Q2 2025 Microsoft Corp Earnings Call
Sure.
Yes.
[music].
Okay.
[music].
Yes.
Luke.
[music].
Hum.
Yes.
Okay.
Speaker Change: Greetings and welcome to the Microsoft fiscal year, 2025 second quarter earnings Conference call.
Speaker Change: At this time all participants are in a listen only mode.
Speaker Change: A question and answer session will follow the formal presentation.
Speaker Change: If anyone should require operator assistance. Please press star zero on your telephone keypad.
Speaker Change: As a reminder, this conference is being recorded.
Robertson: It is now my pleasure to introduce your host Robertson Vice President of Investor Relations. Please go ahead.
Robertson: Good afternoon, and thank you for joining us today on the call with me are Satya Nadella, Chairman and Chief Executive Officer, Amy Hood, Chief Financial Officer, Alex <unk>, Chief Accounting Officer, and Keith to all of our corporate Secretary and Deputy General Counsel.
Robertson: On the Microsoft Investor Relations website, you can find our earnings press release and financial summary, slide deck, which is intended to supplement our prepared remarks during today's call.
Robertson: And provides the reconciliation of differences between GAAP and non-GAAP financial measures.
Robertson: A more detailed outlook slides will be available on the Microsoft Investor Relations website, when we provide outlook commentary on today's call.
Robertson: On this call we will discuss certain non-GAAP items. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP there.
Robertson: They are included as additional clarifying items to aid investors in further understanding the company's second quarter performance in.
In addition to the impact these items and events have on the financial results.
Robertson: All growth comparisons we make on the call today relate to the corresponding period of last year unless otherwise noted we will also provide growth rates in constant currency when available as a framework for assessing how our underlying businesses performed excluding the effect of foreign currency rate fluctuations where growth rates are the same in constant currency, we will refer to the <unk>.
Robertson: Growth rate holding.
Robertson: We will post our prepared remarks to our website immediately following the call until the complete transcript is available today's.
Robertson: Today's call is being webcast live and recorded.
Robertson: 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.
Robertson: A replay of the call and view the transcript on the Microsoft Investor Relations website.
Robertson: 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.
Robertson: Actual results could materially differ because of factors discussed in today's earnings press release and the comments made during this conference call and in the risk factors section of our Form 10-K forms 10-Q, and other reports and filings with Securities and Exchange Commission.
Robertson: We do not undertake any duty to update any forward looking statements and with that I'll turn the call over to Satya.
Satya: Brett this quarter, we saw continued strength in Microsoft cloud, which surpassed $40 billion in revenue for the first time up 21% year over year.
Satya: Enterprises are beginning to move from proof of concept to enterprise wide deployments to unlock the full auto why OPI.
Satya: And our AI business has now surpassed an annual revenue run rate of $13 billion up 175% year over year.
Satya: Before I get into the details of the quarter I want to comment on the core thesis behind our approach to how we manage our fleet and how we allocate our capital to compute.
Satya: AI scaling laws continue to compound across both pre training and inference time compute.
Satya: We ourselves have been seeing significant efficiency gains in both training and inference for years now on influence we have typically seen more than two X price performance gain for every hardware generation and more than 10 X for every model generation due to software optimizations.
Satya: And as <unk> becomes more efficient and accessible we will see exponentially more demand.
Satya: Therefore, much as we have done with the commercial cloud we are focused on continuously scaling our fleet globally and maintaining the right balance of cross training and inference as well as Geo distribution from.
Satya: From now on it's a more continuous cycle governed by both revenue growth and capability growth.
Satya: Thanks to the compounding effects of software driven AI scaling laws and Moores law.
Satya: With that I will walk through the progress, we're making across every layer of the tech stack.
Satya: <unk> is the infrastructure layer for AI, we continue to expand our data center capacity in line with both near term and long term demand signals we.
Satya: We have more than doubled our overall data center capacity in the last three years and we've added more capacity last year than any other year in our history.
Satya: Data centers networks racks, and silicon are all coming together as a complete system to drive new efficiencies to power. Both the cloud workloads are today in the next generation AI workloads.
Satya: We continue to take advantage of Moore's law and refresh our fleet as evidenced by our support of the latest from AMD, Intel Nvidia as well as our first party silicon innovation from Maya cobalt boost and HSM.
Satya: When it comes to cloud migrations, we continue to see customers like UBS move workloads to Azure UBS alone migrated mainframe workloads encompassing nearly 400 billion records and two petabytes of data and we remain the cloud of choice for customers mission critical.
Satya: Oracle SAP and Vmware apps.
Satya: At the data layer, we are seeing Microsoft fabric breakout we now have over 19000 paid customers from Hitachi to Johnson controls two schaeffler fabric is now the fastest growing analytics product in our history. <unk> is also deeply integrated with fabric with over 30 million.
Satya: Monthly active users up 40% since last year.
Satya: Beyond fabric, we are seeing new AI driven data patterns emerge if you look underneath Chad GPT, a copilot or enterprise AI apps, you see the growth of raw storage database services and App platform services as these workload scale.
Satya: The number of Azure open AI apps running on Azure databases, and Azure App services more than doubled year over year driving significant growth in adoption across sequel, Hyperscale and Cosmos DB now onto <unk> platform and tools as we shared last week. We are thrilled open AI has made a new large azure commitment.
Satya: Through our strategic partnership we continue to benefit mutually from each other's growth and with open Apis exclusively running on Azure customers can count on us to get access to the world's leading models and open AI has a lot more coming soon so stay tuned.
Satya: Azure AI foundry features best in class tooling run times to build agents multi agent apps.
Satya: Ops API access to thousands of models two months in we already have more than 200000 monthly active users.
And we are well positioned with our support of both opening allies, leading models and the best selection of open source models and that's the lens.
