Welcome to the Microsoft Conference Call. All lines will be in a listen-only mode until the Q&A portion of the call. Today's conference is being recorded. If you have any objections, you may disconnect at this time. I'd like to turn the call over to Todd Setcavage Sir, you may begin.
Thank you, Sarah, and thank you, everyone, for joining the call this afternoon. Joining me today are Peter Klein, Chief Financial Officer of Microsoft; Frank Brod, Chief Accounting Officer; and John Seethoff, Deputy General Counsel. Early this morning, Microsoft announced the definitive agreement to acquire Skype, the world's leading internet communication company. A copy of the press release, as well as this morning's webcast of the press conference, can be found on our website at microsoft.com/investor. Today's call is being webcast live and recorded. A transcript of this call will also be posted to our website. If you ask a question, it will be included in our live transmission in a transcript and any future use of the recording. During this call, we'll be making forward-looking statements. These statements are based on current expectations and assumptions that are subject to risks and uncertainties.
Actual results could materially differ from factors discussed in the press release, in the comments made during this conference call, and in the risk factors section of the Form 10-K, 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. With that, Peter, we'll start with a few opening remarks, and then we'll open the line for questions. With that, let me turn it over to Peter.
Great, thanks, Todd, and good afternoon, everyone, and thanks for joining us. As Todd said, thanks for joining on such short notice, it's a big day for Microsoft. It's a big day for Skype. We're very excited about our announcement that we've entered into an agreement to purchase Skype for total consideration of $8.5 billion. You know, Skype and Microsoft share a vision for how real-time communications can really enhance both consumers' and businesses' lives across a multitude of devices, and it's a very natural thing for the companies to come together. As I said this morning on the press conference, it's typically ideal in an acquisition when you have the combination of a strong and growing business as well as a natural strategic fit into what we're doing as a company, and I think those characteristics apply here. As I noted, Skype is a strong and growing business.
Last year, with $860 million in revenue, $264 million in EBITDA, improving margins over the last three years from 20% - 31%, and in addition, with an opportunity to grow new revenue streams. You've got a very strong business with a lot of momentum in terms of an engaged customer base, strong revenue growth, and operating leverage, really in a great position. As Tony talked about, occupying a great spot sort of in the nexus of some of the main internet trends that we're seeing in the market today. A great opportunity, a great brand, a great technology, and a great company. At the same time, we believe the combination accelerates what we're both trying to do from businesses to consumers and across devices.
If you think about investments we've made at Microsoft in real-time communications, notably in the Office Suite of Products with Microsoft Lync and the market momentum we're having with that, there's real synergy in what we can do to connect the user bases for all of our products. Similarly, on the consumer side, with all of our consumer services and the Skype consumer service, and finally, the ability to do this in a differentiated way across all device types, whether those are TVs or mobile phones or PCs, is really compelling. From a strategic perspective and from a financial perspective, we think this is a really exciting opportunity for us, and we're excited to move forward with it. With that, happy to open it up and take some questions.
Okay, thanks, Peter. We want to answer as many questions from as many of you as possible, so as now customary, please stick to just one question. Operator, please go ahead and repeat your instructions.
Yes, thank you. At this time, we will begin a question-and-answer session. To ask a question, please press star one and unmute your phone. To withdraw your question, press star two. One moment, please, while we wait for questions. Our first question comes from Walter Pritchard with Citi. Go ahead, sir, your line is open.
Hi, thanks, Peter and Todd, thanks for doing the call. I'm wondering if you could maybe, Peter, just talk a bit about prioritizing the initiatives around Skype as, you know, after you close the deal. It's an asset that seems like you could leverage in many parts of your business, some of which you've highlighted there, and wondering if you could talk a bit about, you know, MBD, where you've got Lync versus, you know, the connect in EDD and so forth, and where you see the most potential to drive incremental revenue for Microsoft over the few, a couple few years after the deal closes.
Yeah, thanks, Walter. You've actually hit on it. We see a breadth of opportunity both across the business side and the consumer side. We talked a little bit about that at the press conference this morning. It really does broadly apply. Obviously, there's a very direct opportunity on the enterprise side with Lync, and we think that's a really compelling economic opportunity. At the same time, we're going to connect and extend across the consumer side, whether that's Windows Live or Kinect. I really see it as both, which is really one of the things that's most compelling about the opportunity. As I also said, it's hard to talk about specific product roadmaps at this time, but we'll have more to say about the implementation plan as we get the regulatory approvals that are necessary and begin to close the deal.
Operator, next question, please.
Yes, our next question comes from Adam Holt with Morgan Stanley. Sir, your line is open.
Hi, guys. I've gotten a lot of questions today about how you all arrived at the value. The last round that was done here in the fourth quarter of 2009 was at less than a $3 billion valuation. Obviously, quite a premium to that today. Can you talk a little bit about how you arrived at the value and how you think about returns with respect to that value? Thanks.
Yeah, thanks, Adam. As you know, any valuation or value of an acquisition is a function of a couple of things. One is the intrinsic value of the asset that you're buying, and we've talked a lot about the strength of the Skype business and the opportunity and the growth trajectory going forward. The second part is how you can add value jointly, synergies , if you will, and that's exactly how we looked at it. We looked at the trajectory and the strength of the business, the user base that they have, and the assets they have, the things that we can do together, and arrived at a valuation that we think is good for all shareholders. As we said, economically, we think this is going to be good for us. It's going to be accretive to cash flow, you know, excluding amortization charges right away.
