Apple Inc AAPL
Q1 2013 Earnings Call Transcript
Transcript Call Date 01/23/2013

Operator: Good day, everyone, and welcome to this Apple Incorporated First Quarter Fiscal Year 2013 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, ma'am.

Nancy Paxton - IR: Thank you. Good afternoon, and thanks to everyone for joining us today. Speaking today are Apple's CFO, Tim Cook; and CFO, Peter Oppenheimer; and they'll be joined by Treasurer, Gary Wipfler, for the Q&A session with 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, stock-based compensation 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 2012, and the Form 8-K filed with the SEC today along with the attached 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 Cook for introductory remarks.

Tim Cook - CEO: Thanks, Nancy, and good afternoon everyone and thank you for joining us. We are incredibly pleased to report an extraordinary quarter with $54.5 billion in revenue and new records for iPhone and iPad sales. No technology company has ever reported these kind of results. Apple is in one of the most prolific periods of innovation in new products in its history.

Just in the last few months, we've introduced new products in every category that we make. Each one of these reflects our dedication to making the very best products in the world. At Apple, we think about the smallest details and we're unwilling to cut corners in delivering the best customer experience in the world. This relentless commitment to innovation and excellence is the reason our customers choose to buy our products and this will always be the driving force behind Apple.

Apple today is over 80,000 people strong and we are one team working together to surprise and delight our customers. Part of my job is to preserve our culture and drive it forward so we remain the world's most innovative company. People join Apple to do their very best work of their lives and there's no greater reward than seeing how customers love to use our products.

We continue to believe that our fundamentals, our remarkable people, our clear and focused strategy, our new product pipeline, our booming ecosystem, and more than 400 Apple retail stores will serve us well in the coming months and years ahead.

Tomorrow marks the anniversary of a revolution. On January 24, 1984, Steve introduced the first Macintosh right here at a shareholder meeting at Cupertino. On the evening news that night, they said it was supposed to be one of the easiest computers to use, and thanks to the new mouse you hardly have to touch the keyboard. We’ve come a long way since 1984, but we rely on the same spirit and drive that brought the original Mac and other revolutionary products, like the iPod, the iPhone and the iPad, into the world. You're going to hear a lot of impressive numbers during this call, but they are not the only way that we measure success at Apple.

The most important thing to us is that our customers love our products, not just buy them, but love them. Everyone here is laser-focused on creating an unprecedented customer experience. We've now sold well over 0.5 billion iOS devices, including a staggering 10 per second last quarter alone. We couldn't have achieved these milestones without the very best products in the world, and unmatched execution by our engineering, operations and sales teams to deliver so many innovative and beautifully designed products. It's simply phenomenal.

Everyone at Apple has their eyes on the future, a future driven by the incredible hard work and dedication by the most talented and creative team on earth, who all share a common purpose of continuing to create the world's best products and in doing so, enrich the lives of our customers. Today, we are proud to share with you our latest results. Peter will review the highlights of our Q1 earnings, and I'll be back for the Q&A.

Peter?

Peter Oppenheimer - SVP and CFO: Thanks, Tim. We're very pleased to report the results of Apple's first fiscal quarter. We established new all-time quarterly records for iPhone and iPad sales, significantly broadened our ecosystem, and generated Apple's highest quarterly revenue and net income ever.

Revenue for the quarter was $54.5 billion compared to $46.3 billion in the year ago quarter, an increase of $8.2 billion year-over-year. As a reminder, our first quarter this fiscal year has been 13 weeks, whereas the first quarter last year included a 14th week. As such, average weekly revenue was $4.2 billion in the current year quarter, compared to $3.3 billion in the year ago quarter, an increase of 27%. The strong year-over-year growth was fueled by record iPhone, iPad, and iTunes sales.

Operating margin was $17.2 billion, representing 31.6% of revenue. Net income was a record $13.1 billion, just ahead of the amount generated in last year's 14-week quarter and translated to diluted earnings per share of $13.81.

Beginning this fiscal year, we are reorganizing the presentation of our results to provide greater transparency. First, we have established a new operating segment of Greater China, given the very significant contribution of that region to our overall business. We define Greater China to include Mainland China, Hong Kong, and Taiwan.

Second, for segment reporting purposes, we are allocating certain manufacturing costs in variances, including costs related to product tooling and manufacturing process equipment to our operating segments instead of including these expenditures in corporate expenses, as we've done in the past.

We've recast our operating income for each quarter in fiscal 2011 and 2012 to reflect this change, and have provided a reconciliation on apple.com/investor. These changes had no impact on overall reported operating income.

Third, we have realigned a presentation of product information in our summary data schedule to provide greater visibility to revenue by product category. Under this new format, revenue from iPhone, iPad, Mac and iPod sales is presented exclusive of related service and accessory revenue.

All revenue from iTunes, standalone Apple and third-party software and services is presented as a single line item and revenue from all Apple and third-party accessory sales is presented as a single line item. We believe this presentation provides a logical grouping of revenue sources and also provides greater transparency into our results.