Satya: Deep seeks all one launch today via the Modelled catalog on foundry and get help with automated red teaming condensate integration and security scanning.
Satya: Our five family of SLM has now been downloaded over 20 million times and we also have more than 30 models from partners like Bayer Pgi, Rockwell automation and Siemens to address industry specific use cases.
Satya: With how we build deploy and maintain code is fundamentally changing.
Satya: And get up copilot as increasingly the tool of choice for both digital native like Asos, and Spotify as well as worlds largest enterprises like HB HSBC and KPMG.
Satya: We have been delighted by the early response to get up Copilot <unk> code with more than 1 million sign ups in just the first week post launch all up get up now is home to 150 million developers up 50% over the past two years.
Satya: Now on to the future of work.
Satya: The Croissant 365 co pilot is the UI for AI. It help supercharge employee productivity and provides access to a swarm of intelligence agents to streamline employee workflow.
Satya: We're seeing accelerated customer adoption across all deal sizes as we win new Microsoft 306, why copilot customers and see the majority of existing enterprise customers come back to purchase more seats. When you look at customers, who purchased copilot during the first quarter of availability. They have expanded their seat collectively by more than 10 X over the past 18 months.
Satya: <unk>.
Satya: To share just one example, novartis has added thousands of seats each quarter over the past year and now have 40000 seats.
Satya: Barclays Carrier group Pearson and University of Miami, All purchased 10000 or more seats this quarter and overall the number of people who use copilot daily again more than doubled quarter over quarter employees are also engaging with copilot more than ever usage intensity increased more than 60% quarter over quarter.
Satya: And we are expanding our Tam with copilot chat, which was announced earlier this month copilot chat along with Copilot studio is now available to every employee to start using agents right in the flow of work.
Satya: With copilot studio, we're making it simple to build an agent as it is to create an excel spreadsheet more than a 160000 organizations have already used copilot studio and they collectively created more than 400000 custom agents in the last three months alone up over two <unk> quarter over quarter.
Satya: We've also introduced our own first party agents to facilitate meetings manage projects result, culminate jarden inquiries and axis Sharepoint data and we also continue to see partners like Adobe SDP service now and look the ability of third party agents and integrate with co pilot what is driving copilot has.
Satya: The UI for AI as well as our momentum with agents is Alba rich data cloud, which is the world's largest source of organizational knowledge billions of emails documents and chats hundreds of millions of teams meetings in millions of Sharepoint sites are added each day. This is the enterprise.
Satya: Knowledge cloud it is growing fast up over 25% year over year.
Satya: More broadly what we are seeing is copilot plus agents disrupting business applications and we are leaning into this with dynamics 365, we took share as organizations like Ecolab, Lenovo RPX total energies and violent switched to our AI powered apps from legacy <unk>.
Satya: <unk>.
Satya: In healthcare <unk> copilot surpassed 2 million monthly physician patient encounters up 54% quarter over quarter. It is being used by top providers like mass General Brigham, Michigan Medicine, Vanderbilt University Medical center to increase productivity of their physicians.
Satya: When it comes to Windows, we are seeing momentum build as we approach end of support for Windows that customers are choosing the latest windows 11 devices for their enhance security and advanced AI capabilities.
Satya: 15% of premium priced laptops in the U S. This holiday will copilot plus species and we expect the majority of the PC sold in the next several years to be copilot plus species.
Satya: Also see more and more developers from Adobe and <unk> got to Whatsapp build apps that leverage built in NPA use.
Satya: And they will soon be able to run deep seeks our one digital models locally on copilot plus species as well as the vast ecosystem of Gpus available on windows and beyond Copilot, plus Pcs. The most powerful AI workstation for local development is a windows PC running WSI to powered by Nvidia Rdx Gpus.
Satya: Now on to security, we continue to make progress with our scale future initiative and we are applying what we have learned introducing over 80, new product capabilities over the past year.
Satya: With security copilot organizations across private and public sector like city of Johannesburg, Eastman Intesa National Australia Bank NTT can resolve incidents, 30% Foster data governance is increasingly critical and customers now use Microsoft purview to.
Satya: Audit over 2 billion copilot interactions for safe and compliant use.
Satya: Now onto our consumer businesses, starting with Linkedin.
Satya: More professionals than ever are engaging and high value conversations on Linkedin with comments up 37% year over year <unk> short form video continues to grow on the platform with video creation all up growing at twice the rate of other post format. We're also innovating with agents to help recruiters and small.
Satya: <unk> find qualified candidates foster and our hiring business again took share in subscriptions Linkedin premiums some past $2 billion in annual revenue for the first time this quarter subscriber growth has increased nearly 50% over the past two years and nearly 40% of subscribers have used our AI features to improve.
Satya: Their profiles and Linkedin marketing solution remains the leader in <unk> advertising.
Satya: Now I want to search advertising and news, we once again took share across being an edge edge. So fast 30% market share in the U S on windows and has taken share for 15 consecutive quarters.
Satya: The investments we have made in improving our AD rates are paying off and advertisers increasingly see our network is an essential platform to optimize rois and our copilot consumer App is seeing increased engagement and retention with its improved speed unique personality first of its kind features like copilot vision just.
Satya: Today, we made think depot powered by all one free for all copilot users globally now.
Satya: And I want to gaming, we are focused on improving the profitability of the business in order to position. It for long term growth driven by higher margin content and platform services and we are delivering on this plan Blackhawk six was top selling game on Xbox and Playstation this quarter and saw more players in its launch.
Satya: Quarter than any other paid released in the franchise history, and we saw Ray reviews of Indiana Jones, and the Great Circle, which has already been played by more than 4 million people.
Satya: Also continue to see strong momentum for X box cloud gaming with a record 140 million hours streamed this quarter all up game pass set a new quarterly records for revenue and grew its BC subscriber base by over 30% as we focus on driving fully paid subscribers.
