Apple Earnings Call: Live Update

1:52 PT - JS: Hi everybody, this is Jason Snell, Editorial Director of Macworld, and I'm here (virtually) with Associate Editor Dan Moren to discuss Apple's latest financial results. We'll be covering Apple's conference call with analysts here, live, beginning at 2 p.m. Pacific time today.

1:53 PT - DM: Or 5 p.m. Eastern if you happen to be joining us from the East coast, as I am. Never mind that timestamp! It's all lies.

1:53 PT - JS: You can get more information about the results themselves in detail in our news story, which will be updated regularly over the next hour or more. Keep hitting that reload button, folks!

1:54 PT - DM: But to give a quick sum-up of the results as already posted, the general perception seems to be: what failing economy? Apple's once against posting record revenue, record profits, and record sales despite the troubles facing the . Pretty impressive.

1:55 PT - JS: We can already say that this was the best Apple quarter ever -- yet again. Just when you think the iPod couldn't sell more units, this year's holiday-quarter sales once again broke the record, although it's definitely showing slowed growth (three percent more iPods were sold this holiday quarter than last), but it's a growth rate that's not far off from what we've seen the last few quarters. However, iPod revenue was down a bit, which is interesting -- and might be a sign of the troubled economy.

1:57 PT - JS: On the Mac side, it was a strong (albeit not record-breaking) quarter, but what's most interesting is that the acceleration of laptops as the main portion of the Mac product line continued. Desktop sales crashed, but laptop sales were up. A full 71 percent of the Macs sold last quarter were laptops, which is a record. For the last couple of years it's been more like 60 percent, and if you go back five years, laptops were more of a half-and-half proposition.

1:57 PT - DM: I don't think that's really that surprising; when I look around these days, I'm seeing everybody using laptops more and more. It also doesn't hurt that Apple rolled out redesigned MacBooks at the beginning of this quarter. Apple's notebook line-up is, in many ways, more fleshed-out than their desktop line-up.

2:01 PT - DM: And here we go. We're being welomed to the conference call. Here come the introductory remarks. As usual, we'll be hearing from CFO Peter Oppenheimer, COO Tim Cook, and the quiet man, Treasurer Gary Whistler. There will be the usual forward-looking statements that shouldn't be taken as gospel because, of course, the Apple executives can't see the future...yet.

2:02 PT - DM: Here's Peter. "We're extremely pleased to have record results for December quarter. Surpassing $10 bilion in quarterly revenue for first time in Apple's history. We entered the holiday season with our best product lineup ever and our customers responded." 6% growth over prior quarter's results. Operating marginw as 20.9% due to higher gross margin. Translated to earnings per share of $1.78.

2:03 PT - DM: Non-GAAP measures are being used, fully described in the press release. Adjusted sales $11.8 billion, $1.6 billion than reported revenue. Adjusted gross margin 4.5 billion; 1 billion higher than reported.

2:03 PT - JS: Non-GAAP means they're talking about how much money Apple took in during the quarter, versus how much they're officially accounting for this quarter -- this is because Apple defers some money over the life of a few products, specifically the iPhone, making it harder to gauge how good a particular quarter was if you use the official "GAAP" numbers.

2:04 PT - DM: Mac products and services first. Sold 2.5 million Macs, 9% growth over prior December quarter results. Very solid growth, partiocularly in contrast to the rest of the market. Latest update from IDC numbers estimated that the overall market for PCs contracted last quarter. Customer response to new MacBooks and MacBook Pros strong, year-over-year growth of 34 percent laptop growth. Desktop unit sales declined by 25% year-over-year. Prior December quarter, desktop sales grew at large rate due to new iMacs. Year-over-year decline is a reflection of shift towards portables and customer response to October announcement. 16% contraction in global desktop shipments during December quarter. Very pleased with overall Mac share gains and believe iLife '09 and iWork '09 will set Mac farther ahead competition. Began and ended quarter with 3-4 weeks of channel inventory.

2:06 PT - JS: So the short version is, the introduction of the new MacBook and MacBook Pro was a hit, because that's what drove the bulk of new Mac sales in the quarter.

