UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the quarterly period ended June 27, 1997 OR
[ ] Transition report pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the transition period from ___________ to ___________
Commission file number 0-10030
APPLE COMPUTER, INC.
(Exact name of Registrant as specified in its charter)
CALIFORNIA 94-2404110
[State or other jurisdiction [I.R.S. Employer
of incorporation or organization] 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 [X] No [ ]
127,329,661 shares of Common Stock Issued and Outstanding as of August 1, 1997
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
APPLE COMPUTER, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(Dollars in millions, except per share amounts)
THREE MONTHS ENDED NINE MONTHS ENDED
June 27, June 28, June 27, June 28,
1997 1996 1997 1996
Net sales $1,737 $2,179 $5,467 $7,512
Costs and expenses:
Cost of sales 1,389 1,776 4,419 7,055
Research and development 101 155 391 458
Selling, general and administrative 307 364 1,027 1,209
In-process research and development - - 375 -
Restructuring costs - - 155 207
1,797 2,295 6,367 8,929
Operating loss (60) (116) (900) (1,417)
Interest and other income, net 4 65 16 82
Loss before benefit from income taxes (56) (51) (884) (1,335)
Benefit from income taxes - (19) - (494)
Net loss $ (56) $ (32) $ (884) $ (841)
Loss per common share $(0.44) $(0.26) $ (7.04) $ (6.81)
Cash dividends paid per common share $ -- $ -- $ -- $ .12
Common shares used in the
calculations of loss per share
(in thousands) 126,500 123,735 125,547 123,463
1
APPLE COMPUTER, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
(In millions)
June 27, 1997 September 27,
(Unaudited) 1996
Current assets:
Cash and cash equivalents $ 1,018 $ 1,552
Short-term investments 212 193
Accounts receivable, net of allowance
for doubtfulaccounts of $100 ($91 at
September 27, 1996) 1,207 1,496
Inventories:
Purchased parts 175 213
Work in process 23 43
Finished goods 336 406
534 662
Deferred tax assets 307 342
Other current assets 215 270
Total current assets 3,493 4,515
Property, plant, and equipment:
Land and buildings 460 480
Machinery and equipment 525 544
Office furniture and equipment 121 136
Leasehold improvements 180 188
1,286 1,348
Accumulated depreciation and amortization (746) (750)
Net property, plant, and equipment 540 598
Other assets 308 251
$ 4,341 $ 5,364
2
APPLE COMPUTER, INC.
CONSOLIDATED BALANCE SHEETS (Continued)
LIABILITIES AND SHAREHOLDERS' EQUITY
(Dollars in millions)
June 27, 1997 September 27,
(Unaudited) 1996
Current liabilities:
Notes payable to banks $ 127 $ 186
Accounts payable 812 791
Accrued compensation and employee benefits 115 120
Accrued marketing and distribution 269 257
Accrued warranty and related 139 181
Accrued restructuring costs 167 117
Other current liabilities 281 351
Total current liabilities 1,910 2,003
Long-term debt 951 949
Deferred tax liabilities 284 354
Shareholders' equity:
Common stock, no par value; 320,000,000
shares authorized; 126,559,143 shares issued
and outstanding at June 27, 1997 (124,496,972
shares at September 27, 1996) 476 439
Retained earnings 750 1,634
Other (30) (15)
Total shareholders' equity 1,196 2,058
$ 4,341 $ 5,364
3
APPLE COMPUTER, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In millions)
NINE MONTHS ENDED
June 27, 1997 June 28, 1996
Cash and cash equivalents, beginning
of the period $1,552 $ 756
Operating:
Net loss (884) (841)
Adjustments to reconcile net loss to cash
generated by (used for) operating activities:
Depreciation and amortization 77 110
Net book value of property, plant, and
equipment retirements 40 43
In-process research and development 375 ---
Changes in assets and liabilities, net of
effect of the acquisition of NeXT:
Accounts receivable 297 639
Inventories 128 714
Deferred tax assets 35 (150)
Other current assets 55 (26)
Accounts payable 20 (403)
Accrued restructuring costs 50 159
Other current liabilities (133) 119
Deferred tax liabilities (70) (252)
Cash generated by (used for) operating
activities (10) 112
Investing:
Purchases of short-term investments (781) (244)
Proceeds from sale of short-term investments 762 440
Purchases of property, plant and equipment (42) (55)
Cash used to acquire NeXT (384) ---
Other (32) (33)
Cash generated by (used for) investing activities (477) 108
Financing:
Decrease in notes payable to banks (59) (274)
Increase in long-term borrowings -- 646
Increases in common stock, net of related tax
benefits and effect of the acquisition of NeXT 12 25
Cash dividends -- (14)
Cash generated by (used for) financing activities (47) 383
Total cash generated (used) (534) 603
Cash and cash equivalents, end of the period $1,018 $ 1,359
4
APPLE COMPUTER, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Interim information is unaudited; however, in the opinion of
the Company's management, all adjustments necessary for a fair
statement of interim results have been included. All adjustments are
of a normal recurring nature unless specified in a separate note
included in these Notes to Consolidated Financial Statements. The
results for interim periods are not necessarily indicative of results to
be expected for the entire year. These financial statements and notes
should be read in conjunction with the Company's annual
consolidated financial statements and the notes thereto for
the fiscal year ended September 27, 1996, included in its Annual
Report on Form 10-K for the year ended September 27, 1996 (the
"1996 Form 10-K").
2. In the second quarter of 1996, the Company announced and
began to implement a restructuring plan aimed at reducing costs and
restoring profitability to the Company's operations. The restructuring
plan was necessitated by decreased demand for Company products
and the Company's adoption of a new strategic direction. These
actions resulted in a net charge of $179 million after subsequent
adjustments recorded in the fourth quarter of 1996. In the second
quarter of 1997, the Company announced and began to implement
supplemental restructuring actions to meet the foregoing objectives
of the plan. The Company recognized a $155 million charge in the
second quarter for the estimated incremental costs of those actions.
The restructuring actions consist of terminating approximately 3,100
full-time employees, as adjusted, approximately 2,400 of whom have
been terminated from the second quarter of 1996 through June 27,
1997, excluding employees who were hired by SCI Systems, Inc. and
MCI Systemhouse, the purchasers of the Company's Fountain,
Colorado manufacturing facility and the Napa, California data center
facility, respectively; canceling or vacating certain facility leases as a
result of those employee terminations; writing down certain land,
buildings and equipment to be sold as a result of downsizing
operations and outsourcing various operational functions; and
canceling contracts for projects and technologies that are not central
to the Company's core business strategy. The restructuring actions
under the plan have resulted in cash expenditures of $135 million
and noncash asset write-downs of $32 million
from the second quarter of 1996 through June 27, 1997. During the
third quarter of 1997, the Company made adjustments to the
categories and timing of expected restructure spending based on
revised estimates. The Company expects that the remaining $167
million accrued balance at June 27, 1997 will result in cash
expenditures of approximately $100 million over the next twelve
months and $12 million thereafter. The Company expects that most
of the contemplated restructuring actions related to the plan will be
completed within the next six months and will be financed through
current working capital and, if necessary, continued short-term
borrowings.
5
The following table depicts the restructuring accrual activity from
September 27, 1996 to June 27, 1997: (In millions)
Category Net
Balance at Additions Adjustments Balance at
September 27, During During June 27,
1996 Q2'97 Spending Q3'97 1997
Payments to employees
involuntarily
terminated (C) $33 $109 $65 $(10) $67
Payments on canceled
or vacated facility
leases (C) 15 16 6 (5) 20
Write-down of operating
assets to be sold (N) 47 20 25 13 55
Payments on canceled
contracts (C) 22 10 9 2 25
$117 $155 $105 $0 $167
C: Cash; N: Noncash
3. On February 4, 1997, the Company acquired all of the outstanding shares
of NeXT Software, Inc. ("NeXT"). NeXT, headquartered in Redwood City,
California, had developed, marketed and supported software that enables
customers to easily and quickly implement business applications on the
Internet/World Wide Web, intranets and enterprise-wide client/server networks.
