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 26, 1998 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
Cupertino, California 95014
(Address of principal executive (Zip Code)
offices)
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 ____
134,639,382 shares of Common Stock Issued and Outstanding as of August 4, 1998
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 NINE MONTHS
ENDED ENDED
June 26, June 27, June 26, June 27,
1998 1997 1998 1997
Net sales $ 1,402 $ 1,737 $ 4,385 $ 5,467
Costs and expenses:
Cost of sales 1,042 1,389 3,323 4,419
Research and development 76 101 230 391
Selling, general and
administrative 216 307 673 1,027
In-process research and
development 7 -- 7 375
Restructuring costs -- -- -- 155
____ _____ _____ _____
1,341 1,797 4,233 6,367
Operating income (loss) 61 (60) 152 (900)
Interest and other income
(expense), net 48 4 63 16
____ _____ _____ _____
Income (loss) before provision
for income taxes 109 (56) 215 (884)
Provision for income taxes 8 -- 12 --
____ _____ _____ _____
Net income (loss) $ 101 $ (56) $ 203 $ (884)
____ _____ _____ _____
Earnings (loss) per common share:
Basic $ 0.76 $ (0.44) $ 1.55 $ (7.04)
Diluted $ 0.65 $ (0.44) $ 1.40 $ (7.04)
Shares used in computing
earnings (loss) per common
share (in thousands):
Basic 133,068 126,500 130,971 125,547
Diluted 171,786 126,500 145,177 125,547
See accompanying notes to condensed consolidated financial statements
(unaudited).
2
APPLE COMPUTER, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
(In millions)
June 26, 1998 September 26, 1997
(Unaudited)
Current assets:
Cash and cash equivalents $ 1,203 $ 1,230
Short-term investments 790 229
Accounts receivable, net of allowance
for doubtful accounts of $90 ($99 at
September 26, 1997) 915 1,035
Inventories:
Purchased parts 54 141
Work in process 8 15
Finished goods 67 281
______ ______
129 437
Deferred tax assets 192 259
Other current assets 146 234
______ ______
Total current assets 3,375 3,424
Property, plant, and equipment:
Land and buildings 352 453
Machinery and equipment 379 460
Office furniture and equipment 93 110
Leasehold improvements 134 172
______ ______
958 1,195
Accumulated depreciation and amortization (593) (709)
______ ______
Net property, plant, and equipment 365 486
Other assets 301 323
______ ______
$ 4,041 $ 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)
June 26, 1998 September 26, 1997
(Unaudited)
Current liabilities:
Notes payable to banks $ -- $ 25
Accounts payable 573 685
Accrued compensation and employee benefits 91 99
Accrued marketing and distribution 234 278
Accrued warranty and related 124 128
Accrued restructuring costs 77 180
Other current liabilities 290 423
______ ______
Total current liabilities 1,389 1,818
Long-term debt 953 951
Deferred tax liabilities 213 264
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; 133,130,984 shares issued and
outstanding at June 26, 1998 (127,949,220
shares at September 26, 1997) 592 498
Retained earnings 792 589
Other (48) (37)
______ ______
Total shareholders' equity 1,486 1,200
______ ______
$ 4,041 $ 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)
NINE MONTHS ENDED
June 26, 1998 June 27, 1997
Cash and cash equivalents, beginning of the period $1,230 $1,552
Operating:
Net income (loss) 203 (884)
Adjustments to reconcile net income (loss) to cash
generated by (used for) operating activities:
Depreciation and amortization 88 77
Loss on sale of property, plant, and equipment -- 31
In-process research and development 7 375
Gain on equity investment in ARM (40) --
Provision for deferred income taxes 6 (54)
Changes in operating assets and liabilities, net
of effects of acquisition of NeXT:
Accounts receivable 112 297
Inventories 308 128
Other current assets 68 55
Accounts payable (112) 20
Accrued restructuring costs (73) 83
Other current liabilities (115) (133)
_____ _____
Cash generated by (used for) operating activities 452 (5)
Investing:
Purchase of short-term investments (1,620) (781)
Proceeds from sales and maturities of
short-term investments 1,059 762
Net proceeds from sale of property,
plant, and equipment 79 12
Purchase of property, plant, and equipment (29) (42)
Cash paid for acquisition of technology (10) --
Proceeds from sale of ARM shares 24 --
Cash used to acquire NeXT -- (384)
Other 27 (49)
_____ _____
Cash used for investing activities (470) (482)
Financing:
Decrease in notes payable to banks (25) (59)
Increase in long-term borrowings 2 --
Increase in common stock 14 12
_____ _____
Cash used for financing activities (9) (47)
Total cash used (27) (534)
Cash and cash equivalents, end of the period $ 1,203 $ 1,018
_____ _____
Supplemental cash flow disclosures:
Cash paid during the period for interest $ 50 $ 51
Cash received during the period for
income taxes, net $ 14 $ 23
See accompanying notes to condensed consolidated financial statements
(unaudited).
