UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D. C.D.C. 20549
                                   ___________

                                  Form 10-Q
                                  ___________

                                  (Mark One)

         [X]     Quarterly report pursuant to Section_X_ QUARTERLY REPORT PURSUANT TO SECTION 13 orOR 15(d) of 
the Securities Exchange Act ofOF THE 
             SECURITIES EXCHANGE ACT OF 1934
             For the quarterly period ended June 27,December 26, 1997 OR
             [   ]   Transition report pursuant to SectionTRANSITION REPORT PURSUANT TO SECTION 13 orOR 15(d) of 
the Securities Exchange Act ofOF 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                    94-2404110
     [State942404110
     (State or other jurisdiction         [I.R.S.(I.R.S. Employer Identification No.)
of incorporation or organization] 	     Identification No.]organization)

         1 Infinite Loop                                95014
       Cupertino, California
     95014
[Address(Address of principal executive offices]             [Zip Code]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]X      No  [   ]

        
127,329,661____


132,768,062 shares of Common Stock Issued and Outstanding as of AugustJanuary 30, 1998

                                      1 1997




PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

                             APPLE COMPUTER, INC.

         CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
                (Dollars in millions, except per share amounts)

THREE MONTHS ENDED NINE MONTHS ENDED JuneDecember 26, 1997 December 27, June 28, June 27, June 28, 1997 1996 1997 1996 Net sales $1,737 $2,179 $5,467 $7,512$ 1,578 $ 2,129 Costs and expenses: Cost of sales 1,389 1,776 4,419 7,0551,225 1,732 Research and development 101 155 391 45879 149 Selling, general and administrative 307 364 1,027 1,209 In-process research and development - - 375 - Restructuring costs - - 155 207 1,797 2,295 6,367 8,929234 372 1,538 2,253 Operating loss (60) (116) (900) (1,417)income (loss) 40 (124) Interest and other income (expense), net 7 4 65 16 82 LossIncome (loss) before benefit fromprovision (benefit) for income taxes (56) (51) (884) (1,335) Benefit from47 (120) Provision (benefit) for income taxes - (19) - (494)-- -- Net lossincome (loss) $ (56)47 $ (32) $ (884) $ (841) Loss(120) Basic earnings (loss) per common share $(0.44) $(0.26) $ (7.04) $ (6.81) Cash dividends paid per common share $ --0.37 $ --(0.96) Diluted earnings (loss) per share $ --0.33 $ .12(0.96) Common shares used in the calculations of lossbasic earnings (loss) per share (in thousands) 126,500 123,735 125,547 123,463127,989 124,532 Common and common equivalent shares used in the calculations of diluted earnings (loss) per share (in thousands) 139,839 124,532
1See accompanying notes to condensed consolidated financial statements (unaudited). 2 APPLE COMPUTER, INC. CONDENSED CONSOLIDATED BALANCE SHEETS ASSETS (In millions)
June 27,December 26, 1997 September 27,26, 1997 (Unaudited) 1996 Current assets: Cash and cash equivalents $ 1,0181,193 $ 1,5521,230 Short-term investments 212 193434 229 Accounts receivable, net of allowance for doubtfulaccountsdoubtful accounts of $100$96 ($9199 at September 27, 1996) 1,207 1,49626, 1997) 902 1,035 Inventories: Purchased parts 175 21399 141 Work in process 23 435 15 Finished goods 336 406 534 662300 281 404 437 Deferred tax assets 307 342233 259 Other current assets 215 270207 234 Total current assets 3,493 4,5153,373 3,424 Property, plant, and equipment: Land and buildings 460 480402 453 Machinery and equipment 525 544416 460 Office furniture and equipment 121 136100 110 Leasehold improvements 180 188 1,286 1,348151 172 1,069 1,195 Accumulated depreciation and amortization (746) (750)(640) (709) Net property, plant, and equipment 540 598429 486 Other assets 308 251324 323 $ 4,3414,126 $ 5,3644,233
2See accompanying notes to condensed consolidated financial statements (unaudited). 3 APPLE COMPUTER, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (Continued) LIABILITIES AND SHAREHOLDERS' EQUITY (Dollars in millions)
June 27,December 26, 1997 September 27,26, 1997 (Unaudited) 1996 Current liabilities: Notes payable to banks $ 12724 $ 18625 Accounts payable 812 791655 685 Accrued compensation and employee benefits 115 12092 99 Accrued marketing and distribution 269 257261 278 Accrued warranty and related 139 181126 128 Accrued restructuring costs 167 117144 180 Other current liabilities 281 351367 423 Total current liabilities 1,910 2,0031,669 1,818 Long-term debt 952 951 949 Deferred tax liabilities 284 354261 264 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; 126,559,143128,018,985 shares issued and outstanding at June 27,December 26, 1997 (124,496,972(127,949,220 shares at September 27, 1996) 476 43926, 1997) 499 498 Retained earnings 750 1,634636 589 Other (30) (15)(41) (37) Total shareholders' equity 1,196 2,0581,244 1,200 $ 4,3414,126 $ 5,3644,233
3See accompanying notes to condensed consolidated financial statements (unaudited). 4 APPLE COMPUTER, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In(Dollars in millions)
NINETHREE MONTHS ENDED JuneDecember 26, 1997 December 27, 1997 June 28, 1996 Cash and cash equivalents, beginning of the period $1,552 $ 7561,230 $ 1,552 Operating: Net loss (884) (841)income (loss) 47 (120) Adjustments to reconcile net lossincome (loss) to cash generated by (used for) operating activities: Depreciation and amortization 77 11028 25 Changes in operating assets and liabilities: Accounts receivable 133 4 Inventories 33 174 Deferred tax assets 26 18 Other current assets 27 (38) Accounts payable (30) 29 Accrued restructuring costs (36) (12) Other current liabilities (82) 30 Deferred tax liabilities (3) (18) Cash generated by operating activities 143 92 Investing: Purchase of short-term investments (399) (542) Proceeds from sales and maturities of short-term investments 194 102 Net book valueproceeds from sale of property, plant, and equipment retirements 40 43 In-process research and development 375 --- Changes in assets and liabilities, net of effect of the acquisition of NeXT: Accounts receivable 297 639 Inventories 128 714 Deferred tax assets 35 (150) Other current assets 55 (26) Accounts payable 20 (403) Accrued restructuring costs 50 159 Other current liabilities (133) 119 Deferred tax liabilities (70) (252) Cash generated by (used for) operating activities (10) 112 Investing: Purchases of short-term investments (781) (244) Proceeds from sale of short-term investments 762 440 Purchases45 2 Purchase of property, plant, and equipment (42) (55)(7) (20) Other (14) (10) Cash used to acquire NeXT (384) --- Other (32) (33) Cash generated by (used for)for investing activities (477) 108(181) (468) Financing: DecreaseIncrease (decrease) in notes payable to banks (59) (274)(1) (6) Increase (decrease) in long-term borrowings -- 6461 1 Increases in common stock, net of related tax benefits and effect of the acquisition of NeXT 12 25 Cash dividends -- (14)1 3 Cash generated by (used for) financing activities (47) 3831 (2) Total cash generated (used) (534) 603used (37) (378) Cash and cash equivalents, end of the period $1,018 $ 1,3591,193 $ 1,174 Supplemental cash flow disclosures: Cash paid during the quarter for interest $ 20 $ 20 Cash paid(received) during the quarter for income taxes, net $ (18) $ 20
4See accompanying notes to condensed consolidated financial statements (unaudited). 5 APPLE COMPUTER, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTSNotes to Condensed Consolidated Financial Statements (Unaudited) 1. 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. The results for interim periods are not necessarily indicative of results to be expected for the entire year. These financial statements and notes should be read in conjunction with the Company's annual consolidated financial statements and the notes thereto for the fiscal year ended September 27, 1996,26, 1997, included in its Annual Report on Form 10-K for the year ended September 27, 199626, 1997 (the "1996"1997 Form 10-K"). 2. The Company has adopted Statement of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings Per Share". In accordance with SFAS 128, primary earnings per share have been replaced with basic earnings per share, and fully diluted earnings per share have been replaced with diluted earnings per share which includes potentially dilutive securities such as outstanding options and convertible securities. Prior periods have been presented to conform to SFAS 128, however, as the Company had a net loss in the prior period, basic and diluted loss per share are the same as the primary loss per share previously presented. 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. The following table sets forth the computation of basic and diluted earnings per share (in thousands, except net income (loss) and per share amounts):
For the Quarter ended For the Quarter ended December 27, 1997 December 27, 1996 Numerator: Net income (loss) $ 47 $ (120) Denominator: Denominator for basic earnings (loss) per share -- weighted average shares outstanding 127,989 124,532 Effect of Dilutive Securities: Convertible preferred stock 9,091 -- Dilutive options outstanding 2,759 -- Dilutive potential common shares 11,850 -- Denominator for diluted earnings per share -- adjusted weighted-average shares and assumed conversions 139,839 124,532 Basic earnings (loss) per share $ 0.37 $ (0.96) Diluted earnings (loss) per share $ 0.33 $ (0.96)
6 For purposes of calculating diluted earnings per share for the first quarter of 1998, the Company assumed that all employees exchanged their existing options (See Note 5 to the Condensed Consolidated Financial Statements) for new options with an exercise price of $13.6875 effective December 15, 1998. Therefore, all options outstanding as of December 26, 1997, were included in the computation of diluted earnings per share as they were all considered to have exercise prices less than $18.05, the average market price of common shares during the first quarter of 1998. However, the effect on dilutive earnings per share of approximately 8.5 million of the outstanding options was weighted to reflect that they were only considered outstanding and dilutive options from December 19, 1997, the date of the Company's option exchange offer to its employees, through the end of the quarter. 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 were not included in the computation of diluted earnings per share because the effect of using the if-converted method would be anti-dilutive. For additional disclosures regarding the outstanding preferred stock, employee stock options and the Notes, see the 1997 Form 10-K. 3. In the second quarter of 1996, the Company announced and began to implement a restructuring plan aimed at reducing costs and restoring profitability to the Company's operations. The restructuring plan was necessitated by decreased demand for Companythe Company's products and the Company's adoption of a new strategic direction. These actions resulted in a net charge of $179 million after subsequent adjustments recorded in the fourth quarter of 1996. In the second quarter ofDuring 1997, the Company announced and began to implement supplemental restructuring actions to meet the foregoing objectives of the plan. The Company recognized a $155$217 million charge in the second quarterduring 1997 for the estimated incremental costs of those actions.actions, including approximately $8 million of costs related to the termination of the Company's former Chief Executive Officer. The combined restructuring actions consist of terminating approximately 3,1003,600 full-time employees, as adjusted, approximately 2,4003,000 of whom have been terminated from the second quarter of 1996 through June 27,December 26, 1997, excluding employees who were hired by SCI Systems, Inc. and MCI Systemhouse, the purchasers of the Company's Fountain, Colorado manufacturing facility and the Napa, California data center facility, respectively; canceling or vacating certain facility leases as a result of those employee terminations; writing down certain land, buildings and equipment to be sold as a result of downsizing operations and outsourcing various operational functions; and canceling contracts for projects and technologies that are not central to the Company's core business strategy. The restructuring actions under the plan have resulted in cash expenditures of $135$195 million and noncash asset write-downs of $32$57 million from the second quarter of 1996 through June 27,December 26, 1997. During the third quarter of 1997 and the first quarter of 1998, the Company made adjustments to the categories and timing of expected restructure spending based on revised estimates. The Company expects that the remaining $167$144 million accrued balance at June 27,as of December 26, 1997 will result in cash expenditures of approximately $100$102 million over the next twelve months and $12$10 million thereafter. The Company expects that most of the contemplated restructuring actions related to the plan will be completed within the next six monthsduring fiscal 1998 and will be financed through current working capital and, if necessary, continued short-term borrowings. 57 The following table depicts the restructuring accrual activity from September 27, 1996 to June 27,through December 26, 1997:
(In millions)
