Peter Oppenheimer - CFO Tim Cook - COO Gary Wipfler - Treasurer Nancy Paxton - IR and Corporate Finance

David Bailey - Goldman Sachs Richard Gardner - Citigroup Bill Richards - UBS Andrew Neff - Bear Stearns Bill Shope - JP Morgan Kathy Huberty - Morgan Stanley Robert Semple - Credit Suisse Harry Blount - Lehman Brothers Gene Munster - Piper Jaffray Shannon Cross - Cross Research Richard Farmer - Merrill Lynch Chris Whitmore - Deutsche Bank Charles Wolf - Needham & Co Keith Bachman - Banc of America Brian Blair - Wedge Partners Shaw Wu - American Technology Research John Jarvis - Boston Company Bill Fearnley - FTN Midwest Steve Lidberg - Pacific Crest Securities Jonathan Hoopes - ThinkEquity Partners Jesse Tortora - Prudential

Good day, and welcome to this Apple Computer fourth quarter financial results 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, Investor Relations and Corporate Finance. Please go ahead.

Thank you and good afternoon, and thanks to everyone for joining us. Speaking today is Apple CFO, Peter Oppenheimer, and he will be joined by Apple COO, Tim Cook, and Apple Treasurer, Gary Wipfler, for the Q&A session with analysts. Today, we are releasing preliminary results of Apple's fourth fiscal quarter. As our press release indicates, these results may be subject to significant adjustment due to the likely restatement of historical results that we have previously disclosed. Though preliminary, we are providing this information today as we believe it is in investor's best interests that we present current results and the related trends of the business. Please note that some of the information you will hear during our discussion today may consist of forward-looking statements regarding revenue, gross margin, operating expenses, other income and expense, taxes, earnings per share, future products, non-cash stock-based compensation expense, and the likely restatement of historical financial results pending the determination of appropriate accounting treatment for Apple's historical stock option granting practices. Actual results and trends could differ materially from our forecast. For more information, please refer to the risk factors discussed in Apple's Form 10-K for 2005, the Form 10-Q for the first and second fiscal quarters of 2006, and the Form 8-K filed with the SEC today and the attached press release. With that, I would like to turn the call over to Peter Oppenheimer for introductory remarks.

