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Thursday, April 24, 2008

Did anything change at Apple?

Apple beat revenues by a wide margin and guided next quarter's revenues to in-line with the street. They had a gross margin miss relative to the consensus but not their guidance. The main drivers of the story are unchanged -- Mac market share gains and the 3G iPhone shipping in June.

The margin "miss" in the current quarter was driven by much lower sequential sales in operating systems -- 170mm in Leopard revenue last quarter became 40mm this quarter. Honestly, I'm amazed they get away with that. If I were a Mac user, I'd be so angry that I had to buy an annual software update. But they get away with it.

I also believe that Apple did not buy much NAND in the March quarter and iPods sold reflected earlier and higher component prices. NAND prices were lower than the prior quarter but not low relative to current NAND pricing. Apple's tepid margin guidance may reflect a larger storage iPod refresh coming that will offset the component cost declines they're enjoying due to lowered NAND prices. NAND pricing has gotten even more favorable for them and iPods are stagnant. As iPods have become so ubiquitous among consumers, the line is dependent on increased features to drive replacements and new units. iPods have fixed pricing and Apple wants to hold pricing if at all possible. It is likely they will double storage in the next refresh of the line -- they already did it at the high end of the NAND portfolio (the iTouch and iPhone). It's not hard to see it coming in the Nano too. This could explain the weaker margin guidance relative to models. iPods represent a decent chunk of revenue -- 10.6 mil at an average selling price of $171 gets you to 1.8 bil (24%) of 7.5 bil total. If they choose not to refresh the iPod line, they'll likely start to show declining iPod revenue... and no one wants to see that.

Apple gets substantial kickbacks from AT&T for the iPhone and analysts were excited about the deferred revenue component. This will help bolster gross margins as the iPhone base builds -- it flows through over the life of contracts and is essentially pure profit. iPhones have a high cost up front for Apple in that they recognize all the cost of goods on the sale of the phone but they reap the benefits of that sale for 2 years afterward. In theory, they could sell the hardware at a loss and still recoup the phone's cost over the life of the AT&T contract. Obviously, it's better if they make money on both ends, which they do... they just make a better margin on the back-end.

This quarter may be a little dicey as the 3G iPhone won't ship until June, the enterprise connects to Microsoft Exchange won't ship till June, the iPod refresh won't happen until... well, who knows... and the Macbook enthusiasm likely fades somewhat as the ubergeeks already got theirs. However, September and December should be gangbusters.

I think you have to buy Apple on weakness. None of the main drivers are different or gone.

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