Apple
APPLE INC (Form: 8-K, Received: 01/28/2015 16:49:40)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 8-K

CURRENT REPORT

Pursuant to Section 13 OR 15(d) of The Securities Exchange Act of 1934

January 28, 2015

Date of Report (Date of earliest event reported)

 

 

 

 

LOGO

Apple Inc.

(Exact name of registrant as specified in its charter)

 

California   001-36743       94-2404110

(State or other jurisdiction

of incorporation)

 

(Commission    

File Number)    

 

(IRS. Employer

Identification No.)

1 Infinite Loop

Cupertino, California 95014

(Address of principal executive offices) (Zip Code)

(408) 996-1010

(Registrant’s telephone number, including area code)

Not applicable

(Former name or former address, if changed since last report.)

Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:

 

¨

Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)

 

¨

Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)

 

¨

Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))

 

¨

Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))

 

 

 


Item 8.01 Other Events.

Apple Inc. (the “Company”) is furnishing herewith updated financial statements and other affected financial information for the periods included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 27, 2014 (the “Form 10-K”). These financial statements and other affected financial information have been updated to reflect changes made in fiscal year 2015 to the Company’s reportable operating segment data and categorization of product-level net sales reporting.

In fiscal year 2015, management began reporting business performance and making decisions primarily on a geographic basis, including the results of its retail stores in each respective geographic segment. Accordingly, to align with the way the business is currently managed, the Company’s reportable operating segments now consist of the Americas, Europe, Greater China, Japan and Rest of Asia Pacific. Retail is no longer reported as a separate reportable operating segment. Additionally, the Company began allocating certain costs to its operating segments that were previously included in other corporate expenses, including certain share-based compensation costs. The Company also changed its categorization of product-level net sales reporting to reflect its evolving products and services.

Pursuant to guidance prepared by the staff of the Securities and Exchange Commission, the Company has updated the applicable items that were contained in the Form 10-K reflecting the above mentioned changes in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, “Financial Statements and Supplementary Data” in Exhibits 99.1 and 99.2 filed in this Current Report on Form 8-K (the “Form 8-K”), respectively. The information included in this Form 8-K is presented for information purposes only in connection with the changes in the Company’s reportable operating segment data and categorization of product-level net sales reporting. There is no change to the Company’s previously reported Consolidated Statements of Operations, Consolidated Statements of Comprehensive Income, Consolidated Balance Sheets, Consolidated Statements of Shareholders’ Equity and Consolidated Statements of Cash Flows included in the Form 10-K. This Form 8-K does not reflect events occurring after the Company filed the Form 10-K and does not modify or update the disclosures therein in any way, other than as noted above. The Company began to report comparative results reflective of the above mentioned changes with the filing of the Company’s Quarterly Report on Form 10-Q for the quarter ended December 27, 2014.

 

2


Item 9.01 Financial Statements and Exhibits.

 

(d)

Exhibits.

The following exhibits are furnished herewith:

 

Exhibit

Number

  

Exhibit Description

23.1    Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm.
99.1    Updated Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, from the Registrant’s Annual Report on Form 10-K for the fiscal year ended September 27, 2014, as filed with the Securities and Exchange Commission on October 27, 2014.
99.2    Updated Part II, Item 8. Financial Statements and Supplementary Data, from the Registrant’s Annual Report on Form 10-K for the fiscal year ended September 27, 2014, as filed with the Securities and Exchange Commission on October 27, 2014.
101.INS    XBRL Instance Document.
101.SCH    XBRL Taxonomy Extension Schema Document.
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF    XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB    XBRL Taxonomy Extension Label Linkbase Document.
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document.

 

3


SIGNATURE

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 hereunto duly authorized.

 

Apple Inc.
Date: January 28, 2015 By: /s/ Luca Maestri

Luca Maestri

Senior Vice President,

Chief Financial Officer

 

4


EXHIBIT INDEX

 

Exhibit

Number

  

Exhibit Description

23.1    Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm.
99.1    Updated Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, from the Registrant’s Annual Report on Form 10-K for the fiscal year ended September 27, 2014, as filed with the Securities and Exchange Commission on October 27, 2014.
99.2    Updated Part II, Item 8. Financial Statements and Supplementary Data, from the Registrant’s Annual Report on Form 10-K for the fiscal year ended September 27, 2014, as filed with the Securities and Exchange Commission on October 27, 2014.
101.INS    XBRL Instance Document.
101.SCH    XBRL Taxonomy Extension Schema Document.
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF    XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB    XBRL Taxonomy Extension Label Linkbase Document.
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document.

 

5

Exhibit 23.1

Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm

We consent to the incorporation by reference in the following Registration Statements:

 

(1)

Registration Statement (Form S-8 No. 333-195509) pertaining to Apple Inc. 2014 Employee Stock Plan,

 

(2)

Registration Statement (Form S-8 No. 333-193709) pertaining to Topsy Labs, Inc. 2007 Stock Plan,

 

(3)

Registration Statement (Form S-3 ASR No. 333-188191) of Apple Inc.,

 

(4)

Registration Statement (Form S-8 No. 333-184706) pertaining to AuthenTec, Inc. 2007 Stock Incentive Plan and AuthenTec, Inc. 2010 Incentive Plan, as amended,

 

(5)

Registration Statement (Form S-8 No. 333-180981) pertaining to Chomp Inc. 2009 Equity Incentive Plan,

 

(6)

Registration Statement (Form S-8 No. 333-179189) pertaining to Anobit Technologies Ltd. Global Share Incentive Plan (2006),

 

(7)

Registration Statement (Form S-8 No. 333-168279) pertaining to Siri, Inc. 2008 Stock Option/Stock Issuance Plan,

 

(8)

Registration Statement (Form S-8 No. 333-165214) pertaining to Apple Inc. 2003 Employee Stock Plan, la la media, inc. 2005 Stock Plan and Quattro Wireless, Inc. 2006 Stock Option and Grant Plan,

 

(9)

Registration Statement (Form S-8 No. 333-146026) pertaining to Apple Inc. 2003 Employee Stock Plan and Apple Inc. Amended Employee Stock Purchase Plan,

 

(10)

Registration Statement (Form S-8 No. 333-125148) pertaining to Employee Stock Purchase Plan and 2003 Employee Stock Plan, and

 

(11)

Registration Statement (Form S-8 No. 333-75930) pertaining to 1997 Employee Stock Option Plan;

of our report dated October 27, 2014, except for Note 11 – Segment Information and Geographic Data, as to which the date is January 28, 2015, with respect to the consolidated financial statements of Apple Inc., included in this Current Report on Form 8-K.

/s/ Ernst & Young LLP

San Jose, California

January 28, 2015

Exhibit 99.1

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This section and other parts of this Current Report on Form 8-K (“Form 8-K”) contain forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, that involve risks and uncertainties. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Forward-looking statements can also be identified by words such as “future,” “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “will,” “would,” “could,” “can,” “may,” and similar terms. Forward-looking statements are not guarantees of future performance and the Company’s actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in Part I, Item 1A of the Company’s Annual Report on Form 10-K for the fiscal year ended September 27, 2014 (“Form 10-K”) under the heading “Risk Factors,” which are incorporated herein by reference. The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included in Exhibit 99.2 in this Form 8-K. All information presented herein is based on the Company’s fiscal calendar. Unless otherwise stated, references to particular years, quarters, months or periods refer to the Company’s fiscal years ended in September and the associated quarters, months and periods of those fiscal years. Each of the terms the “Company” and “Apple” as used herein refers collectively to Apple Inc. and its wholly-owned subsidiaries, unless otherwise stated. The Company assumes no obligation to revise or update any forward-looking statements for any reason, except as required by law.

Overview and Highlights

The Company designs, manufactures and markets mobile communication and media devices, personal computers and portable digital music players, and sells a variety of related software, services, accessories, networking solutions and third-party digital content and applications. The Company sells its products worldwide through its retail stores, online stores and direct sales force, as well as through third-party cellular network carriers, wholesalers, retailers and value-added resellers. In addition, the Company sells a variety of third-party iPhone, iPad, Mac and iPod compatible products, including application software, and various accessories through its online and retail stores. The Company sells to consumers; small and mid-sized businesses; and education, enterprise and government customers.

Fiscal 2014 Highlights

Net sales rose 7% or $11.9 billion during 2014 compared to 2013. This was driven by increases in net sales of iPhone, Mac and Services. Net sales and unit sales increased for iPhone primarily due to the successful introduction of iPhone 5s and 5c in the latter half of calendar year 2013, the successful launch of iPhone 6 and 6 Plus beginning in the fourth quarter of 2014, and expanded distribution. Mac net sales and unit sales increased primarily due to strong demand for MacBook Air and MacBook Pro which were updated in 2014 with faster processors and offered at lower prices. Net sales of Services grew primarily due to increased revenue from sales through the App Store, AppleCare and licensing. Growth in these areas was partially offset by the year-over-year decline in net sales for iPad due to lower unit sales in many markets, and a decline in net sales of Other Products. All of the Company’s operating segments other than the Rest of Asia Pacific segment experienced increased net sales in 2014, with growth being strongest in the Greater China and Japan operating segments.

During the first quarter of 2014, the Company introduced iPad Air, its fifth generation iPad and iPad mini with Retina display. At its Worldwide Developer Conference in June 2014, the Company announced iOS 8 and OS X Yosemite. In September 2014, the Company introduced iPhone 6 and 6 Plus, released iOS 8, announced Apple Pay, which became available in the U.S. in October 2014, and previewed Apple Watch, which is expected to be available in early calendar 2015. In October 2014, the Company introduced iPad Air 2, iPad mini 3, iMac with Retina 5K Display and an updated Mac mini; and released OS X Yosemite.

During 2014, the Company completed various business acquisitions, including the acquisitions of Beats Music, LLC, which offers a subscription streaming music service, and Beats Electronics, LLC, which makes Beats headphones, speakers and audio software.

 

1


In April 2014, the Company increased its share repurchase authorization to $90 billion and the quarterly dividend was raised to $0.47 per common share, resulting in an overall increase in its capital return program from $100 billion to over $130 billion. During 2014, the Company utilized $45 billion to repurchase its common stock and paid dividends and dividend equivalents of $11.1 billion. The current share repurchase program is expected to be completed by the end of December 2015. The Company also issued $12.0 billion of long-term debt during 2014 with varying maturities through 2044 and launched a commercial paper program, with $6.3 billion outstanding as of September 27, 2014.

Fiscal 2013 Highlights

Net sales rose 9% or $14.4 billion during 2013 compared to 2012. This resulted from growth in net sales of iPhone; Services; and iPad. Growth in 2013 reflected strong sales of iPhone 5, strong continuing sales of iPhone 4 and 4s, the introduction of iPhone 5c and 5s, strong performance of the iPad mini and fourth generation iPad, and continued growth in the Company’s online sales of apps, digital content and services. Growth in these areas was partially offset by declines in net sales of Mac and Other Products. All of the Company’s operating segments experienced increased net sales in 2013, with net sales growth being particularly strong in the Americas, Greater China and Japan operating segments. Growth in total net sales was higher during the first half of 2013, rising $12.6 billion or 14.7% over the same period in 2012. First half growth in 2013 was driven by iPhone and iPad introductions at or near the beginning of 2013.

During the first quarter of 2013, the Company introduced the fourth generation iPad and iPad mini, a new MacBook Pro with Retina display, a new iPod touch, a new iMac, and expanded the rollout of iPhone 5 which began in September 2012. In June 2013 at its Worldwide Developer Conference, the Company announced iOS 7 and OS X Mavericks, announced iTunes Radio, introduced a significant upgrade to MacBook Air, and provided a preview of all new Mac Pro desktops that were introduced during 2014. In September 2013, the Company introduced iPhone 5s and 5c, released iOS 7, launched iTunes Radio, and announced that beginning in September 2013 iPhoto, iMovie and iWork Apps for iOS would be available as free downloads with all new iPhone, iPad and iPod touch devices (“iOS devices”).

In April 2013, the Company announced a significant increase to its program to return capital to shareholders by raising the total amount it expected to utilize for the program through December 2015 to $100 billion. This included increasing its share repurchase authorization to $60 billion and raising its quarterly dividend to $0.44 per common share beginning in May 2013. During 2013, the Company utilized $23.0 billion to repurchase common shares and paid dividends of $10.5 billion or $1.64 per common share. In conjunction with its capital return program, in May 2013 the Company issued $17.0 billion of long-term debt with varying maturities through 2043.

 

2


Sales Data

In 2015, the Company changed its reportable operating segments and categorization of product-level net sales reporting to align with the way the business is currently managed and to better reflect its evolving products and services. The 2014, 2013 and 2012 presentation of this data has been reclassified to conform to the 2015 presentation.

The following table shows net sales by operating segment and net sales and unit sales by product during 2014, 2013 and 2012 (dollars in millions and units in thousands):

 

                                                                                                                            
     2014      Change      2013      Change      2012  

Net Sales by Operating Segment:

        

Americas

   $ 80,095         4%       $ 77,093         8%       $ 71,060   

Europe

     44,285         8%         40,980         4%         39,326   

Greater China

     31,853         18%         27,016         14%         23,756   

Japan

     15,314         11%         13,782         26%         10,913   

Rest of Asia Pacific

     11,248         (7)%         12,039         5%         11,453   
  

 

 

       

 

 

       

 

 

 

Total net sales

$ 182,795      7%    $ 170,910      9%    $ 156,508   
  

 

 

       

 

 

       

 

 

 

Net Sales by Product:

iPhone (1)

$ 101,991      12%    $ 91,279      16%    $ 78,692   

iPad (1)

  30,283      (5)%      31,980      3%      30,945   

Mac (1)

  24,079      12%      21,483      (7)%      23,221   

Services (2)

  18,063      13%      16,051      25%      12,890   

Other Products (1)(3)

  8,379      (17)%      10,117      (6)%      10,760   
  

 

 

       

 

 

       

 

 

 

Total net sales

$ 182,795      7%    $ 170,910      9%    $ 156,508   
  

 

 

       

 

 

       

 

 

 

Unit Sales by Product:

iPhone

  169,219      13%      150,257      20%      125,046   

iPad

  67,977      (4)%      71,033      22%      58,310   

Mac

  18,906      16%      16,341      (10)%      18,158   

 

  (1)  

Includes deferrals and amortization of related non-software services and software upgrade rights.

 

 

  (2)  

Includes revenue from the iTunes Store, App Store, Mac App Store and iBooks Store (collectively “iTunes”), AppleCare, licensing and other services.

 

 

  (3)  

Includes sales of iPod, Apple TV, Beats Electronics and Apple-branded and third-party accessories.

 

The Company’s fiscal year is the 52 or 53-week period that ends on the last Saturday of September. The Company’s fiscal years 2014, 2013 and 2012 ended on September 27, 2014, September 28, 2013 and September 29, 2012, respectively. Both fiscal years 2014 and 2013 spanned 52 weeks. Fiscal year 2012 spanned 53 weeks, with a 14 th week included in the first quarter of 2012, as is done approximately every six years to realign the Company’s fiscal quarters more closely to calendar quarters. Inclusion of the additional week in 2012 increased the Company’s overall net sales and operating expenses for the year.

 

3


Product Performance

iPhone

The following table presents iPhone net sales and unit sales information for 2014, 2013 and 2012 (dollars in millions and units in thousands):

 

                                                                                                                            
     2014      Change      2013      Change      2012  

Net sales

   $ 101,991         12%       $ 91,279         16%       $ 78,692   

Percentage of total net sales

     56%            53%            50%   

Unit sales

     169,219         13%         150,257         20%         125,046   

The year-over-year growth in iPhone net sales and unit sales in 2014 resulted primarily from the successful introduction of new iPhones in the latter half of calendar year 2013, the successful launch of iPhone 6 and 6 Plus beginning in September 2014, and expanded distribution. iPhone unit sales grew in all of the Company’s operating segments, while iPhone net sales grew in all segments except Rest of Asia Pacific. Overall average selling prices (“ASPs”) for iPhone were relatively flat in 2014 compared to 2013, with growth in ASPs in the Americas segment being offset by a decline in ASPs in the Greater China, Japan and Rest of Asia Pacific segments.

The growth in iPhone net sales and unit sales during 2013 resulted from increased demand for iPhone in all of the Company’s operating segments primarily due to the launch of iPhone 5 beginning in September 2012 and strong ongoing demand for iPhone 4 and 4s. All of the Company’s operating segments experienced increases in net sales and unit sales of iPhone during 2013 compared to 2012. The year-over-year impact of higher iPhone unit sales in 2013 was partially offset by a 3% decline in iPhone ASPs primarily as a result of a shift in product mix towards lower-priced iPhone models, particularly iPhone 4. All of the Company’s operating segments experienced a decline in iPhone ASPs during 2013.

iPad

The following table presents iPad net sales and unit sales information for 2014, 2013 and 2012 (dollars in millions and units in thousands):

 

                                                                                                                            
     2014      Change      2013      Change      2012  

Net sales

   $ 30,283         (5)%       $ 31,980         3%       $ 30,945   

Percentage of total net sales

     17%            19%            20%   

Unit sales

     67,977         (4)%         71,033         22%         58,310   

Net sales and unit sales for iPad declined in 2014 compared to 2013. iPad net sales and unit sales grew in the Greater China and Japan segments but this growth was more than offset by a decline in all other segments. Overall iPad ASPs were relatively flat in 2014 compared to 2013 with a shift in mix to higher-priced iPads being offset by the October 2013 price reduction of iPad mini. ASPs increased in the Japan and Rest of Asia Pacific segments but were slightly down in other segments.

