Apple SEC Form 10-Q
Apple today released its Quarterly Form 10-Q, which offers detailed information on the company's financial operations and assessment of its future operations. The company said that it had already invested nearly $20 million on R&D (Research & Development) on its generation operating system Mac OS X 10.4 Tiger, which is set for release in the first half of 2004. The company offered details on trends away from from higher-end, higher-margin Pro products, details about the company's retail accounting standards, and revealed that its fiscal first quarter earnings would have been reduced by $20 million had it used a more widely accepted method accounting for stock-compensation expenses.Apple spends $19.3M in Tiger development: In the fourth quarter of 2004, the Apple said it began to incur substantial development costs associated with the upcoming upgrade of Mac OS X 10.4 (code-named "Tiger"). Apple said that "Tiger achieved technological feasibility following its public demonstration in August 2004 and the subsequent release of a developer beta version of the product." Therefore, during the first quarter of 2005 and the fourth quarter of 2004, Apple capitalized approximately $14.8 million and $4.5 million, respectively, of costs associated with the development of Tiger. Apple said that R&D expenditures increased 3 percent to $123 million in the first quarter of 2005 compared to $119 million in the year-ago quarter primarily to an increase in employees to support the increased R&D efforts.
Expensing stock options will reduce earnings: If the company had calculated the fair-market value of its employee stock options, Apple said its earnings for the first fiscal 2005 quarter (ending December 2004) and fourth fiscal 2004 (ending September 2004) would have decreased by $20 million and $29 million, respectively. The result would have been reduce earnings by $0.04 per share in the December 2004 quarter.
New stock-compensation method in Fourth Quarter 2005: Apple says it currently measures compensation expense for its employee stock-based compensation plans using the intrinsic value method prescribed by APB Opinion No. 25 and is still currently evaluating the SFAS 123R. Apple said the SFAS 123R will be effective for Apple beginning in its fourth quarter of fiscal 2005 and expects its adoption to have a material impact on its results of operations.
Apple laid off 415, expecting more: Apple recorded total restructuring charges of approximately $23 million during the year ended September 25, 2004, including approximately $14 million in severance costs, $5.5 million in asset impairments, and a $3.5 million charge for lease cancellations. Of the $23 million charge, $16 million had been utilized by the end of the first quarter of 2005, with the remaining $7 million consisting of $3.7 million for employee severance benefits and $3.3 million for lease cancellations. These combined costs will result in the termination of 485 positions, 415 of which had been terminated prior to the end of the first quarter of 2005 and the rest of which are expected in the coming months.
Employees cash out during December quarter: Apple has 5 million shares of authorized preferred stock, none of which is outstanding--all of which the Board of Directors is authorized to determine or alter the rights, preferences, privileges and restrictions. Executive officers, including Timothy Cook, Peter Oppenheimer, Jonathan Rubinstein, Bertrand Serlet, andAvadis Tevanian, have entered into trading plans that pre-establishes the amounts, prices and dates of future stock purchases or sales. Combined Apple employees excersied more than 12,000 options at an average exercise price of just under $19.00, leaving more than 43,000 unexercised options at average price of nearly $22.50.
Cash reserves generating more income: Total interest and other income, net, increased $17 million to $26 million during the first quarter of 2005 compared to $9 million in the comparable quarter of 2004. The increase is due primarily to higher cash and short-term investment balances and increasing investment yields resulting from higher market interest rates. Apple said that no gains or losses were recognized on any by sales of short-term investments before their maturity during either the first quarter of 2005 or 2004.
Expenses increase due to higher revenue, retail expansion: Selling, General, and Administrative Expense (SG&A) increased 37% or $127 million to $470 million in the first quarter of 2005 compared to $343 million in the same quarter of 2004. This increase is due primarily to higher direct and channel variable selling expenses resulting from the significant year-over-year increase in total net sales for the first quarter, the Company's continued expansion of its Retail segment in both domestic and international markets, and a current year increase in discretionary spending on marketing and advertising.
Short-term portfolio growing: As of December 25, 2004, and September 25, 2004, $449 million and $180 million, respectively, of the Company's investment portfolio that was classified as short-term investments had maturities ranging from 1 to 5 years. The remainder of the Company's short-term investments had underlying maturities between 3 and 12 months.
Cash reserves increase to nearly $6.5 billion: As of December 25, 2004, the Company had $6.448 billion in cash, cash equivalents, and short-term investments, an increase of $984 million over the same balances at the end of fiscal 2004. The principal components of this increase were cash generated by operating activities of $775 million and proceeds of $254 million from the issuance of common stock under stock plans--al of which was partially offset by purchases of property, plant, and equipment of $58 million.
Apple considers asset repatriation: Approximately $3.5 billion of Apple's cash, cash equivalents, and short-term investments is held by Apple's foreign subsidiaries and would be subject to U.S. income taxation on repatriation to the U.S. Apple says it is currently assessing the impact of the one-time favorable foreign dividend provisions recently enacted as part of the AJCA and may decide to repatriate earnings from some of its foreign subsidiaries to help reduce its tax liabilities.
Retail, corporate upgrades increase expenditures: The Company's total capital expenditures were $58 million during the first quarter of fiscal 2005, $33 million of which were for retail store facilities and equipment related to the Company's Retail segment and $25 million of which were for corporate infrastructure, including information systems enhancements and operating facilities enhancements and expansions.
Apple to spend $125M on retail expansion in 2005: The Company currently anticipates it will utilize approximately $240 million for capital expenditures during 2005, approximately $125 million of which is expected to be utilized for expansion of Apple's retail segment and the remainder utilized to support normal replacement of existing capital assets and enhancements to general information technology infrastructure.