As for the details of this quarter, I'd like to begin with iPhone. We were very pleased to sell 47.8 million iPhones compared to 37 million in the year ago quarter, an increase of over 10 million iPhones. This represents a rate of almost 3.7 million iPhones per week in the current year quarter, compared to 2.6 million per week in the year ago quarter. That's an average increase of 39% per week consistent with IDC's latest published forecast for the global smartphone market in the December quarter.

On a sequential basis, iPhone sales grew 78% in the September – over the September quarter's results. That's over 3.5 times IDC's latest published projection for sequential growth of the overall market resulting in iPhone market share growth. We experienced strong iPhone growth in each of our geographic segments, most notably Greater China, where iPhone sales more than doubled year-over-year.

In the U.S., Kantar Worldpanel Comtech estimates that iPhone share of smartphone sales increased from 45% in the year ago quarter to over 51% in the current year quarter. iPhone sales were driven by the tremendous popularity of iPhone 5, which we're extremely proud to have launched in 100 countries by the end of December resulting in the fastest iPhone rollout ever.

We ended the quarter with about 10.6 million iPhones in channel inventory, a sequential increase of about 1.5 million iPhones and ended the quarter within our target range of four to six weeks of iPhone channel inventory on a look forward basis.

While other mobile devices and operating systems faced increasing security risks and fragmented inconsistent user experiences iPhone and iOS continue to deliver an exceptional experience that people love. They also provide a secure and trusted ecosystem that IT departments require. iPhone continues to be embraced by government agencies and businesses across the globe.

Many U.S. government agencies are issuing iPhones by the thousands as part of their new mobile strategies. Some examples include NASA and National Oceanic Atmospheric Association, Immigration and Customs Enforcement, and the Transportation Security Administration.

We're also seeing continued growth iPhone growth in business across the board from companies replacing existing smartphone deployments to businesses adding first-time smartphone users. Companies around the world like Neiman Marcus, Skanska and Volvo are issuing iPhone to their employees to improve interactions with customers and give workers access to essential corporate data.

Turning to iPad, we were thrilled to sell 22.9 million iPads during the quarter compared to 15.4 million in the year ago quarter. That translates to over 1.7 million iPads per week in the current year a quarter compared to 1.1 million per week in the year ago quarter, and average increase of 60% per week ahead of IDC's latest published estimate of 56% growth for the tablet market.

Customers are loving the fourth generation iPad with its faster performance and spectacular Retina display, and the iPad mini has been a tremendous hit, offering the full iPad experience and an incredible design that you can hold in one hand.

In addition to the tremendous response from consumers, iPad continues to be the tablet of choice for businesses and government agencies, transforming the way their employees work. Financial institutions like Barclays, Nomura Securities, and Bank of Beijing are deploying iPad to enable employees to better service customers and work securely with financial portfolios and products. In particular, Barclays' rollout of over 8,000 iPads has generated tremendous employee engagement and feedback, making it the most successful IT deployment in Barclays' history.

State and local governments in the United States are also rapidly adopting iPad. Court systems, accounting inspectors, and law enforcement agencies use iPad to streamline processes and replace huge amounts of paper. And state legislatures in Virginia, Texas, and West Virginia are all using the iPad to give lawmakers instant access to government documents and information.

Outside the U.S., 10,000 iPads are being deployed as part of broad adoption of the local government workflow solution in Sweden and over 5,000 iPads have been purchased by the government in the Netherlands for the Dutch tax authority and the Dutch court system.

We began and ended the quarter with about 3.4 million iPads in channel inventory. That left us below our target range of four to six weeks of iPad channel inventory on a look-forward basis.

Turning to Mac, we sold 4.1 million units in the quarter compared to 5.2 million in the year ago quarter. That's an average of about 312,000 Macs per week in the current year quarter compared to 371,000 per week in the year ago quarter, a decline of 16%. IDC estimates the global personal computer market contracted by 6% during the December quarter.

We introduced a new 13-inch MacBook Pro Retina display as well as our stunning new iMacs in October. As we projected a quarter ago, we were significantly constrained with respect to the new iMacs and we're only able to ship them for the final month of the December quarter. We believe our Mac sales would have been much higher absent those constraints. We began and ended the quarter with between three and four weeks of Mac channel inventory on a look-forward basis, which is below our target range of four to five weeks.

Moving to iPod, we sold 12.7 million iPods compared to 15.4 million in the year ago quarter. iPod touch was a popular item in the holiday season and continue to account for over half of all iPods sold during the December quarter. iPod share of the U.S. market for MP3 players was over 70% in the December quarter based on the latest data published by NPD and iPod continued to be the top-selling MP3 player in most countries we track based on the latest data published by GfK.

iTunes generated record results, with revenue of $2.1 billion in the quarter. We established new all-time quarterly records for revenue from music, from movies and from apps. We significantly expanded the footprint of our ecosystem during the quarter, adding iTunes music stores in 56 countries, including Russia, Turkey, India, and South Africa. That brings us to a total of 119 countries where customers can choose from over 20 million songs to purchase and download.

