Bill Snyder

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Apple Sales Rise, Shares Dip

Bill Snyder

Updated from 9:41 a.m. EST

Led by strong sales to consumers, Apple Computer beat Wall Street's earnings expectations for the December quarter and reported its best sales in four years, the computer maker reported after the close on Wednesday.

Nonetheless, a small slip in margins due to some quality problems, and a somewhat slower-than-expected transition to the fast newG5 Macs, apparently disappointed some investors. As a result shares of Apple dropped Thursday, along with other technology companies.

As of 11:00 a.m. EST, Apple stock was off $1.24, or 5.1%, to $22.96.

Wall Street's reaction to the report was well summed up by the headline on a note by Morgan Stanley analyst Rebecca Runkle. "Apple: Firing on most cylinders."

For the fiscal first quarter of 2004, the Cupertino, Calif., company earned a net profit of $63 million, or 17 cents a share, compared with a loss of $8 million, or 2 cents a share, a year earlier. The quarter's results included an after-tax investment gain of $3 million, which increased earnings per diluted share by a penny. Analysts polled by Thomson First Call were expecting a profit of 15 cents.

Sales jumped 36% year over to $2.006 billion, a bit better than the $1.932 billion expected by Wall Street.

Gross margins were 26.7%, down from 27.6% in the year-ago quarter, and 40 basis points below prior guidance.

Apple, which has had product-quality problems in the past, took a larger warranty reserve to cover problems with the screens of some notebooks. The problem with the displays has been cured and should not appear in newly manufactured machines, the company said.

Looking ahead, Apple expects to earn between 8 cents and 10cents a share on revenue of $1.8 billion for its current, second quarter. Analysts expected earnings of 7 cents a share on sales of $1.7billion.

With Apple constantly fighting to increase share against so-called Wintel machines, keeping the technology edge is a key, so as lower-than-expected rollout of the robust PowerMac took a bit of the luster off the report.

PowerMac sales were definitely disappointing -- 206,000 units for $398 million, vs. expectations of 250,000 units and $446 million, commented Fil Zucchi, managing member of Zebra Fund, LLC, a long/short equity/options fund, and a contributor toStreetInsight.com.

"This is probably the reason the stock is getting hurt."

Another problem: iMac units declined 10% sequentially and 24% year over year compared to expectation of flat quarter-to-quarter performance, said Morgan Stanley's Runkle, who nevertheless raised her second-quarter EPS estimates to 9 cents. Runkle, whose company is seeking investment banking business with Apple, advised investors to monitor PowerMac sales and inventor levels "since this is such a key product."

As is often the case, Apple's strong run up in recent months left some investors feeling that the stock is a bit pricey, and at least one analyst expressed concern that the company's cost model is still quite high.

Last week, the company surprised industry watchers by announcing it will supply its popular iPod portable music players to Hewlett-Packard , which will then resell them with an H-P label.

"For Apple, it represents the ability to further accelerate unit growth and gain volume -- which it needs to leverage its cost structure -- by tapping into H-P's massive distribution capabilities," commented Joel Wagonfeld, a principal of First Albany. "However, the fact that Apple has agreed to supply its most successful product to a key competitor on a Wintel platform ... provides an important signal. We think this move reflects Apple's difficulty in driving increased PC penetration via its new non-PC offerings," he said in a note to clients. First Albany does not have a current investment banking relationship with Apple.

Music has been a key to Apple's resurgence, and strong iPod sales were responsible for at least part of December's revenue surprise. Since the company launched its iTunes music store in April, the stock has shot up nearly 75%. That's true despite Apple's still-diminutive PC share: In 2003, it claimed less than 2% of the global market by units, according to estimates from Gartner Dataquest and Merrill Lynch.

On Tuesday, Merrill Lynch -- which had dropped coverage of the stock -- issued a report recommending investors buy the shares.In the note, analyst Steve Milunovich predicted sales will jump 18% in fiscal 2004 to $7.3 billion, while EPS will double to 42 cents.

"We think Apple has gotten its act together in focusing on core markets, building a mature management team, and most important innovating again," he wrote. Merrill has a recent investment banking relationship with Apple.