蘋果 (AAPL) 2014 Q3 法說會逐字稿

Good day, everyone, and welcome to the Apple Incorporated Third-Quarter Fiscal Year 2014 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 Nancy Paxton, Senior Director of Investor Relations.

Please go ahead.

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

Speaking first is Apple CEO, Tim Cook, and he'll be followed by CFO, Luca Maestri, and then we'll open the call to questions from analysts.

Please note that 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, taxes, 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 2013, the Form's 10-Q for the first two quarters of FY14, and the Form 8-K filed with the SEC today, along with the associated press release.

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

I'd now like to turn the call over to Tim for introductory remarks.

Thank you, Nancy, and good afternoon, everyone.

It's been a very busy and exciting time at Apple, and I'd like to review some of the highlights of our June quarter.

We hosted our best ever Worldwide Developers Conference last month, with over 20 million people from around the world watching our keynote session, which is a new record.

We've had overwhelming response from customers and developers to the new features we previewed in OS X Yosemite, and iOS 8.

Yosemite has been redesigned with a fresh look and powerful new apps, and iOS 8 is the biggest release since the launch of the App Store.

With powerful continuity features, these upcoming releases while Macs and iOS devices to work together in even smarter ways.

Customers can start an activity like writing an email on one device, and pass it to another, picking up where they left off without missing a beat.

They'll even be able to make and receive iPhone calls on their Mac with just a click.

These are features that only Apple can deliver.

With iOS 8, we've opened over 4,000 APIs, providing more flexibility and opportunity for developers than ever before.

iOS 8 provides developers with amazing new frameworks, enables wider use of touch ID to securely authenticate users within apps, and lets developers further customize the user experience with major extensibility features such as third-party keyboards.

We've also introduced Swift, an innovative new programming link, which for both iOS and OS X. Swift is the result of the latest research on programming languages, combined with decades of experience within building Apple platforms.

It makes writing code interactive and fun, eliminates entire classes of unsafe code, and generates apps that run lightning fast.

It's easy to learn, allowing even more people to dream big and create whole new categories of apps.

We believe our new OS releases combined with Swift will result in a huge leap forward for the Apple ecosystem, and we can't wait to see what developers will create with Yosemite, iOS 8, and Swift.

When we introduced iOS seven years ago, it was a revolutionary operating system for iPhone.

Over the years, we've extended it to the iPod family with iPod touch, and later to a tablet form factor with iPad.

An explosion of apps, accessories, and services for these devices has created an incredibly vibrant ecosystem.

We're extending iOS in even more dimensions, as customers around the world make iPhones and iPads an essential part of their lives at home, at school, at work, and on the go.

We're putting a huge effort into delivering the best experience for our customers, wherever they use iOS.

That includes a safe and intuitive user interface while driving, called car play, which is being integrated by 29 major car brands.

Including Audi, BMW, Ford, General Motors, Honda, Hyundai, Mercedes, Toyota, and Volvo.

And after market systems like Pioneer and Alpine.

We've created a new tool for developers called HealthKit, which lets health and fitness apps work together and empowers customers to choose what health data they share.

We're taking the first steps in this area in collaboration with the Mayo Clinic, whose new apps can automatically receive data from a blood pressure app for example, and share it with a physician.

Or a nutrition app can inform fitness apps how many calories are being consumed each day.

Our own health app will provide an easy to read dashboard of all health and fitness data.

We're enabling new ways to control lights, and doors, and thermostats, and other connected devices around the house using Siri with the HomeKit feature of iOS 8. And in the enterprise, we're including new security, productivity, and device management features in iOS 8. We forged a relationship with IBM to deliver a new class of mobile business solutions to enterprise customers around the world.

We're working together to provide companies access to the power of big data analytics, right on every employees iPhone or iPad.

Using Swift, we'll collaborate to bring over 100 mobile first apps to enterprise clients, each addressing a specific industry need or opportunity.

This is a radical step for enterprise, and opens up a large market opportunity for Apple.

But more importantly, it's great for productivity and creativity of our enterprise customers.

