December 6, 2000 9:00 AM PST

Price and profit cuts loom for Apple

How does Apple Computer hold a fire sale without also starting a blaze that could leave its earnings in ashes?

That is the question some analysts are asking after a devastating profit warning Tuesday from Apple. The Cupertino, Calif.-based company warned that fiscal first-quarter 2001 revenue would be about $1 billion, or some $600 million less than already reduced projections, as the company braces for a quarterly loss as great as $250 million.

With 11 weeks worth of inventory sitting on dealers' shelves and overall consumer PC buying down as much as 30 percent from last holiday season, Apple must slash prices to clear out the stock, analysts say.

How that affects other computer makers depends on how they deal with slowing consumer sales and how Apple executes its price cuts. Either way, analysts say, Apple may have to sell its future--maybe two to four quarters of profits--to clean up the mess.

In a research note Wednesday, Prudential Securities analyst Kimberley Alexy praised Apple for "taking the necessary actions required to clear excess channel inventories." But she warned the downside of clearing out the stock could carry over into Apple's fiscal second quarter.

"Apple is between a rock and a hard place," said Robertson Stephens analyst Eric Rothdeutsch. "The only lever they have to pull for a while is the pricing lever. But we're already seeing price declines from other PC manufacturers, so Apple has some challenges."

Apple's problems are largely of its own making, analysts say, as the company made several key strategic errors in the spring and early summer for which it is now paying. But the timing could not be worse for Apple as a consumer-PC sales slowdown grips the industry and a price war looms.

The company is staggering from three consecutive waves of bad news, said Gartner analyst Chris LeTocq. "They messed up with education sales in the summer and the G4 Cube in September, then the PC market goes to hell in November."

Learning from Compaq
Compaq Computer is the measure by which Apple--and the industry--must gauge the effect of clearing bloated inventories, analysts say.

In March 1998, Compaq warned that it had 12 weeks of inventory sitting on dealers' shelves. To clear out stock, Compaq slashed prices and battened down for three rough quarters.

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Can Apple survive the fall?
Stephen Baker, analyst, PC Data
The effects were felt industrywide, said Technology Business Research analyst Lindy Lesperance. "When Compaq stuffed the channel, it took them two quarters of cutting prices to move that inventory out, and everybody suffered for it," she said.

Compaq's slashing led to a price war and dramatically drove down the cost of PCs. While businesses and consumers benefited from lower selling prices, Compaq's actions forced lower profit margins on virtually every competitor, Lesperance said.

Apple's problem is more complex because the company sells to a limited base of Mac enthusiasts. If Apple cuts prices too aggressively, it will have to live with the permanent consequences of those actions, as Mac enthusiasts are likely to balk at price increases.

"You use rebates, and you don't mess with pricing," said Gartner analyst Chris LeTocq. "Apple is not going to mess with the pricing, because you can't bring pricing back up."

Tracing the problem
Apple's woes started in June when the company pulled its education business back from dealers and took it direct. That action, right at the beginning of the busy back-to-school buying season, hurt the company's education sales. The timing of the action couldn't have been worse for one of Apple's strongest markets, chief executive Steve Jobs acknowledged in an October earnings call with financial analysts.

In August, Apple executed badly in getting new products to market while failing to clear out older models first. As a result, the top-selling Mac in August was a discounted PowerMac G4 model selling for around $1,200 and not speedy new dual-processor PowerMacs or the stylish G4 Cube, according to PC Data.

Apple also failed to recognize it had exhausted its run of good sales, which were more focused on Mac enthusiasts. While the company had expected big sales of the G4 Cube, questions about suspected cracks in the units and oversaturation of the Mac market stalled Cube sales.

"Apple's constituency was starved for products for a long time, but I think Apple pretty much has satiated the band," Rothdeutsch said.

IDC analyst Roger Kay, who puts the Mac upgrade cycle at about 18 months or more, concurred.

"The math that they have to sell to the same base is the discouraging part, because those guys recently have all bought fancy new equipment," he said.

At the same time, sales of the iMac, which had been winning new customers for Apple, began to stall. LeTocq said Apple's failure to offer CD-RW drives on iMac or on any other Apple system clearly contributed to the sales slowdown.

"Missing out on the CD-RW phenomenon clearly hurt Apple," he said.

In a conference call Tuesday, Jobs said Apple had missed the boat on CD-RW but added that the company plans to offer the technology on new Macs next year.

Inventory swells
Despite rebates and other efforts to clear out excess inventory, Apple hit a wall in October and September. Sources close to dealers and distributors report a little dip to 67,800 units sitting on shelves in October from 68,500 units in September. Both months were up from about 41,000 units in August.

Apple confirmed Tuesday that it is sitting on 11 weeks of inventory, a big spike from just more than three weeks of inventory in June, when the company was well below the industry average.

But the company faced challenges in October and November as PC sales suddenly slowed for all computer makers--in October dropping 18 percent at retail, according to NPD Intelect. The slowing sales disproportionally hurt Apple, because it sells systems more to Mac enthusiasts than to the larger market of new users and because of the large volume of its inventory sitting on dealers' shelves, analysts say.

Preliminary November estimates from PC Data put Apple retail sales down nearly 25 percent from a year earlier.

Rothdeutsch described slowing consumer-PC sales as a meltdown. "We're going to see some aggressive price cuts, and it's going to get even more bloody before the end of the quarter," he said.

While LeTocq believes Apple is doing the right thing to clear out excess inventory, he says the prospects for the future are dim, particularly if the Mac market already is saturated.

"Even if we do see an upturn in all consumer sales, how ready is Apple going to be to take advantage of it?" he asked.

 

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