Microsoft Corporation (MSFT) — Q4 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 our 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 fourth quarter performance in addition to the impact 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’ll 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. Good afternoon, everyone. We achieved record results this fiscal year driven by our commercial cloud, which exceeded $50 billion in revenue for the first time, increasing by 36% compared to last year. The past five months have clearly shown that the intensity of digital technology is essential for business resilience. Companies that develop their own digital capabilities will recover more quickly and emerge stronger from this situation. We are witnessing businesses speeding up the digital transformation of their operations across all areas, from manufacturing to sales and customer service, to better meet customer demands, such as curbside pickup and contactless shopping in retail and telemedicine in healthcare. This is why we are creating a comprehensive modern technology stack supported by the cloud and AI, focusing on security and compliance to assist every organization in their digital transformation. I will now discuss our innovation and momentum, starting with Azure. Every organization now requires a distributed computing framework to handle critical workloads. We are developing Azure to be the world's computer, offering more data center regions than any other provider, including new regions in Italy, New Zealand, and Poland this quarter. We have consistently led in hybrid technology and are accelerating our innovations to fulfill customer needs, regardless of their location. Azure Arc is the first control plane designed for a multi-cloud, multi-edge environment, and we are enhancing it with Azure Arc-enabled Kubernetes. New features in Azure Stack HCI enable organizations to integrate the cloud into their own data centers. Our acquisitions of Affirmed and Metaswitch, along with Azure Edge Zones, extend Azure capabilities to the network edge, benefiting telecom operators transitioning to 5G. Our unique approach across cloud and edge is attracting new customers in various industries, including Land O'Lakes, the National Australia Bank, and Johns Hopkins Medicine, as well as prominent ISVs like Citrix, Finastra, SAS, and Workday. At the data level, Azure is the only cloud service offering limitless data and analytics capabilities, creating a cloud-native data environment for all organizations. Our SQL Hyperscale, Cosmos DB, Synapse Analytics, and the new Synapse Link, which provides live analytics on real-time transactions, set Azure apart. In AI, we offer the most extensive range of tools, frameworks, and infrastructure. We are excited about the advancements our partner OpenAI is achieving, with their new GPT3 model marking a significant milestone in AI, trained on our Azure AI supercomputer. New features in Azure Cognitive Services simplify the development of applications that communicate naturally in 49 languages and their variants, and to extract insights from unstructured data, including paper forms and medical records. Microsoft Bot Framework now includes robust authoring tools to create advanced conversational bots with low-code solutions, and Azure Machine Learning allows organizations to deploy AI safely and responsibly. All these innovations are driving usage, with 13.5 billion transactions processed in Azure Cognitive Services in June alone, alongside 2.5 billion messages sent and 9 million hours of speech transcribed. Companies from Bridgestone to UnitedHealth Group and EY are leveraging Azure AI to innovate and better serve their customers. Now turning to developer tools. The significance of developers has never been more pronounced as they respond to emergencies, recoveries, and evolving needs. We provide the most popular and highly regarded developer tools to create applications across any platform. We've seen increased activity across various metrics and are enhancing our offerings with new tools to enable and secure remote development. Through Codespaces, we combine the strengths of GitHub, Visual Studio, and Azure to allow developers to transition from code to cloud in seconds. New advanced security features in GitHub utilize semantic analysis to identify vulnerabilities in code, and GitHub Discussions facilitate collaboration in software communities beyond the codebase. Over 3 million organizations, including most of the Fortune 50, now use GitHub. California's state government utilizes GitHub and Azure DevOps for 90% of its digital COVID-19 response infrastructure. Additionally, all 5,000 engineers at Autodesk rely on GitHub to eliminate silos within the organization. Etsy developers are using GitHub for over 50 production deployments each day. Next, regarding the Power Platform. With Power Platform, anyone in an organization can quickly create applications, build virtual agents, automate workflows, or analyze data. Citizen developers and business leaders at firms like Schlumberger and T-Mobile are employing Power Platform to tackle challenges posed by COVID-19. Power BI holds a commanding position in cloud business intelligence and is growing significantly faster than competitors, with 96% of Fortune 500 companies utilizing it to glean insights from their data. Overall usage across Power Platform is rapidly increasing, with Power Apps' monthly active users rising by 170% year-over-year and Power Automate up by 75%. In just six months, Power Virtual Agents have already recorded over 6.7 million sessions. We launched a comprehensive return-to-workplace solution in Power Platform yesterday that will assist organizations like CBRE in ensuring employee safety and health as they return to office settings. We are also investing in robotic process automation. Our acquisition of Softomotive, combined with Power Automate, allows customers like KPMG to automate manual business processes across both legacy and modern applications. Now to Dynamics 365. Dynamics 365 is enabling organizations in every sector to digitize their end-to-end operations—from sales and customer service to supply chain management—allowing them to quickly adapt to changing market environments. Customer Insights is the fastest growing Dynamics 365 application, assisting companies like Walgreens Boots Alliance and Chipotle in providing more personalized experiences to customers. This quarter, BNY Mellon chose Dynamics 365 to enhance relationships with clients. Over 4,500 organizations now utilize Dynamics 365 for Commerce, Finance, and Supply Chain Management, making it one of the fastest-growing SaaS solutions in its field. FedEx, for instance, employs Dynamics 365 for precise logistics and inventory management. In retail, Dynamics 365 Connected Store offers analytics on in-store traffic and curbside pickup, prioritizing safety as stores reopen. We are also investing in solutions that help merchants process online transactions securely. New security features in Dynamics 365 Fraud Protection assist in protecting online sales, and we are collaborating