Edgar Filing: APPLE COMPUTER INC

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 28, 2003 OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

Commission file number 0-10030

APPLE COMPUTER, INC.

(Exact name of Registrant as specified in its charter)

CALIFORNIA		942404110
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1 Infinite Loop
Cupertino, California		95014
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (408) 996-1010

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ý No o

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

Yes ý No o

362,500,925 shares of Common Stock Issued and Outstanding as of August 1, 2003

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

APPLE COMPUTER, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

(in millions, except share and per share amounts)

	Three Months Ended				Nine Months Ended
	June 28, 2003		June 29, 2002		June 28, 2003			June 29, 2002

Net sales	$	1,545	$	1,429	$	4,492		$	4,299
Cost of sales	1,117		1,038		3,240			3,077
Gross margin	428		391		1,252			1,222
Operating expenses:
Research and development	120		106		360			330
Selling, general, and administrative	299		272		898			831
Restructuring costs	—		—		26			24
Total operating expenses	419		378		1,284			1,185
Operating income (loss)	9		13		(32		)	37

Gains on non-current investments, net	2		—		2			23
Interest and other income, net	15		26		67			87
Total interest and other income, net	17		26		69			110

Income before provision for income taxes	26		39		37			147
Provision for income taxes	7		7		10			37

Income before accounting change	19		32		27			110
Cumulative effect of accounting change, net of income taxes of $1	—		—		(2		)	—

Net income	$	19	$	32	$	25		$	110
Earnings per common share before accounting change:
Basic	$	0.05	$	0.09	$	0.07		$	0.31
Diluted	$	0.05	$	0.09	$	0.07		$	0.30

Earnings per common share after accounting change:
Basic	$	0.05	$	0.09	$	0.07		$	0.31
Diluted	$	0.05	$	0.09	$	0.07		$	0.30
Shares used in computing earnings per share (in thousands):
Basic	360,793		356,370		360,113			353,800
Diluted	363,777		366,882		362,421			363,438

See accompanying notes to condensed consolidated financial statements.

APPLE COMPUTER, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(in millions, except share amounts)

	June 28, 2003			September 28, 2002

ASSETS:

Current assets:
Cash and cash equivalents	$	3,507		$	2,252
Short-term investments	1,038			2,085
Accounts receivable, less allowances of $49 and $51, respectively	568			565
Inventories	38			45
Deferred tax assets	176			166
Other current assets	219			275
Total current assets	5,546			5,388
Property, plant and equipment, net	639			621
Goodwill	85			85
Acquired intangible assets	27			34
Other assets	144			170
Total assets	$	6,441		$	6,298

LIABILITIES AND SHAREHOLDERS’ EQUITY:

Current liabilities:
Accounts payable	$	880		$	911
Accrued expenses	838			747
Current debt	307			—
Total current liabilities	2,025			1,658
Long-term debt	—			316
Deferred tax liabilities and other non-current liabilities	218			229
Total liabilities	2,243			2,203

Commitments and contingencies

Shareholders’ equity:
Common stock, no par value; 900,000,000 shares authorized; 366,992,631 and 358,958,989 shares issued and outstanding, respectively	1,935			1,826
Deferred stock compensation	(68		)	(7		)
Retained earnings	2,350			2,325
Accumulated other comprehensive income (loss)	(19		)	(49		)
Total shareholders’ equity	4,198			4,095
Total liabilities and shareholders’ equity	$	6,441		$	6,298

See accompanying notes to condensed consolidated financial statements.

APPLE COMPUTER, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(in millions)

	Nine Months Ended
	June 28, 2003			June 29, 2002

Cash and cash equivalents, beginning of the period	$	2,252		$	2,310
Operating Activities:
Net income	25			110
Cumulative effect of accounting change, net of taxes	2			—
Adjustments to reconcile net income to cash generated by operating activities:
Depreciation, amortization and accretion	93			85
Non-cash restructuring	12			4
Provision for (benefit from) deferred income taxes	(16		)	(2		)
Loss on disposition of property, plant, and equipment	2			6
Gains on sales of short-term investments, net	(21		)	(5		)
Gains on sales of non-current investments, net	(2		)	(23		)
Changes in operating assets and liabilities:
Accounts receivable	(3		)	(160		)
Inventories	7			(23		)
Other current assets	56			(154		)
Other assets	(15		)	(13		)
Accounts payable	(31		)	103
Other current liabilities	107			79

Cash generated by operating activities	216			7

Investing Activities:
Purchase of short-term investments	(1,981		)	(3,478		)
Proceeds from maturities of short-term investments	1,954			1,917
Proceeds from sale of short-term investments	1,072			519
Proceeds from sale of non-current investments	36			25
Purchases of property, plant, and equipment	(106		)	(110		)
Other	33			(33		)

Cash generated by (used for) investing activities	1,008			(1,160		)

Financing Activities:
Proceeds from issuance of common stock	31			89

Cash generated by financing activities	31			89

Increase (decrease) in cash and cash equivalents	1,255			(1,064		)
Cash and cash equivalents, end of the period	$	3,507		$	1,246

Supplemental cash flow disclosures:
Cash paid for interest	$	10		$	10
Cash paid for income taxes, net	$	35		$	8

See accompanying notes to condensed consolidated financial statements.

APPLE COMPUTER, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 1 - Summary of Significant Accounting Policies

Apple Computer, Inc. and its subsidiaries (the Company) designs, manufactures, and markets personal computers and related personal computing and communicating solutions for sale primarily to education, creative, consumer, and business customers.

Basis of Presentation and Preparation

The accompanying condensed consolidated financial statements include the accounts of the Company. Intercompany accounts and transactions have been eliminated. The preparation of these condensed consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in these condensed consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates. Interim information is unaudited; however, in the opinion of the Company’s management, all adjustments of a normal recurring nature necessary for a fair statement of interim periods presented have been included. The results for interim periods are not necessarily indicative of results to be expected for the entire year.

These condensed consolidated financial statements and accompanying notes should be read in conjunction with the Company’s annual consolidated financial statements and the notes thereto for the fiscal year ended September 28, 2002, included in its Annual Report on Form 10-K for the year ended September 28, 2002 (the 2002 Form 10-K). Unless otherwise stated, references to particular years or quarters refer to the Company’s fiscal years ended in September and the associated quarters of those fiscal years.

Accounting for Asset Retirement Obligations

On September 29, 2002, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 143, Accounting for Asset Retirement Obligations, which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The standard applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or normal use of the assets. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The fair value of the liability is added to the carrying amount of the associated asset and this additional carrying amount is depreciated over the life of the asset. All of the Company’s existing asset retirement obligations are associated with commitments to return property subject to operating leases to original condition upon lease termination. The Company estimated that as of September 29, 2002, gross expected future cash flows of $9.5 million would be required to fulfill these obligations.

As of the date of adoption, the Company recorded a $6 million long-term asset retirement liability and a corresponding increase in leasehold improvements. This amount represents the present value of expected future cash flows associated with returning certain of the Company’s leased properties to original condition. The difference between the gross expected future cash flow of $9.5 million and its present value at September 29, 2002, of $6 million will be accreted over the life of the related leases as an operating expense. Net of the related income tax effect of approximately $1 million, adoption of SFAS No. 143 resulted in an unfavorable cumulative-effect type adjustment to net income during the first quarter of 2003 of approximately $2 million. This adjustment represents cumulative depreciation and accretion that would have been recognized through the date of adoption of SFAS No. 143 had the statement been applied to the Company’s existing asset retirement obligations at the time they were initially incurred.

The following table reconciles changes in the Company’s asset retirement liability for the first nine months of 2003 (in millions):

Asset retirement liability recorded at 9/29/02	$	5.5
Additional asset retirement obligations recognized	0.3
Accretion recognized	1.1
Asset retirement liability as of 6/28/03	$	6.9

Accounting for Restructuring Charges

In June 2002, the Financial Accounting Standards Board issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 supersedes Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs To Exit an Activity (Including Certain Costs Associated with a Restructuring) and requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, as opposed to when management is committed to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. This Statement was effective for exit or disposal activities initiated after December 31, 2002. The provisions of SFAS No. 146 were required to be applied prospectively after the adoption date to newly initiated exit activities.

Stock-Based Compensation

The Company measures compensation expense for its employee stock-based compensation plans using the intrinsic value method prescribed by Accounting Principles Board (APB) Opinion 25, Accounting for Stock Issued to Employees, and has provided pro forma disclosures of the effect on net income and earnings per share as if the fair value-based method had been applied in measuring compensation expense. The Company has elected to follow APB No. 25 because, as discussed below, the alternative fair value accounting provided for under SFAS No. 123, Accounting for Stock-Based Compensation, requires use of option valuation models that were not developed for use in valuing employee stock options and employee stock purchase plan shares. Under APB No. 25, when the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of the grant, no compensation expense is recognized.

As required under SFAS No. 123, the pro forma effects of stock-based compensation on net income and earnings per common share for employee stock options granted and employee stock purchase plan purchases have been estimated at the date of grant and beginning of the period, respectively, using a Black-Scholes option pricing model. For purposes of pro forma disclosures, the estimated fair value of the options and shares is amortized to pro forma net income over the options’ vesting period and the shares’ plan period.

The Black-Scholes option valuation model was developed for use in estimating the fair value of freely traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected life of options and the Company’s expected stock price volatility. Because the Company’s employee stock options and employee stock purchase plan shares have characteristics significantly different from those of freely traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not provide a reliable measure of the fair value of the Company’s employee stock options and employee stock purchase plan shares.

