Apple’s Q2 2018 earnings call: iPhone X was top seller all quarter

Apple released record second-quarter 2018 financial results today and once again hosted a live question-and-answer session for financial analysts to speak with Apple CEO Tim Cook and CFO Luca Maestri. We covered the session live, with updates below in chronological order as the call proceeded.

Cook began by noting the success of the quarter, and that it was the sixth consecutive quarter of revenue growth. He noted that Apple did $100 billion in iPhone revenue over the first half of fiscal 2018, and that iPhone X has been the most successful iPhone model each week since its launch. He also said that this is the first cycle in which the top-of-the-line iPhone model was also the most popular seller since Apple split the line from iPhone 6 and 6 Plus.

The initial focus on iPhone X was no surprise. In today’s earnings release, Cook pushed back against reports that the device has fallen short of expectations, pointing out that “[c]ustomers chose iPhone X more than any other iPhone each week in the March quarter, just as they did following its launch in the December quarter.” Same- and Plus-sized sequels to the iPhone X are expected to launch this September, making the success of the initial version particularly important.

Apple Pay continued its strong growth, doubling and tripling transactions year-over-year, with Beijing and Shanghai getting commuter transit payments. It’s also successful in Tokyo, with Brazil coming.

Wearables — Apple Watch, Beats, and AirPods — are now the size of a Fortune 300 company. Apple Watch alone grew to a March quarter record, and it’s the top-selling watch in the world. Mainland China, Hong Kong, and Thailand got carrier support during the quarter, and watchOS 4.2 added features for skiers and snowboarders. AirPods continue to grow in popularity in gyms, coffee shops, and other places; Cook said they were a runaway hit.

HomePod, Cook said, is widely recognized as having the best audio quality in size and class. He still believes it will change the way people listen to music at home, and Apple is looking forward to adding new features and introducing the device in new markets soon.

After reviewing some recent educational announcements, Cook noted that iOS 11.3 improved ARKit with superior quality and surface processing only six months after its debut. iOS 11.3 also added encrypted medical record management to iPhones and increased Apple’s visible commitment to privacy, which he said should be a fundamental human right.

“We’re now halfway through our fiscal 2018,” Cook said, with $150 billion in revenues, and growth in all markets. “We have the best pipeline of products and services we’ve ever had” and the most satisfied customers, plus meaningful returns of cash to shareholders. “We’re narrowing the site selection for a new U.S. campus and look forward to sharing more information on that later this year.”

Luca Maestri repeated the press release’s growth statistics, noting 20 percent growth in developing markets, including China — a market some analysts recently claimed that Apple was losing. The average selling price of an iPhone has grown to $728, driven primarily by sales of iPhone X, iPhone 8, and iPhone 8 Plus.

Maestri claims that customer satisfaction across all iPhones is 95 percent, and even higher — at 99 percent — if counting only the last three devices. Services is growing at a fast pace all around the world, he said, with the App Store garnering record revenue and Apple Music’s 40 million subscribers generating record revenue, as well. AppleCare revenue also grew at its highest rate in five quarters.

HomePod, Apple Watch, and AirPods constituted 90 percent of total growth for the Other Products category. Mac sales went up across developing countries, and nearly 60 percent of the quarter’s Mac purchases came from customers new to the Mac. iPad growth was also up mostly strongly in Japan, Eastern Europe, and the Middle East. iPad market share is now 53 percent for the quarter, with 95 percent customer satisfaction, and 73 percent of business customers intend to purchase iPads.

Apple expects to use a new $100 billion share repurchase plan quickly. Maestri notes that the company has increased its dividend 6 times over the last six years and expects to continue to do so.

Q&A begins

First question is on iPhone repositioning — Is the iPhone X price point sustainable in the market? Cook says that revenues are up 14 percent year-over-year on iPhone, with iPhone X driving the gains. There are different customers in the smartphone market, so they’re going to continue to provide different iPhones to meet the needs of different customers.

For the iPhone X, specifically, customers chose it more than any other iPhone every week since it was launched. “The iPhone X is a beloved product,” he said. “It’s like when a team wins the Super Bowl, you might want them to win by a few more points, but it’s like a Super Bowl winner — I couldn’t be prouder of the product.”

Can you talk about the biggest drivers of acceleration for services? Cook says the great news about it is that it’s not a single geography or service — the minimum for each geography was 25 percent. App Store, Apple Music, iCloud, and Apple Pay all set records. If you look at the number of paid subscriptions, they’ve moved up over 100 million year-over-year to 270 million this quarter. Short-term forecasting is reflected in the guidance Apple has provided, and they’re on target to double the services revenue of 2016 by 2020.