From the pocket to the car, to the workplace, home, and gym, we have a very large vision of what iOS can be, and we're incredibly excited about our plans.

Turning to our financial results.

Today, we're reporting record June quarter revenue thanks to the very strong performance of iPhone, Mac, and the continued growth of revenue from the Apple ecosystem.

Our teams executed brilliantly during the quarter, with earnings-per-share up 20% year-over-year, our highest growth rate in seven quarters.

We sold over 35 million iPhones, setting a new third quarter record.

We generated healthy growth in our entry priced, mid tier, and lead iPhone categories.

I'm especially happy about our progress in the brick countries, where iPhone sales were up a very strong 55% year-over-year.

We also had a record June quarter from back sales, with growth of 18% year-over-year, and a market that is shrinking by 2% according to IDCs latest estimate.

The demand has been very strong for our portables in particular, and we've had a great customer response to the new higher performance, lower priced MacBook Air.

It was another strong performance for the App Store, and the other services contributing to the thriving Apple ecosystem.

In fact, for the first nine months of this fiscal year, the line item that we call iTunes Software and Services has been the fastest-growing part of our business.

iTunes billings grew 25% year-over-year in the June quarter, and reached an all-time quarterly high, thanks to the very strong results from the App Store.

We're continuing to invest in our incredible ecosystem, which is a huge asset for Apple, and a very important differentiator of our customer experience.

iPad sales met our expectations, but we realized they didn't meet many of yours.

Our sales were gated in part by a reduction in channel inventory, and in part by market softness in certain parts of the world.

For example, IDCs latest estimate indicates a 5% overall decline in the US tablet market, as well as a decline in the Western European tablet market in the June quarter.

But what's most important to us is that customers are enjoying their iPads, and using them heavily.

In a survey conducted in May by ChangeWave, iPad Air registered a 98% customer satisfaction rate, while iPad mini with the retina display received an astonishing 100% customer satisfaction rate.

The survey also found that among people planning to purchase a tablet within 90 days, 63% plan to buy an iPad.

And our own data indicates that more than half of customers purchasing an iPad are buying their very first iPad.

Another recent study by Custora found that iPad accounts for 80% of all the US tablet based e-commerce purchases.

We're very bullish about the future of the tablet market, and we're confident that we can continue to bring significant innovation to this category through hardware, software, and services.

We think our partnership with IBM, providing a new generation of mobile enterprise applications, designed with iPad's legendary ease-of-use and backed by IBM's cloud services and data analytics will be one such catalyst for future iPad growth.

Looking ahead, we are very excited about our agreement to purchase Beats Electronics and Beats Music.

Music is part of Apple's DNA, and we think the addition of the Beats team will be great for music lovers.

Beats provides Apple with a fantastic subscription music service, access to rare talent, and a fast growing line up of products that we can build upon.

Not counting Beats, we've completed 29 acquisitions since the beginning of FY13, including 5 since the end of the March quarter.

And we've brought some incredible technology, and more importantly, some incredible talent into Apple in the process.

We're hard at work and investing heavily on exciting opportunities across our business, and we have an incredible pipeline of new products and services that we can't wait to show you.

With that, I'd like to turn the call over to Luca to discuss our Q3 results in more detail.

Thank you Tim, and good afternoon, everyone.

We set a new June quarter record for revenue at $37.4 billion, up $2.1 billion or 6% year-over-year.

This result was towards the high end of our guidance range, despite the reduction in channel inventory for both iPhone and iPad.

The revenue growth was driven by strong sales of iPhones and Macs, as well as the continued great performance of iTunes software and services.

Gross margin was 39.4%, above our guidance range, and operating margin was $10.3 billion, representing 27.5% of revenue.

Net income was $7.7 billion translating to diluted earnings-per-share of $1.28, a 20% year-over-year increase.

For details by product, I'd like to start with iPhone.

We sold 35.2 million iPhones, an increase of 4 million over last year, representing 13% growth.

As Tim mentioned, iPhone sales grew well across all three of our entry priced, mid-tier, and lead product categories.

