Brett Iversen:

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, Alice Jolla, Chief Accounting Officer, and Keith Dolliver, Corporate Secretary and Deputy General Counsel. 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 and provides the reconciliation of differences between GAAP and non-GAAP financial measures. More detailed outlook slides will be available on the Microsoft Investor Relations website when we provide outlook commentary on today’s call. 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. They are included as additional clarifying items to aid investors in further understanding the company's fourth quarter performance in addition to the impact these items and events have on the financial results. 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 growth rate only. We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If 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 replay the call and view the transcript on the Microsoft Investor Relations website. 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. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call, and in the risk factor section of our Form 10-K, Forms 10-Q, and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that, I’ll turn the call over to Satya.

Amy Hood:

Thank you, Satya, and good afternoon everyone. This quarter, revenue was $64.7 billion, up 15% and 16% in constant currency. Earnings per share was $2.95 and increased 10% and 11% in constant currency. In our largest quarter of the year, we again delivered double-digit top and bottom line growth with continued share gains across many of our businesses and record commitments to our Microsoft Cloud platform. Commercial bookings were significantly ahead of expectations and increased 17% and 19% in constant currency. This record commitment quarter was driven by growth in the number of 10-million-dollar-plus and 100-million-dollar-plus contracts for both Azure and Microsoft 365 and consistent execution across our core annuity sales motions. Commercial remaining performance obligation increased 20% and 21% in constant currency to $269 billion. Roughly 40% will be recognized in revenue in the next 12 months, up 18% year-over-year. The remaining portion, recognized beyond the next 12 months, increased 21%. And this quarter, our annuity mix was 97%. At a company level, Activision contributed a net impact of approximately 3 points to revenue growth, was a 2 point drag on operating income growth, and had a negative $0.06 impact to earnings per share. A reminder that this net impact includes adjusting for the movement of Activision content from our prior relationship as a third-party partner to first-party, and includes $938 million from purchase accounting adjustments, integration, and transaction-related costs. FX did not have a significant impact on our results and was roughly in line with our expectations on total company revenue, segment level revenue, COGS, and operating expense growth. Microsoft Cloud revenue was $36.8 billion and grew 21% and 22% in constant currency, roughly in line with expectations. Microsoft Cloud gross margin percentage decreased roughly 2 points year-over-year to 69% in line with expectations. Excluding the impact of the change in accounting estimate for useful lives, gross margin percentage decreased slightly driven by sales mix shift to Azure, partially offset by improvement in Azure even with the impact of scaling our AI infrastructure. Company gross margin dollars increased 14% and 15% in constant currency and gross margin percentage decreased slightly year-over-year to 70%. Excluding the impact of the change in accounting estimate, gross margin percentage increased slightly, even with the impact from purchase accounting adjustments, integration, and transaction-related costs from the Activision acquisition. Operating expenses increased 13% with 9 points from the Activision acquisition. At a total company level, headcount at the end of June was 3% higher than a year ago. Operating income increased 15% and 16% in constant currency and operating margins were 43%, relatively unchanged year-over-year. Excluding the impact of the change in accounting estimate, operating margins increased slightly driven by the higher gross margin noted earlier and improved operating leverage through continued cost discipline. Now to our segment results. Revenue from Productivity and Business Processes was $20.3 billion and grew 11% and 12% in constant currency, slightly ahead of expectations driven by better-than-expected results across all business units. Office commercial revenue grew 12% and 13% in constant currency. Office 365 commercial revenue increased 13% and 14% in constant currency with ARPU growth primarily from E5 momentum as well as Copilot for Microsoft 365. Paid Office 365 commercial seats grew 7% year-over-year with installed base expansion across all customer segments. Seat growth was again driven by our small and medium business and frontline worker offerings, although both segments continued to moderate. Office commercial licensing declined 9% and 7% in constant currency, with continued customer shift to cloud offerings. Office consumer revenue increased 3% and 4% in constant currency with continued momentum in Microsoft 365 subscriptions, which grew 10% to 82.5 million. LinkedIn revenue increased 10% and 9% in constant currency driven by better-than-expected performance across all businesses. Dynamics revenue grew 16% driven by Dynamics 365 which grew 19% and 20% in constant currency. We saw continued growth across all workloads and better-than-expected new business. Dynamics 365 now represents roughly 90% of total Dynamics revenue. Segment gross margin dollars increased 9% and 10% in constant currency and gross margin percentage decreased roughly 1 point year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage decreased slightly driven by Office 365 as we scale our AI infrastructure. Operating expenses increased 5%, and operating income increased 12% and 13% in constant currency. Next, the Intelligent Cloud segment. Revenue was $28.5 billion, increasing 19% and 20% in constant currency, in line with expectations. Overall, server products and cloud services revenue grew 21% and 22% in constant currency. Azure and other cloud services revenue grew 29% and 30% in constant currency, in line with expectations and consistent with Q3 when adjusting for leap year. Azure growth included 8 points from AI services where demand remained higher than our available capacity. In June, we saw slightly lower-than-expected growth in a few European geos. In our per-user business, the enterprise mobility and security installed base grew 10% to over 281 million seats with continued impact from moderated growth in seats sold outside the Microsoft 365 suite. Therefore, our Azure consumption business continues to grow faster than total Azure. In our on-premises server business, revenue increased 2% and 3% in constant currency. Growth was driven by demand for our hybrid solutions although with slightly lower-than-expected transactional purchasing. Enterprise and partner services revenue decreased 7% on a strong prior year comparable for Enterprise Support Services. Segment gross margin dollars increased 16% and gross margin percentage decreased roughly 2 points year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage decreased slightly driven by sales mix shift to Azure, partially offset by the improvement in Azure noted earlier, even with the impact of scaling our AI infrastructure. Operating expenses increased 5% and operating income grew 22% and 23% in constant currency. Now to More Personal Computing. Revenue was $15.9 billion, increasing 14% and 15% in constant currency, with 12 points of net impact from the Activision acquisition. Results were above expectations driven by Windows commercial and Search. The PC market was as expected and Windows OEM revenue increased 4% year-over-year. Windows commercial products and cloud services revenue increased 11% and 12% in constant currency, ahead of expectations due to higher in-period revenue recognition from the mix of contracts. Devices revenue decreased 11% and 9% in constant currency, roughly in line with expectations, as we remain focused on our higher margin premium products. While early days, we’re excited about the recent launch of our Copilot+ PCs. Search and news advertising revenue ex-TAC increased 19%, ahead of expectations, primarily due to improved execution. Healthy volume growth was driven by Bing and Edge. And in Gaming, revenue increased 44% with 48 points of net impact from the Activision acquisition. Xbox content and services revenue increased 61%, slightly ahead of expectations, with 58 points of net impact from the Activision acquisition. Stronger-than-expected performance in first-party content was partially offset by third-party content performance. Xbox hardware revenue decreased 42% and 41% in constant currency. Segment gross margin dollars increased 21%, with 10 points of net impact from the Activision acquisition. Gross margin percentage increased roughly 3 points year-over-year primarily driven by sales mix shift to higher margin businesses. Operating expenses increased 43% with 41 points from the Activision acquisition. Operating income increased 5% and 6% in constant currency. Now back to total company results. Capital expenditures including finance leases were $19 billion, in line with expectations, and cash paid for PP&E was $13.9 billion. Cloud and AI related spend represents nearly all of total capital expenditures. Within that, roughly half is for infrastructure needs where we continue to build and lease datacenters that will support monetization over the next 15 years and beyond. The remaining cloud and AI related spend is primarily for servers, both CPUs and GPUs, to serve customers based on demand signals. For the full fiscal year, the mix of our cloud and AI related spend was similar to Q4. Cash flow from operations was $37.2 billion, up 29% driven by strong cloud billings and collections. Free cash flow was $23.3 billion, up 18% year-over-year, reflecting higher capital expenditures to support our cloud and AI offerings. For the full-year, cash flow from operations surpassed $100 billion for the first time, reaching $119 billion. This quarter, other income and expense was negative $675 million, more favorable than anticipated with lower-than-expected interest expense and higher-than-expected interest income. Our losses on investments accounted for under the equity method were as expected. Our effective tax rate was approximately 19%, higher than anticipated due to a state tax law signed in June that was effective retroactively. And finally, we returned $8.4 billion to shareholders through dividends and share repurchases, bringing our total cash returned to shareholders to over $34 billion for the full fiscal year. Now, moving to our outlook. My commentary for both the full-year and next quarter is on a U.S. dollar basis unless specifically noted otherwise. Let me start with some full year commentary for FY2025. First, FX. Assuming current rates remain stable, we expect FX to have no meaningful impact to full-year revenue, COGS, or operating expense growth. Next, we continue to expect double-digit revenue and operating income growth as we focus on delivering differentiated value for our customers. To meet the growing demand signal for our AI and cloud products, we will scale our infrastructure investments with FY2025 capital expenditures expected to be higher than FY2024. As a reminder, these expenditures are dependent on demand signals and adoption of our services that will be managed through the year. As scaling these investments drives growth in COGS, we will remain disciplined on operating expense management. Therefore, we expect FY2025 OpEx growth to be in the single digits. And given our focused commitment to managing at the operating margin level, we still expect FY2025 operating margins to be down only about one point year-over-year. And finally, we expect our FY2025 effective tax rate to be around 19%. Now, to the outlook for our first quarter. Based on current rates, we expect FX to decrease total revenue and segment level revenue growth by less than one point. We expect FX to decrease COGS growth by less than one point and to have no meaningful impact to operating expense growth. In commercial bookings, increased long-term commitments to our platform and strong execution across core annuity sales motions should drive healthy growth on a growing expiry base. As a reminder, larger long-term Azure contracts, which are more unpredictable in their timing, can drive increased quarterly volatility in our bookings growth rate. Microsoft Cloud gross margin percentage should be roughly 70%, down year-over-year driven by the impact of scaling our AI infrastructure. We expect capital expenditures to increase on a sequential basis given our cloud and AI demand, as well as existing AI capacity constraints. As a reminder, there can be quarterly spend variability from cloud infrastructure buildouts and the timing of delivery of finance leases. Next to segment guidance. In Productivity and Business Processes, we expect revenue to grow between 10% and 11% in constant currency, or US$20.3 to US$20.6 billion. In Office Commercial, revenue growth will again be driven by Office 365 with seat growth across customer segments and ARPU growth through E5 and Copilot for Microsoft 365. We expect Office 365 revenue growth to be approximately 14% in constant currency. In our on-premises business, we expect revenue to decline in the mid to high-teens. In Office consumer, we expect revenue growth in the low to mid-single digits, driven by Microsoft 365 subscriptions. For LinkedIn, we expect revenue growth in the high single digits driven by continued growth across all businesses. And in Dynamics, we expect revenue growth in the low to mid-teens driven by Dynamics 365. For Intelligent Cloud we expect revenue to grow between 18% and 20% in constant currency, or US$28.6 billion to US$28.9 billion. Revenue will continue to be driven by Azure which, as a reminder, can have quarterly variability primarily from our per-user business and in-period revenue recognition depending on the mix of contracts. In Azure, we expect Q1 revenue growth to be 28% to 29% in constant currency. Growth will continue to be driven by our consumption business, inclusive of AI, which is growing faster than total Azure. We expect the consumption trends from Q4 to continue through the first half of the year. This includes both AI demand impacted by capacity constraints and non-AI growth trends similar to June. Growth in our per-user business will continue to moderate. And in H2, we expect Azure growth to accelerate as our capital investments create an increase in available AI capacity to serve more of the growing demand. In our on-premises server business, we expect revenue to decline in the low single digits as continued hybrid demand will be more than offset by lower transactional purchasing. And in Enterprise and partner services, revenue should decline in the low single digits. In More Personal Computing, we expect revenue to grow between 9% and 12% in constant currency, or US$14.9 billion to US$15.3 billion. Windows OEM revenue growth should be relatively flat, roughly in line with the PC market. In Windows commercial products and cloud services, customer demand for Microsoft 365 and our advanced security solutions should drive revenue growth in the mid-single digits. As a reminder, our quarterly revenue growth can have variability primarily from in-period revenue recognition depending on the mix of contracts. In Devices, revenue growth should be in the low to mid-single digits. Search and news advertising ex-TAC revenue growth should be in the mid to high-teens. This will be higher than overall Search and news advertising revenue growth, which we expect to be in the low single digits. And in Gaming, we expect revenue growth in the mid-30s, including approximately 40 points of net impact from the Activision acquisition. We expect Xbox content and services revenue growth in the low to mid-50s, driven by the net impact from the Activision acquisition. Hardware revenue will again decline year-over-year. Now back to company guidance. We expect COGS between US$19.95 billion to US$20.15 billion, including approximately $700 million from purchase accounting, integration, and transaction-related costs from the Activision acquisition. We expect operating expense of US$15.2 billion to US$15.3 billion, including approximately $200 million from purchase accounting, integration, and transaction-related costs from the Activision acquisition. Other income and expense should be roughly negative $650 million driven by losses on investments accounted for under the equity method as interest income will be mostly offset by interest expense. As a reminder, we are required to recognize gains or losses on our equity investments, which can increase quarterly volatility. We expect our Q1 effective tax rate to be approximately 19%. In closing, we remain focused on delivering innovations that matter to our global customers of every size. That focus extends to delivering on our financial commitments as well. We delivered operating margin growth of nearly three points year-over-year even as we accelerated our AI investments, completed the Activision acquisition, and had a headwind from the change of useful lives last year. So, as we begin FY2025, we will continue to invest in the cloud and AI opportunity ahead aligned, and if needed adjusted, to the demand signals we see. We are committed to growing our leadership across our commercial cloud and within that, the AI platform, and we feel well positioned as we start FY2025. With that, let's go to Q&A, Brett.

Operator:

[Operator Instructions] And our first question comes from the line of Keith Weiss with Morgan Stanley. Please proceed.

Satya Nadella:

Thank you, Keith. Let me start, and then Amy can add to this. I think, I would say we primarily start right now from the demand side. What I mean by that is what's the product – shape of the product portfolio, what we learned even from the cloud transition, which, as you know, Keith, was similar in the sense it was both a knowledge-intensive and a capital-intensive transition. We needed to have the product portfolio where there was the right mix of, I'll call it, infrastructure meters as well as SaaS applications. So that's the first thing that we are looking at. And how is that value landing with customers and what's the growth rate. So when I think about what's happening with M365 Copilot as perhaps the best Office 365 or M365 suite we have had, the fact that we're getting recurring customers, so our customers coming back buying more seats. So GitHub Copilot now being bigger than even GitHub when we bought it. What's happening in the contact center with Dynamics. So I would say – and obviously, the Azure AI growth, that's the first place we look at. That then drives bulk of the CapEx spend, basically, that's the demand signal because you got to remember, even in the capital spend, there is land and there is data center build, but 60-plus percent is the kit, that only will be bought for inferencing and everything else if there is demand signal, right? So that's, I think, the key way to think about capital cycle even. The asset, as Amy said, is a long-term asset, which is land and the data center, which, by the way, we don't even construct things fully, we can even have things which are semi-constructed, we call [cold] (ph) shelves and so on. So we know how to manage our CapEx spend to build out a long-term asset and a lot of the hydration of the kit happens when we have the demand signal. There is definitely spend for training. Even there, of course, we will only be scaling training as we see the demand accrue in any given period in time. So I would say it's more important to manage, to capture the opportunity with the right product portfolio that's driving value. And on that front, I feel good about the breadth of Microsoft offering, whether it's in consumer side, whether it's on commercial per seat side or on the consumption meters, that's, I think, the fundamental driver.

Keith Weiss:

That's super helpful. Thank you very much.

Operator:

And the next question comes from the line of Mark Moerdler with Bernstein Research. Please proceed.

Satya Nadella:

Yes. Thanks again, Mark, for the question. So to me, look, at the end of the day, GenAI is just software. So it is really translating into fundamentally growth on what has been our M365 SaaS offering with a newer offering that is the Copilot SaaS offering, which today is on a growth rate that's faster than any other previous generation of software we launched as a suite in M365. That's, I think, the best way to describe it. I mean the numbers I think we shared even this quarter are indicative of this, Mark. So if you look at it, we have both the landing of the seats itself quarter-over-quarter that is growing 60%, right? That's a pretty good healthy sign. The most healthy sign for me is the fact that customers are coming back there. That is the same customers with whom we landed the seats coming back and buying more seats. And then the number of customers with 10,000-plus seats doubled, right? It's 2x quarter-over-quarter. That, to me, is a healthy SaaS core business. And on top of that, some of the things that Amy shared around Dynamic. That's another exciting place for us, which is one, we are gaining share. We are – Dynamics with the GenAI built-in is sort of really biz app, it's probably the category that gets completely transformed with GenAI. Contact centers being a great example. We ourselves are on course to save hundreds of millions of dollars in our own customer support and contact center operations. I think we can drive that value to our customers. And then on the Azure side, you see the numbers very clearly. In fact, I think last quarter is when we started giving you that. You saw an acceleration of that this quarter. One of the other pieces, Mark, is AI doesn't sit on its own, right? So it's just for – we have a concept of design wins in Azure. So in fact, 50% of the folks who are using Azure AI are also using a data meter. That's very exciting to us because the most important thing in Azure is to win workloads in the enterprise. And that is starting to happen. And these are generational things once they get going with you. So that's, I think, how we think about it at least when I look at what's happening on our demand side.

Mark Moerdler:

Thank you.

Operator:

The next question comes from the line of Kash Rangan with Goldman Sachs. Please proceed.

Amy Hood:

Thanks, Kash. That's a very good question. There's really two pieces, I think, as I heard your question that I would reflect on. The first is, could we see sort of consistent revenue growth without maybe what you would say is more of this sort of elevated capital expense number or something that continues to accelerate. And the answer to that is yes because there's two different pieces, right? You're seeing half of this go toward long-term builds that Satya mentioned, the pace at which we fill those builds with CPUs or GPUs will be demand-driven. And so if we see differences in demand signal, we can throttle that investment on the CPU side, which we've done for I guess, a long time at this point, as I reflect, and we'll use all that same learning and demand signal understand to do the same thing on the GPU side. And so you're right that you could see relatively consistent revenue patterns and yet see these inconsistencies and capital spend quarter-to-quarter. The other thing, I would note, Kash, is you'll also notice there's a growing distinction between our CapEx number, and on occasion, the cash that we pay for PP&E and you're going to start to see that more often in this period because it happens when we use leases. Leases sort of show up all at once. And so you'll see a little bit more volatility. I've mentioned it back in my comments before, but I mentioned it again just because you're starting to see that distinction in my comments and hopefully that's helpful context.

Kasthuri Rangan:

Thank you. It was triggered by the jump in CapEx. And as Amy pointed out, you're guiding to accelerating Azure revenue growth rate, which, I guess, follows the CapEx surge. Thank you so much once again.

Operator:

The next question comes from the line of Brent Thill with Jefferies. Please proceed.

Amy Hood:

Thanks, Brent. Actually, no. As I was talking on the quarter, I mean Commercial bookings were much better than we expected going into the quarter. Commitments were very good execution across both the core sort of annuity renewal motion was good, as expected, the larger long-term commitments were better than we expected. So Brent, I would not say there was anything really unusual in how I thought about what we saw in our commercial execution through the quarter.

Brett Iversen:

Thanks, Brent. Operator, next question please.

Karl Keirstead:

Okay. Great. So maybe I'll direct this to Amy. Amy, I know when you set your Azure guidance, you're always looking to meet or beat the high-end. The 30% you put up in the June quarter, amazing number given the scale of Azure, but it did come in at the low end of your range. And I'd just love for you to maybe elaborate on the delta. I guess as I reflect on what you said in your comments. There's two things that I heard you say. One, it sounded like there's persistent capacity constraints that you think might get alleviated in the second half? And then secondly, you mentioned perhaps some modest softness in Europe. I presume that's a little bit more economic rather than Azure specific. Is that the right way to frame the performance in the quarter? Thank you.

Karl Keirstead:

Yes. Thank you, Amy.

Operator:

The next question comes from the line of Brad Zelnick with Deutsche Bank. Please proceed.

Amy Hood:

Thanks, Brad. Maybe separate a couple of things. We are – and we've talked about now for quite a few quarters, we are constrained on AI capacity. And because of that, actually, we've, to your point, have signed up with third parties to help us as we are behind with some leases on AI capacity. We've done that with partners who are happy to help us extend the Azure platform, to be able to serve this Azure AI demand. And you do see us investing quite a bit as we've talked about in builds so that we can get back in a more balanced place.

Brad Zelnick:

Excellent. Thanks for the color.

Operator:

The next question comes from the line of Mark Murphy with JPMorgan. Please proceed.

Satya Nadella:

Yes, that's a great question. In fact, the GitHub design system and the GitHub Copilot workspace design system, which now, for example, you start with an issue, you create a plan, from a plan, you create a spec, or you create a spec and from a spec, you create a plan and then you go operate across the full repo. That's effectively the design system that is getting replicated inside of even the M365 Copilot. And you see this even now – for example, you get an email, you're in sales, you want to respond to the customer. The data from the email is essentially context for a prompt but you expand by bringing in all of your CRM data, right? So this customer email is in the context of some order, all of the CRM record gets completed in context and a reply gets generated with the CRM data. That's the type of stuff that's already happening. Then you take something like Copilot Studio, you can start even grounding it in more data and then completing workflows. So you could say if this email comes from this customer whose order date is got a particular issue with it. You can then go and escalate it to somebody else who gets a notification in Teams. And those are the kinds of workflows that are getting built within IT or by end users themselves, what used to be line of business applications to us are Copilot extensions going forward. So we think of this as really a new design system for knowledge and frontline work to drive productivity, which would be very akin to what has happened in software engineering. So when you think about marketing or finance or sales or customer service, we will effectively replicate what you just said, which is the type of productivity we've seen in developers, will come to all of these functions as they think about their work, workflow and workout effect, all being driven by Copilots.

Brett Iversen:

Thanks, Mark. Operator, we have time for one last question.

Keith Bachman:

Hi. Good evening, and thank you for the opportunity to ask the question. I actually wanted to veer towards gaming, if I could, for a second. Xbox content services revenue grew 61%, 58 points held from Activision. So net is about 3 points of growth. How should investors think about the longer-term growth potential in this area? You've made significant investments, including the Activision deal. But how should investors be thinking about the growth potential of the gaming? Or what are the puts and takes to help make considerations here? Thank you.

Amy Hood:

No. I do think the real goal here is to be able to take a broad set of content to more users in more places, and really build what looks more like to us, the software annuity and subscription business. With enhanced transactions and the ownership of IP, which is quite valuable long-term. As Satya mentioned, things where with the ownership of IP, it can be monetized in multiple ways. And I think we're really encouraged by some of the progress and how we're making progress with Game Pass as well with some of the new announcements. Thank you, Keith.

Amy Hood:

Thank you.

Operator:

This concludes today's conference. You may now disconnect your lines at this time. Enjoy the rest of your day.

Brett Iversen:

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; Alice Jolla, Chief Accounting Officer; and Keith Dolliver, Corporate Secretary and Deputy General Counsel. 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 and provides the reconciliation of differences between GAAP and non-GAAP financial measures. More detailed outlook slides will be available on the Microsoft Investor Relations website when we provide outlook commentary on today's call. 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. They are included as additional clarifying items to aid investors in further understanding the company's third quarter performance in addition to the impact these items and events have on the financial results. 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 growth rate only. We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If 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 replay the call and view the transcript on the Microsoft Investor Relations website. 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. Actual results could materially differ because of factors discussed in today's earnings press release, in 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 the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that, I'll turn the call over to Satya.

Amy Hood:

Thank you, Satya, and good afternoon, everyone. Our third quarter revenue was $61.9 billion, up 17%; and earnings per share was $2.94, up 20%. Results exceeded expectations, and we delivered another quarter of double-digit top and bottom line growth with continued share gains across many of our businesses. In our commercial business, bookings increased 29% and 31% in constant currency, significantly ahead of expectations, driven by Azure commitments with an increase in average deal size and deal length as well as strong execution across our core annuity sales motions. In Microsoft 365, suite strength contributed to ARPU expansion for our Office Commercial business, although new business growth continued to moderate for stand-alone products sold outside the Microsoft 365 suite. Commercial remaining performance obligation increased 20% and 21% in constant currency to $235 billion. Roughly 45% will be recognized in revenue in the next 12 months, up 20% year-over-year. The remaining portion recognized beyond the next 12 months increased 21%. And this quarter, our annuity mix increased to 97%. In our consumer business, PC market demand was slightly better than we expected, benefiting Windows OEM, while advertising spend landed relatively in line with our expectations. In gaming, we also saw better-than-expected performance of Activision titles, benefiting Xbox content and services. At a company level, Activision contributed a net impact of approximately 4 points to revenue growth, was a 2-point drag on operating income growth and had a negative $0.04 impact to earnings per share. A reminder, that this net impact includes adjusting for the movement of Activision content from our prior relationship as a third-party partner to first party and also includes $935 million from purchase accounting adjustments, integration and transaction-related costs. FX did not have a significant impact on our results and was roughly in line with our expectations on total company revenue, segment level revenue, COGS and operating expense growth. Microsoft Cloud revenue was $35.1 billion and grew 23%, ahead of expectations. Microsoft Cloud gross margin percentage decreased slightly year-over-year to 72%, a bit better than expected. Excluding the impact of the change in accounting estimate for useful lives, gross margin percentage increased slightly, driven by improvement in Azure and Office 365, even with the impact of scaling our AI infrastructure, partially offset by sales mix shift to Azure. Company gross margin dollars increased 18% and gross margin percentage increased slightly year-over-year to 70%. Excluding the impact of the change in accounting estimate, gross margin percentage increased roughly 1 point even with the impact from the purchase accounting adjustments, integration and transaction-related costs from the Activision acquisition. Growth was driven by the improvement in Azure and Office 365 just mentioned as well as sales mix shift to higher-margin businesses. Operating expenses increased 10% with 9 points from the Activision acquisition. At a total company level, head count at the end of March was 1% lower than a year ago. Operating income increased 23% and operating margins increased roughly 2 points year-over-year to 45%, excluding the impact of the change in accounting estimate, operating margins increased roughly 3 points, driven by the higher gross margin noted earlier and improved operating leverage through continued cost discipline. Now to our segment results. Revenue from Productivity and Business Processes was $19.6 billion and grew 12% and 11% in constant currency, in line with expectations. Office Commercial revenue grew 13% and 12% in constant currency. Office 365 commercial revenue increased 15%, in line with expectations, driven by healthy renewal execution, ARPU growth from continued E5 momentum and early Copilot for Microsoft 365 progress. Paid Office 365 commercial seats grew 8% year-over-year with installed base expansion across all customer segments. Seat growth was again driven by our small and medium business and frontline worker offerings, although growth continued to moderate in SMB. Office Commercial Licensing declined 20% and 18% in constant currency, with continued customer shift to cloud offerings. Office Consumer revenue increased 4%, slightly below expectations. Microsoft 365 subscriptions grew 14% to $80.8 million. LinkedIn revenue increased 10% and 9% in constant currency, ahead of expectations, driven by slightly better-than-expected performance in our premium subscriptions and Talent Solutions businesses. However, in Talent Solutions, bookings growth continues to be impacted by the weaker hiring environment in key verticals. Dynamics revenue grew 19% and 17% in constant currency, ahead of expectations. Growth was driven by Dynamics 365, which grew 23% and 22% in constant currency with continued growth across all workloads and better-than-expected new business, although bookings growth remains moderated. Segment gross margin dollars increased 11%, and gross margin percentage decreased slightly year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage increased slightly driven by improvement in Office 365. Operating expenses increased 1% and operating income increased 17% and 16% in constant currency. Next, the Intelligent Cloud segment. Revenue was $26.7 billion, increasing 21%, ahead of expectations with better-than-expected results across all businesses. Overall, Server products and cloud services revenue grew 24%. Azure and other cloud services revenue grew 31% ahead of expectations, while our AI services contributed 7 points of growth as expected. In the non-AI portion of our consumption business, we saw greater-than-expected demand broadly across industries and customer segments as well as some benefit from a greater-than-expected mix of contracts with higher in-period recognition. In our per-user business, the Enterprise Mobility and Security installed base grew 10% to over 274 million seats, with continued impact from the growth trends in new stand-alone business noted earlier. In our on-premises server business, revenue increased 6%, ahead of expectations, driven by better-than-expected renewal strength, particularly for contracts with higher in-period revenue recognition. Enterprise and partner services revenue decreased 9% on a strong prior year comparable for enterprise support services. Segment gross margin dollars increased 20% and gross margin percentage decreased slightly year-over-year. Excluding the impact of the change in accounting estimate [indiscernible] percentage increased slightly, primarily driven by the improvement in Azure noted earlier, even with the impact of scaling our AI infrastructure, partially offset by sales mix shift to Azure. Operating expenses increased 1% and operating income grew 32%. Now to More Personal Computing. Revenue was $15.6 billion, increasing 17% with 15 points of net impact from the Activision acquisition. Results were above expectations, driven by better-than-expected performance in gaming and Windows OEM. Windows OEM revenue increased 11% year-over-year, ahead of expectations, primarily driven by the slightly better PC market noted earlier as well as mix shift to higher monetizing markets. Windows commercial products and cloud services revenue increased 13% and 12% in constant currency, below expectations with impact from the growth trends in new stand-alone business noted earlier as well as lower in-period revenue recognition from a mix of contracts. Devices revenue decreased 17% and 16% in constant currency as we remain focused on our higher-margin premium products. Overall, Surface demand was slightly lower than expected. Search and News advertising revenue ex TAC increased 12% ahead of expectations with continued volume growth and increased engagement on Bing and Edge. And in gaming. Revenue increased 51% and 50% in constant currency with 55 points of net impact from the Activision acquisition. Results were ahead of expectations, primarily driven by Call of Duty. Xbox content and services revenue increased 62% and 61% in constant currency with 61 points of net impact from the Activision acquisition. Xbox hardware revenue decreased 31% and 30% in constant currency. Segment gross margin dollars increased 27% and 26% in constant currency, with 13 points of net impact from the Activision acquisition. Gross margin percentage increased roughly 4 points year-over-year, primarily driven by sales mix shift to higher-margin businesses. Operating expenses increased 41% with 43 points from the Activision acquisition. Operating income increased 16% and 15% in constant currency. Now back to total company results. Capital expenditures, including finance leases, were $14 billion to support our cloud demand, inclusive of the need to scale our AI infrastructure. Cash paid for PP&E was $11 billion. Cash flow from operations was $31.9 billion, up 31%, driven by strong cloud billings and collections. Free cash flow was $21 billion, up 18% year-over-year, reflecting higher capital expenditures to support our cloud and AI offerings. This quarter, other income and expense was negative $854 million, lower than anticipated, driven by losses on investments accounted for under the equity method. Our effective tax rate was approximately 18%. And finally, we returned $8.4 billion to shareholders through dividends and share repurchases. Now moving to our Q4 outlook, which unless specifically noted otherwise, is on a U.S. dollar basis. First, FX. Based on current rates, which reflect the recent strengthening of the U.S. dollar, we now expect FX to decrease total revenue and segment level revenue growth by less than 1 point. When compared to our January guide for Q4, FX, this is a decrease to total revenue of roughly $700 million. We expect FX to decrease COGS growth by approximately 1 point and operating expense growth by less than 1 point. In commercial bookings, we expect solid growth on a relatively flat expiry base driven by continued strong commercial sales execution. As a reminder, larger, long-term Azure contracts, which are more unpredictable in their timing, can drive increased quarterly volatility in our bookings growth rate. Microsoft Cloud gross margin percentage should decrease roughly 2 points year-over-year. Excluding the impact from the change in accounting estimate, Q4 cloud gross margin percentage will be down slightly as improvement in Azure, inclusive of scaling our AI infrastructure will be offset by sales mix shift to Azure. We expect capital expenditures to increase materially on a sequential basis driven by cloud and AI infrastructure investments. As a reminder, there can be normal quarterly spend variability in the timing of our cloud infrastructure build-outs and the timing of finance leases. We continue to bring capacity online as we scale our AI investments with growing demand. Currently, near-term AI demand is a bit higher than our available capacity. Next, to segment guidance. In Productivity and Business Processes, we expect revenue to grow between 9% and 11% in constant currency or US$19.9 billion to US$20.2 billion. In Office Commercial, revenue growth will again be driven by Office 365 with seat growth across customer segments and ARPU growth primarily through E5. We expect Office 365 revenue growth to be approximately 14% in constant currency. We continue to progress with adoption of CoPilot for Microsoft 365 and remain excited for the long-term growth opportunity. In our on-premises business, we expect revenue to decline in the mid to high teens. In Office Consumer, we expect revenue growth in the low to mid-single digits, driven by Microsoft 365 subscriptions. For LinkedIn, we expect revenue growth in the mid to high single digits driven by continued growth across all businesses. And in Dynamics, we expect revenue growth in the low to mid-teens, driven by Dynamics 365. For both LinkedIn and Dynamics, the continued bookings growth moderation noted earlier is a headwind to Q4 revenue growth. For Intelligent Cloud, we expect revenue to grow between 19% and 20% in constant currency or US$28.4 billion to US$28.7 billion. Revenue will continue to be driven by Azure, which, as a reminder, can have quarterly variability primarily from our per-user business and in-period revenue recognition depending on the mix of contracts. In Azure, we expect Q4 revenue growth to be 30% to 31% in constant currency or similar to our stronger-than-expected Q3 results. Growth will be driven by our Azure Consumption business and continued contribution from AI with some impact from the AI capacity availability noted earlier. Our per-user business should see benefit from Microsoft 365 suite momentum. Though we expect continued moderation in seat growth rates given the size of the installed base. In our on-premises server business, we expect revenue growth in the low to mid-single digits with continued hybrid demand, including licenses running in multi-cloud environments. And in Enterprise and Partner Services revenue should decline in the mid- to high single digits on a high prior year comparable for enterprise support services. In More Personal Computing, we expect revenue to grow between 10% and 13% in constant currency or US$15.2 billion to US$15.6 billion. Windows OEM revenue growth should be in the low to mid-single digits as PC market unit volumes continue at pre-pandemic levels. In Windows Commercial Products and Cloud Services, customer demand for Microsoft 365 and our advanced security solutions should drive revenue growth in the mid-single digits. As a reminder, our quarterly revenue growth can have variability primarily from in-period revenue recognition depending on the mix of contracts. In Devices, revenue should decline in the mid-teens as we continue to focus on our higher-margin premium products. Search and news advertising ex TAC revenue growth should be in the low to mid-teens, driven by continued volume strength. This will be higher than overall search and news advertising revenue growth, which we expect to be relatively flat. And in Gaming, we expect revenue growth in the low to mid-40s, including approximately 50 points of net impact from the Activision acquisition. We expect Xbox content and services revenue growth in the high 50s driven by approximately 60 points of net impact from the Activision acquisition. Hardware revenue will decline again year-over-year. Now back to company guidance. We expect COGS between US$19.6 billion to US$19.8 billion, including approximately $700 million from purchase accounting, integration and transaction-related costs from the Activision acquisition. We expect operating expense of US$17.15 billion to US$17.25 billion, including approximately $300 million from purchase accounting, integration and transaction-related costs from the Activision acquisition. Therefore, we now expect full year FY2024 operating margins to be up over 2 points year-over-year, even with our cloud and AI investments, the impact from the Activision acquisition and the headwind from the change in useful lives last year. This operating margin expansion reflects the hard work across every team to drive efficiencies and maintain disciplined cost management, knowing we will continue to grow our cloud and AI investments next year. Other income and expense should be roughly negative $850 million as interest income will be more than offset by interest expense and losses on investments accounted for under the equity method. As a reminder, we are required to recognize gains or losses on our equity investments which can increase quarterly volatility. We expect our Q4 effective tax rate to be approximately 18%. Now I’d like to share some closing thoughts as we look to the next fiscal year. We continue to focus on building businesses that create meaningful value for our customers and therefore, significant growth opportunities for years to come. In FY2025, that focus on execution should again lead to double-digit revenue and operating income growth to scale to meet the growing demand signal for our cloud and AI products, we expect FY2025 capital expenditures to be higher than FY2024. These expenditures over the course of the next year are dependent on demand signals and adoption of our services. So we will manage that signal through the year. We will also continue to prioritize operating leverage. And therefore, we expect FY2025 operating margins to be down only about 1 point year-over-year, even with our significant cloud and AI investments, as well as a full year of impact from the Activision acquisition. We are leading the AI platform wave and are committed to bringing that value to our global customers as we enter the final quarter of our fiscal year. With that, let’s go to Q&A, Brett.

