Apple's third-quarter earnings: everything is selling better and in bigger numbers — except the iPhone 8

iPhone sales rebounded overall, but the average selling price didn't budge.

Apple has released a third-quarter earnings report that beat its own expectations.

In past years Apple published its third-quarter report in late October, about a month after that year's new iPhone began shipping. This year, because of the iPhone 8 and the iPhone X, the report landed today — a week after iPhone X pre-orders opened, just as the phone starts shipping. That way, if iPhone sales for the quarter looked weak, Apple could still talk about the attention its expensive iPhone X has drawn.

As it turns out, Apple has a handsome set of numbers to show even without mentioning the iPhone X.

From July through September, Apple took in US$52.579 billion in revenue and US$10.714 billion in net profit, up 12% and 18.9% from the same period last year — the highest revenue it has ever recorded in a fourth fiscal quarter (the third calendar quarter).

After the report came out, Apple's stock jumped 3.13% in after-hours trading, pushing its market value toward US$900 billion.

Every hardware line was growing at the same time: the Mac, the iPad and the Apple Watch all posted double-digit growth, some as high as 50%.

iPhone sales rose for a second quarter in a row too — by only 2%, but enough to halt the slide that began with the 6s in 2016. Look closely, though, and this was not really the iPhone 8's doing.

More iPhones sold, but mostly the older models

The iPhone X only went on sale today, so this third-quarter report shows what happened after the iPhone 8 arrived.

The iPhone 8 may be the weakest-selling annual iPhone Apple has ever had. In the past, the second quarter was always Apple's trough, with consumers waiting for the new product in September.

Third-quarter numbers then get a lift from the new iPhone.

Consumers usually start pre-ordering around the middle of the quarter and don't get their phones until the final week. But "sales" in Apple's earnings report doesn't mean sales to consumers — it means sales into the sales channel, and that happens earlier.

Under Tim Cook's management, Apple's hardware takes an average of just five days to go from the production line to retail stores, carriers and online sellers. By the time a consumer pre-orders a new phone from a carrier, the channel has already placed its order with Apple.

Apple sold 46.68 million iPhones in the third quarter, barely different from the previous quarter, which had no new model at all. Measured by average price and by absolute unit sales, the iPhone 8 did not even match the iPhone 6s of 2015.

In fact, each new iPhone since 2014 has done less to lift sales. Counting the year after each launch, the iPhone 6 still holds the record; every model since has been weaker, with sales falling off quickly once the holiday shopping season ends. Even the iPhone 7, which did better at Christmas, never caught up with the iPhone 6.

With no obvious upgrades, and hemmed in by an iPhone X coming a month and a half later, the iPhone 8 gave consumers no reason to trade up. Instead it was earlier models like the iPhone 7 that sold better.

The iPhone's average selling price this quarter was US$618 — less than a dollar below the same period last year, even though the iPhone 8 and 8 Plus start at prices 11% and 9% higher than last year's 7 and 7 Plus.

A flat average price can only mean that more of the quarter's iPhone buyers picked cheaper, older models.

Third-party data says the same thing.

According to late-October data from the market research firm CIPR, the iPhone 8 and 8 Plus accounted for just 16% of all iPhones Apple sold in this year's third quarter; when the iPhone 6 and 6 Plus went on sale two years ago, the new models took 20%. The iPhone 7 and 7 Plus accounted for 58% of sales, and still older models for 35% — mainly because prices on the older phones drop once a new iPhone arrives.

There is another catch: the sales figure in the earnings report is not the number of phones that reached consumers, but the number supplied to distributors.

If the iPhone 8 units pushed into the channel in the third quarter don't sell through, orders for the rest of the year will inevitably shrink. That is what happened with the iPhone 6s: distributors took on too much stock, it sat there, and Cook eventually admitted Apple spent more than $2 billion clearing the iPhones piled up in the sales channel.

This time it may come faster. Less than two months after launch, the iPhone 8 is already being cleared out; JD.com and Suning are both offering discounts of more than 1,000 yuan, which makes the iPhone 8 cheaper than some iPhone 7 models.

