This Day On The Street
Continue to site right-arrow
ADVERTISEMENT
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
TheStreet Open House

Why Apple Gets a Sell Rating

Stocks in this article: AAPL RIMM MSFT

By Chris Bulkey, principal analyst at Technology Research Group

Clarification from author: Last September, FASB approved Apple's request to change the way it accounts for iPhone sales. We addressed the accounting change in our F1Q10 earnings assessment titled "Disclosure and Transparency the Real Issues." The earnings press release disclosed the accounting change, but did not specifically quantify financial impact as it pertained to expectations for the quarter. Because the change was detailed in our F1Q10 assessment, we did not rehash the issue in this latest report. Comments on the year on year reduction in revenue deferrals were meant to call attention to the fact that Apple is now working with less "backlog" as a result of new accounting policies.

NEW YORK ( TheStreet) -- Apple (AAPL - Get Report) reported revenue and earnings of $13.5 billion and $3.33 per share for the second quarter of fiscal 2010 (TRG estimates: $12.02 billion and $2.44 per share).

On the surface this looks like a blowout quarter. Top and bottom-line growth totaled 49% and 86%, both well ahead of expectations. A look behind the numbers suggests otherwise.

Aggressive earnings management comes as no surprise. As noted in previous reports, accounting concerns emerged in fiscal 2009 and accelerated in F1Q10. What does surprise us is the fact that smart money does not appear to be seeing through the trickery. Shares are up sharply in initial after hours trading - misguided bullishness in our view.

Revenue Recognition

Signs of backlog reduction were again apparent. Deferred revenue was reduced 75% year on year and also moved lower on a sequential basis. The decline over the preceding quarter would seem plausible given lower volume (sales down 14% vs. F1Q10). In the previous year, however, revenue deferrals nearly tripled amid 48% sequential sales decline. A reversal of historical tendencies in this latest quarter aggravates the measurable year on year reduction and should raise a red flag.

Earnings Quality

If we normalize reduced R&D expenses (year on year basis, as a % of revenue) and a lenient tax rate, earnings fall to $2.93 per share in sustainable operating terms (12% below reported levels). Precise tax deferrals won't be known until the 10-Q is filed, but we note that corresponding line items on the balance sheet were down roughly 25% year on year (thus pointing to some degree of earnings management). Similarly, we'll have to wait for the 10-Q to assess discretionary expense capitalization and product warranty accounting - both of which were sources of non-operational income in previous quarters. If recent trends hold, sustainable operating earnings will fall even further after factoring in these items.

R&D spending not only raises suspicion in terms of a year on year decline, but the problem becomes even more acute on a comparable basis. Competitor Research In Motion (RIMM), rated sell, spent 6.50% of revenue on product development in its latest quarter as compared to only 3.16% for Apple.

1 of 2

Check Out Our Best Services for Investors

Action Alerts PLUS

Jim Cramer and Stephanie Link reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

Jim Cramer's protégé, David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
Try it NOW
Try it NOW
Try it NOW

Check Out Our Best Services for Investors

Dividend Stock Advisor

Jim Cramer's protégé, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Options Profits

Our options trading pros provide over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • Actionable options commentary and news
  • Real-time trading community
Try it NOW
Try it NOW
Try it NOW
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!

Markets

DOW 17,164.95 -251.90 -1.45%
S&P 500 1,994.99 -26.26 -1.30%
NASDAQ 4,635.24 -48.1670 -1.03%

Partners Compare Online Brokers

Free Reports

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs