Microsoft (MSFT) Q4 2020 Earnings Call Transcript

Automated Voice: (00:00) Greetings and welcome to the Microsoft fiscal year, 2020 fourth quarter earnings conference call at this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mike Spencer, general manager and investor relations for Microsoft. Thank you, sir. You may begin. Mike Spenser: (00:31) Good afternoon and thank you for joining us today on the call with me or Satya Nadella, chief executive officer Amy Hood, chief financial officer, Frank Brode, chief accounting officer and Keith Dahlberg deputy general counsel. On the Microsoft Investor Relations website, you can find our earnings press release and our financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provides a reconciliation of differences between gap and non-gap financial measures. Mike Spenser: (00:56) Unless otherwise specified. We will refer to non-gap metrics on the call. The non-gap financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with gap. They are included as additional clarifying items, paid investors and further understanding the company's fourth quarter performance, in addition to the impact these items and events had on the financial results. All growth comparisons we make on the call today relate to the corresponding period of last year, unless otherwise noted. Mike Spenser: (01:23) 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 in constant currency, we will 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. Mike Spenser: (01:48) 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. Mike Spenser: (02:03) Actual results could materially differ because of factors discussed in today's earnings press release, and the comments made during this conference call and in the risk factor section of our form 10 K, forms 10 Q and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward looking statement. And with that, I'll turn the call over to Satya. Satya Nadella: (02:22) Thank you, Mike. Good afternoon, everyone. We delivered record results this fiscal year powered by our commercial cloud, which surpassed 50 billion in revenue for the first time, up 36% year over year. The last five months have made it very clear that digital tech intensity is key to business resilience. Organizations that build their own digital capability will recover faster and emerge from this crisis stronger. Satya Nadella: (02:54) We are seeing businesses accelerate the digitization of every part of their operations, from manufacturing to sales and customer service to reimagine how they meet customer needs from curbside pickup and contactless shopping in retail to telemedicine and healthcare. That's why we are building the full modern technology stack powered by cloud and AI and underpinned by security and compliance to help every organization digitally transform. Satya Nadella: (03:26) Now I'll highlight our innovation and momentum starting with Azure. Every organization today needs a distributed computing fabric to run essential workloads. We are building Azure as the world's computer to support them with more data center regions than any other provider including new regions as of this quarter in Italy, New Zealand and Poland. We have always led in hybrid and we are accelerating our innovation to meet customers' needs wherever they are. Satya Nadella: (04:01) Azure Arc is the first control plane built for a multicloud multi edge world and we're taking it further with Azure Arc enabled Kubernetes. New capabilities in Azure stack HCI help organizations bring the cloud to their very own data centers. And our acquisitions of Affirmed and Metaswitch along with Azure edge zones, extend Azure to the network edge, expanding our offering to telecom operators as they move to 5G. Our differentiated approach across cloud and edge is winning new customers in every industry. From Land O'Lakes the national Australia bank to Johns Hopkins Medicine, as well as leading ISVs, including Citrix, Fenestra, SAS and Workday. At the data layer, azure is the only cloud with limitless data and analytics capabilities that can deliver a cloud native data estate for every organization. Satya Nadella: (05:03) The combination of SQL, hyperscale, cosmos GB, synapse analytics and the new synapse link which enables live analytics on real time transactions differentiate Azure. In AI, we have the most comprehensive portfolio of tools, frameworks, and infrastructure. We're thrilled with the progress our partner, open AI, is making. The new GPD three model constitutes a new breakthrough in AI and was trained on our Azure AI supercomputer. Satya Nadella: (05:38) New capabilities in Azure cognitive services, make it easier to build applications that speak naturally in 49 languages and its variants, and to generate insights from unstructured data, including paper-based forms and medical records. Microsoft bot framework now includes powerful authoring tools to build sophisticated, conversational bots with low code. And with the Azure machine learning, organizations can deploy AI more responsibly and safely. Satya Nadella: (06:09) All this innovation is driving usage. In June alone 13.5 billion transactions were processed in Azure cognitive services, 2.5 billion messages sent, 9 million hours of speech transcribed. From Bridgestone to United Health Group to EUI, companies are relying on Azure AI to innovate and better meet customer needs. Now to developer tools. The role of developers is more important than ever from emergency response to recovery, to reimagining the world. Satya Nadella: (06:42) We have the most used and loved developer tools to build any application for any platform. We've seen increased activity across multiple measures, and we are going further with new tools to power secure remote development. With code spaces, we are bringing together the best of GitHub, Visual Studio and Azure to help developers go from code to cloud in seconds. New advanced security features and GitHub use semantic analysis to scan code for vulnerabilities and GitHub discussions help software communities collaborate outside of the code base. Satya Nadella: (07:22) More than 3 million organizations, including the majority of the fortune 50 now use GitHub. The state of California is using GitHub and Azure DevOps to power 90% of its digital COVID-19 response infrastructure. All the 5,000 engineers at Autodesk rely on GitHub to break down silos across the organization. And at Etsy, developers are using GitHub to deploy to production more than 50 times per day. Now to power platform. Satya Nadella: (07:51) With power platform, anyone in an organization can rapidly create an application, build a virtual agent, automate a workflow or analyze data. Citizen developers and business decision makers at companies like Schlumberger and T-Mobile are using our platform to address challenges created by COVID-19. Power BI is the clear leader in business intelligence in the cloud, and is growing significantly faster than competition. 96% of the fortune 500 now use Power BI to find insights in their data. Satya Nadella: (08:25) More broadly across the power platform. You're seeing accelerating usage. Power apps, monthly active users increased 170% year over year. Power automate is up 75% and in just six months, power virtual agents are already so far 6.7 million sessions. Just yesterday we launched an end to end return to workplace solution in power platform that'll help organizations like CBRE, keep employees safe and healthy when they go back to their office. We continue to invest in robotic process automation. Satya Nadella: (08:59) Our acquisition of soft motor when coupled with power automate enables customers, including KPMG to automate manual business processes across both legacy, as well as modern applications. Now to Dynamics 365, that Dynamics 365 is helping organizations in every industry digitize their end to end business operations from sales and customer service to supply chain management so that they can rapidly adapt to changing market conditions. Satya Nadella: (09:29) Customer insights is the fastest growing Dynamics 365 application ever helping organizations like Walgreens Boots Alliance and Chipotle offer more personalized customer experiences. BNY Mellon chose Dynamics 365 this quarter to help investment managers build stronger relations with their customers. More than 4,500 organizations now use Dynamics 365 commerce, finance and supply chain management, making it one of the fastest growing SAS solutions in its category. Satya Nadella: (10:02) FedEx, for example, uses Dynamics 365 to drive more precise logistics and inventory management. In retail Dynamics 365 connected store now offers in-store traffic analytics and curbside pickup, prioritizing safety as stores reopen, and we continue to invest in solutions to protect merchants as they process more online transactions. New account protection and loss prevention features in Dynamics 365 prod protection help protect online revenue. Satya Nadella: (10:33) We are working with financial services firms like Capital One to improve fraud detection and keeps customers secure. Now to LinkedIn. In spite of revenue headwinds due to low hiring needs, we are seeing record engagement as LinkedIn's more than 706 million professionals turn to the network to connect, learn, and plan for the future. Satya Nadella: (10:56) Content shared was up nearly 50% year over year and LinkedIn live streams were up 89% since March. People will increasingly need to move beyond current domain expertise to learn new skills and they're turning to LinkedIn. Professionals watched nearly four times the amount of LinkedIn learning content in June than they did a year ago. We are making it easier for them to access LinkedIn Learning's more than 16,000 online courses directly in the flow of their work. Satya Nadella: (11:31) Our new learning app and teams will allow organizations to integrate LinkedIn Learning as well as their own content to create a continuous feedback loop between work, skills and the learning needed for upskilling and reskilling employees. Now to Microsoft 365 and Teams. When, where, and how the world works is fundamentally changing. Microsoft 365 is empowering people and organizations to be productive and secure as they adapt to more fluid ways of working as well as learning. Satya Nadella: (12:07) Microsoft Teams is helping people be together even when they are apart. It's the only solution with meetings, call chat, content collaboration with office, as well as business process workflows in a secure, integrated user experience. We are reimagining every aspect of the meeting's experience with new capabilities like together mode and the dynamic stage to help people feel more connected and reduce cognitive load. Satya Nadella: (12:34) We expanded the gallery view in teams so that people can see and interact with up to 49 participants at a time and break out rooms and live reactions will help people build social capital in a virtual world. Deeper integration between teams and power platform brings an integrated data platform, Microsoft data flags for easier, faster application creation and deployment. Enabling a new category of enterprise grade apps and chat bots and Teams. Satya Nadella: (13:04) Teams is rapidly becoming the communication's backbone as customers accelerate moving voice to the cloud. We are expanding Teams beyond the workplace, making it easy to add personal Teams account on mobile so you can stay connected with friends and family across work as well as your life. Teams users generated more than 5 billion meeting minutes in a single day this quarter. And we are seeing increased usage intensity across the platform as people communicate, collaborate and coauthor content in teams. Satya Nadella: (13:40) 69 organizations now have more than 100,000 users of Teams and over 1,800 organizations have more than 10,000 users of Teams. We're working alongside the educators as they prepared for remote hybrid and in-person scenarios this fall. More than 150 million students and teachers around the world now rely on our tools, including Teams, Stream, OneNote as well as Flipgrid to prioritize student engagement and learning outcomes. Satya Nadella: (14:13) Our new Microsoft cloud for healthcare is helping providers schedule, manage and conduct viral visits using Teams and engage with patients using Dynamics 365. In healthcare, there were more than 46 million Teams meetings this past month. The NHS in the UK chose Microsoft 365 to empower it's 1.2 million employees with the latest productivity and collaboration tools to deliver better patient outcomes. Satya Nadella: (14:41) More broadly we're seeing increased usage of Microsoft 365 and larger and larger strategic agreements. Alcoa and Telstra are empowering their entire workforce, including first line employees with Microsoft 365 and Teams. Across industries customers like 3M CenturyLink, GE and Providence are increasingly choosing our Microsoft- Satya Nadella: (15:03) G and Providence are increasingly choosing a Microsoft 365 premium offerings for differentiated security compliance, voice, and analytics value. Microsoft 365 E5 user base more than doubled year over year. People are turning to Windows PCs more than