Apple Inc. 10-K Summary: Fiscal Year Ended September 30, 2006
Business Context and Reporting Period
This Annual Report on Form 10-K covers the fiscal year ended September 30, 2006, for Apple Computer, Inc. (Apple). The fiscal year consisted of 53 weeks, adding one week to the first quarter to align with calendar quarters. Apple designs, manufactures, and markets personal computers (Macintosh), portable digital music players (iPod), and related software and services (iTunes Store). A significant portion of the filing is dedicated to an Explanatory Note regarding the restatement of financial statements for fiscal years 2004, 2005, and 2006 due to an investigation into stock option grant practices between 1997 and 2001.
Key Financial Metrics
| Metric | Fiscal 2006 | Fiscal 2005 (Restated) | Fiscal 2004 (Restated) |
|---|---|---|---|
| Net Sales | $19,315 million | $13,931 million | $8,279 million |
| Gross Margin | $5,598 million (29.0%) | $4,042 million (29.0%) | $2,257 million (27.3%) |
| Operating Income | $2,453 million | $1,643 million | $313 million |
| Net Income | $1,989 million | $1,328 million | $266 million |
| Diluted EPS | $2.27 | $1.55 | $0.34 |
| Cash, Cash Equivalents, and Short-Term Investments | $10,110 million | $8,261 million | $5,464 million |
| Operating Cash Flow | $2,220 million | $2,535 million | $934 million |
| Long-Term Debt | $0 | $0 | $0 |
Note: All financial data presented above reflects the restated figures required by the stock option investigation.
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 39% year-over-year to $19.3 billion. This was driven by a 69% increase in iPod sales ($7.7 billion) and an 18% increase in Macintosh sales ($7.4 billion).
- Product Mix Shift: Portable Macintosh unit sales grew 42%, while desktop unit sales declined 3%. The company completed its transition to Intel microprocessors for Macintosh systems in August 2006.
- Restatement Impact: Due to the stock option investigation, Apple recorded additional non-cash stock-based compensation expense. The after-tax impact was $4 million in 2006, $7 million in 2005, and $10 million in 2004. The investigation found that incorrect measurement dates were used for certain grants, though no misconduct by current management was found.
- Operating Expenses: Selling, General, and Administrative (SG&A) expenses increased 31% to $2.4 billion, primarily due to the expansion of the Retail segment (165 stores as of year-end) and increased marketing spend. R&D expenses increased 33% to $712 million.
Guidance, Outlook, and Risks
- Restatement and Litigation: The company faces risks of additional litigation and government enforcement actions related to the stock option restatement. Several derivative and class-action lawsuits have been filed. The company is cooperating with the SEC and the U.S. Attorney's Office.
- Intel Transition: While the transition to Intel processors is complete, risks remain regarding market acceptance and the availability of third-party software applications (e.g., Microsoft Office, Adobe Creative Suite) optimized for Intel-based Macs.
- Competition: The company faces intense price competition in the PC market and significant competition in the digital music space. Margins are under pressure from industry-wide pricing trends and the shift toward lower-margin consumer products like the iPod.
- Supply Chain: Apple relies on single or limited sources for key components (microprocessors, ASICs) and outsources manufacturing, primarily in Asia. Disruptions in these areas could materially affect operations.
- Outlook: Management expects gross margins to decline sequentially in the first quarter of 2007 due to a shift in revenue mix toward lower-margin products (iPod and iTunes content).
Key Facts for Investor Verification
- Restatement Validity: Verify the finality of the stock option restatement and the status of ongoing litigation (e.g., In re Apple Computer, Inc. Derivative Litigation).
- Intel Software Ecosystem: Monitor the release and adoption of "Universal" versions of critical third-party software (Microsoft Office, Adobe Creative Suite) to ensure the Intel transition does not hinder professional user adoption.
- Retail Segment Economics: Assess the profitability of the rapidly expanding retail footprint (165 stores) and the associated fixed costs (leases, depreciation) relative to sales growth.
- Component Supply Agreements: Review the $1.25 billion prepayment for NAND flash memory components and the associated long-term supply agreements with vendors like Intel and Samsung.
- Product Mix Margins: Track the ratio of high-margin professional hardware sales versus lower-margin consumer electronics (iPod) to evaluate future gross margin sustainability.