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  • Greetings, and welcome to the Microsoft Fiscal Year 2018 Fourth Quarter Earnings Conference

  • Call.

  • (Operator Instructions) As a reminder, this conference is being recorded.

  • It is now my pleasure to introduce your host, Michael Spencer, General Manager of Investor

  • Relations.

  • Thank you, sir.

  • You may begin.

  • Good afternoon and thank you for joining us today.

  • On the call with me are Satya Nadella, CEO; Amy Hood, CFO; Frank Brod, CAO; and Carolyn

  • Frantz, Deputy General Counsel and Corporate Secretary.

  • On the Microsoft IR 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 reconciliation of differences between the GAAP and non-GAAP financial measures.

  • Unless otherwise specified, we refer to non-GAAP metrics on the call.

  • The non-GAAP financial measures provided should not be considered as a substitute for, or

  • superior to, the measures of financial performance prepared in accordance with GAAP.

  • They are included as additional clarifying items to aid investors in further understanding

  • the company's fourth quarter performance, in addition to the impact that these items

  • and events had on the financial results.

  • All growth comparisons we make on the call today relate to the corresponding period of

  • last year, unless otherwise noted.

  • We 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 refer to growth rate only.

  • We will post our prepared remarks to our website immediately following the call until the complete

  • transcript is available.

  • Today's call is being webcast live and recorded.

  • If you ask a question, it will be included in our live transmission, in the transcript

  • and in any future use of the recording.

  • You can replay the call and view the transcript on the Microsoft IR website.

  • (Forward-Looking Cautionary Statements) And with that I'll turn the call over to Satya.

  • Thank you, Mike and thanks to everyone on the phone for joining.

  • I'm proud of our strong results this quarter and even more proud of what we've accomplished

  • over the last 12 months.

  • We delivered more than $110 billion in revenue for the full-year with double-digit top line

  • and bottom line growth.

  • And our commercial cloud business surpassed more than $23 billion in revenue for the year

  • with gross margin expanding to 57%.

  • The strength of our results reflects accelerating innovation and the trust customers are placing

  • in us to power their digital transformation.

  • I shared our vision for the intelligent cloud and the intelligent edge a little over a year

  • ago, a vision that is now quickly becoming reality, and impacting every customer in every

  • industry.

  • Everything we've accomplished this year has been about accelerating our lead in this new

  • era and the tremendous opportunity ahead.

  • We focus on the right secular technology trends and growing markets and follow that up with

  • solid roadmap execution.

  • We reorganized our engineering teams to break free of the categories of the past and better

  • align with the emerging tech stack from Silicon to AI to experiences, to better serve the

  • needs of our customers today and long into the future.

  • We reoriented our sales and marketing teams adding industry and technical expertise to

  • partner more deeply with our customers on their digital transformation journeys.

  • And most importantly, we drove innovation to deliver differentiated value across the

  • cloud and the edge.

  • Now I'll briefly highlight some of our innovation in momentum.

  • We introduced Microsoft 365 to empower employees in the modern workplace.

  • Microsoft 365 is now a multi-billion dollar business that gives our customers the path

  • to the cloud and broadens our reach with new and under penetrated markets, including more

  • than 2 billion first line workers and industry-specific workflows.

  • Across Microsoft 365, we are helping people be more productive, collaborate and stay secure

  • on any device with AI infused experiences they use every day, and it's driving usage.

  • We have more than 135 million users of Office 365 commercial, Outlook Mobile is being used

  • on more than 100 million iOS and android devices, and more than 200,000 organizations are using

  • Microsoft Teams as the hub for team work.

  • We invested to make Windows 10 the most modern, secure always up-to-date operating system.

  • Windows 10 is now active on nearly 700 million devices and the growth of the enterprise deployment

  • this year exceeded our expectations.

  • It was a record year for LinkedIn.

  • Now with more than 575 million members, and revenue growth of 37% in Q4, the fifth consecutive

  • quarter of revenue acceleration.

  • We saw record levels of engagement in job postings again this quarter with sessions

  • growth up 41% YoverY.

  • The strong engagement is driven by the quality of the feed, video messaging and acceleration

  • of mobile usage with mobile sessions up more than 55% YoverY.

  • We will continue to reinvest to make LinkedIn the essential platform to connect the world's

  • professionals and help them achieve more with experiences followed by LinkedIn and Microsoft

  • Graphs.

  • Dynamics 365 gives organizations an alternative to monolithic style of suites of business

  • location with modular modern extensible and AI driven apps that unlock insights across

  • every part of the organization, from sales to HR.

  • It gained traction as our third commercial cloud growth engine with revenue up 61% YoverY.

  • Our investments in Power BI, PowerApps and Flow, as the new analytics and application

  • platform are gaining significant momentum with ISVs and enterprise customers.

