Microsoft Fiscal Year 2016 Fourth Quarter Earnings Conference Call
Microsoft Earnings Conference Call
Satya Nadella, CEO and Amy Hood, CFO
Tuesday, July 19, 2016
Chris Suh, General Manager, Investor Relations:
Good afternoon, and thank you for joining us today. On the call with me today are Satya Nadella, chief executive
officer, Amy Hood, chief financial officer, Frank Brod, chief accounting officer, and John Seethoff, deputy general
counsel and corporate secretary.
On our website, Microsoft.com/investor, 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 fourth-quarter performance in addition to the impact that these items and events had on the financial
Additionally, any mention of operating expense refers to segment operating expenses as defined in the footnotes of
our Form 10-Q, which includes research & development, sales & marketing, and general & administrative,
but excludes the impact of integration & restructuring charges.
As a reminder, in May, we announced plans to further streamline the phone hardware business. During the fourth quarter,
restructuring and related impairment expenses were $1.1 billion.
All growth comparisons we make on the call today relate to the corresponding period of last year unless otherwise
noted. We 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. At the segment level, we provide
constant currency growth for both revenue and gross margin. However, due to the recent change to our segment reporting
groupings, we are not able to provide segment level constant currency operating expense growth, and consequently
cannot derive constant currency segment operating income either. We do provide constant currency operating expense
and operating income growth at the company-wide level.
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 until July 19th, 2017.
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 statement.
And with that, I’ll turn the call over to Satya.
Satya Nadella, CEO, Microsoft:
Thank you, Chris, and to everyone on the call for joining.
I also want to thank every Microsoft team member and partner who contributed to a successful year. We’re proud of
what we achieved and particularly how we are positioned for new growth.
Today, Amy and I will share fourth quarter results, and our perspective on the year ahead.
We delivered $22.6 billion in revenue this quarter, an increase of 5 percent for the quarter in constant currency.
This past year was a pivotal one in both our transformation and in our partnerships with customers who are also
driving their own digital transformation.
Our progress is best captured in the results of our three ambitions starting with productivity and business process.
In a world of infinite information but finite attention and time, we aim to change the nature of work with digital
technology. In pursuit of this ambition, we continue to add value to our products, grow usage, and increase our
addressable market. Along these lines, let me start with Office 365 and then move to Dynamics 365.
In the last quarter we advanced our collaboration tools. We launched Microsoft Planner, which helps teams manage
operations as well as Skype Meetings, which is aimed at helping small businesses collaborate. In June, we further
strengthened our security value proposition with the release of Advanced Security Management. Lastly, we continued
to add intelligence and machine learning to Office to help people automate their tasks and glean insights from data.
These advancements helped to drive increased usage across enterprises, small and medium businesses, and consumers.
In the enterprise Office 365 commercial seats grew 45 percent year over year and revenue grew 59 percent in constant
currency. Also 70 percent of our Office enterprise agreement renewals are in the cloud. Innovative companies like
Facebook, Hershey, Discovery Communications, Cushman Wakefield, all adopted Office 365 and now see how transformative
this service can be for their own business.
We’re enthusiastic about the early feedback and growth opportunity from companies using our newly released Office
365 E5, which includes powerful security controls, advanced analytics, and cloud voice. These customers tell us
that they love the simplification that comes with standardizing across all of our productivity workloads. We see
momentum in small and medium businesses with a growing number of partners selling Office 365. Now after nearly 90,000,
a 25 percent increase year over year. We continue to grab share and adding over 50,000 customers each month for
28 consecutive months.
We also see momentum amongst consumers with now more than 23 million Office 365 subscribers. Across segments, customers
increasingly experienced the power of Office on their iOS and Android mobile devices. In fact, we now have more
than 50 million iOS and Android monthly active devices, up more than four times over last year.
Now let’s talk about progress with the other pillar of this ambition, Dynamics 365. We’re removing any impedance
that exists between productivity, collaboration and business process. This month we took a major step forward with
the introduction of Microsoft Dynamics 365 and Microsoft App Source.
Dynamics 365 provides business users with purpose-built SaaS applications. These applications have intelligence built-in,
they integrate deeply with communications and collaboration capabilities of Office 365.Dynamics 365, along with App Source and our rich application platform introduces a disruptive and customer-centric
business model so customers can build what they want and use just the capabilities they need.
The launch of Dynamics 365 builds on the momentum we’re already seeing in this business. Customers around the globe
are harnessing the power of Dynamics in their own transformation, including 24-hour Fitness and AccuWeather. Overall
Dynamics now has nearly 10 million monthly paid seats, up more than 20 percent year over year, and Q4 billings grew
more than 20 percent year over year.
Overall business processes represent an enormous addressable market projected to be more than $100 billion by 2020.
It’s a market we’re increasingly focused on, and I believe we’re poised with both Dynamics 365 and Microsoft App
Source to grow and drive opportunity for our partners.
Across Office 365 and Dynamics 365, developers increasingly see the opportunity to build innovative apps and experiences
with the Microsoft Graph. And we now have over 27,000 apps connected to it. Microsoft App Source will be a new way
for developers to offer their services and reach customers worldwide. Lastly, with Office 365 and Dynamics 365,
we have the opportunity to connect the world’s professional cloud and the world’s professional network with our
pending LinkedIn deal.
