Apple looks good to the core – Mac sales surge, and iPhone is just fine

Editor’s note: Ezra Gottheil is an analyst with Computer Business Quarterly and Technology Business Research in Hampton, N.H.

Apple had another excellent quarter.

Despite the fact that iPhone sales did not contribute significantly to the quarter’s performance, Apple (Nasdaq: AAPL) recorded the second-highest operating income, $1.39 billion, in company history, exceeded only by the holiday fourth quarter of calendar year 2007. Revenue was up 38% from 2Q07, the largest rate of year-to-year growth since 2005.

Macs led Apple’s continuing success, and while iPod growth has slowed, the media players contributed 22% of Apple revenue, and TBR believes they are very profitable devices for Apple. iPhone sales were down in 2Q08 because of the anticipation of the iPhone 3G, which did not arrive until early in 3Q08. It is clear, however, that the iPhone continues to be a spectacular success for Apple.

The big story is the rapid growth of the Mac.

Apple set new records for total PC and notebook revenues and unit sales. Year-to-year revenue growth exceeded 40% for both notebooks and desktops, the fourth consecutive quarter of 40%+ growth for notebooks and the third consecutive quarter for desktops. Year-to-year Mac unit growth exceeded 26% in every geographic region, and was more than 50% in Asia-Pacific for the sixth consecutive quarter. Apple’s retail stores continue to drive Mac sales, with 44% year-to-year growth in unit sales, with more than one-half of the 476,000 Macs sold in retail stores going to customers who did not own an Apple PC. TBR believes Apple’s retail infrastructure supports not only growth but also prices, as Apple continues to sustain increases in ASP. ASPs for PCs rose only 0.7% over 2Q07, to $1,446, but this is the tenth consecutive quarter of ASP increases. TBR believes customers consider the availability of support in the retail stores to be part of the Apple package that justifies higher prices.

Apple said the magic words, “product transition.”

In explaining how the company expects to bring down its gross margin from 34.8% in 2Q08 to a projected 31.5% in 3Q08, Apple CFO Peter Oppenheimer mentioned an upcoming product transition. “Product transition” is Apple-speak for cool new stuff. TBR believes Apple will refresh its notebooks with the latest Intel Centrino 2 processors, which will improve performance and increase battery life. We think the company will do more than update internals, however. In addition to a redesign, TBR believes Apple will add TV tuners and may introduce a larger screen MacBook. Currently the only Apple notebooks with screens larger than 13 inches are MacBook Pros, starting at $1999. To maintain the necessary product differentiation, Apple will probably use quad-core processors for the new MacBook Pros. iMac desktop PCs are not likely to get a dramatic overhaul, but Apple will probably beef them up.

The iPhone is doing, fine, thank you.

Because of the anticipated transition to the iPhone 3G in early July, Apple not only emptied inventories of the original iPhone in 2Q08, it failed to recognize revenue from iPhones sold after the iPhone 3G announcement in March, waiting for the full complement of new software delivered with the 3G. iPhone sales and revenues obviously slumped in 2Q08, during which Apple sold 717,000 units and recognized $419 million in revenue, all from iPhones sold prior to 2Q08. The sale of one million of the new iPhone 3Q within three days early in 3Q08, and the rapid expansion of the iPhone market to seventy countries by the end of the year, make it clear to TBR that Apple will easily outstrip its projection of 10 million iPhones to be sold during CY 2008. Because the revenue from iPhone sales is spread over the 2-year expected life of the phone, Apple will be recognizing increasing significant revenues from all its iPhone sales, which have totaled 6.1 million units from 2Q07 through 2Q08.

TBR believes Apple will continue to thrive.

There are very few clouds on Apple’s horizon. Macs are increasingly accepted as strong alternatives to Windows-based PCs, and market share is growing worldwide. The iPod has largely saturated its market, and will not continue to grow, but Apple still dominates media players. And the iPhone has gone from success to great success. While the company’s growth may be slowed by economic conditions, TBR believes it will retain and grow its strong and profitable positions in PCs, media players and wireless handsets.