See accompanying notes to condensed consolidated financial statements.

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APPLE COMPUTER, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 1—Summary of Significant Accounting Policies

        Apple Computer, Inc. and its subsidiaries (the Company) designs, manufactures and markets personal computers and related personal computing and communicating solutions for sale primarily to education, creative, consumer, and business customers.

Basis of Presentation and Preparation

        The accompanying condensed consolidated financial statements include the accounts of the Company. All information is based on the Company's fiscal calendar. Intercompany accounts and transactions have been eliminated. The preparation of these condensed consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in these condensed consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates. Interim information is unaudited; however, in the opinion of the Company's management, all adjustments of a normal recurring nature necessary for a fair statement of interim periods presented have been included. The results for interim periods are not necessarily indicative of results to be expected for the entire year.

        These condensed consolidated financial statements and accompanying notes should be read in conjunction with the Company's annual consolidated financial statements and the notes thereto for the fiscal year ended September 29, 2001, included in its Annual Report on Form 10-K for the year ended September 29, 2001 (the 2001 Form 10-K). All off balance sheetThe Company does not currently utilize any off-balance-sheet financing arrangements which consist primarily of obligations underother than standard operating leases have been fully disclosed infor the Company's 2001 Form 10-K. The naturerental of the Company's off balance sheet financing arrangements has not changed significantly since the 2001 Form 10-K was filed.equipment and facilities.

Recent Accounting Pronouncements

        In June 2001, the Financial Accounting Standards Board issued SFASStatement of Financial Accounting Standards (SFAS) No. 143,Accounting for Asset Retirement Obligations, which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The standard applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) normal use of the assets. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The fair value of the liability is added to the carrying amount of the associated asset and this additional carrying amount is depreciated over the life of the asset. The Company is required to adopt the provisions of StatementSFAS No. 143 for the first quarter of its fiscal 2003. Because of the effort that may be necessary to comply with the adoption of StatementSFAS No. 143, it is not practicable for management to estimate the impact of adopting this Statement at the date of this report.

        In August 2001, the Financial Accounting Standards Board issued FASB StatementSFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets (Statement 144), which supersedes both FASB StatementSFAS No. 121,Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of (Statement 121) and the accounting and reporting provisions of APB Opinion No. 30,Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions (Opinion 30), for the disposal of a segment of a business (as previously defined in that Opinion). StatementSFAS No. 144 retains the fundamental provisions in StatementSFAS No. 121 for recognizing and measuring impairment losses on long-lived assets held for use and long-lived assets to be disposed of by sale, while also resolving significant implementation issues associated with SFAS No. 121. For example,

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implementation issues associated with Statement 121. For example, StatementSFAS No. 144 provides guidance on how a long-lived asset that is used as part of a group should be evaluated for impairment, establishes criteria for when a long-lived asset is held for sale, and prescribes the accounting for a long-lived asset that will be disposed of other than by sale. StatementSFAS No. 144 retains the basic provisions of Opinion 30 on how to present discontinued operations in the income statement but broadens that presentation to include a component of an entity (rather than a segment of a business). Unlike StatementSFAS No. 121, an impairment assessment under StatementSFAS No. 144 will never result in a write-down of goodwill. Rather, goodwill is evaluated for impairment under StatementSFAS No. 142,Goodwill and Other Intangible Assets.

        The Company is required to adopt StatementSFAS No. 144 no later than its first fiscal year beginning after December 15, 2001. Management does not expect the adoption of StatementSFAS No. 144 for long-lived assets held for use to have a material impact on the Company's financial statements because the impairment assessment under StatementSFAS No. 144 is largely unchanged from StatementSFAS No. 121. The provisions of the Statement for assets held for sale or other disposal generally are required to be applied prospectively after the adoption date to newly initiated disposal activities. Therefore, management cannot determine the potential effects that adoption of StatementSFAS No. 144 will have on the Company's financial statements.

Note 2—Earnings Per Share

        Basic earnings per common share is computed by dividing income available to common shareholders by the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per common share is computed by dividing income available to common shareholders by the weighted-average number of shares of common stock outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the dilutive potential shares of common stock had been issued. The dilutive effect of outstanding options is reflected in diluted earnings per share by application of the treasury stock method. Dilutive potential shares of common stock related to stock options were excluded from the calculation of diluted loss per common share for the sixnine months ended March 31,June 30, 2001 because their effect would have been antidilutive.

