In which Cook goes through numbers from Apple's second quarter, the first year-over-year decline the company has seen in over a decade.

Apple CEO Tim Cook and CFO Luca Maestri spoke with analysts during the company's Q2 2016 earnings call. Here's our ongoing live transcript of their remarks, courtesy Rene Ritchie and special guest typist Jason Snell of Six Colors! If you want more info on Apple's results, check out Jason's charts and numbers for the quarter.*

Cook's opening remarks

Tim Cook

Thanks Nancy. Good afternoon everyone and thank you for joining us. Today we're reporting the results of a very busy and challenging quarter and we're also announcing an update to our capitol return program. Revenue for the quarter was 50.6 billion which was within our guidance range. Despite the pause in our growth, our results represent excellent execution by our team in the face of ongoing macro economic headwinds in much of the world and difficult year-over-year comparisons. We saw continuing currency weakness in the vast majority of out international markets. In constant currency our revenue declined by 9% from last year, 400 basis points than the reported decline of 13%. For the first half of the fiscal year, our revenue in constant currency was up 1% year on year.

Despite challenges, there were a number of encouraging signs during the quarter. Our installed base of over 1 billion active devices continued to grow strongly. We added a huge number of Android switchers and new-to-Mac customers. And we generated very strong growth from services.

We sold 51.2 million iPhones in the quarter, consistent with the range of our own expectations but lower than the exceptional year-ago quarter when we saw an acceleration in iPhone upgrades and 40% iPhone sales growth over the previous year.

To provide some additional color, iPhone sales come from three sources: customers who upgrade from previous iPhone models, customers who switch from Android and other operating systems, and customers who purchase a smartphone for the first time.

As we look at each of these three sources of iPhone sales, we see a business that is healthy and strong.

First, from an upgrade perspective, during the first half of this year the upgrade rate for the iPhone 6s cycle has been slightly higher than what we experienced in the iPhone 5s cycle two years ago, but it is lower than the accelerated upgrade rate we saw with iPhone 6, which as you know was a big contributor to our phenomenal revenue growth a year ago. Most importantly, our customers are incredibly loyal. A recent Kantar survey of U.S. smartphone purchasers indicated a 95% iPhone loyalty rate, the highest ever measured for any smartphone.

Second, we continue to see a very high level of customers switching to iPhone from Android and other operating systems. In fact, we added more switchers from Android and other platforms in the first half of this year than any other six month period ever.

And third, with only 42% smartphone penetration of the global handset market today, iPhone is still attracting millions of first time smartphone buyers each quarter, especially from emerging markets.

For example, in India our iPhone sales were up 56% from a year ago.

Next I'd like to talk about services, which was our second largest revenue generating category during the quarter. Setting aside the amount we received from a patent settlement in the December quarter, the March quarter services revenue was our highest ever.

Services revenue jumped 20% to 6 billion dollars. App Store revenue was up 35% to beat last quarter's all-time record, and Apple Music continues to grow in popularity with over 13 million paying customers today.

We feel really great about the early success of Apple's first subscription business and our music revenue has now hit an inflection point after many quarters of decline.

The services business is powered by our huge install base of active devices which crossed 1 billion units earlier this year. As we discussed on this call in January, those 1 billion plus active devices are a source of recurring revenue that is growing independent of the unit shipments that we report every three months.

In fact, the purchase value of services tied to our install base was a record 9.9 billion dollars in the March quarter, up 27% over last year, accelerating from the 24% growth rate in the December quarter.

The reach of Apple Pay also continues to expand following a very successful launch in China in the March quarter and last week's rollout in Singapore.

Apple Pay is growing at a tremendous rate with more than five times the transaction volume of a year ago and one million new users per week.

There are more than ten million contactless ready locations in the countries where Apple Pay has launched today, including over two and half million locations now accepting Apple Pay in the United States and more expansion is coming soon.

Turning to the Mac, we met our sell-in expectations in addition to reducing channel inventory by about a hundred thousand units. Overall, the Mac continues to attract a large percentage of new customers.

In our latest survey of major markets, over half of buyers were new to the Mac. And in some countries the percentage is extremely high, like in China where over 80% of customers were purchasing a Mac for the first time.

We're confident in our Mac business and our ability to continue to innovate and gain share in that area.

Turning to the Apple Watch, unit sales met our expectations in the quarter. For some color on how we think of Apple Watch sales, we expected seasonality to be similar to the historical seasonality of iPod, which typically generated 40% or more of its annual unit sell-through in the December quarter.