Operator:

[Operator Instructions] And our first question comes from the line of Keith Weiss with Morgan Stanley. Please proceed.

Satya Nadella:

Thank you, Keith for the question, let me start and then Amy, you can add. At a high level, the way we, as a management team, talk about it is there are two sides to this, right? There is training and their inference. Given that we want to be a leader in this big generational shift and paradigm shift in technology, that's on the training side. We want to be able to allocate the capital required to essentially be training these large foundation models and stay on the leadership position there. And we've done that successfully all the way today, and you've seen it flow through our P&L, and you can continue to see that going forward. Then Amy referenced what we also do on the inference side, which is, one, we first innovate and build products. And of course, we have an infrastructure business that's also dependent on a lot of ISVs building products that run on our infrastructure. And it's all going to be demand driven. In other words, we track – we're closely what's happening with inference demand, and that's something that we will manage, as Amy said in her remarks very, very closely. So we feel – and obviously, we've been doing this, quite frankly, Keith, for now multiple years. So this is not the quarter. I realize in the news, it's a lot more in the quarter nowadays. But if you look at it, we have been doing what is essentially capital allocation to be a leader in AI for multiple years now, and we plan to sort of essentially keep taking that forward.

Keith Weiss:

Excellent. Thank you so much.

Operator:

The next question comes from the line of Brent Thill with Jefferies. Please proceed.

Satya Nadella:

Great question, Brent. There are a couple of things I’d say. On the Azure side, which I think is what you specifically asked, we feel very good about the – we are fundamentally a share taker there because if you look at it from our perspective at this point, Azure has become a protocol for pretty much anybody who is doing an AI project. And so that's sort of been a significant help for us in terms of acquiring even new customers. Some of the logos I even referenced in my remarks, our new Azure customers. So, that's one. The second thing that we're also seeing is AI just doesn't sit on its own. So, AI projects obviously start with calls to AI models, but they also use a vector database. In fact, Azure Search, which is really used by even ChatGPT is one of the fastest-growing services for us. We have Fabric integration to Azure AI. And so, Cosmos DB integration. So, the data tier, the dev tools is another place where we are seeing great traction. So, we are seeing adjacent services in Azure that get attached to AI. And lastly, I would say, migrations to Azure as well. So, this is not just all an AI story. We are also looking at customers, I mean, this is something that we have talked about in the past, which is there's always an optimization cycle, but there's also – as people optimize, they spend money on new project starts, which will grow and then they'll optimize. So, it's a continuous side of it. So, these are the three trends that are playing out on Azure in terms of what at least we see on demand side.

Brett Iversen:

Thanks, Brent. Operator, next question please.

Mark Moerdler:

Thank you very much for taking my question and congratulates on the quarter and the guidance. I want to follow up on the AI, obviously. We’re seeing companies shifting their IT spending to invest in and learn about AI rather than receiving additional budgets for AI. At some point, for AI to be transformative, as everyone expects, it needs to be accretive to spending. Satya, when do you believe AI will hit the maturity level, will be net increase to IT or outside of IT spending? And what would be the leading indicators of that maturation? And Amy, am I characterizing this correctly as it relates to Azure? Some projects are being delayed so that, that spending could be shifted from core Azure toward Azure AI? Thank you.

Amy Hood:

And Mark, maybe to answer your question on, are we seeing project starts transition from maybe the – something that was core consumption to an AI project? In our results, that’s not what we saw. We saw more what Satya was speaking to earlier, which is, you see maybe growth in migrations again. You’re seeing work in the data space, again, and you’re seeing AI project starts. And I think that’s why maybe you see our growth be different, of course, than you see IT budget spend. It’s because it’s a share, I think, improvement plus also really focusing on what Satya said, it’s about spending maybe in other areas that we don’t traditionally think of as being in the IT budget spend under a CIO. It’s spend being done by the Head of Customer Service, it’s spend being done by the Head of Marketing. And I do think that will be important as we think about the opportunity ahead.

Brett Iversen:

Thanks, Mark. Operator, next question please.

Karl Keirstead:

Thank you. And Satya and Amy, congrats on these outstanding Azure results. I’d love to hone in a little bit on the seven-point lift to Azure growth from AI, outstanding number, but it’s leveling off a little bit from six points in December. I’m wondering if you could unpack that a little bit. To what extent did the capacity issues that you Amy highlighted on the call, impact that number? Is there any seasonality? I wouldn’t think so or any other factor that can swing around that number that you’d advise us to keep in mind? Thanks so much.

Karl Keirstead:

Okay. Helpful. Thank you.

Operator:

And the next question comes from the line of Raimo Lenschow with Barclays. Please proceed.

Satya Nadella:

Yes, it's a great question. So the way we see it play out is, if you think about it, the way Office was used broadly for knowledge work was in the context of business processes, right? So it's not like – when people do knowledge work, they're not doing knowledge work, they're doing knowledge work and support of making progress in the context of sales enablement, customer service, revenue ops, supply chain or what have you, right? So that's the first thing to note. And they do it inside of e-mail. They do it inside of Teams. They do it inside of Excel, PowerPoint, Word and what have you. Now we have the ability to essentially bridge the work and the work artifacts inside of these knowledge worker tools with the workflow and the business process and the business process data. So when we think about our Copilot, our Copilot has that ability to integrate, whether it's with ServiceNow, it has the ability to integrate with SAP with Salesforce, with obviously Dynamics. That's what we are seeing. In fact, you'll hear us talk a lot about it at our developer conference, which is the extensibility and Copilot Studio is really off to the races in terms of the product that most people are excited because one of the things in the enterprise if you want to ground your Copilot with enterprise data, which is in all of these SaaS applications and Copilot Studio is the tool to use it, to make that happen. And so that's what we are seeing, which is we are building a Copilot, which also happens to be an orchestrator of all in other Copilots, which to us appear as extensions. And net-net, what happens is some of these knowledge worker tools that people have used all the time, right? Because when you think about Teams, when you're having a meeting, you're not doing a random meeting, the meeting is in the context of some business process. It could be a supply chain meeting where you're trying to understand which suppliers to bet on or what terms to do. And so now you can access all that data right in the Team's context. So that's I think what's exciting for us, having built all these horizontal tools, which I would say we're under underappreciated for the amount of work. How people use those tools to make progress on business process, but we now get to bridge that between the business applications and knowledge worker tools, tomorrow horizontally.

Brett Iversen:

Thanks Raimo. Operator, next question please.

Michael Turrin:

Hey. Great. Appreciate you taking the question. I wanted to go back to Azure. You've been hinting at stabilization there for the past couple of quarters, but still very good to see the balance. Maybe you can expand on just what the commercial bookings number, appreciating the variability there does in terms of visibility. And any characterization you can give us around what you're seeing in areas like cost optimization and core workload growth coming back is just helpful context for us in unpacking the numbers. Thank you.

Michael Turrin:

Consistent core cloud growth is still pretty exciting to us as well. Thank you.

Brett Iversen:

Thanks, Michael. Operator, next question please?

Kirk Materne:

Yes. Thanks for taking the question. I'll add my congrats in the quarter. Hey Satya, I was wondering if you could chime in on a discussion that comes up a lot with investors, which is, is there a sort of data quality problem in the market in terms of being able to take advantage of all these new GenAI capabilities? And I was just curious, if you could comment on, do you see companies making inroads on sort of addressing that? And do you see that as sort of an inhibitor to AI growth at all at this point? Thanks.

Kirk Materne:

Thank you.

Operator:

Our last question will come from the line of Alex Zukin with Wolfe Research. Please proceed.

Amy Hood:

Thanks for the question. It's a good opportunity to clarify. And I would not say that there is a capacity constraint on the Copilots. It's a real priority for us to make sure we optimize the allocation of our capacity to make sure that those per user businesses are able to continue to grow. And so think about that as our priority one. And so then what that does mean is capacity constraints when we have them, you'll tend to see them on the Azure infrastructure side, the consumption side of the business is a better way of thinking about it

Brett Iversen:

Thanks, Alex. 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.

Amy Hood:

Thank you.

Brett Iversen:

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; Alice Jolla, Chief Accounting Officer; and Keith Dolliver, Corporate Secretary and Deputy General Counsel. 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, and provides the reconciliation of differences between GAAP and non-GAAP financial measures. More detailed outlook slides will be available on the Microsoft Investor Relations website, when we provide outlook commentary on today's call. Microsoft, completed the acquisition of Activision Blizzard this quarter and we are reporting its results in our More Personal Computing segment, beginning on October 13, 2023. Accordingly, our Xbox content and services revenue growth investor metric includes the net impact of Activision. Additionally, our press release and slide deck contains supplemental information regarding the net impact of the Activision acquisition on our financial results. 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. They are included as additional clarifying items to aid investors in further understanding the company's second-quarter performance in addition to the impact these items and events have on the financial results. 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 growth rate only. We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If 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 replay the call and view the transcript on the Microsoft Investor Relations website. During this call, we'll 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. Actual results could materially differ because of factors discussed in today's earnings press release, in 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 the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that, I'll turn the call over to Satya.

Amy Hood:

Thank you, Satya, and good afternoon, everyone. This quarter, revenue was $62 billion, up 18% and 16% in constant currency. When adjusted for the prior year's Q2 charge, operating income increased 25% and 23% in constant currency, and earnings per share was $2.93, which increased 26% and 23% in constant currency. Results exceeded expectations and we delivered another quarter of double-digit top and bottom-line growth. Strong execution by our sales teams and partners drove share gains again this quarter across many of our businesses, as Satya referenced. In our commercial business, strong demand for our Microsoft cloud offerings, including AI services drove better-than-expected growth and large long-term Azure contracts. Microsoft 365 suite strength contributed to ARPU expansion for our office commercial business, while new business growth continued to be moderated for standalone products sold outside the Microsoft 365 suite. Commercial bookings were ahead of expectations and increased 17% and 9% in constant currency on a low expiry base. The strength in long-term Azure contracts mentioned earlier, along with strong execution across our core annuity sales motions, including healthy renewals drove our results. Commercial remaining performance obligation increased 17% and 16% in constant currency to $222 billion, roughly 45% will be recognized in revenue in the next 12 months, up 15% year-over-year. The remaining portion recognized beyond the next 12 months increased 19%. And this quarter, our annuity mix was 96%. In our consumer business, the PC and advertising markets were generally in line with our expectations. PC market volumes continued to stabilize at pre-pandemic levels [Technical Difficulty] Gaming console market was a bit smaller. As a reminder, my Q2 commentary includes the net impact of Activision from the date of acquisition, inclusive of purchase accounting, integration, and transaction-related expenses. The net impact includes adjusting for the movement of Activision content from our prior relationship as a third-party partner to first-party. At a company level, Activision contributed approximately 4 points to revenue growth, was a 2 point drag on adjusted operating income growth, and a negative $0.5 impact to earnings per share. This impact includes $1.1 billion from purchase accounting adjustments, integration and transaction-related costs, such as severance-related charges related to last week's announcement. FX was roughly in line with our expectations on total company revenue, segment-level revenue, COGS, and operating expense growth. Microsoft Cloud revenue was $33.7 billion, ahead of expectations, and grew 24% and 22% in constant currency. Microsoft Cloud gross margin percentage was 72%, relatively unchanged year-over-year. Excluding the impact of the change in accounting estimate for useful lives, gross margin percentage increased roughly 1 point, driven by improvement in Azure and Office 365, partially offset by the impact of scaling our AI infrastructure to meet growing demand. Company gross margin dollars increased 20% and 18% in constant-currency and gross margin percentage increased year-over-year to 68%. Excluding the impact of the change in accounting estimate, gross margin percentage increased roughly 2 points, even with the impact of $581 million from purchase accounting adjustments, integration, and transaction-related costs from the Activision acquisition. Growth was driven by improvement in devices, as well as the improvement in Azure and Office 365 as just mentioned. Operating expenses increased 3% with 11 points from the Activision acquisition, partially offset by 7 points of favorable impact from the prior year Q2 charge. The Activision impact includes $550 million from purchase accounting adjustments, integration, and transaction-related cost. At a company level, headcount at the end of December was 2% lower than a year ago. Operating margins increased roughly 5 points year-over-year to 44%. Excluding the impact of the change in accounting estimate, operating margins increased roughly 6 points driven by the higher gross margin noted earlier, the favorable impact from the prior year Q2 charge, and improved operating leverage through disciplined cost control. Now, to our segment results. Revenue from Productivity and Business Processes was $19.2 billion and grew 13% and 12% in constant currency, ahead of expectations, primarily driven by better-than-expected results in LinkedIn. Office commercial revenue grew 15% and 13% in constant currency. Office 365 commercial revenue increased 17% and 16% in constant currency, in line with expectations, driven by healthy renewal execution and ARPU growth from continued E5 momentum. Paid Office 365 commercial seats grew 9% year-over-year to over $400 million with installed base expansion across all customer segments. Seat growth was again driven by our small and medium business and frontline worker offerings, offset by the continued growth trends in new standalone business noted earlier. Office commercial licensing declined 17% and 18% in constant currency with continued customer shift to cloud offerings. Office Consumer revenue increased 5% and 4% in constant currency with continued momentum in Microsoft 355 subscriptions, which grew 16% to 78.4 million. LinkedIn revenue increased 9% and 8% in constant currency, ahead of expectations, driven by slightly better-than-expected performance across all businesses. In our Talent Solutions business bookings growth was again impacted by weaker hiring environment in key verticals. Dynamics revenue grew 21% and 19% in constant currency, driven by Dynamics 365, which grew 27% and 24% in constant currency with continued growth across all workloads. Bookings growth was impacted by weaker new business, primarily in Dynamics 365 ERP and CRM workloads. Segment gross margin dollars increased 14% and 12% in constant currency and gross margin percentage increased slightly year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage increased roughly 1 point, primarily driven by improvement in Office 365. Operating expenses decreased 5% and 6% in constant currency, with 5 points of favorable impact from the prior-year Q2 charge. Operating income increased 26% and 24% in constant currency. Next, the Intelligent Cloud segment, revenue was $25.9 billion, increasing 20% and 19% in constant currency, ahead of expectations, with better-than-expected results across all businesses. Overall server products and cloud services revenue grew 22% and 20% in constant currency. Azure and other cloud services revenue grew 30% and 28% in constant-currency, including 6 points of growth from AI services. Both AI and non-AI Azure services drove our outperformance. In our per-user business, the Enterprise Mobility and Security installed base grew 11% to over 268 million seats with continued impact from the growth trends in new standalone business noted earlier. In our on-premises server business, revenue increased 3% and 2% in constant currency, ahead of expectations, driven primarily by the better-than-expected demand related to Windows Server 2012 end of support. Enterprise and partner services revenue increased 1% and was relatively unchanged in constant currency with better-than-expected performance across enterprise support services and industry solutions. Segment gross margin dollars increased 20% and 18% in constant currency and gross margin percentage was relatively unchanged. Excluding the impact of the change in accounting estimate, gross margin percentage increased roughly 1 point, driven by the improvement in Azure noted earlier, partially offset by the impact of scaling our AI infrastructure to meet growing demand. Operating expenses decreased 8% and 9% in constant currency, with 9 points of favorable impact from the prior year Q2 charge, operating income grew 40% and 37% in constant currency. Now, to more Personal Computing. Revenue was $16.9 billion, increasing 19% and 18% in constant currency, in line with expectations overall. Growth includes 15 points of net impact from the Activision acquisition. Windows OEM revenue increased 11% year-over-year, ahead of expectations, driven by slightly better performance and higher monetizing consumer markets. Windows Commercial products and cloud services revenue increased 9% and 7% in constant-currency, below expectations primarily [Technical Difficulty] period revenue recognition from the mix of contracts. Annuity billings growth remains healthy. Devices revenue decreased 9% and 10% in constant currency, ahead of expectations due to stronger execution in the commercial segment. Search and news advertising revenue ex-TAC increased 8% and 7% in constant currency, relatively in line with expectations, driven by higher search volume, offset by negative impact from a third-party partnership. And in gaming, revenue increased 49% and 48% in constant currency, with 44 points of net impact from the Activision acquisition. Total gaming revenue was in line with expectations of stronger-than-expected performance from Activision was offset by the weaker-than-expected console market noted earlier. Xbox content and services revenue increased 61% and 60% in constant currency, driven by 55 points of net impact from the Activision acquisition. Xbox hardware revenue grew 3% and 1% in constant currency. Segment gross margin dollars increased 34% and 32% in constant currency with 17 points of net impact from the Activision acquisition. Gross margin percentage increased roughly 6 points year-over-year, driven by higher devices gross margin and sales mix shift to higher-margin businesses. Operating expenses increased 38% with 48 points of impact from the Activision acquisition, partially offset by 6 points of favorable impact from the prior year Q2 charge. Operating income increased 29% and 26% in constant currency. Now back to total company results. Capital expenditures, including finance leases were $11.5 billion, lower-than-expected due to delivery for a third-party capacity contract shifting from Q2 to Q3. Cash paid-for PP&E was $9.7 billion. These data center investments support our cloud demand, inclusive of needs to scale our AI infrastructure. Cash flow from operations was $18.9 billion, up 69% driven by strong cloud billings and collections on a prior year comparable that was impacted by lower operating income. Free cash flow was $9.1 billion, up 86% year-over-year, reflecting the timing of cash paid-for property and equipment. This quarter, other income and expense was in line with expectations, negative $506 million, driven by interest expense and net losses on investments, partially offset by interest income. Our effective tax rate was approximately 18%. And finally, we returned $8.4 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. First FX, based on current rates, we expect FX to increase total revenue and segment-level revenue growth by less than 1 point. And we expect no impact to COGS and operating expense growth. In commercial bookings, strong execution across our core annuity sales motions, including healthy renewals along with long-term Azure commitments should drive healthy growth on a growing expiry base. Microsoft Cloud gross margin percentage should decrease roughly 1 point year-over-year, excluding the impact from the accounting estimate change, Q3 cloud gross margin percentage will be relatively flat as improvement in Office 365 and Azure will be offset by sales mix shift to Azure, as well as the impact of scaling our AI infrastructure to meet growing demand. We expect capital expenditures to increase materially on a sequential basis, driven by investments in our cloud and AI infrastructure and the flip of a delivery date from Q2 to Q3 from a third-party provider noted earlier. As a reminder, there can be normal quarterly spend variability in the timing of our cloud infrastructure build-out. Next to segment guidance. In Productivity and Business Processes, we expect revenue of $19.3 billion to $19.6 billion or growth between 10% and 12%. In Office Commercial revenue growth will again be driven by Office 365 with seat growth across customer segments and ARPU growth through E5. We expect Office 365 revenue growth to be approximately 15% in constant currency. While it's early days for Microsoft 365 Copilot, we're excited by the adoption we've seen to date and continue to expect revenue to grow over time. In our on-premise business, we expect revenue to decline in the low 20s. In Office Consumer, we expect revenue growth in the mid-to-high single-digits, driven by Microsoft's 365 subscriptions. For LinkedIn, we expect revenue growth in the mid-to-high single digits, driven by continued growth across all businesses. And in Dynamics, we expect revenue growth in the mid-teens, driven by Dynamics 365. For Intelligent Cloud, we expect revenue of $26 billion to $26.3 billion or growth between 18% and 19%. Revenue will continue to be driven by Azure, which, as a reminder, can have quarterly variability, primarily from our per-user business and from in-period revenue recognition, depending on the mix of contracts. In Azure, we expect Q3 revenue growth in constant currency to remain stable to our stronger-than-expected Q2 results. Growth will be driven by our Azure consumption business with continued strong contribution from AI. Our per-user business should see benefit from Microsoft 365 Suite momentum though we expect continued moderation in seat growth rates given the size of the installed base. In our on-premises server business, we expect revenue growth in the low-to-mid single-digits with continued hybrid demand, including licenses running in multi-cloud environments. And in the enterprise and partner services revenue should decline approximately 10% on a high prior year comparable for enterprise support services and more Personal Computing, we expect revenue of $14.7 billion, $15.1 billion or growth between 11% and 14%. Windows OEM revenue growth should be relatively flat as PC market unit volumes continue at pre-pandemic levels. In Windows Commercial products and cloud services, customer demand for Microsoft 365 and our Advanced Security Solutions should drive revenue growth in the mid-teens. As a reminder, our quarterly revenue growth can have variability, primarily from in-period revenue recognition, depending on the mix of contracts. In Devices, revenue should decline in the low-double-digits as we continue to focus on our higher-margin premium products. Search and news advertising ex-TAC revenue growth should be in the mid-to-high single-digits, about 8 points higher than overall search and news advertising revenue, driven by continued volume strength. And in gaming, we expect revenue growth in the low 40s, including approximately 45 points of net impact from the Activision acquisition. We expect Xbox content and services revenue growth in the low-to-mid 50s, driven by approximately 50 points of net impact from the Activision acquisition. Hardware revenue will decline year-over-year. Now back to company guidance. We expect COGS between $18.6 billion to $18.8 billion, including approximately $700 million of amortization of acquired intangible assets from the Activision acquisition. We expect operating expenses of $15.8 billion to $15.9 billion, including approximately $300 million from purchase accounting, integration, and transaction-related costs from the Activision acquisition. Other income and expenses should be roughly negative $600 million as interest income will be more than offset by interest expense and other losses. As a reminder, we are required to recognize gains or losses on our equity investments, which can increase quarterly volatility. We expect our Q3 effective tax rate to be in line with our full-year rate, which we now expect to be approximately 18%. Now, some additional thoughts on the full-fiscal year. First FX, assuming current rates remain stable, we now expect FX to increase Q4 and full-year revenue growth by less than 1 point. We continue to expect no meaningful impact to full-year COGS or operating expense growth. Second Activision. For the full-year FY 2024, we expect Activision to be accretive to operating income, when excluding purchase accounting, integration and transaction-related cost. At a total company level, we delivered strong results in H1 and demand for our Microsoft Cloud continues to drive the growth in our outlook for H2. Our commitment to scaling our cloud and AI investment is guided by customer demand and a substantial market opportunity. As we scale these investments, we remain focused on driving efficiencies across every layer of our tech stack and disciplined cost management across every team. Therefore, we expect full-year operating margins to be up 1 to 2 points year-over-year, even as AI capital investments drive COGS growth. This operating margin expansion excludes the impact from the Activision acquisition and the headwind from the change in useful lives last year. In closing, we are focused on execution. So our customers can realize the benefits of AI productivity gains as we invest to lead this AI platform wave. With that, let's go to Q&A, Brett.

Operator:

[Operator Instructions] And our first question comes from the line of Mark Moerdler with Bernstein Research. Please proceed.

Satya Nadella:

You want me to go first and...

Satya Nadella:

Yes, let me -- just on the inferencing and training, most of what you've seen for the most part is all inferencing. So, none of the large model training stuff is in any of our higher numbers at all. What small batch training, so somebody is doing fine-tuning or what have you, that will be there, but that's sort of a minor part. So, most of what you see in the Azure number is broadly inferencing. And Mark, I think it may be helpful to sort of think about, like what is the new workload in AI? The new workload in AI, obviously, in our case starts with one of the frontier -- I mean, starts with the Frontier model Azure OpenAI. But it's not just about just one model, right. So, you first -- you take that model, you do RLHF, you may do some fine-tuning, you do retrieval, which means you are sort of either heating some storage meter or you're heating some compute meters. And so to -- and by the way, you will also distil a large model to a small model and that would be a training perhaps. But that's a small batch training that uses essentially inference infrastructure. So, I think that's what's happening. So you could even say these AI workloads themselves will have a lifecycle which is they'll get rebuilt, then there'll be continuously optimized over time. So, that's sort of one-side. And I think if I understand your question, what's happening with the traditional optimization, and I think last quarter we said. One, we're going to continue to have these cycles where people will build new workloads, they will optimize the workloads and then they'll start new workloads. So I think that that's what we continue to see. But that period of massive, I'll call it, optimization only and no new workloads start, that I think has ended at this point. So what you're seeing is much more of that continuous cycles by customers, both whether it comes to AI or whether it comes to the traditional workloads.

Mark Moerdler:

Perfect. Thank you very much for the deep answer.

Operator:

Our next question comes from the line of Brent Thill with Jefferies. Please proceed.

Amy Hood:

Thanks, Brent. First of all, thanks for the question. The teams are obviously been hard at work on this topic. We do point out that, Q2 because of the impact of the charge a year ago, you're seeing larger margin improvement than I would say, sort of a run-rate margin improvement. So, let me first say that. Secondly, the absolute margin improvement has also been very good and it speaks to, I think one of the things Satya talked about and I reiterated a bit, which is that, we want really to make sure we're making investments, we're making them in consistency across the tech stack. The tech stack we're building, no matter what team is on, is inclusive of AI enablement. And so think about as building that consistency without needing to add a lot of resources to do that. It's been a real pivot of our entire investment infrastructure to be working on this work. And I think that's important, because it means you're shifting to an AI-first position, not just in the language we use, but in what people are working on day-to-day. That does obviously create a leverage opportunity. There has also been really good work put in by many teams on improving the gross margin of the products; we talked about it with Office 365, we talked about in Azure core. We even talked about it across our devices portfolio, where we've seen material improvements over the course of the year. And so, when you kind of take improvements at the gross margin level, plus this consistency of re-pivoting our workforce toward the AI-first work we're doing, without adding material number of people to the workforce, you end up with that type of leverage. And we still need to be investing. And so, the important part, invest towards the thing that's going to shape the next decade and continue to stay focused on being able to deliver your day-to-day commitments. And so it's a great question. And hopefully, that helps piece apart a few of the components.

Brett Iversen:

Thanks, Brent. Joe next question, please.

Kash Rangan:

Hi, thank you very much. A superb quarter of great improvements. Just one question for you Satya. Cloud computing changed the tech stack in ways that we could not imagine 10 years back, the nature of the database layer, the operating system layer, every layer just changed dramatically. How do you foresee generative AI changing the tech stack as we know it? Thank you so much.

Kash Rangan:

Terrific. Thank you so much.

Operator:

Our next question comes from the line of Karl Keirstead with UBS. Please proceed.

Amy Hood:

Thanks, Karl. Maybe I'll start and Satya feel free to add on. I think we feel really good about where we have been in terms of adding capacity. You started to see the acceleration in our capital expense starting almost a year ago, and you've seen us scale through that process. And that is going toward as we talked about Servers and also new data center footprints to be able to meet what we see as this demand and really changing demand as we look forward. And so, I do feel like the team has done a very good job. I feel like, primarily obviously, this is being built by us, but we've also used third-party capacity to help when we could have that help us in terms of meeting customer demand. And I think looking forward, you'll tend to C&I guide toward it, accelerated capital expense to continue to be able to add capacity in the coming quarters, given what we see in terms of pipeline.

