Apple Inc., Q4 2008 Earnings Call, Oct-21-2008 - NasdaqGS:AAPL

NasdaqGS:AAPL

During the Apple Inc. Q4 2008 Earnings Call, Timothy D. Cook, an executive at Apple, provided several insights and responses to analyst questions. Here is a detailed list of his comments:

1. Mac Channel Inventory:

   • Began and ended the quarter with between three and four weeks of Mac channel inventory, which is below the target range of four to five weeks.
   • This indicates a healthy turnover of Mac inventory.

2. iPod Channel Inventory:

   • Began and ended the quarter with between four and six weeks of iPod channel inventory, which is within the target range.
   • This suggests appropriate inventory levels for iPods.

3. iPhone Channel Inventory:

   • By the end of the quarter, Apple was shipping iPhones to carriers in 51 countries and had over 30,000 points of distribution.
   • For the 44 countries that launched before the end of August, the weeks of inventory at the end of the quarter was less than six weeks.
   • For the remaining seven countries where launches occurred in late September or early October, there wasn’t enough data to quantify the weeks of inventory.
   • At the end of the quarter, there was about 2 million iPhones in total channel inventory across all 51 countries, which is considered appropriate.

4. Impact on Mac Sales:

   • U.S. K-12 institutional sales were down 7% year-over-year to about 200,000 units, due to state and local budget constraints, particularly in California where sales were down 28% year-over-year.
   • Purchases of 1,000 units or more were significantly down, both sequentially and year-over-year.
   • If the unit sales had grown at the previous rate of 29% instead of contracting by 7%, Mac unit sales would have been 75,000 units higher.

5. Portable Transition Impact:

   • Customers delayed purchases due to rumors and press reports about a potential portable transition.
   • Saw some slowing in sales toward the final weeks of September and the initial weeks of October.
   • After announcing the new products, there was a considerable rebound in sales, indicating optimism for the results.

6. Q&A Session:

   • On the iPod side, iPod sales were up 8% for the full quarter. In the final weeks of September and the early weeks of October, sales were running flat year-over-year on a worldwide perspective.
   • It’s difficult to predict whether the usual seasonal holiday lift will occur in the same pattern as before due to forecasting challenges.
   • On the Mac side, there were purchasing delays due to the portable transition and the K-12 institutional business was down year-over-year in the last quarter.
   • It’s difficult to separate how much the slowdown was due to purchase delay versus the economy.
   • The rebound in sales after the announcement of the new products was great, but forecasting demand with the current visibility is challenging.

7. iPhone Volume for Q4:

   • Began shipping in many more countries, from six to 51, and launched the phone on July 11th, resulting in a channel build of about 2 million units.
   • Will expand into more countries, aiming to be in over 70 by the end of the year, but the new markets have less opportunity than the existing 50.
   • Confident that year-over-year sales will be up significantly, but the sequential growth is uncertain due to the economic climate and other factors.

8. Price and Feature Enhancements:

   • Significant price cuts on the iPod Touch, moving the entry price from $299 to $229, and other models down to $299 and $399 respectively.
   • Doubled the memory on the iPod Nano while providing a new design.
   • Lowered the entry price of the MacBook from $1099 to $999 and brought MacBook Pro features down to the MacBook price range, reducing the price gap by $700.

9. Supply and Demand Visibility:

   • Still filling the channel to get the new iPod product at the right level.
   • Felt that the level of iPhone channel inventory was appropriate.
   • Significant backlogs on the new Mac products and working hard to fill orders as quickly as possible.
   • Predicting demand is challenging, but confident in the ability to produce a lot of Macs, although it’s uncertain if it will be enough due to demand variability.

These comments provide insights into various aspects of Apple's business, including inventory management, sales trends, and strategic initiatives.

Nancy Paxton, Senior Director of Investor Relations and Corporate Finance at Apple Inc., made the following statements during the Q4 2008 Earnings Call:

1. Opening Remarks:

   • "Thank you. Good afternoon and thanks to everyone for joining us."

2. Forward-Looking Statements Disclaimer:

   • "Please note that some of the information you will hear during our discussion today will consist of forward-looking statements including without limitation those regarding revenue, gross margin, operating expenses, other income and expense, stock-based compensation expense, taxes, and earnings per share."
   • "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 three quarters 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."

