蘋果 (AAPL) 2009 Q2 法說會逐字稿

Good day, and welcome to the Apple Incorporated second quarter fiscal year 2009 earnings release 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 Ms.

Nancy Paxton, Senior Director of Investor Relations.

Please go ahead, ma'am.

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

Speaking today is Apple's CFO Peter Oppenheimer joined by Apple's COO Tim Cook and Treasurer Gary Whistler for the Q&A session with analysts.

Please note some of the information you'll hear during our discussion today will consist of forward-looking statements, including without limitation, those regarding revenue, gross margin, operating expenses, other income and expense, stock-based compensation expense, taxes, earnings per share and future products.

Actual results or trends could differ materially from our forecast.

For more information, please refer to the risk factors discussed in Apple's form 10-K for 2008, the form 10-Q for the first fiscal quarter of 2009 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 like to turn the call over to Apple's CFO Peter Oppenheimer for introductory remarks.

Thank you, Nancy.

Thank you for joining us.

We're extremely pleased to report the best nonholiday quarter revenue and earnings in our history.

These results exceeded our expectations and we continue to be very pleased with our performance in this economy.

Revenue for the quarter was $8.16 billion, representing 9% growth over the prior March quarter's results.

Operating margin percentage for the quarter was one of our highest ever at 20.4%, primarily due to higher than anticipated revenue and gross margin.

Net income was $1.2 billion which translated to earnings per share of $1.33.

In terms of non-GAAP measures, adjusted sales totaled $9.06 billion for the March quarter, which was $900 million higher than our reported revenue.

Adjusted gross margin was $3.62 billion, which was $650 million higher than our reported gross margin.

And adjusted net income was $1.66 billion, $450 million higher than our reported net income.

We continue to believe that these non-GAAP financial measures provide added transparency to our business, and hope they're helpful to you in your analysis and understanding of our performance.

Turning to the details of our results, I would like to begin with our Mac products and services.

For the March quarter, we sold 2.22 million Macs, compared to 2.29 million Macs in the year ago quarter, a 3% decline.

In the year ago March quarter, Mac sales increased 51% year over year, due in part to the January 2008 launch of the MacBook Air, creating a very difficult compare.

Our Mac shipments in this year's March quarter compares favorably to the 7% year over year contraction in the market overall, based on the latest estimate for the quarter published by IDC.

We successfully transitioned the entire Mac desktop line in March, and continued to see strong year-over-year growth in MacBook shipments.

Our overall unit sell through of Macs was flat year over year, and given the tough year over year comp and the challenging economic environment, we feel very positive about our Mac performance.

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

We experienced strong sales with the January release of iLife '09 and iWork '09.

We believe the outstanding features of iLife and iWork are among the very compelling reasons why customers are drawn to the Mac experience.

Now, I would like to discuss our music products and services.

We sold over 11 million iPods, representing a new March quarter unit record and 3% growth over the year ago quarter.

We generated very strong year-over-year growth and sales of iPod Touch as customers continue to embrace the superior features of the platform, coupled with the rapidly growing array of applications available through the App Store.

Customers and reviewers responded favorably to the March introduction of the all new iPod Shuffle, the world's smallest music player, featuring a great new industrial design, voice-over technology, and convenient new earphone cord controls.

We remain very pleased with iPod market share.

Our share of the US market for MP3 players was over 70% based on the latest monthly data published by NPD, and we continued to gain share year over year in most International markets based on the latest data published by GFK.

We saw healthy year over year iPod unit sales growth in a number of large markets including the UK, France, Germany, Japan, Australia and China.

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

The iTunes store delivered another great quarter, fueled by strong sales of music, video and apps.

We recently introduced a number of changes to the iTunes store, including the availability of DRM-free iTunes Plus titles from all four major labels, as well as thousands of independent artists.

The App Store continues to be an unparalleled success with developers and customers, and now offers over 35,000 applications, compared to the 15,000 available as of our last conference call.

We're within hours of reaching our 1 billionth download, an astounding number given the number of short nine month history of the App Store.

We believe the App Store is a key strategic differentiator of the iPhone and iPod Touch experience and is more evidence of what we have always said: that software is a key ingredient for great mobile experience.

We continue to believe that we're years ahead of the competition, and we're very excited about the prospect of even more compelling apps as developers take advantage of the many new features that will be enabled by the iPhone OS 3.0 this summer.

