Apple Comes Clean On Fate Of Margins (AAPL)

Apple Inc. (NASDAQ: AAPL) is trading lower in the after-hours period after its annual report was filed with the SEC after the close of trading today.  The drop is due to ongoing margin pressures.  Frankly, this is no surprise if you have read any of our own earnings commentary.

The 10-K has two sentences which account for tonight’s drop under the GROSS MARGIN section of the 10-K on page 38 of the annual report.  The sentences read, “The Company expects its gross margin percentage to decrease in future periods compared to levels achieved during 2010 and anticipates gross margin levels of about 36% in the first quarter of 2011. This expected decline is 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.”

This may actually be good news for many component makers out there who are on the higher-end that serve Microsoft.  That is what “potential future component cost” means.  The other translation is “supplier pricing power.”   There is also a currency issue that will grow more and more as a concern.

Apple goes on to further note, “In general, gross margins and margins on individual products will remain under downward pressure due to a variety of factors, including continued industry wide global product pricing pressures, increased competition, compressed product life cycles, product transitions and expected and potential increases in the cost of key components including but not limited to microprocessors, NAND flash memory, DRAM and LCDs, as well as potential increases in the costs of outside manufacturing services and a potential shift in the Company’s sales mix towards products with lower gross margins. In response to these competitive pressures, the Company expects it will continue to take product pricing actions, which would adversely affect gross margins. Gross margins could also be affected by the Company’s ability to manage product quality and warranty costs effectively and to stimulate demand for certain of its products. Due to the Company’s significant international operations, financial results can be significantly affected in the short-term by fluctuations in exchange rates.”

Although total R&D expense increased 34% during 2010, it declined as a percentage of net sales given the 52% year-over-year increase in net sales in 2010.

Apple shares closed down $0.22 at $307.83 today, which is the second lowest close after earnings.  The lowest close was $307.47 last Friday.  Shares are down 0.5% in the after-hours session.

JON C. OGG