AAPL profits were up sharply in the December quarter
AAPL reported December quarter results after the close of the New York market yesterday. At $15.7 billion, sales were up 32% year on year. Earnings per share, based on the company’s new method of accounting for iPhone profits, were $3.67, or 47% more than the $2.50 AAPL tallied in the prior-year period (as actually reported, the 2008 eps number was $1.78, about 30% lower than the revised figure).
Unit sales of Mac computers were up 33%–an AAPL record and 2x the market growth;
iPhones doubled–again a record and 3x the smartphone market growth (though apparently the consensus was looking for more);
and iPods were down 8%–here AAPL really is the market. iPod Touch was up 55%, though, allowing music player revenue to rise by 1%.
What was the accounting change?
It affects the way AAPL accounts for sales of the iPhone and Apple TV (the later doesn’t make much difference to eps). In the simplest terms, AAPL sells an iPhone to a network operator in exchange for a cash payment + a share of the revenue the phone’s user generates for the network over a two-year contract. AAPL used to use subscription (project) accounting to report its earnings from a given phone (see my post on project accounting). More or less, AAPL recognized the revenue as income as it came in and subtracted a proportionate amount of its costs. Now AAPL reports the entire two-year revenue, minus costs, as soon as the phone is sold. In the December quarter, it looks to me as if the change added $1.15 to eps.
Why do it?
For one thing, the Financial Accounting Standards Board said it was okay. For another, professional investors were doubtless using the new eps already, which were disclosed in footnotes to prior earnings releases–meaning individual investors a very important AAPL constituency, were the only ones potentially in the dark.
Also, in my experience, companies using project accounting never get full credit for their earning power. While unit sales are growing, larger and larger amounts of deferred revenue build up on the balance sheet (over $8 billion in AAPL’s case when it officially made the change). That only shows in income as sales begin to roll over and decline. At that point, investor attention is no longer focused on how much the company is taking in. All eyes are on the slowing of sales momentum instead. So a company that uses project accounting is penalized twice.
Two results of the change
Under the new method, AAPL’s fiscal 2009 earnings were $9.08/fully diluted share. If we pluck a number out of the air and say fiscal 2010 will produce eps up 27% year on year to $11.80–probably a conservative number–then the company’s pe is about 17, much lower than what I think is the common perception.
On the other hand, the change emphasized exactly how much the iPhone means to AAPL. We know that the change in accounting added $2.83/share to AAPL’s (old method) reported earnings of $6.25 last fiscal year. Assume that 20% of the reported number came from iPhone, which would roughly be its share of revenues. That would amount to $1.25. The total iPhone contribution would then be $4.08 out of $9.08, or 45%. As we enter the new fiscal year, the iPhone contribution percentage would be rising.
What happens to AAPL if iPhone growth slows down? The half – of AAPL’s profits that now come from iPhone had to grow at 100% year on year for the entire company to grow by 50%. This implies iPhone supplied something like three-quarters of the extra profit the company reported.
Suppose the iPhone slows to “only” 40%? Can the other half–Macs +iPods–boost its contribution enough for AAPL as a whole to grow at 30%? Maybe, maybe not. So this worry is now out on the table.
Can the much-anticipated tablet being presumably introduced on Wednesday be another area of strong growth for AAPL? Probably. Will it be big enough to matter, that is, can it grow to the size of the iPod or the Mac, if not the iPhone? My guess is no, that APPL as a growth stock is a smartphone company, but I’ll be listening carefully on Wednesday.
Addendum: I’ve started to think more seriously about AAPL, indirectly, really, in trying to figure how the e-reader/video player market will evolve.
In one way of looking at what APPL has done, it has created forums for buying content–iTunes and the iPhone apps store–where it says it makes no money, but where the forums drive hardware sales. At the same time, it built music players into a market that doubled the size of the company. Then it built its smartphone business into one that doubled the size of the company again.
So–the two questions for APPL as a stock are: can it built another content forum that will be either first to market or exclusive enough to drive consumers to its tablet offering? and will (its share of) the tablet market be big enough to double the size of the company again?