Preface

Microsoft reports revenue by “Devices and Consumer” and “Commercial” divisions, and reports in the following six segments:

 

Devices and Consumer (D&C)
HardwareComputing and Gaming Hardware
Licensing

Phone Hardware

Windows® OEM, Windows Phone®, Office Consumer, IP Licensing

Nokia™ devices

OtherBing and MSN, Office 365™ Home Premium, 1st Party Video Games, Marketplaces
Commercial
LicensingWindows Enterprise, Server Products, Office Business, Dynamics, Unified Communications
OtherEnterprise Services, Office 365™, Azure™, Dynamics CRM Online

 

The document is structured in the following manner:

 

Summary of the Financial results for FY2015 Q4

Revenue and Operating Income for FY2015 Q4

Contributions by Business Segment

Microsoft’s Volume Licensing Revenue Summary for FY2015, 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 surprised many analysts by reporting better than expected earnings for the fourth quarter of their 2015 fiscal year, although expectations were rather conservative due to sluggish PC sales and conservative guidance from the company. The software giant reported revenue of $22.2 billion, compared with $23.38 billion from the same quarter a year ago. Diluted Earnings-Per-Share were 62 cents, compared to 55 cents a year ago. Analysts were expecting EPS of 58 cents and revenue of $22.04 billion.

 

Unfortunately, the fiscal results will be recorded as Microsoft’s largest loss ever as the company wrote off $7.6 billion from its Nokia acquisition and restructuring costs after eliminating 7800 jobs, most of which were related to Nokia.

 

It’s worth noting that as customers transition from perpetual licenses for Office to Office 365, which is a cloud based subscription, revenue must be reported throughout the course of the subscription, rather than upfront as was the case with perpetual Office sales. Microsoft believes the long term result will be more revenue per customer, although it may appear as a short term decline.

 

Revenue and Operating Income (FY15 4th Quarter)

Three Months Ended June 30

 
 ($ in millions, except per share amounts)

Revenue

Gross Margin

Operating Income (Loss)

Earnings  (Loss) per Share

2014 As Reported (GAAP)

$23,382

$15,749

$6,482

$0.55

  Impairment, Integration, and Restructuring Charges

127

0.01

2014 As Adjusted (Non-GAAP)

$23,382

$15,749

$6,609

$0.56

2015 As Reported (GAAP)

$22,180

$14,712

$(2,053)

$(0.40)

  Impairment, Integration, and Restructuring Charges

8,438

1.02

2015 As Adjusted (Non-GAAP)

$22,180

$14,712

$6,385

$0.62

Percentage Change Y/Y (GAAP)

(5)%

(7)%

(132)%

(173)%

Percentage Change Y/Y (Non-GAAP)

(5)%

(7)%

(3)%

11%

 

Contributions by Business Segment

 

In Millions

 

4th_quarter_fy_2015

 

SEGMENT REVENUE AND GROSS MARGIN

(In millions)(Unaudited)

 

Three Months Ended June 30,

 

Twelve Months Ended June 30,

 

 

 

2015

 

2014

 

2015

 

2014

Revenue

 

 

 

 

 

Devices and Consumer Licensing

 $     3,233

 

 $  4,903

 

 $   14,969

 

 $19,528

Computing and Gaming Hardware

1,933

 

1,342

 

10,183

 

9,093

Phone Hardware

1,234

 

1,982

 

7,524

 

1,982

Devices and Consumer Other

2,300

 

1,762

 

8,825

 

7,014

Commercial Licensing

10,451

 

11,233

 

41,039

 

42,085

Commercial Other

3,076

 

2,262

 

10,836

 

7,546

Corporate and Other

(47)

 

(102)

 

204

 

(415)

  Total revenue

 $   22,180

 

 $23,382

 

 $   93,580

 

 $86,833

 

 

 

 

 

 

Gross Margin

 

 

 

 

 

Devices and Consumer Licensing

 $     2,966

 

 $  4,521

 

 $   13,870

 

 $17,439

Computing and Gaming Hardware

435

 

18

 

1,788

 

892

Phone Hardware

(104)

 

54

 

701

 

54

Devices and Consumer Other

594

 

291

 

2,022

 

1,393

Commercial Licensing

9,529

 

10,298

 

37,830

 

38,615

Commercial Other

1,350

 

691

 

4,199

 

1,855

Corporate and Other

(58)

 

(124)

 

132

 

(493)

  Total gross margin

 $   14,712

 

 $15,749

 

 $   60,542

 

 $59,755

  • 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.

