Earnings Call: Q1 2014

Oct 24, 2013

Greetings, and welcome to the Microsoft Fiscal Year First Quarter 2014 Earnings. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. It is now my pleasure. And now I'll introduce and turn the call over to Chris Sutt, General Manager, Investor Relations for Microsoft. Thank you, Chris. You may begin. Our website, microsoft.com/investor is our financial summary slide deck, is intended to follow our prepared remarks and provide the reconciliation of differences between GAAP and non GAAP financial measures. Our website also includes information related to our new financial reporting segment, which were announced on September 19, 2013 and discussed with investors on our conference call on September 26. As a reminder, we will post today's prepared remarks to our website immediately following the call any future use of the recording. You can replay the call and view the transcript at the Microsoft Investor Relations website until October 24, 2014. During this call, we will be making forward looking statements, which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed Earnings Press Release, in the comments made during this conference call and in the Risk Factors section of our Form 10 ks, Form 10 Q and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward looking statement. Before I hand the call over to Amy, I'd like to remind you that all growth Results. Unless specified otherwise, all impacted numbers for the current quarter have been adjusted for the cumulative effect of last year's revenue deferral related to the Windows upgrade offer, Windows 8 presales, the Office offer and a 100 and $13,000,000 revenue deferral in the current quarter, primarily related to Windows 8.1 presale. You can find details of the adjustments and reconciliation of differences between GAAP and non GAAP financial measures in our financial summary slide deck. And with that, I'll turn it over to Amy. Good afternoon and thank you for joining us today. By now you've had a chance to look at our press release, earnings slide deck, Key Performance Indicators and our 10 Q. Our results have been reported using the new reporting framework I first discussed at our Financial Analyst Meeting in September. Since this is a new way to think about our business, I'm sure you'll have a lot of questions. So after our prepared remarks, we'll allow a little more time than usual for Q and A. And with that, let me dive right in. This quarter, we delivered record 1st quarter revenue. We did it while working focused and delivering. Our enterprise business remains strong despite a macro environment that some have characterized as tough. We are driving our business forward with industry leading solutions in key areas like collaboration, unified communications and cloud services. And high customer satisfaction is driving high enterprise agreement renewal rates. At the same time, we are making meaningful progress in our consumer business. We saw growing engagement and adoption across our major consumer services, including Office 365 Home Premium, Skyping and SkyDrive. And with the new Windows, we're building high value experiences for our consumers that allow people to use our devices and services all day long, whether at work or at home. From a geographic perspective, we saw broad based revenue growth. Overall, both developed and emerging markets showed strength. The U. S. And parts of Western Europe were particularly strong, while China was weak. Now let me share some quick thoughts on the PC market, which turned out better than we had expected. We're seeing signs of stabilization in the business segment with 2 consecutive quarters of growth and a relatively stable outlook for the next couple of quarters. While the consumer segment is more volatile with increasing competition per share of wallet, It also performed better than expected, particularly in developed markets. With that backdrop, let's move on to Windows. We're seeing favorable reviews and customer enthusiasm for Windows 8.1, which became available last week. Windows 8.1 delivers customization capabilities made the UI simpler and easier to use, added new and smart ways to search, improved power management and allowed multitasking even on a tablet. Combined with the progress our OEM partners are making, we are collectively increasing the selection of Windows devices available to meet the dynamic needs of all segments of the market. This holiday, we'll see competitive opening price points on tablets and laptops, such as the Dell and Spireon 15 for less than $300 We'll also see exciting mobile devices from 6 inches phones to 10 inches tablets, many with Microsoft Office. In the 6 inches category, we're incredibly excited by the Nokia Lumia 1520 tablet announced this past Tuesday. For 8 inches tablets, Toshiba, Dell and Lenovo will have devices available for less than $300 And for 10 inches tablets, we of course like the Nokia Lumia 20 5 20 with LTE. In addition to 3rd party devices, we're also excited about our 1st party lineup. With Surface, we are making progress with better end market execution. As a result, we more than doubled the number of units we sold over the prior quarter. In terms of mix, Surface RT did better than expected. With Surface Pro, we saw some customers delay purchase in anticipation of Surface Pro 2, which delivers significantly improved battery and processor performance. Moving on to the enterprise where demand for our solutions continues to be strong. Earlier this month, we announced our fall wave of enterprise products of services, which touches nearly every aspect of IT. We're seeing solid growth, we're outperforming our competitors, we are taking share in areas like virtualization and the data platform. Our hybrid infrastructure and management offerings continue to be top choices for CIOs with Windows Server Premium and System Center growing double digits again this quarter. The latest versions of Windows Server, System Center and Windows Intune deliver enhancements in