Will Apple Beat 2009 Revenue Consensus?

Nov.14.08 | About: Apple Inc. (AAPL)

Four months ago, the analyst consensus estimate for 2009 had Apple (NASDAQ: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

Click to enlarge


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%)

Click to enlarge


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

-

Click to enlarge