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 March 26, 2005 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 Rule 12b-2 of the Exchange Act).

Yes  ý    No  o

 

823,933,916 shares of common stock issued and outstanding as of April 22, 2005

 

 



 

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

 

Six Months Ended

 

 

 

March 26, 2005

 

March 27, 2004

 

March 26, 2005

 

March 27, 2004

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

3,243

 

$

1,909

 

$

6,733

 

$

3,915

 

Cost of sales

 

2,275

 

1,379

 

4,769

 

2,849

 

Gross margin

 

968

 

530

 

1,964

 

1,066

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

119

 

123

 

242

 

242

 

Selling, general, and administrative

 

447

 

345

 

917

 

688

 

Restructuring costs

 

 

10

 

 

10

 

Total operating expenses

 

566

 

478

 

1,159

 

940

 

Operating income

 

402

 

52

 

805

 

126

 

 

 

 

 

 

 

 

 

 

 

Other income and expense:

 

 

 

 

 

 

 

 

 

Gains on non-current investments

 

 

 

 

4

 

Interest and other income, net

 

33

 

12

 

59

 

21

 

Total other income and expense

 

33

 

12

 

59

 

25

 

 

 

 

 

 

 

 

 

 

 

Income before provision for income taxes

 

435

 

64

 

864

 

151

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

145

 

18

 

279

 

42

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

290

 

$

46

 

$

585

 

$

109

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.36

 

$

0.06

 

$

0.73

 

$

0.15

 

Diluted

 

$

0.34

 

$

0.06

 

$

0.69

 

$

0.15

 

 

 

 

 

 

 

 

 

 

 

Shares used in computing earnings per share (in thousands):

 

 

 

 

 

 

 

Basic

 

808,172

 

730,694

 

798,602

 

727,796

 

Diluted

 

857,011

 

756,460

 

848,553

 

750,336

 

 

See accompanying notes to condensed consolidated financial statements.

 

2



 

APPLE COMPUTER, INC.

 

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(in millions, except share amounts)

 

 

 

March 26, 2005

 

September 25, 2004

 

 

 

 

 

 

 

ASSETS:

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

2,254

 

$

2,969

 

Short-term investments

 

4,803

 

2,495

 

Accounts receivable, less allowances of $51 and $47, respectively

 

888

 

774

 

Inventories

 

164

 

101

 

Deferred tax assets

 

297

 

231

 

Other current assets

 

601

 

485

 

Total current assets

 

9,007

 

7,055

 

Property, plant and equipment, net

 

742

 

707

 

Goodwill

 

80

 

80

 

Acquired intangible assets

 

33

 

17

 

Other assets

 

249

 

191

 

Total assets

 

$

10,111

 

$

8,050

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY:

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

1,773

 

$

1,451

 

Accrued expenses

 

1,579

 

1,200

 

Total current liabilities

 

3,352

 

2,651

 

Non-current liabilities

 

373

 

323

 

Total liabilities

 

3,725

 

2,974

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, no par value; 1,800,000,000 shares authorized; 823,136,748 and 782,887,234 shares issued and outstanding, respectively

 

3,195

 

2,514

 

Deferred stock compensation

 

(70

)

(93

)

Retained earnings

 

3,255

 

2,670

 

Accumulated other comprehensive income (loss)

 

6

 

(15

)

Total shareholders’ equity

 

6,386

 

5,076

 

Total liabilities and shareholders’ equity

 

$

10,111

 

$

8,050

 

 

See accompanying notes to condensed consolidated financial statements.

 

3



 

APPLE COMPUTER, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(in millions)

 

 

 

Six Months Ended

 

 

 

March 26, 2005

 

March 27, 2004

 

 

 

 

 

 

 

Cash and cash equivalents, beginning of the period

 

$

2,969

 

$

3,396

 

 

 

 

 

 

 

Operating Activities:

 

 

 

 

 

Net income

 

585

 

109

 

Adjustments to reconcile net income to cash generated by operating activities:

 

 

 

 

 

Depreciation, amortization, and accretion

 

82

 

69

 

Stock based compensation expense

 

20

 

13

 

Provision for (benefit from) deferred income taxes

 

13

 

(4

)

Tax benefit from stock options

 

275

 

12

 

Loss on disposition of property, plant, and equipment

 

4

 

 

Gains on non-current investments

 

 

(4

)

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable, net

 

(114

)

181

 

Inventories

 

(63

)

(7

)

Other current assets

 

(116

)

(17

)

Other assets

 

(56

)

(25

)

Accounts payable

 

322

 

(163

)

Other liabilities

 

359

 

116

 

Cash generated by operating activities

 

1,311

 

280

 

 

 

 

 

 

 

Investing Activities:

 

 

 

 

 

Purchases of short-term investments

 

(5,304

)

(976

)

Proceeds from maturities of short-term investments

 

2,750

 

660

 

Proceeds from sales of short-term investments

 

242

 

52

 

Proceeds from sales of non-current investments

 

 

5

 

Purchases of property, plant, and equipment

 

(101

)

(79

)

Other

 

(19

)

12

 

Cash used for investing activities

 

(2,432

)

(326

)

 

 

 

 

 

 

Financing Activities:

 

 

 

 

 

Payment of long-term debt

 

 

(300

)

Proceeds from issuance of common stock

 

406

 

108

 

Cash generated by (used for) financing activities

 

406

 

(192

)

Decrease in cash and cash equivalents

 

(715

)

(238

)

Cash and cash equivalents, end of the period

 

$

2,254

 

$

3,158

 

 

 

 

 

 

 

Supplemental cash flow disclosures:

 

 

 

 

 

 

 

 

 

 

 

Cash paid for interest

 

$

 

$

10

 

Cash paid for income taxes, net

 

$

47

 

$

15

 

 

See accompanying notes to condensed consolidated financial statements.

 

4



 

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 software, services, peripherals and networking solutions.  The Company also designs, develops and markets a line of portable digital music players along with related accessories and services including the online distribution of third-party music and audio books.   The Company sells its products worldwide through its online stores, its own retail stores, its direct sales force and third-party wholesalers, resellers and value added resellers.  In addition to its own hardware, software and peripheral products, the Company sells a variety of third-party hardware and software products through its online and retail stores.  The Company sells to education, consumer, creative professional, business and government 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.  Certain prior year amounts in these condensed consolidated financial statements and notes thereto have been reclassified to conform to the current period’s presentation.

 

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 25, 2004, included in its Annual Report on Form 10-K for the year ended September 25, 2004 (the 2004 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.

 

Common Stock Split

On February 28, 2005, the Company effected a two-for-one stock split to shareholders of record as of February 18, 2005.  All share and per share information have been retroactively adjusted to reflect the stock split.

 

Research and Development

Research and development costs are expensed as incurred. Development costs of computer software to be sold, leased or otherwise marketed are subject to capitalization beginning when a product’s technological feasibility has been established and ending when a product is available for general release to customers pursuant to Statement of Financial Accounting Standards (SFAS) No. 86, Computer Software to be Sold, Leased, or Otherwise Marketed. In most instances, the Company’s products are released soon after technological feasibility has been established; therefore, costs incurred subsequent to achievement of technological feasibility are usually not significant, and generally all software development costs have been expensed.

 

In the fourth quarter of 2004, the Company began incurring substantial development costs associated with the latest version of Mac OS X (code-named “Tiger”) subsequent to achievement of technological feasibility as evidenced by public demonstration in August 2004 and the subsequent release of a developer beta version of the product. Therefore, during the second quarter and first quarter of 2005 and the fourth quarter of 2004, the Company capitalized approximately $14.7 million, $14.8 million and $4.5 million, respectively, of costs associated with the development of Tiger.  Amortization of this asset to cost of sales will commence when Tiger begins shipping and will be recognized on a straight-line basis over a 3 year estimated useful life.  The final version of the product was released in April 2005.

 

During the second quarter of 2004, the Company incurred substantial development costs associated with FileMaker Pro 7 subsequent to achievement of technological feasibility as evidenced by public demonstration and release of a developer beta version, and prior to the release of the final version of the product in March 2004. Therefore, during

 

5



 

the second quarter of 2004, the Company capitalized approximately $2.3 million of costs associated with the development of FileMaker Pro 7.  In accordance with SFAS No. 86, amortization of this asset to cost of sales began in March 2004 when FileMaker Pro 7 was shipped and is being recognized on a straight-line basis over a 3 year estimated useful life.

