Apple Earnings 2017-07-01
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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 July 1, 2017
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: 001-36743
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) | |
(408) 996-1010
(Registrant’s telephone number, including area code)
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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ☒ | Accelerated filer | ☐ | |||
Non-accelerated filer | ☐ (Do not check if a smaller reporting company) | Smaller reporting company | ☐ | |||
Emerging growth company | ☐ | |||||
If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐ No ☒
5,165,228,000 shares of common stock, par value $0.00001 per share, issued and outstanding as of July 21, 2017
Apple Inc.
Form 10-Q
For the Fiscal Quarter Ended July 1, 2017
TABLE OF CONTENTS
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Item 6. | ||
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
Apple Inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In millions, except number of shares which are reflected in thousands and per share amounts)
Three Months Ended | Nine Months Ended | ||||||||||||||
July 1, 2017 | June 25, 2016 | July 1, 2017 | June 25, 2016 | ||||||||||||
Net sales | $ | 45,408 | $ | 42,358 | $ | 176,655 | $ | 168,787 | |||||||
Cost of sales | 27,920 | 26,252 | 108,400 | 102,337 | |||||||||||
Gross margin | 17,488 | 16,106 | 68,255 | 66,450 | |||||||||||
Operating expenses: | |||||||||||||||
Research and development | 2,937 | 2,560 | 8,584 | 7,475 | |||||||||||
Selling, general and administrative | 3,783 | 3,441 | 11,447 | 10,712 | |||||||||||
Total operating expenses | 6,720 | 6,001 | 20,031 | 18,187 | |||||||||||
Operating income | 10,768 | 10,105 | 48,224 | 48,263 | |||||||||||
Other income/(expense), net | 540 | 364 | 1,948 | 921 | |||||||||||
Income before provision for income taxes | 11,308 | 10,469 | 50,172 | 49,184 | |||||||||||
Provision for income taxes | 2,591 | 2,673 | 12,535 | 12,511 | |||||||||||
Net income | $ | 8,717 | $ | 7,796 | $ | 37,637 | $ | 36,673 | |||||||
Earnings per share: | |||||||||||||||
Basic | $ | 1.68 | $ | 1.43 | $ | 7.18 | $ | 6.66 | |||||||
Diluted | $ | 1.67 | $ | 1.42 | $ | 7.14 | $ | 6.62 | |||||||
Shares used in computing earnings per share: | |||||||||||||||
Basic | 5,195,088 | 5,443,058 | 5,239,847 | 5,505,456 | |||||||||||
Diluted | 5,233,499 | 5,472,781 | 5,274,394 | 5,535,931 | |||||||||||
Cash dividends declared per share | $ | 0.63 | $ | 0.57 | $ | 1.77 | $ | 1.61 | |||||||
See accompanying Notes to Condensed Consolidated Financial Statements.
Apple Inc. | Q3 2017 Form 10-Q | 1
Apple Inc.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(In millions)
Three Months Ended | Nine Months Ended | ||||||||||||||
July 1, 2017 | June 25, 2016 | July 1, 2017 | June 25, 2016 | ||||||||||||
Net income | $ | 8,717 | $ | 7,796 | $ | 37,637 | $ | 36,673 | |||||||
Other comprehensive income/(loss): | |||||||||||||||
Change in foreign currency translation, net of tax effects of $(35), $2, $(3) and $2, respectively | 120 | 46 | (41 | ) | 64 | ||||||||||
Change in unrealized gains/losses on derivative instruments: | |||||||||||||||
Change in fair value of derivatives, net of tax benefit/(expense) of $(16), $27, $(269) and $(10), respectively | (166 | ) | (175 | ) | 1,002 | (66 | ) | ||||||||
Adjustment for net (gains)/losses realized and included in net income, net of tax expense/(benefit) of $176, $46, $276 and $256, respectively | (409 | ) | (88 | ) | (1,135 | ) | (1,061 | ) | |||||||
Total change in unrealized gains/losses on derivative instruments, net of tax | (575 | ) | (263 | ) | (133 | ) | (1,127 | ) | |||||||
Change in unrealized gains/losses on marketable securities: | |||||||||||||||
Change in fair value of marketable securities, net of tax benefit/(expense) of $(197), $(641), $536 and $(663), respectively | 364 | 1,170 | (980 | ) | 1,217 | ||||||||||
Adjustment for net (gains)/losses realized and included in net income, net of tax expense/(benefit) of $16, $8, $12 and $(45), respectively | (32 | ) | (12 | ) | (25 | ) | 84 | ||||||||
Total change in unrealized gains/losses on marketable securities, net of tax | 332 | 1,158 | (1,005 | ) | 1,301 | ||||||||||
Total other comprehensive income/(loss) | (123 | ) | 941 | (1,179 | ) | 238 | |||||||||
Total comprehensive income | $ | 8,594 | $ | 8,737 | $ | 36,458 | $ | 36,911 | |||||||
See accompanying Notes to Condensed Consolidated Financial Statements.
