The hidden financial impact of Apple's iPhone

Posted:
in General Discussion edited January 2014
If Apple 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.Â* That's just from the 5.4 million iPhones Apple has already sold as of the end its fiscal second quarter.



The reason?Â* 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.Â* 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 statementÂ?March 29 in this instance.Â* Non-current deferred revenue is revenue that Apple will start to recognize one year after the date stated on the financial statement.Â* 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.Â* That's what I set out to demonstrate in this article.Â* 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:







The Subscription Method of Accounting




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.Â* For some reason, analysts seem to overlook explaining this important detail to their readers.Â* 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.Â* 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.Â* 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:Â* Suppose Apple sells a 16 GB iPhone on June 25, 20x8 for $500.00.Â* Under the subscription method of accounting, Apple must divide the sale of the iPhone by 730 and recognize the individual proportions over 730 days.Â* Thus, Apple would recognize nearly $0.68 per day for the next 730 days.Â* 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.Â* 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 revenueÂ?remember that current deferred revenue is always calculated as 365 days from the date of the financial statement.Â* 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.Â* 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.Â* That is more than 11 million iPhones per quarter over the entire course of the year.Â* 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.Â* 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.Â* 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.Â*



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.Â* First, in a perfect world, one would know exactly when each of the 10 million iPhones was sold during the quarter.Â* 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.Â* Yet, that information is not and will never be available.Â* 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.Â* 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.Â* 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. Â*Â*Â*Â*



Next, one must determine how much Apple is making in revenue on each iPhone sold.Â* 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.Â* 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.Â* 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.Â* Under this scenario, one can conservatively assume that Apple will record an ASP (average selling price) of $400 per iPhone sold.Â* 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.Â*



So if Apple were to sell all 10 million iPhones on the first day Q4, Apple would post actual non-GAAP based sales of $4 billion.Â* 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.Â* 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.Â* Apple would post about $2 billion in deferred revenue-current on its consolidated schedule of deferred revenue as of September 30, 2008Â?this number is an accurate reflection of 10 million iPhones sold at a $400 ASP.Â* It would also record about $1.556 billion in deferred revenue-non-current on its consolidate schedule of deferred revenue.Â* The table below reflects the cumulative financial impact that sales of 10 million iPhones in Q4 would have on subsequent quarters:







The results are pretty staggering.Â* 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.Â* 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.Â* As a matter of fact, that number would be even higher than is indicated on the chart as Apple has delayed the recognition of iPhone revenue for all iPhones sold between March 6 and July 11.Â* 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 resultsÂ?inaccurate numbers for Q1, but reliable numbers for Q2, Q3, Q4 of 2009 and Q1 of 2010.Â* The table below exhibits the financial impact that the iPhone would have on Apple's results in Q1 2009 Â? Q4 2009 if Apple sold 10 million iPhones in Q4 and 10 million iPhones in Q1.Â* The calculation is based on the same assumptions made in the Q4 calculations:








By now, one should be able appreciate how the revenue would really starts to pile up if Apple started selling 10 million iPhones a quarter at a $400 average selling price.Â* The point of this article is to give a ballpark idea of the potential impact the iPhone could have on Apple's financial health.Â* Munster believes that Apple could sell as many as 45 million iPhones in fiscal 2009.Â* At 20 million iPhones, Apple begins to approach the amount of revenue it recognize from iPod revenue in the typical quarter.Â* For example, last quarter Apple recognized nearly $1.818 billion in revenue from iPod sales and is expected to recognize about $1.817 billion this quarter.Â* If Apple does sell 45 million iPhones in 2009, it will easily eclipse the amount of revenue it recognizes from iPod sales by close to 30-40%.Â* In fiscal Q2, the iPhone only contributed $378 million, or roughly 5%, of Apple's total revenue.Â* At a sales pace of 10 million iPhones a quarter, that number can easily quadruple by the end of Q2 2009.Â* Moreover, the numbers posted in the chart above do not even contemplate sales from AppleTV which is also included in the deferred revenue line items along with the iPhone.



Yet, it would be irresponsible not to point out the obvious and major assumptions of this analysis.Â* First, it's probably unlikely that Apple will start to sell 10 million iPhones a quarter starting in Q4.Â* I wouldn't count out that 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.Â* Still, I think Wall Street currently underestimates just how big of a financial impact the iPhone could have on Apple's financial results.Â* Apple is obviously not trading based on an anticipation of the analysis outlined above, which indicates 30% revenue growth from the iPhone alone.Â* 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.Â* 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 nowÂ?especially with 22 forward P/E according to my 2009 estimates.Â* But then again: I was shocked to see Apple trade at $50 in July of 2006 and I've been long ever since.



