Apple Inc. 10-Q Summary: Quarter Ended March 29, 2003
Business Context and Reporting Period
This filing is a Quarterly Report on Form 10-Q for Apple Computer, Inc. (now Apple Inc.) for the three and six-month periods ended March 29, 2003. The company designs, manufactures, and markets personal computers, peripherals, and software. The reporting period covers the second quarter of fiscal year 2003, a time characterized by weak global economic conditions, a transition to the Mac OS X operating system, and significant expansion of the company's retail segment.
Key Financial Metrics
| Metric (in millions) | Q2 2003 | Q2 2002 | 6 Months 2003 | 6 Months 2002 |
|---|---|---|---|---|
| Net Sales | $1,475 | $1,495 | $2,947 | $2,870 |
| Gross Margin | $418 (28.3%) | $409 (27.4%) | $824 (28.0%) | $831 (29.0%) |
| Operating Income (Loss) | $(4) | $28 | $(41) | $24 |
| Net Income | $14 | $40 | $6 | $78 |
| Diluted EPS | $0.04 | $0.11 | $0.02 | $0.22 |
| Cash and Cash Equivalents | $3,410 | N/A | N/A | N/A |
| Total Short-Term Investments | $1,116 | N/A | N/A | N/A |
| Current Debt | $310 | N/A | N/A | N/A |
Liquidity: As of March 29, 2003, the company held $4.526 billion in cash, cash equivalents, and short-term investments. Working capital was $3.461 billion. The company generated $208 million in cash from operating activities for the six-month period.
Material Changes vs. Prior Period
- Revenue: Net sales decreased 1% year-over-year for the quarter but increased 3% for the six-month period. This was driven by a 93% increase in Retail segment sales and strong growth in PowerBook and peripheral sales, offset by declines in Power Macintosh and iMac unit sales.
- Profitability: Operating income turned negative for the quarter ($(4) million) compared to $28 million in the prior year, primarily due to increased operating expenses and restructuring costs. Net income dropped 65% to $14 million.
- Restructuring: The company incurred $26 million in restructuring costs for the six months ended March 29, 2003, compared to $24 million in the prior year. This included the closure of a Singapore manufacturing facility and headcount reductions.
- Segment Performance: The Retail segment saw net sales surge to $135 million (up 93% YoY), while the Americas, Europe, and Japan segments all experienced declines in net sales ranging from 3% to 7%.
Guidance, Outlook, and Risks
Outlook: Management expects net sales, gross margin, and total operating expenses to be relatively flat in the third quarter of 2003 compared to the second quarter. Interest and other income is expected to decline significantly to approximately $15 million due to lower interest rates and portfolio repositioning. The company anticipates a slight profit for the third quarter.
Management Commentary:
- Product Mix: Strong demand for PowerBooks and peripherals (including iPod) is offsetting weakness in professional desktop systems (Power Macintosh) and the education channel.
- Retail Expansion: The company opened two new stores in Q2, bringing the total to 53. Retail sales are increasingly incremental to total company sales.
- Accounting Changes: Adoption of SFAS No. 143 (Asset Retirement Obligations) resulted in a $2 million cumulative-effect adjustment to net income.
Risks and Contingencies:
- Legal: Three shareholder class-action lawsuits regarding stock purchases between 2000 and 2001 are pending; the company intends to defend them vigorously. A patent infringement suit by Pitney Bowes was settled in Q2 2003 for a non-material amount.
- Regulatory: The EU Waste Electrical and Electronic Equipment Directive may impose substantial future liabilities for recycling and disposal, though specific costs cannot yet be estimated.
- Market: Continued weak economic conditions, intense price competition, and the transition to Mac OS X are delaying upgrades by professional and education customers.
- Supply Chain: Risks related to the SARS outbreak in Asia and dependency on single-source suppliers for key components (e.g., microprocessors).
Key Facts for Investor Verification
- CEO Compensation: Verify the impact of the March 2003 agreement where CEO Steve Jobs exchanged 27.5 million stock options for 5 million shares of restricted stock, valued at $74.75 million, to be amortized over three years.
- Stock Option Exchange Program: Confirm the details of the voluntary program announced in March 2003 allowing employees to exchange out-of-the-money options for new options at fair market value, and its potential dilutive effect.
- Retail Segment Economics: Assess the sustainability of the Retail segment's growth, noting it still reported an operating loss of $4 million for the six-month period despite significant sales growth.
- Interest Income Volatility: Monitor the decline in interest and other income, which is expected to drop to $15 million in Q3, significantly impacting net income given the company's thin operating margins.
- Power Macintosh Decline: Track the continued decline in Power Macintosh unit sales (down 26% YoY), which impacts overall gross margin as these units typically carry higher margins.