5
APPLE COMPUTER, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Note 1 - Basis of Presentation
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 (Unaudited). 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 Forms 10-K and 10-K/A for the year ended September 26, 1997 (the "1997
Form 10-K").
Note 2 - Earnings Per Share
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 has been replaced with basic earnings per share, and fully
diluted earnings per share has been replaced with diluted earnings per share
which includes potentially dilutive securities such as outstanding options and
convertible securities. Prior periods presented have been presented to conform
to SFAS 128; however, as the Company had a net loss in those periods, basic
and diluted loss per share are the same as the primary loss per share
previously reported.
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. For fiscal years 1997, 1996, 1995,
1994, and 1993, basic earnings (loss) per share was $(8.29), $(6.59), $3.50,
$2.63, and $0.74, respectively. For those same fiscal years, there were no
material differences between amounts previously reported as fully diluted
earnings (loss) per share and diluted earnings (loss) per share calculated in
accordance with SFAS 128.
6
The following table sets forth the computation of basic and diluted earnings
(loss) per share (in thousands, except net income (loss) and per share amounts)
For the Three Months Ended For the Nine Months Ended
June 26, June 27, June 26, June 27,
1998 1997 1998 1997
Numerator:
Numerator for basic
earnings (loss) per
share -- Net income
(loss) (in millions) $ 101 $ (56) $ 203 $ (884)
Interest expense on
convertible debt 11 -- -- --
Numerator for diluted
earnings (loss) per
share - Adjusted net
income (loss)
(in millions) $ 112 $ (56) $ 203 $ (884)
Denominator:
Denominator for basic
earnings (loss) per
share -- weighted
average shares
outstanding 133,068 126,500 130,971 125,547
Effect of dilutive securities:
Convertible preferred
stock 9,091 -- 9,091 --
Dilutive options 6,985 -- 5,115 --
Convertible debt 22,642 -- -- --
Dilutive potential
common shares 38,718 -- 14,206 --
Denominator for diluted
earnings (loss) per share -
adjusted weighted-average
shares and assumed
conversions 171,786 126,500 145,177 125,547
Basic earnings (loss)
per share $ 0.76 $ (0.44) $ 1.55 $ (7.04)
Diluted earnings (loss)
per share $ 0.65 $ (0.44) $ 1.40 $ (7.04)
7
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 upon conversion were included in the computation of
diluted earnings per share for the three months ended June 26, 1998, as the
effect of using the if-converted method was dilutive for that period. The
common shares represented by these Notes were not included in the computation
of diluted earnings per share for other periods presented because the effect
of using the if-converted method for those periods would be anti-dilutive. For
additional disclosures regarding the outstanding preferred stock, employee
stock options and the Notes, see the 1997 Form 10-K.
