Know thyself

Know Thyself…And Thy Customer

Daniel Hartzler

CAPS600- Graduate Project

May 12, 2013

Arthur Smith

Southwestern College Professional Studies

Abstract

Know thyself. It is an ancient saying of unknown origin. In Hamlet, Polonius instructs his son that above all else he must, “To thine own self be true.” Deep words of wisdom that ring true for each of us. For most businesses, the same logic would apply. Businesses that find what they are best at and focus on that are typically profitable. Apple Inc. has taken that approach one step further. It's good to know yourself, but it's better to know your customers. In their successes and failures this logic is demonstrated time and again.

The successes, and often the failures of Apple have been tied to this notion. The company’s history is also very closely tied to that of one of the founders, Steve Jobs. The connection is such that the history of the company can be divided into four periods based on the connection of Jobs to the company. The first period covers the business during Steve Jobs first tenure with Apple from 1977 to 1985. The second period covers from 1985 to 1996 with several different CEOs. The third period is from 1997-2011, and covers Jobs return to Apple through his resignation and eventual death in 2011. The fourth and final period goes from 2011 to the present and looks at the present and future of Apple after Jobs. This report will be looking at the history for each of these four periods and providing analysis of the financial status and stock trends of the corporation during the period.

Period 1: Startup to Jobs’ Resignation

The first period runs from the start of the company in 1977 to 1985. From the start, the company took a different approach. Steve Jobs, Steve Wozniak and Ronald Wayne founded the company on April fool’s day 1976 (Grossman, McCracken, 2011), an unlikely coincidence that may have mirrored how the founders felt about their chances in the industry on that day. The business started in a garage and began selling the Apple I in July of that year for $666.66(Apple, 2009). The model was essentially just a motherboard with no keyboard or monitor.

From the start of the company a theme that has been repeated is success through innovation. The company was incorporated on January 3^rd, 1977(Apple, 2009) without Wayne, who sold his shares back to his partners. A new partner and investor, Mike Markkula, provided $250,000 in funding at the time of incorporation (Apple, 2009). After four months, Apple Computers released the Apple II on April 16^th, 1977(Apple, 2009). The Apple II began Apple's innovation theme by incorporating color graphics and an open architecture which was not present in competitor models at the time.

In December 1979, Apple gave Xerox $1 Million in pre-IPO Apple Stock in exchange for the right to visit Xerox PARC facilities for three days(Apple, 2009) While at the facility Jobs and other Apple engineers saw a Xerox experimental computer with a Graphic User Interface or GUI and a mouse. This interface allowed users to operate the computer using windows, pull down menus, icons and buttons. Jobs would later say that, “Within ten minutes … it was clear to me that all computers would work this way someday.”(Grossman, McCracken, 2011)

Over the next few years, Jobs would work on designing the Lisa, but in 1982, he would be forced out of the development team due to arguing within the group (Apple, 2009). Jobs moved to the Macintosh project, which was a low cost computer design. There was a lot of competition between the Lisa and Macintosh teams over which unit would be produced and sold first. Ultimately, the Lisa was released first in 1983, as the first computer sold to the public that had a GUI. The Lisa was not very well received by consumers, mainly because of the high price and limited software titles (Apple, 2009).

Apple continued its theme of innovation when it released the Macintosh in 1984. The innovation began with a $1.5 Million television commercial directed by Ridley Scott, which aired in the third quarter of the Super Bowl (Grossman, McCracken, 2011). The commercial, which can be viewed at http://www.youtube.com/watch?v=p3GlG2KwnUc, depicts the world as the society in George Orwell's book 1984, and Macintosh as the colorful rebel in that world.

The Macintosh sold well at first, but saw slumping sales in 1985 due to consumer complaints about the lack of memory. The original version of the Macintosh had 128 KB of memory, and no memory expansion slots. Alan Kay, an Apple employee at the time, called the Macintosh, “a Honda with a one-gallon gas tank” (Grossman, McCracken, 2011). Frustrated by the decrease in sales, and Jobs managerial approach, which could easily be described as rough and demanding, Apple's board of directors removed Jobs from his managerial duties. Jobs would resign from Apple and form NeXT Inc. within the year (Apple, 2009)

Financial Analysis

From an accounting perspective, there is very little financial information from the period. The business was started with almost nothing financially. The first infusion of cash came in the form of $250,000 from investor Mark Markkula. Apple must have been very successful in the early years after the release of the Apple II. In 1979 when they visited the Xerox PARC facility, they paid for the right to visit with $1 Million in pre IPO stock. This showed creativity in financing and hinted at a trend of Apple utilizing its stock rather than borrowing from lenders to finance operations.

