Trade Tension, High Prices Hinder iPhone Sales, Says Apple, in Rare Earnings Warning

Wednesday's letter, released after U.S. markets closed, cited weak performance in China. Cook said lower-than-forecast iPhone, Mac and iPad revenue accounted for all the shortfall and “much more than our entire year-over-year revenue decline.”

Citing a slowing China economy in the second half of 2018 and the nation’s second-lowest September quarter in 25 years, Cook pointed to “rising trade tensions” between China and the U.S.: “As the climate of mounting uncertainty weighed on financial markets, the effects appeared to reach consumers as well, with traffic to our retail stores and our channel partners in China declining as the quarter progressed.” Cook called the China market contraction “particularly sharp.” Thursday, the Office of the U.S. Trade Representative didn't comment.

Analysts lowered ratings and cut price targets for Apple stock. Referencing trade tensions with China, Seeking Alpha analyst Trading Places Research said it’s the first time “a macro shock has affected Apple's revenue in the post iPhone era.” It noted Cook used the word China 11 times “and every one of them was aimed at the President.”

Tariffs are a “direct threat to American workers and companies, hindering economic growth and slowing hiring,” said Josh Kallmer, Information Technology Industry Council executive vice president-policy. “Companies of all sizes and their customers will continue to be hit with negative impacts.” Kallmer urged the Trump administration to continue “critical negotiations” with the Chinese government and work toward a long-term solution that “rolls back tariffs, changes China’s unfair trade policies, and ends this mutually damaging trade war.”

Demand for iPhone upgrades was lower than expected in the quarter, said Cook. Outside of iPhone troubles in China, iPhone upgrades fell short of projections in developed markets, he said, citing “macroeconomic challenges in some markets.” Other factors limiting iPhone sales: fewer carrier subsidies, U.S. dollar-strength-related price increases and iPhone owners “taking advantage of significantly reduced pricing for iPhone battery replacements.”

Industry sources were surprised by the degree of Apple’s shortfall. Bob O’Brien, president of Display Supply Chain Consultants (DSCC), called holiday season iPhone sales an “awfully big miss,” in an email, noting Apple’s “other” products category was up 19 percent year on year, meaning the iPhone was down 15 percent in revenue. He estimated unit sales took a 20 percent dive, saying the Q4 average price has been historically higher than Q3 in previous years due to the “holiday effect.”

O’Brien has seen no evidence of an “anti-Apple bias” in China but “can’t escape [the] feeling that the trade tensions have hurt the sales of the most prominent US brand.” Using Apple’s numbers, he cited a 20 percent sales revenue drop, saying the smartphone market in China isn’t growing and is “disappointing” to a lot of players, but “there's nothing that's happening in the overall market that approaches that level.”

The iPhone XR, launched in October, a month after the higher priced XS and XS Max, has been the “biggest source of weakness,” DSCC CEO Ross Young emailed us. While “not aware of any particular anti-Apple programs in China in response to the Trump tariffs,” Young said, “it seems to be an outcome nonetheless.” Chinese smartphone brands and Samsung have been able to beat the XR on price and performance, offering OLED vs. LCD displays at the same price point, he said.

Weak holiday quarter performance is also an indication Apple may have reached a price ceiling with consumers, analysts said. Seeking Alpha analyst Bill Maurer noted customers aren’t happy with Apple’s “rising price structure.” That led many to take advantage of the battery replacement program (see 1712290019) Apple implemented after reports it intentionally slowed down older model iPhones. The company attributed slower performance to aging batteries and, after a user outcry, cut the price of an out-of-warranty replacement battery by $50 to $29 for users of iPhone 6 or later models. “Why get a new $749 or more expensive phone if you can just replace your battery for $29,” Maurer noted.

Apple needs to revisit its iPhone strategy this year, moving from too costly and too large toward a middle ground, Maurer said. He’s among analysts saying the company could launch a smaller, lower cost phone this year.

Apple suppliers took a hit Thursday, too. RF chip supplier Qorvo dropped 9.1 percent; Face ID optical component company Lumentum fell 8.4 percent; Skyworks Solutions was off 10.7 percent; Gorilla Glass maker Corning fell 6.2 percent; and Broadcom, Micron Technology and Intel dropped 8.9, 5.3 and 5.5 percent. Warren Buffet’s Berkshire Hathaway, with a stake in Apple, saw class A shares fall 4.6 percent Thursday.

Cook highlighted areas of strength for the company saying the installed base of active Apple devices hit a historic high, growing by 100 million units in 12 months. Wearables and the Mac are bright spots, with wearables growing 50 percent year on year, and Apple's services business generated $10.8 billion revenue in the quarter, on track to doubling from 2016 to 2020. Non-iPhone businesses have less exposure to emerging markets, Cook said.

Apple Notebook

In an announcement out of the Amazon playbook, Apple trumpeted Thursday that its App Store customers set records over the holidays, spending $1.2 billion between Christmas Eve and New Year’s Eve and more than $322 million on Tuesday alone. Apple said its services unit set records in multiple categories: the App Store, Apple Music, Cloud Services, Apple Pay and the App Store’s ad search business. Gaming and self-care were the most popular categories of app downloads and subscriptions during the holidays, said the company.