Microsoft Corporation (MSFT) — Q3 2020 Earnings Call Transcript

Good afternoon, and thank you for joining us today. On the call with me are Satya Nadella, Chief Executive Officer; Amy Hood, Chief Financial Officer; Frank Brod, Chief Accounting Officer; and Keith Dolliver, Deputy General Counsel. On the Microsoft Investor Relations website, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provides a reconciliation of differences between GAAP and non-GAAP financial measures. Unless otherwise specified, we will refer to non-GAAP metrics on the call. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the company's third quarter performance in addition to the impact these items and events have on the financial results. All growth comparisons we make on the call today relate to the corresponding period 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. Where growth rates are the same in constant currency, we'll refer to growth rate only. We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission in the transcript and in any future use of the recording. You can replay the call and view the transcript on the Microsoft Investor Relations website. During this call, we will be making forward-looking statements, which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call and in the Risk Factors section of 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.

Thank you, Mike. We delivered double-digit top line and bottom line growth once again this quarter, driven by the strength of our commercial cloud. As COVID-19 impacts every aspect of our work and life, we have seen 2 years' worth of digital transformation in two months. From remote teamwork and learning to sales and customer service to critical cloud infrastructure and security, we are working alongside customers every day to help them stay open for business in a world of remote everything. There is both immediate surge demand and systemic structural changes across all of our solution areas that will define the way we live and work going forward. Our diverse portfolio, durable business models, and differentiated technology stack across the cloud and the edge position us well for what's ahead. And now, I'll highlight our innovation and momentum, starting with modern work. We are empowering people and organizations for a world of secure remote work and learning with Microsoft 365 and Teams. As work norms evolve, organizations are realizing they need a comprehensive solution that brings together communications, collaboration, and business process, built on a foundation of security and privacy. Microsoft Teams supports multiple communications modalities in a shared workspace. It's the only solution with meetings, calls, chat, collaboration, and with the power of Office and business process workflows in a single integrated user experience with the highest security as well as compliance. Teams keeps all your work and communication, conversations, documents, whiteboards, and meeting notes in context. It helps people collaborate inside and outside meetings, making them more efficient and effective while reducing fatigue. We're accelerating Teams innovation, adding new capabilities each week, and now support meetings of all sizes, meetings that scale from 250 active participants to live events for up to 100,000 attendees to streaming broadcasts. We saw more than 200 million meeting participants in a single day this month, generating more than 4.1 billion meeting minutes. Teams now has more than 75 million daily active users, engaging in rich forms of communication and collaboration, and two-thirds of them shared, collaborated, or interacted with files on Teams. The number of organizations integrating their third-party and Line Of Business apps with Teams has tripled in the past two months. In healthcare alone, there were more than 34 million Teams meetings in the past month. New capabilities enable providers like Northwell Health, New York State's largest health provider to deliver first-class telehealth. And the NHS in the United Kingdom is using Teams to ensure staff have the tools they need to do their vital work. Now that home offices are doubling as home schools, educational outcomes are at a premium. The combination of Teams and curriculum in OneNote and social learning with Flipgrid gives teachers a complete remote learning solution so that they can improve student outcomes. More than 183,000 educational institutions now rely on Teams. In the United Arab Emirates, more than 350,000 students are using Teams. In Italy, the University of Bologna chose Teams to move 90% of their courses for 80,000 students online in just three days. Twenty organizations with more than 100,000 employees are now using Teams, including Continental AG, Ernst & Young, Pfizer, and SAP. Just last week, Accenture became the first organization to surpass 0.5 million users, and we expanded our partnership with the NFL to include Teams, which powered their first-ever virtual draft. More broadly, we continue to see momentum with organizations across Microsoft 365. Office 365 now has 258 million paid seats. Usage of Windows Virtual Desktop tripled this quarter as organizations deploy virtual desktops and apps on Azure to enable secure remote work. From Interpublic Group and Cola to Vodafone, the world's leading companies are choosing Microsoft 365 as their productivity cloud. And we continue to see strong demand for our premium offerings from customers like Mastercard, Autodesk, AARP, and Coca-Cola, which chose not only Microsoft 365 but Dynamics 365 and Azure in a five-year multi-cloud agreement. We're also expanding our opportunity with consumers with Microsoft 365 Personal and Family, which now has more than 39 million subscribers, and we're bringing Teams to consumers for the first time so that they can stay connected with family and friends. Windows 10 now has more than 1 billion monthly active devices, up 30% year-over-year, and we are seeing demand for Windows 10 PCs from small screens to large screens to dual screens. Now on to security. Security remains a strategic priority for every organization, and the shift to remote only increases the need for integrated end-to-end, zero-trust security architecture that reduces both cost and complexity. Third-party analysts affirm our leadership as the only company that offers comprehensive identity, security, and compliance solutions. This quarter, we introduced new capabilities to protect customer data no matter where it resides. Microsoft Defender ATP now supports Linux in addition to Windows and macOS with iOS and Android to come soon. A new insider risk management in Microsoft 365 helps organizations detect and mitigate malicious activity. The world's largest hedge fund, Bridgewater Associates, is using security services built into Microsoft 365 to protect employees and core services in a zero-trust environment. Retailer ASOS is using Azure Sentinel to detect and mitigate threats, and the need to secure remote identity and