Google Inc. v. Rockstar Consortium US LP et al

Filing 48

NOTICE by Google Inc. Notice of Filing of Motions to Stay or, In the Alternative, to Transfer to the Northern District of California (Attachments: # 1 Exhibit A, # 2 Exhibit B - Part 1, # 3 Exhibit B - Part 2, # 4 Exhibit B - Part 3, # 5 Exhibit B - Part 4, # 6 Exhibit B - Part 5, # 7 Exhibit B - Part 6, # 8 Exhibit B - Part 7, # 9 Exhibit B - Part 8, # 10 Exhibit B - Part 9, # 11 Exhibit C, # 12 Exhibit D, # 13 Exhibit E, # 14 Exhibit F, # 15 Exhibit G, # 16 Exhibit H, # 17 Exhibit I)(Warren, Matthew) (Filed on 3/25/2014)

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EXHIBIT 2
Part 1

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IN THE UNITED STATES DISTRICT COURT
FOR THE EASTERN DISTRICT OF TEXAS
MARSHALL DIVISION

ROCKSTAR CONSORTIUM US LP AND
MOBILESTAR TECHNOLOGIES, LLC
Plaintiffs,
v.
SAMSUNG ELECTRONICS CO., LTD.,
SAMSUNG ELECTRONICS AMERICA, INC.,
SAMSUNG TELECOMMUNICATIONS
AMERICA, LLC, GOOGLE INC.,
Defendants.

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Civil Action No. 13-cv-0900-JRG
JURY TRIAL DEMANDED

DECLARATION OF KRISTIN J. MADIGAN
IN SUPPORT OF DEFENDANTS’ MOTION TO STAY OR, IN THE ALTERNATIVE,
TO TRANSFER TO THE NORTHERN DISTRICT OF CALIFORNIA

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I, Kristin J. Madigan, hereby declare as follows:
1.

I am Of Counsel at Quinn Emanuel Urquhart & Sullivan, LLP, counsel for

defendants. I submit this declaration in support of Defendants’ Motion To Stay Or, In The
Alternative, To Transfer To The Northern District Of California. I have personal knowledge of
the following facts, and would competently testify to them if called upon to do so.
2.

Attached hereto as Exhibit 1 is a true and correct copy of Robert McMillan, How

Apple and Microsoft Armed 4,000 Patent Warheads, Wired Enterprise, May 21, 2012.
3.

Attached hereto as Exhibit 2 is a true and correct copy of Joff Wild, Rockstar

CEO says he would not bet against further suits to follow those issued last week, IAM Magazine,
November 4, 2013, available at http://www.ip-rockstar.com/Press_Releases/First
%20enforcement%20actions%20%E2%80%93%20Intellectual%20Asset%20Management.pdf.
4.

Attached hereto as Exhibit 3 is a true and correct copy of the Order Authorizing

and Approving (A) The Sale of Certain Patent and Related Assets Free And Clear of All Claims
and Interests, (B) The Assumption and Assignment of Certain Executory Contracts, (C) The
Rejection of Certain Patent Licenses and (D) The License Non-Assignment and Non-Renewal
Protections, In re Nortel Networks Inc., et al., No. 09-10138 (D. Del. July 11, 2011), Docket. No.
5935.
5.

Attached hereto as Exhibit 4 is a true and correct copy of a document titled Apple

Inc. Form 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the quarterly period ended June 25, 2011.
6.

Attached hereto as Exhibit 5 is a true and correct copy of the Certificate of

Limited Partnership of Rockstar Bidco, LP.

01980.00011/5808453.3

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7.

Attached hereto as Exhibit 6 is a true and correct copy of the Certificate of

Formation of Rockstar Consortium LLC.
8.

Attached hereto as Exhibit 7 is a true and correct copy of the Certificate of

Limited Partnership of Rockstar Consortium US LP.
9.

Attached hereto as Exhibit 8 is a true and correct copy of the Certificate of

Formation of MobileStar Technologies LLC.
10.

Attached hereto as Exhibit 9 is a true and correct copy of Robert McMillan,

Facebook Infringes My Patents Too, Says CEO Who Just Sued Google, Wired Enterprise,
November 1, 2013.
11.

Attached hereto as Exhibit 10 is a true and correct copy of an excerpt from the ip-

rockstar.com website page titled “About Rockstar.”
12.

Attached hereto as Exhibit 11 is a true and correct copy of an excerpt from the ip-

rockstar.com website page titled “Innovation.”
13.

Attached hereto as Exhibit 12 is a true and correct copy of patent assignment

record Reel No. 031523, Frame No. 0182-90, from the United States Patent And Trademark
Office.
14.

Attached hereto as Exhibit 13 is a true and correct copy of an excerpt from the ip-

rockstar.com website page titled “Grow together through innovation.”
15.

Attached hereto as Exhibit 14 is a true and correct copy of a website page from

www.LinkedIn.com for “Rockstar Consortium.”
16.

Attached hereto as Exhibit 15 is a true and correct copy of website pages from

www.LinkedIn.com for thirty-three individuals who include “Rockstar Consortium” as their
current employer.

01980.00011/5808453.3

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17.

Attached hereto as Exhibit 16 is a true and correct copy of Joff Wild, Star Man,

Intellectual Asset Management, July/August 2013, available at http://www.iprockstar.com/Press_Releases/IAM%20Rockstar%20Article%20JulyAugust%202013.pdf.
18.

Attached hereto as Exhibit 17 is a true and correct copy of a website page from

www.LinkedIn.com for Mark Wilson, as accessed on December 19, 2013.
19.

Attached hereto as Exhibit 18 is a true and correct copy of a website page from

www.LinkedIn.com for Mark Wilson.
20.

Attached hereto as Exhibit 19 is a true and correct copy of a website page from

www.LinkedIn.com for Michael Dunleavy.
21.

Attached hereto as Exhibit 20 is a true and correct copy of an excerpt from the ip-

rockstar.com website page titled “Corporate Leaders.”
22.

Attached hereto as Exhibit 21 is a true and correct copy of Exhibits Q-U to

Docket No. 1, Charter Communications v. Rockstar et. al., No. 14-0055 (D. Del. Jan. 17, 2014).
23.

Attached hereto as Exhibit 22 is a true and correct copy of a website page from

www.LinkedIn.com for Don Lindsay.
24.

Attached hereto as Exhibit 23 is a true and correct copy of excerpts from the

following websites:
www.finnegan.com
www.fisherbroyles.com
www.foley.com
www.harrityllp.com
www.massbbo.org

01980.00011/5808453.3

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25.

Attached hereto as Exhibit 24 is a true and correct copy of Joff Wild, Rockstar

getting ready to roll . . ., Intellectual Asset Management, February 19, 2012.
26.

Attached hereto as Exhibit 25 is a true and correct copy of a website page from

www.LinkedIn.com for Chris Cianciolo.
27.

Attached hereto as Exhibit 26 is a true and correct copy of a table from

www.uscourts.gov titled “U.S. District Courts—Median Time Intervals From Filing to
Disposition of Civil Cases Terminated, by District and Method of Disposition, During the 12Month Period Ending June 30, 2013.”
I declare under penalty of perjury that the foregoing is true and correct. Executed on
March 21, 2014, at San Francisco, California.
/s/ Kristin J. Madigan
Kristin J. Madigan

01980.00011/5808453.3

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CERTIFICATE OF SERVICE
I hereby certify that all counsel of record have consented to electronic service and are
being served with a copy of this document via the Court’s CM/ECF system per Local Rule CV5(a)(3) on March 21, 2014.
/s/ J. Mark Mann
J. Mark Mann

01980.00011/5808453.3

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EXHIBIT 1

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Scott Widdowson is a specialist, one of 10 reverse-engineers working full time for a stealthy
company funded by some of the biggest names in technology: Apple, Microsoft, Research In Motion,
Sony, and Ericsson. Called the Rockstar Consortium, the 32-person outfit has a single-minded
mission: It …
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How Apple and Microsoft Armed 4,000
Patent Warheads
By Robert McMillan
05.21.12
6:30 AM
Follow @bobmcmillan

Inside the reverse-engineering lab at Rockstar, Scott Widdowson is looking for products that
infringe on the company's 4,000 patents. Photo: Rockstar
In many ways, Scott Widdowson is your typical electrical engineer. Most days, when the weather’s
good, he bikes the 15 miles along the Ottawa River to his company’s offices in the west end of the
Canadian capital. Once there, he settles in for a day of reading technical specifications, poring over
computer textbooks, or prying apart consumer electronics — logic probe in one hand and a soldering

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iron in the other.
But Widdowson is a specialist. He’s one of 10 reverse-engineers working full time for a stealthy
company funded by some of the biggest names in technology: Apple, Microsoft, Research In Motion,
Sony, and Ericsson. Called the Rockstar Consortium, the 32-person outfit has a single-minded
mission: It examines successful products, like routers and smartphones, and it tries to find proof
that these products infringe on a portfolio of over 4,000 technology patents once owned by one of
the world’s largest telecommunications companies.
When a Rockstar engineer uncovers evidence of infringement, the company documents it, contacts
the manufacturer, and demands licensing fees for the patents in question. The demand is backed by
the implicit threat of a patent lawsuit in federal court. Eight of the company’s staff are lawyers. In
the last two months, Rockstar has started negotiations with as many as 100 potential licensees. And
with control of a patent portfolio covering core wireless communications technologies such as LTE
(Long Term Evolution) and 3G, there is literally no end in sight.
“Pretty much anybody out there is infringing,” says John Veschi, Rockstar’s CEO. “It would be hard
for me to envision that there are high-tech companies out there that don’t use some of the patents in
our portfolio.”
Rockstar has its roots in last year’s high-profile auction of 6,000 patents owned by the bankrupt
Canadian telco giant Nortel. Google made headlines when it cast the first bid of $900 million for the
portfolio, but the search giant was soon in a heated bidding war with a consortium of rivals led by
Apple and Microsoft. The final sale price was $4.5 billion, and Rockstar Bidco, as it was then called,
was the winner.
“Pretty much anybody out there is infringing, I would think. It would be hard for me to envision that
there are high-tech companies out there that don’t use some of the patents in our portfolio.” — John
Veschi
Since then, Rockstar Bidco has given way to a new entity, called Rockstar Consortium. And for the
first time, the consortium’s strategy for the Nortel patents is clear. Ownership of about 2,000 of the
patents was shifted to the individual companies that won the auction: Apple, Microsoft, et al. But the
remaining 4,000 have been transferred to Rockstar Consortium, which is now a pure patent
exploitation operation funded by all of the winning bidders except EMC, which has dropped out of
the picture, according to Veschi.
Rockstar is a special kind of company. Because it doesn’t actually make anything, it can’t be
countersued in patent cases. That wouldn’t be the case with Apple or Microsoft if they had kept the
patents for themselves. And because it’s independent, it can antagonize its owners’ partners and
customers in ways that its owner companies could not. “The principals have plausible deniability,”
says Thomas Ewing, an attorney and intellectual property consultant. “They can say with a straight
face: ‘They’re an independent company. We don’t control them.’ And there’s some truth to that.”
When the Rockstar Bidco group purchased Nortel’s patents, the U.S. Department of Justice took a
look at the deal, as part of a broader investigation into several large technology patent sales. The DoJ
was concerned that patent attacks might somehow be used to knock Rockstar’s competitors out of
the smartphone or tablet market. But in February, the DoJ closed its investigation, in part because
Microsoft and Apple had promised to license many of their core wireless patents under reasonable
terms to anyone who needed them.
But the new company — Rockstar Consortium — isn’t bound by the promises that its member
companies made, according to Veschi. “We are separate,” he says. “That does not apply to us.”
Rockstar owners could choose to simply recoup their investment by licensing the patents and then
reselling them — much as Microsoft did recently when it bought patents from AOL and then turned
around and sold them to Facebook. Or Rockstar could play into the strategic interests of its owner
companies by going after Google, and Android partners such as HTC, says Colleen Chien, a law
professor at Santa Clara University who has made a study of the market for technology patents.

