Apple's (NASDAQ:AAPL) iPhone 8 and 8 Plus will ship next week, but the flagship iPhone X won't see the light of day until Nov. 3. That's disappointing news for consumers and investors alike, as a lot is riding on the 10th-generation iPhone, which includes game-changing 3D-sensing capabilities and Apple's first adoption of an OLED display in an iPhone.
Finisar (NASDAQ:FNSR) and Lumentum Holdings (NASDAQ:LITE) are expected to be the two primary suppliers of vertical-cavity surface-emitting laser (VCSEL) sensors that facilitate the iPhone X's 3D sensing. Investors have been seeing clues from both companies for months. Could one of them be responsible for the hold up?
Finisar is probably the bottleneck
Just last week, Finisar reported fiscal Q1 earnings, and conceded that it was facing manufacturing delays related to VCSEL production. On the call, CEO Jerry Rawls said, "While we continue to make progress with our high-power VCSEL array program, the timing of our production ramp has been delayed due to a change we needed to make in our manufacturing process."
Clearly, if one of Apple's primary suppliers for one of iPhone X's headline selling features is running into a hiccup with component production, the timeline could slip and the launch could be at risk. Perhaps Apple could have moved forward with the launch with just one supplier (Lumentum) ready for higher levels of production, but the optics there would be terrible -- far worse than a delayed launch.
iPhone launches are frequently plagued by supply constraints, and Apple used to brag about launch volumes, but moving forward with the original timeline could have resulted in extreme customer frustration if Apple quoted extended shipping times right out of the gate after fulfilling a minimal number of orders. Worse yet, waiting for days in line for the latest and greatest iPhone has become a cultural phenomenon, and you don't want to send most of those customers home empty-handed, wasting their time. Imagine the headlines!
There's really no good solution here.
The timeline could also explain Apple's bullish outlook
Meanwhile, I've been trying to reconcile Apple's guidance with the iPhone X launch timeline. The Mac maker's fiscal Q4 guidance had suggested that the iPhone X might ship on time, calling for revenue of $49 billion to $52 billion. That high end would represent an all-time revenue record for the September quarter. But now, that outlook appears to be at risk if only the iPhone 8 and 8 Plus, whose updates are rather incremental, are available before Apple closes the books for fiscal 2017 at the end of this month.
But let's look at the chronological timeline. A lot has changed in just a few months.
- June 15: Finisar reports fiscal Q4 earnings, and says that it has "made really good progress with our high-powered VCSEL array program." Perhaps more importantly, Finisar expects to "soon receive customer approval for -- to ship meaningful volumes in our second fiscal quarter." Finisar's fiscal Q2 is from August to October.
- Aug. 1: Apple reports fiscal Q3 earnings and provides revenue guidance of $49 billion to $52 billion.
- Aug. 12: Lumentum reports fiscal Q4 earnings, says that it has received $200 million worth of 3D sensing orders (only $5 million was recognized during that quarter), and notes that it "accelerated our 3D sensing ramp immediately after receiving customer approval for production readiness early in the fourth quarter." It appears that Lumentum is good to go on volume production.
At this point, it looks as if two of the most important 3D-sensing suppliers are ready to roll with VCSEL production ahead of a blockbuster iPhone X launch. This could be why Apple's guidance was so strong. And then, the aforementioned curve ball from just last week:
- Sept. 7: Finisar reports fiscal Q1 earnings, and offers soft outlook for the fiscal Q2 that it was previously so optimistic about (i.e., "meaningful volumes"). Rawls says, "Therefore, while we do expect to receive customer approval to ship production units in the second quarter, we only expect to achieve a relatively low level of revenue in the quarter. We expect to start shipping much larger quantities in the fiscal third quarter." Finisar's fiscal Q3 is from November to January.
So much for "meaningful volumes." We're now talking about just a "relatively low level" of VCSEL revenue in fiscal Q2, when the iPhone X was presumably supposed to launch. Rawls notes (emphasis added):
Well, I can't give you much detail about the exact process change and the documentation that goes with that. But suffice to say, that change required a delay in the customer approval for the production quantities. I mean, we have shipped thousands, maybe hundreds of thousands of units so far. But production units are millions of units. And so we haven't hit that level yet. So that production, I mean, that approval we think will come this quarter, in our second quarter. And we will ship, well, I don't know, a few million dollars' worth and probably in this quarter.
Put another way: As of just last week, nearly halfway through Finisar's fiscal Q2, Apple still had not approved Finisar for production. Whereas in June, Finisar thought production approval was imminent, so that it could start shipping in fiscal Q2.
So the real question for investors is whether or not Apple was aware of these delays when it issued guidance on Aug. 1. If Apple was aware of the delays, then its forecast is predicated on iPhone 8 and 8 Plus selling extremely well (combined with the price increases) to hit its forecast. If Apple was not aware of the delays on Aug. 1, then its forecast could have been relying on a timely iPhone X launch that at this point won't occur until November -- pushing the launch into Apple's fiscal Q1.
This latter scenario appears to be the case: Apple was apparently caught off guard by Finisar's delays. Perhaps Apple investors should go ahead and start bracing now for a revenue miss when Apple reports fiscal Q4 earnings next month. Thanks, Finisar!