Apple now sitting on $10B in deferred revenue, more than Samsung or Google earned last quarter

Posted:
in iPhone edited January 2014
Apple reported net earnings of $7.5 billion for the quarter ending in September, but it also amassed more than $10 billion in deferred revenues that it hasn't yet declared as income.

AAPL deferred revenues


Apple's deferred revenues began rapidly building when the company initiated "subscription accounting" in 2007 with the release of the original iPhone, a practice that set aside a portion of new income that the company did not officially, immediately recognize it in its earnings reports, even though the company had collected the money.

Instead, Apple incrementally recognized a fraction of that deferred revenue each quarter over a two year period. The practice was designed to ensure that revenue wasn't counted ahead of delivering a full product, because in Apple's accounting, the iPhone wasn't finished until two years of software updates had been provided to the end user. Incredibly, none of Apple's critics in the tech media, or even in mainstream financial reporting circles, seems to realize this pool of billions even exists

Apple maintained the same delayed accounting for Apple TV, and later added similar accounting for iPad and Mac sales, explaining that with such subscription accounting in place, it could legally distribute updates and new features over the two or four year lifespan of new products without needing to charge even a nominal fee for the updates.

Apple's deferred revenues also include high margin sales of support contracts such as AppleCare, which are sold upfront and recognized as income over time as they expire, as well as gift cards for iTunes and the App Store that hold credits that have not yet been spent. Apple splits its deferred revenues into current (amounts it will recognize over the next 365 days) and non-current (deferred for longer than one year).

Apple has now amassed a rapidly growing pile of deferred revenue that is unlike any of its peers, and far greater than the recently released quarterly earnings of Microsoft, Samsung, or Google. Incredibly, none of Apple's critics in the tech media, or even in mainstream financial reporting circles, seems to realize this pool of billions even exists.

Windows 8.1 is not an upgrade

Microsoft, for example, has temporarily reported deferred revenues related to pre-sales of Windows, simply because it offers some PC buyers the right to download new software in the future once it becomes available. In the last quarter this only involved $113 million related to Windows 8.1. A year ago, Microsoft reported global pre-sales for both Windows 8 and a new version of Office, and the combined total was $1.3 billion.

As Microsoft explains in its quarterly report, "Software updates are evaluated on a case-by-case basis to determine whether they meet the definition of an upgrade, which may require revenue to be deferred and recognized when the upgrade is delivered [...] If updates are determined to not meet the definition of an upgrade, revenue is generally recognized as products are shipped or made available.""We evaluated Windows 8.1 and determined that it did not meet the definition of an upgrade" - Microsoft

Additionally, rather than holding that deferred revenue over years of incremental recognition, as Apple does with its iOS and OS X products, Microsoft simply delayed its revenue until it actually delivered the software to its users. "Windows 8.1 will enable new hardware, further the integration with other Microsoft services and address customer issues with Windows 8, and will be provided to Windows 8 customers when available at no additional charge," the company stated.

"We evaluated Windows 8.1 and determined that it did not meet the definition of an upgrade and thus have not deferred revenue related to this update. Windows 8.1 revenue was deferred for pre-sales of Windows 8.1 to original equipment manufacturers and retailers before general availability."

Android does not get updates

In the mobile world, nobody seems to be deferring revenue like Apple, in part apparently because nobody updates end users' software the way Apple does. Google's combined statements including Motorola only point to $907 million in deferred revenue, a figure up just $17 million over the past year. Google doesn't detail in its 10-Q what this deferred revenue includes.

In contrast, Apple's deferred revenue increased by $1.48 billion over the year ago quarter, and next quarter Apple said it will not only continue to grow, but grow at a faster rate: an estimated $900 million in additional deferred revenue, due to its increasing the amount it will defer for iOS, OS X and new iLife and iWork apps now being offered for free.

iLife


That indicates that by the end of calendar 2013, Apple will be sitting on around $11.3 billion in deferred revenue. That's essentially pure profit, because it's scraped off the top of reported revenue before reporting the earnings that are already leading the PC and mobile industries. Apple is earning more than everyone else by a huge margin, and it's not even needing to count all of its revenue at the time of sale in order to do so.

Investors looking at Apple's performance are therefore comparing earnings numbers that are misleadingly low, by billions of dollars. It's no secret that Apple is more profitable that all of its peers by a huge margin. But Apple actually makes even more than is publicly considered by pundits and analysts who only look at surface numbers.

Bloomberg does not get Apple

Illustrating the media's confusion, Adam Satariano, writing for Bloomberg, issued a report under the completely false headline, "Apple Forecasting Slower Holiday Sales Amid Samsung Gains."

