JP Morgan Technology, Media & Telecom Conference
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JP Morgan Technology, Media & Telecom Conference
Who: Dave O'Hara, CFO, ASG and C&E
When: Tuesday, May 24, 2016
Where: Boston, MA
MARK MURPHY: Okay, good morning, everyone. Thank you very much for joining us. I'm Mark Murphy, software analyst with JP Morgan, and it is a great pleasure to be joined here by Dave O'Hara, who is CFO of Applications and Services, Cloud and Enterprise for Microsoft, so many of the parts of the business that are critically topical to all of us these days.
Dave, thank you for joining us.
DAVE O'HARA: Absolutely.
MARK MURPHY: So I'm actually going to begin by mentioning the Safe Harbor Statement before we begin. Microsoft may make some forward-looking statements during this presentation, and you should refer to their SEC filings or the risk factors relating to their business. And that's true whether you are here in person or listening on the web.
How did I do?
DAVE O'HARA: Great.
MARK MURPHY: So Dave, do you want to start with any type of opening comments or any type of quick introduction opening comments do you want to make or do you want to start straight into Q&A?
DAVE O'HARA: Well, just a couple of comments for set-up. One is, as you mentioned, I'm CFO for ASG and C&E. ASG for those that maybe aren't as familiar is what we think of as Office and Online, and then C&E is what used to be the old server and tools business, so it's Azure and SQL. And so if you look across ASG and C&E, it essentially represents the bulk of our commercial business from a Microsoft perspective, and then some consumer stuff thrown in. So most of the stuff that we deal with on a day-to-day basis has to do with the commercial business.
MARK MURPHY: Okay. So you've been with the company for about 15 years, and I'm not including the Great Plains part of the existence. So it's a long time you've been there. I think externally it feels a lot more exciting and dynamic than it did to us several years ago. The company is executing one of the most successful cloud transformations that we've seen. I think there's a feeling that the innovation engine is really cranking. You've got great stuff coming out of the research lab and there's also this new found type of openness coming out of the company towards other operating systems, other competitors in the ecosystem. What is it that has you most excited at this point and what do you think it means for Microsoft?
DAVE O'HARA: Sure, I think there's a lot of things to be excited about. You mentioned Great Plains acquisitions. I think one of the very first people in that, certainly it was in the first week, was Satya and Satya was running what was then known as B Central and Satya became part of the Dynamics business. So we worked together back then and then also in the Bing days and he was running what is now C&E. So I feel like Satya is bringing both a considerable breadth of understanding of the business, because he's worked in so many different parts of it, and I think it's easier for him maybe to see all the connected pieces.
He just brings a new openness, as you mentioned, to some of the partnerships that we have. But if you look at where the company has come in the last couple of years I think it's fairly instrumental in showing where we're going, which is some of the Office on the iPad, for example, SQL on Linux, those are just examples of where we're really more focused on embracing what the customer wants and when they want it and in what environment they want that to run and so it's not about you're either Microsoft or non-Microsoft. I think it's just a new way of working in the world that we have, which is you can be on Microsoft in some of your products and opens source on others and we can make it all work together.
So I think it's just really we're forming deeper partnerships, we're working with customers to run a more open environment, we're offering products that we haven't offered in the past. The shift from on-prem to cloud, all of those things are things that we jumped on early. I think Steve started a lot of that, Satya has continued that. And I think he continued it in an accelerated way.
And then the last thing I would say, as we move into the cloud world is there's a lot of benefits to being in the cloud, there's also a lot of ‑‑ not everybody can be in the cloud. It's an expensive business to be in. And it takes a lot to get to scale. And I feel like we're on the front end of that. We started early and I think we're probably ‑‑ that's one of the reasons we're a leader in the cloud, is we started early, we invested early, and I think we're in a good spot.
MARK MURPHY: So in terms of being in a good spot, so we actually published a CIO survey last month over 200 CIOs responsible for $126 billion in annual IT spending. One of the questions was moving forward which of the IT mega-vendors will be the most critical and indispensible to your IT infrastructure. Microsoft is claiming 47 percent of that vote and that was actually up from what we had seen in a prior years. So what was interesting was looking at the list below that. Amazon AWS came in second on that list. And so they edged out Cisco, which kind of held ground. And when you look at the composition of the list below that everyone else from Oracle to SAP to EMC and IBM lost ground from the prior survey. So I want to ask you how would you interpret that. When you consider that, look at the change happening below the level of Microsoft, what is it showing us?
