TBR 1Q11 Microsoft Initial Response Report

TBR

T EC H N O LO G Y B U S I N ES S R ES EAR C H , I N C .

Microsoft Corp.

SOFTWARE BUSINESS QUARTERLYSM

1Q11 INITIAL RESPONSE

Publish Date: April 29, 2011 Authors: Allan Krans ([email protected]), Senior Analyst and Matthew Casey, Research Analyst Content Editor: Stuart Williams, SBQ Practice Manager

First Calendar Quarter 2011

Third Fiscal Quarter 2011 Ended March 31, 2011

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TBR

Microsoft 1Q11 Initial Response | Software Business Quarterly ©2011 Technology Business Research, Inc. 2

Microsoft is re-examining long-held strategies and establishing new business charters to ensure long-term growth

Executive Summary

TBR Position Company Objectives

• Microsoft is realigning its core businesses in response to shifting market trends while continuing its forward progress with cloud expansion initiatives.

• The realignment of the next-generation Windows operating system to run on ARM processors is an example of the way Microsoft is adjusting long-held strategies to capitalize on emerging trends such as the proliferation of mobile computing.

• Cloud is not generating significant financial returns for Microsoft, but the company will maintain high levels of investment to expand its portfolio and win partner commitment to build scale.

Drive adoption of cloud services with Azure, Office Web Applications and Office 365 to offset cloud margin pressure with volume

• Building cloud volume will be a long-term initiative for Microsoft, but the company is gradually putting the offerings and partnerships in place.

• A strategic partnership with Toyota, as well as partner expansion in the media and entertainment industry, will expand the reach of Microsoft’s Azure platform into new verticals.

Maintain dominance of Windows and productivity software products to drive strong cash flow

To address the second consecutive quarter of year-to-year declines in its core Windows division, Microsoft announced future ARM processor support and increased investments to position Azure as a cloud platform.

Expand presence in enterprise software (middleware and applications) to capture high-margin revenue growth

Microsoft announced the launch of Windows Intune and System Center 2012 in 1Q11, cloud-based management and security platforms that will help migrate additional Microsoft customers and partners to the cloud.

MSFT 1Q11 PERFORMANCE VS. EXPECTATIONS

(in $ Millions) Consensus Guidance Range Actual

Revenue 16,040$ N/A 16,428$

Operating Income N/A N/A 2,856$

Non- GAAP EPS 0.55$ N/A 0.61$

MSFT 2Q11 GUIDANCE AND EXPECTATIONS

(in $ Millions) TBR Estimate Consensus Guidance Range

Revenue 17,400$ 17,380$ N/A

Operating Income 6,985$ N/A N/A

Non-GAAP EPS N/A 0.60$ N/A

TBR


A diverse portfolio produced financial stability in 1Q11, empowering Microsoft to execute on its cloud strategy Key Developments

Accelerating growth in the consumer market means abandoning old friends and entering new segments

• Microsoft’s seventh consecutive quarter of revenue growth, at 13.3% in 1Q11, was driven by strength in its Office, Server & Tools, and Entertainment & Devices divisions, which masked a second quarter of weakness in Windows Division revenue.

• While Microsoft claims multiple factors influenced Windows Division revenue during 1Q11, the correlations with rising tablet adoption, declining consumer PC shipments and Microsoft’s late entry into this segment are difficult to ignore.

• In 1Q11, the company marked the end of x86 processor exclusivity with Intel by announcing additional support of AMD and ARM SoC architectures, empowering Microsoft to expand the availability of its core Windows products to more devices, including smartphones and tablets.

Microsoft focuses on gaining share in the enterprise cloud management market

• As consumer PC shipments continued to decline in 1Q11, Microsoft allocated additional focus to the enterprise cloud management market as a source of future revenue growth.

• Approximately 90% of Microsoft’s $9.6 billion R&D budget for 2011 will be allocated to its cloud strategy as the company commits to accelerating its cloud product portfolio.

