Apple Inc. 10-Q Summary: Quarter Ended March 28, 1997
Business Context and Reporting Period
This filing covers the quarterly period ended March 28, 1997, and the six-month period ended on that date. Apple Computer, Inc. (now Apple Inc.) reported continued declines in net sales, unit shipments, and market share during the period. The company is in the midst of a significant restructuring plan aimed at reducing costs and restoring profitability, which includes terminating approximately 3,500 employees and outsourcing manufacturing and logistics functions. A major strategic event during the quarter was the acquisition of NeXT Software, Inc. for $424 million, intended to provide the foundation for a new operating system.
Key Financial Metrics
| Metric | Q2 1997 | Q2 1996 | 6 Months 1997 | 6 Months 1996 |
|---|---|---|---|---|
| Net Sales ($ millions) | 1,601 | 2,185 | 3,730 | 5,333 |
| Gross Margin ($ millions) | 303 | (421) | 700 | 54 |
| Gross Margin % | 18.9% | (19.3%) | 18.8% | 1.0% |
| Operating Loss ($ millions) | (716) | (1,182) | (840) | (1,301) |
| Net Loss ($ millions) | (708) | (740) | (828) | (809) |
| Loss Per Share | (5.64) | (5.99) | (6.62) | (6.55) |
| Cash and Equivalents ($ millions) | 1,273 | 1,552 (Sep '96) | 1,273 (End) | 500 (End '96) |
| Operating Cash Flow ($ millions) | N/A | N/A | 194 | (175) |
| Long-Term Debt ($ millions) | 952 | 949 (Sep '96) | 952 | 949 |
Note: The Q2 1996 gross margin was negative due to a $616 million charge for inventory write-downs and order cancellations. The Q2 1997 results include a $375 million charge for in-process research and development related to the NeXT acquisition and a $155 million restructuring charge.
Material Changes vs. Prior Period
- Revenue Decline: Net sales decreased 27% year-over-year in Q2 1997 and 30% for the six-month period. This was driven by a 33% drop in Macintosh unit sales and a 44% drop in peripheral unit sales.
- Market Share Erosion: Apple's worldwide PC market share fell to 3.1% from 5.8%, and U.S. share dropped to 4.0% from 7.3%.
- NeXT Acquisition: The company acquired NeXT for $424 million ($319 million cash, stock, and debt assumption). This resulted in a $375 million non-cash charge for in-process R&D, significantly impacting the operating loss.
- Restructuring: A supplemental restructuring plan was announced, incurring a $155 million charge. Cumulative restructuring costs from Q2 1996 through Q2 1997 totaled $334 million ($179M in 1996, $155M in 1997).
- Credit Rating Downgrade: In Q2 1997, Standard & Poor's downgraded Apple's senior debt to 'B' and subordinated debt to 'CCC+'. Moody's downgraded ratings to 'B3' and 'Caa' and placed the company on negative credit watch.
Guidance, Outlook, and Risks
Outlook: Management expects net sales to remain below prior-year levels through at least the fourth quarter of 1997. The company does not expect to return to profitability until at least the fourth quarter of 1997, if not later. R&D and SG&A expenses are expected to decrease in the third and fourth quarters as restructuring benefits are realized.
Liquidity: Cash and cash equivalents totaled $1,273 million. The company expects to fund operations and restructuring costs (estimated at $170 million over the next 12 months) through current working capital and short-term borrowings. However, notes payable to banks are due prior to July 1, 1997, and there is no assurance that refinancing will be available.
Key Risks:
- Product Viability: Success depends on the timely delivery of a new operating system ("Rhapsody") based on NeXT technology and enhancements to the current Mac OS. There is no assurance of backward compatibility or developer support.
- Competition: Intense competition from Microsoft Windows and MS-DOS platforms, which dominate the market, continues to pressure pricing and margins.
- Supply Chain: Constraints on microprocessor availability (PowerPC) and reliance on third-party manufacturers for production introduce risks regarding quality, quantity, and flexibility.
- Legal: Ongoing litigation includes shareholder class actions, consumer class actions regarding monitor advertising, and a pending IRS tax dispute for years 1989-1991.
Investor Verification Checklist
- Refinancing Capability: Verify the company's ability to refinance $133 million in notes payable due before July 1, 1997, given recent credit downgrades.
- Restructuring Execution: Monitor the actual cash outflow for the $227 million accrued restructuring liability and the timeline for cost reductions.
- NeXT Integration: Assess the progress of integrating NeXT technologies into the Mac OS and the market reception of the "dual track" OS strategy.
- Inventory Management: Watch for further inventory write-downs or charges related to obsolete components, given the history of excess inventory.
- Market Share Trends: Track quarterly unit sales and market share data to determine if the decline has stabilized or is accelerating.