access management is increasing demand for Azure Active Directory, now at 300 million active users. Now on to developer tools. We have the most complete developer tool chain, independent of language, framework or cloud from GitHub to the world's most popular code editing tool, Visual Studio Code. And our developer relevance is increasing. For over a decade, developers have come together remotely on GitHub to build the world's software. As of today, we have 50 million developers on GitHub. From Twilio to the U.S. Department of Veterans Affairs to more than 10,000 engineers at Daimler, GitHub is where developers go from idea to code and code to cloud. Developers are also collaborating on mission-critical projects from tracking the spread of COVID-19 to implementing contact tracing to helping expand access to personal protective equipment. We are bringing GitHub to even more developers, making core features free for the first time for teams of any size, and our acquisition of npm makes GitHub the largest software repository for JavaScript. Now on to Power Platform. COVID-19 has accelerated the urgent need for every business to create no-code/low-code apps and workflows in hours or days, not weeks or months. Power Platform is already used by more than 3.4 million citizen developers and business decision-makers. If you can create an Excel spreadsheet, you can create an app, build a virtual agent, automate a workflow, analyze data, and share insights in real time. In just two weeks, Swedish Health Services, the largest nonprofit health provider in the Seattle area, used Power Apps to track critical supplies. Thousands of organizations are relying on new integration between Microsoft Teams and Power Apps to share timely information. And governments around the world are using Power BI to share the latest COVID-19 data with their citizens. Leaders in every industry, from global healthcare company, GSK, to Coca-Cola to Toyota, are all using Power Platform to accelerate their automation. Now on to Dynamics 365. Dynamics 365 is helping thousands of organizations accelerate digital transformation as they remote every part of their operations from manufacturing to supply chain management to sales and customer service, inclusive of new scenarios like curbside pickup, contactless shopping, remote customer assistance, and operations. Patagonia is using Dynamics 365 Commerce to rapidly move to new, more intelligent distribution and fulfillment models, including contactless shopping. And we are working with card issuers like American Express so merchants who use Dynamics 365 Fraud Protection can reduce fraudulent activity as they process more transactions online. In field service, the world's largest commercial real estate services firm, CBRE, is using Dynamics 365 Remote Assist to help keep its life sciences tenants' labs fully operational from afar. And enterprise software company, C3.ai, founded by Tom Siebel, shifted its entire sales force to Dynamics 365 Sales in less than two weeks. Now to LinkedIn. Amidst the changing jobs market, LinkedIn's role in creating economic opportunity for every member of the global workforce has never been more acute. LinkedIn is where more than 690 million professionals go to connect, learn new skills and find new opportunities, contributing to record levels of engagement across the platform in Q3. We are helping organizations attract, retain and develop talent with our portfolio of Talent Solutions, Talent Insights, Glint and LinkedIn Learning. Professionals watched nearly 4 million hours of content on LinkedIn Learning in March, a nearly 50% increase month-over-month. With LinkedIn Live, people and organizations can broadcast video content to their networks in real-time. Streams are up 158% since February. And the combination of LinkedIn Sales Navigator and Dynamics 365 gives sales professionals tools for more effective remote selling. Now on to gaming. People everywhere are turning to gaming to sustain human connection while practicing social distancing, and we continue to deliver new, exclusive first- and third-party content to attract and retain gamers. We saw all-time record engagement this quarter, with nearly 19 million active users of Xbox Live, led by the strength on and off-console. Xbox Game Pass has more than 10 million subscribers, and we are seeing increased monetization of in-game content and services. And our Project xCloud gaming service now has hundreds of thousands of users in preview across seven countries, with eight more launching in the coming weeks. Now on to Azure. Now more than ever, organizations are relying on Azure to stay up and running, driving increased usage. We have more data center regions than any other cloud provider. And this quarter, we announced new regions in Mexico as well as in Spain. We are the only cloud that extends to the edge, with consistency across operating models, development environments, and infrastructure stack. Now Azure Edge Zones extend Azure to the network edge, connecting directly with the carriers' 5G network to enable immersive real-time experiences that require ultra-low latency. And our acquisition of Affirmed Networks will help operators deploy and maintain 5G networks and services cost-effectively and securely. From BlackRock to Coca-Cola to Genesys, leading companies in every industry are choosing Azure. The NBA is using Azure and our AI capabilities to build their own direct-to-consumer experiences, and the world's largest companies like AB InBev and Mars continue to migrate their SAP workloads to our cloud. In AI, customers are applying a comprehensive portfolio of tools and services and infrastructure to address unique challenges, including those created by COVID-19. In healthcare, we are seeing compute, data, and AI come together to help speed up response from testing to therapeutics and vaccine development. Healthcare providers have created more than 1,400 bots using our Healthcare Bot service, helping more than 27 million people access critical healthcare information. The Centers for Disease Control is using the Healthcare Bot to help people self-assess for coronavirus symptoms. Adaptive Biotechnologies is using our tools to decode the immune system's response to the virus. And ImmunityBio is using more than 24 petaflops of computing power on our cloud to help researchers build models in days instead of months. Enterprises are using our speech services to manage a record influx of customer service inquiries, including Poste Italiane, which is using it to automatically respond to nearly 170,000 calls per day. All of 6 million hours of speech were transcribed in March alone. In closing, we will continue to work and innovate alongside our customers as their digital-first responders today and as their trusted digital transformation partners going forward. With that, I'll hand it over to Amy, who will cover our financial results in detail and share our outlook, and I look forward to rejoining for your questions.

