Thoughts on Apple’s Q2 FY 2014 earnings

Apple’s earnings were out today, and so I thought I’d do a quick run-down of some of the most interesting numbers, as I did for Google last week. Time permitting, I’ll do this for some of the other major tech companies as they report too. Some of what’s below is based on stuff Apple explicitly reports, while the rest is based on calculations and assumptions. I’ll try to be very clear about which is which.


First, Apple’s hardware lines. Because Apple’s numbers are so cyclical in nature, I try to use both year on year growth and 4-quarter trailing numbers to make comparisons more meaningful and to better tease out long-term trends. Here, then, is year on year 4-quarter trailing revenue growth for the four major hardware product lines:

Growth rates for 4 major Apple product lines

The obvious trend is down and to the right, though it’s a bit more nuanced than that. But iPod is clearly very much in decline at this point, and it’s reasonable to speculate how much longer it will stick around. But iPhone growth has clearly slowed enormously too, as the law of large numbers kicks in, and as key markets approach saturation. However, iPhone growth actually ticked up this quarter after consistent declines for several quarters before that, suggesting that growth in China, Japan and other both emerging and developed markets helped to turn things around a bit. It’ll be very interesting to watch this number going forward. The Mac line has also recovered a bit in the last couple of quarters.

But iPad is the most worrying one, since that’s the newest product line and competes in a segment that’s presumably far from saturation. Some of the year on year decline was due to exceptional events in the same quarter the previous year, but not all. Even sell-through fell by 3% year on year. As such, you have to wonder what’s going on. I suspect the answer is a combination of the following:

  • Smartphones will eventually work out to about 1 per person, whereas tablets will be significantly less, both because of the higher out-of-pocket price and because they tend to be shared. As such, the ceiling for tablets overall is much lower than for smartphones.
  • Tablets, like smartphones but more so, come in several flavors, that are used for different things. A large chunk of the tablet market is not used in the way the iPad is designed to be used, and is fed by low-cost Android devices, especially in China. As such, the addressable market for the iPad as a percentage of the overall tablet market may well be lower than the addressable share of the smartphone market.
  • The iPad is a victim of its own success. Many people who want one have one, and don’t feel an urgent need to replace it quickly. Many first- and second-generation iPads are likely still in use, and three quarters of all iPads Apple has sold were sold in the last two years. If the replacement cycle is longer than for iPhones, which seems entirely reasonable, then many of those buyers won’t buy another for some time. As such, as we move past the initial wave of adoption, growth will slow until at some point we start to see successive significant waves of upgrades.
  • Competitors such as Samsung have caught up with the basic functionality/price combination of the iPad far more quickly than major competitors caught up with the iPhone. There are still downsides to Android tablets – the lack of apps being the biggest – but there’s no arguing that Samsung’s and Amazon’s devices are compelling, and they’re selling pretty well at least in certain markets. This further limits iPad’s share, whereas it took much longer for smartphone competitors to eat into the segment of the market the iPhone targeted.

Taken together, I think these factors help explain what’s going on with the iPad. The big question, then, is whether the current trend is likely to continue, or whether there is anything Apple could do to turn it around in the near future. I suspect that we are unlikely to see another massive wave of first adopters, except possibly in the education market, and as such a high proportion of future sales will come from upgrades. That means it may well be slow going until Apple gives people a compelling reason to upgrade. Assuming most current iPad owners will eventually upgrade, it then becomes a question of what those upgrade cycles are, which no-one really knows yet.

Overall hardware revenue, combining the impacts of those various individual product line growth rates, looks like this:

Apple hardware revenueHardware revenue growth clearly slowed considerably from 2011 through 2013, and then flattened out (it actually shrank for two quarters in 2013). But it’s now started growing again, by roughly a couple of billion dollars a quarter, driven by iPhone growth and Mac stability.

iTunes, Software & Services

The headlines in hardware are pretty straightforward, and there aren’t many ways to drill down into them beyond what Apple reports. But the iTunes, Software & Services line is particularly interesting because of what’s happening underneath the surface, which you can glean from comments on the earnings call and some calculations and assumptions. First, here are the numbers the company reports:

iTunes reported numbers

For clarity, iTunes/Software/Services is the segment Apple reports alongside its major hardware segments and Accessories. iTunes net sales is a number the company usually gives on the earnings call, and represents what Apple actually books as revenue from iTunes (including iOS and Mac App Store) sales, net of payments to developers. iTunes billings is the total amount billed to customers, including gross amounts paid for apps. These numbers are all heading up and to the right, even on a quarterly basis (these are quarterly numbers not 4-quarter numbers as above). iTunes now generates over $2 billion per quarter for Apple every quarter, a milestone it first reached a year ago. And gross billings exceeded $5 billion for the first time.

Now, time for some deductions. Using the net and gross iTunes numbers, we can calculate roughly how much Apple paid developers, and therefore roughly how much revenue the App Stores generated both for Apple and for developers 1. Given that, and given that we have iTunes net sales to go on as well, we can further subdivide the iTunes, Software & Services line into its constituent parts as follows:

iTunes Software and Services split

Several things are evident from this chart:

  • iTunes content revenue (i.e. music, video and books) is now in decline over the long term, having peaked in mid 2013. This is likely driven largely by the popularity of streaming music services, which are causing a decline in Apple’s music downloads. This explains why Apple is reportedly looking into providing a subscription music service that would go beyond iTunes Radio. Video may be holding up better, though there too consumption is shifting to ad-supported and streaming services in major markets like the US, so I believe Apple should plan to launch a subscription video service as well. Taken together, these moves should help return this part of the business to growth.
  • iTunes app revenue is growing like mad. It’s easily the fastest growing part of Apple’s business, with around 100% year on year growth, compared with under 20% for the rest of the ISS segment, and the much lower rates shown above for Apple’s hardware products. This is an increasingly important business for Apple, and it likely crossed the $1 billion mark either this quarter or last quarter, meaning that at the current run rate it won’t be long before it passes the Mac.
  • Software & Services revenue (i.e. everything else in the segment that’s not iTunes) is also growing nicely, despite the hit from making OS X and iWork free. I’d love to know more about the composition of this part of Apple’s financial reporting, but frankly it’s a black box, containing things as diverse as iCloud subscriptions, AppleCare warranties, Aperture and Final Cut Pro. My guess is that iCloud subscriptions and AppleCare are major components of the growth, because they’re closely tied to hardware sales, but a guess is all it is. But this chunk of revenue has now eclipsed iTunes Content as a revenue source, which is another milestone.

All of this reinforces my sense that Apple has to be looked at as a business in several parts, which I wrote about earlier today on Techpinions. Each of these parts reinforces every other part, in a tightly integrated fashion. Looking at any of the individual lines in isolation misses the point. As one illustration of this fact, look at the revenue per iTunes account from Software and Services, from iTunes as a whole, and from content and apps separately (on a trailing 4-quarter basis):

Revenue per iTunes account

First, every line apart from apps is falling, but that is actually steadily climbing, even with the big jump in the number of iTunes accounts this most recent quarter. It’s now over $5 per year per account, which doesn’t sound like a lot, but over 800 million accounts it does add up. The decline in other lines is likely the result of two factors: firstly, the overall decline in content outlined above, and secondly, as Apple penetrates further into other markets outside the US, the range of content available to those users is smaller, and their disposable income is lower too. The fact that app revenue per user is still growing is somewhat amazing in that context, and may be the result of multiple device ownership. On the other hand, if Apple could create a compelling subscription music service, even if just a fraction of its users paid the usual $8-10 per month, it could dramatically increase content revenues.

There’s so much more to be said about all this, but in the interests of length I’ll leave it there for today. As ever, I’d welcome comments on any of this, or other interesting aspects of Apple’s earnings.


  1. This is an assumption, and I’m comfortable making it, but Apple has never explicitly said whether there are any other products for which it reports net rather than gross revenue beyond apps. While it sold books under the agency model, those would have been included too, since the price was set by the content owner, not Apple, and Apple merely took a standard cut, as it did with apps. Since Apple lost the price-fixing court case, it has ceased pricing books this way and as such I believe has stopped reporting the associated revenue in this way too. I’d love to hear if anyone has an alternative view on all this