Apple Earnings Call: What You Need to Know

Apple (Nasdaq: AAPL) reported third-quarter earnings this week and hosted an investor call. Here's a Foolish digest for current or prospective Apple investors.

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What follows is a lightly edited transcript of the conference call.

Nancy Paxton, Apple, Inc., Senior Director of Investor Relations
Good afternoon, and thanks to everyone for joining us. Speaking today is Apple CFO, Peter Oppenheimer, and he'll be joined by Apple COO, Tim Cook, and Treasurer, Gary Whippler, for 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 expenses, stock-based compensation expense, taxes, earnings per share, and future products. Actual results or trends could differ materially from our forecasts. For more information, please refer to the risk factors discussed in Apple's Form 10K for 2009 as amended, the Form 10Q for the first two quarters of fiscal 2010, and the Form 8K 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. With that, I'd like to turn the call over to Peter Oppenheimer for introductory remarks.

Peter Oppenheimer, Apple, Inc., Chief Financial Officer
Thank you, Nancy. Thank you for joining us. We are extremely pleased to report outstanding results for the June quarter. During the quarter, we began shipping iPad to millions of delighted customers in ten countries. We launched a very popular iPhone 4. We shipped iOS 4 with many great new features. And we set a new all-time record for quarterly Mac sales. We're shipping the best products in Apple's history, and the response from our customers has been terrific. And as a result, we are thrilled to announce today our highest quarterly revenue ever, surpassing the previous record set in the most recent holiday quarter. Revenue was $15.7 billion, an increase of $6 billion or 61% over the prior June quarter's result. The tremendous revenue growth was driven primarily by the very successful launch of iPad, in addition to strong sales of iPhone and Mac. Operating margin was $4.23 billion, representing 27% of revenue. Net income was $3.25 billion, up 78% over the year-ago quarter. And earnings per share were $3.51.

Turning to the details of our results, I'd like to begin with our Mac products and services. We generated record quarterly sales of 3.47 million Macs, exceeding the previous record established in the most recent December quarter by over a hundred thousand. This represents 33% year-over-year growth compared to IDC's latest published estimate of 22% growth for the market overall in the June quarter. We are pleased to have outgrown the global market in both the desktop and portable categories. We experienced strong double-digit Mac growth in each of our geographies. Led by both the continued momentum of iMac in the very popular MacBook Pro family, which was updated in April with faster processors, more powerful graphics, and even longer battery life. We are also pleased to report record Mac sales in our U.S. education institution business, despite state budget constraints. We began and ended the quarter with between three and four weeks of Mac channel inventory.

Moving on to our music products, we sold 9.4 million iPods, compared to 10.2 million in the year-ago quarter. Sales of iPod Touch continue to be very strong, with sales growing 48% year-over-year. The continued mix shift toward iPod Touch resulted in an overall iPod ASP increase of 12%, generating total iPod revenue growth of 4%. iPod's share of the U.S. market for MP3 players remains at over 70% based on the latest monthly data published by NPD. iPod also continues to be the top-selling MP3 player and to gain share internationally year-over-year in nearly every country we track based on the latest data published by GFK. The iTunes Store had another great quarter, with revenue exceeding $1 billion and growing 25% year-over-year. The App Store continues to be an unparalleled success, with more than 225,000 apps available, including more than 11,000 apps specifically for iPad. iPhone, iPod Touch, and iPad users have downloaded over five billion apps from the App Store. We ended the quarter within our target range of four to six weeks of iPod channel inventory.

I'd now like to turn to iPhone. We were very pleased with iPhone sales of $8.4 million, including over 1.7 million iPhone 4s in the initial five countries where it was launched. This represents 61% year-over-year growth and is considerably higher than IDC's latest published estimate of 38% growth for the global smartphone market overall in the June quarter. Customers are loving the great new features of iPhone 4, including face time for video calling, the high resolution retina display, HD video recording, and the beautiful new glass and stainless steel design. Recognized revenue from the iPhone handset sales, accessory sales, and carrier payments was $5.33 billion during the quarter, compared to $3.06 billion in the year-ago quarter, an increase of 74%. The sales value of iPhones alone was about $5 billion, which yields an ASP of about $595. At the end of the June quarter, we had iPhone distribution with 154 carriers in 88 countries. We continue to experience very strong year-over-year growth, particularly in Asia, Europe, and Japan. Additionally, we continue to be very pleased with strong sales growth from both long-standing and new carrier partners.

During the quarter, we surpassed two months' sales of 100 million iOS devices. Response to the iOS 4 since its June 21st launch has been very favorable, with customers and reviewers praising its many new features, including multitasking, folders, enhanced mail, and deeper enterprise support.

