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Apple Inc. (NASDAQ:AAPL)

F2Q08 Earnings Call

April 23, 2008 5:00 pm ET

Executives

Nancy Paxton - Senior Director, Investor Relations and Corporate Finance

Peter Oppenheimer - Chief Financial Officer, Senior Vice President

Timothy D. Cook - Chief Operating Officer

Gary Wipfler - Treasurer

Analysts

Ben Reitzes - Lehman Brothers

Bill Fearnley - FTN Midwest

Mike Abramsky - RBC Capital Markets

David Bailey - Goldman Sachs

Katy Huberty - Morgan Stanley

Richard Gardner - Citigroup

Andrew Neff - Bear Stearns

Gene Munster - Piper Jaffray

Shannon Cross - Cross Research

Keith Bachman - Bank of Montreal

Shaw Wu - American Technology Research

Jeff Fidacaro - Merrill Lynch

Toni Sacconaghi - Sanford Bernstein

Charles Wolf - Needham & Company

Operator

Good day, everyone and welcome to this Apple Incorporated second quarter 2008 quarterly results conference call. Today’s call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Nancy Paxton, Senior Director Investor Relations and Corporate Finance. Please go ahead.

Nancy Paxton

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

Please note that some of the information you will hear during our discussion today may consist of forward-looking statements regarding revenue, gross margin, operating expenses, other income and expense, stock-based compensation expense, taxes, earnings and future products. Actual results or trends could differ materially from our forecasts.

For more information, please refer to the risk factors discussed in Apple's Form 10-K for 2007, the Form 10-Q for the first quarter of fiscal 2008, and the Form 8-K filed with the SEC today and the attached press release.

Apple assumes no obligation to update any forward-looking statements or information which speak as of their respective dates.

And with that, I would like to turn the call over to Peter Oppenheimer for introductory remarks.

Peter Oppenheimer

Thank you, Nancy and thank you for joining us. We are very pleased to report the highest March quarter revenue and earnings in Apple's history. Revenue in the March quarter was $7.51 billion, an increase of more than $2.2 billion over the previous March quarter’s revenue of $5.26 billion. The tremendous growth in the quarter was driven by very strong demand for Macs, higher revenue from iPod and iTunes and the continued popularity of the iPhone.

Operating margin for the quarter was better than expected at 17.5%, primarily due to the higher-than-anticipated revenue and gross margin. Net income was $1.05 billion, which was up 36% over the prior March quarter’s results and translated to earnings per share of $1.16.

Before going through the details of the March quarter, I would like to give you a few data points indicating just how exceptionally well Apple performed. Revenue growth in the March quarter accelerated to 43% year over year, which is more than twice the 21% growth rate we achieved in the March quarter last year.

We saw healthy growth in all regions, with the U.S. sales growing 40% and international sales growing 47%.

Sales in our 208 retail stores, most of which are in the U.S., were extremely strong, growing 74% year over year, driven in part by traffic of 33.7 million visitors, up 57% from the year-ago quarter.

In the retail stores, 50% of the CPUs we sold were to customers who were new to the Mac, adding growth to our platform.

And finally, our U.S. education business generated Mac unit growth of 35% year over year, its highest growth rate in any quarter in the last eight years.

I would now like to talk about our Mac products and services, which represented 59% of total quarterly revenue. We are extremely pleased to have shipped 2.29 million Macs, just shy of the record number of Macs we sold this past holiday quarter and representing 51% growth over the prior March quarter’s results.

This is a 3.5 times the overall PC market rate of growth for the March quarter based on the latest forecast published by IDC, up from the 2 to 3 times market growth rate we have been reporting almost every quarter for the last three years.

Sales of desktops grew 37%, driven by strong demand for the iMac, as well as increased sales of Mac Pro, which we updated in January.

Sales of portables grew 61%, driven by continued strong demand for Macbook and Macbook Pros, both of which were refreshed during the quarter, as well as the successful launch of the Macbook Air. Macbook Air represents a new portable category for Apple and customers have responded very well to its breakthrough design and ultra portability.

We ended the quarter with between three and four 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 10.6 million iPods, an increase of 1% from the year-ago quarter, and we experienced about the same seasonal rate of decline between the December and March quarters as we did last year.

iPod revenue grew 8% year over year from higher ASPs in every geographic segment due to the success of the iPod Touch. We continue to be very pleased with customer response to the iPod Touch and believe the introduction of the software development kit in late June will broaden this appeal even further as great new applications are developed.

After declining 17% year over year in the December quarter, Shuffle sales were also down significantly in the March quarter but the weekly rate of sales improved considerably following the February 19th price reduction.

We continue to achieve our objectives of maintaining our high MP3 market share in the U.S. and gaining share internationally. Our share of the U.S. MP3 market was 73% according to the latest data published by NPD. Outside the U.S., we gained share in nearly every market we have data for based on the latest information from GFK and BCN.

We began and ended the quarter within our target range of four to six weeks of iPod channel inventory.