with financial firms like Capital One to enhance fraud detection and customer security. Now onto LinkedIn. Despite revenue challenges due to reduced hiring needs, we are experiencing record engagement levels, with LinkedIn’s 706 million professionals utilizing the platform to connect, learn, and plan for the future. Content shared on the platform has increased by nearly 50% year-over-year, and LinkedIn Live streams have surged by 89% since March. As professionals strive to acquire new skills beyond their current expertise, they rely on LinkedIn. In June, users consumed nearly four times more LinkedIn learning content compared to the previous year, and we are facilitating easier access to over 16,000 online courses directly in their work processes. Our new learning app within Teams will incorporate LinkedIn Learning along with users’ own educational content to create an ongoing feedback loop between work, skills, and the necessary development for employee upskilling and reskilling. Moving on to Microsoft 365 and Teams. The way people work and learn is undergoing a fundamental transformation. Microsoft 365 is enabling individuals and organizations to improve productivity and security as they adapt to more flexible work and learning environments. Microsoft Teams facilitates social interaction among dispersed individuals. It stands out as the only solution integrating meetings, calls, chat, content, collaboration tools with office and business workflow processes within a secure user experience. We are reimagining meetings with features like Together Mode and the Dynamic Stage to help users feel more connected and alleviate cognitive load. We've expanded the Teams gallery view, allowing users to see and interact with up to 49 participants simultaneously, while breakout rooms and live reactions foster social connections in a virtual setting. The deeper integration between Teams and Power Platform offers an integrated data platform, Microsoft Dataflex, simplifying and accelerating application development and deployment, leading to a new class of enterprise apps and chatbots. Teams is quickly becoming the communications backbone, as businesses shift voice communications to the cloud. We are making Teams available for personal use, allowing users to connect effortlessly with friends and family on mobile devices while balancing work and life. This quarter, Teams users generated over 5 billion meeting minutes in just one day, and we are observing heightened activity levels across the platform as people engage in communication, collaboration, and content creation. Currently, 69 organizations have over 100,000 Teams users, and over 1,800 organizations have more than 10,000 users. We are collaborating with educators in preparation for remote, hybrid, and in-person learning scenarios this fall. Over 150 million students and teachers globally now depend on our tools, including Teams, Stream, OneNote, and Flipgrid to emphasize student engagement and enhance learning outcomes. Our new Microsoft Cloud for Healthcare is assisting providers in scheduling and managing virtual appointments via Teams while engaging with patients using Dynamics 365. Recently, there were more than 46 million Teams meetings within the healthcare sector. The NHS in the UK selected Microsoft 365 to equip its 1.2 million employees with cutting-edge productivity and collaboration tools aimed at improving patient outcomes. More generally, we’re experiencing increased use of Microsoft 365 and larger strategic contracts. Companies like Alcoa and Telstra are providing their entire workforce, including frontline staff, with Microsoft 365 and Teams. Across various sectors, customers including 3M, CenturyLink, GE, and Providence are increasingly opting for our Microsoft 365 premium offerings which provide added security, compliance, voice, and analytics advantages. The number of Microsoft 365 E5 users has more than doubled year-over-year. There has been a significant rise in Windows PC usage, with time spent on Windows 10 increasing by over 55% year-over-year. Additionally, we have broadened our range of surface devices and accessories to help individuals work, learn, and connect from anywhere, benefiting the entire OEM ecosystem. Now shifting to security and compliance. The acceleration of remote operations underscores the importance of a zero-trust security framework that offers holistic protection for people, devices, applications, and data. We are the only company with an integrated, end-to-end system supported by over 8 trillion signals each day. Azure Active Directory now serves over 345 million monthly active users from over 200,000 organizations. Our security efforts not only safeguard employee identities but also protect customer and partner identities. For instance, General Motors uses Azure Active Directory to secure interactions among its employees, dealers, and customers. Azure Sentinel has garnered more than 6,500 customers. The growing adoption of IoT across various industries presents new security challenges, and our acquisition of CyberX this quarter will enhance security for customers’ IoT installations. Lastly, we are committed to helping clients secure their most sensitive information. Microsoft Information Protection enables companies like Siemens AG to safeguard sensitive data wherever it resides, while the new Microsoft 365 Records Management assists customers in governing data and mitigating risk. Now onto gaming. It was a truly transformative quarter for gaming. We recorded unprecedented engagement and monetization, fueled by both console and alternative channels, as people globally engage with gaming to connect, socialize, and play. Looking ahead, we are expanding our ability to empower the world’s 2 billion gamers with the freedom to play anytime and anywhere, on any device. Xbox Game Pass is experiencing unprecedented subscriber growth across both console and PC, now featuring content from over 100 studios. Our xCloud gaming service is currently operational in 15 countries. Just last week, we announced that xCloud will be incorporated into Xbox Game Pass, allowing subscribers to stream games on their phones or tablets while connecting with nearly 100 million Xbox Live players worldwide. In terms of content, we are delivering unique first and third-party offerings to attract and retain gamers. Xbox Series X will launch this fall with the most extensive lineup for a console launch ever. Minecraft has also reached a remarkable new high of nearly 132 million monthly active users during the quarter. In conclusion, we are enhancing our opportunities and investing across the complete modern technology framework. Over the next decade, technology spending is expected to double as a share of GDP. We are strategically positioned to take advantage of this growth by innovating and establishing the essential technologies that enable every person and organization globally to enhance their own technological capabilities. Now, I will pass it on to Amy, who will provide detailed updates on our financial results and outlook. I look forward to returning for your questions.

