Once you dig deeper, Apple's record quarter is not so impressive
Not since the Soviet Union, have I seen any entity so brazenly try to rewrite history. With today's fiscal first quarter 2010 earnings announcement, Apple effectively changed its quarterly performance going back two years. In a quarter or a year from now who will remember the earnings results as they were actually reported? This blog and a few others like it may be the only record of what really happened.
But Apple did as much to rewrite the present as the past, by how today's Q1 results were presented. The company gave no warning that it would adopt new accounting rules, which made what would have been slightly-better-than-expected results seemingly blowout. Fortunately, Apple's rewriting the past -- and its comparison to original earnings reports -- sheds some light on the current quarter's results and how Apple manipulated their delivery.
Coming into the quarter, Apple guided that revenue would be between $11.3 billion and $11.6 billion, with earnings per share ranging between $1.70 and $1.78. Wall Street consensus estimates were much higher: $12.06 billion revenue and $2.07 earnings per share. But Apple reported a staggering $15.68 billion revenue and net profit of $3.38 billion, or $3.67 a share. The huge disparity creates the perception that Apple had a helluva quarter. How could it not be when beating the Street by $3.62 billion revenue and $1.60 earnings per share? It could be because Apple changed its accounting, choosing to do so without warning.
Apple had been reporting results as GAAP, generally accepted accounting principles, as required but separate non-GAAP results since fiscal fourth quarter 2008, too. Some analysts prepare guidance as GAAP and non-GAAP, but the GAAP numbers are used for estimating revenue, net income and earnings per share. Today's change effectively eliminates Apple's non-GAAP reporting.
There is nothing I can see under current disclosure laws that would have prevented Apple from issuing some statement about the accounting change, as long as the information was given out to everyone. Select disclosure to some Wall Street analysts would rightly draw fire from the US Securities and Exchange Commission. By Apple announcing the reporting change before the earnings announcement, Wall Street analysts would have been able to appropriately revise their quarterly revenue and earnings estimates upwards. But Apple didn't give them that chance. Now why is that?
As I've long asserted, in business perception is everything. Apple's unannounced accounting change has created the perception of well-earned record revenue and earnings. That's the way many blogs and news sites first reported the results and continue to do so. But an examination of actual product sales shows a strong quarter, but not a colossal one. The big boost came from the accounting change, which gave Apple another boost: Perception about its performance.
It's the only way I can reconcile Apple's behavior. If the company had any interest in transparency, Wall Street and shareholders would have received notice of the accounting change. By withholding the information, Apple got a big perception boost and some after-hours lift on the share price.
Questioning Record Performance
As soon as Apple issued its earnings press release, I IMed Betanews founder Nate Mook: "Apple earnings seem too high. I'm going to hold off posting anything until [the] con call. Could be they changed reporting." The change in reporting wasn't immediately obvious from the press release.
By waiting, many Apple blogs and news sites got up a report before me. But I didn't want my reporting to be unduly manipulated. So I waited, for which my only regret is how much misinformation is already out there. But some financial news sites are doing the story right, like story "Apple just makes target, once you look under the hood," by Therese Poletti, for MarketWatch. She writes:
Apple's quarter was actually pretty much on target, when one looks at the unit sales of its devices. IPhones, iPods and Mac computers sold pretty much in line with analysts' forecasts for the period.
Apple's 8.7 million iPhone shipments actually fell short of analyst consensus estimates. The 3.36 million Mac shipments were slightly above analyst consensus, while the about 300,000 sequential unit increase is inline with holiday quarter expectations based on continually consistent growth rates. According to IDC, in the United States, Mac shipments grew 31 percent year over year. Competitors did better: HP growth was 45.1 percent. Toshiba, which pushed Apple from fourth place to fifth in market share, delivered a whopping 71.5 percent growth. But iPhone and Mac shipments are receiving credit for a quarter where reporting changes matter much more.
