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, 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 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 ____
136,417,113 shares of Common Stock Issued and Outstanding as of February 1, 1999
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
APPLE COMPUTER, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(in millions, except share and per share amounts)
December 26, 1998 December 26, 1997
Net sales $1,710 $1,578
Cost of sales 1,228 1,225
Gross margin 482 353
Operating expenses:
Research and development 76 79
Selling, general, and administrative 279 234
Total operating expenses 355 313
Operating income 127 40
Gain from sale of investment 32 --
Interest and other income (expense), net 10 7
Total interest and other income (expense), net 42 7
Income before provision for income taxes 169 47
Provision for income taxes 17 --
Net income $ 152 $ 47
Earnings per common share:
Basic $1.12 $ 0.37
Diluted $0.95 $ 0.33
Shares used in computing earnings per share (in thousands):
Basic 135,270 127,989
Diluted 172,062 139,839
See accompanying notes to condensed consolidated financial statements.
2
APPLE COMPUTER, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(in millions, except share amounts)
ASSETS
December 26, 1998 September 25,1998
Current assets:
Cash and cash equivalents $1,221 $1,481
Short-term investments 1,357 819
Accounts receivable, less allowances of
$81 and $81, respectively 913 955
Inventories 25 78
Deferred tax assets 166 182
Other current assets 185 183
Total current assets 3,867 3,698
Property, plant, and equipment, net 344 348
Other assets 381 243
Total assets $4,592 $4,289
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 655 $ 719
Accrued expenses 829 801
Total current liabilities 1,484 1,520
Long-term debt 954 954
Deferred tax liabilities 231 173
Total liabilities 2,669 2,647
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; 135,348,625 and
135,192,769 shares issued and
outstanding, respectively 637 633
Retained earnings 1,050 898
Accumulated other comprehensive
income (loss) 86 (39)
Total shareholders' equity 1,923 1,642
Total liabilities and
shareholders' equity $4,592 $4,289
See accompanying notes to condensed consolidated financial statements.
3
APPLE COMPUTER, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(in millions)
THREE MONTHS ENDED
December 26, 1998 December 26, 1997
Cash and cash equivalents,
beginning of the period $1,481 $1,230
Operating:
Net income 152 47
Adjustments to reconcile net income to cash
generated by operating activities:
Depreciation and amortization 23 28
Provision for deferred income taxes 10 3
Loss on sale of property, plant, and equipment (1) --
Gain on sale of ARM shares (32) --
Changes in operating assets and liabilities:
Accounts receivable 42 133
Inventories 53 33
Other current assets (2) 27
Other assets 14 5
Accounts payable (64) (30)
Accrued restructuring costs -- (32)
Other current liabilities 28 (82)
Cash generated by operating activities 223 132
Investing:
Purchase of short-term investments (1,135) (399)
Proceeds from sales and maturities of short-
term investments 597 194
Net proceeds from property, plant, and
equipment retirements -- 42
Purchase of property, plant, and equipment (5) (7)
Proceeds from sale of ARM shares 37 --
Other 20 --
Cash used for investing activities (486) (170)
Financing:
Decrease in notes payable to banks -- (1)
Increase in long-term borrowings -- 1
Increases in common stock 3 1
Cash generated by financing activities 3 1
Total cash used (260) (37)
Cash and cash equivalents, end of the period $1,221 $1,193
Supplemental cash flow disclosures:
Cash paid for interest $ 20 $ 20
Cash paid (received) for income taxes, net $ (7) $ (18)
See accompanying notes to condensed consolidated financial statements.
4
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 condensed consolidated financial statements and accompanying
notes should be read in conjunction with the Company's annual consolidated
financial statements and the notes thereto for the fiscal year ended September
25, 1998, included in its Annual Report on Form 10-K for the year ended
September 25, 1998 (the 1998 Form 10-K).