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        The following table sets forth the computation of basic and diluted earnings (loss) per share (in thousands, except net income (loss) and per share amounts):

        Options to purchase approximately 44 and 45 million shares of common stock that were outstanding at March 30,as of June 29, 2002 and March 31,June 30, 2001 respectivelythat were not included in the computation of diluted earnings per share for the second quarterquarters then ended because the options' exercise price wasprices were greater than the average market priceprices of the Company's common stock during these periods,quarters, and therefore, the effect would behave been antidilutive.

        At June 30, 2001, the Company had outstanding options to purchase approximately 97.1 million shares of its common stock, all of which were excluded from the computation of diluted loss per share for the nine-month period then ended because the effect would have been antidilutive.

Note 3—Consolidated Financial Statement Details (in millions)

Inventories

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Property, Plant, and Equipment

Accrued Expenses

Interest and Other Income, Net

Inventory Prepayment

        In April 2002, the Company made a $100 million prepayment to an Asian supplier for the purchase of components over the following nine months. In return for this deposit, the supplier agreed to supply the Company with a specified level of components in the three consecutive fiscal quarters ending December 28, 2002. If the supplier fails to supply the agreed upon level of components in any of those three fiscal quarters, the Company may cancel the arrangement and receive the amount of the prepayment not utilized plus a penalty. Approximately $83 million of this deposit remained unused as of June 29, 2002, and is reflected in the condensed consolidated balance sheets in other current assets. The amount of the prepayment not utilized by the Company on or before December 31, 2002, is refundable to the Company by January 31, 2003.

        Although the supplier's existing debt is unrated, its public debt pricing is consistent with other BBB rated companies. The deposit is unsecured and has no stated interest component. The Company is imputing an amount to cost of sales and interest income during each period the deposit is outstanding at an appropriate market interest rate to reflect the economics of this transaction. In light

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of the supplier's implied debt rating and because the Company's prepayment is unsecured, non-performance by and/or economic deterioration of the supplier could place all or some of the Company's deposit at risk.

Capitalized Software Development Costs

        Generally, the Company expenses research and development costs as they are incurred. However, development costs of computer software to be sold, leased or otherwise marketed are subject to capitalization beginning when a product's technological feasibility has been established and ending when a product is available for general release to customers. In almost all instances, the Company's products are released soon after technological feasibility has been established. Therefore, costs incurred subsequent to achieving technological feasibility are usually not significant, and historically most software development costs have been expensed. However, during 2001 the Company incurred substantial development costs associated with the initial release of Mac OS X® operating system subsequent to release of a public beta version of the product and prior to release of the final product version. As a result, during 2001, the Company capitalized approximately $5.4 million of development costs associated with development of Mac OS X. Related amortization is being recognized on a straight-line basis over the estimated 8 year useful life of the asset.

        During the third quarter of 2002, the Company incurred substantial development costs associated with the upgrade of Mac OS X version 10.2 (code named "Jaguar") subsequent to achievement of technological feasibility as evidenced by public demonstration and release of a developer beta version of the software in May 2002. Therefore, during the third quarter of 2002, the Company capitalized approximately $9.1 million of development costs associated with development of Jaguar and anticipates capitalizing additional development costs during the fourth quarter. Amortization of this asset will be recognized on a straight-line basis over 3 years upon completion and release of the final version of Jaguar, which is planned for the fourth quarter of 2002.

        During 2002, the Company also capitalized certain costs related to development of its new PowerSchool® enterprise student information system. Capitalization, which began in the first quarter of 2002, amounted to approximately $6 million during the first nine months of fiscal 2002. The enterprise student information system is expected to be completed and released in the fourth quarter of 2002. Amortization of this asset will be recognized on a straight-line basis over 3 years.

        All capitalized software development costs and related accumulated amortization are reflected in the condensed consolidated balance sheets in other assets.

