Apple’s (AAPL) conference call took place on April 26, 2016, 05:00 PM ET. Below is the full transcript of the conference call.
ValueWalk's Raul Panganiban interviews Dr. Kathryn Kaminski, Chief Research Strategist at AlphaSimplex, and discuss her approach to investing and the trends she is seeing in regards to quant investing and hedge funds. Q1 2021 hedge fund letters, conferences and more The following is a computer generated transcript and may contain some errors. Interview with AlphaSimplex's Read More
Please stand by we are about to begin. Good day everyone and welcome to this Apple Incorporated Second Quarter Fiscal Year 2016 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.
Nancy Paxton:Senior Director, Investor Relations:
Thank you. Good afternoon and thanks to everyone for joining us today. Speaking first is Apple CEO, Tim Cook, and he will be followed by CFO, Luca Maestri after that, we’ll open the call to 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 margin, operating expenses, other income and expense, taxes, future business outlook, and plans for capital return and debt.
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 2015 the Form 10-Q for the first quarter of fiscal 2016 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 speaks as of their respective dates. In addition today’s comments will refer to a metric we described as the purchased value of services tied to our install base.
This is a non-GAAP measure and a reconciliation to the corresponding GAAP measure can be found on our Investor Relations website at apple.com/investor.
I’d now like to turn the call over to Tim for introductory remarks.
Tim Cook – Apple’s CEO:
Thanks, Nancy, and good afternoon, everyone, and thank you very for joining us. Today, we’re reporting results of a very busy and challenging quarter and we’re also announcing an update to our capital return program. Revenue for the quarter, was $50.6 billion, which was within our guidance range. Despite the pause in our growth, our results reflect excellent execution of our team in the face of ongoing macroeconomic headwinds in much of the world and difficult year-over-year comparisons.
We saw continued currency weakness in the vast majority of our international markets, in constant currency, our revenue declined by 9% from last year, 400 basis points less than the reported decline of 13%. For the first half of the fiscal year, our revenue in constant currency was up 1% year-on-year. Despite challenges, there were a number of encouraging sings during the quarter.
Our installed base of over 1 billion active devices continue to grow strongly, we added a huge number of Android Switches are new to Mac customers and we generated very strong growth from services.
We sold 51.2 million iPhones in the quarter consistent with the range of our own expectation but lower than the exceptional year-ago quarter when we saw an acceleration in iPhone upgrade and 40% iPhone sales growth over the previous year. To provide some additional color, iPhone sales come from three sources; Customers who upgrade from previous iPhone models, customers who switch from Android and other operating systems, and customers who purchase a smartphone for the host on. As we look at each of these three sources of iPhone sales, we see a business that it’s healthy and strong. First from an upgrade perspective.
During the first half of this year the upgrade rate for the iPhone 6S cycle has been slightly higher than what we experienced in the iPhone 5S cycle two years ago but it is lower than the accelerated upgrade rate we saw with iPhone 6 which as you know was a big contributor to our phenomenal revenue growth a year-ago.
Mostly importantly, our customers are incredibly loyal. Our recent survey of U.S smartphone purchasers indicated a 95% iPhone loyalty rate, the highest ever measured for any smartphone. Second, we continue to see a very high level of customers switching to iPhone from Android and other operating systems. In fact we added more switchers from Android and other platforms in the first half of this year than any other six month period ever.
And third, with only 42% smartphone penetration of the global handset market today iPhone is still attracting millions of first time smartphone buyers each quarter especially from emerging markets. For example, in India our iPhone sales were up 56% from a year ago.
Next I would like to talk about services which was our second largest revenue generating category during the quarter. Setting aside the amount we received from our patent settlement in the December quarter the March quarter services revenue was our highest ever. Services revenue jumped 20% to $6 billion. App Store revenue was up 35% to beat last quarter’s all time record and Apple Music continues to growing popularity with over 13 million paying subscribers today.
We feel really great about the early success of Apple’s first subscription business and our music revenue has now hit an inflection point after many quarters of decline. The services business is powered by our huge install base of active devices which crossed 1 billion units earlier this year. As we discussed on this call in January, there is 1 billion plus active devices are a source of recurring revenue that is growing independent of the unit shipments we’ve report every three months. In fact the purchase value of services tied to our installed base was a record $9.9 billion in the March quarter up 27% over last year accelerating from the 24% growth rate we reported in the December quarter.
The reach of Apple Pay also continued to expand following a very successful launch in China in the March quarter and last week’s rollout in Singapore. Apple Pay is growing at a tremendous rate with more than 5 times the transaction volume over year ago and 1 million new users per week. There are more than 10 million contactless ready locations in the countries where Apple Pay has launched today including over 2.5 million locations now accepting Apple Pay in the United States and more expansion of Apple Pay is coming soon.