During the first quarter of 1999, the Company amended its By-laws to provide
that beginning with the first fiscal quarter of 1999 each of the Company's
fiscal quarters would end on Saturday rather than Friday. Accordingly, one
day was added to the first quarter of 1999 so that the quarter ended on
Saturday, December 26, 1998. This change did not have a material effect on
the Company's results of operations for the quarter and had no effect on the
amount of revenue recognized during the quarter.
Note 2 - Earnings Per Share
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.
5
The following table sets forth the computation of basic and diluted earnings
per share (in thousands, except net income and per share amounts):
December 26, 1998 December 26, 1997
Numerator:
Numerator for basic earnings per share -
Net income (in millions) $ 152 $ 47
Interest expense on convertible debt 11 --
Numerator for diluted earnings per share
- -- Adjusted net income (in millions) $ 163 $ 47
Denominator:
Denominator for basic earnings per share -
weighted average shares outstanding 135,270 127,989
Effect of dilutive securities:
Convertible preferred stock 9,091 9,091
Dilutive options 5,059 2,759
Convertible debt 22,642 --
Dilutive potential common shares 36,792 11,850
Denominator for diluted earnings per share -
adjusted weighted-average shares
and assumed conversions 172,062 139,839
Basic earnings per share $ 1.12 $ 0.37
Diluted earnings per share $ 0.95 $ 0.33
Options to purchase approximately 85,000 shares of common stock were
outstanding as of December 26, 1998, that were not included in the
computation of diluted earnings per share for the three months ended December
26, 1998, because the options' exercise price was greater than the average
market price of the Company's common stock during the period and, therefore,
the effect would be antidilutive.
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
December 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 the three months
ended December 26, 1997, 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
1998 Form 10-K.
6
Note 3 - Consolidated Financial Statement Details (in millions)
Inventories 12/26/98 9/25/98
Purchased parts $ 10 $ 32
Work in process 3 5
Finished goods 12 41
Total inventories $ 25 $ 78
Property, Plant, and Equipment 12/26/98 9/25/98
Land and buildings $ 340 $ 338
Machinery and equipment 277 277
Office furniture and equipment 79 80
Leasehold improvements 129 129
Accumulated depreciation and amortization (481) (476)
Net property, plant, and equipment $ 344 $ 348
Accrued Expenses 12/26/98 9/25/98
Accrued compensation and employee benefits $ 80 $ 99
Accrued marketing and distribution 254 205
Accrued warranty and related costs 124 132
Other current liabilities 371 365
Total accrued expenses $ 829 $ 801
Three Months Ended
Interest and Other Income (Expense) 12/26/98 12/26/97
Interest income $ 32 $ 22
Interest expense (16) (16)
Other income (expense), net (6) 1
Interest and other income (expense), net $ 10 $ 7
7
Note 4 - Equity Investment Gains
As of September 25, 1998, the Company owned 25.9% of the outstanding stock
of ARM Holdings plc (ARM), a publicly held company in the United Kingdom
involved in the design of high performance microprocessors and related
technology. Through September 25, 1998, the Company accounted for this
investment using the equity method. On October 14, 1998, the Company sold
2.9 million shares of ARM stock for net proceeds of approximately $37 million,
a gain of approximately $32 million recorded as other income, and related
income tax expense of approximately $3 million.
As a result of this sale, the Company's ownership interest in ARM fell to
19%. Consequently, beginning in the first quarter of fiscal 1999, the Company
no longer accounts for its remaining investment in ARM using the equity
method and has categorized its remaining shares as available for sale
requiring the shares be carried at fair value, with unrealized gains and
losses reported as a component of shareholders' equity. During the first
quarter of 1999, the Company increased the carrying value of its remaining
shares in ARM by $180 million to adjust their total carrying value at
December 26, 1998, to their market value of approximately $197 million. The
carrying value of the ARM shares is included in other assets. The total
unrealized gain net of taxes recognized in other comprehensive income during
the first quarter of 1999 was approximately $113 million.