Changing the Present
In fairness, there is nothing untoward in Apple's accounting change. In September, the Financial Accounting Standards Board revised GAAP to Apple's benefit. Under older rules, Apple had to defer most iPhone, iPod touch and Apple TV revenue for 24 months. Subscription accounting rules mandated that Apple had to recognize most of the revenue over time rather than in the quarter realized from sales. According to Piper Jaffray analyst Gene Munster, Apple reported $78 per iPhone each quarter, deferring $595 per device per quarter. Under the new rules, which must be adopted before 2011, Apple could realize most of the revenue during the quarter of sale. Apple plans to defer $25 per iPhone and $10 per Apple TV per quarter.
Apple is following the new GAAP rules as it is required to. There is nothing wrong with Apple's new reporting method. It's what the company is supposed to do. The problem I see: How Apple took advantage of the change to boost earnings perceptions.
During yesterday's Apple earning conference call, BMO Capital Markets analyst Keith Bachman asked Apple CFO Peter Oppenheimer: "What revenue and EPS would have been under the previous accounting policy for the December quarter?" Oppenheimer responded: "Keith, actually, I did not say that. That's actually not something that we have the time to try and figure out." He dodged the question!
But Apple's changing-the-past ways give some insight into just how much the accounting change affects the Q1's reported results. By far, iPhone contributed the most to the quarter's results as reported: $5.6 billion, or nearly 36 percent of total revenue. Assuming Apple would have otherwise deferred $595 per iPhone, for 8.7 million units that works out to $5.2 billion. Munster's numbers work. Assuming Apple defers $25 per iphone that's $648 per 8.7 million iPhones or $5.66 billion, or fairly close to reported revenue. I'll let the number stand at that, but there are dots I would connect with a bit more information.
Changing the Past
Apple's revision of past quarterly results offers some insight into the accounting change's impact. For example, during fiscal fourth quarter 2009, Apple reported $9.87 billion revenue and net profits of $1.67 billion, or $1.82 a share. Apple shipped 7.4 million iPhones, with reported revenue of $2.9 billion. Under Apple's revised earnings, by retroactively applying the new accounting rules, revenue jumps to $12 billion and net income to $2.52 billion, or $2.77 a share. Apple's revenue jumps by $2.13 billion with the accounting change. Meanwhile, net profits increase by $850 million and earnings per share by 95 cents.
Another example: The year-ago quarter, when Apple reported $10.17 billion revenue and net profits of $1.23 billion, or $1.35 earnings per share. Apple shipped 4.36 million iPhones, with reported revenue of $1.25 billion. Under the revised results, Apple revenue was $11.88 billion and net profits were $2.26 billion, or $2.50 earnings per share. Apple's revenue increases by $1.71 billion, net profits by $1.03 billion and earnings per share by $1.15.
One more: Fiscal Q4 2008, when Apple first starting reporting non-GAAP results alongside GAAP results for iPhone. Apple reported $7.9 billion and net profits of $1.14 billion, or $1.26 earnings per share. Apple shipped 6.9 million iPhones, but only reported revenue of $806 million. The revised figures raise revenue to $11.52 billion and net profit to $2.25 billion, or $2.48 earnings per share. The difference: $3.62 billion revenue, $1.11 billion net income, or $1.22 billion. But the differences between the reported and revised figures leave something out. Apple acknowledged deferring $4.6 billion from iPod 3G sales.
Apple justifies the past revisions as making quarterly comparisons more accurate. There's sense for one year, but two? The bigger accomplishment: Apple's past quarterly results look much better today than they did yesterday, and for a company so hellbent on perception, on marketing, on looking good, the revised results are a helluva makeover.
Surely, some Apple fans will defend the past quarterly revisions -- the changing of financial history -- arguing that it's what the company would have made anyway. But Apple didn't report the revised results in those past quarters. You can revise the historical record, but you can't change the past or the decisions Apple investors made three months or eight quarters ago.