Sales from iTunes were very strong in the quarter and NPD reported that we have surpassed Wal-Mart to become the largest music retailer in the U.S. The iTunes store has over 50 million customers and over 85% share of the U.S. market for legally purchased and downloaded music based on the latest information from Nielsen Soundscan.

Our movie rental service has been well-received by customers and we have also just begun selling TV shows in Germany and will continue to expand video content internationally.

We are very pleased with iPhone momentum and customer feedback continues to be outstanding. We remain confident in achieving our goal of selling 10 million iPhones in calendar 2008.

We sold 1.7 million iPhones during the March quarter and expanded our sales presence to include Austria and Ireland. Total revenue recognized during the quarter from sales of iPhone, iPhone accessories, and payments from carriers was $378 million. Total deferred revenue from iPhone and Apple TV was $1.93 billion at the end of the March quarter, compared to $1.44 billion at the end of the December quarter.

Developer response to the iPhone 2.0 beta software we announced on March 6th has been tremendous. Over 200,000 developers have signed up and downloaded the software development kit. Interest in the iPhone enterprise beta program has also been off the charts. We have received applications from over one-third of the Fortune 500 and over 400 higher ed institutions. Hundreds of companies and institutions have been accepted into the program and more are being added each week.

Because we announced the specific new features to be included in the iPhone 2.0 release and plan to provide them to iPhone customers as a free upgrade in late June, we will delay the start of revenue recognition for all iPhones sold on or after our March 6th announcement date until the iPhone 2.0 software is delivered.

The revenue and cost of sales associated with these iPhones will be recognized ratably over the remaining terms of their respective 24-month estimated lives. Revenue recognition of handsets sold prior to March 6th and payments from carries has not changed as a result of our announcements.

I would now like to turn to the Apple retail stores which had another terrific quarter with revenue growing 74% year over year to $1.45 billion. The stores sold 458,000 Macs during the quarter, an increase of 67% year over year. We opened four stores during the quarter to end with 208. With an average of 205 stores opened during the quarter, average revenue per store was $7.1 million, compared to $4.8 million in the year-ago quarter, an increase of 48%.

Operating profit doubled year over year to $334 million from $164 million. A primary objective in our stores has been helping people to get more out of their Macs and the stores delivered 580,000 one-hour personal training sessions during the quarter.

We opened our 15th store in the United Kingdom during the March quarter and we looked forward to opening our first stores in Australia, China, and Switzerland in the coming months. We expect to open about 45 stores during fiscal 2008 and continue to be very confident in the investments we are making in the stores and the asset we are building.

Total company gross margin was 32.9%, which was a little stronger than our guidance due to a more favorable commodity environment, higher overall revenue, and a weaker dollar.

Operating expenses were $1.16 billion, including $112 million in stock-based compensation expense. OI&E was $162 million, below our guidance due to the lower interest rate environment.

The tax rate for the quarter was about 29%, below the expected 32% due to higher foreign earnings and lower interest income. We expect the tax rate for the second half of fiscal 2008 to be 31%.

We generated $1 billion in cash during the quarter, ending with $19.4 billion. Cash flow from operations was $1.2 billion. In the first half of fiscal 2008, we generated $4 billion in cash from $2.6 billion in net income, the difference being driven largely by the iPhone and strong working capital management.

Looking ahead to the June quarter, I would like to review our outlook which includes the types of forward-looking information that Nancy referred to at the beginning of the call.

For the quarter, we are targeting revenue of about $7.2 billion, or approximately 33% growth over the prior June quarter. We expect the total quarterly costs of non-cash stock-based compensation to be approximately $135 million.

We expect gross margin to be about 33%, reflecting approximately $20 million related to stock-based compensation expense.

We expect OpEx to be about $1.185 billion, including about $115 million related to stock-based compensation expense.

We expect OI&E to decline to about $115 million due to the impact of recent interest rate cuts, and we expect the tax rate to be about 31%.

We expect to generate EPS of about $1.00.

In closing, we are extremely proud of our growth and business performance in the March quarter. Our 51% Mac sales increase is the strongest quarterly growth rate we’ve generated in almost two decades and 3.5 times the market rate of growth. We are very excited about the delivery of the iPhone 2.0 software in late June and the vast potential for compelling solutions that our SDK opens up for the developer community.

We remain very confident in our business and continue to be excited about the new products in our pipeline.

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will come from Ben Reitzes with Lehman Brothers.

Ben Reitzes - Lehman Brothers

Good afternoon. Thanks a lot. Nice revenue and performance. I wanted to ask you a little bit about gross margin. You know, 32.9 was really good but I was wondering if you had thought actually more could flow to the bottom line and what maybe some of the negative cross-currents were. And then also, what gives you the confidence of 33% the next quarter? Just a little bit more on that would be helpful, thanks, and then I just have a follow-up on iPhone.

Peter Oppenheimer

Ben, maybe I’ll let Tim make a few comments about the commodity environment and then let me talk more broadly about gross margin in the March quarter and what we expect in June.