The App Store had a record-breaking December quarter with over 2 billion downloads in the month of December alone. The App Store now offers more than 775,000 apps to over a 0.5 billion accountholders in 155 countries, including over 300,000 native iPad apps. Cumulative app downloads have now surpassed 40 billion and we are delighted to have paid our app developers over $7 billion for sales of their incredible work. iCloud continues to grow at amazing rate now with 250 million accounts and our customers love our iMessage service sending a staggering 2 billion plus iMessages per day.

I'd now like to turn to the Apple Retail Stores. Revenue was an all-time high of over $6.4 billion, with growth fueled primarily by record iPhone, and iPad sales. We opened a total of 11 new stores during the quarter including four new stores in Greater China. We exited the quarter with 401 stores, a 150 of which are outside the United States. We also relocated or expanded 14 stores that had outgrown their former space during the quarter.

With an average of 396 stores opened, average revenue per store was $16.3 million or $1.25 million per store per week, compared to $1.22 million per store per week in the year ago quarter. Retail segment income was $1.6 billion. We hosted a record of 121 million visitors to our stores during the quarter compared to 110 million in the year ago quarter. That translates to 23,000 visitors per store per week, a 7% increase year-over-year.

Total Company gross margin was 38.6% which was about 260 basis points higher than our guidance. About half this difference was driven by lower product and transitory costs that we reflected in our guidance, while the remainder resulted from higher mix of iPhones, a weaker U.S. dollar and leverage on the higher revenue. Operating expenses were $3.9 billion and included $460 million in stock-based compensation expense. OI&E was $462 million and the tax rate for the quarter was 26%.

Turning to our cash, our cash for short-term and long-term marketable securities totaled $137.1 billion at the end of the December quarter compared to $121 billion at the end of the September quarter, a sequential increase of almost $16 billion.

The increase in cash was net of $2.5 billion in dividends paid and $2 billion in an upfront payment injunction with our accelerated share repurchase program. Over $94 billion of our total cash was offshore at the end of the December quarter.

Cash flow from operations was a record $23.4 billion, growing by almost $6 billion year-over-year, a 33% increase. Our Board of Directors has declared a dividend of $2.55 per common share payable on February 14, 2013 to shareholders of record as of the close of business on February 11, 2013.

As we move ahead into the March 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. In addition to the reporting changes that have already mentioned, to further increase transparency into business we are changing our approach to how we provide guidance.

In recent years, our guidance reflected a conservative point estimate of results every quarter that we had reasonable confidence in achieving. Going forward, we plan to provide a range of guidance that reflects our belief of what we are likely to achieve. While we cannot forecast with complete accuracy, we believe we are likely to report within the range of guidance we provide. Therefore, for the March quarter, we're providing revenue guidance of between $41 billion and $43 billion compared to $39.2 billion in the year ago quarter.

We expect gross margin to be between 37.5% and 38.5%, reflecting approximately $90 million related to stock-based compensation expense. We expect OpEx to be between $3.8 billion and $3.9 billion, including about $480 million related to stock-based compensation. We expect O&E to about $350 million and we expect tax rate to be about 26%.

In closing, we're thrilled of generated over $54 billion of revenue in a 13-week period while executing multiple major product transitions. We sold over 75 million iOS devices during the quarter, which is a staggering number. We're producing our best products ever and the execution by our engineering, operations and sales team to deliver 10s of millions of such innovative beautifully designed products in such a short timeframe is phenomenal.

We're very pleased with our record iPhone and iPad sales, our record music, moving in app sales and the continued expansion of our robust ecosystem. Finally, we remain very confident in our new product pipeline.

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

Transcript Call Date 01/23/2013

Operator: Katy Huberty, Morgan Stanley.

Kathryn Huberty - Morgan Stanley: It's clear that iPhone 5 did incredibly well in the U.S. based on the carryover report to-date, but international sell-through data points have been more mixed, how would you characterize trends outside the U.S. for iPhone and are you confident that you have all the right price points and screen sizes to fully capture the non-U.S. demand for iPhone specifically?

Tim Cook - CEO: Katy, it's Tim. As Peter said, sequentially we increased over 70% from the September quarter, which was 3.5 times market. So we could not be happier with that. In terms of the geographic distribution, we'd saw our highest growth in China and it was into the triple-digits, which was higher than the market there and so I would characterize it as we're extremely pleased.

Kathryn Huberty - Morgan Stanley: Then maybe a question for Peter, with a such large cash generation again this quarter and confidence in the product pipeline, you made those comments and a stock price that is off at highs, why not step up and buy back even more stock than you had originally planned at this point?

Peter Oppenheimer - SVP and CFO: Sure. This is something that we continuously assess. The opportunities to both invest in the business and return cash. We're pleased to have started our share repurchase program this quarter and combined with our dividend, we returned about $4.5 billion of cash this quarter and we started the buyback program and expect to return about $45 billion over three years to our shareholders. We do consider increasing these programs and we'll do what we think is in the best interest of our shareholders.

Operator: Bill Shope, Goldman Sachs.