Turning to the Mac, we made our sell-in expectations in addition to reducing channel inventory by about 100,000 units. Overall the Mac continues to attract a large percentage of new customers. In our latest survey of major markets over 0.5 of buyers were new to the Mac and in some countries the percentage is extremely high like in China for over 80% of customers were purchasing a Mac for the first time. We are confident in our Mac business and our ability to continue to innovate and gain share in that area.
Turning to the Apple Watch, units sales met our expectations in the quarter. For some color on how we think about Apple Watch sale, we expected seasonality to be similar to the historical seasonality of iPad which typically generated 40% or more of its annual unit sale through in the December quarter. We started to ship Apple Watch just one year ago and is quickly become the best selling and most loved smart watch in the world. In fact, unit sales of Apple Watch during its first year exceeded sales of iPhone in its first year.
Last month we refresh the line up for the spring with new bands and a new starting price point and the response from the customers has been great. Apple Watch is an increasingly essential part of users’ lives from responding to messages, managing calendars and navigating with maps to helping them be more fit and in some cases the heart rate sensor has even help stabilize. We are really excited about the first year with Apple Watch, we have learned a lot and we believe and we believe it has an exciting future ahead.
We are announcing fantastic new products during the March quarter. iPhone SE became available on March 31, so none of it sales were reflected in our second quarter results, but so far this quarter we’re seeing terrific customer response. iPhone SE is the most powerful phones found ever, and it’s a great option of customers all over the world who want a compact phone with advanced features in a great price without compromising performance.
Demand has been very strong and exceed supply at this point, but we are working hard to get the iPhone SE into the hands of every customer who wants this phone as quickly as possible. The addition of the iPhone SE in the iPhone line up places us in a better strategic position to attract even more customers into our eco-system. We also unveiled the stunning 9.7 inch iPad Pro with cutting edge performance in our most advanced display by yet. The reviews of our new iPad Pro is being great and we are hearing from customers that the features and capabilities in the new Pro make ultimately upgrade for iPad owners and a great PC replacement.
In the June quarter, we expect to see our best iPad revenue compare in over two years. iPad is the best selling, best reviewed in most used tablet on the market. Customers tell us that they love iPad for its unique mixed, affordability, capability and versatility with over a million iPad apps in the app store to help them work, play, learn and create.
We also announced Care Kit our new software framework that developers can use to help people take a more active role in their health, like keeping track of their care plans, monitoring your symptoms and medication and delivering the insights they need to make smart decisions about their health.
We are very excited about the way’s iPhone and Apple Watch are helping people lead healthier lives. We believe there is a great promise here for the future and we are very interested for this contagious.
As always, we are contributing to society beyond our products promoting the use of renewable energy across our facilities and inside our supply chain and developing cutting edge technologies to revolutionize recycling in the materials we use. We are unwavering in our commitment to protect the security and privacy of our customers and their data and we are actively promoting inclusion and cloudy across our business.
As we continue through the June Quarter I’d like to remind you that we measured the health of customer demand based on sell-through. Despite ending Q2 within our channel inventory targets in light of the macroeconomic environment we planned to lower our channel inventories in the June quarter. This will impact our reported revenue in Q3. Luca will provide more details on this in his commentary.
Before I turn over the call to him I will summarize by saying that the future of Apple is very bright. Our product pipeline has amazing innovations in store. We are very excited about bringing together developers for our four major platforms at our worldwide developers’ conference in June. We are forging ahead with important investments in research and development, in our infrastructure, and in our supply chain.
We have made 15 acquisitions in the last four quarters to accelerate our product and services roadmaps and we are always on the lookout for companies with great technology, talent and strategic fit.
Creating value for shareholders by developing great products and services that enrich people’s lives will always be our top priority and the key factor driving our investment in capital allocation decision. As our business continues to generate high level to free cash flow we’re in the fortunate position to expand our capital return program again this year as we’ve done each year since we started the program four years ago. Today we are announcing an extension of the timeframe of the program by four quarters through a March of 2018 and we’re expanding the total program size from $200 billion to $250 billion. Looking at more details on this announcements and our results for the March quarter.
Luca Maestri: Apple’s Senior Vice President and Chief Financial Officer:
Thank you, Tim and good afternoon everyone. Let me start with the March quarter results. Revenue for the quarter landed within our guidance range of $50.6 billion compared to $58 billion in the year-ago quarter, a decline of 13%. As we had expected our comparisons to last year were influenced by the continued strength of the US dollar against foreign currency.