  • Azure is the only hyper-scale cloud that extends to the edge across identity, data, application

  • platform, security and management.

  • And our differentiated architectural approach drove another strong quarter of growth.

  • We are investing aggressively to build Azure as the world's computer.

  • We expanded our global data center footprint to 54 regions, more than any other cloud provider

  • and with the most comprehensive compliance coverage in the industry.

  • We added nearly 500 new Azure capabilities in the last year alone focused on both existing

  • workloads and new workloads such as IoT and AI at the edge.

  • We introduced Azure Stack and Azure Sphere, two first of their kind cloud to edge solutions

  • that are already seeing strong customer demand.

  • We're democratizing data science and AI with Azure Cognitive Services, Azure ML and data

  • services such as Azure Cosmos DB to help organizations of all sizes convert their data into insights

  • and experiences for competitive advantage.

  • The world's leading companies are running on Azure and I'm especially proud that Walmart

  • chose Azure and Microsoft 365 to accelerate its digital transformation for their associates

  • and customers.

  • In gaming, we are pursuing our expansive opportunity from the way games are created and distributed

  • to how they're played and viewed, surpassing $10 billion in revenue this year for the first

  • time.

  • We are investing aggressively in content, community and cloud services across every

  • end point to expand usage and deepening engagement with gamers.

  • The combination of XBox Live, Game Pass subscriptions and (inaudible) are driving record levels

  • of growth and engagement.

  • Not only are we investing to grow organically, but we're also investing inorganically in

  • opportunities that expand our total addressable market and accrue value to our platforms and

  • our customers.

  • Take LinkedIn, we have united the world's leading professional cloud with the world's

  • leading professional network and proved that we have an integration model that works, enabling

  • LinkedIn to accelerate growth while retaining its member-first ethos.

  • With Get Help, we recognized the increasingly vital role the developers play in value creation

  • and growth in the era of the intelligent cloud and intelligent edge.

  • Our pending acquisition will enable us to bring our tools and services to new audiences,

  • while enabling Get Help to grow and retain its independence and developer-first ethos

  • in community.

  • PlayFab accelerates our vision to build a world class cloud platform for the gaming

  • industry across mobile, PC and console and the addition of five new gaming studios bolsters

  • our first body content development to support our fast-growing gaming services.

  • Microsoft has always been a partner-led company, and partners increasingly see more opportunity

  • on our platforms inspiring leading companies like SAP, Adobe and GE as well as fast-growing

  • start-ups like in Mobi to play an even larger role in our vibrant and growing partner ecosystems,

  • an asset that gives us scale in this new era.

  • In closing, our opportunity has never been greater.

  • We will continue to innovate and invest across our solution areas in serving our customers

  • and their unmet and un-articulated needs.

  • With this tremendous opportunity comes great responsibility.

  • We're relentlessly working to instill trust in technology across everything we do, it's

  • why we will continue to lead the industry dialogue on trust, advocate for customer privacy,

  • drive industry-wide cybersecurity initiative and champion ethical AI.

  • Our investments in business model are fundamentally aligned with our customer's long-term interests

  • and success.

  • This opportunity and responsibility grounds up in our mission to empower every person

  • and every organization on the planet to achieve more.

  • I'm proud of our progress and I'm proud of the more than 100,000 Microsoft employees

  • around the world, who are focused on our customer success in this new era.

  • Now I'll hand over to Amy, who will cover our financial results in detail and share

  • our outlook and I look forward to rejoin you for the questions.

  • Thank you, Satya and good afternoon, everyone.

  • This quarter, revenue was $30.1 billion, up 17% and 15% in constant currency.

  • Gross margin dollars increased 19% and 16% in constant currency.

  • Operating income increased 30% and 24% in constant currency.

  • Earnings per share was $1.13, increasing 7% and 3% at constant currency.

  • As a reminder, FY17 included a $1.8 billion tax benefit related to previously non-deductible

  • losses.

  • In our largest quarter of the year, our sales teams and partners delivered exceptional commercial

  • results.

  • We saw strong performance in most of our geographic regions against the backdrop of favorable

  • macroeconomic conditions and positive IT spending trends.

  • Customer commitment to our top platform continues to increase.

  • In F Y18, we closed a record number of multi-million dollar commercial cloud agreement and more

  • than doubled the number of $10 million plus Azure agreements.

  • Our annuity mix increased 3 points year-over-year to 89%.

  • As a result, commercial bookings increased 18% even with a strong prior year comparable.

  • Commercial unearned revenue was $29 billion, growing 23% and 21% in constant currency,

  • significantly higher than anticipated due to stronger than expected cloud billings.

  • Our commercial cloud revenue was $6.9 billion, growing 53% and 50% in constant currency with

  • strong performance across the US, Western Europe and the UK.

