Apple Q4 Earnings Call Transcript

123jump.com Staff
27 Oct, 2010
New York City

The PC maker revenue surged 67% to $20.34 billion in the quarter. Net quarterly profit soared 70% to $4.31 billion driven by strong sales of Macintosh computers, iPhones and iPad multimedia devices. Earnings rose to $4.64 per diluted share versus $2.77 per diluted share, in the year-ago quarter.

Apple Inc. ((AAPL))
Q4 2010 Earnings Call Transcript
October 18, 2010 5:00 p.m. ET

Executives

Nancy Paxton – Senior Director, Investor Relations and Corporate Finance
Peter Oppenheimer – Senior Vice President and Chief Financial Officer
Steven P. Jobs – Chief Executive Officer
Timothy D. Cook – Chief Operating Officer

Analysts

Richard Gardner – Citigroup
Gene Munster – Piper Jaffray
Michael Abramsky – RBC Capital Markets
Benjamin Reitzes – Barclays Capital
Kathryn Huberty – Morgan Stanley
Toni Sacconaghi – Sanford C. Bernstein
Shannon Cross – Cross Research
Christopher Whitmore – Deutsche Bank

Presentation

Operator

Good day, everyone. Welcome to this Apple Incorporated Fourth Quarter Fiscal Year 2010 Earnings Release. 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

Thank you. Good afternoon and thanks to everyone for joining us. 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 revenues, gross margin, operating expenses, other income and expense, stock-based compensation expense, taxes, earnings per share and future products. Actual results or trends could differ materially from our forecast.

For more information, please refer to the risk factors discussed in Apple''s Form 10-K for 2009 as amended, the Forms 10-Q for the first three quarters of fiscal 2010 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 date.

And with that, I''d like to turn the call over to Apple''s CFO, Peter Oppenheimer, for introductory remarks.

Peter Oppenheimer

Thank you, Nancy. Thank you for joining us. We''re extremely pleased to report the conclusion of a great fiscal year for Apple with outstanding results for the September quarter. Our innovative product line up is the best ever and customer response has been tremendous. As a result, we set new all-time records for Mac, iPhone and iPad sales in the September quarter. And we are thrilled to report the highest quarterly revenue and earnings in Apple''s history.

Revenue for the quarter was $20.34 billion, an increase of more than $8.1 billion over the prior September quarter''s results, representing growth of 67%. The very strong growth was fueled primarily by record iPhone sales, the tremendous popularity of iPad and our best Mac quarter ever. Operating margin was $5.45 billion, representing 26.8% of revenue.

Net income was $4.31 billion, which exceeded our previous quarterly earnings record by $930 million and represented 70% growth over the year-ago quarter''s earnings. These results translated to earnings per share of $4.64.

Turning to the details of the quarter, I''d like to begin with our Mac products and services. We set a new quarterly record with sales of almost 3.9 million Macs, exceeding the previous record established in the June quarter by over 400,000. This represents 27% year-over-year growth, more than double IDC''s latest published estimate of 11% growth for the market overall in the September quarter.

We experienced strong double-digit growth in both Mac desktop and portable categories, lead by very strong sales of iMac, which was updated in July and the continued popularity of the MacBook Pro and MacBook. Mac growth was strong in each of our geographic segments, lead by Asia Pacific at 56% year-over-year and Japan at 49%. We began and ended the quarter with between three and four weeks of Mac channel inventory.

Moving to our music products, we sold nearly 9.1 million iPods compared to 10.2 million in the year-ago quarter. In September, we announced a great new line up of iPods for the holiday season, including our redesigned iPod shuffle featuring clickable buttons, the re-invented iPod nano with multitouch and the new iPod touch with retina display and FaceTime video calling.

iPod''s share of the U.S. market for MP 3 players remains over 70%, based on the latest monthly data published by NPD. iPod also continued to be the top-selling MP3 player and to gain share internationally in year-over-year in most of the countries we track, based on the latest data we publish by GFK. We remain within our target range of four to six weeks of iPod channel inventory on a look-back basis.

The iTunes store also had another strong quarter with revenue over $1 billion. In September, we launched iTunes 10, including a number of new features such as $0.99 TV rentals, Airplay wireless music playback and PING, which offers social music discovery to millions of iTunes users in 23 countries. We also introduced the new Apple TV, which provides a simple way to watch movies and TV shows on your HDTV for the breakthrough price of just $99.

I''d now like to turn to iPhone. We were extremely pleased to have sold 14.1 million iPhones compared to just under 7.4 million in the previous September quarter. This represents 91% year-over-year growth and is well ahead of IDC''s latest published estimate of 64% growth for the global SmartPhone market overall in the September quarter.

Recognized revenue from iPhone handset and accessory sales was $8.82 billion during the quarter, compared with $4.61 billion in the year-ago quarter, an increase of 92%. The sales value of iPhones alone was about $8.6 billion, which yields an ASP of about $610.

At the end of the September quarter, we had iPhone distribution through 166 carriers in 89 countries. We continued to experience very strong year-over-year growth, particularly in Asia, Europe and Japan, where iPhone sales more than doubled year-over-year.

We were very happy to be shipping iPhone 4 in China as of the last day of the September quarter. And we''ve been very pleased with customer response to date.

