Report: iPhone margins are nearly 60%
Turley Muller has been arguing for more than a year that Wall Street seriously underestimates the impact of the iPhone on Apple's (AAPL) bottom line.
Muller, a former mortgage trading analyst, currently unemployed, tracks Apple's performance in his blog Financial Alchemist, where his estimates of Apple's earnings put the Street's consensus to shame. Over the past four quarters, he has missed reported EPS by 4 cents, 2 cents, 1 cent and 0 cents, respectively. (In those same four quarters, the Street underestimated Apple's EPS by 15 cents, 40 cents, 24 cents and 18 cents.)
In fact, in our latest Analyzing the Analysts report, Muller's predictions were closer to actual results than any other analysts' in four categories out of seven — including the tricky non-GAAP revenues non-GAAP earnings.
On Wednesday Muller issued his third detailed report on the iPhone's profit margins, and it's an eye opener. Bottom line: Apple's gross margins on the iPhone are now so high — Muller's estimate is 58.4% — that the company can use them to subsidize price cuts on the rest of its product line without any noticeable impact on overall gross margins.
It's striking, says Muller, that Apple's typically conservative gross margin guidance for the fourth fiscal quarter, which ends in September, is an enviable 34%, despite all the mitigating factors pushing margins down — some of Apple's own doing, some coming from outside the company. Muller lists a few:
- [Apple] transitioned entire notebook line.
- Cut prices across entire notebook line and/or added increased performance.
- Back to School promotion (Mac discounts plus free 8GB iPod touch).
- Revenue mix shifted towards lower margin Macs from weak business spending affecting the Mac Pro line.
- Component prices increased, coupled with higher commodity and energy prices.
Offsetting all this are the iPhone's steadily rising gross margins, due to a complex mix of current and deferred revenue from several generations of iPhones — each with their own individual margins.
This is not an easy thing to explain. Muller takes a crack at in the full report — which you can read here. But the takeaway message is that profit margins from current iPhone sales are extraordinarily high, despite the $99 price tag on the original 8GB model, as summarized in Muller's final spreadsheet:
(Key: ASP = Average selling price; IP = Intellectual property; COGS = Cost of goods sold; GP = Gross profit)
See also:
The software also costs a great deal to develop.
ex ped: That issue has been raised and answered below, I believe.
Ok, folks, can we dispense with the "what about this" and "what about that?" The man gathered the relevant numbers to come up with an estimate of Apple's gross margins. He didn't the other numbers because those numbers are not relevant to a calculation of gross margin. Period. Before you begin browbeating someone for leaving out your pet statistic, do some basic accounting homework to find out how certain numbers are arrived upon. Then you can put forth a reasonably intelligent comment and not embarrass yourself.
What about AppleCare? What percentage of iPhone, iPod, and Mac buyers buy AppleCare? My informal poll says quite a bit. Is the 60% margin on the iPhone even larger due to all the AppleCare contracts?
@John from Portland
You are correct, the R&D costs are not included. However, those are one time costs. They were spent whether Apple made 1000 or 100,000,000 million units. You forgot to ask about marketing, advertising, and other sales costs. Those costs go up as more units are sold, but decrease on a per unit basis as the number of sold increases.
These costs are unknowable, as Apple doesn't release them. Muller calculates from what is known, as do other analysts. Given what can be computed, his results are impressive.
Your concerns are outside the scope of interest of this article.
@ Alan
I did include an estimate for labor and direct manufacturing overhead in the components line item.
Looking at the balance sheet – deferred revenue vs deferred costs, Q/Q, 58% on Q3 iPhone is about what it would take to move the combined GM accrued on the balance sheet from 52.9% to 55.2%
R&D costs are accounted for differently and are completely separate from profit margins. Companies associate these manufacturing/inventory costs in the Statement of Cash Flows where R&D shows up in the income statement. These are different financial statements designed to tell you different things about how the company uses money.
Research and production are separated financially. Think about it–research will never have income. It's always just expenses. Yes, the fruits of research lead to income and profit, but those are associated with a general overhead number used by the company.