The growth in net sales and unit sales of iPad during 2013 resulted from growth in iPad unit sales in all of the Company’s operating segments. This growth was driven by the launch of iPad mini and the fourth generation iPad beginning in the first quarter of 2013. The year-over-year growth rate of total iPad unit sales was significantly higher than the growth rate of total iPad net sales for 2013 due to a reduction in iPad ASPs of 15% in 2013 compared to 2012. This decline resulted primarily from introduction of the lower priced iPad mini and the full year impact of the price reduction on iPad 2 made in 2012. The decline in iPad ASPs was experienced to various degrees by all of the Company’s operating segments.

 

4


Mac

The following table presents Mac net sales and unit sales information for 2014, 2013 and 2012 (dollars in millions and units in thousands):

 

                                                                                                                            
     2014      Change      2013      Change      2012  

Net sales

   $ 24,079         12%       $ 21,483         (7)%       $ 23,221   

Percentage of total net sales

     13%            13%            15%   

Unit sales

     18,906         16%         16,341         (10)%         18,158   

The year-over-year growth in Mac net sales and unit sales for 2014 was primarily driven by increased sales of MacBook Air, MacBook Pro and Mac Pro. Mac net sales and unit sales increased in all of the Company’s operating segments. Mac ASPs decreased during 2014 compared to 2013 primarily due to price reductions on certain Mac models and a shift in mix towards Mac portable systems.

Mac net sales and unit sales for 2013 were down or relatively flat in all of the Company’s operating segments. Mac ASPs increased slightly partially offsetting the impact of lower unit sales on net sales. The decline in Mac unit sales and net sales reflected the overall weakness in the market for personal computers.

Services

The following table presents net sales information of Services for 2014, 2013 and 2012 (dollars in millions):

 

                                                                                                                            
     2014      Change      2013      Change      2012  

Net sales

   $ 18,063         13%       $ 16,051         25%       $ 12,890   

Percentage of total net sales

     10%            9%            8%   

The increase in net sales of Services in 2014 compared to 2013 was primarily due to growth in net sales from iTunes, AppleCare and licensing. iTunes generated a total of $10.2 billion in net sales during 2014 compared to $9.3 billion during 2013. Growth in net sales from iTunes was driven by increases in revenue from app sales reflecting continued growth in the installed base of iOS devices and the expanded offerings of iOS apps and related in-app purchases. This was partially offset by a decline in sales of digital music.

The increase in net sales of Services in 2013 compared to 2012 was primarily due to growth in net sales from iTunes, AppleCare and licensing. iTunes generated a total of $9.3 billion in net sales during 2013, a 24% increase from 2012. Growth from iTunes reflected continued growth in the installed base of iOS devices, expanded offerings of iOS apps and related in-app purchases, and expanded offerings of iTunes digital content.

Segment Operating Performance

The Company manages its business primarily on a geographic basis. As the Company continues to expand its business, management believes collaboration across its online, retail and indirect channels is integral to better serving its customers and optimizing its financial results. In 2015, the Company’s management began reporting business performance and making decisions primarily on a geographic basis, including the results of its retail stores in each respective geographic segment. Accordingly, to align with the way the business is currently managed, the Company’s reportable operating segments now consist of the Americas, Europe, Greater China, Japan and Rest of Asia Pacific. Retail is no longer reported as a separate reportable operating segment. The Americas segment includes both North and South America. The Europe segment includes European countries, as well as India, the Middle East and Africa. The Greater China segment includes China, Hong Kong and Taiwan. The Rest of Asia Pacific segment includes Australia and Asian countries, other than those countries included in the Company’s other operating segments. Each operating segment provides similar hardware and software products and similar services. Further information regarding the Company’s operating segments may be found in Exhibit 99.2 of this Form 8-K in the Notes to Consolidated Financial Statements in Note 11, “Segment Information and Geographic Data.”

 

5


Americas

The following table presents Americas net sales information for 2014, 2013 and 2012 (dollars in millions):

 

                                                                                                                            
     2014      Change      2013      Change      2012  

Net sales

   $ 80,095         4%       $ 77,093         8%       $ 71,060   

Percentage of total net sales

     44%            45%            45%   

The growth in the Americas segment in 2014 was due to increased net sales of iPhone, Mac and Services that were partially offset by a decline in net sales of iPad and Other Products and weakness in foreign currencies relative to the U.S. dollar compared to 2013. iPhone growth resulted primarily from the successful introduction of iPhone 5s and 5c in September 2013 and the successful launch of iPhone 6 and 6 Plus in September 2014. Mac growth was driven primarily by increased net sales and unit sales of MacBook Air and Mac Pro.

The growth in the Americas segment net sales during 2013 was driven by increased sales of iPhone following the introduction of iPhone 5 in September 2012 and iPhone 5s and 5c in September 2013, increased sales from iTunes, and increased sales of iPad, particularly iPad mini. These increases were partially offset by a decrease in net sales of Mac and Other Products and a decline in iPad ASPs.

Europe

The following table presents Europe net sales information for 2014, 2013 and 2012 (dollars in millions):

 

                                                                                                                            
     2014      Change      2013      Change      2012  

Net sales

   $ 44,285         8%       $ 40,980         4%       $ 39,326   

Percentage of total net sales

     24%            24%            25%   

The growth in the Europe segment in 2014 was due to increased net sales of iPhone, Mac and Services, as well as strength in European currencies relative to the U.S. dollar, partially offset by a decline in net sales of iPad. iPhone growth resulted primarily from the successful introduction of iPhone 5s and 5c in the second half of calendar 2013 and the successful launch of iPhone 6 and 6 Plus in over 20 countries in Europe in September 2014. Mac growth was driven primarily by increased net sales and unit sales of MacBook Air, MacBook Pro and Mac Pro.

The growth in net sales in the Europe segment during 2013 was primarily driven by increased sales of iPhone, iPad and higher net sales from iTunes. These increases were partially offset by decreases in net sales of Mac and Other Products and a decline in iPad ASPs. Net sales in the Europe segment continued to be negatively impacted by unfavorable economic conditions in parts of the region reflected by second half 2013 net sales falling 4% compared to the second half of 2012, which followed an 11% increase in net sales during the first half of 2013.

Greater China

The following table presents Greater China net sales information for 2014, 2013 and 2012 (dollars in millions):

 

                                                                                                                            
     2014      Change      2013      Change      2012  

Net sales

   $ 31,853         18%       $ 27,016         14%       $ 23,756   

Percentage of total net sales

     17%            16%            15%   

The Greater China segment experienced year-over-year growth in net sales in 2014 that was significantly higher than the growth rate for the Company overall. Greater China growth was driven by higher unit sales and net sales of all major product categories, in addition to higher net sales of Services. Growth in net sales and unit sales of iPhone was especially strong, driven by the successful launch of iPhone 5s and 5c in Mainland China and Hong Kong in September 2013, the successful launch of iPhone 6 and 6 Plus in Hong Kong in September 2014, increased demand for the Company’s entry-priced iPhones and the addition of a significant new carrier in the second quarter of 2014.

 

6


The growth in net sales in the Greater China segment during 2013 resulted from two major iPhone introductions during the year, iPhone 5 in December 2012 and iPhone 5c and 5s in September 2013. Further contributing to the growth in 2013 was the introduction of the fourth generation iPad and iPad mini during the second quarter of 2013 and an increase in iPhone channel inventory as of the end of 2013 compared to the end of 2012. While net sales in the Greater China segment were up 14% for all of 2013, net sales for the second half of 2013 declined 3% compared to the second half of 2012.

Japan

The following table presents Japan net sales information for 2014, 2013 and 2012 (dollars in millions):

 

     2014      Change      2013      Change      2012  

Net sales

   $ 15,314         11%       $ 13,782         26%       $ 10,913   

Percentage of total net sales

     8%            8%            7%   

In 2014 the Japan segment generated year-over-year increases in net sales and unit sales of every major product category and experienced growth in net sales of Services. The year-over-year growth in iPhone was driven by the successful launch of iPhone 5s and 5c in September 2013, the successful launch of iPhone 6 and 6 Plus in September 2014, increased demand for the Company’s entry-priced iPhones and the addition of a significant new carrier in the fourth quarter of 2013. These positive factors were partially offset by weakness in the Japanese Yen relative to the U.S. dollar.

The increase in net sales in the Japan segment during 2013 reflected significant increases in unit volumes of iPhone and iPad, strong growth from iTunes net sales and an increase in iPhone channel inventory as of the end of 2013 compared to the end of 2012. These positive factors were partially offset by declines in ASPs for iPhone and iPad and by weakness in the Japanese Yen relative to the U.S. dollar.

Rest of Asia Pacific

The following table presents Rest of Asia Pacific net sales information for 2014, 2013 and 2012 (dollars in millions):

 

     2014      Change      2013      Change      2012  

Net sales

   $ 11,248         (7)%       $ 12,039         5%       $ 11,453   

Percentage of total net sales

     6%            7%            7%   

Net sales in the Rest of Asia Pacific segment declined in 2014 compared to 2013 due to year-over-year reductions in net sales in all major product categories except Mac and reductions in unit sales of iPad. Net sales in 2014 were also negatively affected by the weakness in several foreign currencies relative to the U.S. dollar, including the Australian dollar.

The year-over-year growth in Rest of Asia Pacific segment net sales during 2013 was primarily driven by the launch of iPhone 5 and higher sales from iTunes, partially offset by a decrease in net sales of iPad and Mac.

Gross Margin

Gross margin for 2014, 2013 and 2012 are as follows (dollars in millions):

 

     2014      2013      2012  

Net sales

   $ 182,795       $ 170,910       $ 156,508   

Cost of sales

     112,258         106,606         87,846   
  

 

 

    

 

 

    

 

 

 

Gross margin

   $ 70,537       $ 64,304       $ 68,662   
  

 

 

    

 

 

    

 

 

 

Gross margin percentage

     38.6%         37.6%         43.9%   

The year-over-year increase in the gross margin percentage in 2014 was driven by multiple factors including lower commodity costs, a favorable shift in mix to products with higher margins and improved leverage on fixed costs from higher net sales, which was partially offset by the weakness in several foreign currencies relative to the U.S. dollar, price reductions on select products and higher cost structures on certain new products.

 

7


The year-over-year decrease in gross margin in 2013 compared to 2012 was driven by multiple factors including introduction of new versions of existing products with higher cost structures and flat or reduced pricing; a shift in sales mix to products with lower margins; introduction of iPad mini with gross margin significantly below the Company’s average product margins; higher expenses associated with changes to certain of the Company’s service policies and other warranty costs; price reductions on certain products, including iPad 2 and iPhone 4; and unfavorable impact from foreign exchange fluctuations.

The Company anticipates gross margin during the first quarter of 2015 to be between 37.5% and 38.5%. The foregoing statement regarding the Company’s expected gross margin percentage in the first quarter of 2015 is forward-looking and could differ from actual results. The Company’s future gross margins can be impacted by multiple factors including, but not limited to those set forth in Part I, Item 1A of the Form 10-K under the heading “Risk Factors” and those described in this paragraph. In general, the Company believes gross margins will remain under downward pressure due to a variety of factors, including continued industry wide global product pricing pressures, increased competition, compressed product life cycles, product transitions, potential increases in the cost of components and potential strengthening of the U.S. dollar, as well as potential increases in the costs of outside manufacturing services and a potential shift in the Company’s sales mix towards products with lower gross margins. In response to competitive pressures, the Company expects it will continue to take product pricing actions, which would adversely affect gross margins. Gross margins could also be affected by the Company’s ability to manage product quality and warranty costs effectively and to stimulate demand for certain of its products. Due to the Company’s significant international operations, financial results can be significantly affected by fluctuations in exchange rates.

Operating Expenses

Operating expenses for 2014, 2013 and 2012 are as follows (dollars in millions):

 

     2014      Change      2013      Change      2012  

Research and development

   $ 6,041         35%       $ 4,475         32%       $ 3,381   

Percentage of total net sales

     3%            3%            2%   

Selling, general and administrative

   $ 11,993         11%       $ 10,830         8%       $ 10,040   

Percentage of total net sales

     7%            6%            6%   

Total operating expenses

   $ 18,034         18%       $ 15,305         14%       $ 13,421   

Percentage of total net sales

     10%            9%            9%   

Research and Development (“R&D”) Expense

The year-over-year growth in 2014 and 2013 R&D expense was driven primarily by an increase in headcount and related expenses, including share-based compensation costs and machinery and equipment to support expanded R&D activities. The Company continues to believe that focused investments in R&D are critical to its future growth and competitive position in the marketplace and are directly related to timely development of new and enhanced products that are central to the Company’s core business strategy. As such, the Company expects to make further investments in R&D to remain competitive.

Selling, General and Administrative (“SG&A”) Expense

The growth in SG&A expense during 2014 compared to 2013 was primarily due to increased headcount and related expenses, including share-based compensation costs; higher spending on marketing, advertising and professional services; and the Company’s continued expansion of its retail stores. The growth in SG&A during 2013 compared to 2012 was primarily due to the Company’s continued expansion of its retail stores and increased headcount and related expenses, partially offset by decreased spending on professional services.

 

8


Other Income and Expense

Other income and expense for 2014, 2013 and 2012 are as follows (dollars in millions):

 

     2014     Change      2013     Change      2012  

Interest and dividend income

   $ 1,795         $ 1,616         $ 1,088   

Interest expense

     (384        (136        0   

Other expense, net

     (431        (324        (566
  

 

 

      

 

 

      

 

 

 

Total other income/(expense), net

   $ 980        (15)%       $ 1,156        121%       $ 522   
  

 

 

      

 

 

      

 

 

 

The decrease in other income and expense during 2014 compared to 2013 was due primarily to higher interest expense on debt and higher expenses associated with foreign exchange rate movements, partially offset by lower premium expenses on foreign exchange contracts and higher interest income. The year-over-year increase in other income and expense during 2013 was due primarily to higher interest and dividend income resulting from the Company’s higher cash, cash equivalents and marketable securities balances and lower premium expenses on foreign exchange contracts, partially offset by interest expense on debt issued in the third quarter of 2013 and higher expenses associated with foreign exchange rate movements. The weighted-average interest rate earned by the Company on its cash, cash equivalents and marketable securities was 1.11%, 1.03% and 1.03% during 2014, 2013 and 2012, respectively. The Company had no debt outstanding during 2012 and accordingly did not incur any related interest expense.

Provision for Income Taxes

Provision for income taxes and effective tax rates for 2014, 2013 and 2012 are as follows (dollars in millions):

 

     2014      2013      2012  

Provision for income taxes

   $ 13,973       $ 13,118       $ 14,030   

Effective tax rate

     26.1%         26.2%         25.2%   

The Company’s effective tax rates for all years differ from the statutory federal income tax rate of 35% due primarily to certain undistributed foreign earnings, a substantial portion of which was generated by subsidiaries organized in Ireland, for which no U.S. taxes are provided because such earnings are intended to be indefinitely reinvested outside the U.S.

As of September 27, 2014, the Company had deferred tax assets arising from deductible temporary differences, tax losses and tax credits of $5.1 billion and deferred tax liabilities of $20.3 billion. Management believes it is more likely than not that forecasted income, including income that may be generated as a result of certain tax planning strategies, together with future reversals of existing taxable temporary differences, will be sufficient to fully recover the deferred tax assets. The Company will continue to evaluate the realizability of deferred tax assets quarterly by assessing the need for and the amount of a valuation allowance.

During the fiscal year ended September 27, 2014, the U.S. Internal Revenue Service (“IRS”) concluded its review of the years 2004 through 2009. The IRS is currently examining the years 2010 through 2012. In addition, the Company is subject to audits by state, local and foreign tax authorities. Management believes that adequate provisions have been made for any adjustments that may result from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in the Company’s tax audits are resolved in a manner not consistent with management’s expectations, the Company could be required to adjust its provision for income taxes in the period such resolution occurs.

 

9


Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), which amends the existing accounting standards for revenue recognition. ASU 2014-09 is based on principles that govern the recognition of revenue at an amount an entity expects to be entitled when products are transferred to customers. ASU 2014-09 will be effective for the Company beginning in its first quarter of 2018. Early adoption is not permitted. The new revenue standard may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption. The Company is currently evaluating the impact of adopting the new revenue standard on its consolidated financial statements.

Liquidity and Capital Resources

The following table presents selected financial information and statistics as of and for the years ended September 27, 2014, September 28, 2013 and September 29, 2012 (in millions):

 

     2014     2013     2012  

Cash, cash equivalents and marketable securities

   $ 155,239      $ 146,761      $ 121,251   

Property, plant and equipment, net

   $ 20,624      $ 16,597      $ 15,452   

Long-term debt

   $ 28,987      $ 16,960      $ 0   

Working capital

   $ 5,083      $ 29,628      $ 19,111   

Cash generated by operating activities

   $ 59,713      $ 53,666      $ 50,856   

Cash used in investing activities

   $ (22,579   $ (33,774   $ (48,227

Cash used in financing activities

   $ (37,549   $ (16,379   $ (1,698

The Company believes its existing balances of cash, cash equivalents and marketable securities will be sufficient to satisfy its working capital needs, capital asset purchases, outstanding commitments and other liquidity requirements associated with its existing operations over the next 12 months. To provide additional flexibility in managing liquidity, the Company began accessing the commercial paper markets in the third quarter of 2014. The Company currently anticipates the cash used for future dividends and the share repurchase program will come from its current domestic cash, cash generated from on-going U.S. operating activities and from borrowings.

As of September 27, 2014 and September 28, 2013, $137.1 billion and $111.3 billion, respectively, of the Company’s cash, cash equivalents and marketable securities were held by foreign subsidiaries and are generally based in U.S. dollar-denominated holdings. Amounts held by foreign subsidiaries are generally subject to U.S. income taxation on repatriation to the U.S. The Company’s marketable securities investment portfolio is invested primarily in highly-rated securities and its investment policy generally limits the amount of credit exposure to any one issuer. The policy requires investments generally to be investment grade with the objective of minimizing the potential risk of principal loss.

