During Apple's earnings report on Tuesday, investors and analysts had many concerns, including things like the iPhone sales, how the trade war with China affected business there, and the development of the service segment.
One thing few seemed to focus on was the research and development expenses. But maybe they should have paid it a little more attention. Apple's earnings fell in the last quarter despite an increase in sales, and the incongruous result is largely a product of yet another significant upturn in the company's research efforts.
Additionally, Apple Finance Manager Luca Maestri indicated that Apple's R&D investment will not slow down anytime soon.
"It is very important for us to continue to invest in the business, especially on the R&D side, because we always want to bring more innovation to the market, we want to improve the user experience and differentiate our products and services in the market," Maestri said on a conference call with analysts. "So we will continue to do so."
Apple's sales increased, but profits fell
During the fiscal third quarter, Apple's sales increased 1
To put it another way, Apple's sales increased $ 544 million from the third quarter a year ago to just completed the third quarter. But profits fell by $ 1.48 billion over the same period.
Part of the explanation for the discrepancy between the top and bottom lines was that the cost of selling well – its direct cost of producing and delivering its products and services – increased. Despite higher sales, Apple's gross profit – the amount of revenue left after accounting for its direct costs – actually decreased by about 1% from the same period the year before. It's probably a function of the price cuts and trade-in incentives that Apple used to help juice, especially in China.
Overall, Apple's direct costs were $ 738 million higher in the third quarter of the year than they were a year earlier, more than wiping out sales profits.
Apple's R&D spending is huge and growing
But the next biggest factor that weighs heavily on Apple's main line was research and development spending. Apple spent $ 4.3 billion on R&D in the just completed quarter. Compared to last year, there was an increase of $ 556 million, or 15%, which far exceeds sales growth.
Perhaps more significantly, Apple spent 7.9% of its revenue on research in the quarter, compared to about 7% in the same period the year before. On an annual basis, this would be the highest proportion it had spent on R&D in 18 years. The last time Apple devoted more of its sales to research was in 2001, when it saw a decline in revenue due to the dot-com bust and invested heavily in developing the iPod, iTunes and a new operating system for Mac computers.
The company's R&D expenditure was probably boosted as part of the revenue from the fact that the third quarter is typically a seasonally slow release. But the jump still reflects a larger trend.
Since Apple's research expenditures fell below 2.2% of sales in 2012, the company has consistently increased the amount of R&D revenue. Throughout last year, it provided 5.4% of sales to R&D. In the first nine months of this year, 6.2% has been devoted.
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Part of the increase is a result of falling sales. But it also reflects the fact that Apple is spending more and more dollars on its R&D efforts even though revenue has fallen. In the first nine months of this year, it spent $ 12.1 billion on research, $ 1.6 billion, or 15.5%, more than it spent in the same period last year.
Apple may not be reaping investment soon
As research spending has risen, Apple R&D efforts have become one of the largest in the world. But the company doesn't have much to show for it, at least not in terms of hits on new products. The latest major new product, Apple Watch, debuted in 2015, a year in which R&D spending was about half what it is likely to be this year. Reported investments in cars and interactive TVs, meanwhile, have not yet borne much fruit.
Citigroup's Jim Suva was the only analyst to question Apple's R&D efforts on Tuesday, wondering what he and other analysts should expect in the future.
"You've invested a lot, a lot, a lot, a lot," he said. "Are we at some point now," he continued, "where much of the harvesting is going to happen?"
Maestri refused to answer his question directly, but the answer suggested that Apple will not move to harvest mode. The amount of revenue Apple spends on all its operating expenses, which includes marketing and administration costs in addition to research and development, has been "competitive" with other technology companies, he said.
"We want to continue to be competitive, and at the same time we do not want to under-invest in the business," he said.