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Microsoft, Ericsson and EMC declined to comment for this story. The other Rockstar owners didn’t
respond to messages.
To say that technology patents have become more important over the past decade is to risk comic
understatement. A patent is essentially a government-sanctioned monopoly designed to give the
inventor a two-decade head start to commercialize any new technology. But in practice, patents are
weapons. Technology companies load up on patents like Cold War nations stockpiling nuclear
bombs, hoarding them for use when an important market is at stake. And few companies have been
loading up on patents as aggressively as Apple and Google, two companies that had nothing to do
with the smartphone market 10 or 15 years ago when many of Nortel’s wireless patents were being
developed.
Many companies stockpile patents for defensive purposes, but others actively look for ways they can
make money from them — big money. The kind of reverse-engineering practiced by Widdowson
happens more often than most people realize. It’s just not widely discussed.
“Big companies are doing this work with a combination of their own resources and outsourcing,”
says Fas Mosleh, senior vice president of IP transactions with Kanzatec, a Los Altos, California,
company that sells the type of reverse-engineering services that Widdowson practices in Rockstar’s
Ottawa lab.
The companies that do this are big because the costs are big. When patent fights go to trial, the legal
fees typically run into the millions of dollars. “This is the sport of kings,” says Ewing. “Ordinary
people can’t play in this arena.”
But the rewards can be great too. In 2007, a U.S. jury hit Microsoft with $1.5 billion in damages after
finding that it violated Lucent’s MP3 patents (that verdict was later appealed, and most of the case
settled out of court). On Friday, the U.S. International Trade Commission threatened to halt the
import of all Motorola Mobility’s Android phones and tablets after finding that Motorola had
violated a Microsoft patent on how to fire off meeting requests from a mobile device.

Welcome to Ground Zero
Right now, ground zero for the patent wars is the smartphone market, where everyone from Google,
Oracle, Microsoft, and Apple to Motorola, HTC and Samsung are battling it out in the courts. Some
companies use patents as a competitive weapon, launching legal wars of attrition against
competitors. Others find that they can make big money in some areas without necessarily having to
win in the marketplace. Qualcomm makes nearly $4 billion annually licensing its mobile patents.
IBM, one of the top patent-holders on the planet, makes over $1 billion each year.
“The creation of these conglomeration of patents — what this does is create a barrier to entry for the
little guy.” — Julie Samuels
Veschi says that he — and not Rockstar’s board of directors — is calling the shots when it comes to
licensing deals. The company’s mission is “to manage the patent portfolio to achieve a return on
investment, probably through a combination of licensing and sales,” says Veschi. “So, in some cases,
we might be selling some patents, and in other cases, we might be licensing some patents.” Rockstar
hasn’t sued anyone yet, but Veschi expects that to happen too.
Because it doesn’t actually produce anything, some knock Rockstar as a straight-up patent troll.
“This deal is indicative of a much larger fundamental problem that we see today,” says Julie
Samuels, a staff attorney with the Electronic Frontier Foundation. She says she hears from small
companies regularly who get pressured out of the U.S. market because they simply can’t defend
themselves against massive patent claims, whether legitimate or not. None of them want to talk to
the press, though, for fear of drawing attention — and possibly more legal troubles — to themselves.
Ultimately, Samuels worries that patents — especially software patents — will hurt innovators rather
than help them. And that’s exactly the opposite of what patents are supposed to do.
“The creation of these conglomerations of patents … what this does is create a barrier to entry for the
little guy,” Samuels says. “It makes it so much harder to break into the market if you are a creator or
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an innovator.”

After surviving the Nortel meltdown, Rockstar CEO John Veschi now controls 4,000 patents. Photo:
Dan Krauss/Wired

Building in the Nortel Crater
With just 32 employees, Veschi’s company is tiny, but it has a big legacy. It’s the final resting place of
the patent portfolio of Canada’s most storied technology company, Nortel Networks, a
telecommunications giant whose origins date back to 1882 when it was the telephone manufacture
and repair department of the Bell Telephone Company of Canada. Three-quarters of Rockstar’s
employees, including Veschi and Widdowson worked at Nortel and kept their jobs by helping the
creditors understand and then sell Nortel’s patent portfolio.
Nortel flamed out spectacularly in 2009, in a complex international bankruptcy that cost more than
30,000 employees their jobs, left others without pension and life insurance coverage, and saw
several top executives face fraud charges in a trial that’s still ongoing.
“How the hell did you guys go bankrupt? Why weren’t you Google? Why weren’t you Facebook?” —
John Veschi
Employee pensions were slashed in half when the company could no longer meet payment
obligations. Some workers lost life insurance or medical benefits when the company’s self-funded
programs collapsed. And they’re still hurting three years later, waiting for courts in the United
States, Canada, and the United Kingdom to hammer out final bankruptcy settlements, says Anne
Clark-Stewart, a spokeswoman with Nortel Retirees and Former Employees Protection Canada, a
group representing more than 20,000 former Nortel employees.
But what was a tragedy for the company’s employees turned out to be an unprecedented opportunity
for Rockstar’s investors. Nortel had a massive patent portfolio — nearly 9,000 patents in all — most
of them related to computer networking. And according to Veschi, they were high-quality patents —
the kind that you’d normally find in a Bell Labs or an IBM; the kind that would be likely to stand up
in a court case. Nortel’s patents covered broad areas of wireless networking, telecom switching,

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internet routers, modems, personal computers, even search and social networking.
“A lot of people are still surprised to see the quality and the diversity of the IP that was in Nortel,” he
says. “And the fundamental question comes back: ‘How the hell did you guys go bankrupt? Why
weren’t you Google? Why weren’t you Facebook? Why weren’t you all these things, because you guys
actually had the ideas for these business models before they did?’ They were within a Bell Labs-y
kind of environment, and maybe the wherewithal of turning them into businesses wasn’t necessarily
there.”
Nortel went bankrupt because it was mismanaged and, ultimately, fizzled out in the marketplace.
Best known as a maker of telephone-company hardware and corporate phone systems, it once
boasted more than 90,000 employees. But it lost out in the data center to Cisco, and it was
outmaneuvered in its traditional telecom business by China’s Huawei.

No More Friendly Canadians
When Veschi signed on in 2008, Nortel hadn’t done much work to license its intellectual property. It
was run by friendly Canadians who didn’t want to antagonize partners and customers by suing them.
But the company had been remarkably adept at filing patents. “We had huge patent ceremonies in
the CTO group that we made a big production of every year,” says Gillian McColgan, a former Nortel
technical manager who is now chief technology officer with Rockstar.
Nortel’s patents sold for $4.5 billion — $1.3 billion more than the combined value of all of the
company’s business units.
Employees were paid bonuses, and sometimes, they’d join up with senior management at fancy
award ceremonies held at swank venues such as the five-star Adolphus Hotel in Dallas, home to
Queen Elizabeth II whenever she’s in Texas.
Nortel had long patented its inventions, but encouraged by former CEO Mike Zafirovski, it started
doing something called “defensive patenting.” Engineers were encouraged to file patents that could
be used to fire back in the event that someone brought a patent suit against Nortel. “A large focus of
our patenting efforts had been around in the pre-bankruptcy era, had been trying to identify what
our competitors might do, and laying down inventions in those spaces to protect ourselves,”
McColgan says.
“We ended up with a large portfolio of patents that are directed toward products and areas of
technology that our competitors were working in, where we didn’t necessarily have products
ourselves,” she adds.
When Nortel went belly up, patents representing tens of billions of dollars in research and
development were suddenly made available on the open market. It was an unprecedented
opportunity for patent buyers. “There had never been anything like it up to this point, not even
close,” says David Descoteaux, a banker with Lazard, an investment firm that advised Nortel
through the bankruptcy.
It wasn’t just the quality of the patents that attracted serious investors. It was the sheer volume.
Having thousands of high-quality patents to aim at a competitor is a uniquely useful weapon in this
new sport of kings.
Patent attorneys love large patent portfolios because they make negotiations easier, says Thomas
Ewing, the IP consultant. “When you get to these big numbers … you’re not talking about merits
anymore. The merit discussion just goes out the window,” he says. The reason? Whey you’re paying
lawyers between $10,000 to $15,000 per patent to drill down and research each patent, it’s usually
less expensive to cut a licensing deal. “Anything over 200, nobody’s talking about merits,” he says.
But Google, Apple, and Microsoft saw the same promise as Veschi, and soon, they marshaled forces
for a bidding war over Nortel’s patent portfolio. When the dust settled, Nortel’s patents sold for $4.5
billion — $1.3 billion more than the combined value of all of the company’s business units.

