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 December 26, 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 942404110
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
1 Infinite Loop 95014
Cupertino, California
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (408) 996-1010
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
Common Share Purchase Rights
(Titles of classes)
___________
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 ____
132,768,062 shares of Common Stock Issued and Outstanding as of January 30, 1998
1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
APPLE COMPUTER, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(Dollars in millions, except per share amounts)
THREE MONTHS ENDED
December 26, 1997 December 27, 1996
Net sales $ 1,578 $ 2,129
Costs and expenses:
Cost of sales 1,225 1,732
Research and development 79 149
Selling, general and administrative 234 372
1,538 2,253
Operating income (loss) 40 (124)
Interest and other income (expense), net 7 4
Income (loss) before provision (benefit)
for income taxes 47 (120)
Provision (benefit) for income taxes -- --
Net income (loss) $ 47 $ (120)
Basic earnings (loss) per share $ 0.37 $ (0.96)
Diluted earnings (loss) per share $ 0.33 $ (0.96)
Common shares used in the calculations
of basic earnings (loss) per share (in
thousands) 127,989 124,532
Common and common equivalent shares
used in the calculations of diluted
earnings (loss) per share (in thousands) 139,839 124,532
See accompanying notes to condensed consolidated financial statements
(unaudited).
2
APPLE COMPUTER, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
(In millions)
December 26, 1997 September 26, 1997
(Unaudited)
Current assets:
Cash and cash equivalents $ 1,193 $ 1,230
Short-term investments 434 229
Accounts receivable, net of allowance
for doubtful accounts of $96 ($99 at
September 26, 1997) 902 1,035
Inventories:
Purchased parts 99 141
Work in process 5 15
Finished goods 300 281
404 437
Deferred tax assets 233 259
Other current assets 207 234
Total current assets 3,373 3,424
Property, plant, and equipment:
Land and buildings 402 453
Machinery and equipment 416 460
Office furniture and equipment 100 110
Leasehold improvements 151 172
1,069 1,195
Accumulated depreciation and amortization (640) (709)
Net property, plant, and equipment 429 486
Other assets 324 323
$ 4,126 $ 4,233
See accompanying notes to condensed consolidated financial statements
(unaudited).
3
APPLE COMPUTER, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (Continued)
LIABILITIES AND SHAREHOLDERS' EQUITY
(Dollars in millions)
December 26, 1997 September 26, 1997
(Unaudited)
Current liabilities:
Notes payable to banks $ 24 $ 25
Accounts payable 655 685
Accrued compensation and employee benefits 92 99
Accrued marketing and distribution 261 278
Accrued warranty and related 126 128
Accrued restructuring costs 144 180
Other current liabilities 367 423
Total current liabilities 1,669 1,818
Long-term debt 952 951
Deferred tax liabilities 261 264
Commitments and contingencies
Shareholders' equity:
Series A non-voting convertible preferred
stock, no par value; 150,000 shares
authorized, issued and outstanding 150 150
Common stock, no par value; 320,000,000
shares authorized; 128,018,985 shares
issued and outstanding at December 26,
1997 (127,949,220 shares at September
26, 1997) 499 498
Retained earnings 636 589
Other (41) (37)
Total shareholders' equity 1,244 1,200
$ 4,126 $ 4,233
See accompanying notes to condensed consolidated financial statements
(unaudited).
4
APPLE COMPUTER, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in millions)
THREE MONTHS ENDED
December 26, 1997 December 27, 1996
Cash and cash equivalents, beginning
of the period $ 1,230 $ 1,552
Operating:
Net income (loss) 47 (120)
Adjustments to reconcile net income
(loss) to cash generated by operating
activities:
Depreciation and amortization 28 25
Changes in operating assets and liabilities:
Accounts receivable 133 4
Inventories 33 174
Deferred tax assets 26 18
Other current assets 27 (38)
Accounts payable (30) 29
Accrued restructuring costs (36) (12)
Other current liabilities (82) 30
Deferred tax liabilities (3) (18)
Cash generated by operating activities 143 92
Investing:
Purchase of short-term investments (399) (542)
Proceeds from sales and maturities of
short-term investments 194 102
Net proceeds from sale of property,
plant, and equipment 45 2
Purchase of property, plant, and equipment (7) (20)
Other (14) (10)
Cash used for investing activities (181) (468)
Financing:
Increase (decrease) in notes payable to banks (1) (6)
Increase (decrease) in long-term borrowings 1 1
Increases in common stock, net of related
tax benefits 1 3
Cash generated by (used for)
financing activities 1 (2)
Total cash used (37) (378)
Cash and cash equivalents, end of the period $ 1,193 $ 1,174
Supplemental cash flow disclosures:
Cash paid during the quarter for interest $ 20 $ 20
Cash paid(received) during the quarter
for income taxes, net $ (18) $ 20
See accompanying notes to condensed consolidated financial statements
(unaudited).
5
APPLE COMPUTER, INC.
Notes to Condensed 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 Condensed 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 26, 1997, included in its Annual Report on Form 10-K for the
year ended September 26, 1997 (the "1997 Form 10-K").
2. The Company has adopted Statement of Financial Accounting Standards No.
128 ("SFAS 128"), "Earnings Per Share". In accordance with SFAS 128,
primary earnings per share have been replaced with basic earnings per share,
and fully diluted earnings per share have been replaced with diluted earnings
per share which includes potentially dilutive securities such as outstanding
options and convertible securities. Prior periods have been presented to
conform to SFAS 128, however, as the Company had a net loss in the prior
period, basic and diluted loss per share are the same as the primary
loss per share previously presented.
Basic earnings per share is computed by dividing income available to common
shareholders by the weighted-average number of common shares outstanding
during the period. Diluted earnings per share is computed by dividing income
available to common shareholders by the weighted-average number of common
shares outstanding during the period increased to include the number of
additional common shares that would have been outstanding if the dilutive
potential common shares had been issued. The dilutive effect of outstanding
options is reflected in diluted earnings per share by application of the
treasury stock method. The dilutive effect of convertible securities is
reflected using the if-converted method. The following table sets forth the
computation of basic and diluted earnings per share (in thousands, except net
income (loss) and per share amounts):
For the Quarter ended For the Quarter ended
December 27, 1997 December 27, 1996
Numerator:
Net income (loss) $ 47 $ (120)
Denominator:
Denominator for basic earnings
(loss) per share -- weighted
average shares outstanding 127,989 124,532
Effect of Dilutive Securities:
Convertible preferred stock 9,091 --
Dilutive options outstanding 2,759 --
Dilutive potential common shares 11,850 --
Denominator for diluted
earnings per share -- adjusted
weighted-average shares and
assumed conversions 139,839 124,532
Basic earnings (loss) per share $ 0.37 $ (0.96)
Diluted earnings (loss) per share $ 0.33 $ (0.96)
6
For purposes of calculating diluted earnings per share for the first quarter
of 1998, the Company assumed that all employees exchanged their existing
options (See Note 5 to the Condensed Consolidated Financial Statements) for
new options with an exercise price of $13.6875 effective December 15, 1998.
Therefore, all options outstanding as of December 26, 1997, were included in
the computation of diluted earnings per share as they were all considered to
have exercise prices less than $18.05, the average market price of common
shares during the first quarter of 1998. However, the effect on dilutive
earnings per share of approximately 8.5 million of the outstanding options was
weighted to reflect that they were only considered outstanding and dilutive
options from December 19, 1997, the date of the Company's option exchange
offer to its employees, through the end of the quarter. The Company has
outstanding $661 million of unsecured convertible subordinated notes (the
"Notes") which are convertible by their holders into approximately 22.6
million shares of common stock at a conversion price of $29.205 per share
subject to the adjustments as defined in the Note agreement. The common
shares represented by these Notes were not included in the computation of
diluted earnings per share because the effect of using the if-converted method
would be anti-dilutive. For additional disclosures regarding the outstanding
preferred stock, employee stock options and the Notes, see the 1997 Form 10-K.
3. 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 the Company's 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. During 1997, the Company announced and began to
implement supplemental restructuring actions to meet the foregoing objectives
of the plan. The Company recognized a $217 million charge during 1997 for
the estimated incremental costs of those actions, including approximately $8
million of costs related to the termination of the Company's former Chief
Executive Officer. The combined restructuring actions consist of terminating
approximately 3,600 full-time employees, approximately 3,000 of whom have
been terminated from the second quarter of 1996 through December 26, 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 $195
million and noncash asset write-downs of $57 million from the second quarter
of 1996 through December 26, 1997. During the third quarter of 1997
and the first quarter of 1998, the Company made adjustments to the categories
and timing of expected restructure spending based on revised estimates. The
Company expects that the remaining $144 million accrued balance as of
December 26, 1997 will result in cash expenditures of approximately $102
million over the next twelve months and $10 million thereafter. The
Company expects that most of the contemplated restructuring actions related to
the plan will be completed during fiscal 1998 and will be financed through
current working capital and, if necessary, continued short-term borrowings.
7
The following table depicts the restructuring activity through
December 26, 1997:
(In millions)
Category Balance as of Spending Adjustments Balance as
September During During of December
26, 1997 Q1'98 Q1'98 26, 1997
Payments to employees
involuntarily terminated
(C) $ 76 $ 23 $ 1 $ 54
Payments on canceled or
vacated facility leases (C) 25 2 3 26
Write-down of operating
assets to be sold (N) 39 4 (3) 32
Payments on canceled
contracts (C) 40 7 (1) 32
$180 $ 36 $ -- $144
(C): Cash; (N): Noncash.
4. In August 1997, the Company agreed to acquire certain assets of
Power Computing Corporation ("PCC"), a company which Apple had licensed
to distribute the Mac OS operating system. In addition to the acquisition of
certain assets such as PCC's customer database and the license to
distribute the Mac OS, the Company has the right to retain certain key
employees of PCC. The agreement with PCC also includes a release of claims
between the parties.
On January 28, 1998, the Company completed its acquisition of
certain assets of PCC. The total purchase price was approximately $115
million, which included 4,159,000 shares of the Company's common stock
valued at $80 million, the forgiveness of approximately $28 million of
receivables due from PCC, assumption by the Company of certain
customer support liabilities of PCC, and closing and related costs. The
difference between the total purchase price and the $75 million expensed as
"Termination of License Agreement" in the fourth quarter of 1997 will be
capitalized in the second quarter of 1998 and then amortized over a period of
three years.
5. In order to address concerns regarding the retention of the Company's
key employees, in December 1997 the Board of Directors approved an option
exchange program which permits employees to exchange all (but not less than
all) of their existing options (vested and unvested) with an exercise price of
greater than $13.6875 on a one-for-one basis for new options with an exercise
price of $13.6875, the fair market value of the Company's common stock on
December 19, 1997, and a new four year vesting schedule beginning in
December 1997.