We started shipping Apple Watch just one year ago and has quickly become the best-selling and most loved smartwatch in the world. In fact, unit sales during its first year exceeded sales of iPhone in its first year.

Last month we refreshed the lineup for the spring with new bands and a new starting price point and the response from customers has been great.

Apple Watch is an increasingly essential part of users lives, from responding to messages, managing calendars and navigating with maps to helping them be more fit. And in some cases the heart rate sensor has even helped save lives.

We're really excited about the first year with Apple Watch. We've learned a lot and we believe it has an exciting future ahead.

We announced some fantastic new products during the March quarter. iPhone SE became available on March 31st, so none of its sales were reflected in our second quarter results. But so far this quarter we're seeing terrific customer response.

iPhone SE is the most powerful 4-inch phone ever and it's a great option for customers all over the world for customers who want a compact phone with advanced features and a great price without compromising performance.

Demand has been very strong and exceeds supply at this point but we're working hard to get iPhone SE into the hands of every customer who wants one as quickly as possible.

The addition of the iPhone SE in the iPhone lineup places us in a better strategic position to attract even more customers into our ecosystem.

We also unveiled the stunning 9.7-inch iPad Pro with cutting edge performance and our most advanced display yet. The reviews of our new iPad Pros have been great and we're hearing from customers that the features and capabilities in the new Pros make them both the ultimate upgrade for iPad owners and a great PC replacement.

In the June quarter we expect to see our best iPad revenue compare in over two years.

iPad is the best selling, best reviewed, and most used tablet on the market. Customers tell us they love iPad for its unique mix of portability, capability, and versatility, with over a million iPad apps in the App Store to help them work, play, learn, and create.

We also announced CareKit, a new software framework that developers can use to help people take a more active role in their health by keeping track of their care plans, monitoring their symptoms and medications, and delivering the insights they need to make smart decisions about their health.

We're very excited about the ways iPhone and Apple Watch are helping people lead healthier lives. We believe there's great promise here for the future and we are very interested in where this can take us.

As always, we're contributing to society beyond our products, promoting the use of renewable energy across our facilities and inside our supply chain and developing cutting edge technologies to revolutionize recycling of the materials we use.

We are unwavering in our commitment to protect the security and privacy of our customers and their data and we're actively promoting inclusion and equality across our business.

As we continue through the June quarter I'd like to remind you that we measure the health of customer demand based on sell through. Despite ending Q2 within our channel inventory targets in light of the macro economic environment we plan to lower our channel inventories in the June quarter. This will impact our reported revenue in Q3. Luca will provide more details on this in his commentary.

Before I turn over the call to him, I'll summarize by saying the future of Apple is very bright. Our product pipeline has amazing innovations in store. We're very excited about bringing together developers for our four major platforms at our world wide developers conference in June.

We're forging ahead with important investments in research and development, in our infrastructure, and in our supply chain. We've made 15 acquisitions in the last four quarters to accelerate our products and roadmaps and we're always on the lookout for companies with great technology, talent, and strategic fit.

Creating value for shareholders by developing great products and services that enrich people's lives will always be our top priority and the key factor driving our investment and capital allocation decisions.

As our business continues to generate high levels of free cash flow, we're in the fortunate position to expand our capitol return program again this year, as we've done each year since we started the program four years ago.

Today we're announcing an extension of the timeframe of the program by four quarters through March of 2018, and we're expanding the total program size from 200 billion to 250 billion. Luca has more details on this announcement and our results for the March quarter.

Luca Maestri on those details

Luca Maestri

Thank you Tim and good afternoon everyone. Let me start with the March quarter results.

Revenue for the quarter landed within our guidance range of 50.6 billion compared to 58 billion in the year-ago quarter, a decline of 13%. As we had expected, our comparisons to last year were influenced by the continued strength of the U.S. dollar against foreign currencies.

Tim said in constant currency our revenue declined by 9%. On a geographic basis, in Asia, our revenue grew strongly in Japan but it declined in Greater China and the rest of Asia Pacific. However, our business is fairing better than the numbers might suggest. We have significant channel inventory reductions and currency weakness that affected our reported revenue for both these segments.

In Mainland China, revenue was down 11% and the decline was 7% in constant currency terms. Keep in mind that we were up against an extremely difficult year-ago compare when our Mainland China revenue grew 81%.

We remain very optimistic about the China market over the long term and we are committed to investing there for the long run.

Gross margin was 39.4%, near the high end of our guidance range thanks to strong cost performance.

