Microsoft (MSFT) Q3 2022 Earnings Call Transcript | The Motley Fool

microsoft (msft -0.40%) Third Quarter 2022 Earnings Call April 26, 2022 at 5:30 PM m. and

content:

• prepared remarks
• questions and answers
• call participants

prepared remarks:

operator

Reading: Msft earnings call transcript

Ladies and gentlemen, thank you for waiting. Welcome to Microsoft’s Third Quarter FY2022 Earnings Conference Call. [operator instructions] as a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Brett Iversen, General Manager, Investor Relations.

thank you. you can start.

brett iversen – managing director, investor relations

Good afternoon and thank you for joining us today. On the call with me are Satya Nadella, President and CEO; amy hood, chief financial officer; Alice Jolla, Director of Accounting; and Keith Dolliver, Deputy General Counsel. on microsoft’s investor relations website, you can find our earnings press release and financial summary slideshow, which is intended to supplement our comments prepared during today’s call and provides reconciliation of the differences between the measures GAAP and non-GAAP financials. Unless otherwise specified, we will refer to non-gaap metrics in the call.

The non-GAAP financial measures provided should not be considered a substitute for or superior to measures of financial performance prepared in accordance with GAAP. they are included as additional clarifying items to help investors better understand the company’s third-quarter performance, as well as the impact these items and events have on financial results. All growth comparisons we make in today’s call relate to the corresponding period last year, unless otherwise noted. We will also provide constant currency growth rates when available as a framework for evaluating how our underlying businesses performed, excluding the effect of foreign currency exchange 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 on our website immediately after the call until the full transcript is available. today’s call is being broadcast live and recorded. if you ask a question, it will be included in our live stream, 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 make 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 differ materially due to factors discussed in today’s earnings release, in comments made during this conference call and in the risk factors section of our form 10-k, forms 10-q and other reports and presentations with the values ​​and exchange commission.

We do not undertake any obligation to update any forward-looking statement. and with that, i will pass the call to satya.

satya nadella – president and CEO

thanks, brett. It was a record third quarter, fueled by the continued strength of Microsoft Cloud, which exceeded $23 billion in revenue, up 32% from the prior year. In the future, digital technology will be the key input that will drive global economic output. Across the technology stack, we’re expanding our opportunity and engagement as we help customers differentiate, build resiliency, and do more with less.

I will now highlight examples that start with blue. we’re building a distributed cloud and edge computing fabric to help all organizations build, run, and manage mission-critical workloads anywhere. this quarter, we helped more customers than ever, simplifying and accelerating their migrations to the cloud. and it’s still early.

we are gaining tier 1 infrastructure workloads, leaders in every industry from blackrock to bridgestone to lufthansa are moving mission critical workloads to azure. And we’re the market leader for customers’ SAP workloads in the cloud. Atos, Chevron, Fujitsu, and Woolworths all migrated their SAP applications to Azure in recent months. Overall, we’re seeing larger, more strategic blue commitments from industry leaders, including Boeing, Kraft Heinz, US Bank, and Westpac, who have chosen our cloud to accelerate their digital transformations.

The number of azure deals over $100 million more than doubled year-over-year, and we’re seeing consumption growth across all industries, customer segments, and geographies. now to data and ai. our data stack is unique in bringing best-in-class operational databases, analytics, and governance in one integrated data fabric. Cosmos DB’s transactions and data volume increased more than 100% year over year for the third consecutive quarter.

synapse’s data volume more than doubled year over year, and we’re seeing strong adoption of the domain as we help organizations govern, protect, and manage their data estate across platforms and clouds. from deutsche borse to ey, clients from all industries use our comprehensive data platform. In AI, we continue to see strong use of Azure machine learning. The number of monthly inference requests increased 86% year over year, and companies like Pepsico use the service to predict which products are most likely to sell.

and our azure openai service brings together advanced language models with the enterprise capabilities of azure, helping companies like carmax turn customer reviews into personalized content for shoppers. Now to the development tools. From Azure Devops and GitHub to Visual Studio, we have the most comprehensive and appreciated Saas service for developers. increasingly, every new developer project starts with our tools.

visual studio has over 31 million monthly active users, including most of the fortune 500. GitHub usage is increasing among independent developers and startups, as well as among the world’s most established companies. 90% of the fortune 100 uses github. In fact, Mercedes-Benz, for example, uses GitHub Enterprise to provide a unified development platform for more than 20,000 employees to build, ship, and maintain software.

now to the power platform. power platform has become the leading business process automation and productivity suite for experts across all industries. power platform exceeded $2 billion in revenue in the last 12 months, up 72% year over year, making it one of the fastest growing companies at scale. power apps is the market leader in low-code and no-code app development, and power bi has over 200,000 customers.

And our acquisition of minit adds new process mining capabilities, helping organizations identify bottlenecks and opportunities for operational efficiency. now to dynamics 365. dynamics 365 is growing faster than the business app market in general. For example, in a world of supply chain constraints, we’re helping companies like Cracker Barrel and Unilever predict disruptions before they happen.

Companies like Heineken and Siemens are turning to Dynamics 365 to drive and deliver more consistent and personalized customer service and engagement. We are leading innovation in the new industrial metaverse to help companies optimize their operations using technologies such as IoT, digital twins, connected spaces, and mixed reality applications. And we’re further differentiating the Microsoft Cloud by bringing together Dynamics 365, Teams, and Synapse to usher in a new era of collaborative apps that transform every function and business process. When it comes to industry, our six industrial clouds are helping customers accelerate time to value.

