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Apple Inc. (NASDAQ:AAPL)

F4Q07 Earnings Call

October 22, 2007 5:00 pm ET

Executives

Nancy Paxton - Senior Director, Investor Relations andCorporate Finance

Peter Oppenheimer - Chief Financial Officer

Timothy D. Cook - Chief Operating Officer

Analysts

Ben Reitzes - UBS

Gene Munster - Piper Jaffray

Richard Gardner - Citigroup

David Bailey - Goldman Sachs

Katy Huberty - Morgan Stanley

Shannon Cross - Cross Research

Andrew Neff - Bear Stearns

Harry Blount - Lehman Brothers

Toni Sacconaghi - Sanford Bernstein

Bill Fearnley - FTN Midwest

Rob Semple - Credit Suisse

Mike Abramsky - RBC Capital Markets

Keith Bachman - Bank of Montreal

Andy Hargreaves - Pacific Crest Securities

Operator

Good day, everyone and welcome to this Apple Incorporatedfourth quarter 2007 quarterly results conference call. Today’s call is beingrecorded. At this time, for opening remarks and introductions, I would like toturn the conference over to Ms. Nancy Paxton, Senior Director InvestorRelations and Corporate Finance. Please go ahead.

Nancy Paxton

Thank you. Good afternoon and thanks to everyone for joiningus. Speaking today is Apple CFO Peter Oppenheimer, and he’ll be joined by AppleCOO Tim Cook and Treasurer Gary Wipfler for the Q&A session with analysts.

Please note that some of the information you’ll hear duringour call may consist of forward-looking statements regarding revenue, grossmargin, operating expenses, other income and expense, stock-based compensationexpense, taxes, and earnings. Actual results or trends could differ materiallyfrom our forecasts. For more information, please refer to the risk factorsdiscussed in Apple's Form 10-K for 2006, the Forms 10-Q for the first, second,and third quarters of 2007, and the Form 8-K filed with the SEC today and theattached press release.

Apple assumes no obligation to update any forward-lookingstatements or information which speak as of their respected dates. With that, Iwould like to turn the call over to Peter Oppenheimer for introductory remarks.

Peter Oppenheimer

Thank you, Nancy. Thank you for joining us. We are pleasedto report record results, including the highest September quarter revenue andearnings in Apple's history. Revenue of $6.22 billion increased 29% over theprior September quarter. The revenue was driven by record Mac sales andcontinued strong demand for iPods.

Operating margin for the quarter was stronger than expectedat 17.1%, resulting primarily from higher revenue and gross margin than we hadanticipated. Net income was $904 million, which was up 67% over the priorSeptember quarter’s results and translated to earnings per share of $1.01.

I would like to first talk about our Mac products andservices, which represented 62% of our total quarterly revenue. We areextremely pleased to have shipped 2.16 million Macs, 400,000 above the Junequarter’s all-time record for Apple and representing 34% growth over theyear-ago quarter.

On a worldwide basis, Apple's growth rate was over two timesIDC’s most recently published market growth rates for the September quarter.Customers responded very favorably to the new iMacs we announced in August,driving 31% year-over-year growth in desktop systems. Demand for Apple's Macbooksand Macbook Pros continued to be very strong. Sales of portables increased 37%over the prior September quarter and accounted for 62% of Macs sold. We endedthe quarter with slightly less than three weeks of Mac channel inventory.

Now I would like to discuss our music products and services,which accounted for 36% of total revenue during the quarter. We sold 10.2million iPods, representing 17% growth over the year-ago quarter. We began andended the quarter within our target range of four to six weeks of iPod channelinventory.

Reaction to the new iPods announced last month has been verypositive and we are shipping the best iPod lineup ever as we head into theholiday buying season. Apple executed a very smooth transition to an all-newiPod lineup without a hitch.

Other music revenue grew 33% year over year, once againfueled by strong iTunes store sales. We are very pleased with initial reactionto the iTunes WiFi music store and our new relationship with Starbucks. iTunescontinued to account for over 85% of songs purchased and downloaded in the U.S.,according to the latest data available from Nielsen Soundscan, and iTunescustomers have now purchased over 3 billion songs and 100 million TV shows.

Based on the latest data from ISPI market research, 17% ofglobal music sales in the first half of calendar 2007 were digital, up from 11%in all of 2006. We believe that the popularity of iTunes has been instrumentalto the growth in this trend.

Based on the latest data from NPD, iTunes continues to bethe third largest distributor of music in the United States, having surpassedboth Target and Amazon.

We are thrilled to have sold 1.1 million iPhones during thequarter and customers are really loving the product. Our research shows that anamazing 95% of iPhone customers would recommend the iPhone to others.Additionally, the research firm Strategy Analytics, estimates that iPhone wasthe fourth highest selling handset in the U.S. market in the September quarter.

We are recognizing revenue from iPhone handset sales usingsubscription accounting over a 24-month estimated economic life. Total revenuerecognized during the quarter from sales of iPhones, iPhone accessories, andpayments from AT&T was $118 million. Total deferred revenue from iPhone andApple TV was $636 million at the end of the September quarter compared to $180million at the end of the June quarter.