Category Net Balance at Additionsas of Spending Adjustments Balance atas September 27, During During June 27, 1996 Q2'97 Spending Q3'97of December 26, 1997 Q1'98 Q1'98 26, 1997 Payments to employees involuntarily terminated (C) $33 $109 $65 $(10) $67$ 76 $ 23 $ 1 $ 54 Payments on canceled or vacated facility leases (C) 15 16 6 (5) 2025 2 3 26 Write-down of operating assets to be sold (N) 47 20 25 13 5539 4 (3) 32 Payments on canceled contracts (C) 22 10 9 2 25 $117 $155 $105 $0 $16740 7 (1) 32 $180 $ 36 $ -- $144
C:(C): Cash; N: Noncash 3. On February 4,(N): Noncash. 4. In August 1997, the Company acquired allagreed to acquire certain assets of Power Computing Corporation ("PCC"), a company which Apple had licensed to distribute the outstanding sharesMac OS operating system. In addition to the acquisition of NeXT Software, Inc. ("NeXT"). NeXT, headquartered in Redwood City, California, had developed, marketedcertain assets such as PCC's customer database and supported software that enables customersthe license to easily and quickly implement business applications ondistribute the Internet/World Wide Web, intranets and enterprise-wide client/server networks.Mac OS, the Company has the right to retain certain key employees of PCC. The agreement with PCC also includes a release of claims between the parties. On January 28, 1998, the Company completed its acquisition of certain assets of PCC. The total purchase price was $425approximately $115 million, as adjusted, and was comprised of cash payments of $319 million and the issuance of 1.5 millionwhich included 4,159,000 shares of the Company's common stock to the NeXT shareholders valued at approximately $25$80 million, according to the terms of the purchase agreement; the issuanceforgiveness of approximately 1.8$28 million options to purchaseof receivables due from PCC, assumption by the Company's common stock to the NeXT optionholders valued at approximately $16 million based on theCompany of certain customer support liabilities of PCC, and closing and related costs. The difference between the exercisetotal purchase price of the options and the market value$75 million expensed as "Termination of License Agreement" in the fourth quarter of 1997 will be capitalized in the second quarter of 1998 and then amortized over a period of three years. 5. In order to address concerns regarding the retention of the Company's stock on the date the options were granted; cash payments of $56 million to the NeXT debtholders; and cash payments of $9 million for closing and related costs, as adjusted. The acquisition was accounted for as a purchase and, accordingly, the operating results pertaining to NeXT subsequent to the date of acquisition have been includedkey employees, in the Company's consolidated operating results. The purchase price, including the fair value of the net tangible liabilities assumed, was $427 million, as adjusted, of which $375 million was allocated to purchased in-process research and development and $52 million was allocated to goodwill and other intangible assets. The purchased in-process research and development was charged to operations upon acquisition, and the goodwill and other intangible assets are being amortized on a straight-line basis over 2 to 7 years. The purchase price allocation is based on preliminary estimates of the fair value of the acquired net assets and in-process research and development and may be subject to adjustment as management completes its evaluation of the technology acquired and additional information becomes available during 1997. The following unaudited proforma summary combines the consolidated results of operations of the Company and NeXT as if the acquisition had occurred at the beginning of the nine months ended June 27, 1997 and June 28, 1996, after giving effect to certain adjustments, including in-process research and development, amortization of intangible assets, lower interest income as a result of lower cash investment balances, and lower interest expense as a resultof the settlement of the NeXT debt, and related income tax effects. The proforma summary does not necessarily reflect the results of operations as they would have been had the Company and NeXT been combined as of the beginning of such periods. 6 Proforma Results of Operations (dollars in millions) Nine Months Ended June 27,1997 June 28, 1996 [S] [C] [C] Net sales $ 5,484 $ 7,544 Net loss $ (900) $(1,249) Loss per common share $ (7.14) $ (9.99) 4. In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("FAS 128"). Under the provisions of FAS 128, primary earnings per share will be replaced with basic earnings per share, and fully diluted earnings per share will be replaced with diluted earnings per share for companies with potentially dilutive securities such as outstanding options and convertible debt. FAS 128 is effective for annual and interim periods ending after December 15, 1997 and will require restatement of all comparative per share amounts. The basic loss per share will be no different than the primary loss per share as presented in the accompanying consolidated statements of operations as neither consider outstanding options or convertible debt. If and when the Company becomes profitable, it will be required to present both basic and diluted earnings per share. Basic earnings per share, which does not consider potentially dilutive securities, will be greater than the replaced primary earnings per share which did consider those securities. Diluted earnings per share will not differ materially from the replaced fully diluted earnings per share. 5. In July of 1997 the Board of Directors adopted a resolution allowingapproved an option exchange program which permits employees to exchange all (but not less than all) of their existing options (vested and unvested) to purchase Apple common stock (other than options granted by and assumed from NeXT Software, Inc.) for options havingwith an exercise price of $13.25greater than $13.6875 on a one-for-one basis for new options with an exercise price of $13.6875, the fair market value of the Company's common stock on December 19, 1997, and a new threefour year vesting periodschedule beginning in JulyDecember 1997. 6. In October 1997, the American Institute of 1997. 6.Certified Public Accountants issued Statement of Position ("SOP") 97-2, "Software Revenue Recognition." SOP 97-2 establishes standards relating to the recognition of all aspects of software revenue. SOP 97-2 is effective for transactions entered into in fiscal years beginning after December 15, 1997 and may require the Company to modify certain aspects of its revenue recognition policies. The Company does not expect the adoption of SOP 97-2 to have a material impact on the Company's consolidated results of operations. 7. 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 the issues for thosethese 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. 7. On August 6, 1997, the Company and Microsoft Corporation ("Microsoft") announced patent cross licensing and technology agreements between the two companies. In addition, Microsoft will purchase 150,000 shares of Apple Series 'A' Non-voting Convertible Preferred Stock ("Preferred Stock") for $150 million. Except under limited circumstances, the shares of Preferred Stock may not be sold by Microsoft prior to August 5, 2000. Upon any sale of the Preferred Stock by Microsoft, the shares will automatically be converted into shares of Apple common stock at a conversion price of $16.50 per share and the shares can be converted at Microsoft's option at such price after August 5, 2000. Each share of Preferred Stock is entitled to receive, if and when declared by the Company's Board of Directors, a dividend of $30 per share per annum, payable in preference to any dividend on the Company's common stock, plus, if the dividends per share paid on the common stock are greater than the dividends pershare paid on the Preferred Stock on an as converted basis, then the Board of Directors shall declare an additional dividend such that the dividends per share paid on the Preferred Stock on an as converted basis, shall equal the dividends per share paid on the common stock. 8. In August 1997, the Board of Directors adopted a resolution to reserve 5 million shares for issuance under a new stock option plan for non-officer employees of the Company. 9. The information set forth in Item 1 of Part II hereof is hereby incorporated by reference. 78 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 Operating Results and Financial Condition" below. The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto.thereto included elsewhere in this Form 10-Q. All information is based on the Company's fiscal calendar. Overview During the first quarter of 1998 the Company experienced significant improvement in its financial performance, reporting its first operating profit since the fourth quarter of 1996 and earning higher gross margins than in both the previous quarter and the same quarter of the prior year. Operating expenses were substantially lower than in the previous quarter and the same quarter from the prior year, reflecting reductions in all functional areas of the Company as a result of continued restructuring actions. However, both net sales and unit sales of Macintosh computer systems fell slightly from the previous quarter and fell substantially from the same quarter in the prior year. The second quarter has historically been the weakest for the Company. Therefore, sequential revenue growth is not expected until at least the third quarter, while year-over-year revenue growth is not expected until at least the fourth quarter. The Company believes that gross margin levels on its current products are sustainable for several quarters and that operating expenses will continue to trend downward through the third quarter. 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 those discussed in the subsection entitled "Factors That May Affect Operating Results and Financial Condition" below. The Company's future operating results and financial condition are dependent upon the Company's ability to successfully develop, manufacture, and market technologically innovative products in order to meet dynamic customer demand patterns, and are also dependent upon its ability to effect a change in marketplace perception of the Company's prospects, including the viability of the Macintosh platform. Inherent in this process are a number of factors that the Company must successfully manage in order to achieve favorable future operating results and a favorable financial condition. Potential risks and uncertainties that could affect the Company's future operating results and financial condition include, among other things, continued competitive pressures in the marketplace and the effect of any reaction by the Company to such competitive pressures, including pricing actions by the Company; the availability of key components on terms acceptable to the Company; 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 to make timely delivery of a new and substantially backward-compatible operating system; the Company's ability to successfully integrate the technologies, processes and employees of NeXT Software, Inc. ("NeXT") ,which was acquired by the Company in 1997, with those at Apple; the Company's ability to successfully implement its strategic direction and restructuring actions, including reducing its expenditures; the Company's ability to attract, motivate and retain employees, including a new Chief Executive Officer; the effects of significant adverse publicity; the availability of third-party software for particular applications; and the impact on the Company's sales, market share and gross margins as a result of the Company winding down its Mac OS licensing program. 9
Results of Operations First First First Fourth Quarter Quarter Quarter Quarter 1998 1997 Change 1998 1997 Change (Tabular information: Dollars in millions, except per share amounts)
Results of Operations Third Quarter Nine Months Ended June 27, June 28, 1997 1996 Change 1997 1996 Change Net sales $ 1,737 $ 2,179 (20%$1,578 $2,129 (26%) $ 5,467 $ 7,512 (27%$1,578 $1,614 (2%) Gross margin $ 348 $ 403 (14%$353 $397 (11%) $ 1,048 $ 457 129%$353 $320 10% Percentage of net sales 20.0% 18.5% 19.2% 6.1%22% 19% 22% 20% Research and development $ 101 $ 155 (35%$79 $149 (47%) $ 391 $ 458 (15%$79 $94 (16%) Percentage of net sales 5.8% 7.1% 7.2% 6.1%5% 7% 5% 6% Selling, general and administrative $ 307 $ 364 (16%$234 $372 (37%) $ 1,027 $ 1,209 (15%$234 $259 (10%) Percentage of net sales 17.7% 16.7% 18.8% 16.1% In-process research and development $ --- $ --- $ 375 $ ---15% 17% 15% 16% Special Charges Restructuring costs $-- $-- NM $-- $62 NM Percentage of net sales --- --- 6.9% --- Restructuring costs $ --- $ --- $ 155 $ 207-- -- -- 4% Termination of license agreement $-- $-- NM $-- $75 NM Percentage of net sales --- --- 2.8% 2.8%-- -- -- 5% Interest and other income (expense), net $7 $4 75% $7 $9 (22%) Net income (loss) $47 $(120) 139% $47 $ 4 $ 65 (94%) $ 16 $ 82 (80%) Loss before benefit from income taxes $ (56) $ (51) (10%) $ (884) $(1,335) 34% Benefit from income taxes --- (19) NM (494) NM Net loss $ (56) $ (32) (75%) $ (884) $ (841) (5%) Loss(161) 129% Basic earnings (loss) per share $(.44) $ (.26) (69%) $(7.04) $ (6.81) (3%) Third Second Quarter Quarter 1997 1997 Change Net sales $ 1,737 $ 1,601 8% Gross margin $ 348 $ 303 15% Percentage of net sales 20.0% 18.9% Research and development $ 101 $ 141 (28%) Percentage of net sales 5.8% 8.8% Selling, general and administrative $ 307 $ 348 (12%) Percentage of net sales 17.7% 21.7% In-process research and development $ --- $ 375 NM Percentage of net sales --- 23.4% Restructuring costs $ --- $ 155 NM Percentage of net sales --- 9.7% Interest and other income, net $ 4 $ 8 (50%) Net loss $ (56) $ (708) 92% Loss$0.37 $(0.96) 139% $0.37 $(1.26) 129% Diluted earnings (loss) per share $ (.44) $ (5.64) 92%$0.33 $(0.96) 134% $0.33 $(1.26) 126%
NM: Not meaningful. 8 Overview During the third quarter of 1997 the Company experienced modest increases in net sales, units shipped and estimated share of the personal computer market compared to the prior quarter. Despite these modest increases, results of all three quarters of 1997 showed significant declines in net sales, units shipped and the estimated share of the personal computer market compared to the same quarters of the prior year. In the third quarter the Company continued to effect supplemental restructuring actions it announced and began in the second quarter. The restructuring actions effected through the end of the third quarter have resulted in a decrease in operating expenses in that quarter compared to the prior quarter and the same quarter of the prior year. Although the Company believes that planned restructuring actions to be effected through the end of the fourth quarter will result in a decrease in operating expenses in that quarter compared to the prior quarter and the same quarter of the prior year, the Company does not believe it will return to profitability in the fourth quarter.Meaningful Net Sales Q3Q1 98 Compared with Q1 97 compared with Q3 96Net sales represent the Company's gross sales net of returns, rebates and discounts. Net sales decreased 20%26% in the thirdfirst quarter of 19971998 compared with the same quarter of 1996.1997. Total Macintosh computer unit sales and peripheral unit sales decreased 17%31% and 27%49%, respectively, in the thirdfirst quarter of 1997,1998, compared with the same period of 1996, which1997. The effect on net sales of this decline in computer and peripheral unit sales in the Company believesfirst quarter of 1998 was due principally to customer concerns regardingpartially offset by the successful introduction of the Company's strategic direction, financial condition, future prospects and the viabilityPower Macintosh G3 systems in November 1997, which accounted for approximately 21% of the Macintosh platform, and to competitive pressures in635,000 systems shipped during the marketplace.first quarter of 1998. The average aggregate revenue per Macintosh unit increased 8%6% in the thirdfirst quarter of 19971998, compared with the same period of 1996,1997, as a result of a shift in mix towardfrom the Company's newer"Value" (entry level Power Macintosh) products to its "Flagship" line of high-performance Power Macintosh computers and higher priced PowerBook(Registered Trademark) products, partially offset by continued pricing actions, including rebates, across most product linesdue to increases in an effort to stimulate demand. Thethe average aggregate revenue per peripheralacross all product decreased 25% inlines. In general, the third quarter of 1997 compared with the same period of 1996, as a result of a shift in mix toward certain lower priced products and continued pricing actions, including rebates, across most product lines in an effort to stimulate demand. The average aggregate revenue per Macintosh computer unit and per peripheral unit willis expected to remain under significant downward pressure due to a variety of factors, including industrywideindustry wide pricing pressures, increased competition, and the need to stimulate demand for the Company's products. International net sales represented 53%50% of total net sales in the thirdfirst quarter of 19971998 compared with 52%56% of total net sales in the same period of 1996.1997. International net sales declined 19%34% in the thirdfirst quarter of 19971998 compared with the same period of 1996.1997. Net sales decreased significantly in the European markets and in Japan decreasedJapanese markets during the thirdfirst quarter of 19971998 compared with the same period of 1996,1997 as a result of decreases in Macintosh and peripheral unit sales andsales. Further discussion relating to factors contributing to the average aggregate revenue per Macintosh unit, partially offset by an increasedecline in net sales in the average aggregate revenue per peripheral unitJapanese market may be found in Japan.this Part I, Item 2 of Form 10-Q 10 under the subheading "Global Market Risks" included under the heading "Factors That May Affect Future Results and Financial Condition," which information is hereby incorporated by reference. Domestic net sales declined 22%16% in the thirdfirst quarter of 1997,1998 over the comparable period of 1996,1997, due to decreases in unit sales of Macintosh computers and peripheral products, and in the average aggregate revenue per peripheral unit, partially offset by an increaseincreases in the average aggregate revenue per Macintosh and peripheral unit. During the thirdfirst quarter of 19971998 compared with the comparable period of 1996,1997, the Company's estimated share of the worldwide and U.S. personal computer markets declineddecreased to 3.7%2.6% from 5.1%4.3%, as adjusted, and to 4.6%3.3% from 6.5%5.2%, as adjusted, respectively, based upon current market information provided by industry sources. In addition, theThe Company believes that its licensees' sharequarterly net sales will be below the level of the worldwide personal computer market during such period increased to approximately 0.4% from approximately 0.1%. 9 Nine Months Ended June 27, 1997 comparedprior year's comparable periods through at least the third fiscal quarter of 1998, if not longer. Q1 98 Compared with Nine Months Ended June 28, 1996Q4 97 Net sales decreased 27%2% in the first nine monthsquarter of 19971998 compared with the same period of 1996. Total Macintosh computer unit sales and peripheral unit sales decreased 27% and 33%, respectively, in the first nine months of 1997, compared with the same period of 1996, as a result of a decline in worldwide demand for most product families, which the Company believes was due principally to customer concerns regarding the Company's strategic direction, financial condition, future prospects and the viability of the Macintosh platform, and to competitive pressures in the marketplace. In addition,Macintosh unit sales were negatively affected primarily during the first six months of 1997 as a result of the Company's inability to fulfill all purchase orders of Power Macintosh products due to the unavailability of sufficient quantities of certain components and product transition constraints. The average aggregate revenue per Macintosh and peripheral unit increased slightly in the first nine months of 1997 compared with the same period of 1996, primarily due to a shift in mix toward the Company's newer and higher priced PowerBook products, substantially offset by continued pricing actions, including rebates, across most product lines in an effort to stimulate demand. International net sales represented 53% of total net sales in the first nine months of 1997 and of 1996. International net sales declined 28% in the first nine months of 1997 compared with the same period of 1996. Net sales in European markets and Japan decreased during the first nine months of 1997 compared with the same period in 1996, as a result of decreases in Macintosh and peripheral unit sales and the average aggregate revenue per Macintosh unit, partially offset by an increase in the average aggregate revenue per peripheral unit. Domestic net sales declined 27% in the first nine months of 1997, over the comparable period of 1996, due to decreases in unit sales of Macintosh computers and peripheral products and the average aggregate revenue per peripheral unit, slightly offset by an increase in the average aggregate revenue per Macintosh unit. Q3 97 compared with Q2 97 Net sales increased 8% in the third quarter of 1997 compared with the secondfourth quarter of 1997. Total Macintosh computer unit sales increased 16%decreased 4% in the thirdfirst quarter of 19971998 compared with the prior quarter primarily as a resultquarter. The effect on net sales of the Company satisfying pent-up demand for certain of its "Flagship" line of higher-end Power Macintosh products by resolving certain product transition and component constraint issues which existedthis decline in the second quarter,unit sales was partially offset by an easingthe successful introduction of pent-up demandthe Company's Power Macintosh G3 systems in November 1997, which accounted for new PowerBookapproximately 21% of the 635,000 systems shipped during the first quarter of 1998. In addition, net sales were positively impacted as the Company began marketing many of its products which were introduceddirectly to end users in the second quarter.U.S. through the Company's on-line store, which opened in November 1997. The Company generated $15 million in revenue from its on-line store during the first quarter of 1998. Unit sales of peripheral products increased slightlydecreased 15% in the thirdfirst quarter of 19971998 compared with the second quarter of 1997.prior quarter. The average aggregate revenue per Macintosh and peripheralcomputer unit decreased slightly in the third quarterincreased 5% as a result of 1997 compared with the second quarter of 1997, primarily due to continued pricing actions, including rebates, across most product lines in an effort to stimulate demand and a shift in product mix away from the Company's higher priced PowerBook"Value" products substantially offset by a shift in product mix toward the Company's newer and higher pricedto its "Flagship" line of high- performance Power Macintosh products.computers and due to increases in the average aggregate revenue across most other product lines. International net sales represented 53%50% of total net sales in the thirdfirst quarter of 1997,1998, compared with 49%42% in the secondfourth quarter of 1997. International net sales increased 18%16% in the thirdfirst quarter of 1998 compared with the secondfourth quarter of 1997, primarily as a result of an increaseincreases in Macintosh and peripheral unit net sales in Europe and increases in net sales of Macintosh units in Japan due to increases in Macintosh unit sales and the average aggregate revenue per Macintosh unit, slightly offset by decreases in peripheral unit sales and the average aggregate revenue per peripheral unit. The net sales increase in Japan was slightly offset by a decrease in the European markets. 10 Japan. Domestic net sales declined slightlydecreased 16% in the thirdfirst quarter of 19971998 compared with the prior quarter due to a decreasedecreases in Macintosh and peripheral unit sales, slightly offset by increases in the average aggregate revenue per Macintosh unit, substantially offset by increases in Macintosh and peripheral unit sales and the average aggregate revenue per peripheral unit. During the thirdfirst quarter of 19971998 compared with the secondfourth quarter of 1997, the Company's estimated share of the worldwide and U.S. personal computer markets increaseddecreased to 3.7%2.6% from 3.2%3.3%, as adjusted, and to 4.6%3.3% from 4.2%4.6%, as adjusted, respectively, based upon current market information provided by industry sources. In addition, the Company believes that its licensees' share of the worldwide personal computer market during such period increased to approximately 0.4% from approximately 0.3%. In general, the Company's resellers purchase products on an as- needed basis. Resellers frequently change delivery schedules and order rates depending on changing market conditions. Unfilled orders ("backlog") can be, and often are, canceled at will. The Company attempts to fill orders on the requested delivery schedules. The Company's backlog decreased to approximately $293 million at August 1, 1997, from approximately $409 million at May 2, 1997, primarily due to satisfying pent-up demand for the Company's "Flagship" line of Power Macintosh products as discussed above.Backlog In the Company's experience, the actual amount of product backlog at any particular time is not necessarily a meaningful indication of its future business prospects. In particular, backlog often increases in anticipation of or immediately following introduction of new products because of over-orderingoverordering by dealers anticipating shortages. Backlog often is reduced once dealers and customers believe they can obtain sufficient supply. Because of the foregoing, as well as other factors affecting the Company's backlog, backlog should not be considered a reliable indicator of the Company's ability to achieve any particular level of revenue or financial performance. The Company believes that net sales willFurther information regarding the Company's backlog may be belowfound in Part I, Item 2 of this Form 10-Q under the level ofsubheading "Product Introductions and Transitions" included under the prior year's comparable periods through at least the first quarter of 1998, if not longer.heading "Factors That May Affect Future Results and Financial Condition," which information is hereby incorporated by reference. 