Preface

One of the key tenets of negotiation is “knowledge is power”. Analyzing Microsoft®’s Quarterly earnings report for the first quarter of the Financial Year 2013 will provide valuable information as you prepare to negotiate your licensing agreement.

 

The document is structured in the following way:

  1. A summary of the financial results for FY2013 Q1.
  2. Microsoft®’s Licensing Revenue Summary for FY 2013, Q1.
  3. Risk Factors
  4. Predictions for the next Quarter as well as recent releases and new products that will be launched during 2012 – 2013

 

Summary of the Financial Results

Revenue and Operating Income (FY13 1st Quarter)

Revenue for the quarter was $16.01 billion, down 9% from the same period a year ago. Operating income was $5.3 billion, down 7%. Earnings per share was 53 cents, down 8%. Cash flow from operations was $8.5 billion, which is virtually identical to the same period last year. Total operating income was $31.6 billion for the trailing year.

 

The decrease in earnings should be considered in context. Microsoft® released Windows® 8 on October 26 and Office 2013® is expected during CQ1-2013. These are mainstream products in both the consumer and enterprise space and the recent decline in earnings is at least partially a result of customers waiting to invest in the latest versions, both as initial purchases and also as upgrades. Customers and investors have further cause for optimism as Microsoft® also introduced the Surface Tablet and Windows® RT on October 26, 2012.

 

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Contribution per Segment

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*  Windows®: The Windows® and Windows® Live Division struggled again this quarter but as previously noted this may be largely attributed to the upcoming release of Windows® 8. Microsoft® reported revenue of $3.2 billion for the quarter, down from $4.9 billion in last year’s Q1 result. Approximately 75% of Windows® revenues are generated by OEMs who preinstall the Operating System on new PCs and Microsoft®  has deferred $1.3 billion for the Windows® Upgrade offer and pre-sales to the Original Equipment Manufacturers (OEMs).

 

Microsoft® continues to reflect performance of the global PC market. During the past year, Microsoft® indicated that the PC market increased by less than 2%. While sales to the traditional PC market have become relatively flat, tablet PCs have created a new market which Microsoft® entered on October 26 with the release of the Surface® Tablet running Windows® RT. It is interesting to note that Windows® and Windows®  Live are experiencing double digit growth in Volume Licensing and that Windows® 8 presale revenue is 40% greater than that of Windows® 7 in comparative launch quarters.

 

*  The Server & Tools business posted $4.6 billion in first quarter revenue, an 8% increase from the prior year period. Approximately 80% of Server & Tools revenue comes from Volume Licensing and multi-year licensing grew 19% during the recent quarter.

 

*  The Microsoft® Business Division reported $5.5 billion in first quarter revenue, a 1% decrease from the same period the previous year. The division reports multi-year licensing revenues to be up by 8%. Office 2013® was released to manufacturing on October 11 and is expected to be available during CQ1-2013.

 

Volume Licensing Revenue Summary (Q4 FY12)

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 an unearned revenue balance of $19.6 billion, a 1% decrease from last year’s record high of $20.1 billion.

 

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 $19.6 billion as noted above which has been contracted but not billed.

 

Risk Factors

We discuss in detail the risks facing Microsoft® when we analyze the Financial Year. For more information on the identified risks, refer to the “Management’s Discussion and Analysis of Financial Conditions 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, we would like to highlight three significant risks for Microsoft® over the next two quarters. Understanding these risks will provide you with leverage when negotiating your agreement.

 

1.  Adoption of Windows® 8 and Office 2013®: Although dominant on PCs and Laptops, Microsoft® has strong competition when it comes to mobile devices, specifically tablets. Windows® 8 and Office 2013® have taken significant steps into that arena and it will be interesting to see what the rate of adoption will be.

