Good day and welcome to the Apple Incorporated First Quarter Fiscal Year 2019 Earnings Conference Call. Today's call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Nancy Paxton, Senior Director of Investor Relations. Please, go ahead.

Thank you. Good afternoon and thanks to everyone for joining us. Speaking first today is Apple CEO, Tim Cook, and he'll be followed by CFO, Luca Maestri. After that, we'll open the call to questions from analysts. Please note that some of the information you'll hear during our discussion today will consist of forward-looking statements, including without limitation those regarding revenue, gross margin, operating expenses, other income and expense, taxes, capital allocation, and future business outlook. Actual results or trends could differ materially from our forecast. For more information, please refer to the Risk Factors discussed in Apple's most recently filed periodic reports on Form 10-K and Form 10-Q, and the Form 8-K filed with the SEC today, along with the Associated Press release. Apple assumes no obligation to update any forward-looking statements or information, which speak as of their respective dates. I'd now like to turn the call over to Tim for introductory remarks.

Thank you, Nancy and thanks to everyone for joining us today. This isn't the first time you've heard from us regarding the December quarter, so the first thing I want to do is provide some final results and connect those back to the letter we shared at the beginning of the month. As you know, our December quarter revenue was below our original expectations, coming in at $84.3 billion. That's down 5% from a year ago, or down 3% adjusting for foreign exchange. We noted four factors that would impact our results when we provided guidance in November: different iPhone launch timing from a year ago, FX headwinds, supply constraints on certain products and macroeconomic conditions in emerging markets. One of those factors, weak macro conditions in some emerging markets was significantly more severe than we originally foresaw, especially in Greater China. As our letter noted, that challenge was compounded by quarterly iPhone upgrades that were lower than we anticipated. We'll return to upgrades in a moment, but I'd first want to say a bit more about our business in Greater China. Our revenue there was down by $4.8 billion from last year with declines across iPhone, Mac and iPad. Most of the shortfall relative to our original guidance and over 100% of our worldwide year-over-year revenue decline was driven by our performance in Greater China. Despite iPhone upgrades being lower than we anticipated, our business grew outside of China, including new records in the Americas, Western Europe, Central and Eastern Europe and our rest of Asia Pacific segment. We had record performance in large markets, including the United States, Canada, Mexico, Germany, Italy, Spain and Korea. In the letter we shared earlier this month, we said we are proud to participate in the Chinese marketplace and that we believe…

Thank you, Tim. Good afternoon, everyone. As Tim said, revenue for the December quarter was $84.3 billion. This result was below our expectations, but we were able to set new all-time revenue records in the U.S., Canada, Latin America, Western Europe, Central and Eastern Europe and Korea. Our results were especially strong in the U.S. where revenue was up by more than $1.5 billion compared to a year ago and in several markets where revenue grew by double digits including among others Germany, Spain, Poland, Mexico, Malaysia and Vietnam. Looking at product categories. iPhone revenue declined 15% from a year ago while revenue from the rest of our business grew 19% to an all-time record, including our best results ever for Services, for Wearables and for Mac. Company gross margin was 38%. This quarter for the first time, we're making an important new disclosure to our investors as we believe it will foster a better understanding of our business. We are now reporting on a quarterly basis, gross margin for products in aggregate and for Services in aggregate. Products gross margin was 34.3% and Services gross margin was 62.8%. On a sequential basis, products gross margin increased 60 basis points due to positive leverage from the holiday quarter, partially offset by higher cost structures as we launched several new products and by headwinds from foreign exchange. Services gross margin also increased 170 basis points sequentially due to favorable mix and leverage, partially offset by foreign exchange. While both products and services gross margins improved sequentially, total company gross margin was down 30 basis points due to a different mix between products and services. Net income was $20 billion about flat to last year and diluted earnings per share were an all-time record at $4.18, an increase of 7.5% over last…

Thank you, Luca. And we ask that you limit yourselves to two questions. And may we have the first question please?

Certainly. Our first question will come from Katy Huberty with Morgan Stanley.

Thank you. Good afternoon. Services growth did decelerate from the growth rates in recent quarters, so can you talk about the factors that played into that slower growth? And then, appreciate the new disclosure around paid subscribers. But if you compare what you added in 2018 versus what you expect to add over the next two years, that implies a slowdown in annual net new subscribers. So should we be thinking about services as a lower growth segment than what you experienced in 2018? And then I have a follow-up.

