蘋果 (AAPL) 2008 Q2 法說會逐字稿

Good day, everyone and welcome to the Apple, Incorporated's second quarter 2008 quarterly results conference call.

Today's call is being recorded.

At this time for opening remarks and introductions I would like to turn the call over to Nancy Paxton, Senior Director, Investor Relations and Corporate Finance.

Please go ahead.

Thank you, good afternoon, and thanks to everyone for joining us.

Speaking today is Apple's CFO, Peter Oppenheimer.

He'll be joined by Apple's COO, Tim Cook, and Treasurer, Gary Wipfler for Q and A session with analysts.

Please note that some of the information you'll hear during our discussion today may consist of forward-looking statements regarding revenue, gross margins, operating expenses, other income and expense, stock-based compensation expense, taxes, earnings and future products.

Actual results or trends may differ materially from our forecast.

For more information, please refer to the risk factors discussed in Apple's form 10-K for 2007, the form 10-Q for the first quarter of fiscal 2008 and the form 8-K filed with the SEC today and the attached press release.

Apple assumes no obligation to update any forward-looking statements or information which speak as of their respective dates.

With that, I would turn the call over to Peter Oppenheimer for introductory comments.

Thank you, Nancy and thank you for joining us.

We are very pleased to report the highest March quarter revenue and earnings in Apple history.

Revenue in the March quarter was $7.51 billion, an increase of more than $2.2 billion over the previous March quarter's revenue of $5.26 billion.

The tremendous growth in the quarter was driven by very strong demand for Macs, higher revenue from iPod and iTunes and the continued popularity of the iPhone.

Operating margin for the quarter better than expected at 17.5%, primarily due to the higher than anticipated revenue and gross margin.

Net income was $1.05 billion, which was up 36% over the prior March quarter's results and translated to earnings per share of $1.16.

Before going through the details of the March quarter, I'd like to give you a few data points indicating just how exceptionally well Apple performed.

Revenue growth in the March quarter accelerated to 43% year-over-year, which is more than twice the 21% growth rate we achieved in the March quarter last year.

We saw healthy growth in all regions, with the U.S.

sales growing 40%, and international sales growing 47%.

Sales in our 208 retail stores, most of which are in the U.S., were extremely strong, growing 74% year-over-year, driven in part by traffic of 33.7 million visitors, up 57% from the year ago quarter.

In the retail stores, 50% of the CPUs we sold were to customers who were new to the Mac, adding growth to our platform.

And finally, our U.S.

education business generated Mac unit growth of 35% year-over-year, its highest growth rate in any quarter in the last 8 years.

I'd now like to talk about our Mac products and services which represented 59% of total quarterly revenue.

We're extremely pleased to have shipped 2.29 million Macs, just shy of the record number of Macs we sold this past holiday quarter, and representing 51% growth over the prior March quarter's results.

This is a 3.5 times the overall PC market rate of growth for March quarter, based on the latest forecast published by IDC, up from the 2 to 3 times market growth rate we had been reporting almost every quarter for the last three years.

Sales of desktops grew 37%, driven by strong demand for the iMac as well as increased sales of Mac Pro, which we updated in January.

Sales of portables grew 61%, driven by continued strong demand for MacBook and the MacBook Pros, both of which were refreshed during the quarter, as well as the successful launch of the MacBook Air.

MacBook Air represents a new portable category for Apple, and customers have responded very well to its breakthrough design and ultraportability.

We ended the quarter with between three and four weeks of Mac channel inventory.

Now I'd like to discuss our music products and services, which accounted for 36% of total revenue during the quarter.

We sold 10.6 million iPods, an increase of 1% from year ago quarter, and we experienced about the same seasonal decline between the December and March quarters as we did last year.

IPod revenue grew 8% year over year from higher ASPs in every geographic segment due to the success of the iPod Touch.

We continue to be very pleased with customer response to the iPod Touch, and believe the introduction of the software development kit in late June will broaden this appeal even further, as great new applications are developed.

After declining 17% year-over-year in the December quarter, Shuffle sales were also down significantly in the March quarter, but the weekly rate of sales improved considerably following the February 19th price reduction.

We continue to achieve our objectives of maintaining our high MP3 market share in the U.S.

and gaining share internationally.

Our share of the U.S.

MP3 market was 73%, according to the latest data published by NPD.

Outside the U.S., we gained share in nearly every market we have data for, based on the latest information from GFK and BCN.

We began and ended the quarter within our target range of 4 to 6 weeks of iPod channel inventory.

