Apple Inc.

Zach James Analyst

April 21st, 2009

Ticker Exchange Industry Sector Classification Market Cap. 52 Week Price range Recent Price Current P/E Projected 2011 P/E 2008 EPS Projected 2011 EPS Beta

AAPL Nasdaq Computer Hardware Technology Capital Appreciation 109.91B $78.20 - $192.24 123.42 22.92 25 $5.36 $6.55 1.70

Recommendation:

HOLD
Pros: Innovative Product Mix with Tight Integration Competitive Dynamics Poised to Capture Market Share Customer Retention iPhone Growth Great Brand Name Very Strong Balance Sheet

Cons: Susceptibility to a slowdown in U.S. Consumer Spending Distribution Concerns Lack of value offerings Pressure On Margins Extremely Competitive Industries Porters Five Forces: Threat of Competition: High Threat of New Entrants: Moderate Threat of Substitutes: High Power of Suppliers: Moderate Power of Buyers: High

Brief Overview
Apple Inc. designs, manufactures, and markets personal computers, portable digital music players, and mobile communication devices and sells a variety of related software, services, peripherals, and networking solutions. The Company sells its products worldwide through its online stores, its retail stores, its direct sales force, and third-party wholesalers, resellers, and value-added resellers. It sells to consumer, small and mid-sized business (SMB), education, enterprise, government, and creative customers.

PURCHASE RATIONALE
The Educational Investment Fund purchased stock in Apple Inc. in October 2008. The EIF was underweight their target for Technology by 361 BPS and was looking for a stock that would fill the void. Apple Inc. is primarily involved in computer hardware manufacturing, consumer device manufacturing, and software development, and the EIF had no exposure in these Industries at the time Thereby, the EIF established a 3.33% equity position in AAPL by purchasing 245 shares at a cost of $92.34 per share.

PORTFOLIO CONSIDERATIONS

Apple is in the Technology sector where the EIF holds six companies. The EIF is currently 430 bps and 119 bps overweight our Spring 2009 Target and the S&P 500 weighting respectively. Apple is classified as a capital appreciation stock because it has no dividend yield. Currently the EIF has 49.40% of its equity in capital appreciation stocks, and is 940 bps above the Spring 2009 target of 40%.

INDUSTRY OVERVIEW
The computers and peripherals industry includes PC equipment, handheld devices, complex information technology systems and network equipment. Technological factors such as interoperability of hardware products and compatibility with the web have brought about industry consolidation. The US computers and peripherals industry is one of the largest global markets, including companies such as Apple, IBM, Dell, and Hewlett-Packard. Consumer and business income drive demand for computers. The profitability of computer hardware manufacturers depends on purchasing and production efficiencies and on technological expertise. It is harder for a new entrant to compete because large companies have economies of scale in purchasing and production. So while the larger firms are built on purchasing power and mass production, smaller firms concentrate on product specialty and technological superiority.

The manufacturing process for a computer consists of integrating circuit boards, disk drives, and input/output devices into a final product. Companies in this industry will typically assemble computer from components bought from other manufacturers. Computer manufacturers rely heavily on technology to produce better products and lower costs. R&D spending is very important for companies, as products must continually be innovated with new technology. There is a common industry concept called Moores law which states that the capacity of a computer chip must double every 18 months to keep up with evolving technology. Companies with patent capital, close links to component and equipment developers and the ability to afford R&D expenditures and capital investments will be poised to benefit the most from future growth in the industry. The industry has experienced pricing pressures, as the result of price wars, technological advances, and a week economy that have contributed to a fall in prices by 25% this year. Consumers may witness reduced technological advancements in the long run as companies shift their focus from innovating to slashing prices.

COMPANY OVERVIEW
Apple Inc is a designer, manufacturer, and marketer of personal computers, portable digital music players, and mobile communication devices and sells a variety of related software, services, peripherals, and networking solutions. Apple sells its products worldwide through its online stores, its retail stores, its direct sales force, and third-party wholesalers, resellers, and value-added resellers. In addition, Apple sells a variety of third-party Macintosh, iPod, and iPhone compatible products, including application software, printers, storage devices, speakers, headphones, and various other accessories and peripherals. The companys customers can be described as education, consumers, creative professional, business, and government customers. Apple Inc is a technology company that offers a vast product mix to a wide range of customers. The business strategy the company is to create an entire environment in which all its products coexist and integrate functions with one another in order to effectively realize the benefits of what Steve Jobs calls the digital lifestyle. Apple is positioned as the market leader in the portable media player category, with its iPod, and is the largest music retailer in the world, with iTunes. Apple sells more music online than Wal-Mart sells CDs in its stores. Apples business strategy is to take advantage of these leadership positions by convincing customers that switching all of their digital products to the Apple brand is beneficial. Apple plans to expand this strategy by opening new retail stores and creating aggressive marketing campaigns. The retail stores reinforce Apples unique brand name and promotes its broad product line to reach more customers for targeted sales and customer support. If historical results can be used to predict the future, the new

retail stores should be a huge success. Apple plans to make inroads into the business community by offering products that may coexist with existing business technology systems. This strategy has shown success also, as one-third of Fortune 500 companies have signed onto a beta plan since the iPhone 3G was released. Apple holds zero debt, which gives it very little credit risk. This is something I think is very important in the current economic environment. There is no risk of working capital shortages and the company generates large amounts of cash. Apples balance sheet is very solvent and liquid; it has good cash flow and will generate positive earnings throughout this economic trough. Apples fiscal year is the 52 or 53-week period that ends on the last Saturday of September. Please keep this in mind as you review my financials.