Helped by the enterprise market and by product changes, the Mac and the iPad both sold for more — and sold better

Apple sold 5.386 million Macs this quarter, up 25% year on year. That makes the Mac the fastest-growing of its major hardware lines, and this its fastest growth in 10 quarters.

Part of the reason is that Mac sales were terrible in the third quarter last year, before the new MacBook Pro appeared — some models hadn't been updated in years.

The growth is still a little surprising. In the second quarter this year the Mac was flat, with sales up just 1%.

But by units and by revenue alike, the Mac is now back where it stood in the last quarter of last year, when the new MacBook Pro had just launched. The Mac's average selling price also jumped from $1,302 last quarter to $1,331.

On the earnings call, Cook said the Mac's growth came from rising demand for the MacBook Pro. There was no new model this year, but Apple changed the MacBook Pro's product strategy and offered more configurations of the same machine: the entry-level version without the Touch Bar now comes with 8GB or 16GB of memory and up to 1TB of storage, which widens its price range to between 10,888 and 20,488 yuan. The entry-level MacBook Pro can now sell for more.

The MacBook Pro has also reached more schools; Cook said purchases in education grew by double digits year on year.

The awkward part is that the Touch Bar, which Apple made so much of last year, still hasn't gone anywhere — this year's macOS update did little to make better use of that touch strip.

The iPad's story is the same as the Mac's: pricier and selling better. Apple sold 10.326 million iPads this quarter, up 14%, and the average selling price rose $30 from the previous quarter.

The fastest growth came from the Apple Watch

Revenue in the "other products" category totaled $3.231 billion, up 36% — the largest gain of any Apple business. The category covers the iPod, the Apple Watch, AirPods and similar products, and its revenue, in Cook's words, now matches that of a company in the "world's top 400."

On the call, Cook said the "wearables business," which includes the Apple Watch, AirPods and Beats, grew 75% year on year. The Apple Watch was the main contributor, and he added that it has now grown more than 50% for three quarters running: "LTE has made Apple a game changer."

What is known so far suggests that the Apple Watch Series 3, which can make calls on its own, does more to make consumers reach for their wallets.

According to a report from KGI Securities, demand for the cellular version of the Apple Watch Series 3 ran far above its earlier forecasts, accounting for 80%-90% of all Apple Watch sales after launch.

The market research firm GBH Insights published a report after the new watch went on sale saying that 70% of Apple Watch Series 3 buyers were new customers who had never owned an Apple Watch. They also leaned toward the more expensive cellular version: among those who had already bought one, more than 80% chose it.

The Apple Watch has moved from its original positioning as a fashion item to sport and health, and that strategy is now maturing. The new watch's added features, the new workout modes in the software and the NFC reading of gym-equipment data are all updates built around the goal of being a health device. IDC's report says the Apple Watch will go from a basic fitness tracker to a fully featured wearable.

The Apple Watch has, however, run into trouble in China, where the government suspended the standalone calling function over security concerns. How long that will weigh on sales is still unclear.

After the App Store's overhaul, revenue from selling apps jumped too

Beyond accessories, the "services" business — Apple Music, the App Store, iCloud and other internet services — looked good all round, with revenue above $8 billion and growth above 34%.

The App Store in iOS 11 got its biggest redesign ever. It is now an app-recommendation publication: the front page carries Apple Music-style card recommendations, there is a daily "App of the Day" section, and games have been split off into their own category. Human editors write introductions, how-to guides, developer interviews and more.

According to a report from the app market research firm Apptopia, making it into the new App Store's "App of the Day" or "Game of the Day" section lifts a developer's average downloads by 1,747%, and by 792% for games.

Apple's recommendation pushes a featured app up 137 places in the rankings on average, and featured games up an average of 321 places overall. That gives smaller developers more of a shop window, and it earns Apple more money.

Services is the only Apple business that has grown without a break, even last year when hardware was falling across the board.

It is a new source of revenue growth: in theory, Apple only has to hold on to its existing iPhone users to keep earning from services. About 700 million iPhones are in use around the world today, and every one of them might spend money on one Apple service or another.