6. In October 1997, the American Institute of Certified Public
Accountants issued Statement of Position ("SOP") 97-2, "Software Revenue
Recognition." SOP 97-2 establishes standards relating to the recognition of all
aspects of software revenue. SOP 97-2 is effective for transactions entered
into in fiscal years beginning after December 15, 1997 and may require the
Company to modify certain aspects of its revenue recognition policies. The
Company does not expect the adoption of SOP 97-2 to have a material impact
on the Company's consolidated results of operations.
7. 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 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.
8. The information set forth in Item 1 of Part II hereof is hereby
incorporated by reference.
8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
This section and other parts of this Form 10-Q contain forward-looking
statements that involve risks and uncertainties. The Company's actual results
may differ significantly from the results discussed in the forward-looking
statements. Factors that might cause such differences include, but are not
limited to, those discussed in the subsection entitled "Factors That May
Affect Operating Results and Financial Condition" below.
The following discussion should be read in conjunction with the condensed
consolidated financial statements and notes thereto included elsewhere in this
Form 10-Q. All information is based on the Company's fiscal calendar.
Overview
During the first quarter of 1998 the Company experienced significant
improvement in its financial performance, reporting its first operating profit
since the fourth quarter of 1996 and earning higher gross margins than in both
the previous quarter and the same quarter of the prior year. Operating expenses
were substantially lower than in the previous quarter and the same
quarter from the prior year, reflecting reductions in all functional areas of
the Company as a result of continued restructuring actions. However, both net
sales and unit sales of Macintosh computer systems fell slightly from the
previous quarter and fell substantially from the same quarter in the prior
year. The second quarter has historically been the weakest for the Company.
Therefore, sequential revenue growth is not expected until at least the third
quarter, while year-over-year revenue growth is not expected until at least
the fourth quarter. The Company believes that gross margin levels on its
current products are sustainable for several quarters and that operating
expenses will continue to trend downward through the third quarter. The
foregoing statements are forward looking. The Company's actual results could
differ because of several factors, including those set forth in the following
paragraph, and those discussed in the subsection entitled "Factors That May
Affect Operating Results and Financial Condition" below.
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 are also dependent upon 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, among other things, 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 Mac OS and to make timely
delivery of a new and substantially backward-compatible operating system; the
Company's ability to successfully integrate the technologies, processes and
employees of NeXT Software, Inc. ("NeXT") ,which was acquired by the Company
in 1997, 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; the availability of third-party software for particular
applications; and the impact on the Company's sales, market share and gross
margins as a result of the Company winding down its Mac OS licensing program.
9
Results of Operations
First First First Fourth
Quarter Quarter Quarter Quarter
1998 1997 Change 1998 1997 Change
(Tabular information: Dollars in millions, except per share amounts)
Net sales $1,578 $2,129 (26%) $1,578 $1,614 (2%)
Gross margin $353 $397 (11%) $353 $320 10%
Percentage of net sales 22% 19% 22% 20%
Research and development $79 $149 (47%) $79 $94 (16%)
Percentage of net sales 5% 7% 5% 6%
Selling, general and
administrative $234 $372 (37%) $234 $259 (10%)
Percentage of net sales 15% 17% 15% 16%
Special Charges
Restructuring costs $-- $-- NM $-- $62 NM
Percentage of net sales -- -- -- 4%
Termination of license
agreement $-- $-- NM $-- $75 NM
Percentage of net sales -- -- -- 5%
Interest and other income
(expense), net $7 $4 75% $7 $9 (22%)
Net income (loss) $47 $(120) 139% $47 $ (161) 129%
Basic earnings (loss)
per share $0.37 $(0.96) 139% $0.37 $(1.26) 129%
Diluted earnings (loss)
per share $0.33 $(0.96) 134% $0.33 $(1.26) 126%
NM: Not Meaningful
Net Sales
Q1 98 Compared with Q1 97
Net sales represent the Company's gross sales net of returns, rebates and
discounts. Net sales decreased 26% in the first quarter of 1998 compared with
the same quarter of 1997. Total Macintosh computer unit sales and peripheral
unit sales decreased 31% and 49%, respectively, in the first quarter of
1998, compared with the same period of 1997. The effect on net sales of this
decline in computer and peripheral unit sales in the first quarter of 1998 was
partially offset by the successful introduction of the Company's Power
Macintosh G3 systems in November 1997, which accounted for approximately
21% of the 635,000 systems shipped during the first quarter of 1998. The
average aggregate revenue per Macintosh unit increased 6% in the first quarter
of 1998, compared with the same period of 1997, as a result of a shift in mix
from the Company's "Value" (entry level Power Macintosh) products to its
"Flagship" line of high-performance Power Macintosh computers and due to
increases in the average aggregate revenue across all product lines. In
general, the average aggregate revenue per Macintosh computer unit and per
peripheral unit is expected to remain under significant downward pressure due
to a variety of factors, including industry wide pricing pressures, increased
competition, and the need to stimulate demand for the Company's products.
International net sales represented 50% of total net sales in the first quarter
of 1998 compared with 56% of total net sales in the same period of 1997.
International net sales declined 34% in the first quarter of 1998 compared with
the same period of 1997. Net sales decreased significantly in the European and
Japanese markets during the first quarter of 1998 compared with the same
period of 1997 as a result of decreases in Macintosh and peripheral unit
sales. Further discussion relating to factors contributing to the decline in
net sales in the Japanese market may be found in this Part I, Item 2 of Form
10-Q
10
under the subheading "Global Market Risks" included under the heading
"Factors That May Affect Future Results and Financial Condition," which
information is hereby incorporated by reference.
