Categories

Asymcar 44: The view from Tokyo with Bertel Schmitt

Bertel Schmitt, industry propagandist, journalist and legend joins us for a rousing conversation on production, low-end cars, Tesla, and the Great ‘Round-the-globe Automotive Factory tour Tour.

One of the most fun shows I’ve ever recorded. Highly recommended.

Listen here.

Sponsor: OpenBundle and The Commoditization of Google

We know the story so far. Newspapers controlled distribution, allowing them to bundle content with ads to form a lucrative business. Then Google modularized and commoditized content and moved the profits elsewhere in the value chain by bundling search results with ads.

For one slice of the web — high quality professional content — the discovery method is no longer the hardest thing. Trust is. Discovery is modularized into search, social, newsletters, rss, apps, or directly visiting the trusted source.

OpenBundle integrates trusted sources with a subscription tool, taking the power back. Consumers get credentials to 9 publications of their choosing for one subscription, and publishers take advantage of bundle economics without a middleman, and take back the role of delivering their own content.

If you run a publication with a paywall, please reach out at openbundle.io. We’re forming our launch cohort and would love to tell you about it.

On knowing the value of everything and the price of nothing

At the latest Apple Summit in Los Angeles the question of Apple’s valuation was foremost on many minds. The illustration I used there to discuss valuation is shown below.

It shows the history of revenues (by reported segments) and gross margin for the five largest companies in the world by market capitalization. I have been publishing this illustration for five years[1] in order to contrast the growth and perception of value between companies that might be considered comparable with Apple. Thus the graphs show the top and (near) bottom lines of the companies over an epoch of about a decade.[2]

In contrast with the histories above, there is a price set on the equities today. These prices are captured by the market capitalizations as follows:

Current market cap (billion)  Peak market capitalization (Billion)
Apple

$918

$955

Amazon

$844

$856

Alphabet

$810

$825

Microsoft

$780

$789

Facebook

$584

$589

 

Market capitalizations are interesting because they show perceptions of value. The traders in the equity are negotiating with each other on what the shares are worth and, as a voting system in a liquid public asset, share pricing is very representative of the perceptions about that asset. Representative because there are literally millions of decisions being made on a daily basis which determine this price.

Notes:
  1. initially with Samsung rather than Facebook because it was originally a set of “challengers” to Apple. The fact that with only one substitution the illustration turned into a view of the five largest companies in the world was a welcome surprise. []
  2. This being the iPhone epoch []

Apple Summit, Los Angeles

Technorati and I are proud to announce the first investor summit dedicated to the long-term investors in Apple.

We will host folks interested in discussing the fundamentals of Apple as a business and how it operates as a recurring revenue model.

Titled “The Goose That Lays The Golden Eggs” it was inspired by a blog post from 2013 foreshadowing how human nature instinctively discounts Apple and yet how that nature is mismatched to how Apple actually works.

If you are curious about why Wall Street says “Sell” and Warren Buffet says “Buy” on Apple you might want to spend some time with us.

Agenda:

  • How to read the company’s performance given its published results. We will review how to build a model of the company’s financials and how it can be used to forecast the next quarter. We can go line-by-line through the income statement.
  • How to think about the markets Apple considers important. This is the best way to forecast the company’s performance beyond its current portfolio. This requires calibrating your sense of timing of innovations. What is too early, what is too small, what is something where Apple can’t exercise control? Innovation theory is essential to this understanding. If you know where Apple could go next and where it won’t it helps you build patience into your planning.
  • How to understand Apple’s culture and its resources and processes. This gets into the critical management question that leadership at Apple is concerned with. I’ve had a few conversations with and have some great insight from former managers. Curiously, this is Apple’s greatest competitive advantage and its sustainability is the key “moat” question. Most people don’t even realize that this is the most important question for investors.
  • How to understand the market’s reaction to Apple. If you understand the three points above it becomes necessary to juxtapose how others see the company. There is a compelling case of asymmetry of information even though “everyone” is watching the same data. I use the fable of “The Goose that Lays the Golden Eggs” to best describe how most people react when they observe Apple. Apple is something which cannot possibly exist and therefore it is fragile and must be treated as a transient system. It leads to deep discounting in the market. This cognitive illusion has an opposite: monopolies are over-valued because they are seen as invulnerable and permanent even though they are brittle. I use antifragility as another metaphor. Many anecdotes from Steve Jobs also indicate that he understood this asymmetry and instilled it in the company. Investors need to understand this dynamic in order to profit from it.

Sign up here.

