My Oppenheimer Code posts for the prior two fiscal quarters are now collected in the Earnings Previews + Archive section.
I know what maybe 20-30 of you1 may be thinking after reading the post title and likely groaning at the 100th bad pun I’ve tried.
“Wait, isn’t now the time
on Sprockets when we dance where that home gamer AAPL blogger takes a quick look at gross margin? So what’s this about operating margin now? I mean, that’s gross margin and then OpEx!”
It sure is! You’re not alone in wondering whether this is getting above my pay grade. (Which for this blog, is…well…zero. 😀 ) And I’m not sure, to borrow a phrase from Tim Cook, where the string will lead (which is to say, how useful looking at operating margin will really be).
But there is a reason why I’ll be introducing some basic operating margin commentary for at least this quarter (in addition to gross margin discussion), and likely for the foreseeable future of the Oppenheimer Code series. No, that reason is not “because I should have been doing this from the beginning.” 😛
The reason (or maybe “catalyst” is more appropriate?) is China Mobile.
So…why is China Mobile causing me to study up on operating margin now? (Yup, I’m not even a journalist and here I am burying the lede, but at least I think this is fun. 😛 ) Because China Mobile has over 763 million subscribers, 181 million on 3G, none of whom have had access to an iOS product with TD-LTE or even TD-SCDMA 3G networking until now. And they pretty much all are resident within a certain revenue geography classified by Apple just a few quarters ago.
I’m well aware many of you are ahead of me on this stuff, but hey, if you’re still reading, there’s this section on Apple’s quarterly and annual reports that I won’t overlook going forward:
The following table shows information by operating segment for the three- and nine-month periods ended June 29, 2013 and June 30, 2012 (in millions):
Three Months Ended Nine Months Ended June 29,
Americas: Net sales $ 14,405 $ 12,806 $ 48,798 $ 43,702 Operating income $ 5,140 $ 5,161 $ 17,637 $ 18,082 Europe: Net sales $ 7,614 $ 8,237 $ 29,878 $ 28,300 Operating income $ 2,450 $ 3,229 $ 10,308 $ 11,834 Greater China: Net sales $ 4,641 $ 5,389 $ 19,684 $ 17,106 Operating income $ 1,440 $ 2,468 $ 6,771 $ 7,955 Japan: Net sales $ 2,543 $ 2,009 $ 10,121 $ 8,204 Operating income $ 1,343 $ 1,068 $ 5,158 $ 4,600 Rest of Asia Pacific: Net sales $ 2,046 $ 2,498 $ 9,201 $ 8,631 Operating income $ 729 $ 878 $ 3,098 $ 3,549 Retail: Net sales $ 4,074 $ 4,084 $ 15,756 $ 14,599 Operating income $ 667 $ 828 $ 3,316 $ 3,833
Look for it within the “Segment Information and Geographic Data” Note of Apple’s 10-Q and 10-K filings – Apple’s operating income data by revenue geography. (Boldface emphasis on “Greater China” is mine.)
As you can see, Apple reports five revenue geographies, not including Retail (Apple Retail Stores): The Americas, Europe, Greater China (newly added for fiscal Q1 2013), Japan, and the “Rest of Asia Pacific”.
Of course, this data is high-level and intentionally opaque (why give your competitors any more information than the SEC requires you to disclose to the public, after all?). Net sales and operating income are all that Oppenheimer and company are providing on the regional/retail level. Meaning that you’re left with guesswork at best should you wish to attempt apportioning COGS and OpEx for each region. 2
At the same time, there are certain assumptions that should stand on half-decently-solid ground. Certain components of manufacturing cost of an iPhone (the enclosure, the chip, the NAND flash, the display, etc.) should be fairly similar for a given model across all revenue geographies, for instance. At a high level, gross margin should be determined more by product mix than the costs of selling in any particular country or group of countries. 3 (At least, management has never implied otherwise.)
On the OpEx side of things, Apple will presumably scale employees, overhead and other SG&A-type costs to a degree commensurate with both (a) the current scale of the revenue geography and, to a lesser (?) extent, (b) the perceived potential of the revenue geography. In short, while no two revenue geographies are alike, I’m gonna go out on a limb and say that none of the five revenue geographies is a substantial outlier in terms of proportionate share of COGS or OpEx. Meaning that it might be possible to get a degree of understanding as to the relative pre-tax profit contribution of each revenue geography to Apple’s bottom line.
You’re welcome to disagree – and if you do, you might want to just close the browser window or skip over to the gross margin discussion – but I’m thinking that expanding the margin discussion to at least acknowledge the five revenue geographies will prove helpful in grasping that extra bit of understanding about Apple’s financials. A drop in the ocean, perhaps, but you gotta start somewhere.
So first, some not-at-all-expert discussion on operating margin, which we’ll keep to the five revenue geographies for simplicity’s sake.
Why not Retail? To oversimplify (hey, I’m a simple person), it’s kind of a different beast. Important, for sure, but disparate – of the 13 countries the Apple Retail Stores are in, the vast majority (by number) are in the US. On a related note, those far fewer Apple Stores located in the Greater China segment probably have absolutely ridiculous – but unquantifiable – revenues compared to, say, an average mall store in the US.
Also, Apple Retail Stores, which are also resellers of non-Apple product, have in the aggregate had operating margins lower than 25% for most of the past 12 quarters – levels that none of the other revenue geographies have ever seen in that same span of time. Which does make sense, given a less Apple-centric product mix, and especially the overhead costs necessarily associated with the brick-and-mortar (and glass and steel and wood) points of sale. So I’m leaving Retail out of the operating margin discussion, at least for now.
