dividend

A transcript of the May 1, 2026 Asymco One Office Hours, recorded one day after Apple's Fiscal Q2 2026 earnings call. Horace Dediu presents his analysis of the quarter and takes questions from Asymco One subscribers. Hosted by Horace Dediu and Farshad Nayeri.

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Horace Dediu: So I'll do a short presentation, and then we're going to open it up for questions. We are speaking approximately one day after Fiscal Second Quarter 2026 earnings call. Let's dig into it and see if we can understand it even better.

First, I think that there was a comfortable beat from already a highly elevated expectation.

So we had a range of estimates— I collected those from Yahoo and TipRanks, each one had about 30 [analysts], probably a lot of overlap between them. So we had a range of about 105 to 115 in terms of revenues in billion, and then we had EPS in a range of about 1.6 to about 2.15.

And not only did it beat the consensus, but also you can see what happened a year earlier, which is the circle at the bottom of the graph. So the beat was from already a pretty high growth rate expected from the year before.

So we have a measure of how each of us, myself included, performed relative to the actual results.

I was about 1.8% under revenues delivered, and 1.6% on EPS. And then you can see red is Yahoo and blue is TipRanks.

So speaking for myself, I was perhaps a little bit too conservative on my revenues, and I was a little bit more accurate, relatively speaking, on EPS. Roughly speaking, again, I think these are not big errors, 1% to 2%. Worst case, 3% on the consensus basis.

Now, on the segments, these are the actual growth that we ended up with, iPhone almost 22%, 16% on services, 8% on the iPad, which is impressive. 5.7 on the Mac, we'll talk about that a little bit, and 5% on wearables and growth.

Segment level, again, the worst case, you're looking at an 8% overestimation on the Mac. The Mac— I think a lot of people, once they saw the Neo come out, once they heard about the Mac mini stockouts, when they heard about the Claude bots, you know, everybody buying up all these Macs, there was an expectation of a big boom in the Mac, but those all happened fairly late in the quarter. My expectation was a little bit over, but not as much. I was off about 3% on that estimate. So although we saw 5.7% growth, some people expected double digits. Also, the pros had the same fault there.

Overall, though, I think these are pretty impressive. I didn't break out the geographic segments. China grew extremely well. Rest of the world, that grew very well. Management also pointed out that they're doing very well in developing markets. So overall, regionally, there were some extraordinary performances. But as we see here, just the iPhone was incredible, 22%. Very similar to performance in the previous holiday quarter, where, again, unprecedented growth, or at least in the near history of the product.

And we'll get into some reasoning why that is. People talk about super cycles, people talk about the assumption that we have these giant surges once in a while. Well, here's how to look at it.

There are two graphs here. The bottom graph shows in green the net sales, but trailing 12 months, so it's smoothed out, so we don't see the spikes on the holidays. That's the green line. Above that, we have the EPS line. Now you'll see how they tracked very similarly for a while, and then they began to diverge. That occurred around COVID. It also occurred during the surge in services, especially subscriptions and services. But still, there's a similar pulse, if you will, a cyclicality to it.

I mean, part of that has to do with the introduction of a new form factor. This has been true all the way back since 2012. When a new iPhone comes, especially a new, distinctive-looking iPhone, people will go out, especially in China, buy it for showing off that they have the latest, which there's nothing wrong with that. But then the second year usually is not the same, the phone is not new, it's the same form factor. That has to do a lot with tooling. That's a long, old story, that the tooling is depreciated on a two-year schedule, so you're going to produce roughly the same look a couple of years in a row, and then by the next cycle, you'll see people upgrading or replacing their older phones. So you're going to have this— I guess what they used to call a super cycle.

And you see it also in the upper graph, where I try to separate out of sales just the phones. Now this is an estimate because we have no unit sales for the phones since 2018, so some of that is an estimate. But you'll see again, once you smooth out the cyclicality, you'll see these surges once in a while. Now, again, this is a valid observation, but I don't think it's the main driver. The oscillation isn't huge, it might be significant, but it's a blend of many things.

The bottom graph is particularly interesting. The gray areas are when the stock price fell. And the red line represents the derivative of EPS. And you'll see how, when that is about to dip, there's usually a stock price sale going on. I wouldn't say it's predictive, but it's an interesting pattern to go through.