Thank you, and good afternoon, everyone. As Satya discussed, the COVID-19 health crisis is changing the way our employees, customers, partners, and communities live and work together. In a new environment, our team addressed surging usage and remote business process adjustments effectively. Therefore, in Q3, revenue was $35 billion, up 15% and 16% in constant currency. Gross margin dollars increased 18% and 20% in constant currency. Operating income increased 25% and 28% in constant currency. Our earnings per share was $1.40, increasing 23% and 27% in constant currency. Let me take a moment to discuss the impact of COVID-19 on the quarter. In our consumer business, the landscape evolved quickly following our mid-quarter guidance update. The supply chain in China returned to more normal operations at a faster pace than we had anticipated. We saw increased demand from work, play, and learn-from-home scenarios, benefiting Windows OEM, Surface, Office Consumer, and Gaming. This was partially offset by a significant reduction in advertising spend, which impacted our Search and LinkedIn businesses. In our commercial business in March, we noted healthy Azure consumption, and, as Satya mentioned, increased usage across Windows Virtual Desktop, Power Platform, and Microsoft 365, particularly in Teams and our advanced security solutions. However, we also experienced changes to our sales dynamics, particularly in the industries and segments most impacted by COVID-19, with a slowdown in our transactional business across segments, especially in small and medium businesses. In Enterprise Services, growth rates slowed as consulting projects were delayed. Renewals on annual contracts in LinkedIn's Talent Solutions business were affected by the weak job market. Moving to our overall results, commercial bookings increased 7% and 12% in constant currency on a relatively small expiration base and strong prior year comparable. Growth was driven by strong renewal execution, consistent with prior quarters, though we did see impacts from the previously mentioned sales dynamics. Commercial remaining performance obligation increased 24% to $89 billion, with approximately 50% expected to be recognized in revenue in the next 12 months, in line with prior quarter trends. Our commercial revenue annuity and mix increased 2 points year-over-year to 92%. Commercial cloud revenue reached $13.3 billion, growing 39% and 40% in constant currency. The commercial cloud gross margin percentage increased 4 points year-over-year to 67%. We observed a significant improvement in Azure gross margin percentage, with short-term utilization gains helping to more than offset the sales mix shift to Azure. The company's gross margin percentage was 69%, up 2 points year-over-year, driven by favorable segment sales mix and improvements across all three of our segments. FX reduced revenue growth by 1 point and had no impact on operating expense growth, while the impact on COGS growth was slightly more favorable than expected, also reducing growth by 1 point. Operating expenses grew 10%, slightly below expectations, primarily due to lower marketing and travel spend in March. Operating margins improved this quarter as a result of higher gross margins and disciplined investment decisions in strategic high-growth areas. Now to our segment results. Revenue from Productivity and Business Processes totaled $11.7 billion, increasing 15% and 16% in constant currency. Office Commercial revenue grew 13% and 15% in constant currency, while Office 365 Commercial revenue increased 25% and 27% in constant currency, driven by installed base growth across all workloads and customer segments, along with higher ARPU and strong upsell to E5. Office 365 Commercial seats grew by 20% to nearly 258 million, with an increasing mix from Microsoft 365. Office Consumer revenue grew 15% and 17% in constant currency, fueled by growth in Office 2019 and Office 365 subscription revenue, leading to 39.6 million Office 365 Consumer subscribers. Dynamics revenue grew 17% and 20% in constant currency, supported by Dynamics 365 growth of 47% and 49% in constant currency. LinkedIn revenue increased 21% and 22% in constant currency, although early quarter momentum was slightly offset by a slowdown in advertising. Segment gross margin dollars rose 16% and 18% in constant currency, with gross margin percentage increasing 1 point year-over-year as improvements in Office 365 and LinkedIn margins more than offset the growing mix of cloud revenue. Operating expense increased 12% and 13% in constant currency, driven by ongoing investments in LinkedIn and cloud engineering, while operating income rose 20% and 23% in constant currency. Next, the Intelligent Cloud segment posted revenue of $12.3 billion, increasing 27% and 29% in constant currency, exceeding expectations due to strong customer demand for hybrid offerings. Server products and cloud services revenue increased 30% and 