Note 4—Financial Instruments

Short-Term Investments

        All highly liquid investments with maturities of three months or less are classified as cash equivalents; highly liquid investments with maturities greater than three months are classified as short-term investments. Approximately $942 million and $313 million of the Company's investment portfolio classified as short-term investments was in government agency securities and high investment grade corporate debt with underlying maturities ranging from 1 to 5 years as of the end of the third quarter of 2002 and the end of fiscal 2001, respectively. The remainder of the Company's short-term investments had underlying maturities between 3 and 12 months.

Non-Current Debt and Equity Investments and Related Gains

        The Company has held significant investments in ARM Holdings plc (ARM), Samsung Electronics Co., Ltd. (Samsung), Akamai Technologies, Inc. (Akamai) and EarthLink Network, Inc. (EarthLink). The combined fair value of these investments was $48 million and $128 million as of June 29, 2002 and

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September 29, 2001, respectively. The Company believes it is likely there will continue to be significant fluctuations in the fair value of these investments in the future.

These investments have beenare reflected in the condensed consolidated balance sheets asin non-current debt and equity investments and have been categorized as available-for-sale requiring that they be carried at fair value with unrealized gains and losses, net of taxes, reported in equity as a component of accumulated other comprehensive income. All realized

        The Company recognizes an impairment charge to earnings when it judges such investments have experienced a decline in value below cost basis that is other-than-temporary. The Company includes recognized gains and losses resulting from the sale or from other-than-temporary declines in fair value associated with such investments in other income and expense.

        The market values of the Company's investments in EarthLink and Akamai at June 29, 2002, were approximately $36 million and $5 million below their cost bases, respectively. Based on the sale ofrelatively short time these investmentsinvestments' cost bases have been included in other income. The combinedexceeded their fair value and the financial condition and near-term prospects of both EarthLink and Akamai, the Company currently believes these investments was $79 million and $128 million as of March 30, 2002 and September 29, 2001, respectively. The Company believes it is likely there will continuedeclines in fair value to be significant fluctuations intemporary. However, should the fair value of these investments remain below the Company's cost bases and/or the financial condition or prospects of EarthLink or Akamai deteriorate, the Company may determine in a future period that this decline in fair value is other-than-temporary, requiring an impairment loss be recognized in the future.period such a determination is made.

        During the first quarter of 2002, the Company sold 4.7 million shares of ARM stock for both net proceeds and a gain before taxes of $21 million. During the first quarter of 2002, the Company also sold 250,000 shares of Akamai and 117,000 shares of EarthLink stock for net proceeds of approximately $2 million each and a gain before taxes of $710,000 and $223,000, respectively. During the first quarter of 2001, the Company sold 3.8 million shares of ARM stock for net proceeds of approximately $35 million and a gain before taxes of $35 million. During the first quarter of 2001, the Company also sold 1 million shares of Akamai stock for net proceeds of approximately $39 million and a gain before taxes of $36 million. No sales of the Company's non-current debt and equity investments were made in either the second or the third quarter of 2002.

        During the first, second, and third quarters of fiscal 2001, the Company recognized gains on sale of shares of its investment in ARM of $35 million, $127 million, and $12 million, respectively. During the first quarter of 2001, the Company recognized a gain of $36 million on sale of shares of its investments in Akamai. As of the end of the second quarter of 2002.2001, the Company determined that the decline in the fair value of its investment in EarthLink was other-than-temporary. As a result, the Company recognized a $114 million charge to earnings to write down the basis of its investment in EarthLink to $86 million. Also during the second quarter of fiscal 2001, the Company determined that the decline in fair value of certain of its strategic investments in privately held companies was other-than-temporary and, accordingly, recognized a charge to earnings of approximately $8 million.

Samsung

        During the fourth quarter of 1999, the Company invested $100 million in Samsung to assist in the further expansion of Samsung's TFT-LCD flat-panel display production capacity. The investment was in the form of three year unsecured bonds, which were convertible into approximately 550,000 shares of Samsung common stock beginning in July 2000. The bonds carried an annual coupon rate of 2% and paid a total yield to maturity of 5% if redeemed at their maturity.

