Apple.doc

Colin Umphreys November 2008Andrew Shane Buy ReportPete Markovich

Key Ratios*EPS (ttm) $5.36Cash per sh. $27.57PE (ttm) 16.84PEG (5yr exp) 0.81Price/Book (mrq) 4.07Price/Sales (ttm) 2.64EV/EBITDA (ttm) 8.25Debt/Equity n/aCurrent Ratio (mrq) 2.46Dividend Rate n/a*finance.yahoo.com

Projected2007A2008A2009E2010E2011E2012ESales Growth %24.29%35.30%39.98%39.98%39.98%39.98%Sales2400632479454636363789077124686Cost of Goods Sold158522133429863418005851181901Gross Profit81541114515600218373056642785Total Operating Expenses37454870681795421335618696Other Income and Expense599620868121517002380EBIT500868959651135101891026470Interest Expense000000Earnings Before Taxes500868959651135101891026470Income Tax Expense151220612885403856527912Earnings After Taxes34964834676694711325818558Net Income34964834676694711325818558

Stock Info*HQ Cupertino, CA

Ticker AAPLIndstry TechSector PC hardwareClass GrowthMktCap $80.16B Beta 1.92Price $89.5352wkHi $202.9652wkLo $85Out.Shs. 888.33M *finance.yahoo.com*chart from Merrill Lynch

ProfileApple, Inc. designs and manufactures computers, mobile phones, portable music players, and related accessories. Apple also provides MAC operating system software, multimedia software, internet software, business application software, and wireless connectivity services. Competitive AdvantageApple creates integrated software applications and systems that are designed solely for use by Apple’s innovative products. Cash Flow CompanyApple’s balance sheet consists of $24.5 billion cash and short-term investments; roughly $27 per share.Investment ThesisApple, Inc. offers a compelling valuation reflecting strong upside potential driven by innovative products and integrated software solutions.

Table of ContentsOverview 2Competitive Advantage 2Recent News 2Management 2Peer Companies 3Investor Relations 4Macro and Apple, Inc. 7Industry Outlook 7Apple in the Industry 7Revenue Breakdown 8SWOT 9Porter’s Five Forces 10Other Analysts? 11Growth Analysis 12Profitability Analysis 13Financial Strength Analysis 13Management Effectiveness 14Liquidity 15Extended DuPont 15Relative Valuation 16Pro Forma Income Statements 17Recommendation and Summary 19Annual Income Statement 20Balance Sheet 21Statement of Cash Flows 22Value Line 23


Company Profile1

Apple, Inc. designs and manufactures computers, mobile phones, portable music players, and related operating software and accessories. Operational focus is divided three ways, between software products, computer products, and communication products. Software products include the iPod, iTunes, Safari internet browser, and Quicktime, among others. Computer products include the MacBook, and communication products include the iPhone. Apple, Inc. was founded in 1976, and is headquartered in Cupertino, California. Apple generates retail sales through 215 stores and apple.com. Competitive AdvantageApple’s competitive advantage is the software that supports its innovative products. Apple creates unique software applications and systems that are designed solely for use by the Apple brand name.

Apple in Recent Headlines2

11/16/2008 – The Apple 3G iPhone will reach the Taiwan mobile phone market in December 2008.

11/15/2008 – Apple iPhones now allow users to perform internet Google searches through voice recognition software.

11/13/2008 – True Move, a Thai communications giant, will introduce the Apple 3G iPhone to the Thailand market within the next quarter.

11/09/2008 – Mark Papermaster was ordered to stop work as Apple’s Senior VP of Devices Hardware Engineering due to litigation over a non-compete clause with IBM, his former employer.

11/05/2008 – While car companies, banks, and insurance giants plead for government money, Apple reports $24.5 Billion in cash and short-term investments.

Management3

CEO – Steve Jobso Steve Jobs is the co-founder of Apple Inc. and Pixar Studios. He returned

to Apple’s CEO position in 1997. COO – Timothy D. Cook

o Timothy Cook earned his MBA from Duke University and worked for

IBM and Compaq before joining Apple.

1 Finance.yahoo.com2 Googlefinance.com3 Apple.comColin Umphreys November 2008Andrew Shane Buy ReportPete Markovich

CFO – Peter Oppenheimer o Peter Oppenheimer earned his MBA from the University of Santa Clara

and was the CFO of Automatic Data Processing before joining Apple.