The $4.5 Billion Sales Job
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John Veschi and his small team of former Nortel employees had front-row seats to the bidding war.
In fact, they deserve a lot of the credit for driving the patent portfolio sale as high as it went.
Veschi is serious and intense. A half-marathon runner who likes to talk, but with a peripatetic way of
qualifying his thoughts in mid-sentence. His first job out of school was as an officer at Fort
Monmouth, New Jersey, the now-decommissioned Army signals facility that was once the workplace
of Julius Rosenberg.
Veschi signed on to run Nortel’s licensing business in the summer of 2008 — just six months before
the company declared bankruptcy. He had run licensing practices at Lucent and semiconductor
maker LSI before Nortel, and he saw a rare opportunity: a vast portfolio of top-quality patents that
nobody had yet tried to license.
“I was getting my equity struck at a nice low point and the future was rosy and I could help make it
that way. We could be less wimpy about our IP.” — John Veschi
He thought it was the perfect time to jump onboard and work on building a licensing business that
rivaled Lucent or IBM. “I was getting my equity struck at a nice low point and the future was rosy
and I could help make it that way,” he said, because “we could be less wimpy about our IP.”
What he ended up with was a quick hiring freeze and then, after bankruptcy, the job of analyzing
Nortel’s 8,500 patents, figuring out which ones should be sold with the company’s business units,
and which ones could be sold separately at auction. When this job — called the Patent Segmentation
Exercise — was done, Veschi had a portfolio of 6,000 patents to put up at auction.
It’s a remarkable story. Veschi and his small team ended up riding along with Nortel right through
the bankruptcy, and ultimately selling Nortel executives and creditors on the idea that the patents
should be split apart from the rest of company’s assets and sold separately. That wasn’t immediately
obvious to some creditors and company executives who thought they could bump up the sale prices
of Nortel’s business units by rolling in more patents. “It was at the time controversial,” says Michael
Lasinski, an early ally of Veschi’s who worked on a committee for unsecured Nortel creditors during
the bankruptcy.
Lasinski was quick to see the value of Nortel’s patents because, like Veschi, he’d had some
experience in the patent marketplace. He’d worked at the Ocean Tomo Patent Brokerage, a company
that had pioneered the idea of Sotheby’s-style patent auctions.
Veschi and his team started building financial models. From his time at Lucent, he knew how to
show just how much Nortel’s patent portfolio could bring in. At first, some executives thought it
would be less than a billion dollars. But with Lasinski’s support the models showed a lot more
money. The team built a database of Nortel’s patents and mapped them out to current and emerging
networking standards to show where they might play.
Then came the sales job of proving just how valuable these patents were to potential buyers. Google
was first out of the gate, with a $900 million stalking horse bid — a bid pre-approved by Nortel’s
management and creditors aimed at establishing the minimum amount that the patents would sell
for in bankruptcy auction.
It didn’t take long for others to jump in. At first, Apple, Intel, RIM, and others were interested, as
was a patent company called RPX, which buys up patents defensively, so they cannot be used against
its investors. By the time the bidding got to $4.5 billion, there were just two groups: Rockstar, and a
group called Ranger. Ranger was Intel and Google.

Does Rockstar Own 4G?
After the Rockstar group acquired the 6,000 Nortel patents, about 2,000 were transferred to the
companies behind the consortium. But 4,000 remained with Rockstar the company, which is
actively trying to make money from them.
It turned out that Nortel had patents that covered parts of the up-and-coming mobile data
technology called Long Term Evolution. Also known as 4G, this is the standard now bringing
speedier internet access to mobile phones. Many of those patents are now owned by Rockstar and
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could be enforced against mobile phone companies — Google, for example — in the coming months.
“You knew you were making tens or hundreds of millions of dollars’ difference.” — Scott Widdowson
But Nortel’s patents also covered core networking technologies used by routers and switches and
many other areas. The European Telecommunications Standards Institute, the standards body for
the European telecommunications industry, has a database that lists whose patents may apply to
emerging telecommunications standards, and it lists 43 standards areas, many relating to LTE,
where Nortel patents — some of them now transferred to Rockstar — are in play.
Close to 25 of Rockstar’s employees are former Nortel workers, including lawyers, managers and
engineers. Having longtime Nortel engineers like Widdowson and McColgan — people who know the
business and the patent portfolio — is going to help Veschi do a better job in figuring out where to go
looking for licensing fees. Widdowson won’t say what he’s working on, by the way, except that it’s
related to consumer telecommunications technology.
But that’s not why Widdowson says he stuck it out through the bankruptcy. He was offered another
job, and he turned it down.
Former coworkers might have found this a little strange, but it turned out that Widdowson liked the
work he was doing. The mesh of the legal and technical work was a new challenge for him, but there
was another reason he stuck with it. He felt like he was helping his former Nortel colleagues who
were hurting because of the bankruptcy.
McColgan reports a similar story. Even though she had colleagues telling her she was “off her
rocker,” she stuck it out with the patent work because she thought she could make a difference and
increase the amount paid back to Nortel’s workers.
“You knew you were making tens or hundreds of millions of dollars’ difference,” Widdowson says,
“which is not usual for someone who is an engineer.”
Pages: 1 2 3 View All

Robert McMillan is a writer with Wired Enterprise. Got a tip? Send him an email at:
robert_mcmillan [at] wired.com.
Read more by Robert McMillan
Follow @bobmcmillan on Twitter.

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81 Comments

Jesse Petersen

•

This is exactly what's wrong with the patent system.
•

Scott Sterling

•

In a free enterprise system, if you legitimately own a patent, what is wrong with asking
another company that wants to use your patent to pay a small fee?
Is it complicated and messy? Of course. But what exactly is wrong with it?
•

MustBeSaid

•

What's wrong is the over the top time allowance on patents. That you're allowed to
patent computer code and businesses processes which are nothing more than a
description of a way to produce a desired result. They're a recipe and you can't
patent a
recipe.
That the USPTO doesn't do any real work in checking for infringement. They grant
moronic patents left and right then leave it up to overpriced lawyers and courts to
figure it out. Big companies can afford this, small, medium or individual inventors
cannot.Companies are allowed to patent things they have no intention of ever
producing just so they can block others who actually spend the time, money and
energy to develop those things.You shouldn't be allowed to hold onto a patent
without proof that you're actively developing or using that patent for something
other than licensing. Before you're allowed to license you should have to at least
bring a product to market or show a working, viable prototype that uses that
patent.This whole process of sketching some overly simplistic idea on a napkin and
getting a patent on it along with a thousand others like it just to sit on it and sue
anyone who comes up with the idea and actually uses it should be illegal. Patent
trolling should be illegal which is all these "rockstar" guys really are.They and the
lawyers that handle these lawsuits produce nothing. They protect nothing probably
90% of the time. Protecting a patent that should have never been granted or should
have long since expired is just legal extortion.
•

Cowboydroid

•

The thing that is "wrong" with it is that many large corporations are taking
advantage of the lax approval process the patent office has had for the last 15ish

10

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Case 2:13-cv-00900-JRG Document 52-4 Filed 03/21/14 Page 35 of 38 PageID #: 1851
Case 09-10138-KG Doc 5935 Filed 07/11/11 Page 34 of 37

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EXHIBIT 4

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APPLE INC

FORM Report)
10-Q
(Quarterly

Filed 07/20/11 for the Period Ending 06/25/11
Address
Telephone
CIK
Symbol
SIC Code
Industry
Sector
Fiscal Year

ONE INFINITE LOOP
CUPERTINO, CA 95014
[phone]
0000320193
AAPL
3571 - Electronic Computers
Computer Hardware
Technology
09/30

http://www.edgar-online.com
© Copyright 2011, EDGAR Online, Inc. All Rights Reserved.
Distribution and use of this document restricted under EDGAR Online, Inc. Terms of Use.

Case 2:13-cv-00894-JRG Document 41-3 Filed 03/25/14 Page 64 of 176 PageID #: 624
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q
(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 25, 2011
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from

to

.

Commission file number: 000-10030

APPLE INC.
(Exact name of Registrant as specified in its charter)
California

94-2404110

(State or other jurisdiction
of incorporation or organization)

(I.R.S. Employer Identification No.)

1 Infinite Loop
Cupertino, California

95014

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code: [phone]
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days.
Yes

No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data
File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or
for such shorter period that the registrant was required to submit and post such files).
Yes

No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.
Large accelerated filer
Non-accelerated filer

(Do not check if a smaller reporting company)

Accelerated filer
Smaller reporting company

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes

No

927,090,886 shares of common stock issued and outstanding as of July 8, 2011

Case 2:13-cv-00894-JRG Document 41-3 Filed 03/25/14 Page 65 of 176 PageID #: 625
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PART I. FINANCIAL INFORMATION
Item 1.

Financial Statements
APPLE INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(in millions, except share amounts which are reflected in thousands and per share amounts)
Three Months Ended
June 25,
June 26,
2011
2010

Net sales
Cost of sales
Gross margin

$

28,571
16,649
11,922

$

15,700
9,564
6,136

Nine Months Ended
June 25,
June 26,
2011
2010

$

79,979
47,541
32,438

$

44,882
26,710
18,172

Operating expenses:
Research and development
Selling, general and administrative
Total operating expenses

628
1,915
2,543

464
1,438
1,902

1,784
5,574
7,358

1,288
3,946
5,234

Operating income
Other income and expense
Income before provision for income taxes

9,379
172
9,551

4,234
58
4,292

25,080
334
25,414

12,938
141
13,079

Provision for income taxes
Net income

$

2,243
7,308

$

1,039
3,253

$

6,115
19,299

$

3,374
9,705

Earnings per common share:
Basic
Diluted

$
$

7.89
7.79

$
$

3.57
3.51

$
$

20.91
20.63

$
$

10.69
10.51

Shares used in computing earnings per share:
Basic
Diluted

926,108
937,810

912,197
927,361

See accompanying Notes to Condensed Consolidated Financial Statements.
2

922,917
935,688

907,762
923,341

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Case 2:13-cv-00900-JRG Document 52-5 Filed 03/21/14 Page 5 of 55 PageID #: 1859
APPLE INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(in millions, except share amounts)
June 25,
2011

ASSETS:
Current assets:
Cash and cash equivalents
Short-term marketable securities
Accounts receivable, less allowances of $55 in each period
Inventories
Deferred tax assets
Vendor non-trade receivables
Other current assets
Total current assets

$

Long-term marketable securities
Property, plant and equipment, net
Goodwill
Acquired intangible assets, net
Other assets
Total assets

$

LIABILITIES AND SHAREHOLDERS’ EQUITY:
Current liabilities:
Accounts payable
Accrued expenses
Deferred revenue
Total current liabilities

$

Deferred revenue - non-current
Other non-current liabilities
Total liabilities

12,091
16,304
6,102
889
1,892
5,369
4,251
46,898
47,761
6,749
741
1,169
3,440
106,758

15,270
7,597
3,992
26,859

September 25,
2010

$

$

$

11,261
14,359
5,510
1,051
1,636
4,414
3,447
41,678
25,391
4,768
741
342
2,263
75,183