Note 5 - Comprehensive Income
The Company adopted Statement of Financial Accounting Standards (SFAS)
No. 130, "Reporting Comprehensive Income", beginning with the Company's
first quarter of 1999. SFAS No. 130 separates comprehensive income into two
components, net income and other comprehensive income. Other
comprehensive income refers to revenue, expenses, gains and losses that under
generally accepted accounting principles are recorded as an element of
shareholders' equity but are excluded from net income. While SFAS No. 130
establishes new rules for the reporting and display of comprehensive income,
it has no impact on the Company's net income or total shareholders' equity.
The Company's other comprehensive income is comprised of foreign currency
translation adjustments from those subsidiaries not using the U.S. dollar as
their functional currency and from unrealized gains and losses on marketable
securities categorized as available for sale. See Note 4 regarding unrealized
gains on available for sale securities.
The components of comprehensive income, net of tax, are as follows
(in millions):
Three Months Ended
12/26/98 12/26/97
Net income $ 152 $ 47
Other comprehensive income:
Change in accumulated translation adjustment 12 (4)
Unrealized gain on investments, net 113 --
Total comprehensive income $ 277 $ 43
8
Note 6 - Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information", and in
June 1998 issued SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities." A discussion of these accounting standards is included in
the notes to consolidated financial statements included in the 1998 Form 10-K
under the subheading "Recent Accounting Pronouncements."
In March 1998, the AICPA issued Statement of Position (SOP) 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use," which provides guidance on accounting for the costs of computer
software intended for internal use. SOP 98-1 must be adopted by the Company
effective as of fiscal 2000 and is not expected to have a material impact on
the Company's consolidated results of operations or financial position.
During the fist quarter of 1999, the Company adopted AICPA SOP 97-2,
"Software Revenue Recognition." SOP 97-2 established standards relating to
the recognition of software revenue. SOP 97-2 was effective for transactions
entered into by the Company beginning in the first quarter of fiscal 1999. The
adoption of this accounting standard did not have a material impact on the
Company's results of operations.
Note 7 - Contingencies
The Company is subject to various legal proceedings and claims which are
discussed in detail in the 1998 Form 10-K. 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.
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 8 - Reclassifications
Certain amounts in the Condensed Consolidated Statement of Cash Flows for
the three months ended December 26, 1997, have been reclassified to conform
to the 1999 presentation.
9
Note 9 - Subsequent Events
On February 1, 1999, the Company took further actions to improve the
flexibility and efficiency of its manufacturing operations by moving final
assembly of certain of its products to original equipment manufacturers. These
restructuring actions will result in the Company recognizing a charge to
operations of approximately $9 million during the second quarter of 1999.
On February 2, 1999, the Company sold 2 million shares of ARM stock for net
proceeds of approximately $59 million and a gain before taxes of approximately
$55 million which will be recognized as other income by the Company in the
second quarter of 1999. Subsequent to this sale, the Company holds
approximately 7.3 million shares of ARM stock which represent approximately
14.9% of the currently outstanding shares.
10
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 1998 Form 10-K and the
condensed consolidated financial statements and notes thereto included
elsewhere in this Form 10-Q. All information is based on the Company's fiscal
calendar.
Results of Operations
Tabular information (dollars in millions, except per share amounts):
First First First Fourth
Quarter Quarter Quarter Quarter
1999 1998 Change 1999 1998 Change
Net sales $1,710 $1,578 8% $1,710 $1.556 10%
Macintosh CPU unit sales
(in thousands) 944 635 49% 944 834 13%
Gross margin $ 482 $ 353 37% $ 482 $ 417 16%
Percentage of net sales 28.2% 22.4% 28.2% 26.8%
Research and development $ 76 $ 79 (4%) $ 76 $ 73 4%
Percentage of net sales 4% 5% 4% 5%
Selling, general and
administrative $ 279 $ 234 19% $ 279 $ 235 19%
Percentage of net sales 16% 15% 16% 15%
Gain from sale of
investment $ 32 $ -- NM $ 32 $ -- NM
Interest and other income
(expense), net $ 10 $ 7 43% $ 10 $ 5 100%
Provision for income taxes $ 17 $ -- NM $ 17 $ 8 112%
Effective tax rate 10% --% 10% 7%
Net income $ 152 $ 47 223% $ 152 $ 106 43%
Basic earnings per share $ 1.12 $ 0.37 203% $ 1.12 $ 0.79 42%
Diluted earnings per share $ 0.95 $ 0.33 188% $ 0.95 $ 0.68 40%
NM: Not Meaningful
Net income for the first quarter of 1999 includes a $32 million gain before
tax associated with the sale by the Company of 2.9 million shares of its
investment in ARM which were recognized as other income. Income tax expense
recognized in the first quarter on this gain was approximately $3 million.
