On Wednesday, when Apple announces its fiscal 2009 first-quarter earnings, the business press will rush to report the key metrics: number of units sold for Macs, iPods and iPhones, as well as overall company sales, earnings, and gross margins.

But according to some long-time Apple watchers, what really matters tomorrow is whether reporters and analysts will fail — once again — to recognize the rapidly growing value of Apple's hidden revenue stream.

That revenue stream — roughly 40% higher than the one everybody is focused on — flows from the sales of iPhones, which grew 583% in fiscal year 2008. Most analysts, however, don't include it in their reports to clients because it isn't recorded in Apple's books.

The problem stems from a decision that Bullish Cross' Andy Zaky calls "one of the worst in Apple's history." Rather than recognize income from sales of the iPhone in the quarter in which it is collected, Apple spreads it out over eight quarters — the life of a typical iPhone contract.

Deferred earnings: Apple’s hidden revenue bonus

The result of this so-called subscription accounting is that revenue from the iPhone in any one quarter is like an iceberg: we only see the tip of it. The other 7/8ths are sitting in Apple's coffers, waiting to be parceled out in future earnings reports.

The failure of traders to take those 7/8ths into account is one of the reasons — along with concerns about the CEO's health and the global economic slowdown — that Apple's (AAPL) share price has fallen in just over a year from $202 to the low $80s.

"What we have here," wrote Zaky on Monday in a post entitled How the iPhone and Poor Apple Management have contributed to the Downfall of Apple, "is a perfect recipe for media misrepresentation, analyst confusion and market disorientation regarding Apple's fundamentals."

The day Apple released its iPhone revenue bomb

In October, Apple finally addressed the problem. Making a rare telephone appearance in an Apple's quarterly earnings call with reporters and analysts, Steve Jobs tried to focus their attention on Apple's so-called non-GAAP (generally accepted accounting practices) earnings.

"Because by its nature subscription accounting spreads the impact of iPhone's contribution to Apple's overall sales, gross margin, and net income over two years, it can make it more difficult for the average Apple manager or the average investor to evaluate the company's overall performance. As long as our iPhone business was small relative to our Mac and music businesses, this didn't really matter much. But this past quarter, as you heard, our iPhone business has grown to about $4.6 billion, or 39% of Apple's total business, clearly too big for Apple management or investors to ignore. Hence our introduction today of non-GAAP financial results alongside our reported GAAP results.

As you can see, the non-GAAP financial results are truly stunning. By eliminating subscription accounting, adjusted sales for the quarter were $11.68 billion, 48% higher than the reported revenue of $7.9 billion, while adjusted income was $2.44 billion, 115% higher than the reported net income of $1.14 billion. Adjusted net income that is more than double our reported income — if this isn't stunning, I don't know what is, all due to the incredible success of the iPhone 3G." (transcript)

Apple's stock jumped 18% in after-hours trading as some traders realized that the analysts they follow had underestimated Apple's earnings by nearly $3.8 billion.

For many Apple investors, the key question tomorrow is whether Apple will sufficiently emphasize adjusted earnings in their quarterly report. For example, will they compare adjusted earnings for this quarter with the same quarter last year, giving analysts — for the first time — a metric by which they can report year-to-year non-GAAP growth?

Zaky wants the company to drop generally accepted accounting practices altogether. He writes:

"Apple should immediately cease giving GAAP-based earnings guidance and instead offer guidance on adjusted earnings. If Steve Jobs really wants the market to shift its focus from Apple's GAAP-based earnings to real earnings, then he really needs to start offering guidance on an adjusted basis – a practice that several other tech companies already employ." (link)

Below the fold: Zaky's charts comparing Apple's adjusted price-to-earnings and price-to-cash ratios to those of Google (GOOG), Amazon (AMZN), RIM (RIMM) and other major tech companies. Needless to say, he believes that given Apple's growth rate and balance sheet, its shares are vastly undervalued.

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Blogger-analyst Andy Zaky, whose earnings estimates for Apple (AAPL) this year have proved considerably more accurate than the professionals' (see here), is predicting "the mother of all earnings blowouts" when the Christmas quarter's results come in.

In a preliminary report published Monday on Seeking Alpha and his blog Bullish Cross, Zaky estimates that when Apple releases its fiscal 2009 Q1 results in January, it will report earnings of $1.96 per share on sales of $11.29 billion — significantly higher than the $1.44 EPS on $10.08 billion that the pros are currently modeling.

"That would be the largest revenue beat by any company I've ever seen," writes Zaky, who attributes the gap between his numbers and the Street's to "irrational bearish exuberance."

Shrugging off concerns about consumer spending this quarter, Zaky is calling for sales growth in all three of Apple main product lines:

• iPods: 22 million units (up from 11.05 million in Q4)
• Macs: 2.8 million (up from 2.61 million)
• iPhones: 8 million (up from 6.89 million)

Note that Zaky, as the name of his blog suggests, is bullish — and long — on Apple and tends to err on the side of optimism. His 2008 Q4 predictions overshot actual results for both iPhones (7.5m est. vs. 6.89m act.) and Macs (2.9m est. vs. 2.61m act.).

