Microsoft Corporation (MSFT) — Q3 2021 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; Alice Jolla, 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 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 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 sections of our Form 10-K, Forms 10-Q, and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that, I’ll turn the call over to Satya.

Thank you, Brett. This quarter has set a record driven by the sustained strength of our commercial cloud. Over a year into the pandemic, digital adoption is not slowing down; in fact, it is accelerating, and this is just the start. Digital technology will form the basis for resilience and growth over the next decade. We are enhancing and constructing the cloud stack to boost the digital capabilities of every organization globally. Now, I will focus on our expanding opportunity and momentum, beginning with Azure. As the cost of goods sold becomes more digital, computing will become increasingly common and decentralized. We are developing Azure to meet the needs of organizations in a multi-cloud, multi-edge environment. We have more data center regions than any other provider, including new regions in China, Indonesia, and Malaysia, as well as in the United States. Azure has always been hybrid by design, and we are intensifying our innovation to engage customers in their current environments. Azure Arc extends the Azure control plane across on-premises, multi-cloud, and edge, and is further enhanced with machine learning and Kubernetes capabilities. Companies like Fujitsu and KPMG are leveraging Arc to simplify hybrid management and operate Azure data services anywhere. Our unique position across the cloud and edge is fostering deeper and more strategic partnerships with leading companies in every industry, from Total and Repsol in Energy to Kaiser Permanente in healthcare and Amadeus in travel. Turning to data and analytics, the competitiveness of every company will hinge on their ability to transform data into predictive and analytical insights. The next-generation analytics service, Azure Synapse, accelerates the time to insight by integrating data integration, enterprise data warehousing, and big data analytics into a single service. No other provider delivers the limitless scale, price performance, and comprehensive integrations of Synapse. For example, organizations can manage large-scale data processing workloads with Spark integration and build advanced AI models with Azure machine learning. Power BI enables anyone within the organization to access insights. We are witnessing adoption from thousands of customers, including AB InBev, Dentsu, and Swiss Re. The number of queries performed with Synapse surged by 105% last quarter alone. We are leading in hyperscale SQL and non-SQL databases to accommodate the growing volume, variety, and speed of data. More customers are choosing Azure for their relational database workloads, with SQL Server on Azure VMs usage rising by 129% year-over-year. Cosmos DB continues to be the preferred database for cloud-native app development at any scale, marking a 170% increase in transaction volume year-over-year. Moving on to developers, as organizations strive to build their digital capabilities, they will need to modernize existing applications and develop new ones using a standardized approach. We provide the most widely used tools that enable developers to move quickly from idea to code and from code to cloud. Visual Studio has over 25 million monthly active users, and GitHub boasts nearly 65 million developers. In the past year, the number of monthly active organizations on GitHub jumped by 70%. Significant technological achievements in the last year, such as critical COVID-19 vaccine trials and the first powered flight on Mars, were made possible due to the open-source communities on GitHub. In the PaaS layer, we are innovating to help developers integrate AI into their solutions. Large-scale AI models are becoming platforms, highlighted by the remarkable advancements from OpenAI, whose models are exclusively trained and hosted on Azure. GPT-3 generates an average of 4.5 billion words daily, with hundreds of applications in production across various industries. Azure Cognitive Services enables organizations to create applications that see, hear, speak, search, understand, and accelerate decision-making. New features permit developers to incorporate semantic search into their applications, helping companies like AT&T, Duolingo, and Progressive develop custom neural voices for their products. We are also advancing with Azure Percept, a complete platform that simplifies the development, training, and deployment of AI at the edge. As the virtual and physical worlds converge, the metaverse is emerging as a primary platform through digital twins, simulated environments, and mixed reality. We are making headway and gaining traction across both public and private sectors. Bentley Systems is constructing a digital twin of Dublin to transform urban planning using our Azure Digital Twins and Azure IoT. PepsiCo is simulating its manufacturing processes to enhance product consistency using our autonomous systems platform. Companies such as Airbus, Toyota, L'Oreal, and Intel are utilizing mixed reality to navigate complex challenges in every sector. The U.S. Army, for instance, is set to use HoloLens-based headsets, enhanced by our cloud services. The new Microsoft Mesh builds on this progress, allowing holographic interactions with authentic presence on any device. Early adoption by Accenture showcases this innovative technology in creating immersive virtual office experiences. Power Platform is emerging as the next-generation suite for business process automation and productivity for domain experts across all functions. We have taken a distinctive approach to this expansive, high-growth market, combining robotic process automation, low-code and no-code tools, virtual agents, and business intelligence. With Power Platform, any domain expert can quickly automate workflows, create apps, develop virtual agents, or analyze data, significantly increasing productivity across organizations through intelligent automation. Just as Office revolutionized productivity for knowledge workers, Power Platform aims to do the same for domain experts. Currently, Power Platform has nearly 16 million active users monthly, a 97% increase year-over-year, with revenue rising by 84% year-over-year. Companies like Telstra, T-Mobile, Toyota North America, and Unilever have established centers of excellence for Power Platform, utilizing low-code and no-code tools for various applications such as COVID-19 screening and product quality control. In robotic process automation, Coca-Cola saved significant development time by integrating Power Automate with legacy systems for automating shipment verifications and payroll processing, among other tasks. In analytics, Daimler opted for Power BI to gather insights across the organization while ensuring top security levels. Shifting to business applications, Dynamics 365 experienced a remarkable quarter as companies increasingly adopt intelligent business applications for adaptation and growth. Revenue surged by 45% as we continue to capture market share. We are enhancing Dynamics 365 capabilities to meet urgent organizational challenges. New integrations with Teams facilitate seamless communication for meetings, chats, calls, and collaborations directly within Dynamics 365. The new Dynamics 365 Intelligent Order Management supports omnichannel fulfillment for businesses. Adoption of Dynamics 365 is rising across industries, from ABN AMRO in financial services to BMW in automotive. Across the Microsoft Cloud, we are leading