MICROSOFT Earningcall Transcript Of Q2 of 2024
chairman and chief executive officer; Amy Hood, chief financial officer; Alice Jolla, chief accounting officer; and Keith Dolliver, corporate secretary and deputy general counsel. On the Microsoft investor relations website, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provides the reconciliation of differences between GAAP and non-GAAP financial measures. More detailed outlook slides will be available on the Microsoft investor relations website when we provide outlook commentary on today's call. On this call, we will discuss certain non-GAAP items. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the company's fourth quarter performance in addition to the impact these items and events have on the financial results. All growth comparisons we make on the call today relate to the corresponding period of last year, unless otherwise noted. We will also provide growth rates in constant currency when available as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. Where growth rates are the same in constant currency, we will refer to the growth rate only. We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript, and in any future use of the recording. You can replay the call and view the transcript on the Microsoft investor relations website. During this call, we will be making forward-looking statements, which are predictions, projections, or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release and the comments made during this conference call and in the risk factors 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 -- Chair and Chief Executive Officer Thank you, Brett. We had a solid close to our fiscal year. All-up, annual revenue was more than $245 billion, up 15% year over year and Microsoft Cloud revenue surpassed $135 billion, up 23%. Before I dive in, I want to offer some broader perspective on the AI platform shift. Similar to the Cloud, this transition involves both knowledge and capital-intensive investments. And as we go through this shift, we are focused on two fundamental things. First, driving innovation across a product portfolio that spans infrastructure and applications, so as to ensure that we are maximizing our opportunity while in parallel, continuing to scale our cloud business and prioritizing fundamentals, starting with security. Second, using customer demand signal and time to value to manage our cost structure dynamically and generate durable long-term operating leverage. With that, let me highlight examples starting with Azure. Our share gains accelerated this year driven by AI. We expanded our data center footprint announcing investments across four continents. These are long-term assets around the world to drive growth for the next decade and beyond. We added new AI accelerators from AMD and NVIDIA, as well as our own first-party silicon Azure Maia, and we introduced new Cobalt 100, which provides best-in-class performance for customers like Elastic, MongoDB, Siemens, Snowflake, and Teradata. We continue to see sustained revenue growth from migrations. Azure Arc is helping customers in every industry from ABB and Cathay Pacific to LALIGA to streamline their cloud migrations. We now have 36,000 Arc customers up 90% year over year. We remain the hyperscale cloud of choice for SAP and Oracle workloads Atos, Coles, Daimler Truck AG, Domino's, Haleon, for example, all migrated their mission-critical SAP workloads to our Cloud and with our Azure VMware solution, we offer the fastest and most cost-effective way for customers to migrate their VMware workloads, too. With Azure AI, we are building out the app server for the AI wave providing access to the most diverse selection of models to meet customers' unique cost, latency, and design considerations. All up, we now have over 60,000 Azure AI customers up nearly 60% year over year and average spend per customer continues to grow. Azure OpenAI service provides access to best-in-class frontier models, including as of this quarter GPT-4o and GPT-4o mini. It's being used by leading companies in every industry, including H&R Block, Suzuki, Swiss Re, Telstra, as well as digital natives like Freshworks, Meesho, and Zomato. With Phi-3, we offer a family of powerful small language models, which are being used by companies like BlackRock, Emirates, Epic, ITC, Navy Federal Credit Union, and others. And with Models as a Service, we provide API access to third-party models, including as of last week, the latest from Cohere, Meta, and Mistral. The number of paid Models as a Service customers more than doubled quarter over quarter, and we are seeing increased usage by leaders in every industry from Adobe and Bridgestone to Novo Nordisk and Palantir. Now on to data. Our Microsoft intelligent data platform provides customers with the broadest capabilities spanning databases, analytics, business intelligence, and governance along with seamless integration with all of our AI services. The number of Azure AI customers also using our data and analytics tools grew nearly 50% year over year. Microsoft Fabric, our AI-powered next-generation