Thank you, Nancy. Thank you for joining us. We are pleased to report very strong preliminary results for the fourth quarter, and the best Mac shipments by far in any quarter in Apple's history. The quarter's revenue was $4.84 billion, representing 32% year-over-year growth. The strong revenue was fueled by robust sales of our Mac portable products, a successful back-to-school season, and the continued popularity of our music products. Preliminary operating margin for the quarter was 12.6%, and preliminary net income was $546 million, or $0.62 per diluted share on a GAAP basis. I would like to talk first about our Mac products, which represented 58% of our total quarterly revenue. We shipped a total of 1.61 million Macs, significantly greater than the previous quarterly record of 1.38 million Macs sold in the first quarter of Apple's fiscal 2000. Our September quarter Mac shipments grew 30% over the prior year, which is more than three times IBC's latest published market growth projections for the quarter. We believe this growth rate is particularly remarkable, given the tough comparison to the prior year's September quarter, which was up 48% year over year. The strong growth in Mac sales was largely due to unprecedented demand for our portable products, with sales of nearly 1 million units, representing 61% of all Macs sold during the quarter. Ending channel inventory of Macs was below our target range of four to five weeks. With our Mac Pro launch in August, we have transitioned all of our Macs to the Intel architecture in nine months. We are extremely pleased with our team's speed and skill in executing this complex transition, and our developers continue to make great progress as well. There are over 4,000 universal applications available today and we estimate that by the end of December, 80% of the 500 Mac applications we consider most important to our customers will be available in universal versions. Our music products generated another quarter of strong results, representing 42% of total company revenue and increasing 36% year over year. iPod shipments grew 35% year over year, to $8.73 million, bolstered by the announcement of our new iPods on September 12th, and our very popular back-to-school promotion. Reviews of the new iPods have been very positive, and we are very confident in our new line-up, despite increased competition this holiday season. Channel inventory of iPods as of the end of the quarter was within our target range of four to six weeks on a look-back basis. The iTunes store continues to be the world's leading online music store, and now offers movies in addition to over 3.5 million songs, 220 television programs, 9,000 music videos, and 20,000 audiobooks. Based on the latest data available from Nielsen SoundScan, iTunes accounts for 85% of songs purchased and downloaded in the U.S. The iPod ecosystem continues to thrive, with over 3,000 accessory products currently available. We estimate that over 70% of the 2007 model year cars sold in the U.S. will offer direct iPod integration as an option. The Apple retail stores posted very strong results. Revenue for the quarter was $936 million, up 41% year over year, and segment operating profit was $50 million. For the full year, revenue from the stores increased by over $1 billion, and average revenue per store grew to almost $24 million. We opened 10 new stores during the September quarter, ending with 165. With an average of 158 stores open during the quarter, average revenue per store was $5.9 million. The stores sold a record 323,000 Macs during the quarter, representing 60% year-over-year growth. Based on our latest survey, over 50% of the customers buying Macs in our stores were new to the Mac. Applying that rate to the quarter's results, we estimate that the average store added about 1,000 new Mac customers during the quarter. Over 20 million people visited the stores during the quarter, and customers attended over 125,000 personal training sessions. Our education channel had an outstanding quarter, selling a record number of Macs, driving 20% year-over-year growth. We are particularly pleased with this growth, which is significantly greater than IDC's most recently published forecast for the U.S. education market for the quarter. It was the most successful back-to-school quarter ever for our higher ed business, where shipments of Mac portables increased 49% year over year. This result was due in large part to the popularity of the MacBook in higher ed, as well as our very successful back-to-school promotion. In terms of geographic results, including sales from our retail stores, quarterly revenue in the Americas, Europe, and Japan was up 33%, 27%, and 26% respectively. Preliminary gross margin was 29.2% on a GAAP basis, about 80 basis points higher than our guidance, primarily due to product mix. Included in GAAP cost of goods sold was $5 million of stock-based compensation expense. Preliminary GAAP operating expenses were $803 million, including $34 million in expense related to stock-based compensation. Op-ex was about $17 million higher than guidance, primarily due to higher-than-expected revenue. OI&E was $113 million, about $13 million higher than guidance, largely due to higher-than-expected cash balances and higher-than-expected yields on cash investments. The tax rate for the quarter was about 24%, below our guidance of 32%, due to a one-time credit resulting from the settlement of prior-year tax audits in the United States, and proportionately higher-than-anticipated operating income from foreign jurisdictions with lower tax rates. We had a very strong cash generation during the quarter, increasing our cash balance by $934 million, to end with over $10.1 billion. This was primarily a function of strong earnings and working capital management. Looking ahead to the December quarter, I would like to review our outlook, which excludes the impact of any restatement and includes the types of forward-looking information that Nancy referred to at the beginning of the call. For the quarter, we are targeting revenue between $6 billion and $6.2 billion. We expect total quarterly costs of non-cash, stock-based compensation to be approximately $45 million. We expect GAAP gross margin to be about 28.25%, reflecting approximately $6 million related to stock-based compensation expense. We expect GAAP op-ex to be about $905 million to $920 million, including about $39 million related to stock-based compensation expense. We expect OI&E to be about $120 million, and we expect the tax rate to be about 32%. We expect to generate GAAP EPS of about $0.70 to $0.73, including an anticipated $0.03 per share related to non-cash, share-based compensation expense. In closing, we are very proud of our accomplishments of the company in fiscal 2006. We sold over 5.3 million Macs, representing our best year ever, and we reached new heights with iPod shipments, selling more than 39 million. We generated $19.3 billion in revenue, representing 39% year-over-year growth, and we have added $11 billion in top-line growth in the last two years. We skillfully executed an incredibly complex architecture transition, converting our entire Mac line to Intel microprocessors in nine months. We remain committed to innovation and we are very enthusiastic about our product pipeline. With that, I would like to open the call to questions.

