Welcome to the First Quarter Fiscal Year 2016 Microsoft Corporation Earnings Conference Call. As a reminder this conference is being recorded. I would now like to turn the call over to Chris Suh, General Manager of Investor Relations. Chris, please proceed.

Thank you. Good afternoon and thanks 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 John Seethoff, Deputy General Counsel. On our website, microsoft.com/investor, you can find our earnings press release and financial summary slide deck which is intended to supplement our prepared remarks during today's call and provide the reconciliation of differences between GAAP and non-GAAP financial measures. Our website also includes information related to our new financial reporting segments announced in September. This is also the first quarter that reflects the revenue recognition accounting for Windows 10. As a reminder, we report Windows revenue prior to any accounting adjustment in our More Personal Computing segment. The corresponding revenue deferral for Windows 10 sales is then reported in corporate and other in our segment reporting. Earnings commentary today and going forward will focus on results prior to the net deferral impact as we believe this is the best reflection of business health. Unless otherwise specified, we will refer to non-GAAP metrics on the call. The non-GAAP measures exclude the impact of last year's integration and restructuring charges and the current Windows 10 net revenue deferral. 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 first-quarter performance in addition to the impact that these items and events had on the financial results. Additionally, any mention of operating expense refers to segment operating expenses as defined in the footnotes of our Form 10-Q and includes research and development, sales and marketing and general and administrative but exclude the impact of last year's…

Thank you, Chris. Good afternoon, everyone. I'm looking forward to today's call. This quarter we delivered $21.7 billion in revenue and group profit. Also as part of our commitment to balance capital returns, we meaningfully increased our quarterly dividend and continued our stock repurchase plan. More importantly, we are focused and making progress towards the goals for fiscal year 2018 that we shared six months ago. Now more than 110 million active devices are running Windows 10. We are well on our way to reaching 1 billion Windows 10 active devices. People are moving from needing to choosing to loving Windows. Similarly we are making great progress towards our goal of $20 billion in annualized commercial cloud revenue run rate, which now exceeds $8.2 billion. The results speak to our differentiated cloud strategy, expanded market opportunity and the speed at which customers are adopting our service. As I reflect on the quarter, it is important to note that we are investing in significant addressable markets where we also have meaningful differentiation. Today we'll walk through our financial results for the first quarter and discuss how we are delivering new innovation and growing users and usage across each of our three segments. Let's start off with productivity and business process. Clearly, how people work has changed dramatically but one thing remains true, everyone wants to get more out of every moment of their life. After all, time is our scarcest commodity. That's why we set out to reinvent productivity and business process. The recent release of Office is a big step forward. We designed Office 2016 and Office 365 to take the work out of working together. We want to help change the nature of work within organizations of all sizes by focusing on the mobility of the person's experience, enabling…

Thank you, Satya, and good afternoon everyone. Before addressing this quarter's results, I want to briefly comment on the reporting segment change we announced during the quarter. We believe our new segments in combination with the supplemental metrics and the profit measure of operating incomes provide transparency into our progress against our ambitions. As Chris mentioned, my commentary today on our results and outlook will reflect the new segments and excludes the net revenue deferral impact of Windows 10. Last quarter, we discussed the material impact that foreign exchange movement would have on our financial results through fiscal 2016. In Q1, the FX impact on total revenue was 5 points, with most of the impact in the Intelligent Cloud and Productivity and Business Processes segments given their high annuity mix. This was in line with the expectations we shared in July. This quarter, revenue was $21.7 billion, down 7% and 2% in constant currency, primarily due to the changes we've made in our phone business. Gross margin declined by 3% but was up 3% in constant currency. We were thoughtful with operating expenses, realizing savings but investing as well. As a result, operating income grew 1% or 11% in constant currency. Earnings per share was $0.67 growing 3% and growing 15% in constant currency. We continued to see solid performance across most developed markets while the challenging macro conditions in Brazil, China, Japan, and Russia persisted this quarter. Commercial results are now included in each of the reporting segments, therefore each quarter I will cover overall commercial results in my commentary. Our commercial business continues to be healthy, with momentum in cloud services and a higher annuity mix across all segments. Commercial bookings were slightly better than we expected and grew 10% in constant currency. We executed well on expirations…

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

Thank you. Our first question comes from the line of Keith Weiss with Morgan Stanley. Please proceed.

