Apple Earnings Call - Live Update

1:27 PT. - JS: Hi, everyone, and welcome to our live coverage of Apple’s Q2 financial results. I’m Macworld Editorial Director Jason Snell, and with me to cover this monetary extravaganza is Macworld Associate Editor Dan Moren. For the record, I’m wearing green today. Because green is the color… of money.

1:41 PT - JS: The results are out and we’ve got a news story about it. Apple’s analyst phone call begins at 2 p.m. Pacific.

1:53 PT - DM: We begin, as always, with the traditional piano elevator music. I believe this would be Bach’s Sonata in $7.51 billion. Bach, as you probably know, was renowned for his fondness for financial result conference calls.

1:55 PT - JS: While we’re waiting, let me give you a brief overview of the results. Mac unit sales were down over last quarter. Now, keep in mind that Apple’s first financial quarter is always its best, because it’s the quarter in which everyone buys iPods for the holidays, so most of the quarter-to-quarter measurements will be down this quarter. Macs obviously aren’t quite as big a stocking-stuffer gift, so the drop-off is less. This quarter ends a string of rising Mac sales that had gone on for the three previous quarters. However, the drop-off in sales was entirely due to the reduced sale of desktop Macs. Apple’s Laptop line had what I believe is its fourth consecutive record quarter in terms of units. The 1.43 million Mac laptops sold in the last quarter is the most Apple has ever sold.

1:57 PT - DM: We’ve been told that we’ll be getting underway shortly. Additional participants are supposedly being added to the call. You want to be early to get good seats.

1:58 PT - JS: In terms of overall revenue, Apple’s down from that humongous quarter last time, but if you remove the holiday quarters, the company’s upward revenue trend continues. In fact, this quarter’s revenue—$7.5 billion dollars—is more revenue than Apple made in the quarter encompassing the 2006 holiday season. It’s a small revenue quarter only by the massive standards of Apple’s $9.6B first quarter of this year.

2:00 PT - JS: Apple’s also shown a rebound when it comes to what the financial wizards call the ASP, or Average Sale Price, of iPods. Last year the number was dipping into the $160 range, but in the first quarter of this year it was $181, and for this quarter it was still $171. That suggests that iPod sales have skewed a bit higher-end lately—probably owing to increase sales of the iPod touch.

2:01 PT - DM: Here we go—no, false alarm. Still admitting more people. Popular this quarter, aren’t we? Whoops, someone left the speakerphone on for a second there. A fascinating insight into the lives of Apple’s financial personnel!

2:04 PT - DM: Alrighty, now we’re beginning for real. Here comes the open remarks from Nancy Paxton. As usual, we’ll be getting Peter Oppenheimer, Tim Cook, and the mysteriously silent treasurer Gary Wipfler. As usual, there are some “forward-looking” statements: we consider these “your mileage may vary” disclosures.

2:05 PT - DM: And now, heeeeeere’s Peter. As usual, Peter is very pleased to announce the best March quarter. $7.51 billion revenue, about $2 billion better than year again quarter. Operating margin better than expected at 17.5% because of better revenue. Earnings per share were $1.16. Here are some data points.

2:06 PT - DM: Revenue growth accelerated to 43% year over year, twice the 21% growth rate from March quarter last year. Healthy growth all over, international sales grew. 47%. Sales in retail were extremely song, growing 74% year over year. 33.7 million visitors, up 57% from YAQ. Retail stores sold to 50% new to the Mac customers, continuing to grow the platform. US education business grew 35% year over year, highest growth rate in any quarter in last 8 years.

2:07 PT - JS: Once again, the “more than 50% of the Mac sales in our retail stores were from people new to the Mac” claim is carted out. The mind boggles, but they keep saying it.

2:07 PT - DM: Mac products grew 59% year over year; 2.289 million Macs shipped, 51% growth over last March quarter. Sales of desktops grew 37% year over year, driven by strong demand for iMac, and Mac Pro. Sales of portables grew 61%: continued strong demand for MacBook and MacBook Pros, and successful launch of MacBook Air. Customers have responded well to breakthrough design of the Air and ultraportability. Ended quarter with 3-4 weeks of channel inventory.