Andy Zaky is an AppleInsider contributor and the founder and author of Bullish Cross, an online publication that provides in-depth analysis of Apple's financial health.



Disclosure: Andy owns long term 2009 and 2010 call options in Apple. The information contained in this post is not to be taken as either an investment or trading recommendation, and serious traders or investors should consult with their own professional financial advisors before acting on any thoughts expressed in this publication.
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Comments

  • Reply 1 of 78
    MacProMacPro Posts: 17,155member
    Thank you for that article. It is fascinating and makes me feel warm and fuzzy about my AAPL holdings
  • Reply 2 of 78
    Quote:

    Andy owns long term 2009 and 2010 call options in Apple.



    This is called : putting your money where your mouth is.
  • Reply 3 of 78
    This is a truly nicely done piece of financial reporting, AI!



    But, before we all get excited about this: my 2¢ is that the effect of the deferred revenue has already been factored into the stock price.

    \
  • Reply 4 of 78
    jasonfjjasonfj Posts: 530member
    Quote:
    Originally Posted by OlivierL View Post


    This is called : putting your money where your mouth is.



    or: putting your mouth where you money is.
  • Reply 5 of 78
    ouraganouragan Posts: 416member
    You can build a speculative bubble only so much. This is one more paper which assumes that consumers are dumb, can't find any alternative to Apple's products (Remember Windows 95, anyone?) and are willing to mortgage their house just to own one of these shiny, Made in China, Apple product.



    Yet, 95% of people won't touch an Apple product because it's TOO EXPENSIVE.



    Now, I'm sure some will make money with stock options which are quite different from stock. Speculators will speculate and often make money. But they don't build anything that lasts. And that is the tragedy of the Mac and, now, the iPhone platforms. They won't last at CURRENT PRICES.



  • Reply 6 of 78
    jeffdmjeffdm Posts: 12,946member
    Quote:
    Originally Posted by anantksundaram View Post


    This is a truly nicely done piece of financial reporting, AI!



    But, before we all get excited about this: my 2¢ is that the effect of the deferred revenue has already been factored into the stock price.

    \



    It should be, the gist of the article has been known for about a year already.
  • Reply 7 of 78
    vinitaboyvinitaboy Posts: 156member
    If what you say is true, anantksundaram, how do you account for the AAPL pullback to $117 (+/-) earlier this year and $176 today? Does the backend iPhone revenue come and go with the tide? And if so, what will happen when 20 million (+) units reach customers' hands in the next twelve months? Looks like a tsunami to me. What say you?
  • Reply 8 of 78
    SpamSandwichSpamSandwich Posts: 29,063member
    Quote:
    Originally Posted by ouragan View Post


    You can build a speculative bubble only so much. This is one more paper which assumes that consumers are dumb, can't find any alternative to Apple's products (Remember Windows 95, anyone?) and are willing to mortgage their house just to own one of these shiny, Made in China, Apple product.



    Yet, 95% of people won't touch an Apple product because it's TOO EXPENSIVE.



    Now, I'm sure some will make money with stock options which are quite different from stock. Speculators will speculate and often make money. But they don't build anything that lasts. And that is the tragedy of the Mac and, now, the iPhone platforms. They won't last at CURRENT PRICES.







    What makes the iPhone unpalatable is at&t, not the Apple part of the equation.
  • Reply 9 of 78
    I think a new topic of interest is whether Apple will change the accounting approach for the new iPhones since there is no monthly share of phone account revenue. The cash flow and the booked profits would jump for the new phone sales while the profits from old sales would continue to stretch out as you have shown.
  • Reply 10 of 78
    nvidia2008nvidia2008 Posts: 9,262member
    Good article, thank you. Questions for everybody:



    1. What is the cost that Apple takes for each iPhone? That is, normally on a per-unit basis, gross profit margin = selling price - manufacturing cost. What happens when all the manufacturing cost is taken as a hit in that financial quarter, whereas the "profit" from the phone only comes back over the next 2 years? Is this why Apple is so aggressive with income from telcos because this very instantly offsets the manufacturing cost of each unit?



    Because otherwise on a per-unit basis within a month or even a financial quarter, each sale of an iPhone would be making a loss, on a gross-profit margin basis. I am confused. And I generally dislike accountants as well? LOL.



    2. What exactly about SarbanesOxcart forces Apple to do this?



    3. Sorry if I missed it, but does the subscription method of accounting apply to the payment by the telco for each unit? Or can it be recognised in the financial quarter it is paid to Apple (say, 30 days after the telco submits the reports to Apple etc.) ??
  • Reply 11 of 78
    iq78iq78 Posts: 256member
    They might since they no longer generate a subscription review (or do they?).



    However, I think they should stick with this accounting model because the end user (at least in the US) is still stuck with a 2-year contract on a subsedized phone. This is a great model to use on a potentially saturated market, which can happen when you are dealing with 2-year contracts.



