Apple's first-quarter results for 2019 are in. Here's our transcript of the call.
Apple CEO Tim Cook and CFO Luca Maestri spoke with analysts during the company's Q1 2019 earnings call. Here's our ongoing live transcript of their remarks! If you want more info on Apple's results, we recommend checking out the awesome charts from Six Colors.
Cook's opening remarks
Tim Cook
Thank you, Nancy and thanks to everyone for joining us today. This isn't the first time you've heard from us regarding the December quarter so the first thing I want to do is provide some final results and connect those back to the letter we shared at the beginning of the month.
As you know, our December quarter revenue was below our original expectations coming in at $84.3 billion. That's down 5% from a year ago or down 3% adjusting for foreign exchange. We noted four factors that would impact our results when we provided guidance in November: different iPhone launch timing from a year ago, FX headwinds, supply constraints on certain products, and macroeconomic conditions in emerging markets. One of those factors, weak macro conditions in some emerging markets, was significantly more severe than we originally foresaw, especially in Greater China. As our letter noted, that challenge was compounded by quarterly iPhone upgrades that were lower than we anticipated. We'll returned to upgrades in a moment, but I first want to say a bit more about our business in Greater China. Our revenue there was down by $4.8 billion from last year with declines across iPhone, Mac, and iPad. Most of the shortfall relative to our original guidance and over 100% of our worldwide, year over year revenue decline was driven by our performance in Greater China. Despite iPhone upgrades being lower than we anticipated, our business grew outside of China including new records in the Americas, Western Europe, Central and Eastern Europe, and our rest of Asia Pacific segment. We had record performance in large markets including the United States, Canada, Mexico, Germany, Italy, Spain, and Korea.
In the letter we shared earlier this month, we said we are proud to participate in the Chinese marketplace and that we believe our business has a bright future there over time. But I think some of that got lost. So I want to share a bit more detail on the positives we see in China. We generated record December quarter services revenue in Greater China fueled by an amazing ecosystem with over 2.5 million registered iOS developers. We saw very strong results from our wearables business there with revenues up over 50%. We also continued to grow our total active installed base by adding new customers. In fact, more than two thirds of all customers in China who bought a Mac or an iPad during the December quarter were purchasing that product for the first time. Finally, for perspective, despite the challenging December quarter our revenue from China grew slightly for the full calendar year. Macroeconomic factors will come and go, but we see great upside in continuing to focus on the things that we can control.
Returning to iPhone, I'd like to talk about our results in the context of those lower than expected upgrades. iPhone XR, iPhone XS, and iPhone XS Max are by far the best iPhones we've ever shipped. They share advanced technologies, including the A12 Bionic, the most powerful chip ever in a smartphone with our next generation neural engine, capable of 5 trillion operations per second. These are also completely modern iPhones with stunning, large full screen displays and Face ID, the most secure authentication of any kind available in a smartphone. And the cameras are simply amazing with Portrait Mode and Depth Control to allow users to create studio-quality photos as well as stunning 4K video, opening a whole new era of photography. We couldn't be more proud of our iPhone lineup and our industry-leading customer satisfaction. We wouldn't change our position for anyone's. Now, our customers are holding on to their older iPhones a bit longer than in the past. When you paired this with the macroeconomic factors, particularly in emerging markets, it resulted in iPhone revenue that was down 15% from last year. Our iPhone results accounted for significantly more than our entire year over year revenue decline. In fact, outside of iPhone our business grew strongly by 19%. So what's behind this? It's important to understand what's going on from the customer perspective at the point of purchase. We believe that is the sum of several factors. First, foreign exchange: The relative strength of the U.S. dollar has made our products more expensive in many parts of the world. In Turkey, for example, the lira depreciated by 33% over the course of calendar 2018 and in the December quarter our revenue there was down by almost $700 million from the previous year. Second, subsidies: For various reasons, iPhone subsidies are becoming increasingly less common. In Japan, for example, iPhone purchases were traditionally subsidized by carriers and bundled with service contracts. Competitive promotional activity frequently increased the amount of subsidy during key periods. Today, local regulations have significantly restricted those subsidies as well as related competition. As a result, we estimate that less than half of iPhones sold in Japan in Q1 of this year were subsidized compared to about three quarters a year ago and that the total value of those subsidies have come down as well. Third, our battery replacement program. For millions of customers, we made it inexpensive and efficient to replace the battery and hold onto their existing iPhones a bit longer. Some people have suggested that we shouldn't have done this because of the potential impact on upgrades, but we strongly believe it was the right thing to do for our customers.
