One of the key tenets of negotiation is “knowledge is power”. Analysing Microsoft’s® Quarterly earnings report for the second quarter of the Financial Year 2012 will provide valuable information as you prepare to negotiate your licensing agreement.
The document is structured in the following way:
- A summary of the financial results for FY2012 Q2.
- Microsoft’s® Licensing Revenue Summary for FY 2012, Q2.
- Risk Factors
- Predictions for the next Quarter as well as new products that will be launched during 2012.
Summary of the Financial Results
Revenue and Operating Income (Annual FY11)
Revenue for FY12 Q2 was $20.89 billion, a 5% increase from the prior year period. Operating income, net income, and diluted earnings per share for the quarter were $7.99 billion, $6.62 billion, and $0.78 per share, compared with $8.17 billion, $6.63 billion and $0.77 per share, respectively, in the prior year period. It must be noted that the results from FY11 Q2 included recognition of $224 million of deferred revenue related to the Office 2010® technology guarantee program.
Contribution per Segment
- The Microsoft® Business Division reported $6.28 billion in second quarter revenue, a 3% increase from the prior year period. Nearly 200 million licenses of Office 2010® have been sold in the 18 months since launch. Revenue from Exchange and SharePoint® grew by 10% or more over the prior year period, and revenue from Lync® and Dynamics® CRM grew by more than 30%.
- Being the holiday season, a significant contribution came from the Entertainment and Devices Division.
- Windows® and Windows® Live revenue decreased – attributed to supply chain shortages. The decline is becoming a significant pattern as customers move to new form factors.
- The Server & Tools business posted $4.77 billion in second quarter revenue, an 11% increase from the prior year period, reflecting double-digit revenue growth in Windows® Server and SQL Server® premium editions and more than 20% growth in System Center® revenue.
Volume Licensing Revenue Summary (Q2 FY12)
Unearned revenue from volume licensing programs 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. Also included in unearned revenue are payments for post-delivery support and consulting services to be performed in the future. Unearned revenue for the Quarter was $15.3 billion.
A significant portion of Microsoft’s® revenue is recurring. For this quarter, Business Revenue grew by 9% and multi-year licensing revenue grew by 12% while transactional revenue (once-off purchases) only grew by 3%. Microsoft® continues to drive for predictable cash flow through comprehensive licensing programmes that require long-term and in many cases enterprise-wide commitments.
We discuss in detail the risks facing Microsoft® when we analyse the Financial Year-end. For more information on the risks Microsoft® has identified, refer to: “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” sections of Microsoft’s® SEC filings. These can be obtained at http://www.microsoft.com/investor/
For the sake of this document, I would like to highlight four significant risks for Microsoft® over the next two quarters. Understanding these risks will provide you with leverage when negotiating your agreement.
1. The launch of SQL Server® 2012 and System Center® 2012: Microsoft® has made significant changes to the product use rights.
For SQL Server® 2012, Microsoft® is moving towards a “per core” licensing model. A core license will cost ¼ of the price of the previous per processor license. The licenses can only be bought in pairs and the initial order needs to be for four cores. For many years, Microsoft® used the physical processor licensing model to differentiate itself against Oracle® and IBM®. Where the pricing of SQL Server® becomes more expensive is when the processors you are using are bigger than quad core. Apart from Microsoft® wanting to ensure take-up on its new database products, this sensitivity to the new licensing model could mean concessions will be made.
With System Center® 2012, Microsoft® has made two changes. The first is that you are now required to purchase the full System Center® suite. In addition to this, the licenses can only be purchased with Software Assurance included. Microsoft® is effectively insisting on commitment to the full management platform. Should you have alternative technologies in place such as VMWare® or Alteris® for example, that commitment could be substantial. For Microsoft®, this all or nothing approach holds significant risk and once again provides you with leverage, specifically of you are investing in the Enterprise Client Access License Suite (eCAL).