(Operator Instructions) We'll take our first question from David Bailey - Goldman Sachs. David Bailey - Goldman Sachs: Great, thank you very much. Two short questions, please. Can you help us understand the impact of the lower price points associated with the new iPods are going to have on your blended ASP and gross margin for the December quarter? Just a follow-up, the component environment has been very favorable the past few quarters, can you give us your outlook on the remainder of the year for your component prices?

David, I'll start with the iPod questions and Tim can discuss the component environment. As a result of the price reductions that we took on September 12th and the introduction of the new $79 Shuffle, we believe that our ASPs and iPods will be down in the December quarter from what they were in September, but we are very excited about the line that we just announced and are looking forward to the holiday season and confident.

David, in the notebook hard drive area, we expect that since supply exceeds demand in this area, there'll be favorable pricing. For DRAM, NAND Flash, and LCD panels, demand trailer exceeds supply due to the usual seasonal demands. We expect other commodities to decline consistent with historical trends. David Bailey - Goldman Sachs: Okay, thank you.

Thanks, David. Could we have the next question, please?

That will come from Richard Gardner - Citigroup. Richard Gardner - Citigroup: Thank you very much. I had two questions. One, I was hoping, Peter, you could give us the typical walkthrough on the pluses and minuses for gross margins in the fourth quarter. Secondly, was hoping you could give us a status update on your retail pilots with incremental retail customers?

Rich, as I said in my prepared remarks, the gross margin declined by about 110 basis points in the September quarter from the June quarter, which was actually less than what we had guided down. We had guided down closer to 200 basis points. The reason for this difference was primarily a better mix of higher margin products. Richard Gardner - Citigroup: Actually, Peter, could you give us the same walkthrough for the December quarter?

For the December quarter? Sure. Guiding margin down about a point as a result of the quarter having much higher iPod and other music product sales and also having a full quarter of the lower iPod pricing.

Rich, in terms of expanding distribution on the Macintosh, as you know, we've had a pilot going by in seven stores. We've just concluded this week to expand that during this quarter to over 50. The stores are located around the country, and they will be selling both desktops and notebooks as well as some Mac software and accessories. We'll continue to evaluate how the program is going over the next several months to conclude what the next step should be. We're also running a small pilot with Circuit City which we really just started and there's no data available. But we will obviously monitor that and conclude what to do with that in the future. Richard Gardner - Citigroup: All right. Thanks a lot.

Thanks, Rich. Could we have the next question, please?

That will come from Bill Richards - UBS. Bill Richards - UBS: Good afternoon, thanks. So Steve says in this release that 2007 will be one of the most exciting product years in the history of Apple. Does that mean we should all show up for MacWorld? What does that mean versus 2006? Any other comments?

Ben, as you know, we don't comment on our product road map in terms of specifics, but we are very confident of what we have in the pipeline and very excited that our customers will be pleased with it. Bill Richards - UBS: I guess with regard to a couple of other things. With regard to other music, that line was a little below expectations while virtually every other line was much better than expected. Is there something going on with download habits, Peter or Tim, and can you elaborate there? Should that line pick up with the addition of movies?

Ben, in the quarter, it was relatively flat sequentially, but up over 70% year-over-year. In the quarter, we reduced our channel inventory on the Apple-branded iPod accessories in advance of our announcements on September 12th, so that played into it. Also, the summer is usually not the best quarter for music sales. People are on vacation and it generally is not the strongest quarter for new album releases either. Bill Richards - UBS: So you would expect that to pick up quite a bit into the holidays, normal seasonality? Nothing special to --

Not providing a quantitative forecast, but qualitatively, seasonally, and with album releases, we have seen that in the past. Bill Richards - UBS: Lastly, inventory and receivables went up. Was that in line with your expectations? Looks like channel inventory is okay, but what about those two lines? What are you preparing for the on the inventory line, or what does it say about the linearity of the quarter on the AR side?

In terms of inventory, it was up about $100 million year-over-year. We've opened 41 stores this year. Virtually all of the increase in inventory is in the retail stores to serve customers. As it relates to accounts receivables, they were up a little over $350 million, but as I said in my prepared remarks, in the last two years, we've added $11 billion in top line growth. The DSO performance was very strong in the quarter at 24 days. Bill Richards - UBS: All right. So the inventory was due to increased stores and getting ready for the holidays?

