Apple’s Share Repurchase Program - August 2015

At the end of the recent June quarter, Apple’s management announced roughly $90 billion of the current $140 billion share repurchase program had been completed. The $90 billion includes a $6 billion May 2015 ASR (Accelerated Share Repurchase program) to be completed in November 2015.

Apple’s fully diluted share count from the company’s Condensed Consolidated Statement Of Operations as June 27, 2015 reflected 5.733 billion shares in the fully diluted share count. This is a 1.06% decline in the fully diluted share count from the March quarter and a year-over-year decline in the count of 4.06%.

Since the share count high in FQ4 2012, the fully diluted share count has been reduced as of the end of the recent June quarter by 13.02%. In FY2014 Apple deployed $24 billion for share repurchases at an average share cost of about $84. In the first nine months of the current fiscal year Apple deployed $16 billion for repurchases at an average price of $120 per share.

The graph below illustrates the dramatic reduction in the fully diluted share count since the September quarter of 2012 (FQ4 2012). 

Apple used a combination of cash-on-hand and debt to complete the $90 billion in repurchases to-date. The June quarter Form 10-Q (FQ3 2015) indicates $50 billion in debt had been acquired for the repurchase of shares as of the end of the period on June 27, 2015. As of the same date Apple had cash and marketable securities on the balance sheet totaling about $203 billion. Of the roughly $203 billion in cash and marketable securities, $181 billion was held by foreign subsidiaries outside the United States. Apple’s decision to acquire debt for the repurchase of shares forestalls the need to repatriate foreign-sourced funds and remit declared but yet unpaid US taxes on those dollars. 

As of the end of the June quarter, the fully diluted share count is now below FY2005 split-adjusted levels. In other words, the company has already eliminated 10 years of “share creep” or increases in the fully diluted share count from a variety of sources including stock-based compensation and any shares used to facilitate the company’s many acquisitions. 

With $50 billion remaining in the current repurchase program extending through the March quarter of FY2017, Apple will continue to materially reduce the fully diluted share count over the next seven fiscal quarters. 

Apple's R&D Expenses

In the recent June quarter, Apple’s R&D expenses surpassed $2 billion in a quarterly period for the first time. R&D expenses rose nearly 27% year-over-year in the June quarter and were 72% higher than in the corresponding quarter two years ago. 

In the first nine months of the current fiscal year, Apple has spent $5.847 billion on research and development, nearly reaching the $6.041 billion spent in all of FY2014. The company is on track to spend in the range of $8 billion on R&D expenses in FY2015, exceeding the prior year’s investment by 30% or more. R&D expenses reached over 4% of reported revenue in the second half of FY2014 and may again reach that level of revenue consumption in the second half of FY2015. Over the first nine months of the current fiscal year, revenue has risen by 30% while R&D expenses have risen by 34% during the period.

Rising R&D expenses suggest increasing investment by management in the development of new products and services as well as ongoing development of the company’s existing product and service lines.

Apple Turns Back The Clock On The Fully Diluted Share Count

During management’s March quarter conference call with analysts, Apple CFO Luca Maestri announced the company had completed roughly $80 billion of the planned $140 billion in share repurchases. The average price at which shares had been repurchased was stated as $85.

To put the $80 billion in repurchases in perspective, I have charted the fully diluted share count for fiscal years 2005 through 2014 and added the fully diluted share count as reported in the March quarter 10-Q filing by the company. 

The graph below illustrates the fact the fully diluted share count as of the end of the recent March quarter is below the fully diluted share count at the beginning of this nearly ten-year period on a split-adjusted basis. With $60 billion in additional repurchases to be made through the March quarter of FY2017, Apple has turned back the clock on what might be called “share creep” from stock-based compensation and other distributions of new shares. 

By the end of the recent March quarter the company had reduced the fully diluted share count by 11.83% since FY2012 or over a period of ten fiscal quarters. The fully diluted share count will continue to diminish as management exhausts the remaining $60 billion in repurchases over the next eight fiscal quarters.

The ongoing reduction in the fully diluted share count will continue to amplify the impact of the company’s rising net income on reported earnings per share. 

Apple’s Deferred Revenue Balances

Apple defers up to $25 in revenue per iOS device sold and $40 in revenue per Macintosh sold to future periods. The amounts deferred represent an estimate of the value of the free software upgrades Apple provides to device owners over the anticipated useful life of the product. This value is included in the purchase price of each device and recognized as revenue over subsequent periods following the period of original purchase.