DAVE O'HARA: Well I think it is certainly showing a trend in the cloud. AWS showing up on the list is a business that didn't even exist 10 years ago, barely existed 5 years ago. And so the cloud I think is a big piece of that. And some of the folks on that list have done better than others in the cloud and I think that shows up in your survey. Strictly form a Microsoft perspective it's great to see certainly. I think we have a good trusted relationship with enterprise and so they talk to us about a lot of their needs.
We have a few things that maybe aren't available from everybody else. One is we do have a hybrid environment. We see a lot of our customers who are both on-prem and in cloud and it's not an either/or. They really feel the need to continue getting value out of the investments they've already made in on-prem, but also augmenting that with the cloud. So I think we offer that which is unique and differentiated. We have a bigger geo-footprint than most, I think, certainly in any country we have a good presence. And you see that in how we're building out the cloud, which is we want to serve countries ‑‑ we want to serve all geos and make sure that customers are getting cloud wherever they need it, whenever they need it.
So I think that's probably part of the reason that we show up high on the list, is we're an existing vendor with them. They probably have a lot of our tech already. They want to augment it with even more of our tech. And they have a trusted relationship with us.
MARK MURPHY: So one of the other questions in the survey, we asked all these CIOs how much of their infrastructure as a service work would be conducted on the various IaaS platforms in future years. So this was a forward looking question. So we were asking across Amazon AWS, Azure, and also the Google Cloud platform. And what we found was interesting. It came in 25 percent for AWS, 24 percent for Azure. And so what I would say is if that is going to be correct that would represent a pretty material recalibration of the market share as it stands today, right. What is it that would enable that type of recalibration?
DAVE O'HARA: Well, I would step back for a second and just say from a cloud perspective we really see the cloud as being ‑‑ the cloud overall, the cloud business overall, we really see that as being even bigger than the existing IT business today. And so I think just moving to the cloud there is sort of ‑‑ there's an inherent growth rate in how you think about cloud versus previous IT setups.
And so I think it's going to be a bigger pie. Hopefully we'll get our share of the pie. We're working hard to get our share of the pie. I do think that a lot of customers just want ‑‑ they don't want take a dependency on one vendor. And there's so many different workloads that they can parse out some of those workloads and some of it they can run on AWS and some on Azure.
From a Microsoft perspective we really look at the cloud offering as being the whole cloud offering, it's 365; it's CRM; it's ERP; it's our EMS solution; it's the core Azure infrastructure. So you know, I think that it's not just the infrastructure piece. It certainly will be competitive from an infrastructure piece, but it's about the value added services on top of that. And I think all of that shows up in the survey. I do think that customers genuinely are looking to do business with more than one vendor and they like the offerings from more than one vendor and so they'll figure out a way to make all that work together.
MARK MURPHY: What do you think the impact of price cuts will be in the future? I think we look back on this, we can now see some of the data for AWS and it will be on this incredible growth trajectory. Then there will be a quarter where they execute some price cuts and the top line will kind of flatten out for about a quarter there, maybe even a minor decline, and then it will get back on this trajectory. I'm wondering from your perspective how do you deal with and how do you handle price cuts that may be executed by you, they may be executed by others. And as part of that question, do you think is there inherently a part of this stack that over time just gets priced down kind of in a spot market? Is there a commodity part of this stack that you would compare and contrast?
DAVE O'HARA: I don't know if I'd use the word "commodity." I would certainly from an infrastructure perspective that's the table stakes for being in the game. And so we just ‑‑ we feel like that's a core part of the offering, but really we feel like the ultimate value is in the services that are offered on top of the infrastructure. But you need the infrastructure to make all that work. And so we do believe that infrastructure will continue to be a critical part of it. But we think it's about the bigger cloud and less about how we think about infrastructure.
From a pricing perspective the last couple of years, or the last 18 months, have been more sane maybe than the first couple of years that preceded that. I think there's a lot of question about how big it will be and who is going to get what share and we're always going to be competitive on price. I don't think you'll ever see us lead price down. But we're certainly going to be competitive on price.