Turning to iPad, we're off to an amazing start, and we're extremely pleased with customer response with sales to date. Through the end of the June quarter, we shipped 3.27 million iPads to customers in 10 countries. Recognized revenue from sales of iPad and iPad accessories during the quarter was $2.17 billion. The sales value of iPads alone was almost two-point-one, which yields an ASP of about $640. Feedback from customers continues to be outstanding as more and more of them experience iPad and take advantage of its multi-touch user interface, large screen and high quality graphics to browse the Web, read and send email, read eBooks and much more. We look forward to bringing iPad to customers in nine additional countries on July 23rd.

I'd now like to turn to the Apple Retail Stores, which had an outstanding quarter, generating record revenue and customer traffic. Retail revenue was $2.58 billion, compared to $1.49 billion in the year-ago quarter, an increase of 73%. Our stores sold 677,000 Macs, compared to 492,000 Macs in the year-ago quarter, an increase of 38%. About half the Macs sold in our stores during the June quarter were to customers who had never owned a Mac before. We opened seven new stores during the quarter, including four in the U.S., two in Australia, and one in Canada, ending with 293 stores. With an average of 287 stores open during the June quarter, average revenue per store was $9 million, compared to $5.9 million in the year-ago quarter. Retail segment margin was $593 million, compared to $387 million in the year-ago quarter. We hosted a record 60.5 million visitors in our stores during the quarter, compared to 38.6 million visitors in the year-ago quarter, an increase of 57%. We expect to open 24 stores this quarter, including our fabulous new stores in Paris and Shanghai, which opened earlier this month, our Covenant Garden store in London, and our first two stores in Spain to be opened in Barcelona and Madrid.

Total company gross margin was 39.1%, which was 310 basis points above our guidance. This difference was driven by two categories of factors. The first category accounted for a little over half of the difference. When we provided our guidance with the June quarter, we identified five things that we expected to drive a sequential decline in gross margin from the March to June quarters. These were the first quarter of iPad sales, a stronger U.S. dollar, our portable Mac transition, the beginning of the education buying season, and the iPhone 4 transition. Collectively, these things did have an impact sequentially, but to a lesser extent than we had anticipated in our guidance. The second category of factors which accounted for the remainder of the difference consisted of unanticipated favorable adjustments, as well as leverage on the higher-than-expected revenue. Operating expenses were $1.9 billion, and included $181 million in stock-based compensation expense. OI&E for the quarter was $58 million. Our tax rate for the quarter was 24.2%, about 3 points below our guidance as a result of two factors. First, we had a better mix of foreign earnings, and this accounted for about two-thirds of the difference. Second, we finalized favorably some prior-year U.S. tax audits, accounting for the remainder of the difference. As a result of a better mix of foreign earnings, we have lowered our expected fourth-quarter tax rate from 27% to about 26.5%.

Turning to cash, our cash flow short term and long term marketable securities total $45.8 billion at the end of the June quarter, compared to $41.7 billion at the end of the March quarter, an increase of $4.1 billion. Cash flow from operations was $4.8 billion. Our investment priority for cash continues to be the preservation of capital, and we are continuing to focus on relatively short-dated high-quality investments and remain comfortable with our investment portfolio.

Looking ahead to 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. As we announced on Friday, we will be offering free cases to all customers who have purchased an iPhone 4 through September 30th. As a result, we will be deferring revenue corresponding to the value of the cases that have yet to be ordered by or delivered to eligible customers under this offer as of the end of the September quarter. We estimate this deferral to be about $175 million, and we expect the September quarter deferral to be recognized as revenue in the December quarter. We will recognize the cost of the cases upon delivery to our customers. We expect revenue to be about $18 billion, compared to $12.2 billion in the September quarter last year. We expect gross margin to be about 35%, reflecting approximately $40 million related to stock-based compensation expense. We expect most of the sequential decline to be due to a higher mix of iPhone 4 and iPad sales, which have higher cost structures and provide great value to customers, as well as the revenue deferral impact of the iPhone 4 case offer. To a lesser extent, we expect the sequential decline to be driven by back-to-school promotion and the absence of the favorable adjustments that benefited gross margin in the June quarter. We expect OpEx to be about $2 billion, including about $195 million related stock-based compensation expense. We expect OI&E to be about $50 million reflective of the short-term interest rate environment, and we expect the tax rate to be about 26.5%. We are targeting EPS of about $3.44.

In closing, we are thrilled with our record June quarter revenue and strong financial performance. We are very pleased with sales of iPad and iPhone 4. We're working hard on catching up with customer demand for these great products, and we looking forward to rolling them out to even more customers in more countries this quarter. We are very pleased with the market share gains for our iPhones, Macs and iPods, and remain very confident in our new product pipeline. With that, I'd like to open the call to questions.

Shannon Cross, Cross Research
Thank you very much, and good afternoon. Could you talk a bit about what you're hearing from corporations on their thoughts on the iPhone, the iPad, and Mac, just what you're seeing in terms of corporate adoption?