Last month, JD Power & Associates announced for the fourth consecutive time, Apple ranked highest in its survey of customer satisfaction among manufactures of SmartPhones, citing particularly strong performance and ease of operation, operating system, features and physical design. Adoption of iPhone within the enterprise continues to accelerate; in fact, since we''ve shipped iPhone 4, we''ve seen extraordinary growth from 60% to more than 80% of Fortune 500 companies deploying or piloting iPhone.

Enterprise CIOs continue to add iPhone to their approved device list worldwide. Most recently, Fortune 500 companies like Proctor & Gamble, General Electric, Pfizer, Allstate and Cardinal Health and global 500 accounts such as Aviva Group, Total, Novartis, Roche and Sanofi-Aventis have made iPhone available to their employees.

We ended the quarter with about 3.3 million iPhones in channel inventory, a sequential increase of about 825,000, to support the launch of iPhone 4. We continue to have a sizeable backlog and believe we could have sold even more iPhones if we had been able to supply them.

Turning to iPad, we''re thrilled with its momentum. In just the second quarter of availability, we sold almost 4.2 million iPads with distribution in 26 countries by the end of the September quarter. We''re seeing great enthusiasm for iPad from consumers, educators and businesses. Enterprise CIOs are adding iPad to their approved device list at an impressive rate.

Since the launch of iPad, over 65% of the Fortune 100 are already deploying or piloting iPad. Some recent examples of companies approving iPad include Proctor & Gamble, Lowe''s, Hyatt, NBC Universal and Novartis. Recognized revenue from sales of iPad and iPad Accessories during the quarter was $2.8 billion. The sales value of iPads alone was about $2.7 billion, which yields an ASP of about $645.

We were able to increase the supply of iPads over the course of the quarter, building channel inventory by about 500,000 units to end the quarter with between three and four weeks of channel inventory, below our target range of four to six weeks. We are expanding U.S. iPad distribution to include Wal-Mart, Target, Verizon and AT&T stores. We are also expanding distribution internationally.

Combining iPhone, iPad and iPod touch, we surpassed cumulative iOS device sales of 125 million last month. During the September quarter, we released iOS4.1. which builds on the innovations of iOS4, bringing FaceTime video calling, multitasking, folders and game center to iPod touch in addition to iPhone customers. And in November, we plan to release iOS4.2, which will bring many of the great new features of iOS4 to iPad.

iOS4.2 will also include AirPrint, Apple''s new printing architecture that automatically finds printers on local networks and enables printing from iOS devices over Wi-Fi without the need to install drivers or download software. The App store continues to be an unparalleled success. There are now over 200,000 registered iOS developers that continue to bring outstanding and creating new Apps to the iOS platform, including over 65,000 game and entertainment titles and over 30,000 Apps designed specifically for iPad.

And we launched iAd in July, which provides marketers with the ability to place interactive ads in popular Apps for iPhone, iPod touch and iPad. We were very happy with the results so far. Customers are loving the media rich ads and marketers are very pleased with viewer engagement.

I''d now like to turn to the Apple retail stores, which had a record-breaking quarter. Retail revenue was $3.57 billion compared to $2.04 billion in the year-ago quarter, an increase of 75%. Our stores sold a record 874,000 Macs compared to 670,000 Macs in the year-ago quarter, an increase of 30%. About half the Macs sold in our stores during the September quarter were to customers who had never owned a Mac before.

We opened 24 stores during the September quarter, 16 of which were outside the United States, including spectacular stores in Beijing, Shanghai, London and Paris. Our new Beijing and Shanghai stores opened on the last day of the quarter and first day sales from those stores exceeded all previous store openings. Our four China stores are our highest traffic stores in the world and are among our highest performing.

We also entered our 11th country, with the opening of stores in Barcelona and Madrid. That brings us to a total of 317 stores worldwide as of the end of the quarter, with 84 of them outside the United States. With an average of 301 stores open during the September quarter, average revenue per store was $11.8 million compared to $7.8 million in the year-ago quarter, an increase of 52%.

Retail segment margin was $917 million compared to $564 million in the year-ago quarter. We hosted a record 74.5 million visitors in our stores during the quarter compared to 45.9 million visitors in the year-ago quarter, an increase of 62%.

As we look ahead to fiscal 2011, we see great opportunity to continue our retail growth with our focus on international expansion. In total, we expect to open 40 to 50 stores in our fiscal 2011 with over 50% of them outside the United States.

We will also begin replacing several stores in the United States to get them right sized for Apple''s current product line and to meet our service goals. Total company gross margin was 36.9%, which was 190 basis points above our guidance. About two-thirds of this favorability was driven by lower commodity and other costs and the remainder was mostly attributable to a better than planned mix of iPhone sales.

Operating expenses were $2.07 billion and included$ 185 million of stock-based compensation expense. OI&E was $14 million, and the tax rate for the quarter was 21%, about five points below our guidance, largely a result of two factors.

First, we had a higher mix of foreign earnings than we planned. Second, we had some discrete one-time tax benefits in the quarter as well. Our tax rate for fiscal 2010 was about 24.5%.

Turning to cash. Our cash plus short-term and long-term marketable securities totaled $51 billion at the end of the September quarter compared to $45.8 billion at the end of the June quarter, an increase of $5.2 billion. Cash flow from operations was $5.7 billion.

The September quarter was the culmination of a monumental year for Apple. In fiscal 2010, we launched several new Macs establishing record sales of over $13.6 million and achieving 31% year-over-year sales growth, significantly outpacing the growth of the overall PC market.