Bill Shope - Goldman Sachs: Kathy had eluded to this many of your smartphone competitors are now focusing on differentiating themselves with larger screen sizes than that of the iPhone 5 in your predecessor products, I mean how do you think about the competitive dynamics for the market right now, in that respect do you think that's a valid point of differentiation? Do you think there is a long-term case for a larger screen size or at least the larger variety of screen sizes for iPhones and for the smartphone category in general?

Tim Cook - CEO: Bill, its Tim. The iPhone 5 offers as you know a new 4-inch Retina display which is the most advanced display in the industry, and no one comes close to matching the level of quality as the Retina display. It also provides a larger screen size for iPhone customers without sacrificing the one-headed ease-of-use that our customers love. So, we put a lot of thinking into screen size and believe we picked the right one.

Bill Shope - Goldman Sachs: I guess, and then shifting on to the question on iPhone demand, obviously you saw healthy growth in the key categories this quarter. Then in the context of your guidance, can you give us some color about how you're viewing in-demand trends for the iPhone coming out of the December quarter and how that compares to what you consider to be normal seasonality at this point in the product cycle? And also, did you see any meaningful deterioration in iPhone demand at the end of the December quarter or thus far in the March quarter that would lend credence to some near-term conservatism?

Tim Cook - CEO: Bill, let me take the second half of that and then I'll hand it back to Peter for the first half. If you look at the iPhone sales across the quarter, we were very constrained for much of the quarter on iPhone 5. As we began to produce more and ship more, sales went up with the production. iPhone 4 was actually in constraint for the entire quarter, and sales remained strong, and so that's how sales progressed across the quarter. I'll let Peter talk about the guidance.

Peter Oppenheimer - SVP and CFO: So, Bill, for iPhone, as we told you last year, we built about 2.6 million units of channel inventory in the March quarter which allowed us at that time to get into our four-to-six-week inventory target. So, the underlying sell-through was about 32.5 million, and we would expect sell-through growth year-over-year as it has for – in the quarter, as it has for many quarters in a row.

Tim Cook - CEO: Bill, let me make one additional point on this. I know there's been lots of rumors about order cuts and so forth, and so let me just take a moment to make a comment on this. I don't want to comment on any particular rumor because I would – in my life doing that, but I would suggest it's good to question the accuracy of any kind of rumor about build plans, and also stress that even if a particular data point were factual, it would be impossible to accurately interpret the data point as to what it meant for our overall business, because the supply chain is very complex and we obviously have multiple sources for things, yields might vary, supplier performance can vary, the beginning inventory positions can vary, I mean, there's just an ordinate long list of things that would make any single data point not a great proxy for what's going on.

Operator: Toni Sacconaghi, Sanford Bernstein

Toni Sacconaghi - Sanford Bernstein: I just wanted to make sure that I fully understand your comments about guidance, in the new guidance range that you're providing. Are you effectively saying that when you provided guidance before, it was uniquely conservative and that level of conservatism no longer exists? We're actually getting the real planning range for Apple and that this is fundamentally different from how you approached and provided guidance?

Peter Oppenheimer - SVP and CFO: Tony, it's Peter. In the past we provided a single-point estimate of guidance that was conservative, that we had reasonable confidence in achieving. This quarter and going forward we're going to provide a range of guidance that we believe that we're likely to report within. No guarantee as forecasting is difficult, but we believe that we will report within that range.

Toni Sacconaghi - Sanford Bernstein: So, I'm just comparing the word so you think you'll report in the range before or are you -- I think on average it clips to your guidance on EPS by 35%, was the guidance before something that you felt reasonably confident in achieving or was there an implicit buffer in there because I'm trying to reconcile the fact that you said you thought it was reasonable before, but your historical president was you eclipsed it enormously on an ongoing basis and this time you're saying there is a likelihood of falling within the range and I want to understand the distinction?

Peter Oppenheimer - SVP and CFO: I'll go through it again. In the past, we gave you a single-point estimate of guidance that was conservative, that we had as reasonable confidence as you can that we would achieve. We're now providing you a range of guidance that we expect to as best we can report within.

Toni Sacconaghi - Sanford Bernstein: Then if I could follow-up, Tim you started the call talking about Apple's philosophy of really ensuring that you satisfy your customers and making great products. Against that backdrop how important is market share preservation, this quarter you held share maybe increased it fractionally on a year-over-year basis in the global smartphone market, but clearly you had an exciting new product. Is holding share in the smartphone market in 2013 a priority for Apple, yes or no, and why, and realistically, how does Apple hold share given that the market segment that – and price point that you play in is expected to grow a lot slower and you have pretty dominant share in that high-end?

Tim Cook - CEO: Toni, the most important thing to Apple is to make the best products in the world that enrich customers' lives. That's our high order bid. That means that we aren't interested in revenue for revenue's sake. We could put the Apple brand in a lot of things and sell a lot more stuff, but that's not what we're here for. We want to make only the best products. So what does that mean for market share? We've been able to do that, and I think we've had a great track record here on iPod of doing different products at different price points and getting a reasonable share for doing that. So, one doesn't – I wouldn't view these things as mutually exclusive as some might. But the high-order bid is making a great product that enriches customers' lives. So, that's what we're focused on.