Overall the Microsoft cloud is winning significant customer support with more than $12 billion in commercial cloud
annualized revenue run rate, we’re on track to achieve our goal of $20 billion in Fiscal Year’18. Also, nearly 60
percent of the Fortune 500 companies have at least three of our cloud offerings. And we continue to grow our annuity
mix of our business. In fact, commercial annuity mix increased year over year to 83 percent.
Now let’s get into the specifics of the intelligent cloud, an area of massive opportunity as we are clearly one of
the two enterprise cloud leaders. Companies looking to digitally transform need a trusted cloud partner and turn
to Microsoft. As a result Azure revenue and usage again grew by more than 100 percent this quarter.
We see customers choose Microsoft for three reasons. They want a cloud provider that offers solutions that reflect
the realities of today’s world and their enterprise grade needs. They want higher level services to drive digital
transformation. And they want a cloud open to developers of all types.
Let me expand on each. To start a wide variety of customers turn to Azure, because of their specific real-world needs.
Multinationals choose us, because we are the only hybrid and hyper-scale cloud spanning multiple jurisdictions.
We cover more countries and regions than any other cloud provider, from North America to Asia, to Europe to Latin
America. Our cloud respects data sovereignty and makes it possible for an enterprise application to work across
these regions and jurisdictions.
More than 80 percent of the world’s largest banks are Azure customers, because of our leadership support for regulatory
requirements, advanced security and commitment to privacy. Large ISVs like SAP and Citrix, as well as startups like
Sprinkler, also choose Azure, because of our global reach and a broad set of platform services. Last week GE announced
it will adopt our cloud for its IoT approach.
Next, Azure customers also value our unique higher-level services. Now with 33,000 we nearly doubled in one year
the number of companies worldwide that have selected our enterprise mobility solutions. The Dow Chemical Company
leverages EMS along with Azure, Office 365 and Dynamics, to give its thousands of employees secure, real time access
to data and apps from anywhere.
Just yesterday we announced Boeing will use Azure IoT Suite and Cortana Intelligence to drive digital transformation
in commercial aviation, with connected airline systems optimization, predictive maintenance, and much more. This
builds on great momentum in IoT, including our work with Rolls-Royce, Schneider Electric and others. This is great
progress but our ambitions are set even higher.
Our intelligent cloud also enables cognitive services. Cortana Intelligence Suite offers machine learning capabilities
and advanced predictive analytics. Customers like Jabil Circuit, Fruit of the Loom, Land O’Lakes, Libare already
realize the benefits of these new capabilities.
Lastly, central to our intelligent cloud ambition is providing developer with the tools and capabilities they need
to build apps and services for the platforms and devices of their choice. The new Azure Container Service, as well
as .NET Core 1.0 for open source and our ongoing work with companies such as Red Hat, Docker, Mesosphere, reflects
significant progress on this front. We continue to see traction from open source with nearly a third of customer
virtual machines on Azure running Linux.
On the server side, premium server revenue grew double digits in constant currency year-over-year. New SQL Server
2016 helps us expand into new markets with built-in advanced analytics and unparalleled performance. More than 15,000
customers, including over 50 percent of the Fortune 500, have registered for the private preview of SQL Server for
Linux. And we’re not slowing down. We will launch Windows Server 2016 and System Server 2016 later this year.
Now let’s talk about the progress in more personal computing. We’ve increased Windows 10 monthly active devices and
are now at more than 350 million. This is the fastest adoption rate of any prior Windows release. While we are proud
of these results, given changes to our phone plan, we’ve changed how we will assess progress. Going forward we will
track progress by regularly reporting the growth of Windows 10 monthly active devices, in addition to progress on
three aspects of our Windows strategy.
First, deliver more value and innovation, particularly for enterprise customers. Second, grow new monetization through
services across a unified Windows platform. Third, innovate in new device categories in partnership with our OEMs.
Let me walk through each.
We continue to pursue our goal of moving people from needing Windows to choosing Windows to loving Windows. In two
weeks we will launch Windows 10 anniversary update, which takes a significant step forward in security. We’re also
extending Windows Hello to support apps and websites and delivering a range of new features like Windows Ink and
updates to Microsoft Edge.
We expect these advances will drive increased adoption of Windows 10, particularly in the enterprise in the coming
year. We already have strong traction with over 96 percent of our enterprise customers piloting Windows 10. Next,
as we grow our install base and engagement we generate more opportunity for Microsoft and our ecosystem.
Bing profitability continues to grow with greater than 40 percent of the search revenue in June from Windows 10 devices.
Bing PC query share in the United States approached 22 percent this quarter, not including volume from AOL and Yahoo!.
The Cortana search box has over 100 million monthly active users, with 8 billion questions asked to date.
We continue to drive growth in gaming by connecting fans on Xbox Live across Windows 10, iOS and Android.
Just this quarter we launched our Minecraft Realms subscription on Android and iOS. Overall engagement
on Xbox Live is at record levels, with more than 49 million monthly active users up 33 percent year-over-year. At
E3 we announced our biggest lineup of exclusive games ever for Xbox One and Windows 10 PCs. And we announced Xbox
play anywhere titles where gamers can buy a game once and play it on both their Windows 10 PC and Xbox One. We also
announced two new members of the Xbox One console family, the Xbox One S and Project Scorpio.
