The Mac Observer--Complete Transcript Of 4th Quarter Conference Call

October 14th, 1999

[11:10 AM] Complete Transcript Of 4th Quarter Conference Call
Apple's Fourth Quarter Conference Call with Analysts

This article is a transcript of Apple's conference call conducted by Fred Anderson, Apple Computer's Chief Financial Officer, late yesterday afternoon. It's a rare, in-depth view Apple only provides professional analysts, the financial press and now--thanks to the Internet--you. See the Apple press release for the consolidated balance sheets.

Remember, that except for the historical information contained herein, the statements below are forward-looking and involve risks and uncertainties.

The conference call began with a review of the financial numbers from the press release. Then, an Apple employee introduced Mr. Anderson. Thus begins our transcription.

Mr. Anderson: Thank you Nancy, as our press release indicates, income before non-recurring items was $90 million, slightly above the earnings estimate of $75 to $85 million, announced on September 20^th.

We shipped 772,000 units (last quarter) representing a 7% decline from the year ago quarter. iMacs accounted for 58% of all units shipped, followed by PowerMac systems at 28%. Power Books represented 13% of units. iBooks and servers represented less than 1% each.

As I forewarned you during last quarter's conference call, the September quarter proved to be a period of significant product transition. Demand for all our new products has been incredibly strong. We exited the September quarter with an extraordinary large backlog of over 400,000 Macintosh systems, representing over $700 million in unrealized revenue.

The first new product was the iBook introduced at MacWorld on July 21^st. As expected the availability of the iBook was limited during the quarter, a situation that was exacerbated by a slower than anticipated manufacturing ramp, and the earthquake in Taiwan which I will discuss later. We received orders for over 200,000 iBooks during the quarter but were able to ship only 6,000 units.

The second new product was the G4 professional desktop introduced at Seybold on August 31^st. Customer reaction and bookings have been very strong. However, as we disclosed on Sept. 20^th, Motorola was unable to manufacture the planned volume of microprocessors during the quarter. Despite receiving orders for over 150,000 G4 systems during the quarter, we were able to ship only 64,000 G4 units, which was far short of our plan.

In order to better match G4 demand with chip availability from Motorola, Apple today announced that it has reconfigured the processor speeds of Power Mac G4. The G4 offering will now include 350 MHz, 400 MHz, 450 MHz configuration. The 500 MHz G4 will not be available till the first calendar quarter of next year.

The third product transition was the new iMac family, which we announced and began shipping last week. We have received orders for over 250,000 in the first week since its announcement. As expected our product transition led to a reduction in the sales value of ending channel inventory which were down 30% from the end of the June quarter.

Gross margins of 28.7% were far better than expected for a number of reasons. First and most significantly, iMac and Power Mac G3 gross margins improved from last quarter due to stable pricing and lower manufacturing costs. Secondly, we had a higher mix of higher margin software sales in the quarter, and, thirdly, warranty costs were lower than anticipated. A reflection of the improving quality of our products. Average selling prices remained stable during the quarter at $1,682.

As for expenses, operating expenses were relatively flat at $317 million during the quarter. Head count increased to 9,736 in the quarter, up from 8,853 in the June quarter. The increase was primarily due to an increase in temporary workers hired to support the ramp of our new products.

As mentioned in the press release, Apple recognized an after-tax gain of $37 million from the sale of 3 million of our shares of ARM holdings. This contributed 21 cents to diluted earnings per share. We still hold 16 million shares of ARM that is currently worth in excess of $300 million. Apple has also recognized an after-tax restructuring charge during the quarter to operations of 16 million for cancellation charges related to previously out-sourced services, and a previously discontinued business. This reduced diluted earnings per share by $0.09 cents.

In terms of a balance sheet, we finished the quarter with cash and short term investments of over $3.2 billion dollars, and net cash of over $2.9 billion. Cash flow from operation during the quarter was $218 million. We ended the quarter with $20 million, or two days of inventory. Day sales outstanding decreased to 46 compared to 52 days at the end of June.

During the quarter we repurchased 1.25 million shares of AAPL stock at an average price of $60. Of the original $500 million authorized for repurchase, $425 million remain as of the end of the quarter.

We have had numerous questions about the impact of the Taiwan earthquake on our business. So I would like to provide you with a brief update. There was no structural damage to any of our production facilities, all of which are now fully operational. We lost power for the last week of the quarter, and power outages and rationing continued to occur for the two weeks following the end of the quarter. We lost one week of production on both Power Books and iBooks during the last week of the September quarter. Some component supplies were also impacted. But we believe this situation will be resolved well before the end of the quarter.

Looking ahead for the next three months, the December quarter will be the first quarter where all four product families will be shipping in volume for the entire quarter. We expect units and revenues to be up significantly from the prior and year ago quarter.

We expect to be able to catch up with the backlog on the G4 desktop, but expect to be supply constrained on the iBook during the quarter. At this point we do not expect the Taiwan earthquake to have a material impact on our planned revenues for the quarter.

For gross margins, we expect the December quarter to be sequentially down due to substantial higher memory prices and a mixed shift towards iMacs and iBooks, which have lower gross margins than our professional products. We expect operating expenses to increase significantly as we invest in advertising and other promotional activities in support of our new product line-up, and the consumer holiday buying season.

Also driving the increase in operating expense is the fact that Apple's fiscal first quarter will be a 14 week quarter. Every six years we have to add one week to our first fiscal quarter to synchronize with the calendar. For the December quarter we are targeting operating expenses at about 18.5% of revenue. And lastly we expect the tax rate to move up to approximately 25%.