Excellent. Thank you guys for taking the question and a very nice quarter indeed. I wanted to ask about the Azure in particular and the public cloud performance that you saw this quarter. It again seems like you're seeing an acceleration in that overall business and more broadly it seems like industry-wide both you guys and AWS are seeing something of an inflection point going on in terms of more and more business accruing to those public cloud environments. So my question is just that, would you agree with that statement that there is an inflection going on in the business? And if so, what do you think is causing that and is there a changing nature in how people are using that cloud? And then maybe for Amy, is there something we should bear in mind in terms of your traditional business, sort of the on-premise business that may be impacted as that inflection takes place that we should bear in mind as you go forward?

Yeah, I'll start, Keith, thanks for the question. Overall what we have seen is the public cloud or cloud infrastructure makes it much more possible for businesses of all sizes and developers of all sizes to get at infrastructure with much less friction than ever before. I grew up in our server business in the past. We were definitely the one to democratize servers by bringing servers to small businesses. But when I think about what's happening for example in Office 365, where we are adding 50,000 small business customers who now get the most sophisticated server technology, but now as a SaaS service, that's what's really happening world over with all application categories and that's where the growth is. I don't know long-term whether there is a zero-sum equation, but right now and in the intermediate timeframe, we see in our case growth in both sides. And in our case the vision also we have for distributed cloud infrastructure is just that, it is distributed. So we don't think of our server as a legacy business. I think of it as the edge of our cloud. If you look at what we are doing with SQL, we will have the ability for any customer of SQL to stretch even a single table from between their on-premise to the cloud. Those are the kinds of things that we are excited about. But we clearly are seeing very rapid growth and adoption of our Azure cloud. But in our case there are two unique aspects. One is this true distributed hybrid. And second is we don't think of Azure in isolation. We think about it in the combination of Office 365, Dynamics, EMS, because really it's one cloud infrastructure first of all from a capital perspective that sort of serves all of these and there's a virtuous cycle between all of these for our customers as well.

And Keith, your second question, the place you'll actually see it will be in the gross margin percentage. As Satya said, I do expect both to grow, both the on-premise and the cloud. But I expect the mix to increasingly shift toward the cloud given its sort of robust growth rate, which will impact the gross margin percentage over time.

Excellent. That's very helpful, thank you.

Thanks, Keith. We'll take the next question, please.

Thank you. Our next question comes from the line of Mark Moerdler with Bernstein Research. Please proceed.

Thank you. Congratulations on the quarter everyone. Two questions, but related. Let me give you the first one. The commercial cloud annualized revenue run rate grew slightly from $8 billion to $8.2 billion or a little more than each of those. You had Office 365, Azure, Dynamics CRM Online, and all of them seem to be growing very fast. How should we think about the difference? Should we figure that the run rate reaccelerates next year? Next quarter, excuse me. And then I have a follow-up.

The way to really think about that number just because of some of the seasonality in our business, Mark, is to think about the year-over-year growth rate of 70%. For me that is more symbolic of how you should think about the pace. And that is a very fast number on a increasingly growing base.

That makes perfect sense. Thank you. The second one is the cloud margins improved nicely. Given the data that's in here, it looks like they've all started to move up. Azure seems to move up. You'd said in the FAM the gross margins for 2015 (37:31) should be about 44%. How should we think about cloud gross margins for 2015? I know you don't know obviously the mix of all the cloud products, but how should we think about the improvement there?

Thanks, Mark. Looking in the old segments, I know you all have done, we saw a year-over-year improvement in the overall commercial other segment that we disclosed this time too of about 10 points year over year. We saw sequential improvement from Q4 to Q1. We're still focused on continuing to have that sequential improvement, and especially as some of the things Satya talked about, which is the addition of premium services, the pace of innovation especially on the premium end. And if you think about our launch of E5, which is a premium SKU in Office 365, it continues to give us the opportunity to both get more efficient in the infrastructure and to add higher margin products especially at the fast end.