Operating margin was 27.7% of revenue and net income was 10.5 billion dollars. Diluted earnings per share were $1.90 and cash flow from operations was strong at 11.6 billion.

For details by product I'll start with iPhone. We sold 51.2 million iPhones in the quarter compared to 61.2 million in the year-ago quarter, a decline of 16%. It was a particular challenging comparison to the record quarter a year ago when iPhone sales grew 40% when we entered last March quarter in supply demand imbalance, which was recovered during the quarter.

Also, this year we reduced channel inventory by 450 thousand units while we increased inventory by a million units a year ago. We have exited the quarter within our five-to-seven week target range for channel inventory.

iPhone ASP was $642.00 compared to $659.00 in the year-ago quarter, with weak international currencies and very popular mid-tier and entry offerings contributing to the difference year-over-year.

iPhone's momentum in business markets continues to be very impressive. A recent survey by 451 Research, formerly known as ChangeWave, found that among U.S. corporate buyers planning to purchase smartphones in the June quarter, 78% plan to purchase iPhones. That's the highest June quarter iPhone purchase intent ever measured by the survey and five points higher than a year ago.

Turning to services, we generated six billion dollars in revenue an increase of 20% over the March quarter last year, thanks primarily to the strong performance of the App Store, with revenue growing 35% to a new, all-time high. According to App Annie, the App Store generated 90% more global revenue than Google Play in the March quarter, up from a 75% lead in 2015.

Among our customers who purchased apps and content from our iTunes Stores, the average amount spent per customer reached a new all-time record in the March quarter.

Next I'd like to talk about the Mac. We sold 4 million Macs, compared to 4.6 million last year, a decline of 12%. It was a challenging quarter for personal computer sales across the industry but we believe we gained market share.

Despite the overall market slowdown, we generated double-digit Mac growth in a number of markets including Russia, Korea, Singapore, Taiwan, and the UAE. And just last week, we updated the MacBook, our thinnest and lightest Mac, with the latest processors, faster graphics, faster flash storage, and longer battery life. We think our customers are going to love this update.

We ended the quarter within our 4-5 week target range for Mac channel inventory.

Turning to iPad, we sold 10.3 million compared to 12.6 million compared in the year-ago quarter. We also reduced channel inventory by about 200,000 units and we exited the quarter within our 5-7 target range.

In the same segments of the tablet market where we compete, we continue to be highly successful. Recent data from NPD indicates that iPad has a 78% share for tablets priced above $200. And the latest data published by IDC indicates iPad accounts for 72% of the U.S. commercial tablet market comprising business, government, and education.

iPad customer metrics are also extremely positive. In February, 451 Research measured a 97% consumer satisfaction rate for iPad Air 2, and among consumers planning to purchase a tablet within the next 6 months, 59% planned to purchase an iPad. More than three times the purchase intention rate of the next highest brand measured.

Corporate buyers reported a 94% satisfaction rate for iPad and a June quarter purchase intent of 71%.

Revenue from other products grew 30% over last year, thanks to Apple Watch. We have expanded distribution to 60 countries and introduced bands in beautiful new colors for spring, so customers can personalize their watches in more ways with a range of colors, styles, and materials.

Our customers are very happy with Apple Watch, with 451 Research measuring 94% customer satisfaction.

We're also making great progress with our enterprise initiatives. IBM now has engagements for more than 200 deployments of native iOS apps for large enterprise customers to accelerate mobile transformation.

Our mobility partner program also continues to grow with 108 partners across 20 countries.

We see continued broad industry adoption of iOS apps to transform how professionals do their work and serve their customers. For example, retail bankers are using iOS apps on iPads to greet and onboard customers, reduce queue times, and improve the customer experience.

In hospitals, doctors and nurses are using iOS apps on iPhone and iPad to share and communicate more effectively so they can spend more time with patients and less time on administrative tasks.

Let me now turn to our cash positions. We ended the quarter with $232.9 billion in cash plus marketable securities, a sequential increase of 17.2 billion. 208.9 billion of this cash, or 90% of the total, was outside of the United States.

We issued 15.5 billion in U.S. dollar denominated notes during the quarter, including our first green bond [indecipherable] to fund initiatives such as renewable energy and environmental design projects.

We exited the March quarter with 72 billion in term debt. We returned 10 billion dollars to investors during the quarter including 2.9 billion in dividends and equivalents, and 7 billion on repurchases of 71.8 million Apple shares through open market transactions.

We have now completed over 163 billion of the current 200 billion capital return program, including 117 billion in share repurchases.