Another financial tool that Apple utilized was donation. In the early 1980’s, Apple Computers donated an Apple II and Apple LOGO software package to every public school in California. Not only does this demonstrate an openness to contribute to society and education, donations are often considered part of the business strategy for many businesses. The fair market value of donations that a business makes can be deducted from taxable income for the period (Internal, 2013). So by donating computers and software, they gain an equivalent amount of income that cannot be taxed. Many businesses utilize a donation strategy as part of their tax strategy, shielding a portion of their Net Income from taxation.

Stock Analysis

An important development in the financial history of Apple during this period is the release of their stock. On September 7^th, 1984 Apple released their initial Public Offering or IPO, officially selling their stock. The IPO earned more money than any other IPO since that of Ford Motor Company in 1956. It also set a record by instantly creating about 300 Millionaires, which is more than any other company in history (Apple, 2009). According to the initial Public Offering, they issued 4 Million shares of stock at a price of $22 per share (SWTPC, 2013)

Apple had its work cut out for it as the small start-up company that was competing against industry giants like IBM. From the start, their innovative products were attractive to investors. There is a gap in the data regarding stock prices until 1984. On October 1^st, 1984, Stock in Apple Computers Inc. was selling at $24.87 a share compared to the price of $124.24 for a share of IBM Stock. As depicted in Chart 1, over the next few months Apple's stock raised to $29.00 a share and then declined again as a result of consumer complaints around the power of the Macintosh.
Period 2: Multiple CEOs and Approaches

The next period for Apple begins in 1985. Jobs had been removed from his position by Sculley and the board of directors. In the first period, Apple had established an identity as an innovator in the personal computer industry. In the absence of Jobs vision and leadership, the company lost track of both their own identity and the understanding of their customers as well. Their next innovation did not come out until 1989. In September of that year, Apple Computers released the Macintosh Portable. The predecessor to the modern laptop, it featured a Black and white LCD screen and a mouse trackball, that could be removed and placed on either side of the keyboard (Apple, 2009). The Macintosh Portable was well received, but the bulkiness of the model and short battery life were soon identified as shortcomings of this model. In 1991, Apple continued to innovate releasing the PowerBook. The PowerBook was the first of the modern laptops, with the same form and ergonomic layout that modern laptops utilize. They also released System 7, which introduced color to the computer operating system. System 7 programming code remained as the foundation of the Mac OS, or Macintosh Operating System, until 2011(Apple 2009).

Over the next few years, Apple would release several different computer models in various designs with different software packages. The result of this flood of models was that consumers were confused by the packages and sales dropped. During this period Apple also tried to branch out into several different consumer electronic fields. Some areas they explored were portable CD players, digital cameras, Televisions, speakers and video consoles. They also sunk large amounts of money into the Newton project. It seems that Apple had lost sight of their identity and was searching for what consumers wanted rather than providing a single product that met their needs.

The Newton was Apple's attempt to delve into the Personal Data Assistant or PDA market. This market was not a new field, and already had established industry leaders. Apple felt that their advantage lied in marketing the newton to the education field. They felt that teachers would benefit from using a PDA in the classroom. This approach was not well accepted at the time, and may well have been ahead of its time. Now, iPads are becoming common in classrooms.

After a series of flopped projects and a failed lawsuit with Microsoft, accusing them of using a GUI similar to that of the LISA, Michael Spindler replaced Sculley as CEO. Apple had realized that the Macintosh needed to be upgraded to compete with the changing market. They had the options to create a new computer line or platform, or they could rework the Macintosh to run on more powerful hardware. In 1994, Apple made its decision and decided to form the AIM Alliance. This alliance with Motorola and IBM would utilize IBM and Motorola hardware and Apple's software (Apple, 2009). The hope was that by combining forces and technologies the Alliance could defeat Microsoft, who was grabbing market share by pushing their software on cheaper systems. Later that year, Apple releases the Power Macintosh, which was the product of the combination.

In 1996, Michael Spindler was replaced by Gil Amelio as the Apple Computers Inc. CEO. Amelio came into the position with a plan for reinventing the company. The end result was many employees were laid off. Apple then made several attempts to create a replacement for the operating system. The first attempt was the Taligent project, followed by the Copland and Gershwin operating systems (Apple, 2009). Eventually Amelio decided the best route was to purchase NeXT and use its NeXTSTEP operating system for $400 Million. This move brought Steve Jobs back to Apple as an advisor. It also turned out to be a fruitful decision for the company as the operating system is the basis for every operating system since 2001, including the iPad and iPhone (Grossman, McCracken, 2011). Unfortunately, Amelio could not escape the fallout of the financial drought, and on July 9, 1997 the board of directors removed him and replaced him with Jobs as the interim CEO.

During the Amelio phase, in 1996 and 1997, Apple experienced over $1.6 Billion in losses (Grossman, McCracken, 2011). The search for identity and innovation had led the business to invest in many products that did not provide significant revenue for the business. Even though the business was faltering, Amelio was given substantial bonuses and stock options during the 1996 fiscal year. He received a $2.3Million bonus and $4.8 Million in stock awards (Securities, 1997). This came in a period in which the company reported Net losses of $816 Million. The following year in 1997Apple reported Net losses of $1.045 Billion (Securities, 1997). This result is also mirrored in the decline of Shareholders equity over the two years from $2.9 Billion to $1.2 Billion.

During the period, we see some signs on the balance sheet that the company was failing in their business strategies. Between 1993 and 1997, long term debt rose from $7 Million to $951 Million. At the same time, Total Assets had risen to $6.2 Billion and then declined to $4.2 Billion. This indicated that the business was spending or consuming massive amounts of resources in order to try and survive.

Amelio had done such a poor job running the company, that he was not even able to sell it. Deals with both Sun Microsystems and IBM fell through before being completed (Grossman, McCracken, 2011).

Apple’s stock value had continued a rapid in 1986 and 1987, almost doubling its value and reaching a top closing price of $79 a share (Yahoo, 2013). Then suddenly the value drops to around $40 a share. This change in value is due to Apple initiating a stock split. On June 15^th, 1987 Apple initiated a 2 for 1 stock split.

A stock split is when a company effectively splits the existing stock by a whole number ratio. As the stock is split, the price of the stock is also split along the same ratio lines and each investor receives an equivalent number of shares equal to the percentage of their ownership on the determined day of the split (Libby, Libby, Short, 2011). So if an investor had 10 shares valued at $100 apiece for a total worth of $1,000, then after a 2 for 1 split, they would have 20 share of $50 value stock for an equal value of $1,000 total. This can be used by business as an indicator of future prosperity for the business. Some businesses also use a split to improve the sales of their stock. The theory is that it is easier to find ten investors willing to buy one share apiece of $10 value stock, than it is to find one investor to buy one share of $100 value stock (Libby, Libby, Short, 2011). In the included charts, the adjusted stock is a representation of what the stock value would be based on the current value of one share of the stock after three stock splits.

Apple’s stock continues to grow and be prosperous until mid to late 1992. At that time, Apple had experienced success with the Macintosh and PowerBook lines, but the flooding of the market with several different types of systems and software packages, resulted in consumer confusion and ultimately lowered stock values. The lack of direction and identity was felt by the investors and values continued to fall to a ten year low in 1996.

Jobs started his reunion tour with Apple with a failing company and not much else. He wasted no time turning things around as the interim CEO, or iCEO as he called it. It turned out to be very apropos, given the forthcoming “i” line of products. He started by making major changes including, removing board members, cutting staff, abandoning several products, and slashing costs. He even did the unthinkable, taking a $150 Million lifeline from one of the company’s biggest competitors, Microsoft (Apple, 2009). At the 1997 Macworld Expo, Jobs announced that Apple and Microsoft had teamed up to release a version of Microsoft Office for the Macintosh. When Bill Gates made a guest appearance on the large video screens behind Jobs during the announcement, the audience at the event booed (Grossman, McCracken, 2011).

In 2001, Jobs continued the innovation of the company in what has been described as a relatively small press conference at Apple's headquarters. He explained that Apple had decided to enter the MP3- player business, reached into his pocket, and pulled out the first iPod. In this simple act he had redefined Apple as a consumer electronics company. Jobs had succeeded where the “interim” CEO's had failed in reinventing the company.

