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[January 24, 2013]
APPLE INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge) This section and other parts of this Form 10-Q 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 also can be identified by words such as "anticipates," "expects," "believes," "plans," "will," "would," "could," 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 II, Item 1A of this Form 10-Q under the heading "Risk Factors," which are incorporated herein by reference. The following discussion should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended September 29, 2012 (the "2012 Form 10-K") filed with the U.S. Securities and Exchange Commission (the "SEC") and the condensed consolidated financial statements and notes thereto included elsewhere in this Form 10-Q. All information presented herein is based on the Company's fiscal calendar. Unless otherwise stated, references in this report to particular years, quarters or months refer to the Company's fiscal years ended in September and the associated quarters or months 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.
Available Information The Company's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), are filed with the SEC. The Company is subject to the informational requirements of the Exchange Act and files or furnishes reports, proxy statements, and other information with the SEC. Such reports and other information filed by the Company with the SEC are available free of charge on the Company's website at www.apple.com/investor when such reports are available on the SEC's website. The public may read and copy any materials filed by the Company with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Room 1580, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at www.sec.gov. The contents of these websites are not incorporated into this filing. Further, the Company's references to the URLs for these websites are intended to be inactive textual references only.
Executive Overview 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, peripherals, networking solutions, and third-party digital content and applications. The Company's products and services include iPhone ®, iPad®, Mac®, iPod ®, Apple TV®, a portfolio of consumer and professional software applications, the iOS and Mac OS X® operating systems, iCloud®, and a variety of accessory, service and support offerings. The Company also sells and delivers digital content and applications through the iTunes Store®, App Store™, iBookstore™, and Mac App Store. 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.
The Company is committed to bringing the best user experience to its customers through its innovative hardware, software, peripherals, and services. The Company's business strategy leverages its unique ability to design and develop its own operating systems, hardware, application software, and services to provide its customers new products and solutions with superior ease-of-use, seamless integration, and innovative design. As part of its strategy, the Company continues to expand its platform for the discovery and delivery of third-party digital content and applications through the iTunes Store. As part of the iTunes Store, the Company's App Store and iBookstore allow customers to discover and download applications and books through either a Mac or Windows-based computer or through "iOS devices," namely iPhone, iPad and iPod touch. The Company's Mac App Store allows customers to easily discover, download and install Mac applications. The Company also supports a community for the development of third-party software and hardware products and digital content that complement the Company's offerings. The Company's strategy also includes expanding its distribution network to effectively reach more customers and provide them with a high-quality sales and post-sales support experience.
21 -------------------------------------------------------------------------------- The Company participates in several highly competitive markets, including the market for mobile communications and media devices with its iOS devices; personal computers with its Mac computers; portable digital players with iPod; and distribution of third-party digital content and applications with the iTunes Store, App Store, iBookstore, and Mac App Store. While the Company is widely recognized as a leading innovator in the markets where it competes, these markets are highly competitive and subject to aggressive pricing. To remain competitive, the Company believes that continual investment in research and development and marketing and advertising is critical to the development and sale of innovative products and technologies. The Company's research and development spending is focused on investing in new hardware and software products, and in further developing its existing products, including iPhone, iPad, Mac, and iPod hardware; iOS and OS X operating systems; and a variety of application software and online services.
The Company uses a variety of direct and indirect distribution channels, such as its retail stores, online stores, and direct sales force, and third-party cellular network carriers, wholesalers, retailers, and value-added resellers.
The Company believes that sales of its innovative and differentiated products are enhanced by knowledgeable salespersons who can convey the value of the hardware and software integration, and demonstrate the unique solutions that are available on its products. The Company further believes providing direct contact with its targeted customers is an effective way to demonstrate the advantages of its products over those of its competitors and providing a high-quality sales and after-sales support experience is critical to attracting new and retaining existing customers. To ensure a high-quality buying experience for its products in which service and education are emphasized, the Company continues to expand and improve its distribution capabilities by expanding the number of its own retail stores worldwide. Additionally, the Company has invested in programs to enhance reseller sales by placing high quality Apple fixtures, merchandising materials and other resources within selected third-party reseller locations.