As Tim mentioned, today we're announcing the latest update to our program which we are increasing to a total of 250 billion. Once again, we're allocating the majority of the expansion of the program to share repurchases given our strong confidence in Apple's future and the value we see in our stock.

The board has increased the share repurchase authorization by 35 billion, increasing it from the current 140 billion level to 175 billion. We will also continue to net share settle vesting employee restricted stock units.

We also know that a dividend is very important to many of our investors who value income and we're raising it for the fourth time in less than four years.

The quarterly dividend will grow from $0.52 per share to $0.57 per share an increase of about 10%. This is effective with our next dividend, which the board has declared today and is payable on May 12, 2016 to shareholders of record as of May 9, 2016.

We continue to plan for annual dividend increases going forward. With 12 billion in annual dividend payments, we're proud to be one of the largest dividend payers in the world.

In total, with this updated program, during the next eight quarters, we expect to return 87 billion to our investors which represents about 15% of our market cap at the current stock price.

As in the past, we expect to fund our capital return program with U.S. cash, future U.S. cash flow generation, and borrowing from both domestic and international debt markets.

We will continue to review capital allocation regularly, and solicit input on our program from a broad base of shareholders. This allows us to be thoughtful about the size, the mix, and the pace of the program.

As we move ahead into the June 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 expect revenue to be between 41 and 43 billion dollars. The revenue guidance implies a year-over-year decline as we lap an incredibly strong June quarter last year where revenue grew 33% due, in part, to accelerated iPhone upgrade purchases.

This tough compare is compounded by the continued week macro environment this year and the strong U.S. dollar which affects our revenue growth in international markets. Embedded in this guidance is a planned channel inventory reduction worth over 2 billion dollars as we have elected to be prudent about our channel inventory position given the current macro environment.

The guidance also reflects a range of possible scenarios related to how quickly we can get into supply demand balance for iPhone SE. Due to these factors our expected demand is greater than the revenue range implied.

Sequentially, our guidance implies a revenue decline of 15% to 19% which is comparable to the 17% sequential decline that we've averaged from the March to June quarter for the last three years, despite the anticipated channel inventory adjustments I just described.

We expect seasonal sequential declines in iPhone and iPad sales, and a sequential increase in Mac sales.

We also expect iPhone ASPs to decline to sequentially as we get farther form the launch of iPhone 6s and iPhone 6s Plus, and as iPhone SE enters the mix.

We know that our revenue guidance falls short of market estimates for the third quarter. We believe the difference comes primarily from three areas.

First, the 2 billion dollar plus channel inventory reduction I just mentioned.

Second, the affect of the channel inventory reduction and the launch of iPhone SE on iPhone ASPs. As well as the current constrained supply of iPhone SE.

And third, different estimates for Mac, which we expect to grow sequentially at a rate similar to what we experienced in the past June quarters.

We expect gross margins to be between 37.5 and 38%. We expect continued cost improvements to be more than offset by the sequential loss of leverage from lower revenue and a different mix of products.

We expect OPEX to be between 6 and 6.1 billion. We expect OINE to be about 300 million and we expect the tax rate to be about 25.5%.

On the channel inventory reduction

Simona Jankowski, Goldman Sachs: My first question is a clarification in terms of putting in context the $2B in-channel inventory reduction. What was that last year, just to help us make a comparison on a year-over-year basis? And the bigger question, Tim, was: With the smartphone market now reaching a pretty mature growth phase, how does Apple think of itself going forward? Is it as a growth company, or as a more mature tech company? And if it's still the former, how does that change how you think about M&A, especially given the position you're in with your balance sheet, strategically?

Luca Maestri

Mona, let me give you data points on the sell-through and then I'll let Tim answer the strategic question. We had a channel inventory reduction that was worth a bit less than $800M a year ago.

Tim Cook

Simona, hi, it's Tim. In terms of, do I think the smartphone market is mature, I think that the market, as you know, is currently not growing. However, my view of that is that that's an overhang of the macroeconomic environment in many different places in the world. And we're very optimistic that this too shall pass, and that the market, and particularly us, will grow again.

The reason that we're optimistic is, we look at the three places that iPhone sales come from, and from an upgrade point of view, as I mentioned in my comments, we compare favorably—slightly better—than the upgrade cycle that we saw on the iPhone 5S. We're lower than the iPhone 6, but I think all of us know that that was an extraordinary cycle that accelerated upgrades from 2016 into 2015 and that comparable will be tough for this year, but that's a transitory thing.

