Apple
APPLE INC (Form: 10-Q, Received: 04/28/2015 17:07:21)
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 28, 2015

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

 

 

 

LOGO

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   x     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   x     No   ¨

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

 

Large accelerated filer

 

x

  

Accelerated filer

 

¨

Non-accelerated filer

 

¨   (Do not check if a smaller reporting company)

  

Smaller reporting company

 

¨

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

Yes   ¨     No   x

5,761,030,000 shares of common stock, par value $0.00001 per share, issued and outstanding as of April 10, 2015

 

 

 


Table of Contents

Apple Inc.

Form 10-Q

For the Fiscal Quarter Ended March 28, 2015

TABLE OF CONTENTS

 

         Page  
Part I   

Item 1.    

 

Financial Statements

     3   

Item 2.

 

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

     23   

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     36   

Item 4.

 

Controls and Procedures

     37   
Part II   

Item 1.

 

Legal Proceedings

     38   

Item 1A.

 

Risk Factors

     39   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     49   

Item 3.

 

Defaults Upon Senior Securities

     49   

Item 4.

 

Mine Safety Disclosures

     49   

Item 5.

 

Other Information

     49   

Item 6.

 

Exhibits

     50   

 

2


Table of Contents

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      Six Months Ended  
     March 28,
2015
     March 29,
2014
     March 28,
2015
     March 29,
2014
 

Net sales

   $ 58,010       $ 45,646       $ 132,609       $ 103,240   

Cost of sales

     34,354         27,699         79,212         63,447   
  

 

 

    

 

 

    

 

 

    

 

 

 

Gross margin

  23,656      17,947      53,397      39,793   
  

 

 

    

 

 

    

 

 

    

 

 

 
                 

Operating expenses:

Research and development

  1,918      1,422      3,813      2,752   

Selling, general and administrative

  3,460      2,932      7,060      5,985   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total operating expenses

  5,378      4,354      10,873      8,737   
  

 

 

    

 

 

    

 

 

    

 

 

 
                 

Operating income

  18,278      13,593      42,524      31,056   

Other income/(expense), net

  286      225      456      471   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before provision for income taxes

  18,564      13,818      42,980      31,527   

Provision for income taxes

  4,995      3,595      11,387      8,232   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income

$ 13,569    $ 10,223    $ 31,593    $ 23,295   
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings per share:

Basic

$ 2.34    $ 1.67    $ 5.43    $ 3.76   

Diluted

$ 2.33    $ 1.66    $ 5.39    $ 3.74   
                 

Shares used in computing earnings per share:

Basic

  5,793,799      6,123,302      5,818,441      6,197,903   

Diluted

  5,834,858      6,156,699      5,858,330      6,233,430   

Cash dividends declared per share

$ 0.47    $ 0.44    $ 0.94    $ 0.88   

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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Table of Contents

Apple Inc.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

(In millions)

 

                                                                   
     Three Months Ended      Six Months Ended  
     March 28,
2015
     March 29,
2014
     March 28,
2015
     March 29,
2014
 

Net income

   $ 13,569       $ 10,223       $ 31,593       $ 23,295   
  

 

 

    

 

 

    

 

 

    

 

 

 

Other comprehensive income:

Change in foreign currency translation, net of tax

  (180   (19   (246   (86

    

Change in unrealized gains/losses on derivative instruments:

Change in fair value of derivatives, net of tax

  1,037      (109   3,019      104   

Adjustment for net (gains)/losses realized and included in net income, net of tax

  (739   (13   (1,304   59   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total change in unrealized gains/losses on derivative instruments, net of tax

  298      (122   1,715      163   
  

 

 

    

 

 

    

 

 

    

 

 

 

    

Change in unrealized gains/losses on marketable securities:

Change in fair value of marketable securities, net of tax

  593      235      137      193   

Adjustment for net (gains)/losses realized and included in net income, net of tax

  36      (39   22      (50
  

 

 

    

 

 

    

 

 

    

 

 

 

Total change in unrealized gains/losses on marketable securities, net of tax

  629      196      159      143   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total other comprehensive income

  747      55      1,628      220   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total comprehensive income

$ 14,316    $ 10,278    $ 33,221    $ 23,515   
  

 

 

    

 

 

    

 

 

    

 

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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Table of Contents

Apple Inc.

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(In millions, except number of shares which are reflected in thousands and par value)

 

                                                 
     March 28,
2015
     September 27,
2014
 
ASSETS:      

Current assets:

     

Cash and cash equivalents

   $ 14,489       $ 13,844   

Short-term marketable securities

     18,607         11,233   

Accounts receivable, less allowances of $83 and $86, respectively

     10,905         17,460   

Inventories

     2,396         2,111   

Deferred tax assets

     5,141         4,318   

Vendor non-trade receivables

     7,259         9,759   

Other current assets

     9,094         9,806   
  

 

 

    

 

 

 

Total current assets

  67,891      68,531   
         

Long-term marketable securities

  160,443      130,162   

Property, plant and equipment, net

  20,151      20,624   

Goodwill

  4,711      4,616   

Acquired intangible assets, net

  4,061      4,142   

Other assets

  3,937      3,764   
  

 

 

    

 

 

 

Total assets

$ 261,194    $ 231,839   
  

 

 

    

 

 

 
         
LIABILITIES AND SHAREHOLDERS’ EQUITY:

Current liabilities:

Accounts payable

$ 23,159    $ 30,196   

Accrued expenses

  22,827      18,453   

Deferred revenue

  8,944      8,491   

Commercial paper

  3,799      6,308   
  

 

 

    

 

 

 

Total current liabilities

  58,729      63,448   
         

Deferred revenue – non-current

  3,571      3,031   

Long-term debt

  40,072      28,987   

Other non-current liabilities

  29,816      24,826   
  

 

 

    

 

 

 

Total liabilities

  132,188      120,292   
  

 

 

    

 

 

 
         

Commitments and contingencies

         

Shareholders’ equity:

Common stock and additional paid-in capital, $0.00001 par value: 12,600,000 shares authorized; 5,762,278 and 5,866,161 shares issued and outstanding, respectively

  25,376      23,313   

Retained earnings

  100,920      87,152   

Accumulated other comprehensive income

  2,710      1,082   
  

 

 

    

 

 

 

Total shareholders’ equity

  129,006      111,547   
  

 

 

    

 

 

 

Total liabilities and shareholders’ equity

$ 261,194    $ 231,839   
  

 

 

    

 

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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Table of Contents

Apple Inc.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(In millions)

 

                                                 
     Six Months Ended  
     March 28,
2015
     March 29,
2014
 

Cash and cash equivalents, beginning of the period

   $ 13,844       $ 14,259   
  

 

 

    

 

 

 

Operating activities:

Net income

  31,593      23,295   

Adjustments to reconcile net income to cash generated by operating activities:

Depreciation and amortization

  5,054      4,031   

Share-based compensation expense

  1,815      1,377   

Deferred income tax expense

  1,879      2,059   

Changes in operating assets and liabilities:

Accounts receivable, net

  6,555      3,401   

Inventories

  (285   (65

Vendor non-trade receivables

  2,500      1,419   

Other current and non-current assets

  2,448      14   

Accounts payable

  (5,428   (2,375

Deferred revenue

  993      1,414   

Other current and non-current liabilities

  5,679      1,638   
  

 

 

    

 

 

 

Cash generated by operating activities

  52,803      36,208   
  

 

 

    

 

 

 

Investing activities:

Purchases of marketable securities

  (92,523   (90,360

Proceeds from maturities of marketable securities

  5,871      10,869   

Proceeds from sales of marketable securities

  48,924      80,241   

Payments made in connection with business acquisitions, net

  (115   (559

Payments for acquisition of property, plant and equipment

  (5,586   (3,367

Payments for acquisition of intangible assets

  (155   (163

Other

  88      (23
  

 

 

    

 

 

 

Cash used in investing activities

  (43,496   (3,362
  

 

 

    

 

 

 

    

Financing activities:

Proceeds from issuance of common stock

  309      341   

Excess tax benefits from equity awards

  357      363   

Taxes paid related to net share settlement of equity awards

  (608   (430

Dividends and dividend equivalents paid

  (5,544   (5,430

Repurchase of common stock

  (12,000   (23,000

Proceeds from issuance of long-term debt, net

  11,332      0   

Repayments of commercial paper, net

  (2,508   0   
  

 

 

    

 

 

 

Cash used in financing activities

  (8,662   (28,156
  

 

 

    

 

 

 

Increase in cash and cash equivalents

  645      4,690   
  

 

 

    

 

 

 

Cash and cash equivalents, end of the period

$ 14,489    $ 18,949   
  

 

 

    

 

 

 

Supplemental cash flow disclosure:

Cash paid for income taxes, net

$ 7,058    $ 5,369   

Cash paid for interest

$ 220    $ 161   

See accompanying Notes to Condensed Consolidated Financial Statements.

 

6


Table of Contents

Apple Inc.

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 1 – Summary of Significant Accounting Policies

Apple Inc. and its wholly-owned subsidiaries (collectively “Apple” or the “Company”) designs, manufactures and markets mobile communication and media devices, personal computers and portable digital music players, and sells a variety of related software, services, accessories, networking solutions and third-party digital content and applications. The Company sells its products worldwide through its retail stores, online stores and direct sales force, as well as through third-party cellular network carriers, wholesalers, retailers and value-added resellers. In addition, the Company sells a variety of third-party iPhone, iPad, Mac and iPod compatible products, including application software, and various accessories through its online and retail 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. 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.

These condensed consolidated financial statements and accompanying notes should be read in conjunction with the Company’s annual consolidated financial statements and the notes thereto for the fiscal year ended September 27, 2014, included in its Annual Report on Form 10-K as updated by the Company’s Current Report on Form 8-K dated January 28, 2015 (hereinafter, the “2014 Form 10-K”). The Company’s fiscal year is the 52 or 53-week period that ends on the last Saturday of September. An additional week is included in the first fiscal quarter approximately every six years to realign fiscal quarters with calendar quarters. The Company’s fiscal years 2015 and 2014 each include 52 weeks. Unless otherwise stated, references to particular years, quarters or months refer to the Company’s fiscal years ended in September and the associated quarters or months 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 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.

The following table shows the computation of basic and diluted earnings per share for the three- and six-month periods ended March 28, 2015 and March 29, 2014 (net income in millions and shares in thousands):

 

                                                                                                   
     Three Months Ended      Six Months Ended  
     March 28,
2015
     March 29,
2014
     March 28,
2015
     March 29,
2014
 

Numerator:

           

Net income

   $ 13,569       $ 10,223       $ 31,593       $ 23,295   

Denominator:

           

Weighted-average shares outstanding

     5,793,799         6,123,302         5,818,441         6,197,903   

Effect of dilutive securities

     41,059         33,397         39,889         35,527   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted-average diluted shares

  5,834,858      6,156,699      5,858,330      6,233,430   
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic earnings per share

$ 2.34    $ 1.67    $ 5.43    $ 3.76   

Diluted earnings per share

$ 2.33    $ 1.66    $ 5.39    $ 3.74   

Potentially dilutive securities, whose effect would have been antidilutive, were not significant for the three- and six-month periods ended March 28, 2015 and the three- and six-month periods ended March 29, 2014. The Company excluded these securities from the computation of diluted earnings per share.

 

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Table of Contents

Note 2 – Financial Instruments

Cash, Cash Equivalents and Marketable Securities

The following tables show the Company’s cash and available-for-sale securities’ adjusted cost, gross unrealized gains, gross unrealized losses and fair value by significant investment category recorded as cash and cash equivalents or short- or long-term marketable securities as of March 28, 2015 and September 27, 2014 (in millions):

 

                                                                                                                                           
  March 28, 2015  
  Adjusted
Cost
  Unrealized
Gains
  Unrealized
Losses
  Fair
Value
  Cash and
Cash
Equivalents
  Short-Term
Marketable
Securities
  Long-Term
Marketable
Securities
 

Cash

   $ 9,879       $ 0       $ 0      $ 9,879       $ 9,879       $ 0       $ 0   
                                                 

Level 1 (1) :

                   

Money market funds

     1,457         0         0        1,457         1,457         0         0   

Mutual funds

     2,384         0         (126     2,258         0         2,258         0   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     3,841         0         (126     3,715         1,457         2,258         0   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 
                             

Level 2 (2) :

                   

U.S. Treasury securities

     42,854         145         (12     42,987         0         1,791         41,196   

U.S. agency securities

     6,901         11         (2     6,910         585         1,056         5,269   

Non-U.S. government securities

     7,114         86         (80     7,120         41         271         6,808   

Certificates of deposit and time deposits

     3,473         0         0        3,473         1,163         1,252         1,058   

Commercial paper

     2,956         0         0        2,956         1,364         1,592         0   

Corporate securities

     100,658         427         (370     100,715         0         10,325         90,390   

Municipal securities

     942         5         (1     946         0         24         922   

Mortgage- and asset-backed securities

     14,782         75         (19     14,838         0         38         14,800   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     179,680         749         (484     179,945         3,153         16,349         160,443   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 
                             

Total

   $ 193,400       $ 749       $ (610   $ 193,539       $ 14,489       $ 18,607       $ 160,443   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 
  September 27, 2014  
  Adjusted
Cost
  Unrealized
Gains
  Unrealized
Losses
  Fair
Value
  Cash and
Cash
Equivalents
  Short-Term
Marketable
Securities
  Long-Term
Marketable
Securities
 

Cash

   $ 10,232       $ 0       $ 0      $ 10,232       $ 10,232       $ 0       $ 0   
                                                 

Level 1 (1) :

                   

Money market funds

     1,546         0         0        1,546         1,546         0         0   

Mutual funds

     2,531         1         (132     2,400         0         2,400         0   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     4,077         1         (132     3,946         1,546         2,400         0   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 
                             

Level 2 (2) :

                   

U.S. Treasury securities

     23,140         15         (9     23,146         12         607         22,527   

U.S. agency securities

     7,373         3         (11     7,365         652         157         6,556   

Non-U.S. government securities

     6,925         69         (69     6,925         0         204         6,721   

Certificates of deposit and time deposits

     3,832         0         0        3,832         1,230         1,233         1,369   

Commercial paper

     475         0         0        475         166         309         0   

Corporate securities

     85,431         296         (241     85,486         6         6,298         79,182   

Municipal securities

     940         8         0        948         0         0         948   

Mortgage- and asset-backed securities

     12,907         26         (49     12,884         0         25         12,859   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     141,023         417         (379     141,061         2,066         8,833         130,162   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 
                             

Total

   $ 155,332       $ 418       $ (511   $ 155,239       $ 13,844       $ 11,233       $ 130,162   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

 

  (1)  

The fair value of Level 1 securities is estimated based on quoted prices in active markets for identical assets or liabilities.

 

 

  (2)  

The fair value of Level 2 securities is estimated 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.

 

 

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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 net realized gains or losses recognized by the Company related to such sales were not significant during the three- and six-month periods ended March 28, 2015 and March 29, 2014. The maturities of the Company’s long-term marketable securities generally range from one to five years.

As of March 28, 2015 and September 27, 2014, gross unrealized losses related to individual securities that had been in a continuous loss position for 12 months or longer were not significant.

During the three- and six-month periods ended March 28, 2015 and March 29, 2014, the Company did not recognize any significant impairment charges. As of March 28, 2015, the Company considers the declines in market value of its marketable securities investment portfolio to be temporary in nature and does not consider any of its investments other-than-temporarily impaired. 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.

Derivative Financial Instruments

The Company uses 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.

To help protect the net investment in a foreign operation from adverse changes in foreign currency exchange rates, the Company may enter into foreign currency forward and option contracts to offset the changes in the carrying amounts of these investments due to fluctuations in foreign currency exchange rates. The Company 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 re-measurement 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 long-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 March 28, 2015 are expected to be recognized within 12 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. These amounts were not significant during the three- and six-month periods ended March 28, 2015 and March 29, 2014.

 

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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. The Company did not recognize any significant net gains or losses related to the loss of hedge designation on discontinued cash flow hedges during the three- and six-month periods ended March 28, 2015 and March 29, 2014.

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. These amounts were not significant during the three- and six-month periods ended March 28, 2015 and March 29, 2014.

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. The ineffective portions and amounts excluded from the effectiveness testing of fair value hedges recognized were not significant during the three- and six-month periods ended March 28, 2015 and March 29, 2014.

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. The net gains and losses recognized for foreign currency forward and option contracts not designated as hedging instruments were not significant during the three- and six-month periods ended March 28, 2015 and March 29, 2014.

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 March 28, 2015 and September 27, 2014 (in millions):

 

                                                                          
     March 28, 2015  
     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

   $ 3,045       $ 86       $ 3,131   

Interest rate contracts

   $ 329       $ 0       $ 329   
                      

Derivative liabilities (2) :

  

Foreign exchange contracts

   $ 27       $ 91       $ 118   

Interest rate contracts

   $ 458       $ 0       $ 458   
     September 27, 2014  
     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

   $ 1,332       $ 222       $ 1,554   

Interest rate contracts

   $ 81       $ 0       $ 81   
                      

Derivative liabilities (2) :

  

Foreign exchange contracts

   $ 41       $ 40       $ 81   

 

  (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.

 

 

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The following tables show the pre-tax gains and losses of the Company’s derivative instruments designated as cash flow, net investment and fair value hedges on OCI and the Condensed Consolidated Statements of Operations for the three- and six-month periods ended March 28, 2015 and March 29, 2014 (in millions):

 

                                                                                                   
     Three Months Ended      Six Months Ended  
     March 28,
2015
     March 29,
2014
     March 28,
2015
     March 29,
2014
 

Gains/(Losses) recognized in OCI – effective portion:

  

Cash flow hedges:

  

Foreign exchange contracts

   $ 1,591       $ (121    $ 4,176       $ 143   

Interest rate contracts

     (429      (27      (517      (6
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

$ 1,162    $ (148 $ 3,659    $ 137   
  

 

 

    

 

 

    

 

 

    

 

 

 
                 

Net investment hedges:

Foreign exchange contracts

$ (6 $ (19 $ 112    $ 5   
  

 

 

    

 

 

    

 

 

    

 

 

 
                 

Gains/(Losses) reclassified from AOCI into net income – effective portion:

Cash flow hedges:

Foreign exchange contracts

$ 1,166    $ 22    $ 1,928    $ (52

Interest rate contracts

  (353   (4   (452   (8
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

$ 813    $ 18    $ 1,476    $ (60
  

 

 

    

 

 

    

 

 

    

 

 

 
                 

Gains/(Losses) on derivative instruments:

Fair value hedges:

Interest rate contracts

$ 122    $ 0    $ 239    $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

 
                 

Gains/(Losses) related to hedged items:

Fair value hedges:

Interest rate contracts

$ (122 $ 0    $ (239 $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

 

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 March 28, 2015 and September 27, 2014 (in millions):

 

                                                                                                   
     March 28, 2015      September 27, 2014  
     Notional
Amount
     Credit Risk
Amounts
     Notional
Amount
     Credit Risk
Amounts
 

Instruments designated as accounting hedges:

           

Foreign exchange contracts

   $ 37,855       $ 3,045       $ 42,945       $ 1,333   

Interest rate contracts

   $ 18,013       $ 329       $ 12,000       $ 89   
                             

Instruments not designated as accounting hedges:

           

Foreign exchange contracts

   $ 27,486       $ 86       $ 38,510       $ 222   

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.