12,015
5,723
2,984
20,722

1,407
9,149
37,415

1,139
5,531
27,392

12,715
56,239
389
69,343

10,668
37,169
(46)
47,791

Commitments and contingencies
Shareholders’ equity:
Common stock, no par value; 1,800,000,000 shares authorized; 926,903,779 and
915,970,050 shares issued and outstanding, respectively
Retained earnings
Accumulated other comprehensive income/(loss)
Total shareholders’ equity
Total liabilities and shareholders’ equity

$

See accompanying Notes to Condensed Consolidated Financial Statements.
3

106,758

$

75,183

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Case 2:13-cv-00900-JRG Document 52-5 Filed 03/21/14 Page 6 of 55 PageID #: 1860
APPLE INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(in millions)
Nine Months Ended
June 25,
June 26,
2011
2010

Cash and cash equivalents, beginning of the period
Operating activities:
Net income
Adjustments to reconcile net income to cash generated by operating activities:
Depreciation, amortization and accretion
Stock-based compensation expense
Deferred income tax expense
Changes in operating assets and liabilities:
Accounts receivable, net
Inventories
Vendor non-trade receivables
Other current and non-current assets
Accounts payable
Deferred revenue
Other current and non-current liabilities
Cash generated by operating activities
Investing activities:
Purchases of marketable securities
Proceeds from maturities of marketable securities
Proceeds from sales of marketable securities
Payments made in connection with business acquisitions, net of cash acquired
Payments for acquisition of property, plant and equipment
Payments for acquisition of intangible assets
Other
Cash used in investing activities
Financing activities:
Proceeds from issuance of common stock
Excess tax benefits from equity awards
Taxes paid related to net share settlement of equity awards
Cash generated by financing activities

$

11,261

$

5,263

19,299

9,705

1,271
870
2,232

698
655
1,298

(592)
162
(955)
(1,551)
2,480
1,276
2,608
27,100

(79)
(487)
(1,256)
(1,001)
2,812
806
(239)
12,912

(75,133)
16,396
34,301
0
(2,615)
(266)
34
(27,283)

(41,318)
19,758
14,048
(615)
(1,245)
(63)
(36)
(9,471)

577
915
(479)
1,013

733
652
(384)
1,001

Increase in cash and cash equivalents
Cash and cash equivalents, end of the period

$

830
12,091

$

4,442
9,705

Supplemental cash flow disclosure:
Cash paid for income taxes, net

$

2,563

$

2,657

See accompanying Notes to Condensed Consolidated Financial Statements.
4

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Apple Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Note 1 – Summary of Significant Accounting Policies
Apple Inc. and its wholly-owned subsidiaries (collectively “Apple” or the “Company”) designs, manufactures, and markets mobile
communication and media devices, personal computers, and portable digital music players, and sells a variety of related software, services,
peripherals, networking solutions, and third-party digital content and applications. The Company sells its products worldwide through its retail
stores, online stores, and direct sales force, as well as through third-party cellular network carriers, wholesalers, retailers and value-added
resellers. In addition, the Company sells a variety of third-party iPhone, iPad, Macintosh (“Mac”), and iPod compatible products including
application software, printers, storage devices, speakers, headphones, and various other accessories and supplies through its online and retail
stores. The Company sells to consumers, small and mid-sized businesses, education, enterprise and government customers.
Basis of Presentation and Preparation
The accompanying condensed consolidated financial statements include the accounts of the Company. Intercompany accounts and transactions
have been eliminated. The preparation of these condensed consolidated financial statements in conformity with U.S. generally accepted
accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the amounts reported in these condensed
consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates. Certain prior period
amounts in the condensed consolidated financial statements and notes thereto have been reclassified to conform to the current period’s
presentation.
These condensed consolidated financial statements and accompanying notes should be read in conjunction with the Company’s annual
consolidated financial statements and the notes thereto for the fiscal year ended September 25, 2010, included in its Annual Report on Form 10K (the “2010 Form 10-K”). Unless otherwise stated, references to particular years or quarters refer to the Company’s fiscal years ended in
September and the associated quarters of those fiscal years.
During the first quarter of 2011, the Company adopted the Financial Accounting Standard Board’s (“FASB”) new accounting standard on
consolidation of variable interest entities. This new accounting standard eliminates the mandatory quantitative approach in determining control
for evaluating whether variable interest entities need to be consolidated in favor of a qualitative analysis, and requires an ongoing
reassessment of control over such entities. The adoption of this new accounting standard did not impact the Company’s condensed consolidated
financial statements.
Revenue Recognition
Revenue Recognition for Arrangements with Multiple Deliverables

For multi-element arrangements that include tangible products containing software that is essential to the tangible product’s functionality,
undelivered software elements relating to the tangible product’s essential software, and undelivered non-software services, the Company
allocates revenue to all deliverables based on their relative selling prices. In such circumstances, the Company uses a hierarchy to determine the
selling price to be used for allocating revenue to deliverables: (i) vendor-specific objective evidence of fair value (“VSOE”), (ii) third-party
evidence of selling price (“TPE”), and (iii) best estimate of the 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.
5

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For sales of iPhone, iPad, Apple TV, for sales of iPod touch beginning in June 2010, and for sales of Mac beginning in June 2011, the Company
has indicated it may from time-to-time provide future unspecified software upgrades and features free of charge to customers. In June 2011, the
Company announced it would provide various non-software services (“the online services”) to owners of qualifying versions of iPhone, iPad,
iPod touch and Mac. The Company has identified up to three deliverables in arrangements involving the sale of these devices. The first
deliverable is the hardware and software essential to the functionality of the hardware device delivered at the time of sale. The second
deliverable is the embedded right included with the purchase of iPhone, iPad, iPod touch, Mac and Apple TV to receive on a when-and-ifavailable basis, future unspecified software upgrades and features relating to the product’s essential software. The third deliverable is the online
services to be provided to qualifying versions of iPhone, iPad, iPod touch and Mac. The Company allocates revenue between these deliverables
using the relative selling price method. Because the Company has neither VSOE nor TPE for these deliverables, the allocation of revenue has
been based on the Company’s ESPs. Amounts allocated to the delivered hardware and the related essential software are recognized at the time of
sale provided the other conditions for revenue recognition have been met. Amounts allocated to the embedded unspecified software upgrade
rights and the online services are deferred and recognized on a straight-line basis over the estimated lives of each of these devices, which range
from 24 to 48 months. Cost of sales related to delivered hardware and related essential software, including estimated warranty costs, are
recognized at the time of sale. Costs incurred to provide non-software services are recognized as cost of sales as incurred, and engineering and
sales and marketing costs are recognized as operating expenses as incurred.
The Company’s process for determining its ESP for deliverables without VSOE or TPE considers multiple factors that may vary depending upon
the unique facts and circumstances related to each deliverable. The Company believes its customers, particularly consumers, would be reluctant
to buy the types of unspecified software upgrade rights embedded with iPhone, iPad, iPod touch, Mac and Apple TV. This view is primarily
based on the fact that unspecified upgrade rights do not obligate the Company to provide upgrades at a particular time or at all, and do not
specify to customers which upgrades or features will be delivered. The Company also believes its customers would be unwilling to pay a
significant amount for access to the online services because other companies offer similar services at little or no cost to users. Therefore, the
Company has concluded that if it were to sell upgrade rights or access to the online services on a standalone basis, including those rights and
services attached to iPhone, iPad, iPod touch, Mac and Apple TV, the selling price would be relatively low. Key factors considered by the
Company in developing the ESPs for the upgrade rights include prices charged by the Company for similar offerings, market trends for pricing
of Mac and iOS software, the Company’s historical pricing practices, the nature of the upgrade rights (e.g., unspecified and when-and-ifavailable), and the relative ESP of the upgrade rights as compared to the total selling price of the product. The Company may also consider,
when appropriate, the impact of other products and services, including advertising services, on selling price assumptions when developing and
reviewing its ESPs for software upgrade rights and related deliverables. The Company may also consider additional factors as appropriate,
including the pricing of competitive alternatives if they exist and product-specific business objectives. When relevant, the same factors are
considered by the Company in developing ESPs for service offerings such as the online services; however, the primary consideration in
developing ESPs for the online services is the estimated cost to provide such services over the life of the related devices, including consideration
for a reasonable profit margin.
Beginning with the Company’s June 2011 announcement of the upcoming release of the online services and Mac OS X Lion, the Company’s
combined ESP for the unspecified software upgrade rights and the right to receive the online services are as follows: $16 for iPhone and iPad,
$11 for iPod touch, and $22 for Mac. The Company’s ESP for the embedded unspecified software upgrade right included with each Apple TV is
$5 for 2011. Amounts allocated to the embedded unspecified software upgrade rights and the online services associated with iPhone, iPad, iPod
touch and Apple TV are recognized on a straight-line basis over 24 months, and amounts allocated to the embedded unspecified software
upgrade rights and the online services associated with Mac are recognized on a straight-line basis over 48 months.
The Company recognizes revenue in accordance with industry specific software accounting guidance for sales of software upgrades. Therefore,
beginning in July 2011 the Company will defer all revenue from the sale of upgrades to the Mac OS and iLife software and recognize it ratably
over 36 months.
Earnings Per Common Share
Basic earnings per common share is computed by dividing income available to common shareholders by the weighted-average number of shares
of common stock outstanding during the period. Diluted earnings per common share is computed by dividing income available to common
shareholders by the weighted-average number of shares of common stock outstanding during the period increased to include the number of
additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued. Potentially dilutive
securities include outstanding options, shares to be purchased under the employee stock purchase plan, and unvested restricted stock units
(“RSUs”). The dilutive effect of potentially dilutive securities is reflected in diluted earnings per common share by application of the treasury
stock method. Under the treasury stock method, an increase in the fair market value of the Company’s common stock can result in a greate r
dilutive effect from potentially dilutive securities.
6

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The following table summarizes the computation of basic and diluted earnings per common share for the three- and nine-month periods ended
June 25, 2011 and June 26, 2010 (in thousands, except net income in millions and per share amounts):
Three Months Ended
June 25,
June 26,
2011
2010

Numerator:
Net income
Denominator:
Weighted-average shares outstanding
Effect of dilutive securities
Weighted-average diluted shares

$

7,308

$

926,108
11,702
937,810

Basic earnings per common share
Diluted earnings per common share

$
$

7.89
7.79

3,253

Nine Months Ended
June 25,
June 26,
2011
2010

$

912,197
15,164
927,361
$
$

3.57
3.51

19,299

$

922,917
12,771
935,688
$
$

20.91
20.63

9,705
907,762
15,579
923,341

$
$

10.69
10.51

Potentially dilutive securities representing approximately 2,000 shares and 220,000 shares of common stock for the three months ended June 25,
2011 and June 26, 2010, respectively, and 206,000 shares and 498,000 shares of common stock for the nine months ended June 25, 2011 and
June 26, 2010, respectively, were excluded from the computation of diluted earnings per common share for these periods because their effect
would have been antidilutive.
Fair Value Measurements
Fair value is the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure
fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the
fair value measurement:
Level 1 – Quoted prices in active markets for identical assets or liabilities.
Level 2 – Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar
assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the
full term of the assets or liabilities.
Level 3 – Inputs that are generally unobservable and typically reflect management’s estimate of assumptions that market participants would use
in pricing the asset or liability.