So what's happening now? You'll see from the iPhone, there's a new surge happening. Now, when Tim has been asked this question, he says that, well, the iPhone 17's really nice, people really love it, and that's a good answer, but the fact is, it's a distinctive-looking product. Some say it's the orange color, but it's certainly attractive. So we're seeing this pattern, a nice surge.

We'll get into the guidance in a minute, and that actually demonstrates that we're in some kind of an acceleration. But here's the thing, underneath all that, services is just absolutely steady growth, compound growth, and as a result, it just lifts the whole story.

Here, services is at the bottom. Normally, in a graph like this, you want to put the oldest products at the bottom and the newer ones at the top, but I wanted to highlight the fact that services is foundational, in the sense of showing how it holds up everything else.

Most people put it the other way, they say the iPhone holds everything up, but services is looking more and more to be the thing that keeps people in the ecosystem. There's a lot of value there. There's a lot of things people depend on there, and I think it's one of the reasons people don't switch. So it's another one of these stories that people aren't appreciating enough. It's been years and years of pounding the table on services, but here you see it, just how important it is. It's the tide that lifts all the boats, and the boats being all the products.

So let's now talk a little bit about margins. Unbelievable, unbelievable margins. We just hit almost 50% on gross margins. Gross margin here is the blue line. And that's composed of two subcategories. We have services in red at the top, and we have products with the purple triangles.

And although products margins are exceptional— they're right around 40%— those services, again, are pulling the whole average up, and you can see that bend in the curve in the blue line, where we were very steady around 40%, but as services took more and more; it just pulled the whole curve up.

And we also see here operating and net margins, which also are going up, naturally. There is a little bit more operating expense. We'll get into that, which maybe decreases the slope of the bottom line. But this gross margin is absolutely incredible. We just haven't seen anything like this since 2010-11. We saw that surge back then, and then it sort of leveled out, and everybody was happy with 40%, and now we're flirting with 50. I just cannot believe it.

Just one more thing. I remember being an analyst decades ago, when I was looking at different companies in hardware and software, in phones and computers and so on, and everybody was really impressed by Microsoft, because Microsoft, had an 80% gross margin, because there was very little cost of sales. That's exceptional. An 80% margin business is a money printing machine. And everybody was impressed and jealous of Microsoft that they could pull that off. Of course, Microsoft, a software company, is going to have extraordinary margins, right?

And so for a phonemaker like Nokia, there was something to be jealous of. And here we are with Apple services, a significant component on the business, approaching also almost 80% right now. And it's still rising. I just can't get over how impressive this is.

R&D Acceleration

A little bit about the difference between gross and net— you have to take out the operational expenses, and this is what we have here. It's interesting what's happened. Obviously, you see R&D overtaking on the absolute basis. So R&D overtook SG&A already in 2021. And now it's just [going] almost vertical.

By reading a little bit the guidance, I think it's going to taper a bit into the next quarter. But what we see is a significant R&D increase, also as a percent of sales, which you're seeing below in the graph below, but in a stacked fashion. In that sense, the two of them together are now approaching— haven't yet reached— a percentage of sales that was in evidence around 2007 and 8, when the iPhone was just emerging. But you'll see back then, R&D was tiny, SG&A was huge as a percent of sales. So much so that R&D—this is during Steve Jobs era, R&D was like 2% of sales. And now it's approaching 8%, which is extraordinary. Because that's an engineering company that's doing breakthrough work.

And that's something that Apple's not recognized for doing. There's a negative side of spending a lot on R&D. The positive, though, is that Apple is doing a lot of fundamental research now. This isn't fixing products, this isn't updating OS. This is engineering that is really driving what might be considered breakthrough. And that's something— and I've said this to the media when interviewed about Ternus and the succession— I said, the new CEO will need to be— this is before he was announced— I said [the CEO] would need to be someone who is acceptable to engineering, because Apple is an engineering company today. Fundamentally, culturally, operationally, it's an engineering company, and it is being now led by an engineer.

Steve Jobs was not an engineer. And none of the other CEOs were engineers. Tim Cook was an operations manager. He was excellent in a fundamental part of the business. And that is acceptable to engineers, culturally speaking. But the thing is that John is an engineer's engineer. He understands the culture of engineering and will understand how to motivate and retain talent, as well as to allocate capital effectively, not wasting it on pipe dreams. Engineers have a tendency to try to chase dreams, by the way, so you got to be harsh sometimes to shut things down. So, keep an eye on the R&D— it's a great story.