Our healthcare cloud was front and center at himss last month, where we introduced azure healthcare data services to unify disparate clinical imaging and medical technology data. cleveland clinic will use the solution to normalize data from different systems and integrate insights into the clinician’s workflow. And with our acquisition of Nuance, I’m excited about our opportunity to apply the company’s deep business AI experience to accelerate growth of both Nuance’s business and our industry clouds. now let’s go to linkedin.

once again we saw record engagement as over 830 million professionals use the platform to connect, learn, grow and get hired. In the midst of the great shake-up, we are seeing a skills-first job market emerge. The number of companies using LinkedIn skills filters to fill open positions has doubled year over year. And in this dynamic labor market, hiring on LinkedIn has increased by 88%.

talent solutions revenue increased 43%, marking the sixth consecutive quarter of accelerated growth. our marketing solutions business continues to thrive as we offer advertisers high reach and return on investment. and creators are increasingly turning to the platform to establish their voices and grow their communities using tools like newsletters to share content they’re passionate about. 28 million members now subscribe to at least one newsletter on linkedin, up 51% from last quarter.

now let’s move on to microsoft 365 and teams. The past two years have shown that every organization needs a digital fabric that connects the entire organization from the boardroom to the front lines with customers and partners. No company is better positioned to meet this need than Microsoft with Microsoft 365 and Teams. teams is the most used and advanced work platform and the only solution with meetings, calls, chat, collaboration and automation of business processes.

And organizations, from enterprises to SMBs, rely on computers to run their businesses. our comprehensive approach reduces complexity and costs. Microsoft 365 customers can save up to 60% compared to a patchwork of single point identity, productivity, collaboration, and meeting solutions. equipment usage has never been higher.

We see growth in all segments, including very small businesses with essential equipment. teams is the leading platform for collaborative applications. From Asana to Zendesk, there are over 1,000 third-party apps available in the Teams app store. and companies across industries, including cbre, cvs health and the uk’s national health service, have built custom line-of-business applications within teams, bringing the business process directly into the workflow.

and we’re adding new growth engines to meet the demands of hybrid working with team rooms, team phones, and microsoft veeva. Teams Rooms is bridging the gap between people working remotely and those in the office with innovations like Front Row. Teams Phone with Operator Connect enables organizations to easily bring their existing calling service to Teams. the operator’s total connection minutes increased 8 times quarter over quarter.

and veeva has over 10 million monthly active users at companies like bloom, cerner, mark’s & Spencer This quarter, we added LinkedIn’s Glint employee engagement tool to Veeva, ensuring that leaders can more easily solicit employee feedback and receive actionable insights. All of this innovation is driving growth in Microsoft 365. Public and private sector organizations, including American Family Insurance, Government of Queensland, and Telefonica, are increasingly choosing our premium e5 offerings for security, compliance, voice, and advanced analytics. /p>

now let’s go to the windows. the computer has never been more relevant to work, life and play. the number of use cases is increasing as is the amount of time spent on parts. Over 100 million PCs have been shipped in each of the last eight quarters and windows continues to gain ground.

with windows 11, we continue to see the highest quality scores of any version of the operating system. Businesses are adopting Windows 11 at a faster rate than any previous version. With Windows 365, we’re bringing the power of Azure computing to Windows PCs, enabling companies like Lands’ End, SCS, and Xerox to deliver the full Windows experience to any employee device. new integrations between windows 11 and windows 365 will allow switching between cloud pc and local pc with one click.

and we continue to help organizations like aig, grant thornton and sage move their on-premises virtualization services to the cloud with azure virtual desktop. On the consumer, Windows is key to curating our content and services to help everyone with their daily tasks, from browsing and searching to learning, gaming and shopping, all with built-in security and privacy. We’re seeing strong engagement with nearly 500 million monthly active users of our personalized content feed, Microsoft Start. As usage continues to grow, we see a flywheel emerging between content consumption and commerce as we create new opportunities for content creators and advertisers.

and our browser, microsoft edge continues to gain share as we help people save money and shop safely. Now to safety. Security is a top priority for all organizations undergoing digital transformation. To keep our customers safe, we build security by design into every product we sell.

And we provide end-to-end solutions spanning security, compliance, identity, device management, and privacy across clouds and platforms informed by 24 trillion threat signals every day. This comprehensive capability has been critical during recent world events, and we continue to disrupt cyberattacks and share threat intelligence with the Ukrainian government and other public sector agencies. multi-cloud and cross-platform support is central to our approach. In security, we are the only cloud provider with native multi-cloud protection for all three of the industry’s leading cloud platforms.

In identity, we now provide permissions management across all clouds. Azure Active Directory is the undisputed market leader with over 550 million monthly active users. In management, the number of Windows, Android, and iOS devices protected by Intune grew more than 60% year over year. And we’re expanding into new market segments with Microsoft Defender for Business, which will help keep small businesses safe.

This innovation and differentiation is driving our overall growth. The entire number of customers relying on our security solutions grew nearly 50% year-over-year to 785,000, including Citrix, Domino’s Pizza, Fujitsu, Heineken, Petronas, who trust us to protect their multi-cloud infrastructure. and we have more than 15,000 partners in our security ecosystem, more than anyone in the industry. Now let’s play.

Our ambition is to empower gamers to play when, how and where they want. With our Xbox S and X Series consoles, we’ve had global share for two consecutive quarters, and we’re the market leader this quarter among next-gen consoles in the US, Canada, UK and Western Europe. And with Xbox Cloud Gaming, we’re redefining how games are distributed, played and viewed. To date, over 10 million people have streamed games.