Apple Summit

Just in Time

The iMac launched May 6 1998, exactly 20 years ago. It is not the most significant computer to ever exist. It was a clear descendant of the original Mac which established the “all-in-one” desktop computer category. That category, to which it still belongs, is a modest segment. The last time Apple reported portable sales separately was in late 2012 when the desktops/servers and pro systems combined made up only 20% of all Mac sales by units. If iMac were 10% of Mac sales, it would represent about 2 million units in 2017.

Desktops evolved into laptops and personal computing evolved into pocket  computing. Becoming more personal means more intimacy and this is leading to wearable computing. There is more beyond that to be sure.

But the iMac is a historically significant machine. It allowed Apple to start on a new trajectory. It did this by first offering a financial lifeline. Sales of Macs, which were at the time the only source of revenues for Apple, increased from 2.7 million to 3.8 million a year. This at a time when Windows PCs were shipping about 100 million units. That was enough to ensure survival. Today Mac units are five times higher while Windows PCs are about 2.5 times higher. The following graph shows the impact of iMac on the Mac’s trajectory. 

Sponsor: Drive your ITOM towards Digital Transformation with SaaS

With Enterprises moving towards Digital Transformation, traditional ITOM monitoring solutions have difficulty scaling up to the dynamic environment which encompasses adapting to public and private cloud infrastructure, faster production cycles to name a few. Site24x7 has the versatility to support this complex and dynamic environment which facilitates Digital transformation. Site24x7 covers SaaS based End-to-End monitoring of your entire IT Stack. This includes monitoring the performance of your Servers, VMs, AWS, Public & Private Clouds, Network, Application Performance, Website Performance. End User Monitoring and more. With IT Automation, user also gets to orchestrate incident remediation across the hybrid IT environment. Effective Performance management is also facilitated with a number of performance reports and alerting features.

Site24x7 is the Price Leader in the performance monitoring segment providing the best in class value. It also offers the flexibility for ITOM and DevOps teams to scale based on their requirements through Add-ons.

Determining The Average Apple Device Lifespan

In The Number I provided a model for estimating the number of active Apple devices at any point in time. The relationship between active devices and cumulative devices sold gives us a rule of thumb that says that 2 out of 3 devices ever sold are active.

I propose now that knowing active devices and cumulative devices sold allows one to determine the average device lifespan.

The following graph is a visual representation of how to obtain it:

Note that the second graph shows how the lifespan evolved over time.

Here’s how to compute this yourself: Visually, the lifespan is the distance horizontally between the two vertical bars such that the bars are the same length. The top vertical bar measures the gap between the area (cumulative devices) and the curve (active devices) and the lower bar is the gap between the area and the x-axis, i.e. the cumulative devices. When those two bars are the same size the distance between them is the lifespan (at the time of the top bar.)

Arithmetically, the average lifespan at a given time t is the duration between t and the moment when the cumulative devices sold reached the cumulative retired devices at time t.[1]

For example today–as the visual above represents–the lifespan is the time since cumulative devices sold reached the current total retired devices. The cumulative retired devices can be calculated as 2.05 billion cumulative sold minus 1.3 billion active or 750 million. The time when cumulative devices sold reached 750 million was the third quarter 2013. The lifespan is thus estimated at the time between now and Q3 2013 or 17 quarters or about 4 years and three months.

Note that cumulative devices sold includes Macs, iPhones, iPads, Apple Watches and iPod touch. Since (apart from the Watch[2] ) this information is public, the only figure needed to determine lifespan at any time is active devices and that total is available through the logistic fit described in The Number.

In The Number I argued that active devices is a breakthrough in quantifying the value of Apple’s business. The first insight is into the size of device (read: user)  base, the second is in the resilience of that device base (2/3 in use). Now we see the third insight: the specific length of time or duration of use per device–a proxy for user satisfaction and loyalty. This I (and Deming) argue, is the most important measure of the health of a business because it speaks of the future and not, as all other figures do, the past.

I’ll show in the next post how this single number allows us to calculate the net present value of Apple’s future cash flows, or, by definition, Apple’s enterprise value.

Notes:
  1. For a simulation and tabular explanation see below []
  2. Which I calculate to a satisfactory precision here []

The Number

The first number that Tim Cook mentioned in the fourth quarter investor conference call was the number of active Apple devices. The 1.3 billion monthly active devices is the most important measure of the health of Apple’s business. It’s the primary way the company chooses to measure itself and it’s the best instrument available to understand the company’s strategy.

This is only the second time this number was revealed. The previous figure, given in January 2016, was 1 billion active devices. Thus, while Apple sold 586,744,000 devices[1] the number of active devices increased by 300,000,000. While the number of units sold is frequently updated and attracts a lot of attention, the number of units active is very infrequently updated and attracts little attention. Yet the number of active devices speaks of the future of the company and should be carefully scrutinized while the number of devices sold speaks of the past and should be cursorily glanced at.