Sales for iTunes were very strong for the quarter enter and NPD has reported we have surpassed Wal-Mart to become the largest music retailer in the U.S.

The iTunes store has over 50 million customers and over 85% share of the U.S.

share of the market for legally purchased and downloaded music, based on the latest information from Nielsen SoundScan.

Our movie rental service has been well received by customers and we have also just begun selling TV shows in Germany and will continue to expand video content internationally.

We are very pleased with iPhone momentum and customer feedback continues to be outstanding.

We remain confident in achieving our goal of selling 10 million iPhones in calendar 2008.

We sold 1.7 million iPhones during the March quarter and expanded our sales presence to include Austria and Ireland.

Total revenue recognized during the quarter from sales of iPhones, iPhone accessories and payments from carriers was $378 million.

Total deferred revenue from iPhone and Apple TV was $1.93 billion at the end of the March quarter compared to $1.44 billion at the end of the December quarter.

Developer response to the iPhone's 2.0 beta software we announced on March 6 has been tremendous.

Over 200,000 developers have signed up and downloaded the software development kit.

Interest in the iPhone enterprise beta program has also been off the charts.

We received applications from over one third of the Fortune 500 and over 400 higher ed institutions.

Hundreds of companies and institutions have been accepted into the program and more are being added each week.

Because we announced these specific new features to be included in the iPhone 2.0 release, and plan to provide them to iPhone customers as a free upgrade in late June, we will delay the start of revenue recognition for all iPhones sold on or after our March 6 announcement date until the iPhone 2.0 software is delivered.

The revenue and cost of sales associated with these iPhones will be recognized ratably over the remaining terms of their respective 24-month estimated lives.

Revenue recognition of handsets sold prior to March 6 and payments from carriers has not changed as a result of our announcement.

I would now like to turn to the Apple retail stores, which had another terrific quarter, with revenue growing 74% year-over-year to $1.45 billion.

The store sold 458,000 Macs during the quarter, an increase of 67% year-over-year.

We opened four stores during the quarter to end with 208.

With an average of 205 stores open during the quarter, average revenue per store was $7.1 million compared to $4.8 million the year ago quarter, an increase of 48%.

Operating profits doubled year-over-year to $334 million from $164 million.

A primary objective in our stores has been helping people to get more out of their Macs, and the stores delivered 580,000 one-hour personal training sessions during the quarter.

We opened our 15th store in the United Kingdom during the March quarter, and look forward to opening our first stores in Australia, China and Switzerland in the coming months.

We expect to open about 45 stores during fiscal 2008 and continue to be very confident in the investments we are making in the stores and the asset we are building.

Total company gross margin was 32.9%, which was a little stronger than our guidance due to a more favorable commodity environment, higher overall revenue and a weaker dollar.

Operating expenses were $1.16 billion, including $112 million in stock based compensation expense.

OI&E was $162 million, below our guidance due to the lower interest rate environment.

The tax rate for the quarter was about 29%, below the expected 32%, due to higher foreign earnings and lower interest income.

We expect the tax rate for the second half of fiscal 2008 to be 31%.

We generated $1 billion in cash during the quarter, ending with $19.4 billion.

Cash flow from operations was $1.2 billion.

In the first half of the fiscal 2008, we generated $4 billion in cash from $2.6 billion in net income.

The difference being driven largely by the iPhone and strong working capital management.

Looking ahead to the June quarter, I'd like to review our outlook, which includes the types of forward-looking information that Nancy referred to at the beginning of the call.

For the quarter, we are targeting revenue of about $7.2 billion or approximately 33% growth over the prior June quarter.

We expect the total quarterly costs of non-stock cash based compensation to be approximately $135 million.

We expect gross margins to be about 33%, reflecting approximately $20 million related to stock based compensation expense.

We expect OpEx to be about $1.185 billion, including about $115 million related to stock-based compensation expense.

We expect OI&E to decline to about $115 million, due to the impact of recent interest rate cuts and we expect the tax rate to be about 31%.

We expect to generate EPS of about a $1.

In closing, we're extremely proud of our growth in business performance in the March quarter.

Our 51% Mac sales increase is the strongest quarterly growth rate we've generated in almost two decades, and 3.5 times the market rate of growth.

We're very excited about the delivery of the iPhone 2.0 software in last June and the vast potential for compelling solutions that our SDK opens up for the developer community.

We remain very confident in our business and continue to be excited about the businesses in our pipeline.

