Microsoft Corporation (MSFT) F4Q 2013 Results Earnings Call July 18, 2013 5:30 PM ET
Chris Suh - General Manager, Investor Relations
Amy Hood - Chief Financial Officer
Walter Pritchard - Citigroup
Mark Moerdler - Sanford Bernstein
Phil Winslow - Credit Suisse
Keith Weiss - Morgan Stanley
Heather Bellini - Goldman Sachs
Rick Sherlund - Nomura
Brent Thill - UBS
Ed Maguire - CLSA
John DiFucci - JPMorgan
Kash Rangan - Merrill Lynch
Ross MacMillan - Jefferies
Gregg Moskowitz - Cowen
Raimo Lenschow - Barclays
Brendan Barnicle - Pacific Crest Securities
Karl Keirstead - BMO Capital Markets
Welcome to Microsoft's Fiscal Year 2013 Fourth Quarter Earnings Conference Call. All lines have been placed in a listen-only mode until the question-and-answer session. Today’s call is being recorded. If anyone has any objections, please disconnect at this time.
And I would now like to turn the meeting over to Chris Suh, General Manager of Investor Relations. Chris, you may begin.
Thank you, Operator. On our website microsoft.com/investor is our financial summary slide deck, which is intended to follow our prepared remarks and provides a reconciliation of differences between GAAP and non-GAAP financial measures. As a reminder, we will post today's prepared remarks to our website immediately following the call until the complete transcript is available.
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 July 18, 2014.
During this call, we will be making forward-looking statements that 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 Factor section of our 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.
Before I hand the call over to Amy, I’d like to remind you that all growth comparisons we make on the call today will relate to the corresponding period of last year. Also, unless specified otherwise, all impacted numbers for the current quarter have been adjusted for the cumulative effect of the revenue deferral and recognition related to the Office and Windows upgrade offers, the $900 million charge for inventory adjustments primarily related to the new Surface RT pricing we announced earlier this week and the goodwill impairment charge from last year. You can find the 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 the call over to Amy.
Thanks Chris and good afternoon everyone. Thanks for joining us today. In many ways, our fourth quarter results reflect the trends we saw developing throughout the fiscal year. The consumer x86 PC market declined as users continued to prioritize devices to touch and ability. At the same time we saw continued strength in our enterprise product and cloud solution and increased adoption of our consumer services.
This quarter our Windows business declined as the device market continued to evolve beyond the traditional PC. We are working to transition the business into this modern era of computing taking advantage of the new scenarios enabled our Windows 8. As we said before, given the complexity of the ecosystem this journey will take but we continue to make incremental progress.
In June, we released the public preview of Windows 8.1. It blends the desktop and modern experience. It has new features and improvements in areas such as personalization, search, built-in app and cloud connectivity. Windows 8.1 will be a free update to existing Windows 8 users and will be made available to OEMs in August, less than one year since launch.
To increase and improve retail distribution, we entered into a strategic partnership with BestBuy to create a Windows store in over 600 BestBuy locations. These store-within-a-store locations provide a large scale hands-on consumer experience that showcases Microsoft devices and services. The percentage (inaudible) devices available at retail continues to improve. The first 8x Windows tablet became available at retail a few weeks ago. It has legacy application compatibility, includes Microsoft Office and retails for less than $400. We expect additional compelling small screen devices to be available in the coming months.
Less than a year ago, we launched Surface RT and Surface Pro, each with a unique value proposition. Surface is one part of our journey to bring innovative, compelling Windows devices to market in a modern era of computing. (Inaudible) analyze our progress and fine-tune our action plan as needed.
Hear what we did this quarter. We reduced the price of Surface RT by $150 to $349 per device. As a result of this price change as well as inventory adjustments for related parts and accessories we recorded a $900 million charge to our income statement. While this resulted in a negative $0.07 impact on earnings, we believe this pricing adjustment will accelerate Surface RT adoption and position us better for long term success.