As we look at switchers, we're extremely excited that for the first half we've set a record for switchers from other platforms, the largest we've ever seen in any six-month period before. So we've got traction there, and then on emerging markets, if you look at India we grew by 56 percent, and we're placing increasing emphasis in these areas where it's clear there will be dispropotionate growth versus the more developed areas.

The next thing is, with the iPhone SE, we have seen our ability to attract even more customers into the platform with a[n] incredible product that is at a new price point for us, with the latest technology, so we're optimistic about attracting even more customers with that. We also look at our pipeline and are very excited about what's in our pipeline. And so all of those things make me optimistic.

Your other question was on M&A, and regardless of the first, we are always looking in the market about things that could complement things that we do today, become features in something we do, or allow us to accelerate entry into a category that we're excited about. And so as I've said before, our test is not on the size--we would definitely buy something larger than we've bought thus far--it's more about the strategic fit and whether it's sort of a great technology and great people. So we continue to look and we stay very active in the M&A market.

On iPhone ASP trends

Gene Munster, Piper Jaffray: Tim, could you talk a little bit about the iPhone ASP trends and specifically you mentioned that the SE is going to impact, but how are you thinking about the aspirational market share that's out there and your actual market share and using price to close that gap. Is it just the SE or could there be other iPhone models that will be discounted to try to be more aggressive in emerging markets. And one for Luca, can you talk a little bit about the Services segment in terms of what piece of the services is driving growth. It may be a little bit about the profitability on a net basis versus a growth basis that you've referred to in the past.

Tim Cook

Gene, I think the SE is attracting two types of customers. One is customers that wanted the latest technologies, but wanted it in a more compact package. And we clearly see even more people than we thought in that category. And then secondly, it's attracting people who aspire to own an iPhone, but couldn't quite stretch to the entry price of the iPhone, and we've established a new entry. And so I think both of these markets are very, very important to us, and we're really excited about where it can take us. I do think that we will be really happy with the sort of new-to-iPhone customers that we see from here, because of the early returns we've had. We are currently supply constrained, but we'll be able to work our way out of this at some point. But it's great to see the overwhelming demand for it. I'll let luca comment on the ASP.

Luca Maestri

So on the ASPs, we mentioned that we're going to be down sequentially, and this is really the combination of two factors, as we go from the March quarter to the June quarter. It's the fact that we are having the SE enter in the mix, and that's obviously going to add a downward pressure on ASP, and also this channel-inventory reduction that we've talked about, obviously the channel-inventory reduction will come from higher-end models and that is also affecting the sequential trend on ASPs.

The question on services, when we look at our services business it's obviously growing very well across the board. The biggest element, the part of the services business that is growing very well, we mentioned 35 percent, is the App Store. It's interesting for us that our music business, which had been declining for a number of quarters, now that we have both a download model and a streaming model, we have now hit an inflection point and we really believe that this will be the bottom and we can start growing from there over time. We have many other services businesses that are doing very well, we have an iCloud business that is growing very quickly, faster than the App Store--from a much lower base, but I think it's important for us as we continue to develop these businesses. Tim has talked about Apple Pay, it doesn't provide a meaningful financial contribution at this point, but as we look at the amount of transactions that are going through Apple Pay right now, we think ahead to the long term, that could be an interesting business for us as well.

From a profitability standpoint, we mentioned last time that when you look at it on a gross basis, so in terms of purchased value of these services, the profitability of the business is similar to company average. Of course when you net out the amount that is paid to developers and you look at it in terms of what is reported in our P&L, that business has a profitability that is higher than company average. We don't get into the specifics of specific products or services, but it's very clear it's significantly higher than company average.

On gross margin guidance

Katy Huberty, Morgan Stanley: First for Luca, this is the worst gross margin guide in a year and a half or so. And over the last couple of quarters you've talked about a number of tailwinds including component costs, the lower accounting deferrals that went into effect in September, you just mentioned the services margins are above corporate average. So the question is, are some of those tailwinds winding down? Or is the significant guide-down in gross margins for the June quarter entirely related to volume and the SE.

Luca Maestri

Katy, clearly the commodity environment remains quite favorable, and we continue to expect cost improvements. The other dynamics that you've mentioned are still there. Obviously, what is different, and particularly when you look at it on a sequential basis coming out of the March quarter, we will have loss of leverage, and that obviously is going to have an aggregate impact on margins. And the other factor that's important to keep in mind is this different mix of products, and particularly when you look at iPhone—what I was mentioning to Gene earlier—I think we got a couple of things that are affecting not only ASPs but obviously they also affect margins, and it's a the fact that we have a channel inventory reduction at the top end of the range. And we've got the introduction of the iPhone SE at the entry level of the range. And so when you take into account those factors, those are the big elements that drive our guidance range right now.