11
Net Sales
Net sales for the first quarter of 1999 were $1.71 billion, an 8% increase
over the same quarter in 1998. The increase in net sales is primarily
attributable to a year-over-year 49% increase in Macintosh CPU unit volume.
Volumes were favorably affected by sales of iMac, the Company's moderately
priced Macintosh system designed for education and consumer markets
introduced during the fourth quarter of 1998, which represented 55% or
519,000 of the total Macintosh CPU units sales during the first quarter of
During the first quarter of 1999, the Company also experienced year-over-year
unit volume growth in both its Power Macintosh G3 and Powerbook G3
product lines of 23% and 39%, respectively. Further contributing to the year-
over-year increase in net sales was approximately $33 million of incremental
net sales in the first quarter of 1999 related to the introduction MacOS 8.5,
the most recent version of the Company's Macintosh operating system. The
positive effect of these factors on first quarter 1999 net sales was partially
offset by two principal factors. First, average revenue per Macintosh system,
a function of total net sales related to hardware shipments and total
Macintosh CPU unit sales, fell 26% to $1,776 during the first quarter of 1999
as compared to the same quarter in 1998. The decline in the average revenue
per Macintosh system was the result of lower priced iMac systems comprising a
significant portion of first quarter 1999 net sales, the decline in net sales
from the phase out of certain peripheral products, and the overall industry
trend towards lower priced products. Second, net sales of imaging and display
products decreased by $93 million to $116 million in the first quarter of 1999
compared with the same quarter in 1998 reflecting the Company's continuing
phase-out of most imaging and many display products.
Net sales increased sequentially $154 million or 10% during the first quarter
of 1999 as compared to the fourth quarter of 1998. The sequential revenue
increase is attributable to a 13% rise in Macintosh unit shipments and
incremental net sales from MacOS 8.5 upgrades. The rise in unit sales during
the first quarter is attributable to a 21% increase in iMac unit sales
compared to the fourth quarter of 1998 and a similar 15% increase in unit
shipments of Power Macintosh G3 professional Macintosh systems partially
offset by a 17% sequential decline in unit shipments of G3 Powerbooks
resulting from the introduction of several new Powerbook models during the
fourth quarter of 1998.
International sales for the first quarter of 1999 represented 47% of
consolidated net sales versus 50% in the first quarter of 1998 and 37% during
the fourth quarter of 1998. In total, international net sales during the first
quarter of 1999 were relatively unchanged from the same quarter in 1998, but
rose $229 million or 40% sequentially from the fourth quarter of 1998. This
sequential increase in international net sales was caused by the introduction
of the iMac during the current quarter in Europe and Asia and by strong sales
internationally of the Company's Power Macintosh G3 and Powerbook G3
product lines. On a year-over-year basis, total Macintosh unit sales during
the first quarter of 1999 increased 55% in Europe, 26% in Japan, and 33% in
the rest of Asia. Domestic net sales increased 14% or $114 million during the
first quarter of 1999 as compared to 1998 while declining sequentially from
the fourth quarter of 1998 $75 million or 8%.