Operator:

Our next question comes from the line of Brad Zelnick with Deutsche Bank. Please proceed.

Satya Nadella:

No, thank you for the question, Brad. So, a couple of things. In my comments I said increase in relation to our previous suites like, let's say, E3 or E5. Whatever two months in, it's definitely much faster than that. And so, from that perspective. It's exciting to see, I’d say, the demand signal, the deployment signal. I was looking at by tenant, even usage, it's faster than anything else because it's easier, right. I mean, it's sort of -- it shows up in your app, if you click on it, like any ribbon thing and it becomes a daily habit. So it in fact, it reminds me a little bit of sort of the back-in-the day of PC adoption, right. It's kind of -- I think it first starts off with few people having access. There are many companies that are doing standard issue, right. So just like PCs became standard issue at some point after PCs being adopted by early adopters. I think that's the cycle that at least we expect. In terms of what we're seeing, it's actually interesting, If you look at the data we have, summarization, that's what it's like number-one, like I'm doing summarization of Teams meetings inside of Teams, during the meeting, after the meeting, word documents summarization, I get something in email on summarizing. So summarization has become a big deal. Drafts, right, you're drafting emails, drafting documents. So, anytime you want to start something, the blank page thing goes away and you start by prompting and drafting. Chat, to me, the most powerful feature is now you have the most important database in your company, which happens to be the database of your documents and communications. It is now queryable by natural language in a powerful way, right. I can go and say, what are all the things Amy said, I should be watching out for next quarter and it will come out with great detail. And so Chat, summarization, draft, also by the way, actions. One of the most used thing is, here's the Word document, go complete, I mean, create a PowerPoint for me. So, those are the stuff that is also beginning. So, I feel like these all become -- but fundamentally, what happens is, if you remember the PC adoption cycle, what it did was work artifact and work flow changed, right. You can imagine what forecasting was before excel and email and what it was after. So similarly, you'll see work and workflow change as people summarize faster, draft regulatory submissions faster. Chat to get knowledge from your business. And so, those are the things that we are seeing as overall patterns.

Brad Zelnick:

Excellent, thank you so much.

Operator:

Our next question comes from the line of Mark Murphy with J.P. Morgan. Please proceed.

Amy Hood:

Mark, without getting into tons of line items, it's more simple to think of it as really, it's people adopting it for inferencing at the API generally. I mean that's the easiest way to think about it. And we also saw growth in GitHub Copilot which you talked -- which Satya talked about and we saw a growing number of third parties using it in some small ways for training. But this is primarily an inferencing workload right now in terms of what's driving that number. We used to think of it that way.

Mark Murphy:

Thank you.

Operator:

Our next question comes from the line of Brad Reback with Stifel. Please proceed.

Amy Hood:

That's a great question, Brad. Let me split apart the components. And then we can come back to whether they should equalize or just go on sort of a bit, actually believe it or not, somewhat independent trajectory and I will explain why I say that. Your seat growth as we talk about is primarily from, at this point, small and medium-size businesses and really frontline workers scenarios. And to your point on occasion, those are lower ARPU seats, but there are also -- there are new seats and so you see that in the seat count number. And as we get through and we've seen that come down a little bit quarter-over-quarter and we've guided for that really to happen again next quarter, but a very separate thing is being able to add ARPU. And traditionally, and again this quarter, right, that's come over-time from E3. Then from E5. And we're continuing to see very healthy seat momentum and you heard very good renewals. So, all of that, right, completely independent in some way from seat growth. Then the next thing, that actually we just talked about, maybe in Brad's question I'm trying to recall is that, you're going to see Copilot revenue will run there as ARPU, right. That won't show a seat growth. So you'll have E3, E5 transition, Copilot, all show-up in ARPU over time, and then you’ll have the seat growth be primarily still small business and frontline worker and maybe new industry scenarios. So, I tend to not really, Brad, think about them as related lines, believe it or not. I think about them as sort of unique Independent motions we run and there is still room for seat growth and obviously with the levers we've talked about, there's room for ARPU growth as well.

Brett Iversen:

Thanks, Brad. Joe we have time for one last question.

Tyler Radke:

Thanks for taking my question. Satya your enthusiasm about GitHub Copilot was noticeable on the conference call and at the AI Summit in New York last week. I'm wondering how you're thinking about pricing, obviously, this is driving pretty incredible breakthroughs and productivity for developers. But how do you think about your ability to drive ARPU on the GitHub Copilot over-time and just talk us through how you're thinking about the next phase of new releases there?

Brett Iversen:

Thanks, Tyler. 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.

Satya Nadella:

Thank you.

Brett Iversen:

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; Alice Jolla, Chief Accounting Officer; and Keith Dolliver, Corporate Secretary and Deputy General Counsel. 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, and provides the reconciliation of differences between GAAP and non-GAAP financial measures. More detailed outlook slides will be available on the Microsoft Investor Relations website when we provide outlook commentary on today's call. Microsoft, completed the acquisition of Activision Blizzard, on October 13, 2023. We will share more on the expected impact of the Activision acquisition during the outlook commentary portion of today's call. 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. They are included as additional clarifying items to aid investors in further understanding the company's first-quarter performance, in addition to the impact these items and events have on the financial results. All growth comparisons we make on the call today, relate to the corresponding period of last year unless otherwise noted. We'll 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 growth rate only. We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If 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 replay the call and view the transcript on the Microsoft Investor Relations website. During this call, we'll 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. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call, and in the Risk Factors section of our Form 10-K, Form 10-Q, and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that, I'll turn the call over to Satya.

Amy Hood:

Thank you, Satya, and good afternoon, everyone. This quarter's revenue was $56.5 billion, up 13% and 12% in constant currency. Earnings per share was $2.99 and increased 27% and 26% in constant currency. Consistent execution by our sales teams and partners drove a strong start to the fiscal year. Results exceeded expectations and we saw share gains again this quarter across many businesses, as customers adopt our innovative solutions to transform their businesses. In our commercial business, the trends from the prior quarter continued. We saw healthy renewals, particularly in Microsoft 365 E5 and growth of new business continued to be moderated for standalone products sold outside the Microsoft 365 suite. In Azure, as expected the optimization trends were similar to Q4. Higher-than-expected AI consumption contributed to revenue growth in Azure. And our consumer business, PC market unit volumes are returning to pre-pandemic levels. Advertising spend, landed roughly in line with our expectations and in gaming strong engagement helped by the Starfield launch benefited Xbox content and services. Commercial bookings increased 14% and 17% in constant currency, in line with expectations, primarily driven by strong execution across our core annuity sales motions, with continued growth in the number of $10 million plus contracts for both Azure and Microsoft 365. Commercial remaining performance obligation, increased 18% to $212 billion, and roughly 45% will be recognized in revenue in the next 12 months, up 15% year-over-year. The remaining portion, which will be recognized beyond the next 12 months increased 20% and this quarter, our annuity mix was 96%. FX did not have a significant impact on our results and was roughly in line with our expectations on total company revenue, segment-level revenue, COGS, and operating expense growth. Microsoft Cloud revenue was $31.8 billion and grew 24% and 23% in constant currency, ahead of expectations. Microsoft Cloud's gross margin percentage increased slightly year-over-year to 73%, a point better than expected, primarily driven by improvements in Azure. Excluding the impact of the change in accounting estimate for useful lives, Microsoft Cloud's gross margin percentage increased roughly 2 points, driven by the improvement just mentioned in Azure as well as Office 365, partially offset by the impact of scaling our AI infrastructure to meet growing demand. Company gross margin dollars increased 16% and 15% in constant currency and gross margin percentage increased year-over-year to 71%. Excluding the impact of the change in accounting estimate, the gross margin percentage increased roughly 3 points, driven by the improvement in Azure and Office 365 as well as sales mix shift to higher margin businesses. Operating expenses increased 1%, lower than expected due to cost-efficiency focus as well as investments that shifted to future quarters. Operating expense growth was driven by marketing, LinkedIn, and cloud engineering, partially offset by devices. At a total company level, headcount at the end of September was 7% lower than a year ago. Operating income increased 25% and 24% in constant currency. Operating margins increased roughly 5 points year-over-year to 48%. Excluding the impact of the change in accounting estimate, operating margins increased roughly 6 six points, driven by improved operating leverage through cost management and the higher gross margin noted earlier. Now to our segment results. Revenue from Productivity and Business Processes was $18.6 billion and grew 13% and 12% in constant currency, ahead of expectations, driven by better-than-expected results in Office 365 Commercial and LinkedIn. Office Commercial revenue grew 15% and 14% in constant currency. Office 365 Commercial revenue increased 18% and 17% in constant currency, slightly better than expected with a bit more in-period revenue recognition, while billings remained relatively in line with expectations. Growth continues to be driven by healthy renewal execution and ARPU growth, as E5 momentum remains strong. Paid Office 365 Commercial seats grew 10% year-over-year, with installed-base expansion across all customer segments. Seat growth was again driven by our small and medium business and frontline worker offerings with continued impact from the growth trends in new standalone business noted earlier. Office Commercial licensing declined 17%, in line with the continued customer shift to cloud offerings. Office Consumer revenue increased 3% and 4% in constant currency with continued momentum in Microsoft 365 subscriptions, which grew 18% to 76.7 million. LinkedIn revenue increased 8%, ahead of expectations, driven by slightly better-than-expected performance across all businesses. Growth was driven by Talent Solutions, though we continue to see negative year-over-year bookings there from the weaker hiring environment in key verticals. Dynamics revenue, grew 22% and 21% in constant currency, driven by Dynamics 365, which grew 28% and 26% in constant currency with continued growth across all workloads. Segment gross margin dollars increased 13% and gross margin percentage increased slightly year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage increased roughly, 1 point, driven by improvements in Office 365. Operating expenses increased to 2% and operating income increased 20% and 19% in constant currency. Next, the Intelligent Cloud segment. Revenue was $24.3 billion, increasing 19% and ahead of expectations, with better-than-expected results across all businesses. Overall, server products and cloud services revenue grew 21%. Azure and other cloud services revenue grew 29% and 28% in constant currency, including roughly 3 points from AI Services. While the trends from prior quarter continued, growth was ahead of expectations, primarily driven by increased GPU capacity and better-than-expected GPU utilization of our AI services, as well as slightly higher-than-expected growth in our per-user business. In our per user business, the enterprise mobility and security installed base, grew 11% to over 259 million seats with continued impact from the growth trends in new standalone business noted earlier. In our on-premises server business, revenue increased 2% ahead of expectations, driven primarily by demand in advance of Windows Server 2012 end of support. Enterprise and partner services revenue increased 1% and was relatively unchanged in constant currency ahead of expectations, driven by a better-than-expected performance in Enterprise Support Services. Segment gross margin dollars increased 20% and 19% in constant currency and gross margin percentage increased slightly. Excluding the impact of the change in accounting estimate, gross margin percentage increased roughly 2 points, driven by the improvement in Azure noted earlier, even as we scale our AI infrastructure to meet growing demand. Operating expenses increased 2% and 1% in constant currency, operating income grew 31% and 30% in constant currency. Now to More Personal Computing, revenue was $13.7 billion, increasing 3% and 2% in constant currency, above expectations, with better-than-expected results across all businesses. Windows OEM revenue increased 4% year-over-year, significantly ahead of expectations, driven by stronger-than-expected consumer channel inventory builds and the stabilizing PC market demand noted earlier, particularly in commercial. Windows Commercial products and cloud services revenue increased 8%, driven by demand for Microsoft 365 E5. Devices revenue decreased 22%, ahead of expectations due to stronger execution in the commercial segment. Search and news advertising revenue, ex-TAC increased 10% and 9% in constant currency, slightly ahead of expectations. We saw increased engagement on Bing and Edge share gains again this quarter, although search revenue growth continues to be impacted by a third-party partnership. And in gaming, revenue increased 9% and 8% in constant currency, ahead of expectations, driven by better-than-expected subscriber growth in Xbox Game Pass as well as first-party content, primarily due to the Starfield launch. Xbox content and services revenue increased 13% and 12% in constant currency and Xbox hardware revenue declined 7% and 8% in constant currency. Segment gross margin dollars increased 13% and 12% in constant currency, and gross margin percentage increased roughly 5 points year-over-year, driven primarily by sales mix-shift to higher-margin businesses. Operating expenses declined 1% and operating income increased 23% and 22% in constant currency. Now back to total company results. Capital expenditures, including finance leases were $11.2 billion to support cloud demand, including investments to scale our AI infrastructure. Cash paid for PP&E was $9.9 billion. Cash flow from operations was $30.6 billion, up 32% year-over-year, driven by strong cloud billings and collections. Free cash flow was $20.7 billion, up 22% year-over-year. This quarter, other income and expense was $389 million, higher-than-anticipated, driven by interest income, partially offset by net losses on investments and foreign currency remeasurement. Our effective tax rate was approximately 18%. And finally, we returned $9.1 billion to shareholders, through share repurchases and dividends. Now moving to our Q2 outlook, which unless specifically noted otherwise is on a U.S. dollar basis. The Activision acquisition closed on October 13. So my commentary includes the net impact of the deal from the date of acquisition. Our outlook includes purchase accounting impact, integration, and transaction-related expenses based on our current understanding of the purchase price allocation and related deal accounting. The net impact includes adjusting for the movement of Activision content from our prior relationship as a third-party partner to first party. Now to FX. Based on current rates, we expect FX to increase total revenue and segment-level revenue growth by approximately 1 point. We expect FX to have no impact to COGS and operating expense growth. In commercial bookings, we expect consistent execution across our core annuity sales motions, including healthy renewals. The growth will be impacted by a low growth expiry base. Therefore, we expect bookings growth to be relatively flat. Microsoft Cloud gross margin percentage to be relatively flat year-over-year, excluding the impact from the accounting estimate change, Q2 Cloud gross margin percentage will be up roughly 1 point, primarily driven by improvement in Azure and Office 365, partially offset by the impact of scaling our AI infrastructure to meet growing demand. We expect capital expenditures to increase sequentially on a dollar basis, driven by investments in our cloud and AI infrastructure. As a reminder, there can be normal quarterly spend variability in the timing of our cloud infrastructure buildout. Next to segment guidance. In Productivity and Business Processes, we expect revenue to grow between 11% and 12% or $18.8 billion to $19.1 billion. Growth in constant currency will be approximately 1 point lower. In Office Commercial, revenue growth will again be driven by Office 365 with seat growth across customer segments and ARPU growth through E5. We expect Office 365 revenue growth to be up roughly 16% in constant currency. We're excited for Microsoft 365 Copilot general availability on November 1st, and expect the related revenue to grow gradually over time. In our on-premise business, we expect revenue to decline in the mid-to-high teens. In Office Consumer, we expect revenue growth in the mid-single-digits, driven by Microsoft 365 subscriptions. For LinkedIn, we expect revenue growth in the mid-single-digits, driven by Talent Solutions and Marketing Solutions. Growth continues to be impacted by the overall market environment for recruiting and advertising, especially in the technology industry, where we have significant exposure. And in Dynamics, we expect revenue growth in the high teens, driven by Dynamics 365. For Intelligent Cloud, we expect revenue to grow between 17% and 18% or $25.1 billion to $25.4 billion. Revenue growth in constant currency will be approximately 1 point lower. Revenue will continue to be driven by Azure, which as a reminder can have quarterly variability, primarily from our per-user business and from in-period revenue recognition, depending on the mix of contracts. In Azure, we expect revenue growth to be 26% to 27% in constant currency, with an increasing contribution from AI. Growth continues to be driven by Azure consumption business and we expect the trends from Q1 to continue into Q2. Our per user business should continue to benefit from Microsoft 365 suite momentum, though we expect continued moderation in seat growth rates, given the size of the installed base. For H2, assuming the optimization and new workload trends continue and with the growing contribution from AI, we expect Azure revenue growth in constant currency to remain roughly stable compared to Q2. And our on-premises server business, we expect revenue growth to be roughly flat with continued hybrid demand, particularly from licenses running in multi-cloud environments. And in enterprise and partner services, revenue should decline by low-to-mid single digits. Now to more Personal Computing, which includes the net impact from the Activision acquisition. We expect revenue of $16.5 billion to $16.9 billion. Windows OEM revenue growth should be mid-to-high single digits with PC market unit volumes expected to look roughly similar to Q1. In devices, revenue should decline in the mid-teens as we continue to focus on our higher-margin premium products. In Windows Commercial products and cloud services, customer demand for Microsoft 365 and our advanced security solutions should drive revenue growth in the low-to-mid teens. Search and news advertising ex-TAC revenue growth should be mid-single digits with roughly 4 points of negative impact from a third-party partnership. Growth should be driven by volume strength, supported by Edge browser share gains and increasing Bing engagement, as we expect the advertising spend environment to be similar to Q1. A reminder that this ex-TAC growth will be roughly 4 points higher than overall search and news advertising revenue. And in gaming, we expect revenue growth in the mid-to-high 40s. This includes roughly 35 points of net impact from the Activision acquisition, which as a reminder includes adjusting for the third-party to first-party content change noted earlier. We expect Xbox content and services revenue growth in the mid-to-high 50s, driven by roughly 50 points of net impact from the Activision acquisition. Now back to company guidance. We expect COGS between $19.4 billion to $19.6 billion, including approximately $500 million of amortization of acquired intangible assets from the Activision acquisition. We expect operating expense of $15.5 billion to $15.6 billion, including approximately $400 million from purchase accounting adjustments, integration and transaction-related cost from the Activision acquisition. Other income and expense should be roughly negative $500 million, as interest income will be more than offset by interest expense, primarily due to a reduction in our investment portfolio balance and the issuance of short-term debt, both for the Activision acquisition. As a reminder, we are required to recognize gains or losses on our equity investments, which can increase quarterly volatility. We expect our Q2 effective tax rate to be between 19% and 20%. Now, some additional thoughts on H2 as well as the full fiscal year. First, FX, assuming current rates remain stable, we expect FX to have no meaningful impact to full year revenue COGS or operating expense growth. Therefore, in H2, we expect FX to decrease revenue COGS and operating expense growth by 1 point. Second, Activision, we expect approximately $900 million for purchase accounting adjustments as well as integration and transaction-related costs in each quarter in H2. For a full FY '24, we remain committed to investing for the cloud and AI opportunity, while also maintaining our disciplined focus on operating leverage. Therefore, as we add the net impact of Activision, inclusive of purchase accounting adjustments as well as integration and transaction-related expenses, we continue to expect full year operating margins to remain flat year-over-year. In closing, with our strong start to FY '24, I am confident that as a team, we will continue to deliver healthy growth in the year ahead, driven by our leadership in commercial cloud and our commitment to lead the AI platform wave. With that. Let's go to Q&A, Brett.

Operator:

Yes. [Operator Instructions] And our first question comes from the line of Keith Weiss with Morgan Stanley. Please proceed.

Satya Nadella:

Maybe I can start, Keith, and Amy you can add to it. Overall there are multiple things, Keith, they're all happening obviously simultaneously. If you just take Azure and try to characterize, where's the growth for Azure coming from or what sort of drivers for Azure numbers, there are three things all happening in parallel. Like, for example, take cloud migrations. A good reminder of where we are and even the core cloud migration story is the new Oracle announcement. Once we announced that the Oracle databases are going to be available on Azure, we saw a bunch of unlock from new customers who have significant Oracle estates that have not yet moved to the cloud because they needed to rendezvous with the rest of the app estate in one single cloud. And so we're excited about that. So in some sense, even the financial services sector, for example, is a good place where there's a lot of Oracle that still needs to move to the cloud. The second thing, of course, is the workloads start, then workloads get optimized, and then new workloads start, and that cycle continues. We'll lap some of those optimization cycles that were fairly extreme perhaps in the second half of our fiscal. And the third thing is, for us, that's unique and different is new workload starts around AI. Given our leadership position, we are seeing complete new projects start, which are AI projects. And as you know, AI projects are not just about AI meters, they have lots of other cloud meters as well. So that sort of gives you one side of what's happening in terms of enterprise. The other piece is on the SaaS side, obviously, again, this is a new product that's going to go through the enterprise adoption cycle. The results around productivity, which we demonstrated with GitHub Copilot, is what's giving us good confidence and our customers, more importantly, good confidence around what these products represent in terms of value. And so we are in the very early innings there, and so we look forward to seeing the traction for these products going forward.

Keith Weiss:

Excellent. Thank you, guys.

Operator:

Your next question comes from the line of Mark Moerdler with Bernstein Research. Please proceed.

Satya Nadella:

No. Thank you for the question, Mark. Yeah, it is true that we have -- the approach we have taken is a full stack approach all the way from whether it's ChatGPT or Bing Chat or all our Copilots, all share the same model. So in some sense, one of the things that we do have is very, very high leverage of the one model that we used -- which we trained, and then the one model that we are doing inferencing at scale. And that advantage sort of trickles down all the way to both utilization internally, utilization of third parties, and also over time, you can see the sort of stack optimization all the way to the silicon because the abstraction layer to which the developers are riding is much higher up than low-level kernels if you will. So, therefore, I think there is a fundamental approach we took, which was a technical approach of saying we'll have Copilots and Copilot stack all available. That doesn't mean we don't have people doing training for open source models or proprietary models. We also have a bunch of open source models. We have a bunch of fine-tuning happening, a bunch of RLHF happening. So there's all kinds of ways people use it. But the thing is, we have scale leverage of one large model that was trained and one large model that's being used for inference across all our first-party SaaS apps, as well as our API in our Azure AI service…

Satya Nadella:

Yeah. I mean, one other thing I'd just add to perhaps Mark's question as well as Keith's is, this platform transition, I think is very important for us to be very disciplined on both. I'll call our tech stack as well as our capital spend all to be concentrated. The lesson learned from the cloud side is -- we're not running a conglomerate of different businesses, it's all one tech stack up and down Microsoft's portfolio, and that, I think, is going to be very important because that discipline, given what the spend like -- it will look like for this AI transition any business that's not disciplined about their capital spend accruing across all their businesses could run into trouble.

Brett Iversen:

Thanks, Mark. Joe, next question, please.

Brent Thill:

Thanks, Amy. Good to see the 12% growth. Many investors are asking, can you sustain double-digit growth, especially with a stronger AI boost coming in the next several quarters?

Brett Iversen:

Thanks, Brent. Joe, next question, please.

Raimo Lenschow:

Hey. Thank you. You sound very optimistic about the opportunity in the office space with Copilot coming out now very soon. Can you speak a little bit about -- what you're seeing in the customer base that tested this already in terms of how excited they were -- the special features there, and what does it mean in terms of adoption curve for that going forward once you go GA on 1st of November? Thank you.

Raimo Lenschow:

Thank you.

Operator:

The next question comes from the line of Karl Keirstead with UBS. Please proceed.

Amy Hood:

Thanks, Karl. A couple of things. As I talked about Q2 and then into H2. We've been very consistent that the optimization trends have been consistent for us through a couple of quarters now. Customers are going to continue to do that. It's an important part of running workloads that is not new. There obviously were some quarters where it was more accelerated, but that is a pattern that is and has been a fundamental part of having customers, both make new room for new workload adoption and continue to build new capabilities. And so I think that impact remains through the rest of the year, and my view is unchanged on that. And then of course, I think the key component has always been new workload starts. And at the scale we're talking about, being able to have stability in our Azure business, does mean that we will have a lot of new workload starts. And primarily we're expecting those to come from AI workloads. But AI workloads don't just use our AI services. They use data services and they use other things. And so that combination, I think, looking on a competitive basis, we feel good about our execution, we feel good about taking share and we feel good about consistent trends. And so I feel good about that guide and what it says about where we are on share.

Brett Iversen:

Thanks, Karl. Joe, next question, please.

Bradley Sills:

Wonderful. Thanks so much. Very impressive to see the Office 365 commercial seat growth hanging in here in that double digit range. It's very impressive just given the scale of that business. We think of Office as having such a dominant market position. Curious, how you think about the -- where that seat is coming from and how many more of those seats are out there to go get?

Bradley Sills:

Thank you.

Operator:

Your next question comes from the line of Brent Bracelin with Piper Sandler. Please proceed.

Amy Hood:

You think -- thanks for that question. I think there are a couple things going on and I do -- I would say in particular, this was a very good leverage quarter in that segment. Number one, the Azure revenue growth and the stability we're seeing in it, absolutely is that help the operating leverage. The second component of that is in our core Azure business. The team continues to deliver thoughtful gross margin improvement across both technical decisions, software implementations. Our teams on the infrastructure build side have done really good work to deliver that, and so that's been helpful as well. And then, of course, on operating expenses, there's been a good focus on continuing even within that segment, to make sure we're focusing that work on leading in the AI transition with Azure. And so you're right, even as we're investing in AI infrastructure, which will and should show up as revenue, it'll also show up in COGS and still deliver good margin. But this does have a slightly -- as I talked about earlier, easier comp in Q1 and Q2, given it was some of our highest growth operating expense quarters in our company's history a year ago.

Brett Iversen:

Thanks, Brent. Joe, we have time for one last question.

Gregg Moskowitz:

Okay. Thank you very much for taking the question. And maybe just a follow-up to what Brent was just asking about, but on the gross margin line. Amy, the Microsoft cloud gross margin is up 2 points year-over-year, excluding the useful life change, a little more improvement than we've seen in some time and some investors were worried that it might go in the other direction, given increased AI investments. And so, as you look forward, do you think that you could drive some continued gross margin improvement over the medium term and even as higher CapEx will filter into the model? Thanks.

Satya Nadella:

And I'll just add that it'll be very well paired at the company level. I realize all of you care a lot about each one of our segments and each one of our KPIs, and I do too, but at the end of the day, our stack and the way it works, the way we do our capital allocation, the way we think about even the optimization of the demand to utilization is across the entirety of all of our segments and all of our products.

Brett Iversen:

Thanks, Gregg. That wraps up the Q&A portion of today's earnings call. Thank you for join us today and we look-forward to speaking with all of you soon.

Satya Nadella:

Thank you.

Brett Iversen:

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; Alice Jolla, Chief Accounting Officer; and Keith Dolliver, Deputy General Counsel. 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 and provides the reconciliation of differences between GAAP and non-GAAP financial measures. More detailed outlook slides will be available on the Microsoft Investor Relations website when we provide outlook commentary on today's call. 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. They are included as additional clarifying items to aid investors in further understanding the company's fourth quarter performance in addition to the impact these items and events have on the financial results. All growth comparisons we make on the call today relate to the corresponding period of last year, unless otherwise noted. We'll 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 growth rate only. We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If 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 replay the call and view the transcript on the Microsoft Investor Relations website. During this call, we'll 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. Actual results could materially differ because of factors discussed in today's earnings press release, in 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 the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that, I'll turn the call over to Satya.

Amy Hood:

