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July 24, 2007

Apple 3Q07 Earnings Preview

My friend and Real Money colleague, Bob Faulkner, is handling the Apple conference call for the website this quarter. Bob specializes in technology so his input is especially interesting. I'll be listening to the call as well.

In the "Continue Reading" section I have reporduced Bob's preview. I generally agree with him across the board. Beyond what Bob has mentioned, key things to watch are Mac and iPod unit sales and ASPs and comments surrounding margins and memory pricing. Estimates for Mac sales are around 1.6 million units while iPod estimates have been drifting lower to 9.0 to 9.5 million. On margins, expect cautious commentary toward 4Q due to the recent increases in memory pricing. I think this area represents the greatest risk to Apple shares in the near-term.

Here is Bob's preview....

APPL will be reporting FQ3 results after the close tomorrow night with a conference call at 5:00 PM EDT. The expectations are high and there will be more eyes focused upon these results then the new Harry Potter book. Current consensus is for revenue of $5.28B (+21% YY; flat QQ) and EPS of $0.72.

In the prior quarter, the company reported revenue of $5.26B (+21% YY; -26% QQ) and EPS of $0.87. GM was 35.1% up 530 bps YY and 410 bps QQ primarily the result of low component pricing, product mix, lower services cost and leverage. OM was 18.7% an increase of 660 bps from last year and essentially flat sequentially. Cash from operations was a very solid $700M versus cash used in the year ago period. Total cash and equivalents increased about $700M to $12.6B. A/R declined about $700M dropping DSOs to an amazingly low 16 days (-5 days). Inventory fell $100M putting DOI at 5 days, down one day from FQ2.

The driver for the top-line last quarter was essentially the notebook business with revenue up 82% and units up 79% versus the year ago period. While iPod units were strong (+24% YY), revenue actually declined 2% YY on lower pricing.

Guidance for FQ3 was for revenue of about $5.1 billion with GM of about 32% (increasing component prices). Opex should be about $915 (including iPhone launch expenses) with other income of about $150 million and a 32% tax rate. This translated into EP of approximately $0.66.

Some people (myself included as you can see from the put position below) expected a sell-off in AAPL’s stock following the introduction of the iPhone. Obviously that didn’t happen and it has continued to ratchet higher fueled in part by four “target price” increases in the month of July alone. Add to that various stories about market share gains for Macs in the quarter, difficulty meeting demand for the new LED-lit notebooks and record sales at retail stores.

All that plus the iPhone too, this quarter is going to be a BOOMER, isn’t it? Well, yes, no and maybe. APPL will easily surpass it’s own guidance since its guidance is usually low-balled. But how high is up?

The iPhone sales will be tricky for a number of reasons. First and foremost is the subscription accounting. The company will recognize revenue from these products over 24 months, not all in the quarter of sale. While that is well understood by the street, I can’t say that it is by the investing public. A possible partial offset of this issue is how many were sold? There have been a wide variety of estimates of what went out the door in those last two days of June but from APPL’s perspective, that’s not the point. Products that were sold by AT&T well into the following week were likely shipped to the carrier before the close of the quarter so the actual number of units “sold” could be higher than many expect.

Certainly the last big issue will be the impact on iPod sales. Yes, there probably was cannibalization by the iPhone but it’s not a perfect world. Anyone expecting otherwise is probably living in a fantasy world. What’s more important is that the profitability on the iPhone will eclipse the iPod but without damaging the iTunes revenue stream. That works for me.

In reality, I’m not certain it matters what AAPL reports as long as it’s above their own estimates. There is so much enthusiasm for the stock right now given the potential for the iPhone and its various relatives that any attempt to take the stock down will be met solidly by dip-buyers who thought they’d missed out on this name.

Posted by Steve Birenberg at July 24, 2007 10:50 AM in AAPL