Note 3 - Restructuring Activities
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 4,200 full-time
employees, approximately 3,400 of whom have been terminated from the second
quarter of 1996 through June 26, 1998, 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 $236
million and noncash asset write-downs of $83 million from the second quarter of
1996 through June 26, 1998. The Company has periodically made adjustments to
the categories and timing of expected restructure spending based on revised
estimates. The Company expects that the remaining $77 million accrued balance
as of June 26, 1998 will result in cash expenditures of approximately $35
million over the next three months and $25 million thereafter. The remaining
contemplated restructuring actions related to the plan will be initiated
before the end of fiscal 1998 and completed before the end of calendar year
1998. Remaining restructuring actions are expected to be financed through
current working capital.
8
The following table depicts the restructuring activity through June 26, 1998:
(In millions)
Balance as of Balance as of
Category September 26, 1997 Spending Adjustments June 26, 1998
Payments to employees
involuntarily
terminated (C) $ 76 $ 49 $ -- $ 27
Payments on canceled
or vacated facility
leases (C) 25 9 3 19
Write-down of operating
assets to be sold (N) 39 30 8 17
Payments on canceled
contracts (C) 40 15 (11) 14
___________________________________________________
$180 $103 $ -- $ 77
(C): Cash; (N): Noncash.
Note 4 - Stock Option Exchange
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 allowed 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. A
total of 4.4 million options with a weighted-average exercise price of $20.01
per share were exchanged for new options as a result of this program.
Note 5 - Equity Investment Gains
As of March 27, 1998, the Company owned 37.4% of the outstanding stock of ARM
Holdings plc ("ARM"), a privately held company in the United Kingdom involved
in the design of high performance microprocessors and related technology. The
Company accounts for this investment using the equity method. On April 17,
1998, ARM completed an initial public offering of its stock on the London
Stock Exchange and the NASDAQ National Market. The Company sold 18.9% of its
shares in the offering for a gain before foreign taxes of approximately $24
million which was recognized as other income. Foreign taxes recognized on this
gain were approximately $7 million.
At the time an equity method investee sells existing or newly issued common
stock to unrelated parties in excess of its book value, the equity method
requires that the net book value of the investment be adjusted to reflect the
investor's share of the change in the investee's shareholders' equity
resulting from the sale. It is the Company's policy to record an adjustment
9
reflecting its share of the change in the investee's shareholders' equity
resulting from such a sale as a gain or loss in other income. Consequently, the
Company also recognized in the third quarter of 1998 other income of
approximately $16 million to reflect its remaining 25.9% ownership interest in
the increased net book value of ARM following its initial public offering. As
of June 26, 1998, the carrying value of the Company's investment in ARM was
approximately $21 million. The fair value of this investment at that date
based on listed market values was approximately $219 million. The Company is
subject to a "lock-up" agreement under which it is restricted from selling any
of its ARM shares before October 16, 1998. The Company will continue to
account for its investment in ARM using the equity method.
Note 6 - Technology Acquisition
In May 1998, the Company acquired certain technology that was under
development. The acquisition resulted in the recognition of $7 million of
purchased in-process research and development which was charged to operations
upon acquisition.
Note 7 - Recent Accounting Pronouncements
In October 1997, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 97-2, "Software Revenue Recognition" which
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.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative
Instruments and Hedging Activities" which establishes accounting and reporting
standards for derivative instruments and hedging activities. SFAS 133 requires
that an entity recognize all derivatives as either assets or liabilities in
the statement of financial position and measure those instruments at fair
value. The Statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. Earlier application of the Statement is
permitted. The Company is still in the process of assessing the impact that the
Statement will have on the Company's consolidated financial statements.
Note 8 - Contingencies
The Company is subject to various legal proceedings and claims which are
discussed in detail in the 1997 Form 10-K and in the Form 10-Q for the period
ended December 27, 1997. The Company is also subject to certain other legal
proceedings and claims which have arisen in the ordinary course of business
and which have not been fully adjudicated. The results of legal proceedings
cannot be predicted with certainty; however, in the opinion of management, the
Company does not have a potential liability related to any legal proceedings
and claims that would have a material adverse effect on its financial
condition or results of operations.