As Tim said in constant currency our revenue declined by 9%. On the geographic basis, in Asia our revenue grew strongly in Japan, but it decline in greater China and the rest of Asia-Pacific. However, our business in these two regions is fairly better than the numbers might suggest. We have significant channel inventory reductions and currency weakness which affected our reported revenue for both these segment.
In Mainland, China revenue was down 11% and the decline was 7% in constant currency terms. Keep in mind that we’re up against an extremely difficult year-ago compare when our Mainland China revenue grew 81%. We remained very optimistic about the China market over the long-term and we’re committed to investing there for long run.
Gross margin was 39.4% near at the high-end of our guidance range thanks to strong cost performance. Operating margin was 27.7% of revenue and net income was $10.5 billion diluted earnings per share were a $0.90 and cash flow from operations was strong at $11.6 billion.
For details by product, I will start with iPhone. We sold 51.2 million iPhones in the quarter compared to 61.2 million in the year-ago quarter, a decline of 16%. It was particularly challenging comparison to the record quarter a year-ago when iPhone sales grew 40% as we entered last March quarter in supply demand imbalanced which was recovered during the quarter. Also this year we reduced channel inventory by 450,000 units while we increase the inventory by a 1 million units a year-ago.
We have exceeded the quarter within our five to seven week target range for channel inventory.
iPhone ASP was $642 compared to $659 in the year-ago quarter. We have weak international currencies in very popular mid-tier eventually offerings contributing to the difference year-over-year. IPhones momentum in business markets continues to be very impressive. A recent survey by 451 Research, formerly known as ChangeWave founded among US corporate buyers for any to purchase smartphones in the June quarters 78% planned to purchase iPhones.
That’s the highest June quarter iPhone purchase intent as I measured by the survey and five point higher than a year-ago.
Turning to services, we generated $6 billion in revenue, an increase of 20% over the March quarter last year. Thanks primarily to the continuous strong performance of the App Store with revenue growing 35% to a new all time high. According to up any the App Store generated 90% more global revenue than Google Play in the March quarter up from a 75% lead in 2015. Among our customers who purchase apps from our item stores, they average amount spent for customer reached a new all-time record in the March quarter.
Next I’d like to talk about the Mac. We sold 4 million Mac, compared to 4.6 million last year a decline of 12%. It was a challenging quarter for personal computer sales across the industry but we believe we gained market share. Despite the overall market slowdown we generated double-digit Mac growth in a number of markets including Russia, Korea, Singapore, Taiwan and UAE, and just last week we updated the MacBook, out famous and like this Mac with the latest browse faster graphics, fastest track storage and longer battery life. We think our customers are going to love this update.
We ended the quarter within our four to five week target range for Mac channel inventory.
Turning to iPad, we saw 10.3 million compared to 12.6 million in the year-ago quarter. We also reduced channel inventory by about 200,000 units and we exited the quarter within our five to seven week target range.
In the same segments of the tablet market where we compete, we continue to be highly successful, recent data from NPD indicates that iPad has 78% share of the US market for tablets, price about $200, and the latest data published by IDC indicates that iPad accounts for 72% of the US commercial tablet market comprising business, government and education.
iPad customer metrics are also extremely positive. In February 451 Research measured a 97% consumer satisfaction rate for iPad Air 2 and among consumers planning to purchase a tablet within the next six months 59% plan to purchase an iPad more than three times the purchase intention rate of the next highest brand measured. Corporate buyers reported a 94% satisfaction rate for iPad and in June quarter purchasing of 71%.
Revenue from other products grew 30% over last year, thanks to Apple Watch. We have expanded distribution to 60 countries and introduced bands in beautiful new colors for spring, so customers can personalize their watches in more ways with the range of color styles and materials. Our customers are very happy with Apple Watch with 451 Research measuring 94% customer satisfaction.
We’re also making great progress with our enterprise initiatives IDM now has engagements for more than 200 deployments of native iOS apps for large enterprise customers to accelerate mobile transformation. Our mobility partner program also continues to grow with 108 partners across 20 countries. We see continued broad industry adoption of native iOS apps to transform how professionals do their work and serve their customers, for example retail bank that are using iOS apps on iPads to greet and onboard customers reduce skew times and improve the customers’ experience. Any hospitals doctors and nurses are using iOS apps on iPhone and iPad to share and communicate more effectively so that they can spend more time with patients and less time on administrative tests.
Let me now turn to our cash position. We ended the quarter with $232.9 billion in cash plus marketable securities a sequential increase of $17.2 billion. $208.9 billion of this cash or 90% of the total was outside the United States. We issued $15.5 billion in US dollar denominated notes during the quarter including our first green bond trench to find initiatives such as renewable energy and environmental design projects.
