Apple Inc (AAPL) More capital return to shareholders. Global Credit Research GCRE004. FICC Research Dept.

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1 Global Credit 22 May 2018 Apple Inc (AAPL) More capital return to shareholders A new share repurchase program of $100bn and 16% hike in dividends Q2 Revenues up 16% y/y, FOCF up 15% y/y iphone revenues up 14% y/y, China up 21% y/y Services up 31% y/y and on track to reach 2020 target Strong credit profile with high capabilities to generate cash flows. Debt free on an adjusted basis. Global Credit Research GCRE004 FICC Research Dept. Credit Analyst Stefan Tudor, CFA (81) stefan.tudor@daiwa.co.jp Daiwa Securities Co. Ltd. Credit Opinion Q2 results confirm Apple s strong capabilities to generate cash flows, an expanding platform and a high liquidity profile. Revenues set an all-time record for March quarter, increasing 16% y/y to $61.1bn. Free operating cash flow (FOCF) followed revenues growth, increasing 15% y/y to $10.9bn. As all geographic reportable segments were growing we view as positive the geographical diversification of sales. The main growth driver remains iphone which accounts for 62% of total revenues. iphone revenues increased 14.4% to $38bn mainly driven by higher ASP. iphone shipments increased a modest 3% y/y but we consider this number positive given the decline in worldwide shipments and higher iphone ASP. Growth in Greater China revenues is especially positive as it is the largest smartphone market with high growth potential. iphone shows characteristics of a Veblen good as unit sales increased even at higher prices. A more expensive price gives iphone more value as it offers higher status and a perception of exclusivity. We expect the smartphone shipments to remain weak in the near future mainly due to a longer replacement cycle. However in the medium to long term, AR might revive the smartphone market and iphone could become a powerful AR device. Services increased 31% y/y to $9.2bn and Apple is on track to reach its 2020 revenue target of $24bn. Active installed base reached 1.3bn in January and the number of paid subscriptions surpassed 270m across all of Services offerings. Growth of Services segment is positive because it brings relatively stable income, more diversity in the product mix and it has an accretive impact on overall margins. We also notice the expansion of retail stores with new stores in Korea, Austria and Japan. There are 502 stores worldwide at the moment and the network of retail stores differentiate Apple from its competitors and are a powerful marketing tool. Other Products showed the highest growth rate in the product mix. Other Products increased 38% to $4bn due primarily to growth of wearables. Other product account only for 6% in revenues but growth of this segment is important to bring more diversity in the product-mix. Apple has an excellent liquidity profile with $145bn of adjusted net cash and growing operating cash flows. The new share repurchase program of $100bn and 16% hike in dividends decreases significantly Apple s liquidity. However even after increasing the capital return to shareholders, Apple remains debt free and the announcement is in line with company s target of zero net cash announced in the prior quarter. We expect Apple s focus, double integration and wow experience to enable it to sustain a strong market position and good profitability despite a maturing smartphone market and intensifying competition. For more details on focus, double integration and wow experience that drive Apple s growth please refer to our previous report: Apple- 3 driving forces behind Apple s strong cash flows released on March 5th, Important disclosures, including any required research certifications, are provided on the last page(s) of this report.

2 Profitability Highlights of Q2 Results Revenues increased 16% y/y to $61.1bn primarily driven by iphone, Services, Other Products segments. All geographic reportable segments showed y/y growth. Apple manages its business primarily on a geographic basis with 5 reportable segments: (1) Americas, including both North & South America Americas revenues were up 17% to $24.8bn due to higher sales of iphone, Services and Other Products. Americas account for 41% of total revenues and 38% of operating income, having the largest share among reportable areas. (2) Europe, including European countries, India, the Middle East and Africa Europe revenues were up 9% to $13.8bn as strength in foreign currencies relative to US dollar had a positive impact. Europe accounts for 23% in total revenues and 21% of operating income. (3) Greater China, including China, HK, Taiwan Sales in Greater China increased 21% y/y to $13bn due to higher sales of iphone, wearables and Services. The strength in foreign currencies relative to US dollar had a positive impact on sales. Greater China accounts for 21% of total revenues and 24% of total operating income. (4) Japan Japan revenues increased 22% y/y to $5.5bn due to higher net sales of iphone and Services. FX had a positive impact on Japan sales. Japan had 9% share in revenues and 11% share in total operating income. (5) Rest of Asia Pacific, including Australia, other Asian countries Revenues in Rest of Asia-Pacific were up 4% y/y to $4bn due to positive FX impact. Rest of Asia Pacific had 6% share both in total revenues and in total operating income. Operating Expenses increased 16% y/y to $7.5bn due to higher R&D and SG&A expenses. R&D expenses increased 22% y/y to $3.4bn due to increases in headcount-related expenses and material costs. 6% of total revenues were spent on R&D as Apple considers R&D investments critical to firm s growth and to its competitive position in the market place. SG&A increased 12% to $4.2bn due to an increase in headcount-related expenses and infrastructure-related costs. EBITDA increased 13% y/y to $18.6bn with EBITDA margin down 0.6pp to 30.5%. EBITDA margin decreased 0.6pp to 30.5% due to higher product cost structures. Segment Information iphone sales increased 14% y/y to $38bn due primarily to a different mix of iphones with higher average selling prices. The main growth driver was ASP (average selling price) which increased 11% y/y to $728 due to a different mix of iphones with higher average selling prices. iphone unit sales increased 3% y/y to 52.2m with iphone X being the top seller among iphone models. According to IDC, Apple s market share in global smartphone shipments increased 0.9pp to 15.6% while global smartphone market declined 3% y/y. Apple performance is highly sensitive to iphone sales as iphone accounts for 62% of its revenues - 2 -

