Apple Needs to Execute, No Longer Innovate

On Tuesday, Apple (AAPL) released its earnings for its first quarter of fiscal 2008 that ended December 29, 2007. Its revenue was $9.6 billion, up 35% y-o-y, and 54% sequentially driven by the strong sales of Macs, iPhones, and iPods. Net income was $1.58 billion, or $1.76 per diluted share, up 58% y-o-y. Gross margin was 34.7%, up from 31.2% last year. Its cash balance increased by over $3 billion in the quarter, and now rests at over $18.4 billion. Read my earlier post on what I think it might do with it.

In the quarter, Apple shipped 2.32 million Macs, which is a y-o-y growth of 44%. Mac products and services accounted for 47% of the revenue in the quarter. Its OS Leopard, released on October 26th, has already raked in revenue of $170 million during the quarter.

Music products and services represented 50% of revenue in the quarter. Apple sold over 22.1 million iPods (up 5% y-o-y), and over 2.3 million iPhones during the quarter. The total iPhone count has now moved to 4 million since the launch. The total revenue from sales of the iPhone, iPhone accessories, and payments from carriers was $241 million in the quarter. It is not just the iPhone that is doing well, even the iPhone-inspired smartphone HTC Touch did well with sales of 2 million.

The iPhone launched successfully in the U.K., Germany, and France. Apple will roll out the iPhone in some more European countries and Asia in 2008. It looks set to achieve its 2008 goal of 10 million. Apple’s international business grew 46% y-o-y, which is a good sign with the slowdown of the U.S. economy. Its domestic business also did well with 27% y-o-y growth.

However, Wall Street is bent out of shape. Apple’s shares dropped 11% or $17 to $138.49 in after-hours trading Tuesday. One reason for this is that its revenue target of $6.8 billion or 29% growth y-o-y is considerably below the analyst consensus of $6.99 billion. Another reason is the flat domestic sales of iPods. There are also concerns that with the U.S. economy slowing down, consumers might not go for its high-end gadgets.

Whatever the reasons might be, I think it is a good time to buy the stock. It is currently trading around $129 after hitting 52-week high of $202.96 on December 27.

Why? There are several reasons:

The iPod franchise is still spectacular, and maintains over a 70% market share. It is basically becoming a multi-billion dollar, highly profitable cash cow.

Apple is turning its attention to the Mac business, with good results, and a large, high growth market opportunity awaits it.

Similarly, the iPhone is also in a large, high growth smartphone market, where Apple has rapidly risen to the #2 market share position behind RIM.

I am delighted that Steve Jobs did not pull yet another “new thing” at MacWorld this year. Instead, Apple is focusing on the businesses that are already in gear.

For Apple, today, execution, not innovation, is the name of the game. Apple stock is a long-term buy and hold over the next three years.

click to enlarge

Comments

[Tom B:]

I'd love see Apple's movie download business take off. It seems to me, the competitors (AMZN UnBox; Netflix downloads) are deeply flawed.

2008 Jan 24 09:56 AM

[In the money:]

"I am delighted that Steve Jobs did not pull yet another 'new thing' at MacWorld this year."

The Macbook Air was a new thing...

2008 Jan 24 10:11 AM

[jonesy:]

Agree that Apple hasn't chosen to "enter" a completely new market this year, but that doesn't mean they've stopped innovating. Instead, Apple is very much innovating within the six markets (personal computers, cell phones, portable personal devices, home entertainment devices, music distribution, and video/movie distribution) that they've already entered. Plus, new software will make it possible for many of their devices to quietly enter new "markets".

And I would hope that they never stop.

2008 Jan 24 10:40 AM

[FreeRange:]

This headline, and assumption, is ridiculous. Apple will always be an innovator, and consistently innovates within their existing businesses, as well as innovating in new ones. Why in the world should they do anything different. It is about innovation AND execution. You can never stop innovating or your dead in the technology space, and this is where Apple excels!

2008 Jan 24 11:00 AM

[Jon T:]

Some people see things very oddly indeed.

If Apple's record results quarter after quarter are demonstrating anything than perfect execution then I'm a Dutchman.

And please, what an inane comment about innovation! Apple has innovation in its DNA and that is why it will stay ahead of all the competition year after year after year...