Turning to the iPhone, we were extremely pleased to have sold almost 3.8 million handsets in the March quarter, 123% increase over the 1.7 million handsets sold in the year ago quarter.

We continue to expand iPhone's geographic reach during the quarter, and are now selling it in 81 countries.

Revenue recognized from iPhone handset sales, accessory sales, and carrier payments was $1.52 billion, compared to $378 million in the year ago quarter, an increase of over 300%.

The sales value of iPhones sold during the quarter was over $2.2 billion.

On March 17th, we provided developers with a preview of iPhone OS 3.0 and began the developer seeding process.

The iPhone OS 3.0 release will include an updated software development kit with over 1,000 new developer APIs, enabling in app purchases, peer to peer connections, app control of accessories and push notifications.

The iPhone OS 3.0 release will also add over 100 customer features, including cut, copy and paste, spotlight search, landscape keyboard and view for all key iPhone apps and MMS support.

Developers have responded very enthusiastically to the new SDK, and we expect that customers will love the many new features of iPhone OS 3.0 and the new apps that will be available.

Because we announced these specific new features and plan to provide iPhone customers to them as a free upgrade, we have delayed the start of revenue recognition for all iPhones sold on or after March 17th announcement date, until the iPhone OS 3.0 Software is released this summer.

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 for handsets sold prior to March 17th is not affected by the announcement.

I would now like to turn to the Apple retail stores.

The stores recognized $1.47 billion of revenue during the March quarter compared to $1.45 billion in the year ago quarter.

Our stores sold 438,000 Macs, about half of which were to customers who have never owned a Mac before.

We opened one new store during the quarter, bringing us to 252 stores.

With an average of 251 stores open during the quarter, average revenue per store was $5.9 million, compared to $7.1 million in the year ago quarter.

Retail segment margin was $308 million, compared to $334 million in the year ago quarter.

We believe that the year-over-year decline in average store sales and segment margin is a reflection of the continued weak consumer spending environment, coupled with third party channel expansion relative to the year ago quarter.

We hosted 39.1 million visitors in our stores compared to 33.7 million visitors in the year ago quarter, An increase of 16%.

We also hosted a record 644,000 personal training sessions during the quarter, an increase of 11% year over year.

We remain on track to open a total of about 25 stores during fiscal 2009, about half of which we expect to be outside the U.S.

Total Company gross margin was 36.4%, which was 390 base points better than our guidance.

This difference was primarily driven by three factors: first, commodity and other hardware component costs were significantly lower than we planned.

We have been very disciplined with our inventory management, which allowed us to take advantage of the continued favorable commodity market during the quarter.

Second, sales of higher margin products, including software and accessories were better than planned.

Third, we benefited from lower freight and warranty costs.

Operating expenses were $1.3 billion including $152 million in stock based compensation expense.

OpEx was $26 million below our guidance as we spent less in many areas of the Company.

OI&E was $63 million and the tax rate for the quarter was 30.3%.

Turning to cash, our cash plus short term and long-term marketable securities totaled $28.9 billion at the end of the March quarter, compared to $28.1 billion at the end of the December quarter.

Cash flow from operations in the March quarter was $841 million.

Our investment priority for the cash continues to be preservation of capital which has served us well in the current environment.

We're continuing to focus on short dated, high quality investments and remain comfortable with our investment portfolio.

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

We'll continue our practice of providing guidance based on GAAP, and will report our June quarter non-GAAP financial measures to you in July, when we release our results.

Forecasting the current macroeconomic environment remains challenging, so we will continue to provide a range of guidance for the June quarter.

We expect revenue to be between $7.7 billion and $7.9 billion.

This reflects not starting revenue recognition for iPhones sold on or after March 17th until the date of the iPhone OS 3.0 Software is released.

We expect gross margin to be about 33%, reflecting approximately $30 million related to stock-based compensation expense.

We expect Op Ex to be about $1.35 billion, including $150 million related to stock-based compensation.

We expect OI&E to be about $55 million, reflective of the short term interest rate environment, and we expect the tax rate to be about 31%.

We're targeting EPS in the range of $0.95 cents to $1.

In closing, we're very pleased with our record March quarter results, and how well Apple is performing in this economy.

