Good day, everyone, and welcome to the Apple Incorporated First Quarter Fiscal Year 2014 Earnings Release 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 of Investor Relations. Please go ahead, ma’am.

Thank you. Good afternoon, and thanks to everyone for joining us. Speaking first today is Apple CFO Peter Oppenheimer. And he’ll be joined by CEO Tim Cook, and Vice Vice President and Corporate Controller Luca Maestri for a Q&A session with analysts. Please note that some of the information you’ll hear during our discussion today will consist of forward-looking statements, including without limitation, those regarding revenue, gross margins, operating expenses, other income and expense, stock-based compensation expense, taxes, and future products. Actual results or trends could differ materially from our forecast. For more information, please refer to the risk factors discussed in Apple’s Form 10-K for 2013 and the Form 8-K filed with the SEC today, along with the associated press release. Apple assumes no obligation to update any forward-looking statements or information, which speak as of their respective dates. I’d now like to turn the call over to Peter Oppenheimer for introductory remarks.

Thank you, Nancy. We’re very pleased to report the results of the first quarter of Apple’s fiscal year ’14. We established new all-time quarterly records for iPhone and iPad sales and had one of our best Mac quarters ever, driving the highest quarterly revenue and operating profit in Apple’s history. We were also very pleased with our results in emerging markets around the world. Revenue for the quarter was $57.6 billion, up $3.1 billion, or 6%, from the year ago quarter and near the high end of our guidance range. No technology company has ever generated that much revenue in a single quarter, and we’re especially pleased to have generated that record despite foreign exchange headwinds, the year over year decline in iPod sales, and the higher revenue deferral rates from iOS devices and Macs that we discussed last quarter. These three factors negatively impacted revenue by about $2.5 billion, and without them, our year over year revenue growth would have been about 10%. Gross margin was 37.9%, above the high end of our guidance range, and operating margin was an all-time record of $17.5 billion, representing 30.3% of revenue. Net income was $13.1 billion, translating to diluted earnings per share of $14.50, a new record. As for the details of the quarter, I’d like to begin with iPhone. Despite supply constraints on iPhone 5S, we sold 51 million iPhones compared to 47.8 million in the year ago quarter. That’s an increase of over 3 million phones, or 7%, and a new quarterly record. iPhone sales growth was very strong year over year in Japan, thanks to the addition of NTT Docomo in September and our continued partnership with Softbank and KDDI. In fact, based on the latest data published by Kantar, iPhone accounts for 69% share of the smartphone…

Thank you, Peter. We ask that you limit yourself to one question and one follow up. Operator, may we have the first question, please?

[Operator instructions.] First, we’ll go to Katy Huberty with Morgan Stanley.

Peter, revenue guidance embeds a sequential decline that’s bigger than what you experienced in the March 2013 quarter, and I think implies iPhone units may not grow in the March quarter year on year. So can you just talk about what’s driving the cautious view on the top line for March?

The biggest reason for the larger sequential decline in revenue this year relates to changes in channel inventory between the years. And I’ll go through some detail, but let me actually do it on a year over year basis. I’d like to go through some things about the guidance, and I think you’ll see that the underlying performance of our business is stronger than what the guidance might imply. We expect four factors to negatively impact the year over year revenue comparison by over $2 billion. These are channel inventory increases in the year ago quarter that we don’t expect to repeat, lower iPod sales, a stronger U.S. dollar against a number of currencies, particularly the yen and the Australian dollar, and the higher per unit deferral for Mac and iOS devices that I talked about in my prepared remarks. Let me go through these a little more. First, beginning with channel inventory, in the March quarter last year, we increased channel inventory for both iPhone and iPad, whereas this year we increased the channel inventory for both product families in the December quarter, and we exited within our target range of channel inventory. For iPhone, specifically last year, the supply of iPhone 5 was short for the entire December quarter, and we were not able to achieve supply and demand balance for iPhone 5 until the March quarter. As a result, we increased the iPhone inventory last year by about 1.1 million units. In contrast, this year we executed the fastest rollout for our new iPhones, and we included China in wave one, in the launch in September, and we were able to exit the quarter in supply and demand balance. For iPad, we introduced the Mini in the December quarter last year, and we were not able to meet demand in any week of the quarter. We didn’t reach supply and demand balance for the iPad Mini until the March quarter last year, and we increased inventory in the March quarter by 1.4 million units. In contrast, this year we exited the December quarter near supply and demand balance. So looking past the inventory changes year-to-year, we expect the value of the underlying sell through to grow year over year, and we’re very confident in what we’re shipping. Turning to iPod, sales declined by 52% year over year in the December quarter, and we would expect them to continue to decline year over year in the March quarter. And FX is a headwind for us with the strengthening dollar against a number of currencies. So when you consider these factors, we’re very pleased with the underlying performance of the business and the revenue growth is stronger than what the guidance might imply.