Yes. Bill Richards - UBS: Thanks a lot, guys.

Your next question comes from Andrew Neff - Bear Stearns. Andrew Neff - Bear Stearns: Two things. Just a point of clarification. Japan, the CPUs were down. Can you give us background on what's going on in Japan? Second, to the extent you can talk about with the ongoing investigation, can you give us some sense about the role that you've clarified that Steve Jobs may have in this options investigation?

As we reported about two weeks ago in our release, the special committee of Apple's board with its independent advisors reported their key findings. One of which was that the investigation found no misconduct by any member of Apple's current management team, and that includes Steve.

Andy, on the Japan side, when you combine the channel results with our retail store results, Macintosh units on a year-over-year basis declined by 10%. The market in Japan is among the weakest in the world and IBC was also expecting a contraction during the quarter. However, having said that, we're not pleased with our performance there and we've got a number of activities underway to attempt to improve them. I would point out that despite the reduction in the Macintosh area that from a year-over-year point of view, revenue was up 26% in Japan on strong iPod sales. Andrew Neff - Bear Stearns: That's what I was trying to understand, because the CPUs were down, but the revenues were up strongly so I was trying to clarify that.

Yes, and that's due to strong iPod sales. Andrew Neff - Bear Stearns: Okay, Tim. Thanks very much.

Can we have the next question, please?

That will come from Bill Shope - JP Morgan. Bill Shope - JP Morgan: Great, thanks. Can you guys give us an update on the progress you're seeing in the international markets with the iPod as you did last quarter? Then on the iTunes side, do the video sales have similar economics to music sales, as you've said in the past, or is this changing as U.S. scales the video business?

Bill, we don't report individual product gross margins, but we're running the music store at above breakeven levels. Our view continues to be that selling music and TV shows and now movies helps us to sell iPod and accessories. As it relates to international iPod results, we continue to be happy with our progress. In the U.K., Canada, Japan, and Australia, our market share ranges from 40 to 50% and in many western European countries, we've picked up market share year-over-year, typically 6 to 7 points in place like France and Germany and Italy and Spain. Bill Shope - JP Morgan: Great, thank you.

Could we have the next question, please?

Your next question comes from Kathy Huberty - Morgan Stanley. Kathy Huberty - Morgan Stanley: Just going back to inventory and channel inventories for Macs, do you feel you can get that back to normal levels ahead of the holiday season?

We did drop below the four to five weeks, as Peter said in his opening remarks. That was due primarily to very, very strong demand on the MacBook and a great reception to the iMac that we announced in early September, the new lineup of iMac. I do anticipate being able to get the channel back to reasonable levels during the quarter, but I'm not forecasting what will happen at the end of the quarter. Kathy Huberty - Morgan Stanley: How should we think about any potential stalls in the Mac business ahead of the Leopard launch next year? Has that typically happened in the past?

We have all of our thinking embedded in our guidance, but as Steve announced at the developer's conference, the Leopard will be shipping in the spring of next year. Kathy Huberty - Morgan Stanley: Okay, great. Thanks.

Thanks, Katie. Can we have the next question, please?

That will come from Robert Semple of Credit Suisse. Robert Semple - Credit Suisse: Yes, thanks. Guys, can you characterize the demand for the new Nano launch? I guess in the context of last year, Tim, last year you found the demand staggering and you could only get a million units out the door in the final three-four weeks of September. How did the rollout go this year relative to last?

The customer reception was excellent, the analyst reviews have been very, very favorable. If you look at the quarter in the months, iPod demand really accelerated significantly post the launch and it was that acceleration that allowed us to exceed our expectations for the quarter. Robert Semple - Credit Suisse: Switching gears to the desktop, growth was about 4% year on year, on a unit basis and probably not that surprising given the cannibalization trends we're seeing in the overall market. But as you look at that business going forward, is that a reasonable growth rate you should be looking for or can it improve with new product introductions and things like that?

