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 April 1, 2006

 

 

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: 000-10030

 


 

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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

 

Large accelerated filer  ý

Accelerated filer  o

Non-accelerated filer  o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

 

 

Yes  o

No  ý

 

 

850,508,144 shares of common stock issued and outstanding as of April 26, 2006

 

 



 

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

 

 

 

April 1, 
2006

 

March 26, 
2005

 

April 1, 
2006

 

March 26, 
2005

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

4,359

 

$

3,243

 

$

10,108

 

$

6,733

 

Cost of sales (1)

 

3,062

 

2,275

 

7,247

 

4,769

 

Gross margin

 

1,297

 

968

 

2,861

 

1,964

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development (1)

 

176

 

119

 

358

 

242

 

Selling, general, and administrative (1)

 

592

 

447

 

1,224

 

917

 

 

 

 

 

 

 

 

 

 

 

Total operating expenses

 

768

 

566

 

1,582

 

1,159

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

529

 

402

 

1,279

 

805

 

 

 

 

 

 

 

 

 

 

 

Other income and expense

 

76

 

33

 

157

 

59

 

 

 

 

 

 

 

 

 

 

 

Income before provision for income taxes

 

605

 

435

 

1,436

 

864

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

195

 

145

 

461

 

279

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

410

 

$

290

 

$

975

 

$

585

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.49

 

$

0.36

 

$

1.17

 

$

0.73

 

Diluted

 

$

0.47

 

$

0.34

 

$

1.11

 

$

0.69

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

Basic

 

840,910

 

808,172

 

835,658

 

798,602

 

Diluted

 

878,537

 

857,011

 

875,725

 

848,553

 

 


 

 

Three Months Ended

 

Six Months Ended

 

 

 

April 1,
2006

 

March 26,
2005

 

April 1,
2006

 

March 26,
2005

 

(1) Stock-based compensation expense was allocated as follows:

 

 

 

 

 

 

 

 

 

Cost of sales

 

$

5

 

$

1

 

$

10

 

$

1

 

Research and development

 

$

13

 

$

1

 

$

28

 

$

3

 

Selling, general, and administrative

 

$

24

 

$

8

 

$

48

 

$

16

 

 

See accompanying notes to condensed consolidated financial statements.

 

2



 

APPLE COMPUTER, INC.

 

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(in millions, except share amounts)

 

 

 

April 1, 2006

 

September 24, 2005

 

 

 

 

 

 

 

ASSETS:

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

6,346

 

$

3,491

 

Short-term investments

 

1,880

 

4,770

 

Accounts receivable, less allowances of $48 and $46, respectively

 

861

 

895

 

Inventories

 

204

 

165

 

Deferred tax assets

 

459

 

331

 

Other current assets

 

1,536

 

648

 

Total current assets

 

11,286

 

10,300

 

Property, plant and equipment, net

 

1,005

 

817

 

Goodwill

 

69

 

69

 

Acquired intangible assets, net

 

41

 

27

 

Other assets

 

1,510

 

338

 

Total assets

 

$

13,911

 

$

11,551

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY:

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

2,108

 

$

1,779

 

Accrued expenses

 

2,348

 

1,705

 

Total current liabilities

 

4,456

 

3,484

 

Non-current liabilities

 

773

 

601

 

Total liabilities

 

5,229

 

4,085

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, no par value; 1,800,000,000 shares authorized; 849,188,157 and 835,019,364 shares issued and outstanding, respectively

 

4,014

 

3,521

 

Deferred stock compensation

 

 

(60

)

Retained earnings

 

4,673

 

4,005

 

Accumulated other comprehensive income (loss)

 

(5

)

 

Total shareholders’ equity

 

8,682

 

7,466

 

Total liabilities and shareholders’ equity

 

$

13,911

 

$

11,551

 

 

See accompanying notes to condensed consolidated financial statements.

 

3



 

APPLE COMPUTER, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(in millions)

 

 

 

Six Months Ended

 

 

 

April 1, 2006

 

March 26, 2005

 

 

 

 

 

 

 

Cash and cash equivalents, beginning of the period

 

$

3,491

 

$

2,969

 

 

 

 

 

 

 

Operating Activities:

 

 

 

 

 

Net income

 

975

 

585

 

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

 

 

 

 

 

Depreciation, amortization, and accretion

 

102

 

82

 

Stock-based compensation expense

 

86

 

20

 

Provision for deferred income taxes

 

83

 

13

 

Excess tax benefits from stock options

 

 

275

 

Loss on disposition of property, plant, and equipment

 

3

 

4

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

34

 

(114

)

Inventories

 

(39

)

(63

)

Other current assets

 

(892

)

(116

)

Other assets

 

(1,195

)

(56

)

Accounts payable

 

329

 

322

 

Other liabilities

 

672

 

359

 

Cash generated by operating activities

 

158

 

1,311

 

Investing Activities:

 

 

 

 

 

Purchases of short-term investments

 

(3,792

)

(5,304

)

Proceeds from maturities of short-term investments

 

6,683

 

2,750

 

Proceeds from sales of short-term investments

 

 

242

 

Purchases of property, plant, and equipment

 

(275

)

(101

)

Other

 

(61

)

(19

)

Cash generated by (used for) investing activities

 

2,555

 

(2,432

)

Financing Activities:

 

 

 

 

 

Proceeds from issuance of common stock

 

212

 

406

 

Excess tax benefits from stock-based compensation

 

283

 

 

Repurchases of common stock

 

(353

)

 

Cash generated by financing activities

 

142

 

406

 

Increase (decrease) in cash and cash equivalents

 

2,855

 

(715

)

Cash and cash equivalents, end of the period

 

$

6,346

 

$

2,254

 

 

 

 

 

 

 

Supplemental cash flow disclosure:

 

 

 

 

 

 

 

 

 

 

 

Cash paid for income taxes, net

 

$

84

 

$

47

 

 

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, audio books, music videos, short films, and television shows. 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. Certain prior year amounts in the consolidated financial statements and notes thereto have been reclassified to conform to the current year 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 24, 2005, included in its Annual Report on Form 10-K (the 2005 Form 10-K).

 

The Company’s fiscal year is the 52 or 53-week period that ends on the last Saturday of September. The Company’s first quarter of fiscal year 2006 contained 14 weeks and the first quarter of its fiscal year 2005 contained 13 weeks. The Company’s fiscal year 2006 will end on September 30, 2006 and include 53 weeks while fiscal year 2005 included 52 weeks. 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.

 

Software Development Costs

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 Mac OS X version 10.4 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. During the first and second quarters of 2005, the Company capitalized approximately $14.8 million and $14.7 million, respectively, of costs associated with the development of Tiger. In accordance with SFAS No. 86, amortization of this asset to cost of sales began in April 2005 when the Company began shipping Tiger and is being recognized on a straight-line basis over a three-year estimated useful life.