For purposes of the pro forma disclosures provided pursuant to SFAS No. 123, the expected volatility assumptions used by the Company prior to the third quarter of 2003 have been based solely on the historical volatility of the Company’s common stock over the most recent period commensurate with the estimated expected life of the Company’s stock options. Beginning in the third quarter of 2003, the Company has modified this approach to consider other relevant factors including implied volatility in market traded options on the Company’s common stock and the impact of unusual fluctuations not reasonably expected to recur on the historical volatility of the Company’s common stock. The Company will continue to monitor these and other relevant factors in developing the expected volatility assumption used to value future awards.

Beginning in the third quarter of 2003, the Company shortened its estimate of the expected life of new options granted to its employees from 4 years to 3.5 years. The Company bases its expected life assumption on its historical experience and on the terms and conditions of the stock options it grants to employees. The change in the expected life assumption made during the third quarter of 2003 was the result of the expected impact of shortening the contractual life of new options granted to employees from 10 years to 7 years and changing the vesting provisions of new options granted to employees from 4 year straight-line annual vesting to 4 year straight-line quarterly vesting.

For purposes of pro forma disclosures, the estimated fair value of the options and shares is amortized to pro forma net income over the options’ vesting period and the shares’ plan period. The Company’s pro forma information for the three and nine month periods ended June 28, 2003 and June 29, 2002 follows (in millions, except per share amounts):

	Three Months Ended						Nine Months Ended
	6/28/03			6/29/02			6/28/03			6/29/02

Net income - as reported	$	19		$	32		$	25		$	110
Add: Stock-based employee compensation expense included in reported net income, net of tax	6			—			6			—
Deduct: Stock-based employee compensation expense determined under the fair value based method for all awards, net of tax	(40		)	(60		)	(141		)	(185		)

Net loss - pro forma	$	(15	)	$	(28	)	$	(110	)	$	(75	)

Net income per common share - as reported
Basic	$	0.05		$	0.09		$	0.07		$	0.31
Diluted	$	0.05		$	0.09		$	0.07		$	0.30

Net loss per common share - pro forma
Basic	$	(0.04	)	$	(0.08	)	$	(0.30	)	$	(0.21	)
Diluted	$	(0.04	)	$	(0.08	)	$	(0.30	)	$	(0.21	)

Note 2 – Financial Instruments

Cash, Cash Equivalents and Short-Term Investments

The following table summarizes the fair value of the Company’s cash and available-for-sale securities held in its short-term investment portfolio, recorded as cash and cash equivalents or short-term investments as of June 28, 2003, and September 28, 2002 (in millions):

	As of 6/28/03		As of 9/28/02

Cash	$	174	$	161

U.S. Treasury and Agency securities	45		47
U.S. corporate securities	2,453		1,952
Foreign securities	835		92
Total cash equivalents	3,333		2,091

U.S. Treasury and Agency securities	358		681
U.S. corporate securities	456		988
Foreign securities	224		416

Total short-term investments	1,038		2,085

Total cash, cash equivalents, and short-term investments	$	4,545	$	4,337

The Company’s short-term investment portfolio consists of investments in U.S. Treasury and Agency securities, U.S. corporate securities, and foreign securities. The Company’s U.S. corporate securities consist primarily of commercial paper, certificates of deposit, time deposits, and corporate debt securities. Foreign securities consist primarily of foreign commercial paper, certificates of deposit and time deposits with foreign institutions, most of which are denominated in U.S. dollars. The Company had net unrealized gains on its investment portfolio of $20 million as of September 28, 2002, and net unrealized losses of $2 million as of June 28, 2003. The Company occasionally sells short-term investments prior to their stated maturities. As a result of such sales, the Company recognized gains of $3 million and $2 million during the third quarters of 2003 and 2002, respectively. Recognized gains on the sale of short-term investments were $21 million and $5 million during the first nine months of 2003 and 2002, respectively. These gains were included in interest and other income, net.

As of June 28, 2003, and September 28, 2002, $338 million and $1.087 billion, respectively, of the Company’s investment portfolio that was classified as short-term investments had maturities ranging from 1 to 5 years. The remainder of the Company’s short-term investments had underlying maturities of between 3 and 12 months.

Non-Current Debt and Equity Investments and Related Gains

The Company has held significant investments in ARM Holdings plc (ARM), Akamai Technologies, Inc. (Akamai) and EarthLink Network, Inc. (EarthLink). These investments have been reflected in the consolidated balance sheets as long term assets within other assets and have been categorized as available-for-sale requiring that they be carried at fair value with unrealized gains and losses, net of taxes, reported in equity as a component of accumulated other comprehensive income. All realized gains on the sale of these investments have been included in interest and other income. The combined fair value of these investments held by the Company was $39 million as of September 28, 2002.

During the third quarter of 2003, the Company sold all of its remaining holdings in both ARM and EarthLink, consisting of 278,000 shares of ARM stock for net proceeds of approximately $295,000, and a gain before taxes of $270,000, and 3,960,000 shares of Earthlink stock for net proceeds of approximately $23 million, and a gain before taxes of $2 million. During the first quarter of 2003, the Company sold 2,580,000 shares of EarthLink stock for net proceeds of approximately $13.7 million, an amount that approximated the Company’s carrying value of the shares. As of June 28, 2003, the fair value of the Company’s remaining investment in Akamai was $14 million.

During the first quarter of 2002, the Company sold 4.7 million shares of ARM stock for both net proceeds and a gain before taxes of $21 million. During the first quarter of 2002, the Company also sold 250,000 shares of Akamai and 117,000 shares of EarthLink stock for net proceeds of approximately $2 million each and a gain before taxes of $710,000 and $223,000, respectively.

Debt

The Company currently has debt outstanding in the form of $300 million of aggregate principal amount 6.5% unsecured notes that was originally issued in 1994. The notes, which pay interest semiannually, were sold at 99.925% of par, for an effective yield to maturity of 6.51%. The notes, along with approximately $7 million of related unamortized deferred gains on closed interest rate swaps, are due in February of 2004 and therefore have been classified as current debt as of June 28, 2003.

Derivative Financial Instruments

The Company uses derivatives to partially offset its business exposure to foreign exchange and interest rate risk. Foreign currency forward and option contracts are used to offset the foreign exchange risk on certain existing assets and liabilities and to hedge the foreign exchange risk on expected future cash flows on certain forecasted revenues and cost of sales. From time to time, the Company enters into interest rate swap agreements to modify the interest rate profile of certain investments and debt. The Company’s accounting policies for these instruments are based on whether the instruments are designated as hedge or non-hedge instruments. The Company records all derivatives on the balance sheet at fair value. As of the end of the third quarter of 2003, the general nature of the Company’s risk management activities and the general nature and mix of the Company’s derivative financial instruments have not changed materially from the end of fiscal 2002.

Foreign Exchange Risk Management

The Company enters into foreign currency forward and option contracts with financial institutions primarily to protect against foreign exchange risk associated with existing assets and liabilities, certain firmly committed transactions and certain probable but not firmly committed transactions. Generally, the Company’s practice is to hedge a majority of its existing material foreign exchange transaction exposures. However, the Company may not hedge certain foreign exchange transaction exposures due to immateriality, prohibitive economic cost of hedging particular exposures, or limited availability of appropriate hedging instruments.

Interest Rate Risk Management

The Company sometimes enters into interest rate derivative transactions, including interest rate swaps, collars, and floors, with financial institutions in order to better match the Company’s floating-rate interest income on its cash equivalents and short-term investments with its fixed-rate interest expense on its long-term debt, and/or to diversify a portion of the Company’s exposure away from fluctuations in short-term U.S. interest rates. The Company may also

enter into interest rate contracts that are intended to reduce the cost of the interest rate risk management program. The Company does not hold or transact in such financial instruments for purposes other than risk management.

Accounting for Derivative Financial Instruments

On October 1, 2000, the Company adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 established accounting and reporting standards for derivative instruments, hedging activities, and exposure definition. SFAS No. 133 requires that all derivatives be recognized as either assets or liabilities at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in fair value will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings, or recognized in other comprehensive income until the hedged item is recognized in earnings. As of June 28, 2003, the Company had a net deferred loss associated with cash flow hedges of approximately $4 million net of taxes, substantially all of which is expected to be reclassified to earnings by the end of the first quarter of fiscal 2004.