 

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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 March 28, 2015 and September 27, 2014, the Company received $3.7 billion and $2.1 billion, respectively, of cash collateral related to the derivative instruments under its collateral security arrangements, which were recorded as other current liabilities within accrued expenses in the Condensed Consolidated Balance Sheets. The Company did not have any derivative instruments with credit-risk related contingent features that would require it to post additional collateral as of March 28, 2015 and September 27, 2014.

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 March 28, 2015 and September 27, 2014, 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 $3.6 billion and $1.6 billion, respectively, resulting in net derivative liabilities of $859 million and $549 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 that are not covered by collateral, third-party financing arrangements or credit insurance. As of March 28, 2015, the Company had one customer that represented 10% or more of total trade receivables, which accounted for 11%. As of September 27, 2014, the Company had two customers that represented 10% or more of total trade receivables, one of which accounted for 16% and the other 13%. The Company’s cellular network carriers accounted for 63% and 72% of trade receivables as of March 28, 2015 and September 27, 2014, respectively.

Vendor Non-Trade Receivables

Additionally, 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. Vendor non-trade receivables from three of the Company’s vendors accounted for 48%, 18% and 16% of total vendor non-trade receivables as of March 28, 2015 and three of the Company’s vendors accounted for 51%, 16% and 14% of total vendor non-trade receivables as of September 27, 2014.

Note 3 – Condensed Consolidated Financial Statement Details

The following tables show the Company’s condensed consolidated financial statement details as of March 28, 2015 and September 27, 2014 (in millions):

Inventories

 

                                                 
     March 28, 2015      September 27, 2014  

Components

   $ 537       $ 471   

Finished goods

     1,859         1,640   
  

 

 

    

 

 

 

Total inventories

$ 2,396    $ 2,111   
  

 

 

    

 

 

 

Property, Plant and Equipment, Net

 

                                                 
     March 28, 2015      September 27, 2014  

Land and buildings

   $ 5,627       $ 4,863   

Machinery, equipment and internal-use software

     32,107         29,639   

Leasehold improvements

     4,726         4,513   
  

 

 

    

 

 

 

Gross property, plant and equipment

  42,460      39,015   

Accumulated depreciation and amortization

  (22,309   (18,391
  

 

 

    

 

 

 

Total property, plant and equipment, net

$ 20,151    $ 20,624   
  

 

 

    

 

 

 

 

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Accrued Expenses

 

                                                                 
     March 28, 2015      September 27, 2014  

Accrued warranty and related costs

   $ 5,143       $ 4,159   

Accrued taxes

     2,017         1,209   

Accrued marketing and selling expenses

     1,384         2,321   

Accrued compensation and employee benefits

     1,254         1,209   

Deferred margin on component sales

     1,130         1,057   

Other current liabilities

     11,899         8,498   
  

 

 

    

 

 

 

Total accrued expenses

$ 22,827    $ 18,453   
  

 

 

    

 

 

 

Other Non-Current Liabilities

 

                                                                 
     March 28, 2015      September 27, 2014  

Deferred tax liabilities

   $ 23,825       $ 20,259   

Other non-current liabilities

     5,991         4,567   
  

 

 

    

 

 

 

Total other non-current liabilities

$ 29,816    $ 24,826   
  

 

 

    

 

 

 

Other Income/(Expense), Net

The following table shows the detail of other income/(expense), net for the three- and six-month periods ended March 28, 2015 and March 29, 2014 (in millions):

 

                                                                                                   
     Three Months Ended      Six Months Ended  
     March 28, 2015      March 29, 2014      March 28, 2015      March 29, 2014  

Interest and dividend income

   $ 675       $ 410       $ 1,329       $ 837   

Interest expense

     (163      (85      (294      (169

Other expense, net

     (226      (100      (579      (197
  

 

 

    

 

 

    

 

 

    

 

 

 

Total other income/(expense), net

$ 286    $ 225    $ 456    $ 471   
  

 

 

    

 

 

    

 

 

    

 

 

 

Note 4 – Goodwill and Other Intangible Assets

The Company’s acquired intangible assets with definite useful lives primarily consist of patents and licenses and are amortized over periods typically from three to seven years. The following table summarizes the components of gross and net intangible asset balances as of March 28, 2015 and September 27, 2014 (in millions):

 

                                                                                                           
     March 28, 2015      September 27, 2014  
     Gross
Carrying
Amount
     Accumulated
Amortization
     Net
Carrying
Amount
     Gross
Carrying
Amount
     Accumulated
Amortization
     Net
Carrying
Amount
 

Definite-lived and amortizable acquired intangible assets

   $ 7,672       $ (3,711    $ 3,961       $ 7,127       $ (3,085    $ 4,042   

Indefinite-lived and non-amortizable acquired intangible assets

     100         0         100         100         0         100   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total acquired intangible assets

$ 7,772    $ (3,711 $ 4,061    $ 7,227    $ (3,085 $ 4,142   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Note 5 – Income Taxes

As of March 28, 2015, the Company recorded gross unrecognized tax benefits of $4.6 billion, of which $1.6 billion, if recognized, would affect the Company’s effective tax rate. As of September 27, 2014, the total amount of gross unrecognized tax benefits was $4.0 billion, of which $1.4 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 $844 million and $630 million of gross interest and penalties accrued as of March 28, 2015 and September 27, 2014, respectively, which are classified as other non-current liabilities in the Condensed Consolidated Balance Sheets.

Management believes that an adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in the Company’s tax audits are resolved in a manner not consistent with management’s expectations, the Company could be required to adjust its provision for income taxes in the period such resolution occurs. Although timing of the resolution and/or closure of audits is not certain, the Company does not believe it is reasonably possible that its unrecognized tax benefits would materially change in the next 12 months.

On June 11, 2014, the European Commission issued an opening decision initiating a formal investigation against Ireland for alleged state aid to the Company. The opening decision concerns the allocation of profits for taxation purposes of the Irish branches of two subsidiaries of the Company. The Company believes the European Commission’s assertions are without merit. If the European Commission were to conclude against Ireland, the European Commission could require Ireland to recover from the Company past taxes covering a period of up to 10 years reflective of the disallowed state aid. While such amount could be material, as of March 28, 2015 the Company is unable to estimate the impact.

Note 6 – Debt

Commercial Paper

In 2014, the Board of Directors authorized the Company to issue unsecured short-term promissory notes (“Commercial Paper”) pursuant to a commercial paper program. The Company intends to use net proceeds from the commercial paper program for general corporate purposes, including dividends and share repurchases. As of March 28, 2015 and September 27, 2014, the Company had $3.8 billion and $6.3 billion of Commercial Paper outstanding, respectively, with a weighted-average interest rate of 0.10% and 0.12%, respectively, and maturities generally less than nine months.

The following table provides a summary of cash flows associated with the issuance and maturities of Commercial Paper for the six months ended March 28, 2015 (in millions):

 

                        

Maturities less than 90 days:

Proceeds from (repayments of) commercial paper, net

$ 985   

    

Maturities greater than 90 days:

Proceeds from commercial paper

  547   

Repayments of commercial paper

  (4,040
  

 

 

 

Maturities greater than 90 days, net

  (3,493
  

 

 

 

    

Total repayments of commercial paper, net

$ (2,508
  

 

 

 

 

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Long-Term Debt

As of March 28, 2015, the Company has outstanding floating- and fixed-rate notes with varying maturities for an aggregate principal amount of $39.9 billion (collectively the “Notes”). The Notes are senior unsecured obligations, and interest is payable in arrears, quarterly for the domestic floating-rate notes, semi-annually for the domestic fixed-rate notes and annually for the foreign fixed-rate notes. The following table provides a summary of the Company’s long-term debt as of March 28, 2015 and September 27, 2014:

 

                                                                                                           
    March 28, 2015     September 27, 2014  
    Amount
(in millions)
    Effective
Interest Rate
    Amount
(in millions)
    Effective
Interest Rate
 

Floating-rate notes due 2016 (1)

  $ 1,000        0.51%      $ 1,000        0.51%   

Floating-rate notes due 2017 (2)

    1,000        0.33%        1,000        0.31%   

Floating-rate notes due 2018 (1)

    2,000        1.10%        2,000        1.10%   

Floating-rate notes due 2019 (2)

    1,000        0.56%        1,000        0.54%   

Floating-rate notes due 2020 (3)

    500        0.51%        0        0   

Fixed-rate 0.45% notes due 2016 (1)

    1,500        0.51%        1,500        0.51%   

Fixed-rate 1.05% notes due 2017 (2)

    1,500        0.32%        1,500        0.30%   

Fixed-rate 1.00% notes due 2018 (1)

    4,000        1.08%        4,000        1.08%   

Fixed-rate 2.10% notes due 2019 (2)

    2,000        0.55%        2,000        0.53%   

Fixed-rate 1.55% notes due 2020 (3)

    1,250        0.50%        0        0   

Fixed-rate 2.85% notes due 2021 (2)

    3,000        0.81%        3,000        0.79%   

Fixed-rate 2.15% notes due 2022 (3)

    1,250        0.82%        0        0   

Fixed-rate 1.00% Euro-denominated notes due 2022  (4)

    1,534        2.94%        0        0   

Fixed-rate 2.40% notes due 2023 (1)

    5,500        2.44%        5,500        2.44%   

Fixed-rate 3.45% notes due 2024 (2)

    2,500        0.92%        2,500        0.90%   

Fixed-rate 0.38% Swiss Franc-denominated notes due 2024 (5)

    915        0.28%        0        0   

Fixed-rate 2.50% notes due 2025 (3)

    1,500        2.60%        0        0   

Fixed-rate 1.63% Euro-denominated notes due 2026  (4)

    1,534        3.45%        0        0   

Fixed-rate 0.75% Swiss Franc-denominated notes due 2030 (5)

    392        0.74%        0        0   

Fixed-rate 3.85% notes due 2043 (1)

    3,000        3.91%        3,000        3.91%   

Fixed-rate 4.45% notes due 2044 (2)

    1,000        4.48%        1,000        4.48%   

Fixed-rate 3.45% notes due 2045 (3)

    2,000        3.58%        0        0   
 

 

 

     

 

 

   

Total borrowings

  39,875      29,000   
 

 

 

     

 

 

   

Unamortized discount

  (80   (52

Hedge accounting fair value adjustments

  277      39   
 

 

 

     

 

 

   

Total long-term debt

$ 40,072    $ 28,987   
 

 

 

     

 

 

   

 

  (1)  

Tranche relates to the $17.0 billion debt issuance in the third quarter of 2013.

 

 

  (2)  

Tranche relates to the $12.0 billion debt issuance in the third quarter of 2014.

 

 

  (3)  

Tranche relates to the $6.5 billion debt issuance in the second quarter of 2015.

 

 

  (4)  

Tranche relates to Euro-denominated debt issuance of 2.8 billion in the first quarter of 2015.

 

 

  (5)  

Tranche relates to Swiss Franc-denominated debt issuance of SFr1.3 billion in the second quarter of 2015.

 

During the first six months of 2015, the Company issued 2.8 billion of Euro-denominated notes, $6.5 billion of U.S. dollar-denominated notes and SFr1.3 billion of Swiss Franc-denominated notes. To manage foreign currency risk associated with the Euro-denominated notes, the Company entered into currency swaps with an aggregate notional amount of $3.5 billion, which effectively converted the Euro-denominated notes to U.S. dollar-denominated notes. To manage interest rate risk on the U.S. dollar-denominated fixed-rate notes maturing in 2020 and 2022, the Company entered into interest rate swaps with an aggregate notional amount of $2.5 billion, which effectively converted the fixed interest rates on these notes to a floating interest rate. For further discussion regarding the Company’s use of derivative instruments to manage interest rate and foreign currency risk, see the Derivative Financial Instruments section of Note 2, “Financial Instruments.”

 

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Table of Contents

The effective interest rates for the Notes include the interest on the Notes, amortization of the discount and, if applicable, adjustments related to hedging. The Company recognized $161 million and $289 million of interest expense on its long-term debt for the three- and six-month periods ended March 28, 2015, respectively. The Company recognized $84 million and $168 million of interest expense on its long-term debt for the three- and six-month periods ended March 29, 2014, respectively.

Future principal payments for the Company’s Notes as of March 28, 2015 are as follows (in millions):

 

                        

2015

$ 0   

2016

  2,500   

2017

  2,500   

2018

  6,000   

2019

  3,000   

Thereafter

  25,875   
  

 

 

 

Total future principal payments

$ 39,875   
  

 

 

 

As of March 28, 2015 and September 27, 2014, the fair value of the Company’s Notes, based on Level 2 inputs, was $40.2 billion and $28.5 billion, respectively.

Note 7 – Shareholders’ Equity

Dividends

The Company declared and paid cash dividends per share during the periods presented as follows:

 

                                                 
     Dividends
Per Share
     Amount
(in millions)
 

2015:

     

Second quarter

   $ 0.47       $ 2,734   

First quarter

     0.47         2,750   
  

 

 

    

 

 

 

Total cash dividends declared and paid

$ 0.94    $ 5,484   
  

 

 

    

 

 

 
         

2014:

Fourth quarter

$ 0.47    $ 2,807   

Third quarter

  0.47      2,830   

Second quarter

  0.44      2,655   

First quarter

  0.44      2,739   
  

 

 

    

 

 

 

Total cash dividends declared and paid

$ 1.82    $ 11,031   
  

 

 

    

 

 

 

Future dividends are subject to declaration by the Board of Directors.

Share Repurchase Program

In 2014, the Company’s Board of Directors increased the share repurchase authorization to $90 billion of the Company’s common stock, of which $80.0 billion had been utilized as of March 28, 2015. The Company’s share repurchase program does not obligate it to acquire any specific number of shares. Under the program, shares may be repurchased in privately negotiated and/or open market transactions, including under plans complying with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

The Company has entered, and in the future may enter, into accelerated share repurchase arrangements (“ASRs”) with financial institutions. In exchange for up-front payments, the financial institutions deliver shares of the Company’s common stock during the purchase periods of each ASR. The total number of shares ultimately delivered, and therefore the average repurchase price paid per share, is determined at the end of the applicable purchase period of each ASR based on the volume weighted-average price of the Company’s common stock during that period. The shares received are retired in the periods they are delivered, and the up-front payments are accounted for as a reduction to shareholders’ equity in the Company’s Condensed Consolidated Balance Sheet in the periods the payments are made. The Company reflects the ASRs as a repurchase of common stock in the period delivered for purposes of calculating earnings per share and as forward contracts indexed to its own common stock. The ASRs met all of the applicable criteria for equity classification, and therefore, were not accounted for as derivative instruments.

 

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Table of Contents

The following table shows the Company’s ASR activity and related information during the six months ended March 28, 2015 and the year ended September 27, 2014:

 

                                                                                                   
     Purchase
Period End

Date
     Number of
Shares
(in thousands)
     Average
Repurchase
Price
Per Share
     ASR
Amount
(in millions)
 

August 2014 ASR

     February 2015         81,525  (1)       $ 110.40       $ 9,000   

January 2014 ASR

     December 2014         134,247           $ 89.39       $ 12,000   

April 2013 ASR

     March 2014         172,548           $ 69.55       $ 12,000   

 

  (1)  

Includes 59.9 million shares delivered and retired at the beginning of the purchase period, which began in the fourth quarter of 2014, 8.3 million net shares delivered and retired in the first quarter of 2015 and 13.3 million shares delivered and retired at the end of the purchase period, which concluded in the second quarter of 2015.

 

Additionally, the Company repurchased shares of its common stock in the open market, which were retired upon repurchase, during the periods presented as follows:

 

                                                                          
     Number of
Shares
(in thousands)
     Average
Repurchase
Price
Per Share
     Amount
(in millions)
 

2015:

        

Second quarter

     56,400       $ 124.11       $ 7,000   

First quarter

     45,704       $ 109.40         5,000   
  

 

 

       

 

 

 

Total open market common stock repurchases

  102,104    $ 12,000   
  

 

 

       

 

 

 

2014:

Fourth quarter

  81,255    $ 98.46    $ 8,000   

Third quarter

  58,661    $ 85.23      5,000   

Second quarter

  79,749    $ 75.24      6,000   

First quarter

  66,847    $ 74.79      5,000   
  

 

 

       

 

 

 

Total open market common stock repurchases

  286,512    $ 24,000   
  

 

 

       

 

 

 

Note 8 – Comprehensive Income

Comprehensive income consists of two components, net income and OCI. OCI refers to revenue, expenses, and gains and losses that under GAAP are recorded as an element of shareholders’ equity but are excluded from net income. The Company’s OCI consists of foreign currency translation adjustments from those subsidiaries not using the U.S. dollar as their functional currency, net deferred gains and losses on certain derivative instruments accounted for as cash flow hedges and unrealized gains and losses on marketable securities classified as available-for-sale.