3 Chart 1: 2018Q1 Worldwide Smartphone Market (unit market share) Source: IDC ipad sales increased 6% y/y to $4.1bn due primarily to a different mix of ipads with higher average selling prices. ipad units sales increased 2% to 9.1m due to double digits growth in Japan, Latin America, Midle East and Africa, Central and Eastern Europe. Half of the purchases were by customers new to ipad and Apple is gained market share of the tablet global market according to IDC. ASP increased 3.5% to $451 due to a different mix of ipads with higher average prices. In Mar 2018, Apple introduced a new 9.7-inch ipad with Apple Pencil compatibility, which began shipping at the end of the second quarter of Mac sales were flat at $5.8bn but installed base of Macs showed double digits growth. Apple lost market share according to IDC as Mac unit sales declined 3% to 4.1million while PC shipments were flat. However active installed base of Macs showed double digit growth as almost 60% of purchases came from new customers. ASP increased 3% to $1,434 due to a different mix of Macs with higher average sales prices. Revenues in Other Products segment were up 38% y/y to $4bn due primarily to higher unit sales of Apple Watch, AirPods and launch of HomePod. Other Products includes sales of Apple TV, Apple Watch, Beats products, ipod touch, AirPods, HomePod. HomePod, Apple s wireless speaker began shipping in February 2018 and it is currently available in the United States, the United Kingdom and Australia. Services increased 31% y/y to $9.2bn due primarily to licensing, App Store and AppleCare. Services include revenue from Digital Content and Services (itunes, App Store, Apple Music), icloud, AppleCare, Apple Pay, licensing. Services growth was broad-based in terms of services and geographic region. App Store, Apple Music, Apple Pay reached an all-time record while icloud storage revenue increased by over 50% y/y. Revenues increased more than 25% y/y in each geographic reportable segment

4 Across all of Services offerings, the number of paid subscriptions surpassed 270 million. Services share in total revenues increased 2% to 15%. Apple established a goal of doubling its 2016 services revenue of $24bn by the year Liquidity Apple announced a new share repurchase program of $100bn and 16% increase in cash dividends. Apple authorized a new program to repurchase up to $100bn of its common stock intended to be executed at a fast pace. Additionally it announced an increase in quarterly cash dividend from $0.63 to $0.73 per share beginning with the dividend to be paid during the third quarter of Apple completed $200bn out of $210bn approved in the existing share repurchase program In 2012, Apple announced plans to initiate a dividend and share repurchase program with the primary objective of neutralizing the impact of dilution from future employee equity grants and employee stock purchase programs. Apple had already a huge cash amount that could be used to finance this capital return program. However Apple chose not to pay 35% taxes to repatriate its cash and started issuing debt from 2013 to finance its capital return program. Apple utilized $200bn as of end of March The program is expected to be executed by the end of June Apple estimates future tax payments of $38 bn + 14 bn Apple set a provisional tax payable of $38bn, the amount it estimated to pay as repatriation tax for its deferred foreign income. Apple plans to pay the tax in installments in accordance with the law. In 2016, the European Commission announced its decision that Ireland granted state aid to Apple and ordered Ireland to calculate and recover additional taxes. Apple expects the recovery amount to be 14bn in line with the European Commission s announced amount. Ireland is still computing the recovery amount. Adjusted net cash (cash+ cash equivalents+ marketables- total debt) decreased 11% q/q to 145.4bn as marketables amount decreased. No bank credit line. Cash (including cash equivalents, marketables) decrease 6% q/q to $267bn as Apple targets to become approximately net cash neutral over time. Total debt was flat at $122bn. Apple had $12bn of commercial paper outstanding with maturities generally less than 9 months. Amount of long term debt was $101.4bn and it consists of senior unsecured obligations. FOCF increased 15% y/y to $10.9bn due to growth of revenues. CFO increased 21% y/y to $15.1bn due to growth of revenues. Inventories increased 73% q/q to $7.6bn due to component purchases. CapEx increased 41% y/y to $4.2bn. Apple expects capital expenditure to reach a total of $16bn in FY18. Company s guidance for Q3 Apple provides guideline only for a quarter ahead. Revenues are expected to be between $51.5bn and $53.5bn, growing between 13.4%- 17.8% y/y. Gross margins are expected to be stable between 38%- 38.5% even with raising revenues due to a difficult cost environment. Operating expenses are expected to be between $7.7bn- $7.8bn, growing between 14.9%-16.4% y/y

