Status Update

Sep 26, 2013

Slides

Greetings and welcome to the Microsoft Conference Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Chris Suh, General Manager, Investor Relations for Microsoft. Thank you, Chris. You may now begin. Thank you, Jesse. Good morning, everyone, and thanks for joining us on the conference call today. With me are Frank Broad, Corporate Vice President and Chief Accounting Officer And John Setoff, Vice President and Deputy General Counsel. Today's call is being webcast live and recorded. If you ask a question, it will be website until September 26, 2014. During this call, we may make 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 in today's conference call and in the Risk Factor 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. Last week at our Financial Analyst Meeting, Our Chief Financial Officer, Amy Hood, shared with you our new reporting segments. Today, we will review these segments in more detail and we will provide the recasted fiscal 2012 fiscal 2013 segment information. We will also discuss the key performance indicators or KPIs that we will be providing at our next earnings release in October. We're sharing these metrics today so that you will have a better understanding of the information that you will have available starting with this quarter end. On our website, microsoft.com/investor is our slide deck, which is intended to follow our prepared remarks. You can also find the related 8 ks filing and our recast historical quarterly segment results on our website. We will not be discussing quarterly results or any topics other than segments and KPIs today. Our Q1 fiscal Keane earnings call is scheduled for October 24, and we'll provide the results for the quarter at that time. Thanks again for joining us today. And with that, I'm going to turn the call over to Frank. Well, thank you, Chris, and good morning, everyone. We announced last week that we're changing our financial reporting segments effective for fiscal year 2014. The new segments reflect the organizational structure announced in July And the view used by management to analyze results and allocate resources. We had several Objectives in mind as we thought through this new segment reporting structure. Our goals were to provide insight into our business And to deliver increased accountability on gross margins. Our new segments have been aggregated with similar product and service activities And gross margin profiles. For example, all hardware is now reported together in the hardware segment. This will enable us to better monitor and manage our businesses. The accounting and disclosure rules also require that Microsoft report its results In the new segment presentation, beginning with the 1st period in which the business is managed on a new basis. So beginning in the Q1 of fiscal year 2014, we are monitoring performance internally at a business group level The results in 5 new reporting segments plus corporate. On slide number 5, for those of you who are following along, The 5 segments roll up into 2 broad groupings, Devices and Consumer and Commercial. Under Devices and Commercial, we have the licensing and other segments. We will also have a corporate and other line. We will reflect one time revenue deferrals and recognition here, including things like tech guarantees and presales prior to general availability of We'll also continue to record corporate level expenses that are not attributable to a segment here. We will report revenue and gross margin for each of these five segments. We will report operating expense and operating income For the Devices and Consumer Group and the Commercial Group. So moving to Slide 6. From a reporting segment perspective, we have changed from a product view to one that is based on business model and customer segments. As you would expect, our accounting methodology has not changed. For revenue and cost of revenue, We will continue to directly attribute to the segments. Chris will walk you through the revenue product mapping in just a few minutes. For operating expenses, sales and marketing was previously directly attributed or allocated across the segments. These expenses will now be recorded directly or by identified customer segments. In the past, the majority of our research and development expense was mapped by product with some shared across segments. Now R and D will be primarily shared with others mapped directly to the segment grouping. An example of direct The value of that expense only accrues to devices and consumers. So it's appropriate that that expense is The reason for sharing operating expenses across segments is that these expenses drive value across the platform As we seek to deliver seamless experiences across devices, whether on premise or in the cloud. In many ways, it's similar to our new organization, which is now aligned functionally rather than by product. The new financial reporting structure will provide our company with more transparency, Greater accountability and better execution, not only for today, but also for the long term. So now, I'll turn the call back over to Chris, who will provide further details. Thanks, Frank. In order to help you update your models from the old reporting segments to the new, we'll now walk through the product mapping In detail, to help facilitate this discussion, I will leverage