2:09 PT - DM: Music accounted for 36% of revenue. 10,644,000 iPod sales. 1% up year over year, 8% revenue up and higher ASPs in every geographic segment, due to iPod touch. Beleive intro intro of software development kit will broaden interest even further. Shuffle sales were down in March quarter, but sales up following price reduction in February. Apple continues to maintain its objective of high market share in the US and to gain share outside the U.S. Share of the U.S. MP3 market was 73%, according to latest data. Outside US, grew share in every market. Began and ended quarter within target range of 4-6 weeks of channel inventory.

2:10 PT - DM: Sales from iTunes very strong in quarter, becoming largest retailer in US and beating Wal-Mart. Over 85% of US share of legally purchased music. Movie rental service well-received, and just begun selling TV shows in Germany. Will continue selling videos internationally.

2:11 PT - JS: What, iTunes is selling TV shows in Germany? Get Hasselhoff on the line, now!

2:11 PT - DM: Pleased with iPhone sales: 1.7 million in March quarter and expanded to include Austria and Ireland. Total sales recognized was $378 million. Total deferred revenue was $1.93 billion at end of March quarter. Compared to $1.44 billion in Dec. quarter. Developer response to iPhone SDK is “tremendous.” Over 200,000 developers have signed up and downloaded kit. Interest in iPhone enterprise is good: over 400 higher ed, and more than 1/3 of Fortune 500 companies. Because of free update, will delay revenue between announcement of new features until the features are available to customers.

2:13 PT - DM: Let’s discuss Apple retail, with 74% growth to $1.45 billion. 458,000 Macs sold, 67% increase year over year. Opened four stores, to end with 208. With an average of 205 stores, $7.1 million in average revenue, compared to $4.8 million in the year ago quarter. Primary objective in store is getting more out of the Mac, so 580,000 one-hour personal training sessions in the quarter. Planning first stores in Australia, China, and Switzerland. 45 stores to open in FY 2008.

2:14 PT - DM: Total gross margin was 32.9%, due to favorable commodity environment, weaker dollar, and higher revenue. $112 million in stock-based compensation. Tax rate slightly lower due to higher foreign earning, but expect 31% rate for second half of FY 2008.

2:15 PT - DM: $1 billion in cash in quarter, for $19 billion. In first half of FY 2008, generated $4 billion in cash. Looking ahead to next quarter, they anticipate revenue of $7.2 billion, approx 33% growth over prior June quarter. Expect gross margins about 33%, $20 million related to stock-based compensation. Generate earnings per share of about $1.

2:16 PT - JS: Interesting that they’re anticipating $7.2B revenue for the third quarter. In the past two years the third quarter has had more revenue than the second quarter. My initial response to the target of a slight drop in revenue for sequential quarters is that Apple is being really conservative. Maybe it’s the economy? If things go like they have the past two years, Apple’s third quarter would be better than its second./p>

2:16 PT - DM: 51% Mac sales increase is strongest sales in almost two decades, and about 2.5x market growth. Excited about iPhone SDK in June. Continue to be excited about new products in pipeline.

2:17 PT - DM: Phew. Enough numbers for you? Here comes the slightly less dense Q&A section.

2:17 PT - DM: Lehman Brothers: 32.9% was good gross margin, but a little color?

Cook: Commodity pricing in both DRAM and NAND flash market hit historically low level during March quarter. Expect pricing in current quarter to remain favorable, folding that into guidance. LCD is near supply/demand balance, stable pricing. Hard drive, optical drives, and other in balance. Expect historical pricing trends to be followed.

Lehman: Anything go against you in the quarter?

Oppenheimer: As we commented in last quarter, we expected gross margin to decline by 2.7% and exceeded guidance, only reduced by 1.8%. Better than expected results primarily due to favorable commodity environment, higher revenue, and weaker dollar. Sequential decline from Q1 primarily due to Leopard entering second quarter of sales. Change in OS accounted for 80% of sequential decline; also affected by shuffle price change; and international price reductions from changing economy. Higher mix of iTunes with lower gross margin, and decline from holiday quarter, as expected. Somewhat offset by favorable component pricing, ahead of guidance.