Timothy D. Cook

Ben, commodity pricing in both DRAM and the NAND Flash markets hit historically low levels during the March quarter and we would expect that pricing in the current quarter to remain favorable, and we folded that into our guidance.

We believe that the LCD markets near a supply/demand balance and we’ll have relatively stable pricing.

Hard drives, optical drives and most other commodities are in a supply/demand balance and we would expect these commodities to follow historical pricing trends.

Ben Reitzes - Lehman Brothers

And in terms of the quarter, did anything go against you though that was unexpected in the gross margin line, or was there an impact from the lower price of the shuffles that maybe some of us didn’t anticipate?

Peter Oppenheimer

Let me continue on and I’ll address that and talk a little bit about the June quarter as well. As we commented in last quarter’s call, we expected gross margin to decline by about 2.7%. We actually exceeded our guidance this quarter by 90 basis points and the gross margin only reduced by 1.8%.

And the better-than-expected results were primarily due to the favorable commodity environment that Tim discussed, higher revenue in the quarter, and a weaker dollar. The sequential declines in Q1 was primarily due to Leopard entering its second quarter of sales, and as we mentioned on last quarter’s call and as we have seen in the past, a new OS has significantly more sales in its debut quarter. And the change in Leopard and the other Apple software sequentially accounted for over 80% of the gross margin decline that we saw, as we expected.

Other factors affecting gross margin in the quarter were the Shuffle price change; we took several international price reductions as a result of a changing currency market; a higher mix of iTunes, which has lower gross margin; and a sequential decline in the revenues from the holiday quarter, again which were expected.

These factors were somewhat offset by favorable component pricing, allowing us to achieve a gross margin of 32.9%, again which was ahead of our guidance of 32.

Ben Reitzes - Lehman Brothers

That was pretty detailed. That’s good. In terms of the iPhone, just really switching up and then I’ll cede the floor here, with regard to the iPhone we’ve all noticed less availability, especially as we got towards the end of the quarter and recently. Is there anything -- and then we are widely expecting new products, but is there anything you can say that will give us confidence that you can grow that segment sequentially given the current amount of supply out there? Is there anything you are worried about and what not on the iPhone side in terms of shortages or anything? Or should we assume that you have a handle on that and can grow that business sequentially?

Timothy D. Cook

We are confident on hitting the 10 million for the year. I think that would be the main point.

In terms of the shortages that you referenced, we expected iPhone to decline more on a sequential basis than it did, so we really beat our unit expectations and as a result, as we got toward the end of the quarter we started to experience some stock out.

At this point, both inventory in our stores and our channel inventories are currently low. Our U.S. stores have experienced more stock outs, or relatively more, and we believe the reason is that there are more phones being bought there with the intention of unlocking, which remains a significant number.

Ben Reitzes - Lehman Brothers

Okay, and you don’t want to clarify that number this time?

Timothy D. Cook

I can’t clarify it. It’s not that I don’t want to; it’s that it is very difficult to come up with a very precise estimate of it, but we do believe the number continues to be significant and our view continues to be that this is a proxy for the worldwide demand of the phone, and our focus is very much on rolling out to more geos and we are on target to roll out into more countries in Europe and to enter Asia later in the year.

Ben Reitzes - Lehman Brothers

Great, thanks so much, guys.

Operator

We’ll move to Bill Fearnley with FTN Midwest.

Bill Fearnley - FTN Midwest

I wanted to ask a couple of channel questions, if I could. Could you guys give some more color on the direct versus indirect mix? And then also, could you give us any update on where you are with the expansion of the Best Buy footprint?

Peter Oppenheimer

Bill, the direct sales in the quarter were 53% and that was up from 49 in the year-ago quarter.

Timothy D. Cook

And in terms of Best Buy, we ended with a little over 400 stores, which was to our plan, and we continue to target to be at 600 in the summer. The rollout is going extremely well and we are very, very happy with it.

Bill Fearnley - FTN Midwest

And then a follow-up on education, if I could; with education, can you delineate between student buy programs and institutional buying and education, what you experienced this quarter and what you experienced for the upcoming quarter?

Timothy D. Cook

The numbers that Peter quoted in the preamble, we were up 35% and both institutional and individual buying was relatively strong. The quarter that we are now in is a big K-12 quarter and of course back to school is more of a higher education quarter. I wouldn’t want to predict exact numbers but as Peter had mentioned, the 35% is the highest growth rate we’ve seen in ED in eight years.

And we recently learned that we surpassed Dell last year in the portables market share for higher education, so we have significant momentum in this area.

Bill Fearnley - FTN Midwest

And there has been a lot of chatter about state and local government spending. Are you guys happy with the institutional part of the education business?

Timothy D. Cook

I am always worried about budgets and will continue to worry about budgets but the results that we have seen to date, with a 35% increase year over year, we have not seen any issue today.

Bill Fearnley - FTN Midwest

Appreciate it, thank you.

Operator

We’ll move on to Mike Abramsky with RBC Capital.