Note 3 – Condensed Consolidated Financial Statement Details (in millions)

Inventories

	6/28/03		9/28/02
Purchased parts	$	1	$	9
Work in process	—		—
Finished goods	37		36

Total inventories	$	38	$	45

Other Current Assets

	6/28/03		9/28/02
Vendor non-trade receivables	$	106	$	142
Other current assets	113		133

Total other current assets	$	219	$	275

Property, Plant, and Equipment

	6/28/03			9/28/02
Land and buildings	$	348		$	342
Machinery, equipment, and internal-use software	367			367
Office furniture and equipment	73			67
Leasehold improvements	336			281
	1,124			1,057

Accumulated depreciation and amortization	(485		)	(436		)

Total net property, plant, and equipment	$	639		$	621

Other Assets

	6/28/03		9/28/02
Non-current deferred tax assets	$	59	$	70
Non-current debt and equity investments	14		39
Capitalized software development costs, net	16		19
Other assets	55		42

Total other assets	$	144	$	170

Accrued Expenses

	6/28/03		9/28/02
Deferred revenue	$	331	$	253
Accrued marketing and distribution	128		136
Accrued compensation and employee benefits	117		93
Accrued warranty and related costs	67		69
Other current liabilities	195		196

Total accrued expenses	$	838	$	747

Interest and Other Income, Net

	Three Months Ended						Nine Months Ended
	6/28/03			6/29/02			6/28/03			6/29/02
Interest income	$	15		$	29		$	56		$	92
Interest expense	(2		)	(2		)	(6		)	(8		)
Gain on sales of short term investments	3			2			21			5
Other income (expense), net	(1		)	(3		)	(4		)	(2		)

Interest and other income, net	$	15		$	26		$	67		$	87

Inventory Prepayment

In April 2002, the Company made a $100 million prepayment to an Asian supplier for the purchase of components over the following nine months. In return for this deposit, the supplier agreed to supply the Company with a specified level of components during the three consecutive fiscal quarters ending December 28, 2002. Approximately $53 million of this deposit remained unused as of September 28, 2002 and was reflected in the condensed consolidated balance sheets in other current assets. During the first six months of 2003, the remainder of the deposit balance was fully utilized for the purchase of components. The deposit was unsecured and had no stated interest component. The Company imputed an amount to cost of sales and interest income during each period the deposit was outstanding at a 3.25% interest rate to reflect the economics of this transaction.

Goodwill and Other Intangible Assets

The Company is currently amortizing its acquired intangible assets with definite lives over periods ranging from 3 to 7 years. The Company ceased amortization of goodwill at the beginning of fiscal 2002 when it adopted SFAS No. 142, Goodwill and Other Intangible Assets.

The following table summarizes the components of gross and net intangible asset balances (in millions):

	As of 6/28/03							As of 9/28/02
	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount

Goodwill (a)	$	85	$	—		$	85	$	85	$	—		$	85
Other intangible assets	5		(5		)	—		5		(5		)	—
Acquired technology	42		(15		)	27		42		(8		)	34

Total acquired intangible assets	$	132	$	(20	)	$	112	$	132	$	(13	)	$	119

(a) Accumulated amortization related to goodwill of $55 million arising prior to the adoption of SFAS No. 142 has been reflected in the gross carrying amount of goodwill as of June 28, 2003, and September 28, 2002.

Amortization associated with acquired technology for the three and nine-month periods ended June 28, 2003 and June 29, 2002 follows (in millions):

	Three Months Ended				Nine Months Ended
	6/28/03		6/29/02		6/28/03		6/29/02
Acquired technology amortization	$	2	$	1	$	7	$	4

Note 4 – Restructuring Actions

Fiscal 2003 Restructuring Actions

The Company recorded total restructuring charges of approximately $27 million during the nine months ended June 28, 2003, including approximately $7.4 million in severance costs, a $5 million charge to write-off deferred compensation, $7.1 million in asset impairments and a $7.3 million charge for lease cancellations. Of the $27 million, nearly all had been spent by the end of the third quarter of 2003, except for approximately $500,000 of severance costs and approximately $5.0 million related to operating lease costs on abandoned facilities. During the third quarter of 2003, approximately $500,000 of the amount originally accrued for lease cancellations was determined to be in excess due to the sublease of a property sooner than originally estimated and an approximately $500,000 shortfall was identified in the severance accrual due to higher than expected severance costs related to the closure of the Company’s Singapore manufacturing operations. These adjustments had no net effect on reported operating expense.

Q2’03 Restructuring Actions

During the second quarter of 2003, the Company’s management approved and initiated restructuring actions that resulted in recognition of a total restructuring charge of $2.8 million, including $2.4 million in severance costs and $400,000 for asset write-offs and lease payments on an abandoned facility. Actions taken in the second quarter were for the most part supplemental to actions initiated in the prior two quarters and focused on further headcount reductions in various sales and marketing functions in the Company’s Americas and Europe operating segments and further reductions associated with PowerSchool-related activities in the Americas operating segment, including an accrual for asset write-offs and lease payments on an abandoned facility. The second quarter actions resulted in the termination of 93 employees, 87 of who were terminated prior to the end of the third quarter of 2003.

Except for certain costs associated with operating leases on the abandoned facility, the Company currently anticipates that substantially all of the remaining accrual for severance costs of approximately $300,000 will be spent by the end of the fourth quarter of fiscal 2003.

Q1’03 Restructuring Actions

During the first quarter of 2003, the Company’s management approved and initiated restructuring actions with a total cost of $24 million that resulted in the termination of manufacturing operations at the Company-owned facility in Singapore, further reductions in headcount resulting from the shift in PowerSchool product strategy that took place at the end of fiscal 2002, and termination of various sales and marketing activities in the United States and Europe. These restructuring actions will ultimately result in the elimination of 260 positions worldwide, all but one of which were eliminated by the third quarter of 2003.

Closure of the Company’s Singapore manufacturing operations resulted in severance costs of $1.8 million and costs of $6.7 million to write-off manufacturing related fixed assets, whose use ceased during the first quarter. PowerSchool related costs included severance of approximately $550,000 and recognition of $5 million of previously deferred stock compensation that arose when PowerSchool was acquired by the Company in 2001 related to certain PowerSchool employee stockholders who were terminated in the first quarter of 2003. Termination of sales and marketing activities and employees, principally in the United States and Europe, resulted in severance costs of $2.8 million and accrual of costs associated with operating leases on closed facilities of $6.7 million. The total net restructuring charge of $23 million recognized during the first quarter of 2003 also reflects the reversal of $600,000 of unused restructuring accrual originally made during the first quarter of 2002.

Except for certain costs associated with operating leases on closed facilities, the Company currently anticipates that all of the remaining accrual for severance costs of approximately $200,000 will be spent by the end of the fourth quarter of fiscal 2003.

The following table summarizes activity associated with restructuring actions initiated during the first and second quarters of 2003 (in millions):

	Employee Severance Benefits				Deferred Compensation Write-off				Asset Impairments				Lease Cancellations				Totals

Total charge	$		7.4		$		5.0		$		7.1		$		7.3		$		26.8
Total spending thru 6/28/03	(7.4			)	—				—				(1.8			)	(9.2			)
Total non-cash items	—				(5.0			)	(7.1			)	—				(12.1			)
Adjustments	0.5				—				—				(0.5			)	—

Accrual at 6/28/03	$	0.5			$	—			$	—			$	5.0			$	5.5

Fiscal 2002 Restructuring Actions

During fiscal 2002, the Company recorded total restructuring charges of approximately $30 million related to actions intended to eliminate certain activities and better align the Company’s operating expenses with existing general economic conditions and to partially offset the cost of continuing investments in new product development and investments in the Company’s Retail operating segment.

Q4’02 Restructuring Actions

During the fourth quarter of 2002, the Company’s management approved and initiated restructuring actions with a total cost of approximately $6 million designed to reduce headcount costs in corporate operations and sales and to adjust its PowerSchool product strategy. These restructuring actions resulted in the elimination of approximately 180 positions worldwide at a cost of $1.8 million, 176 of which were eliminated by June 28, 2003. Eliminated positions were primarily in corporate operations, sales, and PowerSchool related research and development in the Americas operating segment. The shift in product strategy at PowerSchool included discontinuing development and marketing of PowerSchool’s PSE product. This shift resulted in the impairment of previously capitalized development costs associated with the PSE product in the amount of $4.5 million. As of June 28, 2003, substantially all of the severance accrual had been utilized, except for insignificant severance and related costs associated with 4 remaining employees identified for subsequent termination.

Q1’02 Restructuring Actions

During the first quarter of 2002, the Company’s management approved and initiated restructuring actions with a total cost of approximately $24 million. These restructuring actions resulted in the elimination of approximately 425 positions worldwide at a cost of $8 million. Positions were eliminated primarily in the Company’s operations, information systems, and administrative functions. In addition, these restructuring actions also included significant changes in the Company’s information systems strategy resulting in termination of equipment leases and cancellation of existing projects and activities. The Company ceased using the assets associated with first quarter 2002 restructuring actions during that same quarter. Related lease and contract cancellation charges totaled $12 million, and charges for asset impairments totaled $4 million. The first quarter 2002 restructuring actions were primarily related to corporate activity not allocated to operating segments. During the first quarter of 2003, the Company reversed the remaining unused accrual of $600,000.

The following table summarizes activity associated with restructuring actions initiated during the first and fourth quarters of 2002 (in millions):

	Employee Severance Benefits			Asset Impairments			Lease and Contract Cancellations			Totals

Q4’02 Charge	$	2		$	4		$	—		$	6
Q1’02 Charge	8			4			12			24
Total spending thru 9/28/02	(10		)	—			(11		)	(21		)
Total non-cash items	—			(8		)	—			(8		)
Adjustments	—			—			(1		)	(1		)
Accrual at 12/28/02	$	0		$	0		$	0		$	0

Note 5 – Shareholders’ Equity

CEO Restricted Stock Award

On March 19, 2003, the Company entered into an Option Cancellation and Restricted Stock Award Agreement (the Agreement) with Steven P. Jobs, its Chief Executive Officer (CEO). The Agreement cancelled stock option awards previously granted to Mr. Jobs in 2000 and 2001 for the purchase of 27.5 million common shares of the Company’s common stock. Mr. Jobs retained options to purchase 60,000 shares of the Company’s common stock granted in August of 1997 in his capacity as a member of the Company’s Board of Directors, prior to becoming the Company’s CEO. The Agreement replaced the cancelled options with a restricted stock award of 5 million shares of the Company’s common stock. The restricted stock award generally vests three years from date of grant. Vesting of some or all of the restricted shares will be accelerated in the event Mr. Jobs is terminated without cause, dies, or has his management role reduced following a change in control of the Company.