10
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.
Note 9 - Reclassifications
Certain amounts in the 1997 Condensed Consolidated Statement of Cash Flows
have been reclassified to conform to the 1998 presentation.
11
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
Future 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 and in the
Company's 1997 Form 10-K. All information is based on the Company's fiscal
calendar.
Results of Operations
(Tabular information: Dollars in millions, except per share amounts)
Third Quarter Nine Months Ended
June 26, June 27,
1998 1997 Change 1998 1997 Change
______________________ _________________________
Net sales $1,402 $1,737 (19%) $4,385 $5,467 (20%)
Gross margin $ 360 $ 348 3% $1,062 $1,048 1%
Percentage of net sales 26% 20% 24% 19%
Research and development $ 76 $ 101 (25%) $ 230 $ 391 (41%)
Percentage of net sales 5% 6% 5% 7%
Selling, general and
administrative $ 216 $ 307 (30%) $ 673 $1,027 (34%)
Percentage of net sales 15% 18% 15% 19%
Special Charges
In-process research and
development $ 7 $ -- NM $ 7 $ 375 NM
Percentage of net sales --% --% --% 7%
Restructuring costs $ -- $ -- NM $ -- $ 155 NM
Percentage of net sales --% --% --% 3%
Interest and other income
(expense), net $ 48 $ 4 1100% $ 63 $ 16 294%
Provision for income taxes $ 8 $ -- NM $ 12 $ -- NM
Effective tax rate 7% --% 6% --%
Net income (loss) $ 101 $ (56) 280% $ 203 $ (884) 123%
Basic earnings (loss)
per share $ 0.76 $(0.44) 273% $ 1.55 $(7.04) 122%
Diluted earnings (loss)
per share $ 0.65 $(0.44) 248% $ 1.40 $(7.04) 120%
12
Results of Operations - continued
(Tabular information: Dollars in millions, except per share amounts)
Third Second
Quarter Quarter
1998 1998 Change
______________________
Net sales $1,402 $1,405 --%
Gross margin $ 360 $ 349 3%
Percentage of net sales 26% 25%
Research and development $ 76 $ 75 1%
Percentage of net sales 5% 5%
Selling, general and
administrative $ 216 $ 223 (3%)
Percentage of net sales 15% 16%
Special Charges
In-process research and
development $ 7 $ -- NM
Percentage of net sales --% --%
Interest and other income
(expense), net $ 48 $ 8 500%
Provision for income taxes $ 8 $ 4 100%
Effective tax rate 7% 7%
Net income $ 101 $ 55 84%
Basic earnings per share $ 0.76 $ 0.42 81%
Diluted earnings per share $ 0.65 $ 0.38 71%
NM: Not Meaningful
13
Net Sales
Net sales represent the Company's gross sales net of returns, rebates,
discounts and price protection. Net sales for the third quarter and first nine
months of 1998 were $1.402 billion and $4.385 billion, respectively, decreases
of 19% and 20%, respectively, over the corresponding periods in 1997. The
decline in net sales is attributable to several factors. The Company has
experienced a $355 million decrease in net sales of peripheral products between
the first nine months of 1998 and the same period in 1997 primarily due to the
discontinuance by the Company of certain imaging and display products. Net
sales in Asia were adversely affected primarily by the region's current
economic problems, declining 37% or $476 million during the first nine months
of 1998 compared to the same period in 1997. The average revenue per Macintosh
system, a function of total net sales generated by hardware shipments and total
Macintosh CPU unit sales, fell 7% and 6%, respectively, between the third
quarter and first nine months of 1998 compared to the corresponding periods in
1997, reflecting the effect of aggressive pricing of the Company's Power
Macintosh G3 systems introduced in the first quarter of fiscal 1998, the
decline in net sales from the phase out of certain peripheral products, and
the overall industry trend towards lower-priced products. Lastly, overall
CPU units sales for the comparable nine month periods decreased approximately
14% from 1997.
