Microsoft Corporation (MSFT) Earnings Call Transcript

Okay, I think we're live. Welcome back, everybody. I'm Brad Zelnick with the Deutsche Bank software team. Really delighted to be here hosting this session with Microsoft, where we have the company's Executive Vice President, Chief Financial Officer of its Commercial business, Dave O'Hara. Dave, welcome.

Thank you, Brad.

Thanks for being here. Format of this will be a 35-minute or so fireside chat for as long as we last. I've got a bunch of prepared questions to ask, Dave. And if there's time, maybe we'll -- I'll keep my eyes on my phone, on my inbox. If you have any questions, I'll try to weave them into the conversation. Again, if we have time. But with that, Dave, let's jump right into it. If you don't mind, maybe for those that are less familiar with you, your title, can you explain your role and what it is that you do at Microsoft?

Sure. I am the Commercial CFO for Microsoft, which is just what it means, which is the CFO for all of our Commercial business. People ask me what is -- tell me what's in the Commercial business, and I say anything that's not in Consumer, which is true, and it's a fairly accurate framing. So it's all of our -- it's Azure, it's Office, it's Windows Commercial, it's SQL, it's all of the Commercial stuff, and then I also have CorpDev.

Excellent. Thank you for that. And maybe if we could talk. Macro environment is on everybody's mind. Maybe if we could just reflect on last quarter, the company sounded very confident in the strong momentum in the Commercial business, but did call out some softening specifically in the small to medium business segment. And we're now 2 months into Q1. Has anything changed in terms of the trends that you're seeing there? And also several other software companies have come out and spoken about larger sales cycle delays in large enterprise-type deals. Is this something that Microsoft is beginning to see as well?

Well, I would say at a macro level, I think everybody is still trying to figure it out and understand where the world is going. But for us, we were, as you noted, we had a good Q4. We had a really good bookings number, our record bookings number for us. And we've had a few quarters of that in a row. And so we'd like to see that. We see that as a sign of future strength and so feel good about where we're at. And we feel like long term, the cloud is just going to continue to expand. On the SMB side, we saw a little bit of a pullback. But even with that, we still saw a good growth. It was just probably a tick less than we might have otherwise expected. We still have the same outlook. I think -- like you said, I think everybody is still trying to figure it out. But I also think that people are looking at this as an opportunity to really transform and they're investing accordingly.

That makes sense. And to your point on Commercial bookings, you've now had 3 quarters in a row with greater than -- or 35% or greater Commercial bookings growth at constant currency and led by large, long-term Azure commitments. And I kind of imagine this does give you some degree of visibility and confidence in the business trajectory for the year. But what do you think is driving customers' confidence in making these large type of commitments, especially in these times?

Well, I think, one, first and foremost, is we can show them how they can save money by investing in cloud technology and investing in the future. And so they look at it as an opportunity to take your OpEx down. When we look at a company, we really think the opportunity for us is basically anything they spend on OpEx, like everything ultimately can be automated and everything ultimately can run better in the cloud. And so we just make that pitch to them. I think the other thing is we just have a good lineup of products. Cloud started out as infra but it's much more than that now. And we have solutions that fit all up and down the stack. And so I think the reason that they're willing to make commitments is -- one is, if they make a long-term commitment and a big commitment, they're going to get a better deal from us and they know that. And two is, they're just kind of at the point where I think they just feel like it's past the question of does this make sense. They know it makes sense. The question is how fast can they move and how efficiently can they move. And so we're seeing lots of people make big investments and lots of people come in with big ideas.

Yes. I am always, I guess, surprised not surprised when I hear of these massive 9-figure, multiyear, strategic commitments with the world's most known brands. But when we think about Azure, obviously, there's demand that falls into that category all the way down to smaller innovative-type companies looking to do more with less and some of what you talked about. But how reliant is Azure growth on larger long-term deals? And is it fair to think about Azure is driving customer spend on other Microsoft products as well, like Power Platform, Dynamics, Office? Like how have these customer conversations evolve in terms of pulling through more and more of the portfolio?

