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APPLE INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge) This section and other parts of this Form 10-Q contain forward-looking
statements, within the meaning of the Private Securities Litigation Reform Act
of 1995, that involve risks and uncertainties. Forward-looking statements
provide current expectations of future events based on certain assumptions and
include any statement that does not directly relate to any historical or current
fact. Forward-looking statements also can be identified by words such as
"anticipates," "expects," "believes," "plans," "will," "would," "could," and
similar terms. Forward-looking statements are not guarantees of future
performance and 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 Part II,
Item 1A of this Form 10-Q under the heading "Risk Factors," which are
incorporated herein by reference. The following discussion should be read in
conjunction with the Company's Annual Report on Form 10-K for the year ended
September 29, 2012 (the "2012 Form 10-K") filed with the U.S. Securities and
Exchange Commission (the "SEC") and the condensed consolidated financial
statements and notes thereto included elsewhere in this Form 10-Q. All
information presented herein is based on the Company's fiscal calendar. Unless
otherwise stated, references in this report to particular years, quarters or
months refer to the Company's fiscal years ended in September and the associated
quarters or months of those fiscal years. Each of the terms the "Company" and
"Apple" as used herein refers collectively to Apple Inc. and its wholly-owned
subsidiaries, unless otherwise stated. The Company assumes no obligation to
revise or update any forward-looking statements for any reason, except as
required by law.
Available Information
The Company's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q,
Current Reports on Form 8-K, and amendments to reports filed pursuant to
Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), are filed with the SEC. The Company is subject to the
informational requirements of the Exchange Act and files or furnishes reports,
proxy statements, and other information with the SEC. Such reports and other
information filed by the Company with the SEC are available free of charge on
the Company's website at www.apple.com/investor when such reports are available
on the SEC's website. The public may read and copy any materials filed by the
Company with the SEC at the SEC's Public Reference Room at 100 F Street, NE,
Room 1580, Washington, DC 20549. The public may obtain information on the
operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The
SEC maintains an Internet site that contains reports, proxy and information
statements and other information regarding issuers that file electronically with
the SEC at www.sec.gov. The contents of these websites are not incorporated into
this filing. Further, the Company's references to the URLs for these websites
are intended to be inactive textual references only.
Executive Overview
The Company designs, manufactures, and markets mobile communication and media
devices, personal computers, and portable digital music players, and sells a
variety of related software, services, peripherals, networking solutions, and
third-party digital content and applications. The Company's products and
services include iPhone ®, iPad®, Mac®, iPod ®, Apple TV®, a portfolio of
consumer and professional software applications, the iOS and Mac OS X® operating
systems, iCloud®, and a variety of accessory, service and support offerings. The
Company also sells and delivers digital content and applications through the
iTunes Store®, App Store™, iBookstore™, and Mac App Store. The Company sells its
products worldwide through its retail stores, online stores, and direct sales
force, as well as through third-party cellular network carriers, wholesalers,
retailers, and value-added resellers. In addition, the Company sells a variety
of third-party iPhone, iPad, Mac and iPod compatible products, including
application software, and various accessories through its online and retail
stores. The Company sells to consumers; small and mid-sized businesses; and
education, enterprise and government customers.
The Company is committed to bringing the best user experience to its customers
through its innovative hardware, software, peripherals, and services. The
Company's business strategy leverages its unique ability to design and develop
its own operating systems, hardware, application software, and services to
provide its customers new products and solutions with superior ease-of-use,
seamless integration, and innovative design. As part of its strategy, the
Company continues to expand its platform for the discovery and delivery of
third-party digital content and applications through the iTunes Store. As part
of the iTunes Store, the Company's App Store and iBookstore allow customers to
discover and download applications and books through either a Mac or
Windows-based computer or through "iOS devices," namely iPhone, iPad and iPod
touch. The Company's Mac App Store allows customers to easily discover, download
and install Mac applications. The Company also supports a community for the
development of third-party software and hardware products and digital content
that complement the Company's offerings. The Company's strategy also includes
expanding its distribution network to effectively reach more customers and
provide them with a high-quality sales and post-sales support experience.
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The Company participates in several highly competitive markets, including the
market for mobile communications and media devices with its iOS devices;
personal computers with its Mac computers; portable digital players with iPod;
and distribution of third-party digital content and applications with the iTunes
Store, App Store, iBookstore, and Mac App Store. While the Company is widely
recognized as a leading innovator in the markets where it competes, these
markets are highly competitive and subject to aggressive pricing. To remain
competitive, the Company believes that continual investment in research and
development and marketing and advertising is critical to the development and
sale of innovative products and technologies. The Company's research and
development spending is focused on investing in new hardware and software
products, and in further developing its existing products, including iPhone,
iPad, Mac, and iPod hardware; iOS and OS X operating systems; and a variety of
application software and online services.
The Company uses a variety of direct and indirect distribution channels, such as
its retail stores, online stores, and direct sales force, and third-party
cellular network carriers, wholesalers, retailers, and value-added resellers.