After a year and a half of decline, China is growing again

The other sign of improvement is China. Greater China revenue ended six straight quarters of decline and finally grew 12% in this year's third quarter, to $9.8 billion, making it Apple's third-largest market after the United States and Europe.

Last quarter China dragged Apple's worldwide growth rate down by 11%; Apple CFO Luca Maestri explained that the decline came mainly from Hong Kong, where the number of visiting tourists had shrunk sharply. This time Cook said the fall in Hong Kong "has moderated," and that "in China, both upgrades among existing Apple users and switchers from Android grew year on year."

Asked about iPhone 8 pre-orders in China, Cook, as usual, gave no figures: "In China, third-party sales channels reflect people's interest more than actual pre-orders. So I don't want to give a number that could be misleading. We'll have to wait a bit to get a clear picture of supply and demand."

The surprise was Japan, where the market fell 11% this time.

Apple is betting future growth on the more expensive iPhone X

The iPhone X has only just gone on sale and is not counted in this report, which did not stop it from being the center of attention.

The first question Cook answered on the earnings call was about iPhone X supply. "iPhone X production is going well, especially considering how advanced this product is … At this point we can't predict when the iPhone X will reach a balance of supply and demand."

Apple has said iPhone X pre-orders "far exceeded expectations." Jun Zhang, an analyst at Rosenblatt Securities, put a number on it: in China, orders reached 5.5 million units within five hours of pre-orders opening. For comparison, the iPhone 8 sold 4 million units in its first three days, and the best-selling iPhone 6 sold 12 million.

The iPhone X's effect will show up in full in this year's fourth-quarter report. It is already Apple's main promotional product: every advertising channel has switched to large iPhone X posters, and even Apple's own home page has nothing left on it but the iPhone X.

On the iPhone X's 8,388-yuan starting price, Cook's explanation was that "many consumers pay for their phones monthly," which makes the iPhone X "about the price of a cup of coffee a day."

Be that as it may, a high price cannot fail to affect what people decide to buy.

The real reason may be that Apple had no choice.

In theory Apple could give up some margin and let the iPhone X take a bigger market. According to information that has already leaked, the iPhone X's bill of materials costs $412.5 (about 2,700 yuan).

But high margins have always been the main reason Apple's stock keeps climbing. Cook restored the dividend and the share buyback program. By one count, Apple now hands about 30% of its net profit back to investors every year.

That has done its work on the share price. In the two weeks after the iPhone 8 launch Apple's stock slid steadily, and at its low point was down more than 7% from its all-time high of $164.94 on September 1 this year, wiping out more than $50 billion in market value.

Lately the stock has climbed back. Since September 25 it has risen more than 6%, roughly back to where it stood before the launch event; year to date, Apple is up more than 50%.

Wall Street likes the iPhone X even more. "The iPhone X is priced at $999, the iPhone 8 and 8 Plus also got price increases, and Apple changed the pricing ladder across storage tiers. This shows Apple is taking a more aggressive approach to capture higher profits," KeyBanc analyst Andy Hargreaves wrote in a report.

Similar views turned up two weeks earlier, when Apple's stock was falling. The investment bank Drexel Hamilton argued that many consumers would skip the iPhone 8 altogether and buy the iPhone X, which would lift Apple's revenue and its share price. Raymond James also believed demand for the iPhone X would run higher than Apple's own expectations, and advised investors to buy the stock.

But share prices move on the short term. Can an expensive iPhone X really keep the iPhone growing for another decade?

Everyone understands the rule: raise the price and sales fall; only the rate of the fall differs from product to product. You may be able to buy an iPhone X for "the price of a cup of coffee a day," but figures as conspicuous as 8,388 yuan and $999 cannot fail to affect buying behavior, however many people they affect.

For now the iPhone X's performance rests on loyal users in a hurry to buy an iPhone the moment it is available, people who are not that sensitive to price.

Whether that fervor lasts another six months is hard to say.

Cover image shot on site.