Thank you, Satya, and good afternoon everyone. This quarter, revenue was $38 billion, up 13% and 15% in constant currency. Gross margin dollars increased 10% and 12% in constant currency. Operating income increased 8% and 12% in constant currency. Earnings per share was $1.46, increasing 7% and 9% in constant currency after adjusting for the net tax benefit related to the transfer of intangible properties from the fourth quarter of fiscal year '19. In our largest quarter of the year, our sales teams and partners again delivered strong results, mirroring many trends from the end of the third quarter. In our commercial business, increased usage and steady execution, along with ongoing demand for our distinctive, high-value cloud services drove another strong quarter. In our consumer business, demand from work, learn, and play from home scenarios positively influenced our Gaming, Surface, and Windows OEM non-Pro businesses. However, we noted some weakness in purchasing from small and medium businesses, which mainly affected our transactional Office and Windows OEM-Pro businesses and led to some moderation in our Office 365 commercial paid seat growth. In our Search business, although rates stabilized throughout the quarter, we observed a continued decline in advertising spending on our platform. Now, looking at our overall results. Customer commitment to our cloud continues to increase. In FY20, we secured a record number of multi-million dollar commercial cloud agreements, with significant growth in the number of $10-million-plus Azure contracts. Despite a strong prior-year comparison, commercial bookings growth exceeded expectations, rising 12% year-over-year driven by consistent renewal execution and more large, long-term Azure contracts. Consequently, the commercial remaining performance obligation increased 23% to $107 billion. Approximately 50% of this balance will be recognized as revenue in the next 12 months, up 21% year-over-year, reflecting consistent execution across our core annuity sales motions. The remaining 50%, to be recognized beyond the next 12 months, experienced a 25% year-over-year increase, underscoring the growing long-term customer commitment to our cloud platform. This quarter, our annuity mix increased 4 points year-over-year to 94%. Commercial cloud revenue rose 30% and 32% in constant currency to $14.3 billion, surpassing $50 billion for the fiscal year. Commercial cloud gross margin percentage grew 1 point to 66%, despite a revenue mix shift to Azure and substantial customer engagement and usage to support remote work scenarios. As expected, foreign exchange reduced revenue growth by around 2 points and COGS growth by about 1 point. Foreign exchange had no effect on operating expense growth, which was slightly less favorable than anticipated. Our margins this quarter reflect investments aimed at delivering greater customer value in this challenging environment, thereby strengthening our long-term competitive position. We invested in enhancing cloud infrastructure capacity usage, offering free trials for essential remote work scenarios, and flexible financing options across the ecosystem. Moreover, we redefined our retail stores strategy, maintaining a focus on increasing our investments in strategic, high-growth opportunities for the future. Consequently, Company gross margin percentage decreased 2 points year-over-year to 68%, with additional impacts from a lower margin sales mix. Operating expense grew 13%, which included a $450 million charge related to the realignment of our retail stores strategy. Operating margins fell 2 points year-over-year to 35%. Now moving to our segment results. Revenue from Productivity and Business Processes was $11.8 billion, increasing 6% and 8% in constant currency. Office commercial revenue rose 5% and 7% in constant currency, affected by the previously mentioned slowdown in small and medium businesses and a strong prior-year comparison from a higher mix of contracts with more in-period recognition. Office 365 commercial revenue grew 19% and 22% in constant currency, aligning with expectations, driven by installed base growth across all workloads and customer segments, in addition to higher ARPU. Demand for our valuable security and voice components led to strong upselling to Office 365 and Microsoft 365 E5. Paid Office 365 commercial seats increased 15% year-over-year, slightly below trends from previous quarters. This reflects the strong uptake of free trial offers we provided to help customers rapidly adjust to necessary remote work scenarios, alongside some growth moderation in first-line worker and small and medium business offerings. Office consumer revenue grew 6% and 7% in constant currency, as stronger than expected growth in Office 365 consumer subscriptions was partially countered by transactional weakness. Thus, we recorded a significant quarter-over-quarter increase in Office 365 consumer subscribers, up by over 3 million to 42.7 million. Dynamics revenue grew 13% and 15% in constant currency, driven by Dynamics 365 growth of 38% and 40% in constant currency. This fiscal year, total Dynamics revenue exceeded $3 billion, with over 60% stemming from Dynamics 365. LinkedIn revenue rose 10% and 11% in constant currency, though the weak job market significantly impacted annual bookings in our Talent Solutions business, despite high usage levels. Segment gross margin dollars remained relatively unchanged, increasing 3% in constant currency, while gross margin percentage fell 4 points year-over-year. Operating expense climbed 10% and 11% in constant currency, and operating income decreased 9% and 5% in constant currency. Next, the Intelligent Cloud segment. Revenue totaled $13.4 billion, with an increase of 17% and 19% in constant currency, slightly exceeding expectations, fueled by sustained customer demand for our differentiated hybrid offerings. On a significant base, server products and cloud services revenue experienced a 19% and 21% increase in constant currency. Azure revenue grew 47% and 50% in constant currency, consistent with expectations, driven by continued robust growth in our consumption-based business. In our per-user business, growth continued to moderate due to the size of our enterprise mobility installed base, which expanded 26% to over 147 million seats. Our on-premise server business remained relatively stable, growing 1% in constant currency, ahead of expectations, supported by strong renewal execution and ongoing demand for our hybrid and premium solutions. Enterprise Services revenue remained relatively unchanged, experiencing a 2% increase in constant currency as growth in Premier Support Services balanced out consulting delays. Segment gross margin dollars rose 19% and 21% in constant currency, with gross margin percentage increasing by 1 point year-over-year. Operating expense increased by 19%, while operating income rose 19% and 22% in constant currency. Turning to More Personal Computing. Revenue reached $12.9 billion, increasing 14% and 16% in constant currency, with better than expected performance across all businesses as we continued to benefit from work, learn, and play from home scenarios. In Windows, overall OEM revenue grew 7%, benefiting from improved supply in April that fulfilled unmet demand from Q3. In OEM Pro, this advantage was more than offset by the impact of small and medium businesses in May and June. In OEM non-Pro, benefits from work and learn from home scenarios persisted but moderated throughout the quarter. Inventory levels concluded the quarter within the normal range. Windows Commercial products and cloud services revenue grew 9% and 11% in constant currency, driven by Microsoft 365 and the ongoing demand for our advanced security solutions. In Surface, revenue surged 28% and 30% in constant currency, showing strength across consumer and commercial segments. Search revenue ex-TAC declined 18% and 17% in constant currency, influenced by the previously mentioned trends. Gaming revenue increased 64% and 66% in constant currency, significantly exceeding expectations, with