Peer Companies4

Microsoft (MSFT) provides software and computer products to a global customer base. Software products include: Windows operating systems, Microsoft Office, entertainment software, and digital imaging software. Microsoft also offers Microsoft Live, a network based instant messaging tool, personal workstations, laptops, Zune digital music products, and the XBOX video game system. Microsoft products reach customers through indirect sales channels and Microsoft.com. Microsoft was founded in 1975, and headquarters are located in Redmond, Washington. Dell, Inc. (DELL) designs, manufactures, and sells computer systems and services. Products include personal workstations, laptops, storage systems, hard-disk backup systems, anti-virus software, and entertainment software. Dell also provides computer accessories such as: printers, projectors, and scanners. Dell sells products though sales representatives, dell.com, and various indirect channels. Dell, Inc. was founded in 1984, and headquarters are located in Round Rock, Texas. International Business Machines (IBM) is a developer and provider of information technologies. Their products include networking systems, data storage systems, IT outsourcing services, product life cycle software, infrastructure management software, and information management software. Along with IT services, IBM manufactures and sells personal workstations. IBM products reach customers through direct sales channels and ibm.com. IBM was founded in 1924, and headquarters are located in Armonk, New York. Hewlett-Packard (HPQ) provides various software solutions, products, and services. Products include: IT management programs, voice-over IT software, IT outsourcing systems, personal workstations, laptops, scanners, printers, digital imaging software, and calculators. HP sells products through indirect channels and hp.com. Hewlett-Packard was founded in 1939, and headquarters are located in Palo Alto, California.Research in Motion (RIMM) provides wireless communication systems and products. Products include BlackBerry wireless devices and RIM wireless handhelds. RIM focuses on developing third party communication through wireless networks. Products reach customers through licensed vendors. Research in Motion was founded in 1984, and headquarters are located in Waterloo, Canada.Sun Microsystems (JAVA) provides global networking solutions. Its software includes open-source servers, hard-disk backup systems, data storage systems, media systems, and microprocessors. Sun Microsystems also provides support services for hardware and client management, and personal computers. JAVA was founded in 1982, and headquarters are located in Santa Clara, California. Peer Company EPS Comparison5

4 Finance.yahoo.com5 Valueline.comColin Umphreys November 2008Andrew Shane Buy ReportPete Markovich

2005 2006 2007 2008AAPL 1.44 2.27 3.93 5.20MSFT 1.16 1.20 1.42 1.87IBM 5.22 6.06 7.18 8.80JAVA 0.12 0.64 0.52 0.49RIMM 0.84 1.10 2.26 3.80HPQ 1.62 2.03 2.68 3.20DELL 1.56 1.14 1.31 1.40

Peer Company Market Cap Comparison6

AAPL MSFT IBM JAVA RIMM HPQ DELL

Market Cap 80.217B 173.44B 107.920B 3.043B 23.88B 74.600B 21.326B

Investor Relations – Joan Hoover1. Who do you see as your biggest competitors today and going forward?

Macintosh family of notebook and desktop computers Dell Inc, Hewlett-Packard, Sony, Sun Microsystems, IBM

Mac OS X operating system and related software Microsoft

iPod music players Microsoft, Samsung, Sony, and a bunch of no name, local venders. It’s a

fragmented marketiPhone

RIM (Blackberry), Nokia, LG, Google (Android) Large market going forward

2. Looking at your FY08 performance, your revenue was down in the 2nd and 3rd

quarters. How has the current economic environment affected growth rates in the latter half of your FY08? What are you doing to prevent any future declines in sales, especially pertaining to this holiday season?

Like you said we saw a deceleration in our growth rates for the 2nd

quarter. We realized negative growth rates in the 2nd quarter for Mac

(computer) and iPod units sold, along with negative growth rates in the 2nd and 3rd quarters for iPhone unit sales.

We saw strong 4th quarter unit sale growth rates throughout all our product divisions, including an iPhone unit sale increase of 861%.

Can’t say how the current environment has affected our performance, but can attribute decelerated performance to what we believe was consumer anticipation of new portables being introduced causing postponed purchases.

6 Netadvantage.standardandpoors.comColin Umphreys November 2008Andrew Shane Buy ReportPete Markovich

K-12 sales (represents 1000 units or more) were off - customers preserving budget.

3. How is your strategy on these core products changing due to the recent economic conditions? How does this impact the pricing of your product line going forward? What other potential products are you looking to get into and what products have been put on hold?

There has not and will not be any change to our strategy. We will continue to build the best priced products and to sell them for

value. We haven’t put any products on hold and I am unable to comment

about any upcoming products that have not been released.

4. I know some consumers and analysts were predicting you would come out with a touch technology generation of notebook computers around this time. Did the current economic crisis impact the company’s decision? And can we expect to see this in the future?

No Touch technology is a part of our intellectual portfolio as you are aware.

That’s all I can comment on that issue.

5. What are you doing to ensure that key employees and executives are remaining at Apple? How are you dealing with executive succession into the future?

The company depends on key employees for success into the future. Experienced personnel in our industry are in high demand and competition

is intense. The company has relied on equity rewards as a means of recruiting and retaining talent.

We attract some of the best talent around, and take great care in hiring the best. We are very selective throughout our hiring process.

We are a fun place to work; I have worked here for 21 years. We stress teamwork and believe that smaller teams move a lot faster. We are a flat organization, with a minimum amount of politics We obviously have a succession plan in place, and our bench is very deep Steve Jobs is happy, excited about the future, and having fun.