numbers we have previously disclosed. Unless otherwise noted, I will be referencing the Q4 of fiscal 2013. While the framework uses last Q4, you should be able to leverage the to extrapolate to other periods. So let's start with the Windows division here on Slide 7. Last quarter, we reported that OEM revenue accounted for approximately 65% of the division's total revenue and non OEM accounted for the remaining 35%. All of the Windows OEM revenue is now reported in the Devices and Consumer Licensing segment. Non OEM revenue included Surface devices and accessories, Windows volume licensing, Hardware such as keyboards and mice, retail Windows and Windows Services. Surface and hardware are now shown in the Devices and Consumer Hardware segment. Windows volume licensing is primarily reported in commercial licensing. There is a small portion related to academic or students, which will be included in devices and consumer licensing. For retail windows, approximately 90% of it will be reflected in Devices and Consumer Licensing. The remainder that is recorded in Devices and Consumer Other is related to the retail versions of Windows sold in retail stores. And finally, Windows Services is 100% reported in Devices and Consumer Other. Okay. Now let's move to slide 8 to discuss Server and Tools. This one's a little bit easier. As we've discussed previously, product revenue, including transactional and multiyear was about 80% of the division's total, while Enterprise Services was the remaining 20%. Going forward, All of our traditional licensing, including server and CAL, will be mapped to commercial licensing. Enterprise Services And Azure will be reported in Commercial Other. Okay. Moving to slide 9. For the Online Services division, Bing and MSN will now be 100% reported in Devices and Consumer 85% of the division's total, with about 70% related to annuity sales and 15% being transactional. For annuity revenue, most of this revenue is now reported in commercial licensing, with the exception of Office 365 and Dynamics CRM which will be reported in commercial other. All of the non annuity or transactional sales go to commercial licensing. For consumer revenue, which accounted for roughly 15% of the total, is largely mapped to devices and consumer licensing. The portion related to Office 365 Home Premium and retail stores are now in devices and consumer other. As you look at prior periods, keep in mind that the strength we have seen in our business annuity revenue in recent quarters As a result, in business revenue becoming an even greater percentage of the revenue within that segment. From our Entertainment and Devices division, Xbox revenue now lands in 2 segments console revenues, Xbox Live subscription and second and third party games are all recognized in the Devices and Consumer Hardware segment. We do include the Xbox Live and games revenue together with the console as these businesses are inherently linked to the Xbox console itself. 1st party games and marketplaces, Such as Xbox Live transactions are reported in the Devices and Consumer Other segment. Windows Phone and IP Licensing are mapped to devices and consumer licensing. Skype will be reported in the commercial licensing segment consistent with the opportunity that we see within the commercial business as we bring the technology And products of Lync and Skype together. Okay. So that's the detailed mapping of the old to new product mapping. Starting with the old segment first. On Slide 12, we bring it all together, now organized into a new segment view. We think this is a helpful view that shows both the movement of the numbers across a single table And the underlying logic also becomes evident in this matrix view as well. Okay. I'm going to move now to slide 13. We want to provide you with a preview of our updated KPIs. The best starting point for a thorough KPI discussion is to put them in the right context. With each quarterly earnings release, we share our results in a variety of ways. Our earnings press release, a slide deck of quarterly results, our earnings conference call and in the MD and A section of our quarterly filings. Across these various components, we provide our actual financial results as well as the material drivers of business during that quarter. The KPIs are intended to be metrics that supplement the information we provide in the earnings release and MD and A. The goal is to provide additional insight that Helps you understand our results and also to gauge the progress we are making as our business continues to evolve. We believe that in total, the information shared across our earnings results, the MD and A supported by KPIs and combined now with the addition of gross margin reported by segment, provide for a fairly comprehensive and meaningfully improved ways to understand how our business is doing. So let's get into the details by starting with Slide 14. I'd like to spend the next few slides talking you through what's changing and the rationale. To To ease in understanding the changes, these slides have been structured to start with the old KPI structure in the old segments and then show you what's changed and what's not. On this first slide are the KPIs that are consolidated across Microsoft. At the all up Microsoft level, we've historically shared with you bookings, Unearned revenue by segment and the contracted not billed amount. For FY 2014, we plan to keep all of these KPIs. The bookings and unearned revenue are good representations of the health of our business beyond the current quarter. The contracted not billed balance, as you know, is the amount associated with multiyear contracts already signed with our customers It is important to note, we do think that the contracted not billed number will evolve over time, especially in future years as the composition of our billings gradually change toward more 1 year subscription agreements versus multi year. There are also 2 new metrics that we will add to our consolidated Microsoft KPI. First, we will include the expected future recognition by quarter of the total unearned revenue amount. 