10-Q 1 a10-qq1201712312016.htm 10-Q Document

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
 
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2016
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
 
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Apple Inc.
(Exact name of Registrant as specified in its charter)
 
 
 
 
California
 
94-2404110
(State or other jurisdiction
of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
1 Infinite Loop
Cupertino, California
 
95014
(Address of principal executive offices)
 
(Zip Code)
(408) 996-1010
(Registrant’s telephone number, including area code)
 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes      No  

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

Yes      No  

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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
 
  
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  

5,246,540,000 shares of common stock, par value $0.00001 per share, issued and outstanding as of January 20, 2017
 



Apple Inc.
Form 10-Q
For the Fiscal Quarter Ended December 31, 2016
TABLE OF CONTENTS

2


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
 
December 31,
2016
 
December 26,
2015
Net sales
$
78,351

 
$
75,872

Cost of sales
48,175

 
45,449

Gross margin
30,176

 
30,423

 
 
 
 
Operating expenses:
 
 
 
Research and development
2,871

 
2,404

Selling, general and administrative
3,946

 
3,848

Total operating expenses
6,817

 
6,252

 
 
 
 
Operating income
23,359

 
24,171

Other income/(expense), net
821

 
402

Income before provision for income taxes
24,180

 
24,573

Provision for income taxes
6,289

 
6,212

Net income
$
17,891

 
$
18,361

 
 
 
 
Earnings per share:
 
 
 
Basic
$
3.38

 
$
3.30

Diluted
$
3.36

 
$
3.28

 
 
 
 
Shares used in computing earnings per share:
 
 
 
Basic
5,298,661

 
5,558,930

Diluted
5,327,995

 
5,594,127

 
 
 
 
Cash dividends declared per share
$
0.57

 
$
0.52

See accompanying Notes to Condensed Consolidated Financial Statements.

3


Apple Inc.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(In millions)
 
 
Three Months Ended
 
December 31,
2016
 
December 26,
2015
Net income
$
17,891

 
$
18,361

Other comprehensive income/(loss):
 
 
 
Change in foreign currency translation, net of tax effects of $76 and $19, respectively
(375
)
 
(102
)
 
 
 
 
Change in unrealized gains/losses on derivative instruments:
 
 
 
Change in fair value of derivatives, net of tax benefit/(expense) of $(228) and $(38), respectively
1,468

 
287

Adjustment for net (gains)/losses realized and included in net income, net of tax expense/(benefit) of $(211) and $66, respectively
306

 
(445
)
Total change in unrealized gains/losses on derivative instruments, net of tax
1,774

 
(158
)
 
 
 
 
Change in unrealized gains/losses on marketable securities:
 
 
 
Change in fair value of marketable securities, net of tax benefit/(expense) of $989 and $508, respectively
(1,808
)
 
(922
)
Adjustment for net (gains)/losses realized and included in net income, net of tax expense/(benefit) of $(11) and $(26), respectively
20

 
47

Total change in unrealized gains/losses on marketable securities, net of tax
(1,788
)
 
(875
)
 
 
 
 
Total other comprehensive income/(loss)
(389
)
 
(1,135
)
Total comprehensive income
$
17,502

 
$
17,226

See accompanying Notes to Condensed Consolidated Financial Statements.

4


Apple Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(In millions, except number of shares which are reflected in thousands and par value)
 
 
December 31,
2016
 
September 24,
2016
ASSETS:
Current assets:
 
 
 
Cash and cash equivalents
$
16,371

 
$
20,484

Short-term marketable securities
44,081

 
46,671

Accounts receivable, less an allowance of $53 in each period
14,057

 
15,754

Inventories
2,712

 
2,132

Vendor non-trade receivables
13,920

 
13,545

Other current assets
12,191

 
8,283

Total current assets
103,332

 
106,869

 
 
 
 
Long-term marketable securities
185,638

 
170,430

Property, plant and equipment, net
26,510

 
27,010

Goodwill
5,423

 
5,414

Acquired intangible assets, net
2,848

 
3,206

Other non-current assets
7,390

 
8,757

Total assets
$
331,141

 
$
321,686

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Current liabilities:
 
 
 
Accounts payable
$
38,510

 
$
37,294

Accrued expenses
23,739

 
22,027

Deferred revenue
7,889

 
8,080

Commercial paper
10,493

 
8,105

Current portion of long-term debt
3,499

 
3,500

Total current liabilities
84,130

 
79,006

 
 
 
 
Deferred revenue, non-current
3,163

 
2,930

Long-term debt
73,557

 
75,427

Other non-current liabilities
37,901

 
36,074

Total liabilities
198,751

 
193,437

 
 
 
 
Commitments and contingencies

 

 
 
 
 
Shareholders’ equity:
 
 
 
Common stock and additional paid-in capital, $0.00001 par value: 12,600,000 shares authorized; 5,255,423 and 5,336,166 shares issued and outstanding, respectively
32,144

 
31,251

Retained earnings
100,001

 
96,364

Accumulated other comprehensive income/(loss)
245

 
634

Total shareholders’ equity
132,390

 
128,249

Total liabilities and shareholders’ equity
$
331,141

 
$
321,686

See accompanying Notes to Condensed Consolidated Financial Statements.

5


Apple Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In millions)
 
Three Months Ended
 
December 31,
2016
 
December 26,
2015
Cash and cash equivalents, beginning of the period
$
20,484

 
$
21,120

 
 
 
 
Operating activities:
 
 
 
Net income
17,891

 
18,361

Adjustments to reconcile net income to cash generated by operating activities:
 
 
 
Depreciation and amortization
2,987

 
2,954

Share-based compensation expense
1,256

 
1,078

Deferred income tax expense
1,452

 
1,592

Other
(274
)
 
110

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
1,697

 
3,896

Inventories
(580
)
 
(102
)
Vendor non-trade receivables
(375
)
 
1,826

Other current and non-current assets
(1,446
)
 
(1,058
)
Accounts payable
2,460

 
(852
)
Deferred revenue
42

 
(29
)
Other current and non-current liabilities
1,946

 
(313
)
Cash generated by operating activities
27,056

 
27,463

 
 
 
 
Investing activities:
 
 
 
Purchases of marketable securities
(54,272
)
 
(47,836
)
Proceeds from maturities of marketable securities
6,525

 
3,514

Proceeds from sales of marketable securities
32,166

 
28,262

Payments made in connection with business acquisitions, net
(17
)
 
(86
)
Payments for acquisition of property, plant and equipment
(3,334
)
 
(3,612
)
Payments for acquisition of intangible assets
(86
)
 
(394
)
Payments for strategic investments

 
(126
)
Other
(104
)
 
(172
)
Cash used in investing activities
(19,122
)
 
(20,450
)
 
 
 
 
Financing activities:
 
 
 
Proceeds from issuance of common stock

 
1

Excess tax benefits from equity awards
178

 
224

Payments for taxes related to net share settlement of equity awards
(629
)
 
(597
)
Payments for dividends and dividend equivalents
(3,130
)
 
(2,969
)
Repurchases of common stock
(10,851
)
 
(6,863
)
Change in commercial paper, net
2,385

 
(1,240
)
Cash used in financing activities
(12,047
)
 
(11,444
)
 
 
 
 
Increase/(Decrease) in cash and cash equivalents
(4,113
)
 
(4,431
)
Cash and cash equivalents, end of the period
$
16,371

 
$
16,689

 
 
 
 
Supplemental cash flow disclosure:
 
 
 
Cash paid for income taxes, net
$
3,510

 
$
3,398

Cash paid for interest
$
497

 
$
396


See accompanying Notes to Condensed Consolidated Financial Statements.