12
Consistent with the historical seasonal pattern, the Company anticipates a
sequential decline in net sales during the second quarter of 1999 but expects
the second quarter to show year-over-year growth in both net sales and unit
shipments. 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 for the first quarter of 1999 was 28.2% as compared to 22.4% for
the same quarter in 1998 and 26.8% for the fourth quarter of 1998. The year-
over-year increase in gross margin is attributable to various operational
changes made by the Company throughout fiscal 1998 that improved
operational efficiency and reduced product costs. These changes included
simplification of the Company's product line, focus on the use of industry
standard parts, expanded use of supplier inventory hubs, outsourcing of
various aspects of product manufacturing, and streamlining of product
distribution channels and policies. Margins have also been favorably impacted
during the last year by the declining cost of various components of the
Company's products, particularly those sourced from Asia. The sequential
increase in gross margin from the fourth quarter of 1998 to the first quarter
of 1999 is primarily attributable to high margin incremental net sales of
MacOS 8.5 during the current quarter. Such sales accounted for a sequential
improvement in first quarter 1999 gross margin of approximately 1.5
percentage points.
The Company expects gross margins to decline sequentially during the second
quarter of 1999 due to lower net sales of MacOS upgrades and pricing pressure
on consumer products. 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 below in the subsection
entitled "Factors That May Affect Future Results and Financial Condition."
There can be no assurance that current or targeted 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, potential
increases in the cost of raw material and outside manufacturing services, 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 that 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
anticipated 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.
13
Operating Expenses
Selling, general and administrative expenses increased approximately $45
million or 19% during the first quarter of 1999 as compared to both the same
quarter of 1998 and sequentially over the fourth quarter of 1998. These
increases are reflective of increased advertising and promotional spending
during the 1998 holiday season associated with the worldwide introduction of
iMac and MacOS 8.5. Expenditures for research and development remained
relatively consistent in terms of absolute dollars between the first quarter
of 1999, the same quarter in 1998, and the fourth quarter of 1998.
The Company expects operating expenses to decline sequentially during the
second quarter of 1999 by approximately $40 to $45 million due to seasonally
lower marketing expenditures. This expected decline in operating expenses
does not include the effect of the restructuring charge described in the
following paragraph. 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 below in the subsection
entitled "Factors That May Affect Future Results and Financial Condition."
On February 1, 1999, the Company took further actions to improve the
flexibility and efficiency of its manufacturing operations by moving final
assembly of certain of its products to original equipment manufacturers. These
restructuring actions will result in the Company recognizing a charge to
operations of approximately $9 million during the second quarter of 1999.
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, realized gains and losses on the sale of securities,
certain foreign exchange gains and losses, and other miscellaneous income and
expense items.
As of September 25, 1998, the Company owned 25.9% of the outstanding stock
of ARM Holdings plc ("ARM"), a publicly held company in the United
Kingdom involved in the design of high performance microprocessors and
related technology. Through September 25, 1998, the Company accounted for
this investment using the equity method. On October 14, 1998, the Company
sold 2.9 million shares of ARM stock for net proceeds of approximately $37
million, a gain of approximately $32 million recorded as other income, and
related income tax expense of approximately $3 million.
As a result of this sale, the Company's ownership interest in ARM fell to 19%.
Consequently, beginning in the first quarter of fiscal 1999, the Company no
longer accounts for its remaining investment in ARM using the equity method
and has categorized its remaining shares as available for sale requiring the
shares be carried at fair value, with unrealized gains and losses reported as a
component of shareholders' equity. During the first quarter of 1999, the
14
Company increased the carrying value of its remaining shares in ARM by $180
million to adjust their total carrying value at December 26, 1998, to their
market value of approximately $197 million. The carrying value of the ARM
shares is included in other assets. The total unrealized gain net of taxes
related to ARM shares recognized in other comprehensive income during the
first quarter of 1999 was approximately $113 million.
On February 2, 1999, the Company sold 2 million shares of ARM stock for net
proceeds of approximately $59 million and a gain before taxes of approximately
$55 million which will be recognized as other income by the Company in the
second quarter of 1999. Subsequent to this sale, the Company holds
approximately 7.3 million shares which represent approximately 14.9% of the
currently outstanding stock of ARM.