During 2014, cash generated from operating activities of $59.7 billion was a result of $39.5 billion of net income, non-cash adjustments to net income of $13.2 billion and an increase in net change in operating assets and liabilities of $7.0 billion. Cash used in investing activities of $22.6 billion during 2014 consisted primarily of cash used for purchases of marketable securities, net of sales and maturities, of $9.0 billion; cash used to acquire property, plant and equipment of $9.6 billion; and cash paid for business acquisitions, net of cash acquired, of $3.8 billion. Cash used in financing activities of $37.5 billion during 2014 consisted primarily of cash used to repurchase common stock of $45.0 billion and cash used to pay dividends and dividend equivalents of $11.1 billion, partially offset by net proceeds from the issuance of long-term debt and commercial paper of $12.0 billion and $6.3 billion, respectively.

During 2013, cash generated from operating activities of $53.7 billion was a result of $37.0 billion of net income, non-cash adjustments to net income of $10.2 billion and an increase in net change in operating assets and liabilities of $6.5 billion. Cash used in investing activities of $33.8 billion during 2013 consisted primarily of cash used for purchases of marketable securities, net of sales and maturities, of $24.0 billion and cash used to acquire property, plant and equipment of $8.2 billion. Cash used in financing activities of $16.4 billion during 2013 consisted primarily of cash used to repurchase common stock of $22.9 billion and cash used to pay dividends and dividend equivalents of $10.6 billion, partially offset by net proceeds from the issuance of long-term debt of $16.9 billion.

 

10


Capital Assets

The Company’s capital expenditures were $11.0 billion during 2014. The Company anticipates utilizing approximately $13.0 billion for capital expenditures during 2015, which includes product tooling and manufacturing process equipment; data centers; corporate facilities and infrastructure, including information systems hardware, software and enhancements; and retail store facilities.

Debt

In April 2014, the Board of Directors authorized the Company to issue unsecured short-term promissory notes (“Commercial Paper”) pursuant to a commercial paper program. The Company intends to use the net proceeds from the commercial paper program for general corporate purposes, including dividends and share repurchases. As of September 27, 2014, the Company had $6.3 billion of Commercial Paper outstanding, with a weighted-average interest rate of 0.12% and maturities generally less than nine months.

In the third quarter of 2014 and 2013, the Company issued $12.0 billion and $17.0 billion of long-term debt, respectively. The debt issuances included floating- and fixed-rate notes with varying maturities for an aggregate principal amount of $29.0 billion (collectively the “Notes”). The Company has entered, and may enter in the future, into interest rate swaps to manage interest rate risk on the Notes. Interest rate swaps allow the Company to effectively convert fixed-rate payments into floating-rate payments or floating-rate payments into fixed-rate payments. In the third quarter of 2014, the Company entered into interest rate swaps with an aggregate notional amount of $9.0 billion, which effectively converted most of the fixed-rate notes into floating-rate notes, and in the third quarter of 2013, the Company entered into interest rate swaps with an aggregate notional amount of $3.0 billion, which effectively converted the floating-rate notes into fixed-rate notes.

Capital Return Program

In April 2014, the Company’s Board of Directors increased the share repurchase program authorization from $60 billion to $90 billion of the Company’s common stock, of which $67.9 billion had been utilized as of September 27, 2014. The share repurchase program is expected to be completed by the end of December 2015. The Company’s share repurchase program does not obligate it to acquire any specific number of shares. Under the program, shares may be repurchased in privately negotiated or open market transactions, including under plans complying with Rule 10b5-1 under the Exchange Act.

The increase to the Company’s share repurchase program authorization resulted in a total capital return program of over $130 billion. The Company expects to complete the capital return program by the end of December 2015 by paying dividends and dividend equivalents, repurchasing shares and remitting withheld taxes related to net share settlement of restricted stock units. To assist in funding its capital return program, the Company expects to access the debt markets, both domestically and internationally.

The following table presents the Company’s dividends, dividend equivalents, share repurchases and net share settlement activity from the start of the capital return program in August 2012 through September 2014 (in millions):

 

                                                                                                                                                                    
     Dividends and
Dividend
Equivalents Paid
     Accelerated
Share
Repurchases
     Open  Market
Share
Repurchases
     Taxes Related
to Settlement of
Equity Awards
     Total  

2014

   $ 11,126       $ 21,000       $ 24,000       $ 1,158       $ 57,284   

2013

     10,564         13,950         9,000         1,082         34,596   

2012

     2,488         0         0         56         2,544   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 24,178       $ 34,950       $ 33,000       $ 2,296       $ 94,424   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

11


Off-Balance Sheet Arrangements and Contractual Obligations

The Company has not entered into any transactions with unconsolidated entities whereby the Company has financial guarantees, subordinated retained interests, derivative instruments, or other contingent arrangements that expose the Company to material continuing risks, contingent liabilities, or any other obligation under a variable interest in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to the Company, or engages in leasing, hedging, or R&D services with the Company.

The following table presents certain payments due by the Company under contractual obligations with minimum firm commitments as of September 27, 2014, and excludes amounts already recorded on the Consolidated Balance Sheet, except for long-term debt (in millions):

 

                                                                                                                                                                    
     Payments Due in
Less Than 1 Year
     Payments Due in
1-3 Years
     Payments Due in
4-5 Years
     Payments Due in
More Than 5 Years
     Total  

Long-term debt

   $ 0       $ 5,000       $ 9,000       $ 15,000       $ 29,000   

Operating leases

     662         1,321         1,127         1,877         4,987   

Purchase commitments

     24,529         0         0         0         24,529   

Other obligations

     2,056         1,276         19         0         3,351   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 27,247       $ 7,597       $ 10,146       $ 16,877       $ 61,867   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Operating Leases

The Company’s major facility leases are typically for terms not exceeding 10 years and generally contain multi-year renewal options. Leases for retail space are for terms ranging from five to 20 years, the majority of which are for 10 years, and often contain multi-year renewal options. As of September 27, 2014, the Company’s total future minimum lease payments under noncancelable operating leases were $5.0 billion, of which $3.6 billion related to leases for retail space.

Purchase Commitments

The Company utilizes several outsourcing partners to manufacture sub-assemblies for the Company’s products and to perform final assembly and testing of finished products. These outsourcing partners acquire components and build product based on demand information supplied by the Company, which typically covers periods up to 150 days. The Company also obtains individual components for its products from a wide variety of individual suppliers. Consistent with industry practice, the Company acquires components through a combination of purchase orders, supplier contracts and open orders based on projected demand information. Where appropriate, the purchases are applied to inventory component prepayments that are outstanding with the respective supplier.

Other Obligations

The Company’s other obligations were comprised mainly of commitments to acquire capital assets, including product tooling and manufacturing process equipment and commitments related to advertising, R&D, Internet and telecommunications services and other obligations.

The Company’s other non-current liabilities in the Consolidated Balance Sheets consist primarily of deferred tax liabilities, gross unrecognized tax benefits and the related gross interest and penalties. As of September 27, 2014, the Company had non-current deferred tax liabilities of $20.3 billion. Additionally, as of September 27, 2014, the Company had gross unrecognized tax benefits of $4.0 billion and an additional $630 million for gross interest and penalties classified as non-current liabilities. At this time, the Company is unable to make a reasonably reliable estimate of the timing of payments in individual years in connection with these tax liabilities; therefore, such amounts are not included in the above contractual obligation table.

 

12


Indemnification

The Company generally does not indemnify end-users of its operating system and application software against legal claims that the software infringes third-party intellectual property rights. Other agreements entered into by the Company sometimes include indemnification provisions under which the Company could be subject to costs and/or damages in the event of an infringement claim against the Company or an indemnified third-party. However, the Company has not been required to make any significant payments resulting from such an infringement claim asserted against it or an indemnified third-party. In the opinion of management, there was not at least a reasonable possibility the Company may have incurred a material loss with respect to indemnification of end-users of its operating system or application software for infringement of third-party intellectual property rights. The Company did not record a liability for infringement costs related to indemnification as of September 27, 2014 or September 28, 2013.

The Company has entered into indemnification agreements with its directors and executive officers. Under these agreements, the Company has agreed to indemnify such individuals to the fullest extent permitted by law against liabilities that arise by reason of their status as directors or officers and to advance expenses incurred by such individuals in connection with related legal proceedings. It is not possible to determine the maximum potential amount of payments the Company could be required to make under these agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each claim. However, the Company maintains directors and officers liability insurance coverage to reduce its exposure to such obligations and payments made under these agreements historically have not been material.

Critical Accounting Policies and Estimates

The preparation of financial statements and related disclosures in conformity with U.S. generally accepted accounting principles (“GAAP”) and the Company’s discussion and analysis of its financial condition and operating results require the Company’s management to make judgments, assumptions and estimates that affect the amounts reported in its consolidated financial statements and accompanying notes. Note 1, “Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements in Exhibit 99.2 in this Form 8-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 it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates and such differences may be material.

Management believes the Company’s critical accounting policies and estimates are those related to revenue recognition, valuation and impairment of marketable securities, inventory valuation and valuation of manufacturing-related assets and estimated purchase commitment cancellation fees, warranty costs, income taxes and legal and other contingencies. Management considers these policies critical because they are both important to the portrayal of the Company’s financial condition and operating results, and they require management to make judgments and estimates about inherently uncertain matters. The Company’s senior management has reviewed these critical accounting policies and related disclosures with the Audit and Finance Committee of the Company’s Board of Directors.

Revenue Recognition

Net sales consist primarily of revenue from the sale of hardware, software, digital content and applications, accessories, and service and support contracts. The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collection is probable. Product is considered delivered to the customer once it has been shipped and title, risk of loss and rewards of ownership have been transferred. For most of the Company’s product sales, these criteria are met at the time the product is shipped. For online sales to individuals, for some sales to education customers in the U.S., and for certain other sales, the Company defers revenue until the customer receives the product because the Company retains a portion of the risk of loss on these sales during transit. The Company recognizes revenue from the sale of hardware products, software bundled with hardware that is essential to the functionality of the hardware and third-party digital content sold on the iTunes Store in accordance with general revenue recognition accounting guidance. The Company recognizes revenue in accordance with industry specific software accounting guidance for the following types of sales transactions: (i) standalone sales of software products, (ii) sales of software upgrades and (iii) sales of software bundled with hardware not essential to the functionality of the hardware.

 

13


For multi-element arrangements that include hardware products containing software essential to the hardware product’s functionality, undelivered software elements that relate to the hardware product’s essential software and/or undelivered non-software services, the Company allocates revenue to all deliverables based on their relative selling prices. In such circumstances, the Company uses a hierarchy to determine the selling price to be used for allocating revenue to deliverables: (i) vendor-specific objective evidence of fair value (“VSOE”), (ii) third-party evidence of selling price (“TPE”) and (iii) best estimate of selling price (“ESP”). VSOE generally exists only when the Company sells the deliverable separately and is the price actually charged by the Company for that deliverable. ESPs reflect the Company’s best estimates of what the selling prices of elements would be if they were sold regularly on a stand-alone basis.

For sales of qualifying versions of iOS devices, Mac and Apple TV, the Company has indicated it may from time to time provide future unspecified software upgrades and features free of charge to customers. The Company also provides various non-software services to owners of qualifying versions of iOS devices and Mac. Because the Company has neither VSOE nor TPE for the unspecified software upgrade rights or the non-software services, revenue is allocated to these rights and services based on the Company’s ESPs. Revenue allocated to the unspecified software upgrade rights and non-software services based on the Company’s ESPs is deferred and recognized on a straight-line basis over the estimated period the software upgrades and non-software services are expected to be provided for each of these devices, which ranges from two to four years.

The Company’s process for determining ESPs involves management’s judgment and considers multiple factors that may vary over time depending upon the unique facts and circumstances related to each deliverable. Should future facts and circumstances change, the Company’s ESPs and the future rate of related amortization for software upgrades and non-software services related to future sales of these devices could change. Factors subject to change include the unspecified software upgrade rights offered, the estimated value of unspecified software upgrade rights, the estimated or actual costs incurred to provide non-software services and the estimated period software upgrades and non-software services are expected to be provided.

The Company records reductions to revenue for estimated commitments related to price protection and other customer incentive programs. For transactions involving price protection, the Company recognizes revenue net of the estimated amount to be refunded, provided the refund amount can be reasonably and reliably estimated and the other conditions for revenue recognition have been met. The Company’s policy requires that, if refunds cannot be reliably estimated, revenue is not recognized until reliable estimates can be made or the price protection lapses. For the Company’s other customer incentive programs, the estimated cost is recognized at the later of the date at which the Company has sold the product or the date at which the program is offered. The Company also records reductions to revenue for expected future product returns based on the Company’s historical experience. Future market conditions and product transitions may require the Company to increase customer incentive programs that could result in reductions to future revenue. Additionally, certain customer incentive programs require management to estimate the number of customers who will actually redeem the incentive. Management’s estimates are based on historical experience and the specific terms and conditions of particular incentive programs. If a greater than estimated proportion of customers redeems such incentives, the Company would be required to record additional reductions to revenue, which would have an adverse impact on the Company’s results of operations.

Valuation and Impairment of Marketable Securities

The Company’s investments in available-for-sale securities are reported at fair value. Unrealized gains and losses related to changes in the fair value of securities are recognized in accumulated other comprehensive income, net of tax, in the Company’s Consolidated Balance Sheets. Changes in the fair value of available-for-sale securities impact the Company’s net income only when such securities are sold or an other-than-temporary impairment is recognized. Realized gains and losses on the sale of securities are determined by specific identification of each security’s cost basis. The Company regularly reviews its investment portfolio to determine if any security is other-than-temporarily impaired, which would require the Company to record an impairment charge in the period any such determination is made. In making this judgment, the Company evaluates, among other things, the duration and extent to which the fair value of a security is less than its cost; the financial condition of the issuer and any changes thereto; and the Company’s intent to sell, or whether it will more likely than not be required to sell, the security before recovery of its amortized cost basis. The Company’s assessment on whether a security is other-than-temporarily impaired could change in the future due to new developments or changes in assumptions related to any particular security.

 

14


Inventory Valuation and Valuation of Manufacturing-Related Assets and Estimated Purchase Commitment Cancellation Fees

The Company must order components for its products and build inventory in advance of product shipments and has invested in manufacturing process equipment, including capital assets held at its suppliers’ facilities. In addition, the Company has made prepayments to certain of its suppliers associated with long-term supply agreements to secure supply of inventory components. The Company records a write-down for inventories of components and products, including third-party products held for resale, which have become obsolete or are in excess of anticipated demand or net realizable value. The Company performs a detailed review of inventory that considers multiple factors including demand forecasts, product life cycle status, product development plans, current sales levels and component cost trends. The Company also reviews its manufacturing-related capital assets and inventory prepayments for impairment whenever events or circumstances indicate the carrying amount of such assets may not be recoverable. If the Company determines that an asset is not recoverable, it records an impairment loss equal to the amount by which the carrying value of such an asset exceeds its fair value.

The industries in which the Company competes are subject to a rapid and unpredictable pace of product and component obsolescence and demand changes. In certain circumstances the Company may be required to record additional write-downs of inventory, inventory prepayments and/or manufacturing-related capital assets. These circumstances include future demand or market conditions for the Company’s products being less favorable than forecasted, unforeseen technological changes or changes to the Company’s product development plans that negatively impact the utility of any of these assets, or significant deterioration in the financial condition of one or more of the Company’s suppliers that hold any of the Company’s manufacturing process equipment or to whom the Company has made an inventory prepayment. Such write-downs would adversely affect the Company’s results of operations in the period when the write-downs were recorded.

The Company records accruals for estimated cancellation fees related to component orders that have been cancelled or are expected to be cancelled. Consistent with industry practice, the Company acquires components through a combination of purchase orders, supplier contracts and open orders in each case based on projected demand. Where appropriate, the purchases are applied to inventory component prepayments that are outstanding with the respective supplier. Purchase commitments typically cover the Company’s forecasted component and manufacturing requirements for periods up to 150 days. If there is an abrupt and substantial decline in demand for one or more of the Company’s products, if the Company’s product development plans change, or if there is an unanticipated change in technological requirements for any of the Company’s products, then the Company may be required to record additional accruals for cancellation fees that would adversely affect its results of operations in the period when the cancellation fees are identified and recorded.

Warranty Costs

The Company provides for the estimated cost of warranties at the time the related revenue is recognized based on historical and projected warranty claim rates, historical and projected cost-per-claim and knowledge of specific product failures that are outside of the Company’s typical experience. Each quarter, the Company re-evaluates these estimates to assess the adequacy of its recorded warranty liabilities considering the size of the installed base of products subject to warranty protection and adjusts the amounts as necessary. If actual product failure rates or repair costs differ from estimates, revisions to the estimated warranty liabilities would be required and could materially affect the Company’s results of operations.

Income Taxes

The Company records a tax provision for the anticipated tax consequences of the reported results of operations. The provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled. The Company records a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized.

The Company recognizes tax benefits from uncertain tax positions only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.

 

15


Management believes it is more likely than not that forecasted income, including income that may be generated as a result of certain tax planning strategies, together with future reversals of existing taxable temporary differences, will be sufficient to fully recover the deferred tax assets. In the event that the Company determines all or part of the net deferred tax assets are not realizable in the future, the Company will make an adjustment to the valuation allowance that would be charged to earnings in the period such determination is made. In addition, the calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of GAAP and complex tax laws. Resolution of these uncertainties in a manner inconsistent with management’s expectations could have a material impact on the Company’s financial condition and operating results.