Apple did not forecast slower holiday sales.

Instead, it outlined slower year over year growth, but guided for "faster" quarterly sales than in previous years (as Satariano acknowledged in his story), on top of the fact that it will be deferring recognition of over $1 billion of its income in the quarter, around $900 million more than usual.

In a Bloomberg video (below) titled "Margins Mystery Revealed," John Erlichman doesn't reveal any actual mystery, instead telling the story of "other players that are trying to gear up for strong holiday sales" against the iPad.

Samsung and other firms have been "trying to gear up" against the iPad since it appeared in 2010, but Samsung's tablet and PC business continues to make roughly a tenth of Apple's non-phone earnings, even with the deferred revenues delaying a portion of Apple's take from being reported each quarter.

Pressed to address Apple's margins, Erlichman said the takeaway from Apple's conference call was, "had they not done some of these accounting things, those margins would have been higher overall," further noting in passing, "this is a company that is still generating huge piles of cash."



In his thirteenth paragraph, after detailing Strategy Analytics' data on Apple's perilously small share of the global markets for smartphones and tablets, Satariano also added that Apple's "Chief Financial Officer Peter Oppenheimer said margins would have been better, if not for a new accounting method Apple is using for software."

The story makes no mention of the fact that Apple's "accounting things" now involves more money than Samsung's entire smartphone, PC, netbook and tablet operations reported in the past quarter.
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Comments

  • Reply 1 of 80
    Amazing, yet the market treats it as if it's going out of business.
  • Reply 2 of 80
    It's incorrect to say that the deferred revenue is pure profit. The deferred revenue has to offset the development costs which are amortized over the life of the products.

    If you assume Apple's software margins are 50%, then only 50% of the deferred OS X revenue, for example, will become profit. The most of the rest will go to capitalized costs, mainly programmer's salaries.
  • Reply 3 of 80
    Quote:
    Originally Posted by sog35 View Post

     

    So basically $7.4 Billion in revenue will occur without Apple selling a single thing for the next 4 quarters.


     

    Not exactly true. If they now defer $100 for software, and they didn't raise the price of Macs $100, the total revenue is the same. They just lost $7.4 billion of revenue in the current quarter, to be made up over the next year.

  • Reply 4 of 80
    just_mejust_me Posts: 590member
    Quote:

    Originally Posted by Caligula66 View Post



    Amazing, yet the market treats it as if it's going out of business.

    Only in people in this forum does.

     

    Everyone knows apple is here to stay one way or another.

  • Reply 5 of 80
    just_mejust_me Posts: 590member
    Quote:

    Originally Posted by konqerror View Post



    It's incorrect to say that the deferred revenue is pure profit. The deferred revenue has to offset the development costs which are amortized over the life of the products.



    If you assume Apple's software margins are 50%, then only 50% of the deferred OS X revenue, for example, will become profit. The most of the rest will go to capitalized costs, mainly programmer's salaries.

     

    This.

     

    But its a DED "feature" lol

  • Reply 6 of 80
    Quote:

    Originally Posted by konqerror View Post



    It's incorrect to say that the deferred revenue is pure profit. The deferred revenue has to offset the development costs which are amortized over the life of the products.



    If you assume Apple's software margins are 50%, then only 50% of the deferred OS X revenue, for example, will become profit. The most of the rest will go to capitalized costs, mainly programmer's salaries.

     

    But the costs are not deferred along with revenues. So those costs are accounted for now, and the profit is recognized over time, and as it is recognized, new costs do not appear. So the deferred revenue is pure gravy once it’s recognized. 

  • Reply 7 of 80
    Quote:

    Originally Posted by konqerror View Post

     

     

    Not exactly true. If they now defer $100 for software, and they didn't raise the price of Macs $100, the total revenue is the same. They just lost $7.4 billion of revenue in the current quarter, to be made up over the next year.


     

    Yes that is the point. If Apple recognized all this income at sale (like everyone else) it would have reported billions more each quarter over the past year. It’s just a reserve of billions waiting to be counted as part of future revenue.

  • Reply 8 of 80
    Quote:

    Originally Posted by AppleInsider View Post

     Incredibly, none of Apple's critics in the tech media, or even in mainstream financial reporting circles, seems to realize this pool of billions even exists

     

    Perhaps because they understand GAAP much better than you and what deferred revenue is and the intricacies involved with it. It's absolutely not straight profit sitting around, there is a reason it is deferred. A warmed over approach to explain the topic fails the non-financial reader on multiple levels. There are significant $$ reasons Apple uses this method to report earnings.