networking, storage and device management for Windows and alternative platforms. These enhancements will help customers realize the promise of hybrid cloud computing across their data centers, hosted clouds and Windows Azure. In the data platform, SQL Server continues to outpace the market. The next version, SQL Server 2014, We'll offer new in memory and cloud capabilities that will increase performance and unlock new hybrid scenarios. Later this month, We will make Windows Azure HD Insight, our Hadoop based big data solution generally available. We continue to bring additional value to the Windows Azure platform. This quarter, we delivered a number of updates that enable faster connectivity, improve security and integrate access and identity across on premise and cloud applications. With all of the innovation we're delivering to our enterprise customers, We continue to be uniquely positioned to capture more and more of the addressable market. Before handing it off to Chris, I'd like to say a couple of additional things. As part of our new reporting framework, we've disclosed segment gross margin. The segment breakout is important in understanding our performance because each of our businesses are impacted by different dynamics and have different margin profile. In devices and consumer, the sequential change in gross margin dollars reflects the progress we are making towards our strategy of delivering a compelling family of devices and services. While we feel good about the increased traction we saw with Surface this quarter, we know there is more to do. We are intensely focused on improving our capabilities in key areas like demand planning and supply chain management and on achieving scale as quickly as possible. In commercial, we're already seeing the benefits of the investments we've made to transform our business model from perpetual software licensing to services. In our commercial cloud business, which includes Office 365, Azure and other Microsoft services, we saw year over year gross margin expansion. With regards to our pending acquisition of substantially all of Nokia's devices and services business, we still expect the transaction to close Q1 of calendar 2014. We will provide an update to the EPS impact, if any, post closing. So in summary, We are executing better, getting our customers what they want and making meaningful progress through the early stages of our transformation. And we've accomplished all of this, while also working through the 1 Microsoft realignment and several significant announcements. We're committed to executing and delivering and so far that's what we've done. With that backdrop for the quarter, I'll hand it over to Chris to give more details about our performance before I come back and share thoughts on the outlook. Thanks, Amy. First, I'll review our overall results and then I'll move on to the details by business segment. Total revenue was up 7% to $18,600,000,000 and came in about $700,000,000 better than our expectations. And without the impact from foreign exchange, revenue would have been $200,000,000 or 1 percentage point better. Annuity revenue was particularly strong and grew 11% driven by commercial performance. Cost of goods sold increased 23%, which was in line with our expectation of over 20% growth. This increase was primarily due to surface costs and also higher depreciation related to the CapEx investments we made to support our cloud service strategy. As a result, gross margin grew 3% to $13,500,000,000 reflecting the changing mix of our revenue. All up operating expenses grew 8%, which was generally in line with our expectations with G and A, which declined due to lower legal expenses. We continue to be thoughtful and diligent in how and where we focus our resources. In advertising, the team has embraced 1 Microsoft and the benefits are already accruing with improved messaging and results. And in R and D, we're continuing to focus our resources while accelerating our cadence. Operating income and earnings per share both declined 3% to $6,400,000,000 $0.63 respectively. Unearned revenue grew a healthy 14% to $20,100,000,000 and our contracted not billed balance grew to over $21,000,000,000 driven by commercial strength. Our inventory balance sequentially increased by $675,000,000 mostly due to builds of Xbox 360 and Xbox 1. Ahead of the holiday selling season, Xbox represents over half of our inventory balance. Inventory for Surface products This quarter, we announced a 22% increase in our quarterly dividend to $0.28 per share and also announced $40,000,000,000 share repurchase program. We returned $3,800,000,000 of cash to shareholders, our highest quarterly amount since the Q2 of fiscal 2011. I'm now going to talk about the performance in HR Reporting segment. Our Devices and Consumer Licensing segment is comprised principally of Windows OEM, Consumer Office and Windows Phone including related patent licensing. Our Windows OEM business performed better than expected declining 7% versus our expectation of a mid teens decline. As Amy noted, we believe we are seeing stabilization in business PCs, which grew again this quarter and drove Pro revenue growth of 6%. We also saw better than expected performance The consumer part of our business. Non Pro revenue declined 22%, but was several points better than expected. Excluding the impact of China, which continues to have a different dynamic than other emerging markets, non pro revenue declined 17%. Together with our OEM retail partners, we brought an incredible breadth of Windows devices to market. We've also made meaningful improvements to our advertising campaign, which now clearly highlights the value proposition of our devices. As we head into holiday, we're excited by the opportunities to bring Consumer Office licensing revenue declined this quarter. The financial impact of the shift to Office 365 Home Premium was generally in line with our expectations. Office 365 subscribers benefit from the natural integration of services such as SkyDrive