With that, I'd like to open the call to questions.

Thank you.

(OPERATOR INSTRUCTIONS).

Our first question will come from Ben Reitzes with Lehman Brothers.

Thanks a lot.

Nice performance and revenue.

Wanted to ask you a little bit about gross margin.

32.9 was really good, but I was wondering if you had thought actually more could flow to the bottom line and what maybe some of the negative cross currents were.

And then also what gives you the confidence of 33% the next quarter?

Just a little bit more on that would be helpful.

Thanks.

And then I just have a follow-up on iPhone.

Okay.

Ben, maybe I'll let Tim make a few comments about the commodity environment and then let me talk more broadly about gross margin in the March quarter and what we expect in June.

Great.

Ben, commodity pricing in both DRAM and the NAND flash market hit historically low levels during the March quarter.

We would expect pricing in the current quarter to remain favorable and we folded that into our guidance.

We believe that the LCD market is near our supply/demand balance will have relatively stable pricing.

Hard drives, optical drives, and most other commodities are in a supply/demand balance and we would expect these commodities to follow historical pricing trends.

Okay.

And in terms of the quarter, did anything go against you, though, that was unexpected?

In the gross margin line or was there an impact from the lower price of the Shuffles that maybe some of us didn't anticipate?

Ben, it's Peter.

Let me continue on and I'll address that and talk a little bit about the June quarter as well.

As we commented in last quarter's call, we expected gross margin to decline by about 2.7%.

We actually exceeded our guidance this quarter by 90 basis points.

The gross margin only reduced by 1.8%.

And the better than expected results were primarily due to the favorable commodity environment that Tim discussed, higher revenue in the quarter, and a weaker dollar.

The sequential decline from Q1 was primarily due to Leopard entering its second quarter of sales.

As we mentioned on last quarter's call and as we've seen in the past, the new OS has significantly more sales in its debut quarter.

The change in Leopard and the other Apple software sequentially accounted for over 80% of the gross margin decline that we saw, as expected.

Other factors affecting the gross margin in the quarter were the Shuffle price change.

We took several international price reductions as a result of a change in currency market.

Higher mix of iTunes, which has a lower gross margin, and a sequential decline in the revenues from the holiday for the quarter.

These factors were offset by favor valuable component pricing allowing us to achieve a gross margin of 32.9%, which was ahead of our expected 32.

That was pretty detailed.

In terms of the iPhone and I'll cede the floor.

With regard to the iPhone we've noticed less availability, especially as we got towards the end of the quarter and recently and is there anything -- and then they were widely expecting new products but is there anything you can say that will give us confidence that you could grow that segment sequentially given the current amount of supply out there?

Is there anything you're worried about and whatnot on the iPhones side in terms of shortages or should we assume you have a handle on that and can grow that business sequentially?

Ben, it's Tim.

We're confident in hitting the 10 million for the year.

That would be the main point.

In terms of the shortages you referenced, we expected iPhone to decline more on a sequential basis than it did.

We beat our unit expectations.

As a result, as we got to the end of the quarter we started to experience some stock out.

At this point, both inventory in our stores and our channel inventories are currently low.

Our U.S.

stores have experienced more stock outs, or relatively more and we believe the reason is that there are more phones being bought there with the intention of unlocking, which remains a significant number.

Okay.

And you don't want to clarify that number at this time?

I can't clarify it.

It's not that I don't want to.

It's that it's very difficult to come up with a very precise estimate of it.

But we do believe the number continues to be significant.

And our view continues to be that this is a proxy for the worldwide demand of the phone.

And our focus is very much on rolling out to more GO's and we're on target to roll out into more countries in Europe and to inter Asia later in the year.

Great.

Thanks so much, guys.

Thank you, Ben.

Could we have the next question, please?

Yes, we'll move to Bill Fearnley with FTN Midwest.

Yes, wanted to ask a couple of channel questions if I could.

Could you guys give more color on the direct versus indirect mix and also could you give us any update on where you are with the expansion of the Best Buy footprint?

Bill, the direct sales in the quarter were 53% and that was up from 49 in the year ago quarter.

And in terms of Best Buy, we ended with a little over 400 stores, which was to our plan and we continued to target to be at 600 in the summer.

And the roll out is going extremely well, and we're very, very happy with it.

And then a follow-up on education, if I could.

With education, can you delineate between student buy programs and institutional buying in education, what you experienced this quarter and what you will experience in the upcoming quarter.

The numbers that Peter quoted in the preamble, we were up 35% in both institutional and individual buying was relatively strong.

