Lewis: One of the other segments that has gotten a lot more attention in the last couple of years is Apple's services segment. This just keeps humming along. This most recent quarter, it came in at $7.3 billion, which is good for 22% growth year over year.

Evan Niu: That's an all-time record, too.

Lewis: Yeah, it's crazy. And Apple's services business is now a Fortune 100 company, which is baffling. That's huge.

Niu: Right. On a trailing-12-month basis, it's now a $27 billion business, which is larger than Facebook, for example. This is very high-margin stuff. It's growing very quickly. Apple Music is one big driver. They didn't give an update this quarter on how many subscribers there are, but the last update was at WWDC in June, so just a couple months ago, and there were 27 million Apple Music subscribers. That's pretty strong. They just keep adding subscribers. Spotify has maintained their lead with 60 million right now. But both Apple and Spotify are marching higher, so both are benefiting from the growing market for overall paid streaming music that people are willing to pay for again. The other bit they mentioned was iCloud storage, which was interesting, because I don't really think they have a very strong value proposition with cloud storage compared to some of their competitors. But they did mention they're seeing some nice revenue growth from selling those iCloud storage plans, which are subscription plans. They also mentioned that paid subscriptions, which is a number they've only recently started to disclose, continues to go up. We're now at 185 million paid subscriptions that are going through all of their stores combined. Those aren't individual customers, that's just the number of subscriptions, so, one user may have multiple subscriptions. But, that's up from 165 million last quarter, and 150 million the quarter before that. So, over the course of six months, they've added 35 million paid subscriptions, and they get a 15% cut of that revenue -- they get a cut, and the cut changes based on how long that relationship is there. But either way, that's a very profitable revenue coming in, and it's recurring, it's consistent. So, this business is really doing well.

Lewis: In a lot of ways, this was a surprising quarter. We talk about how this is kind of what we think of as the summer doldrums, right before they kick into fever pitch with, theoretically, at least, the new iPhone release. But, I think one of the biggest surprises, looking at their report and some of the commentary here, was seeing the iPad segment register some really solid growth. This is a segment that I think a lot of people have written off.

Niu: Right. It's been really weak for many years. I think what they finally figured out is what's going to unlock unit sales. Unit sales were up 15%, and that new $329 iPad they introduced in March is clearly a hit. And that's the lowest price they've offered on a relatively new 9.7-inch iPad to date. Clearly that approach is working, because they basically did what they did with the iPhone SE, which is take more current specs, put it in a more or less recycled form factor, but then drop the price and be really aggressive with it, versus the historical strategies they've always had which is, when you introduce a new product, you reduce the price on the old product and step it down. Now, what they're doing is releasing newer products that are still combinations of old products, but they're coming in really aggressively. $329, that's almost an impulse buy for what that iPad is capable of. And you can see that, because average selling prices were basically flat sequentially -- so, it was $435 or so -- and they also introduced a 10.5 inch iPad Pro, but that was in June at the end of the quarter, so that probably had less of an impact. I'm sure there were some nice sales there, but as far as the whole quarter goes, that $329 iPad is definitely doing well. I had an article that charted the growth, and iPad's units have been declining for years and years, and all of the sudden you get this huge spike in unit sales. So, I think investors were very encouraged with that, even though, in terms of revenue, it didn't really do that much. The revenue was kind of flat, I think it was up 2%. So, revenue-wise this is not a huge uplift. But the units, that's a really strong unit number. And, of course, for Apple, it's all about growing the installed base, and once you get people first time in, they'll upgrade eventually. So, there's some long-winded benefits there.

Lewis: And that's one of the things that ultimately feed into that services segment revenue, too. The more people that are holding onto their phones, using their Mac devices, using their iPads, that's going to bolster the strength of services, which is super high-margin revenue. So, that cycle is great to see, even if it's in a segment that people haven't really been paying too much attention to lately.

Niu: Exactly. And they also mentioned, tying this all together, that the number of people -- because, there's a lot of people who buy these devices and don't really spend much money on apps or Services. And they have mentioned, consistently, over the last couple quarters including this quarter, that the number of people who are transacting on their stores is increasing, it's something vague like, it's double digits. But there's growth within the installed base of people who are starting to become more active and actively spending more money, too. So, yeah, to your point, it's all tied together as they build the installed base, even if there's not the immediate benefit. You still have a good chance to make more money later on through services and content sales, and more and more people are doing that.