Through the Apple Premium Reseller Program, certain third-party resellers focus on the Apple platform by providing a high level of integration and support services, and product expertise.
Products A detailed discussion of the Company's products may be found in Part I, Item 1, "Business," of the Company's 2012 Form 10-K.
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 condensed consolidated financial statements and accompanying notes. Note 1, "Summary of Significant Accounting Policies" of this Form 10-Q and in the Notes to Consolidated Financial Statements in Part II, Item 8 of the Company's 2012 Form 10-K describes the significant accounting policies and methods used in the preparation of the Company's condensed 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.
22 -------------------------------------------------------------------------------- Revenue Recognition Net sales consist primarily of revenue from the sale of hardware, software, digital content and applications, peripherals, 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 and risk of loss 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.
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. If the facts and circumstances underlying the factors considered change, including the estimated or actual costs incurred to provide non-software services or the estimated period the software upgrades and non-software services are expected to be provided, or should future facts and circumstances lead the Company to consider additional factors, 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.
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.
23 -------------------------------------------------------------------------------- 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 Condensed 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 the 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.
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 each fiscal quarter 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 based on projected demand information. These commitments typically cover the Company's 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.
24 -------------------------------------------------------------------------------- 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 reevaluates its 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.
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 II, Item 1 of this Form 10-Q under the heading "Legal Proceedings" and in Note 6, "Commitments and Contingencies" in the Notes to Condensed Consolidated Financial Statements of this Form 10-Q, the Company is subject to various legal proceedings and claims, including those 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.
25 -------------------------------------------------------------------------------- Net Sales The following table shows net sales by operating segment and net sales and unit sales by product during the three months ended December 29, 2012 and December 31, 2011 (in millions, except unit sales in thousands): Three Months Ended December 29, December 31, 2012 2011 Change Net Sales by Operating Segment: Americas $ 20,341 $ 17,714 15% Europe 12,464 11,256 11% Greater China (a) 6,830 4,080 67% Japan 4,443 3,550 25% Rest of Asia Pacific 3,993 3,617 10% Retail 6,441 6,116 5% Total net sales $ 54,512 $ 46,333 18% Net Sales by Product: iPhone (b) $ 30,660 $ 23,950 28% iPad (b) 10,674 8,769 22% Mac (b) 5,519 6,598 (16)% iPod (b) 2,143 2,528 (15)% iTunes, Software and Services (c) 3,687 3,020 22% Accessories (d) 1,829 1,468 25% Total net sales $ 54,512 $ 46,333 18% Unit Sales by Product: iPhone 47,789 37,044 29% iPad 22,860 15,434 48% Mac 4,061 5,198 (22)% iPod 12,679 15,397 (18)% (a) Greater China includes China, Hong Kong and Taiwan.
(b) Includes deferrals and amortization of related non-software services and software upgrade rights.
(c) Includes revenue from sales on the iTunes Store, the App Store, the Mac App Store, and the iBookstore, and revenue from sales of AppleCare, licensing and other services.
(d) Includes sales of hardware peripherals and Apple-branded and third-party accessories for iPhone, iPad, Mac and iPod.
26 -------------------------------------------------------------------------------- The Company's fiscal year is the 52 or 53-week period that ends on the last Saturday of September. An extra week is added to the Company's first quarter approximately every six years to realign the Company's fiscal quarters more closely to calendar quarters. A 14th week was added to the first quarter of 2012, while the first quarter of 2013 spanned only 13 weeks. Inclusion of the 14th week increased the Company's overall net sales and operating expenses for the first quarter of 2012.
Despite the lack of a 14th week in the first quarter of 2013, net sales increased $8.2 billion or 18% compared to the first quarter of 2012. Several factors contributed positively to this increase: • iPhone net sales were $30.7 billion in the first quarter of 2013 representing an increase of $6.7 billion or 28% compared to the first quarter of 2012. iPhone unit sales totaled 47.8 million in the first quarter of 2013, which represents an increase of 10.7 million units or 29% compared to the same period in 2012. iPhone year-over-year growth reflects strong 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. Net sales of iPhone accounted for 56% of the Company's total net sales for the first quarter of 2013 compared to 52% in the first quarter of 2012.