The quarter that we're now in is a big K-12 quarter, and back to school is more of a higher education quarter.

I wouldn't want to predict exact numbers, but as Peter had mentioned, the 35% is the highest growth rate we've seen in ed in eight years.

And we recently learned that we surpassed Dell last year in the portable market share for higher education.

So we have significant momentum in this area.

There's been a lot of chatter about state and local government spending.

Are you guys happy with the institutional part of the education business?

I'm always worried about budgets and will continue to worry about budgets, but the results that we've seen to date with 35% increase year-over-year, we have not seen any issue today.

Appreciate it.

Thank you.

Thanks, Bill.

Can we have the next question, please?

We'll move on to Mike Abramsky with RBC Capital.

Can you qualify the reasons for the delay of the start of revenue recognition on the iPhone and what your thinking was there?

Based on the 2.0 release and also what kind of impact we should be -- how we should think about relaying that into our iPhone numbers?

Okay.

We are doing this as I said, in my prepared remarks, because we announced the specific new features that will be included in the iPhone 2.0 software that we plan to provide for customers for free who purchased after our announcement on March 6.

So we will delay revenue recognition on phones sold between March 6th and the date of the delivery of the software.

Once we deliver the software, we will resume revenue recognition of the phones on what we sold between March 6th and that date and begin to recognize as we had in the past iPhone revenue on a go-forward basis.

As I said in my prepared remarks, this does not impact phones sold prior to March 6th or payments from carriers.

Okay.

So really what we're looking at is just the exclusion of hardware revenue next quarter, really, from iPhone.

Until the software is delivered.

Okay.

And it just on the iPhone, with regard to your 10 million guidance, can you talk a little bit about how important either 3G might be to that or how important at least the timing of some of your pending products that you're referring to in your press release and on your excitement around the iPhone, kind of weighs into that 10 million?

Based on current momentum.

We don't comment on new products but I would just reiterate that we're confident with hitting the 10 million, and obviously, a part of that is rolling out to more geographies.

We've been working very hard at this and feel confident we'll be able to roll out in more places to Europe and inner Asia during the year.

And does that forecast include some now going-forward assumption in your part of an unlocked phone percentage?

The unit number includes phones of all types.

Locked and unlocked.

Okay.

And then final question.

Just you haven't said anything in your call about sort of economic headwinds.

It's obviously something people are focusing on.

It seems you're benefiting from resistance to some of those headwinds and also share gain.

Any commentary you can offer in addition to the comments you've made that help us understand some of the kind of sustained drivers of that?

Mike, it's Peter.

We're going to leave economic commentary to others, and we're focused on managing our business, which performed exceptionally well in the March quarter.

I credit it to just outstanding innovative products that drove amazing results.

The U.S.

business performed quite well in March.

Our revenue grew 40%.

And this growth rate was twice last year's March quarter U.S.

growth rate of 20, and faster than we grew in the December quarter of 27%.

Mac sales in the U.S.

were up 51%.

And traffic through our stores were up 12 million people year-over-year.

We only have 208 stores.

So we remain very confident in our business and in our strategy, and we'll continue to invest in hardware and software products to delight our customers.

We read the same things that you do, but I provided guidance for the June quarter, which has revenue growing at 33%.

And again, that is an acceleration from the rate we saw last June by about 10 points.

Okay.

Thanks.

Thanks, Mike.

Could we have the next question, please?

Yes.

We will move to David Bailey with Goldman Sachs.

Great.

Thank you very much.

I was wondering, did you give a date on when you're expecting to deliver the 2.0 software for the iPhone and could you help us understand what impact that has on gross margin, if any?

David, what we've said is we intent to deliver the iPhone 2.0 software in late June, and I've included the delay in revenue recognition and the 33% gross margin that I've given you for the quarter.

This affects iPhone handset sales only between March 6 and when we deliver the software, and it does not impact phones sold prior to March 6th or payments from carriers.

But it is fair to say it does have a negative impact on gross margin during that period?

Well, we will not recognize revenue until we deliver the software.

And so that has an impact.

And just on your starts for the June quarter you have revenue down I think 4% quarter over quarter and typically it's up.

Is there any particular area that you expect to be subseasonal in the next quarter?

Let me talk a little bit about it.

We're guiding to $7.2 billion, which again is a 33% increase from the year ago quarter, and is an acceleration of about 10 points from what we saw last June when we grew 24%.

We factored several things into our thinking.