The total purchase price was $425 million, as adjusted, and was comprised of
cash payments of $319 million and the issuance of 1.5 million shares of the
Company's common stock to the NeXT shareholders valued at approximately $25
million according to the terms of the purchase agreement; the issuance of
approximately 1.8 million options to purchase the Company's common stock to the
NeXT optionholders valued at approximately $16 million based on the difference
between the exercise price of the options and the market value of the Company's
stock on the date the options were granted; cash payments of $56 million to the
NeXT debtholders; and cash payments of $9 million for closing and related
costs, as adjusted. The acquisition was accounted for as a purchase and,
accordingly, the operating results pertaining to NeXT subsequent to the date
of acquisition have been included in the Company's consolidated operating
results. The purchase price, including the fair value of the net tangible
liabilities assumed, was $427 million, as adjusted, of which $375 million was
allocated to purchased in-process research and development and $52 million
was allocated to goodwill and other intangible assets. The purchased in-process
research and development was charged to operations upon acquisition, and the
goodwill and other intangible assets are being amortized on a straight-line
basis over 2 to 7 years. The purchase price allocation is based on preliminary
estimates of the fair value of the acquired net assets and in-process research
and development and may be subject to adjustment as management completes its
evaluation of the technology acquired and additional information becomes
available during 1997.
The following unaudited proforma summary combines the consolidated results of
operations of the Company and NeXT as if the acquisition had occurred at the
beginning of the nine months ended June 27, 1997 and June 28, 1996, after
giving effect to certain adjustments, including in-process research and
development, amortization of intangible assets, lower interest income as a
result of lower cash investment balances, and lower interest expense as a
resultof the settlement of the NeXT debt, and related income tax effects. The
proforma summary does not necessarily reflect the results of operations as they
would have been had the Company and NeXT been combined as of the beginning of
such periods.
6
Proforma Results of Operations
(dollars in millions) Nine Months Ended
June 27,1997 June 28, 1996
[S] [C] [C]
Net sales $ 5,484 $ 7,544
Net loss $ (900) $(1,249)
Loss per common share $ (7.14) $ (9.99)
4. In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings Per Share"
("FAS 128"). Under the provisions of FAS 128, primary earnings per share will
be replaced with basic earnings per share, and fully diluted earnings per
share will be replaced with diluted earnings per share for companies with
potentially dilutive securities such as outstanding options and convertible
debt. FAS 128 is effective for annual and interim periods ending after December
15, 1997 and will require restatement of all comparative per share amounts.
The basic loss per share will be no different than the primary loss per share
as presented in the accompanying consolidated statements of operations as
neither consider outstanding options or convertible debt. If and when the
Company becomes profitable, it will be required to present both basic and
diluted earnings per share. Basic earnings per share, which does not consider
potentially dilutive securities, will be greater than the replaced primary
earnings per share which did consider those securities. Diluted earnings per
share will not differ materially from the replaced fully diluted earnings per
share.
5. In July of 1997, the Board of Directors adopted a resolution allowing
employees to exchange all (but not less than all) of their existing options
(vested and unvested) to purchase Apple common stock (other than options
granted by and assumed from NeXT Software, Inc.) for options having an
exercise price of $13.25 and a new three year vesting period beginning in July
of 1997.
6. The Internal Revenue Service ("IRS") has proposed federal income tax
deficiencies for the years 1984 through 1991, and the Company has made certain
prepayments thereon. The Company contested the proposed deficiencies by filing
petitions with the United States Tax Court, and most of the issues in dispute
have now been resolved. On June 30, 1997, the IRS proposed income tax
adjustments for the years 1992 through 1994. Although a substantial number of
the issues for those years have been resolved, certain issues still remain in
dispute and are being contested by the Company. Management believes that
adequate provision has been made for any adjustments that may result from tax
examinations.
7. On August 6, 1997, the Company and Microsoft Corporation ("Microsoft")
announced patent cross licensing and technology agreements between the two
companies. In addition, Microsoft will purchase 150,000 shares of Apple Series
'A' Non-voting Convertible Preferred Stock ("Preferred Stock") for $150
million. Except under limited circumstances, the shares of Preferred Stock may
not be sold by Microsoft prior to August 5, 2000. Upon any sale of the
Preferred Stock by Microsoft, the shares will automatically be converted into
shares of Apple common stock at a conversion price of $16.50 per share and the
shares can be converted at Microsoft's option at such price after August 5,
2000. Each share of Preferred Stock is entitled to receive, if and when
declared by the Company's Board of Directors, a dividend of $30 per share per
annum, payable in preference to any dividend on the Company's common stock,
plus, if the dividends per share paid on the common stock are greater than the
dividends pershare paid on the Preferred Stock on an as converted basis, then
the Board of Directors shall declare an additional dividend such that the
dividends per share paid on the Preferred Stock on an as converted basis, shall
equal the dividends per share paid on the common stock.
8. In August 1997, the Board of Directors adopted a resolution to reserve
5 million shares for issuance under a new stock option plan for non-officer
employees of the Company.
9. The information set forth in Item 1 of Part II hereof is hereby
incorporated by reference.
7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
The following discussion should be read in conjunction with the consolidated
financial statements and notes thereto. All information is based on the
Company's fiscal calendar.
(Tabular information: Dollars in millions, except per share amounts)
Results of Operations
Third Quarter Nine Months Ended
June 27, June 28,
1997 1996 Change 1997 1996 Change
Net sales $ 1,737 $ 2,179 (20%) $ 5,467 $ 7,512 (27%)
Gross margin $ 348 $ 403 (14%) $ 1,048 $ 457 129%
Percentage of
net sales 20.0% 18.5% 19.2% 6.1%
Research and
development $ 101 $ 155 (35%) $ 391 $ 458 (15%)
Percentage of
net sales 5.8% 7.1% 7.2% 6.1%
Selling, general and
administrative $ 307 $ 364 (16%) $ 1,027 $ 1,209 (15%)
Percentage of
net sales 17.7% 16.7% 18.8% 16.1%
In-process research
and development $ --- $ --- $ 375 $ --- NM
Percentage of
net sales --- --- 6.9% ---
Restructuring costs $ --- $ --- $ 155 $ 207 NM
Percentage of
net sales --- --- 2.8% 2.8%
Interest and other
income, net $ 4 $ 65 (94%) $ 16 $ 82 (80%)
Loss before benefit
from income taxes $ (56) $ (51) (10%) $ (884) $(1,335) 34%
Benefit from
income taxes --- (19) NM (494) NM
Net loss $ (56) $ (32) (75%) $ (884) $ (841) (5%)
Loss per share $(.44) $ (.26) (69%) $(7.04) $ (6.81) (3%)
Third Second
Quarter Quarter
1997 1997 Change
Net sales $ 1,737 $ 1,601 8%
Gross margin $ 348 $ 303 15%
Percentage of
net sales 20.0% 18.9%
Research and
development $ 101 $ 141 (28%)
Percentage of
net sales 5.8% 8.8%
Selling, general and
administrative $ 307 $ 348 (12%)
Percentage of
net sales 17.7% 21.7%
In-process research
and development $ --- $ 375 NM
Percentage of
net sales --- 23.4%
Restructuring costs $ --- $ 155 NM
Percentage of
net sales --- 9.7%
Interest and other
income, net $ 4 $ 8 (50%)
Net loss $ (56) $ (708) 92%
Loss per share $ (.44) $ (5.64) 92%
NM: Not meaningful.
8
Overview
During the third quarter of 1997 the Company experienced modest
increases in net sales, units shipped and estimated share of the
personal computer market compared to the prior quarter. Despite
these modest increases, results of all three quarters of 1997 showed
significant declines in net sales, units shipped and the estimated
share of the personal computer market compared to the same
quarters of the prior year. In the third quarter the Company
continued to effect supplemental restructuring actions it announced
and began in the second quarter. The restructuring actions effected
through the end of the third quarter have resulted in a decrease in
operating expenses in that quarter compared to the prior quarter
and the same quarter of the prior year. Although the Company
believes that planned restructuring actions to be effected through
the end of the fourth quarter will result in a decrease in operating
expenses in that quarter compared to the prior quarter and the same
quarter of the prior year, the Company does not believe it will return
to profitability in the fourth quarter.
Net Sales
Q3 97 compared with Q3 96
Net sales decreased 20% in the third quarter of 1997 compared with
the same quarter of 1996. Total Macintosh computer unit sales and
peripheral unit sales decreased 17% and 27%, respectively, in the
third quarter of 1997, compared with the same period of 1996,
which the Company believes was due principally to customer
concerns regarding the Company's strategic direction, financial
condition, future prospects and the viability of the Macintosh
platform, and to competitive pressures in the marketplace. The
average aggregate revenue per Macintosh unit increased 8% in the
third quarter of 1997 compared with the same period of 1996, as a
result of a shift in mix toward the Company's newer
and higher priced PowerBook(Registered Trademark) products, partially offset
by continued pricing actions, including rebates, across most product
lines in an effort to stimulate demand. The average aggregate
revenue per peripheral product decreased 25% in the third quarter
of 1997 compared with the same period of 1996, as a result of a shift
in mix toward certain lower priced products and continued
pricing actions, including rebates, across most product lines in an
effort to stimulate demand. The average aggregate revenue per
Macintosh unit and per peripheral unit will remain under significant
downward pressure due to a variety of factors, including
industrywide pricing pressures, increased competition, and the need
to stimulate demand for the Company's products.