Many of our most popular titles, including Flight Simulator, are now available on phones, tablets, and low-end PCs for the first time. Our Game Pass library now includes hundreds of PC and console titles, including more games from third-party publishers than ever before. subscribers have played billions of hours in the last 12 months, up 45%. And with Azure, we’re creating the best cloud for game studios of all sizes to build, host, and grow their games, new capabilities, speed, development time, and to help connect gamers across platforms.

Azure gaming revenue so far this fiscal year is up 66%. Finally, we are entering a new era where every business will become a digital business. our portfolio of enduring digital businesses and diverse business models built on a common technology stack position us well to capture the massive opportunities that lie ahead. With that, I’ll give it to Amy.

amy hood – CFO

thank you, satya, and good afternoon everyone. This quarter, revenue was $49.4 billion, an increase of 18% and 21% in constant currency. Earnings per share were $2.22 and increased 14% and 18% in constant currency when adjusted for fiscal ’21 third quarter tax benefit. Several items affected our financial performance that were not included in the guidance provided in our January earnings call.

first, nuances. my comments today on third quarter results and fourth quarter outlook include the impact of the nuance acquisition, which closed on march 4th. our results include $111 million in revenue and a negative impact of $0.01 on earnings per share, including purchase accounting, integration and transaction-related expenses. Within our results, unless specifically stated otherwise, nuance was not a determinant of growth rates.

we continue to expect nuance acquisition to be minimally dilutive in fiscal year 2022 and cumulative in fiscal year 2023 for non-gaap eps. second, fx. the United States. The dollar strengthened throughout the quarter and created an additional one-point exchange rate headwind for the company’s total revenue compared to expectations.

As a result, revenue and earnings per share were negatively affected by $302 million and $0.03 per share, respectively. finally, the war in ukraine. we suspend all new sales of our products and services in russia. Revenues generated in Russia represent less than 1% of the company’s total revenues and we expect them to decrease significantly.

The impact to operating income this quarter was approximately $130 million split evenly between lower revenue and higher bad debt expense, resulting in a negative impact of $0.01 to earnings per share. our results for the quarter are better than we expected in terms of revenue, operating income and eps as we again delivered another strong quarter of growth in gross and net revenue. In our commercial business, strong demand for our differentiated cloud and hybrid offerings, coupled with excellent execution from our sales and partner teams, drove increased engagement with our platform as well as increased use of our services that satya mentioned above. Commercial bookings increased 28% and 35% in constant currency, well above expectations, driven by strong execution on our main annuity sales moves.

We also saw better-than-expected growth in long-term large blue contracts versus a very strong comparable prior year. Nuance benefited reserves by approximately five points. our local transactional license revenues in the office and server businesses were affected more than expected due to the transition from our open license program to our cloud solution provider program. the remaining business performance obligation increased 32% and 34% in constant currency to $155 billion, with a roughly equal split that we will recognize within and the portion beyond the next 12 months.

and our annuity mix increased two points year over year to 96%. commercial cloud revenue was $23.4 billion and grew 32% and 35% in constant currency, again above expectations. Microsoft Cloud’s gross margin percentage decreased slightly year over year to 70%. Excluding the impact of the change in useful life accounting estimate, Microsoft Cloud gross margin percentage increased approximately three points, driven by improvement in cloud services, partially offset by the change in sales mix. to azure.

In our consumer business, as satya heard, we saw market share gains in PCs, game consoles, and our edge browser. Now back to the company level. as noted above, us dollar strengthened throughout the quarter.

fx reduced total company revenue by three points, one point off expectations, decreased cogs by one point, in line with expectations, and decreased operating expense growth by two points, one point favorable to expectations. gross margin in dollars increased 18% and 21% in constant currency, and gross margin percentage decreased slightly year over year to 68%. Excluding the impact of the change in accounting estimate, gross margin percentage increased by approximately one point, primarily driven by the improvement in our cloud services mentioned above. operating expenses increased 15% and 17% in constant currency, slightly lower than expected, as investments carried over to future quarters were partially offset by the inclusion of nuances.

At the total company level, the number of employees grew 20% year over year as we continued to invest in key areas such as cloud engineering, client implementation, linkedin and sales, including approximately four points of growth thanks to the addition of nuances. operating income increased 19% and 23% in constant currency, and operating margins increased slightly year over year to 41%. Excluding the impact of the change in accounting estimate, operating margins expanded approximately two points year over year. Now to our segment results.

Productivity and business process revenue was $15.8 billion and grew 17% and 19% in constant currency, in line with expectations. better-than-expected results in office 365, linkedin and office consumer were offset by impacts from incremental fx, the open license transition, russia, as well as weaker-than-expected results in dynamics. office business revenues grew 12% and 14% in constant currency. Office 365 commercial revenue increased 17% and 20% in constant currency, driven by installed base expansion across all workloads and customer segments, as well as higher Arpu due to continued momentum from income from e5.

Office 365 paid business seats grew 16% year-over-year to nearly 345 million, with continued growth in our offerings for small and medium-sized businesses and frontline workers. and nearly 45% of our commercial office 365 seats were purchased through microsoft 365. office commercial licenses were lower than expected, down approximately 28% and 25% in constant currency, driven by the factors discussed above and a lower mix of contracts with higher revenues. revenue recognition for the period. Office consumption revenue grew 11% and 12% in constant currency, above expectations, driven by continued momentum from Microsoft 365 subscriptions, which grew 16% to 58.4 million.

