UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

(Mark One)

 

 

Commission file number: 000-10030

Apple Inc.

(Exact name of Registrant as specified in its charter)

 

 

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

Apple Computer, Inc.

(Former name or former address, if changed since last report.)

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  x   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.

 

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

Yes  o   No  x

861,874,894 shares of common stock issued and outstanding as of January 24, 2007

 

 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

APPLE INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

(in millions, except share and per share amounts)

 

		Three Months Ended
		December 30, 2006			December 31, 2005
Net sales		$	7,115		$	5,749
Cost of sales (1)		4,895			4,185
Gross margin		2,220			1,564
Operating expenses:
Research and development (1)		184			182
Selling, general, and administrative (1)		714			632
Total operating expenses		898			814
Operating income		1,322			750
Other income and expense		126			81
Income before provision for income taxes		1,448			831
Provision for income taxes		444			266
Net income		$	1,004		$	565
Earnings per common share:
Basic		$	1.17		$	0.68
Diluted		$	1.14		$	0.65
Shares used in computing earnings per share (in thousands):
Basic		857,691			830,781
Diluted		883,297			874,207
(1)      Includes stock-based compensation expense, which was allocated as follows:
Cost of sales		$	6		$	5
Research and development		$	16		$	15
Selling, general, and administrative		$	24		$	24

 

See accompanying Notes to Condensed Consolidated Financial Statements.

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APPLE INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(in millions, except share amounts)

 

		December 30, 2006			September 30, 2006
ASSETS:
Current assets:
Cash and cash equivalents		$	7,159		$	6,392
Short-term investments		4,710			3,718
Accounts receivable, less allowances of $50 and $52, respectively		1,621			1,252
Inventories		303			270
Deferred tax assets		648			607
Other current assets		2,223			2,270
Total current assets		16,664			14,509
Property, plant and equipment, net		1,362			1,281
Goodwill		38			38
Acquired intangible assets, net		146			139
Other assets		1,251			1,238
Total assets		$	19,461		$	17,205
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Current liabilities:
Accounts payable		$	3,885		$	3,390
Accrued expenses		3,452			3,081
Total current liabilities		7,337			6,471
Non-current liabilitiesand other non-current liabilities		896			750
Total liabilities		8,233			7,221
Commitments and contingencies
Shareholders’ equity:
Common stock, no par value; 1,800,000,000 shares authorized; 860,219,891 and 855,262,568 shares issued and outstanding, respectively		4,594			4,355
Retained earnings		6,611			5,607
Accumulated other comprehensive income		23			22
Total shareholders’ equity		11,228			9,984
Total liabilities and shareholders’ equity		$	19,461		$	17,205

 

See accompanying Notes to Condensed Consolidated Financial Statements.

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APPLE INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(in millions)

		Three Months Ended
		December 30, 2006			December 31, 2005
Cash and cash equivalents, beginning of the period		$	6,392		$	3,491
Operating Activities:
Net income		1,004			565
Adjustments to reconcile net income to cash generated by operating activities:
Depreciation, amortization, and accretion		74			52
Stock-based compensation expense		46			44
Provision for deferred income taxes		73			70
Loss on disposition of property, plant, and equipment		5			—
Changes in operating assets and liabilities:
Accounts receivable		(369		)	(436		)
Inventories		(33		)	(79		)
Other current assets		36			(757		)
Other assets		28			(771		)
Accounts payable		495			1,117
Other liabilities		454			478
Cash generated by operating activities		1,813			283
Investing Activities:
Purchases of short-term investments		(2,581		)	(3,185		)
Proceeds from maturities of short-term investments		934			3,396
Proceeds from sales of short-term investments		655			—
Purchases of property, plant, and equipment		(142		)	(82		)
Payment for acquisition of intangible assets		(115		)	—
Other		15			(36		)
Cash (used in) generated by investing activities		(1,234		)	93
Financing Activities:
Proceeds from issuance of common stock		101			134
Excess tax benefits from stock-based compensation		87			149
Cash generated by financing activities		188			283
Increase in cash and cash equivalents		767			659
Cash and cash equivalents, end of the period		$	7,159		$	4,150
Supplemental cash flow disclosure:
Cash paid for income taxes, net		$	114		$	22

 

See accompanying Notes to Condensed Consolidated Financial Statements.