  • Commercial cloud gross margin percentage increased 6 points to 58%.

  • In line with our commitment at the beginning of the year, we improved the gross margin

  • percentage in each cloud service with Azure seeing the most significant improvement.

  • Our company gross margin percentage was 68%, ahead of our expectation and up 1 point year-over-year

  • from improvement on personal computing segment driven by Surface.

  • FX increased revenue growth by 2 points, 1 point lower than anticipated due to a stronger

  • US dollar.

  • At the segment level, FX had a positive impact of 3 points on productivity and business process

  • within intelligent cloud and 1 point on more personal computing revenue.

  • The FX impact was immaterial.

  • This quarter, operating expenses were 9% and 8% in constant currency, above our expectations

  • due to revenue driven expense, such as sales compensation given the strength of the quarter

  • and severance expense primarily in our sales organizations, offset by FX favourability.

  • Strong revenue growth improved device gross margin percentage and continued to targeted

  • investment in cloud engineering, cloud sales capacity and LinkedIn created operating income

  • leverage.

  • This quarter, operating income increased again up 3 points year-over-year.

  • Now to our segment results.

  • Revenue from productivity and business processes was $9.7 billion, increasing 13% and 10% in

  • constant currency, in line with our expectations even with the headwinds from a stronger dollar

  • and a higher-than-anticipated mix of cloud billings in our Office Commercial and Dynamics

  • businesses during the quarter.

  • As a reminder, under ASC 606, cloud revenue is ratably recognized, while annuity on-premises

  • revenue has a component of upfront recognition.

  • A higher mix of cloud billings is reflected in more on our revenue and less in period

  • recognition in a quarter.

  • Office Commercial revenue increased 10% and 8% in constant currency.

  • Office 365 Commercial revenue grew 38% and 35% in constant currency and Office 365 Commercial

  • Seats grew 29%.

  • We continue to see healthy installed base growth and ARPU expansion from customer adoption

  • of premium workloads in E3 and E5.

  • Office consumer revenue increased 8% and 6% in constant currency, driven by recurring

  • subscription revenue and growth in the subscriber base, now at 31.4 million.

  • Our Dynamics business grew 11% and 8% in constant currency, with double digit billings growth.

  • Dynamic 365 grew 61% and 56% in constant currency.

  • LinkedIn revenue grew 37% and 34% in constant currency with strong execution across all

  • businesses.

  • As Satya highlighted, engagement continue to accelerate and we also saw record levels

  • of job postings, benefiting from a robust US job market.

  • Segment gross margin dollars grew 13% and 10% in constant currency.

  • Gross margin percentage was relatively unchanged year-over-year, even as cloud mix increased,

  • driven by margin expansion in Office 365 and LinkedIn.

  • Operating expenses increased 7% as we continue to invest in LinkedIn, cloud engineering and

  • commercial sales capacity.

  • Operating income increased 20% and 13% in constant currency.

  • Revenue from the intelligent cloud segment was $9.6 billion, increasing 23% and 20% in

  • constant currency, with better than expected results in both our on-premise and Azure businesses.

  • Server products and cloud services revenue increased 26% and 24% in constant currency,

  • driven by continued strong Azure revenue growth of 89% and 85% in constant currency.

  • Azure producer services have performed ahead of expectations with our enterprise and mobility

  • installed base growing 55% year-over-year to over $82 million.

  • Our on-premises server business grew 8% and 6% in constant currency with double-digit

  • growth in premium server products revenue and healthy renewals benefiting from a significant

  • value customers seek in our hybrid solutions.

  • Enterprise Services revenue grew 8% and 7% in constant currency, as growth in Premier

  • Support Services and Microsoft Consulting Services was partially offset by declining

  • customer support agreements for Windows Server 2003.

  • Segment gross margin dollars increased 23% and 20% in constant currency.

  • Gross margin percentage was relatively unchanged as material improvement in the Azure gross

  • margin percentage was offset by a growing mix of Azure IaaS and PaaS revenues.

  • Operating expenses increased 11% with ongoing investments in cloud engineering and sales

  • capacity to support top line growth.

  • Operating income grew 34%, up 30% in constant currency.

  • Finally, More Personal Computing.

  • Revenue was $10.8 billion, up 17% and 16% in constant currency, with better than expected

  • results in Windows Commercial, OEM Pro and Surface.

  • In the commercial space, we saw an accelerating pace of Windows 10 Enterprise deployment this

  • quarter.

  • Customer demand for modern and secure hardware and stronger than expected PC growth in geographies

  • were (inaudible) high contributed to OEM revenue growth of 14%, ahead of the overall commercial

  • market.

  • Windows Commercial Products and Clouds Services grew 23% and 19% in constant currency, driven

  • by double-digit billings growth as well as the higher mix in quarter recognition for

  • multi-year agreements.

