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Apple
Q4 results - First Pass

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By Plato90s
October 17, 2002

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(missed the first few minutes since the broadcast now requires QT6, a pretty annoying time to make things not backwards compatible)

Apple has released results for its just-closed quarter, and results appear to be what investors expected to see.

Revenue is flat QoQ, as projected, and Apple was marginally profitable before special items, as projected. But it's not quite "business as usual" since there are several little twists in the results Apple reported.

First of all, the $60M loss that Apple has posted is most likely due to its investment in Earthlink [ELNK]. The stock has been below Apple's last "fair valuation" for months, and Apple chose to re-evaluate the fair value this quarter. Remember that Apple already prepped the market for the possibility for a loss, which led to the drop down to a new 52-week low.

Like 2001, Apple may have planned to take its medicine in one big swallow, and then hopefully have ELNK recover enough to record a "profit" based on the higher valuation.

On the PowerMac front, it appears the jump to 1.25Ghz has paid dividends. Unit sales didn't increase by much [5%] but the revenue jumped by 21%. That means more customers were choosing the high end (and more profitable) models.

On the other hand, the LCD-iMac continues to have no legs as revenues (and units) dropped again. Apple recognizes this as well, and has cut the lowest end model LCD-iMac down to $1200, below the original introductory price. But I believe even that price level is too high to move significant volume and re-inflate iMac sales back up to the 400k+ level.

The PowerBook is in even worse shape, as it has dropped to a near-historic low of 58k unit shipped. That beats last year's low of 57k by a slim margin. The problem in both quarters is the same; too high of a price tag for a product trailing the competition by too much. We can see that PowerMac revenue (not unit volume) was reinvigorated by dual 1.25Ghz configuration. Apple needs to do something similar with PowerBook, foregoing some of its original design parameters in order to repair this product line. Make the desktop-replacement PowerBook.

The retail operation is profitable, but it carries the same caveat I expressed back in May.

Because of the way operation expense for the retail segment are recognized, the profitability of that segment depends very strongly on the assumptions used to calculate the proper expense load. It's very much open to whatever interpretation Apple management wants to put on it.

So we don't really know if Apple Retail is indeed profitable in the sense that regular retail stores are profitable.

At the same time, we're told that 40% of sales at Retail weren't previously Mac owners. This is one claim to be read carefully, because the exact quote, as reported by Reuters, is (emphasis added)

"40 percent of the Macintoshes, measured by processors, were bought by users new to the Mac platform, he (Fred Anderson) said. "

The only reason I can think of for Fred Anderson to specify "by processor" is that many of these buyers bought PowerMacs, and that if he had reported the percentage "by unit", it would be a lower number. That implies that out of 34k Macs sold via retail, LESS than 13.6k (40%) went to "users new to the Mac platform".

But this is a distinction that will likely be lost in translation. In a matter of days (probably hours), the story will be defined as:

"40% of Apple Retail customers are Switchers"

Even though that 40% figure is not by unit, and also includes people who are buying their first computer.

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I want to take a moment here to congratulate the Apple management and Board of Directors on their recent accomplishment of improving their sense of business ethics.

First, there's the departure of Larry Ellison, who is both biased and delinquent as a Director.

Second, Apple management has given back $2M in bonuses already paid.

Hopefully, we'll be seeing more signs of a greater sense of business ethics and determination to protect shareholder interests ahead of management interests. Next steps should include bringing more independent directors to the Board, the resignation of Jerome York from both the audit and compensation committees, and...

top executives (including Jobs) voluntarily giving back those new options they got for guiding Apple through such an under performing year.

(back to earnings)

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For all that the .Mac decision angered the customers, it was one of the little twists that enabled Apple to meet projections. Consider that if you have 150,000 subscribers each paying $50. That $7.5M may not sound like much, but it's essentially all profit because the expenses are built-in to the previous quarters already.

Considering Apple's entire non-recurring-item pre-tax profit is $7M, we can see how important that $7.5M was to Apple.

That's why Steve Jobs was willing to anger up to 800k other iTool subscribers, because Fred Anderson probably told him how important that revenue was about to become for Apple.

How important is the non-recurring-item pre-tax profit to Apple? So important that the PDF file included with the earning release devoted an entire page to explaining how Apple is really profitable before special items. Apple never bothers to explain during the good times that up to 50% of its profits are from non-recurring items, but they are very eager to explain it in bad times.

What Apple most definitely doesn't want to draw your attention to is the fact that revenue from non-Mac hardware sales increased by $80M QoQ. That's the key to Apple reaching its earnings target (both revenue and income), and that extra $80M most likely comes from .Mac and Jaguar. Unlikely to be iPod sales because the unit levels announced isn't that different from previous quarters. In any case, the current level of peripheral/others sales is probably not sustainable, which is why Apple predicted that revenues are likely to be flat for the Christmas quarter as well.

Most of these details won't matter to the market as trading begins tomorrow. We can reasonably expect AAPL to be hammered back down to the $14 level due to the earnings release. With IBM meeting profit estimates and Dell increasing their revenue projections, Apple's results will be seen not as an industry-wide issue but rather a company-specific one.

So the lower limit for Apple remains the $12.50 floor defined by the 44k+ position in Oct 12.5 puts, and there's no real hope of pushing $15 for a few weeks. While we can anticipate a refresh of the PowerBook in this quarter, the best bet is to buy in the <$14 range and wait for $16-$17 in the January expiration cycle.


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