However overdoing it can be a problem. There are downsides to an engineering-led company where, again, it turns into kind of an engineering welfare state. Engineers tend to get projects and do a lot of navel-gazing, which needs to be managed carefully.

Now, let's just touch on ACTIVE. Active is the number of users, the fundamental measure of the value of the company. It's not counting iPhones. It's counting users, and these are the comments from management, just so we capture them. They come every quarter. Sometimes some products are mentioned, sometimes they're not.

So here's what we have exactly on the topic. Record upgraders and customers new to the Mac. They mentioned that Mac lifespans have been long, which is good and bad. They talk about the iPad, half the customers being— over half— new to the product. Same with the Apple Watch, this has been going on for a while.

So this is going to be important when we measure installed base, because if we see every quarter an estimate for the number of watches, or Macs, or iPads, you just take half of that and allocate it to the installed base, and the other half is growth of the installed base. So there's an interesting way to measure that, and I've been applying it. We're going to keep an eye on this.

And finally, there was a mention with respect to India during an answer to the question. The citation is that the iPhone, Mac, iPad, watch, all of these have a majority of customers that are new to the product in India. As you would expect, part of the developing market story. But this drum is still getting beaten. And that's a positive. Always want to look forward to that every quarter.

So let's jump in now to what I thought was the most unexpected comment during the call. I've pasted in here exact, verbatim the comments from the CFO. I need to point out a few things here, and I've highlighted these things in bold.

One is the dividend. The dividend number is 3.8. Last quarter was 3.9, so that's not a surprise. However, open market purchases were only $11 billion. Now, that is represented in the graph by the buyback, and that is this mustard color. And you'll notice it is extremely low. The previous quarter, we were over 25 on buyback, so we're less than half that. This is an anomaly. You'll see that it does not match the rest of the graph at all.

The blue area is dividends. The reddish area is net share repurchases, or settlements. And there's a pattern to both. Dividends has been growing in a predictable fashion, very steady. Buybacks have been somewhat steady, but up and down a little bit. During the last few periods, we've seen something unprecedented.

Now, you'll see that the 11 from last quarter was offset by a much higher number the previous quarter, but on balance, we're still down. And there's also these comments that say that they are abandoning the net cash neutral position. And I'm wondering if it's already started, because this $11 billion caught me by surprise.

I've highlighted that "our repurchase activity at any time can be affected by a number of factors that we take into account." So this was essentially explaining why sometimes there's a difference in the amount of purchases, right? And then in the middle of that commentary, he says, "as you're aware, we recently announced a CEO transition." Why does that comment fit in the middle of a paragraph, talking about the general theme?

I read this as it suggests that already the CEO choice is deciding how much to allocate to capital returns. And it appears— and again, I could be wrong— but it appears that John is probably against the idea of huge returns to shareholders in capital form. So keep an eye on this. This was, I found, very, very strange and out of character in a way. Very out of character of a Tim Cook presentation. I'm not judging it, I'm just pointing out that it isn't normal.

So here's the bottom line. This is the graph representing what's happening with the entire cash position and return of capital. The debt has decreased slightly, and it has been decreasing. And that's a good thing. As interest rates go up, you don't want to hold debt. A lot of that is fixed rate, but they're not taking on more. It seems like they're paying it down.

Net cash, which is the blue dotted line, has now been increasing two quarters in a row. Now, it's increased in the past, but never for long. It's had only one tick, during the holiday period. Here, where we're seeing two ticks— holiday and the quarter after.

Now, if you'll notice here, I'm going to try to zoom in. Those red lines represent what I would say were the trajectories to get to net cash zero. So that blue line, since they announced it, they kept missing the target. You would see that, another year goes by, and there's a notch up. Overall, the trend is down, but they haven't kept that path down all the way to zero. And that is now completely abandoned.

