Microsoft Corporation (MSFT) Earnings Call Transcript & Summary

Welcome to our next session. I'm really happy to have Kirk Koenigsbauer from Microsoft on. Very German name, by the way, so I will be proud to talk to you. Kirk, you had like a very long career in Microsoft. And so it's there's so many different areas we can and should talk about and I'm looking forward to talking about.

Maybe we'll start with like a more broader question is if you think about your time in Microsoft, you saw many changes. But if you think about the last 2 years, like when it comes to what's going on there, how the pandemic has impacted all of that, like how did that impact you and the Microsoft team?

Yes. Yes well first, you make me sound old.

Yes.

But no, I mean I think the last couple of years, there's no question it's been nothing short of extraordinary. And how it's supercharged so much of digital transformation in the industry, it's just amazing. I've been in this productivity and collaboration space for a long time, as you suggested. Whether it's how people are creating and innovating marketing team, sales teams, logistics teams, supply chain -- supply chain tough right now, as we all know, servicing customers, everything is just undergoing a really massive shift, and it's been amazing to see. I think from customers, what we're hearing pretty consistently, it's actually quite consistent across the board. There are a couple of different challenges. And I think one is really around hybrid, which I'm sure you've been talking about and at the conference and other places. But hybrid is sort of going to be the new normal for us. And the interesting thing that we hear and that we find in our research, in fact, we do this survey called the Work Trends report. And it's about 30,000 employees across a bunch of different industries globally, a bunch of different markets, big companies, large companies, small companies, midsize, the whole gamut. And we found this really interesting paradox as we think about hybrid. On the one hand, 70% of that population really love the flexibility that remote work has provided, and they want that in the future. They think that that's an important part of their job and what they want to go do. But at the same time, these same people, these same people, 67% of them actually want more in-person time for collaboration and for creation. So we talk about this as a hybrid paradox. But the reality, I think that we're all going to live and people are going to want the best of both worlds. It's been 2 years doing this stuff, and people aren't going to want to go back to the old ways. And so we're going to be in this sort of hybrid, this hybrid environment for sure. But another trend that I'm sure you're seeing too is what we talk about as the Great Reshuffle. Some people talk about is the Great Resignation, but I actually think it's a little more accurate to talk about it as the Great Reshuffle where there are lots and lots of people that are sort of rethinking their place in the workforce. 41% of people that we survey are considering leaving their current employers, and a similar percentage are just thinking about doing something different. And so there's just a massive talent war that's going on. There's a massive refocus on the employee and the need to develop employees and skill those employees, retain those employees. You're not going to hire your way out of this problem that we face. And it's changing leadership, it's changing a bunch of different dimensions. And then I guess I would say the last big trend that's pretty consistent across every customer I talk to is security, just the threat of phishing and ransomware and breach and IP theft and all the stuff, insider compliance issues and so forth. With all the change that's going on, companies are more than ever really worried about their security platform and how to protect from the end point right up through their cloud platform and their infrastructure and all this stuff. And it's a very interesting time because it's so consistent across each of these dimensions, at least from what we're seeing in the space.

Yes, yes. And it must be fascinating for you because you are like the overarching umbrella. You were kind of touching all of these actually in your company.

Yes, it's a fun time to be in this part of the business for sure, no question. No question.

Yes, yes. And in our conversation, I kind of want to touch on [ the good view ] of the points you made already, to go dig a little bit deeper. Like let's start maybe on the Microsoft 365 side. Like you moved successfully to the cloud. I've been watching. Obviously as a financial analyst, I look at numbers. I look at the number of people that are converting or have converted, et cetera. How do you think about the opportunity for further seat growth? Like I mean we're approaching now numbers where years ago you would have said, yes, no, that's it, that's converted. Now you keep growing. There's a lot of new areas coming as well. Like how do you think about that volume growth?

