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September 18th, 2018: Jony Ive Talks with The Washington Post, Apple Products Removed from Tariffs List, Sonos Earnings

Today’s update will begin with a rare Jony Ive interview over at The Washington Post.

Jony Ive Talks with The Washington Post

Last week, Jony Ive sat down with The Washington Post’s Christina Passariello for a post-event interview. Passariello talked with Jony last year for her huge profile on Apple Park when she worked for the WSJ.

Here’s Passariello:

“Jony Ive, Apple’s design chief, on Wednesday unveiled a new iPhone, the biggest deal at the biggest gadget launch of the year. But a different product is closest to his heart: the Apple Watch.

Ive, Apple’s chief designer, gave Apple’s original wearable device a complete makeover in form and function. The Apple Watch Series 4, which Apple also introduced Wednesday as part of its annual product event, is slimmer and has new health tracking features such as the ability to take an electrocardiogram and detect hard falls — and is increasingly independent from the iPhone. That gives it a more profound purpose, in Ive’s vision, and sets it apart from other technology.

‘Every bone in my body tells me this is very significant,’ Ive said in an interview in the Steve Jobs Theater at Apple’s headquarters following the event. Ive, like the former Apple CEO who was his close friend, speaks of Apple innovations with fervor. The new watch ‘will be a more marked tipping point in understanding and adoption of the product.’”

Were the new iPhones really “the biggest deal” from last week’s event? Judging from various reactions to the unveiling, Apple Watch stole the show.

Also, it would have been helpful if Passariello discussed a little bit of the background regarding Apple Watch development. There is no other product in Apple’s lineup that is more closely connected to Jony than Apple Watch. The trials and tribulations associated with developing Apple Watch contributed to Jony coming close to burning out, which partly explained his move to Chief Design Officer a few years back.

The most interesting quote found in the piece was Jony saying Apple Watch Series 4 marks a “tipping point in understanding and adoption of the product.”The key word in that sentence: understanding.

For the past four years, a fair amount of the criticism and cynicism facing Apple Watch came from people not seeing the point of the device. Why should Apple Watch exist when we are glued to our iPhones? After all, it was only a few years ago when consensus thought watches faced extinction given how we turned to our smartphones for the time.

Jony is claiming that the combination of hardware and software found in Series 4 will begin to dispel any remaining confusion and mystery as to why Watch exists. More importantly, Series 4 will go a long way in showing how Watch fits in with the rest of Apple’s product line.

This is where our attention can turn to items like the Watch’s larger display (useful for viewing notifications and messages) and the improved optical heart sensor and digital crown (crucial for better health monitoring).

Here’s more from Passariello:

“Ive won’t give away how Apple wearables could spiral beyond the watch, though company watchers expect an augmented reality device could be in the works. He hints that the watch, on the other hand, could evolve in the years to come.

‘The clues for the future are when you can have a high degree of confidence that you personally are connected to the Net — not your phone, you,’ said Ive. Sporting a new watch with a white rubberized band, Ive said the gadget has helped him lessen his dependence on his phone.”

Turning back to Jony’s Watch video from last week’s event, he mentioned how the Watch is liberating. It’s clear that one form of liberation comes from reduced iPhone dependency. However, the other form of liberation is found with this idea of being personally “connected to the Net.” The Watch ends up serving as one of the smallest barriers we have ever seen when it comes to utilizing technology without having it take over our lives.

Apple Watch is a proactive digital assistant. Up to now, many people would probably classify Siri as that digital assistant. In reality, the entire watch represents the proactive assistant. For example, Apple Watch can now monitor your activity to determine if you experienced a hard fall. Not only that, but the device will also call for help on your behalf. Heart rate monitoring is another example of Apple Watch proactively helping you throughout the day by alerting you only when there is something you should know. These are tasks that the iPhone will never be able to handle. More importantly, they represent a new way of interacting with technology. This gets to the heart of why Apple Watch is such a big deal.

One random tidbit:

According to Passariello, Apple had to remove the red dot on the Series 4 Digital Crown in order for it be conductive for a pulse (for ECG). Regardless of the motivation behind the change, Apple sure has embraced Digital Crown design as a Watch branding opportunity.

(click/tap image to enlarge)

Apple Products Removed from Tariffs List

The saga involving U.S. tariffs and Apple continues. Here’s Bloomberg:

“The Trump administration spared a category of high-tech products that includes the Apple Watch and AirPods headphone from the next round of tariffs it has imposed on Chinese goods, according to the office of the U.S. Trade Representative.

President Donald Trump announced the tariffs in a statement on Monday, as the government released the final list of about $200 billion of Chinese products that will be hit with a new 10 percent tariff.

A product code that covers Apple Inc.’s Watch and AirPods -- as well as similar smart watches, fitness trackers and other goods made by competitors including Fitbit Inc. -- was not on the list. A separate code that covers the Mac mini was also not on the list of new tariffs…

The first product code covers wireless devices, and it was included on a preliminary list the administration released in July. Other Apple products under the code include the HomePod speaker, BeatsWL headphones, and AirPort and Time Capsule internet routers. The value of such imports from China is about $12 billion, according to one of the people…

White House economic adviser Larry Kudlow, speaking at the Economic Club of New York on Monday, said the administration frequently consults with Cook and takes his views seriously.

‘We’ve spoken to Mr. Tim Cook many times. He’s a really smart guy. He’s given us some good advice,’ Kudlow said.”