Apple Inc. | Q3 2017 Form 10-Q | 2
Apple Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(In millions, except number of shares which are reflected in thousands and par value)
July 1, 2017 | September 24, 2016 | ||||||
ASSETS: | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 18,571 | $ | 20,484 | |||
Short-term marketable securities | 58,188 | 46,671 | |||||
Accounts receivable, less allowances of $55 and $53, respectively | 12,399 | 15,754 | |||||
Inventories | 3,146 | 2,132 | |||||
Vendor non-trade receivables | 10,233 | 13,545 | |||||
Other current assets | 10,338 | 8,283 | |||||
Total current assets | 112,875 | 106,869 | |||||
Long-term marketable securities | 184,757 | 170,430 | |||||
Property, plant and equipment, net | 29,286 | 27,010 | |||||
Goodwill | 5,661 | 5,414 | |||||
Acquired intangible assets, net | 2,444 | 3,206 | |||||
Other non-current assets | 10,150 | 8,757 | |||||
Total assets | $ | 345,173 | $ | 321,686 | |||
LIABILITIES AND SHAREHOLDERS’ EQUITY: | |||||||
Current liabilities: | |||||||
Accounts payable | $ | 31,915 | $ | 37,294 | |||
Accrued expenses | 23,304 | 22,027 | |||||
Deferred revenue | 7,608 | 8,080 | |||||
Commercial paper | 11,980 | 8,105 | |||||
Current portion of long-term debt | 6,495 | 3,500 | |||||
Total current liabilities | 81,302 | 79,006 | |||||
Deferred revenue, non-current | 2,984 | 2,930 | |||||
Long-term debt | 89,864 | 75,427 | |||||
Other non-current liabilities | 38,598 | 36,074 | |||||
Total liabilities | 212,748 | 193,437 | |||||
Commitments and contingencies | |||||||
Shareholders’ equity: | |||||||
Common stock and additional paid-in capital, $0.00001 par value: 12,600,000 shares authorized; 5,169,782 and 5,336,166 shares issued and outstanding, respectively | 34,445 | 31,251 | |||||
Retained earnings | 98,525 | 96,364 | |||||
Accumulated other comprehensive income/(loss) | (545 | ) | 634 | ||||
Total shareholders’ equity | 132,425 | 128,249 | |||||
Total liabilities and shareholders’ equity | $ | 345,173 | $ | 321,686 | |||
See accompanying Notes to Condensed Consolidated Financial Statements.
Apple Inc. | Q3 2017 Form 10-Q | 3
Apple Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In millions)
Nine Months Ended | |||||||
July 1, 2017 | June 25, 2016 | ||||||
Cash and cash equivalents, beginning of the period | $ | 20,484 | $ | 21,120 | |||
Operating activities: | |||||||
Net income | 37,637 | 36,673 | |||||
Adjustments to reconcile net income to cash generated by operating activities: | |||||||
Depreciation and amortization | 7,673 | 7,957 | |||||
Share-based compensation expense | 3,666 | 3,180 | |||||
Deferred income tax expense | 4,764 | 5,191 | |||||
Other | (142 | ) | 419 | ||||
Changes in operating assets and liabilities: | |||||||
Accounts receivable, net | 3,381 | 4,623 | |||||
Inventories | (1,014 | ) | 518 | ||||
Vendor non-trade receivables | 3,312 | 6,166 | |||||
Other current and non-current assets | (3,229 | ) | 1,049 | ||||
Accounts payable | (5,212 | ) | (9,567 | ) | |||
Deferred revenue | (418 | ) | (1,148 | ) | |||
Other current and non-current liabilities | (2,476 | ) | (5,363 | ) | |||
Cash generated by operating activities | 47,942 | 49,698 | |||||
Investing activities: | |||||||
Purchases of marketable securities | (123,781 | ) | (112,068 | ) | |||
Proceeds from maturities of marketable securities | 19,347 | 14,915 | |||||
Proceeds from sales of marketable securities | 76,747 | 69,926 | |||||
Payments made in connection with business acquisitions, net | (248 | ) | (146 | ) | |||
Payments for acquisition of property, plant and equipment | (8,586 | ) | (8,757 | ) | |||
Payments for acquisition of intangible assets | (209 | ) | (753 | ) | |||
Payments for strategic investments, net | (87 | ) | (1,376 | ) | |||
Other | 313 | (321 | ) | ||||
Cash used in investing activities | (36,504 | ) | (38,580 | ) | |||
Financing activities: | |||||||
Proceeds from issuance of common stock | 274 | 247 | |||||
Excess tax benefits from equity awards | 534 | 391 | |||||
Payments for taxes related to net share settlement of equity awards | (1,646 | ) | (1,361 | ) | |||
Payments for dividends and dividend equivalents | (9,499 | ) | (9,058 | ) | |||
Repurchases of common stock | (25,105 | ) | (23,696 | ) | |||
Proceeds from issuance of term debt, net | 21,725 | 17,984 | |||||
Repayments of term debt | (3,500 | ) | (2,500 | ) | |||
Change in commercial paper, net | 3,866 | 3,992 | |||||
Cash used in financing activities | (13,351 | ) | (14,001 | ) | |||
Increase/(Decrease) in cash and cash equivalents | (1,913 | ) | (2,883 | ) | |||
Cash and cash equivalents, end of the period | $ | 18,571 | $ | 18,237 | |||
Supplemental cash flow disclosure: | |||||||
Cash paid for income taxes, net | $ | 9,752 | $ | 8,990 | |||
Cash paid for interest | $ | 1,456 | $ | 892 | |||
See accompanying Notes to Condensed Consolidated Financial Statements.
