Apple Inc. 10-Q Summary: Quarter Ended June 26, 2004
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended June 26, 2004 (Fiscal Q3 2004) and the nine-month period ended June 26, 2004. Apple Computer, Inc. designs, manufactures, and markets personal computers (Macintosh), the iPod digital music player, and related software and peripherals. The company operates through geographic segments (Americas, Europe, Japan) and a Retail segment.
Key Financial Metrics
| Metric (in millions) | Q3 2004 | Q3 2003 | 9M 2004 | 9M 2003 |
|---|---|---|---|---|
| Net Sales | $2,014 | $1,545 | $5,929 | $4,492 |
| Gross Margin | $559 (27.8%) | $428 (27.7%) | $1,625 (27.4%) | $1,252 (27.9%) |
| Operating Income | $72 | $9 | $198 | $(32) |
| Net Income | $61 | $19 | $170 | $25 |
| Diluted EPS | $0.16 | $0.05 | $0.45 | $0.07 |
| Cash & Equivalents | $3,120 | $3,396 (Sep 2003) | Short-term investments: $1,846 | |
| Total Liquidity | $4,966 (Cash + Short-term investments) | |||
| Debt | $0 | $304 (Current) | $300M notes repaid in Feb 2004 | |
| Operating Cash Flow (9M) | $491 | $216 |
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 30% year-over-year in Q3 and 32% for the nine-month period. This was driven by a 124% increase in iPod sales and an 86% increase in Retail segment sales.
- Profitability: Operating income surged from $9 million in Q3 2003 to $72 million in Q3 2004. The company returned to profitability for the nine-month period ($198M) compared to a loss of $32 million in the prior year.
- Product Mix: Macintosh unit sales grew 14% in Q3. However, iMac sales declined 22% due to a shift in consumer preference toward portables and pricing pressure. Power Mac and PowerBook sales increased significantly.
- Restructuring: The company incurred $8 million in restructuring costs in Q3 2004 (vs. none in Q3 2003), primarily related to the closure of the Sacramento manufacturing facility and headcount reductions.
- Debt Repayment: The company repaid its $300 million unsecured notes upon maturity in February 2004, resulting in zero debt outstanding as of June 26, 2004.
Guidance, Outlook, and Risks
- Supply Constraints: Management warned that manufacturing problems at IBM, the sole supplier of the G5 processor, constrained Power Mac sales in Q3 and are expected to constrain shipments in Q4 2004. The launch of the new iMac (G5-based) was delayed to September 2004.
- Capital Expenditures: The company anticipates utilizing approximately $200 million for capital expenditures in fiscal 2004, with $121 million allocated to Retail segment expansion.
- Executive Health: CEO Steven P. Jobs underwent successful surgery for a pancreatic tumor in late July 2004 and was expected to return to work in September 2004. Tim Cook assumed day-to-day operations during his recovery.
- Legal Proceedings: The company faces various litigation, including shareholder class actions regarding stock price (dismissed but appealed), patent infringement claims (e.g., Antor Media, Compression Labs), and consumer class actions regarding iPod battery life and iBook logic boards. Management believes none will have a material adverse effect.
- Stock-Based Compensation: The company continues to use the intrinsic value method (APB 25) but disclosed pro forma net income would be significantly lower ($36M for Q3) if the fair value method (SFAS 123) were applied.
Investor Verification Checklist
- IBM G5 Supply Chain: Verify the status of IBM's G5 processor manufacturing issues and their impact on Q4 2004 revenue guidance.
- Retail Segment Economics: Assess the sustainability of the Retail segment's profitability ($7M Q3 profit) given the high fixed costs of leases and the $386 million in outstanding retail lease commitments.
- iMac Transition: Monitor the September 2004 launch of the new G5-based iMac to determine if it can reverse the 22% decline in iMac sales.
- Stock Compensation Impact: Review the potential financial impact of the proposed FASB standard requiring the expensing of stock options, which could materially reduce future reported earnings.
- Legal Exposure: Track the status of the shareholder class action appeal and the consolidated iPod battery life litigation.