Lion to be a massive profit generator in its launch quarter?

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    Posted: 05 June 2011 07:20 PM

    a few questions about Lion, and its effect on AAPL earnings:

    I always considered the iterations of Mac OS X a bit of a slightly above break-even component of apples product line, a necessary cost to keep the Mac sales chugging along by running the most innovative OS available.

    But with the recent few years of dramatic Mac sales growth, my question now is how big a revenue generator is Lion going to become by way of sales to pre-existing Mac owners upgrading?

    Over the last 3 - 4 years apple has sold 40 million plus Macs, all highly capable of running Lion. Presuming at least 50% of users upgrade in the first quater of release (Q3 or Q4?), and presume a upgrade price of $50 per upgrade, we end up with $1 billion of additional revenue in the launch quarter (or $2 billion if the upgrade price is $99).

    Of that $1 billon (or $2 billion), how is the COGS calcualted for Lion? Has the R&D for Lion over the last couple of years already been covered by development costs in previous quarters? meaning the revenue is mostly going straight to earnings, with minimal amount of cost for distribution?

    Has OS releases for apple become Microsoft-like? with a signifiacnt profit bump in the launch quarter of a new OS release? If so, has this been factored in by wall street?

    [ Edited: 05 June 2011 07:23 PM by Burgess ]

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  • Posted: 05 June 2011 08:14 PM #1

    To answer your question, Apple aggressively writes down R&D expenses until a product is nearly ready to ship leaving little of the costs to be amortized.

    Mac OS X commercial upgrades have a very high margin with the costs essentially limited to duplication, shipping and the amortization of the capitalized R&D.

    Lion is the first commercial upgrade since the release of Leopard in 2007 that comes to market at the full retail price of $129 (or whatever the retail price will be when released). Snow Leopard was made available for $29.

    Historically the bulk of the upgrade revenue comes in during the first two quarters following initial release and will generate sizable revenue for Apple.

    But much has changed in the four years since the release of Leopard including total revenue more than quadrupling from FY 2007 to FY 2011. Lion sales will have a definite impact on revenue but the percentage contribution to total revenue may not be as great as in years past.

         
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    Posted: 05 June 2011 08:15 PM #2

    iOSWeekly - 05 June 2011 10:20 PM

    a few questions about Lion, and its effect on AAPL earnings:

    I always considered the iterations of Mac OS X a bit of a slightly above break-even component of apples product line, a necessary cost to keep the Mac sales chugging along by running the most innovative OS available.

    But with the recent few years of dramatic Mac sales growth, my question now is how big a revenue generator is Lion going to become by way of sales to pre-existing Mac owners upgrading?

    Over the last 3 - 4 years apple has sold 40 million plus Macs, all highly capable of running Lion. Presuming at least 50% of users upgrade in the first quater of release (Q3 or Q4?), and presume a upgrade price of $50 per upgrade, we end up with $1 billion of additional revenue in the launch quarter (or $2 billion if the upgrade price is $99).

    Of that $1 billon (or $2 billion), how is the COGS calcualted for Lion? Has the R&D for Lion over the last couple of years already been covered by development costs in previous quarters? meaning the revenue is mostly going straight to earnings, with minimal amount of cost for distribution?

    Has OS releases for apple become Microsoft-like? with a signifiacnt profit bump in the launch quarter of a new OS release? If so, has this been factored in by wall street?

    Don’t have all your answers since we are missing some key data, like release date & price, but if you look at deagols model he tracks an estimate on installed base.  As far as the R&D most of it is expensed in previous qtrs, but I believe they can capitalize in the release qtr once they announce a release date.  The GM is probably in the 85-90% range for software so it is easy money for Apple.

         
  • Posted: 05 June 2011 08:20 PM #3

    pats - 05 June 2011 11:15 PM

    As far as the R&D most of it is expensed in previous qtrs, but I believe they can capitalize in the release qtr once they announce a release date.  The GM is probably in the 85-90% range for software so it is easy money for Apple.

    Agreed.  grin

    I haven’t been closely following the final developer builds. I’m assuming we’re close to a commercial release.

         
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    Posted: 05 June 2011 08:26 PM #4

    I agree, I’m thinking two weeks via the App store.  As far as the base I found a slide from the 2010 keynote


    As far as pace of upgrade here is a slide on one month in for Snow Leopard

    [ Edited: 05 June 2011 08:31 PM by pats ]      
  • Posted: 05 June 2011 09:08 PM #5

    Apple prices OS upgrades aggressively because its what makes the Mac platform so much better than the competition.  Apple is not reliant on this revenue source like MS so it can afford to penetrate its installed base of Macs to create the wide acceptance and satisfaction of a state of the art OS.

    I haven’t run any numbers to offer a range of EPS impact but don’t expect anything substantial.

         
  • Posted: 05 June 2011 09:57 PM #6

    Mercel - 06 June 2011 12:08 AM

    Apple prices OS upgrades aggressively because its what makes the Mac platform so much better than the competition.  Apple is not reliant on this revenue source like MS so it can afford to penetrate its installed base of Macs to create the wide acceptance and satisfaction of a state of the art OS.

    I haven’t run any numbers to offer a range of EPS impact but don’t expect anything substantial.

    There is, of course, a hardware sales benefit as well. many users take the opportunity to invest in new hardware at the time of major OS upgrades as means to “save” on the cost of the upgrade because it comes pre-installed on new personal computers. Watch for an additional sales boost to Mac hardware following the commercial release of Lion.

         
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    Posted: 05 June 2011 10:00 PM #7

    I hadn’t considered that lion may almost be ready for launch - If it happens in the last weekend of the quarter it would likely have the same profit impact as an iphone launch normally does.

    average GM% would also receive a big boost if PATS estimates are anything to go buy.