Dynamics revenue grew 22% and 25% in constant currency, driven by Dynamics 365. This grew 35% and 38% in constant currency, substantially faster than the market, although slightly more lower than expected as we focus on stronger execution on our recent investments. linkedin revenue increased 34% and 35% in constant currency, with better-than-expected performance in talent solutions, as well as continued strength in marketing solutions and record levels of engagement on the platform. segment gross margin in dollars increased 16% and 19% in constant currency, and gross margin percentage remained relatively flat year over year.

Excluding the impact of the change in accounting estimate, gross margin percentage increased approximately two points, driven by improvement across all cloud services. operating expenses increased 13% and 14% in constant currency, and operating income increased 19% and 23% in constant currency. next, the smart cloud segment, which includes roughly four weeks of hue results. Revenue was $19.1 billion, up 26% and 29% in constant currency.

Excluding the impact of nuances and approximately $150 million in fx more than expected, revenue results exceeded expectations. Overall, server product and cloud services revenue increased 29% and 32% in constant currency. azure and other cloud services grew 46% and 49% in constant currency, above expectations, driven by the continued strength of our consumption-based services. the inclusion of nuance cloud services did not change azure’s constant currency growth rate.

In our per-user business, the enterprise mobility and security installed base grew 25% to more than 218 million seats. in our on-premises server business, revenue increased 5% and 7% at constant currency, above expectations, driven by strong demand for our hybrid offerings, partially offset by the aforementioned open license transition previously. the inclusion of nuanced offers on installs did not change the constant currency growth rate of the server. business services revenue grew 5% and 6% in constant currency, driven by growth in business support services.

the inclusion of tint professional services affected constant currency growth rate by one point. segment dollar gross margin increased 24% and 27% in constant currency, and gross margin percentage decreased approximately one point year over year. Excluding the impact of the change in accounting estimate, gross margin percentage increased approximately one point with improvements in Azure, partially offset by the change in sales mix to Azure. operating expenses increased 17% and 19% in constant currency, and operating income grew 29% and 33% in constant currency.

Now to more personal computing. revenue was $14.5 billion, up 11% and 13% in constant currency, above expectations, driven by better-than-expected performance in search and windows, offset by acreage. fx reduced segment revenue approximately $100 million more than expected. Windows OEM revenue increased 11%, with continued strength in the commercial PC market, which has higher revenue per license.

revenue from windows commercial products and cloud services grew 14% and 19% in constant currency, above expectations, driven by demand for microsoft 365, with some benefit from greater mix of contracts with higher revenue recognition in the period. Floor space revenue grew 13% and 18% in constant currency, lower than expected, driven by the consumer channel, partially offset by strength in commercial. ex-tac news and search ad revenue up 23% and 25% in constant currency, better than expected, benefiting from increased search volumes even as we saw headwinds during March from the impact of the war in ukraine. and in games.

Compared to the prior year, revenue increased 6% and 8% in constant currency. Xbox hardware revenue was better than expected as increased console supply in the quarter fueled 14% growth and 16% growth in constant currency. xbox content and services revenue grew 4% and 6% in constant currency, below expectations, driven by lower engagement across the platform, even while remaining above pre-lockdown levels pandemic. segment gross margin in dollars increased 10% and 13% in constant currency, and gross margin percentage decreased slightly.

Operating expenses increased 17% and 18% in constant currency, and operating income increased 7% and 10% in constant currency. Now back to the total results of the company. capital expenditures, including finance leases, were $6.3 billion, in line with expectations. cash paid for pp&e was $5.3 billion.

Cash flow from operations was $25.4 billion, an increase of 14%, as strong cloud billings and collections were partially offset by higher vendor payments related to the accumulation of hardware inventory as we manage ongoing uncertainty in the supply chain. free cash flow was $20 billion, up 17%. This quarter, other income and expenses were negative $174 million, less than anticipated, driven by net investment losses, including market value losses on our equity portfolio and net losses on foreign currency revaluation. Stock market declines led to net investment losses this quarter compared to net investment gains last year, a negative two-point impact on year-over-year EPS growth.

Our effective tax rate was approximately 17%. and finally, we returned $12.4 billion to shareholders through share buybacks and dividends. Now, before we move on to our perspective, a few reminders. first, fx.

with the us uu. stronger dollar and based on current rates, we now expect fx to reduce the company’s total revenue growth by approximately two points and reduce total cog growth and operating expenses by approximately one point. within segments, we anticipate approximately three points of negative currency impact on revenue growth in productivity and business processes and two points in intelligent cloud and more personal computing. second, my comments for the coming quarter include a full quarter of the impact of the nuance acquisition.

third, we anticipate that the war in ukraine will continue to impact our business in the fourth quarter with an approximately $110 million impact on revenue and a minimal impact on operating expenses. Below, we have factored in the current impact of the closures in China on our outlook. however, extended production shutdowns leading into May would further negatively affect our outlook on oem windows, surface and xbox hardware. Finally, the outlook we offer, unless specifically stated otherwise, is based on USD.

With that context in place, let’s move on to our fourth quarter outlook. in our biggest quarter of the year. we expect our differentiated market position, customer demand across the solutions portfolio and consistent execution to drive another strong quarter of revenue growth. in commercial reserves, a growing maturity base in the fourth quarter, strong execution on our top annuity sales moves and increased engagement with our platform should drive healthy growth compared to a strong comparable prior year.

