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APPLE WATCH

Everything to look out for in Apple’s earnings

By Mike Murphy

When Apple announces earnings for the second quarter of its fiscal 2016 today, it may report a quarterly decline in revenue for the first time in over a decade. (Quartz will be live-charting the earnings call starting at 4pm ET today.)

Some Wall Street analysts are predicting Apple sales to fall for the next few quarters, and the current set of earnings should provide some insight into the near future of the company and its direction.

In recent quarters, Apple’s revenue growth has been slowing to a near standstill, which some, such as Deutsche Bank analyst Sherri Scribner, attribute to the stagnating market in developed countries, and a price war in developing ones—a fight Apple’s traditionally expensive devices don’t fare well in. As Scribner mentioned in a recent note to investors, four-fifths of the smartphones sold in India, a burgeoning market for such devices, cost less than $150.

According to a report released over the weekend, Apple accounted for 40% of the profits generated by Silicon Valley companies in 2015. A slowing Apple could have wide-ranging implications beyond its own shareholders. Here’s what to look out for on Tuesday’s earnings call:

How China’s doing

In terms of revenue, China is Apple’s second-largest market after the Americas, accounting for over $18 billion in sales in its first quarter. It’s been growing rapidly for the last few years, since Apple signed a deal with the nation’s largest network, China Mobile, in 2014, allowing China’s growing middle class to more easily access iPhones.

But last week, some of Apple’s offerings, including digital-content services iBooks and iTunes Movies, went offline in China at the demand of local regulators. According to the New York Times, Apple has been able to launch products in China—such as Apple Pay—where other US companies have not. But Apple’s services that compete directly with Chinese internet services, like iBooks, may now come under greater scrutiny from the Chinese government, which, as Reuters noted, could stall the company’s growth in the country. Apple’s products and services need to, as the company always suggests, ‘just work,’ and if regulators cut off access to services, the phones may lose some of their sheen.

There are also questions about the size of the market Apple can reach in China. As Scribner points out in her note, 70% of the Chinese smartphone market is for phones that cost less than $300. “Based on average disposable income, the purchase of Apple’s least expensive phone, the iPhone SE, would consume almost 13% of the average person’s annual disposable income in China,” Scribner said.

How “Other Products” are doing

Apple has yet to say how many Apple Watches it has sold, and its sales are rolled up into the “Other Products” line on its income statement—along with things like Beats headphones and Apple TV devices. The Wall Street Journal reported (paywall) over the weekend that it’s likely Apple sold up to 12 million smartwatches in its first year of availability. Sure, that is far more than the number of first-generation iPhones or iPads it sold. But Apple now sells tens of millions of those devices, meaning that relative to those devices, it’s not selling particularly well right now.

The greatest criticism leveled against the Watch is its lack of a defining purpose. And as the first product developed and released under CEO Tim Cook’s reign, its lukewarm reception has been used as evidence that Apple has lost its ability to innovate with new products. Apple is likely to release a new version of the Apple Watch later this year, and its “Other Products” line will likely indicate how much demand there really is for the Watch.

Apple’s services business

Although not as exciting as new phones, tablets or watches, Apple’s services business has continued to grow, even as sales of computers and phones have stagnated.

Apple has figured out, through its app and content stores, after-sales services, Apple Pay, and a few other services, how to continue to make money off of customers who aren’t buying new phones. It’s done an excellent job of locking customers into its ecosystem, and in a note to investors last week, Credit Suisse analysts predicted that Apple’s services business could continue to grow from about $14 billion to over $35 billion—about 30% of Apple’s gross profits—by 2020. This quarter’s number, when iPhone sales are likely declining, could indicate how robust that theory is.

iPhone sales

iPhone sales now account for about two-thirds of Apple’s quarterly revenue, according to Bloomberg, so a decline in iPhone sales will likely not be completely offset by any gains the company may make in services or watches or anything else.

The iPhone SE, Apple’s new phone based on an old design, was released right at the end of the quarter, so we’ll likely have to wait until next quarter to see if it’s having any effect on the supposedly high number of iPhone users who haven’t wanted to upgrade to a 6 or Plus because of the size.

Apple may well announce that it sold fewer iPhones this past quarter than it did a year earlier, but as long as the number isn’t wildly down, it’s likely that the longer-term prospects for the company won’t be altered. The next new phone, likely the iPhone 7, will see a return to growth of iPhone sales. As Piper Jaffray analyst Gene Munster said in a recent note to investors: ”Beyond June, we believe the future of Apple remains bright with the shift to annual upgrade offerings, emergence of the Apple Watch, increased contribution from Services, and the potential for the Apple Car.”