The following table shows the pre-tax amounts reclassified from AOCI into the Condensed Consolidated Statements of Operations, and the associated financial statement line item, for the three- and six-month periods ended March 28, 2015 and March 29, 2014 (in millions):

 

                                                                                    
         Three Months Ended      Six Months Ended  

Comprehensive Income Components

 

Financial Statement

Line Item

   March 28,
2015
     March 29,
2014
     March 28,
2015
     March 29,
2014
 

Unrealized (gains)/losses on derivative instruments:

             

Foreign exchange contracts

  Revenue    $ (558    $ 119       $ (1,007    $ 303   
  Cost of sales      (608      (141      (921      (251
  Other income/(expense), net      (1      4         (1      14   

Interest rate contracts

  Other income/(expense), net      353         4         452         8   
    

 

 

    

 

 

    

 

 

    

 

 

 
  (814   (14   (1,477   74   

Unrealized (gains)/losses on marketable securities

Other income/(expense), net   56      (60   34      (77
    

 

 

    

 

 

    

 

 

    

 

 

 

Total amounts reclassified from AOCI

$ (758 $ (74 $ (1,443 $ (3
    

 

 

    

 

 

    

 

 

    

 

 

 

 

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The following table shows the changes in AOCI by component for the six months ended March 28, 2015 (in millions):

 

                                                                                                   
     Cumulative
Foreign
Currency
Translation
     Unrealized
Gains/Losses
on Derivative
Instruments
     Unrealized
Gains/Losses
on Marketable
Securities
     Total  

Balance at September 27, 2014

   $ (242    $ 1,364       $ (40    $ 1,082   
  

 

 

    

 

 

    

 

 

    

 

 

 

Other comprehensive income/(loss) before reclassifications

  (365   3,548      200      3,383   

Amounts reclassified from AOCI

  0      (1,477   34      (1,443

Tax effect

  119      (356   (75   (312
  

 

 

    

 

 

    

 

 

    

 

 

 

Other comprehensive income/(loss)

  (246   1,715      159      1,628   
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at March 28, 2015

$ (488 $ 3,079    $ 119    $ 2,710   
  

 

 

    

 

 

    

 

 

    

 

 

 

Note 9 – Benefit Plans

Stock Plans

The Company had 436.6 million shares reserved for future issuance under its stock plans as of March 28, 2015. RSUs granted generally vest over four years, based on continued employment, and are settled upon vesting in shares of the Company’s common stock on a one-for-one basis. Each share issued with respect to RSUs granted under the Company’s stock plans reduces the number of shares available for grant under the plan by two shares. RSUs cancelled and shares withheld to satisfy tax withholding obligations increase the number of shares available for grant under the plans utilizing a factor of two times the number of RSUs cancelled or shares withheld. Stock options count against the number of shares available for grant on a one-for-one basis.

Rule 10b5-1 Trading Plans

During the three months ended March 28, 2015, Section 16 officers Timothy D. Cook, Angela Ahrendts, Luca Maestri and Daniel Riccio had equity trading plans in place in accordance with Rule 10b5-1(c)(1) under the Exchange Act. An equity trading plan is a written document that pre-establishes the amounts, prices and dates (or formula for determining the amounts, prices and dates) of future purchases or sales of the Company’s stock, including shares acquired pursuant to the Company’s employee and director equity plans.

Restricted Stock Units

A summary of the Company’s RSU activity and related information for the six months ended March 28, 2015 is as follows:

 

                                                                          
     Number of
RSUs
(in thousands)
     Weighted-Average
Grant Date Fair
Value
     Aggregate
Intrinsic Value
(in millions)
 

Balance at September 27, 2014

     103,822       $ 70.98      

RSUs granted

     38,445       $ 102.36      

RSUs vested

     (19,423    $ 65.24      

RSUs cancelled

     (2,980    $ 75.15      
  

 

 

       

Balance at March 28, 2015

  119,864    $ 81.87    $ 14,773   
  

 

 

       

RSUs that vested during the three- and six-month periods ended March 28, 2015 had fair values of $317 million and $2.0 billion, respectively, as of the vesting date. RSUs that vested during the three- and six-month periods ended March 29, 2014 had fair values of $198 million and $1.3 billion, respectively, as of the vesting date.

Stock Options

The Company had 2.3 million stock options outstanding as of March 28, 2015, with a weighted-average exercise price per share of $18.15 and weighted-average remaining contractual term of 2.6 years, substantially all of which are exercisable. The aggregate intrinsic value of the stock options outstanding as of March 28, 2015 was $239 million, which represents the value of the Company’s closing stock price on the last trading day of the period in excess of the weighted-average exercise price multiplied by the number of options outstanding.

The total intrinsic value of options at the time of exercise was $119 million and $367 million for the three- and six-month periods ended March 28, 2015, respectively, and $148 million and $707 million for the three- and six-month periods ended March 29, 2014, respectively.

 

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Table of Contents

Share-Based Compensation

The following table shows a summary of the share-based compensation expense included in the Condensed Consolidated Statements of Operations for the three- and six-month periods ended March 28, 2015 and March 29, 2014 (in millions):

 

                                                                                                   
     Three Months Ended      Six Months Ended  
     March 28,
2015
     March 29,
2014
     March 28,
2015
     March 29,
2014
 

Cost of sales

   $ 142       $ 110       $ 282       $ 219   

Research and development

     384         300         758         589   

Selling, general and administrative

     401         286         775         569   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total share-based compensation expense

$ 927    $ 696    $ 1,815    $ 1,377   
  

 

 

    

 

 

    

 

 

    

 

 

 

The income tax benefit related to share-based compensation expense was $311 million and $662 million for the three- and six-month periods ended March 28, 2015, respectively, and was $230 million and $495 million for the three- and six-month periods ended March 29, 2014, respectively. As of March 28, 2015, the total unrecognized compensation cost related to outstanding stock options and RSUs expected to vest was $8.1 billion, which the Company expects to recognize over a weighted-average period of 2.9 years.

Note 10 – Commitments and Contingencies

Accrued Warranty and Indemnification

The following table shows changes in the Company’s accrued warranties and related costs for the three- and six-month periods ended March 28, 2015 and March 29, 2014 (in millions):

 

                                                                                                   
     Three Months Ended      Six Months Ended  
     March 28,
2015
     March 29,
2014
     March 28,
2015
     March 29,
2014
 

Beginning accrued warranty and related costs

   $ 5,195       $ 3,980       $ 4,159       $ 2,967   

Cost of warranty claims

     (1,030      (865      (2,074      (1,929

Accruals for product warranty

     978         1,253         3,058         3,330   
  

 

 

    

 

 

    

 

 

    

 

 

 

Ending accrued warranty and related costs

$ 5,143    $ 4,368    $ 5,143    $ 4,368   
  

 

 

    

 

 

    

 

 

    

 

 

 

The Company generally does not indemnify end-users of its operating system and application software against legal claims that the software infringes third-party intellectual property rights. Other agreements entered into by the Company sometimes include indemnification provisions under which the Company could be subject to costs and/or damages in the event of an infringement claim against the Company or an indemnified third-party. However, the Company has not been required to make any significant payments resulting from such an infringement claim asserted against it or an indemnified third-party. In the opinion of management, there was not at least a reasonable possibility the Company may have incurred a material loss with respect to indemnification of end-users of its operating system or application software for infringement of third-party intellectual property rights. The Company did not record a liability for infringement costs related to indemnification as of March 28, 2015 or September 27, 2014.

The Company has entered into indemnification agreements with its directors and executive officers. Under these agreements, the Company has agreed to indemnify such individuals to the fullest extent permitted by law against liabilities that arise by reason of their status as directors or officers and to advance expenses incurred by such individuals in connection with related legal proceedings. It is not possible to determine the maximum potential amount of payments the Company could be required to make under these agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each claim. However, the Company maintains directors and officers liability insurance coverage to reduce its exposure to such obligations, and payments made under these agreements historically have not been material.

Concentrations in the Available Sources of Supply of Materials and Product

Although most components essential to the Company’s business are generally available from multiple sources, a number of components are currently obtained from single or limited sources. In addition, the Company competes for various components with other participants in the markets for mobile communication and media devices and personal computers. Therefore, many components used by the Company, including those that are available from multiple sources, are at times subject to industry-wide shortage and significant pricing fluctuations that could materially adversely affect the Company’s financial condition and operating results.

 

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Table of Contents

The Company uses some custom components that are not commonly used by its competitors, and new products introduced by the Company often utilize custom components available from only one source. When a component or product uses new technologies, initial capacity constraints may exist until the suppliers’ yields have matured or manufacturing capacity has increased. If the Company’s supply of components for a new or existing product were delayed or constrained, or if an outsourcing partner delayed shipments of completed products to the Company, the Company’s financial condition and operating results could be materially adversely affected. The Company’s business and financial performance could also be materially adversely affected depending on the time required to obtain sufficient quantities from the original source, or to identify and obtain sufficient quantities from an alternative source. Continued availability of these components at acceptable prices, or at all, may be affected if those suppliers concentrated on the production of common components instead of components customized to meet the Company’s requirements.

The Company has entered into agreements for the supply of many components; however, there can be no guarantee that the Company will be able to extend or renew these agreements on similar terms, or at all. Therefore, the Company remains subject to significant risks of supply shortages and price increases that could materially adversely affect its financial condition and operating results.

Substantially all of the Company’s hardware products are manufactured by outsourcing partners that are located primarily in Asia. A significant concentration of this manufacturing is currently performed by a small number of outsourcing partners, often in single locations. Certain of these outsourcing partners are the sole-sourced suppliers of components and manufacturers for many of the Company’s products. Although the Company works closely with its outsourcing partners on manufacturing schedules, the Company’s operating results could be adversely affected if its outsourcing partners were unable to meet their production commitments. The Company’s purchase commitments typically cover its requirements for periods up to 150 days.

Other Off-Balance Sheet Commitments

Operating Leases

The Company leases various equipment and facilities, including retail space, under noncancelable operating lease arrangements. The Company does not currently utilize any other off-balance sheet financing arrangements. The major facility leases are typically for terms not exceeding 10 years and generally contain multi-year renewal options. As of March 28, 2015, the Company had a total of 453 retail stores. Leases for retail space are for terms ranging from five to 20 years, the majority of which are for 10 years, and often contain multi-year renewal options. As of March 28, 2015, the Company’s total future minimum lease payments under noncancelable operating leases were $5.1 billion, of which $3.4 billion related to leases for retail space.

Other Commitments

The Company utilizes several outsourcing partners to manufacture sub-assemblies for the Company’s products and to perform final assembly and testing of finished products. These outsourcing partners acquire components and build product based on demand information supplied by the Company, which typically covers periods up to 150 days. The Company also obtains individual components for its products from a wide variety of individual suppliers. Consistent with industry practice, the Company acquires components through a combination of purchase orders, supplier contracts and open orders based on projected demand information. Where appropriate, the purchases are applied to inventory component prepayments that are outstanding with the respective supplier. As of March 28, 2015, the Company had outstanding off-balance sheet third-party manufacturing commitments and component purchase commitments of $19.0 billion.

In addition to the commitments mentioned above, the Company had other off-balance sheet obligations of $4.1 billion as of March 28, 2015, which were comprised of commitments to acquire capital assets, including product tooling and manufacturing process equipment, and commitments related to advertising, research and development (“R&D”), Internet and telecommunications services, energy and other obligations.

 

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Table of Contents

Contingencies

The Company is subject to various legal proceedings and claims that have arisen in the ordinary course of business and that have not been fully adjudicated, certain of which are discussed in Part II, Item 1 of this Form 10-Q under the heading “Legal Proceedings” and in Part II, Item 1A of this Form 10-Q under the heading “Risk Factors.” In the opinion of management, there was not at least a reasonable possibility the Company may have incurred a material loss, or a material loss in excess of a recorded accrual, with respect to loss contingencies. However, the outcome of litigation is inherently uncertain. Therefore, although management considers the likelihood of such an outcome to be remote, if one or more of these legal matters were resolved against the Company in a reporting period for amounts in excess of management’s expectations, the Company’s consolidated financial statements for that reporting period could be materially adversely affected.

Smartflash LLC, et al., v. Apple Inc., et al.

On May 29, 2013, Smartflash LLC and Smartflash Technologies Limited filed an action against the Company in the United States District Court for the Eastern District of Texas, Tyler Division, alleging that the Company infringed certain patents relating to data storage and access systems. On February 24, 2015, a jury returned a verdict against the Company, and awarded damages of approximately $533 million. The Company is challenging the verdict, believes it has valid defenses and has not recorded a loss accrual at this time.

Apple Inc. v. Samsung Electronics Co., Ltd, et al.

On August 24, 2012, a jury returned a verdict awarding the Company $1.05 billion in its lawsuit against Samsung Electronics Co., Ltd and affiliated parties in the United States District Court, Northern District of California, San Jose Division. On March 6, 2014, the District Court entered final judgment in favor of the Company in the amount of approximately $930 million. Because the award is now subject to appeal, the Company has not recognized the award in its results of operations.

Note 11 – Segment Information and Geographic Data

The Company reports segment information based on the “management” approach. The management approach designates the internal reporting used by management for making decisions and assessing performance as the source of the Company’s reportable operating segments.

The Company manages its business primarily on a geographic basis. The Company’s reportable operating segments consist of the Americas, Europe, Greater China, Japan and Rest of Asia Pacific. The Americas segment includes both North and South America. The Europe segment includes European countries, as well as India, the Middle East and Africa. The Greater China segment includes China, Hong Kong and Taiwan. The Rest of Asia Pacific segment includes Australia and Asian countries, other than those countries included in the Company’s other operating segments. Each operating segment provides similar hardware and software products and similar services. The accounting policies of the various segments are the same as those described in Note 1, “Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements in Part II, Item 8 of the 2014 Form 10-K.

The Company evaluates the performance of its operating segments based on net sales and operating income. Net sales for geographic segments are generally based on the location of customers and sales through the Company’s retail stores located in those geographic locations. Operating income for each segment includes net sales to third parties, related cost of sales and operating expenses directly attributable to the segment. Advertising expenses are generally included in the geographic segment in which the expenditures are incurred. Operating income for each segment excludes other income and expense and certain expenses managed outside the operating segments. Costs excluded from segment operating income include various corporate expenses such as R&D, corporate marketing expenses, certain share-based compensation expenses, income taxes, various nonrecurring charges and other separately managed general and administrative costs. The Company does not include intercompany transfers between segments for management reporting purposes.

 

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Table of Contents

The following table shows information by operating segment for the three- and six-month periods ended March 28, 2015 and March 29, 2014 (in millions):

 

                                                                                                   
     Three Months Ended      Six Months Ended  
     March 28,
2015
     March 29,
2014
     March 28,
2015
     March 29,
2014
 

Americas:

           

Net sales

   $ 21,316       $ 17,982       $ 51,882       $ 42,771   

Operating income

   $ 7,186       $ 6,029       $ 17,887       $ 14,098   
           

Europe:

           

Net sales

   $ 12,204       $ 10,941       $ 29,418       $ 25,276   

Operating income

   $ 4,112       $ 3,605       $ 9,994       $ 8,228   

Greater China:

           

Net sales

   $ 16,823       $ 9,835       $ 32,967       $ 19,331   

Operating income

   $ 6,714       $ 3,541       $ 13,080       $ 6,788   
           

Japan:

           

Net sales

   $ 3,457       $ 4,047       $ 8,905       $ 9,092   

Operating income

   $ 1,699       $ 1,832       $ 4,187       $ 4,162   

Rest of Asia Pacific:

           

Net sales

   $ 4,210       $ 2,841       $ 9,437       $ 6,770   

Operating income

   $ 1,600       $ 904       $ 3,449       $ 2,272   

A reconciliation of the Company’s segment operating income to the Condensed Consolidated Statements of Operations for the three- and six-month periods ended March 28, 2015 and March 29, 2014 is as follows (in millions):

 

                                                                                                   
     Three Months Ended      Six Months Ended  
     March 28,
2015
     March 29,
2014
     March 28,
2015
     March 29,
2014
 

Segment operating income

   $ 21,311       $ 15,911       $ 48,597       $ 35,548   

Research and development expense

     (1,918      (1,422      (3,813      (2,752

Other corporate expenses, net

     (1,115      (896      (2,260      (1,740
  

 

 

    

 

 

    

 

 

    

 

 

 

Total operating income

$ 18,278    $ 13,593    $ 42,524    $ 31,056   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This section and other parts of this Quarterly Report on Form 10-Q contain forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, that involve risks and uncertainties. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Forward-looking statements can also be identified by words such as “future,” “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “will,” “would,” “could,” “can,” “may,” and similar terms. Forward-looking statements are not guarantees of future performance and the Company’s actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in Part II, Item 1A of this Form 10-Q under the heading “Risk Factors,” which are incorporated herein by reference. The following discussion should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended September 27, 2014 (the “2014 Form 10-K”) filed with the U.S. Securities and Exchange Commission (the “SEC”), as updated by the Company’s Current Report on Form 8-K dated January 28, 2015, and the condensed consolidated financial statements and notes thereto included elsewhere in this Form 10-Q. All information presented herein is based on the Company’s fiscal calendar. Unless otherwise stated, references in this report to particular years, quarters, months or periods refer to the Company’s fiscal years ended in September and the associated quarters, months, or periods of those fiscal years. Each of the terms the “Company” and “Apple” as used herein refers collectively to Apple Inc. and its wholly-owned subsidiaries, unless otherwise stated. The Company assumes no obligation to revise or update any forward-looking statements for any reason, except as required by law.

Available Information

The Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are filed with the SEC. The Company is subject to the informational requirements of the Exchange Act and files or furnishes reports, proxy statements, and other information with the SEC. Such reports and other information filed by the Company with the SEC are available free of charge on the Company’s website at investor.apple.com/sec.cfm when such reports are available on the SEC’s website. The public may read and copy any materials filed by the Company with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Room 1580, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at www.sec.gov . The contents of these websites are not incorporated into this filing. Further, the Company’s references to the URLs for these websites are intended to be inactive textual references only.

Overview and Highlights

Company Background

The Company designs, manufactures and markets mobile communication and media devices, personal computers and portable digital music players, and sells a variety of related software, services, accessories, networking solutions and third-party digital content and applications. The Company’s products and services include iPhone ® , iPad ® , Mac ® , iPod ® , Apple TV ® , a portfolio of consumer and professional software applications, the iOS and OS X ® operating systems, iCloud ® , Apple Pay™ and a variety of accessory, service and support offerings. In September 2014, the Company announced Apple Watch™, which began shipping in April 2015. The Company also sells and delivers digital content and applications through the iTunes Store ® , App Store™, Mac App Store, and iBooks Store™ (collectively “iTunes”). The Company sells its products worldwide through its retail stores, online stores and direct sales force, as well as through third-party cellular network carriers, wholesalers, retailers and value-added resellers. In addition, the Company sells a variety of third-party iPhone, iPad, Mac and iPod compatible products, including application software and various accessories through its online and retail stores. The Company sells to consumers, small and mid-sized businesses and education, enterprise and government customers.

