1:56 PT – DM: Hello, and thanks for joining us at Apple’s federally mandated conference call to discuss its just-released third quarter financial results. As always, I’m Macworld Associate Editor Dan Moren, here for the play by play.
1:56 PT – JS: And I’m Macworld Editorial Director Jason Snell, alongside Dan for the color commentary.
1:56 PT – DM: At the moment we are, as usual, being serenaded by lovely classical music as we wait for the usual suspects to join us on the line here. It’s probably not giving away too much to say we expect to hear from Apple COO Tim Cook and CFO Peter Oppenheimer. The preliminary numbers are already out, though, and Apple seems to have had a fantastic quarter, with revenues of $8.34 billion and profits of $1.23 billion, up both over the last quarter and the year-ago quarter.
1:58 PT – DM: I wonder if they actually fly a string quartet into Cupertino and then just hold the phone up to them. Spare no expense!
1:59 PT – JS: Are you insane, man? There’s a recession on. It’s a trio.
1:59 PT – DM: I hear Yo-Yo Ma refused, due to contract negotiations.
1:59 PT – JS: Some interesting things I’ve spotted in the initial financial data: iPod sales were down over the year-ago quarter for the first time ever, which shows perhaps that we have finally passed the peak of iPod mania. However, iPhone mania appears to be picking up the slack. This was also the second-highest number of Macs Apple has ever sold in a quarter, although the average selling price of the Mac did decline, reflecting Apple’s price cuts in the face of the bad economy.
2:00 PT – DM: Bad economy or not, though, people are still clearly buying Macs, iPhones, and even iPods. Not the Apple TV, though—oh, I kid!
2:00 PT – JS: And if you look at a graph of Apple’s overall revenue — and I am, which is why I mentioned it! — you’d actually have a hard time spotting that global economic meltdown. Apple’s revenue growth proceeds unabated, punctuated by the gigantic holiday quarter.
2:02 PT – JS: Another numbers thing. Sixty-seven percent of the Macs sold in this quarter were laptops, reversing the downward tick last quarter. Generally Apple keeps selling more laptops every quarter, and it’s back on the way up.
2:02 PT – DM: And here we go. Here comes Nancy Paxton for opening comments. We’ll be hearing from Peter Oppenheimer, Tim Cook, and the ever laconic Gary Whistler, treasurer. As usual, there’re forward-looking statements that we shouldn’t bank on.
2:03 PT – DM: Hereeeeee’s Peter. Record June quarter revenue and earnings and the highest non-holiday quarter revenue and earnings in Apple’s history. Extremely busy quarter for new products, enthusiastic response. $8.34 billion in revenue, 12% growth year over year. Very proud, particularly given economic environment. Operating margin over 20%, better than expected revenue. $1.23 billion income, earnigs per share $1.35. $1.4 billion higher adjusted revenue; adjusted net income $1.9 billion, $700 million higher than reported net income.
2:05 PT – JS: Basically the non-GAAP numbers are what the company really sold and made during the quarter, separating out the iPhone revenue that’s spread over the course of two years rather than being taken in a single hit. It’s a better barometer of the last three months of Apple’s business, rather than being smoothed out by two years’ worth of previous sales.
2:05 PT – DM: Mac products and services. 2.6 million Macs, nearly meeting all-time quarterly record last September. More than 100,000 units over prior year; 4% year over year growth while 3% contraction of market overall. Revved both desktops and laptops. Mac portable shipments increased 13% year over year. Customer reponse to the new portables has been very favorable. Sales accelerated following launch. Began the quarter with between 3-4 weeks of Mac channel inventory.
2:06 PT – DM: Music. 10.2 million iPods, down from 11 million year ago quarter. A few reasons: reduced channel inventory by over 400,000. Sell through declined by 4% year over year. How are we looking at this market? Three categories of pocket product: traditional MP3 players (shuffle, nano, classic), iPod touch, and iPhone. Internally forecasted year over year decline for traditional MP3 players, hence iPod touch and iPhone. Expect traditional MP3 players to decline over time as they cannibalize with iPod touch and iPhone. Despite decline in sales, research shows about 50% of traditional iPod purchasers are buying their first iPods. iPod touch sales grew more than 130% year over year. Share of US market is over 70%, based on NPD’s data. iPod top selling MP3 player and continued to gain share year over year internationally. Began and ended quarter with 4-6 weeks channel inventory.
