Nancy Paxton - Senior Director, IR and Corporate Finance Peter Oppenheimer - SVP and CFO Tim Cook - COO

Ben Reitzes - Barclays Capital Bill Shope - Credit Suisse Richard Gardner - Citigroup Gene Munster - Piper Jaffray Bill Fearnley - FTN Midwest Toni Sacconaghi - Sanford Bernstein Shannon Cross - Cross Research Maynard Um - UBS David Bailey - Goldman Sachs Mark Moskowitz - JPMorgan Keith Bachman - Bank of Montreal Mike Abramsky - RBC Capital Markets Charles Wolf - Needham & Company

Good day and welcome to this Apple Incorporated Apple First Quarter Fiscal Year 2009 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, Investor Relations and Corporate Finance. Please go ahead, ma'am.

Thank you. Good afternoon and thanks to everyone for joining us. Speaking today is Apple's CFO, Peter Oppenheimer, and he will be joined by Apple's COO, Tim Cook, and Treasurer, Gary Wipfler, for the Q&A session with 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, stock-based compensation expense, taxes and earnings per share. 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 2008 and Form 8-K filed with the SEC today and the attached press release. Apple assumes no obligation to update any forward-looking statements or information, which speak as of their respective dates. With that, I'd like to turn the call over to Apple's CFO, Peter Oppenheimer, for introductory remarks.

