Apple Delivers Disappointing Sales

Image source: Apple.

Apple reported earnings for the quarter ended in March, meaning the second quarter of fiscal 2016 for the company, on Tuesday, April 26. Investors reacted with pessimism to the announcement, and Apple stock was falling by a staggering 8% after the closing bell on Tuesday. The market tends to overreact to negative news in the short term, but the fact remains that Apple is delivering disappointing sales numbers, and that's an important reason for concern.

Disappointing salesTotal revenue during the quarter came in at $50.56 billion, a 13% decline from the same period in the prior year. Management guidance was for sales in the range of $50 billion to $53 billion, so even if revenue was within the company's guidance, sales still came in near the low end of the range.

iPhone revenue totaled $32.9 billion during the quarter, representing 65% of total sales. Unit sales fell 16% year over year to 51.2 million, while sales in dollar terms declined by 18%. The average selling price in the iPhone segment declined to $642 versus $691 in the previous quarter, which is probably related to the fact that the new iPhone SE sells for lower prices than previous iPhone models.

Looking at the other business segments, revenue was as weak as expected in the iPad and Mac divisions, while other services and products delivered a more encouraging performance.

  • Revenue in the iPad division was $4.4 billion, declining by 19% versus the same quarter in the prior year.
  • Sales of Mac products amounted to $5.1 billion, a 9% annual decrease.
  • The services division, which includes revenue from Internet services, AppleCare, Apple Pay, and licensing, saw a 20% increase in revenue, reaching $6 billion. Interestingly, this segment is now considerably bigger than both Mac and iPad.
  • The "other products" segment covers Apple TV, Apple Watch, Beats products, iPod, and third-party accessories. This division produced $2.2 billion in revenue, a 30% annual increase.

From a geographical perspective, performance in China, the second biggest market for Apple behind North America, was particularly worrisome. Apple made $12.5 billion in Greater China sales last quarter, representing 25% of total revenue and declining by a steep 26% year over year.

This was the first time Apple reported declining revenues in 13 years, and it was also the first quarter with declining iPhone sales since the product was introduced in 2007. Even worse, management is expecting continued weakness in the third quarter of fiscal 2016. Guidance is for sales in the range of $41 billion to $43 billion, a decline of 17% to 13% from $49.6 billion in the third quarter of fiscal 2015.

Raising cash distributionsGross margin was 39.4% of sales during the quarter, a modest decline versus 40.8% in the year-ago quarter. Operating income fell from $18.3 billion to almost $14 billion. This drop caused a contraction in earnings per share, from $2.33 per unit in the second quarter of fiscal 2015 to $1.9 per share last quarter.

The business is still producing healthy cash flows, and management increased the size of the capital distribution program. Apple produced $11.6 billion in operating cash flow during the quarter, and the company returned nearly $10 billion to shareholders via dividends and buybacks. From the inception of its capital return program in August 2012 through March 2016, Apple has returned over $163 billion to shareholders, including $117 billion in share repurchases.

As part of its new capital distribution program, Apple increased the size of its share repurchase authorization from $140 billion announced last year to $175 billion. In addition, the company raised dividends by 10%, from $0.52 to $0.57 quarterly per share.

Apple ended the quarter with a massive cash hoard of nearly $232 billion in cash and liquid investments. Most of that money is held overseas, though, and repatriating it would mean a huge tax burden for the company. For this reason, Apple said in the press release that the company will probably resort to debt to finance its enlarged capital distribution program going forward.

Apple is doing the right thing by rewarding investors for their patience with growing dividends and buybacks. However, the company's ability to generate sustained sales growth going forward is a major concern, which will probably weigh on the stock over the middle term.

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Andrs Cardenal owns shares of Apple. The Motley Fool owns shares of and recommends Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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