Provision for Income Taxes
As of December 26, 1998, the Company had deferred tax assets arising from
deductible temporary differences, tax losses, and tax credits of $663 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, 1998, a valuation allowance of $180 million was recorded
against the deferred tax asset for the benefits of tax losses which may not be
realized. Realization of approximately $73 million of the asset representing
tax loss and credit carryforwards is dependent on the Company's ability to
generate approximately $209 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 quarter of 1999 was only 10%
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.
16
Liquidity and Capital Resources
The following table presents selected financial information and statistics for
each of fiscal quarters ending on the dates indicated (dollars in millions):
12/26/98 9/25/98 12/26/97
Cash, cash equivalents, and short-
term investments $2,578 $2,300 $1,627
Accounts receivable, net $913 $955 $902
Inventory $ 25 $ 78 $404
Working capital $2,383 $2,178 $1,704
Days sales in accounts receivable (a) 49 56 52
Days of supply in inventory (b) 2 6 30
Days payables outstanding (c) 51 60 50
Operating cash flow $223 $282 $132
(a) Based on ending net trade receivables and most recent quarterly net sales
for each period
(b) Based on ending inventory and most recent quarterly cost of sales for each
period
(c) Based on ending accounts payable and most recent quarterly cost of sales
adjusted for the change in inventory
As of December 26, 1998, the Company had approximately $2.58 billion in
cash, cash equivalents, and short-term investments, an increase of $278
million over the same balances at the end of fiscal 1998. During the first
quarter of 1999, the most significant sources of cash were $152 million of net
income, declines in net accounts receivable of $42 million and inventory of
$53 million, and proceeds on the sales of ARM shares of $37 million. These
factors were partially offset by a decrease in accounts payable of $64
million. The Company's cash and cash equivalent balances as of December 26,
1998, and September 25, 1998, include $4 million and $56 million,
respectively, pledged as collateral to support letters of credit.
The Company's debt ratings are currently 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 (S&P) Rating Agency, and
B3 and Caa2, respectively, by Moody's Investor Services (Moody's). 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. On November 9, 1998, S&P
upgraded the Company's senior debt to B+ from B- and upgraded its
subordinated debt to B- from CCC citing the Company's improved profitability
and financial profile for the upgrade. Despite these recent upgrades, the
Company's continued 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.
16
The Company believes that its balances of cash, cash equivalents, and short-
term investments will be sufficient to meet its cash requirements over
the next twelve months. However, given the Company's current debt ratings, if
the Company should need to obtain short-term borrowings, there can no
assurance that such borrowings could be obtained at favorable rates. The
inability to obtain such borrowings at favorable rates could materially
adversely affect the Company's results of operations, financial condition, and
liquidity.
Year 2000 Compliance
The information presented below related to Year 2000 (Y2K) compliance
contains forward looking statements that are subject to risks and
uncertainties. The Company's actual results may differ significantly from
those discussed below and elsewhere in this Form 10-Q regarding Year 2000
compliance.
The Company's Information Systems and Technology department (IS&T)
began addressing the Y2K issue in 1996 as part of its Next Generation
strategy, which addressed the need for ongoing enhancement and replacement
of the Company's various disparate legacy information technology (IT)
Systems. In 1998, the Company established a Year 2000 Executive Steering
Committee (Steering Committee) composed of senior executives of the
Company and the Company's Year 2000 Project Management Office (PMO).
The PMO reports to the Executive Vice President and Chief Financial Officer,
the Steering Committee, and the Audit and Finance Committee of the Board of
Directors.