The Windows Store continues to grow with new Universal Windows Apps like Bank of America, Roku, Sirius FM, Instagram,
Facebook, Wine, Hulu and popular PC games like Quantum Break.
Finally we are innovating in new device categories in partnership with OEMs. Our hardware partners are embracing
the new personal computing vision with over 1,500 new devices designed to take advantage of Windows 10 innovations
like touch, pen, Hello and better performance and power efficiency.
Microsoft’s family of Surface devices continues to drive category growth and we are reaching more commercial customers
of all sizes with the support of our channel partners. We recently announced a new Surface Enterprise Initiative,
with IBM and Booz Allen Hamilton, to enable more customer segments. Also in the past year we grew our commercial
Surface partner channel from over 150 to over 10,000.
Lastly, this quarter more and more developers and enterprise customers got to experience two entirely new device
categories from Microsoft Surface Hub and Microsoft HoloLens. While we are still in the early days of both of these
devices, we are seeing great traction with both enterprise customers and developers making us optimistic about future
In closing I want to reflect on the opportunity ahead of us. Simply put, businesses will not just use digital technologies,
but they will become digital companies. This generates an enormous opportunity for Microsoft and our partners. We
are the ones who can empower digital transformation across all industries, companies and geographies with our technology
With that, I’ll hand it over to Amy to go through this quarter’s results in greater detail and share our outlook
and I look forward to rejoining you after that to answer questions.
Amy Hood, EVP & CFO, Microsoft:
Thank you Satya, and good afternoon everyone.
This quarter, revenue was $22.6 billion, up 2 percent and 5 percent in constant currency. Gross margin was flat but
up 4 percent in constant currency. Operating income this quarter declined by 3 percent, and grew 6 percent in constant
currency. And earnings per share was 69 cents, increasing 11 percent year over year or 27percent
in constant currency.
Across most markets, our execution and results were generally as expected with some strength in the US but we did
see additional softness in Brazil, the Middle East and Africa, which were impacted by macroeconomic headwinds.
From a seasonality perspective the fourth quarter is always an important one for our commercial business. Our results were
strong as our sales teams led with our cloud offers. Healthy renewals helped to drive double digit annuity performance
in constant currency. Our total annuity mix reached 83 percent, up 1 point year-over-year.
While our commercial cloud continued to drive a higher annuity mix overall, we also had better than expected transactional
revenue performance, as products like Office 2016 and SQL Server 2016 generated more deal volume.
The dollar volume of expiring enterprise agreements was smaller this quarter than last year. On that base, our commercial
bookings increased 4 percent in constant currency driven by customer preference for our cloud offers. Commercial
unearned revenue slightly beat our expectations at $24.6 billion or 8 percent growth in constant currency. Our contracted
not billed balance exceeded $25.5 billion.
As Satya called out earlier, our commercial cloud annualized revenue run rate exceeded $12.1 billion, growing more
than 50 percent year over year. Additionally, more than 70 percent of customers who signed enterprise agreements
this quarter attached cloud offerings. Our commercial cloud gross margin was 42 percent, declining year over year
driven by investments for cloud capacity, deployment, and support.
Now let’s turn to company gross margin performance. We were above our COGS expectations due to approximately $200
million of inventory adjustments from the change in our phone hardware business. And as expected, our mix of cloud
services revenue continued to increase, resulting in gross margin percentage declines in the Productivity and Business
Processes and Intelligent Cloud segments. Importantly, gross margin dollars expanded year over year in constant
In Q4, the FX impact on total and segment level revenue was in line with expectations. FX had a 3 point negative
impact on Productivity and Business Processes and Intelligent Cloud results, and a 2 point negative impact on More
Personal Computing results.
As we’ve noted in previous quarters, we’re not able to provide constant currency impact at the segment level for
operating expenses and, therefore, segment operating income. This quarter total operating expenses grew 1 percent
in constant currency above our expectations due to legal settlement and revenue-driven sales cost. At the company
level, our operating income great 6 percent in constant currency as FX had 9 point impact on our results.
Now let’s turn to each segment.
This quarter, our Productivity and Business Processes segment delivered results above our expectations with nearly
$7 billion in revenue, an increase of 5 percent and 8 percent in constant currency.
In Office Commercial, revenue increased by 5 percent and 9 percent in constant currency as Office 365 growth outpaced
the shift from our on-premise business. Our seat growth was driven by broad-based momentum across commercial customers
of all sizes. While we generally expect transactional purchasing to continue to decline, results across all products
came in higher than anticipated this quarter.
Office consumer revenue increased 19 percent, and 18 percent in constant currency, outperforming the consumer PC
market driven by seat growth, recurring subscription revenue and 6 points of growth from Japan which had a particularly
weak quarter a year ago.
And our Dynamics business grew 6 percent, up 7 percent in constant currency with strong billings and seat growth.
Segment gross margin dollars were flat, and up 4 percent in constant currency. The gross margin percentage declined
on a higher cloud revenue mix within the segment, coupled with an increase in cloud investments. Operating expenses
grew 6 percent from investments in commercial cloud sales programs and engineering. As a result, operating income
declined 5 percent.
The Intelligent Cloud segment delivered slightly more than $6.7 billion in revenue, growing 7 percent and 10 percent
in constant currency. Demand and use of our hybrid cloud offerings led to another quarter of double digit annuity
revenue growth within server products and cloud services, partially offset by a decline in our transactional, on-premise
Enterprise Services revenue grew 12 percent and 14 percent in constant currency, as customer demand for Windows Server
2003 end of support agreements and Premier services, continued this quarter.
