Apple’s Supply Deal With Toshiba

During the third quarter earnings conference call, Apple (AAPL - Analyst Report) said that it has entered into a long term supply agreement with Toshiba Corporation. Under the agreement, Apple made a pre payment of $500 million to secure long term supply of NAND Flash chips for use in its future mobile devices. No specific details on the agreement were provided during the call. 

This prepayment is not reflected in the June quarter results but will impact the company’s fourth quarter cash balance. We expect fourth quarter cash balance to decline to $23.7 billion. For the third quarter, Apple generated cash flow of $2.3 million versus $0.8 million generated in the second quarter. Cash, short-term investments, and long-term marketable securities were $31.1 billion at the end of June quarter versus $28.9 billion at the end of the March quarter. 

As Flash components are a key element in Apple’s products, including the iPhone, iPod touch, iPod nano and iPod shuffle and serves as media storage, this deal with Toshiba will add to incremental revenues and fuel profitability at Apple. With this deal, the company may launch more products. It could be that Apple may come out with its own netbook towards the end of the year for about $899. Apple’s products are generally a big hit with huge demand as soon as they come out. 

In our view, Apple can’t afford to fall short of components and through this deal it plans to make arrangements before hand. Apple has always relied on its primary supplier Samsung Electronics, a Korean company for NAND flash supply. However, it is not unusual for Apple to change its component suppliers. Earlier for its iPhone 3G S unit, Apple chose Toshiba’s 16-Gbyte MLC (multilevel-cell) NAND flash costing $24, according to some sources. We view this new deal to be equally important for Toshiba, world's No. 2 maker of NAND flash chips, which is struggling with sluggish chip prices and intense competition from Samsung Electronics – world's largest NAND flash memory maker. 

In 2005, Apple paid $1.25 billion in advance to Hynix, Intel (INTC - Analyst Report), Micron Technologies (MU - Snapshot Report), Samsung Electronics and Toshiba to secure the supply of NAND flash memory. This agreement runs through 2010. 

Apple has a history of beating its own expectations and accordingly reported upbeat third quarter results, which were well above the consensus expectations and the company’s guidance. The company reported diluted EPS of $1.35 on revenues of $8.34 billion. However, the fourth quarter outlook was below consensus expectations. Our estimates of diluted EPS of $1.32 on revenues of $9.0 billion for the fourth quarter are higher than the company’s regular conservative guidance. We maintain a Hold rating on Apple.