The Company believes that sales of its innovative and differentiated products
are enhanced by knowledgeable salespersons who can convey the value of the
hardware and software integration, and demonstrate the unique solutions that are
available on its products. The Company further believes providing direct contact
with its targeted customers is an effective way to demonstrate the advantages of
its products over those of its competitors and providing a high-quality sales
and after-sales support experience is critical to attracting new and retaining
existing customers. To ensure a high-quality buying experience for its products
in which service and education are emphasized, the Company continues to expand
and improve its distribution capabilities by expanding the number of its own
retail stores worldwide. Additionally, the Company has invested in programs to
enhance reseller sales by placing high quality Apple fixtures, merchandising
materials and other resources within selected third-party reseller locations.
Through the Apple Premium Reseller Program, certain third-party resellers focus
on the Apple platform by providing a high level of integration and support
services, and product expertise.
Products
A detailed discussion of the Company's products may be found in Part I, Item 1,
"Business," of the Company's 2012 Form 10-K.
Critical Accounting Policies and Estimates
The preparation of financial statements and related disclosures in conformity
with U.S. generally accepted accounting principles ("GAAP") and the Company's
discussion and analysis of its financial condition and operating results require
the Company's management to make judgments, assumptions, and estimates that
affect the amounts reported in its condensed consolidated financial statements
and accompanying notes. Note 1, "Summary of Significant Accounting Policies" of
this Form 10-Q and in the Notes to Consolidated Financial Statements in Part II,
Item 8 of the Company's 2012 Form 10-K describes the significant accounting
policies and methods used in the preparation of the Company's condensed
consolidated financial statements. Management bases its estimates on historical
experience and on various other assumptions it believes to be reasonable under
the circumstances, the results of which form the basis for making judgments
about the carrying values of assets and liabilities. Actual results may differ
from these estimates and such differences may be material.
Management believes the Company's critical accounting policies and estimates are
those related to revenue recognition, valuation and impairment of marketable
securities, inventory valuation and valuation of manufacturing-related assets
and estimated purchase commitment cancellation fees, warranty costs, income
taxes, and legal and other contingencies. Management considers these policies
critical because they are both important to the portrayal of the Company's
financial condition and operating results, and they require management to make
judgments and estimates about inherently uncertain matters. The Company's senior
management has reviewed these critical accounting policies and related
disclosures with the Audit and Finance Committee of the Company's Board of
Directors.
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Revenue Recognition
Net sales consist primarily of revenue from the sale of hardware, software,
digital content and applications, peripherals, and service and support
contracts. The Company recognizes revenue when persuasive evidence of an
arrangement exists, delivery has occurred, the sales price is fixed or
determinable, and collection is probable. Product is considered delivered to the
customer once it has been shipped and title and risk of loss have been
transferred. For most of the Company's product sales, these criteria are met at
the time the product is shipped. For online sales to individuals, for some sales
to education customers in the U.S., and for certain other sales, the Company
defers revenue until the customer receives the product because the Company
retains a portion of the risk of loss on these sales during transit. The Company
recognizes revenue from the sale of hardware products, software bundled with
hardware that is essential to the functionality of the hardware, and third-party
digital content sold on the iTunes Store in accordance with general revenue
recognition accounting guidance. The Company recognizes revenue in accordance
with industry specific software accounting guidance for the following types of
sales transactions: (i) standalone sales of software products, (ii) sales of
software upgrades and (iii) sales of software bundled with hardware not
essential to the functionality of the hardware.
For multi-element arrangements that include hardware products containing
software essential to the hardware product's functionality, undelivered software
elements that relate to the hardware product's essential software, and/or
undelivered non-software services, the Company allocates revenue to all
deliverables based on their relative selling prices. In such circumstances, the
Company uses a hierarchy to determine the selling price to be used for
allocating revenue to deliverables: (i) vendor-specific objective evidence of
fair value ("VSOE"), (ii) third-party evidence of selling price ("TPE") and
(iii) best estimate of selling price ("ESP"). VSOE generally exists only when
the Company sells the deliverable separately and is the price actually charged
by the Company for that deliverable. ESPs reflect the Company's best estimates
of what the selling prices of elements would be if they were sold regularly on a
stand-alone basis.
For sales of qualifying versions of iOS devices, Mac and Apple TV, the Company
has indicated it may from time to time provide future unspecified software
upgrades and features free of charge to customers. The Company also provides
various non-software services to owners of qualifying versions of iOS devices
and Mac. Because the Company has neither VSOE nor TPE for the unspecified
software upgrade rights or the non-software services, revenue is allocated to
these rights and services based on the Company's ESPs. Revenue allocated to the
unspecified software upgrade rights and non-software services based on the
Company's ESPs is deferred and recognized on a straight-line basis over the
estimated period the software upgrades and non-software services are expected to
be provided for each of these devices, which ranges from two to four years.
The Company's process for determining ESPs involves management's judgment and
considers multiple factors that may vary over time depending upon the unique
facts and circumstances related to each deliverable. If the facts and
circumstances underlying the factors considered change, including the estimated
or actual costs incurred to provide non-software services or the estimated
period the software upgrades and non-software services are expected to be
provided, or should future facts and circumstances lead the Company to consider
additional factors, the Company's ESPs and the future rate of related
amortization for software upgrades and non-software services related to future
sales of these devices could change.
