Investor Update

Jun 1, 2012

Welcome to the Microsoft Conference Call. At this time, all participants are in a listen only mode. Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now I'd like to turn the meeting over to Mr. Bill Kofetz, General Manager, Investor Relations. Thank you, operator, and thank you everyone for joining us this morning. With me today are Frank Broad, Chief Accounting Officer and John Seedoff, Deputy General Counsel. Today Microsoft announced the Windows upgrade offer. This offer provides consumers who buy a new eligible Windows 7 PC Starting June 2, an option to purchase a downloadable upgrade to Windows 8 Pro for an estimated retail price of $14.99 during the promotional period. The option is redeemable when Windows 8 becomes generally available. For additional details, please visit www.windowsupgradeoffer.com. The purpose of the call today is to help you understand the financial statement impacts of the Windows Upgrade offer. On today's call, I will provide some background on the offer and then Frank will walk you through the accounting treatment and the impact to the financial statements. Note that we will not be discussing quarterly results or any topics beyond this announcement. We will host our Q4 earnings call on July 19th And we'll provide you with the results for the quarter at that time. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript And any future use of the recording. You can replay the call and view the transcript at the Microsoft Investor Relations website until June 1, 2013. 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 earnings press release In the comments made during this conference call and in the Risk Factors section of our Form 10 ks, Form 10 Qs and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward looking statement. Okay. And with that, let's get started. The purpose of the Windows upgrade offer is to enhance customer satisfaction and support current sales for our hardware partners until general availability of the next version of the operating system. Starting tomorrow, June 2, consumers that purchase new Windows 7 PCs pre installed with Windows 7 Home Basic, Home Premium, Professional or Ultimate will be eligible to purchase a downloadable upgrade to Windows 8 Pro For $14.99 upon general availability. Qualifying purchases must be made before January 31, 2013 And offers must be redeemed by February 28, 2013. This promotion is designed for consumers, including students, home users and enthusiasts. As a result, Microsoft will limit the promotional period To one upgrade promotional price to one upgrade offer per PC purchase and a maximum limit of 5 upgrade offers per customer. Organizations can be eligible subject to the maximum limit per organization, but our expectation is that the majority of purchases will be by consumers As businesses have other options such as volume licensing that gives them greater flexibility. Microsoft will manage the offer redemption process, including eligibility verification, payment, software delivery and support. Eligible consumers will register for the offer through the Windows upgrade offer website and after successful registration will receive a confirmation email. At general availability of Windows 8, Those pre registered will receive an additional email with their promotion code and purchase instructions. They will then be able to purchase and download the upgrade. The software is designed for end user redemption. The upgrade will be delivered as an electronic software download from Microsoft So the consumer won't have to go back to their OEM or retailer to get Windows 8. So in summary, we are very excited about the Windows upgrade offer That gives people the opportunity to purchase the new Windows PC they want today with the knowledge they can easily upgrade to Windows 8 when it's available. Now I will turn the call over to Frank, who will walk you through the financial statement impact of the offer. Well, thank you, Bill, and good morning, everyone. As Bill said, I'm here to walk you through the accounting treatment of the offer and the resulting impact to our revenue recognition. Under the Windows upgrade offer, When a consumer purchases a new PC with a qualifying Windows 7 license, they also get the right to purchase an upgrade to Windows 8 Pro At a significant discount. There are 2 steps to the accounting treatment. First, accounting real estate that we must account for this transaction As the sale of 2 elements, the first element is the Windows 7 license and the second element is a Windows 8 Pro upgrade. And then secondly, we must allocate the discount proportionately between the two elements based on the estimated fair value of each. The net revenue allocated to Windows 7 will be recognized on the date of the sale, while the net revenue allocated to the upgrade will be deferred And subsequently recognized upon the earlier of the fulfillment date or the expiration of the program, which is February 28, 2013. Fulfillment occurs when a consumer successfully completes the offer redemption process. In other words, once they have paid for and downloaded Windows 8 Pro Through Microsoft. The net revenue allocated to Windows 8 will be deferred as short term unearned revenue on the balance sheet. This deferral impacts only the timing of the revenue recognition and will not have any impact on our cash flows from operations. For the Q4 of fiscal 2012, we expect to defer between $450,000,000 $550,000,000 of revenue related to this offer. This deferral will result in a reduction in 4th