For Tim, appreciate the optimism around longer term iPhone unit growth, but with developed-market penetration in anywhere from 60 to 80 percent, the growth is going to have to come from new markets. You talked about India, can you just spend a little bit more time on that market? What are some of the hurdles you have to overcome for that to be a larger part of the business? When should we expect Apple to have more distribution, and specifically your own stores, in that country?

Tim Cook

Katy, in the short term let me just make a couple of comments on the developed markets to make sure this is clear. If you look at our installed base of iPhone today versus two years ago, it's increased by 80 percent. And so when you think about upgrade cycles, upgrade cycles would have varying rates on them. As I talked about in the comments, iPhone 6S upgrade rate is slightly higher than the iPhone 5S, but lower than the iPhone 6. But the other multiplier in that equation is obviously the size of the installed base. And so the nut of that is, I think there's still really, really good business in the developed market, so I wouldn't want to write those off, and it's our jobs to come up with great products that people desire, and also to continue to attract over Android switchers. With our worldwide share, there's still quite a bit of room in the developed markets as well.

And from an India point of view, if you look at India—and each country has a different story, a bit—the things that have held not only us back, perhaps, but some others as well, is that the LTE roll-out with India just really begins this year. And so we'll begin to see some really good networks coming on in India. That will unleash the power and capability of the iPhone in a way that an older network, 2.5G or even some 3G networks, would not do. And so the infrastructure is one key one, and the second one is building the channel out. Unlike the U.S. as an example, where the carriers in the U.S. sell the vast majority of phones that are sold in the United States, in India the carriers in general sell virtually no phones. And so it's out in retail, and retail is many, many different small shops, and so we've been in the process—we've got something we've just started in the last few weeks—we've been working in India for a couple of years, or more, but we've been working with great energy over the last 18 months or so, and I'm encouraged by the results that we're beginning to see there, and we believe there's a lot, lot more there. It is already the third-largest smartphone market in the world, but because the smartphones that are working there are low-end primarily because of the network and the economics, the market potential has not been as great there, but I sort of view India is where China was maybe 7-10 years ago, from that point of view. And I think there's a really great opportunity there.

On iPhone SE growth potential

Tony Sacconaghi, Bernstein: My sense is that, you talked about adjusting for the changes in channel inventory that you're kind of guiding for relatively normal sequential growth, and I think if you do the math, it's probably the same or perhaps a touch worse in terms of iPhone unit growth sequentially, relative to normal between fiscal Q2 and Q3. I guess the question is, given that you should be entering new markets and you should see pronounced elasticity from the SE device, why wouldn't we be seeing something that was dramatically above normal seasonal in terms of iPhone revenues and units for this quarter? And maybe you could push back on me, but I can't help thinking that when Apple introduced the iPad mini, in a similar move to move down market, there was great growth for one quarter, and the iPad never grew again, and margins and ASPs went down. And it looks like you're introducing the SE, and at least on a sequential basis, you're not calling for any uplift, even adjusting for channel inventory. And ASPs I presume will go down, and certainly it's impacting gross margins as you've guided to. So could you respond to, a) why you're not seeing the elasticity and b) is the analogy with the iPad mini completely misplaced?

Tim Cook

Let me see if I can address your question. The channel inventory reduction that Luca referred to, the vast majority of that is in iPhone. So that would affect the unit compare that you may be thinking about. The iPhone SE, we're thrilled with the response that we've seen on it. It is clear that there is demand there, even much beyond what we thought, and so that is really why we have the constraint that we have. And so, do I think it will be like the iPad mini? No, I don't think so. I don't see that. I think that the tablet market in general, one of the challenges with the tablet market is that the replacement cycle is materially different than in the smartphone market. And so, as you probably know, we haven't had an issue in customer satisfaction on the iPad, it's incredibly high, and we haven't had an issue with usage of the iPad, the usage is incredibly high. But the consumer behavior there is, you tend to hold on for a very long period of time before an upgrade. We continue to be very optimistic on the iPad business, and as I had said in my remarks, we believe we're going to have the best compare for iPad revenue this quarter that we've had in quite some time. And so we'll report back in July on that one, but I think iPhone has a particularly different kind of cycle to it, than the tablet market.

