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October 19, 2006

Follow-Up Comments On Apple

I have a few follow-up comments to my earnings call coverage of Apple Computer (AAPL). First, analyst commentary fell along the lines I expected. Estimates are going up, bullish analysts are reiterating their recommendations, and cautious analysts remain worried about valuation. So far I don’t see any upgrades or downgrades. Second, analysts are saying that the lower tax rate added 6 cents. My analysis indicated 4 cents. I assumed a slightly lower 30% tax rate was expected while analysts were at 32 cents.

My earnings commentary was lengthy so I left a few things out....

I did initially find some questions beyond the tax rate when I plugged the numbers into my spreadsheet. Both inventories and accounts receivable seemed a little too high relative to the last couple of years. The ratios weren’t bad, just elevated. This came up on the call and management stated very firmly that channel inventories are a little low for Macs and right on target for iPods. The increased inventory was attributed to 41 new Apple Stores plus a desire to meet excellent demand and not let shipping times get stretched out. Comments on receivables were limited but the CFO said they were in line with his expectations.

Also on the balance sheet, I noticed a large increase in other current assets. This did not come up on the call. This line has been rising rapidly but the increase was unusually sequentially at least compared to a year ago. I’ll try to follow-up on this with the company. Payables were also up sharply, likely reflecting the receivables increase. Management noted that they felt working capital management was a strength in the quarter and were proud of the cash flow generation.

The Other Music line which reflects iTunes sales, Apple branded accessories, and accessory licenses was flat sequentially. Since more than doubling in the December 2006 quarter, this revenue line has stalled on absolute basis (although it was still up 70% yoy). In response to a question, management indicated that iTunes sales are seasonally weak in the September quarter due to lower PC use in the summer and a weak album release schedule. Additionally, accessory inventories were reduced ahead of the introduction of the new nanos and shuffle. Sequential growth should reappear in the current quarter.

iPod market share in the UK, Canada, Japan, and Australia is 40-50% according to management. In France, German, Italy, and Spain, the company said its market share has grown by 6-7 points. These markets are important as there is some evidence of maturity in the US market where iPod penetration is highest and AAPL has a market share of 75%.

The Mac distribution test with Best Buy appears successful as it will be expanded form 7 stores to 50 stores. There is also a test under way with Circuit City but it is just getting started in a few stores. My sense is that management is willing to look a more favorably on distribution outside of internal efforts.

Management provided no numbers but the new shuffle will ship before the end of the month and I sense expectations are very high for this time. It is a sexy little package and buzz is good. At under $100, it will be a very strong holiday item. Also, it makes a great second iPod for all the heavy users out there who want something new but don’t want to drop several hundred bucks. Could unit shipments of shuffles reach 5 million or more all by themselves this quarter?

Finally, as usual, management provided no insight to the new product questions which were heightened by Jobs press release comments. They did say that they are “very confident” in the product pipeline.

Hopefully, I can join in others in reducing my obsession with all things Apple until the Christmas selling season begins in earnest. Until that time, the outlook remains very bullish.

Posted by Steve Birenberg at October 19, 2006 03:26 PM in AAPL