Apple also announced today that IBM began manufacturing Power PC G4 processor chips beginning in the first half of calendar year 2000 providing Apple with a second supplier for the G4 Power PC processor.

With that I would like to open the call to questions from analysts.

(Questions have been paraphrased, and not all were transcribed.)

Question: Why did inventory go up to two days versus the 6 hours in last quarter?

Fred: (laughing) Well, I would attribute it to a combination of the product transition and the Taiwan earthquake.

Question: On the G4 production from IBM, is that going to ramp up quickly or slowly, and how much of your G4 supply do you anticipate ultimately getting from IBM?

Fred: No, I really can't shed anymore light on that than what I have given you. Which is to say, again, that we expect IBM to ramp up and to begin to producing the G4 processor for Apple sometime during the first half of the calendar year, and at that point we will be dual-sourced from both Motorola and IBM. I really can't speculate on what the split might be between the two.

Question: Does the IBM agreement extend to other products? Is it a multi-year agreement?

Fred: The agreement was between IBM and Motorola, and Apple is not a party to the agreement. And I'm really not at…first of all I don't know the details of their agreement, and secondly if I were it's confidential between the two companies and I am not at liberty to comment.

Question: Can you give us more insight into your gross margins for this quarter, what kind of a step down are you expecting?

Fred: Sure, first let me give you again some of the qualitative factors. The positive would be that we expect significant revenues from Mac OS 9 upgrades, which as you know is being introduced this month. So that's a positive for gross margins because the OS upgrades carry very high gross margins. That's offset by a couple of factors, which I already mentioned. One is because of the holiday season and the huge backlog we currently have of both iMacs and iBooks. We expect a higher mix of those consumer products, which have lower gross margins. Secondly, the whole industry is going to be hit by much higher memory prices this quarter. We anticipate that you would get demand and supply more in equilibrium as we enter the next calendar year, but this quarter is going to be really tight and we have been conservative and factored in significant price increases in memory. Those are the three most significant factors I think will change compared to this last quarter. As to gross margins, which were above 28%, I'm not going to forecast it, but I think it could be down one to two points from the prior quarter, but it's really hard to predict. I don't think anyone sitting here can predict how much memory prices are going to go up.

Question: Is memory the primary factor in gross margin declines then?

Fred: It's a significant factor, I would say that mix shift down to consumer products is also a significant factor.

Question: I read on the web that OS X might not ship on time, and, secondly, on the reconfiguration of the G4 is the only thing different in the new ones the speed of the processors? In other words, will Sawtooth be shipping with the 450 MHz and the 400mhz?

Fred: Let me take the G4 question first. Yes, your assumption is right, the prior three configurations remain exactly the same, except you'll have 50 MHz lower in the processor for each of those configurations. As to Mac OS X, to be honest with you, we are focused right now on Mac OS 9. We think its an incredible upgrade to the current operating system with 50 new features and Sherlock II the meta search engine. It has incredible value, so we look forward to selling a lot of those this quarter. I'm not aware of any schedule delays on Mac OS X, but I have to admit that's not something I'm spending a lot of time on right now.

Question: It looks like the price point of the new G4 configurations are the same as the old G4 models. Is that correct?

Fred: That is correct

Question: Well, if I got a 450 MHz machine at the old price, are you guys going to send me a bill? I would have expected at least a token price reduction because you're doing a take away on consumers.

Fred: Let me try to answer that very directly. You're correct that there is a 50 MHz lower processor. On the other hand, DRAM prices have shot through the roof, as I know you know. So we're not getting a windfall here, guys, because of the big increases in memory prices.

Question: When you look to next year's growth, what do you see? Secondly, what type of tax base can we expect next year and beyond?

Fred: We set a target in terms of unit growth rates for fiscal year 2000. I'm not going to get into quarter or first half. Our unit growth rate targets, not forecasts, but targets, are 35 to 40%, and revenue is in the 20 to 25% range on year over year basis for fiscal year 2000.

Tax rate is targeted at 25%. In 2001, to be conservative, I would use a 33% fully taxed rate. I think it will between 30 to 33% depending how effective our tax planning is.

Question: How do you absorb the higher DRAM prices?

Fred: I think the reaction of all the personal computer vendors, including Apple, is you try to offset it with lower component prices in other areas. Or you raise your prices, or you take it out of your gross margins and naturally we are trying hard to neutralize it by being aggressive in negotiating lower costs in other areas that aren't in such short supply.

Question: Can you tell us how much back order Apple had at this time last year, and what are the statistics on the type of users that are buying the iMac now?

Fred: We haven't been recording backlog publicly for the last couple of years because, quite frankly, it was so inconsequential that we didn't think that it was meaningful. I don't have in front of me what the backlog was. But I'll tell you that in most recent quarters it's been running somewhere between $100 and $200 million, so what we end with was an abnormally high backlog which has only increased since the close of the quarter with the announcement of the new iMac. Of course, we didn't have any of those in backlog and then we received 250,000 orders for the new iMac since we closed the quarter. So, in any event, if I did have it in front of me, I think it would say that it was certainly at least $500 million higher than the 4^th quarter of the prior year.

In terms of the iMac, we don't have any recently update information on the source of customers, but it has been running about a third new customers, about 10% Wintel customers. Those two total about 45% plus, and about 55% are existing Mac customers, and I don't think that has fundamentally changed. As we do the next update I think it will be close to the same.

Question: Is Apple going to announce an ISP strategy?

Fred: I expect that Apple will have something to say in this area in a few months.

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