We exceeded the March quarter with $72 billion in term debt. We return $10 billion to investors during the quarter including $2.9 billion in dividends and equivalents and $7 billion on repurchases of 71.8 million Apple shares through open market transactions. We’ve now completed over $163 billion of the current $200 billion capital return program including $117 billion in share repurchases.
As Tim mentioned, today we announcing the latest update through our program which we had increasing to a total of $250 billion. Once again we are allocating the majority of the expansion of the program to share repurchases. Given our strong confidence in Apple’s future and the value we seen in our stock. The board has increased the share repurchase authorization by $35 billion raising it from the current $140 billion level to $175 billion.
We also know that the dividend is very important to many of our investors who value income and we are raising it for the fourth time in less than four years. The quarterly dividend we grow from $0.52 per share to $0.57 per share, an increase about 10%. This is effected with our next dividend which the board has declared today and is payable on May 12, 2016 to shareholders of record as May 9, 2016. We continue to plan for annual dividend increases going forward with $12 billion in annual dividend payments we’re proud to be one of the largest dividend payers in the world.
In total, with this updated program during the next eight quarters we expect to return $87 billion to our investors which represents about 15% of our market cap of current stock price.
As in the past, we expect to fund our capital return program with US cash, US cash flow generation and borrowing from both domestic and international debt markets. We will continue to review capital allocation regularly and solicit input in our program from a broad base of shareholders. This allows us to be thoughtful about the size, the mix and the pace of the program.
As we move ahead into the June quarter, I like to review our outlook which includes the types of forward-looking information that Nancy referred to at the beginning of the call. We expect revenue to be between $41 billion and $43 billion. The revenue guidance implies the year-over-year decline as we ramping incredibly strong June quarter last year when revenue grew 33% do impart to accelerated iPhone upgrade purchases. This stuff compares compounded by the continued weak macro environment this year and the strong US dollar which effects our revenue growth in international markets.
Embedded in this guidance is a planned channel inventory reduction worth over $2 billion as we have elected to be prudent about our channel inventory position given the macro environment. The guidance also reflects the range of possible scenarios created to how quickly we can get into supply demand balance for iPhone SE. Due to these factors our expected demand is greater than the revenue range implies. Sequentially our guidance implies a revenue decline of 15% to 19% which is comparable to the 17% sequential decline that we have averaged from the March to June quarter for the last three years.
Despite the anticipated channel inventory adjustments as just described. We expect seasonal sequential declines in iPhone and iPad sales and a sequential increase in Mac sales.
We also expect iPhone ASP’s to decline sequentially as we get further from the launch of iPhone 6s and 6s plus and as iPhone SE and trust the mix. We noted our revenue guidance for short of market estimates for the third quarter. We believe the difference comes primarily from three areas. First, the $2 billion plus channel inventory reduction I just mentioned.
Second the effect of the channel inventory reduction and the launch of iPhone SE on iPhone ASP’s as well as the current constrained supply of iPhone SE and third different estimates for Mac which we expect to grow sequentially at a rate similar to what we have experienced in the past June quarters.
We expect gross margins to be between 37.5% and 38%. We expect continued cost improvements to be more than offset by the sequential loss of leverage from lower revenue and a different mix of products. We expect OpEx to be between $6 billion and $6.1 billion, we expect OI&E to be about $300 million and we expect the tax rate to be about 25.5%.
With that I like to open the call to questions.
Nancy Paxton: Apple’s Investor Relations
Thank you Luca and we ask that you limit to one part question and one follow up. Operator may we have our first question please.
Question & Answer
And ladies and gentlemen it is star one to ask a question. First we will hear from Simona Jankowski with Goldman Sachs.
Simona Jankowski, Goldman Sachs:
Hi. Thank you so much. My first question was actually just the clarification in terms of putting in context that $2 billion in channel inventory reduction. What was that last year just to help us to make the comparison on a year-over-year basis and then the bigger question Tim with the smartphone market now reaching up a pretty much of a growth phase, how would Apple think of itself going forward is it as a growth company or is a more matured tech company and if it still the former how does that change how you think about M&A especially given the position you’re in with your balance sheet strategically.
Simona let me give you a data point on the sell-through and then I let Tim answer the strategic question. We had channel inventory reduction that was worth a bit less than $800 million a year-ago.