the continued advantage from play-at-home scenarios driving record engagement and monetization across the platform, as well as a notable rise in console sales. Xbox content and services revenue rose 65% and 68% in constant currency, propelled by strong growth in third-party transactions, GamePass subscriptions, and Minecraft. Segment gross margin dollars increased 12% and 15% in constant currency, while gross margin percentage slightly decreased by 1 point year-over-year due to the mix shift toward Gaming. Operating expense rose 10%, including the retail store charge, while operating income grew 15% and 19% in constant currency. Returning to total Company results, capital expenditures, including finance leases, reached $5.8 billion, up 8% year-over-year, to support growing usage and demand for cloud services. Cash paid for PP&E was $4.7 billion. Cash flow from operations was $18.7 billion, increasing 16% year-over-year, driven by healthy cloud billings and collections. Meanwhile, free cash flow was $13.9 billion, up 16%. For the fiscal year, we generated over $60 billion in operating cash flow and over $45 billion in free cash flow, supported by a year of improving margins and operating leverage across our businesses. In other income and expense, interest income and net gains on derivatives, investments, and foreign currency remeasurement were largely offset by interest expense. Our effective tax rate stood slightly below 17%, lower than expected due to the geographic mix of revenue. Lastly, we returned $8.9 billion to shareholders via share repurchases and dividends, marking a 16% year-over-year increase, which brings our total cash returned to shareholders to over $35 billion for the full fiscal year. Before we proceed to our outlook, I would like to inform you about a change in accounting estimate related to the useful life of server and network equipment assets in our cloud infrastructure. Effective from the start of fiscal year '21, we will extend the depreciable life for these assets to four years, applying to the asset balances on our balance sheet as of June 30, 2020, as well as future asset purchases. This modification will not influence historical depreciation expense, the total depreciation expense across the asset's life, or cash flow, but it will affect the timing of depreciation expense for these assets going forward. Based on the outstanding balances from June 30, we anticipate that fiscal year '21 operating income will receive a favorable impact of approximately $900 million in the first quarter and about $2.7 billion for the entire fiscal year. This has been incorporated into the guidance we will provide in today's call, and further details on the mechanics of the change can be found in our earnings materials. Now, let’s discuss our outlook for the next quarter. In our commercial business, given our unique positioning in growing markets, we expect ongoing commitment to our cloud platform, along with robust usage and consumption growth. For our consumer business, we anticipate some continued benefits from work, learn, and play from home scenarios in Gaming and Surface, though at a moderated pace as stay-at-home guidelines ease in various regions worldwide. Nonetheless, we expect the small and medium business weakness observed in Q4 to persist, which will affect transactional sales, primarily in Office and Windows OEM. Commercial bookings growth should remain healthy but will be influenced by the strong prior-year comparison and low growth in the Q1 expiry base. The commercial cloud gross margin percentage will increase by about 4 points year-over-year due to the aforementioned accounting estimate change. Excluding this effect, improvement in Azure IaaS and PaaS gross margin percentage will likely be offset by the revenue mix shift toward Azure. In dollar terms, we anticipate capital expenditures to remain roughly aligned with last quarter to accommodate the rising usage and demand for our cloud services. Regarding foreign exchange, based on current rates, it should decrease total Company, Productivity and Business Process, and Intelligent Cloud revenue growth by about 1 point, with no impact on More Personal Computing revenue, total Company COGS, and operating expense growth. Now moving to segment guidance. In Productivity and Business Processes, we expect revenue between $11.65 billion and $11.9 billion. In Office commercial, strong prior-year comparisons will again see revenue growth driven by Office 365, with continuous upsell opportunities to E5. However, growth will be affected by a decline of around 30% in our on-premises business due to the transactional weakness in small and medium businesses mentioned earlier. In Office consumer, we foresee revenue being relatively unchanged year-over-year as subscription growth will be counterbalanced by a downturn in our transactional business. In LinkedIn, we anticipate low to mid-single-digit revenue growth, largely due to weak bookings and consequently revenue growth in the Talent Solutions business. In Dynamics, we expect continued momentum from Dynamics 365 driven by our modern and intelligent solutions, resulting in low-double-digit revenue growth. For Intelligent Cloud, we project revenue between $12.55 billion and $12.8 billion. The growth in Azure revenue will again stem from our consumption-based business, and we expect ongoing benefits from Microsoft 365 suite momentum in the per-user business, although growth will again be challenged by the increasing size of the installed base. In our on-premises server business, against a solid prior-year comparison, we expect revenue to increase slightly year-over-year due to the enduring value of our hybrid and premium annuity offerings. In Enterprise Services, we foresee revenue being relatively unchanged year-over-year similar to last quarter. In More Personal Computing, we predict revenue between $10.95 billion and $11.35 billion. In our Windows OEM business, we expect revenue to decline in the low teens affected by robust prior-year comparisons resulting from the end of support for Windows 7, alongside the ongoing slowdown in small and medium businesses. Windows commercial products and cloud services are expected to show healthy double-digit growth linked to continued Microsoft 365 momentum and the appeal of our advanced security offerings. In Surface, strong demand against a low prior-year comparison that was disrupted by product lifecycle transitions should result in mid-teens growth. In Search ex-TAC, we expect revenue to fall in the low 20% range. And in Gaming, we anticipate revenue growth in the high teens as we maintain strong user engagement across the platform. Finally, for overall Company guidance, we expect COGS of $10.75 billion to $10.95 billion and operating expense between $10.7 billion and $10.8 billion, with continuous investment aligned with our significant long-term ambitions. Other income and expense should stand at negative $50 million as interest expense is expected to exceed interest income. Lastly, we expect our Q1 tax rate to be around 16%, lower than our anticipated full-year rate, due to the volume of equity vests in our first quarter. In conclusion, we remain committed to our customers' success in these challenging times while managing the Company for long-term growth and profitability. We will continue to expand our cloud infrastructure to meet the growing customer usage and demand for our unique cloud offerings. Given our strong execution and increasing competitive advantage in high growth sectors, we persist in our commitment to investing in long-term opportunities ahead. Before we proceed to Q&A, I want to extend a special thank you to Frank Brod, our Chief Accounting Officer, who will soon be retiring. On behalf of the entire company, we appreciate your considerable impact and partnership over the years. You have been instrumental in our success. I'm pleased to welcome Alice Jolla, who has closely collaborated with Frank and me for many years, as our new Chief Accounting Officer. Alice, we look forward to your contributions in this role.