Tim Cook, Apple, Inc., Chief Operating Officer
Hi, Shannon, it's Tim. If you'll look at the iPhone, we are now up to more than 80% of the Fortune 100 that are deploying or piloting that, the iPhone. And we also see very good momentum in the Fortune 500. In fact, over 60% of the Fortune 500 are deploying or piloting iPhone. This is also transcending into education institutions and we see around 400 higher education institutions which have approved the iPhone for faculty, staff, and students. And so iPhone is really taking off, and iOS 4 was another help in doing that. In terms of the Macintosh, you can see the Mac had an incredible quarter. We're still selling principally to consumer in education, but we are seeing businesses with increasing interest in the Mac. It's more difficult to measure because many of those sales are filled through the channel. But we're obviously thrilled with growing 33% year-on-year.

Shannon Cross
Great. And then the iPad?

Tim Cook
The iPad, very surprisingly, in the first quarter-so in the first 90 days, we already have 50% of the Fortune 500 that are deploying or testing the iPad. It's incredible. That's the Fortune 100, excuse me.

Shannon Cross
That's great. And then I had a follow-up for Peter. When you talked about the gross margin upside this quarter, you mentioned that half of it came from those five areas performing better than you'd expected. Can you give us any more specifics on why exactly those areas were better than you'd anticipated?

Peter Oppenheimer
Sure. Shannon, the largest contributors were higher iPhone sales than we had included in our guidance, and also higher accessory sales, as well.

Shannon Cross
OK, great. Thank you.

Richard Gardner, Citigroup
OK, great. Thanks. Tim, I wanted to start just by asking you to give us a supply demand breakdown for each of the product categories, if you would, and talk about any notable supply constraints within each product line, and how severe they are, and when you expect them to be alleviated.

Tim Cook
OK, Rich. Starting with the Mac, there were no significant supply demand issues during the quarter, and there are none currently. On the iPod, it's the same, none of significance last quarter, and none currently. The iPad and the iPhone are significantly different. Both of these products, the iPad, and specifically the iPhone 4, we had backlog at the end of last quarter that we were not able to fill. And currently we are still selling both of those products as fast as we can make them. So we still are quoting longer lead times than we like, and we're working around the clock to try to get supply and demand in balance. In the scheme of things, it's a good problem to have.

Richard Gardner
And Tim, are you willing to provide, I guess, any additional color on what's causing-what the sources of constraint are, and when you expect those to be alleviated? Or is it just simply a demand problem and not so much a supply problem?

Tim Cook
Well, I think high demand is never a problem. On the iPad, as I had mentioned last quarter, we went into the iPad thinking that planning a one million per month capacity was a very bold move. And in fact, if you look, a lot of the industry analysts were predicting that we would only sell somewhere around that number for the whole calendar year. And as you know, we did one million the first month, and then the second million the second month, and the third million the third month. And so basically what we're doing is, we're increasing capacity as quickly as we can. And you know there's a number of things that we have to increase in order to do that. But I'm fairly confident that we will be able to increase the capacity. It's not a situation where there's something profound that we can't eventually increase. The iPhone, we just started ramping in June. We had very limited days last quarter. As you know, we launched on the 24th, and the quarter ended on the 26th. And we're still ramping and increasing volume, but again, there's not a specific thing that is an overwhelming gauge. It's just the matter of getting up the ramp.

Richard Gardner
OK. And then, if I could, Peter, you mentioned actually the mix of iPhone 4 and iPad sales as a negative for gross margin this coming quarter. And iPhone 4 -- well, iPhone in general, has typically had margins that are well above the corporate average. I'm just wondering why you would put that on the negative side of the ledger for gross margins for September. And I was hoping you could tell us -- give us a little more detail on the adjustments that positively affected the gross margin in June.

Peter Oppenheimer
Sure. Let me start with your second question. I don't want to go into a lot of specificity there, but we did have some adjustments that occurred in our supply chain and some other product costs that benefited us in June. They were the larger contributor of the second set of factors that I outlined for you. As regards our gross margin for the September quarter, we have just introduced the iPad and the iPhone 4. We are delivering great value to customers. And these products have higher cost structures. In the case of the iPhone 4, it has a higher cost structure than the predecessor product that we were shipping. So while the margin there is attractive, on a sequential basis, we have been pretty aggressive here with pricing, and it's going to play through a bit on the margin line.

Richard Gardner
Thank you.

Gene Munster, Piper Jaffray
Good afternoon, and congratulations. The iPhone number was strong, despite a lot of moving parts in the channel, in terms of inventory this quarter versus a year ago when you launched the 3GS. Can you talk a little bit about what those dynamics were and how they affected the 8.4 million in number you printed?