6


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’s products and services include iPhone®, iPad®, Mac®, iPod®, Apple Watch®, Apple TV®, a portfolio of consumer and professional software applications, iOS, macOS™, watchOS® and tvOS™ operating systems, iCloud®, Apple Pay® and a variety of accessory, service and support offerings. The Company sells and delivers digital content and applications through the iTunes Store®, App Store®, Mac App Store, TV App Store, iBooks Store™ and Apple Music® (collectively “Digital Content and Services”). The Company sells its products worldwide through its retail stores, online stores and direct sales force, as well as through third-party cellular network carriers, wholesalers, retailers and value-added resellers. In addition, the Company sells a variety of third-party Apple-compatible products, including application software and various accessories through its retail and online stores. The Company sells to consumers, small and mid-sized businesses and education, enterprise and government customers.
Basis of Presentation and Preparation
The accompanying condensed consolidated financial statements include the accounts of the Company. Intercompany accounts and transactions have been eliminated. In the opinion of the Company’s management, the condensed consolidated financial statements reflect all adjustments, which are normal and recurring in nature, necessary for fair financial statement presentation. The preparation of these condensed consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the amounts reported in these condensed consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates. Certain prior period amounts in the condensed consolidated financial statements have been reclassified to conform to the current period’s presentation. These condensed consolidated financial statements and accompanying notes should be read in conjunction with the Company's annual consolidated financial statements and the notes thereto included in its Annual Report on Form 10-K for the fiscal year ended September 24, 2016 (the “2016 Form 10-K”).
The Company’s fiscal year is the 52 or 53-week period that ends on the last Saturday of September. The Company’s fiscal year 2017 will include 53 weeks and ends on September 30, 2017 and its fiscal year 2016 included 52 weeks and ended on September 24, 2016. A 14th week has been included in the first quarter of 2017, as is done every five or six years, to realign fiscal quarters with calendar quarters. Unless otherwise stated, references to particular years, quarters, months and periods refer to the Company’s fiscal years ended in September and the associated quarters, months and periods of those fiscal years.
Earnings Per Share
Basic earnings per share is computed by dividing income available to common shareholders by the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing income available to common shareholders by the weighted-average number of shares of common stock outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued. Potentially dilutive securities include outstanding stock options, shares to be purchased by employees under the Company’s employee stock purchase plan, unvested restricted stock and unvested restricted stock units (“RSUs”). The dilutive effect of potentially dilutive securities is reflected in diluted earnings per share by application of the treasury stock method. Under the treasury stock method, an increase in the fair market value of the Company’s common stock can result in a greater dilutive effect from potentially dilutive securities.

7


The following table shows the computation of basic and diluted earnings per share for the three months ended December 31, 2016 and December 26, 2015 (net income in millions and shares in thousands):
 
Three Months Ended
 
December 31,
2016
 
December 26,
2015
Numerator:
 
 
 
Net income
$
17,891

 
$
18,361

 
 
 
 
Denominator:
 
 
 
Weighted-average shares outstanding
5,298,661

 
5,558,930

Effect of dilutive securities
29,334

 
35,197

Weighted-average diluted shares
5,327,995

 
5,594,127

 
 
 
 
Basic earnings per share
$
3.38

 
$
3.30

Diluted earnings per share
$
3.36

 
$
3.28

Potentially dilutive securities whose effect would have been antidilutive are excluded from the computation of diluted earnings per share.
Note 2 – Financial Instruments
Cash, Cash Equivalents and Marketable Securities
The following tables show the Company’s cash and available-for-sale securities’ 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 December 31, 2016 and September 24, 2016 (in millions):
 
December 31, 2016
 
Adjusted
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
Cash and
Cash
Equivalents
 
Short-Term
Marketable
Securities
 
Long-Term
Marketable
Securities
Cash
$
9,359

 
$

 
$

 
$
9,359

 
$
9,359

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Level 1 (1):
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
4,640

 

 

 
4,640

 
4,640

 

 

Mutual funds
1,004

 

 
(137
)
 
867

 

 
867

 

Subtotal
5,644

 

 
(137
)
 
5,507

 
4,640

 
867

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Level 2 (2):
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
48,431

 
47

 
(333
)
 
48,145

 
1,022

 
13,074

 
34,049

U.S. agency securities
4,284

 
4

 
(10
)
 
4,278

 
404

 
1,999

 
1,875

Non-U.S. government securities
7,574

 
79

 
(136
)
 
7,517

 

 
408

 
7,109

Certificates of deposit and time deposits
5,893

 

 

 
5,893

 
334

 
4,089

 
1,470

Commercial paper
3,750

 

 

 
3,750

 
536

 
3,214

 

Corporate securities
140,697

 
469

 
(737
)
 
140,429

 
76

 
20,283

 
120,070

Municipal securities
955

 

 
(9
)
 
946

 

 
111

 
835

Mortgage- and asset-backed securities
20,486

 
23

 
(243
)
 
20,266

 

 
36

 
20,230

Subtotal
232,070

 
622

 
(1,468
)
 
231,224

 
2,372

 
43,214

 
185,638

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
247,073

 
$
622

 
$
(1,605
)
 
$
246,090

 
$
16,371

 
$
44,081

 
$
185,638



8


 
September 24, 2016
 
Adjusted
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
Cash and
Cash
Equivalents
 
Short-Term
Marketable
Securities
 
Long-Term
Marketable
Securities
Cash
$
8,601

 
$

 
$

 
$
8,601

 
$
8,601

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Level 1 (1):
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
3,666

 

 

 
3,666

 
3,666

 

 

Mutual funds
1,407

 

 
(146
)
 
1,261

 

 
1,261

 

Subtotal
5,073

 

 
(146
)
 
4,927

 
3,666

 
1,261

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Level 2 (2):
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
41,697

 
319

 
(4
)
 
42,012

 
1,527

 
13,492

 
26,993

U.S. agency securities
7,543

 
16

 

 
7,559

 
2,762

 
2,441

 
2,356

Non-U.S. government securities
7,609

 
259

 
(27
)
 