Simona, hi its Tim. In terms of there I think the smartphone market is mature. I think the market as you know is currently not growing however my view that is that’s an overhang of sort of the macroeconomic environment in many different places in the world and we are very optimistic that just two the market and particularly ours will grow again. The reason that we are optimistic is we look at the sort of the three places that iPhone sales come from and from an upgrade point of view as I mentioned in my comments we compare favorably slightly better than the upgrade cycle that we saw on the iPhone 5S were lower than iPhone 6 but I think all of us know that was an extraordinary cycle that accelerated upgrades from 2016 into 2015 and so that comparable will be tough for this year but that’s a transitory thing.
As we look at switchers we are extremely excited for the first half we set a record from switchers from other platforms the largest we’ve ever seen in any six month period before. So we’ve got traction there and then on emerging markets if you take a look at India we grew by 56% and we’re placing increasing emphasis in these areas where it’s clear there is a will be disproportionate growth versus the more developed areas.
The next thing is with the iPhone SE we have seeing our ability to attract even more customers into platform with a incredible product that is that a new price point for us with our with latest technology and so we’re optimistic about attracting even more customers with that. We also looking to pipeline and we’re very excited about what’s in our pipeline and so all of those things make me optimistic. Your other question was on M&A and I mean regardless of the first we are always looking in the market about things that could compliment things that we do today become features and something we do or allow us to accelerate entry into a category that we’re excited about. And so as I said before, our test is not on the size we would definitely buy something larger than we bought thus far it’s more about the strategic fit in whether it’s sort of a great technology and great people and so we continue to look and we stay very active in the M&A market.
Thank you, Simona. We have the next question please.
From Piper Jaffray, we’ll hear from Gene Munster.
Gene Munster, Piper Jaffray:
Good afternoon, Tim could you talk little bit about the iPhone ASP trends and specifically you mentioned that the SE is going impact. But how are you thinking about the aspirational market share that’s out there and your actual market share in the using price to close that gap is it just the SE or could there be other iPhone models that will be discount and to try to be more aggressive in emerging markets and one for Luca can you talk little bit about the services segment in terms of what’s piece of the services is driving growth and maybe a little bit about the profitability on a net basis versus a gross basis that you’ve referred to in the past.
Thanks Gene. Gene I think the SE is attracting two types of customers, one is customers that wanted the latest technology but wanted in a more compact package and we clearly see even more people than we thought in that category and then secondly, its attracting people who aspired on iPhones but could and quite stretch to the entry price of the iPhone and we have established the new entry and so I think both of these markets are very, very important to us and we are really excited about where it can take us. I do think that we will be really happy with the sort of new to iPhone customers that we see from here because of the early returns we have had. We are currently supply constrained and that we will be on the work our way out of this at some point.
But it’s great to see the overwhelming demand for it. Now let Luca comment on the ASPs.
So on the ASPs Gene we have mentioned that we are going to be down sequentially and this is really the combination of two factors when we go from the March quarter to the June quarter is the fact that we are we are having the SE entering the mix and then obviously is going to have a downward pressure on ASP and also this channel inventory reduction that I was talked about obviously the channel inventory reduction will come from higher-end models and that is also affecting the sequential trend on ASP’s. The question on services. When we look at our services business obviously growing very well across the board the biggest element and the parts of the services business that is growing very well we mentioned 35% is the app store.
It’s interesting for us that our music business which had been declining for a number of quarters now that we have both a download model and a streaming model. We now hit an inflection point and we really believe that this would be the bottom and we can’t start growing from there over time. We have many other services business, businesses that are doing very well. We have an business that is growing very quickly faster than the app store from a much lower base but I think it’s important for us as we continue to evaluate these businesses.
Tim has talked about Apple Pay it doesn’t provide a meaningful financial contribution at this point but as we look at the amount of transactions that are going through Apple Pay right now and we think ahead for the long-term that could be an interesting business for us as well.
From a profitability standpoint, we have mentioned last time that when you look at it on a gross base so in terms of purchased value of these services are the profitability of the businesses as similar to Company average. Of course when you net out the amount that is paid to developers and you look at it at what in term of what is reported in our P&L obviously that business has a profitability that is higher than Company average we don’t get into the specifics of specific products or services but it is very clear it’s significantly higher than company average.
Thanks Gene. Could we have next question please.
Katy Huberty with Morgan Stanley
Katy Huberty, Morgan Stanley.
Yes thank you. First for Luca this is the worst cross margin guide in the year and half or so and over the last couple of quarters you talked about a number of tailwinds including component cost the lower accounting deferral that went into effect in September. You just mentioned the services margins are above corporate average. So the question is some of those tailwinds winding down or is the significant guide down in gross margins for the June quarter entirely related to volume and the 5 SE and then I have a follow up for Tim.
