Cook: Poor sales in China, iPhone sales lower than expected

According to foreign media reports, Apple's stock price fell by about 8% in after-hours trading on Wednesday, affected by Apple CEO Tim Cook's letter to investors on Wednesday, which lowered his performance expectations for the first quarter of 2019 (the fourth quarter of the 2018 natural year).

In the letter, Cook said that many factors caused the company's revenue to fall short of expectations, including poor sales in the Chinese market and lower-than-expected iPhone sales.

[[254612]]

First , the three iPhone models launched in September 2018 were not shipped at the same time as in 2017, making year-on-year comparisons difficult. For example, Apple’s most expensive flagship iPhones, the iPhone XS MAX and XS, were shipped in the fourth quarter of last year, while the iPhone X, the most expensive flagship launched in September 2017, was not shipped until the first quarter of 2018.

Second , Apple has long anticipated that the strengthening of the US dollar will lead to exchange losses. In 2018, the US dollar index rose by nearly 5%, which led Apple to expect that its revenue growth would be about 200 basis points lower than the previous year. At present, this expectation has not changed much.

Third, after launching three new mobile phones and updating the Apple Watch (fourth generation) in September 2018, Apple also launched new iPad Pro, AirPods wireless headphones, MacBook Air laptops and other upgraded products in October of that year, resulting in supply-side restrictions on sales of certain products in the fourth quarter of 2018. For example, sales of the fourth generation of Apple Watch and iPad Pro were affected for almost the entire quarter, and AirPods wireless headphones, Apple's most popular accessory, and MacBook Air laptops were also affected.

At the same time, the economic weakness in "some emerging markets" has a greater impact than Apple had previously predicted. Supply-side constraints and poor performance in emerging markets have become the main reasons why Apple decided to lower its revenue guidance for the first quarter of fiscal 2019. The combined impact of factors such as too many and too frequent new product launches and a strong US dollar has led to fewer iPhone upgrades, which account for nearly 60% of Apple's revenue, than the company expected.

Therefore, Apple's revenue forecast was lowered from US$89 billion to US$93 billion to US$84 billion; the gross profit margin was lowered from 38% to 38.5% to around 38%.

The following is the full text of Cook's letter to investors:

To Apple Investors:

We are revising our earnings forecast for Apple's fiscal 2019 Q1 ending December 29, 2018. We currently expect:

• - Revenue of approximately $84 billion;
• - Gross profit margin of approximately 38%;
• - Operating expenses of approximately $8.7 billion;
• -Other profit/expenses of approximately $550 million;
• -The tax rate is approximately 16.5%.

We expect the number of shares used in the calculation of diluted earnings per share to be approximately 4.77 billion.

Based on these estimates, our Q1 revenue will be below our initial guidance, with other items remaining broadly in line with expectations.

While it will still take several weeks for us to complete and report final results, we wanted to provide you with some preliminary information now. Our final results may differ from these preliminary estimates.

When we discussed our Q1 revenue guidance with you about 60 days ago, we knew that the quarter would be impacted by both macroeconomic and Apple-specific factors. Based on our estimates of those outcomes, we expected Q1 revenue to be up slightly year-over-year. As you may recall, we discussed four factors at the time:

First, we knew that the different timing of the iPhone launch would impact our year-over-year comparisons. Our high-end iPhone XS and iPhone XS Max shipped in the fourth quarter of fiscal 2018 -- to get into the channel and early sales -- while last year iPhone X began shipping in the first quarter of fiscal 2018. We knew this would create a difficult comparison in the first quarter of fiscal 2019, and this played out broadly in line with our expectations.

Second , we knew that the strength of the U.S. dollar would be a headwind and forecast that it would reduce our revenue growth by about 200 basis points from the same period last year. This was broadly in line with our expectations.

Third, we knew we had an extremely high volume of new products in Q1 and predicted that supply constraints would hinder our sales of certain products in Q1. Again, this was largely consistent with our expectations. Sales of Apple Watch Series 4 and iPad Pro were limited for all or most of the quarter. AirPods and MacBook Air were also limited.

Fourth, we expected economic weakness in some emerging markets. This turned out to have a much larger impact than we expected, with fewer iPhone upgrades than the company expected, which account for nearly 60% of Apple's revenue.

These and other factors resulted in fewer iPhone upgrades than we expected. Both of these factors led to a reduction in our revenue guidance. I want to discuss both of these in more depth.