 

Stock-Based Compensation

On September 25, 2005, the Company adopted SFAS No. 123 (revised 2004) (SFAS No. 123R), Share-Based Payment, which addresses the accounting for stock-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. In January 2005, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 107,

 

5



 

which provides supplemental implementation guidance for SFAS No. 123R. SFAS No. 123R eliminates the ability to account for stock-based compensation transactions using the intrinsic value method under Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and instead generally requires that such transactions be accounted for using a fair-value-based method. The Company uses the Black-Scholes-Merton (“BSM”) option-pricing model to determine the fair-value of stock-based awards under SFAS No. 123R, consistent with that used for pro forma disclosures under SFAS No. 123, Accounting for Stock-Based Compensation. The Company has elected the modified prospective transition method as permitted by SFAS No. 123R and accordingly prior periods have not been restated to reflect the impact of SFAS No. 123R. The modified prospective transition method requires that stock-based compensation expense be recorded for all new and unvested stock options, restricted stock, restricted stock units, and employee stock purchase plan shares that are ultimately expected to vest as the requisite service is rendered beginning on September 25, 2005, the first day of the Company’s fiscal year 2006. Stock-based compensation expense for awards granted prior to September 25, 2005 is based on the grant date fair-value as determined under the pro forma provisions of SFAS No. 123. The Company recorded incremental stock-based compensation expense of $26 million and $58 million during the second quarter and first six months of 2006, respectively, as a result of the adoption of SFAS No. 123R. In accordance with SFAS No. 123R, beginning in the first quarter of 2006 the Company has presented excess tax benefits from the exercise of stock-based compensation awards as a financing activity in the condensed consolidated statement of cash flows.

 

No stock-based compensation costs were capitalized as part of the cost of an asset as of April 1, 2006. The income tax benefit related to stock-based compensation expense was $12 million and $26 million for the three and six-month periods ended April 1, 2006, respectively. As of April 1, 2006, $400 million of total unrecognized compensation cost related to stock options and restricted stock units is expected to be recognized over a weighted-average period of 2.55 years.

 

Prior to the adoption of SFAS No. 123R, the Company measured compensation expense for its employee stock-based compensation plans using the intrinsic value method prescribed by APB Opinion No. 25. The Company applied the disclosure provisions of SFAS No. 123 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 was equal to the market price of the underlying stock on the date of the grant, no compensation expense was recognized.

 

The following table illustrates the effect on net income after taxes and net income per common share as if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based compensation during the three and six-month periods ended March 26, 2005 (in millions, except per share amounts):

 

 

 

Three Months
Ended

 

Six Months 
Ended

 

 

 

3/26/05

 

3/26/05

 

 

 

 

 

 

 

Net income - as reported

 

$

290

 

$

585

 

 

 

 

 

 

 

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

 

9

 

18

 

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

 

(27

)

(56

)

 

 

 

 

 

 

Net income - pro forma

 

$

272

 

$

547

 

 

 

 

 

 

 

Net income per common share - as reported

 

 

 

 

 

Basic

 

$

0.36

 

$

0.73

 

Diluted

 

$

0.34

 

$

0.69

 

 

 

 

 

 

 

Net income per common share - pro forma

 

 

 

 

 

Basic

 

$

0.34

 

$

0.68

 

Diluted

 

$

0.32

 

$

0.64

 

 

6



 

Further information regarding stock-based compensation can be found in Note 6 of these Notes to Condensed Consolidated Financial Statements.

 

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

 

 

 

4/1/06

 

3/26/05

 

4/1/06

 

3/26/05

 

 

 

 

 

 

 

 

 

 

 

Numerator (in millions):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

410

 

$

290

 

$

975

 

$

585

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted-average shares outstanding, excluding unvested restricted stock

 

840,910

 

808,172

 

835,658

 

798,602

 

Effect of dilutive options, restricted stock units, and restricted stock

 

37,627

 

48,839

 

40,067

 

49,951

 

 

 

 

 

 

 

 

 

 

 

Denominator for diluted earnings per share

 

878,537

 

857,011

 

875,725

 

848,553

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.49

 

$

0.36

 

$

1.17

 

$

0.73

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share

 

$

0.47

 

$

0.34

 

$

1.11

 

$

0.69

 

 

Potentially dilutive securities representing approximately 1.5 million and 0.9 million shares of common stock for the quarters ended April 1, 2006 and March 26, 2005, respectively, and 3.3 million and 1.1 million shares of common stock for the six months ended April 1, 2006 and March 26, 2005, respectively, were excluded from the computation of diluted earnings per share for these periods because their effect would have been antidilutive. Potentially dilutive securities include stock options, restricted stock units, and restricted stock.

 

7



 

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 April 1, 2006, and September 24, 2005 (in millions):

 

 

 

4/1/06

 

9/24/05

 

 

 

 

 

 

 

Cash

 

$

477

 

$

127

 

 

 

 

 

 

 

U.S. Treasury and Agency securities

 

35

 

89

 

U.S. corporate securities

 

3,600

 

2,030

 

Foreign securities

 

2,234

 

1,245

 

Total cash equivalents

 

5,869

 

3,364

 

 

 

 

 

 

 

U.S. Treasury and Agency securities

 

437

 

216

 

U.S. corporate securities

 

1,232

 

3,662

 

Foreign securities

 

211

 

892

 

Total short-term investments

 

1,880

 

4,770

 

 

 

 

 

 

 

Total cash, cash equivalents, and short-term investments

 

$

8,226

 

$

8,261

 

 

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 totaling $5.3 million on its investment portfolio, the majority of which related to investments with stated maturities less than one year as of April 1, 2006, and net unrealized losses of $5.9 million on its investment portfolio, approximately half of which related to investments with stated maturities less than one year as of September 24, 2005.

 

As of April 1, 2006 and September 24, 2005, approximately $76 million and $287 million, respectively, of the Company’s short-term investments had underlying maturities ranging from 1 to 5 years. The remaining short-term investments had maturities of 3 to 12 months.

