Datasets:

jlh-ibm
/

earnings_call

================================================================================
Corporate Participants
================================================================================

* Satya Nadella
Microsoft Corporation - CEO & Director
* Amy E. Hood
Microsoft Corporation - Executive VP & CFO
* Michael Spencer
Microsoft Corporation - General Manager of IR

================================================================================
Conference Call Participiants
================================================================================

* Brent John Thill
Jefferies LLC, Research Division - Equity Analyst
* Raimo Lenschow
Barclays Bank PLC, Research Division - MD & Analyst
* Gregg Steven Moskowitz
Mizuho Securities USA LLC, Research Division - MD of Americas Research
* Mark L. Moerdler
Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst
* Stewart Kirk Materne
Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst
* Keith Weiss
Morgan Stanley, Research Division - Equity Analyst
* Heather Anne Bellini
Goldman Sachs Group, Inc., Research Division - MD & Analyst
* Brad Alan Zelnick
Crédit Suisse AG, Research Division - MD

================================================================================
Presentation
--------------------------------------------------------------------------------
Operator [1]
--------------------------------------------------------------------------------

Greetings, and welcome to the Microsoft Fiscal Year 2020 Fourth Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Mike Spencer, General Manager and Investor Relations for Microsoft. Thank you. Sir, you may begin.

--------------------------------------------------------------------------------
Michael Spencer, Microsoft Corporation - General Manager of IR [2]
--------------------------------------------------------------------------------

Good afternoon, and thank you for joining us today. On the call with me are Satya Nadella, Chief Executive Officer; Amy Hood, Chief Financial Officer; Frank Brod, Chief Accounting Officer; and Keith Dolliver, Deputy General Counsel.
On the Microsoft Investor Relations website, you can find our earnings press release and our financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provides a reconciliation of differences between GAAP and non-GAAP financial measures. Unless otherwise specified, we will 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 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 will refer to growth rate only.
We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript and in any future use of the recording. 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, in 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, Microsoft Corporation - CEO & Director [3]
--------------------------------------------------------------------------------