• iPad net sales were $10.7 billion in the first quarter of 2013 representing an increase of $1.9 billion or 22% compared to the first quarter of 2012. Unit sales of iPad were 22.9 million during the first quarter of 2013, an increase of 48% compared to the same period in 2012.
The year-over-year increase in net sales and unit sales was driven by strong demand for iPad in all of the Company's operating segments as a result of the launch of iPad mini and the fourth generation iPad with Retina® display in the first quarter of 2013. The year-over-year growth rate of iPad unit sales was higher than the growth rate of iPad net sales during the first quarter of 2013 due to a reduction in average selling prices as a result of a shift in product mix toward lower-priced iPad models, including iPad mini. Net sales of iPad accounted for 20% of the Company's total net sales in the first quarter of 2013 compared to 19% in the first quarter of 2012.
• Net sales for iTunes, software and services were $3.7 billion in the first quarter of 2013 representing an increase of $667 million or 22% compared to the first quarter of 2012. This increase was due primarily to growth of iTunes which generated total net sales of $2.1 billion for the first quarter of 2013. iTunes growth reflects continued growth in the installed base of iOS devices and expanded iTunes digital content and applications offerings around the world, resulting in higher net sales on the App Store and higher net sales of digital content. Net sales of iTunes, software and services accounted for 7% of the Company's total net sales for both the first quarter of 2013 and 2012, respectively.
The following factors contributed to the partial offset of the overall increase in net sales in the first quarter of 2013 compared to the same quarter in 2012: • Mac net sales were $5.5 billion in the first quarter of 2013 representing a decrease of $1.1 billion or 16% compared to the first quarter of 2012.
Mac unit sales decreased by 1.1 million or 22% in the first quarter of 2013 compared to the same period in 2012. Declines in Mac net sales and Mac unit sales were experienced to some extent in all of the Company's operating segments and reflect overall declines in unit sales of both desktop and portable systems. Mac sales were negatively impacted during the first quarter of 2013 by a number of factors including supply constraints through the end of the quarter on the Company's new iMac models that were announced in October 2012 but did not ship until the final month of the quarter; one less week in the first quarter of 2013 compared to the first quarter of 2012; and the overall weakness in the market for personal computers. Net sales of Mac declined to 10% of the Company's total net sales in the first quarter of 2013 compared to 14% in the first quarter of 2012.
• iPod net sales were $2.1 billion in the first quarter of 2013 representing a decrease of $385 million or 15% compared to the first quarter of 2012.
Unit sales of iPods decreased by 18% during the first quarter of 2013 compared to the same period in 2012. Net sales of iPods accounted for 4% of the Company's total net sales for the first quarter of 2013 compared to 5% in the first quarter of 2012.
27 -------------------------------------------------------------------------------- Segment Operating Performance The Company manages its business primarily on a geographic basis. Prior to 2013, the Company's reportable operating segments consisted of the Americas, Europe, Japan, Asia-Pacific and Retail. In 2013, the Company established a new reportable operating segment, Greater China, which was previously included in the Asia-Pacific segment. Segment data for prior periods has been reclassified to reflect establishment of the Greater China segment. The Americas segment includes both North and South America. The Europe segment includes European countries, as well as 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 Japan and those countries included in the Greater China segment. The Retail segment operates Apple retail stores in 13 countries, including the U.S. The results of the Americas, Europe, Greater China, Japan and Rest of Asia Pacific segments do not include results of the Retail segment. Each operating segment provides similar hardware and software products and similar services. Further information regarding the Company's operating segments may be found in Note 7, "Segment Information and Geographic Data" in Notes to Condensed Consolidated Financial Statements of this Form 10-Q.