32% in constant currency. Azure revenue grew 59% and 61% in constant currency, reflecting continued strong growth in our consumption-based business. In our per-user business, our enterprise mobility installed base increased by 34% to over 134 million seats, benefiting from Microsoft 365. Our on-premises server business also grew 11% and 12% in constant currency, largely driven by demand for our hybrid and premium solutions. Enterprise Services revenue rose 6% and 7% in constant currency, with growth in Premier Support Services offsetting consulting delays. Segment gross margin dollars increased 30% and 32% in constant currency, and gross margin percentage improved by 2 points year-over-year as Azure gross margins significantly improved. Operating expense increased by 19%, primarily due to ongoing investments in Azure, while operating income grew 42% and 46% in constant currency. Now to More Personal Computing. Revenue was $11 billion, increasing 3% and 4% in constant currency, surpassing our revised expectations from our mid-quarter guidance due to better-than-expected Windows OEM, Surface, and Gaming revenue, which outweighed lower-than-expected Search revenue. The OEM and Surface revenue benefited from an improved supply chain in China, increased demand from remote scenarios, and the continued effects of Windows 7 end of support. However, in OEM non-Pro, those dynamics faced offsetting pressures in the entry-level category. Windows Commercial products and cloud services grew 17% and 18% in constant currency, driven again by Microsoft 365 and demand for our advanced security solutions. Search revenue ex TAC increased 1%, below our expectations, due to significantly reduced advertising spend. In Gaming, revenue declined 1% and remained relatively unchanged in constant currency despite higher user engagement than anticipated. Xbox's content and services revenue increased 2%, thanks to strong growth in Game Pass subscribers and Minecraft. Segment gross margin dollars increased 6% and 8% in constant currency, while gross margin percentage rose 2 points year-over-year, attributed to a higher-margin sales mix. Operating expense was down 3%, due to a redeployment of engineering resources to higher growth opportunities, and as a result, operating income grew 15% and 17% in constant currency. Now back to total company results. Capital expenditures, including finance leases, were $3.9 billion, up 15% year-over-year to support growing demand for our cloud services, with COVID-19-related delays lowering expectations. Cash paid for PP&E was $3.8 billion. Cash flow from operations increased by 29% year-over-year to $17.5 billion, driven by healthy cloud billings and collections, while free cash flow was $13.7 billion, a 25% increase. Other income and expense was negative $132 million, lower than anticipated due to FX remeasurement and net recognized losses on investments. As a reminder, we are required to recognize unrealized gains or losses on our equity portfolio. Our effective tax rate was slightly above 16%, in line with expectations. Finally, we returned $9.9 billion to shareholders through share repurchases and dividends, a 33% increase year-over-year. Now let's move to our outlook, starting with our expectations for the COVID-19-related impact. In our consumer business, we expect continued demand across Windows OEM, Surface, and Gaming due to the shift to remote work, play, and learn from home. Our outlook assumes this benefit will persist through much of Q4, though growth rates could be affected as stay-at-home guidelines ease. We assume advertising spend levels from March will not improve in Q4, which will impact Search and LinkedIn. In our commercial business, our robust position in durable growth markets suggests we will see consistent performance on a large annuity base, with continued usage and consumption growth across our cloud offerings. However, we anticipate that the sales dynamics observed in March will persist, including a significant impact on LinkedIn from the weak job market and increased volatility in new deal closures. In commercial bookings, growth from strong renewal performance on a larger Q4 expiry base will be offset by some large commitments from the prior year and the previously mentioned sales dynamics. We expect commercial cloud gross margin percentage to stay relatively consistent year-over-year, as improvements in IaaS and PaaS gross margin percentages will be offset by a revenue mix shift to Azure. With the easing of supply chain constraints, we expect a material sequential increase in capital expenditures to support growing usage and demand for our cloud services. In terms of FX, we expect a larger impact to our results due to the stronger U.S. dollar. Based on current rates, FX should now decrease total company, Productivity and Business Processes, and Intelligent Cloud revenue growth by approximately 2 points, and also decrease More Personal Computing revenue