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October 19, 2006

Apple Reports Another Great Quarter

Apple Computer (AAPL) reported another excellent quarter. There is absolutely no reason that anyone who was bullish prior to the quarter should change their opinion. And there is reason to believe bears might have to rethink their position. Estimates will rise by about the same 5% increase in the stock price after hours so the stock is no more expensive that it was prior to the report.

The quarter was very strong at 62 cents on revenues of $4.84 billion. Consensus was 51 cents on $4.64 billion in revenues. An unusually low tax rate helped significantly by a one-time credit helped EPS by about 4 cents but even at 58 cents it was a superb quarter from an earnings standpoint.

Revenue upside came from better than expected unit sales of Macs and iPods. For Macs, notebooks were the star at almost 1 million units. I found the ASP to be quite good as well. I had modeled it down by a $100-200 after watching the new Macbooks priced at $1099 fly out the door. I guess they sold plenty of black ones and MacBook Pros which sell at premium prices.. Desktops were actually not bad at up 4% considering the massive shift industrywide in favor of laptops. Desktops should pick up next Spring when Adobe releases new software that runs native on the Intel Macs.

iPods also were better than expected as unit sales of 8.7 million exceeded management guidance and were ahead of recent downwardly revised estimates. The $10 ASP decline was more or less expected. On the call, management characterized demand for the new nanos as “excellent” and said that there was a noticeable pickup in demand after the new nanos were announced.....

Gross margins of 29.2% beat guidance by about 100 basis points and were generally in line with analyst estimates. Some analysts were at 30%. Any variance was likely explained by component pricing and product mix.

Operating margins were superb as operating expense growth was flat sequentially against a 10% sequential increase in sales. This fact along with the revenue upside explains the EPS surprise.

Guidance of $6 to $6.2 billion in revenue and 70-73 cents was slightly below consensus as usual. When the media reports that AAPL lowered guidance what they are really saying is that guidance is below consensus as there was no prior 1Q07 guidance. This news as is as expected and not any worse as some analysts recently had worried. Commentary related to unit shipments, gross margins, and operating expenses for next quarter was constructive.

Let’s say AAPL is at mid-point of their revenue guidance. That would mean that revenues grow $1.3 billion sequentially. Last year, the company shipped 14 million iPods. That figure was boosted by 1 to 1.5 million by a 14th week against just 13 this year. Let’s say that this year we get 15.7 million units, or a sequential gain of 7 million units. Management cautioned that ASPs will come down in 4Q. Let’s call it $170 or down 10% year over year. 7 million incremental iPods at $170 is $1.1 billion in revenue.

If that is the case then revenue growth from Macs and all else needs to be only $200 million to meet guidance. That should be a layup. On the call, management noted that seasonality and the non-recurrence of an inventory drawdown should lead to an uptick in Other Music sales which is the iTunes Music Store and accessories. Year over year growth was 70% on this line in the just completed quarter. Last Christmas was when this segment really ramped so let’s call it a 20% year over year gain this year and you got another $100 million in incremental revenue.

That leaves Macs needing to be up just $100 million to meet the midpoint of revenue guidance. Last year, sequential growth in Mac revenue was 7% or $100 million. Mac revenues in the September quarter were $2.2 billion. Leaving aside the fact that we just completed the highest unit quarter for AAPL in 6 years and that the company is clearly gaining significant market share and that seasonality provides a tailwind, Mac revenues need a sequential gain of just 5% to meet guidance if my prior assumptions are correct. That seems awfully conservative given that MacBooks will be a hot Christmas item.

So the bottom line is that guidance appears conservative unless there is a sudden shortfall in Mac or iPod demand. It seems unfathomable that Macs will fall short so that leaves iPods. I guess it is possible that there is a miss as Zune will be out there and music phones are gaining popularity. But even if there is a 1 million unit shortfall, that is made up by just 125,000 extra Mac units. I think that is likely, probably conservative.

I know that AAPL has to beat the number again next quarter to drive the stock but hopefully this analysis shows that is likely. And if next quarter comes through, the story seems clean for calendar 2007 as the press release quoted Steve Jobs as saying it will be “one of the most exciting new product years in Apple’s history.” Hmmmm.

I am staying long and still expect the shares to make a new all-time high by Christmas.

Posted by Steve Birenberg at October 19, 2006 03:24 PM in AAPL