The Company has recorded the value of the restricted stock award of $74.75 million as a component of shareholders’ equity and is amortizing that amount on a straight-line basis over the 3-year service/vesting period. The value of the restricted stock award was based on the closing market price of the Company’s common stock on the date of the award. Quarterly amortization of approximately $6.3 million is being recognized as an operating expense. The 5 million restricted shares have been included in the calculation of diluted earnings per share utilizing the treasury stock method.

Stock Repurchase Plan

In July 1999, the Company’s Board of Directors authorized a plan for the Company to repurchase up to $500 million of its common stock. This repurchase plan does not obligate the Company to acquire any specific number of shares or acquire shares over any specified period of time. Since inception of the stock repurchase plan through the end of fiscal 2000, the Company had repurchased a total of 5.05 million shares at a cost of $191 million. No shares have been repurchased since the end of fiscal 2000. During the fourth quarter of 2001, the Company entered into a forward purchase agreement to acquire 1.5 million shares of its common stock in September of 2003 at an average price of $16.64 per share for a total cost of $25.5 million. The total cost to acquire the same number of shares at the closing price of the Company’s common stock on June 28, 2003, would be approximately $28.7 million. The Company was authorized to repurchase up to an additional $283 million of its common stock as of June 28, 2003.

Comprehensive Income

Comprehensive income consists of two components, net income and other comprehensive income. Other comprehensive income refers to revenue, expenses, gains and losses that under generally accepted accounting principles are recorded as an element of shareholders’ equity but are excluded from net income. The Company’s other comprehensive income is comprised of foreign currency translation adjustments from those subsidiaries not using the U.S. dollar as their functional currency, from unrealized gains and losses on marketable securities categorized as available-for-sale, and from net deferred gains and losses on certain derivative instruments accounted for as cash flow hedges.

The following table summarizes components of total comprehensive income, net of taxes, during the three and nine-month periods ended June 28, 2003, and June 29, 2002 (in millions):

	Three Months Ended						Nine Months Ended
	6/28/03			6/29/02			6/28/03			6/29/02

Net income	$	19		$	32		$	25		$	110
Other comprehensive income:
Net change in unrealized derivative gains/losses	(3		)	(46		)	7			(33		)
Change in accumulated translation adjustment	16			11			30			7
Net change in unrealized investment gains losses	7			(7		)	10			(39		)
Reclassification adjustment for investment gains included in net income	(3		)	—			(17		)	(17		)

Total comprehensive income	$	36		$	(10	)	$	55		$	28

The following table summarizes activity in other comprehensive income related to derivatives, net of taxes, held by the Company during the three and nine-month periods ending June 28, 2003 and June 29, 2002 (in millions):

	Three Months Ended						Nine Months Ended
	6/28/03			6/29/02			6/28/03			6/29/02

Change in fair value of derivatives	$	(5	)	$	(31	)	$	(9	)	$	(1	)
Adjustment for net losses (gains) realized and included in net income	2			(15		)	16			(32		)
Change in unrealized gain on derivative instruments	$	(3	)	$	(46	)	$	7		$	(33	)

The following table summarizes the components of accumulated other comprehensive income, net of taxes (in millions):

	As of 6/28/03			As of 9/28/02

Unrealized gains on available-for-sale securities	$	6		$	13
Unrealized losses on derivative investments	(4		)	(11		)
Cumulative translation adjustments	(21		)	(51		)

Accumulated other comprehensive income (loss)	$	(19	)	$	(49	)

Note 6 – Employee Benefit Plans

2003 Employee Stock Option Plan

At the Annual Meeting of Shareholders held on April 24, 2003, the shareholders approved an amendment to the 1998 Executive Officer Stock Plan to change the name of the plan to the 2003 Employee Stock Option Plan (the 2003 Plan), to provide for broad-based grants to all employees in addition to executive officers and other key employees and to prohibit future “repricings” of employee stock options, including 6-months-plus-1-day option exchange programs, without shareholder approval. Based on the terms of individual option grants, options granted under the 2003 Plan generally expire 7 to 10 years after the grant date and generally become exercisable over a period of 4 years, based on continued employment, with either annual or quarterly vesting. The 2003 Plan permits the granting of incentive stock options, nonstatutory stock options, restricted stock, stock appreciation rights, and stock purchase rights.

1997 Employee Stock Option Plan

In August 1997, the Company’s Board of Directors approved the 1997 Employee Stock Option Plan (the 1997 Plan), a non-shareholder approved plan for grants of stock options to employees who are not officers of the Company. Options may be granted under the 1997 Plan to employees at not less than the fair market value on the date of grant. Based on the terms of individual option grants, options granted under the 1997 Plan generally expire 7 to 10 years after the grant date and generally become exercisable over a period of 4 years, based on continued employment, with either annual or quarterly vesting. As a result of shareholder approval of amendments to the 1998 Executive Officer Stock Plan in April 2003, the Company will terminate the 1997 Employee Stock Option Plan and cancel all remaining unissued shares, following the completion of the employee stock option exchange program in October 2003.

Employee Stock Option Exchange Program

On March 20, 2003, the Company announced a voluntary employee stock option exchange program (the Exchange Program) whereby eligible employees, other than executive officers and members of the Board of Directors, had an opportunity to exchange outstanding options with exercise prices at or above $25.00 per share for a predetermined smaller number of new stock options issued with exercise prices equal to the fair market value of one share of the Company’s common stock on the day the new awards are issued, which will be at least six months plus one day after the exchange options are cancelled. On April 17, 2003, in accordance with the Exchange Program, the Company accepted and cancelled options to purchase 16,569,193 shares of its common stock and granted a promise to issue approximately 6,892,309 new options to participating employees. The new stock options will be issued on October 20, 2003, which is the first business day that is six months and one day after cancellation of the exchanged options. No financial or accounting impact to the Company’s financial position, results of operations or cash flow for the three months ended June 28, 2003, was associated with this transaction.

1997 Director Stock Option Plan

In August 1997, the Company’s Board of Directors adopted a shareholder approved Director Stock Option Plan (DSOP) for non-employee directors of the Company. Initial grants of 30,000 options under the DSOP vest in three equal installments on each of the first through third anniversaries of the date of grant, and subsequent annual grants of 10,000 options are fully vested at grant.

Employee Stock Purchase Plan

The Company has a shareholder approved employee stock purchase plan (the Purchase Plan), under which substantially all employees may purchase common stock through payroll deductions at a price equal to 85% of the lower of the fair market values as of the beginning and end of six-month offering periods. Stock purchases under the Purchase Plan are limited to 10% of an employee’s compensation, up to a maximum of $25,000 in any calendar year. During the first nine months of 2003, approximately 2.1 million shares were issued under the Purchase Plan. In the third quarter of 2003, the Company’s shareholders also approved an amendment to the Employee Stock Purchase Plan to increase the number of shares authorized for issuance by 4 million shares. As of June 28, 2003, approximately 4 million shares were reserved for future issuance under the Purchase Plan. Beginning with the six-month offering period that started on June 30, 2003, the number of shares authorized for issuance is limited to a total of 1 million shares per offering period.

Stock Option Activity

A summary of the Company’s stock option activity and related information for the nine-month periods ended June 28, 2003, and June 29, 2002 follows (option amounts are presented in thousands):

			Outstanding Options
	Shares Available For Grant		Number of Shares		Weighted Average Exercise Price

Balance at 9/28/02	6,571		109,430		$	28.17
Options Granted	(3,225	)	3,225		$	15.12
Restricted Share Grant	(5,000	)	—		—
Options Cancelled	47,689		(47,689	)	$	39.85
Options Exercised	—		(887	)	$	11.48
Plan Shares Expired	(1	)	—		—
Balance at 6/28/03	46,034		64,079		$	19.06

Balance at 9/29/01	10,075		97,179		$	29.25
Additional Options Authorized	15,000		—
Options Granted	(22,153	)	22,153		$	20.09
Options Cancelled	3,491		(3,491	)	$	31.27
Options Exercised	—		(6,147	)	$	12.06
Plan Shares Expired	(2	)	—		—
Balance at 6/29/02	6,411		109,694		$	28.29

Total options outstanding at June 28, 2003 to purchase approximately 64.1 million shares do not include options to purchase approximately 6.9 million shares that are expected to be issued in October 2003 pursuant to the Employee Stock Option Exchange Program discussed above.

The options outstanding as of June 28, 2003, have been segregated into six ranges for additional disclosure as follows (option amounts are presented in thousands):

	Options Outstanding				Options Exercisable
Range of Exercise Prices	Options Outstanding as of 6/28/03	Weighted- Average Remaining Contractual Life in Years	Weighted Average Exercise Price		Options Exercisable as of 6/28/03	Weighted Average Exercise Price

$ 0.83 - $ 16.81	17,266	6.33	$	13.39	11,087	$	12.17
$ 16.82 - $ 18.13	7,974	5.97	$	17.29	5,460	$	17.28
$ 18.14 - $ 18.50	17,039	7.34	$	18.50	10,325	$	18.50
$ 18.51 - $ 20.39	13,049	8.23	$	20.24	5,681	$	20.17
$ 20.40 - $ 32.28	6,012	7.74	$	23.49	2,646	$	23.51
$ 32.29 - $ 69.78	2,739	6.53	$	48.04	1,960	$	48.02

$ 0.83 - $ 69.78	64,079	7.08	$	19.06	37,159	$	18.60

Note 7 – Stock-Based Compensation

The Company has provided pro forma disclosures in Note 1 of these Notes to Condensed Consolidated Financial Statements of the effect on net income and earnings per share as if the fair value method of accounting for stock compensation had been used for its employee stock option grants and employee stock purchase plan purchases. These pro forma effects have been estimated at the date of grant and beginning of the period, respectively, using the Black-Scholes option pricing model.

