2nd Fiscal Quarter Review And Analysis

On Wednesday Apple Computer announced results for the companyis 2nd fiscal quarter ended March 31,2002.The results provided both good news for the quarter and revealed the challenges Apple faces moving forward to grow sales and increase the companyis profitability.

In the conference call with analysts following release of the quarterly numbers, Apple CFO Fred Anderson detailed for Wall Street and AAPL investors the factors which enabled the company to slightly exceed Wall Street estimates for the period that ended in March and why his revenue and earnings guidance concerning the current quarter and the three month period that ends in September are conservative, perhaps muted, as the company looks forward.

For the quarter ended March 31, 2002 Apple reported:

A net profit per share of US$.11, compared to US$.12 in the year-earlier period. In the year earlier period Apple recorded US$65 million in income from interest and other items versus US$27 million for the March 2002 period.

A reduction in income on earnings from Appleis cash and equivalents due to lower interest rates accounted for much of the difference in net profits per share this year compared to the year earlier period. Also, a slight increase of 13 million shares in the fully diluted share tally in 2002 versus 2001 contributed marginally to the drop in earnings per share. Wall Street was expecting earnings per share of US$.10, Apple bested estimates by US$.01 per share.

Revenues for the quarter were US$1.5 billion, up 4 percent from the year ago quarter.

Wall Street was expecting revenues for the quarter of about US$1.46 billion. Apple exceeded Wall Street estimates by roughly US$400 million. Revenues benefited from the shipment of 813,000 Macs in the 2002 period versus 751,000 units one year ago, an increase of 8 percent in overall unit shipments.

The 813,000 Macs shipped in the 2nd fiscal quarter included 220,000 of the new flat-panel iMacs and about 150,000 of the CRT iMacs. Apple continues to offer the CRT iMac for the benefit of schools and consumers looking for a sub-$1,000 computer.

Gross margins for the March 2002 period were 27.4 percent versus 26.9 percent for the year-earlier period. Although gross margins increased in year-over-year comparison, gross margins were lower than the 30.1% achieved in the three-moth period that ended in December 2001.

Appleis cash position remained steady at about US$4.3 billion compared to the December 2001 period.

Looking Forward

For the period ending June 30, 2002, Apple expects revenues of about US$1.6 billion and earnings per share of about US$.11, versus the previous Wall Street estimate of US$.13 per share.

Influencing the projection of flat earnings in the current period are increased component costs due to higher prices for DRAM chips, flat panel displays and the additional costs of air freighting iMacs from the manufacturing facilities to the United States and locations abroad. For the March 2002 quarter, sales outside the United States accounted for 45 percent of Appleis worldwide sales.

The cost of air freighting iMacs versus shipping via water routes is an additional US$35 per unit. Clearly, Apple has chosen to forgo profits in order to more quickly meet consumer demand. Apple estimates 50 to 75 percent of iMacs shipped in the current quarter will be shipped by airfreight. For the September period Apple estimates 25 percent of iMacs will arrive by airfreight, a number more in line with the companyis historical practices.

Although Apple executives did not quantify the backlog of iMac orders, Fred Anderson did say the back order was "substantial". Outside of the new iMac, Apple had channel inventory equal to about 4.5 weeks worth of sales at the end of March. This is a slight decline from the December period and puts to rest rumors of "channel stuffing" (or dumping product into stores and distributor warehouses) in order to better the quarteris numbers.

Component Costs

During the March quarter Apple experienced a three-fold increase in DRAM costs and a 25 percent increase in costs for flat panel displays. Apple executives expect DRAM costs to level off, but the cost for flat panel display to increase marginally before the end of the June quarter.

Also impacting gross margins for the June quarter and the quarteris earnings per share is Appleis commitment to offer the new iMacs at the original price for consumers who had an iMac on order when the new prices were announced. Apple will not fulfill all orders at the original price until sometime in May.

The increase in components costs, Appleis decision not to pass the higher costs on to consumer who had iMacs on order when the company increased prices and the need to ship upwards of 75 percent of iMacs via of airfreight to meet consumer demand will further reduce the companyis gross margin on sales in the current quarter.

Supply Will Soon Meet Demand

At the end of the March quarter Apple was shipping iMacs at the rate of 9,000 to 10,000 units per day in order to meet unprecedented consumer demand. The rate of manufacture has dropped from peak production levels at the end of the March quarter, but Apple will continue to maintain high manufacture rates until supply meets demand. Apple expects to finally meet pent-up demand for the new iMac toward the end of the June quarter. In answer to an analystis question, Fred Anderson said that Apple could sustain iMac shipments of 4,000 to 5,000 units per day throughout the quarter. The key constraint remains component availability.

Pro-Level Problems

For the March 2002 quarter, Apple reported that sales of pro-level products (G4 minitowers and PowerBooks) were soft. During the conference call with analysts, Apple executives suggested that the wait for an OS X compliant version of Photoshop which began shipping in this current quarter to have materially reduced the demand for Appleis higher margin products.

Apple is focused on the continuing evangelization of Mac OS X and executives would not comment on future product releases or updates to the minitower or PowerBook lines. Apple announced that the company has shipped more than 3 million units with Mac OS X installed, but declined to offer specific numbers of actual Mac OS X users.

Government And Education

Apple executives stated that government agencies have taken an interest in Mac OS X because of its enhanced security features and although government sales are a small part of Appleis current sales totals, the government market continues to grow for the companyis products. Sales to government agencies increased 60% in 2001 versus 2000.

Apple has previously cautioned that due to reductions in state and local tax revenue and budgets developed during the recession, they expect the current education season to present challenges to growth. However, the company highlighted their success in what they called "one to one" programs in which each student and teacher is provided with a computer as an area in the education market where the company has found success and expects growth.

Apple executives are cautiously optimistic for the current education-buying season. Apple expects the sales mix for the quarter to change with a higher rate of growth for the iBook during the education-buying season due to its popularity among schools and teachers.

Retail Stores

Although Apple executives would not comment on a change in sales focus at the stores, the company considers the strategy of placing Apple Stores in high-traffic, higher cost locations to be a success. Appleis other retail strategies were also hailed a success.

29 Apple Stores are now open for business. 20 additional stores are slated for opening before the end of the calendar year. During the March quarter Apple Stores generated US$70 million in revenues and produced a US$4 million operational loss.

Apple continues to estimate that 40 percent of unit sales at Apple Stores are to non-Mac owners, but declined to offer specific statistics to back this up. Interesting to note, the company believes sales to many non-Mac owners requires on average a few visit to the store by the buyer before the purchase is made.

Analysis

The new iMacis popularity indicates that the product is an undisputed winner with consumers. Apple has chosen to forgo higher margins in order to more quickly meet consumer demand for the product. Apple has also chosen to forsake higher profits in an effort to gain market share by continuing to roll out new stores, refusing to cheapen components and by guaranteeing the original price to consumers who had iMacs on order at the time the price increase was announced.

The 2nd fiscal quarteris numbers give AAPL investors reason to cheer. The company slightly bested Wall Street estimates. Looking forward, consumers and AAPL investors also have reason to cheer - Apple is committed to providing the best possible computer at the best possible price. Growth in unit sales and market share are a higher priority to Apple than the level of immediate profit on each unit sold.

Apple executives are providing Wall Street and AAPL investors with conservative, perhaps muted, guidance moving forward. I expect Apple to deliver results that exceed the lowered guidance for the current quarter.

Join the discussion on the companyis Q2 results in our forums.

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