Microsoft Fiscal Year 2017 Third Quarter Earnings Conference Call
Microsoft Fiscal Year 2017 Third Quarter Earnings Conference Call
MSFT Earnings Conference Call
Chris Suh, Satya Nadella, Amy Hood
Thursday, April 27, 2017
CHRIS SUH: 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 John Seethoff,
deputy general counsel and corporate secretary.
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.
As a reminder, this is the first full quarter of LinkedIn results. As a result, comparisons made to prior years will
be affected accordingly. During this call, Amy will discuss the financial impact of LinkedIn as she provides the
overview of business results for the quarter. Our key investor metrics remain unchanged due to the LinkedIn acquisition.
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 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.
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 April 27th, 2018.
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: Thank you, Chris, and thanks to everyone on the phone for joining.
Today I’ll share results for the third quarter, and discuss what’s ahead.
I’m proud of the progress this quarter.
We delivered $23.6 billion in revenue — up 7 percent in constant currency.
Across all industries, organizations are looking to digitally transform with state-of-the-art cloud services, AI and
new natural user interface technology.
Increasingly, these organizations are turning to Microsoft as a partner they can trust for the innovation and their
own digital capability building.
Now let’s look at the progress we made this quarter by segment, starting with Productivity and Business Processes.
We crossed a major milestone with more than 100 million monthly active users of Office 365 commercial. Office 365
commercial seats grew 35 percent year-over-year, and revenue is up 45 percent in constant currency.
Across industries, customers recognize Office 365 is the productivity platform of choice. Companies like H&R Block,
Johnson & Johnson, Deutsche Bӧrse AG and Louis Vuitton Moet Hennessey all chose Office 365.
And we continue to innovate and add new value. This quarter we made Microsoft Teams broadly available to Office 365
customers in 181 markets. Our new chat-based workspace is already empowering a new way to work for more than fifty
thousand customers including Accenture, J. Walter Thompson, J.B. Hunt and Expedia. Teams also creates a new platform
opportunity for developers to reach 100 million Office 365 users with rich extensibility for bots, apps and services.
Additionally, we are expanding the relevance of Office 365 to new segments. Retail, hospitality and manufacturing
companies have a huge need to empower their front-line employees. Our expanded offering for this segment includes
Microsoft StaffHub, Teams, OneDrive, Skype for Business, and more to give these critical employees a robust collaboration
toolkit to maximize their impact.
Now let me talk about the second part of our ambition in this segment – reinventing business processes.
Accelerating our growth opportunity with LinkedIn by driving value for members and customers remains our top priority.
This quarter, we redesigned the LinkedIn desktop to create a more seamless, intuitive experience across devices.
We continue to invest in the LinkedIn feed, bringing curated news and views to help members stay informed on what’s
most important to them. Our innovation across both desktop and mobile is driving strong engagement momentum, with
sessions up more than 20 percent again this quarter.
LinkedIn marked an important milestone this week, exceeding 500 million members, and our jobs platform hit record
levels with more than 10 million jobs posted. The strong momentum with jobs and engagement is continuing to fuel
the growth across Talent, Marketing, Sales and Learning Solutions.
We took significant steps this week to redefine social selling with deeper integration of Sales Navigator and Dynamics
365 – enabling sales professionals to dramatically increase their effectiveness by drawing on the relationships in
their personal networks. Customers like Visa are choosing Dynamics 365 because of our deep integration across Office
365 and now Sales Navigator. I’m excited to put the Microsoft enterprise salesforce and partner ecosystem behind
this new opportunity.
Dynamics 365 solves a critical challenge for businesses, helping them break free of monolithic, siloed suites of applications
to unlock insights across organizations. You see this in our new Dynamics 365 Talent application which combines HR
business processes with LinkedIn Recruiter to help companies manage the employee life cycle from recruiting to retention.
Our innovation in Dynamics is driving strong revenue growth with Dynamics 365 up 82% in constant currency this quarter.
Now, let’s talk about the progress we are making in our Intelligent Cloud segment.
Our commercial cloud annualized revenue run rate now exceeds $15.2 billion.
Customers are increasingly choosing the Microsoft Cloud. They value our differentiated approach as the most trusted,
global, hyper-scale cloud with hybrid support and higher level services to help drive their digital transformation.
Moreover, they appreciate the agility, operational consistency and security across the entire digital estate – spanning
Enterprise Mobility, Office 365, Dynamics 365 and Azure.
Take Maersk, the largest transport and logistics firm in the world with operations in 130 countries and a fleet of
over a thousand vessels. Maersk began their journey to the Microsoft Cloud with Office 365, Enterprise Mobility &
Security and Windows 10. They chose Dynamics 365 for Operations to streamline container production and maintenance.
Now Maersk is using Azure to digitally transform its supply chain management and global trade. The intelligent services
in Azure deliver up-to-the-minute insights on carrier performance and equipment usage with real-time data visualization
and advanced analytics, enabling them to trim costs and create new revenue streams. For a company that ships 17 million
containers annually, the ability to react quickly can mean the difference of tens of millions of dollars to the bottom
line. This is a great example of our three clouds coming together to enable deep digital transformation.
Across industries, customers are choosing Azure. UBS announced they are using Azure for risk management and GEICO
chose Azure for hybrid capabilities. Publicis Groupe announced they will use Azure and Cortana Intelligence Suite
to deliver AI-powered marketing solutions at scale. Flipkart, India’s leading online marketplace, chose Azure as
the platform to enable their rapid growth.
We continue to rapidly innovate and add new capability to drive further customer value. Microsoft IoT Central is the
first SaaS offering that provides the end-to-end solution for organizations of all sizes to manage their entire IoT
ecosystem across devices, cloud, analytics, networks, and software. This week at Hannover Messe, the world’s largest
industrial trade show, manufacturers showcased how they are using our solutions to transform all aspects of manufacturing,
from water management to food and beverage packaging to improving safety on the factory floor.