        Prior to its sale, the Company had categorized its investment in Samsung as available-for-sale requiring that it be carried at fair value with unrealized gains and losses, net of taxes, reported in equity as a component of accumulated other comprehensive income. With the adoption of SFAS No. 133 in the first quarter of 2001, the Company was required to account for the conversion option embedded in the Samsung bonds separately from the related debt. The conversion feature was carried at fair value with any changes in fair value recognized in earnings in the period in which they occurred. Included in the $17 million gross SFAS No. 133 transition adjustment recorded in earnings during the

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first quarter of fiscal 2001 was a $23 million favorable adjustment for the restatement to fair value as of October 1, 2000, of the derivative component of the Company's investment in Samsung. To adjust the carrying value of the derivative component of its investment in Samsung to fair value as of December 30, 2000, the Company recognized an unrealized loss of approximately $13 million during the first quarter of 2001. During the second quarter of 2001, the Company sold this investment for book value, including accrued interest, receiving net proceeds of approximately $117 million.

Other Strategic Investments

        The Company has additional minority debt and equity investments in several privately held technology companies with a book value of approximately $17$15 million and $18 million as of March 30,June 29, 2002, and September 29, 2001, respectively. These investments, which are reflected in the condensed consolidated balance sheets in other assets, are inherently risky because the products and/or markets of these companies are typically not fully developed.

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Derivative Financial Instruments

        The Company uses derivatives to partially offset its business exposure to foreign exchange and interest rate risk. Foreign currency forward and option contracts are used to offset the foreign exchange risk on certain existing assets and liabilities and to hedge the foreign exchange risk on expected future cash flows on certain forecasted revenues and cost of sales. From time to time, the Company enters into interest rate swap agreements to modify the interest rate profile of certain investments and debt. The Company records all derivatives on the balance sheet at fair value. As of the end of the secondthird quarter of 2002, the general nature of the Company's risk management activities and the general nature and mix of the Company's derivative financial instruments have not changed materially from the end of fiscal 2001.

Foreign Exchange Risk Management

        The Company enters into foreign currency forward and option contracts with financial institutions primarily to protect against foreign exchange risk associated with existing assets and liabilities, certain firmly committed transactions and certain probable but not firmly committed transactions. Generally, the company'sCompany's practice is to hedge a majority of its existing material foreign exchange exposure associated with existing assets and liabilities and firmly committed transactions, and to hedge a significant portion of its foreign exchange exposure associated withfrom probable but not firmly committed transactions associated with expected future cash flows on certain forecasted foreign currency revenues and cost of sales expected to occur over the following three to nine months.

Interest Rate Risk Management

        The Company sometimes enters into interest rate derivative transactions, including interest rate swaps, collars, and floors, with financial institutions in order to better match the Company's floating-rate interest income on its cash equivalents and short-term investments with its fixed-rate interest expense on its long-term debt, and/or to diversify a portion of the Company's exposure away from fluctuations in short-term U.S. interest rates. The Company may also enter into interest rate contracts that are intended to reduce the cost of the interest rate risk management program. The Company does not hold or transact in such financial instruments for purposes other than risk management.

        Due to prevailing market conditions, lower interest rates, and uncertainties related to the timing and depth of an economic recovery, the Company entered into interest rate swap agreements in January and February 2002 to convert its $300 million of fixed rate debt to a floating rate based on 6 month LIBOR.

Accounting for Derivative Financial Instruments

        On October 1, 2000, the Company adopted Statement of Financial Accounting Standards (SFAS)SFAS No. 133, "AccountingAccounting for Derivative Instruments and Hedging Activities."Activities. SFAS No. 133 establishes accounting and reporting standards for derivative instruments, hedging activities, and exposure definition. SFAS No. 133 requires that all derivatives be recognized as either assets or liabilities at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in fair value will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings, or recognized in other comprehensive income until the hedged item is recognized in earnings. Net of the related income tax effect of approximately $5 million, adoption of SFAS No. 133 resulted in a favorable cumulative-effect-type adjustment to other comprehensive income of approximately $12 million, substantially all of which was reclassified to earnings by the end of the second quarter of fiscal 2001.

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        As of March 30,June 29, 2002 the Company had a net deferred gainloss associated with cash flow hedges of approximately $17$29 million, net of taxes, substantially all of which is expected to be reclassified to earnings by the end of the fourthfirst quarter of fiscal 2002.2003.

