Apple’s services are buoying its return to growth as its iPhone engine stalls

It looks like Apple’s big bet on building an array of services like iCloud, Apple Music and the App Store is starting to be the big business the company hoped it would be.

Wall Street and Apple had expected to return to growth this quarter following the holiday season, though it was supposed to be largely incremental. And while it wasn’t exactly a blowout, Apple still pleasantly surprised Wall Street with better results than what was expected. Apple said it sold 78.3 million iPhones — its main growth engine — whereas Wall Street expected Apple to sell 76.3 million iPhones in the holiday quarter. In the first quarter last year, Apple sold 74.8 million iPhones.

Apple’s services, meanwhile, were its fastest-growing business and may become one of Apple’s most powerful businesses in the coming years.

Looking at the return to growth from last quarter, it also seems apparent that Apple’s slight jump from the first quarter last year was significantly buoyed by its ever-growing services revenue. Apple’s services revenue was up 18 percent year-over-year in the first quarter, coming in at $7.2 billion. In the first quarter last year, the company reported around $6.1 billion in services revenue. With the $2.5 billion split in its net revenue year-over-year, it looks like that services revenue accounted for a significant chunk of the difference.

“It was our best quarter ever for services,” Apple CEO Tim Cook said on the earnings call. “App Store customers broke all-time records in the holiday quarter, including $3 billion in purchases in December alone, making it the App Store’s single best month ever.”

Cook said the company expects to double the size of their services business in the next four years, expecting the company’s services revenues to be the size of a Fortune 100 company this year.

For years Apple has continued to incrementally build a strong business off its App Store and iCloud, among other services, and it looks like the bet is starting to pay off. Apple frequently notes that its services revenue is larger than some major tech companies in the market, and the pieces — like App Store revenue and Apple Music subscriptions — are starting to come together into a fully fledged business that may prove to be another engine while it figures out how to re-ignite the iPhone and its other products.

The jump from the same quarter last year — where the company reported $75.9 billion in revenue — marks a return to growth for the first time in several quarters for Apple. Apple reported earnings of $3.36 per share on revenue of $78.4 billion. Wall Street was looking for Apple to deliver earnings of $3.22 per share on revenue of $77.38 billion.

While this quarter wasn’t a critical one for Apple necessarily — Wall Street had been expecting its growth story to come to an end at some point — it’s setting the stage for an important year. Apple is entering a new phase of the company where it has to either come out with a breakout innovation on the smartphone that will boost it back into growth, or figure out how to diversify its revenue beyond just phones and tablets.

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And it’s been trying, to say the least. Apple has been touting its services revenue and is going beyond just phones and tablets, with side products like the wireless AirPod earbuds and the Apple Watch. For now, these seem like products for niche markets — such as fitness tracking in the case of the watch — but it’s clear Apple is trying to look for new growth markets. With Fitbit struggling, it seems clear that Apple has a chance to carve out the fitness tracker market, and wireless earbuds are uncharted territory that could become a strong new product for the company.

Apple does have one major tailwind going into 2017: Previous holdout brands like Nintendo are finally starting to make their way onto mobile devices. While Super Mario Run wasn’t all that successful of a launch — with around only 5 percent of people who downloaded buying the full game — Nintendo is still allowing games like Pokémon GO and Fire Emblem to make their way onto the iPhone. Getting these apps isn’t necessarily about lock-in into the Apple ecosystem any more, it’s about actually monetizing for Apple and creating a healthy revenue stream for the company that exists alongside the rest of its product lines.

Here’s the full scorecard:

  • Revenue: $78.4 billion, up 3 percent year-over-year (Analysts expected $77.4 billion)
  • Earnings: $3.36 per share (Analysts expected $3.32)
  • iPhones sold: 78.3 million, up 5 percent year-over-year (Analysts expected 76.3 million)
  • iPads sold: 13.1 million, down 19 percent year-over-year
  • Macs sold: 5.4 million, up 1 percent year-over-year
  • Other products revenue: $4 billion, down 8 percent year-over-year
  • Q2 guidance: between $51.5 billion and $53.5 billion

Shares of Apple were up as much as 3 percent in extended trading.

The drop in its other products revenue, in particular, may seem a little disconcerting for Wall Street. Apple’s array of new products, from headphones to watches, may indeed prove to just be niche categories instead of blockbusters like the iPhone.

At the beginning of 2016, Apple for the first time in recent memory saw a decline in its revenue. Apple more or less saw the same thing continuing throughout the year and, of course, Wall Street tempered its expectations as time went on. Apple signaled that it would return to growth this quarter in its last earnings report, but not necessarily to some dramatic extent. Holiday seasons are always strong for Apple, and the company released a significant iteration on the iPhone, but it wasn’t necessarily a massive shift from its typical design that might inspire a wave of new customers.

As a result, the stock hasn’t really gone anywhere in a while:

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