6. How does Apple continue to maintain its innovative and creative culture? We make few products, and do a few things really, really well. We grow organically which gives us the lowest risk and the highest profit

through the leveraging of fixed investments

7. What do you think of Microsoft’s new ad campaign? Flush it down the toilet, it’s copycatish.


8. Will the Mac/PC campaign continue? The Mac/PC campaign has been great for us these last two years and I just

think they keep getting better. Yes, the campaign will continue.

9. What will Mark Papermaster’s role be at Apple? When will he be able to work again? What will be Tony Fadell’s relationship with Apple in the future?

Mark will run our iPod and iPhone engineering. Tony will be a consultant and is staying on the payroll. In regards to the legal battle, I only know what you know.

10. How will you keep the iPhone from consuming iPod sales in the future? Don’t care as long as it’s the iPhone that’s consuming sales.

11. Are there any plans after the expiration of your AT&T exclusive contract to expand the iPhone to other carriers?

We will cross that bridge when we get there. I can say that both companies have a good relationship, and both

companies are happy with the current arrangements. In terms of our carrier plans abroad, we have enjoyed exclusive

arrangements in our five primary countries: UK, France, Germany, Spain and Ireland

Macro-Economic Conditions Uncertainty about current global economic conditions could pose a risk to Apple as consumers and businesses consider postponing spending. This slowdown would have a negative effect on the demand for Apple’s products and services.

Industry Outlook7

The fundamental outlook for the Computer Hardware Industry is neutral. It is estimated that unit sales of personal computers for 2008 will rise 14%, marking the sixth consecutive year of double-digit expansion. The changing consumer preference from desktop computers towards wireless and portable computers has helped drive sales and boost margins for PC makers. This trend has greatly influenced Apple, which ranks second behind only IBM in market cap for the PC industry as a whole. Strong growth trends in the PC industry can also be attributed to a focus on global market opportunities. According to Standard and Poor’s, PC unit shipments in the Asia/Pacific region expanded by almost 22% in 2007, while “rest of the world” (ROW) shipments, which includes Eastern Europe, Latin America and the Middle East, rose 25%. Although sales have done well in recent years for PC vendors, one can expect slowing economic growth to dampen PC demand. Worldwide PC sales are expected to drop to about 10% in 2009.

7 Netadvantage.standardandpoors.comColin Umphreys November 2008Andrew Shane Buy ReportPete Markovich

However, the long-term outlook for the computer industry remains attractive as continued global demand for technology products such as smart phones, personal digital assistants, and lightweight portable computers boosts productivity and communications.

Apple’s PositionApple’s position in the US market remains strong with an 8.1% market share. The company’s ability to outgrow the industry in terms of PC units sold reflects management’s ability to effectively market a product with an above average selling price. With continued sales of quality products at above average prices, Apple will maintain is strong position in competing for US and global market share.

Apple’s business segments face strong competition as technological advances have resulted in the introduction of new products with competitive prices and performance characteristics. Over the last year, price competition has become intense, whereby larger competitors such as Microsoft have aggressively cut prices and margins in an attempt to gain market share. Some of these competitors have substantial resources, allowing them to provide such products and services at little or no profit. Competition will continue to intensify into the future as peer companies attempt to imitate Apple’s approach.Revenue BreakdownNet Sales per product line:

Net Sales By Product (in millions):2008

(% ttl) Change 2007 Change 2006

Desktops $ 5,603 (17.25%) 39%

$ 4,020 21%

$ 3,319

Portables $ 8,673 (26.7%) 38%

$ 6,294 55%

$ 4,056

Total Mac unit sales $ 14,276 (43.95%) 38%

$ 10,314 40%

$ 7,375

iPod $ 9,153 (28.18%) 10%

$ 8,305 8%

$ 7,676

Other music related products and services $ 3,340 (10.28%) 34%

$ 2,496 32%

$ 1,885

iPhone and related products and services $ 1,844 (5.68%) NM

$ 123 NM -

Peripherals and other hardware $ 1,659 (5.51%) 32%

$ 1,260 15%

$ 1,100

Software, service, and other sales $ 2,207 (6.79%) 46%

$ 1,508 18%

$ 1,279

Total net sales $ 32,479 35% $ 24,006 24%

$ 19,315

SWOT AnalysisStrengths


Healthy Balance Sheet – Apple has zero debt and $24.5B cash on hand ($27.07 per diluted share). This gives Apple the ability to self-finance new products and grow organically.

Innovation – Apple derives a competitive advantage from its focus on, and success with innovation. Ex: iPod, iPhone, iTunes, etc.

Integration of the Entire Solution – Apple controls and develops its own hardware, software, and operating systems, giving them a wide moat against potential entrants.

Retail Strategy – Apple’s retail stores are conveniently placed in high traffic areas, providing opportunity to expand their customer base for all product lines.

Weaknesses iPhone Cannibalization – Apple will begin to see flat iPod growth in the future

due to cannibalization from iPhone.

Opportunities Emerging Global Market – For FY2008, Apple’s net sales in 40% in Europe and

29% in Japan. Apple expects to bring their iPhone to 70 countries by the end of FY2008.

Research and Development – Apple believes that increased investment in R&D is necessary to continue to market expansion.

