Apple: Was It Really So Bad?

Apple reported its quarterly results a little while ago, and its conference call with analysts is set to begin at 2 pm PT. The results fell short of what analysts had expected. The main culprit — iPhone sales. With rumors about an upgrade rampant during the summer months, consumers seemed to hold back on buying new iPhones. Shares immediately fell more than 26 dollars — more than 6 percent — in after-hours trading.

My admittedly imprecise liveblog notes from the conference call are below:

2:01 pm: And so we wait for the start of the earnings call. There’s some nice classical guitar music playing.

2:03 pm: Still waiting for people to dial in. You’re welcome, operator, for my patience.

2:04 pm: And we’re getting under way.

Boilerplate. Forward-looking statements, blah blah blah.

Here’s Tim Cook. This is our first earnings call since the passing of Steve Jobs. Steve was a great leader and mentor and inspired people at Apple to do extraordinary things. Only Apple brings together software hardware and services. As we move forward, we will continue doing that.

And here’s Peter Oppenheimer. Record September quarter revenue and earnings. Record on Mac sales, record September quarter for iPhone sales.

Year-over-year increase in revenue was iPad, Mac and iPhone sales.

Mac sales increased strongly in each of the operating segments, especially Asia. MacBook Pro was especially strong, he says. Portables 74 percent, but desktop sales were strong too. Six million Lion downloads during the quarter.

Some 6.6 million iPods sold, down year over year, but ahead of our expectations, and iPod touch accounted for more than half of iPods sold.

2:09 pm: iPod is still strongest in most of the countries we track.

iTunes: $1.5 billion revenue. 16 billion songs downloaded.

iPhone: 17.1 million iPhones. 21 percent year-over-year growth. Sales in Asia Pacific doubled year over year.

We expected sales to decline as the result of new-product rumors of new iPhones.

Ended the quarter with 5.75 million in channel inventory, which is within the target.

$11 billion recognized revenue from iPhone sales compared to $8 billion previously.

2:11 pm: 93 percent of Fortune 500 are trying iPhones, up from 91 percent last quarter. Citing Lowe’s, rolling out iPhones with a custom application for employees. SAP, Jaguar, LandRover, CSX all named as customers.

Naming enterprise customers as part of an earnings call, if I’m not mistaken, is something new for Apple.

iPad: 11.1 million versus 4.2 million year-ago quarter. We said from the beginning the tablet market is a huge opportunity. (You got that right.)

2:13 pm: $6.9 billion in iPad-related revenue.

And now talking about the airline industry? What? Did Apple just pivot toward showing a new, enterprise-friendly face?

iCloud comments: We believe iCloud is the easiest way for customers to manage their content. The App Store has 500,000 applications, now available in 123 countries.

Retail sales up 1 percent year over year. Strong Mac sales offset by lower iPhone sales. 1.1 million Macs sold during the quarter. Again, about half of these are people who have never owned a Mac. The halo effect is still intact.

2:17 pm: 357 stores open at the quarter. $10.7 million average sales per store. $679 million sales total at retail. 77.5 million visitors.

Now guidance: International expansion. 77 stores (?) will open, about three-quarters of them outside the U.S. (I may have gotten that number wrong.)

Cash: $81.6 billion as of the end of the quarter versus $76.2 billion net of cash paid for Nortel patents. Cash flow from operations 10.4 billion.

2:19 pm: More guidance. This December quarter will have 14 weeks. $37 billion versus 26.7 billion with a gross margin of about 40 percent.

EPS: $9.30 in the quarter expected.

Oppenheimer sums up the year’s unit sales results: 72 million iPhones, 32 million iPads, 17 million Macs.

2:21 pm: And now time for Q&A:

Goldman Sachs’s Bill Shope: Given that 4S was launched close to holiday season, any risk of shortage?

Cook: We’re off to a great start with the 4S. Thrilled with the start. Confident we will have a large supply. Not sure about whether supply and demand will be in balance. Demand high now. Confident we will set all-time record for iPhones this quarter.

2:22 pm: Cook: As we predicted, iPhone sell-through decline did occur among the rumors, but not as much as we thought. The reduction hit extreme highs during the back end of the quarter.

Cook: In our wildest dreams we couldn’t have gotten off to a better start with iPhone 4S.

Katy Huberty from Morgan Stanley, asking about gross margins.

Oppenheimer: We expect gross margins to be relatively flat. We think there’s a favorable component cost environment. And a strong mix of iPhones. We expect these to be offset by higher cost structures and lower price points for the other iPhones. Plus the stronger dollar.

Question for Cook on traction in China. How big could China be for Apple over time? Could it be as big as the U.S.?