We're extremely enthusiastic about the launch of the iPhone OS 3.0 and can't wait to get it into customer's hands this summer.

We're also very excited about the other products in our pipeline.

We remain confident in our strategy, and are working hard to deliver the world's most innovative and extraordinary products.

With that, I would like to open the call to questions.

(Operator Instructions).

Your first question will come from Richard Gardner with Citigroup.

Thanks.

Well, great job on the quarter, and in the absence of too much else to pick on, I guess I'll ask the standard component question of Tim, what is your outlook in terms of pricing and component supply going into the June quarter, please?

Hi, Rich.

Last quarter, we believe that most of the excess inventory in the supply chain was consumed, and so where we see the component environment still being favorable, on an overall basis, there will be some commodities like NAND as an example which will increase sequentially.

NAND in particular has recently increased due to reduced wafer starts from several of the suppliers attempting to address the profitability issues.

Other than that, I think last quarter was about wringing out excess inventory, environment we continue to be favorable.

But I don't expect to see the level of reductions that we experienced in calendar quarter one.

But you do expect, Tim, the aggregate building materials to be down sequentially in the June quarter?

I expect it to be within a similar range as last quarter.

Okay.

All right.

Thanks.

Thanks, Rich.

Next question, please?

That will come from Keith Bachman with Bank of Montreal.

Hi, thanks.

Peter, for you, cash flow was actually down year over year.

It is the first time going back for some period of time that I've seen cash flow from operations be down on the year over year for the March quarter.

Could you talk a little bit about what was driving that and specifically, was there anything on the deferred revenue recognition, sorry, the deferred balance, that changed consistent with the revenue recognition policies or the look thereof when you went to the new Software platform?

Keith, no there's nothing with iPhone or deferred revenue or cost from a policy change that played into that.

I was actually very pleased with the cash generation in the quarter.

It was up over $700 million from the end of the December quarter.

There are three things to discuss with you that did play into the cash generation in the quarter.

First, as we talked about on the last quarter's call, we did make our prepayment to LGD for $500 million.

Second, you'll notice our accounts payable was down from the December to March quarter by over $700 million.

Right.

Climb in AP as we leave the holiday quarter and conclude the March quarter, it is very typical for us.

There's nothing new there, but that does play into the sequential results.

The third component to discuss with you is our tax payments.

We made about $1.3 billion in tax payments in the March quarter.

And there are a couple of things that were driving that.

First of all, for the current fiscal year, so, this year, fiscal '09, we make our first estimated tax payments in the March quarter for the current fiscal year, and in fact, there are two that are due in the quarter.

This year, the tax payments were higher than what we saw last year, because A, we're making more money and B, given the equity markets, the credits that the Company gets from employee option and RSU gains are down.

So, we paid more tax for that and also we prepaid some potential audit settlements that were accrued on the balance sheet.

We paid them on a cash basis this quarter for prior years and we trued up for fiscal '08 this quarter as well.

So, all three of those things combined for $1.3 billion in tax payments this quarter and that was up significantly year over year.

Ok, thank you, Peter.

Thanks, Keith.

Next question, please.

That will come from Ben Reitzes with Barclays Capital.

Good afternoon.

Thank you.

Could you talk a little bit about the Mac business.

It seems the desktop side exceeded our expectations, obviously due to the launch.

But sequentially, the ASP in desktops if my math is right looks like it was down quite a bit.

Could you talk about what's going on in the Mac business, how the new Macs are doing.

What you think of your pipeline but also what's going on with ASPs like am I right there was a mix down in the desktop area and just what's going on in particular with regard to the mix with this tough economy and maybe notebooks and desktops.

Okay.

Hi, Ben, it's Tim.

Hey, Tim.

Across the quarter, as we got into March and announced a new desktop line, we saw an acceleration of sales.

It was that acceleration that allowed us on a sell-through basis to approximately be equal to the year before.

After we did the desktop launch, we began to ship a higher mix of desktops than we were before the transition, and that helped push the overall ASP down.

Within the desktops themselves, the top end of the line, Mac Pro, we had a lower mix to the Mac Pro, a higher mix to the Mac mini than we had before the transition and really all throughout the quarter, the pro products that are primarily being sold to the creative professionals were weaker than they were in the year ago quarter.

And we believe that that's mainly economic, related as you would guess businesses are cutting back on technology expenditures.