Current Business Strategy

Apple describes its business strategy as a commitment to bring the best personal computing, portable digital music and mobile communication experience to students, educators, creative professionals, businesses, government agencies, and consumers through its innovative hardware, software, peripherals, services, and internet offerings. The company designs its business strategy to most effectively leverage its unique ability to design and develop its own operating system, hardware, application software, and services to provide its customers new products and solutions with superior ease-of-use, seamless integration, and innovative industrial design. Apple prides itself on being the only computer manufacturer that designs both the hardware and operating software on each machine, and strives to manufacturer the best products for both categories through continual investment in research and development. These aspects of the company allow Apple to make technology simple, which is a key to their success. The ability to design easy-to-use gadgets by coupling its software and hardware will enable it o continue to expand across its broad product line. The company aims to capitalize on the convergence of the personal computer, digital consumer electronics and mobile communications by creating and refining innovations like the iPod, the iPhone, Apple TV and the iTunes Store. Creating products that best capture the benefits of the digital lifestyle doesnt create value unless it gets distributed to as many people as possible. In the most recent conference calls, company management has explicitly stated that Apple will take the initiative of expanding distribution in upcoming years through retail storefronts. Apples storefronts are exposing a new generation of users to the companys product lines. In fact, more than half of the customers buying Macs at Apple retail stores were new to the Mac. Apples sales strategy is to establish direct contact, primarily through its retail stores or online, with targeted customers. Apple believes that the most efficient and effective way

to demonstrate the advantages of its Mac computers and other products over those of its competitors is through direct contact with the ultimate customer. The company describes its retail as being designed to simplify and enhance the presentation and marketing of the Companys products and related solutions. The company currently operates stores with average revenue per store totaling $29.9 million compared to $23.1 million a year-ago. The companys total number of retail stores is 247. Many analysts predict a 20% average annual growth in new store openings as the company expands into new customer areas.

Target Customers
Education: Apple has put a heavy focus on the use of technology in education and has been committed to delivering tools to help educators teach and students learn. The Company designs a range of products and services to address the needs of education customers, including the service of one-to-one learning. A one-to-one learning solution consists of a portable computer for every student and teacher along with the installation of a wireless network. Creative Professionals: This is the Companys most important market for both hardware and software products. It is also important for the many third-party developers who provide Mac-compatible hardware and software solutions. Creative customers utilize the Companys products for a variety of activities including digital video and film production and editing; digital video and film special effects, compositing and titling; digital still photography and workflow management; graphic design, publishing, and print production; music creation and production; audio production and sound design; and web design, development, and administration. The majority of film production and advertising is created on Mac computers utilizing software such as Adobe Photoshop, Aperture and iMovie. Information Technology: To serve IT professionals Apple uses hardware and software that utilizes the UNIX platform and allows for open source technologies. These open standards allow for IT managers to integrate Apple products into their existing systems. An example is the ability to use a Microsoft Exchange email server to push email to an iPhone or to the Mail program in OS X. However, a Microsoft software and hardware from companies like Research in Motion do not make it possible to use Apples open source Cal DAV or email server to push information. Business: Apple has a plan in place to increase its footprint in the business market. Like mentioned above, the open source technologies allow for companies to place Apple products inside of their IT infrastructure without disrupting any existing software or hardware. Unlike the Blackberry service, which requires a company

to install a new system for Email, Apples open source technology allows for any server to send email to its devices. The largest email server utilized by companies is the Microsoft Exchange service, and the iPhone 2.0 opened the iPhone for the possibility of deployment for companies using the service. Apple has created an iPhone 2.0 Beta Program designed to create interest for the iPhone in very large enterprises. So far about a third of the Fortune 500 were in the program. Out of our holdings, Disney, Oracle and the Southern Company were participating. This market represents an exciting opportunity for Apple to grow their market share.

Operating Segments
Apple manages the business primarily on a geographic basis. The reportable operating segment consists of the Americas, Europe, Japan, and Retail. As can be inferred from the previous sentence, the former three segments do not include activities related to the latter segment, Retail. The Retail segment operates as the account for transactions originating from Apple-owned retail stores. As for the geographic separation, Americas includes both North and South America, Europe consists of European countries as well as the Middle East and Africa.

Net Sales by Operating Segment Americas net sales Europe net sales Japan net sales Retail net sales Other Segments net sales Total net sales

2008 $14,573 $7,622 $1,509 $6,315 $2,460 $32,479

Change 2007 26% 40% 39% 53% 40% 35% $11,596 $5,460 $1,082 $4,115 $1,753 $24,006

Change 2006 23% 33% (11%) 27% 30% 24% $9,415 $4,096 $1,211 $3,246 $1,347 $19,315

Apple has seen tremendous growth in 2008 across all operating segments. The retail segment truly stands out as the fastest growth story. This illustrates the success Apple is currently seeing with its retail initiative of providing not only the best products, but also the best customer service. Percentage of Sales by 2008 2007 2006 Operating Segment Americas net sales 44.86 48.30% 48.75% Europe net sales 23.47% 22.75% 21.20% Japan net sales 4.65% 4.50% 6.2% Retail net sales 19.44% 17.15% 16.8% Other Segments net sales 7.57% 7.30% 6.97% Total net sales 100.00% 100.00% 100.00%

Apple is a company that until recently focused only on North America. The effects of this focus can be seen by the huge amount of sales driven by North America. The percentage metric is decreasing over time however.