As you know, after lowering the price of iPhone to $399 lastmonth, we offered $100 credit to customers who had purchased an iPhone prior tothe price reduction. We are accounting for the credits as they are redeemed bycharging the associated product cost to cost of goods sold. We anticipate mostof these redemptions to occur by the end of the December quarter.

We are on track to begin selling iPhones in Europe onNovember 9th, partnering with O2 in the U.K. and with T-Mobile in Germany. Aswe announced last week, we will begin selling the iPhones in France beginningon November 29th, partnering with Orange.

I would like to now turn to the Apple retail stores, whichposted record quarterly revenue and traffic, driven by very strong interest inMacs, our new iPods, and the iPhone.

Revenue was $1.25 billion, representing 42% year-over-yeargrowth. The stores generated $268 million in segment margin compared to $156million in the year-ago quarter. We opened 12 new stores during the quarter,ending with 197 stores. With an average of 190 stores open during the quarter,average revenue per store was $6.6 million compared to the $5.6 million in the year-agoquarter.

The stores sold 473,000 Macs during the quarter,representing 46% year-over-year growth. Once again, over 50% of the customersbuying Macs in our stores during the quarter were new to Mac.

We delivered over 300,000 personal training sessions andended the quarter with 387,000 members in our one-to-one and pro-care programs.Over 31 million people visited our stores during the quarter, representing over12,500 customers per store per week.

We will continue to invest in new stores in the U.S. andinternationally, with approximately 40 stores scheduled to open in the comingyear, including previously announced high-profile stores in New York andBoston. We are also pleased to announce plans for our first store in China,which will open in Beijing next summer.

Our U.S. education channel also posted an outstandingquarter, with record revenue and Mac shipments. Our new account initiative inthe K12 market was very successful and our extremely popular back-to-schoolpromotion drove strong Macbook and Macbook Pro sales, contributing to our best,higher ed quarter ever, with 36% year-over-year growth in total Mac sales.

Total company gross margin was 33.6%, which was lowersequentially but higher than expected, due to a number of factors. We benefitedfrom a higher margin product mix, a weakening U.S. dollar, abetter-than-expected commodity environment, and a higher mix of directbusiness.

Operating expenses were $1.03 billion, including $58 millionin stock-based compensation expense. We capitalized $22 million of softwaredevelopment expense related to Leopard during the quarter.

OI&E was $170 million. The tax rate for the quarter wasabout 27%, lower than our anticipated rate of 32%, primarily due to a benefitfrom the settlement of prior year audits. We had very strong cash generationduring the quarter, increasing our cash balance to end with $15.4 billion. Cashflow from operations was $1.7 billion.

Looking ahead to the December quarter, I would like toreview our outlook, which includes the types of forward-looking informationthat Nancy referred to at the beginning of the call. For the quarter, we aretargeting revenue of about $9.2 billion. We expect the total quarterly costs ofnon-cash, stock-based compensation to be approximately $92 million.

We expect gross margin to be about 31%, reflectingapproximately $12 million related to stock-based compensation expense. We areguiding gross margin down sequentially as a result of several factors,including the full quarter impact of our recent product transitions and reducedpricing, lower sales of iLife and iWork in their second quarter, seasonallyhigher component costs, and a higher mix of indirect sales.

We expect op-ex to be about $1.165 billion, including about$80 million related to stock-based compensation. We expect OI&E to be about$195 million and we expect the tax rate to return to about 32%.

We expect to generate EPS of about $1.42, including ananticipated $0.07 per share related to stock-based compensation.

In closing, we are extremely proud of our record-breakingfiscal 2007 results. We generated over $24 billion in revenue and $3.5 billionin net income. We sold 7 million Macs and 52 million iPods, each growing bymore than 30% over the prior year. We introduced the revolutionary iPhone andsold over 1 million in the first 74 days. Our retail stores hosted over 100million visitors and produced $4.1 billion in revenue.

We exited the September quarter with great momentum. Macshipments exceeded our previous quarterly record by 400,000 systems and we’revery excited about the arrival of Leopard later this week. We introduced anentirely new lineup of iPods last month and customer reaction has been verystrong.

We’ve clearly accelerate the momentum for iPhone sales withour new pricing and we are very enthusiastic about our entry into the Europeanmobile phone market next month.

We are looking forward to our best December quarter ever, aswe head into the holiday buying season with the strongest product lineup inApple history.

With that, I would like to open the call to questions.

Question-and-AnswerSession

Operator

(Operator Instructions) We’ll take our first question from Ben Reitzesfrom UBS.

Ben Reitzes - UBS

I don’t like to cheerlead, but nice quarter. The question isregarding the guidance. With regard to your usual pattern, Peter, you seem tobe more conservative usually. You guided up versus the street by quite a bit to$9.2 billion, maybe arguably $700 million better. What are you seeing thatallows you to be so confident in the face of some people being worried aboutthe economy at this time?