Gross margin dollars grew 1 percent and 5 percent in constant currency, and gross margin percentages declined as
cloud mix accelerated. This quarter, operating income declined 17 percent driven by investment in sales resources
Now to our final segment, More Personal Computing. Revenue was $8.9 billion, down 4 percent and 2 percent in constant
First, our OEM results. Our total OEM business grew 11 percent this quarter, outperforming the overall PC market
which was better than we expected in most markets including the US, the UK and Germany partially offset by incremental
weakness in India and Russia.
OEM Non-Pro revenue increased 27 percent, and similar to last quarter, was driven by a higher mix of premium devices.
OEM Pro revenue grew 2 percent, reflecting a stabilizing commercial PC market and a higher mix of business PCs sold
with Windows Pro. Inventory across both OEM Pro and Non-Pro remained at normal levels. Windows volume licensing
grew 3 percent and 9 percent in constant currency with ongoing annuity growth. IP licensing declined, impacted by
both a decrease in total unit volume and lower revenue per unit.
We continued to execute well in our search business this quarter. And as we committed, Bing was profitable for the
full fiscal year driven by increasing revenue per search and search volume.
As expected, devices revenue significantly decreased this quarter. Revenue declined 35 percent, also 35 percent in
constant currency, due to Phone, where revenue declined 70 percent in constant currency. Surface revenue increased
9 percent in constant currency as Surface Pro 4 and Surface Book growth was partially offset by unit declines in
our prior generation Surface 3.
And in Gaming, revenue declined 9 percent or 8 percent in constant currency driven by lower Xbox 360 unit volumes
and reduced Xbox One pricing. Our overall gaming ecosystem showed healthy growth with 49 million monthly active
Xbox Live users, or a 33 percent increase, and 4 percent Xbox Live revenue growth.
Segment gross margin dollars declined 3 percent, or roughly flat in constant currency, as decreases due to Xbox consoles
and the Phone inventory adjustment were partially offset by our OEM and search results. Operating expenses decreased
this quarter by 13 percent, based primarily on reduced Phone spend and the transition of display advertising sales
to AOL, resulting in segment operating income growth of 59 percent.
Now back to our overall company results.
We invested 3.1 billion in capital expenditures, consistent with our plan for accelerated investment as we added
both commercial and consumer global cloud capacity to meet near term and longer term customer demand.
During the quarter, we continued to rebalance our investment portfolio which resulted in other income and expense
of $267 million from net recognized gains on investments, partially offset by interest expense.
Our non-GAAP effective tax rate was 15 percent this quarter, lower than we expected. Our income tax expense reflected
a favorable mix between US and foreign countries as well as benefits associated with distributions from foreign
This quarter, we returned $6.4 billion to shareholders through stock repurchases and dividends.
Before turning to next quarter’s outlook, I want to share our view on the shape of next fiscal year. My commentary,
both on the year and next quarter, does not include LinkedIn. However, we still expect the transaction to close
in the second quarter.
For the full year, we expect the FX impact to lessen throughout the year assuming current rates remain stable. In
H1, we expect a total impact of 1 point, reducing to zero in H2.
The fundamentals of our commercial business remain strong, and we anticipate that cloud services and healthy renewals
will continue to drive high annuity mix. As I’ve noted before, our commercial transactional business is influenced
by different dynamics. Most important, it is impacted by a structural transition to the cloud across all workloads.
But, it is also more sensitive to overall macroeconomic conditions and changes in corporate budgets. We expect volatility,
as we saw both in Q3 and Q4 this year, to continue in the next fiscal year.
Before discussing our total company gross margin expectations, let me first address commercial cloud gross margin.
We expect the commercial cloud gross margin percentage and dollars to materially improve next fiscal year. We have
invested heavily to build share, expand geographically and ensure world-class support and reliability for our commercial
customers. Going forward, we expect those investments to provide benefits of scale. We also anticipate our cloud
capital expenditure growth curve will slow. Given seasonality and revenue mix, commercial cloud gross margin will
see variability quarter to quarter but an overall trend of material improvement.
At the company level, as each cloud service continues to grow and improve its gross margin percentage, our company
gross margin should only decline roughly a point in FY17.
We now expect our full year operating expense will be $31.1 to $31.4 billion as we continue to prioritize spend on
strategic growth opportunities.
Lastly, our effective tax rate. Our tax rate is impacted by three factors: the proportion of services revenue versus
licensing revenue, the geographic mix of revenue, and the timing of equity vests. As our cloud continues to gain
momentum, we expect our tax rate to increase. With quarterly variability based on these factors, we anticipate our
non-GAAP tax rate to be 20 percent for the full year, plus or minus two points.
Now to the outlook for next quarter.
Based on current currency rates and forecasted geographic mix of revenue, we expect 2 points of negative impact on
total revenue in Q1. By segment, the negative impact is 2 points in Productivity and Business Processes, 2 points
in Intelligent Cloud and 1 point in More Personal Computing.
We expect commercial unearned revenue to be within the range of $21.8 to $22 billion, in line with historical seasonality.