Product Mix:
The earlier discussion of the business strategy of Apple indicated Apples fervent aspirations of creating products that fully integrate with one another. A detailed discussion on each of Apples primary products and its contribution to the integrated digital life is discussed below. Personal Computing Products: Apple offers an assortment of personal computing products including desktop and notebook computers along with server and storage products. These products are the MacBook, MacBook Pro, MacBook Air, Mac mini, iMac, Mac Pro, and Xserve. The MacBook, iMac and Mac mini are targeted at consumer and education users. The MacBook Pro, Mac Pro and Xserve target business and professional users with more powerful hardware. Xserve is a server system for companies to host both Internet and intranet services. These devices can be thought of as the hub that connects all of the devices used In an Apple-centric digital life. Most peripherals and devices will sync using personal computing products and, of course, software functions in these machines. Entertainment Products and Services: This is Apples dominant market as its iPod product line has over 70% market share. Apple offers its iPod line or portfolio digital music players and to both Mac and Windows users. In addition, the company provides digital music management software called iTunes that is designed to sync information with iPod products. To distribute entertainment services to these products, Apple offers an online service that delivers music, audio books, music videos, short films, television shows, movies, podcasts and iPod games through its iTunes Store. There are multiple versions of the iPod that can be purchased ranging from the $49 shuffle to the $400 iPod touch. The iPod touch mimics an iPhone in that it features the Companys Multi-Touch user interface with Wi-Fi wireless networking. The company also has a product named Apple TV that permits users to wirelessly play iTunes content on a widescreen television. iPhone: The current incarnation of the iPhone is the iPhone 3G. This is a handheld device that combines the features of a mobile phone, a 3G network, a global positioning system, and iPod media player with touch controls. The user interface is based

on the Multi-Touch display allowing users to control the device with a touch screen. Software: Apples current operating system is called Mac OS X. It is built on an opensource UNIX-based foundation. All Mac computers come pre-shipped with Mac OS X. The company also has a software suite that is designed to organize and improve the digital lifestyle called iLife 08. This suite includes iPhoto (used to organize photographs), iMovie (used to organize movies), iDVD (used to make custom DVDs), GarageBand (Used to make custom music), iWeb (used to create websites), iTunes (used to organize music). Other software packages are the iWork suite, Final Cut Studio, Logic Studio, FileMaker Pro, Safari, QuickTime, Mobile Me.

Percentage of Sales by Product Mix Desktops Portables iPod Other music related products iPhone Peripherals Software Total net sales

2008 $5,603 $8,673 $9,153 $3,340 $1,844 $1,659 $2,207 $32,479

Change 2007 39% 38% 10% 34% 32% 46% 35% $4020 $6,294 $8,305 $2,496 $123 $1,260 $1,508 $24,006

Change 2006 21% 55% 8% 32% N/A 15% 18% 24% $3,319 $4,056 $7,676 $1,885 N/A $1,100 $1,279 $19,315

The iPod is Apples biggest product as it provides the most revenue for the company and has the highest market share in the digital music player market. However, the fastest growth in the company is coming from computer and software sales. Percentage of Sales by 2008 2007 2006 Product Mix Desktops 17.25% 16.75% 17.18% Portables 26.70% 26.22% 20.99% iPod 28.18% 34.60% 39.74% Other music related products 10.28% 10.40% 9.75% iPhone 5.68% .05% Peripherals 5.11% 5.25% 5.70% Software 9.40% 6.28% 6.62% Total net sales 100.00% 100.00% 100.00%

PORTERS FIVE FORCES

Threat of Competition - High

The personal computer, consumer electronics and mobile communications industries are highly volatile and competitive. Apple must continually introduce new products and technologies and stimulate customer demand in order to grow or retain its competitive position. Microsofts operating system and the hardware that utilizes it enjoy a majority of market share. Apple must create products that encourage consumers to switch their technology preferences. It is doing so by acclimating consumers to the Apple brand through the iPod/iPhone products. Due to the dynamic nature of the industry, it is very possible for a competitor to produce a product that customers will prefer over the iPod/iPhone. Established companies supplying smartphones such as Research in Motion and Nokia will continue to put up an intense fight for market share against Apples iPhone. Competition is Apples biggest risk because its current business model for growing sales is through market share growth of the Macintosh platform.

Threat of New Entrants - Moderate

There is high risk of new entrants in some of Apples markets and low risk in others. Because of this I balanced the threat as a moderate one. The biggest area exposed to threat of new entrants is software. There are practically no capital requirements to creating new software; there are only time requirements. As easy as it may be for a new entrant to code software, it is incredibly difficult for a worldwide community to collaborate and create a piece of hardware like the iPhone or MacBook. Therefore, the threat of new entrants into this space is fairly low. A new entrant couldnt acquire all the necessary raw materials to create the hardware, develop an innovative function for the hardware and produce it to support the large market without a large amount of capital. If an entity did have the capital, it would be very difficult to compete on price with existing entities due to economies of scale and the assumption that the new entrant would likely sell its product to a small niche market.

Threat of Substitutes - High

There are numerous substitutes to all of the products in the Apple universe. First, Apples computer hardware and software is in fierce competition with the Windows and PC combo. The latter combo currently holds a very large market share that Apple is trying to grasp. Customers are likely very familiar with this combo, and therefore it

presents an incredibly risky substitute product to Apple. Especially, since switching costs arent very high. There are numerous smart phones that can act as a substitute to the iPhone. The Blackberry and Windows Mobile devices are very viable substitutes that include many of the same features as the iPhone. This is a very dangerous substitute as people whom dont like AT&T, and have service through another carrier are forced into one of these substitutes. Finally, the rest of Apples products compete with a substitute product vying for Apples customers. The iPod can be replaced with a Zune and the Apple TV can be replaced with a Sling box. iTunes faces substitutes for both its music organization software and online store. Windows Media Player is shipped with every Windows PC and organizes music effectively. There are many online stores that offer music and movies for download like Amazon. Though the real store substitute is the peer-to-peer file sharing protocols that allow many people to acquire vast amounts of media for free.

Power of Suppliers - Moderate

Apple currently obtains key components for the manufacturing of hardware from single or limited sources, so it is subject to some supply and pricing risks. I made the power of suppliers moderate though because most key components in an Apple product are available from multiple sources. Also, Apple has entered into many long-term agreements for the supply of components that lock in prices that Apple views as favorable.

Power of Buyers - High

As my entire report has alluded to, revenue is derived through product sales, which is driven by consumer demand. As a result, the consumer has a lot of power through its ability to choose what products to purchase. If Apple sees a drop-off in demand for any of its products it must usually lower its price or enhance the product to warrant the existing price, which runs the possibility of hurting margins.