International net sales represented 53% of total net sales in the third
quarter of 1997 compared with 52% in the same period of 1996.
International net sales declined 19% in the third quarter of 1997
compared with the same period of 1996. Net sales in the European
markets and in Japan decreased during the third quarter of 1997
compared with the same period of 1996, as a result of
decreases in Macintosh and peripheral unit sales and the average
aggregate revenue per Macintosh unit, partially offset by an increase
in the average aggregate revenue per peripheral unit in Japan.
Domestic net sales declined 22% in the third quarter of 1997, over
the comparable period of 1996, due to decreases in unit sales of
Macintosh computers and peripheral products and in the average
aggregate revenue per peripheral unit, partially offset by an increase
in the average aggregate revenue per Macintosh unit.
During the third quarter of 1997 compared with the comparable
period of 1996, the Company's estimated share of the worldwide and
U.S. personal computer markets declined to 3.7% from 5.1%, as
adjusted, and to 4.6% from 6.5%, as adjusted, respectively, based
upon market information provided by industry sources. In addition,
the Company believes that its licensees' share of the worldwide
personal computer market during such period increased to
approximately 0.4% from approximately 0.1%.
9
Nine Months Ended June 27, 1997 compared with Nine Months Ended
June 28, 1996
Net sales decreased 27% in the first nine months of 1997 compared
with the same period of 1996. Total Macintosh computer unit sales
and peripheral unit sales decreased 27% and 33%, respectively, in the
first nine months of 1997, compared with the same period of 1996,
as a result of a decline in worldwide demand for most product
families, which the Company believes was due principally to
customer concerns regarding the Company's strategic direction,
financial condition, future prospects and the viability of the
Macintosh platform, and to competitive pressures in the marketplace.
In addition,Macintosh unit sales were negatively affected primarily
during the first six months of 1997 as a result of the Company's
inability to fulfill all purchase orders of Power Macintosh products
due to the unavailability of sufficient quantities of certain
components and product transition constraints. The average
aggregate revenue per Macintosh and peripheral unit increased
slightly in the first nine months of 1997 compared with the same
period of 1996, primarily due to a shift in mix toward the Company's
newer and higher priced PowerBook products, substantially offset by
continued pricing actions, including rebates, across most product
lines in an effort to stimulate demand.
International net sales represented 53% of total net sales in the first
nine months of 1997 and of 1996. International net sales declined
28% in the first nine months of 1997 compared with the same period
of 1996. Net sales in European markets and Japan decreased during
the first nine months of 1997 compared with the same period in
1996, as a result of decreases in Macintosh and peripheral unit sales
and the average aggregate revenue per Macintosh unit, partially
offset by an increase in the average aggregate revenue per
peripheral unit.
Domestic net sales declined 27% in the first nine months of 1997,
over the comparable period of 1996, due to decreases in unit sales of
Macintosh computers and peripheral products and the average
aggregate revenue per peripheral unit, slightly offset by an increase
in the average aggregate revenue per Macintosh unit.
Q3 97 compared with Q2 97
Net sales increased 8% in the third quarter of 1997 compared with
the second quarter of 1997. Total Macintosh computer unit sales
increased 16% in the third quarter of 1997 compared with the prior
quarter primarily as a result of the Company satisfying pent-up
demand for certain of its "Flagship" line of higher-end Power
Macintosh products by resolving certain product transition and
component constraint issues which existed in the second quarter,
partially offset by an easing of pent-up demand for new PowerBook
products which were introduced in the second quarter. Unit sales of
peripheral products increased slightly in the third quarter of 1997
compared with the second quarter of 1997. The average aggregate
revenue per Macintosh and peripheral unit decreased slightly in the
third quarter of 1997 compared with the second quarter of 1997,
primarily due to continued pricing actions, including rebates,
across most product lines in an effort to stimulate demand and a
shift in product mix away from the Company's higher priced
PowerBook products, substantially offset by a shift in product mix
toward the Company's newer and higher priced "Flagship" line of
Power Macintosh products.
International net sales represented 53% of total net sales in the third
quarter of 1997, compared with 49% in the second quarter of 1997.
International net sales increased 18% in the third quarter compared
with the second quarter of 1997, primarily as a result of an increase
in net sales in Japan due to increases in Macintosh unit sales and the
average aggregate revenue per Macintosh unit, slightly offset by
decreases in peripheral unit sales and the average aggregate revenue
per peripheral unit. The net sales increase in Japan was slightly
offset by a decrease in the European markets.
10
Domestic net sales declined slightly in the third quarter of 1997
compared with the prior quarter, due to a decrease in the average
aggregate revenue per Macintosh unit, substantially offset by
increases in Macintosh and peripheral unit sales and the average
aggregate revenue per peripheral unit.
During the third quarter of 1997 compared with the second quarter
of 1997, the Company's estimated share of the worldwide and U.S.
personal computer markets increased to 3.7% from 3.2%, as adjusted,
and to 4.6% from 4.2%, as adjusted, respectively, based upon market
information provided by industry sources. In addition, the Company
believes that its licensees' share of the worldwide personal computer
market during such period increased to approximately 0.4% from
approximately 0.3%.
In general, the Company's resellers purchase products on an as-
needed basis. Resellers frequently change delivery schedules and
order rates depending on changing market conditions. Unfilled orders
("backlog") can be, and often are, canceled at will. The Company
attempts to fill orders on the requested delivery schedules. The
Company's backlog decreased to approximately $293 million at
August 1, 1997, from approximately $409 million at May 2, 1997,
primarily due to satisfying pent-up demand for the Company's
"Flagship" line of Power Macintosh products as discussed above.
In the Company's experience, the actual amount of product backlog
at any particular time is not necessarily a meaningful indication of its
future business prospects. In particular, backlog often increases in
anticipation of or immediately following introduction of new
products because of over-ordering by dealers anticipating shortages.
Backlog often is reduced once dealers and customers believe they can
obtain sufficient supply. Because of the foregoing, as well as other
factors affecting the Company's backlog, backlog should not be
considered a reliable indicator of the Company's ability to achieve
any particular level of revenue or financial performance.
The Company believes that net sales will be below the level of the
prior year's comparable periods through at least the first quarter of
1998, if not longer.
Gross Margin
Gross margin represents the difference between the Company's net
sales and its cost of goods sold. The amount of revenue generated by
the sale of products is influenced principally by the price set by the
Company for its products relative to competitive products. The cost
of goods sold is based primarily on the cost of components and, to a
lesser extent, direct labor costs. The type and cost of components
included in particular configurations of the Company's products (such
as memory and disk drives) are often directly related to the
need to market products in configurations competitive with other
manufacturers. Competition in the personal computer industry is
intense and, in the short term, frequent changes in pricing and
product configuration are often necessary in order to remain
competitive. Accordingly, gross margin as a percentage of net sales
can be significantly influenced in the short term by actions
undertaken by the Company in response to industrywide competitive
pressures.
Gross margin increased from 18.5% to 20.0% of sales during
the third quarter of 1997 compared to the same period of 1996,
primarily as a result of an increase in the gross margin
percentage on the sale of the Company's PowerBook products
and a shift in mix towards these products which yield a high
gross margin per unit, as well as an increase in the gross
margin percentage on the sale of the Company's "Value" line
of Power Macintosh products (formerly generally referred to
as entry level and Performa(Registered Trademark) products).
Gross margin increased from 6.1% to 19.2% of sales during the first
nine months of 1997 compared to the same period of 1996, primarily
as a result of a $616 million charge in the second quarter of 1996
11
that related principally to the write-down of certain inventory, as
well as to the cost to cancel excess component orders necessitated by
significantly lower than expected demand for many of the Company's products,
primarily its "Value" line of Power Macintosh products. Also, the Company
separately incurred a $60 million charge in the second quarter of 1996 to
reflect the estimated cost to correct certain quality problems in certain of
the "Value" line of Power Macintosh products, as well as PowerBook products.
In addition, gross margins in the second quarter of 1996, and to a lesser
degree the first quarter of that year, were adversely affected by aggressive
pricing actions in Japan in response to extreme competitive actions by other
companies, as well as pricing actions in the U.S. and Europe across all
product lines in order to stimulate demand.
