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Here's How Apple Will Benefit From Falling NAND Flash Prices

Ashraf Eassa, The Motley Fool

Apple (NASDAQ: AAPL) is a major consumer of memory chips. Each of the more than 217 million iPhones that the company sold during its fiscal year 2018 incorporated a sizable chunk of both DRAM -- which is a type of computer memory that's used as primary system memory -- and NAND flash -- which is used for storage in smartphones, PCs, and data center servers. 

Apple uses both DRAM and NAND in its other computing product lines, too, including the iPad, Mac, Apple Watch, and Apple TV.

Apple CEO Tim Cook at the company's product launch event.

Image source: Apple.

Because Apple uses memory chips so extensively across numerous product lines, the company's gross margin -- and, ultimately, its overall profitability -- depends somewhat on market conditions for both types of memory. When memory prices are high, Apple's gross margin could suffer; when they decline, its gross margin can benefit.

During Apple's most recent earnings call, analyst Katy Huberty asked Apple CFO Luca Maestri: "... [A]s a follow-up, NAND prices fell significantly during the September quarter. Why aren't we seeing that flow through to margin expansion for the overall company?"

Let's take a look at what Maestri had to say.

Maestri's answer

Maestri began by saying that Apple will "be getting some benefits from commodities in general and memory in particular," adding that "memory on a sequential basis [is] about 30 basis points favorable for us, going into the December quarter." 

Put another way, if everything else were held constant, Apple's gross margin -- which was 38.3% last quarter -- would be set to rise to 38.6% in the current quarter. That might not seem like a large jump, but consider that Apple guided to revenue of between $89 billion and $93 billion for the coming quarter. At the midpoint of that range -- $91 billion -- that memory-related improvement in gross margin would be worth about $273 million in pretax profit -- which is a lot of money.

What's the bad news?

Apple's guidance for the current quarter calls for gross margin to be between 38% and 38.5% -- below what that figure would be with the memory tailwind and all else being equal. Clearly, Apple is facing some gross margin headwinds elsewhere. 

Maestri provided investors with some insight into why Apple's gross margin guidance for the current quarter isn't better. 

On the positive side, Maestri explained that in addition to the memory tailwind, the company will "be benefiting from the leverage, which is typical of our seasonality in the December quarter." This simply means that because the company will ship significantly more product compared to the prior quarter, it can spread its fixed production costs across a larger sales base, improving gross margin. 

Maestri said, however, that "currencies have weakened against the U.S. dollar, and the impact we expect at the gross margin level from foreign exchange is a 90 basis point headwind sequentially." 

So, foreign exchange movements more than offset the good news on the commodity side of things. 

That's not all, though. Maestri also said that the company has "higher cost structures because, as I said, we've launched so many new products in the last six weeks."

As a reminder, back on Apple's earnings call in May, Maestri explained that "typically when we launch a new product, that product tends to have a higher cost structure than the product it replaces." On the bright side, Maestri explained at the time that although "that is something we need to work through every time we launch a new product ... we have a pretty good track record and history of taking those cost structures down over time."

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Ashraf Eassa has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple and is long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.