  • In Consumer, OEM non-pro revenue declined 3%, slightly below the consumer PC market

  • driven by continued pressure in the entry level price category, even as we continued

  • to take share in the premium category.

  • Inventory levels were within the normal range.

  • Search revenue ex TAC increased 17% and 16% in constant currency driven by enhancements

  • to our advertising platform and Bing volume growth across both US and international markets.

  • Surface revenue increased 25% and 21% in constant currency, driven by strong performance at

  • the latest editions in the portfolio against the low prior-year comparable.

  • In gaming, revenue grew 39% and 38% in constant currency.

  • Xbox software and services grew 36% and 35% in constant currency, mainly from a third-party

  • title.

  • Xbox Live monthly active users increased 8% to 57 million.

  • Segment gross margin dollars grew 21% and 18% in constant currency.

  • Gross margin percentage increased driven by new Surface additions offset by sales mix

  • to lower margin businesses.

  • Operating expenses grew 9% and 8% in constant currency, driven by seasonality changes and

  • advertising spend versus the prior year and investments in engineering across search and

  • AI.

  • Operating income grew 38% and 32% in constant currency.

  • Now back to total company results.

  • Capital expenditures, including finance leases were $4.1 billion and increased on a sequential

  • basis, in line with expectations.

  • Cash paid for property, plant and equipment was $4 billion, reflecting investments to

  • support growth in our cloud business as well as the $250 million real estate acquisition.

  • Free cash flow was $7.4 billion and down 15% year-over-year, reflecting higher capital

  • expenditures in support of our cloud business.

  • Cash flow from operations grew 4% year-over-year and included tax payments related to the adoption

  • of ASC 606 and TCJA as well as an earlier start to the hardware inventory build for

  • holiday than in the prior year.

  • Excluding the impact of these items, operating cash flow grew approximately 13%, driven by

  • strong cloud billings and collections.

  • Other income and expense is approximately $300 million lower than expected due to FX

  • re-measurement.

  • Our non-GAAP effective tax rate was 18%, higher than anticipated due to the geographic mix

  • of our revenue.

  • And finally, we returned $5.3 billion to shareholders through dividends and share repurchases, an

  • increase of 16%.

  • Our Q4 share repurchase was $2.1 billion, up 31% year-over-year, but down sequentially,

  • given the suspension of share repurchase activity in advance of the announced Get Help acquisition.

  • Now let's move to the outlook.

  • My commentary for both the full year and next quarter does not include any impact from Get

  • Help, which we still expect to close by the end of the calendar year.

  • Overall, the key drivers and trends of our business through the next fiscal year remain

  • largely unchanged from April and assume a consistent macro environment.

  • First on FX, assuming that rates remain stable, we expect no impact to full-year revenue growth

  • with any FX benefits in H1 offset in H2 (inaudible) to decrease cogs and operating expense growth

  • by 1 point.

  • Second, our commercial business.

  • Given corporate IT spend optimism and increasing demand for cloud services, our strong competitive

  • product position and consistent sales execution, we expect another year of strong revenue growth

  • and higher annuity mix across Commercial business.

  • As customer commitment to our cloud increases, we are seeing larger and longer-term agreements.

  • As a result, we may see increased quarterly volatility in commercial bookings growth and

  • commercial unearned revenue.

  • Productivity and Business Processes should continue to grow double-digits, driven by

  • Office 365, Dynamic 365 and LinkedIn.

  • Customer demand for our hybrid offering should drive high-teens growth in our server products

  • and cloud services KPI.

  • And now just specifically, we expect an increasing mix of Iaas and PaaS consumption based revenues.

  • In Windows, we expect strong business fundamentals in our OEM Pro and Windows Commercial businesses,

  • though the rates of revenue growth was slow through the year against the strong FY18 comparable.

  • Third, commercial cloud gross margin percentage.

  • We expect continued improvement in each commercial cloud service as well as in the overall commercial

  • cloud gross margin percentage.

  • The rate of improvement will moderate relative to FY18 as revenue mix continues to shift

  • Azure IaaS and PaaS consumption-based services and we have realized less year-over-year improvement

  • in our per user services.

  • We will continue to increase our investments in CapEx to meet growing demand for cloud

  • services, although we do expect the growth rate for the year to moderate.

  • Next, operating expenses.

  • Given our strong execution, we will continue to invest in the trends and growing markets

  • we believe are fundamental to long-term shareholder value creation.

  • Investment in commercial cloud, LinkedIn, Gaming and AI should result in operating expense

  • growth of roughly 7%.

  • Even with these strategic investments and the continued shift to our cloud businesses,

  • we expect operating margin to be up slightly year-over-year.

  • Other income expense should be slightly negative, in line with prior guidance and with quarterly

  • variability, primarily due to changes in FX re-measurement, interest rates, and valuation

  • changes with the adoption of the new accounting rules, financial investments.

