Apple Reinvents Consumer Electronics

| About: Apple Inc. (AAPL)

By Carl Howe

I'm still reeling from Wednesday's conference call with Peter Oppenheimer, CFO of Apple (NASDAQ:AAPL). Yes, we're going to have to redo our financial projections for Apple, but that's not the thing that's got my mind spinning. It's the fact that with very little fanfare, Apple has just blown past where everyone else was and reinvented the business model for its consumer electronics business.

We just published our Analyzing Apple report yesterday, but we're going to publish a revision free of charge today to all the people who bought it. This announcement completely changes the Apple forecast for the foreseeable future.

It was just last week that people were raving that Apple was going to introduce music subscriptions for iTunes. DRM companies like INTENT Mediaworks were claiming that it was almost a done deal because of the record labels' lust for recurring revenue.

They were so wrong.

Yes, Apple is introducing subscriptions. But they are for iPhones and Apple TV, not for music. And it's not like a subscription to the Boston Globe where you pay every month; it's like a subscription to the Wall Street Journal where you pay the full price up front, and the company gets to sit on your money. Nice work (and cash flow) if you can get it.

You can listen to Peter Oppenheimer yourself on the Apple earnings conference call or read it at SeekingAlpha.com. He dropped the bombshell in his opening remarks:

Before I talk about the outlook for the June quarter, I'd like to provide a little more information about our strategy for the iPhone and Apple TV and how we plan to account for them. We believe the iPhone is a revolutionary device that is years ahead of the competition. At Macworld, we demonstrated a number of the iPhone's breakthrough features, including its pioneering multi-touch display and user interface, visual voicemail, desktop class e-mail and web browsing, and of course, the best iPod ever.

We plan to build on this incredible foundation by continuing to develop new software features as well as entirely new applications and incorporate them into the iPhone. Since iPhone customers will likely be our best advocates for the product, we want to get them many of these new features and applications at no additional charge as they become available. Since we will be periodically providing new software features to iPhone customers free of charge, we will use subscription accounting and recognize the revenue and product cost of goods sold associated with iPhone handset sales on a straight line basis over 24 months. So while the cash from iPhone sales will be collected at the time of sale, we will be recording deferred revenue and costs of goods sold on our balance sheet, and amortizing both of them into our earnings on a straight line basis over 24 months. We will continue to expense our iPhone engineering, sales and marketing costs as we incur them. This accounting policy will have no impact on cash flow or the economics of our business.

Apple's proven capability to create innovative software gives us a tremendous competitive advantage in the consumer electronics industry. We are taking this bold step to leverage what we do best. We hope the result will be to surprise and delight our iPhone customers, which should result in happier customers and more customers as we enter this billion unit per year mobile phone market. We also plan to recognize payments from AT&T Cingular as revenue over time, as earned. We will report iPhone results each quarter that will include unit sales, and recognize revenue for iPhones, iPhone accessories and payments from AT&T Cingular.

Similar to iPhone, we plan to periodically provide new software features and enhancements at no charge to our Apple TV customers. We will also recognize the revenue and product cost of goods sold associated with Apple TV on a straight line basis over 24 months. This will be included in the other music-related products and services in the data summary we provide you each quarter. Additionally, we will provide you with a schedule each quarter in our earnings release that indicates the total deferred revenue, including the combined amounts related to the iPhone and Apple TV.

So instead of recording revenue from the sale of a $499 iPhone and the $100 Bluetooth headset and $79 iPhone Applecare on the day of a sale, Apple will instead record revenue of about $25 a month for that device for 24 months. The money that the consumer actually pays will go in an account called "deferred revenue."

Think of it as a prepaid 24-month subscription to the device, and you've got the picture.

Now this may appear to be just a detail for the accounting geeks among us. But it's not. Apple just added a whole lot of value to those required two-year Cingular contracts. What Apple just said is that unlike most phone handset makers, this isn't going to be device you re-buy every nine months or so to get the latest model. Based on the information Wednesday's earnings call, we predict the iPhone will be a device that gets better every six to twelve months you own it. The same goes for Apple TV too. Others may talk about reinventing consumer electronics; Apple just did it.

Now, lots of people, including the Wall Street Journal, were wondering if Cingular were crazy to sign up for an Apple phone sight-unseen and guarantee the company a cut in phone revenues, something no handset maker has ever been able to achieve. Now Cingular is looking crazy like a fox. Do you think you're going to get your iPhone updates if you pop out your Cingular subscriber card and move over to T-Mobile? I don't think so. Cingular is going to have iPhone customers locked in like there is no tomorrow, just for the visual voice mail and iPhone update features. And this is for a handset for which there is no subsidy and which won't be discounted until 2010 -- if then.

Oh my. You so don't want to be Motorola this morning. The KRZR just became KRZR.toast.

I'll save all this means for a separate iPhone post. But where earnings calls with most CFOs are dull as dirt, this one reinvented the business models for the mobile phone and TV industries. We'd love to be the company responsible for managing Apple's soon-to-be-collosal cash hoard. Apple's going to give Microsoft a run for "most money in the bank" around 2010.

All we can say is, if this is such unimportant news that it gets announced in an earnings call, I can't wait to hear Apple's big announcements this year.

UPDATE: MarketCircle CEO Alykhan Jetha had a similar reaction to mine. AppleInsider also noted the announcement as significant.

Full disclosure: the author owns Apple stock at the time of writing (and is very happy about that today too)

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Tagged: , Personal Computers, Earnings
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