We introduced the tremendously popular iPhone 4 with breakthrough features, including FaceTime and retina display, fueling full year sales of 40 million iPhones, an increase of 93% over fiscal 2009. We launched a groundbreaking iPad, selling nearly 7.5 million to delighted customers in two quarters alone.

We also brought great new features to iOS and iTunes and continued to innovate with completely new designs for iPod. And as a result, we generated record revenue of over $65 billion, an increase of over $22 billion year-over-year or 52%. Earnings of $14 billion grew even faster at 70% year-over-year. To put this growth into perspective, in fiscal 2010, Apple generated almost five times the revenue in more than 10 times the earnings it did just five years earlier in fiscal 2005.

As we move ahead into the December quarter, I''d like to review our outlook, which includes the types of forward-looking information that Nancy referred to at the beginning of the call. We expect revenue to be about $23 billion compared to $15.7 billion in the December quarter last year. We expect gross margins to be about 36%, reflecting approximately $52 million related to stock-based compensation expense.

We expect OpEx to be about $2.325 billion, including about $250 million related to stock based compensation. We expect OI&E to be about $65 million and we expect the tax rate to be about 25.5%. We are targeting EPS of about $4.80.

In closing, we''re thrilled with our record September quarter and fiscal year 2010 results. We''re very enthusiastic about our innovative product lineup and our significant opportunities for growth as we head into fiscal 2011. And we remain extremely confident in our new product pipeline.

Before taking your questions, I would like to turn the call over to our CEO, Steve Jobs.

Steven P. Jobs

Thanks, Peter. Hi, everybody. As most of you know, I don''t usually participate in Apple''s earnings calls, since you are all in such capable hands with Peter and Tim. But I just couldn''t help dropping by for our first $20 billion quarter, I''d like to chat about a few things and then stay for the rest of the Q&A if that''s all right.

First, let me discuss iPhone. We sold 14.1 million iPhones in the quarter, which represents a 91% unit growth over the year-ago quarter and was well ahead of IDC''s latest published estimate of 64% growth for the global SmartPhone market in the September quarter. And it handily beats RIM''s 12.1 million BlackBerrys sold in their most recent quarter, ending in August.

We''ve now passed RIM. And I don''t see them catching up with us in the foreseeable future. They must move beyond their area of strength and comfort into the unfamiliar territory of trying to become a software platform company. I think it''s going to be a challenge for them to create a competitive platform and to convince developers to create apps for yet a third software platform after iOS and Android.

With 300,000 Apps on Apple''s App Store, RIM has a high mountain ahead of them to climb. What about Google? Last week, Eric Schmidt reiterated that they are activating 200,000 Android devices per day and have around 90,000 Apps in their App Store. For comparison, Apple has activated around 275,000 iOS devices per day on average for the past 30 days, with a peak of almost 300,000 iOS devices per day on a few of those days. And Apple has 300,000 Apps on its App Store.

Unfortunately, there is no solid data on how many Android phones are shipped each quarter. We hope that manufactures will soon start reporting the number of Android handsets they ship each quarter. But today, that just isn''t the case. Gartner reported that around 10 million Android phones were shipped in the June quarter and we a wait to see if iPhone or Android was the winner in this most recent quarter.

Google loves to characterize Android as open and iOS and iPhone as closed. We find this a bit disingenuous and clouding the real difference between our two approaches. The first thing most of us think about when we hear the word open is Windows, which is available on a variety of devices.

Unlike Windows, however, where most PCs have the same user interface and run the same Apps, Android is very fragmented. Many Android OEMs, including the two largest, HTC and Motorola, install proprietary user interfaces to differentiate themselves from the commodity Android experience. The users will have to figure it all out. Compare this with iPhone, where every handset works the same.

A Twitter client, Twitter Deck recently launched their App for Android. They reported that they had to contend with more than 100 different versions of Android software on 244 different handsets. The multiple hardware and software iterations presents developers with a daunting challenge. Many Android Apps only work on selected Android handsets running selected Android versions. And this is for handsets that have been shipped less than 12 months ago.

Compare this with iPhone, where there are two versions of the software, the current and the most recent predecessor to test against. In addition to Google''s own App marketplace, Amazon, Verizon and Vodafone have all announced that they are creating their own App stores for Android. So there will be at least four App stores on Android, which customers must search among to find the App they want and developers will need to work with to distribute their Apps and get paid.

This is going to be a mess for both users and developers. Contrast this with Apple''s integrated App Store, which offers users the easiest to use, largest App Store in the world, pre-loaded on every iPhone. Apple''s App store has over three times as many Apps as Google''s marketplace and offers developers one stop shopping to get their Apps to market easily and to get paid swiftly.

Even if Google were right and the real issue is closed versus open, it is worthwhile to remember that open systems don''t always win. Take Microsoft''s Plays for Sure music strategy, which use the PC model, which Android uses as well, of separating the software components from the hardware components. Even Microsoft finally abandoned this open strategy in favor of copying Apple''s integrated approach, with their Zune Player, unfortunately, leaving their OEMs empty handed in the process.

Google flirted with this integrated approach with their Nexus One phone. In reality, we think the open versus closed argument is just a smoke screen to try and hide the real issue which is what''s best for the customer, fragmented versus integrated. We think Android is very fragmented and becoming more fragmented by the day. And as you know, Apple strives for the integrated model so that the user isn''t forced to be the systems integrator.