Operator: Ben Reitzes, Barclays.

Ben Reitzes - Barclays: First question is with regard to Macs. Could you talk a little bit more about what happened? It would seem that the shortfall there is well over $1 billion in the quarter, maybe even as much as $1.5 billion. How much of that was pushed into the March quarter within that new March guidance?

Tim Cook - CEO: Ben, it's Tim. Thanks for asking that question; I wanted to talk about this. If you look – I think the best way to answer this is, if you look at the previous year, our Mac sales were about 5.2 million. This year they were 4.1 million, and so the difference is 1.1. So, let me try to bridge that. iMacs were down by 700,000 units year-over-year. As you remember, we announced the new iMacs late in October, and when we announced those, we announced that they would ship the first one, the 21.5-inch would ship in November and we did ship it at the end of November. We announced that the 27-inch would ship in December and we did ship that in mid-December. So there were limited weeks of ramping on these products during the quarter. We left the quarter with significant constraints on the iMac, and we believe we know that our sales would have been materially higher if those constraints would not have exist. We tried to tell people this on the conference call in October. I think I said that we would have significant constraints on iMac, and so – but I recognize to some folks this may be a surprise. Number two, if you look at last year, as Peter went through in his opening comments, we had 14-weeks in the quarter. We have 13-weeks in the quarter this year. Last year, in the average week we sold 370,000 Macs. The third part of the bridge here would be that our channel inventory was down from the beginning of the quarter by over 100,000 units, and that's because, obviously, we didn't have the iMacs and channel inventory was in significant constrain. So if you just take these three factors, they bridge more than the difference of between this year's sales and last year's sales. Now, in addition to these three points, I would point out two other things, and these are lesser things than the total of these other three, obviously. One, the market for PCs is weak. IDC's last estimate, I believe, was around negative 6%. Two, we sold 23 million iPads and we, obviously, could have sold more than this, because we could not build enough iPad minis to come into a demand balance. So, we've always said there is some cannibalization there. I'm sure there was some cannibalization of Macs there. But the three large factors or the aggregated total of the three large, the iMacs, the difference in seven days of the previous year having seven extra days and the channel inventory, I think more than explains the difference between this year and the previous year. As a side note, if you looked at our portables alone, they were in line with IDC's projections of market growth.

Ben Reitzes - Barclays: Then just my follow-up is with regard to web services, online services, there's been a lot of publicity around Maps. Can you give us an update there? Then looking forward, how does the year look in terms of innovation in terms of iOS 7, and your online and web services, how will that drive Apple?

Peter Oppenheimer - SVP and CFO: Let me start with the second part of this. We are working on some incredible stuff. The pipeline is chock full. I don't want to comment about a specific product, but we feel great about what we've got in store. In terms of Maps, we've made a number of improvements to map since the introduction of iOS 6 back in September, and we'll roll out even more improvements across the rest of the year. We're going to keep working on this, as I've said before, until it lives up to our incredibly high standards. Users can already see many of these improvements, because they include things like improved satellite and flyover imagery, improved categorization, improved local information for thousands of businesses and so forth. The usage in Maps is significantly higher than it was prior to iOS 6. In terms of other services, we feel fantastic about how we're doing. In Notification Center, we've now sent over 4 trillion notifications. This is mind-blowing. As Peter mentioned in his opening comments, for iMessage we've now sent over 450 billion, and are currently sending now over 2 billion per day. With Game Center, we've got over 200 million registered users. We have 800,000 apps on the App Store, with over 40 billion downloads. So, I feel really, really great about it. There's obviously more stuff we can do, and you can bet we're thinking about all of it.

Operator: Steve Milunovich, UBS.

Steven Milunovich - UBS Securities: Could you review your comments about gross margin in the quarter? Also looking ahead perhaps commenting on a few areas; first of all, where you are on your product cost curve relative to where you expect it to be? Then also any comments on mix; within the iPhone line in terms of 5 versus 4S, amount of storage? Then also on the iPad; last quarter you said you really didn't know what the proportion of minis would be. Can you make any comments in terms of the demand for mini relative to what you expected?

Peter Oppenheimer - SVP and CFO: Sure, Steve. It's Peter. I'll start. I'll make a comment on mini, go through gross margin, and maybe Tim can pick up on some of your iPhone questions. With the iPad mini, it's hard to know. We could not make enough in the quarter. We were constrained every week. Customers love the mini and we wish that we could have made more and we ended the quarter with significant backlog. For the gross margin in the December quarter, we were about 260 basis points ahead of our guidance. About half this difference was driven by lower product and transitory cost, and we had reflected in our guidance, and the rest came from a higher mix of iPhones, a weaker dollar, and leverage on the higher revenue. As we look forward, we think the gross margin will be somewhere between about 10 basis points and 110 basis points lower sequentially. We believe that there are two primary factors that will benefit gross margin sequentially. First, and the largest of the two, our teams have made meaningful progress in reductions in product and transitory costs from the actions that they've been working on to get down the cost curve, so we expect to benefit in the March quarter beyond what we saw in the December quarter. Second, we expect a more typical level of deferred revenue from device sales. We expect these factors to be more than offset by 10 to 120 basis points by the loss of leverage coming out of the December quarter, which is very typical for us, and a different mix of our current products. Regarding mix, as an example, as we indicated last quarter, the iPad mini gross margin is significantly below the corporate average and we expect to be able to meet demand for this product in the March quarter, which again we could not in the December quarter.