7,841

 
110

 
818

 
6,913

Certificates of deposit and time deposits
6,598

 

 

 
6,598

 
1,108

 
3,897

 
1,593

Commercial paper
7,433

 

 

 
7,433

 
2,468

 
4,965

 

Corporate securities
131,166

 
1,409

 
(206
)
 
132,369

 
242

 
19,599

 
112,528

Municipal securities
956

 
5

 

 
961

 

 
167

 
794

Mortgage- and asset-backed securities
19,134

 
178

 
(28
)
 
19,284

 

 
31

 
19,253

Subtotal
222,136

 
2,186

 
(265
)
 
224,057

 
8,217

 
45,410

 
170,430

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
235,810

 
$
2,186

 
$
(411
)
 
$
237,585

 
$
20,484

 
$
46,671

 
$
170,430

 
(1)
Level 1 fair value estimates are based on quoted prices in active markets for identical assets or liabilities.
(2)
Level 2 fair value estimates are based on observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

The Company may sell certain of its marketable securities prior to their stated maturities for strategic reasons including, but not limited to, anticipation of credit deterioration and duration management. The maturities of the Company’s long-term marketable securities generally range from one to five years.
The Company considers the declines in market value of its marketable securities investment portfolio to be temporary in nature. The Company typically invests in highly-rated securities, and its investment policy generally limits the amount of credit exposure to any one issuer. The policy generally requires investments to be investment grade, with the primary objective of minimizing the potential risk of principal loss. Fair values were determined for each individual security in the investment portfolio. When evaluating an investment for other-than-temporary impairment the Company reviews factors such as the length of time and extent to which fair value has been below its cost basis, the financial condition of the issuer and any changes thereto, changes in market interest rates and the Company’s intent to sell, or whether it is more likely than not it will be required to sell the investment before recovery of the investment’s cost basis. As of December 31, 2016, the Company does not consider any of its investments to be other-than-temporarily impaired.
Derivative Financial Instruments
The Company may use derivatives to partially offset its business exposure to foreign currency and interest rate risk on expected future cash flows, on net investments in certain foreign subsidiaries and on certain existing assets and liabilities. However, the Company may choose not to hedge certain exposures for a variety of reasons including, but not limited to, accounting considerations and the prohibitive economic cost of hedging particular exposures. There can be no assurance the hedges will offset more than a portion of the financial impact resulting from movements in foreign currency exchange or interest rates.
To help protect gross margins from fluctuations in foreign currency exchange rates, certain of the Company’s subsidiaries whose functional currency is the U.S. dollar may hedge a portion of forecasted foreign currency revenue, and subsidiaries whose functional currency is not the U.S. dollar and who sell in local currencies may hedge a portion of forecasted inventory purchases not denominated in the subsidiaries’ functional currencies. The Company may enter into forward contracts, option contracts or other instruments to manage this risk and may designate these instruments as cash flow hedges. The Company typically hedges portions of its forecasted foreign currency exposure associated with revenue and inventory purchases, typically for up to 12 months.

9


To help protect the net investment in a foreign operation from adverse changes in foreign currency exchange rates, the Company may enter into foreign currency forward and option contracts to offset the changes in the carrying amounts of these investments due to fluctuations in foreign currency exchange rates. In addition, the Company may use non-derivative financial instruments, such as its foreign currency-denominated debt, as economic hedges of its net investments in certain foreign subsidiaries. In both of these cases, the Company designates these instruments as net investment hedges.
The Company may also enter into non-designated foreign currency contracts to partially offset the foreign currency exchange gains and losses generated by the 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 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 December 31, 2016 are expected to be recognized within 10 years.
Cash Flow Hedges
The effective portions of cash flow hedges are recorded in accumulated other comprehensive income (“AOCI”) until the hedged item is recognized in earnings. Deferred gains and losses associated with cash flow hedges of foreign currency revenue are recognized as a component of net sales in the same period as the related revenue is recognized, and deferred gains and losses related to cash flow hedges of inventory purchases are recognized as a component of cost of sales in the same period as the related costs are recognized. Deferred gains and losses associated with cash flow hedges of interest income or expense are recognized in other income/(expense), net in the same period as the related income or expense is recognized. The ineffective portions and amounts excluded from the effectiveness testing of cash flow hedges are recognized in other income/(expense), net.
Derivative instruments designated as cash flow hedges must be de-designated as hedges when it is probable the forecasted hedged transaction will not occur in the initially identified time period or within a subsequent two-month time period. Deferred gains and losses in AOCI associated with such derivative instruments are reclassified immediately into other income/(expense), net. Any subsequent changes in fair value of such derivative instruments are reflected in other income/(expense), net unless they are re-designated as hedges of other transactions.
Net Investment Hedges
The effective portions of net investment hedges are recorded in other comprehensive income (“OCI”) as a part of the cumulative translation adjustment. The ineffective portions and amounts excluded from the effectiveness testing of net investment hedges are recognized in other income/(expense), net.
Fair Value Hedges
Gains and losses related to changes in fair value hedges are recognized in earnings along with a corresponding loss or gain related to the change in value of the underlying hedged item.
Non-Designated Derivatives
Derivatives that are not designated as hedging instruments are adjusted to fair value through earnings in the financial statement line item to which the derivative relates. As a result, during the three months ended December 31, 2016, the Company recognized gains in net sales, cost of sales and other income/(expense), net of $273 million, $332 million and $508 million, respectively.
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 December 31, 2016 and September 24, 2016 (in millions):
 
December 31, 2016
 
Fair Value of
Derivatives Designated
as Hedge Instruments
 
Fair Value of
Derivatives Not Designated
as Hedge Instruments
 
Total
Fair Value
Derivative assets (1):
 
 
 
 
 
Foreign exchange contracts
$
1,453

 
$
1,104

 
$
2,557

Interest rate contracts
$
186

 
$

 
$
186

 
 
 
 
 
 
Derivative liabilities (2):
 
 
 
 
 
Foreign exchange contracts
$
977

 
$
536

 
$
1,513

Interest rate contracts
$
331

 
$

 
$
331


10


 
September 24, 2016
 
Fair Value of
Derivatives Designated
as Hedge Instruments
 
Fair Value of
Derivatives Not Designated
as Hedge Instruments
 
Total
Fair Value
Derivative assets (1):
 
 
 
 
 
Foreign exchange contracts
$
518

 
$
153

 
$
671

Interest rate contracts
$
728

 
$

 
$
728

 
 
 
 
 
 
Derivative liabilities (2):
 
 
 
 
 
Foreign exchange contracts
$
935

 
$
134

 
$
1,069

Interest rate contracts
$
7

 
$

 
$
7


(1)
The fair value of derivative assets is measured using Level 2 fair value inputs and is recorded as other current assets in the Condensed Consolidated Balance Sheets.
(2)
The fair value of derivative liabilities is measured using Level 2 fair value inputs and is recorded as accrued expenses in the Condensed Consolidated Balance Sheets.