Threats Strong Price Competition –Apple’s competitors have substantial resources and

may be able to provide “copycat” products and services at little or no profit. Highly Competitive Industry – Apple competes in a fast changing industry

characterized by rapid technological advance, resulting in frequent introduction of new, competitive products.

Poor Economic Conditions – As economic conditions weaken, consumers and businesses may postpone spending and/or trade down to cheaper products.

Porter’s Five ForcesSupplier PowerApple faces no threat from suppliers. Design, innovation, and production occur from within.

Barriers to EntryThe computer hardware industry is a capital intensive industry, which provides a hurdle for new entrants. Apple’s fully integrated and product specific software also provides a wide moat.


Buyer PowerBuyers recognize the value of Apple’s products and have limited effect on pricing. Apple provides the highest level of innovation and quality, as well as industry-leading customer service.

Threat of SubstitutesSubstitutes for Apple’s basic products are designed and developed by their peers. For example, the Microsoft Zune, Blackberry, and Dell personal laptop offer customers alternatives to the iPod, iPhone, and MacBook. However, there are limited substitutes for the combination of Apple’s innovative products and integrated software.

Degree of RivalryThe nature of the computer hardware industry offers rivalry from established companies. This is due to the limited number of such technologically advanced and user-friendly products. Apple faces notable price competition from peers.


Analyst Ratings8

November 17, 2008NPD maintains its Buy rating and $250 price target on shares of Apple. October 22, 2008 (Apple posts 4Q FY08 results)AAPL easily beats its plan, reporting EPS of $1.26 on $7.9B revenue. B. Brodie, an S&P analyst, maintains a $240 target. October 22, 2008

8 Nasdaq.com; rueters.comColin Umphreys November 2008Andrew Shane Buy ReportPete Markovich

T. Smith, an S&P analyst, gives AAPL a 12-month target price of $137 with a PE multiple of 24.October 22, 2008Citigroup reiterates a Buy rating on Apple, but lowers its price target from $170 to $153.

Growth Analysis9

Growth TrendsAAPL 2008 2007 2006 2005 2004

Sales Growth last 5YR $8,473 $4,691 $5,384 $5,652 $2,072 Sales Growth 35.30% 24.29% 38.65% 68.27% 33.38%EPS last 5YR $5.48 $4.04 $2.36 $1.65 $0.37 EPS Growth 35.64% 71.19% 43.03% 345.95% 311.11%

Comparative Growth AAPL RIMM MSFT DELL IBM HPQ Industry Sector

Sales Growth (TTM) 35.30% 98.48% 14.14% 9.86% 9.69% 12.44% 6.98% 2.10%Sales - 5 Yr. Growth Rate 39.23% 81.31% 13.42% 11.54% 4.00% 13.01% 10.27% 11.68%EPS Growth (TTM) 36.32% 100.46% 23.96% 6.61% 26.56% 30.46% -- --EPS - 5 Yr. Growth Rate 124.70% -- 21.96% 10.32% 18.51% -- 22.80% 14.76%

One of Apple’s many strengths is its ability to maintain high growth rates for both sales and EPS. Apple has averaged nearly 40% growth over the past five years with the lowest amount of growth coming in 2007, where Apple reported a 24.29% increase. Apple’s growth rate easily outpaces that of its competitors, with the exception of Research In Motion. Apple’s emphasis on innovation and expansion has allowed them to maintain such high growth rates, and will provide year over year opportunity for higher growth.

Growth Analysis: VERY STRONG

9 All historical financial data derived from Apple 10-K, 2008; all current financial ratios from reuters.com Colin Umphreys November 2008Andrew Shane Buy ReportPete Markovich

Profitability Analysis

Profitability TrendsAAPL 2008 2007 2006 2005 2004

Gross Margin 34.31% 33.97% 28.98% 29.02% 27.29%Operating Margin 19.32% 18.37% 12.70% 11.84% 3.94%Profit Margin 14.88% 14.56% 10.30% 9.58% 3.33%

Comparative ProfitabilityTTM unless otherwise noted AAPL RIMM MSFT DELL IBM HPQ Industry Sector

Gross Margin 34.31% 50.87% 80.93% 18.20% 43.32% 24.53% 8.82% 21.31%Operating Margin 19.32% 28.69% 35.98% 5.18% 14.91% 9.17% 3.85% 6.55%

Profit Margin 14.88% 21.03% 28.78% 4.44% 11.24% 7.41% 3.08% 4.55%

As seen above, Apple has maintained an increasing trend for all three of its margins. This shows they are turning a greater percentage of their sales into profit. The noticeable increase has been in the operating margin. Apple has held expenses in check, while their revenues have exploded, bringing drastic increase in operating and profit margins.