Tim Cook - CEO: Steve, I'll make some comments on mix. If you look – your question on iPhone mix; let me bring up three points. One, the ASP for iPhone was essentially the same year-over-year in the quarter that we just finished. Underneath that, if you looked at the mix of iPhone 5 to total iPhone, and then in the previous year you look at 4S to total iPhones, since it was the top iPhone, those mixes are similar. Then, thirdly, I think you asked about capacities, in Q1 we saw similar results as we saw in Q1 of the previous year. So does that answer your question on mix?

Steven Milunovich - UBS Securities: Yes, it does. Then second question would be on CapEx. You spend almost as much as Intel does. I think you guys have said, you're not going to become vertically integrated per se, but in a sense you are, since most of that, I assume, is buying equipment for your partners. Could you talk about the strategy here and how much of a differentiator this gives Apple in terms of your ability to ramp new products over time, and maybe a little bit more about how deep you will you go in terms of semiconductor, componentry, et cetera?

Peter Oppenheimer - SVP and CFO: We expect to spend about $10 billion in CapEx this fiscal year. That will be up little under $2 billion year-over-year. We expect to spend a little bit under $1 billion in retail stores, and the other $9 billion is spent in a variety of areas. We're buying equipment that we will own that we will put in our partners’ facilities. Our primary motivation there is for supply, but we get other benefits as well. We're also adding to our data center capabilities to support all the services that Tim spoke about in answering Ben's question, and in facilities and in infrastructure. So that's where the capital is going.

Operator: Shannon Cross, Cross Research Group.

Shannon Cross - Cross Research: Tim, can you talk a bit about what happened last year in terms of the refresh cycle, where you had about 80% of your revenue refreshed in the last few months? And then how you're thinking about this year? I mean, I know you said you ship products when they’re ready, but I mean is this a situation where you're going to try to stagger it out a little bit this year, or will it be sort of a similar situation to 2012?

Tim Cook - CEO: It's a question I won't answer, Shannon, but the 80% was an unusually high percentage for us. I don't know exactly what the historic numbers on that, but I can tell you that the number of RAMS were unprecedented in the fact that we had new products in every category – is something we have not done before. We feel great to have delivered 70 products for the holiday season though, and our customers have certainly expressed joy over it.

Shannon Cross - Cross Research: And then I guess can you talk a bit more about China? You provided which is great; you've broken out the Greater China revenue. But can you talk about what you're hearing from customers and from some of your partners there; your thoughts on retail distribution and expansion, and just sort of overall what you're seeing over – what you saw over the holiday period, and then, what you sort of expect from China going forward?

Tim Cook - CEO: Yeah, if you look at our total Greater China, which would include our retail stores that are in China, our revenues were $7.3 billion in the quarter. So, this is incredibly high, it's up over 60% year-on-year. And again, that's comparing 13 to 14 weeks, and so it's really the underlying growth is higher than that. We saw exceptional growth in iPhones into the triple digits. iPad, we shipped iPad very late in the quarter in December and despite that saw a very nice growth. We are expanding in Apple retail there. In the year ago quarter, we had six stores, we now have 11. We obviously have many more to open there and our premium resellers, we went over 400, up from a little over 200 in the previous year and we increased iPhone point of sales from 7,000 to over 17,000 there. Now, this isn't nearly what we need and it's not the final by any means. We're not even close to that, but we're making – I feel that we're making great progress. I was just over there recently and talking to a lot of different people. I am very happy with how things are going.

Peter Oppenheimer - SVP and CFO: It's clear that China, it's already our second largest region as you can see from the data that we've given you and it's clear there's a lot of potential there.

Operator: Gene Munster, Piper Jaffray.

Gene Munster - Piper Jaffray: Tim, you made comment in the past that Apple TV experience is (indiscernible) and Apple wants to fix that problem. If we can take a step outside of the form factor debate whether it's a box or – can you just talk on high-level how important this market is to Apple, number one? Number two is, can you accomplish what you ultimately want to accomplish with the reality of where is content is today and how content is distributed?

Tim Cook - CEO: Gene you're asking me all the questions that I don't want to answer, but let me sit back and find some comments to make this productive. In terms of the product that we sell today the Apple TV we sold more last quarter than we've ever sold before, eclipsing 2 million during the quarter. It was up almost 60% year-on-year and so there is actually very, very good growth in that product. And what was the small niche at one time of people that loved it is a much larger number that love it. I have said in the past this is an area of intense interest for us, and it remains that and I tend to believe that there is a lot we can contribute in this space, and so we continue to pull the string and see where it leads us. But I don't want to be more specific…

Gene Munster - Piper Jaffray: Just a housekeeping for Peter; Peter you gave gross margin guidance this quarter, but no EPS guidance, is there anything any moving parts between the gross margin and the operating line that we should be aware of that might have account that nuances in how you're giving guidance?