As a reminder, the ever-increasing mix of larger, longer-term blue contracts, which are more unpredictable in their timing, always creates greater quarterly volatility in our booking growth rate. Microsoft’s cloud gross margin percentage should decline by about a point year over year. Excluding the impact of the change in accounting estimate, fourth quarter gross margin percentage will increase approximately one point, driven by continued improvement in our cloud services, partially offset by a change in revenue mix to Azure. capital expenditures, we expect a sequential increase in dollars as we continue to invest to meet growing global demand for our cloud services.

next to the segment orientation. in productivity and business processes, we expect revenue between $16.65 billion and $16.9 billion. In business office, revenue growth will again be driven by office 365 with healthy seat growth across all customer segments and arpu growth up to e5. we expect office 365 revenue growth to be one or two points lower sequentially on a constant currency basis.

In our local business, we expect revenue to decline similarly to last quarter. In office consumption, we expect revenue to grow in the high digits, driven by Microsoft 365 subscriptions. For LinkedIn, we expect revenue growth of around 20, driven by a strong job market and healthy engagement in the office. platform. and dynamically, we expect revenue growth similar to last quarter.

For the intelligent cloud, we expect revenue between $21.1 billion and $21.35 billion. Revenue will continue to be driven by Azure, which, as a reminder, may have quarter-to-quarter variability, primarily from our business per user and revenue recognition in the period, depending on the mix of contracts. We expect Azure revenue growth to be roughly two points lower sequentially on a constant currency basis, with slightly more U.S. currency impact. uu. growth in dollars than at the segment level.

Azure revenue will continue to be driven by strong growth in our consumer business. And our business per user should continue to benefit from the momentum of the Microsoft 365 suite, although we expect growth rates to moderate given the size of the installed base. In our on-premises server business, we expect revenue to decline in the low to mid single digits as demand for our hybrid offerings will be more than offset by the prior year’s strong comparable, which included four points of profit, a benefit from contracts with higher revenue recognition in the period, as well as continued transactional weakness from the aforementioned licensing program transition. and in business services, we expect revenue growth to be in the high single digits.

In more personal computing, we expect revenue between $14.65 billion and $14.95 billion. As mentioned above, our guidance reflects the current limitations of the China shutdowns, which had a negative impact on Q4 supply for OEM, Surface, and Xbox consoles. In Windows OEM, we expect low- to mid-single-digit revenue growth, driven by the continued shift to a commercial PC market, where revenue per license is higher. In commercial Windows products and cloud services, customer demand for Microsoft 365 and our advanced security solutions should drive growth in the low double digits.

acreage, revenue should grow in low double digits. In search and ex-tac news advertising, we expect revenue growth of approximately 20%. and in gaming, we expect revenue to decline in the mid to high single digits, driven by reduced engagement hours year over year as well as limited console supply. We expect xbox content and services revenue to decline in the mid-single digits, although engagement hours are expected to remain higher than pre-pandemic levels.

Now back to the company orientation. we expect cogs of $16.6 billion to $16.8 billion and operating expenses of $14.8 billion to $14.9 billion, resulting in another quarter of operating margin expansion, excluding the change in the useful life. we expect other income and expenses to be negative $50 million, reflecting the impact of the foreign exchange rate remeasurement based on market conditions in April. like the rest of our guidance, this number does not reflect further equity and currency movement until the fourth quarter.

As a reminder, we are required to recognize market-adjusted gains or losses on our equity portfolio, which may increase quarterly volatility. and we expect our fourth quarter effective tax rate to be approximately 18%. We expect to close fiscal year 22, even in a more complex macro environment, with the same consistency that we have delivered throughout the year, with solid revenue growth, share growth and improved operating margins as we invest in the areas that are key to sustaining that growth. As we look ahead to FY23, our track record of delivering high value to our customers in many enduring and diverse growth markets gives us confidence that we will drive continued healthy double-digit growth in revenue and operating income. .

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now brett, let’s go to questions and answers.

brett iversen – managing director, investor relations

Thank you Amy. now we will move on to questions and answers. [operator instructions] jesse, can you repeat your instructions?

questions & answers:

operator

Reading: Msft earnings call transcript

absolutely. [operator instructions] our first question comes from keith weiss with morgan stanley. continue with her question.

keith weiss – morgan stanley – analyst

excellent. thank you so much for answering the question and really impressive results. and what we see is a pretty tough climate, definitely from a stock market perspective. But if we think about interest rates, we think about inflation, right now there is a conflict in Europe.

seems to be a difficult backdrop. you are operating very well. I mean, the acceleration on that scale is really incredible. And if I’m not mistaken, office 365 business also accelerated in the quarter.

really impressive results. but I think the question most investors will have is where do you get confidence in the durability of this growth, given how volatile this macro environment is? Are they conversations you’re having with customers? Is that what you see in the backlog? maybe if you could give us some kind of insight on what gives you the confidence to put out that guidance, to put out those healthy comments for fiscal year 23. what are you seeing that maybe can help give us and investors a little more confident in the durability of this growth in this environment?

satya nadella – president and CEO

yes. maybe start, maybe three levels, keith. one is just the competitiveness of our technology stack from infrastructure to saas applications when it comes to commercial cloud and also how can we monetize for example the installed base of our consumer franchises as well. so, in both places, we feel that we are competitive and increasingly, coming out of the pandemic, to gain participation.

I would also say that in many of these places we have price leadership. I mean, take the one point I made, which is if there is any macro headwind where you have more value for less price means you win. And in our case, when it comes to our commercial cloud offerings, we have significant advantages across the stack. The second thing is in the conversations that we’re having with our clients, the interesting thing that I find about maybe even the past challenges, whether they’re macro or micro, is that I don’t hear of companies looking at their budgets from it or digital transformation projects like the place for cuts.

