Will Apple Beat 2009 Revenue Consensus?

Four months ago, the analyst consensus estimate for 2009 had Apple (AAPL) earning $6.36 in EPS on approximately $40 billion in revenue. Since that time, the economy has gone through a major financial crisis, which has led many analysts to revise their estimates down, quite dramatically. As of Wednesday, the analysts were now looking for Apple to earn $5.35 in EPS on approximately $37.5 billion in revenue in 2009. The consensus has Apple literally contracting on the year—down from $5.36 in EPS in 2008. These extraordinarily bearish consensus estimates have set Apple up to beat revenue expectations by approximately $900 million each quarter in 2009.

I expect Apple to earn about $6.63 in EPS on $41.2 billion in revenue beating expectations by $1.28 in EPS and $3.63 billion in revenue. This amounts to an average quarterly beat of $907 million in revenue and $0.32 in EPS. Even before this recent bout of downward revisions to the estimate, I saw the consensus as already pricing in a moderate to severe recession.

The biggest problem with the current consensus estimate is that it either contemplates flat growth in unit sales across all of Apple's product lines (including Macs and iPhones), or it fails to realize that Apple has a massive current deferred revenue pot that it will fully recognize in 2009. Sitting in a small corner of Apple's financial statement, current deferred revenue is something that can easily be overlooked by analysts who either don't fully analyze the company, or don't normally cover the company.

Due to the subscription method of accounting for iPhone and Apple TV sales, Apple recognizes the revenue it receives from the devices over a 730-day period (rather than at point of sale). At the end of every accounting period, Apple reports its total current and non-current deferred revenue for the iPhone and Apple TV on its consolidated schedule of deferred revenue. Current deferred revenue is revenue that Apple will recognize over a 365-day period from the date of the financial statement, while non-current deferred revenue is revenue that Apple will begin to recognize starting 365 days after the date on the financial statement.

Thus, at the end of Apple's fiscal fourth quarter, current deferred revenue is literally revenue that Apple will recognize in the ensuing fiscal year. At the end of 2007, for example, Apple had $346 million in current deferred revenue, which it has to recognize equally over the 365 days of fiscal 2008. That averages to about $86.5 million that Apple got recognize for each quarter of 2008 without having to sell a single item in the period. Now compare that number to 2009.

Current deferred revenue at the close of Apple fiscal Q4 2008 was $3.518 billion—over 10 times the amount going into fiscal 08. This means that if Apple didn't sell a single product in 2009, it would automatically get to recognize $880 million per quarter (compared to the $86.5 million that Apple has to recognize each quarter in 2008). Now here's where things get complicated, and where the flaw in the analyst consensus is revealed. It's important to follow this point very closely.

Since Apple went into 2008 with a revenue benefit of $346 million, while going into 2009 with revenue benefit of $3.518 billion, one must back out these benefits to get an idea of what the consensus is really indicating about Apple's business in 2009. By backing out these benefits, one gets a clearer picture of how Apple actually performed in 2008 (without regard to benefits from sales in 2007) and how the analysts think Apple will actually perform in 2009 (without regard to benefits received from sales in 2008). By doing this, one will be able to determine the actual growth rate estimates in unit sales and revenue by the analysts. Basically, it answers the question of what will 2009 sales contribute in total revenue minus deferred revenue benefits.

Here's the basic math:

• If you subtract the $346 million benefit Apple received in 2008, Apple would have reported $32.133 billion in revenue ($32.478 billion - $.346 billion).

• If you subtract the $3.518 billion revenue benefit that Apple will recognize in 2009 from the analyst consensus estimate of $37.57 billion in revenue, he or she would arrive at a $34.052 billion figure.

What this tells us is that the analysts believe that Apple will grow its revenue by only $1.919 billion in 2009 when backing out the current deferred revenue benefit.

That's a mere 5.9% growth rate in revenue despite the fact that Apple's Mac sales are growing at over 3 times the industry average, and despite the fact that iPhone unit sales grew over 400% in Q4 alone. Even iPod sales are still growing at nearly 5-8% per period and iTunes continues to grow at over 30% on a YoY basis each quarter. Also, it's important to note that any time Apple sells over 5 million iPhone within any given quarter, Apple not only gets to recognize $400 million in revenue in that particular period, but it gets to recognize roughly $400 million in revenue each quarter for 7 quarters thereafter. This literally means that iPhone sales in Q1 alone could add about $1.6 billion in revenue for the year, which would make up almost all of the $1.919 billion in sales growth that the analysts are expecting for 09.

This fact single-handedly suggests that the consensus is plainly factoring in negative revenue growth for all of Apple's products in 2009 save the iPhone. Because even if Apple sells only 2.5 million iPhones in Q2 after selling 5 million Q1, Apple would have already surpassed analyst revenue growth estimates for 2009—even if sales are exactly flat across all of its other product lines. Basic common sense should tell any investor that such estimates are entirely irrational. While a moderate to deep recession will undoubtedly affect Apple's business, the natural growth rate and penetration in even a flat economic environment will offset the negative effects of a slowdown. Unless we're talking 10-12% unemployment and 5-6% negative GDP growth throughout 2009, the analyst consensus simply makes no sense.