First, our Mac channel inventory this past quarter did increase by about 60,000 in the March quarter, as an result of the MacBook Air launch and accelerated sales velocity.

Second, we will not begin recognition of new iPhone sales until we deliver the iPhone 2.0 software in late June as I discussed.

Third, we expect a sequential decrease in iPod sales as we've seen in the last couple of years, so nothing new there.

And fourth, we'll see the full quarter impact of the iPod Shuffle and some international price reductions that we took in February.

So that's what went into our thinking, but again, I couldn't be happier with the performance of the business.

I think the guidance we're giving is very strong and would just end by saying again it's a growth rate that is faster than what we saw in the year ago quarter.

Thank you very much.

Thanks, David.

Can we have the next question, please?

Yes, we will move to Kathy Huberty of Morgan Stanley.

Thanks.

I want to go back to the margin question because this is the first quarter that both gross and operating margins are down year on year since March 2006.

Peter, do you now feel you need to reinvest some of the margin upside to address the growth opportunities internationally and in some of the new product categories such that year on year declines will be more of the norms going forward or was there something specific in the calendar first quarter that will go away later this year?

Katie, when we gave you guidance in January we gave guidance for 32% gross margin and we reported 32.9 so we did better than we thought.

So our gross margin was better than what we had expected.

We are continuing to come out with new innovative products.

It is a competitive world.

And we are thinking thoughtfully about driving both our top and bottom lines and continuing to gain market share in hall three of our product areas.

Peter, quickly, are you still planning to open about half of the new stores internationally this year?

I don't know if it will be quite half but our international store openings will be greater this year than they were last as of the end of the quarter, we had 208 stores open in total, and 27 of those were outside the U.S.

And we have increased our store opening forecast, this year a by little bit to 45 stores this year.

Thanks.

Thanks, Katie.

Can we have the next question please.

Richard Gardner with Citigroup.

Thanks, Peter and Tim and everybody, actually.

I wanted to ask about the gross margin.

I'm still struggling to understand the gross margin that you reported in the quarter.

I understand that you said that the decline in Leopard sales represented the biggest portion of that.

But it looked like from the segment data that you reported that Leopard revenue was down about $100 million sequentially perhaps so that would be about a point of impact on the gross margin sequentially and given the price cut you did on Shuffle it seems that at most was another point impact on the gross margin.

And yet since October, we've had DRAM and NAND pricing down 60 to 70% or more, and panel pricing has been pretty favorable as well.

I was wondering if there was anything about the timing of when you procured the components that went into the systems that you built in Q1 that had an impact on the gross margins.

In other words, was a lot of the NAND and DRAM that went into the products procured in the December quarter?

If that's the case, should we expect to get some benefit as you procure a lot of NAND and DRAM now at much lower prices on the Q2 gross margin?

Thank you.

Rich, I'd like to make a couple comments about one of the first things you said and then Tim can address some of your later points.

Our Leopard revenues in the December quarter as we talked about last in January was $170 million and they were just over $40 million in the March quarter.

So together, a little over $210 million in the first half.

Leopard is by far the best selling release in our history.

But sequential decline in Leopard and also, iLife and iWork went into its third quarter were a bit greater than what you thought.

So the impact of sequential gross margin decline therefore was a little bigger.

And you also have to factor in in addition to the pricing actions that we took, lower sequential revenues, so we had less leverage on fixed costs and iTunes was a bigger mix of the business this quarter than last.

And it has a lower gross margin as well.

So there were a number of factors that played into the gross margin coming down, but again, it's better than what we expected it to be.

We guided to 32 and achieved 32.9.

Tim?

I would just add, Rich, that the component advantages as you said were large during the quarter, and those really off set most of the lighter points that Peter talked about, which were the Shuffle price cut, the international price cuts that we did to adjust for currency, the higher mix of iTunes sales and the lower overall revenue and the effect it has on the structure.

So we did receive significant benefit, particularly in the DRAM and NAND areas.

And if I could follow up, Tim, with one other question.

Yes.

You mentioned that you said that you thought that memory pricing would continue to be very favorable in the June quarter.

And yet, in the case of both DRAM and NAND, we're at very, very low levels and in many cases for many suppliers, close to cash cost.

What gives you confidence I guess that the pricing will continue to be favorable here as we go into the second quarter and you and other companies start to procure more DRAM and NAND for a typical seasonal build.

To be specific, favorable does not mean it goes lower than where it was in March.

It means that we envision it trading in a fairly narrow trading range.

