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Does Apple Get $36 Monthly Service Revenue for Each iPhone?

Apple iPhone by any other standard would still sell wellIn Apple's earnings announcement the other day, it would be easy to overlook that it was starting to report results in both GAAP (generally accepted accounting principles) and non-GAAP forms. Accounting standards are a soporific to many, but when a company moves from one to the other, it's time to pay attention -- particularly when, like Apple, the company won't be using the same form of reporting as used by its competitors in what will likely be one of its major product lines: cell phones. But the combination of the two reports offer some insight into just how much money an iPhone makes for the company.

Moving away from one standard to another means a good chance that the numbers you've always heard no longer mean what they used to. Apple recently started adding non-GAAP results, which puts a whole different spin on its last earnings announcements. The argument for doing so sounds reasonable on the surface:

Management uses Adjusted Sales to evaluate the Company's growth rate, revenue mix and performance relative to competitors. Given the significant increase in iPhone unit sales during the quarter ended September 27, 2008, Adjusted Sales provides a meaningful measurement of the Company's growth by reflecting amounts generally due to Apple at the time of sale related to products sold within the period. Further, eliminating the effects of deferred revenue (current sales deferred to future periods and prior sales being recognized currently) provides more transparency into the Company's underlying sales trends.
In other words, Apple wants to deemphasize the subscription nature of much of its revenue and costs, as GAAP requires. Usually when money is collected up front for product or service use that lasts some period of time, the amount is recognized in portions over that period (two years in the case of the iPhone).

The SEC requires reporting in GAAP but doesn't prevent companies from using other systems as well. It's not unusual for tech companies to offer non-GAAP interpretations, particularly if the GAAP rules force an awkward treatment that doesn't realistically reflect the company's economics and market. However, there's a danger when a company reports in this manner and then tries to compare its operations with those of a competitor. Cell phone service revenues are often recognized over time. Apple's getting some portion of the service charges. But to talk about all the revenue up front when someone might drop service, particularly if economic times are bad, and other service-based companies recognize revenue over time is not a way to better competitive understanding. Clearly revenue from selling a Mac is recognized up front because the machine is sold and that is that. This is possibly one way to make one company's numbers look better than those of another one. Now you have to start asking whether the numbers are really Apple to apples comparisons.

The combination of numbers does show some interesting things. Last quarter's GAAP revenue $7.9 billion, but the non-GAAP was $11.68 billion. Given that Apple TV is probably a financially negligible product, the amount in two-year service revenue is probably on the order of $3 billion. As Apple sold 6,892,000 iPhones, that would work out to about $435 dollars in its cut of service revenue, or $36 a month per phone. That is on top of the cost of the unit itself. So, as some are suggesting, Apple literally could drop the iPhone price to $99 and still make a bundle. The question is how long the service providers will be able to cough up that amount of the service revenue given the worsening economic climate. If Apple has that much room, and more, to play with pricing, carriers might decide that they're taking the big chance and not getting enough return for their investment.

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