 

Stock-Based Compensation

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (revised 2004) (SFAS 123R), Share-Based Payment, that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments.  SFAS 123R eliminates the ability to account for share-based compensation transactions using the intrinsic value method under Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and generally would require instead that such transactions be accounted for using a fair-value-based method. The Company is currently evaluating SFAS 123R to determine which fair-value-based model and transitional provision it will follow upon adoption. The options for transition methods as prescribed in SFAS 123R include either the modified prospective or the modified retrospective methods. The modified prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock as the requisite service is rendered beginning with the first quarter of adoption, while the modified retrospective method would record compensation expense for stock options and restricted stock beginning with the first period restated. Under the modified retrospective method, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented.  SFAS 123R will be effective for the Company beginning in its first quarter of fiscal 2006. Although the Company will continue to evaluate the application of SFAS 123R, management expects adoption to have a material impact on its results of operations.

 

The Company currently measures compensation expense for its employee stock-based compensation plans using the intrinsic value method prescribed by APB Opinion No. 25. The Company applies the disclosure provisions of SFAS No. 123, Accounting for Stock-based Compensation, as amended by SFAS No. 148, Accounting for Stock-based Compensation – Transition and Disclosure as if the fair-value-based method had been applied in measuring compensation expense. 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.

 

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 share 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.

 

6



 

The Company’s pro forma information for the three and six month periods ended March 26, 2005 and March 27, 2004 follows (in millions, except per share amounts):

 

 

 

Three
Months Ended

 

Six
Months Ended

 

 

 

3/26/05

 

3/27/04

 

3/26/05

 

3/27/04

 

 

 

 

 

 

 

 

 

 

 

Net income - as reported

 

$

290

 

$

46

 

$

585

 

$

109

 

 

 

 

 

 

 

 

 

 

 

Add: Stock-based employee compensation expense included in reported net income, net of tax

 

9

 

6

 

18

 

13

 

 

 

 

 

 

 

 

 

 

 

Deduct: Stock-based employee compensation expense determined under the fair-value-based method for all awards, net of tax

 

(27

)

(34

)

(56

)

(70

)

 

 

 

 

 

 

 

 

 

 

Net income - pro forma

 

$

272

 

$

18

 

$

547

 

$

52

 

 

 

 

 

 

 

 

 

 

 

Net income per common share - as reported

 

 

 

 

 

 

 

 

 

Basic

 

$

0.36

 

$

0.06

 

$

0.73

 

$

0.15

 

Diluted

 

$

0.34

 

$

0.06

 

$

0.69

 

$

0.15

 

 

 

 

 

 

 

 

 

 

 

Net income per common share - pro forma

 

 

 

 

 

 

 

 

 

Basic

 

$

0.34

 

$

0.02

 

$

0.68

 

$

0.07

 

Diluted

 

$

0.32

 

$

0.02

 

$

0.64

 

$

0.07

 

 

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, restricted stock and restricted stock units is reflected in diluted earnings per share by application of the treasury stock method.  Under the treasury stock method, an increase in the fair market value of the Company’s common stock can result in a greater dilutive effect from outstanding options, restricted stock and restricted stock units.  Additionally, the exercise of employee stock options and the vesting of restricted stock and restricted stock units can result in a greater dilutive effect on earnings per share.

 

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

 

 

 

Three
Months Ended

 

Six
Months Ended

 

 

 

3/26/05

 

3/27/04

 

3/26/05

 

3/27/04

 

 

 

 

 

 

 

 

 

 

 

Numerator (in millions):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

290

 

$

46

 

$

585

 

$

109

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average-shares outstanding, excluding unvested restricted stock

 

808,172

 

730,694

 

798,602

 

727,796

 

Effect of dilutive options, restricted stock units and restricted stock

 

48,839

 

25,766

 

49,951

 

22,540

 

 

 

 

 

 

 

 

 

 

 

Denominator for diluted earnings per share

 

857,011

 

756,460

 

848,553

 

750,336

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.36

 

$

0.06

 

$

0.73

 

$

0.15

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share

 

$

0.34

 

$

0.06

 

$

0.69

 

$

0.15

 

 

7



 

Potentially dilutive securities, including stock options, restricted stock units, and restricted stock, to acquire approximately 0.9 million and 13.7 million shares of common stock for the three months ended March 26, 2005 and March 27, 2004, respectively, and 1.1 million and 18.6 million shares of common stock for the six months ended March 26, 2005 and March 27, 2004, respectively were excluded from the computation of diluted earnings per share for these periods because their effect would have been antidilutive.

 

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 March 26, 2005 and September 25, 2004 (in millions):

 

 

 

3/26/05

 

9/25/04

 

 

 

 

 

 

 

Cash

 

$

165

 

$

200

 

 

 

 

 

 

 

U.S. Treasury and Agency securities

 

3

 

87

 

U.S. corporate securities

 

1,255

 

1,795

 

Foreign securities

 

831

 

887

 

Total cash equivalents

 

2,089

 

2,769

 

 

 

 

 

 

 

U.S. Treasury and Agency securities

 

870

 

1,080

 

U.S. corporate securities

 

3,272

 

1,352

 

Foreign securities

 

661

 

63

 

Total short-term investments

 

4,803

 

2,495

 

 

 

 

 

 

 

Total cash, cash equivalents, and short-term investments

 

$

7,057

 

$

5,464

 

 

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 losses, net of taxes, of $5.8 million on its investment portfolio, approximately half of which related to investments with stated maturities of less than one year, as of March 26, 2005.  As of September 25, 2004, the Company had net unrealized losses, net of taxes, of $4 million on its investment portfolio, primarily related to investments with stated maturities of less than one year. The Company occasionally sells short-term investments prior to their stated maturities. No material gains or losses were recognized on any such sales during the three and six month periods ending March 26, 2005 or March 27, 2004.

 

As of March 26, 2005 and September 25, 2004, $327 million and $180 million, 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 between 3 and 12 months.

 

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 revenue and cost of sales. From time to time, the Company enters into interest rate derivative 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. As of the end of the first six months of 2005, 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 2004.

 

Foreign Exchange Risk Management

The Company may enter into foreign currency forward and option contracts with financial institutions to protect against foreign exchange risk associated with existing assets and liabilities, certain firmly committed transactions and

 

8



 

forecasted future cash flows. 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.

 

Accounting for Derivative Financial Instruments

The Company accounts for all derivatives at fair value. Derivatives that are not hedges are 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 March 26, 2005, the Company had a net deferred gain associated with cash flow hedges of approximately $3.8 million net of taxes, substantially all of which is expected to be reclassified to earnings by the end of the fourth quarter of fiscal 2005.

 

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

 

Inventories

 

 

 

3/26/05

 

9/25/04

 

Purchased parts

 

$

1

 

$

1

 

Finished goods

 

163

 

100

 

 

 

 

 

 

 

Total inventories

 

$

164

 

$

101

 

 

Other Current Assets

 

 

 

3/26/05

 

9/25/04

 

Vendor non-trade receivables

 

$

354

 

$

276

 

Other current assets

 

247

 

209

 

 

 

 

 

 

 

Total other current assets

 

$

601

 

$

485

 

 

Property, Plant, and Equipment, Net

 

 

 

3/26/05

 

9/25/04

 

Land and buildings

 

$

354

 

$

351

 

Machinery, equipment, and internal-use software

 

460

 

422

 

Office furniture and equipment

 

82

 

79

 

Leasehold improvements

 

474

 

446

 

 

 

1,370

 

1,298

 

 

 

 

 

 

 

Accumulated depreciation and amortization

 

(628

)

(591

)

 

 

 

 

 

 

Total property, plant, and equipment, net

 

$

742

 

$

707

 

 

Other Assets

 

 

 

3/26/05

 

9/25/04

 

Non-current deferred tax assets

 

$

88

 

$

86

 

Capitalized software development costs, net

 

48

 

25

 

Other assets

 

113

 

80

 

 

 

 

 

 

 

Total other assets

 

$

249

 

$

191

 

 

Accrued Expenses

 

 

 