with industry and cross-industry solutions while broadening our investments to assist organizations in leveraging our comprehensive tech stack alongside industry-specific customizations to enhance value delivery, increase agility, and reduce costs. This quarter, we launched new industry clouds for financial services, manufacturing, and nonprofits, building on the success of healthcare and retail clouds. Our upcoming acquisition of Nuance will integrate our solutions directly into key healthcare processes. Now regarding LinkedIn, we again achieved record engagement, with LinkedIn's 756 million members using the platform to connect, learn, create content, and find job opportunities. Conversations grew by 43%, content sharing was up 29%, and LinkedIn hours surged by 80%. We support creators in expanding their economic opportunities, with thousands of expert instructors monetizing their content through LinkedIn Learning. Freelancers now have dedicated pages to attract clients, while creator mode allows members to build followings and engaged communities. As we face an escalating skills gap, we are helping employers create feedback loops between skills, learning, credentials, and jobs. Sixty percent of the Fortune 500 leverage LinkedIn Learning for employee development. For instance, Nationwide Insurance uses LinkedIn Learning to personalize training for 26,000 associates. New tools that combine courses with skills assessments enable companies like BlackRock, Gap, and TaskRabbit to find job candidates with verified skills. Businesses continue to rely on LinkedIn as a trusted platform to reach professionals ready to collaborate. LinkedIn Marketing Solutions revenue rose over 60% year-over-year. In the past year, revenue exceeded $3 billion and is growing nearly three times faster than the B2B digital advertising sector. Now, addressing Microsoft 365 and Teams, hybrid work demands a new operational model, which is why we developed Teams as the central hub for all work, learning, and collaboration. Teams now boasts over 145 million daily active users, nearly double the count from a year ago. In regions where employees have returned to work, such as Australia, China, New Zealand, South Korea, and Taiwan, we see continued growth in usage. The number of organizations with over 1,000 users integrating their third-party and line-of-business applications with Teams has increased nearly threefold year-over-year. We are speeding up our innovation, adding more than 300 new features over the past year, including over a hundred added so far in 2021. New inclusive meeting features for hybrid work, such as custom gallery views, enable everyone to be seen and heard, regardless of whether they are working from home, a meeting room, an office, or a factory. Customers like GM and Sanofi utilize Teams for unified communications, including voice. Teams is evolving beyond communication, creating a new category of modern collaborative applications as organizations use Power Platform to develop custom apps, bots, and workflows within Teams. For example, American Airlines recently mentioned in their earnings call the cost savings achieved by employing a Power app within Teams to help frontline workers manage critical data operations. Teams is transforming internal collaboration and business operations for companies. We introduced support for shared workspaces with external individuals, and we are witnessing Teams being utilized for various applications, including virtual retail showrooms, personal shopping, and interactive webinars. This quarter, we launched Microsoft Viva, creating a new market category focused on employee experience. Viva integrates knowledge, learning, communication, and insights directly within Teams and Microsoft 365. Companies like Coca-Cola and Unilever plan to use Viva to enhance employee well-being in this new hybrid work environment. Overall, Microsoft 365 users generated over 38 billion collaboration minutes in one day during this quarter. Office 365 nearly reached 300 million paid seats. Organizations in both the private and public sectors, including the City of Helsinki, Bausch Health, and Stryker, are increasingly opting for our premium solutions driven by advanced security, compliance, voice, and analytics. People are relying on Windows PCs more than ever to stay connected, productive, and secure. Windows 10 now operates on more than 1.3 billion monthly active devices, and Microsoft 365 consumer subscriptions have surpassed 50 million for the first time. Now addressing security, the current threat landscape is more complex and challenging than ever, making security crucial for our customers. This is leading to increased demand for our comprehensive capabilities across identity, security compliance, and management, supported by cloud-scale AI and human expertise across all platforms. Our distinguishing factor and source of customer value is the interconnectedness of identity, endpoint applications, cloud data, and infrastructure, all enabled by our cloud-native XDR and SIEM. This is guided by our operational security posture, which analyzes over eight trillion signals daily. Our strategy empowers organizations to implement a Zero Trust architecture while minimizing the complexity, cost, and risks associated with integrating disparate point solutions. More than 400,000 customers, including many established global firms like Boston Consulting Group, HCA Healthcare, Lowe's, and UBS, utilize our offerings. Signal employs Azure Confidential Computing to safeguard the data of its millions of customers. We are additionally enhancing our protective measures for organizations. We are committed to our goal of eliminating passwords by introducing password-less sign-in to Azure AD. Our Azure AD paid customer base has more than doubled year-over-year, exceeding 300,000. Enhancements in Microsoft 365 Defender equip organizations to better understand, prevent, and mitigate active threats, blocking 30 billion email threats and nearly seven billion endpoint threats in the past year alone. Our compliance manager currently provides over 300 pre-built assessments for regulations such as GDPR. Now regarding gaming, we are broadening our opportunities as we support gamers and creators in connecting and building communities across devices. Xbox is increasingly popular for gaming and socializing, leading to record engagement this quarter, driven by both on-console and off-console strength. Through Game Pass, we are revolutionizing how games are distributed, played, and experienced. Recently, we introduced cloud gaming via the web, expanding our reach on PC and mobile. Content drives the growth of our services. Following our acquisition of ZeniMax Media, we have made 20 iconic and beloved games accessible via Game Pass, with more exciting titles to come. As gaming transitions into metaverse economies, we are developing new tools that empower creators to sell their products on our platform. Minecraft boasts nearly 140 million monthly active users, a 30% year-over-year increase, making it a leading platform in the creator economy. Creators have earned over $350 million from more than one billion downloads of mods, add-ons, and additional experiences in Minecraft alone, not accounting for activity outside our marketplace. A vibrant marketplace is also forming in Flight Simulator, allowing partners to sell content directly within the game. In conclusion, we are driving innovation across the entire tech stack as we differentiate and lead in key areas critical to our customers' future success. I'm excited about the opportunities before us. Now, I'll pass it over to Amy to detail our financial results and provide our outlook, and I look forward to rejoining you for the question segment.