Americas Net sales in the Americas segment increased $2.6 billion or 15% during the first quarter of 2013 compared to the first quarter of 2012. The growth in net sales during the first quarter of 2013 was primarily driven by increased demand for iPhone following the launch of iPhone 5, increased demand for iPad following the launch of iPad mini and the fourth generation iPad with Retina display in the first quarter of 2013, and higher sales from iTunes. These increases were partially offset by decreases in net sales of Mac and iPod. The Americas segment represented 37% and 38% of the Company's total net sales in the first quarter of 2013 and 2012, respectively.
Europe Net sales in the Europe segment increased $1.2 billion or 11% during the first quarter of 2013 compared to the first quarter of 2012. The growth in net sales during the first quarter of 2013 was primarily driven by increased demand for iPhone following the launch of iPhone 5 and increased demand for iPad following the launch of iPad mini and the fourth generation iPad in the first quarter of 2013, and higher sales from iTunes. These increases were partially offset by decreases in net sales of Mac and iPod. Net sales in the Europe segment continue to be negatively impacted by the region's uncertain economic conditions. The Europe segment represented 23% and 24% of the Company's total net sales in the first quarter of 2013 and 2012, respectively.
Greater China Net sales in the Greater China segment increased $2.8 billion or 67% during the first quarter of 2013 compared to the first quarter of 2012. The growth in net sales during the first quarter of 2013 was primarily driven by increased demand for iPhone following the launch of iPhone 5 and increased demand for iPad, partially offset by decreases in net sales of Mac and iPod. The Greater China segment grew to 13% of the Company's total net sales for the first quarter of 2013 compared to 9% during the first quarter of 2012.
Japan Net sales in the Japan segment increased $893 million or 25% during the first quarter of 2013 compared to the first quarter of 2012. The growth in net sales was mainly due to increased demand for iPhone following the launch of iPhone 5 and higher sales from iTunes. The Japan segment represented 8% of the Company's total net sales in both the first quarter of 2013 and 2012.
Rest of Asia Pacific Net sales in the Rest of Asia Pacific segment increased $376 million or 10% during the first quarter of 2013 compared to the first quarter of 2012. The growth in net sales during the first quarter of 2013 was primarily driven by increased demand for iPhone following the launch of iPhone 5 and strong demand for iPad, partially offset by decreases in net sales of Mac and iPod. The Rest of Asia Pacific segment represented 7% and 8% of the Company's total net sales for the first quarter of 2013 and 2012, respectively.
28 -------------------------------------------------------------------------------- Retail Net sales in the Retail segment increased $325 million or 5% during the first quarter of 2013 compared to the first quarter of 2012. The growth in net sales during the first quarter of 2013 was primarily driven by increased demand for iPhone following the launch of iPhone 5 and strong demand for iPad following the launch of iPad mini and the fourth generation iPad. The growth rate of the Retail segment was somewhat lower than the Company's overall growth rate primarily as a result of expanded third-party distribution of iPhone and iPad.
The Company opened 11 new retail stores during the first quarter of 2013, 10 of which were outside the United States, ending the quarter with 401 stores open compared to 361 stores at the end of the first quarter of 2012. With an average of 396 and 358 stores opened during the first quarter of 2013 and 2012, respectively, average revenue per store decreased to $16.3 million in the first quarter of 2013, compared to $17.1 million in the first quarter of 2012.
However, given the 14th week added to the first quarter of 2012, revenue per store on a per week basis increased 3% during the first quarter of 2013 compared to the first quarter of 2012. The Retail segment represented 12% and 13% of the Company's total net sales in the first quarter of 2013 and 2012, respectively.
The Retail segment reported operating income of $1.6 billion during the first quarter of 2013 as compared to $1.9 billion during the first quarter of 2012.
The year-over-year decrease in Retail operating income during the first quarter of 2013 was primarily attributable to an overall decline in the segment's gross margin percentage similar to that experienced by the Company overall that was only partially offset by the relatively modest increase in the Retail segment's net sales. As of December 29, 2012, the Retail segment had approximately 44,700 full-time equivalent employees.
