Highlights From AAPL's Q2 Conference Call: Strongest March Qtr in Apple History

Last night (after the close), Apple (NASDAQ: AAPL) reported Q2 EPS of $6.40, $1.05 better than the analyst estimate of $5.35. Revenue for the quarter came in at $24.67 billion versus the consensus estimate of $23.27 billion. Shares are trading up 2.75% this afternoon.

Highlights From AAPL's Q2 Conference Call:

(Peter Oppenheimer) We are very pleased to report the highest March quarter revenues and earnings in Apple's history.

We set a new all-time quarterly record for iPhone sales and a new March quarter record for Mac sales, and we're thrilled with the momentum for iPad.

Revenue for the quarter was $24.7 billion, which was $11.2 billion over the prior March quarter's result, and represents the largest year-over-year quarterly revenue growth we've ever generated.

This tremendous increase of 83% was fueled primarily by record iPhone sales, very robust demand for iPad, and strong growth in Mac sales.

Operating margin was an all-time high of almost $7.9 billion, representing 31.9% of revenue. Net income was almost $6 billion. This represented 95% growth over the year-ago quarter's earnings, and translated to earnings per share of $6.40.

Beginning with our Mac products and services. We established a new March quarter record, with sales with 3.76 million Macs, representing 28% growth over the year-ago quarter.

We're extremely pleased with this very strong growth, particularly given IDC's most recently published estimate of a 3% contraction for the PC market overall.

Moving to our music products, we sold 9 million iPods compared to 10.9 million in the year-ago quarter. Though lower year over year, total iPod sales were ahead of our expectations, with iPod touch continuing to account for over half of all iPods sold. IPod share of the U.S. market for MP3 players remains at over 70% based on the latest monthly data published by NPD.

The iTunes Store turned in its best quarter ever, with revenue of almost $1.4 billion, thanks to record revenue from music, video, iOS apps, and books.

We were very pleased to begin offering the full catalog of 17,000 e-books from Random House in the iBooks Store during the March quarter. The iBooks Store now includes e-books from more than 2,500 publishers in over 20 categories. And customers have downloaded over 100 million books.

We were thrilled to have sold a record 18.6 million iPhones compared to 8.8 million in the previous March quarter. This represents 113% year-over-year growth, which is significantly ahead of IDC's latest published estimate of 74% growth for the global smartphone market overall in the March quarter.

Recognized revenue from iPhone handset and accessory sales was $12.3 billion during the quarter compared to $5.45 billion in the year-ago quarter, an increase of 126%.

We were very pleased to begin selling iPhones on the Verizon network in the U.S. in the March quarter. And we were also happy to add SK Telecom in Korea as well as Saudi Telecom in Saudi Arabia. Including some carrier consolidation, we ended the quarter with iPhone distribution through 186 carriers in 90 countries.

We ended the quarter with about 5.2 million iPhones in channel inventory, a sequential increase of about 1.7 million, to support new carrier launches and existing channel partners. This placed us within our target range of four to six weeks of iPhone channel inventory.

IPhone is continuing to see strong growth within the enterprise segment. Today, 88% of the Fortune 500 are testing or deploying iPhone. With strong employee demand and custom app development fueling adoption, we are seeing great scale of iPhone deployments in businesses worldwide.

Turning to iPad, we continue to be thrilled with its momentum. We sold 4.7 million iPads during the March quarter, launching iPad 2 in the U.S. on March 11th and in 25 additional countries on March 25th. Customer enthusiasm has been tremendous for iPad 2, and we're working hard to get it into the hands of customers as quickly as possible. Including both the original iPad and iPad 2, we had distribution in 59 countries by the end of the March quarter.

Given the very strong customer demand and despite the increased geographic distribution, iPad channel inventory declined by 400,000 from the beginning of the quarter, implying sell-through of about 5.1 million.

Recognized revenue from sales of iPad and iPad accessories during the quarter was $2.8 billion.