and Skype and have the flexibility to access the service from numerous endpoints. Whether via traditional licensing or subscription, customers continue to see the value in Office as overall attach of Office increased this quarter. The Windows Phone ecosystem is seeing sustained growth. While we have work to do, our share is growing in many geographies, the device portfolio is expanding Revenue grew $401,000,000 driven almost entirely by Surface. With improved sales and marketing efforts, Combined with pricing and promotional activities, we saw surface units and revenue grow sequentially from Q4 with a mix of sales shifting towards 32 gigabyte RT device. Demand increased for this device both in retail and in education. From a gross margin perspective, in addition to product costs, which grew as a result of increased Surface sales, we also incurred non product expenses as we readied inventory lines for the new Surface lineup and the holiday sales cycle. Moving to Devices and Consumer Other. As a reminder, this segment includes Our online marketplaces, advertising, Xbox Studios, Office 365 Home Premium and other consumer products and services. This quarter revenue growth in this segment was driven by both an increase in advertising revenue and also volumes in our online marketplaces. Search advertising revenue grew 47%, driven by continued revenue per search improvement and query volume growth. Bing has and also infrastructure cost growth as we expand the geographic footprint of our services. Turning now to our commercial business, where all up commercial revenue across both on prem and cloud services grew 10% this quarter. Notably, even as we invest for growth, we saw gross margin expansion in our commercial cloud business. Across our commercial portfolio, we saw healthy renewals, a continued shift to premium products and strong adoption of our cloud services. Our enterprise cloud strategy is resonating with customers and server product revenue grew 12%. SQL Server revenue grew double digits with SQL Server premium revenue growing over 30%. Our commercial office products also remained strong and grew 11%. Within this, SharePoint, Exchange and Link collectively grew double digits with Link growing nearly 30%. Helping to drive this demand for our server and office products is deployment of hybrid cloud solutions. This quarter revenue for our Importantly, we're seeing strong customer adoption with Office 365 seats and Azure customers both growing triple digits. Dynamics CRM Online is also expanding its space with 2 thirds of new Dynamics CRM customers opting for With that overview of our commercial business, let me share the financial performance in each of our commercial reporting segment. Revenue in the Commercial Licensing segment grew 7% and in our Commercial Other segment revenue Grew 28 percent to $1,600,000,000 As a reminder, corporate and other is where we consolidate adjustments for tech guarantees, presales and the like. In the comparable quarter of last year, we had aggregate deferrals of $1,400,000,000 for Windows and Office And this quarter, we deferred $113,000,000 primarily related to Windows 8.1 pre sales. Having now talked through our results for the past quarter, let me turn it over to Amy to discuss our forward looking guidance. Thanks, Chris. As we look towards the Q2, we are assuming the macro environment remains generally the same. With this, we expect many of the dynamics we saw in the Q1 to continue with strong performance in our commercial business and ongoing improvement in our consumer business. Importantly, we're set up for a terrific holiday season. We have a wide variety of Windows based devices in market. Earlier this week, we launched Surface 2 and Surface Pro 2. And in November, we'll launch our next generation console, Xbox 1. Building on the performance and unique experiences the gamers love, It will also deliver an innovative entertainment experience by bringing movies, music, sports and live TV together in one place. With that, let's get into the outlook, starting with Devices and Consumer. In licensing, we expect revenue to be $5,200,000,000 to $5,400,000,000 This range reflects similar dynamics to what we saw in the Q1. As I noted earlier, we expect the business PC market to be stable. However, consumer PC market is subject to more volatility. In hardware, we expect revenue to grow 35% to 45% to $3,800,000,000 to $4,100,000,000 reflecting the expanded Surface lineup and the much anticipated Xbox 1 launch. The 10 percentage point range reflects variability in device unit volumes. In the consumer hardware business, such variability is not uncommon, especially during launches and the holiday season. And in devices and consumer other, we expect revenue to be $1,700,000,000 to $1,800,000,000 Search revenues should continue to grow, reflecting improved revenue per search and query volume. As a reminder, in Q2 of the prior year, We launched Halo 4, which contributed $380,000,000 of revenue to this segment. Now Moving on to commercial. We expect revenue to grow 9% to 11% in line with the Q1. As we think about this part of the business, we're confident in our ability continue to add value to our products, while providing low total cost of ownership for our customers. In commercial licensing, We expect revenue to be $10,700,000,000 to $10,900,000,000 with similar dynamics to what we saw in the Q1. This includes healthy renewals and strong annuity revenue growth from volume licensing with Software Assurance. In Commercial Other, we expect revenue to $1,700,000,000 to $1,900,000,000 reflecting ongoing momentum in our commercial cloud business and enterprise services. As CIOs increasingly look To capitalize on the opportunities of cloud computing, we are confident they will continue to look to Microsoft for their IT solutions. Moving on to cost of revenue, which we expect to be $7,900,000,000 to $8,300,000,000 next quarter. This range primarily relates to the unit variability assumed in the hardware revenue. In Surface, we