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If actual product failure rates or repair costs differ from estimates, revisions to the estimated warranty liability would be required and could negatively affect the Company’s results of operations.
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Stock-Based Compensation The Company accounts for stock-based compensation in accordance with Statement of Financial Accounting Standards (SFAS) No.
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123R, Share-Based Payment.
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Under the provisions of SFAS No.
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123R, stock-based compensation cost is estimated at the grant date based on the award’s fair-value as calculated by the Black-Scholes-Merton (BSM) option-pricing model and is recognized as expense ratably over the requisite service period.
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The BSM model requires various highly judgmental assumptions including volatility, forfeiture rates, and expected option life.
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If any of the assumptions used in the BSM model change significantly, stock-based compensation expense may differ materially in the future from that recorded in the current period.
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Income Taxes The Company records a tax provision for the anticipated tax consequences of the reported results of operations.
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In accordance with SFAS No.
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109, Accounting for Income Taxes, 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...
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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.
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The Company records a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized.
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The Company is currently evaluating the repatriation provisions of the American Jobs Creation Act of 2004, which, if implemented by the Company, would affect the Company’s tax provision and deferred tax assets and liabilities.
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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 the tax effects of the deferred tax liabilities, will be sufficient to fully recover the remaining deferred tax assets.
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In the event that all or part of the net deferred tax assets are determined not to be realizable in the future, an adjustment to the valuation allowance would be charged to earnings in the period such determination is made.
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Similarly, if the Company subsequently realizes deferred tax assets that were previously determined to be unrealizable, the respective valuation allowance would be reversed, resulting in a positive adjustment to earnings or a decrease in goodwill in the period such determination is made.
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In addition, the calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws.
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Resolution of these uncertainties in a manner inconsistent with management’s expectations could have a material impact on the Company’s results of operations and financial position.
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Products The Company offers a range of personal computing products including desktop and notebook personal computers, related devices and peripherals, and various third-party hardware products.
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In addition, the Company offers software products including Mac OS® X, the Company’s proprietary operating system software for the Macintosh®; server software and related solutions; professional application software; and consumer, education and business oriented application software.
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The Company also designs, develops and markets to Macintosh and Windows users its line of iPod® digital music players along with related accessories and services including the online distribution of third-party music through the Company’s iTunes Music Store®.
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A detailed discussion of the Company’s products may be found in the 2005 Form 10-K. Certain newly introduced products and/or upgrades to existing products are discussed below.
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In January 2006, the Company announced the new iMac® and MacBook™ Pro, which are the first Macintosh computers to run on Intel microprocessors.
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The iMac and MacBook Pro feature the Company’s new translation technology, Rosetta™, which allows most PowerPC-based Macintosh applications to run on these new Intel-based Macintosh computers.
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iMac® The Company’s new iMac featuring the Intel Core Duo processor is available in a 17-inch widescreen LCD display with a 1.83 GHz processor and 160GB Serial ATA hard drive.
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The iMac is also available in a 20-inch widescreen LCD display with a 2.0 GHz processor and 250GB Serial ATA hard drive.
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Both models include a built-in iSight™ video camera for video conferencing, Front Row™ with the Apple Remote, 512 MB of 667 MHz DDR2 SDRAM expandable to 2GB, 8x SuperDrive™ with double-layer support, and PCI Express-based ATI Radeon X1600 with 128MB GDDR3 memory.
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Every new iMac comes with iLife® ‘06.
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MacBook™ Pro The Company’s new MacBook Pro featuring the Intel Core Duo processor is expected to begin shipping in February 2006.
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The MacBook Pro features an aluminum enclosure that is one-inch thin, weighs 5.6 pounds, includes a built-in iSight video camera for video conferencing, Front Row with the Apple Remote, iLife ‘06, two USB 2.0 ports, one FireWire® 400 port, a gigabit Ethernet port, built-in AirPort Extreme® wireless networking and Bluet...
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The new MacBook Pro also features Apple’s new patent-pending MagSafe™ magnetic power connector.
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iPod® Radio Remote In January 2006, the Company announced iPod Radio Remote, a wired remote control with FM radio capabilities.
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The iPod Radio Remote allows users to skip tracks, adjust the volume of their iPods, and listen to FM radio stations while displaying station and song information on their iPod screens.
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iLife® ‘06 In January 2006, the Company introduced iLife ‘06, an upgrade to its consumer-oriented digital lifestyle application suite, which features iWeb™, iPhoto® 6, iMovie® HD6, iDVD® 6, and GarageBand™ 3. iWeb™ is a new application in the iLife’06 suite.