2:21 PT - DM: Lehman: In terms of iPhone, less availability towards end of quarter. Anything to give us confidence that can grow segment sequentially? Shortages?

2:21 PT - DM: Cook: We’re confident on hitting 10 million units for the year. In terms of shortages; we expected it to decline more on sequential basis than it did; beat our expectations, so started to decline in supply. US stores are experiencing more stock outs, and believe more phones being bought there with intention of unlocking, which remains a significant number.

2:22 PT - DM: Lehman: Can’t clarify that number?

2:22 PT - DM: Cook: Very difficult to come up with a good estimate at present. We believe it’s a proxy for the worldwide demand of the phone. Hoping to help by rolling out to rest of world.

2:23 PT - JS: Let’s deconstruct the fact that Apple remains “confident” on hitting its goal of shipping 10 million iPhones this year. A lot has been made of this, but it’s not unreasonable at all. This quarter, the first of calendar year 2008, Apple sold 1.7 million iPhones. Let’s assume relatively slow growth next quarter, from 1.7 to 1.9 million. For the third quarter, let’s assume that additional international roll-outs and the release of a new iPhone model drives some more sales, to 2.5 million. And for the holiday quarter, let’s estimate a doubling of the prior quarter to 5 million, which happened last year, owing to holiday sales. That’s more than 11 million right there. Very, very doable.

2:23 PT - DM: STN Midwest: Channel questions. Direct vs indirect mix? Any update on expansion to Best Buy?

2:23 PT - DM: Oppenheimer: Direct sales were 53%, up from 49% in YAQ.

Cook: Little over 400 stores in Best Buy. Aim to be at 600 in the summer. Rollout going extremely well.

Lehman: On education: delineate between students and institutions?

Cook: Up 35%. Both institutional and individual were strong. Now in big K-12 quarter; back to school more of higher education quarter. 35% is highest growth rate in Ed in 8 years (good for Ed!). Recently learned that surprased Dell last year in portables in education.

2:25 PT - DM: RBC Capital: Qualify the reasons for delay of revenue recognition for iPhone? Also, how to relay that into iPhone numbers?

Oppenheimer: We’re doing this because we announced specific new features that will be included in iPhone 2.0 software that we we plan to provide for free to customers who purchased after March 6th announcement. Delay revenue recognition between March 6th and date of delivery for software. Once software delivered, will resume revenue recognition and begin to recognize iPhone revenue on a go-forward basis (doesn’t impact phones before March 6th or payments for carriers). [Does this mean iPhone 2.0 will not be free to those who bought before March 6th, or am I unclear?]

RBC Capital: Discuss importance of 3G and timing of pending products on how it weighs into the 10 million at current momentum?

Cook: Confident with hitting the 10 million. If part of that is more geography, we are confident we can roll out more places in Europe and Asia this year.

2:28 PT - JS: An interesting accounting decision that is over my head, I admit, since I Am Not An Accountant. But basically Apple’s not going to count its revenue for iPhone hardware sales from the day the company announced the iPhone 2.0 software until it’s released in June. What that seems to mean is that iPhone revenue is a bit lower this quarter than it would otherwise be, because most of a month wasn’t counted. But presumably the iPhone 2.0 software will ship in June as promised, at which point the dam will break and the third-quarter number should include all of the pent-up revenue, plus the stuff left over from this quarter.

RBC Capital: Does that include unlocked phone percentage?

Cook: Unit number includes locked and unlocked phones.

RBC Capital: Economic headwinds? Any comments.

Oppenheimer: We’re going to leave economic commentary to others. We’re focused on managing our business, which performed exceptionally well in March quarter, based on outstanding, innovative business. Revenue in US grew 40%, twice last year’s March growth rate of 20%, and faster than December quarter growth. Traffic in stores up, and we only have 200 stores. Very confident in business and strategy (this is all Peter’s usual boilerplate).