Gross margin increased from 18.9% to 20.0% of sales during the third
quarter of 1997 compared with the second quarter of 1997,
primarily as a result of an increase in the gross margin percentage on
the sale of the Company's "Flagship" line of Power Macintosh
products and a shift in mix towards these products which yield a
high gross margin per unit, as well as an increase in the gross margin
percentage on the sale of the Company's "Value" line of Power
Macintosh products, offset in part by a reduced mix in PowerBook
products.
The gross margin levels in the third quarter of 1997 compared with
the second quarter of 1997 and the third quarter of 1996, and in the
first nine months of 1997 compared with the corresponding period of
1996, were also adversely affected by a stronger U.S. dollar relative
to certain foreign currencies. This negative impact was offset by
hedging gains. The Company's operating strategy and pricing take
into account changes in exchange rates over time; however, the
Company's results of operations can be significantly affected in
the short term by fluctuations in foreign currency exchange rates.
There can be no assurance that the Company will be able to sustain
the gross margin levels achieved in the third quarter and in the first
nine months of 1997. Gross margins will remain under significant
downward pressure due to a variety of factors, including continued
industrywide pricing pressures around the world, increased
competition, and compressed product life cycles. In response to those
downward pressures, the Company expects it will continue to
take pricing actions with respect to its products. Gross margins could
also be affected by the Company's ability to effectively manage
quality problems and warranty costs, and to stimulate demand for
certain of its products.
12
Research and Development
Third Quarter Nine Months Ended
June 27, June 28,
1997 1996 Change 1997 1996 Change
Research and
development $ 101 $ 155 (35%) $ 391 $ 458 (15%)
Percentage of net
sales 5.8% 7.1% 7.2% 6.1%
Third Second
Quarter Quarter
1997 1997 Change
Research and
development $ 101 $ 141 (28%)
Percentage of net
sales 5.8% 8.8%
Research and development expenditures decreased in amount in the
third quarter of 1997 compared with the second quarter of 1997 and
the third quarter of 1996, and during the first nine months of 1997
compared with the same period of 1996. The decreases are primarily
due to certain restructuring actions initiated by the Company late in
the second quarter of 1997. Research and development expenditures
also decreased as a percentage of sales in the third quarter of 1997
compared with the second quarter of 1997 and the third quarter of
1996, primarily due to the impact of such restructuring actions,
partially offset by a decrease in the level of net sales. The increase as
a percentage of net sales for the first nine months of 1997 compared
with the same period of 1996 resulted from a decrease in the level of
net sales, partially offset by the impact of such restructuring actions.
The Company believes that continued investments in research and
development are critical to its future growth and competitive
position in the marketplace and are directly related to continued,
timely development of new and enhanced products that are central
to the Company's core business strategy. The Company believes its
research and development expenditures will decrease slightly in the
fourth quarter of 1997 compared with the third quarter of 1997 as
the Company completes and more fully realizes the cost reduction
benefits of its restructuring plan. For additional information
regarding the restructuring plan, refer to Note 2 of the Notes to the
Consolidated Financial Statements (Unaudited) in Part I, Item I, and
to Factors That May Affect Future Results and Financial Condition as
well as Liquidity and Capital Resources in Part I, Item II of this
Quarterly Report on Form 10-Q, which information is hereby
incorporated by reference.
13
In-Process Research and Development
Third Quarter Nine Months Ended
1997 1996 Change June 27, June 28, Change
1997 1996
In-process research
and development $ --- $ --- $ 375 $ --- NM
Percentage of net
sales --- --- 6.9% ---
Third Second
Quarter Quarter
1997 1997 Change
In-process research
and development $ --- $ 375 NM
Percentage of net
sales --- 23.4%
NM: Not meaningful.
As a result of the NeXT acquisition, the Company took a substantial
charge for in-process research and development during the second
quarter of 1997. For additional information regarding the acquisition
of NeXT, refer to Note 3 of the Notes to the Consolidated Financial
Statements (Unaudited) in Part I, Item I, and to Factors That May
Affect Future Results and Financial Condition as well as Liquidity and
Capital Resources in Part I, Item II of this Quarterly Report on
Form 10-Q, which information is hereby incorporated by reference.
14
Selling, General and Administrative
Third Quarter Nine Months Ended
1997 1996 Change June 27, June 28, Change
1997 1996
Selling, general and
administrative $ 307 $ 364 (16%) $ 1,027 $ 1,209 (15%)
Percentage of net
sales 17.7% 16.7% 18.8% 16.1%
Third Second
Quarter Quarter
1997 1997 Change
Selling, general and
administrative $ 307 $ 348 (12%)
Percentage of net
sales 17.7% 21.7%
Selling, general and administrative expenditures decreased in
amount in the third quarter of 1997 compared with the second
quarter of 1997 and the third quarter of 1996, and during the first
nine months of 1997 compared with the same period of 1996. The
decreases are primarily due to certain restructuring actions initiated
by the Company late in the second quarter of 1997. Selling,
general and administrative expenditures also decreased as a
percentage of sales in the third quarter of 1997 compared with the
second quarter of 1997 and the third quarter of 1996, primarily due
to the impact of such restructuring actions partially offset by a
decrease in the level of net sales. The increase as a percentage of net
sales for the first nine months 1997 compared with the same period
of 1996 resulted from a decrease in the level of net sales, partially
offset by the impact of such restructuring actions.
The Company believes its selling, general and administrative
expenditures will continue to decrease in the fourth quarter of 1997
compared with the third quarter of 1997, as the Company completes
and more fully realizes the cost reduction benefits of its
restructuring plan, slightly offset by the amortization
expense on the intangible assets the Company recognized as a result
of the acquisition of NeXT. For additional information regarding the
Company's restructuring actions and the acquisition of NeXT, refer to
Notes 2 and 3, respectively, of the Notes to the Consolidated Financial
Statements (Unaudited) in Part I, Item I, and to Factors That May
Affect Future Results and Financial Condition as well as Liquidity and
Capital Resources in Part I, Item II of this Quarterly Report on Form
10-Q, which information is hereby incorporated by reference.
15
Restructuring Costs
Third Quarter Nine Months Ended
1997 1996 Change June 27, June 28, Change
1997 1996
Restructuring costs $ --- $ --- $ 155 $ 207 NM
Percentage of net
sales --- --- 2.8% 2.8%
Third Second
Quarter Quarter
1997 1997 Change
Restructuring costs $ --- $ 155 NM
Percentage of net
sales --- 9.7%
NM: Not meaningful.
For information regarding the Company's restructuring actions
initiated in the second quarters of 1997 and 1996, refer to Note 2 of
the Notes to the Consolidated Financial Statements (Unaudited) in
Part I, Item I, and to Factors That May Affect Future Results and
Financial Condition as well as Liquidity and Capital Resources in Part
I, Item II of this Quarterly Report on Form 10-Q, which information
is hereby incorporated by reference.
Interest and Other Income, Net
Third Quarter Nine Months Ended
1997 1996 Change June 27, June 28, Change
1997 1996
Interest and other
income, net $ 4 $ 65 (94%) $ 16 $ 82 (80%)
Third Second
Quarter Quarter
1997 1997 Change
Interest and other
income, net $ 4 $ 8 (50%)
Interest and other income, net, decreased in the third quarter of
1997 and for the first nine months of 1997 compared with the same
periods of 1996, primarily due to $69 million of realized gains on
sales of available-for-sale securities realized in the third quarter of
1996. Interest and other income, net, decreased in the third quarter
of 1997 compared with the second quarter of 1997 as a result of
lower average cash balances, due to cash used to acquire NeXT, to
fund the restructuring actions begun in the second quarter of 1997
and to fund operations. The Company expects interest income to be flat in
the fourth quarter of 1997 compared with the immediate prior quarter.
16
The Company's senior and subordinated long-term debt ratings
remain unchanged from the second quarter. In the second quarter of
1997, the Company's senior and subordinated long-term debt were
downgraded to B and CCC+, respectively, by Standard and Poor's
Rating Agency and to B3 and Caa, respectively, by Moody's Investor
Services. These actions could increase the Company's cost of funds in
future periods.
Income Tax Benefit
Third Quarter Nine Months Ended
1997 1996 Change June 27, June 28, Change
1997 1996
Benefit from income
taxes -- $ (19) NM -- $ (494) NM
Effective tax rate -- 37% -- 37%
Third Second
Quarter Quarter
1997 1997 Change
Benefit from income
taxes -- -- NM
Effective tax rate -- --
NM: Not meaningful.
