Apple’s Q3 2018 earnings call: iPhone X and subscriptions drove growth

After releasing record third-quarter financial results today, Apple CEO Tim Cook and CFO Luca Maestri hosted their quarterly live question-and-answer session for financial analysts. We are covering the session live, with updates below in chronological order as the call proceeds.

Today’s Q&A comes as Apple’s executives once again celebrate double-digit percentage revenue growth across every territory except Japan, which grew by 7 percent. China was up 19 percent year-over-year, versus 16 percent for the rest of the Asia-Pacific region, 14 percent for Europe, and 20 percent in the Americas. The company is predicting between 16 and 19 percent overall growth for the next quarter.

iPhone and Services

Tim Cook opened the call by noting that iPhone had a very strong quarter: The active install base grew by double-digits, due to switchers, first-time buyers, and existing customers. iPhone X was the top-seller for the quarter again, with 98 percent customer satisfaction.

Another major area for the company is stellar Services growth, helped by growth of Apple’s active installed base. The company is on target to double Services revenue by 2020. Paid subscriptions have now surpassed $300 million, up 60 percent in the past year. Subscription revenue is an increasing percentage of the Services business, and the number of apps offering subscriptions is now at nearly 30,000.

The App Store has exceeded Apple’s wildest expectations and generated twice the revenue of Google Play so far for the year. Apple Music grew 50 percent, AppleCare has grown, and cloud services were up 50 percent year-over-year.

Apple’s free services are also surging. The company saw all-time highs for use of Messages and FaceTime; Siri requests are already at 100 billion for the year; and the number of articles read on Apple News has doubled. Apple Pay usage has also increased, tripling from a year ago.

Apple Watch and Wearables

Cook said that Wearables is the third major area — up 60 percent year-over-year, and now up to $10 billion in revenue for the year. Apple Watch grew in the mid-40 percent range for the quarter, and AirPods growth is beginning to resemble the early days of iPod, as they’re becoming increasingly visible in public. With watchOS 5’s release in the fall, Apple Watch will become stronger for fitness, communication, and quick access to information, including workout data.

Maestri noted that Apple Watch is the best-selling smartwatch by a wide margin, and AirPods have been selling as fast as Apple can make them since they were introduced roughly a year and a half ago.

iOS 12: Siri and ARKit 2

Starting with iOS 12, Siri will take a “major step forward” with Siri Shortcuts, which let any app work with Siri, significantly expanding its adoption and making it more useful. iOS 12’s under-the-hood enhancements make it much faster, and its activity-monitoring features will let users understand how much time they’re spending on their devices.

ARKit 2 will enable the creation of more dynamic AR apps, and Apple is uniquely positioned to provide the best AR experience, Cook said, because of the integrated Apple software and hardware.

Mac and macOS

While Cook only briefly discussed macOS Mojave, noting that Safari will be adding privacy features this year, he spent a bit more time discussing the iOS-to-macOS porting initiative previewed at WWDC — previously codenamed Marzipan.

Cook said that Mac developers will be empowered to bring their best iOS apps to the Mac. While he says that they’re different OSes, iOS frameworks are being brought over with specific Mac behaviors to make it possible to easily port iOS apps to Mac. Apple will release its first in-house-ported titles with Mojave and will bring the iOS-to-Mac tools to developers next year.

Maestri noted that the MacBook Pro launched later this year than last, putting it at a sales disadvantage, but that it still did well in a number of countries.

Apple TV and HomePod

After noting that HomePod availability has expanded into several additional markets, Cook said that the Apple TV has seen major growth since the introduction last fall of Apple TV 4K. As noted at WWDC, video providers across the world are choosing Apple TV 4K to deliver subscriptions — Charter will be offering it later this year to 50 million households within the Spectrum app. iTunes will have the largest collection of Dolby Atmos-supported movies anywhere by this fall.

Q&A

How will services grow further over the next three to five years, given that they’re already on track to hit the company’s expectations, and will margins continue to be in the 38 to 38.5 percent range?

Cook says that while Apple couldn’t be happier with the way things are going, the company is planning new services in addition to current ones to boost services growth further. Maestri says the margin should be flat — Apple was able to offset potential margin issues this quarter, and between foreign currency exchange costs and the costs of introducing new products, offset by growing services and the falling cost of memory, it should be balanced out for the September quarter.

Any color on individual members of the iPhone family, and iPhone’s competitive position, given that there have now been nine months of experience with iPhone X? Cook says that Apple has continued to see iPhone X growth week by week, despite its higher price, and that it’s been the top-selling product. The iPhone X, 8, and 8 Plus are growing nicely as a fraction of the family’s sales. This cycle, they’ve learned that customers want innovative products (!). iPhone X was even the top-selling phone in urban China.

What about the trade situation with China? Cook says this is the fourth consecutive quarter of double-digit growth in China, and they have had such growth in iPhone, iPad, Services, and the Watch. In terms of the tariffs: Our view on tariffs is that they show up as a tax on the consumer and wind up resulting in lower economic growth. Sometimes they can bring about a significant risk of unintended consequences.

It’s clear that some of the details between China and the U.S. are in need of modernizing, but Apple doesn’t think tariffs are the way to do that. In terms of ones that have exited the comment period, there are three of them — U.S.-imposed tariff on steel and aluminum, plus two others on $50 billion on goods coming out of China. None of Apple’s products was directly affected by them.

There’s a fourth tariff for $200 billion of goods, and that one is out for public comment; Apple will share its views on that one before the end of the public comment process. It might not be obvious, but Apple needs to analyze both its purchases from other companies and its own products that could be impacted from a revenue process. The impact to Apple is very difficult to quantify, but all of that said, Cook is optimistic that it will be sorted out, as there is an inescapable mutuality between the U.S. and China, which means the world only prospers if both do, and both countries prosper working with each other. They’re hoping that calm heads prevail.

What’s the situation with the Oprah partnership, and how is Apple Music doing? Cook says they’re “very excited to work with Oprah,” who has an unmatched ability to connect with audiences around the world. Apple hired two highly respected TV executives last year and has been working on a project that it is not yet ready to share all the details about, but the company feels really good about what it will offer. The key catalyst is cord-cutting — it’s only going to continue to accelerate and is likely to happen faster than people thought.

Apple TV grew by very, very strong double digits in Q3, Cook says, and different providers are picking up the Apple TV to use for their services. Within 300 million-plus-paid subscriptions, there are third-party video services growing 100 percent year-over-year. All the outside information Apple sees points to dramatic changes speeding up in the content industry, so the company’s glad to be working on the service it won’t discuss further today.

In terms of Apple Music, there are well over 50 million listeners now, including paid and trial subscribers. Apple has a leadership position in Japan and is making strong inroads in countries where it’s been for a long time. It’s not a competition between existing players — the real challenge is to grow the market. Outside of China, less than 200 million people are using subscription music systems around the world, so there’s a chance to build the overall market.

How healthy is the smartphone market, given that iPhone unit sales have been pretty flat for years? Cook says that the market is healthy — the best market in the world to be in, for a consumer tech company. Whether it grows 1-2 percent, 5 percent, 10 percent, or shrinks, it’s still a huge market. iPhone revenues are up 20 percent for the quarter, and given “the cycle” of an iPhone, unit sales are single-digit, revenues are up double-digit.

Some replacement cycles are lengthening, based on subsidy plans becoming a much smaller percentage of sales around the world. But for Apple, coming out with a great, innovative product brings enough people to the table to make for really good business. Apple’s installed base is one of the key drivers of services, and the active installed base for iPhone grew double digits over the year-ago quarter, which you can see in services numbers. Apple doesn’t really care whether someone buys a replacement battery instead of a replacement phone — it’s just focused on making great new products people want to buy.

Given that there’s a war on in the home — internet of things and connected homes — how important is it to have a beachhead in the home and outside? Cook: HomePod and Apple TV are only a small part of what’s at home, including the Mac, iPhone, and iPad all being used at home. Siri is now being used a lot for home-related functions, and Cook is using Apple Watch, iPhone, iPad, and HomePod to control home automation. The smartphone has become the repository across the whole of your life, and Apple is focused on everything.

Is the iPhone the onroad into the Apple ecosystem, or is it the Beats headphone or smaller accessories that are attracting new people into the Apple market? Cook says that the AirPods, Apple Watch, etc. are products within the ecosystem. However, he’s heard that some users are coming to the iPhone because of the Apple Watch, but also the other way around; it’s not always a linear path, as it is different for each user.