quarter revenue and an increase in short term honored revenue. When thinking about the size of the deferral for the Q4, keep in mind that while the offer does not begin until June 2, We must include the impact from licenses already in the channel, but have not yet been sold through to consumers. We will continue to defer a portion of revenue related to qualifying Windows 7 sales during the offer period, which runs through January 31, 2013. This means that we will have additional deferrals in the 1st and second quarters of fiscal year 'thirteen. We'll provide additional details on future impact of those deferrals during our Q4 earnings call on July 19. Thanks, Frank. And with that, we will go ahead and take some questions. Please restrict your questions to items covered in today's call. Operator? Thank you. Our first question comes from Rick Schwerlin with Nomura. Line is open. Sorry, I had to unmute. Two questions. First, If the timing of the product, let's say it's out the end of September, the last day of September, just for argument's sake, Is the amount of deferred revenue that reverses and is recognizable A function of how many consumers redeem the coupon on that date or Are there other revenue recognition considerations such as well the shipment of the product and then you can recognize more of the revenue that's shipped in the quarter? I'm just not real sure that every consumer is going to redeem coupons. So there must be some estimates you make as well about Percentages. So how would you think about that? Let's say you got one day left in the September quarter, how much revenue might be triggered in that month as a result? Yes, that's a very good question because contrary to how we handled some of the tech guarantees in the past, this one has some little bit different features. And that's there is a discount. The consumer has to take direct action and Microsoft is fulfilling the obligations directly to the So in this case, when Windows 8 becomes generally available, that will be the first opportunity then that the consumer will have to redeem the upgrade offer. And we'll recognize revenue based upon each individual consumer that redeems that offer because they have Under the accounting rules, we cannot recognize revenue until we have delivered that second piece of product Windows 8 license in this case. So it would be hard to tell you exactly what we recognize at any given day. We hope there will be enthusiasm. There will be a lot of people redeeming on that time. But for those who don't redeem the licenses during this period, we will be recognizing the revenue at the Our next question comes from Heather Bellini with Goldman Sachs. Your line is open. Hi. Thank you very much for holding the call. I was just wondering if are there any associated COGS bill that would also shift between quarters that we need to think about? And then I just had one follow-up. There's no associated COGS with the program. Okay. And then what Percentage of revenue, for Windows 7, the percentage of revenue that was deferred was about 50% By our math, I mean, is it about the same this time? Yes. In this case, Heather, Yes, it was 50% when we went from Vista to Windows 7 with the technical guarantee program because the two elements were roughly the value and the consumer wasn't paying an additional amount at this time. So the dynamics of this accounting are a little bit different. The deferral rate will actually depend upon which SKU of Windows 8 is purchased. I was just at Windows 7 because Starter is not eligible, but all the other ones are there. So the percentage is going to vary based upon the mix of what is purchased After this guarantee goes into effect on June 2. So that's why we're giving you a specific range. And I would say when you update your model, You should use this range of $450,000,000 to $550,000,000 and it's fairly broad because your consumer preference and behavior during the time period of this offer will certainly have an impact And we'll try to give you more information in the July call on what you should expect in the next quarter. Right. Okay. Operator, next question please. Our next question comes from Walter Pritchard with Citi. Your line is open. Hi, thanks. Bill, could you talk a bit about just the Deciding on a program like this where you're charging and moving people to the high end SKU, is there what's behind trying to move people to high end SKU? And it seems like you probably get less uptake given you're charging for it, but just wanted to understand the change in thinking here versus what you've done in the past. Yes. This offer is really to help consumers to get to our highest and most valuable edition of Windows 8. It allows consumers to buy a PC today and get the value that we think is really going to come From the professional edition of Windows 8. So that's kind of the thinking behind it. Do you think you in any way reduce the number of people that move to the Move with the offer and it would seem like you would want as many people as possible on aid and by charging for it. I know there was shipping and handling before, But by charging for it and by making it a high end thing, it seems like you might actually have fewer people take advantage of it and that might be counter to what you want to do. Yes. Again, I think we're obviously driving a lot of value in the Windows 8 Professional Edition and we think that consumers are really going to want it. That's part of the value that we're going to offer from that. There's one other nuance in there which is You can use this