Year in review: Finance

What a difference just six months make. For Apple, that time has been the difference between a strong, profitable first half, and a harrowing close in which it struggled to make it through the Christmas season as unscathed as possible.

“It’s like Apple came around a bend in the road driving 90 miles an hour and slammed right into a brick wall,” said Andrew Neff, Apple analyst at Bear, Sterns and Company. “It was only after the accident that they realized there were some things wrong with the car that led to the accident.”

Six months of bliss

A strong 1999 led Apple into a blazingly hot first two quarters of 2000, with the company posting a net profit of $233 million, or $1.28 per diluted share in the first quarter, compared to $135 million, or 84 cents a share, a year earlier. Apple’s net profit of $200 million, or $.55 per diluted share in the second quarter, compared to a net profit of $203 million, or $.60 per diluted share in the year-before quarter.

Things got even better in the following three months. Apple sold 1,016,000 units during the second quarter, including more than 350,000 Power Mac G4 systems and nearly 450,000 iMac systems, driving unit growth of 12 percent. Hardware sales stayed solid from January to July, as the company outlined its Mac OS X and Internet strategies (including an ISP partnership with EarthLink) in January; upgraded desktop and portable products in February; added Circuit City as a Mac retailer in July; and revamped its hardware line in July.

Through June, Apple had 11 consecutive profitable quarters, with net profits up 43 percent. “The turnaround is over,” Chief Financial Officer Fred Anderson told analysts in July. “We’re now in the early stages of a strong growth story.” Little did he know that a number of admitted miscues and a slowing economy would knock the train off the tracks.

The slowdown

Buried in the financial numbers for the second quarter were signs that sales were slowing.

“iMac sales were a bit below expectations (in fiscal third quarter),” Anderson said in July. He blamed the slump on anticipation of new products and disagreed with other PC-industry analysts who had been reporting that slowing sales were an industry-wide problem.

An analysis of online sales through catalog retailers showed that Apple’s sales began a downward move in April and dramatically plummeted in early July — clear signs that the company would soon have to reassess its future earnings outlook.

“Things were going very well in early April,” said Tim Haight, vice president of OneChannel.net’s editorial content. “Online sales from e-retailers were up 92 percent compared to the first week in January. But in early July, sales went south, off 30 percent for example, in the week ending July 8.”

The “speed bump”

While new iMacs gave Apple a burst of sales energy, it wasn’t enough to turn the tide. It was clear in late September that new products would not save Apple from a re-evaluation of third quarter and fourth quarter earnings. Apple warned analysts and investors on September 28 that fiscal fourth-quarter profits would fall “substantially below expectations,” some 27 percent below what analysts had forecast.

Anderson blamed the shortfall on slower September sales, lower educational sales that usually peak in September and slower Power Mac G4 Cube sales.

“We’ve clearly hit a speed bump,” Jobs said.

Other PC makers were also indicating softening sales, but for Apple to lower its earnings forecast from the expected 45 cents a share to about 30 cents was more than a little surprising for many market analysts.

“Sure, we have known for the better part of this year that a PC downturn was coming,” Scott Bleier, chief investment strategist at Prime Charter Ltd., said in October. “But for Apple, the downturn is worse because they sell less boxes to the business market and more to the more volatile consumer market.”

The company’s stock took a beating, losing half its value in a matter of hours. Days later, Apple implemented a hiring freeze, but not even that could cushion the final fourth quarter numbers, which came in at 30 cents a share on profit of $108 million.

The blame game

During conference calls with analysts, Steve Jobs pointed to several factors behind the company’s poor financial numbers.

Several of Apple’s problems — a misconception among consumers about processor speed, the lack of a CD-RW drive, an overpriced G4 Cube, bad timing in taking back educational sales from independent dealers — are of Apple’s own making, Jobs admitted in October and December. But he also pointed to Motorola and its inability to deliver faster G4 processors in a timely fashion for much of Apple’s woes.

“Apple has been unable to ship G4 processors running above 500MHz for the past year due to our G4 processor suppliers inability to provide us faster processor chips,” Jobs said. “Our plan is to begin closing the ‘megahertz gap’ during the first half of calendar 2001 and to make substantial progress during the remainder of the year.”

It only gets worse

Even after kicking in new marketing promotions and rebates of up to $500, it was apparent in late November that a continued softening of the U.S. economy and a general slowdown in PC sales meant that Christmas would not be a merry one at 1 Infinite Loop.

In early December, Apple warned that fiscal first-quarter 2001 revenue would be about $1 billion, or some $600 million less than already-reduced projections, as the company braced for a quarterly loss as great as $250 million — its first loss in three years.

Apple revealed that it was sitting on 11 weeks worth of inventory, and that clearing out the stock would mean lower-than-expected earnings for not only the current quarter, but deep into 2001. Still, Jobs said Apple expects to return to profitability in the January-to-March quarter, assuming it can exit this quarter with a more-normal six weeks worth of inventory.

The skeptical fix

Analysts largely agree that Apple must clear out inventory, roll out new, faster and cheaper products and release Mac OS X before the end of March — all things Jobs has promised for sooner rather than later.

But even then, analysts are pessimistic that Apple can stage one of its famous turnarounds in just three months, given that the fiscal second quarter is historically its slowest for sales.

“I am not convinced they can make a profit in the (fiscal) second quarter, much less break-even,” said Merrill Lynch & Co. Inc. analyst Steven Fortuna. “They say they will be able to get rid of existing inventory and get rid of their current problems. Fine. But, they have to come out with new products in January and hope the economic and PC industry slowdowns don’t get worse. That’s a big ‘if’.”

“Consumers just aren’t spending money on PCs. It’s just that simple,” commented Dan Niles, an analyst at Lehman Brothers in San Francisco. “This new projection is about 40 percent less than the earlier projection. It shows that everything they did to try and spur sales — rebates, price cuts, and new promotions — simply didn’t cut it. Their estimate was way off. A profit in the second quarter? Doubtful.”

Most analysts believe the slowdown in personal computer sales will continue into the new year, resulting in additional price reductions. But for Apple, analysts think it is more vulnerable to these conditions because consumer sales are at the core of its business.

“I’m hopeful (for Apple), but a realist,” said Charles Wolf, Apple analyst at Warburg Dillon Read. “This economic downturn is hitting all PC makers. Apple is going to have to be gutsy and different. But I wouldn’t expect less from Steve Jobs.”

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