Mike Abramsky - RBC Capital Markets

Thanks very much. Can you just qualify a little bit more the reasons for the delay of the start of revenue recognition on the iPhone and what your thinking was there based on the 2.0 release? And also, what kind of impact we should -- how we should think about relaying that into our iPhone numbers?

Peter Oppenheimer

We are doing this -- as I said in my prepared remarks -- because we announced specific new features that will be included in the iPhone 2.0 software that we plan to provide for customers for free who purchased after our announcement on March 6th. So we will delay revenue recognition on phones sold between March 6th and the date of the delivery of the software.

Once we deliver the software, we will resume recognition, revenue recognition of the phones on what we sold between March 6th and that date and begin to recognize, as we had in the past, iPhone revenue on a go-forward basis. And as I said in my prepared remarks, this does not impact phones sold prior to March 6th or payments from carriers.

Mike Abramsky - RBC Capital Markets

Okay, so really what we are looking at is just the exclusion of hardware revenue next quarter, really from iPhone?

Peter Oppenheimer

Until the software is delivered.

Mike Abramsky - RBC Capital Markets

Okay and just on the iPhone with regard to your 10 million guidance, can you talk a little bit about how important either 3G might be to that or how important at least the timing of some of your pending products that you are referring to in your press release and on your excitement around the iPhone kind of weighs into that 10 million, based on current momentum?

Timothy D. Cook

We don’t comment on new products but I would just reiterate that we are confident with hitting the 10 million and obviously a part of that is rolling out to more geographies and we’ve been working very hard at this and feel confident that we will be able to roll out in more places than Europe and to enter Asia during the year.

Mike Abramsky - RBC Capital Markets

And does that forecast include some now going forward assumption on your part of an unlocked phone percentage?

Timothy D. Cook

The unit number includes phones of all types, locked and unlocked.

Mike Abramsky - RBC Capital Markets

And then final question, you haven’t said anything in your call about economic headwinds. It’s obviously something people are focusing on. It seems you are benefiting from resistance to some of those headwinds and also share gains. Any commentary you can offer in addition to the comments you’ve made that help us understand some of the kind of sustained drivers of that?

Peter Oppenheimer

We are going to leave economic commentary to others and we are focused on managing our business, which performed exceptionally well in the March quarter, and I credit it to just outstanding innovative products that drove amazing results.

The U.S. business performed quite well in March. Our revenue grew 40% and this growth rate was twice last year’s March quarter U.S. growth rate of 20 and faster than we grew in the December quarter of 27%.

Mac sales in the U.S. were up 51% and traffic through our stores were up 12 million people year over year and we only have 208 stores. So look, we remain very confident in our business, in our strategy, and we will continue to invest in hardware and software products to delight our customers.

We read the same things that you do but I have provided guidance for the June quarter, which has revenue growing at 33% and again, that is an acceleration from the rate we saw last June by about 10 points.

Mike Abramsky - RBC Capital Markets

Okay, thanks.

Operator

We will move to David Bailey with Goldman Sachs.

David Bailey - Goldman Sachs

Thank you very much. I was wondering, did you give a date on when you are expecting to deliver the 2.0 software for the iPhone? And could you help us understand what impact that has on gross margin, if any?

Peter Oppenheimer

David, what we said is we intend to deliver the iPhone 2.0 software in late June and I have included the delay in revenue recognition in the 33% gross margin that I have given you for the quarter. And again, this affects iPhone handset sales only between March 6th and when we deliver the software and it does not impact phones sold prior to March 6th or payments from carriers.

David Bailey - Goldman Sachs

But it is fair to say it does have negative impact on gross margin during that period?

Peter Oppenheimer

Well, we will not recognize revenue until we deliver the software, and so that has an impact.

David Bailey - Goldman Sachs

And then just on your target for the June quarter, you have revenue down I think 4% quarter over quarter, and typically it is up. Is there any particular area that you expect to be sub-seasonal in the next quarter?

Peter Oppenheimer

Well, let me talk a little bit about it. We are guiding to $7.2 billion, which again is a 33% increase from the year-ago quarter and is an acceleration of about 10 points from what we saw last June where we grew 24%.

We factored several things into our thinking. First, our Mac channel inventory this past quarter did increase by about 60,000 in the March quarter, as a result of the Macbook Air launch and accelerated sales velocity.

Second, we will not begin recognition of new iPhone sales until we deliver the iPhone 2.0 software in late June, as I’ve discussed.

Third, we expect a sequential decrease in iPod sales, as we have seen in the last couple of years, so nothing new there.

And fourth, we will see the full quarter impact of the iPod Shuffle and some international price reductions that we took in February.

So that’s what went into our thinking but again, I couldn’t be happier with the performance of the business. I think the guidance we are giving is very strong and would just end by saying again, it’s a growth rate that is faster than what we saw in the year-ago quarter.

David Bailey - Goldman Sachs

Thank you very much.

Operator

We will move to Katy Huberty with Morgan Stanley.