3/26/05

 

9/25/04

 

Deferred revenue - current

 

$

427

 

$

342

 

Accrued marketing and distribution

 

186

 

147

 

Accrued compensation and employee benefits

 

164

 

134

 

Accrued warranty and related costs

 

154

 

105

 

Other current liabilities

 

648

 

472

 

 

 

 

 

 

 

Total accrued expenses

 

$

1,579

 

$

1,200

 

 

9



 

Non-current Liabilities

 

 

 

3/26/05

 

9/25/04

 

Deferred revenue - non-current

 

$

231

 

$

202

 

Deferred tax liabilities

 

132

 

113

 

Other non-current liabilities

 

10

 

8

 

 

 

 

 

 

 

Total non-current liabilities

 

$

373

 

$

323

 

 

Interest and Other Income, Net

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

3/26/05

 

3/27/04

 

3/26/05

 

3/27/04

 

Interest income

 

$

39

 

$

15

 

$

67

 

$

29

 

Interest expense

 

 

(1

)

 

(3

)

Other income (expense), net

 

(6

)

(2

)

(8

)

(5

)

 

 

 

 

 

 

 

 

 

 

Interest and other income, net

 

$

33

 

$

12

 

$

59

 

$

21

 

 

Note 4 – Restructuring Actions

 

2004 Restructuring Actions

The Company recorded total restructuring charges of approximately $23 million during the year ended September 25, 2004, including approximately $14 million in severance costs, $5.5 million in asset impairments, and a $3.5 million charge for lease cancellations.  Of the $23 million charge, $18.4 million had been utilized by the end of the second quarter of 2005, with the remaining $4.6 million consisting of $1.5 million for employee severance benefits and $3.1 million for lease cancellations. These actions will result in the termination of 485 positions, 441 of which had been terminated prior to the end of the second quarter of 2005.

 

The following table summarizes activity associated with restructuring actions initiated during fiscal 2004 (in millions):

 

 

 

Employee
Severance
Benefits

 

Asset
Impairments

 

Lease
Cancellations

 

Totals

 

 

 

 

 

 

 

 

 

 

 

Total charge

 

$

14.0

 

$

5.5

 

$

3.5

 

$

23.0

 

Total spending through March 26, 2005

 

(12.0

)

 

(0.4

)

(12.4

)

Total non-cash items

 

 

(5.2

)

 

(5.2

)

Adjustments

 

(0.5

)

(0.3

)

 

(0.8

)

Accrual at March 26, 2005

 

$

1.5

 

$

 

$

3.1

 

$

4.6

 

 

2003 Restructuring Actions

The Company recorded total restructuring charges of approximately $26.8 million during the year ended September 27, 2003, including approximately $7.4 million in severance costs, a $5.0 million charge to write-off deferred compensation, $7.1 million in asset impairments and a $7.3 million charge for lease cancellations. Of the $26.8 million charge, all had been utilized by the end of the second quarter of 2005, except for approximately $2.3 million related to operating lease costs on abandoned facilities.

 

10



 

The following table summarizes activity associated with restructuring actions initiated during fiscal 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 through March 26, 2005

 

(7.9

)

 

 

(4.5

)

(12.4

)

Total non-cash items

 

 

(5.0

)

(7.1

)

 

(12.1

)

Adjustments

 

0.5

 

 

 

(0.5

)

 

Accrual at March 26, 2005

 

$

 

$

 

$

 

$

2.3

 

$

2.3

 

 

Note 5 – Shareholders’ Equity

 

Preferred Stock

The Company has 5 million shares of authorized preferred stock, none of which is outstanding. Under the terms of the Company’s Restated Articles of Incorporation, the Board of Directors is authorized to determine or alter the rights, preferences, privileges and restrictions of the Company’s authorized but unissued shares of preferred stock.

 

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.  The Company has not engaged in any transactions to repurchase its common stock since fiscal 2003. Since inception of the stock repurchase plan, the Company had repurchased a total of 13.2 million shares at a cost of $217 million. The Company was authorized to repurchase up to an additional $283 million of its common stock as of March 26, 2005.

 

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 consists of foreign currency translation adjustments from those subsidiaries not using the U.S. dollar as their functional currency, unrealized gains and losses on marketable securities categorized as available-for-sale, and 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 six-month periods ended March 26, 2005, and March 27, 2004 (in millions):

 

 

 

Three
Months Ended

 

Six
Months Ended

 

 

 

3/26/05

 

3/27/04

 

3/26/05

 

3/27/04

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

290

 

$

46

 

$

585

 

$

109

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

Net change in unrealized derivative gains/losses

 

17

 

22

 

8

 

14

 

Change in foreign currency translation

 

(7

)

(2

)

15

 

12

 

Net change in unrealized investment gains/losses

 

(1

)

1

 

(2

)

2

 

Reclassification adjustment for investment gains included in net income

 

 

 

 

(3

)

 

 

 

 

 

 

 

 

 

 

Total comprehensive income

 

$

299

 

$

67

 

$

606

 

$

134

 

 

11



 

The following table summarizes activity in other comprehensive income related to derivatives, net of taxes, held by the Company during the three and six-month periods ended March 26, 2005, and March 27, 2004 (in millions):

 

 

 

Three
Months Ended

 

Six
Months Ended

 

 

 

3/26/05

 

3/27/04

 

3/26/05

 

3/27/04

 

 

 

 

 

 

 

 

 

 

 

Change in fair value of derivatives

 

$

4

 

$

1

 

$

(8

)

$

(17

)

Adjustment for net losses realized and included in net income

 

13

 

21

 

16

 

31

 

Change in unrealized derivative gains/losses

 

$

17

 

$

22

 

$

8

 

$

14

 

 

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

 

 

 

As of
3/26/05

 

As of
9/25/04

 

 

 

 

 

 

 

Unrealized losses on available-for-sale securities

 

$

(6

)

$

(4

)

Unrealized gains (losses) on derivative investments

 

4

 

(4

)

Cumulative foreign currency translation

 

8

 

(7

)

Accumulated other comprehensive income (loss)

 

$

6

 

$

(15

)

 

Note 6 – Employee Benefit Plans

 

2003 Employee Stock Option Plan

The 2003 Employee Stock Option Plan (the 2003 Plan), formerly the 1998 Executive Officer Plan, is a shareholder approved plan that provides for broad-based grants to all employees in addition to executive officers and other key employees. 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 units, 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. 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. In October 2003, the Company terminated the 1997 Employee Stock Option Plan and cancelled all remaining unissued shares totaling 28,590,702.   No new options can be granted from the 1997 Plan.

 

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.

 

Rule 10b5-1 Trading Plans

Certain of the Company’s executive officers, including Mr. Timothy D. Cook, Mr. Peter Oppenheimer, Mr. Jonathan Rubinstein, Dr. Bertrand Serlet, and Dr. Avadis Tevanian, Jr., have entered into trading plans pursuant to Rule 10b5-1(c)(1) of the Securities Exchange Act of 1934, as amended. A trading plan is a written document that pre-establishes the amounts, prices and dates (or formula for determining the amounts, prices and dates) of future purchases or sales of the Company’s stock including the exercise and sale of employee stock options and shares acquired pursuant to the Company’s employee stock purchase plan and upon vesting of restricted stock units.

 

12



 

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. The number of shares authorized for issuance is limited to a total of 1 million shares per offering period. As of March 26, 2005, approximately 2.7 million shares were reserved for future issuance under the Purchase Plan.

 

Subsequent Event – Employee Stock and Bonus Plans

At the Annual Meeting of Shareholders held on April 21, 2005, the Company’s shareholders approved the Performance Bonus Plan, a performance-based annual cash incentive plan for the Company’s executive officers. The shareholders also approved amendments to the 2003 Employee Stock Option Plan, including an increase in the number of shares reserved for issuance under the plan by 49 million shares. In addition, the shareholders approved an amendment to the Company’s Employee Stock Purchase Plan to increase the number of shares reserved for issuance thereunder by 2 million shares.