For purposes of the pro forma disclosures provided pursuant to SFAS No. 123, the option awards expected to be issued in October 2003 and the awards cancelled as part of the Employee Stock Option Exchange Program have been accounted for using modification accounting. In accordance with SFAS No. 123, the grant date of the awards to be issued is the date of acceptance of the exchange offer by participating employees. The cancellation of certain of the Company’s Chief Executive Officer’s options and replacement with restricted shares in March 2003 is also being accounted for using modification accounting for purposes of the pro forma disclosures provided pursuant to SFAS No. 123.

The assumptions used for the three and nine-month periods ended June 28, 2003, and June 29, 2002, and the resulting estimates of weighted-average fair value per share of options granted and for stock purchases during those periods are as follows:

	Three Months Ended						Nine Months Ended
	6/28/03			6/29/02			6/28/03			6/29/02

Expected life of stock options	3.5 years			4 years			3.5 - 4 years			4 years
Expected life of stock purchases	6 months			6 months			6 months			6 months
Interest rate - stock options	2.27		%	4.19		%	2.39		%	3.96		%
Interest rate - stock purchases	1.49		%	2.71		%	1.65		%	3.57		%
Volatility - stock options	40		%	65		%	56		%	65		%
Volatility - stock purchases	35		%	52		%	40		%	51		%
Dividend yields	—			—			—			—

Weighted-average fair value of options granted during the period	$	4.91		$	11.80		$	6.66		$	10.30
Weighted-average fair value of employee stock purchases during the period	$	3.32		$	6.50		$	4.08		$	6.73

Note 8 – Commitments and Contingencies

Lease Commitments

The Company leases various equipment and facilities, including retail space, under noncancelable operating lease arrangements. The Company does not currently utilize any other off-balance-sheet financing arrangements. The major facility leases are for terms of 5 to 10 years and generally provide renewal options for terms of 3 to 5 additional years. Leases for retail space are for terms of 5 to 14 years and often contain multi-year renewal options. As of September 28, 2002, the Company’s total future minimum lease payments under noncancelable operating leases were $464 million, of which $209 million related to leases for retail space. As of June 28, 2003, total future minimum lease payments related to leases for retail space increased to $304 million.

Accrued Warranty and Indemnifications

The Company offers a basic limited parts and labor warranty on its hardware products. The basic warranty period for hardware products is typically one year from the date of purchase by the end-user. The Company also offers a 90-day basic warranty for Apple software and for Apple service parts used to repair Apple hardware products. The Company provides currently for the estimated cost that may be incurred under its basic limited product warranties at the time related revenue is recognized. Factors considered in determining appropriate accruals for product warranty obligations include the size of the installed base of products subject to warranty protection, historical warranty claim rates, historical cost-per-claim, and knowledge of specific product failures that are outside of the Company’s typical experience. The Company assesses the adequacy of its preexisting warranty liabilities and adjusts the amounts as necessary based on actual experience and changes in future expectations.

The following table reconciles changes in the Company’s accrued warranties and related costs for the nine-month periods ended June 28, 2003 and June 29, 2002 (in millions):

	Nine Months Ended
	6/28/03			6/29/02

Beginning accrued warranty and related costs	$	69		$	87
Cost of warranty claims	(53		)	(61		)
Accruals for product warranties	51			43
Ending accrued warranty and related costs	$	67		$	69

The Company generally does not indemnify end-users of its operating system and application software against legal claims that the software infringes third-party intellectual property rights. Other licensing agreements entered into by the Company sometimes include indemnification provisions under which the Company could be subject to costs and/or damages in the event of an infringement claim against the Company or an indemnified third-party. However, the Company has not been required to make any significant payments resulting from such an infringement claim asserted against itself or an indemnified third-party and, in the opinion of management, does not have a potential liability related to unresolved infringement claims that would have a material adverse effect on its financial condition, liquidity or results of operations. Therefore, the Company did not record a liability for infringement costs as of either June 28, 2003, or September 28, 2002.

Contingencies

Beginning on September 27, 2001, three shareholder class action lawsuits were filed in the United States District Court for the Northern District of California against the Company and its Chief Executive Officer. These lawsuits are substantially identical, and purport to bring suit on behalf of persons who purchased the Company’s publicly traded common stock between July 19, 2000, and September 28, 2000. The complaints allege violations of the 1934 Securities Exchange Act and seek unspecified compensatory damages and other relief. The Company believes these claims are without merit and intends to defend them vigorously. The Company filed a motion to dismiss on June 4, 2002, which was heard by the Court on September 13, 2002. On December 11, 2002, the Court granted the Company’s motion to dismiss for failure to state a cause of action, with leave to plaintiffs to amend their complaint. Plaintiffs filed their amended complaint on January 31, 2003, and on March 17, 2003, the Company filed a motion to dismiss the amended complaint. A hearing on the Company’s motion was held on July 11, 2003, and the Court has yet to rule on the matter.

The Company is subject to certain other legal proceedings and claims that have arisen in the ordinary course of business and have not been fully adjudicated. In the opinion of management, the Company does not have a potential liability related to any current legal proceedings and claims that would have a material adverse effect on its financial condition, liquidity or results of operations. However, the results of legal proceedings cannot be predicted with certainty. Should the Company fail to prevail in any of these legal matters or should several of these legal matters be resolved against the Company in the same reporting period, the operating results of a particular reporting period could be materially adversely affected.

The parliament of the European Union has finalized the Waste Electrical and Electronic Equipment Directive (the Directive). The Directive makes producers of electrical goods, including personal computers, financially responsible for the collection, recycling, and safe disposal of past and future products. The Directive must now be approved and implemented by individual European Union governments by August 13, 2004, while the producers’ financial obligations are scheduled to start August 13, 2005. The Company’s potential liability resulting from the Directive related to past sales of its products and expenses associated with future sales of its product may be substantial. However, because it is likely that specific laws, regulations, and enforcement policies will vary significantly between individual European member states, it is not currently possible to estimate the Company’s existing liability or future expenses resulting from the Directive. As the European Union and its individual member states clarify specific requirements and policies with respect to the Directive, the Company will continue to assess its potential financial impact. Similar legislation may be enacted in other geographies, including federal and state legislation in the United States, the cumulative impact of which could be significant.

Note 9 - Segment Information and Geographic Data

The Company manages its business primarily on a geographic basis. The Company’s reportable operating segments are comprised of the Americas, Europe, Japan, and Retail. The Americas segment includes both North and South America, except for the activities of the Company’s Retail segment. The Europe segment includes European countries as well as the Middle East and Africa. The Japan segment includes only Japan. The Retail segment currently operates Apple-owned retail stores in the United States. Other operating segments include Asia-Pacific, which includes Australia and Asia except for Japan, and the Company’s subsidiary, FileMaker, Inc. Each reportable geographic operating segment provides similar hardware and software products and similar services, and the accounting policies of the various segments are the same as those described in the Summary of Significant Accounting Policies in Note 1, except as described below for the Retail segment.

The Company evaluates the performance of its operating segments based on net sales. The Retail segment’s performance is also evaluated based on operating income. Net sales for geographic segments are based on the location of the customers. Operating income for each segment includes revenue from third parties, cost of sales, and operating expenses directly attributable to the segment. Operating income for each segment excludes other income and expense and certain expenses that are managed outside the operating segments. Costs excluded from segment operating income include various corporate expenses, manufacturing costs not included in standard costs, income taxes, and various nonrecurring charges. Corporate expenses include research and development, corporate marketing expenses, and other separately managed general and administrative expenses including certain corporate expenses associated with support of the Retail segment. The Company does not include intercompany transfers between segments for management reporting purposes. Segment assets exclude corporate assets. Corporate assets include cash, short-term and long-term investments, manufacturing facilities, miscellaneous corporate infrastructure, goodwill and other acquired intangible assets, and retail store construction-in-progress that is not subject to depreciation. Except for the Retail segment, capital expenditures for long-lived assets are not reported to management by segment. Capital expenditures by the Retail segment were $30 million and $60 million during the third quarter and first nine months of 2003, respectively. For the third quarter and first nine months of 2002, capital expenditures by the Retail segment were $16 million and $67 million, respectively.

Operating income for all segments, except Retail, includes cost of sales at standard cost. Certain manufacturing expenses and related adjustments not included in segment cost of sales, including variances between standard and actual manufacturing costs and the mark-up above standard cost for product supplied to the Retail segment, are included in corporate expenses.

To assess the operating performance of the Retail segment several significant items are included in its results for internal management reporting that are not included in results of the Company’s other segments. First, cost of sales for the Retail segment includes a mark-up above the Company’s standard cost to approximate the price normally charged to the Company’s resellers operating retail stores in the United States. For the third quarter of 2003 and the third quarter of 2002, this resulted in the recognition of additional cost of sales above standard cost by the Retail segment and an offsetting benefit to corporate expenses of approximately $25 million and $11 million, respectively. For the first nine months of 2003 and the first nine months of 2002, this resulted in the recognition of additional cost of sales above standard cost by the Retail segment and an offsetting benefit to corporate expenses of approximately $71 million and $32 million, respectively.