Satya: Across endpoints in closing, we continue to innovate across Opex stack to help our customers in this era and I'm energized by the many opportunities ahead with that let me turn it over to Amy.
Speaker Change: You Satya and good afternoon, everyone.
Speaker Change: This quarter revenue was $69 6 billion up 12% gross margin dollars increased 13% and 12% in constant currency, while operating income increased 17% and 16% in constant currency earnings per share was $3 23.
Speaker Change: The increase of 10%.
Speaker Change: We delivered another quarter of double digit top and bottom line growth results were driven by strong demand for our cloud and AI offerings.
Speaker Change: Also improved our operating leverage with higher than expected operating income growth.
Speaker Change: As you heard from Scott, yet, our AI business annual revenue run rate surpassed $13 billion and was above expectations.
Speaker Change: Commercial bookings increased 67% and 75% in constant currency and we're significantly ahead of expectations driven by Azure commitments from opening I.
Speaker Change: Execution was strong across our core annuity sales motion with growth in the number of $100 million plus contracts for both Azure and Microsoft 365.
Commercial remaining performance obligation increased to $298 billion up 34% and 36% in constant currency roughly 40% will be recognized in revenue in the next 12 months up 21% year over year and remaining portion recognized beyond the next 12 months increased 45%.
Speaker Change: And this quarter, our annuity mix was 97%.
Speaker Change: <unk> did not have a significant impact on our results and was roughly in line with expectations on total company revenue more personal computing revenue total company Cogs and operating expense.
Speaker Change: <unk> decreased revenue more than expected in our commercial segments.
Speaker Change: Microsoft Cloud revenue was $40 9 billion and grew 21% Microsoft cloud gross margin percentage was 70% in line with expectations and decreased two points year over year, driven by scaling our AI infrastructure.
Speaker Change: Company gross margin percentage increased slightly year over year to 69%, primarily driven by sales mix shift to higher margin businesses as well as improvement in gaming and search partially offset by the impact of scaling our AI infrastructure.
Speaker Change: Operating expenses increased 5% lower than expected and operating margins increased two points year over year to 45%.
Speaker Change: Better than expected margin expansion was driven by delivering efficiencies across our businesses as we invest to scale AI infrastructure and build applications.
Speaker Change: At a total company level head count at the end of December was 2% higher than a year ago and was relatively unchanged from last quarter.
Speaker Change: Now to our segment results revenue from productivity and business processes was $29 4 billion and grew 14% and 13% in constant currency, even with the unfavorable FX impact noted earlier.
Speaker Change: Results were ahead of expectations driven by Microsoft pre 65 commercial.
Speaker Change: Microsoft for 65, commercial cloud revenue increased 16% and 15% in constant currency slightly ahead of expectations due to better than expected performance in <unk>, five and Microsoft for 65 co pilot.
Speaker Change: <unk> hundred 65 co pilot, we continue to see growth in adoption expansion and usage.
Speaker Change: <unk> growth was again driven by <unk>, five and <unk> hundred 65, copilot paid <unk> hundred 65 commercial seats grew 7% year over year with installed base expansion across our customer segments, primarily in our small and medium business and frontline work our offerings.
Speaker Change: <unk> hundred 65 commercial products revenue increased 13% significantly ahead of expectations driven by higher than expected transactional purchasing with the launch of office 2024, as well as the windows commercial on premises components.
Speaker Change: Better than expected performance of <unk> hundred 65 suites noted earlier.
Speaker Change: And for 65 consumer cloud revenue increased 8%.
Speaker Change: Slightly ahead of expectations. We saw continued momentum in <unk> hundred 65, consumer subscriptions, which grew 10% to $86 3 million with mix shift to <unk> hundred 65 basic.
Speaker Change: Linkedin revenue increased 9% with continued growth across all lines of business and.
Speaker Change: And our talent solutions business results were slightly below expectations driven by continued weakness in the hiring market in key vertical.
Speaker Change: Inventory of 65 revenue increased 19% and 18% in constant currency slightly ahead of expectations with growth across all workloads.
Speaker Change: Segment gross margin dollars increased 13% and 12% in constant currency and gross margin percentage decreased slightly year over year, driven by scaling our AI infrastructure.
Speaker Change: Operating expenses increased 6% and operating income increased 16% and 15% in constant currency.
Speaker Change: Next the intelligent cloud segment.
Speaker Change: Revenue was $25 5 billion and grew 19% with more unfavorable FX impact than expected.
Speaker Change: Excluding the unfavorable FX impact results in Azure non AI services on Prem server and enterprise and partner services were slightly lower than expected, partially offset by better than expected results in Azure AI surfaces.
Speaker Change: Azure and other cloud services revenue grew 31% Azure growth included 13 points from AI services, which grew 157% year over year and was ahead of expectations, even as demand continued to be higher than our available capacity growth.
Speaker Change: Growth in our non AI services was slightly lower than expected due to go to market execution challenges, particularly with our customers that we primarily reached through our scale motion as we balance driving near term non AI consumption with AI growth.
Speaker Change: And our on premises server business revenue decreased 3% slightly below expectations driven by slower than expected purchasing around windows server 2025 launch.
Speaker Change: Enterprise and partner services revenue decreased 1% below expectations with lower than expected performance across enterprise support services and industry solutions.
Speaker Change: Segment gross margin dollars increased 12% and 13% in constant currency and gross margin percentage decreased four points year over year, driven by scaling our AI infrastructure operating expenses increased 10% and operating income grew 14%.
Speaker Change: Now to more personal computing.
Speaker Change: Revenue was $14 7 billion relatively unchanged year over year with better than expected results driven primarily by Windows OEM prebuilt usage from a third party partnerships and search as well as call of duty launch performance in gaming.
Speaker Change: And does the OEM and devices revenue increased 4% year over year ahead of expectations driven by commercial inventory build in advance of Windows, 10, and support as well as uncertainty around tariffs.