If anything, some of these projects are how they’re going to accelerate their transformation or actually automation, for example. I haven’t seen this level of demand for automation technology to improve productivity because in an inflationary environment, the only deflationary force is software. so that’s the second micro thing, the tone thing that’s different. however, at the end of the day, I mean none of us here are trying to forecast macro.

so all we think about is that the tams we’re competing in are big. As a percentage of GDP, spending on technology, on a secular basis, will double by the end of the decade. we just want to keep driving usage, driving engagement and being competitive. that’s how we see what we’re doing, and that’s where our confidence comes from in terms of our outlays, whether it’s opex or capex.

so i don’t know, amy, if you want to add anything else.

amy hood – CFO

I think the only thing, satya, I could add is that I think always, and I think we’ve used this language quite often, focused on long-term opportunity. you talked about it as the tam we are focused on. I would also say that there is still a lot of that tam ahead. and it’s still pretty early in the transitions that you’re talking about from a digital transformation perspective, from an automation perspective, from the kind of value and real productivity improvements that can be made.

And I think the continuity of execution has certainly been very good from a sales and partner standpoint. but I would also say, in your opinion, that we are investing in a long-term opportunity and our confidence that that long-term outcome is correct is where I think that is the basis for what you and I are talking about, giving this answer from.

keith weiss – morgan stanley – analyst

exceptional. great quarter.

brett iversen – managing director, investor relations

thanks, keith. jesse next question please.

operator

Reading: Msft earnings call transcript

absolutely. our next question comes from brent thill with jefferies. continue with your question.

brent thill – jefferies – analyst

thank you. Amy, based on your guidance, are you changing any of your close rate considerations or adding more supply chain constraints? Or is this the same guidance methodology that you have been providing us with in the past?

amy hood – CFO

I guess we’re talking specifically about most of the guidance in the more personal computing segment, where supply chain constraints, which are specifically related to production shutdowns in china. In general, I follow the same principle that I try to follow, which is that I give you my best knowledge as of today. I took note and tried to make it very clear that if the production shutdowns were to extend into May, there would be an additional negative impact on those from a supply constrained position. As you know, in the OEM business, revenue is recognized at the point of production.

and then for the xbox and surface consoles, it’s on sale. so production delays even before May can obviously have a big impact on the quarter. so we’re looking at it, and I tried to make it transparent in the guide. Other than that, my orientation is reasonably consistent with the way I like to do it.

brent thill – jefferies – analyst

great. thanks.

brett iversen – managing director, investor relations

thanks, brent. Jesse, next question please.

operator

Reading: Msft earnings call transcript

our next question comes from mark moerdler with bernstein research. continue with your question.

moerdler brand – sanford c. bernstein – analyst

thank you very much. congratulations on the quarter and for the solid guidance. I think it will not only help stocks but hopefully help the industry a little bit more. I’d like to look at the office, which was probably stronger than people expected.

where are we on the upsell opportunity from e3 to e5? And can you give us any idea of ​​the size of how much of the growth not just now but in the future? do you think it will come from frontline users? thanks.

amy hood – CFO

Maybe I’ll start answering that question, and satya, if you want to add something. very specifically, mark, i would say that this quarter was pretty similar in nature to what you saw in the last few. Seat growth, while across all segments, was especially good for frontline workers and SMEs. that somewhat masked, as often happens, the arpu improvement, since they tend to be lower priced skus, the arpu improvement that we’re seeing in transitions to e5.

the transition from e3 to e5 still has a chance. I would say that we are in the first transitions of that. So in terms of what I think going forward, there’s certainly still room for job growth, specifically in the frontline worker, as you noted, as well as expansion of smb and then arpu through the e5 transition . what i would add that satya mentioned in her comments and again in her first reply is really the value that is available to customers in e5, whether it be security, compliance, phone, analytics, the value of that suite, and if you think further Broadly, the value of Microsoft 365, which adds more components around windows, I think we’re offering high value, and that tends to give us some optimism that we can continue to do well in that segment.

I don’t know, satya, if there’s anything you would add to that.

satya nadella – president and CEO

not. you covered it well, amy. I mean, I think the fundamentals are still pretty solid here, whether it’s e5 growth, smb growth, frontline worker. I would also add emerging markets.

I mean, this is the first time I feel like we’ve got products that cater to emerging markets, like kit essentials, where we can even break into markets that we’ve never sold anything to in the past. and then the new growth engines that you talked about, team phones, team rooms, veeva and even windows 365 are all things that we can drive growth from again. and the point about our value is probably very, very strong at a time like this, in particular. and we see it, like the only thing I would also say is that the usage data that we’re seeing is peaking everywhere.

and that’s the other thing: we will definitely optimize to drive usage and deployment, and that will be our priority.

moerdler brand – sanford c. bernstein – analyst

thank you very much. I really appreciate it. congratulations.

brett iversen – managing director, investor relations

thanks, mark. Jesse, next question please.

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our next question comes from karl keirstead with ubs. continue with your question.

karl keirstead – ubs – analyst

good. great. Amy, you mentioned a transactional weakness, which in the March quarter, we may see in the local office segment, and in your guidance in the server product segment, you suggested that we might see it there as well. is it something you would characterize as microsoft specific? as he described in his comments, he is transitioning clients out of his open license program.