Yes, no question. Well, Microsoft 365 has been -- it's amazing the momentum that we're seeing now. And as we've disclosed, about 1/3 of our total Office 365 seats are now sold through Microsoft 365. And so broadening this value proposition beyond just sort of productivity and collaboration, it's all the management stuff that products like EMS provide to all the security offerings that we provide, and then of course, the sort of premium Windows experiences in the commercial piece. It's really allowed us to sort of broaden the notion of what our cloud productivity and collaboration service is. And it's kind of become the sort of de facto world productivity cloud. And that's great. In terms of your question though specifically, you're right. The sort of legacy or the history of our franchise around sort of all things Office and now evolving obviously to Microsoft 365, it's been largely centered on the information worker or the knowledge worker. But that's really changing with Microsoft 365. We do see new opportunities, new avenues to deliver these kinds of productivity and collaboration experiences that are going to drive seat growth. I think M365 is also an ARPU play. We can talk about that if you want to. But on the seat side, there's a couple of different vectors that I think are interesting. One, that has really frankly gotten a lot of recognition over the last 2 years, kind of going back to your first question, which is around the notion of the front line or the first-line worker. And this is a population, a set of the employee base, that has kind of been left behind. These are your service professionals, your retail professionals, your manufacturing shop floor professionals, your health care professionals; folks that don't necessarily sit at a desk all day and sort of type away like a lot of us do. They are on the first line of everything for sales, for service, for support, obviously transportation safety, security, health. We've seen it over the course of the last 2 years and how important that is to the economy. And that population has historically been kind of left behind in terms of being connected to the rest of the workforce. And so lots of CEOs, CIOs, business leaders that we talk to are interested in lighting up and being able to connect that population to the rest of the employee base, to be able to lead with them and communicate and the mission alignment and all that. But that's also where a big chunk of digital transformation is happening, sort of in every one of these industries that I've been referencing. The first-line worker, the frontline worker experience is really getting digitized in a massive way. And that's a big seat growth driver for us. The other -- another one that I think is pretty important to us, which we talked about in the past, is the SMB space, the small midsize business space. But I would sort of put a finer point on the very small business opportunity. The sort of solo-preneur up to say, 10, 20, 25 seats, something along that line. That's a really -- we feel like that's a really big opportunity for Microsoft 365 also. And we have created a bunch of new SKUs over the course of the last few years with Microsoft 365 to put the sort of power of the platform into the hands of small businesses, including these really small businesses. And that's been a big opportunity for us. In fact just last week, we also announced a new SKU called Microsoft Teams Essentials, which is essentially a product specifically designed for the small business space. Super competitive, $4 a month, all-in-one sort of meeting and conferencing solution, we think that that's a big deal. I also personally get pretty excited about security offerings in the small business space. We can't forget yet that a lot of big companies, that's where a lot of the focus is on ransomware and phishing and all that stuff, but it's happening in the small business space too. And frankly, they don't have the tooling or the expertise at that level. They don't have big IT shops or partners sort of supporting them on a day-to-day basis. So security is important there. And then the last one, I guess, I would just say is around emerging markets. We have served emerging markets, of course, at Microsoft broadly. But I would say our focus has been largely on the large sort of organizations in any given emerging market or developing market. And we think that there's a lot of opportunity sort of in a breadth of the smaller organization. So it's midsize and SMBs again. And Teams is really our vector and our avenue there because it just is changing the dynamic in such an important way. So I don't know. We see a lot of opportunity with M365 to drive seats going forward. And we've seen some good growth through both the FLW, the first-line worker piece, and the SMB space over the last couple of quarters.

Yes. No, yes, exactly. And you mentioned ARPU already. That looks like to have volume and have price [ OEM ] I remember I made a mistake a few years ago. I said price increase, and Amy kind of kills me on the call. So selling more value to customers. The -- where are we on the different SKUs there in terms of like adoption and opportunity?

