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July 18, 2006

Some Thoughts Ahead of Apple's Earnings

I wrote the following before my Barron's showed up on Saturday with a bullish cover story on Apple Computer (AAPL). Barron's has previously written negatively on AAPL so it shouldn't come as a surprise that AAPL shares have firmed up this week. The story is consistent with what I have been writing about AAPL.

I'll have more comments about AAPL after the company reports earnings Wednesday after the close. The comments below provide some perspective on what to expect and how the shares might react.

In a note from last Friday, UBS discussed whether the steady and large decline in AAPL shares discounts slower iPod growth, the options backdating controversy, and delays in shipments of new versions of the iPods. UBS and most other analysts acknowledge that Macs are selling very well, ahead of estimates entering the soon to be reported 3Q. The bullish theory would be that if the shares are discounting the known weaknesses then a relief rally could occur after AAPL reports next Wednesday afternoon.....

UBS noted one thing that might work against the relief rally: current estimates for 4Q ending September seem likely to be well above guidance the company will provide on its conference call. Right now, consensus calls for a 12% sequential gain in revenues and with just a few cent uptick in EPS. UBS thinks that AAPL is likely to guide for flat to up revenues especially if long rumored delays in the introduction of new iPods are confirmed. In 2005, APPL guided for flat sequential growth in the September quarter and then came throughh with growth of over 4.5%.

The flip side of the lower 3Q revenue due to new iPod delays is that new iPods will ship mostly in the December quarter which is 1Q07 for AAPL.

So the question becomes, has the market gotten ahead of analyst estimates and already discounted guidance that will probably be below consensus? Bulls also have to hope that commentary from management and analysts supports a strong December quarter with likely spillover into the March quarter.

I remain long AAPL anticipating better than expected Mac sales in the September and December to be the driver of the shares. I also think the upgrade to the Mac operating system due in August will help drive results, especially profits, as software carries very high margins. Finally, iPods could again become a positive catalyst if new models are shipped in plenty of time for the holiday season.

I’ve been wrong to hold AAPL so far this year but I do not plan to throw in the towel when I believe that sentiment is overly negative relative to the fundamentals I expect over the next several quarters.

Posted by Steve Birenberg at July 18, 2006 01:44 PM in AAPL