2:08 PT – JS: These are the sorts of data scraps that you don’t get in the revenue reports themselves. Apple doesn’t break out products individually, so it’s very informative to find that the iPod touch showed strong year-over-year growth, which is Apple’s way of blaming the fact that the iPod numbers have peaked on the traditional iPods, not the snazzy new iPod, the iPod touch, which continues to grow.
2:08 PT – DM: Over 5.2 million handsets sold in June quarter, compared to 717,000 sold in year over quarter. More than 1 million 3GS handsets sold in weekend after launch. Not able to meet demand immediately, but working to adjust. 3GS is available in 18 countries today, and being rolled out this summer to the rest of the 80 countries where iPhone is sold. App Store now offers over 65,000 apps and iPhone 3.0 helped pave the way for developers. Customer reponse to App Store has been phenomenal. 1.5 billionth download last week. App Store is a key differentiator of iPod touch/iPhone experience. Recognized revenue from iPhone was $1.69 billion during quarter, compared to $419 million year ago quarter, up over 300%. Sales value was $2.9 billion. Did not begin to recognize revenue or product cost from March 17th until June 17th; those iPhones are recognized ratably over remaining terms of estimated lives.
2:11 PT – DM: iTunes Store had a good quarter too. As of last week, customers have purchased and downloaded over 8 billion songs from iTunes Store.
2:11 PT – DM: Apple Stores. $1.5 billion in revenue, compared to $1.45 billion in year ago quarter. 492,000 Macs sold, compared to 476,000 Macs year ago quarter, and about half the Macs sold were sold to new customers. 6 new stores in the quarter, 258 stores total, and 27 store remodels. Average of 254 stores open during quarter, average revenue per store $5.9 million compared to $6.8 million. $321 million was retail segment margin. 36 million visitors in the store, increase of 22% over last year. Launched new One-to-One program. On track to open a total of 25 stores of fiscal 2009 and to remodel 100 stores. Opening first store in France in holiday quarter.
2:13 PT – DM: 36.3% total company gross margin. Difference driven by three factors: component costs incread, but not as high as expected; spent less than expected in several areas; efficiently ramped new products in quarter, spending less than planned. Benefited from weaker US dollar. Operating expenses $1.35 billion. Cash plus short term securities is $31.1 billion, increasing over $2.2 billion. Cashflow was $2.3 billion. Investment priority is preservation of capital. Continuing to focus on short, high quality investments. In first week of September quarter made $500 million prepayment to Toshiba for NAND flash.
2:14 PT – JS: Once again, we see that Apple is an extremely conservative company financially. It invests carefully, keeps billions of dollars of cash on hand, and places careful bets on future components costs (like NAND flash) in order to keep future costs down.
2:14 PT – DM: Outlook for 4th quarter: revenue of $8.7 billion-$8.9 billion. Gross margins around 34%, $28 million stock-based compensation. $1.445 billion in operating expenses; OIE $30 million. Tax rate about 30%. Targeting EPS $1.18-$1.23.
2:16 PT – DM: Very enthusiastic about Snow Leopard coming out. Confident in strategy and working hard to continue to deliver industry’s most exciting new products. And now, it’s question time!
2:16 PT – JS: So basically, another fantastic quarter from Apple, with the iPod market maturing but the iPod touch and iPhone showing massive growth, all during an economic downturn that has seemed to have very little impact on Apple.
2:16 PT – DM: Gene Munster, Piper Jaffray: Demand for low-price MBP, how does that develop? And how do you see the Wireless carrier relationships evolving?
2:17 PT – DM: Tim Cook: In terms of MBP, some models currently constrained. Didn’t have material effect on last quarter, factored supply into guidance. In terms of wireless carriers, most are thrilled with iPhone. Very good set of relationships. Obviously looking to expand.
2:18 PT – DM: PJ: See expanding relationships with carriers?
2:18 PT – DM: Tim: Nothing to announce today. I think AT&T is an excellent relationship and we’re very happy with it.
2:18 PT – DM: SDN Capital: Any detail you can give on education/pro segment?
2:18 PT – DM: Tim: Relative to market, consumer market performed better for Apple. US K12 educational business is getting hit by budget shortfalls. Very negligible amounts of stimulus funds flow to state last quarter; may or may not occur this quarter. Pro business has been affected more than consumer business, reflected by ASPs. Business accounts often delaying purchases.
2:19 PT – DM: SDN: Numbers for this quarter?
2:19 PT – DM: Tim: -6% in institutional business. K12 lower; higher ed, around 0%.
2:20 PT – DM: SDN: In terms of mix, any additional details on first 30 days of mix-shift with price changes on laptops?