  • And finally tax rate.

  • We have refined our estimates of the impact from TCJA, the mix of service versus license

  • revenue and the geographic mix of revenue, and now expect our FY19 effective tax rate

  • to be roughly 17% with quarterly variability.

  • Now, to the outlook for first quarter.

  • First, FX.

  • Assuming current rates remains stable, we expect FX to increase revenue growth by approximately

  • 1 point and decrease COGS and operating expenses by 1 point.

  • Second, our commercial business.

  • We expect another healthy quarter with commercial unearned revenue down approximately 10 percent

  • sequentially, in line with historical seasonality.

  • Commercial cloud gross margin percentage will improve slightly on a sequential basis.

  • Third, we expect another quarter of sequential growth in capital expenditures as we continue

  • to support growing, global customer demand.

  • Now to the segment guidance.

  • In Productivity and Business Processes, we expect revenue between $9.25 and $9.45 billion

  • driven by double digit growth in Office Commercial and Dynamics.

  • LinkedIn revenue growth should remain high on a stronger prior year comparable.

  • In Intelligent Cloud, we expect revenue between $8.15 and $8.35 billion.

  • Azure revenue growth should reflect a balance of continued strength in our IaaS and PaaS

  • consumption-based services and a moderating growth -- rate of growth in our per user services.

  • In More Personal Computing, we expect revenue between $9.95 billion and $10.25 billion.

  • In OEM Pro, we expect revenue growth in line with the commercial PC market, in OEM non-pro,

  • we expect similar dynamics we've seen in Q4.

  • In Surface, we continue to expect strong performance from our latest additions, including the new

  • Surface Go to drive growth similar to Q1 of the prior year, Search ex TAC to see another

  • quarter of mid-teens growth with consistent execution against rate and volume growth opportunities.

  • In Gaming, we expect mid-teens revenue growth with continued strong user engagement on our

  • platform.

  • The Software & Services growth rate will moderate due to strong third-party titles launched

  • a year ago.

  • We expect COGS of $9.5 billion to $9.7 billion and operating expenses at $9.2 billion to

  • $9.3 billion.

  • Other income and expenses expected to be approximately negative $100 million.

  • And finally, we expect our Q1 effective tax rate to be slightly lower than our full year

  • rate due to the (inaudible) equity vests that take place during our first quarter.

  • Mike, let's go to Q&A.

  • Thanks, Amy.

  • We'll now move up to Q&A.

  • Operator, can you please repeat your instructions?

  • (Operator Instructions) Keith Weiss, Morgan Stanley.

  • I wanted to dig into Azure a little bit.

  • I think growth overall in Azure this quarter is probably ahead of most people's expectations

  • and it sounds like the type of business that's being done on Azure is becoming more strategic

  • and changing all of it, so Satya, I was hoping you can talk to us a little bit about the

  • types of workloads, the type of sort of services that are being used on Azure, how that evolved

  • over the past year?

  • And Amy for you, maybe there is a new KPI, I believe you gave us sort of the growth in

  • the enterprise mobility of 55%, was that in line with your expectations, because I knew

  • you were sort of tempering our expectations on growth in that part of the business, is

  • that growing in line with kind of the slowdown you were expecting or is that better than

  • you had imagined?

  • Yes, so let me first of all thank Keith for the questions.

  • So, let me start, overall in terms of the workload mix, it's been fairly stable, which

  • is our hybrid value proposition really has continued to resonate so that means there

  • is a bunch of workloads that are migrating to the cloud, people use both Azure Stack

  • plus Azure, so that continues to drive a lot of IaaS growth for us as people are sort of

  • looking basically to lift and shift a lot of their current data center workloads.

  • Then on top of it, we even have modernization of app that is accelerating.

  • And that drives a lot of the higher level services in particular, our data services

  • as well as our AI services, but when AI services, they are essentially compute but what happens

  • is all those compute then requires storage and data and that's another place where we

  • see increasing acceleration.

  • The one thing that I would say that I'm increasingly seeing is Tier 1 workloads.

  • In some sense, when you think about some of the commitments being made back on the biggest

  • brands in the world in terms of what they're doing, one, it's very core to their operation

  • and two, they're running it in the cloud.

  • And so that's one thing that definitely is a market defense for us.

  • And to your question on the per user services, specifically Enterprise Mobility, Keith, it

  • was a bit better than I had anticipated in Q4 and really the driver of these per user

  • services such as EMF, actually is the value proposition that Satya refers to and we refer

  • to as Microsoft 365 and we saw strength broadly.

  • And if you think about that it's the Windows Commercial, it's Office 365 Commercial and

  • EMF and really that I think what we've heard a lot was the value of the security and management

  • continuing to add more supportive end point, offer really tremendous value to customers

  • and we did see a bit more strength than I was anticipating in Q4.

