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, Marketplaces|
|Licensing||Windows® Enterprise, Server Products, Office Business, Dynamics, Unified Communications|
|Other||Enterprise Services, Office 365™, Azure, Dynamics CRM Online|
The document is structured in the following manner:
- Summary of the financial results for FY2014 Q4
- Revenue and Operating Income for FY2014 Q4
- Contributions per business segment
- Microsoft’s® Volume Licensing Revenue Summary for FY2014, Q4
- 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 respectable quarter, although earnings per share failed to meet Wall Street expectations. The software giant reported revenue of $23.38 billion, compared with $19.9 billion from the same quarter a year ago. Non-diluted Earnings Per Share were 56 cents, compared to 59 cents a year ago. Analysts were expecting EPS of 60 cents and revenue of $23 billion. The perceived shortfall was the result of losses resulting from Microsoft’s acquisition of the Nokia™ Devices Business in April. If we were to exclude the Nokia™ impact, MS earnings were 66 cents per share, which exceeded the Street’s expectation of 60 cents.
Revenue and Operating Income (FY14 4th Quarter)
Contributions per Segment
A description of each segment and their financial performance as provided by MS appears below:
- 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.
D&C Revenue increased $2.98 billion (42%), but it’s important to note that this includes $1.99 billion of Nokia™ Phone Hardware revenue.
D&C Licensing revenue increased by 9%, due to increased revenue from Consumer Office (up 21%) and Windows®Phone revenue (up 95%). It’s important to note that the dramatic increase in Windows® Phone licensing revenue is largely the result of a $382 million recognition at the conclusion of the commercial agreement with Nokia™. Windows®OEM revenue increased 3%, reflecting an 11% increase in revenue from Windows® OEM Professional. Non-Pro Windows® OEM revenue was down 9%.
MS reported that Office 365® Home and Personal now has more than 5.6 million subscribers, adding more than one million new subscribers during the recent 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 by $1.28 billion (11%) as a result of increasing Commercial Licensing and Commercial cloud services. Commercial Office and Commercial Office 365™ revenue grew by 4%. Revenue from Server products, including Azure, grew 16%. Commercial gross margin increased $984 million (10%).
Volume Licensing Revenue Summary (Q4 FY14)
Enterprise demand for products and services drove strong multi-year commitments resulting in $11.22 billion in revenue for the quarter, an increase of 6% over the previous year. This increase may be largely attributed to momentum and emphasis upon cloud services as Commercial Cloud revenue increased by 147%. Server product revenue increased by 14%, driven by double-digit growth of SQL Server and System Server. Office Commercial revenue grew by 4%. Windows® volume licensing revenue was up 11%. Commercial gross margin improved by 10%.
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 $25.2 billion (up 29%) 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. Internal Changes: Last quarter we cited “public perception” as a risk factor for Microsoft®. We realize that is somewhat subjective, but the company has been in the news more than usual recently and it’s not always positive or related to products. On July 17, MS announced that they would lay off 18,000 workers over the coming year, representing about 14% of their workforce. This is the second time MS has performed widespread lay-offs and is more than three times the size of their previous cut of 5800 jobs back in 2009. Wall Street appears to have embraced the announcement as is often the case when a company announces plans to reduce spending, but it’s important to remember that software companies aren’t the same as most. Computer software is truly a product of the minds of programmers and testers. Software companies don’t build widgets where the end product is a result of combining multiple tangible components. Companies such as MS and Google™ work very hard to create a comfortable and positive work environment. When employees are happy and morale is high, they are much more productive and the quality of work improves. By contrast, if employees worry about whether they will still have a job it can have a very detrimental effect. Combine that with an emerging emphasis on cloud computing, rather than the traditional PC based focus and the potential for employee insecurity increases substantially. This is not to say that the lay-offs are a bad idea, as MS has become bloated in a number of areas, but the implications reach far beyond simple cost savings.
2. Apple™ and IBM®: Much has been speculated about the importance of the recently announced collaboration between Apple™ and IBM®. In its simplest form, IBM® and Apple™ will work together to bring Apple™ devices such as the iPad™ and iPhone™ into the enterprise space. Apple™ products dominate the consumer markets, but their high price, questionable security, and that which many would consider “form over function” have prevented Apple™ from making much meaningful traction in the enterprise. The deal with IBM® gives Apple™ credibility in a market which has eluded them throughout the history of the company. For the traditionally conservative IBM®, the deal enables solutions with the hugely popular Apple™ products. IBM® has already announced more than 100 enterprise focused applications specifically for the iPhone™ and iPad™.
Perhaps the greater significance to the partnership is that Apple™ is willing to work with a company other than themselves. Apple™ and IBM® rarely find themselves competing with each other, so neither has much to lose from a competitive standpoint, but if Apple™ CEO Tim Cook is willing to work with IBM® it may signal a willingness to forge other partnerships as well. If Apple™ gains traction with IBM™ they may seek similar relationships with other enterprise vendors and could seriously impact Microsoft’s® market.
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 have 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. MS feels a need to participate in the mobility space with hardware of their own, but with the disappointment of the Surface such a fresh memory, it’s hard not to question the wisdom of acquiring the Nokia™ division.
4. Windows® 8.1: We cannot remove Windows® 8.x from our list of Risk Factors. MS released version 8.1 on April 8 as expected, and while it offers some much needed improvements, particularly for desktop and laptop users without touch-enabled devices, Windows® 8 is still an awkward compromise between a tablet OS and a PC OS. Many (most?) users appear to continue to use Windows® 7 if they don’t need touch functionality as those who have tried Windows®8 have reported widespread criticism. Microsoft® is aggressively working to address the problems and there is another update expected in August, but that is the last update expected for 8.1 until springtime 2015 when we expect to see the “Threshold” release which some believe may eventually be referred to as Windows® 9.
FY14 Predictions and Roadmap Information
At the end of Satya Nadella’s first complete fiscal quarter as CEO, he is continuing to impress many observers. While we may not know how long some of the plans and decisions may have been under development prior to his appointment as CEO, he is acknowledging some MS shortcomings and implementing practices which are a significant departure from the actions of his predecessor. Of particular note is the availability of Office 365™ on the iPad™ (and reportedly coming soon to Android™ tablets). Mr. Nadella has also acknowledged the frustration felt by many developers due to the lack of consistency between Windows® running on PCs, phones, tablets, Xbox®, and other devices. He claims to have plans to simplify development at some level to enable developers to create applications that work on multiple devices. Last week he announced that MS would lay-off 18,000 employees during the coming year, although most of those were related to the acquisition of Nokia’s™ smartphone division. While the layoff announcement was rewarded by Wall Street, it results in internal turmoil which surrounds MS employees every day.
Whether these changes ultimately prove to be a wise proactive strategy or a desperate attempt to remain competitive, the market perception and internal culture is slowly changing after too many years of stagnation. Nadella appears willing to relax some of the restrictive practices MS has held for years and we may find that MS will be more willing to partner with external companies than they have in the past. They are aggressively pursuing business in the cloud and the once criticized Office 365™ has proven to be the fastest growing product in company history. Even the recent announcement that MS will drop the “Devices and Services” mantra seems to further confirm their commitment to all things cloud.
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 MS to leverage that model in the future.
Dynamics CRM “Leo” – Released
Dynamics GP 2015 – Q4, 2014
Exchange Server 2013 SP1 – Released
Lync® Server 2014 – Q3, 2014
“Mohoro” Desktop as a Service – Late 2014
NetBreeze “Subra” – Released
Office 2013 SP1 – Released
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 2 – Released
Windows® 8.1 Update 2 – August, 2014
Windows Server® 2012 R2 – Released
Windows® “Threshold” – April, 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®.