growth, total company COGS, and operating expense growth by about 1 point. Now for segment guidance, which features wider ranges than usual due to uncertainties in our business related to higher in-quarter sales and revenue recognitions. In Productivity and Business Processes, we expect revenue between $11.65 billion and $11.95 billion. Approximately 80% of this revenue comes from the earnout on existing contracts and agreement renewals. The remaining 20%, primarily from annuity agreements, transactional licensing, and LinkedIn, is subject to more volatility in the current environment. In Office Commercial, revenue growth will continue to be driven by Office 365, with strong upsell opportunities, particularly for our advanced security solutions. However, growth will be somewhat offset by ongoing weaknesses in transactions, some effects from the previously mentioned sales dynamics, and a challenging prior year comparison, where 4 points of growth stemmed from a larger mix of contracts with higher in-period recognition. In Office Consumer, we expect low single-digit revenue growth, sequentially lower as subscription growth is countered by a slowdown in our Office 2019 transactional business. In LinkedIn, we anticipate continued strong engagement on the platform, but a substantial portion of revenue is tied to customer hiring needs and advertising. Consequently, we expect a marked slowdown to mid-single-digit revenue growth. In Dynamics, we project low double-digit revenue growth with continued Dynamics 365 momentum, slightly offset by a slowdown in new projects with longer lead times. For Intelligent Cloud, we anticipate revenue between $12.9 billion and $13.15 billion. Approximately 80% of this revenue will come from earnouts on existing annuity contracts, agreement renewals, and consumption from existing Azure workloads. The remaining 20%, mostly from new annuity agreements, transactional licensing, and enterprise services consulting revenue, remains subject to fluctuations. In Azure, revenue growth will again be propelled by our consumption-based business, with ongoing strong growth throughout our customer base, although we expect some moderation in the most affected industries and segments. Our per-user growth will be influenced by the expanding installed base and sales dynamics discussed earlier. In our on-premises server business, we predict revenue to dip by low single digits against a strong prior year comparison, with sustained hybrid demand offset by some transactional weaknesses. In Enterprise Services, we foresee a low single-digit revenue decline due to ongoing delays in our consulting business. In More Personal Computing, we expect revenue between $11.3 billion and $11.7 billion. About 75% of that revenue across OEM, Surface, Search, and Gaming is earned within the quarter. In Windows, overall OEM revenue growth should be in the low to mid-single digits due to a strong prior year comparison. In Windows Commercial products and cloud services, we expect mid-single-digit revenue growth, tempered by transactional business headwinds and identified sales dynamics. In Surface, continued strong demand should lead to revenue growth in the low teens. In Search ex TAC, we expect revenue to decline in the mid-20% range, similar to March, while in Gaming, we expect revenue growth in the high teens with robust user engagement across the platform. Returning to overall company guidance, we expect COGS of $11.55 billion to $11.75 billion, and operating expense of $11.8 billion to $11.9 billion. Other income and expense should be negative $100 million, as interest expense is expected to more than counter interest income. Finally, we anticipate our Q4 effective tax rate to be around 18%, slightly higher than our full year tax rate of 17% due to the geographic mix of revenue. I would like to conclude by sharing a few thoughts as we look beyond Q4 and into the next fiscal year. Our focus remains on strategically managing the company for the long term, optimizing decisions for greater customer value and long-term financial growth and profitability. We will continue to provide increased support to our customers and partners as they navigate the uncertain future ahead, deepening our engagement and delivering added value. We will also aggressively expand our cloud infrastructure to cater to current usage surges and the growing customer demand for our differentiated cloud offerings in the future. Significant investments will continue to be made against strategic growth opportunities, both organically and through strategic acquisitions like Affirmed Networks this quarter. Given our strong financial position and free cash flow generation, we have the flexibility to pursue these goals and maintain our commitment to capital return. Microsoft thrives when our customers thrive, and we are well-positioned to continue investing in and contributing to their future success. With that, Mike, let's go to Q&A.

