Apple Computer (AAPL) #1 [10]

"One more thing...." This is Apple CEO Steve Jobs's famous trademark end to a press conference that is a lead-in to something important. Today, Jobs will utter those words in San Jose at an invitation-only event. The new "thing" must be something compelling in order to reverse the sell-off sparked overnight when Apple reported fourth quarter revenue and iPod sales that fell well short of expectations.

This was the first time in three years Apple has missed sales forecasts. While the company reported record sales of $3.68 bln, up an impressive 56.5% year/year, yet the figure was below the market's consensus estimate of $3.74 bln. Further, as the main driver of the stock's rise from $10 to $50 in two year's time, iPod sales missed the low end of expectations. Apple sold 6.45 mln units, well below the consensus estimate of 7.45 mln, and even the lowest end of the 6.7-8.5 mln range.

In the quarter, which ended on September 24th, Apple earned $430 mln, or $0.50 per share. There were numerous one-off items that skewed the results, including tax benefits and a lower tax rate. Excluding items, Apple earned $0.38 per share, narrowly surpassing expectations by a penny. The shortfall in revenues was the result of lower iPod shipments and sales. iPod revenues increased 126% y/y to $1.2 bln - up 220% y/y and 5% q/q. During the quarter, Apple transitioned from the popular Mini to the latest and smallest generation iPod, the Nano. The newest installment has been hugely successful with Apple shipping a whopping million units in just seventeen days. Apple continues to experience overwhelming demand for the product. The product transition and supply constraints for the Nano are likely causes for the shortfall in sales.

Apple shipped 1.24 mln units, or $1.6 bln worth of PCs in the quarter, up 47.8% y/y and over 3x the growth rate for the industry. Inventories for the Mac ranged from 3-4 weeks, in the comfort zone of where they should be after the key back-to-school season. This quarter Apple enjoyed strong notebook and vertical educational sales. It shipped 602k desktops (+56% y/y) and 634k notebooks - a new single quarter record. The trend towards a higher makeup of portables vs. desktops helped widen margins as portables carry a higher average selling price. The iPod "halo effect" is in full force, as the digital audio player draws in consumers to Apple's Mac suite of products, which represent 60% of total revenues. Management noted that new Mac customers improved by 50 basis points sequentially to 45% at retail. What this suggests is that Apple will continue to take a bigger bite out of the PC market as the conversion rate to Mac endures.

Gross margins of 28.1% beat guidance by 40 basis points due to an improved portable mix and component cost environment. Operating expenses declined 70 basis points to 16.8% of sales. The two cent upside in guidance for the first quarter will do little to quiet concerns of further erosion in iPod sales. Apple expects to earn $0.46 per share in the first quarter on $4.7 bln in sales versus the current consensus of $0.48 on $4.53 bln. The weak top line number reported after Tuesday's close spread like a virus through the technology stocks in Asia and in Europe, as it prompted concerns about a slowdown in consumer spending.

Apple is a victim of its own success, as the market is demanding more and more in terms of growth. Shares tumbled over 8% in pre-market action, but have been paring their losses in regular trading. The market will be waiting anxiously to see just what is Apple's next big thing. Many predict it will be a video iPod, which would bring on more licensing opportunities than the digital audio player and would link Apple into the digital home. Knowing Apple, it could be anything. We would argue investors take advantage of exaggerated weakness as the strength of Apple rests in its imagination and innovation. The company is entering a seasonally strong period with the holidays approaching, which will drive sales for all of its products, from the Nano to the Mac mini. Shares are trading at 34.2x trailing twelve month earnings vs. the 5-yr historical average of 60.0x.