At the same time that price has been going down costs have been going down, as well, as people get to scale. And I think implied, when people ask the question about price implied in that is whatever price changes you make down just causes you to lose money and we believe at the same time that as pricing gets adjusted down our costs are getting adjusted down. We're getting the benefits of scale. And so we still think there's good margins in the infrastructure business, but really it's about the whole cloud business.
MARK MURPHY: So let me give you a quick question on a different type of survey that we did also last month. We published a survey of 43 of Microsoft's top resell partners, resellers, distributors, consulting firms, et cetera. We asked them to rate all your products in terms of their momentum. And I think not surprisingly Azure and Office 365 came in first and second. I think we'd all expect that. I think the question we commonly get is how do you sustain the growth as these businesses are reaching some type of apex? How do you see the sustainability of the growth trends for Office 365 and Azure moving forward? And do you have any kind of thought on just overall what inning we're in for each of those segments?
DAVE O'HARA: Sure. Let me talk about 365 first. I think we shared some numbers at the analyst briefing; I'd say it's probably a year ago, where we talked about Office and its transition to the cloud. We said that by FY '18 I think we said that two-thirds of our Exchange workloads would be in the cloud and by FY '18 I think half of our Office workloads would be in the cloud. So that's a couple of years out, however you want to measure it, and from a fiscal year perspective. And so we feel like there's a lot of runway in Office. The other thing I would mention is with our E5 offering, which we just launched, there's an opportunity to provide additional SKUs in Office, that provide additional functionality with that, Power Bi, security and Voice in the cloud. And those are all new offerings for us.
So I think sometimes people look at it and say Office has really high penetration and sort of it's at the upper end of its market. We really believe one is there's a lot of cloud runway left. And two is there's an opportunity through Office to bring in new services that we haven't offered yet. And it's a great way to do it ‑‑ candidly, it's a great way to do it cost effectively, which we're already in those sales environments and we're already talking to those customers. So we think there's new offerings we can bring. So we don't look at Office and say what it is today is what it will be five years from now. We really think there's a chance to build out that business in a very healthy way.
MARK MURPHY: So let's go directly into that. So the assessment across your partners in terms of the technology, the vision, the momentum of the company, is lopsidedly positive. It comes through very clearly in our survey work. What is it that you think that they're looking to, clearly many would be referring to Azure and Office 365, but are there technologies that are on the leading edge, are there emerging technologies? Maybe there are products in the research lab that perhaps some of your partners are more mindful of and have better awareness than the rest of us externally at this point?
DAVE O'HARA: Well, let me ‑‑ so let me give a little longer answer than that, but I'll try to keep it short. One is that I think from a cloud perspective there just aren't going to be that many cloud vendors that can compete effectively. And if you're a partner what you want is you want new opportunities, because for partners they need to go out and generate new revenue. And so new markets, new opportunities mean new revenue for partners. And I think they legitimately see Microsoft as one of the cloud vendors that's going to be around a while.
I'll, again, go back to ‑‑ my second point would be E5. Those are all new services that we haven't previously offered. And those are all new services that maybe haven't had a partner strategy in the past. There might have been companies providing some of those services that didn't embrace partners or had a more direct approach. And I think partners see it as an opportunity for them to break into new categories. I also think the third thing is that it's just new stuff for them to bring to customers, rather than the same solutions for the last few years. Maybe it's getting a little stale. There's something new for them to talk about.
And so I think it's the combination of all those things, they see us as viable, they see us as trusted, they see us as coming out with new services, new opportunities for them to go build some trust and make some money with some customers. That is all good.
MARK MURPHY: And so for the benefit of the audience, the elements of the E5 SKU that you're referring to as being new are you speaking of Power BI?
DAVE O'HARA: Well, so we've had a voice offering, we've had a Power BI offering, we've even had security offerings. But if you look at what we've got in E5 there's a lot of newness in each of those. And so Power BI is an example I think that what we had before was maybe not the easiest solution to implement and didn't have a broad appeal. And what we do with Power BI now I think is certainly easier to setup, easier to run, has better appeal for customers, before it was literally power users on the business intelligence that saw the value in Power BI. I think with our pricing strategy and our go to market strategy with E5, and even if you look at the ease of use and the visualizations, people look at Power BI now and they say, hey, that has applicability to a broader set of the customer base. The more users can take advantage of it, which again from a partner perspective it's just all goodness.