Apple Inc. | Q3 2017 Form 10-Q | 4
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 and personal computers, and sells a variety of related software, services, accessories, networking solutions and third-party digital content and applications. The Company’s products and services include iPhone®, iPad®, Mac®, Apple Watch®, Apple TV®, a portfolio of consumer and professional software applications, iOS, macOS®, watchOS® and tvOS™ operating systems, iCloud®, Apple Pay® and a variety of accessory, service and support offerings. The Company sells and delivers digital content and applications through the iTunes Store®, App Store®, Mac App Store, TV App Store, iBooks Store® and Apple Music® (collectively “Digital Content and Services”). 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 Apple-compatible products, including application software and various accessories through its retail and online stores. The Company sells to consumers, small and mid-sized businesses and 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. In the opinion of the Company’s management, the condensed consolidated financial statements reflect all adjustments, which are normal and recurring in nature, necessary for fair financial statement presentation. 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 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 included in its Annual Report on Form 10-K for the fiscal year ended September 24, 2016 (the “2016 Form 10-K”).
The Company’s fiscal year is the 52 or 53-week period that ends on the last Saturday of September. The Company’s fiscal year 2017 will include 53 weeks and ends on September 30, 2017 and its fiscal year 2016 included 52 weeks and ended on September 24, 2016. A 14th week was included in the first quarter of 2017, as is done every five or six years, to realign fiscal quarters with calendar quarters. Unless otherwise stated, references to particular years, quarters, months and periods refer to the Company’s fiscal years ended in September and the associated quarters, months and periods of those fiscal years.
Earnings Per Share
Basic earnings per 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 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 stock options, shares to be purchased by employees under the Company’s employee stock purchase plan, unvested restricted stock and unvested restricted stock units (“RSUs”). The dilutive effect of potentially dilutive securities is reflected in diluted earnings per 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 greater dilutive effect from potentially dilutive securities.
Apple Inc. | Q3 2017 Form 10-Q | 5
The following table shows the computation of basic and diluted earnings per share for the three- and nine-month periods ended July 1, 2017 and June 25, 2016 (net income in millions and shares in thousands):
Three Months Ended | Nine Months Ended | ||||||||||||||
July 1, 2017 | June 25, 2016 | July 1, 2017 | June 25, 2016 | ||||||||||||
Numerator: | |||||||||||||||
Net income | $ | 8,717 | $ | 7,796 | $ | 37,637 | $ | 36,673 | |||||||
Denominator: | |||||||||||||||
Weighted-average shares outstanding | 5,195,088 | 5,443,058 | 5,239,847 | 5,505,456 | |||||||||||
Effect of dilutive securities | 38,411 | 29,723 | 34,547 | 30,475 | |||||||||||
Weighted-average diluted shares | 5,233,499 | 5,472,781 | 5,274,394 | 5,535,931 | |||||||||||
Basic earnings per share | $ | 1.68 | $ | 1.43 | $ | 7.18 | $ | 6.66 | |||||||
Diluted earnings per share | $ | 1.67 | $ | 1.42 | $ | 7.14 | $ | 6.62 | |||||||
Potentially dilutive securities whose effect would have been antidilutive are excluded from the computation of diluted earnings per share.