What's very important, however, is that — in spite of these factors — our total active installed base of devices has grown from 1.3 billion at the end of January 2018 to 1.4 billion by the end of December, reaching a new all-time high for each of the main product categories and for all five of our geographic segments.
Not only is our large and growing installed base a powerful testament to the satisfaction and loyalty of our customers but it's also fueling our fast growing services business. In fact, services revenue set an all-time record of $10.9 billion in the December quarter, growing 19%. We not only generated our highest global services revenue ever, but we also had all-time records across multiple categories of services including the App Store, Apple Pay, cloud services, and our App Store search ad business. And we had a December quarter record for AppleCare. And I'm very proud to say that nearly 16 years after launching the iTunes Store, we generated our highest quarterly music revenue ever thanks to the great popularity of Apple Music — now with over 50 million paid subscribers. The App Store wrapped up its best year ever, with record holiday period results propelled by the biggest Christmas Day and Christmas week ever. Customers also spent over $322 million on New Year's Day alone, setting a new single-day record for both the number of customers and purchase volume. It was also a great holiday season for Apple Pay, with over 1.8 billion transactions in the quarter, well over twice the volume of the year ago quarter. Merchant adoption continues to reach new milestones. Customers can now use Apple Pay with iPhone and Apple Watch at nearly 3,000 Speedway locations, while all Target, Taco Bell, and Jack in the Box stores will be accepting Apple Pay soon. We launched Apple Pay in three new countries in the December quarter — Germany, Belgium, and Kazakhstan — and it's now live in 27 markets around the world. The roll out in Germany has been a huge success, with Deutsche Bank reporting more activations for Apple Pay in one week than for Android in an entire year. This is yet another example of what's possible when you bring together Apple's world-class hardware, software, and ecosystem with our engaged and active user base. Shoppers around the world love Apple Pay and it has increasingly become an indispensable part of daily life. Revenue from cloud services continues to grow rapidly, with year over year revenue up over 40% in the December quarter. And readership of Apple News set a new record with over 85 million monthly active users in the three countries where we've launched, the United States, the UK, and Australia. Here in the U.S., the latest data from ComScore shows that Apple News has the largest audience of all news apps and the international audience will continue to grow with our first ever bilingual launch in Canada, available to customers later this quarter.
In summary, we're very happy not only with the growth but also the breadth of our services portfolio. Our revenue from services has grown from less than $8 billion in calendar 2010 to over $41 billion in calendar 2018. The largest category represents less than 30% of total services revenue and the new services we've launched in the last few years are all experiencing tremendous growth.
We had our best quarter ever for Mac revenue which was up 9% fueled by our new MacBook Air and Mac Mini introduced in October. The MacBook Air includes a beautiful new Retina Display, Touch ID, and Force Touch trackpad, while the new Mac Mini provides a powerful, flexible solution for everything from home automation to giant render farms.
iPad revenue was up 17%, its highest growth rate in almost six years. Powered by the new iPad Pro released in November with its edge to edge Liquid Retina Display, Face ID, and A12X Bionic chip, the new iPad Pro has been described by reviewers as a tablet with no equal and the most powerful mobile device ever made.
We also had our best quarter ever for wearables, home, and accessories with 33% growth in total and almost 50% growth from wearables, thanks to strong sales of both Apple Watch and AirPods.