The following table shows the pre-tax gains and losses of the Company’s derivative and non-derivative instruments designated as cash flow, net investment and fair value hedges in OCI and the Condensed Consolidated Statements of Operations for the three months ended December 31, 2016 and December 26, 2015 (in millions):
 
Three Months Ended
 
December 31,
2016
 
December 26,
2015
Gains/(Losses) recognized in OCI – effective portion:
 
 
 
Cash flow hedges:
 
 
 
Foreign exchange contracts
$
1,727

 
$
326

Interest rate contracts
7

 
8

Total
$
1,734

 
$
334

 
 
 
 
Net investment hedges:
 
 
 
Foreign exchange contracts
$

 
$

Foreign currency debt
122

 
10

Total
$
122

 
$
10

 
 
 
 
Gains/(Losses) reclassified from AOCI into net income – effective portion:
 
 
 
Cash flow hedges:
 
 
 
Foreign exchange contracts
$
(511
)
 
$
515

Interest rate contracts
(1
)
 
(4
)
Total
$
(512
)
 
$
511

 
 
 
 
Gains/(Losses) on derivative instruments:
 
 
 
Fair value hedges:
 
 
 
Interest rate contracts
$
(872
)
 
$
(111
)
 
 
 
 
Gains/(Losses) related to hedged items:
 
 
 
Fair value hedges:
 
 
 
Interest rate contracts
$
872

 
$
111


11


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 December 31, 2016 and September 24, 2016 (in millions):
 
December 31, 2016
 
September 24, 2016
 
Notional
Amount
 
Credit Risk
Amount
 
Notional
Amount
 
Credit Risk
Amount
Instruments designated as accounting hedges:
 
 
 
 
 
 
 
Foreign exchange contracts
$
40,526

 
$
1,453

 
$
44,678

 
$
518

Interest rate contracts
$
24,500

 
$
186

 
$
24,500

 
$
728

 
 
 
 
 
 
 
 
Instruments not designated as accounting hedges:
 
 
 
 
 
 
 
Foreign exchange contracts
$
57,144

 
$
1,104

 
$
54,305

 
$
153

The notional amounts for outstanding derivative instruments provide one measure of the transaction volume outstanding and do not represent the amount of the Company’s exposure to credit or market loss. The credit risk amounts represent the Company’s gross exposure to potential accounting loss on derivative instruments that are outstanding or unsettled if all counterparties failed to perform according to the terms of the contract, based on then-current currency or interest rates at each respective date. The Company’s exposure to credit loss and market risk will vary over time as currency and interest rates change. Although the table above reflects the notional and credit risk amounts of the Company’s derivative instruments, it does not reflect the gains or losses associated with the exposures and transactions that the instruments are intended to hedge. The amounts ultimately realized upon settlement of these financial instruments, together with the gains and losses on the underlying exposures, will depend on actual market conditions during the remaining life of the instruments.
The Company generally enters into master netting arrangements, which are designed to reduce credit risk by permitting net settlement of transactions with the same counterparty. To further limit credit risk, the Company generally enters into collateral security arrangements that provide for collateral to be received or posted when the net fair value of certain financial instruments fluctuates from contractually established thresholds. The Company presents its derivative assets and derivative liabilities at their gross fair values in its Condensed Consolidated Balance Sheets. The net cash collateral received by the Company related to derivative instruments under its collateral security arrangements was $1.1 billion as of December 31, 2016 and $163 million as of September 24, 2016, which were recorded as accrued expenses in the Condensed Consolidated Balance Sheets.
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 December 31, 2016 and September 24, 2016, the potential effects of these rights of set-off associated with the Company’s derivative contracts, including the effects of collateral, would be a reduction to both derivative assets and derivative liabilities of $2.7 billion and $1.5 billion, respectively, resulting in a net derivative liability of $222 million and a net derivative asset of $160 million, respectively.
Accounts Receivable
Trade Receivables
The Company has considerable trade receivables outstanding with its third-party cellular network carriers, wholesalers, retailers, value-added resellers, small and mid-sized businesses and education, enterprise and government customers. The Company generally does not require collateral from its customers; however, the Company will require collateral in certain instances to limit credit risk. In addition, when possible, the Company attempts to limit credit risk on trade receivables with credit insurance for certain customers or by requiring third-party financing, loans or leases to support credit exposure. These credit-financing arrangements are directly between the third-party financing company and the end customer. As such, the Company generally does not assume any recourse or credit risk sharing related to any of these arrangements.
As of December 31, 2016 and September 24, 2016, the Company had one customer that represented 10% or more of total trade receivables, which accounted for 11% and 10%, respectively. The Company’s cellular network carriers accounted for 55% and 63% of trade receivables as of December 31, 2016 and September 24, 2016, respectively.
Vendor Non-Trade Receivables
The Company has non-trade receivables from certain of its manufacturing vendors resulting from the sale of components to these vendors who manufacture sub-assemblies or assemble final products for the Company. The Company purchases these components directly from suppliers. Vendor non-trade receivables from three of the Company’s vendors accounted for 49%, 14% and 13% of total vendor non-trade receivables as of December 31, 2016, and two of the Company’s vendors accounted for 47% and 21% of total vendor non-trade receivables as of September 24, 2016.

12


Note 3 – Condensed Consolidated Financial Statement Details
The following tables show the Company’s condensed consolidated financial statement details as of December 31, 2016 and September 24, 2016 (in millions):
Property, Plant and Equipment, Net
 
December 31,
2016
 
September 24,
2016
Land and buildings
$
10,932

 
$
10,185

Machinery, equipment and internal-use software
45,309

 
44,543

Leasehold improvements
6,518

 
6,517

Gross property, plant and equipment
62,759

 
61,245

Accumulated depreciation and amortization
(36,249
)
 
(34,235
)
Total property, plant and equipment, net
$
26,510

 
$
27,010

Other Non-Current Liabilities
 
December 31,
2016
 
September 24,
2016
Deferred tax liabilities
$
26,948

 
$
26,019

Other non-current liabilities
10,953

 
10,055

Total other non-current liabilities
$
37,901

 
$
36,074

Other Income/(Expense), Net
The following table shows the detail of other income/(expense), net for the three months ended December 31, 2016 and December 26, 2015 (in millions):
 
Three Months Ended
 
December 31,
2016
 
December 26,
2015
Interest and dividend income
$
1,224

 
$
941

Interest expense
(525
)
 
(276
)
Other income/(expense), net
122

 
(263
)
Total other income/(expense), net
$
821

 
$
402

Note 4 – Acquired Intangible Assets
The Company’s acquired intangible assets with definite useful lives primarily consist of patents and licenses. The following table summarizes the components of gross and net acquired intangible asset balances as of December 31, 2016 and September 24, 2016 (in millions):
 