Thank you, Mike. Good afternoon, everyone. We delivered record results this fiscal year powered by our commercial cloud, which surpassed $50 billion in revenue for the first time, up 36% year-over-year. The last 5 months have made it very clear that digital tech intensity is key to business resilience. Organizations that build their own digital capability will recover faster and emerge from this crisis stronger. We are seeing businesses accelerate the digitization of every part of their operations from manufacturing to sales and customer service, to reimagine how they meet customer needs from curbside pickup and contactless shopping in retail to telemedicine in healthcare. That's why we are building the full modern technology stack powered by cloud and AI, and underpinned by security and compliance, to help every organization digitally transform.
Now I'll highlight our innovation and momentum, starting with Azure. Every organization today needs a distributed computing fabric to run essential workloads. We are building Azure as the world's computer to support them with data center regions -- more data center regions than any other provider, including new regions as of this quarter in Italy, New Zealand and Poland. We have always led in hybrid, and we are accelerating our innovation to meet customers' needs wherever they are. Azure Arc is the first control plane built for a multi-cloud, multi-edge world, and we are taking it further with Azure Arc-enabled Kubernetes. New capabilities in Azure Stack HCI help organizations bring the cloud to their very own data centers. And our acquisitions of Affirmed and Metaswitch, along with Azure Edge Zones, extend Azure to the network edge, expanding our offering to telecom operators as they move to 5G.
Our differentiated approach across cloud and edge is winning new customers in every industry from Land O'Lakes, the National Australia Bank to Johns Hopkins Medicine, as well as leading ISVs including Citrix, Fenestra, SAS and Workday.
At the data layout, Azure is the only cloud with limitless data and analytics capabilities that can deliver a cloud-native data estate for every organization. The combination of SQL Hyperscale, Cosmos DB, Synapse Analytics and the new Synapse Link, which enables live analytics on real-time transactions, differentiate Azure. In AI, we have the most comprehensive portfolio of tools, frameworks and infrastructure.
We're thrilled with the progress our partner, OpenAI, is making. Their new GPT-3 model constitutes a new breakthrough in AI, and we trained -- and was trained on our Azure AI supercomputer. New capabilities in Azure Cognitive Services make it easier to build applications that speak naturally in 49 languages and its variants, and to generate insights from unstructured data including paper-based forms and medical records. Microsoft Bot Framework now includes powerful authoring tools to build sophisticated conversational bots with low code. And with Azure machine learning, organizations can deploy AI more responsibly and safely.
All this innovation is driving usage. In June alone, 13.5 billion transactions were processed in Azure Cognitive Services, 2.5 billion messages sent, 9 million hours of speech transcribed. From Bridgestone to UnitedHealth Group to EY, companies are relying on Azure AI to innovate and better meet customer needs.
Now to developer tools. The role of developers is more important than ever. From emergency response to recovery to reimagining the world, we have the most used and loved developer tools to build any application for any platform. We have seen increased activity across multiple measures, and we are going further with new tools to power secure remote development. With Codespaces, we are bringing together the best of GitHub, Visual Studio and Azure to help developers go from code to cloud in seconds. New advanced security features in GitHub use semantic analysis to scan code for vulnerabilities, and GitHub discussions help software communities collaborate outside of the code base.
More than 3 million organizations, including the majority of the Fortune 50, now use GitHub. The State of California is using GitHub and Azure DevOps to power 90% of its digital COVID-19 response infrastructure. All the 5,000 engineers at Autodesk rely on GitHub to break down silos across the organization. And at Etsy, developers are using GitHub to deploy production -- to production more than 50 times per day.
Now to Power Platform. With Power Platform, anyone in an organization can rapidly create an application, build a virtual agent, automate a workflow or analyze data. Citizen developers and business decision makers at companies like Schlumberger and T-Mobile are using Power Platform to address challenges created by COVID-19. Power BI is the clear leader in business intelligence in the cloud and is growing significantly faster than competition. 96% of the Fortune 500 now use Power BI to find insights in their data.
More broadly across the Power Platform, we are seeing accelerating usage. Power Apps monthly active users increased 170% year-over-year. Power Automate is up 75%, and in just 6 months, Power Virtual Agents have already surpassed 6.7 million sessions. Just yesterday, we launched an end-to-end return-to-workplace solution in Power Platform that will help organizations like CBRE keep employees safe and healthy when they go back to their office. And we continue to invest in robotic process automation. Our acquisition of Softomotive, when coupled with Power Automate, enables customers, including KPMG, to automate manual business processes across both legacy as well as modern applications.
Now to Dynamics 365. Dynamics 365 is helping organizations in every industry digitize their end-to-end business operations from sales and customer service to supply chain management so that they can rapidly adapt to changing market conditions. Customer Insights is the fastest-growing Dynamics 365 application ever, helping organizations like Walgreens Boots Alliance and Chipotle offer more personalized customer experiences. BNY Mellon chose Dynamics 365 this quarter to help investment managers build stronger relations with their customers.
More than 4,500 organizations now use Dynamics 365 commerce, finance and supply chain management, making it one of the fastest-growing SaaS solutions in its category. FedEx, for example, uses Dynamics 365 to drive more precise logistics and inventory management. In retail, Dynamics 365 Connected Store now offers in-store traffic analytics and curbside pickup, prioritizing safety as stores reopen. And we continue to invest in solutions to protect merchants as they process more online transactions. New account protection and loss-prevention features in Dynamics 365 Fraud Protection help protect online revenue, and we are working with financial services firms like Capital One to improve fraud detection and keep customers secure.
Now to LinkedIn. In spite of revenue headwinds due to lower hiring needs, we are seeing record engagement as LinkedIn's more than 706 million professionals turn to the network to connect, learn and plan for the future. Content shared was up nearly 50% year-over-year and LinkedIn Live streams were up 89% since March. People will increasingly need to move beyond current domain expertise to learn new skills, and they're turning to LinkedIn. Professionals watched nearly 4x the amount of LinkedIn Learning content in June than they did a year ago. And we are making it easier for them to access LinkedIn Learning's more than 16,000 online courses directly in the flow of their work. A new learning app in Teams will allow organizations to integrate LinkedIn Learning as well as their own content to create a continuous feedback loop between work, skills and the learning needed for upskilling and reskilling employees.
Now to Microsoft 365 and Teams. When, where and how the world works is fundamentally changing. Microsoft 365 is empowering people and organizations to be productive and secure as they adapt to more fluid ways of working as well as learning. Microsoft Teams is helping people be together even when they are apart. It's the only solution with meetings, call, chat, content, collaboration with Office as well as business process workflows in a secure, integrated user experience. We are reimagining every aspect of the meetings experience with new capabilities like Together Mode and the Dynamic Stage to help people feel more connected and reduce cognitive load. We expanded the gallery view in Teams so that people can see and interact with up to 49 participants at a time, and breakout rooms and live reactions will help people build social capital in a virtual world.
Deeper integration between Teams and Power Platform brings an integrated data platform, Microsoft Dataflex, for easier, faster application creation and deployment, enabling a new category of enterprise grid apps and chatbots in Teams. Teams is rapidly becoming the communications backbone as customers accelerate moving voice to the cloud, and we are expanding Teams beyond the workplace, making it easy to add personal Teams account on mobile so you can stay connected with friends and family across work as well as your life.
Teams users generated more than 5 billion meeting minutes in a single day this quarter, and we are seeing increased usage intensity across the platform as people communicate, collaborate and co-author content in Teams. 69 organizations now have more than 100,000 users of Teams, and over 1,800 organizations have more than 10,000 users of Teams.
We are working alongside educators as they prepare for remote hybrid and in-person scenarios this fall. More than 150 million students and teachers around the world now rely on our tools, including Teams, Stream, OneNote as well as Flipgrid to prioritize student engagement and learning outcomes. Our new Microsoft Cloud for Healthcare is helping providers schedule, manage and conduct virtual visits using Teams and engage with patients using Dynamics 365. In healthcare, there were more than 46 million Teams meetings this past month. The NHS in the U.K. chose Microsoft 365 to empower its 1.2 million employees with the latest productivity and collaboration tools to deliver better patient outcomes.
More broadly, we are seeing increased usage of Microsoft 365 and larger strategic agreements. Alcoa and Telstra are empowering their entire workforce, including first-line employees, with Microsoft 365 and Teams. Across industries, customers like 3M, CenturyLink, GE and Providence are increasingly choosing our Microsoft 365 premium offerings for differentiated security, compliance, voice and analytics value. Our Microsoft 365 E5 user base more than doubled year-over-year.
People are turning to Windows PCs more than ever, with minutes spent in Windows 10 up more than 55% year-over-year. And we expanded our family of Surface devices and accessories to help people work, learn and connect from anywhere as we create new categories that benefit the entire OEM ecosystem.
Now on to security and compliance. Remote everything continues to accelerate the need for a Zero Trust security architecture that protects people, devices, applications and data holistically. And we are the only company with an integrated end-to-end capability informed by more than 8 trillion signals each day. Azure Active Directory now has more than 345 million monthly active users across more than 200,000 organizations, and we are not only securing employee identities but customer and partner identities as well.
General Motors, for example, is using Azure Active Directory to secure interactions between its employees, dealers and customers. Azure Sentinel now has more than 6,500 customers. The accelerating adoption of IoT across industries is creating new security challenges, and our acquisition of CyberX this quarter will help secure customers' IoT deployments.
Finally, we are helping customers protect their more sensitive information. Microsoft Information Protection is enabling companies, such as Siemens AG, to protect sensitive data wherever it exists. And new Microsoft 365 Records Management helps customers govern data and reduce risk.
Now on to gaming. It is simply a breakthrough quarter for gaming. We saw record engagement and monetization led by strength on- and off-console as people everywhere turned to gaming to connect, socialize and play with others. Stepping back, we are expanding our opportunity to empower the world's 2 billion gamers to play wherever and whenever they want on any device. Xbox Game Pass has seen record subscriber growth across both console and PC and now includes content from more than 100 studios. Our xCloud gaming service is already live in 15 countries. And just last week, we announced that we will bring xCloud to Xbox Game Pass so subscribers can stream games to a phone or a tablet and play along with nearly 100 million Xbox live players around the world.
In content, we are delivering differentiated first- and third-party content to attract and retain gamers. Xbox Series X launched this fall with the largest launch lineup for any console ever. And Minecraft reached a new high of nearly 132 million monthly active users during the quarter.
In closing, we are expanding our opportunity and investing across the full modern technology stack. Over the next decade, technology spending as a percentage of GDP is projected to double, and we are well positioned to participate in that growth by innovating and defining the key technologies that empower every person and every organization on the planet to build more of their own tech intensity.
With that, I'll hand it over to Amy who will cover our financial results in detail and share our outlook, and I look forward to rejoining for your questions.