MARK MURPHY: So with all this goodness coming down the pipeline and all the innovation that we're seeing from Microsoft, what is it that you think might be missing from your cloud portfolio? And I think we do field a lot of questions on the build versus buy decision, when you look back on it. It feels like the approach has been much more build recently.
DAVE O'HARA: I think it's been much more build, but even if you look at, again going back to E5 with our security offering, there is a couple of components in there from companies that we acquired. And a lot of times what we would do for an acquisition would be considered in Microsoft terms a tuck in, but it's super-strategic. And I think that security is an example of that. It's hard for any one company to catch up and so we always have a good solid, organic build strategy and we'll continue to do that. But I do think there are select acquisitions we can do that will augment the offerings that we have. And then our job is to just put those together in a way that makes sense for customers and have a good go to market strategy. But we'll continue to pursue M&A opportunities, but they have to make sense.
MARK MURPHY: Let's talk for a moment about your transactional versus the annuity business. I think broadly we see so many signs that Microsoft is a net consolidator across the industry in a whole lot of new areas, gaining scale, gaining share, excuse me, in markets of large scale. In the most recent quarter I think it was clear the core fundamentals remained very solidly intact. Everything having to do with annuity, everything having to do with cloud, but you had mentioned a larger than expected decline in the transactional business, which I think as part of that included some of the on-premise server business. And so I actually, if it's okay with you, I want to ask you a few questions on this.
The first one, which ‑‑ (off mike).
DAVE O'HARA: Well transactional is across both the Office product and the server product. So it was both.
MARK MURPHY: Office and server and then which geographies, I think we were curious, almost every company is mentioning Russia, Brazil, China, emerging markets generally, is that where you saw the issues, did it extend beyond that?
DAVE O'HARA: Yeah, that was part of it. I mean just a couple of data points which we've published, one is that from a commercial business perspective 86 percent of our revenue is annuity and that percentage is growing. And so we've been on a push to get people to do more annuity versus non-annuity. And the non-annuity piece is the transactional piece, so some of this is a natural transition. Those get accounted for a little differently.
And so I think there's been some movement from non-annuity to annuity, which we see as goodness. There was also some weakness for the reasons that you mentioned, Mark. Brazil, Russia, et cetera, those markets are less annuity, so when we talk about 86 percent that's across the commercial business all up, but in certain geos they're more transaction heavy, and those would be a couple of geos that are transaction heavy.
MARK MURPHY: So if you step back and said, you know, you think through what happened with transactional, and we're all trying to weigh, that could be largely macro or it could be an effect of this transition from on prem to cloud. What are you using as a guide to try to understand what's driving the dynamic?
DAVE O'HARA: Sure. I think it's a few things. Certainly those few, I think there's a geo to it, there's also a non-annuity versus annuity, and then I think there's just a lot of customers that are trying to figure out what they're going to do, are we going to go to the cloud, when are we going to go to the cloud, what does that look like, what's that roadmap?
And so maybe they're just stepping back and saying, you know, let's take a long-term view on this, and we're working with them on that. I think all of those things contributed to probably a little softer transactional business than we had expected.
MARK MURPHY: Any gut feel on whether that transactional software intensifies from here, or abates or maybe what will determine that going forward?
DAVE O'HARA: Well, I think those will all be contributing factors. Our goal really is to make sure they're a Microsoft customer, and whether they choose to transact with us through annuity or through non-annuity, we're less hung up on that. It's more about making sure that they're getting the services and the product that they want from Microsoft. So we're working closely with them on that.
I would say that, you know, our guidance reflects what we see as the trends in the transactional business, but we'll see how it plays out. But we feel good about the business. We feel good about where we're at.
MARK MURPHY: Okay. Now I want to come back to, because you had made a comment around Office 365, so coming back to our partner survey, again, looking at it through that lens, we asked all these partners to look across their customer base and tell us for their typical corporate client what percent of their employees are a subscriber of Office 365 today? And that came in at 39 percent. We then said, where do you think it goes in five years? They came in at 67 percent.
