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Kass: Getting to the Core of Apple

The increase in selling, general and administrative costs can be associated with the store launches. There is a strong positive correlation (R-squared) of 0.93 comparing store openings with SG&A costs. The company is opening more stores internationally while the domestic market is reaching a saturation point. In the U.S., the company is opening more stores in smaller markets and opening additional stores in markets where they already have a presence. The average SG&A cost per store is increasing by about 9% a year based on the company opening an average of 39 stores a year.

Revenue has increased by a compound annual growth rate of 35% from 2006 to 2012 while research and development costs increased by a CAGR of 25%. The consensus estimates have revenue growing at 12%. Our estimates, however, are closer to a CAGR of 9% given the cited factors of narrowing competitive advantage.

From 2005 to 2011 (excluding 2009), gross profit margins have ended higher than when they were reported in December (first quarter for Apple) of that year. The trend changed in 2012, when gross profit margins started the year around 44.5% and ended the year near 40%. Company guidance was for 36% gross profit margin and declining going forward.

Apple helped advance the idea of a company being successful by being both a software and hardware manufacturer. Google is advancing its Android software with its Nexus 7 tablet, and Microsoft is doing the same with new Windows software and the Surface. Microsoft is also betting on the success of its phones via its partnership with Nokia (NOK).

Nokia has taken a beating over the years in the phone market but not without reason. Nokia is dependent on the operating systems of other software companies (Microsoft) and has had little innovation when compared to Apple. Nokia has seen little net income margin improvements and has debt on the balance sheet; Apple is debt-free with continuous innovation and improving net income margins. Apple also better manages its SG&A costs than Nokia, which leads to improving margins.

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