offer on any PC as opposed to just the specific one that you buy. So It is eligible on any prior PC, which is also something that's different from kind of some of the prior programs that we've had. Operator, next question please. Our next question comes from Mark Moerdler from Sanford Bernstein. Your line is open. Thank you. The question I have is as follows. It sounds like you're offering from a range of the different versions of 7. So doesn't that mean that people who are planning to go to Windows 8 are going to prefer to go to a less expensive version of 7 because it's the same price for it basically to go to 8 professional? I mean, I think people make decisions on the PC that they're going to buy based on the overall capabilities of the machine and what they're going to use it for in the interim. They're going to they're obviously they kind of buy a device and there's an associated version of Windows. Clearly, your scenario is possible, but I don't know that people kind of make their purchasing decisions based on kind of that rationale. Okay. One other quick follow-up question to it. You're saying that you could use this on a different machine. Is that meaning that if You buy a PC with Windows 7 and you have a PC running XP, you can continue to use the Windows 7 license on the PC you already own and now run the Windows 8 on the old Yes, you can do that. On any compatible PC, so it's got to have Yes, the capability to be able to run it, but generally if it's something that's been bought in the last several years that would be possible. Sorry. Go ahead. Mark, you still there? Yeah. I was just going to ask even if Does it need to be a physical license on that machine? You need to have a genuine version of the software. So in other words, You had to have it can't be a pirated version of the software, but as long as you have OCOA then yes, You'd be able to do that. Thank you. I appreciate it. Operator, next question. Our next question comes from Phil Winslow with Credit Suisse. Your line is open. Hi. Thanks guys. Just wanted to dig in a little bit to that sort of the deferral percentage again. Maybe if you could give us a sense That's $450,000,000 to $550,000,000 kind of what that deferral range sort of implies for this quarter? And then also, I'm not sure if you all have done any work whether it be survey work etcetera or if you've looked at anything in the past of how you kind of think uptake This will be to kind of help us, I guess, model out the flow over the next couple of quarters. I know you're going to give us After Q4, but maybe just sort of any sort of high level about how you're thinking about it that would be great. Thanks. Yes. I mean I think beyond what Frank said earlier in terms of how to think about the different SKUs and the value associated with that, we certainly can't give Any comments on the PC market? I think you guys can do your research and work through that. So on your first question. And on the second question, look, like I said in my comments earlier, we expect obviously We built a great product with Windows 8. We expect that people are going to love it and that we're obviously hoping for high uptake as people have Machines as they go forward in the next few months to know that they'll get Windows 8 as they can make that buying So we're obviously quite you saw the release preview yesterday. I think the feedback has been good And we feel good about the momentum that we have around the product. Operator, next question. Our next question comes from Brendon Barnacol with Pacific Crest Securities. Your line is open. Great. Thanks. Rick, I had two follow-up questions. One, what's different about this program versus say the Tech Guaranty program in Windows 7 that's resulting in the different deferred revenue treatment? And then second, I I think in Q4 for the Windows 7 release the deferral was about $200,000,000 to $300,000,000 Now that came later in the month of June. This went substantially higher. Is that the only reason for the change? Are there other reasons that the deferrals are so much different this time? Yes. Let me start with the Second question first, Brendan. Yes, the deferral amount of $450,000,000 to $500,000,000 is larger than the Windows 7 deferral. Part of that is the start date of the promotion. This one starts June 2 and the Windows 7 offer actually started June 26 at that time. So and also the market is now larger. You only have more license It's being sold in the Q4 of this fiscal year than we did in the Q4 of fiscal year 'nine. And then we've also expanded the program, so it covers More SKUs. In this case, we're recovering now the home basic version as well. So that's the main reason For that, the percentages are different primarily because the program is conceived in a different fashion Under the Windows 7 second guarantee, basically the consumer paid one price and got a License today for Windows Vista and then a license when it was available for Windows 7. So we effectively Split the revenue between the two licenses, so about 50% was recognized currently, 50% was recognized when the Windows 7 was delivered to the consumer. Under this program, with Microsoft administering directly to the Delivery of the product is based more on the consumer behavior of Windows 8 is based on the consumer's behavior much more so than our actions will make it available that they'll have to go into the website To register that, to go into the website then to pay and to download the new version. So that makes the timing a little bit More uncertain, I guess, from