The Company records reductions to revenue for estimated commitments related to
price protection and other customer incentive programs. For transactions
involving price protection, the Company recognizes revenue net of the estimated
amount to be refunded, provided the refund amount can be reasonably and reliably
estimated and the other conditions for revenue recognition have been met. The
Company's policy requires that, if refunds cannot be reliably estimated, revenue
is not recognized until reliable estimates can be made or the price protection
lapses. For the Company's other customer incentive programs, the estimated cost
is recognized at the later of the date at which the Company has sold the product
or the date at which the program is offered. The Company also records reductions
to revenue for expected future product returns based on the Company's historical
experience. Future market conditions and product transitions may require the
Company to increase customer incentive programs that could result in reductions
to future revenue. Additionally, certain customer incentive programs require
management to estimate the number of customers who will actually redeem the
incentive. Management's estimates are based on historical experience and the
specific terms and conditions of particular incentive programs. If a greater
than estimated proportion of customers redeems such incentives, the Company
would be required to record additional reductions to revenue, which would have
an adverse impact on the Company's results of operations.
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Valuation and Impairment of Marketable Securities
The Company's investments in available-for-sale securities are reported at fair
value. Unrealized gains and losses related to changes in the fair value of
securities are recognized in accumulated other comprehensive income, net of tax,
in the Company's Condensed Consolidated Balance Sheets. Changes in the fair
value of available-for-sale securities impact the Company's net income only when
such securities are sold or an other-than-temporary impairment is recognized.
Realized gains and losses on the sale of securities are determined by specific
identification of each security's cost basis. The Company regularly reviews its
investment portfolio to determine if any security is other-than-temporarily
impaired, which would require the Company to record an impairment charge in the
period any such determination is made. In making this judgment, the Company
evaluates, among other things, the duration and extent to which the fair value
of a security is less than its cost; the financial condition of the issuer and
any changes thereto; and the Company's intent to sell, or whether it will more
likely than not be required to sell, the security before recovery of the its
amortized cost basis. The Company's assessment on whether a security is
other-than-temporarily impaired could change in the future due to new
developments or changes in assumptions related to any particular security.
Inventory Valuation and Valuation of Manufacturing-Related Assets and Estimated
Purchase Commitment Cancellation Fees
The Company must order components for its products and build inventory in
advance of product shipments and has invested in manufacturing process
equipment, including capital assets held at its suppliers' facilities. In
addition, the Company has made prepayments to certain of its suppliers
associated with long-term supply agreements to secure supply of inventory
components. The Company records a write-down for inventories of components and
products, including third-party products held for resale, which have become
obsolete or are in excess of anticipated demand or net realizable value. The
Company performs a detailed review of inventory each fiscal quarter that
considers multiple factors including demand forecasts, product life cycle
status, product development plans, current sales levels, and component cost
trends. The Company also reviews its manufacturing-related capital assets and
inventory prepayments for impairment whenever events or circumstances indicate
the carrying amount of such assets may not be recoverable. If the Company
determines that an asset is not recoverable, it records an impairment loss equal
to the amount by which the carrying value of such an asset exceeds its fair
value.
The industries in which the Company competes are subject to a rapid and
unpredictable pace of product and component obsolescence and demand changes. In
certain circumstances the Company may be required to record additional
write-downs of inventory, inventory prepayments and/or manufacturing-related
capital assets. These circumstances include future demand or market conditions
for the Company's products being less favorable than forecasted, unforeseen
technological changes or changes to the Company's product development plans that
negatively impact the utility of any of these assets, or significant
deterioration in the financial condition of one or more of the Company's
suppliers that hold any of the Company's manufacturing process equipment or to
whom the Company has made an inventory prepayment. Such write-downs would
adversely affect the Company's results of operations in the period when the
write-downs were recorded.
The Company records accruals for estimated cancellation fees related to
component orders that have been cancelled or are expected to be cancelled.
Consistent with industry practice, the Company acquires components through a
combination of purchase orders, supplier contracts, and open orders based on
projected demand information. These commitments typically cover the Company's
requirements for periods up to 150 days. If there is an abrupt and substantial
decline in demand for one or more of the Company's products, if the Company's
product development plans change, or if there is an unanticipated change in
technological requirements for any of the Company's products, then the Company
may be required to record additional accruals for cancellation fees that would
adversely affect its results of operations in the period when the cancellation
fees are identified and recorded.
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Warranty Costs
The Company provides for the estimated cost of warranties at the time the
related revenue is recognized based on historical and projected warranty claim
rates, historical and projected cost-per-claim, and knowledge of specific
product failures that are outside of the Company's typical experience. Each
quarter, the Company reevaluates its estimates to assess the adequacy of its
recorded warranty liabilities considering the size of the installed base of
products subject to warranty protection and adjusts the amounts as necessary. If
actual product failure rates or repair costs differ from estimates, revisions to
the estimated warranty liabilities would be required and could materially affect
the Company's results of operations.
Income Taxes
The Company records a tax provision for the anticipated tax consequences of the
reported results of operations. The provision for income taxes is computed using
the asset and liability method, under which deferred tax assets and liabilities
are recognized for the expected future tax consequences of temporary differences
between the financial reporting and tax bases of assets and liabilities, and for
operating losses and tax credit carryforwards. Deferred tax assets and
liabilities are measured using the currently enacted tax rates that apply to
taxable income in effect for the years in which those tax assets are expected to
be realized or settled. The Company records a valuation allowance to reduce
deferred tax assets to the amount that is believed more likely than not to be
realized.