In the December quarter (FQ1 2015) Apple added on a sequential basis $945 million to the company’s deferred revenue total. The year-over-year rise was $1.039 billion. At the end of the quarter Apple had $12.467 billion in current and non-current deferred revenue on the balance sheet. 

The graph below illustrates Apple’s deferred revenue balances on a quarterly basis and the year-over-year change in the deferred revenue total in each quarter.

While the pace of growth in the company’s deferred revenue total moderated as revenue growth moderated beginning in the latter half of FY2013 with very little movement in the total throughout FY2014, much faster rates of revenue growth this fiscal year and through at least the first half of FY2016 may deliver rising deferred revenue balances each quarter for the next several quarters. In other words, more revenue may be deferred in each quarter this fiscal year than is recognized from revenue deferred in prior periods. 

Robert Paul Leitao

Apple's Fully Diluted Share Count

Apple is engaged in the largest capital return program in enterprise history. The capital return program is comprised of the company’s regular quarterly dividend and the current $90 billion share repurchase program set to be completed by the end of this calendar year.

The graphs below illustrates the significant drop in the reported fully diluted share count since the $90 billion share repurchase program began.

During the December quarter conference call with analysts held in January, Apple CFO Luka Maestri stated the company had completed $73 billion of the planned share repurchases under the $90 billion share repurchase program. The Form 10-Q for the quarter puts the amount already invested in share repurchases at $72.90 billion comprised of both accelerated share repurchase programs and open market share repurchases

For the December quarter Apple reported the fully diluted share count at 5.882 billion shares. This contrasts with the split-adjusted 6.337 billion shares in the reported fully diluted share count in the September quarter (FQ4) of 2012. To further illustrate the dramatic drop in fully diluted share count, I have charted the percentage changes in the fully diluted share count on a sequential and year-over-year basis. From the peak in FQ4 2012 the fully diluted share count has fallen 12.84% through the December quarter. In the recent December quarter, there were 6.788% fewer shares in the fully diluted share count than in the prior-year period.  

Because Apple averages the number of fully diluted shares in each quarterly reporting period, any and all repurchases in a quarter this calendar year will have a residual and beneficial impact on earnings per share in the corresponding quarter in 2016. Although there is much speculation Apple will announce an expansion of the current repurchase program in April, the repurchases are currently scheduled to be completed by the end of CY2015.

Since the September quarter of FY2012, on a split-adjusted basis, Apple has achieved a net reduction of approximately 755.50 million shares. While much has been written about Apple’s decision to borrow funds to complete the share repurchase program rather than repatriate foreign-sourced earnings, using the current $1.88 per share dividend as a guide, the company is currently saving in annual cash disbursements from the elimination of dividends on the repurchased shares about $1.420 billion.

Notwithstanding speculation Apple will announce an expansion of the current $90 billion share repurchase program along with the announcement of a dividend increase during the March quarter conference call in April, the existing share repurchase program with $17 billion remaining to be invested in share repurchases has already substantially reduced the company’s fully diluted share count.

Robert Paul Leitao

Apple And The Irrelevance of Trailing 12-Month Earnings

In Apple’s December quarter (FQ1 2015), revenue rose 29.53% on a year-over-year basis to $74.599 billion. On a sequential basis, the revenue growth rate was 77.10%. This was the fastest rate of year-over-year revenue growth since the March quarter of FY2012. The sequential revenue growth rate surpassed the 63.89% rate of growth in the December quarter of FY2012 (FQ1 2012). 

The graph below illustrates the dramatic rise in revenue in the three-month period ended December 27, 2014 (FQ1 2015). 

In the same quarter earnings per share rose 47.83% year-over-year and on a sequential basis earnings per share rose 115.49%. This was the fastest rate of year-over-year earnings per share growth since the March quarter of FY2012 and the sequential earnings per share growth rate was the fastest rate of growth in the company’s recent history. 

The graph below provides a perspective on Apple’s earnings per share growth rate, amplified by the ongoing share repurchase program, relative to the rates of growth over the most recent twenty five fiscal quarters.

For the current fiscal year, I am targeting revenue of $235 billion (inclusive of the successful launch of the Apple Watch in April). At 28.56% revenue growth, FY2015 would deliver the fastest rate of revenue growth since the 44.58% revenue growth rate in FY2012. Assuming no less than 23% of revenue flows to the net income line and Apple reaches my current revenue target, net income would reach $54 billion and an eps outcome well above $9 per share. 