  • Reply 9 of 80
    Quote:

    Originally Posted by Corrections View Post

     

     

    But the costs are not deferred along with revenues. So those costs are accounted for now, and the profit is recognized over time, and as it is recognized, new costs do not appear. So the deferred revenue is pure gravy once it’s recognized. 


     

    Um, matching accrued expenses are where then? Yikes.

  • Reply 10 of 80
    Quote:

    Originally Posted by Corrections View Post

     

     

    But the costs are not deferred along with revenues. So those costs are accounted for now, and the profit is recognized over time, and as it is recognized, new costs do not appear. So the deferred revenue is pure gravy once it’s recognized. 


     

    That's not correct. You capitalize software development costs.

     

    http://www.fasb.org/summary/stsum86.shtml

    Quote:


     This Statement specifies that costs incurred internally in creating a computer software product shall be charged to expense when incurred as research and development until technological feasibility has been established for the product. Technological feasibility is established upon completion of a detail program design or, in its absence, completion of a working model. Thereafter, all software production costs shall be capitalized and subsequently reported at the lower of unamortized cost or net realizable value. Capitalized costs are amortized based on current and future revenue for each product with an annual minimum equal to the straight-line amortization over the remaining estimated economic life of the product.


  • Reply 11 of 80
    Quote:

    Originally Posted by konqerror View Post

     

     

    That's not correct. You capitalize software development costs.

     

    http://www.fasb.org/summary/stsum86.shtml


     

    That’s irrelevant, it would be done that way regardless. Google and Microsoft capitalize their development costs. They just don’t ALSO have $10 billion in deferred revenue waiting to be recognized. 

  • Reply 12 of 80
    Quote:
    Originally Posted by Corrections View Post

     

     

    That’s irrelevant, it would be done that way regardless. Google and Microsoft capitalize their development costs. They just don’t ALSO have $10 billion in deferred revenue waiting to be recognized. 


     

    You completely miss the point and are going in circular arguments. At best, deferred revenue is neutral. They make the same amount of money, just made later. On the other hand, this is likely a negative overall impact: they lost the income from selling OS X, iWork etc. while they can't jack up the price of the hardware to account completely for this (people don't account for the benefits, and many people, like businesses, didn't want iWork to begin with).

     

    I understand that you are saying that there is some certainty, the costs and the revenue are already known for the next 4 quarters. That's not worth nearly as much to stockholders as $7 billion in new revenue, which many people think this implies. And given that their software revenue is something like 10%, it hardly offsets volatility in iPhone and iPad sales.

  • Reply 13 of 80
    Quote:

    Originally Posted by konqerror View Post

     

     

    You completely miss the point and are going in circular arguments. At best, deferred revenue is neutral. They make the same amount of money, just made later. On the other hand, this is likely a negative overall impact: they lost the income from selling OS X, iWork etc. while they can't jack up the price of the hardware to account completely for this (people don't account for the benefits, and many people, like businesses, didn't want iWork to begin with).


     

    Of course it’s neutral. And duh its the same amount later. The point is that Apple is compared against other firms by its reported revenue. As sales increase (and iPhones are up 26%), that’s an increasing amount that’s not being counted. 



    And of course Apple is "making less" by giving away its software. But some of that software wasn’t going to be sold otherwise, and the profit margins on digital copies of apps is rather high. It’s not like Apple is bundling a licensed copy of MS Office on new Macs.  

  • Reply 14 of 80
    malaxmalax Posts: 1,598member

    Also, for readers who haven't taken an accounting class, this article should not be read as suggesting that in the future $10 billion in cash will magically appear.  Apple has already received all the money they are going to get from current sales (hence their cash stockpile grows and grows).  This just means that in future quarters and years, Apple's reported revenue will be higher (as they recognized revenue for the cash they have already received).  As a practical matter the most important part of this is that Apple has taken advantage of another (perfectly legal and ethical) strategy to reduce or defer taxes (they don't have to pay taxes on revenue until they recognize it, and it almost always better to defer taxes if you can).

     

    Hopefully analysts factor this into their arcane calculations, but who knows how that will turn out.  I wouldn't be surprised if we start hearing reports in the future that downplay Apple revenue numbers because billions of those dollars occurred in the past.

  • Reply 15 of 80
    malaxmalax Posts: 1,598member
    Quote:

    Originally Posted by sog35 View Post

     

    So basically if Apple didn't change their accounting method they would have $10B more in profits the last year........

     

    I really don't see why they need to defer revenue for hardware for 2 years.  This a really conservative method.




    It's a nice tax-deferral strategy.