2:20 PT – DM: Tim: Units grew faster than revenue in portable area, so ASPs did fall some. One reason is price cuts, another is transitional cost of major transition replacing the whole line-up in a day. We are seeing a mix-down versus historic, part of that is promotional customer who is buying up the line is delaying purchases in this economy. 7 to 9 points ahead of the market, and thrilled with those numbers.
2:20 PT – JS: Basically, Apple cut MacBook prices (presumably to stimulate sales) and the result was that the average selling price of a Mac laptop went down to roughly $1,250 from $1,350 in the previous quarter and $1,440 in the year-ago quarter.
2:21 PT – DM: Goldman Sachs, David Bailey: Some idea of how $99 iPhone is doing relative to other price points? Change in mix since the launch?
2:21 PT – DM: Tim: As we made the changes, both launch of 3GS and price drop on 3G, saw significant acceleration in total unit sales. Want to hold mix data, since it’s competitive data. Demand for 3GS has been very robust. Working very hard to fill that demand.
2:22 PT – DM: GS: Update on progress with large enterprise accounts with iPhone?
2:22 PT – DM: Tim: Great opportunity for us. Seeing growing interest with release of 3GS and iPhone 3.0 due to hardware encryption and improved security policies. Doing well with small business and with large organizations that allow people to purchase phones for individual use. Almost 20% of Fortune 100 have purchased 10,000 units or more. Multiple corporations and government orgs that have purchased 25,000 each; iPhone approved in over 300 higher education institutions. JD Power has ranked iPhone highest in overall satisfaction with business customers. Think we’re at the tip of the iceberg with what iPhone can do with business customers.
2:24 PT – DM: Richard Gardner, CitiGroup: Guiding up 4-7% sequentially, plus deferred revenue, why guiding below normal seasonailty?
2:24 PT – DM: Peter: Give you guidance we have reasonable confidence in achieving. For Mac, while we usually see increase from June to Sept quarters and we expect to see one this year, expect sequential increase to be less than previous years since every portable refreshed last quarter and desktops in the March quarter. Additionally, education institution sales remain under pressure from budget shortfalls. As regards to iPod, similar to June, traditional MP3 players should decline year over, iPod touch will grow significantly. Last year, sold very few phones in June quarter because of July launch. This year introduced 3GS in June, selling 5.2 million in the quarter, very optimistic going June to September, but just don’t have experience with seasonality with this distribution.
2:26 PT – DM: Ben Reitzes: Gross margins. Exceeded expectations, guiding above 30%, now at 34%. Long term estimate of 30% no longer holds? Model higher than 30%, due to better execution or business model change?
2:27 PT – DM: Peter: Very proud of team execution. Regarding gross margin, for Sep quarter, had a chance to go through complete process and guiding to 34% for Sep quarter, which is down from the 36% from just reported. Declined sequentially from back-to-school promotion, higher component cost, and new laptop product transition. First: many key components, cost is rising. Second: continue to focus on delivering state of art products at price points competitors can’t match.
2:28 PT – DM: Reitzes: With regard to surge at end of quarter of iPhones: what is inventory situation like?
2:28 PT – DM: Tim: iPhone channel inventory was flat sequentially. Same number beginning and end of quarter. Selling more units at end, channel isn’t loaded with the number of units they’d want. About 1.83 million units, including in transits that have invoiced and demo units.
2:29 PT – DM: Credit Suisse: Response to $999 MacBook and to MBP price cuts: Mac business more or less elastic than previously indicated?
2:29 PT – DM: Tim: Obviously thrilled with results had since portable announcement. Mac sales did accelerate after WWDC and shipment of portables. As expected, some number of people that are buying higher models since MBP is now $1199, instead of $1999. We’re not thinking fundamentally different. (Wait, is that a marketing slogan? Shouldn’t they be thinking different?) We’re not going to put the Apple brand on a product that doesn’t stand for innovation and that doesn’t have the legendary ease of use that we’re known for.
2:31 PT – DM: CS: Quantitative color on gross margin/EPS impacts from deferred revenue in June quarter?
2:31 PT – DM: Peter: You can estimate now that you know June quarter sales.
2:31 PT – DM: Cross Research: Update on Snow Leopard? How to think about $29 price point? What drove decision to go so low and adoption rates?
2:31 PT – DM: Tim: Snow Leopard is an even better Leopard. Redefines around 90% of the projects that make up OS X. Builds in Exchange support, lots of powerful new technologies. Priced it very aggressively so that all users can upgrade, and hoping that they do that. As announced, continue to expect to ship it later this quarter.