 

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Table of Contents

Business Strategy

The Company is committed to bringing the best user experience to its customers through its innovative hardware, software and services. The Company’s business strategy leverages its unique ability to design and develop its own operating systems, hardware, application software and services to provide its customers products and solutions with innovative design, superior ease-of-use and seamless integration. As part of its strategy, the Company continues to expand its platform for the discovery and delivery of digital content and applications through iTunes ® , which allows customers to discover and download digital content, iOS and Mac applications, and books through either a Mac or Windows-based computer or through iPhone, iPad and iPod touch ® devices (“iOS devices”). The Company also supports a community for the development of third-party software and hardware products and digital content that complement the Company’s offerings. The Company believes a high-quality buying experience with knowledgeable salespersons who can convey the value of the Company’s products and services greatly enhances its ability to attract and retain customers. Therefore, the Company’s strategy also includes building and expanding its own retail and online stores and its third-party distribution network to effectively reach more customers and provide them with a high-quality sales and post-sales support experience. The Company believes ongoing investment in research and development (“R&D”), marketing and advertising is critical to the development and sale of innovative products and technologies.

Business Seasonality and Product Introductions

The Company has historically experienced higher net sales in its first quarter compared to other quarters in its fiscal year due in part to seasonal holiday demand. Additionally, new product introductions can significantly impact net sales, product costs and operating expenses. Product introductions can also impact the Company’s net sales to its indirect distribution channels as these channels are filled with new product inventory following a product introduction, and often, channel inventory of a particular product declines as the next related major product launch approaches. Net sales can also be affected when consumers and distributors anticipate a product introduction. However, neither historical seasonal patterns nor historical patterns of product introductions should be considered reliable indicators of the Company’s future pattern of product introductions, future net sales or financial performance.

Second Quarter Fiscal 2015 Highlights

Net sales rose 27% or $12.4 billion during the second quarter of 2015 compared to the same quarter in 2014. Net sales and unit sales increased for iPhone and Mac following the launches of new iPhone and Mac models in the fourth quarter of 2014 and first quarter of 2015, and net sales of Services increased primarily due to growth from iOS app sales. This growth was partially offset by lower net sales and unit sales of iPad and by the effect of weakness in most foreign currencies relative to the U.S. dollar. Total net sales increased in each of the Company’s operating segments except Japan, with particularly strong growth in Greater China and Rest of Asia Pacific, where year-over-year net sales increased 71% and 48%, respectively.

During the second quarter of 2015, the Company introduced updates to MacBook Air ® and MacBook Pro ® and announced the all-new MacBook ® , which began shipping in April 2015.

The Company utilized $7.0 billion to repurchase shares of its common stock and paid dividends of $2.7 billion or $0.47 per share during the second quarter of 2015. Additionally, the Company issued $6.5 billion of U.S. dollar-denominated and SFr1.3 billion of Swiss Franc-denominated long-term debt.

 

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Table of Contents

Sales Data

The following table shows net sales by operating segment and net sales and unit sales by product during the three- and six-month periods ended March 28, 2015 and March 29, 2014 (dollars in millions and units in thousands):

 

                                                                                                     
     Three Months Ended        Six Months Ended  
     March 28,
2015
     March 29,
2014
     Change        March 28,
2015
     March 29,
2014
     Change  

Net Sales by Operating Segment:

                   

Americas

   $ 21,316       $ 17,982         19%         $ 51,882       $ 42,771         21%   

Europe

     12,204         10,941         12%           29,418         25,276         16%   

Greater China

     16,823         9,835         71%           32,967         19,331         71%   

Japan

     3,457         4,047         (15)%           8,905         9,092         (2)%   

Rest of Asia Pacific

     4,210         2,841         48%           9,437         6,770         39%   
  

 

 

    

 

 

         

 

 

    

 

 

    

Total net sales

$ 58,010    $ 45,646      27%    $ 132,609    $ 103,240      28%   
  

 

 

    

 

 

         

 

 

    

 

 

    
                         

Net Sales by Product:

iPhone (1)

$ 40,282    $ 26,064      55%    $ 91,464    $ 58,562      56%   

iPad (1)

  5,428      7,610      (29)%      14,413      19,078      (24)%   

Mac (1)

  5,615      5,519      2%      12,559      11,914      5%   

Services (2)

  4,996      4,573      9%      9,795      8,970      9%   

Other Products (1)(3)

  1,689      1,880      (10)%      4,378      4,716      (7)%   
  

 

 

    

 

 

         

 

 

    

 

 

    

Total net sales

$ 58,010    $ 45,646      27%    $ 132,609    $ 103,240      28%   
  

 

 

    

 

 

         

 

 

    

 

 

    

Unit Sales by Product:

iPhone

  61,170      43,719      40%      135,638      94,744      43%   

iPad

  12,623      16,350      (23)%      34,042      42,385      (20)%   

Mac

  4,563      4,136      10%      10,082      8,973      12%   

 

  (1)  

Includes deferrals and amortization of related non-software services and software upgrade rights.

 

 

  (2)  

Includes revenue from iTunes, AppleCare ® , Apple Pay, licensing and other services.

 

 

  (3)  

Includes sales of iPod, Apple TV, Beats Electronics and Apple-branded and third-party accessories.

 

 

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Table of Contents

Product Performance

iPhone

The following table presents iPhone net sales and unit sales information for the three- and six-month periods ended March 28, 2015 and March 29, 2014 (dollars in millions and units in thousands):

 

                                                                                                     
     Three Months Ended      Six Months Ended  
     March 28,
2015
     March 29,
2014
     Change      March 28,
2015
     March 29,
2014
     Change  

Net sales

   $ 40,282       $ 26,064         55%       $ 91,464       $ 58,562         56%   

Percentage of total net sales

     69%         57%            69%         57%      

Unit sales

     61,170         43,719         40%         135,638         94,744         43%   

The year-over-year growth in iPhone net sales and unit sales in the second quarter and first six months of 2015 resulted from the launch of new iPhones in the fourth quarter of 2014 and first quarter of 2015; and expanded distribution. Overall average selling prices (“ASPs”) for iPhone increased by 10% and 9% in the second quarter and first six months of 2015, respectively, compared to the same periods in 2014, due to a shift in mix to iPhone 6 and 6 Plus and an increased mix of higher storage capacity iPhones, partially offset by the effect of weakness in most foreign currencies relative to the U.S. dollar.

iPad

The following table presents iPad net sales and unit sales information for the three- and six-month periods ended March 28, 2015 and March 29, 2014 (dollars in millions and units in thousands):

 

                                                                                                     
     Three Months Ended      Six Months Ended  
     March 28,
2015
     March 29,
2014
     Change      March 28,
2015
     March 29,
2014
     Change  

Net sales

   $ 5,428       $ 7,610         (29)%       $ 14,413       $ 19,078         (24)%   

Percentage of total net sales

     9%         17%            11%         18%      

Unit sales

     12,623         16,350         (23)%         34,042         42,385         (20)%   

Net sales and unit sales for iPad declined in the second quarter and first six months of 2015 compared to the same periods in 2014. The Company believes the decline in sales is due in part to a longer repurchase cycle for iPads and some level of cannibalization from the Company’s other products. iPad ASPs declined by 8% and 6% during the second quarter and first six months of 2015, respectively, compared to the same periods in 2014, primarily as a result of a shift in mix to lower-priced iPads and the effect of weakness in most foreign currencies relative to the U.S. dollar, partially offset by an increased mix of higher storage capacity iPads.

Mac

The following table presents Mac net sales and unit sales information for the three- and six-month periods ended March 28, 2015 and March 29, 2014 (dollars in millions and units in thousands):

 

                                                                                                     
     Three Months Ended      Six Months Ended  
     March 28,
2015
     March 29,
2014
     Change      March 28,
2015
     March 29,
2014
     Change  

Net sales

   $ 5,615       $ 5,519         2%       $ 12,559       $ 11,914         5%   

Percentage of total net sales

     10%         12%            9%         12%      

Unit sales

     4,563         4,136         10%         10,082         8,973         12%   

The year-over-year growth in Mac net sales and unit sales for the second quarter and first six months of 2015 was driven by strong demand for MacBook Air and the launch of new Mac desktops in the first quarter of 2015. Mac ASPs declined by 8% and 6% during the second quarter and first six months of 2015, respectively, compared to the same periods in 2014, primarily as a result of the effect of weakness in most foreign currencies relative to the U.S. dollar, a shift in mix to lower-priced Macs, and price reductions on Mac portables in the second half of 2014.

 

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Table of Contents

Services

The following table presents Services net sales information for the three- and six-month periods ended March 28, 2015 and March 29, 2014 (dollars in millions):

 

                                                                                                     
     Three Months Ended      Six Months Ended  
     March 28,
2015
     March 29,
2014
     Change      March 28,
2015
     March 29,
2014
     Change  

Net sales

   $ 4,996       $ 4,573         9%       $ 9,795       $ 8,970         9%   

Percentage of total net sales

     9%         10%            7%         9%      

The increase in net sales of Services in the second quarter and first six months of 2015 compared to the same periods in 2014 was primarily due to growth from licensing and iTunes, partially offset by the effect of weakness in most foreign currencies relative to the U.S. dollar. iTunes generated a total of $2.8 billion and $5.4 billion in net sales during the second quarter and first six months of 2015, respectively, compared to $2.6 billion and $5.0 billion during the second quarter and first six months of 2014, respectively. Growth from iTunes was driven primarily by increases in revenue from iOS app sales reflecting continued growth in the installed base of iOS devices, the expansion in third-party iOS apps available, and increased volume of in-app purchases. This growth was partially offset by year-over-year decreases in combined net sales of digital media, consisting of music, movies, TV shows and books, of 4% and 5% in the second quarter and first six months of 2015, respectively.

Segment Operating Performance

The Company manages its business primarily on a geographic basis. Accordingly, the Company determined its reportable operating segments, which are generally based on the location of its customers, to be the Americas, Europe, Greater China, Japan and Rest of Asia Pacific. The Americas segment includes both North and South America. The Europe segment includes European countries, as well as India, the Middle East and Africa. The Greater China segment includes China, Hong Kong and Taiwan. The Rest of Asia Pacific segment includes Australia and Asian countries, other than those countries included in the Company’s other operating segments. Each operating segment provides similar hardware and software products and similar services. Further information regarding the Company’s operating segments may be found in Part I, Item 1 of this Form 10-Q in the Notes to Condensed Consolidated Financial Statements, in Note 11, “Segment Information and Geographic Data.”

Americas

The following table presents Americas net sales information for the three- and six-month periods ended March 28, 2015 and March 29, 2014 (dollars in millions):

 

                                                                                                     
     Three Months Ended      Six Months Ended  
     March 28,
2015
     March 29,
2014
     Change      March 28,
2015
     March 29,
2014
     Change  

Net sales

   $ 21,316       $ 17,982         19%       $ 51,882       $ 42,771         21%   

Percentage of total net sales

     37%         39%            39%         41%      

The year-over-year growth in Americas net sales for the second quarter and first six months of 2015 was driven primarily by growth in net sales and unit sales of iPhone, partially offset by a decline in net sales and unit sales of iPad. iPhone channel inventory decreased more in the second quarter and first six months of 2015 than in the prior year periods due to increased customer demand.

Europe

The following table presents Europe net sales information for the three- and six-month periods ended March 28, 2015 and March 29, 2014 (dollars in millions):

 

                                                                                                     
     Three Months Ended      Six Months Ended  
     March 28,
2015
     March 29,
2014
     Change      March 28,
2015
     March 29,
2014
     Change  

Net sales

   $ 12,204       $ 10,941         12%       $ 29,418       $ 25,276         16%   

Percentage of total net sales

     21%         24%            22%         24%      

The year-over-year increase in Europe net sales for the second quarter and first six months of 2015 was driven primarily by growth in net sales and unit sales of iPhone, partially offset by a decline in net sales and unit sales of iPad and the effect of weakness in European currencies relative to the U.S. dollar. iPhone channel inventory decreased significantly more in the first six months of 2015 than in the prior year period due to increased customer demand.

 

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Table of Contents

Greater China

The following table presents Greater China net sales information for the three- and six-month periods ended March 28, 2015 and March 29, 2014 (dollars in millions):

 

                                                                                                     
     Three Months Ended      Six Months Ended  
     March 28,
2015
     March 29,
2014
     Change      March 28,
2015
     March 29,
2014
     Change  

Net sales

   $ 16,823       $ 9,835         71%       $ 32,967       $ 19,331         71%   

Percentage of total net sales

     29%         22%            25%         19%      

During the second quarter and first six months of 2015, Greater China experienced year-over-year increases in net sales that were significantly higher than those experienced by the Company overall. iPhone net sales and unit sales grew strongly following the launch of new iPhone models in Greater China in the fourth quarter of 2014 and first quarter of 2015. iPhone channel inventory increased more in the second quarter and first six months of 2015 than in the prior year periods in anticipation of increased customer demand.

Japan

The following table presents Japan net sales information for the three- and six-month periods ended March 28, 2015 and March 29, 2014 (dollars in millions):

 

                                                                                                     
     Three Months Ended      Six Months Ended  
     March 28,
2015
     March 29,
2014
     Change      March 28,
2015
     March 29,
2014
     Change  

Net sales

   $ 3,457       $ 4,047         (15)%       $ 8,905       $ 9,092         (2)%   

Percentage of total net sales

     6%         9%            7%         9%      

The year-over-year decrease in Japan net sales for the second quarter and first six months of 2015 was driven primarily by a significant adverse impact from weakness in the Japanese Yen relative to the U.S. dollar, as well as lower net sales and unit sales of iPhone. iPhone channel inventory decreased during the first six months of 2015.

Rest of Asia Pacific

The following table presents Rest of Asia Pacific net sales information for the three- and six-month periods ended March 28, 2015 and March 29, 2014 (dollars in millions):

 

                                                                                                     
     Three Months Ended      Six Months Ended  
     March 28,
2015
     March 29,
2014
     Change      March 28,
2015
     March 29,
2014
     Change  

Net sales

   $ 4,210       $ 2,841         48%       $ 9,437       $ 6,770         39%   

Percentage of total net sales

     7%         6%            7%         7%      

The year-over-year increase in Rest of Asia Pacific net sales for the second quarter and first six months of 2015 primarily reflects strong growth in net sales and unit sales of iPhone, partially offset by a decline in net sales and unit sales of iPad and the effect of weakness in foreign currencies relative to the U.S. dollar. iPhone channel inventory increased more in the second quarter and first six months of 2015 than in the prior year periods in anticipation of increased customer demand.

 

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Table of Contents

Gross Margin

Gross margin for the three- and six-month periods ended March 28, 2015 and March 29, 2014 was as follows (dollars in millions):

 

                                                                   
     Three Months Ended      Six Months Ended  
     March 28,
2015
     March 29,
2014
     March 28,
2015
     March 29,
2014
 

Net sales

   $ 58,010       $ 45,646       $ 132,609       $ 103,240   

Cost of sales

     34,354         27,699         79,212         63,447   
  

 

 

    

 

 

    

 

 

    

 

 

 

Gross margin

$ 23,656    $ 17,947    $ 53,397    $ 39,793   
  

 

 

    

 

 

    

 

 

    

 

 

 

Gross margin percentage

  40.8%      39.3%      40.3%      38.5%   

The increase in the gross margin percentage during the second quarter and first six months of 2015 compared to the same periods in 2014 was driven primarily by a favorable shift in mix to products with higher margins and, to a lesser extent, by improved leverage on fixed costs from higher net sales. These positive factors were partially offset primarily by higher cost structures on new products and, to a lesser extent, by the effect of weakness in most foreign currencies relative to the U.S. dollar.

The Company anticipates gross margin during the third quarter of 2015 to be between 38.5% and 39.5%. The foregoing statement regarding the Company’s expected gross margin percentage in the third quarter of 2015 is forward-looking and could differ from actual results. The Company’s future gross margins can be impacted by multiple factors including, but not limited to, those set forth in Part II, Item 1A of this Form 10-Q under the heading “Risk Factors” and those described in this paragraph. In general, the Company believes gross margins will remain under downward pressure due to a variety of factors, including continued industry wide global product pricing pressures, increased competition, compressed product life cycles, product transitions, potential increases in the cost of components, and potential strengthening of the U.S. dollar, as well as potential increases in the costs of outside manufacturing services and a potential shift in the Company’s sales mix towards products with lower gross margins. In response to competitive pressures, the Company expects it will continue to take product pricing actions, which would adversely affect gross margins. Gross margins could also be affected by the Company’s ability to manage product quality and warranty costs effectively and to stimulate demand for certain of its products. Due to the Company’s significant international operations, financial results can be significantly affected by fluctuations in exchange rates.

Operating Expenses

Operating expenses for the three- and six-month periods ended March 28, 2015 and March 29, 2014 were as follows (dollars in millions):

 

                                                                   
     Three Months Ended      Six Months Ended  
     March 28,
2015
     March 29,
2014
     March 28,
2015
     March 29,
2014
 

Research and development

   $ 1,918       $ 1,422       $ 3,813       $ 2,752   

Percentage of total net sales

     3.3%         3.1%         2.9%         2.7%   

Selling, general and administrative

   $ 3,460       $ 2,932       $ 7,060       $ 5,985   

Percentage of total net sales

     6.0%         6.4%         5.3%         5.8%   

Total operating expenses

   $ 5,378       $ 4,354       $ 10,873       $ 8,737   

Percentage of total net sales

     9.3%         9.5%         8.2%         8.5%   

Research and Development

The growth in R&D expense during the second quarter and first six months of 2015 compared to the same periods in 2014 was driven primarily by an increase in headcount and related expenses, including share-based compensation costs, and material costs to support expanded R&D activities. The Company continues to believe that focused investments in R&D are critical to its future growth and competitive position in the marketplace and are directly related to timely development of new and enhanced products that are central to the Company’s core business strategy.

Selling, General and Administrative

The growth in selling, general and administrative expense during the second quarter and first six months of 2015 compared to the same periods in 2014 was primarily due to increased headcount and related expenses, including share-based compensation costs, and higher spending on marketing and advertising.