At June 27, 1997, the Company had deferred tax assets arising from
deductible temporary differences, tax losses, and tax credits of $591
million before being offset against certain deferred tax liabilities for
presentation on the Company's balance sheet. A substantial portion
of this asset is realizable based on the ability to offset existing
deferred tax liabilities. In the first nine months of 1997, a valuation
allowance of $174 million was recorded against the deferred tax
asset for the benefits of tax losses which may not be realized.
Realization of approximately $85 million of the asset is dependent on
the Company's ability to generate approximately $245 million of
future U.S. taxable income. Management believes that it is more
likely than not that the asset will be realized based on forecasted U.S.
income. However, there can be no assurance that the Company will
meet its expectations of future U.S. income. As a result, the amount of
the deferred tax assets considered realizable could be reduced in the
near and long term if estimates of future taxable U.S. income
are reduced. Such an occurrence could materially adversely affect
the Company's financial results. The Company will continue to
evaluate the realizability of the deferred tax assets quarterly by
assessing the need for and amount of the valuation allowance.
17
Factors That May Affect Future Results and Financial Condition
Overview
The Company's future operating results and financial condition
are dependent upon the Company's ability to successfully develop,
manufacture, and market technologically innovative products in
order to meet dynamic customer demand patterns, and its ability to
effect a change in marketplace perception of the Company's
prospects, including the viability of the Macintosh platform.
Inherent in this process are a number of factors that the
Company must successfully manage in order to achieve favorable
future operating results and a favorable financial condition.
Potential risks and uncertainties that could affect the Company's
future operating results and financial condition include, without
limitation, continued competitive pressures in the marketplace
and the effect of any reaction by the Company to such competitive
pressures, including pricing actions by the Company; the
availability of key components on terms acceptable to the
Company; the Company's ability to supply products in certain
categories; the Company's ability to supply products free of latent
defects or other faults; the Company's ability to make timely
delivery to the marketplace of technological innovations,
including its ability to continue to make timely delivery of
planned enhancements to the current Macintosh operating
system ("Mac(Registered Trademark) OS") and to make timely delivery of a
new and substantially backward-compatible OS; the Company's ability to
successfully integrate NeXT technologies, processes and employees
with those at Apple; the Company's ability to successfully
implement its strategic direction and restructuring actions,
including reducing its expenditures; the Company's ability to
attract, motivate and retain employees, including a new Chief
Executive Officer; the effects of significant adverse publicity; and
the availability of third-party software for particular
applications.
The Company expects that it will not return to profitability in the
fourth quarter of 1997.
Restructuring of Operations and New Business Model
During 1996, the Company began to implement certain
restructuring actions aimed at reducing its cost structure,
improving its competitiveness, and restoring sustained
profitability. In the second quarter of 1997, the Company
announced and began to implement supplemental restructuring
actions, including significant headcount reductions, to meet the
foregoing objectives. There are several risks inherent in the
Company's efforts to transition to a new cost structure. These
include the risk that the Company will not be able to reduce
expenditures quickly enough to restore sustained profitability
and the risk that cost-cutting initiatives will impair the
Company's ability to innovate and remain competitive in the
computer industry.
As part of its restructuring effort, the Company has been
implementing a new business model. Implementation of the new
business model involves several risks, including the risk that by
simplifying and modifying its product line the Company will
increase its dependence on fewer products, potentially reduce
overall sales, and increase its reliance on unproven products and
technology. Another risk of the new business model is that by
increasing the proportion of the Company's products to be
manufactured under outsourcing arrangements, the Company
could lose control of the quality or quantity of the products
manufactured, or lose the flexibility to make timely changes in
production schedules in order to respond to changing market
conditions. In addition, the new business model could adversely
affect employee morale, thereby damaging the Company's ability
to retain and motivate employees. Also, because the new business
model contemplates that the Company will rely to a greater extent
on collaboration and licensing arrangements with third parties,
the Company will have less direct control over certain of its
research and development efforts, and its ability to create
innovative new products may be reduced. In addition, the new
business model now includes the acquisition of NeXT. There can
be no assurance that the technologies acquired from NeXT will be
successfully exploited, or that key NeXT employees and processes
will be retained and successfully integrated with those at Apple.
Also, the new business model now includes the "spin-out" of the
Company's Newton(Registered Trademark) unit into a
18
separate but wholly-owned subsidiary named Newton, Inc. There
can be no assurance that Newton, Inc. will be successful as a
separate entity. Finally, even if the new business model is
successfully implemented, there can be no assurance that it will
effectively resolve the various issues currently facing the
Company. Although the Company believes that the actions it is
taking and will take under its new business model, including its
restructuring plan, its acquisition of NeXT, and its "spin-out" of
Newton, Inc., should help restore marketplace confidence in the
Company, there can be no assurance that such actions will enable
the Company to achieve its objectives of reducing its cost
structure, improving its competitiveness, and restoring sustained
profitability. The Company's future operating results and
financial condition could be adversely affected should it
encounter difficulty in effectively managing the transition to
the new business model and cost structure.
For information regarding the Company's restructuring actions
and the acquisition of NeXT, refer to Notes 2 and 3, respectively, of
the Notes to the Consolidated Financial Statements (Unaudited) in
Part I, Item I, and to Liquidity and Capital Resources in Part I,
Item II of this Quarterly Report on Form 10-Q, which information
is hereby incorporated by reference.
Product Introductions and Transitions
Due to the highly volatile nature of the personal computer
industry, which is characterized by dynamic customer demand
patterns and rapid technological advances, the Company
frequently introduces new products and product enhancements,
including the recent introductions of certain PowerBook and
Power Macintosh products, and the introduction of Mac OS 8 in
July of 1997. The success of new product introductions is
dependent on a number of factors, including market acceptance,
the Company's ability to manage the risks associated with product
transitions, the availability of application software for new
products, the effective management of inventory levels in line
with anticipated product demand, the availability of products in
appropriate quantities to meet anticipated demand, and the risk
that new products may have quality or other defects in the early
stages of introduction. Accordingly, the Company cannot
determine the ultimate effect that new products will have on its
sales or results of operations. In addition, although the number of
new product introductions may decrease under the Company's
new business model, the risks and uncertainties associated with
new product introductions may increase as the Company
refocuses its product offerings on key growth segments and to
the extent new product introductions are in markets that are new
to the Company.
The rate of product shipments immediately following introduction of a new
product is not necessarily an indication of the future rate of shipments for
that product, which depends on many factors, some of which are not under the
control of the Company. These factors may include initial large purchases by a
small segment of the user population that tends to purchase new technology
prior to its acceptance by the majority of users ("early adopters"); purchases
in satisfaction of pent-up demand by users who anticipated new technology
and, as a result, deferred purchases of other products; and overordering by
dealers who anticipate shortages due to the aforementioned factors. These
factors may be offset by others, such as the deferral of purchases by many
users until new technology is accepted as "proven" and for which commonly
used software products are available; and the reduction of orders by dealers
once they believe they can obtain sufficient supply of products previously in
backlog.
Backlog is often volatile after new product introductions due to the
aforementioned demand factors, often increasing coincident with introduction,
and then decreasing once dealers and customers believe they can obtain
sufficient supply of the new products.
The measurement of demand for newly introduced products is further complicated
by the availability of different product configurations, which may include
various types of built-in peripherals and software. Configurations may also
require certain localization (such as language) for various markets and, as
a result, demand in different geographic areas may be a function of the
availability of third-party software in those localized versions. For example,
the availability of European-language versions of software products
19
manufactured by U.S. producers may lag behind the availability of U.S. versions
by a quarter or more. This may result in lower initial demand for the
Company's new products outside the United States, even though localized
versions of the Company's products may be available.
The increasing integration of functions and complexity of
operations of the Company's products also increase the risk that
latent defects or other faults could be discovered by customers or
end-users after volumes of products have been produced or
shipped. If such defects were significant, the Company could
incur material recall and replacement costs under product
warranties.
The Company has announced plans for two operating systems.
The Company plans to continue to introduce major upgrades to
the current Mac OS and later introduce a new OS (code named
"Rhapsody") which is expected to offer advanced functionality
based on Apple and NeXT software technologies. However, the
NeXT software technologies that the Company plans to use in the
development of Rhapsody were not originally designed to be
compatible with the Mac OS. As a result, there can be no
assurance that the development of Rhapsody will be successful.
