Microsoft Fiscal Year 2019 Third Quarter Earnings Conference Call
Good afternoon and thank you for joining us today. On the
call with me are Satya Nadella, chief executive officer, Amy Hood, chief
financial officer, Frank Brod, chief accounting officer, and Keith Dolliver,
deputy general counsel.
On the Microsoft Investor Relations website, you can find
our earnings press release and financial summary slide deck, which is intended
to supplement our prepared remarks during today’s call and provides the
reconciliation of differences between GAAP and non-GAAP financial measures.
Unless otherwise specified, we will refer to non-GAAP
metrics on the call. The non-GAAP financial measures provided should not be
considered as a substitute for, or superior to, the measures of financial
performance prepared in accordance with GAAP. They are included as additional
clarifying items to aid investors in further understanding the company’s
third-quarter performance in addition to the impact that these items and events
had on the financial results.
All growth comparisons we make on the call today relate to
the corresponding period of last year unless otherwise noted. We will also
provide growth rates in constant currency, when available, as a framework for
assessing how our underlying businesses performed, excluding the effect of foreign
currency rate fluctuations. Where growth rates are the same in constant
currency, we will refer to the growth rate only.
We will post our 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 in any future use
of the recording. You can replay the call and view the transcript on the
Microsoft Investor Relations website.
During this call, we will be making forward-looking
statements which 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, Forms 10-Q, and other reports and filings with the Securities and
Exchange Commission. We do not undertake any duty to update any forward-looking
It was another strong quarter with
double-digit topline and bottom-line growth – the result of picking the right
secular trends, accelerating innovation, and maintaining a relentless focus on
our customers’ success.
Our trusted, extensible cloud platform –
spanning application infrastructure, data & AI, productivity &
collaboration, as well as business applications – enables every organization to
create their own intelligent systems and experiences to compete and grow.
Now I’ll briefly highlight key areas of
innovation and growth across our business.
Microsoft 365 empowers everyone – from the
largest multinationals to small businesses; from knowledge workers to firstline
workers – with an integrated, secure, compliant experience on any device. It is
the ONLY comprehensive productivity, collaboration and communications solution
that integrates with an organization’s business process workflows.
Microsoft Teams brings together everything a
team needs – messaging, video conferencing, meetings and collaboration – into a
single, integrated user experience scaffolding, eliminating the need for
discreet apps that only increase an organization’s security and compliance
exposure. 91 of the Fortune 100 use Teams, and more than 150 organizations have
over 10,000 active users.
And we are expanding Teams to new industries
like healthcare, with priority notifications for patient care and the ability
to securely access patient records.
Cybersecurity is a central challenge, and
Microsoft is the clear leader in cloud security with our unparalleled
operational security posture, and our growing portfolio of security and
compliance solutions – spanning identity, device endpoints, email, information,
cloud applications as well as infrastructure.
In financial services, National Bank of
Canada, BNP Paribas, and Refinitiv – a joint-venture between Thomson Reuters
and Blackrock – all chose Microsoft 365 for our advanced security and
We expanded Microsoft Threat Protection to
include the Mac and manage vulnerabilities in third-party applications –
providing the best defense for customers’ heterogenous environments. And we
introduced two, first-of-their-kind services: Azure Sentinel analyzes security
signals at massive scale across an entire organization, using AI to detect,
investigate and respond rapidly to threats. Microsoft Threat Experts is a new
‘cyberthreat hunting’ service that provides access to our security experts on
All this innovation is driving growth: Office
365 commercial now has 180 million users. Our EMS install base reached 100
million. And the Outlook apps on iOS and Android surpassed more than 100
million users for the first time this quarter.
We expanded our Surface family of devices with
the Surface Hub 2S, which brings together Teams, Windows, and our category
creating Surface hardware to power teamwork for organizations like Volvo,
Domino’s Pizza, Northwestern University and Nasa Jet Propulsion Labs.
Finally, Windows 10 is now active on more than
800 million devices and continues to gain traction in the enterprise as the
most secure and productive operating system.
Today, traditional systems of record and
engagement are often siloed, limiting the value of an organization’s most
important asset – its data. Dynamics 365 solves this challenge – connecting all
their systems and creating digital feedback loops – enabling any organization
to become a true, AI-first company.
The Open Data Initiative we announced last
year with Adobe and SAP delivers on this promise, and is already enabling
customers like Unilever to unify their business data across all their
line-of-business applications to unlock new AI-driven insights.
Personalization is increasingly key to every
organization’s marketing strategy – enabling them to effectively engage
customers, tailor their experiences and increase return on investment. Tivoli,
is one of the world’s oldest amusement parks, is using AI in Dynamics 365 to
help personalize marketing campaigns and transform how their firstline workers
engage with guests, reducing churn and increasing customer loyalty.
And we are not stopping there. We are
leading in two emerging categories: robotic process automation and mixed
reality. Our Power Platform brings together robotic process automation with
self-service analytics and no code-low code app development.