3. Introduction of CFO:

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

Peter Oppenheimer, Apple's CFO during the Q4 2008 Earnings Call, provided the following information and insights:

1. Financial Highlights:

   • Apple reported record-breaking results for the September quarter, including:
     • Selling more Macs than in any other quarter in Apple's history.
     • Selling more iPhones in the September quarter than in all previous quarters combined.
     • Selling more iPods than in any prior non-holiday quarter.
     • Generating more revenue and earnings than in any previous September quarter.

2. Financial Results:

   • Revenue for the quarter was $7.9 billion, representing 27% growth over the previous September quarter.
   • Operating margin for the quarter was 18.3%, better than expected due to higher-than-anticipated gross margin.
   • Net income was $1.14 billion, up 26% over the prior September quarter, translating to earnings per share of $1.26.

3. Subscription Accounting for iPhone and Apple TV:

   • Due to providing new features and software applications to iPhone and Apple TV customers for free in the future, Apple uses subscription accounting to recognize revenue and cost of sales for these products on a straight-line basis over their two-year estimated economic lives.
   • This results in the deferral of almost all revenue and cost of sales related to iPhone and Apple TV during the quarter in which these products are sold to customers.

4. Non-GAAP Financial Measures:

   • Apple is supplementing its GAAP results with non-GAAP financial measures to provide more insight into the underlying sales trends and evaluate the sales dollars of iPhones and Apple TVs sold during the quarter.
   • Non-GAAP measures include:
     • Adjusted Sales: Totaling $11.7 billion, $3.8 billion higher than the reported revenue of $7.9 billion.
     • Adjusted Cost of Sales: Corresponding to adjusted sales, calculated by backing out the quarter's amortization of deferred costs related to iPhone and Apple TV and adding back the total cost of the iPhones and Apple TVs shipped in the quarter.
     • Adjusted Gross Margin: $4.6 billion, $1.8 billion higher than the recorded gross margin.
     • Adjusted Net Income: $2.4 billion, $1.3 billion higher than the reported net income.

5. iPhone Performance:

   • Sold nearly 6.9 million iPhones during the quarter, exceeding the 6.1 million units shipped over the entire lifetime of the first generation iPhone.
   • Recognized revenue from iPhone handset sales, accessories, and carrier payments totaled $806 million during the quarter.
   • Expanded iPhone distribution from six to 51 countries, and plans to be in more than 70 countries by the end of the December quarter.

6. Mac Products and Services:

   • Shipped over 2.6 million Macs, a new company record, representing 21% year-over-year growth.
   • Mac sales grew faster than the market but were impacted by purchase delays based on speculation about new portable launches and budgetary constraints affecting education institutions.

7. Music Products and Services:

   • Sold 11 million iPods, a new record for a non-holiday quarter, with an 8% increase over the year-ago quarter.
   • Introduced new iPod models, including the fourth-generation iPod Nano and the second-generation iPod Touch.
   • Continued to gain market share in most international markets.

8. Retail Stores:

   • Delivered strong results with revenue growing 37% year-over-year to $1.72 billion.
   • Sold 596,000 Macs during the quarter, an all-time quarterly record, with over half sold to customers who had never owned a Mac before.
   • Opened 31 new stores during the quarter, including 13 outside the U.S., ending the quarter with 247 stores.

9. Financial Metrics:

   • Total company gross margin was 34.7%, better than anticipated, due to a better component pricing environment, higher software sales, and payments from carriers related to the first-generation iPhone.
   • Operating expenses were $1.3 billion, including $120 million in stock-based compensation expense.
   • OI&E was $140 million.
   • Tax rate for the quarter was 28.2%.

10. Outlook for the December Quarter:

    • Provided guidance based on GAAP, targeting revenue between $9 billion and $10 billion.
    • Expected gross margin to be between 30% and 31%, reflecting the recent introductions of new iPods and notebooks.
    • Expected operating expenses to be between $1.45 billion and $1.47 billion, including about $150 million related to stock-based compensation.
    • Expected OI&E to be about $140 million and the tax rate to be about 30.5%.
    • Targeting EPS between $1.06 and $1.35.

11. Closing Remarks:

    • Generated nearly $32.5 billion in revenue for fiscal 2008, a 35% increase from 2007.

    • Generated $9.1 billion in cash during the fiscal year.

    • Remained focused on developing innovative products, managing the business, and gaining share in each market.