--------------------------------------------------------------------------------
Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4]
--------------------------------------------------------------------------------

Thank you, Satya, and good afternoon, everyone. This quarter, revenue was $38 billion, up 13% and 15% in constant currency. Gross margin dollars increased 10% and 12% in constant currency. Operating income increased 8% and 12% in constant currency and earnings per share was $1.46, increasing 7% and 9% in constant currency when adjusting for the net tax benefit related to the transfer of intangible properties from the fourth quarter of fiscal year '19. In our largest quarter of the year, our sales teams and partners again delivered strong results with many similar trends to the end of the third quarter.
In our commercial business, increased usage, consistent execution and continued demand for our differentiated, high-value cloud services drove another strong quarter. And in our consumer business, increased demand from work-, learn- and play-from-home scenarios again benefited our Gaming, Surface and Windows OEM non-Pro businesses. We also saw weakness in small and medium business purchasing, which primarily impacted our transactional Office and Windows OEM Pro businesses, and drove some moderation to our Office 365 Commercial paid seat growth. And in our search business, though rates stabilized through the quarter, we saw a continued reduction in advertising spend on our platform.
Moving to our overall results, customer commitment to our cloud continues to grow. In FY '20, we closed a record number of multimillion-dollar commercial cloud agreements with material growth in the number of $10 million-plus Azure contracts. And on a strong prior-year comparable, commercial bookings growth was ahead of expectations, increasing 12% year-over-year, driven by consistent renewal execution and an increase in the number of large, long-term Azure contracts. As a result, commercial remaining performance obligation increased 23% to $107 billion.
Approximately 50% of this balance will be recognized in revenue in the next 12 months, up 21% year-over-year, reflecting consistent execution across our core annuity sales motions. The remaining 50%, which will be recognized beyond the next 12 months, increased 25% year-over-year, highlighting the growing long-term customer commitment to our cloud platform. And this quarter, our annuity mix increased 4 points year-over-year to 94%.
Commercial cloud revenue grew 30% and 32% in constant currency to $14.3 billion, surpassing $50 billion for the fiscal year. And commercial cloud gross margin percentage expanded 1 point to 66% despite revenue mix shift to Azure and significant customer engagement and usage to support remote work scenarios. In line with expectations, FX reduced revenue growth by approximately 2 points and COGS growth by approximately 1 point. FX had no impact on operating expense growth, slightly less favorable than expected.
Our margins this quarter reflect investments to deliver greater customer value in this challenging environment and, therefore, strengthen our long-term competitive position. We invested in capacity for cloud infrastructure usage, free trial offers for critical remote work scenarios and flexible financing options across the ecosystem. Additionally, we re-envisioned our retail store strategy as we stayed focused on growing our investments in these strategic high-growth opportunities of the future. As a result, company gross margin percentage was down 2 points year-over-year to 68%, with additional impact from lower-margin sales mix. Operating expense grew 13%, including a $450 million charge related to the realignment of our retail store strategy. And operating margins declined 2 points year-over-year to 35%.
Now to our segment results. Revenue from Productivity and Business Processes was $11.8 billion, increasing 6% and 8% in constant currency. Commercial -- Office Commercial revenue grew 5% and 7% in constant currency, impacted by the small and medium business slowdown noted earlier, as well as a strong prior-year comparable where 4 points of growth were from a greater mix of contracts with higher in-period recognition. Office 365 commercial revenue grew 19% and 22% in constant currency, in line with expectations, and was again driven by installed-base growth across all workloads and customer segments as well as higher ARPU.
Demand for our high-value security and voice components drove strong upsell to Office 365 and Microsoft 365 E5. Paid Office 365 commercial seats increased 15% year-over-year, slightly below prior quarter trends. This reflects the strong adoption of free trial offers we made to enable customers to quickly adapt to needed remote work scenarios as well as some growth moderation in first-line worker and small and medium business offerings.
Office Consumer revenue grew 6% and 7% in constant currency as stronger-than-expected growth in Office 365 consumer subscriptions was partially offset by transactional weakness. As a result, we saw a significant quarter-over-quarter increase in Office 365 consumer subscribers, up more than 3 million to 42.7 million.
Dynamics revenue grew 13% and 15% in constant currency driven by Dynamics 365 growth of 38% and 40% in constant currency. This fiscal year, total Dynamics revenue surpassed $3 billion with over 60% from Dynamics 365.
LinkedIn revenue increased 10% and 11% in constant currency as a weak job market materially impacted annual bookings in our Talent Solutions business even as usage remained high. Segment gross margin dollars were relatively unchanged and increased 3% in constant currency, and gross margin percentage decreased 4 points year-over-year. Operating expense increased 10% and 11% in constant currency and operating income decreased 9% and 5% in constant currency.
Next, the Intelligent Cloud segment. Revenue was $13.4 billion, increasing 17% and 19% in constant currency, slightly ahead of expectations, driven by continued customer demand for our differentiated hybrid offerings. On a significant base, server products and cloud services revenue increased 19% and 21% in constant currency. Azure revenue grew 47% and 50% in constant currency, in line with expectations, driven by continued strong growth in our consumption-based business.
In our per-user business, growth continued to moderate given the size of our enterprise mobility installed base, which grew 26% to over 147 million seats. And our on-premise server business was relatively unchanged and grew 1% in constant currency, ahead of expectations, driven by strong renewal execution and continued demand for our hybrid and premium solutions.
Enterprise Services revenue was relatively unchanged and grew 2% in constant currency as growth in premier support services offset consulting delays. Segment gross-margin dollars increased 19% and 21% in constant currency, and gross-margin percentage increased 1 point year-over-year. Operating expense increased 19% and operating income grew 19% and 22% in constant currency.
Now to More Personal Computing. Revenue was $12.9 billion, increasing 14% and 16% in constant currency with better-than-expected performance across all businesses as we continue to benefit from work-, learn- and play-from-home scenarios.
In Windows, overall OEM revenue grew 7%, benefiting from improved supply in April that met unfulfilled Q3 demand. In OEM Pro, this benefit was more than offset by the impact from small and medium businesses in May and June. And in OEM non-Pro, the benefit from work- and learn-from-home scenarios continued but did moderate through the quarter. Inventory levels ended the quarter in a normal range. Windows Commercial products and cloud services revenue grew 9% and 11% in constant currency driven by Microsoft 365 and the continued demand for our advanced security solutions.