Anything to preempt risks of China going forward? “China and the U.S. have this unavoidable mutuality,” said Cook, whereby each only wins if the other wins, and the world only wins if both win. He repeated prior comments, noting that open countries do better than closed ones and that it’s not just about allocating the existing pie differently, but growing it. He believes that view will prevail over time.

What are the next drivers of services growth? AR? Cook said that the great thing about services is that several services that make up the total are growing nicely. Because the active install base is now above 1.3 billion and has grown in the double digit percentages year-over-year, this is a huge opportunity for Apple.

What’s working for Apple in China right now? “iPhone X was the most popular smartphone in all of China last quarter,” said Cook. “Other Products,” including wearables, did well in China, as did services. Apple gained share in the Chinese market for the Mac, as well. Cook also disclosed that the iPhone had the three top-selling phones in China, led by the iPhone X, without noting which devices were numbers two and three.

When asked about Apple’s cost structure, Maestri said that Apple was dealing with a more difficult cost environment because of memory pricing, which has hit the company’s component sourcing. He later said that he expects NAND pricing will turn the corner soon, and DRAM hopefully by the end of the year.

Maestri also noted that the company focuses on stock buybacks over dividends because it believes Apple’s stock is undervalued but wants to make purchases of stock efficiently at the right times.

In response to a question on privacy, Cook said that Apple devices, rather than cloud servers, store as much of the user’s confidential, encrypted data as possible, and Apple doesn’t allow as much data to be shared from the device as on other platforms.

What’s Apple’s health care opportunity — is it merely selling watches or is there more to it, including services? Cook says that Apple thinks about it very broadly, including ResearchKit and CareKit and health care records, which all came from pulling the string with the Apple Watch and seeing where it went. “It’s an area of great interest where we think we can make a big difference,” said Cook. “It’s a major strategic thrust of ours.”

What are the drivers for Apple in mainland and greater China over the next few years, as well as in India? “In India, we set a new first-half record, so we continue to put great energy there,” said Cook. “Our objective is to go over there with all of our initiatives and everything else … it’s clear that many people will be moving into the middle class over time. China, I continue to believe, is a phenomenal country [for both the market and app developers], doing unbelievably creative work, and innovative work.”

“On a 90-day clock, lots of different things can happen,” said Cook, “but my own personal view on China is that it’s a great market.” Apple is certainly looking beyond 90 days: “The market for us is more than iPhone, the Mac gained share there was well, the Watch gained some traction there, [and services, as well].”

What are Apple’s thoughts on iPhone X pricing — is it better in Apple’s view to maximize unit sales or ASPs? Cook said: “We price for the value that we’re delivering, and iPhone X is the most innovative product on the market … jam-packed with technologies that really set up the smartphone for the next decade, so that’s how we priced it. We were surprised that through all of this period of time that the iPhone X has been the most selling, most popular every week since the launch.” If the iPhone X technologies move to lower price points, that will give Apple more unit demand.

“Our primary consideration is always around maximizing gross margin dollars,” said Maestri.

iPhone and smartphone growth is supposedly saturated, but we don’t see that in India, a questioner says. Is there a way to get India market share up to a similar level as in other countries? Cook: “If you look at last year … there were still a half-billion feature phones sold in the world; many of those were sold into emerging markets. We still believe that over time every phone sold will be a smartphone. So it seems to us that with that many feature phones being sold, that’s a pretty big opportunity.”

Regarding the iPhone, Apple’s market share globally is low compared to the full market of smartphones, so Apple’s task is to convince people to switch to Apple while taking care of current customers who might upgrade. “We spend quite a bit of time on this, as you might guess.” India, as the third-largest market in the world, has extremely low Apple share, so Apple is working with the carriers in that market to build their LTE networks and improve infrastructure. Cook doesn’t feel that the smartphone market is saturated, either overall or for the iPhone. He said the iPhone is the best consumer electronic product in the history of the world, and he sees continued opportunity to make it sell even better.

Two-thirds of Apple is outside the U.S., says Maestri, so a weak dollar makes Apple’s sales go up, and a strong dollar is a headwind. The process to innovate products at Apple includes replacing existing products with higher-cost structure models that then come down in cost over time. Apple has gotten good at this over time but can’t predict gross margins six to 12 months out.