And Peter, you’re guiding OpEx flattish sequentially, despite the big revenue downtick. Are there any one-time items in SG&A and R&D in the March quarter? Or is the run rate reflective of investments for future opportunities?

It’s definitely the latter, and let me have Luca take you through some details.

Yes, at the midpoint of the range of our guidance, we are expecting a minor decrease of $50 million. This is largely due to the lower variable expenses that we’re going to have, in line with the seasonal sequential decline in revenue. But one thing that Peter already mentioned in his remarks is that we continue to invest very heavily in R&D. We make investments in areas that are visible to all of you today, but also in areas that are not visible, which we’re very excited about. And for the things that are not visible to you, obviously were impacting ahead of the revenue that these products and services will generate in the future. So there is nothing that is one-off in nature in our guidance.

From Goldman Sachs, we’ll go to Bill Shope.

I have a question on the revenue guidance as well. The ramp of China Mobile would presumably act as a tailwind to the March quarter, yet that’s not apparent in the numbers. Can you comment on how you’re thinking about demand trends for China Mobile and perhaps how it compares to prior large carrier ramps?

Let me start, then Tim may want to have some comments. We’re thrilled to be working with China Mobile, and Docomo also. We had a great launch with both carriers, Docomo in the December quarter and China Mobile just in the last couple of weeks. These carrier additions will have a positive impact on our iPhone sales year over year. China Mobile’s 4G service is only available in 16 cities today, and they plan to complete the rollout of more than 500,000 4G base stations, which will cover more than 340 cities by year-end. With the addition of Docomo last quarter, we were able to achieve 69% smartphone market share in Japan, which we’re thrilled with. However, the benefit of these two carrier additions this quarter is being partially offset by a couple of things: first of all, the comparison last year from our late launch of the iPhone 5 and the new iPad in Mainland China, achieving supply and demand balance for the Mini and the iMac in the March quarter, and the impact of currency, particularly the yen. And we’re also deferring more revenue on the iOS devices and Mac. And so to summarize, we’re very, very pleased with what we’re seeing from both carriers. We expect to continue to do well, but we’ve got some things that are offsetting it, that we factored into the guidance.

I would add, as a further update, we’ve been selling with China Mobile now for about a week, and last week was the best week for activations we’ve ever had in China. So it’s been an incredible start, and at this moment, we’re just selling in 16 cities with China Mobile, and as Peter alluded to, this number is projected to be over 300 cities by the end of this year. And so we’ve got quite the ramp in front of us, and we’re incredibly excited. This comes after a new high water mark in China for us last quarter. We grew revenues including our retail stores at 31%, and we had some very, very strong sales on iPad. iPads in greater China were up 64% year over year, Macs were up 28%. This compares to a tablet market in China that’s growing at 21% per IDC, and a PC market that is contracting by 7%. And so in addition to the great iPhone news with China Mobile and how we’re looking there, we really turned in a stellar quarter in greater China overall, and we are very proud of it.

Can you comment on your progress so far in getting down the cost curve for the iPhone/iPad? And would you say you’re in line with the types of improvements you’ve seen in cycles prior to the iPhone 5?

You can see that we projected in the guidance, gross margins between 37% and 38%, and that’s despite going from a holiday quarter to a non-holiday quarter, which we lose quite a bit of leverage from doing that. And so one of the primary things that’s going on there is cost. So yeah, we’re happy with how we’re doing.

And next we’ll hear from Shannon Cross with Cross Research.