Yes, yes. Well, I think you're right to articulate it. I mean Microsoft 365 has the opportunity for seat growth but also for ARPU growth as well. And I would say originally, frankly it was much more of an ARPU play initially. Because we were converting these seats from on-prem or the basic Office 365 workloads to this broader M365 suite. But we see quite a bit of headroom ahead of us. Right now, and we disclosed this in the last couple of quarters, the E5 offering that we have, think of that as our highest -- for folks who don't follow along the minutia of our SKUs, it's the sort of highest premium tier for Microsoft 365. And that right now is only 8% of our installed base. And so we feel like we've got a lot of upside there, whether it's -- I referenced security briefly in the SMB space. But a lot of organizations are looking to provide the kind of security and compliance and identity solutions that are required today. There's a big chunk of management value that's there. There's a big chunk of what we call a phone system or modern ways to do sort of VoIP-based calling and PSTN-based calling. And so we think that there's quite a bit of headroom left in this E5 space. I do think overall, there is a little bit of a balance, of course, as we drive more SKUs, right, more seats. And we've raised ARPU, we have to think about the balance on either side there. But we see opportunity on both vectors.

And where are we on the -- I seem to remember like a few quarters ago, you talked about E3 as the hero SKU. Like is there still like E1 to E3, kind of?

Yes. Yes, it's a little -- it's a -- we have a number of different SKUs. Because we address large organizations, large enterprises, midsize companies, and small businesses, we have a host of different SKUs. And we do use this sort of nomenclature of E1, E3, E5. For some reason, we don't like even numbers, I guess. We have them for the enterprise SKUs. We have a set of SKUs for the SMB side. And of course, we have a consumer business too with over 50 million subscribers. But yes, the -- our objective, of course, is to penetrate into a market or a customer in some way, whether it's with an E3 SKU or whatever, and then sort of expand the rooms of the house is sort of an analogy that we use internally, to drive that higher ARPU with more scenarios. Whether it's maybe they're starting off with just the basics of productivity and collaboration, but then there's a really natural opportunity to attach security on top of it, or compliance on top of it or a phone system on top of it. That's kind of our playbook.

Yes. Okay. And then on talk a little bit about the Windows franchise, it doesn't get as much airtime anymore, which is kind of I think it's unfair because it's a very big and important product for you. What have you seen as you think about the pandemic and supply chain management constraints that are playing out here? Like what have been your observations there?

Yes, yes. No, for sure. Windows remains a huge anchor of growth for the company. And it's a super important way that we service our customers, attracting customers and so forth. So we talk about it a lot internally, and it's super important. The dynamics, related to your supply chain point, are a little different on the consumer side. You sort of see -- we do see some supply chain impact. We see that show up sort of in the OEM piece, of course, as you see that. On the commercial side, it's a little bit different. We're a little bit less dependent there. Because a lot of what's happening in the commercial space is companies are buying their PCs, and then they're upgrading them to Microsoft 365, which includes the per user component in Windows. And so there, we see actually a really strong ARPU opportunity for Windows Commercial by moving customers to Microsoft 365. And they are what customers are doing are -- not to sound like a broken record, but going back to the same point again, they want Windows to be more secure. And so for example, we have this offering called Microsoft Defender, which is essentially end point security solution that is part of Microsoft 365 part of Windows. And that's one of the ways that customers are sort of upselling. I've mentioned management infrastructure is another big part of it. How do you manage Windows, frankly multiple device types across this sort of in this new hybrid world where lots of people are remote. You've got to think about things like virtualization. We have a new offering called Windows 365, which is a virtualization offering, which we're really excited about, just came out recently. And then of course, there is the natural upgrade cycle of machines. And we've seen lots of organizations with the focus on employee experience, wanting to make sure that their employees have good devices so that they can get their job done. And so we have benefited from an upgrade cycle in the commercial space too. So we're bullish on what we see in terms of Windows Commercial value going forward. We think it will continue to be a big growth driver for us.

Yes. And it's funny, like just to give you some feedback. Like as I start going back to the office, I just all of a sudden I discover the ancient nature of my machine. And I think like there needs to be an upgrade cycle here.

Yes for sure.

Yes. And let's shift gear a little bit again. The -- Teams has been one of the super success stories there for you guys over the last few years. Like where are we in terms of adoption, but also adoption of the different subcomponents that were sitting within Teams?