5 Chart 2: I/S ($m) Q Q Q Q Q Y/Y 3 Months Ending 04/01/ /01/ /30/ /30/ /31/2018 Change Revenues 52,896 45,408 52,579 88,293 61, % Cost of Sales 32,305 27,920 32,648 54,381 37, % Gross Profit 20,591 17,488 19,931 33,912 23, % Total Operating Expenses 6,494 6,720 6,811 7,638 7, % Selling, General & Administrative 3,718 3,783 3,814 4,231 4, % R&D 2,776 2,937 2,997 3,407 3, % Operating Income 14,097 10,768 13,120 26,274 15, % Depreciation & Amortization 2,332 2,354 2,484 2,745 2, % EBITDA 16,429 13,122 15,604 29,019 18, % Pretax Income 14,684 11,308 13,917 27,030 16, % Net Income 11,029 8,717 10,714 20,065 13, % Chart 3: I/S- % of revenues Q Q Q Q Q Months Ending 04/01/ /01/ /30/ /30/ /31/2018 Revenues 100% 100% 100% 100% 100% Cost of Sales 61% 61% 62% 62% 62% Gross Profit 39% 39% 38% 38% 38% Total Operating Expenses 12% 15% 13% 9% 12% Selling, General & Administrative 7% 8% 7% 5% 7% R&D 5% 6% 6% 4% 6% Operating Income 27% 24% 25% 30% 26% Depreciation & Amortization 4% 5% 5% 3% 4% EBITDA 31% 29% 30% 33% 30% Pretax Income 28% 25% 26% 31% 26% Net Income 21% 19% 20% 23% 23% - 5 -

6 Chart 4: B/S ($m) Q Q Q Q Q Y/Y Q/Q FY End 04/01/ /01/ /30/ /30/ /31/2018 Change Change Cash, Cash Equivalents & STI 67,101 76,759 74,181 77,153 87, % 14% Cash & Cash Equivalents 15,157 18,571 20,289 27,491 45, % 64% ST Investments 51,944 58,188 53,892 49,662 42, % -14% Accounts & Notes Receiv 11,579 12,399 17,874 23,440 14, % -39% Inventories 2,910 3,146 4,855 4,421 7, % 73% Other ST Assets 20,400 20,571 31,735 38,796 20, % -48% Total Current Assets 101, , , , , % -10% Property, Plant & Equip, Net 27,163 29,286 33,783 33,679 35, % 4% LT Marketable Securities 189, , , , , % -14% Other LT Assets 15,639 18,255 18,177 21,361 23, % 8% Total Noncurrent Assets 232, , , , , % -10% Total Assets 334, , , , , % -10% Payables & Accruals 50,238 53,751 73,230 89,266 58, % -34% ST Debt 13,991 18,475 18,473 18,478 20, % 11% Current Portion of LT Debt 3,999 6,495 6,496 6,498 8, % 31% Other ST Liabilities 9,113 9,076 9,111 8,044 9, % 24% Total Current Liabilities 73,342 81, , ,788 89, % -23% LT Debt 84,531 89,864 97, , , % -2% Other LT Liabilities 42,577 41,582 43,251 46,885 49, % 7% Total Noncurrent Liabilities 127, , , , , % 0% Total Liabilities 200, , , , , % -10% + Share Capital & APIC 33,579 34,445 35,867 36,447 38, % 4% + Retained Earnings 100,925 98,525 98, ,593 91, % -12% + Other Equity , % 264% Total Equity 134, , , , , % -10% Cash&Marketables 256, , , , ,226 4% -6% Working Capital 28,648 31,573 27,831 28,022 40,733 42% 45% Total Debt 98, , , , ,840 24% 0% Net Debt 83,365 89,768 95,391 94,909 76,781-8% -19% Adjusted Net Debt 158, , , , ,386-8% -11% Ratios Equity/ Total Assets 40% 38% 36% 34% 35% Total Debt/ Equity Net Debt/ Equity Adjusted Net Debt/ Equity Chart 5: C/S ($m) Q Q Q Q Q Y/Y 3 Months Ending 04/01/ /01/ /30/ /30/ /31/2018 Change Net Income 11,029 8,717 10,714 20,065 13,822 25% Depreciation & Amortization 2,332 2,354 2,484 2,745 2,739 17% Others 838 2,708 2,458 5,483 1,431 71% Cash from Operating Activities 12,523 8,363 15,656 28,293 15,130 21% CapEx 2,975 2,277 3,865 2,810 4,195 41% Cash from Investing Activities 14,202 3,180 9,942 13,590 28, Dividends Paid 3,004 3,365 3,270 3,339 3,190 6% Cash from Financing Activities 465 1,769 3,996 7,501 26, FOCF 9,548 6,086 11,791 25,483 10,935 15% FCF 1,679 5,183 5,714 14,703 43,