Combining iPhone, iPad, and iPod touch, we reached just under 189 million cumulative iOS device sales through the end of the March quarter. In March, we introduced iOS 4.3, with new features including faster Safari mobile browsing performance with the Java Nitro script engine, iTunes Home Sharing, enhancements to AirPlay, and a personal hotspot feature for sharing an iPhone 4 cellular data connection over Wi-Fi.

Store traffic continues to be amazingly strong. And in the March quarter, we hosted a record 71.1 million visitors in our stores compared to 47 million visitors in the year-ago quarter, an increase of 51%. Retail revenue was $3.19 billion compared to $1.68 billion in the year-ago quarter, an increase of 90%.

Capitalizing on the February MacBook Pro update, the stores delivered another record Mac quarter, selling 797,000 Macs compared to 606,000 Macs in the year-ago quarter, an increase of 32%. And about half the Macs sold in our stores during the March quarter were to customers who have never owned a Mac before.

We operated 323 stores during the quarter. Average revenue per store was $9.9 million compared to $5.9 million in the year-ago quarter, an increase of 67%.

International Retail Store sales remain strong, with our average international store volume exceeding our very productive average U.S. store volume.

Retail segment margin more than doubled year over year to $807 million compared to $373 million in the year-ago quarter.

We anticipate opening 40 new stores in fiscal 2011, nearly three-quarters of which will be outside the United States, including our fifth store in China.

Total company gross margin was 41.4%, which was 290 basis points higher than our guidance. More than half of this difference came from better product mix than planned, particularly higher iPhone sales.

Operating expenses were $2.34 billion and included $236 million in stock-based compensation expense. OI&E was $26 million. And the tax rate for the quarter was 24.2%, below our guidance of 25.5% due to changes in our full-year forecast to foreign earnings, R&D tax credit, and state taxes.

Turning to cash, our cash plus short-term and long-term marketable securities totaled $65.8 billion at the end of the March quarter compared to $59.7 billion at the end of the December quarter, a sequential increase of $6.1 billion.

Cash flow from operations was $6.2 billion, an increase of 157% year over year. The increase in cash is net of approximately $900 million to combine prepayments and capital expenditures related to the strategic supplier agreement that we referred to in our last quarterly call.

(Guidance for June Qtr) We expect revenue to be about $23 billion compared to $15.7 billion in the June quarter last year. We expect gross margin to be about 38%, reflecting approximately $55 million related to stock-based compensation expense. We expect OpEx to be about $2.5 billion, including about $255 million related to stock-based compensation expense. We expect OI&E to be about $70 million. And we expect the tax rate to be about 25%. We are targeting EPS at about $5.03.

(Q&A) Can you comment, Peter, on whether or not you're seeing any supply chain disruptions from the recent earthquake in Japan? And if so, how should we think about that in terms of that being factored into your guidance? (A) Bill, this is Tim. Let me just step back and talk about Japan in general and try to get all of your questions in advance. First of all, this is an incredible tragedy, and our hearts go out to everyone involved. Apple, as a company, has a very long history and has many strong ties to the people in Japan; and we're very, very saddened by the situation. And we've undertaken various actions to assist in the relief effort. The economic impact that we'll address today pales in comparison to the human impact. Regarding our business in Japan, we had some revenue impact in Q2, but it was not material to Apple's consolidated results. We believe revenues will be approximately $200 million less in Q3. And this has been factored into the guidance that Peter provided you earlier in his comments. Regarding our global supply chain, as a result of outstanding teamwork and unprecedented resilience of our partners, we did not have any supply or cost impact in our fiscal Q2 as a result of the tragedy. And we currently do not anticipate any material supplier cost impact in our fiscal Q3. To provide a bit more color on this, we source hundreds, literally hundreds of items from Japan. And they range from components such as LCDs, optical drives, NAND Flash, and DRAM, to base materials such as resins, coatings, and foil that are part of the production processes several layers back in the supply chain. The earthquake and subsequent tsunami and the associated nuclear crisis caused disruptions for many of these suppliers. And many unaffected suppliers have been impacted by power interruptions. But since the disaster, Apple employees have literally been working around the clock with our supplier partners in Japan, and have been able to implement a number of contingency plans. Our preference from the beginning of this tragedy has been to remain with our long-term partners in Japan. And I have to say they have displayed an incredible resilience that I've personally never seen before in the aftermath of this disaster. So while we do not anticipate, currently anticipate any material impact to our component supply or costs in our fiscal Q3, we do need to caution everyone that the situation remains unpredictable given recent aftershocks, the uncertainty about the nuclear plant, and potential power interruptions. Further, there are some supply risks that are beyond the current quarter. And although we know of no issue today that we view as unsolvable, the situation is still uncertain, and there are obviously no guarantees. For this reason, it's difficult to predict whether the issues created by the tragedy would impact revenues beyond Q3. However, I'll be happy to address Q4 on our next call in July.