Recent updates enable citizen developers to
build higher-quality PowerApps faster and easier… and, along with new
capabilities in Power BI empower customers like SNCF, France’s national
railway, to create a more data-centric culture.
Our new HoloLens 2 is the most advanced,
intelligent edge device available… and, in combination with Dynamics 365 and
new Azure mixed reality services – enables organizations like PACCAR and
Chevron to digitize physical spaces and interactions to empower their firstline
employees with the right information at the right time, in the context of their
business process work.
All this innovation is driving growth:
Revenue from our Power Platform grew triple digits year-over-year, and, for the
first time, more than 50 percent of our Dynamics revenue was driven by the
LinkedIn again exceeded expectations across
all lines of business – driven by record levels of engagement in the feed,
content shared across the platform, and messages sent this quarter.
Marketing Solutions was up 46 percent
year-over-year, and customers are relying on our new Pages experience and
audience targeting capabilities to connect with LinkedIn’s nearly 630 million
We saw record job postings again this quarter
and are making it easier for job seekers to find more relevant and higher
paying jobs – and get personalized salary insights.
We have the most comprehensive solution for
every organization to manage and engage their most important resource – their
talent. New tools in Glint empower managers to quickly analyze and action feedback
to have the greatest impact on team performance. And with our combination of
LinkedIn Talent Solutions, Talent Insights, LinkedIn Learning, and Glint – we
are helping employers access data driven insights to attract, retain and
develop the best talent in an increasingly competitive jobs marketplace.
And we’re accelerating our innovation. Azure
Stack extends our hybrid differentiation, enabling customers like Airbus
Defense and Space to build and run cloud applications at the edge. And now with
our new Azure Stack HCI, customers can build and run virtualized applications
on-premises in a consistent way.
Azure Data Box Edge is a powerful, new,
AI-enabled edge appliance that sits within a customer’s environment – in their
data center or on a factory floor – so they can use AI to reason over data at
More than 95 percent of the Fortune 500 run
their workloads on our cloud, including TD Bank. And AT&T chose Azure to
shape the future of 5G with computing on the edge.
We are building Azure as the world’s
computer, with more global datacenter regions – and now two in South Africa –
and more compliance certifications than any other cloud provider. And just last
week we announced two new Azure government regions to meet the stringent
requirements for maintaining the security and integrity of classified U.S.
Every organization needs an IoT strategy to
manage the 20 billion connected devices coming online by 2020. Our
comprehensive Azure IoT platform enables customers to build, manage and secure
their connected devices, and our recently announced acquisition of Express
Logic furthers our goal, bringing our cloud to more than 6 billion MCU-powered
BMW Group is partnering with us to speed the
adoption of industrial IoT, both in automotive and more broadly in
manufacturing, and Renault-Nissan-Mitsubishi Alliance and Volkswagen both chose
Azure to fuel their new connected car experiences.
Data and analytics is the foundation for
building an organization’s AI capability, and we are investing to make Azure
the best cloud for data estates – from data warehousing to real-time stream
analytics. Daimler chose Azure as its new platform for big data and advanced
analytics, and third-party analysts affirm our price-performance lead in this fast-growing
And we are investing to make Azure the best
place to build AI. This quarter we introduced new Azure Cognitive Services for
fraud detection and image identification. Telefonica is using our Azure AI
services to create new intelligent experiences for their customers around the
world and transform customer engagement.
Developers will play an increasingly vital
role in value creation – and we are committed to giving them the tools they
need to be productive on any platform. GitHub surpassed 36 million registered
users, and free private repositories expand the opportunities for all
developers, with private repository creation more than doubling this quarter.
The new Visual Studio 2019 optimizes developer productivity and team
And I’m excited to share more about how we
are empowering developers at our Build conference in two weeks.
Now to gaming.
We are investing in content, community and
cloud to capture our massive opportunity in gaming, delivering record user
engagement again this quarter.
Microsoft Game Stack brings together our
tools and services to empower game developers – from independent creators to
the biggest game studios – to build, operate and scale cloud-first games across
mobile, PC and console. Our Xbox Live community – now 63 million strong – is
key to our approach and we are enabling developers to reach these highly
engaged gamers on iOS and Android for the first time.
Our fast-growing gaming subscription
service, Game Pass, is expanding our reach, bolstered by our growing
pipeline of first-party content. And Project xCloud, our new game streaming
service, will be in public trials later this year.
closing, I’m energized by our progress – and incredibly optimistic about our
all our businesses, we are delivering differentiated value for customers and
creating new categories of growth that position us well for the future.
that, now I’ll hand it over to Amy who will cover our financial results in
detail and share our outlook.
