Apple Inc. financials: adjusting the rosy picture
By Alexander Chepakovich, CFA 2011-10-19Yesterday Apple Inc. released its fourth quarter and whole year financial results. They are very impressive. Year-on-year net sales increased by 66 percent. This, combined with gross margin improvement from 39.4% to 40.5% and total operating expenses increasing by only 37%, resulted in a 84% jump in operating income (from 18.4 to 33.8 billion dollars). Net income increased accordingly (by a whopping 85%) from 14.0 to 25.9 billion dollars.
The company's stellar performance is remarkable by almost any measure. However, to get the true picture, one needs to adjust the nambers for the real cost of share-based compensation (or stock option plans - allegedly used by companies to stimulate creativity and productivity of their employees). For the fiscal year ended on September 24, 2011, the company reported combined share-based compensation expenses of $298 million. This is the calculated value of stock options awarded during the year. The calculation is done using the Black-Scholes option pricing model, which uses the stock's current market price, price volatility, the option's strike price, time to option expiration and short-term interest rates as inputs for calculation of the option's value. This number, however, is not even close to the actual cost of the share-based compensation arrangement.
Let's do some math. The number of shares outstanding increased by 13.307 million in the fiscal year. If the company has just sold them at the market price (the average share price during the period was around $340 per share), then it would have realized $4.5 billion. However, because the selling price for the stock issued when stock options are exercised is equal to the option's strike price, the accrual amount the company got from the issuance of new stock was only $831 million (as stated in the consolidated statement of cash flows). The difference ($3.7 billion) is what was pocketed by some very special employees of Apple Inc.
The cost of this extra employee compensation was borne by the company's shareholders, as the shares were in effect sold to the company employees at steep discounts to the market price.
Thus, the get the true net income, one needs to add $0.3bn to the reported number and subtract $3.7bn. The net effect will be minus $3.4 billion, or around $23 billion.
By the way, what did Apple do with such windfall profits? Out of the total cash of $37.5 billion generated by the company's operating activities, only about $8bn was used for purchase of tangible and intangible assets and acquisitions, the rest was "invested" in "marketable securities". Remarkably, with all this flood of cash, Apple does not pay any dividends.
As of September 24, 2011, Apple Inc. had $81 billion worth of cash and marketable securities. I would question the company's rationale for hording money. One can even suspect some sinister reasons for doing this, such as an attempt to boost or manipulate income.
In any case, I think distributing this cash to shareholders in the form of dividends or share buyback would be the right thing for Apple to do. The company has to leave it up to investors to decide what to do with the money. If they want to invest in a hedge fund, they, for sure, will find another way to doing this.