Thank you, Nancy. Thank you for joining us. We're extremely pleased to report record results for the December quarter that includes surpassing $10 billion in quarterly revenue for the first time in Apple's history, setting a new record for iPod sales and generating all-time high quarterly earnings. We entered the holiday season with our best product lineup ever and our customers responded. Revenue for the quarter was $10.17 billion, representing 6% growth over the prior December quarter's result and exceeding the high end of our guidance range. Operating margin for the quarter was better than expected at 20.9% due to higher than anticipated gross margin and strong operating expense management. Net income was $1.6 billion, which translated to earnings per share of $1.78. As we discussed on last quarter's conference call, we supplement our analysis of the business internally by using non-GAAP financial measures that correspond to the total sales and product costs of iPhones and Apple TVs sold during the quarter. Our earnings press release provides a full description of these non-GAAP measures, including how we use them, how they are derived and their limitations. In terms of non-GAAP measures, adjusted sales totaled $11.8 billion for the December quarter, which was $1.6 billion higher than our reported revenue. Adjusted gross margin was $4.5 billion, which was $1 billion higher than our reported gross margin, and adjusted net income was $2.3 billion, which was $700 million higher than our reported net income. We continue to believe that these non-GAAP financial measures provide added transparency to our business and hope they are helpful to you in your analysis in understanding of our performance during the December quarter. Now turning to the details of our results, I'd like to begin with Mac products and services. For the December quarter, we sold 2.5 million Macs, representing 9% growth over the prior December quarter's results. We are extremely proud of this very solid growth, particularly in contrast to the performance of the rest of the market. In its latest update published last week, IDC estimated that the overall market for personal computers contracted during the December quarter. Customer response to the new MacBook and MacBook Pro introduced in October was very strong, driving year-over-year portables growth of 34% and an overall portable mix of 71%, the highest ever for Apple. Desktop unit sales declined by 25% year-over-year. It's important to remember that in the prior December quarter, desktop sales grew by a phenomenal 53% year-over-year, given the very successful launch of the new iMac in August 2007. In addition to this tough comparison, we believe the year-over-year decline in desktop sales is a reflection of the shift towards portables in the overall market in customer response to our October announcements. IDC's latest published estimate indicates a 16% contraction in global desktop shipments during the December quarter. We are very pleased with overall Mac share gains, and believe our outstanding new features in iLife '09 and iWork '09 introduced earlier this month will distance the Mac experience even farther from the competition. We began and ended the quarter with between three and four weeks of Mac channel inventory. Now, I'd like to discuss our music products and services. We sold over 22.7 million iPods, a new quarterly record, representing 3% growth over the previous record sales in the year ago quarter. We were thrilled with customer response to the new iPods introduced in September. Customers love the sleek design and selection of the new Nano, while the superior features of the iPod touch, coupled with the amazing breadth and popularity of content on the App Store have helped establish the iPod Touch as an outstanding gaming, entertainment, communications and information platform. We remain very pleased with iPod market share. Our share of the US market for MP3 players was over 70% in the month of December, based on the latest data published by NPD. And we continue to gain share year-over-year in international markets based on the latest data published by GFK. For the latest period reported, iPod's share of the MP3 market was over 70% in the UK and Australia, over 60% in Japan and over 50% in Canada. We were also pleased with continued year-over-year share gains in France, Germany, Italy and Spain. We ended the quarter within our target range of four to six weeks of iPod channel inventory or a look-forward basis. The iTunes Store had a record quarter had a record quarter; thanks to strong music and video sales and the continued tremendous success of the apps store. We experienced our biggest music quarter ever including our highest sales ever for both Christmas day and Christmas week. We are continuing to change the value proposition for mobile devices with the apps store and developer and customer excitement has been incredible. We now offer over 15,000 applications, an increase of over 10,000 since our last quarterly conference call with many more apps being added each day. We are also thrilled that customer downloads since the July 11 launch had surpassed 500 million. Turning to the iPhone, we sold 4.4 million handsets in the December quarter which brings our cumulative counter 2008 iPhone sales to $13.7 million, well ahead of the 10 million unit goal for the year that we set when we introduced the iPhone. We continue to expand iPhone's geographic reach and we're selling in over 70 countries by the end of the quarter. Recognized revenue from iPhone handset sales, accessory sales, and carrier payments was $1.25 billion compared to $241 million in the year ago quarter. The sales value of iPhones sold was over $2.6 billion. We're proud of how rapidly iPhone has achieved such remarkably strong traction in the market. Based on its 2008 Business Wireless Smartphone Customer Satisfaction Study, J.D. Power and Associates ranks the iPhone in overall customer satisfaction among business wireless smartphone users, and according to AdMob's December 2008 Mobile Metrics Report, iPhone accounted for 32% of worldwide smartphone ad request in 48% of US smartphone ad request in the month of December, more than RIM, Windows, and Palm combined. It's clear that customers are now attracted to iPhone not only for its amazing functionality and revolutionary multi-touch user interface, but also for its unique ability to let users easily purchase, download, and use thousands of applications ranging from games to social networking to financial planning, and health management and our competitors are scrambling to try and copy our success. The incredible success of the apps store is more evidence of what we have always said that software is the key ingredient for great mobile experience and we continue to believe that we are years ahead of the competition. I'd now like to turn to the Apple retail stores which hosted a record 46.7 million visitors during the December quarter or 14,400 visitors per store per week. Revenue of $1.74 billion also established a new record and grew 2% year-over-year. Our stores sold 515,000 Macs during the quarter, almost half of which were to customers who have never owned a Mac before. Average revenue per store was $7 million compared to $8.5 million in the prior year and the retail segment margin was $353 million compared to $405 million in the year ago quarter. This reflects the very difficult retail environment in the US where most of our stores are located. In addition, we have expanded Mac distribution with Best Buy over the past year and third-party channels discounted and bundled aggressively this holiday season particularly with iPods to drive profit to their stores. Given the retail conditions around us, our stores performed very well during the December quarter. We ended the quarter with 251 stores, and we now operate retail stores in 10 countries. During the quarter, we opened our first store in Germany in Munich, and it's off to a great start. Our stores achieved the highest ever service volumes as customers came in record numbers for help at our Genius Bars and personal training sessions. Total company gross margin was 34.7% which was above 420 basis points better than our guidance. About half of this difference was due to a more favorable component pricing environment than we had anticipated at the beginning of the quarter. The remainder was split fairly between two areas: First, lower than expected transportation, warranty, support, and other costs, and second, favorable adjustments and settlements primarily related to prior quarter supply chain matters. Operating expenses were $1.4billion including $142 million in stock-based compensation expense. Total OpEx was below the low end of our guidance range as a result of lower spending in most areas of the company, particularly in sales, retail and marketing. OI&E was $158 million. The tax rate for the quarter was 29.7%; slightly below guidance, as a result of a onetime benefit from congressional approval of the R&D tax credit which was applied retroactively for January of 2008. Turning to our cash, our cash plus short-term and long-term marketable securities totaled $28.1 billion at the end of the December quarter compared to $24.5 billion at the end of the September quarter, an increase of over $3.6 billion. During the December quarter, we changed our accounting practice for certain fixed income investments to more closely reflect the timing of when those marketable securities will mature. This change resulted in the reclassification of all investments maturing more than one year in the future from short-term marketable securities to long term marketable securities. We have reclassified prior balances to reflect this presentation as well. Our investment priority for the cash continues to be preservation of capital which has served us well in the current environment. We are continuing to focus on short dated high quality investments and are comfortable with our investment portfolio. Cash flow from operations in the December quarter was over $3.9 billion. Looking ahead to the March quarter, I'd like to review our outlook which includes the types of forward-looking information that Nancy referred to at the beginning of the call. We will continue our practice of providing guidance based on GAAP and will report our March quarter non-GAAP financial measures to you in April when we release our results. We are shipping the best products in our history and we remain very confident in our business. Our visibility remains rather low in the current environment, making our forecasting challenging, and we are therefore going to provide a broad range of revenue and earnings guidance for the March quarter. We expect revenue to be between about $7.6 billion and $8 billion. We expect gross margin to be about 32.5%, reflecting approximately $28 million related to stock-based compensation expense compared to 34.7% gross margin in the December quarter. This sequential decline reflects the impact of the stronger US dollar. The favorable supply chain adjustments and settlements from the December quarter are not reoccurring, and the sequentially lower revenue as we have seen in past years. We expect OpEx to be about $1.33 billion, including about $150 million related to stock-based compensation. We expect OI&E to be about $60 million reflective of the short-term interest rate environment and we expect the tax rate to be about 31%. We are targeting EPS in the range of about $0.90 to $1. In closing, we are extremely proud of our performance and record results in the December quarter. We are fortunate to have the world's best customers and employees especially in these times. We are continuing to focus on developing the industry's most innovative products, and we are very excited about our new product pipeline. With that, I'd like to open the call to questions.