Challenges in emerging markets

While we anticipated some challenges in key emerging markets, we did not anticipate the magnitude of the economic slowdown. In fact, our revenue shortfall and year-over-year global revenue decline of more than 100% occurred in Greater China across the iPhone, Mac, and iPad product lines.

As growing uncertainty impacted China's financial markets in the second half of 2018, the impact appeared to be felt by consumers as well. Traffic to our retail stores and channel partners in China declined as the quarter progressed. Market data showed that the contraction in the smartphone market in Greater China was particularly sharp.

Despite these challenges, we continue to see a bright future for our business in China. The iOS developer community in China is one of the most innovative, creative and vibrant in the world. Our products enjoy high levels of interest and satisfaction among customers. Our service revenue in China hit a record high, and our installed base of devices grew over the past year. We are proud to participate in the Chinese market.

iPhone

The lower-than-expected iPhone revenue, mainly due to the decline in iPhone revenue in Greater China, was the reason for the company's overall revenue to fall short of expectations and the main reason for our year-on-year revenue decline. In fact, categories other than iPhone (Services, Mac, iPad, Wearables/Home/Accessories) grew nearly 19% year-on-year.

In addition to Greater China and other emerging markets being the primary drivers of the year-over-year iPhone revenue decline, iPhone upgrades in some developed markets were also not as strong as we had expected. While macroeconomic challenges in some markets were a major contributor to this trend, we believe there are other factors broadly impacting iPhone performance, including reduced subsidies from carriers, a strong U.S. dollar, and some consumers taking advantage of significantly reduced iPhone battery replacement prices to choose to replace batteries rather than replace their phones.

Many positive results in the first quarter

While the downward revision to our earnings guidance is disappointing, our performance in many areas demonstrated exceptional strength.

Our installed base of activated devices hit an all-time high – growing by more than 100 million in the last 12 months. Customers are using more Apple devices than ever before, a testament to our customers’ continued loyalty, satisfaction and engagement.

As I mentioned earlier, our revenue outside of iPhone grew nearly 19% year-over-year in the first quarter, including all-time highs in Services, Wearables, and Mac. Our non-iPhone businesses have less exposure to emerging markets, and the vast majority of Services revenue is related to the installed base rather than product sales in the quarter.

Our services revenue exceeded $10.8 billion in the first quarter, with all geographic regions achieving new quarterly records, and we are on track to achieve our goal of doubling the size of this business from 2016 to 2020.

Wearable device revenue increased by nearly 50% year-on-year, and Apple Watch and AirPods were widely welcomed by consumers during the holiday shopping season. The launch of the new MacBook Air and Mac mini drove the year-on-year growth of Mac revenue, while the launch of the new iPad Pro drove iPad revenue to increase by double-digit percentages year-on-year.

We also expect record revenue in Q1 in several developed markets, including the U.S., Canada, Germany, Italy, Spain, the Netherlands, and South Korea. While we see challenges in some emerging markets, we also see record revenue in Mexico, Poland, Malaysia, and Vietnam.

We expect Apple to post record earnings per share.

Looking ahead

Our profitability and cash flow generation are strong, and we expect to end the first quarter with approximately $130 billion in net cash. As we have stated before, we plan to become net cash neutral over time.

As we exit a challenging quarter, we remain as confident as ever in the fundamental strength of our business. We manage Apple for the long term, and Apple has always used adversity to re-examine its past practices and leverage its culture of flexibility, adaptability, and creativity to emerge better.

Most importantly, we now have renewed confidence and excitement about our future product pipeline and services. Apple's innovation is unmatched by other companies, and we are not giving up on innovation.

We can't change the macroeconomic situation, but we are taking and accelerating other initiatives to improve our performance. One of these initiatives is making it easier to trade in phones in Apple retail stores, providing finance for purchases over time and helping to transfer data from your current phone to a new one. This is not only great for the environment, it's great for customers because their current phone is a subsidy for their new phone, and it's great for developers because it helps grow our installed base.

This is one of the steps we are taking to respond. We are able to make these adjustments because Apple’s strength is our resilience, the talent and creativity of our team, and the deep love we bring to the work we do every day.

Expectations of Apple are high, because they should be. We are committed to exceeding those expectations every day.

This has always been Apple's approach and will always be the same.