Overheard at the Q309 Apple Earnings Report

| Analysis

Apple never talks about unannounced products and keeps a lot of sales info closely held for competitive reasons. Even so, CFO Peter Oppenheimer and COO Tim Cook still made some interesting remarks during Tuesday's earnings report that provide some insight into the state of Apple.

A lot of investors ask Apple about how the conventional iPod sales are doing, especially in light of the top of the line iPod touch and iPhone. There was a time when Apple wasn't sure what the cannibalization rate was, but now they definitely forsee the demise of the dedicated music player.

Peter Oppenheimer: "We sold 10.2 million iPods which was down from 11 million in the year ago quarter. There were two key reasons for this decline: First, we reduced channel inventory by over 400,000 [in anticipation of reduced sales]. Second, sales declined by 4 percent year-over-year. I would like to discuss how we're looking at this market. We have three categories of what we call pocket products. Traditional MP3 players, iPod Touch and iPhone. For traditional MP3 players, which include shuffle, nano and classic, we saw a year-over-year decline which we internally had forecasted to occur. This is one of the original reasons we developed the iPhone and the iPod Touch."

He went on to say, "We expect our traditional MP3 players to decline over time as we cannibalize ourselves [TMO emphasis] with the iPod Touch and the iPhone. However, we have a great business that we believe will last for many, many years and which we will continue to manage well and offer the world's most innovative products."

The gist here is that Apple fully expects the dedicated pocket MP3 player to go away, but go away slowly. So slowly that they're not in any hurry to terminate the line. Rather, Apple will keep selling the product, so long as there's some demand, presumably by people who need the, well, lack of features of a standard MP3 player. Research also comes into play: "Despite the decline in our sales, our research shows that about 50 percent of our recent traditional iPod purchasers are buying their first iPod, including those in our high market share countries such as the US, Japan, Australia, Canada and the UK."

Mr. Oppenheimer also revealed that Apple plans to open its first retail store in France during the holiday quarter (Oct-Dec). He also stated that Apple's Gross Margins were better than expected thanks to lower than expected warranty costs. However, the cause of that gain, displays, hard disks, etc., wasn't explained.

Peter Oppenheimer: "Turning to cash, our cash plus short-term [and] long-term marketable securities totaled $31.1 billion at the end of the June quarter compared to $28.9 billion at the end of the March quarter, an increase of over 2.2 billion.... Our investment priority for the cash continues to be preservation of capital [TMO emphasis] which has served us well in the current environment.

Translation: Apple appears to believe that accumulating capital for the sake of having it is more beneficial than using it for some other purpose. That working capital, by the way, gives Apple tremendous buying power when it comes to purchasing the commodities required for their products, NAND Flash, hard disks, and displays, in very large quantities. Often, Apple pays cash in advance resulting in the ability to get to the head of the line with commodity suppliers.

Turning to the iPhone, Mr. Cook explained on of the key elements of the relationship between AT&T and Apple. Apple gets to focus in product rather than wireless delivery technologies, something he admitted Apple doesn't want to do.

Tim Cook: "Also, think that most of the carriers that we're doing business with are thrilled over the lower churn that they experience and the higher RPUs and the customers are demanding the iPhone. So I feel like we've got a very good set of relationships and are obviously continuing to look to expand those." [presumably in foreign markets.]

RPU is Revenue Per User, a key metric in determining how a carrier views a particular smartphone. AT&T likes the iPhone because once a customer switches to AT&T to get an iPhone, that customer is less likely to blow off the carrier and switch, losing access to the iPhone's voice and data functions. That's what he meant by lower "churn." That has to be a key motivator for AT&T to make Apple happy with its own network performance.

Charles Wolfe of Needham and Company asked a blunt question about the Apple App Store pricing. "In terms of application prices, there appears to be a race to the bottom. I've noticed that there is an increasing number of $0.99 offerings. Do you regard this as a concern, and, if so, are you taking any steps to enable consumers to separate quality aps from the garbage?"

Sometimes a sharp question gets a sharp response and sometimes it gets a defensive, revealing response if the issue is a hot spot. In this case, it did.

Tim Cook: "Charlie, we're always looking for ways to categorize aps differently. And we do have some ideas in this area. As you know today, we do it by type of app and also show popular aps and top selling aps, et cetera. We realize there is opportunity there for further improvement and are working on that."

Apple may publicly swoon over 65,000 apps for the iPhone and iPod touch, but it also knows that a lot of it is crap, bought by only a few people and discarded. Apple's mantra, after all is excellence, so it's not surprising that this is an area of concern. Look for changes in how Apple categorizes and touts App Store apps.

There were some other tidbits covered in yesterday's articles, but combing through the transcript is always good for some additional insights into how Apple operates and thinks.

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Comments

iBill

Great tidbits from the CC, thanks for posting. I especially liked Charlie Wolf’s question, and I thought the response from Tim was well done.

AdanC

I can’t imagine the howls from the developers’ community when Apple get more stringent in their selection process by telling the developers that their apps are craps.

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