Legal and Other Contingencies

As discussed in Part I, Item 3 of the Form 10-K under the heading “Legal Proceedings” and in Exhibit 99.2 of this Form 8-K in the Notes to Consolidated Financial Statements in Note 10, “Commitments and Contingencies,” the Company is subject to various legal proceedings and claims that arise in the ordinary course of business. The Company records a liability when it is probable that a loss has been incurred and the amount is reasonably estimable. There is significant judgment required in both the probability determination and as to whether an exposure can be reasonably estimated. In the opinion of management, there was not at least a reasonable possibility the Company may have incurred a material loss, or a material loss in excess of a recorded accrual, with respect to loss contingencies for legal and other contingencies. However, the outcome of legal proceedings and claims brought against the Company is subject to significant uncertainty. Therefore, although management considers the likelihood of such an outcome to be remote, if one or more of these legal matters were resolved against the Company in a reporting period for amounts in excess of management’s expectations, the Company’s consolidated financial statements for that reporting period could be materially adversely affected.

 

16

Exhibit 99.2

 

Item 8. Financial Statements and Supplementary Data

 

Index to Consolidated Financial Statements

   Page  

Consolidated Statements of Operations for the years ended September 27, 2014, September  28, 2013 and September 29, 2012

     2   

Consolidated Statements of Comprehensive Income for the years ended September 27, 2014, September  28, 2013 and September 29, 2012

     3   

Consolidated Balance Sheets as of September 27, 2014 and September 28, 2013

     4   

Consolidated Statements of Shareholders’ Equity for the years ended September 27, 2014, September  28, 2013 and September 29, 2012

     5   

Consolidated Statements of Cash Flows for the years ended September 27, 2014, September  28, 2013 and September 29, 2012

     6   

Notes to Consolidated Financial Statements

     7   

Selected Quarterly Financial Information (Unaudited)

     33   

Reports of Ernst & Young LLP, Independent Registered Public Accounting Firm

     34   

All financial statement schedules have been omitted, since the required information is not applicable or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements and notes thereto.

 

1


CONSOLIDATED STATEMENTS OF OPERATIONS

(In millions, except number of shares which are reflected in thousands and per share amounts)

 

                                                        
    Years ended  
    September 27,
2014
    September 28,
2013
    September 29,
2012
 

Net sales

  $ 182,795      $ 170,910      $ 156,508   

Cost of sales

    112,258        106,606        87,846   
 

 

 

   

 

 

   

 

 

 

Gross margin

    70,537        64,304        68,662   
 

 

 

   

 

 

   

 

 

 

Operating expenses:

     

Research and development

    6,041        4,475        3,381   

Selling, general and administrative

    11,993        10,830        10,040   
 

 

 

   

 

 

   

 

 

 

Total operating expenses

    18,034        15,305        13,421   
 

 

 

   

 

 

   

 

 

 

Operating income

    52,503        48,999        55,241   

Other income/(expense), net

    980        1,156        522   
 

 

 

   

 

 

   

 

 

 

Income before provision for income taxes

    53,483        50,155        55,763   

Provision for income taxes

    13,973        13,118        14,030   
 

 

 

   

 

 

   

 

 

 

Net income

  $ 39,510      $ 37,037      $ 41,733   
 

 

 

   

 

 

   

 

 

 

Earnings per share:

     

Basic

  $ 6.49      $ 5.72      $ 6.38   

Diluted

  $ 6.45      $ 5.68      $ 6.31   

Shares used in computing earnings per share:

     

Basic

    6,085,572        6,477,320        6,543,726   

Diluted

    6,122,663        6,521,634        6,617,483   

Cash dividends declared per common share

  $ 1.82      $ 1.64      $ 0.38   

See accompanying Notes to Consolidated Financial Statements.

 

2


CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In millions)

 

                                                        
    Years ended  
    September 27,
2014
    September 28,
2013
    September 29,
2012
 

Net income

  $ 39,510      $ 37,037      $ 41,733   
 

 

 

   

 

 

   

 

 

 

Other comprehensive income/(loss):

     

Change in foreign currency translation, net of tax effects of $50, $35 and $13, respectively

    (137     (112     (15
 

 

 

   

 

 

   

 

 

 

Change in unrecognized gains/losses on derivative instruments:

     

Change in fair value of derivatives, net of tax benefit/(expense) of $(297), $(351) and $73, respectively

    1,390        522        (131

Adjustment for net losses/(gains) realized and included in net income, net of tax expense/(benefit) of $(36), $255 and $220, respectively

    149        (458     (399
 

 

 

   

 

 

   

 

 

 

Total change in unrecognized gains/losses on derivative instruments, net of tax

    1,539        64        (530
 

 

 

   

 

 

   

 

 

 

Change in unrealized gains/losses on marketable securities:

     

Change in fair value of marketable securities, net of tax benefit/(expense) of $(153), $458 and $(421), respectively

    285        (791     715   

Adjustment for net losses/(gains) realized and included in net income, net of tax expense/(benefit) of $71, $82 and $68, respectively

    (134     (131     (114
 

 

 

   

 

 

   

 

 

 

Total change in unrealized gains/losses on marketable securities, net of tax

    151        (922     601   
 

 

 

   

 

 

   

 

 

 

Total other comprehensive income/(loss)

    1,553        (970     56   
 

 

 

   

 

 

   

 

 

 

Total comprehensive income

  $ 41,063      $ 36,067      $ 41,789   
 

 

 

   

 

 

   

 

 

 

See accompanying Notes to Consolidated Financial Statements.

 

3


CONSOLIDATED BALANCE SHEETS

(In millions, except number of shares which are reflected in thousands and par value)

 

                                     
    September 27,
2014
    September 28,
2013
 
ASSETS:   

Current assets:

   

Cash and cash equivalents

  $ 13,844      $ 14,259   

Short-term marketable securities

    11,233        26,287   

Accounts receivable, less allowances of $86 and $99, respectively

    17,460        13,102   

Inventories

    2,111        1,764   

Deferred tax assets

    4,318        3,453   

Vendor non-trade receivables

    9,759        7,539   

Other current assets

    9,806        6,882   
 

 

 

   

 

 

 

Total current assets

    68,531        73,286   

Long-term marketable securities

    130,162        106,215   

Property, plant and equipment, net

    20,624        16,597   

Goodwill

    4,616        1,577   

Acquired intangible assets, net

    4,142        4,179   

Other assets

    3,764        5,146   
 

 

 

   

 

 

 

Total assets

  $ 231,839      $ 207,000   
 

 

 

   

 

 

 
   
LIABILITIES AND SHAREHOLDERS’ EQUITY:   

Current liabilities:

   

Accounts payable

  $ 30,196      $ 22,367   

Accrued expenses

    18,453        13,856   

Deferred revenue

    8,491        7,435   

Commercial paper

    6,308        0   
 

 

 

   

 

 

 

Total current liabilities

    63,448        43,658   

Deferred revenue – non-current

    3,031        2,625   

Long-term debt

    28,987        16,960   

Other non-current liabilities

    24,826        20,208   
 

 

 

   

 

 

 

Total liabilities

    120,292        83,451   
 

 

 

   

 

 

 

Commitments and contingencies

   

Shareholders’ equity:

   

Common stock and additional paid-in capital, $0.00001 par value; 12,600,000 shares authorized; 5,866,161 and 6,294,494 shares issued and outstanding, respectively

    23,313        19,764   

Retained earnings

    87,152        104,256   

Accumulated other comprehensive income/(loss)

    1,082        (471
 

 

 

   

 

 

 

Total shareholders’ equity

    111,547        123,549   
 

 

 

   

 

 

 

Total liabilities and shareholders’ equity

  $ 231,839      $ 207,000   
 

 

 

   

 

 

 

See accompanying Notes to Consolidated Financial Statements.

 

4


CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(In millions, except number of shares which are reflected in thousands)

 

                                                                                                                                 
    Common Stock and
Additional Paid-In Capital
    Retained    

Accumulated
Other

Comprehensive

   

Total

Shareholders’

 
    Shares     Amount     Earnings     Income/(Loss)     Equity  

Balances as of September 24, 2011

    6,504,937      $ 13,331      $ 62,841      $ 443      $ 76,615   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

  0      0      41,733      0      41,733   

Other comprehensive income/(loss)

  0      0      0      56      56   

Dividends and dividend equivalents declared

  0      0      (2,523   0      (2,523

Share-based compensation

  0      1,740      0      0      1,740   

Common stock issued, net of shares withheld for employee taxes

  69,521      200      (762   0      (562

Tax benefit from equity awards, including transfer pricing adjustments

  0      1,151      0      0      1,151   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances as of September 29, 2012

  6,574,458      16,422      101,289      499      118,210   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

  0      0      37,037      0      37,037   

Other comprehensive income/(loss)

  0      0      0      (970   (970

Dividends and dividend equivalents declared

  0      0      (10,676   0      (10,676

Repurchase of common stock

  (328,837   0      (22,950   0      (22,950

Share-based compensation

  0      2,253      0      0      2,253   

Common stock issued, net of shares withheld for employee taxes

  48,873      (143   (444   0      (587

Tax benefit from equity awards, including transfer pricing adjustments

  0      1,232      0      0      1,232   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances as of September 28, 2013

  6,294,494      19,764      104,256      (471   123,549   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

  0      0      39,510      0      39,510   

Other comprehensive income/(loss)

  0      0      0      1,553      1,553   

Dividends and dividend equivalents declared

  0      0      (11,215   0      (11,215

Repurchase of common stock

  (488,677   0      (45,000   0      (45,000

Share-based compensation

  0      2,863      0      0      2,863   

Common stock issued, net of shares withheld for employee taxes

  60,344      (49   (399   0      (448

Tax benefit from equity awards, including transfer pricing adjustments

  0      735      0      0      735   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances as of September 27, 2014

  5,866,161    $ 23,313    $ 87,152    $ 1,082    $ 111,547   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying Notes to Consolidated Financial Statements.

 

5


CONSOLIDATED STATEMENTS OF CASH FLOWS

(In millions)

 

                                                                          
    Years ended  
    September 27,
2014
    September 28,
2013
    September 29,
2012
 

Cash and cash equivalents, beginning of the year

  $ 14,259      $ 10,746      $ 9,815   
 

 

 

   

 

 

   

 

 

 

Operating activities:

Net income

  39,510      37,037      41,733   

Adjustments to reconcile net income to cash generated by operating activities:

Depreciation and amortization

  7,946      6,757      3,277   

Share-based compensation expense

  2,863      2,253      1,740   

Deferred income tax expense

  2,347      1,141      4,405   

Changes in operating assets and liabilities:

Accounts receivable, net

  (4,232   (2,172   (5,551

Inventories

  (76   (973   (15

Vendor non-trade receivables

  (2,220   223      (1,414

Other current and non-current assets

  167      1,080      (3,162

Accounts payable

  5,938      2,340      4,467   

Deferred revenue

  1,460      1,459      2,824   

Other current and non-current liabilities

  6,010      4,521      2,552   
 

 

 

   

 

 

   

 

 

 

Cash generated by operating activities

  59,713      53,666      50,856   
 

 

 

   

 

 

   

 

 

 

Investing activities:

Purchases of marketable securities

  (217,128   (148,489   (151,232

Proceeds from maturities of marketable securities

  18,810      20,317      13,035   

Proceeds from sales of marketable securities

  189,301      104,130      99,770   

Payments made in connection with business acquisitions, net

  (3,765   (496   (350

Payments for acquisition of property, plant and equipment

  (9,571   (8,165   (8,295

Payments for acquisition of intangible assets

  (242   (911   (1,107

Other

  16      (160   (48
 

 

 

   

 

 

   

 

 

 

Cash used in investing activities

  (22,579   (33,774   (48,227
 

 

 

   

 

 

   

 

 

 

Financing activities:

Proceeds from issuance of common stock

  730      530      665   

Excess tax benefits from equity awards

  739      701      1,351   

Taxes paid related to net share settlement of equity awards

  (1,158   (1,082   (1,226

Dividends and dividend equivalents paid

  (11,126   (10,564   (2,488

Repurchase of common stock

  (45,000   (22,860   0   

Proceeds from issuance of long-term debt, net

  11,960      16,896      0   

Proceeds from issuance of commercial paper, net

  6,306      0      0   
 

 

 

   

 

 

   

 

 

 

Cash used in financing activities

  (37,549   (16,379   (1,698
 

 

 

   

 

 

   

 

 

 

Increase/(decrease) in cash and cash equivalents

  (415   3,513      931   
 

 

 

   

 

 

   

 

 

 

Cash and cash equivalents, end of the year

$ 13,844    $ 14,259    $ 10,746   
 

 

 

   

 

 

   

 

 

 

Supplemental cash flow disclosure:

Cash paid for income taxes, net

$ 10,026    $ 9,128    $ 7,682   

Cash paid for interest

$ 339    $ 0    $ 0   

See accompanying Notes to Consolidated Financial Statements.

 

6


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Summary of Significant Accounting Policies

Apple Inc. and its wholly-owned subsidiaries (collectively “Apple” or the “Company”) designs, manufactures and markets mobile communication and media devices, personal computers and portable digital music players, and sells a variety of related software, services, accessories, networking solutions and third-party digital content and applications. The Company sells its products worldwide through its retail stores, online stores and direct sales force, as well as through third-party cellular network carriers, wholesalers, retailers and value-added resellers. In addition, the Company sells a variety of third-party iPhone, iPad, Mac and iPod compatible products, including application software, and various accessories through its online and retail stores. The Company sells to consumers, small and mid-sized businesses, and education, enterprise and government customers.

Basis of Presentation and Preparation

The accompanying consolidated financial statements include the accounts of the Company. Intercompany accounts and transactions have been eliminated. The preparation of these consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the amounts reported in these consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates.

The Company’s fiscal year is the 52 or 53-week period that ends on the last Saturday of September. The Company’s fiscal years 2014, 2013 and 2012 ended on September 27, 2014, September 28, 2013 and September 29, 2012, respectively. An additional week is included in the first fiscal quarter approximately every six years to realign fiscal quarters with calendar quarters. Fiscal years 2014 and 2013 spanned 52 weeks each. Fiscal year 2012 spanned 53 weeks, with a 14th week included in the first quarter of 2012. Unless otherwise stated, references to particular years, quarters, months and periods refer to the Company’s fiscal years ended in September and the associated quarters, months and periods of those fiscal years.

During the first quarter of 2014, the Company adopted updated accounting standards that (i) required disclosure of additional information about the amounts reclassified out of accumulated other comprehensive income (“AOCI”) by component and (ii) required gross and net disclosures about offsetting assets and liabilities. The adoption of these updated standards only impacted the disclosures in the Notes to Consolidated Financial Statements; accordingly, the adoption had no impact on the Company’s financial position or results of operations. The Company has provided these additional disclosures in Note 8, “Comprehensive Income” and Note 2, “Financial Instruments,” respectively.

In 2015, the Company changed its reportable operating segments, began allocating certain costs to its operating segments that were previously included in other corporate expenses and changed its categorization of product-level net sales reporting. The Company has reclassified the 2014, 2013 and 2012 amounts to conform to the 2015 presentation as further described in Note 11, “Segment Information and Geographic Data.”

Common Stock Split

On June 6, 2014, the Company effected a seven-for-one stock split to shareholders of record as of June 2, 2014. All share and per share information has been retroactively adjusted to reflect the stock split.

Revenue Recognition

Net sales consist primarily of revenue from the sale of hardware, software, digital content and applications, accessories and service and support contracts. The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collection is probable. Product is considered delivered to the customer once it has been shipped and title, risk of loss and rewards of ownership have been transferred. For most of the Company’s product sales, these criteria are met at the time the product is shipped. For online sales to individuals, for some sales to education customers in the U.S., and for certain other sales, the Company defers revenue until the customer receives the product because the Company retains a portion of the risk of loss on these sales during transit. The Company recognizes revenue from the sale of hardware products, software bundled with hardware that is essential to the functionality of the hardware, and third-party digital content sold on the iTunes Store in accordance with general revenue recognition accounting guidance. The Company recognizes revenue in accordance with industry specific software accounting guidance for the following types of sales transactions: (i) standalone sales of software products, (ii) sales of software upgrades and (iii) sales of software bundled with hardware not essential to the functionality of the hardware.

 

7


For the sale of most third-party products, the Company recognizes revenue based on the gross amount billed to customers because the Company establishes its own pricing for such products, retains related inventory risk for physical products, is the primary obligor to the customer and assumes the credit risk for amounts billed to its customers. For third-party applications sold through the App Store and Mac App Store and certain digital content sold through the iTunes Store, the Company does not determine the selling price of the products and is not the primary obligor to the customer. Therefore, the Company accounts for such sales on a net basis by recognizing in net sales only the commission it retains from each sale. The portion of the gross amount billed to customers that is remitted by the Company to third-party app developers and certain digital content owners is not reflected in the Company’s Consolidated Statements of Operations.

The Company records deferred revenue when it receives payments in advance of the delivery of products or the performance of services. This includes amounts that have been deferred for unspecified and specified software upgrade rights and non-software services that are attached to hardware and software products. The Company sells gift cards redeemable at its retail and online stores, and also sells gift cards redeemable on the iTunes Store for the purchase of digital content and software. The Company records deferred revenue upon the sale of the card, which is relieved upon redemption of the card by the customer. Revenue from AppleCare service and support contracts is deferred and recognized over the service coverage periods. AppleCare service and support contracts typically include extended phone support, repair services, web-based support resources and diagnostic tools offered under the Company’s standard limited warranty.

The Company records reductions to revenue for estimated commitments related to price protection and other customer incentive programs. For transactions involving price protection, the Company recognizes revenue net of the estimated amount to be refunded. For the Company’s other customer incentive programs, the estimated cost of these programs is recognized at the later of the date at which the Company has sold the product or the date at which the program is offered. The Company also records reductions to revenue for expected future product returns based on the Company’s historical experience. Revenue is recorded net of taxes collected from customers that are remitted to governmental authorities, with the collected taxes recorded as current liabilities until remitted to the relevant government authority.