are still in the early stages of the lifecycle. As you know, there are many things going to bring hardware to market, including both variable and fixed cost. We are intensely focused on building volumes and achieving scale to cover these costs and get to profitability. As you think about the economic model for Xbox, you should keep in mind that console margins are just one aspect of the overall platform's financial performance. Attach of games, 3 Xbox Live services also contribute to the economic model. We expect the launch of Xbox 1 to be the biggest in Xbox history and we feel great about our ability to continue our leadership position in the living room. Moving on to operating results. We expect OpEx to grow 6% to 8% to 8.5000000000 dollars to $8,600,000,000 We also reaffirm our full year guidance of $31,300,000,000 to 31 $900,000,000 We continue to invest in innovative experiences for our customers while remaining focused on expense. We still expect full year capital expenditures to be about $6,500,000,000 even though we only spent $1,200,000,000 in the Q1. Given the nature of the investments, there is variability from quarter to quarter due to our success based approach as well as the timing of delivery and completion. We expect our tax rate for the full year to be between 18% 20% depending on our geographical mix of earnings. When adjusting for tech guarantees and product deferrals, we expect unearned revenue to be roughly in line with historical trends. So in summary, I'm really pleased with our results this quarter. It was a great start to the fiscal year as we executed and delivered across all of our businesses. We are on track with implementing the transformation of the company around the 1 Microsoft strategy and at the same time are not missing a beat in executing faster. And as we look forward to the Q2, our enterprise business will remain strong and we're also set up for a fantastic holiday season with Surface, Xbox 1 and a host of devices from our partners, which will allow us to reach new customers and drive increased engagement. With that, I'll turn it to Chris and then we'll take your questions. Thanks, Amy. And with that, we're going to move on to the Q and A. Operator, please go ahead and repeat your instructions. Thank One moment please as we poll for questions. Thank you. Our first question comes from the line of Brent Thill with UBS. Please proceed with your question. Good afternoon. Amy and Chris, thanks for the additional details. I know everyone appreciates the forward looking details. My question is on the commercial revenue, obviously an impressive number in a seasonally soft Q1. Your guidance assumes also a continued Good trajectory. Maybe if you can walk through why you think you're outgrowing your peers and what has led to this double digit number? Thanks, Brent, for that question. I do think when I think about the commercial business and focus on our unearned revenue growth of 14%, plus our bookings growth, which is quite strong as well of 6%. I think about, the road map. The strength of the commitments that customers are making is really for the forward looking. It's a 3 year commitment to the Microsoft platform, both to our cloud and on prem solutions, the breadth and strength of that road map and our offerings. And I think in many ways, that's what gives us the confidence that we're outperforming our peers. And also I think it speaks a lot to the innovation and the roadmap we've shown Whether it's for Azure, Office 365 or our broader server portfolio, I do feel quite good about both our competitive position and our ability to execute. I think we did a great job in the field this quarter remaining focused on delivering what we needed to deliver to our customers and we were quite pleased. Great. Thanks, Brad. Next question please. Thank you. Our next question comes from the line of Phil Winslow with Credit Suisse. Please proceed with your question. Hi, thanks guys and congrats on a great quarter. Just want to focus in on Xbox and Xbox platform. Amy, wondering if you could give us maybe some color on how it This quarter, but in particular as you look into the December quarter here, obviously you gave that gross margin guidance, but I was wondering if you could talk sort of high level about how you're Approaching just the Xbox 1 launch, say, versus Xbox 360 from a perspective of how you're pricing it relative to COGS and just sort of How the build of Xbox 1 looks versus sort of 360? Thanks, Phil. Let me I think it's a great question. It gives me the opportunity to talk about the breadth of the portfolio that we'll have to offer at Holiday, and then talk a little bit about the gross and profile and philosophy we have amongst those products. We are excited that we'll have a great value offer at Holiday with Xbox 360 date. And we'll also have a great choice with our innovative Xbox One platform to really give us a good breadth rolling into holiday of selections across price points. We did with Xbox 1 make a decision to really enable a first class experience out of the box. There's Connect, there's a headset and there's a console. And depending on where you are around the globe, As I said, the best way always to think about the life value of the Xbox plan is over its lifecycle. I'm excited about the increased opportunity that Xbox One allows us to attach more and different services beyond what we've historically thought of as simply a gaming platform. And when I think about the opportunity going Forward, it is important in Q2 to realize that will impact our gross margin in the short term. But winning the platform at Holiday and our positioning to DoDAT allows us to grow profitability in a far different way over the life cycle. So hopefully that helps. Great, Bill. Thank you. We'll move on to the next question please. Thank you. Our next question comes from the line of John DiFucci with JPMorgan Chase. Thank you. Please proceed with your question. Thanks. Amy, billings were about what we modeled for the quarter. But