Thanks, Amy. We'll now move over to Q&A. Operator, can you please repeat your instructions?

Very impressive quarter in a difficult time, and I hope all of you and your families are all safe and healthy. Satya, a question for you. You did a really great job of talking to how well the expanded portfolio, a really broad portfolio that Microsoft brings to the market has helped customers during a crisis period and a period that engendered a lot of change within the way organizations were operating. Can you talk to us a little bit about how much of that sort of assistance and how much of that you were able to actually take to revenues, if you will? How much of that is stuff that you could actually monetize today versus given the customer relationship, given the focus on the long term, you have to sort of let play out over time, and it's about kind of expanding usage and expanding the relationships with customers that you expect to pay out over a longer period?

Thank you, Keith, for your question. Our perspective is to support our customers during their most critical times, rather than focusing on immediate revenue implications. We believe that when our customers succeed, we will succeed in the long run, which is central to our business model. Currently, we are mainly in the first response phase, where there's a high demand for remote work solutions such as Teams, remote desktop, and security tools. Some sectors, such as healthcare, education, public organizations, and certain retail segments, are experiencing an increase in demand that we are scaling to meet. As we move into the next phase of recovery, economic activity will gradually return, and we'll need to adjust our strategies accordingly. Hybrid work will be part of the landscape for some time, and our product strengths will be helpful to our customers. For example, Teams is not just about numerous video meetings; it is a tool for productivity that will become increasingly valuable as work dynamics evolve. The third phase will involve structural changes that will be permanent, like the advancements in telemedicine and education driven by AI. Businesses utilizing digital twins will gain a significant advantage in automation and planning. We see opportunities to contribute to productivity growth, but in the immediate term, we are focused on strengthening relationships, acquiring new customers, and increasing usage within existing ones, which will ultimately benefit our economics in the long run.

And maybe just to add on to that, the way you might think about that, Keith, is the first stage for many of the licensing protocols was to include trial offers for many of our customers who were in need of the specific things we just discussed and, over time being able to convert that into a monetization engine or, for example, to take some of the usage surge we've seen even across our consumer properties or even in gaming or Office 365, which is now Microsoft 365 for consumers. I think there's a lot of opportunity here for us to continue to add value. And when you add value, long-term customer value certainly goes up.

Congratulations, Satya and Amy, on the quarter and how you've been able to shift the business over many years to position it so well into these difficult times. We understand there are supply chain issues that have been impacting server deliveries in the quarter, and the changes in demand have been massive. During the quarter, there were disruptions in Azure, Xbox Live, and Teams, we heard. How is Microsoft coping with these sudden demands from work from home? Do you have enough capacity? How quickly can you add capacity? Can you give us a sense of how you deal with that on the Azure and the overall business side?

Yes. Maybe I'll start, and Amy, you can add to this. Overall, first, I think I would say the current cloud architecture whether it's at the infrastructure level or the SaaS applications with M365 or Azure have been, I think, very, very helpful in us being able to all as an economy pivot to this new way of working, working from home, remoting all of our operations. If you think about it, like the orders of magnitude increase we've seen in usage, in our own case with our applications such as Teams or Virtual Desktop have been tremendous. And that's happening, as I said, in different segments with our customers as they move to remote operations and are dealing, in some cases, with their own surge demand or what you've seen even in gaming and other entertainment categories. So I would say these architectures withheld well. We did have, as you mentioned, some supply chain issues coming into the quarter, which have largely worked themselves out. But we have a data center architecture and a footprint that really supports our customers' needs for both the elasticity of demand they need but also compliance. So one of the things is data sovereignty and security is not going to go away ever, especially in the geopolitical environment we live in. If anything, it's going to be more important for us to support this need for people to scale while keeping them compliant. And so we feel well positioned for that. With that, I'll transition to Amy to add further.

I think, Mark, in many ways, the way you see that capacity show up is in the Q4 CapEx guide. And so while we spent $3.9 billion in Q3, that was certainly short, in particular, on the server side in terms of getting what we need into the data centers. Things got a lot better in March, and they're continuing to get better. And so I feel good that we'll have a healthy CapEx number in Q4 but more importantly continue to get ahead of the surge demand and also there's the continuing demand growth we're seeing across the properties.

I actually have two questions for you. Could you provide details about new logo growth in Azure and Office 365 compared to net expansions? Any insights on what happened during the quarter would be appreciated. Additionally, Satya, how do you view the adoption curve of Azure and the acceleration of cloud workloads over the next few years due to potential changes resulting from COVID? Do you think your three-year outlook for cloud adoption is improving because of the current situation?

Yes. Let me address the second question first, and then you can take the first. It's clear that transitioning to the public cloud is capital efficient, even during challenging economic times. For any business, the discussions we've been having indicate that those facing tough economic cycles should move to the efficient frontier as quickly as possible. This shift will provide them with greater agility, elasticity, and improved unit economics, both during and after this crisis. The migration to the cloud represents a significant long-term change. Additionally, the architecture of cloud solutions will include both the cloud and edge computing. It's not just about moving away from on-premise solutions; it's about having an architecture that meets the growing importance of edge computing. This is why our initiatives in edge computing, our collaboration with Affirmed Networks, and the launch of Azure Edge Zones align with what we see as the foundational infrastructure architecture for the future.

