Microsoft® has been the subject of much discussion and speculation during recent months as many have questioned their continued strength in the industry. There is no question that PC sales have been significantly impacted by the emergence of tablets and even smartphones as these devices have become more powerful and are entering the SMB and Enterprise space in a major way. Reported sales of the Surface™ Tablet have been mediocre, at best, and while the Surface™ Tablet and Windows® Phones often receive critical acclaim, their market share pales in comparison to the iPad®, iPhone®, and devices running Google’s® Android™ Operating System.
While media reports and “expert” opinions are often presented with a particular bias or specific agenda, Earnings Reports to the SEC are arguably the best source to assess the true value and stability of a publicly traded company. This does not suggest that these reports aren’t presented with an agenda, but unlike media reports and editorial opinions, SEC Filings are subject to intense scrutiny and penalties for misrepresentation.
The document is structured in the following way:
- A summary of the financial results for FY2013 Q4.
- Contributions per business segment
- Microsoft’s® Licensing Revenue Summary for FY2013, Q4.
- Risk Factors
- Predictions for the future as well as recent releases and new products that will be launched during coming months
Summary of the Financial Results
Revenue and Operating Income (FY13 4th Quarter)
Revenue for the quarter was $19.9 billion, up 10% from the same period a year ago, although the year ago quarter included a $6 billion write down for the value of their 2007 acquisition of online ad service iQuantive®. Operating income was $6.07 billion, up 10% after accounting adjustments. Earnings per share were 59 cents. Net cash from operations was $5.9 billion, which is down 23% from the same period last year. Total operating income was $26.8 billion for the trailing year.
The reported GAAP figures include revenue deferrals resulting from the Windows® 8 Upgrade Offer and Office 2013 Upgrade Offer.
|Three Months Ende June 30|
(In millions, except per share amounts and percentages)
2012 As reported (GAAP)
Windows Upgrade Offer
2012 As adjusted (non-GAAP)
2013 As reported (GAAP)
Office Upgrade Offer
2013 As adjusted (non-GAAP)
Contribution per Segment
Windows® Division – The Windows® Division includes OS and related software, certain online services, and PC hardware products, including the Surface™ and Surface™ Pro. They reported $4.4 billion in revenue during the recent quarter, which is up $259M or 6% from a same period last year, but that was offset by a $540M revenue deferral associated with the Windows® Upgrade Offer. Excluding the impact of the accounting deferral, OEM revenue was down 15% and represents approximately 65% of the division’s revenue. The remaining revenue comes from commercial and retail sales of Windows® , Surface™, PC hardware products (keyboards, mice, etc.), and online advertising.
The 15% decrease in OEM revenue is an alarming trend and there is really nothing on the horizon to suggest that the trend will reverse. PC sales were down 11% last quarter as consumers and businesses continue to migrate to tablets. Business customers continue to purchase other MS® products but the increasing popularity of tablets and BYOD policies is blurring the line between business and consumer markets. Unfortunately for Microsoft®, relatively few tablets are running Windows® RT so they need to recoup the lost revenue elsewhere. Volume Licensing customers who allow tablets and smartphones to access corporate networks are required to pay for licenses for the devices in most cases so that is a growing revenue stream but MS® has not released sales figures in this area.
Another cause for concern in the Windows® Division is that reported sales during recent quarters have appeared artificially high as more than $1.5 billion have been recognized as part of the Windows® Upgrade Offer.
The Server & Tools Business Division reported $5.5 billion in fourth quarter revenue, a 9% increase from the prior year period. Approximately 80% of Server & Tools revenue comes from product sales via Volume Licensing, OEM, and retail packaged product. The remainder comes from Enterprise Services. The fastest growing sellers for the division are SQL Server®, Windows® Server, and System Center.
Server and Tools has seen steady growth and will become a focal point for MS® as they evolve into a Devices and Services company. This division in particular benefits from Microsoft’s® solid reputation for providing robust and reliable enterprise class products.
The Microsoft® Business Division reported $7.2 billion in fourth quarter revenue, a 14% increase from the same period last year. This is another report that deserves closer evaluation. During the quarter, MS® recognized $782 million of revenue related to the Office 2013 Upgrade Offer. Excluding the impact of the Office Upgrade deferral, revenue grew $107 million or 2%.
Business revenue increased $379 million or 7%, reflecting growth in multi-year volume licensing revenue and a 13% increase in Microsoft® Dynamics revenue. Consumer revenue increased $509 million or 51%, driven by the deferral related to the Office Upgrade Offer. Adjusting for the impact of the Office Upgrade Offer, consumer revenue declined $273 million, or 27%.
Volume Licensing Revenue Summary (Q4 FY13)
Enterprise demand for products and services drove strong multi-year commitments resulting in multi-year licensing revenue growth of 15% over the previous year and a record unearned revenue balance of $22.4 billion, a 15% increase over the same period year ago.
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. Microsoft® currently reports $22.4 billion as noted above which has been contracted but not billed.