Note 2 – Financial Instruments
Cash, Cash Equivalents and Marketable Securities
The following tables show the Company’s cash and available-for-sale securities by significant investment category as of July 1, 2017 and September 24, 2016 (in millions):
July 1, 2017 | |||||||||||||||||||||||||||
Adjusted Cost | Unrealized Gains | Unrealized Losses | Fair Value | Cash and Cash Equivalents | Short-Term Marketable Securities | Long-Term Marketable Securities | |||||||||||||||||||||
Cash | $ | 8,529 | $ | — | $ | — | $ | 8,529 | $ | 8,529 | $ | — | $ | — | |||||||||||||
Level 1 (1): | |||||||||||||||||||||||||||
Money market funds | 3,088 | — | — | 3,088 | 3,088 | — | — | ||||||||||||||||||||
Mutual funds | 1,004 | — | (118 | ) | 886 | — | 886 | — | |||||||||||||||||||
Subtotal | 4,092 | — | (118 | ) | 3,974 | 3,088 | 886 | — | |||||||||||||||||||
Level 2 (2): | |||||||||||||||||||||||||||
U.S. Treasury securities | 52,616 | 77 | (230 | ) | 52,463 | 1,013 | 20,104 | 31,346 | |||||||||||||||||||
U.S. agency securities | 5,328 | 3 | (9 | ) | 5,322 | 2,255 | 1,774 | 1,293 | |||||||||||||||||||
Non-U.S. government securities | 6,987 | 156 | (50 | ) | 7,093 | — | 64 | 7,029 | |||||||||||||||||||
Certificates of deposit and time deposits | 6,731 | — | — | 6,731 | 894 | 5,191 | 646 | ||||||||||||||||||||
Commercial paper | 5,187 | — | — | 5,187 | 2,683 | 2,504 | — | ||||||||||||||||||||
Corporate securities | 150,089 | 882 | (312 | ) | 150,659 | 109 | 27,522 | 123,028 | |||||||||||||||||||
Municipal securities | 938 | 3 | (2 | ) | 939 | — | 127 | 812 | |||||||||||||||||||
Mortgage- and asset-backed securities | 20,762 | 34 | (177 | ) | 20,619 | — | 16 | 20,603 | |||||||||||||||||||
Subtotal | 248,638 | 1,155 | (780 | ) | 249,013 | 6,954 | 57,302 | 184,757 | |||||||||||||||||||
Total | $ | 261,259 | $ | 1,155 | $ | (898 | ) | $ | 261,516 | $ | 18,571 | $ | 58,188 | $ | 184,757 | ||||||||||||
Apple Inc. | Q3 2017 Form 10-Q | 6
September 24, 2016 | |||||||||||||||||||||||||||
Adjusted Cost | Unrealized Gains | Unrealized Losses | Fair Value | Cash and Cash Equivalents | Short-Term Marketable Securities | Long-Term Marketable Securities | |||||||||||||||||||||
Cash | $ | 8,601 | $ | — | $ | — | $ | 8,601 | $ | 8,601 | $ | — | $ | — | |||||||||||||
Level 1 (1): | |||||||||||||||||||||||||||
Money market funds | 3,666 | — | — | 3,666 | 3,666 | — | — | ||||||||||||||||||||
Mutual funds | 1,407 | — | (146 | ) | 1,261 | — | 1,261 | — | |||||||||||||||||||
Subtotal | 5,073 | — | (146 | ) | 4,927 | 3,666 | 1,261 | — | |||||||||||||||||||
Level 2 (2): | |||||||||||||||||||||||||||
U.S. Treasury securities | 41,697 | 319 | (4 | ) | 42,012 | 1,527 | 13,492 | 26,993 | |||||||||||||||||||
U.S. agency securities | 7,543 | 16 | — | 7,559 | 2,762 | 2,441 | 2,356 | ||||||||||||||||||||
Non-U.S. government securities | 7,609 | 259 | (27 | ) | 7,841 | 110 | 818 | 6,913 | |||||||||||||||||||
Certificates of deposit and time deposits | 6,598 | — | — | 6,598 | 1,108 | 3,897 | 1,593 | ||||||||||||||||||||
Commercial paper | 7,433 | — | — | 7,433 | 2,468 | 4,965 | — | ||||||||||||||||||||
Corporate securities | 131,166 | 1,409 | (206 | ) | 132,369 | 242 | 19,599 | 112,528 | |||||||||||||||||||
Municipal securities | 956 | 5 | — | 961 | — | 167 | 794 | ||||||||||||||||||||
Mortgage- and asset-backed securities | 19,134 | 178 | (28 | ) | 19,284 | — | 31 | 19,253 | |||||||||||||||||||
Subtotal | 222,136 | 2,186 | (265 | ) | 224,057 | 8,217 | 45,410 | 170,430 | |||||||||||||||||||
Total | $ | 235,810 | $ | 2,186 | $ | (411 | ) | $ | 237,585 | $ | 20,484 | $ | 46,671 | $ | 170,430 | ||||||||||||
(1) | Level 1 fair value estimates are based on quoted prices in active markets for identical assets or liabilities. |
(2) | Level 2 fair value estimates are based on 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. |
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 maturities of the Company’s long-term marketable securities generally range from one to five years.
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 investment policy generally limits the amount of credit exposure to any one issuer. The policy generally requires investments to be investment grade, with the primary objective of minimizing the potential risk of principal loss. Fair values were determined for each individual security in the investment portfolio. When evaluating an investment for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below its cost basis, the financial condition of the issuer and any changes thereto, changes in market interest rates 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 cost basis. As of July 1, 2017, the Company does not consider any of its investments to be other-than-temporarily impaired.
Derivative Financial Instruments
The Company may use derivatives to partially offset its business exposure to foreign currency and interest rate risk on expected future cash flows, on net investments in certain foreign subsidiaries and on certain existing assets and liabilities. However, the Company may choose not to hedge certain exposures for a variety of reasons including, but not limited to, 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 or interest rates.