2:06 PT - DM: 22.7 million iPods. 3% growth over year again quarter. Thrilled with customer response of new iPods: new iPod nano and iPod touch. The breadth of content on App Store has helped bolster iPod touch. Remain very pleased with iPod market share. Share is over 70% in month of December, based on NPD's numbers. Continue to gain share in international markets. iPod share of MP3 market over 70% in UK and Australia; over 60% in Japan; over 50% in Canada. Year-over-year share gains in France, Germany, Italy, and Spain. Ended quarter in target range of 4-6 weeks of channel inventory.

2:07 PT - DM: iTunes Store had good quarter as well. Biggest music quarter ever included highest sales ever for Christmas Day and Christmas week. Developer and customer excitement has been incredible for App Store. Over 15,000 application, increase of over 10,000 since last conference call. Customer downloads have topped 500 million.

2:08 PT - DM: 4.4 million iPhones sold. Cumulative iPhone sales for 2008 were 13.7 million, well ahead of 10 million target. Selling in over 70 countries by end of quarter. Recognized revenue was $1.25 billion, compared to $241 million in year ago quarter. Sales value of iPhones sold during quarter over $2.6 billion.

2:08 PT - DM: Based on 2008 customer satisfication study, J.D. Power & Associates ranked iPhone in overall customer satisifaction for business smartphone users. More than RIM, Windows, Palm combined for ad hits on the iPhone. Competitors are scrambling to try and copy success. Reiterating that software is the key ingredient for mobile experience.

2:10 PT - DM: Apple Retail store segments. 46.7 million vistitors, 14.4 thousand visitors per store per week. Revenue grew 2% year over year. Average store revenue was down, reflecting "difficult retail environment" in the U.S.Average per-store revenue was $7 million, compared to $8.5 million in the year-ago quarter, and margin was down as well. Very difficult retail market. Expanded with Best Buy this year. A lot more bundling with iPods this year. Stores performed very well during December quarter. Ended quarter with 251 stores, in 10 countries. During quarter, opened first store in Germany in Munich. Stores achieved highest ever service volumes; record numbers for Genius Bars and training. 34.7 percent gross margin. Due to more favorable component pricing market; lower transportation, warranty costs, etc. Operating expernse $1.4 billion. Total op-ex below low-end of guidance range, as a result of lower spending, particularly sales and marketing.

2:11 PT - JS: For a while now Apple has been claiming that half the Macs they sell at its retail stores were to new Mac buyers. This is the first time they've said "almost half," instead of actually half. So it's less than 50%, but still an impressive number.

2:12 PT - DM: Congressional approval of one time R&D tax credit lowered tax rate. $28.1 billion in cash and short-term investment. Compared to $24.5 billion; increase of over $3.6 billion. Changed accounting practice in December quarter. Investment priority continues to be preservation of capital. Short-dated high quality investments. Cash flow from operations over $3.9 billion.

2:13 PT - DM: Here's the outlook for next quarter. Continue providing guidance based on GAAP. Forecast is challenging and therefore providing broad range of guidance. Between $7.6-8 billion revenue; gross margin 32.5%, compared to 34.7% in December quarter. Sequential decline reflects stronger U.S. dollar, favorable supply chain situation is not recurring, and sequentially lower revenue. Tax rate to be about 31%. Earnings per share to be $0.90-$1.00.

2:15 PT - DM: "We are fortunate to have the world's best customers and employees, especially in these difficult times. We are continuing to focus on developing the industry's most innovative products. And we're very excited about our new product pipeline." And now we're going to Q&A.

2:16 PT - DM: Barclays Capitals: And he's going to ask how Steve is. It's the first question, folks. Will the company run different or the same under Tim? Is Tim the likely candidate if worst case scenario where Steve is unable to return.

2:16 PT - DM: Peter: Steve is the CEO of Apple and plans to remain in major strategic decisions; Tim is responsible for day-to-day operations.