Yes, Katy clearly, the commodity environment remains quite favorable and we continue to expect cost improvements. The other dynamics that you’ve mentioned still there obviously what is different and I think if you look at it on a sequential basis coming out of the March quarter we will have lots of leverage and that obviously is going to have a negative impact on margins and the other factor that’s important to keep in mind is this different mix of products and particularly when you look at iPhone what I was mentioning to area I think we got couple of things that are effecting not only ASPs but obviously they also effect margins and it’s a fact that we have channel inventory reduction at the top end of range and we’ve got an introduction of the iPhone SE at the entry level of the range and so when you taking to account those factors those are the main elements that drive our guidance range right now.
Okay. Thank you and then question for Tim appreciate the optimism around longer term iPhone unit growth, but with developed market penetration in the anywhere from 60% to 80%. The growth is going to have to come from new markets you talked about India. Can you just spend a little bit more time on that market what are some of the hurdles you have to overcome for that to be a larger part of the business when should we expect Apple to have more distribution in specifically your own stores in that country. Thanks.
Katy in the short term let me just make a couple of comments on the developed markets just to make sure this is clear. If you look at our install base of iPhone today versus two years ago its increased by 80% and so when you think about upgrade cycles, upgrade cycles would have hearing right on it is as I talked about in the comments the iPhone 6S upgrade rate is slightly higher than the iPhone 5S, but lower than iPhone 6. But the other multiplier in that equation is obviously the size of the install base and so I have the noted ideas that I think there is still really, really good business in the developed markets so good to right those off and it’s our jobs to come with great products that people desire and also to continue to attract over Android switchers with our worldwide shares there is still quite a bit of room in the developed markets as well. And from an India point of view if you look at India and each country has a different story of it.
But the things that have helped not only us back perhaps, but some others as well is that the LTE rollout with India just really begins this year and so we will begin to see some really good networks coming on in India that will unleash the power and capability of the iPhone in a way that an older network 2.5G or even some 3G networks would not do and so the infrastructure is one key one in the second one is building the channel out. The unlike the US it’s an example where the carriers in the US sale the vast majority of phones that are sold in the United States.
In India the carriers in general sale virtually no phones and so it’s out in retail and retail is many-many different small shops and so we have been in the process we have start something we just started in the last few weeks. We have been working in India now for a couple of years or more, but we have been working with great energy over the last 18 months or so and I am encouraged by the results that we are beginning to see there and believe there is a lot-lot more there. It is already the third largest smartphone market in the world, but because the smartphones that are working there are low in primarily because of the network and the economics. The market potential has not been as a great there, but I sought a view India is where China was maybe seven to ten years ago from that point of view and I think there is really great opportunity there.
Thank you Katy. Could we have next question please.
Toni Sacconaghi with Bernstein
Toni Sacconaghi, Sanford C. Bernstein:
Thank you. I have one and then a follow up is well. My sense is that you talked about adjusting for the changes in channel inventory that you’re kind of guiding for relatively normal sequential growth and I think if you do math it’s probably the same or perhaps it touch worse in terms of iPhone unit growth sequentially relative to normal seasonality between fiscal Q2 and Q3.
I guess the question is given that you should be entering new markets and you should see from the SE device why wouldn’t we’ll be see something that was dramatically above normal seasonal in terms of iPhone revenues and units for this quarter and maybe you can push back on me but I can’t help thinking that when Apple introduced the iPad Mini in a similar move to move down market it was great growth for one quarter and the iPad never grew again and margins and ASPs went down and it looks like you’re introducing the SE and at least kind of sequential basis not calling for any uplift even adjusting for channel inventory and ASP’s I presume will go down and certainly it’s impacting gross margins as you guided. So could you respond to A, why you’re not seeing the elasticity and B is the analogy with the iPad Mini completely misplaced?
Tony its Tim. Let me see if I can address the question. That the channel inventory reduction that Luca refer to the vast majority of that is an iPhone instead that would affect the unit can fair a bit but maybe thinking about. The iPhone SE we are thrilled with the response that we’ve seen on it. It is clear that there is a demand there even much beyond what we through and so that is really why we have the constrained that we have and so do I think it will be like the iPad Mini, no I don’t think so I don’t see that.
What I think the tablet market in general the one of the challengers with the tablet market is that the replacement cycle is materially different then in the smartphone market and so as you probably know we haven’t had an issue in customer satisfaction on the iPad it’s incredibly high and we haven’t had an issue with the usage of the iPad the usage is incredible but the consumer behavior there is tend to hold for very long time before an upgrade. We continue to be very optimistic on the iPad business and as I had said in my remarks we believe we are going to have the best compare for iPad revenue this quarter that we have had in quite some time and so we will report back in July on that one but I think iPhone has a particularly different kind of cycle to it, then the than the tablet market.