Peter Oppenheimer

Regarding the economy, we’ll leave forecasting the globaleconomy to others. But as I commented at the end, Apple is shipping the bestproducts that we have ever made in our history. We just eclipsed the recordthat we set for Mac sales last quarter by 400,000. iPod sales accelerated afterthe transition and we’ll shipping the best iPods that we’ve ever made, and theiPhone is doing really, really well. So we’re quite confident in the businessand we’ve exited the September quarter with a lot of momentum.

Ben Reitzes - UBS

More precisely on the guidance for iPods, it would seem thatlaunching in September, did you feel that a lot of iPod sales are pushed intothe December quarter and not necessarily pushed, but just naturally the fulllineup hasn’t had a chance to be fully reflected and that’s part of the reasonfor the guidance as well, or -- and how do we reconcile the sequential for Macsas well? It would seem the guidance implies Macs are up.

Peter Oppenheimer

Let me begin with Macs and maybe I’ll let Tim address youriPod question. For Macs, in the two most recent quarters, units have beenrelatively flat from the September quarter to the December quarter, as oureducation business falls off and is more or less offset by holiday consumerbuying.

This year, it’s possible that Mac sales could besequentially a little lower, given the extraordinary success of theback-to-school promotion, which intensified the seasonality of the Septemberquarter.

Ben Reitzes - UBS

Okay, so you’re saying Macs could be lower due to thatpromotion? Okay.

Peter Oppenheimer

It could be. We had just a fantastic September quarter butreally back to school and our higher ed results were an all-time high for thecompany.

Timothy D. Cook

Ben, in terms of iPod, sales accelerated dramatically afterthe introduction of the new iPod and based on some early market share datawe’ve seen from the U.K., France, and Germany, our share is up significantly inthe month of December, or September. The U.K.up 12 points, Japanup 12 points, and Franceup 6 points.

Given these kinds of increases, we feel that we are verywell positioned going into the holiday quarter.

Ben Reitzes - UBS

Got it. And then lastly, with regard to gross margin, Peter,you talked about going from 33.6 to 31, and you mentioned that the iLife salesgo down but we have Leopard shipping on the 26th. I was surprised to hear younot mention that as a major offset on the gross margin line.

Peter Oppenheimer

Well, as I commented in my prepared remarks, we are lookingforward to Leopard shipping this week. We are very excited about Leopard, butin terms of -- and I didn’t think you’d forget about that, but I wanted to focusyou on some factors that I think on the net basis will cause more gross marginsto go down, and that’s why I made the comment that I did.

Ben Reitzes - UBS

Thanks a lot, guys.

Nancy Paxton

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

Operator

Next we’ll go to Gene Munster from Piper Jaffray.

Gene Munster - PiperJaffray

Good afternoon and congratulations. Peter, if you could talka little bit about the line item, iPhone related products and services, interms of when I’m doing the math here as far as revenue contribution perquarter for the iPhone, it’s the 1/8th or -- is it by the month or by thequarter? Can you give a little bit of clarity on that?

Second is how does it work for the AT&T revenue share --is it also calculated by day, by month or by quarter?

Peter Oppenheimer

Gene, in terms of iPhone, we are recognizing revenue fromhandset sales over a 24-month period of time. We actually do do that on a dailybasis. Our revenue from iPhone, which includes amortization of handsets, accessorysales, and payments from AT&T was $118 million in the quarter.

Gene Munster - PiperJaffray

Okay, so for the AT&T contribution and the iPhonecontribution, it’s on a 24-month, it depends on the month that the phone issold, is that correct? It’s not the quarter, it’s the month?

Peter Oppenheimer

No, for the handset, we are amortizing that revenue over 24months but as regards payments from AT&T, we will recognize those paymentsas revenue over time as earned, and I’m not going to get into some more detailthan that.

Gene Munster - PiperJaffray

Okay, so that could be by the day, potentially?

Peter Oppenheimer

Gene, I’m just not going to get into any more detail aboutour carrier agreements.

Gene Munster - PiperJaffray

Okay, and I guess this is probably another category of moredetails, but is the AT&T, is it generally a longer term kind of agreementor more near-term, or any thoughts along that --

Peter Oppenheimer

You know, as we indicated a couple of quarters ago, it is amulti-year exclusive agreement.

Gene Munster - PiperJaffray

Okay, and then just one final question; from the Best Buystores, how many Best Buy stores were kind of up and running at the end of thequarter? How many do you expect by the end of the December quarter?

Timothy D. Cook

Gene, we had 230 operating at the end of the Septemberquarter and we expect more than 270 at the end of the December quarter.

Gene Munster - PiperJaffray

Has that had an impact on the business or do you still kindof see that --

Timothy D. Cook

We’re very pleased with it. It had very good results and weare looking forward to expanding it in this quarter.

Nancy Paxton

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

Operator

Next we’ll go to Richard Gardner of Citigroup.