We also increased retail distribution in the quarter. Surface is now available in 29 markets and 10,000 retail locations. We expanded the availability of Surface to our business and institutional customers. Through our new channel expansion program, commercial customers are able to purchase Surface devices from authorized resellers in the U.S. Over the next few months we will authorize commercial distributors and resellers in more countries.
So in summary on Windows, we are working hard with our partners to gain share in the evolving and growing device markets. I want to be very clear, we know we have to do better and that's one reason we made a strategic and organizational changes we made last week. With over 1.5 billion Windows users around the world, a transition of this magnitude takes time. We are confident we are moving in the right direction.
Now on to our enterprise business which continues to be strong. We closed out the year with record on our revenue up $22.4 billion as businesses continued to make long term commitments to the Microsoft platform. Within our server and tools business, we continue to make significant improvements in performance reliability and scalability with SQL server. As a result, customers are increasingly moving mission critical and BI workloads to the platform. Our SQL Server has been the unit share leader in the market for some time. It has consistently outgrown in the market over the past 12 months and is now the second largest database in revenue share.
We recently announced the next versions of Windows Server and System Center which will continue to deliver on our Cloud OS vision. With new features and enhancements in virtualization, storage and networking, we are empowering our customers to more officially manage their application services and their private, hosted and public cloud infrastructures.
In Windows Azure, we continue to innovate and broaden our cloud platform offering. We recently announced an important enterprise partnership with Oracle. It will enable customers to our Oracle software on Hyper-V and in Windows Azure. In June, we announced the public review of Windows Azure in China, operated by 21Vianet making Microsoft the first multinational organization to offer public cloud services in China.
As a result of the greater choice and flexibility, we are seeing increased customer tractions, those in terms of an increase in Enterprise customers but also the average deal size. Our productivity solutions continue to be a top priority for CIOs. As Enterprise customers look to modernize their productivity infrastructures, they are increasingly turning to Office 365.
We recently announced the expansion of commercial availability into several new markets, making Office 365 available in over 125 markets worldwide. I’m pleased to share that momentum is accelerating. An Office 365 is now on a $1.5 billion annual revenue run rate.
During the quarter, we saw ongoing momentum for our consumer services such as Office 365 Home Premium, SkyDrive, Xbox LIVE, Skype and Outlook.com. By giving consumers rich, high value experiences across productivity, litigations and entertainment, these services can help you about products and our overall ecosystem, our strategic advantage in today’s marketplace where the line between home and work is boring for many customers.
Our unified communication offering of Skype and Lync are great example of our customer enterprise products can be mutually reinforcing and create more opportunity for Microsoft. In summary, the third quarter contains many of the trends we saw developing throughout the fiscal year.
We continue to make important stride for our strategy, to create a family of devices and services for individuals and businesses, to empower them for the activities they value the most. Some of our investments are already paying off while others reinforce the foundation that positions us for future growth and profitability.
With that, I’ll hand it over to Chris to get more details about this quarter before I come back to share thoughts on the first quarter of fiscal 2014.
Thanks Amy. First, I’m going to review our overall results and then I'll move onto the details by business segment. Revenue was up 3% to $19.2 billion and operating income declined 11% to $6.2 billion. Earnings per share declined 19% to $0.59. Foreign exchange had $257 million or 1 percentage point negative impact revenue this quarter and $177 million or 3 percentage point negative impact to net income.
From a geographic perspective, revenue in the U.S. was strong relative to other regions. Annuity revenue continued to be strong growing 13%. We have record unearned revenue of $22.4 billion and our contracted-not-billed balance was approximately $21 billion.
Now, to the result of the Windows division, our revenue declined 5% this quarter. The x86 PC market continued to decline while business PC showed modest growth. We estimate consumer PCs declined more than 20%. As a result, OEM revenue declined 15%.
OEM revenue lagged the PC market primarily due to market dynamics in China and lower ASPs reflecting the introduction of our small screen touch offering in the current period incentive program. Non-OEM revenue grew 22% driven by sales of Surface and continued double-digit growth in volume licensing as businesses across all areas and segments continue to value the Windows platform.