Katy Huberty - Morgan Stanley

Good afternoon. I want to go back to the margin question because this is the first quarter that both growth and operating margins are down year-on-year since March of ’06. Peter, do you feel that you now need to reinvest some of the margin upside to address the growth opportunities internationally and in some of the new product categories, such that year-on-year declines will be more of the norm going forward? Or was there something specific in the calendar for first quarter that will go away later this year?

Peter Oppenheimer

Katy, again when we gave you our guidance in January, we gave guidance for 32% gross margin and we reported 32.9, so we did better than we thought, so our gross margin was better than what we had expected.

We are continuing to come out with new innovative products. It is a competitive world and we are thinking thoughtfully about driving growth both in our top and bottom lines and continuing to gain market share in all three of our product areas.

Katy Huberty - Morgan Stanley

And then Peter, just quickly, are you still planning to open about half of the new stores internationally this year?

Peter Oppenheimer

I don’t know if it will be quite half but our international store openings will be greater this year than they were last. As of the end of the quarter, we had 208 stores open in total and 27 of those were outside the U.S. And we’ve increased our store opening forecast this year by a little bit to 45 stores for the year.

Katy Huberty - Morgan Stanley

Great, thanks.

Operator

We’ll move to Richard Gardner with Citigroup.

Richard Gardner - Citigroup

Thanks, Peter, and Tim, and everybody, actually. I wanted to ask about the gross margin. I am still struggling to understand the gross margin that you reported in the quarter. I understand that you said that the decline in Leopard sales represented the biggest portion of that but it looked like from the segment data that you reported that Leopard revenue was down about $100 million sequentially perhaps. And so that would be about a point of impact on the gross margin sequentially. And given the price cut you did on Shuffle, it seems like that at most was another point impact on the gross margin. And yet since October we’ve had DRAM and NAND pricing down 60% to 70% or more and panel pricing has been pretty favorable as well.

So I’m just wondering if there was anything about the timing of when you procured the components that went into the systems that you built in Q1 that had an impact on the gross margin. In other words, was a lot of the NAND and DRAM that went into Q1 products procured in the December quarter? And if that’s the case, should we expect to get some benefit as you procure a lot of NAND and DRAM now at much lower prices on the Q2 gross margin? Thank you.

Peter Oppenheimer

Rich, let me -- I’d like to make a couple of comments about some of the first things you said and then Tim can address some of your later points.

Our Leopard revenues in the December quarter as we talked about in January was $170 million, and they were just over $40 million in the March quarter. So together, a little over $210 million in the first half. Leopard is by far the best-selling release in our history.

But the sequential decline in Leopard and also iLife and iWork went into its third quarter, were a bit greater than what you thought, so the impact of sequential gross margin decline therefore was a little bigger.

And you also have to factor in, in addition to the pricing actions that we took, lower sequential revenue, so we had less leverage on fixed costs, and iTunes was a bigger mix of the business this quarter than last, and it has a lower gross margin as well.

So there were a number for factors that played into the gross margin coming down but again, it’s better than what we expected it to be. We guided to 32 and achieved 32.9. Tim.

Timothy D. Cook

I’d just add, Rich, that the component advantages as you said were large during the quarter, and those really offset most of the later points that Peter talked about, which were the Shuffle price cut, the international price cuts that we did to adjust for currency, the higher mix of iTunes sales, and the lower overall revenue and the effect it has on the structure.

And so we did receive significant benefit, particularly in the DRAM and NAND Flash areas.

Richard Gardner - Citigroup

And if I could follow-up, Tim, with one other question; you mentioned that you said that you thought that memory pricing would continue to be very favorable in the June quarter and yet in the case of both DRAM and NAND, we’re at very, very low levels and in many cases for many suppliers, close to cash costs. What gives you confidence that the pricing will continue to be favorable here as we go into the second quarter and you and other companies start to procure more DRAM and NAND for typical seasonal build?

Timothy D. Cook

To be specific here, favorable does not mean that it goes lower than where it was in March. It means that we envision it trading in a fairly narrow trading range and therefore not increasing that much as we head into the quarter. But I don’t believe that it will go lower because as you say, many people are already charging -- certainly not absorbing all of their fixed cost in the current prices.

Richard Gardner - Citigroup

Okay. Thank you.

Operator

We’ll move to Andrew Neff with Bear Stearns.

Andrew Neff - Bear Stearns

Just a couple of quick things; one, on OI&E, is there anything aside from lower interest rates, given your cash flows, leading to a lower number? Two, can you give us a sense about what the delay in the iPhone recognition meant to the current quarter? Three, the tax rate, can you clarify whether it was down this quarter and this 31%, do we use that going forward? And last, just in terms of as you look at the consumer, obviously you had great numbers but are you seeing any impact on the consumer, are you taking steps to address that -- can you just talk about consumer behavior in general?

Peter Oppenheimer

I may not get all of your questions so if I forget one, remind me and I’ll certainly come back to it. I’m going to actually just probably go in reverse order.

In terms of the consumer, we had a very good December quarter and we had an amazing March quarter and I in my prepared remarks wanted to go through some things that I thought would be helpful to you, and I think in a prior question I did, but I’ll go back through just a couple of them.