In addition, education in the US contracted by about 11% year over year, and this is a result of states not having tax revenues as projected, and we're hoping that as we get into this quarter, that the stimulus funds that were approved last quarter begin to flow to the states and we see some benefit from that.

But that remains to be seen.

So, net net, yes.

ASPs did decline.

It was, desktops were a piece of it.

But doing all of the desktops in a single day, which was -- it is unprecedented for us to do that, really helped us drive more sales in March and get the Mac business to a much better level by the end of quarter.

In the notebook business, we did have an ASP decline sequentially.

That was mainly driven by a higher mix to the $999 MacBook that we had announced part way through the quarter in the October, late October time frame.

I think that's actually a good thing, not a bad thing, because I think what you see is for us anyway, the consumer is holding up much better than the professional, and much better than education.

Education is gated by tax receipts and funding and the professional is really cutting backs expenses and delaying -- I don't think it is business we're losing necessarily but delaying purchases.

It is no secret that, you know, that the netbook is obviously doing pretty well.

Do you have any thoughts there on that category now that you've been able to watch it for a few quarters and what you're thinking and it has obviously held up the market a bit in the recent data.

And you don't have it and you still outperform the market.

Just any thoughts on where you are and where you aren't that you might want to share?

Well, you know, for us, it is about doing great products.

And when I look at what is being sold in the netbook space today, I see cramped keyboards, terrible software, junky hardware.

Very small screens.

And just not a consumer experience, and not something that we would put the Mac brand on, quite frankly.

And so, it is not a space as it exists today, that we're interested in.

Nor do we believe that customers in the long-term would be interested in.

It is a segment we would choose not to play in.

That said, we do look at the space and are interested to see how customers respond to it.

People that want a small computer, so to speak, that does browsing and e-mail might want to buy an iPod Touch or they might want to buy an iPhone.

So, we have other products to accomplish some of what people are buying netbooks for.

So, in that particular way, we play on an indirect basis.

Then, of course, if we find a way where we can deliver an innovative product that really makes a contribution, then we'll do that.

We have some interesting ideas in the space.

The product pipeline is fantastic for the Mac.

As we look back over the last four plus years, 17 of the 18 quarters of the last four and a half years, we've exceeded the market rate of growth and to exceed it in this horrendous economy, I think is quite an accomplishment, especially when you look at these very low-priced net books that are -- I think it is a stretch to call it a personal computer.

Are really propping up the unit numbers from the industry as a whole.

So, we feel great about our performance.

It is a very solid performance, especially into this environment.

And the pipeline looks fantastic.

All right.

Great.

Well, I'll be there in June and look forward to hearing from you.

Thanks.

Thank you, Ben.

Next question, please.

That will come from Bill Fearnley with FTN Equity Capital.

Can I ask a question on the App Store?

Is there any additional color you can give directionally on the mix between paid and free downloads on the App Store overall, any additional color between the iPhone and the iPod Touch and then I had a quick follow-up, if I could.

Bill, I'm sorry.

We don't disclose the free versus the paid.

But we're just hours away from our billionth download and couldn't be happier with the store's results.

Bill, this is Tim.

I would add to that, a couple of things.

One, one of the keys behind the growth of the iPod this quarter, despite the economic environment was that the iPod Touch more than doubled year over year.

So, it was a tremendous result, and as Peter mentioned earlier in his remarks, the sum of iPhone plus iPod Touch is now about 37 million units and so it provides an enormous platform for developers to develop on and would be -- with our recent SDK changes, the developers are working on now, I think it just unleashes a whole new level of innovation that keeps Apple years ahead of everyone else.

Ok.

That's helpful.

Thanks.

Then, could you guys provide the direct/indirect sales mix for the quarter and did it is are an effect on the gross margin for the quarters and does it have any bearing on your guidance for the third quarter?

Thanks.

Bill, the direct percent in the March quarter was 48%.

It really didn't have a bearing on gross margin.

It was reasonably close to what we thought.

As we enter the June quarter, the education buying season begins.

That is -- one of the reasons why I expect gross margin to be down sequentially.

Along with the impact of the US dollar and the commodity and component environment.

Thanks, guys.

Congrats on a good quarter.

Thank you.

Thanks, Bill.

Next question, please.