Compared to its peers, Apple maintains strong ratios. All three of its ratios are well above the industry and sector averages, tripling both the average operating margin and profit margin. The only competitors to outpace Apple in profitability are Research in Motion and Microsoft. These two companies posted better margins, but the difference can be attributed to the companies’ products. The entirety of Research in Motion’s revenue is generated by mobile phones, and the majority of Microsoft’s revenue is derived from software sales. Microsoft’s Zune is a competitor to Apple’s Ipod, but it remains a small portion of their revenue. The fact that Apple’s ratios are below these two competitors is not significant. They compete against specific Apple products, and the relative proportion of sales is not equal.

Profitability Analysis: VERY STRONG

Financial Strength Analysis

Financial Strength TrendsAAPL 2008 2007 2006 2005 2004

P/E 31.50 26.30 29.10 26.20 37.90P/B 7.34 6.45 5.89 4.70 2.06P/S 4.69 3.83 3.00 2.51 1.26P/CF 15.86 16.79 26.11 13.79 11.16


Financial Strength ValuationTTM unless otherwise noted AAPL RIMM MSFT DELL IBM HPQ Industry Sector

P/E 17.90 14.28 11.21 7.67 9.93 9.85 5.93 7.43P/B (MRQ) 4.07 5.00 5.68 6.93 4.11 2.01 2.51 4.56P/S 2.64 2.96 3.06 0.31 1.07 0.69 0.7 2.22P/CF 16.15 13.04 9.55 5.65 6.53 6.84 4.04 13.19

Apple has maintained strong valuation ratios over the last five years. It also maintains higher valuations compared to its competitors. This indicates that the market continues to account for the double-digit growth Apple has maintained. The market values Apple’s financial strength more than margins, and in some cases, growth. The market’s confidence in Apple should continue into the future, since there are no indications of deterred long-term growth.

Financial Strength Analysis: STRONG

Management Effectiveness Analysis

Management Effectiveness TrendsAAPL 2008 2007 2006 2005 2004

Return on Assets 12.22% 13.79% 11.56% 11.56% 3.43%Return on Capital Employed 32.79% 34.46% 28.23% 24.31% 7.55%

Return on Equity 22.99% 24.06% 19.92% 17.88% 5.44%

Comparative Management EffectivenessTTM unless otherwise noted AAPL RIMM MSFT DELL IBM HPQ Industry Sector

Return on Assets 14.89% 32.36% 27.17% 10.08% 10.57% 9.26% 3.69% 4.26%Return on Investment 23.27% 43.00% 42.48% 27.06% 17.61% 16.46% 5.73% 6.13%Return on Equity 27.19% 43.93% 54.06% 63.58% 49.36% 22.22% 7.41% 6.89%

Apple has demonstrated strong management effectiveness in recent years, and compared to its peers. The last year, Apple has seen a slight decrease in all three of its returns, though still maintains far higher numbers than the industry and sector. Similar to the comparative profitability, Research in Motion and Microsoft both have higher returns for all three ratios. Dell has higher returns on investment and equity, and IBM has a higher return on equity. Even though Apple outperforms in all other areas, IBM and Dell are able to possess higher current returns on equity, indicating that they either have greater sales or significantly less shareholder equity than Apple. Since Apple is a consumer electronics company, and both IBM and Dell are more focused on business users, it is more likely that they have higher sales revenues.

Management Effectiveness Analysis: NEUTRAL


Liquidity Analysis

Liquidity TrendsAAPL 2008 2007 2006 2005 2004

Quick Ratio 2.43 2.33 2.20 2.91 2.62Current Ratio 2.46 2.37 2.24 2.96 2.66Debt to Equity Ratio 0.00 0.00 0.00 0.00 0.00LT Debt to Equity Ratio 0.00 0.00 0.00 0.00 0.00Interest Coverage N/A N/A N/A N/A N/A

Comparative LiquidityMRQ unless otherwise noted AAPL RIMM MSFT DELL IBM HPQ Industry Sector

Quick Ratio 2.43 2.00 1.46 1.14 0.92 1.02 1.84 2.14Current Ratio 2.46 2.28 1.53 1.20 0.99 1.22 2.24 2.57Debt to Equity Ratio 0.00 0.46 5.88 67.76 125.05 26.55 30.34 28.9LT Debt to Equity Ratio 0.00 0.00 0.00 63.32 66.25 17.22 20.14 17.11Interest Coverage (TTM) N/A -- -- -- 247.88 -- 0.07 0.63

Apple’s liquidity is a major strength. Over the past five years, Apple has seen a slight overall decrease in their current and quick ratios, but has had a positive trend for the past three years. Apple is a cash rich company and has no debt, short-term or long-term, on its balance sheet. This results in Apple not having any margin decreasing interest expense. None of its competitors can claim this liquidity advantage. Both Microsoft and Research in Motion have no long-term debt but still have current debt obligations that they must meet. Apple’s quick and current ratios are well above its competitors and are above or consistent with the industry and sector. There is no threat of Apple in financing current obligations.