The Company recognizes tax benefits from uncertain tax positions only if it is
more likely than not that the tax position will be sustained on examination by
the taxing authorities, based on the technical merits of the position. The tax
benefits recognized in the financial statements from such positions are then
measured based on the largest benefit that has a greater than 50% likelihood of
being realized upon ultimate settlement.
Management believes it is more likely than not that forecasted income, including
income that may be generated as a result of certain tax planning strategies,
together with future reversals of existing taxable temporary differences, will
be sufficient to fully recover the deferred tax assets. In the event that the
Company determines all or part of the net deferred tax assets are not realizable
in the future, the Company will make an adjustment to the valuation allowance
that would be charged to earnings in the period such determination is made. In
addition, the calculation of tax liabilities involves significant judgment in
estimating the impact of uncertainties in the application of GAAP and complex
tax laws. Resolution of these uncertainties in a manner inconsistent with
management's expectations could have a material impact on the Company's
financial condition and operating results.
Legal and Other Contingencies
As discussed in Part II, Item 1 of this Form 10-Q under the heading "Legal
Proceedings" and in Note 6, "Commitments and Contingencies" in the Notes to
Condensed Consolidated Financial Statements of this Form 10-Q, the Company is
subject to various legal proceedings and claims, including those that arise in
the ordinary course of business. The Company records a liability when it is
probable that a loss has been incurred and the amount is reasonably estimable.
There is significant judgment required in both the probability determination and
as to whether an exposure can be reasonably estimated. In the opinion of
management, there was not at least a reasonable possibility the Company may have
incurred a material loss, or a material loss in excess of a recorded accrual,
with respect to loss contingencies for legal and other contingencies. However,
the outcome of legal proceedings and claims brought against the Company is
subject to significant uncertainty. Therefore, although management considers the
likelihood of such an outcome to be remote, if one or more of these legal
matters were resolved against the Company in a reporting period for amounts in
excess of management's expectations, the Company's consolidated financial
statements for that reporting period could be materially adversely affected.
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Net Sales
The following table shows net sales by operating segment and net sales and unit
sales by product during the three months ended December 29, 2012 and
December 31, 2011 (in millions, except unit sales in thousands):
Three Months Ended
December 29, December 31,
2012 2011 Change Net Sales by Operating Segment:
Americas $ 20,341 $ 17,714 15%
Europe 12,464 11,256 11%
Greater China (a) 6,830 4,080 67%
Japan 4,443 3,550 25%
Rest of Asia Pacific 3,993 3,617 10%
Retail 6,441 6,116 5%
Total net sales $ 54,512 $ 46,333 18%
Net Sales by Product:
iPhone (b) $ 30,660 $ 23,950 28%
iPad (b) 10,674 8,769 22%
Mac (b) 5,519 6,598 (16)%
iPod (b) 2,143 2,528 (15)%
iTunes, Software and Services (c) 3,687 3,020 22%
Accessories (d) 1,829 1,468 25%
Total net sales $ 54,512 $ 46,333 18%
Unit Sales by Product:
iPhone 47,789 37,044 29%
iPad 22,860 15,434 48%
Mac 4,061 5,198 (22)%
iPod 12,679 15,397 (18)%
(a) Greater China includes China, Hong Kong and Taiwan.
(b) Includes deferrals and amortization of related non-software services and
software upgrade rights.
(c) Includes revenue from sales on the iTunes Store, the App Store, the Mac App
Store, and the iBookstore, and revenue from sales of AppleCare, licensing and
other services.
(d) Includes sales of hardware peripherals and Apple-branded and third-party
accessories for iPhone, iPad, Mac and iPod.
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The Company's fiscal year is the 52 or 53-week period that ends on the last
Saturday of September. An extra week is added to the Company's first quarter
approximately every six years to realign the Company's fiscal quarters more
closely to calendar quarters. A 14th week was added to the first quarter of
2012, while the first quarter of 2013 spanned only 13 weeks. Inclusion of the
14th week increased the Company's overall net sales and operating expenses for
the first quarter of 2012.
Despite the lack of a 14th week in the first quarter of 2013, net sales
increased $8.2 billion or 18% compared to the first quarter of 2012. Several
factors contributed positively to this increase:
• iPhone net sales were $30.7 billion in the first quarter of 2013
representing an increase of $6.7 billion or 28% compared to the first
quarter of 2012. iPhone unit sales totaled 47.8 million in the first
quarter of 2013, which represents an increase of 10.7 million units or 29%
compared to the same period in 2012. iPhone year-over-year growth reflects
strong demand for iPhone in all of the Company's operating segments
primarily due to the launch of iPhone 5 beginning in September 2012 and
strong ongoing demand for iPhone 4 and 4S. Net sales of iPhone accounted
for 56% of the Company's total net sales for the first quarter of 2013
compared to 52% in the first quarter of 2012.