2:32 PT – DM: Cross Research: Commodity markets? How do we think about pre-buy with Toshiba? Additional pre-buys?
2:32 PT – DM: Tim: Market for DRAM and large sized LCDs have shifted to constrained market, pricing shfited. NAND flash has stablizied, expecting supply/demand balance. Pricing is declining on hard drives, optical drives. In terms of Toshiba, we do have a long-term supply agreement with Toshiba: $500 million pre-pay was a condition of the deal. Flash is a key commodity. In terms of doing additional deals, always open to doing additional deals with right terms and conditions. Two in this fiscal year, including one with LG on LCDs and may do others.
2:34 PT – DM: Sanford Bernstein: Last quarter, commented that percentage of $999 Macs had increased sequentially. Comment on this quarter? $999 offering a bigger percentage of total Mac notebooks this quarter than last quarter?
2:35 PT – DM: Tim: Not exact mix numbers, but at a macro-point, here’s what we saw happening. After transition, non-education business, people upselling from $999 to $1199. For $200, significant amount of features. Before transition, we saw a mix that was larger to the $999, but did see that change at WWDC. Education itself, K12 buys lower price unit.
2:36 PT – DM: SB: Comment on dynamics on iPhone side? Sounds like lower price point actually served more as traffic driver for 3GS than anticipated? That product a meaningful contributor?
2:36 PT – DM: Tim: Focused on total iPhone units. Very happy when total comes out. Too early to tell what ultimate mix of those products will be. iPhone 3GS is constrained and is only shipping in 18 countries of 80+ that they’re in. Some amount of time. A phenomenon at beginning of purchasing when you have people upgrading. Those people are more likely to select the new phone. Only been a few weeks, wouldn’t want to make any grand statements about what things will happen in longer term.
2:37 PT – DM: SB: Sequential gross-margin decline more benign than previous guidance? Component market tougher, back to school is broader, and notebook price cuts. Is offset in terms of guiding to lower gross margin sequential decline, iPhone-related or other considerations?
2:38 PT – DM: Peter: Always hard to talk about gross margin year over year, different product cycles, component markets, etc. Are benefiting from higher mix of iPhone revenues, and that helps gross margin. That is a factor. But as guiding for Sept quarter, gone through normal process, resulted in 34% that we provided.
2:39 PT – DM: SB: Lowered channel inventory on iPods about 400,000 units: should we be thinking about reduction being consistent as a percentage of what you anticipate for reduced iPhone sales in following quarter?
2:39 PT – DM: Tim: Look at over 400,000 we reduced by, two primary reasons: in March, announced and launched a new shuffle towards end of quarter and Easter holiday was at beginning of June quarter, so ended March with a bit more inventory; with these events behind, reduce channel inventory, and that accounts for about half of 400k reduction. Second reason: overall demand is lower, due to weaker economy, cannibalization of iPhone, and reduction of market for traditional MP3 players. As a result, adjusted channel inventory to account for lower demand, and that accounted for the rest of the reduction. As a reminder, began and ended quarter within target of 4-6 weeks.
2:41 PT – DM: RBC Capital: Competitors are unveiling application stores and media and touch features. How do you plan to maintain iPhone momentum and continue innovating?
2:41 PT – DM: Tim: Just sort of summarize what’s happened in last 90 days. Just shipped latest version of world’s most advanced iPhone software, and App Store is in 77 countries, and an installed base of 45 million. App Store is a success, 65,000 apps and 1.5 billion downloads. RIM and Nokia stores between 1,000-2,000 each, and Android under 5,000. Substantial lead on apps, software, and a great deal of hardware innovation. Feel extremely good about competitive position and continue to believe we’re years ahead of others.
2:43 PT – DM: RBC: Additional distribution of pricing models important to sustain growth? Sustain growth based on current strategy?
2:43 PT – DM: Tim: Think we just took a major change with the introduction of a $99 product. Viewed that there was elasticity there. In regards to other question, we are working very hard to continue expanding distribution both within countries and to add new countries, because world has more than 80 countries.
2:44 PT – DM: RBC: Positive response to Mac price cuts, does that mean you still feel that lower-price PC category isn’t in your business model?
2:44 PT – DM: Tim: Our goal is not to build the most computers, it’s to build the best. Whatever price point we can build the best at, we will play there. At this point, we don’t see the way to build a great product for this $399-$499, this kind of price point unit. And, as I’ve said before—and I think this is playing out in many areas—many customers become disappointed and disenchanted after they’ve bought one of these. Focused on making best value. Now can buy MacBook Pro for $800 less than last year. Feel very good about strategy and pricing, and results bear it out. Macs have outrun the market 18 of the last 19 quarter. And I think we do have the right approach.