In the US, iPhone accounts for 41.9% of the smartphone subscriber base according to the latest data from Comscore.

Up from 41.3% in the previous measurement period.

Also, based on the latest survey by ChangeWave, iPhone earned a 97% customer satisfaction rate.

And among respondents planning to purchase a smartphone within 90 days, 50% plan to purchase an iPhone.

Up from 42% in the March quarter, and 44% a year ago.

IPhone sales were at the high end of our expectations, despite new product rumors that we believe resulted in purchase delay.

In addition, tax increases and the regulatory environment in Japan affected smartphone sales in what has been one of iPhone's fastest growing markets in recent quarters.

Considering these factors, the performance of iPhone was even more impressive in the June quarter, and it boosts our confidence for the future.

We'll reduce iPhone channel inventory by about 150,000 from the end of the March quarter, leaving us within our target range of 4 weeks to 6 weeks.

Apple continues to innovate through hardware, software and services to make iPhone the best smartphone for business.

Today, companies have equipped millions of employees with iPhones, and have seen tremendous benefits in productivity, employee satisfaction, and profitability.

For instance, medical device leader Medtronic has developed over 175 internal iOS apps for over 16,500 iPhones used by its employees to facilitate sales, improve productivity, and ensure that essential marketing materials are up to date.

Throughout the global offices of Nestle, the largest food company in the world, over 25,000 iPhones are accessing corporate networks, improving communication, and connecting employees to critical internal resources.

And at NASA, over 26,000 iPhones are in use by scientists, flight crew members, technicians, and researchers.

Turning to iPad, we sold 15.3 million units compared to 14.6 million in the June quarter last year.

iPad sales grew overall in the developing markets, with particularly strong year-over-year growth in the Middle East, where iPad sales were up 64%.

In China, where they grew 51%, and in India, where they were up 45%.

This growth was more than offset by lower sales in more mature markets.

We reduced iPad channel inventory by 500,000 from the end of the March quarter, which left us within our target range of 4 weeks to 6 weeks.

In the enterprise, global companies are using iPad to improve customer service, boost worker productivity, and enhance critical processes.

iPad continues to be the standard for teams across the airline industry.

Quantas Airline has over 15,000 iPads, deployed to pilots, as well as cabin, customer service, and ground crews to announce key processes across their daily operations.

And governments are deploying thousands of iPads worldwide.

One of the largest examples is Sweden, where over 100,000 iPads are being used by local government offices across the country.

In education, iPad remains the tablet of choice, with 85% share of the US education tablet market according to the latest published estimate from IDC.

We've now sold 13 million iPads to education customers globally.

We're bringing teachers and students great new tools to build and experience educational counting on iPad.

As of this month, teachers using the free iTunes U app, can create, edit, and manage entire courses that are actually on iPad for the first time.

And students can discover new ways to collaborate, including the ability to start class discussions and ask questions right from their iPad.

Next, I'd like to talk about the Mac.

We saw 4.4 million Macs compared to under 3.8 million in the year-ago quarter, an increase of 18% year-over-year, and a new June quarter record.

The increase was driven by portables, thanks to very strong growth of MacBook Air.

We achieved strong double-digit Mac growth across many countries, including the US, Canada, Mexico, the UK, Germany, France, Australia, China, India, and the Middle East.

This growth is particularly impressive given the contraction of the overall PC market.

Macs have now gained global market share for 32 of the last 33 quarters.

Macs performed well in the US education buying season, with double-digit growth in the K to 12 market, driven primarily by large deployments of MacBook Air.

The Shawnee Mission School District in Kansas chose Apple to provide an entire solution that will equip every teacher with a MacBook Air and an iPad Air, every high school student with a MacBook Air, and every middle school and elementary student with an iPad.

The Rowan-Salisbury School System in North Carolina is deploying thousands of MacBook Air's to students and teachers in grades 9 through 12 as part of the district's digital learning initiatives.

We ended the quarter with Mac channel inventory slightly below our 4 week to 5 week target range.

The Apple ecosystem continues to grow and thrive.

Total revenue from iTunes software and services was $4.5 billion, an increase of 12% year-over-year.