Domestic net sales declined 16% in the first quarter of 1998 over the
comparable period of 1997, due to decreases in unit sales of Macintosh
computers and peripheral products, partially offset by increases in the average
aggregate revenue per Macintosh and peripheral unit.
During the first quarter of 1998 compared with the comparable period of 1997,
the Company's estimated share of the worldwide and U.S. personal computer
markets decreased to 2.6% from 4.3%, and to 3.3% from 5.2%, respectively,
based upon current market information provided by industry sources.
The Company believes that quarterly net sales will be below the level of the
prior year's comparable periods through at least the third fiscal quarter of
1998, if not longer.
Q1 98 Compared with Q4 97
Net sales decreased 2% in the first quarter of 1998 compared with the fourth
quarter of 1997. Total Macintosh computer unit sales decreased 4% in the first
quarter of 1998 compared with the prior quarter. The effect on net sales of
this decline in unit sales was partially offset by the successful introduction
of the Company's Power Macintosh G3 systems in November 1997, which accounted
for approximately 21% of the 635,000 systems shipped during the first quarter
of 1998. In addition, net sales were positively impacted as the Company began
marketing many of its products directly to end users in the U.S. through the
Company's on-line store, which opened in November 1997. The Company
generated $15 million in revenue from its on-line store during the first
quarter of 1998. Unit sales of peripheral products decreased 15% in the first
quarter of 1998 compared with the prior quarter. The average aggregate
revenue per Macintosh computer unit increased 5% as a result of a shift in mix
from the Company's "Value" products to its "Flagship" line of high-
performance Power Macintosh computers and due to increases in the average
aggregate revenue across most other product lines.
International net sales represented 50% of total net sales in the first
quarter of 1998, compared with 42% in the fourth quarter of 1997.
International net sales increased 16% in the first quarter of 1998 compared
with the fourth quarter of 1997, primarily as a result of increases in
Macintosh and peripheral unit net sales in Europe and increases in net sales
of Macintosh units in Japan.
Domestic net sales decreased 16% in the first quarter of 1998 compared with
the prior quarter due to decreases in Macintosh and peripheral unit sales,
slightly offset by increases in the average aggregate revenue per Macintosh
and peripheral unit.
During the first quarter of 1998 compared with the fourth quarter of 1997, the
Company's estimated share of the worldwide and U.S. personal computer
markets decreased to 2.6% from 3.3%, and to 3.3% from 4.6%, respectively,
based upon current market information provided by industry sources.
Backlog
In the Company's experience, the actual amount of product backlog at any
particular time is not 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 overordering
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. Further information
regarding the Company's backlog may be found in Part I, Item 2 of this Form
10-Q under the subheading "Product Introductions and Transitions" included
under the heading "Factors That May Affect Future Results and Financial
Condition," which information is hereby incorporated by reference.
11
Gross Margin
Gross margin represents the difference between the Company's net sales and its
cost of goods sold. 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 industry wide competitive
pressures.
Gross margin increased from 18.6% to 22.4% of sales during the first quarter
of 1998 compared to the same period of 1997, and increased from 19.8% to
22.4% of sales compared to the fourth quarter of 1997. This was primarily as a
result of a shift in revenue mix towards the Company's higher margin
"Flagship" line of high-performance Power Macintosh computers, including
Power Macintosh G3 systems, with relatively stable margins quarter-to-quarter
on the Company's "Value" product line.
The gross margin levels in the first quarter of 1998 compared to the fourth
quarter of 1997 were not significantly affected by changes in foreign exchange
rates. 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.
While the Company believes the overall gross margin levels achieved in the
first quarter of 1998 are sustainable for several quarters, there can be no
assurance that such margins will be maintained. In general, gross margins will
remain under significant downward pressure due to a variety of factors,
including continued industry wide global pricing pressures, increased
competition, compressed product life cycles, and potential changes to the
Company's product mix. In response to these 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.
Research and Development
First First First Fourth
Quarter Quarter Quarter Quarter
1998 1997 Change 1998 1997 Change
Research and development $79 $149 (47%) $79 $94 (16%)
Percentage of net sales 5% 7% 5% 6%
Research and development expenditures decreased in amount and as a
percentage of net sales in the first quarter of 1998 compared with the fourth
quarter of 1997 and the first quarter of 1997 due to various restructuring
actions which resulted in reductions in headcount and cancellation of certain
research and development related projects.
The Company believes that continued and focused 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 anticipates that research and development expenditures
in the second quarter of 1998 will be comparable to those in the first quarter.
12
Selling, General and Administrative
First First First Fourth
Quarter Quarter Quarter Quarter
1998 1997 Change 1998 1997 Change
Selling, general and
administrative $234 $372 (37%) $234 $259 (10%)
Percentage of net sales 15% 17% 15% 16%
Selling, general and administrative expenditures decreased in amount and as a
percentage of net sales in the first quarter of 1998 when compared to the
fourth quarter of 1997 and the first quarter of 1997 due to various
restructuring actions which resulted in reductions in headcount, the closing
of facilities, the write-down of assets, and lower ongoing variable expenses.
The Company anticipates that selling, general and administrative expenditures
will decline further during the second quarter of 1998 as compared to the first
quarter of 1998 as the Company completes and more fully realizes the cost
reduction benefits of its restructuring plan and lower ongoing variable selling
expenses.