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
For the sake of this document, we would like to highlight significant risks for Microsoft®. Understanding these risks will provide you with leverage when negotiating your agreement.
1. Devices and Services: Microsoft® recently announced a long anticipated reorganization. Re-orgs are nothing new at MS but this one appears to be bigger than most. Many would argue that this reorganization is long overdue and current projections are that it will take approximately six months to implement. While the changes are probably wise in the long run, they are not without risk. Re-orgs are very disruptive to employees as they often don’t know how their roles will be impacted or who their new management may be. The result is often new or different goals by which employees are measured. Microsoft® has been publically criticized for their performance review and stack ranking practices. Meeting review goals is directly tied to promotions, salary increases, bonuses, and stock offerings. Any factors that threaten an employee’s ability to meet their agreed upon goals can be very detrimental to morale and productivity.
2. Windows® 8.1: One may argue that Windows® 8 was improperly marketed from the beginning. Most version updates are intended to replace the previous version. Vista® replaced XP, Windows® 7 replaced Vista®, etc. While we’re sure Microsoft® would like Windows® 8 to immediately replace Windows® 7, that was never the expectation or even the goal. Windows® 7 has been available almost four years and has been well received by businesses and consumers alike. The major significance to Windows® 8 is that it allows touch screen capability. Since most PCs still don’t have touch functionality, there is little reason for most users to update at this time. Unfortunately for Microsoft®, the media has widely reported that sales of Windows® 8 have been disappointing. We don’t know how sales to date are tracking with Microsoft’s® confidential internal projections, but the external reports have been damaging. Rarely have we seen an interim update which was as highly anticipated as that of Windows® 8.1, but since the same touch screen factors remain, it seems unlikely that sales are likely to improve significantly in the short term. Windows® 8.1 is expected to be released to OEMs during August with general availability in September or October and will be free to Windows® 8 licensees.
3. Changing Customer Actions: Microsoft’s® traditional business of locally based operating systems and applications is being replaced by portable devices such as tablets and smartphones, often using non-MS® OS and applications. The recently announced reorganization is intended to address this but market changes represent a major divergence from Microsoft’s® business model.
4. Windows® RT and The Surface™ Tablet: Microsoft’s® attempt to enter the tablet market has been questioned by many from the beginning. They alienated their OEM customers when MS® elected to release the MS-branded Surface™. Some loyal Microsoft® OEMs (Asus®, Dell®, Lenovo®) released RT based tablets, while others took somewhat of a wait-and-see approach. Microsoft® recently reduced the price of the Surface™ by $150 to stimulate sales, resulting in a $900 million write-off during the recent quarter. Lenovo® has announced that they will discontinue their RT offering (IdeaPad Yoga 11™). After fewer than ten months, it may be time to declare The Surface™ and Windows® RT a failure.
FY13/14 Predictions and Roadmap Information
The recently announced reorganization within Microsoft® is consistent with statements and actions made by the company during recent months. MS® is now clearly focusing on server products and cloud delivery. They claim to have reevaluated the role and definition of an operating system. Historically, MS® has considered the OS to be just software that managed hardware, but at a recent workshop on Cloud Operating Systems, the VP of Server and Tools Marketing Takeshi Numoto stated that “Now, instead of thinking of an OS on a per-machine basis, we think of an OS that pulls together compute, storage and network resources — across multiple datacenters”.
During the coming year we can expect significant updates to System Center® 2012, Windows® Server 2012, SQL Server® 2012, and the release of SQL Server® 2014. In the cloud, look for updates or additions to the Azure™ products, InTune, and SQL Database.
Not only does MS® intend to release major updates to multiple products, but they also plan to shorten the product delivery cycles from three years to one. They also intend to release the R2 versions of Windows Server® 2012 and System Center® 2012 simultaneously.
At first glance, one may applaud the effort to shorten the release cycle, but it may also be met with some resistance in the field. Of course it depends upon the changes to functionality, UI, and system requirements, but annual updates to such complex and far reaching products may be met with resistance from IT departments and end users alike. There is also a question as to whether a year is long enough to develop adequate new functionality to justify a major update or new release.
It will be interesting to see how well Microsoft® can execute on so many changes. The re-org is expected to take until the end of the calendar year to fully implement. There are some significant releases planned during that time and Microsoft® has not demonstrated the agility to quickly execute major changes during recent years.
BizTalk® Server 2013 – Released
Dynamics® CRM – Q3 2013
Dynamics ERP® – Released for Azure Hosted Versions
Exchange Server® 2013 Cumulative Update 2 (CU2) – Released
Lync® Server 2013 – Q3 2013
System Center® 2012 R2 – Q4 2013
Visual Studio® 1012 Update 2 – Released
Windows® 8.1 – Q3 2013
Windows® Phone 8 “Apollo” – Q3 2013
Windows® Server 2012 R2 – Q4 2013
Release schedules 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 (MAPS) 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.
For Further information, please contact Emerset.