(Operator Instructions). And our first question will come from Ben Reitzes of Barclays Capital. Ben Reitzes - Barclays Capital: Okay, thanks a lot and nice performance. Well, given that I'm going first, I'll ask how Steve is. I hope he's doing well and I just want to know how you'll run the company differently. With Tim or the same, and if need be, if Tim, do you feel like you would be the likely candidate if the worse case scenario were to happen; were Steve unable to return? Do you feel like you would be the candidate that would steer the helm here?

Ben, it's Peter. Steve is the CEO of Apple and plans to remain involved in major strategic decisions and Tim will be responsible for our day-to-day operations.

Ben, let me add something to that and backup just a bit. There is extraordinary breadth and depth and tenure among the Apple executive team, and they lead 35,000 employees that I would call wicked smart - and that's in all areas of the company from engineering to marketing to operations and sales and all the rest. And the values of our company are extremely well entrenched. We believe that we are on the face of the earth to make great products and that's not changing. We are constantly focusing on innovating. We believe in the simple not the complex. We believe that we need to own and control the primary technologies behind the products that we make, and participate only in markets where we can make a significant contribution. We believe in saying no to thousands of projects, so that we can really focus on the few that are truly important and meaningful to us. We believe in deep collaboration and cross-pollination of our groups, which allow us to innovate in a way that others cannot. And frankly, we don't settle for anything less than excellence in every group in the company, and we have the self-honesty to admit when we're wrong and the courage to change. And I think regardless of who is in what job those values are so embedded in this company that Apple will do extremely well. And I would just reiterate a point Peter made in his opening comments that I strongly believe that Apple is doing the best work in its history. Ben Reitzes - Barclays Capital: Thanks a lot, Tim. And I wanted to wish you all the best and Steve as well. The last question for me is just a little more on retail. Could you guys with the flat performance sequentially and what's going on in the environment, are you guys planning to scale down your expansion? And is there anything we should be concerned about long term if retail slows any impact on margin, maybe with regard to capacity utilization or utilization of your properties? Anything you're thinking about there in this type of slower environment?

Ben, we plan to open about 25 stores in fiscal 2009, about half of those will come internationally. And Ron and his team are continuing to be very selective with real estate and won't take a bad site. Our stores are amazingly productive and are providing outstanding service to our customers. I went through some of that in my prepared remarks. The environment around us was a bit tough, but the stores performed very, very well. We are very confident in our stores and the asset that we are building. Ben Reitzes - Barclays Capital: Thanks a lot. I'll cede the floor.

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

And that will come from Bill Shope with Credit Suisse. Bill Shope - Credit Suisse: Okay, thanks. Peter, in the past you've noted that in Apple's experience at least the iPod segment is fairly price elastic, but the Mac segment is fairly inelastic. Now, that you've had several quarters of iPhone data, could you help us understand whether or not you characterize this segment as elastic or inelastic, and if it is elastic, do you think handset price reductions would eventually make sense in this environment to spur unit demand?

Bill, it's Tim. This segment is clearly elastic. And you can see that over the course of the time that we have been selling iPhone, you've seen the price. And I'll just talk to the US market for a moment to make this simple. It moved from $599 to $399. We saw a tremendous jump in the run rate. And then as we went from $399 to $199 and introduced the iPhone 3G, we saw another significant jump in the run rate. So there's clearly a price elasticity in this market. We believe that the $199 level. And this includes signing up for contract obviously that this is a compelling value and we see nothing in the marketplace anywhere close to it. We still believe that we're years ahead of the competition from a software point of view. And when you throw in the Applications Store with the statistics that Peter pointed earlier with over 15,000 Apps and over half a billion downloads in a very, very short period of time, we feel very, very good about our competitive position. Bill Shope - Credit Suisse: Okay. And then a quick question on the gross margin line. Given the gross margin upside and the guidance of the gross margins and the March quarter, I'm assuming it's not still reasonable to assume gross margins will average out at 30% for fiscal 2009, as it did a few quarters ago, is that true?

Well, we reported our December quarter and I've given you our guidance for the March quarter. But as I look forward, I would see our gross margins being about 30% in the second half of the fiscal 2009. Our guidance in the March quarter of 32.5 is benefiting from a very favorable commodity environment and thanks to our hedging program, we've not seen the full impact of the US dollar strengthening, which began in August of last year. We continue to anticipate gross margins, as I said, about 30 in the second half. Considering the commodity environment and the stronger dollar, we are also continuing to focus on delivering state-of-the-art products at price points our competitors can't match. We want to provide increasing value to our customers and we are not going to leave any pricing umbrellas. Bill Shope - Credit Suisse: Okay. Thanks, guys.