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 may hedge a portion of forecasted foreign currency revenue, and 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 may enter into forward contracts, option contracts or other instruments to manage this risk and may designate these instruments as cash flow hedges. The Company typically hedges portions of its forecasted foreign currency exposure associated with revenue and inventory purchases, typically for up to 12 months.
Apple Inc. | Q3 2017 Form 10-Q | 7
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. In addition, the Company may use non-derivative financial instruments, such as its foreign currency-denominated debt, as economic hedges of its net investments in certain foreign subsidiaries. In both of these cases, the Company designates these instruments as net investment hedges.
The Company may also enter into non-designated foreign currency contracts to partially offset the foreign currency exchange gains and losses generated by the remeasurement of certain assets and liabilities denominated in non-functional currencies.
The Company may enter into interest rate swaps, options, or other instruments to manage interest rate risk. These instruments may offset a portion of changes in income or expense, or changes in fair value of the Company’s term debt or investments. The Company designates these instruments as either cash flow or fair value hedges. The Company’s hedged interest rate transactions as of July 1, 2017 are expected to be recognized within 10 years.
Cash Flow Hedges
The effective portions of cash flow hedges are recorded in accumulated other comprehensive income (“AOCI”) until the hedged item is recognized in earnings. 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. Deferred gains and losses associated with cash flow hedges of interest income or expense are recognized in other income/(expense), net in the same period as the related income or expense is recognized. The ineffective portions and amounts excluded from the effectiveness testing of cash flow hedges are recognized in other income/(expense), net.
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 AOCI associated with such derivative instruments are reclassified immediately into other income/(expense), net. Any subsequent changes in fair value of such derivative instruments are reflected in other income/(expense), net unless they are re-designated as hedges of other transactions.
Net Investment Hedges
The effective portions of net investment hedges are recorded in other comprehensive income (“OCI”) as a part of the cumulative translation adjustment. The ineffective portions and amounts excluded from the effectiveness testing of net investment hedges are recognized in other income/(expense), net.
Fair Value Hedges
Gains and losses related to changes in fair value hedges are recognized in earnings along with a corresponding loss or gain related to the change in value of the underlying hedged item.
Non-Designated Derivatives
Derivatives that are not designated as hedging instruments are adjusted to fair value through earnings in the financial statement line item to which the derivative relates. As a result, during the three- and nine-month periods ended July 1, 2017, respectively, the Company recognized a loss of $77 million and a gain of $129 million in net sales, gains of $12 million and $91 million in cost of sales and gains of $49 million and $481 million in other income/(expense), net.
The Company records all derivatives in the Condensed Consolidated Balance Sheets at fair value. The Company’s accounting treatment for these derivative instruments is based on its hedge designation. The following tables show the Company’s derivative instruments at gross fair value as of July 1, 2017 and September 24, 2016 (in millions):
July 1, 2017 | |||||||||||
Fair Value of Derivatives Designated as Hedge Instruments | Fair Value of Derivatives Not Designated as Hedge Instruments | Total Fair Value | |||||||||
Derivative assets (1): | |||||||||||
Foreign exchange contracts | $ | 485 | $ | 242 | $ | 727 | |||||
Interest rate contracts | $ | 253 | $ | — | $ | 253 | |||||
Derivative liabilities (2): | |||||||||||
Foreign exchange contracts | $ | 842 | $ | 362 | $ | 1,204 | |||||
Interest rate contracts | $ | 264 | $ | — | $ | 264 | |||||
Apple Inc. | Q3 2017 Form 10-Q | 8
September 24, 2016 | |||||||||||
Fair Value of Derivatives Designated as Hedge Instruments | Fair Value of Derivatives Not Designated as Hedge Instruments | Total Fair Value | |||||||||
Derivative assets (1): | |||||||||||
Foreign exchange contracts | $ | 518 | $ | 153 | $ | 671 | |||||
Interest rate contracts | $ | 728 | $ | — | $ | 728 | |||||
Derivative liabilities (2): | |||||||||||
Foreign exchange contracts | $ | 935 | $ | 134 | $ | 1,069 | |||||
Interest rate contracts | $ | 7 | $ | — | $ | 7 | |||||
(1) | 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. |
(2) | 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 shows the pre-tax gains and losses of the Company’s derivative and non-derivative instruments designated as cash flow, net investment and fair value hedges in OCI and the Condensed Consolidated Statements of Operations for the three- and nine-month periods ended July 1, 2017 and June 25, 2016 (in millions):
Three Months Ended | Nine Months Ended | ||||||||||||||
July 1, 2017 | June 25, 2016 | July 1, 2017 | June 25, 2016 | ||||||||||||