Our iTunes stores generated all-time record billings of $5.4 billion in the June quarter, up 25% year-over-year, driven by very strong growth in App Store sales.

These iTunes billings translated to quarterly iTunes revenue of almost $2.6 billion, up 8% from the year-ago quarter.

Software and services revenue was $1.9 billion, up 19% from a year ago.

App Store momentum remains very strong, and cumulative app downloads have topped 75 billion.

We continue to be amazed by our vibrant and diverse developer community, and we're extremely proud that our developers have now earned over $20 billion for sales of their apps to the App Store.

Nearly half of which have been earned in the last 12 months.

This number truly stands out among our competition, as our developers continue to benefit from the broad reach and thoughtful design of the App Store, coupled with Apple's large loyal and very engaged customer base.

Let me now turn to our cash position.

We ended the quarter with $164.5 billion in cash plus marketable securities, a sequential increase of $13.9 billion.

Our domestic cash was $26.8 billion at the end of the June quarter, a sequential increase of $8.3 billion, and $137.7 billion or 84% of our total cash was offshore.

Cash flow from operations was $10.3 billion.

We executed another very successful debt offering in April, issuing a total of $12 billion in notes across 3 year, 5 year, 7 year, 10 year and 30 year maturities.

In addition, during the quarter, we entered the commercial paper market for the first time, with $2 billion in short-term obligations outstanding as of the end of June.

We also continued to execute our shareholder return program, with $8.3 billion of capital returned to investors during the June quarter.

We spent $5 billion to repurchase 59 million of Apple shares through open market transactions.

We paid almost $2.9 billion in dividends and equivalents, and utilized over $400 million to net share settle vesting employee RSUs.

We've now taken action on over $74 billion of our $130 billion capital return program, including $51 billion in share repurchases with six quarters remaining to its completion.

And finally, our board has declared a dividend of $0.47 per common share payable on August 14, 2014 to shareholders of record as of August 11, 2014.

Now, as we move ahead into the September 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.

We expect revenue to be between $37 billion and $40 billion, compared to $37.5 billion in the year-ago quarter.

We expect gross margin to be between 37% and 38%.

We expect OpEx to be between $4.75 billion and $4.85 billion.

We expect OI&E to be about $250 million, and we expect the tax rate to be about 26.1%.

Finally, we expect the Beats transaction to close this quarter, and we expect the acquisition to be accretive to our earnings in our FY15.

With that, let me open the call to questions.

Thank you, Luca, and we ask that you limit yourself to one one-part question and one follow-up please.

Operator, may we have the first question?

(Operator Instructions)

Katy Huberty, Morgan Stanley.

Luca, this is the third quarter in a row that gross margin came in above your guidance.

Can you talk about what's driving that gap, and why you expect to the margin to come down sequentially in the September quarter?

Yes, Katy, it was obviously a surprise also to us.

We were expecting, obviously, a loss in leverage from the sequential decline in revenue, which obviously happened.

We also expected some unfavorable mix, which also happens.

It's typical as we move away from the launch quarter.

And we were expecting some cost improvements.

These cost improvements came in, they came in stronger than we were anticipating.

The commodity markets continue to be favorable.

The product quality continues to be excellent.

Our teams executed really, really well.

And all these things came together at the same time, and it was a very nice surprise for us.

As we look forward to into Q4, yes, we've got it to 37% to 38%.

Again, the mix is the normal mix that we see as we continue to move through the product cycle.

And obviously in Q4, we've got some transition costs because we're expecting a very busy Fall.

We're very excited about what we've got in the pipeline.

And that's the reason why guide to that range.

And then, just a follow-up on that last point, Luca.

In the press release, you referenced an excitement about new products and services.

Can you remind us of your guidance philosophy as it relates to product cycles?

Do you imbed assumptions around the contribution from new products?

And if so, do those tend to be more conservative than for products that already ship today?

So our guidance, Katy, is that we put out numbers that we believe at this point in time with all of the information that is available to us.

We're going to land within.

Okay, so we take into account the fact that we've seen some purchase delays already due in Q3.

