Apple Inc. 10-Q Summary: Quarter Ended June 28, 2003
Business Context and Reporting Period
This filing is a Quarterly Report (Form 10-Q) for Apple Computer, Inc. (now Apple Inc.) for the three and nine-month periods ended June 28, 2003. The company designs, manufactures, and markets personal computers, peripherals, and software. The reporting period covers the third quarter of fiscal year 2003, a time characterized by the launch of the iTunes Music Store, the introduction of new iPod models, and ongoing restructuring efforts to align costs with market conditions.
Key Financial Metrics
| Metric (in millions) | Q3 2003 | Q3 2002 | 9M 2003 | 9M 2002 |
|---|---|---|---|---|
| Net Sales | $1,545 | $1,429 | $4,492 | $4,299 |
| Gross Margin | $428 (27.7%) | $391 (27.4%) | $1,252 (27.9%) | $1,222 (28.4%) |
| Operating Income (Loss) | $9 | $13 | $(32) | $37 |
| Net Income | $19 | $32 | $25 | $110 |
| Diluted EPS | $0.05 | $0.09 | $0.07 | $0.30 |
| Cash & Equivalents | $3,507 | $2,252 (Sep 2002) | $3,507 | $2,252 (Sep 2002) |
| Short-term Investments | $1,038 | $2,085 (Sep 2002) | $1,038 | $2,085 (Sep 2002) |
| Total Debt (Current) | $307 | $0 | $307 | $316 (Long-term) |
Note: Debt of $300 million in unsecured notes was reclassified from long-term to current as it matures in February 2004.
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 8% year-over-year in Q3 and 4% for the nine-month period. This growth was driven primarily by a 130% increase in Retail segment sales and a 405% surge in iPod sales.
- Profitability Decline: Despite revenue growth, operating income fell to $9 million in Q3 from $13 million in the prior year. For the nine-month period, the company reported an operating loss of $32 million compared to an operating income of $37 million in the prior year. This was largely due to increased operating expenses and restructuring costs.
- Product Mix Shift: Total Macintosh unit sales declined 5% in Q3 and 6% for the nine-month period. Desktop sales (Power Mac and iMac) fell significantly (20% and 24% respectively for the nine months), while portable sales (PowerBook and iBook) increased. The decline in high-margin desktop sales pressured overall gross margins.
- Restructuring: The company incurred $26 million in restructuring costs during the first nine months of 2003, primarily related to the closure of Singapore manufacturing operations and headcount reductions in sales and marketing.
- Investment Income: Interest and other income decreased 35% in Q3 and 37% for the nine-month period due to lower market interest rates and the sale of short-term investments.
Guidance, Outlook, and Risks
Management Outlook (Q4 2003):
- Sales: Expected to increase by a high single-digit percentage compared to Q3.
- Earnings: Expected to show a slight sequential increase.
- Gross Margin: Expected to be approximately 100 basis points lower than Q3 due to lower Mac OS sales and manufacturing ramp-up costs for the new Power Mac G5.
- Operating Expenses: Expected to be approximately $420 million (excluding ~$10 million of capitalized software costs).
- Interest Income: Expected to decline to approximately $10 million due to lower yields.
- Tax Rate: Expected to remain at 28%.
Key Risks and Contingencies:
- Product Transitions: Success depends on the market acceptance of the upcoming Power Mac G5 and Mac OS X "Panther" releases.
- Education Market: Continued weakness in the U.S. education channel due to funding pressures and competition.
- Supply Chain: Risks related to component shortages, particularly microprocessors, and potential disruptions from the SARS outbreak in Asia.
- Legal Proceedings: Ongoing shareholder class action lawsuits regarding stock purchases between 2000 and 2001; the company intends to defend vigorously.
- Regulatory: Potential financial liability from the European Union's Waste Electrical and Electronic Equipment Directive regarding recycling obligations.
Investor Verification Checklist
- Power Mac G5 Ramp: Verify the timing and initial market reception of the Power Mac G5 launch in Q4 2003, as this is critical for reversing desktop sales declines.
- Retail Segment Economics: Monitor the Retail segment's path to profitability, given its significant operating losses ($6 million for 9M 2003) and high fixed costs (lease commitments of $304 million).
- Education Channel Recovery: Assess whether the 5% unit sales growth in Q3 education is a trend reversal or a temporary fluctuation amidst broader budget deficits.
- Stock-Based Compensation: Note that the company currently uses the intrinsic value method (APB 25) for stock options. Pro forma net loss under the fair value method (SFAS 123) was $(110) million for the nine months ended June 28, 2003. Investors should monitor FASB developments regarding mandatory expensing.
- Debt Maturity: Confirm the company's plan to utilize existing cash balances to settle the $300 million debt maturing in February 2004.