Good day, everyone, and welcome to the Apple Incorporated Third 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.

Thank you. Good afternoon, and thanks everyone for joining us today. Speaking first is Apple CEO, Tim Cook; and he will be followed by CFO, Luca Maestri, and then we'll open the call for questions from 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, taxes, 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, the Form 10-Q for the first two quarters of fiscal 2014, 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 Tim for introductory remarks.

Thanks, Nancy. Good afternoon, everyone. It’s been a very busy and exciting time at Apple and I'd like to review some of the highlights of our June quarter. We hosted our best ever Worldwide Developer’s Conference last month with over 20 million people from around the world watching our keynote session, which is the a record. We've had overwhelming response from customers and developers to the new features we previewed in OS X Yosemite and iOS 8. Yosemite has been redesigned with a fresh look and powerful new apps and iOS 8 is the biggest release since the launch of the App Store. With powerful continuity features, these upcoming releases will allow Macs and iOS devices to work together in even smarter ways. Customers can start on activity like writing an email on one device and pass it to another, picking up where they left off without missing a beat. They will even be able to make and receive iPhone calls on their Mac with just a click. These are features that only Apple can deliver. With iOS 8, we have opened over 4000 APIs providing more flexibility and opportunity for developers than ever before. iOS 8 provides developers with amazing new frameworks, enables wide use of Touch ID to securely authenticate users within apps and lets developers further customize the user experience with major extensibility features such as third-party keyboards. We have also introduced Swift, an innovative new programming language for both iOS and OS X. Swift is the result of the latest research on programming languages, combined with decades of experience within building Apple platforms. It makes writing code interactive and fun, eliminates entire classes of unsafe code and generates apps that run lightning fast. It's easy to learn, allowing even more people to dream big and create…

Thank you, Tim and good afternoon everyone. We set a new June quarter record for revenue at $37.4 billion, up $2.1 billion or 6% year-over-year. This result was towards the high end of our guidance range, despite a reduction in channel inventory for both iPhone and iPad. The revenue growth was driven by strong sales of iPhones and Macs, as well as the continued great performance of iTunes softwares and services. Gross margin was 39.4%, above our guidance range and operating margin was $10.3 billion, representing 27.5% of revenue. Net income was $7.7 billion, translating to diluted earnings per share of $1.28, a 20% year-over-year increase. For details by product, I'd like to start with iPhone. We sold 35.2 million iPhones, an increase of 4 million over last year, representing 13% growth. As Tim mentioned, iPhone sales grew well across all three of our entry-price, mid-tier and lead product categories. In the U.S., iPhone accounts for 41.9% of the smartphone subscriber base according to the latest data from ComScore, up from 41.3% in the previous measurement period. Also based on the latest survey by ChangeWave, iPhone earned a 97% customer satisfaction rate and among responders planning purchase a smartphone within 90 days, 50% planned to purchase an iPhone, up from 42% in the March quarter and 44% a year ago. iPhone sales were at the high end of our expectations, despite new product rumors that we believe resulted in purchase delay. In addition, tax increases and the regulatory environment in Japan affected smartphone sales in what has been one of iPhone’s fastest growing markets in recent quarters. Considering these factors, the performance of iPhone was even more impressive in the June quarter and it boosts our confidence for the future. We reduced iPhone channel inventory by about 150,000 from the…

Thank you, Luca. And we ask that you limit yourself to one question and one follow-up please. Operator, may we have the first question.

(Operator Instructions). And your first question will come from Katy Huberty with Morgan Stanley.

Luca, this is the third quarter in a row that gross margin came in above your guidance. Can you talk about what’s driving that gap and why you expect the margin to come down sequentially in the September quarter?

Yes, Katy, it was obviously a surprise also to us. We were expecting obviously a loss in leverage from the sequential declining revenue which obviously happened. We also expect that some unfavorable mix, which also happens -- it's typical as we move away from the launch quarter. And we were expecting some cost improvements. These cost improvements came in. They came in stronger than we were anticipating. The commodity markets continue to be favorable, the product quality continues to be excellent, our teams executed really, really well. And all these things came together at the same time and it was a very nice surprise for us. As we look forward into Q4, yes, we’ve guided to 37% to 38%. Again, the mix is the normal mix that we see as we continue to move through the product cycle. And obviously in Q4, we got some transition costs because we’re expecting a very busy fall. We're bit excited about what we've got in the pipeline. And that’s the reason why we guided to that range.

And then just a follow-up on that last point, because in the press release you referenced the excitement about new products and services. Can you remind us of your guidance philosophy as it relates to product cycles? Do you embed assumptions around the contribution from new products? And if so, do those tend to be more conservative than for products that’s already shipped today?