From Credit Suisse, we'll hear from Bill Shope.

Thanks, guys.

Given your gross margin performance over the past several quarters as well as the guidance, how should we think about the long-term 30% gross margin target you've mentioned in the past?

It seems that, just looking at the product mix, particularly on a GAAP basis, it is mathematically very difficult to get there without some fairly drastic changes to the business model.

How do you guys think about that longer term?

I've given you our guidance for the June quarter at about 33.

For the September quarter, I think our gross margins would be about 30.

We -- I'm not going to make comments on fiscal 2010.

I think the important part is as you look forward is just to understand that we're very, very focused on delivering extraordinary products to our customers, and we're going to provide them ever-increasing value and we just don't want you to count on the gross margins that you've recently seen, which have benefited from just a tremendous commodity and component environment.

Ok.

And then you sort of mentioned this when you talked about consumer versus professional education, but would you say that you're seeing signs of stabilization in the consumer market that some of the other tech companies have cited in recent weeks, and with that in mind, can you comment on the linearity of the quarter and what you sort of saw on a trend line basis as you progressed through the quarter?

Yes, Bill, this is Tim.

We're not economists.

We're not entering the game of predicting bottoms and that sort of thing.

We'll report our results and give a view of the next quarter.

But if you look at the different product areas which is the way we think about it, if you looked at the iPod linearity through the quarter and you overlaid last year, you would see very little difference in the two curves.

We were up 3% year over year and so very, very similar.

Not much to mention, except for the point I made earlier that from a mixed point of view, the iPod Touch is a run away hit.

And it is clearly being driven by the App Store we talked about earlier.

On the Mac side, as I mentioned earlier, our units sell through accelerated in March, after we turned every desktop in the Company on the same day.

And so March was a very important month for the Mac business.

When you look at iPhone, the iPhone linearity through the quarter, it was reasonably linear business after the first week or two with very little up and down in the aggregate.

Obviously it is a new business for us.

It is the first March quarter that we've had rolled out to a significant number of countries.

So, we were exceptionally pleased to see that.

Instead of the normal seasonality curve that one would associate with most consumer electronics.

Ok.

Very helpful.

Thank you.

Thanks, Bill.

Next question, please.

That will come from Gene Munster with Piper Jaffray.

Good afternoon, congratulations.

I've got a question on the iPhone.

Our survey work suggests the exclusive relationship with AT&T is the number one reason why people don't purchase an iPhone.

Given the revenue shares no longer exist, can you walk us through your thinking in terms of why remain exclusive through AT&T and any update on Steve Jobs.

Thanks.

On AT&T, Gene, we view AT&T as a very good partner.

We believe that they're the best wireless provider in the US, and we're very happy to be doing business with them.

They have done a very good job with iPhone.

They put the full force and weight of their company behind it.

It is a major strategic thrust for them.

So, we're very happy with the relationship that we have and do not have a plan to change it.

Is there a structural reason why you need to maintain with AT&T from a technology perspective?

From a technology point of view, as you know, Verizon is on CDMA and we chose from the beginning of the iPhone to focus on one phone for the whole of the world.

And when you do that, you really go down the GSM route.

Because CDMA is -- doesn't really have a life to it after a point in time.

Ok.

And then I guess one more before the Steve Jobs question is any color on kind of the holdup as far as getting China up and rolling on the iPhone?

Let me just comment on BRIC in general.

We now have the four BRIC countries, Brazil, Russia, India and China, we have three of those up and we have 8,000 storefronts in those three selling the iPhone.

We feel very good about that.

We're putting a lot of energy in growing those.

China, we're not in yet.

We would like to be in China within the next year, and are clearly working on that.

But I've got nothing specific to announce today on it.

And on Steve Jobs?

I'll let Peter make a comment there.

Gene, what is your question.

Any update regarding Steve Jobs and his return.

We look forward to Steve returning to Apple at the end of June.

Great.

Thank you.

Thanks, Gene.

Next question, please.

We'll hear from Toni Sacconaghi with Sanford Bernstein.

Yes, thank you.

I wanted to revisit the Mac question.

Your Mac business was down 8% in the Americas, I presume that the US was potentially worse than that.

According to Gartner, the US market was flat this quarter.

So, you actually did lose material share in -- I think, as you noted, despite the fact that you had a new desktop line-up that created a surge in your run rate at the end of the quarter.