2. The decline of Windows® revenue: On several occasions during the remarks to investors and press, Microsoft® refers to the decline in the PC market and the geometric increase in use of mobile devices. Although much of the decline in revenue is attributed to lower demand for PCs in general and the decline of the Netbook, there is a lot that is unsaid, specifically the rise of Android as a significant competitor in the mobile market.
Reference is made to the association with Nokia but very little to Windows® mobile sales. It is in Microsoft’s® interest to ensure continued use of its Windows® Operating System® as well as the growth of virtual technologies such as its Virtual Desktop Infrastructure (VDI) and the Windows 8® mobile OS. Again this provides you with leverage when negotiating your licensing agreement.
3. On-going Investment in Office 365®: Peter Klein Chief Financial Officer, makes the comment that, “Today, more than 100,000 businesses have made the commitment to our online services.” Although Office 365® is still in its infancy, the significant investment Microsoft® has made still continues to provide risk. Until commitments are translated into real revenue, Microsoft® will continue to be concerned. This means they will be very eager to offer concessions should you be looking at being an early adopter.
4. Rising Operational Costs: Although they assure investors that costs are under control, Operating Expenses grew by 4% and the cost of goods sold rose by 17% year on year. This could mean that more emphasis will be placed on overall profit margins that could influence your negotiations.
FY12 Predictions and Roadmap Information
1. Microsoft® expects the Windows® OS market to be challenging: “We expect revenue to continue to be impacted by marketing similar to the past several quarters…We also expect the hard disk drive shortage to continue to challenge the PC market through at least the next quarter.”
As mentioned earlier, when it comes to the device OS and Mobility, Microsoft® will be very concerned about losing any more ground to competitors and ensuring the Windows® OS remains on enterprise desktops. This provides you with significant leverage.
2. As for the Microsoft® Business Division: “Multi-year licensing revenue, approximately 60% of the division’s total should grow low double digits.” Much of the growth in Q2 was attributed to Unified Communication (Exchange® and Lync®). It will be interesting over the next few quarters to see the impact the Skype® acquisition will have on this revenue.
Competition for the Business Desktop is becoming intense and much of Microsoft’s® revenue in the enterprise space is being driven though SharePoint®, Exchange® and Lyncr. If you are looking at deploying these technologies, Microsoft® will encourage you to build an integrated platform. Apart from discounts on the licenses, you also want to negotiate for additional support in the form of early adopter programmes, deployment planning services and other resources that could be made available to you.
3. Microsoft® is expecting low double-digit revenue growth in the Server and Tools division. They also predict an 18% growth in Enterprise Services. Microsoft® will be very eager to encourage early adoption of System Center® 2012. Again it is important to negotiate for value added services along with discounts. The predicted growth in Enterprise Services indicates the possibility of discounts when including services with your Enterprise Agreement.
4. Turning to the Online Services Division: “We are focused on improving the financial performance of our search business and are looking for ways to increase Revenue per Search and streamline costs”. Online services is of real concern to Microsoft® as the recent joint-venture with Yahoo® is not realizing the kind of benefits that were originally expected.
5. “We continue to expect unearned revenue at the end of the fiscal year to grow low double-digits compared to the prior fiscal year.“ Microsoft® is trying to move most of the revenue to multi-year license agreements. Request a business case for the difference between a transactional option such as Select Plus versus a comprehensive program such as the Enterprise Agreement.
6. “We expect COGS to grow about 8 – 10% for the third quarter and mid-teens for the full fiscal year. We now expect operating expenses to be $28.5 to $28.9 billion for the full fiscal year, including the impact of Skype®.”
7. “As we look forward, we have the strongest product pipeline we have ever had. We’re pleased with the early enthusiasm around our upcoming wave of products that enable CIOs to cloud-optimize their business. And we are excited by the opportunity to unify the consumer experience across our phones, PCs, tablets and TVs with our new Metro-style® design.” This summary provides you with an indication of Microsoft’s® key areas of focus over the next two quarters. Being aware of these priorities provides you with valuable information you will be to use in your negotiations.