We see tremendous value in having Apple rather than our users be the systems integrator. We think this is a huge strength of our approach compared to Google''s, when selling to users who want their devices to just work, we believe integrated will trump fragmented every time. And we also think our developers can be more innovative if they can target a singular platform rather than 100 variants. They can put their time into innovative new features rather than testing on hundreds of different handsets.

So we are very committed to the integrated approach, no matter how many times Google tries to characterize it as closed. And we are confident that it will triumph over Google''s fragmented approach, no matter how many times Google tries to characterize it as open.

Second, I''d like to comment on the avalanche of tablets poised to enter the market in the coming months. First, it appears to be just a handful of credible entrants, not exactly an avalanche. Second, almost all of them use seven-inch screens, as compared to iPad''s near 10-inch screen. Let''s start there.

One naturally thinks that a seven-inch screen would offer 70% of the benefits of a 10-inch screen. Unfortunately, this is far from the truth. The screen measurements are diagonal, so that a seven-inch screen is only 45% as large as iPad''s 10-inch screen. You heard me right, just 45% as large.

If you take an iPad and hold it up right in portrait view and draw an imaginary horizontal line half way down the screen, the screens on the seven-inch tablets are a bit smaller than the bottom half of the iPad''s display. This size isn''t sufficient to create great tablet Apps, in our opinion.

While one could increase the resolution of the display to make up for some of the difference, it is meaningless unless your tablet also includes sandpaper, so that the user can sand down their fingers to around one quarter of their present size. Apple has done extensive user testing on touch interfaces over many years and we really understand this stuff.

There are clear limits of how close you can physically place elements on a touch screen before users cannot reliably tap, flick or pinch them. This is one of the key reasons we think the 10-inch screen size is the minimum size required to create great tablet Apps.

Third, every tablet user is also a SmartPhone user. No tablet can compete with the mobility of a SmartPhone. Its ease of fitting into your pocket or purse, its unobtrusiveness when used in a crowd. Given that all tablet users will already have a SmartPhone in their pockets, giving up precious display area to fit a tablet in our pockets is clearly the wrong tradeoff. The seven-inch tablets are tweeners, too big to compete with a SmartPhone and too small to compete with an iPad.

Fourth, almost all of these new tablets use Android software, but even Google is telling the tablet manufactures not to use their current release, Froyo, for tablets and to wait for a special tablet release next year. What does it mean when your software supplier says not to use their software in your tablet and what does it mean when you ignore them and use it anyway?

Fifth. iPad now has over 35,000 Apps on the App store. This new crop of tablets will have near zero. And sixth and last, our potential competitors are having a tough time coming close to iPad''s pricing even with their far smaller, far less expensive screens.

The iPad incorporates everything we''ve learned about building high value products from iPhones, iPods and Macs. We create our own A4 chip, our own software, our own battery chemistry, our own enclosure, our own everything. And this results in an incredible product at a great price. The proof of this will be in the pricing of our competitors'' products which will likely offer less for more.

These are among the reasons we think the current crop of seven-inch tablets are going to be DOA, dead on arrival. Their manufactures will learn the painful lesson that their tablets are too small and increase the size next year, thereby abandoning both customers and developers who jumped on the seven-inch bandwagon with an orphan product. Sounds like lots of fun ahead.

So thank you and let me turn it back to Peter for the Q&A session.

Peter Oppenheimer

Great.

Nancy Paxton

We''re ready to open the call to questions now, please.

Question-and-Answer Session

Operator

Ladies and gentlemen, the question-and-answer session will be conducted electronically. If you’d like to ask a question, you may do so by pressing the star key followed by the digit one on your touchtone telephone. If you are using a speakerphone, please release your mute function to allow your signal to reach our equipment. Once again that is star one. And your first question will come from Richard Gardner with Citi.

Richard Gardner – Citigroup

Okay. Great. Thank you. I had two quick ones if I could. One is supply constraints on iPad. Could you talk about how severe the supply constraints are on that product and how quickly you expect them to improve? And then a follow-up for Peter on gross margin please.

Timothy D. Cook

Hi, Rich, it''s Tim. Relative to iPad supply/demand, we got into a balance situation in September with the limited number of distribution points in the 26 countries where we sold the iPad. And so we exited the quarter in a supply position that allows us to expand distribution prior to the holidays as we plan for some time. And hopefully you''ve seen some of the recent announcements of added partners in the United States. We are also expanding internationally and will be launching additional countries as the quarter goes on.

Richard Gardner – Citigroup

Okay. Great. And then Peter, you mentioned several sequential tailwinds for gross margin during the September quarter. Could you talk about the headwinds in the quarter and what impact they had on gross margins sequentially, please?

Peter Oppenheimer

I''m sorry, Rich, for the September quarter?

Richard Gardner – Citigroup

For the September quarter, yes.

Peter Oppenheimer

Well, in our last conference call, yes, we talked about several things that we thought would cause margins to come down some. And all those things did play out, but margins came down actually about half of what we thought that they would. And we did a bit better in the quarter because commodity and other costs were better than we thought and we sold more iPhones than we had planned to.

Richard Gardner – Citigroup

All right. Well, thank you and Steve, good to have you on the call. Thanks for joining.

Steven P. Jobs

Sure. Thank you.

Nancy Paxton

Thanks, Rich. Could we have the next question please?

Operator

From Piper Jaffrey, we''ll hear from Gene Munster.