But we're seeing in some safe trends in certain geographies that that continues to happen.

And what you see this quarter is that our guidance range is $3 billion as opposed to $2 billion during the third quarter just to take into account the fact that we've got many moving pieces.

Okay.

Thank you.

Thank you, Katy.

Could we have the next question please?

Bill Shope, Goldman Sachs.

With the pockets of market weakness you noted for tablets, could you give us some more detail on how you're thinking about the category longer-term?

And in particular, in the context of your usage comments.

How are you sticking about the competitive landscape now and how that may evolve?

And then I guess related to that, what do you think could be the next driver of renewed growth for the category?

Hello, Bill, it's Tim.

If you back up from this, the category that we created, which has just been a little over four years, we've now sold 225 million iPads.

Which is I think, probably a larger number than anyone would have predicted at the time, including ourselves, quite frankly.

We still feel the category as a whole is in its early days, and that there's also significant innovation that can be brought to the iPad, and we plan on doing that.

When I look at the top level numbers, I get really excited when I see that more than 50% of the iPads that we're selling are going to someone who is a first time tablet buyer.

I get excited when I see that the retail share according to NPD in the month of June was 59% in units, and over 70% in terms of dollars.

And of course, Luca had mentioned in his preamble, that our education share is 85%.

We also are in virtually all Fortune 500 companies.

We're in 99% at of them to be exact, and 93% of the global 500.

However, when we dig into the business market deeper, though our market share in the US in the commercial sector is good at 76%, this is according to IDC, the penetration in business is low.

It's only 20%.

And to put that in some kind of context, if you looked at penetration of notebooks in business, it would be over 60%.

And so we think that there's a substantial upside in business, and this was one of the thinkings behind the partnership with IBM that we announced last week.

We think that the core thing that unleashes this is a better go-to-market, which IBM clearly brings to the table.

But even more importantly, apps that are written with mobile first in mind, many of the -- not all, but many of the enterprise apps that have been written for iPad have been essentially ports from a desktop arrangement and haven't taken full advantage of mobile.

And so we're excited about bringing that to business, along with partnering with IBM, which we think is a first-class company.

And seeing what that can do to sales and business, which I honestly believe the opportunity is huge.

The market is still predicted in 2018, I think these are Gartner numbers, to be about $350 million in size.

And to put that in some context, I think the PC market right now is about $315 million.

And so I think our theory that has been there honestly since the first time that we shipped iPad, that the tablet market would eventually surpass the PC market.

That theory is still intact, I just think we have to do some more things to get the business side of it moving in a faster trajectory.

And I think we're now onto something that can really do that.

So as I look at it and sort of back up from the 90 day clock kind of thing, I'm incredibly excited.

I'm excited about the plans that we have on the product side, and also on the go-to-market side, and, in particular, the IBM announcement.

One other point I might add on this, because I think this is interesting, and I don't think it came out in our commentary so far, is the market is very bifurcated on iPad.

In the brick countries, iPad did extremely well.

The growth was very high.

Like in the China, it was in the 50%s, in the Middle East it was in the 60%s.

Luca may have mentioned those numbers.

In the developed countries, like the US, the market is clearly weaker there.

It's interesting to note, however, that the US as an example, we had a very, very strong Macintosh market in the US.

And so there's probably a bit of higher ed kind of stuff beginning to play out too, where higher ed is clearly still very much notebook oriented.

K-12, on the other hand, we sell two and half iPads for every Mac into K-12.

So we're clearly headed into that seasonal now, and it typically starts in graduation time frame in fiscal Q3 for us.

So I think that's probably another thing that we're seeing.

That's helpful, thank you.

One more question, if I could.

You had, obviously, great performance in the brit countries, and you touched on China for a few categories.

Can you talk about the overall demand environment you saw for China in the quarter?

Obviously, there's some seasonal factors to consider, but how should we think about your performance versus your expectations and how you're thinking about it the rest of the calendar year?

China, honestly, was surprising to us that it was -- we thought it would be strong, but it well went past what we thought.