This quarter we saw continued progress in the transition from Windows XP and today almost three-quarters of enterprise desktops are running Windows 7. Volume licensing of Windows delivered more than $4 billion in revenue this year.
Next, I’ll walk through our Server and Tools business which posted another solid quarter with 9% revenue growth and double-digit bookings growth. Product revenue grew 9%, driven primarily by growth in premium versions of Windows, Server and SQL Server .Our cloud momentum continues with strong customer adoption, upsell the higher level services and increased innovation. We released a number of Azure services, including mobility, media and website services and a growing number of customers who are already using multiple services for the cloud platform needs. We added 25% more enterprise customers this quarter and now over 50% of the Fortune 500 are using Windows Azure.
In the data center, system center revenue grew 14% and the premium version of Windows Server continued to see significant revenue growth. Hyper-V, our virtualization product, continued to gain market share over the past year. Companies such as Aston Martin and Grant Thornton continue to look to Hyper-V and System Center to deliver their critical business application.
In the data platform business, SQL Server revenue grew 16% and again outpaced the broader market. Last month, we announced SQL Server 2014, the next version of our data platform which has in-memory capabilities built right into the core database. We also announced Power VI for Office 365, a cloud based BI solutions that combine power of SQL server with the familiarity of Office.
Now I'll move on to the Microsoft Business Division where revenue grew 2%. Within that, business revenue grew 7%, driven by 10% growth in annuity revenue. Consumer revenue declined 27%. Results in our consumer business were driven by declines in the consumer x86 PC market and the shift to subscription, offset in part by attach gains. As our customers transition to the new subscription model, there is a short term impact to revenue due to the changes in the timing of revenue recognition but over time we expect our revenue to grow and become more recurring and predictable.
With the subscription model, we are providing greater value to our customers with the frequent product updates, new cloud services and attractive pricing. We saw strong early adoption of the subscription offering and now have more than 1 million Office 365 Home Premium subscribers. It's been a big year for Office 365 and as Amy said, it's now on a $1.5 billion annual revenue run rate. This was our strongest quarter ever with more net fee adds in the quarter than all of fiscal 2012. We are seeing strong upsell with one in three Office 365 now running premium workloads.
In terms of our productivity offerings, we continue to see strength of Exchange, SharePoint and Lync each growing double-digits. Lync revenue grew over 30% driving our enterprise communication business to deliver more than $1 billion revenue in this fiscal year. Additionally, we met a key milestone in the Lync and Skype integration and users can now seamlessly communicate in voice and IM across the two services.
Next, I'll move on to the Online Services division where revenue grew 9% and operating performance improved by $107 million or 22%. Online advertising revenue was up 11% driven by both rate and volume improvements in our search business.
In the Entertainment and Devices division, revenue grew 8%. Xbox LIVE transaction revenue grew nearly 20% and is providing economic opportunities for publishers in the soft console market. This quarter we announced our next generation gaming and entertainment console Xbox One and at E3 we showcased in impressive line of games that will be coming to the new platform.
Progress with Windows Phone continues as our partners, including Nokia, Samsung, Huawei and HTC are delivering new phones at a broader range of price points. Telefonica also recently announced an enhanced marketing effort to promote Windows Phone 8 devices and with the recent Sprint announcement, Windows Phone 8 devices will now be available on all major U.S. operators.
Now I'll cover the remainder of the income statement. Cost of goods sold increased 14% principally driven by Surface and growth in cloud infrastructure. Operating expenses grew 9% primarily related to sales and marketing for Surface and Windows 8. This quarter, our CapEx increased as we continued to invest in our cloud infrastructure and expand our geographic footprint to support the growth in our online businesses. And finally we returned $2.9 billion to shareholders in buybacks and dividends.
Now, I'll turn the call back to Amy for our outlook.