CRITICAL ISSUES
Consumer Spending Apples stock price is justified by future earnings growth. The stock has rebounded significantly in 2009 and it seems to be reflecting investors confidence in Apple to perform well in uncertain economic times. Many analysts, including me, have sales and earnings growing at a much slower rate than in previous years. However, it is possible that the macroeconomic situation could deteriorate further and cause a drawback in sales for Apple. This is especially true, as Apple derives the majority of its revenues

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from the US market, so a decline in US consumer spending could pose a serious threat to Apples performance. There has been a significant slowdown in worldwide PC demand over the last half of 2008 and first quarter of 2009. However, many analysts believe PC sales have bottomed, and only can go up from here. Apple is positioned to capitalize on industry growth, as well as its ability to produce a valuable product and take market share from its competitors. I currently predict that market share for Mac computers will grow through 2011, as many consumers are attracted to the product due to their experiences with the iPod/iPhone. Macs are generally priced at a more expensive price-point than PCs, which could be a problem in an environment of diminished spending, especially considering Apple lacks any sort of value line of notebooks. Apple has however addressed this releasing a plastic version of the iMac in white for $999, while the new aluminum iMacs sell for $1299 ad $1599. If consumer spending were to slow further than expected, expected earnings could take a hit, as customers wont be as willing to buy a higher quality and higher priced Mac. If consumer spending picks up, Apple stands to benefit greatly.

Margin Pressure
Apple has experienced downward pressure on its gross and operating margins recently due to both intensifying competition and economic slowdown, and is continuing to deal with these pressures. Apple did not give in to price pressure in introducing its new Mac Books at the end of 2008, as the company decided not to forego its premium price and decrease margins. The decession seems to have worked in Apples favor so far, as the premium price hasnt adversely impacted sales as much as some believed. Margin size directly affects the profitability of a firm, so it is desirable to grow and sustain high margins. Macs and iPhones have higher margins than do iPods, therefore, if sales trends continue and computer sales increase at a faster rate than iPod sales margins should increase. iPhone sales are expected to be a leader in driving Apples revenue growth over the coming years, and with 70% Margins, they will provide much assistance in keeping margins high.

New Product Offerings

The markets that Apple operates in have frequent introduction of new products and short product life cycles. Apple must constantly innovate in order to grow or maintain its competitive position. This means upgrading products like the iPhone regularly and introducing new products when the technology becomes available. Apple is regarded as an industry leader in innovation and must remain if the share price is to be supported. It must also make sure that its innovations do not interfere with its initiative to develop the entire solution for the digital lifestyle.

Retail Performance
Apples expansion of retail has and will require substantial fixed investment in equipment and leasehold improvements, information systems, inventory and personnel. Stores are designed to serve as high-profile venues to promote brand awareness and serve as vehicles for sales. A decline in sales from what is expected or poor performance of stores will cause investments made in the stores to be classified as sunk costs. However, if the retail initiative is successful and more traffic comes into the stores, sales will increase and the investments will be warranted.

Business Demand
Apple has not penetrated itself very deeply into the business enclave. Apple has made it a point to increase sales to this market by focusing on open standards so that a company doesnt have to overhaul its systems to incorporate Apple products. So far it has been successful with many companies incorporating computers and iPhones into their enterprise resource planning systems. Growth in this market could be a huge driver for revenues derived from computer and iPhone sales. My earnings do not factor much growth in business demand, but if it were to pick up faster than expected Apple will benefit greatly.

Reliance On Third-Party Content Providers

Apple contracts with certain third parties to offer their digital content through the iTunes Store. The company pays substantial fees to obtain the rights to audio and video content. Apples licensing arrangements are sort-term and do not guarantee the continuation or renewal of these arrangements on reasonable terms, if at all. Some content providers currently or in the future may offer competing products and services, and could take action to make it more difficult or impossible for Apple to license their content in the future. Many content providers are concerned of Apples growing market dominance in the distribution of audio and video content. Many of which are taking action or considering taking action to derail Apples attempts to be a main channel of distribution, as they foresee Apple having too much bargaining power, due to their role in the determining what to provide on its distribution channel (iTunes) and what they will not provide. If Apple is unable to continue to offer a wide variety of content at reasonable price with acceptable usage rules, the Companys operating results ma be adversely affected.

INVESTMENT RECOMMENDATION

Hold 3.90% equity position

PROS TO RECOMMENDATION
Innovative Product Mix with Tight Integration Competitive Dynamics Poised to Capture Market Share Customer Retention iPhone Growth Great Brand Name Very Strong Balance Sheet

CONS TO RECOMMENDATION
Susceptibility to a slowdown in U.S. Consumer Spending Distribution Concerns Lack of value offerings Pressure On Margins Extremely Competitive Industries

ANALYST RECOMMENDATIONS

Based on the above ratings, the average estimate is a Moderate Buy. I believe analysts are looking at the current economic situation and at Apples strong product mix, revenue growth, and brand name.

Baker Hughes

COMPETITION

Apple is confronted by aggressive competition in all areas of its business. The markets for consumer electronics, personal computers, software, digital media devices, and mobile communication are highly competitive. Meteoric technological advances in both hardware and software have markedly increased the capabilities and use of all of these products, which creates markets characterized by intense competition and continuous upheaval of existing norms. There is frequent introduction of new products with competitive price, feature and performance characteristics. Over the past several years, price competition in these markets has been particularly intense. Apples competitors who sell personal computers based on the Wintel standard have aggressively cut prices and lowered their product margins to gain market share. Apples music products and services face significant competition from other companies promoting their own digital music and content products and services. Apples strategy is to create competitive advantage by offering superior innovation and integration of the entire digital lifestyle package including the hardware (Mac computers and iPod/iPhone), software (OS X and iTunes) and distribution of content (iTunes Music Store). No other company controls the entire package of products that Apple offers, which positions Apple in a unique and competitively superior position. The iPhone is a relatively new product in a market Apple has just begun to compete in. This means Apple faces a new set of competitors in regards to the iPhone including Research in Motion, Palm and Nokia. The market for mobile communications can be described as being just as aggressive as Apples other markets. Below is a description, from Yahoo Finance, of Apples competition in each of its product categories:

Personal Computing Products

Dell: Dell, Inc. and its subsidiaries engage in the design, development, manufacture, marketing, sale, and support of computer systems and services worldwide. It offers desktop PCs and workstations; servers and networking products; laptop computers; and storage solutions, including storage area networks, network-attached storage, directattached storage, disk and tape backup systems, and removable disk backup. The company also provides third party software, which include operating systems, business and office applications, anti-virus and related security software, and entertainment software, as well as peripherals, including software titles, printers, flat panel monitors and projectors, televisions, laptop accessories, networking and wireless products, digital

cameras, power adapters, and scanners. In addition, it offers infrastructure-consulting services, deployment services, asset recovery and recycling services, training services, support services, and managed services. Further, the company provides various financing alternatives, asset management services, and other customer financial services. Its customers include large corporate, government, healthcare, and education accounts, as well as small-to-medium businesses and individual consumers. The company sells its products and services directly to customers through sales representatives, telephone-based sales, and online at www.dell.com, as well as through various indirect sales channels. Dell, Inc. was founded in 1984 and is headquartered in Round Rock, Texas. Hewlett-Packard: Hewlett-Packard Company provides various products, technologies, software, solutions, and services worldwide. The companys Enterprise Storage and Servers segment provides storage and server products in industry standard servers, business critical systems, and Storage Works offerings. Its HP Services segment offers a portfolio of multi vendor IT services, such as technology, consulting and integration, and outsourcing services. Hewlett-Packards HP Software segment offers a suite of business technology optimization software solutions comprising support that allow customers to manage and automate their IT infrastructure, operations, applications, IT services, and business processes. This segment also delivers a suite of carrier-grade software platforms for developing and deploying voice, data, and converged services to network and service providers. Its Personal Systems Group segment provides a line of personal computers (PCs) consisting of commercial PCs, consumer PCs, workstations, handheld computing devices, digital entertainment systems, calculators and other related accessories, and software and services for the commercial and consumer markets. The companys Imaging and Printing Group segment offers inkjet printers, digital photography and entertainment products, LaserJet printers, graphics and imaging, and printer supplies. Its HP Financial Services segment provides leasing, financing, and utility programs; asset recovery services; and financial asset management services for enterprise customers, as well as an array of specialized financial services to small-and medium-sized businesses, and educational and governmental entities. The company also offers certain network infrastructure products, including Ethernet switch products under the proCurve brand. Hewlett-Packard was founded in 1939 and is headquartered in Palo Alto, California.

Entertainment Products and Services

SanDisk: SanDisk Corporation designs, develops, manufactures, and markets NAND-based flash storage card products that are used in various consumer electronics products. Flash storage technology allows data to be stored using limited power in a compact format that retains the data after the power has been turned off. The company offers removable data storage solutions, universal serial bus flash drives, embedded flash

memory drive solutions for data and code storage, flash-based digital media players, and MP3 players. Its products are used in digital cameras, mobile phones, gaming devices, laptop computers, other portable devices, and digital audio and video players, as well as in personal computing, network servers, and consumer markets. The company also provides other flash storage products that are embedded in various systems for the enterprise, industrial, military, and other markets. It offers its products through retail and original equipment manufacturer distribution channels in the Americas, Europe, the Middle East, Africa, the Asia Pacific, and Japan. The company was founded in 1988 as SanDisk Corporation and changed its name to SanDisk Corporation in 1995. SanDisk Corporation is based in Milpitas, California. Napster: Napster, Inc. offers interactive music services that enable fans to sample, listen to, subscribe to, and purchase from online music catalogs utilizing secure and legal platforms. The company focuses on its online music distribution business under the Napster brand. It enables its subscribers to access radio, Billboard charts, preprogrammed playlists, personalization features, message boards, and community features, as well as to enjoy their music on various media, including personal computers, CDs, MP3 players, music-enabled cellular phones, and digital media devices for the living room. The company delivers online music to its customers as individual downloads and through subscriptions accessible through the Internet and wireless devices; Napster and Napster To Go, the Web-based music subscription services, which provide consumers in the United States with access to approximately 6 million tracks, as well as in Canada, Germany, the United Kingdom, and Japan. It offers a wireless music service branded Napster Mobile; a Web-based MP3 store to preview song clips and purchase individual tracks; a library of independent music; and ringtones, as well as OTA downloads with dual delivery and wallpapers via various mobile carriers, including Cingular/ATT, Swisscom, O2 UK, TIM, and SunComm. It has strategic partnerships with Ericsson; Cingular/AT&T; Swisscom; Sony; Sandisk; Gateway; Toshiba; Creative Labs; Lenovo; Tower Records Japan; Circuit City; Radio Shack; AOL; and XM. The company provides its services in the Americas, Japan, and Europe. Napster, Inc. was founded in 2000 and is headquartered in Los Angeles, California.

