Higher iPad Sales to Dampen Apple's Gross Margins

Apple expects gross margins to decrease next year as the iPad—which yields lower margins than the iPhone 4—forms a larger share of the firm's revenue, the company reported in a 10-K filing Wednesday.

Apple iPhone 4
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Apple iPhone 4

The news is not entirely surprising. As indicated in its earnings report last week, the company expects margins for the current quarter to fall to 36 percent, down from an average of about 39.4 percent in fiscal 2010. Apple cited aggressive pricing of the iPad as part of the reason for the dip, and margins are still expected to remain above 2008 levels of 35.2 percent.

Still, the news prompted investors to bid the stock lower after-hours.

Brian Marshall, an analyst at investment bank Gleacher & Co., remains bullish on Apple shares into next year. He sees any drop in the share price as an opportunity for those who currently do not hold Apple to start buying.

In the long-run, Apple remains confident in its earnings potential. Stronger-than-expected demand for the iPhone 4could counter-balance the effect of increasing iPad sales on margins.

On the other hand, margins will remain on the low side if demand for the iPad continues to grow—at least until Apple can drive down the cost of the iPad's display. The iPod Touch could also provide a bit of a drag on margins, since it contains many of the iPhone 4's components at a fraction of the price.

Margins will trend a bit higher if Apple can meet supply of the iPhone 4, and if it sells more high-end Macs with the arrival of OS X Lion in the middle of the year. (The launch of the next iPhone in summer 2011 should also give a boost to margins.) The debut of the MacApp store in January and the expansion of iPhone service to Verizon subscribers could also help boost earnings.