Again, we'll have to figure out why. The buyback, as I mentioned, halved— at least more than halved— to 11. Net cash zero abandoned, $100 billion net cash reduction. You'll see that this blue dot line has gone down by about half. It was down even further than that until it came back a bit. So that is going from about $160 billion net cash to the current $62 billion, which is why we get to 100 reduction. And $1 trillion overall return, which is, again, something they mentioned. In fact, they're at $1.085 trillion. And still $100 billion will be allocated further. Whether they actually spend it is another matter, but that's been approved.

So now— is this good news or bad news? I don't think it matters. I think at the end of the day, the value of the company doesn't change because of this. The value might be captured in the share price, or it might be captured as a percentage of the company that has been increasing.

In fact, let me just pop into the next slide. What does this mean? Are we never going to reach what I call the halving? Well, we were at the maximum 26.5 billion shares. And now we've reduced that to about 14.6. Half would be 13.2. So we're still going down. But there's 1.4 billion shares to go before it's half of what the max was. Now, this is an arbitrary figure. I just thought it was an interesting target to have. And as you can see, it's getting asymptotic as the price goes up. It should be harder and harder to get there. But we have $100 billion allocated. $260 billion at the current share price would need to be spent to get to half. But probably we're not going to get there. I really don't— if I were a betting man, I would say we're probably going to see this taper.

Let's look a little bit at guidance. This is based on what management already communicated. So if you put in the numbers they gave us, you will get revenue growth of 16%, coming at about— well, they guided 14 to 17, so I'm estimating 16 conservatively right now. That gets you to $108.7 billion. If you put in the other numbers— the margin, the OI&E and the tax— and do something about this share reduction. (We're still going to probably see a share reduction.) We're going to look at EPS 1.92. Which is another 22% growth. This is what we had last quarter as well.

I'm putting gross margin at the top of the guidance. [Last quarter] they went over. They guided high, and even so they went over, so I'm going to assume they're going to still hit towards the upper end of the range. I'm exactly at the upper end of that range.

If those things are true, the iPhone almost necessarily has to grow about 19%. Now, here, I'm dialing the Mac way up to 18% growth, because I do think they're going to get a lot more Mac Neos into customers' hands. Now, that's a lower price point, but it will drive sales. So yeah, I could be a little bit high on this. If I am, then iPhone needs to go a little bit higher because I still think they're going to get the revenue there.

They did warn that iPad is facing a tough comp, so I'm putting iPad down 3%. Wearables and home, 4%. It was 5% last time, so maybe consistency there. And Services, just the same as before, 16%, could come in a little bit less. But if it does, again, it's going to be put into something else like the iPhone.

So overall revenue growth, I think 16% is very much being telegraphed. And as I always say, they already have April on their books. They're communicating exactly at the end of April. They're not going to lie to us and withhold data from April. They know about a third [of the quarter] already, so that's why this guidance is so useful.

And, as you saw with my error analysis, nowadays, people's estimates are very close. There's a lot of consistency. We're not off more than a couple percentage from each other. That's just because they're so accurate on their guidance.

And speaking of analysts, one more graph. This is just some of the latest price targets. I'm just trying to bring everything together that came out today. This is all very brand new. A lot of targets moved up. Not that it's all that important, but people are getting more and more excited. Almost all the targets from anybody who has a positive— effectively a buy rating— is now above $310 as a target. There's two who are negative, that are at 270 and below. This is Barclays and Rosenblatt. And then there's a few which have no ratings. So they're typically neutral.

But overall, all these numbers are higher than they used to be. Now, again, I don't use that very much, but it's worth keeping an eye on things just to get a sense of how the sentiment is out there. And it looks like the stock is responding positively today. Not by much— 3% or so, last I checked. But that's the story today.

So given that, this is my first take on the quarter. Love to take questions.

-- End of Presentation --

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• Geopolitics: China concentration; Taiwan tail risk
• Financials: Solid near-term growth
• AI: Critical narrative shift; to be proven
• Growth Strategy: User expansion
• Business Model: Evolution: hardware → services → Personal AI platform
• Moat: Privacy + integration; trust

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Apple has so far returned $761.5 billion to shareholders. 143.3 billion in accumulated dividends and $618.2 billion in share buybacks. These are the gray areas in the graph above. The question that often comes up is: isn't this capital return program a misallocation? In particular isn't buying back shares and retiring them a waste of money?