We came in at 26% of revenue growth, including our retail.

And if you look at the units, the unit growth was really off the charts across the board.

iPhone 48% off, that compares to a market estimate of 24 %. So growing at two times the market.

iPad was up as well, as I've mentioned before.

The Mac was up 39%, and that's versus a market in China that's also contracting along with markets in those parts of the world.

And in China, it was projected to contract by 5%.

So we're seeing some substantial strength there, and the thing that actually growing the most is the iTunes software and services category which has the App Store in it, et cetera.

And that area is almost doubling year-over-year.

So it's very, very exciting what we're seeing there.

We are still in the process of rolling out, along with our partner China Mobile, the TDL TE into more cities, and so we're still in the early going on that.

That just started in January, as you know.

And my understanding is, that later this year, there will be a license for the other operators to begin shifting SDD LTE, which I think is another big opportunity in China.

Okay, great.

Thanks, Tim.

Thank you, Bill.

Could we have the next question please?

Toni Sacconaghi, Sanford Bernstein.

Yes, thank you.

I have one for Luca, and one for Tim please.

Luca, I wanted to revisit the gross margin question.

You've talked about guidance for next quarter, that the drivers of the sequential decline being a normal mix through the cycle and transition costs.

Your guidance to the midpoint is down 190 basis points in gross margin.

Last year, in Q4, gross margins were up 10 basis points sequentially in fiscal Q4.

And the product transition issues or cycle issues that you elude to seem essentially identical.

So I'd like to try and understand what might make this Q4 different, let's say, than last Q4.

Yes, I understand this question.

Also, when you look at it in terms of absolute numbers of gross margin, last year it was 37%.

So our range is about that level.

There's obviously many, many things that affect us in different ways from one year to the other.

Foreign-exchange is a case where a lot of the emerging market currencies and the yen, and the Austrian dollar, the Canadian dollar, they've been weaker against the US dollar.

That has an impact on margin.

And also when you think about our product cycle, I think we don't get into the specifics, but that this is not exactly the same cycle as we've had a year ago.

Is it better if we look back two years to the iPhone 5, your product margins were down 260 basis points sequentially.

So is the reference there that we should be thinking in terms of changes that are more akin to what we saw two years ago, rather than to this year?

I wouldn't necessarily draw that analogy.

I think we need to start thinking from the fact that we had a very, very strong Q3.

A lot of things came together extremely well.

37% to 38% is a range that we think is very good.

And that's where we are right now, and we still have several weeks in the quarter.

Okay, thank you.

Tim, I wanted to get your input on the impact of trade in programs for the iPhone, particularly in mature markets where they're most prevalent.

As best I can tell, if I look at the last four quarters, and not hyper focus on 90 days, it looks like the iPhone has been about flat in units terms in the Americas, and up low single digits in Europe.

And I think Europe includes India, which is obviously very fast-growing.

So perhaps low single-digits in Europe.

So if we look at those Western geographies, we've seen relatively flattish iPhone unit sales over the last year.

I know you don't report it, but just sort of based on overall revenue reporting.

I'm wondering if you can comment on what you're seeing in terms of iPhone trade-in programs?

And this is four quarters, so over a complete cycle, whether you think they're elongating or shrinking, and what impact these very increasing prevalent trade-in programs might be having on them.

And what impact your pricing of older generation devices might be having on them.

The theory that you have, Toni, is not precisely correct.

If I looked at Europe, the operating segments of Europe for year-to-date for 2014 versus the same period last year, iPhone units were actually up 10%.

Your more macro question, or what I understand to be your more macro question, do I think there's some sort of cannibalization going on of trade-in programs on new product sales.

What I think is happening in the aggregate as you look across the world, is that trade-ins are actually hugely beneficial for our ecosystem.

Because people wind up -- we have more people that are able to join the party when we have a trade-in.

Because in essence, it winds up being used by in the -- probably the prime example is someone else within the family.

Or in the example that has become more common in the last year, someone trades it in, and then that goes to either somebody else in that country that is very price sensitive, or somebody in a different country.

And I see all of this as good.

