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by Jason Snell & Dan Moren

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By Jason Snell

This is Tim: Apple’s CEO answers the analysts

Tim Cook

After Apple announces its quarterly earnings as it did today, there’s a conference call between Apple executives and financial analysts. These calls are generally preceded by a bunch of prepared statements that can provide a little bit of insight into how Apple’s business works, but is mostly focused on things most Apple watchers already know.

Then comes the question-and-answer session, which while hardly extemporaneous—you get the sense that most of the questions have been anticipated and talking points formulated—lets Apple CEO Tim Cook provide a level of detail into how Apple’s business is shaping up that can be illuminating.

And so, presented with minimal editing, here’s a transcript of how Cook answered the analysts on Monday…

On Apple Pay:

What we wanted to achieve with Apple Pay was, first and foremost, to have an incredible consumer experience. And so we focused very much on on making it elegant and simple. And hopefully your trials have proven that. I know I used it over the weekend and it worked fantastically.

We also wanted to focus on security and privacy. And so we see huge issues with the security of the traditional credit-card system. And many people that have entered mobile payments are doing so in a way that they want to monetize the data that they collect from the customers. And we think customers in general do not want this. That they’d like to keep their data private.

And so we wanted to have ease of use, security, and privacy, and maximize all three. By doing so, we think we will sell more devices, because we think it’s a killer feature. It’s far better than reaching in your pocketbook and trying to find the card that you’re looking for and half the time it not working.

We do not charge the customer for the benefit, we do not charge the merchant for the benefit. However, there are commercial terms between Apple and the issuing banks. But we’re not disclosing what they are. Like any other contractual arrangement, those are a private sort of thing.

We see it as an incredible service that is the most customer-centric mobile payment system that there is. And we’re very proud of it and can’t wait to sign up more retailers and also extend it around the world.

On the iPhone 6 product “ramp,” or launch:

The ramp itself is going great. It’s the fastest ever in our history. So I couldn’t be happier with it. That said, today demand is far outstripping supply. It’s unclear, looking at the data, when supply will catch up with demand. I don’t want to leave you with a that we know we’re going to get to a supply and demand balance with both of the new products this quarter because I don’t know that at this point. It’s very difficult to gauge demand without first finding the balance. It’s clear that as of today, and certainly as of the end of the quarter where you’re looking at the data, we’re not nearly balanced, we’re not close, we’re not on same planet. But that said, I’m really confident that supply is gonna be great. And that’s the reason you see incredibly strong guidance that we’re giving, from 63.5 to 66.5. But as this point it’s just very difficult to gauge what the true demand is. It’s very unusual to see every country having a marked improvement over the previous year. And that’s what we’re seeing on iPhone. So I couldn’t be happier with the way the demand looks.

At this point we’re selling everything that we make. And so it’s difficult to say that we’ve estimated well on the SKU mix, or the split between the iPhone 6 vs. 6 Plus. From everything we can tell, we’ve done a pretty good job on that. But I’ve stopped short of saying there’s no issue at all. Because it’s hard to tell when you’re at a point where you’re selling everything you’re making. It’s a good problem to have.

On the mix of repeat iPhone buyers versus new customers:

It’s difficult to answer exactly. Let me back up and give you some data maybe that will help frame the topic. If you look at some of our top countries and how they did in mid-year of selling a customer the first iPhone they’d ever bought. What you would see is that in countries like China, over 80 percent of people that we were selling the 4S to were buying the first iPhone ever. In the U.S. it was over 60 percent. Those kind of give you some goal posts of large countries, in terms of first-time ownership at our entry level. As you step across and look at the 5s, which was at that time the top-end phone, in China still almost half the people were buying the first iPhone ever, and about a quarter of the U.S. population buying a 5s we buying their first one.

The way I look at those numbers are, that on a forward basis, what I would expect—obviously we don’t give guidance on this stuff—is that I still see a fairly large opportunity in people buying their first iPhone ever. And I think with these products we just announced, the 6 and 6 Plus, that opportunity increases, not decreases.

