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July 21, 2006

Some More Thoughts on Apple

My friend Jeff Bagley did his usual great job covering the Apple Computer (AAPL) earnings release and conference call. I fully endorse his bullish view but since I've written extensively on AAPL, I wanted to offer a few observations of my own.

As I have been saying for some time, I think the key to the quarter and the outlook is Mac sales. And the news from the June quarter is very good. MacBook unit volume was 798,000, a 61% increase vs. a year ago. There was plenty of anecdotal evidence that laptop sales were strong but this is really a good figure. I think it is 100,000 or more units ahead of some analyst estimates. The momentum appears very good and the next two quarters will show similarly huge increases. To put the 798,000 in perspective, in the seasonal strong September and December quarters of 2005, AAPL averaged about 600,000 laptop sales.

Despite the huge increase in laptops, overall Mac units were up only 12% because desktops down 23% from 2005. It still isn’t clear when the new Intel desktops for the professional market will ship but I think the huge jump in laptop sales last quarter bodes very well for the quarters after the desktops finally ship. So if you believe that MacBook momentum will be sustained for at least several more quarters, overall Mac growth will get a huge boost when the new professional desktops ship. This should give some comfort to the 2007 growth profile.

As for iPods, there was clearly relief when the unit figure came in at 8.1 million.....

I suspect that iPods got a boost from MacBook sales, as at least for college students, there was a buy a MacBook, get a free nano promotion. ASPs were flat vs. a year ago, so this promotion doesn’t look like it was too damaging and it was probably a good way to clear inventory ahead of the update to the nano line that is due anytime.

Looking ahead, in the September 2005 quarter, iPod shipments were 6.5 million, so the product line should show continued growth if shipment and demand levels just hold steady. Even without a refresh, that seems plausible given back-to-school demand. Things get much tougher in the December quarter, however, since AAPL shipped 14 million units a year ago. I suspect the next scare for AAPL shares will come when analysts begin to point out the possibility of no growth or negative growth for iPods in the December quarter.

Two other issues that created a problem in the second quarter looked a lot better last quarter. First, much concern was expressed 90 days ago when units and revenues at the company's retail stores saw growth of just 7% and 11%, respectively. In the September quarter, growth returned as units rose 50% and revenues climbed 29%. Similarly, last quarter's quarters slow growth rate in Japan reversed, as revenue growth accelerated to a year over year gain of 14% vs. just 8% in the March quarter.

Accessory growth remains on fire, up 90% year over year. This remains an underappreciated part of the Apple story and likely provides a nice boost to margins that is less dependent on volatile component pricing.

Lastly, software, another high margin business is set to contribute to the next couple of quarters. In the June quarter, software sales were down 9%. In 2005, I believe that the last big upgrade to the Mac operating system came in the June quarter so it was a tough comparison. That upgrade is due in the current quarter, so look for a big acceleration in software for the next few quarters. Sequential growth in software upon the introduction of the last OS was over 40%.

Put it all together and yesterday's big gains in AAPL are totally justified. I think the coast is clear for more gains as MacBooks continue to gain market share, new professional desktops are introduced, the operating system upgrade is launched, and the iPod line is upgraded for the first time in a year. All that should power the shares for the next several months. And as Jeff points out, AAPL has plenty of room to gain market share and expand its share of the consumer electronics wallet, so the multiyear growth story remains completely intact.

Posted by Steve Birenberg at July 21, 2006 10:41 AM in AAPL