And therefore, not increasing that much as we head into the quarter.

But I don't believe that it will go lower because as you say, many people are already charging, certainly not absorbing all of their fixed costs in the current pricing.

Okay.

Thank you.

Thanks, Rich.

Could we have the next question, please?

We'll move to Andrew Neff with Bear Stearns.

One on OI&E, is there anything given the cash flows leading to a lower number, can you give us a sense in what the delay in the iPhone recognition meant to the current quarter, three, the tax rate, can you clarify whether it was down this quarter and is 31%, we use that going forward and last just in terms of just as you look at the consumer, obviously, you had great numbers.

But are you seeing any impact to the consumer, are you taking any steps to address that?

Are you just talking about consumer behavior in general?

Andy, I may not get all of your questions so if I forget one, remind me

I'll remember them.

I'll certainly come back to it.

And I'm going to actually just probably go in reverse order.

In terms of the consumer, we had a very good December quarter.

And we had an amazing March quarter.

In my prepared remarks, I wanted to go through some things that I thought would be helpful to you, and I think in a prior question, I did, but I'll go back through just a couple of them.

And particularly in the U.S., our revenues in the United States grew 40% year-over-year.

Mac shipments were up 51% in the U.S.

Basically, at the level we saw around the world.

And we saw about 34 million people in our 208 retail stores, most of which were in at the U.S.

So our business performed exceptionally well in the March quarter across each of our customer segments.

Including our retail stores.

In terms of the tax rate, we had been forecasting 32% for the year.

With a higher mix of foreign earnings that we saw in the March quarter and lower interest income, really as a result of the rate environment, our tax rate for the year looks to be 31%.

And so that's what we're forecasting for the June quarter.

And for the September quarter.

So in order to get the 31% for the year, we had an adjustment in the March quarter.

That's why the tax rate was 29%.

Then I know that you had an OI&E question which I'll led Gary answer.

Was there one other before I turn it over to Gary?

The impact of the iPhone recognition in the current quarter, can you quantify what that was?

You have to make your estimates but we sold 1.7 million phones during the quarter.

We made the announcement on March 6.

You know what we sell the phones for, and we recognize the revenue over 24 months.

Just to clarify that, the number that you sold, that is still in the -I just want to make sure I understand it.

So that after March 6, you still counted them as shipments, you just don't show the revenue is what you're saying.

Correct.

Correct.

Gary, just on the OI&E.

Andy, I think you asked if there was anything else in the OI&E besides lower effective deals and the answer is no.

We're basically investing in very short dated high quality highly liquid instruments, and as consequence, the yield on our portfolio has dropped a little bit, 4.9% a quarter ago.

We exited that last quarter.

We were earning about 3.9%.

We expect it to go down a little bit more.

There wasn't any material write-offs in the portfolio in regard to investment and auction rate securities and asset backed securities.

We don't have any of those.

Do you know what you're going to do with all that cash?

Andy, no change to announce to you today.

Thank you.

Thanks, Andy, could we have the next question please?

Yes, we'll move to Gene Munster with Piper Jaffray.

So you obviously do not recognize the revenue after March 6.

Do you recognize the costs and expenses related to that?

Is that correct?

No, Gene, we'll delay the recognition of both the revenue and the product cost on the iPhone from the beginning on March 6 until we release the software.

But we'll continue to expense our operating expenses around selling and advertising and engineering as period costs as we always have.

Okay.

And then second, will you be charging for the upgrade for those who bought iPhones before March 6 for the version 2.0?

No.

As I said in my prepared remarks, we will be providing that software to the then-current iPhone customers for free.

Okay.

So then why, if everybody is going to get it for free, why are you deferring after March 6?

Because the customers that purchased the phone on or after March 6th presumably were aware of the software that we told them that we were going to come out with and that they were going to get it for free.

And as a result of our announcement, the way you properly account for that is to defer the revenue.

And that's what we're going to do.

Okay.

Lastly, as far as the inventory in the U.S.

Apple stores throughout this quarter, should we assume that it will start to creep back up throughout the quarter?

Or should we just kind of assume it's going to be sporadic availability throughout the quarter?

We're shipping product every day, Gene, but I'm not going to forecast the exact in stock levels of the stores.

We've factored in our current thinking of supply/demand into the guidance.

Great.

Thank you.

Thanks, Gene, could we have the next question, please?

Shannon Cross from Cross Research.

A couple questions.

First, could you talk a little bit about what we're seeing about the pricing of some of your European carrier partners with regard to the iPhone?

