5 Things Microsoft Corporation's Management Wants You to Know

Source: Microsoft.

Software giant Microsoft (NASDAQ: MSFT  )  recently kicked off a new fiscal year. As the company begins its fiscal 2015, it has a new CEO in Satya Nadella and shares have been enjoying upward momentum. So what did Microsoft have to say on its last conference call? Let's dig into some of the call's most interesting quotes and find out.

The commercial segment is crushing it

As always, Microsoft's enterprise business pays the bills. The company's end of support for Windows XP continues to drive enterprise upgrades for the operating system, while Microsoft's server offerings are soaring.

In addition to transitioning to the Cloud, our customers continue to invest in premium versions of our [on-premises] server products like Windows Server, System Center and SQL Server. As a result, our server licensing revenue grew 14% this quarter.

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We also had another breakout year for SQL Server. With SQL Server 14 we released industrial leading in memory technology across all database workloads of online transaction processing, data warehousing and business intelligence. And we grew our SQL business by more than 19%.

The highly profitable commercial licensing segment remains the company's top business in terms of both revenue and gross margin. Commercial licensing contributes nearly two-thirds of Microsoft's gross profit.

Microsoft is moving down-market

In a world in which Google has spurred aggressive price competition by making operating systems free (both Android and Chrome), Microsoft has little choice but to adapt.

In addition, we made the decision to evolve the Windows business model. Now Windows licenses are $0 for any OEM building a device less than 9 inches. We also added a low-cost Windows offering with Bing integration for OEM. This new offering combined with lower hardware specs means OEMs will bring a fantastic lineup of value-based Notebooks and tablets to the markets this holiday.

It's a necessary step if Microsoft hopes to compete in the low-end laptop and tablet markets where Chromebooks and Android devices are dominant. Microsoft must be aggressive to win over OEMs.

Office 365 subscriptions are on the rise

Office's transition to a subscription model is proceeding very well, and the subscriber base for Office 365 continues to grow at a healthy pace.

We saw strong Commercial seat growth across Office 365 particularly with SMB customers. Additionally, we added over 1 million new subscribers to Office 365 Home and Personal, and we ended the quarter with 5.6 million users.

Bringing Office to the iPad has also strengthened Office 365's value proposition, and the initial reception was positive. Nadella added that there have been over 35 million downloads of the Word, Excel, PowerPoint, and OneNote on iOS. Nadella's vision has always been to offer Office on a wide range of devices, and that strategy is already paying off.

Say hello to the phone hardware segment

Now that the acquisition of Nokia's devices business is complete, Microsoft has established a new reportable segment: phone hardware. Low-end devices continue to drive Windows Phone's market share gains.

With the closing of the Nokia devices and services acquisition during the quarter, we established a new segment, phone hardware, to provide transparency into the progress we will make as we improve and grow the phone business. This quarter Lumia device sales were primarily driven by good performance in the lower price point 500 and 600 series. Sales of non-Lumia devices were in line with the overall feature phone market dynamics. Our gross margins were affected by decisions we made to rationalize the device portfolio as well as acquisition related amortization expense.

Phone hardware revenue totaled $2 billion this quarter with a product mix that is skewed toward low-end devices that aren't as profitable as their higher-end counterparts. The new segment reported a gross margin of 22%, well below Microsoft's corporate average of 68%.

Surface Mini was real and killing it hurt profitability

Industry watchers widely expected Microsoft to launch a Surface Mini tablet at the company press event in May. The device was a no-show, and reports later suggested Microsoft axed the product at the last minute. The company also accidentally left clues as to the Surface Mini's existence. CFO Amy Hood confirmed during the conference call that Microsoft changed its mind.

In late June we launched Surface Pro 3. While it is still early, sales are outpacing earlier versions of Surface Pro, and we are excited to bring the device to many more markets this summer. During the quarter we reassessed our product road map and decided not to ship a new form factor that was under development. Combined with the transition of production toward our latest Surface offering, we made inventory adjustments, which affected our gross margins.

Software is generally a high-margin business, while hardware is usually the opposite. Microsoft is seeing margin dilution from entering the hardware business, but first-party hardware is strategically important to the company's competition with Apple.

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