Peter Oppenheimer - SVP and CFO: No, Gene. Our prior method of providing guidance was a point estimate for each line item of the P&L, including EPS and our guidance for the March quarter and how we will give guidance in the future, we're going to give a range for revenue, for gross margin and for OpEx and therefore there are many possibilities for EPS within the range, that we'll leave you to think through and we'll report our actual results for March to you in April.

Operator: Keith Bachman, Bank of Montreal.

Keith Bachman - Bank of Montreal: The first one is, Tim, could you talk a little bit about the data, even if anecdotal, on how iPhone sales proceeded in terms of new customers versus upgrades and how that compared to, say, if you go to the 4S last year?

Tim Cook - CEO: I don't have those specific numbers in front of me, but the iPhone 5, obviously with the numbers that we're selling and selling to a lot of new customers.

Keith Bachman - Bank of Montreal: Okay, because we'd had heard feedback that there was a lot more of an upgrade cycle to existing customers, but it sounds like that's not a statement that you would agree with?

Tim Cook - CEO: I don't know who you were talking to, and so, again, this is one of those things I would caution on using as a proxy for the world. There are many carriers created differently.

Keith Bachman - Bank of Montreal: Well, let me turn to my next question then. Peter, as we think about the March quarter, I'm a bit confused how to think about iPads. And you mentioned that iPad mini was constrained. Any kind of comments on what seasonality would be, and more importantly, how are you thinking about the aggregate amount of inventory that's in the channel for iPads? Will that amount increase, decrease, or stay the same as we reflect on how to model units in the March quarter?

Tim Cook - CEO: Keith, it's Tim. Let me make a couple of comments. iPad mini was very constrained. We ended with underneath our target channel inventory range which Peter had commented earlier. We believe that we can achieve supply-demand balance on iPad mini later this quarter. That would likely mean that we would need more units in the channel than we have today. I think that would be a fair conclusion to draw.

Peter Oppenheimer - SVP and CFO: Keith, I'll add to that. For total iPad sales, we don't provide a sub-level forecast, but we would expect a large year-over-year increase in iPad sales, but a post-holiday sequential decline for iPad sales, which I think is typical. As Tim said, we expect to be able to meet demand for the mini.

Tim Cook - CEO: Keith, it's probably worth pointing out just to be totally clear, for the last quarter, we had strong sales of iPad and iPad mini.

Operator: Scott Craig, Bank of America Merrill Lynch

Scott Craig - Bank of America Merrill Lynch: Tim, can you maybe discuss the tablet market a little bit in relation to Macs and other PCs and sort of how you are thinking about the cannibalization of that market for the iPad relative to the PC market? Then secondly, typically could you sort of talk about some of the component constraints and you certainly talked about iPhone 4 being constrained than the iPad mini et cetera. So as you enter into the quarter where do you see the challenges for meeting demand for the calendar first quarter?

Tim Cook - CEO: Sure, let me take the second part of that first. I think overall our team did just a fantastic job ramping out record number of new products during the quarter. We did have significant shortages due to robust demand on both iPad mini and both models of the iMac that persisted the entire quarter, and we are still short of both of those today as a matter of fact. Additionally, supply of iPhone 5 was short to demand until late in the quarter and iPhone 4 was short for the entire quarter. We believe that we can achieve supply/demand balance on iPad mini during this quarter and on iPhone 4 during this quarter. On iMac we're confident that we're going to significantly increase the supply, but the demand tier is very strong and we're not certain that we will achieve a supply/demand balance during the quarter. In terms of cannibalization and how we think about this, I see cannibalization as a huge opportunity for us. One, our based philosophy to never fee cannibalization, if we do somebody else will just cannibalize it and so we never fear it. We know that iPhone has cannibalized the My Pod business it doesn't worry that it's done that. We know that iPhone would cannibalize through Macs, that doesn't worry us. On iPad in particular, we have the mother of all opportunities here, because the Windows market is much, much larger than the Mac market is, and I think it is clear that it's already cannibalizing some and I think there's a tremendous amount of more opportunity there. As you know I've said for two or three – actually three years now I believe that I believe the tablet market would be larger than the PC market at some point, I still believe that and you can see by the growth in tablets and the pressure on Pcs that those lines are beginning to converge. I think the other thing for us, maybe not for others, but for us if somebody who buys an iPad mini or an iPad and it's their first Apple product we had great experience through the years of knowing that when somebody buys their first Apple product, that a percentage of these people wind up buying another type of Apple product. And so, if you remember, what we had termed the halo effect for some time with the iPod with the Mac, we're very confident that that will happen and we're seeing some evidence of that on the iPad as well. And so, I see cannibalization as a huge opportunity.

Operator: Mark Moskowitz, JPMorgan.