Yes, Katy, let me take that one. First of all, when we talk about the services business, it's very important to start from the momentum that we have. As you know, we have set an ambitious target for ourselves to double the size of our business from fiscal 2016 to 2020, which implied at the time a 19% CAGR. So far, we've been able to grow about 20%. In fiscal 2018, we grew 22%. So we are on track to achieve our objective. And it's important to understand what is driving the growth of the business. First of all, it's our installed base. As we just told you, the installed base continues to grow very nicely. It has reached 1.4 billion active devices at the end of December and really very little of our services revenue is driven by what we sell in the last 90 days. The second factor for the growth of the services business is that within this installed base the percentage of users who are paying for at least one service is growing very strongly. This is due to several factors. First of all, we're offering more and more services. During the last few years, as you know, we launched Apple Music, Apple Pay and advertising service for our developers on the App Store. All these businesses are growing very strongly. Second, we are making it easier for our customers to transact on our digital stores. We accept many more payment methods today which are very common in certain countries around the world. We've also increased the distribution coverage for many of these services. We're bringing AppleCare to more points of sale around the world. We are launching Apple Pay in more and more markets and so on. Thirdly, as you mentioned, our subscriptions are becoming…

Thank you for that color. Just a quick follow-up, Luca. Share repurchases in the December quarter were well below the run rate from the June and September quarters. How much did the weaker quarter play into your ability to carry out the buyback at the same level? And what should we think about is the right run rate going forward?

Well, we've always said that we're very committed to executing our program. We have done almost $250 billion of repurchases from the beginning of the program. But we've also said that we want to execute the program in an efficient, effective, I will say, disciplined manner. And that takes into account also overall market conditions. So, that's what we did during the course of the December quarter. We -- our fundamental view remains the same. We are optimistic about our future and we think there is great value in our stock. And so we will continue to execute the program. We will continue to report at the end of every quarter. And by the way, when we report our March quarter results, we will also talk about the next step in our capital return program which is something that we do traditionally in the spring.

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

The next question will come from Steve Milunovich with Wolfe Research.

Great. Thank you very much. Some have the perception that you priced the new products, the new iPhones too high, what have you learned about price elasticity? And do you feel that perhaps you pushed the envelope a little bit too far and might have to bring that down in the future?

Steve, it's Tim. If you look at what we did this past year, we priced the iPhone Xs in the U.S. the same as we priced the iPhone X a year ago. The iPhone Xs Max which was new was $100 more than the Xs. And then we priced the XR right in the middle of where the entry iPhone 8 and entry iPhone 8 Plus have been priced. So, it's actually a pretty small difference in the United States compared to last year. However, the foreign exchange issue that Luca spoke of in the call and -- made that difference or amplified that difference in international markets, in particular the emerging markets which tended to move much more significantly versus the dollar. And so what we have done in January and in some locations and some products is essentially absorbed part or all of the foreign currency move as compared to last year and therefore get close or perhaps right on the local price from a year ago. So, yes, I do think that price is a factor. I think part of it is that, the FX piece. And then secondly in some markets as I had talked about in my prepared remarks, the subsidy is probably the bigger of the issues in the developed markets. I had mentioned Japan, but also even in this country even though the subsidy has gone away for a period of time. If you're a customer that your last purchase was a 6s or 6 or in some cases even a 7, you may have paid $199 for – and now in an unbundled world it's obviously much more than that. And so we are working through those and we've got a number of actions to address that including the trade-in and the installment payments which I had mentioned as well.

I know that you're not giving units going forward, but you said you might make qualitative comments. I was wondering, if you have a comment particularly on the ASP on a year-over-year basis?

Well Steve, we did mention on the call last quarter that the different timing of our phone launches would affect the year-over-year compares. If you remember, our top models the Xs and Xs Max shipped during the September quarter, which plays the channel fill and the initial sales in that quarter. While last year the iPhone X shipped in Q1 in the December quarter, plays in the channel fill and initial sales in the December quarter. So we knew that this would create a difficult compare for Q1 of 2019 and this is essentially what happened. It was pretty much in line with our expectations. To give you more color I would say that, the XR is our most popular model and it's followed by Xs Max and then the Xs.

