25 January 2010

AAPL: Income Statement Analysis for the December 2009 Quarter

Apple (NASDAQ: AAPL) reported earnings of $3.67 per diluted share in the quarter that ended 26 December 2009, which was the first quarter of Apple's fiscal 2010. 

In this quarter, Apple revised, in a very substantial way, how it accounts for Revenue due to sales of the iPhone (and the less important Apple TV).  This change, which complies with
the latest standards issued by the Financial Accounting Standards Board, enables Apple to recognize "substantially all" iPhone and Apple TV Revenue in the period that the sale to a consumer took place.  Apple had been required to recognize Revenue from these products over each product's two-year estimated economic life.  This "subscription accounting" method resulted in substantial amounts of deferred Revenue and costs, reducing the reported values for each.

Apple restated its results (required for "retrospective adoption") for each quarter of fiscal 2007, 2008, and 2009 to be consistent with the latest, non-subscription approach.  For example, earnings for the first quarter of fiscal 2009 (quarter ending December 2008) were revised from $1.78 per share to $2.50 per share. 

It would have been helpful if Apple had also provided before-and-after data for the December 2009 quarter, but the results for the latest period were only prepared in accordance with the new accounting principles.  Therefore, the latest results cannot easily be compared with analyst estimates, or even our own "look-ahead" estimates, because most analysts assumed the continued use of subscription accounting.

This post examines Apple's Income Statement for the latest quarter.  The principal sources for the analysis were the  earnings announcement, the formal 10-Q report, and the transcript (available from Seeking Alpha) from the conference call.  We used the restated data provided by Apple for all historical results.

In a second article, we will report Apple's scores as measured by the GCFR financial gauges.  The follow-up post will also provide the latest figures for the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

Apple Inc. sells Macintosh® desktop and laptop computers, iPod® music and video players, the iPhone™ portable communications devices, the OS X operating system, iLife and iWork application software, and various accessories.  The imminent addition of a tablet computer to the product line has triggered an avalanche of speculation and valuable publicity for this company known for elegant product design, innovation, the loyalty of its customers, and the cult-like status afforded CEO (and savior) Steve Jobs

Additional background information about Apple and the business environment in which it is currently operating can be found in the beginning of the look-ahead.

Please click here to see a full-sized, normalized depiction of the actual results for the just-concluded quarter, as well as the restated quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

Revenue of $15.7 billion in the December quarter was 32 percent more than last year.  CFO Peter Oppenheimer stated:

"Our actual revenue of $15.68 billion exceeded the [$11.3 billion to $11.6 billion] guidance that we gave under the old accounting principles by over $4 billion and roughly half of that was attributed to the performance of the business."

This comment would seem to suggest that Revenue would have been roughly $13.5 billion if the earlier accounting principles had remained in effect.

Revenue growth was greatest in the Asia-Pacific region, up 142 percent, from a relative low base.  European net sales increased an impressive 40 percent.

Apple sold more Macintosh computers and more iPhones than ever before.  The number of Macs sold was 33 percent greater than in the December 2008, although Revenue per Macintosh unit sold fell 6 percent, from $1412 to $1324.

The number of iPhones sold doubled.  iPhones and related products were responsible for 35.6 percent of total Revenue in the quarter.  iPhone Revenue was 90 percent more than in the December 2008 quarter.

Revenue per iPod increased 9 percent.

Units Sold
Q/E Dec 2009
Units Sold
Q/E Dec 2008
Analyst Estimates
Q/E Dec 2008
4.368.17 - 11.3
2.79 - 3.31
17.75 - 23

These three articles ( first, second, third) by Philip Elmer-DeWitt at BrainstormTech were the sources for the analyst estimates listed above.

The Cost of Goods Sold was 59.1 percent of Revenue in the quarter, which translates into a Gross Margin of 40.9 percent, up from a restated 37.9 percent in December 2008.  Apple stated that the:

"The primary contributors of this increase were lower commodity and other product costs, a more favorable sales mix toward products with higher gross margins, and increased leverage on fixed costs, which were partially offset by product price reductions."

Apple spent 4.6 percent less on Research and Development than our $417 million estimate, which was not affected by the restatements.  As a percentage of Revenue, R&D expenses decreased from 2.7 percent in the December 2008 quarter to 2.5 percent in the latest period.

Sales, General, and Administrative (SG&A) expenses were 8.2 percent more than our $1.19 billion estimate. These expenses amounted to 8.2 percent of Revenue, down from 9.2 percent last year.

Together, R&D and SG&A expenses totaled $1.686 billion, which is just slightly more than the $1.64 billion identified in Apple's guidance for operating expenses (exclusive of CGS).

The quarter did not include any separately identified "Other" operating expenses, such as restructuring charges, workforce reduction expenses, asset impairments.

These various operating items combined to produce Operating Income of $4.725 billion, which was 52.4 percent more than in 2008's fourth quarter. The increase can be attributed to strong Revenue growth and the 3 percent improvement in Gross Margin.

Net interest and other non-operating items summed to income of $33 million, which was down substantially from $158 million last year.  The decline was mostly due to lower interest rates on the company's cash balances.  With no debt, Apple did not incur interest payments.

The 29-percent effective income tax rate was less burdensome than the previous December's (restated) 30.8-percent rate.

The lower effective tax rate during the first quarter of 2010 as compared to the same quarter in 2009 is due primarily to an increase in foreign earnings on which U.S. income taxes have not been provided.

Bottom-line Net Income rose by 50 percent to $3.378 billion ($3.67 per diluted share), compared to (restated) earnings in the year-earlier quarter of $2.255 billion ($2.50 per share).

Full disclosure: No position in AAPL at time of writing.

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