11 Gross Margin Gross margin represents the difference between the Company's net sales and its cost of goods sold. The amount of revenue generated by the sale of products is influenced principally by the price set by the Company for its products relative to competitive products. The cost of goods sold is based primarily on the cost of components and, to a lesser extent, direct labor costs. The type and cost of components included in particular configurations of the Company's products (such as memory and disk drives) are often directly related to the need to market products in configurations competitive with other manufacturers. Competition in the personal computer industry is intense and, in the short term, frequent changes in pricing and product configuration are often necessary in order to remain competitive. Accordingly, gross margin as a percentage of net sales can be significantly influenced in the short term by actions undertaken by the Company in response to industrywideindustry wide competitive pressures. Gross margin increased from 18.5%18.6% to 20.0%22.4% of sales during the thirdfirst quarter of 19971998 compared to the same period of 1996, primarily as a result of an increase in the gross margin percentage on the sale of the Company's PowerBook products1997, and a shift in mix towards these products which yield a high gross margin per unit, as well as an increase in the gross margin percentage on the sale of the Company's "Value" line of Power Macintosh products (formerly generally referred to as entry level and Performa(Registered Trademark) products). Gross margin increased from 6.1%19.8% to 19.2%22.4% of sales during the first nine months of 1997 compared to the same periodfourth quarter of 1996,1997. This was primarily as a result of a $616 million chargeshift in the second quarter of 1996 11 that related principally to the write-down of certain inventory, as well as to the cost to cancel excess component orders necessitated by significantly lower than expected demand for many ofrevenue mix towards the Company's products, primarily its "Value" line of Power Macintosh products. Also, the Company separately incurred a $60 million charge in the second quarter of 1996 to reflect the estimated cost to correct certain quality problems in certain of the "Value" line of Power Macintosh products, as well as PowerBook products. In addition, gross margins in the second quarter of 1996, and to a lesser degree the first quarter of that year, were adversely affected by aggressive pricing actions in Japan in response to extreme competitive actions by other companies, as well as pricing actions in the U.S. and Europe across all product lines in order to stimulate demand. Grosshigher margin increased from 18.9% to 20.0% of sales during the third quarter of 1997 compared with the second quarter of 1997, primarily as a result of an increase in the gross margin percentage on the sale of the Company's "Flagship" line of high-performance Power Macintosh products and a shift in mix towards these products which yield a high gross margin per unit, as well as an increase in the gross margin percentagecomputers, including Power Macintosh G3 systems, with relatively stable margins quarter-to-quarter on the sale of the Company's "Value" line of Power Macintosh products, offset in part by a reduced mix in PowerBook products.product line. The gross margin levels in the thirdfirst quarter of 1998 compared to the fourth quarter of 1997 compared with the second quarter of 1997 and the third quarter of 1996, and in the first nine months of 1997 compared with the corresponding period of 1996, were also adverselynot significantly affected by a stronger U.S. dollar relative to certainchanges in foreign currencies. This negative impact was offset by hedging gains.exchange rates. The Company's operating strategy and pricing take into account changes in exchange rates over time; however, the Company's results of operations can be significantly affected in the short term by fluctuations in foreign currency exchange rates. There can be no assurance thatWhile the Company will be able to sustainbelieves the overall gross margin levels achieved in the thirdfirst quarter and in the first nine months of 1997. Gross1998 are sustainable for several quarters, there can be no assurance that such margins will be maintained. In general, gross margins will remain under significant downward pressure due to a variety of factors, including continued industrywideindustry wide global pricing pressures, around the world, increased competition, and compressed product life cycles.cycles, and potential changes to the Company's product mix. In response to thosethese downward pressures, the Company expects it will continue to take pricing actions with respect to its products. Gross margins could also be affected by the Company's ability to effectively manage quality problems and warranty costs, and to stimulate demand for certain of its products. 12
Research and Development ThirdFirst First First Fourth Quarter Nine Months Ended June 27, June 28,Quarter Quarter Quarter 1998 1997 1996 Change 1998 1997 1996 Change Research and development $ 101 $ 155 (35%$79 $149 (47%) $ 391 $ 458 (15%$79 $94 (16%) Percentage of net sales 5.8% 7.1% 7.2% 6.1% Third Second Quarter Quarter 1997 1997 Change Research and development $ 101 $ 141 (28%) Percentage of net sales 5.8% 8.8%5% 7% 5% 6%
Research and development expenditures decreased in amount in the third quarter of 1997 compared with the second quarter of 1997 and the third quarter of 1996, and during the first nine months of 1997 compared with the same period of 1996. The decreases are primarily due to certain restructuring actions initiated by the Company late in the second quarter of 1997. Research and development expenditures also decreased as a percentage of sales in the third quarter of 1997 compared with the second quarter of 1997 and the third quarter of 1996, primarily due to the impact of such restructuring actions, partially offset by a decrease in the level of net sales. The increase as a percentage of net sales forin the first nine monthsquarter of 19971998 compared with the same periodfourth quarter of 19961997 and the first quarter of 1997 due to various restructuring actions which resulted from a decrease in the levelreductions in headcount and cancellation of net sales, partially offset by the impact of such restructuring actions.certain research and development related projects. The Company believes that continued and focused investments in research and development are critical to its future growth and competitive position in the marketplace and are directly related to continued, timely development of new and enhanced products that are central to the Company's core business strategy. The Company believes itsanticipates that research and development expenditures will decrease slightly in the fourth quarter of 1997 compared with the third quarter of 1997 as the Company completes and more fully realizes the cost reduction benefits of its restructuring plan. For additional information regarding the restructuring plan, refer to Note 2 of the Notes to the Consolidated Financial Statements (Unaudited) in Part I, Item I, and to Factors That May Affect Future Results and Financial Condition as well as Liquidity and Capital Resources in Part I, Item II of this Quarterly Report on Form 10-Q, which information is hereby incorporated by reference. 13
In-Process Research and Development Third Quarter Nine Months Ended 1997 1996 Change June 27, June 28, Change 1997 1996 In-process research and development $ --- $ --- $ 375 $ --- NM Percentage of net sales --- --- 6.9% --- Third Second Quarter Quarter 1997 1997 Change In-process research and development $ --- $ 375 NM Percentage of net sales --- 23.4%
NM: Not meaningful. As a result of the NeXT acquisition, the Company took a substantial charge for in-process research and development during the second quarter of 1997. For additional information regarding1998 will be comparable to those in the acquisition of NeXT, refer to Note 3 of the Notes to the Consolidated Financial Statements (Unaudited) in Part I, Item I, and to Factors That May Affect Future Results and Financial Condition as well as Liquidity and Capital Resources in Part I, Item II of this Quarterly Report on Form 10-Q, which information is hereby incorporated by reference. 14first quarter. 12
Selling, General and Administrative ThirdFirst First First Fourth Quarter Nine Months EndedQuarter Quarter Quarter 1998 1997 1996 Change June 27, June 28,1998 1997 Change 1997 1996 Selling, general and administrative $ 307 $ 364 (16%$234 $372 (37%) $ 1,027 $ 1,209 (15%$234 $259 (10%) Percentage of net sales 17.7% 16.7% 18.8% 16.1% Third Second Quarter Quarter 1997 1997 Change Selling, general and administrative $ 307 $ 348 (12%) Percentage of net sales 17.7% 21.7%15% 17% 15% 16%
Selling, general and administrative expenditures decreased in amount in the third quarter of 1997 compared with the second quarter of 1997 and the third quarter of 1996, and during the first nine months of 1997 compared with the same period of 1996. The decreases are primarily due to certain restructuring actions initiated by the Company late in the second quarter of 1997. Selling, general and administrative expenditures also decreased as a percentage of sales in the third quarter of 1997 compared with the second quarter of 1997 and the third quarter of 1996, primarily due to the impact of such restructuring actions partially offset by a decrease in the level of net sales. The increase as a percentage of net sales forin the first nine monthsquarter of 1998 when compared to the fourth quarter of 1997 compared withand the same periodfirst quarter of 19961997 due to various restructuring actions which resulted from a decrease in reductions in headcount, the levelclosing of net sales, partially offset byfacilities, the impactwrite-down of such restructuring actions.assets, and lower ongoing variable expenses. The Company believes itsanticipates that selling, general and administrative expenditures will continue to decrease indecline further during the fourthsecond quarter of 19971998 as compared withto the thirdfirst quarter of 1997,1998 as the Company completes and more fully realizes the cost reduction benefits of its restructuring plan slightly offset by the amortization expense on the intangible assets the Company recognized as a result of the acquisition of NeXT. For additional information regarding the Company's restructuring actions and the acquisition of NeXT, refer to Notes 2 and 3, respectively, of the Notes to the Consolidated Financial Statements (Unaudited) in Part I, Item I, and to Factors That May Affect Future Results and Financial Condition as well as Liquidity and Capital Resources in Part I, Item II of this Quarterly Report on Form 10-Q, which information is hereby incorporated by reference. 15
Restructuring Costs Third Quarter Nine Months Ended 1997 1996 Change June 27, June 28, Change 1997 1996 Restructuring costs $ --- $ --- $ 155 $ 207 NM Percentage of net sales --- --- 2.8% 2.8% Third Second Quarter Quarter 1997 1997 Change Restructuring costs $ --- $ 155 NM Percentage of net sales --- 9.7%
NM: Not meaningful. For information regarding the Company's restructuring actions initiated in the second quarters of 1997 and 1996, refer to Note 2 of the Notes to the Consolidated Financial Statements (Unaudited) in Part I, Item I, and to Factors That May Affect Future Results and Financial Condition as well as Liquidity and Capital Resources in Part I, Item II of this Quarterly Report on Form 10-Q, which information is hereby incorporated by reference.lower ongoing variable selling expenses.
Interest and Other Income (Expense), Net ThirdFirst First First Fourth Quarter Nine Months EndedQuarter Quarter Quarter 1998 1997 1996 Change June 27, June 28,1998 1997 Change 1997 1996 Interest and other income (expense), net $ 4 $ 65 (94%) $ 16 $ 82 (80%) Third Second Quarter Quarter 1997 1997 Change Interest and other income, net $ 4 $ 8 (50%$7 $4 75% $7 $9 (22%)
Interest and other income (expense), net, decreased inis comprised of interest income on the third quarterCompany's cash and investment balances, interest expense on the Company's debt, gains and losses recognized on investments accounted for using the equity method, foreign exchange gains and losses not allowed to be recognized as revenue or cost of 1997 and for the first nine months of 1997 compared with the same periods of 1996, primarily due to $69 million of realized gains on sales, of available-for-sale securities realized in the third quarter of 1996. Interest and other miscellaneous income net, decreasedand expense items. Over the last two years, the Company's debt ratings have been downgraded to non-investment grade. The Company's cost of funds may increase in the third quarter of 1997 compared with the second quarter of 1997future periods as a result of lower average cash balances, due to cash used to acquire NeXT, to fund the restructuring actions begundowngrading in the second quarter of 1997 and to fund operations. The Company expects interest income to be flat in the fourth quarter of 1997 compared with the immediate prior quarter. 16 The Company'sits senior and subordinated long-term debt ratings remain unchanged fromto B3 and Caa2, respectively, by Moody's Investor Services, and the second quarter. In the second quarterdowngrading in October 1997 of 1997, the Company'sits senior and subordinated long-term debt were downgraded to BB- and CCC+,CCC, respectively, by Standard and Poor's Rating Agency and to B3 and Caa, respectively, by Moody's Investor Services. These actions could increase the Company's costAgency. Provision (Benefit) for Income Taxes As of funds in future periods.
Income Tax Benefit Third Quarter Nine Months Ended 1997 1996 Change June 27, June 28, Change 1997 1996 Benefit from income taxes -- $ (19) NM -- $ (494) NM Effective tax rate -- 37% -- 37% Third Second Quarter Quarter 1997 1997 Change Benefit from income taxes -- -- NM Effective tax rate -- --
NM: Not meaningful. At June 27,December 26, 1997, the Company had deferred tax assets arising from deductible temporary differences, tax losses, and tax credits of $591$696 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. In the first nine monthsAs of December 26, 1997, a valuation allowance of $174$211 million was recorded against the deferred tax asset for the benefits of tax losses which may not be realized. Realization of approximately $85 million of the asset representing tax loss and credit carryforwards is dependent on the Company's ability to generate approximately $245 million of future U.S. taxable income. Management believes that it is more likely than not that the assetforecasted U.S. income, including income that may be generated as a result of certain tax planning strategies, will be realized based on forecasted U.S. income.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. 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. 1713 Factors That May Affect Future Results and Financial Condition Overview The Company's future operating results and financial condition are dependent upon the Company's ability to successfully develop, manufacture, and market technologically innovative products in order to meet dynamic customer demand patterns, and its ability to effect a change in marketplace perception of the Company's prospects, including the viability of the Macintosh platform. Inherent in this process are a number of factors that the Company must successfully manage in order to achieve favorable future operating results and a favorable financial condition. Potential risks and uncertainties that could affect the Company's future operating results and financial condition include, without limitation, 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; the availability of key components on terms acceptable to the Company; 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 Macintosh operating system ("Mac(Registered Trademark) OS") and to make timely delivery of a new and substantially backward-compatible OS; the Company's ability to successfully integrate NeXT technologies, processes and employees with those at Apple; the Company's ability to successfully implement its strategic direction and restructuring actions, including reducing its expenditures; the Company's ability to attract, motivate and retain employees, including a new Chief Executive Officer; the effects of significant adverse publicity; and the availability of third-party software for particular applications. The Company expects that it will not return to profitability in the fourth quarter of 1997. Restructuring of Operations and New Business Model During 1996, the Company began to implement certain restructuring actions aimed at reducing its cost structure, improving its competitiveness, and restoring sustainedsustainable profitability. In the second quarter ofDuring 1997, the Company announced and began to implement supplemental restructuring actions, including significant headcount reductions, to meet the foregoing objectives. There are several risks inherent in the Company's efforts to transition to a new cost structure. These include the risk that the Company will not be able to reduce expenditures quickly enough to restore sustainedsustainable profitability and the risk that cost-cutting initiatives will impair the Company's ability to innovate and remain competitive in the computer industry. As part of its restructuring effort, the Company has been implementing a new business model. Implementation of the new business modelthis restructuring involves several risks, including the risk that by simplifying and modifying its product line the Company will increase its dependence on fewer products, potentially reduce overall sales, and increase its reliance on unproven products and technology. Another risk of the new business modelrestructuring is that by increasing the proportion of the Company's products to be manufactured under outsourcing arrangements, the Company could lose control of the quality or quantity of the products manufactured and distributed, or lose the flexibility to make timely changes in production schedules in order to respond to changing market conditions. As part of its restructuring, the Company announced and opened its on- line store in November 1997, which makes available most of its products to end-users in the U.S. There can be no assurance the on-line store will result in greater sales. The Company also began manufacturing products on a build-to-order basis in November 1997. There can be no assurance this manufacturing process will result in decreased costs or increased gross margins. The Company is also reducing the number of wholesale and retail channel partners, particularly in the Americas, which places a greater volume of sales through fewer partners. There can be no assurance that this will not adversely impact the Company. In addition, the new business modelactions taken in connection with the restructuring could adversely affect employee morale, thereby damaging the Company's ability to retain and motivate employees. Also, because the new business modelCompany contemplates that the Company will relyrelying to a greater extent on collaboration and licensing arrangements with third parties, the Company will have less direct control over certain of its research and development efforts, and its ability to create innovative new products may be reduced. In addition, the new business model now includes the acquisition of NeXT. Therethere can be no assurance that the technologies acquired from NeXT will be successfully exploited, or that key NeXT employees and processes will be retained and successfully integrated with those at Apple. Also, the new business model nowrestructuring includes the "spin-out"winding down of the Company's Newton(Registered Trademark) unit into a 18 separate but wholly-owned subsidiary named Newton, Inc.Mac OS licensing program. There can be no assurance that Newton, Inc.the winding down of this program will result in greater sales, market share, and increased gross margins to the Company. In addition, there can be successful asno assurance that this action will not result in the availability of fewer application software titles for the Mac OS, which may result in a separate entity.decrease to the Company's sales, market share and gross margins. Finally, even if the new business modelrestructuring is successfully implemented, there can be no assurance that it will effectively resolve the various issues currently facing the Company. Although the Company believes that the actions it is taking and will take under its new business model,in connection with the restructuring, including its restructuring plan, its acquisition of NeXT and the winding down of its "spin-out" of Newton, Inc.,Mac OS licensing program, should help restore marketplace confidence in the Company, there can be no assurance that such actions will enable the Company to achieve its objectives of reducing its cost structure, improving its competitiveness, and restoring sustainedsustainable profitability. The Company's future consolidated operating results and financial condition could be adversely affected should it encounter difficulty in effectively managing the transitionrestructuring and new cost structure. Additional information relating to the new business model and cost structure. For information regarding the Company's restructuring actions and the acquisition of NeXT, refer to Notes 2 andoperations may be found in Part I of this Form 10-Q in Note 3 respectively, of the Notes to theCondensed Consolidated Financial Statements (Unaudited) in Part I, Item I, and to Liquidity and Capital Resources in Part I, Item II of this Quarterly Report on Form 10-Q,, which information is hereby incorporated by reference. Product Introductions and Transitions Due to the highly volatile nature of the personal computer industry, which is characterized by dynamic customer demand patterns and rapid technological advances, the Company frequently introducesmust continuously introduce new products and product enhancements, including the recenttechnologies and enhance existing products in order to remain competitive. Recent introductions ofinclude certain PowerBook and Power Macintosh products, including the Power Macintosh G3 computers in November 1997, and the introduction of Mac OS 8 in July of 1997. The success of new product introductions is dependent on a number of 14 factors, including market acceptance, the Company's ability to manage the risks associated with product transitions, the availability of application software for new products, the effective management of inventory levels in line with anticipated product demand, the availability of products in appropriate quantities to meet anticipated demand, and the risk that new products may have quality or other defects in the early stages of introduction. Accordingly, the Company cannot determine the ultimate effect that new products will have on its sales or results of operations. In addition, although the number of new product introductions may decrease underas a result of the Company's new business model,restructuring actions, the risks and uncertainties associated with new product introductions may increase as the Company refocuses its product offerings on key growth segments and to the extent new product introductions are in markets that are new to the Company. The rate of product shipments immediately following introduction of a new product is not necessarily an indication of the future rate of shipments for that product, which depends on many factors, some of which are not under the control of the Company. These factors may include initial large purchases by a small segment of the user population that tends to purchase new technology prior to its acceptance by the majority of users ("early adopters"); purchases in satisfaction of pent-up demand by users who anticipated new technology and, as a result, deferred purchases of other products; and overordering by dealers who anticipate shortages due to the aforementioned factors. These factors may be offset by others, such as the deferral of purchases by many users until new technology is accepted as "proven" and for which commonly used software products are available; and the reduction of orders by dealers once they believe they can obtain sufficient supply of products previously in backlog. Backlog is often volatile after new product introductions due to the aforementioned demand factors, often increasing coincident with introduction, and then decreasing once dealers and customers believe they can obtain sufficient supply of the new products. The Company has in the past experienced difficulty in anticipating demand for new products, resulting in product shortages which have adversely affected the Company's operating results. The measurement of demand for newly introduced products is further complicated by the availability of different product configurations, which may include various types of built-in peripherals and software. Configurations may also require certain localization (such as language) for various markets and, as a result, demand in different geographic areas may be a function of the availability of third-party software in those localized versions. For example, the availability of European-languageEuropean- language versions of software products 19 manufactured by U.S. producers may lag behind the availability of U.S. versions by a quarter or more. This may result in lower initial demand for the Company's new products outside the United States,U.S., even though localized versions of the Company's products may be available. The increasing integration of new or enhanced functions and complexity of operations of the Company's products also increase the risk that latent defects or other faults could be discovered by customers or end-users after volumes of products have been produced or shipped. If such defects were significant, the Company could incur material recall and replacement costs under product warranties. The Company has announced plans for two operating systems. The Company plans to continue to introduce major upgrades to the current Mac OS and later introduce a new OSoperating system (code named "Rhapsody") which is expected to offer advanced functionality based on Apple and NeXT software technologies. However, the NeXT software technologies that the Company plans to use in the development of Rhapsody were not originally designed to be compatible with the Mac OS. As a result, there can be no assurance that the development of Rhapsody willcan be successful.completed at reasonable cost or at all. In addition, Rhapsody may not be fully backward-compatible with all existing applications, which could result in a loss of existing customers. Finally, it is uncertain whether Rhapsody or the planned enhancements to the current Mac OS will gain developer support and market acceptance. Inability to successfully develop and make timely delivery of a substantially backward-compatible Rhapsody or of planned enhancements to the current Mac OS, or to gain developer support and market acceptance for those operating systems, may have an adverse impact on the Company's consolidated operating results and financial condition. 15 Competition The personal computer industry is highly competitive and is characterized by aggressive pricing practices, downward pressure on gross margins, frequent introduction of new products, short product life cycles, continual improvement in product price/performance characteristics, price sensitivity on the part of consumers, and a large number of competitors. The Company's consolidated results of operations and financial condition have been, and in the future may continue to be, adversely affected by industrywideindustry wide pricing pressures and downward pressures on gross margins. The industry has also been characterized by rapid technological advances in software functionality and hardware performance and features based on existing or emerging industry standards. Many of the Company's competitors have greater financial, marketing, manufacturing, and technological resources, as well as broader product lines and larger installed customer bases than those of the Company. The Company's future consolidated operating results and financial condition may be affected by overall demand for personal computers and general customer preferences for one platform over another or one set of product features over another. The Company is currently the primary maker of hardware that uses the Mac OS. The Mac OS has a minority market share in the personal computer market, which is dominated by makers of computers that run the MS-DOSMicrosoft Windows 95 and Microsoft Windows NT operating systems. The Company believes that the Mac OS, with its perceived advantages over MS-DOSWindows, and Windows, hasthe general reluctance of the Macintosh installed base to incur the costs of switching platforms, have been a driving forceforces behind sales of the Company's personal computer hardware for the past several years. Recent innovations in the Windows platform, including those included in Windows 95 and Windows NT, or those expected to be included in a new version of Windows 98,to be introduced in 1998, have added features to the Windows platform whichthat make the differences between the Mac OS and Microsoft's Windows operating systems less significant. The Company is currently taking and will continue to take steps to respond to the competitive pressures being placed on its personal computer sales as a result of the recent innovations in the Windows platform. The Company's future consolidated operating results and financial condition maywill be affected bysubstantially dependent on its ability to maintain andcontinuing improvements to the Macintosh platform in order to maintain perceived functional advantages over competing platforms. The Company had previously entered into agreements to license its Mac OS to other personal computer vendors (the "Clone Vendors") as part of an effort to increase the installed base for the Macintosh platform. 