I look forward to rejoining for your questions.
you, Satya, and good afternoon everyone.
quarter, revenue was $30.6 billion, up 14% and 16% in constant currency. Gross
margin dollars increased 16% and 18% in constant currency. Operating income
increased 25% and 27% in constant currency. And earnings per share was $1.14,
increasing 20% and 22% in constant currency.
sales teams and partners delivered strong results across each of our segments,
once again resulting in double-digit top and bottom line growth. From a
geographic perspective, most markets performed in line with our expectations,
however, results in Japan were much stronger than we anticipated.
our commercial business, cloud services strength drove our annuity mix to 90%,
up 1 point year over year. Commercial unearned revenue was better than expected
at $25.1 billion, up 19% and 20% in constant currency. Commercial bookings growth
was strong, increasing 30% and 34% in constant currency. Bookings growth was
driven by healthy renewals on an expiration base that was over 20% larger than
a year ago as well as an increase in the number of larger, long-term Azure
contracts. As a reminder, an increased mix of these larger, long-term Azure
contracts with low upfront billings will drive more volatility in our
commercial bookings and unearned revenue growth.
Cloud revenue was $9.6 billion, growing 41% and 43% in constant currency,
highlighted by healthy growth in the US, Western Europe, the UK, and Germany.
Commercial cloud gross margin percentage increased 5 points year over year to
63% driven again by significant improvement in Azure gross margin.
gross margin percentage was 67%, ahead of our expectations, and up year over
year primarily from an increase in margin in our More Personal Computing
segment due to sales mix shift.
reduced revenue growth by 2 points and COGS growth by 1 point in line with
reduced operating expenses growth by 1 point, less than anticipated. Even with
this headwind, operating expenses grew in line with expectations, increasing 9%
and 10% in constant currency.
revenue growth, improving gross margins, and disciplined investment in
strategic and high growth areas resulted in operating margin expansion.
to segment results.
from Productivity and Business Processes was $10.2 billion, increasing 14% and
15% in constant currency, ahead of expectations driven by performance in Japan
commercial revenue grew 12% and 14% in constant currency. Office 365 commercial
revenue grew 30% and 31% in constant currency driven by installed base
expansion across all workloads and customer segments, as well as ARPU growth
from our customers’ continued shift to our E3 and E5 offerings. Office 365
commercial seats grew 27% and benefited from the strong performance of our
Microsoft 365 academic offers. Office consumer revenue grew 8% and 10% in
constant currency, ahead of our expectations, with 4 points of growth from
transactional sales in Japan. Office 365 consumer subscribers grew to 34.2
Dynamics business grew 13% and 15% in constant currency, driven by Dynamics 365
revenue growth of 43% and 44% in constant currency. We saw continued progress
in our Finance and Operations offering, with strong growth in customer billings
revenue increased 27% and 29% in constant currency with continued strength
across all businesses. LinkedIn sessions increased 24% as engagement once again
reached record levels.
gross margin dollars increased 15% and 17% in constant currency and gross
margin percentage increased 1 point year over year as improvements in LinkedIn
and Office 365 margins more than offset increased cloud mix.
expenses increased 4% and 6% in constant currency driven by continued
investment in LinkedIn and cloud engineering. Operating income increased 28%
and 30% in constant currency.
the Intelligent Cloud segment. Revenue was $9.7
billion, increasing 22% and 24% in constant currency, ahead of expectations
driven by continued customer demand for our differentiated hybrid offerings.
Server products and cloud services revenue increased 27% and 29% in constant
currency. Azure revenue grew 73% and 75% in constant currency, driven by strong
growth in our consumption-based business across all customer segments,
partially offset by tempering growth in our per-user business. Our enterprise
mobility installed base grew 53 percent to over 100 million seats. And our
on-premises server business grew 7% and 9% in constant currency, driven by the
continued strength of our hybrid solutions, premium offerings, and GitHub, as
well as increased transactional demand ahead of end of support for Windows
Server and SQL Server 2008.
Services revenue increased 4% and 5% in constant currency, driven by growth in
Premier Support Services.
gross margin dollars increased 21% and 23% in constant currency. Gross margin
percentage decreased slightly as the growing mix of Azure IaaS and PaaS revenue
was partially offset by another quarter of material improvement in Azure gross
expenses increased 22% and 23% in constant currency, driven by continued
investment in cloud and AI engineering, GitHub, and commercial sales capacity.
Operating income increased 21% and 23% in constant currency.
to the More Personal Computing segment. Revenue was $10.7 billion, increasing 8%
and 9% in constant currency as better than expected performance in Windows was
partially offset by lower than expected Gaming revenue.
Windows, the overall PC market was stronger than we anticipated driven by
improved chip supply that met both unfulfilled Q2 commercial and premium
consumer demand as well as better than expected Q3 commercial demand.
Therefore, OEM Pro revenue grew 15% and OEM Non-Pro revenue declined 1%.
levels were within the normal range.
commercial products and cloud services revenue grew 18% and 20% in constant
currency, with continued double-digit billings growth and a higher mix of
in-quarter recognition from multi-year agreements. Windows 10 deployments
across new and existing devices remained healthy.