Yes, yes. Well in terms of broad adoption, we announced 250 million monthly active users of Teams. And as someone who's been on the Teams' journey from day 1, it's pretty awesome to see what that growth has been. And no question, the product was growing before the pandemic, and there's definitely been a lot of acceleration through it. We see one thing that I look at quite a bit is our -- we're seeing broad deployments across big, big enterprises. And now we're -- over 130 organizations have 100,000-seat or more deployments, which is a really good signal of what that adoption looks like. And then of course, there's a long tail of organizations that are deploying broadly too. When you talk about within the subcomponents, just as a reminder for folks that may not be as steeped, Teams has core chat and messaging capability, collaboration capability. It's got this VoIP-based calling service as well that we call phone system. It has Office integration. And of course, there's a platform for third parties, ISVs as well as businesses, IT departments to build their own line of business solutions into Teams. And really across the board, we're seeing a nice uptick on all those. Obviously Meetings, as you might expect, has been a huge growth driver over the course of the last couple of years. But we see we really see growth across all across the board. Just as an example going back to our first-line worker conversation, we've seen just 150% increase in usage around these frontline worker solutions inside of Teams itself. And so it's become a really nice host for us to birth new experiences. In fact, I'll tell you, I recently took over responsibility for one of our workloads called Yammer. And the growth -- and we've integrated Yammer inside of Teams. The growth of Yammer inside of Teams is so fast now, it's eclipsed the stand-alone part of the Yammer business. We have many, many stories like that of new products that we're birthing, that we're launching as a part of Teams and growing as a part of that growth. So it's been really exciting to see that.

Yes. And the -- where are we on the -- specifically on video voice because that's the -- I mean to me, it's almost a hidden success story. Because like the more conversations I have with people in the field, the more like yes, this is kind of really good. It's not Skype anymore. This is kind of -- feels like very, very good and powerful. Where are we on that realization and adoption?

Yes, it is a bit of a sleeper, I guess. We have about 80 million monthly active users on what we talk about as our phone system solution. That essentially is again our voice over IP sort of P2P calling between like you and me, if you and I wanted to have a phone call, we could do that over Teams. And that is growing immensely, particularly over the last couple of years. We have completely -- you mentioned Skype before. We've completely replotted the back-end infrastructure that manages all of our calling, all of our meeting and calling infrastructure essentially. And so we feel very, very good about our position there. I think the interesting thing that's happened is that the basic phone call is never going to be the same. I mean people want to now see each other, whether they're using Teams or Zoom or FaceTime or whatever, what like -- it doesn't really matter. There's a whole new standard for what a calling experience is. And so we feel really quite fortunate to be in a position where Teams in and of itself is not just a voice over IP solution, but it's a solution that can integrate in these great collaboration experiences and deep integration with office and so forth, whether you're doing a one-on-one or a team meeting. And so we really feel that that's helped drive some of this. And it's really I think changing calling forever. And of course, hybrid is going to be a big part of that. So the other piece that's been important for us is we really have re-pivoted how we work with our operators. And you talk about all these different markets and working with them closely to build the PSTN component of the solution into this has been a big part too. And so we feel really good about the broad traction of end user usage as well as partners getting on board with us with Teams.

Yes, yes, yes. No, that sounds really exciting here. And as I said, I see it more and more. So it's kind of really good, good progress. The -- another thing that, I have to admit, like doesn't probably get enough airtime on our side is Viva. And I do the German pronunciation. I hope that's correct. Can you talk -- I mean if I talk to Microsoft people, there are a lot -- there is a huge level of excitement around that. It hasn't really kind of come over to our side. Can you just talk to that a little bit?