Using $9 per share as an example, at the closing price of $126.46 on February 12, 2015, the shares are currently trading at just over 14 times estimated FY2015 earnings per share. This contrasts with the price earnings multiple of 17.12 times trailing 12-month earnings as of this February date. 

In my view, net income and the rate of net income growth are the primary drivers of Apple’s share price appreciation. The company is in only the second quarter of what may be a six-quarter epoch of accelerated rates of revenue and earnings growth. Looking back and using 12-month trailing earnings as a guide at this point in time will only obfuscate the potential for share price appreciation moving forward.

At this point in time, trailing 12-month earnings is an irrelevant metric. Net income and net income growth over the next several quarters amplified by the ongoing share repurchase program are where Apple watchers should cast their gaze. 

Robert Paul Leitao

Briefly… Why I’m Bullish On Apple

What analyst Brian White at Cantor Fitzgerald calls a “super cycle” I call the “Apple iPhone Echo Effect.” The success of the iPhone 6 handsets is far-reaching and will continue through the release of the successor flagship handsets next fiscal year.

The unified and uniform eco-system Tim Cook lauded in his commentary yesterday at the Goldman Sachs  Technology and Internet Conference is unrivaled and can not be matched. The IBM agreement will act as a “booster rocket” on enterprise sales.

Due to the market’s consistently conservative valuation of the company, Apple has been able to repurchases just over 1 in 8 fully diluted shares since the peak split-adjusted share count in FQ4 2012. That’s even considering the averaging of the fully diluted share count in the December quarter. The annual cash savings at the current dividend rate from the repurchases is now about $1.425 billion (and rising).

Because Apple averages the fully diluted share count each quarter, any quarter in which repurchases occur, the repurchases will have a residual and beneficial impact on the eps growth rate in the following fiscal year’s corresponding quarter. In other words, the share repurchases have a “pair of legs.”

As revenue growth rates reach double digits, the rate of growth exceeds the rate of growth in operating expenses which delivers a higher percentage of revenue to the net income line. This will likely be the case at least through the March quarter of FY2016. This will boost net income per revenue dollar with an amplified impact on eps from the share repurchase program.

While it’s common to view Apple’s growth in percentage terms, even if revenue and earnings growth rates begin to moderate beginning in FQ3 2016, the volume of revenue and earnings growth need to be considered. The cash generation, even at more moderate rates of reported growth, will continue to generate cash at volumes to support a significant and ongoing capital return program.

Combine the “Apple iPhone echo effect” with the release of the Apple Watch and the surge in revenue and net income in just the first four quarters after the new product line is released is not factored in current analyst estimates.

There isn’t a competitor on the planet that can successfully design and deliver a wrist-based digital device on the scale of Apple or with full compatibility with hundreds of millions of smartphones.

Again, the market and consumers the world over are currently expecting a “watch.” The only resemblance the Apple Watch will have to a watch is that it will tell time and it will be attached to the wrist. That’s why I call the Apple Watch the “ultimate skeuomorph.”

More on my bullish stance in a future post.

Robert Paul Leitao

The Apple Watch As The Ultimate Skeuomorph

I posted this view of the Apple Watch in the Braeburn Group community last evening:

The Apple Watch As The Ultimate Skeuomorph

In my view, the tech pundits just don’t get the Apple Watch. They keep viewing it as a watch. If the Apple Watch was primarily a timepiece, I can understand the current thinking. The only similarities the Apple Watch has to a watch is that it will function as a watch and is strapped to the wrist. The wrist is among the most anatomically comfortable locations for a wearable and more than a century of social acceptance of a wrist-based device makes the form of a watch a natural for a device.

I don’t recall the last time a forthcoming device was so misunderstood. There’s no shortage of timepieces in our world from our cars, to our computers to our smartphones to our offices to our clock radios. Consumers don’t need another clock. Although I don’t like the term, from a social/luxury goods standpoint, the Apple Watch is it’s own form of a skeuomorph. In other words, Apple has taken a highly socially acceptable form (the wrist watch) and is using the form to drive fast adoption and easy luxury goods designation of a wearable computing device. The fact that it tells time and is called the “Apple Watch” provides the means to gain social acceptance and take advantage of the luxury goods perception of a finely-crafted timepiece.

In a way, it’s skeuomorphism on a new level. This is brilliant. Apple announces the new line and presents it in the context of a watch (comfortable, socially accepted and easy to designate as a luxury item) then leaves plenty of time space for that context to seep into the public perception. As the product approaches release and through the release Apple then ramps up talk of its functions and the press then runs reports on the astonishing advanced functionality Apple has put into a “watch.” There is really no reference for a product launch of this kind and with this approach in the era of mass adoption of personal computing devices.