data platform, now has over 14,000 paid customers, including leaders in every industry. from Accenture and Kroger to Rockwell Automation and Zeiss, up 20% quarter over quarter. And this quarter, we introduced new first-of-its-kind, real-time intelligence capabilities in Fabric, so customers can unlock insights on high-volume, time-sensitive data. Now on to developer tools. GitHub Copilot is by far the most widely adopted AI-powered developer tool. Just over two years since its general availability, more than 77,000 organizations from BBVA, FedEx, and H&M to Infosys and Paytm have adopted Copilot up 180% year over year. And we're going further with Copilot Workspace, we offer Copilot native end-to-end developer productivity across plan, build, test, debug, and deploy cycle. Copilot is driving GitHub growth all up. GitHub's annual revenue run rate is now $2 billion. Copilot accounted for over 40% of GitHub's revenue growth this year and is already a larger business than all of GitHub was when we acquired it. We are also integrating generative AI across Power Platform, enabling anyone to use natural language to create apps, automate workflows or build a website. To date, over 480,000 organizations have used AI-powered capabilities in Power Platform, up 45% quarter over quarter. In total, we now have 48 million monthly active users of Power Platform, up 40% year over year. Now on to future work. Copilot for Microsoft 365 is becoming a daily habit for knowledge workers as it transforms work, workflow, and work artifacts. The number of people who use Copilot daily at work nearly doubled quarter over quarter as they use it to complete tasks faster, hold more effective meetings and automate business workflows and processes. Copilot customers increased more than 60% quarter over quarter. Feedback has been positive with majority of enterprise customers coming back to purchase more seats, all up the number of customers with more than 10,000 seats more than doubled quarter over quarter, including Capital Group, Disney, Dow, Kyndryl, Novartis, and EY alone will deploy Copilot to 150,000 of its employees, and we are going further adding agent capabilities to Copilot. New Team Copilot can facilitate meetings and create and assign task. And with Copilot Studio, customers can extend Copilot for Microsoft 365 and build custom Copilots that proactively respond to data and events using their own first and third-party business data. To date, 50,000 organizations from Carnival Corporation, Cognizant, and Eaton to KPMG, Majesco, and McKinsey have used Copilot Studio, up over 70% quarter over quarter. We're also extending Copilot to specific industries, including healthcare with DAX Copilot, more than 400 healthcare organizations, including Community Health Network, Intermountain, Northwestern Memorial Healthcare, and Ohio State University Wexner Medical Center have purchased DAX Copilot to date, up 40% quarter over quarter and the number of AI-generated clinical reports more than tripled. Copilot is also transforming ERP and CRM business applications. We again took share this quarter as customers like Thermo Fisher Scientific switched to Dynamics. Our new Dynamics 365 contact center is a Copilot-first solution that infuses generative AI throughout the contact center workflow. Companies like 1-800-Flowers, Mediterranean Shipping, Synoptek will rely on it to deliver better customer support. And Dynamics 365 Business Central is now trusted by over 40,000 organizations for core ERP. Microsoft Teams has become essential to how hundreds of millions of people meet, call, chat, collaborate, and do business. We once again saw year-over-year usage growth. Teams premium has surpassed 3 million seats, up nearly 400% year over year as organizations like dentsu, Eli Lilly, and Ford, chose it for advanced features like end-to-end encryption and real-time translation. When it comes to devices, we introduced our new category of Copilot Plus PCs this quarter. They are the fastest, most intelligent Windows PCs ever. They include a new system architecture designed to deliver best-in-class performance and breakthrough AI experiences. We are delighted by early reviews, and we are looking forward to the introduction of more Copilot Plus PCs powered by all of our silicon and OEM partners in the coming months. More broadly, Windows 11 active devices increased 50% year over year, and we are seeing accelerated adoption of Windows 11 by companies like Carlsberg, E.ON, National Australia Bank. And now on to security. We continue to prioritize security above all else. We are doubling down on our Secure Future Initiative as we implement our principles of secure by design, secure by default, and secure operations. Through this initiative, we are also continually applying what we are learning and translating it into innovation for our customers, including how we approach AI. Over 1,000 paid customers used Copilot for security, including Alaska Airlines, Oregon State University, Petrofac, Wipro, WTW, and we are also securing customers' AI deployments with updates to Defender and Purview. All