Cook: China progress has been amazing. It was just 2 percent in fiscal 2009. Now it’s 12 percent. It is our fastest-growing major region by far. $4.5 billion of revenue in the quarter, and that’s four times or up 270 percent year over year.

A year ago, in fiscal 2010, we were just above $3 billion in China sales. We have placed new stores there, six in greater China. Online store hasn’t been open a year yet. We are now up to 7,000 points of sales on the iPhone in China. How far can it go? Certainly in my lifetime I’ve never seen a country with as many people rising into the middle class, with people wanting to buy Apple products. It has quickly become No. 2 of top revenue countries, and we’re placing additional investment and stores there as well as doing quite a few other things to continue to deliver our products to China. Also placing additional focus on areas that have shown great promise. Brazil was up 118 percent year over year. Russia is looking more promising. The Middle East has significant opportunity. Several of these markets Apple has not been strong in are being introduced to the iPhone and then getting excited about other products that we have. In China, the sky is the limit. I wouldn’t discount some of the other places. (Wow, that was a long answer!)

2:30 pm: Question about supply chain for Tim. Didn’t get it.

Cook: We have an outstanding team in this area. We keep trying to improve all the time. We have used our balance sheet to do strategic deals to get parts that were important. (Like flash memory, for one thing.) Our approach has been, and I think will always be, to do business with as few people as we can, to go very deep with them. You can’t do that when you go out to many, many different people. They give us great quality and reasonable prices.

Now a question about the competitive market for tablets. Asking about Amazon Fire.

Cook: We had an outstanding quarter. At the same time, we were setting a Mac record. But we’ve seen several competitors come to market to try and compete. They have had different form factors and price points. I think it’s reasonable to say that none have gained any traction thus far. As they were coming to market, our share went up. We were responsible for three out of every four tablets sold.

Question from Gene Munster at Piper Jaffray: Asking about deferred revenue from carriers because of the launch of the iPhone 4S.

Oppenheimer: We waited. The biggest impact was the rumors late in the quarter. We have just started selling the iPhone 4S, and it’s off to a fantastic start with Sprint and KDDI.

2:34 pm: Gene now asks about size of the tablet market. How do you think about the market?

Cook: We thought from the beginning it would be huge, but it has been even greater than we thought. We’ve sold 40 million on a cumulative basis. If you forecast out in time, the tablet market will be larger than the PC market. That is not a guidance number, it’s just something I believe. There will be many more people that can access it. I think it’s a huge opportunity for Apple across time.

Barclay: Ben Reitzes: Do you have any idea of how many units were pushed out and deferred into the next quarter? And in general, what do you think, how should we be thinking about pent-up demand relating to the iPhone 4S launch?

Cook: You can’t run the experiment twice. We won’t know how many we would have sold. I believe it was substantial. That is the reason we called it out. Anyone monitoring the press (especially AllThingsD) would have known about it. When we launched iPhone 4 we did 1.7 million, and when we launched 4S we did 4 million in the first weekend.

Question about iPad category: In Macs, you’re up sequentially. Any thoughts on iPad seasonality?

Oppenheimer: We would expect to establish new records for both iPhone and iPad in the December quarter. On Mac, we will continue to outgrow the market.

Shannon Cross: Can you talk a little more about Siri in the future? Is it a feature or is there a more fundamental way to interact with devices?

Cook: The number of people interacting with it is amazing. We see this as a profound innovation. Over time, many, many people will use it in a substantial way. What percentage of their input will be by that? Our guts have been telling us that it is substantial and that it’s an incredible innovation.

Cross: Comment on supply chain on hard-drive issues in Thailand?

Cook: Hearts go out to people of Thailand. We have lots of factories that supply them. There are several factories that are not operable, and recovery time is not known. As you can appreciate, weather has not allowed the ability to assess. Our primary exposure is on the Mac. The number of drives and drive components that come from Thailand is high. There will be a shortage of disk drives. How it affects Apple, we placed our assessment in the guidance we’ve given.

2:41 pm: Tony Sacconaghi. Asking Cook to comment on ongoing patent fight with Samung. What are your ultimate objectives on litigation? Injunction or royalties?

Cook: No comment on litigation. We spend a lot of time and money and resources in coming up with incredible innovations. We don’t like it when someone else takes those. That is why we, unfortunately, have been pushed into the court system as a result.

Toni: What kind of remedies do you see?

Cook: No comment.

Toni: Price reductions on the 3G offering. You’ve gone to free, and cut prices dramatically. How are you thinking about this price reduction? New segments of consumers?