Thank you, Amy. We'll now move over to Q&A. Out of respect to others on the call, we request that participants please only ask one question. Operator, could you please repeat your instructions?

Thank you guys for taking the question and very nice quarter. Satya, I was hoping if you could help us with your view of what the enterprise spending environment looks like through this difficult period? On one side of the equation, we have very good secular trends that are still very well in place. And like you said, digital transformation is accelerating. On the other side, though, we do have difficult macro conditions out there, and we're seeing it in places like SMB and the like. Can you help us understand how that's putting out on the ground in terms of your customers? Are you still able to get those big deals over the line? And how do you see that playing out through the rest of the fiscal year? Like, how should we think about those impacts through FY21?

Thank you, Keith, for the question. Over the past five months, we have learned that digital technology is no longer seen merely as a new project, but is now crucial for business resilience. Business continuity is a major topic at the board level everywhere. Digital technology’s role in business resilience was not a top priority before, but now it is. When considering digital transformation, I see it in two areas: resilience and what Microsoft can do to enhance business resilience, such as enabling remote operations and automating processes. These aspects are expected to grow. Additionally, we need to adapt to an increase in e-commerce, a contactless world, and reconfigured supply chains. Both of these factors are long-term trends. However, it's important to acknowledge that GDP may be negative. This is why we anticipate many ups and downs, but digital technology and digital transformation will remain critical. We are focused on enhancing the value proposition of all areas I mentioned and ensuring we support our customers as they navigate these challenging times.

