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October 14th, 1999

[Analysis] An Embarrassment of Riches, A Brief Analysis of Apple's Earnings Report
by Wes George

Apple's conference call yesterday with analysts was the most bizarre earnings report I've ever heard. In essence, Fred Anderson said Apple has almost as many back orders in the first two weeks of this quarter for Macintosh systems than were actually delivered last quarter. 400,000 of those backlogged systems were left over from last quarter, representing an incredible $700 million in unrealized revenue. Another 250,000 unfilled orders represent the first week of the new iMac's debut, and aren't even counted into this figure!

This is very positive news only because of Apple's privileged position among computer vendors. If Apple were Dell, the $700 million in unrealized revenue would leak away as prospective buyers wandered off to buy a PC from one of Dell's dozen or so competitors. Instead, for Apple, backlogs merely mean higher margins because there is no downward pricing pressure. Gross margins were 28.7% last quarter increasing from the June quarter by about 1%, while the rest of the PC vendors have endured gross margin erosion.

Apple can afford the luxury of asking its customers to queue up quietly and wait. The iMac DV, the iBook, and the G4 have no direct competition in a very tangible way. There are no clone vendors to mop up the impatience. Moreover, the difference between an Apple designed system and a Wintel box is now greater than ever. With the expected debut of OS X next year, the divergence in quality will only increase.

Nevertheless, one would hope the immense backlog of orders represents an anomaly. $700 million languishing as unrealized revenue is no way to do business in the long run. Mr. Anderson assured analysts this situation is a one-time miscalculation due to a confluence of events largely beyond Apple's control. A combination of G4 production problems at Motorola, slower than anticipated ramp up of iBook production, an earthquake, and the introduction of five new products all conspired to the detriment of Apple's ability to deliver in a big way.

Mr. Anderson didn't mention Apple's corporate culture has tolerated backlogs as a modus operandi for a least a decade. Although today's backlog is many times larger than usual by historical standards. Apple needs to bring supply versus demand forecasts into line with reality.

One could argue that Apple's huge backlog, if it continues, is a sign of arrogance, especially in light of the way they intend to resolve the G4 shortage by lowering MHz ratings while maintaining the earlier G4 price points. This is a tactic one might expect from a monopoly like Microsoft, not a company in a desperate battle for market share.

But let's be fair, the G4 MHz problem is a short term Motorola induced situation and the solution seems to be at hand for the next year. IBM will begin production of the G4 processor in 2000 and Apple will become, at long last, dual sourced for this pivotal component.

On the other hand, the backlog Apple carries into this quarter, as Maria Bartolomo said this morning on CNBC is "an embarrassment of riches." Investors have to be cheered that demand for Apple's products are exceeding everyone's--but perhaps Steve Job's--imagination. Mr. Anderson has assured analysts that the backlog will be mopped up by November.

That's really the big, if short term, question: Can Apple meet the massive demand for its products during the Christmas season? Has Apple taken into consideration the predictions that this Y2K Christmas is likely to see a very high percentage of technology related purchases?

If the new iMacs continue to sell at even 25 percent of the pace they set during their first week of introduction, Apple can expect to sell at least 700,000 iMacs by Christmas. Add that to a conservatively estimated 200,000 or so G4 sales and perhaps 700,000 iBooks and you have a record breaking quarter for Apple of about 1.6 million units sold! And that's not even considering Power Books. Average units sold for the last 7 quarters has been less than 700,000 units per quarter. Again, the question is, can Apple meet the demand for it products?

Perhaps the most long term bullish news for Apple has been apparent for a while now. Apple is presently entering an entirely new product cycle on, not just one, but three new computer families. This will be the first quarter that all three (iMac DV, iBook and G4) will ramp up to full production. Judging from the first generation iMac, all of these new products have a life cycle of at least a year. The forecast for Apple's bottom line over the next five quarter is very strong, even if Apple decides to rest on its laurels, which isn't likely with Steve Jobs at the helm. For Steve this is merely a foundation to build on.



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