Scramble Saves Apple

After only delivering 125,000 flat panel iMacs up to the time of the Tokyo keynote, Apple shipped another 95,000 in the last ten days to bring the quarter in on target. The guidance figures from Fred Anderson, Apple's CFO, in January gave expectations of sales of $1.5bn and profits of $0.11 per share. Both of these were met, and they slightly exceeded the consensus of analysts estimates, from Thomson/FirstCall, of $1.46bn and $0.10. That Apple did everything possible to bring in these figures without stuffing the channel should increase confidence in the shares.

However profit was down to $40m from $43m last quarter because of reduced margins (now 27.4%). Cash and short term investments were maintained at $4.3bn and expenses at $381m.

Macs

Shipments were 813,000, up 8% from last quarter and 4% year on year. Apart from the 220,000 flat panel iMacs, Apple also sold 152,000 CRT iMacs, 141,000 iBooks (185,000 last quarter), and 89,000 PowerBooks (116,000 last quarter).

There has been no noticeable fall off in iMac sales since the recent price increases, and Apple will continue to airfreight iMacs until the backlog is cleared.

iPod

Sales dropped to 57,000 from 125,000 last quarter. Apparently this was less of a drop than the rest of the MP3 market experienced (-71%).

As discussed previously (Time to Update the iPod?), the iPod risks becoming another Newton. For it to be a success, Apple needs to reduce the price of the 5 GB entry level model and increase the devices (camcorders, etc.) it backs up and the software (Final Cut Pro, etc.) it works with. Until then, the user base will stay small and it will be a distraction rather than a serious contributor to the bottom line.

OS X

Over 3 million Macs have been sold with OS X installed, but no figures are available for the number of users. Apple hopes that the release of Photoshop 7 will help drive acceptance in the professional market.

Retail

Sales were strongly up from $48m to $70m at Apple's Retail Stores, reducing the quarterly loss from $8m to $4m. An average of 27 stores were open, with two more open by quarter end. After taking a breather to reevaluate retail, Apple expects to open another 20 by December 31.

Investors should remember that the stores received at least 10% of the 125,000 flat panel iMacs up to the time of the Macworld Tokyo keynote. As these needed little selling and would have been largely top end models - at an average selling price of $2,000 (including extra software, RAM, etc.) - these could account for sales of $25m.

As Fred says, Apple has taken many successful decisions in establishing the retail stores: placing them in high traffic upscale smalls, making them solution centers, emphasising service, and appointing knowledgeable staff. This has led to an average of 5,000 visitors per store per week, and 99% of visitors being willing to recommend them to their friends.

However the stores still need to average approximately $4m sales per quarter to break even. For this they need people who are used to and comfortable with closing sales on, what for most people, are major purchases. When Apple accepts this, the retail stores will have the success they clearly deserve.

The store within a store in CompUSA will also be strengthened, as another 50 outlets will have Apple personnel. Apple has seen marked sales increases from the 150 outlets already staffed in this way and equivalent success from trials in Europe where it will also look to rollout the program.

Going Forward

Guidance for this quarter is earnings flat ($0.11 per share) to up on sales of $1.6bn.

One of Apple's strengths over the past few years has been Fred's managing of investor expectations. Bad surprises quickly kill shares, and investors have long memories. So with Fred's emphasis that the earnings figure is very conservative, it is clear there is upside potential.

He expects the iMac backlog to be cleared by the end of May, with production to be less than 5,000 per day for the 90 day quarter. Margins will be reduced by the need to airfreight ($35 per unit), the still increasing cost of flat screens (another $10 per screen has been allowed for), and the still high cost of DRAM. Any decreases in these costs will quickly feedback into the margins, but this also leaves Apple more exposed to flat panel costs than other PC manufacturers.

In education, June was the best quarter last year, instead of the usual September (last July saw the poorly managed changeover to Apple's in house team). However, Apple continues to see deferrals of major contracts because of funding constraints caused by the economy. So a major question for investors is how much budget constraints will affect education purchases this quarter as these would usually give a strong boost to figures for the iBook and higher margin CRT iMacs.

Government sales last year saw strong growth of 50% from an admittedly small base. With the the increased security and connectivity of OS X, further strong double digit growth is expected this year, and 50% wouldn't surprise Fred.

Retail is expected to have a profitable quarter this year. However, given the size of the improvement needed and my comments above, I do not expect this before Q4 at the earliest.

So what should we expect in this quarter? An increase in Mac shipments to above 900,000 will largely come from clearing the backlog of flat panel iMacs. As many of these will be the lower priced models at old prices (hence reduced margins), they won't do much for profitability, but 400,000 of these seems reasonable. With education market purchases, CRT iMacs should at least be at the current level of 150,000. Similarly, portables should manage to reach this quarter's total of 230,000. Power Mac sales will probably decrease considerably, unless Apple is able to release powerful new models before Macworld in July.

In the longer term, Apple is targeting gross margins of 28%. This should be readily achievable as soon as it no longer needs to airfreight all iMacs. It is also looking for increased profit from increased sales rather than by increasing the margins. Combined with the commitment to increasing R&D and the targeted purchase of external software and software companies, this should be good for both Apple users and Apple investors.