2:17 PT - DM: Tim: Ben, I think, let me add something to that, and back up just a bit. There is an extraordinary breadth and depth and tenure among the Apple executive team. And these executives lead over 35,000 employees that I would call all 'wicked smart'. And that's in all areas of the company, from engineering, to marketing, to operations, sales, and all the rest. And the values of compay are extremely well-entrenched. You know, we believe we're on the face of the Earth to make great products, and that's not changing. We're constantly focusing on innovating. We believe in the simple not the complex. We believe that we need to own and control the primary technologies behind the products that we make, and participate only in markets where we can make a significant contribution. We believe in saying no to thousands of projects to that we can really focus on the few that are truly important and meaningful to us. We believe in deep collaboration and cross-pollinization of our groups which allows us to innovate in a way others can not. And frankly, we don't settle for anything less than excellence in every group in the company, and we have the self-honesty to admit where we're wrong, and the courage to change. And I think regardless of who is in what job, those values are so embedded in this company that Apple will do extremely well. And I would just reiterate a point Peter made in his opening comment, that I strongly believe that Apple is doing the best work in its history.

2:18 PT - DM: Barclays: Wish you all the best and Steve as well. On retail: with flat performance sequentially, are you planning on scaling down your expansion? Anything to concern about long-term if impact is slowing, given environment?

2:19 PT - DM: Peter: Plan to open about 25 stores in fiscal '09; about half internationally. Ron and his team are continuing to be very selective. Very confident in our stores and the assets that we're building.

2:20 PT - DM: Credit Suisse: Mac segment is inelastic; iPod elastic. Is iPhone elastic or inelastic? Will handset price reductions eventually make sense for spurring demand?

2:20 PT - DM: Tim: This segment is clearly elastic. The price in the U.S. market has moved from $599 to $399, tremendous jump; $399 to $199 saw another jump in the run rate. $199 level includes signing up for contract, but is compelling value and see nothing in the marketplace that's anyplace close. Still believe years ahead of competition from software point of view, and throw in the App Store, we feel very very good about competitive poistion.

2:21 PT - DM: Credit Suisse: Gross-margin line. Not still reasonable to believe gross margin will average out at 30% as previously suggested?

2:22 PT - DM: Peter: Looking forward, about 30% in second half of fiscal 2009. Guidance in March quarter of 32.5% is benefiting from favorable commodity environment. Not taken the full impact of U.S. dollar strengthening. Not going to leave any pricing umbrellas.

2:23 PT - DM: Citigroup: First, wider range than normal for guidance for March quarter, but more narrow than December quarter forecast. Base of recurring revenue for iPhone, or is there something else giving confidence for business going into March?

2:24 PT - DM: Peter: Models are not as precise as they have been; visibility isn't as good as it had been in past. Prior quarters, more of a single point estimate for top line; December quarter was billion dollar range, but it's a bigger quarter with much higher sales expected. $400 million range pretty wide for Apple, though.

2:24 PT - DM: Tim: Think back to timing of guidance, banks were going down what seemed like every other day. Does seem like economy is in bad shape, but it's not as unpredictable as it was in October perhaps.

2:25 PT - DM: Citigroup: Followup, component pricing environment update from quarter to quarter. What do you do to mitigate that on cost of goods, given prices adjusted less frequently?

2:25 PT - DM: Tim: Last quarter was incredibly favorable, key factor in reason gross margin beat guidance. DRAM, NAND flash, and LCDs did much better than expected. Further reductions from those levels are not likely. Do, however, in aggregate, expect continue favorable environment on supply and price on most commodities. Still be positive overall, but not as good as Q1.

2:26 PT - DM: Piper Jaffray: Are there markets where you're priced too high, given non-subsidized market for iPhone?

2:27 PT - DM: Tim: Over 70 countries for iPhone. Some countries are non-subsidized market. Largest example is India. Sales less in non-subsidized markets, obviously. Huge market opportunities and will make adjustments in future to play in a stronger way.

2:28 PT - JS: See, it's psychology 101: A lower up-front will drive sales, even if you end up spending more money on a monthly basis.

2:28 PT - DM: Piper Jaffray: No price umbrella means subsidized vs. non-subsidized?

2:28 PT - DM: Tim: We're not going to build a low-end voice phone. Our objective is not to be unit share leader, it's to build the world's best phone.

2:28 PT - DM: Piper Jaffray: How do you think about that sub-$500 market for netbooks, computers?