7

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Note 2 – Financial Instruments
Cash, Cash Equivalents and Marketable Securities
All highly liquid investments with maturities of three months or less at the date of purchase are classified as cash equivalents. The Company’s
marketable debt and equity securities have been classified and accounted for as available-for-sale. Management determines the appropriate
classification of its investments at the time of purchase and reevaluates the available-for-sale designations as of each balance sheet date. The
Company classifies its marketable debt securities as either short-term or long-term based on each instrument’s underlying contractual maturity
date. Marketable debt securities with maturities of 12 months or less are classified as short-term and marketable debt securities with maturities
greater than 12 months are classified as long-term. The Company classifies its marketable equity securities, including mutual funds, as either
short-term or long-term based on the nature of each security and its availability for use in current operations.
The following tables summarize the Company’s available-for-sale securities’ adjusted cost, gross unrealized gains, gross unrealized losses and
fair value by significant investment category recorded as cash and cash equivalents or short-term or long-term marketable securities as of
June 25, 2011 and September 25, 2010 (in millions):
June 25, 2011
Adjusted
Cost

Cash

$

Unrealized
Losses

Fair
Value

Cash and
Cash
Equivalents

Short-Term
Marketable
Securities

Long-Term
Marketable
Securities

0 $

2,769 $

2,769 $

0
0
0

0
0
0

1,414
150
1,564

1,414
0
1,414

0
150
150

0
0
0

51
17
18

0
(1)
(1)

10,787
10,002
6,144

1,139
391
427

1,876
1,980
1,952

7,772
7,631
3,765

4,538
6,326
30,441
3,389
71,543
$

0 $

10,736
9,986
6,127

Level 2:
U.S. Treasury securities
U.S. agency securities
Non-U.S. government securities
Certificates of deposit and time
deposits
Commercial paper
Corporate securities
Municipal securities
Subtotal

2,769 $
1,414
150
1,564

Level 1:
Money market funds
Mutual funds
Subtotal

Total

Unrealized
Gains

4
0
167
35
292

0
0
(9)
(1)
(12)

4,542
6,326
30,599
3,423
71,823

893
4,977
81
0
7,908

1,231
1,349
7,242
524
16,154

2,418
0
23,276
2,899
47,761

75,876 $

292 $

(12) $

76,156 $

16,304 $

47,761

8

12,091 $

0 $

0

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September 25, 2010
Adjusted
Cost

Cash

$

Unrealized
Losses

Fair
Value

Cash and
Cash
Equivalents

Short-Term
Marketable
Securities

Long-Term
Marketable
Securities

0 $

1,690 $

1,690 $

0 $

0

0

0

2,753

2,753

0

0

42
10
13

0
0
0

9,914
8,727
2,661

2,571
1,916
10

2,130
4,339
865

5,213
2,472
1,786

2,735
3,168
17,349
1,899
46,388
$

0 $

9,872
8,717
2,648

Level 2:
U.S. Treasury securities
U.S. agency securities
Non-U.S. government securities
Certificates of deposit and time
deposits
Commercial paper
Corporate securities
Municipal securities
Subtotal

1,690 $
2,753

Level 1:
Money market funds

Total

Unrealized
Gains

5
0
102
19
191

(1)
0
(9)
(1)
(11)

2,739
3,168
17,442
1,917
46,568

374
1,889
58
0
6,818

850
1,279
4,522
374
14,359

1,515
0
12,862
1,543
25,391

50,831 $

191 $

(11) $

51,011 $

14,359 $

25,391

11,261 $

The net unrealized gains as of June 25, 2011 and September 25, 2010 related primarily to long-term marketable securities. The Company may
sell certain of its marketable securities prior to their stated maturities for strategic reasons including, but not limited to, anticipation of credit
deterioration and duration management. The Company recognized net realized gains of $14 million and $70 million during the three- and ninemonth periods ended June 25, 2011, respectively. The Company recognized no significant net realized gains or losses during the three- and ninemonth periods ended June 26, 2010. The maturities of the Company’s long-term marketable securities generally range from one year to five
years.
As of June 25, 2011 and September 25, 2010, gross unrealized losses related to individual securities that had been in a continuous loss position
for 12 months or longer were not significant.
The Company considers the declines in market value of its marketable securities investment portfolio to be temporary in nature. The Company
typically invests in highly-rated securities, and its policy generally limits the amount of credit exposure to any one issuer. The Company’s
investment policy requires investments to generally be investment grade, primarily rated single-A or better, with the objective of minimizing the
potential risk of principal loss. Fair values were determined for each individual security in the investment portfolio. When evaluating the
investments for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has
been below cost basis, the financial condition of the issuer and any changes thereto, and the Company’s intent to sell, or whether it is more likely
than not it will be required to sell, the investment before recovery of the investment’s amortized cost basis. During the three- and nine-month
periods ended June 25, 2011 and June 26, 2010, the Company did not recognize any significant impairment charges. As of June 25, 2011, the
Company does not consider any of its investments to be other-than-temporarily impaired.
Derivative Financial Instruments
The Company uses derivatives to partially offset its business exposure to foreign currency exchange risk. The Company may enter into foreign
currency forward and option contracts to offset some of the foreign exchange risk on expected future cash flows on certain forecasted revenue
and cost of sales, on net investments in certain foreign subsidiaries, and on certain existing assets and liabilities. To help protect gross margins
from fluctuations in foreign currency exchange rates, certain of the Company’s subsidiaries whose functional currency is the U.S. dollar hedge a
portion of forecasted foreign currency revenue. The Company’s subsidiaries whose functional currency is not the U.S. dollar and who sell in
local currencies may hedge a portion of forecasted inventory purchases not denominated in the subsidiaries’ functional currencies. The Company
typically hedges portions of its forecasted foreign currency exposure associated with revenue and inventory purchases for three to six months. To
help protect the net investment in a foreign operation from adverse changes in foreign currency exchange rates, the Company may enter into
foreign currency forward and option contracts to offset the changes in the carrying amounts of these investments due to fluctuations in foreign
currency exchange rates. The Company may also enter into foreign currency forward and option contracts to partially offset the foreign currency
exchange gains and losses generated by the re-measurement of certain assets and liabilities denominated in non-functional currencies. However,
the Company may choose not to hedge certain foreign currency exchange exposures for a variety of reasons including, but not limited to,
materiality, accounting considerations and the prohibitive economic cost of hedging particular exposures. There can be no assurance the hedges
will offset more than a portion of the financial impact resulting from movements in foreign currency exchange rates.
9

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The Company’s accounting policies for these instruments are based on whether the instruments are designated as hedge or non-hedge
instruments. The Company records all derivatives on the Condensed Consolidated Balance Sheets at fair value. The effective portions of cash
flow hedges are recorded in other comprehensive income until the hedged item is recognized in earnings. The effective portions of net
investment hedges are recorded in other comprehensive income as a part of the cumulative translation adjustment. The ineffective portions of
cash flow hedges and net investment hedges are recorded in other income and expense. Derivatives that are not designated as hedging
instruments are adjusted to fair value through earnings in the financial statement line item the derivative relates to.
The Company had a net deferred gain associated with cash flow hedges of approximately $21 million and a net deferred loss associated with
cash flow hedges of approximately $252 million, net of taxes, recorded in other comprehensive income as of June 25, 2011 and September 25,
2010, respectively. Deferred gains and losses associated with cash flow hedges of foreign currency revenue are recognized as a component of net
sales in the same period as the related revenue is recognized, and deferred gains and losses related to cash flow hedges of inventory purchases
are recognized as a component of cost of sales in the same period as the related costs are recognized. Substantially all of the Company’s hedged
transactions as of June 25, 2011 are expected to occur within six months.
Derivative instruments designated as cash flow hedges must be de-designated as hedges when it is probable the forecasted hedged transaction
will not occur in the initially identified time period or within a subsequent two-month time period. Deferred gains and losses in other
comprehensive income associated with such derivative instruments are reclassified immediately into earnings through other income and expense.
Any subsequent changes in fair value of such derivative instruments are reflected in other income and expense unless they are re-designated as
hedges of other transactions. The Company did not recognize any significant net gains or losses related to the loss of hedge designation on
discontinued cash flow hedges during the three- and nine-month periods ended June 25, 2011 and June 26, 2010.
The Company’s unrealized net gains and losses on net investment hedges, included in the cumulative translation adjustment account of
accumulated other comprehensive income (“AOCI”), were not significant as of June 25, 2011 and September 25, 2010, respectively. The
ineffective portions and amounts excluded from the effectiveness test of net investment hedges are recorded in other income and expense.
The Company recognized in earnings a net loss on foreign currency forward and option contracts not designated as hedging instruments of $45
million and $100 million during the three- and nine-month periods ended June 25, 2011, respectively, and a net gain on foreign currency forward
and option contracts not designated as hedging instruments of $25 million and $15 million during the three- and nine-month periods ended
June 26, 2010, respectively. These amounts, recorded in other income and expense, represent the net gain or loss on the derivative contracts and
do not include changes in the related exposures, which generally offset a portion of the gain or loss on the derivative contracts.
10

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The following table summarizes the notional principal amounts of the Company’s outstanding derivative instruments and credit risk amounts
associated with outstanding or unsettled derivative instruments as of June 25, 2011 and September 25, 2010 (in millions):
June 25, 2011
Notional
Credit Risk
Principal
Amounts

