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Apple's Most Important Catalyst May Be Better Than You Thought

By Daniel Sparks - Updated Apr 24, 2019 at 8:47PM

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The tech giant's second largest segment is a major cash cow.

Check out the latest Apple earnings call transcript.

Apple's (AAPL 2.45%) fiscal first-quarter financial results are out. While they showed a year-over-year decline in iPhone revenue, as expected, there was one major surprise figure in the report: a fat gross profit margin for the company's important services segment.

Revealed for the first time, the meaty gross profit margin is good news for investors. Not only is services Apple's second-largest segment, but it's also growing rapidly.

Here's a closer look at Apple's impressive momentum in its services business.

iOS app icons

iOS app icons. Image source: Apple.

A 63% gross profit margin

Apple's services business, which includes revenue from services and digital stores such as the App Store, Apple Music, Apple Pay, iCloud, the iTunes Store, AppleCare, and the Apple Book Store, represents the company's way of monetizing its large installed base of 1.4 billion active devices. But just how much gross profit this segment has been contributing to Apple has been unclear, making it difficult for investors to know how important the segment is.

Until now, the profitability of Apple's services segment has been a close-kept secret for the tech giant. Of course, with services growing rapidly in recent years and swelling to represent a larger percentage of revenue, you can bet investors have been curious.

As it turns out, Apple's services business boasts a gross margin significantly higher than the company's corporate average gross margin. In its just-reported first quarter of fiscal 2019, Apple's services gross margin was 63%. That compares with Apple's 38% gross margin for its consolidated business.

But even this look at Apple's services profitability fails to fully appreciate how healthy the segment is. The company's gross margin for its services segment is notably on the upswing, Apple revealed in its earnings release on Tuesday. Its services gross margin of 63% is up from 58% in the year-ago quarter.

Such a fat gross margin means that even though services revenue accounted for just 13% of Apple's total fiscal first-quarter revenue, the segment made up more than 21% of the tech giant's gross profit for the quarter.

A major catalyst

Looking beyond the key segment's gross profit margin, there are other notable reasons for investors to be impressed with the segment.

Capturing the segment's strong momentum, services revenue rose 19% year over year in Apple's first quarter. Strong growth like this from a sustainable catalyst could help Apple return to top-line consolidated growth in fiscal 2020 even if iPhone sales continue to face headwinds. At just 13% of total revenue, services is still small relative to the company's overall business, but strong growth from the segment will likely help it grow to represent a larger portion of revenue over time and ultimately have a bigger impact on Apple's consolidated performance.

Finally, Apple called out several other impressive metrics from within the segment during the company's fiscal first-quarter earnings call. Cloud services revenue, CEO Tim Cook said, was up 40% year over year during the quarter. Meanwhile, Apple Pay continues to gain traction, with transactions doubling year over year in 2018 to 1.8 billion. Finally, Apple also said Apple News now has over 85 million monthly active users. 

Apple's iPhone business may be struggling, with revenue from the segment falling 15% year over year in the company's fiscal first quarter. But the tech giant's services segment is absolutely booming.

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