up, we now have 1.2 million security customers over 800,000, including Dell Technologies, Deutsche Telekom, TomTom use four or more workloads up 25% year over year. And Defender for Cloud, our cloud security solutions, surpassed $1 billion in revenue over the past 12 months as we protect customer workloads across multi-cloud and hybrid environments. Now let me turn to our consumer businesses, starting with LinkedIn. LinkedIn continues to see accelerated member growth and record engagement 1.5 million pieces of content are shared every minute on the platform and video is now the fastest-growing format on LinkedIn with uploads up 34% year over year. LinkedIn Marketing Solutions continues to be a leader in B2B digital advertising, helping companies deliver the right message to the right audience on a safe, trusted platform. And when it comes to our subscription businesses, premium sign-ups increased 51% this fiscal year, and we are adding even more value to our members and customers with new AI tools. Our reimagined AI-powered LinkedIn Premium experience is now available for every premium subscriber worldwide, helping them more easily and intuitively connect to opportunity, learn, and get career coaching. Finally, hiring took share for the second consecutive year and now on to search advertising and news. We are ensuring that Bing, Edge, and Copilot collectively are driving more engagement and value to end users, publishers, and advertisers. Our overall revenue ex-TAC increased 19% year over year and we again took share across Bing and Edge. We continue to apply generative AI to pioneer new approaches to how people search and browse. Just last week, we announced we are testing a new generative search experience, which creates a dynamic response to users' query while maintaining click share to publishers. And we continue to drive record engagement with Copilot for the web, consumers have used Copilot to create over 12 billion images and conduct 13 billion chats to date, up 150% since the start of the calendar year. Thousands of news and entertainment publishers trust us to reach new audiences with Microsoft Start. And in fact, we have paid them $1 billion over the last five years. We are helping advertisers increase their ROI, too. We have seen positive response to Performance Max, which uses AI to dynamically create and optimize ads. And Copilot in Microsoft Ad Platform helps marketers create campaigns and troubleshoot using natural language. Now on to gaming. We now have over 500 million monthly active users across platforms and devices, and our content pipeline has never been stronger. We previewed a record 30 new titles at our showcase this quarter. 18 of them, such as Call of Duty, Black Ops 6 will be available on Game Pass. Game Pass Ultimate subscribers can now stream games directly on devices they already have, including as of last month, Amazon Fire TV. Finally, we are bringing our IP to new audiences. Fallout, for example, made its debut as a TV show on Amazon Prime this quarter. It was the second most watched title on the platform ever and hours played on Game Pass for the Fallout franchise increased nearly 5x quarter over quarter. In closing, I'm energized about the opportunities ahead. We are investing for the long term in our fundamentals, in our innovation, and in our people. With that, let me turn it over to Amy. Amy E. Hood -- Executive Vice President, Chief Financial Officer Thank you, Satya. And good afternoon, everyone. This quarter, revenue was $64.7 billion, up 15% and 16% in constant currency. Earnings per share was $2.95 and increased 10% and 11% in constant currency. In our largest quarter of the year, we again delivered double-digit top and bottom-line growth with continued share gains across many of our businesses and record commitments to our Microsoft Cloud platform. Commercial bookings were significantly ahead of expectations and increased 17% and 19% in constant currency. This record commitment quarter was driven by growth in the number of $10 million-plus and $100 million-plus contracts for both Azure and Microsoft 365 and consistent execution across our core annuity sales motions. Commercial, remaining performance obligation, increased 20% and 21% in constant currency to $269 billion. Roughly 40% will be recognized in revenue in the next 12 months, up 18% year over year. The remaining portion recognized beyond the next 12 months, increased 21%. And this quarter, our annuity mix was 97%. At a company level, Activision contributed a net impact of approximately 3 points to revenue growth, was a 2-point drag on operating income growth and had a negative $0.06 impact to earnings per share. A reminder that this net impact includes adjusting for the movement of Activision content from our prior relationship as a third-party partner to first party and includes $938 million from purchase accounting adjustments, integration, and transaction-related costs. FX did not have a significant impact on our results and was roughly in line with our expectations on total company revenue, segment-level revenue, COGS, and operating expense