 

Stock Option Plan Activity

A summary of the Company’s stock option activity and related information for the six month periods ended March 26, 2005 and March 27, 2004 is set forth in the following table (shares in thousands):

 

 

 

 

 

Outstanding Options

 

 

 

Shares
Available
For Grant

 

Number of
Shares

 

Weighted
Average
Exercise Price

 

Balance at 9/25/04

 

24,050

 

110,722

 

$

10.52

 

Options Granted

 

(3,798

)

3,798

 

$

32.72

 

Options and Restricted Stock Units Cancelled

 

2,232

 

(2,232

)

$

10.80

 

Options Exercised

 

 

(38,868

)

$

9.96

 

Plan Shares Expired

 

(1,030

)

 

 

Balance at 3/26/05

 

21,454

 

73,420

 

$

11.96

 

 

 

 

 

 

 

 

 

Balance at 9/27/03

 

91,660

 

126,024

 

$

9.54

 

Options Granted

 

(32,496

)

32,496

 

$

11.07

 

Restricted Stock Units Granted

 

(4,800

)

 

 

Options Cancelled

 

3,352

 

(3,352

)

$

10.24

 

Options Exercised

 

 

(10,256

)

$

8.84

 

Plan Shares Expired

 

(30,752

)

 

 

Balance at 3/27/04

 

26,964

 

144,912

 

$

9.92

 

 

The options outstanding as of March 26, 2005 have been segregated into seven ranges for additional disclosure as follows (option amounts are presented in thousands):

 

 

 

Options Outstanding

 

Options Exercisable

 

Range of
Exercise Prices

 

Options
Outstanding
as of
3/26/05

 

Weighted-
Average
Remaining
Contractual Life
in Years

 

Weighted
Average
Exercise Price

 

Options
Exercisable
as of
3/26/05

 

Weighted
Average
Exercise
Price

 

 

 

 

 

 

 

 

 

 

 

 

 

$0.62 - $8.66

 

11,988

 

4.78

 

$

7.16

 

9,430

 

$

7.04

 

$8.67 - $10.12

 

10,819

 

5.58

 

$

9.28

 

9,787

 

$

9.26

 

$10.13 - $10.23

 

11,232

 

6.54

 

$

10.20

 

6,721

 

$

10.20

 

$10.24 - $10.90

 

13,990

 

5.85

 

$

10.87

 

2,632

 

$

10.80

 

$10.91 - $11.73

 

11,907

 

5.80

 

$

11.39

 

4,339

 

$

11.40

 

$11.74 - $27.45

 

10,533

 

5.77

 

$

17.40

 

5,445

 

$

18.97

 

$27.46 - $44.50

 

2,951

 

6.75

 

$

36.03

 

111

 

$

30.58

 

 

 

 

 

 

 

 

 

 

 

 

 

$0.62 - $44.50

 

73,420

 

5.76

 

$

11.96

 

38,465

 

$

10.66

 

 

13



 

The Company had 4.830 million restricted stock units outstanding as of March 26, 2005, which were excluded from the options outstanding balances in the preceding tables.  None of these restricted stock units were vested as of March 26, 2005. These restricted stock units have been deducted from the shares available for grant under the Company’s stock option plans.

 

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.

 

The assumptions used for the three and six month periods ended March 26, 2005 and March 27, 2004, 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

 

Six
Months Ended

 

 

 

3/26/05

 

3/27/04

 

3/26/05

 

3/27/04

 

 

 

 

 

 

 

 

 

 

 

Expected life of stock options

 

3.5 years

 

3.5 years

 

3.5 years

 

3.5 years

 

Expected life of stock purchases

 

6 months

 

6 months

 

6 months

 

6 months

 

Interest rate - stock options

 

3.70

%

2.33

%

3.13% - 3.70

%

2.33% - 2.35

%

Interest rate - stock purchases

 

2.54

%

0.96

%

1.67% - 2.54

%

0.96% - 1.10

%

Volatility - stock options

 

40

%

40

%

40

%

40

%

Volatility - stock purchases

 

41

%

34

%

32% - 41

%

34% - 44

%

Expected dividend yields

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average fair value of options granted during the period

 

$

13.54

 

$

3.50

 

$

10.94

 

$

3.48

 

Weighted-average fair value of employee stock purchases during the period

 

$

7.30

 

$

2.47

 

$

5.53

 

$

2.46

 

 

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 16 years, the majority of which are for 10 years, and often contain multi-year renewal options. As of September 25, 2004, the Company’s total future minimum lease payments under noncancelable operating leases were $617 million, of which $436 million related to leases for retail space.  As of March 26, 2005, total future minimum lease payments related to leases for retail space increased to $489 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 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 and projected warranty claim rates, historical and projected cost-per-claim, and knowledge of specific product failures that are outside of the Company’s

 

14



 

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.

 

15



 

The following table reconciles changes in the Company’s accrued warranties and related costs for the three and six month periods ended March 26, 2005 and March 27, 2004 (in millions):

 

 

 

Three
Months Ended

 

Six
Months Ended

 

 

 

3/26/05

 

3/27/04

 

3/26/05

 

3/27/04

 

 

 

 

 

 

 

 

 

 

 

Beginning accrued warranty and related costs

 

$

135

 

$

80

 

$

105

 

$

67

 

Cost of warranty claims

 

(43

)

(27

)

(77

)

(48

)

Accruals for product warranties

 

62

 

27

 

126

 

61

 

Ending accrued warranty and related costs

 

$

154

 

$

80

 

$

154

 

$

80

 

 

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 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 subject to indemnification 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 March 26, 2005 or September 25, 2004.

 

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 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 within thirty days. Plaintiffs filed their amended complaint on January 31, 2003, and on March 17, 2003, the Company filed a motion to dismiss the amended complaint. The Court heard the Company’s motion on July 11, 2003 and dismissed Plaintiffs’ claims with prejudice on August 12, 2003. Plaintiffs appealed the ruling.  The Ninth Circuit Court of Appeal heard the matter on February 17, 2005 and affirmed the District Court’s ruling in an unpublished decision dated April 4, 2005.  Plaintiffs will not seek further review and the matter is concluded.

 

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 individually or in the aggregate 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.

 

Production and marketing of products in certain states and countries may subject the Company to environmental and other regulations including, in some instances, the requirement to provide customers the ability to return product at the end of its useful life, and place responsibility for environmentally safe disposal or recycling with the Company. Such laws and regulations have recently been passed in several jurisdictions in which the Company operates including various European Union member countries, Japan and certain states within the U.S.  Although the Company does not anticipate any material adverse effects in the future based on the nature of its operations and the thrust of such laws, there is no assurance that such existing laws or future laws will not have a material adverse effect on the Company’s results of operations and financial position.

 

16



 

Note 9 - Segment Information and Geographic Data

 

In accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, the Company reports segment information based on the “management” approach. The management approach designates the internal reporting used by management for making decisions and assessing performance as the source of the Company’s reportable segments.

 

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, Europe, and Japan reportable segments do not include activities related to the Retail segment.  The Americas segment includes both North and South America. The Europe segment includes European countries as well as the Middle East and Africa. The Japan segment includes only Japan. The Retail segment operates Apple-owned retail stores in the U.S., Japan, and the U.K.  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 Company’s 2004 10-K in Note 1, “Summary of Significant Accounting Policies,” 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 generally based on the location of the customers. Operating income for each segment includes net sales to third parties, related 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 and variances not included in standard costs, income taxes, and various nonrecurring charges. Corporate expenses include research and development, corporate marketing expenses, manufacturing costs and variances not included in standard costs, 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 $16 million and $20 million during the second quarters of 2005 and 2004, respectively, and $49 million and $48 million during the first six months of 2005 and 2004, respectively.

 

Operating income for all segments, except Retail, includes cost of sales at manufacturing standard cost, other cost of sales, related sales and marketing costs, and certain general and administrative costs. This measure of operating income, which includes manufacturing profit, provides a comparable basis for comparison between the Company’s various geographic segments.  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.

 

Management assesses the operating performance of the Retail segment differently than it assesses the operating performance of the Company’s geographic segments. The Retail segment revenue and operating income is intended to depict a measure comparable to that of the Company’s major channel partners in the U.S. operating retail stores so the Company can evaluate the Retail segment performance as if it were a channel partner. Therefore, the Company makes three significant adjustments to the Retail segment for management reporting purposes that are not included in the results of the Company’s other segments.