Net sales were unchanged in the third quarter of 1998 compared with the second
quarter of 1998. A slight sequential decrease in unit sales from 650 thousand
in the second quarter of 1998 to 644 thousand in the third quarter was offset
by an increase in the average revenue per Macintosh system of 2%. The slight
overall decline in unit sales is primarily attributable to the lack of
available consumer oriented products and production capacity constraints
related to the introduction of new PowerBook G3 systems at the end of the third
quarter of 1998. The overall product mix continued to shift towards products
incorporating the Power Macintosh G3 microprocessor. Sales of G3 powered
Macintosh systems accounted for approximately 84% of Macintosh systems
shipped during the third quarter of 1998 as compared to 51% of Macintosh
systems shipped during the prior quarter. Net sales of imaging and display
products decreased by $25 million to $127 million in the third quarter of 1998
compared with the prior quarter reflecting the continuing phase-out of most
imaging and display products.
International sales for the three and nine month periods ended June 26, 1998
represented 43% and 47%, respectively, of consolidated net sales in each of the
periods versus 53% for the same periods in 1997. International net sales fell
35% in the third quarter of 1998 compared with the same period of 1997,
primarily due to decreased revenue in the European and Japanese markets as a
result of significant decreases in Macintosh unit sales and the average revenue
per Macintosh system, partially offset by increases in the average revenue per
peripheral unit. Overall sales in the European and Japanese markets were
negatively affected during the current quarter by the lack of available
consumer oriented products. Sales in Asia were also negatively affected by the
region's continuing economic problems. Domestic net sales increased slightly
in the third quarter of 1998 over the comparable period of 1997 due to
14
increases in unit sales of Macintosh systems, partially offset by decreases in
the average revenue per Macintosh system and in peripheral unit sales.
The Company anticipates modest sequential quarterly revenue growth for the
fourth quarter of fiscal 1998, and year-over-year quarterly revenue growth is
not expected before the first quarter of fiscal 1999. The foregoing statements
are forward looking. The Company's actual results could differ because of
several factors, including those set forth below in the subsection entitled
"Factors That May Affect Future Results and Financial Condition".
Gross Margin
Gross margin increased as a percentage of sales during the third quarter and
the first nine months of 1998 compared to the corresponding periods of 1997,
and increased from the second quarter of 1998 to the third quarter of 1998
from 25% to 26% of sales. These increases were primarily a result of a shift in
revenue mix towards the Company's higher margin Power Macintosh G3 systems
and newer PowerBook G3 systems, the unusually low volume of lower margin
consumer products shipped during the third quarter of 1998, and the continuing
benefits derived from new distribution channel policies and improved inventory
management.
As consumer products become a larger share of the Company's net sales over
upcoming quarters, management anticipates that gross margins will trend
down gradually. The foregoing statement is forward looking. The Company's
actual results could differ because of several factors, including those set
forth in the following paragraph and below in the subsection entitled
"Factors That May Affect Future Results and Financial Condition".
There can be no assurance that anticipated consolidated gross margin levels
will be achieved or that current margins on existing individual products will
be maintained. In general, gross margins and margins on individual products
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, including higher unit sales of consumer products with
lower average selling prices and lower gross margins. 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. The Company's
operating strategy and pricing take into account changes in foreign currency
exchange rates over time; however, the Company's results of operations can be
significantly affected in the short term by fluctuations in exchange rates.
Research and Development
Expenditures for research and development decreased in amount and as a
percentage of net sales during the third quarter and the first nine months of
15
1998 compared to the corresponding periods of 1997, and remained relatively
flat in amount and as a percentage of net sales during the third quarter of
1998 compared with the second quarter of 1998. These reductions on a year-
over-year basis are due to various restructuring actions which resulted in
reductions in headcount and cancellation of certain research and development
projects.