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iWeb allows users to create online photo albums, blogs and podcasts and customize websites using editing tools and pre-designed templates.
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iPhoto® 6 adds new photo management and editing features, supports up to 250,000 photos, and introduces Photocasting™.
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Photocasting allows .Mac users to share and automatically update photo albums over the Internet with anyone who uses a Macintosh or Windows-based PC.
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iMovie® HD 6 now includes new real-time effects that take advantage of Core Video technology, which uses the computer’s video card’s graphics processing unit to deliver hardware acceleration to quickly preview video effects.
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iMovie 6 also provides a solution to make video podcasts, which can be published with iWeb, and includes audio enhancement tools and sound effects.
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iDVD® 6 now allows users to take content shot with HDV and widescreen DV cameras and author custom DVDs with widescreen menus, movies, and high resolution slideshows.
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iDVD 6 features 10 new Apple-designed menu themes in both widescreen (16:9) and standard (4:3) formats.
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GarageBand™ 3 now allows users to record, produce, and publish through iWeb their own podcasts, including artwork, sound effects, and music jingles.
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iWork™ ‘06 In January 2006, the Company introduced iWork ‘06, a new version of the Company’s suite of productivity software designed to help users create, present, and publish documents and presentations.
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iWork ‘06 includes Pages® 2 and Keynote™ 3.
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Pages® 2 features mail merge with Mac OS® X Address Book, which allows users to personalize documents by dragging and dropping individual contacts into documents using templates with predefined fields.
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Pages 2 also features new templates for newsletters, flyers, posters, school reports, scrapbooks, brochures, business proposals, and invoices.
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Pages 2 allows users to insert tables that have basic calculation functionality within any document and users can export their Pages 2 document to other formats.
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Keynote™ 3 offers additional ways to create presentations and interactive slideshows.
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It features new cinematic transitions including vertical and horizontal blinds, revolving door, and swoosh.
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A new view mode, Light Table, allows users to view an entire presentation and reorganize slides using drag and drop.
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Net Sales The first quarter of 2006 spanned 14 weeks while the first quarter of 2005 spanned 13 weeks.
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This additional week is added to the first fiscal quarter approximately every six years to realign fiscal quarters with calendar quarters.
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Net sales and Macintosh unit sales by operating segment and net sales and unit sales by product follow (net sales in millions and unit sales in thousands): Notes: (a) Other Segments include Asia Pacific and FileMaker.
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(b) Includes iMac, eMac, Mac mini, Power Mac, and Xserve product lines.
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(c) Includes iBook and PowerBook product lines.
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(d) Consists of iTunes Music Store sales, iPod services, and Apple-branded and third-party iPod accessories.
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(e) Includes sales of Apple-branded and third-party displays, wireless connectivity and networking solutions, and other hardware accessories.
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(f) Includes sales of Apple-branded operating system software, application software, third-party software, AppleCare, and Internet services.
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(g) Derived by dividing total Macintosh net sales by total Macintosh unit sales.
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(h) Derived by dividing total iPod net sales by total iPod unit sales.
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Net sales during the first quarter of 2006 increased 65% or $2.3 billion from the first quarter of 2005.
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The increase was due in part to the fact that the first quarter of 2006 spanned 14 weeks while the first quarter of 2005 spanned 13 weeks.
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Several other factors contributed to this increase including the following: • Net sales of iPods rose $1.7 billion or 140% during the first quarter of 2006 compared to the first quarter of 2005.
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Unit sales of iPods totaled 14.0 million in the first quarter of 2006, which represents an increase of 207% from the 4.6 million iPod units sold in the first quarter of 2005.
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Strong sales of iPods during the first quarter of 2006 continued to be experienced by all of the Company’s operating segments and were driven by strong demand for the newest version of the iPod with video playing capabilities introduced in October 2005, the release of the iPod nano in September 2005, and expansion of t...
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Net sales per iPod unit sold decreased 22% primarily due to the introduction of the lower priced iPod shuffle in January 2005 and a shift in sales towards the lower-priced iPod nano.
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• Net sales of other music related products and services increased $314 million or 177% during the first quarter of 2006 compared to the first quarter of 2005 primarily due to increased net sales from the iTunes Music Store and of iPod services and accessories.