Revenue Recognition for Arrangements with Multiple Deliverables

For multi-element arrangements that include hardware products containing software essential to the hardware product’s functionality, undelivered software elements that relate to the hardware product’s essential software, and undelivered non-software services, the Company allocates revenue to all deliverables based on their relative selling prices. In such circumstances, the Company uses a hierarchy to determine the selling price to be used for allocating revenue to deliverables: (i) vendor-specific objective evidence of fair value (“VSOE”), (ii) third-party evidence of selling price (“TPE”) and (iii) best estimate of selling price (“ESP”). VSOE generally exists only when the Company sells the deliverable separately and is the price actually charged by the Company for that deliverable. ESPs reflect the Company’s best estimates of what the selling prices of elements would be if they were sold regularly on a stand-alone basis. For multi-element arrangements accounted for in accordance with industry specific software accounting guidance, the Company allocates revenue to all deliverables based on the VSOE of each element, and if VSOE does not exist revenue is recognized when elements lacking VSOE are delivered.

For sales of qualifying versions of iPhone, iPad and iPod touch (“iOS devices”), Mac and Apple TV, the Company has indicated it may from time to time provide future unspecified software upgrades and features to the essential software bundled with each of these hardware products free of charge to customers. Essential software for iOS devices includes iOS and related applications and for Mac includes OS X and related applications. The Company also provides various non-software services to owners of qualifying versions of iOS devices and Mac. The Company has identified up to three deliverables regularly included in arrangements involving the sale of these devices. The first deliverable is the hardware and software essential to the functionality of the hardware device delivered at the time of sale. The second deliverable is the embedded right included with the purchase of iOS devices, Mac and Apple TV to receive on a when-and-if-available basis, future unspecified software upgrades and features relating to the product’s essential software. The third deliverable is the non-software services to be provided to qualifying versions of iOS devices and Mac. The Company allocates revenue between these deliverables using the relative selling price method. Because the Company has neither VSOE nor TPE for these deliverables, the allocation of revenue is based on the Company’s ESPs. Revenue allocated to the delivered hardware and the related essential software is recognized at the time of sale provided the other conditions for revenue recognition have been met. Revenue allocated to the embedded unspecified software upgrade rights and the non-software services is deferred and recognized on a straight-line basis over the estimated period the software upgrades and non-software services are expected to be provided for each of these devices, which ranges from two to four years. Cost of sales related to delivered hardware and related essential software, including estimated warranty costs, are recognized at the time of sale. Costs incurred to provide non-software services are recognized as cost of sales as incurred, and engineering and sales and marketing costs are recognized as operating expenses as incurred.

 

8


The Company’s process for determining its ESP for deliverables without VSOE or TPE considers multiple factors that may vary depending upon the unique facts and circumstances related to each deliverable. The Company believes its customers would be reluctant to buy unspecified software upgrade rights for the essential software included with its qualifying hardware products. This view is primarily based on the fact that unspecified software upgrade rights do not obligate the Company to provide upgrades at a particular time or at all, and do not specify to customers which upgrades or features will be delivered. The Company also believes its customers would be unwilling to pay a significant amount for access to the non-software services because other companies offer similar services at little or no cost to users. Therefore, the Company has concluded that if it were to sell upgrade rights or access to the non-software services on a standalone basis, including those rights and services attached to iOS devices, Mac and Apple TV, the selling prices would be relatively low. Key factors considered by the Company in developing the ESPs for software upgrade rights include prices charged by the Company for similar offerings, market trends in the pricing of Apple-branded and third-party Mac and iOS compatible software, the nature of the upgrade rights (e.g., unspecified versus specified) and the relative ESP of the upgrade rights as compared to the total selling price of the product. The Company may also consider additional factors as appropriate, including the impact of other products and services provided to customers, the pricing of competitive alternatives if they exist, product-specific business objectives and the length of time a particular version of a device has been available. When relevant, the same factors are considered by the Company in developing ESPs for offerings such as the non-software services with additional consideration given to the estimated cost to provide such services.

In 2014, 2013 and 2012, the Company’s combined ESPs for the unspecified software upgrade rights and the rights to receive the non-software services included with its qualifying hardware devices have ranged from $5 to $40. As of September 27, 2014, the combined ESPs for Mac was $40 and for iPhone and iPad ranged from $15 to $25. Revenue allocated to such rights is deferred and recognized on a straight-line basis over the estimated period the rights are expected to be provided for each device, which ranges from two to four years.

Shipping Costs

For all periods presented, amounts billed to customers related to shipping and handling are classified as revenue, and the Company’s shipping and handling costs are included in cost of sales.

Warranty Costs

The Company generally provides for the estimated cost of hardware and software warranties at the time the related revenue is recognized. The Company assesses the adequacy of its pre-existing warranty liabilities and adjusts the amounts as necessary based on actual experience and changes in future estimates.

Software Development Costs

Research and development (“R&D”) costs are expensed as incurred. 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 most instances, the Company’s products are released soon after technological feasibility has been established. Costs incurred subsequent to achievement of technological feasibility were not significant, and software development costs were expensed as incurred during 2014, 2013 and 2012.

Advertising Costs

Advertising costs are expensed as incurred and included in selling, general and administrative expenses. Advertising expense was $1.2 billion, $1.1 billion and $1.0 billion for 2014, 2013 and 2012, respectively.

Share-based Compensation

The Company recognizes expense related to share-based payment transactions in which it receives employee services in exchange for (a) equity instruments of the Company or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. Share-based compensation cost for restricted stock and restricted stock units (“RSUs”) is measured based on the closing fair market value of the Company’s common stock on the date of grant. The Company recognizes share-based compensation cost over the award’s requisite service period on a straight-line basis for time-based RSUs and on a graded basis for RSUs that are contingent on the achievement of performance metrics. The Company recognizes a benefit from share-based compensation in the Consolidated Statements of Shareholders’ Equity if an incremental tax benefit is realized. In addition, the Company recognizes the indirect effects of share-based compensation on R&D tax credits, foreign tax credits and domestic manufacturing deductions in the Consolidated Statements of Operations. Further information regarding share-based compensation can be found in Note 9, “Benefit Plans.”

 

9


Income Taxes

The provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled. The Company records a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized.

The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. See Note 5, “Income Taxes” for additional information.

Earnings Per Share

Basic earnings per 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 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 potentially dilutive securities had been issued. Potentially dilutive securities include outstanding stock options, shares to be purchased under the Company’s employee stock purchase plan, unvested restricted stock and unvested RSUs. The dilutive effect of potentially dilutive securities is reflected in diluted earnings per share by application of the treasury stock method. Under the treasury stock method, an increase in the fair market value of the Company’s common stock can result in a greater dilutive effect from potentially dilutive securities.

The following table shows the computation of basic and diluted earnings per share for 2014, 2013 and 2012 (net income in millions and shares in thousands):

 

     2014      2013      2012  

Numerator:

        

Net income

   $ 39,510       $ 37,037       $ 41,733   

Denominator:

        

Weighted-average shares outstanding

     6,085,572         6,477,320         6,543,726   

Effect of dilutive securities

     37,091         44,314         73,757   
  

 

 

    

 

 

    

 

 

 

Weighted-average diluted shares

     6,122,663         6,521,634         6,617,483   
  

 

 

    

 

 

    

 

 

 

Basic earnings per share

   $ 6.49       $ 5.72       $ 6.38   

Diluted earnings per share

   $ 6.45       $ 5.68       $ 6.31   

Potentially dilutive securities, the effect of which would have been antidilutive, were not significant for 2014, 2013 and 2012. The Company excluded these securities from the computation of diluted earnings per share.

Financial Instruments

Cash Equivalents and Marketable Securities

All highly liquid investments with maturities of three months or less at the date of purchase are classified as cash equivalents. The Company’s marketable debt and equity securities have been classified and accounted for as available-for-sale. Management determines the appropriate classification of its investments at the time of purchase and reevaluates the designations at each balance sheet date. The Company classifies its marketable debt securities as either short-term or long-term based on each instrument’s underlying contractual maturity date. Marketable debt securities with maturities of 12 months or less are classified as short-term and marketable debt securities with maturities greater than 12 months are classified as long-term. The Company classifies its marketable equity securities, including mutual funds, as either short-term or long-term based on the nature of each security and its availability for use in current operations. The Company’s marketable debt and equity securities are carried at fair value, with the unrealized gains and losses, net of taxes, reported as a component of shareholders’ equity. The cost of securities sold is based upon the specific identification method.

 

10


Derivative Financial Instruments

The Company accounts for its derivative instruments as either assets or liabilities and carries them at fair value.

For derivative instruments that hedge the exposure to variability in expected future cash flows that are designated as cash flow hedges, the effective portion of the gain or loss on the derivative instrument is reported as a component of AOCI in shareholders’ equity and reclassified into income in the same period or periods during which the hedged transaction affects earnings. The ineffective portion of the gain or loss on the derivative instrument, if any, is recognized in current income. To receive hedge accounting treatment, cash flow hedges must be highly effective in offsetting changes to expected future cash flows on hedged transactions. For options designated as cash flow hedges, changes in the time value are excluded from the assessment of hedge effectiveness and are recognized in income. For derivative instruments that hedge the exposure to changes in the fair value of an asset or a liability and that are designated as fair value hedges, both the net gain or loss on the derivative instrument as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in earnings in the current period. For derivative instruments designated as a hedge of the foreign currency translation exposure of the net investment in a foreign operation, the net gain or loss on the effective portion of the derivative instrument is reported in the same manner as a foreign currency translation adjustment. For forward exchange contracts designated as net investment hedges, the Company excludes changes in fair value relating to changes in the forward carry component from its definition of effectiveness. Accordingly, any gains or losses related to this component are recognized in current income. Derivatives that do not qualify as hedges are adjusted to fair value through current income.

Allowance for Doubtful Accounts

The Company records its allowance for doubtful accounts based upon its assessment of various factors. The Company considers historical experience, the age of the accounts receivable balances, credit quality of the Company’s customers, current economic conditions and other factors that may affect customers’ ability to pay.

Inventories

Inventories are stated at the lower of cost, computed using the first-in, first-out method, or market. If the cost of the inventories exceeds their market value, provisions are made currently for the difference between the cost and the market value.

Property, Plant and Equipment

Property, plant and equipment are stated at cost. Depreciation is computed by use of the straight-line method over the estimated useful lives of the assets, which for buildings is the lesser of 30 years or the remaining life of the underlying building; between two to five years for machinery and equipment, including product tooling and manufacturing process equipment; and the shorter of lease terms or ten years for leasehold improvements. The Company capitalizes eligible costs to acquire or develop internal-use software that are incurred subsequent to the preliminary project stage. Capitalized costs related to internal-use software are amortized using the straight-line method over the estimated useful lives of the assets, which range from three to five years. Depreciation and amortization expense on property and equipment was $6.9 billion, $5.8 billion and $2.6 billion during 2014, 2013 and 2012, respectively.

Long-Lived Assets Including Goodwill and Other Acquired Intangible Assets

The Company reviews property, plant and equipment, inventory component prepayments and certain identifiable intangibles, excluding goodwill, for impairment. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Recoverability of these assets is measured by comparison of their carrying amounts to future undiscounted cash flows the assets are expected to generate. If property, plant and equipment, inventory component prepayments and certain identifiable intangibles are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the assets exceeds its fair value. The Company did not record any significant impairments during 2014, 2013 and 2012.

The Company does not amortize goodwill and intangible assets with indefinite useful lives, rather such assets are required to be tested for impairment at least annually or sooner whenever events or changes in circumstances indicate that the assets may be impaired. The Company performs its goodwill and intangible asset impairment tests in the fourth quarter of each year. The Company did not recognize any impairment charges related to goodwill or indefinite lived intangible assets during 2014, 2013 and 2012. 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. In 2014 and 2013, the Company’s goodwill was allocated to the Americas and Europe reportable operating segments.

The Company amortizes its intangible assets with definite useful lives over their estimated useful lives and reviews these assets for impairment. The Company typically amortizes its acquired intangible assets with definite useful lives over periods from three to seven years.

 

11


Fair Value Measurements

The Company applies fair value accounting for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. The Company defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, which are required to be recorded at fair value, the Company considers the principal or most advantageous market in which the Company would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as risks inherent in valuation techniques, transfer restrictions and credit risk. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:

Level 1 – Quoted prices in active markets for identical assets or liabilities.

Level 2 – Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 – Inputs that are generally unobservable and typically reflect management’s estimate of assumptions that market participants would use in pricing the asset or liability.

The Company’s valuation techniques used to measure the fair value of money market funds and certain marketable equity securities were derived from quoted prices in active markets for identical assets or liabilities. The valuation techniques used to measure the fair value of the Company’s debt instruments and all other financial instruments, all of which have counterparties with high credit ratings, were valued based on quoted market prices or model driven valuations using significant inputs derived from or corroborated by observable market data.

In accordance with the fair value accounting requirements, companies may choose to measure eligible financial instruments and certain other items at fair value. The Company has not elected the fair value option for any eligible financial instruments.

Foreign Currency Translation and Remeasurement

The Company translates the assets and liabilities of its non-U.S. dollar functional currency subsidiaries into U.S. dollars using exchange rates in effect at the end of each period. Revenue and expenses for these subsidiaries are translated using rates that approximate those in effect during the period. Gains and losses from these translations are recognized in foreign currency translation included in AOCI in shareholders’ equity. The Company’s subsidiaries that use the U.S. dollar as their functional currency remeasure monetary assets and liabilities at exchange rates in effect at the end of each period, and inventories, property and nonmonetary assets and liabilities at historical rates. Gains and losses from these remeasurements were not significant during 2014, 2013 and 2012 and have been included in the Company’s results of operations.

 

12


Note 2 – Financial Instruments

Cash, Cash Equivalents and Marketable Securities

The following tables show the Company’s cash and available-for-sale securities’ adjusted cost, gross unrealized gains, gross unrealized losses and fair value by significant investment category recorded as cash and cash equivalents or short- or long-term marketable securities as of September 27, 2014 and September 28, 2013 (in millions):

 

                                                                                                                                    
    2014  
    Adjusted
Cost
    Unrealized
Gains
    Unrealized
Losses
    Fair Value     Cash and
Cash
Equivalents
    Short-Term
Marketable
Securities
    Long-Term
Marketable
Securities
 

Cash

  $ 10,232      $ 0      $ 0      $ 10,232      $ 10,232      $ 0      $ 0   

Level 1:

             

Money market funds

    1,546        0        0        1,546        1,546        0        0   

Mutual funds

    2,531        1        (132     2,400        0        2,400        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

    4,077        1        (132     3,946        1,546        2,400        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Level 2:

             

U.S. Treasury securities

    23,140        15        (9     23,146        12        607        22,527   

U.S. agency securities

    7,373        3        (11     7,365        652        157        6,556   

Non-U.S. government securities

    6,925        69        (69     6,925        0        204        6,721   

Certificates of deposit and time deposits

    3,832        0        0        3,832        1,230        1,233        1,369   

Commercial paper

    475        0        0        475        166        309        0   

Corporate securities

    85,431        296        (241     85,486        6        6,298        79,182   

Municipal securities

    940        8        0        948        0        0        948   

Mortgage- and asset-backed securities

    12,907        26        (49     12,884        0        25        12,859   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

    141,023        417        (379     141,061        2,066        8,833        130,162   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 155,332      $ 418      $ (511   $ 155,239      $ 13,844      $ 11,233      $ 130,162   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

                                                                                                                                    
    2013  
    Adjusted
Cost
    Unrealized
Gains
    Unrealized
Losses
    Fair Value     Cash and
Cash
Equivalents
    Short-Term
Marketable
Securities
    Long-Term
Marketable
Securities
 

Cash

  $ 8,705      $ 0      $ 0      $ 8,705      $ 8,705      $ 0      $ 0   

Level 1:

             

Money market funds

    1,793        0        0        1,793        1,793        0        0   

Mutual funds

    3,999        0        (197     3,802        0        3,802        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

    5,792        0        (197     5,595        1,793        3,802        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Level 2:

             

U.S. Treasury securities

    27,642        24        (47     27,619        431        7,554        19,634   

U.S. agency securities

    16,878        12        (52     16,838        177        3,412        13,249   

Non-U.S. government securities

    5,545        35        (137     5,443        50        313        5,080   

Certificates of deposit and time deposits

    2,344        0        0        2,344        1,264        844        236   

Commercial paper

    2,998        0        0        2,998        1,835        1,163        0   

Corporate securities

    54,586        275        (252     54,609        0        8,077        46,532   

Municipal securities

    6,257        45        (22     6,280        4        1,114        5,162   

Mortgage- and asset-backed securities

    16,396        23        (89     16,330        0        8        16,322   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

    132,646        414        (599     132,461        3,761        22,485        106,215   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 147,143      $ 414      $ (796   $ 146,761      $ 14,259      $ 26,287      $ 106,215   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The Company may sell certain of its marketable securities prior to their stated maturities for strategic reasons including, but not limited to, anticipation of credit deterioration and duration management. The net realized gains or losses recognized by the Company, related to such sales, were not significant during 2014, 2013 and 2012. The maturities of the Company’s long-term marketable securities generally range from one to five years.

 

13


As of September 27, 2014 and September 28, 2013, gross unrealized losses related to individual securities that had been in a continuous loss position for 12 months or longer were not significant.