2:29 PT - DM: Tim: We're watching that space, but right now from our point-of-view, those products are based on hardware that's much less powerful than what we think that customers want, software quality that is not good, cramped keyboards, small displays. So we don't think people are going to be pleased with those products, but we'll see. We are watching that space. About 3% of PC industry was in this netbook kind of category so it's a category we watch. We've got some ideas here. But right now, we think the products are inferior and will not provided experience to customers that they're happy with.

2:30 PT - DM: Citigroup: Apple TV, any seasonality involved in that business?

2:30 PT - DM: Tim: Tremendous pickup year over year. Up almost 3x versus year ago quarter. We still consider this a hobby, but it is clear that the movie rental business has really helped Apple TV, and there are more and more customers that want to try it. Continue to invest because we fundmentally believe there is something there for us in the future.

2:30 PT - DM: STM Midwest: On desktops in pro segment: how does that affect the Mac numbers?

2:31 PT - DM: Tim: The Mac Pro percentage of our desktop business is not large. Desktop number is primarily iMac. The pro segment was down year-over-year, because small businesses are cutting back on expenditures in economic climate.

2:31 PT - DM: STM: Any update on education market? Lot of chatter about state budgets. Any sense of what you're looking at in calendar 2009?

2:31 PT - DM: Tim: Results last quarter, down 6% year over year total. K-12 component is more sensitive, down 10% year over year. Very significant funding in this environment. Data that we're collecting, 39 of 50 states have some form of shortfall. K-12 was weak in Q4 and Q1; don't forecast individual markets, but don't see it picking up until there's a huge infrastructre outlay; hopefully now that we have new president, maybe that'll be underway.

2:33 PT - DM: STM: Any updates on Snow Leopard, timeline? Any thoughts on progress?

2:33 PT - DM: Tim: No comments to share today. Very excited, but we don't have a launch date to announce today.

2:33 PT - DM: Sanford Bernstein: iPhone channel inventory was 2 million units, last quarter. Update?

2:33 PT - DM: Tim: In launch quarter, channel was approx. 2million units. In Q1 despite launching in 20 additional countries and additional channels, we ended quarter with sequentially lower channel inventories. Very comfortable with level we're at. Obviously, have to take changes in channel inventory in both quarters in consideration in looking sequentially at the sell-through.

2:34 PT - DM: Sanford Bernstein: Can you help "dimension for me" how big the draw down was in channel inventory?

2:35 PT - JS: Dimension! It's the funnest verb ever.

2:35 PT - DM: Tim: Draw down was about a quarter million. In terms of weeks, we can't be specific, because of all the additional countries added. Not sure of seasonal pattern of demand from quarter-to-quarter. Based on info from carrier partners, very comfortable with inventory level.

2:35 PT - DM: Sanford Bernstein: Comment on relative strength of iPod business, domestic and internationally? Stronger than expected. Relative growth rates of iPod business in U.S. and international?

2:36 PT - DM: Tim: In terms of geography, look at U.S.: iPod sales contracted at unit level 3% year-over-year. All of growth you see in number was all international. Look of linearity at worldwide level: very similar until last week of quarter; rush of buying last week of quarter. All of growth occurred in last week of quarter. Attribute to macroeconomic environment and affect on consumer buying behavior.

2:37 PT - JS: Interesting - this suggests that the iPod has finally reached a plateau in the United States. But there's still some growth to be had overseas.

2:37 PT - DM: Sanford Bernstein: What kind of impact did mix have on gross margins? Visibility from last quarter that iPhone margins higher than company average, so it pushes up gross margins. Some difference in revneue growth rate across all three markets in this quarter.

2:37 PT - DM: Peter: We don't talk a lot about year-over-year gross margin changes. More straight forward to talk about it sequentially. This year versus last, very different currency and commodity situations. Literally flat in percent terms year over year.

2:38 PT - DM: Cross Research: How are you thinking about operating expense? As relates to revenue growth?

2:38 PT - DM: Peter: We're very confident in our strategy and our business, and we're going to invest our way through this downturn just as we did for the last one. We're continuing to invest in engineering, marketing, customer experience to bring industry's most innovative products to market.