Richard Gardner -Citigroup

Thank you. I had two questions. First of all, I thought itwas quite encouraging that your PC channel inventories were below your targetrange, despite the fact that you did expand the Best Buy agreement in thequarter, and I was hoping you could give us some detail on why that was thecase.

And then secondly, I was also surprised to hear that highercomponent prices were one of the reasons that you cited for sequentially lowergross margin in the fourth calendar quarter because, based on our checks, mostcomponents seem to be coming down in price now, so I was hoping that Tim, youmight be able to reconcile that for us.

Timothy D. Cook

Sure. On your component question, here’s something we seegoing on in the quarter; as you know, Rich, DRAM and NAND Flash markets werefavorable last quarter and we believe that will continue during our Q1. Harddrive and LCDs were tight last quarter and they continue to be at the beginningof this quarter, but we do expect these to stabilize as the quarter unfolds.The other commodities are trading near or are declining near historical norms.

In terms of the channel inventory on the Mac, we primarilyhave low inventories at the end of the quarter because our sales were higherthan expected.

Richard Gardner -Citigroup

Okay, and Tim, that channel inventory calculation is done ona forward sales basis, correct?

Timothy D. Cook

It’s done on a look-back basis.

Richard Gardner -Citigroup

Okay. All right, and then finally, I was hoping for clarificationon how your accounting for the iPhone rebate in the quarter? I know youmentioned it in the prepared remarks, but I --

Peter Oppenheimer

Sure. We are accounting for the credits as they are redeemedby customers and will charge the associated product costs to costs of goodssold. And as I indicate in my prepared remarks, we anticipate that most ofthese redemptions will occur by the end of the December quarter.

Richard Gardner -Citigroup

Great. Thank you.

Nancy Paxton

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

Operator

Next we’ll go to David Bailey of Goldman Sachs.

David Bailey -Goldman Sachs

Yes, thank you. I was wondering if you could help usunderstand your pricing strategy for iPhone in Europe,where the pricing is higher and effectively going up versus the U.S.price as the dollar weakens?

Peter Oppenheimer

We set our price in Europe, David, when we announced andthat price also includes VATs and other related duties.

David Bailey -Goldman Sachs

And then could you just follow-up and tell us what thepercentage of direct sales were in the quarter and maybe give us some idea ofwhat you are expecting for the December quarter, since this will be a drag ongross margin?

Peter Oppenheimer

Sure. In the September quarter, our direct sales were 57% oftotal company revenue, and that was up from 53% in the year-ago quarter. Ican’t give you a forecast for this December quarter, but last year in Q1,direct sales were 44% of total company revenue.

David Bailey -Goldman Sachs

Thank you very much.

Nancy Paxton

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

Operator

Next we’ll go to Katy Huberty from Morgan Stanley.

KatyHuberty - Morgan Stanley

Thank you. Europe out grew the U.S. now for four quarters ina row. Is that sustainable or are there some currency factors that are showingup in the numbers?

Timothy D. Cook

Europe did have excellent growth. In fact, year over year,we were up 37% in revenue and 47% in units, as you combine the retail storeswith the channel results.

In terms of Mac units, this is over four times the IDCprojected gain for Western Europe, and so we are thrilled with the result.Europe did not have the typical lull in August that we have seen. The iMacannouncement and then followed by the iPod announcement early September wasenough to overcompensate for that.

We factored our view of the future into the guidance thatPeter provided earlier.

Katy Huberty - MorganStanley

And then just quickly, Peter, are there any nuances thatwill show up in the model as non-U.S. revenues become a larger percentage ofthe business, as it relates to either the margin profile or tax rate over time?

Peter Oppenheimer

Well, I’m not sure how to really answer the first part ofyour question, but in terms of the second part, generally for most U.S.companies, growth in foreign earnings is a benefit to your taxes, your U.S. taxrate.

Katy Huberty - MorganStanley

Thanks.

Nancy Paxton

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

Operator

(Operator Instructions) Next we’ll go to Shannon Cross ofCross Research.

Shannon Cross - CrossResearch

Good afternoon. Just going back to the revenue question,could you talk maybe, Peter, a little bit about the biggest drivers quarterover quarter? Because obviously there’s a substantial ramp coming and is itmore Mac or iPod or anything you can give us? Because it’s a big increase.

Peter Oppenheimer

It is and as we’ve said before, the holiday quarter isusually the big quarter for iPods and as I said, we’re shipping the best iPodsthat we’ve ever made and are looking forward to the December quarter.

Shannon Cross - CrossResearch

Okay, and then maybe if you could talk a little bit aboutthe ramp in iPhone through the quarter? Obviously a pick-up as you lowered theprice, Any more color you can give us there?

Timothy D. Cook

Shannon, we certainly saw sales accelerate after the pricereduction and as Peter mentioned earlier, we were able to sell 1.1 million forthe quarter, giving us a cumulative number of 1.4, and so we were very happy tocheck that major checkpoint off our list.

Shannon Cross - CrossResearch

Okay, and then just one final question; maybe you could talka little bit about efforts you have to address the SMB channel, both with Macsand iPhone? Just curious if that’s helping to ramp and if any specifics you cangive us.