Who bears the cost.

Is this carrier driven?

Any commentary you can make on that?

Shannon, Tim.

The carrier partners are free to price the iPhone has low as they wish.

Beyond that I wouldn't comment on the specific commercial arrangements between us and the carriers because those are confidential.

Okay.

And any thoughts on maintaining a 2.5 GI phone once the 3G is out.

We don't comment on new products.

Sorry.

Okay.

Thought I would try.

Final question though is on the channel.

Because obviously you Mac sales are quite strong.

Can you talk a little bit about where you're seeing the strength in the channel?

Obviously you're expanding a bit more on your stores but you know from a CES standpoint or consumer electronics versus direct and also just any comments you can make about linearity during the quarter.

We're seeing strength in all geography.

It has been amazing at how balanced it's been.

If you look at the Mac in the Americas, we were up 52% year-over-year.

In Europe we were up 48, in Japan we were up 47.

It's very solid throughout.

And Asia Pacific we were actually up 62.

And so these are obviously all multiples to the market growth.

Within each of those, the consumer appears to be very strong.

Our pro business also has a very nice pick up last quarter.

The Mac Pro sold more units since it debuted with the new Intel processor.

Education was up 35% in the U.S.

And so overall, just strength everywhere.

We felt very good.

Okay.

And then linearity for iPhones as well as Mac.

On the Mac side, the only unusual thing on the linearity was we started shipping the MacBook Air late in January.

It was constrained most of the quarter.

And so a lot of those shipments did go out in the month of March.

By the end of March, we were at near a supply/demand balance on it.

Just one final question.

Actually, in linearity of the iPhone.

In iPhone we really outstripped our supply toward the end of the quarter.

We sold more than expected.

We thought there would be more of a sequential decline there than there was.

And so it was reasonably strong but March in particular was strong.

And any indication you can give us with regard to MacBook Air, on gross margins above or below, I don't know, anything you can give us as a metric?

The customers love it.

So no comment on gross margin, no.

Not at the individual unit level.

Okay.

Thank you.

Thanks, Shannon.

Can we have the next question, please?

Could we have the next question, please?

Yes, we'll move to our next question.

Keith Bachman with Bank of Montreal.

Hi, guys.

Peter when you ship the SDK, is there a catch up period for the phones that were shipped or is it all ratably from that point?

If I understand your question, Keith, we will begin to recognize the revenue and the product costs once we ship the 2.0 software over the remaining lives of the -- remaining lives for the phone.

So there is no catch up period, it will be ratably from that point.

Yes, ratably for the remaining life.

Peter, I want to go to the gross margin side, when at the year-over-year comps, gross margins were down 220 basis points.

You flagged some areas that were different on the sequential basis.

Leopard would be out of the equation.

In fact, software was a richer mix when you look at March to March.

Could you just pick out a couple of the other large drivers of change on a year-over-year basis and particularly if you could identify whether the mix between CPUs and iPods was favorable or unfavorable.

Keith, it's really hard for me to do year-over-year, gross margin comparisons.

You got your different points in your product cycles, different commodity cycles, different mix.

And that's why we've traditionally talked about gross margin on a sequential detail.

I prefer to just stick with the sequential comments that I gave you which again, gross margin is better than what we thought it would be.

Fair enough.

Last question for you, Peter.

If you have your operating segments and if you thought about, is there a deviation in the operating segments in the amount of gross margin they report by geography?

In other words, was the variance in terms of the individual geographies materially different than what you had as a company as a whole?

Well, we'll put out the 10-Q in the next week or so in our segment reporting that the gross margin level will be there.

You can look at prior 10-Q's to see the different gross margins in the segments.

There is a little bit of variability.

But we're quite happy with each of our segments.

Okay.

I'll cede the floor.

Thank you.

Can we have the next question, please?

We'll move to Shaw Wu with American Technologies.

I have a question on your acquisition of PAE Semi.

Any comments or color you can give around that?

Thanks.

Shaw, we occasionally buy smaller technology companies from time to time, and we don't have a practice of commenting on our purpose or plan so I can't.

Okay.

Thanks.

Thanks, Shaw.

Could we have the next question, please?

Yes.

We have Jeff Fidacaro with Merrill Lynch.

When you look at growth it's down second quarter.

Given your strength has accelerated to three times the market growth, could you highlight comparable seasonality in the Mac business in your June quarter?

Sure.