Overall Devices and Consumer revenue decreased by $1.3 billion or 13%, due to lower revenue from Phone Hardware, Windows OEM, Windows Phone and Consumer Office. By contrast, Surface, Xbox, and search advertising saw increases for the quarter. D&C Gross Margin $993 million (20%) due to lower revenue but was partially offset by a 6% decrease in the cost of revenue.

 

Commercial

 

  • 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 only slightly as server products and services grew 4% while Commercial Office products and services revenue declined by 4% as customers continue to migrate to Office 365. Commercial revenue was also impacted by unfavorable foreign currency fluctuations.

 

Volume Licensing Revenue Summary (Q4 FY15)

 

Commercial Licensing revenue decreased 7% to $10.5 billion. This was primarily the result of decreased revenue from Commercial Office perpetual licenses as many users moved to Office 365.

 

Commercial Cloud revenue continued to grow at an impressive rate, up 88% with an annualized revenue rate of more than $8 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 $25.3 billion in unearned revenue, up 1% over last year.

 

Risk Factors

 

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.

 

Windows 10

 

We would be remiss if we failed to identify Windows 10 as a risk, particularly since it is scheduled to be released next week. Microsoft has a great deal riding on Windows 10 although the greatest risk may be one of public perception if it disappoints. In reality, the expectations are so high for Windows 10 and the attention is so great that it will almost certainly disappoint some, but a major misstep would likely be highly visible and widely scrutinized.

 

The value of public perception surrounding Windows 10 should not be underestimated. Microsoft products are firmly entrenched within the lucrative business and enterprise sectors, but the company is also striving for deeper penetration in the consumer space. One of the goals is to engage new customers, often by giving them free software, with hopes that they will embrace the platform and Microsoft can upsell them at some point. By making applications available on competing operating systems, Microsoft has a huge untapped market in the consumer space. Consumers are often easily influenced and public perception and reputation can be a major factor when selecting products. Whereas companies often perform an exhaustive analysis before committing to a product or platform, consumers are much more likely to try something new, particularly if it offers a “Wow” factor or even favorable reputation (consider Apple’s success in the consumer space) Microsoft needs to leverage that with new features within Windows 10 such as HoloLens, the Edge browser, Cortana, integration across multiple devices, and others. A successful launch of Windows 10 without any major issues would be very beneficial for the credibility of Microsoft and that of Windows 10.

 

Corporate Customers may be Slow to Upgrade

 

Despite all the anticipation surrounding Windows 10, many corporate customers appear to be taking a wait-and-see approach to upgrading. This isn’t uncommon for something as important as an operating system, and it’s quite possible that Windows 10 will be compelling enough to accelerate the upgrade plans for some, but in corporate environments where new “features” rarely outweigh the baseline importance of an installed and familiar OS we shouldn’t expect a rapid enterprise migration to the latest version of Windows.

 

Windows Phone

 

Microsoft wrote-off a massive $7.6 billion due to the failure of their investment in Nokia smartphones. They are also laying off 7800 employees, primarily associated with the Windows Phone business. The smartphone market has matured and Android dominates it with numerous handsets from multiple phone manufacturers. Microsoft is making their applications compatible with Android and iOS which, while wise in many ways, further reduces the incentive for anyone to buy a Windows phone. Microsoft originally attempted to enter the smartphone market under the leadership of Steve Ballmer when the company still embraced a “Windows only” strategy. Now that the vision has changed to “Mobile first, cloud first” in which Microsoft intends to make their products work on multiple platforms the need to offer something as expensive as a Windows Phone seems pointless.