Timothy D. Cook

The SMB market is difficult to measure. However, in terms ofwhat we can see operating out of our online stores and out of our retailstores, we are doing well there and growing.

In terms of iPhone, you know, we’ve said many times that weare providing a solution in iPhone that many businesses love. It gives thepeople a desktop class e-mail, which is very unusual for a phone and is anunprecedented Internet device. And I think clearly there are some businessesbuying them and very much enjoying them.

Shannon Cross - CrossResearch

Are you working with Salesforce.com on their initiative tomodify their software for iPhone?

Timothy D. Cook

Yes.

Shannon Cross - CrossResearch

Okay, great. Thanks.

Nancy Paxton

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

Operator

Next we’ll go to Andrew Neff of Bear Stearns.

Andrew Neff - BearStearns

Thanks. Just a couple of things; one, if you could clarify,Peter, what you were saying about the tax rate this quarter. Is it anythingthat we’ll see again next year? Maybe give us a sense of the guidance for nextyear?

Second, I guess Tim, if you’d like, you told us when youthought you shipped the millionth iPod. Any sense of when you are going to shipthe three-millionth iPhone -- I’m sorry, iPhone?

Timothy D. Cook

I’ll start with that one. The answer is we are notpredicting, Andy. I would reiterate that we are very confident with shipping 10million in the calendar year of next year. We are very happy to ship ourone-millionth and by the end of the quarter, 1.4.

I think it’s interesting to note that the 1.4 million, ittook us over 24 months, over two years to achieve a comparable number on iPodand so we’re thrilled here. We’ve very focused on going into the U.K. andGermany on early, in early November and then in France in late November andwe’re on target to enter Asia in calendar 2008. A lot of focus on iPhone.

Peter Oppenheimer

Andy, to your tax rate question, the tax rate in theSeptember quarter was about 27%, which was lower than our anticipated 32%,primarily due to a benefit from prior year audits that we had. And as I gaveyou in my guidance, I expect the tax rate to return to 32% in the Decemberquarter.

Andrew Neff - BearStearns

Also, could you just give a sense about Japan? That’s theone market that seems to be, on the Mac side, lagging and that’s been laggingfor some time. You’ve talked about the market growth issues before. Anythingelse going on in Japanthat you could talk about?

Timothy D. Cook

Andy, it’s fair to say that Japan continues to be our mostchallenging major market. It is the only market that we -- a major market thatwe’re not growing significantly in. However, for this past quarter, we werevery encouraged with the Macintosh results. The iMac was very well-received andthe overall Macintosh had its best year-over-year performance in Japan in sevenquarters, with units up 14% year over year and that compared to an IDC estimateof the market in Japan contracting an additional 2%. So it’s a tough market.

In terms of revenue, the revenue that you see on the sheet,the iPod had a very difficult compare because we sold a very large number toone telecom company for promotional purposes a year ago, so that was the maindriver in the revenue decline.

Andrew Neff - BearStearns

Lastly, Peter, over the last I guess eight quarters, you’veexceeded guidance. And I know that you are trying to give us a good sense ofwhat is going to happen, but how should we interpret now you are looking at avery strong quarter, you’re a little above where the street is. How should wecalibrate your guidance at this point?

Peter Oppenheimer

Andy, I give you guidance each quarter that we believe wehave a reasonable chance of achieving, and I’ve talked to you about our view ofhow we are performing in our product areas and Tim has made some comments insome of our distribution areas as well. And we are very confident in ourstrategy and the team here at Apple has been working incredibly hard for anumber of years and things are just really coming together quite well for usand I couldn’t be happier.

Nancy Paxton

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

Operator

Next we’ll go to Harry Blount from Lehman Brothers.

Harry Blount - LehmanBrothers

Thanks. Peter, just sorry to keep coming back to this rebatequestion, but it sounds like you are going to recognize that rebate as a periodimpact on COGS, but I think you are recognizing the rest of COGS on the iPhoneover a 24-month amortization. Is that -- am I hearing that correctly?

Peter Oppenheimer

Yes, as regard the iPhone $100 credit. We will account forit when customers redeem their credit. We will charge it to the cost of theproduct to cost of goods sold, and we expect most of the redemptions to occurby the end of the December quarter.

Harry Blount - LehmanBrothers

Just to clarify though, why are you doing the rebate as aperiod cost, whereas the rest of COGS for the iPhone is more amortized over the24 months?

Peter Oppenheimer

Sure. The credit was an additional but unspecified productdeliverable to iPhone customers, which is why we are not accounting for beforeit was redeemed but accounting for it at the point of redemption.

Harry Blount - LehmanBrothers

Okay, and then on the European carrier revenue rec, is thatalso going to be structurally similar to the AT&T revenue rec in terms ofwhat the components that are period costs versus the components that are amortizationcosts?

Peter Oppenheimer

In terms of payments that we may receive from Europeancarriers?

Harry Blount - LehmanBrothers

Just the handset amortized over 24 months, the accessoriesrecognized in the period, and the payments. Is it that same structure?