        The following table summarizes activity in other comprehensive income related to derivatives, net of taxes, held by the Company during the three and sixnine month period ending March 30,periods ended June 29, 2002 and March 31,June 30, 2001, respectively (in millions):

Note 5—Shareholders' Equity

Stock Repurchase Plan

        In July 1999, the Company's Board of Directors authorized a plan for the Company to repurchase up to $500 million of its common stock. This repurchase plan does not obligate the Company to acquire any specific number of shares or acquire shares over any specified period of time. No shares were repurchased during the first sixnine months of fiscal 2002. Since inception of the repurchase plan, the Company has repurchased or committed to repurchase a total of 6.55 million shares of its common stock at a cost of $217 million.

Comprehensive Income

        Comprehensive income consists of two components, net income and other comprehensive income. Other comprehensive income refers to revenue, expenses, gains and losses that under generally accepted accounting principles are recorded as an element of shareholders' equity but are excluded from net income. The Company's other comprehensive income is comprised of foreign currency translation adjustments from those subsidiaries not using the U.S. dollar as their functional currency, from unrealized gains and losses on marketable securities categorized as available-for-sale, and from net deferred gains and losses on certain derivative instruments accounted for as cash flow hedges.

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        The following table summarizes components of total comprehensive income (loss), net of taxes, during the three and nine month periods ended June 29, 2002 and June 30, 2001, respectively (in millions):

        The following table summarizes the components of accumulated other comprehensive income, net of taxes (in millions):

Note 6—Goodwill and Other Intangible Assets

        The Company adopted SFAS No. 142, "GoodwillGoodwill and Other Intangible Assets", in the first quarter of fiscal 2002. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually in accordance with the provisions of SFAS No. 142.annually. SFAS No. 142 also requires that intangible assets with definite lives be amortized over their estimated useful lives and reviewed for impairment in accordance with SFAS No. 144, "AccountingAccounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of."Of.

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        The Company established reporting units based on its current reporting structure. For purposes of testing goodwill for impairment, goodwill has been allocated to these reporting units to the extent it relates to each reporting unit. The Company completed the first step of the transitional goodwill impairment test and has determined that no potential impairment existed. As a result, the Company recognized no transitional impairment loss in the first quarter of 2002 in connection with the adoption of SFAS No. 142. The Company will evaluate goodwill at leastfor impairment on an annual basis each September and whenever events and changes in circumstances suggest that the carrying amount may not be recoverable from its estimated future cash flow.

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        The following table summarizes the components of gross and net intangible asset balances (in millions):

        Expected future annual amortization expense related to acquired technology and other intangible assets is as follows (in millions):

        Amortization expense related to intangible assets is as follows (in millions):

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        Net income (loss) and net income (loss) per share adjusted to exclude amortization of goodwill in 2001 fiscal periods follows (in millions, except per share amounts):

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Note 7—Acquisition of Nothing Real, LLC.Acquisitions

        In February 2002, the Company acquired certain assets of Nothing Real, LLC (Nothing Real), a privately-held company that develops and markets high performance tools designed for the digital image creation market. Of themarket, for $15 million purchase price, thein cash. This acquisition has been accounted for as a purchase. The Company has allocated approximately $7 million of the purchase price to acquired technology, which will be amortized on a straight-line basis over its estimated life of 5 years. The remaining $8 million, which has been identified as contingent consideration rather than recorded as an additional component of the cost of the acquired assets, will be allocated to future compensation expense in the appropriate periods over the next 3 years.

        During the third quarter of 2002, the Company acquired certain assets of Zayante, Inc., Prismo Graphics, and Silicon Grail Corporation for a total of $21 million in cash. These acquisitions have been accounted for as asset acquisitions. The purchase price for these acquisitions, except for $1 million identified as contingent consideration which will be allocated to compensation expense over the next 3 years, has been allocated to acquired technology and will be amortized on a straight-line basis over 3 years, except for certain assets acquired from Zayante associated with patent royalty streams that will be amortized over 10 years.

        On June 30, 2002, the Company acquired Emagic, GmbH, a provider of professional solutions for computer-based music production, for approximately $30 million in cash. This acquisition will be accounted for as a purchase and recorded in the fourth quarter of 2002.