growth. Microsoft Cloud revenue was $36.8 billion and grew 21% and 22% in constant currency, roughly in line with expectations. Microsoft Cloud gross margin percentage decreased roughly 2 points year over year to 69%, in line with expectations. Excluding the impact of the change in accounting estimate for useful lives, gross margin percentage decreased slightly, driven by sales mix shift to Azure, partially offset by improvement in Azure even with the impact of scaling our AI infrastructure. Company gross margin dollars increased 14% and 15% in constant currency, and gross margin percentage decreased slightly year over year to 70%. Excluding the impact of the change in accounting estimate, gross margin percentage increased slightly even with the impact from purchase accounting adjustments, integration, and transaction-related costs from the Activision acquisition. Operating expenses increased 13% with 9 points from the Activision acquisition. At a total company level, headcount at the end of June was 3% higher than a year ago. Operating income increased 15% and 16% in constant currency, and operating margins were 43%, relatively unchanged year over year. Excluding the impact of the change in accounting estimate, operating margins increased slightly driven by the higher gross margin noted earlier, and improved operating leverage through continued cost discipline. Now to our segment results. Revenue from Productivity and Business Processes was $20.3 billion and grew 11% and 12% in constant currency, slightly ahead of expectations, driven by better-than-expected results across all business units. Office commercial revenue grew 12% and 13% in constant currency. Office 365 Commercial revenue increased 13% and 14% in constant currency with ARPU growth primarily from E5 momentum, as well as Copilot for Microsoft 365. Paid Office 365 commercial seats grew 7% year over year, with installed base expansion across all customer segments. Seat growth was again driven by our small and medium business and frontline worker offerings, although both segments continued to moderate. Office commercial licensing declined 9% and 7% in constant currency with continued customer shift to cloud offerings. Office consumer revenue increased 3% and 4% in constant currency, with continued momentum in Microsoft 365 subscriptions, which grew 10% to $82.5 million. LinkedIn revenue increased 10% and 9% in constant currency, driven by better-than-expected performance across all businesses. Dynamics revenue grew 16%, driven by Dynamics 365, which grew 19% and 20% in constant currency. We saw continued growth across all workloads and better-than-expected new business. Dynamics 365 now represents roughly 90% of total Dynamics revenue. Segment gross margin dollars increased 9% and 10% in constant currency, and gross margin percentage decreased roughly 1 point year over year. Excluding the impact of the change in accounting estimate, gross margin percentage decreased slightly, driven by Office 365 as we scale our AI infrastructure. Operating expenses increased 5%, and operating income increased 12% and 13% in constant currency. Next, the intelligent cloud segment. Revenue was $28.5 billion, increasing 19% and 20% in constant currency, in line with expectations. Overall, server products and cloud services revenue grew 21% and 22% in constant currency. Azure and other cloud services revenue grew 29% and 30% in constant currency, in line with expectations and consistent with Q3 when adjusting for leap year. Azure growth included 8 points from AI services, where demand remained higher than our available capacity. In June, we saw slightly lower-than-expected growth in a few European geos. In our per user business, the enterprise mobility and security installed base grew 10% to over 281 million seats, with continued impact from moderated growth in seats sold outside the Microsoft 365 suite. Therefore, our Azure consumption business continues to grow faster than total Azure. In our on-premises server business, revenue increased 2% and 3% in constant currency. Growth was driven by demand for our hybrid solutions, although with slightly lower-than-expected transactional purchasing. Enterprise and partner services revenue decreased 7% on a strong prior year comparable for enterprise support services. Segment gross margin dollars increased 16% and gross margin percentage decreased roughly 2 points year over year. Excluding the impact of the change in accounting estimate, gross margin percentage decreased slightly, driven by sales mix shift to Azure, partially offset by the improvement in Azure noted earlier, even with the impact of scaling our AI infrastructure. Operating expenses increased 5%, and operating income grew 22% and 23% in constant currency. Now to more personal computing. Revenue was $15.9 billion, increasing 14% and 15% in constant currency, with 12 points of net impact from the Activision acquisition. Results were above expectations, driven by Windows commercial and search. The PC market was as expected and Windows OEM revenue increased 4% year over year. Windows commercial products and