The Small Apple: Falling Far From the Expectations

Updated from 5:17 p.m. ET

There's only so long a 10% Nasdaq rally could have made investors forget about the sickly PC sector.

Apple (AAPL Quote) warned after the close of regular trading Tuesday that its fiscal first-quarter sales and earnings would each come in below expectations. The company said it expects sales for the period ending Dec. 30 to total a scant $1 billion, a considerable $600 million below the consensus forecast of analysts polled by First Call/Thomson Financial and more than $1.3 billion below the company's sales in the year-ago period. The first-quarter shortfall forced Apple to lower its guidance for fiscal 2001 sales to $6 billion to $6.5 billion, well shy of the previous $7.8 billion consensus.

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"The magnitude of this thing is huge," said Lehman Brothers analyst Dan Niles. "They lowered $1.6 billion down to $1 billion? That's a 40% miss. That's enormous. It's got to be one of the biggest misses, on a percentage basis, that I can remember on the top line." (Lehman hasn't done recent underwriting for Apple.)

Apple said slow sales in October and November have left it with about 11 weeks of inventory in the retail channel, about five or six weeks more than it likes to maintain. The company hopes that aggressive discounting will help it get inventory down. But the price-slashing comes at the expense of profit margins and is coupled with a big promotional campaign that will add $135 million to Apple's expenses.

The Horror

Thus the bottom line looks as horrid as the top line. Apple said that it expects to post a net loss of $225 million to $250 million in the first quarter. Analysts had already reduced their estimates for the quarter to a meager gain of 3 cents, down from the year-ago's 50 cents.

CEO Steve Jobs was in confessional mode on the conference call the company held following the warning. Apple's microprocessors looked underpowered by industry standards, he admitted. The company had frittered away its once formidable lead in the education market and underestimated consumers' interest in read/write CD drives. In each case, he promised, Apple would fix what ails it. And who knows? Maybe the release of OS/X, the company's next-generation operating system, would unleash some much-needed demand from consumers. Apple would be profitable again in the fiscal second quarter, which ends in March, Jobs reassured analysts on the call.

Industry mavens rarely tire of claiming that it's difficult to generalize Apple's problems to the rest of the PC and PC-dependent sector. Apple, whose products run a proprietary operating system and use proprietary microprocessors, is generally considered distinct from commodity players like Dell (DELL Quote) and Hewlett-Packard (HWP Quote), which build machines using the Windows operating system and chips made by Intel (INTC Quote) or Advanced Micro Devices (AMD Quote).

But it looks like everyone is at risk this time. Apple's warning is further evidence that the holiday sales rush just isn't coming this year. Gateway last week (GTW Quote) told investors that a horrible Thanksgiving weekend would keep it from meeting estimates. Hewlett-Packard also said it was seeing softer-than-expected sales. The longer this goes on, the greater the chance that other PC makers will start confessing that inventories are getting out of control, even with aggressive price-cutting.

"You've got to give them credit for one thing," Niles said of Apple. "They're admitting that they have a problem, and they're taking drastic measures up front. Other vendors are going to be seeing a little channel inventory. I was in the store the other day -- I think it was Circuit City -- and I had three sales people seeing if they could help me. It's ugly out there."

Butt-ugly. Apple was lately sitting at $14.78 on Island after finishing regular trading at $17.