We don't measure our success in 90-day increments. We manage Apple for the long term and when we consider the keys to our success over time there are three that stand out: our highly satisfied and loyal customers, our large and growing active installed base, and at the heart of it all our deeply ingrained culture of innovation. Thanks to all this, our ecosystem is stronger than ever before. We have an amazingly talented team creating hardware, software, and services optimizing each of them to create an unparalleled user experience. Apple Watch is a powerful example of that. It's humbling to read e-mails from customers around the world telling us how Apple Watch has dramatically changed their lives by motivating them to be more fit and active, by alerting them to potentially serious health conditions such as A-Fib, and by helping them in times of crisis with features like Fall Detection and Emergency SOS. We believe we are just beginning to see the impact we can make to improving health and are deeply inspired by the possibilities. Another example is the work we're doing with silicon. We've embedded machine learning directly into the silicon with our A12 Bionic chip. Our custom neural engine not only provides power efficiency and incredible performance in a very small package, but it also enables processing of data and transactions directly on the device. This means iPhone can recognize patterns, make predictions, and learn from experience and it does all this while keeping personal information private. This is a powerful example of how innovation and privacy can go hand in hand at a time when these issues are increasingly important to our users.
We are undertaking and accelerating a number of initiatives to improve our results. It's not in our DNA to just stand around and wait for macroeconomic conditions to improve. One such initiative is making it simple to trade in an iPhone in our stores and raising awareness of this opportunity. Because of the quality and durability of iPhones, they maintain significant residual value making trade ins a great opportunity. It's not only great for the environment, it's great for the customer, as their existing phone acts as a subsidy for their new phone and it's great for developers, as a phone that is traded in and redistributed can help grow our active installed base. Beginning last week, we started making it easier for people to pay for their phones over time with installment payments and we're working on rolling out this program to more geographies as soon as we can. We are as confident as ever in the fundamental strength of our business and we have a very strong pipeline of products and services with some exciting announcements coming later this year. Apple innovates like no other company on Earth and we are not taking our foot off the gas. We'll continue to invest through near-term headwinds just as we always have and will emerge stronger as a result. Now for more details on our December quarter results I'd like to turn the call over to Luca.
Luca Maestri provides more detail on the quarter
Luca Maestri
Thank you, Tim. Good afternoon everyone. As Tim said, revenue for the December quarter was $84.3 billion. This result was below our expectations but we were able to set new all time revenue records in the U.S., Canada, Latin America, Western Europe, Central and Eastern Europe, and Korea. Results were especially strong in the U.S. where revenue was up by more than $1.5 billion compared to a year ago and in several markets where revenue grew by double digits including, among others, Germany, Spain, Poland, Mexico, Malaysia, and Vietnam. Looking at product categories iPhone revenue declined 15% from a year ago where revenue from the rest of our business grew 19%, an all time record, including our best results ever for services, for wearables, and for Mac. Company gross margin was 38%. This quarter for the first time we're making an important new disclosure to our investors, as we believe it will foster a better understanding of our business. We are now reporting, on a quarterly basis, gross margin for products in aggregate and for services in aggregate. Products gross margin was 34.3% and services gross margin was 62.8%. On a sequential basis, products gross margin increased 60 basis points due to positive leverage from the holiday quarter partially offset by higher cost structures as we launched several new products and by headwinds from foreign exchange. Services gross margin also increased 170 basis points sequentially due to favorable mix and leverage partially offset by foreign exchange. While both products and services gross margins improved sequentially, total company gross margin was down 30 basis points due to a different mix between products and services. Net income was $20 billion, about flat to last year, and diluted earnings per share with an all time record at $4.18 an increase of 7.5% over last year. Operating cash flow was also very strong at $26.7 billion.