Thank you, Satya, and good afternoon everyone. My comments today reflect the impact of the ZeniMax acquisition for approximately three weeks this quarter as well as our outlook. There is no impact from the Nuance acquisition that is expected to close by the end of the calendar year. Our third quarter revenue was $41.7 billion, up 19% and 16% in constant currency, and earnings per share was $1.95 and increased 39% and 34% in constant currency when adjusted for the tax benefit related to the recent India Supreme Court decision on withholding taxes. Many trends across industries, customer segments, and geographical markets continued to improve, which coupled with strong execution by our sales and partner teams, drove another quarter of double-digit top and bottom-line growth. In our commercial business, accelerating digital transformation enabled by our unique Microsoft Cloud value drove healthy demand for our hybrid and cloud offerings. Strong Azure consumption, increased platform commitments, and higher usage of Teams, Power Platform, and our security offerings were key beneficiaries. Within our small and medium business customer segment, continued improvement in cloud purchasing trends more than offset transactional licensing weakness. And in LinkedIn's Talent Solutions business, annual contracts and job postings improved with the job market. In our consumer business, Windows OEM and Microsoft 365 consumer subscriptions benefited from a much stronger than expected PC market despite significant ongoing constraints in the supply chain. Improvement in the advertising market again benefited our Search and LinkedIn businesses, and in gaming, we continue to see record engagement and strong monetization across our platform as well as demand that significantly exceeded supply for Xbox Series X and S consoles. Moving to our overall results, commercial bookings growth was ahead of expectations increasing 39% and 38% in constant currency on a growing expiration base and low prior year comparable. Growth was driven by consistent execution across our core annuity sales motions and an increase in the number of larger long-term Azure contracts. As a result, commercial remaining performance obligation increased 31% and 32% in constant currency to $117 billion with a roughly equivalent split between the revenue that will be recognized within and the portion beyond the next 12 months, and our annuity mix increased two points year-over-year to 94%. Commercial cloud revenue also better than expected grew 33% and 29% in constant currency to $17.7 billion. Commercial cloud gross margin percentage expanded three points year-over-year to 70%, driven by the change in accounting estimate for the useful life of server and network equipment assets. Excluding this impact, commercial cloud gross margin percentage was up slightly with improvement in Azure gross margin mostly offset by sales mix shift to Azure. With a weaker US dollar, FX increased revenue growth by approximately three points, about one point more favorable than anticipated. FX increased COGS and operating expense growth by approximately two points, both in line with expectations. Gross margin dollars increased 19% and 16% in constant currency. Gross margin percentage was 69%, relatively unchanged year-over-year with roughly one point of favorable impact from the change in accounting estimate noted earlier. Excluding this impact, company gross margin percentage was down, driven by strong revenue growth in cloud and gaming that resulted in sales mix shift. Operating expense increased 5% and 3% in constant currency, lower than anticipated, primarily driven by investments that shifted to future quarters. Overall, company headcount grew again this quarter, up 12% year-over-year, reflecting our focused investments across key areas like cloud engineering, sales, and customer deployment. Year-over-year growth in operating expense includes roughly two points of impact from continued COVID-related savings. Operating income increased 31% and 27% in constant currency, and operating margins expanded four points year-over-year to 41%, including nearly two points of favorable impact from the change in accounting estimate and roughly one point of favorable impact from COVID-related savings. Now to our segment results. Revenue from productivity and business processes was $13.6 billion and grew 15% and 12% in constant currency, primarily driven by Office 365 and LinkedIn. Office Commercial revenue grew 14% and 10% in constant currency. Office 365 Commercial revenue grew 22% and 19% in constant currency, again driven by installed base expansion across all workloads and customer segments as well as higher ARPU. Demand for our high-value security, compliance, and voice offerings drove strong momentum in E5 again this quarter. Paid Office 365 commercial seats grew 15% year-over-year to nearly $300 million with acceleration to the cloud in our small and medium business segment and a recovery in growth in our first-line worker offerings. The accelerated cloud adoption negatively impacted Office Commercial licensing, which declined 25% and 27% in constant currency, a bit below expectations. In Office Consumer, revenue grew 5% and 2% in constant currency, slightly below expectations, primarily