September 25, 2010
Notional
Credit Risk
Principal
Amounts

Instruments qualifying as accounting hedges:
Foreign exchange contracts

$

12,282

$

128

$

13,957

$

62

Instruments other than accounting hedges:
Foreign exchange contracts

$

6,415

$

14

$

10,727

$

45

The notional principal amounts for outstanding derivative instruments provide one measure of the transaction volume outstanding and do not
represent the amount of the Company’s exposure to credit or market loss. The credit risk amounts represent the Company’s gross exposure to
potential accounting loss on derivative instruments that are outstanding or unsettled if all counterparties failed to perform according to the terms
of the contract, based on then-current currency exchange rates at each respective date. The Company’s gross exposure on these transactions may
be further mitigated by collateral received from certain counterparties. The Company’s exposure to credit loss and market risk will vary ove r
time as a function of currency exchange rates. Although the table above reflects the notional principal and credit risk amounts of the Company’s
foreign exchange instruments, it does not reflect the gains or losses associated with the exposures and transactions that the foreign exchange
instruments are intended to hedge. The amounts ultimately realized upon settlement of these financial instruments, together with the gains and
losses on the underlying exposures, will depend on actual market conditions during the remaining life of the instruments.
The Company generally enters into master netting arrangements, which reduce credit risk by permitting net settlement of transactions with the
same counterparty. To further limit credit risk, the Company generally enters into collateral security arrangements that provide for collateral to
be received or posted when the net fair value of certain financial instruments fluctuates from contractually established thresholds. The Company
presents its derivative assets and derivative liabilities at their gross fair values. As of June 25, 2011, the Company received cash collateral related
to the derivative instruments under its collateral security arrangements of $8 million, which it recorded as accrued expenses in the Condensed
Consolidated Balance Sheet. As of September 25, 2010, the Company posted cash collateral related to the derivative instruments under its
collateral security arrangements of $445 million, which it recorded as other current assets in the Condensed Consolidated Balance Sheet. The
Company did not have any derivative instruments with credit-risk related contingent features that would require it to post additional collateral as
of June 25, 2011 or September 25, 2010.
11

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The following tables summarize the gross fair value of the Company’s derivative instruments as reflected in the Condensed Consolidated
Balance Sheets as of June 25, 2011 and September 25, 2010 (in millions):
June 25, 2011
Fair Value of
Derivatives
Not Designated

Fair Value of
Derivatives
Designated
as Hedge
Instruments

as Hedge
Instruments

Total
Fair Value

Derivative assets (a):
Foreign exchange contracts

$

125 $

14 $

139

Derivative liabilities (b):
Foreign exchange contracts

$

64 $

6 $

70

Fair Value of
Derivatives
Designated
as Hedge
Instruments

September 25, 2010
Fair Value of
Derivatives
Not Designated
as Hedge
Instruments

Total
Fair Value

Derivative assets (a):
Foreign exchange contracts

$

62 $

45 $

107

Derivative liabilities (b):
Foreign exchange contracts

$

488 $

118 $

606

(a)

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

(b)

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

The following table summarizes the pre-tax effect of the Company’s derivative instruments designated as cash flow and net investment hedges in
the Condensed Consolidated Statements of Operations for the three- and nine-month periods ended June 25, 2011 and June 26, 2010 (in
millions):
Three Month Periods

Gains/(Losses)
Reclassified
from AOCI
into Income Effective
Portion (e)
June 25,
June 26,
2011 (a)
2010 (b)

Gains/(Losses)
Recognized in
OCI Effective
Portion (e)
June 25,
June 26,
2011
2010

Cash flow hedges:
Foreign exchange contracts

June 26,
2010

Other income
$

12 $

83 $

(162) $

Net investment hedges:
Foreign exchange contracts

Total

Location

Gains/(Losses)
Recognized –
Ineffective
Portion and
Amount
Excluded
from
Effectiveness
Testing
June 25,
2011

67 and expense $

15 $

(50)

1
16 $

0
(50)

Other income

$

(7)
5 $

(18)
65 $
12

0
(162) $

0 and expense
67
$

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Nine Month Periods

Gains/(Losses)
Reclassified
from AOCI
into Income Effective
Portion (e)
June 25,
June 26,
2011 (c)
2010 (d)

Gains/(Losses)
Recognized in
OCI Effective
Portion (e)
June 25,
June 26,
2011
2010

Cash flow hedges:
Foreign exchange contracts

June 26,
2010

Other income
$

(270) $

145 $

(701) $

Net investment hedges:
Foreign exchange contracts

Total

Location

Gains/(Losses)
Recognized –
Ineffective
Portion and
Amount
Excluded
from
Effectiveness
Testing
June 25,
2011

80 and expense $

(104) $

(88)

1
(103) $

0
(88)

Other income

$

(21)
(291) $

(16)
129 $

0
(701) $

0 and expense
80
$

(a)

Includes gains/(losses) reclassified from AOCI into income for the effective portion of cash flow hedges, of which $(101) million and
$(61) million were recognized within net sales and cost of sales, respectively, within the Condensed Consolidated Statement of Operations
for the three months ended June 25, 2011. There were no amounts reclassified from AOCI into income for the effective portion of net
investment hedges for the three months ended June 25, 2011.

(b)

Includes gains/(losses) reclassified from AOCI into income for the effective portion of cash flow hedges, of which $78 million and $(11)
million were recognized within net sales and cost of sales, respectively, within the Condensed Consolidated Statement of Operations for
the three months ended June 26, 2010. There were no amounts reclassified from AOCI into income for the effective portion of net
investment hedges for the three months ended June 26, 2010.

(c)

Includes gains/(losses) reclassified from AOCI into income for the effective portion of cash flow hedges, of which $(382) million and
$(319) million were recognized within net sales and cost of sales, respectively, within the Condensed Consolidated Statement o f
Operations for the nine months ended June 25, 2011. There were no amounts reclassified from AOCI into income for the effective portion
of net investment hedges for the nine months ended June 25, 2011.

(d)

Includes gains/(losses) reclassified from AOCI into income for the effective portion of cash flow hedges, of which $109 million and $(29)
million were recognized within net sales and cost of sales, respectively, within the Condensed Consolidated Statement of Operations for
the nine months ended June 26, 2010. There were no amounts reclassified from AOCI into income for the effective portion of net
investment hedges for the nine months ended June 26, 2010.

(e)

Refer to Note 5, “Shareholders’ Equity and Stock-Based Compensation” of this Form 10-Q, which summarizes the activity in AOCI
related to derivatives.

Accounts Receivable
The Company has considerable trade receivables outstanding with its third-party cellular network carriers, wholesalers, retailers, value-added
resellers, small and mid-sized businesses, and education, enterprise and government customers that are not covered by collateral, third-party
financing arrangements or credit insurance. As of June 25, 2011, trade receivables from one customer accounted for 12% of the Company’s total
trade receivables. Trade receivables from two of the Company’s customers accounted for 15% and 12% of total trade receivables as of
September 25, 2010. The Company’s cellular network carriers accounted for 60% and 64% of trade receivables as of June 25, 2011 and
September 25, 2010, respectively.
Additionally, the Company has non-trade receivables from certain of its manufacturing vendors. Vendor non-trade receivables from two of the
Company’s vendors accounted for 56% and 22% of total non-trade receivables as of June 25, 2011 and vendor non-trade receivables from two of
the Company’s vendors accounted for 57% and 24% of total non-trade receivables as of September 25, 2010.
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Note 3 – Condensed Consolidated Financial Statement Details
The following tables summarize the Company’s condensed consolidated financial statement details as of June 25, 2011 and September 25, 2010
(in millions):
Property, Plant and Equipment
June 25, 2011

Land and buildings
Machinery, equipment and internal-use software
Office furniture and equipment
Leasehold improvements
Gross property, plant and equipment
Accumulated depreciation and amortization
Net property, plant and equipment

$

$

September 25, 2010

2,028 $
5,789
172
2,359
10,348
(3,599)
6,749 $

1,471
3,589
144
2,030
7,234
(2,466)
4,768

Accrued Expenses
June 25, 2011

Accrued warranty and related costs
Deferred margin on component sales
Accrued taxes
Accrued compensation and employee benefits
Accrued marketing and selling expenses
Other current liabilities
Total accrued expenses

$

$

1,190
1,362
1,130
546
488
2,881
7,597

September 25, 2010

$

$

761
663
524
436
396
2,943
5,723

Non-Current Liabilities
June 25, 2011

Deferred tax liabilities
Other non-current liabilities
Total other non-current liabilities

$
$

7,331
1,818
9,149

September 25, 2010

$
$

4,300
1,231
5,531

Note 4 – Income Taxes
As of June 25, 2011, the Company recorded gross unrecognized tax benefits of $1.2 billion, of which $534 million, if recognized, would affect
the Company’s effective tax rate. As of September 25, 2010, the total amount of gross unrecognized tax benefits was $943 million, of which
$404 million, if recognized, would affect the Company’s effective tax rate. The Company’s total gross unrecognized tax benefits are classified as
other non-current liabilities in the Condensed Consolidated Balance Sheets. The Company had $266 million and $247 million of gross interest
and penalties accrued as of June 25, 2011 and September 25, 2010, respectively, which are classified as other non-current liabilities in the
Condensed Consolidated Balance Sheets.
Management believes that an adequate provision has been made for any adjustments that may result from tax examinations. However, the
outcome of tax audits cannot be predicted with certainty. If any issues addressed in the Company’s tax audits are resolved in a manner not
consistent with management’s expectations, the Company could be required to adjust its provision for income tax in the period such resolution
occurs. Although timing of the resolution and/or closure of audits is not certain, the Company does not believe it is reasonably possible that its
unrecognized tax benefits would materially change in the next 12 months.
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Note 5 – Shareholders’ Equity and Stock-Based Compensation
Preferred Stock
The Company has five million shares of authorized preferred stock, none of which is issued or outstanding. Under the terms of the Company’s
Restated Articles of Incorporation, the Board of Directors is authorized to determine or alter the rights, preferences, privileges and restrictions of
the Company’s authorized but unissued shares of preferred stock.
Comprehensive Income
Comprehensive income consists of two components, net income and other comprehensive income. Other comprehensive income refers to
revenue, expenses, gains, and losses that under GAAP are recorded as an element of shareholders’ equity but are excluded from net income. The
Company’s other comprehensive income consists of foreign currency translation adjustments from those subsidiaries not using the U.S. dollar as
their functional currency, unrealized gains and losses on marketable securities categorized as available-for-sale, and net deferred gains and losses
on certain derivative instruments accounted for as cash flow hedges.
The following table summarizes the components of total comprehensive income, net of taxes, during the three- and nine-month periods ended
June 25, 2011 and June 26, 2010 (in millions):
Three Months Ended
June 25,
June 26,
2011
2010

Net income
Other comprehensive income:
Change in unrecognized gains/losses on derivative instruments
Change in foreign currency translation
Change in unrealized gains/losses on marketable securities
Total comprehensive income