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

And the next question from Richard Gardner with Citigroup. Richard Gardner - Citigroup: Okay, thank you. Peter, I guess one for you and then one for Tim. First of all, you mentioned that you were giving a wider range than normal for guidance for the March quarter. However, the range is considerably narrower than the one that you provided for the December quarter. And I realize that you're building up a base of recurring revenue with the iPhone. Is that the only factor that leads you to give a more narrow range for the March quarter? Or is there something else that's giving you confidence in the business going into March, which is traditionally a tougher quarter for consumer companies?

Our models are not as precise as they have been. And our visibility really isn't as good as it had been in the past. And in prior quarters Rich, we had really given more of a single point estimate for the top line. As you know, and as you said in the December quarter, we gave $1 billion range for revenue. But it was a much bigger quarter with a much higher level of sales expected to occur, and actually did occur in the last weeks of the quarter. But I would consider a $400 million range pretty wide for us. Yes, we do have recurring parts of our business. And so we are shipping the best products that we ever have as a company. So that gives us some confidence as well.

Rich, I would just add that if you think back to the timing of the guidance, we were in a period of time where banks were going down, what seemed like every other day and it does seem like where things, where the economy is clearly in bad shape that it is not as unpredictable as it was in October perhaps. Richard Gardner - Citigroup: Okay. And then as a follow-up for you Tim. You typically give us an update on the component pricing environment from quarter-to-quarter. We've seen some pretty dramatic increases at least in spot prices for things like DRAM, NAND, and flat panels here recently. And I'm wondering if you can remind us what you do to mitigate the impact of that on your cost of goods, given that you tend to adjust prices less frequently than some of your PC competition?

Maybe I should talk about what I think will occur in the quarter and what occurred last quarter. Last quarter was incredibly favorable. Peter said that it was a key factor in the reason our gross margin beat our guidance. We saw several commodities do much better than we thought like DRAM and NAND Flash and LCDs and we saw frankly some commodities selling at or near variable costs and we think further reductions from those levels are just not likely. We do, however, in the aggregate, expect a continued favorable environment, on both supply and price this quarter, for NAND, for DRAM, for LCD, and for drives, and for most other commodities. And so, I think when you look at it in the aggregate, it will still be positive, but the falls from where we were are not going to be like they were in the Q1 time frame.

Okay. And Rich I would caution you to remember that there's a difference between the spot markets and the contract markets. Richard Gardner - Citigroup: Okay, all right. Thank you, Tim.

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

From Piper Jaffray, we'll hear from Gene Munster. Gene Munster - Piper Jaffray: Good afternoon and congratulations. If you talk about the pricing environment to the pricing umbrella on the iPhone, if you look at your addressable markets and almost billion subs that you currently address, about 60% of those markets are non-contractual markets. Are those markets that you're potentially interested in and how should we think about your addressable market, if they're a market that you're basically priced too high for?

Gene, it's Tim. We are now in over 70 countries in the iPhone and you're correct. Some of those countries are non-subsidized markets. Examples of that are -- the largest example of that would be India in terms of the size of the market that we're currently in and they are like that and our sales are clearly materially less in those markets than they are in the subsidized markets that have post pay contracts. And so, we're constantly evaluating the best way to play in these markets. We know that there's a huge market opportunity there, and we'll make adjustments in the future accordingly to play in a stronger way. Gene Munster - Piper Jaffray: Okay. So when you talk about no pricing umbrella, you're referring more towards the subsidized markets versus non-subsidized.

Yeah. That clearly, and you know us. We're not going to play in the low end voice song business. That's not who we are. It's not why we're here. We'll let somebody else do that. Our objective is not to be the unit share leader in the cell phone industry. It's to build the world's best phones. Gene Munster - Piper Jaffray: Okay. And second, obviously the strength again came from portables and Macs and if you're going to look at the overall industry growth, there's some evidence that that kind of a sub $500 netbooks are starting to gain share and grow little bit more quickly, which obviously impacts to your overall market share. How should we think about or how do you think about that kind of that sub $500 market?

We're watching that space. But, right now from our point of view the products in there are principally based on hardware that's much less powerful than we think customers want. Software technology that is not good, cramped keyboards small displays... And so, we don't think that people are going to be pleased with those types of products. But we'll see. We are watching the space, as you know about 3% of the industry or the PC industry last year was in this netbook kind of category. And so, it's a category we watch. We've got some ideas here. But, right now we think the products there are inferior and will not provide an experience to customers that they're happy with. Gene Munster - Piper Jaffray: Okay, one last very quick question in terms of Apple TV. Is there any seasonality that you typically see a little bit of an uptick as any seasonality develops in that business?