Let me provide more color for the various products categories. iPhone revenue was $52 billion. On a geographic basis most of the decline from last year came from Greater China and other emerging markets where difficult macro and foreign exchange conditions affected our results. We also believe that the reduction of carrier subsidies and our battery replacement program had an impact in a number of countries around the world. And as Tim mentioned we had a lower number of upgrades than we had anticipated at the beginning of the quarter. However, our global active installed base of iPhones continues to grow and has reached an all time high at the end of December. We are disclosing that number now for the first time and it has surpassed 900 million devices up year over year in each of our five geographic segments and growing almost 75 million in the last 12 months alone. We plan to provide information on the iPhone installed base as well as total installed base on a periodic basis. Customer satisfaction and loyalty for iPhone continue to be outstanding and are the highest in the industry. The latest survey of U.S. consumers from 451 Research indicates customer satisfaction of 99 percent for iPhone XR, XS, and XS Max combined. And among business buyers who plan to purchase smartphones in the March quarter, 81% plan to purchase iPhones. Based on the latest information from Kantar. iPhone experience a 90% customer loyalty rating for iPhone customers in the U.S., 23 points above the next highest brand measured. Turning to services, it was our best quarter ever with revenue of $10.9 billion, up 19% year over year with new December quarter records in all five of our geographic segments. Many services categories set new all time revenue records and we are on track to achieve our goal of doubling our fiscal 2016 services revenue by 2020. To be clear, and as we have already explained 90 days ago, our 2020 goal remains unchanged and it excludes the impact of the revenue reclassification between products and services we recorded in connection with ASC606, the new revenue recognition accounting standard, that we adopted at the beginning of fiscal '19. The level of engagement of our customers in our ecosystem continues to grow. The number of transacting accounts on our digital stores reached a new all time high during the quarter with the number of paid accounts growing by strong double digits over last year. And we now have over 360 million paid subscriptions across our services portfolio, an increase of 120 million versus a year ago. Given the continued strength and momentum in this part of the business, we now expect the number of paid subscriptions to surpass half a billion in 2020. Our subscription business has become very large and diversified covering many different categories from entertainment, to health and fitness, to lifestyle. In fact, more than 30,000 third-party subscription apps are available today on the App Store and the largest of them accounts for only 0.3% of our total services revenue. Next I'd like to talk about the Mac. We saw great response to the new MacBook Air and Mac Mini that we introduced in October which helped drive a 9% increase in Mac revenue over last year to a new all time record. Mac revenue was up in the vast majority of countries we track, with double digit growth in many large markets, such as the U.S., Western Europe, Central and Eastern Europe, Japan, Korea, and South Asia. Our active installed base of Macs reached a new all time high and half of all the customers purchasing Macs in the December quarter were new to Mac. We also have great results for iPad. With revenue up 17% percent from a year ago and strong performance of both iPad and iPad Pro and generated double digit growth in four of our five geographic segments. Similar to the Mac, our installed base of IPads reached a new all time high and among customers purchasing iPad during the quarter, half were new to iPad. The most recent consumer survey from 451 Research measured a 94% customer satisfaction rating for iPad overall with iPad Pro models scoring as high as 100%. Among business customers who plan to purchase tablets in the March quarter 68% plan to purchase iPads. Wearables, home, and accessories revenue grew 33% to an all time record in each of our geographic segments. Revenue from this category was up over $1.8 billion compared to a year ago thanks to the amazing popularity of Apple Watch and AirPods, both of which were supply constrained as we exited the quarter. Based on revenue over the past four quarters our wearables business is approaching the size of a Fortune 200 company. Our retail and online stores generated strong results from Mac and iPad and all time record performance from services and from wearables. Following the launch of the new iPhone trade-in campaign, our stores more than doubled the volume of iPhones traded in compared to last year reaching an all time high in Q1. We added Thailand to our footprint with a beautiful store in Bangkok and we opened a stunning new store in Champs-Élysées in Paris exiting the quarter with 506 physical stores in 22 countries.
In enterprise across multiple industries our technology continues to enable businesses to do their best work. In healthcare iPhones and iOS apps continue to streamline and support clinical workflows, communications, and care delivery across leading health systems including Johns Hopkins Medicine, Massachusetts General Hospital, Stanford Healthcare, and St. Jude Children's Research Hospital. In manufacturing, SKF, the world's largest producers of bearings and seals, has transformed their manufacturing processes on iOS and iPhone with incredible success. With custom iOS apps available to production operators across their worldwide locations, SKF has reduced production errors from 20% to zero while saving 70% in system-related time. Apple technology has made possible a simplified user experience integrating the SAP cloud platform yielding better accuracy, efficiency, and employee experiences across the board. We're also seeing great innovation in the construction industry with iPad and new third party apps made for iOS. For instance, Procore Technologies has introduced an app to help decrease building errors on the job site by using Metal in split view with the iPad camera, construction workers can compare building plans and 3D models to what is actually being built in real time. This new iOS app reduces wasted raw materials and helps keep building projects on time and on budget.