 Andy Zaky's GAAP-Based Earnings Estimates for FY 2009 (in Millions)

	Q1 2009	Q2 2009	Q3 2009	Q4 2009	FYE 2009
Revenue	$11,290	$9,489	$9,794	$10,623	$41,196
Cost of Goods Sold	$7,395	$6,405	$6,464	$6,926	$27,190
Gross Margin	$3,895	$3,084	$3,330	$3,697	$14,006
Operating Expenses	$1,510	$1,460	$1,510	$1,600	$6,080
Operating Income	$2,385	$1,624	$1,820	$2,097	$7,926
OI&E	$150	$160	$150	$170	$630
Net, Before Taxes	$2,535	$1,784	$1,970	$2,267	$8,556
Taxes	$748	$535	$591	$657	$2,531
Net Income	$1,787	$1,249	$1,379	$1,610	$6,025
Earnings Per Share	$1.96	$1.38	$1.52	$1.77	$6.63
Diluted Shares	912	908	908	908	909,000

Andy Zaky's Expected Growth Rate for FY 2009

	FYE 2008	FYE 2009	Growth
Revenue	$32,479	$41,196	$8,717 (26.8%)
Cost of Goods Sold	$21,334	$27,190	$5,856 (27.4%)
Gross Margin	$11,145	$14,006	$2,861 (25.7%)
Operating Expenses	$4,870	$6,080	$1,210 (24.8%)
Operating Income	$6,275	$7,926	$1,651 (26.3%)
OI&E	$620	$630	$10 (1.6%)
Net, Before Taxes	$6,895	$8556	$1,661 (24.1%)
Taxes	$2,061	$2,531	$470 (22.8%)
Net Income	$4,834	$6,025	$1,191 (24.6%)
Earnings Per Share	$5.36	$6.63	$1.27 (23.7%)
Diluted Shares	902	909	6,861 (0.01%)

Andy Zaky's Estimates Compared to the Consensus for FY 2009

	Consensus	Andy Zaky	Upside Surprise
Revenue	$37,570	$41,196	$3,626 (9.7%)
Cost of Goods Sold	$25,923	$27,190	$1,267 (4.9%)
Gross Margin	$12,398	$14,006	$1,608 (13.0%)
Operating Expenses	$6,000	$6,080	$80 (1.3%)
Operating Income	$6,398	$7,926	$1,528 (23.9%)
OI&E	$600	$630	$30 (5.0%)
Net, Before Taxes	$6,998	$8556	$1,558 (22.3%)
Taxes	$2,133	$2,531	$398 (18.7%)
Net Income	$4,865	$6,025	$1,160 (23.8%)
Earnings Per Share	$5.35	$6.63	$1.28 (23.9%)
Diluted Shares	909	909	-

Disclosure: Long AAPL.

Comments

[W.Barrett:]

Andy,
Given your infomative data regarding deferred revenue going into 2008 of $346 million, and with Apple going into 2009 with revenue benefit of $3.518 billion, two quick questions. Does Apple spread the deferred revenues out over one year or two? and where do you believe Apple's share price will be by the end of the 3rd quarter fiscal year 2009?
Thank you.

2008 Nov 14 08:34 AM

[UncleJohnK:]

Just to clarify deferred revenue by comparing it to the corporate Software Market... Most software is sold with a maintenance contract per year in the 20% range of the purchase price which is usually paid up front. Since it is a 12 month contract, it can only be booked monthly which makes sense since the work is performed over 12 months. The nice think is, the Cash arrives on day one. Apple's revenue stream is similar since they get a percentage of the carriers revenue over the life of the user contract, usually 2 years. I don't know if Apple gets the revenue up front, but its still a nice thing since the deferred revenue pot continues to grow as carriers sign more customers.

2008 Nov 14 08:37 AM

[Andy Zaky:]

Its current deferred revenue. So its recognized over 2009. There's two categories of deferred revenue. Current and noncurrent. Current is recognized in 2009 and noncurrent in 2010.

2008 Nov 14 08:41 AM

[ironpants:]

Of course they will beat.
Unfortunately, the stock will be punished yet again for good deeds.
Just can't win with all the shorting and manipulation.
The SEC needs a leader who protects real investors, not traders.

2008 Nov 14 09:00 AM

[Ranchr:]

Yesterday, I posted the following comment on several other blogs and in light of your analysis it is even more important for analysts to consider what is actually occurring in the Apple stores.

"The only numbers that should count are the numbers of shoppers in the Apple Stores.

I frequently check Apple’s pulse by visiting 4 stores, located within 90 minutes of my Sarasota, FL area home. I’ve also visited three stores in England, since July, and get regular reports from friends and family there, as well as, personal visits to stores in New York and California.

During the past few weeks I personally visited stores in Brandon and Estero (Naples), Florida and received a report on the opening of their latest store in England.

The UK store was packed two weeks ago and, last night, I stopped in the store at the International Plaza in Tampa.