due to transactional weakness in Japan. Microsoft 365 consumer subscriptions grew to $50.2 million, up 27% year-over-year. Dynamics revenue grew 26% and 22% in constant currency, better than expected, driven by Dynamics 365 revenue growth accelerating to 45% and 40% in constant currency, with particular strength in Power Apps in our finance and operations offering. LinkedIn revenue increased 25% and 23% in constant currency, ahead of expectations. Our Marketing Solutions business accelerated again this quarter to 64% revenue growth. Segment gross margin dollars increased 15% and 12% in constant currency and gross margin percentage was relatively unchanged year-over-year with nearly 2 points of favorable impact from the change in accounting estimate. Operating expense increased 4% and 2% in constant currency, and operating income increased 26% and 20% in constant currency, including 4 points due to the change in accounting estimate. Next, the Intelligent Cloud segment. Revenue was $15.1 billion, ahead of expectations, increasing 23% and 20% in constant currency. Server products and cloud services revenue increased 26% and 23% in constant currency, ahead of expectations. Azure revenue grew 50% and 46% in constant currency, better than anticipated, driven by continued strength in our consumption-based business. And in our per-user business, growth in our Enterprise Mobility and Security installed base accelerated again this quarter, up 30% to over 174 million seats. And on a strong prior year comparable that benefited from the end of support for Windows Server 2008, our on-premises server business increased 3% and was relatively unchanged in constant currency, with strong annuity performance driven by continued customer preference for our hybrid and premium offerings. Enterprise Services revenue grew 10% and 8% in constant currency with better-than-expected performance in Microsoft Consulting Services. Segment gross margin dollars increased 27% to 24% in constant currency. Gross margin percentage increased 2 points year-over-year with roughly 2 points of favorable impact from the change in accounting estimate. Operating expense increased 12% and 10% in constant currency, and operating income grew 41% and 36% in constant currency with roughly 7 points of favorable impact from the change in accounting estimate. Now to More Personal Computing. Revenue was $13 billion, increasing 19% and 16% in constant currency with better-than-expected performance in gaming, Windows OEM, and Search. In Windows, the stronger PC market resulted in overall OEM revenue growth of 10%, driven by continued customer demand. OEM non-Pro revenue grew 44% and OEM Pro revenue declined 2% on a prior year comparable that included the end of support for Windows 7. Windows commercial products and cloud services grew 10% and 7% in constant currency with a lower-than-expected mix of in-quarter recognition from multiyear agreements. In Surface, revenue grew 12% and 7% in constant currency lower than expected, primarily due to execution challenges in the commercial segment. Search revenue ex-TAC increased 17% and 14% in constant currency benefiting from the improved advertising market noted earlier. And in Gaming, revenue increased 50% and 48% in constant currency. Xbox hardware revenue grew 232% and 223% in constant currency driven by our new consoles. Xbox content and services revenue, which now includes ZeniMax, grew 34% and 32% in constant currency with better-than-expected performance of first-party titles, particularly Minecraft. Segment gross margin dollars increased 14% and 11% in constant currency. Gross margin percentage decreased two points year-over-year driven by sales mix shift to gaming. Operating expense decreased 3% and 4% in constant currency, and operating income grew 27% and 22% in constant currency. Now back to total company results. Capital expenditures including finance leases were $6 billion in line with expectations driven by ongoing investment to support growing global demand from increased customer usage of our cloud services. Cash paid for PP&E was $5.1 billion. Cash flow from operations was $22.2 billion and increased 27% year-over-year driven by strong cloud billings and collections. Free cash flow was $17.1 billion, up 24%. Other income and expense was $188 million higher than anticipated, primarily driven by net gains on investments. As a reminder, we are required to recognize mark-to-market gains or losses on our equity portfolio. Our non-GAAP effective tax rate was approximately 14%. And finally, we returned $10 billion to shareholders through share repurchases and dividends. Now let's move to the outlook. As a reminder in Q4, we begin to see growth rates that reflect the first full quarter impact of COVID-19 a year ago both across revenue and operating expenses. Last year across Windows, OEM, Gaming, and Surface we saw surges in purchasing and usage that will negatively impact Q4 growth rates. In our Search and LinkedIn businesses, Q4 growth rates will be positively impacted given the advertising and job markets a year ago. And in our transactional business, the slowdown in purchasing in Office and Server last year will benefit Q4 growth rates, particularly in our small and medium business segment. Next, in our