  • Amy, the commercial unearned revenue and bookings were again super-strong and evidently Microsoft

  • is benefiting from fairly strong EA renewal activity.

  • So, when you look out into fiscal 2019, how would you compare the degree of renewal activity

  • versus fiscal 2018 and fiscal 2017, it sounds like you're still constructive but I'd love

  • to hear some color whether it feels as good as the fiscal year you just ended.

  • Thank you.

  • Thanks Karl.

  • Let me break up that question a little bit because you actually asked a couple of things

  • that are important.

  • Number one, the unearned strength that we saw at the end of Q4, you're right, was very

  • good execution on renewals, reasonably large renewal base.

  • But there was also very good execution of adding new workloads, adding new opportunity

  • in Q4, things such as Azure as an example or Dynamics 365 as an example.

  • So really Q4 wasn't just renewal activity, it was also new workflows and new value.

  • So when you look into 2019, I'm optimistic on both of those fronts, good execution continuing

  • on renewal as well as adding new value and new opportunity.

  • And the third component of the question was really how do they renewal base correlates

  • FY 2018, and the answer is, it's a little bigger, but it actually has the same amount

  • of volatility, quarter-to-quarter.

  • So Q1's renewal base is actually almost equivalent to last year.

  • I was wondering -- if you could help us think about how Azure hybrid benefit has changed

  • the type of net expansion rate, you're experiencing on your ELAs, come up for renewal and I know

  • you're kind of -- a little bit touching on that with Karl, but is there any way to help

  • think about how that in particular might be helping the expansion rates of those accounts

  • and can you help us think about how this might be -- how that might be helping drive growth

  • in your existing contracts?

  • And then the other question would be, you mentioned that you're moving from per user

  • consumption that you're going to see more growth in consumption-based services versus

  • per user, as your workload grows, and I'm just kind of wondering if you could share

  • with us, is there any gross margin impact there does one have higher gross margins than

  • the other?

  • Or is there anything that we should be taking from how you're parsing those comments about

  • how we think of Azure's gross margin progression going forward?

  • So on the first one, I actually think that these hybrid use benefits have been sort of

  • the best kept secrets.

  • So I'm actually hoping that going into this next fiscal year, we do a much better job

  • and customers do a much better job for their own benefit because the advantage Azure has

  • because of the hybrid use benefits across the entire workloads, a pretty phenomenal

  • and we had a good set of sessions at our partner meetings this week, just really making sure

  • everybody understand those benefits.

  • So I don't think that has really played out, if its meeting all the growth we've seen,

  • is in spite of that not being broadly, really driving growth.

  • But to your second question, I'll even say the following which is that I think that there

  • is clearly a difference in GN between the per user and consumption.

  • But the key is even the Consumption Services come in different forms.

  • There is the IaaS services, there is the data services and some of the higher level services,

  • some of these IoT services now even have SaaS components to it.

  • So, therefore I think that the mix will be different by quarter-by-quarter, but increasingly

  • our strategy is in many times to get customers to get going with what is core storage or

  • core compute but then they scale into these higher level services.

  • And I would say, Heather, on the two components just to add, the Azure had the benefit -- I

  • think we're starting, as Satya said, we started to see some impact from that in my opinion

  • in Q4 in the on-prem KPI.

  • But it really was more in Windows and the value, as we continue to see, in sequel next

  • year, I do think there's some opportunity for customers to realize real value from these

  • hybrid benefits and so it adds confidence to my high-teens KPI growth for the year,

  • is that this is a very customer value-oriented offer.

  • To your question on GN, Satya is obviously correct on that one and I would say the way

  • we think about it is actually more -- we have Azure per user, it really does move more with

  • M-365 per user.

  • It's almost better to put that in your mind as behaving more and having margin structures

  • more like Office 365 and behave quite similarly, tend to have good quarters when we do good

  • execution of Office 365, until my comments were more and continue to be around having

  • people understand that sales motion and that it tends to move in that direction.

  • So, I have two related questions and the first is, if you look at this quarter, intelligent

  • cloud revenue grew 23% and the gross margin dollars grew at same 23%.

  • Given the fast growing lower margin Azure business, we're not seeing any longer negative

  • margin impact, have you reached the point where the incremental dollar of Azure revenue

  • is close to the overall intelligent cloud gross margin?

  • And then a second, I apologize, slightly long question, CapEx spending in the quarter and

  • the full year were both strong, you could argue its possibilities here, it's driven

  • by all the capacity demand or you having to spend a lot of it on replacing equipment as

  • they are aging out, how should we think about the mix in CapEx between building demand and

  • replacing what's there?

  • Let me take both of those.

  • On the first one, in terms of the G, I misquoted it, right.