We don't forecast out the portable and desktop area, but as you mentioned, there is a widespread movement to portables, and our portables grew 56% year-over-year. So we're incredibly pleased with what is a blowout quarter. Robert Semple - Credit Suisse: Okay, thanks.

Thanks, Rob. Can we have the next question, please?

That will come from Harry Blount, Lehman Brothers. Harry Blount - Lehman Brothers: Hi, guys. Thank you very much. A couple of quick questions. One is, Peter, could you give a little bit of a sense on direct and indirect trends? Specifically, you guys highlighted last quarter the focus on improving the international penetration. I was wondering if you are in fact seeing a significant increase in the indirect percentage of the iPods? Also, if you could make some directional comments on the PC side?

Harry, our direct percent in Q4 of the September quarter was 54% in total, and that was up from 50% in the June quarter and the year-ago quarter was 52%. As I indicated in my prepared remarks, our Americas and Europe and Japan revenues were up reasonably closely and I would say that we're very happy with both the performance of our indirect channel and our growth overseas. Harry Blount - Lehman Brothers: So the change you're seeing, Peter, is that similar then within product categories as well, the iPods versus the PCs?

As you know, the iPod has a much broader distribution. It's a little less than 40,000 points around the world, direct and indirect. And Mac distribution is a little over 7,000 points. Harry Blount - Lehman Brothers: Okay. You guys have made significant improvements in the bill of materials on the iPod. Would it be fair to say that the iPods have now achieved similar gross margins as the PC product line?

I don't want to comment quite that specifically. I will say that the iPods' gross margin was above 20% in the September quarter, but the gross margin was down a bit from the June quarter as a result of the price reductions that we took in September and our transition. Harry Blount - Lehman Brothers: Last question is, you mentioned traffic in the stores greater than 20 million, can you be a bit more specific?

It was a bit above 20 million. The performance in the stores was just outstanding. The revenue was $934 million. We were up year-over-year 41%. Mac sales were up 60%. Our new to Mac for Mac sales actually went over 50% this quarter. And it's amazing, given that we've sold 323,000 Macs in the quarter, that a little more than half of the people had never owned a Mac before. We were thrilled by that. Harry Blount - Lehman Brothers: Thank you.

Can we have the next question, please?

That will come from Gene Munster with Piper Jaffrey. Gene Munster - Piper Jaffray: Good afternoon. The 1.5 or 1.6 Mac number is obviously impressive. As you look at that number, is there any way for us to think about what potentially could be pent-up demand in that number versus the pure demand? I guess it's a difficult question, but how do you think about this kind of tradeoff?

Gene, I think the Mac results were a combination of us completing the Intel transition. The exceptional customer response to the innovative products that included those that were transitioned and very, very strong back to school and education sales including two large K-12 deals that totaled 50,000 units during the quarter. Gene Munster - Piper Jaffray: As you look at the December quarter, can you remind us last year, I know that the iMac was pretty successful in the December quarter. Does the baton get shifted for the holiday quarter to the iMac from the notebooks? Is that one way to look at it, or is there any differentiation there?

In the holiday quarter, typically the consumer side of the house does extremely well and consumers are buying both notebooks and desktops. Gene Munster - Piper Jaffray: Lastly on the Shuffle, any idea on when that's going to be shipping?

We will ship by the end of October. Gene Munster - Piper Jaffray: Thank you.

Next question, please.

That will come from Shannon Cross - Cross Research. Shannon Cross - Cross Research: Just a couple questions. Can you give us any color on boot camp downloads? What are your surveys saying, people are coming, over 50% in the store are switchers, are they looking running OSX or Windows?

On boot camp, Shannon, we're over 1 million downloads, which we are very, very pleased with. We continue to have a plan to integrate boot camp in Leopard next spring.

Regarding the performance in the stores, again, this quarter we went over 50% new to Mac and I think customers are coming in looking at Macs based upon just our great hardware, the stability of OSX, the great iLife software and the great experience they're having in the stores. Shannon Cross - Cross Research: Can you give any metrics in terms of iTunes stores, games were just launched, videos. What kind of take rates? At one point, I heard a goal of 1 million videos, or movies per week, by the end of the year. Is that still a goal?