Yes. We started out talking about the Microsoft Cloud. So when we're going to make a pitch to a customer, we talk about all the offerings that we have. And Azure, as you noted, is a good entree because it's infrastructure. And at some level, the companies are better off starting there, but there are so many offerings beyond that Power Apps, Dynamics, any of the database offerings. And so we really look at it. I think that's the reason that they want to sign a long-term relationship. One is not only do they get a better deal, two is they get more of a road map, and they can understand where they're going long term as opposed to just doing a transaction. So it's really about a deep partnership. We have that conversation with lots and lots of customers and I get involved in lots of deals as well. And so many of the CEOs started out by saying, "I don't want a transaction, I want a partnership." And that's what we're looking for, too, is a long-term partnership. And throughout that partnership, they end up using a lot of our technology not just Azure. Azure is often just the starting point.

Got it. Makes perfect sense. And overall, Azure growth rates remain very impressive, but there's still healthy debate around the trajectory from here over the next couple of years as just the revenue base just gets larger and larger. And I appreciate you're not going to give us long-term guidance. But can you walk us through the inputs and process of how Microsoft itself thinks about capacity planning and the visibility you feel you have the overall commercial demand?

Yes. I mean it's a very different world, obviously, than we had even 5 years ago because our CapEx number is much more meaningful, much larger. But we also feel like we have way better signal into how much we should be spending on CapEx because we have these long-term contracts. We have deep conversations with customers. We have the biggest global footprint from a cloud perspective. That's all signal and that all tells us where we think the world is going. And so to build a data center takes a long time, and so you have to be fairly accurate. But not only that, you have to continue to drive efficiency. So how we think about the long-term growth of Azure, it's a unique market in the sense that you have 3 super deep-pocketed players, who are willing to do what it takes to win a customer. And so I feel like from a pricing perspective, it's always very competitive. And we'll do whatever it takes to be competitive and continue to grow share. So pricing is always, for lack of a better description, under pressure. But we feel like we're charging a fair price and customers believe we're charging a fair price. So pricing, there's probably pressure on that side. On the hardware and software side, there are definitely efficiencies of scale. And so we've seen some of that through some of the margin expansion that we've been able to achieve over the years, it's just the efficiency. So you might have price pressure on the top end. You might have bigger contracts, which result in more predictable revenue. You have all the efficiencies in the hardware and software side and then you get the benefits of scale across all the OpEx that we're spending. And so all of that, we sort of -- every quarter, we pull all of that together and say, here's where we're at from our Cloud business, but it really starts with the Microsoft Cloud. So not just any one product, it's a Microsoft Cloud and making that work across all of those inputs and intakes.

You mentioned the CapEx cycle. The capital that you're deploying in Microsoft Cloud today, how do we think about that like just in terms of -- and I'm not -- I don't want to get into the accounting and the changes in depreciation and things like that, but just more from a capacity planning standpoint, like how far ahead are you thinking and is the company looking at?

Well, we have a rolling 3-year plan on how we think about CapEx. But really, it's about the next 18 months in terms of what you can control. So it's best to have a directional thinking on how we think about 3 years out, 18 months out, we do a lot of planning. And then we adjust as we go. And what we've seen over the last 5 years is each year we have to adjust up a little bit. On the other hand, you get way more VMs out of a machine these days, you get -- you can store way more servers in a data center, the chips are much better and so you can process -- there's a lot more consumption that can be run through a data center today than 2, 3, 4, 5 years ago. And so we get all those efficiencies as well. So you have to factor all of that into the planning process and just say where do we think we're going to be. And then you have to get smarter about how you provision land and there's -- it's -- I feel like we're so much more sophisticated in that process than we were when we started that. It's been really fun to see.