 

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Table of Contents

Other Income/(Expense), Net

Other income/(expense), net for the three- and six-month periods ended March 28, 2015 and March 29, 2014 was as follows (dollars in millions):

 

                                                                                                     
     Three Months Ended             Six Months Ended         
     March 28,
2015
     March 29,
2014
     Change      March 28,
2015
     March 29,
2014
     Change  

Interest and dividend income

   $ 675       $ 410          $ 1,329       $ 837      

Interest expense

     (163      (85         (294      (169   

Other expense, net

     (226      (100         (579      (197   
  

 

 

    

 

 

       

 

 

    

 

 

    

Total other income/(expense), net

$ 286    $ 225      27%    $ 456    $ 471      (3)%   
  

 

 

    

 

 

       

 

 

    

 

 

    

The increase in other income/(expense), net during the second quarter of 2015 compared to the same period in 2014 was due primarily to higher interest income and a gain on strategic investments, partially offset by higher premium expenses on foreign exchange contracts and higher interest expense on debt. The decrease in other income/(expense), net during the first six months of 2015 compared to the same period in 2014 was due primarily to higher premium expense on foreign exchange contracts, higher expenses associated with foreign exchange movements and higher interest expense on debt, partially offset by higher interest income. The weighted-average interest rate earned by the Company on its cash, cash equivalents and marketable securities was 1.43% and 1.04% in the second quarter of 2015 and 2014, respectively, and 1.42% and 1.03% in the first six months of 2015 and 2014, respectively.

Provision for Income Taxes

Provision for income taxes and effective tax rates for the three- and six-month periods ended March 28, 2015 and March 29, 2014 were as follows (dollars in millions):

 

                                                                   
     Three Months Ended      Six Months Ended  
     March 28,
2015
     March 29,
2014
     March 28,
2015
     March 29,
2014
 

Provision for income taxes

   $ 4,995       $ 3,595       $ 11,387       $ 8,232   

Effective tax rate

     26.9%         26.0%         26.5%         26.1%   

The Company’s effective tax rates for the second quarter and first six months of 2015 and 2014 differ from the statutory federal income tax rate of 35% due primarily to certain undistributed foreign earnings, a substantial portion of which was generated by subsidiaries organized in Ireland, for which no U.S. taxes are provided because such earnings are intended to be indefinitely reinvested outside the U.S. The higher effective tax rate during the second quarter and first six months of 2015 as compared to the same periods in 2014 is due primarily to a different geographic mix of earnings.

The U.S. Internal Revenue Service is currently examining the years 2010 through 2012. In addition, the Company is subject to audits by state, local and foreign tax authorities. Management believes that adequate provisions have been made for any adjustments that may result from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in the Company’s tax audits are resolved in a manner not consistent with management’s expectations, the Company could be required to adjust its provision for income taxes in the period such resolution occurs.

On June 11, 2014, the European Commission issued an opening decision initiating a formal investigation against Ireland for alleged state aid to the Company. The opening decision concerns the allocation of profits for taxation purposes of the Irish branches of two subsidiaries of the Company. The Company believes the European Commission’s assertions are without merit. If the European Commission were to conclude against Ireland, the European Commission could require Ireland to recover from the Company past taxes covering a period of up to 10 years reflective of the disallowed state aid. While such amount could be material, as of March 28, 2015 the Company is unable to estimate the impact.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), which amends the existing accounting standards for revenue recognition. ASU 2014-09 is based on principles that govern the recognition of revenue at an amount an entity expects to be entitled when products are transferred to customers. ASU 2014-09 will be effective for the Company beginning in its first quarter of 2018. Early adoption is not permitted. The new revenue standard may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption. The Company is currently evaluating the impact of adopting the new revenue standard on its consolidated financial statements.

 

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Table of Contents

Liquidity and Capital Resources

The following tables present selected financial information and statistics as of March 28, 2015 and September 27, 2014 and during the first six months of 2015 and 2014 (in millions):

 

                                                 
     March 28,
2015
     September 27,
2014
 

Cash, cash equivalents and marketable securities

   $ 193,539       $ 155,239   

Property, plant and equipment, net

   $ 20,151       $ 20,624   

Long-term debt

   $ 40,072       $ 28,987   

Commercial paper

   $ 3,799       $ 6,308   

Working capital

   $ 9,162       $ 5,083   

 

                                                 
     Six Months Ended  
     March 28,
2015
     March 29,
2014
 

Cash generated by operating activities

   $ 52,803       $ 36,208   

Cash used in investing activities

   $ (43,496    $ (3,362

Cash used in financing activities

   $ (8,662    $ (28,156

The Company believes its existing balances of cash, cash equivalents and marketable securities will be sufficient to satisfy its working capital needs, capital asset purchases, outstanding commitments and other liquidity requirements associated with its existing operations over the next 12 months. The Company currently anticipates the cash used for future dividends, the share repurchase program and debt repayments will come from its current domestic cash, cash generated from on-going U.S. operating activities and from borrowings.

As of March 28, 2015 and September 27, 2014, the Company’s cash, cash equivalents and marketable securities held by foreign subsidiaries were $171.3 billion and $137.1 billion, respectively, and are generally based in U.S. dollar-denominated holdings. Amounts held by foreign subsidiaries are generally subject to U.S. income taxation on repatriation to the U.S. The Company’s marketable securities investment portfolio is invested primarily in highly-rated securities and its investment policy generally limits the amount of credit exposure to any one issuer. The policy requires investments generally to be investment grade with the objective of minimizing the potential risk of principal loss.

During the six months ended March 28, 2015, cash generated from operating activities of $52.8 billion was a result of $31.6 billion of net income, non-cash adjustments to net income of $8.7 billion and an increase in the net change in operating assets and liabilities of $12.5 billion. Cash used in investing activities of $43.5 billion during the six months ended March 28, 2015 consisted primarily of cash used for purchases of marketable securities, net of sales and maturities, of $37.7 billion and cash used to acquire property, plant and equipment of $5.6 billion. Cash used in financing activities of $8.7 billion during the six months ended March 28, 2015 consisted primarily of cash used to repurchase common stock of $12.0 billion, cash used to pay dividends and dividend equivalents of $5.5 billion and cash used for repayments of commercial paper, net of $2.5 billion, partially offset by proceeds from the issuance of long-term debt, net of $11.3 billion.

During the six months ended March 29, 2014, cash generated from operating activities of $36.2 billion was a result of $23.3 billion of net income, non-cash adjustments to net income of $7.5 billion and an increase in net change in operating assets and liabilities of $5.4 billion. Cash used in investing activities of $3.4 billion during the six months ended March 29, 2014 consisted primarily of cash used to acquire property, plant and equipment of $3.4 billion. Cash used in financing activities of $28.2 billion during the six months ended March 29, 2014 consisted primarily of cash used to repurchase common stock of $23.0 billion and cash used to pay dividends and dividend equivalents of $5.4 billion.

Capital Assets

The Company’s capital expenditures were $4.1 billion during the first six months of 2015. The Company anticipates utilizing approximately $13.0 billion for capital expenditures during 2015, which includes product tooling and manufacturing process equipment; data centers; corporate facilities and infrastructure, including information systems hardware, software and enhancements; and retail store facilities.

 

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Table of Contents

Debt

In 2014, the Board of Directors authorized the Company to issue unsecured short-term promissory notes (“Commercial Paper”) pursuant to a commercial paper program. The Company intends to use the net proceeds from the commercial paper program for general corporate purposes, including dividends and share repurchases. As of March 28, 2015, the Company had $3.8 billion of Commercial Paper outstanding, with a weighted-average interest rate of 0.10% and maturities generally less than nine months.

As of March 28, 2015, the Company has outstanding floating- and fixed-rate notes with varying maturities for an aggregate principal amount of $39.9 billion (collectively the “Notes”). The Company has entered, and in the future may enter, into interest rate swaps to manage interest rate risk on the Notes. Interest rate swaps allow the Company to effectively convert fixed-rate payments into floating-rate payments or floating-rate payments into fixed-rate payments. In addition, the Company has entered, and in the future may enter, into currency swaps to manage foreign currency risk on the Notes. During the first six months of 2015, the Company issued 2.8 billion of Euro-denominated notes, $6.5 billion of U.S. dollar-denominated notes and SFr1.3 billion of Swiss Franc-denominated notes. To manage foreign currency risk associated with the Euro-denominated notes, the Company entered into currency swaps with an aggregate notional amount of $3.5 billion, which effectively converted the Euro-denominated notes to U.S. dollar-denominated notes. To manage interest rate risk on the U.S. dollar-denominated fixed-rate notes maturing in 2020 and 2022, the Company entered into interest rate swaps with an aggregate notional amount of $2.5 billion, which effectively converted the fixed interest rates on these notes to a floating interest rate.

Capital Return Program

In 2014, the Company’s Board of Directors increased the share repurchase program authorization from $60 billion to $90 billion of the Company’s common stock, which resulted in a total capital return program of over $130 billion. As of March 28, 2015, $80.0 billion of the share repurchase program has been utilized. The Company’s share repurchase program does not obligate it to acquire any specific number of shares. Under the program, shares may be repurchased in privately negotiated or open market transactions, including under plans complying with Rule 10b5-1 under the Exchange Act.

The following table presents the Company’s dividends, dividend equivalents, share repurchases and net share settlement activity from the start of the capital return program in August 2012 through March 28, 2015 (in millions):

 

                                                                                                                            
     Dividends and
Dividend
Equivalents
Paid
     Accelerated
Share
Repurchases
     Open Market
Share
Repurchases
     Taxes
Related to
Settlement of
Equity Awards
     Total  

Q2 2015

   $ 2,743       $ 0       $ 7,000       $ 96       $ 9,839   

Q1 2015

     2,801         0         5,000         512         8,313   

2014

     11,126         21,000         24,000         1,158         57,284   

2013

     10,564         13,950         9,000         1,082         34,596   

2012

     2,488         0         0         56         2,544   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

$ 29,722    $ 34,950    $ 45,000    $ 2,904    $ 112,576   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

On April 27, 2015, the Company announced that the Board of Directors raised the cash dividend by 11% to $0.52 per share, beginning with the dividend to be paid during the third quarter of 2015. The Company plans to increase its dividend on an annual basis subject to declaration by the Board of Directors.

Additionally, the Company announced on April 27, 2015 that the Board of Directors increased the share repurchase authorization from $90 billion to $140 billion, increasing the total capital return program from $130 billion to $200 billion, which the Company expects to execute by the end of March 2017 by paying dividends and dividend equivalents, repurchasing shares and remitting withheld taxes related to net share settlement of restricted stock units. To assist in funding its capital return program, the Company expects to continue to access the debt markets, both domestically and internationally.

 

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Table of Contents

Off-Balance Sheet Arrangements and Contractual Obligations

The Company has not entered into any transactions with unconsolidated entities whereby the Company has financial guarantees, subordinated retained interests, derivative instruments, or other contingent arrangements that expose the Company to material continuing risks, contingent liabilities, or any other obligation under a variable interest in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to the Company, or engages in leasing, hedging, or R&D services with the Company.

Operating Leases

The Company’s major facility leases are typically for terms not exceeding 10 years and generally contain multi-year renewal options. As of March 28, 2015, the Company had a total of 453 retail stores. Leases for retail space are for terms ranging from five to 20 years, the majority of which are for 10 years, and often contain multi-year renewal options. As of March 28, 2015, the Company’s total future minimum lease payments under noncancelable operating leases were $5.1 billion, of which $3.4 billion related to leases for retail space.

Purchase Commitments

The Company utilizes several outsourcing partners to manufacture sub-assemblies for the Company’s products and to perform final assembly and testing of finished products. These outsourcing partners acquire components and build product based on demand information supplied by the Company, which typically covers periods up to 150 days. The Company also obtains individual components for its products from a wide variety of individual suppliers. Consistent with industry practice, the Company acquires components through a combination of purchase orders, supplier contracts, and open orders based on projected demand information. Where appropriate, the purchases are applied to inventory component prepayments that are outstanding with the respective supplier. As of March 28, 2015, the Company had outstanding off-balance sheet third-party manufacturing commitments and component purchase commitments of $19.0 billion.

Other Obligations

In addition to the commitments mentioned above, the Company had other off-balance sheet obligations of $4.1 billion as of March 28, 2015, that were comprised of commitments to acquire capital assets, including product tooling and manufacturing process equipment, and commitments related to advertising, R&D, Internet and telecommunications services, energy and other obligations.

The Company’s other non-current liabilities in the Condensed Consolidated Balance Sheets consist primarily of deferred tax liabilities, gross unrecognized tax benefits and the related gross interest and penalties. As of March 28, 2015, the Company had non-current deferred tax liabilities of $23.8 billion. Additionally, as of March 28, 2015, the Company had gross unrecognized tax benefits of $4.6 billion and an additional $844 million for gross interest and penalties classified as non-current liabilities. At this time, the Company is unable to make a reasonably reliable estimate of the timing of payments due to uncertainties in the timing of tax audit outcomes.

Indemnification

The Company generally does not indemnify end-users of its operating system and application software against legal claims that the software infringes third-party intellectual property rights. Other agreements entered into by the Company sometimes include indemnification provisions under which the Company could be subject to costs and/or damages in the event of an infringement claim against the Company or an indemnified third-party. However, the Company has not been required to make any significant payments resulting from such an infringement claim asserted against it or an indemnified third-party. In the opinion of management, there was not at least a reasonable possibility the Company may have incurred a material loss with respect to indemnification of end-users of its operating system or application software for infringement of third-party intellectual property rights. The Company did not record a liability for infringement costs related to indemnification as of March 28, 2015 or September 27, 2014.

The Company has entered into indemnification agreements with its directors and executive officers. Under these agreements, the Company has agreed to indemnify such individuals to the fullest extent permitted by law against liabilities that arise by reason of their status as directors or officers and to advance expenses incurred by such individuals in connection with related legal proceedings. It is not possible to determine the maximum potential amount of payments the Company could be required to make under these agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each claim. However, the Company maintains directors and officers liability insurance coverage to reduce its exposure to such obligations, and payments made under these agreements historically have not been material.

 

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Critical Accounting Policies and Estimates

The preparation of financial statements and related disclosures in conformity with U.S. generally accepted accounting principles (“GAAP”) and the Company’s discussion and analysis of its financial condition and operating results require the Company’s management to make judgments, assumptions, and estimates that affect the amounts reported in its condensed consolidated financial statements and accompanying notes. Note 1, “Summary of Significant Accounting Policies” in Part I, Item 1 of this Form 10-Q and in the Notes to Consolidated Financial Statements in Part II, Item 8 of the 2014 Form 10-K, as updated by the Company’s Current Report on Form 8-K dated January 28, 2015, describes the significant accounting policies and methods used in the preparation of the Company’s condensed consolidated financial statements. Management bases its estimates on historical experience and on various other assumptions it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates and such differences may be material.

Management believes the Company’s critical accounting policies and estimates are those related to revenue recognition, valuation and impairment of marketable securities, inventory valuation and valuation of manufacturing-related assets and estimated purchase commitment cancellation fees, warranty costs, income taxes, and legal and other contingencies. Management considers these policies critical because they are both important to the portrayal of the Company’s financial condition and operating results, and they require management to make judgments and estimates about inherently uncertain matters. The Company’s senior management has reviewed these critical accounting policies and related disclosures with the Audit and Finance Committee of the Company’s Board of Directors.

Revenue Recognition

Net sales consist primarily of revenue from the sale of hardware, software, digital content and applications, accessories, and service and support contracts. The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collection is probable. Product is considered delivered to the customer once it has been shipped and title, risk of loss and rewards of ownership have been transferred. For most of the Company’s product sales, these criteria are met at the time the product is shipped. For online sales to individuals, for some sales to education customers in the U.S., and for certain other sales, the Company defers revenue until the customer receives the product because the Company retains a portion of the risk of loss on these sales during transit. For payment terms in excess of the Company’s standard payment terms, revenue is recognized as payments become due unless the Company has positive evidence that the sales price is fixed or determinable, such as a successful history of collection, without concession, on comparable arrangements. The Company recognizes revenue from the sale of hardware products, software bundled with hardware that is essential to the functionality of the hardware and third-party digital content sold on the iTunes Store in accordance with general revenue recognition accounting guidance. The Company recognizes revenue in accordance with industry specific software accounting guidance for the following types of sales transactions: (i) standalone sales of software products, (ii) sales of software upgrades and (iii) sales of software bundled with hardware not essential to the functionality of the hardware.

For multi-element arrangements that include hardware products containing software essential to the hardware product’s functionality, undelivered software elements that relate to the hardware product’s essential software and/or undelivered non-software services, the Company allocates revenue to all deliverables based on their relative selling prices. In such circumstances, the Company uses a hierarchy to determine the selling price to be used for allocating revenue to deliverables: (i) vendor-specific objective evidence of fair value (“VSOE”), (ii) third-party evidence of selling price (“TPE”) and (iii) best estimate of selling price (“ESP”). VSOE generally exists only when the Company sells the deliverable separately and is the price actually charged by the Company for that deliverable. ESPs reflect the Company’s best estimates of what the selling prices of elements would be if they were sold regularly on a stand-alone basis.

For sales of qualifying versions of iOS devices, Mac and Apple TV, the Company has indicated it may from time to time provide future unspecified software upgrades and features free of charge to customers. The Company also provides various non-software services to owners of qualifying versions of iOS devices and Mac. Because the Company has neither VSOE nor TPE for the unspecified software upgrade rights or the non-software services, revenue is allocated to these rights and services based on the Company’s ESPs. Revenue allocated to the unspecified software upgrade rights and non-software services based on the Company’s ESPs is deferred and recognized on a straight-line basis over the estimated period the software upgrades and non-software services are expected to be provided for each of these devices, which ranges from two to four years.

The Company’s process for determining ESPs involves management’s judgment and considers multiple factors that may vary over time depending upon the unique facts and circumstances related to each deliverable. Should future facts and circumstances change, the Company’s ESPs and the future rate of related amortization for software upgrades and non-software services related to future sales of these devices could change. Factors subject to change include the unspecified software upgrade rights offered, the estimated value of unspecified software upgrade rights, the estimated or actual costs incurred to provide non-software services and the estimated period software upgrades and non-software services are expected to be provided.