Peter Oppenheimer

We will recognize the revenue from handsets over 24 months,regardless of where they are sold. We will recognize revenue from iPhoneaccessories at the time of sale, and we will recognize payments from AT&Tand other carriers as revenue over time as earned.

Harry Blount - LehmanBrothers

Okay. Tim, real quickly, just a benchmark on the number ofMac distribution locations, the number of iPod locations?

Timothy D. Cook

We’re over 40,000 on iPod and within the last year, we’veadded about 2,000 Mac locations, to around 8,700 currently.

Nancy Paxton

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

Operator

Next we’ll go to Toni Sacconaghi from Sanford Bernstein.

Toni Sacconaghi -Sanford Bernstein

Thank you. I’m trying to get a better sense of howsignificant elasticity was around the price cut with the iPhone. My sense wasobviously in Q2, you did 135,000 phones a day. In -- excuse me, in Q3. In thispast quarter, you were probably doing 5,000 to 10,000 phones a day before youcut the price, and then you averaged about 18,500 phones after you cut theprice on the iPhone per day. Can you give us a sense of what the trajectory ofdaily sales volumes was from the iPhone immediately following the price cut andthen how that ended 22 days later at the end of the quarter? Was it relativelyconstant? Did it actually get better as the word leaked out? Can you give us asense of that? Because clearly when you initially announced the product, youhad a strong deceleration from enormous anticipation to when you cut the price.

Timothy D. Cook

Toni, we were very happy with the elasticity that we saw. Itenabled us to far surpass our expectation of hitting around a million unitscumulatively by the end of the quarter. Some number of these were sold topeople that have an intention to unlock and where we don’t know precisely howmany people are doing that, our current guess is there is probably 250,000 ofthe 1.4 million that we sold where people had bought them with the intention ofdoing that. Many of those happened after the price cut.

We’re not going to project precise numbers, as I told Andybefore, in terms of as we go into Q1, but we remain very confident with hitting10 million units in calendar year 2008.

Toni Sacconaghi -Sanford Bernstein

And can you give me a sense of the daily sales rateimmediately following the price cut versus the daily sales rate, either at theend of the quarter or over the last week? Has it been maintained or have weseen -- have we seen an acceleration or a degradation in that daily sales rate?

Timothy D. Cook

The only thing that I’ll say, Toni, is we obviously saw anacceleration once we took the price cut. We’re not going to get into disclosingour daily sales.

Toni Sacconaghi -Sanford Bernstein

And then, you raised the issue of the unlock intention. Ipresume that phones that are sold that ultimately are not subscribed to theAT&T network are not eligible for any payments from AT&T, correct?

Timothy D. Cook

That’s correct. The payments on AT&T depend on beinglocked to AT&T, obviously.

Toni Sacconaghi -Sanford Bernstein

And then in terms of thinking about next quarter, the cellphone market is modestly seasonal. Typically your Mac business has been flat toslightly up and in Q1, your iPod business has been up 100% or more. The phonemarket tends to be up about 15% or so as a market. Is that how you areanticipating, all else being equal, obviously you’re entering three newcountries this quarter, but if we think about how you guys think aboutseasonality, do you think this might be more or less seasonal, given its pricepoint, than the typical phone market? And how do we think about that?

Timothy D. Cook

Well, in the phone market for our phone estimate, we lookedat the three new markets that we are going into for the first time and so thathad a lot to do with our own internal estimate. And then we looked at theseasonality of the phone market as well in the U.S.

Nancy Paxton

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

Operator

Next we’ll go to Rob Semple of Credit Suisse. Mr. Semple,your line is open.

Nancy Paxton

Rob, are you there? Could we move on to the next caller,please?

Operator

Next we’ll go Mike Abramsky from RBC Capital Markets. Hearingno response, we’ll move to our next question. We’ll go to Keith Bachman fromBank of Montreal. Hearing no response, we’ll move on to Bill Fearnley of FTNMidwest.

Bill Fearnley - FTNMidwest

Hi, at Apple, can you guys hear us? This is Bill Fearnley.Can you hear me? Because you missed Rob Semple, you missed some of the otherguys as well. Am I connected?

Nancy Paxton

Yes, we can hear you.

Bill Fearnley - FTNMidwest

Okay, we just skipped over three of my colleagues so there’sa problem with the conference call bridge. A quick question for you, if Icould, on the iPhone; in terms of the iPhone, Tim, last call you had mentionedthat you had had a couple of corporate customers that were piloting the iPhonein the enterprise. Anything you can share there for an update?

Also, any update on any cannibalization that you are seeingwith the iPhone versus the iPod? And then also, on pilots, if I missed it inthe preamble, I apologize, but are there any updates on the pilot with Circuit City? Thanks.

Timothy D. Cook

On Circuit City, we’re not doing a pilot with Circuit City.We are focusing on expanding with Best Buy. I had mentioned the numbers on thatearlier. We ended with 230 Best Buy stores and expect to be north of 270 by theend of the quarter.