Dr. Edward Deming once said that the numbers that best define a company are two factors that do not appear on any financial statement. These factors are the value of a satisfied customer and the value of a dissatisfied customer. These factors must be multiplied by every other number in a financial statement in order to assess the prospects of the business. A high satisfaction leads to repeat purchases and referrals, growing the business; while a low satisfaction leads to ending relationships and a repulsion of potential new customers.

These numbers determine everything about the future and nobody quite knows what they are.

It’s tempting to suppose that, by asking, you can find out if customers are satisfied. Certainly the company cites these answers to the question of satisfaction and it’s partially useful to have some data. But customers are people and people are social beings. They are flawed in that they want to be liked and will use their powers of deduction to determine whether what they say will lead to their being liked more. Thus they will say things which they judge the listener will want to hear.

This auto-suggestion is especially likely when the answer (satisfaction) is so difficult to ascertain and the feeling is so fleeting.

You can’t rely on surveys alone to know if people like your product. You have to base that number on what they do.

This is where the active device data comes in.

A liked product will be used and a well-liked product will be used more. Usage is valuable not just in its intensity but also in its duration. When you see activity of a device it’s always a good sign if that is both frequent and long-lasting.

The following graph shows the history of cumulative devices sold by Apple since mid-2007, when the iPhone was launched. That total is now 2.05 billion devices. I have added early estimates on the number of active devices (in red) based on assumptions about product life-span. I added the company’s own reported figures since then.

I then tried to paint a continuous curve for this active number using a logistic function which assumes a diffusion into a population of addressable users, shown as the grey line above. The logistic curve is a good tool because it has a solid theoretical foundation in social behaviors.

The formula for this line is S÷(1+EXP(−1×(tog)) where S is the point of saturation or maximum population size, t is the period or count of quarters (1 for Q1 2007 and 2 for Q2 2007, etc), o is the offset to 50% or the point of inflection, in quarters, and g is the growth factor.

The S-curve above corresponds to S=1.8 billion, o=35 and g=8.

I chose these parameters because they best fit the data. It does not mean the reality will be precisely this but this is the best guess so far. It implies that there will be about 1.8 billion active devices sometime close to 2022 and tells us how we get there. This can and will change but for now this is the best guess using a theory that has worked in similar circumstances.

Working backwards from this active base estimate, we have predictive power on units sold, and even on revenues. However this is not the whole story. It’s not even the main story. What matters is what it tells us of the relationship between past behavior (purchases) and future behavior (use, referral, repeat purchase). This is hinted at by the ratio between purchases and active devices. In other words, the ratio between cumulative units and active units tells us whether the products are used and for how long. Having a continuous estimate of active uses allows for a reliable measure of satisfaction.

The following graph shows this estimate.

Note that the ratio remains remarkably constant. It’s currently about 64%. It’s so constant that perhaps we can invent a rule of thumb which says that two out of every three devices ever sold by Apple is still in use. And that this rule is always true.

This begins to be interesting.

The staying power and predictability of the business[2] comes from a guarantee that activity is rigidly tied to purchase.

This speaks more than any satisfaction survey. It’s a measure of actions based on interaction rather than words based on human frailty.

There is no better number available to predict Apple’s business.

Notes:
  1. This is an estimate that includes Macs, iPhones, iPads and Apple Watch but does not include Apple TV or accessories such as AirPods. []
  2. i.e. Free cash flow []

Apple Remarks to Investors in FQ1 2018 Earnings Conference Call, Categorized and Annotated

The following is a transcript of the comments from Tim Cook (CEO) and Luca Maestri (CFO) at Apple’s Q1 2018 Earnings Conference Call February 1, 2018. I color coded my interpretation of the comments into four categories:

  • Grey: Background and promotional commentary
  • Red: Strategy and signals of what management considers important and may include data beyond the regularly reported numbers.
  • Green: Financial data
  • Black: Commentary.
  • Blue: My commentary, in brackets.

For a quick read of Apple’s strategy, read the Red text. These comments are not repeated in financial reports. Highly recommended.

For a quick read of Apple’s financial performance, read the green text (which are replicated in financial reports). Read this if you don’t want to wade through the financial reports.

For marketing or product material, read the grey text.This is sometimes unique but also repeats product launch information.

—-
Tim Cook:  Thanks, Nancy and thanks everyone on the call, and welcome to everyone today. Before we dive into the quarter, I’d like to take a moment to talk about a significant milestone we recently crossed.