deferred revenue was about $700,000,000 less than we expected anyway, which was equal to the upside in revenue. I'm just curious, did you end up recognizing a greater portion of revenue upfront this quarter than you normally would? Because like I realize Given how you recognize revenue, I guess the question could be said, was the transactional portion of the revenue in like the commercial segment greater than it is typically this quarter. Hi, John. This is Chris. I'm going to jump in a little bit and I'll let Amy add on. I think the way to think about the way we think about it We did see growth across annuity and non annuity in the business, but also the changing dynamic is the mix of the dollars that are going into unearned revenue. As we bill More contracts in some of our subscription offerings that also changes the nature of the term. If you think about 1 year subscription offerings and things like this. That has a little bit of effect on the unearned revenue balance as well. Let me add a little bit. I would have said John, Both of the things you said are true and both are good, which is I do think our unearned balance growing 14% year over year was better than we actually had expected from our perspective. And we also saw very good non annuity performance within the quarter, particularly in Office and in SQL, which I think are very good time, we believe, for both the to see the strength broad based. As you know, the annuity portion tends to be related to large customers making long commitments. Some of the non annuity is exciting because it tends to be smaller customers who've decided to go ahead and upgrade to the most recent version of Office, which which is also encouraging. Okay. Thank you. Thanks, John. We'll move to the next question please, operator. Certainly. Our next question comes from the line of Walter Pritchard with Citigroup. Please proceed with your question. Hi, guys. This is Ken Wong for Walter. Yes. I guess we wanted to focus a bit on Windows. And the OEM business was down just 7% this quarter versus down 15% last quarter And what seemed like a really you guys had a lot of pressures on ASPs and whatnot. I guess what drove the sort of the quick turnaround from quarter to quarter? Maybe Let me try to break it up a little bit kind of make sure I understand and get a chance to talk about the overall Performance. Business was better than we expected. So actually ASPs We're probably higher than many people had modeled and then we had expected due to mix. Growing 6% in the Pro segment was both better than we expected and probably better than many people had considered. Now in the Consumer segment, The minus 22% taking out China to minus 17%, I think it's generally overall when you Take those two numbers probably in line with most of the device level estimates for PCs we've seen across the industry and from some of our peers reporting in the system. I do think we were impacted by some inventory levels. It did come down a bit actually this quarter as well. So I think overall, we do think that things are probably More stable in the business segment and encouraging and in consumer and developed markets particularly were better than we had seen. Thank you, Ken. Thank you. Yes. Next question please. Thank you. Certainly. Our next question comes from the line of Keith Weiss with Morgan Stanley. Please proceed with your question. Excellent. Thank you guys for taking the question. You saw a real market uptick in the advertising revenue with the search advertising revenue. Any particular catalyst you could point us to in sort of what really catalyzed that part of the business and how sustainable that's going to be on a go forward basis? Sure. Thanks, Keith. A couple of things. It was driven as noted both by RPS improvements and volume improvements, which is encouraging. I also think underlying that are some real technical improvements we've made within the search engine. Algos are better and the investments we're making are really allowing us to monetize at a higher level. We also saw some strength and a few other geos, which helped increase the performance there. So I do believe that that trend we expect to continue into Q2. Excellent. Thank you, guys. Thanks, Keith. Next question, please. Thank you. Our next question comes from the line of Heather Bellini with Goldman Sachs. Please proceed with your question. Hi, great. Thank you, Amy and Chris. I just was wondering, you talked about the entry of a lot of new SKUs that are coming out for the holiday season. I'm just as we start thinking about building our OEM models, How do we think about ASPs for this 8 inches and below category that you referenced there's a lot of product coming out with? Good question, Heather. Let me talk about first the importance of the breadth of the offers that we're putting into market. With Windows 8.1, one of the focus we had was to expand both the opportunity for screen sizes and to reach new price points and to cover really from the smallest to the largest with touch and non touch. And I think our ability to work with partners and some of the sales execution we've seen in the field has led to have a broad opportunity at retail for holiday for devices. It is important, I do hope in some ways this is a question that's a bit awkward. You always want to say ASPs it's good to have ASPs go up. Transparently going forward as we make more progress, especially in the smaller screen sizes, we should expect units to go up I'd be very excited about that in terms of share, but ASPs would trend down. I don't think that will have a material our guidance does not assume a Real Impact ASPs in Q2. But over the long term, I actually do understand the question and would expect ASPs to be on that trend line assuming we are successful in those lower end device sizes. Thank you very much. Thanks Heather. Thank you. Next question please. Thank you. Our next question comes from the line of Mark Moerdler with Sanford Bernstein. Please proceed with your question. Thank you. And Amy, thank