Gaming, revenue grew 5% and 7% in constant currency, below expectations, driven
by lower than expected monetization across third party titles and console
sales. Xbox software and services revenue grew 12% and 15% in constant
currency, with continued momentum in Xbox Live and Game Pass subscriber growth.
revenue grew 21% and 25% in constant currency, driven by continued strength
across our consumer and commercial segments, particularly in Japan.
gross margin dollars increased 13% and 15% in constant currency and gross
margin percentage increased 2 points due to sales mix shift to higher margin
products in Windows and Gaming.
expenses increased 1% and 2% in constant currency and operating income
increased 25% and 28% in constant currency.
back to total company results.
expenditures including finance leases were down sequentially to $3.4 billion,
and lower than initially planned, primarily due to normal quarterly spend
variability in the timing of cloud infrastructure buildout. Cash paid for
property, plant, and equipment was $2.6 billion.
flow from operations increased 11% year over year driven by strong cloud
billings and collections. Free cash flow was $11 billion and increased 19% year
over year, reflecting the timing of lower cash payments for property, plant,
income was $145 million, driven by interest income and net gains on derivatives
and investments, offset partially by debt and finance lease expense.
effective tax rate came in lower than anticipated at 16%.
finally, we returned $7.4 billion to shareholders through share repurchases and
dividends, an increase of 17%.
let’s move to next quarter’s outlook.
on FX. Assuming the current rates remain stable, we expect FX to decrease
revenue growth by approximately 2 points and COGS and operating expenses growth
by approximately 1 point. Within the segments, we anticipate about 2 points of
negative FX impact on revenue growth in Productivity and Business Processes and
Intelligent Cloud, and 1 point in More Personal Computing.
we again expect customer demand and solid execution to drive continued strong
performance across our commercial business in our largest quarter of the
year.The expiry base will grow in Q4,
but at a more moderated rate than in Q3 and we expect commercial unearned revenue
to increase 36% to 37% sequentially.
cloud gross margin percentage should continue to improve year over year as
material improvement in Azure gross margin will be partially offset by the
continued mix of revenue towards Azure IaaS and PaaS services.
capex, our full year outlook remains unchanged. Therefore, we expect a
sequential dollar increase in capital expenditures in Q4 as we continue to
invest to meet growing customer demand.
to segment guidance.
Productivity and Business Processes, we expect revenue between $10.55 and $10.75
billion. The Office commercial revenue growth rate will be slightly down
sequentially as is normal for Q4 due to the high mix of cloud billings during
this quarter. As a reminder, under ASC 606, a higher mix of cloud billings is
reflected in more unearned revenue and less in-period revenue recognition.
Dynamics should see another quarter of double-digit revenue growth driven by
Dynamics 365. LinkedIn revenue growth should be in the low 20’s against a high
prior year comparable.
Intelligent Cloud, we expect revenue between $10.85 and $11.05 billion. In
Azure, we expect continued strong growth in our consumption-based business and
moderating growth in our per-user business given the increasing size of the
installed base. In our on-premises server business, demand for our hybrid
solutions and premium offerings should remain strong, and we expect continued
benefit from the upcoming end of support for Windows Server and SQL Server
2008, though as a reminder, the prior year comparable will impact the year over
year growth rate.
More Personal Computing, we expect revenue between $10.8 and $11.1 billion. In
Windows, overall OEM growth rates should normalize, with revenue growth roughly
in line with the PC market.
Surface, we expect low double-digit growth, with continued momentum across our
commercial and consumer segments.
Search ex-Tac, we expect revenue growth similar to Q3.
in Gaming, we expect revenue to decline year over year, driven by the tough
comparable in Xbox software and services and the continuation of the hardware
trends from Q3.
back to overall company guidance.
expect COGS of $10.65 to $10.85 billion and operating expenses of $10.7 to $10.8
Income and expense should be approximately $50 million as interest income is
partially offset by interest and finance lease expense.
finally, we expect our effective tax rate in Q4 to be approximately 17%, with
some potential volatility given it is the final quarter of our fiscal year.
I’d like to provide some closing thoughts as we look forward to FY20.
we feel very good about the progress we’ve made thus far in FY19. Our decision
to invest with significant ambition in high growth areas coupled with strong
execution has resulted in material revenue growth at scale and a stronger
position in many key markets. As FY20 approaches, we again see tremendous
opportunity to drive sustained long-term growth. We will invest aggressively in
strategic areas like Cloud thru AI and Github, Business Applications thru Power
Platform and LinkedIn, Microsoft 365 thru Teams, Security, and Surface as well
as Gaming. At the same time, we will continue to drive improvement and
efficiency as our business scales. This consistent approach of investing in
future growth while delivering strong operating performance will result in
double digit revenue and operating income growth in FY20 with stable operating
that, Mike, let’s go to Q&A.
MICHAEL SPENCER:Thanks, Amy.
We’ll now move over to Q&A.Operator, can you please repeat your
Goldman Sachs: Great, thank you so
much for taking the question today.Amy,
if I go back and look through your KPIs, it looks like the year-over-year
growth in commercial bookings has never been this high on a constant currency
basis.At least I was able to go back
through fiscal ’13.You mention an
increase in the number of larger, long-term Azure contracts, which obviously is
a driver of this. But, is there any more color you could share?Is this coming from a handful of customers?