2008 Jan 24 01:38 PM

[Sramana:]

I find you guys rather simplistic.

There is innovation. And then there is Innovation. Of course, Apple will continue to innovate within the categories they are already in. What I am saying is that they should focus within those categories, and not worry about that "another thing" that the market expects from them every year at MacWorld.

Steve Jobs likes to be a rock star. But at this point, he needs to be more of a businessman than a rockstar.

I have to say, you guys and your comments assume that I am naive or something!

2008 Jan 24 01:43 PM

[JJIrons:]

I find your call to action for Apple amusing and naive even though you are scolding those who have called you so. No longer innovate? Innovation is WHO Apple is. I'm sorry but it is you who put the statement in your headline, not us. Live with your words or don't say them.

2008 Jan 24 04:58 PM

[yet another...:]

John Gruber (daringfireballnet) pointed out something we've all missed. The iPod grew this holiday season at the same rate as last year... in REVENUES. Last year the shiny new ipod was the low-end shuffle so units spiked. This year the shiny new ipod was the high end touch. Low end music players are destined to be given away like calculators. The iPhone and iPod touch show Apple, successfully, continuing to grow this franchise... profitably.

And the consistent revenue growth thesis does NOT include the iPhone. Which is more than an ipod but certainly IS an ipod and is certainly part of the same franchise.

2008 Jan 24 05:16 PM

[Realtosh:]

I agree that Apple needs to execute. They’ve been doing a stand up job no maker what the stock market does. I do understand your concern that Apple strengthen its’ current businesses before going and looking for new ones. They’ll never stop innovating, that’s what makes it Apple. I imagine that you’re hoping that they continue to innovate within their current business segments.

I wonder how you feel about Apple growing and innovating in one particular area – selling to business. Don’t you think that Apple can do a lot of internal organic growth with the $18B in cash on its' balance sheets?

Last month you mentioned the possible acquisition of Dell. It would be a game changer. After digesting Dell, Apple would change the market share game permanently in one swoop - which is probably what you're suggesting. There would be much press coverage and the IB fees involved would be out of this world.

But does it make sense to purchase all of Dell, only to have to shut down many divisions? Even though Dell was worth 50% more 2 years ago, it was still valued at $45B this morning, and trading up all day. Apple has little need to continue producing low-end boxes that contribute nothing to earnings.

Apple and Google are the desirable companies to work for in Silicon Valley. With so many struggling hardware and software companies, some folks likely worry about the long-term prospects of their current employer and/or of their jobs. All Apple need do is hang a Hiring Talented and Experienced Account Reps sign. Apple would get quite a number of interested individuals and possibly teams, especially if they can show they are truly committed to the Business market. Purchasing Dell would show commitment, but doing so is so costly. Surely, there must be some other way to curry favor among their future hires – experienced account reps.

With $18B in cold cash couldn't Apple buy into the channel? There must some way to acquire and/or set up an infrastructure to sell to and service business clients. Smaller, more strategic acquisitions together with internal growth of call centers, distribution centers, and service organization makes more sense. Combined with raiding the staff of other business software and hardware vendors, Apple could create a formidable organization for a fraction of the almost $50B required to acquire Dell, with none of the baggage either.

Spending so much in such an acquisition would have its’ benefits but seems not the most efficient use of funds. Consider that much of Dell’s market share is low-cost, low-profit sales. Dell had net income of $2.5B per year in the most recent quarterly report (3Q08). Apple has over $1.5B in net earnings and over $3B in cash flow in the Dec’07 quarter alone. Cash flow figures give us some visibility on apple’s actual performance; now that Apple hides so much of their revenue and earnings (iPhone, AppleTV) in 24 month installments.

Dell is probably the single largest payer of fees to Microsoft, or close to it. Trying to change that overnight would incur that wrath of the very customers that the Dell acquisition would justify. Alternatively, keeping the Microsoft payment spigot on is not at all strategic for Apple either. Customers would move to Apple more willingly if it were their own decision to do so. Forcing so many customers to make the move en masse to Apple, would create opportunities for HP and others, who would not share in the cost of the Dell acquisition.

So creating the infrastructure to sell to business will take a lot of work. It certainly wouldn’t be easy. But it is both possible and much cheaper than buying Dell. This way Apple could focus their effort on the most profitable segments of the market and cherry-pick the best products to offer and the best customer types to pursue.