Gross Margin Gross margin for the three months ended December 29, 2012 and December 31, 2011 was as follows (in millions, except gross margin percentages): Three Months Ended December 29, December 31, 2012 2011 Net sales $ 54,512 $ 46,333 Cost of sales 33,452 25,630 Gross margin $ 21,060 $ 20,703 Gross margin percentage 38.6% 44.7% The gross margin percentage in the first quarter of 2013 was 38.6% compared to 44.7% in the first quarter of 2012. The year-over-year decrease in gross margin during the first quarter of 2013 was driven by multiple factors including introduction of new versions of existing products with higher cost structures and flat or reduced pricing, introduction of iPad mini with gross margin significantly below the Company's average product margins, price reductions on certain existing products, and the impact of the significant number of product introductions during the quarter on product transition costs. These factors were partially offset by a higher mix of iPhone during the first quarter of 2013.
The Company expects its gross margin percentage to be lower in 2013 than experienced in 2012, and the Company anticipates gross margin to be between 37.5% and 38.5% during the second quarter of 2013. The lower gross margin expected in 2013 is largely due to anticipation of a higher mix of new and innovative products with flat or reduced pricing that have higher cost structures and deliver greater value to customers and anticipated component cost and other cost increases. Future strengthening of the U.S. dollar could further negatively impact gross margin.
The foregoing statements regarding the Company's expected gross margin percentage in 2013 and the second quarter of 2013 are forward-looking and could differ from actual results because of several factors including, but not limited to, those set forth below in Part II, Item 1A, "Risk Factors" of this Form 10-Q and those described in this paragraph. In general, gross margins and margins on individual products 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 and potential increases in the cost of components, 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 in the short-term by fluctuations in exchange rates.
29 -------------------------------------------------------------------------------- Operating Expenses Operating expenses for the three months ended December 29, 2012 and December 31, 2011, were as follows (in millions, except for percentages): Three Months Ended December 29, December 31, 2012 2011 Research and development expense $ 1,010 $ 758 Percentage of net sales 1.9% 1.6% Selling, general and administrative expense $ 2,840 $ 2,605 Percentage of net sales 5.2% 5.6% Total operating expenses $ 3,850 $ 3,363 Percentage of net sales 7.1% 7.3% Research and Development ("R&D") Expense R&D expense increased 33% or $252 million to $1.0 billion in the first quarter of 2013 compared to $758 million in the first quarter of 2012. This increase was due primarily to an increase in headcount and related expenses 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 SG&A expense increased $235 million or 9% to $2.8 billion in the first quarter of 2013 compared to $2.6 billion in the first quarter of 2012. The year-over-year increase in SG&A expense was due primarily to increases in overall headcount and related expenses, higher spending on professional services, and increased variable costs associated with the overall growth of the Company's net sales.
Other Income and Expense Other income and expense for the three months ended December 29, 2012 and December 31, 2011, was as follows (in millions): Three Months Ended December 29, December 31, 2012 2011 Interest and dividend income $ 421 $ 228 Other income/(expense), net 41 (91 ) Total other income/(expense), net $ 462 $ 137 Total other income and expense increased by $325 million during the first quarter of 2013 compared to the first quarter of 2012. The increase in other income and expense during the first quarter of 2013 as compared to the first quarter of 2012 was due primarily to higher interest and dividend income on the Company's higher cash, cash equivalents and marketable securities balances and lower premium expenses on foreign exchange contracts. The weighted-average interest rate earned by the Company on its cash, cash equivalents and marketable securities was 1.07% and 1.02% in the first quarter of 2013 and 2012, respectively.
Provision for Income Taxes The Company's effective tax rate during the first quarter of 2013 was 26.0% compared with 25.3% for the first quarter of 2012. The Company's effective rate for both periods differs from the statutory federal income tax rate of 35% due primarily to certain undistributed foreign earnings for which no U.S. taxes are provided because such earnings are intended to be indefinitely reinvested outside the U.S. The higher effective tax rate during the first quarter of 2013 as compared to the same quarter of 2012 is due primarily to a lower proportion of foreign earnings in the current year.
30 -------------------------------------------------------------------------------- The Internal Revenue Service (the "IRS") has completed its field audit of the Company's federal income tax returns for the years 2004 through 2006 and proposed certain adjustments. The Company has contested certain of these adjustments through the IRS Appeals Office. The IRS is currently examining the years 2007 through 2009. All IRS audit issues for years prior to 2004 have been resolved. 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.