Tony: You alluded to replacement cycles and differences between the iPad and the iPhone. My sense was, when you were going through the iPhone 6 cycle, was that you had commented that the upgrade cycle was not materially different. I think your characterization was that it had accelerated a bit in the U.S. but international had grown to be a bigger part of your business and the replacement cycles there were typically a little bit longer. And so I'm wondering, if it was only a modest difference between the 5S and the 6, how big a difference are we really seeing in terms of replacement cycles across the last three generations? And maybe you can help us, if the replacement cycle was flat this year relative to what you saw last year, how different would your results have been this quarter and the first half?

Tim Cook

There's a lot there. Let me just say, I don't recall saying the thing that you said I said about the upgrade cycle. So let's get that out of the way. Now let me just describe, without the specific numbers, the iPhone 6S upgrade cycle that we've measured for the first six months of our fiscal year, is slightly better than the rate that we saw with the iPhone 5S two years ago. But it's lower than the iPhone 6. And I don't mean just a hair lower, it's a lot lower. And so without giving you exact numbers, if we would have the same rate on 6S that we did 6, it would be time for a huge party. It would be a huge difference. Now the great news from my point of view is, I think we're strategically positioned very well, because we've announced the SE, we're attracting customers that we previously didn't attract, that's really great, and this tough compare eventually isn't the benchmark. And the installed base is up 80 percent over the last two years. So all of those, I think, bode well. And the switcher comments I made earlier, I wouldn't underestimate that. Because that's very important for us in every geography.

On China

Shannon Cross, Cross Research Group: Tim, can you talk a bit about what's going on in China? I know the Greater China revenue I think was down 26 percent, you did talk about mainland China. But just if you could talk about some of the trends you're seeing there, and how you think it's playing out, and maybe your thoughts about SE adoption within China as well.

Tim Cook

If you take Greater China, we include Taiwan, Hong Kong, and mainland China in the Greater China segment that you see reported on your data sheet. The vast majority of the weakness in the Greater China region was in Hong Kong. And our perspective on that is, it's a combination of the Hong Kong dollar being pegged at the U.S. Dollar, so it carries the burden of the strength of the U.S. Dollar, and that has driven tourism, international shopping, and trade down significantly compared to what it was in the year-ago. If you look at mainland China, which is one that I am personally very focused on, we're down 11 percent in mainland China on a reported basis. On a constant currency basis we're only down 7. And the way that we really look at sort of the health or underlying demand, is look at sell-through, and if you look at it there we were down 5. And keep in mind, that that's down 5 on a comp a year ago that was up 81. And so as I sort of back up from this and look at the larger picture, I think China is not weak, as has been talked about, I see China as, may not have the wind at our backs that we once did, but it's a lot more stable than what I think is the common view of it. And so we remain really optimistic on China. We opened seven stores there during the quarter. We're now at 35, we'll open five more this quarter, to achieve 40, which we talked about before. And the LTE adoption continues to rise there, but it's got a long way ahead of it. And so, we continue to be really optimistic about it. And just would ask folks to sort of look underneath the numbers at the details in them before concluding anything.

Shannon: My second question is with regard to OpEx leverage, or thinking about, when I look at the revenue, you're revenue is below our expectations, but OpEx is more or less in line. How are you thinking about potential for leverage, I don't know, cost containment maybe, when macro is bad and revenue is under pressure, and how are you juggling that versus the required investment you need to go forward?

Luca Maestri

Of course we think about it, we think about it a lot. And so when you look at our results, for example, our OpEx for the March quarter was up 10 percent. Which is the lowest rate you've seen in years. And when you look within OpEx, you actually see two different dynamics: you see continued significant investments in research and development, because we really believe that's the future of the company, we continue to invest in initiatives and projects ahead of revenue, we have a much broader portfolio than we used to have, we do much more in-house technology development than we used to do a few years ago, which we think is a great investment for us to make. And so that part, we did need to protect, and we want to continue to invest in the business, right? And then when you look at our SG&A portion of OpEx for the March quarter, it was actually down slightly, and so obviously we think about it, and of course we look at our revenue trend and we take measures accordingly. And when you look at the guidance that we provided for the June quarter, that 10 percent year-over-year increase that I mentioned to you for the March quarter goes down to a range of 7-9 percent up, and again the focus is on making investments in R&D and continuing to run SG&A extremely tightly and in a very disciplined way. As you know, our E to R, expense to revenue ratio, is around 10 percent, something that we're very proud of. It's a number that is incredibly competitive in our industry, and we want to continue to keep it that way. At the same time, we don't want to under-invest in the business.

