Apple ’s ( AAPL ) fiscal second-quarter earnings report was a real downer. Every major metric was down for the former growth company, including revenue, earnings, gross margin, iPhone sales, iPad sales and Mac sales. Also down is Apple stock, which tumbled as much as 8.3% Wednesday after the company’s unsettling Q2 report late Tuesday. Apple stock was down more than 6%, below 98, in afternoon trading in the stock market today . Shares dived through their 50-day moving average price line, a key support level. IBD’s Take: How healthy is Apple stock? Find out at IBD Stock Checkup Apple earned $1.90 a share, down 18% year over year, on sales of $50.56 billion, down 13%, in its fiscal Q2 ended March 26. Analysts on average expected Apple to earn $2 a share on sales of $51.97 billion. For the current Q3, Apple is targeting sales of $42 billion, well below Wall Street’s forecast of $47.32 billion. In Q3 2015, Apple reported revenue of $49.6 billion. Apple’s gross profit margin dipped to 39.4% in Q2 vs. 40.8% a year earlier. Apple expects its gross margin to decline again this quarter, to 37.5%-38%. At least 12 financial analysts cut their price targets on Apple stock following the earnings news. One analyst, Oppenheimer’s Andrew Uerkwitz, lowered his rating on Apple stock to perform from outperform. Here are five key takeaways from Apple’s fiscal Q2 report: 1. iPhone Sales Forecasts Fall Apple topped estimates for iPhone sales in the March quarter, but still saw its first-ever year-over-year decline in units. It sold 51.19 million iPhones in fiscal Q2, down 16%. Wall Street was looking for Apple to sell about 50 million iPhones. But Apple signaled a similar percentage decline in iPhone sales for the June quarter. The company plans to lower iPhone sales channel inventory by $2 billion, or about 3 million units, in fiscal Q3. Apple’s Q3 guidance implies iPhone sales of about 38 million units vs. consensus estimates for 44.1 million, Canaccord Genuity analyst Michael Walkley said. In Q3 2015, Apple sold 47.5 million iPhones. “We believe overall weaker-than-expected iPhone demand, continued U.S. dollar strength and customers waiting to upgrade to iPhone 7 contributed to the weak guidance,” Walkley said in a research report. Bernstein analyst Toni Sacconaghi said the iPhone guidance is “sobering,” given that Apple just launched a lower-cost smartphone, the iPhone SE, which the company says is seeing “very strong” demand. The iPhone SE, which starts at $399, could be cannibalizing sales of Apple’s premium smartphones, namely the flagship iPhone 6S series. The SE features top-of-the-line components, but a smaller, 4-inch display. Oppenheimer’s Uerkwitz says iPhone sales will remain weak until the launch of the rumored iPhone 8 in late 2017. He says the upcoming iPhone 7 won’t offer enough compelling features to spur upgrades. The iPhone 8 is likely to feature an OLED display, new camera designs and support for mobile virtual reality headsets. Apple CEO Tim Cook said iPhone sales remain “healthy and strong.” Apple’s iPhone business accounted for 65% of the company’s total revenue in Q2. Apple continues to see a high level of people switching from Android smartphones, he said on the firm’s earnings conference call with analysts. He added that Apple is attracting many first-time smartphone buyers and people upgrading from older iPhones. Lower iPhone sales are the result of macroeconomic issues and difficult comparisons to the “extraordinary” iPhone 6 cycle, which met a pent-up demand for larger-screen iPhones, Cook said. 2. India Next Big Smartphone Market Apple sees big opportunities for iPhone sales in India, Cook said. But the populous country has lagged in its deployment of faster wireless networks, namely LTE. India’s LTE rollout began in earnest only this year. “We’ll begin to see some really good networks coming on in India,” Cook said. “That will unleash the power and capability of the iPhone in a way that an older network, a 2.5G or even some 3G networks, would not do.” Another hurdle that Apple faces in India is retail distribution. In India, mobile phones are sold in many small shops, not through wireless carriers like in the U.S. “I view India as where China was maybe seven to 10 years ago,” Cook said. “I think there’s a really great opportunity there.” IPhone sales in India grew 56% in Q2. Meanwhile, iPhone sales in China stalled last quarter. Apple’s total revenue from Greater China, including Taiwan and Hong Kong, tumbled 26% to $12.49 billion in Q2. 3. Services Now Apple’s No. 2 Business Apple’s service unit, which includes the App Store, Apple Music, Apple Pay and iCloud, saw sales rise 20% to $5.99 billion in Q2. It is now the company’s second-largest business segment after the iPhone, topping the declining iPad and Mac businesses. Apple’s App Store revenue was up 35% to an all-time record. Apple Music grew to over 13 million paying subscribers. “We feel really great about the early success of Apple’s first subscription business, and our music revenue (including iTunes) has now hit an inflection point after many quarters of decline,” Cook said. Services represented 12% of Apple’s total revenue last quarter. Apple’s services have much higher margins than the company average, Piper Jaffray analyst Gene Munster said in a report, “likely 60% or higher at the gross level and in the high-40% range moving to 50% at the operating level.” The main function of Apple’s services, however, is to drive hardware sales, UBS analyst Steven Milunovich pointed out in a report. “Services’ main function is to create the ecosystem that allows Apple to charge premium hardware prices,” Milunovich said. 4. Apple’s Declining Gross Margins A Concern Profit margins are “the Achilles’ heel” of Apple stock, BTIG analyst Walter Piecyk said in a report. The maturing smartphone market and the launch of the lower-margin iPhone SE could pressure already declining gross margins. “Bulls would argue that nothing in the consumer electronics history has been like the iPhone and that margin will sustain,” he said. “If investors start doubting that, it could be an incremental problem for the stock.” At the midpoint of its guidance, Apple expects its gross margin to decline to 37.8% in the current quarter, from 39.7% in the year-earlier period. 5. R&D Spending Up As Apple Plans For Next Big Thing Apple is investing heavily in research and development for future products. The company’s R&D spending is likely to rise 21% to $10.3 billion in calendar 2016, Piper Jaffray’s Munster said. “We believe Apple is experimenting with a car (Project Titan) as well with virtual and mixed reality,” Munster said. “While we believe VR/MR is the future of screens, it will likely be directly cannibalistic to iPhone. Therefore, the best candidate to significantly move the needle from where we are today over the next decade is the car, but we note that neither project is likely to change the question about long-term growth over the next few quarters.” With Apple posting its first year-over-year decline in sales since 2003 in Q2, the pressure is on Cook to find a new sales driver, FBN Securities analyst Shebly Seyrafi said in a note. “We are concerned that, over four years since assuming the CEO position in late 2011, CEO Tim Cook has not delivered any real transformative products,” Seyrafi said. The Apple Watch, introduced a year ago, isn’t inspiring much confidence, he said. “There is speculation about Apple working on a car due in the fiscal 2019-2020 time frame and on Apple developing a virtual reality product, but the car entry would be years away and it would not at all be clear if Apple would succeed here (especially considering Tesla ’s ( TSLA ) recent success with its Model 3),” Seyrafi said.