Gene Munster – Piper Jaffray

Good afternoon and congratulations. And I''ll start with Steve, if you could talk a little bit about the iPad opportunity, you went through and give us some good insight in terms of the competitive landscape. But as analysts we''re here trying to put some estimates out there and we''re not doing a great job of trying to figure out this trajectory in the iPad. Can you help us understand how you think about the business a year, two years down the road in terms of size of your overall business impact on enterprise, education, anything you can give to help us on that front and then a follow-up question?

Steven P. Jobs

Well, the iPad is clearly going to affect notebook computers. And I think the iPad proves it''s not a question of if, it''s a question of when. And there''s a lot of I think development and progress that will occur over the next few years but we''re already seeing tremendous interest in iPad from education and much to my surprise, from business. We haven''t pushed it real hard in business. And it''s being grabbed out of our hands and I talk to people every day in business in all kinds of businesses, that are using iPads all the way from Boards of Directors that are shipping iPads around instead of board books down to nurses and doctors in hospitals and other large and small businesses.

So the more time that passes, the more I am convinced that we''ve got a tiger by the tail here. And this is a new model of computing, which we''ve already got tens of millions of people trained on, with the iPhone, and that lends itself to lots of different aspects of life, both personal, educational and business. So I see it as very general purpose, and I see it as really big. And the timing, one could argue about the timing endlessly, but I don''t think one could argue that it''s going to happen anyhow.

Gene Munster – Piper Jaffray

Do you think this could be your second biggest business with iPhone?

Steven P. Jobs

I try to not predict. I try to just report, so we''ll keep you posted.

Gene Munster – Piper Jaffray

Okay. Just a quick follow-up, Steve.

Steven P. Jobs

As you know, we''re already shipping more of them than Macs, after just a few quarters.

Gene Munster – Piper Jaffray

And on the flash side any update on your stance on Flash?

Steven P. Jobs

Flash memory, we love Flash memory.

Gene Munster – Piper Jaffray

Okay. Peter, just one quick question. Our tracks were you had about three weeks lead time in most of your countries on the iPhone throughout the quarter. You mentioned you could have sold more iPhones. How do you think about what the true demand could have been from the quarter?

Timothy D. Cook

Gene, it''s Tim. I think the three weeks you''re referring to is the quote that''s on the Apple Online store. What I would say, is that the demand in all countries is absolutely staggering. And at this point, I can''t predict when supply will meet demand. I feel great about our ability to move the supply and the sales up from an 8 million kind of number to over 14 but it''s clear last quarter that wasn''t enough. And we''re obviously working on that but it will take some time to increase further.

Gene Munster – Piper Jaffray

Were you more supply constrained in the September quarter versus the June quarter, I know totally different dynamics in the quarter, but any perspective on the two quarters?

Timothy D. Cook

It''s clear that the iPhone 4 and the announcement of iPhone 4 and the demand for it took the demand to an entirely different level. And we had anticipated a very different level but it''s even higher than that.

Gene Munster – Piper Jaffray

Great. Thank you.

Nancy Paxton

Thanks, Gene. Could we have the next question, please?

Operator

From RBC Capital Markets, we''ll go to Mike Abramsky.

Michael Abramsky – RBC Capital Markets

Yes. Thanks for taking my question. Steve, appreciate your commentary. You are the tablet market right now and this is, I think, the second time now you''ve come on to talk about or certainly from one-time during your presentation to talk about competition. And I''m just wondering if much like Apple encroaching on RIM''s monopoly in enterprise, if you think Apple is going to be able to sustain share growth for tablets, amid some of those new competitive headwinds. Some of those players may try different things and strategies like tethering and Flash, multi-tasking, less constrictive App restrictions and subsidized pricing, and just wondered, if you think that may create itself a more fragmented market or how you see that rolling out with regard to Apple?

Steven P. Jobs

I have a hard time envisioning what those strategies you mentioned are. I mean, in terms of pricing, so far the little we''ve seen the tablets with far less functionality are having a hard time matching us in price. Flash hasn''t presented any problem at all. As you know, most of the video on the web is available in HTML 5 and having the iTunes media store and over 35,000 Apps on the App Store for iPad dwarfs anything else. And we think we have a very good product here that''s going to be hard to match and we''re not done. We''re working on a lot of things here for the future. So I don''t know exactly what these strategies are and we''ve priced iPad pretty aggressively. So we''re out to win this one.

Michael Abramsky – RBC Capital Markets

Okay. Thank you and just lastly, SmartPhones, do you see that as a zero sum game?

Steven P. Jobs

Well, as you know, the largest market of phones today around the world are non-SmartPhones. And so over the next several years, those non-SmartPhones, many of those non-SmartPhones are going to convert to SmartPhones and the pie is going to continue to grow. And I think there will be room for some number of companies to be successful, but eventually as most of those phones do convert to SmartPhones, it will turn into a zero sum game or at least a lot closer to that. But I think right now it''s a battle for developers and battle for the mind share of developers and battle for the mind share of customers and right now iPhone and Android are winning that battle.

Michael Abramsky – RBC Capital Markets

Thanks very much, Steve.

Nancy Paxton

Thanks, Mike. Could we have the next question please?

Operator

Benjamin Reitzes with Barclays Capital.

Benjamin Reitzes – Barclays Capital

Yeah. Good afternoon. Thanks a lot. First, for Peter, can you just talk a little bit about what gross margins, you have gross margins guidance of 36, with component prices still favorable and probably more iPhones being sold sequentially. Could you talk about why margins would go down sequentially? It would seem also that you released the revenue on the bumper program? And then I have a follow-up for Steve.