There was a tremendous pickup year-over-year. In fact Apple TV unit sales were up almost three times versus the year ago quarter. However, let me be clear. We still consider this a hobby. It is clear that the movie rental business has really helped Apple TV and there are more and more customers that want to try it. And we're going to continue to invest in it, because we fundamentally believe there is something there for us in the future. Gene Munster - Piper Jaffray: Great thank you.

Thanks Gene. Could we have the next question please?

From FTN Midwest we hear from Bill Fearnley. Bill Fearnley - FTN Midwest: Yes. Thank you. If I could ask a question on the desktops in the Pro segment. In the Pro segment, how does that affect the Mac numbers and the desktop numbers? Any update on the Pro segment on the audio and video side and then I have a follow-up.

The Mac Pro percentage of our desktop business is not large. Our desktop number is primarily iMac. But, to answer your question specifically that the Pro segment was down year-over-year as you might expect because small businesses are cutting back on expenditures in this current economic climate. Bill Fearnley - FTN Midwest: Any update? Switching to another end user market is important. And any update on the education market when there is a lot of chatter about what's happening with state budgets and you folks certainly didn't do a lot here in the last quarter in education. But do you start getting a sense of what you might be looking at for the calendar 2009? Any update to the education market here?

Yes sure. If you look at our results last quarter, we were down 6% year-over-year in total and if you look at the K-12 component of that which is more sensitive to the state budgets, K-12 was down 10% year-over-year. There's very significant funding uncertainty in this environment and as you mentioned state budget shortfalls are almost everywhere. In fact, in the data that we're collecting 39 out of the 50 states have some form of shortfall. And so, K-12 was weak. In the previous quarter in Q4 it was weak again last quarter. We don't forecast individual markets but I don't see this picking up very quickly until there's a huge infrastructure outlay and hopefully now with a new President we may get some of that underway. Bill Fearnley - FTN Midwest: And, if I could switch gears and just get a product update from you as well. Any additional thoughts here on Snow Leopard? You've talked about it in the past. Any updates there on what you might have for a timeline? And if you're not prepared to give a timeline, any thoughts on progress in the development versus your expectations there?

No comments to share today. Yeah, we're very excited about the next release, but we do not have a specific launch date to announce today. Bill Fearnley - FTN Midwest: Thanks guys.

Thanks Bill. Could we have the next question please?

That will come from Toni Sacconaghi with Sanford Bernstein. Toni Sacconaghi - Sanford Bernstein: Yes, thank you. I have a couple of questions please. Peter on the last call you had stated that iPhone channel inventory was 2 million units. Can you provide an update on that inventory level please?

Tony, hi, it's Tim. Actually, I think I said last time that we did have a channel build in the previous quarter as you mentioned in the launch quarter of iPhone 3G. It was approximately 2 million units. In Q1, despite launching in 20 or so additional countries and some additional channels within countries that we had previously launched, we ended the quarter with sequentially lower channel inventories. The level that we're at we're very comfortable with. And I think you have to obviously take the changes in channel inventories in both quarters into consideration in looking at sequentially the sell through. Toni Sacconaghi - Sanford Bernstein: Can you help dimension? How significant was that change or can you help us think through in terms of weeks of inventory? If there was a modest draw down in channel inventory, it may or may not suggest that you're above your targeted range for other products of four to six weeks. Can you help dimension? Specifically, how big was the drawdown in channel inventory?

Sure. I'll be specific. The draw down was about a quarter of a million. In terms of your question on weeks, that I can't be specific about because we were in 70 countries for the first time last quarter. This is the first time with that many countries that we're moving from a December quarter to a March quarter and so frankly we're uncertain as exactly the seasonal pattern of demand, as we move from quarter to quarter. But, based on the information we've gotten from our carrier partners, we feel very comfortable with our inventory level. Toni Sacconaghi - Sanford Bernstein: Thank you that's helpful. Can I switch to another topic? Can you comment on relative strength in the iPod business domestic versus internationally? I think relative to investor expectations, iPod numbers were better than expected in part given some of the data points that emerged during the quarter about US iPod sales. Can you comment on relative growth rates of the iPod business in the US versus international? And can you comment on linearity of growth in the iPod business over the course of the quarter?

Yeah. In terms of geography Toni, if you look at the US, the iPod sales contracted at the unit level about 3% year-over-year. So all of the growth that you -- that you see in our number -- that 22.7 was all international. If you look at the linearity at a worldwide level, it would look very similar for each of the weeks until you get to the last week of the quarter. We saw a rush of buying the last week of the quarter. Specifically, all of our growth occurred in the last week of the quarter. We attribute that to the macroeconomic environment and its effect on consumer buying behavior. Toni Sacconaghi - Sanford Bernstein: Okay. And then, finally can you help us understand. If you think about your gross margins on a year-over-year basis, what kind of impact mix had on gross margins? Clearly we had some visibility from last quarter that the iPhone margins are substantially higher than the company average. That pushes up gross margins. Can you help us understand given that there were some difference in revenue growth rate across all three products this year, this quarter, and what the mix impact from each product was on the margins in a year-over-year basis?