In Productivity and Business Processes, we expect revenue to be $6.4 to $6.6 billion. We will continue to grow our
install base and drive premium mix through offers like Office 365 E5. We anticipate continued transactional declines
as customer migration to the cloud accelerates. In our consumer business, we will outpace the consumer PC market
but the benefit from Japan’s improved results over a weak prior period and the benefit from last year’s Office 2016
launch are not expected to repeat.
For Intelligent Cloud, we expect revenue between $6.1 and $6.3 billion driven by continued annuity strength across
Azure and our hybrid cloud offerings offset by ongoing declines in our transactional on premise server business,
and moderating growth from support agreements in Enterprise Services.
In More Personal Computing, we expect revenue between $8.7 and $9 billion. We anticipate that our OEM revenue will
be more in line with overall PC market trends. Devices revenue will decline again from our actions in Phone. Gaming
revenue will be driven by the same factors as in Q4, and in Search, we expect Bing’s growth trajectory to continue.
We expect COGS to be $7.5 to $7.6 billion, with variability due to device sales. We expect operating expenses between
$7.35 and $7.45 billion.
We expect other income and expenses to be approximately zero, as realized gains on investments should offset debt
With that, Chris, let’s go to Q&A.
CHRIS SUH: Thanks, Amy.
We’ll move now to the Q&A section. Operator can you please repeat your instructions.
KEITH WEISS, Morgan Stanley: Thank you guys for taking the question and a very nice quarter. I wanted to dig
into Azure and maybe one question for Satya and one question for Amy.
Satya, you mentioned the Boeing agreement. What was interesting about that is not just a large company moving significant
workloads onto Azure, but from my reading it sounds like there’s a distribution side of this agreement, that you
guys are going to help them distribute some of those applications on a going forward basis. I was wondering if you
could touch a little bit on that. Is that a one-time thing, or is that something that you look to do more often
with some of these large companies moving workloads onto Azure?
And then for Amy, thank you for the additional detail on sort of the cloud gross margin profile on a going forward
basis. When we dig into just Azure you said in the past that you expect to match the gross margin profile of what
we’re seeing in Amazon Web Services. Does that commentary still hold and maybe you could give us sort of a mark
to market on how you’re doing in terms of matching up Azure’s gross margin profile to what you’ve seen from your
top competitor there.
SATYA NADELLA: Thanks, Keith, for those questions. So let me start on the first one. You’re absolutely right
that one of the phenomena now is that pretty much anyone who is a customer of Azure is also in some form an ISV.
And that’s no longer just limited to people who are "in the classic tech industry," or the software business. That’s
the same case with GE. It’s the same case with Boeing. It’s the same case with Schneider Electric or ABB, or anyone
of the customers we are working with, because they all are taking some of their assets and converting them into
SaaS applications on Azure.
And that’s something that we will, in fact, have distribution agreements with. And App Source, it’s a pretty major
announcement for us, because we essentially created for SaaS applications, and infrastructure applications, a way
to distribute their applications through us and our channel. And I think it makes, in fact, our cloud more attractive
to many of them, because of that. So we look -- I think going forward we will look to see -- or you’ll see us do
much more of this with many other customers of ours.
AMY HOOD: And to your question on Azure gross margins specifically and how we think about that in comparison,
let me first say the additional color I gave in terms of comments, in terms of material improvement, clearly also
apply to our Azure portfolio, as well. We’re encouraged by the improvements we’ve seen year-over-year and we do
expect material improvement in FY’17, both from the benefits of scale in the investments we’ve made, but importantly
also in the revenue trajectory we’re seeing and the makeup of that revenue. Boeing’s agreement is one such agreement,
in terms of embedding a premium service at a premium gross margin. We signed many of those this quarter that we
feel quite good about.
I think I have a strong line of sight to AWS’ margin profile, and still feel good about the progress we’re making,
not just on the workloads that are relevant, apples to apples, with Azure, but also in our broader cloud portfolio
and our ability to have very healthy margins across Dynamics 365, as well as Office 365, in conjunction with many
of the innovations we’re doing across Azure. So while I am focused on both the workload improvements, I’m also focused
on what’s possible across the entirety of the cloud.
KEITH WEISS: Excellent, thank you very much.
CHRIS SUH: We’ll go to the next question please, operator.
KARL KEIRSTEAD, Deutsche Bank: Thank you.
So, Satya or Amy, last quarter the stock was hit in part on a deceleration in your on-premise server product business
and I think our commentary around the transactional part of that suggested it softened a little bit. I think your
tone on this call is a lot better around the transactional performance and it looks like that business accelerated
a little bit. Perhaps you could explain what changed in the course of the three months to make the transactional
piece at least if I’m hearing you correctly feel a little bit better. Thank you.
SATYA NADELLA: Yeah, let me start and then, Amy, you can add to it.
Overall, Karl, the focus for us is in what I describe as this hyperscale plus hybrid approach. When you think about
the cloud approach, which is pretty unique to us. And the way we track progress is to see how is our annuity growth
of our server business and how is our cloud growth. And if you look at this last quarter our annuity grew double
digits and our cloud grew triple digits. And that’s a pretty healthy growth rate and that’s something that by design,
both in terms of the technical architecture, as well as the traction we have in the marketplace and our sales efforts
and so on, are playing out well and we are very bullish about that going forward.
The transactional business is much more volatile, because of the macro environment, IT budgets, and also the secular
shift to the cloud. You know, the question again that gets asked is about the cannibalization. But if you look at
Boeing or you look at any of the other examples that I talk about when it comes to the cloud, our servers never
did what these customers are now doing in our cloud. So at a fundamental long-term secular basis we have new growth,
new workloads, and that’s what we are focused on and that’s a much bigger addressable market than anything our transactional
server business had in the past.
CHRIS SUH: Thank you, Karl.
We’ll take the next question please.
BRENT THILL, UBS: Thanks, Amy. In Q3 the transactional business was weak and you said that the business bounced
back in Q4. Was that just a mere fact of you cleaning up some of the flip business, or did you see additional strength
on top of some of those closed transactions on the transactional business in Q4?
AMY HOOD: Thanks, Brent. Let me split your question into two components. The first thing really that I think
Satya and I both focus on every quarter, every month, is how much of our business are we continuing to shift to
annuity and specifically to the cloud? We structure all of our motions at this company from how we engineer to how
we do our go to markets to how we think about sales engagement to how we do our investments fundamentally toward
that long-term structural transition in the market.
And so to your question on transactional performance, there were some deals that didn’t get done in Q3 that got done
in Q4, and there were some deals done in Q4 on the Office side with large companies that I’m thrilled by, but at
the same time we still will focus on those deals moving to the cloud over time. And so this volatility that we are
going to see because of macro and because of budget constraints, especially on transactional, we will focus on because
we expect excellent execution and have accountability to do that in the field, but our first priority every time
is to make sure we are focused on annuity growth and digital transformation in our company, which is best done through
BRENT THILL: Just to be clear, Amy, in terms of the sales motion, are they incented more towards cloud versus
transactional going into this year?
AMY HOOD: Yeah.
SATYA NADELLA: Absolutely.
BRENT THILL: Thank you.
CHRIS SUH: Thanks, Brent.
We’ll move to the next question, please.
HEATHER BELLINI, Goldman Sachs: Great. Satya, I had a question for you on Azure. I was just wondering if you
could talk about the percentage of Azure revenue coming from ISVs, and then how do you see this helping you compete
with AWS? And can you talk about why these partners may be choosing you over the competition? Thank you.
SATYA NADELLA: Sure. Let me take that second part in terms of what is our differentiation. And in my remarks
I sort of pointed out the couple of dimensions. But overall I believe this hyperscale plus hybrid architecturally
helps us a lot with enterprise customers because we meet them where their realities are today and also the digital
transformation needs going forward. So that’s one massive advantage we have.
And the second area for us is also the nexus between what’s happening in Office 365, Dynamics 365, App Source, and
information act this last quarter some of the most strategic announcements were all around our application platform,
at our partner conference there was a significant amount of excitement with the tools that we announced like Power
Apps and Power BI, Azure Functions and Flow, these are tools that our developers and system integrators and solution
partners will use in order to be able to customize applications around Azure. And so to me that’s another huge advantage
and a competitive differentiation for us.
And then, lastly, we have the best support for what I would say is the most open platform for all developers. Not
only is .NET first class, but Linux is first class, Java is first class, Azure Container Service cuts across both
containers running on Windows, running across Linux. So again, speaks to the enterprise realities. So those would
be the places where we’re fairly differentiated, and that’s what you see us gaining, both for enterprise customers
The question you asked is an interesting one, which is if I had to sort of slice it by classic ISVs, it would be
one third or so of our revenue. But the first question that Keith asked is probably more indicative of what’s happening,
which is every customers is also an ISV. So every customer who starts off consuming Azure is also turning what is
their IP in most cases into an ISV solution which ultimately will even participate in App Source.
So at least the vision that we have is that every customer is a digital company that will have a digital IP component
to it, and that we want to be able to partner with them in pretty unique ways.
AMY HOOD: And I would also add, Heather, the importance of the motion in our field organization and go to
market with ISVs is incredibly high in terms of selling with and along with those ISVs, both making them successful,
and thereby helping us build very important scale though the platform. And we’ve seen a lot of improvement in the
past four quarters on that front.
HEATHER BELLINI: Great. Thank you.
AMY HOOD: Thanks, Heather.
CHRIS SUH: Thank you, Heather.
We’ll move to the next question, please.
MARK MOERDLER, Bernstein Research: Thank you.
Amy, how much of the weakness in transactional has been caused by clients that otherwise would have bought a license
now under annuity? In other words, are you driving the transactional weakness to some extent by driving the growth
in on prem? And then I have a quick follow-up for Satya.
AMY HOOD: It’s probably not exactly how I would say it, Mark. I do believe that every conversation that we’re
having with customers is cloud-led. That cloud-led conversation and making a plan for customers to best change and
transform their own business certainly is a far more in-depth one than on occasion is required by long-time transactional
purchasers, especially in Office as an example, because what we’re talking about now is really pivoting your business
for the long-term.
And so I’m sure there are examples where that has elongated the sales cycle for good reason, but I would generally
point back to say most of these are driven at the structural level, which is structurally over time on premises
transactional business will move to the cloud or to a hybrid structure through an annuity revenue stream.
Now over any short-term period, the majority of what we have seen is really either they’re a budget constraint, a
macroeconomic change, or people, to the question you’ve laid out, maybe in the midst of making their cloud transition
plan and maybe that has elongated the ales cycle to an extent. But, again, I don’t view that as negative performance.
I view that as strategic relevance long-term inside of digital accounts.
MARK MOERDLER: That makes a lot of sense. Thank you.
AMY HOOD: Thanks, Mark.
WALTER PRITCHARD, Citi: Hi, thanks. Amy, I’m wondering, you saw very strong unearned revenue in the quarter,
but I know that you saw a contracted backlog that grew sequentially below what a typical June quarter does in commercial
bookings that were up about 4 percent off of a fairly easy comp. And I’m wondering if you can just help us understand
the dynamics in new and renewal signings that drove that combination of really strong unearned but somewhat weaker
trends in the bookings?
AMY HOOD: Sure. Strong unearned in particular was actually better than expected Azure billings in the quarter
that drove unearned above the high end of our guide. And I think we were quite please by that performance.
In terms of C&B, that’s the reference I made in my comments to the lower expiry base. Quarter to quarter and
year to year we just have different amounts of contracts expiring. And so this was one of our lower contract bases
and was lower than a year ago. So the fact that we were able to grow on that low expiry base is actually very good
CHRIS SUH: Thank you, Walter.
We’ll take the next question please.
RAIMO LENSCHOW, Barclays: Thank you. Two questions on the Office side. First of all, you obviously are really
reaching very large numbers in terms of the numbers of seats that you have, can you talk a little bit about the
seat growth, because both for consumer and for commercial it seems to be coming down. Is that kind of the law of
large numbers coming in, or is there anything else? And then the consumer Office, the consumer Office performance
was very, very strong, and that almost needs to be stronger from transactions because otherwise I don’t get to the
numbers. Can you talk a little bit about the source of the strength here? Thank you.
AMY HOOD: Thanks, Raimo. Let me start with the Office consumer question. We haven’t had a chance to touch
on that, and then we’ll talk about commercial seat growth.
You’re right, the Office consumer growth still has quite a bit of transactional business to it, even though we have
moved and you saw that growth, the subscriber base, sort of materially. The growth in quarter versus our expectations
was really two things that are transactionally focused. One, the PC market was a little better than we thought,
and particularly in developed markets the PC growth was better than we thought. And developed markets are where
we see the most transactional business with consumer Office that impacts in quarter.
So the strength from the outperformance or better market in consumer PCs in developed markets is a direct correlation
to our performance in Office consumer. And so that’s how to think about that big delta.
The other thing was, Japan was a little better, and when Japan is better it’s why you also see the interesting relationship
in constant currency. We have a lot of yen exposure in that segment. So the Japan performance being better also
helped, and that is a purely -- it’s more transactional than even our rest of world business.
So you’re right, Raimo, in terms of what impacted that number in-quarter versus the underlying market dynamics.
On commercial seats, listen, we’re very proud of that big number, growth number, but you’re right we’re also getting
a very big base. And so while we feel great about continuing to add seats at that type of rate, converting, and
adding net new into our install base, you will see that growth rate come down, just because the business is getting
RAIMO LENSCHOW: Thank you.
CHRIS SUH: Thanks, Raimo.
We’ll take the next question, please.
GREGG MOSKOWITZ, Cowen and Company: Okay, thanks very much and good afternoon.
Amy, you spoke about a slowdown in the cloud CAPEX growth curve in Fiscal’17. I assume you’re referring to the growth
in absolute dollars moderating and not just the rate of change in percentage terms. But any additional color that
you could provide on the company’s CAPEX requirements over the course of the next year would be appreciated.
AMY HOOD: Thanks, Gregg.
You’re right; my comments are more pivoted toward the absolute dollar amounts, which is what I tend to focus on in
my comments. So it’s a good clarification and thanks for asking.
In terms of how we think about the absolute numbers, first I should say I think most people assume and it is true
to a certain extent, so much of this is the growth in our commercial businesses across Azure and Dynamics and Office
365 and that’s true. But we’re also seeing quite good growth in some of the consumer businesses, which also are
built on our cloud infrastructure; search, some of our gaming assets, our Xbox Live business going forward. And
so many of these assets, including increased usage of our consumer properties inside our productivity business and
Office do require capital spend.
And so the growth is pretty broad-based to support. And so as I think about moderation, it is the absolute dollar.
It’s not due to any change in our aspiration or belief in the growth curve of revenue and I want to be clear on
that. It really is about continuing to benefit from scale and engineering improvements that will allow us to do
that even as we see broad-based growth.
GREGG MOSKOWITZ: Very helpful, thank you.
CHRIS SUH: Great. We’ll take the next question, please.
ROSS MCMILLAN, RBC: Thanks so much for taking my question. Amy, I had one on the same lines, on CAPEX, and
I just wondered if you could provide some insights. We’re at 26 data center regions today. I think you have 34 planned.
So that would imply we’re about three-quarters of the way to that spending cycle. But should we view 34 as a ceiling,
or is it possible that we could see further data center regions built out beyond that 34? And then I had one follow-up.
SATYA NADELLA: Let me start and then, Amy, you can add to this.
In some sense, Ross, you’re sort of trying to ask us to project forward and say what is the legitimate digital security
and digital sovereignty needs of all the different types of businesses that we want to serve using the cloud all
over the world. The position that we have taken is that we want to serve customers where they are and not assume
very simplistically that digital sovereignty needs of customers can be met out of a fewer data center approach,
because right now given the secular trend to move to the cloud across all of the regulated industries, across the
globe, we think it’s wiser for us and our investors long-term to be able to meet them where they are. And that’s
what you see us.