Can you talk a bit more about opportunities in the mobile payment market? And maybe talk about what you’re seeing with regard to use of the touch sensor for mobile payments in your iTunes store, and then how you sort of think about this as an opportunity, whether over time it’s revenue or margin?

Let me sort of avoid the last part of your question, but in general, we’re seeing that people love being able to buy content, whether it’s music or movies or books, from their iPhone, using Touch ID. It’s incredibly simple and easy and elegant, and it’s clear that there’s a lot of opportunity there. The mobile payments area in general is one that we’ve been intrigued with, and that was one of the thoughts behind Touch ID. But we’re not limiting ourselves just to that. So I don’t have anything specific to announce today, but you can tell by looking at the demographics of our customers and the amount of commerce that goes through iOS devices versus the competition that it’s a big opportunity on the platform.

And we’ll hear from Toni Sacconaghi with Sanford Bernstein.

I have one for Tim, and then a follow up, please. Tim, I wanted to just step back and talk a little bit about iPhone market share. The market data isn’t out for Q1, but if we look at your prior four quarters, fiscal ’13, Apple grew its iPhone units about 20%. The market grew in the 40s. I think this quarter, even with a new product and having China front loaded, the iPhone is going to grow at a fraction of ultimately what the market is likely to grow at. And I know your belief and philosophy historically has been that you want to make the best product, and that’s the most important thing, but in Macs, you’ve actually succeeded in making the best product and being able to gain share. You cited again how you’ve gained share in 30 out of the last 31 quarters in Mac. But in iPhone, that is not happening. And so my question is, what is different about the smartphone market that is not allowing you to hold or gain unit share despite apparently having the best product, and do you propose to do anything differently going forward, because I think it’s great to have an aspiration to make the best products, but I think that’s in the spirit of ultimately growing at least in line with or faster than the market. And that doesn’t appear to be happening.

As I’ve said before, our objective has always been to make the best, not the most. And we feel we’re doing that. If you look at what we did this year, we announced two iPhones for the first time, rather than one. And looking at last quarter, if you looked at our sell through - so not sell in, but the sell through - of what I’ll just call our entry phone, or mid phone, and our top phone, with the 5S, all of those grew year over year versus the phones that were in those categories previously. If you look at the emerging markets, which is one of the things that I’ve alluded to that we have to grow in these areas and grow at reasonable amounts, in Latin America we grew at 76% year over year. In the Middle East and Africa, we grew at 65%. In central and eastern Europe, we grew 115%. In China, we grew at 20%. However, as you know, we just added China Mobile, the largest carrier there, in this quarter, and did not have channel load in China Mobile last quarter. We just started selling those in January. Also, in Japan, as we’ve added Docomo, iPhone units were up 40%. Now, when you translate that performance into revenue in Japan, and we have the issue with the yen that Peter spoke about earlier, and so the revenue growth looks much less than that, because of the strength of the dollar there. In North America, we did not do as well, and this weighed our results. Our North American business contracted somewhat year over year. And if you look at the reason for this, one was that as we entered the quarter, and forecasted our iPhone sales, where we achieved what we thought,…

I’d like to follow that up, just on your comments on China. You’ve characterized the agreement with China Mobile as huge. Could you tell me what would define success for you in China Mobile one and three years out? What ultimately should we be looking at to measure and ultimately determine whether this was huge?

I’m not going to give you a forecast for it. I think if you just back up and look at it from a common sense point of view, China Mobile has more subscribers than anyone in the world. They have three quarters of a billion, and so I do see it as a watershed moment for Apple, and have a very strong belief in the ability of those two companies to do great things together.

Ben Reitzes with Barclays.

My question is for Tim. You’re at the midpoint of your guidance. It obviously implies a decline in revenue in the quarter coming up, and you haven’t done that forever. You came pretty close a couple of quarters ago, but you had some growth. And my question is, are you still a growth company? And should we expect the growth rate to accelerate as we go throughout the year? And why, if that’s the case?

