At the end of the day yesterday, Apple suddenly halted trading of its shares pending news, then published a letter to investors directly from Tim Cook. In it, he admits that Apple's last-quarter results are worse than it expected, and that the market should prepare itself for bad news: it was harder than expected.

You'll probably read a lot about this letter out there today, which is truly a rare sight from Apple. The news that sales might be slow in December given the 'best' iPhone lineup yet was surprising, but what makes it truly remarkable is the specific factors that Tim Cook names in the letter:

1. China has had a serious impact on the company's bottom line, with Cook saying that "we did not foresee the magnitude of the economic deceleration, particularly in Greater China" and that trade tensions may be to blame.
2. iPhone sales were worse than expected for a plethora of reasons, from carrier subsidies disappearing to "USD-related price increases."
3. Sales of devices were constrained as it struggled to supply devices, with Watch Series 4, iPad Pro, Airpods and MacBook Air intermittently out of stock during the entire quarter.

The letter specifically blames China's slowing economy for the earnings miss, with "over 100 percent" of the revenue decline happening in China. 

Cook blames "uncertainty in financial markets" and cites a sharp drop in foot traffic to its stores, but tiptoes around another problem: the US market is so saturated that there's fewer people to sell to, so a good result hinged on epic China growth. That didn't happen, and there's nowhere to hide.

There are further hints at this later in the letter, when detailing why iPhone sales slipped (emphasis mine):

While Greater China and other emerging markets accounted for the vast majority of the year-over-year iPhone revenue decline, in some developed markets, iPhone upgrades also were not as strong as we thought they would be. While macroeconomic challenges in some markets were a key contributor to this trend, we believe there are other factors broadly impacting our iPhone performance, including consumers adapting to a world with fewer carrier subsidies, US dollar strength-related price increases, and some customers taking advantage of significantly reduced pricing for iPhone battery replacements. 

Reading between the lines, Apple may have accidentally found consumers' price ceiling sooner than expected. It attempted to raise the price of the top-end for a second year running, pushing the average person to just replace their battery (following the battery-performance scandal) to prolong their older devices. I know a ton of people who took this path after seeing the latest pricing, and I'm willing to bet it's worse than described in the letter.

In other words, Apple's base appears to have started balking at its own prices, and its devices are lasting much longer as a byproduct of that. 

I'd also argue that the iPhone refresh in late 2018 was poorly executed: it featured an extremely similar phone (Xs) to the previous year with fewer than ever meaningful reasons to upgrade, at a higher price, while muddying the lineup for potential upgrades with a new device (Xr) that made it difficult for consumers to decide what to choose.

If I were an iPhone owner, I know what I would have done: given up on deciding and tried the $29 battery replacement first, since it would also resolve a large number of my performance problems. 

With this in mind it's an incredibly convenient quarter for the company to have stopped reporting unit sales, as we'll never really know just how good or bad that sales makeup was, just high-level numbers, lessening how much we can learn about what really changed.

There's lots of good in the letter, from services (iCloud, Apple Music, etc) revenue growing around the world, a huge increase in wearables sales and success in some traditional markets, but much will be written about how it's the beginning of the end. Journalism loves to doom-and-gloom Apple, but while this is extraordinary, it's a blip on a ridiculously-good record: if your "bad" quarter was $84 billion in revenue, things aren't so uncomfortable.

If anything, it's the beginning of Apple needing to prove it really can redefine itself again as the iPhone matures. We don't know if Apple can do that under Tim Cook, and as far as I can tell, there's nothing on the near-term horizon to continue to hedge these results if they get worse, unlike the entry of iPhone as iPod began to fizzle.

It's going to be an interesting 2019. Stay tuned for January 29, when the actual results are published.

Further reading: Stratechery's fantastic 2017 post on Apple's "China problem."

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