Apple (AAPL) has responded swiftly to scattered reports of "dead spots" on iPhone touchscreens — and received high marks from users for the speed and efficiency with which defective devices were replaced. But now a London-based analyst familiar with the provenance of Apple’s touch-sensitive technology suggests that the company may have a growing problem on its hands.

The dead zones are typically described as horizontal strips about a half-inch wide that have permanently lost responsiveness to touch input. Customers who returned their iPhones with 14 days of purchase have been given a new one on the spot. Others have been issued loaner iPhones — sometimes for free — while their units were sent out for repair.

So far the number of iPhones affected seems to be small, although it’s difficult to tell because some of the Apple discussion threads where the problem first surfaced seem to have been removed. We counted 11 separate customers with dead zone iPhones on one MacRumor board (see here) and 4 more on an AppleInsider thread (see here). One of the Apple discussion threads still active includes reports of at least 7 separate incidents.

Apple sold 270,000 iPhones in the first day and a half and expects to sell 1 million before the end of September.

The possibility that the number iPhones with permanent screen problems could grow over time was raised in a note to clients sent today by Richard Windsor, a security analyst at Nomura International. According to MarketWatch (UK):

Windsor explained that the screen of the iPhone uses a chemical
deposition to provide touch sensitivity based on heat. The
international property rights for this technology, he said, were
purchased from a bankrupt Finnish company that was trying to make a
similar device. But that company encountered the problem that with
extensive use, the film would begin to degrade and the screen would
lose its sensitivity. Windsor said the problem typically manifested
itself within three to six months. While Apple should have been aware
and fixed the problem, the broker said, only time will confirm that all
is well with that touch screen. (link)

Some commentators have questioned Windsor’s analysis, noting that this description of Apple’s screen technology is wrong in at least one critical respect: the iPhone’s touch sensitivity is based not on heat but on charge capacitance. (See discussion here.) According to How Stuff Works, touch screens like the iPhone’s work by monitoring changes in electrical current. As they put it: "Capacitive touch-screens use a layer of capacitive material to hold an electrical charge; touching the screen changes the amount of charge at a specific point of contact. (see diagram, right)

Although Apple has not yet responded to press inquiries, its support
staff has been unusually pro-active, even
monitoring online complaints and stepping in unbidden. In one of
the Apple discussion boards still extant, an iPhone user calling
himself Keith Wilson 1 reported on July 8 that he
could not activate the top part of his screen. Resetting the device did
not help and the nearest Apple store was 200 miles away. The next day he posted this:

Today I am in awe of Apple Support. This may not be true for everyone,
but got an unsolicited call at my office from Apple Support on this
issue and they were helpful and we put together a return on the phone.
Hope to have my working iPhone in a couple of days.

[Diagram courtesy of How Stuff Works]

The lawsuit filed against Apple (AAPL) and AT&T (T) by a user named Jose Trujillo has generated a lot of heated discussion here and elsewhere, much of it aimed at lawyers and their litigious clients. (See iPhone Class Action Suit Filed in Cook County and subsequent comments.)

Leaving aside the lawyer jokes (we’ve heard ‘em all), there seems to be some confusion about the facts of the case, which centers on whether or not Apple informed purchasers ahead of time that the iPhone’s battery was sealed and would need to be professionally replaced after a fixed number of charges — leaving the owner without a cell phone in the interim.

The complaint  claims that this information did not appear in the product’s packaging and never came up in Apple’s promotion or marketing of the device. (link) A group called the Foundation for Consumer and Taxpayer Rights made a similar complaint about a week after the iPhone went on sale. (link)

At the risk of being called as a witness in the trial, this is what I’ve learned about what Steve Jobs and Apple said about the battery issue and when they said it:

At the MacWorld keynote in which he introduced the iPhone, Jobs gave specs on battery
life but did not volunteer the information that
it wasn’t user replaceable. Neither does Apple’s Jan. 9 iPhone press release.