iPhone
Research in Motion: Research In Motion Limited engages in the design, manufacture, and marketing of wireless solutions for the mobile communications market worldwide. It provides platforms and solutions for access to time-sensitive information, including email, phone, short messaging service, Internet, and intranet-based applications. The companys technology enables an array of third party developers and manufacturers to enhance their products and services with wireless connectivity to data. Its portfolio of products includes the BlackBerry wireless platform, the RIM Wireless Handhelds product line, software development tools, and other hardware and software solutions. The companys BlackBerry wireless solution comprises wireless devices, software, and services. It also

enables the use of personal information management functions, such as calendar, address book, task list, and other functions associated with personal organizers. In addition, Research In Motion offers BlackBerry Mobile Data System that allows users to access data from enterprise applications and the Internet; BlackBerry Internet Service, which allows the integration of up to 10 supported email accounts on the same BlackBerry smart phone; and BlackBerry Enterprise Solution and BlackBerry Internet Service that allow Internet browsing and full phone functionality on the users smart phone, as well as offers a range of multimedia capabilities. Further, it licenses BES software, as well as offers client access licenses, technical support, and upgrades. The company distributes its products through wireless communications carriers or carrier partners. Research In Motion was founded in 1984 and is headquartered in Waterloo, Canada. Palm: Palm, Inc. provides mobile products for individual users and business customers worldwide. The company offers integrated technologies that enable people to stay connected with their family, friends, and colleagues; access and share the information; and manage their daily lives on the go. Its mobile products include smartphones and handheld computers, which provide various business productivity tools, and personal and entertainment applications. The company offers Centro and Treo 755p smartphones on the Palm operating system platform and the Treo 700wx, 750, 500, and 800w smartphones powered by Windows Mobile operating system. It provides Palm and Tungsten handheld computers, including Palm Z22, Tungsten E2, and Palm TX that incorporate data synchronization technology, enabling the devices to synchronize with desktop applications, such as Outlook, and an infrared port for exchanging information between devices. The company also offers various add-ons and accessories, including portable keyboards, memory expansion cards for storage and content, modems, headsets, and carrying cases. Palm, Inc. sells its products to wireless carriers, distributors, retailers, and resellers through its sales force, as well as to end users through its Web site at palm.com. The company, formerly known as palmOne, Inc., was founded in 1992 and is headquartered in Sunnyvale, California. Palm, Inc. (NasdaqNM:PALM) operates independently of 3Com Corporation, as of July 27, 2000.

Software
Microsoft: Microsoft Corporation provides software products for computing devices worldwide. Its Client segment offers Windows product family that comprises Windows Vista; Windows XP Professional and Home; Media Center Edition; Tablet PC Edition; and other Windows operating systems. The companys Server and Tools segment provides integrated server infrastructure and middleware software that support software applications and tools built on the Windows Server operating system. This segment offers Windows Server operating system; Microsoft SQL Server; Microsoft Enterprise Services; product support services; Visual Studio; System Center products; Forefront Security products; Biz Talk Server; and MSDN. Its Online Services Business provides

an on-line advertising platform for publishers and advertisers; personal communications services, such as email and instant messaging; and online information. It offers Live Search; MSN; MapPoint; MSN Internet Access; MSN Premium Web Services; Windows Live; MSN Mobile Services; AvenueA Razor fish media agency services; Atlas online tools for advertisers; and the Drive PM ad network for publishers. The companys Microsoft Business Division provides Microsoft office product set comprising enterprise content management, collaboration, unified communications, and business intelligence products; and Microsoft Dynamics products for financial management, customer relationship management, supply chain management, and analytics applications. Its Entertainment and Devices Division offers the Xbox video game system, including consoles and accessories, third-party games, games published under the Microsoft brand, and Xbox Live operations. This division also provides Zune digital music and entertainment device; PC software games; online games; Mediaroom, and Internet protocol television software; mobile and embedded device platforms; and Surface computing platform. Microsoft was founded in 1975 and is headquartered in Redmond, Washington.

RATIO ANALYSIS

Financial Health
Apple carries absolutely zero debt, making its financial ratios look very attractive. Its current and quick ratios are well ahead of industry averages and its competitors. The liabilities of Apple consist of accounts payable and accrued expenses.

Profitability
In recent years Apple has seen improvement in its profitability. The success of the iPod has led to higher sales volume allowing for an increase in the scale of the production process. This has increased margins and returns substantially. Apples profitability is better than the industry and its hardware competitors, but is well behind Microsoft. This is due to the product mixes these companies offer. Apple provides both software and hardware. Dell and HP only provide hardware. Microsoft only provides software. Software has much higher margins than hardware due to the only material cost being labor. It makes logical sense for Apples ratios to be in between those of its hardware (low margin) and software (high margin) competitors, as it provides both.

Asset Utilization
Apples asset turnover has trended down in recent years, and its inventory turnover has been decreasing as. Though both numbers are healthy for a company in Apples

position. Apple underperforms its hardware competitors in asset turnover and outperforms them in inventory turnover. It outperforms Microsoft in both measurements.

Valuation
Apples valuation multiples have been volatile in recent years, but have declined drastically in 2008 and early 2009. I believe this is due to the macro-economic situation and the uncertainty that results for Apples future earnings. It trades at a premium to its competitors due to greater growth prospects, better margins, and superb management.

DuPont Analysis
Apple is ahead of the industry and its hardware competitors in ROA, but trails Microsoft significantly. The company has Return on Equity that is below the industry average and many of its competitors. However, this is due to Apple having zero debt, which results in the company being less leveraged than the industry and its competitors, which hampers its ROE.

PROFORMA ASSUMPTIONS

Revenues
For 2009 I grew revenues at ~8.5%, which is a much slower rate than Apple has averaged over the past 5 year. This rate acknowledges Apples strategic product mix and position in the industry, while recognizing the effects of a recessionary environment on the demand for Apples products. For 2010 I predicted that revenues increase by 12%, as unemployment declines and the economy underlining the market begins to regain its footing. I believe Mac sales will continue to gain market share, which will be the driver of revenue growth. If Apple releases the iPhone in China before or during 2010, I think a significantly higher rate of revenue growth is attainable. For 2011 I grew revenues at 20%, due to the possibility of the iPhone being distributed throughout China, as well as Apple increasing its exposure internationally, and achieving increased growth in its product line worldwide, therby enhancing their Market share. I still expect Mac to gain market share in the US, but at a slightly slower pace than before.

