Apple's margin miss raises questions

SAN FRANCISCO (Reuters) - Apple Inc's profitability, long the envy of the tech sector, is coming under scrutiny after the company's rare margin miss halted Apple's surging shares in their tracks.

Apple's (AAPL.O) first margin miss in at least two years renewed chatter among some investors that its profitability may have peaked, as prices fall in the smartphone industry and the lower-margin iPad became a bigger part of the mix.

Margins aside, the company delivered another stellar quarter, with sales surging 67 percent and profit up 70 percent. But gross margin came in at 36.9 percent, below Wall Street's target of 38.2 percent despite improving component costs. The iPad also did not turn in the blockbuster performance many had anticipated.

Shares in the second-largest corporation in the S&P 500 fell as much as 5.6 percent in morning trade and closed down $8.51, or 2.7 percent, at $309.49.

The iPhone helped boost Apple's overall margins over past years, but may have peaked last year at 41.8 percent. But the latest model of the device, the iPhone 4, carries higher costs, analysts say, which could compress overall profitability going forward. The iPhone 4 was launched in June.

"There's no getting around that fact, the iPhone 4 margins aren't what we thought they were," said Pacific Crest Securities analyst Andy Hargreaves.

Hargreaves said it is not yet clear whether the lower margin on the iPhone was a one-time issue as the company ramps production, or more permanent. But Apple has already warned that margins will be impacted by the iPad, which it is pricing aggressively in a bid to dominate the fledgling tablet market.

Although Apple does not reveal margins for its individual product lines, BMO Capital markets analyst Keith Bachman estimated that iPhone margins declined to about 45 percent in the September quarter from 55 percent in the June quarter.

THE LION'S SHARE

The iPhone made up 43 percent of revenue in the September quarter. Stripping out carrier subsidies, the average selling price was $610, Apple said, comparable to the year-ago period.

Research group iSuppli estimated the iPhone 4's components cost $187.51, up from $170.80 for the previous model, although the cost differential may be even larger.

Some analysts see the iPhone margin crunch as temporary. Oppenheimer analyst Yair Reiner said the device's profitability should improve going forward.

"Ramping iPhone production as quickly as they were forced to do gummed up the works and forced Apple's supply chain to run less efficiently than it should," he said. "If history is any guide here, Apple will work out the kinks in its supply chain in the coming quarters."

Apple's margins should also benefit in the December quarter from foreign exchange and the potential release of a new operating system for the Mac, for which Apple will provide a sneak peek at a media event on Wednesday.

This quarter, Apple -- infamous for its conservative outlooks -- forecast a margin of only 36 percent, due to a higher proportion of the lower-margin iPads and iPods in its overall product mix. Analysts are targeting 37.6 percent.

Demand has not been an issue for the iPhone. The company sold 14.1 million iPhones in the fiscal fourth quarter, a surge of 91 percent and well above analysts' expectations. The device is now available through 166 carriers in 89 countries.

But it is facing stiff competition from phones running Google's (GOOG.O) Android software. Because Android is free for handset makers to license, it means phones that run off that software will in theory cost less to make and have more discounting room if needed.

There has been plenty of media attention in recent weeks on the rise of Android: the most popular platform among U.S. customers who bought smartphones in the past six months, despite the launch of the iPhone 4 in June, Nielsen reported.

So it was perhaps not surprising that Chief Executive Steve Jobs made a rare appearance on Apple's earnings call, where he lashed out at his rival. He called Google's claim that Android is an open operating system "disingenuous" and called the platform "fragmented."

Google declined to comment.

(Editing by Edwin Chan, Gary Hill)