2:29 PT - DM: Goldman Sachs: Did you give a date for 2.0 iPhone software? Impact on gross margin, if any?

2:29 PT - DM: Oppenheimer: Intend to deliver iPhone 2.0 software in *late* June. Included delay in revenue of recognition in 33% gross margin for quarter. Affects iPhone handset sales only between March 6th and when we deliver software. Does not impact phones prior to March 6th or payments for carrier.

2:30 PT - DM: Godlman Sachs: Negative impact for gross margin in that period?

2:30 PT - DM: Oppenheimer: Not recognize revenue, so that will have an impact.

2:30 PT - DM: Goldman Sachs: Sequentially down revenue guidance? Any reasons?

2:31 PT - DM: Oppenheimer: Factored several things. Mac channel inventory grew 60,000 in past quarter b/c of MacBook Air launch and increased sales velocity. Also, the iPhone revenue delay. iPod sales decline sequentially. Plus shuffle price change and overseas price changes. Strong guidance and a growth rate faster than year ago quarter.

2:31 PT - JS: Here’s the explanation for the lower than expected revenue target. Mac inventory grew last quarter, they expect a seasonal decrease in iPhone sales, and the iPhone revenue won’t begin being accrued until iPhone 2.0 software ships. We shall see. Apple is generally very conservative in its estimates. This shows you how they arrive at that conservative approach.

2:32 PT - DM: Morgan Stanley: Back to margin question. Gross and operating margins both down since 2006. Reinvest margin upside to address growth opportunities internationally and in new product categories? Will decline be normal going forward, or something specific for this quarter?

2:33 PT - DM: Oppenheimer: We gave guidance for 32% gross margin, and we had 32.9%; better than expected. Continuing to come out with new and innovative products. Thinking about continuing to gain market shares in all three categories.

2:33 PT - DM: Morgan Stanley: Stil half of stores opening internationally?

2:33 PT - DM: Not exactly, but probably more internationally stores than previous. 45 new stores for the year.

2:34 PT - DM: Citi Group: More about gross margin! Looked like Leopard revenue down $100 million sequentially. Should we expect to see benefit on NAND and DRAM pricing?

2:34 PT - JS: I love—and by love I mean hate—the endless questions in these calls that try to get Apple to give little tidbits of information about their business that the company’s executives generally don’t want to provide. There are lots of circuitous questions that are asked specifically to glean tiny shards of data out of this normally secretive company. Of course, this entire call is mandated by federal regulations involving public companies disclosing financial information. Essentially, Apple is doing this because it has to. But it only discloses what it absolutely needs to, and beyond that it’s a black box, by choice. Hearing the push and pull is fascinating, especially when I’m not the one doing the pushing (for once).

2:35 PT - DM: Oppenheimer: Leopard revenue was $170 million in January. Just over $40 million in March quarter. Together: $210 million in first half. Leopard is best selling release in our history. Sequential decline in Leopard and iLife/iWork were bit greater than thought, so impact of sequential decline a bit bigger. Also, lower sequential revenue, and iTunes was a bigger mix of quarter this business than last, and it has lower gross margin as well. Number of factors played into gross margin coming down.

2:36 PT - DM: Cook: Component advantages were large during quarter and those offset most of the points Peter talked about: shuffle price cut, international price cuts, higher mix of iTunes, and lower overall revenue and effect on the structure. Did receive significant benefit in DRAM and NAND.

2:37 PT - DM: Citi Group: What gives you confidence that NAND and DRAM will continue to be favorable going into next quarter?

2:38 PT - DM: Cook: Favorable does not mean it goes lower than where it was; we envision it trading in a fairly narrow trading range, and thus not *increasing* that much heading into the quarter. Probably won’t get lower, though.

2:38 PT - DM: Bear Stearns (hey, they still exist!): Give us a sense of what delay in iPhone recognition meant to current quarter? Tax rate down this quarter? Any impact from consumer behavior?