When it comes to AI this quarter we made our cognitive services for face recognition and computer vision broadly available
to enable any developer to become an AI developer.
We are excited about how Azure Stack and SQL Server are helping to define the edge computing paradigm.
Azure Stack will enable customers to extend Azure capabilities to their private datacenters in a truly consistent
hybrid computing environment.
SQL Server 2017, coming this Fall, is the first database with cloud-tiering and artificial intelligence built in.
It runs on Windows and Linux, supports Docker container deployment, and popular programming languages such as R &
Python for machine learning and data science.
We will share more about all these advances and more at our upcoming BUILD developer conference.
Now I’ll turn to our progress in More Personal Computing.
Almost two years ago, we introduced a new approach with Windows 10, transforming the way customers experience Windows
on all their devices. Now, customers are always up-to-date, running the most secure Windows ever.
This quarter the Windows business grew 5% in constant currency and we delivered the next phase of innovation with
the Creators Update.
Creators Update is about inspiring the creator in us all. We create technology so that others can create their own
content and technology. We want to empower people to paint in 3D or paint with numbers in Excel. We empower people
to create in Word or in Minecraft. These new forms of creation and expression are shaping Windows for the next generation.
Gaming is a key scenario to expand our opportunity across the PC and console. We are building on our already strong
foundation with Xbox One and our Xbox Live community, up 13 percent to 52 million active users this quarter. With
Creators Update, we integrated gameplay broadcasting into Windows 10 PCs as well as Xbox One. We are off to a very
strong start with both streamers and viewers. In fact, the majority of streaming in the industry today is on PC and
console, and we are uniquely positioned to provide the best, most complete gaming experience from hardware to software
to broadcast services. It’s early days and we are excited to pursue this new, growing opportunity.
This quarter we also revealed more about our forthcoming Project Scorpio, which will be the most powerful console
ever and will enable true 4k gaming in the living room.
Our commercial customers continue to adopt Windows 10 as the secure, trusted platform of choice. Customers like the
Department of Education in the UK, British Telecommunications, and the Adventist Health System, one of the largest
healthcare providers in the United States, all chose Windows 10.
When I talk to business and government leaders, they value security and privacy of their data, the reliability of
their systems, and choice and control over how and when they deploy. We remain committed to our core values of trust,
transparency, privacy and security for every customer.
Finally, devices. This quarter our Surface results fell short of expectations impacted by end of product life cycle
and increased price competition. We continue to innovate and invest in creating new computers and computing experiences.
Surface Pro; Book; Hub; Studio and HoloLens are all creating new markets for the Windows ecosystem and pushing differentiation
with new natural user interface capabilities – ink, vision, voice, touch and mixed reality.
In the context of Mixed Reality, we just passed the one year anniversary of Microsoft HoloLens. We now have more than
150 exclusive HoloLens apps in the Store. Moreover, many of our commercial customers are using HoloLens to drive
digital transformation and seeing real impact. HoloLens based innovation was featured front and center at NRF, HIMMS
and most recently this week at Hannover. Digital transformation across these industries is being shaped by new technologies
from IoT to Mixed Reality to AI and the cloud.
ThyssenKrupp Elevator is using HoloLens and Azure to digitize their entire sales and order process, shortening delivery
times up to 4x, and chose Dynamics 365 to enable transformation in their steel division.
Leading global medical technology company Stryker chose Office 365 to empower employees and is using HoloLens to improve
operating room design for surgeons, staff and ultimately, the patients. All this creates a strong foundation for
the broader opportunity ahead with digital transformation.
I’m proud of the progress this quarter and I’m enthusiastic about what’s to come. In the coming weeks, we will share
more about how Microsoft is innovating uniquely to empower every customer – from students and teachers, to business
professionals to developers.
Now, let me hand it over to Amy to walk through this quarter’s results in more detail and share our outlook.
I look forward to rejoining you after for questions.
Amy Hood: Thank you, Satya and good afternoon everyone.
Our third quarter revenue was $23.6 billion, up 6 percent and 7 percent in constant currency. Gross margin
grew 7 percent and 9 percent in constant currency. Operating income grew 2 percent or 5 percent in constant currency.
And earnings per share was $0.73, an increase of 16 percent and 19 percent in constant currency.
This was the first full quarter of company results with LinkedIn, which had a significant impact on revenue,
gross margin and operating income. At a company level, LinkedIn contributed approximately 4 points of revenue and
gross margin growth and 6 points of drag on operating income growth which includes $371 million from amortization
of acquired intangibles.
From a geographic perspective, our results were mostly in line with macroeconomic trends. Our performance in Japan
was better than expected, driven by increased public sector spending and improved market conditions.
Our commercial annuity mix was 88 percent, even with another quarter of higher than expected transactional revenue
results. Commercial bookings increased 12 percent, or 11 percent in constant currency. Commercial unearned revenue
followed historical seasonal trends, coming in at $20.4 billion, and growing 9 percent and 10 percent in constant
currency. And our contracted not billed balance increased to more than $27.5 billion.
Another strong quarter of cloud services performance drove our commercial cloud revenue run rate over $15.2 billion,
growing 52 percent. Our commercial cloud gross margin percentage increased to 51 percent, up 6 points from last year,
with improvement across Office 365, Azure, and Dynamics 365. And gross margin dollars grew 74 percent, keeping us
on pace for material gross margin percentage and dollar improvement this fiscal year. As a reminder, our commercial
cloud includes Office 365, Azure, Dynamics 365 and other cloud properties, but does not include LinkedIn.