Apple’s active installed base reached 1.3 billion devices in January and is at an all-time high for all of our major products. 1.3 billion devices represents an astonishing 30% growth in just two years. It speaks to the strength and reliability of our products and our ecosystem, as well as the loyalty, satisfaction and engagement of our customers. It’s also fueling tremendous growth in our services business, which I’ll talk about a little later in the call. [This is probably Apple’s most important number. For at least the next 20 years this is the key performance metric and it can be used to derive company’s valuation. A summary of the history of active devices vs. units sold is shown in the graph below:]

Turning to the December quarter. We’re thrilled to report Apple’s biggest quarter ever, which set new all-time records in both revenue and earnings. We generated revenue of $88.3 billion, which is above the high-end of our guidance range, and it is up almost $10 billion or 13% over the previous all-time record we set a year ago.

It’s also our fifth consecutive quarter of accelerating revenue growth with double digit growth in each of our geographic segments around the world. What makes us even more remarkable is that the quarter we’re reporting today was 13-weeks long, while the year ago quarter was 14-weeks. When we look at the average revenue per week in the December quarter this year compared to last year, our growth was a stunning 21%. [The 13-week vs. 14-week year-on-year comparison is repeated several times. The summary differences are shown in the table below:] 

Our growth was broad-based and a key driver was iPhone, which generated its highest revenue ever. iPhone X was the best-selling smartphone in the world in the December quarter according to Canalys, and it has been our top selling phone every week since it launched. iPhone 8 and iPhone 8 Plus rounded out the top three iPhones in the quarter. In fact, revenue for our newly launched iPhones was the highest of any lineup in our history, driving total Apple revenue above our guidance range. [The iPhone X is a huge hit. It drove the average selling price $100 higher y/y. This is not only unprecedented for Apple but for the entire Industry. The average smartphone sells for less than $300 while iPhones sold for $800. The gap is widening. The following graph shows the product mix and the average resulting price.] 

I want to take a moment to recognize the tremendous amount of work that went into creating iPhone 10. Our teams carried out an extremely complex launch from both an engineering and operations perspective, executing an outstanding product ramp that required years of research and development; one that introduced innovative features like an edge-to-edge Super Retina Display and the TrueDepth Camera, which enables face ID. Our customers love these new features and the new gestures like simply swiping up from the bottom, which make using iPhone even more intuitive and enjoyable.

Our team has put the technology of tomorrow in our customers’ hands today, set a standard for the next decade of smartphones and we are very proud of their achievements.

It was another very strong quarter for services with revenue of $8.5 billion, up 18% over last year, and we’re on pace to achieve our goal of doubling our 2016 services revenue by 2020. The number of paid subscriptions across our services offerings passed 240 million by the end of the December quarter, that’s an increase of 30 million in the last 90 days alone, which is the largest quarterly growth ever. [Services has been growing relentlessly for over a decade. This steadiness of growth makes is a juggernaut. Apple is increasingly speaking about subscriptions as the key metric and 240 million is reaching record territory. The rise of Services is shown below (both revenues and consumer spending.)]


We had an all-time record quarter for the App Store with our best holiday season ever. We’re seeing great excitement around augmented reality with customers now enjoying over 2,000 ARKit enabled app, spanning every category in the App Store. In December, when Pokémon GO released its new augmented reality features built with ARKit, it jumped the top of the App Store charts. Last week, on a stop in Toronto, I met developers who are hard at work on creative applications using ARKit from art appreciation to ecommerce, and I was very impressed with what I saw.

Just for months after ARKit launched to the public, we’ve already released ARKit 1.5 in beta to developers around the world, and the response has been tremendous. Augmented reality is going to revolutionize many of the experiences we have with mobile devices. And with ARKit, we’re giving developers the most advanced tools on the market to create apps for the most advanced operating system running on the most advanced hardware. This is something only Apple can do.

In addition to the App Store, several other services had their biggest quarter ever, including Apple Music, iCloud and Apple Pay, all of which saw growth in both active users and revenue.

Apple Pay has reached an important milestone in the U.S. As a result of 50% year-over-year growth in merchant adoption, it’s now accepted at more than half of all American retail locations, which includes more than two-thirds of the country’s top 100 retailers. Now available in 20 markets, global Apple Pay purchase volume more than tripled year-over-year and we’re delighted to be expanding to Brazil in the coming months. [There are no absolute data points on Apple Pay but we do have some scattered growth data. The US data is cited here but in my experience it’s more popular in select countries like UK where users are using it habitually]

Today, you can use Apple Pay to take the subway in Guangzhou, China, see a concert at London’s Wembley Stadium or buy a souvenir in Yosemite National Park. In the U.S., we launched Apple Pay Cash in December, and it’s off to a terrific start. Millions of people are already using it to send and receive money with friends and family quickly, easily and securely; to split a bill, pay someone back, or send last minute gift right from the messages app.