As of September 27, 2014, the Company considers the declines in market value of its marketable securities investment portfolio to be temporary in nature and does not consider any of its investments other-than-temporarily impaired. The Company typically invests in highly-rated securities, and its investment policy limits the amount of credit exposure to any one issuer. The policy generally requires investments to be investment grade, with the primary objective of minimizing the potential risk of principal loss. Fair values were determined for each individual security in the investment portfolio. When evaluating an investment for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below its cost basis, the financial condition of the issuer and any changes thereto, changes in market interest rates, and the Company’s intent to sell, or whether it is more likely than not it will be required to sell, the investment before recovery of the investment’s cost basis. During 2014, 2013 and 2012 the Company did not recognize any significant impairment charges.

Derivative Financial Instruments

The Company uses derivatives to partially offset its business exposure to foreign currency and interest rate risk. The Company may enter into forward contracts, option contracts, swaps, or other derivative instruments to offset some of the risk on expected future cash flows, on net investments in certain foreign subsidiaries and on certain existing assets and liabilities. However, the Company may choose not to hedge certain exposures for a variety of reasons including, but not limited to, accounting considerations and the prohibitive economic cost of hedging particular exposures. There can be no assurance the hedges will offset more than a portion of the financial impact resulting from movements in foreign currency exchange or interest rates.

To help protect gross margins from fluctuations in foreign currency exchange rates, certain of the Company’s subsidiaries whose functional currency is the U.S. dollar hedge a portion of forecasted foreign currency revenue. The Company’s subsidiaries whose functional currency is not the U.S. dollar and who sell in local currencies may hedge a portion of forecasted inventory purchases not denominated in the subsidiaries’ functional currencies. The Company typically hedges portions of its forecasted foreign currency exposure associated with revenue and inventory purchases, typically for up to 12 months.

To help protect the net investment in a foreign operation from adverse changes in foreign currency exchange rates, the Company may enter into foreign currency forward and option contracts to offset the changes in the carrying amounts of these investments due to fluctuations in foreign currency exchange rates.

The Company may also enter into foreign currency forward contracts and option contracts to partially offset the foreign currency exchange gains and losses generated by the re-measurement of certain assets and liabilities denominated in non-functional currencies.

The Company may enter into interest rate swaps, options, or other instruments to manage interest rate risk. These instruments may offset a portion of changes in income or expense, or changes in fair value of the Company’s long-term debt or investments.

The Company records all derivatives in the Consolidated Balance Sheets at fair value. The Company’s accounting treatment for these instruments is based on the hedge designation. The effective portions of cash flow hedges are recorded in AOCI until the hedged item is recognized in earnings. Gains and losses related to changes in fair value hedges are recognized in earnings along with a corresponding loss or gain related to the change in value of the underlying hedged item. The effective portions of net investment hedges are recorded in other comprehensive income (“OCI”) as a part of the cumulative translation adjustment. The ineffective portions of cash flow hedges and net investment hedges are recorded in other income and expense. Derivatives that are not designated as hedging instruments are adjusted to fair value through earnings in the financial statement line item to which the derivative relates.

Deferred gains and losses associated with cash flow hedges of foreign currency revenue are recognized as a component of net sales in the same period as the related revenue is recognized, and deferred gains and losses related to cash flow hedges of inventory purchases are recognized as a component of cost of sales in the same period as the related costs are recognized. Deferred gains and losses associated with cash flow hedges of interest income or expense are recognized as a component of other income/(expense), net in the same period as the related income or expense is recognized. The Company’s foreign currency and interest rate transactions hedged with cash flow hedges as of September 27, 2014 are expected to occur within 12 months and four years, respectively.

 

14


Derivative instruments designated as cash flow hedges must be de-designated as hedges when it is probable the forecasted hedged transaction will not occur in the initially identified time period or within a subsequent two-month time period. Deferred gains and losses in AOCI associated with such derivative instruments are reclassified immediately into other income and expense. Any subsequent changes in fair value of such derivative instruments are reflected in other income and expense unless they are re-designated as hedges of other transactions. The Company did not recognize any significant net gains or losses related to the loss of hedge designation on discontinued cash flow hedges during 2014, 2013 and 2012.

The gain/loss recognized in other income and expense for foreign currency forward and option contracts not designated as hedging instruments was not significant during 2014, 2013 and 2012. These amounts represent the net gain or loss on the derivative contracts and do not include changes in the related exposures, which generally offset a portion of the gain or loss on the derivative contracts.

The following table shows the notional amounts of the Company’s outstanding derivative instruments and credit risk amounts associated with outstanding or unsettled derivative instruments as of September 27, 2014 and September 28, 2013 (in millions):

 

                                                                           
    2014     2013  
    Notional
Amount
    Credit Risk
Amounts
    Notional
Amount
    Credit Risk
Amounts
 

Instruments designated as accounting hedges:

       

Foreign exchange contracts

  $ 42,945      $ 1,333      $ 35,013      $ 159   

Interest rate contracts

  $ 12,000      $ 89      $ 3,000      $ 44   

Instruments not designated as accounting hedges:

       

Foreign exchange contracts

  $ 38,510      $ 222      $ 16,131      $ 25   

The notional amounts for outstanding derivative instruments provide one measure of the transaction volume outstanding and do not represent the amount of the Company’s exposure to credit or market loss. The credit risk amounts represent the Company’s gross exposure to potential accounting loss on derivative instruments that are outstanding or unsettled if all counterparties failed to perform according to the terms of the contract, based on then-current currency or interest rates at each respective date. The Company’s gross exposure on these transactions may be further mitigated by collateral received from certain counterparties. The Company’s exposure to credit loss and market risk will vary over time as currency and interest rates change. Although the table above reflects the notional and credit risk amounts of the Company’s derivative instruments, it does not reflect the gains or losses associated with the exposures and transactions that the instruments are intended to hedge. The amounts ultimately realized upon settlement of these financial instruments, together with the gains and losses on the underlying exposures, will depend on actual market conditions during the remaining life of the instruments.

The Company generally enters into master netting arrangements, which are designed to reduce credit risk by permitting net settlement of transactions with the same counterparty. To further limit credit risk, the Company generally enters into collateral security arrangements that provide for collateral to be received or posted when the net fair value of certain financial instruments fluctuates from contractually established thresholds. The Company presents its derivative assets and derivative liabilities at their gross fair values in its Consolidated Balance Sheets. As of September 27, 2014, the Company received $2.1 billion of cash collateral related to the derivative instruments under its collateral security arrangements, which were recorded as accrued expenses in the Consolidated Balance Sheet. As of September 28, 2013, the Company posted cash collateral related to the derivative instruments under its collateral security arrangements of $164 million, which were recorded as other current assets in the Consolidated Balance Sheet. The Company did not have any derivative instruments with credit-risk related contingent features that would require it to post additional collateral as of September 27, 2014 or September 28, 2013.

Under master netting arrangements with the respective counterparties to the Company’s derivative contracts, the Company is allowed to net settle transactions with a single net amount payable by one party to the other. As of September 27, 2014 and September 28, 2013, the potential effects of these rights of set-off associated with the Company’s derivative contracts, including the effects of collateral, would be a reduction to both derivative assets and derivative liabilities of $1.6 billion and $333 million, respectively, resulting in net derivative liabilities of $549 million and $57 million, respectively.

 

15


The following tables show the Company’s derivative instruments at gross fair value as reflected in the Consolidated Balance Sheets as of September 27, 2014 and September 28, 2013 (in millions):

 

    2014  
    Fair Value of Derivatives
Designated as Hedge Instruments
    Fair Value of Derivatives Not
Designated as Hedge Instruments
    Total
Fair Value
 

Derivative assets (1) :

     

Foreign exchange contracts

  $ 1,332      $ 222      $ 1,554   

Interest rate contracts

  $ 81      $ 0      $ 81   

Derivative liabilities (2) :

     

Foreign exchange contracts

  $ 41      $ 40      $ 81   

 

    2013  
    Fair Value of Derivatives
Designated as Hedge Instruments
    Fair Value of Derivatives Not
Designated as Hedge Instruments
    Total
Fair Value
 

Derivative assets (1) :

     

Foreign exchange contracts

  $ 145      $ 25      $ 170   

Interest rate contracts

  $ 44      $ 0      $ 44   

Derivative liabilities (2) :

     

Foreign exchange contracts

  $ 389      $ 46      $ 435   

 

  (1)

The fair value of derivative assets is measured using Level 2 fair value inputs and is recorded as other current assets in the Consolidated Balance Sheets.

 

 

  (2)

The fair value of derivative liabilities is measured using Level 2 fair value inputs and is recorded as accrued expenses in the Consolidated Balance Sheets.

 

The following tables show the pre-tax effect of the Company’s derivative instruments designated as cash flow, net investment and fair value hedges on OCI and the Consolidated Statements of Operations for 2014, 2013 and 2012 (in millions):

 

                                                                                                                       
    Gains/(Losses) Recognized in
OCI - Effective  Portion
    Gains/(Losses) Reclassified from AOCI
into  Net Income - Effective Portion
 
    2014     2013     2012     2014     2013     2012  

Cash flow hedges:

     

Foreign exchange contracts

  $ 1,750      $ 891      $ (175   $ (154   $ 676      $ 607   

Interest rate contracts

    (15     12        0        (16     (6     0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 1,735      $ 903      $ (175   $ (170   $ 670      $ 607   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net investment hedges:

           

Foreign exchange contracts

  $ 53      $ 143      $ (5   $ 0      $ 0      $ 0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    Gains/(Losses) On Derivative Instruments     Gains/(Losses) Related to Hedged Items  
    2014     2013     2012     2014     2013     2012  

Fair value hedges:

           

Interest rate contracts

  $ 39      $ 0      $ 0      $ (39   $ 0      $ 0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The Company recognized a charge of $120 million, $301 million and $658 million in other income and expense during 2014, 2013 and 2012, respectively, for the ineffective portions of and amounts excluded from the effectiveness testing of cash flow hedges. The ineffective portions of and amounts excluded from the effectiveness testing of net investment and fair value hedges recognized in other income and expense were not significant during 2014, 2013 and 2012.

 

16


Accounts Receivable

Trade Receivables

The Company has considerable trade receivables outstanding with its third-party cellular network carriers, wholesalers, retailers, value-added resellers, small and mid-sized businesses, and education, enterprise and government customers. The Company generally does not require collateral from its customers; however, the Company will require collateral in certain instances to limit credit risk. In addition, when possible, the Company attempts to limit credit risk on trade receivables with credit insurance for certain customers or by requiring third-party financing, loans or leases to support credit exposure. These credit-financing arrangements are directly between the third-party financing company and the end customer. As such, the Company generally does not assume any recourse or credit risk sharing related to any of these arrangements.

As of September 27, 2014, the Company had two customers that represented 10% or more of total trade receivables, one of which accounted for 16% and the other 13%. As of September 28, 2013, the Company had two customers that represented 10% or more of total trade receivables, one of which accounted for 13% and the other 10%. The Company’s cellular network carriers accounted for 72% and 68% of trade receivables as of September 27, 2014 and September 28, 2013, respectively. The additions and write-offs to the Company’s allowance for doubtful accounts during 2014, 2013 and 2012 were not significant.

Vendor Non-Trade Receivables

The Company has non-trade receivables from certain of its manufacturing vendors resulting from the sale of components to these manufacturing vendors who manufacture sub-assemblies or assemble final products for the Company. The Company purchases these components directly from suppliers. Three of the Company’s vendors accounted for 51%, 16% and 14% of total vendor non-trade receivables as of September 27, 2014 and three of the Company’s vendors accounted for 47%, 21% and 15% of total vendor non-trade receivables as of September 28, 2013. The Company does not reflect the sale of these components in net sales and does not recognize any profits on these sales until the related products are sold by the Company, at which time any profit is recognized as a reduction of cost of sales.

Note 3 – Consolidated Financial Statement Details

The following tables show the Company’s consolidated balance sheet details as of September 27, 2014 and September 28, 2013 (in millions):

Inventories

 

                                     
    2014     2013  

Components

  $ 471      $ 683   

Finished goods

    1,640        1,081   
 

 

 

   

 

 

 

Total inventories

$ 2,111    $ 1,764   
 

 

 

   

 

 

 

Property, Plant and Equipment

 

                                     
    2014     2013  

Land and buildings

  $ 4,863      $ 3,309   

Machinery, equipment and internal-use software

    29,639        21,242   

Leasehold improvements

    4,513        3,968   
 

 

 

   

 

 

 

Gross property, plant and equipment

  39,015      28,519   

Accumulated depreciation and amortization

  (18,391   (11,922
 

 

 

   

 

 

 

Net property, plant and equipment

$ 20,624    $ 16,597   
 

 

 

   

 

 

 

 

17


Accrued Expenses

 

                                     
    2014     2013  

Accrued warranty and related costs

  $ 4,159      $ 2,967   

Accrued marketing and selling expenses

    2,321        1,291   

Accrued taxes

    1,209        1,200   

Accrued compensation and employee benefits

    1,209        959   

Deferred margin on component sales

    1,057        1,262   

Other current liabilities

    8,498        6,177   
 

 

 

   

 

 

 

Total accrued expenses

$ 18,453    $ 13,856   
 

 

 

   

 

 

 

Non-Current Liabilities

 

                                     
    2014     2013  

Deferred tax liabilities

  $ 20,259      $ 16,489   

Other non-current liabilities

    4,567        3,719   
 

 

 

   

 

 

 

Total other non-current liabilities

$ 24,826    $ 20,208   
 

 

 

   

 

 

 

Other Income and Expense

The following table shows the detail of other income and expense for 2014, 2013 and 2012 (in millions):

 

                                                        
    2014     2013     2012  

Interest and dividend income

  $ 1,795      $ 1,616      $ 1,088   

Interest expense

    (384     (136     0   

Other expense, net

    (431     (324     (566
 

 

 

   

 

 

   

 

 

 

Total other income/(expense), net

$ 980    $ 1,156    $ 522   
 

 

 

   

 

 

   

 

 

 

Note 4 – Goodwill and Other Intangible Assets

On July 31, 2014, the Company completed the acquisitions of Beats Music, LLC, which offers a subscription streaming music service, and Beats Electronics, LLC, which makes Beats ® headphones, speakers and audio software (collectively, “Beats”). The total purchase price consideration for these acquisitions was $2.6 billion, which consisted primarily of cash, of which $2.2 billion was allocated to goodwill, $636 million to acquired intangible assets and $258 million to net liabilities assumed. Concurrent with the close of the acquisition, the Company repaid $295 million of existing Beats outstanding debt to third-party creditors. In conjunction with the Beats acquisitions, the Company issued approximately 5.1 million shares of its common stock to certain former equity holders of Beats. The restricted stock was valued at approximately $485 million based on the Company’s common stock on the acquisition date. The majority of these shares, valued at approximately $417 million, will vest over time based on continued employment with Apple.

The Company also completed various other business acquisitions during 2014 for an aggregate cash consideration, net of cash acquired, of $957 million, of which $828 million was allocated to goodwill, $257 million to acquired intangible assets and $128 million to net liabilities assumed.

The Company completed various business acquisitions during 2013 for an aggregate cash consideration, net of cash acquired, of $496 million, of which $419 million was allocated to goodwill, $179 million to acquired intangible assets and $102 million to net liabilities assumed.

The Company’s gross carrying amount of goodwill was $4.6 billion and $1.6 billion as of September 27, 2014 and September 28, 2013, respectively. The Company did not have any goodwill impairments during 2014, 2013 or 2012.

 

18


The following table summarizes the components of gross and net intangible asset balances as of September 27, 2014 and September 28, 2013 (in millions):

 

                                                                                                                                               
    2014     2013  
    Gross
Carrying
Amount
    Accumulated
Amortization
    Net
Carrying
Amount
    Gross
Carrying
Amount
    Accumulated
Amortization
    Net
Carrying
Amount
 

Definite-lived and amortizable acquired intangible assets

  $ 7,127      $ (3,085   $ 4,042      $ 6,081      $ (2,002   $ 4,079   

Indefinite-lived and non-amortizable acquired intangible assets

    100        0        100        100        0        100   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total acquired intangible assets

  $ 7,227      $ (3,085   $ 4,142      $ 6,181      $ (2,002   $ 4,179   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Amortization expense related to acquired intangible assets was $1.1 billion, $960 million and $605 million in 2014, 2013 and 2012, respectively. As of September 27, 2014, the remaining weighted-average amortization period for acquired intangible assets is 3.8 years. The expected annual amortization expense related to acquired intangible assets as of September 27, 2014, is as follows (in millions):

 

                  

2015

  $ 1,204   

2016

    1,083   

2017

    825   

2018

    592   

2019

    175   

Thereafter

    163   
 

 

 

 

Total

  $ 4,042   
 

 

 

 

Note 5 – Income Taxes

The provision for income taxes for 2014, 2013 and 2012, consisted of the following (in millions):

 

                                                        
    2014     2013     2012  

Federal:

     

Current

  $ 8,624      $ 9,334      $ 7,240   

Deferred

    3,183        1,878        5,018   
 

 

 

   

 

 

   

 

 

 
    11,807        11,212        12,258   
 

 

 

   

 

 

   

 

 

 

State:

     

Current

    855        1,084        1,182   

Deferred

    (178     (311     (123
 

 

 

   

 

 

   

 

 

 
    677        773        1,059   
 

 

 

   

 

 

   

 

 

 

Foreign:

     

Current

    2,147        1,559        1,203   

Deferred

    (658     (426     (490
 

 

 

   

 

 

   

 

 

 
    1,489        1,133        713   
 

 

 

   

 

 

   

 

 

 

Provision for income taxes

  $ 13,973      $ 13,118      $ 14,030   
 

 

 

   

 

 

   

 

 

 

The foreign provision for income taxes is based on foreign pre-tax earnings of $33.6 billion, $30.5 billion and $36.8 billion in 2014, 2013 and 2012, respectively. The Company’s consolidated financial statements provide for any related tax liability on undistributed earnings that the Company does not intend to be indefinitely reinvested outside the U.S. Substantially all of the Company’s undistributed international earnings intended to be indefinitely reinvested in operations outside the U.S. were generated by subsidiaries organized in Ireland, which has a statutory tax rate of 12.5%. As of September 27, 2014, U.S. income taxes have not been provided on a cumulative total of $69.7 billion of such earnings. The amount of unrecognized deferred tax liability related to these temporary differences is estimated to be approximately $23.3 billion.