 

The following table shows the gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and the length of time that individual securities have been in a continuous unrealized loss position at April 1, 2006 (in millions):

 

 

 

Less than 12 Months

 

12 Months or Greater

 

Total

 

Security Description

 

Fair Value

 

Unrealized 
Loss

 

Fair 
Value

 

Unrealized 
Loss

 

Fair 
Value

 

Unrealized 
Loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury and Agency Securities

 

$

390

 

$

(1

)

$

52

 

$

 

$

442

 

$

(1

)

U.S. corporate securities

 

2,582

 

(2

)

201

 

(2

)

2,783

 

(4

)

Foreign securities

 

777

 

 

29

 

(1

)

806

 

(1

)

Total

 

$

3,749

 

$

(3

)

$

282

 

$

(3

)

$

4,031

 

$

(6

)

 

The unrealized losses on the Company’s investments in U.S. Treasury and Agency securities, U.S. corporate securities, and foreign securities were caused primarily by changes in interest rates. The Company typically invests in highly rated securities with low probabilities of default. The Company’s investment policy requires investments to be rated single-A or better. Therefore, the Company considers the declines to be temporary in nature. As of April 1, 2006, the Company does not consider the investments to be other-than-temporarily impaired.

 

Market values were determined for each individual security in the investment portfolio. When evaluating the investments, the Company reviews factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer, and the Company’s ability and intent to hold the investment for a period of time which may be sufficient for anticipated recovery in market value.

 

8



 

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. The Company records all derivatives on the balance sheet at fair value. Derivatives that are not hedges are adjusted to fair value through earnings. 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 April 1, 2006, the Company had a net deferred gain associated with cash flow hedges of approximately $1 million net of taxes, substantially all of which is expected to be reclassified to earnings by the end of the fourth quarter of fiscal 2006. As of the end of the second quarter of 2006, 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 2005.

 

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 firm commitments, forecasted future cash flows, and net investments in foreign subsidiaries. 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.

 

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

 

Other Current Assets

 

 

 

4/1/06

 

9/24/05

 

Vendor non-trade receivables

 

$

1,123

 

$

417

 

NAND flash memory prepayments

 

97

 

 

Other current assets

 

316

 

231

 

 

 

 

 

 

 

Total other current assets

 

$

1,536

 

$

648

 

 

Property, Plant, and Equipment, Net

 

 

 

4/1/06

 

9/24/05

 

Land and buildings

 

$

485

 

$

361

 

Machinery, equipment, and internal-use software

 

525

 

470

 

Office furniture and equipment

 

87

 

81

 

Leasehold improvements

 

634

 

569

 

 

 

1,731

 

1,481

 

 

 

 

 

 

 

Accumulated depreciation and amortization

 

(726

)

(664

)

 

 

 

 

 

 

Total property, plant, and equipment, net

 

$

1,005

 

$

817

 

 

Other Assets

 

 

 

4/1/06

 

9/24/05

 

Long-term NAND flash memory prepayments

 

$

1,153

 

$

 

Non-current deferred tax assets

 

134

 

183

 

Capitalized software development costs, net

 

29

 

38

 

Other assets

 

194

 

117

 

 

 

 

 

 

 

Total other assets

 

$

1,510

 

$

338

 

 

9



 

Accrued Expenses

 

 

 

4/1/06

 

9/24/05

 

Deferred revenue - current

 

$

634

 

$

501

 

Accrued marketing and distribution

 

196

 

221

 

Accrued compensation and employee benefits

 

197

 

167

 

Accrued warranty and related costs

 

255

 

188

 

Deferred margin on component sales

 

350

 

26

 

Other current liabilities

 

716

 

602

 

 

 

 

 

 

 

Total accrued expenses

 

$

2,348

 

$

1,705

 

 

Non-Current Liabilities

 

 

 

4/1/06

 

9/24/05

 

Deferred revenue - non-current

 

$

300

 

$

281

 

Deferred tax liabilities

 

460

 

308

 

Other non-current liabilities

 

13

 

12

 

 

 

 

 

 

 

Total non-current liabilities

 

$

773

 

$

601

 

 

Other Income and Expense

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

4/1/06

 

3/26/05

 

4/1/06

 

3/26/05

 

Interest income

 

$

87

 

$

39

 

$

175

 

$

67

 

Other expense, net

 

(11

)

(6

)

(18

)

(8

)

 

 

 

 

 

 

 

 

 

 

Other income and expense

 

$

76

 

$

33

 

$

157

 

$

59

 

 

Note 4 – Restructuring Actions

 

2004 and 2003 Restructuring Actions

The Company recorded total restructuring charges of approximately $23.0 million during 2004, including approximately $14.0 million in severance costs, $5.5 million in asset impairments, and a $3.5 million charge for lease cancellations in conjunction with the vacating of a leased sales facility related to a European workforce reduction during the fourth quarter of 2004. Of the $23.0 million charge, $20.7 million had been utilized by the end of the second quarter of 2006, with the remaining $2.3 million consisting of $0.2 million for employee severance benefits and $2.1 million for lease cancellations. These actions have resulted in the termination of 451 positions.

 

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

 

 

 

Employee

 

 

 

 

 

 

 

 

 

Severance

 

Asset

 

Lease

 

 

 

 

 

Benefits

 

Impairments

 

Cancellations

 

Totals

 

 

 

 

 

 

 

 

 

 

 

Total charge

 

$

14.0

 

$

5.5

 

$

3.5

 

$

23.0

 

Total spending through April 1, 2006

 

(12.5

)

 

(1.4

)

(13.9

)

Total non-cash items

 

 

(5.2

)

 

(5.2

)

Adjustments

 

(1.3

)

(0.3

)

 

(1.6

)

Accrual at April 1, 2006

 

$

0.2

 

$

 

$

2.1

 

$

2.3

 

 

The Company recorded total restructuring charges of approximately $26.8 million during 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 primarily related to the closure of the Company’s Singapore manufacturing operations during the first quarter of 2003. Of the $26.8 million charge, all had been utilized by the end of the second quarter of 2006, except for approximately $1.5 million related to operating lease costs on abandoned facilities.

 

10



 

The following table summarizes activity associated with restructuring actions initiated during 2003 (in millions):

 

 

 

Employee

 

Deferred

 

 

 

 

 

 

 

 

 

Severance

 

Compensation

 

Asset

 

Lease

 

 

 

 

 

Benefits

 

Write-off

 

Impairments

 

Cancellations

 

Totals

 

 

 

 

 

 

 

 

 

 

 

 

 

Total charge

 

$

7.4

 

$

5.0

 

$

7.1

 

$

7.3

 

$

26.8

 

Total spending through April 1, 2006

 

(7.9

)

 

 

(5.3

)

(13.2

)

Total non-cash items

 

 

(5.0

)

(7.1

)

 

(12.1

)

Adjustments

 

0.5

 

 

 

(0.5

)

 

Accrual at April 1, 2006

 

$

 

$

 

$

 

$

1.5

 

$

1.5

 

 

Note 5 – Shareholders’ Equity

 

Preferred Stock

The Company has five 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.