In Surface, revenue grew 28% and 30% in constant currency, with strength across consumer and commercial segments. Search revenue ex TAC declined 18% and 17% in constant currency driven by the trends noted earlier. And in Gaming, revenue increased 64% and 66% in constant currency, significantly ahead of expectations, with the continued benefit from play-at-home scenarios driving record levels of engagement and monetization across the platform as well as a significant increase in console sales.
Xbox content and services revenue increased 65% and 68% in constant currency with strong growth in third-party transactions, Game Pass subscribers and Minecraft. Segment gross-margin dollars increased 12% and 15% in constant currency, and gross-margin percentage decreased 1 point year-over-year with the mix shift to Gaming. Operating expense increased 10%, including the retail stores charge, and operating income grew 15% and 19% in constant currency.
Now back to total-company results. In line with expectations, capital expenditures, including finance leases, were $5.8 billion, up 8% year-over-year, to support growing usage and demand for cloud services. Cash paid for PP&E was $4.7 billion. Cash flow from operations was $18.7 billion and increased 16% year-over-year driven by healthy cloud billings and collections. And free cash flow was $13.9 billion, up 16%. For the fiscal year, we generated over $60 billion in operating cash flow and over $45 billion in free cash flow driven by a year of improving margins and operating leverage across our businesses.
In other income and expense, interest income, net gains on derivatives, investments and foreign currency remeasurement were mostly offset by interest expense. Our effective tax rate was slightly below 17%, lower than expected due to the geographic mix of revenue. And finally, we returned $8.9 billion to shareholders through share repurchases and dividends, an increase of 16% year-over-year, bringing our total cash returned to shareholders to over $35 billion for the full fiscal year.
Now before we turn to our outlook, I'd like to update you on a change in accounting estimate to the useful life of server and networking equipment assets in our cloud infrastructure. Effective at the start of fiscal year '21, we are extending the depreciable life for these assets to 4 years, which will apply to the asset balances on our balance sheet as of June 30, 2020, as well as future asset purchases. This change will not impact historical depreciation expense, the total depreciation expense over the life of the asset or cash flow, but it will impact the timing of depreciation expense in the future for these assets.
As a result, based on the outstanding balances as of June 30, we expect fiscal year '21 operating income to be favorably impacted by approximately $900 million in the first quarter and approximately $2.7 billion for the full fiscal year. This has been included in the guidance we'll provide on today's call, and you will find additional details on the mechanics of the change in our earnings materials.
Now let's move to our next-quarter outlook. In our Commercial business, given our differentiated position in growth markets, we expect continued commitment to our cloud platform as well as strong usage and consumption growth. In our Consumer business, we expect some continued benefit from work-, learn- and play-from-home scenarios in Gaming and Surface, though at a more moderated rate, as stay-at-home guidelines ease in many places around the world. However, we expect the small- and medium-business weakness we saw in Q4 to continue, which will impact transactional sales, primarily in Office and Windows OEM.
In commercial bookings, growth should again be healthy, but we will be impacted by the strong prior-year comparable and a low growth in the Q1 expiry base. Commercial cloud gross margin percentage will increase approximately 4 points year-over-year from the accounting estimate change noted earlier. Excluding this impact, continued improvement in Azure IaaS and PaaS gross margin percentage will be mostly offset by revenue mix shift to Azure. And on a dollar basis, we expect capital expenditures to be roughly in line with last quarter to support the growing usage and demand for our cloud services.
Next, to FX. Based on current rates, FX should decrease total company, Productivity and Business Process and Intelligent Cloud revenue growth by approximately 1 point and have no impact on More Personal Computing revenue, total company COGS and operating expense growth.
Now to the segment guidance. In Productivity and Business Processes, we expect revenue between $11.65 billion and $11.9 billion. In Office Commercial, on a strong prior year comparable, revenue growth will again be driven by Office 365 with continued upsell opportunity to E5. However, growth will be impacted by a decline of approximately 30% in our on-premises business driven by the transactional weakness in small and medium businesses noted earlier. In Office Consumer, we expect revenue to be relatively unchanged year-over-year as subscription growth will be offset by a decline in our transactional business.
In LinkedIn, we expect low to mid-single-digit revenue growth, primarily from weak bookings and, therefore, revenue growth in the Talent Solutions business. And in Dynamics, continued Dynamics 365 momentum from our modern and intelligent solutions will drive revenue growth in the low double digits.
For Intelligent Cloud, we expect revenue between $12.55 billion and $12.8 billion. In Azure, revenue growth will again be driven by our consumption-based business. And in our per-user business, we expect continued benefit from Microsoft 365 Suite momentum, though growth will again be impacted by the increasing size of the installed base. In our on-premises server business, on a strong prior year comparable, we expect revenue to be up slightly year-over-year driven by the durable value of our hybrid and premium annuity offerings. In Enterprise Services, we expect revenue to be relatively unchanged year-over-year, similar to last quarter.
In More Personal Computing, we expect revenue between $10.95 billion and $11.35 billion. In our Windows OEM business, we expect revenue to decline in the low teens range, impacted by the strong prior-year comparable that benefited from the end of support for Windows 7 as well as the continued slowdown in small and medium businesses. In Windows Commercial products and cloud services, we expect healthy double-digit growth from continued Microsoft 365 momentum and the value of our advanced security offerings.
In Surface, solid demand against a low prior-year comparable that was impacted by product life cycle transitions should drive growth in the mid-teens. In Search ex TAC, we expect revenue to decline in the low 20% range. And in Gaming, we expect revenue growth in the high teens with continued strong user engagement across the platform.
Now back to overall company guidance. We expect COGS of $10.75 billion to $10.95 billion and operating expense of $10.7 billion to $10.8 billion with continued investment against our significant long-term ambition. Other income and expense should be negative $50 million as interest expense is expected to more than offset interest income. And finally, we expect our Q1 tax rate to be approximately 16%, lower than our expected full-year rate, given the volume of equity vests in our first quarter.
In closing, we are committed to our customers' success in these challenging times and to managing the company for long-term growth and profitability. We will continue to expand our cloud infrastructure to support the growing customer usage and demand across our differentiated cloud offerings. And given our strong execution and growing competitive advantage in high-growth areas, we remain committed to investing against the long-term opportunity ahead of us.
Now before turning to Q&A, I have one special thank you. Frank Brod, our Chief Accounting Officer, will soon be retiring. And on behalf of the entire company, thank you for your significant impact and close partnership over the years. You played a key role in our success. And I'd like to welcome Alice Jolla, who has been working alongside Frank and I for many years, as our new Chief Accounting Officer. Alice, we look forward to having you in this position. With that, Mike, let's go to Q&A.