 

Overall Strategy

 

So much has been said and speculated about the Mobile First, Cloud First strategy, but what if it’s wrong? As previously noted, the greatest impact would likely be in the consumer space but if Microsoft can’t capture significant revenue from consumers they’re going to look for it elsewhere. Unfortunately, if we divide by consumers and businesses, Microsoft will likely look to business customers to make up for lost revenue in the consumer space. With relatively few exceptions, Microsoft’s business customers are so heavily invested in Microsoft technology that it is rarely cost effective for them to abandon it. Microsoft knows this and if they become desperate to avoid declining revenues in the consumer space they will likely look to business and enterprise customers to fill the void.

 

FY15 and FY16 Predictions and Roadmap Information

 

Greater separation between consumer and business pricing

 

We expect to see a continued separation between Microsoft’s consumer business and their enterprise business. As noted elsewhere in this report, Microsoft is doing whatever they can to gain traction in the consumer space. We expect to see continued incentives to attract consumers to Microsoft products across all platforms but it’s unlikely corporate customers will be permitted to take advantage of these incentives.

 

Office 365 E5

 

Last week Microsoft announced that they will replace Office 365 E4 by the end of the year. The new top tier Office suite for enterprise customers will be Office 365 E5 and it promises to be a surprisingly robust bundle with virtually all Office 365 functionality available. This comes as no surprise since it leverages the release of Windows 10 and other new products but we believe it may be a precursor of future product bundling changes. Microsoft will continue to squeeze as much revenue as they can from their enterprise customers and they will give the appearance (and substance) of added value to justify price increases.

 

Products Optimized for the Cloud

 

Since cloud optimization is different from on-premises datacenter optimization (different APIs, etc.) we expect Microsoft to separate the two whenever appropriate. The new emphasis will be to design and build for deployment in the cloud, whether on Azure or competing platforms. Of course Microsoft will continue to support on-premises deployment and we have seen nothing to indicate that they will stop updating these products when necessary, but the company has clearly embraced the cloud as its future.

 

Future of Windows Support

 

Microsoft has stated that Windows 10 will be the final version release of Windows. This has led to considerable speculation about the future of operating systems from Microsoft and also whether they would introduce a subscription model to ensure updates over time. Last week Microsoft cleared up much of the confusion when they announced that Windows 10 will receive five years mainstream support and an additional five years of extended support.

 

As for Windows 10 being the final version, that doesn’t mean Microsoft will never release another operating system. The Windows brand is thirty years old today and will be forty by the end of extended support. We expect a new OS from Microsoft during the coming years, but it won’t carry the Windows logo.

 

Commoditization in the Cloud

 

Most businesses and an increasing number of consumers have accepted that the cloud is here to stay.  This presents both risks and opportunities for cloud hosting companies and Microsoft is uniquely positioned to benefit from the inevitable commoditization. Service providers that offer little more than data centers to store data and host someone else’s applications or websites will likely fail or be consumed by bigger players such as Microsoft, AWS, IBM, and others. For Microsoft, the cloud represents an opportunity to host some of their biggest products for their biggest customers. Even as hosting margins erode due to competition, Microsoft can afford to discount deeply as a means to provide a single solution for their customers and in doing so, keep them from moving to competitors offerings.

 

Product Releases

 

Dynamics CRM – Released

Exchange 2016 – 2nd half, 2015

Office 2016 – fall, 2015

Office 2016 for Mac – 2nd Half, 2015

Office for Windows 10 – Released

Power BI – July 24

SharePoint Server 2013 SP1 Cumulative Updates – Monthly

SharePoint 2016 – Q2 2016

Skype for Business (aka Lync Server) – Released

System Center – 2016

Visual Studio 2015 – Released

Windows 10 – July 29

 

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 (MAP) 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.

Nov 2016