 

Restricted Stock Units

The Company’s Board of Directors has granted restricted stock units to members of the Company’s senior management team, excluding its CEO. These restricted stock units generally vest over four years either at the end of the four-year service period, in two equal installments on the second and fourth anniversaries of the date of grant, or in equal installments on each of the first through fourth anniversaries of the grant date. Upon vesting, the restricted stock units will convert into an equivalent number of shares of common stock. The amounts of the restricted stock units expensed by the Company are based on the closing market price of the Company’s common stock on the date of grant and are amortized on a straight-line basis over the four-year requisite service period. The restricted stock units have been reflected in the calculation of diluted earnings per share utilizing the treasury stock method.

 

During the second quarter of 2006, 2.4 million of previously granted restricted stock units vested. A majority of these vested restricted stock units were net-share settled such that the Company withheld shares with value equivalent to the employees’ minimum statutory obligation for the applicable income and other employment taxes, and remitted the cash to the appropriate taxing authorities. The total shares withheld of 954,079 was based on the value of the restricted stock units on their vesting date as determined by the Company’s closing stock price of $59.96. Total payments for the employees’ tax obligations to the taxing authorities were approximately $57 million. These net-share settlements had the effect of share repurchases by the Company as they reduced and retired the number of shares that would have otherwise been issued as a result of the vesting and did not represent an expense to the Company.

 

CEO Restricted Stock Award

On March 19, 2003, the Company’s Board of Directors granted 10 million shares of restricted stock to the Company’s CEO that vested on March 19, 2006. The amount of the restricted stock award expensed by the Company was based on the closing market price of the Company’s common stock on the date of grant and was amortized on a straight-line basis over the three-year requisite service period.

 

Upon vesting during the second quarter of 2006, the restricted stock award was net-share settled such that the Company withheld shares with value equivalent to the CEO’s minimum statutory obligation for the applicable income and other employment taxes, and remitted the cash to the appropriate taxing authorities. The total shares withheld of 4.6 million was based on the value of the restricted stock award on the vesting date as determined by the Company’s closing stock price of $64.66. The remaining shares net of those withheld were delivered to the Company’s CEO. Total payments for the CEO’s tax obligations to the taxing authorities were approximately $296 million. The net-share settlement had the effect of share repurchases by the Company as they reduced and retired the number of shares outstanding and did not represent an expense to the Company.

 

11



 

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.

 

During the second quarter of 2006, the Company withheld a total of 4.6 million shares of its common stock at a price of $64.66 per share related to the net-share settlement upon vesting of restricted stock to pay the CEO’s minimum statutory obligation for the applicable income and other employment taxes. This share withholding was not part of the Company’s authorized stock repurchase plan. Other than this net-share settlement, the Company has not engaged in any transactions to repurchase its common stock since 2001. The Company has repurchased a total of 13.1 million shares at a cost of $217 million under this plan and was authorized to repurchase up to an additional $283 million of its common stock as of April 1, 2006.

 

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 U.S. 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 April 1, 2006 and March 26, 2005 (in millions):

 

 

 

Three 
Months Ended

 

Six 
Months Ended

 

 

 

4/1/06

 

3/26/05

 

4/1/06

 

3/26/05

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

410

 

$

290

 

$

975

 

$

585

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

Net change in unrealized derivative gains/losses

 

(5

)

17

 

(3

)

8

 

Change in foreign currency translation

 

5

 

(7

)

(3

)

15

 

Net change in unrealized investment gains/losses

 

 

(1

)

1

 

(2

)

 

 

 

 

 

 

 

 

 

 

Total comprehensive income

 

$

410

 

$

299

 

$

970

 

$

606

 

 

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

 

 

 

As of 
4/1/06

 

As of 
9/24/05

 

 

 

 

 

 

 

Unrealized gains (losses) on derivative investments

 

$

1

 

$

4

 

Cumulative foreign currency translation

 

(3

)

 

Unrealized losses on available-for-sale securities

 

(3

)

(4

)

Accumulated other comprehensive income (loss)

 

$

(5

)

$

 

 

12



 

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 April 1, 2006 and March 26, 2005 (in millions):

 

 

 

Three 
Months Ended

 

Six 
Months Ended

 

 

 

4/1/06

 

3/26/05

 

4/1/06

 

3/26/05

 

 

 

 

 

 

 

 

 

 

 

Change in fair value of derivatives

 

$

2

 

$

4

 

$

7

 

$

(8

)

Adjustment for net gains (losses) realized and included in net income

 

(7

)

13

 

(10

)

16

 

Change in unrealized derivative gains (losses)

 

$

(5

)

$

17

 

$

(3

)

$

8

 

 

Employee Benefit Plans

 

2003 Employee Stock Option Plan

The 2003 Employee Stock Plan (the 2003 Plan) is a shareholder approved plan that provides for broad-based grants to employees, including executive officers. 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 four 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 four years, based on continued employment, with either annual or quarterly vesting. In October 2003, the Company terminated the 1997 Plan and no new options can be granted from this 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 the date of grant. Based on the terms of individual option grants, options granted under the DSOP generally expire 10 years after the grant date.

 

Rule 10b5-1 Trading Plans

Certain of the Company’s executive officers, including Mr. Timothy D. Cook, Ms. Nancy R. Heinen, Mr. Peter Oppenheimer, Mr. Jonathan Rubinstein, Mr. Philip W. Schiller, Dr. Bertrand Serlet, and Dr. Avadis Tevanian, Jr. (formerly an executive officer), 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.

 

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 one million shares per offering period. As of April 1, 2006, approximately 2.9 million shares were reserved for future issuance under the Purchase Plan.

 

13



 

Stock Award Activity

A summary of the Company’s stock award activity and related information for the six-month periods ended April 1, 2006 and March 26, 2005 (stock award amounts are presented in thousands) is set forth in the following table:

 

 

 

 

 

Outstanding Options

 

 

 

Shares 
Available

 

Number of

 

Weighted- Average

 

 

 

For Grant

 

Shares

 

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 Canceled

 

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 9/24/05

 

58,957

 

73,221

 

$

17.79

 

Options Granted

 

(1,907

)

1,907

 

$

66.32

 

Restricted Stock Units Granted

 

(2,700

)

 

 

Options Canceled

 

1,324

 

(1,324

)

$

25.23

 

Restricted Stock Units Canceled

 

200

 

 

 

Options Exercised

 

 

(16,402

)

$

11.21

 

Plan Shares Expired

 

(69

)

 

 

Vested and Expected to Vest Balance at 4/1/06

 

55,805

 

57,402

 

$

21.11

 

 

The weighted average remaining contractual life of options outstanding and exercisable was 5.16 years and 4.68 years, respectively, as of April 1, 2006. The options outstanding as of April 1, 2006 have been segregated into six ranges for additional disclosure as follows (option amounts are presented in thousands):