In looking at how much of it cannibalizes, it is very hard to answer that question within a degree of preciseness.

But my gut is, is that the cannibalization factor is low, because you wind up attracting people that are much more price sensitive than there.

I think the great thing is our products command a much higher resale value than others do.

And so that leads to a larger trade-in.

And from my perspective, that means a larger ecosystem, more people that wind up getting on iPhone.

And as you know, from following us for quite some time, if we get somebody to try an Apple product, and then buy an Apple product, the likelihood that they begin buying other Apple products that may be in different categories or upgrading to one in that category in the future is very high.

So, net-net, I view it to be positive.

It's very difficult to quantify with certainty.

Thank you.

Thank you, Toni.

Could we have next question, please?

Steve Milunovich, UBS.

Thank you.

Steve, we lost you.

Steve, are you there?

Yes.

Tim, you mentioned that Japan was fairly flat due to regulations and taxes.

Could you elaborate on that, and what comparisons perhaps you see going forward?

Yes, that was actually Luca, but I can comment on it.

The VAT was increased from 5% to 8% at close to the beginning of the quarter, I think it was actually April 1, or so.

That was the first planned the VAT increase.

There are other or at least one additional planned VAT increase in the future.

This is a part of the overall tax reform package in Japan.

Secondly, the carriers received some guidance from the regulators to essentially stop incenting people to transfer from another carrier at a higher amount than they were retaining their own customers.

And so, it appears that the combination of these two things dampened the whole market for smartphones in Japan.

We haven't been able to get very detailed data on share, but my expectation is we're not going to see very much of a share change.

And we're beginning to see some coming back of that market, as we step into this quarter.

Maybe not back to the level that it was previously, but you can begin to see the market growing again, which we view as very positive.

In the past, when we've seen these type of things, tax changes, et cetera, there's usually a rush to buy before the tax increase.

A pause that happens thereafter, and then the market eventually goes back to some kind of steady state that may not be exactly where it was, but it nears it.

So I think that's likely our guts -- or I think that's what happens on the VAT side.

The other piece is a little harder to conclude what will happen in terms of that guidance, and how long that might be in place.

I don't know that part.

Okay.

That's very helpful.

And then, you talked about your three tiers of iPhones.

I wonder if you would be willing to break out in any more detail the growth, and particularly, defend the 5C in the mid tier.

I know our surveys continue to find in the US that it's falling little bit as a percentage of business, but you seem to believe it's doing exactly what you expected it to do.

I can tell you this.

That if you look at the growth rates, we don't divide out each one, but if you look at year-over-year growth rates.

And so this would be comparing the 5C to last year, it would be comparing the 4S, which was in the mid tier.

The growth in that sector was the highest growth during the quarter we just finished.

Of the three tiers?

Of the three tiers.

So we're extremely happy with how it performed last quarter.

Thank you.

Thanks, Steve.

Could we have the next question please?

Paul Bender, Credit Suisse.

Thanks.

I have just one question for Luce, and one for Tim.

For Luca, you mentioned that commodity pricing, I guess the environment was good for you.

Is it your worth and assumption in your guidance that that continues to be favorable and a tailwind for you?

And then my question for Tim is that, with the installment plans that are being introduced in the US, I imagine that given the increases of flexibility for people to upgrade faster.

Would you expect that to happen for iPhone?

Are your see any evidence of that as these contexts come up?

Because we've had them out now for several months.

And how do you see that impacting your business?

Because obviously, the US iPhone part of your business is still very significant, and it could be quite a catalyst for the iPhone business going forward I would imagine.

Or would you be more tentative into how is that playing out?

I'll take both of these.

This is Tim.

On the component question, what we saw in the June quarter was that NAND, mobile DRAM and LCD, the pricing on all of those it declined.

While PC DRAM increased, despite the market for PCs contracting.

In the September quarter, what is factored in our guidance, is that LCDs and mobile DRAM continued to decline.

That NAND pricing remains essentially flat from last quarter, and that PC DRAM has a slight price increase.

And in terms of other commodities that I didn't talk about, we've assumed that they would decline at historical rates.