• iPad net sales were $10.7 billion in the first quarter of 2013
representing an increase of $1.9 billion or 22% compared to the first
quarter of 2012. Unit sales of iPad were 22.9 million during the first
quarter of 2013, an increase of 48% compared to the same period in 2012.
The year-over-year increase in net sales and unit sales was driven by
strong demand for iPad in all of the Company's operating segments as a
result of the launch of iPad mini and the fourth generation iPad with
Retina® display in the first quarter of 2013. The year-over-year growth
rate of iPad unit sales was higher than the growth rate of iPad net sales
during the first quarter of 2013 due to a reduction in average selling
prices as a result of a shift in product mix toward lower-priced iPad
models, including iPad mini. Net sales of iPad accounted for 20% of the
Company's total net sales in the first quarter of 2013 compared to 19% in
the first quarter of 2012.
• Net sales for iTunes, software and services were $3.7 billion in the first
quarter of 2013 representing an increase of $667 million or 22% compared
to the first quarter of 2012. This increase was due primarily to growth of
iTunes which generated total net sales of $2.1 billion for the first
quarter of 2013. iTunes growth reflects continued growth in the installed
base of iOS devices and expanded iTunes digital content and applications
offerings around the world, resulting in higher net sales on the App Store
and higher net sales of digital content. Net sales of iTunes, software and
services accounted for 7% of the Company's total net sales for both the
first quarter of 2013 and 2012, respectively.
The following factors contributed to the partial offset of the overall increase
in net sales in the first quarter of 2013 compared to the same quarter in 2012:
• Mac net sales were $5.5 billion in the first quarter of 2013 representing
a decrease of $1.1 billion or 16% compared to the first quarter of 2012.
Mac unit sales decreased by 1.1 million or 22% in the first quarter of
2013 compared to the same period in 2012. Declines in Mac net sales and
Mac unit sales were experienced to some extent in all of the Company's
operating segments and reflect overall declines in unit sales of both
desktop and portable systems. Mac sales were negatively impacted during
the first quarter of 2013 by a number of factors including supply
constraints through the end of the quarter on the Company's new iMac
models that were announced in October 2012 but did not ship until the
final month of the quarter; one less week in the first quarter of 2013
compared to the first quarter of 2012; and the overall weakness in the
market for personal computers. Net sales of Mac declined to 10% of the
Company's total net sales in the first quarter of 2013 compared to 14% in
the first quarter of 2012.
• iPod net sales were $2.1 billion in the first quarter of 2013 representing
a decrease of $385 million or 15% compared to the first quarter of 2012.
Unit sales of iPods decreased by 18% during the first quarter of 2013
compared to the same period in 2012. Net sales of iPods accounted for 4%
of the Company's total net sales for the first quarter of 2013 compared to
5% in the first quarter of 2012.
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Segment Operating Performance
The Company manages its business primarily on a geographic basis. Prior to 2013,
the Company's reportable operating segments consisted of the Americas, Europe,
Japan, Asia-Pacific and Retail. In 2013, the Company established a new
reportable operating segment, Greater China, which was previously included in
the Asia-Pacific segment. Segment data for prior periods has been reclassified
to reflect establishment of the Greater China segment. The Americas segment
includes both North and South America. The Europe segment includes European
countries, as well as the Middle East and Africa. The Greater China segment
includes China, Hong Kong and Taiwan. The Rest of Asia Pacific segment includes
Australia and Asian countries, other than Japan and those countries included in
the Greater China segment. The Retail segment operates Apple retail stores in 13
countries, including the U.S. The results of the Americas, Europe, Greater
China, Japan and Rest of Asia Pacific segments do not include results of the
Retail segment. Each operating segment provides similar hardware and software
products and similar services. Further information regarding the Company's
operating segments may be found in Note 7, "Segment Information and Geographic
Data" in Notes to Condensed Consolidated Financial Statements of this Form 10-Q.
Americas
Net sales in the Americas segment increased $2.6 billion or 15% during the first
quarter of 2013 compared to the first quarter of 2012. The growth in net sales
during the first quarter of 2013 was primarily driven by increased demand for
iPhone following the launch of iPhone 5, increased demand for iPad following the
launch of iPad mini and the fourth generation iPad with Retina display in the
first quarter of 2013, and higher sales from iTunes. These increases were
partially offset by decreases in net sales of Mac and iPod. The Americas segment
represented 37% and 38% of the Company's total net sales in the first quarter of
2013 and 2012, respectively.
Europe
Net sales in the Europe segment increased $1.2 billion or 11% during the first
quarter of 2013 compared to the first quarter of 2012. The growth in net sales
during the first quarter of 2013 was primarily driven by increased demand for
iPhone following the launch of iPhone 5 and increased demand for iPad following
the launch of iPad mini and the fourth generation iPad in the first quarter of
2013, and higher sales from iTunes. These increases were partially offset by
decreases in net sales of Mac and iPod. Net sales in the Europe segment continue
to be negatively impacted by the region's uncertain economic conditions. The
Europe segment represented 23% and 24% of the Company's total net sales in the
first quarter of 2013 and 2012, respectively.
