Apple Earnings: iPhone Drags, but Services Hits a New Record

The iPhone was the biggest drag on Apple's (AAPL 1.27%) first-quarter results, but the company continues to make progress in growing the highly profitable services business. The global smartphone slowdown is hitting Apple particularly hard, as premium phones aren't selling like they used to. On the bright side, Apple is on track to hit both of its services-related targets, and the services segment saw gross margin expand sequentially.

In this segment, host Dylan Lewis talks Apple with Fool contributor Evan Niu. To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

This video was recorded on May 3, 2019.

Dylan Lewis: All right, Evan, why don't we switch gears from talking about a business that you and I are both not super fond of, though fascinated with, to a company that we love to talk about, and that is Apple. It would not be an Apple earnings show without Evan Niu. You are our resident expert. The company put out numbers this week. Pretty strong reaction from the market. They seemed to like what they saw.

Evan Niu: Yeah. The total revenue was down about 5% to $58 billion. iPhone was the biggest drag on that top line. Revenue from iPhone was down 17% to about $31 billion. But I think the market's been expecting that and pricing it in, so it's not really all that surprising, particularly when you think about what's happening with the smartphone market globally. Worldwide unit volumes are starting to come down a little bit. The market's matured, volumes have peaked. In particular, the premium end with the smartphone market, where Apple primarily plays, is getting hit the hardest. Even though they don't disclose iPhone unit volumes anymore, we're getting some third-party estimates that think that iPhone units probably fell somewhere between 20% and 30%.

Lewis: Yeah, and that's tough to overcome when the biggest contributor to your top line is a business that's struggling. Part of the problem with them, too, is that one of the big growth opportunities for them with the iPhone was China. That market has stalled a little bit. We aren't seeing some of the growth that we have seen there historically. When people don't have the wage growth, the lifestyle growth, that they're expecting, a lot of the premium products are going to suffer.

Niu: Yeah, and the local brands of China are doing really well. Huawei, their units were up something like 50% last quarter because they're putting out these really good phones at really affordable prices, and that's really resonating now. Whereas Apple, their units went down something like 30% in China, according to some recent estimates. They're definitely losing quite a bit of share there. But at the same time, Apple's trying to pull certain levers to try to grow that business again. I think there are some signs that it's working, which we can get to when we talk about their guidance.

Lewis: Yeah. I will say, before we move over there, hardware wasn't all bad. We saw some good numbers out of the iPad segment, 22% growth. It's still only about $5 billion of the top line. But that is the strongest growth we've seen there in I think five or six years. Wearables, Home also did pretty well. Same number there, about $5 billion contributing to the top line.

We can talk about hardware all day, though. What Apple really wants us to focus on is the Services segment, Evan.

Niu: Right. They've been really hammering the Services narrative for a couple of years now. Services hit a new quarterly record of $11.5 billion. On a trailing 12-month basis, Services is now up to about $43 billion. They're on target to hit this $50 billion number in 2020 that they put out a couple of years ago. That's very much within reach at this point, particularly when you add in these new services that they introduced last month, you have News Plus, TV Plus, this Apple credit card and a subscription gaming service. Over the past six quarters, they've been adding 30 million paid subscriptions. At this point, they're up to 390 million. In January, they set a different target, saying, "We're going to hit 500 million paid subscriptions at some point in 2020." So even if you assume no acceleration from these new services, that would be 120 million more subscriptions over the next year. That puts them well over 500 million. On that target, too, I think they're really executing pretty well on growing the Services business and trying to convince investors why they should care, and also putting up the numbers to back that up.

Lewis: As an investor, I care, because that is high-margin revenue that is coming in, and I'm happy about that. You think about having 500 million people paying something to the company, and that really just builds out the ability to add stuff down the road. If they start adding more services, if they build out something on the streaming side, who knows, that creates the market and the appetite for a lot of that stuff that they can just tack stuff onto, especially once people are in the habit of paying Apple or going in through the App Store or what have you to add stuff to whatever hardware they're using.

Niu: And to your point about profitability, gross margin on the Services business did take up a little bit on a sequential basis. But at the same time, you don't know where that's going to go in the future because each of these services has a very different margin profile. This video stuff is going to be so expensive, to buy and develop and produce all this original video content, which we know is so expensive, from looking at companies like Netflix, for example. Each service is totally different. But that number is still overall, heading in the right direction.