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Apple’s Profitable Flywheel is Rock Solid
The December outlook was better than it first appeared. Adjusting for the number of weeks in the quarter, growth in December should be 7% y/y compared to the Street that was at 5%. Additionally, the active installed base, Services, China, and gross margin showed surprising strength, evidence that the Apple revenue flywheel is rock solid.

Key Takeaways

December guidance is better than it looks when you set aside consensus, and focus on the business, which is growing about 7% in December compared to 1% in September.
The product flywheel is intact, as evidence by the installed base of active devices setting an new all-time high and continuing to grow "nicely".
Concerns about China were largely overblown, with sales up 4% in constant currency and iPhone likely gaining share.
Apple is working on generative AI and has the pole position among Big Tech to lead in personalized AI.

Decoding guidance

Shares of AAPL were down 1% just before CFO Luca Maestri give guidance that December revenue to be 5% below the Street. Following that comment, shares of AAPL were trading down 4%. Maestri added some context that there are 13 weeks in this December quarter compared to last year’s 14 weeks, a detail most analyst likely had factored into their models. Luca added that if this December quarter had 14 weeks, revenue would likely be 7% y/y, compared to up 1% in the just reported September quarter.

Guessing how many analysts correctly factored in 13 weeks into their models is a fools errand. The bottom line is each week the business is expected to grow 7% y/y in December, and that’s a measurable step up from the 1% growth in September.

Additionally, the calendar will normalize in March and reveal a business that will likely continue to grow at around 5%, a level that I believe investors will be satisfied with.


The product and services flywheel is intact

Apple continued to grow its active device installed base, an important metric for long-term investors who look for Apple to win customers and expand the number of devices and services that they purchase. The last hard number we have on the topic is from the December 2022 quarter, when the company reported an 8% y/y growth in the active base, reaching over 2B devices. I believe the growth has remained constant over the past three quarters, likely in the 2-3% y/y range. If you are curious, I estimate there are now about 1.25B active iPhones alone.

The active installed base topic is important because it’s the foundation of what is driving what I believe is a new chapter of how investors view Apple. Over the next five years, I continue to expect investors to see Apple as a “can’t live without” consumer staples company. The stock’s reaction to a soft December revenue guide and only being down 3% on a 5% guide down is the latest evidence that this investor shift is happening. The Apple flywheel is alive and well, following a 20-year success story in which consumers buy one Apple product, fall in love, buy another product, add a service, upgrade, and repeat.

Apple updates its active installed base about once a year, which means we may have to wait three more months for the next data point. In the meantime, investors will likely be increasing their focus on the metric given if it keeps growing, investors can sleep well at night.


The China market

Going into earnings, there was concern that China would slow dramatically. Some of the reporting predicted iPhone demand would drop off from a soft consumer, alleged government iPhone ban, or reawakened competition from Hauwei. Tim Cook’s surprise visit to China in October further fueled the concern.

Apple’s China revenue ended down 2% y/y in September, compared to up 8% in the June quarter. While things slowed in December, the China growth was better than the 3% decline in March and 7% decline in December 2022. Overall, the results were in line with the China variability we have seen over the past year.

Additional support that Apple’s China business is fine included Cook’s comments on the call that FX had nearly a negative 6% impact on the region, meaning in constant currency China grew by 4% y/y. Cook also reported the top four best selling phones in urban China are iPhone. Lastly, iPhone sales grew in China (constant currency) while the overall high-end smart phone market contracted. In other words, iPhone in China gained share in September.

A separate China topic is related to production, specifically increased tensions related to manufacturing and chip supply, along with China’s investigation into Apple’s largest supplier, Foxconn. All of this highlights the urgency for Apple to diversify production to outside of the country. Today, Deepwater estimates that 40-45% of Apple’s overall revenue is manufactured in China, and expects that to decline to 25-30% in five years. India will likely play the biggest role in Apple’s manufacturing diversification game plan.


Apple and AI

Apple has been reluctant to talk about AI. Consistent with past quarters, in the companies prepared remarks, there was no mention of the upcoming wave.

During Q&A, Harsh Kumar, Piper Sandler analyst, asked what the company is doing in generative AI. Notably, Cook began his response by talking about how AI is making Apple’s existing products better, a theme the company has reiterated over the past nine months. The reason he starts there is that is how Apple thinks about products and features, in the context of the customer benefit. The iPod boasted it could hold 1k songs in your pocket, ignoring the fact that it was powered by 5GB of storage. Apple highlights the benefits of fall detection, better photo management, and immersion in Vision Pro, saving us from the details of how it comes together.

Cook did add that in terms of generative AI, “we obviously have work going on, and you can bet we are investing quite a bit and we are going to invest responsibly”.

There are two takeaways from that comment:

First, the company is going to do something directly in generative AI. Most likely that will take the form of enhanced Siri. The near term use case is having Siri respond to texts and emails. Long term the company is in the best position of any Big Tech company to win in personalized AI because privacy and security is central to Apple’s brand. While personalized AI does not exist today, the concept is to ask Siri to complete a multilayer task, like organize a meeting, book flight, or take action on how to improve a credit score. That will supercharge how we use generative AI.

Second, they’re going to invest responsibly. That means they’ll increase investments in AI R&D and protect margins at the same time. Recently, Mark Gurman from Bloomberg wrote that Apple plans to spend $1B of their ~$28B in annual R&D budge on generative AI. That $1B investing level checks the box of “investing responsibly”. While that number may seem small related to multi-billions being invested by Microsoft, Google, Meta, and Amazon, it’s important to remember that in tech, throwing money at a problem does not always solve the problem. Just ask Meta if they feel they have gotten their money’s worth from the ~$15B a year on Reality Labs spend.


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