20 As partThe Company recently determined that the benefits of its efforts to increase the installed base for the Macintosh platform, the Company announced the licensing of the Mac OS to other personal computer vendors in 1995 and 1996. Several vendors currently sell products that utilize the Macintosh operating system, many of which have licensing arrangements with the Company. As a result of licensing its operating system, the Company competes with other companies producing Mac OS- based computer systems. The benefits to the Company from licensing the Mac OS to third parties may bethe Clone Vendors under these agreements were more than offset by the disadvantagesimpact and costs of competing with them. Thethe licensing program. As a result, the Company is currently in discussions concerningagreed to acquire certain assets, including the naturelicense to distribute the Mac OS, of suchPCC, a Clone Vendor, and has no plans to renew its other Mac OS licensing arrangements going forward, including whether or not to extend such arrangements. Thereagreements. Although the Company believes that this winding down of its licensing program will help reduce the adverse impact of the licensing program on the Company's sales, market share and gross margins, there can be no assurance that this will occur. In addition, there can be no assurance that this winding down of the licensing program will not result in the availability of fewer application software titles for the Mac OS, which may result in a decrease to the Company's Mac OS licensing strategy will prove successful or will financially benefit the Company or, if the Company decides to alter its strategy, that it will be able to modify its existing licensing arrangements to pursue such a strategy.sales, market share and gross margins. As a supplemental means of addressing the competition from MS- DOSWindows and Windows,other platforms, the Company hashad previously devoted substantial resources toward developing personal computer products capable of running application software designed for the MS-DOS or Windows operating systems ("Cross-Platform Products").systems. These products include the RISC-based PowerPC(TradeMark) microprocessor and either include the Pentium or 586-class microprocessor or can accommodate an add-on card containing a Pentium or 586-class microprocessor. These products enablemicroprocessor that enables users to run applications concurrently applications that require the Mac OS, MS-DOS, Windows 3.1 or Windows 95 operating systems. The Company has supplied customers who purchase Cross-Platform Products with Windows operating system software under licensing agreements with certain Microsoft distributors. The Company's abilityplans to market Cross-Platform Products couldtransition the cross-platform business to third-parties during 1998. There can be adversely affected if such Microsoft distributors were unwilling to continue to supply the Company with Windows operating system software on the terms of such licensing agreements.no assurance that this transition will be successful. The Company, International Business Machines Corporation ("IBM") and Motorola, Inc. ("Motorola") havehad agreed upon and announced the availability of specifications for a PowerPC microprocessor-basedmicroprocessor- based hardware reference platform.platform (the "Platform"). These specifications definedefined a "unified" personal computer architecture that giveswould have given the Clone Vendors broad access to both the Power Macintosh platform and the PC environment and utilizeswould have utilized standard industry components. The Company's future operating resultsCompany had intended to license the Mac OS to manufacturers of the Platform. However, the Company has decided it will no longer support the Platform based upon its decision to wind down its Mac OS licensing program, and financial conditionbecause of 16 little industry support for the Platform. The decision not to further develop this Platform may be affected by itsaffect the Company's ability to continue to implement this agreement and to manageincrease the risk associated withinstalled base for the transition to this new hardware reference platform. Microsoft Corporation ("Microsoft") recently announced that it would no longer adapt its Windows NT operating system software, which is being used more by corporations, to run on the PowerPC microprocessor. This decision may adversely affect revenues derived from this new hardware referenceMacintosh platform. Several competitors of the Company have either targeted or announced their intention to target certain of the Company's key market segments, including education and publishing. Many of these companies have greater financial, marketing, manufacturing, and technological resources than the Company. OnIn August 6, 1997, the Company and Microsoft announcedentered into patent cross licensing and technology agreements between the two companies.agreements. Under these agreements, the companies provided patent cross licenses to each other. In addition, for a period of five years from August 1997, Microsoft will make future versions of its Microsoft Office and Internet Explorer products for the Mac OS, and the Company will bundle the Internet Explorer product with Mac OS system software releases and make that product the default internetInternet browser for such releases. The Company also announced thatIn addition, Microsoft will purchasepurchased 150,000 shares of Apple Series 'A' Non-voting Convertible Preferred Stocknon-voting convertible preferred stock for $150 million. While the Company believes that its relationship with Microsoft will be beneficial to the Company and to its efforts to increase the installed base for the Mac OS, the Microsoft relationship is for a limited term and does not cover many of the areas in which the Company competes with Microsoft, including the Windows platform. In addition, the Microsoft relationship may have an adverse effect on, but not limited to,among other things, the Company's relationship with other partners. There can be no assurance that the benefits to the Company of the Microsoft relationship will not be offset by the disadvantages. 21 Support from Third-Party Software Developers Decisions by customers to purchase the Company's personal computers, as opposed to MS-DOS or Windows-based systems, are often based on the availability of third-party software for particular applications. The Company believes that the availability of third-party application software for the Company's hardware products depends in part on third-party developers' perception and analysis of the relative benefits of developing, maintaining, and upgrading such software for the Company's products versus software for the larger MS-DOS and Windows market. This analysis is based on factors such as the perceived strength of the Company and its products, the anticipated potential revenue that may be generated, and the costs of developing such software products. To the extent the Company's recent financial losses and declining demand for the Company's productproducts, as well as the Company's decision to wind down its Mac OS licensing program, have caused software developers to question the Company's prospects in the personal computer market, developers could be less inclined to develop new application software or upgrade existing software for the Company's products and more inclined to devote their resources to developing and upgrading software for the larger MS-DOS and Windows market. Moreover, the Company's current plan to introduce a new operating system (code named "Rhapsody") could cause software developers to stop developing software for the current Mac OS. In addition, there can be no assurance that software developers will decide to develop software for the new operating system on a timely basis or at all. Microsoft is an important developer of application software for the Company's products. Although the Company has entered into a relationship with Microsoft, which includes Microsoft's agreement to develop and ship future versions of its Microsoft Office and Internet Explorer products and certain other Microsoft tools for the Mac OS, such relationship is for a limited term and does not cover many areas in which theCompanythe Company competes with Microsoft. Accordingly, Microsoft's interest in producingapplicationproducing application software for the Company's productsMac OS not covered by the relationship or upon expiration of the relationship may be influenced by Microsoft's perception of its interests as the vendor of the Windows operating system. Global Market Risks A large portion of the Company's revenue is derived from its international operations. As a result, the Company's consolidated operations and financial results could be significantly affected by risks associated with international activities, including economic and labor conditions, political instability, tax laws (including U.S. taxes on foreign subsidiaries), and changes in the value of the United StatesU.S. dollar versus the local currency in which the products are sold. Countries in the Asia Pacific region, including Japan, have recently experienced weaknesses in their currency, banking and equity markets. These weaknesses could adversely affect consumer demand for the Company's products, 17 the U.S. dollar value of the Company's foreign currency denominated sales, the availability and supply of product components to the Company, and ultimately the Company's consolidated results of operations. When the U.S. dollar strengthens against other currencies, the U.S. dollar value of non-U.S. dollar-based sales decreases. When the U.S. dollar weakens, the U.S. dollar value of non-U.S.non- U.S. dollar-based sales increases. Correspondingly, the U.S. dollar value of non-U.S. dollar-based costs increases when the U.S. dollar weakens and decreases when the U.S. dollar strengthens. 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). To mitigate the short-term impact of fluctuating currency exchange rates on the Company's non-U.S. dollar-based sales, product procurement, and operating expenses, the Company regularly hedges its non-U.S. dollar-based exposures. Specifically, the Company enters into foreign exchange forward and option contracts to hedge its assets, liabilities and firmly committed transactions. Currently, hedges of firmly committed transactions do not extend beyond one year. The Company also purchases foreign exchange option contracts to hedge certain other probable but not firmly committed transactions. Hedges of probable but not firmly committed transactions currently do not extend beyond one year. To reduce the costs associated with these ongoing foreign exchange hedging programs, the Company also regularly sells foreign exchange option contracts and enters into certain other foreign exchange transactions. All foreign exchange forward and option contracts not accounted for as hedges, including all transactions intended to reduce the costs associated with the Company's foreign exchange hedging programs, are carried at fair value and are adjusted on each balance sheet date for changes in exchange rates. While the Company is exposed with respect to fluctuations in the interest rates of many of the world's leading industrialized countries, the Company's interest income and expense is most 22 sensitive to fluctuations in the general level of U.S. interest rates. In this regard, changes in U.S. interest rates affect the interest earned on the Company's cash, cash equivalents, and short-term investments as well as interest paid on its notes payable to banks and long-term debt.costs associated with foreign currency hedges. To mitigate the impact of fluctuations in U.S. interest rates, the Company has entered into interest rate swap, collar, and floor transactions. Certain of these transactions are intended to better match the Company's floating-rate interest income on its cash, cash equivalents, and short-term investments with the fixed-rate interest expense on its long-term debt. The Company also enters into these transactions in order to diversify a portion of the Company's exposure away from fluctuations in short-term U.S. interest rates. These instruments may extend the Company's cash investment horizon up to a maximum duration of three years. 