All the iPhone customers are reporting incredible customersatisfaction and we’ve achieved 95% of those who’ve said that they wouldrecommend the phone to others and so I -- you know, these numbers areunprecedented in our history.

Bill Fearnley - FTNMidwest

But you had mentioned specifically enterprise test on theconference call last quarter. Any updates specifically on those enterprisetests that you were running now?

Timothy D. Cook

No, I don’t have any updates on those.

Bill Fearnley - FTNMidwest

Okay, and then in terms of cannibalization, any commentaryyou can give on cannibalization, iPhone, from the iPhone to the iPod, please?

Timothy D. Cook

We saw no obvious cannibalization prior to the new iPodannouncement. Post the new iPod announcement, we really don’t have enough datato comment yet. We will report again in January.

Bill Fearnley - FTNMidwest

Okay, and then one last question, if I could shift gears tothe Macintosh, please. In the pro segment, any update on what you’ve seen interms of uplift from CS3 or some of the other new products that have goneuniversal binary? Thank you.

Timothy D. Cook

We’ve seen an incredible growth in our video business,driven by Final Cut Studio. We’ve seen an incredible growth in our audiobusiness, driven by the new Logic software that we just put out.

In the D&P space, the D&P space is slow. I think asbuyers evaluate changing to both CS3 and Leopard.

Nancy Paxton

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

Operator

Next we’ll go to Rob Semple of Credit Suisse.

Rob Semple - CreditSuisse

Hey, it’s Rob. Can you hear me now?

Nancy Paxton

We can hear you. Sorry about that.

Rob Semple - CreditSuisse

That’s okay. No problem. A question on the iPod Touch and Iguess the iPhone; I know the price cut came about the same time as you launchedthe Touch. Did you see any potential cannibalization I guess away from theiPhone for people that opted for the lower price point of the Touch? I knowthat’s difficult to quantify but just anecdotally, did any of your consumersurveys show that?

Timothy D. Cook

Again, in terms of generically, we did -- we saw no obviousevidence of cannibalization from the iPhone to the iPod prior to the launch ofthe new product and since the launch of the new product, we really don’t haveenough data.

As you know, we were still in the early stages of rampingthe iPod Touch at the end of the quarter.

Rob Semple - CreditSuisse

Okay, and I apologize from this because I was cut off at thebeginning of the presentation, but did you give the CapEx number for thequarter? And then, your outlook for the fiscal year?

Peter Oppenheimer

Rob, I didn’t give the outlook. We’ll do that when we fileour 10-K in a few weeks, but our capital in the quarter was $292 million and itwould have then been 822 for the year, for fiscal ’07.

Rob Semple - CreditSuisse

Okay, and then just lastly, guys, what do you estimate thesize of the Mac installed base right now? And then, what percentage of thatinstalled base is on Tiger?

Timothy D. Cook

Let me give you two numbers, which I think are the mostimportant to you. The vast majority of Macs shipped in the last four years areable to run Leopard. Specifically, this number is about 21 million. When weannounced Tiger, there were 15 million units that were eligible to run Tigerand we did $100 million of revenue on Tiger in the first quarter of launch.

Rob Semple - CreditSuisse

Okay. Thanks, Tim.

Nancy Paxton

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

Operator

Next we’ll go to Mike Abramsky from RBC Capital Markets.

Mike Abramsky - RBCCapital Markets

Thanks. Can you hear me now?

Nancy Paxton

We can hear you.

Mike Abramsky - RBCCapital Markets

Excellent. Thank you. More of a high level question; couldyou just talk a little bit about the drivers that you were experiencing on Macmomentum and market share shifts? There’s obviously several dimensions here --you’ve got new buyers, new product lines, new distribution, new software. Canyou just give us a little color, perhaps, on which one of those are perhapsmost significant to some of the momentum that you are seeing, or perhaps theyall are, and some color on those that are being reflected into your guidance?

Timothy D. Cook

We did have an incredible quarter on the Mac with breakingour previous Mac record by 400,000 units, and it was the end of an incredibleyear for the Mac because we did twice as many Macs as we did in 2004.

We attribute this to one, the fact that we are shipping thebest Macs in the history of the company; and secondly, an incredible receptionthat we received to the new iMac that launched in August; third, we’ve nowshipped over 120 million iPods, and most of these were shipped to Windowscustomers who never owned a Mac, so we introduced the Apple brand to them throughthe iPod.

Net, you can see this as a result, over 50% of the Macs thatwe sold in our retail stores were to customers who never owned a Mac before sowe’ve been very successful at expanding our customer base.

And finally, this was the most successful back-to-schoolseason we have ever had. And so all of those together have led to acontinuation of a huge momentum that now gives us, adds up to 11 quarters outof the last 12 where we’ve grown faster than the market and specifically, thelast several at a multiple of the market.

Mike Abramsky - RBCCapital Markets

Are there any risks of your scale? Obviously you’ve had someadvantages that you’ve touted over some of the larger competitors, includingthe lack of viruses, for example, on your operating system and your hardware,your ability to maintain a far more high touch buying experiences. Do you feelcomfortable that as you scale, you will be able to sustain these advantages?