In subsequent coverage in the press and blogosphere the battery was often described as non-replaceable (see here and here), although the source of this information is not clear. For example, The Small Wave points to a July 9 post in SlashGear that describes the battery as "sadly non-removable." But the first comment on the SlashGear post reads:

I’d hold off on the “non-removable” battery thing until someone from
Apple says for sure… It has to have a removable panel for the GSM SIM
card and that’s likely the gray area along the lower backside. (link)

The battery issue came in for intense scrutiny in the Apple blogs after John Dvorak’s
famous April iPhone podcast, in which he quotes an unnamed Cingular (AT&T)
executive complaining about the "amateur mistake" Apple made in not having a removable battery. “You run 20 minutes and you’re using up half the battery power. You get 40 minutes total talk time." (link)

But Dvorak, as many have noted, was wrong about the battery life. Besides, the issue here is not what the press reported or the blog writers surmised, but what Apple said or didn’t say.

On June 18, Apple issued another press release:

CUPERTINO, California—June 18, 2007—Apple® today announced
that iPhoneâ„¢ will deliver significantly longer battery life when it
ships on June 29 than was originally estimated when iPhone was unveiled
in January. iPhone will feature up to 8 hours of talk time, 6 hours of
Internet use, 7 hours of video playback or 24 hours of audio playback.*

Nothing about battery replacement, what Apple would charge for it or what you were supposed to use for a cell phone while it was being replaced.

On June 29, the iPhone was released and sold like hot cakes.

On July 2, Glenn Fleishmann on TidBits posted an item complaining that
Apple had not yet provided details about the cost of replacing the
battery (see My First Days with the iPhone). A week later, he posted a
corrective:

…in fact, those were apparently available for at least a
day on the Apple Store’s ordering page for the iPhone (click the
Warranty button in the bottom right). Other repair information appears
to have shown up on or around 02-Jul-07. (link)

Among the information Fleishmann says showed up "on or around July 2" is Apple’s "iPhone Service FAQ." That file contains this paragraph:

My iPhone warranty has expired.  What are my service options?

Apple
offers two service options for iPhones that are no longer within
warranty.  If your iPhone requires service only because the battery’s
ability to hold an electrical charge has diminished, Apple will replace
your battery for a service fee of $79, plus $6.95 shipping and handling. (link)

The FAQ also describes Apple’s $29 Apple Care Service Phone program, which provides a loaner cell phone for use during the three business days yours is off being repaired.

According to Trujillo’s complaint, Apple spokesperson Jennifer Hakes confirmed that "Apple posted the battery replacement program details on its website after the iPhone went on sale."

On July 23 Apple posted its iPhone Battery page, describing the proper care and feeding of an iPhone battery. It contains this key paragraph: 

Charge Cycles

A properly maintained iPhone battery is
designed to retain up to 80% of its original capacity at 400 full
charge and discharge cycles. You may choose to replace your battery when it no longer holds sufficient charge to meet your needs.

That "replace" link takes you to a page that tells you what it will cost for the service.

Does any of this justify a class action lawsuit or entitle Mr. Trujillo, his lawyers and the class of iPhone purchasers to damages? You be the judge.

For more on the battery issue, see Joe Nocera’s column in the June 30 New York Times, which looks at it from pretty much every angle except the legal and gives Steve Dowling and others at Apple PR a couple of chances to say their piece. (Free subscription required.)

ADDENDUM: This came in over the transom from an expert in these kind of cases:

Christopher S. Griesmeyer, a partner in the Litigation Practice at Levenfeld Pearlstein LLC in Chicago, who previously represented a U.S. cell phone manufacturer in federal trade secret litigation, notes that information, not technology, is the key to this case.

“While Apple will surely disagree with some of the technical allegations regarding the iPhone, the technology debate is almost irrelevant here,” said Mr. Griesmeyer.  “In many respects, it doesn’t matter whether the battery needs to be replaced once a year, or once a week, and it doesn’t matter how expensive that process will be.  What matters is how well Apple communicated that information to its customers before they bought the phone.  What did Apple know, when did Apple know it, and how long did it take Apple to communicate the information to potential customers?”