Our company gross margin was 66 percent, better than anticipated and up 1 point, as the sales mix of higher margin
products and services coupled with commercial cloud margin improvement more than offset the impact of $218 million
of LinkedIn amortization.
Now to FX. This quarter, the US dollar was weaker than expected. As such, we had one point less FX impact across
our individual reporting segments even though overall company impact was still approximately one point as guided.
FX impacted the Productivity and Business Processes and Intelligent Cloud segments by 1 point and had minimal impact
in More Personal Computing.
Total operating expenses grew 12 percent, with LinkedIn contributing 13 points of growth, including $153 million of
amortization of acquired intangibles expense.
Let’s move to the segment results.
Revenue from our Productivity and Business Processes segment grew 22 percent and 23 percent in constant currency to
$8 billion, with LinkedIn contributing 15 points of growth.
Office Commercial revenue increased 7 percent and 8 percent in constant currency. Office 365 commercial revenue increased
45 percent driven by installed base growth across all workloads and continued ARPU expansion. Our transactional results
came in higher than expected, mostly from performance in large markets like Japan and Western Europe.
Office Consumer revenue increased 15 percent and 14 percent in constant currency primarily from recurring subscription
revenue as well as growth in our subscriber base.
Our Dynamics business grew 10 percent and 11 percent in constant currency with Dynamics 365 customer momentum contributing
to double-digit billings growth.
LinkedIn revenue for the quarter was $975 million.
Segment gross margin dollars grew 15 percent and 17 percent in constant currency, with 11 points of contribution from
LinkedIn, including $218 million of amortization of acquired intangibles. Gross margin percentage declined due to
a higher mix of cloud revenue and the impact of LinkedIn related amortization. Operating expenses increased 44 percent
and 45 percent in constant currency, with 43 points from LinkedIn including $153 million of amortization expense.
Operating income declined 7 percent and 4 percent in constant currency, with 13 points of impact from LinkedIn.
The Intelligent Cloud segment delivered approximately $6.8 billion in revenue, growing 11 percent and 12 percent
in constant currency. Server products and cloud services revenue increased 15 percent, up 16 percent in constant
currency, demonstrating durable double-digit growth. Azure revenue increased 93 percent, up 94 percent in constant
currency, and annuity revenue again grew double-digits. Azure Premium revenue grew triple digits for the eleventh
consecutive quarter, with more than 80 percent of Azure customers using our premium services.
Our Windows Server and SQL Server transactional business continued to perform well, with better than expected
results mainly from Japan and continuing post-launch demand.
As expected, Enterprise Services revenue declined 1 percent and was flat in constant currency, due to a lower
volume of Windows Server 2003 custom support agreements.
Segment gross margin dollars grew 6 percent and 7 percent in constant currency, and segment gross margin percentage
declined due to increasing cloud revenue mix and lower Enterprise Services margins, partially offset by material
improvement in Azure margins. We grew operating expenses by 11 percent with ongoing investment in sales capacity,
cloud engineering and developer engagement. Operating income was flat, and up 3 percent in constant currency.
Now to More Personal Computing. Revenue was $8.8 billion, declining 7 percent, as phone and Surface results
offset healthy growth in Windows, search and gaming.
Our OEM business grew 5 percent this quarter. OEM Pro revenue grew 10 percent, materially ahead of the commercial
PC market mainly due to a higher mix of premium SKUs. Additionally, the commercial PC market was slightly below our
expectations, negatively impacted by channel production timing changes and upcoming Windows SKU pricing changes.
Commercial end customer demand signals remain consistent and positive. OEM Non-Pro revenue declined 1 percent, ahead
of the consumer PC market, with continued positive impact from the Windows premium device category. Overall, inventory
levels remain in the normal range.
Windows commercial products and cloud services grew 6 percent, with healthy enterprise demand as customers
continued to deploy Windows 10 for its advanced security and management capabilities.
Patent licensing declined this quarter, primarily from lower revenue per unit.
Search revenue ex-TAC grew 8 percent and 9 percent in constant currency driven by higher revenue per search
and search volume.
Devices revenue declined 51 percent. We had no material Phone revenue this quarter. Our Surface business declined
26 percent, and 25 percent in constant currency as heightened price competition and product end of lifecycle dynamics
resulted in lower than expected Surface Pro unit volumes.
Our gaming business grew 4 percent and 6 percent in constant currency, as Xbox Live revenue growth offset declines
in hardware. Xbox Live monthly active users grew 13 percent across Xbox One, Windows 10 and mobile platforms, which
contributed to software and services revenue growth of 7 percent and 8 percent in constant currency.
Segment gross margin dollars were flat, up 2 percent in constant currency. Gross margin percentage increased
with a sales shift to higher margin products and services. Operating expenses declined 11 percent, and 10 percent
in constant currency, from lower Phone expense and Surface launch related marketing spend in the prior year. Operating
income grew 20 percent and 23 percent in constant currency.
Now back to overall company results.
We invested approximately $2.1 billion in capital expenditures, including capital leases, less than we expected,
as a portion of the expense will move into Q4.
Other income and expense was $322 million, greater than originally planned, as we saw more opportunities in
the equities market to realize gains during the quarter.
Our non-GAAP effective tax rate was approximately 23 percent.
We returned $4.6 billion to shareholders, continuing our balanced approach to capital allocation through share
repurchase and dividends. After a period of accelerated buyback, we have resumed a buyback pace consistent with our
Now let’s turn to the outlook.
First, FX. Given current rates, we now expect less FX headwinds in our fourth quarter. We expect about 1 point
of negative impact on total revenue. Within the segments, we anticipate about 2 points of negative impact in Productivity
and Business Processes and Intelligent Cloud, and 1 point in More Personal Computing.