In addition, Rhapsody may not be fully backward-compatible
with all existing applications, which could result in a loss of
existing customers. Finally, it is uncertain whether Rhapsody or
the planned enhancements to the current Mac OS will gain
developer support and market acceptance. Inability to
successfully develop and make timely delivery of a substantially
backward-compatible Rhapsody or of planned enhancements to
the current Mac OS, or to gain developer support and market
acceptance for those operating systems, may have an adverse
impact on the Company's operating results and financial
condition.
Competition
The personal computer industry is highly competitive and is
characterized by aggressive pricing practices, downward
pressure on gross margins, frequent introduction of new
products, short product life cycles, continual improvement in
product price/performance characteristics, price sensitivity on
the part of consumers, and a large number of competitors. The
Company's results of operations and financial condition have
been, and in the future may continue to be, adversely affected by
industrywide pricing pressures and downward pressures on gross
margins. The industry has also been characterized by rapid
technological advances in software functionality and hardware
performance and features based on existing or emerging
industry standards. Many of the Company's competitors have
greater financial, marketing, manufacturing, and technological
resources, broader product lines and larger installed customer
bases than those of the Company.
The Company's future operating results and financial condition
may be affected by overall demand for personal computers and
general customer preferences for one platform over another or
one set of product features over another.
The Company is currently the primary maker of hardware that
uses the Mac OS. The Mac OS has a minority market share in the
personal computer market, which is dominated by makers of
computers that run the MS-DOS and Microsoft Windows operating
systems. The Company believes that the Mac OS, with its perceived
advantages over MS-DOS and Windows, has been a driving force
behind sales of the Company's personal computer hardware for
the past several years. Recent innovations in the Windows
platform, including those included in Windows 95 and Windows
NT, or those expected to be included in Windows 98, have added
features to the Windows platform which make the differences
between the Mac OS and Microsoft's Windows operating systems less
significant. The Company is currently taking and will continue
to take steps to respond to the competitive pressures being placed
on its personal computer sales as a result of the recent
innovations in the Windows platform. The Company's future
operating results and financial condition may be affected by its
ability to maintain and increase the installed base for the
Macintosh platform.
20
As part of its efforts to increase the installed base for the
Macintosh platform, the Company announced the licensing of the
Mac OS to other personal computer vendors in 1995 and 1996.
Several vendors currently sell products that utilize the Macintosh
operating system, many of which have licensing arrangements
with the Company. As a result of licensing its operating system,
the Company competes with other companies producing Mac OS-
based computer systems. The benefits to the Company from
licensing the Mac OS to third parties may be more than offset by
the disadvantages of competing with them. The Company is
currently in discussions concerning the nature of such licensing
arrangements going forward, including whether or not to extend
such arrangements. There can be no assurance that the
Company's Mac OS licensing strategy will prove successful or will
financially benefit the Company or, if the Company decides to
alter its strategy, that it will be able to modify its existing
licensing arrangements to pursue such a strategy.
As a supplemental means of addressing the competition from MS-
DOS and Windows, the Company has devoted substantial resources
toward developing personal computer products capable of
running application software designed for the MS-DOS or
Windows operating systems ("Cross-Platform Products"). These
products include the RISC-based PowerPC(TradeMark) microprocessor and
either include the Pentium or 586-class microprocessor or can
accommodate an add-on card containing a Pentium or 586-class
microprocessor. These products enable users to run concurrently
applications that require the Mac OS, MS-DOS, Windows 3.1, or
Windows 95 operating systems. The Company has supplied
customers who purchase Cross-Platform Products with Windows
operating system software under licensing agreements with
certain Microsoft distributors. The Company's ability to market
Cross-Platform Products could be adversely affected if such
Microsoft distributors were unwilling to continue to supply the
Company with Windows operating system software on the terms
of such licensing agreements.
The Company, International Business Machines Corporation
("IBM") and Motorola, Inc. ("Motorola") have agreed upon and announced
the availability of specifications for a PowerPC microprocessor-based
hardware reference platform. These specifications define a
"unified" personal computer architecture that gives access to
both the Power Macintosh platform and the PC environment and
utilizes standard industry components. The Company's future
operating results and financial condition may be affected by its
ability to continue to implement this agreement and to manage
the risk associated with the transition to this new hardware
reference platform. Microsoft Corporation ("Microsoft") recently announced
that it would no longer adapt its Windows NT operating system software,
which is being used more by corporations, to run on the PowerPC
microprocessor. This decision may adversely affect revenues
derived from this new hardware reference platform.
Several competitors of the Company have either targeted or announced their
intention to target certain of the Company's key market segments, including
education and publishing. Many of these companies have greater financial,
marketing, manufacturing, and technological resources than the Company.
On August 6, 1997, the Company and Microsoft announced patent cross licensing
and technology agreements between the two companies. Under these agreements,
the companies provided patent cross licenses to each other. In addition,
Microsoft will make future versions of its Microsoft Office and Internet
Explorer products for the Mac OS, and the Company will bundle the Internet
Explorer product with Mac OS system software releases and make that product
the default internet browser for such releases. The Company also announced
that Microsoft will purchase 150,000 shares of Apple Series 'A' Non-voting
Convertible Preferred Stock for $150 million. While the Company believes that
its relationship with Microsoft will be beneficial to the Company and to its
efforts to increase the installed base for the Mac OS, the Microsoft
relationship is for a limited term and does not cover many of the
areas in which the Company competes with Microsoft, including
the Windows platform. In addition, the Microsoft relationship
may have an adverse effect on, but not limited to, the Company's
relationship with other partners. There can be no assurance that
the benefits to the Company of the Microsoft relationship will not
be offset by the disadvantages.
21
Support from Third-Party Software Developers
Decisions by customers to purchase the Company's personal computers, as
opposed to MS-DOS or Windows-based systems, are often based on the
availability of third-party software for particular applications. The Company
believes that the availability of third-party application software for the
Company's hardware products depends in part on third-party developers'
perception and analysis of the relative benefits of developing,
maintaining, and upgrading such software for the Company's products versus
software for the larger MS-DOS and Windows market. This analysis is based on
factors such as the perceived strength of the Company and its products, the
anticipated potential revenue that may be generated, and the costs of
developing such software products. To the extent the Company's recent
financial losses and declining demand for the Company's product have caused
software developers to question the Company's prospects in the personal
computer market, developers could be less inclined to develop new application
software or upgrade existing software for the Company's products and more
inclined to devote their resources to developing and upgrading software for
the larger MS-DOS and Windows market. Microsoft is an important developer of
application software for the Company's products. Although the Company has
entered into a relationship with Microsoft, which includes Microsoft's
agreement to develop and ship future versions of its Microsoft Office and
Internet Explorer products and certain other Microsoft tools for the Mac OS,
such relationship is for a limited term and does not cover many areas in which
theCompany competes with Microsoft. Accordingly, Microsoft's interest in
producingapplication software for the Company's products not covered by the
relationship or upon expiration of the relationship may be influenced by
Microsoft's perception of its interests as the vendor of the Windows
operating system.
Global Market Risks
A large portion of the Company's revenue is derived from its
international operations. As a result, the Company's operations
and financial results could be significantly affected by risks
associated with international activities, including economic and
labor conditions, political instability, tax laws (including U.S.
taxes on foreign subsidiaries), and changes in the value of the
United States dollar versus the local currency in which the
products are sold. When the U.S. dollar strengthens against other
currencies, the U.S. dollar value of non-U.S. dollar-based sales
decreases. When the U.S. dollar weakens, the U.S. dollar value of
non-U.S. dollar-based sales increases. Correspondingly, the U.S.
dollar value of non-U.S. dollar-based costs increases when the
U.S. dollar weakens and decreases when the U.S. dollar
strengthens. Overall, the Company is a net receiver of currencies
other than the U.S. dollar and, as such, benefits from a weaker
dollar and is adversely affected by a stronger dollar relative to
major currencies worldwide. Accordingly, changes in exchange
rates, and in particular a strengthening of the U.S. dollar, may
negatively affect the Company's consolidated sales and gross
margins (as expressed in U.S. dollars).
To mitigate the short-term impact of fluctuating currency
exchange rates on the Company's non-U.S. dollar-based sales,
product procurement, and operating expenses, the Company
regularly hedges its non-U.S. dollar-based exposures.
