I did a quick piece on the iPad specifically, already, so go read that if you’re so inclined and then come back and read this deeper dive on calendar Q2 earnings. The full set of posts for consumer tech companies’ Q2 earnings is here, and will continue to be updated with new posts as they arrive.
iTunes divergence continues
I’ve talked before about the divergence in trends within iTunes revenues, and it continued this quarter. Apple doesn’t report these numbers directly, but it’s possible to calculate them based on the numbers it does share. Here’s how the iTunes, Software and Services segment splits between its three constituent parts:
The App Stores continue to grow very rapidly, and note that the line in the chart above only reflects Apple’s net revenues from App sales – the gross revenue from App sales is over three times as high, at $4 billion this past quarter alone. Meanwhile, content sales continue to fall as music consumption in particular shifts to subscription and free streaming options. What’s impressive is that Software and Services is holding up so well despite the shift to pricing OS upgrades and iWork at zero. This is likely driven by iCloud, AppleCare and Google search revenues, offset somewhat by software declines, but it’s impressive that it’s the largest of the three sub-segments, at least for now. But it’s entirely possible that Apple will generate more net revenue from apps than content next quarter, and that app revenue will pass Software and Services revenue within a year.
It’s also worth looking at Apple’s app revenue in the context of Google’s, since we now know a little more about that following I/O. Here’s an updated chart showing my estimates for app revenue at both companies, incorporating Q2 data:
Big R&D investment makes sense if new products are coming
The various components of Apple’s expenses move around a fair bit as a percentage of revenues, but none has been moving as consistently upwards both in dollar and percentage terms as its research and development spending:
Some companies spend enormous amounts on R&D as a percentage of revenue on an ongoing basis, but that hasn’t been Apple for a long time. Back in the early 1990s, Apple spent as much as 8.5% of revenues on R&D, but it’s steadily fallen from there to a low of 2% in early 2012. However, since then it’s been going up and up, and now stands at over 3% of revenues. That doesn’t sound like a lot, but bear in mind that revenues have been growing too, and the real increase is an almost doubling from $2.9 billion over four quarters in 2011/2 to $5.5 billion in the most recent four quarters. The last time it reached current levels as a percentage of revenues was all the way back in 2004. The long-term ramp in dollar terms is quite astounding:
Bear in mind that Apple has been producing new iterations of its key products every twelve months during much of this period, and yet the pace of growth in R&D spending is accelerating even in dollar terms. Given that R&D is essentially money the company spends on things it hasn’t yet commercialized, it’s certainly a fairly strong signal that Apple is making considerable investments in new products of one kind or another.
Average selling prices tell an interesting story
Ever since Apple stripped product revenue down to the units themselves and separated out related accessory and service revenue, we’ve been able to get a really good sense of average selling prices for the four major categories. I’ll focus here on iPhone and iPad ASPs, because each of them tells an interesting story.
The iPad is the simpler one to look at, since there’s a more obvious single-direction trend. ASPs have fallen from just below the iPhone at around $600 shortly after launch to the mid-400s today. Keeping the older iPads around at a discount and especially launching the iPad Mini have dragged overall selling prices down, but they’ve been fairly steadily at around $450 for a while now, with a brief blip last quarter.
The iPhone, however, tells a different story, or rather two stories. Firstly, there’s a very strong cyclical trend, with early-cycle buyers favoring the more expensive models – the top of the line, with more storage – and late-cycle buyers going for the cheaper options, whether lower storage or older devices. In the past few quarters, both the 5C and the 4 and 4S have played interesting roles as lower-cost options, with the 5C being heavily promoted in certain markets over the past few months, helping overall iPhone sales but shifting the mix downward in pricing terms. And that’s the second story – iPhone prices are also trending downwards over time, with the repeated arcs in ASPs starting and ending lower with each cycle. But they haven’t fallen nearly as far as iPad prices, as the price of brand-new top of the line iPhones has remained at $650. In some ways, it’s remarkable that Apple has been able to keep ASPs to healthy and still maintain a really good growth rate, while resisting calls to discount the iPhone more heavily.
Regional trends show China taking off, Americas slowing
Here’s a look at year on year growth in trailing four quarter revenues – i.e. how the last four quarters compare to the same four quarters a year earlier:
China’s been a big theme on recent earnings calls, and you can see why: even though the iPhone enjoys a relatively small market share in China, it’s growing rapidly, and Chinese growth is increasingly important to overall Apple growth, especially given that the rest of Asia Pac (excluding Japan) is shrinking. Here’s a different view of revenue growth by region, showing quarterly year-on-year growth in dollars, rather than in percentage terms:
What you can see is that Greater China has for the last three quarters made up a significant chunk of overall growth. In the most recent quarter, only China and Europe made a significant contribution to growth, while in the previous three quarters Japan had also contributed meaningfully, though that growth now seems to be slowing. I would guess that much of the growth is iPhone-driven in all the markets where Apple’s revenue is growing – China thanks to China Mobile, Japan thanks to NTT DoCoMo, and Europe thanks to strong iPhone 5C sales.
To close, it’s worth taking a step back and looking at overall financial performance for Apple. The chart below shows revenues and margins on a trailing 4-quarter basis (which eliminates the quarterly fluctuations and allows us to see the long-term trends):
It’s helpful to do this because it’s a reminder of how enormous, and how profitable, Apple is. Every quarter I inevitably see a slew of comments on Twitter about the sheer scale of Apple, implying that it’s absurd to say that things aren’t going so well as a result. However, Apple hasn’t just been a very big and very profitable company – it’s been a fast-growing one too: just look at the revenue bars in the left half of that chart, and compare it with the right half. With the current set of products, I forecast single-digit growth for Apple for the next few years, at similarly high margins, driven by the iPhone, with the iPad and Mac largely canceling each other out growth-wise and iTunes, Software and Services canceling out the iPod decline.
But the fact is that it’s extremely unlikely given what we saw above in the R&D line, and what we see “reported” every day, that Apple will stick with just its current product lines. If and when Apple does launch one or more new products (wearables, payments, subscription content services or whatever), the growth will pick up again. It will never match the torrid pace of iPhone growth will a single product, but a combination of new products and new strategies for growing existing product lines should lead Apple back to stronger growth later this year or early next.