Second, our commercial business. The fourth quarter is an important one for our commercial business, and we
expect continued annuity growth and healthy renewals as customers adopt and use our growing portfolio of commercial
cloud services. We expect unearned revenue between $26.8 and $27 billion, in line with historical seasonality. Additionally,
we have a large expiry base in the fourth quarter and our sales execution on renewals and upsell opportunities, while
contemplated in our unearned revenue guidance, should also show up in a larger contracted not billed balance and
commercial bookings growth.
Third, capital expenditures. We expect capex to grow sequentially and year-over-year. Quarterly spend variability
will continue and we remain on track for our full year capital expenditure year-over-year growth curve to slow.
Let’s move to the individual segments.
In Productivity and Business Processes, we expect revenue of $8.2 to $8.4 billion, driven by the ongoing annuity
shift to cloud in commercial Office 365. In Office consumer, we expect growth rates to moderate from prior quarters
which were impacted by prior year comparables. We expect consistent growth from Dynamics and approximately $1.05
billion of revenue from LinkedIn, adjusted for the impact of purchase accounting. Similar to Q3, we anticipate that
LinkedIn, excluding amortization, will have minimal impact on segment operating income, and we continue to expect
it to be minimally dilutive to non-GAAP EPS this fiscal year.
In Intelligent Cloud, we expect $7.2 to $7.4 billion in revenue. Performance trends from Q3 should continue
into Q4, with annuity strength and double-digit revenue growth across our server products and cloud services. Enterprise
Services should decline, with lower volumes of Windows Server 2003 custom support agreements.
In More Personal Computing, we expect revenue of $8.4 to $8.7 billion.
In our OEM business, we anticipate that revenue growth will be more aligned with the overall PC market. OEM
Pro growth will continue to be driven by Windows 10 enterprise momentum and aligned to a commercial PC market that
should return to typical seasonality. Our Non-Pro revenue is expected to be above the consumer PC market with continued
benefit from a strong mix of premium devices.
In Search, we expect Bing’s revenue growth ex-TAC to be similar to Q3.
In Gaming, we expect to see continued healthy user engagement on our Xbox platform and we look forward to E3
in June, where we will share more on Project Scorpio and new titles for the next fiscal year.
And in Devices, we expect revenue to decline with negligible revenue from Phone. With Surface, we expect a
more moderate rate of decline, given the prior year comparable and current market dynamics.
We expect COGS of $8.2 to $8.3 billion. This includes approximately $420 million of LinkedIn COGs, of which
$220 million is related to amortization.
We expect operating expenses of $9.1 to $9.2 billion, with roughly $1 billion from LinkedIn, of which $150
million is related to amortization. We now expect full year operating expenses between $32.9 and $33 billion, with
approximately $2.3 billion from LinkedIn. That includes about $360 million of amortization expense.
Other income and expense should be about $150 million.
And for tax, we expect the full fiscal year non-GAAP effective tax rate to be approximately 21 percent, plus
or minus 1 point.
Finally, we encourage you to watch a few upcoming events – our Education event on May 2nd, our Dynamics 365
event on May 3rd, and the upcoming keynotes from BUILD to learn more about our ambitious plans leading into FY18.
We will also host our Financial Analyst Briefing on May 10. The webcast will be available on our Investor Relations
Chris, let’s move to Q&A.
CHRIS SUH: Thanks, Amy.
We’ll now move to the Q&A portion of today’s call. Operator, can you please repeat the instructions.
KEITH WEISS, Morgan Stanley: Thank you very much for taking the question and a very nice quarter. I
wanted to dig into Azure a little bit. You gave us some really interesting statistics about gross margins going
up, premium mix going up. One of the concerns I hear a lot from investors is what happens when we get these
price cuts that go back and forth between you guys and AWS. And it doesn’t seem like the price cuts this quarter
really affected you guys. So I was hoping you could sort of shed some light on to what degree do those price
cuts actually affect you.
And then on the flipside, where does all that growth come from? Where do you get that sort of tripling of premium
growth from what kind of workloads are coming on board to kind of actually drive the underlying growth in that business?
SATYA NADELLA: Sure. Thanks for the question, Keith.
Let me start and then, Amy, if you want you can add.
Again, Keith, when we look at either the capital expense or the technical architecture, and the general approach we
take is about all of our cloud. When you look at what we are trying to get done between Azure, we don’t really
see these themes across Azure, O365, Dynamics 365, and also the things that we’re doing with Xbox Live, for example,
all built as one cloud infrastructure, and a set of rich services in the cloud.
So, for example, some of the cognitive capabilities that are there in Azure first come, because of our first party
AI investments, whether it’s in speech, or vision, or anything else. Even the infrastructure that is there
in Azure came out of our first party investments in Office 365 or, again, Bing and other areas. So we have
an approach which takes all of our cloud pieces together.
And that same thing is reflected even in the customer journeys. I think the Maersk example I walked you through
is probably a good one, where it may start with some commodity workload on Azure, or it may start with Office 365,
but then it will end up with HoloLens and somebody using Dynamics 365 for increased automation. In the case
of Maersk they were using field service and operations inside of Dynamics 365.
So to me those high level services will over time attach in Azure, but also in Dynamics, as well as in Office 365.
So to me that’s why Azure is pretty strategic for us, not just for the attachment of high level services and
what is defined as Azure, but the all-up digital transformation opportunity. That’s how Amy and I even think
about our margin structure. We need to improve on each one of the elements, but all-up we need to improve,
because we think that increased opportunity is what’s unique about our approach.
AMY HOOD: And I think what you’re hearing in that answer from Satya, Keith, is really about whether the
premium services exist, as you heard, at the Azure layer, or whether they show themselves in our productivity and
business process segment.