Second, the Retail segment includes in its net sales proceeds from sales of the Company’s extended warranty and support contracts and also recognizes related cost of sales based on the amount such contracts are normally sold to the Company’s resellers operating retail stores in the United States. This treatment is consistent with how the Company’s major resellers account for the sales and cost of the Company’s extended warranty and support contracts. Because the Company has not yet earned the revenue or incurred the costs associated with the sale of these contracts, an offset to these amounts is recognized in the Americas segment’s net sales and cost of sales. For the third quarter of 2003, this resulted in the recognition of net sales and cost of sales by the Retail segment, with corresponding offsets in the Americas segment, of $7.1 million and $4.8 million, respectively. For the third quarter of 2002, the net sales and cost of sales recognized by the Retail segment for sales of extended warranty and support contracts were $2.0 million and $1.4 million, respectively. For the first nine months of 2003, this resulted in the recognition of net sales and cost of sales by the Retail segment, with corresponding offsets in the Americas segment, of $19.3 million and $13.2 million, respectively. This compares to similar adjustments to net sales and cost of sales during the first nine months of 2002 of $5.0 million and $3.5 million, respectively.

Third, a portion of the operating expenses associated with certain high profile retail stores is allocated from the Retail segment to corporate marketing expense. Allocation of these expenses reflects the unique nature of these stores which, given their larger size and extraordinary design elements, function as vehicles for general corporate marketing, corporate sales and marketing events, and brand awareness. Allocated operating costs are those in excess of operating costs incurred by one of the Company’s more typical retail locations. Stores were open in three such high profile locations in New York, Los Angeles, and Chicago as of June 28, 2003. Expenses allocated to corporate marketing resulting from the operations of these stores were $1.1 million in the third quarter of 2003 and $3.3 million for the nine-months ended June 28, 2003. These costs were not significant during the first nine months of 2002.

Summary information by operating segment follows (in millions):

	*Three Months Ended*						*Nine Months Ended*
	6/28/03			6/29/02			6/28/03			6/29/02
Americas:
Net sales	$	831		$	817		$	2,253		$	2,256
Operating income	$	98		$	76		$	188		$	185

Europe:
Net sales	$	297		$	275		$	986		$	1,003
Operating income	$	39		$	23		$	108		$	114

Japan:
Net sales	$	168		$	168		$	527		$	578
Operating income	$	33		$	35		$	91		$	120

Retail:
Net sales	$	145		$	63		$	428		$	181
Operating loss	$	(2	)	$	(6	)	$	(6	)	$	(18	)

Other Segments (a):
Net sales	$	104		$	106		$	298		$	281
Operating income	$	13		$	15		$	40		$	34

(a) Other Segments consists of Asia-Pacific and FileMaker. Certain amounts in 2002 fiscal periods related to recent acquisitions and Internet services have been reclassified from Other Segments to the Americas segment to conform to the 2003 presentation.

A reconciliation of the Company’s segment operating income to the consolidated financial statements follows (in millions):

	Three Months Ended						Nine Months Ended
	6/28/03			6/29/02			6/28/03			6/29/02

Segment operating income	181			143			421			435
Corporate expenses, net	(172		)	(130		)	(427		)	(374		)
Restructuring costs	—			—			(26		)	(24		)
Total operating income (loss)	$	9		$	13		$	(32	)	$	37

Note 10 - Earnings Per Share

Basic earnings per common share is computed by dividing income available to common shareholders by the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per common share is computed by dividing income available to common shareholders by the weighted-average number of shares of common stock outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the dilutive potential shares of common stock had been issued. The

dilutive effect of outstanding options and restricted stock is reflected in diluted earnings per share by application of the treasury stock method.

The following table sets forth the computation of basic and diluted earnings (loss) per share (in thousands, except net income and per share amounts):

	Three Months Ended				Nine Months Ended
	6/28/03		6/29/02		6/28/03			6/29/02

Numerator (in millions):
Income before accounting change	$	19	$	32	$	27		$	110
Cumulative effect of accounting change, net of income taxes of $1	$	—	$	—	$	(2	)	$	—

Net income	$	19	$	32	$	25		$	110

Denominator:
Weighted average-shares outstanding	360,793		356,370		360,113			353,800
Effect of dilutive options and dilutive restricted stock	2,984		10,512		2,308			9,638

Denominator for diluted earnings per share	363,777		366,882		362,421			363,438

Basic earnings per share before accounting change	$	0.05	$	0.09	$	0.07		$	0.31
Cumulative effect of accounting change, net of tax	—		—		—			—

Basic earnings per share after accounting change	$	0.05	$	0.09	$	0.07		$	0.31

Diluted earnings per share before accounting change	$	0.05	$	0.09	$	0.07		$	0.30
Cumulative effect of accounting change, net of tax	—		—		—			—

Diluted earnings per share after accounting change	$	0.05	$	0.09	$	0.07		$	0.30

Options to purchase approximately 51 million and 45 million shares of common stock that were outstanding at June 28, 2003 and June 29, 2002, respectively, were not included in the computation of diluted earnings per share for the quarters then ended because the options’ exercise prices were greater than the average market price of the Company’s common stock during those quarters, and therefore, their effect would have been antidilutive.

Note 11 – Related Party Transactions and Certain Other Transactions

In March 2002, the Company entered into a Reimbursement Agreement with its Chief Executive Officer, Mr. Steven P. Jobs, for the reimbursement of expenses incurred by Mr. Jobs in the operation of his private plane when used for Apple business. The Reimbursement Agreement is effective for expenses incurred by Mr. Jobs for Apple business purposes since he took delivery of the plane in May 2001. The Company recognized a total of $105,000 in expenses pursuant to the Reimbursement Agreement during the third quarter of 2003, and $266,000 in expenses for the nine-months ended June 28, 2003. For fiscal 2002, the Company recognized a total of $1,168,000 in expenses pursuant to the Reimbursement Agreement related to expenses incurred by Mr. Jobs during 2001 and 2002. All expenses recognized pursuant to the Reimbursement Agreement have been included by the Company in selling, general, and administrative expenses.

Mr. Jerome York, a member of the Board of Directors of the Company, is a member of an investment group that purchased MicroWarehouse, Inc. (“MicroWarehouse”) in January 2000. He also serves as its Chairman, President and Chief Executive Officer. MicroWarehouse is a multi-billion dollar specialty catalogue and online retailer and direct marketer of computer products, including products made by the Company, through its MacWarehouse catalogue. MicroWarehouse accounted for 2.3% and 2.9% of the Company’s net sales for the three and nine-month periods ended June 28, 2003, respectively, and 3.3% of the Company’s net sales in fiscal 2002. Trade receivables from MicroWarehouse were $12.7 million and $20.9 million as of June 28, 2003, and September 28, 2002, respectively. Sales to MicroWarehouse and related trade receivables are generally subject to the same terms and conditions as those with the Company’s other resellers. In addition, the Company purchases miscellaneous equipment and supplies from MicroWarehouse. Total purchases amounted to approximately $431,000 and $1.7 million for the three and nine-month periods ended June 28, 2003, respectively, and $2.9 million in fiscal 2002.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This section and other parts of this Form 10-Q contain forward-looking statements that involve risks and uncertainties, including statements regarding the expected timing and features of new product introductions, statements under the heading “Business Outlook,” statements regarding gross margin and provision for income tax in future periods, statements regarding income tax provisions, statements regarding the likely impact on the Company of new accounting standards, statements about the sufficiency of current cash balances, statements regarding the impact on the Company or outcome of litigation, statements about capital expenditures in future periods and statements regarding the impact on the Company of restructuring actions. The Company’s actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in the subsection entitled “Factors That May Affect Future Results and Financial Condition” below. The following discussion should be read in conjunction with the 2002 Form 10-K and the condensed consolidated financial statements and notes thereto included elsewhere in this Form 10-Q. All information is based on the Company’s fiscal calendar. Unless otherwise stated, references in this report to particular years or quarters refer to the Company’s fiscal years ended in September and the associated quarters of those fiscal years.

Available Information

Beginning in fiscal 2003, the Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are available on our website at www.apple.com/investor when such reports are available on the Securities and Exchange Commission website. The contents of this website are not incorporated into this filing. Further, our reference to the URL for this website is intended to be an inactive textual reference only.

Critical Accounting Policies

The preparation of financial statements and related disclosures in conformity with U.S. generally accepted accounting principles and the Company’s discussion and analysis of its financial condition and results of operations requires the Company’s management to make judgments, assumptions, and estimates that affect the amounts reported in its consolidated financial statements and accompanying notes. Note 1 of the Notes to Consolidated Financial Statements in the Company’s 2002 Form 10-K describes the significant accounting policies and methods used in the preparation of the Company’s consolidated financial statements. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates.

Management believes the Company’s critical accounting policies are those related to revenue recognition, allowance for doubtful accounts, inventory valuation and exposures related to inventory purchase commitments, valuation of long-lived assets including acquired intangibles, and valuation of non-current debt and equity investments. Management believes these policies to be critical because they are both important to the portrayal of the Company’s financial condition and results, and they require management to make judgments and estimates about matters that are inherently uncertain. Additional information about these critical accounting policies may by found in the Company’s 2002 Form 10-K in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” under the heading “Critical Accounting Policies.”

