Microsoft Corporation (MSFT) Earnings Call Transcript & Summary

Okay. We're live. Sorry. Okay. Thank you, everybody. Great to see a full house for Microsoft. We are very pleased to have Jared Spataro with us. He's the Corporate Vice President of Microsoft 365 Marketing. So thank you for making the trip and spending some time with us.

My pleasure. My pleasure. Thank you for having me.

So everybody knows about Office 365, right? Sometimes when we talk about M365, people think we're confused. So it's a huge brand, but walk us through -- help people understand, what is in the product set?

Sure thing. Let's just start -- let's break down the components first, and I'll tell you a little bit about the history. So from a component perspective, Microsoft 365 consists of Office 365; EMS, which is our enterprise management and security suite; and Windows, and that's the Windows commercial value. And we started off actually kind of as a small bundle that we called the Enterprise Cloud Suite. It was based on customers looking to buy those things together, and we bundled them up and gave them a discount. What we found over time though was that customers weren't just buying for the discount. They, of course, appreciated the discount. But increasingly, they wanted to make those purchases together because they were starting to see real benefits from deploying technologies together and getting the benefits of lining up the latest versions of the software to enable essentially new scenarios. So then we took that ECS, that Enterprise Cloud Suite and 2.5 years ago, we launched Microsoft 365 as a product proper. And over the last 2.5 years, we've been very busy, not just taking the components and making them better but also really working hard across the integration of those components, so that we have a new value prop. And in fact, we have a brand-new value prop as we think about the software itself.

Who's the target market for M365?

So it's -- of course, our strength as Microsoft has always been IT, I would say. And if I then go into a segment view, that puts us into enterprise. But what's really nice about Microsoft 365 and bringing those components together is we have expanded our target markets. So let me talk from a couple of perspectives. First, if we just look in enterprise, the combination of those components allows us not just to speak to IT but really speak to the business about business transformation. And that's been -- that's really changed our sales motion. I think we'll talk a little bit about that later. The second thing that Microsoft 365 has allowed us to do, it's allowed us to go into, even in enterprise, into new areas. So as an example, first-line workers, people who largely didn't have access to kind of productivity software previously. And then it's allowed us to go down market into SMB because we're able to bring these services together in a very integrated way and take out a lot of the management that you had to do through IT departments previously. So there's -- Microsoft 365 as a package has allowed us to do a lot of things that we just weren't able to do when on-prem software was the way that we delivered our value.

So -- and as you see enterprises, and you rightly pointed out, in certain pockets of -- if you go outside knowledge workers, there were people that maybe never had access to Office or maybe didn't even have a Windows machine that they were using. How has this kind of enabled people to kind of get more of their employee base on to Microsoft's suite of offerings? And can the IT -- can the company kind of pick and choose, okay, it might be E5. It might be E3 or it might be some other SKU. So how much mixing and matching is going on as a result of this?

There's quite a bit of mixing and matching. Maybe the best example would be to kind of talk to you about what this looks like in a large enterprise. So if we take a step back and look at large enterprise and what they're doing, of course, they have their information workers that they're trying to help us be more productive in the things that I think all of us would be familiar with. These are people who carry laptops with them, who have access to all the computing power of a laptop and then can go to the cloud. For a lot of other workers, the very high-value workers, we call them first-line workers, they may not kind of every day carry that type of computing device. Increasingly, they do carry a phone, but they have kind of been left behind by the technology revolution focused on productivity. In the health care sector, as an example, we have a great customer in St. Luke's regional health care network that we've profiled recently and doctors for them are first-line workers. So these are highly qualified, highly paid individuals. And we're able to use Microsoft 365 deliver our value on a phone now and do so in a way that really helps them to be more productive. What we like to say with Microsoft 365 now is you can license people, depending on what they need, and you connect everyone from the top floor to the shop floor. In other words, you connect everyone across the organization. We think Microsoft 365 is the first platform that really allows us to do that, in a productivity sense, spanning different worker types. And then just getting to the licensing question very specifically, we certainly see people that license really based on the need of the workers. They'll license E3 or E5 for their information workers. We have other licenses called first-line licenses, and they'll use that for those first-line workers. So it just depends on what the needs are at the individual worker level.