And Keith, to expand on that, our bookings growth for the quarter reflects this. People will increasingly focus on the remaining performance obligations, and you'll see commitment in the next 12 months and the following 12 months. There will be some volatility due to the longer-term, larger contracts we have discussed, but in Q4, we closed more of those contracts than we expected.

Excellent. Thank you, guys.

Thanks, Keith. Operator, we'll take our next question, please.

Thank you for taking my question. I was curious, Satya and Amy, considering the success you've had in broadening your customer base, do you have any insights on net expansion rates? I would like to know if you can provide investors with a way to understand the net expansion rate from your existing customers annually, especially in light of your achievements with Azure hybrid benefits and cloud migrations. Any guidance on this would be greatly appreciated. Thank you.

Amy, maybe I'll start and then you can add. I mean, the way at least we think about the core, Heather, as far as how we are architecting, what we're doing here, and that's one of the reasons why even I structured my remarks the way I structured them, which is each of these layers is being built, obviously to reinforce the other layer, but each layer is independent, and we recognize that enterprises are very heterogeneous. They're going to choose multiple layers from multiple vendors, and interoperability will be key. But we have a very differentiated value proposition. I mean, even in this quarter, if you think about the number of customers who started with Teams, built a Power application, in fact had Azure, GitHub, Power DevOps on top of that code base, and then used Azure Synapse, all in one solution. So, you can see that power of our stack. So, each layer is architected such that it reinforces the other and we see increasing adoption including all of these layers. But, I think in the numbers, when we talk about each of the numbers and the growth rates for each of the numbers, that in some sense showcases that. But maybe Amy you want to add more to that.

