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Opaque Transparency: Dissecting AAPL's FY15 Reporting Changes

On Monday’s earnings call, AAPL disclosed a number of reporting changes that would occur beginning with its first fiscal quarter of 2015 (Dec-14). These prospective reporting changes are a classic move to disguise the performance and metrics of two of its newest products.

On its FQ4 earnings call on October 20th, AAPL announced a series of new reporting changes that will begin in FQ1 2015 (Dec-2014).  These changes include:

  • Segment reporting: Historically, AAPL has reported sales on a geographic level for all of its indirect sales distribution and then included a segment called "retail", which effectively captured all of its direct (brick-and-mortar and online) sales.  It will now allocate those retail sales to the geography in which those sales occur and will eliminate the "retail" segment altogether.
  • iTunes, software and services: AAPL will begin rolling in its Apple Pay revenue into the category called "iTunes, Software, and Services", which previously included the net payments for iTunes sales, iOS App purchases (30% retention), AppleCare. Mac App Store, and some other miscellaneous items.
  • Creation of "Other" product category: Previously, AAPL's six main product categories were iPhone, iPad, iPod, Mac, iTunes Software and Services, and Accessories.  AAPL will now condense that to five categories with the elimination of iPod and Accessories, and the addition of "Other".  Other will include iPod, Apple branded accessories, 3rd party accessories, Beats hardware sales, and starting in FQ2 (Mar-2015), Apple Watch.

All of these changes seem 'logical' and somewhat benign at first-glance, but clearly there is a reason for these changes.  AAPL is very deliberate and strategic with any changes its makes, especially with the information it presents to the public in its SEC filings, and after a second look, it appears as though AAPL may be looking to disguise more of its business performance than highlight it.  Here are some thoughts:

  • Retail: The change to the segment reporting is by-far the most "logical" of the changes.  As explained on the call, the elimination of retail as a category better aligns with how management evaluates the business, which is by geography with the associated retail sales of those geographies.  AAPL Retail is heavily concentrated in the Americas region, with nearly 60% of its stores in the United States alone. That said, this new reporting change will boost the Americas region on a revenue basis.  In its most recent quarter (Sept-14), the Americas made up roughly 40% of sales.  China revenue was suppressed by the inability to obtain regulatory approvals on the new iPhone 6 models until FQ1 (Dec-14).  One possible rationale (beyond alignment of management's evaluation) for this particular reporting change may be to show less dependence on foreign sales by allocating retail sales (the majority of which will go to the Americas) by geography.
  • iTunes, Software and Services: Clearly, this reporting update (not change) is to disguise (or rather, not disclose) Apple Pay revenue.  Cook mentioned on the call that there is contractual relationships with the banking institutions (which we knew already) and that those contracts are private matters.  AAPL is rumored to be getting a cut (% of dollar spend) off every Apple Pay transaction.  What that number is, nobody will ever know as it will be embedded in this product category.  What is interesting is that the company usually discloses total iTunes and App Store billings (gross amount) on its earnings calls. Analysts will certainly be trolling for any data they can get out of management as it relates to Apple Pay (# of points-of-sale, additional retailer sign-ups, geographic roll-out, gross dollar transactions of Apple Pay, etc.). 
  • Other: This is the change that I think caught most analysts off-guard, and specifically, the notion that Apple Watch would be rolled up into this nebulous category effectively known as miscellaneous. When asked if the inclusion of Apple Watch in "Other" signaled the company's expectations for the product as "muted", Cook was very quick to dispel that idea.  In fact, he went so far as to say exactly why the company is including Apple Watch in "Other", which is to not disclose unit sales, ASPs or other relevant sales data for competitors to see.  This could become a real problem for analysts if the Apple Watch does end up gaining traction.  Many analysts are modeling a $450 ASP on the Watch (mix of all three models), so if the company were able to move a couple million units in the first quarter of availability, you're talking about nearly a billion dollars of revenue - still not that significant. However, the question will become, at what point will AAPL start breaking out Watch data - when it becomes five billion? ten billion?  

What's interesting about the Watch this is that AAPL broke out iPhone and iPad data separately from nearly the beginning of the product launches.  Perhaps this lack of transparency on Watch performance is based on lessons learned from the past?   The iPod is now a rounding error and its inclusion in this new category was destined to happen - one of the big questions is how long it retains a tab on the AAPL online store website with the other products, rather than being shoved into "accessories"?  I think inclusion of Beats here is also a "logical" choice based on the nature of the product and the fact that AAPL has no desire to show the revenue run-rate of this acquisition.

In any case, these reporting changes and updates were done in a very deliberate manner and designed for the "double-down on secrecy" theme.  Some of them (like segment reporting) are not going to make much of a difference to analysts.  Others, like the roll-ups of Apple Pay and Apple Watch into larger categories will cause nightmares for analysts - at least that is the hope.  The bigger that these revenue streams are, the harder the quarterly financials will be to model out.