Cost of Goods Sold

In prior quarterly conference calls management has advised that its possible to see margins decrease by up to 200 bps. I established COGS at 67% of sales for the next three quarters of 2009 and continuing through 2011, due to the long-term contracts Apple signs with its suppliers. Also, I believe Macintosh computers may see price cuts and updated configurations down the line, that may lower the spread between sales price and gross margin.

Research and Development

Due to the need for Apple to constantly innovate its product offerings I increased the growth rate for Research and Development slightly to 3.68% for 2009 and 3.75% 2010 and 2011.

SG&A
Selling, General and Administrative costs are mixed costs (combining both variable and fixed costs). When sales volume increases, the fixed cost portion will decrease as a % of sales. To account for this, I decreased the SG&A costs as a percentage of sales as YoY when compared to the prior quarter or year by a slight amount as sales increased.

Other Income and Expense

I grew this line item a little less than its historical percentage of sales, at 1.4% for 2009 and 1.5% of sales for 2010 and 2011. Provisions for Income Taxes

Apple doesnt expect a change in their tax rate; therefore I maintained the tax rate of 30.7% of EBT for 2010 and 2011.

Shares Outstading
Apple has given no guidance on its plans to either increase or reduce its share count. I didnt predict any large action that will increase or decrease this number, but I did grow shares outstanding in line with analyst estimates and historical growth due to option exercises moving shares from the authorized but not yet issued account into the open market.

Capital Expenditures

I grew Capital Expenditures for 2010 and 2011 at 25% year over year and estimated capital expenditures of 1.05B in 2009. I chose this percentage after interpreting managements plan to grow retail stores 20% each year in the upcoming years and to expect this to raise capital expenditures. I raised Capital Expenditures 25% to recognize other cash outflows that may occur and new store developments.

VALUATION ASSUMPTIONS Risk Free Rate

I used the agreed upon risk free rate of 4.5%, the historical average of the 30 year Treasury bond yield.

Market Risk Premium

I used the standard EIF market risk premium of 5.7%

Forecasted Beta
I used a beta of 1.7, which is above the average beta of 1.51, but in line with analysts.

Recent Price:
In my analysis I used the closing price on Friday April 17, 2008 of $123.42.

2011 EPS
My 2011 EPS is $6.67, which is greater than the average forecast I found, but definitely attainable for a company with Apples track record of growth if the economy stabilizes.

2011 P/E
I think currently we are seeing low level for the earnings multiple given Apples track record of creating innovative products and consumer demand. There is a great deal of uncertainty surrounding the companys continued a high profile product offerings, and whether or not the company will be able to sell their products at the same rate. I still believe that Apple is well positioned and has a great strategy to do what is necessary to maximize shareholder value. Shares are currently trading at a P/E of 22.93, and I believe by 2011 the P/E will rise to at least 25. Given Apples track record of innovation and surprising growth, I feel this number is reasonable.

RECENT NEWS
FOR APPLE UPSIDE REMAINS From: Seeking Alpha Apple (AAPL) reports its March quarter next week. The stock sits near its 2009 high, up about 40%. Each time the stock has pulled back buyers show up and take it right back up. Recently, the chatter on the street has been bullish as iPhone and Mac demand appears to be holding up better than expected. Apple seems certain to report a quarter better than its guidance. This is widely expected and analysts are ahead of guidance. Estimate increases are far outpacing estimate cuts. Investors have been worried that Apple's premium priced products would falter in the tough economic environment. This does not seem to be the case, as market share gains continue to offset macroeconomic weakness. Other factors helping the stock are Research in Motion's (RIMM) strong earnings report and less worry about the future of Apple without Steve Jobs. I think many investors are missing the big picture on smartphones their penetration is rising so fast in the U.S. that the market is healthy enough to easily accommodate Apple and RIMM. As for Jobs, I've noted before that Apple is at a point in its product lifecycle where changes are evolutionary. Even a move to a netbook is not much more than a larger form factor iPod touch. This is an ideal time for Jobs to be sidelined as it is even more about operational execution than usual. Furthermore, operational execution is massively underappreciated by Apple observers who focus on product rumors, unit volumes, and average selling prices. Those things are important but have always been in the stock price equation. Operational execution was not in the stock price. It is also Tim Cook's, the heir apparent to Jobs, strength so the timing for the stock is even better. If the economy recovers into 2010, Apple shares could rise significantly as estimates begin to move up. The current 2010 consensus is $5.94 vs. $5.10 in 2009. If 2010 goes comfortably north of $6, I could see the stock nearing $150 later this year based on a 20 P/E and giving credit for what will be more than $30 in cash presently earning just 1%. I'll be back next week with a detailed preview of the quarter but remember the stock will react to guidance much more than the quarterly results.

APPLE APPROACHING 1 BILLION APP DOWNLOADS Friday Apple (AAPL) announced that it was closing in on its whopping 1 Billionth application download from the App Store, which now features over 25,000 apps built by thousands of developers. In honor of the milestone, Apple has also posted an updated version of the stores most popular apps ever (iTunes link) - something theyve done only once before, at the end of 2008. The list includes such popular mainstays as Facebook, Koi Pond, and Shazam, allowing the millions of new iPhone owners to discover favorites of months gone by. Its a shame this list will probably be shortlived. This isnt an accident. One attribute that has helped the App Store reach its upcoming billion download milestone so quickly is the fact that its featured App Lists are constantly churning - even the most popular applications probably wont be on the top lists a few weeks down the line. This ensures that users who pop into the store will always have some new, quality apps to try out, boosting downloads and giving new applications a chance to shine. But it can also be frustrating for new iPhone owners, who visit the store unsure of what they should download. This isnt to say theyll leave empty handed - theres always a variety of great apps being showcased on the App Store. But the classics that everyone else already has, like Tap Tap Revenge, Ocarina, and Shazam often arent featured on the App Stores homescreen any more, so new users might miss out on them. Apple has made progress since I wrote about this issue last August, now allowing users to browse through apps by category, each of which features its own top lists. But the need for a more readily available all-time leaderboard still remains. To give an idea of how popular these applications have been, ComScore recently reported that 32% of all iPhones and iPod Touches have a version of Tap Tap Revenge installed, making it the platforms most popular game ever with around 6.5 million installs of TTR and 3 million installs of its sequel. But a new user wouldnt know it from the App Stores homepage - theyd have to drill down to the Games section, where TTR2 is currently ranked as the 7th most popular free game. There have been many other tweaks suggested for the still-nascent App Store, including a section for higher-priced premium apps and a new method for calculating popularity that measures how much money an app has gained, not just the number of times it has been downloaded (the current system tends to strongly favor cheaper apps). Apple has done an incredible job building this platform and masterminding its massive popularity. Now it just needs to give users a better way to find the cream of the crop, not just the latest fad. WHY APPLE BELONGS IN EVERY PORTFOLIO by David Fessler