 

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The Company records reductions to revenue for estimated commitments related to price protection and other customer incentive programs. For transactions involving price protection, the Company recognizes revenue net of the estimated amount to be refunded, provided the refund amount can be reasonably and reliably estimated and the other conditions for revenue recognition have been met. The Company’s policy requires that, if refunds cannot be reliably estimated, revenue is not recognized until reliable estimates can be made or the price protection lapses. For the Company’s other customer incentive programs, the estimated cost is recognized at the later of the date at which the Company has sold the product or the date at which the program is offered. The Company also records reductions to revenue for expected future product returns based on the Company’s historical experience. Future market conditions and product transitions may require the Company to increase customer incentive programs that could result in reductions to future revenue. Additionally, certain customer incentive programs require management to estimate the number of customers who will actually redeem the incentive. Management’s estimates are based on historical experience and the specific terms and conditions of particular incentive programs. If a greater than estimated proportion of customers redeems such incentives, the Company would be required to record additional reductions to revenue, which would have an adverse impact on the Company’s results of operations.

Valuation and Impairment of Marketable Securities

The Company’s investments in available-for-sale securities are reported at fair value. Unrealized gains and losses related to changes in the fair value of securities are recognized in accumulated other comprehensive income, net of tax, in the Company’s Condensed Consolidated Balance Sheets. Changes in the fair value of available-for-sale securities impact the Company’s net income only when such securities are sold or an other-than-temporary impairment is recognized. Realized gains and losses on the sale of securities are determined by specific identification of each security’s cost basis. The Company regularly reviews its investment portfolio to determine if any security is other-than-temporarily impaired, which would require the Company to record an impairment charge in the period any such determination is made. In making this judgment, the Company evaluates, among other things, the duration and extent to which the fair value of a security is less than its cost; the financial condition of the issuer and any changes thereto; and the Company’s intent to sell, or whether it will more likely than not be required to sell, the security before recovery of its amortized cost basis. The Company’s assessment on whether a security is other-than-temporarily impaired could change in the future due to new developments or changes in assumptions related to any particular security.

Inventory Valuation and Valuation of Manufacturing-Related Assets and Estimated Purchase Commitment Cancellation Fees

The Company must order components for its products and build inventory in advance of product shipments and has invested in manufacturing process equipment, including capital assets held at its suppliers’ facilities. In addition, the Company has made prepayments to certain of its suppliers associated with long-term supply agreements to secure supply of inventory components. The Company records a write-down for inventories of components and products, including third-party products held for resale, which have become obsolete or are in excess of anticipated demand or net realizable value. The Company performs a detailed review of inventory that considers multiple factors including demand forecasts, product life cycle status, product development plans, current sales levels and component cost trends. The Company also reviews its manufacturing-related capital assets and inventory prepayments for impairment whenever events or circumstances indicate the carrying amount of such assets may not be recoverable. If the Company determines that an asset is not recoverable, it records an impairment loss equal to the amount by which the carrying value of such an asset exceeds its fair value.

The industries in which the Company competes are subject to a rapid and unpredictable pace of product and component obsolescence and demand changes. In certain circumstances the Company may be required to record additional write-downs of inventory, inventory prepayments and/or manufacturing-related capital assets. These circumstances include future demand or market conditions for the Company’s products being less favorable than forecasted, unforeseen technological changes or changes to the Company’s product development plans that negatively impact the utility of any of these assets, or significant deterioration in the financial condition of one or more of the Company’s suppliers that hold any of the Company’s manufacturing process equipment or to whom the Company has made an inventory prepayment. Such write-downs would adversely affect the Company’s results of operations in the period when the write-downs were recorded.

The Company records accruals for estimated cancellation fees related to component orders that have been cancelled or are expected to be cancelled. Consistent with industry practice, the Company acquires components through a combination of purchase orders, supplier contracts, and open orders in each case based on projected demand. Where appropriate, the purchases are applied to inventory component prepayments that are outstanding with the respective supplier. Purchase commitments typically cover the Company’s forecasted component and manufacturing requirements for periods up to 150 days. If there is an abrupt and substantial decline in demand for one or more of the Company’s products, if the Company’s product development plans change, or if there is an unanticipated change in technological requirements for any of the Company’s products, then the Company may be required to record additional accruals for cancellation fees that would adversely affect its results of operations in the period when the cancellation fees are identified and recorded.

 

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Warranty Costs

The Company provides for the estimated cost of warranties at the time the related revenue is recognized based on historical and projected warranty claim rates, historical and projected cost-per-claim and knowledge of specific product failures that are outside of the Company’s typical experience. Each quarter, the Company re-evaluates these estimates to assess the adequacy of its recorded warranty liabilities considering the size of the installed base of products subject to warranty protection and adjusts the amounts as necessary. If actual product failure rates or repair costs differ from estimates, revisions to the estimated warranty liabilities would be required and could materially affect the Company’s results of operations.

Income Taxes

The Company records a tax provision for the anticipated tax consequences of the reported results of operations. The provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled. The Company records a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized.

The Company recognizes tax benefits from uncertain tax positions only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.

Management believes it is more likely than not that forecasted income, including income that may be generated as a result of certain tax planning strategies, together with future reversals of existing taxable temporary differences, will be sufficient to fully recover the deferred tax assets. In the event that the Company determines all or part of the net deferred tax assets are not realizable in the future, the Company will make an adjustment to the valuation allowance that would be charged to earnings in the period such determination is made. In addition, the calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of GAAP and complex tax laws. Resolution of these uncertainties in a manner inconsistent with management’s expectations could have a material impact on the Company’s financial condition and operating results.

Legal and Other Contingencies

As discussed in Part II, Item 1 of this Form 10-Q under the heading “Legal Proceedings” and in Part I, Item 1 of this Form 10-Q in the Notes to Condensed Consolidated Financial Statements, in Note 10, “Commitments and Contingencies,” the Company is subject to various legal proceedings and claims that arise in the ordinary course of business. The Company records a liability when it is probable that a loss has been incurred and the amount is reasonably estimable. There is significant judgment required in both the probability determination and as to whether an exposure can be reasonably estimated. In the opinion of management, there was not at least a reasonable possibility the Company may have incurred a material loss, or a material loss in excess of a recorded accrual, with respect to loss contingencies for legal and other contingencies. However, the outcome of legal proceedings and claims brought against the Company is subject to significant uncertainty. Therefore, although management considers the likelihood of such an outcome to be remote, if one or more of these legal matters were resolved against the Company in a reporting period for amounts in excess of management’s expectations, the Company’s consolidated financial statements for that reporting period could be materially adversely affected.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

During the six months ended March 28, 2015, the Company issued 2.8 billion of Euro-denominated notes, $6.5 billion of U.S. dollar-denominated notes and SFr1.3 billion in Swiss Franc-denominated notes. To manage foreign currency risk associated with the Euro-denominated notes, the Company entered into currency swaps with an aggregate notional amount of $3.5 billion, which effectively converted the Euro-denominated notes to U.S. dollar-denominated notes. To manage interest rate risk on the U.S. dollar-denominated fixed-rate notes maturing in 2020 and 2022, the Company entered into interest rate swaps with an aggregate notional amount of $2.5 billion, which effectively converted the fixed interest rates on these notes to a floating interest rate. Notwithstanding the resulting foreign currency and interest rate risk applicable to these notes, there have been no material changes to the Company’s market risk during the first six months of 2015. For a discussion of the Company’s exposure to market risk, refer to the Company’s market risk disclosures set forth in Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” of the 2014 Form 10-K.

 

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Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Based on an evaluation under the supervision and with the participation of the Company’s management, the Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act were effective as of March 28, 2015 to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and (ii) accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There were no changes in the Company’s internal control over financial reporting during the second quarter of 2015, which were identified in connection with management’s evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II—OTHER INFORMATION

 

Item 1. Legal Proceedings

The Company is subject to the legal proceedings and claims discussed below as well as certain other legal proceedings and claims that have not been fully resolved and that have arisen in the ordinary course of business. In the opinion of management, there was not at least a reasonable possibility the Company may have incurred a material loss, or a material loss in excess of a recorded accrual, with respect to loss contingencies. However, the outcome of legal proceedings and claims brought against the Company is subject to significant uncertainty. Therefore, although management considers the likelihood of such an outcome to be remote, if one or more of these legal matters were resolved against the Company in a reporting period for amounts in excess of management’s expectations, the Company’s consolidated financial statements for that reporting period could be materially adversely affected. See the risk factor “ The Company could be impacted by unfavorable results of legal proceedings, such as being found to have infringed on intellectual property rights ” in Part II, Item 1A of this Form 10-Q under the heading “Risk Factors.” The Company settled certain matters during the second quarter of 2015 that did not individually or in the aggregate have a material impact on the Company’s financial condition or results of operations.

Apple eBooks Antitrust Litigation (United States of America v. Apple Inc., et al.)

On April 11, 2012, the U.S. Department of Justice filed a civil antitrust action against the Company and five major book publishers in the U.S. District Court for the Southern District of New York, alleging an unreasonable restraint of interstate trade and commerce in violation of §1 of the Sherman Act and seeking, among other things, injunctive relief, the District Court’s declaration that the Company’s agency agreements with the publishers are null and void and/or the District Court’s reformation of such agreements. On July 10, 2013, the District Court found, following a bench trial, that the Company conspired to restrain trade in violation of §1 of the Sherman Act and relevant state statutes to the extent those laws are congruent with §1 of the Sherman Act. The District Court entered a permanent injunction, which took effect on October 6, 2013 and will be in effect for five years unless the judgment is overturned on appeal. The Company has taken the necessary steps to comply with the terms of the District Court’s order, including renegotiating agreements with the five major eBook publishers, updating its antitrust training program and hiring an antitrust compliance monitor. The Company appealed the District Court’s decision. Pursuant to a settlement agreement reached by the parties in June 2014, any damages the Company may be obligated to pay will be determined by the outcome of the appellate decision.

 

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Item 1A. Risk Factors

The following description of risk factors includes any material changes to, and supersedes the description of, risk factors associated with the Company’s business previously disclosed in Part I, Item 1A of the 2014 Form 10-K and in Part II, Item 1A of the Form 10-Q for the quarter ended December 27, 2014, in each case under the heading “Risk Factors.” The business, financial condition and operating results of the Company can be affected by a number of factors, whether currently known or unknown, including but not limited to those described below, any one or more of which could, directly or indirectly, cause the Company’s actual results of operations and financial condition to vary materially from past, or from anticipated future, results of operations and financial condition. Any of these factors, in whole or in part, could materially and adversely affect the Company’s business, financial condition, results of operations and common stock price.

The following discussion of risk factors contains forward-looking statements. These risk factors may be important to understanding other statements in this Form 10-Q. The following information should be read in conjunction with the condensed consolidated financial statements and related notes in Part I, Item 1, “Financial Statements” and Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-Q.

Because of the following factors, as well as other factors affecting the Company’s financial condition and operating results, past financial performance should not be considered to be a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods.

Global and regional economic conditions could materially adversely affect the Company.

The Company’s operations and performance depend significantly on global and regional economic conditions. Uncertainty about global and regional economic conditions poses a risk as consumers and businesses may postpone spending in response to tighter credit, higher unemployment, financial market volatility, government austerity programs, negative financial news, declines in income or asset values and/or other factors. These worldwide and regional economic conditions could have a material adverse effect on demand for the Company’s products and services. Demand also could differ materially from the Company’s expectations as a result of currency fluctuations because the Company generally raises prices on goods and services sold outside the U.S. to correspond with the effect of a strengthening of the U.S. dollar. Other factors that could influence worldwide or regional demand include changes in fuel and other energy costs, conditions in the real estate and mortgage markets, unemployment, labor and healthcare costs, access to credit, consumer confidence and other macroeconomic factors affecting consumer spending behavior. These and other economic factors could materially adversely affect demand for the Company’s products and services.

In the event of financial turmoil affecting the banking system and financial markets, additional consolidation of the financial services industry, or significant financial service institution failures, there could be a new or incremental tightening in the credit markets, low liquidity and extreme volatility in fixed income, credit, currency and equity markets. This could have a number of effects on the Company’s business, including the insolvency or financial instability of outsourcing partners or suppliers or their inability to obtain credit to finance development and/or manufacture products resulting in product delays; inability of customers, including channel partners, to obtain credit to finance purchases of the Company’s products; failure of derivative counterparties and other financial institutions; and restrictions on the Company’s ability to issue new debt. Other income and expense also could vary materially from expectations depending on gains or losses realized on the sale or exchange of financial instruments; impairment charges resulting from revaluations of debt and equity securities and other investments; interest rates; cash balances; volatility in foreign exchange rates; and changes in fair value of derivative instruments. Increased volatility in the financial markets and overall economic uncertainty would increase the risk of the actual amounts realized in the future on the Company’s financial instruments differing significantly from the fair values currently assigned to them.

 

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Global markets for the Company’s products and services are highly competitive and subject to rapid technological change, and the Company may be unable to compete effectively in these markets.

The Company’s products and services compete in highly competitive global markets characterized by aggressive price cutting and resulting downward pressure on gross margins, frequent introduction of new products, short product life cycles, evolving industry standards, continual improvement in product price/performance characteristics, rapid adoption of technological and product advancements by competitors and price sensitivity on the part of consumers.

The Company’s ability to compete successfully depends heavily on its ability to ensure a continuing and timely introduction of innovative new products, services and technologies to the marketplace. The Company believes it is unique in that it designs and develops nearly the entire solution for its products, including the hardware, operating system, numerous software applications and related services. As a result, the Company must make significant investments in R&D. The Company currently holds a significant number of patents and copyrights and has registered and/or has applied to register numerous patents, trademarks and service marks. In contrast, many of the Company’s competitors seek to compete primarily through aggressive pricing and very low cost structures, and emulating the Company’s products and infringing on its intellectual property. If the Company is unable to continue to develop and sell innovative new products with attractive margins or if competitors infringe on the Company’s intellectual property, the Company’s ability to maintain a competitive advantage could be adversely affected.

The Company markets certain mobile communication and media devices based on the iOS mobile operating system and also markets related third-party digital content and applications. The Company faces substantial competition in these markets from companies that have significant technical, marketing, distribution and other resources, as well as established hardware, software and digital content supplier relationships; and the Company has a minority market share in the global smartphone market. Additionally, the Company faces significant price competition as competitors reduce their selling prices and attempt to imitate the Company’s product features and applications within their own products or, alternatively, collaborate with each other to offer solutions that are more competitive than those they currently offer. The Company also competes with illegitimate ways to obtain third-party digital content and applications and with business models that include content provided to users for free. Some of the Company’s competitors have greater experience, product breadth and distribution channels than the Company. Because some current and potential competitors have substantial resources and/or experience and a lower cost structure, they may be able to provide products and services at little or no profit or even at a loss. The Company also expects competition to intensify as competitors attempt to imitate the Company’s approach to providing components seamlessly within their individual offerings or work collaboratively to offer integrated solutions. The Company’s financial condition and operating results depend substantially on the Company’s ability to continually improve iOS and iOS devices in order to maintain their functional and design advantages.

The Company is the only authorized maker of hardware using OS X, which has a minority market share in the personal computer market. This market has been contracting and is dominated by computer makers using competing operating systems, most notably Windows. In the market for personal computers and accessories, the Company faces a significant number of competitors, many of which have broader product lines, lower priced products and a larger installed customer base. Historically, consolidation in this market has resulted in larger competitors. Price competition has been particularly intense as competitors selling Windows-based personal computers have aggressively cut prices and lowered product margins. An increasing number of Internet-enabled devices that include software applications and are smaller and simpler than traditional personal computers compete for market share with the Company’s existing products. The Company’s financial condition and operating results also depend on its ability to continually improve the Mac platform to maintain its functional and design advantages.

There can be no assurance the Company will be able to continue to provide products and services that compete effectively.

To remain competitive and stimulate customer demand, the Company must successfully manage frequent product introductions and transitions.

Due to the highly volatile and competitive nature of the industries in which the Company competes, the Company must continually introduce new products, services and technologies, enhance existing products and services and effectively stimulate customer demand for new and upgraded products. The success of new product introductions depends on a number of factors including, but not limited to, timely and successful product development, market acceptance, the Company’s ability to manage the risks associated with new product production ramp-up issues, the availability of application software for new products, the effective management of purchase commitments and inventory levels in line with anticipated product demand, the availability of products in appropriate quantities and at expected costs to meet anticipated demand and the risk that new products may have quality or other defects or deficiencies in the early stages of introduction. Accordingly, the Company cannot determine in advance the ultimate effect of new product introductions and transitions.

 

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The Company depends on the performance of distributors, carriers and other resellers.

The Company distributes its products through cellular network carriers, wholesalers, national and regional retailers and value-added resellers, many of whom distribute products from competing manufacturers. The Company also sells its products and third-party products in most of its major markets directly to education, enterprise and government customers and consumers and small and mid-sized businesses through its online and retail stores.

Carriers providing cellular network service for iPhone typically subsidize users’ purchases of the device. There is no assurance that such subsidies will be continued at all or in the same amounts upon renewal of the Company’s agreements with these carriers or in agreements the Company enters into with new carriers.

Many resellers have narrow operating margins and have been adversely affected in the past by weak economic conditions. Some resellers have perceived the expansion of the Company’s direct sales as conflicting with their business interests as distributors and resellers of the Company’s products. Such a perception could discourage resellers from investing resources in the distribution and sale of the Company’s products or lead them to limit or cease distribution of those products. The Company has invested and will continue to invest in programs to enhance reseller sales, including staffing selected resellers’ stores with Company employees and contractors, and improving product placement displays. These programs could require a substantial investment while providing no assurance of return or incremental revenue. The financial condition of these resellers could weaken, these resellers could stop distributing the Company’s products, or uncertainty regarding demand for some or all of the Company’s products could cause resellers to reduce their ordering and marketing of the Company’s products.

The Company faces substantial inventory and other asset risk in addition to purchase commitment cancellation risk.

The Company records a write-down for product and component inventories that have become obsolete or exceed anticipated demand or net realizable value and accrues necessary cancellation fee reserves for orders of excess products and components. The Company also reviews its long-lived assets, including capital assets held at its suppliers’ facilities and inventory prepayments, for impairment whenever events or circumstances indicate the carrying amount of an asset may not be recoverable. If the Company determines that impairment has occurred, it records a write-down equal to the amount by which the carrying value of the assets exceeds its fair value. Although the Company believes its provisions related to inventory, capital assets, inventory prepayments and other assets and purchase commitments are currently adequate, no assurance can be given that the Company will not incur additional related charges given the rapid and unpredictable pace of product obsolescence in the industries in which the Company competes.