Now for a new chart for this part of the Oppenheimer Code. (It’s probably best you open this in a new window.)
I’ve charted operating margin geography results from fiscal Q1 2011 onward (which is far back as they go for Greater China in any case). Please don’t mind if it looks a little cluttered – I haven’t tried anything quite like this on Excel before, and combining a stacked column chart with a line chart (2-axis) with 10 different sets of data takes some time to figure out at first. Operating margins are lines (hand-selected colors for better contrast!), the stacked column chart “in the background” represents operating segment revenue for a bit of “optional” additional context (again, excluding Retail). I kept that “faded” so as to not add too much more distraction than there already is. Now, I’m no chart expert but I figured this one out before too long, so my hope is it shouldn’t take you too long to get your bearings here.
All right. Now that you’ve had a chance to look things over, any takeaways from this data? Nothing definitive, of course, and there’s probably all kinds of takeaways/methods to parse the data. But real quick, sure, some things jump right out at you:
– Apple clearly loves Japan (purple line) – it’s a huge profit center and very deserving of its own revenue geography, even though, well, it’s the only “geography” that’s also a single country. It’ll be interesting to see if operating margin “falls” into the high 40s. I know, high 40s…kind of a drop, right. (That may have been sarcasm just then.)
– All geographies are significantly off their highs in operating margin percentage – yet another way of visualizing Apple’s intentional, but poorly-communicated (maybe even non-communicated) shift in margin strategy.
– Two geographies – the Americas (blue line) and maybe Rest of Asia Pacific (black line) – are showing relatively stable operating margins on the cusp of the holiday quarter. (Speaking of which, operating margins did NOT peak in the first fiscal quarter of 2011 and 2012 for most geographies.)
– The Americas geography has had the most stable operating margin since the fiscal Q1 2013 quarter, and the only one in “uptrend” for fiscal 2013.
– One of the geographies (green line) is by far the “lowest-performing”, and unlike the others, has hit a definitive low in operating margin lately.
– That geography (which of course is Greater China) will include a whole bunch of China Mobile subscribers very soon. And in the short term, those subscribers will newly have access to only one Apple product category which just so happens to be the hands-down margin leader. (For future reference, Greater China segment revenue was $8.213B for the March 2013 quarter, a modest 7.5% increase YOY.) Well, if nothing else, call it a probable new margin tailwind amidst the margin “crosswinds” for the March quarter.
So, in a fairly compact nutshell, that’s the reason why I’ve decided to start tracking segment revenue and operating margin. Could be pretty decent timing, considering!
To wrap up, some quick thoughts on gross margin.
– As you know, Oppenheimer guided gross margins in the range of 36.5%-37.5%. The “lower than expected” GM range was impacted a fair amount by the increase in deferrals on account of Apple’s new free included software strategy. Just my home game numbers, mind you, but I’ve estimated a net impact of 80 or so basis points on account of deferred revenue/gross margin solely attributable to the increased deferrals. 4
– “All things being equal”, we’re starting to see the general margin picture forming with respect to the iPhone/iPad mix, at least how it was in fiscal 2013. For now the overarching margin narratives remain refreshingly simple. 5 iPhones enhance overall gross margin. iPads reduce it. Revenue leverage has a direct impact on gross margin. Apple improves margin efficiency as it travels down the cost curve for its current generation of products.
– Potentially relevant subplots, some of which may have few-to-no answers or clues: Will iPhone 5S mix outpace the iPhone 5? What of the 4S vs. the 4? Will Apple provide any *ahem* color on their expectations for the 5C, and will any analyst bother to ask? How are iPad Air and mini retina margins relative to their previous-generation predecessors? Will iPad 2 and iPad mini 1 be significant factors in the iPad unit mix? Will Apple see reduced high-end/lower-ASP product mix (presumably reducing gross margin) as the 2014 fiscal quarters “count down” to Apple’s major product refreshes?
– Mac (a Mac Pro could be three “normal Macs” worth of revenue) and iTunes/software/services (a steady growth category) might have a larger role to play in the March/June/September quarters – for now iPhone and iPad will (continue to) dominate the gross margin conversation, so to speak.
– China Mobile is a tremendous unknown, and by itself could improve Apple’s gross margin for the rest of the fiscal year (I mean, iPhones, right?) – though whether that happens depends on when TD-LTE iPad Air and iPad mini retina models ship, and how well they’re received by China Mobile subscribers or would-be subscribers. Considering that iPhone 5 and iPad 4/mini 1 had identical cellular connectivity, and the new China Mobile deal, TD-LTE iPads really don’t seem like a matter of “if”. Of course, I doubt Apple or anyone on the Street will mind too much if China Mobile sells a ton of “margin-dilutive” TD-LTE iPads to its subscribers along with iPhones.
Next up, to conclude the 5-part Oppenheimer Code series (before my home game estimates, if I can get around to them): The Wall Street expectations game.
1 My thanks for stopping by and making my blog a slowly more-visited home on the Web! Comments, feedback, follows, retweets, etc. are always welcome!
2 I won’t even try to extrapolate per-region gross margin or OpEx from each geography.
3 I presume, but correct me if I’m wrong, that stuff like VAT, import duties, etc. are considered taxes and therefore are excluded from the operating income analysis.
4 In other words, I attempted to work backwards from Oppenheimer’s comment on sequential increase in deferred revenue, which includes both “new” deferrals and “revenue that would have been deferred anyway under the existing system”.
5 There are other factors of course, such as currency, component cost/trends, etc., but they’re not regularly mentioned as significant factors by Oppenheimer to the best of my recollection.