I mean, that are just driving all of their -- like
outsourcing everything to you guys and shutting down their data centers, or do
you see this as kind of a broad-based trend, even in some of the industries
that have been slow to move to the cloud, where this is really starting to
And then, the follow-up would be just Azure gross margins,
where you guys have done a remarkable job just continuing to increase efficiency
there.How much room is left to go and
how do you think about the percentage of COGS in Azure that are variable versus
fixed and has the ratio been changing?
AMY HOOD:Great, Heather.Let me try to take both of those
On your commercial bookings growth question, I find it
easiest to think about commercial bookings, before I answer the larger question
about one time, in two ways.The first
is the expiration base absolutely does matter and that’s how we talked about
it.And we had an actually very good
quarter here in terms of renewals and what I think of as revenue recapture
where we’re able to grow the revenue in existing contracts.And so that absolutely contributed and has
contributed over the past couple of years to what I do believe has been
reasonably consistent commercial bookings strength versus the expiration base.
The second component is what I would put in the bucket of
new business, whether that new business comes as what you saw this this quarter
two ways.There was some on prem
strength this quarter.It does show up
in booking.It doesn’t show up in
unearned and it does show up in the P&L.We had a good quarter there.And
we did have some large Azure contracts which tend to be longer dated and tend
to have low billings up-front.That
means it shows up in bookings and, again, not in the unearned balance in the
And so you will see as we go forward, and you’re already
starting to see it, more volatility in this number, not just based on the way
we’ve traditionally talked about it, which is the movement of the expiration
base, but also in some of these larger, longer term commitments by what we now
think of, not just as customers, but these are really now partnership
relationships that we have where, to your point, we’re co-collaborating to help
customers be successful as they build their digital future.And so you will see a little bit of
volatility in this number as those contracts and those types of contracts start
On your second question of Azure GM, we have continued to
see strong improvement in the core gross margin of Azure.The team has done a nice job on a number of
fronts, continue to make progress on both software innovation, but also
importantly hardware innovation and working with our supply chain to continue
to have and see benefits on that side.It also is increasing use of premium services also contributed to Azure
gross margin improvement.
So while we remain focused on efficiency and the utilization
of the hardware and software, it’s also important to continue to see premium
up-sell, premium workload usage, so the customers are getting the most out of
their deployments and usage of the Azure platform.
In general, it hasn’t changed a ton in terms of that final
component about fixed versus, I think, variable base.It’s still been in, I think, the low 40
percent as a range for us in terms of what’s depreciation versus what’s more
HEATHER BELLINI:Thank you.
MICHAEL SPENCER:Thanks, Heather.
We’ll move to the next question now, please.
KEITH WEISS, Morgan
Stanley:Excellent.Thank you, guys, and a very impressive
I’m going to take a similar question to Heather’s, but I’ll
use you, Satya, to try to get a higher-level answer.During this quarter it just sounds to me like
I’ve heard Amy talk more about exceeding expectations than we have in prior
quarters and exceeding plan more than we have in prior quarters.This matches up from what we’re hearing
actually from sort of talking to customers.It almost sounds like there’s an inflection point going on in the
adoption of cloud and visualization efforts.
The question to you is, are you guys seeing that?Are you starting to see an inflection point
in terms of these adoption trends and the investment that you guys have made
behind it really starting to take hold?
And then perhaps a follow-up for Amy, so operating margins
really exceeded our expectations this quarter and I think consistent with
expectations.Talk a little bit about
kind of what drove that and kind of why we wouldn’t see as much of that on a
go-forth basis in terms of operating margin expansion?
SATYA NADELLA:Yeah.Thanks, Keith, for the question.So, let me start.
I think overall what we are seeing is continued
momentum.If you think about even our
overall approach as being to have a view of an architecture that is grounded in
our customers’ needs.So, we always
believed that in distributed computing you’d need a cloud and an edge, you need
hybrid.And, guess what, today in 2019 hybrid
has become much more mainstream.But we
were talking about this even five years ago.
We also sort of said things that will matter in this
transition to the cloud will be consistency and productivity.So, for example, whether it’s developer
productivity or IT productivity, it’s not any one dimension.You need to bring IT and developers together
to drive agility in an organization and the digital capability building.This is, again, a place where we’ve had all
this traditional strength and that’s showing up in the marketplace.
And also, if you look at our cloud stack, we have
application and infrastructure, data and AI, productivity and collaboration as
well as business applications.That’s
pretty unique again.So that’s, I think
what is showing up at scale as a competitive differentiation and that’s what
you see in our numbers.But most
importantly, I think you’ll see it in the customer momentum and what I believe
is what is customer success.Digital
technology today is not about tech companies doing innovation, it’s about the
rest of the world doing innovation with technology.And Microsoft is uniquely in position to
AMY HOOD:And on your operating margin question, Keith,
there’s a couple of things I would say to that.In this quarter in particular the places where we had a lot of
outperformance were especially high margin areas.And I would point out three:The first is obviously the OEM and chip supply;
the improvement in that in Q3 is obviously very high margin and falls to the
bottom.Japan as a geography for us is a
high transactional market.And so, when
Japan is strong, it tends to be a very high margin landing down to the bottom
line.And the other one is the
on-premises server number, which is very good in terms of hybrid demand this
quarter also is high margins.So when
that happens, you do see, because it’s a lot of, almost 100 percent in-quarter
recognition, a lot of help at the operating margin line.
Now the more sustainable conversation I think we continue to
have on operating margin is our ability to pick the right secular markets and
the right secular trends, you see significant revenue growth.We continue to focus on improving the growth
margin of each individual product area, which creates leverage over time, and
finally focused investment in operating expense and that obviously creates
leverage.And I think you do see that in
general through the year as we continue to keep that formula.
KEITH WEISS:Excellent. That is super helpful. Thanks a lot, guys.It’s been a great quarter again.
MICHAEL SPENCER:Thanks, Keith.
We’ll take the next question now, please.
MARK MOERDLER, Bernstein Research:Thank you.And congratulations on the really strong
Amy, Satya, Amy, can you delve into the impact of Azure
Hybrid Benefit on Azure revenue, Server and Tools, renewals.I don’t think it’s really well
understood.Is it having impact on
Azure’s reported revenue growth because of the fact that some of this may
appear in Server and Tools?
And, Satya, can you give us some added color on why this
specific offering is resonating so well with customers, which is what we’re
SATYA NADELLA:Yeah, maybe I can start on the second part,
and then it leads to the first question.
I would say, Mark, the main thing that this offering enabled
is the flexibility with which customers can adopt hybrid computing.And as I’ve always said that hybrid computing
is important for workloads that are more in the characteristic of -- can be
characterized as lift, shift and modernize.So, that’s one motion.And then
there is new world hybrid as well, which is people are building, in fact
they’ll do an AI training job in the cloud but want to deploy the model close
to the edge.And in both of these cases
Hybrid Benefits actually help with -- our business model is basically
differentiated in supporting the architectural needs and the flexibility needs.
The one additional thing I’ll mention, which is increasingly
becoming clear to us, is operational sovereignty will become important.The world and its distributed computing needs
is not going to become some homogenous set of requirements, but it’s going to
be very heterogeneous, very in many cases regulated.And so what we provide in terms of both the
technology and the business model I think shows up with the maximum
AMY HOOD:And let me talk a little bit about the question
around server products and services and how to think about the hybrid use
benefit.In general today, Mark, almost
all of that benefit shows up in what I would say is the on-premise KPI.And so over time, though, how you should
think about that, it will eventually show up in Azure consumed revenue
growth.This is a benefit that’s
fundamentally about high-value and flexibility and meeting customers where they
are so that they can make the determination of when to make that choice.
And so it tends to be why I keep focusing people back on the
all-up KPI because it’s the best representation of really customer commitment
and usage of our architected from the beginning hybrid cloud.
But to your specific question, it shows up today in the
on-prem number is where you could see most of the strength of that value and
over time as it gets used and consumed, it will show up more in the Azure ACR
MARK MOERDLER:Perfect. Thank you, I appreciate it.
MICHAEL SPENCER:Thanks, Mark.
Operator, we’ll take the next question now, please.
KARL KEIRSTEAD, Deutsche Bank:Thanks.
Amy, I would like to ask you about the big revenue beat in
the Intelligent Cloud segment that drove much of the upside and in particular
the server product KPI that was just addressed, up 9 percent.I’m just wondering if you could frame how
material the contribution of the version 2008 upgrades were, and assuming that
that lift can continue throughout calendar 2019, could it be enough to keep
that on-prem KPI, as you described it, flat or even up slightly in the coming
two quarters despite the tougher comps?
AMY HOOD:Thanks, Karl.
When I think about the on-prem number, I really divide it
into things that have durable value and things I think of as more one-time.When I think about the durable trends that I
expect to see, it’s been the hybrid value prop that we really just talked about
on Mark’s last question, and then the premium mix.Those two we have seen and continue to see.
I do think we felt some benefit of end of support, but I
would not say it was the primary benefit this quarter.The primary benefit was the two things I just
talked about.End of support, obviously
we’ve got SQL in July and then Windows in January.And so I do think we saw some impact,
particularly in SQL, and I do expect we’ll see some of that in Q4.
But the Q4 comparable for on-prem is very big.And so even with some of that benefit of the
durable trends plus, I think, a more temporal one of end of support, I do
expect to see a deceleration in that number in Q4.
I wanted to turn to
the Office 365 Commercial business a bit, and that’s been a consistent, very
strong performer for you all and was again this quarter.But maybe just sort of two related questions
there.First, if I heard you right,
Satya, I think you said there’s 180 million users now on Office 365 Commercial,
which seems like you’re hitting a lot of the customers that you thought might
be there a couple of years ago.So, I
was just curious to get your view on how far along you are in that adoption
cycle and if there’s still a lot more opportunity in terms of seat expansion in
the upcoming year?