2nd, we will also provide to you a view performance of our total commercial cloud revenue each quarter. These KPIs together, we believe are helpful, especially to understand how much of our business continues to shift toward annuity and subscription billings and recurring revenue streams. Now let's go to slide 15, which along with slide 16 are the segment based KPIs. For Windows, we are providing the following additional KPIs. 1st, within OEM revenue, Which is now reported in Devices and Consumer Licensing, we'll share with you the growth of Windows Pro and Windows Non Pro revenue. 2nd, in the commercial licensing segment, we'll provide you with the Windows volume licensing revenue growth. These KPIs together will give you a fairly comprehensive way to gauge the health of the Windows business. Also starting in Q1, we will report quarterly The revenue derived from our Surface products and related accessories as well. For the Microsoft Business division, We remain largely unchanged from the current disclosures of Consumer and Business Office and Microsoft Business Solutions revenue. However, we are adding 2 important new KPIs, both related to our fast growing Office 365 business. First is the Office 365 Home Premium Subscriber Growth. At our analyst meeting, Amy We announced that we had reached the 2,000,000 subscriber mark for our consumer offering. 2nd is Office 3 65 commercial seat growth. These are primarily sold as part of a multiyear licensing agreement, different from the consumer subscription, and hence we thought it was valuable Provide this separately. For server and tools, we continue to provide you we will continue to provide you both product and Enterprise Services Revenue Growth Metrics. Now let's turn to Slide 16. For entertainment and devices KPIs, we will Users and as such, we will continue to provide updates to the user counts as part of our earnings release materials When we achieve notable milestone level. Finally, online services. We will enhance the current KPIs with the addition Okay. So that's a lot of detailed walk through. Let's look at Slide 17, where we Put it all back together in the new segment taxonomy and this is what it looks like. The blue items represent items are new or materially changed and we do think it's a good step function improvement versus our current KPIs and it does supplement the rest of the earnings disclosures In a way that's both helpful and meaningful. Finally, let's move to slide 18, which is our final slide before taking questions. We're now less than 1 month away from our Q1 earnings release date, October 24. On that date, we will report our results in the new segments, including all filings, commentary and any forward looking statements. At the same time, we'll publish the new KPIs starting with the Q1 results. And as we previously said, we'll still provide a supplemental table of the Q1 results in the old segments And help bridge back to any forward looking statements we made last quarter. So with that, Frank and I will take some questions. Again, please limit your questions to items covered only in today's call. Operator, please go ahead and repeat your instructions. Thank you. Ladies and gentlemen, we will now be conducting our question and answer session. A confirmation Thank you. Our first question is coming from the line Brent Thill with UBS. Please proceed with your question. Hey, good morning. Just as it relates to your guidance and how you expect to Given that going forward, you've historically given some metrics around each of the divisions. Is that in the new reporting segment, is that the way that you anticipate Dave helping The Street understand your forward look as well going forward. Yes. Hi, Brett, and thanks for the question. Yes. When we publish our results in Q1, we will any forward looking statements that we make with the Q1 earnings will be Discussed in within the construct of the new reporting segments. And so very similar to the old segments, but updated for the new taxonomy. Great. Thanks. Next question please. Thank you. Our next question is coming from the line of Walter Pritchard with Citi. Please proceed with your question. Hi, thanks. I'm wondering, Frank, if you could talk about the other allocation you had before, How large you expect the other allocation to be here on expenses going forward and any changes you've made in terms of that bucket given all the new segmentation? When you're talking about the other allocation, are you talking about the other segment? Yes. The other more the corporate overhead. Should we expect to see a similar amount of expenses attributed to corporate overhead? Or have you more granularly allocated some of the previous corporate overhead that you had in the past? Well, you'll see 2 separate allocations of other. 