The iPod was not the first MP3-player, and it had less features that many of its competitors at a higher price. But it looked so different and truly was an example of the triumph of form over function. In the first six years, over 100 Million iPods were sold to consumers (Apple, 2009). But that was only half of where Jobs succeeded with the iPod. At first owners would get music by “ripping”, or uploading it from their personal CDs or by downloading it from peer to peer sights like Kazaa or Napster. Apple paired the iPod with iTunes. Jobs convinced the record labels to allow him to sell their music online. iTunes offered songs at $0.99 a piece and in the first week, users bought a million. By 2008 that figure would rise to 5 Billion downloads (Grossman, McCracken, 2011). So, essentially Jobs had convinced consumers to pay for something that, at the time, they were getting for free elsewhere.

Another innovation was released in 2007 at the Macworld expo. “Every once in a while, a revolutionary product comes along that changes everything,” Jobs said in his introduction of the iPhone. The iPhone introduced a new touch screen technology and graphic user interface to the market all in one package. It was akin to having a small computer that fit into your pocket. By 2011, Apple was selling iPhones at a rate of 210,000 a day, capturing two thirds of the industry profits (Grossman, McCracken, 2011). By pairing the iPhones and iPods with apps, music, and movies delivered through iTunes, Apple had developed a formidable revenue chain.

Never satisfied, Jobs pushed into another market and developed the iPad, a tablet computer. Several different companies had previously released tablet computers, without having a single hit. Jobs combined the technology of the iPod and iPhone and the cool factor of an Apple product and overcame the failures of others. In the first year of production, Apple sold over 15 Million units (Grossman, McCracken, 2011).

Financial Analysis

One of Jobs first acts as the iCEO was to cut costs and eliminate several products that he felt were being wasteful and hurting the company. This act is clearly reflected in the financial reporting. Research and development costs in 1995 had been $614 Million and in 1996, they were $604 Million. In 1997, after Jobs took the reins of the business, that figure fell to $485 Million, a reduction of $119 Million or 19.7% from the previous year (Security, 1997). The selling, general and administrative expenses followed the same pattern dropping from $1,568 Million in 1996 to $1,286 Million in 1997. The reduction of both of these figures would directly result in a higher gross margin for the 1997 period as less expense would be deducted from total sales in the calculation of Net Income (Libby, Libby, Short, 2011).

In 2001, Apple had a rough year financially, reporting a gross margin of 23% compared to 27% in 2000 and 28% in 2002. The difference resulted in Apple having to report a $25 Million net loss in 2001 (Securities, 2002). The poor gross margin was the result of a spike in component costs, such as hard disk drives and LCD displays, and the need to lower product prices in the personal computer lines. The company had previously utilized a more aggressive pricing strategy, utilizing premium prices to maximize profit margins, but changes in the market pricing structure strong armed Apple into lowering their prices. This lowering of sales prices negatively affected the Net Sales and ultimately the Net Income for the period.

In 2011, at the end of Jobs time with Apple, Apple reported $108 Billion in Net Sales. The iPhone, iPad and Mac product lines had net sales growth of 87%, 311%, and 25% respectively compared to 2010 figures. In terms of Dollars the iPhone line experienced the largest sales at $47.1 Billion, followed by the Mac lines at 21.7 Billon and the iPad at 20.4 Billion. The iPod was the only product line that decreased, lowering sales by 10% at $821 Million compared to 2010 figures.(Securities, 2011). Early in the period Gross margins had been at 28% and 27% during good years. In 2011 at the end of the period, the gross margin is reported as 40.5%. These figures demonstrate that Apple’s aggressive pricing strategy, of providing well engineered products at premium prices is an effective strategy in the current market.

During the period, Apple was able to pay off all of their long term debt which was accumulated during the previous period. By doing so, Apple increased the strength of their balance sheet, making them a more appealing investment to potential investors. For the last five years of the period Apple carried a $0 balance for long term debt. This points to the fact that they had returned to the strategy of using their stock values and equity to finance operations.