Awesome. Maybe to pivot to Industry Cloud. I feel like the message we've heard coming out of Microsoft has signaled really strong adoption around what you're doing in vertical market-specific offerings. How important is that to the longer-term Azure strategy? And is this an area where we should expect to see more investment maybe similar to what we've seen in health care with Nuance?

Yes, sure. So on the Industry Cloud, really, for those that are familiar, the Industry Clouds are really onboarding to Azure is how we should think about it because they're industry-specific, but it's not super deep functionality. It's not like -- maybe we're creating a vertical product because it competes with the ecosystem, it's really just industry functionality that runs on Azure and gets people onboarded under our cloud. So those are all being well received. But even as an example, when we announced our Sustainability Cloud, Judson and I jumped on with some CEOs from Europe and then we jumped on a call with some CEOs from the U.S. and just said, "Hey, here's what we're doing. All good news." And they're like, "Hey, where is the reporting for XYZ?" And so people just want stuff that's very specific to their company and to their industry and we'll continue to work with the ecosystem to deliver that. Now Nuance, I spent a ton of time on Nuance both pre- and post-acquisition and still spend a ton of time there. Nuance was unique to us in the sense that we do have a very strong ecosystem play, always have, always will. And Nuance was both an app and a platform. It's a platform in the sense that Epic embeds it and Cerner embeds it and other health care providers embed it. And so it provides very specific functionality that the ISVs can use to make their solution better. And so the thing we liked about that is it's not a vertical app. It's really a platform app but is very industry-specific. And I think we will take the opportunity to build all of those that we can. Because I think as long as we're enabling the ecosystem and we're providing specific functionality that maybe they can't -- they don't choose not to build on their own, then that's all good news. And I think we're seeing that show up. So would we do more stuff like Nuance? I think to the degree that we can have something platform-y that works with the ISV community and provides differentiation that they want, yes, absolutely.

The industries that stand out is with rich opportunities?

I think the 6 that we have for Industry Cloud are all seen as an area of focus for us. And so think about any of them, retail, financial services, manufacturing, whatever, health care sustainability. I think the other one is a nonprofit as they look at many of our friends. And so I think all of those are big and broad opportunities for us to partner closely with the ecosystem.

Cool. Dave, maybe to pivot to a different topic. Today's Microsoft really embraces interoperability and open standards and, ultimately, to drive customer benefit. And unsurprisingly, I think Microsoft's multi-cloud value prop is very clear with capabilities such as Azure Arc as an example. Can you talk philosophically about the balance between interoperability versus proactively partnering with great companies like a Databricks, for example, to ultimately drive customer success?

Sure. When you look back on it, it's been a bit of an evolution. I think when we first got into the cloud game and it was us and AWS and some other vendors that have been around a while, too. It was seen as you go win a customer and then the customer runs in your cloud. And it quickly became apparent that, that probably wasn't going to be the way that it all played out. The customers wanted choice. They wanted the opportunity to run the business. They wanted it in whichever cloud they wanted. And candidly, if you start 6 years behind your competitor, then it benefits us to have a multi-cloud environment because that way, if people are running some workloads on AWS and some on us and some on GCP, that our job is to make that run as efficiently as possible. And Azure Arc really does that. What it allows people to do is run Azure services across a variety of clouds, including all the public clouds. And so I think multi-cloud is definitely here to stay. I think the onus is on the public cloud providers to make that work as seamlessly as they can, and we'll continue to invest in that. And so in the early days, it was like, "Hey, here's our cloud, here's their cloud, which one do you want?" And now it's like, "Hey, here's how to best run your business." And I think it's a much better story for customers.

No doubt it's playing out to customers' benefit and we pick that up all the time. Maybe along similar lines, it was a surprise to see -- or at least for me to see, for sure, your announcement of an Oracle Cloud-managed database service for Azure. Can you talk about the size and scope of this specific opportunity, and just more generally, how Microsoft thinks about coopetition?