cloud services revenue increased 11% and 12% in constant currency, ahead of expectations due to higher in-period revenue recognition from the mix of contracts. Devices revenue decreased 11% and 9% in constant currency, roughly in line with expectations as we remain focused on our higher-margin premium products. While early days, we're excited about the recent launch of our Copilot Plus PCs. search and news advertising revenue ex-TAC increased 19%, ahead of expectations, primarily due to improved execution. Healthy volume growth was driven by Bing and Edge. And in gaming, revenue increased 44% with 48 points of net impact from the Activision acquisition. Xbox content and services revenue increased 61%, slightly ahead of expectations with 58 points of net impact from the Activision acquisition. Stronger-than-expected performance in first-party content was partially offset by third-party content performance. Xbox hardware revenue decreased 42% and 41% in constant currency. Segment gross margin dollars increased 21% with 10 points of net impact from the Activision acquisition. Gross margin percentage increased roughly 3 points year over year, primarily driven by sales mix shift to higher-margin businesses. Operating expenses increased 43% with 41 points from the Activision acquisition, operating income increased 5% and 6% in constant currency. Now back to total company results. Capital expenditures, including finance leases, were $19 billion, in line with expectations and cash paid for PP&E was $13.9 billion. cloud and AI-related spend represents nearly all of our total capital expenditures. Within that, roughly half is for infrastructure needs where we continue to build and lease data centers that will support monetization over the next 15 years and beyond. The remaining cloud and AI-related spend is primarily for servers, both CPUs and GPUs to serve customers based on demand signals. For the full fiscal year, the mix of our cloud and AI-related spend was similar to Q4. Cash flow from operations was $37.2 billion, up 29% driven by strong cloud billings and collections. Free cash flow was $23.3 billion, up 18% year over year, reflecting higher capital expenditures to support our cloud and AI offerings. For the full year, cash flow from operations surpassed $100 billion for the first time, reaching $119 billion. This quarter, other income expense was negative $675 million more favorable than anticipated with lower-than-expected interest expense and higher-than-expected interest income. Our losses on investments accounted for under the equity method were as expected. Our effective tax rate was approximately 19%, higher than anticipated due to a state tax law signed in June that was affected retroactively. And finally, we returned $8.4 billion to shareholders through dividends and share repurchases, bringing our total cash return to shareholders to over $34 billion for the full fiscal year. Now moving to our outlook. My commentary for both the full year and next quarter is on a U.S. dollar basis, unless specifically noted otherwise. Let me start with some full year commentary for FY '25. First, FX. Assuming current rates remain stable, we expect FX to have no meaningful impact to full year revenue, COGS or operating expense growth. Next, we continue to expect double-digit revenue and operating income growth as we focus on delivering differentiated value for our customers. To meet the growing demand signal for our AI and cloud products, we will scale our infrastructure investments with FY '25 capital expenditures expected to be higher than FY '24. As a reminder, these expenditures are dependent on demand signals and adoption of our services that will be managed through the year. As scaling these investments drives growth in COGS, we will remain disciplined on operating expense management. Therefore, we expect FY '25 opex growth to be in the single digits. And given our focused commitment to managing at the operating margin level, we still expect FY '25 operating margins to be down only about 1 point year over year. And finally, we expect our FY '25 effective tax rate to be around 19%. Now to the outlook for our first quarter. Based on current rates, we expect FX to decrease total revenue and segment-level revenue growth by less than 1 point. We expect FX to decrease COGS growth by less than 1 point and to have no meaningful impact to operating expense growth. In commercial bookings, increased long-term commitments to our platform and strong execution across core annuity sales motions should drive healthy growth on a growing expiry base. As a reminder, larger long-term Azure contracts, which are more unpredictable in their timing, can derive increased quarterly volatility in our bookings growth rate. Microsoft Cloud gross margin percentage should be roughly 70%, down year over year, driven by the impact of scaling our AI infrastructure. We expect capital expenditures to increase on a sequential basis given our cloud and AI demand, as well as existing AI capacity constraints. As a reminder, there can be quarterly spend variability from cloud infrastructure