We are the only cloud that operates in China under Chinese law, the only cloud that operates in Germany under German
law. And these are very critical competitive advantages to us. And so we will track that and we will be very demand-driven
so there is -- in this case we’re not taking these positions of which regions to open and where to open them well
in advance of our demand. If anything I think our cycle times have significantly come down. So it will be demand-driven.
But I don’t want to essentially put a cap, because if the opportunity arises, and for us it’s a high ROI decision
to open a new region, we will do so.
AMY HOOD: And I would add, in addition to the number of regions, which Satya is talking about, it’s also the
capacity inside a region. Much of our spend is, as you note, on some of the infrastructure to put in place when
you pick a location. The rest of it is continuing to build out in that location the number of servers and networking
equipment required. So there’s really two components. And I think Satya talked about why you would enter a region
and its ROI, and there’s also the correlation to how many servers and that spend and pace over time based on demand.
ROSS MCMILLAN, RBC: Thanks, so much.
Maybe just one quick follow-up, the server products business that Karl talked about did rebound this quarter and
I think it was up about 4 percent constant currency for the year. I know you’re not guiding to that number specifically
and you talked about potential volatility. But is there any sort of range of outcomes that you’re thinking about
for that business? Will it grow? Is it not clear that it will grow? I’d just love any additional color there. Thank
AMY HOOD: In terms of server products and services I tend to think of it as the all-up growth. It’s really
about growing the cloud, growing the hybrid, and then whatever happens in the transactional business happens. And
we are very proud, actually, of the growth this quarter.
I think our guide for Q1, given some of the headwinds we expect in terms of the support agreements what we talked
about in enterprise services continues to expect very healthy double-digit annuity growth driven fundamentally by
Azure in that segment.
ROSS MCMILLAN: Thanks again, congrats.
CHRIS SUH: We’ll go to the next question, please.
MICHAEL TURITS, Raymond James: Hi, guys. Thanks for taking my question.
Satya, around the LinkedIn announcement, there was a lot of discussion about some of the opportunities to use the
assets and information there to help build your HTM and CRM capabilities. And then we very shortly afterwards got
the announcement of Dynamics 365 and App Source. So maybe given the amount of discussion here, you could comment
on the evolution of the strategy and your thought process around broad enterprise application?
SATYA NADELLA: Thanks for that question.
So I sort of look at what we’re doing with Office 365, Dynamics 365, App Source, LinkedIn as all being part of one
strategy. So the move to the cloud for our customers and for us is not just about a new way of delivering the same
value just as a service. It’s really the transformation from having applications that are silos to becoming more
services in the cloud where you can reason able the activity and the data underneath these services to benefit the
customers who are using these services. So that’s what this notion of a graph represents.
So when somebody moves to Office 365, their graph, their people, their relationships with other people inside the
organization, their work artifacts, all move to the cloud. You can connect them with all the business process data
that’s in Dynamics 365, but not just in Dynamics 365, but all the applications in App Source because business process
will always be a much more fragmented market as opposed to just one market share leader by industry, by vertical,
by country, and so that’s our strategy there.
And now the professional cloud or the professional network helps usage across all of that professional usage, whether
it’s in Office 365 or whether you’re a sales person using any application related to sales, you want your professional
network there. Of course, it’s relevant in recruiting, it’s relevant in training, it’s relevant in marketing. So
that’s really our strategy with linked in as the professional network meeting the professional cloud. And so you
are right to point out that these are all part of one overarching strategy, and ultimately it’s about adding value
AMY HOOD: Thanks, Michael.
CHRIS SUH: Thanks so much.
We’ll have time for one more question, please.
MARK MURPHY, J.P. Morgan: Yes, thank you very much.
Satya, we noticed Office 365 commercial seat growth of 45 percent produced Office 365 commercial revenue growth of
59 percent in constant currency. So a favorable spread of about 14 points suggesting ASP growth. I’m wondering if
you could help us understand the drivers, both now and into the future, particularly in terms of the initial response
to the E5 plan and also which products you think are driving the strength as you consider across Exchange, Skype
for Business, Power BI, Yammer, SharePoint, et cetera.
SATYA NADELLA: Yeah, let me start, and Amy you can add to it.
Overall, I would say even in this last year, even just the broader spread of E3 has driven a lot of the growth. And
then, of course, we are very excited about E5, but they’re very, very early days of E5. And the E5 value proposition
across all three of the areas, whether it’s cloud voice or analytics or security, are all three massive areas for
us. And I would say if anything, the initial data from customers around security is very -- is gaining a lot of
traction. But we’re at the same time, one of the things that customers are looking for is making an enterprise wide
architectural decision across all of the workloads.
So E3, E5 and higher penetration of this is what’s going to drive ASP growth. And you’ll see us add more value to
these packages as time goes on as well, because our R&D is focused on that, which is how do we take these buckets
of value creation and reinforce them with all of the future R&D as well.
CHRIS SUH: Thanks, Mark.
So that wraps up the Q&A portion of today’s earnings call. We look forward to seeing many of you in the coming
months at various investor conferences. For those unable to attend in person, these events will be webcast and you
can follow our comments at the Microsoft Investor Relations website. Please contact us if you need any additional
details. And thank you for joining us today.