• In 1Q11 Microsoft launched System Center 2012, enabling private cloud adoption across diverse platforms and virtualization technologies, driving value for enterprise users.

• TBR believes System Center 2012 will empower Microsoft’s go-to-market strategy, providing – alongside Hyper-V – a wholly owned set of cloud and virtualization enterprise products. TBR maintains Microsoft will continue to bolster this suite of business management solutions.

As Microsoft gallops to the cloud, the company wants partners to come along for the ride

• In 1Q11 Microsoft launched Windows Intune, a cloud-based management and security platform that provides a management and services business opportunity for partners to manage.

• Microsoft expanded the market presence of the Azure platform into new verticals, arming partners to better compete within specific verticals with cloud solutions.

• The company also improved its developer network in 1Q11 with new cloud-centered training and accessibility tools for developers.

Executive Summary

TBR


Multi-year commitments from customers are increasing revenue opportunities for Microsoft’s Maintenance and Consulting businesses

Segment Revenue Performance and Strategies

Segment Financials

New License

• New license revenue increased an estimated 13.2% year-to-year to $9.4 billion in 1Q11.

• Customer loyalty to Microsoft products was reflected in new license growth, as multi-year commitments from enterprise customers drove growth.

Maintenance Maintenance and support revenue totaled $3.5 billion in 1Q11 – a 12.0% year-to-year increase.

Consulting

• Microsoft’s professional services/consulting revenue increased 12.4% year-to-year to $818 million.

• TBR believes product refreshes, as well as enterprise deployments, will lead to year-to-year growth in consulting revenue throughout 2011.

Executive Summary

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MICROSOFT TWO-YEAR EMPLOYEE EXPENSE

Operating Expense Per Employee Number of Employees

SOURCE: TBR AND MICROSOFT

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TBR

$8,261,536 $9,340,686 $9,719,640 $11,175,616 $9,353,446 $10,185,167

$3,142,200 $3,679,587 $3,291,973 $3,433,711 $3,519,264 $3,716,383

$868,264 $853,727 $861,387 $954,673 $972,290 $944,290

0%

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MICROSOFT SEGMENT CONTRIBUTIONS

Consulting Maintenance New License


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Microsoft’s Business Division leads 1Q11 growth, as core consumer business slowed in the face of declining consumer PC shipments

Revenues

• Year-to-year revenue growth of 13.3% in 1Q11 was driven primarily by Microsoft’s Business Division, which grew by 23.8%. Microsoft executives attributed this growth to multi-year license agreements, as well as increased transactional activity with corporate PC deployments.

• While Microsoft’s Windows Division still accounts for just over 27% of corporate revenue, but declined in 1Q11 due to reduced consumer PC shipments.

Expenses

• Cost of sales increased 41.5% from a year ago, rising 470 basis points from 1Q10 to 23.7% of total revenue.

• Higher expenses were a result of high Enterprise Services volume within the Server & Tools Division, as well as costs associated with the Yahoo alliance.

• S&M expenses increased 5.9% year-to-year, while R&D rose 2.2% year-to-year.

• G&A expenses rose 0.7% year-to-year, increasing incrementally to $1.2 billion in 1Q11 as Microsoft continues to trim overhead costs.

Margins

Gross profit rose only 6.7% in 1Q11 from a year ago, while gross margin fell 470 basis points to 76.3%.

Financial Model Strategy

$5,173 $5,709

$2,220 $2,269 $4,355 $4,553

$11,748 $12,531

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MICROSOFT OPERATING METRICS

Gross Income

SG&A

R&D

Operating Income


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MICROSOFT PROFITABILITY AND GROWTH

Operating Margin Net Margin Revenue Growth Year-to-Year


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Microsoft is diversifying its product offerings under the umbrella theme of cloud computing

Product Strategies

• Gear product functionality and capabilities toward SMB customers, delivering ease of use versus enterprise-level functionality.

• Counter open-source threats with selective participation and risk mitigation.

• Expand target markets by investing in consumer and enterprise products.