It was our best quarter ever for the Apple Watch with over 50% growth in revenue and units for the fourth quarter in a row and strong double-digit growth in every geographic segment. Sales of Apple Watch Series 3 models were also more than twice the volume of Series 2 a year ago. Apple Watch is the most popular, smart watch in the world and gained market share during the quarter based on the latest estimates from IDC. [Apple Watch is growing consistently. The following graph shows my estimates of volume (total 42 million to date) and revenues (total $15 billion) based on all available data and commentary from management.]

It was the third consecutive quarter of growth for iPad revenue, thanks to the strength of both iPad and iPad Pro. Based on the latest data from IDC, we gained share in nearly every market we track with strong outperformance in emerging markets.

Worldwide, almost half of our iPad sales were the first-time tablet buyers are those switching to Apple, and that’s true in some of our most developed markets, including Japan and France. In China, new and switching users made up over 70% of all iPad sales.

For Mac, we launched the all new, iMac Pro in mid-December. It’s an entirely new product line designed for our Pro users who love the all-in-one design of iMac and require workstation class performance. It’s the fastest, most powerful Mac ever, delivering incredible computational power, for simulation and real time 3D rendering, immersive VR and complex photography audio and video projects. Worldwide, 60% of our Mac sales were the first time buyers and switchers and in China, that number was almost 90%.

We’re looking forward to getting HomePod in customers’ hands beginning next week. HomePod is an innovative wireless speaker, which delivers stunning audio quality wherever its placed in the home, thanks to the advanced Apple engineered hardware and software.

Together with Apple Music, HomePod gives you instant access to one of the world’s largest music catalogs. And with the intelligence of Siri, it’s a powerful assistant you control through natural voice interaction. We’re very happy with the initial response from reviewers who’ve experienced HomePod ahead of its launch, and we think our customers are going to love this new product.

We believe one of the key issues of the 21st century is education. And because of that, we’ve strengthened our commitment and investment into initiatives like everyone can code. To find the innovators of the future, we need to nurture the students of today. Our App Development with Swift curriculum, which is available free on iBooks, has been downloaded more than 1.2 million times worldwide with almost half of those coming from here in the United States. It’s also being taught in dozens of community colleges across the country, putting practical skills in the hands of today’s jobs seekers.

I was in London two weeks ago as we announced that the program was expanding to more than 70 colleges and universities in Europe. Millions of students around the world will have the opportunity to add Swift to their coding vocabulary and gain skills that are essential for today’s economy.

This is an exciting time at Apple and with the best lineup of products and services we’ve ever had and a set of initiatives that show how business can be a force for good in the world. We could not be more excited about our future.

Now, for more details on the December quarter results, I’d like to turn over the call to Luca.

Luca Maestri: Thank you, Tim. Good afternoon, everyone. Our business and financial performance in the December quarter were exceptional, as we set new all-time records for revenue, operating income, net income and earnings per share.

Starting with revenue, we’re reporting an all-time record, $88.3 billion, up nearly $10 billion or 13% over the prior record set last year. It is our fifth consecutive quarter of accelerating revenue growth. As you know, the December quarter a year ago spanned 14-weeks compared to 13-weeks this year, which is important to consider as we have set the underlying performance of our business this year. When we look at average revenue per week, our growth rate was even higher at 21% with growth across all product categories for the third consecutive quarter.

Our results were terrific all around the world with double digit revenue growth in all our geographic segments, an all-time quarterly record in the vast majority of markets we track, including the U.S., Western Europe, Japan, Canada, Australia and Korea, as well as Mainland China, Latin America, The Middle East, Central and Eastern Europe, and India.

In Greater China, we were very happy to generate double digit revenue growth for the second quarter in a row and in emerging markets outside of Greater China, we saw 25% year-over-year growth.

Gross margin was 38.4% at the high end of our guidance range. Operating margin was 29.8% of revenue. Our net income was $20.1 billion an all-time record, and up $2.2 billion over the last year. Diluted earnings per share were $3.89 also an all-time record and cash flow from operations was very strong at $28.3 billion.

During the quarter, we sold 77.3 million iPhones, the highest number ever for a 13-week quarter. Average weekly iPhone sales were up 6% compared to December quarter last year with growth in every region of the world despite the staggered launch of iPhone 10. We established all-time iPhone revenue record in nearly every market we track with double-digit growth in all of our geographic segments. iPhone ASP increased to $796 from $695 a year ago, driven primarily by the launch of iPhone 10 and the success of iPhone 8 and 8 Plus.

We exited the December quarter towards the lower end of our target range of five to seven weeks of iPhone channel inventory with less than 1 million more iPhones in the channel compared to the December quarter a year ago, in line with our growth in average weekly unit sales. Customer interest and satisfaction with iPhone are very, very strong for both consumers and business users.