 

 

 

Options Outstanding

 

Options Exercisable

 

Range of 
Exercise Prices

 

Options 
Outstanding 
as of 
4/1/06

 

Weighted-
 Average Exercise 
Price

 

Options 
Exercisable 
as of 
4/1/06

 

Weighted-
 Average Exercise 
Price

 

$0.62 - $9.25

 

10,067

 

$

7.90

 

9,151

 

$

7.92

 

$9.26 - $10.73

 

7,461

 

$

10.15

 

6,168

 

$

10.15

 

$10.74 - $10.90

 

10,091

 

$

10.89

 

3,294

 

$

10.89

 

$10.91 - $14.91

 

9,572

 

$

11.75

 

7,973

 

$

11.58

 

$14.92 - $46.10

 

8,157

 

$

28.62

 

3,327

 

$

25.65

 

$46.11 - $84.29

 

12,054

 

$

49.83

 

1,108

 

$

46.73

 

 

 

 

 

 

 

 

 

 

 

$0.62 - $84.29

 

57,402

 

$

21.11

 

31,021

 

$

12.91

 

 

Aggregate intrinsic value of options outstanding and options exercisable at April 1, 2006 was $2.4 billion and $1.5 billion, respectively. Aggregate intrinsic value represents the value of the Company’s closing stock price on the last trading day of the fiscal period in excess of the exercise price multiplied by the number of options outstanding or exercisable. Total intrinsic value of options exercised was $414 million and $887 million for the three and six-month periods ended April 1, 2006, respectively, and $373 million and $767 million for the three and six-month periods ended March 26, 2005, respectively.

 

The Company had 3.98 million restricted stock units with a total grant date fair value of $138 million outstanding, as of April 1, 2006, which were excluded from the options outstanding balances in the preceding tables. Aggregate

 

14



 

intrinsic value of unvested restricted stock units at April 1, 2006 was $250 million. The total fair value of restricted stock units vested during the quarter ended April 1, 2006 was $143.9 million. Granted restricted stock units have been deducted from the shares available for grant under the Company’s stock option plans. In conjunction with the amendments to the 2003 Plan that were approved at the Annual Meeting of Shareholders held on April 21, 2005, the number of shares available for grant under the 2003 Plan will be reduced by two times the number of restricted shares and restricted stock units granted. This amendment is effective for all grants made after April 21, 2005.

 

The total fair value of restricted stock vested during the quarter ended April 1, 2006 was $646.6 million. There were no grants or forfeitures of any restricted stock during the three or six months ended April 1, 2006 and as of April 1, 2006, there was no unvested restricted stock outstanding. For the three and six-month periods ended April 1, 2006, total compensation cost recognized related to restricted stock was $2.3 million and $4.6 million, respectively. For the three and six-month periods ended March 26, 2005, total compensation cost recognized related to the nonvested restricted stock was $6.2 million and $12.5 million, respectively.

 

Note 6 - Stock-Based Compensation

 

SFAS No. 123R requires the use of a valuation model to calculate the fair value of stock-based awards. The Company has elected to use the BSM option-pricing model, which incorporates various assumptions including volatility, expected life, and interest rates. The expected volatility is based on the historical volatility of the Company’s common stock over the most recent period commensurate with the estimated expected life of the Company’s stock options, adjusted for the impact of unusual fluctuations not reasonably expected to recur and other relevant factors including implied volatility in market traded options on the Company’s common stock. The expected life of an award is based on historical experience and on the terms and conditions of the stock awards granted to employees.

 

The weighted average assumptions used for the three and six-month periods ended April 1, 2006 and March 26, 2005 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

 

 

 

4/1/06

 

3/26/05

 

4/1/06

 

3/26/05

 

 

 

 

 

 

 

 

 

 

 

Expected life of stock options

 

3.54 years

 

3.50 years

 

3.58 years

 

3.50 years

 

Expected life of stock purchases

 

6 months

 

6 months

 

6 months

 

6 months

 

Interest rate - stock options

 

4.53

%

3.70

%

4.32

%

3.37

%

Interest rate - stock purchases

 

4.46

%

2.54

%

3.73

%

2.11

%

Volatility - stock options

 

40.80

%

40.00

%

40.74

%

40.00

%

Volatility - stock purchases

 

31.39

%

41.12

%

42.04

%

36.52

%

Expected dividend yields

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average fair value of options granted during the period

 

$

25.62

 

$

13.54

 

$

23.52

 

$

10.94

 

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

 

$

16.82

 

$

7.30

 

$

12.60

 

$

5.53

 

 

Note 7 – 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 15 years and generally provide renewal options for terms of 3 to 5 additional years. Leases for retail space are for terms of 5 to 20 years, the majority of which are for 10 years, and often contain multi-year renewal options. As of September 24, 2005, the Company’s total future minimum lease payments under noncancelable operating leases were $865 million, of which $606 million related to leases for retail space. As of April 1, 2006, total future minimum lease payments related to leases for retail space increased to $782 million.

 

15



 

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 its service parts used to repair the Company’s hardware products. The Company provides currently for the estimated cost that may be incurred under its basic limited product warranties at the time the 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 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 estimates.

 

The following table reconciles changes in the Company’s accrued warranties and related costs for the three and six-month periods ended April 1, 2006 and March 26, 2005 (in millions):

 

 

 

Three 
Months Ended

 

Six 
Months Ended

 

 

 

4/1/06

 

3/26/05

 

4/1/06

 

3/26/05

 

 

 

 

 

 

 

 

 

 

 

Beginning accrued warranty and related costs

 

$

247

 

$

135

 

$

188

 

$

105

 

Cost of warranty claims

 

(74

)

(43

)

(151

)

(77

)

Accruals for product warranties

 

82

 

62

 

218

 

126

 

Ending accrued warranty and related costs

 

$

255

 

$

154

 

$

255

 

$

154

 

 

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 April 1, 2006 or September 24, 2005.

 

Concentrations in the Available Sources of Supply of Materials and Product

Although most components essential to the Company’s business are generally available from multiple sources, other key components (including microprocessors and application-specific integrated circuits (“ASICs”)) are currently obtained by the Company from single or limited sources. Some other key components, while currently available to the Company from multiple sources, are at times subject to industry-wide availability and pricing pressures. In addition, the Company uses some components that are not common to the rest of the personal computer industry, and new products introduced by the Company often initially utilize custom components obtained from only one source until the Company has evaluated whether there is a need for and subsequently qualifies additional suppliers. If the supply of a key single-sourced component to the Company were to be delayed or curtailed, or in the event a key manufacturing vendor delays shipments of completed products to the Company, the Company’s ability to ship related products in desired quantities and in a timely manner could be adversely affected. The Company’s business and financial performance could also be adversely affected depending on the time required to obtain sufficient quantities from the original source, or to identify and obtain sufficient quantities from an alternative source. Continued availability of these components may be affected if producers were to decide to concentrate on the production of common components instead of components customized to meet the Company’s requirements. Finally, significant portions of the Company’s CPUs, logic boards, and assembled products are now manufactured by outsourcing partners, primarily in various parts of Asia. Although the Company works closely with its outsourcing partners on manufacturing schedules, the Company’s operating results could be adversely affected if its outsourcing partners were unable to meet their production obligations.

