Despite the sharp advance in Apple (AAPL) shares over the past week, I think the setup is favorable heading into the company’s earnings report after the close on Wednesday. I expect better than expected Mac sales, solid results in iPods, and March quarter guidance no worse than the cautious commentary everyone is expecting. If I am correct, I think the shares can avoid a sell the news reaction and sprint to new highs across the $100 barrier.
Strong Mac sales have been key to my bullish stance on Apple for the past year. One Mac equals seven iPods at a higher margin so continued share gains for Macs really drives APPL’s income statement. I expect December quarter sales to exceed estimates which call for 1.6 to 1.8 million units and flats ASPs. Stronger than expected Mac performance will support recent gains in the shares and leave the iPhone introduction as truly additive. Within the Mac line look for notebooks to be especially strong, potentially producing Apple’s first ever quarter with over 1 million units. Desktop units are likely to be flat with the uptick awaiting the June quarter introduction of Adobe’s new Creative Suite to drive an upgrade cycle for professionals….

iPods face a tough comparison vs. the astounding 14 million unit quarter a year ago which was boosted by an extra week and an unusual 10% sequential jump in ASPs. After some mid-year worry about iPod demand, it appears sales were very healthy this holiday season and many recent estimates call for 17 million units. Anything at 15.5 million or greater is probably good enough. The bigger question for iPods surrounds ASPs. Most estimates range from $155 to $170 per unit, down sharply from $208 a year ago and $179 last quarter. The culprit is a heavy mix shift in favor of the $79 shuffle, which appears to have been a huge seller during the holidays. With units up 20-30% and ASPs down 20-25%, it is possible that iPod revenue could actually be down year-over-year. This would come as a shock to some investors and could emerge as a key negative talking point following the earnings. On the flip side, although management does not breakout margins by product line, it is my belief that the shuffle is the highest margin product in the iPod family.
Modest growth in other music, peripherals and other hardware, and software will support EPS growth but aren’t expected to provide a positive or negative surprise. These line items are expected to contribute about 20% of quarterly revenue. Software is expected to provide a big boost to the June quarter when the latest version of the Mac operating system, Leopard, becomes available.
Consensus estimates for the December quarter call for revenues of $6.42 billion and EPS of 78 cents. Both estimates are well above APPL’s normally conservative guidance. Hitting guidance would be very bad news for APPL shares. In fact, a little bit of upside to consensus is probably expected. Most analysts feel AAPL is being especially conservative in its gross margin guidance and are assuming a mix shift toward Macs will boost operating income.
APPL usually provides guidance for the next quarter. Presently, analyst estimates
are $5.22 billion for revenue and 60 cents for EPS, representing gains of 10% and 25%, respectively. Lack of new product introductions in the quarter are holding back the gains and the possibility of a pause in video iPods ahead of the iPhone introduction in June is plausible. I believe that cautious commentary on the March or June quarters is the biggest risk to APPL shares coming off the report.
Investors may also hope to hear something on the options scandal or new products. I think they will be disappointed. However, I do think that the possibility of exciting new iPod products for next holiday season exists. Imagine an iPhone without the phone as the true video iPod. Make it a 30GB or 60GB machine and you have a full video iPod with a touchscreen interface and wifi for internet connectivity including web mail and text messaging. Throw in photos, contacts, and a calendar and you have a product that would witness huge demand. If the Cingular deal prevents all that functionality, just a new touchscreen true video iPod would still be immensely popular.
Finally, there will likely be comments on the iPhone, specifically addressing the many questions raised about functionality, battery life, and additional versions of the product. I am not sure if APPL will comment but some indication about the product path, especially the integration of 3G wireless technology, would be well received by the investment community.