--------------------------------------------------------------------------------
Michael Spencer, Microsoft Corporation - General Manager of IR [5]
--------------------------------------------------------------------------------

Thanks, Amy. We'll now move over to Q&A. (Operator Instructions) Operator, can you please repeat your instructions?

================================================================================
Questions and Answers
--------------------------------------------------------------------------------
Operator [1]
--------------------------------------------------------------------------------

(Operator Instructions) Our first question comes from Keith Weiss with Morgan Stanley.

--------------------------------------------------------------------------------
Keith Weiss, Morgan Stanley, Research Division - Equity Analyst [2]
--------------------------------------------------------------------------------

A very nice quarter. Satya, I was hoping you could help us with your view of what the enterprise spending environment looks like through this difficult period. On one side of the equation, we have very good secular trends that are still very well in place. And like you said, digital transformation is accelerating. On the other side though, we do have difficult macro conditions out there, and we're seeing it in places like SMB and the like. Can you help us understand how that's splitting out on the ground in terms of your customers? Are you still able to get those big deals over the line? And how do you see that playing out through the rest of the fiscal year? Like, how should we think about those impacts through FY '21?

Thank you, Keith, for the question. The thing that at least we have learned, I would say, in the last 5 months is that digital technology is no longer viewed as just new project starts, but it's becoming perhaps the most key for business resilience. Business continuity obviously is a board-level discussion everywhere. But I don't think digital tech as sort of being key to business resilience was the #1 priority whereas now it is. So I think that that's, I think, what -- when I think about digital transformation now, I break it into 2 things. I think about resilience and all of sort of what Microsoft can do to help any business be more resilient, whether it's remote everything, whether it's about their ability to simulate anything, automate everything, those are the things that I think are going to increase.
Then, of course, there is how you readjust to what is going to be an increased e-commerce, contactless, reimagined world, reconfigured supply chain. So in both of those are secular tailwinds, but no one can take away from sort of the fact that GDP is going to be negative. So that's why I think you're going to see lots of ins and outs. But digital technology by -- and digital transformation itself is going to be pretty key. And therefore, we are very focused on sharpening the value proposition of every part of the stack I described and making sure we are there for our customers as they navigate these tough times.

And Keith, maybe just to add to that a little bit, and I think you saw that in our bookings growth for the quarter and, increasingly, I think people will start to focus as well on the remaining performance obligations. You're starting to see this commitment both in the next 12 months and then in the 12 months past that. And so we are -- obviously, you'll see some volatility in that from the longer-term larger contracts we had talked about. But we did, in Q4, have more of that closed than we anticipated.

