AAPL: Buy Now?

  • Posted: 15 March 2009 02:43 PM

    I see the current trading range for AAPL to be the best buying opportunity in a decade. I don’t expect records results from the March quarter, but a respectable performance with a solid product pipeline in place. I think we will look back at this period as the nadir for the share price and I expect a new high within 24 months. This will be due in part to gaining greater control of the component supply chain and continued investment in new products during the downturn.

         
  • Posted: 15 March 2009 03:32 PM #1

    DawnTreader - 15 March 2009 05:43 PM

    I see the current trading range for AAPL to be the best buying opportunity in a decade. I don’t expect records results from the March quarter, but a respectable performance with a solid product pipeline in place. I think we will look back at this period as the nadir for the share price and I expect a new high within 24 months. This will be due in part to gaining greater control of the component supply chain and continued investment in new products during the downturn.

    DT, I concur with all you write regarding fundamentals. 

    But I see the trading range as being more like 80-102.  Having said that, I do see some encouraging signs on the weekly chart chart.  RSI especially.

    On the other hand, it remains to be seen if the spread of capitalism to the developing world and the productivity gains from the age of information will be stronger than the forces of big government.  I hope you are right about 24 months for a new high, but I am expecting it to take 54 months or even more.  Deficits of 10% of GDP are unprecedented.  The coming tax on energy is particularly pernicious.  Apple sailing into a strong wind.

         
  • Posted: 15 March 2009 05:51 PM #2

    capablanca - 15 March 2009 06:32 PM

      Apple sailing into a strong wind.

    Yes. Apple is sailing into a strong economic headwind. However, in the long-term the current economic situation may work to the company’s economic advantage well into the future.

    Here are the reasons:

    The company generates sufficient free cash flow to satisfy internal capital needs.

    Inevitably, interest rates will rise, underpinning earnings with increasing returns on the company’s cash pile.

    The company continues to invest in new products through the downturn, furthering its industry leadership and establishing a lead time advantage relative to competitors with regard to new product functionality and product differentiation.

    I do expect a huge increase in corporate tax levies. The growing market for the iPhone and the deferred revenue strategy works handsomely to the company’s tax advantage versus competitors.

    The company is ahead of the game in delivering cloud computing solutions to consumers. This is a recurring revenue stream based on subscription services.

    Apple is maintaining pricing control on products and is continuing to gain more control of its component supply channel.

    I expect a few significant acquisitions in the next 24 months as the company continues to cherry pick for desired products and intellectual property. Growth through acquisition is another means to maintain revenue growth and continue the company’s IP advantage.

         
  • Posted: 15 March 2009 06:24 PM #3

    DawnTreader - 15 March 2009 08:51 PM

    I do expect a huge increase in corporate tax levies. The growing market for the iPhone and the deferred revenue strategy works handsomely to the company’s tax advantage versus competitors.

     

    I don’t recall Apple’s F/S disclosure on this point, but generally, monies collected in advance on a sale are reportable for tax (cash basis) ahead of GAAP revenue recognition (accrual basis). 

    I just wanted to be clear that you’re saying because rates are expected higher in the future that Apple has “locked in” lower tax rates today by reporting revenues from cash received upfront on a two year contract?

         
  • Posted: 15 March 2009 07:13 PM #4

    Mercel - 15 March 2009 09:24 PM
    DawnTreader - 15 March 2009 08:51 PM

    I do expect a huge increase in corporate tax levies. The growing market for the iPhone and the deferred revenue strategy works handsomely to the company’s tax advantage versus competitors.

     

    I don’t recall Apple’s F/S disclosure on this point, but generally, monies collected in advance on a sale are reportable for tax (cash basis) ahead of GAAP revenue recognition (accrual basis). 

    I just wanted to be clear that you’re saying because rates are expected higher in the future that Apple has “locked in” lower tax rates today by reporting revenues from cash received upfront on a two year contract?

    No. What I’m saying is Apple will indeed pay the corporate tax rates at the time the revenue is recognized under GAAP rules. I do believe Apple realizes a tax-deferred benefit under the deferred revenue recognition arrangement. In other words, I believe Apple pays taxes on reported earnings under GAAP. I don’t believe Apple pays income tax on the deferred revenue margin at the time the cash is received.

    Should corporate tax rates increase for future periods, Apple would pay a higher rate on the then-recognized iPhone margins.

    Please correct me if you have information that Apple is paying income taxes today on the deferred margin from iPhone sales prior to its recognition under GAAP rules.

    If you are correct and Apple is paying income tax on the cash basis for net revenue received today on deferred iPhone income recognition then the company’s recent performance is even stronger than I had thought and future tax expense ratios relative to future GAAP earnings will be lower than the industry norm. In other words, sine taxes had been already paid on a growing percentage of future GAAP recognized revenue and earnings, taxes as a percent of recognized revenue will drop for future periods.

