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Apple
Analysis of Q2 2001 - Treading Water

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By Plato90s
April 20, 2001

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In analyzing the performance of Apple in Q2 '01 [Jan-Mar 2001], it appears that Apple is merely treading water as it attempts to stay above the line of profitability. After getting a stellar performance from the introduction of the Titanium PowerBook, lackluster performance on the remaining four product lines contributed to make the last quarter a wash.

Starting off with the iMac, Apple refreshed its product lines with CDRW and psychedelic patterns, but unlike previous product line refreshes, Apple failed to see any boost in its unit shipments. Revenues had the appearance of increasing quarter over quarter, but that is false because Apple took charges against all of its product lines for order cancellation charges. In fact, revenues were probably flat for the last 6 months, and there is no comparison against last year's sales figures. Without a more radical overhaul of the iMac line than colors, there's little prospect of increasing sales.

Moving on to the iBook, sales went down the proverbial gutter. With unit sales at a pitiful 55k, Apple has now broken its own all-time low. Lacking any serious refresh since the Lime-Green G3-366, the iBook is simply not an attractive buy. This product line has come a long way from the heady days of 1999, when over 200k iBooks were sold for the Christmas season. The puzzle here is how the iBook could possibly consist of half of Apple's notebook sales in February, which has been reported by CNET, when its quarterly numbers are so bad.

Like the iMac, the iBook is in desperate need of a major overhaul because there is no equivalent laptop on the market any more. The slowest consumer grade laptop sold by Compaq, Dell, and HP are 600Mhz, while the iBook's slower model is half that. The Mhz gap does matter, even in the consumer laptop space. Time for Apple to put its new G3 chips into the iBook, and put in a 13.3" LCD. With LCD prices dropping rapidly, there's no more reason not to any more.

The Cube is the enigma of the quarter. Apple claimed to have sold 12,000 Cubes, but recorded $33M in revenues. That works out to a ridiculous average selling price [ASP] of $2750 per unit. That number is so far off base that there must be some strange math behind it. The clues can be found in Cube inventory. After grossly overestimating demand, Apple manufactured far more Cubes than it could sell, leading to bloated inventory, cancellation charges, and "special marketing expense" [aka rebates]. We can assume that Apple took back much of its Cube overproduction, which manifests itself as the $1299 G4-450 Cube with no BTO options. After taking charges to adjust the fact it took back inventory already booked as *revenue* in Q4 '00, Apple now records revenues from selling these old Cubes in Q2 '01. So, Q4 '00 was overstated, Q1 '01 was understated, and Q2 '01 is overstated once again. So the 12k in shipped Cubes would be the CD-RW models only. Assuming an ASP comparable to past quarters, Apple probably managed to ship another 9-10k in older Cubes. Overall, that means ~230k Cubes shipped in 3 quarters, still far below expectations. At this point, it's a safe call to say the Cube is a complete flop and will not improve with time.

The PowerBook is undoubtedly the highlight of the past quarter. With 134k units sold in one quarter, that makes this the best performance for the PowerBook in the last 18 months. It's also the highest ASP seen in 6 quarters. At this rate, it may well be the best quarter in the last 4 years. The Titanium PowerBook is well designed, priced aggressively, and an extremely profitable product. Even if sales slow down to a more historical level of 100k units shipped per quarter, it will still contribute a large positive to Apple's top- and bottom-line. Congratulations to Apple for creating a real winner in this product line.

Finally, we come to the PowerMac. This is the 2nd worst product line, behind the iBook. At 470k units sold, that's far below the FY2000 level of 520k-700k units/quarter. This is surprising, given that a product line refresh usually brings a boost in both revenues and unit shipments. But like the iMac, the softening economy has taken the wind of PowerMac's sales. Two factors have dragged down revenues, the major price drop issued by Apple on older PowerMacs [400Mhz-500Mhz] and the generally slow sales of high end products in a softening economy. There's no real way out of this one other than continuing to get faster G4's from Motorola or for OS X to tap heretofore unavailable markets for Apple. With OS X not planning to ship pre-installed until July, there won't be much upside for the PowerMac in the next quarter.

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On the inventory side, Apple seems to be playing some interesting tricks. After struggling to master inventory levels in the last quarter, Apple has let it slide once more, with channel inventory [accounts receivable] increasing 44% since last quarter. Fred Anderson claims that the $647M in total on-hand/channel inventory represents four weeks of stock. But that would translate to quarterly revenues of nearly $1.9B, far higher than the $1.4B actually achieved in Q2 or the forward prediction of $1.6B to $1.7B for Q3/Q4.

Fred Anderson also predicted Apple would get $1.5 - $1.6B in revenues in Q2, and he's off by 6-12%. Cranking that bad predictive accuracy forward to Q3/Q4, that makes Apple's inventory at least 6 weeks worth of sales. A more credible prediction of Apple's full year revenues is $5.5B, not the $5.6-$5.8B that Fred Anderson is guiding analysts to.

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On the revenue side, Apple came in a bit lower than expected. Even with the softening economy, expectations were that Apple would bring in at least $1.5B in revenues, that being the low end of the guidance range, but Apple managed to come in 5% lower than even that lowered expectation.

But the rest of the numbers are pretty much as predicted in this post almost 3 weeks ago.

Predicted gross income of $350M-$400M, actual of $385M.

Predicted operating expense of $370M-$400M, actual of $393M.

Predicted net income of $20M-$80M, actual of $43M. Fairly good call, compared to analyst expectations of $3M-$10M.

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The conclusion for Q2 '01 is that Apple had one blockbuster product, the Titanium PowerBook, which managed to salvage an otherwise lackluster quarter. Going forward, Q3 and Q4 will likely have margins similar to this past quarter, as we expect sales of OS X to outbalance part of the lost profits as PowerBook sales decline to a more normal level.

Barring another major catastrophe, Apple won't see another quarter like Q1, but the impact of that one disastrous quarter will be felt through the year. Even if Apple meets its revised revenue projections, total year profits will probably be no more than $0.95 per share. Assuming Apple achieves its historic P/E level of ~20, that means Apple's share price can appreciate to ~$40 by October.