The latest data from 451 Research indicates U.S. customer satisfaction ratings of 96% or higher across iPhone models. In fact, combining iPhone 8, iPhone 8 Plus and iPhone 10, consumers reported an amazing 99% satisfaction rating. And among business customers planning to purchase smartphones in the next quarter, 77% planned to purchase iPhone. Our customers are also incredibly loyal with Kantar’s latest U.S. research, reflecting a 96% iPhone loyalty rate, the highest ever measured. [Customer satisfaction is the second most important figure after active user base. Combining these two figures yields the recurring revenue value of the company. Remember what Deming said: the most important measurements for a company’s value are the multipliers of a satisfied customer and a dissatisfied customer–these numbers never appear on any financial report but they are applied to all the numbers on every report].

Turning to services. We had a terrific quarter with revenue of $8.5 billion, up 18% year-over-year and up 27% in terms of average revenue per week; that is an acceleration to the 24% services growth run rate that we experienced in the September quarter.

The App Store set a new all-time revenue record. The Store’s all-new design is off to a fantastic start with quarterly store visitors, transacting accounts and paying accounts, reaching new all-time highs. During the week beginning December 24th, a record number of customers made purchases or downloaded Apps from the App Store, spending over $890 million in that seven-day period, followed by $300 million in purchases on New Year’s day alone.

And according to App Annie’s latest report, the App Store continues to be the preferred destination for customer purchases by a very wide margin, generating nearly twice the revenue of Google Play. Across all our services offerings, paid subscriptions reached $240 million with growth of 58% over last year and they were a major contributor to the overall strong growth in services revenue[Apple has half the user base of Google Android. This is based on Google’s May 2017 report of 2 billion active devices vs. the 1.3 billion that we just got from Apple. And yet these users collectively spend twice as much on apps. This ratio of “half the users, twice the spending” has been cropping up in individual developer anecdotes and can also be seen in other metrics of engagement and consumption. This should not be surprising as it conforms to the Pareto distribution of economic value.]

As Tim mentioned, it was our best quarter ever for Apple Watch. And when we add to this us from Beats and AirPods, our total revenue from wearables was up almost 70% year-over-year. In fact, wearables were the second largest contributor to revenue growth after iPhone, which is impressive for a business that started only three years ago. In total, our other products category set a new all-time record with quarterly revenue exceeding $5 billion for the first time[Wearables now includes more than watches but watches are likely still the dominant product.]

Next, I’d like to talk about the Mac. We sold 5.1 million Macs during the December quarter, which translates to a 2% year-over-year increase in average sales per week. Mac performance was particularly strong in emerging markets with unit sales up 13% year-over-year and with all-time records in Latin America, in India, Turkey and Central and Eastern Europe. On a worldwide basis, the active install base of Macs was up double-digits year-over-year to a new record.

It was also another growth quarter for iPad. We sold 13.2 million units with average iPad sales per week up 8% over last year’s December quarter. iPad sales grew strong double-digits in many emerging markets, including Latin America, the Middle East, Central and Eastern Europe and India, as well as developed markets, including Japan, Australia and Korea. The active install base of iPad has grown every quarter since its launch in 2010, and it reached a new all-time high in December, thanks to extremely high customer loyalty and large numbers of first-time iPad users. [iPad is clearly recovering from a long decline. ASPs are rising as it’s being positioned as a PC alternative. Its low end functions are being absorbed by large screen iPhones.]

NPD indicates that iPad had 46% share of the U.S. tablet market in the December quarter, up from 36% share a year ago. And the most recent surveys from 451 Research found that among customers planning to purchase tablets within 90 days, 72% of consumers and 68% of business users planned to purchase iPads. Customer satisfaction is also very high with businesses reporting a 99% satisfaction rating for iPad.

We are seeing great traction in enterprise as businesses across industries and around the world standardize on iOS. For example, Intesa Sanpaolo, one of Europe’s leading banks, has chosen iOS as the mobile standard for its entire 70,000 employee base in Italy; choosing iOS for its security, user interface, accessibility and reliability, Intesa Sanpaolo will deploy native apps to improve employee productivity in customer support, human resources, and marketing across the company.

And LensCrafters, one of the largest optical retail brands in North America, will be using over 7,000 iPad Pros to enable digital eye exams and digital optical measurements in a personalized and interactive experience. We’re also rolling out a new initiative, called Apple AtWork to help businesses implement employee choice programs more easily and offer Apple products company-wide.

Resources from both Apple and our channel partners will enable enterprise IT and procurement teams to buy or lease Apple products more efficiently, streamline the setup of iPhone, iPad, and Mac, and deliver a seamless onboarding experience for employees. We launched the program with CDW in the U.S. last week, and we would be expanding to more channels and regions later this year.