Thank you, Satya, and good afternoon, everyone. This quarter, revenue was $56.2 billion, up 8% and 10% in constant currency. Earnings per share was $2.69 and increased 21% and 23% in constant currency. In our largest quarter of the year, results exceeded expectations with focused execution by our sales and partner teams. These execution efforts led to share gains again this quarter in Azure, Dynamics, Security and Edge. In our commercial business, we continued to see healthy renewal strength, which includes our upsell and attach motions, particularly with Microsoft 365 E5. Growth of new business continued to be moderated for products sold outside the Microsoft 365 suite, including stand-alone Office 365, EMS and Windows Commercial products. As expected in Azure, we saw a continuation of the optimization and new workload trends from the prior quarter. In our consumer business, the PC market overall was in line with expectations, although the early timing of back-to-school inventory builds benefited Windows OEM. Advertising spend was slightly lower than anticipated, which impacted search and news advertising and LinkedIn Marketing Solutions. Commercial bookings decreased 2% and 1% in constant currency, in line with expectations against the prior year comparable that was our largest commercial bookings quarter ever. In addition to the healthy execution across our renewal sales motions mentioned earlier, we saw a record number of $10 million-plus contracts for both Azure and Microsoft 365. And the average annualized value for our large, long-term Azure contracts was the highest it's ever been, driven by customer demand for our innovative cloud solutions today as well as interest in AI opportunities ahead. Commercial remaining performance obligation increased 19% and 18% in constant currency to $224 billion. Roughly 45% will be recognized in revenue in the next 12 months, up 13% year-over-year. The remaining portion, which we recognized beyond the next 12 months, increased 22%. And this quarter, our annuity mix increased to 97%. FX impact on total company revenue, segment level revenue and operating expense growth was as expected. FX decreased COGS growth by 1 point, 1 point favorable to expectations. Microsoft Cloud revenue was $30.3 billion and grew 21% and 23% in constant currency, slightly ahead of expectations. Microsoft Cloud gross margin percentage increased roughly 3 points year-over-year to 72%, also slightly ahead of expectations. Excluding the impact of the change in accounting estimate for useful lives, Microsoft Cloud gross margin percentage increased slightly, driven by improvements in Office 365, partially offset by lower Azure margin and the impact of scaling our AI infrastructure to meet growing demand. Company gross margin dollars increased 11% and 13% in constant currency, including 2 points due to the change in accounting estimate. Gross margin percentage increased year-over-year to 70%. Excluding the impact of the change in accounting estimate, gross margin percentage increased slightly, driven by improvements in Office 365. Operating expense increased 2%, in line with expectations as savings across the company from our focus on prioritization and efficiency were offset by the charge related to the Irish Data Protection Commission matter. At a total company level, headcount at the end of June was flat compared to a year ago. Operating income increased 18% and 21% in constant currency, including 4 points due to the change in accounting estimate. Operating margins increased roughly 4 points year-over-year to 43%. Excluding the impact of the change in accounting estimate, operating margins increased roughly 2 points, driven by improved operating leverage through disciplined cost management. Now to our segment results. Revenue from Productivity and Business Processes was $18.3 billion and grew 10% and 12% in constant currency, ahead of expectations with better-than-expected results in Office Commercial, partially offset by LinkedIn. Office Commercial revenue grew 12% and 14% in constant currency. Office 365 Commercial revenue increased 15% and 17% in constant currency, a bit better than expected with particular strength in E5 upsell renewal noted earlier. Paid Office 365 Commercial seats grew 11% year-over-year with installed base expansion across all workloads and customer segments. Seat growth was again driven by our small and medium business and frontline worker offerings. Office Commercial licensing declined 20% and 18% in constant currency with better-than-expected transactional purchasing. Office Consumer revenue increased 3% and 6% in constant currency with continued momentum in Microsoft 365 subscriptions, which grew 12% to $67 million. LinkedIn revenue increased 5% and 7% in constant currency, driven by growth in Talent Solutions, with some continued bookings impact from the weaker hiring environment in key verticals. Growth was partially offset by a decline in Marketing Solutions due to the lower ad spend noted earlier. Dynamics revenue grew 19% and 21% in constant currency, driven by Dynamics 365, which grew 26% and 28% in constant currency, with continued healthy growth across all workloads. Segment gross margin dollars increased 14% and 16% in constant currency, and gross margin percentage increased roughly 3 points year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage increased roughly 1 point, driven by improvements in Office 365. Operating expenses decreased slightly and operating income increased 25% and 29% in constant currency, including 3 points due to the change in accounting estimate. Next, the Intelligent Cloud segment. Revenue was $24 billion, increasing 15% and 17% in constant currency, slightly ahead of expectations. Overall, server products and cloud services revenue increased 17% and 18% in constant currency. Azure and other cloud services revenue grew 26% and 27% in constant currency, including roughly 1 point from AI services, as expected. In our per user business, the Enterprise Mobility and Security installed base grew 11% to over 256 million seats, with impact from the continued growth trends in new business noted earlier. In our on-premises server business, revenue decreased 1% and was relatively unchanged in constant currency, driven by a slight decrease in new annuity contracts, which carry higher in-period revenue recognition. Enterprise Services revenue grew 4% and 5% in constant currency with better-than-expected performance across enterprise support services and industry solutions. Segment gross margin dollars increased 16% and 17% in constant currency, and gross margin percentage increased slightly. Excluding the impact of the change in accounting estimate, gross margin percentage declined roughly 2 points, driven by sales mix shift to Azure and the lower Azure margin noted earlier. Operating expenses increased 10%. Operating income grew 20% and 22% in constant currency, with roughly 6 points from the change in accounting estimate. Now to More Personal Computing. Revenue was $13.9 billion, decreasing 4% and 3% in constant currency, above expectations, driven by better-than-expected performance in Windows, partially offset by Gaming. Windows OEM revenue decreased 12% year-over-year, ahead of expectations due to 7 points of benefit from early back-to-school inventory builds, while the overall PC market was as expected. Devices revenue decreased 20% and 18% in constant currency, roughly in line with expectations. Windows commercial products and cloud services revenue increased 2% and 3% in constant currency, ahead of expectations, due to the renewal strength noted earlier, even with the moderated growth of new business and stand-alone offerings. Search and news advertising revenue ex TAC increased 8%, a bit behind expectations due to lower ad spend noted earlier. Higher search volumes, share gains again this quarter for our Edge browser, and the benefit from the Xandr acquisition were partially offset by the impact from third-party partnerships. And in Gaming, revenue increased 1% and 2% in constant currency, lower than expected due to weakness in first-party and third-party content performance. Xbox content and services revenue increased 5% and 6% in constant currency and Xbox hardware revenue declined 13%. Segment gross margin dollars declined 2% and were relatively unchanged in constant currency, and gross margin percentage increased roughly 1 point year-over-year, driven by sales mix shift to higher-margin businesses. Operating expenses declined 9% and 8% in constant currency. Operating income increased 4% and 6% in constant currency. Now back to total company results. Capital expenditures, including finance leases, were $10.7 billion to support cloud demand, including investments in AI infrastructure. Cash paid for PP&E was $8.9 billion. Cash flow from operations was $28.8 billion, up 17% year-over-year as strong cloud billings and collections were partially offset by a tax payment related to the R&D capitalization provision. Free cash flow was $19.8 billion, up 12% year-over-year. Excluding the impact of this tax payment, cash flow from operations increased 22% and free cash flow increased 19%. This quarter, other income and expense was $473 million, higher than anticipated, driven by net gains on foreign currency remeasurement. Our effective tax rate was approximately 19%. And finally, we returned $9.7 billion to shareholders through share repurchases and dividends, bringing our total cash returned to our shareholders to over $38 billion for the full fiscal year. Now let's turn to next fiscal year and start with a few reminders. First, the change in accounting estimate for the useful life of server and network equipment resulted in $3.7 billion of depreciation expense shifting from FY '23 to future periods. Our FY '23 operating income and margins benefited from this change in accounting estimate and that will be a headwind to growth in FY '24 as the benefit reduces to $2.1 billion. Next, my outlook commentary for both the full year and next quarter is on a U.S. dollar basis unless specifically noted otherwise. And my outlook does not include any impact from the Activision acquisition, which we continue to work towards closing, subject to obtaining required regulatory approvals. Now for some thoughts on the full year of FY '24. With the weaker U.S. dollar and assuming current rates remain stable, we expect FX to increase full year revenue growth by approximately 1 point with no impact to COGS or operating expense growth. The impact in H1 is expected to be greater than H2. At a total company level, revenue growth from our Commercial business will continue to be driven by the Microsoft Cloud and will again outpace the growth from our Consumer business. Even with strong demand and a leadership position, growth from our AI services will be gradual as Azure AI scales and our copilots reach general availability dates. So for FY '24, the impact will be weighted towards H2. To support our Microsoft Cloud growth and demand for our AI platform, we will accelerate investment in our cloud infrastructure. We expect capital expenditures to increase sequentially each quarter through the year as we scale to meet demand signals. We are committed to driving operating leverage, and therefore, we will manage our total cost growth across COGS and operating expense in line with the demand signals we see as well as revenue growth. Increased capital spend will drive higher COGS growth than in FY '23, and FY '24 operating expense growth will remain low as we prioritize our spend. Therefore, we expect full year operating margins to remain flat year-over-year, even with the headwind from the change in accounting estimate. And finally, we expect our FY '24 tax rate to be around 19%. Now to the outlook for the first quarter. First, FX. Based on current rates, we expect FX to increase total revenue and operating expense growth by approximately 1 point with no impact to COGS growth. Within the segments, we expect FX to increase revenue growth in Intelligent Cloud by 1 point with no impact to Productivity and Business Processes or More Personal Computing. In Commercial bookings, strong execution across our core annuity sales motions, including our renewal and upsell motions, along with long-term measure commitments should drive healthy growth on a growing expiry base. Microsoft Cloud gross margin percentage should decrease roughly 1 point year-over-year, driven by the accounting estimate change headwind noted earlier. Excluding that impact, Q1 cloud gross margin percentage will be up roughly 1 point, primarily driven by improvements in Azure and Office 365, partially offset by sales mix shift to Azure and the impact of scaling our AI infrastructure to meet growing demand. We expect capital expenditures to increase sequentially on a dollar basis, as noted earlier, driven by investments in our AI infrastructure. Reminder, there can be normal quarterly spend variability in the timing of cloud infrastructure build-out. Next to segment guidance. In Productivity and Business Processes, we expect revenue to grow between 9% and 11% or USD 18 billion to USD 18.3 billion. In Office Commercial, revenue growth will again be driven by Office 365 with seat growth across customer segments and ARPU growth through E5. We expect Office 365 revenue growth to be roughly 16% in constant currency. In our on-premises business, we expect revenue to decline in the low 20s. In Office Consumer, we expect revenue growth to be in the low to mid-single digits, driven by Microsoft 365 subscriptions. For LinkedIn, we expect revenue growth in the low to mid-single digits. Even with share gains in our hiring business, growth will continue to be impacted by the overall markets for recruiting and advertising, especially in the technology industry, where we have significant exposure. And in Dynamics, we expect revenue growth in the mid- to high teens, driven by continued growth in Dynamics 365. For Intelligent Cloud, we expect revenue to grow between 15% and 16%, or 14% and 15% in constant currency. Revenue should be USD 23.3 billion to USD 23.6 billion. Revenue will continue to be driven by Azure, which, as a reminder, can have quarterly variability primarily from our per user business and from in-period revenue recognition depending on the mix of contracts. In Azure, we expect revenue growth to be 25% to 26% in constant currency, including roughly 2 points from all Azure AI Services. Growth continues to be driven by our Azure consumption business, and we expect the trends from Q4 to continue into Q1. Our per user business should continue to benefit from Microsoft 365 suite momentum, though we expect continued moderation in growth rates, given the size of the installed base. In our on-premises server business, we expect revenue to decline low to mid-single digits against a prior comparable that benefited from annuity purchasing ahead of the SQL Server 2022 launch. And in Enterprise Services, revenue should decline low to mid-single digits year-over-year as growth in Enterprise Support Services will be more than offset by a decline in Industry Solutions. In More Personal Computing, we expect revenue of USD 12.5 billion to USD 12.9 billion. Windows OEM revenue should decline low to mid-teens, including 5 points of negative impact from the earlier back-to-school inventory builds that were pulled into the fourth quarter. Our guide assumes no significant changes to the PC demand environment. In devices, revenue should decline in the mid-30s due to the overall PC market and adjustments we made in our portfolio with an increased focus on our higher-margin premium products. In Windows commercial products and cloud services, customer demand for Microsoft 365 and our advanced security solutions should drive revenue growth in the mid- to high single digits. Search and news advertising ex TAC revenue growth should be mid- to high single digits, roughly 5 points higher than overall search and news advertising revenue, driven by continued volume strength supported by Edge browser share gains. Growth will continue to be impacted by the advertising spend environment and third-party partnerships mentioned earlier. We continue to be excited by Bing usage signals and the longer-term opportunity as we invest in AI. And in Gaming, we expect revenue growth in the mid-single digits. We expect Xbox content and services revenue growth in the mid- to high single digits, driven by first-party and third-party content as well as Xbox Game Pass. Now back to company guidance. We expect COGS between USD 16.6 billion to USD 16.8 billion and operating expense of USD 13.5 billion to USD 13.6 billion. Together, total cost growth should be around 6%. Other income and expense should be roughly $300 million as interest income is expected to more than offset interest expense. Two reminders. This does not include any impact from Activision on interest income and expense, and we are required to recognize mark-to-market gains or losses on our equity portfolio, which can increase quarterly volatility. We expect our Q1 effective tax rate to be around 19%. And finally, as a reminder for Q1 cash flow, we expect to make a $2.7 billion cash tax payment related to the TCJA transition tax. We do not expect payment related to the R&D capitalization provision in Q1. In closing, as a company, we delivered on the FY '23 financial commitments we discussed a year ago on revenue and operating margin. A focus on operational excellence allowed us to achieve these targets while we delivered near-term value to customers and prioritized our investments to continue to lead in the future. As we start FY '24, we are excited for the opportunities ahead and remain focused on delivering the 3 key priorities Satya mentioned. We'll maintain our lead as the top commercial cloud by helping customers use the breadth and depth of the Microsoft Cloud. We'll continue to invest in our cloud and AI infrastructure while scaling with growing demand so we can lead the AI platform wave. And finally, we'll align our costs with growth as we are committed to driving operating leverage. With that, let's go to Q&A, Brett.

Operator:

[Operator Instructions]. Our first question comes from the line of Keith Weiss with Morgan Stanley.

Satya Nadella:

Thank you, Keith, for the question. The fundamental guidance and conversation that we have with customers is twofold. One is the easiest path to value out of generative AI is to adopt certain solutions, for example, GitHub Copilot. In some sense, it's sort of a no-brainer to add productivity leverage for all of the software developers in any organization. Whether you're a bank, you're a retailer or you're a software company, it applies to everyone. So that's probably one of the things that we have seen very good -- even productivity data and great adoption. And then obviously, the excitement that there is already around the M365 Copilot. So first thing we sort of talk about is how we ourselves are deploying all these Copilots across, whether it's Sales Copilot or M365 Copilot or GitHub Copilot, how do you get maximum value out of these horizontal tool chain? And then on top of that, we have taken what we did underneath these products and built it out as a first-class tech stack, right, which we talked at our developer conference, called the Copilot Stack, and then with Azure AI tooling, made it possible for a someone like Moody's to build their own Copilot for their people. So to us, we want to be able to help customers build their generative AI applications on top of Azure AI, and with speed, if you will. And so those are the 2 things that we ask them to identify where they can get the maximum productivity leverage. And then we even swung with our own resources to help them get those things done. And the last comment I'd make is the cloud and data in the cloud enables all this because I think the diffusion cycle here, in some sense, we have a new set of cloud meters that are getting adopted faster because of everything else that came before it in the cloud. So those would be the observations.

Operator:

Our next question comes from the line of Brent Thill with Jefferies.

Satya Nadella:

Sure, Brent. Thank you for the question. Yes, a couple of observations. One is, I think, overall in the cloud, you do see new project starts and then those project starts get optimized and then you sort of time-series all of that, and that's sort of what you see in the normal course. What happened here was during the pandemic, obviously, there were lots of new project starts and optimization in some sense was postponed, and that's where you're seeing, I'll call it, catch-up optimization. And that's something that, to your point, we will lap. Going into the next couple of quarters, I think, it will come down. And we are seeing new project starts, both traditional type of project starts, even cloud migrations, data applications and, of course, obviously, the AI applications. But we'll get back to I'll call the normal pace of new project starts and optimizations going forward, that we will cycle through, I think, in the next couple of quarters, what is the last catch-up optimization.

Operator:

The next question comes from the line of Mark Moerdler with Bernstein Research.

Amy Hood:

Why don't I start on the CapEx question, Satya, then I'll turn it over to you. Mark, really, first of all, both in Q4 and then talking about Q1, the acceleration is really quite broad. It's both on -- both the data centers and a physical basis plus CPUs and GPUs and networking equipment, think of it in a broad sense as opposed to a narrow sense. So it's overall increases of acceleration of overall capacity. And I think if you look back over really FY '23, you wouldn't have seen some of the pace on normal, what I would say, capacity adds, even for the normal Azure workload. So you're seeing both accelerations, the normal Azure workloads plus some of the AI workloads, is partially the reason. So it's why I do comment quite often that it's both overall Commercial Cloud demand and building out capacity for AI. It's both.

Operator:

The next question comes from the line of Kash Rangan with Goldman Sachs.

Satya Nadella:

Sure. Kash, thanks for the question. So maybe I'll start and then, Amy, you can add because I think -- we do think about what's the long-term TAM here, right? I mean this is -- you've heard me talk about this as a percentage of GDP, what's going to be tech spend? If you believe that, let's say, the 5% of GDP is going to go to 10% of GDP, maybe that gets accelerated because of the AI wave. Then the question is how much of that goes to the various parts of our Commercial Cloud and then how competitive are we in each layer, right? So if you sort of break it down, you sort of talked about how Microsoft 365, we think of this Copilot as a third pillar, right? We had the creation tools. We then had all the communication and collaboration services, and we think the AI Copilot is a third pillar. So we are excited about it. Amy talked about how we want to get it out first and part of this preview. And then in the second half of the next fiscal year, we'll start getting some of the real revenue signal from it. So we're looking forward to it. But we think of it long term as a third pillar, like we thought about something like, say, Teams or SharePoint back in the day, or what have you. Then Azure, the way I think about it is we still are, whatever, you're inning 2 or inning 3 of even the cloud migration, especially if you view it, right, whether by industry moves to the cloud, segment move to the cloud as well as country adoption of the cloud, right? So there's still early innings of the cloud migration itself. So there's a lot there still. And then on top of that, there's this complete new world of AI driving a set of new workloads. And so we think of that, again, being pretty expansive from a TAM opportunity and we'll play it out. But at the same time, we are a $111 billion commercial cloud that has grown in 20s, and so therefore, we do hit law of large numbers. But that said, we do think that this is a business that can have sustained high growth, which is something that we are excited about.

Operator:

Our next question comes from the line of Karl Keirstead with UBS.

Amy Hood:

Thanks, Karl. I think maybe I'll first start with the process we have when we release new products. And I absolutely understand we are excited, too, by the demand signal, the customer reaction, really the requests we're getting to be in the paid preview. It's all encouraging. As you know, we've -- last week, we announced pricing, then we'll continue to work through the paid preview process get good feedback. Then we'll announce the general availability date, then we'll get to the GA date. Then we'll, of course, be able to sell it and then recognize revenue. And that is why I continue to say that I am just as excited as everyone else about this, and it should be more H2 weighted. And we've, I think, given you some sizing opportunities. And I think I would use all that. But I do think this is really about pacing. And of course, we've still got to get our Security Copilot and some of the Dynamics workloads priced and released. And we'll continue to work toward that. And of course, I think one of the things that people often, I think, overlook is, and Satya mentioned it briefly when you go back to the pull on Azure, I think in many ways, lots of these AI products pull along Azure because it's not just the AI solution services that you need to build an app. And so it's less about Microsoft 365 pulling it along or any one Copilot. It's that when you're building these, it requires data and it requires the AI services. So you'll see them pull both core Azure and AI Azure along with them. And I think that's an important nuance as well.

Operator:

Our next question comes from the line of Mark Murphy with JPMorgan.

Satya Nadella:

Yes. Judson Althoff would love you for having used his metaphor of remodeling every room of the house with AI because you're absolutely right. I mean that's the opportunity we see. I think what you're also referencing is now there's good empirical evidence and data around the GitHub Copilot and the productivity stats around it. And we're actively working on that for M365 Copilot, also for things like the role-based ones like Sales Copilot or Service Copilot. We see these business processes having very high productivity gains. And so yes, over the course of the year, we will have all of that evidence. And I think at the end of the day, as Amy referenced, every CFO and CIO is also going to take a look at this. I do think for the first time -- or rather, I do think people are going to look at how can they complement their OpEx spend with essentially these Copilots in order to drive more efficiency and, quite frankly, even reduce the burden and drudgery of work on their OpEx and their people and so on. So therefore, I think you're going to see all of that translated into productivity stats, and we're looking forward to getting that data out.

Aleksandr Zukin:

I guess maybe just a multi-parter. You mentioned a couple of times that with the AI workload adoption that you're seeing on Azure, it's starting to look maybe a little bit different from an incremental share gain perspective versus previous generations. Can you maybe expand upon that? How should that drive for Azure consumption, particularly as we get through the year? And do you see a scenario where either the combination of lapping the optimization headwind, plus the AI contribution, plus this incremental tailwind that you're seeing around the workloads actually does drive a reacceleration in Azure, particularly in the second half when you're going to start to see some of those things kick in?

Operator:

Our last question will come from the line of Kirk Materne with Evercore ISI.

Satya Nadella:

Yes, sure. Thank you for the question. Yes, absolutely. I think having your data, in particular, in the cloud is sort of key to how you can take advantage of essentially these new AI reasoning engines to complement, I'll call it, your databases because these AI engines are not databases, but they can reason over your data and to help you then get more insights, more completions, more predictions, more summaries, and what have you. So those are the things when we say Copilot design pattern, that's sort of what that design pattern is all about. The thing that perhaps even in the last quarter, and I had that in my remarks, that's most exciting is how with Microsoft Fabric, especially for the analytics workloads, we brought together compute, storage, governance with a very disruptive business model. I mean to give you a flavor for it, right, so you have your data in an Azure data lake. You can bring SQL Compute to it. You can bring Spark to it. You can bring Azure AI or Azure OpenAI to it, right? So the fact is you have storage separated from all these compute meters, and they're all interchangeable, right? So you don't have to buy each of these separately. That's the disruptive business model. So I feel that we are well -- Microsoft is very well positioned with the way our data architecture lays out our business model around data and how people will plan to use data with AI services. So that's kind of what I mean by getting your data estate in order. And it's just not getting data estate in order but you have to have it structured such that you can have the flexibility that allows you to exercise the data and compute in combinations that makes sense for this new age.

Satya Nadella:

Thank you, all.

Operator:

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

Brett Iversen:

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; Alice Jolla, Chief Accounting Officer; and Keith Dolliver, Deputy General Counsel. 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 and provides the reconciliation of differences between GAAP and non-GAAP financial measures. Additionally, new this quarter, more detailed outlook slides will be available on the Microsoft Investor Relations website when we provide outlook commentary on today's call. 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. They are included as additional clarifying items to aid investors in further understanding the company's third quarter performance in addition to the impact these items and events have on the financial results. 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 growth rate only. We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If 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 replay the call and view the transcript on the Microsoft Investor Relations website. 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. Actual results could materially differ because of factors discussed in today's earnings press release, in 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 the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that, I'll turn the call over to Satya.

Amy Hood:

Thank you, Satya, and good afternoon, everyone. Our third quarter revenue was $52.9 billion, up 7% and 10% in constant currency. Earnings per share was $2.45 and increased 10% and 14% in constant currency. Our results exceeded expectations, driven by focused execution from our sales teams and partners. In our commercial business, revenue was up 19% in constant currency. We saw better-than-expected renewal strength, including across Microsoft 365, which also benefited Windows Commercial given the higher in-period revenue recognition. In Office 365 stand-alone products, we saw improvement in new business growth, while growth trends in EMS and Windows Commercial standalone products remained consistent with Q2. In Azure, customers continued to exercise some caution as optimization and new workload trends from the prior quarter continued as expected. In our consumer business, PC demand was a bit better than we expected, particularly in the commercial segment, which benefited Windows OEM and Surface even as channel inventory levels remain elevated, which negatively impacted results. Advertising spend landed in line with our expectations. We have seen share gains in Azure, Dynamics, Teams, Security, Edge and Bing as we continue to focus on delivering high value as well as new innovative solutions to our customers, including next-generation AI capabilities. Commercial bookings increased 11% and 12% in constant currency on a strong prior year comparable with a declining expiry base and 3 points of unfavorable impact from the inclusion of Nuance in the prior year. The better-than-expected result was driven by strong execution across our renewal sales motions mentioned earlier. Commercial remaining performance obligation increased 26% to $196 billion. Roughly 45% will be recognized in revenue in the next 12 months, up 18% year-over-year. The remaining portion, which will be recognized beyond the next 12 months increased 34%. And this quarter, our annuity mix was again 96%. FX impact on total company revenue, segment level revenue and operating expense growth was as expected. FX decreased COGS growth by 2 points, 1 point favorable to expectations. Microsoft Cloud revenue was $28.5 billion and grew 22% and 25% in constant currency, slightly ahead of expectations. Microsoft Cloud gross margin percentage increased roughly 2 points year-over-year to 72%, a point ahead of expectations driven by cloud engineering efficiencies. Excluding the impact of the change in accounting estimate for useful lives, Microsoft Cloud gross margin percentage decreased slightly, driven by lower Azure margin. Company gross margin dollars increased 9% and 13% in constant currency, including 2 points due to the change in accounting estimate. Gross margin percentage increased year-over-year to 69%. Excluding the impact of the change in accounting estimate, gross margin percentage decreased slightly, driven by a lower mix of OEM revenue. Operating expense increased 7% and 9% in constant currency, about $300 million lower than expected. Operating expense growth was driven by roughly 2 points from the Nuance and Xandr acquisitions as well as investments in cloud engineering and LinkedIn. At a total company level, head count at the end of March was 9% higher than a year ago. Operating income increased 10% and 15% in constant currency, including 4 points due to the change in accounting estimate. Operating margins increased roughly 1 point year-over-year to 42%. Excluding the impact of the change in accounting estimate, operating margins decreased slightly and increased slightly in constant currency. Now to our segment results. Revenue from Productivity and Business Processes was $17.5 billion and grew 11% and 15% in constant currency, ahead of expectations, primarily driven by better-than-expected results in Office commercial. Office commercial revenue grew 13% and 17% in constant currency. Office 365 commercial revenue increased 14% and 18% in constant currency, slightly better than expected with the strong renewal execution mentioned earlier and E5 momentum. Paid Office 365 commercial seats grew 11% year-over-year to over 382 million, with installed base expansion across all workloads and customer segments. Seat growth was again driven by our small and medium business and frontline worker offerings. Office commercial licensing declined 1% and increased 5% in constant currency, better than expected with 11 points of benefit from transactional strength in Japan. Office consumer revenue increased 1% and 4% in constant currency with continued momentum in Microsoft 365 subscriptions, which grew 12% to 65.4 million. LinkedIn revenue increased 8% and 10% in constant currency, driven by growth in Talent Solutions. Dynamics revenue grew 17% and 21% in constant currency, driven by Dynamics 365, which grew 25% and 29% in constant currency, with healthy growth across all workloads. Segment gross margin dollars increased 14% and 18% in constant currency, and gross margin percentage increased roughly 2 points year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage increased slightly, driven by improvements in Office 365, partially offset by sales mix shift to cloud offerings. Operating expenses increased 4% and 5% in constant currency, and operating income increased 20% and 27% in constant currency, including 4 points due to the change in accounting estimate. Next, the Intelligent Cloud segment. Revenue was $22.1 billion, increasing 16% and 19% in constant currency, slightly ahead of expectations. Overall, server products and cloud services revenue increased 17% and 21% in constant currency. Azure and other cloud services revenue grew 27% and 31% in constant currency. In our per user business, enterprise mobility and security installed base grew 15% to nearly 250 million seats. In our on-premises server business, revenue decreased 2% and was relatively unchanged in constant currency with continued demand for our hybrid offerings, including Windows Server and SQL Server running in multi-cloud environments, offset by transactional licensing. Enterprise Services revenue grew 6% and 9% in constant currency with better-than-expected performance across Enterprise Support Services and Microsoft Consulting Services. Segment gross margin dollars increased 15% and 18% in constant currency and gross margin percentage decreased slightly. Excluding the impact of the change in accounting estimate, gross margin percentage declined roughly 3 points, driven by sales mix shift to Azure and the lower Azure margin noted earlier. Operating expenses increased 19% and 20% in constant currency, including roughly 3 points of impact from the Nuance acquisition. Operating income grew 13% and 17% in constant currency, with roughly 6 points from the change in accounting estimate. Now to More Personal Computing. Revenue was $13.3 billion, decreasing 9% and 7% in constant currency with better-than-expected results across all businesses. Windows OEM revenue decreased 28% year-over-year and Devices revenue decreased 30% and 26% in constant currency, both ahead of expectations. We saw better-than-expected PC demand, as noted earlier, particularly in the commercial segment, which has higher revenue per license, although results continue to be negatively impacted by elevated channel inventory levels. Windows commercial products and cloud services revenue increased 14% and 18% in constant currency, significantly ahead of expectations, primarily due to the strong renewal execution with higher in-period revenue recognition noted earlier. Search and news advertising revenue ex TAC increased 10% and 13% in constant currency, including 2 points from the Xandr acquisition. Results were driven by higher search volume with share gains again this quarter for our Edge browser globally and Bing in the U.S. And in Gaming, revenue declined 4% and 1% in constant currency, ahead of expectations. Xbox hardware revenue declined 30% and 28% in constant currency on a high prior year comparable that benefited from increased console supply. Xbox content and services revenue increased 3% and 5% in constant currency, driven by better-than-expected monetization in third-party and first-party content and growth in Xbox Game Pass. Segment gross margin dollars declined 9% and 5% in constant currency, and gross margin percentage increased slightly year-over-year. Operating expenses declined 5% and 3% in constant currency, even with 3 points of growth from the Xandr acquisition. Operating income decreased 12% and 7% in constant currency. Now back to total company results. Capital expenditures, including finance leases were $7.8 billion to support cloud demand. Cash paid for PP&E was $6.6 billion. Cash flow from operations was $24.4 billion, down 4% year-over-year as strong cloud billings and collections as well as lower supplier payments were more than offset by a tax payment related to the R&D capitalization provisions and employee payments primarily related to headcount growth and an increase in employee compensation. Free cash flow was $17.8 billion, down 11% year-over-year. Excluding the impact of this tax payment, cash flow from operations increased 1% and free cash flow declined 5%. This quarter, other income and expense was $321 million, higher than anticipated, driven by net gains on foreign currency remeasurement. Our effective tax rate was approximately 19%. And finally, we returned $9.7 billion to shareholders through share repurchases and dividends. Now moving to our Q4 outlook, which unless specifically noted otherwise, is on a U.S. dollar basis. My commentary for the next quarter and FY '24 does not include any impact from Activision, which we continue to work towards closing in fiscal year 2023, subject to obtaining required regulatory approvals. Now to FX. Based on current rates, we expect FX to decrease total revenue growth by approximately 2 points with no impact to COGS or operating expense growth. Within segments, we anticipate roughly 2 points of negative FX impact on revenue growth in Productivity and Business Processes and Intelligent Cloud and roughly 1 point in More Personal Computing. Overall, our outlook has many of the trends we saw in Q3 continue through Q4. In our largest quarter of the year, we expect customer demand for our differentiated solutions, including our AI platform and consistent execution across the Microsoft Cloud to drive another quarter of healthy revenue growth. Last year, we had our largest commercial bookings quarter ever with a material volume of large multiyear commitments. On that comparable, we expect growth to be relatively flat. We expect consistent execution across our core annuity sales motions with strong renewals and continued commitment to our platform as we focus on meeting customers' changing contract needs, which include shorter term, quick time to value contracts in this dynamic environment. Our key focus remains on delivering customer value. Microsoft Cloud gross margin percentage should be up roughly 2 points year-over-year, driven by the accounting estimate change noted earlier. Excluding that impact, Q4 cloud gross margin percentage will be relatively flat as improvements in Office 365 will offset the lower Azure margin and the impact of scaling our AI infrastructure to meet growing demand. We expect capital expenditures to have a material sequential increase on a dollar basis, driven by investments in Azure AI infrastructure. Reminder there can be normal quarterly spend variability in the timing of our cloud infrastructure build-out. Next, to segment guidance. In Productivity and Business Processes, we expect revenue to grow between 10% and 12% in constant currency or $17.9 billion to $18.2 billion. In Office Commercial, revenue growth will again be driven by Office 365, with seat growth across customer segments and ARPU growth through E5. We expect Office 365 revenue growth to be roughly 16% in constant currency. In our on-premises business, we expect revenue to decline in the low 30s. In Office consumer, we expect revenue growth in the mid-single digits, driven by Microsoft 365 subscriptions. For LinkedIn, we expect mid-single digit revenue growth driven by Talent Solutions with continued strong engagement on the platform. And in Dynamics, we expect revenue growth in the mid- to high teens, driven by continued growth in Dynamics 365. For Intelligent Cloud, we expect revenue to grow between 15% and 16% in constant currency or $23.6 billion to $23.9 billion. Revenue will continue to be driven by Azure, which, as a reminder, can have quarterly variability primarily from our per user business and from in-period revenue recognition depending on the mix of contracts. In Azure, we expect revenue growth to be 26% to 27% in constant currency, including roughly 1 point from AI services. Growth continues to be driven by our Azure consumption business, and we expect the trends from Q3 to continue into Q4, as noted earlier. Our per-user business should continue to benefit from Microsoft 365 suite momentum, though we expect continued moderation in growth rates given the size of the installed base. In our on-premises server business, we expect revenue to decline low single digits as demand for our hybrid solutions, including Windows Server and SQL Server running in multi-cloud environments, will be more than offset by unfavorable FX impact. And in Enterprise Services, revenue should be relatively unchanged year-over-year as growth in Enterprise Support Services will be offset by a decline in Microsoft Consulting Services. In More Personal Computing, we expect revenue of $13.35 billion to $13.75 billion. PC demand should be similar to Q3, and given channel inventory still remains elevated, our revenue will lag overall market growth as it continues to normalize. Therefore, Windows OEM and Devices revenue should both decline in the low to mid-20s. In Windows commercial products and cloud services revenue should decline low to mid-single digits. While we expect healthy annuity billings growth driven by continued customer demand for Microsoft 365 and our advanced security solutions, a reminder that our quarterly revenue growth can have variability, primarily from in-period revenue recognition depending on the mix of contracts. Search and news advertising ex TAC revenue growth should be approximately 10%, roughly 5 points higher than the overall search and news advertising revenue, driven by growth in first-party revenue is similar to Q3. And in Gaming, we expect revenue growth in the mid- to high single digits. We expect Xbox content services revenue growth in the low to mid-teens, driven by third-party and first-party content as well as Xbox Game Pass. Now back to company guidance. We expect COGS to grow between 3% and 4% in constant currency or $16.8 billion to $17 billion and operating expense to grow approximately 2% in constant currency or $15.1 billion to $15.2 billion. Other income and expense should be roughly $300 million as interest income is expected to more than offset interest expense. As a reminder, we are required to recognize mark-to-market gains or losses on our equity portfolio, which can increase quarterly volatility. We expect our Q4 effective tax rate to be in line with our full year rate of approximately 19%. And finally, as a reminder, for Q4 cash flow, we expect to make a $1.3 billion cash tax payment related to the R&D capitalization provision. Now I'd like to share some closing thoughts as we look to the next fiscal year. With our leadership position as we begin this AI era, we remain focused on strategically managing the company to deliver differentiated customer value as well as long-term financial growth and profitability. As with any significant platform shift, it starts with innovation. And we are excited about the early feedback and demand signals for the AI capabilities we have announced to date. We will continue to invest in our cloud infrastructure, particularly AI-related spend as we scale with the growing demand, driven by customer transformation. And we expect the resulting revenue to grow over time. As always, we remain committed to aligning cost and revenue growth to deliver disciplined profitability. Therefore, while the scaled CapEx investments will impact COGS growth, we expect FY '24 operating expense growth to remain low. As a team, we have continually focused on pivoting our resources aggressively to the future as we execute at a high level in the moment to deliver value to our customers. That balance has enabled the company to successfully lead across a number of platform shifts over a number of decades. Therefore, we are committed to leading the AI platform wave and making the investments to support it. With that, let's go to Q&A. Brett?