Gains/(Losses) recognized in OCI – effective portion: | |||||||||||||||
Cash flow hedges: | |||||||||||||||
Foreign exchange contracts | $ | (143 | ) | $ | (170 | ) | $ | 1,267 | $ | 18 | |||||
Interest rate contracts | (2 | ) | (11 | ) | 7 | (53 | ) | ||||||||
Total | $ | (145 | ) | $ | (181 | ) | $ | 1,274 | $ | (35 | ) | ||||
Net investment hedges: | |||||||||||||||
Foreign currency debt | $ | 16 | $ | (128 | ) | $ | 53 | $ | (205 | ) | |||||
Gains/(Losses) reclassified from AOCI into net income – effective portion: | |||||||||||||||
Cash flow hedges: | |||||||||||||||
Foreign exchange contracts | $ | 585 | $ | 142 | $ | 1,418 | $ | 1,325 | |||||||
Interest rate contracts | — | (3 | ) | (3 | ) | (10 | ) | ||||||||
Total | $ | 585 | $ | 139 | $ | 1,415 | $ | 1,315 | |||||||
Gains/(Losses) on derivative instruments: | |||||||||||||||
Fair value hedges: | |||||||||||||||
Interest rate contracts | $ | 185 | $ | 345 | $ | (737 | ) | $ | 484 | ||||||
Gains/(Losses) related to hedged items: | |||||||||||||||
Fair value hedges: | |||||||||||||||
Fixed-rate debt | $ | (185 | ) | $ | (345 | ) | $ | 737 | $ | (484 | ) | ||||
Apple Inc. | Q3 2017 Form 10-Q | 9
The following table shows the notional amounts of the Company’s outstanding derivative instruments and credit risk amounts associated with outstanding or unsettled derivative instruments as of July 1, 2017 and September 24, 2016 (in millions):
July 1, 2017 | September 24, 2016 | ||||||||||||||
Notional Amount | Credit Risk Amount | Notional Amount | Credit Risk Amount | ||||||||||||
Instruments designated as accounting hedges: | |||||||||||||||
Foreign exchange contracts | $ | 43,700 | $ | 485 | $ | 44,678 | $ | 518 | |||||||
Interest rate contracts | $ | 31,500 | $ | 253 | $ | 24,500 | $ | 728 | |||||||
Instruments not designated as accounting hedges: | |||||||||||||||
Foreign exchange contracts | $ | 48,774 | $ | 242 | $ | 54,305 | $ | 153 | |||||||
The notional 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 or interest rates at each respective date. The Company’s exposure to credit loss and market risk will vary over time as currency and interest rates change. Although the table above reflects the notional and credit risk amounts of the Company’s derivative instruments, it does not reflect the gains or losses associated with the exposures and transactions that the 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 are designed to 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 in its Condensed Consolidated Balance Sheets. As of July 1, 2017, the net cash collateral posted by the Company related to derivative instruments under its collateral security arrangements was $162 million, which was recorded as other current assets in the Condensed Consolidated Balance Sheet. As of September 24, 2016, the net cash collateral received by the Company related to derivative instruments under its collateral security arrangements was $163 million, which was recorded as accrued expenses in the Condensed Consolidated Balance Sheet.
Under master netting arrangements with the respective counterparties to the Company’s derivative contracts, the Company is allowed to net settle transactions with a single net amount payable by one party to the other. As of July 1, 2017 and September 24, 2016, the potential effects of these rights of set-off associated with the Company’s derivative contracts, including the effects of collateral, would be a reduction to both derivative assets and derivative liabilities of $1.3 billion and $1.5 billion, respectively, resulting in a net derivative liability of $326 million and a net derivative asset of $160 million, respectively.
Accounts Receivable
Trade Receivables
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. The Company generally does not require collateral from its customers; however, the Company will require collateral in certain instances to limit credit risk. In addition, when possible, the Company attempts to limit credit risk on trade receivables with credit insurance for certain customers or by requiring third-party financing, loans or leases to support credit exposure. These credit-financing arrangements are directly between the third-party financing company and the end customer. As such, the Company generally does not assume any recourse or credit risk sharing related to any of these arrangements.
The Company had no customers that individually represented 10% or more of total trade receivables as of July 1, 2017. As of September 24, 2016, the Company had one customer that represented 10% or more of total trade receivables, which accounted for 10%. The Company’s cellular network carriers accounted for 46% and 63% of total trade receivables as of July 1, 2017 and September 24, 2016, respectively.
Vendor Non-Trade Receivables
The Company has non-trade receivables from certain of its manufacturing vendors resulting from the sale of components to these vendors who manufacture sub-assemblies or assemble final products for the Company. The Company purchases these components directly from suppliers. As of July 1, 2017, the Company had three vendors that individually represented 10% or more of total vendor non-trade receivables, which accounted for 39%, 19% and 16%. As of September 24, 2016, the Company had two vendors that individually represented 10% or more of total vendor non-trade receivables, which accounted for 47% and 21%.