I also believe that the upgrade market for people that were waiting for iPhone 6 or 6 Plus, as we can see from our order backlog, that number is huge. So I would expect that to go on for some period of time, because you have people that time out of contracts at different times. Not everybody does that at launch time. And so I see both the first-time buyer being a great opportunity, and the upgrader, some of the first-time buyers are people that have never owned a smart phone before, and some of them are switchers from Android.

And so right now, all of those look very good to us, but we’re in the early going and we’re selling everything we’re making. And so it’s gonna take some period of time before we have a better handle on what those numbers will look like in steady state. But I’ve never felt so great after a launch before. Maybe that’s the best way to summarize it of all.

There’s not a lot of color that I can give that I feel is terribly accurate, because we’re selling everything that we’re making. And essentially what our current sell-through looks like is our current supply. And so in the long arc of time, once there’s enough supply to meet demand, that mix might look differently. It is clear, or at least I think, that we will see a difference by geography in terms of preference and we thought that going into the launch. And there’s no data that we’ve received to date that would suggest that that’s not the case.

On the Mac’s record quarter, the perceived weakness of the iPad, and cannibalization:

On the Mac, it was just an absolutely blow-away quarter. Our best ever. It will result in our higher market share since 1995. It’s just absolutely stunning. The back to school season voted, and the Mac won and carried the day, and we’re really proud of that. I’m proud of the Mac team, it’s clear that all the work that we’ve put into our notebooks on the hardware and the software side is resonating with our customers. And I think if you went out to college campuses about now, you would see a lot of new Mac notebooks there, based on the sales. And so that feels fantastic. Being up 21 percent in a market that’s shrinking, it just doesn’t get better than that.

For iPad. If I take a step back on iPad, and I know there’s a lot of negative commentary on the markets on this. But I have a little different perspective on it. Here’s sort of my simple perspective: Instead of looking at each 90 days, if you back up and look at it, we’ve sold 237 million in just over 4 years. That’s about twice the number of iPhones that we sold over the first four years of iPhone.

If you look at the last 12 months of iPad, we sold 68 million and FY13 we sold 71, so we were down, but we were down 4 percent on sell-in, and the sell-through was a bit better than the negative four because we took down channel inventory some.

And so to me, I view it as a speed bump, not a huge issue. That said, we want to grow. We don’t like negative numbers on these things. And so looking further in the data, I know that there’s a popular view is that market is saturated, but we don’t see that. I can’t speak to other people, but I do look at our data deeply and the last market research data we have was in the June quarter. Let me give you some of this real data that we’ve got. If you look at our top six revenue countries, in the country that’s sold the lowest percentage of iPads to people who had never bought an iPad before, that number is 50 percent. And the range goes from 50 to over 70.

And so when I look at a first-time buyer rate in that area… that’s not a saturated market. You never have first-time buyer rates of 50 and 70 percent. What you do see is that people hold on to their iPad longer than they do a phone. And because we’ve only been in this business four years, we don’t really know what the upgrade cycle will be for people. And so that’s a difficult thing to call.

What we do know is that people always respond to us doing great products, and we feel really great about we introduced last week. We also know that the deeper the apps go in the enterprise, the more it opens up avenues in enterprise. And that’s a key part of the IBM partnership and what I think customers will get out of that, which is more important than us selling, is changing the way people work. And so I see catalysts going forward.

There are obvious cannibalization things that are occurring. I’m sure that some people looked at a Mac and and iPad and settled on a Mac. I don’t have research to demonstrate that, but I’m sure of that just looking at the numbers. And I’m fine with that, by the way. I’m sure that some people will look at an iPad and an iPhone and decide just to get an iPhone. And I’m fine with that as well. But over the long arc of time, my own judgment is that iPad has a great future. How the individual 90-day clicks work out, I don’t know.

But I’m very bullish on where we can take iPad over time and so we’re continuing to invest in the product pipeline. We’re continuing to invest in distribution. If you look at how we did in emerging markets, like BRIC countries as an example, we were up 20 percent for FY14. And so these numbers are impressive and obviously the BRIC countries are growing as a percentage of our total… it looks a bit different, geography to geography. That’s a long answer to your question, but I thought it was important for you to at least hear my perspective. And you can judge it as you will.