The fact that you may see competition where there may be less differentiation, the real differentiation is where you’re
always been able to achieve margin and margin expansion, which is in the completeness of the solution or its deliver,
the completeness of the business process change or not. And so I think while I do understand that people ask
a lot about that price competition at the lower level, I think what you’re seeing is because we’re able to continue
to move people up the stack, including all the way up to the business process layer, I think you’ll continue to see
us be confident in our ability to move and create
margin and growth.
KEITH WEISS: Outstanding, thank you very much.
CHRIS SUH: Thanks, Keith.
We’ll go to the next question, please.
KARL KEIRSTEAD, Deutsche Bank: Hi, thanks. I’ve got a follow-up actually on Azure, maybe to you,
Satya. And it’s the interplay between the cloud piece Azure and mostly the on-prem piece, what you guys call
the server product. Most of your peers, obviously, when they’re pivoting to the cloud are seeing weakness on
the on-prem side, but what’s unique about Microsoft is not only is Azure growth accelerating, but your server product
growth at 7 percent is up meaningfully year-over-year, as well. So we’re not seeing that tradeoff with Microsoft.
I suspect part of the explanation is that a lot of the Azure growth is net new, but I’m just curious when do you think
customers will actually start migrating existing on-prem Microsoft workloads into Azure, such that that server product
line might start to decelerate. Do you think there’s a prospect of that occurring in Fiscal ’18? Thank
SATYA NADELLA: Yeah, the timeframes of these migrations and so on are a lot more complicated than they
perhaps appear on the surface. Here’s what we think of. For example, right when everyone is talking about
the cloud, the most interesting part is the edge of the cloud, whether it’s IoT, whether it’s the auto industry,
whether it’s what’s happening in retail, essentially compute is going where the data gets generated and increasingly
data is getting generated at the volumes in which its drawing compute to it, which is the edge.
So if you look at even our announcement over this quarter, a lot of what we have done with IoT is create an IoT edge.
Of course we have an amazing cloud with the SaaS services for IoT, but the edge compute, the ability to run
a neural network at the edge, do interferences at the edge is exciting.
Azure Stack is going to completely change what hybrid is and the expectations customers have with hybrid. I
mean the GEICO example is a good one. What’s happening with SQL Server, SQL Server is no longer just about
a database that’s on-premise. It’s a database that’s on premise that can be tiered with the cloud, a single
table can be extended to the cloud, the queries will work across both the tiering.
And so to me the innovative work we’re doing is what I would characterize as the future of true distributed computing,
which is it will remain distributed. And that’s what we are building towards. We’ll talk a lot more at
Build about that architecture and what we are seeing with customers.
Then given that, what you are saying is true, which is there will be some which will be lift and shift of workloads,
but then there is lift, shift and modernizing of workloads. And in that modernizing phase it’s not just being
modernized to live only in what is called the cloud, but it will also be modernized to live in the edge of the cloud.
And so that’s the transformation at play. That’s a multi-year and a generational transformation. Quarter-to-quarter
there will be all kinds of volatility. But what is clear to me and clear to Microsoft’s engineers is that we
have a very clear world view of what is it that we want to get done and we stay focused on it.
AMY HOOD: And I think, Karl, to your question about how that shows up, it’s why you hear us focus more
on the all-up KPI between Azure and this sort of transactional or on-premise number, because the line between them,
both strategically and literally is more important to be blurred and going in that direction. And so this quarter
you saw a little bit healthier than we had thought, I pointed out. It tends to be in this instance Japan was
a little better. It can be product launch related. It can be macro-impacted.
But whether or not you see that in transactional, the uber-trend of being able to see it through the all-up KPI, the
dynamic Satya talked about, you’re going to hear us talk more and more about whether it’s a quote/unquote on-prem
server launch or an Azure feature about the integration of the two.
KARL KEIRSTEAD: Perfect, thank you.
CHRIS SUH: Thank you, Karl. We’ll go to the next question, please.
HEATHER BELLINI, Goldman Sachs: Great, thank you.
Again, I had a follow-up on Azure, as well. I was just wondering, Satya, if you could share with us, and I know
I’ve asked this in the past, but just kind of any qualitative commentary you could give us about PaaS adoption and
I’m also wondering in particular, given the high percentage of workloads on Azure running Linux what type of services
are you typically seeing run on top of the OS and how do you see your monetization of those workloads playing out
And then, Amy, just the follow-up for you would just be, and I apologize we had another earnings call tonight so I
might have missed it, but you usually give a comment about out-year OPEX on the call. And I was just wondering
if you had any high level thoughts there. Sorry, thank you.
SATYA NADELLA: Sure, Heather. Thanks for the question. Overall qualitatively, in terms of
past adoption of Azure, a lot of it comes with what’s happening, for example, in the services we talk about, like
IoT. We now have a much higher level managed service. We even launched a new packaging of it with the
IoT central, which allows developers who are building IoT solutions instead of assembling it themselves to be able
to use this managed service to be that much more agile and productive. So that’s usually the way we make the
atomic parts available, as well as these essentially SaaS services, or PaaS services.
The same thing with data, the Document DB is a massive thing for us. It’s the planet-scale database that supports
JSON and much more. And we see that as a core part of the data tier for many, many applications. We even
see, obviously, the end user parts of the infrastructure when it comes to enterprise mobility. So all-up we
have multiple pieces.
The other area is, of course, the entire tool chain of what’s happening with Visual Studio, to continuous integration,
to continuous deployment, and that’s a place where we have a very, very differentiated solution for developers and
developer productivity, which in some sense you can think of as it’s kind of like the Office 365 for developers,
but that’s all part of Azure.
So those are the places where there is PaaS services, but as I said earlier in response to the question, we also welcome
the use of I would say the most atomic building blocks of Azure, whether it just be a Linux container, Azure Functions,
which is very cost efficient for developers, because we know that over time it may be not just PaaS services in Azure.
