Microsoft® reports revenue by “Devices and Consumer” and “Commercial” divisions, and reports in the following six segments:
|Devices and Consumer (D&C)|
|Hardware||Computing and Gaming Hardware|
|Windows® OEM, Windows Phone®, Office Consumer, IP Licensing|
|Other||Bing® and MSN®, Office 365™ Home Premium, 1st Party Video Games,|
|Licensing||Windows® Enterprise, Server Products, Office Business, Dynamics,|
|Other||Enterprise Services, Office 365™, Azure, Dynamics CRM Online|
The document is structured in the following manner:
- Summary of the Financial results for FY2015 Q1
- Revenue and Operating Income for FY2015 Q1
- Contributions by Business Segment
- Microsoft’s Volume Licensing Revenue Summary for FY2015, Q1
- Risk Factors
- Predictions for the future and products that have recently been released or will be launched during coming months
Summary of the Financial Results
Microsoft had another record first quarter and exceeded Wall Street’s expectations. The software giant reported revenue of $23.20 billion, compared with $18.53 billion from the same quarter a year ago. Diluted Earnings-Per-Share were 54 cents, compared to 62 cents a year ago. Analysts were expecting EPS of 49 to 50 cents and revenue of $22.02 billion.
Revenue and Operating Income (FY15 1st Quarter)
Three Months Ended September 30
|($ in millions, except per share amounts and percentages)|
|2013 As Reported (GAAP)|
|2014 As Reported (GAAP)|
|% Y/Y (GAAP)|
|2014 Impact of Noted Items|
Contributions by Business Segment
A description of each segment and their financial performance as provided by MS appears below:
SEGMENT REVENUE AND GROSS MARGIN
Three Months Ended September 30
|Devices and Consumer Licensing|
|Computing and Gaming Hardware|
|Devices and Consumer Other|
|Corporate and Other|
|Devices and Consumer Licensing|
|Computing and Gaming Hardware|
|Devices and Consumer Other|
|Corporate and Other|
|Total gross margin|
- D&C Licensing, comprising: Windows®, including all original equipment manufacturer (“OEM”) licensing (“Windows OEM”) and other non-volume licensing and academic volume licensing of the Windows operating system and related software (collectively, “Consumer Windows”); non-volume licensing of Microsoft Office, comprising the core Office product set, for consumers (“Consumer Office”); Windows Phone, including related patent licensing; and certain other patent licensing revenue.
- Computing and Gaming Hardware, comprising: the Xbox® 360 gaming and entertainment console and accessories, second-party and third-party video games, and Xbox LIVE® subscriptions (“Xbox® Platform”); Surface™; and Microsoft PC accessories.
- Phone Hardware, comprising: Nokia devices
- D&C Other, comprising: Resale, including Windows® Store, Xbox LIVE transactions, and the Windows Phone Marketplace; search advertising; display advertising; Subscription, comprising Office 365 (“O365”) Home Premium; Studios, comprising first-party video games; our retail stores; and certain other consumer products and services not included in the categories above.
Devices & Consumer revenue increased by 47% to $10.96 billion, due to increased revenue from Office 365™ (up 25%) and sales of the Surface™ Pro 3 ($908 million). Xbox® console sales totaled 2.4 million units which was a 102% increase. Xbox® One launched in 28 new markets.
Microsoft reported that Office 365™ now has more than 7 million subscribers, representing a 25% growth over the previous quarter.
- Commercial Licensing, comprising: server products, including Windows Server®, Microsoft SQL Server®, Visual Studio®, and System Center; Windows® Embedded; volume licensing of the Windows® operating system, excluding academic (“Commercial Windows®”); Microsoft Office for business, including Office, Exchange, SharePoint®, and Lync® (“Commercial Office”); Client Access Licenses, which provide access rights to certain server products (“CAL”); Microsoft® Dynamics business solutions, excluding Dynamics CRM Online; and Skype.
- Commercial Other, comprising: Enterprise Services, including Premier product support services and Microsoft®Consulting Services; Cloud Services, comprising O365, excluding O365 Home Premium (“Commercial O365”), other Microsoft Office online offerings, Dynamics CRM Online, and Windows Azure™; and certain other commercial products and online services not included in the categories above.
Commercial revenue increased 10% to $12.28 billion as a result of a 128% increase in commercial cloud revenue driven by Office 365™, Azure™, and Dynamics CRM. Server products and services revenue increased 13% with double digit growth for SQL Server, System Center, and Windows Server. Lync, SharePoint, and Exchange collectively grew double digits. Windows® Volume Licensing revenue increased by 10%.
Volume Licensing Revenue Summary (Q1 FY15)
Commercial Licensing revenue increased 3% or $262 million. This was primarily the result of increased revenue from Windows® Commercial and server products, but offset by a decline in Office Commercial revenue. Server products (primarily SQL) grew by $406 million or 11%. Somewhat surprisingly, Windows Commercial revenue grew $80 million (10%) thanks to increased renewals and new customers. Office Commercial revenue declined $322 million (7%) as many VL customers transition to Office 365™.
Commercial Other revenue increased $805 million, or an impressive 50%, thanks to a $662 increase (128%) from Commercial Cloud revenue. Azure™ revenue was also up by 121%. Enterprise Services increased $142 million or 13%, which was primarily due to Premier Support Services.
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 $22.6 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.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.