Accounting for Stock-Based Compensation

The Company currently measures compensation expense for its employee stock-based compensation plans using the intrinsic value method prescribed by Accounting Principles Board (APB) Opinion 25, Accounting for Stock Issued to Employees and provides pro forma disclosures of the effect on net income and earnings per share as if the fair value-based method had been applied in measuring compensation expense. The Company has elected to follow APB No. 25 because, as discussed in Note 1 of the Notes to Condensed Consolidated Financial Statements provided in this Form 10-Q, the alternative fair value accounting provided for under SFAS No. 123, Accounting for Stock-Based Compensation, requires use of option valuation models that were not developed for use in valuing employee stock options and employee stock purchase plan shares. Under APB Opinion No. 25, when the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of the grant, no compensation expense is recognized.

The Financial Accounting Standards Board (FASB) decided on April 22, 2003 to require all companies to expense the value of employee stock options. Companies will be required to measure the cost of employee stock options

according to their fair value. The FASB has indicated that it plans to issue in the near future an exposure draft of a new accounting standard addressing this matter. This new accounting standard could become effective as early as 2004. Prior to issuance of this exposure draft, the FASB has indicated it will be addressing several significant technical issues. Among other things, the FASB must determine the extent to which the new accounting standard will permit adjustments to recognized expense for actual option forfeitures and actual performance outcomes. This determination will affect the timing and amount of compensation expense recognized. Also, a method to determine the fair value of employee stock options must be established. Current accounting standards require use of an option-pricing model, such as the Black-Scholes model, to determine fair value and provide guidance on adjusting some of the input factors used in the model. This valuation approach has received significant criticism and may be subject to changes that could have a significant impact on the calculated fair value of employee stock options under the new standard.

At the Company’s annual shareholder’s meeting on April 24, 2003, shareholders approved a proposal requesting that the Company’s Board of Directors (the Board) establish a policy of expensing the value of all future employee stock options issued by the Company. The Board and management appreciate and take seriously the views expressed by the Company’s shareholders. As discussed in the Company’s Form 10-Q for the period ended March 29, 2003, the Company had decided not to expense the value of employee stock options until the FASB finalizes its new accounting standard on the matter. The Company based this decision on the FASB’s announced intention to soon require all companies to expense the value of employee stock options and the FASB’s near-term review of technical issues that will play a significant role in determining the fair value of and accounting for employee stock options. The Company monitors progress at the FASB and other developments with respect to the general issue of employee stock compensation. Further, the Company is evaluating its current employee compensation programs. In the future, should the Company expense the value of employee stock options, either out of choice or due to new requirements issued by the FASB, and/or decide to alter its current employee compensation programs to provide other benefits in place of options, including restricted stock grants or additional cash bonuses, the Company may have to recognize substantially more compensation expense in future periods that could have a material adverse impact on the Company’s future results of operations.

Internet Services Update

In April 2003, the Company launched the iTunes® Music Store in the United States, an online music store that allows customers to find, purchase, and download music for 99 cents per song or, in most cases, $9.99 per album. Requiring no subscription fee, the iTunes Music Store offers customers a broad range of personal rights to the songs they purchase including playing songs on up to three Macintosh® computers, burning songs onto an unlimited number of CDs for personal use, playing songs on an unlimited number of iPod™ portable digital music players, and using songs in any application on their Macintosh system including iPhoto™, iMovie®, and iDVD™. The Company currently expects to deliver a Windows version of the iTunes Music Store before the end of calendar 2003.

Users can easily search the contents of the entire music store to locate songs by title, artist, or album, or browse the entire contents of the music store by genre and artist. Users can also listen to a free 30-second preview of any song in the store. The iTunes Music Store is fully integrated into the latest version of iTunes, allowing customers to purchase, download, organize, share, and listen to their digital music using a single application.

Hardware Products Update

Power Mac® G5

In June 2003, the Company announced the Power Mac G5 that is expected to be available in August 2003. Powered by the PowerPC G5 processor designed by IBM and Apple and featuring up to a 1 GHz front-side bus and the ability to address up to 8GB of memory, the Power Mac G5 utilizes 64-bit processing technology for advanced 64-bit computation, while running existing 32-bit applications natively. The PowerPC G5 processor architecture is based on a completely new execution core that features massively parallel computation, full symmetric multi-processing, two double precision floating point units and an optimized Velocity Engine™.

Power Mac G5 systems include Gigabit Ethernet, FireWire® 800, two FireWire 400 ports, three USB 2.0 ports, dual display support, optical digital audio input and output, analog audio input and output, and a headphone jack. The system also supports 54 Mbps AirPort® Extreme wireless networking and is Bluetooth ready for wireless connections to a host of Bluetooth-enabled peripherals.

The Power Mac G5 features a new anodized aluminum alloy enclosure designed to meet the needs of professional users. The new enclosure is built around four independently controlled thermal zones for advanced airflow management, with fans in each zone that are individually controlled based on a sophisticated combination of thermal and power monitoring, resulting in the Power Mac G5 running substantially quieter than the previous Power Mac G4. The G5 enclosure also features an easy-to-open access panel allowing quick access to internal components for tool-less installation of memory, hard drives, optical drives or an AirPort Extreme card. Front and rear handles allow professionals to rapidly and safely move Power Mac G5s when and where they need them, and front-mounted FireWire, USB 2.0, and headphone ports provide convenient access for popular peripherals.

iPod™

The Company introduced new iPod models in April 2003. The new iPod is smaller and lighter than previous versions and is available in three models with storage capacity of either 10GB, 15GB, or 30GB; the latter holding up to 7,500 songs. In addition to MP3, iPod now supports the AAC audio format. The new iPod also features solid-state interfaces and is available with a new dock that facilitates fast and easy connection to a computer or stereo.

Xserve® and Xserve RAID Storage System

In February 2003, the Company upgraded its Xserve 1U rack servers with more powerful processors, more storage capacity, and a FireWire® 800 interface. At the same time, the Company introduced the Xserve RAID Storage System, a rack storage system that holds up to 14 hot-swapable drive modules capable of holding up to 2.5 terabytes of data. Xserve RAID architecture combines affordable, high-capacity ATA/100 drive technology with a Fibre channel interface for reliable and fast data access. Xserve RAID provides RAID level 5 throughput that supports affordable real-time HD 1080i video editing.

PowerBook®

In January 2003, the Company introduced two new PowerBook models. The 17-inch PowerBook G4 features a 17-inch wide-format active-matrix display, is encased in a durable aluminum alloy enclosure, is 1-inch thick, and weighs as little as 6.8 pounds. The new 17-inch PowerBook G4 also features built-in support for AirPort® Extreme 54 Mbps 802.11g wireless networking, new high-speed FireWire 800, a backlit keyboard with ambient light sensors, and built-in Bluetooth for wireless connection to cell phones and other Bluetooth equipped peripherals. The 12-inch PowerBook G4 features a 12-inch, active-matrix display housed in a lightweight, durable aluminum alloy enclosure weighing approximately 4.6 pounds. The 12-inch PowerBook G4 features a high-speed PowerPC G4 processor, NVIDIA graphics, built-in Bluetooth wireless networking, and battery life of up to five hours on a single charge.

Peripheral Products Update

iSight™

The Company introduced the iSight digital video camera and the beta version of its iChat™ AV software application in June 2003. Together they enable high-quality audio and video conferences between two Macintosh systems over broadband connections. iSight is a small, portable aluminum alloy camera with all audio, video and power provided by a single FireWire cable. iSight features a custom designed lens with auto-focus and a high-end CCD sensor to provide high-resolution images and full-motion video at up to 30 frames per second. iSight includes an integrated microphone that suppresses ambient noise for clear digital audio. With its on-board processor, iSight automatically adjusts color, white balance, sharpness and contrast to provide high-quality images with accurate color reproduction in any lighting conditions. iSight is designed to be center-mounted on the top of any computer screen and uses its integrated tilt and rotate mechanism to easily position the camera for natural, face-to-face video conferencing.

AirPort® Extreme™

AirPort Extreme is the Company’s next generation of Wi-Fi wireless networking technology based on the new ultra-fast 802.11g standard. With speeds up to 54 Mbps, AirPort Extreme delivers almost five times the data rate of today’s 802.11b based products, yet is fully compatible with the millions of 802.11b Wi-Fi devices around the world. AirPort Extreme Base Stations can serve up to 50 Macintosh and Windows users simultaneously, provide wireless bridging to extend the range beyond just one base station, and support USB printer sharing to allow multiple users to wirelessly share USB printers connected directly to the base station. AirPort Extreme was introduced in January 2003.

Displays

In January 2003, the Company introduced the 20-inch Apple Cinema Display® and instituted significant price reductions on its 23-inch Cinema HD Display and its 17-inch Apple Studio Display®. The new 20-inch Apple Cinema Display features an active-matrix, liquid crystal display that incorporates a digital interface.

Software Products and Computer Technologies Update

Mac OS® X Panther

In June 2003, the Company announced Mac OS X version 10.3 “Panther,” the next major version of Mac OS X that is expected to ship by the end of calendar 2003. The fourth major release of Mac OS X in four years, Panther will incorporate many new features including a completely new Finder™; Exposé, a new way to organize windows and instantly see all open windows at once; FileVault, a new feature that secures the contents of a home directory with 128-bit AES encryption; and enhanced support for use on Windows-based networks.