[Wall Street, by contrast, is betting that iPhone unit sales -- like geese -- will head south this winter. On Friday, Barclays Capital trimmed its Q1 estimate to 5 million iPhones from 6.2 million. (link)]

But even Zaky's Q1 sales estimate of $11.29 billion pales beside what he calls Apple's "real" sales and earnings. These are the adjusted — or non-GAAP — numbers that Apple released for the first time last quarter. They include deferred revenue from sales of iPhones — which by generally accepted accounting principles (GAAP) are spread out over 24 months (see The day Apple released its iPhone revenue bomb).

When Zaky estimates Apple's earnings using non-GAAP numbers, the gap between the Street's "consensus" and his "reality" grows even wider. As the table below shows, Zaky is calling for non-GAAP sales of $15.22 billion and earnings of an astonishing $3.54 a share.

The only Wall Street analyst I've found who has projected non-GAAP earnings for this quarter is Piper Jaffray's Gene Munster. He has Apple earning $2.70 per share (non-GAAP) in Q1 on adjusted sales of $12.4 billion.

For Zaky's complete analysis — including bullish and bearish scenarios — see his full report at Bullish Cross here.

There’s a theory favored by savvy Apple watchers that the first generation iPhone — greeted with such hoopla last year — was not actually the real thing.

That iPhone – the one that hundreds of thousands of Americans queued up to buy for up to $599 apiece, the one that Time magazine named the Invention of the Year, the one that six million people purchased before Apple finally stopped making them in May – was just a trial balloon floated by Steve Jobs to test the airwaves.

According to this theory, the real iPhone – the one aimed at the broadest possible market here and abroad — would start at $199, the magic price point at which consumer electronics devices seem to take off and become mass market phenomena. It would have built-in GPS location tracking, "push" e-mail, and wireless syncing with corporate enterprise networks. Most important, it would run hundreds of third-party applications available through an online App Store and operate over so-called third generation (3G) cellular networks that are two to five times faster than the one used by that first, prototype iPhone.

If this theory is true, then the real iPhone era begins on Friday, July 11, at 8:00 a.m.

That's when the iPhone 3G goes on sale at Apple (AAPL) and AT&T (T) outlets in the United States and at the stores of Apple's cellular partners in some 20 other countries around the world. (Strictly speaking, the era begins early Thursday, when the device goes on sale at 12:01 a.m. New Zealand time. Given how the Earth turns, that corresponds to 8:00 a.m. July 10 at Apple's New York City flagship store and 5:01 a.m. at its Cupertino headquarters.)

Some things about the new iPhone haven't changed. Physically, it's almost identical to the first. Same touch screen, same dimensions — except for the back, which is slightly bulgier and made of black plastic instead of metal.

Conceptually, it's still one device that combines three of today's most popular technologies — cellular communications, portable digital music and wireless access to e-mail and the World Wide Web.

And the fundamental breakthrough is the same: unlike most devices that combine several functions and do none of them well, the iPhone puts together three must-have functions and does at least two of them better than they have ever been done before.

Early reviews suggest that the one thing the first iPhone was not particularly good at — telephony — is much improved in the second version, thanks to a redesigned audio system and, perhaps, improvements in AT&T's network.

There's still no physical keyboard, so devotees of RIM's (RIMM) BlackBerry who were turned off by the lack of tactile feedback when dialing or texting on the first iPhone are not likely to be turned on by the second. The battery is still not user-replaceable, a shortcoming that may be even more important this time given the power demands of operating at 3G speeds. (One early reviewer who was getting nine hours of Internet use on the first iPhone clocked less than six hours on the second. See here.)

The built-in camera is the same under-2 megapixel device that can't do video. There's still no way to cut and paste text. And you are still married to AT&T's cellular network for the life of a two-year contract, at least in the United States. In fact, the bonds of that matrimony may be even stronger this time around, given the way AT&T has set up the in-store activation procedure, and will cost U.S. customers at least $10 a month more.

There are many small improvements. You can search address books, delete e-mails en masse, set parental controls and save e-mailed photos. (These improvements will also be available to owners of the original iPhone as part of a free software upgrade.)

Investors will note that Apple has made major changes in its business model. Rather than testing the waters with a handful of exclusive contracts — first with AT&T, then with O2 (TEF) in England, T-Mobile (DT) in Germany and Orange (FTE) in France — Apple has gone global this time, with deals in six of the seven continents and more than 70 countries. To do this, however, it has had to largely abandon the arrangement — unique among cell phone manufacturers — by which carriers sold the iPhone for full price and kicked back a share of their monthly revenue to Apple, which was accounted for in monthly increments over the life of a cell phone contract (usually 24 months).