  • The improvements, particularly in the IaaS and PaaS gross margin of Azure did offset

  • the cloud mix to Azure within the segment.

  • Going forward, continuing to see that, I think we'll see more pressure on gross margin just

  • because the amount of Azure in the mix at the rate it's growing, we're still not at

  • that point where a dollar of gross margin in the cloud is equivalent to a dollar of

  • on-prem.

  • That being said, we have a lot as you saw this quarter, we're going to grow gross margin

  • dollars in that -- even within that frame going into FY 2019.

  • On your second question, in terms of capital spend, if you think about it at a high level,

  • our capital expenditures are growing at a lower rate than our overall cloud revenue

  • was growing and that's why you're starting to see leverage, right, flow through the P&L.

  • And I think that the rate of CapEx growth as I said in FY 2019 will moderate, that happens

  • because of course we're doing some replacement, but we're also adding regions and seeing a

  • lot of global demand and so -- actually -- and improving margins.

  • So, I think that -- when I put it at a very high level, as you asked the question, I tend

  • to think revenues growing faster than my capital, you're seeing leverage through the P&L and

  • we will see a moderating rate in FY 2019, even if Q1 is a big quarter, it's just going

  • to be volatile as CapEx tend to be quarter-to-quarter based on both supply chain and demand.

  • Hi Amy, wondering on the Office product and services on the commercial side, you had I

  • think 8% growth, the lowest you've seen, I know 606 drive some volatility in that business,

  • could you help us understand what drove that in the quarter and I know you're making some

  • changes like to support and so forth as you get into the out years, is there any impact

  • that you expect to the growth rate in that business as we look forward from those changes?

  • Thanks Walter.

  • The entire impact in that KPI actually feel that very good about that number because if

  • you think about the $1 billion plus beat we had to be unearned, it was partially due to

  • the fact we had very good mix shift Office 365 in terms of billings in the quarter.

  • Almost very little of that gets recognized in quarter, and almost all goes to the balance

  • sheet.

  • So, my confidence for FY 2019 in that number being the double-digits we talked about in

  • the full year guide, only gets raised by seeing that execution.

  • So it is really 606 related, it's the way to think about it plus the mix of billings

  • and billing strength.

  • So I don't really think about that is being negative.

  • And you saw the exact same behavior in Dynamic, so it is a pretty similar in-period, in-quarter

  • impact.

  • Amy, question for you, you commented upon the positive spread that you're seeing in

  • the Windows OEM business, both overall but particularly on the commercial side, when

  • you start to think forward, call it a couple of quarters, you obviously told us what the

  • positive drivers were but how do you see those were playing out and can we maintain that

  • positive spread and if so why and if it does maybe narrow, sort of how do you think about

  • the narrowing?

  • So, let me frame it first as the things that I -- and we are seeing really customer-driven,

  • which is if you start with Windows 10, and value the customer (inaudible) and what we're

  • seeing is accelerating enterprise deployment of Windows 10.

  • When that happens, it does create demand for new devices and modern devices that improved

  • security so that then in turn results in a better and stronger overall OEM PC commercial

  • market.

  • In addition, because of the macroeconomic conditions are actually quite good on this

  • front and it was some business optimism creating some wind at our back, I also think people

  • look and say, security and value are important.

  • This is a great time to invest in modern PCs and particularly in markets where pro mix

  • has been strong, I continue to expect to see all of those things happen through the course

  • of next year.

  • Now what you will see, however, those things even do remain true, which I expect them to,

  • if the economic environment stays the same, H2 where we've had really strong revenue growth

  • and a really strong market, well, I think moderate growth wise just because the base

  • it was coming off of in '17 was just a lot lower.

  • So even if I see all the good things and good trends happening that I feel really create

  • great opportunity for us to sell Microsoft 365, you will see growth rates moderate (inaudible).

  • Amy, can I go back to the Server products, you partly answered it with the -- when Heather

  • ask, and I believe hybrid cloud will be a factor here, but the growth was the best we

  • have seen for a long time.

  • Can you just talk about the drivers that kind of were at play here?

  • Thank you.

  • You're right, the first one was the benefit that we saw from hybrid in particular with

  • an outsized impact on Windows Server.

  • The second has been a trend we also talked about a little bit before, we saw strong double-digit

  • growth in premium.

  • So, with those mixed shift as well as I think strength in the hybrid benefits as a value

  • prop to customers, those two are the ones I would actually call out as drivers for the

  • quarter.

  • Good, I mean they should be relatively sustainable, if I listen to them -- to you.

  • I believe the one I think really important thing for us is continuing to focus on creating

  • customer value, the concept of adding a lot of value but having and giving comfort to

  • a customer that as they make a commitment to the Microsoft platform that they can move

  • between a commitment to on-prem to the cloud in a high value way, I do believe is a unique

  • thing that we offer at this time.

