On Monday, September 23rd, Apple (
) announced the company had sold more than nine million 5c and 5s
handsets in the first weekend of sales. The surprisingly high unit
sales number for Apple's newest iPhone handsets caused analysts to
rewrite and reconsider their narratives on Apple's prospects for
early success. Speculation turned to talk of high channel supply of
the iPhone 5c as the source of the expectedly high unit sales
number. Analysts had previously cautioned Apple's apparent
unwillingness to release a lower-cost handset for emerging markets
would dampen the sales growth potential of the new models.
Confusing matters even more, on September 23rd Apple filed a
Form 8-K reiterating revenue and gross margin guidance for the
September quarter and indicating revenue would be near the top end
of the revenue guidance range of $34 billion to $37 billion and
gross margin would be near the top end of the guidance range of 36%
The Issue of iPhone Channel Supply
Apple ended the June quarter with about 11 million iPhone
handsets in the global channel while also reporting an increase in
component supplies. In the June quarter iPhone sell-through was
greater than reported unit sales because Apple reduced channel
supply in the quarter from about 11.6 million units at the end of
the March quarter. In other words, more iPhones were sold to end
users in the June quarter than Apple reported as unit sales.
In the September quarter one year ago, Apple reported ending
channel supply of 9.1 million units. At the time, iPhone 5 supplies
were constrained and ending channel supply was below the desired
range of 4 to 6 weeks of supply on a look-forward basis.
Because Apple chose to replace the iPhone 5 after its one year
in the market with two new models, the global channel could absorb
as many of the new handsets as Apple could deliver. There's no
issue with high iPhone 5c handsets shipments. Apple has always
reported as units sold shipments to resellers when ownership of the
devices change hands, not when those handsets are sold by resellers
to consumers. Additionally, the iPhone 5c is sold in five different
colors. This necessitates more product in the market as sales
Apple's iPhone Paradox
Selling more than nine million new handsets while reiterating
September quarter revenue guidance with millions of 5c handsets
awaiting sales to customers might create an apparent paradox. But
there's no mystery or conflict in the numbers. Apple's decision to
focus its new handset efforts on the top tiers of the smartphone
market and forgo an aggressive effort to gain market share in
emerging markets at this time is in line with Apple's approach to
the company's primary product markets.
The graph below illustrates Apple's revenue mix over the first
three quarters of FY2013:
(click to enlarge)
iPhone revenue represented 53.8% of the company's reported
revenue total over this 39-week period that ended in late June. In
FY2012, iPhone revenue represented 50.3% of the company's reported
revenue total. In the first three quarters of the fiscal year,
iPhone revenue rose15.7% versus 10.7% revenue growth for the
company as a whole. In FY2013 which ended on September 28th,
revenue from iPhone sales may have reached 55% or more of Apple's
revenue total. The iPhone remains Apple's principal revenue and
operating income driver. Emerging markets can wait for now as Apple
seeks gross margin recovery and a return to net income growth.
The graph below illustrates the fast rate of revenue growth in
Apple's Japan revenue segment:
(click to enlarge)
In both FY2012 and the first three quarters of FY2013, Japan has
topped the scales as Apple's fastest growing revenue region. In
FY2012, revenue growth in the Japan region ran at a blistering
94.43% rate. At 23.37%, Japan's FY2013 revenue growth rate through
the June quarter eclipsed the 15.07% revenue growth rate in Greater
China and the 11.66% revenue growth rate for the Americas region.
In the first three quarters of FY2013, Apple's Retail segment
revenue growth rate was a comparatively slow 7.93%.
Regional Operating Income As A Percentage of
The graph below illustrates the percentage of revenue that has
reached the regional operating income line over the most recent
eleven fiscal quarters:
(click to enlarge)
Again, Japan outpaces the performance of Apple's other revenue
segments. In FY2012 and the first three quarters of FY2013, Japan
has consistently delivered regional operating income as a
percentage of revenue above or near the 50% line. It's no wonder
Apple has secured a carrier agreement with NTT DoCoMo (
) as it works out the details of an agreement with China Mobile (
). As Apple continues to focus its iPhone efforts on the top tiers
of the smartphone market, adding NTT DoCoMo to the list of carriers
will boost not only unit sales, but operating income as well.