    A third scenario is taxes will have been paid on the cash basis from deferred iPhone revenue when the dollars are received, but the tax payments ahead of recognition (in other words recognition of tax expense is deferred with recognition of deferred revenue and expense) would mean reported tax expense would have no impact on the cash balances and thus the impact on net cash of the deferred net revenue is reduced by the amount of the cash basis tax payments. In other words, cash flow relative to future GAAP earnings would be significantly higher in future periods due to the pre-payment of income taxes on the reported tax expense for the period.

    You bring up an interesting question that would be helpful to have definitively answered.

         
  • Posted: 15 March 2009 07:40 PM #5

    DawnTreader - 15 March 2009 10:13 PM
    Mercel - 15 March 2009 09:24 PM
    DawnTreader - 15 March 2009 08:51 PM

    I do expect a huge increase in corporate tax levies. The growing market for the iPhone and the deferred revenue strategy works handsomely to the company’s tax advantage versus competitors.

     

    I don’t recall Apple’s F/S disclosure on this point, but generally, monies collected in advance on a sale are reportable for tax (cash basis) ahead of GAAP revenue recognition (accrual basis). 

    I just wanted to be clear that you’re saying because rates are expected higher in the future that Apple has “locked in” lower tax rates today by reporting revenues from cash received upfront on a two year contract?

    No. What I’m saying is Apple will indeed pay the corporate tax rates at the time the revenue is recognized under GAAP rules. I do believe Apple realizes a tax-deferred benefit under the deferred revenue recognition arrangement. In other words, I believe Apple pays taxes on reported earnings under GAAP. I don’t believe Apple pays income tax on the deferred revenue margin at the time the cash is received.
    .

    In its F/S for the 2008 year, Apple reports a deferred tax asset, suggesting payment of tax ahead of GAAP revenue recognition.  When I have more time, I’ll take a second look to learn if the source of these timing differences is disclosed in the notes.

         
  • Posted: 15 March 2009 10:09 PM #6

    Mercel - 15 March 2009 10:40 PM

    In its F/S for the 2008 year, Apple reports a deferred tax asset, suggesting payment of tax ahead of GAAP revenue recognition.  When I have more time, I’ll take a second look to learn if the source of these timing differences is disclosed in the notes.

    I took a quick look at Apple’s 1st fiscal quarter balance sheet and there’s a whopping $1.6 billion in deferred tax assets.

    If you are correct in the assumption that Apple has pre-paid the tax on the deferred revenue margin, it would mean (in addition to some of the other items mentioned in a previous post), Apple’s cash performance would further improve relative to GAAP earnings since the reported tax expense on the deferred margin recognized in the future periods as a component of net income calculations has already been paid.

    Further in the report Apple does state the income tax calculations on the non-GAAP components of the quarter’s performance are based on the tax rate in effect at the time the non-GAAP revenue is received.

         
  • Posted: 16 March 2009 06:44 PM #7

    As a marketing guy, my head aches when I think about this accounting stuff.

    Having said that my understanding is that deferred tax can be an asset or a liability.  It is the amount of net difference between GAAP reporting and tax reporting.  In Apple’s case the latest 10Q shows an increase in liability of $190mm or about .20 per share.  This means that applying tax accounting, earnings for the quarter were .20 lower than reported.

    I cannot find a detailed breakdown of how this amount was calculated.  But amount and direction of this account leads me to believe that the subscription accounting is moot for this purpose.  In other words it appears that subscription accounting is treated the same way by GAAP as it is by IRS.  Otherwise I would anticipate a positive balance (asset) for deferred taxes.

    This begs the question then of where the $190 negative difference comes from.  Surely it cannot all be accelerated depreciation.

    Like I said, my head aches.

    Help me out, AFB bean counters.

         
  • Posted: 16 March 2009 07:03 PM #8

    capablanca - 16 March 2009 09:44 PM

    As a marketing guy, my head aches when I think about this accounting stuff.

    Having said that my understanding is that deferred tax can be an asset or a liability.  It is the amount of net difference between GAAP reporting and tax reporting.  In Apple’s case the latest 10Q shows an increase in liability of $190mm or about .20 per share.  This means that applying tax accounting, earnings for the quarter were .20 lower than reported.

    I cannot find a detailed breakdown of how this amount was calculated.  But amount and direction of this account leads me to believe that the subscription accounting is moot for this purpose.  In other words it appears that subscription accounting is treated the same way by GAAP as it is by IRS.  Otherwise I would anticipate a positive balance (asset) for deferred taxes.

    This begs the question then of where the $190 negative difference comes from.  Surely it cannot all be accelerated depreciation.

    Like I said, my head aches.

    Help me out, AFB bean counters.

    First, accelerated tax depreciation would give rise to a deferred tax LIABILITY, not a deferred tax asset.  The deferred tax asset could be created from a number of things, including the timing difference of reporting GAAP iPhone revenues over time as compared to reporting taxable income on cash received from iPhone revenue.  It could also be nonqualified deferred compensation accruals, and I’m sorry that my time is limited to research this.  As you know, compensation accrued for such plans is not deductible until PAID, so this would also give rise to a deferred tax asset (payment of tax early).  I don’t see, from a cursory review, of what comprises the deferred liabilities on the balance sheet that clarifies things more.

