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Apple Dec. Quarter  Preview: Stable iPhone, Focus On iPhone X, Services

Apple Dec. Quarter Preview: Stable iPhone, Focus On iPhone X, Services

Apple reports Dec-16 quarterly results on January 31st. We continue to be positive on the Apple story, given our thoughts on iPhone X and the features we expect to advance Apple’s lead in AR-enabled devices. We expect Apple’s Dec-16 quarter/Mar-17 guide to largely be a positive event based on our belief that Mar-17 guidance is inline with the Street and will imply iPhone unit growth of about 7% y/y, up from expected growth of 4% y/y in Dec-16.  This would suggest the tail on the iPhone 7 is stronger than last year’s iPhone 6S.  More importantly, Mar-17 guidance should give investors confidence that they can think forward to iPhone X in the fall, an OLED, AR-enabled phone, which should return iPhone to a more predictable 5-8% unit growth. See below for what to expect from iPhone X.

iPhone Dec-16 Units.  For the Dec-16 quarter, we are expecting 78m iPhones, a 4% y/y increase.  Based on our checks throughout the Dec-16 quarter, we believe iPhone reached supply demand equilibrium in the US the second week of December, much later than the iPhone 6S, which was at supply demand equilibrium late in October 2015. Outside the US, supply was near equilibrium.  On Apple’s Sep-16 earnings call, Tim Cook suggested Dec-16 guidance assumes iPhone may not reach supply demand equilibrium in Dec-16, stating “I wouldn’t say [iPhone will be at equilibrium] at this point, because the underlying demand looks extremely strong on both products but particularly on the iPhone 7 Plus versus our forecast going into the product launch.”  Since Dec-16 guidance did not factor iPhone at equilibrium, demand was “extremely strong”, and the iPhone did in fact reach equilibrium in the US and near equilibrium internationally, we now expect a stronger iPhone number than we had previously expected (77m in Dec-16).

iPhone Mar-17 Guidance, Comps Are Our Ally.  We expect guidance for the Mar-17 quarter to imply iPhone units of 56-57m units, which would be up 9-11% y/y, compared to Street expectations of up around 7%.  Apple does not guide for the iPhone, but we back into the iPhone guidance from the revenue guide and commentary around ASPs on the call. The rebound in the iPhone is partly attributed to features of the iPhone 7 Plus (e.g., portrait effect) and partly due to the easy comps.  In Dec-15, iPhone unit growth was flat y/y, down 16% y/y in Mar-16, and down 15% y/y in Jun-16.  These easy comps should allow the iPhone to grow in the 5-12% range going into the iPhone X launch, likely in Sept. 2017.

Services Momentum Continues.  For Dec-16, we expect Services (~13% of revenue) to grow at 23-25% y/y, compared to 24%  y/y in the Sep-16 quarter. On January 5th,  Apple announced that App Store developers earned over $20B in 2016, up 40% y/y.  Assuming a 30% revenue share implies App Store gross sales of $78M per day in 2016. Separately, Apple released New Years day App Store sales of $240M, above our $100M expectation. We estimate that the App Store accounts for more than 65% of Apple’s Services revenue. Given the significance of the App Store to Apple’s Services business coupled with this announcement, we believe Services revenue growth in 2017 may be closer to 20% y/y.

The 2016 App Store numbers and the New Year’s Day App Store sales underscore how quickly Apple is becoming a Services business. We previously shared our thoughts on Apple reinventing itself as a Services business here. In short: the transition to Services is important as new platforms like AR and VR emerge and transform Apple’s existing mobile device businesses.

Gross Margin. We expect Dec-16 gross margin of 39%, compared to guidance of 38-38.5%.  There are two positives and one negative factor impacting margins. The two on the positive side are higher than expected demand for the iPhone 7 Plus with higher storage configurations and Services strength, which carries over 60% gross margins.  Second, also increases our confidence on margin upside.  These two positives are partially offset by iPhone hardware margin (dual cameras) which has been drifting lower.