We will likely re-release game and movie sales at a future date. I don't want to comment specifically, but we are very happy with the performance of the iTunes store with everything that it's selling, and as I said, we think it's a big reason why people are buying iPods and accessories and certainly think it's helping us in the Mac business. Shannon Cross - Cross Research: Okay, Peter, just a clarification on tax rate, you said 32% going forward, but are any of the foreign tax benefits in terms of the mix shift of revenue ongoing, in which case maybe we'll see a lower tax rate?

We contemplated that in the guidance that I've given you for the first quarter. Shannon Cross - Cross Research: Okay, thank you.

Thanks, Shannon. Next question, please.

That will come from Richard Farmer - Merrill Lynch. Richard Farmer - Merrill Lynch: Thank you. I understand you don't want to give specific gross margin numbers by products, but maybe in the same spirit as what you said qualitatively and directionally about the iPod gross margins, are you able to give a similar color on the Mac gross margin in the September quarter, how that changed sequentially?

Yes, I don't want to be that specific. The Mac margins, we are quite happy within the September quarter and that was one of the reasons why our gross margin exceeded the guidance that we gave and part of the product mix that we saw. Richard Farmer - Merrill Lynch: Another one, a little off the beaten path, but I just wonder what you think of Google’s purchase of YouTube? As you think longer term about the evolution of the video distribution market, outside the mainstream content providers, how do you think the landscape is changing and does any of that affect your business? What do you think of that?

Well, I think I'll let the people at Google comment on YouTube, but we continue to believe that video will be big in the portable space, not only in PCs but in iPods and we certainly look forward to participating in that going forward. Richard Farmer - Merrill Lynch: Okay, thanks.

Thanks, Richard. Next question, please.

Chris Whitmore from Deutsche, bank. Chris Whitmore - Deutsche Bank: Question on channel inventories for iPod. Can you give any color to the recently released products versus previous generation products?

We don't give the specific breakout, but I see no issue in clearing the remaining inventory on the products we're shipping previous to the launch. Chris Whitmore - Deutsche Bank: Okay. Can you provide, maybe quantify the number of iPods that were shipped in conjunction with the back to school promotion. How much did that help iPod units in the quarter?

The back to school promotion was a key factor in having excellent education results. We don't disclose the exact number. Chris Whitmore - Deutsche Bank: Okay. Lastly on the MacPro uptake. Any color on customer reception for that upgrade and to what extent is demand still pent up as we're waiting for key applications, like Creative Suite to become universal before we see better shipments for that product?

Both customer and analyst reaction has been very, very positive on the Mac Pro announcement that we made in August. We are still seeing what we believe is a delay in purchasing that we think primarily is associated with applications, in particular, the Creative Suite. Chris Whitmore - Deutsche Bank: Thanks a bunch.

Thanks, Chris. Next question, please.

Your next question comes from Charles Wolf with Needham. Charles Wolf - Needham & Co: Hi, guys, I've got a couple of questions. Do you have any preliminary indication of demand for the Shuffle? I've been hearing it could be huge.

We've been taking orders, obviously, Charlie, from our online store and our channels and we're very excited to get shipments underway in a couple of weeks to really test it. Charles Wolf - Needham & Co: Yes. My second question is, at the developer's conference, Steve said there would be some new, surprising features in Leopard. My first question is, are there new features that haven't been shown yet? Secondly, could virtualization capabilities be one of them?

Charlie, as you know, we don't comment on specifics, but as we said in August, we'll be shipping Leopard in the spring. Charles Wolf - Needham & Co: Okay, thank you.

Thanks, Charlie. Next question, please.

Your next question comes from Keith Bachman - Banc of America. Keith Bachman - Banc of America: Peter, in the iPod shipments for the quartercan you give us any color on how much will be ship-in or channel fill?

As we indicated, we ended the quarter within our four to six-week range. Keith Bachman - Banc of America: Peter, maybe a different way to phrase the question is what is the inventory levels at the end of last quarter?I don't recall in the iPod range. Was there an extra week that may have been put out there in the September quarter?