Yes. And I should tell you, I'm extremely biased here because I am on point for the company to drive our Viva business and run some of our products there. I would tell you, maybe even going back to where we started, this notion of the new hybrid working model as well as this Great Reshuffle has just put an incredible focus on the notion of what is the right employee experience. As I referenced, you got this massive talent war that's out there. Employers have never -- I think in the time at least I've been in this business -- have never really cared so much so deeply about the development of their people, their careers, their learning, their skilling, how they can advance. I think one of the things that's been a real lesson here for leaders over the course of the last 2 years is you have to keep your folks motivated. They have to understand what your mission is. Because people today, they care more than just about getting paycheck. And so there's been a lot of focus on creating a great employee experience. And to be candid with you, it's not been awesome for many, many people for a long time. This is a space that's got -- it's super fragmented. There's a lot of different ISV solutions in there. They're all good individually, but they're not interconnected. And I think what we've decided to do is focus on this employee experience category, and we've introduced this thing called Viva. We just announced it in February, so it's not surprising that it's not super, super well known. But we are working it in a pretty big way. And we just actually hit within the last month, general availability for our 4 -- our first 4 core workloads, which are around learning, knowledge management. We have a workload that's around insights, so what's happening with the wellness and productivity of your employee base. And we have one called Connections, which is helpful to connect people to different employee experiences throughout an organization. All of this, we have our own first-party solutions, but we're opening it up to third parties as well. and we're really quite bullish on it. We bought a company called Ally.io back in September, October. That's a service that provides OKRs, objectives and key results. Think goals and mission alignment up and down in organization. We're excited about that. So this is going to be a big area of investment for us. And our point of differentiation is we're building this right into Microsoft 365 and into Teams. And again, a lot of -- there are solutions out there in the marketplace today, but they're isolated. They're point solutions. When was the last time anybody sort of wanted to go to their learning management portal? It's not very natural. So by building it into Teams where we can have nudges and we can make recommendations based on our broad Microsoft graph of intelligence that we have, and sort of build it into what we talk about is the flow of work, we think we're going to see much, much higher adoption and engagement. And frankly, that's what organizations need. They really need their employees using this stuff, to get the development, to get the skilling, to get the insights that they need to be stronger employees and be able to contribute. And so that's a huge opportunity for us, we think, going forward.

Is that -- just one more question. Is it somewhat link to -- we have the learning experience platforms out there. And I would think it's somewhat might link with Dynamics as well to some degree.

Yes.

Like -- Yes. Okay, okay.

Yes for sure. Like we work really closely obviously with LinkedIn, a big part of Microsoft. We have a very close set of integrations there where our learning application that we built as a part of Viva actually includes, as a part of the service, a bunch of LinkedIn courses. And then it also offers the full LinkedIn catalog of over 20,000 or 30,000 different trainings and coursework that folks can do. And so we essentially have a very tight coupling there between those, but we also work with SuccessFactors, Pluralsight and a bunch of other really sort of well-established learning providers to be able to provide their content into our solution within Teams directly. And we think that's going to be a nice value proposition for people, to grow.

Yes. And you're coming from a different angle. You're coming from the employee productivity angle rather than the compliance HR angle, where it was almost like forced on you. Yes, yes.

That's right. We're putting the employee first in this process, to make sure that they've got really great sort of consumer-grade, consumer ethos types of experiences. And we think that, that will -- again, built into Teams, built into the [work] will be really competitive.

Yes, yes. I can see that. Yes, that sounds really exciting. The -- Kirk, last couple of minutes, I want to talk about security. Like you mentioned it several times already, but I think it needs its own little section here. So that's why I'm talking about it like a little bit more. Can you talk a little bit about the evolution there? Because I remember like I published a big report on that. And I was surprised how much progress you guys have made and how comprehensive you've been. I got the number wrong completely because it was actually a much, much bigger business than I kind of -- and then we modeled [ at a time of 4 at the time. ] Just can you talk a little bit about the evolution there?