Note 8—Restructuring Action

        During the first quarter of 2002, the Company's management approved and initiated a restructuring plan designed to eliminate certain activities and better align its operating expenses with existing general economic conditions and to partially offset the cost of continuing investments in new product development and investments in the Company's Retail operating segment. Accordingly, the Company recognized a restructuring charge of approximately $24 million during the first quarter of 2002. The restructuring plan includes significant changes in the Company's information systems strategy resulting in termination of equipment leases and cancellation of existing projects and activities. The restructuring plan will result in the elimination of approximately 425 positions worldwide, 385400 of which were eliminated by March 30,June 29, 2002. Positions were eliminated primarily in the Company's operations, information systems, and administrative functions.

        Of the original $24 million restructuring charge made during the first quarter of 2002, the Company utilized $9 million during that same quarter. Of the $15 million remaining accrual at the end of the first quarter, the Company spent $12 million during the second quarter and made a downward adjustment of approximately $250,000 to the restructuring accrual due to lower actual costs than originally estimated for certain lease commitments and severance benefits. The Company currently anticipates that substantially all of the remaining $3$2 million accrual, except amounts accrued for future operating lease payments, will be spent by the end of its fiscal 2002.

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        The following table summarizes activity associated with the restructuring plan through March 30,June 29, 2002 (in millions):

Note 9—Segment Information and Geographic Data

        The Company manages its business primarily on a geographic basis. The Company's reportable segments are comprised of the Americas, Europe, Japan, and Retail. The Americas segment includes both North and South America, except for the activities of the Company's Retail segment. The Europe segment includes European countries as well as the Middle East and Africa. The Japan segment includes only Japan. The Retail segment operates Apple-owned retail stores in the United States. Other operating segments include Asia-Pacific, which includes Australia and Asia except for Japan, and the Company's subsidiary, Filemaker, Inc. Each reportable geographic operating segment provides similar products and services.

        The Company evaluates the performance of its operating segments based on net sales and operating income. Net sales for geographic segments are based on the location of the customers. Operating income for each segment includes revenue from third-parties, cost of sales, and operating expenses directly attributable to the segment. Operating income for each segment excludes other income and expense and certain expenses that are managed outside the operating segments. Costs excluded from segment operating income include various corporate expenses, manufacturing costs not included in standard costs, income taxes, and various nonrecurring charges. Corporate expenses include research and development, corporate marketing expenses, and other separately managed general and administrative expenses including certain corporate expenses associated with support of the Retail segment.

        Operating income for all segments except Retail includes cost of sales at standard cost. Manufacturing expenses and related adjustments not included in segment cost of sales, including variances between standard and actual manufacturing costs, warranty costs, and freight costs, and the mark-up above standard cost for product supplied to the Retail segment, are included in corporate expenses. To assess the operating performance of the Retail segment, cost of sales for this segment includes a mark-up above standard cost to approximate the price normally charged to the Company's major channel partners in the United States. For the sixnine month period ended March 30,June 29, 2002, this resulted in the Retail segment recognizingrecognition of additional cost of sales above standard cost by the Retail segment and an offsetting benefit to corporate expenses of approximately $21$32 million.

15        The Retail segment includes in its net sales a commission from the sale of the Company's extended warranty and support contracts. This treatment is consistent with commissions paid to the Company's major channel partners in the United States. Because the revenue from these contracts has yet to be earned by the Company, an offset to this commission is reflected in other segments' net sales. For the nine-month period ended June 29, 2002, this resulted in the recognition of additional net sales

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by the Retail segment, and an offsetting reduction to other segments' net sales of approximately $1.5 million.

        Summary information by operating segment follows (in millions):

        A reconciliation of the Company's segment operating income to the condensed consolidated financial statements follows (in millions):

Note 10—Commitments and Contingencies

Lease Commitments

        The Company leases various equipment and facilities, including retail space, under noncancelable operating lease arrangements. The Company does not currently utilize any other off-balance-sheet financing arrangements. The major facility leases are for terms of 5 to 10 years and generally provide renewal options for terms of 3 to 5 additional years. Leases for retail space are for terms of 5 to 12 years and often contain multi-year renewal options. As of September 29, 2001, the Company's total future minimum lease payments under noncancelable operating leases were $431 million, of which $163 million related to leases for retail space. As of June 29, 2002, total future minimum lease payments related to leases for retail space increased to $182 million.