 

First, the Retail segment’s operating income includes cost of sales for Apple products at an amount normally charged to major channel partners in the U.S. operating retail stores, less the cost of sales programs and incentives provided to those channel partners and the Company’s cost to support those partners. For the second quarter of 2005 and 2004, 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 $102 million and $45 million, respectively. For the first six months of 2005 and 2004, 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 $201 million and $97 million, respectively.

 

17



 

Second, the Company’s extended warranty, support and service contracts are transferred to the Retail segment at the same cost as that charged to the Company’s major retail channel partners in the U.S., resulting in a measure of revenue and gross margin for those items that is comparable between the Company’s Retail stores and those retail channel partners.  The Retail segment recognizes the full amount of revenue and cost of sales of the Company’s extended warranty, support and service contracts at the time of sale. 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 other operating segments’ net sales and cost of sales. For the second quarter of 2005, this resulted in the recognition of net sales and cost of sales by the Retail segment, with corresponding offsets in other operating segments, of $21 million and $15 million, respectively. For the second quarter of 2004, the net sales and cost of sales of extended warranty, support and service contracts recognized by the Retail segment were $12 million and $8 million, respectively. For the first six months of 2005, this resulted in the recognition of additional net sales and cost of sales by the Retail segment, with corresponding offsets in other operating segments, of $41 million and $28 million, respectively. This compares to similar adjustments to net sales and cost of sales during the first six months of 2004 of $24 million and $16 million, respectively.

 

Third, the Company has opened seven high profile stores in New York, Los Angeles, Chicago, San Francisco, Tokyo, Japan, Osaka, Japan, and London, England as of March 26, 2005.  These high profile stores are larger than the Company’s typical retail stores and were designed to further promote brand awareness and provide a venue for certain corporate sales and marketing activities, including corporate briefings.  As such, the Company allocates certain operating expenses associated with these stores to corporate marketing expense to reflect the estimated benefit realized Company-wide. The allocation of these operating costs is based on the amount incurred for a high profile store in excess of that incurred by a more typical Company retail location. Expenses allocated to corporate marketing resulting from the operations of these stores were $7.1 million and $4.0 million in the second quarters of 2005 and 2004, respectively, and $14.0 million and $6.2 million for the first six months of 2005 and 2004, respectively.

 

Summary information by operating segment follows (in millions):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

3/26/05

 

3/27/04

 

3/26/05

 

3/27/04

 

Americas:

 

 

 

 

 

 

 

 

 

Net sales

 

$

1,443

 

$

881

 

$

3,080

 

$

1,805

 

Operating income

 

$

185

 

$

91

 

$

387

 

$

205

 

 

 

 

 

 

 

 

 

 

 

Europe:

 

 

 

 

 

 

 

 

 

Net sales

 

$

705

 

$

449

 

$

1,552

 

$

968

 

Operating income

 

$

100

 

$

72

 

$

233

 

$

169

 

 

 

 

 

 

 

 

 

 

 

Japan:

 

 

 

 

 

 

 

 

 

Net sales

 

$

284

 

$

173

 

$

469

 

$

330

 

Operating income

 

$

45

 

$

27

 

$

66

 

$

48

 

 

 

 

 

 

 

 

 

 

 

Retail:

 

 

 

 

 

 

 

 

 

Net sales

 

$

571

 

$

266

 

$

1,132

 

$

539

 

Operating income

 

$

42

 

$

5

 

$

87

 

$

14

 

 

 

 

 

 

 

 

 

 

 

Other Segments (a):

 

 

 

 

 

 

 

 

 

Net sales

 

$

240

 

$

140

 

$

500

 

$

273

 

Operating income

 

$

25

 

$

24

 

$

62

 

$

42

 

 


(a)                                  Other Segments consists of Asia-Pacific and FileMaker.

 

18



 

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

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

3/26/05

 

3/27/04

 

3/26/05

 

3/27/04

 

 

 

 

 

 

 

 

 

 

 

Segment operating income

 

$

397

 

$

219

 

$

835

 

$

478

 

Corporate expenses, net (b)

 

5

 

(157

)

(30

)

(342

)

Restructuring costs

 

 

(10

)

 

(10

)

Total operating income

 

$

402

 

$

52

 

$

805

 

$

126

 

 


(b)                                 Corporate expenses include research and development, corporate marketing expenses, manufacturing costs and variances not included in standard costs, and other separately managed general and administrative expenses including certain corporate expenses associated with support of the Retail segment.

 

Note 10 – Related Party Transactions and Certain Other Transactions

 

In March 2002, the Company entered into a Reimbursement Agreement with its CEO, 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 became 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 $62,000 and $40,000 in expenses pursuant to the Reimbursement Agreement during the second quarters of 2005 and 2004, respectively, and $481,000 and $322,000 in expenses for the first six months of 2005 and 2004. All expenses recognized pursuant to the Reimbursement Agreement have been included in selling, general, and administrative expenses in the condensed consolidated statements of operations.

 

19



 

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.  Forward-looking statements can be identified by words such as “anticipates,” “expects,” “believes,” “plans,” “predicts,” and similar terms. Forward-looking statements are not guarantees of future performance and 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 2004 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. The Company assumes no obligation to revise or update any forward-looking statements for any reason, except as required by law.

 

Available Information

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 its website at http://www.apple.com/investor when such reports are available on the Securities and Exchange Commission (SEC) website. The public may read and copy any materials filed by the Company with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549.  The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.  The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at http://www.sec.gov.  The contents of these websites are not incorporated into this filing.  Further, the Company’s references to the URLs for these websites are intended to be inactive textual references only.

 

Executive Overview

The Company designs, manufactures and markets personal computers and related software, services, peripherals and networking solutions.  The Company also designs, develops and markets a line of portable digital music players along with related accessories and services including the online distribution of third-party music and audio books. The Company’s products and services include the Macintosh line of desktop and notebook computers, the iPod digital music player, the Xserve server and Xserve RAID storage products, a portfolio of consumer and professional software applications, the Mac OS X operating system, the online iTunes Music Store, a portfolio of peripherals that support and enhance the Macintosh and iPod product lines, and a variety of other service and support offerings. The Company sells its products worldwide through its online stores, its own retail stores, its direct sales force, and third-party wholesalers, resellers and value added resellers. In addition, the Company sells a variety of third-party Macintosh compatible products, including computer printers and printing supplies, storage devices, computer memory, digital video and still cameras, personal digital assistants, and various other computing products and supplies through its online and retail stores. The Company sells to education, consumer, creative professional, business and government customers.  A further description of the Company’s products may be found below and in Part I, Item 1 of the Company’s 2004 Form 10-K.

 

The Company’s business strategy leverages its ability, through the design and development of its own operating system, hardware and many software applications and technologies, to bring to its customers around the world compelling new products and solutions with superior ease-of-use, seamless integration and innovative industrial design.

 

The Company participates in several highly competitive markets, including personal computers with its Macintosh line of computers, consumer electronics with its iPod line of digital music players and distribution of third-party digital music through its online iTunes Music Store.  While the Company is widely recognized as an innovator in the personal computer market as well as a leader in the emerging market for distribution of digital music, these are highly competitive markets that are subject to aggressive pricing and increased competition.  In order to remain competitive, the Company believes that increased investment in research and development (R&D) and marketing and advertising is necessary in order to maintain and extend its position in the markets where it competes.  The Company’s R&D spending is focused on delivering timely updates and enhancements to its existing line of personal computers, displays, operating systems, software applications and portable music players; developing new digital lifestyle consumer and professional software applications; and investing in new product areas such as rack-mount

 

20



 

servers, RAID storage systems, and wireless technologies.  The Company also believes that investment in marketing and advertising programs is critical to increasing product and brand awareness.

 

The Company utilizes a variety of direct and indirect distribution channels.  The Company believes that sales of its innovative and differentiated products are enhanced by knowledgeable salespersons who can convey the value of the hardware, software and peripheral integration, demonstrate the unique digital lifestyle solutions that are available only on Macintosh computers, and demonstrate the compatibility of the Macintosh with the Windows platform and networks.  The Company further believes that providing a high-quality sales and after-sales support experience is critical to attracting and retaining customers.  To ensure a high-quality buying experience for its products in which service and education are emphasized, the Company has expanded and improved its distribution capabilities by opening its own retail stores in the U.S. and internationally.  The Company had 103 stores open as of March 26, 2005.