Or do you think it’s a broader issue where maybe we’re starting to see a small tilt from on-premises to cloud even faster than we’ve seen before? thanks.

amy hood – CFO

thanks, carlos. That is a very good question. I would say that it doesn’t feel like the tilt from on-premises to cloud felt different in a way that would have impacted the quarter more than it normally does in terms of the normal transitions that we’ve seen, to your point, in the office. or frankly even on the server as we have people moving those workloads and migrating those workloads to the cloud. this really was very significant – think of it as the place where partners transact, and we have such a large, valuable and really necessary community of partners that it’s very vast.

and we put this in and had planned this change for January 1st. and we’re executing the change on January 1st as planned, and it’s just taking us a little longer to get this whole community on board to make sure they can transact the way they want to in the program. so I think it’s going to take us longer than we thought. we’re going to continue to see that impact in the fourth quarter.

And I know the teams are working hard to make sure partners feel comfortable with the new system, which is important to us.

satya nadella – president and CEO

and the only thing i would add is that this change is very good for partners, customers and microsoft in the long run. so there is execution ahead, but we want to do this because it benefits everyone.

karl keirstead – ubs – analyst

understood. thanks, satya.

brett iversen – managing director, investor relations

thanks, carlos. Jesse, next question please.

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our next question is from mark murphy with jpmorgan. continue with your question.

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mark murphy – jpmorgan chase and company – analyst

yes. many thanks. satya, a handful of infrastructure software companies have commented that their consumption activity actually started to slow down a few months ago. So, I’m curious, what in your opinion allows your blue trajectory to show better resilience? and indeed do you see some of the newer products being rolled out like azure arc or synapse cognitive services, openai and maybe contributing to the strength in health and stamina of that blue number?

satya nadella – president and CEO

yes. I mean, what I would say, mark, is that what we are seeing is a classic thing that happens with consumption meters, correct, that they grow and then they are optimized and grow again, both existing and new. and so it will always have some amount of volatility which even amy mentioned quarter after quarter. but if I upload this, one thing we see is growth coming from all segments, right? so small business and enterprise.

does it come from all regions? forks. we also look at the type of workloads it comes from. and so he looks healthy in all of those. and if you go down the stack to your point, on the infrastructure side, tier 1 workloads is where i think we’re seeing some big tier 1 workloads, and i had a lot of feedback on the sap move and others workloads.

The second thing I would say is about paas services and our dev saas, that’s another area where we have differentiated value, so we see good growth there. data and ai insurance. I mean, what I really find to be something that I think in the long run is probably going to be one of the biggest drivers of our growth and differentiation is our data structure because we’re the only ones that have complete data. operational store fabric, which is fully integrated into an analytics engine, which is fully integrated into governance. and that is going to be more and more important, right? I mean, you may be dealing with this: a new privacy and governance regulation at one end and your operational store is divorced from that.

so we have a very differentiated offering, and I talked about some of the growth numbers there. ai inference is also finally kicking in. They are very small today. but even when I look at the total, that’s essentially a computation meter, there’s growth there.

so overall I think we’re going to see some cyclicality quarter over quarter depending on customers. in fact we pay microsoft people to reduce customer bills and what we should do. given that we can see cyclicality in terms of how optimizations happen, but overall, we’re still very early days as the world migrates to the cloud and essentially uses cloud computing and infrastructure to drive its product and operational efficiencies. .

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mark murphy – jpmorgan chase and company – analyst

thank you.

brett iversen – managing director, investor relations

thanks, mark. Jesse, next question please.

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Our next question comes from Kash Rangan with Goldman Sachs. continue with your question.

kash rangan – goldman sachs – analyst

thank you very much, congratulations on a spectacular quarter. satya, very clearly in his comments, and in particular, he talked about technology as a percentage of gdp that’s going to double in the next seven or eight years or so. no one could have really predicted, perhaps besides you, that blue would be so big and grow so fast right now relative to, say, five or six years ago. So looking forward, what part of Microsoft’s tech stack do you think is underrepresented in the digital world and therefore has the most chance to win as you develop your tech thesis as a percentage of duplication? of gdp? thank you very much.

satya nadella – president and CEO

I mean, what I keep coming back to, kash, is that all the value of the business, at least as far as I can tell, is created in three layers of the tech stack. what happens with infrastructure anytime something can be 10 times better for example when we talk about the next generation of multi-edge multi-cloud infrastructure that’s still one of the leaders it’s going to be massive ev creation like a percentage of gdp, spending on technology doubles. that’s where everything from azure, azure arc, our database, all of that is very important. the other is kind of old ai.

in other words, the main business logic is not being written. it is being written by software. so when i look, when i use github copilot, there is, there is the future of what, how all the business logic is written. and for me the artificial intelligence layer, both the training supercomputers and the inference layer, that’s a place where you’re going to see us integrate what, today, everyone thinks of as two different businesses, whether it’s azure and windows, they are just a business for me because for me, where the training happens, where the inference happens, the developers will write it once and then it will light up through this distributed fabric.

so that’s another place where I think there’s tons of business value to be created over time. and then of course the ui layer is always the biggest and the next tipping point whether it’s what happens with the metaverse or what happens even on the industrial side with iot and digital twins that’s all the stuff that I think will happen to be the ones that we will focus on. so these three things translated into workloads and what we call our customer solution areas are the ways that we’re at least investing.

kash rangan – goldman sachs – analyst

fascinating. thank you very much.

brett iversen – managing director, investor relations

thank you kash. Jesse, next question please.

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Our next question comes from Michael Turrin of Wells Fargo. continue with the question from him.

michael turrin – wells fargo securities – analyst

hello there. good evening. thanks for taking the question and great job with the results. highlights azure’s growth in commercial booking strength.