Tim Cook
Yeah, Gene, it's Tim. We greatly reduced shipments of the previous generation iPhone beginning around June the 7th, which was our worldwide developers conference and coincided with the announcement of the iPhone 4. But as you probably know, we did not launch the iPhone 4 and the new 8 gigabyte 3GS until June 24th, which was only three days before the end of the quarter. The result of that was that we had significantly lower sales after June the 7th for that period of time as we waited on the official launch. In fact, if you looked at our year-over-year growth rate prior to June 7th, it was around 90%. And as you know, we exited the quarter-you can see this from the data sheets-we exited the quarter with total iPhone sales up 61%. And so basically we did a channel adjustment. We pulled the previous generation of iPhones down significantly in channel inventory. We increased from zero the iPhone 4 inventory and the inventory of the 8 gigabyte 3GS, and the net reduction in the channel was about a quarter of a million units from the beginning of the quarter. And I would remind you that, as you probably guessed, the run rate associated with the sales of the new product are larger than the run rate associated with sales of the old product. And so in terms of any kind of weeks of inventory, it would be much less than where we were running before.

Gene Munster
OK, so last quarter, I think your comment was, you had about 2.7 million units in the channel; is that correct?

Tim Cook
Yeah, that's right. And so we ended with about 2.45. And if you look at the ins and outs in that, just to give you the numbers, the previous generation draw-down by the end of the quarter was slightly less than 1.3 million. And the combination of iPhone 4 and iPhone 3GS was up about a million. And the vast, vast majority of that million was in transit at the end of the quarter, not available for sale.

Gene Munster
OK. So is it safe to say that you would have printed around 8.7 million iPhones assuming a more normalized inventory level throughout the quarter?

Tim Cook
Look, if we would have held inventory flat from the beginning of the quarter, we would have gone a little over 250,000 more units. However, what we would have really wanted to do if we had the opportunity to do it, quite frankly, is to take inventory up quarter-over-quarter, or beginning of the quarter to end of the quarter, because the sales run rate was larger at the end of the quarter with the new product.

Gene Munster
OK. And I just quickly have a philosophical question that I can understand why you guys run out of products and the iPad comes out and it's the first time you're doing it, but these shortages that we have right out of the gates, can you just give us any insight? There's obviously a lot of talk. Do you guys purposely do this just to create buzz? I suspect that that's not the case, but can you give us any insight into a company that understands how to build products as well as you do, that we still have these problems going into these product launches?

Tim Cook
Let me answer that in two different ways. If you look at the previous generation product, we've called a number of units that we're going to sell many weeks beforehand, and when we run out, we run out. And quite frankly, we tend to manage that aggressively on purpose because we would rather the market move very quickly to the new product. And that's what happened here. And frankly speaking, I'm glad that it happened, and it's exactly the way that we want to manage it. In terms of the new product, we do not purposely create a shortage for buzz. I'm not sure where that comes from, but that's certainly not our objective. We would like to fill every customer's order as quickly as we can. The demand for iPhone 4 is absolutely stunning. And we're working very hard to catch up to demand, and I can't predict when that will occur, but I can tell you that everyone's working very hard to do it.

Gene Munster
And this last question, and I'll turn it over, is that since the issues with the antenna, have you seen any changes in demand for-or what changes have you seen in demand for iPhone 4?

Tim Cook
Gene, let me be very clear on this. We are selling every unit we can make currently.

Gene Munster
Great. Thank you

Ben Reitzes, Barclays Capital
Good afternoon. Thanks. I guess I just want to elaborate on that last question a little more. So you haven't seen any slowdown in order rates online, or-you know, your lead times remain the same. And is that what you mean, you haven't seen any slowdown in order rates or any increase in returns that are noticeable in the marketplace?

Tim Cook
Ben, my phone is ringing off the hook for people that want more supply. So right now it's hard to test the real question that you're asking about is there an effect or not, because we're selling every one that we can make. So you can't run the experiment both ways.

Ben Reitzes
And on the return issue, is there anything noticeable? You know, maybe it's an easy answer because we're not seeing a huge slip-up, but are you?

Tim Cook
The returns that we've seen on the iPhone 4 are less than the iPhone 3GS as Steve shared in the presentation on Friday. And the ones for this specific issue are extremely small.

Ben Reitzes
OK. Moving on, with regard to the iPad, when you do think supply and demand will be in balance? Is it -- and maybe if you can, you know, refer back to your experience with other products that had soaring demand and when you got to equilibrium, or is there any other experience that's comparable that you can give us any indication of when you feel you could see an equilibrium with that product?

Tim Cook
We honestly don't know, is the answer. We have been pleasantly surprised at how fast this product has gotten out of the shoot. If you look at how long it took us to sell the first million iPods, 20-plus months, versus the one month of iPad. It's a phenomenal difference. It is not following a typical early adopter curve, and then, you know, taking a long time to cross into the mainstream. And so I don't know how high is high. Our guts tell us that this market is very big, and we believe that iPad is really defining the market. And we want to take full advantage of it, and so we are investing enormous time and resource in increasing our capability in getting iPad out to as many people as we can.