Additional new features in Panther include:

• an enhanced Mail application that organizes email into convenient threads with drag-and-drop addressing and a Safari™-based engine for displaying HTML formatted email;

• Fast User Switching, allowing users to share a single Mac and quickly switch between accounts without having to quit running applications and completely logout of the system;

• a fully integrated iDisk that increases productivity by automatically syncing a user’s offline work to their .Mac Internet server storage once they are online again, so users can work locally on files and have them synced automatically back to their iDisk later;

• integrated faxing synced with the Address Book so sending and receiving faxes is as easy as printing, and includes support for adding cover pages;

• Font Book, a new application that provides system-level font management with double-click font preview, one-click installation and an intuitive iTunes®-like interface for managing font collections, and searching, activating and deactivating fonts;

• a significantly improved Preview application that is a fast PDF reader with fast text searching that builds an instant index of search results in a PDF, text selection and copying, URL support and support for the PDF 1.4 format. Preview leverages powerful improvements to Quartz filtering technology such as colorspace conversion, image sampling and compression for advanced PDF workflows; and

• iChat™ AV, a desktop video conferencing solution for business, education and consumers.

Mac OS® X Panther Server

In June 2003, the Company previewed Mac® OS X version 10.3 “Panther” Server, the next major release of the Company’s UNIX-based server operating system that makes it easy to deploy popular open source solutions for Macintosh, Windows and Linux clients. Panther Server includes powerful open source solutions and easy to use server management capabilities. New features in Panther Server include Automatic Setup for easily setting up multiple servers; Open Directory 2 for hosting scalable LDAP directory and Kerberos authentication services; Samba 3 for providing login and home directory support for Windows clients; and the JBoss application server for running powerful J2EE applications.

iChat™ AV

The Company introduced the beta version of its iChat™ AV software application and the iSight™ digital video camera in June 2003. Together they enable high-quality audio and video conferences between two Macintosh systems over broadband connections. iChat AV also features audio conferences over dial-up connections to the Internet. iChat AV requires no set up or configuration beyond installing the software and plugging in a FireWire® video camera and microphone.

Soundtrack

The Company announced Soundtrack in July 2003. Soundtrack, which is expected to be available in August 2003, is a royalty-free music production tool previously available only with Final Cut Pro® 4. Soundtrack includes more than 4,000 royalty-free, professionally-recorded audio loops and sound effects, giving creative professionals such as video editors, DVD authors and web developers a powerful and easy-to-use tool to create high-quality music scores. Soundtrack also ships with over 30 professional, high-quality audio plug-ins. Plug-ins like Platinum Verb, SpectralGate, Multiband Compressor and AutoFilter, enable users to combine effects with individual tracks to create sophisticated audio. Furthermore, Soundtrack’s support for Mac® OS X’s Audio Units plug-in architecture allows users to further expand their capabilities with additional third-party audio effects developed through the Company’s open-standard plug-in format.

Final Cut Pro® 4

Final Cut Pro 4, a major upgrade to the Company’s professional editing software for film and video, was announced in April 2003 and released in June 2003. Final Cut Pro 4 software introduces RT Extreme for real-time compositing and effects, new interface customization tools, new high-quality 8- and 10-bit uncompressed formats, and full 32-bit floating point per channel video processing. Final Cut Pro 4 also includes three completely new integrated applications – Live Type for advanced titling, Soundtrack for music creation, and Compressor for full featured batch transcoding.

Safari™ 1.0

In June 2003, the Company introduced Safari™ 1.0, the Company’s new Mac OS® X compatible web browser that is capable of loading web pages rapidly. Safari uses the advanced interface technologies underlying Mac OS X and includes built-in Google search; SnapBack to instantly return to search results; a new way to name, organize and present bookmarks; tabbed browsing; and automatic “pop-up” ad blocking. The Company also released a software development kit that allows developers to embed the Safari HTML rendering engine directly into their applications.

DVD Studio Pro® 2

The Company announced DVD Studio Pro 2 in April 2003. It is a completely new DVD authoring product, rebuilt from the ground up with a new user interface, professionally designed and fully customizable templates, an innovative new menu editor, timeline-based track editing and a new software-based MPEG-2 encoder.

Shake® 3

Shake 3, an upgrade of the Company’s compositing and visual effects software, was announced in April 2003 and released in June 2003. Shake 3 includes new Mac® OS X only features such as the Shake Qmaster network render management software and unlimited network rendering licenses which allow visual effects artists to easily distribute rendering tasks across a cluster of Apple’s Xserve rack servers or desktop Power Mac G4 computers for enhanced performance and efficiency. Shake 3 also includes new visual effects features available to Mac OS X, Linux and IRIX customers including motion-tracking and real-time broadcast preview.

Final Cut® Express

Final Cut Express, introduced in January 2003, is a new product based on Apple’s award-winning Final Cut Pro software. Final Cut Express enables small business users, educators, students and advanced hobbyists to perform professional-quality digital video editing. Final Cut Express includes key features used by video editors such as the same interface and workflow as Final Cut Pro, powerful video editing tools, hundreds of special effects, and easy delivery of output to DVD, the Internet, or tape.

Keynote™

Keynote is the Company’s new presentation software introduced in January 2003 that gives users the ability to create high-quality presentations. Designed to be easy to use, Keynote includes professionally designed themes, advanced typography, professional-quality image resizing, animated charts and tables that can be created quickly, and cinematic-quality transitions. Keynote imports and exports PowerPoint, QuickTime®, and PDF files to simplify the creation and sharing of presentations.

iLife™

Introduced in January 2003, iLife is the Company’s integrated suite of four digital lifestyle applications that features the Company’s iTunes®, iPhoto™, iMovie™, and iDVD™ software applications. These applications are integrated to allow users to easily access their digital music, photos and movies from within each application.

Business Outlook

For the fourth quarter of 2003, the Company expects a high single-digit percentage increase in net sales from the third quarter and a slight sequential increase in quarterly earnings. The Company expects fourth quarter gross margin to be approximately 100 basis points lower than the third quarter due to lower Mac OS sales and increased manufacturing costs associated with the production ramp-up of new Power Mac G5 systems. Fourth quarter reported operating expenses are expected to be approximately $420 million. This excludes approximately $10 million of software development costs related to development of Mac OS X Panther that the Company anticipates capitalizing during the fourth quarter. The Company expects fourth quarter interest and other income, net to decline to approximately $10 million due to lower interest yields on the Company’s investment portfolio. The Company’s expects its effective tax rate to remain at 28% during the fourth quarter.

The foregoing statements concerning the Company’s fourth quarter 2003 anticipated net sales, gross margin, operating expenses, interest and other income, net, effective tax rate, earnings, capitalized software development costs, Mac OS sales, and production ramp expenses are forward-looking. The Company’s actual results could differ. The Company’s future operating results and financial condition are dependent upon general economic conditions, market conditions within the PC industry, and the Company’s ability to successfully develop, manufacture, and market technologically innovative products in order to meet the dynamic conditions within the highly competitive market for personal computers. Some of the potential risks and uncertainties that could affect the Company’s future operating results and financial condition are discussed throughout this Item 2, including the discussion under the heading below “Factors That May Affect Future Results and Financial Condition,” and in the 2002 Form 10-K.

Net Sales

Net sales and Macintosh unit sales by operating segment and net sales and unit sales by product follow (net sales in millions and unit sales in thousands):

	Three Months Ended						Nine Months Ended
	6/28/03		6/29/02		Change		6/28/03		6/29/02		Change

Net Sales by Operating Segment:
Americas net sales (a)	$	831	$	817	2	%	$	2,253	$	2,256	0	%
Europe net sales	297		275		8	%	986		1,003		(2	)%
Japan net sales	168		168		0	%	527		578		(9	)%
Retail net sales	145		63		130	%	428		181		136	%
Other segments net sales (a)	104		106		(2	)%	298		281		6	%
Total net sales	$	1,545	$	1,429	8	%	$	4,492	$	4,299	4	%

Unit Sales by Operating Segment:
Americas Macintosh unit sales	452		478		(5	)%	1,167		1,261		(7	)%
Europe Macintosh unit sales	144		160		(10	)%	526		586		(10	)%
Japan Macintosh unit sales	85		98		(13	)%	263		326		(19	)%
Retail Macintosh unit sales	40		20		100	%	128		58		121	%
Other segments Macintosh unit sales (a)	50		52		(4	)%	141		136		4	%
Total Macintosh unit sales	771		808		(5	)%	2,225		2,367		(6	)%

Net Sales by Product:
Power Macintosh net sales (b)	$	234	$	285	(18	)%	$	819	$	1,034	(21	)%
PowerBook net sales	363		234		55	%	951		689		38	%
iMac net sales	301		424		(29	)%	959		1,076		(11	)%
iBook net sales	196		217		(10	)%	563		641		(12	)%
Total Macintosh net sales	1,094		1,160		(6	)%	3,292		3,440		(4	)%

Peripherals and other hardware (c)	285		148		93	%	719		481		49	%
Software (d)	90		64		41	%	273		200		37	%
Service and other sales	76		57		33	%	208		178		17	%
Total other net sales	451		269		68	%	1,200		859		40	%

Total net sales	$	1,545	$	1,429	8	%	$	4,492	$	4,299	4	%

Unit Sales by Product:
Power Macintosh unit sales	133		167		(20	)%	447		590		(24	)%
PowerBook unit sales	161		94		71	%	428		299		43	%
iMac unit sales	287		378		(24	)%	841		983		(14	)%
iBook unit sales

Stock-Based Compensation

Employee Stock Purchase Plan

Three Months Ended

Nine Months Ended