2:39 PT - DM: Cross Research: Walk us through impact of currency on P&L?

2:39 PT - DM: Peter: Hedging program. European hedges...okay, now they're talking about hedges? That's like shrubbery, right?

2:40 PT - JS: Dan, you're fired. After the call is over.

2:40 PT - DM: Cross Research: Warchest?

2:40 PT - DM: Peter: Proud to tell you that we're over $28 billion in cash for all the right reasons. No new update from what we shared with you last quarter.

2:40 PT - DM: UBS: Speak to linearity of guidance? What in particular does guidance assume in remaining two months?

2:41 PT - DM: Peter: Not going to give you an update on this quarter. Provided guidance for March quarter. Guidance has growth year over year.

2:41 PT - DM: UBS: Given iPhone 3G is in early days and had some inventory draw down, can you buck seasonal downtick that you usually see in handset industry and see sequential uptick?

2:41 PT - DM: Tim: Don't forecast product level externally in terms of guidance. Fear that we would have in this market is that economy may slow the adoption rate of smartphones, because they generally command higher monthly fees and that may keep some customers from signing up for higher contracts. Feel very good about our competitive position. Extremely good about product pipeline.

2:42 PT - DM: Goldman Sachs: Pluses and minuses about adding Wal-Mart and what's different from Best Buy and Apple Stores?

2:43 PT - DM: Tim: Just started working with Wal-Mart at end of December, so not enough data. From a reach point of view, Wal-Mart reaches a tremendous amount more people than they can reach in stores. They've got over 4000 or so storefronts, and they are in areas where there are no Apple Stores. Level of reach beyond what Apple and AT&T can provide. Also sell iPods in Wal-Mart and have a good relationship with them. With that data and knowledge that they went into iPhone too.

2:44 PT - DM: Goldman Sachs: Talk about linearity on Macs and iPhones in December quarter?

2:44 PT - DM: Tim: Mac sales were second higher, after the previous quarter. Sell-through accelerated tremendously after introduction of new portables. Quickly served those customers due to good product ramp. Stunning number of 34% year-over-year increase on portables despite tough environment. International on Mac was much stronger than U.S.; U.S. growth was 2%; international was 16% year-over-year. Several countries above 20%, including Canada and those in Latin America. People were delaying purchases on rumors of new portables as mentioned in last call. Not as strong as iPod spike, but similar spike in end of quarter for Macs.

2:44 PT - JS: Every time they talk about the "product pipeline" I get all tingly. They're just taunting us, aren't they? But it serves an important purpose, as a mantra: Apple has products in the pipeline. Apple will continue to release products. They will continue to fit Apple's core values. This is something that many of us think is obvious, but it's a message of stability that's important for the financial and investment community to hear.

2:46 PT - DM: On iPhone, it's difficult to say because of little history. Saw very strong ending of quarter with iPhone, but can't make educated comment on it since it's just second December in business and first in a large way in many countries.

2:46 PT - DM: JP Morgan: As far as retail stores, any sort of context around same store sales in interational vs. U.S.? On multiplier effect, do new stores internationally increase pull through?

2:47 PT - DM: Peter: Retail performance outside U.S. a bit stronger, similar to other parts of the business. Our retail stores are helping us in each of our geogrpahies. Great place for new customers, especially those new to the Mac. Some people choose to buy in stores, some people choose to buy elsewhere, we're fine with either (how generous!). Make sure that Macs and iPods have a great point of sales for new customers to come and experience them. As mentioned, plan to open about 25 stores in fiscal '09, about half international.

2:48 PT - DM: JP Morgan: How are other channels playing out?

2:48 PT - DM: Peter: Resellers are able to do what they want. Here in U.S., several did promotional activities with iPods, such as attaching gift card to iPods. If they want to do it, it's fine. Not as much of that after the holidays.

2:49 PT - DM: Banc of Montreal: Two margin questions: mentioned supply change adjustment in December quarter. Reoccur in March quarter, and describe what it is?

2:49 PT - DM: Peter: Exceeded our gross margin in December quarter by 420 basis points. In the range of quarter of that were favorable adjustments and settlements primarily related to prior quarter in the supply chain. Will not recur in March quarter, which is one of reasons for sequential decline.