 

16



 

Long-Term Supply Agreements

During the first quarter of 2006, the Company entered into long-term supply agreements with Hynix Semiconductor, Inc., Intel Corporation, Micron Technology, Inc., Samsung Electronics Co., Ltd., and Toshiba Corporation to secure supply of NAND flash memory through calendar year 2010. As part of these agreements, the Company agreed to prepay $1.25 billion for flash memory components of which $750 million was paid during the first quarter of 2006 and the remaining $500 million was paid during the second quarter of 2006. These prepayments will be applied to inventory purchases made over the life of each respective agreement.

 

Contingencies

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 financial condition, liquidity, or results of operations.

 

Note 8 - 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 Retail segment operates Apple-owned retail stores in the U.S., Canada, 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 2005 Form 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 such as manufacturing costs and variances not included in standard costs, research and development, corporate marketing expenses, stock-based compensation expense, income taxes, various nonrecurring charges, 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 $42 million and

 

17



 

$16 million during the second quarters of 2006 and 2005, respectively, and $82 million and $49 million during the first six months of 2006 and 2005, 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 2006 and 2005, 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 $128 million and $102 million, respectively, and for the first six months of 2006 and 2005, approximately $327 million and $201 million, respectively.

 

Second, the Company’s service and support 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 service and support 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 2006, this resulted in the recognition of net sales and cost of sales by the Retail segment, with corresponding offsets in other operating segments, of $29 million and $20 million, respectively. For the second quarter of 2005, the net sales and cost of sales of extended warranty, support and service contracts recognized by the Retail segment were $21 million and $15 million, respectively. For the first six months of 2006, 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 $67 million and $45 million, respectively. This compares to similar adjustments to net sales and cost of sales during the first six months of 2005 of $41 million and $28 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 April 1, 2006. 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 $7.6 million and $7.1 million in the second quarters of 2006 and 2005, respectively, and $15.2 million and $14.0 million for the first six months of 2006 and 2005, respectively.

 

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Summary information by operating segment is as follows (in millions):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

4/1/06

 

3/26/05

 

4/1/06

 

3/26/05

 

Americas:

 

 

 

 

 

 

 

 

 

Net sales

 

$

2,122

 

$

1,443

 

$

4,822

 

$

3,080

 

Operating income

 

$

390

 

$

185

 

$

826

 

$

387

 

 

 

 

 

 

 

 

 

 

 

Europe:

 

 

 

 

 

 

 

 

 

Net sales

 

$

966

 

$

705

 

$

2,208

 

$

1,552

 

Operating income

 

$

126

 

$

100

 

$

300

 

$

233

 

 

 

 

 

 

 

 

 

 

 

Japan:

 

 

 

 

 

 

 

 

 

Net sales

 

$

309

 

$

284

 

$

664

 

$

469

 

Operating income

 

$

57

 

$

45

 

$

110

 

$

66

 

 

 

 

 

 

 

 

 

 

 

Retail:

 

 

 

 

 

 

 

 

 

Net sales

 

$

636

 

$

571

 

$

1,708

 

$

1,132

 

Operating income

 

$

29

 

$

42

 

$

119

 

$

87

 

 

 

 

 

 

 

 

 

 

 

Other Segments (a):

 

 

 

 

 

 

 

 

 

Net sales

 

$

326

 

$

240

 

$

706

 

$

500

 

Operating income

 

$

61

 

$

25

 

$

127

 

$

62

 

 


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

 

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

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

4/1/06

 

3/26/05

 

4/1/06

 

3/26/05

 

 

 

 

 

 

 

 

 

 

 

Segment operating income

 

$

663

 

$

397

 

$

1,482

 

$

835

 

Retail manufacturing margin (b)

 

128

 

102

 

327

 

201

 

Stock-based compensation expense

 

(42

)

(10

)

(86

)

(20

)

Other corporate expenses, net (c)

 

(220

)

(87

)

(444

)

(211

)

Total operating income

 

$

529

 

$

402

 

$

1,279

 

$

805

 

 


(b)                                 Represents the excess of the Retail segment’s cost of sales over the Company’s standard cost of sales for products sold through the Retail segment.

 

(c)                                  Other 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 9 – 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 did not recognize any expense pursuant to the Reimbursement Agreement during the three and six-month periods ended April 1, 2006. The Company recognized a total of $62,000 and $481,000 in expenses pursuant to the Reimbursement Agreement during the three and six-month periods ended March 26, 2005. All expenses recognized pursuant to the Reimbursement Agreement have been included in selling, general, and administrative expenses in the condensed consolidated statements of operations.

 

In the first quarter of 2006, the Company entered into an agreement with Pixar to sell certain of Pixar’s short films on the iTunes Music Store. Mr. Steven P. Jobs, the Company’s CEO is also the CEO, Chairman, and a large shareholder of Pixar. During the three and six-month periods ended April 1, 2006 the Company recognized less than $1 million in total royalty expense under this arrangement.

 

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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 Part II, Item 1A. Risk Factors. The following discussion should be read in conjunction with the 2005 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 100 F Street, NE, Room 1580, 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, audio books, music videos, short films, and television shows. The Company’s products and services include the Macintosh® line of desktop and portable computers, the iPod® digital music player, the Xserve® G5 server and Xserve RAID storage products, a portfolio of consumer and professional software applications, the Mac OS® X operating system, the 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 camcorders and digital 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 2005 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 content through its online iTunes Music Store. While the Company is widely recognized as an innovator in the personal computer and consumer electronic markets as well as a leader in the emerging market for distribution of digital content, these are all highly competitive markets that are subject to aggressive pricing and increased competition. To remain competitive, the Company believes that increased investment in research and development (R&D) and marketing and advertising is necessary 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

 

20



 

such as wireless technologies. The Company also believes investment in marketing and advertising programs is critical to increasing product and brand awareness.

 

In June 2005, the Company announced its plan to begin using Intel microprocessors in its Macintosh computers. Through April 1, 2006, the Company had introduced the new iMac®, MacBook™ Pro, and Mac® mini computers, which run on Intel microprocessors. The Company expects to complete the transition of all of its Macintosh computers to Intel microprocessors by the end of calendar year 2006. In April 2006, the Company announced its plans to add a feature to the next version of Mac OS X that will enable Intel-based Macs to run Windows XP. There are potential risks and uncertainties that may occur during this transition, which are further discussed in Part II, Item 1A. Risk Factors.