Greater China
Net sales in the Greater China segment increased $2.8 billion or 67% during the
first quarter of 2013 compared to the first quarter of 2012. The growth in net
sales during the first quarter of 2013 was primarily driven by increased demand
for iPhone following the launch of iPhone 5 and increased demand for iPad,
partially offset by decreases in net sales of Mac and iPod. The Greater China
segment grew to 13% of the Company's total net sales for the first quarter of
2013 compared to 9% during the first quarter of 2012.
Japan
Net sales in the Japan segment increased $893 million or 25% during the first
quarter of 2013 compared to the first quarter of 2012. The growth in net sales
was mainly due to increased demand for iPhone following the launch of iPhone 5
and higher sales from iTunes. The Japan segment represented 8% of the Company's
total net sales in both the first quarter of 2013 and 2012.
Rest of Asia Pacific
Net sales in the Rest of Asia Pacific segment increased $376 million or 10%
during the first quarter of 2013 compared to the first quarter of 2012. The
growth in net sales during the first quarter of 2013 was primarily driven by
increased demand for iPhone following the launch of iPhone 5 and strong demand
for iPad, partially offset by decreases in net sales of Mac and iPod. The Rest
of Asia Pacific segment represented 7% and 8% of the Company's total net sales
for the first quarter of 2013 and 2012, respectively.
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Retail
Net sales in the Retail segment increased $325 million or 5% during the first
quarter of 2013 compared to the first quarter of 2012. The growth in net sales
during the first quarter of 2013 was primarily driven by increased demand for
iPhone following the launch of iPhone 5 and strong demand for iPad following the
launch of iPad mini and the fourth generation iPad. The growth rate of the
Retail segment was somewhat lower than the Company's overall growth rate
primarily as a result of expanded third-party distribution of iPhone and iPad.
The Company opened 11 new retail stores during the first quarter of 2013, 10 of
which were outside the United States, ending the quarter with 401 stores open
compared to 361 stores at the end of the first quarter of 2012. With an average
of 396 and 358 stores opened during the first quarter of 2013 and 2012,
respectively, average revenue per store decreased to $16.3 million in the first
quarter of 2013, compared to $17.1 million in the first quarter of 2012.
However, given the 14th week added to the first quarter of 2012, revenue per
store on a per week basis increased 3% during the first quarter of 2013 compared
to the first quarter of 2012. The Retail segment represented 12% and 13% of the
Company's total net sales in the first quarter of 2013 and 2012, respectively.
The Retail segment reported operating income of $1.6 billion during the first
quarter of 2013 as compared to $1.9 billion during the first quarter of 2012.
The year-over-year decrease in Retail operating income during the first quarter
of 2013 was primarily attributable to an overall decline in the segment's gross
margin percentage similar to that experienced by the Company overall that was
only partially offset by the relatively modest increase in the Retail segment's
net sales. As of December 29, 2012, the Retail segment had approximately 44,700
full-time equivalent employees.
Gross Margin
Gross margin for the three months ended December 29, 2012 and December 31, 2011
was as follows (in millions, except gross margin percentages):
Three Months Ended
December 29, December 31,
2012 2011
Net sales $ 54,512 $ 46,333
Cost of sales 33,452 25,630
Gross margin $ 21,060 $ 20,703
Gross margin percentage 38.6% 44.7%
The gross margin percentage in the first quarter of 2013 was 38.6% compared to
44.7% in the first quarter of 2012. The year-over-year decrease in gross margin
during the first quarter of 2013 was driven by multiple factors including
introduction of new versions of existing products with higher cost structures
and flat or reduced pricing, introduction of iPad mini with gross margin
significantly below the Company's average product margins, price reductions on
certain existing products, and the impact of the significant number of product
introductions during the quarter on product transition costs. These factors were
partially offset by a higher mix of iPhone during the first quarter of 2013.
The Company expects its gross margin percentage to be lower in 2013 than
experienced in 2012, and the Company anticipates gross margin to be between
37.5% and 38.5% during the second quarter of 2013. The lower gross margin
expected in 2013 is largely due to anticipation of a higher mix of new and
innovative products with flat or reduced pricing that have higher cost
structures and deliver greater value to customers and anticipated component cost
and other cost increases. Future strengthening of the U.S. dollar could further
negatively impact gross margin.
The foregoing statements regarding the Company's expected gross margin
percentage in 2013 and the second quarter of 2013 are forward-looking and could
differ from actual results because of several factors including, but not limited
to, those set forth below in Part II, Item 1A, "Risk Factors" of this Form 10-Q
and those described in this paragraph. In general, gross margins and margins on
individual products will remain under downward pressure due to a variety of
factors, including continued industry wide global product pricing pressures,
increased competition, compressed product life cycles, product transitions and
potential increases in the cost of components, as well as potential increases in
the costs of outside manufacturing services and a potential shift in the
Company's sales mix towards products with lower gross margins. In response to
competitive pressures, the Company expects it will continue to take product
pricing actions, which would adversely affect gross margins. Gross margins could
also be affected by the Company's ability to manage product quality and warranty
costs effectively and to stimulate demand for certain of its products. Due to
the Company's significant international operations, financial results can be
significantly affected in the short-term by fluctuations in exchange rates.