largest quarter of the year, we expect the accelerating trends Satya discussed, our differentiated market position, and continued solid execution to result in another strong quarter. Growth in commercial bookings should again be healthy, but impacted by a declining expiry base. As always, an increasing mix of larger long-term Azure contracts, which are more unpredictable in their timing, can drive quarterly volatility in bookings. Commercial cloud gross margin percentage should increase roughly four points year-over-year with less than two points from the change in accounting estimate. As a reminder, the favorable impact continues to lessen over time. Excluding the accounting change, Q4 gross margin percentage will also benefit a bit from investments we made a year ago to support increased usage needs in remote work scenarios. Longer term, commercial cloud gross margin percentage will continue to be impacted by revenue mix shift to Azure, increased usage of our productivity and collaboration solutions, and ongoing strategic investments to support our customers' success. In capital expenditures, we expect a sequential increase on a dollar basis as we continue to invest to meet growing global demand for our cloud services. Now to FX. Based on current rates, we expect FX to increase total company Productivity and Business Processes and Intelligent Cloud revenue growth by approximately three points, More Personal Computing revenue and total operating expense growth by approximately two points, and COGS growth by approximately one point. Next to our segment guidance. In Productivity and Business Processes, we expect revenue between $13.8 billion and $14.05 billion. In Office Commercial, revenue growth will again be driven by Office 365, with healthy seat growth and upsell opportunity to E5. In our on-premises business, we expect revenue to decline in the high teens consistent with the ongoing customer shift to the cloud. In Office Consumer, we expect mid to high teens revenue growth driven by continued momentum in Microsoft 365 consumer subscriptions against the low prior year comparable impacted by the transactional purchasing weakness noted earlier. In LinkedIn, we expect revenue growth in the mid-30% range, driven by continued strong engagement on the platform and improvements in the advertising and job markets. And in Dynamics, continued momentum in Dynamics 365 will drive revenue growth similar to last quarter. For Intelligent Cloud, we expect revenue between $16.2 billion and $16.45 billion. In Azure, revenue will again be driven by strong growth in our consumption-based business. And our per-user business should continue to benefit from Microsoft 365 suite momentum, though we expect some moderation in growth rates given the size of the installed base. In our on-premises server business, we expect revenue growth in the mid-single digits, driven by continued demand for our hybrid and premium annuity offerings against a low prior year comparable and the transactional purchasing noted earlier. And in Enterprise Services, revenue growth to be roughly in line with last quarter. In More Personal Computing, we expect revenue between $13.6 billion and $14 billion. In Windows, overall revenue should grow mid-single digits driven by Windows commercial products and cloud services growth and continued demand for PCs, partially offset by ongoing supply chain impacts and the comparable noted earlier. In Surface on a strong prior year comparable, we expect revenue to decline in the mid-teens as we work through the supply chain and execution challenges noted earlier. In Search ex-TAC, we expect revenue growth in the mid-40s driven by improvements in the advertising market. In gaming, we expect revenue growth in the mid- to high single digits. Significant demand for the Xbox Series X and S will continue to be constrained by supply. And on the strong prior year comparable, we expect Xbox content and services revenue to decline in the mid- to high single digits. Now back to company guidance. We expect COGS of $13.7 billion to $13.9 billion and operating expense of $13.1 billion to $13.2 billion. As a reminder, in operating expense in Q4, we will benefit from continued COVID-related savings as well as the prior year comparable, which included roughly four points of impact from a $450 million charge related to the realignment of our retail store strategy. In other income and expense, interest income and expense should offset each other. And finally, we expect our Q4 effective tax rate to be approximately 16%. Now I'd like to share some closing thoughts as we look to next fiscal year. Overall, we have performed well through three quarters of our fiscal year in a challenging environment, and we fully expect a strong Q4 to lay the foundation for FY 2022. We will, of course, continue to focus on delivering strong revenue growth in the short term. But even more importantly, this year has reinforced the critical importance of investing boldly to capture the significant list of opportunities ahead of us. Excellence in daily execution, coupled with a thoughtful vision for the future that creates value as well as opportunities for our customers globally will lead to long-term revenue and profit growth. With that, Brett, let's go to Q&A.