    Once a phone is purchased by a customer, that customer is out of the "customer pool" for 2-years. You will likely not get any iphone business from that same customer for 2-years. And customers who are in contracts with other carriers will also be out of the customer pool for a given number of months. Because of the dynamics of subsedized phones, I think it is much easier to saturate the market because your potential customer base is small (relative) at any given time.



    On any given day your customer potential is limited to 1) Those people who have recently ended a contract, 2) Those who haven't subsedized a phone purchase for 2-years, or 3) Those who are first time cell phone purchasers.



    This pool of customers is much smaller than anybody who owns or wants to own a cell phone. It is a very different business than selling iPods, where people aren't pinned down to 2-year cycles.



    IAMIQ78
  • Reply 12 of 78
    parkyparky Posts: 383member
    Quote:
    Originally Posted by kinglear View Post


    I think a new topic of interest is whether Apple will change the accounting approach for the new iPhones since there is no monthly share of phone account revenue. The cash flow and the booked profits would jump for the new phone sales while the profits from old sales would continue to stretch out as you have shown.



    They are using this accounting practice not because of the revenue share that they has with AT&T, etc, but rather to counter the issue of 'free software upgrades'.



    If they realise the full revenue at the time of the sale (as they do with the iPod touch for example), they would have to charge for any of the software upgrades, i.e anything that add functionality to the device (not bug fix updates).



    This is because in effect the user has received a better product after the sale was completed, BUT the shareholders have not seen an increase in revenue as it was all taken at point of sale. By deferring the revenue they can offer free upgrades to the software and not fall foul of the Sarbane Oxley rules. The iPhone and Apple TV both use this accounting method, hence the free upgrades to the software which have given great leaps in functionality (or will very soon on the iPhone).



    The iPod touch on the other hand does not use this accounting method, hence the payments required for the software upgrades (new features).
  • Reply 13 of 78
    Thanks for a well-written article! I'd love to see more like this in the future!
  • Reply 14 of 78
    cameronjcameronj Posts: 2,357member
    Quote:
    Originally Posted by nvidia2008 View Post


    Good article, thank you. Questions for everybody:



    1. What is the cost that Apple takes for each iPhone? That is, normally on a per-unit basis, gross profit margin = selling price - manufacturing cost. What happens when all the manufacturing cost is taken as a hit in that financial quarter, whereas the "profit" from the phone only comes back over the next 2 years? Is this why Apple is so aggressive with income from telcos because this very instantly offsets the manufacturing cost of each unit?



    Because otherwise on a per-unit basis within a month or even a financial quarter, each sale of an iPhone would be making a loss, on a gross-profit margin basis. I am confused. And I generally dislike accountants as well? LOL.



    No, costs are always recognized in the same time frame that revenues are.
  • Reply 15 of 78
    cincyteecincytee Posts: 229member
    Quote:
    Originally Posted by AppleInsider View Post


    If Apple 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.



    For me, the implication of this is even more positive in the longer term: These deferred revenues assure that Apple has a revenue stream fairly independent of the current quarter's results. In other words, if the U.S. economy should continue to tank instead of recover over the next 12-18 months, Apple will still have a river of money to route into product development -- a luxury few of its competitors will enjoy. Re-engineered and newly developed Apple products might then gain a generational leap-frog over their rivals' and improve Apple market share further over the coming three- to five-year period. And that would be a sweet reward for Apple shareholders.

    Even assuming the economy does recover, this is still potentially a big strategic-level advantage. It's far more than about guaranteeing decent financial results for a few quarters.
  • Reply 16 of 78
    cameronjcameronj Posts: 2,357member
    Quote:
    Originally Posted by cincytee View Post


    For me, the implication of this is even more positive in the longer term: These deferred revenues assure that Apple has a revenue stream fairly independent of the current quarter's results. In other words, if the U.S. economy should continue to tank instead of recover over the next 12-18 months, Apple will still have a river of money to route into product development -- a luxury few of its competitors will enjoy.



    The river of money stops when the sales stop. This is just an accounting trick, it does not impact when Apple actually gets the money in its bank accounts.
  • Reply 17 of 78
    nvidia2008nvidia2008 Posts: 9,262member
    Quote:
    Originally Posted by cameronj View Post


    No, costs are always recognized in the same time frame that revenues are.



    So, very roughly, according to the article, Apple would recognize nearly $0.68 per day for the next 2 years, for the 16GB model etc. So let's take it as US $600 as the selling price, roughly 70cents a day for 2 years as recognised revenue.



    Now assuming gross profit margins of ~30%, that means Apple's manufacturing cost per unit is about $400.