Based on the initial proposal, Apple products were directly impacted by 13 tariff codes. It looks like two codes were removed - the codes covering wireless devices like Apple Watch, AirPods, and HomePod (85176200) and the Mac mini (84715010). The other codes are still found on the finalized list. This means that the Apple Pencil, Magic Mouse and Trackpad, Apple adapters, and leather cases / covers may still be impacted by tariffs. There is the possibility that certain products are exempt even if their respective tariff code is on the list.

In addition to a few Apple accessories potentially still being on the list, it looks like a number of inputs for Apple U.S. operations remain on the list.

According to the Office of the United States Trade Representative (USTR), 286 tariff lines were removed from the final list (just 5% of lines). The removals were driven by the comments and testimony sent to the USTR.

The tariffs will kick off at 10% effective starting September 24, 2018. The tariffs will increase to 25% on January 1, 2019.

The USTR removed the most visible consumer products from the list (smartwatches and wireless headphones). At the same time, to have tariffs begin at 10% and increase to 25% in January 2019 is an obvious move to limit the impact on the U.S. holiday shopping season.

It is dangerous to rely on too many assumptions when it comes to U.S. tariffs. However, given how smartwatches were removed from the list, it would seem very unlikely that smartphones and tablets will be impacted by the third tranche of tariffs that is supposedly in the works. In addition, Tim Cook apparently was given reassurances that the iPhone would be exempt from tariffs.

Where does this leave Apple?

At this point, the tariffs risk is primarily found with slightly higher R&D and SG&A costs. Higher input costs for various R&D activities may pressure Apple’s net margins. However, management has shown the ability to remain pretty aggressive when it comes to keeping SG&A expense contained. A 10% tariff on select inputs may not even be noticeable when it comes to Apple. A 25% tariff would be more difficult to offset.

Apple would have received only a glancing blow if 25% tariffs were placed on Apple Watch, AirPods, and HomePod. As it stands now, it’s more appropriate to say that Apple will face minimal exposure to tariffs.

Sonos Earnings

Last week, Sonos reported its first earnings report as a public company. If this report was a sign of things to come, Sonos should prepare for a rocky road ahead. Here’s a snippet from the company’s earnings letter:

“We sold 886,514 products, representing 11.4% growth year over year, and generated $208.4 million in revenue. Despite the double-digit percentage increase in products sold, revenue declined 6.6% compared to Q3 of FY2017. This dynamic between year-over-year product unit growth and year-over-year revenue decline can be caused by our new product launches and/or product mix. When we launch a new product, two things happen that can impact quarterly comparability: 1) initial new product channel fill can create higher revenue levels relative to a typical quarter; and, 2) although channels are typically filled two to six weeks before general availability, revenue is not recognized until the date of general availability, which can push revenue resulting from channel fill into one quarter, thus accentuating new product launch impact.

In Q3 FY2018, the largest driver impacting our year-over-year revenue decline was the Q3 FY2017 launch of our PLAYBASE product. PLAYBASE revenue was approximately $18 million lower in Q3 FY2018 than Q3 FY2017, the quarter in which PLAYBASE launched.

In addition to the product launch dynamics discussed above, overall product mix also impacted quarterly comparability. Our Q3 FY2018 product unit growth was driven by a 25% increase in wireless speaker products sold, and primarily by the Sonos One, a product launched in Q1 FY2018 which carries a $199 U.S. manufacturer’s suggested retail price (U.S. MSRP). The decreasing share of the $699 U.S. MSRP PLAYBASE and increasing share of Sonos One further explains the difference between quarterly product unit growth and the decline in revenue, compared to Q3 FY2017.”

There was nothing too shocking or surprising found in this earnings report. Sonos was able to report year-over-year unit sales growth by selling lower-priced speakers.

Speaker Unit Sales

2013: 1.5M
2014: 2.9M (99% growth) – growth driven by Playbar and Play:1
2015: 3.4M (16% growth)
2016: 3.5M (3% growth)
2017: 3.9M (12% growth)
9M18: 4.0M (25% growth) - includes the 2017 holiday season

Revenue

2013: $442M
2014: $775M (75% growth) – growth driven by Playbar and Play:1
2015: $844M (9% growth)
2016: $901M (7% growth)
2017: $993M (10% growth)
9M18: $864M (11% growth) - includes the 2017 holiday season

Management commentary regarding business conditions was on the light side with not much in the way of additional details regarding how its newest products, the Beam and Amp, are performing in the marketplace.

As for why Sonos shares are down 35% over the past week, there probably wasn’t any one particular data point from the earnings report that led to the drop. While the year-over-year revenue decline may have spooked some people, management’s explanation for the decline was logical. Backing out the impact from product launches associated with the PlayBase, revenue would have been closer to flat year-over-year. Meanwhile, management’s FY18 guidance implies 15% revenue growth in FY4Q18 (July to September) with speaker sales landing somewhere around 900,000 to a million units. For comparison purposes, Apple sold somewhere around 600,000 and 700,000 HomePods last quarter.

Instead, Sonos may be suffering from an overall lack of enthusiasm. There just isn’t a compelling financial narrative here. It’s clear that Sonos isn’t even going to be like Fitbit in terms of having a few years of easy growth before trouble appears. Instead, Sonos management had to explain away a year-over-year decline in revenue on the company’s first earnings report as a public company.

At this point, attention has already moved to the very important holiday quarter. The consumer is strong, while the user base of people with stationary speakers in the home has never been larger. However, those tailwinds are being offset by an increasing number of questions regarding speaker usage trends and the competitive landscape. This should make for an interesting buying season in terms of stationary smart speakers in the home.

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