Apple Computer on Tuesday beat analyst expectations for its fiscal third quarter, despite a dramatic drop in earnings. The California-based company reported earnings of £43m, or 12 pence a share -- a 70 percent decline from the same quarter last year, when Apple earned £142m, or 40 pence a share, including investment gains. At the same time, it's an improvement over Apple's massive loss in its first quarter and its slim profit in its second quarter. Analysts expected the Mac maker to earn 10 pence per share, according to First Call. Although revenue declined 19 percent to £1.05bn from £1.3bn in the year-ago quarter, Apple showed a slight gain over its second quarter revenue of £1bn. Apple shares closed up $1.14, or 5 percent, at $25.10. In after-hours trading, though, the stock dropped $2.70 to $22.40, according to Island ECN. Apple realized a £5m favourable after-tax effect from its net equity investment gains, but this was offset by an after-tax charge of £5m related to its acquisition of PowerSchool. These one-time events had no significant effect on the quarter's results. "We're very proud of the innovative products we continue to introduce into the marketplace," Fred Anderson, Apple's chief financial officer, told financial analysts during a Tuesday afternoon conference call. "We feel good about the quarter's results and our ability to generate higher sequential revenues and profits." Apple said it shipped 827,000 Macs during the quarter, which ended June 30. This compares with 1.02 million units a year earlier and 751,000 during the second quarter. The company reported gross margins of 29.4 percent for the quarter, a decrease from 29.8 percent a year earlier. Apple ended the quarter with £3bn in cash and short-term investments. During the conference call, Anderson offered guidance for the current quarter. "In this challenging economic environment, we are expecting (fourth) quarter revenue and earnings per share to be up slightly from the (third) quarter level. We expect gross margin percent and operating expenses to track closely to the third fiscal quarter levels," he said. Anderson delivered one cautionary note, saying that the recent interest-rate cuts will hurt the company's portfolio. NPD Intelect analyst Stephen Baker said that Apple isn't alone in its current problems. "For the same reasons people aren't upgrading Macs, they're not upgrading PCs either," he said. "Apple is in the same boat as all the PC guys, and these problems are not unique to them." Anderson made it clear education contributed greatly to Apple's third-quarter results, with education sales up 7 percent year-over-year in spite of the weak economy. "Our outstanding results in education were driven both by better sales execution...as well as the strong reception by education to the new iBook," he said. "During the quarter we sold over 182,000 new iBooks and ended the quarter with a substantial quarter backlog," Anderson said. Apple's third quarter offered the first hint of the success its retail outlet strategy might produce. While Anderson gave no specific information, he spoke of great sales. "We're very pleased with the early results and...we're on track to open 23 more stores in calendar year 2001," Anderson said. Apple plans to begin reporting financial results for its retail outlets in the quarter that ends in December. In mid-May, the Mac maker opened two of 25 planned retail outlets this year. In August and September, Apple plans to open 10 more stores. During the quarter, Apple took lowered inventory levels by 46,000 units or to slightly less than four weeks worth of inventory on dealer shelves. Part of that was in anticipation of new models expected to be unveiled at the Macworld Expo on Wednesday. In its earnings release, Apple broke out sales into individual product categories. Mac OS X, which Apple released near the end of the second quarter, showed strong sales. The company sold 200,000 units of the operating system in its third quarter. "Considering how well Mac OS X did during just the one week in the last quarter, I'm not surprised it would do well," said Technology Business Research analyst Tim Deal. In May, Apple started pre-installing Mac OS X on new computers, about two months ahead of schedule. Online sales accounted for 40 percent of the company's revenue, up from 34 percent in the second quarter. Overall, notebooks accounted for a record 36 percent of Apple computer sales. In terms of sales of the consumer-oriented iMacs and iBooks, however, Apple reported a dramatically mixed quarter. "We haven't seen any signs of any signs of an upturn in the consumer PC market," Anderson said. "Normally you do get a seasonal bounce with back to school, but we think it's prudent not to count on that this year." Sales of the iMac dropped 36 percent year-over-year as measured in dollars and 32 percent in units. Compared with its second quarter, sales changed little, up 1 percent in dollars and 2 percent in units. Apple sold 306,000 iMacs during the quarter. But the iBook laptop, spurred on by new models introduced May 1, jumped 59 percent in dollars and 81 percent in units, compared with the same period last year. From the second to the third quarter, iBook sales rocketed 270 percent in dollars and 245 percent in units. With both old and new models of iBooks included, the company sold 190,000 units during the quarter. Sales of professional Macs declined overall. PowerMac G4 sales dropped 36 percent both in units and dollars year over year. And compared with the second quarter, PowerMac sales declined 17 percent in dollars and 14 percent in units. Apple sold 225,000 PowerMacs during its third quarter. The PowerMac G4 Cube once again contributed to PowerMac declines during the quarter. Right after the third quarter closed, Apple discontinued the Cube. Anderson said the weaker economy contributed to the slowdown in PowerMac sales, but Mac OS X had an impact, too. "A lot of our (professional) customers are waiting for more of their applications to be moved over to Mac OS X," he said. "In the next few quarters, as we get more and more applications onto Mac OS X, you're going to see a resurgence of sales in our PowerMac line." The PowerBook, Apple's professional portable, declined 9 percent in dollars and 6 percent in units from a year earlier. Sequentially, PowerBook sales fell more steeply: 23 percent in dollars and 21 percent in units. Anderson said the drop in sales was expected, with Apple shipping 106,000 units. The entire computer industry is facing the same problems as Apple. At the same time, Apple retail and catalogue sales reveal startling declines, according to NPD Intelect. Year to date, industry-wide desktop and notebook sales in these categories dropped 20.5 percent in dollars and 18.8 percent in units compared with the same period last year. But Apple's retail and catalogue sales--which account for 60 percent of its business--plummeted 42.8 percent in dollars and 40.6 percent in units from last year. For comparison, Hewlett-Packard and Compaq Computer sales declined 9.9 percent and 17.6 percent in dollars, respectively. Sony sales soared 25 percent in dollars and 72.3 percent in units. Apple's results could have been a lot better with a major change to the 3-year-old iMac, Baker said. "Apple had a good refresh of notebooks and G4 desktops and that set well with many customers," he said. "The problem is the iMac has been a big chunk of their business, and iMac is long in the tooth." International sales made up 44 percent of the quarter's revenues. Geographically, Apple saw gains in most regions from the second quarter, but steep declines from the third quarter of 2000. Year-over-year revenue in the Americas dropped 17 percent, while units fell 12 percent. But sequentially, Apple saw a 10 percent revenue gain and 23 percent in units. Anderson said signs of weakening economic conditions took their toll in the Mediterranean, driving revenue down 22 percent year and units down 32 percent over year in the Europe, Middle East and Africa region. Sequentially, revenue there dipped 23 percent and units 24 percent. Japan declined year over year, down 19 percent in revenue and 22 percent in units. Sequentially, Japanese revenue rose 14 percent and units were up 20 percent. Have your say instantly, and see what others have said. Click on the TalkBack button and go to the ZDNet news forums. Let the editors know what you think in the Mailroom. And read other letters.