By definition, it cannot be. The mechanism of buying shares and retiring them is a process of returning retained capital to shareholders. The other ways this can be done are through dividends (periodic or one-time) or the sale of the company (liquidation). Ignoring the liquidation option which does not make sense for viable companies, the decision between dividends and buybacks comes down to a tax efficiency question.

The result is, however, roughly the same: retained earnings, which are stored by the company as cash typically (net value for Apple today is $57.2 billion), are an asset balanced by a liability to the shareholder called Total Shareholder Equity (valued today as $60.3 billion.) As such, the retained earnings belong to the shareholders. It's why they own the company. It's what their cash share of the value in the company is.

It's also surplus to the company's needs. Had the company needed this cash, it would have spent it on building the products and services it sells or operations that maintain or grow the business. Those expenses appear in cost of sales (COS) or cost of goods sold (COGS) or in operating expenses Sales, General and Administrative (SG&A) or Research and Development (R&D). If it's not spent this way then it drops to the net income line and, crucially, is subject to taxation (about 12% to 15% for Apple). After taxation, once returned, it's taxed again as either capital gains (in the case of buybacks) or dividend income. These rates vary on the jurisdiction of the owner and the current tax policy.

Note that the spending on R&D includes development of future projects which are not directly related to current products. Engineering of current products is expensed against COGS. R&D for Apple ($29.4 billion in last 12 months) is significant, having grown to 9% of sales, as the graph below shows.

For the company to decide to return capital it really does mean that it has no good ideas on how to spend it given what the company knows it can and cannot do. It's a judicious decision and one which honors the relationship between owner and manager with fiduciary responsibility to the owner.

Still, doesn't that mean it's wasted?

No. Giving it to the shareholder means that the company says "It belongs to you, I don't know what to do with it on your behalf, so here, you figure out what to do with it." The shareholder can then make an allocation decision that suits their sense of what is valuable or useful. The return is a deferral of decision to the owner rather than their agent.

To the extent that once returned, the capital is misspent, that is on the spender, not on Apple.

Consider the alternatives. Instead of returning capital, what some managers decide to do is to re-allocate those retained earnings to acquire other companies with the promise of value creation through synergies. However these are often huge wastes of money. The new asset is recorded as "goodwill" on the balance sheet, offsetting the retained shareholder equity. As the synergies fail to materialize, the asset (goodwill) is written off, and shareholder equity decreases accordingly, and so, value evaporates or is transferred to the owners of the acquired company who cash out above market value.

Acquisitions are a process of picking the pocket of shareholders.

The alternative might be to spend heavily on R&D. That is more admirable but the amount involved is enormous and it's very difficult to find enough people and projects worth pursuing without turning R&D into an academic organization. Remember that with R&D at $7.4 billion per quarter, the company is spending 41 times more than it did in 2006.

And doubling or tripling R&D, even if possible, would impact margins to such an extent that Apple's profitability would show very poorly indeed. That would collapse share prices and decrease share-based compensation, limiting the possibility of recruiting talented engineers. It would bring quite a lot of negative consequences.

Another exercise to undertake would be to ask what would happen if the mechanism of share buybacks were made illegal. It was not always legal anyway. That is left as an exercise to the reader.

The Apple product line-up for 2023 is almost completely decided. This is not conjecture but simply an observation of the lead times for developing the types of products that Apple offers. The integration of hardware, software and services, often cited as the key to Apple's sustainable competitive advantage, has a great cost: the time required to develop in an integrated fashion is far longer than the time required to develop in a modular fashion.

2.5 years is not a long time. The development process on truly new products could take 4 to 5 years. Apple Silicon, new Operating Systems and new services could all take longer than 2.5 years. The products we just saw launch this year were planned and engineered at least 2 years ago. The more integrated, the more time is needed. Wearables, AI/ML and process engineering are additional examples of long arcs of development needed to reach products.

This does not mean we can predict what these products will be. We don't have visibility to the process but Apple management does and they will make decisions now on adjacent dependencies in the business. For example, visible efforts in planning the use of cash, the carbon offsetting, capital expenditures and R&D are all synchronized to the roadmap and hints may be read into this data.

The biggest hints are the R&D spending and the company's capital return program. Combined they show a confidence in the roadmap that is hard to overestimate. First, R&D is reaching new highs of about 7% of sales (on a trailing 12 months' basis, see graph below). This is almost the same as the spending on SG&A which has declined as a percent of sales from above 12% pre-iPhone.