So, I guess given that statement, one, do you care about your market share in the US, and second, given the movement in ASPs that you saw toward the lower end and given your share performance in the US, does that shape or change your thinking about Mac pricing in any way?

Toni, it is Tim.

On a worldwide basis, just to make sure we're in sync with the numbers, IDC projected that the market contracted by 7% worldwide.

On a reported basis, we contracted by 3 but as Peter said in his opening comments on a sell-through basis, we were essentially flat year over year.

In the US, the US was our weakest, largest geography in terms of comparison year over year.

But I would remind you that in our U.S.

business, a larger percentage of that business is education-oriented and therefore, subject to the budget constraints that have been significant in many, many of the states, actually almost all of the states.

And so, I think that's one reason why the US is disproportionately affected.

And the second is we saw less pro Macintoshes being bought in the US on a relative basis to other geographies.

We would attribute that also to the economy.

There was some mix down there across the world but much more so in the US where I think the professional markets have been hit much harder.

And so do I care about US share?

Of course I do.

However, I think cycles come and cycles go.

And what we're about is making the best computers in the world, not making the most, and not getting to a point where we're building products that we're not proud of.

And so that first and foremost is our objective.

We believe that if we do that over the long-term, that we will gain share.

I'm not going to worry about the ebb and flow of each 90 days because I think that leads you to make a lot of short-term decisions that are not good for the Company or for the brand over time.

Tim, could you also comment on your thinking about expanding iPhone adoption, recently when you have said that one area where you're spending a lot of time is thinking about how to increase adoption of the iPhone and you've been thinking a lot about elasticity, one comment that it struck me was that you were surprised by -- from your research at the elasticity that you thought was associated with the price of the device.

Can you update me on your thinking or what you've learned about iPhone elasticity now a quarter later?

Well, we had a very good quarter in the March quarter.

With actually a very small, sequential decline from the holiday quarter which was far above where our expectations were.

So, we're really pleased with how we did.

We also announced 3.0 or previewed it to developers, so that they could begin to change their Apps and produce more Apps for the phone which we believe increases the ecosystem and increases the number of people that want and will buy phones, even more.

So, we're coming from a product side, we're very focused on the App Store and we're also focused on geographic roll-outs.

We spent time this quarter on the middle east and Asia and rolled out Saudi Arabia, UAE, Indonesia, Malaysia, Thailand to name a few.

We're obviously focused on more in the future.

And so, between the product plans that we've got and the App Store and the software that you've seen and then things I can't talk about, we have a plan that we believe continues to make us the leader in the space, continues to keep us years ahead of others.

One of the things that we will make sure is that we don't leave a price umbrella for people.

And then finally, I guess one for Peter.

Quickly, in response to one of the other questions, you talked about considerations for margins in terms of forces at work.

To the degree that you can -- can you help give us a bridge in terms of your thinking whether it is qualitatively or quantitatively about how we think about 36.4% gross margins this quarter to 33% next quarter.

Can you rank order the forces, can you explain and then rank order the forces in terms of their impact on that expected deceleration?

Yes.

Toni, I will say the larger two of the three are the stronger US dollar and seasonally lower mix driven largely by the beginning of the education buying season.

Let me talk about each of those.

Regarding the dollar, the dollar is a little bit stronger today than where it was throughout most of the March quarter.

But the bigger impact for us on a sequential basis regarding the dollar is our hedges.

In the December and March quarter, we had hedges in place that were put in place at the time that the dollar was not as strong.

And hedges that we have in place for the June quarter largely were put in place during March at stronger dollar levels.

And that's really what is really the driving factor behind the sequential impact of the dollar.

And of course, the net buying season begins in the June quarter and June tends to be more dominated by K-12 than High Ed.

The September quarter historically is stronger for High Ed than for K-12.

And K-12 being more of an institutional sale, we expect to be competitive this year especially given the funding situation that Tim described.

Thank you.

Thanks, Toni.

Next question, please.

That comes from David Bailey with Goldman Sachs.

Great, thank you very much.

I was wondering if you have any information on the percentage of customers that upgraded their iTunes music library now that you've launched the DRM free feature and if you can give us an idea of what the revenue from that might have been.

David, it has just been a couple of weeks so I think it is sort of too soon to tell and I don't have anything sort of specific on that.