Toni, as I told you before, we don't talk a lot about year-over-year gross margin changes because there's a lot of moving parts. I think it's more straightforward for us to talk about it sequentially. As you look back this year versus last, we have a very different currency situation for example and a different commodity situation. And you know that gross margins were literally flat in percent terms year-over-year. That's all I can say. Toni Sacconaghi - Sanford Bernstein: Thank you.

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

And our next question will come from Shannon Cross with Cross Research. Shannon Cross - Cross Research: Hi. Good afternoon. Just a couple of questions. The first one, Peter, how are you thinking about operating expense? I mean, you gave us the coming quarter's numbers, but just as it relates to revenue growth, is there anything you can talk about because you discussed on the call being a bit more conservative in how you're looking at operating expense? So any thoughts you can give us would be helpful.

Sure. Shannon, we're very confident in our strategy, in our business. We're going to invest our way through this downturn just as we did the last one. We certainly saw the benefits of innovative products and quality points of sale as the economy improved the last time around. So we're continuing to invest in such areas as engineering, marketing, the customer experience to bring the industry's most innovative products to market and delight our customers. Shannon Cross - Cross Research: Okay. Given the discussions on currency, can you walk us a little bit through the impact of currency on your P&L? I mean, top-line we can understand, but in terms of sourcing and sort of how we should think about it from a COGS and SG&A standpoint.

Sure. We do have a hedging program. Our European hedges are recorded to revenue and our Asian and Canadian hedges tend to record to COGS. We do have local expenses, but they're not the biggest part of our business that can help in a changing currency environment. The operations team also has the opportunity to have conversations with suppliers as currency rate moves in. As we introduce new products, we will think about changes and local pricing. That's how we manage it. Shannon Cross - Cross Research: Okay. And then, my final question is just on cash. Could you just discuss any thoughts on the use of cash? Obviously $26 billion is a pretty healthy war chest.

Well, not to make my answer any more difficult, but I am proud to tell you that we're over $28 billion at this point. And that's for all the right reasons; just very strong performance in the business. But there is no new update from what we shared with you last quarter. Shannon Cross - Cross Research: Thank you.

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

And from UBS, we'll hear from Maynard Um. Maynard Um - UBS: Hi. Thank you. Can you just speak to the linearity of your guidance? Obviously you have three weeks under your belt here. What in particular does the guidance assume in the remaining two months?

We're not going to give you an update on this quarter. We've provided our guidance for the March quarter. In this environment, I'm thrilled to be providing guidance that has growth year-over-year. And again, we're shipping the best products that we have ever shipped, and thankfully, customers are responding. Maynard Um - UBS: Okay. You spoke of some uncertainty about the potential iPhone seasonality, but I presume you have visibility because of the order lead times from operators. Given iPhone 3G is still kind of in its early days and you had some inventory drawdown, do you think you can buck the seasonal downtick that you typically see in the handset industry and see a sequential uptick in units?

We don't forecast that at a product level. We obviously do internally, but we don't externally, in terms of our guidance. But the fear that we would have and I think that everyone has in this market, is that the economy may slow the adoption rate of smartphones, because generally smartphones generally command higher monthly fees and that may keep some customers to not signing up for higher contracts. But we will see. We feel very good about our competitive position as I said before and extremely good about our product pipeline. Maynard Um - UBS: Okay. Great, thank you.

Thanks Maynard. Could we have the next question please?

That will come from David Bailey with Goldman Sachs. David Bailey - Goldman Sachs: Okay, thank you very much. I was wondering if you could talk a little bit about the pluses and minuses of adding Wal-Mart as a reseller of iPhone and what's different about Wal-Mart versus Best Buy or your own stores as far as mix and activation capability?

David, it's Tim. We just started working with Wal-Mart on iPhone at the very end of December, and so we have not enough data to draw any conclusion about performance. From a reach point of view, what Wal-Mart does is reach a tremendous amount more people than we could reach in our stores. Obviously, they have over 4,000 or so storefronts and they are in areas of the country that we have no Apple stores and so they provide a level of reach beyond of what we would provide ourselves or beyond what AT&T stores would provide. And so that's the reason we're there. As you know, we also sell iPods in Wal-Mart and have a good relationship with them and have seen what they can do in that space and it was with that data and knowledge that we entered into this relationship with iPhone. David Bailey - Goldman Sachs: Thank you. And then you commented a little bit about the linearity on the iPod side; could you talk about linearity on Macs and iPhone in the December quarter?