1 being at the gross margin level, which will be more of for large GAAP deferrals like real revenue adjustments and all. On the operating expense side, I think you'll continue to see The same sorts of expenses in there that we had before that represents our corporate IT function And finance and G and A, finance and HR and things. So We really don't have any meaningful change in that in the way we're doing that. Corporate R and D had been In there are basic the futuristic R and D had been there. Now that because of the way our R and D is being managed Across the entire platform, that's now being allocated. Got it. And then just on Xbox, it looks like the game royalties and Xbox Live revenue is going into hardware, which is a little strange Given that those are sort of royalty licensing type or subscription type revenue streams, that plus it doesn't look like you're going to be breaking out the live base anymore in terms of the numbers. It feels like we're sort of taking the spotlight off of Xbox Live and Which has been a nice growing revenue stream. I'm just curious the rationale behind that. Well, our Xbox platform It's monetized in several different ways. We sell the consoles. We sell accessories with that. We have a royalty model on 2nd and third party games, which are sold utilizing our technology. And we have Xbox Live, which is primarily a subscription service. We look at those as being completely linked together. They don't function without each other. Xbox Live is a key component. It allows for multi Gaming for players, it provides downloadable game content through the store there. Hosuh has the ability to bring in TV services as well. But when we look at that together, that's all very much connected into our Xbox strategy. And it's the way that our management team looks at the business, looks at it together. What I will point out is, as the business evolves over time, the drivers of the changes in And revenue and profitability will always be brought out. So it's not like you won't hear about Xbox Live anymore, but you'll hear about the Xbox platform And it's total, especially as we launch Xbox 1 later this year. Yes. And this is Chris. And I'll just add to that that as As I said in my comments, we will continue to discuss and talk about the membership numbers and other momentum as Part of our earnings materials, especially as we hit milestones. So, okay. Thanks, Walter. We'll move to the next question please, operator. Thank you. Our next question is coming from the line of Keith Weiss with Morgan Stanley. Please proceed with your question. Excellent. Thank you, guys. Thanks for doing this presentation and giving us all this new information. It sounds like we're going to get a lot more visibility into the business. Maybe first a high level question for Chris. As you're putting together this new reporting structure and new segment structure, Any high level trends that you guys are trying to sort of highlight or you can get better exposed to this reporting structure that You'd like to make us aware of? Yes. Thanks, Keith. That's a good question. I think probably the most important element that I'll call out Is the change to gross margin as part of each reporting segment? Gross margin really is the primary Financial measure by which we're tracking the health and the performance of each of these businesses. And as you can see, The way that we've structured these segments, you can see actually fairly different gross margin profiles in each of the segments. And I think that's a good And clear metric for you to be able to watch over time to see our improvement in gross margin, both from a percentage And a dollar perspective. So I think gross margin is really the thing that I would highlight as the incremental improvement in transparency and accountability In the new segment. Got it. And is there any chance that we'll see any for the new KPIs that you guys are going to be given on a go forward basis, any chance we're going to see Any historical data sets on where those KPIs have been over the past year or so? Yes. I think where it makes sense, we will do so. I Some things just looking back at historical growth rates don't make sense like I'll take Office 365 Home Premium Given that it's only really several months old now, we don't the growth rate going back 8 quarters will either be non existent or not Meaningful. So to the extent that it's an appropriate and meaningful metric, we'll definitely give historical context on it. Got it. And then maybe if I could sneak one last one in. When you guys closed the Nokia Devices and Services transaction. Am I thinking about this right that you're going to have a big chunk of revenue that's currently in devices and The devices licensing that's going to move into the hardware bucket once that comes on board, just give us an idea of how that would slot into the new reporting structure? Are you when you talk about movement, are you saying any current revenue that we generate as a royalty from Nokia? Yes. I'm thinking that Windows Phone licensing moves from one bucket into that from the licensing bucket into that would then be a hardware bucket if you're selling the Because you