It could be, in fact, a Dynamics 365 module.
The canonical example for me is someone who sort of collects data, does a prediction, ultimately then has to do something
about that prediction, which means some automation, like field service. So a lot of what is Dynamics Field
Service is actually in a module growth we are seeing, because of Azure IoT. And that relationship is not just
about Azure PaaS.
AMY HOOD: And to your specific question, Heather, on FY ’18, and OPEX, I did not, because we’re going
to see each other and have more time on May 10th, at the analyst briefing, and that’s where I’ll take some more time
to walk through FY ’18.
HEATHER BELLINI: Thank you.
CHRIS SUH: Thank you, Heather.
We’ll go to the next question, please.
MARK MOERDLER, Bernstein Research: Thank you, excellent.
Two questions, what was the drivers of the big growth in Dynamics 365? Is this large seasonality specifically
in this quarter? Is it a big deal, or should we expect growth in the same vicinity for the near future? And
then as a second question, as discussed in one of the previous questions about server and tools and the healthiness
of that growth, I’m trying to understand the drivers. Is this the product refresh cycle? Is it Azure
driving customer upgrades? Is it something else? Can you give a bit more color? That would be helpful.
I appreciate it.
SATYA NADELLA: Sure, Mark.
And let me start and then, Amy, you can add.
On the Dynamics 365 we are at the very, very beginning phase of the transition of Dynamics from primarily being on-premise
to now being a very modern, modular SaaS service. The Dynamics 365 momentum is picking up. I talked about
the revenue growth rate. And that’s definitely going to be what’s going to be true in the quarters to come
and the years to come.
But we do have a huge on-premise base. There is still a need for those on-premise products that will continue.
But our focus is on transitioning to the cloud and you’ve seen us do this successfully with Office 365. You’ve
seen us do that with Azure. And now we are ready to do that mainstream across what has been traditionally known
as CRM and ERP without, in fact, us thinking and talking about those suites, because we think that’s a pretty old
concept to have suites like that, which is we have now really made the entire Dynamics 365 much more modular, modern,
and much more efficient for customers. So that’s what’s happening in Dynamics.
The same thing on Azure, which is the driver is a lot of it is net new. IoT, for example, was not a workload
on the old server world, whereas it’s one of the big workloads for us, same thing with AI, not an old workload. So
there is new growth in Azure. There is the lift, shift ad modernize motion, as well, as well as a new need
for the edge of the cloud. So all three of them are in play, while recognizing we had a large business called
the server licensing business. So we have three new things that we are driving and a lot of large licensing
pieces that are just transitioning into these three motions.
AMY HOOD: And in particular in this quarter how to think about I think some of the in-period out-performance
versus what we see consistently, in the bucket of consistently premium workload growth has been consistent for us.
The double-digit annuity growth has been consistent for us and that I think is a driver we continue to look
for and be confident in its execution, quarter-to-quarter.
In the more temporal bucket this quarter, as well as last, you saw a bit of it, some geo help in certain geos that
may see and be more transactional in nature. Japan happens to be one of those geos. Then we are still
seeing some post-launch impact, specifically in the Windows Server side. And selling higher end SKUs, post-launch,
which has to do with some of the value inherent. So that’s how I kind of break down the drivers, Mark.
MARK MOERDLER: Excellent. I appreciate it. Thank you and congrats.
AMY HOOD: Thanks.
CHRIS SUH: Thank you, Mark.
We’ll take the next question.
WALTER PRITCHARD, Citi: Hi, thanks. Two things, Amy, I think you mentioned in the script that Windows,
there was some Windows volatility around the new SKU pricing. Could you go into some detail there? And
then secondarily, I know we may get this on analyst day, but around 606, and I know you’re going to adopt that early,
and I think that will change to some degree your annuity revenue, I wonder if you could give us any color, even directionally
on what percentage of that annuity revenue is license, that after 606 will go up front?
AMY HOOD: Great. On 606 we will talk about it in detail, on May 10th, in terms of the timing and
what you can expect. You’ll also note in the queue this quarter we do give a look at the initial impact on
an annual basis, using last year as an example. The biggest difference on an annual basis with the adoption
of 606 will really just be the change from Windows OEM.
Now what we will talk about in more detail is that the quarter-to-quarter results in any given year will be a little
bit more volatile, but over any annual period the biggest difference will really just be the change in some ways
back to how we thought about OEM revenue. So that’s what I would think of on 606.
WALTER PRITCHARD: And then a question on
AMY HOOD: Windows, I’m sorry. I answered them in the opposite order. And on the Windows pricing,
which we talked about, we do and always have worked with Windows SKUs as we release new products and add new value.
This quarter we had a bit of a mix shift to a higher end SKU. And starting in April we’ve introduced
other SKUs that have more value in them at lower processing specs. So what you’ll continue to see is that will
normalize, even though we saw some high-end SKUs this quarter do well. I would expect in Q4 to have the normal
breadth of those SKUs and revert back to looking much more like the commercial PC market itself.
WALTER PRITCHARD: Great, thank you.
CHRIS SUH: Thank you, Walter.
We’ll go the next question, please.
BRAD REBACK, Stifel Nicholas: Great.
Two quick questions, first off, Amy, there’s been a lot of talk about tax law changes on the corporate side. Would
a repatriation holiday impact how you guys allocate capital back to shareholders? And then just real quickly,
on the OPEX side, I know you don’t want to get too specific, but over the last few years you’ve been able to effectively
reallocate upwards of $2 billion from the phone business elsewhere. Is there still a fair amount of ability
to reallocate internally? Thanks.
AMY HOOD: Great. Let me take both of those. Let me separate your first question, because
I think you’re really asking two that I probably don’t relate as directly and I should do that for you. We’ve
been a long-time advocate of structural tax reform. And so we’ll just wait and see how things play out and
as decisions get made and proposals clarified we’ll share more about what that means for us.