Speaker Change: Search and as advertising revenue ex Tac increased 21% and 20% in constant currency ahead of expectations driven by usage from a third party partnership growth continues to be driven by rate expansion and healthy volume growth in both edge and Bang.
Speaker Change: And in gaming revenue decreased 7% and 8% in constant currency as content and services growth continued to be offset by hardware declines.
Speaker Change: Xbox content and services revenue increased 2% ahead of expectations, driven by stronger than expected performance and blizzard and Activision content, including call of duty.
Gross margin dollars increased 13% and 12% in constant currency gross margin percentage increased six points year over year, driven by sales mix shift to higher margin businesses as well as strong execution on margin improvement and gaming and search operating expenses decreased 1% operating income increased 32% and 30% in <unk>.
Speaker Change: Aston currency driven by continued prioritization of higher margin opportunities.
Speaker Change: Now back to total company results.
Speaker Change: Capital expenditures, including finance leases were $22 6 billion.
Speaker Change: In line with expectations and cash paid for PP&E was $15 8 billion more than half of our cloud and AI related spend was on long lived assets that will support monetization over the next 15 years and beyond the remaining out and <unk> spend was primarily for surface, both Cpus and Gpus.
Speaker Change: To serve customers based on demand signals, including our customer contracted backlog.
Speaker Change: Cash flow from operations was $22 $3 billion up 18% driven by strong cloud billings and collections, partially offset by higher supplier employee and tax payments.
Free cash flow was $6 5 billion down 29% year over year, reflecting the capital expenditures needed earlier.
Speaker Change: This quarter other income expense was negative $2 $3 billion lower than our October guidance due to the impairment charge from our crews investment RFS.
Speaker Change: Our effective tax rate came in slightly lower than anticipated at 18%.
Speaker Change: And finally, we returned $9 $7 billion to shareholders through dividends and share repurchases now moving to our Q3 outlook, which unless specifically noted otherwise is on a us dollar basis.
Speaker Change: FX with the strengthening of the U S. Dollar since October we now expect FX to decrease total revenue growth by two points within the segments. We expect FX to decrease revenue growth by two points in productivity and business processes, and intelligent cloud and roughly one point in more personal computing.
Speaker Change: When compared to our October guidance assumptions on Q3 FX impact. This is a decrease to total revenue of roughly $1 billion.
Speaker Change: We expect FX to decrease Cogs growth by approximately two points and operating expense growth by approximately one point.
Speaker Change: Our outlook has many of the trends we saw in Q2 continue through Q3 demand for our differentiated cloud and AI offerings across the Microsoft cloud to drive another quarter of strong growth in commercial bookings with a relatively flat expiry base and a strong prior year comparable in terms of large azure contracts, we expect growth to.
Speaker Change: Roughly flat year over year, we expect consistent execution across our core annuity sales motions and continued long term commitments to our platform.
Speaker Change: As a reminder, larger long term azure contracts, which are more unpredictable and their timing can drive increased quarterly volatility in our bookings growth rate.
Speaker Change: Microsoft Cloud gross margin percentage to be roughly 69% down year over year, driven by the impact of scaling our AI infrastructure.
Speaker Change: <unk> segment guidance in productivity and business processes, we expect revenue to grow between 11 and 12% in constant currency or 29, four to $29 7 billion in U S dollars.
Speaker Change: Microsoft for 65 commercial cloud revenue growth should be between 14, and 15% in constant currency relatively stable compared to our better than expected Q2 results.
Speaker Change: We expect continued ARPA growth three five and <unk> hundred 65, co pilot and we again expect some seat growth moderation given the size of the installed base.
Speaker Change: For <unk> hundred 65 commercial products, we expect revenue to be relatively unchanged year over year as a reminder, and for 65 commercial products include windows commercial on premises components of Emperor 65 suites.
Speaker Change: Our quarterly revenue growth can have variability primarily from in period revenue recognition, depending on the mix of contracts.
Speaker Change: And for 65 consumer cloud revenue growth should be in the mid to high single digits, driven by <unk> hundred 65 subscriptions.
Speaker Change: So Linkedin, we expect revenue growth in the low to mid single digits, Although we expect growth across all businesses. The Q2 trends and talent solutions should continue in Q3 as a headwind to growth and.
Speaker Change: And in dynamics 365, we expect revenue growth to be in the mid teens driven by continued growth across all workloads.
For intelligent cloud, we expect revenue to grow between 19% and 20% in constant currency or $25 nine to $26 2 billion U S. Dollars revenue will continue to be driven by Asia, which as a reminder, GAAP quarterly variability primarily from NPA revenue recognition, depending on the mix of contracts and.
Speaker Change: In Azure, we expect Q3 revenue growth to be between 31% and 32% in constant currency driven by strong demand for our portfolio of services as we shared in October the contribution from our AI services will grow from increased AI capacity coming online and non AI services healthy growth continues although we expect ongoing.
Speaker Change: Impact through <unk> as we work to address the execution challenges noted earlier.
Speaker Change: And while we expect to be AI capacity constrained in Q3 by the end of FY 'twenty five we should be roughly in line with near term demand given our significant capital investments.
Speaker Change: Our on premises server business, we expect revenue to decline in the mid single digits driven by a decrease in transactional purchasing.
Speaker Change: In the enterprise and partner services, we expect revenue growth to be in the low to mid single digits.
Speaker Change: In more personal computing.
Speaker Change: Revenue to be $12 four to $12 8 billion U S dollars with continued prioritization of higher margin opportunities.
Speaker Change: Windows OEM and devices revenue should decline in the low to mid single digits. We expect revenue from windows OEM to be relatively flat year over year as our outlook assumes inventory levels will normalize.
Speaker Change: Actual results may differ based on current tariff uncertainties.