--------------------------------------------------------------------------------
Operator [5]
--------------------------------------------------------------------------------

Our next question comes from Heather Bellini with Goldman Sachs.

--------------------------------------------------------------------------------
Heather Anne Bellini, Goldman Sachs Group, Inc., Research Division - MD & Analyst [6]
--------------------------------------------------------------------------------

I was just wondering, Satya and Amy, just given the success that you guys have in expanding your footprint with customers, is there any sense that you could [fill] with us -- some people talk about net expansion rates, right? Just wondering if you guys have a way of helping investors think about kind of the net expansion rate from your existing customers on an annual basis just given the success you're having with things like Azure hybrid benefits and migrations to the cloud. So any way for us to help think through that would be really helpful.

--------------------------------------------------------------------------------
Satya Nadella, Microsoft Corporation - CEO & Director [7]
--------------------------------------------------------------------------------

Amy, maybe I'll start and then you can add. I mean the way at least we think about the core, Heather, as far as how we are architecting what we're doing here, and that's one of the reasons why even I structured my remarks the way I structured them, which is each of these layers is being built obviously to reinforce the other layer. But each layer is independent. It's -- and we recognize that enterprises are very heterogeneous. They're going to choose multiple layers from multiple vendors, and interoperability will be key.
But we have a very differentiated value proposition. I mean even in this quarter, if you think about the number of customers who started with Teams, built a Power application, in fact had Azure, GitHub, Power DevOps on top of that code base and then used Azure Synapse all in one solution. So you can see that power of our stack. So each layer is architected such that it reinforces the other, and we see increasing adoption, including all of these layers. But I think in the numbers, when we talk about each of the numbers and the growth rates for each of the numbers, that in some sense showcases that. But maybe, Amy, you want to add more to that.

--------------------------------------------------------------------------------
Amy E. Hood, Microsoft Corporation - Executive VP & CFO [8]
--------------------------------------------------------------------------------

Yes. I think the other way to think about it, Heather, and we do, I know, talk about it a little bit every quarter, there are 2 main motions that we focus a lot on here: number one, are we adding new customers; and number two, are we adding workloads within customers. And I think you'll increasingly hear us talk about the number of customers who are purchasing multiple components of the cloud, whether that's Microsoft 365, Azure, the Power Platform Satya just talked about, developer SaaS or GitHub and then numerous cloud opportunities within Dynamics 365. So I think the way I tend to think about it is, is revenue per customer going up? Yes. And are we adding new customers? Yes. And do we feel like we still have room to add additional clouds? I think that will be sort of the language you'll hear us talk through this year.

--------------------------------------------------------------------------------
Operator [9]
--------------------------------------------------------------------------------

Our next question comes from Mark Moerdler with Bernstein Research.

--------------------------------------------------------------------------------
Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [10]
--------------------------------------------------------------------------------

Congrats on the quarter. Amy, cash flow from operations has been an area of concern across the software industry, with some companies reporting payment delays, requests for extended payments, et cetera. This quarter, your CFO was a strong standout. What do you think is the reason for the strength? Is this a function of the channel or enterprise exposure or something else? Any data, any information will be appreciated.

--------------------------------------------------------------------------------
Amy E. Hood, Microsoft Corporation - Executive VP & CFO [11]
--------------------------------------------------------------------------------

Thanks, Mark. We did have, as you saw -- and we have had very consistent performance in our cash flow from operations. And I think a lot of that, as you've noted, has to do with where that strength is coming from, which is, overall it's cloud billings, it's usage, it's consumption-based growth. We do have, as you noted, a lot of exposure to enterprise. That has tended to perform quite well. And we did extend, and I mentioned it in our call in the prepared remarks, a lot of financing options to customers as well. So I feel like we are taking an appropriately balanced approach here and really focusing more on customer enablement. And so we could see some impact, but I think the broad portfolio, Mark, and broad geographic exposure probably has benefited us on CFO.

--------------------------------------------------------------------------------
Satya Nadella, Microsoft Corporation - CEO & Director [12]
--------------------------------------------------------------------------------

And broadly, we will be very much optimizing for helping our customers through this period and our own share.

--------------------------------------------------------------------------------
Amy E. Hood, Microsoft Corporation - Executive VP & CFO [13]
--------------------------------------------------------------------------------

Yes.

--------------------------------------------------------------------------------
Operator [14]
--------------------------------------------------------------------------------

Our next question comes from Kirk Materne with Evercore ISI.

--------------------------------------------------------------------------------
Stewart Kirk Materne, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [15]
--------------------------------------------------------------------------------

Amy and Satya, you noticed the strong growth in the E5 SKU around Office 365 over the last year. Can you just talk perhaps a little bit more specifically about how Teams is perhaps changing the discussion around productivity more broadly, how that's maybe raising your profile even more from a strategic perspective as customers start thinking about how sort of collaboration is going to change in this new world, both in the short and the long term?

--------------------------------------------------------------------------------
Satya Nadella, Microsoft Corporation - CEO & Director [16]
--------------------------------------------------------------------------------

Sure, Kirk. The approach we took with Teams always was to not just think of this as just a chat application, right? I mean we thought about messaging obviously is important. But we said, okay, we had to reimagine how people communicate using both chat as well as video and then, most importantly, how people collaborate in meetings, outside meetings, before and after. So that's sort of the second element. And third, think about business process and workflows dominating inside of the scaffolding of Teams, and then building it with the same compliance and security base of Microsoft 365. So yes, absolutely.
So first of all, Microsoft 365 has entered many new categories. They're all part of our Microsoft 365 value. And so with that and the architectural coherence of Microsoft 365 because, in some sense, complexity, security risk, management costs, these are all real things for enterprises, especially if you've got to go remote everything. So I feel that we have a great value proposition for customers at a time of most acute need where they want to go remote, they need that flexibility when there is hybrid work and yet, they want the low-cost management and high security and compliance. So I think we have a differentiated offer there.
And I'll turn it to Amy if she wanted to add anything to that as well.