Peter Oppenheimer

Sure. Well Ben in providing our guidance we thought about each of those factors you cited and we do see a small sequential decline. This is being primarily driven by a expected mix of new iPods that we''ve just recently announced and more iPad sales in which, as Steve said, we''ve been very aggressive with that with our pricing and are delivering great value to customers. So it''s the higher mix of those on a sequential basis that I see impacting the gross margin slightly.

Benjamin Reitzes – Barclays Capital

Okay. And then Steve, can you just comment on how your hobby is going, Apple TV, and also maybe working, you took the hard drive out of there and it seems like Apple is moving more to a streaming model for potentially a lot of other things. And I was just wondering what your thoughts were for the Apple TV, maybe that kind of business model proliferating into more products, but I was wondering how Apple TV is going and maybe what you thought going forward.

Steven P. Jobs

Well, we don''t talk about unannounced products but I''m happy to tell you what I know about Apple TV. We have gone through streaming model on Apple TV. It''s complete streaming. So all of the content is rented from the iTunes store or is streamed from your computer or soon to be streamed from your iPhone or iPad with AirPlay. And so how is our new model of Apple TV doing?

Well, I can report that in just a very short amount of time, we''ve already sold a quarter million of them, over 250,000. And we''re thrilled with that. I think that it''s a great product and I think that its $99 price point is very enticing. And I think when we get the AirPlay stuff in place before the end of this year, it''s going to give another big reason for people to buy it. So we''re really happy with how its turned out.

Benjamin Reitzes – Barclays Capital

Great. Thanks so much.

Nancy Paxton

Thanks, Ben. Could we have the next question please?

Operator

That will come from Katy Huberty with Morgan Stanley.

Kathryn Huberty – Morgan Stanley

Yes. Thanks. First for Peter. How much of the sequential decline in gross margin related to the iPhone in the September quarter and in particularly the bumper program?

Peter Oppenheimer

Katy, we recorded a revenue deferral of just over $100 million in the September quarter for the bumper program. We would expect to record that in revenue in the December quarter. We did ship a number of bumpers in the September quarter and that is reflected in our gross margin, as is the number that we expect to ship in the December quarter, that''s reflected in our guidance as well.

Kathryn Huberty – Morgan Stanley

And just to be clear, is the iPhone the product segment that dropped the most sequentially as it relates to the gross margins? I guess, people are just asking what drove the sequential downtick which we haven''t seen for some time.

Peter Oppenheimer

You mean in the September quarter?

Kathryn Huberty – Morgan Stanley

Yeah, in the September quarter.

Peter Oppenheimer

Well again, this was not a surprise to us and we on our last conference call highlighted that we would have a higher mix of iPhone 4 sales. And we were very aggressive with feature function there. So it had a different gross margin than its predecessor product. We also sold more iPads. Again, we were very aggressive there with our pricing. And we had the bumper program and some one time items that occurred in June that we said wouldn''t occur in September.

So these were sort of the factors we saw bringing down gross margin. And to some extent, each of them did occur in the September quarter, but we ended up doing 50% better than we thought as a result of the commodity market and selling more iPhones.

Kathryn Huberty – Morgan Stanley

Got it. And then Steve, just as a follow-up, it seems like you fundamentally believe that Apple should be able to out ship Android if you add up all of the Mobile Devices over time. What are the key risks you''re managing the company to make sure you don''t lose that lead, whether it''s distribution or pricing or feature set. What do you think the biggest risks are that you need to watch carefully?

Steven P. Jobs

Well, our goal is to make the best devices in the world. It''s not to be the biggest. As you know, Nokia is the biggest. And we admire them for being able to ship the number of handsets that they do, but we don''t aspire to be like them. They are good at being like them. We want to be like us and we want to make the best ones. So in our part of the market, Android is our biggest competitor. They outshipped us in the June quarter as we were transitioning to iPhone 4. They outshipped us for the first time and according to Gartner''s numbers, which we think are pretty accurate.

And so we''re waiting to find out what happened in this quarter. And if they -- we''ll find out -- I don''t know how we''ll find out but Gartner will put out some numbers and maybe others will and so one of these days we''ll eventually learn. And I imagine we''ll be competing with them for quite some time but we have very different approaches. And we believe in our approach very strongly as providing users a product that just works. And we think there''s lots of users that want that in the world. And their approach is very different than that. And there may be lots of users that want their approach as well, but we''re going to pursue ours and we think that''s the winning approach in the end.

Kathryn Huberty – Morgan Stanley

Thanks.

Nancy Paxton

Thank you, Katy. Could we have the next question please?

Operator

It will come from Toni Sacconaghi with Sanford Bernstein.

Toni Sacconaghi – Sanford C. Bernstein

Yes. Thank you. I guess this is for both Steve and Tim. I wanted to just better understand your aspirations for iPhone and iPad. Tim, I think I''ve heard you say look, we think about the Mac business as being one where we make the best products but we''re competing against kind of a strong incumbent power and Microsoft. And we don''t aspire to have high market share and your iPod business it was kind of the opposite. You had very high volume, you drove price points down to entry points in the marketplace and you have more than 50% market share globally.

I think when we''ve talked about it in the past, you''ve actually said you viewed the iPhone business as being more akin to the iPod business in terms of your aspirations. Steve, it sounded like that wasn''t really consistent with what you said. You said very clearly we don''t want to be Nokia. We just want to make good phones. So perhaps you can help me better understand how we should think about your aspiration for both the iPhone and the iPad.