 

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 142 stores open as of April 30, 2006.

 

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

 

The iPod product line can be purchased in certain department stores, member-only warehouse stores, large retail chains, and specialty retail stores, as well as through the channels listed above.

 

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 condensed consolidated financial statements and accompanying notes. Note 1 of the Notes to Consolidated Financial Statements in the Company’s 2005 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 inventory purchase commitments, warranty costs, stock-based compensation, 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 hardware, software, peripherals, digital content, and service 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 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. 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 in the U.S., and for certain other sales, the Company defers revenue until the customer receives the

 

21



 

product because the Company 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.

 

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 the relevant program. 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 were 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 fiscal quarter 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 were recorded.

 

The Company accrues reserves for estimated cancellation fees related to component orders that have been cancelled or are expected to be 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 150 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

 

22



 

reserves for cancellation fees that would negatively affect gross margins in the period when the cancellation fees are identified.

 

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.

 

Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with Statement of Financial Accounting Standards (SFAS) No. 123R, Share-Based Payment. Under the provisions of SFAS No. 123R, stock-based compensation cost is estimated at the grant date based on the award’s fair-value as calculated by the Black-Scholes-Merton (BSM) option-pricing model and is recognized as expense ratably over the requisite service period. The BSM model requires various highly judgmental assumptions including volatility, forfeiture rates, and expected option life. If any of the assumptions used in the BSM model change significantly, stock-based compensation expense may differ materially in the future from that recorded in the current period.

 

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 and other tax planning strategies, 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, resulting in a positive adjustment to earnings or a decrease in goodwill in the period such determination is made. In addition, the 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 portable 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 content through the Company’s iTunes Music Store®. A detailed discussion of the Company’s products may be found in the 2005 Form 10-K. Certain newly introduced products and/or upgrades to existing products are discussed below.

 

Through April 1, 2006, the Company had introduced the new iMac®, MacBook™ Pro, and Mac® mini computers, which run on the Intel microprocessors. The iMac, MacBook Pro, and Mac mini feature Mac OS X version 10.4

 

23



 

Tiger, iLife®’06, and the Company’s new translation technology, Rosetta®, which allows most PowerPC-based Macintosh applications to run on these new Intel-based Macintosh computers.

 

iMac®

In January 2006, the Company introduced the new iMac, which is available in a 17-inch widescreen LCD display with a 1.83GHz processor and 160GB Serial ATA hard drive. The iMac is also available in a 20-inch widescreen LCD display with a 2.0 GHz processor and 250GB Serial ATA hard drive. Both models include a built-in iSight™ video camera for video conferencing, Front Row™ with the Apple Remote, 512 MB of 667 MHz DDR2 SDRAM expandable to 2GB, built-in Gigabit Ethernet, 8x SuperDrive™ with double-layer support, and PCI Express-based ATI Radeon X1600 graphics.

 

MacBook Pro

In January 2006, the Company introduced MacBook Pro, which weighs 5.6 pounds and includes a built-in iSight video camera for video conferencing, Front Row, the Apple Remote, two USB 2.0 ports, one FireWire® 400 port, built-in Gigabit Ethernet, built-in AirPort Extreme® 802.11g wireless networking and Bluetooth 2.0+EDR, and a slot-load SuperDrive. The new MacBook Pro offers a 15-inch widescreen LCD display, 667MHz DDR2 SDRAM memory expandable to 2GB, a 1.83GHz or 2.0GHz processor, and also features Apple’s new patent-pending MagSafe™ magnetic power adaptor. In April 2006, the Company introduced a 17-inch model of the MacBook Pro.

 

Mac® mini

In February 2006, the Company introduced the new Mac mini that includes Front Row and the Apple Remote. The new Mac mini offers 512 MB of 667MHz DDR2 SDRAM memory expandable to 2GB and either a 1.5GHz or 1.66GHz processor. Every Mac mini now includes built-in Gigabit Ethernet, AirPort Extreme 802.11g wireless networking, Bluetooth 2.0+EDR, and a total of four USB 2.0 ports. Mac mini includes a DVI interface and a VGA-out adapter to connect to a variety of displays, including televisions, and features both analog, and digital audio outputs.

 

iPod® nano

In February 2006, the Company added a 1GB iPod nano, which holds up to 240 songs or 15,000 photos, to its 2GB and 4GB iPod nano product family.

 

iPod Hi-Fi

In February 2006, the Company introduced iPod Hi-Fi, a high-fidelity speaker system that works with the iPod. iPod Hi-Fi has an all-in-one design that features a built-in Universal iPod Dock, touch-sensitive volume control buttons, the Apple Remote for song and volume control, power supply incorporated into the all-in-one design, and the ability to power the iPod Hi-Fi from batteries. The iPod Hi-Fi also includes a dual-purpose 3.5-mm auxiliary input that accepts either analog or digital signals for connection to a wide range of audio sources.

 

iPod® Radio Remote

In January 2006, the Company introduced iPod Radio Remote, a wired remote control with FM radio capabilities. The iPod Radio Remote allows users to skip tracks, adjust the volume of their iPods, and listen to FM radio stations while displaying station and song information on their iPod screens.

 

iLife® ‘06

In January 2006, the Company introduced iLife ‘06, an upgrade to its consumer-oriented digital lifestyle application suite, which features iWeb™, iPhoto® 6, iMovie® HD 6, iDVD® 6, GarageBand™ 3, and iTunes® 6.0.2. All of these applications run natively on both Intel and PowerPC-based Macs (Universal).

 

iWeb™ is a new application in the iLife’06 suite. iWeb allows users to create online photo albums, blogs, and podcasts and customize websites using editing tools.

 

iPhoto® 6 adds new photo management and editing features, supports up to 250,000 photos, and introduces Photocasting™. Photocasting allows .Mac users to share and automatically update photo albums over the Internet with anyone who uses a Macintosh or Windows-based PC.

 

24



 

iMovie® HD 6 now includes new real-time effects that take advantage of Core Video technology, which uses the computer’s video card’s graphics processing unit to deliver hardware acceleration to quickly preview video effects. iMovie HD 6 also provides a solution to make video podcasts, which can be published with iWeb, and includes audio enhancement tools and sound effects.

 

iDVD® 6 now allows users to take content shot with HDV and widescreen DV cameras and author custom DVDs with widescreen menus, movies, and high resolution slideshows. iDVD 6 features 10 new Apple-designed menu themes in both widescreen (16:9) and standard (4:3) formats.