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, 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. The Company generally does not engage in leveraged hedging. The Company's current financial condition is expected tomay increase the costs of its hedging transactions, as well as affect the nature of the hedging transactions into which the Company's counterparties are willing to enter. Inventory and Supply The Company provides reserves against anymakes a provision for inventories of products that have become obsolete or are in excess of anticipated demand, accrues for any cancellation fees of orders for inventories that have been canceled, and accrues for the estimated costs to correct any product quality problems. Although the Company believes its inventory and related reservesprovisions are adequate given the rapid and unpredictable pace of product obsolescence in the computer industry, no assurance can be given that the Company will not incur additional inventory and related charges. In addition, such charges have had, and may again have, a material effect on the Company's consolidated financial position and results of operations. The Company must order components for its products and build inventory well in advance of product shipments. Because the Company's markets are volatile and subject to rapid technology and price changes, there is a risk that the Company will forecast incorrectly and produce excess or insufficient inventories of particular products. The Company's consolidated operating results and financial condition have been in the past and may in the future be materially adversely affected by the Company's ability to manage its inventory levels and respond to short-term shifts in customer demand patterns. Certain of the Company's products are manufactured in whole or in part by third-party manufacturers, either pursuant to design specifications of the Company or otherwise. As part of its restructuring actions, the Company has sold its Fountain, Colorado, manufacturing facility to SCI Systems, Inc. ("SCI") and entered into a related manufacturing outsourcing agreement with SCI; sold its Singapore printed circuit board manufacturing assets to NatSteel Electronics Pte., Ltd. who will then, which is 18 expected to supply main logic boards to the Company under a manufacturing outsourcing agreement; entered into an agreement with Ryder Integrated Logistics, Inc. to outsource the Company's domestic operations transportation and logistics management,management; and has entered into other similar 23 agreements to outsource the Company's European operations transportation and logistics management. As a result of the foregoing actions, the proportion of the Company's products produced and distributed under outsourcing arrangements will continue to increase. While outsourcing arrangements may lower the fixed cost of operations, they will also reduce the direct control the Company has over production.production and distribution. It is uncertain what effect such diminished control will have on the quality or quantity of the products manufactured, or the flexibility of the Company to respond to changing market conditions. Furthermore, any efforts by the Company to manage its inventory under outsourcing arrangements could subject the Company to liquidated damages or cancellation of the arrangement. Moreover, although arrangements with such manufacturers may contain provisions for warranty expense reimbursement, the Company remains at least initially responsible to the ultimate consumer for warranty service. Accordingly, in the event of product defects or warranty liability, the Company may remain primarily liable. Any unanticipated product defect or warranty liability, whether pursuant to arrangements with contract manufacturers or otherwise, could adversely affect the Company's future consolidated operating results and financial condition. Although certain raw materials, processes and components essential to the Company's business are generally available from multiple sources, other processes and key components (including microprocessors and application specific integrated circuits ("ASICs")) are currently obtained by the Company from single sources. If the supply of a key single-sourced material, process or component were to be delayed or curtailed, the Company's business and financial performance could be adversely affected, depending on the time required to obtain sufficient quantities from the original source, or to identify and obtain sufficient quantities from an alternate source. The Company believes that the availability from suppliers to the personal computer industry of microprocessors and ASICs presents the most significant potential for constraining the Company's ability to manufacture products. Some advanced microprocessors are currently in the early stages of ramp-up for production and thus have limited availability. The Company and other producers in the personal computer industry also compete for other semiconductor products with other industries that have experienced increased demand for such products, due to either increased consumer demand or increased use of semiconductors in their products (such as the cellular phone and automotive industries). Finally, the Company uses some components that are not common to the rest of the personal computer industry (including certain microprocessors and ASICs). Continued availability of these components may be affected if producers were to decide to concentrate on the production of common components instead of components customized to meet the Company's requirements. Such product supply constraints and corresponding increased costs could decrease the Company's net sales and adversely affect the Company's consolidated operating results and financial condition. The Company's ability to produce and market competitive products is also dependent on the ability and desire of IBM and Motorola, the sole suppliers of the PowerPC RISC microprocessor for certain of the Company's products,Macintosh computers, to supply to the Company in adequate numbers microprocessors that produce superior price/performance results compared with those supplied to the Company's competitors by Intel Corporation, the developer and producerother developers and producers of the microprocessors used by most personal computers using the MS-DOS and Windows operating systems. In addition, theThe desire of IBM and Motorola to continue producing these microprocessors may be influenced by Microsoft's decision not to adapt its Windows NT operating system software to run on the PowerPC microprocessor. IBM produces personal computers based on Intel microprocessors as well as workstations based on the PowerPC microprocessor, and is also the developer of OS/2, a competing operating system to the Company's Mac OS. Accordingly, IBM's interest in supplying the Company with microprocessors for the Company's products may be influenced by IBM's perception of its interests as a competing manufacturer of personal computers and as a competing operating system vendor. In addition, Motorola has recently announced its intention to stop producing Macintosh clones. As a result, Motorola may be less inclined to continue to produce PowerPC microprocessors. The Company's current financial condition and uncertainties related to recent events could effectaffect the terms on which suppliers are willing to supply the Company with their products. There can be no assurance that the Company's current suppliers will continue to supply the Company on terms acceptable to the Company or that the Company will be able to obtain comparable products from alternate sources on such terms. The Company's future consolidated operating results and financial condition could be adversely affected if the Company is unable 24 to continue to obtain key components on terms substantially similar to those currently available to the Company. 19 Marketing and Distribution A number of uncertainties may affect the marketing and distribution of the Company's products. Currently, the Company distributes its products through wholesalers, resellers, mass merchants, and cataloguers (collectively referred to as "resellers") and direct to higher education institutions. In addition, in November 1997 the Company began selling many of its products directly to end users in the U.S. through the Company's primary meanson-line store. Many of distribution is through third-party computer resellers. Suchthe Company's significant resellers include consumer channelsoperate on narrow product margins. Most such as mass-merchandise stores, consumer electronics outlets, and computer superstores.resellers also distribute products from competing manufacturers. The Company's business and financial results could be adversely affected if the financial condition of these resellers weakened or if resellers within consumer channels were to decide not to continue to distribute the Company's products. Uncertainty over demand for the Company's products may continue to cause resellers to reduce their ordering and marketing of the Company's products. In addition, the Company has in the past and may in the future experience delays in ordering by resellers in light of uncertain demand for the Company's products. Under the Company's arrangements with its resellers, resellers have the option to reduce or eliminate unfilled orders previously placed, in most instances without financial penalty. Resellers also have the option to return products to the Company without penalty within certain limits, beyond which they may be assessed fees. The Company has experienced a reductionrecently revised its channel program, including decreasing the number of resellers and reducing returns, price protection and certain rebate programs, in ordering from historical levels by resellers duean effort to uncertainty concerningreduce channel inventory, increase inventory turns, increase product support within the channel and improve gross margins. In addition, in November 1997 the Company opened its on-line store in the U.S. which makes many of the Company's products available directly to the end-user. Although the Company believes the foregoing changes will improve its consolidated operating results and financial condition, and prospects.there can be no assurance that this will occur. Change in Senior Management On July 9, 1997, the Company announced that Dr. Gilbert F. Amelio had resigned his positions as Chairman of the Board and Chief Executive Officer and that the Company was initiating a search for a new Chief Executive Officer. While the Company intends to name a new Chief Executive Officer as soon as practicable, there can be no assurance that the change in senior management and related uncertainties will not adversely affect the Company's consolidated operating results and financial condition during the period until a new Chief Executive Officer is hired and afterward. In addition, certain members of the Company's senior management have been with the Company for less than twelve months. There can be no assurance that new members of the management team can be successfully assimilated, that the Company will be able to satisfactorily allocate responsibilities or that such new members of its management will succeed in their roles in a timely and efficient manner. The Company's failure to recruit, retain and assimilate new executives, or the failure of any such executive to perform effectively, or the loss of any such executive, could have a material adverse impact on the Company's business, financial condition and results of operations. Changes to Board of Directors The Company announced on August 6, 1997 significant changes to its Board of Directors, replacing all but two former directors. The continuing directors are Gareth C.C. Chang, Corporate Senior Vice President, Marketing, Hughes Electronics and President, Hughes International, and Edgar Woolard.S. Woolard, Jr., retired Chairman of E.I. DuPont de Nemours & Company. The new directors are William V. Campbell, President and CEO of Intuit Corp.; Lawrence J. Ellison, Chairman and CEOChief Executive Officer of Oracle Corp.; SteveSteven P. Jobs, Chairman and CEOChief Executive Officer of Pixar Animation Studios; and Jerome B. York, Vice Chairman of Tracinda Corporation and former CFOChief Financial Officer of IBM and Chrysler Corporation. Dependence on Key Employees During the past several years, the Company has experienced significant voluntary employee turnover as a result of employees' concerns over the Company's prospects, as well as the abundance of career opportunities available elsewhere. The Company is dependent on its key employees in order to achieve its business plan. There can be no assurance the Company will be able to attract, motivate and retain key employees. Failure to do so may have a significant effect on the Company's consolidated operating results and financial condition. 20 Other Factors The Company is in the process of identifying operating and application software challenges related to the year 2000. While the Company expects to resolve year 2000 compliance issues substantially through normal replacement and upgrades of software, there can be no assurance that there will not be interruption of operations or other limitations of system functionality or that the Company will not incur substantial costs to avoid such limitations. Any failure to effectively monitor, implement or improve the Company's operational, financial, management and technical support systems could have a material adverse effect on the Company's business and consolidated results of operations. The majority of the Company's research and development activities, its corporate headquarters, and other critical business operations, including certain major vendors, are located near major seismic faults. The Company's consolidated operating results and financial condition could be materially adversely affected in the event of a major earthquake. Production and marketing of products in certain states and countries may subject the Company to environmental and other regulations which include, in some instances, the requirement that the Company provide consumers with the ability to return to the Company product at the end of its useful life, and leave responsibility for environmentally safe disposal or recycling with the Company. It is unclear what effect such regulationregulations will have on the Company's future consolidated operating results and financial condition. The Company recently evaluated replacingdecided to replace its existing transaction systems in the U.S. (which include order management, product procurement, distribution, and finance) with a single integrated system but has decidedas part of its ongoing effort to continue 25 to use its existingincrease operational efficiency. Substantially all of the transaction systems forin the foreseeable future.European operations were replaced with the same integrated system in 1997. The Company's future consolidated operating results and financial condition could be adversely affected if the Company is unable to implement and effectively manage its existing transaction systems.the transition to this new integrated system. Because of the foregoing factors, as well as other factors affecting the Company's consolidated operating results and financial condition, past financial performance should not be considered to be a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods. In addition, the Company's participation in a highly dynamic industry often results in significant volatility of the Company's common stock price. 