If Apple (NASDAQ:AAPL) didn't sell another iPhone or an Apple TV for the next two years, it would still recognize well over $292.5 million in revenue each quarter for the next year (Q3, Q4, Q1 & Q2), and roughly $763 million in revenue throughout the second half of fiscal 2009. That's just from the 5.4 million iPhones Apple has already sold as of the end its fiscal second quarter.
The reason? Apple's war-chest holds nearly $1.170 billion in currently deferred revenue and $763 million in non-currently deferred revenue from sales of the iPhone and Apple TV as of the close of its fiscal second quarter. Current deferred revenue, found as a line item on Apple's consolidated schedule of deferred revenue (p. 4), is revenue that Apple will recognize every day for the next 365 days, starting from the date noted on the financial statement—March 29 in this instance. Non-current deferred revenue is revenue that Apple will start to recognize one year after the date stated on the financial statement.
If 5.4 million iPhones can add about a third of a billion dollars in revenue to Apple's income statement each quarter over the next four quarters and add an additional $763 million over the following year, imagine what sales of 10 million iPhones per quarter would do. That's what I set out to demonstrate in this article. The table below delineates how much revenue Apple will actually recognize over the next four quarters as a result of the 5.4 million iPhones it has sold as of the end of its fiscal second quarter:
iPhone Revenue Contribution as of the End of Q2 2008 (in Millions)
click to enlarge images
To fully grasp the potential impact of the iPhone on Apple's future financial results, one must be aware of how Apple recognizes its revenue from iPhone and Apple TV sales. For some reason, analysts seem to overlook explaining this important detail to their readers. Under GAAP accounting, a company normally fully recognizes the revenue associated with the sale of a product, such as an iPod, once the device has reached the end user; or less commonly, when the device has shipped. Yet, due to certain idiosyncrasies with Sarbanes-Oxley (SarBox), Apple is forced to use what is called the subscription method of accounting for recognizing iPhone revenue. Under this accounting method, Apple literally divides each iPhone sale by 730, and recognizes the portions from that particular iPhone each day for exactly two years or 730 days.
To appreciate the impact this has on current revenue recognized, current deferred revenue, and non-current deferred revenue, I offer the following illustration: Suppose Apple sells a 16 GB iPhone on June 25, 20x8 for $500.00. Under the subscription method of accounting, Apple must divide the sale of the iPhone by 730 and recognize the individual proportions over 730 days. Thus, Apple would recognize nearly $0.68 per day for the next 730 days. Since the sale occurred on June 25, 20x8, five days before the close of the 3rd fiscal quarter, Apple would recognize only 5 days of revenue from that sale or nearly $3.42 for the quarter. On June 30, when Apple calculates the current deferred revenue and non-current deferred revenue from that sale, it would multiply $0.68 by 365 days to determine the current deferred revenue and multiply $0.68 by 360 to determine non-current deferred revenue—remember that current deferred revenue is always calculated as 365 days from the date of the financial statement. In this scenario, Apple would have exactly $250.00 in current deferred revenue from the iPhone, which it will recognize equally over the following four fiscal quarters; and $246.58 in non-current deferred revenue, which it will recognize over the 360 days starting on June 30, 20x9. As a side note, Apple recognizes revenue from carrier agreements as received over time.
The Financial Impact of Apple Selling 10 million iPhones per Quarter
The well respected senior analyst Gene Munster of Piper Jaffray has repeatedly projected that Apple will sell nearly 45 million iPhones in fiscal 2009. That is more than 11 million iPhones per quarter over the entire course of the year. Given the fact that Apple has expanded its addressable market for the 3G iPhone four-fold, cut the price of the device in half, and is expected to expand that market quite significantly by the end of 2008, I think that Gene Munster's assessment of the iPhone's reach is well founded. If Apple were able to sell 10 million iPhones per quarter beginning in fiscal Q4, which I don't think is entirely out of the question, it would have a massive impact on Apple's revenue growth. This article will assume, solely for the sake of demonstrating the potential financial impact of the iPhone, that Apple will begin selling 10 million iPhones each quarter starting in fiscal Q4.
Using what one knows about subscription accounting and deferred revenue recognition, one must make certain assumption in order to reasonably calculate the amount of revenue that Apple will recognized from the sale of 10 million iPhones per quarter starting in fiscal Q4. First, in a perfect world, one would know exactly when each of the 10 million iPhones was sold during the quarter. Remember, an iPhone sold at the end of the quarter will have less of an impact on that specific quarter's results than an iPhone sold at the beginning of the period.