The PMO developed and manages the Company's worldwide Y2K strategic
plan (Y2K Plan) to address the potential impact of Y2K on the Company's
operations and business processes. In particular, the Y2K Plan addresses four
principal areas that may be impacted by the Y2K issue: Apple Branded
Products; Third Party Relationships; Non-IT Business Systems; and IT
Systems. With respect to the IT Systems and Non-IT Business Systems, the
Y2K Plan consists of four separate but overlapping phases: Phase I - Inventory
and Risk Assessments; Phase II - Remediation Cost Estimation; Phase III -
Remediation; and Phase IV - Remediation Testing. In addition, the Company
has an ongoing Y2K Awareness Program designed to keep employees informed
about Y2K issues. The Company's goal is to substantially complete Phase III -
Remediation during the third quarter of 1999; complete Phase IV -
Remediation Testing during the fourth quarter of 1999, and to continue
compliance efforts throughout the remainder of calendar year 1999. There
have been no significant changes made to this schedule during the first
quarter of 1999, and the Company remains on schedule to meet these goals.
The Company designs and manufacturers microprocessor-based personal
computers, related peripherals, operating system software and application
software, including Macintosh personal computers and the Mac OS which are
marketed under the "Apple" brand (collectively "Apple Branded Products").
17
The Company tested certain Apple Branded Products to determine Y2K
compliance, although such testing did not include third party products bundled
with Apple Branded Products and certain Apple Branded Products no longer
supported by the Company. For purposes of this discussion, Y2K compliant
means a product will not produce errors processing date data in connection
with the year change from December 31, 1999, to January 1, 2000, when used
with accurate date data in accordance with the its documentation, provided all
other products (including other software, firmware and hardware) used with it
properly exchange date data with it. A Y2K compliant product will recognize
the Year 2000 as a leap year. Information regarding the Y2K readiness of all
Apple Branded Products is available on the Apple corporate web site at
www.apple.com. Such information is not to be considered part of this quarterly
report. The Company believes that the unsupported Apple Branded Products
are Y2K compliant because, unlike other companies personal computers and
related products, the Company's products do not rely upon the two digit date
format but used a long word approach which allows the correct representation
of dates up to the year 2040. The current date and time utilities utilized by
Apple Branded Products are 64 bit signed value which covers dates from 30081
BC to 29940 AD. Since the Company does not control the design of non-Apple
Branded Products or third party products bundled with Apple Branded
Products, it cannot assure they are Y2K compliant. Certain products acquired
from NeXT Software, Inc., including OpenStep and NextStep, are not currently
Y2K compliant. The Company intends to develop and make available during
the third quarter of 1999 a software patch intended to allow such products to
become Y2K compliant.
The Company's business operations are heavily dependent on third party
corporate service vendors, materials suppliers, outsourced operations
partners, distributors and others. The Company is working with key external
parties to identify and attempt to mitigate the potential risks to it of Y2K.
The failure of external parties to resolve their own Y2K issues in a timely
manner could result in a material financial risk to the Company. As part of
its overall Y2K program, the Company is actively communicating with third
parties through face to face meetings and correspondence, on an ongoing basis,
to ascertain their state of readiness. Although numerous third parties have
indicated to the Company in writing that they are addressing their Y2K issues
on a timely basis, the readiness of third parties overall varies widely.
Because the Company's Y2K compliance is dependent on the timely Y2K
compliance of third parties, there can be no assurances that the Company's
efforts alone will resolve all Y2K issues.
The costs of the Y2K program are primarily costs associated with the
utilization of existing internal resources and incremental external spending.
The Company previously estimated it had incurred approximately $4.1 million
of incremental external spending directly associated with Y2K issues through
the end of fiscal 1998 and that it would incur future incremental external
spending associated with Y2K issues of approximately $5.1 million to address
those risks identified as high and medium. There have been no material
changes to the Company's costs estimates during the first quarter of 1999.
18
However, as the Company's Y2K Plan continues, the actual future incremental
spending may prove to be higher. Also, this estimate does not include the
costs that could be incurred by the Company if one or more of its significant
third party service providers fails to achieve Y2K compliance. The Company is
not separately identifying and including in these estimates the Y2K costs
incurred that are the result of utilization of the Company's existing internal
resources.