Steve, you also made a comment about seven-inch screens aren''t going to cut it and implying that you''re not going to go down to those lower price points. Is your aspiration for iPhone and iPad to be volume players and market leaders or is it simply to make good products and if you have smaller share like you do in Mac, that''s fine. Can you help me with that please?

Steven P. Jobs

Sure. And I''ll let Tim say what he''s going to say too. First of all, Nokia makes $50 handsets and we don''t know how to make a great SmartPhone for $50. We aren''t smart enough to figure that one out yet, but believe me, I''ll let you know when we do. And so our goal is to make really breakthrough great products, make the best products in every industry that we compete in and to drive the costs down, while constantly making the products better at the same time.

That''s what we did with iPod. We updated our products many times every year with better functionality, often times at the same price and sometimes at a lower price. And it was the relentless improvement, at in some cases, a lower price, that was able to beat our competition and yield the market share that it did. And as you know, we have a very low market share in the phone market in the single digits, in terms of all the handsets. And we have a very high market share now in tablets, because we''re the first mover, but we don''t think about it that way.

The reason we wouldn''t make a seven-inch tablet isn''t because we don''t want to hit a price point. It''s because we don''t think you can make a great tablet with a seven-inch screen. We think it''s too small to express the software that people want to put on these things. And we think as a software-driven company, we think about the software strategies first. And we know that software developers aren''t going to -- they are not going to deal really well with all these different size products when they have to redo their software every time a screen size changes. And they aren''t going to deal well with products where they can''t put enough elements on the screen to build the kind of Apps they want to build.

So when we make decisions on seven-inch tablets, it''s not about cost. It''s about the value of the product when you factor in the software. You see what I''m getting at? So we''re all about making the best products at aggressive prices and that''s what we will do and that''s what we''ve done with the iPod and that''s what we will do with the iPad as well.

Toni Sacconaghi – Sanford C. Bernstein

Tim, maybe you want to comment. If I could push you on that, Steve. So if the market starts to move towards somewhat lower functionality SmartPhones in that migration of non-SmartPhones to SmartPhones that you talked about. If you market starts to move to dramatically lower price points and you feel you can''t make an appropriate product that is good at those price points, you will cede share under those circumstances, do I understand it correctly?

Steven P. Jobs

See, you''re looking at it wrong. You''re looking at it as a hardware person in a fragmented world. You are looking at it as a hardware manufacture that doesn''t really know much about software, who doesn''t think about an integrated product but assumes the software will somehow take care of itself. And you''re sitting around saying well, how can we make this cheaper? Well, we can put a smaller screen on it and a slower processor and less memory and you assume that the software will somehow just come alive on this product that you''re dreaming of.

But it won''t, because these App developers have taken advantage of the products that came before with faster processors, with larger screens, with more capabilities that they can take advantage of to make better Apps for customers. And they aren''t, it''s a hard one because it throws you right back into the beginning of that chicken and egg problem again, to change all of the assumptions on those developers. Most of them will not follow you.

Most of them will say, I''m sorry but I''m not going to go back and write a watered down version of my App just because you''ve got this phone that you can sell for $50 less and you''re begging me to write software for it.

Toni Sacconaghi – Sanford C. Bernstein

Okay. One more if I may, please, Steve. You now have more than $50 billion in cash, you''re generating more than $20 billion a year in cash, it rests very comfortable on your balance sheet earning less than 1% interest. What is your aspiration for that cash and why are you not more open to returning some of that cash to shareholders in the form of buybacks or dividends?

Steven P. Jobs

You know, of course, that''s been suggested to us. We strongly believe that one or more very strategic opportunities may come along, that we can take, that we''re in a unique position to take advantage of, because of our strong cash position. And I think we''ve got, we''ve demonstrated a really strong track record of being very disciplined with the use of our cash. We don''t let it turn a hole in our pocket. We don''t allow it to motivate us to do stupid acquisitions. And so I think that we would like to continue to keep our powder dry, because we do feel that there are one or more strategic opportunities in the future. That''s the biggest reason. And there''s other reasons as well that we could go into, but that''s the biggest one.

Toni Sacconaghi – Sanford C. Bernstein

Thank you.

Nancy Paxton

Thanks, Toni. Could we have the next question please?

Operator

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

Shannon Cross – Cross Research

Thank you very much. Steve and Tim, could you talk a little bit about the corporate opportunity and what I''m looking for is sort of how you''re thinking about Apple as its been positioned over the last several years sort of more of a consumer-focused, SMB-focused company but clearly there''s a huge opportunity with the iPad and the iPhone and probably at some point the Mac into the corporate world. So how do you think about your positioning from a Marketing standpoint, a sales standpoint. Any changes you need to make or how are you sort of addressing this?

Timothy D. Cook

Shannon, it''s Tim. On the iPad, there have been some comments about this earlier just to give you some stats here, about two-thirds of the Fortune 100 are deploying or piloting iPad. And I don''t know about you but I''ve never seen an adoption rate like this in my life in enterprise. Enterprise is historically much slower moving on adoption. We''re also seeing the iPad begin to pick up interest in K-12 which is another market that historically adopts very, very slowly. And so the early data points look great, and as a matter of fact we have built and are building additional capacity internally in the sales organizations to call on businesses. And obviously, we have a huge amount of salespeople already that are calling on education institutions.