Yet, that information is not and will never be available. Thus, no matter how one applies the calculation, the results will always tend to be somewhat inaccurate for Q4, but pretty accurate for all of the following subsequent quarters. In my opinion, the easiest way to calculate the revenue under this scenario is to assume that Apple will sell all 10 million iPhones on the first day of the quarter. Again, doing the calculation this way will tend to yield highly inaccurate results for Q4, but will yield some very precise results for all of the subsequent quarters.
Next, one must determine how much Apple is making in revenue on each iPhone sold. A recent report by Oppenheimer analyst Yair Reiner suggests that AT&T may be paying Apple a $325 subsidy for the iPhone on top of the $199 retail price of the 8GB model and the $299 retail price of the 16GB model. Yet, Apple is likely not getting that much of subsidy world-wide, and thus, it would be a dangerous assumption to base one's calculations on that number. Instead, I think it would be more prudent to rely on earlier reports indicating that Apple is probably getting the industry average of $200 in iPhone subsidies. Under this scenario, one can conservatively assume that Apple will record an ASP of $400 per iPhone sold. Even though Apple might be getting as much as $500 on the 16GB model, it would be safer to take the conservative position of calculating the numbers assuming a $400 ASP in case Apple might not be getting similar subsidies in other parts of the world and with other international carriers.
So assuming that Apple sells all 10 million iPhones the fourth quarter, Apple would post actual non-GAAP based sales of $4 billion. It would recognize about $5.478 million a day for 730 days from those sales alone, and would record nearly $443.8 million in fiscal Q4 based on the 81 days of revenue recognition it enjoyed. Again, I should warn that this is not what would actually happen in Q4, but will be an accurate depiction of the impact that 10 million iPhone sales in Q4 would have in subsequent quarters no matter when those 10 million iPhones are sold during the quarter. Apple would post about $2 billion in deferred revenue-current on its consolidated schedule of deferred revenue as of September 30, 2008—this number is an accurate reflection of 10 million iPhones sold at a $400 ASP. It would also record about $1.556 billion in deferred revenue-non-current on its consolidate schedule of deferred revenue. The table below reflects the cumulative financial impact that sales of 10 million iPhones in Q4 would have on subsequent quarters:
iPhone Revenue Contribution as of the End of Q4 2008 Pro Forma (in Millions)
The results are pretty staggering. If Apple sold 10 million iPhones in Q4 at a $400 ASP, Apple would automatically get to record roughly $800 in revenue each quarter starting in Q1 of 2009, even if it did not sell another iPhone for the rest of the year. While I cannot stress enough that the Q4 number posted in this table is likely inaccurate, Q1-Q3 is an accurate depiction of what Apple would recognize if it sold 10 million iPhones anytime in Q4.
As a matter of fact, that number would be even higher than is indicated in the table as Apple has delayed the recognition of iPhone revenue for all iPhones sold between March 6 and July 11. If Apple were able to sell an additional 10 million iPhones in Q1 as well, then based on the same assumptions and calculations above, it would yield pretty similar results—inaccurate numbers for Q1, but reliable numbers for Q2, Q3, Q4 of 2009 and Q1 of 2010. The table below exhibits the financial impact that the iPhone would have on Apple's results in Q1 2009 – Q4 2009 if Apple sold 10 million iPhones in Q4 and 10 million iPhones in Q1. The calculation is based on the same assumptions made in the Q4 calculations:
iPhone Revenue Contribution as of the End of Q1 2009 Pro Forma (in Millions)
Yet, it would be irresponsible not to point out the obvious and major assumptions of this analysis. First, it's probably unlikely that Apple will start to sell 10 million iPhones a quarter starting in Q4. I wouldn't count out the possibility, but it would be imprudent to suggest that it would be a reasonable expectation for one to anticipate such a large-scale deployment of the device until the first round of research data is published on the issue. Still, I think Wall Street currently underestimates just how big of a financial impact the iPhone could have on Apple's financial results. Apple is obviously not trading based on an anticipation of the analysis outlined above, which indicates 30% revenue growth from the iPhone alone. What the investor and Wall Street should notice is that if Munster happens to be right, it would mean that Apple would report an automatic 30% YoY increase in revenue starting in Q3 2009 even if Apple's other product lines show absolutely no growth whatsoever. With Mac sales growing at an unbelievable pace of 45-50%, and with the iPhone showing the potential of adding 30% in revenue growth, I am absolutely confounded that Apple is not trading at well over $200 share right now—especially with a 22 forward P/E according to my 2009 estimates. But then again: I was shocked to see Apple trade at $50 in July of 2006 and I've been long ever since.
Disclosure: I own long term 2009 and 2010 call options in Apple.