2:39 PT - DM: Oppenheimer: In terms of the consumer, we had a very good Dec. quarter and amazing March quarter. Revenues in US grew 40% year over year, Mac shipments were up 51% in US. 34 million people in 208 retail stores, most of which are in the US. Business performed exceptionally well, across all customer segments, including retail stores.

2:40 PT - DM: Opp: In terms of tax rate, forecasting 32% for year, with higher mix of foreign earnings from Marc. quarter and lower interest income (b/c rate environment), tax rate for the year looks to be 31%, so that’s what they’re forecasting for next two quarters.

2:41 PT - DM: Bear Stearns: iPhone revenue?

2:41 PT - DM: Opp: 1.7 million phones sold during quarter. Recognized revenue over 24 months. (He’s about to let Gary answer a question!)

2:42 PT - DM: Gary: You asked if anything in OI&E other than lower effective yields, but the short answer is “No.” The yield on portfolio has dropped slightly. No material write offs in portfolio—holy cow, I don’t know what he’s saying. But I <3 Gary Wipfler!

2:42 PT - DM: Bear Stearns: What are you going to do with all that cash?

2:43 PT - DM: Opp: No change.

2:43 PT - DM: Piper Jaffray: And we’re back to the iPhone revenue recognition delay.

2:43 PT - DM: Opp: Delay recognition of revenue and product cost of iPhone, but will continue to expense operating expenses on advertising, engineering, period costs, etc.

2:43 PT - DM: PJ: Charging for iPhone 2.0 for those who bought before March 6th?

2:44 PT - DM: Opp says it’s free.

2:44 PT - DM: PJ: Why deferring after March 6th if everybody gets it for free?

2:44 PT - DM: Opp: Customers presuming when they bought it that they’d get it for free. Proper accounting.

2:44 PT - DM: PJ: Will iPhone availability creep back up for quarter?

2:44 PT - DM: Cook: Shipping product everyday, but won’t forecast exact in stock figures. Factored into guidance.

2:45 PT - DM: Cross Research: Pricing of European carrier partners? Any commentary?

2:45 PT - DM: Cook: Carrier partners are free to price iPhone as low as they wish, but won’t comment on specific arrangement b/c it’s confidential (snap!).

2:45 PT - DM: Cross: Maintaining 2.5G iPhone when 3G is out?

2:46 PT - DM: Cook: Won’t comment on new products.

2:46 PT - DM: Cross: Had to try! (That gets a laugh from Tim). Any comments about linearity during quarter and geopgrahy?

2:46 PT - DM: Cook: Strength in all geopgrahies, up in Europe, Japan, US, Asia/Pacific. All multiples compared to market growth. Consumer very strong. Pro had a nice pickup last quarter; Mac Pro sold more units since its debut with Intel processor. Overall, strength everywhere.

2:47 PT - DM: Cook: only unusual thing on linearity, MacBook Air started shipping late. End of March, near supply/demand balance on it. iPhone, outstripped supply towards end of quarter, because sold more than expected. Thought there would be more sequential decline (we call this spinning bad news into good!), but demand remained strong.

2:48 PT - DM: Cross: MacBook Air, gross margins. Any comment?

2:48 PT - DM: Cook: The customers love it! (That gets a laugh from Cross).

2:48 PT - DM: Banc of Montreal: When you ship SDK, is there a catch up point for phones that were shipped?

2:49 PT - DM: Oppenheimer: Begin to recognize revenue and product cost once we ship 2.0 software over the remaining lives for the phone. “Ratably” from that point for the remaining port.

2:49 PT - DM: BoM: Gross margins. Again. Other large drivers of change on year over year basis. Mix of CPUs vs. iPod favorable or unfavorable?

2:50 PT - DM: Opp: Hard to do year over year margin comparisons. Traditionally talked about it on sequential level.

2:50 PT - DM: BoM: Is there deviation in operating segments in amount of gross margin reported by geography? Variance in terms of geography materially different from company as a whole?