Let me now turn to our cash position. We ended the quarter with $245 billion in cash plus marketable securities. We also had $102.8 billion in term debt and $12 billion in commercial paper outstanding for a net cash position of $130 billion. As we explained in the past, it is our plan to reach a net cash neutral position over time. As part of this plan we returned over $13 billion to our investors during the December quarter. We repurchased 38 million Apple shares for $8.2 billion through open market transactions and we paid $3.6 billion in dividends and equivalents. Consistent with our historical cadence, we plan to provide an update on our overall capital return program when we report our March quarter results. As we move ahead into the March quarter I'd like to review our outlook which includes the types of forward looking information that Nancy referred to at the beginning of the call. We expect revenue to be between $55 and $59 billion. This range reflects a negative year over year impact of $1.3 billion from foreign exchange which represents about 210 basis points of last year's revenue and a more uncertain macroeconomic environment than a year ago, especially in emerging markets. We expect gross margin to be between 37% and 38%. On a sequential basis this range reflects seasonal loss of leverage and a 60 basis point unfavorable impact from foreign exchange partially offset by commodity cost savings. We expect OpEx to be between $8.5 and $8.6 billion. We expect OINE to be about $300 million. And we expect the tax rate to be about 17%. Also today our Board of Directors has declared a cash dividend of 73 cents per share of common stock, payable on February 14, 2019 to shareholders of record as of February 11, 2019.
With that, I'd like to open the call to questions.
Analyst questions
Luca Maestri
Katie, let me take that one. First of all when we talk about the services business, it is very important to start from the momentum that we have. As you know we have set an ambitious target for ourselves to double the size of our business from fiscal '16 to 2020 which implied at the time a 19% […]. So far we've been able to grow above 20% — in fiscal '18 we grew 22%, so we are on track to achieve our objective and it's important to understand what is driving the growth of the business. First of all is our installed base. As we just told you the installed base continues to grow very nicely. It has reached 1.4 billion active devices at the end of December and really very little of our services revenue is driven by what we sell in the last 90 days. The second factor for the growth of the services business is that within this installed base the percentage of users who are paying for at least one service is growing very strongly. This is due to several factors. First of all we are offering more and more services. During the last few years as you know we've launched Apple Music, Apple Pay, an advertising service for our developers on the App Store. All these businesses are growing very strongly. Second, we are making it easier for our customers to transact on our digital stores. We accept many more payment methods today which are very common in certain countries around the world. We've also increased our distribution coverage for many of these services. We're bringing AppleCare to more points of sale around the world. We're launching Apple Pay in more and more markets and so on. Thirdly, as you mention our subscriptions are becoming a very large portion of our business and they're growing very well above services average. And the fact that we are saying that we will surpass half a billion during 2020, we're not putting a specific date during 2020, but I think you've seen over recent quarters that we've been adding about a 120 million on a year over year basis for a number of quarters now and this is an incredible staggering number, right, when you think about it. We're also broadening the scope of many of these services. If you take Apple Pay as an example it started off as the most convenient, most private, and most secure way to make a payment in a store or in an app. Then we took Apple Pay to Safari, then we started a peer to peer service, and we are launching it in new markets across the world every quarter so we are broadening that scope. And, of course, similar to what we've done in the past, in the last three years we launched several new services, we're also looking to launch new services going forward that we believe will provide great value to our users and we really are very excited about the opportunities that we see in front of us. I think you're referring to the deceleration in the growth rate that we've seen in the December quarter. And I think you're referring back to the growth that we reported in September. I think an important point I need to make and I think it's helpful that you asked the question is that a portion of this deceleration is truly just a reclassification of the amortization of free services that