So our guidance, Katy is that -- we put our numbers that we believe at this point in time with all the information that is available to us, we're going to land within. So we take into account the fact that we’ve seen some purchase delays for executing Q3, but we have seen some safe trends in certain geographies. That continues to happen. And what you see this quarter is that our guidance range is $3 billion, as opposed to $2 billion during the third quarter, just to take into account the fact that we got many moving pieces.

Thank you Katy. Can we have the next question please?

From Goldman Sachs, we will hear from Bill Shope.

With the pockets of market we just noted for tablets, could you give us some more detail on how you are thinking about the category longer term, and in particular in the context of your usage comments, how are you thinking about the competitive landscape now and how that may evolve? And then I guess, related to that, what do you think to be the next driver of renewed growth for the category?

It’s Tim. If you sort of back up from this, the category that we created, which has just been a little over four years, we have now sold 225 million iPads, which is I think probably a larger number than anyone would have predicted at the time and including ourselves, quite frankly. We still feel that category as a whole is in its early days and that there is also significant innovation that can be brought to the iPad and we plan on doing that. When I look at the top level numbers, I get really excited when I see that more than 50% of the iPads that we're selling are going to someone who is a first time tablet buyer. I get excited when I see that our retail share according to the MPD in the month of June was 59% of UNIX and over 70% in terms of dollars. And of course, Luca has mentioned in his preamble that our education share is 85%. We also are in the -- virtually all Fortune 500 companies, we are in 99% of them to be exact and 93% of the Global 500. However, when we dig into the business market deeper, though our market share in the U.S., in the commercial sector is good at 76% -- this is according to IDC; the penetration in business is low. It’s only 20%. And to put that in some kind of context, if you looked at penetration of notebooks in business, it would be over 60%. And so we think that there is a substantial upside in business. And this was one of the thinkings behind the partnership with IBM that we announced last week. We think that the core thing that unleashes this is a better go to market, which IBM…

One more question if I could. You've had obviously great performance in the BRIC countries and you've touched on China for few categories. Can you talk about the overall demand environment you saw for China in the quarter? Obviously there's some seasonal factors to consider but how should we think about your performance versus your expectations and how you are thinking about it for the rest of the calendar year?

China, honestly was surprising to us that it was -- we thought it would be strong but it well went past what we thought. We came in at 26% of revenue growth, including retail and if you look at the units, the unit growth was really off the charts across the board. I found 48% off that compares to a market estimate of 24%. So growing it two times the market. iPad was up as well, as I've mentioned before. The Mac was up 39% and that’s versus a market in China that’s also contracting along with markets in most parts of the world and China was projected to contract by 5%. And so we're seeing some substantial strength there and the thing that’s actually growing the most is the iTunes software and services category, which has the App Store and et cetera and that area is almost doubling year-over-year. And so it’s very, very exciting what we're seeing there. We are still in the process of rolling out along with our partner China Mobile, the TD-LTE into more cities and we're still in early going on that. That just started in January as you know. And my understanding is that later this year there will be a license for the other operators to begin shipping FDD-LTE, which I think is another big opportunity in China.

Thank you, Bill. Could we have the next question please?

Next we'll go to Toni Sacconaghi with Sanford Bernstein.

I have one for Luca and one for Tim please. Luca, I wanted to revisit the gross margin question. You talked about guidance for next quarter, that the drivers of the sequential decline being a normal mix through the cycle on transition cost. Your guidance to the midpoint is down 190 basis points in gross margin, last year in Q4 gross margins were up 10 basis points sequentially in fiscal Q4 and the product transition issues or cycle issues that you alluded to seem essentially identical. So I'd like to try and understand what might make this Q4 different let’s say than last Q4?

If I understand the question, also when you look at it in terms of absolute levels of gross margin, last year it was 37%. So our range is above that level. There is obviously many, many things that affect us in different ways from one year to the other. Foreign exchange is a case where a lot of the emerging market currencies and the yen and the Australian dollar, the Canadian dollar, they have been weaker against the U.S. dollar. That has an impact on margin. And also when you think our product cycle, I think we don’t get into the specifics but this is not exactly the same cycle as we've had a year ago.

I mean is it better? If we look back two years to the iPhone 5, your product margins were down 260 basis points sequentially. So is the reference there that we should be thinking in terms of changes that are more akin to what we saw two years ago rather than to this year?

I wouldn’t necessarily draw that analogy. I think we need to start thinking from the fact that we had a very, very strong Q3. A lot of things came together extremely well. 37% to 38% is a range that is -- we think is very good, and that’s where we are right now and we still have several weeks in the quarter.