Operator:

[Operator Instructions] Our first question comes from the line of Keith Weiss with Morgan Stanley. Please proceed.

Amy Hood:

Thanks, Keith. In some ways, let me start by saying, it's a great partnership. We're proud to have worked together for a number of years, leading to some of the announcements that you've heard us make more recently. And we talked about the foundation of our partnership remains that when we both are successful, the other benefits. When we grow, it helps them, and when they grow, it helps us. But specifically to your question on how does it show up, it's easiest in this situation, to think about them as a customer of ours like any other customer who would use the Azure infrastructure and our Azure AI services in service of supporting their end customers. And so when they do that, like any other customer who has a commercial relationship with us, we recognize revenue on that behalf. That's probably the simplest frame, Keith, that I hope is helpful.

Brett Iversen:

Thanks, Keith. Joe, next question, please.

Mark Moerdler:

Congratulations on the quarter and the guidance and thanks for taking my question. I'd like to drill into Azure and more specifically, Azure IaaS/PaaS consumption. IaaS/PaaS consumption has really stepped down recently, and it's important to understand the macro versus macro and optimization that will rebound, whether it's going to rebound quickly or is there a more fundamental issue? In other words, is it simply purely macro and everyone is stepping back a little bit and they're going to hit the pedal as soon as this comes back or is there something more fundamental that is driving corporate maybe to step back and that, that slowdown could sustain even when the IT spending rebounds. Thank you.

Amy Hood:

Mark, maybe the one thing I would add to those comments is, we've been through almost a year where that pivot that Satya talked about from we're starting tons of new workloads, and we'll call that the pandemic time, to this transition post, and we're coming to really the anniversary of that starting. And so to talk to your point, we're continuing to set optimization. But at some point, workloads just can't be optimized much further. And when you start to anniversary that, you do see that it gets a little bit easier in terms of the comps year-over-year. And so you even see that in a little bit of our guidance, some of that impact from a year-over-year basis.

Satya Nadella:

Thanks, Mark.

Operator:

Our next question comes from the line of Brent Thill with Jefferies. Please proceed

Satya Nadella:

I mean, overall, we do plan to monetize a separate set of meters across all of the tech stack, whether they're consumption meters or per user subscriptions. The Copilot that's priced and it is there is GitHub Copilot. That's a good example of incrementally how we monetize the prices that are there out there and others are to be priced because they're in preview mode. But you can expect us to do what we've done with GitHub Copilot pretty much across the board.

Brent Thill:

Thanks.

Operator:

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

Satya Nadella:

Yes, a couple of them. One is clearly the accelerated compute is what gets used to drive AI. And the thing that we are very, very focused on is to make sure that we get it very efficient in the usage of those resources. If you think about sort of what the hyperscaler does, it's not just rack and stack sort of hardware. They use software to optimize the performance of a given workload and, in fact, heterogeneous workloads on a given set of hardware. And so we have many knobs that we’ll continuously continue to drive optimization across it. And you see it even in the -- even for a given generation of a large model, where we started them to the cost footprint to where we end in the cost footprint even in a period of a quarter changes. So you can expect us to do what we have done over the decade plus with the public cloud to bring the benefits of, I would say, continuous optimization of our COGS to a diverse set of workloads. The other thing I'd mention is that there are a lot of workloads now. Like one of the reasons why we got together with OpenAI primarily was we came out and said, this type of workload, whether it's a training or an inference workload is going to be much more generally relevant for us, not just in the context of AI. And so you can see us apply it in other context as well.

Raimo Lenschow:

Thank you.

Operator:

Our next question comes from the line of Keith Bachman with BMO. Please proceed

Amy Hood:

Thanks, Keith. It's probably a good opportunity to explain a bit about how I think about where we are, which is -- if you look at all of the businesses we're in and we look about our competitiveness in those businesses. And this is before Satya started to comment a bit about our relative performance versus absolute. And I'll tell you that the energy and focus we put right now is on relative performance and share gains. Right now, we have the largest commercial cloud with increasing commitments by customers, with new workloads, new TAM opportunities that something you're talking about with customers. And our focus is going to be and will be on continuing to take a growing share of that while we continue to focus on our customers' success in getting a ton of value out of what we are selling, whether that's the E5 product, the Microsoft 365, whether that's Windows 365 to help, maybe it's on compute costs and PC cost, whether it's working across the Azure stack. And so with that opportunity plus in our consumer business, the largest number of active devices we've had in Windows, are still being used more being able to focus on edge share and being share and gaming -- bringing it to the PC as well across to mobile, these are the opportunities that we focus on as we think about next year. And so if we feel like and I do, that we are well positioned to continue to take share in so many key places, then I say, great, and we want to be able to focus on investing in AI, which I talked about, will increase COGS growth, but we're committed to making sure we have healthy profitability by keeping operating expenses low. And so what really this past year has been about, but really what Q3 starts to show is our willingness to pivot to the future to make sure we can keep all those commitments that Satya listed. So while I know that's not giving specificity, it is, in fact, how we think about long-term success, in being well positioned in big markets, taking share in those markets, committing to make sure we're going to lead this wave, staying focused on gross margin improvements where we can. Some of them will come in AI over time, given our commitment to the build-out. We will charge for those AI capabilities and then ultimately will deliver operating profit.

Keith Bachman:

All right. Many thanks for the answer.

Operator:

Our next question comes from the line of Karl Keirstead with UBS. Please proceed

Amy Hood:

Thanks, Karl. I think I would step back and say we have seen, I mean, the Office 365 suite but broadly, the Microsoft 365 suite adds a ton of value for users. And so if you think about the users and on the global base, we've been able to add users, which you continue to see. We still have in the frontline scenario at an SMB opportunity to continue to grow. And in the enterprise, where we are a basic productivity tool, the labor market is still tight in most places, and we continue to see customers committed to the value they're getting. And so I -- this is not something that -- I think our focus has really been on continuing to get healthy renewals, continue to add new products at renewal where it makes sense to save customers money and increase value. And so I think that's the story of the resilience you're seeing. And of course, we did have a good E5 quarter, which you're starting to see and it helps on ARPU.

Operator:

Our next question comes from the line of Rishi Jaluria with RBC. Please proceed

Satya Nadella:

Yeah. Thanks, Rishi for the question. So overall, we've taken the approach that we are not waiting for regulation to show up. We are taking an approach where the unintended consequences of any new technology is something that from day 1, we think, about as first class and build into our engineering process all the safeguards. So for example, in 2016 is when we put out the AI principles, we translated the AR principles into a set of internal standards that then are further translated into an implementation process that then we hold ourselves to internal audit essentially. So that's the framework we have. We have a Chief AI Officer who is sort of responsible for both thinking of what the standards are and then the people who even help us internally audit our following of the process. And so we feel very, very good in terms of us being able to create trust in the systems we put out there. And so we will obviously engage with any regulation that comes up in any jurisdiction. But quite honestly, we think that the more there is any form of trust as a differentiated position in AI, I think we stand to gain from that.

Brett Iversen:

Thanks, Rishi. Joe, we have time for one last question.

Michael Turrin:

Hey. Great. Thanks. Appreciate you squeezing me in. I want to ask a question on the consolidation play that Microsoft is positioning for giving. That's something we hear clearly top of mind for IT decision-makers currently. You have clear plays there across security infrastructure apps and other areas. So it would just be great to hear your view on the Microsoft consolidation playbook in the current environment, and if there are certain areas you're particularly focused on or seeing more traction around. Thank you.

Amy Hood:

And maybe one thing I would add, Michael, is that I know the question is consolidation, but another aspect of that is that some of the new business process automation work that's going to get done, whether that's the Dynamics workload that we've talked about, it also will benefit from having the AI services available on Azure, from having the core Azure capabilities as well as actually some front-end stuff that people are buying in Microsoft 365 to close these loops in a new way. And so I think maybe it's not the traditional definition of consolidation. But when people look and say, what vendor adds a lot of value and has the tools that we need and, in many instances, already own to be able to do this business process work, I think we have a great value and, frankly, probably leading tools in almost every vertical.

Brett Iversen:

Thank you, Michael. 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. Thank you, all.

Satya Nadella:

Thanks so much.

Brett Iversen:

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; Alice Jolla, Chief Accounting Officer; and Keith Dolliver, Deputy General Counsel. 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 and provides the reconciliation of differences between GAAP and non-GAAP financial measures. 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. They are included as additional clarifying items to aid investors in further understanding the company’s second quarter performance in addition to the impact these items and events have on the financial results. 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 growth rate only. We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today’s call is being webcast live and recorded. If 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 replay the call and view the transcript on the Microsoft Investor Relations website. 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. Actual results could materially differ because of factors discussed in today’s earnings press release, in 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 the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that, I will turn the call over to Satya.

Amy Hood:

Thank you, Satya and good afternoon everyone. I’d like to start by reiterating Satya’s thoughts on the changing environment and our priorities, which underpin the decisions communicated in last week’s announcement. The resulting Q2 charge negatively impacted gross margin by $152 million, operating income by $1.2 billion, and earnings per share by $0.12. Our second quarter revenue was $52.7 billion, up 2% and 7% in constant currency. When adjusted for the charge, gross margin dollars increased 2% and 8% in constant currency, operating income decreased 3% and increased 6% in constant currency, and earnings per share was $2.32, which decreased 6% and increased 2% in constant currency. In our consumer business, the PC market was in line with our expectations, but execution challenges impacted our Surface business. Advertising spend declined slightly more than expected, which impacted search and news advertising and LinkedIn Marketing Solutions. In our commercial business, we delivered strong growth in line with our expectations. However, as you heard from Satya, we are seeing customers exercise caution in this environment and we saw results weaken through December. We saw moderated consumption growth in Azure and lower-than-expected growth in new business across the standalone Office 365, EMS and Windows commercial products that are sold outside the Microsoft 365 suite. From a geographic perspective, we saw strong execution in many regions around the world. However, performance in the U.S. was weaker than expected. Importantly, we continued to see share gains in areas such as data and AI, Dynamics, Teams, Security and Edge. Commercial bookings increased 7% and 4% in constant currency, lower than expected. Consistent execution across our renewal sales motions, including strong recapture rates and growth in Azure commitments on a high prior year comparable were partially offset by the slowdown in growth of new standalone business noted earlier. Commercial remaining performance obligation increased 29% to 26% in constant currency to $189 billion. Roughly 45% will be recognized in revenue in the next 12 months, up 24% year-over-year. The remaining portion, which will be recognized beyond the next 12 months, increased 32%. Our annuity mix increased 2 points year-over-year to 96%. FX decreased total company revenue by 5 points, in line with expectations. At a segment level, FX decreased Productivity and Business Processes revenue growth by 6 points, 1 point favorable to expectations. FX impact on Intelligent Cloud and More Personal Computing were both in line with expectations. Additionally, FX decreased both COGS and operating expense growth by 2 points, 1 point unfavorable to expectations. Microsoft Cloud revenue was $27.1 billion and grew 22% and 29% in constant currency, ahead of expectations. Microsoft Cloud gross margin percentage increased roughly 2 points year-over-year to 72%, a point better than expected, driven by lower energy costs. Excluding the impact of the change in accounting estimate for useful lives, Microsoft Cloud gross margin percentage decreased roughly 1 point, primarily driven by sales mix shift to Azure. Company gross margin percentage was 67%. Excluding the impact of the change in accounting estimate, gross margin percentage decreased roughly 2 points, driven by a lower mix of Windows OEM revenue and sales mix shift from licensing to cloud. Operating expense when adjusted for the Q2 charge increased 11% and 13% in constant currency, about $500 million lower than expected. Operating expense growth was driven by investments in cloud engineering, the Nuance acquisition and LinkedIn. At a total company level, headcount ended December 19% higher than a year ago. Sequential headcount growth was less than 1%. Year-over-year growth included roughly 6 points from the Nuance and Xandr acquisitions, which closed last Q3 and Q4, respectively. Adjusted for the charge, operating margins decreased roughly 2 points year-over-year to 41%. Excluding the impact of the change in accounting estimate, operating margins declined roughly 4 points, primarily driven by unfavorable FX impact as well as a lower mix of OEM revenue. Now to our segment results. Revenue from Productivity and Business Processes was $17 billion and grew 7% and 13% in constant currency, in line with expectations when excluding the favorable FX impact noted earlier. Office Commercial revenue grew 7% and 14% in constant currency. Office 365 Commercial revenue increased 11% and 18% in constant currency, slightly better than expected with healthy renewal execution and ARPU growth as E5 momentum remains strong. Paid Office 365 Commercial seats grew 12% year-over-year with installed base expansion across all workloads and customer segments. Seat growth was driven by our small and medium business and frontline worker offerings, although we saw some impact from the slowdown in growth of new business noted earlier. Office Consumer revenue declined 2% and increased 3% in constant currency, with continued momentum in Microsoft 365 subscriptions, which grew 12% to 63.2 million, partially offset by declines in our transactional business. LinkedIn revenue increased 10% and 14% in constant currency, driven by growth in Talent Solutions, partially offset by weakness in Marketing Solutions from the advertising trends noted earlier. Dynamics revenue grew 13% and 20% in constant currency, driven by Dynamics 365, which grew 21% and 29% in constant currency. Segment gross margin dollars increased 8% and 16% in constant currency, and gross margin percentage increased roughly 1 point year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage decreased slightly, driven by sales mix shift to cloud offerings. Operating expense increased 12% and 14% in constant currency, including roughly 5 points from the Q2 charge. Operating income increased 6% and 17% in constant currency as the 3 points of favorable impact due to the change in accounting estimate were offset by 3 points of unfavorable impact from the Q2 charge noted earlier. Next, the Intelligent Cloud segment. Revenue was $21.5 billion, increasing 18% and 24% in constant currency, in line with expectations. Overall, server products and cloud services revenue increased 20% and 26% in constant currency. Azure and other cloud services revenue grew 31% and 38% in constant currency. As noted earlier, growth continued to moderate, particularly in December, and we exited the quarter with Azure constant currency growth in the mid-30s. In our per user business, the Enterprise Mobility and Security installed base grew 16% to over 241 million seats with impact from the slowdown in growth of new business noted earlier. In our on-premises server business, revenue decreased 2% and increased 2% in constant currency, with continued hybrid demand offset by weakness in transactional licensing. Enterprise Services revenue grew 2% and 7% in constant currency. Segment gross margin dollars increased 17% and 23% in constant currency, and gross margin percentage decreased slightly. Excluding the impact of the change in accounting estimate, gross margin percentage declined roughly 3 points, driven by sales mix shift to Azure and higher energy costs. Operating expenses increased 34% and 37% in constant currency, including roughly 13 points of impact from the Q2 charge noted earlier and roughly 7 points of impact from the Nuance acquisition. Operating income grew 7% and 15% in constant currency as roughly 7 points of favorable impact of the change in accounting estimate was offset by approximately 7 points of unfavorable impact from the Q2 charge. Now to More Personal Computing. Revenue was $14.2 billion, decreasing 19% and 16% in constant currency, below expectations driven by Surface, Windows Commercial and search. Windows OEM revenue decreased 39% year-over-year, in line with expectations. Excluding the impact from the Windows 11 deferral last year, revenue declined 36% on a strong prior year comparable. Devices revenue decreased 39% to 34% in constant currency, below expectations due to execution challenges on new product launches. Windows Commercial products and cloud services revenue declined 3% and increased 3% in constant currency, lower than expected, primarily due to the slowdown in growth of new business and stand-alone offerings noted earlier. Search and news advertising revenue ex TAC increased 10% and 15% in constant currency, a bit lower than expected, as noted earlier. Our Edge browser gained more share than expected this quarter. The Xandr acquisition contributed roughly 6 points of benefit. And in gaming, revenue declined 13% and 9% in constant currency, in line with expectations. Xbox hardware revenue declined 13% and 9% in constant currency. Xbox content and services revenue declined 12% and 8% in constant currency, given the strong first-party content last year. Segment gross margin dollars declined 29% and 24% in constant currency, and gross margin percentage decreased roughly 7 points year-over-year, driven by lower device gross margin and sales mix shift to lower-margin businesses. Operating expenses increased 6% and 9% in constant currency, including roughly 6 points of impact from the Q2 charge noted earlier and 3 points of impact from the Xandr acquisition. Operating income decreased 47% and 40% in constant currency, including roughly 6 points of unfavorable impact from the Q2 charge noted earlier. Now back to total company results. Capital expenditures, including finance leases, were $6.8 billion to support cloud demand. Cash paid for PP&E was $6.3 billion. Cash flow from operations was $11.2 billion, down 23% year-over-year as strong cloud billings and collections were more than offset by a tax payment related to the TCJA capitalization of R&D provision as well as higher employee and supplier payments. Free cash flow was $4.9 billion, down 43% year-over-year. Excluding the impact of this tax payment, cash flow from operations declined 7% and free cash flow declined 16%. This quarter, other income and expense was negative $60 million, lower than anticipated, driven by a mark-to-market loss on a forward share purchase agreement. Our effective tax rate was approximately 19%. And finally, we returned $9.7 billion to shareholders through share repurchases and dividends. Now moving to our Q3 outlook, which unless specifically noted otherwise, is on a U.S. dollar basis. My commentary for both the full year and next quarter does not include any impact from Activision, which we continue to work towards closing in fiscal year 2023, subject to obtaining required regulatory approvals. First, FX. Based on current rates, we now expect FX to decrease total revenue growth by approximately 3 points, COGS growth by 1 point and operating expense growth by 2 points. Within the segments, we anticipate roughly 4 points of negative impact on revenue growth in Productivity and Business Processes, 3 points in Intelligent Cloud and 2 points in More Personal Computing. In our Consumer business, Windows OEM and devices will see continued declines as the PC market returns to pre-pandemic levels. And LinkedIn and search will be impacted as ad market spending remains a bit cautious. In our Commercial business, we expect business trends that we saw at the end of December to continue into Q3. While customers are more cautious in their spend, we also have the opportunity to improve our execution, given our strong position in global growth markets. In commercial bookings, with a declining expiry base and the strong prior year comparable in terms of large Azure contracts, we expect growth to be relatively flat over year. We expect consistent execution across our core and sales motions and continued commitments to our platform will be offset by impact from the slowdown of new business noted earlier and 3 points of unfavorable impact from the inclusion of Nuance in the prior year. Microsoft Cloud gross margin percentage should be up roughly 1 point year-over-year, driven by the accounting estimate change noted earlier. Excluding that impact, Q3 cloud gross margin percentage will decrease roughly 1 point, driven by Azure. In capital expenditures, we expect a sequential increase on a dollar basis with normal quarterly spend variability in the timing of our cloud infrastructure build-out. Our data center investments continue to be based on a near-term and longer-term customer demand, including AI opportunities. Next, segment guidance. In Productivity and Business Processes, we expect revenue to grow between 11% and 13% in constant currency or $16.9 billion to $17.2 billion. In Office Commercial, revenue growth will again be driven by Office 365 with seat growth across customer segments and ARPU growth through E5. We expect Office 365 revenue growth to be sequentially lower by roughly 1 point on a constant currency basis. In our on-premises business, we expect revenue to decline in the mid-20s. In Office Consumer, we expect revenue growth in the low single digits, driven by Microsoft 365 subscriptions. For LinkedIn, we expect mid-single-digit revenue growth with continued strong engagement on the platform, although impacted by the advertising trends noted earlier and the slowdown in hiring, particularly in the technology industry, where we have significant exposure. And in Dynamics, we expect revenue growth to be in the low to mid-teens, driven by continued growth in Dynamics 365, which is now over 80% of total Dynamics revenue. For Intelligent Cloud, we expect revenue to grow between 17% and 19% in constant currency or $21.7 billion to $22 billion. Revenue will continue to be driven by Azure which, as a reminder, can have quarterly variability primarily from our per user business and from in-period revenue recognition depending on the mix of contracts. In Azure, our per-user business should continue to benefit from Microsoft 365 suite momentum, though we expect continued moderation in growth rate given the size of the installed base. As I noted earlier, we exited Q2 with Azure growth in the mid-30s in constant currency. And from that, we expect Q3 growth to decelerate roughly 4 to 5 points in constant currency. FX impact in Azure is about 1 point more than at the segment level. In our on-premises server business, we expect revenue to decline low single digits as demand for our hybrid solutions will be more than offset by unfavorable FX impact. And in Enterprise Services, revenue should decline low to mid-single digits, driven by Microsoft Consulting Services. In More Personal Computing, we expect revenue of $11.9 billion to $12.3 billion. Windows OEM revenue should decline in the mid to high 30s, in line with the PC market. We expect Q3 PC units to be similar to pre-pandemic levels. In devices, revenues should decline in the mid-40s as we work through the execution challenges noted earlier. In Windows Commercial products and cloud services on a strong prior year comparable, revenue should be relatively flat as customer demand for Microsoft 365 and our advanced security solutions will be partially offset by the slowdown in new business noted earlier. Search and news advertising ex-TAC should grow high single digits, roughly 7 points faster than overall search and news advertising revenue, driven by continued volume strength supported by Edge browser share gains and the inclusion of Xandr. And in gaming, on a prior year comparable that benefited from increased console supply, we expect revenue to decline in the high single digits. We expect Xbox content and services revenue to decline in the low single digits as growth in Xbox Game Pass subscriptions will be more than offset by lower monetization per hour and third-party and first-party content. Now back to company guidance. We expect COGS to grow between 1% and 2% in constant currency or to be between $15.65 billion and $15.85 billion and operating expense to grow between 11% and 12% at constant currency or be $14.7 billion to $14.8 billion. Other income and expense should be roughly $200 million as interest income is expected to more than offset interest expense. As a reminder, we are required to recognize mark-to-market gains and losses on our equity portfolio, which can increase quarterly volatility. We expect our Q3 effective tax rate to be between 19% and 20%. And finally, as a reminder, for Q3 cash flow, we expect to make a $1.2 billion cash tax payment related to the TCJA capitalization of R&D provision. Now some thoughts on H2 and the full year. First, in our Commercial business, revenue grew 20% on a constant currency basis in H1. However, we now expect to see a deceleration in H2, given how we exited December. Next, higher energy costs for the full year are now expected to be $500 million compared to our previous estimate of $800 million. Third, as we continue to prioritize our investments and anniversary the Nuance and Xandr acquisitions, our Q4 operating expense growth should be in the low single digits in constant currency. Finally, we remain committed to operational excellence, aligning cost and growth, investing in our customer success and leading the AI platform wave. As a result, when excluding the Q2 charge and favorable impact from the change in accounting estimate, we expect full year operating margins to be down roughly 1 point in constant currency and roughly 2 points in USD, even with the headwinds from materially lower OEM revenue and higher energy costs. In the first half of the year, over 70% of our revenue came from our Commercial business and over 70% of that from Microsoft Cloud. We have a resilient foundation and durable growth markets where we are gaining share. I’m confident in the ability of our Microsoft team to manage the near-term by continuing to position ourselves for the future. With that, let’s go to Q&A. Brett?

Operator:

[Operator Instructions] Our first question comes from the line of Keith Weiss with Morgan Stanley. Please proceed.

Satya Nadella:

Thank you so much, Keith, for the question. So as you know, we started the OpenAI partnership now in 3 years, 3.5 years ago. And we’ve been actually working very hard on a lot of elements of this partnership over the last 3 years. And so I think the way for our investors to see this is we fundamentally believe that the next big platform wave, as I said, is going to be AI and we strongly also believe a lot of the enterprise value gets created by just being able to catch these waves and then have those waves impact every part of our tech stack and also create new solutions and new opportunities. So whenever we think about platform opportunities and platform shift opportunities, that’s how we come at it. How can we essentially ride the wave for everything that we have today and make it more expansive and then what new can be created. So, if you take that lens, the core of Azure or what is considered cloud computing fundamentally changes in its nature and how compute storage and network come together. That’s, in some sense, under the radar, if you will, for the last 3.5 years, 4 years, we have been working very, very hard to build both the training supercomputers and now, of course, the inference infrastructure because once you use AI inside of your applications, it goes from just being training-heavy to inference. So, that’s sort of, I think core Azure itself is being transformed for the core infrastructure business, it’s being transformed. And so you can see us with data beyond Azure OpenAI services even, think about what Synapse plus OpenAI APIs can do. We already have in Power Platform incorporated capability. You could prompt - I mean one of the reasons why we are the leaders in robotic process automation and workflow automation today is because of some of the AI capabilities that we have in there. GitHub Copilot is in fact, you would say, the most at-scale LLM based product out there in the marketplace today. And so, we fully expect us to sort of incorporate AI in every layer of the stack, whether it’s in productivity, whether it’s in our consumer services. And so we are excited about it. But I think that we are also excited about OpenAI zone innovation, right. So, they commercialize their products. We are excited about the Chat GPT being built on Azure and having the traction it has. So, we look to both, there is an investment part to it and there is a commercial partnership. But fundamentally, it’s going to be something that’s going to drive, I think innovation and competitive differentiation in every one of the Microsoft solutions by leading in AI.

Brett Iversen:

Thanks Steve. Joe, next question please.

Brent Thill:

Thanks. Satya, can you give us your overall macro view? There were some comments you had made that concerned, I think many about the state of the U.S. spending environment. I am just curious if you could comment and follow-up on what you are seeing there just from a spend environment throughout the year. I think many came away with that perceiving that you were saying it’s getting worse, not better. Can you just give us a little more color on that? Thank you.

Brent Thill:

Thank you.

Operator:

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

Satya Nadella:

I would say two things, and then Amy, please feel free to add. One is, it absolutely is, starts with workloads that they have at scale just because of the visibility one has on what’s driving essentially the consumption meters. And there is real guidance that we ourselves [Indiscernible] the product to say, here are the things that you could do optimize your billing. And so – so, that’s sort of what is the fundamental thing, when we say do more with less and how can we help, that’s sort of the first place customers go to. And then the next piece, really, I think is going to be about how they take the optimization that they get and the savings they get along workload and what new project starts. And that’s where I think there is a reprioritization, when should we start the new project. And those are the two things that are happening simultaneously. They don’t perfectly match, but one of the things is they are looking to back some savings on some workloads and then start. So, that’s where I think a little bit of what has to happen is the cycle time where the optimization cycle finishes, the projects start and then the projects ramp. And I think that, that’s what at least on the cloud consumption side you are seeing. And on the per user side, it’s slightly different, which is in per user also, there was real acceleration when it comes to purchases of per user licenses, whether it is for knowledge workers or frontline workers. And again, they are all now making sure that they are all getting used and the usage is going up. Like when we look at our Office 365 usage, all those numbers are pretty up year-over-year in a substantial way. Like I gave you some of the Teams numbers, in fact, one of the things was what will happen to the Teams usage after the pandemic, guess what, they’re up. And so those are the good news. And now once we cycle through that again, the seats will get added and premium, like I am very, very excited about Teams Pro coming out in a couple of weeks. And those are all the things that people will be able to sort of use to ensure that the ARPUs are also going up with value.

Mark Moerdler:

Perfect. Thank you very much.

Operator:

Our next question comes from the line of Kash Rangan with Goldman Sachs. Please proceed.

Satya Nadella:

I mean I think that you can – you have a workload, you optimize the workload and you start a new workload. So, the thing that I would say is when you are done with optimizing a workload is when you are done with the cycle. So, I think if you sort of say, when did we enter this, we accelerated existing [ph] workloads during the pandemic over a period of 2 years. So, we are optimizing. I don’t think we are going to take 2 years to optimize, but we are going to take this year to optimize. And then as we optimize the new projects start and the new project starts don’t start instantly at their peak usage. They start and then they scale. And so those are the two cycles that will happen where there will be a time lag.

Satya Nadella:

That’s correct.

Brett Iversen:

Thanks Kash. Joe, next question please.

Karl Keirstead:

Thank you. This one for Amy. Amy, given the obviously tough environment, it sounds like reaching that full fiscal year 20% constant currency commercial revs guide would be tough. Is that also true for the soft guidance for 10%-plus total revenue growth for the year? And if I could just sneak in a clarification, Amy, just because it’s an important metric. When you talk about a 4-point to 5-point decel in Azure, that’s off of the 38% reported for December, right, not off the 35% exit rate? Thank you.

Karl Keirstead:

Got it. Super helpful. Thanks Amy.

Operator:

Our next question comes from the line of Brad Zelnick with Deutsche Bank. Please proceed.

Amy Hood:

Brad, listen, thanks for that question. Obviously, as we think about the Q4 guidance around low-single digit operating expense growth, we start to, as you know, sort of lap certain real acceleration points that we had last year. And we lapped the acquisitions both of Nuance and of Xandr. So, by the time that we get to the end of Q4, you will see very moderated headcount growth on a year-over-year basis in addition to some of the prioritization decisions we have made. And you are right. We take decisions like the one we had to make to get our cost structure more in line with revenue just incredibly seriously because we have lots of very talented people who were impacted by that. And so I do think that we feel confident in that exit rate. And as I have said, it will certainly imply that year-over-year growth as we lap some of the investments that we have made will be quite small.

Brett Iversen:

Thanks Brad. Joe, next question please.

Brad Reback:

Great. Thanks very much. On Office 365 Commercial, with you guys approaching 400 million seats and the E5 business really starting to accelerate here on that consolidated sort of expense ROI that you are putting forth, should we think about the growth there more evenly balanced between seats and ARPU going forward or still to continue to favor seats? Thanks.

Satya Nadella:

And we are also investing in outside of Microsoft 365 in other per user workloads. We were being a new suite, Power Platform on its own and even standalone offers like even Teams Pro and what have you. So, there is a significant amount of work we want to do besides sort of the suites that we all sort of have at scale.

Brett Iversen:

Thanks Brad. Joe, we have time for one last question.

Tyler Radke:

Yes. Thanks for taking the question. I wanted to ask just about how your visibility has changed in terms of some of the larger Azure customer ramps. Could you just comment on, to the extent those large customer ramps or if any of those projects are getting put on pause? And then is there any way to just kind of quantify the AI potential contribution or maybe GPU-powered contribution that Azure that you are expecting over the coming quarters? Thank you.

Amy Hood:

Hello. Do you want me to move? Hello. Do you want me to use the backup? Hello.

Brett Iversen:

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.

Brett Iversen:

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; Alice Jolla, Chief Accounting Officer; and Keith Dolliver, Deputy General Counsel. 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 and provides a reconciliation of differences between GAAP and non-GAAP financial measures. 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. They are included as additional clarifying items to aid investors in further understanding the company's first quarter performance in addition to the impact these items and events have on the financial results. 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 growth rate only. We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If 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 replay the call and view the transcript on the Microsoft Investor Relations website. 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. 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 the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that, I'll turn the call over to Satya.