Next, in terms of how we’ve thought about that impacting capital return, as you know I think we’ve been and executed
a significant capital return program over the past couple of years, including accelerating a buy-back program that
I think I feel very good about at the corporate level, in terms of the value it’s created. And so I wouldn’t
say that I view those two things as waiting for one to do the other. We’ve, in fact, continued to do what we
thought created the most value for shareholders, which is to invest in ourselves, acquire companies that help us
expand our TAM and grow, return dividends, as well as repurchase shares. And we’ve continued to do that this
quarter, as well. I think you’ll continue to see us take a balanced approach, but I don’t think of those as
The last question on OPEX, I think over the past couple of years we’ve continued to make decisions that said every
dollar we spend are we putting it in the right place for the long-term, whether that’s reallocating or adding new.
And what we expect is to grow new markets and perform really well in them with every dollar that we invest,
whether, frankly, Brad, it’s in OPEX or in COGS.
At this point both of those are very large buckets of investment which Satya and I, as well as the whole senior leadership
team, spend the majority of our time picking markets and making sure we execute in them. So in terms of our
ability to continue to do that, of course there’s opportunities. We learn, frankly, I think every week where
we can do better and where we can continue to invest to accelerate.
That being said, I don’t view any OPEX number as a constraint. More I view is the return healthy, is it growing
the top line, are we executing well on it. And if we are, it will make sense to spend more, and if we aren’t
it won’t. And so I tend to take that approach as opposed to solving for any one number.
BRAD REBACK: Great. Thanks very much.
CHRIS SUH: Thank you, Brad.
We’ll take the next question.
KIRK MATERNE, Evercore ISI: Thanks very much and congrats on the quarter.
Amy, I want to follow-up on your last point around investment and return on it. Around this time last year you
guys started spending a lot more or investing a lot more in OPEX on the Intelligent Cloud side in particular, and
this quarter you saw Intelligent Cloud operating profit on a constant currency basis get back to growth again, which
I think shows that those investments were, indeed, made some sense.
Now that you’ve spent a lot, you’ve obviously added a lot in sales and marketing resources, R&D resources on that
front, could you just give us qualitatively how you’re thinking about that? It seemed like last year you needed
to catch up to a certain degree in terms of go to market capabilities. Do you feel better where you are today
versus your opposition say a year ago just in terms of being able to capture the opportunity on the Intelligent Cloud
SATYA NADELLA: I’ll start and then I’ll transition to you, Amy.
I don’t view it that narrowly, quarter to quarter or even year to year. These are generational opportunities
that will play when it comes to the Intelligent Cloud or what’s happening in augmented reality. Either one
of those things, I think if we started viewing it quarter to quarter or year to year we’ll completely miss the trend.
We definitely need to be smart about two things that Amy said before, which is pick markets that are secular growth
markets and have big TAM. And most importantly what’s our role in it, is this something that the world needs
Microsoft to be doing or is it well served by others? That’s where we spend most of our cycles in.
The fact that we put some sales people and then there’s increased productivity is something that we obviously celebrate
and we track very closely. But the places where we are more likely to go and put our OPEX in the coming quarters
and the coming years are going to be about revenue that’s going to show up from multiple years out. And it
won’t be very transparent to you, and that’s how it is. I mean, we had not gotten started on some of the distributed
computing infrastructure in a completely different place, we wouldn’t have even had Azure. But I completely understand
that all of you measure us by what we’ve done for you lately, and that’s a fine way, an we’ll keep account of it.
But that’s not how it works.
AMY HOOD: I think the important part in what Satya said is the distinction between really engineering
investments that take multiple years of investment and we’ll view on a TAM, and holding ourselves accountable to
sales and marketing investments and are they earning the right return, are we doing them in the right way, are they
in the right market, are we investing in the right types of people and the right capabilities.
What I look and say that this number shows is that we are doing, it is encouraging, that the plan that we put in place,
that the sales team has done a really terrific job of executing on. And all that does is build more confidence
that both we picked a good market and we’re investing in the right type of people to make sure we land that opportunity
at customers, and then the most important thing is that the customer success is what will breed revenue for the next
quarter, the next year. And especially in this market, a generational move here really means, especially for
many of the workloads being moved, these pay off every year for the next ten.
CHRIS SUH: Thank you, Kirk.
We’ll go to the next question, please.
MARK MURPHY, J.P. Morgan: Yes, thank you very much.
Satya, I’m curious how is the pace of conversations around the Internet of Things, machine learning, and cognitive
services, and also what are you seeing as the killer app types of use cases that could resonate with customers in
terms of the more mainstream applicability?
And also, Amy, just given the strength in commercial bookings and also commercial bookings guidance, macro economically
do you see any signs of enterprise budgets opening up somewhat or different activity levels, more receptivity to
transformative projects? I’m just trying to understand maybe how we can separate out your company’s specific
momentum against any conceivable kind of incremental macro tailwind.
SATYA NADELLA: So let me start. The best way to think about how people are using, whether it’s
Azure or Dynamics 365 or other capabilities we have, is in the context of that digital transformation and the outcomes.
So when you say killer apps, the killer apps are how our customers are able to reimagine how they think about
customer engagement, how they think about employee empowerment, or the operational efficiency or how they can change
the products and the business models and the products.
And if you look at even the examples I used in this quarterly earnings call, Maersk and what they’re trying to do
across all of those is pretty transformative. There is machine learning and AI, there is IoT, there is new
type of business process automation with operations, all of that is sort of transforming Maersk.
What ThyssenKrupp has done in their elevator business and other business units, where using anything from HoloLens
to a front line worker to how they’re fundamentally moving their business model from essentially the margin on the
thing to the margin on the service, which has machine learning and AI built into it. Those are the killer transformation
opportunities that we are seeing.
