Microsoft® reports earnings in three operating segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing.
This segmentation is said to align reporting with CEO Satya Nadella’s vision for the company.
This document is structured in the following manner:
Summary of the Financial results for FY2017, Q1
Revenue and Operating Income for FY2017, Q1
Contributions by Business Segment
Microsoft’s Volume Licensing Revenue Summary for FY2017, Q1
Predictions for the future and products that have recently been released or will be launched during coming months.
Summary of the Financial Results
Microsoft surprised analyst’s once again, by reporting better than expected earnings for the first quarter of their 2017 fiscal year. The software giant reported adjusted revenue of $22.33 billion (up from $21.67 billion a year earlier), or $0.76 per share (non-GAAP). This exceeded Wall Street expectations of $21.71 billion and $0.68 EPS.
Microsoft returned $6.6 billion to shareholders during the quarter in the form of dividends and share repurchases.
The company reported contracted, not billed revenue of $25.5 billion. Contracted, not billed is primarily sales from volume licensing agreements which have been booked but not yet recorded. This is a positive indication of future business, suggesting that momentum continues to grow.
We continue to focus on Microsoft’s cloud business as that is the likely replacement to offset losses resulting from declining PC sales. Revenue from the Intelligent Cloud business was up 8% to $6.4 billion.
Revenue and Operating Income (FY17 1st Quarter)
Unless otherwise noted, the numbers presented herein do not consider constant currency (CC) calculations which are used to provide a non-GAAP framework for assessing business performance while excluding foreign currency rate fluctuations.
Contributions by Business Segment
Productivity and Business
Revenue in Productivity and Business grew 6% to $6.7 billion as key products such as cloud services, Office 365™, and Dynamics™ CRM all grew respectably. Revenue from Office commercial products and cloud services grew 5%, driven by a 40% increase in Office 365 Commercial seats and a 51% increase in Office 365 commercial revenue growth. Microsoft reports that there are more than 85 million active commercial Office 365 users.
Dynamics products and cloud services revenue was up 11%, thanks largely to increases in Dynamics online revenue. Dynamics CRM Online paid seats grew by more than 2.5 times.
On the consumer side, Microsoft reports that Office 365 now has approximately 24 million subscribers, with Office and cloud revenue increasing by 8%.
Revenue in the Intelligent Cloud segment rose 8% to $6.4 billion, led by server products and cloud services with an increase of 11%. Azure™ revenue was up 116% with usage of Azure compute more than doubling year-over-year.
Enterprise Services increased 1% with growth in Premiere Support and consulting services.
More Personal Computing
Once again, revenue in the More Personal Computing segment was down, this time by 2%, to $9.3 billion. This was primarily due to declines in phone revenue (72%) and gaming revenue (5%).
Windows OEM revenue was flat year over year, as were Windows commercial products and cloud services.
On the positive side, revenue from Surface devices increased by 38%, and search advertising revenue (excluding traffic acquisition costs) was up 9%.
Volume Licensing Revenue Summary (Q1 FY17)
The reporting segments make it difficult to isolate Volume Licensing revenue, although during the earnings call Microsoft did report that “Commercial bookings” were up 18% year-over-year.
The company continues to report unearned revenue from Volume Licensing programs. Unearned revenue represents customer billings for multi-year licensing arrangements paid either at inception of the agreement or annually at the beginning of each billing coverage period, often referred to as “Contracted not billed”. Also included in unearned revenue are payments for post-delivery support and consulting services to be performed in the future. Microsoft currently reports $25.5 billion in unearned revenue.
We consider the risks facing Microsoft when we analyze the Financial Year. For more information on identified risks, refer to the “Management’s Discussion and Analysis of Financial Conditions and Results of Operations” and “Risk Factors” sections of Microsoft SEC filings. These can be obtained at http://www.Microsoft.com/investor/.
For the sake of this document, we would like to highlight significant risks for Microsoft. Understanding these risks may provide you with leverage when negotiating your agreement.
VMware™ – AWS™ Partnership
Microsoft is betting heavily upon Azure as they attempt to gain market share in the cloud and they have been able to leverage existing relationships with their Volume Licensing customers. Since it’s rare for an organization to completely abandon their on-prem datacenters and make an overnight move to the cloud, many opt for a transitional approach, or hybrid solution. This has created unique opportunities for Microsoft since they already have relationships with most enterprise customers. With Azure and some compelling licensing options, companies can move to the cloud at their own pace, and do so without adding another service provider.
Despite Microsoft’s ability to leverage their existing relationships, Amazon™ Web Services (AWS) dominates the cloud, and they achieved that without a compelling hybrid offering. The partnership with VMware introduces an enterprise class hybrid solution which will further strengthen Amazon’s position and should be seen as a threat to Microsoft and others.