December 31, 2016
 
September 24, 2016
 
Gross
Carrying Amount
 
Accumulated
Amortization
 
Net 
Carrying Amount
 
Gross
Carrying Amount
 
Accumulated
Amortization
 
Net 
Carrying Amount
Definite-lived and amortizable acquired intangible assets
$
7,472

 
$
(4,724
)
 
$
2,748

 
$
8,912

 
$
(5,806
)
 
$
3,106

Indefinite-lived and non-amortizable acquired intangible assets
100

 

 
100

 
100

 

 
100

Total acquired intangible assets
$
7,572

 
$
(4,724
)
 
$
2,848

 
$
9,012

 
$
(5,806
)
 
$
3,206



13


Note 5 – Income Taxes
As of December 31, 2016, the Company recorded gross unrecognized tax benefits of $8.5 billion, of which $3.0 billion, if recognized, would affect the Company’s effective tax rate. As of September 24, 2016, the total amount of gross unrecognized tax benefits was $7.7 billion, of which $2.8 billion, if recognized, would have affected the Company’s effective tax rate. The Company’s total gross unrecognized tax benefits are classified as other non-current liabilities in the Condensed Consolidated Balance Sheets. The Company had $1.2 billion and $1.0 billion of gross interest and penalties accrued as of December 31, 2016 and September 24, 2016, respectively, which are classified as other non-current liabilities in the Condensed Consolidated Balance Sheets.
The Company believes that an adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in the Company’s tax audits are resolved in a manner not consistent with its expectations, the Company could be required to adjust its provision for income taxes in the period such resolution occurs. Although timing of the resolution and/or closure of audits is not certain, the Company believes it is reasonably possible that its gross unrecognized tax benefits could decrease (whether by payment, release or a combination of both) in the next 12 months by as much as $1.1 billion.
On August 30, 2016, the European Commission announced its decision that Ireland granted state aid to the Company by providing tax opinions in 1991 and 2007 concerning the tax allocation of profits of the Irish branches of two subsidiaries of the Company (the “State Aid Decision”). The State Aid Decision orders Ireland to calculate and recover additional taxes from the Company for the period June 2003 through December 2014. Irish legislative changes, effective as of January 2015, eliminated the application of the tax opinions from that date forward. The Company believes the State Aid Decision to be without merit and appealed to the General Court of the Court of Justice of the European Union. Ireland has also appealed the State Aid Decision. While the European Commission announced a recovery amount of up to €13 billion, plus interest, the actual amount of additional taxes subject to recovery is to be calculated by Ireland in accordance with the European Commission's guidance. Once the recovery amount is computed by Ireland, the Company anticipates funding it, including interest, out of foreign cash into escrow, where it will remain pending conclusion of all appeals. The Company believes that any incremental Irish corporate income taxes potentially due related to the State Aid Decision would be creditable against U.S. taxes.
Note 6 – Debt
Commercial Paper
The Company issues unsecured short-term promissory notes (“Commercial Paper”) pursuant to a commercial paper program. The Company uses net proceeds from the commercial paper program for general corporate purposes, including dividends and share repurchases. As of December 31, 2016 and September 24, 2016, the Company had $10.5 billion and $8.1 billion of Commercial Paper outstanding, respectively, with maturities generally less than nine months. The weighted-average interest rate of the Company’s Commercial Paper was 0.61% as of December 31, 2016 and 0.45% as of September 24, 2016.
The following table provides a summary of cash flows associated with the issuance and maturities of Commercial Paper for the three months ended December 31, 2016 and December 26, 2015 (in millions):
 
Three Months Ended
 
December 31,
2016
 
December 26,
2015
Maturities less than 90 days:
 
 
 
Proceeds from/(Repayments of) commercial paper, net
$
1,550

 
$
(393
)
 
 
 
 
Maturities greater than 90 days:
 
 
 
Proceeds from commercial paper
2,544

 
492

Repayments of commercial paper
(1,709
)
 
(1,339
)
Proceeds from/(Repayments of) commercial paper, net
835

 
(847
)
 
 
 
 
Total change in commercial paper, net
$
2,385

 
$
(1,240
)

14


Long-Term Debt
As of December 31, 2016, the Company had outstanding floating- and fixed-rate notes with varying maturities for an aggregate principal amount of $77.4 billion (collectively the “Notes”). The Notes are senior unsecured obligations, and interest is payable in arrears, quarterly for the U.S. dollar-denominated and Australian dollar-denominated floating-rate notes, semi-annually for the U.S. dollar-denominated, Australian dollar-denominated, British pound-denominated and Japanese yen-denominated fixed-rate notes and annually for the euro-denominated and Swiss franc-denominated fixed-rate notes. The following table provides a summary of the Company’s term debt as of December 31, 2016 and September 24, 2016:
 
Maturities
 
December 31, 2016
 
September 24, 2016
 
Amount
(in millions)
 
Effective
Interest Rate
 
Amount
(in millions)
 
Effective
Interest Rate
2013 debt issuance of $17.0 billion:
 
 
 
 
 
 
 
 
 
Floating-rate notes
2018
 
$
2,000

 
1.10%
 
$
2,000

 
1.10%
Fixed-rate 1.000% - 3.850% notes
2018 - 2043
 
12,500

 
1.08% - 3.91%
 
12,500

 
1.08% - 3.91%
 
 
 
 
 
 
 
 
 
 
2014 debt issuance of $12.0 billion:
 
 
 
 
 
 
 
 
 
Floating-rate notes
2017 - 2019
 
2,000

 
0.95% - 1.18%
 
2,000

 
0.86% - 1.09%
Fixed-rate 1.050% - 4.450% notes
2017 - 2044
 
10,000

 
0.95% - 4.48%
 
10,000

 
0.85% - 4.48%
 
 
 
 
 
 
 
 
 
 
2015 debt issuances of $27.3 billion:
 
 
 
 
 
 
 
 
 
Floating-rate notes
2017 - 2020
 
1,753

 
0.95% - 1.87%
 
1,781

 
0.87% - 1.87%
Fixed-rate 0.350% - 4.375% notes
2017 - 2045
 
24,225

 
0.28% - 4.51%
 
25,144

 
0.28% - 4.51%
 
 
 
 
 
 
 
 
 
 
2016 debt issuances of $24.9 billion:
 
 
 
 
 
 
 
 
 
Floating-rate notes
2019 - 2021
 
1,350

 
1.02% - 2.05%
 
1,350

 
0.91% - 1.95%
Fixed-rate 1.100% - 4.650% notes
2018 - 2046
 
23,550

 
1.13% - 4.78%
 
23,609

 
1.13% - 4.58%
Total term debt
 
 
77,378

 
 
 
78,384

 
 