  • Satya, this is more of a big picture question, but over a longer-term period, I'm curious

  • how large you think edge computing will become relative to centralized cloud computing?

  • Yes, I mean, I think the vision that we have always had is that distributed computing in

  • some sense will remain distributed.

  • So, we don't split this into, there's an edge computing, there's a cloud computing, the

  • need for computing is on a secular basis going to increase and as you need to reason over

  • large amounts of data, you need not only storage and compute to be co-located all over as the

  • world gets embedded with computing, that's what we're building for.

  • So, if you think about our real competitive advantage in differentiation is, we have one

  • programming model, one identity model, security, management so that modern developers as well

  • as IT can use the compute available from Azure Sphere to Azure, and the reality is these

  • modern workloads in fact use it all.

  • So, it's not like I just build an Azure Sphere application, I build an application that's

  • fundamentally distributed that also happens to run some compute on Azure CS, that's I

  • think the future which is distributed computing going back to what needs to be truly distributed,

  • event-driven server less even versus this thing about let's just -- how one-time migration

  • to something new.

  • Satya, I want to direct this to you, if I could.

  • I'd like to understand how you view Dynamics' current positioning compared to the market

  • opportunities and the context of the question is Dynamics remains a fairly small part of

  • Microsoft revenues as well if you look at the market share of where Dynamics serve,

  • it's a fairly small part of the market served.

  • So, what do you think Microsoft needs to do to have a larger impact against the market

  • opportunities?

  • Yes, we are very committed and very bullish about the opportunity in Dynamics, with Dynamic

  • 365, for example, what (inaudible) seen in the last fiscal year, which has been the first

  • full fiscal year where we have this modern, modular approach to business applications,

  • I think it's very disruptive in the marketplace because it brings a very different value proposition,

  • it has a price advantage and a value advantage for customers and what is fundamentally a

  • fragmented market this is not business applications never was and never will be a winner take

  • all, I know folks think about it that way, but it's not it's about one small category

  • in one segment called Enterprise, there is a share, high-share is considered 20%, 35%

  • or what have you.

  • So, in some sense this one has always been about being able to serve customers, especially

  • in an increasing digitization world, which is the need for more Business Process Automation

  • is increasing, take an IoT project, translates into a preventive maintenance in Azure and

  • then ends up as field service in Dynamics, that's being one pattern we've seen a ton

  • of traction with.

  • So to me, us going in fact to be a new secular growth opportunities while being disruptive

  • to the status quo of anyone who has high margin and very high priced monolithic products today

  • is basically our strategy going forward.

  • So, Amy we keep expecting the Office 365 commercial seat growth to decelerate materially at some

  • point.

  • Based upon the penetration level, but this quarter, that seat growth actually accelerated

  • about 1 point to 29%, and when we look back on it, the trajectory really isn't too different

  • than where it was even a year ago.

  • So, I'm just curious, is there some underlying driver there that would keep that deceleration

  • relatively manageable going forward or would you continue to see that slowing in a way

  • that that overtime would exert a little drag on Azure through those per user Azure services?

  • This is when we're -- over time, there certainly is going to be a deceleration, just this is

  • a per user business and 365 has that characteristic and Office has it EMF has it.

  • And so this quarter actually what we saw was actually some strength in education was added

  • a good amount of seats this quarter as well as good execution across our other segments

  • so we did see a bit of growth that we -- we're excited to see (inaudible) segment we've been

  • working hard to make additional progress and add value, the team was actually doing a nice

  • job in that segment, creating some really modern offers to get that into the hands of

  • that market as well.

  • But over the long term, and as we continue to move aggressively, we will continue to

  • see seat growth dissipate.

  • But I would also say this is going to take longer than I think may be people would have

  • thought, there are a lot of users as we continue to redefine what Office is that you add to

  • the day, whether that's first line workers, whether that's an increasing number of small

  • businesses who finally have access and value that we're creating for them across things

  • (inaudible) from scheduling all the way to being able to work through minor business

  • process adjustments like Satya has talked about.

  • So, really we continue to redefine what Office means from something that people always associated

  • with Word, Excel and PowerPoint to things that mean mobile or video with stream or collaboration

  • with Teams, I think we have opportunity to continue to add those new users, new types

  • of users that we haven't been accessed before, new capabilities, even to users we have.

  • Great.

  • Thanks, Mark.

  • That wraps up the Q&A portion of today's earnings call.

  • Thank you for joining us today, and we look forward to speaking with all of you soon.

  • You can find additional details at the Microsoft Investor Relations website.

  • Ladies and gentlemen, this does conclude today's teleconference.

  • Again, we thank you for your participation, and you may disconnect your lines at this

  • time.

Greetings, and welcome to the Microsoft Fiscal Year 2018 Fourth Quarter Earnings Conference

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