Notes from Apple’s Q3 2011 Earnings Conference Call

Apple CFO Peter Oppenheimer noted that the company has experienced the highest quarterly earnings and revenues in its history, as well as record sales for the iPhone and iPad. Apple sold 7.5m iPods last quarter, ahead of expectations with the iPod touch being over 50% of all iPods sold. The iPod share is now over 70% of all MP3 player sales in the U.S. according to the latest NPD data, and leads in most other markets as well. The iTunes Store had revenues of almost $1.4 billion the past quarter, with continuing strong sales of music, video and apps. The iTunes Store continues to be the number one music retailer in the world with 15 billion songs downloaded to date.

Turning to the iPhone, the company sold a record 20.3 million iPhones in the past quarter, as compared to 8.4m in the year ago June quarter and over double of the smartphone growth overall. Oppenheimer reported very strong year-over-year iPhone growth everywhere, with quadrupled sales in the Asia-Pacific region. Manufacturing capacity has been increased and the iPhone is now available on 228 carriers in 105 countries. Apple now has 5.9m iPhones in inventory, which constitutes enough to meet a demand of approximately 4-6 weeks. 91% of Fortune 500 companies are now deploying or testing the iPhone, up from 88% last quarter. 57% of global 500 companies are either deploying or testing the iPhone.

Apple sold 9.2m iPads last quarter versus 3.3 million in the year-ago quarter. Production has been increased and Apple is selling every one they’ve made. The iPad is now being distributed in 64 countries with revenue of $6 billion for the iPad versus $2.2 billion one year ago. Apple ended with 1.05m iPads in channel inventory, well below the target range of 4-6 weeks. With the iPad, over 86% of Fortune 500 companies are testing and deploying the device along with strong international adoption—47% of the global 500. Oppenheimer noted that the iPad is making its way into the enterprise in ways that Apple never could have imagined, being used in hospitals, retailers, aircraft cockpits, training, currency tracking and much more.

Combining the iPhone, iPad and iPod touch, Apple reached over 220 million sales cumulatively through the end of the quarter. Last month the company previewed iOS 5 which includes notifications, iMessages, and Newsstand for newspaper and magazine subscriptions as well as a PC-free feature that allows users to get their iOS devices up and running without the need for a Mac or Windows PC.  Apple is looking froward to launching iOS 5 this fall. In June, Apple also provided a preview of iCloud, a new set of services that operates with all of Apple’s desktop and mobile devices to seamlessly transfer and manage data across multiple devices.

Oppenheimer also highlighted some major accounting changes for Apple allowing the company to provide iCloud services to Lion and iLife users as they become available, similar to what Apple has been doing with its iOS devices.

The company will continue to charge for major upgrades to OS X, such as OS X Lion, as well as for major upgrades of iLife. However, revenue will be recognized over a period of three years to give services to users, including iCloud services, which will now be partially deferred. Since iOS devices will also benefit from iCloud, Apple will make additional deferrals related to iPhone, iPod touch, and iPad ranging from $11-$16 per device, due to ongoing delivered value of iCloud over time.

Oppenheimer noted that higher educational buying will start in September and be focused on Macs and iPhones. iPads are also expected to grow significantly, although Apple expects iPod sales to continue to decline. He also mentioned iOS 5 and iCloud as well as a “future product transition” taking place in the fall that Apple will not be discussing today. Oppenheimer reiterated that Apple is “incredibly confident in our business, our product pipeline, and what we’re doing.”

During the Q&A, a question was raised about iPad 2 sales and trends and whether there had been any cannibalization in Mac sales and shifts of people away from portable computers such as MacBooks. Tim Cook responded that Apple believes that some customers did choose to purchase an iPad instead of a new Mac during the quarter, but even more chose to purchase an iPad over a Windows PC. Cook stated that they believe there is much more to cannibalize in the Windows market than in the Mac, and the Mac has attributes that will allow it to continue doing well in the market.

Cook went on to mention that Apple has been selling every iPad they could make during the quarter, and in July has increased supply even further. In some countries, some models are in supply-demand balance.  There is overwhelming demand in many countries such as China where growth has been up by a factor of six year over year. Cook noted that he firmly believes that the iPad demand is just scratching the surface right now.

In responding to questions regarding component pricing, Cook noted that the costs of the future production transition will be a factor in the upcoming quarter, but they believe that component pricing will likely be favourable for the most part.

