Apple Is Sandbagging More Than You Think

| About: Apple Inc. (AAPL)

Apple (NASDAQ:AAPL) reported quarterly earnings recently which have received a lot of attention. Most of the attention is about missing street estimates and a low EPS number for the next quarter. Apple has a history of projecting very conservatively and then beating their projections. Apple takes the 'under-promise over-deliver' mantra to a level you just don't see in many other companies. One place that this shows up is on the balance sheet.

There are 2 lines that don't get much attention in the press or blogosphere but show just how conservative the company is: deferred revenue and other non-current liabilities.

September 29, 2012 September 24, 2011

Deferred revenue

5,953 4,091

Other non-current liabilities

16,664 10,100

Deferred Revenue

The first is deferred revenue, which for Apple is a portion of all the revenue they make selling devices they set aside in case of things like warranty repair. They then bring that money back over the following quarters. If Apple was a slow growing company this would have negligible impact on the reported earnings. However, given Apple's 60%+ historical growth rate (73% according to yahoo finance) and its projected 20% growth rate, Apple gets much more of its revenue in the next quarter/year than it did in the quarter/year before.

This effectively dilutes that revenue. If it had been recognized in the current quarter it would have lowered the P/E. Since it is recognized in a future quarter and the earnings are already substantially higher, the recognition of the previously deferred revenue hardly moves the needle.

This artificially lowers the earnings of the company. Fictional example below:

Company A
Y1 Y2 Y3 Y4
Revenue $10 $12 $14 $16
Expenses ($5) ($6) ($7) ($8)
Earnings $5 $6 $7 $8
Company B
Y1 Y2 Y3 Y4
Revenue $10 $12 $14 $16

Previous Rev

$.8 $1 $1.2 $1.4
Expenses ($5) ($6) ($7) ($8)
Deferred Rev ($1) ($1.2) ($1.4) $1.6
Earnings $4.8 $5.8 $6.8 $7.8

As you can see from the example above, these 2 companies are identical except that Company A appears (at first glance) to be earning more than Company B. This effect is not huge but it does exist for Apple, and it would have earned an extra $1.9 billion dollars if it did not defer revenues this year.

This effect pales in comparison to the other liability on the balance sheet.

Other Non-Current Liabilities

Other Non-Current Liabilities are any liabilities that Apple does not anticipate reconciling within the next year. The vast majority of this item on the balance sheet is money set aside to pay US corporate income tax on foreign earnings. Apple has stated on a number of occasions they do not intend to bring foreign earned money back into the US at the current 35% tax rate. They are, however, setting money aside as if they intended to do so.

In 2011 this account was $10 billion.

In 2012 this account was $16.6 billion.

Change in account +$6.6 billion.

The reported earnings for 2012 are $41.7 billion.

If Apple reported as if they were not planning on bring that money back to the US, earnings would have been $48.3 billion. This would mean a 15% increase in earnings just by changing the accounting practices.

In addition, this would have made the current EPS $51 vs $44, and the P/E as of writing would be 11.8 vs 13.7.

Overall, Apple is a pleasant surprise and a good buy even before you realize how much they are sandbagging the actual performance of the company. Based on information from the balance sheets, cash flow statements, and operations statements they seem to be performing even better than their P/E may originally suggest and could be reporting much higher earnings. If the US were to implement some sort of repatriation holiday or lowered rate it would instantly make Apple realize some or all of that $16.6 billion as actual profits.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.