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My favorite joke with my daughters as they were learning their multiplication tables was, "Why can't you say 288 on the radio?" Because it is "Two Gross." (2 x 144) This article will not be about a dozen, dozen, rather about Gross Margins [GM]. We will look at what the impact of GM will be to Apple (NASDAQ:AAPL) and their earnings for the upcoming FY13 Q1 earnings report due out after the bell on Wednesday, January 23, 2013. To see my explanation of how much impact the 13-week quarter will have when comparing last year's 14-week quarter, click here.

Since Apple reported FY 2012 Q4 earnings on October 25, 2012, its stock has continued the downhill slide. The fall started after it closed at an all-time high of $700.09 on September 21, 2012. Since then, Apple's closing price on Friday of $500.00 has wiped away more than $188B in market capitalization. On the earnings conference call, Apple guided to a very conservative and very low 36.0% GM. This was 400 basis points less than their 40.0% GM results in Q4 FY12.

For those who are new to investing, Gross Margin calculates the percentage of revenue left after subtracting out the cost of goods sold (COGS) or cost of revenue. Using FY12 Q4 earnings as an example, GM was 40.0% of $36.0B in total revenue. In other words if a computer sells for $100 and the GM is 40%, it costs the company $60 for the components, labor, and shipping. Using actual FY12 Q4 numbers, the 40% GM from the $36B in revenue left $14.4B. This $14.4B figure is Gross Profit.

After calculating Gross Profit (Revenue minus COGS), there are a few other calculations you need to do before you get to Earnings or Net Income. In Apple's case, there are relatively fixed expenses that must be deducted. (I am simplifying for the sake of new investors.) Those expenses include Operating Expenses which are further broken down: it includes both Research & Development (R&D), and Selling, General & Administrative. For FY12 Q4, operating expenses totaled $3.46B. If you subtract $3.46B from the $14.4B, that leaves $10.94B. This $10.94B figure is called the Operating Income. We are almost to Net Income...

The last calculation to get to Net Income is adding/subtracting Other Income (usually from investments or interest) and subtracting the taxes. Since Apple has virtually zero long term debt, interest expense is zero. Other Income has averaged out to $0.125B per quarter over the past year. Taxes for Apple have been 25.16% of all of FY12 and was 24.51% in Q4 of FY12. That amounted to $2.67B in tax for Q4. What's the bottom line? (Literally, net income is known in Wall Street gibberish as the Bottom Line.) Net Income for Apple in Q4 FY12 was 8.223B.

To get earnings per share or EPS, divide the Net Income by the number of outstanding shares. According to Yahoo! Finance, just over 940 million shares remained outstanding. That is how Apple calculated earnings of $8.67/share in FY12 Q4.

Here is why you must understand the impact of GM to earnings: Since the Revenue of $35.996B and Gross Profit of $14.401B is substantially larger than the Net Income of $8.223B, even 1% increase or decrease in GM will dramatically affect the smaller EPS number. If GM was 41% in Q4, the Gross Profit would have been $14.746B and the Net Income would have been $8.483B after taxes. That is $260M more in Net Income. That equates to nearly $0.28 per share more in earnings. Can you imagine how different the headlines would have been last October if they had beat by $0.20/share versus an $0.08/share miss? (Analysts' EPS estimate was $8.75 and actual came in at $8.67.)

I predict results will prove to be a blowout on Revenue. I believe Earnings will modestly beat street estimates. (I do not believe the widespread hysteria that Google (NASDAQ:GOOG), Amazon (NASDAQ:AMZN), Samsung (OTC:SSNLF), Nokia (NYSE:NOK), RIM (RIMM) are stealing Apple's lunch money. Remember, when the pie is growing like the mobile phone revolution, losing a percentage or two in tablet market share does not mean you lost!) Take a look at what the street is expecting according to Yahoo! Finance: Revenue 54.7B, EPS $13.41. Apple guided to Revenue of $52B and EPS of $11.75. Compare how much Apple beat their own conservative Revenue guidance in the last two holiday quarters: (All data in the next three tables derived from Apple's Income Statements and Press Releases)

Apple's Revenue - Guidance versus Actual

Holiday QuarterGuidanceActual% Rev Beat
FY11 Q1$23B$26.741B16.27%
FY12 Q1$37B$46.333B25.21%
FY13 Q1$52B????