21 Liquidity and Capital Resources The Company's consolidated financial position with respect to cash, cash equivalents, and short-term investments netincreased to $1,627 million as of notes payable to banks, decreased to $1,103 million at June 27,December 26, 1997, from $1,559$1,459 million atas of September 27, 1996. The Company's financial position with respect to cash, cash equivalents, and short-term investments decreased to $1,230 million at June 27, 1997, from $1,745 million at September 27, 1996.26, 1997. The Company's cash and cash equivalent balance at June 27,balances as of December 26, 1997 and September 27, 1996, includes $17626, 1997 include $164 million and $177$165 million, respectively, pledged as collateral to support letters of credit primarily associated with the Company's purchase commitments under the terms of the sale of the Company's Fountain, Colorado, manufacturing facility to SCI. Cash usedgenerated by operations during the first nine monthsquarter of 19971998 totaled $10 million,$143 million. Cash generated by operations was primarily due to the Company's net loss, adjusted for non-cash expenses such as in-process researchresult of positive earnings and development, and a decrease in certain current liabilities, as well as restructuring costs, partially offset by a decreasedecreases in accounts receivable and inventories. The Company expects to use cash to fund operations over at least the next quarter. Cash used to acquire NeXT totaled $384 millioninventories, partially offset by decreases in the second quarter of 1997. The Company expects no additional cash expendituresaccounts payable and other current liabilities and payments related to the NeXT acquisition. Cashrestructuring actions. Net cash used for the purchase of property, plant, and equipment totaled $42$7 million in the first nine monthsquarter of 1997,1998, and consisted primarily of increases in manufacturing machinery and equipment. The Company expects that the level of capital expenditures for the remainder of 1997 will be comparable to the same period of 1996. The Company's debt ratings remain unchanged fromin the second quarter of 1998 will increase slightly as compared to the first quarter. Over the last two years, the Company's debt ratings have been downgraded to non-investment grade. In October 1997, when the Company's senior and subordinated long-term debt were downgraded to BB- and CCC+,CCC, respectively, by Standard and Poor's Rating AgencyAgency. The Company's senior and subordinated long-term debt ratings by Moody's Investor Services remain unchanged from the second quarter of 1997, when they were downgraded to B3 and Caa, respectively, byCaa2, respectively. Both Standard and Poor's Rating Agency and Moody's Investor Services. TheServices have the Company was also placed on negative credit watch by Moody's Investor Services.outlook. These actions may increase the Company's cost of funds in future periods. In addition, the Company may be required to pledge additional collateral with respect to certain of its borrowings and letters of credit and to agree to more stringent covenants than in the past. The Company believes that its balances of cash and cash equivalents and short-term investments, including proceeds from the August 1997 sale of Apple Series A Non-voting Convertible Preferred Stock to Microsoft, and continued short-termshort- term borrowings from banks, will be sufficient to meet its cash requirements over the next 12twelve months. In addition to funding an expected net loss for at least the next quarter, expectedExpected cash requirements over the next twelve months include an estimated $100$102 million to effect actions under the restructuring plan, most of which will be effected over the next six months. Also, the notes payable to banks all become due prior to September 30, 1997.during fiscal 1998. No assurance can be given that short-term borrowings from banks can be continued, or that any additional required financing could be obtained should the restructuring plan take longer to implement than anticipated or be unsuccessful. If the Company is unable to obtain such financing, its liquidity, results of operations, and financial condition wouldcould be materially adversely affected. The Internal Revenue Service ("IRS") has proposed federal income tax deficiencies for the years 26 1984 through 1991, and the Company has made certain prepayments thereon. The Company contested the proposed deficiencies by filing petitions with the United StatesU.S. 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 the 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. 2722 PART II. OTHER INFORMATION Item 1. Legal Proceedings Reference is made to page 45 of the Company'sAbraham and Evelyn Kostick Trust v. Peter Crisp et al. In January 1996, Annual Report on Form 10-K under the subheading "Litigation" for a discussion of certain consumerpurported shareholder class actions relating to "repetitive stress injury" claims. In July 1997, the Court in the caseaction styled Abraham and Evelyn Kostick Trust v. Peter Crisp et. al.al was filed in the California Superior Court for Santa Clara County naming the Company and its then directors as defendants. The complaint sought injunctive relief and damages and alleged that acts of mismanagement resulted in a depressed price for the Company. In February 1996, the complaint was amended to add a former director as a defendant and to add purported class and derivative claims based on theories such as breach of fiduciary duty, misrepresentation, and insider trading. In July 1996, the Court sustained defendants' demurrer and dismissed the amended complaint on a variety of grounds and granted plaintiffs leave to amend the complaint. In October 1996, the plaintiffs filed a second amended complaint naming the Company's then directors and certain former directors as defendants and again alleging purported class and derivative claims, seeking injunctive relief and damages (compensatory and punitive) based on theories such as breach of fiduciary duty, misrepresentation, and insider trading. In July 1997, the Court granted in part and denied in part the Company's motion to strike most of the substantive allegations of the second amended complaint. The Court had previously sustained the demurrer to plaintiffs' class claims but overruled the demurrer to the shareholder derivative claims. TheIn September 1997, the Company intendsbrought a motion to make additional motions to disposereconsider portions of the case oncourt order. The Third Amended Complaint was filed in October 1997, and eliminated the pleadings, including filingclass action claims and restated claims against certain directors and former directors. In November 1997, the Company's Board of Directors appointed a special investigation committee and engaged independent counsel to assist in the investigation of the claims made in the Third Amended Complaint. Also in November 1997, the Company filed a demurrer to any amended complaint that plaintiffs may elect to serve. On July 8, 1997, the Court in the case styledThird Amended Complaint. A hearing is set for February 1998. LS Men's Clothing Defined Benefit Pension Fund v. Michael Spindler et.et al. In May 1996, an action was filed in the California Superior Court for Alameda County naming as defendants the Company and certain of its current and former officers and directors. The complaint seeks compensatory and punitive damages and generally alleges that the defendants misrepresented or omitted material facts about the Company's operations and financial results, which plaintiff contends artificially inflated the price of the Company's stock. The case was transferred to the California Superior Court for Santa Clara County. In July 1997, the Court sustained the Company's demurrer dismissing the amended complaint with leave to amend. On July 28, 1997,amend, after which plaintiff served a second amended complaint. In September 1997, the Company and the two remaining individual defendants (former directors Markkula and Spindler) brought a motion to dismiss the second amended complaint. In October 1997, the Court granted the motion to dismiss in its entirety with leave to amend as to certain defendants and claims. In November 1997, the plaintiff filed a third amended complaint, adding a former director as a defendant and alleging further misrepresentations by the defendants about the Company's operations and financial results. In January 1998, the Company and the three individual defendants brought a motion to dismiss the third amended complaint, which is set for hearing in February 1998. "Repetitive Stress Injury" Litigation The Company is named in approximately 60 lawsuits, alleging that plaintiffs incurred so-called "repetitive stress" injuries to their upper extremities as a result of using keyboards and/or mouse input devices sold by the Company. These actions are similar to those filed against other major suppliers of personal computers. In October 1996, the Company prevailed in the first full trial to go to verdict against the Company. Since then, approximately ten lawsuits have been dismissed with prejudice by the plaintiffs, and two others have been dismissed by court order. The remaining actions are in various stages of pretrial activity. Ultimate resolution of these cases may depend on industry-wide progress in resolving similar litigation, as well as on the impact of the recent decision handed down by the New York Court of Appeals in the case of Blanco v. American Telephone and Telegraph Co. (a majority of the cases naming the Company as a defendant were filed in New York, and are subject to the decision). In that decision, the court announced a new standard for determining when the statute of limitations period begins to accrue in so- 23 called "repetitive stress" injury cases. While the decision could result in the revival of some cases which were previously dismissed, the decision will not cause the Company to alter its strategy in these cases. Monitor-Size Litigation In August 1995, the Company was named, along with 41 other entities, including computer manufacturers and computer monitor vendors, in a putative nationwide class action filed in the California Superior Court for Orange County, styled Keith Long et al. v. AAmazing Technologies Corp. et al. The complaint alleges that each of the defendants engaged in false or misleading advertising with respect to the size of computer monitor screens. Also in August 1995, the Company was named as the sole defendant in a purported class action alleging similar claims filed in the New Jersey Superior Court for Camden County, entitled Mahendri Shah v. Apple Computer, Inc. Subsequently, in November 1995, the Company, along with 26 other entities, was named in a purported class action alleging similar claims filed in the New Jersey Superior Court for Essex County, entitled Maizes & Maizes v. Apple Computer, Inc. et al. Similar putative class actions have been filed in other California counties in which the Company was not named as a defendant. The complaints in all of these cases seek restitution in the form of refunds or product exchange, damages, punitive damages, and attorneys fees. In December 1995, the California Judicial Council ordered all of the California actions, including Long, coordinated for purposes of pretrial proceedings and trial before a single judge, the Honorable William Cahill, sitting in the County of San Francisco. All of the California actions were subsequently coordinated under the name In re Computer Monitor Litigation, and a master consolidated complaint was filed superseding all of the individual complaints in those actions. In July 1996, Judge Cahill ordered all of the California cases dismissed without leave to amend as to plaintiffs residing in California on the ground that a stipulated judgment entered in September 1995 in a prior action brought by the California Attorney General alleging the same cause of action was res judicata as to the plaintiffs in the consolidated California class action suits. This order may be subject to appellate review at a later stage of the proceedings. Both the New Jersey cases and the consolidated California cases are at a preliminary stage, with no discovery having taken place. In March 1997, the Court in the case styled In re Computer Monitor Litigation preliminarily approved a proposed settlement to which the Company and all but three of the other defendants in the action would be parties and provisionally certified a nationwide settlement class with respect thereto. A hearing regarding final approval of the proposed settlement was held on June 30, 1997 and the Court's decision is pending. If approved, the Company does not anticipate its obligations pursuant to the proposed settlement will have a material adverse effect on its consolidated results of operations or financial condition as reported in the accompanying financial statements. Exponential Technology v. Apple Plaintiff alleges in a lawsuit styled Exponential Technology, Inc. v. Apple Computer, Inc. that the Company, which was an investor in Exponential, breached its fiduciary duty to Exponential by misusing confidential information about its financial situation to cause Exponential to fail, and that the Company fraudulently misrepresented the facts about allowing Exponential to sell its processors to the Company Mac OS licensees. The lawsuit is filed in California State Court in Santa Clara County. In JuneNovember 1997, the Company filed a demurrer to portions of the complaint, which the court granted in part. In January 1998, plaintiff filed an Amended Complaint. Other On August 21, 1997, the Federal Trade Commission andissued its consent decree against the Company, agreed to a consent decree regarding the Company's past processor upgrade practices.practices, specifically certain advertisements which the Commission deemed to have misrepresented the Company's marketing of certain microprocessor upgrade products. Pursuant to the order, the Company is ordered to cease and desist from any such allegedly misleading advertising, to give notice to consumers, and to implement certain programs enabling consumers who are within the order's scope to obtain upgrade kits or rebates, in connection with any purchases within the scope of the order. The termsCompany has complied with all provisions of this decree would include an upgrade offer to customersthe order currently effective, and an agreement to some terms about future activities byhas filed its 60-day compliance with the Company. The consent decree is pending court approval.Commission on October 17, 1997. The Company has various other claims, lawsuits, disputes with third parties, investigations and pending actions involving allegations of false or misleading advertising, product defects, discrimination, infringement of intellectual property rights, and breach of contract and other matters against the Company and its subsidiaries incident to the operation of its business. The liability, if any, associated with these matters wasis not determinable as of the date of this filing.determinable. 24 The Company believes the resolution of the matters cited above will not have a material adverse effect on its financial condition as reported in the accompanying financial statements. However, depending on the amount and timing of any unfavorable resolution of these lawsuits, it is possible that the Company's future consolidated results of operations or cash flows could be materially affected in a particular period. 2825 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Exhibit Number Note Description 10.A.26-1 Amendment to Employment Agreement, dated May 1, 1997, between Apple Computer, Inc. and Gilbert F Amelio 10.A.45 Retention Agreement dated May 1, 1997, between Apple Computer, Inc. and Fred D. Anderson10.A.5 1990 Stock Option Plan, as amended through November 5, 1997. 27 Financial Data Schedule. (b) Reports on Form 8-K Current reports on Form 8-K, dated April 10, 1997 and April 25, 1997, respectively, were filed by Registrant with the Securities and Exchange Commission to report under Item 5 thereof the press releases issued to the public on March 14, 1997 regarding the Registrant's restructuring plan and expected second quarter revenue and the press release issued to the public on April 16, 1997 regarding the Registrant's second quarter results. 2926 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. APPLE COMPUTER, INC. (Registrant) By: /s/Fred D. Anderson Fred D. Anderson Executive Vice President and Chief Financial Officer August 11, 1997 30February 6, 1998 27 INDEX TO EXHIBITS Exhibit Index Number Note Description Page 10.A.26-1 Amendment to Employment Agreement, dated May 1,1997, between Apple Computer, Inc. and Gilbert F. Amelio. 32 10.A.45 Retention Agreement dated May 1, 1997, between Apple Computer, Inc. and Fred D. Anderson. 3410.A.5 1990 Stock Option Plan, as amended through November 5, 1997. 29 27 Financial Data Schedule. 4738 28