 

19


As of September 27, 2014 and September 28, 2013, $137.1 billion and $111.3 billion, respectively, of the Company’s cash, cash equivalents and marketable securities were held by foreign subsidiaries and are generally based in U.S. dollar-denominated holdings. Amounts held by foreign subsidiaries are generally subject to U.S. income taxation on repatriation to the U.S.

A reconciliation of the provision for income taxes, with the amount computed by applying the statutory federal income tax rate (35% in 2014, 2013 and 2012) to income before provision for income taxes for 2014, 2013 and 2012, is as follows (dollars in millions):

 

                                                        
    2014     2013     2012  

Computed expected tax

  $ 18,719      $ 17,554      $ 19,517   

State taxes, net of federal effect

    469        508        677   

Indefinitely invested earnings of foreign subsidiaries

    (4,744     (4,614     (5,895

Research and development credit, net

    (88     (287     (103

Domestic production activities deduction

    (495     (308     (328

Other

    112        265        162   
 

 

 

   

 

 

   

 

 

 

Provision for income taxes

  $ 13,973      $ 13,118      $ 14,030   
 

 

 

   

 

 

   

 

 

 

Effective tax rate

    26.1%        26.2%        25.2%   

The Company’s income taxes payable have been reduced by the tax benefits from employee stock plan awards. For stock options, the Company receives an income tax benefit calculated as the tax effect of the difference between the fair market value of the stock issued at the time of the exercise and the exercise price. For RSUs, the Company receives an income tax benefit upon the award’s vesting equal to the tax effect of the underlying stock’s fair market value. The Company had net excess tax benefits from equity awards of $706 million, $643 million and $1.4 billion in 2014, 2013 and 2012, respectively, which were reflected as increases to common stock.

As of September 27, 2014 and September 28, 2013, the significant components of the Company’s deferred tax assets and liabilities were (in millions):

 

                                     
    2014     2013  

Deferred tax assets:

 

Accrued liabilities and other reserves

  $ 2,761      $ 1,892   

Deferred revenue

    1,787        1,475   

Basis of capital assets and investments

    898        1,020   

Share-based compensation

    454        458   

Other

    644        1,029   
 

 

 

   

 

 

 

Total deferred tax assets

    6,544        5,874   

Less valuation allowance

    0        0   
 

 

 

   

 

 

 

Deferred tax assets, net of valuation allowance

    6,544        5,874   
 

 

 

   

 

 

 

Deferred tax liabilities:

   

Unremitted earnings of foreign subsidiaries

    21,544        18,044   

Other

    120        112   
 

 

 

   

 

 

 

Total deferred tax liabilities

    21,664        18,156   
 

 

 

   

 

 

 

Net deferred tax liabilities

  $ (15,120   $ (12,282
 

 

 

   

 

 

 

Deferred tax assets and liabilities reflect the effects of tax losses, credits and the future income tax effects of temporary differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases and are measured using enacted tax rates that apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.

 

20


Uncertain Tax Positions

Tax positions are evaluated in a two-step process. The Company first determines whether it is more likely than not that a tax position will be sustained upon examination. If a tax position meets the more-likely-than-not recognition threshold it is then measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. The Company classifies gross interest and penalties and unrecognized tax benefits that are not expected to result in payment or receipt of cash within one year as non-current liabilities in the Consolidated Balance Sheets.

As of September 27, 2014, the total amount of gross unrecognized tax benefits was $4.0 billion, of which $1.4 billion, if recognized, would affect the Company’s effective tax rate. As of September 28, 2013, the total amount of gross unrecognized tax benefits was $2.7 billion, of which $1.4 billion, if recognized, would affect the Company’s effective tax rate.

The aggregate changes in the balance of gross unrecognized tax benefits, which excludes interest and penalties, for 2014, 2013 and 2012, is as follows (in millions):

 

                                                        
    2014     2013     2012  

Beginning Balance

  $ 2,714      $ 2,062      $ 1,375   

Increases related to tax positions taken during a prior year

    1,295        745        340   

Decreases related to tax positions taken during a prior year

    (280     (118     (107

Increases related to tax positions taken during the current year

    882        626        467   

Decreases related to settlements with taxing authorities

    (574     (592     (3

Decreases related to expiration of statute of limitations

    (4     (9     (10
 

 

 

   

 

 

   

 

 

 

Ending Balance

  $ 4,033      $ 2,714      $ 2,062   
 

 

 

   

 

 

   

 

 

 

The Company includes interest and penalties related to unrecognized tax benefits within the provision for income taxes. As of September 27, 2014 and September 28, 2013, the total amount of gross interest and penalties accrued was $630 million and $590 million, respectively, which is classified as non-current liabilities in the Consolidated Balance Sheets. In connection with tax matters, the Company recognized interest and penalty expense in 2014, 2013 and 2012 of $40 million, $189 million and $140 million, respectively.

The Company is subject to taxation and files income tax returns in the U.S. federal jurisdiction and in many state and foreign jurisdictions. During the fiscal year ended September 27, 2014, the U.S. Internal Revenue Service (“IRS”) concluded its review of the years 2004 through 2009, which resulted in the Company reducing its gross unrecognized tax benefits by $570 million and recognizing a tax benefit of $166 million. The IRS is currently examining the years 2010 through 2012. In addition, the Company is also subject to audits by state, local and foreign tax authorities. In major states and major foreign jurisdictions, the years subsequent to 1996 and 2002, respectively, generally remain open and could be subject to examination by the taxing authorities.

Management believes that an adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in the Company’s tax audits are resolved in a manner not consistent with management’s expectations, the Company could be required to adjust its provision for income taxes in the period such resolution occurs. Although timing of the resolution and/or closure of audits is not certain, the Company does not believe it is reasonably possible that its unrecognized tax benefits would materially change in the next 12 months.

Note 6 – Debt

Commercial Paper

In April 2014, the Board of Directors authorized the Company to issue unsecured short-term promissory notes (“Commercial Paper”) pursuant to a commercial paper program. The Company intends to use net proceeds from the commercial paper program for general corporate purposes, including dividends and share repurchases. As of September 27, 2014, the Company had $6.3 billion of Commercial Paper outstanding, with a weighted-average interest rate of 0.12% and maturities generally less than nine months.

 

21


The following table provides a summary of cash flows associated with the issuance and maturities of Commercial Paper for 2014 (in millions):

 

                  

Maturities less than 90 days:

 

Proceeds from (repayments of) commercial paper, net

  $ 1,865   

Maturities greater than 90 days:

 

Proceeds from commercial paper

    4,771   

Repayments of commercial paper

    (330
 

 

 

 

Maturities greater than 90 days, net

    4,441   
 

 

 

 

Total proceeds from issuance of commercial paper, net

  $ 6,306   
 

 

 

 

Long-Term Debt

In the third quarter of 2014 and 2013, the Company issued $12.0 billion and $17.0 billion of long-term debt, respectively. The debt issuances included floating- and fixed-rate notes with varying maturities for an aggregate principal amount of $29.0 billion (collectively the “Notes”). The Notes are senior unsecured obligations, and interest is payable in arrears, quarterly for the floating-rate notes and semi-annually for the fixed-rate notes.

The following table provides a summary of the Company’s long-term debt as of September 27, 2014 and September 28, 2013:

 

                                                                           
    2014     2013  
    Amount
(in millions)
    Effective
Interest Rate
    Amount
(in millions)
    Effective
Interest Rate
 

Floating-rate notes due 2016

  $ 1,000        0.51%      $ 1,000        0.51%   

Floating-rate notes due 2017

    1,000        0.31%        0        0   

Floating-rate notes due 2018

    2,000        1.10%        2,000        1.10%   

Floating-rate notes due 2019

    1,000        0.54%        0        0   

Fixed-rate 0.45% notes due 2016

    1,500        0.51%        1,500        0.51%   

Fixed-rate 1.05% notes due 2017

    1,500        0.30%        0        0   

Fixed-rate 1.00% notes due 2018

    4,000        1.08%        4,000        1.08%   

Fixed-rate 2.10% notes due 2019

    2,000        0.53%        0        0   

Fixed-rate 2.85% notes due 2021

    3,000        0.79%        0        0   

Fixed-rate 2.40% notes due 2023

    5,500        2.44%        5,500        2.44%   

Fixed-rate 3.45% notes due 2024

    2,500        0.90%        0        0   

Fixed-rate 3.85% notes due 2043

    3,000        3.91%        3,000        3.91%   

Fixed-rate 4.45% notes due 2044

    1,000        4.48%        0        0   
 

 

 

     

 

 

   

Total borrowings

    29,000          17,000     
 

 

 

     

 

 

   

Unamortized discount

    (52       (40  

Hedge accounting fair value adjustments

    39          0     
 

 

 

     

 

 

   

Total long-term debt

  $ 28,987        $ 16,960     
 

 

 

     

 

 

   

The Company has entered, and may enter in the future, into interest rate swaps to manage interest rate risk on the Notes. Such swaps allow the Company to effectively convert fixed-rate payments into floating-rate payments or floating-rate payments into fixed-rate payments. In the third quarter of 2014, the Company entered into interest rate swaps with an aggregate notional amount of $9.0 billion, which effectively converted the fixed-rate notes due 2017, 2019, 2021 and 2024 into floating-rate notes. In the third quarter of 2013, the Company entered into interest rate swaps with an aggregate notional amount of $3.0 billion, which effectively converted the floating-rate notes due 2016 and 2018 into fixed-rate notes.

The effective rates for the Notes include the interest on the Notes, amortization of the discount and, if applicable, adjustments related to hedging. The Company recognized $381 million and $136 million of interest expense on its long-term debt for the years ended September 27, 2014 and September 28, 2013, respectively. The Company did not have any long-term debt in 2012.

 

22


Future principal payments for the Company’s Notes as of September 27, 2014, are as follows (in millions):

 

                  

2015

  $ 0   

2016

    2,500   

2017

    2,500   

2018

    6,000   

2019

    3,000   

Thereafter

    15,000   
 

 

 

 

Total

  $ 29,000   
 

 

 

 

As of September 27, 2014 and September 28, 2013, the fair value of the Company’s Notes, based on Level 2 inputs, was $28.5 billion and $15.9 billion, respectively.

Note 7 – Shareholders’ Equity

Preferred and Common Stock

During the second quarter of 2014, the Company’s shareholders approved amendments (the “Amendments”) to the Company’s Restated Articles of Incorporation. The Amendments included the elimination of the Board of Directors’ authority to issue preferred stock and established a par value for the Company’s common stock of $0.00001 per share.

Dividends

The Company declared and paid cash dividends per common share during the periods presented as follows:

 

                                     
    Dividends
Per Share
    Amount
(in millions)
 
2014:    

Fourth quarter

  $ 0.47      $ 2,807   

Third quarter

    0.47        2,830   

Second quarter

    0.44        2,655   

First quarter

    0.44        2,739   
 

 

 

   

 

 

 

Total

  $ 1.82      $ 11,031   
 

 

 

   

 

 

 
2013:    

Fourth quarter

  $ 0.44      $ 2,763   

Third quarter

    0.44        2,789   

Second quarter

    0.38        2,490   

First quarter

    0.38        2,486   
 

 

 

   

 

 

 

Total

  $ 1.64      $ 10,528   
 

 

 

   

 

 

 

The Company paid cash dividends of $0.38 per share, totaling $2.5 billion, during the fourth quarter of 2012. Future dividends are subject to declaration by the Board of Directors.

Share Repurchase Program

In 2012, the Company’s Board of Directors authorized a program to repurchase up to $10 billion of the Company’s common stock beginning in 2013. The Company’s Board of Directors increased the share repurchase authorization to $60 billion in April 2013 and to $90 billion in April 2014. As of September 27, 2014, $67.9 billion of the $90 billion had been utilized. The Company’s share repurchase program does not obligate it to acquire any specific number of shares. Under the program, shares may be repurchased in privately negotiated and/or open market transactions, including under plans complying with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

 

23


The Company has entered into four accelerated share repurchase arrangements (“ASRs”) with financial institutions beginning in August 2012. In exchange for up-front payments, the financial institutions deliver shares of the Company’s common stock during the purchase periods of each ASR. The total number of shares ultimately delivered, and therefore the average repurchase price paid per share, will be determined at the end of the applicable purchase period of each ASR based on the volume weighted-average price of the Company’s common stock during that period. The shares received are retired in the periods they are delivered, and the up-front payments are accounted for as a reduction to shareholders’ equity in the Company’s Consolidated Balance Sheet in the periods the payments are made. The Company reflects the ASRs as a repurchase of common stock in the period delivered for purposes of calculating earnings per share and as forward contracts indexed to its own common stock. The ASRs met all of the applicable criteria for equity classification, and therefore, were not accounted for as derivative instruments.

The following table presents the Company’s ASRs:

 

                                                                                                           
    Purchase
Period End
Date
     Number of
Shares
(in thousands)
     Average
Repurchase
Price Per
Share
     ASR
Amount
(in millions)
 

August 2014 ASR

         (1)         59,924  (1)              (1)       $ 9,000   

January 2014 ASR

         (1)         134,247  (1)              (1)       $ 12,000   

April 2013 ASR

    March 2014            172,548  (2)       $ 69.55          $ 12,000   

August 2012 ASR

    April 2013            28,544           $ 68.31          $ 1,950   

 

  (1)

“Number of Shares” represents those shares delivered in advance of settlement and does not represent the final number of shares to be delivered under the ASRs. The total number of shares ultimately delivered, and therefore the average repurchase price paid per share, will be determined at the end of the applicable purchase period based on the volume weighted-average price of the Company’s common stock during that period. The August 2014 ASR and January 2014 ASR purchase periods will end in or before February 2015 and December 2014, respectively.

 

 

  (2)  

Includes 8.0 million shares that were delivered and retired at the end of the purchase period, which concluded in the second quarter of 2014.

 

Additionally, the Company repurchased shares of its common stock in the open market, which were retired upon repurchase, during the periods presented as follows:

 

                                                                                                                 
    Number of Shares
(in thousands)
    Average Repurchase
Price Per Share
    Amount
(in millions)
 
2014:      

Fourth quarter

    81,255      $ 98.46      $ 8,000   

Third quarter

    58,661      $ 85.23        5,000   

Second quarter

    79,749      $ 75.24        6,000   

First quarter

    66,847      $ 74.79        5,000   
 

 

 

     

 

 

 

Total

    286,512        $ 24,000   
 

 

 

     

 

 

 
2013:      

Fourth quarter

    73,064      $ 68.43      $ 5,000   

Third quarter

    62,676      $ 63.82        4,000   

Second quarter

    0      $ 0        0   

First quarter

    0      $ 0        0   
 

 

 

     

 

 

 

Total

    135,740        $ 9,000   
 

 

 

     

 

 

 

 

24


Note 8 – Comprehensive Income

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

The following table shows the gross amounts reclassified from AOCI into the Consolidated Statements of Operations and the associated financial statement line item for 2014 (in millions):

 

Comprehensive Income Components

 

Financial Statement Line Item

  2014  

Unrecognized gains/losses on derivative instruments:

   

Foreign exchange contracts

 

Revenue

  $ 449   
 

Cost of sales

    (295
 

Other income/expense, net

             15   

Interest rate contracts

 

Other income/expense, net

    16   
   

 

 

 
      185   

Unrealized gains/losses on marketable securities

 

Other income/expense, net

    (205
   

 

 

 

Total amounts reclassified from AOCI

  $ (20
   

 

 

 

The following table shows the changes in AOCI by component for 2014 (in millions):

 

                                                                                                       
    Cumulative
Foreign
Currency
Translation
    Unrecognized
Gains/Losses
on Derivative
Instruments
    Unrealized
Gains
/Losses on
Marketable
Securities
    Total  

Balance at September 28, 2013

  $ (105   $ (175   $ (191   $ (471
 

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income/(loss) before reclassifications

    (187     1,687        438        1,938   

Amounts reclassified from AOCI

    0        185        (205     (20

Tax effect

    50        (333     (82     (365
 

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income/(loss)

    (137     1,539        151        1,553   
 

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 27, 2014

  $ (242   $ 1,364      $ (40   $ 1,082   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

25


Note 9 – Benefit Plans

Stock Plans

2014 Employee Stock Plan

In the second quarter of 2014, shareholders approved the 2014 Employee Stock Plan (the “2014 Plan”) and terminated the Company’s authority to grant new awards under the 2003 Employee Stock Plan (the “2003 Plan”). The 2014 Plan provides for broad-based equity grants to employees, including executive officers, and permits the granting of RSUs, stock grants, performance-based awards, stock options and stock appreciation rights, as well as cash bonus awards. RSUs granted under the 2014 Plan generally vest over four years, based on continued employment, and are settled upon vesting in shares of the Company’s common stock on a one-for-one basis. Each share issued with respect to RSUs granted under the 2014 Plan reduces the number of shares available for grant under the plan by two shares. RSUs cancelled and shares withheld to satisfy tax withholding obligations increase the number of shares available for grant under the 2014 Plan utilizing a factor of two times the number of RSUs cancelled or shares withheld. Currently, all RSUs granted under the 2014 Plan have dividend equivalent rights (“DERs”), which entitle holders of RSUs to the same dividend value per share as holders of common stock. DERs are subject to the same vesting and other terms and conditions as the corresponding unvested RSUs. DERs are accumulated and paid when the underlying shares vest. Upon approval of the 2014 Plan, the Company reserved 385 million shares plus the number of shares remaining that were reserved but not issued under the 2003 Plan. Shares subject to outstanding awards under the 2003 Plan that expire, are cancelled or otherwise terminate, or are withheld to satisfy tax withholding obligations with respect to RSUs, will also be available for awards under the 2014 Plan. As of September 27, 2014, approximately 492.6 million shares were reserved for future issuance under the 2014 Plan.