Apple Inc. | Q3 2017 Form 10-Q | 10
Note 3 – Condensed Consolidated Financial Statement Details
The following tables show the Company’s condensed consolidated financial statement details as of July 1, 2017 and September 24, 2016 (in millions):
Property, Plant and Equipment, Net
July 1, 2017 | September 24, 2016 | ||||||
Land and buildings | $ | 12,529 | $ | 10,185 | |||
Machinery, equipment and internal-use software | 49,491 | 44,543 | |||||
Leasehold improvements | 6,961 | 6,517 | |||||
Gross property, plant and equipment | 68,981 | 61,245 | |||||
Accumulated depreciation and amortization | (39,695 | ) | (34,235 | ) | |||
Total property, plant and equipment, net | $ | 29,286 | $ | 27,010 | |||
Other Non-Current Liabilities
July 1, 2017 | September 24, 2016 | ||||||
Deferred tax liabilities | $ | 30,191 | $ | 26,019 | |||
Other non-current liabilities | 8,407 | 10,055 | |||||
Total other non-current liabilities | $ | 38,598 | $ | 36,074 | |||
Other Income/(Expense), Net
The following table shows the detail of other income/(expense), net for the three- and nine-month periods ended July 1, 2017 and June 25, 2016 (in millions):
Three Months Ended | Nine Months Ended | ||||||||||||||
July 1, 2017 | June 25, 2016 | July 1, 2017 | June 25, 2016 | ||||||||||||
Interest and dividend income | $ | 1,327 | $ | 1,036 | $ | 3,833 | $ | 2,963 | |||||||
Interest expense | (602 | ) | (409 | ) | (1,657 | ) | (1,006 | ) | |||||||
Other expense, net | (185 | ) | (263 | ) | (228 | ) | (1,036 | ) | |||||||
Total other income/(expense), net | $ | 540 | $ | 364 | $ | 1,948 | $ | 921 | |||||||
Note 4 – Acquired Intangible Assets
The Company’s acquired intangible assets with definite useful lives primarily consist of patents and licenses. The following table summarizes the components of acquired intangible asset balances as of July 1, 2017 and September 24, 2016 (in millions):
July 1, 2017 | September 24, 2016 | ||||||||||||||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | ||||||||||||||||||
Definite-lived and amortizable acquired intangible assets | $ | 7,358 | $ | (5,014 | ) | $ | 2,344 | $ | 8,912 | $ | (5,806 | ) | $ | 3,106 | |||||||||
Indefinite-lived and non-amortizable acquired intangible assets | 100 | — | 100 | 100 | — | 100 | |||||||||||||||||
Total acquired intangible assets | $ | 7,458 | $ | (5,014 | ) | $ | 2,444 | $ | 9,012 | $ | (5,806 | ) | $ | 3,206 | |||||||||
Apple Inc. | Q3 2017 Form 10-Q | 11
Note 5 – Income Taxes
As of July 1, 2017, the Company recorded gross unrecognized tax benefits of $8.6 billion, of which $2.6 billion, if recognized, would affect the Company’s effective tax rate. As of September 24, 2016, the total amount of gross unrecognized tax benefits was $7.7 billion, of which $2.8 billion, if recognized, would have affected 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 $1.3 billion and $1.0 billion of gross interest and penalties accrued as of July 1, 2017 and September 24, 2016, respectively, which are classified as other non-current liabilities in the Condensed Consolidated Balance Sheets.
The Company 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 its expectations, the Company could be required to adjust its provision for income taxes in the period such resolution occurs. Although timing of the resolution and/or closure of audits is not certain, the Company believes it is reasonably possible that its gross unrecognized tax benefits could decrease (whether by payment, release or a combination of both) in the next 12 months by as much as $700 million.
On August 30, 2016, the European Commission announced its decision that Ireland granted state aid to the Company by providing tax opinions in 1991 and 2007 concerning the tax allocation of profits of the Irish branches of two subsidiaries of the Company (the “State Aid Decision”). The State Aid Decision orders Ireland to calculate and recover additional taxes from the Company for the period June 2003 through December 2014. Irish legislative changes, effective as of January 2015, eliminated the application of the tax opinions from that date forward. The Company believes the State Aid Decision to be without merit and appealed to the General Court of the Court of Justice of the European Union. Ireland has also appealed the State Aid Decision. While the European Commission announced a recovery amount of up to €13 billion, plus interest, the actual amount of additional taxes subject to recovery is to be calculated by Ireland in accordance with the European Commission’s guidance. Once the recovery amount is computed by Ireland, the Company anticipates funding it, including interest, out of foreign cash into escrow, where it will remain pending conclusion of all appeals. The Company believes that any incremental Irish corporate income taxes potentially due related to the State Aid Decision would be creditable against U.S. taxes.
Note 6 – Debt
Commercial Paper
The Company issues unsecured short-term promissory notes (“Commercial Paper”) pursuant to a commercial paper program. The Company uses net proceeds from the commercial paper program for general corporate purposes, including dividends and share repurchases. As of July 1, 2017 and September 24, 2016, the Company had $12.0 billion and $8.1 billion of Commercial Paper outstanding, respectively, with maturities generally less than nine months. The weighted-average interest rate of the Company’s Commercial Paper was 1.01% as of July 1, 2017 and 0.45% as of September 24, 2016.