you for giving so much more data and guidance. We appreciate it. A couple Quick attached questions. You had said that the consumer office last quarter was going to be down roughly 5% due lower than the PCs due to the move to subscription. You said the attach was higher this quarter. Should we think that the dip was roughly in line with that? Let me hi, Mark. This is Chris. Let me try to clarify the numbers, just so we're all on the same page. So We did say consumer office did decline this quarter. Last quarter, you're right, we said about 5 points of impact. And so the impact Indeed was about what we expected, but with the increase in attach, they sort of tended to offset each other in the end. And so the numbers came in As expected. So I think that's the right way to think about it. Okay. Perfect. That answers it. Of course, I can't let Chris I'm going to add a little to the answer, sorry. Mark, I do think it's important for us to continue to reiterate the importance of the success of the Office 365 Home Premium SKU from a strategic standpoint. We have done a very good job and I would say as a mix percentage of the SKU, It continues to do even a little better than we had hoped in terms of execution at the endpoint and driving value. And while that does have an impact on the ASP of the SKU. The long term lifetime value of that product in my belief given the Always up to date first to see innovation, use across multi endpoints, inclusion of Skype, inclusion of SkyDrive really does allow for a higher lifetime value and ultimately a happy customer. And so I really am encouraged by our progress and our execution there. Beautiful. One other quick question. Any sense for what Commercial licensing would have been if not for the move to cloud and subscription. Does it make a material change yet at this point? No, the best way to think about that Mark is if you look at, it's not an exact offset, but when I talked about the commercial business all up, I gave The construct around products like commercial Office, commercial server as all up across both prem, on prem and commercial. So we talked about office Growing 11% across both commercial licensing and commercial other in aggregate. If you look at The specific segment you'll see that Office in the consumer, the commercial licensing segment actually grew 6%. So you can see that we're having outsized growth In the commercial other segment, which is Office 365. So that maybe helps at least dimensionalize the size of the growth in relative terms. I do appreciate it. Thank you both. Thank you. Our next question comes from the line of Rick Sherlund with Nomura Securities. Please proceed with your question. Thanks, guys. Just to follow-up on Mark's question. I believe there was a slide at SAM that showed about $150,000,000 of negative impact in the quarter from the move to the cloud, which in and of itself it's about 1% of revenue. So it's kind of not a very big deal. And I think most of that was from Office versus Server and Tools. So if you say it's about as expected, I guess I'm just looking for some clarification here is the Really the only impact we're seeing in the office segment versus server and tools or was there much impact in that part of the business from the move to subscription. Rick, let me clarify. The $150,000,000 you're right was actually just related to the Consumer Office segment and had no broader connotation beyond that. So that $150,000,000 in a quarter on So that being said, obviously, as we've talked about the momentum in our broad Office 365 revenue. It is a bigger impact across not just Office because I think that's actually not the way of thinking about Office 365's impact. There it's really around Exchange, Link, SharePoint and the broad server impact there is actually more meaningful than its impact on maybe office client on the commercial side. Great. Thanks Rick. Next question please. Thank you. Our next question comes from the line of Ross Millen with Jefferies. Please proceed with your question. Thanks a lot. I have two questions. Just first on the device and consumer licensing business. Your forecast for Q2 suggests a moderating decline. And I was curious as to whether on the corporate OEM side, if you will, That's just a reflection of the ongoing stabilization trend or do you also expect to see improvement on The consumer OEM side. And related to that, how do you think about the impact of the end of life of XP on the corporate OEM side. Do you think that the improvement is completely unrelated to that end of life forthcoming? Or Do you think there could be some impact related to that? Thanks. Great. Let me divide That question, I think as you said 2 parts. Our Q2 guidance for devices and consumer licensing really It says that the trends we saw in Q1 on both sides continue in Q2. So I think that's an important distinction As you noted and asked for clarification on, so I hope that's helpful on that component. And when it comes to end of life of XP, I tend to think about that more as on the VL side as well and the strength there which will be in Commercial Reporting Segment. We continue to make progress on the XP installed base and now A little over 75% of the PCs are running 7%. And so I do think as we continue to get to end of life of XP, You'll see the impact more on the VL side of the business than you would in the device and consumer licensing segment. Thank you very much. That's helpful. And maybe one quick follow-up. Just on the office business overall in the commercial segment, if you think about units, whether licensed or 365. When you just think of the aggregate pool of units, you sort of alluded to it before, but is that Did that perform in line with your expectation or was it actually slightly better on a unit basis? Thank you. That one's it was slightly better. Ross is the best way of thinking about that from a unit perspective. Thank you very much. Congratulations. Thanks, Ross. We'll take the next question please. Certainly. Our next question comes from the