Ben Reitzes
OK. And then just finally maybe, Peter, for you, are you surprised on how many people want the 3-D product for the iPad? And since you launched that product, what is the split between 3-D and Wi-Fi?

Peter Oppenheimer
Ben, we're not going to disclose the splits between that, but all of the models have been very popular, as I commented in my prepared remarks and Tim just did. The demand has just been amazing, and this is off to an incredible start. And overall ASP in the June quarter for iPad was about $640.

Ben Reitzes
Well, it just would seem like that's the base ASP, because now you have a better mix of 3-D, so that might be the low point. But, OK, I'll cede the floor. Thank you so much.

Brian Marshall, Gleacher & Company
Sure, thanks. Nice quarter. Question with regard to the upside that you saw in the Mac as well as the iPhone units, I mean, that's pretty impressive considering iPad came in very strongly this quarter as well. So do you have any updated thoughts, kind of longer term, philosophical perspective about how the iPad will potentially cannibalize or take away some dollars from some of your other product lines going forward?

Tim Cook
It's a very good question, and it's one that we do talk about internally. We've only been selling for three months, and so I think the real answer is that it's too early to tell. If you do look at the quarter that we just finished, we are thrilled that we reported our best Mac quarter ever in the same quarter that iPad sold almost 3.3 million units. And so for us, it's a jaw-dropper.

Brian Marshall
OK. And I was wondering if you could give us any updates on how the iAds business is coming to fruition here?

Peter Oppenheimer
We have just launched the iAd in the early part of July. We're going to learn a lot this calendar year and build a foundation for the future. And beyond that, I don't have any further specifics to share with you today.

Brian Marshall
OK. And my final question is, I was wondering if you could give us an update on how the data center build is coming along in North Carolina? And that's it. Thank you.

Peter Oppenheimer
North Carolina is on schedule. Everything is going fine.

Brian Marshall
Can you share what the schedule is with the pier?

Peter Oppenheimer
We expect to complete it by the end of the calendar year and begin to use it.

Brian Marshall
Great. Thank you very much

Toni Sacconaghi, Sanford C. Bernstein & Co.
Thank you. I wanted to revisit the gross margin question, please. Peter, on your guidance last quarter, you basically said about a quarter of the expected sequential decline in gross margin was expected to come from iPad, about 150 basis points. Relative to your expectation on that, what kind of impact did iPad had on gross margin versus your guidance, and why may it have been different?

Peter Oppenheimer
Toni, the factors that we cited last quarter, largely on a collective basis, were as we thought. And we did about 310 basis points better than we had guided, and a little more than half of that was those five factors not being quite as deep as we thought. And the biggest piece of that difference really came from selling more iPhones and selling accessories. So the other factors were generally about what we thought they would be.

Toni Sacconaghi
So if we think about it, you were expecting to be down about 570 basis points. You were down about 260 basis points. But you had mentioned you had a favorable benefit as well as some operating leverage. What was the collective impact of those two positive forces, of operating leverage and favorable -- so were you down -- you thought you'd be down 570 from those factors, and you were down 400 to 450? And then you had favorable impact of 150 from the other two factors, or how do we think about that in basis points?

Peter Oppenheimer
Sure. So we were ahead of what we thought by about 310 basis points. No more than half of that came from the five factors not being quite as deep as we thought. And it was mostly selling more iPhones and more accessories that drove that. A little less than half the 310 basis points occurred from the unanticipated favorable adjustments and the leverage on the higher revenue. And the favorable adjustments were the bigger piece of that second group.

Toni Sacconaghi
OK. Thank you, that's helpful. On the favorable adjustments, can you comment on whether they were one time and whether they were discretionary? Any more color you can provide on those?

Peter Oppenheimer
I don't expect them to -- the ones that we benefited from -- to reoccur. And again, I don't want to be specific, but these were things that really just occurred in our supply chain and with other product costs.

Toni Sacconaghi
And Tim, you had talked a little bit about channel inventory. It sounds like -- and correct me if I'm wrong -- that you might have 1.4 million in existing channel inventory of the older 3GS, the 16, and the 32 gig. Is that correct? And where and how are those being sold currently?

Tim Cook
Toni, we had about 1.4 on June 26th, which was the end of the fiscal quarter. Currently, we have materially less than that. And those are being sold at basically most -- not all, but most of the -- in most of the countries that we sell the 3GS in.

Toni Sacconaghi
And have you been able to take up that-So since the end of the quarter, June 26th, have you had any progress in increasing your total channel inventory, or are you-do you feel like you're fighting a losing battle?

Tim Cook
I never feel like I'm fighting a losing battle. But on iPhone 4, we are selling things as quickly as we make them. And so we have more work to do there.

Toni Sacconaghi
But I guess that implication would be is if you've taken down inventory of the non-iPhone 4 product, and you're selling them as quickly as you can, that would actually suggest your total inventory would be even lower now than it was on June 26th?

Tim Cook
Keep in mind that we also sell the iPhone 3GS 8 gig that's a new model in the line. And so the 1.4 million that I was referring to that I assumed that you were also referring to are the iPhone 3GS units that were in the previous generation?

Toni Sacconaghi
Correct, they are. Thank you.

Tim Cook
You'd have to look at the whole line.

Toni Sacconaghi
And final question. You had talked a little bit about cannibalization of iPad on Macs, and I know you talked about the iPod and iPod Touch on a year-over-year basis. But sequentially, your ASP is still quite a bit on the iPod business. Do you think there may be any cannibalization of iPad on iPod Touches, and specifically, can you comment on whether iPod Touch was a higher percentage of units sold, or actually if you sold-a higher percentage of units sold in Q3 versus Q2?

Tim Cook
Toni, our iPod ASPs were down about $7.00 sequentially, and that really was driven by the start of the back-to-school promotion, which we began in the month of June, and a stronger U.S. dollar. We did mix, on a year-over-year basis, up into iPod Touch, and I'm sorry, I don't have on a sequential basis the Touch mix in front of me.

Toni Sacconaghi
Thank you.

Keith Bachman, Bank of Montreal Capital Markets
Thank you. I had a couple as well. Peter, when the iPhone-when you're using your accrual accounting or the deferred accounting, rather, on the iPhone, the deferred balances indicated that margins went up over time. Would you anticipate that the iPad margins would increase as we move forward?

Peter Oppenheimer
Look, we were purposely aggressive when we launched the iPad because we absolutely believed we had a great product and we had a great first mover advantage. So we were aggressive coming out of the shoots. And as both Tim and I have commented, we are selling them as quickly as we can make them. I think it was a very, very good way to launch the product for us. We are always working to become more efficient and to ride down the cost curves, and I don't see that motivation being any different on the iPad than it is on our other products.

Keith Bachman
OK. A few to follow up. Peter, is there any comments that you could make on the impact of the bumpers? I know that you said you were incurring the costs in the September quarter. Is there any way to quantify, in terms of basis points or any other metric, that you can give us for the impact in the September quarter?

Peter Oppenheimer
Well, there are two impacts of this. The first is, we will need to defer revenue for the iPhone 4s that we sell where we have not delivered the bumpers, and where we have not heard from the customers wanting to place an order. And I expect the accrual that we'll need to make, which is a revenue accrual with no cost, to be about $175 million in the September quarter. And I would expect to have that be recorded as revenue in the December quarter. We will expense the cost of the bumpers when we ship them to customers, and our most important objective there is to take care of every customer and delight them.

Keith Bachman
OK. I guess the last question for me, then, is directed to Tim. Android-based shipments are certainly increasing and gaining a lot of press. I wondered if you guys could give any color about where you might be seeing Android as competition to the iPhone family in terms of geo or customer sets or any other color there? And that's my last question. Thank you.

Tim Cook
You know, I haven't seen the Android results for June since it's the sum of several companies' shipments. But iPhone sales were up 61% in the June quarter despite the inventory draw -- down in the transition that we spoke about. And that's against the IDC estimate of smartphone market growth of 38%. And so we're growing substantially faster than the market.

Keith Bachman
OK. Thanks very much.

Michael Abramsky, RBC Capital Markets
Thanks very much. Tim, do you think that there's been some sort of -- I think-questions around sustainability of iPad demand after early adopters in international channels fill, even with new product cycles, given the-You know, it's still a relatively new category. And I'm wondering what your thoughts are there. And also, given that there may be some competitive subsidized 3G tablets coming in the fall, how do you see that potentially impacting or not the iPad pricing strategy or demand? Thanks.

Tim Cook
Mike, the only thing I can share right now is that on iPad, we are absolutely selling every unit that we can make. And it looks good in every country that we have launched it in so far and we are excited about launching it in additional countries this coming weekend. Anecdotally, it does seem to me that it is beyond an early adopter stage already, as I indicated earlier, just based on watching the people that are using it. And so, it's the fastest that that has happened in any product I know of or have ever been involved with. 

So I think it's extremely unique and extremely special. In terms of what the competition does, I don't know what they will do and what they will try. It's no secret that everybody's trying to work on something to come out with it, but we're extremely happy with our competitive position. In the business model that we have, if you'll look at the U.S. as an example, since everybody can look at that model, where you have a very affordable rate structure that starts at $15.00 with no (inaudible) at all, and a very aggressive device price, that seems to be what the end user really desires. And so, yes, somebody could come in and jack the rate plans way up, and subsidize the-You know, I'm not so sure that people are really going to want another contract. But we'll see if somebody tries that move. We'll both learn. Right now, we're thrilled with our position.