And then, related,
you know, Amy, you mentioned E3 and E5 were both pretty big contributors on the
ASP front in the quarter.Are we
starting to see a shift in where E5 is sort of increasing in relevance and E3
is played out a bit, or is it sort of equally balanced?I’m just curious to get sort of the mix in
there as well.
SATYA NADELLA:Sure.In terms of overall reach of Office 365, you
know, we continue to see significant opportunity going forward on multiple
dimensions.So, for example, we never
participated as much in I’ll call it non-developed market medium and small
businesses with all of the sophisticated workloads.So, now with a SaaS approach you can reach a
much broader base of business customers all over the world is one opportunity.
opportunity is, if you look at Teams as an example, we are now reaching a lot
of first-line workers, so this is whether it’s in healthcare, whether it’s in
manufacturing, whether it’s in retail, just not knowledge workers, but where
you now have messaging solutions as well as business process workloads
So, it’s that
combination of things where we’re going from knowledge workers to first-line,
and the ability to reach all sizes of businesses is what’s going to continue to
help us, I think, have overall seat growth or socket growth.
And then, of course,
there is the other dimension, which is the levels of Office 365 all the way to
E5 with significant value.And the one
thing I’d mention is, having compliance, security, that spans all of these
tools is also proving out to be a very big architectural advantage and a
customer value proposition, because I think as customers look to use more SaaS
applications, they don’t want an exponential increase in their security
exposure or more compliance burden.And
so, therefore, Office 365’s approach resonates even there.
AMY HOOD:And, Jen, maybe a
little to your question, which is fundamentally about seat growth and RPU as
the drivers of that all-up Office 365 Commercial growth number.This quarter and a little bit last, I
actually think some of the RPU increase has been matched by some of the trends
in seat growth.What I mean by that is,
that 27 percent seat growth is starting to include some lower RPU seats that
Satya just mentioned, whether that’s in academic, in Edu, in frontline workers,
and that’s really important for us to keep having that seat growth even if it’s
not at the same RPU level, those are not seats that we ever could reach before
at any level and that’s absolutely new opportunity for us.But it does kind of mask a little some of the
RPU improvement that we’ve seen.It’s
still E3 and E5.There’s opportunity on
both, although we are starting to see the impact of E5 in that RPU number.
Satya, we’ve seen many indications of Azure winning a
greater share of enterprise workloads recently. Do you think that you have found the right
formula now for Azure to win the majority of workloads in the enterprise IT
And then, Amy, just given the trajectory and the long-term
commitments that you mentioned there, do you see a path for Azure to surpass
Office 365 Commercial and thus become the largest revenue stream for Microsoft,
I’ll say in the next couple of few years?
SATYA NADELLA:Sure. I’ll start, Mark.
Having grown up essentially in our infrastructure business
at Microsoft, I would say that compared to even the previous era where we did
well, in the client-server era, in the face of tough competition and in this
era, again in the face of a different set of competitors, we are doing
well.And we’re doing well, much better
than we did in the previous era, because we are seeing these tier one workloads,
which we never saw in the past.
If you think about it, in the client-server era, we never
participated in the core of the digital infrastructure of financial services or
in healthcare or in retail or in manufacturing.And absolutely when we think about the digital transformational design
wins, deployment, consumption, it’s kind of like what we would have done with
some ISVs of the past.How we worked,
perhaps, with SAP in the ’90s when we were coming out with SQL Server and they
were coming out with R3 is what we’re now doing with many, many, many
businesses as they build out their digital businesses.So that’s sort of perhaps characterizes for
you what’s new in terms of Microsoft’s own growth in this space.
AMY HOOD:And the way that would show up, Mark, is a
little bit I think where you were leading with the question you asked, which is
when we think about the Microsoft Commercial Cloud at $9.6 billion and growing
over 40 percent, how do you see that evolving?And really the question is, we have quite a bit of per seat or per user
type businesses, but what Satya just talked about is really about the Azure
concept of participating both in an expansionary total addressable market,
which I think people have talked about for a long time, but what was different
about what Satya just said is our ability frankly to have higher share in the
next era than we had in the last era.
And so if you look about then our ability to grow and will
Azure be larger over any period of time than our per seat or per user
businesses, it certainly could be but I don’t want that to really diminish the
fact that there’s a lot of room for us in our per seat businesses, particularly
in business applications across LinkedIn, the Power Platform work we’re
doing.Satya mentioned security,
identity, compliance, there is a lot of room for us to continue to add value
and growth in that area as well.
We continue to see this really nice progression in the
Commercial Cloud gross margin and you called out the Azure gross margin
improvements.And within that there’s
some moving pieces.I think you got
better utilization and efficiency of core Azure.You’ve got premium services.And then you’ve got this maybe
counter-prevailing force of the different growth in consumption versus user
Two questions on this, one for Satya.On the premium services, I’m just curious as
to which one or two or three are you seeing maybe breakout and become the
largest or growth the fastest?Which are
most meaningful at this point?