 

The Company also staffs selected third-party stores with the Company’s own employees to improve the buying experience through reseller channels.  The Company has deployed Apple employees in reseller locations around the world including the U.S., Europe, Japan and Australia. The Company also sells to customers directly through its online stores around the world.

 

To improve the accessibility to its iPod product line, the Company has significantly expanded the number of distribution points where iPods are sold. The iPod product line can be purchased in certain department stores, member-only warehouse stores, large retail chains, and specialty retail stores.

 

Critical Accounting Policies and Estimates

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 require 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 2004 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 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 and such differences may be material.

 

Management believes the Company’s critical accounting policies and estimates 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, warranty costs, and income taxes. 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. The Company’s senior management has reviewed these critical accounting policies and related disclosures with the Audit and Finance Committee of the Company’s Board of Directors.

 

Revenue Recognition

Net sales consist primarily of revenue from the sale of products (e.g., hardware, software, music products, and peripherals), and extended warranty and support contracts. The Company recognizes revenue pursuant to applicable accounting standards, including Statement of Position (SOP) No. 97-2, Software Revenue Recognition, as amended, and Securities and Exchange Commission (SEC) Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition.

 

The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collection is probable.  Generally, product is considered delivered to the customer once it has been shipped, and title and risk of loss have been transferred. For most of the Company’s product sales, these criteria are met at the time the product is shipped. For online sales to individuals, for some sales to education customers, and for certain other sales, the Company defers revenue recognition until the customer receives the product because the Company legally retains a portion of the risk of loss on these sales during transit. If at the outset of an arrangement the Company determines the arrangement fee is not, or is presumed not to be, fixed or determinable, revenue is deferred and subsequently recognized as amounts become due and payable.

 

21



 

The Company records reductions to revenue for estimated commitments related to price protection and for customer incentive programs, including reseller and end-user rebates, and other sales programs and volume-based incentives.  The estimated cost of these programs is accrued as a reduction to revenue in the period the Company has sold the product and committed to a plan.  The Company also records reductions to revenue for expected future product returns based on the Company’s historical experience. Future market conditions and product transitions may require the Company to increase customer incentive programs and incur incremental price protection obligations that could result in additional reductions to revenue at the time such programs are offered. Additionally, certain customer incentive programs require management to estimate the number of customers who will actually redeem the incentive based on historical experience and the specific terms and conditions of particular incentive programs. If a greater than estimated proportion of customers redeem such incentives, the Company would be required to record additional reductions to revenue, which could have a material adverse impact on the Company’s results of operations.

 

Allowance for Doubtful Accounts

The Company distributes its products through third-party resellers and directly to certain education, consumer, and commercial customers. The Company generally does not require collateral from its customers. However, when possible the Company does attempt to limit credit risk on trade receivables with credit insurance for certain customers in Latin America, Europe and Asia and by arranging with third-party financing companies to provide flooring arrangements and other loan and lease programs to the Company’s direct customers. These credit-financing arrangements are directly between the third-party financing company and the end customer.  As such, the Company generally does not assume any recourse or credit risk sharing related to any of these arrangements. However, considerable trade receivables that are not covered by collateral, third-party flooring arrangements, or credit insurance are outstanding with the Company’s distribution and retail channel partners.

 

The allowance for doubtful accounts is based on management’s assessment of the collectibility of specific customer accounts and includes consideration of the credit worthiness and financial condition of those specific customers. The Company records an allowance to reduce the specific receivables to the amount that is reasonably believed to be collectible.  The Company also records an allowance for all other trade receivables based on multiple factors including historical experience with bad debts, the general economic environment, the financial condition of the Company’s distribution channels, and the aging of such receivables. If there is a deterioration of a major customer’s financial condition, if the Company becomes aware of additional information related to the credit worthiness of a major customer, or if future actual default rates on trade receivables in general differ from those currently anticipated, the Company may have to adjust its allowance for doubtful accounts, which would affect earnings in the period the adjustments are made.

 

Inventory Valuation and Inventory Purchase Commitments

The Company must order components for its products and build inventory in advance of product shipments. The Company records a write-down for inventories of components and products, including third-party products held for resale, which have become obsolete or are in excess of anticipated demand or net realizable value. The Company performs a detailed review of inventory each period that considers multiple factors including demand forecasts, product life cycle status, product development plans, current sales levels, and component cost trends. The personal computer and consumer electronic industries are subject to a rapid and unpredictable pace of product and component obsolescence and demand changes. If future demand or market conditions for the Company’s products are less favorable than forecasted or if unforeseen technological changes negatively impact the utility of component inventory, the Company may be required to record additional write-downs which would negatively affect gross margins in the period when the write-downs are recorded.

 

The Company accrues necessary reserves for cancellation fees related to component orders that have been cancelled. Consistent with industry practice, the Company acquires components through a combination of purchase orders, supplier contracts, and open orders based on projected demand information. These commitments typically cover the Company’s requirements for periods ranging from 30 to 130 days. If there is an abrupt and substantial decline in demand for one or more of the Company’s products or an unanticipated change in technological requirements for any of the Company’s products, the Company may be required to record additional reserves for cancellation fees that would negatively affect gross margins in the period when the cancellation fees are identified.

 

Valuation of Long-Lived Assets Including Acquired Intangibles

The Company reviews property, plant, and equipment and certain identifiable intangible assets for impairment when events or changes in circumstances indicate the carrying amount of such an asset may not be recoverable.

 

22



 

Recoverability of these assets is measured by comparison of their carrying amount to future undiscounted cash flows the assets are expected to generate. If such assets are considered to be impaired, the impairment to be recognized in earnings equals the amount by which the carrying value of the assets exceeds their fair market value. Although the Company has recognized no material impairment adjustments related to its property, plant, and equipment or identifiable intangibles during the past two fiscal years, except those made in conjunction with restructuring actions, deterioration in the Company’s business in a geographic region or business segment in the future, including deterioration in the performance of individual retail stores, could lead to such impairment adjustments in future periods in which such business issues are identified.

 

In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, the Company performs a review of goodwill for impairment annually, or earlier if indicators of potential impairment exist. The review of goodwill for potential impairment is subjective and requires that: (1) goodwill be allocated to various reporting units of the Company’s business to which it relates; (2) the Company estimate the fair value of those reporting units to which the goodwill relates; and (3) the Company determine the book value of those reporting units. If the estimated fair value of reporting units with allocated goodwill is determined to be less than their book value, the Company is required to estimate the fair value of all identifiable assets and liabilities of those reporting units in a manner similar to a purchase price allocation for an acquired business. This requires independent valuation of certain internally developed and unrecognized assets including in-process research and development and developed technology. Once this process is complete, the amount of goodwill impairment, if any, can be determined.

 

Based on the Company’s estimates as of March 26, 2005 there was no impairment of goodwill. However, changes in various circumstances including changes in the Company’s market capitalization, changes in the Company’s forecasts, and changes in the Company’s internal business structure could cause one or more of the Company’s reporting units to be valued differently thereby causing an impairment of goodwill. Additionally, in response to changes in the personal computer and consumer electronics industries and changes in global or regional economic conditions, the Company may strategically realign its resources and consider restructuring, disposing, or otherwise exiting businesses, which could result in an impairment of property, plant, and equipment, identifiable intangibles, or goodwill.

 

Warranty Costs

The Company provides currently for the estimated cost for product warranties at the time the related revenue is recognized based on historical and projected warranty claim rates, historical and projected cost-per-claim, and knowledge of specific product failures that are outside of the Company’s typical experience. Each quarter, the Company reevaluates its estimates to assess the adequacy of its recorded warranty liabilities considering the size of the installed base of products subject to warranty protection, and adjusts the amounts as necessary.  If actual product failure rates or repair costs differ from estimates, revisions to the estimated warranty liability would be required and could negatively affect the Company’s results of operations.

 

Income Taxes

The Company records a tax provision for the anticipated tax consequences of the reported results of operations. In accordance with SFAS No. 109, Accounting for Income Taxes, the provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards.  Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled. The Company records a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized.  The Company is currently evaluating the repatriation provisions of the American Jobs Creation Act of 2004, which, if implemented by the Company, would affect the Company’s tax provision and deferred tax assets and liabilities.