This 33-year-old company dominates the consumer market spaces it competes in, has no debt, and is sitting on a cash pile of over $25 billion. In the face of the current recession it continues to do well - unlike many of its competitors. Back in 1982, you could have purchased 100 shares of this companys stock for $160. Those same 100 shares would be worth roughly $92,000 dollars at todays splitadjusted share prices. Thats a 5,460% return, something most people wont ever see in a lifetime of investing. Fortunately for us, this companys prospects are only looking brighter. In fact, it has plenty of space to grow and do it all over again. And it wont matter whether youve been there from the beginning or jumping into the bandwagon today - the ride looks to be profitable nonetheless. Let me show you a few reasons why this stock belongs in everyones portfolio. Ignoring Competitors and Analysts Today, its bewildered competitors plod along, introducing ho-hum, cheap, me-too products in a vain attempt to undercut its expensive prices and its ever-increasing market share. Most of these attempts are pitifully ineffective. Regardless, this company just ignores them. Always executing from a tower of strength, it defines and controls the markets it operates in, rewriting the rules for the other players. In addition, it creates new markets where none existed before paradigm-shifting consumers lives and thought processes. The companys uniquely distinctive advertising and its incredibly thoughtful, aesthetic product designs give it a unique position in the consumer electronics industry - one that its not likely to give up anytime soon, if ever. Numerous analysts have predicted the companys demise over the years, saying its products are too expensive and wont sell well in recessionary environments, that its a one man show. The companys response? It ignores the analysts, too. Because they just dont get it. You see, it has something that most analysts dont possess and never seem to be able to put a proper value on: * Long-term creative vision * The will and confidence to ignore all the pundits and naysayers * A first-class management team to drive the execution of its secretive plans

Apple: The Foremost Consumer Electronics Leader If you havent already guessed, Im talking about Apple, Inc. (Nasdaq: AAPL), the foremost consumer electronics company in the world. And its stock belongs in everyones portfolio. Granted, Im a little biased. Ive owned its products since the 1980s and just cant imagine living without them. Its customer base is made up of students, educators, businesses, government agencies and consumers of every sort. The companys business strategy centers on its ability to design and develop not only its products, but the software operating systems they run on. Its Mac computers are first class, easy to use and run all the popular software found on Windows machines. And they run those programs better and without all the viruses, spyware, malware and hacker attacks that constantly plague Windows users. Ive converted several long-time Windows users to Macs, and once they saw how easy they were to use - and how few problems they had, they wondered why they hadnt switched over long before. The company single-handedly redefined the entire music business with its iPod and its iTunes music store. And it did it in a relatively short span of four to five years, generating billions in annual revenues in the process. Its share of the Mp3-player market remains well above 75%. Now its doing it again with the iPhone, the slickest smartphone on the market. Sales of the device grew 245% in 2008, according to a Gartner research report. That compares to 96% for Research in Motion (RIMM) and a paltry 0.8% for Nokia (NOK). While the iPhone is number three in terms of overall marketshare (8.2%), its clearly growing the fastest, and could easily overtake Nokia and RIM in a couple of years. In the simplest of terms, Apple has figured out how to create products that most people would design if they could give their two cents to the Apple product development teams. Theyre simple and easy to use, just like everyone wants them to be. Apples Cash Cow Just Keeps Getting Bigger Apples second-quarter financials will be released April 22, in what is always a highly anticipated conference call. The company constantly downplays future expectations when talking to analysts, and then routinely beats them by a wide margin. This quarters results will be particularly interesting, as it will give investors a better idea as to the effect the recession is having on the company. So far, Apple has appeared to

be somewhat resistant to its effects, helped in no small way by a constant stream of new product innovations and introductions. However, one of the major sources of future revenue is constantly overlooked by analysts. Whenever the company sells an iPhone, it only books about 10% of the money it receives as revenue, and defers the rest. It then books this annually over a period of 10 years. This is a constantly increasing future revenue stream thats like cash in the bank. Great for when times get a little tough. And then theres the Apple effect. This is logic that goes along the lines of: If Apples (iPhone or iPod) is this good, its computers must be great, too. That phenomenon has analysts betting the company will sell 2 to 2.2 million Mac computers for the January-March time period. The company has plenty of room to grow here, too, as it currently has under 10% of the overall PC market. Given how well the company has been performing so far during this recession, it appears that shares are still cheap. Investors interested in owning a few shares might want to wait until after this quarters results are announced on April 22, as there is generally a pullback in the stock after earnings results. Apple is certainly on top of its game, and I believe it will continue to stay there as long as it continues to make the rules that all its competitors have to follow.

SOURCES
1. EIF AAPL report Fall 2008 Ross Morgan 2. EIF portfolio 3 IBIS World: Computer Manufacturer 4. JP Morgan Research 5 Valueline 6 WSJ 7. Deutsche Bank Analyst Report 8. Apple 2008 10-K

9. Yahoo! Finance 10. Morningstar 33 Apple.com 37 Seeking Alpha 39 IBIS World