10 Takeaways From Apple’s Latest SEC Filing, Part 1

Pardon my fascination with {complink 379|Apple Inc.}. One cannot help but obsess over a company that's breaking all records ever set by its peers. Apple has more than doubled sales since 2007 and, rising from the throes of death 10 years ago, surged to the peak of high-tech market valuation, leaving long established rivals floundering in its wake.

Of course, the company's successful sprint to the top of the markets for digital music players (iPod), mobile handsets (iPhone), and computer tablets (iPad) has also sparked concerns and raised numerous questions in the minds of consumers, investment analysts, ordinary investors, and executives at parts suppliers.

The questions being raised include the following: Can Apple hold the fort against previously slumbering but now wide awake rivals like {complink 3538|Motorola Inc.}, {complink 3847|Nokia Corp.}, and {complink 4644|Research In Motion Ltd. (RIM)}? Can it stem the rising tide of pressures on gross margins? Is there a limit to its ability to successfully introduce new, market-defining products? And is there a ceiling to the stratospheric rise in its stock price?

Typically, Apple does not respond to questions regarding its operations, so I decided to mine its latest {complink 7644|Securities and Exchange Commission (SEC)} filing for insight into its operations, management concerns, and future strategies. Take a walk with me through Apple's latest 10-K. It's quite illuminating. The sentences in italics are from Apple's filing.

  1. On product innovation:
  2. Due to the highly volatile and competitive nature of the industries in which the company competes, the company must continually introduce new products, services and technologies, enhance existing products and services, and effectively stimulate customer demand for new and upgraded products.

    My take: This is key to Apple's continued success and probably its Achilles' heel as well. Apple has so become synonymous with innovation that many of its consumers, suppliers, and investors operate on the belief that a distinctly outstanding and refreshing product must be unveiled by Apple each year. So far, the company has delivered. Expect investors to walk away and consumers to be disappointed the year it fails to deliver a less-than-stellar product.

  3. On supplier relationship and management:
  4. The Company remains subject to significant risks of supply shortages and/or price increases that could materially adversely affect the Company’s financial condition and operating results.

    My take: Apple is not alone in feeling the pressure here, and I don’t see this as a strategic hurdle for the company. In fact, Apple is better positioned here than many of its rivals, because its huge cost of goods sold ($39.5 billion in fiscal 2010 ended Sept. 25) gives it significant leverage with suppliers that see it as a fast-growing and must-have customer. However, Apple is also famous for being tough and aggressive with suppliers, which it can afford to do now because of its size but which can also create serious ill-feelings within the community.

  5. On gross profit margin pressure:
  6. The Company expects to experience decreases in its gross margin percentage in future periods, as compared to levels achieved during 2010, largely due to a higher mix of new and innovative products that have higher cost structures and deliver greater value to customers, and expected and potential future component cost and other cost increases.

    My take: Reality check please. Apple's gross profit margin is not coming under pressure simply because of the potential for higher component costs. No, the truth is that the company's current gross profit margin level (39.4 percent in fiscal 2010 and 40.1 percent in the prior year) is not sustainable. The direction is invariably downward, and there's no mystery to this. Apple negotiated good rates with the first iPhone telecom carrier, {complink 502|AT&T Inc.}, for instance, but it is not getting — and is unlikely to get — similar deals with other carriers.

    Also, downward price pressure is a fact of life in the high-tech world, and often those declines cannot be passed on to end users, who now expect lower prices six months after product release. More often than not, a company has to cut prices to remain competitive, and that is happening to Apple as rivals crowd into areas where it's extended the franchise. Apple can only keep the margins high by being ahead of the competition in introducing new and decidedly popular products.

  7. On concerns of resellers competing with Apple-owned outlets:
  8. Some resellers have perceived the expansion of the company’s direct sales as conflicting with their business interests as distributors and resellers of the company’s products. Such a perception could discourage resellers from investing resources in the distribution and sale of the Company’s products or lead them to limit or cease distribution of those products.

    My take: This is boilerplate from a company that must provide as much disclosure to investors as possible. Apple is unlikely to see resellers abandon its products. This won't happen. Period. Resellers need Apple more than it needs them.

  9. R&D budget:
  10. Total research and development expense was $1.8 billion, $1.3 billion and $1.1 billion in 2010, 2009 and 2008, respectively.

    My take: Don't look at the absolute numbers. Rather concentrate on the ratios. As a percentage of sales, Apple's R&D budget is declining rather than rising. In fiscal 2010, Apple's R&D fell to 2.73 percent of revenues from 3.11 percent in fiscal 2009 and 2.96 percent in fiscal 2008. That's not necessarily bad or good; the focus rather should be on where and how the money is being spent.

    However, a company that has marketed itself and continues to distinguish itself on the basis of its innovation must devote a greater and increasing amount of its resources to R&D in order to keep separating itself from the herd of rivals. Apple has enough money in its kitty to spend whatever it wants on R&D.

In the second part of this article, I will present additional comments about Apple's geographic position, its huge cash holdings, and legal wrangling with competing OEMs.

13 comments on “10 Takeaways From Apple’s Latest SEC Filing, Part 1

  1. Parser
    November 22, 2010

    These are excellent points about Apple business and its future. I would like to add also:

    Apple made all that income using expensive products during worldwide recession. The iPad was a product carefully crafted to fill a non-existent space between smart phones and tablet computer running full OS. The first iPhone had also an innovated interface, which no other smart phone had at that time.