 

Management believes it is more likely than not that forecasted income, including income that may be generated as a result of certain tax planning strategies, together with the tax effects of the deferred tax liabilities, will be sufficient to fully recover the remaining deferred tax assets.  In the event that all or part of the net deferred tax assets are determined not to be realizable in the future, an adjustment to the valuation allowance would be charged to earnings in the period such determination is made.  Similarly, if the Company subsequently realizes deferred tax assets that were previously determined to be unrealizable, the respective valuation allowance would be reversed, resulting in a positive adjustment to earnings or a decrease in goodwill in the period such determination is made.  In addition, the

 

23



 

calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws.  Resolution of these uncertainties in a manner inconsistent with management’s expectations could have a material impact on the Company’s results of operations and financial position.

 

Products

The Company offers a range of personal computing products including desktop and notebook personal computers, related devices and peripherals, and various third-party hardware products.  In addition, the Company offers software products including Mac OS® X, the Company’s proprietary operating system software for the Macintosh®; server software and related solutions; professional application software; and consumer, education and business oriented application software. The Company also designs, develops and markets to Macintosh and Windows users its line of iPod® digital music players along with related accessories and services including the online distribution of third-party music through the Company’s iTunes Music Store®. A detailed discussion of the Company’s products may be found in the 2004 Form 10-K.  Certain newly introduced products and/or upgrades to existing products are discussed below.

 

Mac® mini

In January 2005, the Company introduced Mac mini, a Mac computer without a display, keyboard, or mouse, with a starting price of $499 and weighing as little as 2.9 pounds.  Mac mini is available in two models, one containing a 1.25 GHz PowerPC G4 processor and a 40GB hard drive, and one containing a 1.42 GHz PowerPC G4 processor and an 80GB hard drive.  Both models include ATI Radeon 9200 graphics with 32MB of dedicated DDR memory and a slot-load Combo drive for watching DVD movies and burning CDs.  Mac mini includes one FireWire® 400 and two USB 2.0 ports, and a DVI interface that also supports VGA so consumers can connect to LCD or CRT displays. The Mac mini includes built-in 10/100BASE-T Ethernet and a 56K V.92 modem for Internet access, and offers optional support for an AirPort® Extreme Card for 54 Mbps 802.11g wireless networking along with an internal Bluetooth module for the latest in wireless communications.

 

iPod® shuffle

In January 2005, the Company introduced iPod® shuffle, a flash-memory digital music player, which is based on iPod’s shuffle feature that randomly selects songs from the user’s music library or playlists.  iPod shuffle works with iTunes® and its new patent-pending AutoFill feature that automatically selects songs to fill iPod shuffle from a user’s music library on their computer.  iPod shuffle can also be used as a portable USB flash drive with up to 1GB of storage space.  It is available in a 512MB model holding up to 120 songs and a 1GB model holding up to 240 songs.

 

iTunes Music Store®

The Company introduced the iTunes Music Store in Canada in December 2004, and in Ireland in January 2005.  The iTunes Music Store now serves customers in a total of 15 countries in North America and Europe.

 

iLife® ‘05

In January 2005, the Company introduced iLife ‘05, an upgrade to its digital lifestyle suite, which features major new versions of iPhoto™, iMovie®, iDVD® and GarageBand™ and includes the latest version of iTunes®.

 

iPhoto® 5 is the Company’s consumer-oriented digital photo software application.  iPhoto 5 includes advanced editing tools, adds support for uncompressed RAW photos throughout the application and includes a new slideshow builder, which allows users to apply effects, transitions and durations to each individual slide. iPhoto 5 features a new way to create hardcover and softcover photo books and includes new book layouts, double-sided printing, and online book ordering from within iPhoto 5.

 

iMovie® HD, a consumer-oriented digital video editing software application, enables users to import and edit digital videos on their Mac. iMovie HD now allows users to capture and edit High Definition Video (HDV) from HDV camcorders. iMovie HD also includes Magic iMovie, which automatically imports the video into separate clips, adds titles, transitions and music. iMovie HD imports video from HDV and standard DV camcorders, and from video cameras that generate MPEG-4 video.

 

iDVD® is a consumer-oriented software application that enables users to turn iMovie files, QuickTime® files

 

24



 

and digital pictures into DVDs that can be played on most consumer DVD players. iDVD 5 includes 15 new themes featuring moving drop zones that can display video clips or photos in motion across DVD menus.  iDVD 5 also features OneStep DVD, which automatically creates a DVD from footage from a user’s camcorder. With a compatible SuperDrive™, iDVD 5 now supports all single-sided DVD formats.

 

GarageBand™ is a consumer-oriented music creation software application. GarageBand 2 adds 8-track recording so that users can record multiple instruments at once, plus pitch and timing correction to fix tracks. GarageBand 2 now displays and edits musical notation in real time for people who know how to read and write music or want to learn. With GarageBand Jam Packs, including the latest, Jam Pack 4: Symphony Orchestra, GarageBand users can create music in their favorite genre.

 

iLife ‘05 also includes iTunes 4.7.1, the latest version of the Company’s digital music jukebox software application that allows users to purchase music from the Company’s iTunes Music Store. iTunes organizes music using searching, browsing and playlists, and also includes features such as iMix playlist sharing and provides integration with the complete family of iPods, including the new iPod shuffle.

 

iWork 05

In January 2005, the Company introduced iWork ‘05, productivity software designed to take advantage of both Mac OS X and iLife ‘05 to help users create, present and publish documents and presentations. iWork ‘05 introduces Pages™, a new word processor, and also features Keynote™ 2, a new version of the Company’s presentation software.

 

Pages™ gives users the tools to create letters, newsletters, reports, brochures and resumes with advanced typography, multiple columns, footnotes, tables of content and styles. With features like text wrapping and alignment guides, Pages lets users create free-form arrangements of text, graphics, photos, tables and charts. An integrated iLife media browser lets users drag and drop photos from the iPhoto library directly into documents.

 

Keynote™ 2 is the Company’s presentation software that gives users the ability to create presentations, portfolios, interactive slideshows and storyboards. Keynote 2 contains slide animations to synchronize the movement of multiple objects and cinematic real-time animated text. The iLife media browser within Keynote allows users to insert photos, movies and music directly into presentations and with image masking, users can frame the exact part of the photo they want to display. Keynote 2 can also work with a second monitor to display upcoming slides, notes and a timer.

 

Final Cut® Express HD

In January 2005, the Company announced Final Cut Express HD, an update to Final Cut Express, which began shipping in February 2005. This version enables users to capture, edit and output HDV over a single FireWire cable, without requiring any additional software or hardware. Final Cut Express HD supports Digital Cinema Desktop and includes sound editing tools including 99 audio tracks, real-time volume and audio filter adjustment and a voice-over tool. Final Cut Express HD includes LiveType™, which can add HD-quality animated text and motion graphics to videos.  Final Cut Express HD also includes Soundtrack, music creation software that allows users to compose musical scores for their video.

 

Final Cut® Studio

In April 2005, the Company announced Final Cut Studio, a HD video production suite that features Final Cut Pro® 5, an upgrade to the editing software for DV, SD, HD and film. Final Cut Studio also includes tools that complement Final Cut Pro 5 such as Soundtrack® Pro, a new application that gives audio and video professionals a way to create, control and fix audio; Motion 2, an upgrade that now allows real-time motion graphics with GPU accelerated 32-bit float rendering; and DVD Studio Pro® 4, DVD authoring software that burns high definition DVDs to the latest HD DVD specification.  These components of Final Cut Studio will also be sold separately.

 

Shake® 4

In April 2005, the Company announced Shake 4, an upgrade to the Company’s compositing software. Used by artists and visual effects facilities to create visual effects for film and television, Shake 4 features 3D multi-plane compositing, optical flow image processing and integration with Final Cut Pro 5.

 

25



 

Mac OS® X Tiger

In April 2005, the Company began shipping Mac OS X version 10.4 (code named “Tiger”), the Company’s fifth major version of Mac OS X.  Tiger incorporates more than 200 new features and innovations including Spotlight™, a desktop search technology that lets users find items stored on their Mac, including documents, emails, contacts and images; and Dashboard, a new way to instantly access information such as weather forecasts and stock quotes, using a new class of applications called widgets.  The server version of the Mac OS operating system, Mac OS X Tiger Server, also began shipping in April 2005.