Interest and Other Income (Expense), Net
First First First Fourth
Quarter Quarter Quarter Quarter
1998 1997 Change 1998 1997 Change
Interest and other income
(expense), net $7 $4 75% $7 $9 (22%)
Interest and other income (expense), net, is comprised of interest income on
the Company's cash and investment balances, interest expense on the
Company's debt, gains and losses recognized on investments accounted for
using the equity method, foreign exchange gains and losses not allowed
to be recognized as revenue or cost of sales, and other
miscellaneous income and expense items. Over the last two
years, the Company's debt ratings have been downgraded to
non-investment grade. The Company's cost of funds may
increase in future periods as a result of the downgrading in the
second quarter of 1997 of its senior and subordinated long-term
debt to B3 and Caa2, respectively, by Moody's Investor
Services, and the downgrading in October 1997 of its senior
and subordinated long-term debt to B- and CCC, respectively,
by Standard and Poor's Rating Agency.
Provision (Benefit) for Income Taxes
As of December 26, 1997, the Company had deferred tax assets
arising from deductible temporary differences, tax losses, and
tax credits of $696 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.
As of December 26, 1997, a valuation allowance of $211
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 representing tax loss
and credit carryforwards 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 forecasted U.S. income, including income that may be
generated as a result of certain tax planning strategies, will be
sufficient to utilize the tax carryforwards prior to their
expiration in 2011 and 2012 to fully recover this asset.
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 consolidated 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.
13
Factors That May Affect Future Results and Financial Condition
Restructuring of Operations
During 1996, the Company began to implement certain
restructuring actions aimed at reducing its cost structure,
improving its competitiveness, and restoring sustainable
profitability. During 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 sustainable profitability and the risk
that cost-cutting initiatives will impair the Company's ability
to innovate and remain competitive in the computer industry.
Implementation of this restructuring 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 restructuring 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 and distributed, or lose
the flexibility to make timely changes in production schedules
in order to respond to changing market conditions. As part of
its restructuring, the Company announced and opened its on-
line store in November 1997, which makes available most of
its products to end-users in the U.S. There can be no assurance
the on-line store will result in greater sales. The Company also
began manufacturing products on a build-to-order basis in
November 1997. There can be no assurance this manufacturing
process will result in decreased costs or increased gross margins.
The Company is also reducing the number of wholesale and
retail channel partners, particularly in the Americas, which
places a greater volume of sales through fewer partners. There
can be no assurance that this will not adversely impact the
Company. In addition, the actions taken in connection with the
restructuring could adversely affect employee morale, thereby
damaging the Company's ability to retain and motivate
employees. Also, because the Company contemplates relying
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, 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 restructuring includes
the winding down of the Company's Mac OS licensing
program. There can be no assurance that the winding down of
this program will result in greater sales, market share, and
increased gross margins to the Company. In addition, there can
be no assurance that this action will not result in the
availability of fewer application software titles for the Mac OS,
which may result in a decrease to the Company's sales, market
share and gross margins. Finally, even if the restructuring 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 in connection with the restructuring, including its
acquisition of NeXT and the winding down of its Mac OS
licensing program, 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
sustainable profitability. The Company's future consolidated
operating results and financial condition could be adversely
affected should it encounter difficulty in effectively managing
the restructuring and new cost structure.
Additional information relating to the restructuring of
operations may be found in Part I of this Form 10-Q in Note 3
of the Notes to Condensed Consolidated Financial Statements
(Unaudited), 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 must
continuously introduce new products and technologies and
enhance existing products in order to remain competitive.
Recent introductions include certain PowerBook and Power
Macintosh products, including the Power Macintosh G3
computers in November 1997, and the introduction of Mac OS
8 in July 1997. The success of new product introductions is
dependent on a number of
14
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 effect that new products will have on its sales or
results of operations. In addition, although the number of new
product introductions may decrease as a result of the Company's
restructuring actions, 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 Company has in the past experienced difficulty in
anticipating demand for new products, resulting in product
shortages which have adversely affected the Company's
operating results.
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 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 U.S., even though
localized versions of the Company's products may be available.
The increasing integration of new or enhanced 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 operating system
(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 can be completed at reasonable cost or at all. 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 consolidated operating results and
financial condition.
15
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
consolidated results of operations and financial condition have
been, and in the future may continue to be, adversely affected by
industry wide 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, as well as broader product lines and larger installed
customer bases than those of the Company.
The Company's future consolidated 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 Microsoft Windows 95 and Windows
NT operating systems. The Company believes that the Mac
OS, with its perceived advantages over Windows, and the
general reluctance of the Macintosh installed base to incur the
costs of switching platforms, have been driving forces 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 a new version of Windows to
be introduced in 1998, have added features to the Windows
platform that 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 consolidated
operating results and financial condition will be substantially
dependent on its ability to maintain continuing improvements
to the Macintosh platform in order to maintain perceived
functional advantages over competing platforms.
The Company had previously entered into agreements to license
its Mac OS to other personal computer vendors (the "Clone
Vendors") as part of an effort to increase the installed base for
the Macintosh platform. The Company recently determined that
the benefits of licensing the Mac OS to the Clone Vendors
under these agreements were more than offset by the impact and
costs of the licensing program. As a result, the Company
agreed to acquire certain assets, including the license to
distribute the Mac OS, of PCC, a Clone Vendor, and has no
plans to renew its other Mac OS licensing agreements.
Although the Company believes that this winding down of its
licensing program will help reduce the adverse impact of the
licensing program on the Company's sales, market share and
gross margins, there can be no assurance that this will occur. In
addition, there can be no assurance that this winding down of
the licensing program will not result in the availability of fewer
application software titles for the Mac OS, which may result in
a decrease to the Company's sales, market share and gross
margins.