$

7,308

$

$

112
11
140
7,571 $

Nine Months Ended
June 25,
June 26,
2011
2010

3,253

$

19,299

13
(54)
24
3,236 $

$

273
101
61
19,734 $

9,705
41
(43)
33
9,736

The following table summarizes activity in other comprehensive income related to derivatives, net of taxes, held by the Company during the
three- and nine-month periods ended June 25, 2011 and June 26, 2010 (in millions):
Three Months Ended
June 25,
June 26,
2011
2010

Change in fair value of derivatives
Adjustment for net gains/losses realized and included in income
Change in unrecognized gains/losses on derivative instruments

$
$

8 $
104
112 $

Nine Months Ended
June 25,
June 26,
2011
2010

55 $
(42)
13 $

(175) $
448
273 $

91
(50)
41

The following table summarizes the components of AOCI, net of taxes, as of June 25, 2011 and September 25, 2010 (in millions):
June 25, 2011

Net unrealized gains/losses on marketable securities
Net unrecognized gains/losses on derivative instruments
Cumulative foreign currency translation
Accumulated other comprehensive income/(loss)

$

$
15

232
21
136
389

September 25, 2010

$

$

171
(252)
35
(46)

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Equity Awards
A summary of the Company’s RSU activity and related information for the nine months ended June 25, 2011, is as follows (in thousands, except
per share amounts):
WeightedAverage
Grant Date
Fair Value

Number of
Shares

Balance at September 25, 2010
RSUs granted
RSUs vested
RSUs cancelled
Balance at June 25, 2011

13,034
5,232
(4,224)
(609)
13,433

$
$
$
$
$

165.63
296.08
166.49
183.53
215.35

Aggregate
Intrinsic
Value

$ 4,383,924

RSUs that vested during the three- and nine-month periods ended June 25, 2011 had a fair value of $637 million and $1.4 billion, respectively, as
of the vesting dates. RSUs that vested during the three- and nine-month periods ended June 26, 2010 had a fair value of $353 million and $990
million, respectively, as of the vesting dates.
A summary of the Company’s stock option activity and related information for the nine months ended June 25, 2011, is as follows (in thousands,
except per share amounts and contractual term in years):
WeightedAverage
Exercise
Price

Number
of Shares

Balance at September 25, 2010
Options granted
Options cancelled
Options exercised
Balance at June 25, 2011
Exercisable at June 25, 2011
Expected to vest after June 25, 2011

21,725
1
(149)
(7,822)
13,755
12,431
1,324

$
$
$
$
$
$
$

90.46
342.62
124.71
63.20
105.62
99.59
162.24

WeightedAverage
Remaining
Contractual
Term

Aggregate
Intrinsic
Value

2.54 $ 3,036,128
2.43 $ 2,818,845
3.57 $ 217,283

Aggregate intrinsic value represents the value of the Company’s closing stock price on the last trading day of the fiscal period in excess of the
weighted-average exercise price multiplied by the number of options outstanding or exercisable. The aggregate intrinsic value excludes stock
options that have a zero or negative intrinsic value. The total intrinsic value of options at the time of exercise was $248 million and $2.1 billion
for the three- and nine-month periods ended June 25, 2011, respectively, and $559 million and $1.6 billion for the three- and nine-month periods
ended June 26, 2010, respectively.
The Company had approximately 53.6 million shares and 62.7 million shares reserved for future issuance under the Company’s stock plans as of
June 25, 2011 and September 25, 2010, respectively. RSUs granted are deducted from the shares available for grant under the Company’s stock
plans utilizing a factor of two times the number of RSUs granted. Similarly, RSUs cancelled are added back to the shares available for grant
under the Company’s stock plans utilizing a factor of two times the number of RSUs cancelled.
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Stock-Based Compensation
Stock-based compensation cost for RSUs is measured based on the closing fair market value of the Company’s common stock on the date of
grant. Stock-based compensation cost for stock options and employee stock purchase plan rights (“stock purchase rights”) is estimated at the
grant date and offering date, respectively, based on the fair-value as calculated using the Black-Scholes Merton (“BSM”) option- pricing model.
The BSM option-pricing model incorporates various assumptions including expected volatility, expected life and interest rates. The expected
volatility is based on the historical volatility of the Company’s common stock over the most recent period commensurate with the expected life
of the Company’s stock options and other relevant factors including implied volatility in market traded options on the Company’s common
stock. The Company bases its expected life assumption on its historical experience and on the terms and conditions of the stock awards it grants
to employees. The Company recognizes stock-based compensation cost as expense on a straight-line basis over the requisite service period.
The Company did not grant any stock options during the three-month periods ended June 25, 2011 and June 26, 2010. The Company granted
1,370 stock options with a weighted-average grant date fair value of $181.13 per share during the nine months ended June 25, 2011 and granted
approximately 34,000 stock options with a weighted-average grant date fair value of $108.58 per share during the nine months ended June 26,
2010.
The Company did not assume any stock options during the three- and nine-month periods ended June 25, 2011. During the three- and ninemonth periods ended June 26, 2010, the Company assumed 31,000 and 98,000 stock options, respectively, in conjunction with certain business
combinations. The weighted-average fair value of stock options assumed during the three- and nine-month periods ended June 26, 2010 was
$256.63 and $216.82, respectively.
The weighted-average fair value of stock purchase rights per share was $72.63 and $67.70 during the three- and nine-month periods ended
June 25, 2011, respectively, and was $46.82 and $41.98 during the three- and nine-month periods ended June 26, 2010, respectively.
The following table summarizes the stock-based compensation expense included in the Condensed Consolidated Statements of Operations for
the three- and nine-month periods ended June 25, 2011 and June 26, 2010 (in millions):
Three Months Ended
June 25,
June 26,
2011
2010

Cost of sales
Research and development
Selling, general and administrative
Total stock-based compensation expense

$

$

52
119
113
284

$

$

38
80
101
219

Nine Months Ended
June 25,
June 26,
2011
2010

$

$

155
336
379
870

$

$

112
240
303
655

The income tax benefit related to stock-based compensation expense was $113 million and $349 million for the three- and nine-month periods
ended June 25, 2011, respectively, and $77 million and $238 million for the three- and nine-month periods ended June 26, 2010, respectively. As
of June 25, 2011, the total unrecognized compensation cost related to outstanding stock options and RSUs was $2.3 billion, which the Company
expects to recognize over a weighted-average period of 2.8 years.
Employee Benefit Plans
Rule 10b5-1 Trading Plans

During the third quarter of 2011, executive officers Timothy D. Cook, Peter Oppenheimer, D. Bruce Sewell and Jeffrey E. Williams, and
directors William V. Campbell and Arthur D. Levinson had trading plans pursuant to Rule 10b5-1(c)(1) of the Securities Exchange Act of 1934,
as amended (the “Exchange Act”). A trading plan is a written document that pre-establishes the amounts, prices and dates (or a formula for
determining the amounts, prices and dates) of future purchases or sales of the Company’s stock, including the exercise and sale of employee
stock options and shares acquired pursuant to the Company’s employee stock purchase plan and upon vesting of RSUs.
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Note 6 – Commitments and Contingencies
Accrued Warranty and Indemnifications
The following table summarizes changes in the Company’s accrued warranties and related costs for the three- and nine-month periods ended
June 25, 2011 and June 26, 2010 (in millions):
Three Months Ended
June 25,
June 26,
2011
2010

Beginning accrued warranty and related costs
Cost of warranty claims
Accruals for product warranty
Ending accrued warranty and related costs