Of course sales have increased significantly over the time shown in the graph below and the absolute spending is shown the following graph. R&D spending is over $5 billion/quarter or about $20 billion/yr. Some of the results of this will be seen in 2023 or beyond.

Next, capital returns. The company is returning almost all the cash it generates and is reducing its cash balance. It has returned about half a trillion dollars to date. Dividends paid has reached $100 billion and share buybacks about $400 billion. This is the largest capital return in US history.

The company has declared its intention to reduce net cash to zero. This means it will still have substantial cash due to loans in the form of bonds but no "excess" cash will be held by the company. This is in contrast to the strategy under Steve Jobs where he sought to keep as much cash on hand as possible due to the need to weather potential storms, Tim Cook's Apple is being very "casual" about cash.

Steve Jobs had his reasons for hoarding cash. The company had been through periods of existential crisis. The absence of cash jeopardized its independence and it was something he vowed never to happen again.

However if that strategy would be maintained to this day, as the graph shows, the company would have cash of nearly $700 billion today. It would make Apple the world's largest hedge fund, by far. Second only to a very few sovereign funds. Given a conservative cash preservation mandate it also means that that capital would largely go unrewarded because the return on it would have been minimal, negligible. Not to mention also the target it would paint on the company's balance sheet.

So given the trajectory in net cash being so consistent, it's probable that the goal of net zero will be reached mid 2023.

That leaves the question of what will happen at that time?

The answer is nothing. Nothing will happen. The capital return programs will probably be ended and additional cash generation will be paid as dividends going forward. That's it.

Rather than suggesting a change, the capital return program (and the R&D program) suggest a lack of change, consistency. The company management is anticipating a steady capital generation rate, a steady product roadmap (with predictable growth) and a steady customer base (with predictable loyalty).

This future for Apple in 2023 may seem boring. But that's exactly the plan. This is a plan that the company management has been making for a long time and has been executing for a long time. The plan is to be boring on the business side but exciting on the customer product side.

Consistency has been the characteristic trait of the Tim Cook era. It is a smoothing of seasonality with services. It is the clockwork delivery of product updates, regardless of macro and externalities. It is a growth in user base consistent for a decade.

It is perhaps because more people believe that consistency is the future that we have Apple's P/E ratio now in-line with its peers. Paradoxically, being boring is what makes Apple shares so exciting today.

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.

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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.

• 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? ((Companies often borrow because they need to plug gaps in profitability, best measured as "free cash flow".))

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.

Prior to implementing a dividend and share buyback plan, Apple had accumulated about $120 billion in cash and marketable securities. In the eight quarters since implementing the cash return plan, Apple has paid about $21.5 billion in dividends and spent another $53 billion of its shareholder's money buying its own shares and retiring them. That's $74.5 billion in cash that's been removed from its balance sheet.

To avoid some repatriation taxes it also borrowed about $29 billion.

Of course, in the meantime, it also generated cash from operations.

Before the plan's implementation, eyeing the cash allowed for easy tracking of the accumulation of retained earnings. After the plan it's become a bit more complicated. The following graph shows all the quantities involved:

The graph lets us answer the question "What would have happened if Apple had not paid any dividends, bought back shares and taken on debt?" ((The grey and black area of the last column is the total "cash returned to shareholders" and sums up to the $74.5 billion mentioned earlier. The grey area is only theoretically valuable as it depends on the outstanding (i.e. not retired) shares retaining their value. In this case, the value of the shares grew, making this an actual gain for shareholders))

The answer is in the blue line. It would be about $210 billion today. There are about a dozen companies other than Apple worth more than that amount.

As the company is not growing as quickly as it used to, the slope of the blue line is constant (i.e. it's nearly linear.) Though that might be seen as evidence of failure, it's more useful to treat this vast quantity as a recognition of past successes. The company's beleaguered status needs to be carefully preserved.

One of the arguments made for the cause of the increase in Apple's share price of late has been that dividends would attract more institutional investors and provide more liquidity to Apple's shares. Can we test this argument?

We're not dealing with speculation. The decision to start paying dividends was made three weeks ago. It makes sense to assume that this new information has been absorbed by the  markets and market participants have adjusted their positions. Funds that were previously restricted in their investment in Apple due to its lack of dividend policy, could now go ahead.

