On Monday morning, Apple made headlines when it made three major announcements related to: iPhone sales, the adoption rate of iOS 7, and updates to its fiscal 4th quarter guidance, issued back in July. Those updates were as follows:
- [Apple] sold a record-breaking nine million new iPhone 5s and iPhone 5c models, just three days after the launch of the new iPhones on September 20.
- More than 200 million iOS devices are now running the completely redesigned iOS 7, making it the fastest software upgrade in history.
- Total company revenue for the fourth fiscal quarter to be near the high end of the previously provided range of $34 billion to $37 billion, and expects gross margin to be near the high end of the previously provided range of 36% to 37%.
The end result?
- Analysts raise price targets
- Stock jumps over $23 to $490.64 (a move of nearly 5%)
Naturally, this brings about a few questions, but probably most importantly, I want to focus on the main headline, which related to the “record-breaking nine-million iPhones sold over the weekend”:
Some have questioned what this 9M is made up of and how it breaks down between 5s and 5c units. I don’t have much to add on the 5s and 5c breakdown, but I can put context around what is, and perhaps more importantly, what is not included in this number. Note that given updated its guidance in a filing with the SEC, the 9M is almost certainly a GAAP 9M. What the heck is a “GAAP 9M“?
In a previous post, I discussed how Apple recognizes revenue of iPhone units, which is actually really key to understanding this 9M number.
What is Included:
- Sales into the channel: This strictly relates to the iPhone 5C, since that is the only model that currently has significant channel inventory (inventory sitting on shelves with 3rd party retailers such as AT&T, Best Buy, Wal-Mart, Target). Since Apple discontinued the iPhone 5, it certainly needed to fill the channel with 5C units, that were not necessarily sold to 3rd party customers. Since Apple recognizes revenue on a “sell-in” basis, there is a likelihood that a portion of the 9M is simply ‘sitting on shelves’. On CNBC, Gene Munster of Piper Jaffrey estimates between 5.0M and 5.5M 5C units were sold into the channel. If only 2M of those units were “sold to customers”, you’re looking at an inflation of up to 3.0M to 3.5M units, within the 9M number – fair enough.
- Sales directly to customers: Since no Apple-online iPhone 5s sales physically reached customers by the time of the 9M announcement, it is safe to assume that all iPhone 5s units included in the 9M numbers were sales that had been made either directly via physical transaction at Apple-retail stores, through third party resellers who had sold them at their own stores or through their online stores (however, only to the extent of the units that Apple had supplied them). There is a very key differentiation factor here that needs to be understood. The way that Apple-itself recognizes a sale is very different than the way that it recognizes sales via a third-party reseller, such as AT&T.
Case-in-point: If Apple sells a phone on 9/20 that does not physically reach its customer until 9/24, that sale would not be recognized (and thus ‘deferred’) in the 9M number. However, because of the ‘sell-in’ factor, a phone sold via a third-party selling online would be included in the 9M because Apple has already sold that unit into the the channel. So it is irrelevant to Apple when the third-party actually sells it to an end-user because Apple has already recognized the sale. However, we know that there is no over-inflation here because all major carriers are sold out and thus, all sales that went into the third-party channel were effectively sold by this morning’s announcement (point being: nobody is sitting on idle 5s inventory).
What is NOT Included:
What a lot of people are missing is what’s not included in the 9M number. In the key accounting policies as described in its SEC filings, Apple states the following with regards to revenue recognition of certain products:
“For online sales to individuals, for some sales to education customers in the U.S., and for certain other sales, the Company defers revenue until the customer receives the product because the Company retains a portion of the risk of loss on these sales during transit.”
Ok, so what?
The “so-what” is that every single iPhone 5s order made on Apple’s website, whether that be one-second after orders for the 5s became available on 9/20, or two-minutes ago, are not included in the 9M number. Apple does not recognize an online sale until it reaches its customer and the fastest ship-times that the 5s had were 1-3 business days, meaning the earliest it would ship is today, and the earliest that it could possibly reach a customer, and be considered a sale is either Wednesday (9/25) or Thursday (9/26). The number of Apple online sales that have not reached end-customers or have not even shipped yet could be huge – I think it could be five to seven million units of deferred sales right there.
Additionally, all of the major carriers are showing ship times in late October or early November for the iPhone 5s – meaning they don’t have the inventory in stock, and thus Apple has not sold those units into the channel yet, and recognized unit sales on those either – and that’s worldwide. So China Telecom, China Unicom, NTT DoCoMo, and every other big carrier out there likely has “sold” units that Apple has not recognized a sale on yet as the unit has not been sold to the carrier yet. Once again, this is likely a huge multi-million unit number of “sales” that have not been recognized by Apple yet.