Okay, great. That was very helpful. I guess digging into another area of supply, looking at your iPad 2 constraints since launch in March, can you give us some color on where the constraints lie and how you're doing in terms of getting supply back in line with demand? (A) The demand on iPad 2 has been staggering, and we're still amazed at it. We are still heavily backlogged, not only at the end of the quarter, but also up to date. However, I can tell you that I'm extremely pleased that the progress of the manufacturing ramp. And we were so confident that we rolled out to 25 additional countries at the end of last month. And we are shipping to an additional 13 countries next week, and we're planning to add even more countries through the quarter. And so I'm very confident that we can produce a very large number of iPads for the quarter.

I was just hoping to get a little bit more color on what drove the iPhone strength in the quarter, if you could, by region or carrier. You mentioned that you added SK Telecom, and I'm not sure if shipments there were material during the quarter. And then, Peter, the follow-up to that, I guess, is how do we think about iPhone seasonality going into the June quarter given all of the moving parts? We have a full quarter of Verizon in the June quarter. You've got some potential carrier expansion benefits. And yet, you have a product refresh hopefully coming midyear. So I was hoping you could help us think about that a little bit for the June quarter. Thanks. (A) Rich, it's Tim. In terms of iPhone, we did actually very well everywhere. I'd call out two places where it was just off the charts. The U.S. grew 155% year over year. Obviously, adding Verizon (NYSE: VZ) and beginning to offer iPhone to their enormous customer base was key in that. However, as you heard from AT&T's announcement this morning, AT&T did extremely well during the quarter. So the U.S. as a geography grew at 155%, and that's about three times IDC's forecast of growth for the smartphone market, which was about 48%. Also, we continued to be on a tear in China. Greater China saw iPhone sales being up over three times, about 200%, almost 250%. And this catapulted revenue for the first half, our first fiscal half in Greater China to just under $5 billion, which is up almost four times year over year. And so we're extremely happy with how we're doing in China. (A) Rich, to get to the second part of your question, as I commented in my prepared remarks, we were able to increase the iPhone channel inventory by just over 1.7 million units in the March quarter. And we ended within our targeted four to six week range of inventory. In terms of the June quarter, I would expect to see a significant year-over-year increase in sales.

And then also from the perspective of some positive feedback on LTE phones that are out from your competitors, how do you think about the maturity of those networks and Apple's sense of urgency to get products out for those faster networks? And what, if any, bottlenecks exist? (A) I was asked this question or a similar question when we launched the iPhone with Verizon. What I said then, and I still see it as being the case today, and I think you can see this in the products that have been shipped, is that the first generation of LTE chipsets force a lot of design compromises with the handset, and some of those we are just not willing to make; and so we are extremely happy with the iPhone 4 and the iPhone 3GS. And hitting 18.6 million units was something much larger than we thought we could do this quarter. And we're happy to have gotten it out to three more large carriers.

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