Yeah, just one thing that's structurally I think, that we think a lot about and we're very disciplined about is our capital allows us to build all of the cloud services from Office 365 to EMS to Dynamics to Azure. And that diversity of workloads long term is what lead to margin improvement. And there will be changes in seasonality from quarter to quarter, but structurally those two things, the diversity of what we are doing and how capital is utilized across all of it is I think a big structural differentiator for us.

Beautiful. It's great to see that improvement happening. Thank you very much.

Thank you, Mark. We'll go to the next question, please.

Thank you. Our next question comes from the line of Philip Winslow with Credit Suisse. Please proceed. Philip A. Winslow - Credit Suisse Securities (USA) LLC (Broker) Hi. Thanks guys, and congrats on a great quarter. Just a question for Satya then a follow-up to Amy. Satya, you talked about your good adoption of Office 365 on the commercial side both in SMBs and large enterprise. I wonder if you could just break that down and where you're seeing the faster adoption as you start to get into the enterprises, especially that might have enterprise agreements with Microsoft. How is that sales motion going and what is the pitch there? And then to Amy, I thought this was a key point, something that we've been looking for. You noted that the subscriptions recurring business now has offset the cannibalization on the license. Is that something that we should think about going forward or was there something specific about this quarter that would push that out? Thanks.

Yeah first, as far as the Office 365 usage itself, I talked about some of the numbers of 60 million monthly active users, the fact that our seats grew 66% year over year. The small business number I talked about, the 50,000 per month additional customers that we're adding to Office 365. These are all the growth numbers and the usage growth numbers. The mix even, that information protection, I mean that's just another very important point which is amongst the customers who are using Office 365, already 20 million are using some of these premium services like information protection. And of course we're going to further expand that with new SKUs and new categories that are going to become part of Office 365. So I see that stretching on both sides, which is to small business on one end and then these premium SKUs on the other end. And we see nice attach as far as EAs to the cloud as well and that's definitely a big driver of our growth.

And so let me take the second and I'll add something to what Satya said. One of the important things that's distinct about the small business market is that there tends not to be much of a lag in terms of buying and deployment. They want to be able to instantaneously use and get value very quickly and that's something we've actually seen and a real testament to our ability to add so many customers in every quarter. And what you've seen in consumer side, which it was an important point. Once we've built this installed base up to 18 million users on the consumer side, that recurring rate does in fact offset the deferral from new, and so it is an important inflection point for us this quarter. Philip A. Winslow - Credit Suisse Securities (USA) LLC (Broker) Thanks guys and congrats.

Thanks. Next question, please.

Thank you. Our next question comes from the line of Heather Bellini with Goldman Sachs. Please proceed.

Great, thank you. I just had two quick questions. I was wondering, Satya, if you could give us a sense for just a high level commentary about the split of IaaS versus PaaS and Azure and maybe some color on the growth you see in each of those and how you see them evolving. And then the second question would be related to the launch of Windows 10. You gave the Bing example for the month of September and the solid pull forward there, or pull along there. I'm just wondering if you could share with us any other areas where you're seeing a similar kind of pull along with Windows 10 adoption. Thank you.