Note (Update 9/25):
Several people have written to me saying that this “in-transit” number is a moot point because “in-transit” units existed on the 5 and the 5s. That is true, to some extent. Here is the flaw in that comparison. Apple offered pre-orders on the iPhone 5 on September 14th – with many (if not all) of those phones ordered during the first day available for delivery on September 21st (the launch day). How do I know this? I ordered one and had it delivered on 9/21 shortly after waiting in line to buy one.
Point being, all of those pre-order units would have been counted in the 5M announcement (made on September 24, 2012) as they had reached customers by the 21st. Given that Apple did not offer pre-orders on the 5s, NONE of those units would be counted in the 9M, as they were all in-transit on the date of the announcement.
This “in-transit” number only gets larger in 2013 with a wider release, with online orders available in additional countries. Is this tens-of-millions of units? No. Is it potentially a few million? Absolutely.
The other factor to consider is that all three major US carriers (like Apple) were also able to fulfill a good portion of first weekend iPhone 5 pre-orders for 9/21/12 delivery. While these sales would have theoretically been counted in both the 5M (2012) and 9M (2013) numbers, as they had already been “sold into the channel”, it would be worthwhile to compare the order backlogs as of the respective first weekend sales announcements. My guess would be that the combined order backlog for these three US carriers would be significantly higher in 2013 than 2012 (as of 9/23/13 and 9/24/12, respectively). The theory behind that is the 2013 deliveries are a week behind since carriers could not make deliveries by 9/23/13. ‘Nobody’ knows the answer to how much bigger, but given the estimated ship times, one would have to think it’s a significant gap. And that gap also represents a proxy in overall demand between the two respective launches.
Implications for Fiscal Q1:
Apple runs on a fiscal year ending September 28th, 2013 – meaning any revenue attributed to Apple online sales that have not reached their end customers by that cutoff, or any unfulfilled third-party sales (due to lack of inventory) will be pushed into the holiday quarter. My guess is that Apple has already ‘banked’ 15M – 20M iPhone 5s sales that will have occurred between September 20th and September 28th, that they will not be able to recognize revenue on in the September quarter because:
1) Phones sold through Apple Online haven’t physically reached their end customers yet; or,
2) Phones sold through third-party carriers through their online points-of-sale have not been sold into the channel yet due to supply constraints.
That said, this doesn’t even include sales that will go on during the quarter as supply constraints ease up, nor does it include any “channel fill”. Apple targets a 4-6 week (forward-looking) channel inventory supply (e.g., the iPhones you see in an AT&T store when you walk-in) when it exits a quarter. So even if Apple were to reach a supply / demand balance, they would still need to fill the channel (worldwide) to ensure adequate supply on a day-to-day basis – all of which is recognized as revenue, regardless of when an end-user makes the purchase.
The Bottom Line:
Apple’s announcement this morning startled many because of the the sheer magnitude of the gap between what analysts were projecting (5-6M units) versus what was announced (9M units). There was a significant disconnect most likely due to the fact that analysts were not factoring in a channel-fill related to the 5C model, leading some to question whether 9M was really a “solid” number that one could extrapolate true demand from, or more of an “accounting trick” used to create a ‘wow‘ press release? In my opinion, it clearly is a number that, when analyzed in accordance with Apple’s own revenue recognition policies, understates true demand for the product, which has been hamstrung by the supply chain. The Market seemed to agree, as seen by the 5% gap-up.
When you look at how Apple recognizes revenue, you’ll see that 9M was very much distorted by lack of supply, and that true sales far-exceeded it. But in staying consistent with GAAP, Apple likely included its channel build for the 5C, of which a few million units might still be sitting on shelves, but excluded tens-of-millions of Apple online sales that have not been recognized as revenue yet either because the orders haven’t reached their end-customers -and- third-party back-logged online sales that Apple currently does not have the supply to sell into the channel and fill.
All told, you’re looking at a holiday quarter in which I believe Apple will ship in excess of 65M units (with or without a China Mobile deal), implying year-over-year growth of 36%. That is, if Apple’s supply chain can ever catch up with demand.
Of note: Apple’s 9M units sold over the weekend likely banked the company in excess of $5.4 billion in revenue, which would have ranked one weekend’s sales of one product line at #462 of the Fortune 500, exceeding annual revenues of companies such as Facebook, AMD, Priceline.com, Wynn Resorts, Charles Schwab, JetBlue Airways, and Yahoo!.