The December quarter was extremely busy for our retail and online stores, which welcomed 538 million visitors. Traffic was particularly strong during the four-weeks following the launch of iPhone 10, up 46% over last year. And across the quarter, our stores conducted over 200,000 today at Apple sessions, covering topics including photography, music, gaming, and app development, and art and design. Just last weekend, we opened our first store in Seoul, Korea and we’re looking forward to opening our first store in Austria in a few weeks. These newest openings will mark the expansion of our retail store presence to 21 countries.

Let me now turn to our cash position. We ended the quarter with $285.1 billion in cash plus marketable securities, a sequential increase of $16.2 billion. $269 billion of this cash, or 94% of the total, was outside the United States. We issued $7 billion in debt during the quarter, bringing us to $110 billion in term-debt and $12 billion in commercial paper outstanding, for a total net cash position of $163 billion at the end of the quarter. We also returned $14.5 billion to investors during the quarter. We paid $3.3 billion in dividends and equivalents, and spent $5.1 billion on repurchases of 30.2 million Apple shares through open market transactions.

We launched a new $5 billion ASR program, resulting in initial delivery and retirement of 23.6 million shares and we retired 3.8 million shares upon the completion of our 12th ASR during the quarter. We’ve now completed over $248 billion of our $300 billion capital return program, including $176 billion in share repurchases against our announced $210 billion buyback program with $34 billion remaining under our current authorization[An updated look at Apple’s cash is shown below]

Turning to taxes. Due to the recently enacted legislation in the U.S., we estimate making a corporate income tax payment of approximately $38 billion to the U.S. government on our cumulative past foreign earnings. This amount is very similar to what we had been accruing on those earnings in our financial results through fiscal year 2017, including the $38 billion payment. We will have paid over $110 billion of corporate income tax on our total domestic and foreign earnings during the last 10 years for a cash tax rate of about 26%. [Apple has paid more tax than any company in history, and is about the make the largest single payment to the US Treasury.]
Our tax rate of 25.8% for the December quarter was close to our guidance of 25.5% as the lower U.S. statutory rate from the new legislation was effective offset by the remeasurement of deferred tax balances.

As we move ahead into the March quarter, I’d like to review our outlook, which includes the types of forward looking information that Nancy referred to at the beginning of the call; we expect revenue to be between $60 billion and $62 billion; we expect gross margin to be between 38% and 38.5%; we expect OpEx to be between $7.6 billion and $7.7 billion; we expect OI&E to be about $300 million; and we expect the tax rate to be about 15%.

Tax reform will allow us to pursue a more optimal capital structure for our company. Our current net cash position is $163 billion. And given the increased financial and operational flexibility from the access to our foreign cash, we are targeting to become approximately net cash neutral overtime. We will provide an update to our specific capital allocation plans when we report results for our second fiscal quarter, consistent with the timing of updates that we have provided in the past.

Finally, today our Board of Directors has declared a cash dividend of $0.63 per share of common stock, payable on February 15, 2018, to shareholders of record as of February 12, 2018.

The Apple Cash FAQ

  • How much cash does Apple have?

To the nearest million, as of the end of September 2017, Apple’s cash and investments totaled $268,895,000,000. Note that this includes investments in the form of short- and long-term marketable securities. Long-term marketable securities are not always accounted as “cash” because strictly cash is considered a liquid asset and some securities may not be sufficiently so. Nevertheless, most analysts would agree that Apple’s securities are sufficiently liquid to qualify as cash. Note that for archaic reasons this cash is separated into US and non-US holdings with $17 billion located in the US.

  • Most businesses keep very little cash on their books. Why does Apple have so much cash?

Indeed Apple’s cash is extraordinary. It amounts to about 30% of its market capitalization. One reason is that Apple has taken many loans, totaling about $100 billion.

  • Whoa! Why would Apple need to take out loans? Does it have problems with cash flow?[1]

Quite the contrary, Apple’s operating cash flow is eye-watering. In the 2017 fiscal year (ending September) Apple generated $63,598,000,000 from operations. The loans are not needed to operate. They are used to pay shareholders.

  • Why does Apple need to pay shareholders?

Because it’s their money.

  • Wait, I thought you said this was Apple’s cash.

Apple is holding it for them but if it has more than it needs it’s obligated to return it. You see, If you were to look for “cash” in financial statements you find it on the balance sheet as an asset. Since it is growing and since a balance sheet has to balance, there has to be a liability that grows in proportion to offset the cash asset. That liability is called Shareholder’s Equity. This is a “debt” the company has to shareholders. If it pays out cash to shareholders then it zeros out an asset and a corresponding liability. The net is zero as far as Apple is concerned but shareholders get something in return for giving Apple money in the first place.