You mentioned an expected slowdown in azure growth in Q4, but you still suggest very impressive growth on that scale. Can you expand on the big deals, the long-term strategic deals that you’ve referenced multiple times over the past few quarters, how do they impact visibility or maybe the approach to framing goals there? and anything you can add about how adding nuance helps cloud business and the industry’s approach to cloud is also greatly appreciated. thanks.

amy hood – CFO

satya, do you want to start with your comments maybe on the nuances in general and then I can address how the bigger long term?

satya nadella – president and CEO

yes. of course. just a couple of quick things. one is about the strategic commitments that are being made.

we are working on them with the workload at once. so we feel very, very good about the type of workloads. in fact, there’s a migration of a lot of workloads that we may have gained on the client-server ahead that they’re migrating. but what’s most exciting is the kind of tier 1 workloads that we’ve never seen run on any microsoft infrastructure running on azure today and optimized on azure.

so that’s what we see when we win these big strategic deals. As for nuance, to me what’s exciting is that nuance is a platform layer for these AI-powered applications that are being implemented, whether it’s in healthcare or even in the enterprise contact center. so we are very excited that nuance is now part of the microsoft family. you will see us innovate quite aggressively there and increase the impact of these solutions both on the large percentages of our gdp, but also in health care, where I think there is a great need to address problems like the burden on doctors with innovative new solutions . , and we really want to exercise that.

amy hood – CFO

and michael, maybe specifically, you’re absolutely right, I tend to bring up the impact of large azure contracts in the long run, both in the context of trading reserves and some volatility that we can often see because of that. but really, I think the way we think about them may be outside of this phone call is that it’s the beginning of the commitment between us and a customer to start working together to deliver value. and so we go load by workload, opportunity by opportunity. and I think that’s what you were inferring a little bit, which is pretty much the top of the funnel for creating customer value.

We call it achieving success to make sure they’re spending money in the most effective way, making sure we’re tackling the toughest problems they need to solve. and with that comes our investments that we’ve made in deployment resources and usage resources specifically in azure to make that possible with customers. and you’re right to say that I’m talking about them in terms of the volatility they create. what you create within the company is the beginning of a commitment to make sure we’re addressing the workloads and solutions that customers want to see happen across all workloads, frankly, that satya talked about today.

michael turrin – wells fargo securities – analyst

is a great complementary point and also stands out. thank you very much.

brett iversen – managing director, investor relations

thank you, miguel. Jesse, we have time for one last question.

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thank you. our final question will come from keith bachman with bmo. continue with your question.

keith bachman – bmo capital markets – analyst

hello and thank you very much. I wanted to break it down into two parts, but I was wondering if you could comment on what you see to be the strength of the computer market as you look over the calendar year, if you focus on the demand side of the equation, not the of the supply of the equation. and really, the most important related part is, given the outlook you may have for the computer market, how do you think about the durability of the windows side of your business? In particular, if you’d like to comment on the fundamentals related to the PC market, but also the opportunities to continue to mingle, so to speak, with the help of Microsoft 365. Thank you very much.

satya nadella – president and CEO

then let me –

amy hood – CFO

satya, why don’t you start and I’ll add it?

satya nadella – president and CEO

perfect. so i think on the business side, i think it’s well understood that windows is the socket for microsoft 365. we have tremendous value, amy mentioned that earlier. in fact, we just released windows 11 and pro value with windows 365.

That’s resonating really well. customer satisfied adoption rates when it comes to whether it’s security, whether it’s productivity, we feel good about the commercial business. so we will stay focused on that, on the business side. and on the consumer side, the output again, the pandemic, the intensity of use has increased.

So one of the areas of focus for us is that some of the things I talked about in my comments are just usage, right? so when you think of 500 million users engaging with microsoft start, that’s not the kind of commitment we had. and so with the large installed base now, we have significant space there. the growth of browser engagement, we have significant space there. And then of course comes the subscription, whether it’s for gaming, productivity, or suites.

That’s how I see what we’re going to do at least for the foreseeable future. PC is still a very important category in, I think, people’s lives is what we’ve discovered during the pandemic, and if anything, the intensity of use has increased. and there will be a cyclical demand that we will go through, but the number of use cases has definitely, I think, increased structurally.

amy hood – CFO

exactly. I think the only thing I would add on your demand side is that we’ve seen the transition from, I would say, in the middle of the pandemic, definitely a consumer-driven demand cycle. we’ve transitioned it to be a commercial part of the demand side. and I hope that is the case.

Obviously, I think this is the second quarter in a row that we’ve seen that transition. expect the fourth quarter to be even more of that, and then we’ll wait and see how the second half of the year shapes up.

keith bachman – bmo capital markets – analyst

good. Thanks a lot. congratulations.

amy hood – CFO

thank you.

brett iversen – managing director, investor relations

thanks, keith. so 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.

amy hood – CFO

thank you all.

satya nadella – president and CEO

thank you all.

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[operator signature]

duration: 65 minutes

call participants:

brett iversen – managing director, investor relations

satya nadella – president and CEO

amy hood – CFO

keith weiss – morgan stanley – analyst

brent thill – jefferies – analyst

moerdler brand – sanford c. bernstein – analyst

karl keirstead – ubs – analyst

See also : Coinbase is listing for US100 billion on NASDAQ, but you might be better buying bitcoin instead

mark murphy – jpmorgan chase and company – analyst

kash rangan – goldman sachs – analyst

michael turrin – wells fargo securities – analyst

keith bachman – bmo capital markets – analyst

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