$

$

1,103 $
(288)
375
1,190 $

588 $
(155)
157
590 $

Nine Months Ended
June 25,
June 26,
2011
2010

761 $
(790)
1,219
1,190 $

577
(427)
440
590

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 either
June 25, 2011 or September 25, 2010.
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.
Concentrations in the Available Sources of Supply of Materials and Product
Although most components essential to the Company’s business are generally available from multiple sources, certain key components including
but not limited to microprocessors, enclosures, certain liquid crystal displays (“LCDs”), certain optical drives and application-specific integrated
circuits (“ASICs”) are currently obtained by the Company from single or limited sources, which subjects the Company to significant supply and
pricing risks. Many of these and other key components that are available from multiple sources including but not limited to NAND flash
memory, dynamic random access memory (“DRAM”) and certain LCDs, are subject at times to industry-wide shortages and significant
commodity pricing fluctuations. In addition, the Company has entered into certain agreements for the supply of key components including, but
not limited to, microprocessors, NAND flash memory, DRAM and LCDs with favorable pricing, but there can be no guarantee that the Company
will be able to extend or renew these agreements on similar favorable terms, or at all, upon expiration or otherwise obtain favorable pricing in
the future. Therefore, the Company remains subject to significant risks of supply shortages and/or price increases that can materially adversely
affect its financial condition and operating results.
The Company and other participants in the mobile communication and media device, and personal computer industries also compete for various
components with other industries that have experienced increased demand for their products. In addition, the Company uses some custom
components that are not common to the rest of these industries, and new products introduced by the Company often utilize custom components
available from only one source. When a component or product uses new technologies, initial capacity constraints may exist until the suppliers’
yields have matured or manufacturing capacity has increased. If the Company’s supply of a key single-sourced component for a new or existing
product were delayed or constrained, if such components were available only at significantly higher prices, or if a key outsourcing partner
delayed shipments of completed products to the Company, the Company’s financial condition and operating results could be materially
adversely affected. The Company’s business and financial performance could also be adversely affected depending on the time required to
obtain sufficient quantities from the original source, or to identify and obtain sufficient quantities from an alternative source. Continued
availability of these components at acceptable prices, or at all, may be affected if those suppliers decided to concentrate on the production of
common components instead of components customized to meet the Company’s requirements.
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Substantially all of the Company’s iPhones, iPads, Macs, iPods, logic boards and other assembled products are manufactured by outsourcing
partners, primarily in various parts of Asia. A significant concentration of this outsourced manufacturing is currently performed by only a few
outsourcing partners of the Company, often in single locations. Certain of these outsourcing partners are the sole-sourced supplier of components
and manufacturing outsourcing for many of the Company’s key products including but not limited to final assembly of substantially all of the
Company’s hardware products. Although the Company works closely with its outsourcing partners on manufacturing schedules, the Company’s
operating results could be adversely affected if its outsourcing partners were unable to meet their production commitments. The Company’s
purchase commitments typically cover its requirements for periods ranging from 30 to 150 days.
Long-Term Supply Agreements
The Company has entered into long-term agreements to secure the supply of certain inventory components. These agreements generally expire
between 2011 and 2022. As of June 25, 2011, the Company had a total of $2.4 billion of inventory component prepayments outstanding, of
which $701 million are classified as other current assets and $1.7 billion are classified as other assets in the Condensed Consolidated Balance
Sheets. The Company had a total of $956 million of inventory component prepayments outstanding as of September 25, 2010. The Company’s
outstanding prepayments will be applied to certain inventory component purchases made during the term of each respective agreement. As of
June 25, 2011, the Company had off-balance sheet commitments under long-term supply agreements totaling approximately $1.7 billion to make
additional inventory component prepayments and to acquire capital equipment in 2011 and beyond.
Other Off-Balance Sheet Commitments
The Company leases various equipment and facilities, including retail space, under noncancelable operating lease arrangements. The Company
does not currently utilize any other off-balance sheet financing arrangements. The major facility leases are 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 June 25, 2011, the Company’s total
future minimum lease payments under noncancelable operating leases were $2.7 billion, of which $2.2 billion related to leases for retail space.
Additionally, as of June 25, 2011, the Company had outstanding off-balance sheet commitments for outsourced manufacturing and component
purchases of $11.0 billion. Other outstanding obligations were $1.6 billion as of June 25, 2011, and were comprised mainly of commitments to
acquire product tooling and manufacturing process equipment and commitments related to advertising, research and development, Internet and
telecommunications services and other obligations. These commitments exclude the off-balance sheet commitments under the long-term supply
agreements described above.
Contingencies
The Company is subject to various legal proceedings and claims that have arisen in the ordinary course of business and have not been fully
adjudicated, which are discussed in Part II, Item 1 of this Form 10-Q under the heading “Legal Proceedings” and in Part II Item 1A under the
heading “Risk Factors.” In the opinion of management, there was not at least a reasonable possibility the Company may have incurred a material
loss, or a material loss in excess of a recorded accrual, with respect to loss contingencies. However, the outcome of litigation is inherently
uncertain. Therefore, although management considers the likelihood of such an outcome to be remote, if one or more of these legal matters were
resolved against the Company in the same reporting period for amounts in excess of management’s expectations, the Company’s condensed
consolidated financial statements of a particular reporting period could be materially adversely affected.
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On March 14, 2008, Mirror Worlds, LLC filed an action against the Company alleging that certain of its products infringed on three patents
covering technology used to display files. On October 1, 2010, a jury returned a verdict against the Company, and awarded damages of $208
million per patent for each of the three patents asserted. On April 4, 2011, the Judge overturned the verdict in the Company’s favor. Mirro r
Worlds has appealed the ruling. The Company had not recorded a loss contingency for this action.
Production and marketing of products in certain states and countries may subject the Company to environmental, product safety and other
regulations including, in some instances, the requirement to provide customers the ability to return product at the end of its useful life, and place
responsibility for environmentally safe disposal or recycling with the Company. Such laws and regulations have been passed in several
jurisdictions in which the Company operates, including various countries within Europe and Asia and certain states and provinces within North
America. Although the Company does not anticipate any material adverse effects in the future based on the nature of its operations and the thrust
of such laws, there can be no assurance that such existing laws or future laws will not materially adversely affect the Company’s financial
condition or operating results.
Note 7 – Segment Information and Geographic Data
The Company reports segment information based on the “management” approach. The management approach designates the internal reporting
used by management for making decisions and assessing performance as the source of the Company’s reportable segments.
The Company manages its business primarily on a geographic basis. Accordingly, the Company determined its operating and reporting
segments, which are generally based on the nature and location of its customers, to be the Americas, Europe, Japan, Asia-Pacific and Retail
operations. The Americas, Europe, Japan and Asia-Pacific reportable segment results do not include results of the Retail 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
Asia-Pacific segment includes Australia and Asia, but does not include Japan. The Retail segment operates Apple retail stores in 11 countries,
including the U.S. Each reportable operating segment provides similar hardware and software products and similar services. The accounting
policies of the various segments are the same as those described in Note 1, “Summary of Significant Accounting Policies” of this Form 10-Q and
in the Notes to Consolidated Financial Statements in the Company’s 2010 Form 10-K.
The Company evaluates the performance of its operating segments based on net sales and operating income. Net sales for geographic segments
are generally based on the location of customers, while Retail segment net sales are based on sales from the Company’s retail stores. Operating
income for each segment includes net sales to third parties, related cost of sales and operating expenses directly attributable to the segment.
Advertising expenses are generally included in the geographic segment in which the advertising occurs. Operating income for each segment
excludes other income and expense and certain expenses managed outside the operating segments. Costs excluded from segment operating
income include various corporate expenses such as manufacturing costs and variances not included in standard costs, research and development,
corporate marketing expenses, stock-based compensation expense, income taxes, various nonrecurring charges, and other separately managed
general and administrative costs. The Company does not include intercompany transfers between segments for management reporting purposes.
Segment assets exclude corporate assets, such as cash, cash equivalents, short-term and long-term investments, manufacturing and corporate
facilities, miscellaneous corporate infrastructure, goodwill and other acquired intangible assets. Except for the Retail segment, capital
expenditures for long-lived assets are not reported to management by segment.
The Company has certain retail stores that have been designed and built to serve as high-profile venues to promote brand awareness and serve as
vehicles for corporate sales and marketing activities. Because of their unique design elements, locations and size, these stores require
substantially more investment than the Company’s more typical retail stores. The Company allocates certain operating expenses associated with
its high-profile stores to corporate expense to reflect the estimated Company-wide benefit. The allocation of these operating costs to corporate
expense is based on the amount incurred for a high-profile store in excess of that incurred by a more typical Company retail location. The
Company had opened a total of 16 high-profile stores as of June 25, 2011. Amounts allocated to corporate expense resulting from the operations
of high-profile stores were $26 million and $75 million during the three- and nine-month periods ended June 25, 2011, respectively, and $18
million and $54 million during the three- and nine-month periods ended June 26, 2010, respectively.
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Summary information by operating segment for the three- and nine-month periods ended June 25, 2011 and June 26, 2010 is as follows (in
millions):
Three Months Ended
June 25,
June 26,
2011
2010

Americas:
Net sales
Operating income
Europe:
Net sales
Operating income
Japan:
Net sales
Operating income
Asia-Pacific:
Net sales
Operating income
Retail:
Net sales
Operating income

Nine Months Ended
June 25,
June 26,
2011
2010

$
$

10,126
3,596

$
$

6,227
1,997

$
$

28,667
10,250

$
$

17,312
5,482

$
$

7,098
3,107

$
$

4,160
1,631

$
$

20,381
8,414

$
$

13,234
5,457

$
$

1,510
735

$
$

910
390

$
$

4,326
1,996

$
$

2,580
1,185

$
$

6,332
2,782

$
$

1,825
841

$
$

16,062
6,869

$
$

5,524
2,553

$
$

3,505
828

$
$

2,578
593

$
$

10,543
2,665

$
$

6,232
1,447

A reconciliation of the Company’s segment operating income to the condensed consolidated financial statements for the three- and nine-month
periods ended June 25, 2011 and June 26, 2010 is as follows (in millions):
Three Months Ended
June 25,
June 26,
2011
2010

Segment operating income
Stock-based compensation expense
Other corporate expenses, net (a)
Total operating income
(a)

$

$

11,048 $
(284)
(1,385)
9,379 $

5,452 $
(219)
(999)
4,234 $

Nine Months Ended
June 25,
June 26,
2011
2010

30,194 $
(870)
(4,244)
25,080 $

16,124
(655)
(2,531)
12,938

Other corporate expenses include research and development, corporate marketing expenses, manufacturing costs and variances not
included in standard costs, and other separately managed general and administrative expenses, including certain corporate expenses
associated with support of the Retail segment.

Note 8 – Related Party Transactions and Certain Other Transactions
In 2001, the Company entered into a Reimbursement Agreement with its CEO, Steve Jobs, for the reimbursement of expenses incurred by
Mr. Jobs in the operation of his private plane when used for Apple business. The Company did not recognize any expenses pursuant to the
Reimbursement Agreement during the three months ended June 25, 2011 and recognized a total of $15,000 in expenses pursuant to the
Reimbursement Agreement during the nine months ended June 25, 2011. The Company recognized a total of $12,000 and $155,000 in expenses
pursuant to the Reimbursement Agreement during the three- and nine-month periods ended June 26, 2010, respectively. All expenses recognized
pursuant to the Reimbursement Agreement have been included in selling, general and administrative expenses in the Condensed Consolidated
Statements of Operations.
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Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

This section and other parts of this Form 10-Q contain forward-looking statements that involve risks and uncertainties. Forward-looking
statements can be identified by words such as “anticipates,” “expects,” “believes,” “plans,” “predicts,” 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, “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 25, 2010 (the “2010 Form 10-K”) filed with the U.S. Securities and Exchange Commission
(“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 or quarters
refer to the Company’s fiscal years ended in September and the associated quarters of those fiscal years. 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 (“Exchange Act”) are filed with the SEC. Such reports
and other information filed by the Company with the SEC are available on the Company’s website at http://www.apple.com/investor when such
reports are available on the SEC 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 http://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 a range of 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 related accessories, services and support offerings. The
Company also sells and delivers third-party digital content and applications through the iTunes Store ® , App Store SM , iBookstore SM , and Mac
App Store SM . The Company sells its products worldwide through its retail stores, online stores, and direct sales force, as well as through thirdparty 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, printers, storage devices, speakers, headphones, and various other
accessories and peripherals through its online and retail stores. The Company sells to consumers, small and mid-sized businesses, education,
enterprise and government customers.
The Company is committed to bringing the best user experience to its customers through its innovative hardware, software, peripherals, services,
and Internet offerings. 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 industrial design. The Company believes continual investment in research and development is critical to the development and
enhancement of innovative products and technologies. In conjunction with its strategy, the Company continues to build and host a robust
platform for the discovery and delivery of third-party digital content and applications through the iTunes Store. Within the iTunes Store, the
Company has expanded its offerings through the App Store and iBookstore, which allow customers to browse, search for, and purchase thirdparty applications and books through either a Mac or Windows-based computer or by wirelessly downloading directly to an iPhone, iPad or iPod
touch ® . In January 2011, the Company opened the Mac App Store allowing customers to easily find, download and install Apple-branded and
third-party applications for their Macs. The Company also works to support a community for the development of third-party software and
hardware products and digital content that complement the Company’s offerings. Additionally, the Company’s strategy includes expanding its
distribution network to effectively reach more customers and provide them with a high-quality sales and post-sales support experience. The
Company is therefore uniquely positioned to offer superior and well-integrated digital lifestyle and productivity solutions.
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