And, in fact, it’s not about in fact taking any old workload per se, but it’s about reimaging what they want to do
across these, and in that context, of course, they’re lifting and shifting some of the older workloads, but they’re
modernizing the entire business process flow, and that’s what I think the killer opportunity, not any one technology,
but the entire flow.
AMY HOOD: And I think your question about is it really budgets -- I think you used the phrase opening
up. What I think is really interesting, I read probably the same CIO surveys you all do. Frankly the
numbers in those in terms of IT spend or intent to spend aren’t much different than we’ve seen.
For me what I think is missing in that question is really -- it’s not about any one customer saying, wait, I’m going
to spend 2 percent more, 3 percent more. These are companies actually deciding that the change is required,
not from an infrastructure perspective, but to change how they’re running their business itself. And so things
that used to look more to them, like capital expense through COGS or not just an IT budget, this is literally changing
every business process they run or changing the services they offer and thinking about literally driving their revenue
differently. And so I don’t really associate it probably as much with a quote/unquote budget that sits in IT
very narrowly. This is really about every budget that sits not just in IT but under every functional leader
of a company being spent differently and being spent on our technology.
CHRIS SUH: Thank you, Mark.
The next question, please.
ROSS MCMILLAN, RBC Capital Markets: Thanks very much. Two, I think both for Amy. The first is that
now that Azure gross margins have turned positive, would you say it would be reasonable to assume that the creative
cloud gross margins should continue to increase sequentially going forward or could other factors still create some
volatility quarter to quarter?
AMY HOOD: Overall, we continue to expect each service is going to get better and better. That happens
from two things, premium mix revenue doing well as well as the efficiencies we expect to get in COGS resulting in
gross margin improvement.
Now to your specific question on can you expect that every quarter sequentially, the answer is not really. The
mix amongst the services will always result in a pacing change. And so while year over year you may not see
as much, but you will see more sequential volatility as, frankly, you’ve seen over the past six quarters, even when
we’ve seen improvements in each of the underlying services, which tends to be how I focus on it a bit more.
ROSS MCMILLAN: That’s helpful. Maybe one other, if I could, just on CAPEX, I know that it was
-- there’s a timing delta here between Q3 and Q4, but I just wanted to step back. If you think about your CAPEX
plans ex-LinkedIn as you came into the year and how you think you’ll end up, are you going to be about on plan or
do you think you’ll be above or below?
AMY HOOD: Thanks. In general for the full fiscal year we’ll be right at or a little below where
I thought we would have been. And so that’s why the full year perspective that growth will slow is still on
track. And for simplicity I generally would think about all the delta from Q3, I would encourage you to move
it into Q4, as you think about what to expect.
ROSS MCMILLAN: Thanks so much.
CHRIS SUH: Thanks, Ross.
We’ll have time for one final question please.
PHILLIP WINSLOW, Wells Fargo Securities: Awesome.
Thanks, guys, for sneaking me in. Just a question on Office commercial. You guys reported another strong
quarter here, about 8 percent constant currency growth, and obviously continuing that acceleration that you’ve had
over the first three quarters of this year. Now I guess the question is to Satya and then Amy.
Satya, you still have a positive mix shift going on here, because we see the unit count growth, but also the revenue
growth, so positive spread there. Maybe help me walk through where you think we are in sort of this lifecycle
of Office 365, because you obviously had d lot of SKUs.
Then, Amy, in that context, for the last question on gross margins for Commercial Cloud, obviously you’ve made a lot
of headway on Azure, how do you think where we are, similarly on the lifecycle, on the gross margin side of 365?
SATYA NADELLA: Yeah, I can start. I mean I think with Office 365 we are trying to expand the appeal
of Office 365 on multiple dimensions. A lot of what we are still seeing in play is the rapid adoption, or the
increased adoption of Office 365 E3, which is what I think is driving a lot of the growth, the ASP growth.
Now, we have a good start with what is our high-end of the enterprise value, which is E5, some of the value we have,
whether it’s voice or analytics, and security, it resonates and we’re learning, we’re improving and we’re pushing
forward on that front. At the same time we’re also introducing new SKUs for the frontline workers. This is
one of the other first time trends I’m seeing where CEOs are more interested in productivity of their frontline workers
and so that’s another exciting space. It comes at a different ASP point. So it’s not exactly the same
as E5, but very important for us strategically to be able to increase the appeal of Office 365.
We also are working to make Office 365 and seeing good traction in segments like small business. The other aspect
of Office 365, which is important for us, is the international element, because we really never had very high penetration
of our higher end server SKUs in the international markets. And we finally get to sort of do that with the
service offering. So those are all the areas where there is significant room left and we’re not just standing
still in terms of adding value for new segments. So those are all in play.
AMY HOOD: And the way you’ve seen that, and I’ll relate it to margins, is this continued and consistent
install base growth and even still having the opportunities Satya laid out. And most of the RPU improvement
that we’ve seen has been, in fact, still due to the E3 transition, not due to the E5 transition. So we still
feel quite good about the opportunity, especially in some of the customers that have already moved to E3.
And then in terms of gross margin, margin actually here has been steadily improving. We’ve been in this business
a bit longer and it’s more mature. I do think here the opportunity is also RPU-based, actually here, in terms
of continuing to see margin improvement is continuing to raise the dollars per user that we realize to continue to
see that grow.
PHILLIP WINSLOW: Awesome. Thanks, guys.
AMY HOOD: Thanks.
CHRIS SUH: Thank you.
That wraps up the Q&A portion of today’s call. We look forward to seeing many of you in the coming months
at various investor conference events and you can find the details, including webcast information at the Microsoft
Investor Relations website.