Timothy D. Cook

We have been growing a lot of the -- our NPD share is up to16% in the U.S., which is a terrific increase for us. But there is still a lotof room left for growth and as you know, we scaled iPod from being a fairlysmall business to the last holiday quarter, we sold 21 million iPods and we’vesold over 120 million in total so far. We really have an experience at scalingthe product.

Mike Abramsky - RBCCapital Markets

Okay, and last question, you talked about the iPods shippingto Windows and that being a big driver obviously of Mac. In Europe, are youexpecting a similar halo effect due to iPhone sales there helping otherproducts further, like iPods and Macs?

Timothy D. Cook

You know, we’ll see. We’re just launching in Europe onNovember 9th and so we’ve got a lot to learn. However, I would point out thatour European business in the Mac area grew 47% year over year and this is overfour times IDC projection of growth for Western Europe, and so obviously thereis substantial evidence to say that the iPod has really helped us in Europe aswell.

Mike Abramsky - RBCCapital Markets

Okay. Thank you very much.

Nancy Paxton

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

Operator

Next we’ll go to Keith Bachman of Bank of Montreal.

Keith Bachman - Bankof Montreal

Hi, guys. Can you hear me now?

Nancy Paxton

We can hear you.

Keith Bachman - Bankof Montreal

Okay, great. Related to the last comment, Tim, the othersegment in terms of unit growth had tremendous CPU unit growth, as did Europe.How do you think about expanding your channels in those categories, either onthe direct side or the indirect side, whether it be store openings or otherretail partnerships to continue to capture, or have the opportunity to capturesome of that growth?

Timothy D. Cook

Keith, the other segment for us in particular is Asia-Pacific.It did grow 52% year over year. It is our fastest growing region, and as I’vementioned earlier, we have added 2,000 store fronts to Mac distribution overthe last year and we are continuing to asses quality partners and quality storefronts to continue increasing that.

Keith Bachman - Bankof Montreal

But of that amount of 2,000, I know on the direct side howmany you’ve done, but can you give me any sense of what proportion are out ofthe U.S. geo of those 2,000?

Timothy D. Cook

There are many of those that are in Asia and Europe -- manyof those.

Keith Bachman - Bankof Montreal

Okay, let me ask two quickies, then; Tim, do you think --you’ve obviously announced that you are going to do Asia-Pacific in terms ofthe iPhone. Do you think you can enter that market by having a 2.5G phone asopposed to a 3G phone?

Timothy D. Cook

We have nothing to announce today in terms of our entry intoAsia other than to reaffirm our plans to enter in 2008.

Keith Bachman - Bankof Montreal

Okay, the last one then, I just want to sneak one in; Peter,I was also one of the guys cut off at the beginning. Did you indicate what yourcash flow from ops or your free cash flow, either one, for the quarter was,please?

Peter Oppenheimer

Yes, cash flow from operations was $1.7 billion.

Keith Bachman - Bankof Montreal

Okay, thanks, guys.

Nancy Paxton

Thanks, Keith, and we have time for one final question.

Operator

We’ll take our final question from Andy Hargreaves fromPacific Crest Securities.

Andy Hargreaves -Pacific Crest Securities

I’m just wondering if your strategy in terms of gettingvideo content on iTunes has changed, given the increase in available contentonline, and I’m talking about different forms other than professional long-formcontent. Would you guys look to add new forms of content as we move forward?

Peter Oppenheimer

You know, I’m not sure I completely understand yourquestion, but we’ve got the largest library of content available in the worldfor sale to customers, more than 5 million songs, over 500 movies, and hundredsof TV shows. I think our store is unparalleled to anybody else’s.

Andy Hargreaves -Pacific Crest Securities

Okay, and then on the rebates, if we could touch on thatreal quick; can you give us any qualitative or quantitative info on how much insales each $100 rebate has brought back? And then, what the percentage of thosethat have been redeemed are?

Peter Oppenheimer

Sorry, those are not details that we are going to get into.I think customers have really appreciated the $100 credit that we’ve offeredthem and as I’ve said a couple of times this afternoon, we expect most people toredeem by the end of the December quarter.

Andy Hargreaves -Pacific Crest Securities

Thanks.

Nancy Paxton

Thank you, Andy, and apologize for all the technicaldifficulties. A replay of today’s call will be available as a podcast on theiTunes store, as a webcast on Apple.com/investor, and via telephone, and thenumber for the telephone replay is 719-457-0820, the confirmation code is4434584. And these replays will be available beginning at approximately 5:00p.m. Pacific Time today.

Members of the press with additional questions can contactSteve Dowling at 408-974-1896. Financial analysts can contact Joan Hoover or mewith additional questions. Joan is at 408-974-4570 and I’m at 408-974-5420.Thanks again for joining us.

Operator

That does conclude today’s teleconference. We would like tothank you all for your participation and have a great day.

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