 
 
 
 
 
 
 
 
 
 
Unamortized premium/(discount) and issuance costs, net
 
 
(166
)
 
 
 
(174
)
 
 
Hedge accounting fair value adjustments
 
 
(156
)
 
 
 
717

 
 
Less: Current portion of long-term debt
 
 
(3,499
)
 
 
 
(3,500
)
 
 
Total long-term debt
 
 
$
73,557

 
 
 
$
75,427

 
 
As of December 31, 2016 and September 24, 2016, ¥90.4 billion and ¥195.5 billion, respectively, of Japanese yen-denominated notes were designated as a hedge of the foreign currency exposure of the Company's net investment in a foreign operation. The foreign currency transaction gain or loss on the Japanese yen-denominated debt designated as a hedge is recorded in OCI as a part of the cumulative translation adjustment. As of December 31, 2016 and September 24, 2016, the carrying value of the debt designated as a net investment hedge was $767 million and $1.9 billion, respectively. For further discussion regarding the Company’s use of derivative instruments see the Derivative Financial Instruments section of Note 2, “Financial Instruments.”
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 $509 million and $271 million of interest expense on its term debt for the three months ended December 31, 2016 and December 26, 2015, respectively.
As of December 31, 2016 and September 24, 2016, the fair value of the Company’s Notes, based on Level 2 inputs, was $77.7 billion and $81.7 billion, respectively.

15


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)
2017:
 
 
 
First quarter
$
0.57

 
$
3,042

 
 
 
 
2016:
 
 
 
Fourth quarter
$
0.57

 
$
3,071

Third quarter
0.57

 
3,117

Second quarter
0.52

 
2,879

First quarter
0.52

 
2,898

Total cash dividends declared and paid
$
2.18

 
$
11,965

Future dividends are subject to declaration by the Board of Directors.
Share Repurchase Program
In April 2016, the Company’s Board of Directors increased the share repurchase authorization from $140 billion to $175 billion of the Company’s common stock, of which $144 billion had been utilized as of December 31, 2016. 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 Sheets 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.
The following table shows the Company’s ASR activity and related information during the three months ended December 31, 2016 and the year ended September 24, 2016:
 
Purchase Period
End Date
 
Number of Shares
(in thousands)
 
Average Repurchase
Price Per Share
 
ASR Amount
(in millions)
November 2016 ASR
February 2017
 
44,814

(1) 
(1) 

 
$
6,000

August 2016 ASR
November 2016
 
26,850

(2) 
$
111.73

 
$
3,000

May 2016 ASR
August 2016
 
60,452

 
$
99.25

 
$
6,000

November 2015 ASR
April 2016
 
29,122

 
$
103.02

 
$
3,000

 
(1)
“Number of Shares” represents those shares delivered in the beginning of the purchase period and does not represent the final number of shares to be delivered under the ASR. The total number of shares ultimately delivered, and therefore the average repurchase price paid per share, will be determined at the end of the purchase period based on the volume-weighted average price of the Company’s common stock during that period. The November 2016 ASR purchase period will end in February 2017.
(2)
Includes 22.5 million shares delivered and retired at the beginning of the purchase period, which began in the fourth quarter of 2016 and 4.4 million shares delivered and retired at the end of the purchase period, which concluded in the first quarter of 2017.

16


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)
2017:
 
 
 
 
 
First quarter
44,333

 
$
112.78

 
$
5,000

 
 
 
 
 
 
2016:
 
 
 
 
 
Fourth quarter
28,579

 
$
104.97

 
$
3,000

Third quarter
41,238

 
$
97.00

 
4,000

Second quarter
71,766

 
$
97.54

 
7,000

First quarter
25,984

 
$
115.45

 
3,000

Total open market common stock repurchases
167,567

 
 
 
$
17,000

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 months ended December 31, 2016 and December 26, 2015 (in millions):
 
 
 
 
Three Months Ended
Comprehensive Income Components
 
Financial Statement Line Item
 
December 31,
2016
 
December 26,
2015
Unrealized (gains)/losses on derivative instruments:
 
 
 
 
 
 
Foreign exchange contracts
 
Revenue
 
$
(101
)
 
$
(329
)
 
 
Cost of sales
 
13

 
(306
)
 
 
Other income/(expense), net
 
604

 
120

Interest rate contracts
 
Other income/(expense), net
 
1

 
4

 
 
 
 
517

 
(511
)
Unrealized (gains)/losses on marketable securities
 
Other income/(expense), net
 
31

 
73

Total amounts reclassified from AOCI
 
$
548

 
$
(438
)
The following table shows the changes in AOCI by component for the three months ended December 31, 2016 (in millions):
 
Cumulative Foreign
Currency Translation
 
Unrealized Gains/Losses
on Derivative Instruments
 
Unrealized Gains/Losses
on Marketable Securities
 
Total
Balance at September 24, 2016
$
(578
)
 
$
38

 
$
1,174

 
$
634

Other comprehensive income/(loss) before reclassifications
(451
)
 
1,696

 
(2,797
)
 
(1,552
)
Amounts reclassified from AOCI

 
517

 
31

 
548

Tax effect
76

 
(439
)
 
978

 
615

Other comprehensive income/(loss)
(375
)
 
1,774

 
(1,788
)
 
(389
)
Balance at December 31, 2016
$
(953
)
 
$
1,812

 
$
(614
)
 
$
245


17


Note 9 – Benefit Plans
Stock Plans
The Company had 316.4 million shares reserved for future issuance under its stock plans as of December 31, 2016. 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.
Rule 10b5-1 Trading Plans
During the three months ended December 31, 2016, Section 16 officers Timothy D. Cook, Luca Maestri, Daniel Riccio, Philip Schiller and Jeffrey Williams 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 three months ended December 31, 2016 is as follows:
 
Number of
RSUs
(in thousands)
 
Weighted-Average
Grant Date Fair
Value Per Share
 
Aggregate Fair Value
(in millions)
Balance at September 24, 2016
99,089

 
$
97.54

 
 
RSUs granted
42,882

 
$
117.95

 
 
RSUs vested
(18,535
)
 
$
92.65

 
 
RSUs cancelled
(1,577
)
 
$
105.01

 
 
Balance at December 31, 2016
121,859

 
$
105.37

 
$
14,114

RSUs that vested during the three months ended December 31, 2016 and December 26, 2015 had fair values of $2.2 billion and $2.0 billion, respectively, as of the vesting date.
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 months ended December 31, 2016 and December 26, 2015 (in millions): 
 
Three Months Ended
 
December 31,
2016
 
December 26,
2015
Cost of sales
$
229

 
$
204

Research and development
589

 
466

Selling, general and administrative
438

 
408

Total share-based compensation expense
$
1,256

 
$
1,078

The income tax benefit related to share-based compensation expense was $465 million and $413 million for the three months ended December 31, 2016 and December 26, 2015, respectively. As of December 31, 2016, the total unrecognized compensation cost related to outstanding RSUs, restricted stock and stock options was $11.0 billion, which the Company expects to recognize over a weighted-average period of 2.9 years.