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Apple Inc.

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 1 — Summary of Significant Accounting Policies

Apple Inc. (formerly Apple Computer, Inc.) and its wholly-owned subsidiaries (“Apple” or 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 sale of third-party audio and video products.  The Company sells its products worldwide through its online stores, its 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 and iPod compatible products including application software, printers, storage devices, speakers, headphones, and various other accessories and supplies 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.

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 30, 2006, included in its Annual Report on Form 10-K for the year ended September 30, 2006 (the “2006 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 2007 contained 13 weeks and the first quarter of its fiscal year 2006 contained 14 weeks. The Company’s fiscal year 2007 will end on September 29, 2007 and include 52 weeks while fiscal year 2006 included 53 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.

Earnings Per Common 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, shares to be purchased under the employee stock purchase plan, unvested restricted stock and restricted stock units (“RSUs”) 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 RSUs.  Additionally, the exercise of employee stock options and the vesting of restricted stock and RSUs can result in a greater dilutive effect on earnings per share.

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

 

Potentially dilutive securities representing approximately 13.9 million and 2.9 million shares of common stock for the quarter ended December 30, 2006 and December 31, 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 and RSUs.

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 December 30, 2006, and September 30, 2006 (in millions):

 

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 $441,000 on its investment portfolio, primarily related to investments with stated maturities less than one year, as of December 30, 2006, and net unrealized losses totaling $687,000 on its investment portfolio, primarily related to investments with stated maturities less than one year, as of September 30, 2006.

As of December 30, 2006 and September 30, 2006, approximately $1.2 billion and $921 million, respectively, of the Company’s short-term investments had underlying maturities ranging from one to five years.  The remaining short-term investments had maturities less than 12 months.

 

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The following table shows the gross unrealized losses and fair value for those investments that were in an unrealized loss position as of December 30, 2006 and September 30, 2006, aggregated by investment category and the length of time that individual securities have been in a continuous loss position (in millions):

 

		December 30, 2006
		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		$	558		$	—		$	5		$	—		$	563		$	—
U.S. Corporate Securities		1,142			(1		)	98			—			1,240			(1		)
Foreign Securities		310			—			15			—			325			—
Total		$	2,010		$	(1	)	$	118		$	—		$	2,128		$	(1	)

 

		September 30, 2006
		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		$	234		$	—		$	26		$	—		$	260		$	—
U.S. Corporate Securities		943			—			102			(1		)	1,045			(1		)
Foreign Securities		164			—			34			—			198			—
Total		$	1,341		$	—		$	162		$	(1	)	$	1,503		$	(1	)

 

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 December 30, 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 for other-than-temporary impairment, 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.

Derivative Financial Instruments

The Company uses derivatives to partially offset its business exposure to foreign exchange 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. 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. 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 December 30, 2006, the Company had a net deferred loss associated with cash flow hedges of approximately $4 million net of taxes, all of which is expected to be reclassified to earnings by the end of the third quarter of 2007.  As of the end of the first quarter of 2007, 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 2006.

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

Other Current Assets

 

Property, Plant, and Equipment

 

Other Assets

 

Accrued Expenses

 

Non-Current Liabilities

 

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Other Income and Expense

 

Note 4 — Shareholders’ Equity

Preferred Stock

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

Restricted Stock Units

The Company’s Board of Directors has granted RSUs to members of the Company’s senior management team, excluding its CEO. These RSUs 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 RSUs will convert into an equivalent number of shares of common stock. The amounts of the RSUs 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 requisite service period. The RSUs have been reflected in the calculation of diluted earnings per share utilizing the treasury stock method.