Selling, General and Administrative
Selling, general and administrative expenses decreased in amount and as a
percentage of net sales during the third quarter and the first nine months of
1998 compared to the corresponding periods of 1997 and during the third
quarter of 1998 compared to the second quarter of 1998. These decreases are
due to various restructuring actions which resulted in reductions in
headcount, the closing of facilities, the write-down of assets, and changes to
distribution channel policies.
Special Charges
In May 1998, the Company acquired certain technology that was under
development. The acquisition resulted in the recognition of $7 million of
purchased in-process research and development which was charged to operations
upon acquisition.
During the first nine months of 1997, the Company recognized a $375 million
charge for purchased in-process research and development in connection with the
acquisition of NeXT Software, Inc. ("NeXT") and a $155 million charge for
restructuring costs. For further information regarding the Company's
restructuring actions, see Note 3 to the Condensed Consolidated Financial
Statements.
Interest and Other Income (Expense), Net
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, certain foreign exchange gains and losses and other miscellaneous
income and expense items.
As of March 27, 1998, the Company owned 37.4% of the outstanding stock of ARM
Holdings plc ("ARM"), a privately held company in the United Kingdom involved
in the design of high performance microprocessors and related technology. The
Company accounts for this investment using the equity method. On April 17,
1998, ARM completed an initial public offering of its stock on the London
Stock Exchange and the NASDAQ National Market. The Company sold 18.9%
of its shares in the offering for a gain before foreign taxes of
approximately $24 million which was recognized as other income. Foreign taxes
recognized on this gain were approximately $7 million. The Company also
recognized other income of approximately $16 million to reflect the increase
in its remaining 25.9% ownership interest in the net book value of ARM
following its initial public offering.
16
Provision for Income Taxes
As of June 26, 1998, the Company had deferred tax assets arising from
deductible temporary differences, tax losses, and tax credits of $658 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 June 26, 1998, a valuation allowance of $173 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. taxable
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. The Company's
effective tax rate for the first nine months of 1998 was only 5.6% due
primarily to the reversal of a portion of the previously established valuation
allowance and certain undistributed foreign earnings for which no U.S. taxes
were provided.
Liquidity and Capital Resources
The Company's total cash, cash equivalents, and short-term investments
increased to $1,993 million as of June 26, 1998, from $1,459 million as of
September 26, 1997. The Company's cash and cash equivalent balances as of
June 26, 1998 and September 26, 1997 include $58 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 1996
sale of the Company's Fountain, Colorado, manufacturing facility to SCI. On
April 24, 1998, SCI notified the Company that certain performance measures
defined within the letter of credit agreement had been met by the Company. As a
result, effective as of May 29, 1998, the letter of credit and the amount
pledged as collateral by the Company to support the letter of credit was
reduced by $100 million to $50 million. Should the Company fail to meet those
performance measures in the future, it is possible that some or all of the
letter of credit and supporting collateral would have to be reestablished.
Cash generated by operations during the first nine months of 1998 totaled $452
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.
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Net cash used for the purchase of property, plant, and equipment totaled $29
million in the first nine months of 1998, and consisted primarily of increases
in manufacturing equipment and tooling. The Company expects that the level of
capital expenditures in the fourth quarter of 1998 will be consistent with
those experienced through the first three quarters of 1998.
The Company believes that its existing cash, cash equivalents and short-term
investments balances will be sufficient to meet its cash requirements over the
next twelve months. Expected cash requirements over the next twelve months
include an estimated $60 million to effect actions under the restructuring
plan, most of which will be effected during 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.
Over the last two years, the Company's debt ratings have been downgraded to
non-investment grade. As of March 27, 1998, the Company's senior and
subordinated long-term debt ratings were B- and CCC, respectively, by Standard
and Poor's Rating Agency, and B3 and Caa2, respectively, by Moody's Investor
Services. In June 1998, Moody's upgraded the Company's senior debt to B2 from
B3 and subordinated debt to Caa1 from Caa2 citing strengthened debtholder
protection measurements as the major reason for the upgrade. At the same time,
both Moody's and Standard and Poor's revised their outlooks on the Company to
"positive" due to the Company's improved profitability and financial
flexibility. Despite these recent upgrades, the Company's non-investment grade
debt ratings will maintain pressure on the Company's cost of funds in future
periods and may require the Company to pledge additional collateral or agree to
more stringent debt covenants.