1. Windows® 7: Microsoft has announced that they will end mainstream support for Windows 7 on January 13, 2015. This deadline won’t result in the end of support for Volume Licensing customers as they are eligible for an additional five years of extended support, but that isn’t available to consumers. We consider this a risk because it will likely result in considerable customer dissatisfaction surrounding that which is currently Microsoft’s most popular operating system. Microsoft has already upset countless customers in both the consumer and enterprise markets by ending support for Windows® XP earlier this year. To be fair, XP was thirteen years old and was obsolete in many ways, but since XP users were not using touch enabled devices, most upgraded to Windows 7, rather than Windows® 8. Windows 7 is only six years old.
Windows 8 has had somewhat of a questionable reputation from the start and it is often associated with perceived failures such as the Metro interface which works well with touch enabled devices but not with traditional displays. Microsoft is working to address this, but forcing customers to “upgrade” their OS less than a year after doing the same with XP will not be well received.
2. Google Chrome™: Some would consider the mere suggestion that Google’s Chrome™ operating system would ever be a threat to Windows to be laughable, but Microsoft is paying close attention to its growth. We all know that the mass migration to the cloud and demand for mobility enables more thin clients and often times less locally (device) resident processing power, memory, and disk space. Windows still dominates the PC market with an approximate 90% share, but the market demand for PCs is giving way to tablets and smart phones. Android™ is currently installed on almost 85% of smartphones, up five percentage points from a year ago. Both Microsoft and Google™ see the need to produce a single OS that works across all devices. Google™ has been alluding to a convergence of Android™ and Chrome™ for years, and it appears as though Android™ 5.0 may be a significant step toward doing so. Meanwhile, Windows is currently divided among Windows 8, Windows® RT, and the Windows Phone OS which don’t work together seamlessly. Another challenge for Microsoft is that more than 75% of Windows users are using either Windows 7 or XP, rather than the current version. Windows® 10 promises to remedy the current incompatibilities of Windows 8, but version 10 isn’t due to release for about a year. Meanwhile, Google™ recently launched its “Chromebooks™ for Work” campaign which introduces new pricing and features intended for enterprise use.
3. Nokia™: Microsoft is aggressively trying to become a player in the smartphone market which has largely eluded them to date. Their $7.3 billion purchase of Nokia’s™ smartphone division should provide a nice jump start in terms of market presence, but we continue to question the cost of doing so. With MS late to the market in a meaningful way and the existing popularity of the iPhone™ and clear dominance of Android™ phones, Microsoft is unlikely able to buy their way into the market, at least not with a profitable offering. Whether profitable today or not, Microsoft reported $2.6 billion in phone hardware sales during the recent quarter.
4. Windows® 8.1: We cannot remove Windows 8.x from our list of Risk Factors. Microsoft released the second update, which was “minor” according to Microsoft, on August 12. Some users consider the current functionality of Windows 8.1 to be an improvement over its predecessor (8.0), but for desktop and laptop users without touch-enabled devices, Windows 8.1 is still an awkward compromise between a tablet OS and a PC OS. Recent reports suggest that approximately 50% of users are running Windows 7, while only 14% are using Windows 8. It is unlikely we will see significant changes to Windows 8 before Windows 10 (“Threshold”) is released in the second half of 2015, despite the notable omission of a “Windows® 9”.
FY15 Predictions and Roadmap Information
The computing landscape has changed dramatically as businesses and consumers alike increase their dependency upon cloud computing. There are still some who are reluctant to trust another party with their data, but the economies of cloud computing cannot be denied. The efficiency and potential cost savings for customers, whether monetarily or the result of other factors, has created a hosting opportunity large enough to support industry giants Google™, Amazon™, and Microsoft. Microsoft is late to the party, but that doesn’t mean they aren’t a viable competitor, as evidenced by the recent earnings report. Microsoft has a competitive advantage the others lack in that they have existing relationships with customers of their commercial software. Microsoft can present a strong case that Azure™ works particularly well with Windows Server™, SQL Server™, and Active Directory®. They are also attempting to address the needs of private cloud customers wishing to host within their own datacenter with the recently announced “Cloud Platform System”. The Cloud Platform System is a Dell® server capable of running the same Azure™ APIs, services, hypervisor, and everything else which is available in the Azure™ public cloud.
We expect Microsoft to aggressively push their cloud offerings in part because they represent new market opportunities as is the case with the Cloud Platform System, but also because it represents an environment to run their other profitable applications. That said, Microsoft will also continue their new strategy of making their products available on all platforms, rather than only on Windows as has traditionally been the case.
It should come as no surprise that we expect continued emphasis on Azure™, O365™, and cloud based computing. Also, look for more MS apps which have traditionally been exclusive to Windows to become available on competing operating systems. Microsoft has a good model as they offer read-only access on iOS™ and Android™ devices at no charge, and requiring an Office 365™ subscription to create or edit content. Look for Microsoft to leverage that model in the future.
Dynamics CRM Rollup 2 “Leo” – Released
Dynamics CRM 2015 (Vega) – Q4, 2014
Dynamics GP 2015 – Q4, 2014
Exchange Server 2013 SP1 CU 5 – Released
Lync Server 2014 – Q4, 2014
“Mohoro” Desktop as a Service – Late 2014
Office 2013 SP1 – Released
Office 16 – Q2, 2015
Office for iPad® – Released
Office for Android™ – Q4, 2014
SharePoint Server 2013 SP1 Cumulative Updates – Monthly
SQL Server 2012 SP2 – Released
SQL Server 2014 – Released
Visual Studio 2013 Update 4 – RC available 10/16/14
Windows 8.1 Update 2 – Released
Windows Server 2012 R2 – Released
Windows “Threshold” aka Windows 10 – 2nd half, 2015
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 (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.
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.