During the Apple Inc. Q4 2008 Earnings Call, Steven P. Jobs made several key points:

Opening Remarks

• Non-GAAP Financial Results Introduction:

  • Highlighted the introduction of non-GAAP financial results to eliminate the impact of subscription accounting.
  • Explained that subscription accounting spreads the impact of iPhone's contribution to Apple's overall sales, gross margin, and net income over two years, making it difficult to evaluate the company’s overall performance.
  • Noted that the iPhone business has grown to about $4.6 billion, or 39% of Apple's total business, necessitating the introduction of non-GAAP financial results.

• Impact of Non-GAAP Results:

  • Emphasized that the non-GAAP financial results are "truly stunning."
  • Reported that adjusted sales for the quarter were $11.68 billion, 48% higher than the reported revenue of $7.9 billion.
  • Mentioned that adjusted net income was $2.44 billion, 115% higher than the reported net income of $1.14 billion.

iPhone Milestones

• Outsold RIM:

  • Apple outsold RIM (Research in Motion) in the most recent quarter, selling 6.9 million iPhones compared to RIM's 6.1 million BlackBerry devices.
  • Considered this a milestone given that Apple has been in the market for only 15 months.

• World's Third-Largest Mobile Phone Supplier:

  • Based on revenues, Apple has become the third-largest mobile phone supplier, behind Nokia and Samsung.
  • Provided a breakdown of the rankings based on revenues.

App Store

• Remarkable Growth:
  • Customers will download the 200 millionth application from the App Store, only 102 days since its launch on July 11th.
  • There are now over 5,500 applications offered on the App Store in 62 countries around the world.
  • Competitors are scrambling to copy the App Store, but it’s not as easy as it looks.

New Notebooks

• Importance of Notebooks:
  • Notebooks comprise two-thirds or more of the Macs Apple sells.
  • The new MacBooks are some of the best products Apple has ever created.
  • Customers love the new MacBooks, and there has been a very strong launch.
  • The level of quality these products deliver to customers is mind-blowing for their price points.

Green Products

• Greenest Products:
  • The new notebooks are the greenest products Apple has ever offered.

Economy and Market Conditions

• Customer Base:
  • Apple has the best customers in the world, and they are unlikely to abandon the quality and seamless integration they have experienced with Apple products.
• Market Share:
  • Apple still has a minority market share of the PC market and a minuscule market share of the mobile phone market.
  • The percentage of prospective customers needed to significantly increase market share is not that many.
  • Apple retail stores sell half their Macs to new-to-Mac customers.
• Product Lineup:
  • Apple has the best product lineup in its history, and the new MacBooks should trigger a serious upgrade cycle in the installed base.
• Employee Talent:
  • Apple has the most talented and creative employees in the world.
  • Competitors cannot deliver products in the same class as Apple's.
• Financial Stability:
  • Apple has almost $25 billion safely in the bank and zero debt, providing tremendous stability and the ability to invest through the downturn.
  • The downturn may present some extraordinary opportunities for companies with cash, like Apple.

Response to Questions

• October as a Foggy Month:
  • October is a foggy month for predicting the whole quarter, and Apple is being prudent.
• Share Repurchase:
  • Economic downturn may present some extraordinary opportunities for companies with cash.
  • Apple is comfortable with its cash position and it’s not burning a hole in the company's pocket.
• Mac Pricing and Positioning:
  • Apple chooses not to play in certain segments of the market, focusing on specific segments where it can compete on price.
  • Not tremendously worried about the downturn driving customers to lower segments of the market.
• NetBook Category:
  • NetBook category is nascent and there’s not a lot of them getting sold.
  • iPhone can be considered an entry into the NetBook category, allowing for browsing the internet and email.
• iPhone Performance in the Economy:
  • Apple will be glad to tell how the iPhone performs in the economy.
• Opportunities with Cash:
  • Believes there will be some significant opportunities for companies with cash.
  • Hiring every engineer in Silicon Valley is a good idea.
• Price Umbrella:
  • Wants to deliver an increasing level of value to customers and not leave a price umbrella underneath.
  • Focuses on certain segments of the market and not trying to be everything to everybody.
• Digital Living Room Opportunity:
  • The whole category is still a hobby, and no one has succeeded at it.
  • Continues to believe it will be a hobby in 2009.
• Tablet Computing:
  • Creative people are looking at a lot of things, but cannot talk about any of the future products.
• Phone Market Opportunities:

  • Traditional game in the phone market has been to produce a voice phone in a hundred different varieties.

  • As software becomes the differentiating technology, competitors without experience in a software platform business will struggle.

  • Extremely comfortable with Apple’s strategy, approaching the market as a software platform company.