Emerging Markets Can Wait (For Now)
As the smartphone market continues to mature, Apple will address
the hundreds of millions of potential customers in the world's
emerging markets. But that time isn't now. Apple's next big step
will be a carrier agreement with China Mobile. China is Apple's
largest national market outside the United States and the only
country other than the US to deliver 10% or more of Apple's
reported revenue total. Apple doesn't currently have an iPhone
revenue problem. Apple is first confronting the challenge of
reduced operating income per revenue dollar due in large part to
falling gross margin.
Adding China Mobile as an authorized iPhone carrier in the
December quarter and ahead of the early 2014 Lunar New Year
celebrations will "turbo charge" unit sales. The carrier will be
added after the substantial completion of the global rollout of the
new iPhone 5 series handsets. At that time the production ramp for
the new handsets will accommodate the addition of the world's
largest carrier. But Apple's continuing focus is on the top tiers
of the smartphone market
The Problematic iPhone 5
Not only were iPhone 5 handsets in chronic short supply
following release last September, the model was beset with
manufacturing challenges that contributed to the extraordinary
$1.551 billion warranty set-aside that occurred in the March
quarter. To address falling gross margin and the high warranty
costs of the iPhone 5, Apple has not only changed the color scheme
for the new iPhone 5s, the polycarbonate back of the 5c is easier
to make and will allow for some cost savings.
Sales of the 5c need to be measured not against the sales of the
5s, but against the sales potential of the iPhone 5 had it remained
in the market for another year as Apple's mid-line handset.
Channel Supply: Much Ado About Nothing
In the December quarter (FQ1 2014) iPhone unit sell-through will
reach and most likely exceed 60 million units. Apple's decision to
ship as many iPhone 5c handsets as possible into the global channel
is a smart and prudent move. Because the iPhone 5c replaces the
original iPhone 5 in the marketplace, there were no supplies of the
product in the market prior to release.
There's No Mystery In The Numbers
Apple entered the September quarter with about 11 million units
in the global channel. Channel supply consisted in part of two
handsets Apple has removed from the market. Building out channel
supply to meet new product demand will remain a challenge for Apple
through the December quarter.
Apple's management has reiterated revenue guidance for the
quarter not because of challenges with iPhone sales, but because
the quarter began with 11 million units in the global channel and
against a backdrop of negative unit sales growth from the iPad and
Mac lines in the period. There's no conflict between Apple's
reiteration of guidance and high iPhone unit sales in the period.
An apparent paradox does not exist. Reported iPhone unit sales and
unit sales sell-through for the September quarter will be high, but
channel supply gains over the June quarter number may not occur.
There's a distinct possibility Apple will report higher
sell-through than unit sales in the quarter as Apple worked down
channel supply prior to release of the new handsets.
By this time next year Apple may choose to address emerging
markets with a lower-cost iPhone handset. But Apple's biggest
challenge at this time isn't iPhone unit sales growth. The biggest
challenge is the company's increasing reliance on the iPhone line
for revenue growth and aggregate gross margin performance.
Management's obsession with customer satisfaction and attractive
gross margin puts emerging market initiatives on the proverbial
back burner for now.
Apple's Real iPhone Paradox
There's nothing inconsistent about Apple's iPhone strategy. The
real paradox is that even without addressing emerging markets in
this year's product line refresh, Apple's reliance on its most
popular product line continues to rise.
The lack of a MacBook Pro update in the September quarter
exacerbates the unit sales pressure on Apple's oldest and most
enduring product line. The iPod line is virtually immaterial to
Apple's revenue and net income performance outside of each year's
holiday quarter and iPod unit sales continue to decline.
An October refresh of the iPad line will no doubt reinvigorate
unit sales. Expectations of the release of a Retina display iPad
mini have already dampened sales of the existing model. The 9.7"
iPad hasn't had a significant update since March 2012, when the
first Retina display iPad was brought to market.
Apple will first cement its position as the market leader in the
high-end tiers of its current product markets. The iPhone refresh
and the pending iPad refresh will boost the revenue performance of
Apple's two most popular product lines. Urgency for Apple to
address consumers in emerging markets is nothing more than
misplaced anxiety. Apple's biggest risk moving forward is growth
dependence on one line of product as the smartphone market
Apple's revenue growth and the company's return to positive net
income growth will be fueled in the December quarter primarily by
the new iPhone 5 series handsets. The refreshed iPad line will also
benefit the company's top line and bottom line.
While attention at this time is almost exclusively focused on
the new iPhone handsets, the question isn't whether or not Apple's
iPhone strategy will be a success but whether or not the pending
iPad refresh will deliver unit sales growth to keep pace with the
success of Apple's new line of smartphones.
The author is long Apple shares
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