In the Tampa, the store staff were all busy with customers, when I walked in and iMacs, Macbooks and lots of Apple bags were going out the door, at 5:30.

In contrast, Nordstrom and Neiman Marcus were almost empty. Last Sunday the staff in Apple stores in Tampa were overwhelmed with shoppers.

Before they run off at the mouth, these analysts need to go check the numbers that count. Apple is the only bright spot in an awful lot of dead malls.

One more thing...If it’s a Barclay’s or a number of the other analysts, that work for companies in trouble, don’t lob stones at Apple shift gears and figure out how to put out the fire in your own houses!"

2008 Nov 14 09:32 AM

[Buffeted:]

If the SEC were really doing their job, i.e, protecting the investor from unfair manipulation by the media, sketchy analyst and traders,
aapl would never have gone below 120. The share price now is not the result of the overall market down turn but more a reflection of a sustained effort by analysts paid by Hedgefunds to downgrade the stock and lower estimates without solid numbers or credible evidence to back up their their claims. The stuff I have read from analysts on apple over the past few months stinks so bad it's hard to believe there is no investigation.

2008 Nov 14 09:32 AM

[ironpants:]

I sincerely hope that Obama gets that clown Cox out of the SEC.
Apparently, he's totally corrupt and spends his days, and our dollars, shooting nerf hoops in his office or refining his swing on a nearby Washington golfcourse. While Rome burns...

2008 Nov 14 10:20 AM

[Vox Rationalis:]

Also, remember, they've still got revenue coming in from the 1st gen iPhone deal, where they get a monthly cut from AT&T. That will contribute meningfully to revenue during the first couple of quarters, but not so much thereafter.

"While a moderate to deep recession will undoubtedly affect Apple's business, the natural growth rate and penetration in even a flat economic environment will offset the negative effects of a slowdown. Unless we're talking 10-12% unemployment and 5-6% negative GDP growth throughout 2009, the analyst consensus simply makes no sense."

We are NOT in a flat economic environment. We are in an extraordinarily fearful environment. Until the fear is taken care of, I expect consumer spending will be greatly reduced, which will hit all retailers to some degree. It's possible that the last week or two before Christmas will be gangbusters, if markets stabilize, people feel confident in their jobs, and the media stop reporting the worst possible economic news every...single...day. But I'm inclined to think not. I think nearly all consumer-related companies are going to see an unprecedented drop in sales this quarter, which will basically be a dead loss, since Christmas is a once-per-year event.

As an aside about the media: I watched a thestreet.com video with Arthur (yes the curve guy) Laffer, who basically said that the huge amounts of debt that we're adding to the national balance sheet will be a big drag on future economic growth, which needs to be solved by reduced future government spending rather than tax increases, as Obama described in his campaign. He also said that Obama could change into a more Bill Clinton-like economic President, and said he could turn out to be one of our best Presidents. The headline on the story: "Laffer: Obama will tax us to death."

2008 Nov 14 10:27 AM

[sbrode2:]

FYI:
3 weeks ago I went in to purchase and Mac Laptop, I thought I was entering a restaurant where I had to give my name and advised that I would be served in 20 minutes - the store was packed; I purchased The MacBook Pro.

1 week ago I went in to purchase the keyboard and mouse..same experience - wall to wall people. Apple IS the story of innovation and appeal; they are the economy.

Sacramento, California

2008 Nov 14 04:06 PM

[amsmith:]

AAPL currently has around $30/share in cash. At their current revenue rate, how quickly are they adding to that? Either on a monthly or quarterly basis?

2008 Nov 15 11:54 AM

[mollytjm:]

as usual, Andy, very intelligent article. Thank you. with the way the phone plan works, it'll be 2 years of revenue for Apple from each of us (i bought one recently) but after using it only a week, i realized that people will give up a lot of other things before giving up their iPhones...so i would expect to see those of us who already have one, continue to 'stay with the plan' in the future, maintaining that initial, constant income for Apple. And then there's the entire world of people who still want one. Many find a way.

2008 Nov 15 12:46 PM

[dr.anthony:]

Zaky is THE analyst to watch. He is always ahead of the curve and brings to any problem: intelligence, scholarship and thoughtful analysis. He is a pleasure to read and a real treasure to the investing community.

dr.a

2008 Nov 15 04:40 PM

[reph:]

Traders using purely fundamental analysis always find a reason to catch a falling knife. Do you really think Apple is going back to 170? Or even 120? Give me a break. The borrowed money that pushed it there dried up and like the rest of the market, the risk/reward for shorting AAPL is still better than for going long

2008 Nov 15 09:15 PM

[Andy Zaky:]

Man. You always give me great compliments and kind words. Thank you for that. It makes my day.


On Nov 15 04:40 PM dr. anthony wrote:

> Zaky is THE analyst to watch. He is always ahead of the curve and
> brings to any problem: intelligence, scholarship and thoughtful
> analysis. He is a pleasure to read and a real treasure to the investing
> community.
>
> dr.a

2008 Nov 17 01:22 PM