Speaker Change: Devices revenue will decline.
Speaker Change: Search and news advertising ex Tac revenue growth should be in the mid teens from continued growth in both volume and revenue per search with share gains across edge and thing.
Speaker Change: Growth is expected to moderate from last quarter, primarily due to additional FX impact and as the third party partnership usage noted earlier returns to more normal levels.
Speaker Change: Search ex Tac growth will be higher than overall search and news advertising revenue growth, which we expect to be in the mid to high single digits and in gaming, we expect revenue growth to be in the low single digits, we expect Xbox content and services revenue growth to be in the low to mid single digits, driven by first party content as well as Xbox game pass hardware.
Speaker Change: Revenue will decline year over year now back the company guidance.
Speaker Change: We expect Cogs to grow between 19% and 20% in constant currency or to be between $21 six 5% to $21 $85 billion in operating expense to grow between five and 6% in constant currency or to be between $16, four and $16 5 billion U S dollars.
Speaker Change: Other income and expense is expected to be roughly negative $1 billion, primarily driven by investments accounted for under the equity method. As a reminder, we do not recognize mark to market gains or losses on equity method investments and lastly, we expect our Q3 effective tax rate to be approximately 18%.
Speaker Change: Now some additional thoughts on the rest of the fiscal year and beyond first FX.
With the strengthening of the U S. Dollar since October we now expect FX to decrease Q4 revenue and Cogs growth by more than one point and operating expense growth by roughly one point.
Speaker Change: Next capital expenditures.
Speaker Change: We expect quarterly spend in Q3 and Q4 to remain at similar levels as our Q2 spend.
Speaker Change: In FY 'twenty six we expect to continue investing against strong demand signals, including customer contracted backlog, we need to deliver against across the entirety of our Microsoft cloud. However.
Speaker Change: However, the growth rate will be lower than FY 'twenty five and then extend we will begin to shift back to short lived assets, which are more correlated to revenue growth. As a reminder, our long lived infrastructure investments are fungible, enabling us to remain agile as we meet customer demand globally across our Microsoft cloud <unk>.
Speaker Change: <unk> AI workloads as always there can be quarterly spend variability from cloud infrastructure build outs and the timing of delivery of finance leases.
Speaker Change: For the full fiscal year, we continue to expect double digit revenue and operating income growth as we focus on delivering efficiencies across both Cogs and operating expense.
Speaker Change: And <unk>.
Given the operating leverage that we've delivered throughout the year.
Speaker Change: Inclusive of efficiency gains as we scale, our AI infrastructure and utilize our own AI solutions. We now expect FY 'twenty five operating margins to be up slightly year over year.
Speaker Change: And finally, our FY 'twenty five full year effective tax rate should be between 18 and 19% in <unk>.
Speaker Change: Closing, we are committed to delivering real world AI solutions that help customers grow and improve their results. We are confident in our leadership position as we grow with our customers.
Speaker Change: Before turning to Q&A I have one special thank you, Brian Iverson as moving to a new role here as the head of our Americas sales finance team on behalf of the company. Thank you for your tremendous impact leading investor relations for the past four years and for the partnership with both Satya and me.
Speaker Change: And I'd like to welcome Jonathan Nielsen the former head of finance for our security products, who is returning to Investor relations to lead the team with that let's go to Q&A Brett.
Speaker Change: Thanks, Amy we'll now move over to Q&A.
Speaker Change: Spectrum, others on the call we request that participants. Please only ask one question operator can you. Please repeat your instructions.
Speaker Change: Thank you.
Speaker Change: Ladies and gentlemen, if you would like to ask a question. Please press star one on your telephone keypad and a confirmation tone will indicate your lungs in the question queue.
Speaker Change: You May press Star two if you would like to remove your question from the queue for.
Speaker Change: For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.
Speaker Change: And our first question comes from the line of Keith Weiss with Morgan Stanley. Please proceed.
Keith Weiss: Excellent. Thank you guys for taking the question and ethylene Amy's comments Bret.
Speaker Change: Congratulations on the new role has been a pleasure working with you and best of luck in that new role.
Keith Weiss: Looking at the quarter.
Speaker Change: Really solid quarter when it comes to commercial bookings, but again, we were a little bit disappointed on azure coming in at the bottom end of the guidance range.
Speaker Change: I was hoping you could dig into perhaps what some of those execution issues were what the resolution to those issues were.
Speaker Change: And do we still feel comfortable and the acceleration into the back half of the year that you were talking about after the June quarter and after last quarter. Thank you very much.
Speaker Change: Thanks, Keith let me spend a little time on that but what we saw in Q2 and give you. Some additional background on near term execution issues that we're talking about.
Speaker Change: Let me be very specific they are in the non AI ACR component, our AI Azure AI results were better than we thought due to very good work by the operating teams pulling an awesome delivery date, even by weeks.
Speaker Change: When you're capacity constrained weeks matter and it was good execution by the team and you see that in our revenue results on a non AI side really the challenges were and what we call. The scale motions. So think about primarily these are customers, we reach through partners and <unk>.
Speaker Change: Through.
More indirect methods of selling and really the art form there is as these customers.
Speaker Change: We reached this way or trying to balance how do you do in AI workload with continuing some of the work they've done on migrations and other fundamentals. We then took our sales motions in the summer and really change to try to balance those two.
Speaker Change: As you do that you learn with your customers and with your partners on sort of getting that balance right.
Speaker Change: Between where to put our investments where to put the marketing dollars and importantly, where to put people in terms of coverage and being able to help customers make those transitions.
Speaker Change: And I think we are going to make some adjustments to make sure. We are imbalanced because when you make those changes in the summer by the time. It works its way through the system you can see the impact and whether you have that balance right and so the teams are working through that they're already making adjustments and I expect we will see some impact from H two just because when you work through the scale.
