Wednesday, July 29, 2009

The iPhone, Innovation and Subscription Accounting

I credit Mike in Helsinki of the Apple Finance Board forum for approaching the issue of the iPhone's contributions to Apple's non-GAAP revenue in the June quarter. Because Apple recognizes iPhone revenue based on a subscription revenue model, recognizing the revenue and earnings over the anticipated economic life of the product (two years), the iPhone's importance to Apple's reported bottom line is obscured while iPhone unit sales rise relative to corresponding prior periods.

In the current quarter (period ending in September), the iPhone may contribute more in revenue to Apple's corporate coffers than the Mac. While GAAP (or reported revenue and earnings) will reflect only the portions of current and prior iPhone sales to be recognized under the subscription method of accounting, the total revenue (what's reported and what's deferred to future periods) on iPhone handset sales may be greater than all Mac sales combined.

The iPod provided revenue cover for Apple while the Mac line made its transition to Intel chips. The Mac returned the favor during explosive sales growth following the transition to provide revenue cover while Apple developed the iPhone. The iPhone will provide the rich revenue to cover Apple's development costs for new products including chips developed inside Apple specifically for handheld devices.

While Apple may continue to use Intel chips exclusively for the Mac line for some time to come, the chips for the next generation of handheld products may be of Apple's design origin.

The subscription method of accounting for the iPhone reduces the reported revenue arc in current periods but extends the benefit of those sales to reported revenue and earnings for two years from the time of sale. As long as iPhone handset sales continue to grow in comparison to prior year periods, Apple is virtually guaranteed rising quarterly profits should the rate of Mac unit sales growth slow or remain static in relation to corresponding prior periods.

With the prospects for future profits growing brighter with each iPhone unit sold, there's no reason for Apple to reduce its R&D investment or commitment to new product development for the sake of operating margins. It provides Apple with clarity to its future earnings picture unlike any of its competitors and more than ample resources from operations to further the company's innovation lead over those competitors.

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