Stock Analysis

During this period Apple initiated two stock splits. The first was on June 21^st, 2000 and the second on February 28^th, 2005. Both splits were on a 2 for 1 ratio bringing the total shares of issued stock to 1,800,000 (Investor, 2013). If you utilized the adjusted closing values of the stock, the purchase of 1 share at the time of the IPO would be valued at $2.81 versus the $22 issue price recorded on the IPO. (Yahoo, 2013). As mentioned earlier, companies often utilize a stock split to hint at future prosperity. The stock split in 2000 was almost a year before the release of the iPod and the 2005 split was not long before the release of the iPhone. So it does appear that apple was utilizing this strategy to boost stock prices prior to product releases.

Apple’s stock value has continued a fairly consistent rise through the third period as demonstrated in Chart 3. There was a significant decline in 2001, most likely due to the announcement in the first quarter of a Net Loss for the quarter. The sales of iPods do gradually increase stock values over time, but the significant changes are seen in relationship to the release of the iPhone. The iPhone went on sale in June 2007 and stock prices jumped $76.04 over the next six months (Yahoo, 2013). The next significant jump in value coincides with the release of the iPad. At the time of its release in April of 2009 values were at about $125. By the end of the period Stock values were boosted to around $380 a share.
Period 4: Apple After Jobs

The fourth period looks at recent years from 2011 to present. Steve Jobs had been diagnosed in 2004 with pancreatic cancer. Jobs had surgery and turned control of the company over to Tim Cook. He recovered and returned, then in 2009 received a liver transplant during a medical leave. He took one more medical leave in 2011, which turned into a permanent leave when he resigned as CEO on August 24^th (Grossman, McCracken, 2011).

Tim Cook was appointed as CEO following Jobs’ resignation in 2011. He inherited a very profitable business that has a very positive consumer reputation. Apple has a strong identity as an innovator based on the product lines released during the third period. Jobs also left Cook a solid team to help continue the theme of innovation. The most prominent person who remained would be Jonathan Ive, senior vice president of industrial design. Ive is given credit as the lead designer and conceptual presence behind the iMac, MacBook, iPod, iPhone and iPad. Other executives from Apple who have been with the company for more than a decade and remain are Apple CFO, head of product marketing, and the head of Apple’s software development team for the iPhone and iPad (Green,2012).

To date, Apple has not released a new, innovative product in this period. They appear to still be riding the wave of success that was generated in the previous period. Some feel that the computer and smart phone industries are quickly approaching a technological leap, and that does not bode well for Apple (Edwards, 2012). More often, innovation comes from someone farther down the ladder striving to overtake the leader.

The growth that apple exhibited in the last years of the third period, is continued into the final period. Net Sales was reported as $156 Billion, with Net Income of $41 Billion. To put that in perspective, the Net income from 2012 exceeded the total Net Income earned in 2010 and 2011 combined (Securities, 2012). The iPhone continues to lead all products in sales revenue at $80 Billion, over half of the total revenue of the company.

Total Assets of the business totaled over $176 Billion, with Total Shareholders’ equity of $118 Billion for an Assets/Equity ratio of 1.49 (Securities, 2012). This ratio demonstrates a continued financial approach of utilizing shareholder equity to acquire and maintain Assets. This approach if further supported by the fact that Apple continues to carry no long term debt.

The gross margin during 2012 was 43.9% compared to 40.5% in 2011 and 39.4% in 2010. This gain was due to lower commodity and product costs and a higher ratio of iPhone sales to other more costly products. Apple notes, that in the future they expect to see declining margins in the future. They state that this is due to lower margins in new, innovative products which have higher cost structures and provide greater value to consumers.

Apple’s stock values continued to rise after the resignation of Jobs. In September of 2012, Apple stock value reached a company high of $702 (Yahoo, 2013). One way to measure the value of a company’s stocks is their market value. Market Value is equivalent to the value of the stock on the market times the share value, or the total value of all outstanding stock (Libby, Libby, Short, 2011). In terms of market value, Apple became the world’s most valuable company in 2012, surpassing Exxon Mobil, with a Total Market Value of $416.6 Billion(Forbes, 2013).

Apple Computers Inc. was formed by a few young with a vision to change the way the world used computers. As demonstrated in Chart 5, it has not been an easy road, but in recent years Apple computers has emerged as one of the most profitable companies in the world. The identity of an innovator was clearly present in times when Apple was successful. Conversely, during the period when Steve Jobs was not with the company, the identity was lost and the business faltered. Their most innovative products demonstrated a keen understanding of consumers and what they want.