Apple Inc. (NASDAQ:AAPL) reported its fiscal first-quarter earnings on Tuesday after the bell, and it kicked the year off the right way. Apple set an all-time quarterly revenue record — snapping its streak of declines — and broke its previous iPhone sales record. AAPL stock is up strongly Wednesday morning as a result.
But the star of yesterday’s show wasn’t the iPhone. It was the Services division, which includes the App Store, Apple Pay, iTunes, AppleCare and Apple Music. Services didn’t just set another record — it also posted the strongest year-over-year growth of any AAPL division.
Services Is on Fire, Led by the App Store
Apple reported that the quarterly revenue for its Services division topped $7.17 billion for Q1, an increase of 18% compared to the previous year. If that sounds like a lot of money for what is largely made up of mobile payment transaction fees and digital content, it is. In comparison, Netflix, Inc. (NASDAQ:NFLX) experienced its largest-ever subscriber growth in the final quarter of 2016, leading it to post revenue of $2.48 billion.
During the AAPL earnings conference call, CEO Tim Cook noted that he expects the Services division to be the size of a Fortune 100 company by the end of the year. Other key information about the Services division from that earnings call includes:
- App Store revenue for December alone was a record-setting $3 billion
- There are now 2.2 million apps in the App Store, and AAPL paid out over $20 billion to developers in 2016
- The number of Apple Pay users has tripled over the past year, with transaction volume up over 500% year-over-year
- AppleCare and storage services (iCloud) both set all-time records
- Apple’s music business grew for the third straight quarter
Why Services Revenue is Important
You might not know it based on Apple’s record-setting iPhone sales this quarter, but selling hardware is tough.
Once a consumer has an iPhone in his or her hands, it becomes very difficult to convince them to spend a minimum $649 to ditch that smartphone for a new one. In one sense, a huge installed user base — which AAPL has, with more than 1 billion iOS devices in active use — works against the company. When the iPhone first began to take off, AAPL was selling to people who’d never owned one before. Now, that pool of easy sales is dwindling. And Apple is left in the tougher position of convincing its installed user base to upgrade.
Thus the hand-wringing about slowing iPhone sales.
Apple’s Services division largely benefits from that huge installed user base, though. True, AAPL only gets one shot at selling these customers AppleCare. But once they own an iPhone, iPad, iPod, Mac, Apple Watch or AppleTV, they begin to explore Apple’s other services. They are increasingly adopting Apple Pay. They are in a prime position to buy movies on their Apple TV. They are perfect candidates to subscribe to Apple Music. There are plenty of hooks for storing data on iCloud. And of course, there is the App Store and the lure of its millions of apps.
Apple’s Services revenue doesn’t come in big chunks like selling an iPhone. It’s $9.99 a month here, 99 cents for an app there, a few cents for a transaction. But it adds up, especially when over a billion customers are generating it.
More importantly, that revenue doesn’t drop off the same way hardware revenue does when people stop buying new iPhones.
Some services — like iCloud and Apple Music — are subscription-based. AAPL keeps automatically billing the customer’s card every month regardless of whether their iPhone is brand new or five years old. Apple Pay revenues are increasing as more countries and businesses accept it and iPhone owners grow more accustomed to using it.
Bottom Line for AAPL
People never stop buying apps. They may slow down after the initial rush of a new device, but developers keep bring enticing new games and other apps to the App Store. That means the 1 billion users continue to download.
Just look at the 40 million-plus Super Mario Run downloads from the App Store in only four days.
How many iPhones will AAPL sell two years from now? No one knows for sure, but odds are it won’t be many more than it does now. On the other hand, Apple is confident its highflying App Store, Apple Pay and other services will see Services division revenue double in that time.
The iPhone may have driven Apple stock growth over the past decade. But Services revenue is increasingly important as AAPL stock searches for that elusive next hardware hit.
As of this writing, Brad Moon did not hold a position in any of the aforementioned securities.