And then enterprise customers who are used to getting a new machine, getting Windows 10 maybe on that new machine and then either using Office 365 or increasingly using Office 365, like how much of a cultural change is it for enterprise customers to move away from kind of how they used to adopt Windows technology in the past and even Office technology? What is it like when they start morphing over to this type of strategy?

It's a big change. You shouldn't underestimate it. Again, the thing we're tapping into with Microsoft 365 is business transformation in general. I think what customers sometimes aren't ready for is how much we will also change their IT operations because what we do is we're able to remove a lot of the running of servers, a lot of the, for instance, imaging of desktops, a lot of kind of the -- essentially kind of that lower-level repetitive work associated with delivering IT services. Now we're able to help those IT professionals focused on really delivering value. It comes at just the right time because IT right now, increasingly, has that pressure and that desire to be aligned with the business and business objectives. So we feel like we're riding a wave of demand that starts with this business transformation idea but also includes kind of tech transformation in these large enterprises.

So on your most recent earnings call, obviously, had very strong growth in your commercial business. Amy called out some of the drivers of that. But she also specifically highlighted Microsoft 365 as one of the reasons that commercial bookings growth was ahead of expectations. So how do we think about the opportunity ahead and kind of how impactful this could be?

Sure. Let's start with just a reminder of some of the baseline stats because I think that helps to ground everyone. Office 365, we report MAU, so it's monthly active users. And in Q1 of this fiscal year for us, we reported over 200 million monthly active users of Office 365. In Q2, we've reported some numbers on EMS. There we report seats, and that was 127 million seats of EMS. That was growing 35% year-over-year. And then if we get to the third component of Microsoft 365, we have Windows Commercial. We reported that, that grew 25% year-over-year. So each of the components are growing quite nicely. A new data point that I'll share with you and with this room that we haven't shared before is that now when we look at Office 365 purchases, over 1/4 of Office 365 licenses are being purchased through M365 or through Microsoft 365. So in other words, what we're trying to communicate to you is Microsoft 365, as a vehicle, now is allowing us to go in and not just sell Office 365, but also to sell EMS and to sell Windows. So when you think of kind of the upside available for us, just in pure SKU and revenue terms, that's kind of what it looks like. But there's even more as we think about the value prop and kind of it resets the value prop conversation for us.

Right. And it actually makes Windows a subscription business, right? So I know you've got how you guys do rev rec for Windows, how that changed over the years. But it makes it so that you're not just paying a monthly subscription now for Office 365, but Windows, which probably most people in the room would normally think of as just a transactional purchase has started to change.

Correct. And that's because it would be one thing if we just switch these things over to subscription businesses, but then there was no value, but in each of those categories, we have tried really hard to have cloud value. Office, we'll talk more about it, but the intelligence services associated with Office allow us to kind of deliver ongoing value. And EMS, again, the management is cloud-based and intelligent, based on cloud services. And then Windows, just as you indicate, we're able to -- the real hook for us in Windows with Windows commercial ends up being security, but there is other end user value, like time line, as an example, or a cloud-based copy and paste that are simple but mean lots of people across devices. And then, of course, there's some innovation we've introduced with things like Windows Virtual Desktop. We refer to that as WVD. That's an area that is cloud-based. It allows us to really go after this virtualization market with Windows. So you're exactly right.

Some people wonder how much of the strength and the success has been the result of the Windows 7 end-of-life. So can you talk with us a little bit about that in terms of the uptake that you've seen, the strong growth that you've reported? Is there any way to discern how much of an impact for end-of-life has been?

Of course. Of course. Again, just to go back to the data point, Q2, 25% year-over-year growth in billings for Windows Commercial, so that's kind of where we're starting from. Definitely, Windows 7 end-of-life has continued to -- was a driver for us and I think will continue to be as we have even some of those laggards that are catching up. But as we look out, there's just real value in Windows Commercial that goes well beyond having an end-of-life moment for us. And that's what I'm most excited about with Windows. Security really is the anchor. It is the thing that people are excited about. They're starting to recognize that with their OS that a one-and-done doesn't work, that they have to have security services that keep them secure, and then we have these other values. So as we think of -- as we look to long-term growth, we would say that we see sustained double-digit growth in billings in that Windows Commercial business, which is very exciting for us. It's not something that people would have thought of a couple of years ago. We see some real strength there.