Expectations For iPhone X. We expect iPhone X to feature:

  • An OLED screen
  • Wireless charging (a step they’ve already taken with Apple Watch)
  • Dual lens camera systems on both the smaller- and larger-screen models
  • A (possibly dedicated) processor capable of 3D modeling and real-time 3D image processing
  • More sophisticated proximity sensors
  • The iPhone X may be the iPhone model we’ve discussed that removes the home button, using haptic feed back for button presses on the display itself for home button functions. This would enable an edge-to-edge display for an iPhone without a bezel.

With iPhone X, we see Apple doubling down on AR and extending it’s lead among AR-capable devices. iPhone is already significantly ahead of Google’s Tango platform in terms of units shipped, and we expect it to remain out front for the foreseeable future, setting up Apple for long term success in an AR world.

Disclaimer: We actively write about the themes in which we invest: virtual reality, augmented reality, artificial intelligence, and robotics. From time to time, we will write about companies that are in our portfolio.  Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.

Apple, Augmented Reality, Google
4 min. read Show less
Our Expectations For iPhone X

Our Expectations For iPhone X

Yesterday, we talked about the steps forward that Apple took with the iPhone 7 and iPhone 7 Plus. In short: we see Apple building a competitive advantage in augmented reality (AR). The dual lens camera is a precursor to greater augmented reality features that we expect in the next iPhone.

A word on the name: We expect the next iPhone to have a new design. Apple will likely break from it’s historical naming convention and call this iPhone something other than iPhone 7S or iPhone 8 because it will be the 10th anniversary iPhone. Like they did with the 10th version of the Mac OS, it seems logical that they’ll call the next iPhone: iPhone X. Regardless, it’s a suitable code name for those of us outside 1 Infinite Loop.

We expect iPhone X to feature:

  • An OLED screen
  • Wireless charging (a step they’ve already taken with Apple Watch)
  • Dual lens camera systems on both the smaller- and larger-screen models
  • A (possibly dedicated) processor capable of 3D modeling and real-time 3D image processing
  • More sophisticated proximity sensors
  • The iPhone X may be the iPhone model we’ve discussed that removes the home button, using haptic feed back for button presses on the display itself for home button functions. This would enable an edge-to-edge display for an iPhone without a bezel.

With iPhone X, we see Apple doubling down on AR and extending it’s lead among AR-capable devices. iPhone is already significantly ahead of Google’s Tango platform in terms of units shipped, and we expect it to remain out front for the foreseeable future.

The hardware features listed above would enable lots of new AR software use cases. And we expect the keynote to focus on demonstrating these new AR capabilities. Pokemon Go is just the beginning. Games are the obvious choice to highlight new AR features, but we envision killer AR apps in search and discovery, social, education, and many other use cases.

Note that AR goggles are not the type of product we envision Apple shipping in the next couple of years, despite recent rumors. While high speed wireless data transfer is emerging, compelling wearable optics are still tethered today and we don’t think Apple would launch that type of experience for customers.  Rather, we think the iPhone platform is a much stronger play for the company in its bet on AR in the near term.

Next up, services. We think it makes sense for Apple to reinvent itself as a world class digital services company (more here). And again, iPhone is their competitive advantage. But people will experience AR through a combination of mobile hardware and digital services. Tim Cook has acknowledged the company’s strong interest in AR, and we believe they are focusing more on services in preparation for an AR world where this combination is the future of mobile software. 

Disclaimer: We actively write about the themes in which we invest: virtual reality, augmented reality, artificial intelligence, and robotics. From time to time, we will write about companies that are in our portfolio.  Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.

Apple, Augmented Reality, Google
2 min. read Show less
Innovate Like Apple, With Baby Steps

Innovate Like Apple, With Baby Steps

When Steve Jobs introduced the iPhone 10 years ago, he talked about how fortunate he had been to introduce three revolutionary products over the course of his career: Macintosh, iPod and iPhone. For good reason, Apple is known for major leaps forward in innovation. But as we’ve watched their progress over the last two decades, we’ve recognized a pattern of smaller, more incremental changes: baby steps. These are the steps that often disappoint Apple watchers. Sometimes the steps forward appear to be giant leaps, but those are the exception to the rule. Even their most revolutionary products have been the sum of baby steps that preceded them. Nobody’s articulated this better than Kirby Furguson in Everything is a Remix.

