Briefing Document: Apple Computer, Inc. Fiscal Year 2004 Annual Report
Sources: Apple Computer Inc. - 2004 Annual Report
Executive Summary
This document synthesizes the key findings from Apple Computer, Inc.’s Form 10-K report for the fiscal year ended September 25, 2004. The period was marked by significant financial growth, strategic expansion in retail and digital music, and persistent challenges in the competitive personal computer market.
Key Takeaways:
Exceptional Financial Growth: Total net sales for fiscal year 2004 reached $8.28 billion, a 33% increase from $6.21 billion in 2003. Net income surged to $276 million from $69 million in the prior year.
Dominance of Music Products: The iPod and related music products were the primary growth engine. Net sales from iPods and other music products and services grew 316% year-over-year, accounting for 19% of the company’s total net sales in 2004. iPod unit sales increased by 370% to 4.4 million units.
Macintosh Platform Performance: The Macintosh platform saw a 9% increase in total unit sales, driven by strong demand for portable systems. PowerBook and iBook unit sales grew by 30% and 36%, respectively. However, iMac unit sales declined by 16%, attributed to an aging product cycle and a delayed introduction of the new iMac G5.
Retail Segment Success: The retail initiative demonstrated significant success, with net sales increasing 91% to $1.185 billion. The segment achieved profitability for the first time, reporting an operating income of $39 million. The company expanded its retail footprint to 86 stores, including its first international locations in Japan.
Strategic Focus on the “Digital Hub”: Apple’s core strategy revolves around positioning the personal computer as the central “digital hub” for consumer electronics. This is exemplified by the seamless integration of the iPod hardware, iTunes software, and the iTunes Music Store, which expanded into the U.K., France, and Germany during the year.
Intense Competition and Margin Pressure: The company operates in a highly competitive personal computer market characterized by aggressive pricing. While gross margin remained relatively stable at 27.3%, it faces continuous downward pressure. Competition is also intensifying in the digital music market.
Supply Chain Risks: A critical vulnerability is the reliance on single or limited-source suppliers for key components, such as the PowerPC G5 processor from IBM. Manufacturing problems with this component constrained product availability and delayed the new iMac introduction in 2004.
1. Corporate Strategy and Business Model
1.1. Core Business and Mission
Apple Computer, Inc., incorporated in California on January 3, 1977, designs, manufactures, and markets personal computers, software, peripherals, and a line of portable digital music players. The company’s stated mission is “to bringing the best personal computing and music experience to students, educators, creative professionals, businesses and consumers around the world.”
1.2. Key Business Strategies
The company’s business strategy leverages its unique capability to design and develop its own operating system, hardware, and many software applications. This integration aims to deliver products with “superior ease-of-use, seamless integration and innovative industrial design.” Key strategic pillars include:
Continual R&D Investment: A commitment to research and development is considered critical for innovating new and improved products. R&D expenditures totaled $489 million in fiscal 2004.
The “Digital Hub”: Apple believes the personal computer functions as a “digital hub” for connecting and adding value to an ecosystem of digital devices like iPods, digital cameras, and cellular phones. The company’s control over the entire personal computer stack (hardware, OS, applications) is seen as a unique advantage in delivering integrated digital hub solutions.
Expanded Distribution: A core focus is providing a high-quality buying experience. This is achieved through a multi-channel approach:
Apple Retail Stores: 86 company-owned stores were operational by the end of fiscal 2004, designed to control the customer experience and attract new users.
Online Stores: Direct-to-consumer sales through its global online stores.
Direct Sales Force: Targeting education, business, and government customers.
Third-Party Channels: A network of wholesalers, resellers, and value-added resellers, enhanced by the “Apple Sales Consultant Program” which places Apple employees in select third-party locations.
1.3. Target Markets
The company’s customer base is primarily in four key markets:
Education: A 25-year focus, with products like the eMac and iBook and solutions for one-to-one learning. The U.S. education channel accounted for over 16% of net sales in 2004.
Creative Professionals: A critical market for high-end hardware (Power Mac, PowerBook) and professional software (Final Cut Pro, Logic Pro).
Consumer: A major focus, particularly with the iMac, iBook, iLife software suite, and the entire iPod ecosystem.
Business: Targeting business users with products like the Power Mac and PowerBook lines.
2. Financial Performance: Fiscal Year 2004
Fiscal year 2004 marked a period of substantial growth, driven by the unprecedented success of the iPod and related music services, coupled with solid performance from the Macintosh portable and professional lines.
2.1. Consolidated Results
2.2. Performance by Operating Segment
The Americas remain the largest segment, but growth was strong across all regions except Japan, where sales shifted to the new retail stores. The Retail segment’s performance was exceptionally strong.
2.3. Performance by Product Category
The data clearly shows the music category’s explosive growth and its increasing importance to Apple’s revenue mix. Portable Mac sales were strong, while desktop sales, particularly the iMac, declined.
3. Product and Technology Portfolio (as of FY2004)
3.1. Hardware Products
Power Mac G5: Desktop targeted at professional users, featuring a 64-bit PowerPC G5 processor with configurations up to dual 2.5GHz.
iMac G5: All-in-one consumer desktop redesigned to integrate the computer into the flat panel display, featuring a G5 processor and a 17” or 20” widescreen LCD.
eMac: All-in-one desktop with a 17” flat CRT, targeted at education and consumer markets with a starting price of $799.
PowerBook G4: Professional portable line with 12”, 15”, and 17” models, featuring PowerPC G4 processors up to 1.5 GHz and built-in wireless capabilities.
iBook G4: Consumer and education portable line with 12” and 14” models, featuring PowerPC G4 processors up to 1.33 GHz and built-in AirPort Extreme wireless.
Xserve G5 & Xserve RAID: Rack-mount server and high-availability storage systems designed for intensive I/O applications and heterogeneous (Mac, Windows, Linux) environments.
3.2. Music Products and Services
iPod: Fourth-generation portable digital music player featuring the patent-pending “click wheel” and up to 12 hours of battery life. Available in 20GB and 40GB models.
iPod photo: Introduced in October 2004, this model features a color screen to display digital photos alongside the music library. Available in 40GB or 60GB models.
iPod mini: A smaller, lighter iPod with 4GB of storage, introduced in January 2004 and available in five colors.
iPod U2 Special Edition: A special edition iPod featuring a black enclosure, red click wheel, and signatures from the band U2.
iTunes Music Store: Online store for purchasing third-party music and audiobooks. Expanded from the U.S. to the U.K., France, Germany, and nine other European countries in 2004. A Canadian store launch was planned for 2005. The store requires no subscription and allows purchased music to be played on up to five computers and an unlimited number of iPods.
Strategic Alliances: Agreements to pre-install iTunes software on consumer PCs from HP, Founder Technology Group (China), and Synnex Technology (Taiwan). A partnership with BMW produced an in-car iPod adapter.
3.3. Software and Computer Technologies
Mac OS X: The core operating system for Macintosh computers. Version 10.3 “Panther” was the current version, and Version 10.4 “Tiger” was previewed for a 2005 release, set to include new features like Spotlight search and Dashboard widgets.
iLife ‘04: A suite of digital lifestyle applications pre-installed on Macintosh systems, including:
iTunes: Digital music management software.
iPhoto: Digital photo management and editing.
iMovie: Consumer digital video editing.
iDVD: Consumer DVD authoring.
GarageBand: A new music creation application.
Professional Applications: A suite of software for creative professionals, including Final Cut Pro HD (video editing), DVD Studio Pro 3 (DVD authoring), Motion (motion graphics), Shake 3.5 (visual effects), and Logic Pro 7 (music production).
Productivity & Other Software: Keynote (presentations), AppleWorks (integrated productivity), and FileMaker Pro 7 (database management) from its wholly-owned subsidiary.