• Leverage desktop strength as customers transition to SaaS.

• Provide well-received platforms to support partner customization and development.

Services Strategies

• Enable and facilitate partner delivery of services and solutions to end customers.

• Participate and cooperate in partner engagements as a product expert.

• Increase annuity service agreements to provide revenue stability.

• Deliver services to enterprise end-users, forging a direct relationship with Microsoft.

• Deliver the education and training needed to foster the Microsoft ecosystem.

Microsoft’s “we’re all in” cloud strategy is universal, as shown by its commitment to spend 90% of its R&D budget on its cloud solution strategy in 2H11

• Microsoft announced the release of System Center 2012 and Windows Intune, two private-cloud centered solutions that broaden Microsoft’s capabilities within enterprise systems management. System Center 2012 is specifically engineered for high-performing collaboration with Hyper-V.

• In 1Q11, Microsoft announced a partnership with Toyota, and will jointly develop a solution through Azure (Microsoft’s dedicated cloud development platform) to provide advanced telematics services for Toyota customers – launching an innovative partnership and extending Microsoft’s cloud brand into a new segment.

TBR Position:

• TBR believes slow growth in mature markets will continue to force Microsoft to adapt its products into cloud-based solutions to maintain growth and market share within the emerging cloud market.

OS

DB

Apps

BI

MW

Consult

Premium

Base Support

Education

Software Stack

Services Offerings

Go-To-Market and Product Strategies

TBR


Indirect Sales Strategies

• Leverage partners to provide sales coverage across the globe.

• Support partners with marketing resources, development funds and training/certification.

• Implement tiered rebate programs to target specific markets or products.

• Cooperate with partners on joint sales engagements.

• Share support sales and delivery opportunities as a differentiator.

Direct Sales Strategies

• Target largest accounts directly to meet customer needs for continuity and deep global relationships.

• Partner with VARs and SIs to maintain channel involvement across all accounts.

• Overcome customer apprehension regarding SaaS through offering Microsoft-hosted solutions.

LE

SME

SMB

Consumer

10%

Estimated Microsoft Revenue Mix by LOB

25%

35%

30%

Microsoft will jump-start growth in mature markets through the use of verticalization and partnerships Vertical markets are a substantial portion of Microsoft’s expansion plan, as mature software markets are driving vendors to search for new sources of revenue growth • Microsoft’s vertical expansion in 2011 will hinge upon growing its partner network, enabling the company to capitalize

on opportunities presented by growing verticals.

• Key partnerships with Dell and Stellaris Health Network, as well as with athenahealth, helped Microsoft expand into the healthcare industry by offering web-based analytics and collaboration services to hospitals.

• In 1Q11, Microsoft announced a new partner ecosystem directed toward the media and entertainment industry (M&E), focused on guiding M&E customers into the cloud via Microsoft’s Azure platform.

TBR Position: • TBR believes the continued expansion of Microsoft’s partner ecosystem and programs will enable the company to

expand into other industry segments, not just M&E –a critical move for the company to overcome slowed growth in mature markets.

Go-To-Market and Product Strategies

TBR


New leaders will advance Microsoft’s cloud and enterprise strategies from planning to execution

Strategy

• Following difficult prior quarters, Microsoft remains focused on consolidating and strengthening Americas revenue growth.

• Microsoft will balance that commitment with planned investment in international markets as well as in segment-centric product solutions.

Executive Changes

• Satya Nadella was promoted to President of Microsoft’s Servers & Tools Business, and brings experience in both business applications and cloud services to the role.

• TBR believes Nadella’s appointment reinforces Microsoft’s goals of adapting its core product set to the cloud.

• Microsoft appointed Chris Capossela SVP of the Consumer Channels and Central Marketing Group, a new group that combines Microsoft’s Retail, Mobile Operator and Distribution units.

• Executives exiting include Mich Mathews (SVP of Central Marketing) and Kevin Timmons (GM of Datacenter Services), who has defected to Apple.