Plus growing into the business market through internal organic growth is more consistent with your concern that Apple not over-extend itself. Apple can continue to serve the business market by working up from small to mid sized businesses served out of the Apple Stores. Apple can grow this organization and handle increasingly larger businesses profitably. Apple already has experience with some quite large education contracts. let's see what they can do with purchasing Dell.

2008 Jan 24 05:55 PM

[Realtosh:]

Let's see what Apple can do WITHOUT purchasing Dell.

2008 Jan 24 05:59 PM

[Realtosh:]

And yes, the stock in now a no-brainer. On second thought, don't buy it, so that I'll have more time to accumulate greater amounts of AAPL for myself at lower price points. One thing that is nearly certain is that Apple will continue to grow revenues and profits for at least the next 2-3 years with their current businesses that they need to execute. Imagine what happens when they inevitably will innovate at least 1 more new business within the same 2-3 years.

2008 Jan 24 07:19 PM

[humble inve...:]

I agree that execution is vital. But innovation is crucial to growth as well. One area where I'd love to see it -- as an investor and a consumer -- is at the much hyped convergence of computing and entertainment. It could be the biggest category killer of all, which has just begun to be speculated about elsewhere: the iTV. It's a flatscreen that has all the features of appleTV (and perhaps a satellite/cable receiver?) built in, so you don't need all the extra boxes and receivers. The internet and the t.v., finally married simply and elegantly by the company best able to do so. Offered in several sizes to fit a range of budgets. LCD panel technology is so advanced that it's becoming less and less distinguishable brand to brand, so it's the extra features that will make the difference. If Apple isn't working on this, they should be.

2008 Jan 24 08:19 PM

[ThinkFirst:]

There is no other large cap company that innovates AND executes better than Apple. It has a lot more growth ahead as more and more consumers switch to the Mac, and the iPhone increases its penetration in many countries. I expect that sometime this year Apple will expand its iPhone product line to drive growth. In terms of valuation, it has $21 per share in cash and no debt. During the Christmas qtr, it generated operating cash flow per share of $3.1. It should generate about $7 or more in cash per share during the next 12 months. You back out the $21 per share in cash, and you get 6.5% cash flow yield at $130 share price. And this is still a growth company which should be trading at a much lower cash flow yield (i.e. higher stock price). Sometimes, the market is dumb as wood. What I think will happen is that the stock will trade around here for a few days and then suddenly people will wake up and push the stock higher.

2008 Jan 24 10:30 PM

[digivision:]

"Steve Jobs likes to be a rock star. But at this point, he needs to be more of a businessman than a rockstar."
At the moment can you list 5 US tech companies that have performed better than Apple in the last 5 years??? you can't? I know.. obviously SJ is not only a rock star but a damn good business man, as a shareholder I can guarantee you that ..
As far as innovating goes , it's very debatable but Apple hasn't really created anything totally new since the Newton and the emate.

Apple has stopped inventing totally new products in along time instead SJ chose the path of executing innovations on existing markets
ie: phones, Mp3 Players,retail sotres...
Sub notebook..well this they really invented in the late 80's as they did with PDAs but my point is Apple is already executing but they made a choice(smart) to enter different markets therefore expanding their product line, removed the "computers" from Apple and created a new company.
without "anyone" noticing they are now the new Sony but with a more wide range of products and this is only the beginning.. The only problem I see is how many people can SJ find that can keep up with him?
I see both innovation and execution and very good execution , I think having the most successful tech retail chain in the world classifies as pretty good execution

2008 Jan 25 12:29 PM

[TA:]

Nice to see an article critizing Apple that wasn't completely taken over by Apple fanatics with their lame comments like 'The Air is new'

No, there's nothing new about it - NOTHING

3lb notebook - Dell a few years ago(many other manufactures)
Solid State Drive - Dell a year ago
No Ethernet port - ok that's new, most thin laptops actually have one
Changable battery so when you are on a flight and need extra battery life, you can bring a spare - oops, the Air does not have that - such an innovation it would have been too

2008 Jan 25 06:12 PM

[In the money:]

I like how Blah says the air is nothing new, then describes all the new things.

2008 Jan 27 06:24 PM