18


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 months ended December 31, 2016 and December 26, 2015 (in millions):
 
Three Months Ended
 
December 31,
2016
 
December 26,
2015
Beginning accrued warranty and related costs
$
3,702

 
$
4,780

Cost of warranty claims
(1,337
)
 
(1,269
)
Accruals for product warranty
2,333

 
1,725

Ending accrued warranty and related costs
$
4,698

 
$
5,236

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. 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 offers an iPhone Upgrade Program, which is available to customers who purchase a qualifying iPhone in the U.S., the U.K. and mainland China. The iPhone Upgrade Program provides customers the right to trade in that iPhone for a specified amount when purchasing a new iPhone, provided certain conditions are met. The Company accounts for the trade-in right as a guarantee liability and recognizes arrangement revenue net of the fair value of such right with subsequent changes to the guarantee liability recognized within revenue.
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.
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.
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 manufacturing purchase obligations typically cover its requirements for periods up to 150 days.

19


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. As of December 31, 2016, the Company’s total future minimum lease payments under noncancelable operating leases were $7.5 billion. The Company's retail store and other facility leases are typically for terms not exceeding 10 years and generally contain multi-year renewal options.
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, as further 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 for asserted legal and other claims. 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.    
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. On May 18, 2015, the U.S. Court of Appeals for the Federal Circuit affirmed in part, and reversed in part, the decision of the District Court. As a result, the Court of Appeals ordered entry of final judgment on damages in the amount of approximately $548 million, with the District Court to determine supplemental damages and interest, as well as damages owed for products subject to the reversal in part. Samsung paid $548 million to the Company in December 2015, which was included in net sales in the Condensed Consolidated Statement of Operations. On December 6, 2016, the U.S. Supreme Court remanded the case to the U.S. Court of Appeals for the Federal Circuit for further proceedings related to the $548 million in damages. Because the case remains subject to further proceedings, the Company has not recognized any further amounts 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 those Asian countries not included in the Company’s other reportable operating segments. Although the reportable operating segments provide similar hardware and software products and similar services, each one is managed separately to better align with the location of the Company’s customers and distribution partners and the unique market dynamics of each geographic region. 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 2016 Form 10-K.
The Company evaluates the performance of its reportable 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 reportable operating segments. Costs excluded from segment operating income include various corporate expenses such as research and development, 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.

20


The following table shows information by reportable operating segment for the three months ended December 31, 2016 and December 26, 2015 (in millions):
 
Three Months Ended
 
December 31,
2016
 
December 26,
2015
Americas:
 
 
 
Net sales
$
31,968

 
$
29,325

Operating income
$
10,494

 
$
10,018

 
 
 
 
Europe:
 
 
 
Net sales
$
18,521

 
$
17,932

Operating income
$
5,736

 
$
5,779

 
 
 
 
Greater China:
 
 
 
Net sales
$
16,233

 
$
18,373

Operating income
$
6,176

 
$
7,576

 
 
 
 
Japan:
 
 
 
Net sales
$
5,766

 
$
4,794

Operating income
$
2,673

 
$
2,240

 
 
 
 
Rest of Asia Pacific:
 
 
 
Net sales
$
5,863

 
$
5,448

Operating income
$
2,229

 
$
2,032

A reconciliation of the Company’s segment operating income to the Condensed Consolidated Statements of Operations for the three months ended December 31, 2016 and December 26, 2015 is as follows (in millions):
 
Three Months Ended
 
December 31,
2016
 
December 26,
2015
Segment operating income
$
27,308

 
$
27,645

Research and development expense
(2,871
)
 
(2,404
)
Other corporate expenses, net
(1,078
)
 
(1,070
)
Total operating income
$
23,359

 
$
24,171


21


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 24, 2016 (the “2016 Form 10-K”) filed with the U.S. Securities and Exchange Commission (the “SEC”) and the condensed consolidated financial statements and notes thereto included elsewhere in this Form 10-Q. All information presented herein is based on the Company’s fiscal calendar. Unless otherwise stated, references to particular years, quarters, months or periods refer to the Company’s fiscal years ended in September and the associated quarters, months and 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 websites are not incorporated into this filing. Further, the Company’s references to website URLs are intended to be inactive textual references only.
Overview and Highlights
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 Watch®, Apple TV®, a portfolio of consumer and professional software applications, iOS, macOS™, watchOS® and tvOS™ operating systems, iCloud®, Apple Pay® and a variety of accessory, service and support offerings. The Company sells and delivers digital content and applications through the iTunes Store®, App Store®, Mac App Store, TV App Store, iBooks Store™ and Apple Music® (collectively “Digital Content and Services”). The Company sells its products worldwide through its retail stores, online stores and direct sales force, as well as through third-party cellular network carriers, wholesalers, retailers and value-added resellers. In addition, the Company sells a variety of third-party Apple-compatible products, including application software and various accessories through its retail and online stores. The Company sells to consumers, small and mid-sized businesses and education, enterprise and government customers.
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 its Digital Content and Services, which allows customers to discover and download digital content, iOS, Mac, Apple Watch and Apple TV applications, and books through either a Mac or Windows personal computer or through iPhone, iPad and iPod touch® devices (“iOS devices”), Apple TV and Apple Watch. 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.

22


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.
Fiscal Period
The Company’s fiscal year is the 52 or 53-week period that ends on the last Saturday of September. The Company’s fiscal year 2017 will include 53 weeks and will end on September 30, 2017. A 14th week has been included in the first quarter of 2017, as is done every five or six years, to realign the Company’s fiscal quarters with calendar quarters.
First Quarter Fiscal 2017 Highlights
Net sales grew 3% or $2.5 billion during the first quarter of 2017 compared to the first quarter of 2016, primarily driven by strong growth in iPhone and Services, partially offset by lower iPad sales. The positive impact of having an additional week in the first quarter of 2017 was primarily offset by lower year-over-year channel inventory growth, an earlier launch of iPhone 7 and 7 Plus as compared to the prior year and the effect of weakness in foreign currencies relative to the U.S. dollar.
During the first quarter of 2017, the Company introduced a new MacBook Pro® with Touch Bar™, an interface that replaces the traditional row of function keys, and released AirPods™, which are new wireless headphones.
Sales Data
The following table shows net sales by operating segment and net sales and unit sales by product for the three months ended December 31, 2016 and December 26, 2015 (dollars in millions and units in thousands):
 
Three Months Ended
 
December 31,
2016
 
December 26,
2015
 
Change
Net Sales by Operating Segment:
 
 
 
 
 