The March quarter was very strong for us on the iTunes store.

We saw very, very strong growth in music, video and of course, applications.

And then did you say for the September quarter, the margin -- gross margin might go down to about 30%.

I wondered what the reasons you thought they might drop off might be.

I'm not giving guidance for the September quarter at this point.

But in answer to Bill's question, I've said about 30 for the September quarter.

We'll give you more of our thoughts in July on the September quarter.

Ok.

Thank you.

Thanks, David.

Next question, please.

That comes from Scott Craig with Banc of America.

Thanks, good afternoon.

Just with regards to cash flow, Peter, is it there anything in the June quarter that you guys would consider sort of one time items that could impact like we saw this quarter and then I have a follow-up.

Sure.

Let me just kind of quickly go back through what occurred this quarter.

So, from the March to the June quarter, would not expect the holiday phenomena we see each year of going from the holiday quarter to the March quarter.

And necessarily the impact on accounts payable.

I don't have any prepaids to announce that we're going to make in the June quarter.

So, we did make a $500 million prepayment in March.

And then related to the tax payments, we will make an estimated payment for fiscal '09 in the June quarter.

We'll make one in the September quarter as well.

But I don't expect to have any of the prior year audit true ups or to make anymore payments on fiscal '08.

I don't expect the tax payments to have the significance in the June quarter that they did in the March quarter.

Ok.

And then just a follow-up on the iPhone for Tim, perhaps.

You guys started with Walmart, I think toward the end of December last quarter.

Your sales came in probably higher than most people thought.

How much of an impact was Walmart there and what was the channel inventory in the iPhone as you exited the quarter?

That's it for me.

Thanks.

In terms of Walmart, as you probably know, they're a very key partner for us relative to iPod and we did expand through them for iPhone coverage and we believe they do provide us extended reach in areas that we weren't hitting before.

And we're pleased with the results there thus far.

But it is in the early going and so there is -- there's not much to report there yet.

In terms of total distribution across the world, we're selling iPhone now in over 50,000 storefronts in the 81 countries.

So, we have a sizable presence and sizable channels in this space.

In terms of channel inventory, if you remember, last time, last quarter I told you or implied that we had about 1.75 million units in inventory.

And to remind you in case you guys have forgotten, we are very conservative as to how we count inventory.

For an for example, we count demos that aren't sellable in inventory.

We have about 100,000 of those across these 50,000 locations.

We count units that are in transit from our factories to the carriers that are not physically available for sale and at the end of a quarter, or at the end of last quarter in particular, that was around 100,000 units.

So, just to put some context and perspective on that, we also, in many cases, count inventory all the way to the storefront.

I think there are many people in the industry that count units that sell through and cease to count channel inventory beyond the distribution center.

That's not the way we look at it.

We like to be very disciplined in this environment.

So, on your specific question, I'm not going to talk about weeks because we don't have the experience headed into this quarter about the seasonality, given this will be our first June quarter with a sort of a worldwide spread.

But we saw the channel inventory in the countries that we were in at the beginning of the December quarter fall by the end of the quarter.

But with the countries that we added, which I mentioned before, we added a net of around 80,000 units.

So, we ended at 1.83 million units.

And again, that includes all of those categories that I had mentioned earlier.

Net net, we're very comfortable with the inventory, and we have people wanting more of it.

Ok.

Thank you.

Next question, please.

We'll hear from Charles Wolf with Needham.

Yes.

In view of the explosion in the number of applications, for the iPhone and the iTouch, I was wondering what steps Apple is taking to ensure that the iPhone Apps can be discovered and are these any different from music discovery on the iTunes store.

Charlie, we're doing a number of things.

We include easy to find top 50 and 100 Apps, both paid for and free.

We've got them associated in various genres as well and we're expanding those.

And so I think the team has done a fantastic job making Apps easy to discover and fun to discover.

Are there any kind of unusual patterns in application sales by title versus music sales by title?

Charlie, I would have to say that hitting a billion downloads in about nine months is very exciting.

I think customers are having a lot of fun.

I think all of the genres are pretty popular but of course, you know, games and you can see this by the top Apps list.

Are quite popular.

I think that's one of the reasons why the iPod Touch, as an example, has been such a success.

Okay, thanks a lot.

Thanks, Charlie.