we've made in connection with the adoption of the new revenue recognition standard. And as we explained 90 days ago, this amortization of free services in the past was reported and the products and now gets reported and the services. The reclassification is actually dilutive to our growth rate because the amortization of free services is a relatively stable number which gets applied to a growing base. So this reclassification reduces our growth rate versus the previous classification. This factor by itself represents roughly one-third of the deceleration that you've seen. We talked about 27% growth in the September quarter — with the reclassification, that growth rate was about 24.5%. So that explains about a third of that deceleration. There are I would say three factors that explain this difference between the 24.5% to the 19%. The first one is that foreign exchange plays a role — roughly 60% of our services business is outside the United States. And, as you know, the US dollar has appreciated in recent months. And in general we tend not to reprice our services for foreign exchange on a very frequent basis. The second factor is a well-known issue around the App Store in China. The App Store in China is a large business for us. We believe this issue around the approval of new game titles is temporary in nature but clearly is affecting our business right now. And then thirdly we are seeing some level of deceleration in AppleCare which has had very, very strong growth during fiscal '18. Where we are starting to lap some of the increase in distribution coverage that we put in place recently and the channel fill of Apple components that happened when we increased the distribution coverage. But in general we are very, very pleased with 19% growth and we think that the business will continue to grow nicely going forward.
Luca Maestri
Well, we've always said that we're very committed to executing our program. We have done almost $250 billion dollars of repurchases from the beginning of the program, but we've also said that we want to execute the program in an efficient, effective, I would say disciplined manner and that takes into account also overall market conditions. So that's what we did during the course of the December quarter. Our fundamental view remains the same. We are optimistic about our future and we think there is great value in our stock. And so we will continue to execute the program. We will continue to report at the end of every quarter and, by the way, when we report our March quarter results we will also talk about the next step in our capital return program which is something that we do traditionally in the spring.
Tim Cook
Steve, it's Tim. If you look at what we did this past year, we priced the iPhone XS in the U.S. the same as we'd priced the iPhone X a year ago. The iPhone XS Max, which was new, was $100 more than the XS. And then we priced the XR right in the middle of where the entry iPhone 8 and entry iPhone 8 Plus have been priced. So that's actually a pretty small difference in the United States compared to last year. However, the foreign exchange issue that Luca spoke of in the call made that difference or amplified that difference in international markets in particular the emerging markets which tended to move much more significantly versus the dollar. And so what we have done in January and in some locations and some products is essentially absorb part or all of the foreign currency move as compared to last year and therefore get close or perhaps right on the local price from a year ago. So yes, I do think the price is a factor. I think part of it is that the effects piece and then secondly, in some markets, as I had talked about in my prepared remarks, the subsidy is probably the bigger of the issues in the developed markets. I had mentioned Japan but also even in this country even though the subsidy has gone away for a period of time, if you're a customer that your last purchase was a 6s, or 6, or in some cases even a 7, you may have paid $199 for it and now in the unbundled world it's obviously much more than that. And so we are working through those and we've got a number of actions to address that including the trade in and the installment payments which I had mentioned as well.
Luca Maestri
Well, Steve, we did mention on the call last quarter that the different timing of our phone launches would affect the year over year compares. If you remember, our top models the XS and XS Max shipped during the September quarter which placed the channel fill and the initial sales in that quarter, while last year the iPhone X shipped in Q1 in the December quarter placing the channel fill and initial sales in the December quarter. So we knew that this would create a difficult compare for Q1 of '19 and this is essentially what happened. It was pretty much in line with our expectations. To give you more color, I would say that the XR is our most popular model, and it's followed by the XS Max, and then the XS.