 

Steve Ballmer describes Windows® 8 as “the beginning of a new era at Microsoft®”, but it is not without risk. Windows® 7 has been available three years and has been very well received. Unlike with its predecessor Vista, customers are not dissatisfied with the current version and are not anxiously awaiting the next major release.  Windows® 8 will enable much greater cross functionality between traditional PCs and mobile devices, but it also comes with a completely new user interface (“Metro”) and business model which may be a deterrent to some. If customers fully embrace the cross functionality benefits of Windows® 8 it suggests that many will be utilizing Windows® RT on tablet devices as well. Microsoft® feels as though they must offer the Surface Tablet to combat declining PC sales and to become a player in the tablet space. There are elements of this strategy which should not be overlooked. First, MS is a relative latecomer. The tablet market is currently dominated by Apple®, and they recently announced an entry level tablet, the iPad Mini®. While the iPad Mini® will not match the functionality or features of the original iPad®, Surface®, or other offerings from Android® and others, its price range of $329 – $659 will expand Apple®’s market share into the (relatively) low end tablet market and further induce ISVs to write applications for Apple®’s iOS® mobile operating system, thereby increasing Apple®’s overall market share and making it more difficult for Microsoft® to become a significant competitor.

 

Another concern with Microsoft®’s decision to offer the Surface® Tablet is that by branding their own hardware they are now competing with their own OEMs. The strategy is not to strictly emulate that of Apple® as Microsoft® will also license Windows® RT to OEMs, but this is a major diversion from the MS strategy of the past and they certainly risk alienating this major source of partnership and revenue.

 

2. Adoption of Office® 2013 Subscription Pricing: With the release of Office® 2013, Microsoft® is unveiling a new pricing model. This is initially aimed at consumers and small businesses, but the trend should not be ignored. MS Office® has traditionally been among Microsoft®’s most lucrative products, but competitive offerings with (in most cases) adequate functionality have severely eroded Microsoft® ’s ability to command the prices they have in the past. As they do with Office® 365, Microsoft® is steering customers away from the traditional model in which the user pays for the product all at once and may use it as long as they wish. We identify this as a “Risk Factor” not because subscription based pricing is likely to be something to fear, and we realize that subscription pricing is nothing new to VL customers, but it may be wise to consider the possible implications before committing to a long term Office® 2013  Licensing Agreement. Watch for an Office® 2013 Licensing Guide article on this site by mid-November.

 

3. Adoption of Windows® Server® 2012 and associated licensing: In line with the System Center® 2012, licensing Windows® Server® 2012 is also moving to a per-processor model. Windows® Server® in the enterprise is limited to a Standard and Datacenter edition, depending on the extent of the virtual environments. This will have costing implications depending on the number of processors you are using in the Datacenter.

 

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®’s 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®’s Technical Adoption Programs means you have access to high level resources, licensing discounts and business investment funding from Microsoft®.

 

FY13 Predictions and Roadmap Information

  • Many industry analysts expect Windows® 8 adoption to be extremely slow in the enterprise space.
  • The general expectation is that CIOs will continue to invest in cloud solutions to deliver productivity and scalability to their business.
  • Microsoft® deferred $1.3 billion for the Windows® Upgrade offer and pre-sales to the Original Equipment Manufacturers (OEMs). This will be fully recognized during FY 2013.
  • Microsoft® is expecting continued low double digit growth in licensing revenue in the Microsoft® Business Division.
  • For the Servers and Tools Division, Microsoft® believes that revenue from products will account for approximately 80% of their total and services will be 20%. The company expects that multi-year licensing will make up approximately 60% of the division’s revenue, with revenue growing in the low teens.

 

Product Releases

Product DescriptionProduct Description
Windows® 8
October 26 2012
Windows Server® 2012
September 4, 2012
Internet Explorer® 10
October 26, 2012
Office® 2013
Released to Manufacturing October 12, 2012. General availability Q1 2013
Exchange® 2013
Anticipated: Q1 2013
Visual Studio® 2012
September 12, 2012
Dynamics® ERP Online

Dynamics® NAV 2013: October 1, 2012
Dynamics® GP 2013®

Anticipated: December 2012

Office® 365
Anticipated update schedule: “Almost weekly”
Windows Azure®
Rumored CTP release: Q4 2012
SharePoint® 2013
Anticipated: Q1 2013

Nov 2016