Keith, we both began and ended the quarter within this target range. On an absolute number of unit basis, we had a small increase that was due to the transition that we made in September in order to get enough new products into the channel. Keith Bachman - Banc of America: Less than a few hundred thousand units?

A very small increase. Keith Bachman - Banc of America: Okay, fair enough. Thank you. On the same-store sales, Peter, can you give us any color there on the retail side? I know you added some stores, what was the same-stores sales growth?

It was up a couple of percent. The Mac sales, as you can see, were up very strong year-over-year. They were up 60% in units. iPod sales in total were up, but impacted on a per-store basis because we've got a much wider distribution capability this year than we did last. And as I mentioned a few minutes ago, we've got a little under 40,000 points of sale for the iPod around the world. Keith Bachman - Banc of America: I'm not sure I followed that. If you had same-store sales, you're saying it would be marginally positive on year-over-year basis?

No, total iPod sales were up in total, but on a per-store basis, they were down a little bit as a result of the increase in the channel distribution. Keith Bachman - Banc of America: Okay. Thanks very much.

Thanks, Keith. Next question, please?

Your next question comes from Brian Blair - Wedge Partners. Brian Blair - Wedge Partners: Hi, thank you. I was wondering if you could comment at all on any iPod or marketing promotions you're doing in the international markets right now that are different from what we're seeing in the U.S.? If there's anything special going on to try to drive demand in some of the international markets?

Sure. We have some work that we're doing with Coke in Europe, specifically in the U.K. and Germany. They are going to put a specific web site out that is linked directly into iTunes and they will be giving away 70 million free songs over the next month or two. Brian Blair - Wedge Partners: Okay, great. Are there any updates on any of the iTunes stores launching in international markets? It seems like in a number of countries, like Japan, the iPod sales really preceeded iTunes stores for whatever reason. Any update you can give on iTunes as it progresses in international markets, movie downloads in international markets, et cetera?

We today have the iTunes music store in 21 countries, which is covering off close to 90% of where music is legally purchased. We look forward to bringing movies international in 2007. Brian Blair - Wedge Partners: Okay, great. Thank you.

Thank you, Brian. Next question, please.

Your next question comes from Shaw Wu, American Technology Research. Shaw Wu - American Technology Research: Just one quick one on iTV, any initial feedback you can provide us on that product? Second, any comment on what type of units this product could be? Is it a couple hundred thousand units, or a multimillion type of product.

We announced that product before shipping it to give customers a total view of the solution that we're bringing to market as we announced the down loading of movies. We are not projecting the sales of it in the future. We will be shipping it in the first calendar quarter of next year. Shaw Wu - American Technology Research: Okay, thanks.

Thank you, Shaw. Next question, please.

Your next question comes from John Jarvis - Boston Company. John Jarvis - Boston Company: Hi, Peter. I seem to recall last year in the December quarter you had an extra week. I was wondering if you could give us any additional metrics in terms of how that may have affected iPods or Mac units, just to get our arms around forecasting that for this upcoming quarter?

Sure. Last year it was a 14-week quarter for us as we realign our calendar every six or seven years. The iPod shipments in the year ago quarter were certainly benefited by that 14th week, which fell between Christmas and New Year's and as we told you last January, we increased our channel inventories in the quarter by about 550,000 units. So you're thinking through iPods, you should account for the 14th week and an increase in inventory and if you're thinking through Mac sales, certainly contemplate a 14th week.

Next question, please.

Your next question comes from Bill Fearnley, FTN Midwest. Bill Fearnley - FTN Midwest: Thanks, two questions on the guidance. When you look at the economic environment and the consumer in particular, could you give us a view of what you're seeing there as we approach the holiday season? How does that affect guidance? And I have a follow-up.

Gary will take your first question.