Thanks Chris. Before I discuss our expectations for the first quarter, I’d like to spend a few minutes discussing last week’s announcements on One Microsoft. If you haven’t already done so, I encourage you to read out strategy memo and Steve Ballmer's email to employees. Microsoft is rallying to hide a single strategy. As a part of this, we implemented a new organizational structure that will allow us to advance our strategy more quickly and more efficiently.
We are currently in the process of determining what changes, if any, will be made to our reporting segment. In late September, we will host an analyst event, here in Redmond, at which point we will discuss our strategy, our new organizational structure and any changes to our reporting segments. We will also give more thoughts on our full-year outlook at that time. Please look for additional details from Chris over the coming weeks.
Now, moving on to our expectations for the first quarter. In Windows, we expect revenues to continue to be negatively impacted by the decline in the consumer x86 PC market. Excluding the impact of the Windows upgrade offer in the prior year, OEM revenue should account for approximately 65% of the division's revenue and should decline mid teens. Non-OEM revenue should account for approximately 35% of the division's revenue primarily reflecting revenue from volume licensing and Surface including Surface RT at new price points.
While updating your model, please keep in mind that in the first quarter of fiscal 2013, prior to the launch of Surface, OEM accounted for 75% of the division's total revenue. Within Server & Tools, product revenue including transactional and multi-year licensing is about 80% of the division's total. Our Enterprise services is the remaining 20%.
We expect both product and enterprise services revenue to grow high-single digits. In the Microsoft Business Division, we expect business revenue to account for approximately 85% of the division's total. Our consumer revenue should account for the remaining 15%. Business revenue should grow mid-single digit reflecting low double-digit growth in annuity and the shift from transaction licensing to Cloud services.
With the ongoing shift to subscription, consumer revenue will lag the x86 consumer PC market by approximately 5 percentage points, even as the tax continues to grow. This excludes the impact of the Office upgrade offer in the prior year. As a reminder, business revenue accounted for 80% of total revenue in the prior year.
In the online services division, we expect revenue to grow low double digits reflecting growth in service revenue partially offset by lower display revenue. With the Entertainment and Devices divisions, we expect revenue to decline low-single digits as the industry waits the next generation console.
For the first quarter, cost of goods sold will reflect surface as well as the impact of the capital expenditures we made in fiscal 2013. As a result, COG should grow over 20%. Other income and expense includes dividend and interest income offset the interest expense and the net cost of hedging. In the current low interest environment, we expect these items to generally offset.
For the first quarter regarding CapEx, we expect continued growth in our investments and our global data centers. Excluding the impact of the Windows and Office upgrade offers, unearned revenue should roughly follow historical seasonal pattern.
Now, turning briefly to the full fiscal year, we are reducing our operating expense guidance. We now expect fiscal year 2014 operating expenses to be $31.3 billion to $31.9 billion with growth in the low teens for the first quarter. We expect our tax rates to be between 18% and 21% for the full fiscal year.
In summary, as we look back on the year, fiscal 2013 was a pivotal time for Microsoft. With Windows 8, we increased our addressable market. Our OEM partners have started capitalizing on the new opportunities delivering a wide range of new Windows hardware, from phones, the tablets to new PCs.
We extended our first party devices through Surface and the announcement of Xbox One. We modernized productivity with Office 365 changing our business model. For the first time, both businesses and consumers can now access Office through subscription. We took share from key competitors and key enterprise markets. We added several new features, including infrastructure as a service capabilities for Windows Azure. With Azure we are fundamentally changing the way businesses manage their IT infrastructure and we continue the expansion of our data center footprint which enables us to deliver high value services and experiences globally.
As we look to fiscal 2014, we are focused on a single strategy. With our new organizational structure, we believe we'll be able to execute more quickly and more efficiently driving long term growth profitability and shareholder value.
With that I'll turn it back to Chris and we'll take some questions.
Thanks Amy. We want to get to question from as many of you as possible, so please just stick to one question. Operator, please go ahead and repeat your instructions.
Earnings Call Part 2:
- Q&A with Microsoft Corporation CEO
- Information Technology
- Microsoft Corporation