Based on current information, the Company believes the Y2K issue will not
have a material adverse effect on the Company, its consolidated financial
position, results of operations or cash flows. However, there can be no
assurance that the Y2K remediation by the Company or third parties will be
properly and timely completed, and the failure to do so could have a material
adverse effect on the Company, its business, results of operations, and its
financial condition. In particular, the Company has not yet completed its
assessment of the Y2K readiness of its significant third party service
providers. Completion of this assessment may result in the identification of
additional issues which could have a material adverse effect on the Company's
results of operations. In addition, important factors that could cause results
to differ materially include, but are not limited to, the ability of the
Company to successfully identify systems which have a Y2K issue, the nature
and amount of remediation effort required to fix the affected system, and the
costs and availability of labor and resources to successfully address the Y2K
issues.
Further details regarding the Company's Y2K compliance efforts may be found
in the 1998 Form 10-K in Item 7 under the heading "Year 2000 Compliance."
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. 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 and Latin America, political instability, tax laws,
and currency fluctuations; increasing dependence on third-parties for
manufacturing and other outsourced functions such as logistics; the
19
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 availability of third-party software for
particular applications; the Company's ability to attract, motivate and retain
key employees; the effect of Y2K compliance issues; managing the impact of the
European Union's transition to the Euro as its common legal currency; the
Company's ability to retain the operational and cost benefits derived from its
recently completed restructuring program; and the Company's ability to
successfully replace its existing transaction systems in the U.S.
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 1998 Form 10-K.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The information presented below regarding Market Risk contains forward
looking statements that are subject to risks and uncertainties. The Company's
actual results may differ significantly from those discussed below and
elsewhere in this Form 10-Q regarding market risk. . The following discussion
should be read in conjunction with the 1998 Form 10-K and the condensed
consolidated financial statements and notes thereto included elsewhere in this
Form 10-Q.
The Company's exposure to market risk for changes in interest rates relates
primarily to the Company's investments and long-term debt obligations and
related derivative financial instruments. The Company places its investments
with high credit quality issuers and, by policy, limits the amount of credit
exposure to any one issuer. The Company's general policy is to limit the risk
of principal loss and ensure the safety of invested funds by limiting market
and credit risk. All highly liquid investments with a maturity of three months
or less at the date of purchase are considered to be cash equivalents;
investments with maturities between three and twelve months are considered to
be short-term investments. As of December 26, 1998, there are no investments
with maturities greater than 12 months.
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.
20
The Company enters into foreign exchange forward and option contracts with
financial institutions primarily to protect against currency exchange risks
associated with existing assets and liabilities, certain firmly committed
transactions, and probable but not firmly committed transactions. The
Company's foreign exchange risk management policy requires it to hedge a
majority of its existing material foreign exchange transaction exposures.
However, the Company may not hedge certain foreign exchange transaction
exposures that are immaterial either in terms of their minimal U.S. dollar
value or in terms of the related currency's historically high correlation with
the U.S. dollar. Foreign exchange forward contracts are carried at fair value
in other current liabilities. The premium costs of purchased foreign exchange
option contracts are recorded in other current assets and amortized over the
life of the option.
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 and
the anticipatory nature of the exposures intended to hedge, 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.
For a complete description of the Company's interest rate and foreign currency
related market risks, see the discussion in Part II, Item 7A of the Company's
1998 Form 10-K. There has not been a material change in the Company's
exposure to interest rate and foreign currency risks since September 25, 1998.
21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is subject to various legal proceedings and claims which are
discussed in the 1998 Form 10-K. 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 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description
3.3 By-Laws of the Company, as amended through December 15, 1998.
27 Financial Data Schedule.
(b) Reports on Form 8-K
The Company filed a current report on Form 8-K dated December 23, 1998 to
report under Item 8 (Change in Fiscal Year), an amendment to the Company's
By-laws to provide that each fiscal quarter shall end at midnight Saturday of
the 13th week of such quarter, rather than midnight Friday.
22
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 8, 1999
23
INDEX TO EXHIBITS
Exhibit
Index
Number Description Page
3.3 By-Laws of the Company, as amended through December 15, 1998. 25
27 Financial Data Schedule. 49
24