There's More To Apple Than The iPhone (AAPL)

By Hans Wagner | July 31, 2007 AAA

Last week, Apple Inc. (Nasdaq: AAPL) reported outstanding results by substantially beating expectations. Apple recorded revenues of $5.41 billion compared to $4.37 billion last year. Net quarterly profit was $818 million, or $0.92 per diluted share vs. $472 million or $0.54 per diluted share in the same quarter last year. Also, international sales accounted for 40% of the quarter's revenue. But you may be surprised to learn that it was sales of the Mac computer that drove these excellent results - not the hot new iPhone.

Mac is the Profit Driver
Surprising everyone, Apple shipped 1,764,000 Macintosh® computers, representing 33% growth over the year-ago quarter and up 16% sequentially from the prior quarter. Not as surprising, notebooks are driving the growth in Mac sales, up 27% on a unit basis sequentially from the prior quarter and 42% on a unit basis year over year.

The growth rate in the U.S. for Macs was four times the rate forecast by Interactive Data Corporation (NYSE: IDC) and 2.5 times the published growth rate worldwide. Maybe the IDC researchers should go visit a couple of Apple stores to see the activity there.

Revenues from Mac sales were obviously up, but by a smaller percentage than on a unit basis due to lower average selling prices (ASP) for portables. This difference in ASPs is due to product mix and promotions for the education market.

Further, Apple's gross margin rose to 36.9%, up from 30.3% in the same quarter last year. Note that this margin figure is for all of Apple's sales, as the company does not break out gross margins for product lines. Much of this increase in margin is due to very favorable commodity prices for components and slightly higher direct sales through Apple.com. (To learn more, read The Bottom Line On Margins.)

The back-to-school season will feature special Mac promotions that will lower ASPs even more. Apple has done a good job of capturing customers while in school and they continue to purchase Mac computers in the future. These promotions are considered good business for the long term, even if they lead to a lower ASP for the quarter.

Mac sales continue to be the most important driver of financial results for Apple, while the iPod and the iPhone businesses receive most of the popular interest. This interest is helping to guide customers to the Mac computers. Interestingly enough, many customers buying Macs in Apple stores are new to the Mac.

iPods Continue to Sell
The company also sold 9,815,000 iPods during the quarter, representing 21% growth over the same quarter of last year. So far, it looks like the iPod continues to perform well as sales grow year over year. Some analysts expressed concern that the iPhone would cannibalize iPod sales, but so far that doesn't seem to be the case. I suspect the large price difference is the primary reason for this.

In addition, iTunes became the third largest music retailer, surpassing Amazon.com, Inc (Nasdaq: AMZN) and Target Corporation (NYSE: TGT). I expect that the iPod should continue to be an important business segment for Apple as it continues to grow its music and video business.

Then There's the iPhone
The iPhone is one of the most talked about new products in many years. There was much speculation about how the phone would perform and that AT&T (NYSE: T), the only carrier selling the phone, and Apple would sell 500,000 phones in the first weekend it was available.

As it turned out, 270,000 iPhones were sold in the 30-hour period before the quarter ended. That is much more than sales of any other new phone in the first 30 days of sales. In addition, the company expects that it will have sold 1 million phones by the end of the fourth quarter 2007. For comparison's sake, it took seven quarters to sell 1 million iPods. Furthermore, the company still expects to sell 10 million iPhones by the end of 2008.

Starting in the fourth quarter of 2007, Apple will begin selling the iPhone in several countries in Europe. So far, the company has not settled on a carrier, although it is likely to be one of the large carriers in Europe, such as the United Kingdom's Vodafone Group (NYSE: VOD), Spain's Telefonica S.A. (NYSE: TEF) or Germany's T-Mobile, because they each cover most of Europe. In 2008, Apple will introduce the iPhone to Asia.

Investors should be aware that Apple is using the subscription plan for sales of the iPhone, meaning it will spread out the revenue from each sale over a 24-month period. This deferred revenue will show up in Apple's deferred accounts.

The Bottom Line
Apple continues to develop its three business segments: Macs, iPods and the iPhone. The Mac is still the main driver of business revenues, margins and profits, but the iPhone has great potential to be a significant contributor to Apple's financial success. The only problem is the hype that surrounds the iPhone. It is possible that the phone's impact will increase quickly, but not as quickly as many have been saying. For the long term, Apple should continue to beat the market.

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