Liquidity and Capital Resources The following table presents selected financial information and statistics as of December 29, 2012 and September 29, 2012 (in millions): December 29, 2012 September 29, 2012 Cash, cash equivalents and marketable securities $ 137,112 $ 121,251 Accounts receivable, net $ 11,598 $ 10,930 Inventories $ 1,455 $ 791 Working capital $ 25,469 $ 19,111 As of December 29, 2012, the Company had $137.1 billion in cash, cash equivalents and marketable securities, an increase of $15.9 billion from September 29, 2012. The principal component of this net increase was the cash generated by operating activities of $23.4 billion, which was partially offset by payments made for acquisition of property, plant and equipment and intangible assets of $2.5 billion, cash used to pay dividends and dividend equivalent rights of $2.5 billion and cash paid under the Company's accelerated share repurchase program of $1.95 billion.
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. As of December 29, 2012 and September 29, 2012, $94.2 billion and $82.6 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 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, common stock repurchases, dividends on its common stock, and other liquidity requirements associated with its existing operations over the next 12 months.
Capital Assets The Company's capital expenditures were $1.4 billion during the first quarter of 2013 consisting of $82 million for retail store facilities and $1.3 billion for other capital expenditures, including product tooling and manufacturing process equipment, and other corporate facilities and infrastructure. The Company's actual cash payments for capital expenditures during the first quarter of 2013 were $2.3 billion.
The Company anticipates utilizing approximately $10 billion for capital expenditures during 2013, including approximately $850 million for retail store facilities and approximately $9.15 billion for other capital expenditures, including for product tooling and manufacturing process equipment, and corporate facilities and infrastructure, including information systems hardware, software and enhancements.
During 2013, the Company expects to open approximately 30 new retail stores, with approximately three-quarters located outside of the U.S.
Dividend and Stock Repurchase Program Subject to declaration by the Board of Directors, the Company plans to pay quarterly dividends of $2.65 per share for a total of approximately $2.5 billion each quarter.
31 -------------------------------------------------------------------------------- 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 repurchase program is authorized through 2015 with the primary objective of neutralizing the impact of dilution from future employee equity grants and employee stock purchases under the Company's equity plans. The repurchase program does not obligate the Company to acquire any specific number of shares. The Company anticipates that it will utilize approximately $45 billion of domestic cash to pay dividends, repurchase shares, and to remit withheld taxes related to net share settlement of restricted stock units in the first three years of the dividend and stock repurchase programs. The Company anticipates the cash used for future dividends and the repurchase program will come primarily from current domestic cash and from on-going U.S. operating activities and the cash generated from such activities.
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.
Lease Commitments The Company's major facility leases are typically for terms not exceeding 10 years and generally provide renewal options for terms not exceeding five additional years. 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 December 29, 2012, the Company's total future minimum lease payments under noncancelable operating leases were $4.5 billion, of which $3.2 billion related to leases for retail space.
Purchase Commitments with Outsourcing Partners and Component Suppliers 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. As of December 29, 2012, the Company had outstanding off-balance sheet third-party manufacturing commitments and component purchase commitments of $18.9 billion.
Other Obligations In addition to the commitments mentioned above, the Company had additional off-balance sheet obligations of $904 million as of December 29, 2012, that were comprised mainly of commitments to acquire capital assets, including product tooling and manufacturing process equipment, and commitments related to advertising, research and development, Internet and telecommunications services and other obligations.
The Company's other non-current liabilities in the Condensed Consolidated Balance Sheets consist primarily of deferred tax liabilities, gross unrecognized tax benefits and the related gross interest and penalties. As of December 29, 2012, the Company had non-current deferred tax liabilities of $15.7 billion.
Additionally, as of December 29, 2012, the Company had gross unrecognized tax benefits of $2.2 billion and an additional $444 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 due to uncertainties in the timing of tax audit outcomes.
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 December 29, 2012 or September 29, 2012.
32 -------------------------------------------------------------------------------- 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.
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