Speaker Change: Motion it can take some time for that to adjust I feel good that the teams understand and are working through that so hopefully that's helpful. One on that.
Speaker Change: We've talked a little bit about Q3.
Speaker Change: And so we've talked about 31% to 32 after publishing a 31 this quarter.
Speaker Change: Our results that we had felt good about and talked about our ability to land that revenue is the same.
Speaker Change: So again in Q3, we are working from a pretty constrained capacity plays.
Speaker Change: And that's no different than it was our expectation to be in that position last October when I talk to you all.
Speaker Change: And when I talk about being at a capacity constraint. It takes two things you have to have.
Speaker Change: Space, which I generally call long lived assets right, that's the infrastructure and the land and then you have to have kits.
Speaker Change: We're continuing and you've seen that's why our spend has pivoted this way to be in the long lived investment we have been short power and space and so as you see those investments land that we've made over the past three years, we get closer to that balanced by the end of this year and so the.
Speaker Change: Confidence on the AI side continues to be there in terms of being able to sell utilize.
Speaker Change: And I think encouraged by the signals.
Speaker Change: What we're seeing is waiting to see just how are the non AI ACR works through the scale motions in <unk>, but in general the only thing Thats changed is really that scale motion.
Keith Weiss: Keith I hope that's helpful.
Speaker Change: Jamie just one thing I'd add to your question as Amy said.
Speaker Change: Growth rate is actually better than what we expected.
Speaker Change: We worked through some of the supply stuff and more importantly, some of the workloads are scaling well.
Speaker Change: And when you look underneath any of these AI workloads. The other thing that as good as the ratio of even what we would call just regular storage data services App services, so underneath that Chad GPT Europe co pilot or even.
Speaker Change: Emerging AI workloads in the enterprise. So that's all good to the enterprise workloads, whether it's SCB or whether it's Vmware migrations what have you. That's also.
Speaker Change: Good shape and it's just the scale plays where Amy talked to about this nuance right. How do you really tweaked the incentives go to market at a time of platform shifts you kind of want to make sure you lean into even the new design wins and you're just going to keep doing the stuff that you did in the previous generation Thats VR fall, maybe you as F&B.
Speaker Change: Make sure you get the right balance, but let me put it this way you would rather when the new then just protect the past and that sort of one out of the thing that we definitely will lean into always.
Speaker Change: Thanks, Keith Operator next question please.
Mark: Our next question comes from the line of Mark <unk> with Bernstein Research. Please proceed.
Mark: Thank you very much for taking my question.
Mark: Could you give more color on what drove the far larger than expected Microsoft AI revenue, we talked a bit about the azure AI component of it but can you give more color on that in our estimates are the co pilot was much bigger than we had expected and growing much faster any more details on the breakdown of what that.
Speaker Change: That Mike.
Mark: Mike.
Mark: It would be great. Thanks.
Mark: Thanks.
Thanks, Marc for the question, Yes that was as we talked about better than expected a couple of pieces to that which you've correctly identified number one is the azure component, we just talked about and the second piece Youre right Microsoft Co pilot was better.
Mark: And what was important about that it was we saw strength both in.
Hock: Both new and expansion states as Hock, you talked about and usage was it doesn't directly impact revenue, but of course indirectly does is.
Mark: As people get more and more value added and also.
Mark: Price per seat was actually quite good and we should have a good a good signal for value. So.
Mark: Those are the biggest pieces Marc.
Mark: Of that sort of outperformance in terms of our expectations.
Speaker Change: Thank you Mark.
Mark: Operator next question please.
Mark: The next question comes from the line of Brent Thill with Jefferies. Please proceed.
Brent Thill: Thanks, Satya you mentioned deep seek a couple of times in your prepared remarks, I think everyone.
Mark: Would love your thoughts on what Youre seeing there.
Speaker Change: Are we seeing AI scale now at lower costs are we reaching a mark where you can you can see that or do we still have some time to go. Thanks for your thoughts on this.
Brent Thill: Yes, Thanks Brent.
Mark: In my remarks, I talked about.
Brent Thill: Uh huh.
Brent Thill: In some sense, what's happening with AI is no different than what was happening with the regular compute cycle. It's always about bending the curve and then putting more points up the curve.
Brent Thill: So there's Moore's law, that's working in Hyperdrive, then on top of that there is the AI scaling laws.
Brent Thill: The free training and inference time compute that compound and Thats all phosphate you should think of.
Brent Thill: I said in my remarks, which we've observed for a while which is 10 X on improvements power cycle, just because of all the software optimizations on inference and so thats, what you see and that I think deep sea.
Brent Thill: <unk> had some real innovations.
Speaker Change: And some of the things that you've been opening.
Speaker Change: Found an old one and so we're going to obviously now thats all it gets commoditized and it's going to get broadly used in the big beneficiaries of any software.
Speaker Change: Cycle like that is the customer strike because at the end of the day.
Speaker Change: If you think about it.
Speaker Change: The big lesson learned from client server to cloud more people bought silvers accepted was called club.
Speaker Change: So when token prices fall infants computing prices fall that means people can consume more.
Speaker Change: And there'll be more apps written and.
Speaker Change: And it's interesting to see that I referenced. These are models that are pretty often is unimaginable to think that here. We are in sort of beginning of 'twenty five where on the PC you can run a model that requires pretty massive cloud infrastructure, so that type of optimizations meetings.
Speaker Change: It will be much more ubiquitous and so therefore for hyperscale logos.
Speaker Change: RPC flat.
Speaker Change: Platform provider like US. This is all good news as far as I'm concerned.
Speaker Change: Thank you.
Speaker Change: Thanks, Brad Operator next question please.
Speaker Change: The next question comes from the line of Karl Keirstead with UBS. Please proceed.
Speaker Change: Thank you maybe this one as well for <unk> and its also away from the numbers, but it's not.
