Apple's eMac Attack in Schools May Pinch Margins

Steve Jobs wrapped his thumb and forefinger around his nose, and Apple (AAPL Quote) is taking the plunge.

Monday morning, the market-share-light but accolade-heavy computer maker announced a new branch of the iMac family that dipped below the $1,000 barrier from day one. The new eMac is a computer for the education market, key terrain for Apple that has been troublesome since the company's golden age, as schools tried to keep up with the expanded dominance of the PC platform.

The dive in price will contribute to Apple's soft margins in the third quarter, already projected to be a little low. It should overcome that negative by boosting revenue during the heavy educational-buying season that is approaching rapidly. The eMacs won't launch until later in the quarter, limiting their impact to June sales.

Apple's eMac doesn't have any of the snazzy colors of the iMac line, but it has a 700-MHz G4 processor, a hefty 40-GB hard drive and 128 MB of memory, making it an attractive machine. Even more enticing, however, is the $999 price tag, which buys all of the above, a 17-inch flat-front monitor -- not to be confused with flat panel, the monitor is simply easier to read than a rounded-front monitor -- and a CD-ROM read/write drive. For an extra $200, schools can get a computer that can also read and write CD-ROMs as well as read DVDs.

"In the education market, the $1,000 mark is definitely a cutoff point," says A.G. Edwards' Brett Miller. "This version could very well drop down to maybe even $799, and we could see that be the entry level to the flat-panel model." The computer maker currently sells an older version of the iMac with the previous-generation G3 processor for $799.

Apple shares got a 4% boost in Monday trading from enthusiastic investors.

The machine is available only to educational customers, in an attempt to keep the high-revving sales of the desk lamp-esque iMac that started shipping in volume in March. Apple sold 220,000 units of the iMac in its March quarter, a number that Wall Street expects will nearly double in the June quarter. Those machines currently run from $1,399 to $1,799, following a $100 price increase to cover rising flat-panel display supplier costs.

Apple reported a 100,000 iMac backlog when it announced second-quarter earnings on April 17. Needham analyst Charlie Wolf believes those back orders alone cost Apple $35 per machine in air shipment, in addition to his belief that Apple is honoring flat-panel iMac orders placed before the $100 hike. Both factors will weigh down Apple's gross margins from the 27% second-quarter level.

Then again, Miller suggests the gross margin guidance could have included some sandbagging on Apple's part as it calculated the effects of the launch of the then-unannounced eMac. With such a low price point, the eMac will no doubt pinch Apple's margins; prior to the announcement, Wall Street was expecting third-quarter margin issues but a rebound in the fourth quarter up to 28% margins. The eMac may make that tougher.

"I thought they were being a little harsh," Miller says of Apple's margins, given that Apple says it will clear the iMac backlog by early May. "Why are they being hurt so bad on the margins? Now you know why: because they are being aggressive" on the eMac.