On future products. (You didn’t think he was going to spill the beans, did you?):

I’m incredibly optimistic about the future. We’ve already announced two new categories in the last less than 60 days, with Apple Pay and Apple Watch. And obviously we’re working on other things as well. And to the degree I can keep that in the cone of silence, I’m going to do it. And so I’m not sure what to say, I’m not going to give any hints or anything. We look at a lot of different things and we’re fortunate to have a lot of creative people here that want to change the world and have a lot of great ideas.

On Apple’s product cycle for 2015:

For Apple as an investor, I would hope that people would look at what we’ve done and what we’ve delivered and the power and strength of the product line that we’ve announced. And maybe more importantly than all the stuff that you see, is to look at the skills within this company. And the fact that I think it’s the only company on planet that has the ability to integrate hardware and software and services at a world-class level. And that in itself allows Apple to play in so many different areas. And so the challenge becomes one of deciding which ones to say no to, and which ones to say yes to, and one of focus, not ones of, “Do we have any great ideas?” We always have more ideas than we have resources to deal with.

So I would look at that. I would look at what we talked about last week. Things like Continuity. And if you use imagination and think about where that goes—there’s no other company that can do this. Apple is the only one. And I think this becomes so incredibly important moving forward for customers living in an environment where they’re using multiple devices. And so I would look at skills, the capabilities, the passion of the company and the creative engine has never been stronger. And I think you can see that from the Apple Watch, you can see that from Apple Pay. Apple Pay is classic Apple, of taking something that’s incredibly old, outdated, kludgey, everybody’s focused on everything except for the customer. And putting the customer at the center of the experience and making something very elegant. And so I would look at those things. And when I look at those things, as an investor, I feel great.

On Apple’s lack of reported growth in China this quarter and the value of China in the future:

If you look at Greater China, Q4 of 14 vs. Q4 of 13, the obvious difference is that we launched the 5s in Q4 of 13, and this year we’re launching this quarter in Q1 of 15. The second thing that’s not as apparent, but somewhat related to that, is that last year we increased our channel inventory by 1.3 million. This year, we actually decreased it slightly. And so you have a compounded effect of no launch and a huge change in channel inventory in a year-over-year basis.

So the way that I assess the strength of a market is, I look at unit sell-through. And to share with you what it was in greater China, iPhone unit sell through despite no launch in Q4 was up 32 percent year over year. The market was projected by IDC to only grow 13 percent. So we feel incredibly great about that. Macs were up 54 percent year over year. And that’s against IDC’s estimate of a market contraction in China of 7 percent.

And so those are our two stalwarts that were driving results, and so the underlying results look different than the reported results because of the channel inventory kind of differences. The App Store in China is also doing great. The growth there is phenomenal. iPad contracted some during the quarter, but for full year we did grow, we were up 9 percent year over year for the full year.

And so I see lots of positives. As you know, China’s on the early stages of their huge 4G rollout. And this past weekend we launched with China Mobile, China Unicom, and China Telecom. This is the first time we’ve launched a new iPhone with all three carriers and we’ve done it at the early stages of 4G rollout. And so I’m incredibly bullish over it.

In terms of subsidies, there are regulatory pressures on subsidies. We’ve seen that. However, only 20 percent of the iPhones that we’ve been selling in China have had a traditional subsidy applied to it. And so the vast majority don’t. So will it make a difference with that 20? I don’t know yet. Intuitively, you’d think it would, but it’s at least a percentage of a 20 percent instead of a percentage of 100 percent.

So when I look at China, I see an enormous market where there are more people graduating into the middle class than any nation on Earth in history. Just an incredible market where people want the latest technology and products that we’re providing. And so we’re investing like crazy in the market. We’re more than doubling our stores. We’ve got 15 in Greater China today, we’re gonna be close to 40 in the next couple of years. We’ve expanded our online store to cover 315 cities in China. The revenue results for Q4 were more than double previous year. The App Store is growing, Chinese developers have now created 150,000 apps. And so I see lots of very, very positive vectors there. And I couldn’t be more excited.

[Thanks to Dan Moren for the initial transcriptions from our @sixcolorsevent Twitter feed.]

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