Speaker Change: So I wanted to ask you about the historic eight news and the announced changes in the opening I relationship last week. It seems that most of your investors have interpreted this as Microsoft for sure remaining very committed to opening eyes success, but.
Speaker Change: Electing to take more of a back seat in terms of funding open AI as future training Capex needs I was hoping you might frame your strategic decision here around Stargate and Amy whether theres any takeaway for investors from that decision in terms of how youre thinking about capex needs over the next several years. Thank you.
Speaker Change: Yes.
Speaker Change: Thanks for the question Joe.
Speaker Change: We remain.
Speaker Change: Very happy with the partnership with open AI and as you saw they are committed in a big way to Azure.
Speaker Change: And even in the bookings what we recognized is just the first tranche of it and so youll see with given the role for rehab more benefits of that even into the future.
Speaker Change: And obviously that success is our success because we've been all of the other commercial arrangements that we detailed out in the blog.
Speaker Change: We've put out even commensurate with that announcement.
Speaker Change: But to your overall point the thing that I would say is we are building a pretty fungible fleet right, we're making sure the right balance between training and inference, it's geo distributed.
Speaker Change: Working Super hard on all of the software optimizations right I mean, just not the software optimizations that come because they're what deep seek is done but all the work we've done to for example, reduce the prices of GPT models.
Speaker Change: Over the years in partnership with <unk> in fact, we did a lot of the work on the influence optimizations on it and that's been key to driving rates one of the key things to note in AI as you just don't launch the frontier model, but if it's too expensive to serve its no. Good right. It does it won't generate any demand so you've got to have that optimization so that interim.
Speaker Change: And costs are coming down and they can be consumed broadly and so that's the fleet physics, we are managing and also remember you don't want to buy too much of anything at one time because of the Moore's law every year is going to give you to ask your optimization is going to give you a <unk> you want to continuously upgrade the fleet modernize the fleet aged fleet.
Speaker Change: And at the end of the day have the right ratio of monetization.
Speaker Change: And demand driven.
Speaker Change: Monetization to Pimco pass the training expense, so I feel very good about the investments we are making.
Speaker Change: And it's fungible and.
Speaker Change: <unk> allows us to scale more long term business.
Speaker Change: And maybe Carl just to reiterate a little of the comment that I made on Capex, because I think it's helpful to ground a bit more than what kaki was saying a fungible fleet means.
Speaker Change: We have and I think we talked about it.
Speaker Change: Close to $300 billion of RPM.
Speaker Change: That is committed customer contracts that need to be deliver on and the faster we can do that and the more efficiently we can do that.
The better off we are not just the open eye opening I partnership, which is a piece of that but with the entire platform that we need to deliver.
Speaker Change: For our customers and I think the other thing that sometimes missing is when we say fungible, we mean not just.
Speaker Change: The primary use which we've always talked about which is inference, but there is some training post training.
Speaker Change: Which is a key component and then there's just running the commercial cloud, which at every layer under at every modern Aif thats going to be built will be required.
Speaker Change: It will be required to be distributed and it will be required to be global.
Speaker Change: And all of those things are really important because that means you are the most efficient.
Speaker Change: And so the investment you see us making capex.
Speaker Change: Youre right.
Speaker Change: The front end has been this sort of infrastructure build that lets us really catch up not just on the AI infrastructure, we need it.
Speaker Change: About that as the building itself Datacenters.
Speaker Change: But also some of the catch up we needed to do on the commercial cloud side, and then you'll see that.
Speaker Change: Pivoted to more CPU and GPU.
Speaker Change: And that were more directly correlate to revenue and it will be contracted either with the partnership that you asked about the opening or with others.
Speaker Change: So I do think that.
Speaker Change: I want everyone to internalize it is that the capex growth is going through that cycle pivot, which is far more correlated to customer contract delivery no matter, who the end customers.
Speaker Change: Thank you.
Speaker Change: Operator next question please.
Speaker Change: And our next question comes from the line of Brad Zelnick with Deutsche Bank. Please proceed.
Brad Zelnick: Thank you very much for taking my question and I'll Echo my congrats and gratitude to Brent as well.
Speaker Change: Saatchi as we think about Microsoft's very rich copilot portfolio now having been in market for over a year with the products and precision only getting better and the cost of insurance coming down how do you think about the journey from here and perhaps the ability to package and evolve the go to market to address the broadest range of customers and customer requirements out there.
Brad Zelnick: Thanks.
Brad Zelnick: Thanks.
Brad Zelnick: Brad for the question in fact, you saw us.
Brad Zelnick: Make two announcements recently one is on the M 365, copilot side, we now have an copilot chat.
Brad Zelnick: So this is now going to be broadly deployed across the entire installed base effectively because you can.
Brad Zelnick: Can go have this now.
Brad Zelnick: Turned on by our it and everybody can start using web grounded chat with all of the enterprise controls right away and it has copilot studio build can and so that means they can start building agents. So we think of that plus the full co pilot is a good combination.
Brad Zelnick: That I think will accelerate quite frankly in terms of just feed usage and agent.
Brad Zelnick: Building and what have you so thats sort of one and the other thing is you also see even on the consumer side, we just yesterday launched a one.
Brad Zelnick: The thing caught up.
Brad Zelnick: <unk>.
Brad Zelnick: Feature on co pilot now that's powered by all one it's available globally right. So you can see the benefits of insurance optimization and the cost coming down means you can drive more ubiquity of what will features.
Brad Zelnick: Once we're sort of premium tier and that's all.
Brad Zelnick: Definitely something that we will do across same thing is happening and get up copilot same thing in security copilot to across the length and breadth of our portfolio you will see that.
Brad Zelnick: Thank you.
Speaker Change: Thanks, Brad Operator next question please.
Speaker Change: The next question comes from the line of Brad Reback with Stifel. Please proceed.