our standpoint and more variability into when that might happen. So as the consumers You'll go in and upgrade, we'll recognize the revenue license by license and those who haven't taken any action by February 28, 20 13 will be the triggering point to recognize any revenue that had been deferred at that point that hadn't yet been recognized. Got it. So the key difference is the direct versus indirect this time around? That's correct. Right. Great. Thanks for the clarity. Operator, next question please. Our next question comes from Richard Williams with Cross Research. Your line is open. Hi, guys. Could you talk about the uptake rates Compared to prior examples of this kind of initiative? Well, I don't know that We don't actually know what it's going to be. This is what you're assuming. We don't. Again, as Frank just said In his last comment, we actually will recognize the revenue on a license by license basis and anybody who hasn't exercised that will That deferred revenue in February. So obviously as I said earlier in my comments, we're Quite enthusiastic about the product. We think there's a lot of value associated with Windows 8 and Windows 8 Professional Edition and we're obviously hoping that the uptake We'll be quite high, but at this point, I think it's anybody's guess. And just from the implementation of the accounting rules, In this particular instance on the accounting rules that apply to this situation, we're not allowed to even estimate what that I'll take you as we either we recognize when the event happens or when the program expires. So unlike sales returns and things where the company can utilize Some of their market knowledge and under this particular accounting standard, we cannot. Thanks, Richard. Operator, next question please. Our next question comes from Kash Rangan with Merrill Lynch. Your line is open. Hi, thank you very much. I was wondering, curious if you could Comment on why you decided to go with one upgrade price regardless of the kind of SKU that the customer is buying. Now secondly, if you could comment Bill on how Easy or tough will it be to upgrade from 7 to 8 for the consumer, given that you've got the new user interface and touch capabilities, Which may or may not be compatible with the current hardware that's out in the market? That's it. Thank you. Yes. So to your first question, The strategy here has been really around moving people to the Windows 8 Pro Edition. As I said earlier, I think it has the highest capabilities that we're going to offer on Windows 8 and then obviously making sure that we give customers a great experience On Windows 8 is something that we're definitely committed to. I also mentioned earlier that You could obviously also use this on a device that isn't the one that you purchased at the time between now and general availability. I think your point is accurate that we're obviously optimizing Windows 8 for touch, But we've also talked about Windows 8 being a no compromise solution that will also be quite robust with both a mouse and a keyboard. So whatever device that you buy today, you should have a great experience with Windows 8 and that's certainly something that we've contemplated as we look forward to the launch. Thank you, Bill. Thank you. Operator, I think next question please. Our next question comes from Ed McGuire with CLFA. Your line is open. Yes. Good afternoon. I just wanted to clarify that With extending the offer to consumers who have already bought a PC, is there does this Imply that there will be a retroactive adjustment to licenses that have been purchased Previously that are then going to be covered as part of an additional upgrade? Thanks Ed. This will be eligible for people who buy a new PC starting tomorrow through January 31. Okay, got it. That's what I wasn't clear about. Thank you very much. Okay, great. Yes, thanks. And operator, last question please. Our last question comes from Michael Turits with Raymond James. Your line is open. Hey, guys. Obviously, One difference here is that you're charging this time. You didn't charge last time. So of the There actually should be as people pay for this in this quarter, what would be incremental revenue, which will you'll then have to defer obviously. But so in other words of that $500,000,000 ish of deferrals, some comes from a charge that you wouldn't have had otherwise. So in other words of the $500,000,000 how much of it is from just the discount and how much of it is from the $15 that people are paying? Otherwise, it seems like we'll be pulling too much out of our pre existing numbers to pull that whole 500 out. Yes. Hey, Michael. So the revenue deferral That will occur this quarter is on related to people who buy a new PC as I mentioned between tomorrow and the end of the quarter. We won't people won't actually they'll get a notice that will state that they will be eligible to buy Windows 8, They actually won't purchase it and pay the money and download it until after general availability of Windows 8. So we won't have any, to use your words, kind of incremental revenue related to that until again, until after general availability. But it's actually a good clarification on that one for sure. Good. Thanks. Anyway, hey, thanks everybody for joining our call today. This wraps it up. As a reminder, this webcast will be available on Microsoft's Investor Relations website until June 1, 2013. Thank you very much. Again, if you haven't had the opportunity to check out the release preview, Please go do that. We're obviously very excited about it and have a great day.