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The year-over-year increase in sales from the iTunes Music Store relates to significant growth in U.S. sales, the expansion of the iTunes Music Store to seven additional countries by the end of the first quarter of 2006 from the first quarter of 2005, including Japan and Australia, and the introduction of video sales o...
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The Company has also experienced strong growth in sales of both Apple-branded and third-party iPod accessories and services, consistent with the increase in overall iPod unit sales for the first quarter of 2006.
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• The Retail segment’s net sales grew to $1.1 billion during the first quarter of 2006 from $561 million during the first quarter of 2005, a 91% increase, while Retail segment Macintosh unit sales increased 62%.
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These increases are largely attributable to the increase in total stores from 101 stores at the end of the first quarter of 2005 to 135 stores at the end of the first quarter of 2006, as well as a 41% year-over-year increase in average revenue per store.
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• Macintosh net sales increased $119 million or 7% during the first quarter of 2006 compared to the first quarter of 2005.
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Macintosh unit sales increased by 208,000 units or 20% during the first quarter of 2006 compared to the first quarter of 2005.
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The increases in Macintosh net sales and unit sales were driven by higher sales of portable products in all of the Company’s operating segments.
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Net sales and unit sales of the Company’s portable products increased 34% and 39%, respectively.
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The increase in Macintosh portable net sales was partially offset by a decrease in Macintosh desktop net sales of 9%, while Macintosh desktop unit sales increased by 7% year-over-year.
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The year-over-year increase in desktop unit sales with a corresponding decrease in desktop net sales was primarily due to the introduction of the Mac mini in the second quarter of 2005.
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The Mac mini’s starting price of $499 is significantly lower than the starting prices of the Company’s other desktop products and contributed to a decrease in net sales per Macintosh unit sold of 10% year-over-year.
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• Net sales of peripherals and other hardware rose by 7% during the first quarter of 2006 compared to the first quarter of 2005 primarily due to an increase in net sales of RAID storage, iSight digital video cameras, printers, and other hardware accessories.
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• U.S. education channel net sales increased by approximately 16% during the first quarter of 2006 compared to the first quarter of 2005, while Macintosh unit sales were relatively flat compared to the first quarter of 2005.
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Net sales from the higher education market grew 31% in the first quarter of 2006 compared to the first quarter of 2005 due to strong iPod sales, as well as increases in Macintosh portable products and Apple-branded software sales.
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Net sales were relatively flat for K-12 year-over-year.
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• Net sales of software, service, and other sales rose $112 million or 53% during the first quarter of 2006 compared to the first quarter of 2005.
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This growth was primarily attributable to increased net sales in AppleCare Protection Plan (APP) extended service and support contracts, Mac OS X, and third-party software.
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Segment Operating Performance The Company manages its business primarily on a geographic basis.
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The Company’s reportable operating segments are comprised of the Americas, Europe, Japan, and Retail.
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The Americas, Europe, and Japan reportable segments do not include activities related to the Retail segment.
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The Americas segment includes both North and South America.
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The Europe segment includes European countries as well as the Middle East and Africa.
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The Retail segment operated Apple-owned retail stores in the U.S., Canada, Japan, and the U.K. during the first quarter of 2006.
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Each reportable geographic operating segment provides similar hardware and software products and similar services.
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Further information regarding the Company’s operating segments may be found in Part I, Item 1 of this Form 10-Q in the Notes to Condensed Consolidated Financial Statements at Note 8, “Segment Information and Geographic Data.” Americas Net sales in the Americas segment during the first quarter of 2006 increased $1.1 bil...
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The increase in net sales during the first quarter of 2006 was primarily attributable to the significant year-over-year increase in iPod sales, sales of other music related products and services, sales of portable Macintosh systems, and sales of software, service, and other sales.
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These increases were partially offset by a 18% decrease in desktop net sales year-over-year.
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During both the first quarters of 2006 and 2005, the Americas segment represented approximately 47% of the Company’s total net sales.
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The Company experienced a year-over-year increase in its U.S. education channel net sales of 16% compared to the first quarter of 2005 due to strong iPod sales, as well as increases in Macintosh portable products and Apple-branded software sales.
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Europe Net sales in Europe increased $395 million or 47% during the first quarter of 2006 as compared to the same quarter in 2005.
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Total Macintosh unit sales in Europe increased 21% on a year-over-year basis.
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Consistent with the Americas segment, Europe experienced strong sales of iPods, portable products, and other music related products and services.
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The Europe segment also experienced strong sales of Apple-branded and third-party displays and other hardware accessories.
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