    Assuming on average in a particular financial quarter the iPhone is sold in the middle of the financial quarter, so 45 days x 70 cents = $31.50 revenue for the quarter. However the cost for that iPhone in that financial quarter is $400. Therefore each iPhone in that quarter takes a loss of over $350.



    Is this correct?



    Or if the cost was to be correlated closer with the revenue, that means that the cost of each iPhone is also divided by 730days... Which means not only do you have deferred revenue, which is fantastic, but you have also committed your finances to deferred costs... Is this what Apple is doing?



    Quote:
    Originally Posted by parky View Post


    ...This is because in effect the user has received a better product after the sale was completed, BUT the shareholders have not seen an increase in revenue as it was all taken at point of sale...



    This sounds so crazy, but SO is there for a reason I guess, thanks for explaining. I'm sure Apple likes this method for certain other reasons too... I think.



    Quote:
    Originally Posted by IQ78 View Post


    They might since they no longer generate a subscription review (or do they?)....However, I think they should stick with this accounting model because the end user (at least in the US) is still stuck with a 2-year contract on a subsedized phone. This is a great model to use on a potentially saturated market, which can happen when you are dealing with 2-year contracts....Once a phone is purchased by a customer, that customer is out of the "customer pool" for 2-years...



    This makes good sense.
  • Reply 18 of 78
    webheadwebhead Posts: 75member
    Quote:
    Originally Posted by ouragan View Post


    You can build a speculative bubble only so much. This is one more paper which assumes that consumers are dumb, can't find any alternative to Apple's products (Remember Windows 95, anyone?) and are willing to mortgage their house just to own one of these shiny, Made in China, Apple product.



    Yet, 95% of people won't touch an Apple product because it's TOO EXPENSIVE.



    Now, I'm sure some will make money with stock options which are quite different from stock. Speculators will speculate and often make money. But they don't build anything that lasts. And that is the tragedy of the Mac and, now, the iPhone platforms. They won't last at CURRENT PRICES.







    BMWs are sooooo expensive, too expensive for 95% of the population, that product will never last. BMW should fold up their tents and start selling toasters, 95% of the population can afford toasters so that will be a good investment.



    In 1997 I bought a mac performa for $1800.00, it was a piece of crap compared to computers now days, This year I bought a 24" imac for ....$1800.00. What exactly do you mean the mac will not survive at current prices? Comparatively speaking Macs are cheaper now than ever before? The Mac has lasted a long time and is now more popular than ever, why would forecast the demise of the Mac when it's at an all time high?? People don't chose PCs over a Mac because PCs are cheaper, they chose PCs because they don't know any better or only want to play video games with their computers.



    Please explain why the Mac and iPhone will not last (remember the Mac has lasted over 20 years now and the iphone price has been reduced 3 times with more price reductions to come)?



    Can we please stop hearing that Macs are too expensive, it's old news and not true.
  • Reply 19 of 78
    nvidia2008nvidia2008 Posts: 9,262member
    Quote:
    Originally Posted by cameronj View Post


    The river of money stops when the sales stop. This is just an accounting trick, it does not impact when Apple actually gets the money in its bank accounts.



    I tell you, now that I am going to be 30 by the end of the year, this Finance stuff really intrigues me.



    Because, as you mention, Apple gets the money fairly soon (within 30-60 days from the sale), for the total sale price of the iPhone.



    However, the accounting shows the revenue as deferred.



    So, what happens to the money in the meantime?. Does it have to be "declared" as entered into the total cash hoard that Apple has? And then subtracted from the "loose cash" and placed in the "revenue stream"??



    Is this why accountants get so much money for doing all this seemingly purposeless hax?



    Finance and accounting. Most of it is seems like just legalised hacking. This is why it frustrates me so much when I go to a place like H&R Block, when, sometimes the service is good, but other times, it is like, why the F can't I expense this and this, when big corporations (not necessarily Apple) are getting away with, well, whatever they get away with???
  • Reply 20 of 78
    cameronjcameronj Posts: 2,357member
    Quote:
    Originally Posted by nvidia2008 View Post


    So, very roughly, according to the article, Apple would recognize nearly $0.68 per day for the next 2 years, for the 16GB model etc. So let's take it as US $600 as the selling price, roughly 70cents a day for 2 years as recognised revenue.



    Now assuming gross profit margins of ~30%, that means Apple's manufacturing cost per unit is about $400.



    Assuming on average in a particular financial quarter the iPhone is sold in the middle of the financial quarter, so 45 days x 70 cents = $31.50 revenue for the quarter. However the cost for that iPhone in that financial quarter is $400. Therefore each iPhone in that quarter takes a loss of over $350.



    Is this correct?



    That's the opposite of what I said. Costs are recognized when revenues are recognized, so the costs are spread evenly over 2 years just as the revenues.
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