Yes. I think SAPI particular, is very, very committed unique-assisted play. And that we should be able to partner with almost any company in almost any instance, if it's in the best interest of the customer. And we've done business with Oracle for decades. Actually. Judson, who runs sales for us, he came from Oracle. And so he's got long-standing relationships there. I think Oracle has a great offering, a great database offering. I think having those database offerings run in Azure Cloud is a good thing. And we just got together and we said, "Hey, we have a common set of customers that would like to see this happen. Let's make it happen." And it really wasn't a difficult conversation to have. We just felt like if you do this and we do that, and it all works out with the customers, then that's a good thing. The Databricks partnership is a pretty deep partnership for us. Our partnerships can run from sort of marketing partnerships to sort of API partnerships. It's something that's more deeply integrated or even to something like Databricks that actually sells on our paper. And so we just -- depending on the company and depending on the opportunity, I think we're open to having partnership conversations with basically anybody.

No doubt. Maybe while we're on the data topic, Cosmos DB data volumes have been growing at over 100% for 4 quarters now. InApp's data volume is growing very nicely as well. How does Microsoft think about data services creating affinity and stickiness in the cloud? And as well, how should we think about the cost of delivering data-intensive services over time?

Sure. Well, data is a big play for us. It always has been. I mean way back in the day when Microsoft got into the business with SQL, that was sort of our -- that was the big leap into data, and I think everything that we do now sort of builds on that history. And for our cloud offering, Infra is great storage, it's great, but if you can't do something with the data, it's not really going to make a difference. And so we spend a bunch of time and money on making our data products and offerings better and more targeted toward customers. And I think we see that in the growth. I think for us, the stickiness comes from the collection of services, not any one service. And so I don't -- data is probably more sticky than average. But in the end, what they really want is all of their products to work together across the whole cloud. And so from a consumption perspective, there -- some companies use data a lot more than others. And so it just depends. In terms of cost, I think we have a fair value prop for our data services. But again, we look at -- when somebody signs a multibillion dollar contract, when they sign a multiyear, multibillion-dollar contract, there's a piece of that that's data. And so as I noted earlier, we look at it across the whole Microsoft Cloud, and we just need to make sure that we're competitive in the market. And I think we are. And I think we'll continue to drive cost down. I think the most surprising thing to me in the last few years has been how quickly, with the combination of software and hardware, we've been able to take costs out of the model and which allows us to pass better pricing on to customers. And I think they're all seeing that and benefiting from that.

No doubt. Can we just talk about Office?

Yes.

So yes, switching to Office 365 Commercial, in specific. The company's noted moderation in SMB new deal volume recently, how much of recent seat growth is being driven by SMBs versus larger enterprise customers? And how much runway is left for each of these customer segments to maintain seat growth over the medium term?

Sure. Well, there's a few things at work with Office. Office obviously has deep penetration into the enterprise. On the other hand, we're continuing to add functionality to Office that benefits customers. And so even though it might be deeply penetrated, we have other offerings, whether it's Teams or Security or any other of the new offerings that we've come out with lately. And so I think from an enterprise perspective, we have room to grow. Our E5 penetration still has room to grow. From an SMB perspective, it's that accounts for a large chunk of our new users. But I think it will continue to account for a large chunk of our new users. And so it's the -- as we look at building the Office business, it's a combination of both new offerings and new suites for the enterprises, but also sort of simpler, more straightforward offerings for SMBs and frontline workers. And I think both of them are growth opportunities. So our job is to just add as many customers as we can and get them the most value that we can and some combination of that P x Q is the Office business.

So we've talked a little bit about the Q, maybe a little more on the P. There's healthy debate around ARPU as a driver of Office 365 growth. E5 seats were up, I think, 60% year-over-year this past quarter, now account for 12% of the installed base. How should we think about penetration from here? To what extent will SMB and frontline SKUs offset this uplift? And is ARPU likely to be a meaningful growth driver going forward?