Amy Hood:

Thank you, Satya, and good afternoon, everyone. Our first quarter revenue was $50.1 billion, up 11% and 16% in constant currency. Earnings per share was $2.35, increased 4% and 11% in constant currency when adjusted for the net tax benefit for the first quarter of fiscal year 2022. Driven by strong execution in a dynamic environment, we delivered a solid start to our fiscal year, in line with our expectations even as we saw many of the macro trends from the end of the fourth quarter continued to weaken through Q1. In our consumer business, PC market demand further deteriorated in September, which impacted our Windows OEM and Surface businesses. And reductions in customer advertising spend, which also weakened later in the quarter, impacted search and news advertising and LinkedIn Marketing Solutions. As you heard from Satya, in our commercial business, we saw strong overall demand for our Microsoft cloud offerings with a growth of 31% in constant currency as well as share gains across many businesses. Commercial bookings declined 3% and increased 16% in constant currency on a flat expiry base. Excluding the FX impact, growth was driven by strong renewal execution, and we continue to see growth in the number of large long-term Azure and Microsoft 365 contracts across all deal sizes. More than half of the $10 million plus Microsoft 365 bookings came from E5. Commercial remaining performance obligation increased 31% and 34% in constant currency to $180 billion. Roughly 45% will be recognized in revenue in the next 12 months, up 23% year-over-year. The remaining portion, which we recognized beyond the next 12 months, increased 38% year-over-year, and our annuity mix increased one point year-over-year to 96%. FX impacted company results in line with expectations. With the stronger US dollar, FX decreased total company revenue by five points, and at the segment level, FX decreased productivity and business processes and intelligent cloud revenue growth by six points and more personal computing revenue growth by three points. Additionally, FX decreased COGS and operating expense growth by three points. Microsoft Cloud gross margin percentage increased roughly two points year-over-year to 73%. Excluding the impact of the change in accounting estimate for useful lives, Microsoft cloud gross margin percentage decreased roughly one point driven by sales mix shift to Azure and lower Azure margin, primarily due to higher energy costs. Company gross margin dollars increased 9% and 16% in constant currency, and gross margin percentage decreased slightly year-over-year to 69%, excluding the impact of the latest change in accounting estimate, gross margin percentage decreased roughly 3 points, driven by sales mix shift to cloud, the lower Azure margin noted earlier and Nuance. Operating expense increased 15% and 18% in constant currency, driven by investments in cloud engineering, LinkedIn, Nuance and commercial sales. At a total company level, headcount grew 22% year-over-year, as we continue to invest in key areas just mentioned, as well as customer deployment. Headcount growth included roughly 6 points from the Nuance and Xandr acquisitions, which closed last Q3 and Q4, respectively. Operating income increased 6% and 15% in constant currency, and operating margins decreased roughly 2 points year-over-year to 43%. Excluding the impact of the change in accounting estimate, operating margins declined roughly 4 points year-over-year driven by sales mix shift to cloud, unfavorable FX impact, Nuance and the lower Azure margin noted earlier. Now to our segment results. Revenue from productivity and business processes was $16.5 billion and grew 9% and 15% in constant currency, ahead of expectations, with better-than-expected results in Office commercial and LinkedIn. Office commercial revenue grew 7% and 13% in constant currency. Office 365 commercial revenue increased 11% and 17% in constant currency, slightly better than expected, with the strong renewal execution noted earlier. Growth was driven by installed base expansion across all workloads and customer segments, as well as higher ARPU from E5. Demand for security, compliance and voice value in Microsoft 365 drove strong E5 momentum again this quarter. Paid Office 365 commercial seats grew 14% year-over-year, driven by our small and medium business and frontline worker offerings, although we saw a continued impact of new deal moderation outside of E5. Office consumer revenue grew 7% and 11% in constant currency, driven by continued momentum in Microsoft 365 subscriptions, which grew 13% to $61.3 million. Dynamics revenue grew 15% and 22% in constant currency, driven by Dynamics 365, which grew 24% and 32% in constant currency. LinkedIn revenue increased 17% and 21% in constant currency, ahead of expectations, driven by better-than-expected growth in Talent Solutions, partially offset by weakness in marketing solutions from the advertising trends noted earlier. Segment gross margin dollars increased 11% and 18% in constant currency, and gross margin percentage increased roughly 1 point year-over-year. Excluding the impact of the latest change in accounting estimate, gross margin percentage decreased slightly, driven by sales mix shift to cloud offerings. Operating expense increased 13% and 16% in constant currency, and operating income increased 10% and 19% in constant currency, including 4 points due to the latest change in accounting estimate. Next, the Intelligent Cloud segment. Revenue was $20.3 billion, increasing 20% and 26% in constant currency, in line with expectations. Overall, server products and cloud services revenue increased 22% and 28% in constant currency. Azure and other cloud services revenue grew 35% and 42% in constant currency, about 1 point lower than expected, driven by the continued moderation in Azure consumption growth, as we help customers optimize current workloads while they prioritize new workloads. In our per user business, the enterprise mobility and security installed base grew 18% to over 232 million seats, with continued impact from the new deal moderation noted earlier. In our on-premises server business, revenue was flat, and increased 4% in constant currency, slightly ahead of expectations, driven by hybrid demand, including better-than-expected annuity purchasing ahead of the SQL Server 2022 launch. Enterprise Services revenue grew 5% and 10% in constant currency, driven by enterprise support services. Segment gross margin dollars increased 20% and 26% in constant currency, and gross margin percentage decreased slightly. Excluding the impact of the latest change in accounting estimate, gross margin percentage declined roughly three points, driven by sales mix shift to Azure and higher energy costs impacting Azure margins. Operating expenses increased 25% and 28% in constant currency, including roughly eight points of impact from Nuance. And operating income grew 17% and 25% in constant currency with roughly nine points of favorable impact from the latest change in accounting estimate. Now to more Personal Computing. Revenue decreased slightly year-over-year to $13.3 billion and grew 3% in constant currency, in line with expectations overall, but with OEM and Surface weakness offset by upside in gaming consoles. Windows OEM revenue decreased 15% year-over-year. Excluding the impact from the Windows 11 deferral last year, revenue declined 20%, driven by PC market demand deterioration noted earlier. Devices revenue grew 2% and 8% in constant currency, in line with expectations, driven by the impact of a large Hollands deal, partially offset by low double-digit declines in consumer Surface sales. Windows Commercial products and cloud services revenue grew 8% and 15% in constant currency, in line with expectations, driven by demand for Microsoft 365 E5 noted earlier. Search and news advertising revenue, ex TAC, increased 16% and 21% in constant currency, in line with expectations, benefiting from an increase in search volumes and roughly five points of impact from Xandr even as we saw increased ad market headwinds during September. Edge browser gained share again this quarter. And in gaming, revenue grew slightly and was up 4% in constant currency, ahead of expectations, driven by better-than-expected console sales. Xbox hardware revenue grew 13% and 19% in constant currency. Xbox content and services revenue declined 3% and increased 1% in constant currency, driven by declines in first-party content as well as in third-party content where we had lower engagement hours and higher monetization, partially offset by growth in Xbox Game Pass subscriptions. Segment gross margin dollars declined 9% and 4% in constant currency, and gross margin percentage decreased roughly five points year-over-year driven by sales mix shift to lower margin businesses. Operating expenses increased 2% and 5% in constant currency, driven by the Xandr acquisition. And operating income decreased 15% and 9% in constant currency. Now back to total company results. Capital expenditures, including finance leases were $6.6 billion, and cash paid for PP&E was $6.3 billion. Our data center investments continue to be based on strong customer demand and usage signals. Cash flow from operations was $23.2 billion, down 5% year-over-year, driven by strong cloud billings and collections, which were more than offset by a tax payment related to the transfer of intangible property completed in Q1 of FY '22. Free cash flow was $16.9 billion, down 10% year-over-year. Excluding the impact of this tax payment, cash flow from operations grew 2%, and free cash flow was relatively unchanged [indiscernible] year. This quarter, other income and expense was $54 million, driven by interest income, which was mostly offset by interest expense and net losses on foreign currency remeasurement. Our effective tax rate was approximately 19%. And finally, we returned $9.7 billion to shareholders through share repurchases and dividends. Now, moving to our Q2 outlook, which, unless specifically noted otherwise, is on a US dollar basis. My commentary, for both the full year and next quarter, does not include any impact from AC [ph] division, which we still expect to close by the end of the fiscal year. First, FX. With the stronger US dollar and based on current rates, we now expect FX to decrease total revenue growth by approximately five points and to decrease total COGS and operating expense growth by approximately three points. Within the segments, we anticipate roughly seven points of negative FX impact on revenue growth in Productivity and Business Processes, six points in Intelligent Cloud and three points in more Personal Computing. Our outlook has many of the trends we saw at the end of Q1, continue into Q2. In our consumer business, materially weaker PC demand from September will continue, and impact both Windows OEM and Surface device results even as the Windows installed base and usage grows, as you heard from Satya. Additionally, customers focusing our advertising spend will impact LinkedIn and Search and News advertising revenue. In our commercial business, demand for our differentiated hybrid and cloud offerings, together with consistent execution, should drive healthy growth across the Microsoft Cloud. In commercial bookings, continued strong execution across core annuity sales motions and commitments to our platform should drive solid growth on a moderately growing expiry base against a strong prior year comparable, which included a significant volume of large long-term Azure contracts. As a reminder, the growing mix of larger long-term Azure contracts which are more unpredictable in their timing, always drives increased quarterly volatility in our bookings growth rate. Microsoft Cloud gross margin percentage should be up roughly one point year-over-year, driven by the latest accounting estimate change noted earlier. Excluding that impact, Q2 gross margin percentage will decrease roughly two points driven by lower Azure margin, primarily due to higher energy cost, revenue mix shift to Azure and the impact from Nuance. In capital expenditures, we expect a sequential increase on a dollar basis with normal quarterly spend variability in the timing of our cloud infrastructure build-out. Next, to segment guidance. In Productivity and Business Processes, we expect revenue to grow between 11% and 13% in constant currency or USD16.6 billion to USD 16.9 billion. In Office Commercial, revenue growth will again be driven by Office 365, with seat growth across customer segments and ARPU growth from E5. We expect Office 365 revenue growth to be similar to last quarter on a constant currency basis. In our on-premises business, we expect revenue to decline in the low to mid-30s. In Office Consumer, we expect revenue to decline low to mid-single digits as Microsoft 365 subscription growth will be more than offset by unfavorable FX impact. For LinkedIn, we expect continued strong engagement on the platform, although results will be impacted by a slowdown in advertising spend and hiring, resulting in mid to high single-digit revenue growth or low to mid-teens growth in constant currency. And in Dynamics, we expect revenue growth in the low double digits or the low 20s in constant currency, driven by continued share gains in Dynamics 365. For Intelligent Cloud, we expect revenue to grow between 22% and 24% in constant currency or US$ 21.25 billion to US$ 21.55 billion. Revenue will continue to be driven by Azure, which, as a reminder, can have quarterly variability primarily from our per-user business and from in-period recognition depending on the mix of contracts. We expect Azure revenue growth to be sequentially lower by roughly 5 points on a constant currency basis. Azure revenue will continue to be driven by strong growth in consumption, with some impact from the Q1 trends noted earlier. And our per user business should continue to benefit from Microsoft 365 suite momentum, though we expect moderation in growth rate given the size of the installed base. In our on-premise server business, we expect revenue to decline low single digits, as demand for our hybrid solutions, including strong annuity purchasing from the SQL Server 2022 launch, will be more than offset by unfavorable FX impact. And in Enterprise Services, we expect revenue growth to be in the low single digits, driven by enterprise support. In More Personal Computing, we expect revenue of US$ 14.5 billion to US$ 14.9 billion. In Windows OEM, we expect revenue to decline in the high 30s. Excluding the impact from the Windows 11 revenue deferral last year, revenue would decline mid-30s, reflecting both PC market demand and a strong prior year comparable, particularly in the commercial segment. In Devices, revenue should decline approximately 30%, again, roughly in line with the PC market. In Windows commercial products and cloud services, customer demand for Microsoft 365 and our advanced security solutions should drive growth in the mid-single digits or low double digits in constant currency. Search and news advertising, ex TAC, should grow in the low to mid-teens, roughly 6 points faster than overall search and news advertising revenue, driven by growing first-party revenue and the inclusion of Xandr. And in gaming, we expect revenue to decline in the low to mid-teens against a strong prior year comparable. That included several first-party title launches, partially offset by growth in Xbox Game Pass subscribers. We expect Xbox content and services revenue to decline in the low to mid-teens. Now back to company guidance. We expect COGS to grow between 6% and 7% in constant currency or to be between US$ 17.4 billion and US$ 17.6 billion, and operating expense to grow between 17% and 18% in constant currency, or to be between US$ 14.3 billion and US$ 14.4 billion. As we continue to focus our investment in key growth areas, total headcount growth sequentially should be minimal. Other income and expense should be roughly $100 million, as interest income is expected to more than offset interest expense. Further FX and equity movements through Q2 are not reflected in this number. And as a reminder, we are required to recognize mark-to-market gains or losses on our equity portfolio, which can increase quarterly volatility. And we expect our Q2 effective tax rate to be between 19% and 20%. And finally, as a reminder, for Q2 cash flow, we expect to make a $2.4 billion cash tax payment related to the capitalization of R&D provision enacted in 2017 TCJA and effective as of July 1, 2022. Now some thoughts on the full fiscal year. First, FX. Based on current rates, we now expect a roughly five-point headwind to full year revenue growth. And FX should decrease COGS and operating expense growth by approximately three points. At the total company level, we continue to expect double-digit revenue and operating income growth on a constant currency basis. Revenue will be driven by around 20% constant currency growth in our commercial business, driven by strong demand for our Microsoft cloud offerings. That growth will be partially offset by the increased declines we now see in the PC market. With the high margins in our Windows OEM business and the cyclical nature of the PC market, we take a long-term approach to investing in our core strategic growth areas and maintain these investment levels regardless of PC market conditions. Therefore, with our first quarter results and lower expected OEM revenue for the remainder of the year as well as over $800 million of greater than expected energy cost, we now expect operating margins in US dollars to be down roughly a point year-over-year. On a constant currency basis, excluding the incremental impact of the lower Windows OEM revenue and the favorable impact of the latest accounting change, we continue to expect FY 2023 operating margins to be roughly flat year-over-year. In closing, in this environment, it is more critical than ever to continue to invest in our strategic growth markets such as Cloud, Security, Teams, Dynamics 365 and LinkedIn where we have opportunities to continue to gain share as we provide problem solving innovations to our customers. And while we continue to help our customers do more with less, we will do the same internally. And you should expect to see our operating expense growth moderate materially through the year. While we focus on growing productivity of the significant headcount investments we've made over the last year. With that, let's go to Q&A. Brett?

Operator:

Absolutely. [Operator Instructions] Our first question is coming from the line of Keith Weiss with Morgan Stanley. Please proceed with your question.

Amy Hood :

Thanks, Keith. And I do appreciate you asking about that one point, because I do know it is a point of focus every quarter. And what I would say is there is some inherent volatility to that number. A point here or there, you've heard me say it, we've been a point better, and you've heard me say it when we've been a point worse. And I want to focus mostly on what, and how we see the number, which is that it is still a very large growth rate with growth across all segments and with growth across all geos. That was, to the question, generally in line with where we expected. And what we did see through the quarter is a real focus, both by customers, but also by our sales and customer success teams on going proactively to customers and making sure we are helping them optimize their workloads. And as we went through the quarter and as, of course, the macroeconomic environment got more complicated we continued to focus on that, because ultimately, those optimizations bring value even as budgets are still growing and budgeted spend is still growing. And so it's this nuance of you're still seeing digitization. This is still the tailwind that helps customers solve problems. This is still the way to build growth and leverage in your business, and yet you still want to optimize your workloads, you still want to run them the most efficiently so that you can then make room for new workload growth. We saw that across all segments. If there was one segment, well, I may have seen it a bit more, I would say, in the small or midsized segment of the market that tends to be more through partner. We rely on partners to help customers do those same optimizations and prepare workloads. But it is that one point. I know that, people are focused on. But if you step back and say, this is how you drive ultimate share gains and build customer loyalty and help customers grow, I think that needs to be the focus of our teams inside the company and also the partners that we rely on to help customers do that as well. And so as I look forward, there is some inherent volatility to this number. And here, I think you will hear us talk about continuing to invest to make that happen, whether it's in customer success, whether it's in optimizations, whether it's frankly an engineering to help people be able to even have better solutions to optimize against. I do think that will remain top of mind for us even as this remains probably the most exciting opportunity in TAM across infra, data and AI that exist in technology. I don't know, Satya, if you...

Keith Weiss:

Outstanding. Thank you guys.

Operator:

Our next question comes from Mark Moerdler with Bernstein Research. Please proceed with your question.

Amy Hood:

Thanks, Mark. I'll – you're right. Let me go ahead and reiterate part of that, which is that this quarter, as you saw, we did have very good bookings growth. And within the RPO number that you're referring to, we had what we would call long-dated growth, which means we're having and seeing customers continue to sign commitments to the platform, and that goes really to what Satya mentioned is that the plans to invest here remain intact. And so it's about both the optimization that you're talking about, and we are seeing and the guide includes that, and it also includes new workload starting. And those also may not be matched up one-to-one to see sort of a consistent pattern. And that does result in some volatility. The other piece of it, Mark that we didn't talk on before because I was really focused on consumption is that there is per user headwinds as well, right, because we're getting and seeing some of these [loss] (ph) of large numbers in terms of the per seat business. So there's a couple of things going on here Mark again, as you said, a very large base. So it's not just the optimization to new workloads. It's also some per user work as well.

Brett Iversen:

Thanks, Mark. Jesse, next question please.

Brent Thill:

Amy, last quarter, you called out, for the first time, SMB weakness. It sounds like that continued. I think many are questioning if did that get worse this quarter? And did you see it filter now into the enterprise? Can you talk about what you're seeing higher up above SMB?

Brent Thill:

Thank you.

Operator:

Our next question is coming from Mark Murphy with JPMorgan. Please proceed with your question.

Satya Nadella:

Thanks for the question. First, yes, the OpenAI partnership is a very critical partnership for us. Perhaps, it's sort of important to call out that we built the supercomputing capability inside of Azure, which is highly differentiated, the way computing the network, in particular, come together in order to support these large-scale training of these platform models or foundation models has been very critical. That's what's driven, in fact, the progress OpenAI has been making. And of course, we then productized it as part of Azure OpenAI services. And that's what you're seeing both being used by our own first-party applications, whether it's the GitHub Copilot or Design even inside match. And then, of course, the third parties like Mattel. And so, we're very excited about that. We have a lot sort of more sort of talk about when it comes to GitHub universe. I think you'll see more advances on the GitHub Copilot, which is off to a fantastic start. But overall, this is an area of huge investment. The AI comment clearly has arrived. And it's going to be part of every product, whether it's, in fact, you mentioned Power Platform, because that's another area we are innovating in terms of corporate all of these AI models. So, yes, so I think AI is a place where I think we have differentiated capability at an infrastructure layer for training and inference and the model that sells or platforms for third parties and our first-party applications are getting better because of the use of those AI models.

Mark Murphy:

Thank you.

Operator:

Our next question is coming from the line of Karl Keirstead with UBS. Please proceed with your question.

Amy Hood:

Thanks, Karl. And I shared a little bit on the call, but let me share a little more, because I think it's important in terms of how we think about investment and continuing to invest where we're seeing substantial opportunity and growth. The PC market is cyclical. And we had some great benefits for a couple of years during the pandemic, and we chose not to spend against that favorability over the past couple of years, and it fell to the bottom line, and you saw substantially increased margins over that time period. And we did that potentially because it is a cyclical market. And so in the same way I see it now is that PCs are going to be a tough headwind for us for the year. But overall, the Windows back to the installed base, our ability to grow usage, it's still higher than it was. And that's a good opportunity for us. And so in the same way that we let it fall to the bottom line when we saw a surge, it's important to stay consistent in this down market because when you have type of opportunity that we have specifically in the commercial business and the TAMs that Satya talked about has been some of our most exciting. And you have the opportunity with your customers to gain share, to gain confidence, right? And I think it's important to have a steady hand. Now, let me also say it is not as though we are not responding to the macro environment around cost. As I commented, our sequential headcount growth from Q1 to Q2 will be minimal. It will be about investing where we said we would invest, which is in focused areas. It's about moving headcount to make sure inside the company, we've got it on the highest and most important things. We've added a lot of headcount over the past 12 months. And we want to make sure we use those head count in the most productive way possible, and we're going to do that. And also, we're going to, frankly, lap some investments that we've made at the end of H2, Karl. We closed Nuance at the end of Q3. We closed Xandr in Q4. When we come and lap those, you will see a material decline in OpEx investment. You will also see us start to lap some of the headcount surges that we made last year in key areas. And by then, I feel good that we'll see productivity improvements from the headcount have and our focus. And so it's an ability to say, absolutely, I want to stay consistent, and we'll respond to the macro. It's possible to do both those things, and I think that's what we're doing.

Brett Iversen:

Thanks, Karl, Jessie, next question please.

Brad Sills:

Wonderful. Thanks for taking my question. I wanted to ask a question about Office Commercial. A lot of the growth here is driven by subscriber growth. This quarter, for example, 17% constant currency, subscriber growth of 14%. Could you remind us where the incremental subscribers coming from? Could we see that mix of growth shift away from subscribers towards ASP potentially over time? I think you're already over 300 million subscribers. So just any color on just the runway from? Where is the increment C coming from and with all the works that you're doing with E3, E5 and collaboration security analytics, might we see more of the growth coming from ASP versus subscriber growth over time? Thank you so much.

Brad Sills:

Great to hear. Thanks, Amy.

Operator:

Our next question is coming from the line of Gregg Moskowitz with Mizuho. Please proceed with your question.

Satya Nadella:

Yeah. I mean the way we see it is, overall, macro will mean that everybody is going to optimize their build. In fact, as Amy said, our job number one for large swaths of our sort of even customer-facing organizations is to proactively help them optimize. In fact, our incentives in our customer success teams are lined up with them, helping customers “do more with less”. So that's sort of one side. The thing, though, from a customer perspective, the best way for them to align their spend with what is uncertain demand is to move to the cloud. So we see the value prop of the cloud. So the big winner in all of this will be public cloud, because public cloud helps businesses offset the risk of taking demand risk. The other side, as you described today, is the risk around supply chain or energy costs. And so that's another one best way to hedge against an energy cost and we, in fact, more energy efficient, is to move to the cloud. So that's where I think a little bit of – as you all think about what happens to cloud, for us, we look at this and say, this is a period where cloud gain share because we're still in the early innings of adoption. And so we just want to invest going into it, but that might set and build long-term customer loyalty.

Brett Iversen :

Thanks, Gregg. Jesse, we have time for one last question,

Brent Bracelin:

Good afternoon. Thanks for taking the question here. Helpful color on cloud. I wanted to pivot to advertising. This was a segment that crossed over $10 billion, I think, earlier this year. Netflix rolling out ad-supported model next year powered by Microsoft, what is the broader Microsoft advertising ambitions maybe three to five years here, given these are very large and very profitable segments that Microsoft has not historically focused on? Thanks.

Brett Iversen :

Thanks, Brad. 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.

Satya Nadella :

Thank you very much.

Brett Iversen:

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; Alice Jolla, Chief Accounting Officer; and Keith Dolliver, Deputy General Counsel. 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 and provides a reconciliation of differences between GAAP and non-GAAP financial measures. Unless otherwise specified, we will refer to non-GAAP metrics on the call. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the company's fourth quarter performance in addition to the impact these items and events have on the financial results. 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 growth rate only. We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If 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 replay the call and view the transcript on the Microsoft Investor Relations website. During this call, we'll 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. 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 the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that, I'll turn the call over to Satya.

Amy Hood:

Thank you, Satya, and good afternoon, everyone. This quarter, revenue was $51.9 billion, up 12% and 16% in constant currency. Earnings per share was $2.23 and increased 3% and 8% in constant currency. I'd like to start by discussing the impact of the macroeconomic environment on our results this quarter. First, FX. The U.S. dollar strengthened throughout the quarter, creating an additional headwind beyond what we shared mid-quarter. As a result, for the full quarter, revenue and EPS were negatively impacted by $595 million and $0.04 per share, beyond our expectations shared in April. Next, extended production setdowns in China that continued through May and a deteriorating PC market in June contributed to a negative Windows OEM revenue impact of more than $300 million. And finally, reductions in advertising spend impacted LinkedIn Marketing Solutions and search and news advertising revenue by more than $100 million. In our consumer business, despite those macro challenges, we drove another quarter of share gains for Windows in the PC market and for Edge in browsers. In our commercial business, Q4 was the largest quarter ever for long-term commitments to our platform. And as you heard from Satya, we saw share gains in areas such as data and AI, Dynamics, Teams and security. Against a strong prior year comparable, commercial bookings increased 25% and 35% in constant currency, significantly ahead of expectations. Our record commitment quarter was driven by increases in the number of $100 million-plus Azure and $10 million-plus Microsoft 365 contracts as well as consistent strong execution across our core annuity sales motions. Commercial remaining performance obligation increased 34% and 37% in constant currency to $189 billion. Roughly 45% will be recognized in revenue in the next 12 months, up 28% year-over-year. The remaining portion which will be recognized beyond the next 12 months, increased 39% year-over-year, and our acuity mix increased 1 point year-over-year to 96%. Microsoft Cloud revenue was $25 billion and grew 28% and 33% in constant currency. Microsoft Cloud gross margin percentage decreased slightly year-over-year to 69%. Excluding the impact from the change in accounting estimate for useful lives, Microsoft Cloud gross margin percentage increased roughly 1 point, driven by improvement across our cloud services, partially offset by sales mix shift to Azure. Now back to total company level. As noted earlier, FX decreased total company revenue by 4 points, 2 points unfavorable to expectations. Additionally, FX decreased COGS and operating expense growth by 2 points, 1 point favorable to expectations. Gross margin dollars increased 10% and 15% in constant currency, and gross margin percentage decreased year-over-year to 68%. Excluding the impact of the change in accounting estimate and FX, gross margin percentage increased slightly as the improvement in cloud services noted earlier was partially offset by sales mix shift to cloud. Operating expense increased 14% and 16% in constant currency, driven by increased investments in cloud engineering, LinkedIn and Nuance. OpEx growth included roughly 2 points from the decision to scale down operations in Russia, employee severance and the impact from the Xandr acquisition, which closed in June. At a total company level, headcount grew 22% year-over-year as we continued to invest in key areas such as cloud engineering, LinkedIn, sales and customer deployment, and included roughly 6 points of growth from the Nuance and Xandr acquisitions. Operating income increased 8% and 14% in constant currency, and operating margins decreased year-over-year to 40%. Excluding the impact of the change in accounting estimate and FX, operating margins were relatively unchanged as the improvement in cloud services noted earlier and sales mix shift to higher-margin businesses were offset by the impact of the Nuance acquisition. Now to our segment results. Revenue from Productivity and Business Processes was $16.6 billion and grew 13% and 17% in constant currency. FX decreased segment revenue $159 million more than expected. When adjusting for the additional FX headwind, overall segment results were in line with expectations. Office commercial revenue grew 9% and 13% in constant currency. Office 365 commercial revenue increased 15% and 19% in constant currency, in line with expectations, driven by installed base expansion across all workloads and customer segments as well as higher ARPU from continued momentum in E5. Paid Office 365 commercial seats grew 14% year-over-year, driven by our small and medium business and frontline worker offerings, although growth was impacted by some moderation in new deal volume outside of E5, particularly in the small and medium business customer segment. Demand for security, compliance and voice value in Microsoft 365 drove strong E5 momentum again this quarter. E5 now accounts for 12% of our Office 365 commercial installed base. Office commercial licensing was down 32% and 28% in constant currency, lower than expected, driven primarily by a lower mix of contracts with higher in-period revenue recognition. Office consumer revenue grew 9% and 12% in constant currency, in line with expectations, driven by continued momentum in Microsoft 365 subscriptions, which grew 15% to 59.7 million. Dynamics revenue grew 19% and 24% in constant currency, driven by Dynamics 365, which grew 31% and 36% in constant currency, slightly below expectations due to lower-than-expected growth in new business even as our cloud growth continues to outpace the market. LinkedIn revenue increased 26% to 29% in constant currency, lower than expected as Marketing Solutions was impacted by the slowdown of advertising spend noted earlier. And Talent Solutions was impacted by weaker online job posts late in the quarter. Segment gross margin dollars increased 12% and 17% in constant currency, and gross margin percentage decreased slightly year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage increased roughly 1 point, driven by improvement across all cloud services. Operating expense increased 12% and 14% in constant currency, and operating income increased 12% and 19% in constant currency. Next, the Intelligent Cloud segment. Revenue was $20.9 billion, increasing 20% and 25% in constant currency. FX decreased segment revenue $309 million, more than expected. Excluding the additional FX headwind, segment results were in line with expectations. Overall, Server products and cloud services revenue increased 22% and 26% in constant currency. Azure and other cloud services revenue grew 40% and 46% in constant currency, about 1 point lower than expected, driven by a slight moderation in Azure consumption growth across customer segments. In our per user business, the Enterprise Mobility and Security installed base grew 21% to over 230 million seats, with some impact from the small and medium business deal moderation noted earlier. In our on-premises server business, revenue decreased 2% and increased 1% in constant currency, ahead of expectations, driven by a greater-than-expected number of contracts with higher in-period revenue recognition. Enterprise Services revenue grew 5% and 8% in constant currency, lower than expected, driven by declines in Microsoft Consulting Services. Segment gross margin dollars increased 15% and 19% in constant currency, and gross margin percentage decreased roughly 3 points year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage declined roughly 2 points, driven by sales mix shift to Azure, partially offset by improvements in Azure margins. Operating expenses increased 20% and 22% in constant currency, including roughly 7 points of impact from Nuance. And operating income grew 11% and 18% in constant currency. Now to More Personal Computing. Revenue was $14.4 billion, increasing 2% and 5% in constant currency. FX decreased segment revenue $127 million more than expected. Excluding the additional FX headwind, segment results were below our guidance range, driven by the PC and ad trends mentioned earlier. Windows OEM revenue decreased 2% year-over-year. Despite the deteriorating PC market, we saw share gains again this quarter and volumes remained above pre-pandemic levels. Windows commercial products and cloud services revenue grew 6% and 12% in constant currency, lower than expected due to some impact from the small and medium business deal moderation noted earlier. Surface revenue grew 10% and 15% in constant currency, driven by commercial sales. Search and news advertising revenue ex TAC increased 18% and 21% in constant currency, lower than expected, driven by the slowdown in advertising spend noted earlier, partially offset by the inclusion of 3 weeks of results from Xandr. And in gaming, revenue declined 7% and 5% in constant currency, in line with expectations. Xbox hardware revenue declined 11% and 8% in constant currency. Xbox content and services revenue declined 6% and 4% in constant currency, driven by lower engagement hours and monetization in third-party and first-party content, partially offset by growth in Xbox Game Pass subscriptions. Segment gross margin dollars were relatively unchanged and increased 4% in constant currency, and gross margin percentage decreased roughly 1 point year-over-year, driven by increased usage of Windows Commercial Cloud services. Operating expenses increased 8% and 10% in constant currency, and operating income decreased 5% and was relatively unchanged in constant currency. Now back to total company results. Capital expenditures, including finance leases, were $8.7 billion, in line with expectations. Cash paid for PP&E was $6.9 billion. Our data center investments continue to be based on significant customer demand and usage signals. Cash flow from operations was $24.6 billion, increasing 8%, driven by strong cloud billings and collections. Free cash flow was $17.8 billion, up 9% year-over-year. This quarter, other income and expense was negative $47 million, primarily driven by net losses on investments, including mark-to-market losses on our equity portfolio. Equity market declines drove net investment losses this quarter compared to net investment gains last year, resulting in a negative 3-point impact on EPS growth. Our effective tax rate was approximately 18%. And finally, we returned $12.4 billion to shareholders, up 19% year-over-year through share repurchases and dividends, bringing our total cash returned to shareholders to over $46 billion for the full fiscal year. Now moving to our outlook. My commentary for both the full year and next quarter does not include any impact from Activision, which we still expect to close by the end of the fiscal year. Let me start with some full year commentary for FY '23. First, effective at the start of FY '23, we are extending the depreciable useful life for server and network equipment assets in our cloud infrastructure from 4 to 6 years, which will apply to the asset balances on our balance sheet as of June 30, 2022, as well as future asset purchases. Investments in our software that increased efficiencies in how we operate our server and network equipment as well as advances in technology have resulted in lives extending beyond historical accounting useful lives. This change only impacts the timing of depreciation expense in the future for these assets. As a result, based on the outstanding balances as of June 30, we expect fiscal year '23 operating income to be favorably impacted by approximately $3.7 billion for the full fiscal year and approximately $1.1 billion in the first quarter. This has been included in the guidance we will provide on today's call. Additional details on the mechanics of the change are in our earnings materials. Second, on FX. Assuming current rates remain stable, we expect a roughly 4-point impact to full year revenue growth with headwinds in H1 greater than in H2. FX should also decrease COGS and operating expense growth by 2 points. Now to our full year business outlook based on the current macro environment. At every level of the company, we manage performance on a constant currency basis, as we have for many years. Therefore, with the FX volatility we have seen, I will comment on full year in constant currency and in U.S. dollars. We continue to expect double-digit revenue and operating income growth in both constant currency and U.S. dollars. Revenue growth will be driven by continued momentum in our commercial business and a focus on share gains across our portfolio. Operating expense growth will be significant early in FY '23 and will moderate materially over the course of the year as we slow the rate of hiring to focus on key growth areas, increase the productivity of prior year headcount investments and anniversary the Nuance and Xandr acquisitions. And even with this significant level of investment in our future, we expect operating margins based on constant currency to be approximately flat year-over-year in FY '23, excluding the benefit from the latest change in useful life. And in U.S. dollars, we expect FY '23 full year margins to be roughly flat as the useful life benefit is mostly offset by the FX headwind mentioned earlier. And finally, we expect our FY '23 effective tax rate to be roughly 19%. Now to the outlook for the first quarter, which unless specifically noted otherwise, is on a U.S. dollar basis. First, FX. With the stronger U.S. dollar and based on current rates, we expect FX to decrease total revenue growth by approximately 5 points and to decrease total COGS and operating expense growth by approximately 3 points. Within the segments, we anticipate roughly 6 points of negative FX impact on revenue growth in Productivity and Business Processes and Intelligent Cloud and 3 points in More Personal Computing. Overall, our outlook has the trends we saw in June continue through Q1. Continued weakness in the PC market demand and advertising spend will impact Windows OEM, Surface, LinkedIn and search and news advertising revenue. Our differentiated market position, customer demand across our solution portfolio and consistent execution across the Microsoft Cloud should drive another strong quarter of revenue and share growth, although we expect to continue to see growth moderation in our small- and medium-sized business segment. In commercial bookings, strong execution across our core annuity sales motions and increased commitment to our platform should drive healthy growth on a flat expiry base. As a reminder, the growing mix of larger long-term measure contracts, which are more unpredictable in their timing, always drive increased quarterly volatility in our bookings growth rate. Microsoft Cloud gross margin percentage should be up roughly 2 points year-over-year, driven by the latest accounting estimate change noted earlier. Excluding the impact of the change in accounting estimate, Q1 gross margin percentage will decrease roughly 1 point, driven by revenue mix shift to Azure and the impact from the Nuance acquisition, partially offset by continued margin improvement in Azure. In capital expenditures, we expect a sequential decrease on a dollar basis, with normal quarterly spend variability and the timing of our cloud infrastructure build-out. Next is segment guidance. In Productivity and Business Processes, we expect revenue to grow between 12% and 14% in constant currency or US$15.95 billion to US$16.25 billion. In Office commercial, revenue growth will again be driven by Office 365 with seat growth across customer segments and ARPU growth through E5. We expect Office 365 revenue growth to be sequentially lower by roughly 2 points on a constant currency basis with a bit more FX impact on U.S. dollar growth than at the segment level. In our on-premises business, on a prior year comparable, which benefited from contracts with higher in-period revenue recognition, we expect revenue to decline in the mid- to high 30s. In Office consumer, we expect revenue to grow in the low to mid-single digits, driven by Microsoft 365 subscriptions. For LinkedIn, we expect continued strong engagement on the platform, although results will be impacted by the slowdown in advertising spend and hiring, resulting in low to mid-teens rev growth. And in Dynamics, we expect revenue growth in the mid- to high teens, driven by share growth in Dynamics 365. For Intelligent Cloud, we expect revenue to grow between 25% and 27% in constant currency or US$20.3 billion to US$20.6 billion. Revenue will continue to be driven by Azure, which, as a reminder, can have quarterly variability primarily from our per-user business and from in-period revenue recognition, depending on the mix of contracts. We expect Azure revenue growth to be sequentially lower by roughly 3 points on a constant currency basis. Azure revenue will continue to be driven by strong growth in consumption, and our per-user business should continue to benefit from Microsoft 365 suite momentum, although we expect moderation in growth rates, given the size of the installed base. In our on-premises server business, we expect revenue to decline low single digits, driven by strong demand for our hybrid offerings offset by the prior year comparable, which included benefit from contracts with higher in-period revenue recognition. At Enterprise Services, we expect revenue growth to be in the low single digits, driven by enterprise support, partially offset by declines in Microsoft Consulting Services. In More Personal Computing, we expect revenue to grow between 1% and 4% in constant currency or US$13 billion to US$13.4 billion. In Windows OEM, we expect revenue to decline in the high single digits. Excluding the impact from the Windows 11 revenue deferral last year, revenue would decline mid-teens, reflecting continued weakness in the PC market. In Windows commercial products and cloud services, customer demand for Microsoft 365 and our advanced security solutions should drive growth in the high single digits. In Surface, revenue should decline in the low single digits. Search and news advertising ex TAC should grow in the mid- to high teens, roughly 10 points faster than the overall search and news advertising revenue, driven by growing first-party revenue and the inclusion of Xandr. And in gaming, we expect revenue to decline in the low to mid-single digits, driven by declines in first-party content, partially offset by growth in Game Pass subscribers and consoles. We expect Xbox content and services revenue to decline in the low to mid-single digits. Now back to company guidance. We expect COGS to grow between 12% and 14% in constant currency or to be between US$14.9 billion and US$15.1 billion and operating expense to grow between 19% and 20% in constant currency or to be between US$13.3 billion and US$13.4 billion. Total company headcount is expected to continue to grow, with 11,000 hires expected to start in Q1, primarily in cloud engineering, LinkedIn, customer deployment and commercial sales. In other income and expense, interest income and expense should offset each other. As a reminder, we are required to recognize mark-to-market gains or losses on our equity portfolio, which can increase quarterly volatility. And we expect our Q1 effective tax rate to be approximately 19%. Finally, as a reminder on Q1 cash flow, we will be making $3.2 billion of tax payments related to the TCJA transition tax and the transfer of intangible property completed in Q1 of FY '22. In closing, we continue to see strong demand for our products and services and increased commitment to our platform as we remain focused on delivering compelling customer value in this dynamic environment, resulting in continued share gains. As we manage through this period, we will continue to invest in future growth while maintaining intense focus on operational excellence and execution discipline. With that, let's go to Q&A, Brett.