Responding to a question about Apple’s intellectual property strategy in light of recent patent lawsuits, Cook responded that Apple has a very simple view on the matter: “We love competition, but we want people to invent their own stuff” and the company will defend its patent portfolio as it feels is necessary.

Cook was also asked about the iPhone strength over the quarter in terms of penetration into new countries and new carriers. He noted that Apple added 42 new carriers and 15 new countries during the past quarter, with a large improvement due to emerging and developing markets such as China, Latin America, Brazil and the MIddle East—markets where Apple historically has not been as strong. Cook noted the company is now beginning to see fruits of labour in those markets. Cook declined to comment on any specific plans for new carrier expansion, but noted that they feel there are still many great partners out there for them to work with to expand into new markets.

Asked about Google’s strong Android activations compared to Apple’s numbers, Cook indicated that Apple’s numbers are obvious from the iPhone, iPad and iPod touch information the company has already provided: over 33m iOS devices sold in total this past quarter; over 222m iOS devices sold cumulatively. The quarterly numbers are transparent and growing faster than the market by a factor of two in smartphones, and 100% sales of iPad 2’s versus production. The App Store remains the largest by far with developers having made a total of $2.5 billion, a dramatic difference from other tablets that do not seem to be getting any traction. Cook noted that the product, the App Store, and the development proposition are all great, customers are thrilled, and the roadmap confidence is high.

On the Apple TV, Cook noted that it continues to do well, but he doesn’t want to mislead anybody and was clear that Apple still calls it a hobby because it doesn’t want anybody to conclude that it’s “another leg of the stool.”  It is not the same size market as the iPod, iPhone and iPad. Apple loves the Apple TV, as do customers and Cook indicates that they “really got it right” with the new design last fall, but it remains in hobby status. Apple is continuing to invest in it as they believe there is future potential.

A question was raised on what Apple feels are the keys to sustaining iPhone growth in terms of pricing and tariff structure. Cook responded that the carriers set the tariffs, not Apple, so that’s a better question for them. At a macro level, however, virtually every carrier wants to have more customers with smartphones, and Cook firmly believes there is no better device to promote this than the iPhone. Its ease of use is unparalleled, making it an easy sell for carriers to introduce feature phone customers into the smartphone world. Cook noted the key driver to results on the iPhone this quarter were emerging and developing markets, and Apple is therefore putting more energy into those markets that have been a bit more difficult to do well in.

Cook noted that Apple is not avoiding the prepaid market as its necessary to get the kind of volume of iPhone sales and penetration that they desire, particularly in many of the emerging markets. Expanding further in postpaid is on the list as well, however, as Apple believes its better for the customer, the carrier, and the company.

Mac sales did see some cannibalization by iPad. The iPad numbers were bigger than Macs, and it’s clear that some customers bought an iPad instead of a Mac, but many also bought an iPad rather than a Windows PCs. Some people did delay purchases because of Lion. Also a year ago, a new MacBook Pro was launched; in this quarter, a new iMac was launched. The MacBook Pro makes up the majority of units Apple sells in the Mac area, so if you change the MBP rather than the iMac, or vice-versa, it changes the sales results for a given quarter. However, the Mac is still selling at 5x rate of the industry.

Apple suggested iPad sales will grow significantly year over year for the next quarter, and left people to guess as to why that is.

Asked about enterprise sales strategies, Cook noted that Apple has taken a dual-pronged approach, working with carriers to promote iPad and iPhone sales into the enterprise as the carriers are very active and interested in selling services to the enterprise, as well as approaching enterprise sales directly to introduce businesses to the value proposition of the iPad and help them through the testing, deployment and implementation stages. Cook noted that it’s actually very surprising at how fast the enterprise has been adopting the iPad, since that market traditionally takes a very long time to adopt new products, yet the iPad has only been on the market for 15 months. Cook noted that the rate of adoption in business and education has been shocking, making it clear that the device has a universal appeal in many different markets from consumer to business to government.

Responding to a question about Apple’s expectations for iCloud and the potential “halo effect” across Apple’s devices, Oppenheimer noted that the company believes that it has “done it right” with iCloud and will provide customers with a seamless, integrated experience across all Macs and iOS devices and Apple can’t wait to get it into the hands of customers in the fall. Oppenheimer noted that Apple already has a proven track record in delivering content over the Internet with the iTunes Store, App Store, payments to developers and so forth.