As a supplemental means of addressing the competition from
Windows and other platforms, the Company had previously
devoted substantial resources toward developing personal
computer products capable of running application software
designed for the Windows operating systems. These products
include an add-on card containing a Pentium or 586-class
microprocessor that enables users to run applications
concurrently that require the Mac OS, Windows 3.1 or
Windows 95 operating systems. The Company plans to
transition the cross-platform business to third-parties during
1998. There can be no assurance that this transition will be
successful.
The Company, International Business Machines Corporation
and Motorola, Inc. had agreed upon and announced the
availability of specifications for a PowerPC microprocessor-
based hardware platform (the "Platform"). These specifications
defined a "unified" personal computer architecture that would
have given the Clone Vendors broad access to the Power
Macintosh platform and would have utilized standard industry
components. The Company had intended to license the Mac OS
to manufacturers of the Platform. However, the Company has
decided it will no longer support the Platform based upon its
decision to wind down its Mac OS licensing program, and
because of
16
little industry support for the Platform. The decision not to
further develop this Platform may affect the Company's ability
to increase the installed base for the Macintosh 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.
In August 1997, the Company and Microsoft entered into
patent cross licensing and technology agreements. Under these
agreements, the companies provided patent cross licenses to
each other. In addition, for a period of five years from August
1997, 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. In addition, Microsoft
purchased 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, among other things, 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.
Support from Third-Party Software Developers
Decisions by customers to purchase the Company's personal
computers, as opposed to 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 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 products, as well as the
Company's decision to wind down its Mac OS licensing
program, 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 Windows
market. Moreover, the Company's current plan to introduce a
new operating system (code named "Rhapsody") could cause
software developers to stop developing software for the current
Mac OS. In addition, there can be no assurance that software
developers will decide to develop software for the new operating
system on a timely basis or at all.
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 the Company competes
with Microsoft. Accordingly, Microsoft's interest in producing
application software for the Mac OS 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
consolidated 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 U.S. dollar versus
the local currency in which the products are sold.
Countries in the Asia Pacific region, including Japan, have
recently experienced weaknesses in their currency, banking and
equity markets. These weaknesses could adversely affect
consumer demand for the Company's products,
17
the U.S. dollar value of the Company's foreign currency
denominated sales, the availability and supply of product
components to the Company, and ultimately the Company's
consolidated results of operations.
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).
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
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 costs associated with foreign
currency hedges. To mitigate the impact of fluctuations in U.S.
interest rates, the Company has entered into interest rate swap,
collar, and floor transactions.
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 consolidated
operating results and financial position. The Company does not
engage in leveraged hedging.
The Company's current financial condition may 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 makes a provision for 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
provisions are adequate given the rapid and unpredictable pace of
product obsolescence in the computer industry, 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 consolidated
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 consolidated 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 sold its Fountain,
Colorado, manufacturing facility to SCI and entered into a
related manufacturing outsourcing agreement with SCI; sold its
Singapore printed circuit board manufacturing assets to NatSteel
Electronics Pte., Ltd., which is
18
expected to 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 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 and distribution. 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
consolidated operating results and financial condition.
Although certain components essential to the Company's
business are generally available from multiple sources, other
key components (including microprocessors and application
specific integrated circuits ("ASICs")) are currently obtained by
the Company from single sources. If the supply of a key
single-sourced 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 consolidated 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 sole suppliers of the PowerPC RISC
microprocessor for the Company's Macintosh computers, 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, and other developers and producers of the
microprocessors used by most personal computers using the
Windows operating systems. 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. In addition,
Motorola has recently announced its intention to stop producing
Macintosh clones. As a result, Motorola may be less inclined
to continue to produce PowerPC microprocessors.
The Company's current financial condition and uncertainties
related to recent events could affect 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 consolidated operating results and
financial condition could be adversely affected if the Company
is unable to continue to obtain key components on terms
substantially similar to those currently available to the
Company.
19
Marketing and Distribution
A number of uncertainties may affect the marketing and
distribution of the Company's products. Currently, the
Company distributes its products through wholesalers, resellers,
mass merchants, and cataloguers (collectively referred to as
"resellers") and direct to higher education institutions. In
addition, in November 1997 the Company began selling many
of its products directly to end users in the U.S. through the
Company's on-line store. Many of the Company's significant
resellers operate on narrow product margins. Most such resellers
also distribute products from competing manufacturers. 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
continue to cause resellers to reduce their ordering and
marketing of the Company's products. In addition, the
Company has in the past and may in the future experience
delays in ordering by resellers in light of uncertain demand for
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 recently revised its channel program, including decreasing
the number of resellers and reducing returns, price protection
and certain rebate programs, in an effort to reduce channel
inventory, increase inventory turns, increase product support
within the channel and improve gross margins. In addition, in
November 1997 the Company opened its on-line store in the
U.S. which makes many of the Company's products available
directly to the end-user. Although the Company believes the
foregoing changes will improve its consolidated operating
results and financial condition, there can be no assurance that
this will occur.
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 consolidated operating results and financial
condition during the period until a new Chief Executive Officer
is hired and afterward. In addition, certain members of the
Company's senior management have been with the Company
for less than twelve months. There can be no assurance that
new members of the management team can be successfully
assimilated, that the Company will be able to satisfactorily
allocate responsibilities or that such new members of its
management will succeed in their roles in a timely and efficient
manner. The Company's failure to recruit, retain and assimilate
new executives, or the failure of any such executive to perform
effectively, or the loss of any such executive, could have a
material adverse impact on the Company's business, financial
condition and results of operations.
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 C.C. Chang,
Corporate Senior Vice President, Marketing, Hughes
Electronics and President, Hughes International, and Edgar S.
