Apple’s Dramatic Risks and Ambitions

News from Apple is often big news. Apple released its second quarter results yesterday. Revenue was $7.51 billion, down 22% q-o-q and up 42% y-o-y driven by strong demand for Macs and the ever-popular iPhone. Net income was $1.05 billion, or $1.16 per diluted share, up 36% y-o-y. International sales, which were 44% of the revenue, grew 47% and US sales grew 40%.

Apple sold 2.29 million Macs with a growth of 51% y-o-y that is about 3.5 times the overall PC market rate of growth. Macs accounted for 59% of the revenue in the quarter, up from 47% last quarter. Our household now boasts a beautiful, large-screen iMac on which we’re playing with photos and music to create iMovie clips of our travels, horse, and such. We still have 2 Vista laptops, a source of continuous annoyance. Those two are probably on their way out.

With revenue mix shifting towards the Macs, music products and services accounted for 36% of revenue in the quarter, down from 50% last quarter. Sales of iPods at 10.6 million seem to have saturated with a growth of just 1%. A price reduction helped improve the sales of Shuffle. The iPod Touch which is an iPhone without the mobile capabilities helped in the 8% y-o-y iPod revenue growth.

Now to what everyone wants to know about – iPhone sales. Apple sold 1.7 million iPhones in the quarter taking the total to 5.7 million since the launch. In fact, there was shortage of iPhones towards the end of the quarter as demand far exceeded expectations. When AT&T reported net adds of just 1.3 million, there were concerns about iPhone sales crossing the 1 million mark. However, unlocked iPhone sales seem to have bridged the gap and Apple seems confident of meeting the 10 million target for this year.

The iPhone 2.0 software, which is expected to launch in June, would help in its goal. People buying iPhones in the interim will be provided a free upgrade. Therefore, revenue recognition of iPhone sales will be delayed till iPhone 2.0 software is delivered. Total revenue from sales of iPhone, iPhone accessories, and payments from carriers was $378 million. Total deferred revenue from iPhone and Apple TV was $1.93 billion, compared to $1.44 billion in the previous quarter.

Apple launched the iPhone in Austria and Ireland during the quarter but things are not so rosy in Europe. O2, the UK carrier, recently cut the iPhone price from £269 to £169 and T-Mobile had earlier in the month cut the price from €399 (£319) to €99. There are reports of Apple pushing for price cuts in France with the carrier Orange to increase sales. Apple will probably change its distribution model of exclusive carriers outside the US.

Starting with just 4% market share when it was launched last year, Apple has now 9% of the smartphone market share against RIM’s 42% according to ChangeWave Research. And with the iPhone being made compatible for use in the enterprise, it would be interesting to watch its race with RIMM. For the moment, most of Apple’s market share wins are coming at the expense of Palm’s Treo and Motorola’s RAZR, another product that we have two of in our house. Those two, in due course, are also moving on to the iPhone.

For the third quarter, Apple is targeting revenue of around $7.2 billion, or 33% y-o-y growth over the prior June quarter. EPS is expected to be about $1.00.

Meanwhile reports of Apple’s $278 million acquisition of microprocessor design company PA Semi has overshadowed its earnings reports. PA Semi is known for its design of low-power chips. This acquisition has thrown cold water over Intel’s hopes of securing a design win for Atom, its latest low-power lineup and will cause a shift in the iPhone component ecosystem. But more than that Apple has taken on a significant risk by vertically integrating into semiconductors with the hope that they can achieve differentiation in their core electronics, not only in design, OS and applications. If Apple’s move succeeds, then we’re going back to a vertically integrated
computer industry, which is where it all started. The interim Wintel model will come to be looked upon as the detour. We can always trust Steve Jobs to create drama. We can always trust Steve Jobs to be ambitious.

Apple’s stock is trading around $162 with a market cap of around $143 billion. After dropping to nearly $120, it has started picking up in March since its enterprise announcement. And this morning, the upward climb looks resolute.