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

Excellent. Thank you, guys, for taking the question and great quarter. I guess this is a question both for Satya and Amy. We're seeing these really great commercial bookings results come through 39% growth in the current quarter. And Satya, you've been talking to us a lot about these more strategic deals and the acceleration of digital transformation. Can you give us a little bit of color of what comes in these more strategic deals? How does it change the dynamics of what types of solutions people are using for Microsoft, the scope of sort of how deeply you're getting into these customers and sort of how much of the IT budget you're getting? And then maybe talk to us a little bit about the timeframe for which this comes into revenues. What should our expectation be when you get one of these big strategic deals? How long does it take to really ramp up this customer onto the broader Microsoft platform?

Thank you, Keith, for the question. I think we feel very good both, I would say, of consumption and usage today, as well as, as you mentioned, the bookings because both of those at any given point in time is what we look at. The overall approach to the Microsoft Cloud, if you look at the breadth of what any customer may be doing with us, they may be doing hybrid cloud infrastructure with us. They may be, for the first time, doing Tier 1 workloads on the cloud with us, right, whether it's in core financials or in retail or in healthcare. Also, they could be deploying their centers of excellence around Power Platform. And Power Platform sits at the intersection of pretty much Dynamics, Azure, and Teams, for example. And of course, we're seeing the growth of Teams, and Teams, as I've always maintained, is not just about one thing. It's not about just meetings or it's not about just chat. But most importantly, it's a platform that drives, in fact, line of business and business application determination inside of a collaboration workflow. And so that's what we're seeing. And then the other thing I would say that we are now seeing is also that industry-level differentiation of the all-up Microsoft cloud. So whether it's in retail, whether it's in healthcare, or in financial services, we feel that we now can bring the power of the entire cloud together in a much more strategic way.

And maybe just to build on what Satya was saying, Keith, if you think about bookings or the remaining performance obligation, what I tend to think of is, when you hear those words, I think, often we pivot toward these Azure contracts we talk a lot about because they create some volatility. But really, the foundation for these long-term strategic contracts is the Microsoft Cloud holistically. So what you'll see is not just Office 365, but the suite of Microsoft 365. You'll see higher-level additions of security or compliance workloads. You'll see Dynamics 365 as a pillar with Power Platform because they're spanning end-to-end industry solutions to combine it back to what Satya is saying. So you see it add a good bookings number, which is fundamentally about, do you renew what's up for renewal, do you add workloads, do you add users and does it have a component of an Azure commitment. All of those things together are what creates this change. And if you look at remaining performance obligation, you see there a good bit of it that's going to be recognized in the next 12 months and another equally balanced portion that's beyond that. So it's not all long-term. This transition happens quickly, usage builds, it's both per user, it's also for workload and it's consumptive-based. So it's really a more holistic view that I would have people take as opposed to thinking about an Azure contract as long-dated.

Okay, Amy. Thank you, guys.

Operator, next question please?

Thanks. Satya, on healthcare, if you could just frame your aspirations long-term, where you'd like to be in this industry? And if you could just comment on where you still think the lowest hanging fruit is as it relates to the opportunity set, specifically building on the Nuance acquisition?

