Apple (AAPL)

The Role of Cash Compensation

Overview. The Company believes that cash compensation is less effective than long-term equity awards in achieving the goal of the Company’s executive compensation program. Accordingly, cash compensation for the named executive officers, other than Mr. Jobs, represented approximately 11% of the officers’ target total compensation in 2009 and is approximately 35% below the median of target cash compensation provided by peer companies. The named executive officers’ cash compensation includes performance-based cash bonus awards and base salaries.

Performance-Based Cash Bonus Awards. The 2003 Plan, which has been approved by the Company’s shareholders, authorizes the Compensation Committee to issue performance-based cash bonus awards to compensate executive officers for achieving performance goals that are established for a specified performance period. The Company believes that performance-based cash bonus awards are an important component of the executive compensation program because they reward the named executive officers for achieving the annual performance goals established by the Company. However, the bonus awards represent a small percentage of the executives’ total compensation because the Company believes that cash bonus awards are less effective in attracting new executive talent than equity compensation, and they promote retention only in the short-term (the bonus performance period). In addition, the Company prefers to emphasize long-term shareholder value creation over annual operating results. Accordingly, the plan is modestly funded relative to peer companies, as reflected by the following:

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Performance Criteria. Beginning in 2009, the Compensation Committee changed the performance criteria used in the Company’s bonus program from revenue and operating income prepared in accordance with US GAAP to adjusted sales and adjusted operating income. Adjusted sales and adjusted operating income differ from US GAAP in that they exclude the effects of subscription accounting related to sales of iPhones and AppleTV. Because the Company believes these measurements help evaluate the underlying performance of the business, the Company uses such measurements to evaluate management performance and determine appropriate levels of compensation.

Performance Goals. Performance goals are set at target and maximum levels based on objectives in the Company’s internal business plan. The table below shows the performance goals at target and maximum performance levels and the Company’s actual performance for 2009.

Payout Structure. The payout structure is based on an equal weighting of adjusted operating income and adjusted sales because each measure is equally important in the Company’s internal business plan. The performance-based cash bonus awards are denominated as a percentage of the executive’s base salary and payouts are interpolated for achievement of performance between the target and maximum goals. No payout is made unless the target performance goal is achieved. The payout structure in effect for 2009 is shown in the table below.

At the end of the year, the Compensation Committee determines the amount of the award to be paid to each executive officer by comparing the Company’s financial results to the performance goals. The Compensation Committee may, in its discretion, reduce (but not increase) the amount of any individual award based on the officer’s overall performance. In 2009, the Company achieved the maximum performance goals for both adjusted sales and adjusted operating income. As a result, the Compensation Committee awarded the named executive officers, other than Mr. Jobs who does not participate in the bonus program, performance-based cash awards equal to 100% of their base salaries.

Base Salaries. The Compensation Committee determines base salaries for each named executive officer based on the executive officer’s role and responsibilities relative to other members of the executive team. The Company believes that base salaries are less important than long-term equity awards in achieving the goal of the Company’s executive compensation program. The de-emphasized role of base salaries as part of the executive compensation program is reflected in the following:

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4. The Role of Cash Compensation

Base Salaries. The Compensation Committee believes that base salaries are less important than performance-based bonuses and long-term equity awards in meeting the Company’s compensation objectives. The de-emphasized role of salaries as part of total compensation is reflected in the following:

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Performance-Based Cash Incentives. The Performance Bonus Plan, which has been approved by the Company’s shareholders, authorizes the Compensation Committee to issue plan-based cash incentive awards to compensate officers for achieving specific financial objectives that are established annually. The Compensation Committee believes that performance-based cash compensation is an important component of executive compensation because it rewards the named executive officers for achieving the short-term performance goals established by the Company; however, it represents a small percentage of the executives’ total compensation because the Compensation Committee believes that cash bonus programs are less effective in attracting new executive talent than equity compensation, and promote retention only in the short-term—over the performance period. Accordingly, the plan is modestly funded, as reflected by the following:

The Compensation Committee establishes performance goals each year based on revenue and operating income objectives in the Company’s internal business plan. The Compensation Committee has selected these performance goals because they are indicators of increased shareholder value. These performance goals generally exclude the effects of extraordinary, unusual or infrequently occurring events or changes in accounting principles. Because the business plan is highly confidential, the Company does not publicly disclose specific annual internal revenue or operating income objectives. Revealing specific objectives would provide competitors and other third parties with insights into the Company’s confidential planning process and strategies, thereby causing competitive harm.

The Compensation Committee next determines the maximum amount of any cash incentive payment denominated as a percentage of the executive’s base salary. The current payment structure is shown in the payout matrix below.