However, as the following chart shows, the share price climbed continuously before and after the dividend declaration of March 19th (shown in red). Trading patterns did not show unusual highs or lows. In fact, after March 19th the trading volume decreased on a weekly basis.

The other indicator is institutional holdings. The share of institutional investors as percentage of all outstanding shares did not increase significantly, and has been in an overall decline since late 2010.

But this lack of visible response to the decision should not be surprising.

Dividends are a tool to adjust capital structure based on optimal investment decisions. Dividends do not add value. The value of a company reflects the perceived net present value of all free, future cash flows. Whether the cash is in or out of the company is immaterial to its value. In either case the cash belongs to shareholders.

What the market is reflecting is fundamentals, not any change in liquidity due to "more buyers" available. For a long time the fundamentals were not accepted as sustainable. The best explanation for the rise in the share price is therefore that the company's future is now becoming clearer and a cloud of doubt is being lifted.

Today Apple announced both a dividend and a share re-purchase plan which, when combined, will consume 45% of Apple's current US cash reserves.

The dividend will be $2.65/share/quarter and the buyback will cost $10 billion over three years. The dividend will therefore cost about $2.5 billion per quarter (starting next quarter) and the re-purchase will cost about $833 million per quarter (starting next fiscal year).

However, note that Apple's cash has been growing far more quickly. It increased by $16 billion last quarter or $37 billion over the last year. This rate of increase is itself increasing.

To illustrate, I prepared the following chart. It shows historic net income, change in cash and a forecast of the costs of the new uses of cash and future net income (based on my estimates).

I made an assumption that future cash growth will equal net earnings minus costs for the new dividend and share re-purchase. What we should see is that the previously tight coupling between increase in cash and earnings will remain but that there will be a negative offset by $3.333 billion each quarter. In other words, cash will increase but at a slower rate.

This means Apple's total cash should still grow by more than $35 billion this year.

That would result in the following, more subdued, total cash trajectory (for simplicity, I assumed all added cash would be in cash and cash equivalent accounts)

In his third “The Critical Path” podcast, Horace Dediu explained how Apple’s cash can be viewed as a strategic option, an opinion that resonated also with other analysts [1]. Cash is one of the most flexible resources as it can convert quickly into other resources such as brands, companies, technologies, people and even processes. More cash means more strategic flexibility. The large cash reserve Apple has accumulated provides high flexibility for future investments. These characteristics of cash already imply an intrinsic option value. But how big is this value?

Calculating Option Value

To help us determine, I will apply the Black-Scholes model. The model has two key characteristics that are applicable to valuing the option character of Apple’s cash. First, the simple form of the calculation excludes dividends and, as far as we have seen, there is no new information available that would suggest that Apple will pay dividends in the near term. Second, it implies that the option can be exercised at any given time until the end of the option exercise period - just like any buying or investment decision made by consumers. Lastly, we will assume that Apple’s cash (including short-term and long-term cash as well as financial investments) is instantly available. Although large amounts are held by foreign subsidiaries or are invested in maturities longer than one year, we can overcome these practical issues by borrowing against it. As we are interested in the value of the whole pile, we use the latest reported figure of $81.6 billion as the strike price (or exercise price).

What other inputs do we need to determine the option value of Apple’s cash [2]?

• Volatility: A measure that determines financial risk of a certain asset. Apple’s share has shown a volatility of 26,1% over the last year.
• The risk free rate determined by the 10 year US governmental bond interest rate: 1,96%.
• A timeframe in which the option can be exercised. Let’s assume a 10 year timeframe in line with the risk-free rate and an imaginable horizon for mere mortals.
• The value of the underlying (or what Apple is investing in):

The return of the investment exercised with the cash at hand should yield a higher Return on Capital Employed (RoCE) than previously achieved to increase shareholder value. On the other hand, such a high cash pile also provides the flexibility to invest into lower return ventures. Such an investment would be taken if a certain technology or trend has been missed by management or becomes suddenly more important in the priorities of the company. In defensive moves or moat creating ventures, the expected return would be significantly lower or can even be negative. For the last twelve months, Apple has returned 106% in terms of operating income over its capital employed [3]. I use the return to value the underlying. For example, investing $81.6 billion in assets that yield 106% return equals a underlying value of $168 billion.