2:46 PT – DM: Andy Hargreaves: Services and apps are growing really fast; does growth constrained by network capacity of carrier partners?
2:46 PT – DM: Tim: I think that’s a better question for them. But I see them making more adjustments in order to have faster networks and see them having lower churn. Changes their customer acquisition. Adjustments to bring services customers enjoy, like faster networks.
2:47 PT – DM: AH: Data center or NOC on your side?
2:47 PT – DM: Tim: We have no plans to do so. Deliver a world-class handset because of our hardware/software skills and deliver something revolutionary. Other people that have much more skills in networks, who we’re dealing with as partners. That’s their business and they’re quite good at it.
2:48 PT – DM: Morgan Stanley: First, conversation around netbook. Do you think there is an emerging market for a truly mobile device that would have a larger screen where you can do more than on the iPhone?
2:49 PT – DM: Tim: I never want to discount anything in the future, and never want to specifically discuss new products. I think most customers that are buying a portable want a full-featured notebook, and we deliver those and some incredible value. Some of the netbooks that are being delivered are very slow, have software technology that is old, don’t have robust computing experience, lack horespower, have small displays and cramped keyboards, and I could go on and on, but I won’t. I think many people won’t be happy with, and we’re only going to play in things where we can deliver things that are very innovative that we’re proud of.
2:50 PT – DM: Brian Marshall: Question about iPhone activiations. US seems like about 40% of activiations; should the international side start to pick up?
2:50 PT – DM: Tim: We don’t relase the percentage of iPhone sales by geography, wouldn’t want to get into that: we view it as competitive information. Smart phones in general are being sold in larger numbers in environments where post-pay is primary payment mechanism. Not that there are zero phones being sold in pre-pay, but it’s lower. That’s the reality of the smart phone market currently.
2:51 PT – DM: BM: Competitors are playing with pre-pay; you interested in that down the road?
2:51 PT – DM: Tim: We sell pre-pay in markets that are predominantly pre-pay. This is an environment where we are still a beginner. I think our business model works quite well in our post-pay category, but pre-pay is an opportunity for us. Trying it where post-pay is dominant and where pre-pay are dominant. Hopefully improve as we move forward.
2:52 PT – DM: BM: Percent of iPod touch userbase that actually upgraded to 3.0 software?
2:52 PT – DM: Tim: I would call it “a good number” and don’t want to be more specific. Obviously priced that extremely aggressively, and wanted to get the platform out there for developers and for more apps.
2:53 PT – DM: Deutsche Bank: Do supply constraints on iPhone 3GS impact roll out for remaining countries? When supply/demand reach equilibrium?
2:53 PT – DM: Tim: Don’t want to predict when supply/demand balance, but not in the short-term. Very difficult to gauge demand without supply there. In terms of affecting the country roll-out, belive the vast majority of countries where selling 3G, be selling the 3GS by end of the fiscal quarter. Might move a date by a few weeks here or there, but vast majority by end of quarter.
2:54 PT – DM: DB: Any update on China?
2:54 PT – DM: Tim: Nothing to add, but continues to be priority project, and hope to be there within a year.
2:54 PT – DM: Charles Wolff, Needham: On sales of the iPhone, any information on new activiation vs. upgrades.
2:55 PT – DM: Tim: Can’t share that information, some of that’s confidential to carriers.
2:55 PT – DM: Wolff: In terms of application prices in App Store, appears to be a race to the bottom. Increased number of $0.99 offerings, and is this a concern, and any steps to help consumers separate quality apps from garbage?
2:56 PT – DM: Tim: Always looking for ways to categorize apps differently, and we have some ideas. Use categories, prices, etc. Realize there’s an opportunity there for further improvement. Developer sets the price, so it’s up to them what to charge. They’re doing what any good business person would do, doing the elasticity analysis, and figuring out where to sell price. As install base grows, it makes more and more sense to have lower prices, but that’s totally up to developers.
2:57 PT – JS: Last time, Cook said Apple was satisfied with discoverability on the App Store. This time, he said there’s an opportunity to do better. That’s progress, isn’t it?
2:57 PT – DM: And that’s it. Phew. Lot of words out there today. Thanks for joining us, as always, and we look forward to seeing you back here in three months.
2:57 PT – JS: And well typed, Mr. Moren. Thanks to everyone for tuning in. And if you’ll excuse us, Apple’s kicking us out — we don’t have to go back to our home phone system, but we can’t stay in this conference line.