Okay and if I could follow up may be you alluded to replacement cycles and differences between the iPad and the iPhone. My sense was when you’re going through the iPhone 6 cycle was that you had commentated that the upgrade cycle was not materially different. I think your characterization was it is accelerated a bit in US, but international have grown be a bigger party of your business in replacement cycles were typically a little bit longer and so I’m wondering if there was only a modest difference between the 5S and the 6 how bigger difference that we really seeing in terms of replacement cycles across the last three generation and maybe you can help us if the replacement cycle was flat this year relative to what you saw last year how different would your result have been this quarter in the first half.
There is a lot there. I let me just say I don’t recall saying the thing that you said I said about the upgrade cycles you get that out of the way. Now let me describe the without the specific numbers the iPhone 6S upgrade cycle that we measured for the first half of this year so the first six months of our fiscal year to be preside. It’s slightly better than the rate that we saw with the iPhone 5S two years ago.
But it’s lower than the iPhone 6 and I don’t mean a just here lower its a lot lower and so without giving you exact numbers if we would have the same rate on 6S that we did 6 there would it would be time for a huge party. It would be huge difference.
Now the good news the great news from our point of view is I think we are strategically positioned very well. Because we have announced the SE we are attracting customers that we previously didn’t track and that’s really great and this tough compare eventually isn’t the benchmark and so the installed base is up 80% over the last two years and so all of those I think did well and the switcher comments I made earlier I wouldn’t underestimate because that’s very important for us in every geography. Thanks for the question.
Thanks, Toni. Can we have the next question please.
From Cross Research Group, we’ll hear from Shannon Cross.
Shannon Cross, Cross Research:
Thank you very much. I have couple of questions one Tim can you talk a bit about what’s going on in China. I know the greater China revenue I think was down 26% you can talk about Mainland China. But just if you could talk about some of the trends you are seeing there and how you think its planned out and maybe your thoughts on SE adoption was in China as well.
Yes, Shannon thanks for the question. If you take greater China we include Taiwan, Hong-Kong and Mainland China as in the greater China segment you see reported on your data sheet. The vast majority of the weakness in the greater China regions sits in Hong-Kong and our perspective on that is it’s a combination of Hong-Kong driving (inaudible) US dollar and for it carries the burden of the strength of the US dollar and that has driven tourism international shopping and trading down significantly compared to what it was in the year-ago. If you look at Mainland China which is one that I am personally very focused on.
We are down 11% in Mainland China on a reported basis. On a constant currency basis we are only down 7 and the way that we really look at the sort of the health or underlying demand as look at sell-through and if you look at it there we’re down 5 and keep in mind that’s down 5 on a half a year-ago that was up 81 and so is that sort of backup from this and look at the larger picture I think China is not weak as has been talked about I see China as may not have the backs that we once did but it’s a lot more stable than what I think is the common — of it and so we remain really optimistic on China. We open seven stores there during the quarter, we have now are at 35 we will open five more this quarter to achieve 40 which we talked about before and the LTE adoption continuous to rise there but it’s kind a long way of it and so we continue to be really optimistic about it and just would ask folks to sort of look underneath numbers that the details of them before concluding in.
Thanks for question.
Okay thanks and then my second question is with regard to sort of OpEx leverage or thinking about when I look at the revenue your revenue below our expectations but OpEx is pretty much inline. So how are you thinking about potential leverage I don’t know cost containment maybe when macro is bad and revenue is under pressure and how are you kind of versus the required investment you need to go forward?
Shannon, its Luca. Of course we think about it, we think about it a lot and so when you look at our results for example our OpEx for the quarter for the March quarter was up 10% which is the lowest rate that you have seen in years and when you look within OpEx you actually see two different dynamics; you see continued significant investments in research and development because we really believe that’s the future of the company, we continue to invest in initiatives and projects ahead of revenue, we have a much broader portfolio than we use to have, we do much more in house technology development then we use to do a few years ago which we think is a great investment for us to make.
So that part we really need to protect and we want to continue to invest in the business and then when you look at our SG&A portion of OpEx for the March quarter it was actually down slightly. So as we think about it and of course we look at our revenue trend and we take measures accordingly and when you look at the guidance that we provided for the June quarter that 10% year-over-year increase that I mentioned to you for the March quarter goes down to a range of 7% to 9% and again the focus is on making investments in R&D and continuing to run SG&A extremely tightly and in a very disciplined way. As you know, our E2R expands to revenue ratio is around 10% it’s something that we’re very proud of its a number that is incredibly competitive in our industry and we want to continue to keep it that way at the same time we don’t want to that invest in the business.
