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UPDATE 3-Apple forecasts strong revenue even as iPhones drop to under half of sales

Stephen Nellis

sales@ (Recasts with focus on services, accessories)

July 30 (Reuters) - Apple Inc iPhone sales dropped to less than half of quarterly revenue for the first time in seven years, but CEO Tim Cook on Tuesday described the change as successfully diversifying away from a single product and forecast results above Wall Street targets.

Cook told Reuters that "marked improvement in greater China" drove fiscal third-quarter results that topped expectations, despite trade tension, and shares rose 4.25% after hours.

"We actually grew in mainland China," Cook told Reuters. "Non-iPhone revenue grew 17%. We grew in every category outside of iPhone."

IPhone sales fell 12% to $25.99 billion after dropping 17% in the previous quarter. (Graphic: https://tmsnrt.rs/2yAEoCh)

Moribund global mobile phone sales have led Apple to focus growth on music, apps, gaming, video and a soon-to-come credit card. Cook said the company had succeeded in growing the number of device users to increase the market for services and accessories.

Services revenue in the fiscal third quarter rose 12.6% to $11.46 billion, a new record. It missed expectations of $11.73 billion, according to IBES data from Refinitiv, but Cook told Reuters that after factoring out a one-time payment from lawsuits a year ago and foreign-exchange effects, the services segment growth rate would have been 18%.

China sales fell 4% to $9.16 billion, improving on a drop of 22% in the fiscal second quarter.

Apple said it expects revenue for the current fiscal fourth quarter of between $61 billion and $64 billion, compared with analyst estimates of $61.02 billion.

For the fiscal third quarter ended in June, Apple reported a 1% rise in revenue to $53.8 billion and a 7% drop in earnings per share to $2.18, compared with expectations of $53.39 billion and $2.10 per share, according to Refinitiv data.

Hal Eddins, chief economist for Apple shareholder Capital Investment Counsel, said he was pleasantly surprised to see iPhone sales declines slow down versus the prior quarter.

"You really dont hear people talk about their phones like they did several years ago," Eddins said. But, "the key is that when people want to splurge on a phone, they do it with an Apple product."

Apple did not give the number of active Apple devices, but in January it said it was 1.4 billion, with 900 million of those being iPhones. Investors used the number, called the installed base, as a proxy for how many subscribers it can gain for its services business. Cook told investors on a conference call Tuesday that Apple has 420 million paid subscribers to its own services and third-party apps. The company has set a goal of 500 million by 2020.

Trip Miller, managing partner at Apple shareholder Gullane Capital Partners, said he wants to see services growth return to the 20% range and thinks Apple needs to use its billions in cash to buy media properties to fuel its forthcoming television service.

"You have to have a bigger installed base and have services that people get value from," Miller said.

TRADE TENSION STILL LOOMS LARGE

Apple reported results as U.S. and Chinese trade negotiators resumed off-and-on talks. U.S. President Donald Trump has suspended new tariffs on a final $300 billion of Chinese imports, which would include iPhones.

Trade tension has slowed down economic growth in China, a major market for Apple, which effectively cut iPhone prices in China earlier this year after currency exchange rates had made its phones too expensive for many Chinese consumers.

Apple's market share in China declined to 5.8% from 6.4%, according to market research firm Canalys, in part because smartphone rival Huawei Technologies Co Ltd gained market share to become the top handset seller in the country.

But Apple experienced a smaller market share loss than competitors such as Xiaomi Corp, Oppo and Vivo, according to Canalys data. Cook said that iPhone price adjustments, plus the Chinese government's move to cut phone taxes, helped keep iPhone sales in China from eroding further.

"Our trade-in and financing programs are doing extremely well in China," Cook told Reuters. "Because of the active installed base is growing in China, our services business is doing very well, growing double digits."

Apple shares have gained more than 20% since early June, when shares dropped on news that the U.S. Department of Justice had jurisdiction over the company in a potential probe as part of a broader review of whether technology giants engage in anticompetitive practices.

Apple said revenue for its "Wearables, home and accessories" segment that contains devices like the Apple Watch and AirPods was $5.53 billion, compared with analyst estimates of $4.81 billion.

Apple said it returned more than $21 billion to shareholders during the fiscal third quarter, including $17 billion in share repurchases. It declared a dividend of 77 cents per share.

(Reporting by Stephen Nellis in San Francisco; Editing by Peter Henderson and Lisa Shumaker)