Making Cents of iPhone Unit Sales Numbers
“It is very important when evaluating sales figures provided by AAPL surrounding the new iPhone 6 models to understand how certain sales will slot into various accounting periods, and ultimately, how these differences are accounted for in channel inventory.”
Apple's 2014 / 2015 Flagship iPhone Lineup: iPhone 5S, iPhone 6, iPhone 6 Plus
For the past few years, it has become customary for AAPL to make announcements regarding unit sales following its first 24 hours of presales and first weekend of sales. There are a few considerations that need to be take into account when thinking about what these numbers actually mean, but more importantly, how they translate to its quarterly financial statements. A lot of the issues are timing-related, but they can, and do affect how investors and analysts alike interpret the performance of the company. Investors and analysts evaluate the company quarter-by-quarter and can create massive volatility based on those interpretations.
4 MILLION PRESALES
This year was the first year since the iPhone 5 launch in Sept-2012 that AAPL offered presales on its flagship phone - last year, the iPhone 5S was not offered for presale due to extreme supply constraints. Nonetheless, the 4M presales in the first 24-hours this year doubled the iPhone 5, when APPL announced 2M presales in the first 24 hours in September-2012.
Will all 4 Million Presale Units be booked to FQ4?
The answer to this is NO. Without getting into returns and exchanges, which will likely occur, the revenue recognition of sales drives the answer to this question.
- Apple Retail & Online: For all sales through AAPL Retail and Online, revenue is recognized when the customer takes possession of the item. Therefore, if a customer pre-ordered a phone that had a 3-4 week ship time, they will not take possession of that unit by the time AAPL closes its fiscal 4th quarter at 11:59PM on Sept. 27th. Note that all iPhone 6+ models by carrier / color / storage are all currently at 3-4 week ship times. However, all iPhone 6 units are currently at 7-10 business days. My hunch is that the majority, if not all, of these "7-10 business day" units will in-fact be delivered to customers by the 27th. However, if any are still in-transit (e.g., with a 3rd party parcel carrier) when AAPL closes its books on the 27th, they will actually be counted as deferred revenue and reported in the ending channel inventory number.
- 3rd Party Sales: AAPL uses a different revenue recognition methodology on sales through authorized 3rd party retailers such as its wireless carrier partners and big-box retailers. Revenue on these sales are recognized when the 3rd party takes possession of the inventory, NOT when they sell it through to an end user. So this means that all presales through Verizon will be counted in FQ4...right? No. All of the carriers were showing lengthy ship times, particularly for the 6+. AAPL will only recognize revenue on sales to the extent that the 3rd party sold the unit through to a customer or had the item in its inventory on the 27th. Any 3rd party sales that have not passed through the 3rd parties' inventories will be recognized when AAPL sells those units into the channel.
OPENING WEEKEND UNIT SALES
Come the morning of Monday, September 22nd, AAPL will likely make an announcement of how many units it sold over the opening weekend. Will all of these units go to FQ4? YES. The number that they will report on September 22nd is in accordance to GAAP. For people that are not versed in Generally Accepted Accounting Principles, here are the basics:
What will be included?
- AAPL Deliveries to Customers on Opening Weekend: All pre-orders through AAPL's online retail store delivered to customers between 9/19 - 9/21
- AAPL Direct Sales: All sales that have been made directly to customers through AAPL's brick & mortar stores ("the campers")
- 3rd Party Channel Sell-In: All units that AAPL has sold in to the channel regardless of whether somebody has actually purchased the unit. Therefore, any type of channel inventory build will be included in this number, where channel inventory build is defined as units sold into the channel that have not been sold through to end-customers.
What will be excluded?
- AAPL Transitory Units: Online AAPL retail orders that have not been shipped or are in-transit to their respective buyers - shows up as deferred revenue; reported in channel inventory number.
- 3rd Party Channel Unfulfilled Demand: Orders made through 3rd party channel partners that AAPL has not been able to fill (e.g., sell-in to the channel). Even if a channel partner has received an order for an iPhone 6, AAPL will not recognize the revenue until the channel partner has received that unit. So, the backlog of orders sitting with carrier partners will not be recognized as revenue assuming units to fulfill that backlog are not sitting in the carrier partners' inventories yet.