Now factoring in what will most likely be restricted distribution through Apple’s direct channels for at least the first few months following release with expanded distribution through luxury/upscale retailers in time for the holidays, and that’s millions of new visits to Apple retail stores from buyers to the curious spectator.

I’m striving to create a model to quantify the impact of the Apple Watch on iPhone, Mac and iPad sales in addition to the sales of Apple Watch units. As we know, Apple Watch is an Apple Pay-enabled device. Among the reasons why I’m a bit shy on estimates beyond FY2015 at the moment is due to the Apple Watch. That’s a variable no one can accurately quantify at the moment. From the time of release, it will make every other high-end smartphone vendor’s product line appear incomplete by comparison and there isn’t a competitor that can bring to market such a wearable in a classic, luxury goods design. Any effort will look like a cheap rip-off.

In response, EdTech, a long-time member of the Braeburn Group posted his commentary on my viewpoint:

"I would add on to your train of thought with the following notion.  People - and particularly tech savvy people are drawn to the physical aspects of a piece of computing technology. When they look at computer, they see the metal, silicon and glass that go into making the computing device, and because of our love and intimacy with physical things, we gravitate toward using its physical characteristics to evaluate its worth. Hence a generation which grew up looking at feeds and speeds, cycles and power consumption, dimensions and shapes and using those metrics to define the worth and value of the computer.

However, the hardware only defines the limits of what a computer can do. To be more precise, the hardware prescribes the boundaries around what a computer could possibly do. What truly defines the usefulness of that computer, however, is the software that runs on it. Without well designed software, a computing device is merely an expensive ornament or a heavy paperweight. However, software is not a physical entity, it is much more abstract and ephemeral, so it is much more difficult to quantify and evaluate its merits. Software - at least well written software, is more likely to evoke an emotional response than an analytical one in use. And it is the access to brilliantly designed, intuitive, and easy to use software - from OS 6 all the way up to OS X and onwards to iOS, that has brought the magic and wonder of the Apple ethos for excellence and elegance to the computing experience.

Before the app store, the iPhone was merely a phone that also had a web browser and a music player in it. Once Steve Jobs relented and opened up the App store, it took on a new life greater and more impactful than ever before imagined, because it was only then, that the iPhone became a universal ultra mobile conduit for software.

Perhaps there is some strange cosmic irony that Apple is named App-ple, because it is the software stack, the apps, programs, and the OS, that create the usefulness that we find in the iMac, MacBook, iPhone, and iPad. All of those are mere instruments to serve up Apps (software Applications) that are so elegant they draw us in emotionally to the computing experience. Computing hardware is just a box (and in Apple’s case, a pretty box)  that makes the software accessible humans.

The iWatch should be seen in a similar light. It is a conduit for the apps that will provide functionality and that emotional bond that the user will have with the device. Because of this, the more important question, like in all the other cases (iMac, MacBook, iPhone, iPad), isn’t, “how good is the hardware?”, but rather, “how good will the software be that will bring new functionality to that form factor?”, because it will be the software that defines the usefulness of the computing device and henceforth, the Apple Watch.  We tend to evaluate things compared to what we have experienced in the past - but this does not consider that the potential for the new device to be used in completely new ways. That is why much of the world underestimated the iPhone and the iPad initially.

Because of this reliance on software to provide functionality, it is impossible for us to evaluate how good the iWatch will be at launch, just as it was impossible for us to accurately predict how useful the iPhone was going to be at it’s launch, and how useful the iPad would be at its launch. We just don’t have enough experience with the hardware to begin to fathom what are the limits that hardware imposes and what are the depths of usefulness that some enterprising coder is going to be able to coax out from within that boundary. At the end of the day, it is up to the genius of the coder to expand the definition of what is possible given the constraints of the hardware, and it is impossible to know at device launch the limit of creativity that will be brought to bear on this puzzle.

Each major revolution that Apple has brought to computing was based on a fundamental change in user input (keyboard - Apple II, Mouse - Mac, trackball/trackpad - Powerbook/MacBook, Multitouch - iPhone/iPad) and now we have a wrist worn computing device with continuous biometric input and haptic feedback. It is way too early to know how useful the iWatch can become, but the revolution in user interface is one clue…."

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I don't think the market yet grasps what the Apple Watch represents and how in its own way it will transform personal communications and the way we interact with digital devices.

Robert Paul Leitao