Yes. I think the other way to think about it, Heather, and we do I know talk about it a little bit every quarter. There are two main motions that we focus a lot on here. Number one, are we adding new customers; and number two, are we adding workloads within customers? And I think you'll increasingly hear us talk about the number of customers who are purchasing multiple components of the cloud, whether that's Microsoft 365, Azure and the Power platform Satya just talked about, developer SaaS, or GitHub, and then numerous cloud opportunities within Dynamics 365. So, I think the way I tend to think about it is, is revenue per customer going up? Yes. And are we adding new customers? Yes. And do we feel we still have room to add additional clouds? I think that'll be sort of the language you'll hear us talk through this year.

Thank you very much.

Thank you very much for taking my question and congrats on the quarter. Amy, cash flow from operations has been an area of concern across the software industry with some companies reporting payment delays, requests for extended payments, etc. This quarter, your CFO was a strong standout. What do you think is the reason for the strength? Is this a function of the channel or enterprise exposure or something else? Any data, any information will be appreciated?

Thanks, Mark. We have seen very consistent performance in our cash flow from operations. Much of this strength, as you've noted, comes from cloud billing, usage, and consumption-based growth. Additionally, we have significant exposure to the enterprise sector, which has performed well. We also extended various financing options to customers, which I mentioned in our call. I believe we are taking a balanced approach and focusing more on enabling our customers. While we could see some impacts, the breadth of our portfolio and geographic exposure has likely benefited us in cash flow from operations.

And broadly, we will be very much optimizing for helping our customers through this period and our own share.

Yes.

That makes sense. I appreciate. Thank you again.

Thanks, Mark. Operator, we'll take next question, please.

Amy and Satya, you noticed the strong growth in the E5 SKU around Office 365 over the last year. Can you just talk perhaps a little bit more specifically about how Teams is perhaps changing the discussion around productivity more broadly? How that's maybe raising your profile even more from a strategic perspective as customers start thinking about how sort of collaboration is going to change in this new world, both in the short and the long-term? Thanks.

Sure, Kirk. Our approach with Teams has always been to view it as more than just a chat application. While messaging is important, we aimed to reimagine communication through both chat and video, along with enhancing collaboration in meetings, before and after them. Additionally, we focused on integrating business processes and workflows within the structure of Teams, all underpinned by the compliance and security foundation of Microsoft 365. Microsoft 365 has expanded into many new categories, contributing to its overall value. The architectural coherence of Microsoft 365 addresses real challenges for enterprises, particularly around complexity, security risks, and management costs, especially when transitioning to remote work. We believe we offer a compelling value proposition for customers during this critical time, providing the flexibility needed for hybrid work models, along with cost-effective management and robust security and compliance. I think we have a unique offering in this regard. I'll hand it over to Amy to see if she wants to add anything.

No. I actually think the other component, Satya, that I would mention is really the transition we've seen from just Office 365 E5 to Microsoft 365 E5 with the entirety of the value proposition. And this I think has been a pivotal year. And again in Q4, we saw even more transition in the SKU mix to the Microsoft 365 SKU than just simply the Office SKU.

Thank you very much for taking the question. And I have one for Satya. I'm curious how you would assess the net impact of the current environment on Azure inclusive of potentially lower consumption growth among highly impacted industries and of course, the per seat moderation in the EMS, offset by some deceleration in digital transformation or broadly among other customers. In addition, I was curious, if you're seeing more pay-as-you-go type arrangements for Azure than you were previously? Thank you.

Overall, even in industries affected by economic challenges, one key aspect is achieving a new efficient frontier in cloud economics, which can help them improve as they recover. We are noticing some acceleration in moving away from the old systems and reaching that efficient frontier, enabling a quicker recovery. While there are certainly areas experiencing complete economic shutdowns and a slowdown, we also see some organizations using this situation as an opportunity to emerge stronger. The pay-as-you-go model on Azure is increasing, and we are committed to serving both long-term customers and pay-as-you-go users equally. Our primary focus remains on quarter-over-quarter consumption growth by enhancing the value of customers’ digital transformation initiatives.