2003 Employee Stock Plan

The 2003 Plan is a shareholder approved plan that provided for broad-based equity grants to employees, including executive officers. The 2003 Plan permitted the granting of incentive stock options, nonstatutory stock options, RSUs, stock appreciation rights, stock purchase rights and performance-based awards. Options granted under the 2003 Plan generally expire seven to ten years after the grant date and generally become exercisable over a period of four years, based on continued employment, with either annual, semi-annual or quarterly vesting. RSUs granted under the 2003 Plan generally vest over two to four years, based on continued employment and are settled upon vesting in shares of the Company’s common stock on a one-for-one basis. All RSUs, other than RSUs held by the Chief Executive Officer, granted under the 2003 Plan have DERs. DERs are subject to the same vesting and other terms and conditions as the corresponding unvested RSUs. DERs are accumulated and paid when the underlying shares vest. In the second quarter of 2014, the Company terminated the authority to grant new awards under the 2003 Plan.

1997 Director Stock Plan

The 1997 Director Stock Plan (the “Director Plan”) is a shareholder approved plan that (i) permits the Company to grant awards of RSUs or stock options to the Company’s non-employee directors, (ii) provides for automatic initial grants of RSUs upon a non-employee director joining the Board of Directors and automatic annual grants of RSUs at each annual meeting of shareholders, and (iii) permits the Board of Directors to prospectively change the relative mixture of stock options and RSUs for the initial and annual award grants and the methodology for determining the number of shares of the Company’s common stock subject to these grants without shareholder approval. Each share issued with respect to RSUs granted under the Director Plan reduces the number of shares available for grant under the plan by two shares. The Director Plan expires November 9, 2019. All RSUs granted under the Director Plan are entitled to DERs. DERs are subject to the same vesting and other terms and conditions as the corresponding unvested RSUs. DERs are accumulated and paid when the underlying shares vest. As of September 27, 2014, approximately 1.2 million shares were reserved for future issuance under the Director Plan.

Rule 10b5-1 Trading Plans

During the fourth quarter of 2014, Section 16 officers Timothy D. Cook, Luca Maestri, Daniel Riccio, Philip W. Schiller, D. Bruce Sewell and Jeffrey E. Williams had equity trading plans in place in accordance with Rule 10b5-1(c)(1) under the Exchange Act. An equity trading plan is a written document that pre-establishes the amounts, prices and dates (or formula for determining the amounts, prices and dates) of future purchases or sales of the Company’s stock, including shares acquired pursuant to the Company’s employee and director equity plans.

 

26


Employee Stock Purchase Plan

The Employee Stock Purchase Plan (the “Purchase Plan”) is a shareholder approved plan under which substantially all employees may purchase the Company’s common stock through payroll deductions at a price equal to 85% of the lower of the fair market values of the stock as of the beginning or the end of six-month offering periods. An employee’s payroll deductions under the Purchase Plan are limited to 10% of the employee’s compensation and employees may not purchase more than $25,000 of stock during any calendar year. As of September 27, 2014, approximately 7.6 million shares were reserved for future issuance under the Purchase Plan.

401(k) Plan

The Company’s 401(k) Plan is a deferred salary arrangement under Section 401(k) of the Internal Revenue Code. Under the 401(k) Plan, participating U.S. employees may defer a portion of their pre-tax earnings, up to the IRS annual contribution limit ($17,500 for calendar year 2014). The Company matches 50% to 100% of each employee’s contributions, depending on length of service, up to a maximum 6% of the employee’s eligible earnings. The Company’s matching contributions to the 401(k) Plan were $163 million, $135 million and $114 million in 2014, 2013 and 2012, respectively.

Restricted Stock Units

A summary of the Company’s RSU activity and related information for 2014, 2013 and 2012, is as follows:

 

                                                                                                                             
    Number of RSUs
(in thousands)
    Weighted-Average
Grant  Date Fair Value
Per Share
    Aggregate
Intrinsic Value

(in millions)
 

Balance at September 24, 2011

    101,122      $ 33.07     

RSUs granted

    54,597      $ 61.62     

RSUs vested

    (44,137   $ 29.32     

RSUs cancelled

    (6,545   $ 36.57     
 

 

 

     

Balance at September 29, 2012

    105,037      $ 49.27     

RSUs granted

    39,415      $ 78.23     

RSUs vested

    (42,291   $ 45.96     

RSUs cancelled

    (8,877   $ 57.31     
 

 

 

     

Balance at September 28, 2013

    93,284      $ 62.24     

RSUs granted

    59,269      $ 74.54     

RSUs vested

    (43,111   $ 57.29     

RSUs cancelled

    (5,620   $ 68.47     
 

 

 

     

Balance at September 27, 2014

    103,822      $ 70.98      $ 10,460   
 

 

 

     

The fair value as of the respective vesting dates of RSUs was $3.4 billion, $3.1 billion and $3.3 billion for 2014, 2013 and 2012, respectively. The majority of RSUs that vested in 2014, 2013 and 2012 were net-share settled such that the Company withheld shares with value equivalent to the employees’ minimum statutory obligation for the applicable income and other employment taxes, and remitted the cash to the appropriate taxing authorities. The total shares withheld were approximately 15.6 million, 15.5 million and 16.1 million for 2014, 2013 and 2012, respectively, and were based on the value of the RSUs on their respective vesting dates as determined by the Company’s closing stock price. Total payments for the employees’ tax obligations to taxing authorities were $1.2 billion, $1.1 billion and $1.2 billion in 2014, 2013 and 2012, respectively, and are reflected as a financing activity within the Consolidated Statements of Cash Flows. These net-share settlements had the effect of share repurchases by the Company as they reduced and retired the number of shares that would have otherwise been issued as a result of the vesting and did not represent an expense to the Company.

Stock Options

The Company had 6.6 million stock options outstanding as of September 27, 2014, with a weighted-average exercise price per share of $21.99 and weighted-average remaining contractual term of 1.4 years, substantially all of which are exercisable. The aggregate intrinsic value of the stock options outstanding as of September 27, 2014 was $520 million, which represents the value of the Company’s closing stock price on the last trading day of the period in excess of the weighted-average exercise price multiplied by the number of options outstanding. Total intrinsic value of options at time of exercise was $1.5 billion, $1.0 billion and $2.3 billion for 2014, 2013 and 2012, respectively.

 

27


Share-based Compensation

The following table shows a summary of the share-based compensation expense included in the Consolidated Statements of Operations for 2014, 2013 and 2012 (in millions):

 

                                                        
    2014     2013     2012  

Cost of sales

  $ 450      $ 350      $ 265   

Research and development

    1,216        917        668   

Selling, general and administrative

    1,197        986        807   
 

 

 

   

 

 

   

 

 

 

Total share-based compensation expense

  $ 2,863      $ 2,253      $ 1,740   
 

 

 

   

 

 

   

 

 

 

The income tax benefit related to share-based compensation expense was $1.0 billion, $816 million and $567 million for 2014, 2013 and 2012, respectively. As of September 27, 2014, the total unrecognized compensation cost related to outstanding stock options, RSUs and restricted stock was $6.3 billion, which the Company expects to recognize over a weighted-average period of 2.9 years.

Note 10 – Commitments and Contingencies

Accrued Warranty and Indemnification

The Company offers a basic limited parts and labor warranty on its hardware products. The basic warranty period for hardware products is typically one year from the date of purchase by the end-user. The Company also offers a 90-day basic warranty for its service parts used to repair the Company’s hardware products. The Company provides currently for the estimated cost that may be incurred under its basic limited product warranties at the time related revenue is recognized. Factors considered in determining appropriate accruals for product warranty obligations include the size of the installed base of products subject to warranty protection, historical and projected warranty claim rates, historical and projected cost-per-claim and knowledge of specific product failures that are outside of the Company’s typical experience. The Company assesses the adequacy of its pre-existing warranty liabilities and adjusts the amounts as necessary based on actual experience and changes in future estimates.

The following table shows changes in the Company’s accrued warranties and related costs for 2014, 2013 and 2012 (in millions):

 

                                                        
    2014     2013     2012  

Beginning accrued warranty and related costs

  $ 2,967      $ 1,638      $ 1,240   

Cost of warranty claims

    (3,760     (3,703     (1,786

Accruals for product warranty

    4,952        5,032        2,184   
 

 

 

   

 

 

   

 

 

 

Ending accrued warranty and related costs

  $ 4,159      $ 2,967      $ 1,638   
 

 

 

   

 

 

   

 

 

 

The Company generally does not indemnify end-users of its operating system and application software against legal claims that the software infringes third-party intellectual property rights. Other agreements entered into by the Company sometimes include indemnification provisions under which the Company could be subject to costs and/or damages in the event of an infringement claim against the Company or an indemnified third-party. However, the Company has not been required to make any significant payments resulting from such an infringement claim asserted against it or an indemnified third-party. In the opinion of management, there was not at least a reasonable possibility the Company may have incurred a material loss with respect to indemnification of end-users of its operating system or application software for infringement of third-party intellectual property rights. The Company did not record a liability for infringement costs related to indemnification as of September 27, 2014 or September 28, 2013.

The Company has entered into indemnification agreements with its directors and executive officers. Under these agreements, the Company has agreed to indemnify such individuals to the fullest extent permitted by law against liabilities that arise by reason of their status as directors or officers and to advance expenses incurred by such individuals in connection with related legal proceedings. It is not possible to determine the maximum potential amount of payments the Company could be required to make under these agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each claim. However, the Company maintains directors and officers liability insurance coverage to reduce its exposure to such obligations, and payments made under these agreements historically have not been material.

 

28


Concentrations in the Available Sources of Supply of Materials and Product

Although most components essential to the Company’s business are generally available from multiple sources, a number of components are currently obtained from single or limited sources. In addition, the Company competes for various components with other participants in the markets for mobile communication and media devices and personal computers. Therefore, many components used by the Company, including those that are available from multiple sources, are at times subject to industry-wide shortage and significant pricing fluctuations that could materially adversely affect the Company’s financial condition and operating results.

The Company uses some custom components that are not commonly used by its competitors, and new products introduced by the Company often utilize custom components available from only one source. When a component or product uses new technologies, initial capacity constraints may exist until the suppliers’ yields have matured or manufacturing capacity has increased. If the Company’s supply of components for a new or existing product were delayed or constrained, or if an outsourcing partner delayed shipments of completed products to the Company, the Company’s financial condition and operating results could be materially adversely affected. The Company’s business and financial performance could also be materially adversely affected depending on the time required to obtain sufficient quantities from the original source, or to identify and obtain sufficient quantities from an alternative source. Continued availability of these components at acceptable prices, or at all, may be affected if those suppliers concentrated on the production of common components instead of components customized to meet the Company’s requirements.

The Company has entered into agreements for the supply of many components; however, there can be no guarantee that the Company will be able to extend or renew these agreements on similar terms, or at all. Therefore, the Company remains subject to significant risks of supply shortages and price increases that could materially adversely affect its financial condition and operating results.

Substantially all of the Company’s hardware products are manufactured by outsourcing partners that are located primarily in Asia. A significant concentration of this manufacturing is currently performed by a small number of outsourcing partners, often in single locations. Certain of these outsourcing partners are the sole-sourced suppliers of components and manufacturers for many of the Company’s products. Although the Company works closely with its outsourcing partners on manufacturing schedules, the Company’s operating results could be adversely affected if its outsourcing partners were unable to meet their production commitments. The Company’s purchase commitments typically cover its requirements for periods up to 150 days.

Other Off-Balance Sheet Commitments

Operating Leases

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 typically for terms not exceeding 10 years and generally contain multi-year renewal options. Leases for retail space are for terms ranging from five to 20 years, the majority of which are for 10 years, and often contain multi-year renewal options. As of September 27, 2014, the Company’s total future minimum lease payments under noncancelable operating leases were $5.0 billion, of which $3.6 billion related to leases for retail space.

Rent expense under all operating leases, including both cancelable and noncancelable leases, was $717 million, $645 million and $488 million in 2014, 2013 and 2012, respectively. Future minimum lease payments under noncancelable operating leases having remaining terms in excess of one year as of September 27, 2014, are as follows (in millions):

 

2015

   $ 662   

2016

     676   

2017

     645   

2018

     593   

2019

     534   

Thereafter

     1,877   
  

 

 

 

Total

   $         4,987   
  

 

 

 

 

29


Other Commitments

The Company utilizes several outsourcing partners to manufacture sub-assemblies for the Company’s products and to perform final assembly and testing of finished products. These outsourcing partners acquire components and build product based on demand information supplied by the Company, which typically covers periods up to 150 days. The Company also obtains individual components for its products from a wide variety of individual suppliers. Consistent with industry practice, the Company acquires components through a combination of purchase orders, supplier contracts and open orders based on projected demand information. Where appropriate, the purchases are applied to inventory component prepayments that are outstanding with the respective supplier. As of September 27, 2014, the Company had outstanding off-balance sheet third-party manufacturing commitments and component purchase commitments of $24.5 billion.

In addition to the off-balance sheet commitments mentioned above, the Company had outstanding obligations of $3.4 billion as of September 27, 2014, which consisted mainly of commitments to acquire capital assets, including product tooling and manufacturing process equipment, and commitments related to advertising, R&D, Internet and telecommunications services and other obligations.

Contingencies

The Company is subject to various legal proceedings and claims that have arisen in the ordinary course of business and that have not been fully adjudicated. In the opinion of management, there was not at least a reasonable possibility the Company may have incurred a material loss, or a material loss in excess of a recorded accrual, with respect to loss contingencies. However, the outcome of litigation is inherently uncertain. Therefore, although management considers the likelihood of such an outcome to be remote, if one or more of these legal matters were resolved against the Company in a reporting period for amounts in excess of management’s expectations, the Company’s consolidated financial statements for that reporting period could be materially adversely affected.

Apple Inc. v. Samsung Electronics Co., Ltd, et al.

On August 24, 2012, a jury returned a verdict awarding the Company $1.05 billion in its lawsuit against Samsung Electronics Co., Ltd and affiliated parties in the United States District Court, Northern District of California, San Jose Division. On March 6, 2014, the District Court entered final judgment in favor of the Company in the amount of approximately $930 million. Because the award is now subject to appeal, the Company has not recognized the award in its results of operations.

VirnetX, Inc. v. Apple Inc. et al.

On August 11, 2010, VirnetX, Inc. filed an action against the Company alleging that certain of its products infringed on four patents relating to network communications technology. On November 6, 2012, a jury returned a verdict against the Company, and awarded damages of $368 million. On September 16, 2014, the Court of Appeals for the Federal Circuit affirmed the District Court’s decision in part, reversed in part, and vacated the damages award. The case has been remanded for further proceedings.

 

30


Note 11 – Segment Information and Geographic Data

The Company reports segment information based on the “management” approach. The management approach designates the internal reporting used by management for making decisions and assessing performance as the source of the Company’s reportable segments.

The Company manages its business primarily on a geographic basis. As the Company continues to expand its business, management believes collaboration across its online, retail and indirect channels is integral to better serving its customers and optimizing its financial results. In 2015, management began reporting business performance and making decisions primarily on a geographic basis, including the results of its retail stores in each respective geographic segment. Accordingly, to align with the way the business is currently managed, the Company’s reportable operating segments now consist of the Americas, Europe, Greater China, Japan and Rest of Asia Pacific. Retail is no longer reported as a separate reportable operating segment. The Americas segment includes both North and South America. The Europe segment includes European countries, as well as India, the Middle East and Africa. The Greater China segment includes China, Hong Kong and Taiwan. The Rest of Asia Pacific segment includes Australia and Asian countries, other than those countries included in the Company’s other operating segments. Each operating segment provides similar hardware and software products and similar services. The accounting policies of the various segments are the same as those described in Note 1, “Summary of Significant Accounting Policies.”

The Company evaluates the performance of its operating segments based on net sales and operating income. Net sales for geographic segments are generally based on the location of customers and sales through the Company’s retail stores located in those geographic locations. Operating income for each segment includes net sales to third parties, related cost of sales and operating expenses directly attributable to the segment. In 2015, the Company also began allocating certain costs to its operating segments that were previously included in other corporate expenses, including certain share-based compensation costs. Advertising expenses are generally included in the geographic segment in which the expenditures are incurred. Operating income for each segment excludes other income and expense and certain expenses managed outside the operating segments. Costs excluded from segment operating income include various corporate expenses such as R&D, corporate marketing expenses, certain share-based compensation expense, income taxes, various nonrecurring charges and other separately managed general and administrative costs. The Company does not include intercompany transfers between segments for management reporting purposes.

The following table shows information by operating segment for 2014, 2013 and 2012 (in millions):

 

                                                        
    2014     2013     2012  

Americas:

 

Net sales

  $ 80,095      $ 77,093      $ 71,060   

Operating income

  $ 26,158      $ 24,829      $ 26,244   

Europe:

     

Net sales

  $ 44,285      $ 40,980      $ 39,326   

Operating income

  $ 14,434      $ 12,767      $ 15,129   

Greater China:

     

Net sales

  $ 31,853      $ 27,016      $ 23,756   

Operating income

  $ 11,039      $ 8,499      $ 9,978   

Japan:

     

Net sales

  $ 15,314      $ 13,782