Universal Windows Platform
The Universal Windows Platform (UWP) was intended to be a single Windows foundation and development environment which could be shared among PCs and mobile devices. The strategy was to create a single platform so that developers could write their code without having to re-write or modify it to run on different device types such as Windows Phones or Xbox. That’s an interesting strategy, and would be even more interesting if Microsoft had a successful phone, but since even a combined Windows environment represents such a small portion of the OS market share today, the strategy failed to attract a significant number of developers. Microsoft later expanded the strategy with the introduction of “bridges”, which would effectively apply the same standardization to Android and iOS devices as well. This was consistent with CEO Satya Nadella’s goal of making Microsoft products available on non-MS platforms, but the execution largely collapsed when Microsoft stopped supporting the Android bridge.
Microsoft plans to complete the LinkedIn acquisition during the second quarter of fiscal year 2017. They will not include the financial impact of LinkedIn in their guidance for the quarter, but rather, they will report LinkedIn results separately. Beginning in FYQ3, LinkedIn results will be reported as part of Productivity and Business.
FY17 Predictions and Roadmap Information
Windows Server Licensing Changes
The change from per-processor licensing to the new per-core model became effective last month when Windows Server 2016 was released, so this is hardly a prediction at this point, although we believe Microsoft will apply this model to other products whenever they can. Microsoft defends the change as a means to become consistent with other products such as Azure, SQL Server, and BizTalk. There is certainly value in consistency, but it’s important to note than in some cases, the change will result in significantly higher licensing fees.
Continued Growth in the Cloud
We cited the AWS/VMware partnership as a threat to Microsoft’s growth in the cloud, but that doesn’t mean Azure, Office 365, or associated cloud products and services are in jeopardy. This quarters strong numbers prove that Microsoft remains a dominant presence and we expect them to continue to aggressively fight for market share. They will likely further reduce their willingness to negotiate non-cloud products and services, while we should see continued aggressive efforts to move customers to the cloud.
Increasing Software Audits
We have referenced this before, but it’s worth repeating. As Microsoft continues to fill the revenue void left by traditional perpetual license and software sales, we expect them to increase their software licensing audit activity. Microsoft typically demands some sort of audit on most of their Volume Licensing customers at least once every three years. It’s a good business for Microsoft as the cost of the audit is typically paid by the customer (unless they prove that they are almost 100% compliant). By exercising their audit rights, Microsoft forces organizations to verify their compliance and purchase any additional licenses necessary to become fully compliant.
Conversations as a Platform
Earlier this year, Satya Nadella unveiled his plans for that which he calls “Conversations as a Platform”. He described it as an integration of human speech, machine intelligence, and data. It’s difficult to conceptualize exactly what this will mean, but we may get some insights by watching a proof-of-concept project in Singapore.
We expect to see more projects that demonstrate the seemingly endless possibilities of integrating speech and technology, but it’s hard to predict how long it may take before Microsoft can productize or monetize a deliverable.
Azure Stack – Mid-2017
BizTalk Server 2016 – Q4, 2016
Dynamics CRM 2016 update – Q3, 2016
Dynamics GP 2016 update – 2nd half 2016
SharePoint Server 2016 – Released
SQL Server 2016 – Released
System Center 2016 – Released
Windows 10 Mobile – Released
Windows 10 Redstone 1 – Released
Windows 10 Redstone 2 – March, 2017
Windows Server 2016 – Released
Release schedules are subject to change
If your current Windows Server licenses include Software Assurance, it is important to comply with the transition requirements when renewing your agreements. If you provide a time-stamped report from a tool such as the Microsoft Assessment and Planning Toolkit (MAP) you will be able to transition to the actual number of processors in your server farm. This is more cost effective as the alternative is that Microsoft only converts current licenses as opposed to taking the physical server deployment into account. If you are running four and eight processor servers, the cost savings will be significant.
To ensure continued revenue, it is in Microsoft’s interest to encourage you to sign a multi-year licensing agreement. Before you do this, make sure signing the agreement makes economic sense. Microsoft concerns regarding maintaining revenue streams is also something you can leverage in order to gain the concessions you might require.
Understand the Road-map: Being aware of the product road-map not only allows you to plan more effectively and maximize your IT budgets, but it provides you with the knowledge necessary to effectively negotiate agreements that meet your business requirements. This is specifically relevant when it comes to online services.
There are a significant number of product launches over the next twelve to eighteen months. Becoming involved in Microsoft Technical Adoption Programs means you have access to high level resources, licensing discounts and business investment funding from Microsoft.