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FQ1-16 AAPL Channel Inventory

On its FQ1-2016 Earnings' Call on Jan-16, AAPL was probed during its analyst Q&A session about its iPhone channel inventory levels. This was odd in one sense. AAPL historically has disclosed the exact amount of channel inventory it builds or draws-down during its prepared remarks. This quarter, AAPL's CFO, Luca Maestri, merely said:

"We started the quarter below our channel inventory target range and thanks to an extremely successful manufacturing ramp; we were able to exit the quarter slightly above the low end of our target range of five to seven weeks of iPhone channel inventory." [Emphasis Added]

It was only during the Q&A, where Toni Sacconaghi pressed Maestri on the actual channel inventory levels when AAPL revealed exactly how much inventory it had built during the quarter. Maestri indicated that it had an iPhone channel build of 3.3 million units during the quarter. He went on to indicate that it entered FQ1-2016 significantly short of the 5-7 week forward-looking target. The 3.3 million unit build is a significant number of units and matches the highest channel build in the product's history - it built 3.3 million units during the FQ4-2013 quarter, which coincided with the launch of the iPhone 5S / 5C. Additionally, the combined sequential builds (FQ4-15 + FQ1-16) was 5.25M units - that is the highest sequential build ever. Here is AAPL's historical iPhone channel inventory dynamics with reported (sell-in) and underlying sales (sell-through):

Sources: Reported sales are from AAPL SEC Filings (10Qs & 10Ks); End Channel Inventory numbers are obtained from AAPL's earnings' call transcripts posted on Seeking Alpha.

Here's some food-for-thought on the channel inventory build in FQ1-2016:

  • When taking into account the channel build, underlying iPhone unit sales contracted 4.3% year-over-year, vs. the reported sales growth of 0.4%. This is interesting because of a comment made by Cook during the AAPL's FQ4 earnings' call in October, once again in the Q&A portion in response to a question posed by Toni Sacconaghi about expectations for iPhone growth:

"The same – my same response applies and I think we'll do quite good in iPhone. I do believe we'll grow this quarter as we put in our guidance that when you start with a number in the low 30s in terms of the percentage of the installed base that’s upgraded that had a phone pre the iPhone 6 and 6 Plus, that number still likely to leave a lot of headroom beyond December."

Cook is often very careful with his words so the fact that he believed the company would grow sales both in the December quarter and beyond implies that the company fell short of internal expectations on iPhone sales. It also is corroborated with the fact that AAPL would have missed the low-end of its revenue guidance range (an unprecedented scenario) but-for the booking of a $548 million settlement from Samsung in its "Services" revenue - as discussed by Chuck Jones of Forbes.

  • The 4.7% gap between reported sales growth (0.4%) and underlying sales growth (-4.3%) is the largest gap since FQ4-2013 when there was an 8.8% gap (reported sales growth of 25.6% vs. underlying sales growth of 16.8%).
  • To simply analyze channel inventory builds in historical context is not exactly an accurate measurement of the product health because the channel (3rd-party points-of-sale) have expanded significantly over the past few years - specifically in China. For example, AAPL was not selling the iPhone through the world's largest wireless carrier (China Mobile) when it had the 3.3M build in FQ4-2013.
  • However, the 5.25 million unit build that occurred between July 26, 2015 (beginning of FQ4-15) and December 26, 2015 (end of FQ1-16) is concerning. It means that AAPL has a lot of units sitting in the channel that it has already recognized revenue on that it will need to work-off during the March quarter (FQ2-16). This likely lends credence to the relatively low guidance that it provided for the March quarter and related commentary about March being a very tough compare.
  • In short, there are a lot of eerie comparisons this time around with iPhone channel inventory between what occurred in the FQ4-13 / FQ1-14 period, which may not bode well for Street expectations and actual performance. It should be noted, however, that the all-but-confirmed launch of an updated 4" iPhone in March-2016 (dubbed the iPhone 5se) could create new dynamics that haven't been seen before. It could be the first-time ever that AAPL has had two different timed iPhone release cycles in one fiscal year (assuming they bring out an iPhone 7 / 7+ in September-2016, as-expected).

I still think there is much headroom for iPhone growth both domestically and abroad. The research firm Mixpanel put out a report recently showing that 32.2% of active iPhone users are still using a 4" screen (5 / 5S / 5C) meaning they are either not enamored with the larger 4.7" / 5.5" offerings or are still waiting to upgrade. Additionally, the enterprise uptake of iPhones has been accelerating - Cook indicated at the BoxWorks conference that AAPL's TTM enterprise sales (ending in June-2015) were $25 billion - while that includes iPads, iPhones and Macs - I would suspect that the most significant acceleration of those sales is coming from iPhone. Lastly, the Android-switch rate that Cook keeps referring to is real - and that has nothing to do with whether the current installed base has upgraded or not.