29
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Operating Expenses
Operating expenses for the three months ended December 29, 2012 and December 31,
2011, were as follows (in millions, except for percentages):
Three Months Ended
December 29, December 31,
2012 2011
Research and development expense $ 1,010 $ 758
Percentage of net sales 1.9% 1.6%
Selling, general and administrative expense $ 2,840 $ 2,605
Percentage of net sales 5.2% 5.6%
Total operating expenses $ 3,850 $ 3,363
Percentage of net sales 7.1% 7.3%
Research and Development ("R&D") Expense
R&D expense increased 33% or $252 million to $1.0 billion in the first quarter
of 2013 compared to $758 million in the first quarter of 2012. This increase was
due primarily to an increase in headcount and related expenses to support
expanded R&D activities.
The Company continues to believe that focused investments in R&D are critical to
its future growth and competitive position in the marketplace and are directly
related to timely development of new and enhanced products that are central to
the Company's core business strategy. As such, the Company expects to make
further investments in R&D to remain competitive.
Selling, General and Administrative ("SG&A") Expense
SG&A expense increased $235 million or 9% to $2.8 billion in the first quarter
of 2013 compared to $2.6 billion in the first quarter of 2012. The
year-over-year increase in SG&A expense was due primarily to increases in
overall headcount and related expenses, higher spending on professional
services, and increased variable costs associated with the overall growth of the
Company's net sales.
Other Income and Expense
Other income and expense for the three months ended December 29, 2012 and
December 31, 2011, was as follows (in millions):
Three Months Ended
December 29, December 31,
2012 2011
Interest and dividend income $ 421 $ 228
Other income/(expense), net 41 (91 )
Total other income/(expense), net $ 462 $ 137
Total other income and expense increased by $325 million during the first
quarter of 2013 compared to the first quarter of 2012. The increase in other
income and expense during the first quarter of 2013 as compared to the first
quarter of 2012 was due primarily to higher interest and dividend income on the
Company's higher cash, cash equivalents and marketable securities balances and
lower premium expenses on foreign exchange contracts. The weighted-average
interest rate earned by the Company on its cash, cash equivalents and marketable
securities was 1.07% and 1.02% in the first quarter of 2013 and 2012,
respectively.
Provision for Income Taxes
The Company's effective tax rate during the first quarter of 2013 was 26.0%
compared with 25.3% for the first quarter of 2012. The Company's effective rate
for both periods differs from the statutory federal income tax rate of 35% due
primarily to certain undistributed foreign earnings for which no U.S. taxes are
provided because such earnings are intended to be indefinitely reinvested
outside the U.S. The higher effective tax rate during the first quarter of 2013
as compared to the same quarter of 2012 is due primarily to a lower proportion
of foreign earnings in the current year.
30
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The Internal Revenue Service (the "IRS") has completed its field audit of the
Company's federal income tax returns for the years 2004 through 2006 and
proposed certain adjustments. The Company has contested certain of these
adjustments through the IRS Appeals Office. The IRS is currently examining the
years 2007 through 2009. All IRS audit issues for years prior to 2004 have been
resolved. In addition, the Company is subject to audits by state, local, and
foreign tax authorities. Management believes that adequate provisions have been
made for any adjustments that may result from tax examinations. However, the
outcome of tax audits cannot be predicted with certainty. If any issues
addressed in the Company's tax audits are resolved in a manner not consistent
with management's expectations, the Company could be required to adjust its
provision for income taxes in the period such resolution occurs.
Liquidity and Capital Resources
The following table presents selected financial information and statistics as of
December 29, 2012 and September 29, 2012 (in millions):
December 29, 2012 September 29, 2012
Cash, cash equivalents and marketable securities $ 137,112 $ 121,251
Accounts receivable, net $ 11,598 $ 10,930
Inventories $ 1,455 $ 791
Working capital $ 25,469 $ 19,111
As of December 29, 2012, the Company had $137.1 billion in cash, cash
equivalents and marketable securities, an increase of $15.9 billion from
September 29, 2012. The principal component of this net increase was the cash
generated by operating activities of $23.4 billion, which was partially offset
by payments made for acquisition of property, plant and equipment and intangible
assets of $2.5 billion, cash used to pay dividends and dividend equivalent
rights of $2.5 billion and cash paid under the Company's accelerated share
repurchase program of $1.95 billion.
The Company's marketable securities investment portfolio is invested primarily
in highly-rated securities and its investment policy generally limits the amount
of credit exposure to any one issuer. The policy requires investments generally
to be investment grade with the objective of minimizing the potential risk of
principal loss. As of December 29, 2012 and September 29, 2012, $94.2 billion
and $82.6 billion, respectively, of the Company's cash, cash equivalents and
marketable securities were held by foreign subsidiaries and are generally based
in U.S. dollar-denominated holdings. Amounts held by foreign subsidiaries are
generally subject to U.S. income taxation on repatriation to the U.S. The
Company believes its existing balances of cash, cash equivalents and marketable
securities will be sufficient to satisfy its working capital needs, capital
asset purchases, outstanding commitments, common stock repurchases, dividends on
its common stock, and other liquidity requirements associated with its existing
operations over the next 12 months.