--------------------------------------------------------------------------------
Amy E. Hood, Microsoft Corporation - Executive VP & CFO [17]
--------------------------------------------------------------------------------

No. I actually think the other component, Satya, that I would mention is really the transition we've seen from just Office 365 E5 to Microsoft 365 E5 with the entirety of the value proposition. This, I think, has been a pivotal year. And again, in Q4, we saw even more transition in the SKU mix to the Microsoft 365 SKU than just simply the Office SKU.

--------------------------------------------------------------------------------
Operator [18]
--------------------------------------------------------------------------------

Our next question comes from Gregg Moskowitz with Mizuho.

--------------------------------------------------------------------------------
Gregg Steven Moskowitz, Mizuho Securities USA LLC, Research Division - MD of Americas Research [19]
--------------------------------------------------------------------------------

I have one for Satya. I'm curious how you would assess the net impact of the current environment on Azure, inclusive of potentially lower consumption growth among highly impacted industries and, of course, the per-seat moderation in EMS, offset by some acceleration in digital transformation more broadly among other customers. In addition, I was curious if you're seeing more pay-as-you-go-type arrangements for Azure than you were previously.

--------------------------------------------------------------------------------
Satya Nadella, Microsoft Corporation - CEO & Director [20]
--------------------------------------------------------------------------------

Thanks for the question. Overall, as I said, even in industries that have been impacted, say, economically, one of the things is -- getting to the new efficient frontier of cloud economics is one way for them to, in fact, do better as they get into recovery, right? So one of the things that we are seeing, in fact, is some acceleration even of getting rid of the old and getting to the efficient frontier so that then they can recover faster. That doesn't mean that some places where there is absolute real shutdown of economic activity, there isn't a slowdown. But where people are looking to say using even that as an opportunity to come out stronger, we do see that.
For sure, pay-as-you-go on Azure is going to increase and is increasing. And we are fundamentally focused on wherever people want to have those long-term commitments as well as pay-as-you-go customers. So we don't, in some sense, discriminate between the two. What we want to be able to just stay focused on is quarter-over-quarter consumption growth by adding value to customers' digital transformation projects.

--------------------------------------------------------------------------------
Amy E. Hood, Microsoft Corporation - Executive VP & CFO [21]
--------------------------------------------------------------------------------

And I would add maybe, Gregg, a little context is we have been seeing a transition to pay-as-you-go probably for the majority of this year as opposed to saying it has more recently just emerged as a trend. So I wanted to make sure to decouple those a teeny bit. And I think in general for us, this quarter, the consumption patterns were very, very similar actually to what we expected, to Satya's note, with the pressure to, I think, move to this new frontier being really at the forefront of people's minds, far more so than maybe a discussion on per-user impacts.

--------------------------------------------------------------------------------
Operator [22]
--------------------------------------------------------------------------------

Our next question comes from Brent Thill with Jefferies.

--------------------------------------------------------------------------------
Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [23]
--------------------------------------------------------------------------------

You've continued to show great top line double-digit growth and margin improvement. And many are asking, is that same framework in place in this environment, showing this same double-digit growth with margin improvement? Or do things change and you need to invest in new areas that could potentially stall out margins as we go through the cycle?

--------------------------------------------------------------------------------
Satya Nadella, Microsoft Corporation - CEO & Director [24]
--------------------------------------------------------------------------------

Brent, I'll start, and Amy, you can add to this. The way I would say, Brent, is that our focus, especially given that -- what is it, GDP is negative 10% in the world and you pick your timeframe. Right now what I would like us to focus on in the interest of our long-term investors is to say, how can we build this modern tech stack so that it can really capture -- both help customers transform, be resilient and help us get into new categories and build a strong position in those categories.
So my own approach to this would be not to worry as much about short term, whether it's the growth number because when you are growing compared to where GDP is, healthily and competitively, the growth number is high. I'm not trying to match some artificial double-digit growth number, and nor are we trying to sort of think about a margin target because, in some sense, the world needs to do well for us to do well in the long run. And I think the world will come out of this, and we will be stronger if we invest during this phase.

--------------------------------------------------------------------------------
Amy E. Hood, Microsoft Corporation - Executive VP & CFO [25]
--------------------------------------------------------------------------------

And I just want to reiterate how important that is. The opportunity that Satya really outlined in his remarks is, I do believe, fundamental. And so you see us continuing to invest. You'll see it in capital expenditure based on demand. You'll see it in the operating expense line. And a lot of the margin movement you're going to see is going to be actually far more sales mix than it is to think about it as margins going down in a particular product. So for me, it's really about in every product are we investing with a strong position, with a clearer view of the future in a way that we can be a more important part of every customer's budget. And so I think we feel very good about the products we've got, the lineup we've got and the execution engine we've got. And so I think we're far more focused in that way than maybe on a short-term number goal.

--------------------------------------------------------------------------------
Operator [26]
--------------------------------------------------------------------------------

Our next question is from Brad Zelnick with Crédit Suisse.

--------------------------------------------------------------------------------
Brad Alan Zelnick, Crédit Suisse AG, Research Division - MD [27]
--------------------------------------------------------------------------------

Congrats on the amazing results. Amy, I believe in your prepared remarks you had said Q4 CapEx was in line with expectations, and Q1 should be at a similar level. Can you speak to the evolution in cloud CapEx, productivity and utilization trends, your capacity planning process and lead times to stand up incremental capacity? And ultimately, how should we be thinking about the cadence of CapEx going forward?