Liquidity Analysis: VERY STRONG

Extended Dupont Analysis

Extended Dupont ModelAAPL 2008 2007 2006 2005 2004

Profit Margin 14.88% 14.56% 10.30% 9.58% 3.33%Total Asset Turnover 0.82 0.95 1.12 1.21 1.03Equity Multiplier 1.88 1.74 1.72 1.55 1.59Dupont ROE 22.99% 24.06% 19.92% 17.88% 5.44%

Apple has seen significant growth in its return on equity in the past five years. This is primarily due to the significant increase in its profit margins. The equity multiplier has also experienced steady growth. The weakness in Apple’s ROE is its total asset turnover. Apple has seen a steady decline over the past four years in its total asset turnover, hindering the growth of its ROE. However, the total asset turnover has not


damaged Apple’s ROE too significantly and offers an area of improvement for the company.

Extended Dupont Analysis: STRONG

Relative Valuation Analysis

Valuation Relative to Apple's Recent History Current Historic Average Current Price Weight Relative Value PriceP/E 17.90 30.20 88.14 0.40 148.71P/B 4.07 5.29 88.14 0.20 114.50P/S 2.64 3.06 88.14 0.30 102.03P/CF 16.15 16.74 88.14 0.10 91.37 122.13

Valuation Relative to Industry Current Industry Average Current Price Weight Relative Value PriceP/E 17.90 5.93 88.14 0.40 29.20

P/B 4.07 2.31 88.14 0.20 50.03P/S 2.64 0.72 88.14 0.30 24.04

P/CF 16.15 4.94 88.14 0.10 26.96 31.59

Valuation Relative to Peers Current Peer Average Current Price Weight Relative Value PriceP/E 17.90 10.59 88.14 0.40 52.14P/B 4.07 4.75 88.14 0.20 102.78P/S 2.64 1.62 88.14 0.30 54.02P/CF 16.15 8.32 88.14 0.10 45.42 62.16

In the above valuation, different weights were assigned to values that are believed to be better indicators of stock price. As seen in the charts, the P/E ratio is given the highest weight because it is the best indicator of a company’s stock price. Relative to its financial history, Apple is currently undervalued and trading at a significant bargain. Apple’s historical financials indicate strength in the company’s growth and profitability potential as well as the market’s valuation of their continued success. Compared to its peers and its industry, Apple is overvalued. However, this is not a serious concern because Apple differs from its peers and the industry as whole. The discrepancy in current value is a product of Apple, Inc.’s uniqueness.

Relative Valuation Analysis: NEUTRAL

Pro Forma Income Statements


For the pro forma income statements, the average growth in sales over the past five years was calculated and used as the base forecast for the next fiscal year. From the data from the past five years, the standard deviation was calculated and used in order to determine the pessimistic and optimistic forecasts for the future. Growth rates were held constant, refelecting a consistent strategy in future years. All of the calculations are based on the financial data from the past five years and are believed to predict Apple’s future growth. These figures offer a valuation for the company which is found below.

Apple Inc. (NDQ - AAPL)Pro Forma Income Statement

Base Forecast(In $ Millions, except EPS)

2007A 2008A 2009E 2010E 2011E 2012E

Sales Growth % 24.29% 35.30% 39.98% 39.98% 39.98% 39.98%Sales 24,006 32,479 45,463 63,637 89,077 124,686 Cost of Goods Sold 15,852 21,334 29,863 41,800 58,511 81,901 Gross Profit 8,154 11,145 15,600 21,837 30,566 42,785 Total Operating Expenses 3,745 4,870 6,817 9,542 13,356 18,696 Other Income and Expense 599 620 868 1,215 1,700 2,380 EBIT 5,008 6,895 9,651 13,510 18,910 26,470 Interest Expense 0 0 0 0 0 0 Earnings Before Taxes 5,008 6,895 9,651 13,510 18,910 26,470 Income Tax Expense 1,512 2,061 2,885 4,038 5,652 7,912 Earnings After Taxes 3,496 4,834 6,766 9,471 13,258 18,558 Net Income 3,496 4,834 6,766 9,471 13,258 18,558 Shares Outstanding (000's) Basic 864,595 881,592 881,592 881,592 881,592 881,592 Diluted 889,292 902,139 902,139 902,139 902,139 902,139 Earnings per Share ($) Basic $4.04 $5.48 $7.68 $10.74 $15.04 $21.05 Diluted $3.93 $5.36 $7.50 $10.50 $14.70 $20.57



Optimistic Forecast(In $ Millions, except EPS)

2007A 2008A 2009E 2010E 2011E 2012ESales Growth % 24.29% 35.30% 56.66% 56.66% 56.66% 56.66%Sales 24,006 32,479 50,883 79,714 124,883 195,645 Cost of Goods Sold 15,852 21,334 33,422 52,361 82,030 128,510 Gross Profit 8,154 11,145 17,460 27,354 42,853 67,135 Total Operating Expenses 3,745 4,870 7,629 11,953 18,725 29,336 Other Income and Expense 599 620 971 1,522 2,384 3,735 EBIT 5,008 6,895 10,802 16,923 26,511 41,534 Interest Expense 0 0 0 0 0 0 Earnings Before Taxes 5,008 6,895 10,802 16,923 26,511 41,534 Income Tax Expense 1,512 2,061 3,229 5,058 7,925 12,415 Earnings After Taxes 3,496 4,834 7,573 11,864 18,587 29,119 Net Income 3,496 4,834 7,573 11,864 18,587 29,119 Shares Outstanding (000's) Basic 864,595 881,592 881,592 881,592 881,592 881,592 Diluted 889,292 902,139 902,139 902,139 902,139 902,139 Earnings per Share ($) Basic $4.04 $5.48 $8.59 $13.46 $21.08 $33.03 Diluted $3.93 $5.36 $8.39 $13.15 $20.60 $32.28