Sure, Heather. On the first one, on the mix between IaaS and PaaS and SaaS, the thing that we are seeing is, quite frankly, all of these are growing but the most interesting thing for me as a pattern is growth in IaaS leads to growth in other PaaS services or SaaS services. I mean to put it very concretely, take something like Azure Active Directory. That's probably the best manifestation of the virtuous cycle that we see in any of the cloud adoption that we have, right. It could be as someone coming from Office 365. It can be someone coming from Azure, Dynamics, EMS. All of those tenants get into Azure Active Directory which is our largest PaaS service because it's got even developer API, so that means more developers are using it. More IT professionals are using it as the control plane. So that's the network effect that we see when it comes to the PaaS services. And then in terms of infrastructure itself, as again I said, there's people who are tiering, even applications people who build hybrid applications where the storage could be even on premise in some cases, but the mid-tier and the web and the mobile back ends are in the cloud. We see a lot of growth there. We see a lot of growth in our data, both in terms of infrastructure but in the new services like our Data Lake services which are PaaS services. Hadoop is another good example. We see lots of Hadoop usage inside of IaaS but we also see HD inside growth. So I would say there is a real good mix of those two. And then on Windows 10, I mean I'm very, very excited obviously about what's happening with Bing. I think Amy talked about we have a $1 billion quarter with 29% growth and good share position growth in the United States. That's fantastic to see. But gaming is the other place where we talked about Xbox Live now that spans both console and PC. We see increased engagement because of that. We see in fact increased engagement with titles like Minecraft. So we have some high hopes for what we can achieve with engagement around Xbox Live across the console plus PC.

Thank you, Heather. We'll go to the next question, please, operator.

Thank you. Our next question comes from the line of Brent Thill with UBS. Please proceed

Good afternoon. Satya, Michael Dell mentioned with you on stage a week ago that he's seen from his perspective stronger Windows 10 adoption among enterprise customers faster than he had seen in the past. And I'm curious if you're starting to see a halo impact where those that are looking to move up are saying we want to go with more of the complete infrastructure set? And are you seeing different sales motions among those enterprise customers as those customers are coming back to you?

Thanks, Brent. I mean that is absolutely the fact, case, that is we are seeing a much faster adoption cycle, obviously starting with the consumer side but even the 8 million business PCs that are already running Windows 10 before we have started in fact the push on enterprise. We expect the enterprise deployment to start in earnest the beginning of next calendar year or the second half of this fiscal year. But to your point, the fact that there is pull already is a very, very good indicator of, and a good sign, and it's even better than what we saw with Windows 7. And so to me that's all positive news, and but yet we're very, very focused on delivering I think new value to the enterprise customers. Because if you look at Windows 10 we've already talked a lot about all the consumer value. But just take security itself, I think that Windows 10 represents a real breakthrough in terms of security on the endpoint as well as in embedded, which we are really excited about in terms of driving the enterprise upgrade cycle.

Real quick just for Amy on cash flow, is there anything that we should take into account this year versus what happened last year?

I don't think anything unique that I would bring up, no.

Thank you.

Thanks, Brent.

Thanks, Brent. Operator, next question, please.

Thank you. Our next question comes from the line of Raimo Lenschow with Barclays. Please proceed.

Hey. Thanks for taking my question. Beside Azure in the intelligent cloud, you obviously have very, very good momentum on the classic server and tools business. Can you talk a little bit about the volume versus price effect that you see playing out here and how is it now and how do you expect that to play out going forward? And one of the things on Azure was usage, and you mentioned how that kind of improved quite significantly. Satya, can you talk a little bit where you see that current usage standing and where do you think that can go? We obviously didn't get a number, just a growth rate. But where do you see usage? Because that's obviously one of the things that one of your competitors keeps talking, trying knock on you. Thank you.

Yeah, I mean I think the usage number is the one that, Raimo, that we talked about, which is doubling of compute, doubling of storage. We talked about the growth of our EMS, which is a higher level service. We talked about the growth in Active Directory. So we have usage growth in Azure which is very, very healthy.

And on the server question you asked at the beginning, let me say that we did see I think around 9% constant currency growth of the core server product, and a lot of that was premium driven. Now, I have a distinction between a price question that you sort of asked versus seeing the value of a premium SKU. And so I do think it was premium driven as opposed to sort of a price driven in particular.

Perfect. That's helpful thank you.

Thank you, Raimo. Next question please

Thank you. Our next question comes from the line of Karl Keirstead with Deutsche Bank. Please proceed.

Thanks very much. I wouldn't mind going back to Windows 10. Three months ago on the June quarter call, the messaging was that Windows 10 would not likely lift Microsoft's performance results until the second half of fiscal 2016. Yet it feels like as early as this first quarter, it's creating a lift at least to the Windows OEM business. And I just wanted to understand what's changed in the last three months such that it's having an earlier than expected positive impact on Microsoft. Thank you.