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    Posted: 05 June 2011 10:58 PM #8

    iOSWeekly - 06 June 2011 01:00 AM

    I hadn’t considered that lion may almost be ready for launch - If it happens in the last weekend of the quarter it would likely have the same profit impact as an iphone launch normally does.

    average GM% would also receive a big boost if PATS estimates are anything to go buy.

    While not announced there has been rampant speculation that Lion (via the app store) will be heavily discounted relative to historic norms for a new release. I seriously doubt that Lion OS sales will have more than a minor impact on the bottom line.

      JohnG

         
  • Posted: 05 June 2011 11:16 PM #9

    DawnTreader - 06 June 2011 12:57 AM
    Mercel - 06 June 2011 12:08 AM

    Apple prices OS upgrades aggressively because its what makes the Mac platform so much better than the competition.  Apple is not reliant on this revenue source like MS so it can afford to penetrate its installed base of Macs to create the wide acceptance and satisfaction of a state of the art OS.

    I haven’t run any numbers to offer a range of EPS impact but don’t expect anything substantial.

    There is, of course, a hardware sales benefit as well. many users take the opportunity to invest in new hardware at the time of major OS upgrades as means to “save” on the cost of the upgrade because it comes pre-installed on new personal computers. Watch for an additional sales boost to Mac hardware following the commercial release of Lion.

    There’s at least a residual benefit to hardware sales but if Apple prices it at $29 as they did Snow Leopard, the operative word is “residual.”  Given that SL was priced low because it featured “under-the-hood” improvements, Apple may price Lion somewhere between the $129 and $29 this time around.

         
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    Posted: 05 June 2011 11:27 PM #10

    johnG - 06 June 2011 01:58 AM
    iOSWeekly - 06 June 2011 01:00 AM

    I hadn’t considered that lion may almost be ready for launch - If it happens in the last weekend of the quarter it would likely have the same profit impact as an iphone launch normally does.

    average GM% would also receive a big boost if PATS estimates are anything to go buy.

    While not announced there has been rampant speculation that Lion (via the app store) will be heavily discounted relative to historic norms for a new release. I seriously doubt that Lion OS sales will have more than a minor impact on the bottom line.

      JohnG

    Even if only 20%-25% of existing mac users upgrade in the first quarter - thats 15 million copies or thereabouts sold at a very high gross margin - at $50 a unit (my guess) thats more than a minor impact on the bottom line - possibly up to 40-50c earnings per share in a quarter.

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    Posted: 06 June 2011 01:18 AM #11

    I’m less optimistic on both retail price and unit sales.

         
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    Posted: 06 June 2011 01:46 AM #12

    Treehouse - 06 June 2011 04:18 AM

    I’m less optimistic on both retail price and unit sales.

    do you mean a higher or lower retail price?

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  • Posted: 06 June 2011 02:41 AM #13

    Mercel - 06 June 2011 02:16 AM
    DawnTreader - 06 June 2011 12:57 AM
    Mercel - 06 June 2011 12:08 AM

    Apple prices OS upgrades aggressively because its what makes the Mac platform so much better than the competition.  Apple is not reliant on this revenue source like MS so it can afford to penetrate its installed base of Macs to create the wide acceptance and satisfaction of a state of the art OS.

    I haven’t run any numbers to offer a range of EPS impact but don’t expect anything substantial.

    There is, of course, a hardware sales benefit as well. many users take the opportunity to invest in new hardware at the time of major OS upgrades as means to “save” on the cost of the upgrade because it comes pre-installed on new personal computers. Watch for an additional sales boost to Mac hardware following the commercial release of Lion.

    There’s at least a residual benefit to hardware sales but if Apple prices it at $29 as they did Snow Leopard, the operative word is “residual.”  Given that SL was priced low because it featured “under-the-hood” improvements, Apple may price Lion somewhere between the $129 and $29 this time around.

    That’s my point. I expect Lion to be fully priced and purchasing the upgrade could be as much as 13% of the cost of a new system. Many consumers might opt to buy a new Mac and the impact of those particular sales won’t be reflected in Lion sales numbers.

         
  • Posted: 06 June 2011 03:09 AM #14

    Although Apple doesn’t normally capitalize R&D, in the case of OS development, I believe it capitalizes until release, then after release writes down over 3 years, and expenses post-release costs.

    In fact I think the general idea for all products is to expense R&D until the product is certain to ship; capitalize until ship, then write off over expected product life.

    The next release of OSX is always certain to ship, and sales normally continue a while after the following release, so 3 years is a reasonable estimate. You could argue that the following release also benefits from the R&D; another reason to extend to 3 years.

    It’s described in the 10-Ks.

         
  • Posted: 06 June 2011 03:10 AM #15

    DawnTreader - 06 June 2011 05:41 AM

    That’s my point. I expect Lion to be fully priced and purchasing the upgrade could be as much as 13% of the cost of a new system. Many consumers might opt to buy a new Mac and the impact of those particular sales won’t be reflected in Lion sales numbers.

    You and I would play that angle, but the regular consumer knows less about the current OS version than Lions, Tigers and Bears in the Wizard of Oz.  Just the other day, I was asked by a friend where she could buy an iPod Nano to wear as a watch (she was dazzled by the TikTok band I was sporting).  She thought of Best Buy first when I told her the Apple Store was closer to her—she looked puzzled and asked “Apple has a store?” 

    Another example:  I was showing people at a convention what they could do with their iPads and they were blown away with some of the apps I was running.  It really is worthwhile to step back and view Apple’s upside from the perspective of the average consumer—they are still in discovery mode.  That’s why Apple will sell 18M iPhones in Q3—too many are unaware of the normal refresh cycle to drop sequential sales from Q2.