Year 2000 Compliance
Many currently installed computer systems, software products and other
equipment utilizing microprocessors are coded to accept only two digit entries
in the date code field. These date code fields will need to accept four digit
entries to distinguish twenty-first century dates from twentieth century
dates. This is commonly referred to as the "Year 2000 issue".
The Company is aware of the Year 2000 issue and has commenced a program to
identify, remediate, test and develop contingency plans for, the Year 2000
issue (the "Y2K Program"), to be substantially completed by the fall of 1999.
The Company has established a Year 2000 Project Management Office which is
responsible for managing the Y2K Program as it relates to (1) the software and
systems used in the Company's internal business; (2) the Company's software
and hardware products delivered to customers; and (3) third party vendors,
manufacturers and suppliers. The Company currently does not anticipate that
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the cost of the Y2K Program will be material to its financial condition or
results of operations. Nevertheless, satisfactorily addressing the Year 2000
issue is dependent on many factors, some of which are not completely within the
Company's control. Should the Company's internal systems, its software and/or
hardware products to be delivered to customers or the internal systems of one
or more significant vendors, manufacturers or suppliers fail to achieve Year
2000 compliance, the Company's business and its results of operations could be
adversely affected.
The foregoing statements are forward looking. The Company's actual results
could differ because of several factors, including those set forth in the
subsection entitled "Factors That May Affect Future Results and Financial
Condition".
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Factors That May Affect Future Results and Financial Condition
The Company operates in a rapidly changing environment that involves a number
of uncertainties, some of which are beyond the Company's control. In addition
to the uncertainties described elsewhere in this report, there are many
factors that will affect the Company's future results and business which may
cause the actual results to differ from those currently expected. 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; risks
associated with international operations, including economic and labor
conditions, the continuing economic problems being experienced in Asia,
political instability, tax laws, and currency fluctuations; increasing
dependence on third-parties for manufacturing and other outsourced
functions such as logistics; the availability of key components on terms
acceptable to the Company; the continued availability of certain components
essential to the Company's business currently obtained by the Company from
sole or limited sources, including PowerPC RISC microprocessors developed by
and obtained from IBM and Motorola; 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 timely
delivery of future versions of the Mac OS; the Company's ability to
successfully integrate the technologies of NeXT, which was acquired in 1997;
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; the effects of significant
adverse publicity; the availability of third-party software for particular
applications; the effect of year 2000 compliance issues; the Company's ability
to successfully replace its existing transaction systems in the U.S.; 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.
For a discussion of these and other factors affecting the Company's future
results and financial condition, see "Item 7 -- Management's Discussion and
Analysis -- Factors That May Affect Future Results and Financial Condition"
in the Company's 1997 Form 10-K.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is subject to various legal proceedings and claims which are
discussed in detail in the 1997 Form 10-K and in the Form 10-Q for the period
ended December 27, 1997. The Company is also subject to certain other legal
proceedings and claims which have arisen in the ordinary course of business
and which have not been fully adjudicated. The results of legal proceedings
cannot be predicted with certainty; however, in the opinion of management,
the Company does not have a potential liability related to any legal
proceedings and claims that would have a material adverse effect on its
financial condition or results of operations.
Item 5. Other Information
The Company anticipates holding its annual meeting of shareholders on March 24,
1999. Shareholders who intend to present proposals at the next annual meeting
of shareholders must send such proposals to the Company for receipt no later
than October 14, 1998 in order for such proposals to be considered for
inclusion in the proxy statement and form of proxy relating to such meeting.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description
27 Financial Data Schedule.
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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 10, 1998
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INDEX TO EXHIBITS
Exhibit
Index
Number Description Page
27 Financial Data Schedule. 24
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