And even kind of the EMS strength that you've been seeing, if you go back 10 years ago or even prior to that, people would say, "Why I would I pay Microsoft for security, right?" And so you had these markets or these companies evolve that we're offering security for Windows devices because corporates would say, "I don't want to pay Microsoft to do that, they should be making it secure." And you went through this whole debate way back then. But now EMS is central to the story. So how have you seen customer perception evolve now that you've got 127 million users of EMS?

EMS is just foundational to everything we do. Just to review the components for you as we think about what's in EMS, it's identity, management, security and compliance. Those 4 components are what make up EMS. As we think about our value prop for M365, all up, tapping into kind of digital transformation or business transformation, I divide it into 3 buckets. There's a bucket for personal productivity, kind of helping your end users be productive no matter who they are and what they do; organizational productivity, helping the entire org be more productive; and then, finally, this kind of undergirding of security and compliance. EMS is critical to delivering all 3 values, like it's just super, super important. So as you think about identity, increasingly, doing identity right and identity across all your investments, your IT investments becomes a central investment point for you. It becomes a control plane, we like to think of it as. And then even as you get down to management, which kind of was boring for a while, people are starting to recognize this cross-device, cross-platform management, super important and your ability with EMS, as an example, to manage Windows devices, go across and manage iOS and Android, all the devices in your estate is really important. So it for me kind of undergirds the value that we're delivering through the entire suite. And that's what makes it so important. And as we go drive kind of Microsoft 365 revenue, that's what you're seeing is people are starting to recognize that they need to invest in this area.

So if you think about Office 365, you mentioned over 200 million MAUs on your most recent call, the 127 million users of EMS, how do we think about those -- should that -- the gap between those numbers converge? And should we start to see -- or should we think about the potential for EMS as being your Office 365 base in totality?

Absolutely. Let me answer the specific question, then broaden out how you should think about the business. The specific question would be, absolutely. As you think about those 200 million MAU, we would certainly want to attach EMS to all of them. You can definitely think about the diff in those 2 numbers as upside. You also should think about a diff between our MAU and our seats for Office 365 because there is a diff there. We don't disclose seats, but there's a delta that you can be calculating. In general, the pattern that we see would be that we go from components to ME3, so Microsoft 365 E3, and then we step people up into ME5 and so that's the monetization train that we're riding right now. And that's the pattern that we're essentially developing in the sales force. It's caused us to develop a new sales motion entirely to go after it.

What is the new sales motion?

Well, we've got this awesome -- we used to sell kind of just coverage. That's how we did it. Office was essentially, I call it, WXP, Word, Excel PowerPoint, you could add Outlook into that, perhaps Mail, but that was the core value prop for productivity from Microsoft. We stepped way beyond WXP, what people think of as Office. And so that old sales motion of just coverage coming in and saying, "Hey, you have a person. They need e-mail. They need Office." Has now moved into much more of a solution sales kind of oriented thing, where we actually are able to walk in and talk, again, about personal productivity, organizational productivity and security and compliance. The upside to that is we're tapping into new budgets. Awesome. The downside to that is there's a little bit longer sales cycle, if I'm honest with you. So there's kind of some balancing for us to do as we go after this new opportunity.

So when you think about the people who have migrated to Office 365 early but maybe didn't use EMS, do you -- have you noticed a trend? Or are there any situations you could talk about where people have actually -- maybe they were using something else for EMS, but they were using Office 365 and then they started converting over and switched, right? Do you see that happening at all?

Absolutely. One of the ideas or the examples that comes to mind for me is National Bank of Canada. Again, if I start from kind of what got them motivated, they started specifically with this idea of business transformation. They were very interested in kind of coming up to the 21st century and everything that they did. They were heavy, heavy Office users, just generally. But they were Office users kind of for their office staff, not necessarily for their tellers. As we were able to lock them up the stack, they moved into Microsoft 365 as a suite. That means going from Office and adding, again, EMS and Windows Commercial, it also meant, in this particular case, introducing Teams and new ways of collaborating. Within 6 months, that organization went from nothing and kind of no collaboration to 50% of the org using Teams. Within 9 months, they had 80% on. So it was a really nice way of kind of seeing them move from being an old profile customer up to kind of where we like to see our customers.

Amy also talks about the success and the impact that EMS adoption have had on Azure and Azure gross margin. So it's a per-seat pricing model. It does seem like there's a lot of runway there for this to continue to see penetration. Is there also an idea over time where you could see upward SKU migration so that even though someone might be an existing customer paying you $5 per user per month that there's going to be opportunities similar that you have with Office 365, where you can start moving up the SKUs so that existing customers can actually start driving even more incremental revenue?