2:51 PT - DM: Opp: We’ll put out 10-Q in next week or so, segment reporting will be there. Look at prior 10-Qs to see gross margins in segments. Little bit of variability, but happy with all segments.

2:51 PT - DM: Shaw Wu! Shaw! Everybody loves Shaw Wu!: Any color on acquisition of PA Semi?

2:51 PT - DM: Opp: We occasionally buy smaller technology companies from time-to-time, so we don’t comment on our purpose or plan, so I can’t.

2:52 PT - DM: Merill Lynch: On Mac side. PC growth usually down quarter-over-quarter, given strength accelerated to 3x market growth, any seasonality for June quarter?

2:52 PT - DM: Opp: Generally see in June sequential increase in Mac shipments as educational buying season begins. June quarter tends to be weighted towards K-12, at lower ASPs, and Sep quarter more weighted towards higher education.

2:53 PT - DM: ML: Re unlocking, seen any late activations of iPhone from holiday quarter? Vis-a-vis unlocking.

2:53 PT - DM: Opp: As Tim said, it’s hard to estimate. Unlocking is occurring and it’s significant. Our view is that it’s clear interest of demand globally. Hearing reports of iPhones being used in many countries, so it gives us confidence for shipping 10 million in 2008.

2:54 PT - DM: Sanford Bernstein: Can you reconcile US shortages with European price cuts? No undersupply in Europe? Noticeably different demand profile in US vs. Europe, and why not ship phones from Europe to US to meet demand?

2:55 PT - DM: Cook: Believe American stores more succeptable due to people in US buying many, unlocking, and exporting.

2:54 PT - JS: I love that Apple uses the fact that people are buying iPhones and shipping them to foreign countries to be unlocked as a positive. It’s true, it shows great demand, and Apple’s still making a profit on those phones, even without the carrier stuff. It’s true—the iPhone is a big hit overseas, even without deals in many countries. Imagine how well it might do once there’s a more straightforward path to buying it in those countries.

2:55 PT - DM: Cook: In aggregate both Europe and US are low.

2:55 PT - DM: SB: Channel inventory also low during stock outs? Why couldn’t you better balance allocation of units?

2:56 PT - DM: Cook: Once units ship, ability to move them from carrier to carrier is very low. Short term cases of some imbalance. Major point (let’s get back on message): we sold more than we thought we would.

2:56 PT - DM: SB: Sold more Europe than you thought you would?

2:56 PT - DM: Cook: In total, sold more than we thought we would. Expected sharper season decline. First Q1 to Q2 in phone business, so we’ve learned something.

2:57 PT - DM: SB: Last quarter, said not comfortable discussing unlock percentages. Better read on that now? Why the reticence now discussing the number?

2:57 PT - DM: Cook: Don’t feel that we can quantify with precision, so we don’t want to put out a number we can’t stand behind. Go out of our way to classify number as “significant.” Don’t know how we can be more clear than that.

2:58 PT - DM: SB: In Macs, ASPs declined. How to we reconcile that?

2:58 PT - DM: Opp: ASP decline was slight both sequentially and year over year. Largely driven by the transition in quarter and some mix shifts within MacBook/MacBook Pro lines. Small, though.

2:58 PT - DM: Needham and Company: Any color on demographic of MacBook Air purchasers? Numbers suggest selling better than just for Road Warriors. Any sense of how many Windows users purchased Air?

2:59 PT - JS: And let me just say, the voice of Charlie from Needham and company is awesome. He sounds like Johnny Cash. What a great final questioner to go out on!

2:59 PT - DM: Cook: Appealing to all sorts of people. Seems to have universal appeal. Cannibalization factor extremely low for other portables. Part of the reason for a minor sequnetial decline. But can’t offer info on Windows users.

3:00 PT - DM: And that’s it! We’re getting the details about telephone replay, podcast, webcast, etc. We’ll see you in three months!

3:00 PT - JS: Thanks for being here, everybody, and thanks to Dan Moren for doing all the fast fancy fingerwork. We liveblog the financial conference calls so you don’t have to!

The event has ended.

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