Q1 '04 - Changing Horses in Midstream

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By Plato90s
January 22, 2004

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Apple ends calendar 2003 on a fairly high note, introducing a new iPod, more online services, and the highest single quarter revenue level since the dot-com boom. This must be an Apple running on all cylinders, pumping out one great product after another.

Starting with the consumer desktop segment, the iMac and eMac has posted the worst unit shipment numbers in the last 4 years. Apple shipped more iMacs after the black Friday of 2001 than it did in the last quarter. In fact, iMac unit sales level is the absolute lowest level ever for Apple since the original introduction of the bondi-blue iMac. To hit this level during the Christmas shopping season simply understates the fact that the Apple consumer desktop line is on life support. It's dying. And Apple shows no apparent interest in reviving it.

At an average selling price (ASP) of ~$1,100 and with the cheapest LCD-iMac starting at $1,300, there is just no value for Apple in this design. People don't want to pay for an expensive component like an LCD which is permanently linked to a single-CPU desktop in the 1.25Ghz or less range. While it may still appeal to a small niche, the LCD-iMac has now gone the route of high price tag, low market appeal.

Moving on to the consumer laptop segment, is it possible that this being the "year of the laptop", consumers simply switched their purchases to iBook instead of the iMac?

That is true to some extent, since iBook sales increase dramatically QoQ, coming off one of its worst quarters. There was some loss in the ASP as well, but that's to be expected given current economic situations.

The overall picture is not as rosy, since total unit sales for iMac + iBook is 448k, compared to 484k last year. That's 7.4% YoY decline in the consumer price-range products during a year in which Gartner/IDC estimate worldwide PC shipment growth in the Christmas quarter to be at least 8% higher.

So individually, the iBook is doing well and possibly taking some sales from would-be consumer desktop customers, but Apple is still losing sales in this market segment. Where are these customers?

Perhaps they are buying PowerBooks instead, which also had an impressive Christmas season, with over 70% increases YoY. The introduction of the eBook (aka 12" PowerBook) has had the desired effect of driving volume back into the PowerBook segment. The unit sales have steadily increase, paced by the steady decrease in prices as well. More people moved to the high end 17" models, but the PowerBook seem unlikely to recover the $2200+ ASP level.

With 195k PowerBooks sold, we seem to have found Apple's missing customers. Now, we have a quarter which has steadily improved year after year from the lows of 2000.

Unfortunately, the PowerMac line looked a bit unhealthy. With only 6 weeks worth of G5 shipments in Q3, Apple managed unit sales of 221k PowerMacs. With a full quarter, plus a new dual 1.8Ghz model, only 206k were sold.

This is a line which is usually unaffected by holiday buying, since pro desktops aren't exactly the kind of item you expect to find under a Christmas tree, so the data suggests that the initial surge of purchases for the PowerMac G5 has already died out after less than 6 months.

Another possibility is that many of the target audience for the PowerMac G5 has already exhausted their budget and is holding off on purchases until calendar Q1. This will be a trend to be observed in the coming months.

Viewed as a whole, this must be a very merry Christmas in Apple's HQ.

Step back from the stellar Q1 for a moment and let's look at Apple's year, as a whole.

What about revenue and profits? After all, the reason to sell things is to make money

CY 2002 -> $21M net income on $5.839B revenue
CY 2003 -> $137M net income on $6.741B revenue

Pretty good news, except for all those one-time items cluttering the balance sheet. Then it looks even better. Apple went from a -$16M loss in CY 2002 to a $110M operation profit in 2003. Clearly, this is a company which no longer depends on equity sales and earned interest to generate the majority of its income.

Geographically, despite stagnant sales in Japan and disappointing unit sales in Americas, Europe had a phenomenal quarter with revenue outstripping unit sales. It's hard to be certain without the full 10-Q, but the most likely explanation is the 30%+ appreciation of the euro and the significant gain of the UK pound against the dollar over the last 3 months. Even a small increase in the amount of sales can generated a lot more USD than it did last year, and the European segment is up by more than 20%.

On the retail side, it had an amazing quarter with 41% increase in revenue on only 24% increase in CPU unit shipment. Given that all but 1 retail outlet is in the US, there can be no currency effects. Thus it leads logically to the conclusion that the majority of the new revenue is based on peripheral and third party product sales.

In fact, such sales (including iPod) now constitute 36.7% of Apple's total revenues. It is, in fact, the biggest single revenue segment of Apple. The iPod alone outsold 2 of Apple's 4 CPU hardware lines.

That's why Apple is being viewed with concern from some quarters despite having a stellar quarter and a year of great improvements from CY 2002.

In the full calendar year of 2002, Apple shipped 3.098M Mac's.

In the full calendar year of 2003, Apple shipped 3.098M Mac's.

In a year where global PC shipment is estimated to have grown in excess of 11%, Apple is flat. 0% growth in shipment means shrinking market share. The vast increase in out-of-the-box sales doesn't alleviate the concern that Apple has steadily shrunk in market share for the last 4 years.

It can be profitable to be a full solution (hardware, OS, peripheral, software) provider, but not as profitable as the Apple of 5 years ago. During the boom years, Apple average 28% gross margin and 6-10% net operating margin.

In this last quarter, Apple's gross margin is 26.7% and the net margin is 3.7%. And this is a good quarter. Last quarter (Q4 '03), the net margin was 1.8%.

The main thing which worries investors bearish on Apple is the fact that Apple's enterprise value is so low. In CY1999, Apple was at $6.767B in revenue, compared to $6.741B in CY2003, yet the operating income of 1999 was 3x higher ($332M vs. 110M).

A wider product range is good to pump up the top-line revenue growth, but Apple is far more profitable when it actually sells a lot of Macs. Apple Inc. in 2004 is a markedly different company than it was in 1999.

Less profitable, but perhaps with more longevity due to the greater breadth of its product line. Yet AAPL today trades at a higher level than it did in 1999, despite the lower profit potential of the new Apple. It's an open question whether Apple can deliver long term profit growth, or just revenue growth through diversification into lower margin products.

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