 

GarageBand™ 3 now allows users to record, produce, and publish through iWeb their own podcasts, including artwork, sound effects, and music jingles.

 

iWork 06

In January 2006, the Company introduced iWork ‘06, a new Universal version of the Company’s suite of productivity software designed to help users create, present, and publish documents and presentations. iWork ‘06 includes Pages® 2 and Keynote™ 3.

 

Pages® 2 features mail merge with Mac OS® X Address Book, which allows users to personalize documents by dragging and dropping individual contacts into documents using templates with predefined fields. Pages 2 also features new templates for newsletters, flyers, posters, school reports, scrapbooks, brochures, business proposals, and invoices. Pages 2 allows users to insert tables that have basic calculation functionality within any document and users can export their Pages 2 document to other formats.

 

Keynote™ 3 offers additional ways to create presentations and interactive slideshows. It features new cinematic transitions including vertical and horizontal blinds, revolving door, and swoosh. A new view mode, Light Table, allows users to view an entire presentation and reorganize slides using drag and drop.

 

Final Cut Studio 5.1

In March 2006, the Company introduced Final Cut Studio 5.1, an update to the Company’s High-Definition (HD) video production suite. Final Cut Studio 5.1 features Universal versions of Final Cut Pro 5, Soundtrack® Pro, Motion 2, and DVD Studio Pro 4.

 

Aperture 1.1

In April 2006, the Company introduced Aperture 1.1, an update to the Company’s post production tool for photographers that is now a Universal application. Aperture 1.1 features RAW image rendering and a new set of advanced RAW adjustment controls.

 

Apple Remote Desktop 3

In April 2006, the Company introduced Apple Remote Desktop 3, the Company’s third generation desktop management application. Apple Remote Desktop 3 is a Universal application for asset management and remote assistance, and features Spotlight searches across multiple Tiger systems, over 30 Automator actions for automating repetitive system administration tasks, a Dashboard Widget that provides observation of remote systems, and AutoInstall for installing software automatically on mobile systems when they return online.

 

25



 

Net Sales

The first six months of 2006 spanned 27 weeks while the first six months of 2005 spanned 26 weeks. This additional week is added to the first fiscal quarter approximately every six years to realign fiscal quarters with calendar quarters.

 

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

 

 

 

4/1/06

 

3/26/05

 

Change

 

4/1/06

 

3/26/05

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Sales by Operating Segment:

 

 

 

 

 

 

 

 

 

 

 

 

 

Americas net sales

 

$

2,122

 

$

1,443

 

47%

 

$

4,822

 

$

3,080

 

57%

 

Europe net sales

 

966

 

705

 

37%

 

2,208

 

1,552

 

42%

 

Japan net sales

 

309

 

284

 

9%

 

664

 

469

 

42%

 

Retail net sales

 

636

 

571

 

11%

 

1,708

 

1,132

 

51%

 

Other Segments net sales (a)

 

326

 

240

 

36%

 

706

 

500

 

41%

 

Total net sales

 

$

4,359

 

$

3,243

 

34%

 

$

10,108

 

$

6,733

 

50%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unit Sales by Operating Segment:

 

 

 

 

 

 

 

 

 

 

 

 

 

Americas Macintosh unit sales

 

494

 

477

 

4%

 

1,009

 

953

 

6%

 

Europe Macintosh unit sales

 

316

 

276

 

14%

 

703

 

596

 

18%

 

Japan Macintosh unit sales

 

82

 

102

 

-20%

 

163

 

166

 

-2%

 

Retail Macintosh unit sales

 

154

 

144

 

7%

 

347

 

263

 

32%

 

Other Segments Macintosh unit sales (a)

 

66

 

71

 

-7%

 

144

 

138

 

4%

 

Total Macintosh unit sales

 

1,112

 

1,070

 

4%

 

2,366

 

2,116

 

12%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Sales by Product:

 

 

 

 

 

 

 

 

 

 

 

 

 

Desktops (b)

 

$

833

 

$

803

 

4%

 

$

1,745

 

$

1,804

 

-3%

 

Portables (c)

 

739

 

691

 

7%

 

1,551

 

1,295

 

20%

 

Total Macintosh net sales

 

1,572

 

1,494

 

5%

 

3,296

 

3,099

 

6%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

iPod

 

1,714

 

1,014

 

69%

 

4,620

 

2,225

 

108%

 

Other music related products and services (d)

 

485

 

216

 

125%

 

976

 

393

 

148%

 

Peripherals and other hardware (e)

 

264

 

280

 

-6%

 

567

 

564

 

1%

 

Software, service, and other sales (f)

 

324

 

239

 

36%

 

649

 

452

 

44%

 

Total net sales

 

$

4,359

 

$

3,243

 

34%

 

$

10,108

 

$

6,733

 

50%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unit Sales by Product:

 

 

 

 

 

 

 

 

 

 

 

 

 

Desktops (b)

 

614

 

608

 

1%

 

1,281

 

1,231

 

4%

 

Portables (c)

 

498

 

462

 

8%

 

1,085

 

885

 

23%

 

Total Macintosh unit sales

 

1,112

 

1,070

 

4%

 

2,366

 

2,116

 

12%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales per Macintosh unit sold (g)

 

$

1,414

 

$

1,396

 

1%

 

$

1,393

 

$

1,465

 

-5%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

iPod unit sales

 

8,526

 

5,311

 

61%

 

22,569

 

9,891

 

128%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales per iPod unit sold (h)

 

$

201

 

$

191

 

5%

 

$

205

 

$

225

 

-9%

 

 


Notes:

(a)          Other Segments include Asia Pacific and FileMaker.

(b)         Includes iMac, eMac, Mac mini, Power Mac, and Xserve product lines.

(c)          Includes MacBook Pro, iBook, and PowerBook product lines.

(d)         Consists of iTunes Music Store sales, iPod services, and Apple-branded and third-party iPod accessories.

(e)          Includes Apple-branded and third-party displays, wireless connectivity and networking solutions, and other hardware accessories.

(f)            Includes Apple-branded operating system software, application software, third-party software, AppleCare, and Internet services.

(g)         Derived by dividing total Macintosh net sales by total Macintosh unit sales.

(h)         Derived by dividing total iPod net sales by total iPod unit sales.

 

26



 

Net sales during the second quarter of 2006 increased 34% or $1.1 billion from the same period in 2005, and were up 50% or $3.4 billion for the first six months of 2006 compared to the same period in 2005. The increase for the six-month period was due in part to the fact that the first six months of 2006 spanned 27 weeks while the first six months of 2005 spanned 26 weeks. Several other factors contributed to these increases including the following:

 

                  Net sales of iPods rose $700 million or 69% dur