Woolard, Jr., retired Chairman of E.I. DuPont de Nemours &
Company. The new directors are William V. Campbell,
President and CEO of Intuit Corp.; Lawrence J. Ellison,
Chairman and Chief Executive Officer of Oracle Corp.; Steven
P. Jobs, Chairman and Chief Executive Officer of Pixar
Animation Studios; and Jerome B. York, Vice Chairman of
Tracinda Corporation and former Chief Financial Officer of IBM
and Chrysler Corporation.
Dependence on Key Employees
During the past several years, the Company has experienced
significant voluntary employee turnover as a result of
employees' concerns over the Company's prospects, as well as
the abundance of career opportunities available elsewhere. The
Company is dependent on its key employees in order to achieve
its business plan. There can be no assurance the Company will
be able to attract, motivate and retain key employees. Failure to
do so may have a significant effect on the Company's
consolidated operating results and financial condition.
20
Other Factors
The Company is in the process of identifying operating and
application software challenges related to the year 2000. While
the Company expects to resolve year 2000 compliance issues
substantially through normal replacement and upgrades of
software, there can be no assurance that there will not be
interruption of operations or other limitations of system
functionality or that the Company will not incur substantial
costs to avoid such limitations. Any failure to effectively
monitor, implement or improve the Company's operational,
financial, management and technical support systems could
have a material adverse effect on the Company's business and
consolidated results of operations.
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 consolidated 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 regulations
will have on the Company's future consolidated operating
results and financial condition.
The Company recently decided to replace its existing transaction
systems in the U.S. (which include order management, product
procurement, distribution, and finance) with a single integrated
system as part of its ongoing effort to increase operational
efficiency. Substantially all of the transaction systems in the
European operations were replaced with the same integrated
system in 1997. The Company's future consolidated operating
results and financial condition could be adversely affected if the
Company is unable to implement and effectively manage the
transition to this new integrated system.
Because of the foregoing factors, as well as other factors
affecting the Company's consolidated 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.
21
Liquidity and Capital Resources
The Company's consolidated financial position with respect to
cash, cash equivalents, and short-term investments increased to
$1,627 million as of December 26, 1997, from $1,459 million
as of September 26, 1997. The Company's cash and cash
equivalent balances as of December 26, 1997 and September 26,
1997 include $164 million and $165 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 generated by operations during the first quarter of 1998
totaled $143 million. Cash generated by operations was
primarily the result of positive earnings and decreases in
accounts receivable and inventories, partially offset by
decreases in accounts payable and other current liabilities and
payments related to restructuring actions.
Net cash used for the purchase of property, plant, and equipment
totaled $7 million in the first quarter of 1998, and consisted
primarily of increases in manufacturing machinery and
equipment. The Company expects that the level of capital
expenditures in the second quarter of 1998 will increase slightly
as compared to the first quarter.
Over the last two years, the Company's debt ratings have been
downgraded to non-investment grade. In October 1997, the
Company's senior and subordinated long-term debt were
downgraded to B- and CCC, respectively, by Standard and
Poor's Rating Agency. The Company's senior and subordinated
long-term debt ratings by Moody's Investor Services remain
unchanged from the second quarter of 1997, when they were
downgraded to B3 and Caa2, respectively. Both Standard and
Poor's Rating Agency and Moody's Investor Services have the
Company on negative outlook. 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, and continued short-
term borrowings from banks, will be sufficient to meet its cash
requirements over the next twelve months. Expected cash
requirements over the next twelve months include an estimated
$102 million to effect actions under the restructuring plan,
most of which will be effected during fiscal 1998. No assurance
can be given 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 could be materially adversely affected.
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 U.S. 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.
22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Abraham and Evelyn Kostick Trust v. Peter Crisp et al.
In January 1996, a purported shareholder class action styled
Abraham and Evelyn Kostick Trust v. Peter Crisp et. al was
filed in the California Superior Court for Santa Clara County
naming the Company and its then directors as defendants. The
complaint sought injunctive relief and damages and alleged that
acts of mismanagement resulted in a depressed price for the
Company. In February 1996, the complaint was amended to add
a former director as a defendant and to add purported class and
derivative claims based on theories such as breach of fiduciary
duty, misrepresentation, and insider trading. In July 1996, the
Court sustained defendants' demurrer and dismissed the amended
complaint on a variety of grounds and granted plaintiffs leave to
amend the complaint. In October 1996, the plaintiffs filed a
second amended complaint naming the Company's then
directors and certain former directors as defendants and again
alleging purported class and derivative claims, seeking
injunctive relief and damages (compensatory and punitive) based
on theories such as breach of fiduciary duty, misrepresentation,
and insider trading. In July 1997, the Court 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 sustained the demurrer to plaintiffs' class claims but
overruled the demurrer to the shareholder derivative claims. In
September 1997, the Company brought a motion to reconsider
portions of the court order. The Third Amended Complaint
was filed in October 1997, and eliminated the class action
claims and restated claims against certain directors and former
directors. In November 1997, the Company's Board of Directors
appointed a special investigation committee and engaged
independent counsel to assist in the investigation of the claims
made in the Third Amended Complaint. Also in November
1997, the Company filed a demurrer to the Third Amended
Complaint. A hearing is set for February 1998.
LS Men's Clothing Defined Benefit Pension Fund v. Michael Spindler et al.