guys are then be selling the whole bunch. The hardware in the audience. I think I mean, the first point is, I think it's probably too early to say definitively. But I don't I think the best way is once we close the transaction, we'll definitely update it. I think it's not unreasonable to We'll think the hardware will land with hardware, but I don't have any definitive statement On the royalty piece of it that we currently get, but we'll have to sort that out once the transaction closes. Well, I mean, just Conceptually, wouldn't that be similar to a Surface device? And just to make sure I understand, like when you sell a Surface device, does the Operating system on top of the Surface device that all goes into D and C hardware? Yes. That is Yes. We have Yes. Chris, maybe I can help you with that. Today, we do move product from one segment To another, so a Windows license would go in. So what we do is value that license At a cost basis moving from one segment to the other. So there is a small amount of intersegment revenue today. We'll We'll have to look to see now that becomes more expansive after the Nokia acquisition whether we look at that policy and look at what the Most appropriate intersegment pricing would be but the I would suspect it would impact both the where the phone revenue It's recorded as well as the hardware revenue. Okay. But we'll let you know after the acquisition is concluded. Okay. So just so I'm clear on it. So when you sell a Surface device, there is some portion that does go into D and C licensing? There is, yes, a small portion. Okay. Even though it's you're not OEMing it, it's yours? That's correct. Okay. Thanks, Keith. Let's Jesse, can you move the next question, please? Yes. Our next question is coming from the line of Mark Moerdler with Sanford Bernstein. Please proceed with your questions. Thank you. A couple of quick questions. On the commercial cloud revenue growth, is that going to be a dollar amount or a percentage It's growth and which products are included in that? Well, it is a percentage growth and it is comprised of all of the Commercial cloud offerings that are reported in the Commercial Other segment, so that Primarily includes Office 365, Azure, but also Intune, CRM It's the aggregation of that. And we it is a good measure of sort of the performance of Microsoft Commercial cloud business, if you think about us as a leading cloud vendor for business customers around the world. Okay. So that will be a year over year growth or something similar to that? Yes. Okay. And on the MVP one Both of those are seats and a percentage growth, correct, rather than a dollar amount? Yes. Those are seat growth totals, not revenue. And the seat the home premium, we did talk about Hitting the $2,000,000 mark very recently, and so that's a good starting point there. Okay. And on the commercial seats that if I have one Product or I have the Office 365 or Exchange Online, for example, or I have the desktop subscription that counts as a seat that I built and that counts as an seat, right? Yes. Any of the cloud products or other SaaS? Yes. A seat is a seat. If you whatever form of Office 365 that you happen to subscribe to, a paid seat is a paid seat. And whether it's cloud or whether it's subscription? Yes. If it's within the Office 365 product family, We would count it. Okay. Okay. I think I have one last question. Okay. Thank you. Go ahead. You got half the question. No, I was just going to answer the Vindigetsu whether you're going to Which of these or I guess, we won't know until next quarter, which of these you're going to give some historical comparisons for? Yes. I think that will become clear. As I said a little bit ago, to the extent that it makes sense, if there is a good historical track record That fairly reflects the performance of the business. I mean, like I said, some of these new businesses having a growth number that's like 8 digits, Because it compares against literally a non existent number doesn't make sense and it probably is not helpful, So we wouldn't show it, but to the extent that there's an actual number that makes sense, we'll definitely show it. Okay. Thank you. I appreciate it. Thanks, Mark. Thank you. Our next question is coming from the line of Kash Rangan with Merrill Lynch. Please proceed with your question. Hi. Thank you, Chris and Frank. Hope you get some time off after Investing the time to do this wonderful presentation. My question is on the gross margin variability. It looks like on the gross margin side, you've got The devices in consumer hardware, you've got Azure and you've got online. To what extent are you guys going to be able to provide Some directional gross margin considering that there's a fair amount of volatility variability in this particular aspect of the P and L. And also just want to clarify with respect to your guidance, I think Brent asked this question. I just want to revisit that. Are you guys going to be framing your guidance based On server units, PC units as you have done so in the past or are we going to be constructing guidance in a different way? Thank you very much. Okay. So I'll start with the latter, which is a guidance question. We'll be sharing The business driver framework at our Q1 earnings, we will try to provide as much color as we can across the different things that drive the performance of