Operator:

[Operator Instructions] Our first question is coming from Keith Weiss with Morgan Stanley.

Satya Nadella:

Thank you, Keith, for the question. It was a record even for us, even with the context of Q4. So there's obviously something going on in the macro environment, which does feel that it does play to our strength. There are 2 things at least I've observed. One is the -- whether the bookings number or the Mac deals and the size of the Mac deals and the number of them, I think, speak to very much what we have been talking about for a long time now, which is as a percentage of GDP, IT spend is going to increase because every business is trying to fortify itself with digital tech to, in some sense, navigate this macro environment. So that, I think, is probably what is reflected in those numbers. And then the second aspect is also what you just referenced, which is, we do have every layer of the tech stack, right, whether it's infra, data, hybrid work, security, even Power Platform. In each one of these, we do have this best-of-suite value, which includes best-of-category products. And that is leading to share gains. So if you want to bet on a vendor on a long-term basis where you have that best-of-suite value and then you're able to sort of consume it on your terms, I think that, that's effectively what some of those numbers are indicative of.

Mark Moerdler:

Thank you very much and congratulations on the quarter. I'd like to follow up a little bit on that. With all the concerns about macro and recession, everyone is trying to understand how cloud and for Microsoft's case, more specifically, IaaS, PaaS offerings and this slowdown in recession, how do you think about Azure's resiliency? How do you think about Azure's exposure to advertising business, consumer Internet and SMB if we do see a real recession?

Operator:

Our next question is coming from the line of Brent Thill with Jefferies.

Amy Hood :

Thanks, Brent. As I said, it's trying to take into account the current macro environment. And as I said, I took what we saw in June, applied it as best we thought we could through the course of the fiscal year. And if you think about how the -- and if you try to look over the course of the year with some of my comments, you'd say, okay, in H1 versus H2, I would point out 3 things that changed a bit over the course of that time. First, of course, if we're talking about USD would be FX, it's a bigger headwind in H1, it's less of a headwind in H2. The second thing I would point to would be OpEx. As we've talked about in H1, we've obviously added 22% headcount this quarter. We still have 11,000 hires that we have starting in Q1. We've still got Nuance and Xandr in acquisitions, and we anniversary a lot of that as we focus our hiring and focus on the productivity of all of the hiring we've done over the past year. And then the OEM comparables obviously get a lot different when you get from H1 into H2. And so as you're trying to think about the shape and how did I consider it, I sort of took those things into account, thought about the trends we've been seeing in June and applied them as best we can.

Karl Keirstead :

I'd love to probe a little bit more on Azure. Amy, you and Satya talked about very robust large new deal activity. I thought your guidance for Azure constant currency growth in the September quarter of a 3-point decel to 43 is fairly solid. But you did mention that in the June quarter, you experienced a little bit of consumption softness. Do you mind explaining what that was? And when you put all this together, how you're feeling about the Azure business in the next couple of quarters in terms of the slope of the likely deceleration?

Operator:

Our next question is coming from the line of Raimo Lenschow with Barclays.

Satya Nadella:

Yes. Maybe I'll just start and Amy, you can add. I mean, the 2 numbers that our usage -- our user growth numbers, right, the 14% growth in the number of seats of Microsoft 365 and then the E5 growth of 60%, I think, speak to, again, that best-of-suite value in the core and in E5. So we're very, very competitive on both of those. And that's what you're seeing in that seat growth.

Operator:

Our next question is coming from Phil Winslow with Credit Suisse.

Amy Hood :

Thank you. Maybe let me start by talking about Q4's capital spend. Obviously, the big driver of our growth this quarter was in data center spend, both new and newbuilds as well as adding capacity to existing data centers. We are seeing, obviously, good demand signal. So hence, we've guided to another strong spending quarter in Q1 in terms of capital. Although it's a sequential decline, I would think about that more as being timing. It's always -- can move around a little bit just based on when builds are complete or when shipments come in. We do feel that we've gotten in a good place on capacity on a global basis and are focused on making sure our customers can drive the new units they need, the new usage they need in those data centers. I don't know, Satya, if you wanted to add on anything to that.

Operator:

Our next question is coming from the line of Kirk Materne with Evercore ISI.

Amy Hood :

That's a great question, Kirk. I did allude to it a couple of times when discussing Office EMS or the Azure per-user service as well as Windows commercial. And of course, that is because it's all related to selling Microsoft 365. And we did see, as I noted, some weakness in new deals, particularly in the SMB segment outside of E5. So to your point, think of them as SKUs are really intended, right, for that type of audience and customer base. And it came from a couple of things, Kirk, one of which we talked about before is that we are -- that is primarily sold through partner. And so we need to make sure we've got the best value props. We've got to make sure the price is right, offers right and make sure that we are tuning that value prop to what small business customers need today, which is great value, and so we'll keep executing that through partner. We're in the middle of that transition we talked about last quarter, and we're still working on it. The second thing is I would also say that is a spot where you tend to see macro weakness show itself, and we alluded to that as well in my comment because while I can't tell you, in particular, which part of that is some of the partner transition work we're doing versus macro, it certainly feels like both. And so that's certainly a spot that we're watching. I think your point around making sure we've got the right feed, which is absolutely do more with less and that we can help both modernize and get great value through the suites. But it's an important caveat to that. And you saw the way it shows itself, as you might notice is you saw the seat growth be a little lighter than you would have expected in the quarter. And then in Q1, that shows itself as a little bit of decel in that Office 365 growth number quarter-to-quarter.

Operator:

Our final question will come from the line of Alex Zukin with Wolfe Research.

Amy Hood :

Maybe I'll start and let Satya add. When we talked about it, what we saw in June and through the quarter, and then as we're thinking about Q1 is we have seen that deceleration in consumption apply really across customer segments. And in general, it was across geos. I wouldn't point in particular to any specific geo as showing a very different pattern than any other geo. And certainly, we've not applied that logic as we to Q1. I do think it speaks to what Satya and I have said, which is we see customers continuing to optimize, whether that's -- whether it's through reserved instance, whether it's through existing workloads and purchase patterns. And I expect that to continue, which is absolutely what the guide implies. And it implies that these Azure commitments that we signed through the course of the year, because it takes time for it to convert those large contracts until actual consumption and new project growth, as that work gets completed both at the customer and with our help, you'll start to see new projects add as the plus to the optimization that occurs. So it doesn't really -- I would not point to it as being different that we have certainly seen to this point. It's just a consistent deceleration that we've talked about.

Amy Hood:

Thank you.

Operator:

Ladies and gentlemen, this does conclude today's teleconference. Once again, we thank you for your participation, and you may disconnect your lines at this time.

Brett Iversen:

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; Alice Jolla, Chief Accounting Officer; and Keith Dolliver, Deputy General Counsel. 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 and provides the reconciliation of differences between GAAP and non-GAAP financial measures. Unless otherwise specified, we will refer to non-GAAP metrics on the call. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the company’s third quarter performance in addition to the impact these items and events have on the financial results. 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 growth rate only. We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today’s call is being webcast live and recorded. If 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 replay the call and view the transcript on the Microsoft Investor Relations website. 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. Actual results could materially differ because of factors discussed in today’s earnings press release, in the comments made during this conference call, and in the risk factor section of our Form 10-K, Forms 10-Q, and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that, I’ll turn the call over to Satya.

Amy Hood:

Thank you, Satya, and good afternoon, everyone. This quarter, revenue was $49.4 billion, up 18% and 21% in constant currency. Earnings per share was $2.22 and increased 14% and 18% in constant currency when adjusted for the tax benefit from the third quarter of fiscal year 2021. Several items impacted our financial performance that were not included in the guidance provided on our January earnings call. First, Nuance. My comments today across Q3 results and Q4 outlook include the impact from the Nuance acquisition which closed on March 4. Our results include $111 million in revenue and a negative $0.01 impact to earnings per share, including purchase accounting, integration, and transaction related expenses. Within our results, unless specifically noted otherwise, Nuance was not a material driver of growth rates. We continue to expect the Nuance acquisition will be minimally dilutive in FY2022 and accretive in FY2023 to non-GAAP EPS. Second, FX. The U.S. dollar strengthened throughout the quarter and created an incremental 1 point FX headwind to total company revenue compared to expectations. As a result, revenue and EPS were negatively impacted by $302 million and $0.03 per share, respectively. Finally, the war in Ukraine. We suspended all new sales of our products and services in Russia. Revenue generated in Russia represents less than 1% of total company revenue and we expect that it will decline significantly. The impact to operating income this quarter was roughly $130 million split evenly between lower revenue and higher bad debt expense, resulting in a negative $0.01 impact to EPS. Our results for the quarter are better than we expected across revenue, operating income, and EPS as we again delivered another strong quarter of top and bottom line growth. In our commercial business, healthy demand for our differentiated hybrid and cloud offerings together with excellent execution by our sales teams and partners drove increased commitment to our platform as well as higher usage of our services that Satya mentioned earlier. Commercial bookings increased 28% and 35% in constant currency, significantly ahead of expectations driven by strong execution across our core annuity sales motions. We also saw better than expected growth in large, long-term Azure contracts against a very strong prior year comparable. Nuance benefited bookings by roughly 5 points. Our on-premises transactional licensing revenue, across both the Office and Server businesses, was more negatively impacted than expected due to the transition from our Open Licensing program to our Cloud Solution Provider program. Commercial remaining performance obligation increased 32% and 34% in constant currency to $155 billion with a roughly equivalent split between the revenue that will be recognized within and the portion beyond, the next 12 months. And our annuity mix increased 2 points year-over-year to 96%. Commercial Cloud revenue was $23.4 billion and grew 32% and 35% in constant currency, again ahead of expectations. Microsoft Cloud gross margin percentage decreased slightly year-over-year to 70%. Excluding the impact from the change in accounting estimate for useful lives, the Microsoft Cloud gross margin percentage increased roughly 3 points driven by improvement across the cloud services, partially offset by sales mix shift to Azure. In our consumer business, as you heard from Satya, we saw market share gains across PCs, gaming consoles, and our Edge browser. Now back to the company level. As noted earlier, the U.S. dollar strengthened throughout the quarter. FX decreased total company revenue by 3 points, 1 point unfavorable to expectations, decreased COGS by 1 point, in line with expectations, and decreased operating expense growth by 2 points, 1 point favorable to expectations. Gross margin dollars increased 18% and 21% in constant currency and gross margin percentage decreased slightly year-over-year to 68%. Excluding the impact of the change in accounting estimate, gross margin percentage increased approximately 1 point driven primarily by improvement in our cloud services noted earlier. Operating expense increased 15% and 17% in constant currency, slightly lower than expected as investments that shifted to future quarters were partially offset by the inclusion of Nuance. At a total company level, headcount grew 20% year-over-year as we continue to invest in key areas such as cloud engineering, customer deployment, LinkedIn, and sales, and included approximately 4 points of growth from the addition of Nuance. Operating income increased 19% and 23% in constant currency and operating margins increased slightly year-over-year to 41%. Excluding the impact of the change in accounting estimate, operating margins expanded roughly 2 points year-over-year. Now to our segment results. Revenue from Productivity and Business Processes was $15.8 billion and grew 17% and 19% in constant currency in line with expectations. Better than expected results across Office 365, LinkedIn, and Office consumer were offset by impacts from incremental FX, the Open Licensing transition, Russia, as well as lower than expected results in Dynamics. Office commercial revenue grew 12% and 14% in constant currency. Office 365 commercial revenue increased 17% and 20% in constant currency, driven by installed base expansion across all workloads and customer segments, as well as higher ARPU from continued momentum in E5 revenue. Paid Office 365 commercial seats grew 16% year-over-year to nearly 345 million, with continued growth in our small and medium business and frontline worker offerings. And nearly 45% of our Office 365 commercial seats were purchased through Microsoft 365. Office commercial licensing was lower than expected, down 28% and 25% in constant currency, driven by the factors discussed earlier and a lower mix of contracts with higher in-period revenue recognition. Office consumer revenue grew 11% and 12% in constant currency, ahead of expectations, driven by continued momentum in Microsoft 365 subscriptions, which grew 16% to 58.4 million. Dynamics revenue grew 22% and 25% in constant currency driven by Dynamics 365, which grew 35% and 38% in constant currency, substantially faster than the market although a bit lower than expected as we focus on stronger execution on our recent investments. LinkedIn revenue increased 34% and 35% in constant currency, with better than expected performance in Talent Solutions as well as continued strength in Marketing Solutions and record levels of engagement on the platform. Segment gross margin dollars increased 16% and 19% in constant currency and gross margin percentage was relatively unchanged year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage increased roughly 2 points driven by improvement across all cloud services. Operating expense increased 13% and 14% in constant currency, and operating income increased 19% and 23% in constant currency. Next, the Intelligent Cloud segment, which includes approximately four weeks of results from Nuance. Revenue was $19.1 billion, increasing 26% and 29% in constant currency. Excluding the impact of Nuance and the approximately $150 million greater FX than expected, revenue results were ahead of expectations. Overall, server products and cloud services revenue increased 29% and 32% in constant currency. Azure and other cloud services grew 46% and 49% in constant currency, ahead of expectations, driven by continued strength in our consumption-based services. The inclusion of Nuance cloud services did not change the Azure constant currency growth rate. In our per-user business, the enterprise mobility and security installed base grew 25% to over 218 million seats. In our on-premises server business, revenue increased 5% and 7% in constant currency, ahead of expectations driven by healthy demand for our hybrid offerings partially offset by the Open Licensing transition mentioned earlier. The inclusion of Nuance on premises offerings did not change the server constant currency growth rate. Enterprise Services revenue grew 5% and 6% in constant currency, driven by growth in Enterprise Support Services. The inclusion of Nuance professional services impacted the constant currency growth rate by 1 point. Segment gross margin dollars increased 24% and 27% in constant currency and gross margin percentage decreased roughly 1 point year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage increased roughly 1 point with improvements in Azure partially offset by the sales mix shift to Azure. Operating expense increased 17% and 19% in constant currency and operating income grew 29% and 33% in constant currency. Now to More Personal Computing. Revenue was $14.5 billion, increasing 11% and 13% in constant currency, above expectations driven by better than expected performance in search and Windows offset by Surface. FX decreased segment revenue approximately $100 million greater than expected. Windows OEM revenue increased 11%, with continued strength in the commercial PC market, which has higher revenue per license. Windows commercial products and cloud services revenue grew 14% and 19% in constant currency, ahead of expectations, driven by demand for Microsoft 365 with some benefit from a greater mix of contracts with higher in-period revenue recognition. Surface revenue grew 13% and 18% in constant currency, lower than expected, driven by consumer channel, partially offset by strength in commercial. Search and news advertising revenue ex-TAC increased 23% and 25% in constant currency, better than expected, benefiting from an increase in search volumes even as we saw headwinds during March from the impact of the war in Ukraine. And in Gaming, on a high prior year comparable, revenue increased 6% and 8% in constant currency. Xbox hardware revenue was better than expected as increased supply of consoles in quarter drove growth of 14% and 16% in constant currency. Xbox content and services revenue grew 4% and 6% in constant currency, below expectations, driven by lower engagement across the platform, even as it remains above pre-pandemic levels. Segment gross margin dollars increased 10% and 13% in constant currency and gross margin percentage decreased slightly. Operating expenses increased 17% and 18% in constant currency and operating income grew 7% and 10% in constant currency. Now back to total company results. Capital expenditures including finance leases were $6.3 billion, in line with expectations. Cash paid for PP&E was $5.3 billion. Cash flow from operations was $25.4 billion, increasing 14% as strong cloud billings and collections were partially offset by higher supplier payments related to hardware inventory builds as we manage continued uncertainty in the supply chain. Free cash flow was $20.0 billion, up 17%. This quarter, other income and expense was negative $174 million, lower than anticipated driven by net losses on investments, including mark-to-market losses on our equity portfolio, and net losses on foreign currency remeasurement. Equity market declines drove net investment losses this quarter compared to net investment gains last year, a negative 2-point impact on year-over-year EPS growth. Our effective tax rate was approximately 17%. And finally, we returned $12.4 billion to shareholders through share repurchases and dividends. Now, before we turn to our outlook, a few reminders. First, FX; with the stronger U.S. dollar and based on current rates, we now expect FX to decrease total company revenue growth by approximately 2 points and to decrease total COGS and operating expense growth by approximately 1 point. Within the segments, we anticipate roughly 3 points of negative FX impact on revenue growth in Productivity and Business Processes and 2 points in Intelligent Cloud and More Personal Computing. Second, my remarks for the next quarter include a full quarter of impact from the Nuance acquisition. Third, we anticipate the war in Ukraine to continue to impact our business in Q4 with a roughly $110 million impact on revenue and minimal impact on operating expenses. Next, we have taken into account the current impact of shutdowns in China in our outlook. However, extended production shutdowns that reach into May would further negatively impact our outlook across Windows OEM, Surface, and Xbox hardware. Finally, the outlook we give, unless specifically noted otherwise, is on a USD basis. With that context in place, let’s turn to our Q4 outlook. In our largest quarter of the year we expect our differentiated market position, customer demand across the solution portfolio, and consistent execution to drive another strong quarter of revenue growth. In commercial bookings, a growing Q4 expiry base, strong execution across our core annuity sales motions, and increased commitment to our platform should drive healthy growth against a strong prior year comparable. As a reminder, the growing mix of larger long-term Azure contracts, which are more unpredictable in their timing, always drives increased quarterly volatility in our bookings growth rate. Microsoft Cloud gross margin percentage should be down roughly 1 point year-over-year. Excluding the impact of the change in accounting estimate, Q4 gross margin percentage will increase roughly 1 point driven by continued improvement across our cloud services partially offset by a revenue mix shift to Azure. Capital expenditures, we expect a sequential increase on a dollar basis as we continue to invest to meet growing global demand for our cloud services. Next to segment guidance; in Productivity and Business Processes, we expect revenue between $16.65 billion and $16.9 billion. In Office Commercial, revenue growth will again be driven by Office 365 with healthy seat growth across customer segments and ARPU growth thru E5. We expect Office 365 revenue growth to be sequentially lower by a point or two on a constant currency basis. In our on-premises business, we expect revenue to decline similar to last quarter. In Office consumer, we expect revenue to grow in the high single digits, driven by Microsoft 365 subscriptions. For LinkedIn, we expect revenue growth in the high-20s driven by the strong job market and healthy engagement on the platform. And in Dynamics, we expect revenue growth similar to last quarter. For Intelligent Cloud we expect revenue between $21.1 billion and $21.35 billion. Revenue will continue to be driven by Azure which as a reminder can have quarterly variability primarily from our per-user business and from in-period revenue recognition depending on the mix of contracts. We expect Azure revenue growth to be sequentially lower by roughly 2 points on a constant currency basis with a bit more FX impact on U.S. dollar growth than at the segment level. Azure revenue will continue to be driven by strong growth in our consumption business. And our per-user business should continue to benefit from Microsoft 365 suite momentum, though we expect moderation in growth rates given the size of the installed base. In our on-premises server business, we expect revenue to decline in the low-to-mid single digits as demand for our hybrid offerings will be more than offset by the strong prior year comparable, which included 4 points of benefit from contracts with higher in period revenue recognition, as well as continued transactional weakness from the licensing program transition noted earlier. And in Enterprise Services, we expect revenue growth to be in the high single digits. In more Personal Computing, we expect revenue between $14.65 billion and $14.95 billion. As mentioned earlier, our guidance reflects the current constraints from the shutdowns in China, which have negatively impacted Q4 supply for OEM, Surface and Xbox consoles. In Windows OEM we expect revenue growth in the low-to-mid-single digits driven by the continued shift to a commercial-led PC market where revenue per license is higher. In Windows commercial products and cloud services, customer demand for Microsoft 365 and our advanced security solutions should drive growth in the low-double digits. In Surface, revenue should grow in low-double digits. In Search and news advertising ex-TAC, we expect revenue growth of approximately 20%. And in Gaming, we expect revenue to decline in the mid-to-high single digits driven by lower engagement hour’s year-over-year as well as constrained console supply. We expect Xbox content and services revenue to decline mid-single digits though engagement hours are expected to remain higher than pre-pandemic levels. Now back to company guidance. We expect COGS of $16.6 billion to $16.8 billion and operating expense of $14.8 billion to $14.9 billion resulting in another quarter of operating margin expansion excluding the change in useful life. We expect other income and expense to be negative $50 million reflecting FX remeasurement impact based on market conditions in April. Similar to the rest of our guidance, further equity and FX movements through Q4 are not reflected in this number. As a reminder, we are required to recognize mark-to-market gains or losses on our equity portfolio, which can increase quarterly volatility. And we expect our Q4 effective tax rate to be approximately 18%. We expect to close FY22, even in a more complex macro environment, with the same consistency we have delivered throughout the year. With strong revenue growth, share gains, and improved operating margins as we invest in the areas that are key to sustaining that growth. As we look toward FY23, our track record of delivering high value to our customers across many diverse and durable growth markets gives us confidence that we will drive continued healthy double-digit revenue and operating income growth. Now, Brett lets go to Q&A.

Operator:

Absolutely. [Operator Instructions] Our first question is coming from Keith Weiss with Morgan Stanley. Please proceed with your question.

Satya Nadella:

Yes, maybe I’ll start. Maybe at three levels Keith, one is just the competitiveness of our tech stack all up sort of from infrastructure all the way to the SaaS applications when it comes to the commercial cloud and as well as how we are able to monetize for example, the install base of our consumer franchises as well. So both of these places we feel we are competitive and increasingly so coming out of the pandemic to gain share. I’d also say that in many of these places, we have price leadership. I mean, take the one point I made which is, if there is any macro-headwind where you have more value for less price means you win. And in our case, when it comes to our commercial cloud offerings we have significant advantages on that across the stack. The second thing is in the conversations we are having with our customers. The interesting thing I find from perhaps even past challenges whether macro or micro is no, I don’t hear of businesses looking to their IT budgets or digital transformation projects is the place for cuts, if anything, some of these projects are the way they’re going to accelerate their transformation or for that matter automation for example. I have not seen this level of demand for automation technology to improve productivity because in an inflationary environment, the only deflationary force is software. So that’s the second micro thing the tone thing that’s different. At the end of the day though, I mean, none of us here are trying to forecast macro. So all we think of is the TAMs that we are competing in a large, as a percentage of GDP tech spend is on a secular basis by the end of the decade going to double. We just want to keep driving usage, driving share and be competitive, so that’s kind of how we view what we are doing. And that’s where our confidence comes from in terms of our outlays, whether it’s OpEx or CapEx. So I don’t know if Amy, if you want to add to that.

Keith Weiss:

Outstanding. Great quarter.

Operator:

Absolutely. Our next question is coming from Brent Thill with Jefferies. Please proceed with your questions.

Amy Hood:

I assume we’re specifically talking about most of the guidance in the more personal computing segment where the supply chain constraints, which are specifically related to the production shutdowns in China. I generally follow the same principle I try to follow, which is I give you my best knowledge as of today. I did note and tried to do that with a lot of clarity that were the production shutdowns to extend into May, there would be further negative impact on those from a supply constraint position. As you know, on the OEM business, that revenue is recognized at the point of production and then for Xbox consoles as well as Surface it’s a sell-in. So production delays even earlier in May can obviously have big impact on the quarter. So we’re watching it and I’ve tried to make that transparent in the guidance, outside of that my guidance is reasonably consistent with how I – with how I like to do it.

Brett Iversen:

Thanks, Brent. Jesse, next question please.

Mark Moerdler:

Thank you very much. Congratulations on the quarter and on the strong guidance, I think it’s going to not just help the stock, but hopefully help a little bit more across into the industry. I’d like to look at Office which had strength probably more than people expected. Where are we in the up-sell opportunity from E3 to E5? And can you give us any sense of the sizing of how much of the growth not just now, but going forward do you think is going to come from frontline users? Thank you.

Satya Nadella:

No, you counted well, Amy. I mean, I think, the fundamentals are pretty strong here still, whether it’s E5 growth, SMB growth, frontline worker, I’d also add emerging markets. I mean, this is the first time I feel that we have products that fit just emerging markets like Teams Essentials, where we can even really penetrate markets that we’ve never sold anything in the past. And then the new growth engines that you talked about, Teams Phones, Teams Rooms, Viva and even Windows 365 are all things that we can again, drive growth from. And the point about sort of our value is probably a very, very strong in a time like this in particular. And we see it like the one thing also I’d say is the usage data that we are seeing is peak everywhere. And so that’s the other thing, is we definitely will optimize for driving usage and deployment and that’s going to be our priority.

Brett Iversen:

Thanks Mark. Jesse, next question, please.