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-month periods ended December 30, 2006 and December 31, 2005 (in millions):

 

The following table summarizes activity in other comprehensive income related to derivatives, net of taxes, held by the Company during the three-month periods ended December 30, 2006 and December 31, 2005 (in millions):

 

		Three Months Ended
		12/30/06			12/31/05
Change in fair value of derivatives		$	(3	)	$	5
Adjustment for net losses realized and included in net income		(4		)	(3		)
Change in unrealized gain/loss on derivative instruments		$	(7	)	$	2

 

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

 

Employee Benefit Plans

2003 Employee Stock 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, RSUs, 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 Director Stock Option Plan (“Director Plan”) for non-employee directors of the Company, which was approved by shareholders in 1998. Pursuant to the Director Plan, the Company’s non-employee directors are granted an option to acquire 30,000 shares of common stock upon their initial election to the Board (“Initial Options”). The Initial Options vest and become exercisable in three equal annual installments on each of the first through third anniversaries of the grant date. On the fourth anniversary of a non-employee director’s initial election to the Board and on each subsequent anniversary thereafter, the director will be entitled to receive an option to acquire 10,000 shares of common stock (“Annual Options”). Annual Options are fully vested and immediately exercisable on their date of grant.

Rule 10b5-1 Trading Plans

Certain of the Company’s executive officers, including Mr. Timothy D. Cook, Mr. Peter Oppenheimer, Mr. Philip W. Schiller, and Dr. Bertrand Serlet, 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 RSUs.

Employee Stock Purchase Plan

The Company has a shareholder approved employee stock purchase plan (the “Purchase Plan”), under which substantially all employees may purchase common stock through payroll deductions at a price equal to 85% of the lower of the fair market values as of the beginning and end of six-month offering periods. Stock purchases under the Purchase Plan are limited to 10% of an employee’s compensation, up to a maximum of $25,000 in any calendar year. The number of shares authorized for issuance is limited to a total of 1 million shares per offering period.  As of December 30, 2006, approximately 1.6 million shares were reserved for future issuance under the Purchase Plan.

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Stock Award Activity

A summary of the Company’s stock award activity and related information for the three months ended December 30, 2006 is set forth in the following table (stock award amounts and aggregate intrinsic value are presented in thousands):

				Outstanding Options
									Weighted-Average
		Shares Available		Number of		Weighted-Average			Remaining Contractual Term		Aggregate
		for Grant		Shares		Exercise Price			(Years)		Intrinsic Value
Balance at September 30, 2006		54,994		52,982		$	23.23
RSUs Granted		(2,540	)	—		—
Options Granted		(10,742	)	10,742		$	89.29
Options Cancelled		442		(442	)	$	45.74
Options Exercised		—		(4,235	)	$	15.44
Balance at December 30, 2006		42,154		59,047		$	35.64		4.98		$	2,720,012
Exercisable at December 30, 2006				29,560		$	15.74		4.15		$	1,899,599
Expected to Vest after December 30, 2006				29,487		$	57.02		5.81		$	820,413

 

Beginning in April 2005, each RSU granted under the 2003 plan has reduced the number of shares available for grant under that plan by two shares.

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 at time of exercise was $291 million and $473 million for the three months ended December 30, 2006 and December 31, 2005, respectively.

No stock-based compensation costs were capitalized as part of the cost of an asset as of December 30, 2006 or December 31, 2005.  The income tax benefit related to stock-based compensation expense was $14 million for the quarters ended December 30, 2006 and December 31, 2005.  As of December 30, 2006, $741 million of total unrecognized compensation cost related to stock options and RSUs is expected to be recognized over a weighted-average period of 3.40 years.

Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004) (“SFAS No. 123R”), Share-Based Payment, prohibits recognition of a deferred tax asset for an excess tax benefit that has not been realized. The Company will recognize a benefit from stock-based compensation in equity if an incremental tax benefit is realized by following the ordering provisions of the tax law.  In addition, the Company accounts for the indirect effects of stock-based compensation on the research tax credit, the foreign tax credit, and the domestic manufacturing deduction through the income statement.

As of December 30, 2006, the Company had 4.68 million RSUs outstanding with a total grant-date fair value of $245 million, which were excluded from the options outstanding balances in the preceding table.  The weighted-average grant date fair value of RSUs granted during the first three months of 2007 and 2006 was $86.67 and $72.01, respectively.  Aggregate intrinsic value of RSUs at December 30, 2006 was $397 million.  No RSUs vested during the three months ended December 30, 2006.

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 Black-Scholes-Merton 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 and other relevant factors including implied volatility in market traded options on the Company’s common stock. The Company bases its expected life assumption on its historical experience and on the terms and conditions of the stock awards it grants to employees.

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The assumptions used for the three-month periods ended December 30, 2006 and December 31, 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: