This is Tim: Apple’s CEO on the iPad, Apple TV, future products, and China

As usual, Apple CEO Tim Cook was the focus of attention during the company’s quarterly earnings call with analysts on Wednesday. And, as usual, we’ve got a transcript of his answers while on the call, beginning with edited highlights of his opening remarks.

The iPhone was key in driving our stronger-than-expected results. We sold almost 44 million iPhones, setting a new March-quarter record. These strong results were broad-based, both from a product point of view, with demand for each of our three iPhones stronger than its predecessor, and from a geographic standpoint. We gained smartphone share in many developed and emerging markets including the U.S., the U.K., Japan, Canada, Germany, France, Vietnam, and greater China, just to mention a few.

iTunes software and services revenue continued to grow at a double-digit rate, thanks to an incredible ecosystem and our very large, loyal, and engaged customer base. With strong momentum and growing profitability, iTunes is a very important driver of our business, not only here in the United States, but around the world. We now have an almost 800 million iTunes accounts, most of these with credit cards. This is a staggering number.

We continued to gain share in the personal computer market as well. We defied industry trends again by growing while the market contracted. Our bold decision to make OS X free has resulted in the largest-ever percentage of the Mac install base running on the latest version of the operating system, just months after its release.

iPad sales came in at the high end of our expectations, but we realized they were below analyst estimates, and I would like to proactively address why we think there was a difference.

We believe almost all of the difference can be explained by two factors: First, in the March quarter last year, we significantly increased iPad channel inventory, while this year, we significantly reduced it. We will go into more detail about this later.

Second, we ended the December quarter last year with a substantial backlog of iPad minis that were subsequently shipped in the March quarter, whereas we ended the December quarter this year near supply-demand balance.

We continue to believe that the tablet market will surpass the PC market in size within the next few years, and we believe that Apple will be a major beneficiary of this trend.

We are continuing to invest in our retail stores, and since our last call, we’ve opened our first stores in Brazil and Turkey, and we now have retail stores in 15 countries around the world.

And I’m looking forward to welcoming our new retail and online leader, Angela Ahrendts, who will be joining Apple’s executive team next week.

We estimate that over the last six months, we’ve added over 60 million new registered users of our four product categories. Additionally, over two-thirds of people registering an iPad in the past six months were new to iPad, while over half of the people registering iPhones were new to iPhone.

It’s wonderful to add tens of millions of first-time Apple product users, especially considering the strong halo effect we’ve seen over and over again in our history. Customers who have a great experience with their first Apple product often become loyal and happy owners of multiple Apple products over time.

As always, I’d like to thank our talented employees who make these results possible through the creativity and passion they bring to their work every day. And I’d like to thank our hundreds of millions of customers for their loyalty and enthusiasm, and for continually inspiring us to surprise and delight them.

Apple has created tremendous value for shareholders by developing great products that enrich people’s lives, and that will always be our top priority and driving force. We’ll continue to innovate by investing in research and development, and capitalizing on our strengths in hardware, software, and services. We’ll keep investing in our supply chain to promote scale and efficiencies; expanding our global presence by building retail stores; investing in marketing and distribution; and extending our reach into new markets.

We are expanding Apple’s products and services into new categories, and we are not going to under-invest in this business.

We’re also investing through acquisitions, and we’ve acquired 24 companies in the past 18 months.

To invest organically, and to make acquisitions strategically, we need to maintain financial flexibility.

We decided to continue to allocate the vast majority of the incremental capital return to share repurchases, because we believe our current stock price does not reflect the full value of the company.

Finally, before we start the Q&A, I’d like to take a minute to talk about my dear friend and colleague, Peter Oppenheimer. As you know, Peter will be transitioning from the CFO role in June. Peter has been Apple’s CFO for ten years, and the list of his accomplishments is immense. Apple is now more than 20 times the size it was when Peter became our CFO, and his expertise, leadership, and incredibly hard work have been instrumental to the company’s success.

I’d like to thank him very publicly for his contributions to Apple, from the very bottom of my heart, and wish him all the best in his approaching retirement at the end of September.

And I’d also like to recognize him, that he has never never missed guidance in his ten years as CFO, which must be an all-time record for CFOs.

On iTunes software and services profits

Keep in mind, in that category there are several things, not just the app store kind of revenues. And so if you looked at App Store only, it would look a little different than what you’re saying [a sequential decline in profits year over year].

In terms of your question about monetization, I do believe that we can monetize more than we are from a services point-of-view, in existing areas and in new areas, and I’m particularly encouraged that when I look at the App Store and how it’s doing, the strength was broad-based. In fact, in China, the growth was in the triple-digits.

On iPhone 5s vs 5c and charging more for products

We’ve priced things in such a way that we think is a fair price for the value that we’re delivering. And we make those decisions on each thing as it gets closer to market.

On the strength of the iPhone internationally

We saw some pressure in the quarter because of the stricter enforcement of upgrade policies, but this is primarily in the U.S. as I’d mentioned last time.

But if you really look at iPhone, the strength of iPhone was very broad-based, and as I’d mentioned we gained share in a whole host of markets; from developing markets like the U.S., U.K., France, [and] Germany to more of emerging markets like China [and] Vietnam, and had the largest total sales of iPhone in the BRIC countries that we’ve ever seen in our history. And so we feel very, very, very good that the strength was broad-based.

On iPhone replacement cycles and upgrade frequency

Just to be clear, on the iPhone 4 question, we’ve sold a very, very low single-digit percentage of those, and so it has extremely minimal impact or result on the quarter.

In terms of the general upgrade, or the installed base, some of the programs that the carriers are running may serve to increase the upgrade cycle, because there’re some areas where customers can pay a bit more in the beginning and have the ability to essentially upgrade each year.

But what I see as the bigger opportunity for Apple is that the smartphone market is still only a billion or so units, and it will eventually take over the entire mobile phone market. We’ve seen our ability to attract new users to iPhone to be very significant in the emerging markets. I mean, we were seeing new-to-iPhone-numbers on the iPhone 4s, sales in the 80 percentages, in certain large geos.

And so this, to us, gives us a great comfort that we can continue to grow and we may not be able to attract some of those buyers to our top phone because of price point. But if we can get them in on the entry iPhone, it gives them a great product at a great value and gets them into the ecosystem. And, as you know from following us for a while, our ability to keep customers is very good, and our ability to show other products that Apple produces to a family that’s buying Apple products is also very good.

And so, at the macro level, I see the opportunity of the market—and getting more people into the Apple ecosystem—much larger than any of the noise around the different carrier plans. Some of which I think help, and some of which I think work the opposite way, and it’s completely unclear to me how those net.

It’s probably also important to know that the bulk of the things you’re seeing in the U.S. are not occurring in many of the other geos, in terms of the upgrade polices and so forth. I mean, each country has its own kind of cadence associated with this; the U.S. is in the 30 percentages of our business, not 100, so it’s important to weigh it with the proper perspective.

On creating great products that increase upgrading

The most important thing that we do is to make great products that really get our users excited to want the next one, and that will always be the case. And you can bet that that’s where the vast majority of all of our attention is, on doing those things.

In terms of the pressure of getting new products, you have seen in the past that exists, I think you’ve also seen that we have a way of working down the cost curve. That was certainly very key in achieving the 39.3 percent gross margin for this past quarter.

And as I’ve said before, we price things at a level that is fair for the value that we’re providing, and so we’re certainly not stuck on certain price points. We price at values that are fair for the value that we’re delivering.

On the iPad and its decline year over year

It’s a good question. Let’s talk about iPad a little more than we did in the comments.

When I back up from iPad, here’s what I see: It absolutely has been the fastest-growing product in Apple’s history. And it’s been the only product that we’ve ever made that was instantly a hit in three of our key markets, from consumer to business, including the enterprise and education.

And so, if you really look at it, in just four years after we launched the very first iPad, we’ve sold over 210 million, which is more than we or I think anyone thought was possible over that period of time.

And it’s interesting to note that that’s almost twice as many iPhones as we’d sold in a comparable period of time, and over seven times as many iPods as we had sold in the period of time. And so I think it’s important to kind of put that in perspective. We’ve come a long way very very quickly.

Looking at it by market a bit, which I think is important; I think Luca mentioned a little bit of this in his comments, in the education market in the U.S. we have a 95 percent share. And so the focus in education is on penetration, is in getting more schools to buy. And my belief is the match has been lit, and it’s very clear to the educators that have studied this that student achievement is higher with iPad in the classroom than without it. And so I’m confident we’ve got a really great start in education, far beyond the U.S. now; this is happening in many, many parts of the world.

In the enterprise market, we’re seeing virtually all—98 percent—of the Fortune 500s that are using iPad, and we’re seeing, according to the latest data we have, that 91 percent of the activations of tablets in enterprise were iPad. And so this is also an astonishing number, and many of those enterprises are writing apps that are key proprietary apps for running that business. And this is great for that company because they’re more productive as a result of that.

And so once again, our—just like in education in a way, what we have to do in enterprise is focus on penetration. It has to be deeper, and broader, but in terms of having people begin the process, begin writing apps, we’re doing a pretty good job of that.

In the retail market, if you look at the U.S. as a proxy—the NPD numbers from March just came out a few days ago, and we had 46 percent share. And, embedded in that 46 [percent], there’s a lot of things in there that I personally wouldn’t put in the same category as iPad, and that are weighing the share down. It’s certainly a market we wouldn’t play in, and a type of product you would never see an Apple brand on. So we feel like we’re doing well, there.

Office [for iPad], I believe, does help. It’s very unclear to say how much; I believe that if it would have been done earlier, it would have been even better for Microsoft, frankly. There’s lots of alternatives out there from a productivity point of view: some of which we brought to the market, some of which many, many innovative companies have brought. But I do see that Office is still a very key franchise in the enterprise, in particular, and I think having it on iPad is good. And I whole-heartedly welcome Microsoft to the App Store to sell Office. Our customers are clearly responding in a good way that it’s available. But I do think it helps us particularly in the enterprise area.

The other things you look at on iPad that are just blow-away is customer sat[isfaction] is 98 [percent]. There’s almost nothing in the world with a 98 customer sat. And the intention-to-buy numbers look good, with two-thirds of people planning to buy a tablet planning to buy an iPad. The usage numbers are off the charts, far exceeding Android tablets—four times the Web traffic of all Android tablets combined.

And so when I back up from all of these, I feel great. That doesn’t mean that every quarter—every 90 days—is going to be a number that everybody’s thrilled with. But what it means to me is that the trend over time, over the arc of time, that things look very, very, good—that iPad has a great future.

And of course the thing that drives us, more than any of this, are the “next iPads,” if you will, the things that are in the pipeline, the things that we can do to make the product even better. And there’s no shortage of work going in on that, nor any shortage of ideas.

And so when I back up from all of this, I can’t help but still be extremely excited about where we are.

I think we did a reasonable job of explaining what we think the disconnect was between what we had expected—which we hit it at the high end of our expectations—and [Wall] Street’s view of this one. And I believe the vast majority of it is that first thing was just channel inventory that…maybe we should have been even clearer on last quarter to take in to account. But I am very bullish on iPad.

On Amazon and Google’s business diversification

The key thing that…for us, is to stay focused on things that we can do best and that we can perform at a really high level of quality that our customers have come to expect.

And so we currently feel comfortable in expanding the number of things we’re working on. We’ve been doing that in the background, and we’re not ready yet to pull the string on the curtain.

But we’ve got some great things there that we’re working on that I’m very very proud of and very, very excited about.

But for us, we care about every detail, and when you care about every detail and getting it right, it takes a bit longer to do that. And that’s always been the case—that’s not something that just occurred, you know.

As you probably know from following us for a long time, we didn’t ship the first MP3 player, nor the first smartphone, nor the first tablet. In fact, there were tablets being shipped a decade or so before then, but arguably we shipped the first successful modern tablet, the first successful modern smartphone, and the first successful modern MP3 player. And so it means much more to us to get it right, than to be first.

I think you can see so many examples out in the marketplace where it’s clear that the objective has been to be first. But customers, at the end of the day, don’t care about that, or that’s not what they look for from Apple—they want great, insanely great, and that’s what we want to deliver. And so that’s the way we look at it.

Like, from an acquisition point of view, we have done 24 [companies acquired] in 18 months; that shows that we’re on the prowl, I suppose you can say. We look for companies that have great people, and great technology, and that fit culturally. And we don’t have a rule that says we can’t spend a lot, or whatever. We’ll spend what we think is a fair price.

What’s important to us is that strategically, it makes sense, and that it winds up adding value to our shareholders over the long haul. We are not in a race to spend the most, or acquire the most. We’re in a race to make the world’s best products, that really enrich people’s lives.

And so, to the tune that acquisitions can help us do that—and they’ve done that, and continue to do to that—then we will acquire it, and so, yeah, you can bet that we will; you will continue to see acquisitions, some of which we’ll try to keep quiet, and some of which it seems to be impossible to keep quiet.

On the general smartphone landscape

There’s a lot of moving parts, a lot of acquisitions, a lot of people giving up to some degree and deciding to do other things. But at the end of the day, we see it much like we’ve always seen it—as the part of the market that we’re interested in is the market of people that really want the best smartphone.

And that doesn’t mean that they’re all at the high-end of the price band; I mean, we have smartphones that go down to a very affordable price (with the 4s) because we’re proud to ship this product.

I think that this quarter, if you were unsure, hopefully this quarter demonstrates to you that we can do well in a number of geographies—from emerging markets to developing markets.

Some of the numbers that we’ve experienced, just to quote some of the more historic pre-paid markets, through the first half of ’14, Brazil was up 61 percent, Russia was up 97 percent, Turkey was up 56 percent, India was up 55 percent, Vietnam was up 262 percent. I could go on, but the point is that there’s a number of markets out there, where we’re beginning to really catch on to a number of customers, and I am particularly proud of the results in these markets, because these have not been historic strong points for Apple.

We’ve been working at China for awhile, and have learned a lot, and I’m very proud of what we’ve done there, but I think some of these other numbers I just read demonstrates that we’re beginning to have really nice success outside of there as well.

On China growth

We did have an all-time revenue record in greater China—just under $10 billion, at $9.8—iPhone sales were up 28 percent, that’s versus IDC’s market forecast of 20 percent growth. So we gained share. Mac units were up double-digits, in particular they were up 13 percent, and that’s far outpacing IDC’s PC market forecast of a -8 percent. So we gained share there as well.

If you look at the iTunes software and services revenue in China, we more than doubled it year-over-year; we were in the triple-digit percentages. And if you look at iPad and you take out the channel inventories and the ins and outs and look at demand instead of sell-in, we grew by 6 percent. And that compares to IDC’s forecast of a flat tablet market in China for last quarter.

And so we literally did well in every single area in China. It wasn’t just because we were able to come to an agreement with the world’s largest carrier. That was certainly key, but as you can tell from the rest of these numbers, there are other things going on.

Also, I had mentioned this briefly, but I think it’s important to point out that if you look at some of the numbers we’re seeing on first-time iPhone buyers…People that bought the iPhone 4s: 85 percent were first-time iPhone buyers. And the 5c: 69 percent first-time iPhone buyers. So these are extraordinary, and as you would expect, these are also heavily Android-switchers. 62 percent of the people that bought the 4s switched from Android. 60 percent of the people that bought the 5c switched from Android. And, y’know, so we’re incredibly pleased with this.

For the first half [of the year], including our retail stores, greater China revenue topped 19 billion. So this is up 21 percent year over year, and it is our fastest-growing region.

And so we’re looking at this data and deciding to continue investing in a big way. We plan to triple the number of Apple retail stores over the next two years; we’re continuing to expand in online, we’re continuing to build out channel. We’re up to 40,000 points of sale now on iPhone, but we’re not nearly where we need to be on the rest of our product line, and even the 40,000 is a low number in considering the broad land mass and the number of folks in China.

I feel like there’s still loads of opportunity there, and feel really, really good about how we’re doing.

On the Apple TV no longer being a hobby

The reason that I stripped off the “hobby” label is that when you look at the sales of the Apple TV box itself, and you look at the content that was bought directly off of Apple TV for 2013, that number was over a billion dollars. And so it didn’t feel right to me to refer to something that’s over a billion as a hobby. Also, from a investment point of view, we continue to make the product better and better. And so it doesn’t feel right from that point of view, either.

[On Amazon’s deal with HBO] We have HBO Go already on Apple TV, and you have to authenticate in order to use it, but you have to do that with Amazon’s service as well from my brief read of their announcement. I think they, in addition to that, got some older content from HBO to put on there, and I haven’t had a chance to evaluate exactly what it is, and don’t have a personal point of view on that yet.

But if I look broadly at the content on Apple TV, I think it compares extremely favorable to the content that is on the Amazon box. We’ve sold, now, about 20 million of the Apple TV, and so we’ve got a pretty large installed base there. And I’m feeling quite good about that business and where it can go.