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Contingencies

        Beginning on September 27, 2001, three shareholder class action lawsuits were filed in the United States District Court for the Northern District of California against the Company and its Chief Executive Officer. The lawsuits are essentially identical and purport to bring suit on behalf of those who purchased the Company's publicly traded common stock between July 19, 2000, and September 28, 2000. The complaints allege violations of the 1934 Securities Act and seek unspecified compensatory damages and other relief. The Company believes these claims are without merit and intends to defend them vigorously.

        The Company is subject to certain other legal proceedings and claims that have arisen in the ordinary course of business and have not been fully adjudicated. The results of legal proceedings cannot be predicted with certainty; however, in the opinion of management, the Company does not have a potential liability related to any current legal proceedings and claims that would have a material adverse effect on its financial condition, liquidity or results of operations.

        The parliament of the European Union is working on finalizing the Waste Electrical and Electronic Equipment Directive (the Directive). The Directive makes manufacturers of electrical goods, including personal computers, financially responsible for the collection, recycling, and safe disposal of past and future products. The Directive must now be approved and implemented by individual European Union governments by 2005. The Company's potential liability resulting from the Directive related to past sales of its products and expenses associated with future sales of its product may be substantial. However, because it is likely that specific laws, regulations, and enforcement policies will vary significantly between individual European member states, it is not currently possible to estimate the Company's existing liability or future expenses resulting from the Directive. As the European Union and its individual member states clarify specific requirements and policies with respect to the Directive, the Company will continue to assess its potential financial impact.

On February 15, 2001, the Internal Revenue Service (IRS) proposed adjustments to the Company's federal income tax returns for the years 1995 through 1997. The Company disagrees with most of the proposed adjustments and is contesting them through the IRS Appeals Office. Substantially all IRS

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audit issues for years prior to 1995 have been resolved. Management believes that adequate provision has been made for any adjustments that may result from tax examinations.

Note 11—Subsequent EventRelated Party Transactions

        In April 2002,        Mr. Jerome York, a member of the Board of the Directors of the Company, is a member of an investment group that purchased MicroWarehouse, Inc. ("MicroWarehouse") in January 2000. He also serves as its Chairman, President and Chief Executive Officer. MicroWarehouse is a multi-billion dollar specialty catalog and online retailer and direct marketer of computer products, including products made a $100 million prepayment to an Asian supplier for the future purchase of components. In return for this deposit, the supplier has agreed to supplyby the Company, with a specified level of components in each of the fiscal three quarters ended December 28, 2002. If the supplier fails to supply the agreed upon level of components in any of those three fiscal quarters, the Company may cancel the arrangement and receive any unutilized deposit plus a penalty.

        Although the supplier's existing debt is unrated, the pricing ofthrough its public debt is consistent with other BBB rated companies. The deposit is unsecured and has no stated interest component. The Company will impute an amount to cost of sales and interest income during each period the deposit is outstanding at an appropriate market interest rate to reflect the economics of this transaction. In light of the supplier's implied debt rating and because Apple's deposit is unsecured, non-performance by and/or economic deterioration of the supplier could place all or someMacWarehouse catalogue. MicroWarehouse accounted for 2.89% of the Company's deposit at risk.net sales in fiscal 2001 and 3.73% for the nine-month period ended June 29, 2002. Trade receivables from MicroWarehouse were $7.6 million and $27.1 million as of September 29, 2001, and June 29, 2002, respectively.

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Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations

        This section and other parts of this Form 10-Q contain forward-looking statements that involve risks and uncertainties. The Company's actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in the subsection entitled "Factors that May Affect Future Results and Financial Condition" below. The following discussion should be read in conjunction with the 2001 Form 10-K for the fiscal year ended September 29, 2001, and the condensed consolidated financial statements and notes thereto included elsewhere in this Form 10-Q. All information is based on the Company's fiscal calendar.

Critical Accounting Policies

        The preparation of financial statements and related disclosures in conformity with generally accepted accounting principles and the Company's discussion and analysis of its financial condition and results of operations requires the Company's management to make judgments, assumptions and estimates that affect the amounts reported in its consolidated financial statements and accompanying notes. Note 1 of the Notes to Consolidated Financial Statements in the Company's 2001 Form 10-K describes the significant accounting policies and methods used in the preparation of the Company's consolidated financial statements. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates.