 

26



 

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

 

Six Months Ended

 

 

 

3/26/05

 

3/27/04

 

Change

 

3/26/05

 

3/27/04

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Sales by Operating Segment:

 

 

 

 

 

 

 

 

 

 

 

 

 

Americas net sales

 

$

1,443

 

$

881

 

64

%

$

3,080

 

$

1,805

 

71

%

Europe net sales

 

705

 

449

 

57

%

1,552

 

968

 

60

%

Japan net sales

 

284

 

173

 

64

%

469

 

330

 

42

%

Retail net sales

 

571

 

266

 

115

%

1,132

 

539

 

110

%

Other segments net sales (a)

 

240

 

140

 

71

%

500

 

273

 

83

%

Total net sales

 

$

3,243

 

$

1,909

 

70

%

$

6,733

 

$

3,915

 

72

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unit Sales by Operating Segment:

 

 

 

 

 

 

 

 

 

 

 

 

 

Americas Macintosh unit sales

 

477

 

361

 

32

%

953

 

739

 

29

%

Europe Macintosh unit sales

 

276

 

187

 

48

%

596

 

427

 

40

%

Japan Macintosh unit sales

 

102

 

76

 

34

%

166

 

153

 

8

%

Retail Macintosh unit sales

 

144

 

70

 

106

%

263

 

143

 

84

%

Other segments Macintosh unit sales (a)

 

71

 

55

 

29

%

138

 

116

 

19

%

Total Macintosh unit sales

 

1,070

 

749

 

43

%

2,116

 

1,578

 

34

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Sales by Product:

 

 

 

 

 

 

 

 

 

 

 

 

 

Power Macintosh net sales (b)

 

$

320

 

$

349

 

(8

)%

$

701

 

$

747

 

(6

)%

PowerBook net sales

 

413

 

336

 

23

%

720

 

735

 

(2

)%

iMac net sales (c)

 

483

 

252

 

92

%

1,103

 

503

 

119

%

iBook net sales

 

278

 

223

 

25

%

575

 

444

 

30

%

Total Macintosh net sales

 

1,494

 

1,160

 

29

%

3,099

 

2,429

 

28

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

iPod

 

1,014

 

264

 

284

%

2,225

 

520

 

328

%

Other music products (d)

 

216

 

60

 

260

%

393

 

107

 

267

%

Peripherals and other hardware (e)

 

280

 

238

 

18

%

564

 

460

 

23

%

Software (f)

 

134

 

127

 

6

%

251

 

276

 

(9

)%

Service and other sales

 

105

 

60

 

75

%

201

 

123

 

63

%

Total net sales

 

$

3,243

 

$

1,909

 

70

%

$

6,733

 

$

3,915

 

72

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unit Sales by Product:

 

 

 

 

 

 

 

 

 

 

 

 

 

Power Macintosh unit sales (b)

 

141

 

174

 

(19

)%

308

 

380

 

(19

)%

PowerBook unit sales

 

211

 

157

 

34

%

363

 

352

 

3

%

iMac unit sales (c)

 

467

 

217

 

115

%

923

 

444

 

108

%

iBook unit sales

 

251

 

201

 

25

%

522

 

402

 

30

%

Total Macintosh unit sales

 

1,070

 

749

 

43

%

2,116

 

1,578

 

34

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

iPod unit sales

 

5,311

 

807

 

558

%

9,891

 

1,540

 

542

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales per Macintosh unit sold (g)

 

$

1,396

 

$

1,549

 

(10

)%

$

1,465

 

$

1,539

 

(5

)%

 


Notes:

(a)          Other Segments include Asia Pacific and FileMaker.

(b)         Includes Xserve product line.

(c)          Includes eMac and Mac mini product lines.

(d)         Other music products consists of iTunes Music Store sales, iPod-related services, and Apple-branded and third-party iPod-related accessories.

(e)          Net sales of Peripherals and other hardware include sales of Apple-branded and third-party displays, wireless connectivity and networking solutions, and other hardware accessories.

(f)            Net sales of Software include sales of Apple-branded operating system and application software and sales of third-party software.

(g)         Net sales per Macintosh unit sold is derived by dividing total Macintosh net sales by total Macintosh unit sales.

 

27



 

Net sales during the second quarter of 2005 increased 70% or $1.334 billion from the same quarter in 2004, and were up 72% or $2.818 billion for the first six months of fiscal 2005 compared to the same period of fiscal 2004.  Several factors contributed to these increases including:

 

                  Net sales of iPods increased $750 million, or 284% during the second quarter of 2005 compared to the same period in 2004, and increased $1.705 billion or 328% in the first half of 2005.  Unit sales of iPods totaled 5.3 million during the second quarter of 2005, which represents an increase of 558% from the 807,000 units sold in the second quarter of 2004.  For the first six months of 2005, iPod unit sales increased 542% to 9.9 million units sold compared to 1.5 million units sold in the prior year. Since introduction of the iPod product line in fiscal 2002, the Company has sold in excess of 15 million iPods. Strong iPod demand for the quarter and first six months continued to be experienced in all of the Company’s operating segments.  These results were driven by several factors, including strong sales of the new iPod shuffle in January 2005, the release of the new iPod mini in February 2005, price reductions associated with both iPod photo and iPod mini in the second quarter of 2005, and expansion of the iPod’s distribution network during the first six months of 2005.

 

                  Other music products consist of sales associated with the iTunes Music Store and iPod related services and accessories.  Net sales of other music products increased 260% to $216 million in the second quarter of 2005 compared to the same period in 2004.  A similar increase of 267% in net sales of other music products was experienced for the first half of 2005 compared to the first half of 2004.  The Company has experienced strong growth in sales of iPod services and accessories resulting from the increase in overall iPod unit sales for both the second quarter and first half of 2005. Likewise, the iTunes Music Store has experienced strong growth in sales in both the second quarter and first half of 2005 as a result of substantial growth in sales in the U.S. and expansion to Europe and Canada.

 

                  Total Macintosh net sales increased by 29% and 28% during the second quarter and first six months of 2005 compared with the same periods in 2004.  Unit sales during the second quarter and first half of 2005 also reflected increases of 43% and 34%, respectively, compared to the same period in the prior year.   These increases in net sales and unit sales relate primarily to strong demand for the Company’s consumer-oriented iMac and iBook products, offset by a slight decline in Power Macintosh net sales.  Net sales of consumer-oriented products increased 60% and 77% for the three and six months ended March 26, 2005, respectively, compared to the same periods in 2004.  Unit sales showed increases of approximately 71% for both the second quarter and first half of 2005 compared to the same period in the prior year. These increases are largely attributable to the introduction of the Mac mini in January 2005, the iMac G5 at the end of fiscal 2004 and the upgrade of the iBook in October 2004.  In addition, PowerBook net sales increased 23% in the second quarter of 2005 compared with the same period in 2004, primarily as a result of a refresh and a simultaneous price drop to the PowerBook product line in the second quarter of 2005.  The Company also believes that a shift in customer preference from desktop systems to portable systems continues. Net sales per Macintosh unit sold during the second quarter of 2005 decreased 10% to $1,396 compared to the same quarter in 2004, and decreased 5% to $1,465 during the first six months of 2005 from $1,539 in 2004.  These decreases were the result of changes in overall unit mix towards relatively lower-priced consumer products, specifically the impact of the new Mac mini product, partially offset by an increase in direct sales.

 

                  The Retail segment’s net sales grew 115% to $571 million during the second quarter of 2005 and grew by 110% to $1.132 billion in the first half of 2005 compared to the same periods in the prior year.  These increases are largely attributable to the increase in total stores from 78 at the end of the second quarter of 2004 to 103 as of March 26, 2005, as well as a 60% year-over-year increase in average revenue per store. While the Company’s customers in areas where the Retail segment has opened stores may elect to purchase from the Retail segment stores rather than the Company’s preexisting sales channels in the U.S., Japan, and the U.K., the Company believes that a substantial portion of the Retail segment’s net sales is incremental to the Company’s total net sales. See additional comments below related to the Retail segment under the heading “Segment Operating Performance.”

 

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