Yeah, sure. Macs sales were the second highest in our history as Peter alluded to earlier and only surpassed by just 3% from the previous quarter which had a materially better macroeconomic landscape than we did last quarter. As you might guess, when we announced our portables, sell-through accelerated tremendously in October and the team here did an excellent job on the production ramp and therefore we were able to quickly serve those customers and so the October year-over-year data on the Mac is very good, and the portables all quarter as a matter of fact led to this which is a pretty stunning number a 34% year-over-year unit increase on portables for the whole quarter despite the tough environment. International versus the US, international on Mac was much stronger than the US. The US growth on the Macintosh was 2%. The international growth was 16% year-over-year and we saw several countries that were about 20 like Canada and Latin America, Eastern Europe, Asia, Italy several countries over 20. So, the linearity itself strong in October after the portable announcements, weak before and I had mentioned that on the last call I believe that we felt that people were delaying purchases on rumors of the new portables and then for the balance of the quarter we saw again a spike at the end of the quarter which I think was not as strong as iPod but something that was created by the economic environment and the consumer behavior reaction to it. On the iPhone, we have little history here to compare to and so it's difficult to say how we performed versus what it was supposed to be like. We saw a very strong ending of the quarter on iPhone, but in terms of during, I really can't make an educated comment on it given that it's just our second December in the business. Our first December in it, a large wide rolled out through many countries. David Bailey - Goldman Sachs: Great. Thanks a lot, Tim.

Yeah.

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

From JPMorgan, we'll hear from Mark Moskowitz. Mark Moskowitz - JPMorgan: Thank you, good afternoon. This question is probably more for Ron, but I'll ask it anyway. If you, Peter, and then Tim, as far as the retail stores, can you give us any sort of context around the same-store sales philosophy in international versus US in the past year and the kinds of follow-up on the multiplier effect if you will, when you open up these new stores internationally in the past year, are you seeing that pull through not only in the retail but also online and through some of your third-party folks in those regions where you're opening those stores?

The retail performance outside the US was a bit stronger, and similar to what we saw in other parts of the business. And as Tim just alluded to in David's question, we think that our retail stores are helping us in each of our geographies. They are a great place for new customers, particularly those that are new to the Mac to come and experience our products, understand them and some people choose to buy in our stores and some people may buy elsewhere. We're fine with either. We just want to be sure that the Macs and the iPhones, in particular, have a great point of sale for new customers to come and experience them. And that's why we're opening the stores. As I said a few minutes ago, we plan to open about 25 in fiscal 2009, and about half of them will be international. Mark Moskowitz - JPMorgan: Okay. And then, the second question you mentioned earlier about the third-party discount theme you took at Best Buy and others. How have you seen those dynamics kind of play out in the last three weeks or so and how are you mitigating those risks?

Well, I'm not sure there's much to mitigate per se. I mean, the resellers are able to do what they want. Some here in the US, as an example, over the December quarter certainly did do some promotional activities, particularly with iPods, where they may have attached a gift card to it. If that's something they're doing and if they want to do it, it's fine. I've not observed much of that post the holiday as we saw prior to the holiday. Mark Moskowitz - JPMorgan: Thank you.

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

From Bank of Montreal, we have Keith Bachman. Keith Bachman - Bank of Montreal: Hi, guys. I had two margin questions. You alluded to or mentioned that there was a supply chain adjustment to gross margins in the December quarter, and I think you said it was going to reoccur in the March quarter. Could you describe what it is and how much it was? And then, I have a follow-up question, please.

Sure. Keith, we exceeded our gross margin guidance in the December quarter by about 420 basis points. In the range of a quarter of that were some favorable adjustments and settlements, primarily related to prior quarter items we had in the supply chain. I don't expect those to reoccur in the March quarter, and that's one of the three primary reasons why I see the gross margin declining sequentially from the December to the March quarter. Keith Bachman - Bank of Montreal: Okay. Peter, my follow-up question, on the non-GAAP adjustments you provided a schedule this quarter as you did last quarter. The implied or stated gross margin increased substantially. It was about 61% this quarter versus 49% last quarter. What's the reason that gross margins increased so substantially in the non-GAAP adjustments?

Sure. As we explained last quarter, the adjustment column reflects two things. The first is the reversal of the iPhone revenue and product costs recognized during the quarter. Keith Bachman - Bank of Montreal: Right.

And then the addition of sales value and product costs to the iPhones and Apple TVs sold in the quarter. 61% is just simply the mathematical result of these adjustments, the in and the out to revenue and cost of goods sold. The sales value of the iPhones sold and added in during the quarter was $2.6 billion, and that was much larger than the recognized revenue of $1 billion that was backed out. So, it's really just that overweighting that you saw last quarter. However, on a sequential basis, the iPhone 3G gross margin was higher in the December quarter, and this was a result of lower product costs partially offset by a stronger dollar. But it was less than 61% in terms of its gross margin, just like it was less than the 48 last quarter. Keith Bachman - Bank of Montreal: Okay. Thank you.