The Company must order components for its products and build inventory in advance of product announcements and shipments. Consistent with industry practice, components are normally acquired through a combination of purchase orders, supplier contracts and open orders, in each case based on projected demand. Where appropriate, the purchases are applied to inventory component prepayments that are outstanding with the respective supplier. Purchase commitments typically cover forecasted component and manufacturing requirements for periods up to 150 days. Because the Company’s markets are volatile, competitive and subject to rapid technology and price changes, there is a risk the Company will forecast incorrectly and order or produce excess or insufficient amounts of components or products, or not fully utilize firm purchase commitments.

Future operating results depend upon the Company’s ability to obtain components in sufficient quantities.

Because the Company currently obtains components from single or limited sources, the Company is subject to significant supply and pricing risks. Many components, including those that are available from multiple sources, are at times subject to industry-wide shortages and significant commodity pricing fluctuations. While the Company has entered into agreements for the supply of many components, there can be no assurance that the Company will be able to extend or renew these agreements on similar terms, or at all. A number of suppliers of components may suffer from poor financial conditions, which can lead to business failure for the supplier or consolidation within a particular industry, further limiting the Company’s ability to obtain sufficient quantities of components. The effects of global or regional economic conditions on the Company’s suppliers, described in “ Global and regional economic conditions could materially adversely affect the Company” above, also could affect the Company’s ability to obtain components . Therefore, the Company remains subject to significant risks of supply shortages and price increases.

The Company and other participants in the markets for mobile communication and media devices and personal computers also compete for various components with other industries that have experienced increased demand for their products. The Company uses some custom components that are not common to the rest of these industries. The Company’s new products often utilize custom components available from only one source. When a component or product uses new technologies, initial capacity constraints may exist until the suppliers’ yields have matured or manufacturing capacity has increased. Continued availability of these components at acceptable prices, or at all, may be affected for any number of reasons, including if those suppliers decide to concentrate on the production of common components instead of components customized to meet the Company’s requirements. The supply of components for a new or existing product could be delayed or constrained, or a key manufacturing vendor could delay shipments of completed products to the Company.

 

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The Company depends on component and product manufacturing and logistical services provided by outsourcing partners, many of whom are located outside of the U.S.

Substantially all of the Company’s manufacturing is performed in whole or in part by a few outsourcing partners located primarily in Asia. The Company has also outsourced much of its transportation and logistics management. While these arrangements may lower operating costs, they also reduce the Company’s direct control over production and distribution. It is uncertain what effect such diminished control will have on the quality or quantity of products or services, or the Company’s flexibility to respond to changing conditions. Although arrangements with these partners may contain provisions for warranty expense reimbursement, the Company may remain responsible to the consumer for warranty service in the event of product defects and could experience an unanticipated product defect or warranty liability. While the Company relies on its partners to adhere to its supplier code of conduct, material violations of the supplier code of conduct could occur.

The Company relies on sole-sourced outsourcing partners in the U.S., Asia and Europe to supply and manufacture many critical components, and on outsourcing partners primarily located in Asia, for final assembly of substantially all of the Company’s hardware products. Any failure of these partners to perform may have a negative impact on the Company’s cost or supply of components or finished goods. In addition, manufacturing or logistics in these locations or transit to final destinations may be disrupted for a variety of reasons including, but not limited to, natural and man-made disasters, information technology system failures, commercial disputes, military actions or economic, business, labor, environmental, public health, or political issues.

The Company has invested in manufacturing process equipment, much of which is held at certain of its outsourcing partners, and has made prepayments to certain of its suppliers associated with long-term supply agreements. While these arrangements help ensure the supply of components and finished goods, if these outsourcing partners or suppliers experience severe financial problems or other disruptions in their business, such continued supply could be reduced or terminated and the net realizable value of these assets could be negatively impacted.

The Company’s products and services may experience quality problems from time to time that can result in decreased sales and operating margin and harm to the Company’s reputation.

The Company sells complex hardware and software products and services that can contain design and manufacturing defects. Sophisticated operating system software and applications, such as those sold by the Company, often contain “bugs” that can unexpectedly interfere with the software’s intended operation. The Company’s online services may from time to time experience outages, service slowdowns, or errors. Defects may also occur in components and products the Company purchases from third parties. There can be no assurance the Company will be able to detect and fix all defects in the hardware, software and services it sells. Failure to do so could result in lost revenue, significant warranty and other expenses and harm to the Company’s reputation.

The Company relies on access to third-party digital content, which may not be available to the Company on commercially reasonable terms or at all.

The Company contracts with numerous third parties to offer their digital content through the iTunes Store. This includes the right to make available music, movies, TV shows and books currently available through the iTunes Store. The licensing or other distribution arrangements with these third parties are for relatively short terms and do not guarantee the continuation or renewal of these arrangements on reasonable terms, if at all. Some third-party content providers and distributors currently or in the future may offer competing products and services, and could take action to make it more difficult or impossible for the Company to license or otherwise distribute their content in the future. Other content owners, providers or distributors may seek to limit the Company’s access to, or increase the cost of, such content. The Company may be unable to continue to offer a wide variety of content at reasonable prices with acceptable usage rules, or continue to expand its geographic reach. Failure to obtain the right to make available third-party digital content, or to make available such content on commercially reasonable terms, could have a material adverse impact on the Company’s financial condition and operating results.

Some third-party digital content providers require the Company to provide digital rights management and other security solutions. If requirements change, the Company may have to develop or license new technology to provide these solutions. There is no assurance the Company will be able to develop or license such solutions at a reasonable cost and in a timely manner. In addition, certain countries have passed or may propose and adopt legislation that would force the Company to license its digital rights management, which could lessen the protection of content and subject it to piracy and also could negatively affect arrangements with the Company’s content providers.

 

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The Company’s future performance depends in part on support from third-party software developers.

The Company believes decisions by customers to purchase its hardware products depend in part on the availability of third-party software applications and services. There is no assurance that third-party developers will continue to develop and maintain software applications and services for the Company’s products. If third-party software applications and services cease to be developed and maintained for the Company’s products, customers may choose not to buy the Company’s products.

With respect to its Mac products, the Company believes the availability of third-party software applications and services depends in part on the developers’ perception and analysis of the relative benefits of developing, maintaining and upgrading such software for the Company’s products compared to Windows-based products. This analysis may be based on factors such as the market position of the Company and its products, the anticipated revenue that may be generated, expected future growth of Mac sales and the costs of developing such applications and services. If the Company’s minority share of the global personal computer market causes developers to question the Mac’s prospects, developers could be less inclined to develop or upgrade software for the Company’s Mac products and more inclined to devote their resources to developing and upgrading software for the larger Windows market.

With respect to iOS devices, the Company relies on the continued availability and development of compelling and innovative software applications, which are distributed through a single distribution channel, the App Store. iOS devices are subject to rapid technological change, and, if third-party developers are unable to or choose not to keep up with this pace of change, third-party applications might not successfully operate and may result in dissatisfied customers. As with applications for the Company’s Mac products, the availability and development of these applications also depend on developers’ perceptions and analysis of the relative benefits of developing, maintaining or upgrading software for the Company’s iOS devices rather than its competitors’ platforms, such as Android. If developers focus their efforts on these competing platforms, the availability and quality of applications for the Company’s iOS devices may suffer.

The Company relies on access to third-party intellectual property, which may not be available to the Company on commercially reasonable terms or at all.

Many of the Company’s products include third-party intellectual property, which requires licenses from those third parties. Based on past experience and industry practice, the Company believes such licenses generally can be obtained on reasonable terms. There is, however, no assurance that the necessary licenses can be obtained on acceptable terms or at all. Failure to obtain the right to use third-party intellectual property, or to use such intellectual property on commercially reasonable terms, could preclude the Company from selling certain products or otherwise have a material adverse impact on the Company’s financial condition and operating results.

The Company could be impacted by unfavorable results of legal proceedings, such as being found to have infringed on intellectual property rights.

The Company is subject to various legal proceedings and claims that have not yet been fully resolved and that have arisen in the ordinary course of business, and additional claims may arise in the future.

For example, technology companies, including many of the Company’s competitors, frequently enter into litigation based on allegations of patent infringement or other violations of intellectual property rights. In addition, patent holding companies seek to monetize patents they have purchased or otherwise obtained. As the Company has grown, the intellectual property rights claims against it have increased and may continue to increase. In particular, the Company’s cellular enabled products compete with products from mobile communication and media device companies that hold significant patent portfolios, and the number of patent claims against the Company has significantly increased. The Company is vigorously defending infringement actions in courts in a number of U.S. jurisdictions and before the U.S. International Trade Commission, as well as internationally in various countries. The plaintiffs in these actions frequently seek injunctions and substantial damages.

Regardless of the scope or validity of such patents or other intellectual property rights, or the merits of any claims by potential or actual litigants, the Company may have to engage in protracted litigation. If the Company is found to infringe one or more patents or other intellectual property rights, regardless of whether it can develop non-infringing technology, it may be required to pay substantial damages or royalties to a third-party, or it may be subject to a temporary or permanent injunction prohibiting the Company from marketing or selling certain products.

In certain cases, the Company may consider the desirability of entering into licensing agreements, although no assurance can be given that such licenses can be obtained on acceptable terms or that litigation will not occur. These licenses may also significantly increase the Company’s operating expenses.

 

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Regardless of the merit of particular claims, litigation may be expensive, time-consuming, disruptive to the Company’s operations and distracting to management. In recognition of these considerations, the Company may enter into arrangements to settle litigation.

In management’s opinion, there is not at least a reasonable possibility the Company may have incurred a material loss, or a material loss in excess of a recorded accrual, with respect to loss contingencies, including matters related to infringement of intellectual property rights. However, the outcome of litigation is inherently uncertain.

Although management considers the likelihood of such an outcome to be remote, if one or more legal matters were resolved against the Company in a reporting period for amounts in excess of management’s expectations, the Company’s consolidated financial statements for that reporting period could be materially adversely affected. Further, such an outcome could result in significant compensatory, punitive or trebled monetary damages, disgorgement of revenue or profits, remedial corporate measures or injunctive relief against the Company that could materially adversely affect its financial condition and operating results.

The Company is subject to laws and regulations worldwide, changes to which could increase the Company’s costs and individually or in the aggregate adversely affect the Company’s business.

The Company is subject to laws and regulations affecting its domestic and international operations in a number of areas. These U.S. and foreign laws and regulations affect the Company’s activities including, but not limited to, in areas of labor, advertising, digital content, consumer protection, real estate, billing, e-commerce, promotions, quality of services, telecommunications, mobile communications and media, television, intellectual property ownership and infringement, tax, import and export requirements, anti-corruption, foreign exchange controls and cash repatriation restrictions, data privacy requirements, anti-competition, environmental, health and safety.

By way of example, laws and regulations related to mobile communications and media devices in the many jurisdictions in which the Company operates are extensive and subject to change. Such changes could include, among others, restrictions on the production, manufacture, distribution and use of devices, locking devices to a carrier’s network, or mandating the use of devices on more than one carrier’s network. These devices are also subject to certification and regulation by governmental and standardization bodies, as well as by cellular network carriers for use on their networks. These certification processes are extensive and time consuming, and could result in additional testing requirements, product modifications, or delays in product shipment dates, or could preclude the Company from selling certain products.

Compliance with these laws, regulations and similar requirements may be onerous and expensive, and they may be inconsistent from jurisdiction to jurisdiction, further increasing the cost of compliance and doing business. Any such costs, which may rise in the future as a result of changes in these laws and regulations or in their interpretation, could individually or in the aggregate make the Company’s products and services less attractive to the Company’s customers, delay the introduction of new products in one or more regions, or cause the Company to change or limit its business practices. The Company has implemented policies and procedures designed to ensure compliance with applicable laws and regulations, but there can be no assurance that the Company’s employees, contractors, or agents will not violate such laws and regulations or the Company’s policies and procedures.

The Company’s business is subject to the risks of international operations.

The Company derives a significant portion of its revenue and earnings from its international operations. Compliance with applicable U.S. and foreign laws and regulations, such as import and export requirements, anti-corruption laws, tax laws, foreign exchange controls and cash repatriation restrictions, data privacy requirements, environmental laws, labor laws and anti-competition regulations, increases the costs of doing business in foreign jurisdictions. Although the Company has implemented policies and procedures to comply with these laws and regulations, a violation by the Company’s employees, contractors, or agents could nevertheless occur.

The Company also could be significantly affected by other risks associated with international activities including, but not limited to, economic and labor conditions, increased duties, taxes and other costs and political instability. Margins on sales of the Company’s products in foreign countries, and on sales of products that include components obtained from foreign suppliers, could be materially adversely affected by international trade regulations, including duties, tariffs and antidumping penalties. The Company is also exposed to credit and collectability risk on its trade receivables with customers in certain international markets. There can be no assurance the Company can effectively limit its credit risk and avoid losses.

 

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The Company’s retail stores have required and will continue to require a substantial investment and commitment of resources and are subject to numerous risks and uncertainties.

The Company’s retail stores have required substantial investment in equipment and leasehold improvements, information systems, inventory and personnel. The Company also has entered into substantial operating lease commitments for retail space. Certain stores have been designed and built to serve as high-profile venues to promote brand awareness and serve as vehicles for corporate sales and marketing activities. Because of their unique design elements, locations and size, these stores require substantially more investment than the Company’s more typical retail stores. Due to the high cost structure associated with the Company’s retail stores, a decline in sales or the closure or poor performance of individual or multiple stores could result in significant lease termination costs, write-offs of equipment and leasehold improvements and severance costs.

Many factors unique to retail operations, some of which are beyond the Company’s control, pose risks and uncertainties. These risks and uncertainties include, but are not limited to, macro-economic factors that could have an adverse effect on general retail activity, as well as the Company’s inability to manage costs associated with store construction and operation, the Company’s failure to manage relationships with its existing retail partners, more challenging environments in managing retail operations outside the U.S., costs associated with unanticipated fluctuations in the value of retail inventory, and the Company’s inability to obtain and renew leases in quality retail locations at a reasonable cost.

Investment in new business strategies and acquisitions could disrupt the Company’s ongoing business and present risks not originally contemplated.

The Company has invested, and in the future may invest, in new business strategies or acquisitions. Such endeavors may involve significant risks and uncertainties, including distraction of management from current operations, greater than expected liabilities and expenses, inadequate return of capital and unidentified issues not discovered in the Company’s due diligence. These new ventures are inherently risky and may not be successful.

The Company’s business and reputation may be impacted by information technology system failures or network disruptions.

The Company may be subject to information technology system failures and network disruptions. These may be caused by natural disasters, accidents, power disruptions, telecommunications failures, acts of terrorism or war, computer viruses, physical or electronic break-ins, or other events or disruptions. System redundancy may be ineffective or inadequate, and the Company’s disaster recovery planning may not be sufficient for all eventualities. Such failures or disruptions could prevent access to the Company’s online stores and services, preclude retail store transactions, compromise Company or customer data, and result in delayed or cancelled orders. System failures and disruptions could also impede the manufacturing and shipping of products, delivery of online services, transactions processing and financial reporting.

There may be breaches of the Company’s information technology systems that materially damage business partner and customer relationships, curtail or otherwise adversely impact access to online stores and services, or subject the Company to significant reputational, financial, legal and operational consequences.

The Company’s business requires it to use and store customer, employee and business partner personally identifiable information (“PII”). This may include, among other information, names, addresses, phone numbers, email addresses, contact preferences, tax identification numbers and payment account information. Although malicious attacks to gain access to PII affect many companies across various industries, the Company is at a relatively greater risk of being targeted because of its high profile and the amount of PII it manages.

The Company requires user names and passwords in order to access its information technology systems. The Company also uses encryption and authentication technologies designed to secure the transmission and storage of data and prevent access to Company data or accounts. As with all companies, these security measures are subject to third-party security breaches, employee error, malfeasance, faulty password management, or other irregularities. For example, third parties may attempt to fraudulently induce employees or customers into disclosing user names, passwords or other sensitive information, which may in turn be used to access the Company’s information technology systems. To help protect customers and the Company, the Company monitors accounts and systems for unusual activity and may freeze accounts under suspicious circumstances, which may result in the delay or loss of customer orders.

 

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The Company devotes significant resources to network security, data encryption and other security measures to protect its systems and data, but these security measures cannot provide absolute security. To the extent the Company was to experience a breach of its systems and was unable to protect sensitive data, such a breach could materially damage business partner and customer relationships, and curtail or otherwise adversely impact access to online stores and services. Moreover, if a computer security breach affects the Company’s systems or results in the unauthorized release of PII, the Company’s reputation and brand could be materially damaged, use of the Company’s products and services could decrease, and the Company could be exposed to a risk of loss or litigation and possible liability. While the Company maintains insurance coverage that, subject to policy terms and conditions and subject to a significant self-insured retention, is designed to address certain aspects of cyber risks, such insurance coverage may be insufficient to cover all losses or all types of claims that may arise in the continually evolving area of cyber risk.

The Company’s business is subject to a variety of U.S. and international laws, rules, policies and other obligations regarding data protection.

The Company is subject to federal, state and international laws relating to the collection, use, retention, security and transfer of PII. In many cases, these laws apply not only to third-party transactions, but also to transfers of information between the Company and its subsidiaries, and among the Company, its subsidiaries and other parties with which the Company has commercial relations. Several jurisdictions have passed laws in this area, and other jurisdictions are considering imposing additional restrictions. These laws continue to develop and may be inconsistent from jurisdiction to jurisdiction. Complying with emerging and changing international requirements may cause the Company to incur substantial costs or require the Company to change its business practices. Noncompliance could result in penalties or significant legal liability.

The Company’s privacy policy, which includes related practices concerning the use and disclosure of data, is posted on its website. Any failure by the Company, its suppliers or other parties with whom the Company does business to comply with its posted privacy policy or with other federal, state or international privacy-related or data protection laws and regulations could result in proceedings against the Company by governmental entities or others.

The Company is also subject to payment card association rules and obligations under its contracts with payment card processors. Under these rules and obligations, if information is compromised, the Company could be liable to payment card issuers for associated expenses and penalties. In addition, if the Company fails to follow payment card industry security standards, even if no customer information is compromised, the Company could incur significant fines or experience a significant increase in payment card transaction costs.