Particularly in the U.S., our revenues in the United States grew 40% year over year; Mac shipments were up 51% in the U.S., basically at the level we saw around the world; and we saw about 34 million people in our 208 retail stores, most of which were in the U.S.

So our business performed exceptionally well in the March quarter across each of our customer segments, including our retail stores.

In terms of the tax rate, we had been forecasting 32% for the year. With a higher mix of foreign earnings that we saw in the March quarter and lower interest income really as a result of the rate environment, our tax rate for the year looks to be 31%, and so that’s what we are forecasting for the June quarter and for the September quarter. And so in order to get the 31% for the year, we had an adjustment in the March quarter and that is why the tax rate was 29%.

And then I know that you had an OI&E question which I am going to let Gary answer, but was there one other before I turn it over to Gary?

Andrew Neff - Bear Stearns

Just the impact of the iPhone recognition in the current quarter, is there some way to quantify what that was?

Peter Oppenheimer

Well, you’ll have to make your estimates but we sold 1.7 million phones during the quarter. We made the announcement on March 6th. You know what we sell the phones for and we recognize the revenue over 24 months. Gary.

Andrew Neff - Bear Stearns

Just to clarify then, the number that you sold, that is still in the -- I just want to make sure I understand it. So that of the -- after March 6th, if you sold, you still counted them as shipments; you just don’t show the revenue is what you are saying?

Peter Oppenheimer

Correct.

Andrew Neff - Bear Stearns

And Gary, just on the OI&E?

Gary Wipfler

I think you asked if there was anything else in the OI&E besides lower effective yields, and the answer is no. We are basically investing in a very short dated, high quality, highly liquid instruments and as consequence, the yield on our portfolio has dropped a little bit, 4.9% a quarter ago. We exited the last quarter -- we were earning about 3.9% and we expect it to go down a little bit more. And there wasn’t any material write-offs in the portfolio. In regard to investments and auction rate securities and asset-backed securities, we don’t have any of those.

Andrew Neff - Bear Stearns

Any further thoughts on cash use, what you are going to do with all that cash?

Peter Oppenheimer

No change to announce to you today.

Andrew Neff - Bear Stearns

Thank you.

Operator

We’ll move to Gene Munster with Piper Jaffray.

Gene Munster - Piper Jaffray

Good afternoon. Hopefully one last question on the iPhone and the March 6th date; so you obviously recognize -- do not recognize the revenue after March 6th but you would recognize the costs and the expenses related to that, is that correct?

Peter Oppenheimer

No, Gene. We will delay recognition of both the revenue and the product costs on the iPhone beginning on March 6th until we release the software, but we will continue to expense our operating expenses around selling and advertising and engineering as period costs as we always have.

Gene Munster - Piper Jaffray

Okay and then second is will you be charging for the upgrade for those who bought iPhones before March 6th for the version 2.0?

Peter Oppenheimer

No, as I said in my prepared remarks, we will be providing that software to the then current iPhone customers for free.

Gene Munster - Piper Jaffray

Okay. So then why if everybody is going to get it for free, why are you deferring after March 6th?

Peter Oppenheimer

Because the customers that purchased the phone on or after March 6th presumably were aware of the software that we told them that we were going to come out with and that they were going to get it for free, and as a result of our announcement the way you properly account for that is to defer the revenue and that is what we are going to do.

Gene Munster - Piper Jaffray

And just lastly as far as the inventory in the U.S. Apple stores throughout this quarter, should we assume that it will start to creep back up throughout the quarter, or should we just kind of assume it’s going to be sporadic availability throughout the quarter?

Timothy D. Cook

We are shipping product every day, Gene, but I am not going to forecast the exact in-stock levels of the stores. But we’ve factored in our current thinking of supply/demand into the guidance.

Gene Munster - Piper Jaffray

Thank you.

Operator

We’ll move to Shannon Cross with Cross Research.

Shannon Cross - Cross Research

A couple of questions; the first, can you talk a little bit about what we are seeing with the pricing at some of your European carrier partners with regard to the iPhone? Who bears the cost on this? Is this something carrier driven? Any commentary you can make on that?

Timothy D. Cook

The carrier partners are free to price the iPhone as low as they wish and beyond that, I wouldn’t comment on the specific commercial arrangements between us and the carriers because those are confidential.

Shannon Cross - Cross Research

Okay, and any thoughts on maintaining a 2.5G iPhone once the 3G is out?

Timothy D. Cook

We don’t comment on new products, sorry.

Shannon Cross - Cross Research

Okay, thought I would try. You know, we’ve got to try sometimes. Anyway, final question though is on the channel, because obviously your Mac sales were quite strong. Can you talk a little bit about where you are seeing the strength in the channel? Obviously you are expanding a bit more on your stores but from a CES standpoint or consumer electronics versus direct?

And then also just any comment you can make about linearity during the quarter? Thanks.

