Q2 \'04 Conference Call

Apple yesterday . Apple CFO Fred Anderson said he was "exceptionally" pleased with Apple's strongest March quarter in four years, which he said was driven by diverse product portfolio of hardware, software and service products as well as expanded distribution channels and strong online, retail, and channel sales. The conference call offered details on the opening date of the flagship London store, IBM chip production delays, the HP-Apple alliance, details on the retail segment, iTunes song/album pricing, iPod mini problems, and guidance for the June quarter.

Apple's soon-to-be CFO Peter Oppenheimer, who led most of the call with upcoming June retirement of Anderson, said that Apple achieved strong 29% year-over-year revenue in quarter and nearly 33% for the first half of the fiscal year 2004. Operating margin for the quarter was up to 3.2% for the quarter and 3.5% for the first half of the fiscal year, which Oppenheimer said was a testament to the company's business model, which would continue to flourish as revenue increased. Apple said it was focused on driving revenue growth rather than worldwide market share, as it only competes in a limited number of geographies and price-based product ranges.




Apple's pre-tax $7 million restructuring charge was a result of the Elk Grove manufacturing facility closure and due to reduction in marketing/sales staff, although it provided no details on the numbers of layoffs. Apple also noted that 42 percent of total sales made in the US were direct sales, which includes online, retail, and education sales. This was up from 35 percent for year ago quarter.




iBooks surprisingly strong, Power Macs sales slow



Apple's CPU shipments in each of the four Mac product categories declined sequentially from the holiday quarter--traditionally Apple's strongest quarter--by about 10%; however, surprising strong iBook unit sales--up almost 51% over the same quarter in 2003--drove unit sales up 5 percent from the year-ago quarter. Apple said strong iBook sales were a result of strong portable sales to higher education and more one-on-one initiatives as well as strong sales consumer and education sales resulting from the recent G4 iBook upgrade.



Apple shipped 217,000 iMacs, 201,000 iBooks, 174,00 Power Macs, and 157,000 PowerBooks in the second fiscal quarter 2004. One analyst noted that Apple's year-over-year increase in CPU sales (5%) was only a one-third of the industry growth, but Oppenheimer said that was in some part due to reduced channel inventory, now at 4-5 weeks. The reduced inventory reportedly affected Power Mac numbers the most.



Slower-than-anticipated Power Mac unit sales were also affected by Xserve G5 shipping delays. Apple said the XServe G5 began shipping in late March and most of the orders were still in backlog. Delays were caused PowerPC G5 CPU component constraints by its manufacturing partner IBM; however, Apple expects to fill all Xserve backorders in the June quarter, but that Apple wold be in a supply-demand balance by the end of the quarter as the production for Xserve was still was still ramping.



Oppenheimer estimated that the adjusted Power Mc unit sales was closer to 190,000. Apple had previously said it hoped to achieve 200,000 Power Mac unit sales after the launch of the Power Mac G5. In the Q&A, Apple said it now expects to have some quarters with more sales and other with less than the 200,000 target, depending on the product life cycle and seasonality. Apple also said the product mix of G5 Power Mac is much higher than the previous G4 sales.




iPod retail distribution expanded, iPod mini constrained



Apple said that iPod sales showed both a sequential growth by over 10% from previous holiday quarter with sales of over 807,000 units. The new record surpasses the previous quarter sales of 733,000 units. However, while unit shipments increased by nearly 75,000, revenue only increased by $8 million--resulting in a average unit selling price decline from nearly $350 to $337. The decline in unit price is consistent with Apple's projected decline in gross margins as it launched the iPod mini in the US.



Apple said its gross margins on the iPod slipped from 27% to 23%--a number which it expects to continue to fall as it begins shipping more iPod minis (the worldwide launch slipped to July) and HP launches its iPod-based digital MP3 player this summer. Apple said it anticipates 20 percent margins on its iPod going forward.



Apple also said it worked hard to expand the number of distribution points for its products, increasing the number of retail distribution points by nearly 50% in the quarter. Apple said it now had 12,000 distribution points worldwide--most of which were for the iPod and 80% of which were located outside the US. The iPod continues to be the No. 1 MP3 player according to NPDTechWorld (as noted by Apple).



Responding to questions about the 15GB iPod offer given to some Apple customers who had ordered the iPod mini, Oppenheimer said that it had made the offer to an "extremely small" number of people to whom Apple had been unable to deliver an iPod by the promised date.



Despite the delayed worldwide launch of the iPod mini, Apple said that iPod mini is very constrained and that with the upcoming worldwide launch, it doesn't expect to meet demand until the fourth quarter of this year. Apple said that components rather than manufacturing were constraining supply, but that it would "do whatever it takes" to meet demand by the end of the year.



Although Apple had only seen a limited amount of cannibalization of the higher-end iPods by the iPod mini, Oppenheimer said that the supply was very constrained and as more iPod mini's became available, it expected to see a larger number of people choosing the "mini" over the regular iPod.



Apple's retail stores "outstanding", announces London opening




Apple saw a 97% year-over-year increase in retail revenue and a 67% year-over-year increase in unit sales at its Apple retail stores. Apple's 78 stores generated $266 million in revenue, nearly double that of the year-ago quarter. Apple opened 5 new stores in the quarter, including its flagship San Francisco store. Average store revenue was $3.5 million (average of 75 stores)--up from $2.6 in the year-ago quarter.



