Apple's Deferred Revenues Revisited: This Was a Blow-Out Quarter 19 comments
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This quarter, Apple's (AAPL) earnings failed to impress investors (see conference call transcript). Wall Street promptly hurled it off a cliff...
But, wait. What if I told you that Apple forgot to enter 2 of the 2.3 million phones it sold this quarter, that they just skipped them, took the dough, are using it and just left it plain - well- out of the net income? Well, they did. They "deferred" them.
Apple's earnings are far more impressive when you consider that their iPhone and iTV numbers are largely not entered in when they are sold. Rather, Apple stretches the revenues out over a two year period, only entering 1/8 of them each quarter. They have been doing this for a while with Applecare, a product which makes sense to add to net income slowly over time as it is a two to three year service that incurs cost over time. iPhones and iTVs, however are already purchased; the cost of making and selling them is largely over.
Apple instead spreads out their earnings excruciatingly slowly. Only a small fraction of the earnings of the 2.3 million iPhones sold this quarter get seen as earnings on the quarterly statement. The rest are part of the "deferred revenues". In all practical terms, there is nothing deferred about them. The moneys have been received by Apple.
Below are listed the phenomenal growth of these hidden babies over the last series of quarters (click table to enlarge):
This means that over the next two years, most of 3.288 billion dollars of deferred revenues will drop effortlessly to the bottom line. If Apple decided, quite legitimately, it could have taken those 816 million dollars as earnings this last quarter. Instead of 1.58 billion dollars, it easily could have logged 1.58 + 0.816, or 2.396 billion dollars, or about $2.65 a share. If they had reported that number -- $2.65 a share -- which is real net income earned, the stock price would be up to 230 rather than dropping to 130. The earnings are there. They are real. They will be logged in over the next 7 quarters. The street needs to understand that Apple is reporting their earnings differently than most other companies and by doing so their explosive growth is vastly understated. There is nothing disappointing about this quarter. Au contraire, it is a blow-out, beyond anything Apple has yet produced and, as this keeps happening, as the deferreds keep accruing, it's going to be a beautiful next couple of years.
Disclosure: Author has a long position in AAPL
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This article has 19 comments:
What does make sense, however, is to add iPhone revenues and units to the iPod numbers since it is really an extension of the same business.
Also missed, however, is that each of these phones that isn't unlocked generates cost-free revenue to Apple every month in revenue sharing.
Frankly Apple is at a major transition point as its ipod business goes from toy to serious platform. The street is clueless.. so clueless that we should just let 'em sell and get short. It's just like 2 years ago. Except 2 years ago, you had to have faith to see the continued growth. Now, to those of us who have noticed that iPhone/iPod touch are both iPods and OSX platforms, the source of that growth is obvious.
The Street is clueless, and given Apple's seasonality it may take until September until Apple generates such revenues, earnings, and cash flow that they'll have to come out of denial.
So, what the hell, let 'em drive the stock down to $90. Selling at $250 is a lot more profitable if you bought at $90 vs. $190.
Let every clueless doubter have his day.
Pay no attention to that $21/share in CASH... go short old men!
You state '... most of 3.288 billion dollars of deferred revenues will drop effortlessly to the bottom line'. Well, the 'bottom line' is Net Income, and the definition of Net Income is Income minus Cost of Goods Sold, Expenses, any Losses and Taxes. Seems like the Deferred Revenue needs to run through those filters, which would mean that NET Deferred Revenue is only a fraction of that figure.
Or am I just getting my accounting wrong here.
Thanks
Let's say that Apple meets its goal of 10M units by years end. And let's say that we are getting $8/month per unit from the carriers = $100/year. If 20% are unlocked that leaves 8M in the system.
or $800M - with NO costs - per year income. That is $1 / share as a base - without selling a dog-gone thing!
The software development costs to maintain existing iPhones is currently also being done to make new iPhones more attractive. So you could argue that the software development could be expensed against the revenues from future iPhones, or from the royalty payments from AT&T for its exclusive sale of iPhones.
If you think about it, to support this deferred revenue model, the profit on an individual iPhone or even AppleTV has to be phenomenal ... otherwise they would show a loss on the phone by selling below cost in the first year and then making up the deferred revenues in subsequent years.
D
I am NOT an accountant. But I believe you are wrong about how the costs show up. Any real accountants out there - please correct me if I am wrong!
REAL costs (layman's idea) occur when you (Apple) write a check to the factory for factory for making the iPhone. If, however, a part of that cost is deferred, then - just like the revenue - it will not show up on income statements until "realized." (made real??)
Both, however will show up on a balance sheet as deferred costs/income.
The point is that the costs are also deferred so that John T and 2old2run are correct - except 2old, I don't think corporate tax rates are anywhere near 35%, I think only 10%. So that would bring us back up to roughly $1B.
This article is correct except that when revenue is accrued, the tax expenses are not recognized until the revenue is recognized. As the corporate tax rate will never exceed 35%, you can expect that about 65% of the deferred revenue will directly hit the bottom line. Not quite as much as stated previously, but still a lot more than people are recognizing.
Like the article says, it is going to be beautiful.
And, to the point most are concerned with, Apple is capitalizing expenses like R&D as they incur, while deferring COGS with revenues. Is there a deferred COGS number in the 10Q?
Third, I'd point out why the first point is so important. Some people, like myself, went into an Apple Store over Xmas to choose a new iPod. That choice became one between a Classic, a Touch or an iPhone. Remember Steve Jobs called the iPhone the "best iPod ever". I bought the iPhone, and put my old nano in the drawer. The difference being if I had bought a Touch or a Classic, all of the revenue for those purchases would have hit Apple's top line. With the iPhone, only a fraction, 1/8th, of the money I spent hit the top line. My little decision on my iPod replacement, is treated quite differently by Apple's financial report. How many other people consolidated their iPod purchase with a cell phone purchase? That's why the deferred figure is important in truly comparing Apples to Apples. Apple had a blowout quarter and no one seems to know it.
This article is correct except that when revenue is accrued, the tax expenses are not recognized until the revenue is recognized. As the corporate tax rate will never exceed 35%, you can expect that about 65% of the deferred revenue will directly hit the bottom line. Not quite as much as stated previously, but still a lot more than people are recognizing.
Like the article says, it is going to be beautiful.
"over the next two years, most of 3.288 billion dollars of deferred revenues will drop effortlessly to the bottom line."
1) 3.288 is revenue NOT net income, thus not all will drop to the bottom line. Cost of goods sold must be subtracted. Some estimates have been $150-250 per iPhone. In addition, advertising costs be subtracted as they occur and tax expense also.
I would assume only 30-40% of the 1.4 billion of iPhone deferred revenue will drop tp the bottom line.
The article states 3.2 billion addition in net income, which is inflated. Also, only 1.4B of that figure is iPhone deferred revenue.
2) Not all the deferred revenue will be recognized over a two year period. AppleCare can be as long as 3-year period. "Other" current deferred revenue is probably 1 year subscription products like ".Mac" as well as sales of hardware in shipment that Apple still retains risk of loss on. These items are not net of cost either. Thus, for non-iPhone revenue, expenses must be subtracted in order to get net income.
Out of the 3.28B deferred revenue, I would guess only 1 billion will be added to earnings.
Everybody knows Apple gets no credit in the plus column for these revenues whatsoever...
Analysts simply can't wrap their heads around this revenue stream, or company, for that matter...
And yet their 'pronouncements' can wash away billions in market cap overnight.
Go figure.
Buy Apple!
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