By Philip Elmer-DeWitt
July 18, 2009

Apple’s (AAPL) fiscal third quarter earnings are due out Tuesday, July 21, and once again the Street is focused on the big numbers — revenues, earnings and units sold for the Mac, iPhone and iPod.

But savvy analysts will be paying closer attention to the number that is the best measure of a firm’s profitibilty: gross margin, expressed as the ratio of profits to revenues. Or

(Revenue – Cost of sales) / Revenue

Apple’s gross margins, which have averaged 34.8% over the past eight quarters, are the envy of the industry. Dell’s (DELL) first quarter GM, by contrast, was 17.6% and the company warned Wall Street last week that it is expecting a “modest decline” next quarter.

In its April earnings call, Apple low-balled its guidance numbers as usual, forecasting a sharp drop in gross margins over the next 6 months. Specifically, it warned analysts to expect no better than 33% in Q3 and “about 30%” in Q4.

But Turley Muller, for one, doesn’t buy those numbers, and he should know.

Muller, who publishes a blog called Financial Alchemist, is one of a small group of amateur analysts who track Apple closely and publish quarterly estimates that are as good as — and often better than — the professionals’. In fact Muller’s earnings estimates for Q2 were the best of the lot, missing the actual results by just one penny (see here.)

For Q3, he’s expecting Apple to report earnings of $1.35 per share on revenue of $8.3 billion — far higher than the Street’s consensus ($1.16 on $8.16 billion).

Why the discrepancy?

“Again the story appears to be gross margin,” he writes. “Just like last quarter, when Apple blew out the GM number with 36.4% (just as I had predicted) this quarter’s GM (3Q) should be roughly the same as last quarter.

The secret, he says, is in the profitability of the iPhone, “which is through the roof.”

“Apple tries to deflect that,” he says, but the evidence is right there, buried in a chart he found in Apple’s SEC filings (see below). It shows Apple’s schedule for deferred costs and revenue for the iPhone and Apple TV, which for legal reasons are spread out over 24 months rather than being recorded at the time of sale. Because Apple TV revenue is so small relative to the iPhone, this chart is a pretty good proxy for the iPhone alone.

This is complicated stuff, but the bottom line, as Muller points out, is that iPhone profitability has been rising to the point where gross margins on the device are over 50%.

Muller expects the revenue mix for Q3 to be roughly the same as Q2, except “with less low margin iPod revenue and more high margin iPhone revenue.”

He acknowledges that Mac and iPod margins will be lower due to the recent MacBook price cuts and the impact of Apple’s aggressive back to school promotions. “But on balance,” he concludes, “I expect overall gross margin to remain robust around 36.5%.”

For Muller’s detailed guide to calculating gross margins on the iPhone, see here.

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