Remember the Motorola ROKR E1? It was the phone we had all be dreaming of: a combination iPod and mobile phone that made it easy to load music from iTunes. Baby step. Or worse: stumble. We had all been sandwiching our Motorola RAZRs and our iPod nanos together, praying Apple would combine them. After the launch of the ROKR, Playlist summed it up nicely in their review of the device: “While I’m pleased that the phone finally saw the light of day, my pleasure just about ends there. As a phone, it’s hardly cutting edge. And as a music player, it’s a poor substitute for an iPod.” But the iPhone development team learned a lot from that 2005 project with Motorola as they prepared for the 2007 launch of the iPhone. And consumers learned to load music onto their devices, getting in the habit of using their phones as music players.

Remember the watch bands made for the 6th gen iPod nano (2010)? Apple created beautiful watch faces for the device and Phil Schiller even highlighted the trend during a keynote. Baby step. Five years later, Apple introduced Apple Watch. In the interim, the company had sold over 100M iPods and over half a billion iPhones. The Apple Watch was made possible by the technical and production capabilities Apple developed over the course of the iPod’s lifecycle in combination with the addressable market Apple created with the iPhone, which does much of the heavy lifting for the Apple Watch.

In hindsight it seems obvious, but these baby steps were critical. There are many benefits to recognizing and leveraging how gradual innovation truly is. We categorize them in two groups:

  1. Train your customers. As much as we think we want something totally new, we’re creatures of habit. We want new capabilities that fit into and streamline our routines. We want new tools that are immediately understandable. New skills require training, and your customers are no different. Baby steps in features, innovations and user interfaces help to train your customers. And they help you commercialize increasingly complex technology. The first Apple TV, for example, synced media via iTunes in exactly the same way we had been syncing media with iPods for years. We were well trained.
  2. Ramp your production capability. You learn a lot when you build your first product. You learn even more when you scale your first product to 10,000 units. But if each new product or feature is completely different, you can’t transfer the learnings from one to another. The iPhone would not exist if not for the iPod. Even though the iPhone today makes the iPod look irrelevant, it stands on its shoulders. Apple ramped its iPhone production capability to the incomprehensible level it’s at today because of the baby steps it took with the iPod line, ramping capability for flash storage, mobile displays, camera lenses, etc. Especially with physical products, ramping supply chain and production capability happens in baby steps.

We love to look carefully at the baby steps we see Apple taking today and predict what it means for the future. Looking at the iPhone 7 Plus’s dual cameras and software features, we see Apple building a huge competitive advantage in augmented reality. Portrait mode is training customers and helping to drive demand for the hardware; meanwhile, Apple is ramping their own technical and production capability with dual lens devices. The iPhone 7 Plus will have a huge implications for 3D mapping and real-time image processing in an AR world. Similarly, the haptic home button on the iPhone 7 and 7 Plus are training customers to respond to haptic button presses rather than mechanical button presses. We will be well trained for the eventual iPhones that have no home button, have no bezel, but use on-screen buttons with haptic feedback for home button functions.

AirPods (our new favorite toys), in combination with Apple Watch, are clear steps towards a post-mobile world. The watch takes care of notifications, nearly eliminating the need to take your phone out of your pocket for any reason other than a phone call, and AirPods eliminate the need to  take your phone out of your pocket for calls. Glance at your wrist to read a text. Double tap an AirPod to initiate a call-back, talk, and double tap an AirPod to end the call. Even though the iPhone still bears the majority of the processing and wireless burden, Apple is clearly taking steps towards post-mobile computing through the wearables it’s already shipping.

And baby steps work for startups too. Amazon started solely as a bookseller, only to evolve into the Everything Store. Facebook started as a network for college students at Harvard, then Boston and ultimately a network for the entire world. Airbnb started as a place to rent a couch, now it replaces hotel rooms for many.  Baby steps let Apple and others figure out the market and optimize for it before they changed the world. Prove the concept first, dial it in, then scale it. Revolutionary products seem to sneak up on us, but the steps to get there are usually apparent in hindsight.

Disclaimer: We actively write about the themes in which we invest: virtual reality, augmented reality, artificial intelligence, and robotics. From time to time, we will write about companies that are in our portfolio.  Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.

Apple, Augmented Reality, Philosophy
4 min. read Show less