Cook: We did it because we wanted to make the iPhone more accessible to a broader market. We took 3GS to free in the U.S. and other markets. We also lowered the price on the iPhone 4 to $99. We’ve done both of those.

2:44 pm: Uh-oh. My audio just went dead.

Okay, it’s back.

Question about issues relating to unibody casings.

Cook: We treat every concern about a supplier very seriously. We’re investigating the situation. Factored the supply outlook as we see it into numbers supplied earlier.

NAND Flash and DRAM really declined in price last quarter. LCD displays, too, will continue in favorable levels. Most of the other components we expect to fall at or above normal trends. That is with the asterisk concerning hard drives and Thailand.

2:47 pm: We could be moving to a new phase for the company where some of the fastest-growing products in the product line, that could see some price elasticity, could be fastest-growing products next year. Could that put pressure on gross margins? Can you still expand operating margins next year?

Oppenheimer: December quarter we expect gross margin on 40 percent. We have nice leverage on operating margin, just over 30 percent. We are going to just continue to offer the best products we can. You’ll see us be aggressive, and where customers want to buy, that’s fine. We just want them to buy our products.

2:49 pm: Credit Suisse: On the iPad side, could you speak about distribution rollout in that product? Was there any pause rolling out to other countries? Then another question about BRIC countries. What do you need to do in those countries?

Cook: We are in 90 countries on iPad. We have about 40,000 points of sale around the world. To put that in some context, we have 50,000 on iPod and 120,000 on iPhone. There are still countries left to do.

With iPhone, it’s crystal clear there was slowdown. That was not the case with iPad. On the last call I said we were coming into supply-demand balance in some countries with iPad. Then we got into balance around the world. We couldn’t feel better, honestly. The extent of the usage: Comscore 97 percent of Web usage on tablets is from iPad.

In terms of other countries, we have started placing efforts in them. We wouldn’t have done $900 million in Brazil without any effort. There are a few countries with protectionist measures, where the prices are high, where there’s no local content. The basic approach with all the countries are the same with the game plan in China. It’s the rate and pace of the rollout, whether to involve everything we did in China. In China we did everything we know how to do. Everything we do in the U.S., we do in China. We would not do all that in the other countries I mentioned.

2:54 pm: Bank of America question. Any thoughts on cash allocation? Dividend? Buyback? (Yeah, no.) Also a question on cannibalization of Macs via iPad.

Cook: Some are deciding to buying an iPad instead of a Mac, but most are deciding to buy an iPad instead of a Windows-based PC. So we come out very well in that situation. Even so, Mac had its best quarter ever.

Cash: To date, we want to maintain flexibility. The cash isn’t burning a hole in the pocket. We invest the cash conservatively. We won’t do something silly with it. We’ve taken money and done things with it. We’ve acquired several companies and some IP. We’ve invested in the supply chain, and we build out our stores and provided for product tooling and the like. The cash we do spend we do a good job of it and we use it in the right places.

I’m not religious about holding cash or not holding it. We will continually ask ourselves what’s in Apple’s best interests. It’s a topic for the board.

Oppenheimer: Of the $81 billion we have in cash, $54 billion of it is offshore.

2:57 pm: Question: Is buying back shares, is that perhaps kind of a philosophical white flag that you’re not able to produce value through innovation?

Cook: No one would say we’re waving the white flag on innovation. We’ve got a pipeline that is unbelievable.

Q: Would that hold you back from buying back?

Cook: No, they are distinct things. The cash is always a topic, and we’ll always conclude to do what’s in Apple’s best interest. And if you look at what we’ve done with it, you’ll agree.

Cook: We think the smartphone market will absorb the handset market. Handset market is 1.5 billion units and handset is 400 million so far. The big win is to eat into the 1.5 billion, not just for us but for others.

Now a question about the extra week in the December quarter.

Oppenheimer: The extra week will conclude on New Year’s Eve. Usually a good day for us, sales-wise.

A question on Japan: Disparity on units versus revenues in Japan.

Cook: A huge percentage of Japan was from iPhone 4 launch. Year-over-year compare was tough. Mac had a great quarter in Japan, however. The iPhone was a negative year-over-year compare, but we have a strong start in Japan. It was one of the first seven countries.

Chris Whitmore: Asks about medium- to longer-term iPad opportunity. Do you see an opportunity to move it upmarket?

Cook: I don’t want to get into what we might do. We see the tablet market as a huge market. We could not be happier with our position in it. We have some fantastic things in the pipeline. After selling 40 million, we have a good handle on what to do next.

Aaaaand my audio went dead again.

Aaaaand now it’s back again.

And that’s it for the conference call. A very interesting call, overall. Some intriguing variations from the usual script.