Timothy D. Cook

First of all, we are seeing strength in all geographies. It has been amazing at how balance it has been. If you look at the Mac, in the Americas we were up 52% year over year; in Europe, we were up 48%; in Japan, we were up 47%; and so it is very solid throughout. In Asia-Pacific we were actually up 62. And so these are obviously all multiples to the market growth.

Within each of those, the consumer appears to be very strong. Our pro business also had a very nice pick-up last quarter. The Mac Pro sold more units since it debuted with the new Intel processor. Education was up 35% in the U.S. And so overall, just strength everywhere. We felt very good.

Shannon Cross - Cross Research

Okay, and then linearity during the quarter for both iPhones as well as Macs?

Timothy D. Cook

On the Mac side the only unusual thing in the linearity side was we started shipping the Macbook Air late in January. It was constrained most of the quarter and so a lot of those shipments did go out in the month of March.

By the end of March, we were at near a supply/demand balance on it.

Shannon Cross - Cross Research

Okay, and then just one final question -- well, actually, linearity on iPhone and then --

Timothy D. Cook

iPhone again, we really outstripped our supply toward the end of the quarter because we sold more than we had expected. We thought there would be a -- more of a sequential decline there than there was. It was reasonably strong throughout but March in particular was strong.

Shannon Cross - Cross Research

Okay, great. And then just any indication you can give us with regard to Macbook Air on gross margins above or below -- I don’t know, anything you’d give us as a metric?

Timothy D. Cook

The customers love it.

Shannon Cross - Cross Research

So no comment on gross margins? Okay. Thanks.

Timothy D. Cook

Not at the individual unit level.

Shannon Cross - Cross Research

Okay. Thank you.

Operator

We’ll move to our next question; Keith Bachman with Bank of Montreal.

Keith Bachman - Bank of Montreal

Peter, when you in fact ship the SDK, is there a catch-up period for the phones that were shipped or is it all ratably from that point?

Peter Oppenheimer

If I understand your question, Keith, we will begin to recognize the revenue and the product cost once we ship the 2.0 software over the remaining lives of the -- remaining lives for the phone.

Keith Bachman - Bank of Montreal

So there is no catch-up period, it will be ratably from that point?

Peter Oppenheimer

Ratably, yes, over the remaining life.

Keith Bachman - Bank of Montreal

Fair enough. Okay, and then Peter, I want to go to the gross margin side. When I look at the year-over-year comps, gross margins were down about 220 basis points. You flagged some areas that were different on the sequential basis. Leopard would be out of the equation; in fact, software was a richer mix when you look at March to March. Could you just pick out a couple of the other large drivers of change on a year-over-year basis? And particularly if you could identify whether the mix between CPUs and iPods was favorable or unfavorable.

Peter Oppenheimer

Keith, it is really hard for me to do year-over-year gross margin comparisons because you’ve got your different points and your product cycles, different commodity cycles, different mix. And that’s why we’ve traditionally talked about gross margin on a sequential detail and I would prefer to just stick with the sequential comments that I gave you, which again gross margin was better than what we thought it would be.

Keith Bachman - Bank of Montreal

Fair enough. Then last question for me then, Peter, if you -- you have your operating segments and if you thought about is there a deviation in the operating segments and the amount of gross margin they report by geography? In other words, was the variance in terms of the individual geographies materially different than what you had as a company as a whole?

Peter Oppenheimer

We’ll put out the 10-Q in the next week or so and our segment reporting at the gross margin level will be there. You can look at prior 10-Qs to see the different gross margins in the segments. And there’s a little bit of variability but we are quite happy with each of our segments.

Keith Bachman - Bank of Montreal

Okay, I’ll cede the floor. Thank you.

Operator

We’ll move to Shaw Wu with American Technology.

Shaw Wu - American Technology Research

I just had a question on your acquisition of PA Semi -- any comments or color you can give around that? Thanks.

Peter Oppenheimer

Shaw, we occasionally buy smaller technology companies from time to time and we don’t have a practice of commenting on our purpose or plan, so I can’t.

Shaw Wu - American Technology Research

Okay, thanks.

Operator

We have Jeff Fidacaro from Merrill Lynch.

Jeff Fidacaro - Merrill Lynch

Peter, I was wondering if you could touch on the Mac side. When you take a look at PC unit growth, typically it’s down quarter over quarter in the calendar second quarter. Given your strength has accelerated to about three times the market growth, I wonder if you could highlight any comparable seasonality in the Mac business in your June quarter.

Peter Oppenheimer

What we generally see in June is a sequential increase in Mac shipments as the education buying season begins and the June quarter tends to be more heavily weighted to K-12, which buys typically at lower ASPs, and the September quarter tends to be more heavily weighted within the ED buying season by higher education.

Jeff Fidacaro - Merrill Lynch

And just one follow-up; if I move over to the iPhone, when you look at the unlocked or non-activated phones in the prior quarter, some of that was gifts that were bought late in the holiday season. Have you seen any change in behavior from the carryover from that December quarter? Were they actually activated? Have you seen any significant changes?

