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Apple: Unexceedable Expectations

By Arik Hesseldahl What's not to love about Apple Computer's (AAPL) most recent quarter? The results reflected surging profits, computer sales growth that's outpacing the rest of the PC industry, and robust sales of the iPod, the hottest consumer-electronics product around. Annual sales were $13.93 billion, or 68% ahead of 2004. And profit for the year was $1.3 billion, an almost fivefold increase over 2004.

Still, in late trading on Oct. 11, investors sent the stock into a tailspin. Apparently many feel there's a lot not to love about Apple's fiscal fourth-quarter numbers. Investors pushed the stock down $5.60, more than 10%, after bidding it up $1.22, or 2.4%, during regular trading.

Did Apple have an unexpected fumble? Some analysts pointed to disappointing sales of the iPod handheld music players. Apple sold 6.4 million of them in the period -- a million iPod nanos during the final 17 days alone. The iPod accounted for $1.2 billion, or 32%, of Apple's total sales and had more than threefold growth over a year earlier.

THE MISSING PIECE. Those numbers still fell short of some expectations, including those of Goldman Sachs analyst David Bailey, who forecast sales of 7.8 million iPods. Others had been even more optimistic. UBS was banking on 10 million units.

Partly to blame was a shortage of components for the popular pencil-thin nano. Apple CFO Peter Oppenheimer admitted on a conference call that supply is well behind demand, but he declined to forecast when Apple might catch up. He noted that the problem is one of component supply but declined to say which component was the culprit.

Chris Crotty, an analyst at market researcher iSuppi, suspects the bottleneck is due to insufficient supplies of flash memory, the key to cramming 1,000 songs into a tight space. Apple has tied up an exclusive supply of flash memory for the nano from South Korean chipmaker Samsung Electronics (see BW Online, 8/26/05, "A Memorable Deal for Apple and Samsung"). And it's said to be working on more flash supply deals with Hynix Semiconductor and Micron Technology (MU). "It has to be flash, I don't see what else it could be," Crotty says.

IN DENIAL? Shaw Wu, an analyst at American Technology Research, blames Apple's product mix. Wu, who had forecast sales of 8 million iPods in the quarter, says Apple failed to anticipate demand that heavily favors the 4-gigabyte nano over the 2-gigabyte model. "I know there are plenty of 2-gig nanos around. It's the 4-gig that you can't find in the stores," he says. "They keep talking about demand, but I sense a little bit of denial." Indeed, shoppers at can get a 2-gig ipod shipped to them in less than a day, while the wait for a 4-gig model is one to two weeks.

It didn't help that fourth-quarter sales missed analysts' estimates and that first-quarter earnings may miss Wall Street expectations. Last quarter, sales were $3.68 billion, compared with $3.74 billion called for by analysts. Apple forecast first-quarter profit of 46 cents, compared with 48 cents expected by analysts.

It may be that analysts are setting their expectations too high. "From a fundamental point of view, it was a phenomenal quarter," says Gene Munster, a Piper Jaffrey analyst. "From an expectations point of view, it was a disappointment." Wall Street is too focused on the iPod shortfall, Munster says, adding that he would advise buying shares amid "the pullback."

TOUGH CROWD. Meantime, Apple's Catch-22 continues, and it's not clear what it can say to investors to prevent the volatility that led to the Oct. 11 sell-off. In recent quarters, Apple has chosen to issue conservative forecasts, both because it's hard to accurately predict demand for its trendy products -- and because it's clear analysts would just tack on extra. "Whatever they say, people just add on 30% to their earnings," Munster says.

On the other hand, Apple could give more aggressive forecasts and risk falling short. Until Apple's remarkable growth jag starts to slow, analysts would likely bump up those estimates, too. The guessing will continue on Oct. 12, when Apple is due to announce a new round of products. If they win consumers' hearts like so many other recent Apple offerings, investors' funk may last less than a day.

With Peter Burrows in Silicon Valley

Hesseldahl is a reporter for BusinessWeek Online in New York

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