Yes. No, it's been a great 3 or 4 years building out our security offerings. Obviously, security has been important to Microsoft for a while. It's a core part of the operating system. It's been a core part of Azure and M365. But we've really started to focus on it in the last 3, 4 years. And it's great to have Charlie Bell on point a new leader with Satya's group who's sort of running our security offerings all up, and wonderful to have him now with the company. But as I referenced earlier, this is a huge deal for every organization that we talk to. Cybercrime is something like a $6 trillion sort of cost to the economy. And if you sort of think about that for a second, that would actually make it -- if it were a country, it would be the third largest country in the world after China and the United States. So this is a huge, huge deal for every single CEO, CIO, CSO, for sure. And the challenges they face today are things like fragmentation. They've got 50-plus systems. No joke, 50-plus systems for different types of security or compliance workloads in their company. And that creates just a ton of complexity, and it also creates risk in terms of how these are integrated together and are they interoperating as the way that they should. Are they sharing signals and so forth to understand what this risk looks like? A lot of these services are still on-prem-based, and so they're not as up to date. They're not able to take advantage of the power of AI and the cloud compute that it can offer in the security space to sort of get ahead of this as opposed to constantly being on defense. And going maybe a little bit back to the employee experience piece, every company I talk to can't hire enough or fast enough security experts. And so they have to rely on companies like Microsoft. And so we have seen a big push here. Folks want to get to Zero Trust. They have to assume that breach is going to happen. And so how do you sort of -- how do you protect against that? And yes, we announced recently that Microsoft is now a greater than $10 billion business in the security space. So it is a huge, huge deal for us, and we're super committed to the category. So hopefully, that gives you a quick overview.

Yes. No, totally. Yes, yes. I mean one of the stuff that does come up on the earnings call is EMS. And you talked about the growth there. We have a seat number, like -- and it does seem like a very big kind of penetration number as well. Like how do you drive growth there? What are the kind of the factors to consider?

Well, yes, sort of 2 parts there. One is you're absolutely correct. I mean EMS, our Enterprise Mobility and Security suite, is absolutely the cornerstone of our security offerings and our Zero Trust approach. It is the thing that provides the identity plane inside of any organization with Azure Active Directory and the management plane with something that we call Microsoft Endpoint Manager. These are both collectively so core to running a company's infrastructure running it securely. As you referenced, the growth of Azure AD is really strong. We have over 500 million monthly active users there, 300,000 paid orgs. I mean it is a very, very big business for us and a super important one. Again, it's the sort of cornerstone for all this. One thing, by the way, that's not often talked about is it's not just about protecting sort of Microsoft commercial services, but also a host of cloud identity solutions for third parties too. And that's a very, very fast-growing part of the business. And then on the management side, I think it's a little bit under-looked sometime how important this is. The relationship between security and management, I mean they are - it's peanut butter and jelly, essentially. You can't have a strong security infrastructure if your management isn't up to date, if it isn't moving to the cloud, if it isn't ready for hybrid, if it's not consolidating. And so that's why EMS is just so core to our security story all up.

Yes, yes, yes. And then the -- if you think about it, like is there -- And on one hand [ is a seat ]. It's like Amy on every conference call says, like you need to be careful. If you look at Azure, there's EMS in there and seats [ can grow ]. Are they the similar -- same factors that we should think about as we talked earlier on the Office side in terms of further penetration there? Or what would be like other things to consider?

Yes. No, we definitely see that there's room for growth with Azure Active Directory. I mean I think there's still a lot of legacy on-prem out there. There's this push to hybrid, as we've talked a little bit about, and making sure that organizations have a robust identity platform, given the fact that there's so much hybrid, so much for remote work. There's going to be continued consolidation. We've talked about passwordless. Like God, what a hassle passwords have been for the last 30 years. And we've got to move beyond that. And Azure Active Directory, our identity solution is moving in that direction to get rid of passwords, which we think will be key. Verify credentials, there are so many elements of this business that we feel like are going to be real good growth drivers for us going forward, let alone the third-party [ app piece ] that I mentioned too. Customers want -- no one wants to move to a single vendor entirely, of course. But you do want to remove a lot of the complexity that's in the environment today, and this is one of the ways to do it.

Yes. Kirk, I see my time's up. I'm getting a flag here too. And I mean it was so great talking to you there, so many different areas we could have touched on top of that. But it was great having you here. Thanks for that, for the conversation. Really exciting. It's great to have you here as well. Thank you.

Thank you very much. I appreciate the opportunity. Take care.

Thank you. Happy holidays.