Specifically, the Company enters into foreign exchange forward
and option contracts to hedge its assets, liabilities and firmly
committed transactions. Currently, hedges of firmly committed
transactions do not extend beyond one year. The Company also
purchases foreign exchange option contracts to hedge certain
other probable but not firmly committed transactions. Hedges of
probable but not firmly committed transactions currently do not
extend beyond one year. To reduce the costs associated with these
ongoing foreign exchange hedging programs, the Company also
regularly sells foreign exchange option contracts and enters into
certain other foreign exchange transactions. All foreign
exchange forward and option contracts not accounted for as
hedges, including all transactions intended to reduce the costs
associated with the Company's foreign exchange hedging
programs, are carried at fair value and are adjusted on each
balance sheet date for changes in exchange rates.
While the Company is exposed with respect to fluctuations in the
interest rates of many of the world's leading industrialized
countries, the Company's interest income and expense is most
22
sensitive to fluctuations in the general level of U.S. interest rates.
In this regard, changes in U.S. interest rates affect the interest
earned on the Company's cash, cash equivalents, and short-term
investments as well as interest paid on its notes payable to banks
and long-term debt. To mitigate the impact of fluctuations in U.S.
interest rates, the Company has entered into interest rate swap,
collar, and floor transactions. Certain of these transactions are
intended to better match the Company's floating-rate interest
income on its cash, cash equivalents, and short-term investments
with the fixed-rate interest expense on its long-term debt. The
Company also enters into these transactions in order to diversify
a portion of the Company's exposure away from fluctuations in
short-term U.S. interest rates. These instruments may extend the
Company's cash investment horizon up to a maximum duration of
three years.
To ensure the adequacy and effectiveness of the Company's
foreign exchange and interest rate hedge positions, as well as to
monitor the risks and opportunities of the nonhedge portfolios,
the Company continually monitors its foreign exchange forward
and option positions, and its interest rate swap, option and floor
positions both on a stand-alone basis and in conjunction with its
underlying foreign currency- and interest rate-related
exposures, respectively, from both an accounting and an
economic perspective. However, given the effective horizons of
the Company's risk management activities, there can be no
assurance that the aforementioned programs will offset more
than a portion of the adverse financial impact resulting from
unfavorable movements in either foreign exchange or interest
rates. In addition, the timing of the accounting for recognition of
gains and losses related to mark-to-market instruments for any
given period may not coincide with the timing of gains and losses
related to the underlying economic exposures and, therefore,
may adversely affect the Company's operating results and
financial position. The Company generally does not engage in
leveraged hedging.
The Company's current financial condition is expected to
increase the costs of its hedging transactions, as well as affect the
nature of the hedging transactions into which the Company's
counterparties are willing to enter.
Inventory and Supply
The Company provides reserves against any inventories of
products that have become obsolete or are in excess of anticipated
demand, accrues for any cancellation fees of orders for
inventories that have been canceled, and accrues for the
estimated costs to correct any product quality problems.
Although the Company believes its inventory and related
reserves are adequate, no assurance can be given that the
Company will not incur additional inventory and related charges.
In addition, such charges have had, and may again have, a
material effect on the Company's financial position and results of
operations.
The Company must order components for its products and build
inventory well in advance of product shipments. Because the
Company's markets are volatile and subject to rapid technology
and price changes, there is a risk that the Company will forecast
incorrectly and produce excess or insufficient inventories of
particular products. The Company's operating results and
financial condition have been in the past and may in the future
be materially adversely affected by the Company's ability to
manage its inventory levels and respond to short-term shifts in
customer demand patterns.
Certain of the Company's products are manufactured in whole or
in part by third-party manufacturers, either pursuant to design
specifications of the Company or otherwise. As part of its
restructuring actions, the Company has sold its Fountain, Colorado,
manufacturing facility to SCI Systems, Inc. ("SCI") and entered into a
related manufacturing outsourcing agreement with SCI; sold its Singapore
printed circuit board manufacturing assets to NatSteel Electronics Pte., Ltd.
who will then supply main logic boards to the Company under a manufacturing
outsourcing agreement; entered into an agreement with Ryder Integrated
Logistics, Inc. to outsource the Company's domestic operations transportation
and logistics management, and has entered into other similar
23
agreements to outsource the Company's European operations transportation and
logistics management. As a result of the foregoing actions, the proportion of
the Company's products produced and distributed under outsourcing arrangements
will continue to increase. While outsourcing arrangements may lower the fixed
cost of operations, they will also reduce the direct control the Company has
over production. It is uncertain what effect such diminished control will have
on the quality or quantity of the products manufactured, or the flexibility of
the Company to respond to changing market conditions. Furthermore, any efforts
by the Company to manage its inventory under outsourcing arrangements could
subject the Company to liquidated damages or cancellation of the arrangement.
Moreover, although arrangements with such manufacturers may contain provisions
for warranty expense reimbursement, the Company remains at least initially
responsible to the ultimate consumer for warranty service. Accordingly, in
the event of product defects or warranty liability, the Company may remain
primarily liable. Any unanticipated product defect or warranty liability,
whether pursuant to arrangements with contract manufacturers or otherwise,
could adversely affect the Company's future operating results and financial
condition.
Although certain raw materials, processes and components essential to the
Company's business are generally available from multiple sources, other
processes and key components (including microprocessors and application
specific integrated circuits ("ASICs") ) are currently obtained by the
Company from single sources. If the supply of a key single-sourced material,
process or component were to be delayed or curtailed, the Company's business
and financial performance could 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 alternate source. The
Company believes that the availability from suppliers to the personal computer
industry of microprocessors and ASICs presents the most significant potential
for constraining the Company's ability to manufacture products. Some advanced
microprocessors are currently in the early stages of ramp-up for production
and thus have limited availability. The Company and other producers in the
personal computer industry also compete for other semiconductor products
with other industries that have experienced increased demand for such products,
due to either increased consumer demand or increased use of semiconductors
in their products (such as the cellular phone and automotive industries).
Finally, the Company uses some components that are not common to the rest of
the personal computer industry (including certain microprocessors
and ASICs). 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. Such
product supply constraints and corresponding increased costs could decrease
the Company's net sales and adversely affect the Company's operating results
and financial condition.
The Company's ability to produce and market competitive products is also
dependent on the ability and desire of IBM and Motorola, the suppliers
of the PowerPC RISC microprocessor for certain of the Company's products, to
supply to the Company in adequate numbers microprocessors that produce
superior price/performance results compared with those supplied to the
Company's competitors by Intel Corporation, the developer and producer of the
microprocessors used by most personal computers using the MS-DOS and Windows
operating systems. In addition, the desire of IBM and Motorola to continue
producing these microprocessors may be influenced by Microsoft's decision
not to adapt its Windows NT operating system software to run on the PowerPC
microprocessor. IBM produces personal computers based on Intel microprocessors
as well as workstations based on the PowerPC microprocessor, and is also the
developer of OS/2, a competing operating system to the Company's Mac OS.
Accordingly, IBM's interest in supplying the Company with microprocessors for
the Company's products may be influenced by IBM's perception of its interests
as a competing manufacturer of personal computers and as a competing operating
system vendor.
The Company's current financial condition and uncertainties related to recent
events could effect the terms on which suppliers are willing to supply the
Company with their products. There can be no assurance that the Company's
current suppliers will continue to supply the Company on terms acceptable to
the Company or that the Company will be able to obtain comparable products
from alternate sources on such terms. The Company's future operating results
and financial condition could be adversely affected if the Company is unable
24
to continue to obtain key components on terms substantially similar to those
currently available to the Company.
Marketing and Distribution
A number of uncertainties may affect the marketing and distribution of the
Company's products. Currently, the Company's primary means of distribution
is through third-party computer resellers. Such resellers include consumer
channels such as mass-merchandise stores, consumer electronics outlets, and
computer superstores. The Company's business and financial results could be
adversely affected if the financial condition of these resellers weakened or
if resellers within consumer channels were to decide not to continue to
distribute the Company's products.
Uncertainty over demand for the Company's products may cause resellers to
reduce their ordering and marketing of the Company's products. Under the
Company's arrangements with its resellers, resellers have the option to
reduce or eliminate unfilled orders previously placed, in most instances
without financial penalty. Resellers also have the option to return products
to the Company without penalty within certain limits, beyond which they may be
assessed fees. The Company has experienced a reduction in ordering from
historical levels by resellers due to uncertainty concerning the Company's
condition and prospects.
Change in Senior Management
On July 9, 1997, the Company announced that Dr. Gilbert F. Amelio had resigned
his positions as Chairman of the Board and Chief Executive Officer and that
the Company was initiating a search for a new Chief Executive Officer. While
the Company intends to name a new Chief Executive Officer as soon as
practicable, there can be no assurance that the change in senior management
and related uncertainties will not adversely affect the Company's operating
results and financial condition during the period until a new Chief Executive
Officer is hired and afterward.
