Microsoft Corporation (MSFT) — Q1 2022 Earnings Call Transcript

Good afternoon, and thank you for joining us today. On the call with me are Satya Nadella, Chairman Chief Executive Officer, Amy Hood, Chief Financial Officer, Alice Jalla, 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'll 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 first-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 will 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 and constant-currency, we refer to the 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 transcripts 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 our Form 10-K, Form 10-Q, and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statements. And with that, I'll turn the call over to Satya.

Thank you, Brett. We're off to a fast start in fiscal 2022, with Microsoft Cloud quarterly revenue surpassing $20 billion for the first time, up 36% year-over-year. The case for digital transformation has never been more urgent or more clear. Digital technology is a deflationary force in an inflationary economy. Businesses small and large can improve productivity and the affordability of their products and services by building tech in density. The Microsoft Cloud delivers the end-to-end platforms and tools organizations need to navigate this time of transition and change. Now, I'll highlight examples of our innovation and momentum, starting with Azure. Every organization will need a distributed computing fabric across the cloud and the edge to rapidly build, manage, and deploy applications anywhere. We are building Azure as the world's computer, with more datacenter regions than any other provider delivering fast access to cloud services while addressing critical data residency requirements. And we're partnering with mobile operators from AT&T and Verizon in the U.S., to Telefonica and BG in Europe, Telstra and SingTel in Asia Pacific, as they embrace new business models and bring ultra-low latency compute power and storage to the network and the enterprise edge. 78% of the Fortune 500 use our hybrid offerings. And with Azure ANC, customers like Nokia, Royal Bank of Canada and SKF can deploy and run applications at the edge or in multi-cloud environments. Organizations also prefer our Cloud to power the mission-critical apps they rely on every day. G Healthcare and Procter & Gamble migrated critical workloads to Azure this quarter. And leading companies in every industry including Bertelsmann, Kimberly-Clark, the NBA, Softbank, and Decent Crop all chose Azure for their SAP workloads. Now onto data, the leading indicator of digital transformation success in organizations, is their ability to turn data into analytical and predictive insight. Azure Synapse brings together data integration, enterprise data warehousing, and big data analytics into a comprehensive solution. With Synapse Link for Dataverse, organizations can analyze data from business applications like Power Platform and Dynamics 365 with just a few clicks. With Synapse Link for Cosmos DB, they can run real-time, no ETL analytics over their operational data. And with Power BI, anyone in the organization can access these insights. Thousands of active Power BI customers are using Synapse today. More than ever, every business needs a holistic understanding of its data estate. Azure Purview, now generally available, is helping organizations such as FedEx manage and govern on-premise, multi-cloud, and SaaS data. Now onto developers, as every Company becomes a digital Company, they will need standardized tools to modernize existing apps and build new ones. From GitHub to Visual Studio, we have the most used and loved developer tools to build any app on any platform. GitHub is now home to 73 million developers, up 2x since our acquisition three years ago. More and more businesses are choosing GitHub enterprise to provide their developer teams the most advanced platform to build, ship and maintain software. This quarter alone, we introduced more than 70 enterprise features, 84% of the Fortune 100 use GitHub, and we're seeing growing usage from digital native Companies and the world's most established firms. From Pinterest to Procter & Gamble, from Stripe to Society Generale, we're rapidly innovating in AI and our large-scale models are powering everything from meeting recaps in Teams to helping developers code in GitHub to the next best action in Dynamics 365. As machine learning continues to mature, managing the life cycle of models or ML ops has become more prevalent and Azure ML is now the go-to tool for data science teams. Large organizations from Ecolab to Providence Healthcare are relying on Azure AI to better meet customer needs. Now, to Power Platform. With Power Platform, we're helping domain experts drive productivity gains with low-code, no-code tools, robotic process automation, virtual agents, and business intelligence. All up, Power Platform now has nearly 20 million monthly active users, up 76% year-over-year. Power Apps is the undisputed market leader in low-code no-code tools, now with 10 million monthly active users. 91% of the Fortune 500 use the service to build applications, and 129 organizations have more than 10,000 users, including 3M, EY, GSK, Marks and Spencer, Sony, and ZF Group. Now on to Dynamics 365, going forward, every business process will be collaborative, powered by data and AI, and will bridge the digital and physical world. Dynamics 365 ushers in this hyper-connected business process era. We continue to gain share with Dynamics 365 and Teams, we are creating a complete, new category of collaborative applications that help businesses like Rockwell Automation and Willis Towers Watson surface data and insights across the entire organization. Dynamics 365 Customer Insights leads this category. Customers like Meyer are using it to create a 360-degree view of customers in order to deliver more personalized experiences. All up, the number of customer profiles increased 174% year-over-year. Now on to industry. Our industry clouds are bringing together capabilities across the entire Microsoft Cloud along with industry-specific customizations to improve time-to-value, increase agility, and lower costs. We're seeing strong customer adoption of our new Industry Cloud for healthcare, and our clients for financial services and manufacturing will become more broadly available next week. Sustainability is an existential priority for our society and for every business today. When we think about our approach to sustainability, it's more than just the carbon footprint of our own datacenters. With our Microsoft Cloud for sustainability, we're creating an entirely new business process category to help organizations monitor the carbon footprint across their operations. The world's largest baking Company, Grupo Bimbo, for example, is using our tools to report, record, and reduce its emissions in every country where it operates. Now onto LinkedIn, we're experiencing a great reshuffle across the global labor market, as people are rethinking not only where and how they work but why. As more people change jobs than ever before, we saw record engagement as they increasingly turn to LinkedIn to connect, learn, grow, and get hired. LinkedIn now has nearly 800 million members. Confirmed hires on the platform increased more than 160% year-over-year. This quarter, we launched new ways to help job-seekers discover roles that align with how they want to work. In a rapidly-evolving labor market, companies are increasingly turning to LinkedIn Learning to upskill and reskill their employees. We now have over 15,000 enterprise customers of LinkedIn Learning, and we are expanding our opportunity in the creator economy, including offering new ways for LinkedIn Learning instructors to build their audiences and connect with learners live. Businesses continue to choose LinkedIn as the trusted way to reach professionals. LinkedIn advertising revenue was up 61% year-over-year. Now onto Microsoft 365 and Teams. Flexibility and productivity are not mutually exclusive. We are innovating to empower people to have an impact from home, in the office, and anywhere in between. Microsoft Teams is the only solution that supports all the ways people work. Usage has never been higher. A total of 138 organizations now have more than 100,000 users of Teams, and more than 3,000 have more than 10,000 users. Updates to Teams' rooms, including new AI Pod cameras and spatial audio, ensure every meeting attendee is always a first-class participant. The rise of hybrid work is transforming the enterprise phone market, and we're taking share across PSTN and VoIP. Calls originating from Teams chats increased 50% this quarter compared to a year ago. Operator Connect enables organizations to bring their existing service directly into Teams. Leaders in every industry, including Schlumberger, Westpac, ZF Group, REI, and SAP chose Teams this quarter to meet all their internal and external calling needs. Moving forward, organizations will need a digital fabric that spans organizational boundaries to address key challenges like customer service swarming and supply chain resilience. With Teams Connect, employees across multiple companies can chat and collaborate as one extended team without switching tenants. In private preview, we're already seeing strong interest and usage from companies like LVMH and WPP. Teams by itself has become a first-class platform for application development. Employees at Levi Strauss and NTT Data are using ServiceNow applications right within Teams, and organizations are using Power Platform to build their own rich, collaborative apps within Teams for everything, from curbside pickup to care team coordination. The number of organizations with more than 10,000 users integrating third-party and line of business applications with Teams increased 82% year-over-year. We're creating a complete new category with Microsoft Viva, which brings together communications, knowledge, learning, resources, and insights. Our acquisition of Ally.io, a leader in the fast-growing objectives and key results category, adds new tools to help employees drive outcomes, not just output, in hybrid work. Old Mutual, PayPal, and Toyota North America all chose to help strengthen connections between employees and their mission and to drive individual empowerment. Across Microsoft 365, we're seeing growth in all segments, including triple-digit year-over-year usage growth of Teams in front-line. One of Australia's largest retailers chose Teams to bring two-way communications to more than 120,000 frontline employees. Chevron, H&M, Lumen, and St. Jude all turned to our premium Microsoft 365 E-5 offerings for advanced security compliance, voice, and analytics. Now onto Windows. Earlier this month, we launched Windows 11, the biggest update to our operating system in a decade. When I step back and reflect on the future of how we work, connect, and play, one thing is clear, the PC will be more critical than ever. There has been a structural shift in PC demand emerging from this pandemic, and we are delighted with the early response to Windows 11. With every new generation of Windows, we also unlocked the next generation of hardware innovation across our ecosystem. Together with our OEM partners, we are excited to offer the widest choice of Windows 11 devices at every price point in every form factor this holiday. We are providing people and organizations everywhere with the most differentiated devices for productivity, learning, and gaming, and also have a massive opportunity to create a new class of applications that take advantage of the edge and AI capabilities in Windows, coupled with cloud. Windows 11 is also the most open platform. It's pioneering new store commerce models and policies with both Amazon and Epic Games by bringing their marketplaces to the Microsoft Store. Now on to security. Cyber security is the number one threat facing businesses today. Our goal is to help every organization strengthen its defense through the zero trust architecture built on end-to-end solutions that span all clouds and all platforms. We analyze over 24 trillion signals across email, endpoints, and identities each day and translate this intelligence into innovative features to protect our customers. We have prevented more than 70 billion attacks over the past year alone. We now have nearly 650,000 customers using our security solutions, up 50% year-over-year. Businesses like healthcare and Siemens switched to our security solutions to protect their endpoints. In identity, Azure Active Directory now has more than 500 million monthly active users, and we have seen usage of third-party apps increase 1.5X year-over-year. The future of security is password-less. Nearly 240 million users have adopted password-less login to date, and consumers can now completely remove passwords from their personal Microsoft accounts. We are not stopping there. Over the next five years, we'll invest $20 billion to advance our security solutions and protect customers. Now, on to gaming. We continue to attract new gamers and retain those we have gained over the past year and a half. We saw record first-quarter monetization and engagement. This holiday season will bring our biggest lineup of content and exclusive games ever, with three new AAA titles, including Halo Infinite available via Game Pass subscription service, which continues to offer the best value in gaming. We're also bringing XCloud gaming to the console for the first time, enabling Xbox users to discover and stream more than 100 games with just a click. Cloud gaming is now available in 26 countries, now including Australia, Brazil, Mexico, and Japan. We are expanding our opportunity with independent creators as well as top studios. Updates to Azure PlayFab make it easier for developers to integrate the creator marketplace in the games they build. Leading publishers from Bungie to Crafton are all relying on our cloud to scale and operate their games. In closing, we have the most diversified set of digital businesses, and we are innovating to expand our opportunity across the entire portfolio to help our customers in this new era. Next week, we'll hold our flagship Ignite Conference where we will share the next chapter of Microsoft Cloud from large-scale AI, from hybrid work to hybrid infrastructure. I couldn't be more optimistic about the opportunities ahead. With that, I'll hand it over to Amy.

Thank you Satya and good afternoon everyone. Our First-Quarter revenue was $45.3 billion, up 22% and 20% in constant currency. Earnings per share was $2.27, and increased 25% and 23% in constant currency when adjusted for a net tax benefit of $3.3 billion related to the transfer of intangible properties this quarter. Our sales teams and partners delivered a strong start to the fiscal year. In our commercial business, customers continue to choose the Microsoft Cloud. We again saw healthy growth in our Azure consumption-based business and increased usage across products such as Teams and Power Platform, reflecting in the comments. In our on-premises business, annuity performance in Office to Server benefited from a greater-than-expected mix of contracts, with higher in-period revenue recognition. In LinkedIn, the talent solutions business continued to benefit from an improved job market. In our consumer business, Windows OEM performance was better than expected in a growing PC market, despite ongoing supply chain constraints. We also saw positive demand signals for Windows 11 ahead of launch with nearly all devices built this quarter eligible for upgrade. Microsoft 365 subscription growth drove Office consumer results, while advertising market growth drove another strong quarter in LinkedIn, as well as search and news advertising. In gaming, we were able to ship more Xbox Series X and S consoles than expected, even as demand continues to exceed supply. Let's move to our overall results. Against the strong prior-year comparable, commercial bookings grew 11% and 14% in constant currency driven by consistent execution across new, add-on, and renewal sales motions. This quarter, growth was impacted by fewer large long-term Azure contracts, which are unpredictable in their timing. As a result, commercial remaining performance obligations increased 28% and 29% in constant currency to $137 billion with a roughly equivalent split between revenues that will be recognized within and the portion beyond the next 12 months. Our annuity mix increased 2 points year-over-year to 95%. Microsoft Cloud revenue grew 36% and 34% in constant currency to $20.7 billion ahead of expectations. Microsoft Cloud gross margin percentage decreased slightly year-over-year to 71%. Excluding the impact from a change in accounting estimate for the useful life of server and network equipment assets, Microsoft Cloud gross margin percentage increased roughly 4 points, driven by improvement in our Cloud Services, particularly in Azure and Office 365, partially offset by sales mix shift to Azure. With the weaker U.S. dollar, FX increased total Company Productivity and Business Processes and Intelligent Cloud revenue growth by 2 points. In line with expectations, more personal computing revenue growth was increased by 1 point, less favorable than expected. Effects increased costs by 1 point, in line with expectations, and had no impact on operating expenses, slightly more favorable than expected. Gross margin dollars increased 21%, and 19% constant currency. Gross margin percentage was 70%, down slightly year-over-year. Excluding the impact of the change in accounting estimate discussed earlier, gross margin percentage increased roughly 1 point, driven by improvements in Cloud Services noted earlier, partially offset by sales mix shift to Cloud. Operating expenses increased 11%, lower than expected, primarily driven by investments that shifted to future quarters. At a total Company level, headcount grew 14% year-over-year, as we continued to invest in key areas, such as Cloud engineering, sales, customer deployment, and gaming. Operating income increased 27% and 24% in constant currency, and operating margins expanded two points year-over-year to 45%. Excluding the impact of the change in accounting estimate, operating margins expanded roughly four points year-over-year. Now, to our segment results. Revenue from Productivity and Business Processes was $15 billion and grew 22% and 20% in constant currency, with better-than-expected performance in Office, commercial, and LinkedIn. Office commercial revenue grew 18% and 16% in constant currency. Office 365 commercial revenue grew 23% and 21% in constant currency, driven by installed base expansion across all workloads and all customer segments, as well as higher ARPU. Demand for our advanced security, compliance, and voice offerings continued momentum in E5 revenue this quarter. Paid Office 365 commercial seats increased 17% year-over-year, driven by another strong quarter of growth in our small and medium business and front-line worker offerings. Office commercial licensing decreased 13% and 14% in constant currency, significantly ahead of expectations, benefiting from the higher end period revenue recognition noted earlier. Office Consumer revenue grew 10% and 8% in constant currency on a strong prior-year comparable, with better-than-expected growth in Microsoft 365 subscriptions. Dynamics revenue grew 31% and 29% in constant currency. Dynamics 365 revenue growth was 48% and 45% in constant currency with continued strong demand for Power Apps, which grew 202% and 197% in constant currency. And in LinkedIn, revenue increased 42% and 39% at constant currency, with continued strength in marketing solutions and better-than-expected performance in talent solutions from the improved job market. Segment gross margin dollars increased 22% and 20% in constant currency, and gross margin percentage increased slightly. Excluding the impact of the Teams accounting estimate, gross margin percentage increased roughly two points, driven by improvement across all Cloud services. Operating expenses increased 7% and operating income increased 33% and 29% in constant currency. Next, the Intelligent Cloud segment. Revenue was $17 billion, increasing 31% and 29% in constant currency ahead of expectations, driven by continued customer demand for our differentiated hybrid and Cloud offerings. Overall several products and Cloud services revenue increased 35% and 33% in constant currency. Azure and other Cloud services grew 50% and 48% in constant currency ahead of expectations, driven by our consumption-based services. The ARPU user business, enterprise mobility and security installed base grew 30% to over 196 billion seats. In our on-premises business, on a low prior-year comparable, revenue increased 14% and 13% in constant currency ahead of expectations. Strengthening our annuity business was driven by healthy demand for our hybrid offerings that include Windows Server and SQL Server running in multi-cloud environments and higher in-period revenue recognition, including a benefit from annuity purchasing ahead of the Windows Server 2022 launch. Enterprise Services revenue grew 9% and 8% in constant currency driven by growth in Microsoft consulting services and Enterprise Support Services. Technical gross margin dollars increased 28% to 26% in constant currency, and gross margin percentage decreased roughly 1 point, year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage increased roughly two points, driven by improvements in Azure, partially offset by sales mix shift to Azure. Operating expenses increased 13% and 12% in constant currency, and operating income grew 39% and 37% in constant currency. Now, to more personal computing. Revenue was $13.3 billion increasing 12% and 11% in constant currency with better-than-expected performance and Windows OEM and gaming. Windows OEM revenue increased 10% driven by a stronger-than-expected PC market, particularly in the commercial segment, which has higher revenue per license. These results include roughly seven points of impact from the $210 million revenue deferral related to Windows 11 licenses sold to OEMs prior to general availability. The deferral was lower-than-expected as OEMs prioritized upgrading eligible device builds early in the quarter. Windows commercial products and cloud services revenue grew 12% and 10% in constant currency, driven by demand for Microsoft 365. Surface revenue declined 17% and 19% in constant currency on a strong prior-year comparable. Search and news advertising revenue increased 40% and 39% in constant currency, in line with expectations benefiting from the advertising market noted earlier. In gaming, revenue increased 16% at 14% in constant currency ahead of expectations, better than expected console supply and continued strong demand resulted in Xbox hardware revenue growth of 166% and 162% in constant currency. Xbox content services revenue increased 2%, and was relatively unchanged in constant currency against a strong prior-year comparable. Segment gross margin dollars increased 10% and 8% in constant currency. Gross margin percentage decreased roughly 1 point year-over-year, driven by sales mix shift to gaming hardware. Operating expenses increased 15% driven by the ZeniMax acquisition, as well as Windows 11 marketing. Operating income grew 7% and 5% in constant currency. Now, back to total Company results. Capital expenditures, including finance leases, were $7.4 billion, in line with expectations, and cash paid for PP&E was $5.8 billion. Our capital investments, including both new datacenter regions and expansion in existing regions, continued to be based on significant customer demand and usage signals. Cash flow from operations was $24.5 billion, increasing 27% year-over-year, driven by strong Cloud billings and collections. Free cash flow was $18.7 billion, up 30% year-over-year. This quarter, other income and expense was $286 million higher than anticipated, primarily driven by net gains on investments. As a reminder, we are required to recognize market-to-market gains or losses on our equity portfolio. Our non-GAAP effective tax rate was approximately 16%. Finally, we've returned $10.9 billion to shareholders through share repurchases and dividends. Now, before we turn to our outlook, I'd like to provide a couple of reminders. First, the outlook we give, unless specifically noted otherwise, is on a U.S. dollar basis. Second, my remarks for the next quarter do not include the impact from the Nuance acquisition, which we now expect to close by the end of Q2 or early Q3. With that, let's move to our second-quarter outlook. In our commercial business, our differentiated market position, compelling solution portfolio, and consistent execution should drive another strong quarter. Commercial bookings growth should again be healthy but impacted by modest growth in the Q2 XFree base and the normal quarterly volatility from large long-term Azure contracts previously discussed. Microsoft Cloud gross margin percentage decreased roughly two points year-over-year, excluding the impact of the change in accounting estimate previously discussed. Hugh gross margin percentage will increase roughly two points driven by continued improvement across our services despite revenue mix shift to Azure. Longer-term, we expect the Microsoft Cloud gross margin percentage to be impacted by revenue mix shift to Azure, increased usage of our Microsoft Cloud services, and ongoing strategic investments to support our customers' success. On a dollar basis, we expect capital expenditures to be roughly in line with the last quarter, as we continue to invest to support growing demand. Now to FX, based on current rates, we expect FX to increase revenue at the total Company and all individual segment levels by approximately one point and have no impact on total COGS or operating expense growth. Next, to segment guidance. In Productivity and Business Processes, we expect revenue between $15.7 and $15.95 billion. In office commercial, revenue growth will again be driven by Office 365 with healthy growth across customer segments and continued momentum in 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 revenue to grow in the mid-teens with continued momentum in Microsoft 365 Consumer subscriptions. For LinkedIn, a strong job market and continued engagement on the platform should drive revenue growth in the mid-30% range and in dynamics, we expect revenue growth similar to Q1, driven by strength in Dynamics 365, including continued momentum in Power Apps. For Intelligent Cloud, we expect revenue between $18.1 billion and $18.35 billion. Revenue will continue to be driven by Azure, which, as a reminder, can have quarterly variability, primarily from our per-user business and from revenue recognition depending on the mix of contracts. In Q2, we expect healthy drive based growth in our Azure consumption business consistent with recent trends. We expect revenue growth in the mid-single digits driven by continued demand for hybrid solutions. In enterprise services, we expect revenue growth to be in the high single digits. In more personal computing, we expect revenue between $16.35 and $16.75 billion. Despite ongoing supply chain constraints, OEM revenue should grow low to mid-teens including six points of impact from $10 million Windows 11 referral that shifted revenue from Q1 to Q2. In Windows commercial products and cloud services, customer demand for Microsoft 365 and our advanced security solutions should drive low double-digit growth. In Surface, we expect revenue to decline in single digits as we continue to work through supply chain uncertainty, particularly in our premium devices. In Search and News Advertising X Tech, we expect revenue growth in the low to mid-20s. If supply chain uncertainty reduces advertising budgets, our results would be negatively impacted. In gaming, on a high prior-year comparable, that included the launch of our new consoles and strength across Xbox content services, we expect revenue growth in the high single digits. Console sales will continue to be strong engagement on the Xbox platform in a holiday quarter that will include several AAA titles. Now back to Company guidance. $17 to $17.2 billion and operating expenses of $12.7 to $12.8 billion. In other income and expense, interest income and expense should offset each other. Finally, we expect our Q2 effective tax rate to be approximately 17%. In closing, we are off to a strong start in FY '22 with tremendous opportunity to drive sustained, long-term revenue growth. We remain focused on growing high-value usage across our differentiated Microsoft Cloud offerings, and delivering exciting new consumer experiences with Windows 11, Surface, and our Xbox gaming platform as we enter the holiday season. Our consistent approach to investing for these and other future opportunities while continuing to deliver solid operating performance will drive strong results throughout FY 22 and beyond. Now, Brett, let's go to Q&A.

Thanks, Amy. We'll now move over 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 your instructions?

Excellent. Thank you guys for taking the question and congratulations on another remarkable quarter. Satya, I was hoping you could talk a little bit about the edge computing opportunity, something that you started off your remarks with and also something that we're hearing a lot of chatter about within the investor community and within the technology community. Can you talk to us about how you think about sizing that opportunity in terms of the programmable edge, and maybe help us understand the Microsoft architectural approach versus perhaps some of the competitors coming into the marketplace from the CDN perspective, who are talking about the competitive differentiation by having more of a last-mile solution. Can you help us understand the differentiation in those approaches?

That's a great question. As you know, Keith, we architected Azure for the distributed computing fabric to remain distributed. In other words, when we talked about hybrid computing even five years ago, the idea was always that we will have a Cloud and a distributed Cloud infrastructure for application deployment. When we think about Cloud Plus Edge, we even put the multi-cloud control plane in there, right? So whether it's what's happening with 5G and how naturally compute will go to where data is generated with low latency access to a factory floor, to a hospital, to cities where you want to play XCloud gaming, that's one phenomenon. The other is just literally treating every Cloud, whether it's the on-premise data center, the other public cloud, and our public cloud, and being able to use Azure Arc in its control plane to ease the deployment across all clouds. That is another thing that we're seeing. So when I think about what is going to be key in such a distributed world is having that full suite of applications and infrastructure, right? All the way from the management and security control plane, something like Azure Active Directory managing the security principles and identities or the management control planes like Azure Arc, and so we feel well-positioned for it. I think that the multi-cloud, multi-edge world is really how we built Azure in the first place. We're still very early in all of that playing out, but we feel well-positioned.

Excellent. Thank you, guys.

Thanks, Keith. Operator, next question, please.

Amy, commercial bookings up 14% is impressive, but its slowdown from last call was 25% against a more difficult comp. I think you mentioned some color around Azure and the size and duration. Can you just maybe call out anything else there and realize it has come off tough comps?

Thanks, Brent. Yeah, I think the important thing when you think about bookings performance is to talk about what happened before you got to those volatile, the large Azure commitments that create some of the top comparables that we're talking about. That's really the opportunity to execute against selling the Microsoft day to day, which is Dynamics, Microsoft Cloud, GitHub in the broader universe. Our execution on that was quite good. Very good renewals, very good recapture rates, very good add-ons, meaning you sell outside of the normal pattern, and so I feel very good. It's very consistent execution to your point, Brent, this quarter versus others on that front. Then to your point, it's important not to time some of these larger long-dated Azure contracts. That's where the volatility is; the day-to-day execution of Azure commitments was actually very consistent. The volatility comes with some of the bigger things, and a lot of them were in Q4, last on a comparable basis in Q1, and that happens from time to time.

Thank you.

Thanks, Brent. Operator, next question, please.

Thank you. Amy, heading into this Q1 release, I'd say there was a higher-than-normal level of worry from investors about your Windows PC segments in light of all of the unit shipment and supply chain issues, and yet, you put up a Windows OEM number that blew away your guidance and your guidance for the Windows OEM business in December was also way above what people are modeling. How did you dodge that bullet, Amy? Can you unpack that OEM performance for us? And your view into the second half of the fiscal year. Thank you.

Thanks, Karl. I want to start by saying and repeating something that Satya, I think, was careful to include in his remarks. It is the central nature of the PC to relay the nature of both hybrid work and fundamentally about getting jobs done. It continues to exist. The market grew this quarter constrained by supply. I believe Q2 will also be a strong demand quarter that is constrained. Even with that, we see a growing market. In Q1 and Q2, we see strong demand in the commercial segment, tying directly back to some of Satya's comments. Additionally, there is benefit, with revenue per license being higher in commercial than it is in the broad market. Those factors together, which is a growing market, strong Windows performance, and in commercial in particular, resulted in a very strong position in Q1 and Q2.

Got it. Congrats on that result, Amy.

Thank you.

Thanks, Karl. Operator, next question, please.

Thank you very much. Satya, congratulations on the really strong quarter. With inflation, at least in the U.S., increasing and likely to further accelerate due to government spending, Amy, how do you think this increasing inflation will impact your customers and your business? Satya, in your remarks, you discussed how digital is deflationary in an inflationary world. Can you give more color on how the shift to Cloud and Digital will offset inflationary pressure beyond purely pricing? Thank you.

Maybe I'll just start and then Amy, you can add to it. In an inflationary environment, the first place any business should go to is to ensure that they're able to get productivity gains. Even dealing with constraints; for example, if you have supply chain constraints, you want to run your factories at the efficient frontier. That means things like digital twins, simulation, are where you will make sure that every production run has the least amount of wastage. Any way you look at it, whether it's in knowledge work, first-line work, or digital twins and simulation, all those things are going to be the best way for any Company to deal with inflationary pressures. That way, they'll have the best productivity to meet aggregate demand. We are excited to make our software products available to all our business customers to help them manage through this inflationary environment, and I'll let Amy add to that.

Yes, thanks, Satya. Really, that's the crux of the matter, Mark. Many customers across industries and geographies want to adopt digital technology for those reasons Satya outlined. Regardless of the overall environment, we feel like we offer the best portfolio at the Microsoft Cloud and with our Industry Clouds to make that viable with a very fast time to value. Our execution on that, regardless of spending environments, shows that our portfolio offers high value to customers and can deliver results when they need them, which is reflected in many surveys indicating a preference to use the Microsoft Cloud.

Thank you. That's extremely helpful. I appreciate it, and congrats again.

Thanks, Mark. Operator, next question, please.

Hi. Thank you very much. Great quarter. You gave us great useful perspective on inflation. Curious if you can expand your thoughts, Satya and Amy, on the labor shortage we're seeing in the tech market. How are you dealing with that? Also, a deeper perspective on the supply chain and how this marks good visibility considering that you're growing your Cloud business and your CapEx commitments seem quite impressive. How much visibility do you have into component availability? Are you ready to ramp up your CapEx? Thank you.

Thanks, Kash for the question. On the labor market, maybe I'll start. The first place where we're focused is ensuring that, with LinkedIn, we're doing everything to help everyone find their best economic opportunity. Ryan Roslansky, the CEO of LinkedIn, talks about the great reshuffle. Along with the hybrid work change, there is a real question everyone is asking about not just where and how they work, but why they work. Helping to find those opportunities is essential. The second side to this is ensuring productivity among people, whether on the front lines or as knowledge workers, and making sure they have the best tools. That's our focus. Key to dealing with labor shortages is enhancing productivity. The work we do on LinkedIn is a part of that. With that, Amy, I'll hand it over to you.

Thanks, Satya. As you noted, we added 14% year-over-year headcount growth this quarter. We remain focused on being a great employer, enabling people to achieve their goals here. You asked about the supply chain impact, particularly around data centers. Most of that cash consists of long lead times, and we have a good understanding of the required timelines to meet capacity signals we're witnessing. We are managing that well, but it's important to note we're still somewhat impacted. Multiple suppliers are critical in helping us manage through that, and I feel the team has done a commendable job. Regarding specific impacts, I noted that demand will exceed supply in PCs and Surface for us, particularly in premium devices and consoles for Xbox. Further, another challenge will be to monitor the advertising market through the quarter, as their willingness to spend is directly connected to their supply.

Brilliant. Thank you so much.

Thanks, Kash. Operator, next question, please.

Thank you. Could you elaborate on the remarks you made? You discussed hybrid clouds and how certain tools continue to show benefits. What are you observing on the client side regarding this shift, particularly with people migrating to the Cloud and their workloads? Is this overall advantageous for you?

I can talk a bit about what we see in the classic model of lift and shift in modernized motions, which is at the core of hybrid Cloud. That's still in early innings. Every day I wake up to talk to customers planning out that motion and ensuring they can modernize their application portfolio. It's still very strong. Even in the height of our success in the declining server era, we would never reach a Tier-1 company. For example, take all the SAP workloads running on Azure. The other thing happening is real production workloads are moving over. Regarding the data estate, we're seeing significant traction, including with Azure Purview becoming a major driver of data governance as customers need real governance on data. Another critical area is Dev Tools; with the CI/CD on the Cloud, we can modernize applications and ensure agility with GitHub and VS Code becoming the default for any modern development shop. Additionally, the advent of Teams, has introduced a new platform for hosting applications, either developed by enterprises or third parties, which reinforce and compound the growth of Teams to Power Apps, Dynamics, and Azure.

Raimo, to add to that, I want to clarify some of my earlier comments about on-prem server results. It really points to hybrid strength, whether customers operate Windows and SQL server in Azure or multi-cloud environments. It's a commitment to the platform, which is one of the drivers of our server products and Cloud KPI execution this quarter.

Thank you. Very clear. Congrats.

Thanks, Raimo. Operator, next question, please.

Great. Thanks very much. So recently, several of your Tier-1 clients have talked about having trouble hiring fast enough to keep up with demand, but as we look forward, have you seen any early indications that customers may slow down the pace of moving to your commercial Cloud?

I would point to Amy's guidance for the next quarter. Demand across the entire stack is quite robust. Whatever happens in the labor market, whether in tech or any other sector, we are subject to it. However, the demand for software businesses is structural and we want to ensure that we provide the most competitive products available.

The signals we're seeing on consumption and usage suggest that customers are effectively prioritizing what's valuable to them. Yes, the labor market has an impact; we are investing in training and skilling, making deployment easier, and documentation more accessible. Investing in products to enhance productivity is essential.

That's great. Thank you.

Thanks, Brad. Operator, we have time for one last question.

Great. Thanks, guys, for taking my question. Congratulations on a really nice quarter here. Satya, I wanted to ask about the comments you made earlier in the call regarding investments and new releases for some of the industry Cloud, specifically in financial services and manufacturing. How should we view this? Should we see the Azure business results as increasingly driven by these Industry Cloud type solutions instead of horizontal projects like ERP and databases? Is this an incremental opportunity we should be considering?

Thank you for the question. Absolutely, we view the Microsoft Cloud, which includes Azure, Dynamics 365, Microsoft 365, Power Platform, GitHub, and VS Code, as a complete modern tech stack. With the Industry Cloud, we add specific value, whether in retail, manufacturing, healthcare, and our pending Nuance acquisition adds further to that. We're focused on ensuring that not just one piece excels, but each component needs to be competitive on its own. The integration of the Microsoft Cloud with the Industry Cloud enhances the overall value for customers.

That's great. Thank you so much.

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

Thank you.

Thank you.