The chart below shows the option value of the cash as a percentage of enterprise value of Apple (at the time of writing $310 billion) based on the range of the expected return on capital employed. Or in other words, how much of Apple’s current value is explained by the option value in holding such a large cash reserve.

Conclusion

Therefore, with the assumptions above and a RoCE from -10% to 110%, between 8% and 35% of Apple’s current valuation is explained by the option value of cash. We can see that even with large variations of the key input variables, Apple’s enterprise value is partly explained by the option value of cash which, in turn, is attributable to the sheer amount of cash at hand.

If we look at the option value explaining 25% of Apple's enterprise value then 75% or $232 billion is the "Residual Enterprise Value" (REV) representing the value of Apple's cash flow generating operations. That puts Apple's valuation at 6.9x REV/EBIT 2011 or 6.5x REV/EBITDA 2011 -- fairly low relative to recent performance. EBITDA and EBIT have been growing at a rate of 70% for the last two years and at a rate of 84% over the last year alone.

1. It’s good to be king (http://5by5.tv/criticalpath/3) , Apple: Behold The ‘iEndowment,’ Says Wedgewood (http://blogs.barrons.com/techtraderdaily/2011/09/20/apple-behold-the-iendowment-says-wedgewood/)
2. For more information regarding option pricing see http://en.wikipedia.org/wiki/Option_(finance)
3. Operating income of the last twelve month of 33.8 USD billion divided by capital employed of 31.8 USD billion defined as total assets minus cash (or sum of all asset excluding cash)

My recent exposé of Apple's cash (and cash equivalents and long-term securities and short-term securities) drew quite a bit of attention, which is good. Because it needs to be demystified. However, the story does not end there. Part of the problem of cash is that the liquid stuff can often itself change in perceived value due to mis-management.

Cash has to be valued on the basis of what's to become of it. So what can become of it?

The value in liquid assets can be returned to shareholders in the form of a dividend, which means double taxation on profits; not the best idea usually. Or it can be returned in the form of share re-purchase which tends to have only a temporary effect on share prices, again not a great return. The value can also be increased by means of investment in projects that return higher than what investors expect their cost of capital to be. This is the best option but investment is difficult when the amount involved is so big that no project or set of projects could possibly cost enough to employ the capital. Finally, the value can be completely destroyed through large acquisitions.

I say destroyed because the history of large acquisitions is almost universally known to be value destructive (1). The urge to M&A is why cash on the balance sheet for large companies is usually discounted and share prices "get no credit for it." This is plaguing Apple with a P/E ex-cash in the teens.

Is this fair?

Companies faced with low growth are more likely to blow their cash on desperate acquisitions than those with high growth, but the best way to judge the probabiliy of cash evaporation is by looking at management track records.

Which leads us to Microsoft.  Their pursuit of Yahoo shows how desperate they had been in trying to catch Google and how poorly that would have turned out. Having failed only because Yang refused to sell, Microsoft would have gone through a large part of its cash and even raised debt to finance a dud.  With this propensity, it's no wonder that Microsoft's cash is considered an endangered quantity.

Microsoft used to have the largest cash position in tech. They still have $44.5 billion--a mere billion or so less than Apple. Some of the value already evaporated on dividends and medium sized acquisitions ($500 million for Danger that ended up as Kin(dling)). The chances that they'll blow billions again on desperate means to chase competitiveness are high. I would say it's a certainty.

On the other hand we have a high growth company like Apple that has not traditionally spent money on business acquisition. (They do spend on asset acquisitions--IP, code, developers but not on new business models.) Thus, on reputation alone, Apple's cash can be considered "safer" and hence worth more than Microsoft's.

Whether Apple can expose that cash to risk that enhances its value is another matter, but their CEO is on the record stating that "it's not burning a hole in their pocket" and the CFO repeats every quarter he is intent on its preservation.

This, in my opinion, makes the difference between Apple's $45 billion and Microsoft's $44 billion a lot more than $1 billion.

(1) Various studies have shown that at least 50% of acquisitions have been rated as failures. See failure rates by various studies charted below. Source: Prof. Dr. Thomas Straub (2007) "Reasons for frequent failure in Mergers and Acquisitions"