I think it’s important to listen to what Peter said about the guidance, and about the compares year over year, and the point that he made that the underlying sell through, that we’re very confident of growth year over year. And that is the way we look at it. Some people just look at the numbers on a piece of paper, but the way I’d look at the business is our business from a sell through point of view less iPod, because I think all of us have known for some time that iPod is a declining business. And when you do that, the numbers from last quarter, and the deferral, which we’ve just increased, as Peter went through, when you look at that, and look at the numbers from last quarter, it comes up to a double digit growth. And we’re proud of that. I think that’s a pretty good result. We’ll see how we do in the March quarter, but I do think it’s important in the March quarter to take into consideration sell through versus just a view of sell in.

And I guess there’s been a lot of things in the media about your potential to buy back more stock, and shares are around $500 tonight. I was wondering if you thought this was a good level, and whether it was time to accelerate the buyback from current levels. You obviously generated a ton of cash in the quarter, and what are your latest thoughts there?

We’ve been buying back stock. As you know, last year we increased the program overall, our cash return, doubling it to $100 billion. And $60 billion of that is buyback, and we’ve been progressing on that. Luca can give you the precise numbers of it. So we’re a big believer in buying back the stock, and that doesn’t change today, whether the stock goes up or down.

From UBS, we’ll go to Steve Milunovich.

Could you talk a bit more about the gross margin? It did provide an upside surprise to your guidance in the quarter. What were the factors? And then looking forward, what are some of the gives and takes for the March quarter?

Let me answer that one. Let me start with the quarter. We were above the guidance range. It was primarily for two factors. We had favorable product mix, and we had favorable commodity pricing. And so those were the two things that actually helped us come in above the guidance range. For the quarter, for Q2, we’re guiding 37% to 38%, compared to 37.9% in the December quarter. We’re going to have some loss of leverage, as you can imagine, because of the usual seasonal decline in revenue. But we expect that loss of leverage to be largely offset by cost improvements and also by less deferred revenue that we’re going to have in Q2.

And then regarding overall demand, one thing you didn’t mention, Tim, is maturity of the particularly high end smartphone market. I know in our surveys we’re finding, relative to a year ago, a lot higher percentage or Apple buyers already have an Apple handset. So I’m curious if you think the Western world can show decent unit growth over the next year or two. And I was also wondering, the 5C generally is viewed as having turned out to be pretty light in the mix. What are you going to do with that product going forward?

Well, I’ll sidestep the last question, of course, because it’s about future products. But to your question about the 5S in particular, if I look at the sell through year over year, there was growth in that portion of the line, despite adding an entirely new phone underneath it. And so I think that’s a good sign, and that’s despite it being in short supply for the bulk or virtually all of the quarter. And so I do believe that that category of product can grow in those markets, if you’re thinking about the U.S. and western Europe, for example, and Japan. In Japan, we grew 40% last quarter. That’s fairly good.

Brian Marshall with ISI Group.

Obviously the iPhone business grew about 7% year over year, $200 million in [unintelligible] unit sales now. And that’s with two new [unintelligible] being launched in the quarter. Can you help us think about how you guys view the iPhone new user growth out there in the marketplace versus simply a solid replacement cycle that the company has in its installed base?

We saw a significant new to iPhone number. It’s not a number that we throw out, but we particularly saw that on the 5C, which is what we wanted to see. So it’s clearly not just upgraders. As a matter of fact, the upgraders, particularly in North America, would have been less than we thought, because of the changes in the upgrade policy that I talked about earlier.

And then with respect to innovation at the company, obviously iPhone came out in 2007, iPad came out in 2010. 2013 came around, we’ve got some new products, obviously, but nothing really from our new product category. Do you care to comment on the innovation cycle of the company and the cadence there?

It’s never been stronger. I’m very confident with the work that’s going on, and I think our customers are going to love what we’re going to do.

We’ll go to Keith Bachman with Bank of Montreal.

I had a question and a follow up. And Tim, for you, the first one, to follow up from Brian’s question, you’re growing iPhones about 7%. I think the market is going to end up looking up to be 14%. Are you happy with the pricing umbrella that you currently have? When you originally brought out iPhones, in subsequent periods you talked about wanting to push some pricing umbrellas. But are you happy with the pricing umbrellas that you have? In particular, as you think about the 5C, I think most of the industry views have panned the product as not being enough features for that price point. But if you could just talk about the positioning of your broader product portfolio on iPhones. Are you happy where you are?