Tim, I wanted to get your input on the impact of trade-in programs for the iPhone, particularly in mature markets where they are most prevalent. As best I can tell, if I look at the last four quarters, they're not hyper-focused on 90 days. It looks like the iPhone has been about flat in unit terms in the Americas and up low single digits in Europe and I think Europe includes India, which is obviously very fast growing. So perhaps low single digits in Europe. So if we look at those western geographies, we've seen relatively flattish iPhone unit sales over the last year. I know you don’t report it but just sort of based on overall revenue reporting, I'm wondering if you can comment on what you're seeing in terms of iPhone trade-in programs and this is four quarters, still over a complete cycle. Whether you think they are elongating or shrinking and what impact is very prevalent, increasingly prevalent trade-in programs might be having on them and what impact your pricing of older generation devices might be having on them.

Yes, the theory that you have Toni is not precisely correct. Like if I look at Europe, the operating segment of Europe for quarter or year-to-date for 2014 versus the same period last year, iPhone units were actually up 10%. Your more macro question; what I understand to be your macro question of do I think there is some sort of cannibalization going on trade-in programs on new product sales? What I think is happening in the aggregate if you look across the world is that trade-ins are actually hugely beneficial for our ecosystem because people wind up -- we have more people that are able to join the party when we have a trade-in, because in essence, it winds up being used by -- probably the prime example someone else within the family or in the example that has become more common in the last year, someone trades it in and then that goes to either somebody else in that country that is very price sensitive or somebody in a different country and I see all of this as good. In looking at how much of it cannibalizes, it is very hard to answer that question with any degree of preciseness. But my gut is that the cannibalization factor is low, because you wind up having -- you wind up attracting people that are much more price sensitive in there. I think the great thing is that our products command a much higher resale value than others do. And so that leads to a larger trade-in and from my perspective, that being the larger ecosystem, more people that wind up getting on iPhone, and as you know from following us for quite some time, if we get somebody to try an Apple product and then buy an Apple product, the likelihood that they begin buying other Apple products that may be in different categories or upgrading to one in that category and the future is very high. And so net-net, I view it to be positive. It’s very difficult to quantify with certainty.

Thank you, Toni. Could we have the next question please?

From UBS, we will hear from Steve Milunovich.

Tim you mentioned that Japan was fairly flat due to regulations and taxes. Could you elaborate on that and what kind of comparisons perhaps you see going forward?

Yes, it was actually Luca, but I can comment on it. VAT was increased from 5% to 8% close to the beginning of the quarter. I think it was actually April 1 or so. That was the first planned VAT increase. There are other or at least one additional planned VAT increase in the future. This was a part of the overall tax reform package in Japan. Secondly, the carriers received some guidance from the regulators to essentially stop incenting people to transfer from another carrier at a higher amount than they were incenting their -- retaining their own customers. And so it appears that the combination of these two things dampened the whole market for smartphones in Japan. We haven’t been able to get very detailed data on share but my expectation is we're not going to see very much of a share change. And we are beginning to see some coming back of that market as we step into this quarter, may be not back to the level that it was previously but you can begin to see the market growing again which we view as very positive. In the past when we've seen these type of things, tax changes et cetera, there is usually a rush to buy before the tax increase, a pause that happens thereafter and then the market eventually goes back to some kind of steady state that may not be exactly where it was but it nears it. And so I think that’s likely our guts or that’s what happens on the VAT side. The other piece is a little harder to conclude what will happen in terms of that guidance and how long that might be employed. I don’t know that part.

Okay, that’s very helpful. And then you talked about your three tiers of iPhones. I wonder if you would be willing to breakout in any more detail the growth and particularly how to defend the 5C in the mid-tier. I know our surveys continue to find in the U.S. that it's falling little bit as a percentage of business but you seem to believe it’s doing exactly what you expected it to do.

I can tell you this. That if you look at the growth rates, we don’t divide out each one but if you look at year-over-year growth rates and so this would be comparing the 5C to last year. It would be comparing the 4S, which was in the mid-tier. The growth in that sector was the highest growth during the quarter we just finished.

Of the three tiers?

Of the three tiers. And so we are extremely happy with how it performed last quarter.

Thanks Steve. Can we have the next question please?

Kulbinder Garcha with Credit Suisse.

Thanks. I have just one question for Luca and one for Tim. And for Luca, you mentioned that commodity pricing, I guess the environment was good for you. Is it your working assumption in your guidance that continued to be favorable and a tailwind for you? And then my question for Tim is, with the installment plans that are being introduced in the U.S., I imagine that given the increases in flexibility for people to operate faster, would you expect that to happen? Are you seeing any evidence as these contests come up because we've had them out now for several months? And how do you see that impacting your business because obviously the U.S. iPhone part of your business is still very significant and it can be quite a big catalyst to your iPhone business going forward I would imagine or would you be more tensed in how these are playing out?

