Apple's Extra Billion in Deferred Revenues

Apple's (AAPL) earnings at first glance look great, a 57% rise over last year's quarter. However, if you look more closely, the numbers get even more impressive. AAPL has a huge stream of revenues that it doesn't add into the quarter's numbers. These are its deferred revenues. Deferred revenues represent money actually received but not officially booked, because more services may be required by the company to the customer. APPL has recently decided to make a large amount of its sales--iPhones, iTV, Applecare-- go to deferred revenues. So when AAPL sells its iPhones, iTVs and Apple care, it only books a small portion of the revenues in the quarter sold. The company reasons that customers may require other services on these products such as free software upgrades. AAPL sets a two year period over which these products are incrementally added to its balance sheet. Remember the costs of iPhones and iTVs have already been largely incurred.

The street looks at the quarter's numbers and sees 1.58 billion dollars of earnings and 9.6 billion dollars of revenues. What it doesn't see are the deferred revenues, real money already paid. And these are truly juicy. This quarter, AAPL did 1 billion dollars of deferred revenue, money that will be gradually added in quarter after quarter over a 2 year period. You can see that in its cash flow report. That's why its operating cash flow is so high at 2.787 billion, almost twice the net income. This hidden revenue stream has largely been paid. And, as long as iPhones and iTVs are being sold, deferred revenue will be a huge factor, one that must not go unnoticed.

Comments

[drummerjoe:]

What's an iTV?

2008 Jan 24 10:33 AM

[Consider:]

Sure, that's great, but aren't "Deferred Revenues" set forth on the income statement, not "incrementally added to its balance sheet"?

Not disputing your observation, but if you're gonna put it out there on Seeking Alpha, at least get the basic accounting right!

2008 Jan 24 11:08 AM

[kfc:]

The drop in price was due to the lower than expected growth forecast, the amortization of this deferred revenue is included in that forecast which would mean the sales growth is even smaller. Apple is a great company but the reason that its price with a high P/E is that the market expects it to grow significantly every quarter else its P/E should be similar to GE or Coke.

2008 Jan 24 11:39 AM

[topchat:]

Could today's decline in share price be a wrong reading of rumors of scaled down orders by Apple for the iPhone? Could it just as well signal Apple starting the process to ramp up a 3G version of the iPhone? Now what would this do for Apple's fortunes?

2008 Jan 24 11:49 AM

[noibs:]

FYI--Deferred Revenues (aka Unearned Revenue) is presented as a LIABILITY in balance sheets. Apple hides this a bit by including the total of Deferred Revenue in Accrued Expenses (for the current portion) and Noncurrent Liabilities (for the noncurrent potion). Given the fairly large dollar amount of Deferred Revenue, I would argue that it deserves a separate line in the liability section of their balance sheets.

Unfortunately, you cannot figure this out from the quarterly financial statements. If you download Apple's last 10K report to the SEC, Footnote 1 includes their basic revenue recognition policies under current accounting rules, and Footnote 3 shows the inclusion of Deferred Revenues in both Accrued Expenses and Noncurrent Liabilities.

Apple is not doing this because it want to be conservative or for any other reason that it must do this under current accounting provisions. Previously, there has been a fair amount of abuse in this area by many hardware and software sellers.

For example, if I sell you some hardware, with included software, for $X, and if I promise to provide you with free software upgrades for a certain period of time, then I won't fully earn (in an accounting sense) the $X until I have provided all the services I am promising in exchange for getting your cash now. I can recognize a large portion of the $X now--but some of that must be deferred until I have provided you with free software.

2008 Jan 24 01:17 PM

[KenC:]

@kfc, yes, future deferred rev is included in the forecast, but of course, those deferred revs incurred in Q2 will be deferred as well. Not until 2 years have passed, will Apple catch up so that deferred revs will approximate currently recognized revs. Right now, Apple booked $10.5B in revs, but only recognized $9.6B. Next quarter they guide to $6B in revs, but will actually book something closer to $7B, since about $1B will be deferred. The question is whether the market is fully understanding this, or is it only looking at topline figs.

2008 Jan 24 01:46 PM