The Company’s success depends largely on the continued service and availability of key personnel.

Much of the Company’s future success depends on the continued availability and service of key personnel, including its Chief Executive Officer, executive team and other highly skilled employees. Experienced personnel in the technology industry are in high demand and competition for their talents is intense, especially in Silicon Valley, where most of the Company’s key personnel are located.

The Company’s business may be impacted by political events, war, terrorism, public health issues, natural disasters and other business interruptions.

War, terrorism, geopolitical uncertainties, public health issues and other business interruptions have caused and could cause damage or disruption to international commerce and the global economy, and thus could have a material adverse effect on the Company, its suppliers, logistics providers, manufacturing vendors and customers, including channel partners. The Company’s business operations are subject to interruption by, among others, natural disasters, whether as a result of climate change or otherwise, fire, power shortages, nuclear power plant accidents, terrorist attacks and other hostile acts, labor disputes, public health issues and other events beyond its control. Such events could decrease demand for the Company’s products, make it difficult or impossible for the Company to make and deliver products to its customers, including channel partners, or to receive components from its suppliers, and create delays and inefficiencies in the Company’s supply chain. Should major public health issues, including pandemics, arise, the Company could be adversely affected by more stringent employee travel restrictions, additional limitations in freight services, governmental actions limiting the movement of products between regions, delays in production ramps of new products and disruptions in the operations of the Company’s manufacturing vendors and component suppliers. The majority of the Company’s R&D activities, its corporate headquarters, information technology systems and other critical business operations, including certain component suppliers and manufacturing vendors, are in locations that could be affected by natural disasters. In the event of a natural disaster, the Company could incur significant losses, require substantial recovery time and experience significant expenditures in order to resume operations.

 

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The Company expects its quarterly revenue and operating results to fluctuate.

The Company’s profit margins vary across its products and distribution channels. The Company’s software, accessories, and service and support contracts generally have higher gross margins than certain of the Company’s other products. Gross margins on the Company’s hardware products vary across product lines and can change over time as a result of product transitions, pricing and configuration changes, and component, warranty, and other cost fluctuations. The Company’s direct sales generally have higher associated gross margins than its indirect sales through its channel partners. In addition, the Company’s gross margin and operating margin percentages, as well as overall profitability, may be materially adversely impacted as a result of a shift in product, geographic or channel mix, component cost increases, the strengthening U.S. dollar, price competition, or the introduction of new products, including those that have higher cost structures with flat or reduced pricing.

The Company has typically experienced higher net sales in its first quarter compared to other quarters due in part to seasonal holiday demand. Additionally, new product introductions can significantly impact net sales, product costs and operating expenses. The Company could be subject to unexpected developments late in a quarter, such as lower-than-anticipated demand for the Company’s products, issues with new product introductions, an internal systems failure, or failure of one of the Company’s logistics, components supply, or manufacturing partners.

The Company’s stock price is subject to volatility.

The Company’s stock price has experienced substantial price volatility in the past and may continue to do so in the future. Additionally, the Company, the technology industry and the stock market as a whole have experienced extreme stock price and volume fluctuations that have affected stock prices in ways that may have been unrelated to these companies’ operating performance. Price volatility over a given period may cause the average price at which the Company repurchases its own stock to exceed the stock’s price at a given point in time. The Company believes its stock price reflects expectations of future growth and profitability. The Company also believes its stock price reflects expectations that its cash dividend will continue at current levels or grow and that its current share repurchase program will be fully consummated. Future dividends are subject to declaration by the Company’s Board of Directors, and the Company’s share repurchase program does not obligate it to acquire any specific number of shares. If the Company fails to meet expectations related to future growth, profitability, dividends, share repurchases or other market expectations, its stock price may decline significantly, which could have a material adverse impact on investor confidence and employee retention.

The Company’s financial performance is subject to risks associated with changes in the value of the U.S. dollar versus local currencies.

The Company’s primary exposure to movements in foreign currency exchange rates relates to non-U.S. dollar denominated sales and operating expenses worldwide. Weakening of foreign currencies relative to the U.S. dollar adversely affects the U.S. dollar value of the Company’s foreign currency-denominated sales and earnings, and generally leads the Company to raise international pricing, potentially reducing demand for the Company’s products. Margins on sales of the Company’s products in foreign countries and on sales of products that include components obtained from foreign suppliers, could be materially adversely affected by foreign currency exchange rate fluctuations. In some circumstances, for competitive or other reasons, the Company may decide not to raise local prices to fully offset the dollar’s strengthening, or at all, which would adversely affect the U.S. dollar value of the Company’s foreign currency denominated sales and earnings. Conversely, a strengthening of foreign currencies relative to the U.S. dollar, while generally beneficial to the Company’s foreign currency-denominated sales and earnings, could cause the Company to reduce international pricing and incur losses on its foreign currency derivative instruments, thereby limiting the benefit. Additionally, strengthening of foreign currencies may also increase the Company’s cost of product components denominated in those currencies, thus adversely affecting gross margins.

The Company uses derivative instruments, such as foreign currency forward and option contracts, to hedge certain exposures to fluctuations in foreign currency exchange rates. The use of such hedging activities may not offset any, or more than a portion, of the adverse financial effects of unfavorable movements in foreign exchange rates over the limited time the hedges are in place.

The Company is exposed to credit risk and fluctuations in the market values of its investment portfolio.

Given the global nature of its business, the Company has both domestic and international investments. Credit ratings and pricing of the Company’s investments can be negatively affected by liquidity, credit deterioration, financial results, economic risk, political risk, sovereign risk or other factors. As a result, the value and liquidity of the Company’s cash, cash equivalents and marketable securities may fluctuate substantially. Therefore, although the Company has not realized any significant losses on its cash, cash equivalents and marketable securities, future fluctuations in their value could result in a significant realized loss.

 

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The Company is exposed to credit risk on its trade accounts receivable, vendor non-trade receivables and prepayments related to long-term supply agreements, and this risk is heightened during periods when economic conditions worsen.

The Company distributes its products through third-party cellular network carriers, wholesalers, retailers and value-added resellers. The Company also sells its products directly to small and mid-sized businesses and education, enterprise and government customers. A substantial majority of the Company’s outstanding trade receivables are not covered by collateral, third-party financing arrangements or credit insurance. The Company’s exposure to credit and collectability risk on its trade receivables is higher in certain international markets and its ability to mitigate such risks may be limited. The Company also has unsecured vendor non-trade receivables resulting from purchases of components by outsourcing partners and other vendors that manufacture sub-assemblies or assemble final products for the Company. In addition, the Company has made prepayments associated with long-term supply agreements to secure supply of inventory components. As of March 28, 2015, a significant portion of the Company’s trade receivables was concentrated within cellular network carriers, and its vendor non-trade receivables and prepayments related to long-term supply agreements were concentrated among a few individual vendors located primarily in Asia. While the Company has procedures to monitor and limit exposure to credit risk on its trade and vendor non-trade receivables, as well as long-term prepayments, there can be no assurance such procedures will effectively limit its credit risk and avoid losses.

The Company could be subject to changes in its tax rates, the adoption of new U.S. or international tax legislation or exposure to additional tax liabilities.

The Company is subject to taxes in the U.S. and numerous foreign jurisdictions, including Ireland, where a number of the Company’s subsidiaries are organized. Due to economic and political conditions, tax rates in various jurisdictions may be subject to significant change. The Company’s future effective tax rates could be affected by changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, or changes in tax laws or their interpretation, including in the U.S. and Ireland. For example, in June 2014, the European Commission opened a formal investigation of Ireland to examine whether decisions by the tax authorities with regard to the corporate income tax to be paid by two of the Company’s Irish subsidiaries comply with European Union rules on state aid. If the European Commission were to conclude against Ireland, it could require Ireland to recover from the Company past taxes covering a period of up to 10 years reflective of the disallowed state aid, and such amount could be material.

The Company is also subject to the examination of its tax returns and other tax matters by the Internal Revenue Service and other tax authorities and governmental bodies. The Company regularly assesses the likelihood of an adverse outcome resulting from these examinations to determine the adequacy of its provision for taxes. There can be no assurance as to the outcome of these examinations. If the Company’s effective tax rates were to increase, particularly in the U.S. or Ireland, or if the ultimate determination of the Company’s taxes owed is for an amount in excess of amounts previously accrued, the Company’s operating results, cash flows and financial condition could be adversely affected.

 

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Share repurchase activity during the three months ended March 28, 2015 was as follows (in millions, except number of shares, which are reflected in thousands, and per share amounts):

 

                                                                                                   

Q2 Fiscal Periods

   Total Number
of Shares
Purchased
     Average
Price Paid
Per Share
     Total Number of
Shares
Purchased as
Part of Publicly
Announced
Plans or
Programs
     Approximate
Dollar Value of
Shares That
May Yet Be
Purchased
Under the Plans
or Programs 
(1)
 

December 28, 2014 to January 31, 2015:

           

Open market and privately negotiated purchases

     7,969           $ 112.06            7,969          

February 1, 2015 to February 28, 2015:

           

August 2014 ASR

     13,252  (2)         (2)         13,252  (2)      

Open market and privately negotiated purchases

     43,683           $ 126.07            43,683          

    

           

March 1, 2015 to March 28, 2015:

           

Open market and privately negotiated purchases

     4,748           $ 126.35            4,748          
  

 

 

          

Total

  69,652        $ 10,050   
  

 

 

          

 

 

 

 

  (1)  

In 2012, the Company’s Board of Directors authorized a program to repurchase up to $10 billion of the Company’s common stock beginning in 2013. The Company’s Board of Directors increased the authorization to repurchase the Company’s common stock to $60 billion in April 2013 and to $90 billion in April 2014. As of March 28, 2015, $80 billion of the $90 billion had been utilized. The remaining $10 billion in the table represents the amount available to repurchase shares under the authorized repurchase program as of March 28, 2015. Additionally, the Company announced on April 27, 2015 that the Board of Directors increased the share repurchase program authorization from $90 billion to $140 billion. The Company’s share repurchase program does not obligate it to acquire any specific number of shares. Under the program, shares may be repurchased in privately negotiated and/or open market transactions, including under plans complying with Rule 10b5-1 under the Exchange Act.

 

 

  (2)  

In August 2014, the Company entered into an accelerated share repurchase arrangement (“ASR”) to purchase up to $9.0 billion of the Company’s common stock. In February 2015, the purchase period for this ASR ended and an additional 13.3 million shares were delivered and retired. In total, 81.5 million net shares were delivered under this ASR at an average repurchase price of $110.40.

 

 

Item 3. Defaults Upon Senior Securities

None.

 

Item 4. Mine Safety Disclosures

Not applicable.

 

Item 5. Other Information

None.

 

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Item 6. Exhibits

Index to Exhibits  (1)

 

         

Incorporated by Reference

Exhibit

Number

  

Exhibit Description

  

Form

  

Exhibit

  

Filing Date/

Period End

Date

    3.1         

   Restated Articles of Incorporation of the Registrant effective as of June 6, 2014.    8-K    3.1    6/6/14

    3.2

   Amended and Restated Bylaws of the Registrant effective as of February 28, 2014.    8-K    3.2    3/5/14

    4.1

   Form of Common Stock Certificate of the Registrant.    10-Q    4.1    12/30/06

    4.2

   Indenture, dated as of April 29, 2013, between the Registrant and The Bank of New York Mellon Trust Company, N.A., as Trustee.    S-3    4.1    4/29/13

    4.3

   Officer’s Certificate of the Registrant, dated as of May 3, 2013, including forms of global notes representing the Floating Rate Notes due 2016, Floating Rate Notes due 2018, 0.45% Notes due 2016, 1.00% Notes due 2018, 2.40% Notes due 2023 and 3.85% Notes due 2043.    8-K    4.1    5/3/13

    4.4

   Officer’s Certificate of the Registrant, dated as of May 6, 2014, including forms of global notes representing the Floating Rate Notes due 2017, Floating Rate Notes due 2019, 1.05% Notes due 2017, 2.10% Notes due 2019, 2.85% Notes due 2021, 3.45% Notes due 2024 and 4.45% Notes due 2044.    8-K    4.1    5/6/14

    4.5

   Officer’s Certificate of the Registrant, dated as of November 10, 2014, including forms of global notes representing the 1.00% Notes due 2022 and 1.625% Notes due 2026.    8-K    4.1    11/10/14

    4.6

   Officer’s Certificate of the Registrant, dated as of February 9, 2015, including forms of global notes representing the Floating Rate Notes due 2020, 1.55% Notes due 2020, 2.15% Notes due 2022, 2.50% Notes due 2025 and 3.45% Notes due 2045.    8-K    4.1    2/9/15

  10.1*

   Employee Stock Purchase Plan, as amended and restated as of March 10, 2015.    8-K    10.1    3/13/15

  10.2*

   Form of Indemnification Agreement between the Registrant and each director and executive officer of the Registrant.    10-Q    10.2    6/27/09

  10.3*

   1997 Director Stock Plan, as amended through August 23, 2012.    10-Q    10.3    12/28/13

  10.4*

   2003 Employee Stock Plan, as amended through February 25, 2010.    8-K    10.1    3/1/10

  10.5*

   Form of Restricted Stock Unit Award Agreement under 2003 Employee Stock Plan effective as of November 16, 2010.    10-Q    10.10    12/25/10

  10.6*

   Form of Restricted Stock Unit Award Agreement under 2003 Employee Stock Plan effective as of April 6, 2012.    10-Q    10.8    3/31/12

  10.7*

   Summary Description of Amendment, effective as of May 24, 2012, to certain Restricted Stock Unit Award Agreements outstanding as of April 5, 2012.    10-Q    10.8    6/30/12

  10.8*

   2014 Employee Stock Plan.    8-K    10.1    3/5/14

  10.9*

   Form of Restricted Stock Unit Award Agreement under 2014 Employee Stock Plan as of February 28, 2014.    8-K    10.2    3/5/14

  10.10*

   Form of Performance Award Agreement under 2014 Employee Stock Plan effective as of February 28, 2014.    8-K    10.3    3/5/14

  10.11*

   Form of Restricted Stock Unit Award Agreement under 2014 Employee Stock Plan effective as of August 26, 2014.    10-K    10.11    9/27/14

  10.12*

   Form of Performance Award Agreement under 2014 Employee Stock Plan effective as of August 26, 2014.    10-K    10.12    9/27/14

 

50


Table of Contents
         

Incorporated by Reference

Exhibit

Number

  

Exhibit Description

  

Form

  

Exhibit

  

Filing Date/

Period End

Date

  10.13*

   Form of Amendment, effective as of August 26, 2014, to Restricted Stock Unit Award Agreements and Performance Award Agreements outstanding as of August 26, 2014.    10-K    10.13    9/27/14

  10.14*

   Offer Letter, dated August 1, 2013, from the Registrant to Angela Ahrendts.    10-Q    10.14    12/27/14

  31.1**

   Rule 13a-14(a) / 15d-14(a) Certification of Chief Executive Officer.         

  31.2**

   Rule 13a-14(a) / 15d-14(a) Certification of Chief Financial Officer.         

  32.1***

   Section 1350 Certifications of Chief Executive Officer and Chief Financial Officer.         

101.INS**

   XBRL Instance Document.         

101.SCH**

   XBRL Taxonomy Extension Schema Document.         

101.CAL**

   XBRL Taxonomy Extension Calculation Linkbase Document.         

101.DEF**

   XBRL Taxonomy Extension Definition Linkbase Document.         

101.LAB**

   XBRL Taxonomy Extension Label Linkbase Document.         

101.PRE**

   XBRL Taxonomy Extension Presentation Linkbase Document.         

 

  *

Indicates management contract or compensatory plan or arrangement.

 

 

  **

Filed herewith.

 

 

  ***

Furnished herewith.

 

 

  (1)  

Certain instruments defining the rights of holders of long-term debt securities of the Registrant are omitted pursuant to Item 601(b)(4)(iii) of Regulation S-K. The Registrant hereby undertakes to furnish to the SEC, upon request, copies of any such instruments.

 

 

51


Table of Contents

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

April 28, 2015 Apple Inc.
By:  /s/ Luca Maestri

Luca Maestri

Senior Vice President,

Chief Financial Officer

 

52

Exhibit 31.1

CERTIFICATION

I, Timothy D. Cook, certify that:

 

1.

I have reviewed this quarterly report on Form 10-Q of Apple Inc.;

 

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report;

 

4.

The Registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Registrant and have:

 

  (a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  (b)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  (c)

Evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  (d)

Disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting; and

 

5.

The Registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditors and the audit committee of the Registrant’s board of directors (or persons performing the equivalent functions):

 

  (a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize, and report financial information; and

 

  (b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control over financial reporting.

Date: April 28, 2015

By:

/s/ Timothy D. Cook

Timothy D. Cook

Chief Executive Officer

Exhibit 31.2

CERTIFICATION

I, Luca Maestri, certify that:

 

1.

I have reviewed this quarterly report on Form 10-Q of Apple Inc.;

 

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report;

 

4.

The Registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Registrant and have:

 

  (a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  (b)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  (c)

Evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  (d)

Disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting; and

 

5.

The Registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditors and the audit committee of the Registrant’s board of directors (or persons performing the equivalent functions):

 

  (a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize, and report financial information; and

 

  (b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control over financial reporting.

Date: April 28, 2015

By:

/s/ Luca Maestri

Luca Maestri

Senior Vice President,

Chief Financial Officer

Exhibit 32.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER

PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

I, Timothy D. Cook, certify, as of the date hereof, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of Apple Inc. on Form 10-Q for the period ended March 28, 2015 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Form 10-Q fairly presents in all material respects the financial condition and results of operations of Apple Inc. at the dates and for the periods indicated.

Date: April 28, 2015

By:

/s/ Timothy D. Cook

Timothy D. Cook

Chief Executive Officer

I, Luca Maestri, certify, as of the date hereof, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of Apple Inc. on Form 10-Q for the period ended March 28, 2015 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Form 10-Q fairly presents in all material respects the financial condition and results of operations of Apple Inc. at the dates and for the periods indicated.

Date: April 28, 2015

By:

/s/ Luca Maestri

Luca Maestri

Senior Vice President,

Chief Financial Officer