The following table provides a summary of cash flows associated with the issuance and maturities of Commercial Paper for the nine months ended July 1, 2017 and June 25, 2016 (in millions):
Nine Months Ended | |||||||
July 1, 2017 | June 25, 2016 | ||||||
Maturities less than 90 days: | |||||||
Proceeds from/(Repayments of) commercial paper, net | $ | (143 | ) | $ | 4,154 | ||
Maturities greater than 90 days: | |||||||
Proceeds from commercial paper | 12,633 | 1,846 | |||||
Repayments of commercial paper | (8,624 | ) | (2,008 | ) | |||
Proceeds from/(Repayments of) commercial paper, net | 4,009 | (162 | ) | ||||
Total change in commercial paper, net | $ | 3,866 | $ | 3,992 | |||
Apple Inc. | Q3 2017 Form 10-Q | 12
Term Debt
As of July 1, 2017, the Company had outstanding floating- and fixed-rate notes with varying maturities for an aggregate principal amount of $96.6 billion (collectively the “Notes”). The Notes are senior unsecured obligations, and interest is payable in arrears, quarterly for the U.S. dollar-denominated and Australian dollar-denominated floating-rate notes, semi-annually for the U.S. dollar-denominated, Australian dollar-denominated, British pound-denominated and Japanese yen-denominated fixed-rate notes and annually for the euro-denominated and Swiss franc-denominated fixed-rate notes. The following table provides a summary of the Company’s term debt as of July 1, 2017 and September 24, 2016:
Maturities | July 1, 2017 | September 24, 2016 | |||||||||||||||||||||
Amount (in millions) | Effective Interest Rate | Amount (in millions) | Effective Interest Rate | ||||||||||||||||||||
2013 debt issuance of $17.0 billion: | |||||||||||||||||||||||
Floating-rate notes | 2018 | 2018 | $ | 2,000 | 1.10% | 1.10 | % | $ | 2,000 | 1.10% | 1.10 | % | |||||||||||
Fixed-rate 1.000% – 3.850% notes | 2018 | – | 2043 | 12,500 | 1.08% | – | 3.91 | % | 12,500 | 1.08% | – | 3.91 | % | ||||||||||
2014 debt issuance of $12.0 billion: | |||||||||||||||||||||||
Floating-rate notes | 2019 | – | 2019 | 1,000 | 1.48% | 1.48 | % | 2,000 | 0.86% | – | 1.09 | % | |||||||||||
Fixed-rate 2.100% – 4.450% notes | 2019 | – | 2044 | 8,500 | 1.48% | – | 4.48 | % | 10,000 | 0.85% | – | 4.48 | % | ||||||||||
2015 debt issuances of $27.3 billion: | |||||||||||||||||||||||
Floating-rate notes | 2019 | – | 2020 | 1,532 | 1.43% | – | 1.87 | % | 1,781 | 0.87% | – | 1.87 | % | ||||||||||
Fixed-rate 0.350% – 4.375% notes | 2019 | – | 2045 | 24,259 | 0.28% | – | 4.51 | % | 25,144 | 0.28% | – | 4.51 | % | ||||||||||
2016 debt issuances of $24.9 billion: | |||||||||||||||||||||||
Floating-rate notes | 2019 | – | 2021 | 1,350 | 1.31% | – | 2.32 | % | 1,350 | 0.91% | – | 1.95 | % | ||||||||||
Fixed-rate 1.100% – 4.650% notes | 2018 | – | 2046 | 23,610 | 1.13% | – | 4.78 | % | 23,609 | 1.13% | – | 4.58 | % | ||||||||||
Second quarter 2017 debt issuance of $10.0 billion: | |||||||||||||||||||||||
Floating-rate notes | 2019 | 500 | 1.26 | % | — | — | % | ||||||||||||||||
Floating-rate notes | 2020 | 500 | 1.38 | % | — | — | % | ||||||||||||||||
Floating-rate notes | 2022 | 1,000 | 1.68 | % | — | — | % | ||||||||||||||||
Fixed-rate 1.550% notes | 2019 | 500 | 1.59 | % | — | — | % | ||||||||||||||||
Fixed-rate 1.900% notes | 2020 | 1,000 | 1.38 | % | — | — | % | ||||||||||||||||
Fixed-rate 2.500% notes | 2022 | 1,500 | 1.67 | % | — | — | % | ||||||||||||||||
Fixed-rate 3.000% notes | 2024 | 1,750 | 1.98 | % | — | — | % | ||||||||||||||||
Fixed-rate 3.350% notes | 2027 | 2,250 | 2.12 | % | — | — | % | ||||||||||||||||
Fixed-rate 4.250% notes | 2047 | 1,000 | 4.26 | % | — | — | % | ||||||||||||||||
Second quarter 2017 debt issuance of $1.0 billion: | |||||||||||||||||||||||