Sure, Brent. Thanks for the question. When I look at the industry cloud opportunities, we think of healthcare as a very critical opportunity for us and a huge and expansive addressable market. If you think about as a percentage of GDP, obviously, healthcare is significant. And fundamentally, when I think about the provider market, in particular, digital tech is going to play a huge role for every provider to do the things that they care the most about, which is to improve the patient outcomes, reduce cost, and reduce the burden on the physicians. So that's where the Nuance acquisition is a great fit for us. We've been partnered with them. It also enhances our platform approach, Brent. What we have always done is gone into an industry with a platform and an ecosystem approach. For example, with Nuance, they've done a fantastic job of taking what's perhaps the most defining technology of our times, which is AI and applying it to healthcare, which is the most important application space. And they've done that again by really partnering, partnering deeply with EMR systems and the rest of the healthcare ecosystem ultimately to benefit the providers. And so we're really looking forward to that acquisition closing, and we're already partnered with them in our cloud. But this allows us to take that and integrate more deeply with what we're doing with Teams and some of our AI capabilities even more deeply. And we think we can add a significant amount of value both to our partners in the healthcare ecosystem as well as most importantly to the providers.

Thank you.

Thanks, Brent. Operator, next question please?

Thank you very much and again congratulations on the quarter and how well the company is executing. I'd like to change gears a little bit and drill in a bit on the Dynamics 365 business. Frankly, if this part of any other company or even a standalone business, it would be such a center of enthusiasm by investors given how fast it's grown. Satya, when you said Dynamics 365 is taking share from competitors, are you talking about ERP or CRM or is it both? Or is it something different? And what are the key drivers of that strength and growth, and how sustainable do you believe that is? Thank you.

Thanks so much for the question, Mark. And first of all, we're very, very excited about what's happening again with Dynamics 365. And when you ask where is the share coming and where is the growth coming? It's coming from all those categories. But the most interesting thing is, as somebody wants to deploy even an omni-channel solution, for example, in a world where what's physical and what is digital need to come together, unlike anything before, because the pandemic is bringing about such structural change. You need both that federated inventory management, distributed inventory management system I referenced in my remarks. And you need the customer insights product that is probably one of the fastest-growing modules, which is that 360-degree view on customers and customer engagement and then including the supply chain. So bottom line is that, every customer is looking to digitize and bring together the data silos, in fact, silos of CRM and ERP systems. And that's probably one of the most interesting things we have observed is, it's not about replacing even an existing ERP or an existing CRM; it's about buying Dynamics and helping them bridge even some of the disparate CRM and ERP systems they may have. So we do see this as a huge opportunity as the world modernizes and puts in a complete next-generation, more proactive versus reactive business systems. And that's what Dynamics has been architected for. So I feel like coming out of this pandemic and the architecture and all the hard work that team has done over the multiple years now positions us very well.

Thank you. I much appreciate it.

Thanks, Mark. Operator, next question please?

Thanks. Question for Amy on OpEx. Amy, the OpEx growth has been extraordinarily low the last several quarters. The growth rate looks like it's going to inch up a little bit in the June quarter. But you mentioned the investments are shifting to future quarters. You probably don't want to give too much on fiscal 2022. But I'm just wondering whether we should extrapolate that into thinking that OpEx growth in fiscal 2022 should get back to the pre-COVID levels of plus 10%. And if you don't want to be that specific, maybe you could just help us outline some of the variables we should keep in mind as we model that line item post-COVID recovery in fiscal 2022? Thank you.

Thanks, Karl. And I do think in Q4, and it's why, I specifically called out the four points of impact from a year ago because it does start to get to a more normalized rate in Q4. And I say that because our headcount growth which I noted earlier has been 12%. And so, overall, you would expect OpEx growth to at least marry your headcount growth over any period of time, and we've certainly benefited through the year from COVID-related savings. We'll continue to have that in Q4. And as we get to 2022, I would expect to see a little less of that as people get back to the workplace at some level and resume some other normal levels of activity. And so, I do think you're heading in the right direction on that. And listen, I think that type of growth with the type of opportunity we're seeing, the number of TAM expansive opportunities really Satya went through in his comments, where we feel like we've got a unique position and opportunity to take share. I feel pretty confident in being able to certainly land that OpEx growth number.

Got it. Thank you, Amy.

Thanks, Karl.

I want to emphasize that in your models, you should account for the new categories we've entered since last year, which offer significant differentiation. When considering operating expenses, it's not simply about increasing costs from previous years; there is potential for leverage. In fact, we are directing operating expenses towards new total addressable markets.

Operator, next question please?

Yes. Thanks very much and congrats on the quarter. Satya, I was wondering if you could just talk a little bit more about Viva. I realize it's early days on that. But just the kind of feedback you're getting on that product? And how do you see that sort of fitting in? There seem to be some nice adjacencies with Dynamics with Office 365. So I was just kind of curious if you could give us a little bit of a hand on how it's going and sort of your excitement level about it over the next quarter next couple of years? Thanks.

