Apple’s true gross margin, when you remove warranty accruals, has been more stable than its reported results.
Apple’s reported gross margins over the past eight quarters have been between 36.9% and 40.0%.
Warranty accruals have ranged from 1.6% to 3.7% of revenue.
Over the past eight quarters Apple’s gross margin ex-warranty accruals have been between 39.0% and 42.0%.
Apple's (NASDAQ:AAPL) gross margin is subject to intense scrutiny, as it should be, when it announces its quarterly results. With the iPhone generating over 50% of the company's total revenue each new iPhone is critical not just for the revenue it generates but its profitability since its margins are higher than Apple's other hardware products.
It is worthwhile to analyze what percentage warranty accruals are of revenue and the cyclical nature of them pre and post launch of new iPhones as they can have a tremendous impact on EPS. While warranty accruals are impacted by other products, namely iPads, the iPhone's costs probably overwhelm Apple's other products.
An example of this is from the recently-reported June quarter. Apple's warranty accruals decreased from 2.7% of revenue in the March quarter to 2.0% in the June quarter. If the accruals had remained flat gross margin would have been 38.7% vs. 39.4% and EPS would have been $1.24 vs. $1.28. Since the Street had been expecting Apple to report $1.23 in EPS a penny beat may not have generated as much excitement as the actual nickel.
Below are what warranty accruals have been for the past four iPhone launches
I have outlined below the warranty accruals as a percent of revenue from the quarter before the previous four iPhone launches to the subsequent quarter or two. It is worthwhile to see what the accrual "cycles" have been a prelude to Apple's iPhone 6 introduction.
The iPhone 4 was launched on June 24, 2010. Warranty accruals were 1.0% for the March and June 2010 quarters but increased to 2.2% in the September quarter for a 120 basis point increase.
The iPhone 4S didn't experience much of an increase in the quarters around its launch in October 2011. It was first available on the 14th with warranty accruals increasing only 30 basis points from 1.5% of revenue in the September 2011 quarter to 1.8% in the December quarter.
The iPhone 5 had a 70 basis point increase in its warranty accruals from the prior quarter to launch to its first quarter of availability (0.9% in the June 2012 quarter to 1.6% in the September quarter) but it increased by 160 basis points when you take it out to the December 2012 quarter. This timeframe does include the introduction of the iPad4 and first iPad Mini but it may be an indication of the additional warranty expense when a larger screen iPhone was introduced.
In the March 2013 quarter Apple had a one-time warranty accrual charge of $414 million or 0.95% of revenue to adjust its warranty timeframes. This was between iPhone launches so it doesn't come into play in this analysis.
Apple also experienced a significant increase in warranty accruals when the iPhone 5c and 5s were introduced. In the June 2013 quarter accruals were 2.1% of revenue but increased to 3.7% in the September quarter (160 basis points) and only dropped to 3.6% in the December quarter (150 basis points).
What could happen with the iPhone 6
There are two major factors that will have a large impact on earnings when the iPhone 6 is launched, one that could increase accruals and another that would help offset the impact. The negative impact to Apple will be any new technology or larger screen size of the iPhone 6. If it does come out with a sapphire screen this will be the first time it has been used in a large size. It should be more reliable since it is a harder material but there are enough unknowns that until it is in the hands of consumers it would be prudent on Apple's part to increase accruals.
The offset to a margin hit would be a higher price for the iPhone 6. There is a lot of speculation that a 4.7" iPhone will have the same price as the current 5s but that a 5.5" iPhone will sell for $100 more than the 5s. A higher price could more than offset a 150 to 200 margin impact.
Except for the iPhone 4S the previous three iPhone launches have seen warranty accruals (and therefore its gross margin impact) increase between 120 to 160 basis points. I would expect the iPhone 6 to experience a similar increase in accruals and since the June 2014 quarter's accruals were 2.0% of revenue it would not surprise me to see it increase to between 3.5% to 3.8% of revenue.
Apple has guided gross margins for the September quarter to be between 37.0% and 38.0%, down from 39.4% in the June quarter (down between 140 and 240 basis points). Its guidance looks to fully account for the potential impact from higher warranty accruals.
Keep in mind that Apple has been meeting or beating the high-end of its gross margin guidance for the past four quarters and for the past two has beaten it by 130 and 140 basis points, respectively.
I'm currently projecting gross margin to come in at 38.3% or 30 basis points above its high-end of guidance. Once we get the sizes, specs and pricing for the iPhone 6 I'll revisit this estimate.