Absolutely. Microsoft 365, the strategy behind it is based on the idea that as we think about someone who's using Microsoft 365, we find that even from out of the gate, they have a higher ARPU, then they have lower churn, which is really good. And then finally, to your point, exactly, they have a much higher propensity to, over time, consume are what we call our premium SKUs. So E5 and even the components of E5. So it gives us this opportunity to walk them up through the stack, and it's just -- for us, it's a golden formula. We love what Microsoft 365 is doing to drive the business.

Is it -- talk a little bit about the lower churn that you mentioned. How material is it? And what causes the lower churn?

Let's go enterprise down to SMB. Enterprise churn is not something that's been a really big problem for us. But as we move down into SMB, certainly churn is something that is part of just managing the business over time. So Microsoft 365 has helped us because we're delivering new value that goes beyond that kind of Word, Excel, PowerPoint. We definitely had been able to see it change the kind of the shape of what churn looks like in a positive direction for us. And then as we just think about overall kind of using Microsoft 365, our efforts in the new sales motion that we've implemented haven't just been on value selling, but they've also been in value realization. And we've invested, for instance, in what we call CSMs, these are customer success managers. Lots of tech companies do this. It was new for Microsoft over the last couple of years. And across the stack in all segments, we actually go in and help them realize the value. When they're using, and we've got great numbers that show this -- when they're using and getting value, the churn just goes away. Like, they, in fact, add -- they go up the stack in terms of SKUs and they add seats over time.

Right. And again, if we take a look at the security market, typically, it's been a best-of-breed market, right? And I guess, how do you think about your ability to compete with all of the point solutions that exist across the various categories?

So this is a place where it's useful to step back and talk about our strategy with Microsoft 365 in general. I'll apply it to security. I think it will come up as we talk about Teams, as an example. We are really going after what I call a no-compromise strategy. And that is that we think we can be best-in-class and we think we can be best in integration. That has not been possible before, particularly in security. As you look at the players out there, most of them are point players. They have gone after best-in-breed in a particular area. But we see this opportunity to actually do both and to really go after it and to make our investments in a way that matter. As you look at where we've invested in security, we start at identity, talking about that EMS layer. We move up to devices. We go from devices to apps. We move from app to the information in the apps. We go all the way up to the cloud services. And finally, we cap all of that with threat protection that essentially kind of looks across all of those touch points in your infrastructure. And so in each of the areas, we're trying to invest very deeply. We are committed to being best-in-class. But in addition to those investments, we're also investing across those areas in a way that we think makes us very differentiated.

So at Ignite, back in September, you had a couple of product announcement -- well, you have a lot of product announcements, but a couple were Project Cortex, also the Endpoint Manager product that you announced. Any feedback on those so far? And also is this the evolution we should be expecting is just more and more of these add-ons into the SKUs?

Yes. Great feedback. Let me talk about Endpoint Manager. Again, I'd say that management was a place that was sleepy for a while. We feel like it is increasingly becoming strategic as companies recognize, hey, the first step in digital transformation, business transformation, is actually making sure you get your directory right and making sure you manage your devices right. So Endpoint Manager for us, Microsoft Endpoint Manager, brings together Intune and Config Man. These are 2 kind of one cloud, one kind of on-prem-based service and puts them into a single integrated service. That was a really big deal for us. The reaction on that's been super positive. This project Cortex that you refer to, Heather, has been a really big one for us. This opens a new market for us and brand-new TAM. It is essentially the idea of knowledge and capturing knowledge within your company. So using AI to actually identify and codify knowledge in a way that's very valuable. One simple example would be taking a whole heap of contracts, pointing Cortex at it, you can actually pull out Q&A so that you can understand what's in those contracts, everything from late fees to deadlines that would be coming up, things that you'd usually have to have that a human go in and scan for. We can now do that with Cortex. So that's a whole new investment area. We think of it as brand-new TAM for us. And then to answer your final question, man, we're excited because the way we're pursuing M365, Microsoft 365, is to just look for these TAM expansive opportunities. Some are adjacent. Some push us a little bit further out, but to really bring those into our definition of productivity. And we're just saying we're going to expand what productivity looks like by looking at the problems and challenges that customers have.