So I would say on the one hand it speaks to, it's a very large increase, it speaks to this roadmap. On the other hand, if you try to back into a CAGR on that number, it's not as high as where it is today. How do you interpret that because I think there could be some measures we're not capturing, all the pricing uplift, new logos, so on and so forth. Kind of coming just back into the opportunity and how penetrated we are into Office 365.
DAVE O'HARA: Yeah, I mean I would go back to a couple of stats I mentioned earlier, which is we feel like from our view of the business, Exchange will be two-thirds cloud in FY'18, and Office will be 50 percent in FY '18. We still see good runway.
Even if you just look at the business as it is today, we think we still have good healthy room to grow, and we're confident that we're in a good position. I do think that when we ask customers, when you ask customers questions like that, they're looking at Office as it's constituted today, and they don't necessarily see all the new service offerings. So I think Office will continue to increase its footprint.
I think the way that shows up in our financials is RPU goes up because I think people are maybe contracting with us for services that they were getting from someone else previously, so it results in a net savings for them, but it results in a net revenue increase for us. So I think we feel like there's good runway both in the existing business where it's at today and the new service offerings that we'll be bringing onboard in the future.
MARK MURPHY: Any quick comment on the decision point to make your flagship database, SQL Server, available for the first time on the Linux platform? It's been a tremendously successful product. It's in the upper right-hand corner of the Gartner quadrant for the first time, so it is being assessed as the world's number one database. Congratulations on that, by the way.
DAVE O'HARA: Thank you.
MARK MURPHY: What was the decision point that drove the company to keep that on the Windows platform and all of a sudden to decide to make it available on Linux, which I think happens in a year, because I think we've also seen Amazon seems to be another company calling out the database industry as an area of potential for disruption and opportunity.
DAVE O'HARA: Yeah. Well, we certainly see a lot of opportunity within the database and within data in general. There can be a lot of really healthy growth for the companies that are positioned correctly. For people on Linux, it was really about we want to be able to allow a developer to write any app they want on any platform. That's what it comes down to.
And it does come down to helping customers, giving customers choice, because I think when people look at SQL on Linux and they say, wow, is that a big revenue opportunity, how do you think about that? I think long-term there's a lot of good revenue opportunity there. In the short-term, what we've got from a lot of customers was just a sense of relief that they could continue to run the stuff that they're running now, and they could continue to look at new options. And so it's really about giving customers choice.
And so we weren't focused on -- we were focused on saying you can run what you want when you want and we'll figure out a way to make it work. And so I think customers saw it as good for the current environment and the future environment.
MARK MURPHY: So let's come back, I want to ask you one or two more quick questions and then we'll poll the audience and see if anyone wants to ask anything. I want to come back to E5 because you've already mentioned it a couple of times this morning. And so you have this new E5 option for licensing Office 365. It's kind of your top of the line plan, the premo plan. I think our understanding was that E4 was not a really heavily adopted SKU. Perhaps there's a misperception on that. I think E3 was very heavily adopted. And so you are early on, you're very early on in this. What do you expect out of E5, and is there anything you've observed so far in the early innings in terms of just how customers themselves are responding to this E5?
DAVE O'HARA: Yeah, in E5, we just launched in Q3, so to your point, Mark, E3 was certainly our hero SKU where we had the most penetration. And we felt like E5 is a good augmentation to that. If we look at what's available in E3, Office, Exchange, and SharePoint and Skype for Business; and E5 has the security offering, it has Power BI, and it has more voice functionality. And so what we're getting from customers is a lot of curiosity about what it's going to offer that isn't in E3. And so we think we have a good value prop around that.
I also think if you look at the components of E5 and how people would adopt those, Power BI is something they can adopt right away. Security is something they can adopt right away. Voice maybe takes a little longer. And so what we typically see is as enterprise agreements come new people just take a look at their mix and say, hey, you have this new offering out there, how can we think about that? So it gives us a good opportunity to go in and explain the value prop.