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

The next question will come from Toni Sacconaghi with Bernstein.

Yes. Thank you. I have one for Luca and one for Tim. Luca, looks like the midpoint of your Q2 revenue guidance implies the steepest Q1 to Q2 sequential decline in iPhone revenues in history. It also implies a year-over-year deceleration in iPhone revenues. And I'm wondering, if you can comment about whether that's conservatism, whether you're entering the quarter with a high level of channel inventory and maybe you can comment explicitly on that, or whether you actually think the macroeconomic conditions are getting worse?

Yeah. I mean three questions there. The first one is a question around conservatism. As we always do when we provide a range, it's a range that we believe we're going to fall within. We've done pretty well with that up until the December quarter, right? I mean, we've been – we didn't miss in years and years. So that's the idea. There isn't a specific level of conservatism. We believe that this is the range where we're going to fall within. On channel inventory, as you know our historical pattern for iPhone channel inventory is that typically we increase inventory in Q1 and we decrease in Q2. And we think this year will be similar and we've exited the December quarter with levels of inventory that we are comfortable with. So that leaves us with the reality that our iPhone performance in Q1 from a revenue standpoint was minus 15%. And we expect that the key factors that Tim mentioned during the call affecting iPhone performance in Q1 will also have an effect on Q2 starting with the strong U.S. dollar environment. On a year-over-year basis, the negative impact from currency is going to be about $1.3 billion, so that's about a bit more than two points versus last year's revenue and so that obviously plays a role. And the macroeconomic environment particularly in emerging markets will continue to be there. On the positive side, we expect that we will continue to grow revenue nicely from the rest of the business which is not iPhone.

Okay. Tim, at your September event Lisa Jackson, an Apple VP, stated the company needed to quote design products to last as long as possible. And Apple's clearly doing that by helping with the battery replacement program, iOS working on an older range of products et cetera. But I guess the question is why doesn't that mean that replacement or upgrade cycles for iPhones should continue to extend going forward in part because that's almost one of your objectives? And maybe to that end, maybe you can help us understand what iPhones' average replacement cycle might be today, and how that may have changed over the last three to five years. And again, why wouldn't you expect it to elongate over time given some of the aforementioned things? Thank you.

We do design our products to last as long as possible. Some people hold onto those for the life of the product and some people trade them in. And then that phone is then redistributed to someone else. And so it doesn't necessarily follow that one leads to the other. The cycles -- the average cycle has extended. There's no doubt about that. We've said several times I think on this call and before, that the upgrades for the quarter were less than we anticipated due to the -- all the reasons that we had mentioned. So, where it goes in the future, I don't know, but I'm convinced that making a great product that is high quality, that is the best thing for the customer and we work for the user. And so that's the way that we look at it.

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

Next question will come from Shannon Cross with Cross Research.

Thank you very much. I wanted to ask about the trajectory of Services gross margin, up about 500 basis points it appears year-over-year. You talked a little bit about sequential. But what's driving the improvement or will it be volatile as we go through the year depending on quarters and mix? Just whatever color you can give us as we start to forecast this? Thank you.

Yes, Shannon. I think you've seen that Services gross margins increased on a year-over-year basis by a significant amount. Let me start with sequential because I think it's probably most relevant for us. Sequentially, we increased 170 basis points. It's a business that is growing nicely, so we get good support from our scale. Some of these services are scaling quickly and so we tend to expand gross margins there. And also, we had favorable mix. As you probably know, we have a very broad portfolio of Services. Some of them tend to be accretive to the average gross margin for services, also because of the way we account for them. For example, you know that on the App Store, we book revenue on a net basis and therefore the gross margins tend to be accretive. But we also have services that are very successful, that are below the average for the services business. And so depending on how these separate businesses do in the marketplace, we're going to be seeing some level of movement going forward on services margins. But you've seen that for the last 12 months they've gone up nicely 450 basis points and sequentially they've gone up 170 basis points. But I wouldn't draw necessarily a conclusion on how this services gross margin is going to move over time. We will report of course at the end of every quarter. But important to keep in mind, it's a broad portfolio with very different gross margin profiles within the portfolio. It is important for us to grow gross margin dollars. And if at times we grow services that are at a level of gross margins, which is below average, as long as this is good for the customer and as long as we generate gross margin dollars we're going to be very pleased.