Thank you, Shannon. Could we have the next question please.
From UBS. We’ll hear from Steve Milunovich.
Steve Milunovich, UBS:
Thank you. Time I first wanted to ask you about services and how do you use services you’ve obviously highlighted at the last two quarters. Do you view it going forward as a primary driver of earnings or do you view it and you mentioned platforms in terms of the operating system which I would agree with and then in that scenario I would argue with in more a supporter of the ecosystem and supporter of the hardware margins overtime and therefore somewhat subservient to hardware. So it’s great that its growing but longer term I would view its role is more creating ecosystem that supports the high margins on hardware as oppose to independently driving earnings how do you think about it.
The most important thing for us Steve is that we want to have a great customer experience. So overwhelmingly the thing that drives us are too embark on services that help that and become the part of the ecosystem. The reality is that in doing though we have developed a very large and profitable business in the services area and so we felt last quarter and working up to that you should sort of pull back to curtain so that people could our investors could see the services business both in terms of the scale of it and the growth of it. As we said earlier the purchase value of the install base services grew by 27% during the quarter which was an acceleration over the previous quarter and this the value of it hit just we just shy of $10 billion and so it’s huge and we felt it was important to just fell that out.
Okay and then going back to the upgrades of the installed base you’ve clearly mentioned that you kind of pulled forward some demand which makes sense. But there does seem to be lengthening of the upgrade cycle particularly in the US AT&T and Verizon have talked about that investors I think perceived that maybe the marginal improvements on the phone might be less currently and could be less going forward. At the same time I think you just announced that you can get the upgrade program online which I guess potentially could shorten it do you believe that upgrade cycles are currently lengthening and could continue to do so.
What we have seen is that it depends on what you compared to. If you compare to the 5S what we are seeing is the upgrade rate today is slightly higher or that there multiple upgrading if you will in a similar time period in terms of rate then the 5S. But if you compare to 6, you would clearly arrive at the opposite conclusion and so I think it depends on peoples referenced points and we thought it very important in this call to be very clear in terms of kind of what we are seeing and so I think in retrospect you can look at well maybe the corporate measure is more to the 5S and I think everybody incredibly thought that the upgrades were accelerated with (inaudible) in retrospect when you look at the periods they clearly were.
Thanks Steve. Can we have a next question please.
We’ll go to Rod Hall with JPMorgan.
Rod Hall, JPMorgan:
Yes. Thanks guy’s for — in. So I wanted to start with a general more general question I guess Tim this one’s aimed at you as you think about where you thought things is going to ahead last quarter when you reported to us and how its changed this quarter obviously this kind of disappointing demand environment. Can you just help us understand what maybe the top two or three things are that have changed and so as we walk away from this we understand what the differences are and what the direction that changes and I have a follow up.
Yes, I think you’re probably indirectly asking about our comment if you will from last quarter and when we made that we did not contemplate or that we were going to make a 2 plus billion dollar reduction in channels inventory during this quarter and so if you factor that in and look at true customer demand which is the way that we look at it internally I think you’ll find a much more reasonable comparison
Okay great. Thank you and then I just wanted from my follow up I wanted to ask you on about the tax situation a little bit treasury always see made some rule changes and I wonder maybe if Luca you get comment on what the impact to Apple from those is if anything and can be more broadly how you guys see the tax situation for Apple looking forward? Thanks
Yes sure I mean these our new regulations and we are in the process of assessing them frankly from first we don’t anticipate that they going to have any material impact on our tax situation some of them relate to transactions so obviously that’s not an issue for us some of them are around internal debt financing which is not something that we use. So we don’t expect any issue there we are the largest US tax payer by a wide margin and we already pay full US tax and all the profits from the that we make in the United States. So we don’t expect them to have any impact on us and partially form maybe I can continue and let’s Tim provide more color but we’ve been strong advocates for comprehensive corporate tax reforming this country. We continue to do that, we think at reform of tax we will have significant benefits for entire US economy and we remain optimistic that we’re going to get to a point where we can see that tax reform at that point in time of course we will have much more flexibility around optimizing our capital structure and around and providing more return on capital,
The only thing I would add I think there are a growing number of people in both parties that would like to see comprehensive reform and so I am optimistic that it will occur in just a matter of when and that’s difficult to say but I think most people do recognize that if it’s in the US’s interest to
Great thanks guys.
A replay of today’s call will be available for two weeks, podcast on the iTunes store, 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 7495552.
These replays will be available by approximately 5:00 PM Pacific Time today. And members of the press with additional questions can contact Kristin Huguet at 408-974-2414 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.
Ladies and gentlemen that does conclude today’s presentation. We do thank everyone for your participation.