Pessimistic Forecast(In $ Millions, except EPS)

2007A 2008A 2009E 2010E 2011E 2012ESales Growth % 24.29% 35.30% 23.29% 23.29% 23.29% 23.29%Sales 24,006 32,479 40,043 49,369 60,866 75,042 Cost of Goods Sold 15,852 21,334 26,303 32,428 39,980 49,292 Gross Profit 8,154 11,145 13,741 16,941 20,886 25,750 Total Operating Expenses 3,745 4,870 6,004 7,403 9,127 11,252 Other Income and Expense 599 620 764 942 1,162 1,432 EBIT 5,008 6,895 8,501 10,481 12,921 15,931 Interest Expense 0 0 0 0 0 0 Earnings Before Taxes 5,008 6,895 8,501 10,481 12,921 15,931 Income Tax Expense 1,512 2,061 2,541 3,133 3,862 4,762 Earnings After Taxes 3,496 4,834 5,960 7,348 9,059 11,169 Net Income 3,496 4,834 5,960 7,348 9,059 11,169 Shares Outstanding (000's) Basic 864,595 881,592 881,592 881,592 881,592 881,592 Diluted 889,292 902,139 902,139 902,139 902,139 902,139 Earnings per Share ($) Basic $4.04 $5.48 $6.76 $8.33 $10.28 $12.67


Diluted $3.93 $5.36 $6.61 $8.14 $10.04 $12.38

Apple Inc. (NDQ - AAPL)Pro Forma Valuation

Pessimistic Likely OptimisticNet Income 5,960 6,766 7,573Shares Outstanding 881,592 881,592 881,592Pro Forma EPS 6.76 7.68 8.59P-E Multiple 25.37 30.20 35.03Value Per Share 171.49 231.79 300.93Probabilities 0.4 0.5 0.1Weighted Average $214.59 Market Price 11/17/08 $88.14Margin of Safety Buy Threshold $101.36

The above valuation takes into account the forecasted sales for the fiscal year 2009. The weighted average takes into account the probability of each scenario occurring. There is a 50% chance that the base forecast would occur based on past performance. Because of the current economic climate and the unusually high growth rates that Apple has been able to create in the past, there is a greater chance that the pessimistic forecast will occurr than the optimistic forecast. However, there is still a possibility of Apple recording another record year of growth and increasing the value of the company by a large amount.

As shown the current market grossly under prices Apple. The difference between the current market value and the weighted average based on the pro forma valuation is greater than 140%. The valuation places Apple well beyond the 15% margin of safety buy threshold, and therefore is a strong buy. Apples’ competitive advantage will help drive the price of the stock to a level that it is valued at.

Recommendation and Summary

Apple Inc. (NDQ - Apple)


Annual Income Statement(In $ Million Except EPS)

2008 2007 2006 2005 2004 2003Net Sales $32,479 $24,006 $19,315 $13,931 $8,279 $6,207 Cost of Sales 21,334 15,852 13,717 9,888 6,020 4,499 Gross Margin 11,145 8,154 5,598 4,043 2,259 1,708 Operating Expenses Research and Development 1,109 782 712 534 489 471 Selling, general, and administrative 3,761 2,963 2,433 1,859 1,421 1,212 Restructuring costs 0 0 0 0 23 26 Total Operating Expenses 4,870 3,745 3,145 2,393 1,933 1,709 Operating Income 6,275 4,409 2,453 1,650 326 (1)Other Income and Expense 620 599 365 165 57 93 Income before provision for income taxes 6,895 5,008 2,818 1,815 383 92 Provision for Income Taxes 2,061 1,512 829 480 107 24 Income before accounting changes 4,834 3,496 1,989 1,335 276 68

Cumulative effects of accounting changes, net income taxes 0 0 0 0 0 1 Net Income $4,834 $3,496 $1,989 $1,335 $276 $69

Earnings per Common Share Basic $5.48 $4.04 $2.36 $1.65 $0.37 $0.09 Diluted $5.36 $3.93 $2.27 $1.56 $0.36 $0.09

Shares Used in Computing Earnings per Share Basic 881,592 864,595 844,058 808,439 743,180 721,262 Diluted 902,139 889,292 877,526 856,780 774,622 726,932


Apple Inc. (NDQ - Apple)Consolidated Balance Sheet

(In $ Million Except EPS)2008 2007 2006 2005 2004 2003

Assets:

Current Assets: Cash and cash equivalents $11,875 $9,352 $6,392 $3,491 $2,969 $3,396 Short term investments 12,615 6,034 3,718 4,770 2,495 1,170 Accounts receivable 2,422 1,637 1,252 895 774 766 Inventories 509 346 270 165 101 56 Deferred Tax Assets 1,447 782 607 331 231 190 Other Current Assets 5,822 3,805 2,270 648 485 309 Total Current Assets 34,690 21,956 14,509 10,300 7,055 5,887 Property, Plant, and Equipment, net 2,455 1,832 1,281 817 707 669 Goodwill 207 38 38 69 80 85 Acquired Intangible Assets, net 285 299 139 27 17 24 Other Assets 1,935 1,222 1,238 338 191 150 Total Assets $39,572 $25,347 $17,205 $11,551 $8,050 $6,815

Liabilities and Shareholders' Equity:Current Liabilities Accounts Payable $5,520 $4,970 $3,390 $1,779 $1,451 $1,154 Accrued Expenses 8,572 4,310 3,081 1,705 1,200 899

Current Debt 0 0 0 0 0 304 Total Current Liabilities 14,092 9,280 6,471 3,484 2,651 2,357 Non-Current Liabilities 4,450 1,535 750 601 323 235 Total Liabilities 18,542 10,815 7,221 4,085 2,974 2,592

Shareholders' Equity: Common Stock 7,177 5,368 4,355 3,521 2,514 1,926 Deferred stock compensation 0 0 0 (60) (93) (62) Retained Earnings 13,845 9,101 5,607 4,005 2,670 2,394 Accumulated Other Comprehensive Income 8 63 22 0 (15) (35) Total Shareholders' Equity 21,030 14,532 9,984 7,466 5,076 4,223 Total Liabilities and Shareholders' Equity $39,572 $25,347 $17,205 $11,551 $8,050 $6,815


Apple Inc. (NDQ - Apple)Consolidated Statement of Cash Flows

(In $ Million Except EPS)2008 2007 2006 2005 2004 2003

Cash and cash equivalents, beginning of year $9,352 $6,392 $3,491 $2,969 $3,396 $2,252 Operating Activities:Net Income 4,834 3,496 1,989 1,335 276 69 Cumulative effects of accounting changes, net of taxes 0 0 0 0 0 (1)

Adjustments to reconcile net income to cash genertated by operating activities: Depreciation, amortization and accretion 473 317 225 179 150 113 Stock-based compensation expense 516 242 163 42 33 16 Non-cash restructuring 0 0 0 0 5 12 Provision for deferred income taxes (368) 78 53 52 20 (11) Tax benefit from stock options 0 0 0 453 99 7 Loss on disposition of property, plant, and equipment 22 12 15 9 7 2 Gains on sales of short-term investments, net 0 0 0 0 (1) (21) Gains on non-current investments, net 0 0 0 0 (4) (10) Gain on forward purchase agreement 0 0 0 0 0 (6)Changes in operating assets and liabilities: Accounts receivable, net (785) (385) (357) (121) (8) (201) Inventories (163) (76) (105) (64) (45) (11) Other current assets (1,958) (1,540) (1,626) (150) (176) (34) Other assets (492) 81 (1,040) (61) (39) (30) Accounts payable 596 1,494 1,611 328 297 243 Deferred revenue 5,642 1,139 319 0 0 0 Other liabilities 1,279 612 973 533 320 152 Cash generated by operating activities 9,596 5,470 2,220 2,535 934 289 Investing Activities: Purchases of short-term investments (22,965) (11,719) (7,255) (11,470) (3,270) (2,648) Proceeds from maturities of short-term investments 11,804 6,483 7,226 8,609 1,141 2,446 Proceeds from sales of short-term investments 4,439 2,941 1,086 586 801 1,116 Purchases of long-term investments (38) (17) (25) 0 5 45

Payments made in connection with business acquisitions, net of cash acquired (220) 0 0 0 0 0 Payment for acquisition of property, plant, and equipment (1,091) (735) (657) (260) (176) (164) Payment for acquisition of intangible assets (108) (251) (28) 0 0 0 Other (10) 49 10 (21) 11 33 Cash (used in)/generated by investing activities (8,189) (3,249) 357 (2,556) (1,488) 828 Financing Activities: Payments of long-term debt 0 0 0 0 (300) 0 Proceeds from issuance of common stock 483 365 318 543 427 53 Cash used for repurchase of common stock 0 0 0 0 0 (26) Excess tax benefits from stock based compensations 757 377 361 0 0 0 Cash used to net share settle equity awards (124) (3) (355) 0 0 0 Cash generated by financing activities 1,116 739 324 543 127 27 Increase in cash and cash equivalents 2,523 2,960 2,901 522 (427) 1,144

Cash and cash equivalents, end of year $11,875 $9,352 $6,392 $3,491 $2,969 $3,396

Supplemental cash flow disclosures: Cash paid for income taxes, net $1,267 $863 $194 $17 ($7) $45 Cash paid during the year for interest $0 $0 $0 $0 $10 $20


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