Again, this would be generally speaking, it's from a macro point of view, but the economy is slowing because the Fed has hiked 17 times over the last two or three years. But what most of us are hearing from economists out there is that economists think that the economy is headed for a soft landing and the consumer appears resilient in that, especially as energy prices have eased. We intend to agree with this outlook, barring any surprises. Bill Fearnley - FTN Midwest: Thanks. When you look at availability for the upcoming quarter, you come into the quarter having channel inventory that's below expectations. Do you expect being below target inventory here for Macintoshes for a good chunk of the fourth quarter, or do you expect to see some recovery in the beginning of the quarter?

Channel inventory is a function of both supply and demand. We've factored our thinking on both of those into our guidance that Peter has already laid out. Bill Fearnley - FTN Midwest: Do you think you'll have to air freight anything in, or do you think the recovery is going to be manageable here, or do you really have to hustle to get stuff in here into the states to catch up?

We typically air freight portables and we would continue to do that this quarter. Last quarter we also air freighted iMacs because of their popularity in September and we would continue to do so for a portion of those in the current quarter. Bill Fearnley - FTN Midwest: Then one last question on iTunes, if I could. Could you give any more color on profitability of movies versus music? Any update on that since you're getting further down the road here with videos?

Bill, we don't give products' specific gross margins; our philosophy is to run the store a little bit over breakeven. Bill Fearnley - FTN Midwest: Thanks.

Thanks, Bill. Next question, please.

Your next question comes from Steve Lidberg - Pacific Crest Securities. Steve Lidberg - Pacific Crest Securities: Good afternoon. Peter, I was hoping you could provide some thoughts with regards to your ability to attract additional major studio content into the feature film category for iTunes. If there is hesitation or hurdles, what are you facing there? Thanks.

Last October we announced TV shows with just five programs and within a year have over 220 today from over 40 networks. We've just launched movie downloads with one studio and have 75 titles and we plan to add more over time. Steve Lidberg - Pacific Crest Securities: Thank you.

Thanks, Steve. Next question, please.

Your next question comes from Jonathan Hoopes, ThinkEquity Partners. Jonathan Hoopes - ThinkEquity Partners: Thank you very much. Three questions on the retail. Peter, could you tell us how many retail store employees you had?

Yes. We have about 5,800 people in our retail stores. Jonathan Hoopes - ThinkEquity Partners: Okay, thank you. Also on retail, did you mention what the CapEx was for the retail segment?

I didn't, but I would be happy to. Our CapEx in the quarter was $134 million and the retail portion of that was $50 million. Jonathan Hoopes - ThinkEquity Partners: Great, thanks. One last one. Did you mention what the manufacturing margin was for retail?

I didn't. It was $188 million. Jonathan Hoopes - ThinkEquity Partners: Thank you very much.

Thank you, Jonathan. We have time for one final question.

Our final question will come from Jesse Tortora from Prudential. Jesse Tortora - Prudential: Thanks for taking my call. Pete, what do you see the key levers that could provide upside or downside for this quarter?

I'll make a few comments and Tim can chime in. Certainly the level of sales and the mix within the products would be big levers and direct versus indirect sales would be another lever.

Obviously, commodity costs are another one, although I believe we have a reasonable handle on those. So I think the greatest ones are the top line. Jesse Tortora - Prudential: Great. And lastly, have you seen a pickup in either iMac or iPod following the September price moves?

The post-launch in iPod, we saw an acceleration of demand and it was that acceleration that allowed us to exceed our expectations for iPod in the quarter. The announcement of the new iMac lineup in early September was extremely well received. We air freighted units to market in order to cut transit times and get them to our customers as quickly as we could. It was partly the iMac that led to a stalling below the four to five week target on the channel inventory. Jesse Tortora - Prudential: Great. Thanks, guys.

Thanks, Jesse. A recording of today's call will be available for replay via telephone for seven days beginning at 5:00 p.m. Pacific time today. The number for the replay is 719-457-0820 and the confirmation code is 4134501. A replay of the audio webcast of this call will be available beginning at approximately 5:00 p.m. Pacific time today at www.apple.com/investor. Members of the press with additional questions can contact Steve Dowling at 408-974-1896. Financial analysts can contact John Hoover or me with additional questions, John is at 408-974-4570, and I'm at 408-974-5420. Thanks again for joining us.

Thank you. That will conclude today's conference.