the business, But I don't have the specific metrics and measures to share with you today on that one, Kash. On the first question about I think your question was, are we going to provide some sort of a roadmap on gross margin? And I will say that I think the new addition of gross margin into the P and L does help you see the Performance of these different buckets of categories, if you will, of products, so hardware different from traditional licensing and different from And different from services. And I think over time, you'll be able to see if we're making progress from a gross margin percentage and a gross margin dollar perspective. I don't anticipate at this time that we'll provide a specific number as a roadmap, but We'll continue to evolve our thinking on that over time, I'm sure. Got it. Just if I could follow-up very briefly. I know that I respect the fact that you may not be able to provide a gross margin guidance, but are you able to qualitatively talk about the trade offs that Are you willing to make or are you going for share on the Nokia side or share on the Surface side at the expense of short term hit to gross margins? I'm Just wondering if there are ways to think about how the margin outlook for the company progresses. Thank you. Yes, I think it's a good framework. I mean, I think it is good for us to talk about the things In each of these categories that drive our margin performance over time, Amy talked about it at the Analyst Meeting, which we talked about Specific to Azure and the capital expenditures and how we are investing in some sense ahead of the curve and that does Results in some near term margin pressure, but over time as that business gets to scale, that we anticipate the margins improving. So that's the type of Rationale and logic, I think that we can apply to help you all share with you the way that we think about things. And obviously, As we get more as we all, you with us, get more and more accustomed to talking in the new Frameworks, the new reporting segments will continue to evolve and improve hopefully over time as well. So, thanks guys. Thank you. Great. Next question, please. Thank you. The next question is coming from the line of Gregg Moskowitz with Cowen and Company. Please proceed with your question. Okay. Thank you very much and good morning, Frank and Chris. First question is the expected revenue recognition of unearned by quarter that you'll be providing. Will that be Over the next 12 months, the remainder of the current fiscal year or some other period of time? That's a 4 quarter forward looking Recognition schedule. Okay, perfect. And then going back to cloud, we all know that revenue is a lagging indicator For any subscription business, you mentioned that you'll be providing commercial cloud revenue growth, but why not report commercial cloud Bookings growth as well. It's part of the total bookings growth, but it is it's good feedback. We'll take it under We will sort of go back and take it under advisement and take a look and see if there's a meaningful breakout of the bookings that may make sense and be helpful. And we could talk about it maybe on some of the earnings calls, but it's good, Greg. I'll make a note of that. Okay, great. Thanks very much. Thanks. Operator, I think we have time for one more question, please. Thank you. Our last question comes from the line of Rick Sherlund with Nomura Securities. Please proceed with your question. Yeah. Thanks, Chris. I'm just this is one of interpretation. I'm looking at slide 21, it shows hardware gross margin going down from 2012 to 2013 quite a bit. So maybe if we can just kind of drill into that number and understand that a little better. I think you probably have the charge $900,000,000 Q4 charge in that I presume for Surface, Xbox units were down, so there's less of a hardware gross margin gross profit contribution. Xbox Live would have grown. The 2nd party titles software titles were down year over year, So that might have contributed to it as well. I'm just curious what that number is telling us. I think as I analyze it, it looks like there are parts of that business Have lower gross profit contributions. But first, I guess, is the charge in there? And Is there anything more you can comment on in terms of the hardware piece itself and what this might be telling us about the margins on the hardware side? Yes. First off, yes, the charge is included in there. And so that is one of the drivers of the of the margin, year over year margin that you're seeing there. So the $900,000,000 charge that we took a couple is reflected there. And then I think you are actually hitting on the right things. What's going on with Xbox as As we get closer to the end of a cycle on the current console as well as the implications or the impact of Perfect. Those are the 2 things that I would point you to. I think you're spot on. Okay. Well, thank you. Thank you all. So that wraps up the Q and A portion of today's conference call. Thanks everyone for joining us today and thanks for your participation. If you have any follow-up questions, as I suspect you will, as you're updating your model, please do reach out to the IR team and we'll be happy to help where we can. Okay. Thanks again everyone and we'll talk to you soon. Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and thank you for your participation.