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Wednesday, July 19, 2006, 04:00 pm PT (07:00 pm ET)

Notes from Apple's Q306 financial conference call

Apple on Wednesday announced financial results for its fiscal 2006 third quarter ended July 1, 2006, posting revenue of $4.37 billion and a net quarterly profit of $472 million, or $.54 per diluted share. The quarter represents Apple's second highest revenue and earnings totals in the company's history. Some notes from the financial conference call follow:

Apple's Mac business

Overall, Apple experienced the best Mac unit sales in any 13-week quarter of its history.

Apple's Mac business accounted for 55 percent of the company's total quarterly revenue.

Apple sold 529,000 desktops during the quarter and 798,000 notebooks.

The company ended the quarter within its target range of 4- 5 weeks of channel inventory.

Both the Power Mac and Xserve product lines remain on target to transition by the end of year.

75 percent of Mac shipments were Intel-based units.

Apple now sports a total of 7000 Mac distribution points and is conducting some pilot programs to potentially expand that number.

Apple's primary Mac pilot program is with electronics retailer Best Buy. Apple is currently "in a few of their stores," half of which have trained Apple staffers selling products, while half do not. Apple has been "evaluating results" of the program for about 2 months but had nothing to announce during the conference call.

So far, developers have produced over 1200 Universal applications.

According to NPD, Apple's share of US notebook market rose from 6 percent in January to 12 percent in June.

The new MacBook has been "extremely well received."

Although Apple shipped a "significant number" of MacBooks in June, it still exited the quarter with some backlog. However, the company believes it will catch up with demand this quarter, exiting with a supply and demand balance.

Apple's software segment appears to show some weakness both sequentially and year-over-year. However, Apple pointed out that it launched iLife in the previous quarter and Tiger in the year ago quarter, but did not introduce a major software product during the third quarter of 2006.

Boot Camp has been downloaded by a "significant" number of users and customer feedback "very, very good."

Apple sold about 50 percent more notebooks than desktops during the quarter. The company attributes this to notebooks emerging as more compelling PC choices and not a result of Pro users holding out for Intel-based Power Macs.

Apple's iPod business

Apple's iPod business accounted for 45 percent of its total quarterly revenue.

The company ended the quarter within its target range of 4-6 weeks of iPod channel inventory.

Based on the latest data from NPD, iPod holds a 75 percent share of US MP3 market.

The iPod is also the top seller in Canada, Australia, the United Kingdom, France, Spain, Italy and Japan (50 percent).

During the third quarter, Apple got more agressive with iPod marketing outside the US, which helped fuel the aforementioned share gains.

The iTunes Music Store accounts for 85 percent of legal music downloads in the US, according to the latest data from Nielsen SoundScan.

Apple continues to invest "heavily" in its iPod and iTunes engineering, and remains "very excited" about the products forthcoming from those pipelines.

iPod gross margins were up in the June quarter due to a very favorable commodity environment.

Apple's Back-to-School promo did not contribute significantly to Apple's iPod unit sales figure.

Apple's iPod distribution points have increased slightly to over 40,000 due the addition of some "select resellers around the world."

The 6 percent sequential decline in Apple's "other music and related products" segment was a direct result of the 5 percent sequential decrease in iPod shipments.

"We're not sitting around doing nothing," Apple said about the prospect that mobile phones may soon emerge as very capable digital music players and challenge the iPod.

Apple's Retail business

Apple's retail stores combined to sell 216,000 Mac units and generate $715M in revenues during Apple's third quarter, representing yearly growth of 50 percent in units and 29 percent in revenue. Sequentially, the retail segment produced a 40 percent rise in units and a 12 percent increase in revenue.

Apple's retail profits of $29M were fueled by strong customer interest in the company's MacBook and MacBook Pro line of notebook computers.

Apple opened 14 new stores during the quarter, ending with a total of 155 stores.

With an average of 146 stores opening during the quarter, each store accounted for roughly $4.9M in revenues.

Apple's retail stores combined to cater to over 17M customers during quarter.

50 percent of the Mac purchases made at Apple retail stores were made by first-time Mac buyers.

Apple's latest flagship retail store on Fifth Avenue in Manhattan has already seen its 500,000 visitor, making it the company's highest volume retail store.

Apple's Education business

Apple's third fiscal quarter of 2006 was the company's strongest educational quarter in over 10 years, in which the company shipped more Macs to educational customers than it ever had in a single quarter.

Apple's Back-to-School promo (buy qualifying Mac and get a rebate for a free iPod nano) has been very popular with students.

Apple's sales to higher eduction customers grew 31 percent year-over-year.

Other Apple business and segments

Apple Americas accounted for 642,000 Mac sales and $2.188B in revenues. These figures are up 8 percent and 26 percent year-over-year, and 30 percent and 3 percent sequentially.

Apple Europe accounted for 301,000 Mac sales and $899M in revenues. These figures are up 6 percent and 21 percent year-over-year, and down 5 percent and 7 percent sequentially.

Apple Japan accounted for 79,000 Mac sales and $258M in revenues. These figures are up 4 percent and 14 percent year-over-year, and down 4 percent and 17 percent sequentially.

Apple's Asia Pacific (and FileMaker Inc) accounted for 89,000 Mac sales and $310M in revenues. These figures are up 6 percent and 21 percent year-over-year. Sequentially, unit sales rose 35 percent in the Asia Pacific regions but revenues dropped 5 percent.

Apple's "Other Music Related Products and Services" segment accounted for $457M in revenue. The figure represents a 90 percent year-over-year increase but a 6 percent sequential decline.

Apple's "Peripherals and Other Hardware" added $236M in revenue, representing both an 11 percent decrease sequentially and year-over-year.

Apple's "Software, Service and Other Sales" segment accounted for $314M in revenue, a decrease of 9 percent year-over-year and 3 percent sequentially.

The financial side of Q3

Gross margins for the quarter came in at 30.3 percent, a bit higher than expected due to a more favorable mix of direct Mac sales and a very positive commodity environment.

The tax rate came in at just under 29 percent.

The operating margin for the quarter came in at 13 percent.

GAAP operating expenses were about $759M.

Apple saw very strong cash generation during the quarter of $950M to end with $9.2B in cash.

Apple's Direct sales (retail, online, direct to customers, iTunes) increased to 50 percent in Q3, up from 44 percent in Q2.

Apple's next (fourth) fiscal quarter

Apple guided its fourth (September) quarter revenues to fall between $4.5B and $4.6B, with GAAP earnings-per-share of about 43 cents to 46 cents.

Non-cash stock based compensation during the quarter will be about $40M.

GAAP gross margins should come in at 28.4 percent.

GAAP operating expenses are expected to be $785M, including $34 million related to stock-based compensation.

The tax rate for the fourth quarter is expected to be 32 percent.

Apple expects the favorable commodity envoirnment to continue in the fourth quarter, specifically in terms of NAND Flash, displays, and portable hard disks. On the other hand, DRAM prices should be "relatively balanced."

The company expects gross margins to decline due to: a full quarter of the Back-to-School promotion, a higher mix of lower priced products like the MacBook, and price reductions in foreign countries due to the weakness of the US dollar.

Couple of quotes

"We are very pleased to be working with Intel. They have been a great partner for us," said Apple executive vice president Tim Cook.

"We are very confident in the products in our pipeline, and I just don't imagine that creativity at Apple could ever be low," said Apple chief financial officer Peter Oppenheimer.