line of Ed McGuire with CLSA. Please proceed with your question. Hi. Thanks for taking my question. I was wondering if you could address the conditions in China in a little bit more detail, not Just on the consumer, but also in the commercial as well as what your expectations might be given the lifting of the ban on game consoles For Xbox there. And also if you could just address some of the what you're seeing in terms of your commercial cloud adoption outside of the U. S. Thank you. I'll take the first part of the question Annette. So, yes, as I said on the call, Our macro conditions in China, which I think consistent with what some of the other companies have reported as well have been challenging. Our total revenue across all of our business including the PC related businesses were down year over year and I think that overall impacting Our results in China all up. I think the second part of your question was related to Commercial sorry, can you repeat your second question? Sure. Well, I was wondering about Xbox There but also your the trends of commercial cloud adoption in areas outside of the U. S. We haven't really talked specifically about our expectations for China on the Xbox, but let me take the second half of that question. Our performance in both Office 365 and Azure has actually been quite good both in the U. S. To your question and outside the U. S. Part of the reason that you've seen us investing on the capital expense side is to continue to build out the opportunity set, set, because we are seeing good demand outside the U. S. And I do think our ability to be competitive there is just as high as it is or so. We've already seen that growth. Thank you. Great. Thanks, Ed. Next question, please. Thank you. Our next question comes from the line of Jason Maynard with Wells Fargo. Please proceed with your question. Hey, guys. Good afternoon. I wanted to drill a little bit into How you're thinking about holiday on the consumer hardware side and specifically just expectations around Surface? And then also any insight or color you think in terms of whether you what your expectations are with RT versus Pro? Thank you. Thanks, Jason. I think overall for holiday given our guidance, we clearly do expect a healthy holiday performance across the portfolio. I say that because we do have offerings that provide great value forum having Surface V1 RT still in market, Surface 2, Surface 2 Pro, plus Xbox 360, 8 plus Xbox 1 really does provide both a value portfolio and those who want the latest and greatest experience I have something covered. The guidance does include good performance across all of those product lines. We did see, I think, as Chris and I both talked about, a lot of progress in sales execution on surface in particular this quarter and that does give us more confidence about our ability to execute again well in Q2. In particular, as you noted, RT did do quite well this quarter and I look forward To seeing that continue with the Surface 2 device as well at holiday. Great. Thank you, Jason. We'll move to the next question please. Thank you. Our next question comes from the line of Kash Rangan with Bank of America Merrill Lynch. Please proceed with your question. Hi, thank you very much for all the details as well. I'm just maybe my math skills have gotten horribly weak, but I just took the midpoint, Amy, of your revenue guidance for the different line items and also the midpoint of your cost of revenue inputs and the midpoint of your OpEx. And I come up with what looks to be about a 10% reduction to where I think most sell side models are. Maybe I'm doing I'm hoping that I did something wrong here. But if that's the case, I get about 29% off margin relative to the 33% or so that you did last year. So can you just walk us through what are the items that you're assuming in your cost structure, which effectively makes the op income flat, although you are getting good revenue growth rate. I just wonder if there are any one time items or if it's just emblematic of a shift in your business model to devices and consumers, especially with Nokia going forward, wonder if we should not be thinking about op margins, but really op income growth rate. Thank you. Thanks, Kash. I think the one thing I would urge you to do as you think about the guidance we gave is looking specifically at the D and C hardware guidance as well as making sure you're mapping the COGS very specifically to whatever assumption you're making in DMC hardware. Given The business model of Xbox that can and will have an impact in Q2 to the overall gross margin structure. So as you think through that, I think that's probably one of the assumptions that it may sound like using the midpoint could lead you a bit off of where I would have expected. Got it. Thank you very much. Thanks, Kash. Next question please. Thank you. Our next question comes from the line of Raimo Lenschow with Barclays. Please proceed with your question. Thank you. I just want to follow on from Jason's question early on. Can you talk a little bit about where you see the improved success and the sales execution success On the surface, is it kind of commercial? Is it consumer? And what's driving the improvement there? And how much is Kind of the improved revenue run rate also driven by the fact that the channel needed to be ready for the holiday season. Thank you. Hi, Raimo. Thanks for the question. As we talked about, especially for this last quarter, Surface, we saw 2 things I'll mention, which is popularity of the Surface 32 Gigabyte RT device. That one was more successful this last quarter. And we saw we actually saw demand increase in both commercial and in the education commercial education customer segment as well. So We did see some improvement across both those segments. Yes, I would say that another way is that It was in retail and in education, was really our RT performance. Yes, sorry. Sorry, Chris. I just want to make sure that was clear. It really was better execution at retail and at EDU and I still