I think last quarter we did a tremendous job, particularly given the mix was something very different than we thought. It was the first time we’d ever run that particular play before, and demand percentage turned out to be different than we thought. We obviously always look at our results, and conclude what to change moving forward. And if we decide it’s in our best interest to make a change, then we’ll make one. Obviously I’m not going to predict price changes on the earnings call.

Sorry, not price changes, but at least product position. Are you willing to expand the product portfolio into new categories within the phone family?

We’re willing to make any product that’s a great product. Where our line in the sand is, it’s making something that’s not fantastic.

Okay. Then my follow up for you Peter is, you mentioned four factors that influenced guidance. In particular, you talked about inventory. I think most investors would conclude then December wasn’t as good as it looked, if you had increases in channel inventory. So I was hoping you could peel off a little bit and talk about the foreign exchange impact and the higher deferrals. Is there a way to quantify that impact on the guidance in March in particular?

From Pacific Crest Securities, we’ll go to Andy Hargreaves.

Just a quick follow up to some of your comments about demand mix being significantly different, or different than what you thought, in the quarter. Do you have any thoughts on why it was so much different than what you expected it to be?

I think the 5S, people are really intrigued with Touch ID. It’s a major feature that has excited people. And I think that, associated with the other things that are unique to the 5S, got the 5S to have a significant amount more attention and a higher mix of sales.

What Luca is saying is that we’re working on things that are things that you see that we’re shipping today but that we’re working on things that you can’t see today.

The next question will come from Mark Moskowitz with JPMorgan.

What’s your user data kind of telling you right now in terms of the replacement cycle? Are you starting to see a lot of heritage Apple users now refresh their iPhone every three years plus, or their iPad every two years plus, versus previous? Are you seeing any major changes there?

We don’t have great data yet from last quarter. And so I don’t know the answer to your question.

And then the follow up is around this opex being flat relative to the revenue guidance. Is there something around the vertical in terms of maybe increasing focus on the enterprise vertical that you see an opportunity to take advantage of, maybe hiring more folks to service that industry?

It’s clear that the enterprise area has huge potential, and we’re doing well from a percentage of companies that are using iPhone and iPad. It’s up to unbelievable numbers. The iPhone is used in 97% of the Fortune 500, and 91% of the Global 500, and iPad is used in 98% of the Fortune 500 and 93% of the Global 500. And we have a number of accounts, some of which Peter reviewed in the opening remarks, that have tens of thousands of iOS devices working. And also, as I think was mentioned earlier, 90% of tablet activations in corporations are iPads. And 95% of total app activations were on iOS. And I think that’s an incredible measure of ultimately how sticky the products are, because you can get so much productivity out of an iPad and an iPhone. And so I think the road in enterprise is a longer one. The arc is longer than in consumer, which can immediately go out and buy things, etc. And I think we’ve done a lot of the groundwork as you can tell from these numbers that I’ve given you, and I would expect that it would have more and more payback in the future.

And the next question will come from Gene Munster with Piper Jaffray.

Just a follow up to some of the previous questions. Tim, I’ve got to ask it. In the previous quarters, you’ve talked about specifically product categories multiple, and that’s different than variations of existing products. And that would be by the end of 2014. I just want to be clear that’s still on track, and consistent with some of the expenses that we talked about earlier in the call?

Yes, absolutely. No change.

And then second, and this goes back to some of the other themes on the call here too, but you’re obviously going to have a big year in terms of new product categories. And maybe even thinking beyond 2014, when the new products come out and they kind of ramp in 2015, how do you think about the trajectory of the platform, or what would you say to investors to say this is just a product cycle story?

I would just say, innovation is deeply embedded in everybody here, and there’s still so much of the world that is full of very complex products, etc. We have zero issue coming up with things we want to do that we think we can disrupt in a major way. The challenge is always to focus to the very few that deserve all of our energy. And we’ve always done that, and we’re continuing to do that.

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 please enter confirmation code 9268358. These replays will be available by approximately 5 p.m. Pacific time today. And members of the press with additional questions can contact Steve Dowling at 408-974-1896, and financial analysts can contact Joan Hoover or me with additional questions. Joan is at 408-974-4570, and I’m at 408-974-5420. Thanks again for joining us.