Apple’s services demonstrate profitable potential and may be poised for a revival

Apple’s third-quarter earnings report on Thursday revealed a decline in revenue for their flagship hardware products – iPhone, iPad, and Mac. This trend may continue in the current period.

However, the growth of their services division, which includes subscriptions, warranties, licensing fees, and Apple Pay, has helped offset the weakness in hardware sales. In the June quarter, services saw a growth of over 8% with $21.2 billion in sales, surpassing the 5.5% growth of the previous period. Apple expects even faster growth in the unit during the fiscal fourth quarter.

Apple CEO Tim Cook expressed satisfaction with the division’s performance, stating, “The growth was better than we expected.”

Apple’s services business is crucial for shareholders due to its higher margins compared to hardware products, predictable recurring billing, and multiple revenue streams from their vast user base of over 2 billion devices. Services had a gross margin of 70.5% in the June quarter, nearly double the 35.4% margin of all hardware products.

CFO Luca Maestri explained, “Our install base continues to grow, providing us with a larger pool of customers. Additionally, our customers are more engaged, resulting in increased transacting and paid accounts on the ecosystem.”

While sales of iPads and Macs are expected to decline by double-digit percentages annually, Apple anticipates better performance from iPhone sales compared to the 2% decline in the latest quarter.

Although Apple’s services business may not achieve the growth records it set during the pandemic, which exceeded 38%, analysts expect it to generate nearly $60 billion in total sales by fiscal year 2023.

Maestri further explained, “We have a large customer base familiar with our ecosystem, engaged in the ecosystem. However, many are still using only the free portion of our offerings. By offering better and more content over time, we believe we can attract more paid customers.”

Apple’s latest report should ease concerns among analysts regarding the significant slowdown of the services segment since December 2022.

The services business encompasses various products, although Apple does not provide a breakdown. However, during the earnings call, officials shared details about the factors contributing to their optimism in the business.

According to Apple’s annual SEC filing, the services division includes:

• Advertising, such as Apple News and App Store ads, as well as licensing agreements like the default iPhone search engine deal with Google.
• AppleCare, the extended warranty program.
• Cloud services, such as iCloud storage.
• Digital content, including Apple Music, video subscriptions like Apple TV+, and Apple’s share of App Store sales.
• Payment services, including fees from Apple Card and Apple Pay usage.

Cook mentioned, “We achieved an all-time revenue record for total services and several categories, including video, AppleCare, cloud, and payment services.”

Maestri added that advertising, App Store, and music were also experiencing growth, although they only set June quarter records, implying higher revenue from those categories in previous quarters.

Apple disclosed that they have over 1 billion paid subscribers, doubling in three years and increasing by 150 million over the past year. This figure includes subscriptions to Apple’s services and third-party apps on the App Store, as Apple receives a portion of each purchase.

Cook noted that their deal with Major League Soccer to broadcast games on Apple TV exceeded internal expectations for subscribers, partly due to the presence of soccer star Lionel Messi: “The fact that Messi went to Inter Miami helped us out there a bit.”

After the report, Apple shares dropped slightly over 2% to $187.15 in after-hours trading.

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