    [edited for clarity, I hope!]

    [ Edited: 16 March 2009 07:06 PM by ByeTMO ]      
  • Posted: 17 March 2009 12:12 AM #9

    Mercel - 16 March 2009 10:03 PM

    First, accelerated tax depreciation would give rise to a deferred tax LIABILITY, not a deferred tax asset.  The deferred tax asset could be created from a number of things, including the timing difference of reporting GAAP iPhone revenues over time as compared to reporting taxable income on cash received from iPhone revenue.  It could also be nonqualified deferred compensation accruals, and I’m sorry that my time is limited to research this.  As you know, compensation accrued for such plans is not deductible until PAID, so this would also give rise to a deferred tax asset (payment of tax early).  I don’t see, from a cursory review, of what comprises the deferred liabilities on the balance sheet that clarifies things more.

    [edited for clarity, I hope!]

    Yes, I understand that accelerated depreciation tends to create a tax liability.  And that is exactly what is shown on the 10Q: a deferred tax liability of $865mm up from $675mm.  But the effects of depreciation cannot be that large.  Can they? 

    And does not the presence of this liability and the absence of a deferred tax asset suggest that there is no substantial difference in timing with regard to iPhone revenue recognition.

    Sometimes I find Apple’s obsessive secrecy annoying.

         
  • Posted: 17 March 2009 12:31 AM #10

    capablanca - 17 March 2009 03:12 AM
    Mercel - 16 March 2009 10:03 PM

    First, accelerated tax depreciation would give rise to a deferred tax LIABILITY, not a deferred tax asset.  The deferred tax asset could be created from a number of things, including the timing difference of reporting GAAP iPhone revenues over time as compared to reporting taxable income on cash received from iPhone revenue.  It could also be nonqualified deferred compensation accruals, and I’m sorry that my time is limited to research this.  As you know, compensation accrued for such plans is not deductible until PAID, so this would also give rise to a deferred tax asset (payment of tax early).  I don’t see, from a cursory review, of what comprises the deferred liabilities on the balance sheet that clarifies things more.

    [edited for clarity, I hope!]

    Yes, I understand that accelerated depreciation tends to create a tax liability.  And that is exactly what is shown on the 10Q: a deferred tax liability of $865mm up from $675mm.  But the effects of depreciation cannot be that large.  Can they? 

    And does not the presence of this liability and the absence of a deferred tax asset suggest that there is no substantial difference in timing with regard to iPhone revenue recognition.

    Sometimes I find Apple’s obsessive secrecy annoying.

    See above link of DT’s for F/S to which I was referring—Apple has a net deferred tax asset.  And I think the lack of “transparency” is, in part, due to the size of the numbers.  Materiality is art and science.  The notes could be more forthcoming, but Apple only needs to disclose what GAAP requires.

         
  • Posted: 17 March 2009 02:10 AM #11

    As soon as a have moment (or a chronic case of insomnia), I’ll pick apart the components of the SEC filings to see if I can find notations and references to the balance sheet entries. Either way the deferred revenue arrangements mask Apple’s near-term success and will help buoy results moving forward.

         
  • Posted: 17 March 2009 02:07 PM #12

    Mercel - 17 March 2009 03:31 AM

    See above link of DT’s for F/S to which I was referring—Apple has a net deferred tax asset.  And I think the lack of “transparency” is, in part, due to the size of the numbers.  Materiality is art and science.  The notes could be more forthcoming, but Apple only needs to disclose what GAAP requires.

    Thank you. 

    I refer you to the notes in the 10Q, page 11.  Other liabilities contains an item “deferred taxes”.  The change in this item from beginning of quarter to end is $190mm.  This is more than the change in the asset account referred to in the press release you cite.

    It is as if the financial statements, while conforming to GAAP and the law, are then made as abstruse as possible.  Surely the average analyst does not understand them, let alone a poor marketing guy like me.

    All assistance appreciated.

         
  • Posted: 18 March 2009 02:30 AM #13

    According the the same financial statement referenced above, Apple is carrying $965 million in deferred tax liabilities. A $100 million of that liability is in the current period. That would tie in more closely to what I would anticipate to be Apple’s accrued tax liability on deferred iPhone margins. The deferred tax asset remains an enigma.

         
  • Posted: 18 March 2009 03:03 AM #14

    In my continuing research on this issue (including FASB Statement No. 109), the deferred tax asset may relate in whole or in part to certain tax credits that must be used incrementally over successive accounting periods or the value of certain write-downs applicable to acquisitions that for tax benefit purposes must be used over time rather than fully in the current periods.

    In short, I still don’t have a definitive answer.

         
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    Posted: 18 March 2009 03:44 AM #15

    Capablanca, Mercel and DT

    Thank for enlightening on this issue.  The belief about subscription accounting is it would depress early quarters’ eps while inflating later quarters’ eps.  Is this belief still true?

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