Speaker Change: That's great. Thank you very much such as you look out several years any sense of what percent of inference dot on Azure will be done on proprietary models.
Speaker Change: Versus open models and with that said does it matter to Microsoft at the end of the day. Thanks.
Speaker Change: Yes, good question because at some level.
Speaker Change: What you're seeing is.
Speaker Change: Effectively lots of them.
Speaker Change: Models that get used in any application right. When you look underneath even a co pilot or get up co pilot or what have you you already see so many different models.
Speaker Change: You build models you fine tune models, you distill models some of them are.
Speaker Change: The models that Youre distill into an open source model.
Speaker Change: Going to be a combination so we've always maintained that it's always good to have frontier models.
Speaker Change: To always build your application with high ambition using the best.
Speaker Change: A model that is available and then optimize from there all so thats also in all of the seismic theres attempt to allocate to address what you started with a given cogs profile it doesn't need to be the end because you continuously optimized for latency in Cogs and putting in different models and in fact that all of that complexity by the way has to be Matt.
Speaker Change: <unk> by a new App. So one of the things that we are investing heavily on as foundry because from an app developer perspective, you kind of want to keep pace with the Florida <unk> models that are coming in and you want to have an evergreen way for your application to benefit from all of that innovation, but not how will the debt cost.
Speaker Change: The Dev ops cost or what people talk about AI ops cost. So we are also investing significantly in all of the app silver for any workload to be able to benefit from all of these different models open source close stores are different weight classes.
Speaker Change: At the same time from an operations perspective, it's faster easier for you.
Speaker Change: Great. Thank you.
Speaker Change: Thanks, Brad Operator next question please.
Speaker Change: And the next question comes from the line of Brad Sills with Bank of America. Please proceed.
Speaker Change: Wonderful. Thank you so much great to hear about the strength you're seeing in co pilot, we'd love to get some color as to where youre seeing that strength is it departmental deals customers moving from proof of concept to departmental deals maybe multiple departmental deals in the enterprise and you mentioned some uptick in usage trends would love to get some color on just the.
Speaker Change: The common use cases that you're seeing that give you that confidence that that will ramp into monetization later. Thank you.
Speaker Change: Yes, I mean I think.
Speaker Change: The initial sort of set of seats were full places where theres more belief in immediate productivity of sales team.
Speaker Change: In finance, it and supply chain, where there is a lot of flat for example, checkpoint longer data that you want to be able to use in conjunction with web data and.
Speaker Change: Have it produce results that are beneficial.
Speaker Change: Then what's happening very much like what we've seen in the previous generation product Dewey things is that we'll collaborate across functions across rules for example, even in my own daily habits.
I go to chat use look at get resolved and then immediately share using pages with colleagues I sort of call. It think with AI and work with people.
Speaker Change: And that pattern, then requires you to make it more of a standard issue across the enterprise and so thats. What we are seeing in stocks may be at a departmental level quickly. The collaboration network effects will effectively demand that you spread it across you can do it by cohort and what have you had so what we've made it easier even.
Speaker Change: <unk> is to start with copilot chat plus this is so that gives the enterprise customers, even more flexibility to have something thats more ubiquitous.
Speaker Change: Yes.
Speaker Change: Wonderful. Thank you so much.
Speaker Change: Thanks, Brad operator, we have time for one last question.
Speaker Change: Sure.
Speaker Change: And the last question will come from the line of Brent <unk> with Piper Sandler. Please proceed.
Brent Thill: Thank you for taking the question here. Good afternoon I wanted to go back to commercial bookings commercial <unk> I think increased 39 billion sequentially. That's the most we've ever seen on a sequential basis commercial bookings growth, 75% constant currency.
Speaker Change: To X higher than we've seen in the last decade.
Speaker Change: Appreciate there is some volatility with this metric, but it does feel like this quarter. There was a bit of a sea change relative to a minimum on backlog and bookings can you just talk about maybe what the breadth of where that strength came from was it broad based was there a couple of large deals any color there would be helpful. Thanks.
Speaker Change: Thanks, Brad.
Speaker Change: Great question.
Speaker Change: We talked a little bit about what are the main drivers which was.
Speaker Change: One of the Azure commitments at open AI has made and I do want to say well that is obviously.
Speaker Change: A big component.
Speaker Change: Youll continue to see open AI make commitment so I don't I want to separate the concept that it's one time versus an ongoing relationship that will grow as they grow which it absolutely will.
Speaker Change: And to your question on what else is participating in that number up first we did have very good core motion.
Speaker Change: Our promotions are things like to your point.
Speaker Change: Renewals of our existing contracts add ons to those contracts upsell like for example, co pilot or Github copilot or other processes and I think thats important. We also had a good a five quarter.
Speaker Change: Which when we talk a lot about <unk> 65, copilot I forget.
Speaker Change: Also talk about suite momentum and we saw that as well this quarter, which we felt very good about and then the final component is large azure commitments.
Speaker Change: And those really did look as we expected which is good to your point and that you are seeing a really broad based growth.
Speaker Change: Our commitment to take two forms.
Speaker Change: It's existing customers who've worked through their commitments and are making larger commitments, which is a good.
Speaker Change: Commitment signed for the platform and then you have new customers, making commitments and we also saw Baptist partner and so to your point sometime.
Speaker Change: Sometimes I think a big number that looks like this can make you think it's just one thing I think youre right. Some of it was one thing, but a lot of it was good execution consistently across across the workload.
Speaker Change: Helpful color. Thank you.
Speaker Change: Thanks, Brett that wraps up the Q&A portion of today's earnings call. Thank you for joining us today, and we look forward to speaking with all of you soon.
Speaker Change: Thank you all.
Speaker Change: This concludes today's conference you may disconnect your lines at this time.
Speaker Change: Enjoy the rest of your day.