And to your first question on really expanding the customer base versus adding seats or consumption within that customer base, we actually saw both this quarter again, the way you would have seen a little bit of weakness, I guess, in on-premises Office Commercial due to transactional weakness and maybe SMB. But outside of that, Heather, it didn't really show a different pattern than I would have normally expected in terms of a breakdown between those. The one difference I will say is just because there was so much deployment done in the past four weeks, especially around Teams and some of the other workloads, there's certainly a distinction that a lot of that was expanding the footprint as opposed to deployment much faster than I think many enterprises had initially planned to do so.

Satya, I was curious if you could share on the next chapter of Teams and what you think it looks like, and maybe speak to the monetization halo that you're seeing with the rest of the product line spinning off of the great adoption, which seems to be doubling every time you give us the stats. Thanks for getting our firm up on Teams basically in a couple of weeks.

Thanks, Brent. Overall, the way we've always approached Teams is as a user experience and, I would say, a scaffolding to sort of incorporate what's a modern way of working. We always felt that we needed to have, in some sense, best-in-class functionality in each of the modalities, right, whether it's meetings or chat, collaboration, or business process. But the most important thing is to bring these together so that people can get more done, teams of people and organizations can get more done. And that's what you see play out even in this pandemic, if you look at it. Of course, there's no question, meetings are most important. We do a lot of them. But at the same time, what is happening in a meeting is the important context that can't get lost. That's what's going to have continuity, whether it's the whiteboard you created, it's the OneNote you shared, it's the document you edited together, it's a business process alert that you are responding to. Thinking that through holistically is the most important thing. And that's where our focus will be. In fact, some of the stats I shared even around some of the number of business process applications that are getting integrated, one of the most exciting things to me that happened even in this COVID response, people were able to use Power Platform to build new applications in hours, put that into Teams, and then get their first-line workers to be able to track, say, PPE because there was no ERP system that did that. That ability to digitize at high rates and do it in the context of how people work and collaborate, I think, speaks to the power of the Teams platform. And when Teams does well, all of Microsoft 365 does well.

And I'm glad to hear that you all are well, and I hope the same for your families. Satya, in your prepared remarks, you mentioned how Microsoft continues to broaden its relevancy with developers from GitHub, Visual Studio, Visual Studio Code, dev ops, dev server and most recently, obviously, a multi-cloud infrastructures code with Azure Arc. Just two questions on this topic. Firstly, Satya, how do you think about how much of that dev ops life cycle Microsoft needs to address directly versus partnering with third parties or maybe open source? And then secondly, for both Satya and Amy, if COVID-19 is really creating sort of a zeitgeist opportunity for the cloud and digital transformation, how are you seeing your broadening CI/CD pipeline product set impacting Azure's competitive position near and longer term?

Yes. From the beginning, we have stated that our acquisition of GitHub represents our commitment to the developer tools and services sector as an end goal, not just a means to another end. This focus is significant to us, as Microsoft was originally established as a developer tools company. With GitHub, we are dedicated to executing this strategy, prioritizing the diverse choices of developers. We aim to enhance GitHub as a code repository by integrating our top-notch code editing tools, outstanding security features, and the best CI/CD and DevOps capabilities, along with live operations tools like Azure PlayFab. Our approach is inclusive; we support collaboration with others, as reflected in our marketplaces on both Azure and GitHub. Our commitment extends to maintaining an open community that embraces various developer preferences. Furthermore, we are applying the same principles we used to develop Microsoft 365 for knowledge workers and Dynamics 365 for business decision makers to the developer space. We anticipate an increase in software developers, whose workflows will significantly influence those beyond the development field. This makes our focus on this SaaS category crucial.

Hope you guys are staying safe. I wanted to focus on Dynamics. It's obviously not the biggest part of Microsoft, but it's a very important growth one. In this sort of environment where there's a lot of uncertainty, with Dynamics, you're addressing some very fundamental kind of business apps. What do you see there in terms of customer appetite to kind of go for this at this point? Is that kind of an area, because it's now online compared to on-premise, that is seeing more adoption, fast adoption? Or can you talk a little bit about the trends there?

I believe it is crucial for businesses to be agile in adapting to their process needs. For instance, retailers may now require contactless shopping solutions, and Dynamics can support this by enabling the use of standard cameras with AI modules, all backed by a data model that facilitates shopping in physical stores, curbside pickup, or remote assistance. These examples highlight our priority focus. As long as our business applications like Dynamics 365 address immediate needs, we anticipate new projects will initiate, as this is essential for economic recovery. However, applications that require longer implementation times may take customers more time to evaluate. We are confident in our ability to capture emerging scenarios, and we view Power Apps alongside Dynamics as integral to our business applications. Together with Azure, we are well-suited to meet the increasing demands for digitization, especially in situations where businesses cannot afford to wait months for deployment or implementation. This is where we excel.