ever with minutes spending Windows 10 up more than 55% year over year. And we expanded our family of Surface devices and accessories to help people work, learn, and connect from anywhere as we create new categories that benefit the entire OEM ecosystem. Satya Nadella: (15:38) Now to security and compliance. Remote everything continues to accelerate the need for a zero trust security architecture that protects people, devices, applications, and data holistically. And we are the only company with an integrated end-to-end capability informed by more than 8 trillion signals each day. Azure Active Directory now has more than 345 million monthly active users across more than 200,000 organizations. And we are not only securing employee identities, but customer and partner identities as well. General Motors for example, is using Azure Active Directory to secure interactions between its employees, dealers, and customers. Satya Nadella: (16:23) Azure Sentinel now has more than 6,500 customers. The accelerating adoption of IOT across industries is creating new security challenges and our acquisition of CyberX this quarter will help secure customers' IOT deployments. Finally, we are helping customers protect their most sensitive information. Microsoft information protection is enabling companies such as Siemens AG to protect sensitive data wherever it exists. And new Microsoft 365 records management helps customers govern data and reduce risk. Now on to gaming, it is simply a breakthrough quarter for gaming. We saw record engagement and monetization led by strength on and off console as people everywhere turn to gaming, to connect, socialize, and play with others. Satya Nadella: (17:13) Stepping back, we are expanding our opportunity to empower the world's 2 billion gamers to play wherever and whenever they want on any device. Xbox Game Pass is seeing record subscriber growth across both console and PC, and now includes content from more than a hundred studios. Our xCloud gaming services already live in 15 countries. And just last week, we announced that we will bring xCloud to Xbox Game Pass. So subscribers can stream games through a phone or a tablet and play along with nearly 100 million Xbox live players around the world. Satya Nadella: (17:51) In content, we are delivering differentiated first and third party content to attract and retain gamers. Xbox Series X launched this fall with the largest launch lineup for any console ever. And Minecraft reached a new high of nearly 132 million monthly active users during the quarter. In closing, we are expanding our opportunity and investing across the full modern technology stack. Over the next decade, technology spending as a percentage of GDP is projected to double. And we are well positioned to participate in that growth by innovating and defining the key technologies that empower every person and every organization on the planet to build more of their own tech intensity. With that, I'll hand it over to Amy who will cover our actual results in detail and share our outlook. And I look forward to rejoining for your questions. Amy Hood: (18:47) Thank you, Satya. And good afternoon, everyone. This quarter, revenue was $38 billion, up 13% and 15% in constant currency. Gross margin dollars increased 10% and 12% in constant currency. Operating income increased 8% and 12% in constant currency. And earnings per share was $1.46, increasing 7% and 9% in constant currency when adjusting for the net tax benefit related to the transfer of intangible properties from the fourth quarter of the school year '19. Amy Hood: (19:20) In our largest quarter of the year, our sales teams and partners again delivered strong results with many similar trends to the end of the third quarter. In our commercial business, increased usage, consistent execution, and continued demand for our differentiated high value cloud services drove another strong quarter. And in our consumer business, increased demand from work, learn, and play from home scenarios, again benefited our gaming, Surface, and Windows OEM non-pro businesses. Amy Hood: (19:54) We also saw weakness in small and medium business purchasing, which primarily impacted our transactional office, and Windows OEM pro businesses, and drove some moderation to our Office 365 commercial paid seat growth. And in our search business, though rates stabilized through the quarter, we saw a continued reduction in advertising spend on our platform. Moving to our overall results. Customer commitment to our cloud continues to grow. In FY 20, we closed a record number of multimillion dollar commercial cloud agreements, with material growth in the number of $10 million plus as our contracts. And on a strong prior year comparable, commercial bookings growth was ahead of expectations, increasing 12% year over year, driven by consistent renewal execution and an increase in the number of large longterm Azure contracts. Amy Hood: (20:51) As a result, commercial remaining performance obligation increased 23% to $107 billion. Approximately 50% of this balance will be recognized in revenue in the next 12 months of 21% year over year, reflecting consistent execution across our core annuity sales motions. The remaining 50%, which will be recognized beyond the next 12 months, increased 25% year over year, highlighting the growing longterm customer commitment to our cloud platform. Amy Hood: (21:24) And this quarter, our annuity mix increased four points year over year to 94%. Commercial cloud revenue grew 30% and 32% in constant currency to $14.3 billion, surpassing $50 billion for the fiscal year. And commercial cloud gross margin percentage expanded one point to 66%, despite revenue mix shift to Azure and significant customer engagement and usage to support remote work scenarios. Amy Hood: (21:54) In line with expectations, FX reduced revenue growth by approximately two points and Cox growth by approximately one point. FX had no impact on operating expense growth, slightly less favorable than expected. Our margins this quarter reflect investments to deliver greater customer value in this challenging environment, and therefore strengthen our longterm competitive position. We invested in capacity for cloud infrastructure usage. Free trial offers for critical remote work scenarios, and flexible financing options across the ecosystem. Additionally, we re-envisioned our retail store strategy as we stayed focused on growing our investments in these strategic high-growth opportunities of the future. Amy Hood: (22:41) As a result company, gross margin percentage was down two points year over year to 68% with additional impact from lower margin sales mix. Operating expense was 13% including a $450 million charge related to the realignment of our retail store strategy. And operating margins declined 2.2 over a year to 35%. Now towards segment results. Revenue from productivity and business processes was $11.8 billion increasing 6% and 8% in constant currency. Office commercial revenue grew 5% and 7% in constant currency impacted by the small and medium business slowdown noted earlier, as well as a strong prior year comparable where four points of growth were from a greater mix of contracts with higher end period recognition. Amy Hood: (23:31) Office 365 commercial revenue grew 19% and 22% in constant currency, in line with expectations, and was again driven by installed-base growth across all workloads and customer segments, as well as higher ARPU. Demand for our high value security and voice components grow strong upsell to Office 365 and Microsoft 365 E5. Paid Office 365 commercial seats increased 15% year over year, slightly below prior quarter trends. This reflects the strong adoption of free trial offers we made to enable customers to quickly adapt to needed remote work scenarios, as well as some growth moderation in first line worker and small and medium business offerings. Amy Hood: (24:22) Office consumer revenue grew 6% and 7% in constant currency, a stronger than expected growth in Office 365 consumer subscriptions was partially offset by transactional weakness. As a result, we saw a significant quarter over quarter increase in Office 365 consumers subscribers, up more than 3 million to 42.7 million. Dynamics revenue grew 13% and 15% in constant currency, driven by Dynamics 365 growth of 38% and 40% in constant currency. This fiscal year, total Dynamics revenues surpassed $3 billion, with over 60% from Dynamics 365. Amy Hood: (25:05) LinkedIn revenue increased 10% and 11% in constant currency, as a weak job market materially impacted annual bookings and our talent solutions business, even as usage remained high. Segment gross margin dollars were relatively unchanged and increased 3% constant currency and gross margin percentage decreased four points year over year. Operating expense increased 10% and 11% in constant currency, and operating income decreased 9% and 5% in constant currency. Amy Hood: (25:37) Next, the intelligent cloud segment revenue was $13.4 billion, increase in 17% and 19% in constant currency. Slightly ahead of expectations driven by continued customer demand for our differentiated hybrid offerings. On a significant base, server products and cloud services revenue increased 19% and 21% in constant currency. As our revenue grew 47% and 50% in constant currency, in line with expectations driven by continued strong growth in our consumption-based business. In our per user business growth continued to moderate, given the size of our enterprise mobility install base, which grew 26% to over 147 million seats. Amy Hood: (26:26) And our on-premise server business was relatively unchanged, and grew 1% in constant currency. Ahead of expectations, driven by strong renewal execution, and continued demand for our hybrid and premium solutions. Enterprise services revenue was relatively unchanged and grew 2% in constant currency as growth in premier support services offset consulting delays. Segment gross margin dollars increased 19% and 21% in constant currency and gross margin percentage increased one point year over year. Operating expense increased 19%, and operating in crumb grew 19% and 22% in constant currency. Amy Hood: (27:07) Now to more personal computing. Revenue was 12 point $9 billion increasing 14% and 16% in constant currency, with better than expected performance across all businesses as we continue to benefit from work, learn, and play from home scenarios. In Windows, overall OEM revenue grew 7%, benefiting from improved supply in April that net unfulfilled three demand. In OEM pro, this benefit was more than offset by the impact from small and medium businesses in May and June. And in OEM non-pro, the benefit from work and learn from home scenarios continued. It did moderate through the quarter. Amy Hood: (27:51) Inventory levels into the quarter in a normal range, Windows commercial products and cloud services revenue grew 9% and 11% in constant currency, driven by Microsoft 365 and the continued demand for our advanced security solutions. In Surface, revenue grew 28% and 30% in constant currency, with strength across consumer and commercial segments. Search revenue X TAC declined 18% and 17% in constant currency, driven by the trends noted earlier. And in gaming, revenue increased 64% and 66% in constant currency, significantly ahead of expectations, with the continued benefit from play at home scenarios, driving record levels of engagement and monetization across the platform, as well as a significant increase in console sales. Amy Hood: (28:45) Xbox content and services revenue increased 65% and 68% in constant currency, with strong growth in third party transactions, Game Pass subscribers, and Minecraft. Segment gross margin dollars increased 12% and 15% in constant currency and gross margin percentage decreased one point year over year with the mix shift gaming. Operating expense increased 10%, including the retail stores charge, and operating income grew 15% and 19% in constant currency. Amy Hood: (29:20) Now, back to total company results. In line with expectations, capital expenditures, including finance leases, were $5.8 billion, up 8% year over year, to support growing usage and demand for cloud services. Cash pay for PP&E was $4.7 billion. Cash flow from operations was $18.7 billion, and increased 16% year over year, driven by healthy cloud billings and collections. And free cash flow was $13.9 billion, up 16%. for the fiscal year, we generated over $60 billion in operating cashflow and over $ 45 billion in free cash flow, driven by a year... Amy Hood: (30:03) $45 billion in free cash flow, driven by a year of improving margins and operating leverage across our businesses. In other income and expense, interest income, net gains on derivatives, investments, and foreign currency remeasurement were mostly offset by interest expense. Our effective tax rate was slightly below 17%, lower than expected, due to the geographic mix of revenue. Finally, we returned to $8.9 billion to shareholders through share repurchases and dividends. An increase of 16% year over year, bring our total cash return to shareholders over $35 billion for the full fiscal year. Amy Hood: (30:44) Now, before we turn to our outlook, I'd like to update you on a change in accounting estimate to the useful life of server and networking equipment assets in our cloud infrastructure. Effective at the start of fiscal year 21, we are extending the depreciable life for these assets to four years, which will apply to the asset balances on our balance sheet as of June 30, 2020, as well as future asset purchases. This change will not impact historical depreciation expense, the total depreciation expense over the life of the asset, or cash flow. But it will impact the timing of depreciation expense in the future for these assets. Amy Hood: (31:26) As a result, based on the outstanding balances as of June 30, we expect fiscal year 21 operating income to be favorably impacted by approximately $900 million in the first quarter, and approximately $2.7 billion for the full fiscal year. This has been included in the guidance we will provide on today's call. You will find additional details on the mechanics of the change in our earnings materials. Now let's move to our next quarter outlook. Amy Hood: (31:56) In our commercial business, given our differentiated position in growth markets, we expect continued commitment to our cloud platform as well as strong usage and consumption growth. In our consumer business, we expect some continued benefit from work, learn, and play from home scenarios and gaming and surface, though at a more moderated rate, as a stay at home guidelines ease in many places around the world. Amy Hood: (32:23) However, we expect the small and medium business weakness we saw in Q4 to continue, which will impact transactional sales, primarily in office and Windows OEM. In commercial bookings, growth should again be healthy, but we will be impacted by the strong prior year comfortable, and a low growth in the Q1 X freebase. Commercial cloud gross margin percentage will increase approximately four points year over year from the accounting estimate change noted earlier. Excluding this impact, continued improvement in Azure IAAS and PASS gross margin percentage will be mostly offset by revenue mix shift to Azure. And on a dollar basis, we expect capital expenditures to be roughly in line with last quarter to support the growing usage and demand for our cloud services. Amy Hood: (33:13) Next, to FX. Based on current rates, FX should decrease total company, productivity and business process, and intelligent cloud revenue growth by approximately one point, and have no impact on more personal computing revenue, total company cogs, and operating expense growth. Now to the segment guidance. In productivity and business processes, we expect revenue between 11.65 and $11.9 billion. In office commercial on a strong prior year comparable, revenue growth will again be driven by Office 365 with continued upsell opportunity to E5. However growth will be impacted by decline of approximately 30% in our on-premises business, driven by the transactional weakness in small and medium businesses noted earlier. Amy Hood: (34:03) In office consumer, we expect revenue to be relatively unchanged year over year as subscription growth will be offset by a decline in our transactional business. In LinkedIn, we expect low to mid single digit revenue growth, primarily from weak bookings, and therefore revenue growth in the talent solutions business. In dynamics, continued dynamics 365 momentum from our modern and intelligent solutions will drive revenue growth in the low double digits. For intelligent cloud, we expect revenue between 12.55 and $12.8 billion. In Azure, revenue growth will again be driven by our consumption based business. Amy Hood: (34:45) In our per user business, we expect continued benefit from Microsoft 365 suite momentum, though growth will again be impacted by the increasing size of the installed base. In our on premises server business, on a strong prior year comparable, we expect revenue to be up slightly year over year driven by the durable value of our hybrid and premium annuity offerings. The enterprise services, we expect revenue to be relatively unchanged year over year, similar to last quarter. In more personal computing, we expect revenue between 10.95 and $11.35 billion. Amy Hood: (35:23) In our Windows OEM business, we expect revenue to decline in the low teens range, impacted by the strong prior year comparable that benefited from the end of support for Windows 7, as well as the continued slow down and small [inaudible 00:35:37] businesses. In Windows commercial products and cloud services, we expect healthy double digit growth from continued Microsoft 365 momentum, and the value of our advanced security offerings. In surface, solid demand against a low prior year comparable that was impacted by product life cycle transitions should drive growth in the mid teens. In SearchEx Tech, we expect revenue to decline in the low 20% range. In gaming, we expect revenue growth in the high teens, with continued strong user engagement across the platform. Now, back to overall company guidance, we expect cogs of 10.75 to $10.95 billion and operating expense of 10.7 to $10.8 billion with continued investment against our significant longterm ambition. Other income and expense should be negative $50 million as interest expense as expected to more than offset interest income. Finally, we expect our Q1 tax rate to be approximately 16% lower than our expected full year rate, given the volume of equity best in our first quarter. Amy Hood: (36:48) In closing, we are committed to our customers' success in these challenging times, and to managing the company for longterm growth and profitability. We will continue to expand our cloud infrastructure to support the growing customer usage and demand across our differentiated cloud offerings. And, given our strong execution and growing competitive advantage in high growth areas, we remain committed to investing against the long term opportunity ahead of us. Now, before turning to Q&A, I have one special thank you. Amy Hood: (37:25) Frank [Brode 00:37:26], our chief accounting officer will soon be retiring and on behalf of the entire company, thank you for your significant impact and close partnership over the years. You've played a key role in our success. I'd like to welcome Alice [Jala 00:07:46], who has been working alongside Frank and I for many years as our new chief accounting officer. Alice, we look forward to having you in this position. With that, Mike, let's go to Q&A. Mike Spenser: (37:56) Thanks, Amy. We'll now move over to Q&A. Out of respect to others on the call, we request that participants please only ask one question. Operator, can you please repeat your instructions? Automated Voice: (38:07) Absolutely. Ladies and gentlemen, if you would like to ask a question at this time, please press *1 on your telephone keypad. A confirmation tone will indicate that your line is on the question queue. You may press *2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. Our first question comes from Keith Weiss with Morgan Stanley. Please proceed. Keith: (38:32) Excellent. Thank you guys for taking the question and very nice quarter. Satya, I was wondering if you could help us with your view of what the enterprise spending environment looks like through this difficult period. On one side of the equation, we have very good secular trends that are still very well in place. Like you said, digital transformation is accelerating. On the other side, though, we do have difficult macro conditions out there, and we're seeing it in places like SMB and the like. Can you help us understand how that's putting out on the ground, in terms of your customers? Are you still able to get those big deals over the line? How do you see that playing out through the rest of the fiscal year? How should we think of those impacts through FY21? Satya Nadella: (39:14) No, thank you, Keith, for the question. The thing that at least we have learned I would say in the last five months is that digital technology is no longer viewed as just new project starts, but is becoming perhaps the most key for business resilience. Business continuity obviously is a board level discussion everywhere. But I don't think digital tech as sort of being key to business resilience was the number one priority, whereas now it is. When I think about digital transformation now, I break it into two things. I think about resilience and all sort of what Microsoft can do to help any business be more resilient, whether it's remote everything, whether it's about their ability to simulate anything, automate everything. Those are the things that I think are going to increase. Satya Nadella: (40:07) Then, of course, there is how do you readjust to what is going to be an increased e-commerce, contactless, re-imagined world, reconfigured supply chain. In both of those are secular tailwinds, but no one can take away from the fact that GDP is going to be negative. That's why I think you're going to see lots of ins and outs, but digital technology and digital transformation itself is going to be pretty key, and therefore we are very focused on sharpening the value proposition of every part of the stack I described, and making sure we are there for our customers as they navigate these tough times. Keith: (40:48) Got it. That's so helpful. Amy Hood: (40:49) Keith, maybe just to add to that a little bit, and I think you saw that in our bookings growth for the quarter, and increasingly I think people will start to focus as well on the remaining performance obligations. You're starting to see this commitment both in the next 12 months and then in the 12 months past that. You'll see some volatility in that from the longer term, larger contracts we had talked about, but we did, in Q4, have more of that close than we anticipated. Keith: (41:24) Excellent. Thank you guys. Satya Nadella: (41:27) Thanks Keith. Operator will take the next question, please. Automated Voice: (41:29) Thank you. Our next question comes from Heather Bellini with Goldman Sachs. Please proceed. Heather: (41:34) Great. Thank you so much for taking the question. I was just wondering, Satya, just given the success that you guys having expanding your footprint with customers. [Inaudible 00:41:46] that you could share with us ... Some people talk about net expansion rates. Just wondering if you guys have a way of helping investors think about kind of the net expansion rate from your existing customers on an annual basis, just given the success you're having with things like Azure hybrid benefits and migrations to the cloud. Any way for us to help think through that would be really helpful, thank you. Satya Nadella: (42:13) Amy, maybe I'll start, and then you can add. Think about the core, Heather, as far as how we're architecting what we're doing here. That's one of the reasons why even I structure my remarks the way I structure them, which is each of these layers is being built, obviously, to reinforce the other layer, but each layer is independent. We recognize that enterprises are very heterogeneous. They're going to choose multiple layers from multiple vendors, and interoperability will be key, but we have a very differentiated value proposition. Satya Nadella: (42:46) I mean, even in this quarter, if you think about the number of customers who started with teams, built a power application, in fact had Azure, GitHub, powered dev ops on top of that code base, and then used Azure Synapse all in one solution. You can see that power of our stack. So each layer is architected such the degree enforces the other and we see increasing adoption, including all of these layers. But I think in the numbers, when we talk about each of the numbers and the growth rates for each of the numbers, that in some sense showcases that. But maybe Amy, you want to add more to that. Amy Hood: (43:25) Yeah, I think the other way to think about it, Heather, and we do talk about it a little bit every quarter. There are two main motions that we focus a lot on here. Number one, are we adding new customers? And number two, are we adding workloads within customers? I think you'll increasingly hear us talk about the number of customers who are purchasing multiple components of the cloud, whether that's Microsoft 365, Azure, the power platform Satya just talked about, developer SAAS or GitHub, and then numerous cloud opportunities within Dynamics 365. I think the way I tend to think about it is, is revenue per customer going up? Yes. Are we adding new customers? Yes. Do we feel like we still have room to add additional clouds? I think that'll be sort of the language you'll hear us talk through this year. Heather: (44:16) Thank you very much. Automated Voice: (44:25) Thank you. Our next question comes from Mark [Mordler 00:44:26], with Bernstein Research. Please proceed with your question. Mark: (44:30) Thank you very much for taking my question and congrats on the quarter. Amy, cashflow from operations has been an area of concern across the software industry, with some companies reporting payment delays, requests for extended payments, et cetera. This quarter, your CFO was a strong standout. What do you think is the reason for the strength? Is this a function of the channel, or enterprise exposure or something else? Any data, any information would be appreciated. Amy Hood: (45:00) Thanks Mark. We did have, as you saw, and we- Amy Hood: (45:03) Thanks, Mark. We did have, as you saw, and we have had very consistent performance in our cash flow from operations, and I think a lot of that, as you've noted, has to do with where that strength is coming from, which overall it's cloud billings, it's usage, it's consumption-based growth. We do have, as you noted, a lot exposure to enterprise that has tended to perform quite well, and we did extend, and I mentioned it in our call in the prepared remarks, a lot of financing options to customers as well. So I feel like we are taking an appropriately balanced approach here and really focusing more on customer enablement, and so we could see some impact, but I think the broad portfolio, Mark, and broad geographic exposure probably has benefited us on CFO. Satya Nadella: (46:00) And broadly, we will be very much optimizing for helping our customers through this period and our own share. Amy Hood: (46:10) Yes. Mark: (46:10) That makes sense. I appreciate it. Thank you again. Speaker 1: (46:13) Thanks, Mark. Operator, we'll take next question, please. Operator: (46:17) Thank you. Our next question comes from Kirk Materne with Evercore ISI. Please proceed with your question. Keith: (46:23) Yes. Thanks very much. Amy and Satya, you noticed the strong growth in the E5 skew around Office 365 over the last year. Can you just talk perhaps a little bit more specifically about how Teams is perhaps changing the discussion around productivity more broadly, how that's maybe raising your profile even more from a strategic perspective as customers start thinking about how collaboration is going to change in this new world, both in the short and the longterm? Thanks. Satya Nadella: (46:54) Sure, Kirk. The approach we took with Teams always was to not just think of, "Oh, this is just a chat application," right? I mean, we thought about messaging obviously is important, but we said, "Okay, if you had to reimagine how people communicate using both chat as well as a video, and then most importantly, how people collaborate in meetings, outside meetings, before and after, so that's sort of the second element. Third, think about business process and workflows dominating inside of the scaffolding of Teams, and then building it with the same compliance and security base of Microsoft 365. So absolutely. So first of all, Microsoft 365 has entered many new categories. They're all part of now Microsoft 365 value, and so with that and the architectural coherence of Microsoft 365, because in some sense the complexity, security risk, management costs, these are all real things for enterprises, especially if you've got to go remote everything. Satya Nadella: (48:01) So I feel that we have a great value proposition for customers at a time of most acute need where they want to go remote, they need that flexibility when there is hybrid work, and yet they want the low cost management and high security and compliance. So I think we have a differentiated offer that. I'll turn it to Amy, if you wanted to add anything to that as well. Amy Hood: (48:25) No, I actually think the other component, Satya, that I would mention is really the transition we've seen from just Office 365 E5 to Microsoft 365 E5 with the entirety of the value proposition. This I think has been a pivotal year, and again, in Q4, we saw even more transition in the skew mix to the Microsoft 365 skew than just simply the Office skew. Keith: (48:52) Thank you. Speaker 1: (48:54) Thanks, Kirk. Operator, we'll take next question please. Operator: (48:59) Thank you. Our next question comes from Greg Moskowitz with Mizuho. Please proceed. Greg Moskowitz: (49:05) Hi. Thank you very much for taking the question, and I have one for Satya. I'm curious how you would assess the net impact of the current environment on Azure, inclusive of potentially lower consumption growth among highly impacted industries, and of course the per seat moderation in EMS offset by some acceleration in digital transformation more broadly among other customers. In addition, I was curious if you're seeing more pay as you go type arrangements for Azure than you were previously. Thank you. Satya Nadella: (49:36) Thanks for the question. Overall, as I said, even in industries that have been impacted say economically, one of the things is getting to the new efficient frontier of cloud economics is one way for them to, in fact, do better as they get into recovery, right? So one of the things that we're seeing in fact is some acceleration even of getting rid of the old and getting to the efficient frontier, so that then they can recover faster. That doesn't mean that some places where there is absolute real shutdown of economic activity there isn't a slowdown, but where people are looking to, say, using even that as an opportunity to come out stronger, we do see that. Satya Nadella: (50:20) For sure our pay as you go on Azure is going to increase and is increasing, and we are fundamentally focused on wherever people want to have those longterm commitments as well as pay as you go customers, so we don't, in some sense, discriminate between the two. What we want to be able to stay focused on is quarter over quarter consumption growth by adding value to customers' digital transformation projects. Amy Hood: (50:46) And I would add maybe, Greg, a little context is we've been seeing a transition to pay as you go probably for the majority of year, as opposed to saying it has more recently just emerged as a trend. So I wanted to make sure to decouple those a teeny bet. I think in general for us this quarter, the consumption patterns were very, very similar actually to what we expected, to Satya's note, with the pressure to, I think, move to this new frontier being really for at the forefront of people's minds, far more so than maybe a discussion on per user impacts. Greg Moskowitz: (51:38) That's helpful. Thank you both. Speaker 1: (51:40) Thanks, Greg. Operator, we'll move to the next question, please. Operator: (51:44) Our next question comes from Brent Thill with Jefferies. Please proceed with your question. Brent Hill: (51:49) Good afternoon. You've continued to show great top line double digit growth and margin improvement, and many are asking is that same framework in place in this environment, showing double digit growth with margin improvement, or do things change and you need to invest in new areas that could potentially stall out margins as we go through the cycle? Satya Nadella: (52:15) I'll start, and Amy, you can add to this. The way I would say, Brent, is that our focus, especially given that, what is it? GDP is negative 10 in the world, and you pick your timeframe? Right now, what I would like us to focus on in the interest of our longterm investors is to say, "How can we build this modern tech stack so that it can really help customers transform, be resilient and help us get into new categories and build a strong position in those categories?" So my own approach to this would be not to worry as much about short term, whether it's the growth number, because when you're growing compared to where GDP is healthily and competitively, the growth number is high. I'm not trying to match some artificial double digit growth number, and nor are we trying to sort of think about a margin target, because in some sense, the world needs to do well for us to do well in the long run. I think the world will come out of this, and we will be stronger if we invest during this phase. Amy Hood: (53:30) I just want to reiterate how important that is. The opportunity that Satya really outlined in his remarks is, I do believe, fundamental, so you see us continuing to invest. You'll see it in capital expenditure based on demand. You'll see it in the operating expense line, and a lot of the margin movement you're going to see is going to be actually far more sales mix than it is to think about it as margins going down in a particular product. So for me, it's really about in every product, are we investing with a strong position, with a clear view of the future in a way that we can be a more important part of every customer's budget? And so I think we feel very good about the products we've got, the lineup we've got, and the execution engine we've got, and so I think we're far more focused in that way than maybe on a short term number goal. Brent Hill: (54:37) Thank you. Speaker 1: (54:39) Thanks, Brent. Operator, we'll take next question please. Operator: (54:42) Our next question is from Brad Zelnick from Credit Suisse. Please proceed with your question. Brad Zelnick: (54:48) Great. Thank you so much for taking the questions and congrats on the amazing results. Amy, I believe in your prepared remarks, you had said Q4 CapEx was in line with expectations, and Q1 should be at a similar level. Can you speak to the evolution in cloud CapEx productivity and utilization trends, your capacity planning process and lead times to stand up incremental capacity, and ultimately, how should we be thinking about the cadence of CapEx going forward? Amy Hood: (55:15) Thanks Brad. As you saw, we made great progress this quarter catching up from supply chain challenges that I think we entered the quarter with. And as you can imagine, with the team's surge in usage along with other workloads surges, we look forward to continuing to be able to invest to meet that demand ahead of the curve in addition to what Satya mentioned, which is continuing to enter new regions where we see opportunities. So for me, the way to think about it is you see the cloud revenue growth continuing, you see strong consumption and usage growth, and you should expect cloud CapEx to follow in pretty short order. The lead times there have gotten tighter over time, and so you can generally think they'll be more correlated, but obviously there's some demand planning that we like to give ourselves ample room. Brad Zelnick: (56:13) Thank you. Speaker 1: (56:15) Good. Thanks, Brad. Operator, we'll take our last question now, please. Operator: (56:19) Thank you. Our last question comes from [inaudible 00:56:21] with Barclays. Please proceed with your question. Speaker 2: (56:24) Hey. Thanks for squeezing me in and congrats as well. A quick one for me, can you talk a little bit about gaming? So this quarter was kind of we saw they're very strong numbers, and before, it's like [inaudible 00:56:37] but how do you think about that cycle of growth that you get out of gaming? [inaudible 00:56:43] we should be getting more stable with more recurring revenue. Just to talk a little bit about the dynamics there a little bit. Thank you. Satya Nadella: (56:51) Sure. I'll start. Our overall vision, as we have sort of been talking about for, quite frankly, multiple years and building out with in particular our Game Pass strategy, that's what we are going for. This gaming TAM is much more expensive than what we participated in, even with all of the success we had with Xbox. So we think going forward, Xbox, with the approach we are taking has much more of an ability to reach the two plus billion gamers out there, and we are in the early days of building that out. Satya Nadella: (57:27) So this quarter, of course, was stand out for many of the reasons because of the remote nature of how a lot of the activity happened, and also we have a new console. That's very much part of our strategy, but we go beyond the console to the PC. We go to mobile and we have the streaming service, so all of these accrue to what we think in the long run is going to be a much bigger addressable market, and we have a great structural position. We have a social networking, Xbox Live. Obviously, we have a store that monetizes super well, as well as we have the Game Pass subscription. Amy, if you wanted to add to that. Amy Hood: (58:05) Maybe just a few things, which is when I think about gaming and where we are at this point, the reason it's so exciting is I think this quarter reinforces that we have such platform strength built on the view, the support we have of fans of the console. We've extended that and begun to extend it to the PC. We're extending it to mobile. That platform strength will drive this more annuity-like behavior that you're you're thinking about, which is great, and we saw that in the Game Pass subscription growth, again, this quarter building on that base. But then the third party titles will drive some volatility, but that volatility is just reinforcing of position we have and I think the long relationship with fans. So I think we're all pretty excited. I think Satya called it pivotal. I think it certainly is, and we're sort of looking forward to the next console release as well. Speaker 2: (59:04) Thank you. Speaker 1: (59:06) Great. Thanks [inaudible 00:00:59:07]. That wraps up the Q&A portion of today's earnings call. Thank you for joining us, and we look forward to speaking with all of you soon. Take care. Amy Hood: (59:13) Thank you, everyone. Satya Nadella: (59:13) Thank you, everyone. Operator: (59:17) Ladies and gentlemen, this does conclude today's teleconference. Once again, we thank you for your participation, and you may disconnect your line.