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

We'll hear from Mike Abramsky with RBC Capital Markets. Mike Abramsky - RBC Capital Markets: Yeah. Thanks very much. Maybe shifting to the iPhone. There's now a number of competitors coming to the market, many who will have their own sort of variance on the sort of, say, customer experience that iPhone was famous for initiating, and that includes things like Android and Windows and the Palm Pre. I was just wondering, beyond what's obviously been a powerful leadership in applications, how do you think about sustaining that leadership and brand in the face of these competitive developments in this sector going forward?

Mike hi, its Tim. I would say first of all, it's difficult to judge products that are not yet in the market. But the iPhone has sold over 17 million units thus far. It's received the highest overall customer satisfaction of products from many different surveys. And, we've said since the beginning software is the key ingredient and we believe that we're still years ahead on software. And I would include in that software umbrella, the Applications Store, and you can see the explosion that has happened in applications with over half a billion downloads. If you look at others, I think when you think about having multiple variations of displays, multiple variations of resolutions and input methods, and many different forms of hardware, it's a big challenge to a software developer and is not very enticing for them to build a different App for every one of these things. But, we shall see what people will do. We approach this business as a software platform business, and so I think we approach it fundamentally different than people that are approaching it only from a hardware point of view. And so, as I've said before, we're very, very confident with where we are competitively. We are watching the landscape. We like competition. As long as they don't rip off our IP and if they do we're going to go after anybody that does. Mike Abramsky - RBC Capital Markets: That was actually my next question because,

I thought it might be. And that's the reason I want to go ahead and get that out. Mike Abramsky - RBC Capital Markets: Because, it seems until Palm came out, many of the other players had in fact negotiated carefully around your multi-touch IP; whereas, the Palm device particularly seems to almost directly emulate the kind of touch interfaces that you had innovated and that Steve, when he launched the phone, talked about patented. Is that to what you're referring with regarding to ripping off IP?

I don't want to talk about any specific company. I'm just making a general statement that we think competition is good. It makes us all better. And we are ready to suit up and go against anyone. However, we will not stand for having our IP ripped off, and we'll use whatever weapons that we have at our disposal. I don't know that I can be clearer than that. Mike Abramsky - RBC Capital Markets: And lastly, I realize you do have a transition to laptops but given that quarter-over-quarter Macs were down 3%, and amidst a launch of new Macs, can you give us a sense of what you're thinking about either regarding your guidance or just generally on Mac trends going forward?

If you look at the Mac and the slight decline sequentially and you think about the macroeconomic environment from fiscal Q4 to fiscal Q1, I think it's a fantastic result, so I'm thrilled with it. I'll remind you we grew 9% on a sell-in basis and we did take down the channel inventory some in addition to that. And the market as projected by IDC, IDC has said that the worldwide market actually contracted. So, you're comparing 9% to a negative number. So, I feel very, very good about that. If you look at our unit share in retail in the US, in December it was over 16. If you look at the revenue share it was over 32 and Apple was number 1 in revenue share in retail in the US. I think those are all fantastic results and we're extremely proud of them. Mike Abramsky - RBC Capital Markets: Okay. Thank you.

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

From Needham & Company, we'll hear from Charles Wolf. Charles Wolf - Needham & Company: Yes, I have a couple of questions. On the Apple stores, what was the average number of stores open during the quarter?

Hold on Charlie. 249. Charles Wolf - Needham & Company: Okay. And how many one-on-one sessions did you have during the quarter?

I don't have that in front of me and I'm sorry. But, we did set a record as I said in my prepared remarks for one-to-one sessions in the quarter. Charles Wolf - Needham & Company: And my last question. There's been, I believe, 500 million downloads from the App store. I'm curious what percentage were paid and what percentage were free?

That's something, Charlie, that we're not disclosing. But, we are thrilled with the App store. You know, it was a pleasure last week to be able to say that we surpassed 500,000. And, it's huge to say that there's more than 15000 Apps now on the store, which I would point out is again up more than 10000 since we last talked to you on this conference call. Charles Wolf - Needham & Company: Yes. And, with respect to the App store, are you going to continue to report revenues within iTunes or are you going to separate that out at some point in the future?

At this point, it's part of iTunes and no plans to make a change at this point. Charles Wolf - Needham & Company: Okay. Thank you.

Thank you, Charlie. A replay of today's call will be available for two weeks as a podcast on the iTunes store. There is a webcast on apple.com/investor and by telephone and the numbers for the telephone replay are 888-203-1112 or 719-457-0820 and the confirmation code is 4939950. These replays will be available beginning at approximately 5 pm Pacific Time today. Members of the press with additional questions can contact Steve Dowling. He's at 408-974-1896 and financial analysts can contact either Joan Hooper or me with additional questions. Joan is at 408-974-4570 and I'm at 408-974-5420. And, thanks again, for joining us.

Ladies and gentlemen, that does conclude today's presentation. We do thank everyone for your participation and have a wonderful day.