In May 1996, an action was filed in the California Superior
Court for Alameda County naming as defendants the Company
and certain of its current and former officers and directors. The
complaint seeks compensatory and punitive damages and
generally alleges that the defendants misrepresented or omitted
material facts about the Company's operations and financial
results, which plaintiff contends artificially inflated the price of
the Company's stock. The case was transferred to the California
Superior Court for Santa Clara County. In July 1997, the
Court sustained the Company's demurrer dismissing the
amended complaint with leave to amend, after which plaintiff
served a second amended complaint. In September 1997, the
Company and the two remaining individual defendants (former
directors Markkula and Spindler) brought a motion to dismiss
the second amended complaint. In October 1997, the Court
granted the motion to dismiss in its entirety with leave to
amend as to certain defendants and claims. In November 1997,
the plaintiff filed a third amended complaint, adding a former
director as a defendant and alleging further misrepresentations by
the defendants about the Company's operations and financial
results. In January 1998, the Company and the three individual
defendants brought a motion to dismiss the third amended
complaint, which is set for hearing in February 1998.
"Repetitive Stress Injury" Litigation
The Company is named in approximately 60 lawsuits, alleging
that plaintiffs incurred so-called "repetitive stress" injuries to
their upper extremities as a result of using keyboards and/or
mouse input devices sold by the Company. These actions are
similar to those filed against other major suppliers of personal
computers. In October 1996, the Company prevailed in the first
full trial to go to verdict against the Company. Since then,
approximately ten lawsuits have been dismissed with prejudice
by the plaintiffs, and two others have been dismissed by court
order. The remaining actions are in various stages of pretrial
activity. Ultimate resolution of these cases may depend on
industry-wide progress in resolving similar litigation, as well as
on the impact of the recent decision handed down by the New
York Court of Appeals in the case of Blanco v. American
Telephone and Telegraph Co. (a majority of the cases naming
the Company as a defendant were filed in New York, and are
subject to the decision). In that decision, the court announced a
new standard for determining when the statute of limitations
period begins to accrue in so-
23
called "repetitive stress" injury cases. While the decision could
result in the revival of some cases which were previously
dismissed, the decision will not cause the Company to alter its
strategy in these cases.
Monitor-Size Litigation
In August 1995, the Company was named, along with 41 other
entities, including computer manufacturers and computer
monitor vendors, in a putative nationwide class action filed in
the California Superior Court for Orange County, styled Keith
Long et al. v. AAmazing Technologies Corp. et al. The
complaint alleges that each of the defendants engaged in false or
misleading advertising with respect to the size of computer
monitor screens. Also in August 1995, the Company was
named as the sole defendant in a purported class action alleging
similar claims filed in the New Jersey Superior Court for
Camden County, entitled Mahendri Shah v. Apple Computer,
Inc. Subsequently, in November 1995, the Company, along
with 26 other entities, was named in a purported class action
alleging similar claims filed in the New Jersey Superior Court
for Essex County, entitled Maizes & Maizes v. Apple
Computer, Inc. et al. Similar putative class actions have been
filed in other California counties in which the Company was
not named as a defendant. The complaints in all of these cases
seek restitution in the form of refunds or product exchange,
damages, punitive damages, and attorneys fees. In December
1995, the California Judicial Council ordered all of the
California actions, including Long, coordinated for purposes of
pretrial proceedings and trial before a single judge, the
Honorable William Cahill, sitting in the County of San
Francisco. All of the California actions were subsequently
coordinated under the name In re Computer Monitor Litigation,
and a master consolidated complaint was filed superseding all of
the individual complaints in those actions. In July 1996, Judge
Cahill ordered all of the California cases dismissed without
leave to amend as to plaintiffs residing in California on the
ground that a stipulated judgment entered in September 1995 in
a prior action brought by the California Attorney General
alleging the same cause of action was res judicata as to the
plaintiffs in the consolidated California class action suits. This
order may be subject to appellate review at a later stage of the
proceedings. Both the New Jersey cases and the consolidated
California cases are at a preliminary stage, with no discovery
having taken place. 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 consolidated results of
operations or financial condition as reported in the
accompanying financial statements.
Exponential Technology v. Apple
Plaintiff alleges in a lawsuit styled Exponential Technology,
Inc. v. Apple Computer, Inc. that the Company, which was an
investor in Exponential, breached its fiduciary duty to
Exponential by misusing confidential information about its
financial situation to cause Exponential to fail, and that the
Company fraudulently misrepresented the facts about allowing
Exponential to sell its processors to the Company Mac OS
licensees. The lawsuit is filed in California State Court in
Santa Clara County. In November 1997, the Company filed a
demurrer to portions of the complaint, which the court granted
in part. In January 1998, plaintiff filed an Amended Complaint.
Other
On August 21, 1997, the Federal Trade Commission issued its
consent decree against the Company, regarding the Company's
past processor upgrade practices, specifically certain
advertisements which the Commission deemed to have
misrepresented the Company's marketing of certain
microprocessor upgrade products. Pursuant to the order, the
Company is ordered to cease and desist from any such allegedly
misleading advertising, to give notice to consumers, and to
implement certain programs enabling consumers who are
within the order's scope to obtain upgrade kits or rebates, in
connection with any purchases within the scope of the order.
The Company has complied with all provisions of the order
currently effective, and has filed its 60-day compliance with the
Commission on October 17, 1997.
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 is not
determinable.
24
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 consolidated results of operations or cash flows could be
materially affected in a particular period.
25
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description
10.A.5 1990 Stock Option Plan, as amended through November 5, 1997.
27 Financial Data Schedule.
26
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
February 6, 1998
27
INDEX TO EXHIBITS
Exhibit
Index
Number Description Page
10.A.5 1990 Stock Option Plan, as amended through November 5, 1997. 29
27 Financial Data Schedule. 38
28