build-outs and the timing of delivery of finance leases. Next is segment guidance. In productivity and business processes, we expect revenue to grow between 10% and 11% in constant currency or USD 20.3 billion to USD 20.6 billion. In Office Commercial, revenue growth will again be driven by Office 365 with seat growth across customer segments and ARPU growth through E5 and Copilot for Microsoft 365. We expect Office 365 revenue growth to be approximately 14% in constant currency. In our on-premises business, we expect revenue to decline in the mid- to high teens. In Office consumer, we expect revenue growth in the low to mid-single digits, driven by Microsoft 365 subscriptions. For LinkedIn, we expect revenue growth in the high single digits driven by continued growth across all businesses. And in Dynamics, we expect revenue growth in the low to mid-teens, driven by Dynamics 365. For intelligent cloud, we expect revenue to grow between 18% and 20% in constant currency or USD 28.6 billion to USD 28.9 billion. Revenue will continue to be driven by Azure, which, as a reminder, can have quarterly variability primarily from our per-user business and in-period revenue recognition depending on the mix of contracts. In Azure, we expect Q1 revenue growth to be 28% to 29% in constant currency. Growth will continue to be driven by our consumption business, inclusive of AI, which is growing faster than total Azure. We expect the consumption trends from Q4 and to continue through the first half of the year. This includes both AI demand impacted by capacity constraints and non-AI growth trends similar to June. Growth in our per user business will continue to moderate. And in H2, we expect Azure growth to accelerate as our capital investments create an increase in available AI capacity to serve more of the growing demand. In our on-premises server business, we expect revenue to decline in the low single digits as continued hybrid demand will be more than offset by lower transactional purchasing. And in enterprise and partner services revenue should decline in the low single digits. And more personal computing, we expect revenue to grow between 9% and 12% in constant currency or USD 14.9 billion to USD 15.3 billion. Windows OEM revenue growth should be relatively flat, roughly in line with the PC market. In Windows Commercial products and Cloud services, customer demand for Microsoft 365 and our advanced security solutions should drive revenue growth in the mid-single digits. As a reminder, our quarterly revenue growth can have variability primarily from in-period revenue recognition depending on the mix of contracts. In devices, revenue growth should be in the low to mid-single digits. search and news advertising ex-TAC revenue growth should be in the mid- to high teens. This will be higher than overall search and news advertising revenue growth, which we expect to be in the low single digits. And in gaming, we expect revenue growth in the mid-30s, including approximately 40 points of net impact from the Activision acquisition. We expect Xbox content and services revenue growth in the low to mid-50s, driven by the net impact from the Activision acquisition. Hardware revenue will again decline year over year. Now back to company guidance. We expect COGS between USD 19.95 billion to USD 20.5 billion, including approximately USD 700 million from purchase accounting, integration, and transaction-related costs from the Activision acquisition. We expect operating expense of USD 15.2 billion to USD 15.3 billion, including approximately USD 200 million from purchase accounting, integration and transaction-related costs from the Activision acquisition. Other income and expense should be roughly negative $650 million, driven by losses on investments accounted for under the equity method as interest income will be mostly offset by interest expense. As a reminder, we are required to recognize gains or losses on our equity investments, which can increase quarterly volatility. We expect our Q1 effective tax rate to be approximately 19%. In closing, we remain focused on delivering innovations that matter to our global customers of every size. That focus extends to delivering on our financial commitments as well. We delivered operating margin growth of nearly 3 points year over year even as we accelerate our AI investments, completed the Activision acquisition and had a headwind from the change in useful lives last year. So, as we begin FY '25, we will continue to invest in the cloud and AI opportunity ahead. aligned and if needed, adjusted to the demand signals we see. We are committed to growing our leadership across our commercial cloud and within that, the AI platform, and we feel well-positioned as we start FY '25. With that, let's go to Q&A, Brett. Brett Iversen -- Vice President, Investor Relations Thanks, Amy. We'll now move over to Q&A. Out of respect for others on the call, we request that participants please only ask one question. Operator, can you please repeat your instructions? Operator Questions & Answers: |
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