Capital Assets
The Company's capital expenditures were $1.4 billion during the first quarter of
2013 consisting of $82 million for retail store facilities and $1.3 billion for
other capital expenditures, including product tooling and manufacturing process
equipment, and other corporate facilities and infrastructure. The Company's
actual cash payments for capital expenditures during the first quarter of 2013
were $2.3 billion.
The Company anticipates utilizing approximately $10 billion for capital
expenditures during 2013, including approximately $850 million for retail store
facilities and approximately $9.15 billion for other capital expenditures,
including for product tooling and manufacturing process equipment, and corporate
facilities and infrastructure, including information systems hardware, software
and enhancements.
During 2013, the Company expects to open approximately 30 new retail stores,
with approximately three-quarters located outside of the U.S.
Dividend and Stock Repurchase Program
Subject to declaration by the Board of Directors, the Company plans to pay
quarterly dividends of $2.65 per share for a total of approximately $2.5 billion
each quarter.
31
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In 2012, the Company's Board of Directors authorized a program to repurchase up
to $10 billion of the Company's common stock beginning in 2013. The repurchase
program is authorized through 2015 with the primary objective of neutralizing
the impact of dilution from future employee equity grants and employee stock
purchases under the Company's equity plans. The repurchase program does not
obligate the Company to acquire any specific number of shares. The Company
anticipates that it will utilize approximately $45 billion of domestic cash to
pay dividends, repurchase shares, and to remit withheld taxes related to net
share settlement of restricted stock units in the first three years of the
dividend and stock repurchase programs. The Company anticipates the cash used
for future dividends and the repurchase program will come primarily from current
domestic cash and from on-going U.S. operating activities and the cash generated
from such activities.
Off-Balance Sheet Arrangements and Contractual Obligations
The Company has not entered into any transactions with unconsolidated entities
whereby the Company has financial guarantees, subordinated retained interests,
derivative instruments, or other contingent arrangements that expose the Company
to material continuing risks, contingent liabilities, or any other obligation
under a variable interest in an unconsolidated entity that provides financing,
liquidity, market risk, or credit risk support to the Company.
Lease Commitments
The Company's major facility leases are typically for terms not exceeding 10
years and generally provide renewal options for terms not exceeding five
additional years. Leases for retail space are for terms ranging from five to 20
years, the majority of which are for 10 years, and often contain multi-year
renewal options. As of December 29, 2012, the Company's total future minimum
lease payments under noncancelable operating leases were $4.5 billion, of which
$3.2 billion related to leases for retail space.
Purchase Commitments with Outsourcing Partners and Component Suppliers
The Company utilizes several outsourcing partners to manufacture sub-assemblies
for the Company's products and to perform final assembly and testing of finished
products. These outsourcing partners acquire components and build product based
on demand information supplied by the Company, which typically covers periods up
to 150 days. The Company also obtains individual components for its products
from a wide variety of individual suppliers. Consistent with industry practice,
the Company acquires components through a combination of purchase orders,
supplier contracts, and open orders based on projected demand information. As of
December 29, 2012, the Company had outstanding off-balance sheet third-party
manufacturing commitments and component purchase commitments of $18.9 billion.
Other Obligations
In addition to the commitments mentioned above, the Company had additional
off-balance sheet obligations of $904 million as of December 29, 2012, that were
comprised mainly of commitments to acquire capital assets, including product
tooling and manufacturing process equipment, and commitments related to
advertising, research and development, Internet and telecommunications services
and other obligations.
The Company's other non-current liabilities in the Condensed Consolidated
Balance Sheets consist primarily of deferred tax liabilities, gross unrecognized
tax benefits and the related gross interest and penalties. As of December 29,
2012, the Company had non-current deferred tax liabilities of $15.7 billion.
Additionally, as of December 29, 2012, the Company had gross unrecognized tax
benefits of $2.2 billion and an additional $444 million for gross interest and
penalties classified as non-current liabilities. At this time, the Company is
unable to make a reasonably reliable estimate of the timing of payments due to
uncertainties in the timing of tax audit outcomes.
Indemnification
The Company generally does not indemnify end-users of its operating system and
application software against legal claims that the software infringes
third-party intellectual property rights. Other agreements entered into by the
Company sometimes include indemnification provisions under which the Company
could be subject to costs and/or damages in the event of an infringement claim
against the Company or an indemnified third-party. However, the Company has not
been required to make any significant payments resulting from such an
infringement claim asserted against it or an indemnified third-party. In the
opinion of management, there was not at least a reasonable possibility the
Company may have incurred a material loss with respect to indemnification of
end-users of its operating system or application software for infringement of
third-party intellectual property rights. The Company did not record a liability
for infringement costs related to indemnification as of December 29, 2012 or
September 29, 2012.
32
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The Company has entered into indemnification agreements with its directors and
executive officers. Under these agreements, the Company has agreed to indemnify
such individuals to the fullest extent permitted by law against liabilities that
arise by reason of their status as directors or officers and to advance expenses
incurred by such individuals in connection with related legal proceedings. It is
not possible to determine the maximum potential amount of payments the Company
could be required to make under these agreements due to the limited history of
prior indemnification claims and the unique facts and circumstances involved in
each claim. However, the Company maintains directors and officers liability
insurance coverage to reduce its exposure to such obligations, and payments made
under these agreements historically have not been material.
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