Retail expansion increase lease obligations: As of September 25, 2004, the Company had total outstanding commitments on noncancelable operating leases of approximately $617 million, $436 million of which related to the lease of retail space and related facilities. Remaining terms on the Company's existing operating leases range from 2 to 16 years. Total outstanding commitments on noncancelable operating leases related to the lease of retail space rose to $450 million as of December 25, 2004.
GMs may decrease as product mix changes: Unit sales of professional products (Power Mac and PowerBook), generally have higher gross margins than consumer products (iMacs, iBooks, iPods, and content from the iTunes Music Store). A shift in sales mix away from higher margin professional products towards lower margin consumer products could adversely affect future gross margin (GM) and operating margin percentages.
Buying trends may favor lower GM products: Apple said that traditional professional customers may choose to buy consumer products, specifically the iMac G5 and iBook, instead of professional products and that they may choose to buy the iMac G5 due to its relative price performance. Additionally, it predicted that significant future growth in iPod sales could also reduce gross margin and operating margin percentages.
Weak economic conditions affecting Pro sales: Apple believes that weak economic conditions over the past several years are having a pronounced negative impact on its professional and creative customers.
MHz myth affects Pro sales, reduces GMs: Apple also said that current and potential professional, creative, and small business customers, who are most likely to utilize professional systems, believe that the relatively slower MHz rating or clock speed of the Mac's CPU compares "unfavorably to those utilized by other computer manufacturers and translates to slower overall system performance." These factors may result in an adverse impact to sales of the Company's professional products as well as to gross margin and operating margin percentages.
Apple spends more on R&D than its competitors: Apple says it has higher research and development and selling, general and administrative costs, as a percentage of revenue, than many of its competitors. Its ability to compete successfully and maintain attractive gross margins and revenue growth is "heavily dependent upon its ability to ensure a continuing and timely flow of innovative and competitive products and technologies to the marketplace." As a result, Apple incurs higher research and development costs as a percentage of revenue than its competitors who sell personal computers based on other operating systems. Many of these competitors seek to compete aggressively on price and maintain very low cost structures.
Retail expansion, brand marketing increase selling costs: Further, Apple says its selling costs are more than its competitors as a result of its retail expansion and due to costs associated with brand marketing, including its unique operating system: "Apple incurs higher selling costs as a percentage of revenue than many of its competitors. If the Company is unable to continue to develop and sell innovative new products with attractive gross margins, its results of operations may be materially adversely affected by its operating cost structure.
Apple's warranty costs increasing: Apple's costs for warranty claims increased in 2004 as compared with 2003. The company said that it saw a more than 50 percent increase from $21 million in 2003 to $35 million in 2004. Apple said thatfactors considered in determining appropriate accruals for product warranty obligations include the size of the installed base of products subject to warranty protection, historical and projected warranty claim rates, historical and projected cost-per-claim, and knowledge of specific product failures that are outside of its typical experience. For the entire year, Apple said it accrued $135 million in warranty and related costs versus $80 million in 2003.
Retail accounting setup
- The Retail segment's operating income includes cost of sales for Apple products at an amount normally charged to major channel partners in the U.S. operating retail stores, less the cost of sales programs and incentives provided to those channel partners and the Company's cost to support those partners. For the first quarter of 2005 and 2004, this resulted in the recognition of additional cost of sales above standard cost by the Retail segment and an offsetting benefit to corporate expenses of approximately $99 million and $52 million, respectively.
- Since Apple's retail division assumes the full revenue/costs of the extended warranty, support and service contracts, Apple must assume an operating expenditure charge to offset the cost/profit associated with the unrealized revenue/costs. For the first quarter of 2005, this resulted in the recognition of net sales and cost of sales by the Retail segment, with corresponding offsets in other operating segments, of $19 million and $13 million, respectively. For the first quarter of 2004, the net sales and cost of sales recognized by the Retail segment for sales of extended warranty, support and service contracts were $12 million and $8 million, respectively.
- Apple says it has opened seven high profile stores in New York, Los Angeles, Chicago, San Francisco, Tokyo, Osaka, and London, as of December 25, 2004. These high profile stores are larger than its typical retail stores and were "designed to further promote brand awareness and provide a venue for certain corporate sales and marketing activities, including corporate briefings." Apple allocates certain operating expenses associated with these stores to corporate marketing expense to reflect the estimated benefit realized Company-wide. Apple says the allocation of these operating costs is based on the excess amount incurred for a high profile store to that of a more typical Company retail location. Expenses allocated to corporate marketing resulting from the operations of these stores were $6.9 million and $2.2 million in the first quarters of 2005 and 2004, respectively.
- The Retail segment's net sales grew to $561 million during the first quarter of 2005 from $273 million during the same period in 2004, a 105% increase. Mac unit sales increased 63% year-over-year in the first quarter of 2005. These increases are largely attributable to the increase in total stores from 73 stores at the end of the first quarter of 2004 to 101 stores at the end of the first quarter of 2005, as well as a 48% year-over-year increase in average revenue per store. While customers in areas where the Retail segment has opened stores may elect to purchase from the Retail segment stores rather than the Company's preexisting sales channels, Apple says it believes that a substantial portion of the Retail segment's net sales is incremental to its total net sales.
During the last two fiscal quarters, Apple said it incurred expenses associated with the use of Steve Jobs' personal Gulfstream V jet totaling $419,000 and $282,000, respectively.