And so that's factored into the gross margin guidance that Luca gave you.

In terms of the installment plans that you mentioned in the US relative to iPhone, there's a lot of different models that are being tried in the US, and throughout the world.

And actually last quarter, as we estimated, and this is subject to the estimating error, but we're estimating that less in one out of four iPhones were sold on a traditional subsidy plan.

And so that number is markedly different than it would've been two years ago.

The installment plans that you're speaking about which gives the customer the right to upgrade fast, or faster than a usual two-year cycle, we think that that plays to our customer base in a large way.

So that makes us incredibly bullish that customers on those plans would be very likely to upgrade when we announce a new product.

Thank you.

Very helpful.

Thank you, Paul Bender.

May we have the next question please?

Ben Reitzes, Barclays.

Thanks a lot.

Tim, my question is for you.

I guess during the quarter, you did two very big things in our opinion, obviously buying Beats, biggest acquisition in your history.

And you also did this IBM deal, which obviously was in this quarter, but since the last call.

And that was very interesting, obviously, really collaborating with another huge company to get further into the enterprise.

And I was just wondering what are you seeing in Apple that's changing?

These seem like big deals that change your direction a bit, something that you wouldn't have done in the past.

And do you see a lot more partnerships and larger acquisitions on the horizon to grow your TAM in various markets?

Well I think we think we have a lot of really great people, Ben.

And I think we have the capability, as I've said before, I think we have the capability to acquire a sizable company and manage it.

Relative to IBM, I feel the same way.

I think you can only do so many partnerships well.

So, it's unusual that we enter into a partnership.

But in this particular case, I think arguably the companies are so complimentary.

And I've gotten to know Jenny fairly well over the last couple of years, and I think we see the importance of the customer a lot of the same way.

And both feel that mobile and enterprise is just an enormous opportunity.

We're not competing with each other.

And so I think a partnership in that case is particularly great.

Would we do more of either of the things we did?

We're always looking in the acquisition space, but we don't let our money burn a hole in our pocket.

And we don't do things that aren't strategic.

So with Beats, we felt we were getting an incredible subscription service, a very rare set of talent that we think can do great things in Apple.

And access to a very fast-growing business in their headphone and earphone space.

And culturally, we felt there was a match, and music has been deeply embedded in Apple's DNA for many, many years.

So it was a great marriage, and I think the partnership with IBM is a great marriage as well.

If more like that presented themselves, or -- then I think we can manage more things.

I think we have a very, very strong Executive team, and can do that.

But it's not my goal to acquire a certain number of companies or to spend a certain amount of money.

We want to do things that help us make great products and are great for our customers, and so forth.

Sorry.

Just really quick on the IBM.

Does this say something about Apple doing more in big data, and taking a cut maybe of some of the analytics opportunities as well?

We didn't talk about the -- how the business model is going to work.

But generally speaking, I think that each of us have revenue streams in the enterprise, and each of us win from having those revenue streams.

So that's how I look at that.

We win if we can drive that penetration number I spoke about from 20% to 60%.

That would be incredibly exciting here.

The walls would shake.

So that's what I hope for.

Thanks a lot.

Thank you, Ben.

Could we have the next question, please?

Ben Shackner, Macquarie.

Thanks.

Tim, I was just wanting to talks about the app market for enterprise.

Right now, I believe that app developers can sell to the enterprise directly, and therefore, that they can bypass the sharing revenue from these app sales with Apple.

Is Apple going to allow that to continue?

And can you also just more broadly discuss how Apple thinks about the opportunity to sell apps directly to the enterprise?

Thanks.

We have no plans to change the rules with enterprise.

Some enterprises buy proprietary apps that they do not want to offer to others, and so we obviously have a way for them to distribute those into their enterprise on just the employees that they want to.

So I'm not worried about changing that.

We're all for taking friction out of the system, and not adding it.

Again, the big thing for us is getting the penetration number up and getting our product iPhones, and iPads, and Macs in more people's hands.

We think there's a huge opportunity in enterprise to do that.

Thank you, Ben.

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