On how Apple views services

Steve Milanovich, UBS: Tim, I first wanted to ask you about services. How do you view services? You've obviously highlighted it the last two quarters. Do you view it going forward as a primary driver of earnings? Or do you view it—and you mentioned platforms in terms of your operating systems, which I would agree with—and in that scenario, I would argue it's more of a supporter of the ecosystem and a supporter of the hardware margins over time, and therefore somewhat subservient to hardware. So it's great that it's growing, but longer term I would view its role as more creating ecosystems that support the high margins on hardware, as opposed to independently driving earnings. How do you think about it?

Tim Cook

The most important thing for us, Steve, is that we want to have a great customer experience. So overwhelmingly the thing that drives us are to embark on services that help that and become a part of the ecosystem. The reality is that in doing so, we have developed a very large and profitable business in the services area. And so we felt, last quarter and working up to that, that we should sort of pull back the curtain so that our investors could see that services business, both in terms of the scale of it and the growth of it--as we said earlier, the purchase value of the installed-based services grew by 27 percent during the quarter, which was an acceleration over the previous quarter. And the value of it was just shy of $10 billion. And so, it's huge, and we felt it was important to spell that out.

Steve: And doing back to the upgrades of the installed base, you've clearly mentioned that you've kind of pulled forward some demand, which makes sense, but there does seem to be a lengthening of the upgrade cycle, particularly in the U.S. AT&T and Verizon have talked about that, investors I think perceive that maybe the marginal improvements on the phone might be less currently and could be less going forward. At the same time, I think you just announced that you can get the iPhone Upgrade Program online, which I guess potentially could shorten it. Do you believe that upgrade cycles are currently lengthening, and could continue to do so?

Tim Cook

What we've seen is that, it depends on what you compare it to. If you compare to the 5S, what we're seeing is the upgrade rate today slightly higher, that there are more people upgrading, if you will, in a similar time period, in terms of rate, than the 5S. But if you compare to 6, you would clearly arrive at the opposite conclusion. And so I think it depends on people's reference point. We thought it very important in this call to be very clear and transparent about what we're seeing. And so I think in retrospect, you can look at it and say, well maybe the appropriate measure is more to the 5S, and I think everybody intuitively thought that the upgrades were accelerated with the 6, and in retrospect when you look at the periods, they clearly were.

On what's changed since last quarter

Rod Hall, J.P. Morgan: I wanted to start with a more general question. As you think about where you thought things were going to head last quarter, when you reported to us, and how it's changed this quarter--obviously this is kind of a disappointing demand environment--can you just help us understand what maybe the top two or three things are that have changed, so as we walk away from this we understand what the differences are and what the direction of change is.

Tim Cook

I think you're probably indirectly asking about our trough comment, if you will, from last quarter. And when we made that, we did not contemplate or comprehend that we were going to make a two-plus million dollar reduction in channel inventory during this quarter. And so, if you factor that in and look at true customer demand, which is the way that we look at it internally, I think you'll find a much more reasonable comparison.

Rod: I wanted to ask you about the tax situation a little bit. Treasury obviously has made some rule changes, and I wonder maybe if Luca, you could comment on what the impact to Apple from those is, if anything? And Tim, maybe more broadly, how you guys see the tax situation for Apple looking forward?

Luca Maestri

These are new regulations, we are in the process of assessing them, frankly from first read we don't anticipate that they're going to have any material impact on our tax situation. Some of them relate to inversion transactions, obviously that's not an issue for us. Some of them are around internal debt financing, which is not something that we use. So we don't expect any issue there. As you know, we are the largest U.S. taxpayer by a wide margin. And we already pay full U.S. tax on all the profits from the sales that we make in the United States. So we don't expect them to have any impact on us. Tax reform—maybe I can continue and let Tim provide more color—we've been strong advocates for comprehensive corporate tax reform in this country. We continue to do that. We think reform of the tax code would have significant benefits for the entire U.S. economy, and we remain optimistic that we're going to get to a point where we can see that tax reform enacted. At that point in time, of course we would have much more flexibility around optimizing our capital structure and around providing more return of capital to our investors.

Tim Cook

The only thing that I would add, Rod, is that I think there are a growing number of people in both parties that would like to see comprehensive reform, and so I'm optimistic that it will occur. It's just a matter of when. And that's difficult to say. But I think most people do recognize that it's in the U.S.'s interest to do this.