Changes to Board of Directors
The Company announced on August 6, 1997 significant changes to its Board of
Directors, replacing all but two former directors. The continuing directors
are Gareth Chang and Edgar Woolard. The new directors are William Campbell,
President and CEO of Intuit Corp.; Lawrence Ellison, Chairman and CEO of
Oracle Corp.; Steve Jobs, Chairman and CEO of Pixar Animation Studios; and
Jerome York, former CFO of IBM and Chrysler Corporation.
Other Factors
The majority of the Company's research and development activities, its
corporate headquarters, and other critical business operations, including
certain major vendors, are located near major seismic faults. The Company's
operating results and financial condition could be materially adversely
affected in the event of a major earthquake.
Production and marketing of products in certain states and countries may
subject the Company to environmental and other regulations which include,
in some instances, the requirement that the Company provide consumers with
the ability to return to the Company product at the end of its useful life,
and leave responsibility for environmentally safe disposal or recycling with
the Company. It is unclear what effect such regulation will have on the
Company's future operating results and financial condition.
The Company recently evaluated replacing its existing transaction systems
(which include order management, product procurement, distribution, and
finance) with a single integrated system, but has decided to continue
25
to use its existing transaction systems for the foreseeable future. The
Company's future operating results and financial condition could be adversely
affected if the Company is unable to effectively manage its existing
transaction systems.
Because of the foregoing factors, as well as other factors affecting the
Company's operating results and financial condition, past financial
performance should not be considered to be a reliable indicator of future
performance, and investors should not use historical trends to anticipate
results or trends in future periods. In addition, the Company's participation
in a highly dynamic industry often results in significant volatility of
the Company's common stock price.
Liquidity and Capital Resources
The Company's financial position with respect to cash, cash
equivalents, and short-term investments, net of notes payable to
banks, decreased to $1,103 million at June 27, 1997, from $1,559
million at September 27, 1996. The Company's financial position
with respect to cash, cash equivalents, and short-term
investments decreased to $1,230 million at June 27, 1997, from
$1,745 million at September 27, 1996. The Company's cash and
cash equivalent balance at June 27, 1997 and September 27, 1996,
includes $176 million and $177 million, respectively, pledged as
collateral to support letters of credit primarily associated with the
Company's purchase commitments under the terms of the sale of
the Company's Fountain, Colorado, manufacturing facility to SCI.
Cash used by operations during the first nine months of 1997
totaled $10 million, primarily due to the Company's net loss,
adjusted for non-cash expenses such as in-process research and
development, and a decrease in certain current liabilities, as well
as restructuring costs, partially offset by a decrease in accounts
receivable and inventories. The Company expects to use cash to
fund operations over at least the next quarter.
Cash used to acquire NeXT totaled $384 million in the second
quarter of 1997. The Company expects no additional cash
expenditures related to the NeXT acquisition. Cash used for the
purchase of property, plant, and equipment totaled $42 million in
the first nine months of 1997, and consisted primarily of
increases in manufacturing machinery and equipment. The
Company expects that the level of capital expenditures for the
remainder of 1997 will be comparable to the same period of 1996.
The Company's debt ratings remain unchanged from the second
quarter of 1997, when the Company's senior and subordinated
long-term debt were downgraded to B and CCC+, respectively, by
Standard and Poor's Rating Agency and to B3 and Caa,
respectively, by Moody's Investor Services. The Company was also
placed on negative credit watch by Moody's Investor Services.
These actions may increase the Company's cost of funds in future
periods. In addition, the Company may be required to pledge
additional collateral with respect to certain of its borrowings and
letters of credit and to agree to more stringent covenants than in
the past.
The Company believes that its balances of cash and cash
equivalents and short-term investments, including proceeds from the August
1997 sale of Apple Series A Non-voting Convertible Preferred Stock to
Microsoft, and continued short-term borrowings from banks, will be sufficient
to meet its cash requirements over the next 12 months. In addition to funding
an expected net loss for at least the next quarter, expected cash requirements
over the next twelve months include an estimated $100 million to effect
actions under the restructuring plan, most of which will be effected
over the next six months. Also, the notes payable to banks all become due
prior to September 30, 1997. No assurance can be given that short-term
borrowings from banks can be continued, or that any additional required
financing could be obtained should the restructuring plan take longer to
implement than anticipated or be unsuccessful. If the Company is unable to
obtain such financing, its liquidity, results of operations, and financial
condition would be materially adversely affected.
The Internal Revenue Service ("IRS") has proposed federal
income tax deficiencies for the years
26
1984 through 1991, and the Company has made certain
prepayments thereon. The Company contested the proposed
deficiencies by filing petitions with the United States Tax Court,
and most of the issues in dispute have now been resolved. On
June 30, 1997, the IRS proposed income tax adjustments for the
years 1992 through 1994. Although a substantial number of the
issues for these years have been resolved, certain issues still
remain in dispute and are being contested by the Company.
Management believes that adequate provision has been made for
any adjustments that may result from tax examinations.
27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Reference is made to page 45 of the Company's 1996 Annual Report on Form 10-K
under the subheading "Litigation" for a discussion of certain consumer class
actions relating to "repetitive stress injury" claims.
In July 1997, the Court in the case styled Abraham and Evelyn Kostick Trust
v. Peter Crisp et. al. granted in part and denied in part the Company's
motion to strike most of the substantive allegations of the second amended
complaint. The Court had previously sustained the demurrer to plaintiffs'
class claims but overruled the demurrer to the shareholder derivative claims.
The Company intends to make additional motions to dispose of the case on the
pleadings, including filing a demurrer to any amended complaint that plaintiffs
may elect to serve.
On July 8, 1997, the Court in the case styled LS Men's Clothing Defined
Benefit Pension Fund v. Michael Spindler et. al. sustained the Company's
demurrer dismissing the amended complaint with leave to amend. On July 28,
1997, plaintiff served a second amended complaint.
In March 1997, the Court in the case styled In re Computer Monitor Litigation
preliminarily approved a proposed settlement to which the Company and all but
three of the other defendants in the action would be parties and provisionally
certified a nationwide settlement class with respect thereto. A hearing
regarding final approval of the proposed settlement was held on June 30, 1997
and the Court's decision is pending. If approved, the Company does not
anticipate its obligations pursuant to the proposed settlement will have a
material adverse effect on its financial condition as reported in the
accompanying financial statements.
In June 1997, the Federal Trade Commission and the Company agreed to a consent
decree regarding the Company's past processor upgrade practices. The terms of
this decree would include an upgrade offer to customers and an agreement to
some terms about future activities by the Company. The consent decree is
pending court approval.
The Company has various other claims, lawsuits, disputes with third parties,
investigations and pending actions involving allegations of false or
misleading advertising, product defects, discrimination, infringement of
intellectual property rights, and breach of contract and other matters against
the Company and its subsidiaries incident to the operation of its business.
The liability, if any, associated with these matters was not determinable as
of the date of this filing.
The Company believes the resolution of the matters cited above will not have
a material adverse effect on its financial condition as reported in the
accompanying financial statements. However, depending on the amount and timing
of any unfavorable resolution of these lawsuits, it is possible that the
Company's future results of operations or cash flows could be materially
affected in a particular period.
28
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Note Description
10.A.26-1 Amendment to Employment Agreement, dated May 1, 1997,
between Apple Computer, Inc. and Gilbert F Amelio
10.A.45 Retention Agreement dated May 1, 1997, between
Apple Computer, Inc. and Fred D. Anderson
27 Financial Data Schedule.
(b) Reports on Form 8-K
Current reports on Form 8-K, dated April 10, 1997 and April 25,
1997, respectively, were filed by Registrant with the Securities and
Exchange Commission to report under Item 5 thereof the press
releases issued to the public on March 14, 1997 regarding the
Registrant's restructuring plan and expected second quarter
revenue and the press release issued to the public on April 16, 1997
regarding the Registrant's second quarter results.
29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
APPLE COMPUTER, INC.
(Registrant)
By: /s/Fred D. Anderson
Fred D. Anderson
Executive Vice President and Chief Financial Officer
August 11, 1997
30
INDEX TO EXHIBITS
Exhibit
Index
Number Note Description Page
10.A.26-1 Amendment to Employment Agreement, dated May 1,1997,
between Apple Computer, Inc. and Gilbert F. Amelio. 32
10.A.45 Retention Agreement dated May 1, 1997, between Apple
Computer, Inc. and Fred D. Anderson. 34
27 Financial Data Schedule. 47