Americas
$
31,968

 
$
29,325

 
9
 %
Europe
18,521

 
17,932

 
3
 %
Greater China
16,233

 
18,373

 
(12
)%
Japan
5,766

 
4,794

 
20
 %
Rest of Asia Pacific
5,863

 
5,448

 
8
 %
Total net sales
$
78,351

 
$
75,872

 
3
 %
 
 
 
 
 
 
Net Sales by Product:
 
 
 
 
 
iPhone (1)
$
54,378

 
$
51,635

 
5
 %
iPad (1)
5,533

 
7,084

 
(22
)%
Mac (1)
7,244

 
6,746

 
7
 %
Services (2)
7,172

 
6,056

 
18
 %
Other Products (1)(3)
4,024

 
4,351

 
(8
)%
Total net sales
$
78,351

 
$
75,872

 
3
 %
 
 
 
 
 
 
Unit Sales by Product:
 
 
 
 
 
iPhone
78,290

 
74,779

 
5
 %
iPad
13,081

 
16,122

 
(19
)%
Mac
5,374

 
5,312

 
1
 %
 
(1)
Includes deferrals and amortization of related software upgrade rights and non-software services.
(2)
Includes revenue from Digital Content and Services, AppleCare®, Apple Pay, licensing and other services.
(3)
Includes sales of Apple TV, Apple Watch, Beats® products, iPod and Apple-branded and third-party accessories.

23


Product Performance
iPhone
The following table presents iPhone net sales and unit sales information for the first quarter of 2017 and 2016 (dollars in millions and units in thousands): 
 
Three Months Ended
 
December 31,
2016
 
December 26,
2015
 
Change
Net sales
$
54,378

 
$
51,635

 
5
%
Percentage of total net sales
69
%
 
68
%
 
 
Unit sales
78,290

 
74,779

 
5
%
iPhone net sales increased during the first quarter of 2017 compared to the same quarter in 2016, driven by strong growth in each of the geographic operating segments, with the exception of Greater China.
iPad
The following table presents iPad net sales and unit sales information for the first quarter of 2017 and 2016 (dollars in millions and units in thousands): 
 
Three Months Ended
 
December 31,
2016
 
December 26,
2015
 
Change
Net sales
$
5,533

 
$
7,084

 
(22
)%
Percentage of total net sales
7
%
 
9
%
 
 
Unit sales
13,081

 
16,122

 
(19
)%
iPad net sales decreased in the first quarter of 2017 compared to the same quarter in 2016 due to lower iPad unit sales and lower average selling prices for iPad, both due in part to the introduction of the 12.9-inch iPad Pro in the first quarter of 2016.
Mac
The following table presents Mac net sales and unit sales information for the first quarter of 2017 and 2016 (dollars in millions and units in thousands): 
 
Three Months Ended
 
December 31,
2016
 
December 26,
2015
 
Change
Net sales
$
7,244

 
$
6,746

 
7
%
Percentage of total net sales
9
%
 
9
%
 
 
Unit sales
5,374

 
5,312

 
1
%
Mac net sales increased during the first quarter of 2017 compared to the same quarter in 2016 due primarily to a different mix of Macs, including the new MacBook Pro introduced in the first quarter of 2017.
Services
The following table presents Services net sales information for the first quarter of 2017 and 2016 (dollars in millions): 
 
Three Months Ended
 
December 31,
2016
 
December 26,
2015
 
Change
Net sales
$
7,172

 
$
6,056

 
18
%
Percentage of total net sales
9
%
 
8
%
 
 
The year-over-year increase in Services net sales in the first quarter of 2017 compared to the same quarter in 2016 was due primarily to growth from the App Store and AppleCare sales, partially offset by the $548 million received from Samsung Electronics Co., Ltd. in the first quarter of 2016 related to patent infringement matters.

24


Segment Operating Performance
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 those Asian countries not included in the Company’s other reportable operating segments. Although the reportable operating segments provide similar hardware and software products and similar services, each one is managed separately to better align with the location of the Company’s customers and distribution partners and the unique market dynamics of each geographic region. Further information regarding the Company’s reportable operating segments can 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 first quarter of 2017 and 2016 (dollars in millions):
 
Three Months Ended
 
December 31,
2016
 
December 26,
2015
 
Change
Net sales
$
31,968

 
$
29,325

 
9
%
Percentage of total net sales
41
%
 
39
%
 
 
Americas net sales increased during the first quarter of 2017 compared to the same quarter in 2016 due primarily to higher net sales of iPhone, partially offset by lower net sales of iPad.
Europe
The following table presents Europe net sales information for the first quarter of 2017 and 2016 (dollars in millions):
 
Three Months Ended
 
December 31,
2016
 
December 26,
2015
 
Change
Net sales
$
18,521

 
$
17,932

 
3
%
Percentage of total net sales
24
%
 
24
%
 
 
Europe net sales increased during the first quarter of 2017 compared to the same quarter in 2016 due primarily to higher net sales of iPhone, partially offset by the effect of weakness in foreign currencies relative to the U.S. dollar and a decrease in net sales of iPad.
Greater China
The following table presents Greater China net sales information for the first quarter of 2017 and 2016 (dollars in millions):
 
Three Months Ended
 
December 31,
2016
 
December 26,
2015
 
Change  
Net sales
$
16,233

 
$
18,373

 
(12
)%
Percentage of total net sales
21
%
 
24
%
 
 
Greater China net sales decreased during the first quarter of 2017 compared to the same quarter in 2016 due primarily to lower net sales of iPhone and the effect of weakness in foreign currencies relative to the U.S. dollar.

25


Japan
The following table presents Japan net sales information for the first quarter of 2017 and 2016 (dollars in millions):
 
Three Months Ended
 
December 31,
2016
 
December 26,
2015
 
Change  
Net sales
$
5,766

 
$
4,794

 
20
%
Percentage of total net sales
7
%
 
6
%
 
 
Japan net sales increased during the first quarter of 2017 compared to the same quarter in 2016 due primarily to higher net sales of iPhone and Services, and the effect of strength in the Japanese yen relative to the U.S. dollar.
Rest of Asia Pacific
The following table presents Rest of Asia Pacific net sales information for the first quarter of 2017 and 2016 (dollars in millions):
 
Three Months Ended
 
December 31,
2016
 
December 26,
2015
 
Change  
Net sales
$
5,863

 
$
5,448

 
8
%
Percentage of total net sales
7
%
 
7
%
 
 
Rest of Asia Pacific net sales increased during the first quarter of 2017 compared to the same quarter in 2016 due primarily to higher net sales of iPhone and the effect of strength in foreign currencies relative to the U.S. dollar.
Gross Margin
Gross margin for the first quarter of 2017 and 2016 was as follows (dollars in millions):
 
Three Months Ended
 
December 31,
2016
 
December 26,
2015
Net sales
$
78,351

 
$
75,872

Cost of sales
48,175

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