Michael Abramsky
Thanks, Tim.

Charles Wolf, Needham & Company
Yes. In the past, iPhone software developers have complained, not about the App Store rules, but the fact that they were arbitrary. Has Apple done anything to address this issue?

Tim Cook
Charlie, I think that we are always looking to make our developers happy. We have over 225,000 apps on the store with over 5 billion downloads. We were thrilled to have very recently crossed $1 billion in payments to our developers, and we just launched iAd with, you know, the primary objective of developing another revenue stream for them. So we care deeply about our developers, and want to have many, many great apps for our iOS products. And the success that we've had on the store to date is unparalleled.

Peter Oppenheimer
Charlie, I would just add that the vast majority of apps are approved within seven days of their submission, and that many of the apps that aren't approved had bugs in them and are eventually resubmitted and approved. And we obviously -- I think all of us want to ensure that pornography and graphic scenes don't make their way to the platform. I think these are things that-I realize not 100% of everybody's going to agree, but I think many of us would want those to occur.

Charles Wolf
Well, just asking the question slightly differently, do you think the concern of developers is really misplaced?

Tim Cook
We value the input of every developer and very much listen to them and modify our programs accordingly when it's appropriate to do that. And so I'm not going to say every concern out there is misplaced. We are very open to any kind of feedback.

Charles Wolf
OK. Thanks, Tim.

Shaw Wu, Kaufman Brothers
Thanks. I have two questions. First, just on your desktop Mac business; normally it up sequentially from March to June. And I understand there's a secular trend toward portables. Is there anything else-any color you can share there that's occurring?

Tim Cook
Shaw, it's Tim. You have a little bit of yin and yang. When we announce new portables, you'll see a substantial mood portables. And when there's not a new desktop announcement at the same time. And so I think that's more of what we saw than anything else. But, yes, there's clearly a mood to mobility, and in the long, long, long, long grind, I think you'll see portables grow as a percentage of (inaudible) continually.

Shaw Wu
Thanks for the color. And second question is, just on stage time. You talked about how you wanted to turn that into an industry standard. Just wondering how you plan to roll that out. Will it be available on Windows? Will it be available -- I imagine, you know, today it's on the iPhone. What about on the Mac? Any color you can share there? Thanks.

Tim Cook
Shaw, I want to make sure that we get to all of the financial-related questions today, so I'm going to pump that one for another day.

Shaw Wu
OK. Thanks.

Katy Huberty, Morgan Stanley
Yes, thanks. Good afternoon. Tim, when Peter was walking through the iPhone business, he said the iPhone revenues and units were particularly strong in Asia, Europe, and Japan. We'd love your two cents as to why North America isn't on that list. Are we hitting the law of large numbers, or is there anything you can do to really reaccelerate the growth in the domestic market?

Tim Cook
I don't think we're hitting the law of large numbers. I think that the market over time will increasingly-the phone market will increasingly become a smartphone market. And you know, Steve said that long ago. And we've seen that that forecast has come true as the smartphone market continues to grow at multiples of the basic handset market that is shrinking. I think we have a lot of opportunity domestically and in the other parts of the Americas in that. I think Peter's comment was more that our growth as a company, whether you look at Mac, iPhone, or iPod, we're growing faster internationally than we are domestically. And you can see that in the revenues as well. However, I think you have to put that in perspective that the company's revenues in the Americas are growing over 40%, and so this is a huge number. We're not talking about a low number. It's just that the international numbers are absolutely killer.

Katy Huberty
Yep. And then just on a more global basis, a lot of the iPhone growth has come from broadening distribution among carriers and in new countries. Can you just cover the opportunity that you see or don't see to broaden within countries you're already in to go after emerging markets like China and India, and then just quickly thoughts on prepaid markets and whether that's an opportunity for you?

Tim Cook
Yeah, I think both on the Mac and the iPhone, and later the iPad, as we roll it out to more places, I think there's still extraordinary opportunity left. If you look at the Mac as an example, in Asia Pacific the Macs grew 73% year-over-year. This is phenomenal, that we could grow by this much. And in China, we grew 144%. In Korea, we grew 184%. In Hong Kong, we almost doubled. And even in a country like Spain, where the economy has clearly been very difficult, the Mac grew 59%. And so there's some very, very extraordinary numbers in that. In the iPhone space, we are doing well in basically all of the key markets. And so, in terms of expanding that, learning what we've learned with the exclusive deals and continuing to look market by market, as I've indicated in the past, we have elected to open Spain up, and at the end of this month we will go from an exclusive carrier market to having three carriers. And so that's one example. 