Thank you for the question. It highlights a lot. It's a great illustration of what I was mentioning about creating a new category. Looking back over the years, we started discussing Power Platform. As I mentioned in my remarks today, we now have a comprehensive suite of tools that have essentially established this next-generation business process automation and productivity suite in Power Platform, which is scaling and growing significantly. Similarly, we view the experience cloud as a unique cloud opportunity for us. It currently brings together what have been separate tools, such as knowledge mining and management systems in enterprises, connecting them to learning and ultimately enhancing employee experience and communication systems. This is obviously closely related to what we are doing with Microsoft 365 and Office 365, especially Teams. Additionally, it integrates with line of business systems, HRM systems, and all other solutions we offer in Dynamics, along with various third-party SaaS applications. It is still early days, and we will adopt the same approach we have taken in areas like Security, Power Platform, Dynamics, and other sectors where we have successfully developed substantial new businesses as part of Microsoft Cloud. We are very enthusiastic about the potential this opportunity holds.

Thank you.

Thanks, Kirk. Operator, next question please?

Hi. Thank you very much. Congratulations on the quarter. Satya, I know you've said that you expect tech as a percentage of GDP to track about 5% or roughly double over the next 10 years or so. How should we think about Microsoft's share in that context? Is it going to be steady? Or do you see that expanding? And if it is going to expand, what are the key products and markets that will drive your relative share growth as you outperform tech and as tech outperforms GDP? Thank you so much.

No, thanks for the question, Kash. First, we strongly believe in two main principles. One, it’s essential to be competitive at every layer, and two, the integration of these layers into a cohesive architecture of the full stack or the Microsoft cloud is what sets us apart. This will determine our increasing market share as technology itself becomes a larger percentage of GDP. Whether it's hybrid infrastructure or the multi-cloud, multi-edge environment, which I believe will be prominent in ten years, we are well positioned. We have led in this area, currently lead it, and intend to maintain that leadership. Regarding data, our advancements with Synapse just in the past year, both in the cloud and at the edge, are significant. In terms of AI, our collaborations with OpenAI and our cognitive services, as well as our work with the Power Platform, are noteworthy. Developer SaaS is another exciting area for the next decade, focusing on the digital capabilities across every enterprise, where we are the leaders. Consider our offerings like VS Code and GitHub, along with the initiatives in Microsoft 365 and Dynamics for various industries. Ultimately, we don’t take any position for granted, but we are well positioned for a substantial total addressable market and competitive differentiation both within the individual layers and across the entire stack.

Got it. Thank you so much. That just sounds like a share gain story. Thank you so much. I appreciate it.

Thanks, Kash. Operator, next question please?

Okay, very much for taking the question. Satya, in your prepared remarks, you spoke about an increase in verticalization of Azure. Can we double-click on that a bit more? How much incremental opportunity do you see in industries like financials, like manufacturing? And are there other verticals that may make sense to pursue over time as well?

Thank you for the question. We believe that customers are focused on increasing their time to value, reducing costs, and enhancing agility. Customizing workflows and developing industry-specific models is essential, especially as we see more digitization and workflow automation. This requires a deeper understanding of what is currently not digital within an industry. By integrating Microsoft 365, Teams, Power Platform with specific workflows, data in Azure, and Dynamics, we can significantly enhance our customers' time to value across various industries. This approach will help us increase adoption rates, accelerate growth, and differentiate our offerings. We are also focusing on cross-industry workflows, emphasizing that we speak of the Microsoft Cloud as a holistic entity, increasingly tailored by industry and across multiple sectors.

Very helpful. Thank you.

Thank you.

Hey, thanks for squeezing me in. I wanted to ask about security and what we see in terms of changes in the industry and how Microsoft is kind of fit in there, where obviously in the last quarter, that was kind of a big topic. Can you talk a little bit about what you see in terms of customers realizing the broadened offering from Microsoft and how the cloud is playing a changing role there? Thank you.

No. Thank you for the question. Security is a crucial issue for every customer, board, and executive team. Our fundamental approach is to ensure that every customer has adopted a zero trust architecture. The aim is to see how Microsoft can enhance the cyber defense of the entire digital landscape through its involvement in the security industry. We’ve taken a distinctive approach by integrating identity, endpoint application, and infrastructure with XDR and SIEM, which is cloud-native. This integration is significant because we minimize barriers for customers. We ensure that any customer who deploys these systems together has enhanced defense capabilities, along with aggregated data to identify and respond to any security breaches, which is essential. Coupled with our operational security posture, processing 8 trillion events, we continuously assist our customers, contributing to the increase in cloud adoption rates. For instance, during challenges like HAFNIUM, the cloud remained unaffected. We worked diligently to ensure patches were applied even for unsupported servers. Consequently, any business that transitioned to the cloud did not face those issues. Therefore, I believe we will continue to see increased cloud adoption and greater use of comprehensive security suites like ours, accompanied by robust hygiene and operational security practices within a zero trust framework.

Thank you.

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

Thank you all.

Thank you.