- China: Nobody has really been able to provide a good explanation of when or why the iPhone 6 launch in China has been delayed. Reports out of China have indicated that it is "protectionist regulatory barricades" to shift demand towards home-grown handset OEMs like Xiaomi and Meizu. Whatever the case, China continues to grow its revenue presence on AAPL's geographic revenue breakdown. While the lack of any sales on the opening weekend in China will hurt the compare, I'm not sure by how much. The reason for this is that the 5C / 5S were not available on China Mobile when AAPL launched the handsets last September, AND the immensely popular 5S was in very short supply. Therefore, I'm not sure that the China contribution to the 9M opening weekend unit sales last year was huge. However, when you're talking about comparables, any country with the revenue presence of China is going to hurt. We just don't know by how much...yet. The good news is that those sales will merely be pushed to FQ1 of FQ2 2015 numbers.
2014 VS. 2013 COMPARISON
The 2013 9M unit comparable was likely inflated by up to 3M iPhone 5C units sold into the channel and sitting on shelves, which makes for a tough 2014 comparable. However, I do believe AAPL will trump that number for a couple of reasons. #1: Both iPhone models are popular, whereas last year the 5S was estimated to outsell the 5C on opening weekend by as much as 4:1. I believe the iPhone 6+ will outsell the iPhone 6, but not by nearly that margin. #2: The relative popularity of both iPhone models inevitably alleviates supply issues. The iPhone 6+ is going to be in tighter supply, but when people actually see the 6+, I think a lot will opt for the 6, just due to size - the 6 is a significant upgrade in screen size from the 5 / 5S / 5C, but is not too big that they can't hold it in one hand.
IT'S JUST A TIMING ISSUE...ISN'T IT?
In the end, this is not rocket science. These revenue recognition issues are mere timing, but as I stated, they do affect market sentiment. When invested in a company that is measured on the unit sales of one product on a quarter-to-quarter basis, it's important to understand how these numbers are split up and which go to which quarter. If AAPL had chosen to build 3.3M of channel inventory in its holiday quarter last year (FQ1 2014), it very well could have met the 54 - 55M units that the Street was expecting. Instead, it reported 51M units and that miss, more than any other, was the driver that sent shares down 10% in after-hours trading.
KEY NUMBERS / COMMENTARY TO LOOK OUT FOR IN COMING WEEKS
In the coming days and weeks, there are several key numbers / data points / commentary to pay particular attention to:
- Opening Weekend Sales - Reported number will be on GAAP basis and will include channel build if supply is there.
- FQ4 iPhone Unit Sales - Reported GAAP unit sales for the quarter-ending Sept. 27, 2014.
- iPhone ASP - Everybody is expecting a sustained increase to iPhone ASPs because the popular 6+ starts at $299. Additionally, many expect the new storage tiers to entice users to make the $100 jump from 16GB to 64GB with both the iPhone 6 and 6+.
- Backlog Commentary - How has AAPL managed the supply / demand balance? What type of backlog did it exit with?
- Clarity on China - What is going on with the iPhone 6 China launch? Is it regulatory issues? Issues with the carriers? Other?
- Channel Inventory - What was the change in channel inventory between FQ3 2014 and FQ4 2014? Was there a build and if so, how much? As stated, the build last year was an unprecedented 3.3M units, which likely accounted for the shortfall in FQ1 2014. For the iPhone 5, the channel build was only 800,000 units. Note that the channel number is going to include "transitory" units as well - units that have been ordered from AAPL, but did not reach their end customers by 11:59PM on Sept. 27, 2014.
- Commentary on Legacy Models: What is AAPL seeing and therefore, how should analysts be modeling in contributions from the 5S and 5C? With the 16GB and 32GB 5S dropping down to $99 and $149, respectively, is AAPL seeing any meaningful pickup in demand for these phones. My guess is that the revamp of the lineup with the 6 and 6+ are going to make the 5S and 5C look real old real fast in the United States. However, international markets behave differently with price elasticity.
CHANNEL INVENTORY HISTORY:
AAPL's historical ending channel inventory vs. reported sales and underlying sell-through. Note that red "X" marks a quarter in which AAPL refreshed the iPhone product line.