Peter Oppenheimer

As Tim commented, it’s really hard to estimate precisely and we don’t want to throw a number out. Unlocking is occurring and it is significant but our view is that this is -- it’s just a clear interest in demand globally for the iPhone and we think it -- we are hearing reports of iPhones being used in many countries and this is one of the things that gives us confidence in our goal of shipping 10 million in calendar 2008.

Jeff Fidacaro - Merrill Lynch

Thank you.

Operator

We’ll move to Toni Sacconaghi with Sanford Bernstein.

Toni Sacconaghi - Sanford Bernstein

Thank you. I was hoping you could reconcile your statement that iPhone demand was outstripping supply at the end of the quarter with what appears to be an excess supply in most European countries of the phone. You indicated that they can price as they want and we are seeing price cuts of over 50% on the phone, which certainly doesn’t sound like a situation where they are under-supplied.

Were you seeing a noticeably different demand profile in the U.S. relative to your expectations versus Europe? And if so, why couldn’t you simply ship phones from what appears to be an overstocked Europe to the U.S. to fulfill that demand?

Timothy D. Cook

Tony, my point was that stock-outs were occurring in our own stores toward the end of the quarter and we believe that was because our stores are more susceptible to people going in and buying multiple units and then unlocking and exporting them.

However, I also added that currently inventories are low in both our stores and in the channel.

Toni Sacconaghi - Sanford Bernstein

And is that also the case in your European channel or is that an aggregate channel statement?

Timothy D. Cook

I don’t want to be specific at the carrier level but I the aggregate, Europe is low. In the aggregate, the U.S. is low.

Toni Sacconaghi - Sanford Bernstein

And at the very end of the quarter where you were having stock-outs in your own stores, was your channel inventory also low? Because it seemed like the phones were readily available in Europe and through AT&T stores, which obviously beg the question of why were you not able to better balance the allocation of phones, particularly towards the end of the quarter?

Timothy D. Cook

Once the units are already shipped and designated to a carrier, the ability to move them from carrier to carrier is very low. And so you can have very short-term cases where there is some imbalance. But I think the major point is that we sold more than we thought we would and that today, inventories are low and in aggregate in Europe and in aggregate in the U.S.

Toni Sacconaghi - Sanford Bernstein

Can you comment on whether you thought you sold more in Europe than you thought you would?

Timothy D. Cook

No, I’m just going to comment that in total, that we sold more than we expected. We expected a sharper seasonal decline than what we experienced and as you know, this was our first Q1 to Q2 that we’ve been in the phone business, and so we’ve learned something.

Toni Sacconaghi - Sanford Bernstein

And then staying with the phone, I know a couple of other people have asked but last quarter on this call, you said you weren’t comfortable discussing the unlocked percentage because of the high concentration of phones that had been sold at the very end of December and the holiday season and that you felt you’d get a better read on that in January. Invariably you have gotten a better read on that, and so given that you had given out the number before, or an estimate of that number, why the reticence now give at least for last quarter you should have ample ability to be able to quantify that?

Timothy D. Cook

We don’t feel that we can quantify it with precision, and so we don’t want to put out a number that we can’t stand behind. But we’ve gone out of our way to classify the number as significant. I’m not sure how to be more clear than that.

Toni Sacconaghi - Sanford Bernstein

And then switching to Macs, your notebook ASP declined sequentially and year over year, given that you introduced the Macbook Pro which sounded like got off to a good start, and you also mentioned strength in Macbook pros. Were those both relatively small and were price cuts relatively big? Or how do we reconcile the ASP decline?

Peter Oppenheimer

The ASP decline was slight, both on a sequential and year-over-year basis and they were largely driven by the transition that we had in the quarter and some mix shifts within our Macbook and Macbook Pro lines. But again, they were small.

Toni Sacconaghi - Sanford Bernstein

Okay. Thank you very much.

Operator

We’ll move to Charles Wolf with Needham & Company.

Charles Wolf - Needham & Company

I have a couple of questions; one is do you have any color that you can provide on the demographics of Macbook Air purchases? You know, I originally thought it would be for road warriors but the numbers suggest it is selling far better than that.

And sort of in the same vein, do you have any sense of how many Window users purchased a Macbook Air?

Timothy D. Cook

We don’t on the latter, Charlie. What we would share is that it is appealing to all sorts of people, from college professors to students to people that travel a lot. It seems to have universal appeal and also the cannibalization factor was extremely low to the other portables, which is one of the key reasons we were able to have a very minor sequential decline from Q1, where usually it would be much deeper.

Charles Wolf - Needham & Company

Thank you.

Nancy Paxton

Thanks, Charlie and thanks to everyone for joining us. A replay of today’s call will be available for two weeks as a podcast on the iTunes store, as a webcast on apple.com/investor and via telephone. And the numbers for the telephone replay are 888-203-1112, or 719-457-0820, and the confirmation code is 7414725. These replays will be available beginning at approximately 5:00 p.m. 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 am at 408-974-5420. Thanks again.

Operator

That does conclude today’s conference call. We do thank everyone for their participation.

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