Internet & Connectivity Technologies:
Safari: The company’s proprietary web browser for Mac OS X.
QuickTime: Multimedia software for video and audio playback and streaming.
.Mac: A subscription suite of Internet services including email, iDisk storage, and web hosting.
AirPort Extreme & AirPort Express: Wi-Fi wireless networking products based on the 802.11g standard. AirPort Express adds the ability to wirelessly stream music via “AirTunes.”
FireWire (IEEE 1394): A high-speed I/O technology developed by Apple for connecting digital devices.
4. Market Position, Competition, and Risks
4.1. Competitive Landscape
Apple faces aggressive competition across all its business areas.
Personal Computers: The market is “highly competitive” and characterized by “rapid technological advances” and “intense” price competition. Apple’s primary competitors are companies selling PCs based on Windows and Linux operating systems. Apple’s minority market share with the Mac OS is a significant factor.
Digital Music: The initial success of the iPod and iTunes Music Store has “encouraged significant competition” from companies with greater financial and marketing resources. The company anticipates competition will intensify as hardware, software, and content providers collaborate on integrated products. Apple believes its competitive advantage lies in its ability to “more effectively integrate the entire end-to-end music solution.”
4.2. Supply Chain and Manufacturing
Component Sourcing: The company relies on single or limited sources for certain key components, including microprocessors (IBM for G5, Freescale for G4) and ASICs. This creates significant risk. During fiscal 2004, the company “did experience such delays,” which constrained the availability of certain products.
Manufacturing: Final assembly is conducted at its facility in Cork, Ireland, and by external vendors in multiple countries, including Taiwan, China, Korea, and the Czech Republic. Substantially all portable products (PowerBook, iBook, iPod) are assembled by third-party vendors in Taiwan and China. This exposes the company to geopolitical, logistical, and other risks associated with international manufacturing.
4.3. Key Risk Factors
The Form 10-K identifies numerous factors that could affect future results:
Economic and Political Uncertainty: Global economic conditions, war, terrorism, and public health issues could disrupt supply, delivery, or demand for products.
Product Introductions and Quality: The business depends on successfully managing frequent product introductions. Product quality problems can result in decreased sales and increased warranty expenses.
Inventory Risk: The company must order components and build inventory in advance of customer orders in a volatile market, creating risk of excess or obsolete inventory. Purchase commitments typically cover 30 to 130 days.
Third-Party Dependencies:
Software Developers: The availability of third-party software (e.g., Microsoft Office) is critical to the Macintosh platform’s appeal.
Music Content: The iTunes Music Store depends on licensing content from third parties, and these agreements are often short-term and not guaranteed to be renewed on commercially reasonable terms.
Retail Initiative: The retail expansion requires substantial ongoing investment in fixed assets, leases, and personnel. A high proportion of costs are fixed, making the segment vulnerable to sales declines.
Profit Margin Fluctuation: Professional products (Power Mac, PowerBook) generally have higher gross margins than consumer products (iMac, iBook, iPod). A shift in sales mix toward lower-margin consumer products could adversely affect overall profitability.
4.4. Legal Proceedings
As of September 25, 2004, the company was subject to various legal proceedings, including:
iPod Battery Life: Eight separate class-action lawsuits in California (and one in New York) alleging misrepresentation of iPod battery life.
Apple Corps Ltd. Trademark Dispute: A lawsuit filed in London by Apple Corps Ltd. alleging the company breached a 1991 trademark agreement with its music-related activities.
Patent Infringement: Multiple lawsuits alleging infringement of patents related to technologies such as information transmission (Antor Media), JPEG compression (Compression Labs), and interrupt processing (Gobeli Research).
Securities Litigation: Shareholder class-action lawsuits related to stock purchases between July and September 2000. These claims were dismissed by the court, but the plaintiffs had appealed the ruling.
VirginMega/French Competition Council: A complaint filed by VirginMega seeking to force Apple to license its FairPlay digital rights management (DRM) technology. The French Competition Council denied VirginMega’s request.