There are also more countries remaining, and frankly, there's still increased distribution and increased market penetration like enterprise and consumer and a general move in the marketplace from the basic voice-and-text phone to the smartphone, all of which are in the iPhone Saber. And so, honestly, I just see an enormous amount of opportunity out there. And our biggest challenge is to decide which of these to deploy resources against, not to have good ideas about which ones-about making the list of ideas.

Katy Huberty
OK. Thank you.

Mark Moskowitz, JPMorgan
Thank you. Two quick questions. Tim, just come on back to the iPad for a second. I know there's a lot of speculation about potential cannibalization down the road while it's still premature to speculate. I'm just trying to get a sense, could there actually be a reverse effect, where Apple maybe benefits from a halo effect where folks buy the iPad but then they also decide to buy some other Apple devices to keep at home when they're using the iPad on the road. On the early stages, has your data shown that, where you're seeing someone buy an iPad, and then there's a subsequent purchase of a MacBook or an iMac or an iPhone?

Tim Cook
That's a very good question, Mark. I do agree that I think most people external to Apple focus on cannibalization as a negative, when internally, we focused on exactly the opposite, as the synergy between both technically and from a demand point of view. If you look at the iPod historically, all of the people here felt that the iPod created a halo for the Mac, and in fact, as the iPod volumes took off, you will see a dramatic change in the Mac sales back in time that we experienced. And so could that happen on iPhone and iPad? You know, we'll see. I don't want to predict it, but I do think that with our Mac share-the Mac has outgrown the market 17 straight quarters. However, the Mac share is still low. And so there's still an enormous opportunity for the Mac to grow. And certainly, the more customers we can introduce to Apple through iPads and through iPhones and through iPods, you would think that there might be some synergy with the Mac there. And there may be synergy between the iPad and the iPhone as well, and so on and so forth. And so that's the way that we look at it internally instead of the negative, although I know everybody's more focused on the negative piece of it. You know, this is where it's great to be-to have a lower share, because if it turns out that the iPad cannibalizes PCs, then I think it's fantastic for us, because there's a lot of PCs to cannibalize. It's still a big market.

Mark Moskowitz
Thanks, Tim. And maybe I can shift gears to Peter real quickly. Peter, have you had a chance to kind of formulate what could be the scenario whereby some of the subcontractors that you work with -- that they do have to put through significant wage hikes over the next course of contract renewals over the next year or so? How would that impact Apple? Will you have to absorb any of those that kind of pass through on the wage hikes, or will those subcontractors have to absorb 100% of the wage hikes?

Tim Cook
This is Tim again. We don't want to get into the terms of our commercial agreements. We hold these to be competitive advantages and do not want to release those.

Mark Moskowitz
OK, that's fine. Thank you.

Chris Whitmore, Deutsche Bank
Thanks very much. Tim, earlier you mentioned there's a lot of opportunity domestically for the iPhone. Do you need to expand your carrier relationships to tap that, or do you think there's plenty of headroom with AT&T (NYSE: T)?

Tim Cook
You know, I don't want to get into what we will or will not do. I would say that we're very happy to be a partner with AT&T, and you know, they've been a first-class partner and have really pioneered the smartphone growth from a network point of view in the U.S. And that's all I have to say about that.

Chris Whitmore
OK. Secondly, on the gross margin guidance, the back of the envelope seems to suggest iPhone margins will be down maybe 10 or 15 points, quarter-on-quarter. Is that in the right neighborhood? And if so, can you provide a little more color on which components are driving that? It seems to contradict third-party data around the building material costs for that product.

Peter Oppenheimer
Sure. Chris, it's Peter. Let me begin by suggesting that you don't put a lot of credence in these third-party reports that you see. It's always amazing to me the cost categories and the components that never seem to make it into the reports. And as I, I think, answered in Toni's question, look, with the iPhone 4, we have been very aggressive here. This is the best iPhone that we have ever shipped. We're delivering great value to customers. And it has a higher cost structure than its predecessor product. And I don't want to comment on its specific gross margin.

Chris Whitmore
Last question for me. Back to you, Tim. Just trying to ballpark the size of the supply demand gap for the iPhone and the iPad. Again, back to the envelope. Are we talking about a couple million iPhone units short of demand, and maybe half a million iPads short of demand? Is that the kind of gap we're talking about?

Tim Cook
I don't know. That question is very difficult to answer because the way that you truly find out what it is, at least from my own experience and perspective is, you have enough supply to serve the demand, and then you know what the demand is. And today we don't have enough of either iPhone 4 or iPad, and so I truly don't know. Obviously we have taken bets internally in terms of the capacities that we're going for, and we've rolled those into the guidance. And I think you can get from the guidance that I think it's extremely strong that we're pretty confident with being able to pick up the supply.

Chris Whitmore
Thanks a lot.

Nancy Paxton
Thank you, Chris. Thanks again for joining us.