And I would add, maybe Gregg, a little context. We have been seeing a transition to pay-as-you-go probably for the majority of this year, as opposed to saying it has more recently just emerged as a trend. So, I wanted to make sure to decouple those a teeny bit. And I think in general for us, this quarter, the consumption patterns were very, very similar actually to what we expected, to Satya’s note, with the pressure to I think move to this new frontier, being really at the forefront of people's minds, far more so than maybe a discussion on per user impact.

You’ve continued to show great top line double-digit growth and margin improvement. And many are asking, is that same framework in place in this environment, showing the same double-digit growth with margin improvement, or do things change and you need to invest in new areas that could potentially stall out margins as we go through the cycle?

I'll start, and Amy can add to this. Brent, our focus right now is how we can build a modern tech stack that not only helps our customers transform and remain resilient but also allows us to explore new categories and establish a strong presence within them. My perspective is that we shouldn't overly concern ourselves with short-term growth figures, especially when compared to the current negative GDP environment. Instead, I'm not aiming for an arbitrary double-digit growth number, nor are we fixated on margin targets. Ultimately, the overall health of the world economy is crucial for our long-term success. I believe that we will emerge from this challenging period stronger by making strategic investments now.

And I just want to reiterate how important that is. The opportunity that Satya really outlined in his remarks is I do believe, fundamental. And so, you see us continuing to invest. You'll see it in capital expenditure based on demand, you'll see it in the operating expense line. And a lot of the margin movement you're going to see is going to be actually far more sales mix than it is to think about it as margins going down in a particular product. So, for me, it's really about in every product, are we investing with a strong position, with a clear view of the future in a way that we can be a more important part of every customer's budget. And so, I think we feel very good about the products we've got, the lineup we've got and the execution engine we've got. And so, I think we're far more focused in that way than maybe on our short term number goal.

Thank you.

Thanks, Brent. Operator, we'll take next question, please.

Great. Thank you so much for taking the questions and congrats on the amazing results. Amy, I believe, in your prepared remarks, you said Q4 CapEx was in line with expectations and Q1 should be at a similar level. Can you speak to the evolution in cloud CapEx productivity and utilization trends, your capacity planning process and lead times to stand up incremental capacity? And ultimately, how should we be thinking about the cadence of CapEx going forward?

Thanks, Brad. As you saw, we made great progress this quarter catching up from supply chain challenges that I think we entered the quarter with. And as you can imagine, with the Teams surge and usage, along with other workloads surges, we look forward to continuing to be able to adapt to meet that demand ahead of the curve in addition to what Satya mentioned, which is continuing to enter new regions where we see opportunities. So for me, the way to think about it is you see the cloud revenue growth continuing, you see strong consumption and usage growth, and you should expect cloud CapEx to follow in pretty short order. The lead times there have gotten tighter over time. And so, you can generally think they'll be more correlated, but obviously there's some demand planning that we like to give ourselves ample room.

Sure. Thanks, Brad. Operator, we'll take our last question now, please.

Thank you for fitting me in, and congratulations. I have a quick question about Gaming. This quarter showed very strong numbers, but it seems slightly weaker due to tougher comparisons. How do you view the growth cycle in Gaming? Should we expect more stability and recurring revenue moving forward? I'd appreciate your thoughts on the dynamics. Thank you.

Sure, I'll start. Our overall vision has been discussed for several years, focusing particularly on our Game Pass strategy. We believe the gaming total addressable market is much larger than what we've experienced, even through our success with Xbox. Moving forward, we think Xbox has a greater opportunity to reach over two billion gamers, and we are just beginning to expand that. This quarter stood out for several reasons, especially considering the remote nature of many activities, alongside our new console that's integral to our strategy. Our reach extends beyond consoles to include PC, mobile, and our streaming service. All of these factors contribute to what we anticipate will be a significantly larger addressable market in the long run. We have a strong structural position with Xbox Live as a social network, a well-monetizing store, and the Game Pass subscription. Amy, would you like to add anything?

Maybe just a few things, which is when I think about gaming and where we are at this point, the reason it's so exciting I think this quarter reinforces that we have such platform strength built on the view, the support we have of fans at the console. We’ve extended that and begun to extend it to the PC; we're extending it to mobile. That platform strength will drive this more annuity-like behavior that you're thinking about, which is great. And we saw that in the Game Pass subscription growth, again, this quarter building on that base. But then, the third party titles will drive some volatility, but that volatility is just reinforcing of the position we have and I think the long relationship with fans. So, I think we're all pretty excited. I think, Satya called it pivotal, I think, it certainly is and that we're sort of looking forward to the next console release as well.

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

Thank you, everyone.

Thank you, everyone.