2:50 PT - DM: Banc of Montreal: On non-GAAP adjustment, stated gross margin increased substantially from 49% to 61%. What's the reason for increase in non-GAAP adjustment?

2:50 PT - DM: Peter: Reflects two things: reversal of iPhone revenue and product cost recognized during the quarter. 61% is just the mathematical result of these adjustments, in and out, revenue vs. cost sold. $2.6 billion iPhone sales was much larger than revenue of $1 billion that was reported. iPhone 3G gross margin was higher in December quarter, due to lower costs.

2:51 PT - DM: RBC Capital Markets: Number of competitors coming to the market for the iPhone, many with their own variance on customer experience intiating, including Android, Palm Pre, Windows. How do you think about sustaining leadership and brand?

2:52 PT - DM: Tim: I would say first of all difficult to judge products not yet in the market. iPhone has sold over 17 million units thus far, received highest overall customer satisfaction from many different surveys. We've said since the beginning that software is key ingredient, and we're years ahead, and I'd include the App Store in that. If you look at others, I think when you think about having multiple variations of display, resolution, input methods, and hardware, it's a big challenge for a software developer, and not very enticing for them to build an app for all of these. Approach this as a software platform business, and so fundamentally different from those approaching from hardware view. Very confident with where they are competitively. We like competition, as long as they don't rip off our [intellectual property], and if they do, we're going to go after anyone who does.

2:54 PT - JS: Well, that sounds like two separate shots fired across the bow of Palm. First, it's the product that's not even in the market. Second, Palm's phone has some features that are very iPhone like, and it makes you wonder if Apple might consider using the patents it boasted about when it launched the iPhone to stick it to Palm.

2:54 PT - DM: RBC: Until Palm came out that others negotiated around multi-touch IP, but Palm seems to directly emulate touch interface that iPhone innovated, and that Steve talked about patenting; is that what you're referring to?

2:55 PT - DM: Tim: Don't want to talk about any specific company, just making a general statement. We are ready to suit up and go against anyone. However, we will not stand for having our IP ripped off and will use whatever weapons we have at our disposal.

2:56 PT - JS: Translation: Palm, better be sure you're not infringing on Apple's patents when you launch the Pre, or else.

2:55 PT - DM: RBC: Quarter to quarter, Macs down 3% amidst launch of new Macs, give us sense of what you're thinking about Mac trends going forward?

2:56 PT - DM: Tim: If you look at the Mac and the slight decline sequentially and you think about the macroeconomic environment between Q4 and Q1, I think it's a fantastic result. Did take down channel inventory some. Market as projected by IDC says that worldwide market actually contracted, so comparing 9% Mac growth to a negative number, I feel very good. Revenue share over 32 and Apple number one in revenue share in retail in the U.S. All fantastic results and we're very proud of them.

2:57 PT - DM: Needham: On Apple store, what was average number of stores open during quarter?

2:57 PT - DM: Peter: 249.

2:57 PT - DM: Needham: How many one-on-one sessions during quarter?

2:57 PT - DM: Peter: Don't have that in front of me, but we did set a record during quarter.

2:58 PT - DM: Needham: 500 million downloads from App Store. What percentage were paid and were free?

2:58 PT - DM: Peter: We're not disclosing. But we are thrilled with App Store. Pleasure to say we surpassed 500 (he said thousand, but he meant million) and more than 15,000 apps in the store, up more than 10,000 since last conference call.

2:58 PT - DM: Needham: Continue to report revenues of App Store within iTunes or will you separate?

2:59 PT - DM: Peter: This point, part of iTunes, and no plans to change that at this point.

2:59 PT - DM: And that's all she wrote, ladies and gentlemen.

2:59 PT - JS: Thanks for your service, Dan. Well done as usual, except the part about the hedges. Not that part.

2:59 PT - DM: So am I still fired?

2:59 PT - JS: No, you can stay. But sit up straight. Posture, man, posture is important!

2:59 PT - DM: Phew. Well, see you in three months then.

3:00 PT - JS: And as the lady who moderates the call says, "Have a wonderful day."

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