7 Chart 6: Product Segment ($m) Q Q Q Q Q Y/Y 3 Months Ending 04/01/ /01/ /30/ /30/ /31/2018 Change Total Revenues 52,896 45,408 52,579 88,293 61, % iphone Revenue 33,249 24,846 28,846 61,576 38, % Average Sales Price % Number of Units Sold 50,763,000 41,026,000 46,677,000 77,316,000 52,217, % ipad Revenue 3,889 4,969 4,831 5,862 4, % Average Sales Price % Number of Units Sold 8,922,000 11,424,000 10,326,000 13,170,000 9,113, % Mac Revenue 5,844 5,592 7,170 6,895 5, % Average Sales Price 1,392 1,303 1,331 1,349 1, % Number of Units Sold 4,199,000 4,292,000 5,386,000 5,112,000 4,078, % Other Products Revenue 2,873 2,735 3,231 5,489 3, % Services Revenue 7,041 7,266 8,501 8,471 9, % Chart 7: Product Segment- % of total revenues ($m) Q Q Q Q Q Months Ending 04/01/ /01/ /30/ /30/ /31/2018 Total Revenues 52,896 45,408 52,579 88,293 61,137 iphone 63% 55% 55% 70% 62% ipad 7% 11% 9% 7% 7% Mac 11% 12% 14% 8% 10% Other Products 5% 6% 6% 6% 6% Services 13% 16% 16% 10% 15% Chart 8: Product Segment- y/y growth Q Q Q Q Q Months Ending 04/01/ /01/ /30/ /30/ /31/2018 Total Revenues 5% 7% 12% 13% 16% iphone 1% 3% 2% 13% 14% ipad -12% 2% 14% 6% 6% Mac 14% 7% 25% -5% 0% Other Products 31% 23% 36% 36% 38% Services 18% 22% 34% 18% 31% - 7 -

8 Chart 9: Geographical Segment ($m) Q Q Q Q Q Y/Y 3 Months Ending 04/01/ /01/ /30/ /30/ /31/2018 Change Revenue 52,896 45,408 52,579 88,293 61, % Americas 21,157 20,376 23,099 35,193 24, % Asia-Pacific (Australia & Asia) 14,521 10,733 12,613 24,809 16, % Greater China 10,726 8,004 9,801 17,956 13, % Rest of Asia Pacific 3,795 2,729 2,812 6,853 3, % Europe 12,733 10,675 13,009 21,054 13, % Japan 4,485 3,624 3,858 7,237 5, % Operating Income 18,089 14,922 13,120 30,774 15, % Americas 6,668 6,420 7,102 11,316 7, % Asia-Pacific (Australia & Asia) 5,533 3,894 4,504 9,483 6, % Greater China 4,224 3,002 3,630 6,908 4, % Rest of Asia Pacific 1, ,575 1, % Europe 3,851 2,984 3,943 6,893 4, % Japan 2,037 1,624 1,763 3,082 2, % Chart 10: Geographical Segment- % of revenues/ operating income Q Q Q Q Q Months Ending 04/01/ /01/ /30/ /30/ /31/2018 Revenue 52,896 45,408 52,579 88,293 61,137 Americas 40% 45% 44% 40% 41% Asia-Pacific (Australia & Asia) 27% 24% 24% 28% 28% Greater China 20% 18% 19% 20% 21% Rest of Asia Pacific 7% 6% 5% 8% 6% Europe 24% 24% 25% 24% 23% Japan 8% 8% 7% 8% 9% Operating Income 18,089 14,922 13,120 30,774 15,894 Americas 37% 43% 41% 37% 38% Asia-Pacific (Australia & Asia) 31% 26% 26% 31% 30% Greater China 23% 20% 21% 22% 24% Rest of Asia Pacific 7% 6% 5% 8% 6% Europe 21% 20% 23% 22% 21% Japan 11% 11% 10% 10% 11% - 8 -

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