        Management believes the following to be critical accounting policies. That is, they are both important to the portrayal of the Company's financial condition and results, and they require management to make judgments and estimates about matters that are inherently uncertain.

Revenue Recognition

        The Company recognizes revenue pursuant to applicable accounting standards, including SOPStatement of Position (SOP) No. 97-2, "SoftwareSoftware Revenue Recognition", as amended, and Securities and Exchange Commission Staff Accounting Bulletin (SAB) No. 101, "RevenueRevenue Recognition in Financial Statements" (SAB 101)Statements. SAB 101, as amended, summarizes certain of the SEC's views in applying generally accepted accounting principles to revenue recognition in financial statements and provides guidance on revenue recognition issues in the absence of authoritative literature addressing a specific arrangement or a specific industry.

        The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collectibility is probable. Product is considered delivered to the customer once it has been shipped, and title and risk of loss have been transferred. For online sales to individuals, for certain sales to resellers, and for some sales to education customers in the United States, the Company defers revenue until the product is received by the customer because the Company legally retains title and/or a portion of the risk of loss on these sales during transit. For other product sales, these criteria are met by the Company at the time product is shipped. Revenue on multiple element sales arrangements is allocated to various elements based on vendor specific objective evidence of the fair value of each element of the transaction and is recognized as each element is delivered.

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        The Company records reductions to revenue for price protection and for customer incentive programs, including reseller and end-user rebates and other sales programs and volume-based incentives. Future market conditions and product transitions may require the Company to increase customer incentive programs that could result in incremental reductions of revenue at the time the programs are offered. Additionally, certain customer incentive programs require management to estimate the number of customers who will actually redeem the incentive based on historical experience

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and the specific terms and conditions of particular incentive programs. If a greater proportion of customers redeem such incentives than estimated, the Company would be required to record additional reductions to revenue.

Allowance for Doubtful Accounts

        The Company distributes its products through third-party computer resellers and directly to certain education, consumer, and commercial customers. The Company generally does not require collateral from its customers. However, when possible, the Company does attempt to limit credit risk on trade receivables through the use of flooring arrangements for selected customers with third-party financing companies and credit insurance for certain customers in Europe, Asia, and Latin America. However, considerable trade receivables that are not covered by collateral, flooring arrangements, or credit insurance are outstanding with the Company's distribution and retail channel partners.

        The allowance for doubtful accounts is based on management's assessment of the collectibility of specific customer accounts and includes consideration of the credit worthiness and financial condition of those specific customers. The Company records an allowance to reduce the specific receivables to the amount that is reasonably believed to be collectible. The Company also records an allowance for all other trade receivables based on multiple factors including historical experience with bad debts, the general economic environment, the financial condition of the Company's distribution channels, and the aging of such receivables. If there is a deterioration of a major customer's financial condition, if the Company becomes aware of additional information related to the credit worthiness of a major customer, or if future actual default rates on trade receivables in general differ from those currently anticipated, the Company may have to adjust its allowance for doubtful accounts, andwhich would affect earnings in the period the adjustments are made.

Inventory Valuation and Inventory Purchase Commitments

        The Company must order components for its products and build inventory in advance of product shipments. The Company records a write-down for inventories of components and products, including third party products held for resale, which have become obsolete or are in excess of anticipated demand or net realizable value. The Company performs a detailed review of inventory each period that considers multiple factors including demand forecasts, product lifecycle status, product development plans, and component cost trends. The personal computer industry is subject to a rapid and unpredictable pace of product and component obsolescence. If future demand or market conditions for the Company's products are less favorable than forecasted or if unforeseen technological changes negatively impact the utility of component inventory, the Company may be required to record additional write-downs negatively affecting gross margins in the period the write-downs are made.

        The Company accrues necessary reserves for cancellation fees related to component orders that have been canceled. Components are normally acquired through purchase orders typically covering the Company's requirements for periods from 130 to 3 months.130 days. If there is an abrupt and substantial decline in demand for one or more of the Company's products or an unanticipated change in technological requirements for any of the Company's products, the Company may be required to record additional reserves for cancellation fees, negatively affecting gross margins in the period the cancellations fees are identified.

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