I will take both of these. This is Tim. On the component question, what we saw in the June quarter was that NAND, mobile DRAM and LCD, the pricing on all of those declined, while PC DRAM increased, despite the market for PCs contracting. In the September quarter, what is factored in our guidance is that LCDs and mobile DRAM continue to decline, that NAND pricing remains essentially flat last quarter and that PC DRAM has a slight price increase. And in terms of other commodities that I didn’t talk about, we've assumed that they would decline at historical rates and so that’s factored into the gross margin guidance that Luca gave you. In terms of the installment plans that you mentioned in the U.S. relative to iPhone, there is a lot of different models that are being tried in the U.S. and throughout the world. And actually last quarter, as we estimated and this is subject to estimating but we're estimating that less than one out of four iPhones were sold on a traditional subsidy plan. And so that number is markedly different than it would have been two years ago. The installment plan that you're speaking about which gives the customer the right to upgrade SAP or faster than a usual two year cycle, we think that plays to our customer base in a large way. And so that makes us incredibly bullish that customers on those plans would be very likely to upgrade when we announce a new product.

Thank you, Kulbinder. May we have a next question please?

Next we'll hear from Ben Reitzes with Barclays.

Thanks a lot. Tim, questions for you. I guess during the quarter you did two very big things in our opinion, obviously buying Beats, biggest acquisition in your history and you also did this IBM deal, which obviously was in this quarter, but since the last call, and that was very interesting, obviously really collaborating with another huge company to get further into the enterprise. And I was just wondering, what are you seeing in Apple that’s changing? These seem like big deals that change your direction a bit, something that you wouldn’t have done in the past. And do you see a lot more partnerships and larger acquisitions on the horizon to grow your TAM in various markets?

Well, I think we have a lot of really great people and I think we have the capability. As I've said before, I think we have the capability to acquire a sizable company and manage it. And relative to IBM, I feel the same way. I think you can only do so many partnerships well, and so it is unusual that we enter into a partnership. But in this particular case, I think arguably the companies are so complementary, and I've gotten to know Gini fairly well over the last couple of years and I think we see the importance of the customer, a lot of the same way and both feel that Mobile and Enterprise is just an enormous opportunity. And we’re not competing with each other. And so I think a partnership in that case is particularly great. Would we do more of either of the things we did? We’re always looking in the acquisition space, but we don’t let our money burn a hole in our pocket and we don’t do things that aren’t strategic. And so with Beats we felt we were getting an incredible subscription service, a very rare set of talent that we think can do great things in Apple and access to a very fast growing businesses in their headphone and earphone space. And culturally we felt there was a match and music has been deeply embedded in Apple’s DNA for many, many years. And so it was a great marriage and I think the partnership with IBM is a great marriage as well. It’s more like that, presented themselves -- or I think we can manage more things. I think that we have a very, very strong executive team and can do that. But it’s not my goal to acquire certain number of companies or spend a certain amount of money. We want to do things that help us make great products that are great for our customers and so forth.

I am sorry, just really quick on the IBM. Does this say something about Apple doing more in Big Data, and taking a cut maybe of some of the analytics opportunities as well?

Yes, we didn’t talk about how the business model is going to work. But generally speaking, I think that each of us have revenue streams in the enterprise and each of us went from having those revenue streams. So that’s how I look at that. And we win if we can drive that penetration number I spoke about from 20% to 60%. That would be incredibly exciting here. The walls would shake. And so that’s what I hope for.

Thank you Ben. Could we have the next question please?

We will hear from Ben Schachter with Macquarie.

Tim, I just wanted to talk about the app market for Enterprise. Right now I believe that app developers can sell to the enterprise directly and therefore that they can bypass sharing revenue from these app sales with Apple. Is Apple going to allow that to continue, and can you also just more broadly discuss how Apple thinks about the opportunity to sell apps directly to the enterprise?

We have no plans to change the rules with Enterprise. Some enterprises like proprietary apps that they do not want to offer to others and so we obviously have a way for them to distribute those into their enterprise or just the employees that they want to and so I'm not worried about changing that. We’re also taking friction out of the system and not adding it. Again, the big thing for us is getting the penetration number, I think getting our product, iPhones and iPads and Macs in more people hands and we think there is a huge opportunity in Enterprise to do that.

Thank you Ben. A replay of today's call will be available for two weeks as podcast on the iTunes Store, as a webcast on apple.com/investor and via telephone and the numbers for the telephone replay are 888-203-1112888-203-1112 or 719-457-0820719-457-0820 and please enter confirmation code 76136258 [ph]. These replays will be available by approximately 5.00 PM Pacific Time today. Members of the press with additional questions can contact Steve Dowling at 408-974-1896408-974-1896 and financial analysts can contact Joan Hoover or me with additional questions. Joan is at 408-974-4570408-974-4570 and I'm at 408-974-5420408-974-5420. And thanks again to everyone for joining us.

And ladies and gentlemen, that does conclude today’s presentation. We do thank everyone for your participation. Call Send SMS Add to Skype You'll need Skype CreditFree via Skype