We''re also enabling and training our carrier partners to do the same. And you probably saw an announcement last week with AT&T and that''s a direct result of customers wanting to buy the iPad on a post-pay type plan. And so we''re putting a lot of energy in those. IPhone has followed a trajectory that gets into the same kinds of numbers as I''ve quoted on iPad where a little bit higher by now is 85% of the Fortune 100 are deploying or piloting iPhone. And so this isn''t a hobby or something we''re doing lightly.

We put enormous energy in the company, in engineering, in software and it built a number of enterprise features in the OS. You''ve seen that get better and better as we have stepped through the different OS releases. And we''re building the sales capability for those groups as well. It''s clear that both the phone and the iPad have an enormous opportunity.

The Mac is also increasingly getting pulled into an enterprise where the employees are able to select and of course, this is a trend that we like to see and that we think will continue in larger ways but when people are given the choice, they would prefer a Mac and so Macs are being pulled in as well.

We don''t have as much distribution effort on that but as we see if it gets larger, we will move accordingly. The great thing is that we''re maintaining our focus on the consumer. And the consumer is the forefront on thinking of all of our products. And it''s these consumers in the enterprise so to speak that are pulling these products in and so we''re not developing two different lines like many companies do and have enterprise versions and consumer versions.

This is another part of our simplistic approach to things that I think will pay us great dividend and is already starting to do so.

Shannon Cross – Cross Research

Okay. And then -- thank you. I had a follow-up for Peter. I''m getting substantial questions as I''m sure everybody on this call is just about gross margins. So I guess, one of the questions I have is as you''re seeing the increase in volume, is there any kind of a change in terms of the scale leverage you have from a manufacturing standpoint or I know you guided to lower gross margins but the Street of course was higher. So just anything you can give us in terms of color on the gross margins with the iPhone and iPhone 4 in terms of how that''s panning out, how we should think about start up costs that were associated with both that as well as the iPad. Just any color would be great. Thank you.

Peter Oppenheimer

Sure. Well Shannon, we don''t product product-specific gross margins but we are always working aggressively to lower our cost whether it''s the iPhone or any of our other products. And I think we have a very good track record in this regard. And we were happy with our gross margins in the September quarter. They were ahead of what we thought. And we see them being just down slightly in the December quarter as we ship more iPods where we''ve been quite aggressive and continue to ship more iPads as well.

Shannon Cross – Cross Research

Okay. Thank you.

Nancy Paxton

Thank you, Shannon. We have the next question please?

Operator

Our next question will come from Chris Whitmore with Deutsche Bank.

Christopher Whitmore – Deutsche Bank

Thanks very much. I''m interested to understand demand from new carriers to pick up iPhone 4 and whether or not you''re seeing any pressure on subsidies as you look to extend your distribution network on the phone business.

Timothy D. Cook

Chris, the pressure that I''m getting is on supply. I''m getting virtually everyone we''re doing business with wants more supply. So that''s the pressure that I feel.

Christopher Whitmore – Deutsche Bank

Can you give us some color, sorry if I missed it, as I jumped on late but some color in terms of where you are from a number of carriers with iPhone 4. How did you end the quarter, do you have targets for the December quarter in terms of carrier penetration with existing relationships?

Timothy D. Cook

If you count at the country level, we have about 166 relationships that we ended the quarter with and about 89 countries. And so that''s a significant expansion across the last year as we and many countries went from a single carrier relationship to more than one carrier. The latest country that we''ve done that in or that we''ve announced that in, is Germany and we will be launching both with Vodafone and O2 together with our existing partner T-Mobile in Germany later this month.

Christopher Whitmore – Deutsche Bank

In all 166 of those carriers have the phone 4 by year-end, is that the target?

Timothy D. Cook

With iPhone 4, we''re in 85 of those 89 countries. And I believe that we will be in all 89 by the end of the year.

Christopher Whitmore – Deutsche Bank

And what is your experience been when you''re gone non-exclusive from a subsidy and margin standpoint on the phone? Have you had to give anything up in the past?

Timothy D. Cook

We don''t give specific information out on margins but I think you can look at our ASPs and see that they''ve generally stayed above $600 and that''s despite opening up several markets from an exclusive market to a non-exclusive market.

Christopher Whitmore – Deutsche Bank

A question for Steve. Steve, you discussed competitors not matching Apple''s price points so far in the tablet space. Why do you think you have an advantage on the price point for iPad versus the PC manufactures?

Steven P. Jobs

Well, I think part of it is because we engineer so much of it ourselves, the A4 chip inside it is an Apple creation. Everything again as I mentioned from the battery chemistry to the enclosures and we''ve learned a lot. We''ve learned a lot from miniaturization we''ve done on iPods and iPhones. And we''re a very high volume consumer electronics manufacture. So I think we''ve learned a lot, we''ve developed a lot of our own components where others have to buy them on the market, with middlemen getting their cut of things. And I think we''re systems architects and know how to build systems in a very efficient way. So I think this is a product we''ve been training for the last decade.

Christopher Whitmore – Deutsche Bank

Thank you.

Nancy Paxton

Thank you, Chris and thanks to everyone for joining us today. A replay of today''s call will be available for two weeks as a podcast on the iTunes store, a webcast on Apple.com/Investor and via telephones and the numbers are 888-203-1112 or 719-457-0820 and the confirmation code is 1034928. These replays will be available beginning at approximately 5 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 and thanks again for joining us.

Operator

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