    To survive Apple simply has to do inventions by creating market segments or dramatically improve existing niches. And yes the antenna problem and lack of a white iPhone 4 give time for competitors to rehash.

    In recession times getting electronics parts to build anything is really hard. Apple is swiping off supplies out of hands of competitors and non-competitors.  I like Apple products, but I can see corporate inertia building up, similar to the one we all accustomed to – by Microsoft. 

  2. Barbara Jorgensen
    November 23, 2010

    Interesting reading, and good perspective, particularly about retailers competing with Apple stores. If any product is able to hold its price point and brand identiy at the Best Buys of the world, it's Apple. Granted, a lot of these exercises are SEC-required disclosures, and as you point out, Apple is no more at risk than other companies in its line of work. Reality check indeed.

  3. AnalyzeThis
    November 23, 2010

    Well, there is certainly a limit to Apple's ability to successfully introduce new, market-defining products.

    Don't get me wrong, I think Apple will continue to be successful and the long-term outlook for the company is good… but their current performance isn't sustainable.

    Yes, the iPhone and the iPad have proved to be blockbusters. But you're not always going to hit a home run. At some point, there will be a stumble.

    Plus, I think people kind of forget about the rest of Apple's business: yes, iPhone/iPad/iTunes… that's all doing just fine, but what does the future hold for their more traditional products? The desktops and notebooks? I think that area looks slightly bleak. Take the new MacBook Air: is there really that much of a market for it? Will it be as profitable as the iPhone/iPad? Of course not.

    Anyhow, I'm looking forward to the second part of the article!

  4. bolaji ojo
    November 23, 2010

    Hi Parser, What areas do you think Apple should look into next? I am curious. I have been pondering areas the company could explore and would like to know what you think.

  5. DataCrunch
    November 23, 2010

    I wouldn’t be surprised to see Apple using its war chest to acquire software companies, specifically around social media and social entertainment.  I bet an Apple acquisition of Facebook or even Zynga (the FarmVille company, among others), which now has an estimated market cap larger than Electronic Arts, would really shake things up.  Companies would be scrambling after a move like that.  Would be interesting to say the least.

  6. SP
    November 23, 2010

    If Apple acquires facebook, guess they will make it paid service from business perspective. I guess it would hurt many users. But certainly thats a possibility. Apple is really very popular. I saw their new store in a mall in downtown. It was just wow. You feel encouraged to buy atleast something iPhone or iPad or laptop.

  7. elctrnx_lyf
    November 24, 2010

    I still remember the movie pirates of silicon valley which was made on the basis of steve jobs and bill gates story. Bill gates built Microsoft as a software company and they went on to produce products like XBOX. But Apple was always a product company concentrating majorily on the hardware with the macintosh PC's. Apple will continuously try to innovate and bring new products but at some point it might be really tough to come out with any innovative and crazy gadget.

  8. SP
    November 24, 2010

    well as per the rule of thumb, as long as they are innovative they will rule the market. Because people get bored of technology very fast and anything that gives them more convenience, that looks good and is easy on pocket gets an edge. I guess Apple has the caught the nerve right.

  9. Susan Fourtané
    November 25, 2010

    Thanks for a good and interesting read, Bolaji. 

    There is no doubt about the fascination for Apple and Apple products. This fascination might play an important role at the time of the decision making we were discussing before on tablets and smart phones. After all, the ones who have tried Apple have never changed back to any other product, or am I wrong? 


  10. SP
    November 25, 2010

    I gues you are correct, Susan. People are fascinated by Apple products. I came across this funny incidence in beauty salon. One lady went on talking how much she likes Apple brand. The most remarkable thing in her talk was  that Apple deserves to be paid what they cost and that she wont buy anything other than that. I guess Apple has very faithful customer base.

  11. Susan Fourtané
    November 26, 2010

    Hello, SP 

    That's a funny story. I believe Apple has loyal customers, sometimes it seems like Apple users are under a kind of spell, though. For some time now I have been trying to change to Apple. Windows has given me enough reasons to be sick of it. I am now trying to decide if I am going to replace my laptop for a MacBook or the netbook for the Air, as the price is now the same. I have been told many times that I will love Apple once I have one. 


  12. eemom
    November 26, 2010

    I loved reading this article and your percpective on it since I am an avid Apple user myself.  Apple has always defined itself as a market and product innovator.  There products are not only “cool” but they are also robust and realiable.  I have been utilizing the Apple Mac platform for years, when I needed to upgrade my desktop/laptop, I never even considered moving to a PC.  Also, among portable music players, IPODs are still the prized players to have, years after the technology was introduced.  Apple not only introduces the technology, while others chase it, they continue to lead the market and dictate the direction.

  13. Parser
    November 26, 2010

    Hi Bolaji, A market area not touched by Apple is car audio. Ford is making good progress with MS so Apple could improve it with a different car manufacture.

    They could go after whole house electronic equipment from security systems, through entertainment to refrigerator replenishing. A calendar on your desktop can be linked to security system to lock your house when you are out (just a speculation). Apple ideas rely on their great ability to integrate.

    Since Apple industrial design is an art they could go into fashion statement and have a wristwatch with some features supplementary to iPhone. 

    Here are some other possibilities for individual improvements. The missing thing in the iPhone environment is some kind of palpable screen so user can feel the touch. It is not necessary only for keyboard. Also movies have to go to 1080 format. What are your thoughts? 


Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.