  • So hold on, it takes out loans to pay shareholders because it “owes them money” while it has too much money? This makes no sense.

Yes, welcome to tax laws. Although it generates more money than it can use, and that money should thus be returned to shareholders, some of the money is collected outside the US. US (and US only as far as I know) tax laws have a “repatriation tax” that is levied on money coming into the country.  This has nothing to do with corporate taxes which are levied on earnings. So after paying shareholders with the cash it had in the US, Apple had to borrow money to pay shareholders money they had outside the US.

  • Why not just pay the repatriation tax?

Because then shareholders would get less than 70% of their money. They would probably complain and blame the managers for being incompetent. Such blame usually comes with a lawsuit attached.

  • What about the new tax law that lowered the repatriation tax rate?

Now Apple has no option but to pay the tax and repatriate the cash. It’s still a tax. The amount will be about $38 billion or about 15%. Previous repatriation “holiday” levies were around 10%.

  • How exactly does the company give money to shareholders?

The payments are called “dividends” and shareholders must treat them as income–a form of double taxation because these funds are after the company paid earnings tax and possibly repatriation tax. Apple does pay dividends regularly but because of tax inefficiency (i.e. because government policy discourages dividends) the company mainly buys its own shares and retires them.

  • Huh?

Yes, it makes little sense but the math is simple. If the company buys its own shares and makes them disappear then existing shareholders will end up owning more of the company, making their shares more valuable. They can realize the gain if/when they sell the shares (and pay capital gains tax instead of dividend income tax on the already (double) taxed profits.)

  • Does that mean that it is going private?

No. The owners of the company remain the same: whoever owns shares owns the company and they can be traded in public exchanges. In theory they could reduce the share count to a single share and there would presumably be a single shareholder who would own the company, making it “closely held” but the company’s managers are still required to report and act as if it was public. Going private usually means a set of shareholders agree not to allow the shares to float on the open market and thus to also keep the affairs of the company out of public eye. It reduces liquidity and is generally harder for shareholders to exit their investment. This has nothing to do with reducing the number of shares in circulation–which is what Apple is doing.

  • But buying shares does not seem to affect the share price so the shareholders are not benefiting from the repurchasing. Isn’t this a waste of cash? Aren’t the shareholders being robbed?

The share price is an argument between shareholders and potential shareholders on the value of the company. It should reflect reality but many times it doesn’t. Over time however the math catches up with sentiment. In other words realization that there are fewer and fewer shares available compels people to not sell them, increasing the price. Short term investors tend not to pay attention to this but they are not the shareholders who Apple wishes to pay back anyway.

  • Why doesn’t the company spend the money on other things? You said they return what they can’t use. Why can’t they use it?

Simply, because it’s more than can be spent wisely. The company considers its mission to be very narrow: add value in specific areas where they can create tremendous value uniquely and under conditions (technologies and business models) they can control. Many such projects don’t require capital. Manufacturing, data centers and Apple stores require capital but R&D and sales not so much. Creating products is very cash efficient. For example, the iPhone–the most successful product of all time–cost almost nothing to develop; certainly nothing that required Apple to dip into its cash. Funding for the type of product development Apple does comes from existing cash flows and mostly consists of salaries for their employees.

  • What about acquisitions? Why not buy other companies?

It buys companies but usually small ones which are essentially acquisitions of teams and their intellectual property. Apple does not buy “business models” or customers or cash flows which is what large companies are valued for. Operationally, it’s also because Apple has a strong culture and it wishes to preserve it. Acquisitions dilute culture which is why integrations often fail. Statistically, large acquisitions are value destructive and the larger they are, the more likely they are to fail. Incidentally, when a company is acquired with cash that hole in the balance sheet is filled with something called “goodwill” which reflects some intangible value of the new asset. If and when the acquisition is deemed to have failed the goodwill is written off and so is shareholder equity. That’s how shareholders are robbed.

  • What about keeping it? Doesn’t having lots of cash make Apple more powerful?

As individuals we think that having lots of cash makes us rich. For companies it’s the opposite. Cash is a liability. If you come across a company that is cash rich and has nothing else, its enterprise value will be zero. Companies are valued on their future cash flows, meaning their ability to generate cash, not how much they managed to keep. In other words, cash is a measure of past success and investors are interested only in future value. That future value comes from the intelligent allocation of resources toward a valuable goal. A company rich in cash but poor in vision is likely to be taken private or broken up and shut down. Cash is an IOU to shareholders with a thank-you note for the support through the years.

Notes:
  1. Companies often borrow because they need to plug gaps in profitability, best measured as “free cash flow”. []