Fuzzy (iPhone/iPad/Mac) ESP, Jan. 2015 Update – A Seriously Puzzling Part of Apple’s Deferred Revenue Puzzle in 5 Charts

“Background”

Now’s the time on Sprockets where we dance my home game AAPL earnings preview “coverage” where things get even more out there than usual.

Yep, all two of you guessed it – and so we briefly take a second visit into the realm of ESP. No, not that ESP. ESP as in “estimated selling price”. Specifically, that partial, but huge, portion of Apple’s “deferred revenue base”, comprising deferred revenue from iPhone, iPad and Macs unit sold (though not all of it). Which, if I understand correctly, consists of 100% gross margin dollars for GAAP reporting purposes.

One immediate takeaway: Because of this, Apple is (if it continues growing, anyway), permanently “depressing” its gross margin every single year (but not “that much” – maybe 50-60 basis points or so as of FY 14). As far as tax implications and all that other stuff, don’t ask me. And really, don’t be thinking Apple’s automatically doing funny tax business or whatever. I’m sure the IRS has a satellite office at One Infinite Loop, just in case.

For a refresher on what I think Apple’s deferred revenue scheme is all about, you can read here (as I said last time, beware – this is highly “experimental” to say the least, and there’s no way for me to know if my assumptions are generally correct, “accurate” data entry in my Excel spreadsheet notwithstanding)

But to recap the very “basics”, Apple, among other deferrals, defers a certain amount of revenue per unit on a product line basis (so an iPhone 5C and iPhone 6 Plus get the same-dollar deferral as far as I know). It then amortizes (“adds back”, I believe) the deferred revenue each quarter – an 8-quarter schedule for iPhones and iPads, and a 16-quarter schedule for Macs. The “why” escapes me, though there’s certainly a few potential theories (one with some real-world-validation promise – expected time between user replacement).

For quick reference, here’s the ESP assumptions underlying the charts, some of which are known, some of which are estimated, none of which can be tracked precisely – probably according to Apple’s design.

deferral-assumptions

Now for the five charts, in no particular order. If you’re not too perplexed/otherwise still reading at the end, feel free to tweet or comment. Click to see full-size.

Five Charts. Limited Clue.

deferral-1

So, given my assumptions are “correct” and I haven’t committed some dreaded transcription/omission error or something, how much ESP revenue has Apple stashed away (pseudo-temporarily) over the past 5 and change years? About $17B. And yep, iPhone is the chief contributor of acorns, so to speak. It’ll be interesting to see the iPad/Mac ESP deferral trends over time, given that Mac is on a growth trajectory, and iPad, well, not.

deferral-2

Ah, the power of amortization. You can’t really say the point of deferrals are to smooth out quarterly results (I thought it was more a Sarbanes-Oxley thing – any accountants in the house?). Though when Apple isn’t really growing overall, you see net deferrals drop dramatically. Lately, Q1 shows highest net deferral, considering it’s the quarter with highest unit sales. Interestingly, if my assumptions/estimates are kinda sorta correct, there’s very little difference in net deferral between FQ1 2014 and FQ12015. The only “conclusion” I draw in terms of earnings implications is that net deferral isn’t as much of a headwind, considering the analysts’ estimates for growth this quarter.

Well, there is another thing. Apple may be deferring slightly over $900M in revenues, $900M in gross margin, and, if my tax assumptions are correct, over $650M in net income.

deferral-3

This chart is an estimate of Apple’s “rolling deferral balance”, also per hardware product line. Yes, Apple Watch will probably see some ESP deferral, but let’s figure that complication out later – or maybe never. 😀

Of course, as a different way of looking at Apple’s growth, assuming ESP deferral per unit remains constant, Apple wants to see this chart on a constant general upward trend. If my estimates are in the ballpark, Apple has around $6.7B in revenue (which is also 100% gross margin) yet to recognize from this source of deferred revenue. Not “that much” in the context of a >$200B revenue run-rate company, but pretty darn significant in terms of gross margin impact (assuming gross margin of around 38%, or $76B annual run-rate).

deferral-4

As mentioned, in Apple’s ideal scenario, Apple’s deferred revenue balance continues to increase indefinitely. As a natural consequence, assuming consistent amortization schedules, the amount of revenue Apple “brings current” and recognizes per quarter should also generally increase. As an example, Apple could be “adding back” over $700M in iPhone revenue/GM in the December quarter.

deferral-5

The last chart visualizes my “best” guess as to product-line total ESP deferral per quarter (before amortization)…including the December quarter, which obviously is its own wild guess. Sure, it’s not as seasonal, but Mac acorns are continuing to make their presence known in that giant ESP deferred revenue…er…tree or something.

Well, that’s the update. Who knows if I’ll have another update on this (I assume) very esoteric topic. Still confused? Still reading? You’re more than welcome to help me puzzle this out on Twitter or via the comments.

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5 thoughts on “Fuzzy (iPhone/iPad/Mac) ESP, Jan. 2015 Update – A Seriously Puzzling Part of Apple’s Deferred Revenue Puzzle in 5 Charts

  1. “I thought it was more a Sarbanes-Oxley thing – any accountants in the house?” Deferred revenue are due to the fact that Apple give for free the OS update. Doing so they need to recognize some $$ value of those update on the month were the update will/could happen. Hence 2 years for iPhone (standard time for replacement) and 4 years for mac (longer upgrade cycle)

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