And I think that you would say that we've seen that in our pipeline and really in the customer demand scenarios. So I think what we've seen is really more of a shift to some of these quick time-to-value deployments and a real change in terms of new, long lead time projects there, and I think that's probably not surprising.

One scenario I should mention is that for anyone looking to generate revenue, remote sales will be very important. The combination of Dynamics Sales and LinkedIn Sales Navigator is the best solution for driving B2B sales. These types of solutions will be particularly relevant in times like this.

I'm interested in whether you see the current environment as a net tailwind or a net headwind on Azure growth, just as we try to weigh the idea of the pandemic as a forcing function to adopt cloud a little more rapidly versus, on the other hand, potential economic pressure on IT budgets. How do you think that balances out for bookings and for consumption?

Let me start, and Amy, you can add to it. There are, as you said, many different ins and outs here. But if you step back and ask yourself, say, two years from now, 'Is there going to be more being done in the public cloud or hybrid cloud or less?' The answer is more, just because it is more efficient. It is the only way for you to have even the business continuity required in times like this, and your needs going forward of increasing digitization are going to be met with better pricing, better economics at a unit price level for the given business. So that's sort of what we use to forecast out what we commit, both in terms of CapEx, OpEx, innovation, and customer engagement. To your point, ultimately, Microsoft's not immune from what's happening broadly in the world in terms of GDP growth. But at the same time, if there is going to be economic activity, then I would claim that digital as a component of that economic activity is going to increase. And specifically, the full stack we have from infrastructure to our SaaS applications are going to be very competitive in that context.

I think it's very clear that our capital investment and perspective serve as a long-term advantage. Satya mentioned a timeframe of two or three years, and if we look at something like bookings, we might see a trend where people prefer smaller commitments and opt for pay-as-you-go models. This allows for easier transitions without extensive budget discussions within departments. In many ways, we are already observing a shift in thinking towards long-term planning. This will influence bookings, much like big deals have in the past. Overall, I believe that, over the long term, these factors will indeed work in our favor.

And glad to hear you're staying safe. Satya, given the incredible spike you're seeing in Teams and broader Office adoption around remote work, I guess maybe first, given how this crisis has dramatically accelerated some of these adoption curves, how do you think about the longer-term growth and monetization trajectory on Teams and Office maybe versus pre-COVID levels? And then if you think about your competitive positioning, having both the opportunity to solve remote work challenges from a productivity standpoint and infrastructure challenges from an Azure standpoint, how does the combination of those change some of the competitive dynamics in the market right now?

Thank you for your question. As I mentioned earlier, the use of Teams significantly enhances the overall experience of Microsoft 365. Regarding your inquiry about how usage translates into monetization, one important aspect we haven't discussed much during the Q&A is security. A major consideration for organizations adopting remote work is ensuring secure management from identity to device endpoints, applications, and the underlying infrastructure. This necessitates a zero-trust architecture, which is integrated within Teams. Similarly, compliance is crucial; having Teams is one thing, but ensuring information shared within it adheres to established protection policies is vital. This architectural advantage allows us to enforce consistent principles across all applications. We plan to monetize these offerings at various subscription levels within Microsoft 365, and we believe we are well positioned for that. Additionally, we've always maintained that we don't view our capital allocation for cloud infrastructures—whether for Azure, Dynamics 365, Microsoft 365, or xCloud—as separate entities. Instead, we consider them as part of a unified platform built on Azure, which enhances our capital efficiency. From a customer perspective, we aspire to succeed in each layer based on its unique merits while maintaining openness. There are significant benefits to this approach, and our recent deal with Coca-Cola exemplifies a client looking to leverage our security across all three cloud services and products. Moving forward, we intend to focus on being competitive and open across all layers.

And maybe to add that I think in some ways speaks in Alex's question goes back to the very beginning of how we feel the value sits in that Microsoft 365. But even more broadly is that while we've seen a surge in Teams now, there was a lot of surging in security and compliance six months ago and six months before that. We've seen increased usage across multiple products in our line and that includes Windows and the PC. And so this very holistic and broad commercial opportunity, but also that extends, in many ways, to consumer opportunities for us as well, is connected. And that breadth, in a moment and a period like this, all the pieces are important to value long term here to a company being able to transition through the phases that Satya talked about, from this initial phase of emergency response to a hybrid phase to ultimately what I think we all believe is a very different way and a long-term way of working and collaborating together and driving a digital economy. So I think in some ways, the breadth of this company and where we've invested over the past few years, it's not just Teams but maybe a few products that have served us well and served our customers well.

Thanks, Alex. That wraps up the Q&A portion of today's earnings call. Thank you for joining us today, and we look forward to speaking with all of you soon.

Thank you all. Thank you, and stay safe.

Stay safe. Thanks.