Okay, thank you. And then Tim, can you talk a bit about video? You've signed a myriad of deals. There was announcement about -- there are TV app directly on Samsung. So perhaps when this comes out you'll be multi-platform. I'm just curious how you view the opportunity in video. And I guess assuming, you can just leverage the costs that you've made already, it should be accretive to margin I would think?

Yeah, Shannon, we see huge changes in customer behavior taking place now. And we think that it will accelerate as the year goes by to sort of the breakdown of the cable bundle that's been talked about for years. And I think that it'll likely take place at a much faster pace this year. And so we're going to participate in that in a variety of ways. One of those is through Apple TV and you're well familiar with that product. The second way is AirPlay 2, which we have as just pointed out we have support on a number of different third-party TVs. And we're excited about that. It makes the experience in the living room with people using our products even better. We think that people are really going to like that. Another way is, of course, all the third-party video subscriptions that are on the store. We are participating in this today. And I would guess that that's going to accelerate into the future as the bundle breaks down and people begin to buy likely multiple services in place of their current cable bundle. And then finally, original content where we will participate in the original content world. We have signed a multiyear partnership with Oprah. But today I'm not really ready to extend that conversation beyond that point. We've hired some great people that I have a super amount of confidence in and they're working really hard and we'll have something to say more on that later.

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

The next question will come from Walter Piecyk with BTIG.

Great, thanks. I just have a question on the free services. Can you just describe how the math works on that? Is it that the free services are non cash revenue that's getting booked in the Services revenue with no cost and then the costs come out of products? Can you just run us through what the current status versus how you were accounting for that before?

Yes in essence when we sell a product at a certain price, we make an assumption. We estimate the value that can be associated to providing free services. In our case, it's providing Maps services, providing Siri and providing free iCloud to all the customers that purchase our product. And so we calculate an estimated value. That value gets deferred and gets amortized over the estimated period of time that we deliver the free services. In the past that deferral and the subsequent amortization was reported under products. Now in connection with the new revenue recognition standard, we are reclassifying essentially that amortization from products revenue to services revenue. So total revenue has not changed, we just report that estimated value under the Services category. We also reclassify the cost that we need to incur to provide those services. So the gross margin rate of these services is clearly significantly dilutive to the overall Services margin. I hope I've...

So it did make services gross margin, got it. And then my other -- my second question is just, when you think about growth in Services, you have selling more to existing paid subscription customers or it's the 300 million going to 0.5 billion. If you can just talk at a high level as far as when you look at growth going forward, is it about -- what is the mix in terms of selling more to existing users, getting new users or -- and maybe some of the individual services that you see the biggest growth opportunity? Thank you.

Yes. I mean as I said I mean essentially what -- services -- I said services too is our installed base. So the first driver is growing the installed base. Installed base has grown nicely over the last several years. We've added 100 million in the last 12 months alone. So that's the first step. Then within that installed base, of course we want to make sure that there are more people that are so interested in our services that in addition to transacting on those services on a free basis, they also are interested in paying for those services. And I mentioned that the percentage of paid accounts has increased strong double-digits. So we want to continue to do that. We want to make it easier for our customers to actually use our services and so we are accepting more and more payment methods around the world. And clearly, as you said the idea of adding new services is very important to us. During the last three years, we've added Apple Pay, which has been incredibly successful and is a wonderful customer experience. We've added Apple Music, where we now have more than 50 million paid subscribers and continues to grow very nicely. And we've added a very useful service to our developers. We provide an advertising service for developers in the App Store. The way we've added these services in the past, obviously, we're also very interested in adding new services that can provide great value to our customers in the future. Now we don't want to get into product announcements here, but obviously that is part of our strategy.

Thank you all. A replay of today's call will be available for two weeks on Apple Podcast, as a webcast on apple.com/investor and via telephone. And the numbers for the telephone replay are 888-203-1112 or 719-457-0820. Please enter confirmation code 2358120. These replays will be available by approximately 5:00 PM Pacific Time today. Members of the press with additional questions can contact Kristin Huguet at 408-974-2414. Financial analysts can contact Matt Blake or me with additional questions. Matt is at 408-974-7406, and I'm at 408-974-5420. And thanks again for joining us.

That does conclude our conference for today. Thank you for your participation.