Mark Moskowitz - JPMorgan: Question, Tim, around the iPhone. Peter gave us some transparency around the qualitative sequential and year-over-year potential increases in the iPad for the March quarter. How should we think about the iPhone family, (so I think) in terms of year-over-year and quarter-over-quarter potential increases or decreases, and are there any sort of dynamics around slower pace of LTE rollouts by the network carriers having an impact?

Tim Cook - CEO: The thing to consider on iPhone, Mark, is that in the year ago quarter we built 2.6 million units of channel inventory because we did the – one reason was that we did the China launch in the March quarter instead of in the previous quarter. And so the underlying sell-through from the year ago quarter was (32.5). The sell-in was (35) as you can probably see on a sheet in front of you. And so, in thinking through the number of iPhones to predict, we looked at the (32.5) number as a baseline, and we clearly believe that we're going to grow year-over-year, but I don't want to be more specific than that because Peter has already given you some top level guidance and that's how we guide in the aggregate instead of the product level.

Mark Moskowitz - JPMorgan: Then my follow-up is just around the pace of LTE build outs across the globe, either in Europe or parts of Asia has those slower than expected rollouts from the networks perspective, has that had any sort of impact you think on your iPhone sales philosophy and could that change over the next 12 months as you see LTE capacity become more available elsewhere?

Tim Cook - CEO: It's a good question. Today we have 24 carriers around the world that provide LTE support for iPhone 5. Those are in countries like the U.S., Korea, the U.K., Germany, Canada, Japan, Australia and a few others. Next week, we are adding 36 more carriers for LTE support. These carriers will be in countries that we're currently not supporting LTE. So, the LTE coverage now as of next week in Italy, Denmark, Finland, Switzerland, Philippines also several Middle Eastern countries and so if you look at the total of all of these and the incremental subscribers that are in these countries it's over 300 million. So that's the next range of LTE rollout and I'm pleased to tell you about today. Also, as you know, iPhone 5 also supports other ultrafast networks like HSPA+ with downloads up to 42 mbs, which is three times the speed of the iPhone for us. So, we feel very good about the situation that we're in, particularly with these adds next week.

Operator: Chris Whitmore, Deutsche Bank.

Chris Whitmore - Deutsche Bank: Just to follow-up on the iPhone question with respect to guidance just assuming there was some benefit from the Mac carryover effect in iPad release etcetera and adjusting for the inventory it seems you're guiding to mid to high-single digit year-on-year unit growth for the iPhone business from the sell-through standpoint. Is that the right ballpark we should be thinking about and why the big deceleration from the 25% plus weekly sales rate you quoted in your intro comments?

Peter Oppenheimer - SVP and CFO: We are not going to talk about the guidance in a specific product level but let me give you some things we thought about in coming up with the range of $41 billion to $43 billion. That range is 5% to 10% year-over-year increase and there are a few factors that are impacting the year-over-year results, making the strong performance of the business a little bit harder so see. So, let me point a few of these out. First of all, as we talked about several times on the call last year in the March quarter we built 2.6 million units of iPhone channel inventory which allowed us to get into our four to six week range, that increased the revenue in the year ago quarter by $1.6 billion. As Tim talked about that was sell-in that was not sell-through, we're thinking about the business on a sell-through basis, so don't lose sight of the $1.6 billion. Second, the iPhone 5 roll out this year has been our fast as ever. We're selling in 100 countries by the end of December. Last year we did not achieve this country distribution until the March quarter, which included China that we launched in January. Third, we made a very good strategic decision to introduce the iPad mini which customers love and to keep the price-reduced iPad 2 in the line. As a result of this, we saw a reduction in our iPad ASPs of about $101 year-over-year in the December quarter and you can see that our iPad units grew faster than our iPad revenue in the December quarter. We would expect iPad ASPs to be down quite a bit in the March quarter on a year-over-year basis for the same reasons. Then finally, the PC market grew 4% last year in the March quarter, and this year IDC is projecting that to decline by 3%. So, considering these factors the underlying performance of the business is much stronger than the 5% to 10% year-over-year growth implies and we remain very confident in our business and our new product pipeline.

Chris Whitmore - Deutsche Bank: For my follow-up, I wanted to come back to something Tim said earlier about not fearing cannibalization. I wanted to ask in context of your iPhone business, given the strength you're seeing at the low-end of your product line, the iPhone 4 being stacked out during the quarter, there seems to be a lot of demand at lower price points for the iPhone. Why not get more aggressive at lower price bands and move down-market in the iPhone business?

Tim Cook - CEO: I'm not going to go into our pricing strategy, but we feel great about the opportunity of getting products to customers and a percentage of those buying other Apple products. We've obviously seen evidence of that through history and continue to see evidence of that today.

Nancy Paxton - IR: A replay of today's call will be available for two weeks as a podcast on the iTunes Store, as a webcast on apple.com/investor, and via telephone, and the numbers for the telephone replay are 888-203-1112 or 719-457-0820. Please enter confirmation code 1474555. These replays will be available by approximately 5.30 PM Pacific Time today. Members of the press with additional questions can contact Steve Dowling at 408-974-1896 and financial analysts can contact 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.

Operator: Ladies and gentlemen, that does conclude today's presentation. We do thank everyone for your participation.