  • Reply 16 of 80
    maestro64maestro64 Posts: 4,678member
    Quote:
    Originally Posted by sog35 View Post

     

    Current liabilites will be off the books within a year.

     

    So basically $7.4 Billion in revenue will occur without Apple selling a single thing for the next 4 quarters.


    Actually think about this way, after Dec 31 of 2013 Apple stop selling and did nothing, over the next 8 quarter it will show on the official books it generated $11.3B.

  • Reply 17 of 80
    maestro64maestro64 Posts: 4,678member
    Quote:
    Originally Posted by konqerror View Post



    It's incorrect to say that the deferred revenue is pure profit. The deferred revenue has to offset the development costs which are amortized over the life of the products.



    If you assume Apple's software margins are 50%, then only 50% of the deferred OS X revenue, for example, will become profit. The most of the rest will go to capitalized costs, mainly programmer's salaries.

     

    Quote:
    Originally Posted by konqerror View Post

     

     

    Not exactly true. If they now defer $100 for software, and they didn't raise the price of Macs $100, the total revenue is the same. They just lost $7.4 billion of revenue in the current quarter, to be made up over the next year.


    I am not saying you are wrong since I do not read Apple's 10K in that depth. Apple could be accounting R&D expenditure as they happen not amortizing them over time. I suspect they accounting for them as they happen, reason being the accounting of R&D activity would be too difficult to say this activity was specific to this product at this specific time. I work in R&D organizations who have done it both ways and to amortizing it we had to report our work each week and say exactly what we were working on hour by hour. I can guaranty you Apple is not doing this level of accounting with each engineer.

  • Reply 18 of 80
    Quote:
    Originally Posted by konqerror View Post

     

     

    You completely miss the point and are going in circular arguments. At best, deferred revenue is neutral. They make the same amount of money, just made later. On the other hand, this is likely a negative overall impact: they lost the income from selling OS X, iWork etc. while they can't jack up the price of the hardware to account completely for this (people don't account for the benefits, and many people, like businesses, didn't want iWork to begin with).

     

    I understand that you are saying that there is some certainty, the costs and the revenue are already known for the next 4 quarters. That's not worth nearly as much to stockholders as $7 billion in new revenue, which many people think this implies. And given that their software revenue is something like 10%, it hardly offsets volatility in iPhone and iPad sales.


     

    IMO, this strategy from Apple is very clever. Better to report the costs stemming from software development to minimize the tax impact of the incoming massive profits.

  • Reply 19 of 80
    Quote:

    Originally Posted by sog35 View Post

     

    So basically if Apple didn't change their accounting method they would have $10B more in profits the last year........

     

    I really don't see why they need to defer revenue for hardware for 2 years.  This a really conservative method.




    They are just following GAAP rules which are mandatory. At one point they reported both GAAP and non-GAAP results when iphone revenues became too big.

     

    The problem is that those rules are there for a good reason, without them ENRON creative accounting practices were such that they bore no relation to reality.

     

    GAAP rules make sure it cant be the case, but in the specific case of Apple underestimate results by a big margin because the deferred portion of the revenues grow very fast.

    In the more general case, the revenues newly acknowledged from 2 years ago cancel the deferred portion now, and the results are roughly the same. There is some taxes implications too, but those are favorable to Apple (the deferred portion is taxed only when recognised).

     

    the big difference with Google, Microsoft & HP is that Apple make both hardware and software and dont/cant separate the lines of revenues. This rule seems to work for hardware only or software only but is a bit ridiculous here

  • Reply 20 of 80
    maestro64maestro64 Posts: 4,678member
    Quote:
    Originally Posted by malax View Post

     

    Also, for readers who haven't taken an accounting class, this article should not be read as suggesting that in the future $10 billion in cash will magically appear.  Apple has already received all the money they are going to get from current sales (hence their cash stockpile grows and grows).  This just means that in future quarters and years, Apple's reported revenue will be higher (as they recognized revenue for the cash they have already received).  As a practical matter the most important part of this is that Apple has taken advantage of another (perfectly legal and ethical) strategy to reduce or defer taxes (they don't have to pay taxes on revenue until they recognize it, and it almost always better to defer taxes if you can).

     

    Hopefully analysts factor this into their arcane calculations, but who knows how that will turn out.  I wouldn't be surprised if we start hearing reports in the future that downplay Apple revenue numbers because billions of those dollars occurred in the past.


    To make it very simple for people Apple already has this money in the bank account and collecting interest on this before they have to declare it as revenue for reporting purposes. The only thing I am not sure is whether Apple can defer the taxes on this as someone suggest. My educated guess tells me no, they are already accounting this for tax purposes.

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