In what we generally see, in June, is a sequential increase in Mac shipments as the education buying season begins, and the June quarter tends to be more heavily weighted to K-12, which buys typically at lower ASP's, and the September quarter tends to be more heavily weighted within the ed buying season by higher education.

One follow-up, as I move over to the iPhone, when you look at the non-unlocked or unactivated phones prior to the quarter, some were gifts bought late in the holiday season.

Have you seen any change in the carry over from the December quarter, were they actually activated, have you seen significant changes?

As Tim commented, it's really hard to estimate precisely, and we don't want to throw a number out.

Unlocking is occurring.

And it is significant.

But our view is that this is just a clear interest in demand globally for the iPhone.

And we think we're hearing reports of iPhones being used in many countries, and this is one of the things that gives us confidence in our goal of shipping out 10 million in calendar year 2008.

Thank you.

Thanks Jeff.

Could we have the next question, please?

We'll move to Toni Sacconaghi with Sanford Bernstein.

Yes, thank you.

I would hoping you could reconcile your statement that iPhone demand was out stripping supply at the end of the quarter with what appears to be an excess supply in most European countries of the phone.You're indicating they can price as they want and we're seeing price cuts of over 50% on the phone which doesn't sound like a situation where they're under supplied.

Were you seeing a noticeably different demand profile in the U.S.

relative to your expectations versus Europe and if so, why couldn't you simply ship phones from what appears to be an over stocked Europe to U.S.

to fulfill that demand?

Tony, my point was the stock outs were occurring in our own stores toward the end of the quarter, and we have believed that that was because our stores are more susceptible to people going in, buying multiple units and unlocking and exporting them.

However, I also added that currently, inventories are low in both our stores and in the channel.

And is that also the case in your European channel?

Or is that an aggregate channel statement?

I don't want to be specific at the carrier level but in the aggregate, Europe is low, in the aggregate, the U.S.

is low.

And at the very end of the quarter where you were having stock outs in your own stores, was your channel inventory also low?

Because it seemed like the phones were readily available in Europe and through AT&T stores, which obviously begged the question of why were you not able to better balance the allocation of phones, particularly towards the end of the quarter?

Once the unit is already shipped and designated to a carrier, the ability to move them from carrier to carrier is very low.

So you can have very short term cases where there is some imbalance, but I think the major point is that we sold more than we thought we would, and that today, inventories are low in aggregate in Europe and in aggregate in the U.S.

Can you comment on whether you thought you sold more in Europe than you thought you would?

No.

I'm just going to comment that in total, that we sold more than we expected.

We expected a sharper seasonal decline than what we experienced.

And as you know, this was our first Q1 to Q2 that we've been in the phone business, so we've learned something.

And then, staying with the phones, I know a couple other people have asked, but last quarter on this call you said you weren't comfortable discussing the unlocked percentage because of the high concentration of phones that -- concentration of phones that had been sold at the end of December in the holiday season and thought you would get a beater read on that in January.

Invariably you have gotten a better read on that.

Given that you had given out the number before or an estimate of that number, why the reticence now given at least for last quarter you should have ample ability to be able to quantify that.

We don't feel that we can quantify it with precision so we don't want to put out a number that we can't stand behind.

But we've gone out of our way to classify the number as significant.

And you know, I'm not sure how to be more clear than that.

And then switching to Macs, your notebook ASP declined sequentially year-over-year, given that you introduced the MacBook Pro which got off to a good start and strength in MacBook Pros.

Were those both relatively small and were price cuts relatively big?

Or how do we reconcile the ASP decline?

Tony, it's Peter.

The ASP decline was slight both on a sequential and year-over-year basis.

They were largely driven by the transition that we had in the quarter and some mix shifts within our MacBook and MacBook Pro lines.

Again, they were small.

Okay.

Thank you very much.

Thanks, Tony.

The next question, please?

We'll move to Charles Wolf with Needham and Company.

Yes, I have a couple questions.

One is, do you have any color that you can provide on the demographics of MacBook Air purchases?

I originally thought it would be for road warriors, but the numbers suggest it's selling far better than that.

And sort of this is the same vein, do you have any sense of how many Windows users purchased a MacBook Air?

We don't on the latter, Charlie.

What we would share is that this is appealing to all sorts of people from college professors to students to people that travel a lot.

Seems to have universal appeal.

And also, the cannibalization factor was extremely low to the other portables which is one of the key reasons we were able to have a very minor sequential design from Q1 where it usually would be much deeper.

Thank you.

Thank you, Charlie.

Thanks to everyone for joining us.

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