--------------------------------------------------------------------------------
Amy E. Hood, Microsoft Corporation - Executive VP & CFO [28]
--------------------------------------------------------------------------------

Thanks, Brad. As you saw, we made great progress this quarter, catching up from supply chain challenges that I think we entered the quarter with. And as you can imagine, with the Teams surge and usage along with other workload surges, we look forward to continuing to be able to invest to meet that demand ahead of the curve, in addition to what Satya mentioned, which is continuing to enter new regions where we see opportunities. So for me, the way to think about it is you see the cloud revenue growth continuing, you see strong consumption and usage growth and you should expect cloud CapEx to follow in pretty short order. The lead times there have gotten tighter over time, and so you can generally think they'll be more correlated. But obviously, there's some demand planning that we like to give ourselves ample room.

--------------------------------------------------------------------------------
Operator [29]
--------------------------------------------------------------------------------

Our last question comes from Raimo Lenschow with Barclays.

--------------------------------------------------------------------------------
Raimo Lenschow, Barclays Bank PLC, Research Division - MD & Analyst [30]
--------------------------------------------------------------------------------

Congrats as well. A quick one for me. Like, can you talk a little bit about gaming? So this quarter was kind of, we saw very, very strong numbers but -- and before, like, it's slightly weaker because of the tougher comps. But like, how do you think about that cycle of growth that you get out of Gaming? And if we should be getting more stable with more recurring revenue? Just talk a little bit about the dynamics there a little bit.

--------------------------------------------------------------------------------
Satya Nadella, Microsoft Corporation - CEO & Director [31]
--------------------------------------------------------------------------------

Sure. I'll start. I mean our overall vision that we have sort of been talking about for, quite frankly, multiple years and building out with, in particular, our Game Pass strategy, that's what we are going for. This Gaming TAM is much more expansive than what we participated in, even with all of the success we had with Xbox. So we think going forward Xbox, with the approach we are taking, has much more of an ability to reach the 2-plus billion gamers out there, and we are in the early days of building that out. And so this quarter, of course, will stand out for many of the reasons because of the remote nature of how a lot of the activity happened. But -- and also, we have a new console that's very much part of our strategy.
But we go beyond the console to the PC. We go to mobile and we have the streaming service. So all of these accrue to what we think, in the long run, is going to be a much bigger addressable market. And we have a great structural position. We have a social network in Xbox Live. Obviously, we have a store that monetizes super well as well as we have the Game Pass subscription.
So Amy, if you wanted to add to that.

--------------------------------------------------------------------------------
Amy E. Hood, Microsoft Corporation - Executive VP & CFO [32]
--------------------------------------------------------------------------------

Maybe just a few things, which is, when I think about Gaming and where we are at this point, the reason it's so exciting is because I think this quarter reinforces that we have such platform strength built on the view, the support we have of fans of the console. We've extended that and begun to extend it to the PC. We're extending it to mobile. That platform strength will drive this more annuity-like behavior that you're thinking about, which is great. And we saw that in the Game Pass subscription growth again this quarter, building on that base. But then the third-party titles will drive some volatility, but that volatility is just reinforcing of the position we have and I think the long relationship with fans. So I think we're all pretty excited. I think Satya called it pivotal. I think it certainly is, and we're certainly looking forward to the next console release as well.

--------------------------------------------------------------------------------
Michael Spencer, Microsoft Corporation - General Manager of IR [33]
--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------
Amy E. Hood, Microsoft Corporation - Executive VP & CFO [34]
--------------------------------------------------------------------------------

Thank you, everyone.

--------------------------------------------------------------------------------
Satya Nadella, Microsoft Corporation - CEO & Director [35]
--------------------------------------------------------------------------------

Thank you, everyone.

--------------------------------------------------------------------------------
Operator [36]
--------------------------------------------------------------------------------

Ladies and gentlemen, this does conclude today's teleconference. Once again, we thank you for your participation, and you may disconnect your lines at this time.

--------------------------------------------------------------------------------
Definitions
--------------------------------------------------------------------------------
PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the
Transcript has been published in near real-time by an experienced
professional transcriber. While the Preliminary Transcript is highly
accurate, it has not been edited to ensure the entire transcription
represents a verbatim report of the call.

EDITED TRANSCRIPT: "Edited Transcript" indicates that a team of professional
editors have listened to the event a second time to confirm that the
content of the call has been transcribed accurately and in full.

--------------------------------------------------------------------------------
Disclaimer
--------------------------------------------------------------------------------
Refinitiv reserves the right to make changes to documents, content, or other
information on this web site without obligation to notify any person of
such changes.

In the conference calls upon which Event Transcripts are based, companies
may make projections or other forward-looking statements regarding a variety
of items. Such forward-looking statements are based upon current
expectations and involve risks and uncertainties. Actual results may differ
materially from those stated in any forward-looking statement based on a
number of important factors and risks, which are more specifically
identified in the companies' most recent SEC filings. Although the companies
may indicate and believe that the assumptions underlying the forward-looking
statements are reasonable, any of the assumptions could prove inaccurate or
incorrect and, therefore, there can be no assurance that the results
contemplated in the forward-looking statements will be realized.

THE INFORMATION CONTAINED IN EVENT TRANSCRIPTS IS A TEXTUAL REPRESENTATION
OF THE APPLICABLE COMPANY'S CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO
PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS,
OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS.
IN NO WAY DOES REFINITIV OR THE APPLICABLE COMPANY ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER
DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN
ANY EVENT TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S
CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE
MAKING ANY INVESTMENT OR OTHER DECISIONS.
--------------------------------------------------------------------------------
Copyright 2020 Refinitiv. All Rights Reserved.
--------------------------------------------------------------------------------