We're pretty excited about it.
Okay, thanks, Adam. Operator, next question, please.
Yes, our next question comes from Heather Bellini. Go ahead, your line is open.
Hi, good afternoon. Peter, I guess the biggest question I got today was related to why you felt, why Microsoft felt the need to purchase, outright purchase Skype as opposed to partner with Skype. If you could walk us through what you think the benefits you get are out of owning them that you couldn't get out of partnering with the company. Thank you.
Yeah, thanks, Heather. Steve talked a little bit about that this morning at the press conference. As you know, we've had ongoing partnership discussions and a relationship with Skype over the years. What led to the combination now really is the breadth of opportunity that we saw across all pieces of the business. At some point, if there's such a compelling complementarity in what we're doing and an ability to accelerate what each of us is doing broadly across the whole workload of communications, at some level, it makes way more sense to combine the companies, and that's really what led to it, as Steve talked about this morning.
Thanks, Heather. Operator, next question, please.
Thank you. Our next question comes from Phil Winslow with Credit Suisse. Thank you, you may begin.
Phil, are you there? Okay, operator, let's move on to the next question, please.
Yes, our next question comes from Brent Thill with UBS. One moment, please. Our next question comes from Kash Rangan with Merrill Lynch.
Hi, thank you. My question had to do with monetization. I believe Skype's got about 8 or 9 million users. Certainly, the revenue concentration per user at current levels looks to be quite good, but how do you think about how you scale the breadth of paid users? I guess Skype is perceived to be a largely free product, both within the enterprise and to a lesser degree on the consumer side. What can Microsoft do to change the perception that it's free and actually get monetization out of it? Thank you very much.
Yeah, thanks, Kash, and they're already starting to do that. One of the things we talked about this morning is the engagement of the user base, not only the accelerating user base, but the engagement of that. One of the ways you see that is in video. Video is a very sort of high engagement modality, and that's been growing as a percentage of their total user base. Going forward, I think there's, Tony talked this morning about new ways to monetize that customer engagement, either through premium services or through advertising, and I think we've barely scratched the surface on that, as he talked about, and I think those are real opportunities to really take advantage of the growing and engaged user base.
On the enterprise side, Peter?
On the enterprise side, I think we have an opportunity to sort of connect and extend what we're doing with Lync to provide, you know, a really more compelling and broad real-time communications experience, both inside and outside the company.
Thanks, Kash. Operator, next question, please.
Our next question comes from Phil Winslow with Credit Suisse. Sir, your line is open.
Okay, can you hear me now?
Yeah, we got it.
Okay, perfect. I just have a question about gross margins and OpEx contribution. Peter, where do you think the gross margins of Skype should settle out once it's integrated in? When you think about OpEx contributions coming fiscal year and beyond, wondering if you could just give a sense of a level of expense contribution. Thanks.
Yeah, Phil, I think it's a little premature to talk about that. I mean, I would point you to their filing so you can get a sense of kind of what it looks like now. I talked about the margins improving, but I think before we sort of make any more progress, I think it's premature to talk about that going forward.
Okay, thanks, Phil. Operator, next question, please.
Yes, our next question comes from Brent Thill with UBS. Sir, your line is open.
Thanks for getting me in. Peter, there was some concern last quarter about the buyback slowing, and I guess just from your perspective, there was some concern today that this would put the buyback on hold. What's your take in terms of how you're thinking about managing that during this period?
Yeah, thanks, Brent. They're really not related. As we've talked about, we have a long-term strategy and long-term track record in terms of capital structure and cash distribution, which continues. Acquisitions like this are a function of strategy and something that makes a lot of sense for our business economically. They're not really that related.
Thanks for clarifying.
Sure.
Thanks, Brent. Operator, next question, please.
Yes, our next question comes from John DiFucci with JP Morgan.
Hi, thanks, Peter. Just to, if you could maybe expand a little bit on the accretion area. You said the deal was accretive immediately, excluding, I guess, any non-cash amortization, but what exactly are you backing out? Because Skype was slightly unprofitable, and then you're going to forego some kind of interest income on the cash by paying for it in cash, and then just sort of trying to get, or are you actually planning on taking some expense out of Skype, out of their model?
No, it's less that. It's more about if you look at their ongoing, and you know, you can try and project what you think their cash flow is going to be going forward, compared to the foregone interest on the cash. It's accretive from a cash flow perspective, excluding the amortization charges.
Thanks, Peter.
Yeah, thanks, John.
Thanks a lot, John. Operator, let's finish up with one last question here.
Yes, our next question comes from Sandeep Aggarwal with Caris and Co.
Thanks for taking my question. Peter, in terms of the, on a Windows Phone, can you maybe articulate one or two scenarios how the Skype acquisition helps you to accelerate that initial stage of traction you're seeing and maybe how it relates to the partnership with Nokia? Thank you.
Yeah, thanks, Adeeb. As I mentioned, it's probably premature to talk about specific product roadmap issues. I think you can imagine sort of a high level of how the connection through Skype across devices can be a pretty compelling experience, but I think we got to get closer to closing the deal before we talk about specific scenarios or roadmap issues, if you will?
Okay, thank you, Sandy, that'll wrap up our Q&A portion of today's call. We look forward to seeing many of you at conferences this quarter, and for those of you unable to attend any of our events in person, you'll be able to follow our comments at microsoft.com/investor as usual. Please contact us if you have any additional details or need any additional details. Thanks again for joining us today, and take care.
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