Thanks, Karl. Why don't I take that and Satya can add. In particular what we saw this quarter was really as much about the mix of the devices that the OEMs are bringing to market as it was in the absolute unit distinction. And you saw that in the non-Pro revenue performance. And so for us I think really the way to think about the early signs of the impact were the strong device mix, some higher priced units across a wide variety of OEMs as we build into holiday, did provide some slightly better than expected results, as you noted in the non-Pro business. But really some of the other upside that we saw in the quarter was from things that are the second sort of derivative of that, which was our search results were better than we had thought. Because of some of these results about where the PCs were upgraded and the pace at which they were upgraded. And so I do think we are encouraged, as Satya said. But we're a quarter in. And I think what's exciting for us is really the opportunity we have going forward. We're excited about Q2 when the devices hit the shelves. We're excited to have so many first party devices in Q2. And then the next stage after that which is really the enterprise deployment, which as Satya mentioned, we expect in the second half of the year. So it's early, but you're right, we did see some incremental improvement over what we expected.

Thanks, Karl.

Okay. Thank you, Amy.

Thanks.

Next question please.

Thank you. Our next question comes from the line of Walter Pritchard with Citi. Please proceed.

Hi. Thanks. Amy, I'm wondering if you could talk about on the computing side, the personal computing side, you talked about this quarter seeing growth ahead of the PC market. You alluded to a diversity of devices coming in the second half. How do you think about that variable in the model say beyond this sort of launch period where you have a little bit of a differing mix going on in devices and you get to more of a steady state out in kind of years two and three of the Windows 10 launch? Do you think you can grow ahead of the PC market? Or do you think – I know for the last few years you've grown below the PC market. Just wondering how we should think about that.

Thanks, Walter. Let me talk a little bit about what I said in my outlook. This quarter, as I just talked about, the non-Pro outperformance versus the market was really due to a higher revenue per license. I expect that actually to continue in Q2. I expect our overall Pro business to remain in line with business PCs. Once we work through sort of the end of XP bump, that really should be in the line. And as we talked about, as we move through the year, I do expect things to more normalize overall in terms of RPL comparisons. But I do think that's probably the best way to think about the curve over the course of the year.

And then on the commercial licensing part, specifically within productivity, I know you sort of had an old breakout and a new breakout where we don't see commercial licensing necessarily within Productivity. But would you expect that piece, the commercial licensing within Productivity given the transition going on to be stable? Or would that decline as you see the transition over to the cloud in Productivity specifically?

Let me try and if I missed the question or misunderstood it, you can help me again. I think you're asking about our core Office commercial business, the product side versus the service side.

Correct.

And really, okay good. The trend we saw there, as I said, we're 5% up in a constant currency basis. That was 70% cloud minus 8% on prem. That's a trend that's not new for us. We've thought about making this transition as quickly as possible, but what we're seeing, which you heard us talk about, was a transition to increasing premium mix, selling more workloads, doing all of that while we're growing the installed base. So if you think back to how we've talked about the long term, the lifetime value equation, it's those components that I really think about proving out over time, and we had lots of encouraging signs about that. New users, Satya referenced on the small business and mid-market side. Premium mix, we talked about how many premium services we're now selling. And then in terms of renewals, they're quite good, which we talked about. And so I think all of those, when you talk about should we expect the traditional business to be in decline, I don't think that's new. I think what's important is our ability to switch it to the services and add more over time that really I focus on.

Okay. Thank you.

Great. We'll move to the next question, please.

Thank you. Our next question comes from the line of Mark Murphy with JPMorgan. Please proceed.

Yes, thank you very much. Amy, I see the commercial bookings numbers in the KPI sheet, but I do not see the total bookings numbers. I'm wondering if you could just comment on that so that we can try to maintain a consistent analysis there if it's relevant. And also, Satya, now that SQL Server has taken over this number one position in the Gartner Quadrant for the database market, could you help us understand how the roadmap evolves from here? As we did notice Amazon made its debut also in the leader's Quadrant, and I think we're trying to understand how the movement to cloud platforms like Azure could further alter the database landscape and how you could capitalize on that.