I certainly think there's a lot of differentiation between E5 and E3, and there's a lot of goodness in there. And that might be revenues that they're paying to a different provider and that they now decide to go with Microsoft for that, which we see that as a big opportunity for us.
MARK MURPHY: You mentioned voice, and I want to go into that topic, Skype for Business. We've seen a lot of indications that there's strong potential for that product. I was with an IT team recently talking about the potential for that to cause their Microsoft spending to uplift in future years. Could you walk us through that, because I think we're all trying to understand whether you're poised to trump the communications market with Skype for Business?
DAVE O'HARA: So voice is complicated, as anybody who runs voice infrastructure knows. I think even with the cloud and on-prem, the question we get is do you think the world is going to flip to cloud? It's not going to flip. It's all about a transition, and it's all about an orderly transition. Voice is probably that plus some. It's unlikely that companies are going to go in and just throw out their PBX and move over to us, but they might do it sort of an organization at a time, or they might literally say, hey, we're bringing a new building online, and so we'll go use your voice solution for that building. But people don't want to lose their communication capability. And so they're very thoughtful about how and when and why they do that.
And so I do think that over time it's a great opportunity for us. I just think that in that way voice is similar a little bit to sort of an ERP or CRM app, which is you don't just throw it out and start over on day one. You've got to build toward it. And we see that as a good long-term build opportunity for us.
MARK MURPHY: They're not a quick boom but a solid, long-term.
DAVE O'HARA: Solid, long-term, multi-billion dollar market.
MARK MURPHY: Okay. Why don't we -- we have just a few moments left, why don't we check for questions from the audience. If you would raise your hand if you have a question and we have a microphone right here in the center aisle.
We have one right here.
QUESTION: Thanks. Can you talk about recent growth in the SQL Server business and competitive dynamics in that business?
DAVE O'HARA: Sure. I missed the first word, what type of growth, what was your descriptor?
QUESTION: Just recent historical growth.
DAVE O'HARA: Recent growth, okay, thank you. So I do feel, so if you define SQL as strictly licensed database, I look at that as sort of being sort of upper single-digit growth, and we feel good about Mark's earlier point about where we're positioned in the market. We feel good about SQL. We feel good about how we're positioned relative to competitors. And so I think there's an opportunity for us to go take some share from existing competitors.
I think the market overall will grow. The analysts have called it sort of in the mid single digits, maybe a little stronger than that. We would certainly expect to get our share. And so we will see growth with the market in terms of license database. I also think with SQL Azure that will grow along with the size of that market as well.
So when we look at SQL, we really look at SQL across cloud and on prem. But from an on-prem perspective, we certainly expect we will pick up some share along the way from an on-prem perspective.
QUESTION: Can you provide your thoughts on key success factors for sustained competitive advantage in services?
DAVE O'HARA: Sustained competitive advantage in services, I think you need to have the infrastructure to support the services, which is why we're having the big cloud build-out. You need to have services that are easy to set up, easy to digest, and easy to use. To state the other obvious point, you need to have services that people want. And then I think from a Microsoft perspective in terms of how you think about competitive differentiation, we are from an enterprise perspective we're in all of those accounts, we have trusted relationships, that's expensive to build, it takes a long time, hard to replicate.
And so you've got to have all that. I think you've got to have the right services, you have to have the right go to market strategy, you have to have the relationship with customers, and you have to have the infrastructure.
QUESTION: Sorry, try another one. On the transaction slowdown how much of that is self-inflicted versus other?
DAVE O'HARA: You know it's hard to parse. I mean we get as much precision as we can, but we go in and say, okay, how much of this is due to shift from non-annuity to annuity and we have an estimate of how much that is. We say how much is due to things like geo-specific issues. We have an estimate of how much that is. I would say that from a ‑‑ if you say transactional slowdown, I would also put it in context, which is sort of our transactional slowdown, was around $100 million in a $12 billion business. So we don't see it as ‑‑ it's not Armageddon by any stretch. So we would say some of that is shift, some of that is geo-weakness, some of it is probably just a little bit of an unknown. And we try to build all of that into how we view the future.
MARK MURPHY: Okay. With that we are out of time.
Dave, thank you very kindly for joining us, great to have you here.
(Applause.)
DAVE O'HARA: Sure, thanks, Mark.
END
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