When you make a "widget" the only labor costs you allocate to the product are those used to manufacture it. You don't say "well, we spent $1.2bn on R&D for the iPhone and have sold 20mm phones so we'll add $60 per phone to the profit definition. What if the R&D on the iPhone led directly to the super-ninja iTablet. Do you back-allocate a percentage of previously accounted dollars to a new product? Of course not. R&D is a sunk-cost and in poorly functioning companies a sinkhole. But in profitable companies sales drive revenues which are reinvested into innovation which creates new products which drives revenue. Very virtuous cycle.
Put much, much more simply…most profitable companies will chose an amount of R&D dollars to invest based on revenue numbers from the prior year. I don't pretend to know what Apple's number is, but these can range from 6%-20% of revenues. It's like reinvesting dividends. So the more Apple makes the more it can invest on a dollar amount even by keeping the percent invested the same.
Boy, there's a lot of crappy comments on this guy's blog from people who don't understand the basics of accounting or how companies function on the inside.
Turley's analysis has always been dead on. It's great to see a new article on The Financial Alchemist. Given his historic accuracy there is no better read going when planning your Apple investments. I'd much rather see Turley on TV that those jokers who repeatedly miss by so much and can't seem to improve over time (are they even trying?)
I've still been worried about GM and the issue I've been waiting for is the release of the oft rumoured "Macpad". New products like this definitely will pressure margins when first released. Still, it likely won't have that much weight early on so I might as just get used to Apple's low ball estimates and accept Turley's as gospel.
Of course he is not employed by the major financials. They would rather you sold your stock so they could buy it for well less than it's worth. They'd rather put out the typical Katherine Huberty type 'analysis' that doesn't even consider deferred revenues.
Sorry, John, but I think that the reason R&D, advertising, general company overhead, etcetera, is why it's called GROSS margin.
But you're right in that those things affect NET margin. Thus, the company that does no R&D or advertising can increase their net. But it's a short-term gain, because the truth of any business is that you have to spend money to make money.
@ John
You say: "You’re ignoring years of research and development cost."
Yes – this is exactly what Gross Margin means. The cost of sale minus the cost of producing the product. From Wikipedia:
"… can be defined as the amount of contribution to the business enterprise, after paying for direct-fixed and direct-variable unit costs…
Gross Profit = Revenue − Cost of Sales
Cost of Sales includes variable costs and fixed costs directly linked to the product, such as material and labor. It does not include indirect fixed costs like office expenses, rent, administrative costs, etc."
Some direct costs of sales of the iPhone (such as advertising and some distribution costs) are not included because of the deferred revenue accounting – according to Apple – so this gives iPhone a larger margin than would normally be expected. (Those other costs are rolled into the overall corporate admin expenses.)
Still – the simple price vs cost of production is a good principle measure of the profitability of a product. It is not the end-all as you acurately point out.
Where is the R&D cost factored into the iPhone? It's substantial and it's being ignored here. Components, royalties, shipping, packing, and a cable do not make an iPhone.
In his GM analysis, Turley Muller leaves out one of the essential product cost items that contributes to overall product cost: the cost of assembly & test. This cost factor would include the assembly factory overhead and labor cost for assembly and test, which is not included in the cost of individual components. Therefore his iPhone gross margin estimates are too high by at least several percent.
Muller and Elmer-DeWitt obviously believe Apple threw together a bunch of off-the-shelf parts to build an iPhone and turned it over to AT&T. You're ignoring years of research and development cost. You can't be that stupid. Can you?
ex ped: Huh? Can you explain to folks not as smart as you what exactly you are trying say?
It's funny how this is the kind of research PAID analysts like Munster and Wu are supposed to come out with.
If life were fair, Miller would have a job, and those two jokes would be unemployed.
Apple isn't getting any of its high margins for me.
I've got a free Motorola ROKR phone and a much more reasonable T-Mobile account to go with it.
@ Saul, Clearwater Fla
You make me happier than ever not to be Apple's customer.
Not now, not ever. Never a cent for Apple!