look forward to building a commercial channel, which we're just starting to do as we continue to add resellers to our model. Perfect. Thank you. Thanks. Thank you. Our next question comes from the line of Brandon Barnicle with Pacific Crest Securities. Please proceed with your question. Thanks so much, guys. I had 2 quick One was the SQL Server success continues to be very impressive, particularly relative to the field. So I'm wondering where you're seeing kind of the most Is that market share gains? Is that pricing getting into some new markets? If you could provide any color there that would be helpful. And then when's your expectation for the next sort of update Great. Let me take the second one first because it's the easiest. We still do expect transaction to close in the 1st calendar quarter of 2014. And post closing, if there are any EPS impact changes to what we said before, we'll give them post closing. So now back to your original question on SQL, That's a terrific one to get to talk about. Our growth there is as you said both share growth and revenue growth. It's happened, I think generally both in BI, which we've seen a lot of traction with. I don't know if you had a chance to see some of our Power View announcements recently. Our ability to sort of span from end user to the hardest big data problem really has resonated both in the market and with industry analyst who've taken, I think, a strong position that we're the real market leader there. The other thing I would say is a very healthy performance of our premium SKUs. Our premium SKUs have continued to provide market growth and I think are competing quite well with the competition. Great. Thanks guys. Thanks Brendan. Next question please. Thank you. Our next question comes from the line of Gregg Moskowitz Cowen and Company. Please proceed with your question. Thank you very much and good afternoon guys. Just two questions. First, Amy, if I recall correctly, I believe Last quarter you had mentioned an expectation for double digit annuity growth in fiscal 2014. Is that still how you're thinking about the annuity part of the business? And secondly, The year over year cloud revenue growth you reported was certainly impressive, but I was wondering if you could shed some light perhaps on how much of Azure billings or revenue Our incremental versus cannibalistic. Two good questions. I do expect our annuity growth in the guidance we gave, it still does double digit annuity growth going forward. And I think our performance this quarter gives me confidence that the guidance in Our ability to power the cloud whether you want to run it, you want a service provider to run it or you want to use ours It's really an incredibly powerful story. And I think in some ways, whether or not it's cannibalizing becomes somewhat difficult. What we've generally found right now is that it has been often additive. And if you look at our server growth all up, which we tried to provide to help give some parameters around that to give some confidence that we're both growing the base and providing additive opportunity. I think that's the number I would probably look to see the impact there. Great. Thanks very much. Thanks, Greg. Operator, I think we're down to our last question. Certainly. And our last question comes from the line of Kirk Materne with Evercore. Please proceed with your question. Thank you very much for fitting me in. I guess two quick ones for you Amy on the commercial Cloud Offerings. I guess, first around Office 365, you mentioned you've seen pretty good uptake even outside the U. S. I was interested in just your ability To monetize Office 365 and some of the emerging markets that have been challenging over time for Office. And then secondly, as a follow-up to Greg's question on server, Within Azure, how much of the uptick in Azure is coming from sort of existing Microsoft logos versus bringing on net new logos onto the platform. Thanks. Great. Thanks, Kirk. Let me talk about 2 things. I do think It's interesting, maybe the best example of how to think about us moving beyond our traditional markets is the fact that we were the first to commit to a data in China, a market that we've historically had challenges monetizing at a high level. We went there. We're going there with Office 365 and Azure. We look forward to being able to make progress. We're investing both headcount and capital dollars because we do believe this provides an interesting opportunity for us to begin monetizing end markets that have been harder for us to grow in maybe with a more traditional business model. Secondly with Azure, I think we've seen both. But the thing I would say is what's been really helpful is that as we make it easier to attach Azure services to our normal rhythm in the field through our enterprise agreements and through volume licensing. It provides a really helpful way and a really easy selling motion to provide customers flexibility. We added in the normal rhythm of a sales motion. We allow people to try, use and buy and that has served us well in terms of being able to expose Azure More and more customers in a normal selling cycle. So I think that's probably one of the better ways. It's the same actual selling rhythm we've used with Office 365 so successfully. And with that, I wanted to say thank you. I know that this quarter, We changed reporting segments and that requires a lot of work. So thank you for all the work put in to understand our transition that we're trying to make as a company. And so let me turn it back to Chris to say his final words. Great. So that wraps up today's earnings call. We look forward to seeing many of you in the coming months at various investor conferences. For those of you unable to attend in person, these events will generally be webcast and you'll be able to follow our comments at microsoft.com/investor. Please contact us if you need any additional details and thanks for joining us today. Thank you. Thank you. This concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.