Merrill upgrades AAPL on iPhone talk

"The overhang from the stock option timing investigation is diminishing with management saying it does not expect restatements," Farmer told clients in a research note.

The analyst also noted that Apple's CFO Peter Oppenheimer made an indirect statement on Wednesday, alluding to an iPhone in its Q3 quarterly financial call.

"Although the potential for iPod phone is not news, its financial impact is not in consensus estimates and the fact that management publicly alluded to it (albeit indirectly) on the conference call reinforces the possibility that its introduction could be near enough to influence consensus estimates within the next 12 months," Farmer said; however, the analyst does not believe Apple will release such a device until early in 2007.

"We are very confident in our ability to compete in the marketplace. And we're very excited about what we have in the product pipeline, and you know that I can't comment on that," Oppenheimer said in response to an analyst who asked about the impact of Sony's music phones and their success. "As regards cell phones, we don't think that the phones that are available today make the best music players. We think the iPod is. But over time, that is likely to change. And we're not sitting around doing nothing."

Mobile market is huge opportunity for iPhone

Farmer noted that the mobile market, which could approach 1 billion units in 2008, may represent a very significant upside to Apple's revenues and despite barriers to entry, the analyst believes that iPod and iTunes could help Apple quickly find a niche.

"Every 1 percent share potentially captured by Apple (net of iPod cannibalization) could produce as much as $3 billion in incremental revenue assuming a $300 ASP," the firm said its most recent note. "Cracking the phone business won’t be simple given the complexity of the business model and ecosystem but we see iTunes as a key asset that can create differentiation for consumers as phones and other mobile media devices (like iPods) converge over time."

Margins, education to help Apple

In addition, the firm believes that Apple is entering the seasonally strong back to school and holiday retail selling periods, which it believes will contain product refreshes and said that Apple could see increased gross and operating margins in future quarters, based on its June quarter earnings and conservative guidance for the September quarter.

Apple executives yesterday told investors that some component pricing trends will remain favorable in the near future with some offsets from mix shift to MacBooks, pricing adjustments for currency, and a larger mix of educational buying.

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