Apple (AAPL 0.64%) introduced a new, non-GAAP metric recently. Given the company's historical dependence on mostly GAAP metrics, it has taken some slack in the media for adopting the measure. But the fact is that it's a very useful metric, and it gives investors excellent insight into an important aspect of the Mac maker's business.
Image source: Apple.
An undervalued segment gets a key metric
Not only is Apple's user base loyal to the company's portfolio of devices, but their spending on content on these devices has grown over the years. Indeed, these revenue sources have become so important to Apple that in its most recent quarter, the company's "Services" segment, which includes revenue from Internet services like Apple Music, AppleCare, Apple Pay, licensing, and other services, became the company's second-largest segment when measured by revenue for the first time.
In Q2 alone, Apple's services segment revenue was about $6 billion, or 11.8% of total revenue during the quarter. Even more, its services segment revenue was up 20% compared to the year-ago quarter, while revenue in iPhone, iPad, and Mac segments was down 18%, 19%, and 9%, respectively.
As services becomes increasingly important to Apple's results, the tech giant is now providing investors a more accurate picture how this segment is growing, thus Apple's new non-GAAP metric measuring "purchase value of services" tied to Apple's installed base of active devices.
This new metric looks at the gross value of content and services Apple users are purchasing. The metric adjusts for all content and services to be reported on a gross basis instead of some being reported on a net basis and others on a gross basis. Put simply, it essentially levels the playing field for the way all installed-base-related purchases are accounted for.
iOS App Store. Image source: Apple.
Or, in more specific terms, here's exactly how and why Apple adjusts "App Store and certain digital content" installed-base-related purchases to reflect unrecognized services and content purchases, straight from Apple's financial statement:
Apple accounts for such purchases on a net basis by recognizing in Services revenue only the commission it retains from each purchase. This non-GAAP adjustment reflects the portion of the gross amounts billed to customers that Apple remits to third-party app developers and certain digital content owners. Apple considers non-GAAP installed base related purchases to be a useful metric for investors and management as it provides a more complete picture of the transactions generated by the installed base.
For years, analysts have tried to articulate the hidden value in Apple's services segment by emphasizing that the company's fast-growing app store revenue, in particular, is not counted for on a gross basis while other items included in the segment are, thus understating the total segment's growth. But now, with this new metric, investors can accurately assess the progress Apple is making with growing this important segment.
More potential than you think
Apple CEO Tim Cook put the new metric, and its importance to the company, into context during its most recent quarterly conference call (via a Seeking Alpha transcript):
As we discussed on this call in January, those 1 billion-plus active devices are a source of recurring revenue that is growing independent of the unit shipments we report every three months. In fact, the purchase value of services tied to our installed base was a record $9.9 billion in the March quarter, up 27% over last year, accelerating from the 24% growth rate we reported in the December quarter.
The key thing to highlight in this remark from Cook is that the Q2 year-over-year growth rate in purchase value tied to Apple's installed base actually accelerated compared to Q1.
Investors should continue to keep an eye on this metric. It highlights a key source of potential future growth for the Apple. And, significantly, growth coming from the purchase value of services tied to Apple's installed base will be both more reliable and predictable than its unit sales of new products, making revenue from the segment critical to the tech giant.