Next question, please.

From Cross Research, you'll hear from Shannon Cross.

Tim, can you talk a little bit about what you're seeing in terms of the competitive landscape for smart phones, especially as we move closer to the launch of the Palm Pre, and as well the iPhone 3.0.

Then I had a follow-up.

It is difficult to comment on products that aren't shipping.

So, there's nothing intelligent I could say on the Pre.

The iPhone has has now sold over 21 million and has the highest overall customer satisfaction of any product shipping.

And so we think that we're in a great position and with the combination of the App Store and the billionth download that should occur tomorrow, we think that we're years ahead.

We very much look at this business or see it through a Software platform lens and I think that has benefited us and our customers very well.

The breadth of Apps on the store are mind boggling from games to very serious medical kind of applications and so the power of the device and the ecosystem is enormous and I think we're just scratching the surface now on its opportunity.

Ok, great.

Then Peter, we saw your comments on the tape earlier about use of cash but I figured I would ask the question anyway.

Any thoughts on the cash balance, obviously it was not up as much this quarter.

But it sounds like given some of the uses of cash.

But obviously going forward, there is substantial cash generation.

So, any thoughts there?

Let me begin by saying for all of the right reasons, we're making -- we're working hard to try to be sure that your prediction of increased cash does occur.

But no, nothing new to announce to you today.

And we continue to be careful with how we're investing the cash and we're very focused on principal preservation.

What's the timing on the construction of the new headquarters?

Any update there?

No.

No update.

Things are quite busy here and we will begin to focus on that in the future.

But no updates today.

Ok.

Thank you.

We're spending all of our energy on constructing new products.

That's a good choice.

Yes.

Thanks, Shannon.

Next question, please.

We'll hear from Chris Whitmore with Deutsche Bank.

Thank you very much.

Your gross margin guidance seems to imply you expect a reasonably strong education selling season.

At least in terms of mix.

Was that in consideration and combined with the desktop refresh?

Can you help us understand why you expect about a 4.5% sequential revenue decline into the June quarter at its midpoint?

Sure.

As we were putting our guidance for the June quarter together, a couple of things.

First of all, last year, in a much better economy, our Q3 revenue was down 1% sequentially.

This year, our guidance provides for a couple of more points of sequential decline.

However, I think it is important to point out that we are guiding for year over year growth on a GAAP basis and we would expect our adjusted sales growth to be even higher.

But, as we think about this year, first, the economy and its continuing impact on consumers and business and education buying season, which begins this quarter, I discussed earlier that the June quarter is more dominated by K-12.

That's an institution sale.

We expect things to be competitive this year given the economy and the funding situations.

We expect some reductions in ASP sequentially as we usually experience in the June quarter.

Second, we will not begin recording revenue on new iPhones sold since our March 17th event.

And we'll start that when we release the iPhone OS 3.0 Software this summer.

And finally, I talked a bit about some of the gross margin discussion, the currency environment and we expect the dollar to have an impact not only on gross margin but, of course, on our revenue as well.

Largely related to, where we got the quarter hedged and the current spot rates.

What impact do you expect software to have on mix in the June quarter?

We don't give specific product guidance.

But in the March quarter, iLife and iWork sales exceeded our expectations.

One of the reasons why revenue and gross margin was higher than we expected.

Ok.

Final question for me is around protecting your IP.

Last quarter, you talked about rigorously impacting your intellectual property.

We haven't seen any action in the past 90 days.

Does that say something about either number one, your position, your patent position or number two, does a product actually need to ship before you can take action on the IP side?

Thanks.

We think that Apple's innovation in the iPhone as I've said before is leading the industry by years.

And we think competition is great.

We think it makes all of us better.

As long as other companies invent their own stuff.

Thanks, Chris.

A replay of today's call will be available for two weeks as an Podcast on the iTunes store, as a web cast on Apple.com/investor, and by telephone.

The numbers for the telephone replay are 888-203-1112 or 719-457-0820.

And the confirmation code is 6117348.

These replays will be available beginning at approximately 5:00 p.m.

Pacific time today.

Members of the press with additional questions can contact Steve Dowling at 408-974-1896 and financial analysts can contact either Joan Hoover or me with additional questions.

Joan is at 408-974-4570 and I'm at 408-974-5420.

Thanks, again, for joining us.