Why don't you go first.

Yeah, I'll go first. I think the data architecture that underlies what's happening in the enterprise underneath applications is going through a dramatic change. That said, the relational database itself remains still a very strong component, but not the only component anymore, in both on-premise and off-premise. And what we want to make sure as a company is to cover all of that landscape with a very rich data platform. So if you look at what we're doing, the length and breadth of our ambition as well our delivery today, everything from what SQL itself is doing, we have now all in-memory workloads for OLTP, BI, data warehousing built in. We have the ability to now tier even the database with the cloud. This is all the things that are coming in SQL 2016 and we're excited about that. When it comes to the cloud itself, we have a PaaS service with SQL, which is very unique in terms of SQL Azure. We have now the Data Lake service for basically petabyte, exabyte scale data management. We have higher level data services like Azure ML, which is about advanced analytics, a category we didn't even participate in the past. So we've entered that category, Revolution R fits into that. So we have a very rich story and this is not even talking about some of the other end-user BI capabilities like Power BI. So I think we have a very rich vision and execution on what is an expanding data platform opportunity. And it's nice to see us innovate on the new services while we also in what is still the big market, which is the relational database market, claim a leadership position.

And Mark, on the total bookings number, the reason we moved to commercial bookings is it's a far more comparable number to look at period to period. Total bookings, because the volatility frankly in consumer businesses in times like the holiday periods, it can make it far more volatile than usually what many of you have been asking for, which is the continuity and health of the overall commercial business. If you want to get to total bookings, you just add back in all the consumer revenue, is technically is how you would do it. But I do think the more helpful KPI for us in terms of bookings is the commercial one.

Thank you.

Great. Thanks, Mark. Operator, we'll have time for one final question, please.

Thank you. And our last question comes from the line of Ross MacMillan with RBC Capital Markets. Please proceed.

Thanks so much for squeezing me in and congrats on the quarter. Amy, I just had a couple. The first one, just your comment that the consumer Office business you're seeing, basically the subscription revenue now being larger than the offset, if you will, the license side, where do we stand with regard to that on the commercial side of the Office transition?

The way to think about that how is I look at – well, the way I would generally say it is you look at each of the KPIs we give. So the Office commercial business grew 5%. It was negative 8%. If some transition earning back off the balance sheet, the total cloud is 70%. When we start to get to this point and the percentage we already have in the cloud, it is really an offset. And that's probably frankly been true a little bit longer than we talked about technically in terms of what goes off and what comes on given we've now got, as Satya said, 60 million users and more than that in terms of seats sold. Now that can technically, Ross, be interesting in certain quarters of the year where we have very heavy expirations. And so it just depends year over year, but that's why the commercial is slightly harder to do it on because there's some volatility in the ins and outs based on seasonality.

Just if I think about the incremental subscription revenues from the commercial side versus the license declines, it sounds like this year, this fiscal year, we're making that pivot like we have made on the consumer side. Would that be a fair statement?

I want to make this simple and unfortunately it's just slightly complicated. Because so much of our installed base was already on an annuity contract, it makes the transition mathematically hard. I think what you're asking is specifically for a transactional component when the old transactional component has gone. But it's a very hard – but that's a component of the number, not the total. So it's why it's technically difficult to answer the question you're specifically asking, Ross. But the way I would think about it is we are moving such a substantive piece of our EA business and with our annuity mix all up in commercial, up to 86% percent, we're feeling very good about our ability to transition people at LTV and grow the business overall at a very high level.

Thank you, Ross.

Thank you very much.

Thanks.

So that wraps up the Q&A portion of today's earnings call. We look forward to seeing many of you in the coming months at various investor conferences. For those unable to attend in person, these events will be webcast and you can follow our comments at microsoft.com/investor. Please contact us if you need any additional details and thank you for joining today.

Thanks, everyone.

Thank you, everyone.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.