Apple's Sweet-and-Sour Season

The fourth quarter saw Jobs & Co. slip into the red, but only just -- and if you forget one-time charges, there's actually reason to cheer

By Charles Haddad

When it comes to the collapse of the PC market, computer makers can run, but they can't hide. For the past two years, Apple (AAPL ) did as good a job as anyone keeping one step ahead of tech's falling tower of Babel. Through a steady release of innovative products, such as the iPod MP3 player, it remained profitable through 2001 and much of this year as bigger players such as Hewlett-Packard (HPQ ), Compaq, and Gateway (GTW ) were badly hurt by tech's collapse.

Inevitably, the tumble finally caught up with Apple -- and hard. Its fourth-quarter numbers, released last week, tell the whole horrible story. Jobs & Co. reported a net loss of $45 million, or 13 cents a share, vs. a profit of $66 million, or 16 cents a share, a year earlier. The good news is that one-time charges are what drove it into the red. Apple wrote down $49 million for declining investments. Subtract such charges, and the business eked out $7 million in profit -- a whole 2 cents a share. That's almost enough to buy every shareholder a jawbreaker to celebrate. After all, not many tech concerns make a cent these days.


  Which brings me to the good news in Apple's fourth-quarter numbers. With $4.3 billion in cash, the company has the wherewithal to ride out the tough times. Better yet, signs of a turnaround are on the horizon. For starters, the advertising industry is starting to revive, especially in the higher end. TV experienced one of its strongest upfront ad-buying seasons in memory. Much TV advertising -- especially animation -- is done on Macs. Hopefully, this resurgence will prompt ad agencies to start upgrading their equipment.

The most hopeful news is that a very risky strategy appears to be paying off. Against great odds, Apple is succeeding in establishing its own chain of stores. And they're fulfilling their purpose: bringing in new revenue rather than draining Apple's coffers. As CEO Steve Jobs put it, Apple has built a $400 million business from scratch.

The figures are almost too good to be true. In the fourth quarter, revenue from the 40 stores nearly doubled from a year earlier, to $102 million. Each store is averaging $12 million a year in sales. Better yet, independent surveys show that 40% of their buyers are newbies to the Mac. In short, Apple's "switch" ad campaign is working, luring consumers away from Windows. I don't think this will lead to a huge jump in market share, but it will help Apple stay in the 3% to 5% range for all computers sold, which is good enough to stay relevant and profitable.


  Don't break out the party favors just yet, though. A close look at Apple's numbers is anything but reassuring. Quite frankly, its vital signs are weak. Mac shipments fell 14%, to 734,000, from the same quarter a year earlier.

All of its key markets are depressed, including publishing, graphic arts, and advertising. These are the businesses that are willing to pay the highest premiums to own the most powerful Macs, the machines with the highest margins for Apple. No wonder its gross margins, always among the highest in the industry, fell to 26.4% from 30.1% from a year ago.

In education, my worst fears are coming true. Despite such huge publicity coups such as persuading the state of Maine to equip every elementary schools with wireless-ready iBooks, sales to schools fell 12% year-over-year. In part, Apple can't do much to stem the fall-off in academic sales. Schools are the creatures of state and county governments, and their tax base has been clobbered in this no-growth recovery. Few districts are making big orders of new computers. But, sadly, those that are ordering are choosing the likes of Dell (DELL ) over Apple.


  The only good news here is that, while important, education has a much smaller impact on Apple's bottom line than publishing and graphics. Schools tend to buy the least expensive Macs with the smallest profit margins. A revival in advertising would give Apple a much bigger boost than selling every state on wireless iBooks.

In short, don't despair. Buds of future growth are sprouting amid the rubble of Apple's fourth-quarter earnings.

Haddad, Atlanta-based correspondent for BusinessWeek, is a long-time Apple Computer buff. Follow his weekly Byte of the Apple column, only on BusinessWeek Online

Edited by B. Kite

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