The next table will examine potential Revenue if Apple beats by the same percentage as previous holiday quarters:

Apple's FY13 Q1 Revenue Potential

$52B GuidanceIf they beat by 16.27%$60.46B
$52B GuidanceIf they beat by 25.21%$65.11B

Now lets look at GM guidance versus actual results for the last two holiday quarters:

Apple - Gross Margin History
 GM GuidanceGM ActualBasis Point Difference
FY11 Q136.0%38.5%250
FY12 Q140.0%44.7%470
FY13 Q136.0%????

I recommend you check the most comprehensive earnings compilation before Apple reports which is provided by CNN Money's Apple 2.0. There you will see the many guesses of the pros and independents on everything from Revenue, to EPS, to iPhones, iPads, iPods, Macs and GM.

Expectations are all over the map. Let's explore projections from two analysts I highly respect. One is an independent and one is a pro. Mr. Horace Dediu with Asymco has said he is forecasting Revenue of $60.00B, EPS of $15.74 and GM of 39.8%. This is after he modeled 55.5M iPhones, 11.2M iPods, 5.0M Macs and 24.4M iPads. Mr. Gene Munster with Piper Jaffray has said he is forecasting Revenue of $57.05B, EPS of $13.73 and GM of 39.0%. This is after he modeled 50.0M iPhones, 12.3M iPods, 4.83M Macs and 25.0M iPads.

FY13 Q1 Earnings Estimates - AAPL
Horace Dediu$60.00B39.8%$15.7455.5M11.2M5.00M24.4M
Gene Munster$57.05B39.0%$13.7350.0M12.3M4.83M25.0M

Using what we have learned, examine what happens if Dediu or Munster are high or low on calculated GM. Last December, the actual GM came in at 44.6% and last Sept. quarter the actual GM came in at 40.0%. Since this is all over the place and since Apple guided low to 36.0%, we'll examine the impact on Gross Profit, Net Income and EPS with differing GMs. Realize that Apple guided to $4.05B or 7.8% of revenue outlook. [My assumptions for FY13 Q1 to complete chart: Dediu--R&D and Selling G & A are $3.95B; Income tax rate is 25.0%; shares outstanding increased this quarter to 950M. Munster--R&D and Selling G & A is $4.86B for Munster (unless he is just low-balling earnings - which is entirely possible); Income tax rate is 25.0%; shares outstanding 950M.]

The following table reflects projections if their GM changes and net effect on EPS.

Gross Margins - The Bottom Line Impact
If GM is 2% higher$60.00B41.8%$25.08B$15.85B$16.68
If GM is 1% higher$60.00B40.8%$24.48B$15.40B$16.21
Horace Dediu-Calculated$60.00B39.8%$23.88B$14.95B$15.74
If GM is 1% lower$60.00B38.8%$23.28B$14.50B$15.26
If GM is 2% lower$60.00B37.8%$22.68B$14.05B$14.79
If GM is 2% higher$57.05B41.0%$23.39B$13.89B$14.63
If GM is 1% higher$57.05B40.0%$22.82B$13.47B$14.18
Gene Munster-Calculated$57.05B39.0%$22.25B$13.04B$13.73
If GM is 1% lower$57.05B38.0%$21.68B$12.62B$13.28
If GM is 2% lower$57.05B37.0%$21.11B$12.19B$12.83

So a 100 basis point move of Dediu's GM would affect EPS by $0.47. The same 100 basis point move of Munster's GM would affect EPS by $0.45. Since the average estimate for EPS is $13.41 this quarter, 45 or 47 cents makes a big difference in a miss or a beat.

Now you see why Apple's FY13 Q1 is a Gross Margin game. I hope you learned something and look forward to the discussion in the comments. Follow me to see my next article on what we learn about the iPad mini's effect on margins based on Wednesday's earnings conference call. I am also planning on writing an article about the difference between the income tax provisioned and the actual tax paid--Where does the rest go? Hint, you can find it on the balance sheet.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long common and Feb 13 ITM Calls