And then, second, for Amy, as we think about this trend are
you convinced that we’ll continue to see not just for fiscal Q4 but into fiscal
’20 and beyond consistent progression and growth in the overall Commercial
Cloud gross margin?
SATYA NADELLA:Sure.I mean on the first question, Ross, as far as premium services, just
even on the application infrastructure side, for example, in compute there is
increasing need for things like IoT services.Essentially there is a new business application like set of services
that are getting developed to help people manage their complex IoT application
development.IoT Central is a good
example of that.When you have many,
many connected devices, you need a control plane for many of those devices so
that you can tame the complexity of your app deployment, security
management.That’s one example.
The other one is, of course, data.And, the sophistication of the data estate is
growing exponentially both in terms of the needs of the databases required, the
processing that is required close to data.So that’s another place where something like Cosmos DB, which is very
unique in its capability in the marketplace, is definitely another service
that’s got real traction.
Even data warehousing, the scale at which -- this is another
market which we never participated in in the past, whereas now we have one of
the most competitive products when it comes to benchmarking around data
So those are all things that I would say are premium
services that just talking about new applications being built on Azure, not
counting all of the SaaS applications above that.
AMY HOOD:And to your overall Commercial Cloud gross
margin question, you’re right, the fundamental driver is when I look forward
into next year I expect each service, just like it did this year, to really see
gross margin improvement, whether that service is LinkedIn or Dynamics or
Office 365, Azure per user, or Azure IaaS and PaaS.But what you’ll see is a revenue mix shift,
right, that will offset that to Azure IaaS and PaaS.
So what that generally will do will be a headwind to
continued gross amount of the improvement even though you’ll see individual
improvement across all of the GM services, and you’ll continue to see Azure
increase as a percentage of the total revenue.
I want to follow-up on Karl’s question, but more generally
on database products.With the end of
support coming for SQL Server 2008 in July, Satya, can you tell us how that’s
sparking conversations with customers about database offerings on Azure and
moving workloads to the cloud?
And, Amy, can you perhaps help us contextualize the
opportunity to move traditional database workloads onto Azure and what the
expansion economics look like?
SATYA NADELLA:Yeah, a couple of things, Brad.One is overall the need to get on the latest
and greatest database technology just because of what is the increasing need
for compute and data at the edge is what’s driving a lot of the conversation on
SQL Server.Interestingly enough, we
have a lot of requirements around edge devices so that you can have databases
with compute, so that you can really have what is needed at the edge.That’s sort of one conversation.
The other one is, in terms of the cloud migration there is a
variety of different use cases.We see
people who are using SQL DB, which is essentially a PaaS service with complete
compatibility of SQL Server.They want
managed services around SQL Server, which we have.And so both of those are all happening in
A good example of this is, in fact, even the rewrite of --
complete revamp, I would say of Dynamics.Dynamics 365 and its architecture at least in my eyes is a thing of
beauty, because it’s completely been rewritten for the new database technology,
whether it is on the database side or on the data warehouse side, again uses a
whole bunch of micro-services and functions, so that you can do AI close to
That type of architectural approach is what we see is
possible now for every SaaS application vendor out there, as well, because if
you think about the number of business applications that were based on SQL
Server, I feel that that’s an architecture that can support both what they want
to do on the edge, but as well as in the cloud.
AMY HOOD:And on the contextualizing opportunity, the
reason I said it’s not the primary driver is because the vast, vast majority of
our server business is annuity based.And so when it’s annuity based there’s really no opportunity to see it
as upside in Q4 from an end of support frame.For the smaller portion of our business that’s still non-annuity, pure
transactional it does provide, as I talked about earlier, some
opportunity.But, it’s not that
large.The nature of the commitment our
customers now is far more of the annuity type.
BRAD ZELNICK, Credit Suisse:Great, thank you.
MICHAEL SPENCER:Thanks, Brad.
Operator, we’ll take our last question now, please.
RAIMO LENSCHOW, Barclays:Hey, thanks for
squeezing me in.Can you talk a bit on
the Windows OEM side you mentioned that the chip situation is kind of easing a
little bit?Are we kind of fully done
there, in terms of what you see there from the Intel side and did that create
some pent-up demand for the coming quarter that people are thinking about
moving over to Windows 10 with the end of life coming up?Thank you.
AMY HOOD:Thanks, Raimo.I think we
actually in Q3, as I said, met sort of the unfulfilled Q2 demand and Q3.So I don’t think of it as a pent-up situation
heading into Q4 and our guidance certainly does not indicate that that is what
we believe will happen.
What I would
say is I think we feel good about the supply in the commercial segment in the
premium consumer segment, which is where the vast majority of our revenue is in
OEMs.And so I think in those segments
we feel fine for Q4.
RAIMO LENSCHOW:Perfect.I’ll leave it at that.Thank you.Well done.
MICHAEL SPENCER:Thanks, Raimo.
That wraps up
the Q&A portion of today’s earnings call.Thank you for joining us today and we look forward to speaking with all
of you soon.