23,517 23,274

36,465 36,200

17,500 17,250

8,719 8,196

3,800 3,800

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MICROSOFT HEADCOUNT

Manufacturing &DistributionGeneral & Administrative

Services

Research &DevelopmentSales & Marketing

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$5,439 $5,947

$3,234 $3,351 $1,790

$2,780 $4,040

$4,350

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$10,000$12,000$14,000$16,000$18,000

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MICROSOFT REVENUE BY REGION

OEM

APAC

EMEA

Americas


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Resource Management Strategy

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Income Statement MICROSOFT CORP.

Consolidated Statement of Income

(in $ Thousands Except per Share Data)

CALENDAR QUARTER 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 Est.

FISCAL QUARTER 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 Est.

Net Sales 14,503,000$ 16,039,000$ 16,195,000$ 19,953,000$ 16,428,000$ 17,400,000$

Cost of Sales 2,755,000$ 3,170,000$ 3,139,000$ 4,833,000$ 3,897,000$ 3,654,000$

Gross Profit 11,748,000 12,869,000 13,056,000 15,120,000 12,531,000 13,746,000

Sales and Marketing 3,203,000 3,602,000 2,806,000 3,825,000 3,393,000 3,567,000

General and Administrative 1,152,000 987,000 938,000 945,000 1,160,000 956,667

Research and Development 2,220,000 2,350,000 2,196,000 2,185,000 2,269,000 2,237,750

Operating Income 5,173,000 5,930,000 7,116,000 8,165,000 5,709,000 6,984,583

Investment Income 168,000 94,000 114,000 332,000 316,000 177,000

EBITD 5,341,000 6,024,000 7,230,000 8,497,000 6,025,000 7,161,583

Provision for Income Taxes 1,335,000 1,506,000 1,820,000 1,863,000 793,000 1,790,000

Net Income 4,006,000$ 4,518,000$ 5,410,000$ 6,634,000$ 5,232,000$ 5,371,583$

Net Income per Share 0.45$ 0.51$ 0.62$ 0.77$ 0.61$

Diluted Shares Outstanding 8,876,000,000 8,821,000,000 8,695,000,000 8,570,000,000 8,510,000,000

AS A PERCENTAGE OF REVENUE

Net Sales 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Cost of Sales 19.0% 19.8% 19.4% 24.2% 23.7% 21.0%

Gross Margin 81.0% 80.2% 80.6% 75.8% 76.3% 79.0%

SG&A 30.0% 28.6% 23.1% 23.9% 27.7% 26.0%

R&D 15.3% 14.7% 13.6% 11.0% 13.8% 12.9%

Operating Margin 35.7% 37.0% 43.9% 40.9% 34.8% 40.1%

Investment Income (Expense) 1.2% 0.6% 0.7% 1.7% 1.9% 1.0%

EBITD 36.8% 37.6% 44.6% 42.6% 36.7% 41.2%

Income Taxes 9.2% 9.4% 11.2% 9.3% 4.8% 10.3%

Net Margin 27.6% 28.2% 33.4% 33.2% 31.8% 30.9%

YEAR-TO-YEAR CHANGE

Net Sales 6.3% 22.4% 25.3% 4.9% 13.3% 8.5%

Cost of Goods Sold -2.1% 22.6% 10.5% 33.2% 41.5% 15.3%

Gross Profit 8.4% 22.4% 29.5% -1.8% 6.7% 6.8%

SG&A 11.8% 7.7% 6.0% 0.6% 4.5% -1.4%

R&D and Engineering 0.4% 5.6% 6.3% 5.1% 2.2% -4.8%

Operating Income 16.6% 48.7% 58.8% -4.1% 10.4% 17.8%

Investment Income (Expense) 143.3% -39.4% -59.7% -10.3% 88.1% 88.3%

EBITD 31.9% 45.4% 51.7% -4.3% 12.8% 18.9%

Income Taxes 24.4% 37.3% 52.8% -16.1% -40.6% 18.9%

Net Income 34.6% 48.4% 51.4% -0.4% 30.6% 18.9%


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TBR


Balance Sheet MICROSOFT CORP.

Consolidated Balance Sheets

(in $ Thousands)

CALENDAR QUARTER 1Q10 2Q10 3Q10 4Q10 1Q11

FISCAL QUARTER 3Q10 4Q10 1Q11 2Q11 3Q11

ASSETS

Current Assets

Cash & Cash Equivalents 8,155,000$ 5,505,000$ 8,161,000$ 4,023,000$ 7,021,000$

Short-term Investments 31,511,000$ 31,283,000$ 36,012,000$ 37,299,000$ 43,129,000$

Accounts Receivable - Net 9,137,000 13,014,000 9,646,000 12,874,000 10,033,000

Deferred Income Taxes 2,222,000 2,184,000 2,344,000 2,548,000 2,586,000

Inventory 501,000 740,000 1,242,000 861,000 1,056,000

Other 2,992,000 2,950,000 2,176,000 2,149,000 2,438,000

Total Current Assets 54,518,000 55,676,000 59,581,000 59,754,000 66,263,000

Property, Plant, Equip. (Net of Dep.) 7,372,000 7,630,000 7,771,000 7,799,000 7,969,000

Other, Net 23,020,000 22,807,000 24,188,000 24,188,000 25,495,000

Total Assets 84,910,000$ 86,113,000$ 91,540,000$ 91,741,000$ 99,727,000$

LIABILITIES AND EQUITY

Current Liabilities

Accounts Payable 3,279,000$ 4,025,000$ 3,654,000$ 3,863,000$ 3,829,000$

Short-Term Debt 2,249,000$ 1,000,000$ 1,000,000$ -$ -$

Accrued Compensation 2,885,000 3,283,000 2,252,000 2,402,000 2,917,000

Income Taxes Payable 901,000 1,074,000 2,136,000 1,439,000 839,000

Short-term Unearned Revenues 11,171,000 13,652,000 12,767,000 12,063,000 11,887,000

Securities Lending Payable 2,794,000 182,000 909,000 1,355,000 1,245,000

Other 3,145,000 2,931,000 3,139,000 3,190,000 3,325,000

Total Current Liabilities 26,424,000 26,147,000 25,857,000 24,312,000 24,042,000

Long-term Unearned Revenues 1,089,000 4,939,000 1,152,000 1,354,000 11,915,000

Other 11,687,000 8,852,000 17,589,000 17,333,000 9,133,000

Total Liabilities 39,200,000 39,938,000 44,598,000 43,825,000 46,275,000

Stockholders' Equity

Common Stock & PIC 62,517,000 62,856,000 61,935,000 61,646,000 63,234,000

Retained Earnings (16,807,000) (16,681,000) (14,993,000) (13,165,000) (9,782,000)

Total Stockholders' Equity 45,710,000 46,175,000 46,942,000 48,481,000 53,452,000

Total Liabilities & Equity 84,910,000$ 86,113,000$ 91,540,000$ 92,306,000$ 99,727,000$

FINANCIAL RATIOS

Days Sales Outstanding 56.7 73.0 53.6 58.1 55.0

Fixed Asset Turnover 7.9 8.6 8.4 10.3 8.3

Days Cash Outstanding 246.2 206.4 245.5 186.4 274.7

Total Asset Turnover 0.69 0.75 0.73 0.87 0.69

Debt/Asset Ratio 0.46 0.46 0.49 0.48 0.46

Current Ratio 2.06 2.13 2.30 2.46 2.76

Return on Assets 21.9% 22.7% 24.2% 23.6% 24.0%

Return on Equity 41.6% 43.2% 45.9% 44.4% 45.3%

Average Annual Revenue Per Employee 661,591$ 705,269$ 743,762$ 754,292$ 772,691$

Employee Count 90,001 88,596 88,414 88,414 88,800


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TBR 1Q11 Microsoft Initial Response Report

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Transcript of TBR 1Q11 Microsoft Initial Response Report