Steve Jobs was able to dictate these terms — quite advantageous to Apple — because the carriers recognized that being first to sell the iPhone would win them thousands of new customers. In most of the new markets Apple is entering this year, it is acting more like a conventional cellphone manufacturer, taking its (sizeable) profits upfront and letting the carriers subsidize the device with voice and data plans as costly as local market conditions will allow. (See Canada's Rogers Communications (RCI), here for example, to see what kinds of problems this can lead to.) The price of the iPhone itself also varies widely, from as much as $888 for pre-paid phones in Italy to $75 in Mexico and free with certain data plans in the U.K.

Except for those costs, none of this affects the experience of the users.

For them, what will really distinguish this iPhone from the one that preceded it — and from every other smartphone out there — is the flood of software expected to be unleashed when the App Store opens on Friday. Apple has already demonstrated more than a dozen third-party programs for the iPhone, and over the next few months you can expect to hear about hundreds more: business apps that take advantage of the iPhones ability to "push" data down the network when it's available (rather than when it's requested); games that use the device's accelerometer to navigate virtual space; shopping and social networking programs that use satellite tracking to tell you what shops or restaurants and which of your friends (or enemies) are near the spot where you are, right now.

In the end, every successful computing device is ultimately a software "platform," a vehicle for the programs that give it its true value. This is where the real iPhone will stand out, and judging from the interest among the 4,000 third-party developers who have already signed up to write for it, it's got a good headstart.

Last July, Apple (AAPL) announced that revenue from the iPhone would be recorded in an unusual way. Like Apple Care and Apple TV, iPhone sales would not be booked when the device was sold — as they are for a Mac or an iPod — but spread out over the life of the iPhone (set, somewhat arbitrarily, at two years).

More than seven months have passed and nobody — not the analysts, not the investors, and certainly not Wall Street — has quite wrapped their mind around what this bookkeeping oddity means for Apple's bottom line. That's in part because it's complicated, and in part because Apple hasn't provided all the data you would need to fully assess its impact.

But as we enter the fourth quarter of iPhone sales, those so-called deferred earnings are adding up, and some professional Apple watchers are starting to realize that their impact could be substantial. In fact, if the company hits its iPhone sales targets, these earnings could become a windfall — a revenue bomb that explodes to the benefit of shareholders.

The rules by which Apple records revenue from iPhone sales are spelled out in the 10-Q filed with the SEC on Aug. 8, 2007:

The Company began shipping Apple TV in March 2007 and iPhone in June 2007. For both Apple TV and iPhone, the Company may provide future unspecified features and additional software products free of charge to customers. Therefore, sales of Apple TV and iPhone handsets are recognized under subscription accounting in accordance with Statement of Position (“SOP”) No. 97-2. The Company recognizes the associated revenue and cost of goods sold on a straight-line basis over the currently-estimated 24-month economic lives of these products. Costs incurred by the Company for engineering, sales, and marketing are expensed as incurred. (link)

Sounds straightforward enough. But because of the way Apple reports its earnings and its costs of goods sold, it's not so easy to track. And to the dismay of Apple shareholders, the fact that these deferred earnings are piling up seems to have gone right over the heads of the institutional investors who have driven Apple shares down nearly 75 points since December.

One Apple investor who has been beating the deferred revenue drum is Stephen Rosenmen at Seeking Alpha. He's published three articles on the subject since Apple's Q1 earnings report, including one posted today in which he takes a stab at estimating how big Apple's hidden revenue backlog has grown:

To date these deferred revenues have become substantial: current quarter revenue deferred iPhones and iTV (Apple doesn't separate the two) are $816 million with a total of accumulated deferred revenues of $816 million + $624 million, or 1.4 billion dollars in future revenues to be spread out over approximately the next 7 quarters. That doesn't include the rest of the also substantial AppleCare and other deferred revenues which together with the iPhone/iTV create a total deferred revenue base of 3.288 billion. (link)

As Rosenmen points out, those $3 billion and change are not going away. They are like backordered Boeing jets or offshore oil reserves — the equivalent of money in the bank. Moreover, the quarterly revenue from iPhone reserves climbs exponentially as iPhone sales grow — each quarterly payment consisting of 1/8 of that quarter's revenue plus 1/8 of the revenue of each of the previous seven quarters.

The participants at The Mac Observer's Apple Finance Board have been harping on this theme for weeks now, none more vehemently than the investor who calls himself Dawn Trader. He's looking for the bomb to explode in eight or nine quarters:

As we move into the latter quarters of FY 2010, even assuming modest growth in unit sales, the iPhone may be delivering as much as $1.00 eps per quarter from current and deferred revenue recognition not including the monthly service revenue from AT&T.

Below the fold, Rosenman's chart showing the growth of deferred revenues over the past five quarters (the exclamation points are his):

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