The Small But Significant Trends From Apple’s Q2 Earnings

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Apple (NASDAQ:AAPL) published its fiscal Q2 earnings on  Tuesday, reporting a relatively mixed set of results that beat market estimates on earnings amid growth in services revenues, although revenues fell short of expectations due to lackluster iPhone shipments. Below, we provide some of the key takeaways from Apple’s earnings release.

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iPhone ASPs See Sharp Sequential Decline

Shipments of Apple’s iPhone declined by 1% to 50.8 million units on a year-over-year basis, amid weaker demand from China and also due to customers potentially holding off on upgrades ahead of the launch of the 10th anniversary iPhone, which could debut later this year. iPhone ASPs improved by about 2% year-over-year to about $655, driven by strong demand for iPhone 7 Plus models. However, pricing fell by 5.5% sequentially, driven by a stronger U.S. dollar and also potentially due to discounting in markets such as India and China, where the iPhone 7 is viewed as being similar to older models such as the iPhone 6. There is a possibility that things could remain challenging over Q3 as well, as the launch of the next generation devices – which are expected to sport Apple’s first design upgrade in three years – draws closer.

Gross Margins Under Pressure Due To Strong Dollar, Semiconductor Prices

While Apple’s gross margins came in at the high end of its guidance range at 38.9%, they saw a decline of about 50 bps year-over-year, on account of currency headwinds, as well as higher component costs. The price of memory components such as DRAM and NAND has been rising, amid under-supply caused by some manufacturing constraints and also due to strong demand from mobile vendors. For example, PC DRAM prices have nearly doubled since mid-2016, while NAND prices have also been steadily rising. Moreover, Apple’s newer smartphones are also generally more expensive to build compared to its legacy devices, as they sport more advanced components such as dual lens cameras, pressure sensitive screens and taptic engines. Margins are expected to remain under pressure, with Apple guiding gross margins of between 37.5% and 38.5% for Q3 FY’17.

Services Growth Continues Driven By App Store Sales

Apple Services business also had a strong quarter, with revenue rising by around 18% year-over-year to about $7 billion, driven primarily by the App Store (revenues up 40%). While Apple takes a cut of paid app sales, the company also earns a commission (typically 15% to 30%) from third-party subscriptions on its platform. The company noted that it had a total of over 165 million paid subscriptions across Apple-branded services and third-party services. Apple has indicted that it intends to double its Services business by the year 2020, which could prove positive for gross margins over the long run.

Apple Watch and AirPods

Apple’s Other Products division – which includes Apple Watch, iPod and accessories – saw revenues rise by about 31% year-over-year to $2.87 billion. Apple indicated that sales of the Apple Watch nearly doubled year-over-year, driven by the new Series 2 version and the price cut on the earlier version of the device. Apple is also emphasizing the fitness aspects of the Watch – offering GPS and water resistance, as it looks to create more realistic use cases. The AirPods wireless headphones are also gaining traction, with Apple indicating that demand continues to significantly outstrip supply.

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