Mr. Griesmeyer also notes that the class makeup may pose some problems for plaintiffs’ lawyers should the case go to trial.  “Most juries are not going to have much sympathy for a bunch of people who spent $500 or $600 on a phone,” he says.  “At the same time, the plaintiffs’ lawyers are betting that the jury will have even less sympathy for a large corporation that allegedly increased its profits by withholding vital information from its customers.  This is a high-stakes gamble, which is why most cases of this type settle quickly after the court makes a decision on class certification.”

[Photo courtesy of Gizmodo.]

Analysts who had over-estimated iPhone sales and underestimated the Mac re-evaluated Apple (AAPL) in the wake of the company’s impressive third quarter earnings report and issued new price targets across the board.

Goldman Sach’s David Bailey, whose estimate of 700,000 iPhone sold over the first three days was furthest from the mark, increased his price target from $135 to $165.

Piper Jaffray’s Gene Munster, who had upped his iPhone estimate from 200,000 to 500,000 when he saw how long the lines were on iDay, maintained his position as the most bullish analyst on record, moving his target from $205 a share to $211.

Shaw Wu of American Technology Research, who stuck with his original estimate of 125,000 iPhones sold in each of the first two days and won the jellybean contest by being closest to the correct answer (270,000 for the first day and a half of sales), moved his 6-12 month price target from $165 to $185.

(Our own back-of-the-envelope estimate of 172,000 units sold the first night, which was widely ridiculed at the time, turned out to be pretty good.)

Other firms raising their price target on Apple shares yesterday included JMP Securities ($160), Caris & Co. ($165), UBS ($175),
Pacific Crest ($175), Credit Suisse ($185) and Deutsche Bank ($200).

Several observers noted yesterday that as Apple shares rose in the midst of a broad market sell-off, the company’s stock valuation ($127 billion) passed both HP’s (HPQ) and Verizon’s (VZ) at $123 billion apiece.

If you want a graphic snapshot of how Apple’s stock fared compared with the rest of the tech sector yesterday, see Fake Steve Jobs’s "Think Different" summary here.

Finally, in a note to clients, ATR’s Wu put together a list of pros and cons that neatly anticipates the arguments of the Apple bulls and bears, saving us all a lot of tiresome chatter:

The Bulls Will Point To:
·         Mac
shipments came in at 1.76 million units, up 33% Y/Y, much higher than
expectations of around 1.6-1.65 million (we were at 1.64 million).
·
       International sales were very strong, up 29% Y/Y in Europe (21%)
and up 28% Y/Y in Asia-Pacific (7%). Americas (50%) grew 23% Y/Y.
·
       The gross margin came in at 36.9%, well above expectations and
our estimate of 32.4%. This was due to a favorable product mix and
AAPL’s ability to take advantage of favorable component pricing. To a
degree, we also believe this also reflects the high profitability of
iPhone.
·         iPhone ASPs appear to be over $600 (we estimate
$609) indicating that price (so far) isn’t an issue and the high
likelihood of additional high margin payments (subsidy and/or bounty).
·         iPod ASPs remained relatively unchanged Q/Q at $160.
·
       Net cash grew to $13.7 billion, up form $12.6 billion last
quarter, helped by strong cash flow from operations. Net cash per share
is now $15.46 per share, up from $14.18 last quarter.

The Bears Will Point To:
·         AAPL sold 270,000 iPhones exceeding our estimate of 250,000, but below overly aggressive forecasts of 500,000-700,000.
·         Japan (5%) continues to lag, with relatively flat revenue five quarters in a row.
·         iPod shipments of 9.8 million grew 21% Y/Y, continuing its trend towards slowing growth.
·
       AAPL’s accounting treatment of iPhone and Apple TV revenue where
hardware revenue is amortized over 2 years or 8 quarters remains
somewhat confusing and is unprecedented.
·         DSOs increased to 24 days from 16 days last quarter.

That about sums it up.