Luca Maestri
Yeah, I mean three questions there. The first one is the question around conservatism. As we always do when we provide the range it's a range that we believe we're going to fall within. We've done pretty well with that up until the December quarter, right? I mean we've been we didn't miss in years and years. So that's the idea. There isn't a specific level of conservatism. We believe that this is the range where we're going to fall within. On channel inventory, as you know our historical pattern for iPhone channel inventory is that typically we increase inventory in Q1 and we decrease in Q2 and we think this year will be similar. And we've exited the December quarter with levels of inventory that we are comfortable with. So that leaves us with the reality that our iPhone performance in Q1 from a revenue standpoint was a -15% and we expect that the key factors that Tim mentioned during the call affecting iPhone performance in Q1 will also have an effect on Q2, starting with the strong U.S. dollar environment. On a year over year basis, the negative impact from currency is going to be about $1.3 billion. So that's about a bit more than two points versus last year's revenue and so that obviously plays a role. And the macroeconomic environment particularly in emerging markets will continue to be there. On the positive side, we expect that we will continue to grow revenue nicely from the rest of the business which is not iPhone.
Tim Cook
We do design our products to last as long as possible. Some people hold on to those for the life of the product and some people trade them in. And then that phone is then redistributed to someone else. And so it doesn't necessarily follow that one leads to the other. The upgrade cycle has extended, there's no doubt about that. As we've said several times I think on this call and before that the upgrades for the quarter were less than we anticipated due to all the reasons that we had had mentioned. So where it goes in the future, I don't know. But I'm convinced that making a great product that is high quality is the best thing for the customer and we work for the user and so that's the way that we look at it.
Luca Maestri
Yes, Shannon and I think you've seen that services gross margins increased on a year over year basis by a significant amount. Let me start with sequential because I think it's probably most relevant for us. Sequentially we increased 170 basis points. It's a business that is growing nicely so we get good support from our scale. Some of these services are scaling quickly and so we tend to expand gross margins there. And also we had favorable mix — as you probably know we have a very broad portfolio of services. Some of them tend to be accretive to the average gross margin for services, also because of the way we account for them. For example, you know that on the App Store we book revenue on a net basis and therefore the gross margins tend to be accreted. But we also have services that are very successful that are below the average for the services business and so depending on how these separate businesses do in the marketplace we are going to be seeing some level of movement going forward on services margins. But you've seen that for the last twelve months that they've gone up nicely 450 basis points and sequentially they've gone up 170 basis points. But I wouldn't draw, necessarily, a conclusion on how the services gross margin is going to move over time. We will report, of course, at the end of every quarter, but it's important to keep in mind it's a broad portfolio with very different gross margin profiles within the portfolio. It is important for us to grow gross margin dollars. And if at times we grow services that are at a level of gross margins which is below average as long as this is good for the customer and as long as we generate gross margin dollars, we're going to be very pleased.
Tim Cook
Yeah, Shannon we see huge changes in customer behavior taking place now and we think that it will accelerate as the year goes by to sort of the breakdown of the cable bundle that's been talked about for years and I think that it will likely take place at a much faster pace this year. And so we're going to participate in that in a variety of ways. One of those is through Apple TV and you're well familiar with that product. The second way is AirPlay 2 which we have, as you just pointed out, we have support on a number of different third-party TVs and we're excited about that. It makes the experience in the living room with people using our products even better. We think that people are really going to like that. Another way is, of course, all the third-party video subscriptions that are on the store. We're participating in this today and I would guess that that's going to accelerate into the future as the bundle breaks down and people begin to buy likely multiple services in place of their current cable bundle. And then finally original content. We will participate in the original content world. We have signed a multi-year partnership with Oprah. But today I'm not really ready to extend that conversation beyond that point. We've hired some great people that I have super amount of confidence in and they're working really hard and we'll have something to say more on that later.
Luca Maestri
Yeah, in essence, when we sell a product at a certain price we make an assumption — we estimate the value that can be associated to providing free services. In our case, it's providing maps services, providing Siri, and providing free iCloud to all the customers that purchase a product. And so we calculate an estimated value, that value gets deferred and gets amortized over the estimated period of time that we deliver the free services. In the past, that deferral and the subsequent amortization was reported on the products. Now in connection with the new revenue recognition standard, we are reclassifying, essentially, that amortization from products revenue to services revenue. So total revenue has not changed, we just report that estimated value under the services category. We also reclassify the cost that we need to incur to provide those services. So the gross margin rate of free services is clearly significantly dilutive to the overall services margin. I hope I've helped with that.
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