Apple said it expects to open 10 more retail stores by end of the fiscal year for a total of 88 stores by September and that it will open its London "flagship" store by the end of the calendar year. Apple's foot-traffic decreased slightly from the seasonal high of 6,000 visitors per store per week last quarter to 5,800 visitors per store per week in the March quarter (and 4,400 visitors per store per week in the year-ago quarter). Apple said its stores generated a segment profit of $5 million along with $45 million in associated profit realized from manufacturing. Apple, however, declined to comment on the pending litigation on Apple store pricing discrepancies alleged by other resellers, citing coporate policy.



Apple also said that it had seen an increase in sales to business customers, as a result of its small business initiatives at the Apple retail stores. Apple said it saw a sequential increase from 10 percent to 13 percent in sales from its retail stores to small- and medium-sized businesses--which was also up from 5 percent in the year-ago quarter.



Portables, Higher Ed drive education sales



Apple said its US education CPU sales were up 10% year-over-year in the March quarter, which Apple said was over 3 times the market growth estimate by IDC. Apple's education revenue was up 18% from the year-ago quarter. "Results from the education channel were particular encouraging. These results give us reason to be optimistic as we head into the back-to-school season later this year." Apple also said that



Higher education drove the growth with over 40% year-over-revenue growth for the second quarter in a row. K-12 sales were flat year-over-year; however, and Apple said it closed a greater number of one-on-one initiative sales than the year-go quarter. This helped drive a "marked increase" in iBook sales, according to Oppenheimer. "Apple focus on student achievement and learning outcomes positions Apple uniquely in this market."




Americas, Europe shine, Japan slides



Revenue in the Americas (not including the retail segement) was up 29%, while revenue in Europe was up 33%; however, both only saw a slight increase of 7% and 5%, respectively, in Mac shipments. Combining sales from the Americas and Apple's retail sgement, US sales were up 39%, driven in part by recovering economy.



Revenue in Japan plummeted by 21% from the year-ago quarter (as did unit sales in Europe) despite the recent opening of a new Apple Store in Tokyo. Apple admitted it was "not happy" with the results in Japan and said that it had a number activities planned to make those results better. The company also noted that the slower sales in Japan may be due to unexpected localization delays in Mac OS X applications. Apple pointed to Quark Xpress 6.0, which it said is expected to be localized for Japan later this year. Apple said it expects to improvement in Japan as it launches the new initiatives.




Gross margins up, June quarter outlook strong



Apple's gross margins rose to 27.8%, slightly above the company's guidance of 27.5%. The sequential increase was due to a better-than-expected pricing for commodities and more typical warranty expense and product transitions relative to the December quarter. Operating expense was $468 million, excluding the $10 restructuring charge--about $8 million higher-than-expected primarily due to variable selling expense associated with higher revenues.



On March 24, Apple's Board of Directors granted restrictive stock units to select members of Apple's senior management, excluding the CEO: "The Board believes that basing the majority of an executive's pay on equity is the best way to align management's interest with shareholders' interest. The restrictive stock units will vest over 4 years. The Board views these R-issues as important means to retain key executives and does not anticipate making additional grants to these executives during the 4-year time frame." It will add an additional $3.8 million per quarter until fully vested; in addition, the company is reconizing a $6.2 million quarterly expense related Jobs' stock grant.




Apple's cash reserves were down to $4.594 billion, down $197 million sequentially despite $300 million senior debt retirement on Feburary 17, which has left the company debt free. Apple spent $35 million, including $20 million on its retail initiative. Apple DSO (days sales outstanding) improved to 28 days, while its internal inventory fell from 6 days to 4 days. Apple said its retail stores carry 2-3 weeks of inventory.



Looking ahead to the June quarter, Apple says it expects double digit year-over-year growth in both revenue and earnings. It is targetting revenue of $1.925 billion and earnings of $0.12-$0.13, which includes $10 million of additional restructuring related to the closing of its Elk Grove manufacturing facility in California. Apple said it also expects 28% gross margins in the next quarter, despite decreasing iPod margins. Apple said that software sales continue to be strong, with iLife '04 contributing to the success of the March quarter with over 400,000 copies sold on a standalone basis (not including those bundled on CPUs), a higher percentage of direct sales, and up-selling and an improved peripheral attach rate on its direct sales.



Apple expects that memory prices were going to continue to climb during the first part of the quarter, after which it expects some stabilization. The March quarter saw improved LCD prices, high memory prices, and that LCD panels for portables, which fell through the March quarter, will be flat going foward. Apple said it expects a normal decline in other components, although LCD display prices were trending upward.




Best Buy, iTunes, HP, etc.



Apple said the Best Buy pilot program had ended, but that some stores still continued to sell both iPods and Macs: "Best Buy continues to be a very key iPod channel for us. They also continue to sell CPU in some number of the stores. The pilot had run its natural course and we are still analyzing the data to conclude what to do moving forward."



Apple said it has received anecdotal evidence that suggest the iPod has stimulated CPU sales--with new users purchasing computers as well as Windows users purchasing a Mac as a second computer in the household.



Responding to iTunes song pricing, Apple said that the higher-than expected pricing on some albums was due to the disparity in pricing from different labels, but the the "vast majority" of the albums remain at $9.99 and songs remain at $0.99. Apple said the iTunes Music store showed a small profit in the March quarter and looked promising for the company. The company said it expected to provide an update on the iTunes Music Sales and the Pepsi promotion closer to the First Anniversary of the iTunes Store (end of April).



Responding to the various noted iPod mini problems, Apple said it was "highly confident" with the quality of the iPod mini, but that the number of complaints through AppleCare technical support are "extremely small;" Oppenheimer encouraged anyone with problems to contact AppleCare tech support.



Apple noted that iPod mini was not part of the HP-Apple alliance, but that it may be added in the future. HP has already shipped 300,000 computers pre-loaded with iTunes software and is on-track for shipping its digital music player this summer.

by MacNN Staff