Karl Keirstead:

Okay, great. Amy, you called out some transactional weakness, which in the March quarter we can see in the on-prem Office segment and in your guidance in the server products, you suggest we might see it there too. Is that something that you would characterize as Microsoft specific, as you describe in your comments, your transitioning customers off your Open License program? Or do you feel like that’s a broader issue where maybe we’re starting to see a little bit of a tilt from on-prem to cloud even faster than we’ve seen before? Thank you.

Karl Keirstead:

Got it.

Amy Hood:

Absolutely.

Karl Keirstead:

Got it. Thanks Satya.

Operator:

Our next question comes from Mark Murphy with JPMorgan. Please proceed with your question.

Satya Nadella:

Yes, I mean, what I’d say Karl [ph] is that what we are seeing is a classic what happens with consumption meters, right, which is they grow, and then they get optimized and they grow again both existing and new. And so, it’s sort of, will always have some amount of volatility that even Amy referenced quarter-over-quarter. But if I walk up, one thing that we look at is growth coming from all segments, right? So small business and enterprise, is it coming from all regions? And it is. We also look at the type of workloads it’s coming from. And so it looks healthy in all of those. And if you walk up the stack to your point on the infrastructure side, the Tier 1 workloads is where I think we are seeing some big Tier 1 workloads, and I had many comments on SAP and other workloads moving. The second thing I’d say is on the past services and our DevFest that’s another area where we have differentiated value. So we see good growth there. Data and AI for sure, I mean, the thing that I find really to be something that I think the long run is going to probably be one of the bigger drivers of our growth and differentiation is our data fabric, because we are the only guys who have a complete data fabric from the operational store that’s fully integrated into an analytics engine that’s fully integrated into governance. And that increasingly is going to become more and more important, right? I mean you can be dealing with this a new regulation coming on privacy and governance on one end and your operational store being divorced from that. So we have a very differentiated offer and I talked about some of the growth numbers there. The AI inference is also finally kicking. They’re very small today, but even when I look at the total com – that’s just essentially a compute meter, there’s growth there. So overall, I think we will see quarter-over-quarter, some cyclicality, depending on which customers. In fact, we pay people at Microsoft to reduce customer bills and which we should. So given that we may see cyclicality in terms of how optimizations happen, but overall we’re still very early on as the world sort of migrates to the cloud and users, essentially cloud infrastructure and compute is sort of to drive their operational efficiencies and product.

Brett Iversen:

Thanks, Mark. Jesse, next question, please.

Kash Rangan:

Thank you so much. Congrats on a spectacular quarter. Satya, I have very clearly on your comments and particularly you talked about tech as a percentage of GDP doubling over the next seven, eight years or so. Nobody could have really predicted maybe besides yourself, that Azure would be this big and growing this fast at this point in time relative to say five, six years back. So as you look forward, what part of the Microsoft tech stack do you think is underrepresented in the digital word and has therefore more opportunity to gain as you build out your thesis on tech as a percentage of GDP doubling. Thank you so much.

Kash Rangan:

Fascinating. Thank you so much.

Operator:

Our next question comes from Michael Turrin with Wells Fargo. Please proceed with your question.

Amy Hood:

Satya, do you want to start with your comments maybe on Nuance overall, and then – and I can address sort of how the larger long-term contracts.

Amy Hood:

And Michael, maybe specifically you’re absolutely right. I tend to mention the impact of large long-term Azure contract, both in the context of commercial bookings and some volatility we often can see in that because of it. But really, I think the way we think about them maybe outside of this phone call, is that it’s the beginning of the commitment between us and a customer to start to work together to deliver value. And so we go workload by workload, opportunity by opportunity and I think that’s what you were inferring a bit is that it’s almost the top of the funnel to create value for the customer. We call it delivering success to make sure they’re spending the dollars the most effective way, making sure we’re tackling the hardest problems that they need solved. And with that comes our investments that we’ve made and deployment resources and usage resources specifically in Azure to make that possible with customers. And so you’re right to say, I do talk about them in terms of volatility they create, what it creates inside the company is the beginning of a commitment to make sure we’re tackling the workloads and the solutions that the customers want to make happen across all the workloads frankly that Satya has talked about today.

Brett Iversen:

Thanks, Michael. Jesse, we have time for one last question.

Keith Bachman:

Hi, and many thanks. I wanted to break it up into two parts. But I was wondering if you could comment on what you see is the strength of the PC market as you look out over the course of the calendar year, if you focus on the demand side equation, not the supply side of the equation. And really the more important related part is given the outlook that you may have for the PC market. How are you thinking about the durability of the Windows side of your business? In particular, if you comment on the fundamentals related PC market, but also the opportunities to keep mixing up, so to speak helped by Microsoft 365. Many thanks.

Amy Hood:

Why don’t you start and I’ll add on.

Amy Hood:

Exactly. I think the one thing I would add on your demand side, we have seen the transition from, I would say, in the middle of pandemic, definitely a consumer driven demand cycle. We’ve transitioned that to be a commercial part of the demand side. And so I do expect that to be the case, obviously, I think this is the second quarter in the row. We’ve seen that transition expect Q4 to be even more of that. And then we’ll wait and see how the second half of the year shapes up.

Amy Hood:

Thank you.

Amy Hood:

Thanks, everyone.

Operator:

Ladies and gentlemen, this will conclude today’s teleconference. Once again, we thank you for your participation and you may disconnect your lines at this time.

Brett Iversen:

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; Alice Jolla, Chief Accounting Officer; and Keith Dolliver, Deputy General Counsel. 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 and provides the reconciliation of differences between GAAP and non-GAAP financial measures. Unless otherwise specified, we will refer to non-GAAP metrics on the call. The non-GAAP financial measures provided should not be substitute for, or superior to, the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the company's second quarter performance in addition to the impact these items and events have on the financial results. 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. Our growth rates are the same in constant currency, we will refer to the growth rate only. We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If 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 replay the call and view the transcript on the Microsoft Investor Relations website. 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. 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 the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that, I'll turn the call over to Satya.

Amy Hood:

Thank you, Satya, and good afternoon everyone. This quarter, revenue was $51.7 billion, up 20% year-over-year. Earnings per share was 2.48, increasing 22%. The U.S. dollar strengthened during the quarter, and as a result, FX had no impact on total company and segment revenue growth, which was a 1-point headwind compared to expectations. Despite this, we delivered another quarter of strong double-digit revenue growth in each of our business segments, reflecting our unique and differentiated market position across a connected portfolio of diverse businesses. In our commercial business, strong execution by our sales teams and partners combined with continued demand for our Microsoft Cloud offerings drove significant growth in large, long-term Azure contracts, as well as increased usage of Teams and our advanced security and identity offerings. And in LinkedIn, Talent Solutions benefited from a strong job market again this quarter. In our consumer business, increased PC demand and usage, as Satya highlighted, benefitted our Windows OEM business. Continued advertising market growth drove another strong quarter in LinkedIn Marketing Solutions as well as Search and news advertising. And in a strong holiday quarter for gaming, we saw record revenue and engagement on the platform, with significant growth in Game Pass subscribers and first-party titles, as well as continued demand for Xbox Series X and S consoles. Now to our overall results. Commercial bookings grew 32% and 37% in constant currency, significantly ahead of expectations, driven by the large, long-term Azure contracts noted earlier and strong execution across our core annuity sales motions. Commercial remaining performance obligation increased 31% and 32% in constant currency to $147 billion. Roughly 45% will be recognized in revenue in the next 12 months, up 26% year-over-year. The remaining portion, which will be recognized beyond the next 12 months, increased 37% year-over-year, highlighting the long-term commitment customers are making to the Microsoft Cloud. And our annuity mix increased 1 point year-over-year to 94%. Microsoft Cloud revenue grew 32% to $22.1 billion, again ahead of our expectations. Microsoft Cloud gross margin percentage decreased slightly year-over-year to 70%. Excluding the impact from the change in accounting estimate for the useful life of server and network equipment assets, Microsoft Cloud gross margin percentage increased roughly 3 points driven by improvement across our cloud services, partially offset by sales mix shift to Azure. As noted earlier, with the strengthening of the U.S. dollar through the quarter, FX had no company and segment revenue growth impact, and minimal impact on COGS and operating expense growth. Gross margin dollars increased 20%. Gross margin percentage was 67%, relatively unchanged year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage increased roughly 2 points driven primarily by the improvement in our cloud services noted earlier. Operating expense increased 14%, lower than expected, primarily driven by investments that shifted to future quarters. At a total company level, headcount grew 16% year-over-year as we continue to invest in key areas such as cloud engineering, sales, customer deployment, gaming, and LinkedIn. Operating income increased 24% and operating margins expanded 1 point year-over-year to 43%. Excluding the impact of the change in accounting estimate, operating margins expanded roughly 3 points year-over-year. Now to our segment results. Revenue from Productivity and Business Processes was $15.9 billion and grew 19% year-over-year, which included a 1-point FX headwind relative to expectations. Excluding this headwind, revenue exceeded expectations driven by LinkedIn. Office commercial revenue grew 14%. Office 365 commercial revenue growth of 19% was driven by installed base expansion across all workloads and customer segments, as well as higher ARPU. Demand for our advanced security, compliance, and voice offerings drove continued momentum in E5 revenue this quarter. Paid Office 365 commercial seats increased 16% year-over-year, driven by another strong quarter of growth in our small and medium business and frontline worker offerings. Office commercial licensing decreased 17%, in line with expectations and consistent with the ongoing customer shift to the cloud. Office consumer revenue grew 15%, driven by continued momentum in Microsoft 365 subscriptions, which grew 19% to 56.4 million. Dynamics revenue grew 29% year-over-year driven by Dynamics 365, which grew 45% and 44% in constant currency. Continued demand for our modern, low-code app development solutions drove another strong quarter with 161% revenue growth in Power Apps. LinkedIn revenue increased 37% and 36% in constant currency, with continued strength in Marketing Solutions, which grew 43% year-over-year as well as better-than-expected performance in Talent Solutions from the strong job market noted earlier. Segment gross margin dollars increased 20% and 19% in constant currency and gross margin percentage was relatively unchanged year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage increased roughly 2 points driven by improvement across all cloud services. Operating expense increased 13%, and operating income increased 24%. Next, the Intelligent Cloud segment. Revenue was $18.3 billion, increasing 26% year-over-year, which included a 1-point FX headwind relative to expectations. Excluding this headwind, revenue grew ahead of expectations driven by continued customer demand for our differentiated hybrid and cloud offerings. Overall, server products and cloud services revenue increased 29% year-over-year. Azure and other cloud services growth of 46% was driven by continued strength in our consumption-based services. In our per-user business, the enterprise mobility and security installed base grew 28% to over 209 million seats. In our on-premises business, revenue increased 6%, in line with expectations driven by healthy demand for our hybrid offerings that include Windows Server and SQL Server running in multi-cloud environments. Enterprise Services revenue grew 8% and 7% in constant currency, driven by growth in Enterprise Support Services and Microsoft Consulting Services. Segment gross margin dollars increased 21% and 22% in constant currency and gross margin percentage decreased roughly 2 points year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage increased slightly with improvements in Azure partially offset by the sales mix shift to Azure. Operating expense increased 14%, and operating income grew 26%. Now to More Personal Computing. Revenue was $17.5 billion, increasing 15% year-over-year, with better-than-expected performance in Windows OEM, Surface, and Search and news advertising. Revenue growth included a 1-point FX headwind relative to expectations. Windows OEM revenue increased 25%, significantly ahead of expectations, driven by the strong PC market noted earlier, particularly in the commercial segment, which has higher revenue per license. As a reminder, these results include roughly 6 points of positive impact from the $210 million revenue deferral related to, which shifted revenue from Q1 to Q2. Windows commercial products and cloud services revenue grew 13% and 14% in constant currency driven by demand for Microsoft 365. Surface revenue grew 8% year-over-year, ahead of expectations as we were able to ship more devices than anticipated into a strong demand environment. Search and news advertising revenue ex TAC increased 32%, better than expected, benefiting from the strong advertising market noted earlier. And, we saw share gains in our Edge browser on Windows 10 and 11 devices. And in Gaming, revenue increased 8%, in line with expectations. Xbox hardware revenue grew 4% and 3% in constant currency driven by continued strong demand and better than expected console supply on a strong prior year comparable that included the launch of the Xbox Series X and S. Xbox content and service revenue increased 10%, lower than expected, as strong growth in first-party titles and Game Pass subscriptions was partially offset by weaker third-party title performance. Segment gross margin dollars increased 20% year-over-year. Gross margin percentage increased roughly 2 points, driven by sales mix shift to higher margin businesses and improvement in Search and news advertising. Operating expenses increased 17% driven by investments in Gaming, primarily ZeniMax, Search and news advertising, and Windows marketing. Operating income grew 22% and 21% in constant currency. Now back to total company results. Capital expenditures including finance leases were $6.8 billion, up 25% year-over-year, lower than expected, primarily due to quarterly spend volatility in the timing of our cloud infrastructure buildout. Cash paid for PP&E was $5.9 billion. Our capital investments, including both new data center regions and expansion in existing regions, continue to be based on significant customer demand and usage signals. Cash flow from operations was $14.5 billion, increasing 16% year-over-year as strong cloud billings and collections were partially offset by higher supplier payments related to hardware inventory builds. Free cash flow was $8.6 billion, up 3% year-over-year, reflecting higher capital expenditures in support of our growing cloud business. This quarter, other income and expense was $268 million, higher than anticipated, primarily driven by net gains on investments. Our effective tax rate was approximately 17%. And finally, we returned $10.9 billion to shareholders through share repurchases and dividends. Now, before we turn to our outlook, I’d like to provide a couple of reminders. First, my remarks for the next quarter do not include the impact from the Nuance acquisition, although we do expect it to close during Q3. Second, the outlook we give, unless specifically noted otherwise, is on a U.S. dollar basis. With that, let’s move to the third quarter outlook. First, FX. With the stronger U.S. dollar and based on current rates, we now expect FX to decrease total revenue growth by approximately 2 points and to decrease total COGS and operating expense growth by approximately 1 point. Within the segments, we anticipate roughly 2 points of negative FX impact on revenue growth in Productivity and Business Processes and Intelligent Cloud and 1 point in More Personal Computing. Next, we expect our differentiated market position, customer demand for our high-value hybrid and cloud offerings, and consistent execution to drive another strong quarter of revenue growth. In commercial bookings, growth should be healthy but will be impacted by the strong prior year comparable as well as low growth in the expiry base. As a reminder, the growing mix of larger long-term Azure contracts, which are more unpredictable in their timing, drive increased quarterly volatility in our bookings growth rate. Microsoft Cloud gross margin percentage should be roughly flat year-over-year. Excluding the impact of the change in accounting estimate, Q3 gross margin percentage will increase roughly 2 points driven by continued improvement across all cloud services, despite revenue mix shift to Azure. And, on a dollar basis, we expect capital expenditures to be slightly down sequentially with normal quarterly variability in the timing of the cloud infrastructure buildout. Next to segment guidance. In Productivity and Business Processes, we expect revenue between $15.6 billion and $15.85 billion. In Office 365, healthy revenue growth will be driven by the same factors as Q2 with similar seat growth across customer segments and continued momentum in E5. In our on-premises business, we expect revenue to decline in the high-teens, with continued customer shift to the cloud. In Office consumer, we expect revenue to grow in the high single-digits, with continued momentum in Microsoft 365 consumer subscriptions. For LinkedIn, the strong job market and healthy engagement on the platform should drive revenue growth in the low-30% range. And in Dynamics, we expect revenue growth in the mid-20% range driven by strength in Dynamics 365, including continued momentum in Power Apps. For Intelligent Cloud, we expect revenue between $18.75 billion and $19 billion. Revenue will continue to be driven by Azure which, as a reminder, can have quarterly variability primarily from our per-user business and from in-period revenue recognition depending on the mix of contracts. In Azure, we expect revenue growth to be up sequentially in constant currency, driven by our Azure consumption business, with strong growth on a significant base. And our per-user business should continue to benefit from Microsoft 365 suite momentum, though we expect some moderation in growth rates given the size of the installed base. In our on-premises server business, continued demand for our differentiated hybrid offerings should drive revenue growth in the low to mid-single-digits. And in Enterprise Services, we expect revenue growth to be in the low to mid-single-digits. In More Personal Computing, we expect revenue between $14.15 billion and $14.45 billion. Continued strength in PC shipments, particularly in the commercial segment, should benefit Windows OEM despite ongoing supply chain constraints. We expect Windows OEM revenue growth in the high single-digits. In Windows commercial products and cloud services, customer demand for Microsoft 365 and our advanced security solutions should drive growth in the low double-digits. In Surface, revenue should grow in the mid-teens with strength from our premium devices. In Search and news advertising ex-TAC, we expect revenue growth in the mid to high-teens, against a strong prior year comparable that was driven by a recovery in the advertising market. And in Gaming, on a prior year comparable that included significant strength in hardware from our new consoles as well as across Xbox content and services, we expect revenue growth in the mid-single digits. Console sales will continue to be impacted by supply chain uncertainty. And in Xbox content and services, we expect revenue growth in the mid to high-single digits with strong engagement and continued momentum across the platform. Now back to company guidance. We expect COGS of $15.5 billion to $15.7 billion and operating expense of $13.4 billion to $13.5 billion driven by headcount investments in high-growth, strategic areas to drive continued long-term revenue growth. In other income and expense, interest income and expense should offset each other. And we expect our Q3 effective tax rate to be approximately 18%, slightly higher than our full year expected tax rate of approximately 17%. And finally, for FY22, given our strong performance in the first half of the fiscal year and our current H2 outlook, full year operating margins should be slightly up year-over-year even with the impact of changes in accounting estimates noted earlier and the significant strategic investments we are making to capture the tremendous opportunities ahead of us. In closing, digital technologies are increasingly essential to empowering every person and organization on the planet to achieve more and we are well positioned with innovative, high value products. Our diverse, yet connected portfolio of solutions spans end markets, customer sizes and business models, uniquely enabling us to deliver long-term revenue and profit growth. With that, Brett, let’s go to Q&A

Operator:

Absolutely. [Operator Instructions]. Our first question is coming from the line of Keith Weiss with Morgan Stanley. Please proceed.

Satya Nadella:

Thank you, Keith. I'll take that, and Amy you can add on to it. Overall, what we see is pretty strong demand signal. And quite frankly, going into the pandemic, we saw demand increase because of the constraints the pandemic put on corporations and the increased consumer activity. And then coming out of the pandemic, we are seeing actually a lot of constraints in the economy, and the only resource, as I said in my remarks, that can help drive productivity while keeping cost down is digital tech. So when I think -- take something like Power Apps, it's just a great example of something that's right in the middle of our stack, really helps drive that next level of productivity in the labor force for any company in any industry. And so the demand signals we see across the stack from security to our cloud infrastructure to business applications and solutions like Teams is very strong. And the other area, obviously, we're seeing strength is in gaming. That's where we have doubled down in terms of our consumer category creation. And we see the intensity of usage and the business model diversity around games that increasingly, the economics of gaming franchises is also radically becoming much more software-like. So we sort of overall see good demand signal across the stack.

Satya Nadella:

I mean, there's definitely a very competitive talent market and we are competitive in that talent market. And you see it even in our OpEx projections that Amy shared. We are growing our headcount because we see the opportunity. We are not immune from what happens overall in the labor market, but I think we have a good brand and an attractive brand to both get people and to retain people with everything that we are doing. So - but at the same time, we do want to make sure that in our channel and our ecosystem remain healthy and all the signals at least we are getting is that there are no constraints per se other than at the end of the day, all businesses are going to be subject to the laws of economic growth in the overall economy.

Brett Iversen:

Thanks, Keith. Operator, next question, please.

Mark Moerdler:

Thank you very much for taking my question, and congratulations on the strong growth across the overall business and really nice outlook. Satya, given all the commentary on the metaverse, what are the key components of the metaverse or the multiple metaverses that you're seeing? What does Microsoft have today that they're positioned to be able to deliver to meet those requirements? And what do you believe you might be lacking if the partner ecosystem meet those requirements? And to Amy, with the hype cycle underway and increased industry interest in the metaverse, are you changing your investments to meet the potential opportunity?

Amy Hood:

And Mark, maybe just add one bit of perspective to Satya's answer, which is I would bring people's attention to the holistic nature in which he answered the question, starting at the platform layer all the way up through the importance of content and app layer in that the investment will show itself in each component as opposed to maybe in one stand below group or team. And it's because I think of the transition Satya just talked about. If it’s that -- if it's at the platform layer and it applies to all the components, it's better to do that, frankly, across the teams where they can apply it in the right way. And I think that's how I would point to the investment showing itself.

Brett Iversen:

Thanks, Mark. Operator, next question, please.

Brent Thill:

Amy, you really underscored the strength ahead on commercial bookings at 37%. Many are asking where you're seeing the strength into your Azure comment for next quarter, obviously, the acceleration what's giving you the confidence? Thanks.

Operator:

The next question is coming from Karl Keirstead with UBS.

Amy Hood:

Thanks, Karl. I think it's really a combination of things as it is when you go through a fiscal year. Really, I believe that our execution in a very good demand environment has given confidence. Revenue performance has been quite consistent to your point. We have seen some continued upside in OEM. We've seen strength in gaming. We've seen strength in our Microsoft Cloud products. We've seen good consistency out of Dynamics. I mean, at some level, if you really wanted to look at the trend lines, you'd say this has been a very consistent execution by the team across really both of the business units. And so if you think about then what goes into confidence is when you start to add headcount and you add headcount with goals of ROI and you look at that accountability, I feel like the teams have done a nice job. Where we've added heads, they've been into strong markets. They've executed well. Sales teams have done the same. And then on top of that, Karl, I would say there's been good execution on the gross margin numbers. I tend to be an operating margin-focused communicator with you all and inside the company. But gross margins have also been quite good. The teams have executed well on cost purples through the year.

Phil Winslow:

Congrats on another great quarter. I just wanted to focus in on Office 365 Commercial. Obviously, another strong quarter there, both in terms of revenue but also seat growth. And Amy, in your commentary, you highlighted SMB seat performance as well as frontline workers, and Satya mentioned a doubling of the frontline workers year-over-year, which is impressive. But you also commented on revenue per user going up. I wonder if you could help us kind of walk through the growth algorithm here, call it the P times Q, because there are different trends going on both the P and the Q and just sort of how that might be changing going forward versus what you have seen.

Operator:

Our next question is from Brad Zelnick with Deutsche Bank.

Satya Nadella:

Great set of questions. On the first one, I think it's, first and foremost, we absolutely need the skills and the people. And for the people to be sort of more evenly distributed in the broader economy, public sector, private sector, people who are working on behalf of small businesses because absolutely, as digital tech becomes more pervasive across IT as well as OT across the economy, I think the cyber threat is just going to be more pervasive and so therefore, we need other people on the skills. And we will do our power to sort of make sure that, that happens in terms of democratizing even how 1 acquires these skills. That's kind of where not that we have to take a broader definition of what these skills are and how one can acquire the certifications. And this is where what we're doing even with LinkedIn, I'm very, very bullish on. On the product side as well, like something like Sentinel, I do believe, for example, we are now doing very large-scale AI on all of those signals that go into our cloud-native SIEM. And that, I think, is going to help sift through signal from noise and help the productivity of the cyber professionals in any organization. So we are excited about how that workflow gets more efficient. To your point, one of the fundamental responsibilities for us as a platform company is to bi-design. It's all about shifting left on security and building it in to the products. And if anything, when we think about our monetization, our monetization is about really recognizing that the real world is not some homogeneous Microsoft infrastructure world. It is a multi-cloud, multi-platform world. And we will definitely monetize those aspects that we have best-of-breed solutions and suites and offerings. And by the way, as I said in my remarks, the people who are adopting the Microsoft solutions are saving 60%. And so to some degree, there is real time to value and cost savings for anybody who's using our solution. So we're going to be very, very mindful of our responsibility as you said. At the same time, we think we have a security opportunity in being able to secure the entire heterogeneous digital estate of our customers.

Rishi Jaluria:

Wonderful. Thank you so much for taking my questions. And nice to see continued strength in the business. Maybe I wanted to ask a little bit philosophically, Satya. So the pandemic clearly accelerated everyone's time line to migrate to the cloud, even if there wasn't necessarily a big pull forward there. As we think about a post-Omicron world, where there is some level of office reopenings and visibility into that, how should we think about the potential to see maybe another wave or another acceleration of those cloud migrations with that ability to have in office and have hybrid work? Maybe walk us through that.

Brett Iversen:

Thanks, Rishi. 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.

Amy Hood:

Thank you.

Brett Iversen:

Good afternoon, and thank you for joining us today. On the call with me are Satya Nadella, Chairman Chief Executive Officer, Amy Hood, Chief Financial Officer, Alice Jalla, Chief Accounting Officer, and Keith Dolliver, Deputy General Counsel. 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, and provides a reconciliation of differences between GAAP and non-GAAP financial measures. Unless otherwise specified, we'll refer to non-GAAP metrics on the call. The non-GAAP financial measures provided should not be considered as substitute for, or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the Company's first quarter performance, in addition to the impact these items and events have on the financial results. 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 and constant-currency, we refer to the growth rate only. We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If 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 replay the call and view transcripts on the Microsoft Investor Relations website. 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. Actual results could materially differ because of factors discussed in today's earnings press release in the comments made during this conference call, and in the Risk Factors section of our Form 10-K, Form 10-Q, and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statements. And with that, I'll turn the call over to Satya.

Amy Hood:

Thank you Satya and good afternoon everyone. Our First-Quarter revenue was $45.3 billion, up 22% and 20% in constant currency. Earnings per share was $2.27, an d increased 25% and 23% in constant currency when adjusted for a net tax benefit of $3.3 billion related to the transfer of intangible properties this quarter. Our sales teams and partners delivered a strong start to the fiscal year. And our commercial business, customers continue to choose the Microsoft Cloud. We again saw healthy growth in our Azure consumption-based. business, and increased usage across products, such as Teams and Power Platform, and reflected in the comments. In our on-premises business, annuity performance in Office to Server benefited from a greater-than-expected mix of contracts, with higher in-period revenue recognition. And in LinkedIn, the talent Solutions business continued to benefit from an improved job market. In our consumer business, Windows OEM performance was better than expected in a growing PC market, despite ongoing supply chain constraints. We also saw positive demand signals for Windows 11 ahead of launch with nearly all devices built this quarter eligible for upgrade. Microsoft 365 subscription growth drove Office consumer results, advertising market growth drove another strong quarter in LinkedIn, as well as searching News advertising. And in gaming, we were able to ship more Xbox series X and S consoles than expected, even as demand continues to exceed supply. Let's move to our overall results. Against the strong prior-year comparable commercial bookings grew 11% and 14% in constant currency driven by consistent execution across new, add-on, and renewal sales motions. This Quarter, growth was Impacted by fewer large long-term Azure contracts, which are unpredictable in their timing. As a result, commercial remaining performance obligation increased 28% and 29% in constant currency to $137 billion with a roughly equivalent split between revenues that will be recognized within and the portion beyond the next 12 months. And our annuity mix increased 2 points year-over-year to 95%. Microsoft Cloud revenue grew 36% and 34% in constant currency to $20.7 billion ahead of expectations. Microsoft Cloud gross margin percentage decreased slightly year-over-year to 71%. Excluding the impact from a change in accounting estimate for the useful life of server and network equipment assets. Microsoft Cloud, gross margin percentage increased roughly 4 points, driven by improvement in our Cloud Services, particularly in Azure and Office 365, partially offset by sales mix shift to Azure. With the weaker U.S. dollar FX increased total Company Productivity and Business Processes and Intelligent Cloud revenue growth by 2 points. In line with expectations. More personal computing revenue growth was increased by 1 point , less favorable than expected. affects increased cost by 1 point, in line with expectations, and had no impact to operating expense, slightly more favorable than expected. Gross margin dollars increased 21%, and 19% constant currency. Gross margin percentage was 70%, down slightly year-over-year. Excluding the impact of the change in accounting estimate discussed earlier, gross margin percentage increased roughly 1 point, driven by improvements in Cloud Services noted earlier, partially offset by sales mix shift to Cloud. Operating expense increased 11%, lower than expected, primarily driven by investments that shifted to future quarters. At a total Company level, headcount grew 14% year-over-year, as we continue to invest in key areas, such as Cloud engineering, sales, customer deployment, and gaming. Operating income increased 27% and 24% in constant currency, and operating margins expanded two points year-over-year to 45%. Excluding the impact of the change in accounting estimate, operating margins expanded roughly four points year-over-year. Now, to our segment results. Revenue from Productivity and Business Processes was $15 billion and grew 22% and 20% in constant currency, with better -than-expected performance in Office, commercial, and LinkedIn . Office commercial revenue grew 18% and 16% in constant currency. Office 365 commercial revenue grew 23% and 21% in constant currency driven by installed base expansion across all workloads and all customer segments, as well as higher ARPU. Demand for our advanced security, compliance, and voice offerings growth continued momentum in E5 revenue this quarter. Paid office 365 commercial seats increased 17% year-over-year, driven by another strong quarter of growth in our small and medium business and front-line worker offerings. Office commercial licensing decreased 13% and 14% in constant currency, significantly ahead of expectations, benefiting from the higher end period revenue recognition noted earlier. Office Consumer revenue grew 10% and 8% in constant currency on a strong prior-year comparable, with better-than-expected growth in Microsoft 365 subscriptions. Over the past 2 years, our Microsoft 365 subscriber base has grown over 50%, reaching 54.1 million this quarter. Dynamics revenue grew 31% and 29% in constant currency. Dynamic 365 revenue growth was 48% and 45% in constant currency with continued strong demand for Power Apps, which grew 202% and 197% in constant currency. And in LinkedIn, revenue increased 42% and 39% at constant currency, with continued strength in marketing solutions and better-than-expected performance in talent solutions from the improved job market earlier. Segment gross margin dollars increased 22% at 20% in constant currency, and gross margin percentage increased slightly. Excluding the impact of the Teams accounting estimate, gross margin percentage increased roughly two points, driven by improvement across all Cloud services. Operating expense, increased 7% and operating income, increased 33% and 29% in constant currency. Next, the Intelligent Cloud segment. Revenue was $17 billion, increasing 31% and 29% in constant currency ahead of expectations, driven by continued customer demand for our differentiated, hybrid and Cloud offerings. Overall several products and cloud services revenue increased 35% and 33% in constant currency. Azure and other Cloud Services grew 50% and 48% in constant-currency ahead of expectations, driven by our consumption based services. The ARPU user business, the enterprise mobility and security installed base grew 30% to over 196 billion seats. In our on-premises business on a low prior-year comparable revenue increased 14% and 13% in constant currency ahead of expectations. Strengthen, our annuity business, was driven by healthy demand for our hybrid offerings that include Windows Server and SQL Server running in multi-cloud environments and higher in-period revenue recognition, including benefit from annuity purchasing ahead of the Windows Server 2022 launch. Enterprise Services revenue grew 9% and 8% in constant currency driven by growth in Microsoft consulting services and Enterprise Support Services. Technical gross margin dollars increased 28% to 26% in constant currency and gross margin percentage decreased roughly 1 point, year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage increased roughly 2 points, driven by improvements in Azure, partially offset by sales mix shift to Azure. Operating expense, increased 13% and 12% in constant currency and operating income grew 39% and 37% in constant currency. Now, to more personal computing, revenue was $13.3 billion increasing 12% and 11% in constant currency with better-than-expected performance and Windows OEM and gaming. Windows OEM revenue increased 10% driven by a stronger-than-expected PC market, particularly in the commercial segment, which has higher revenue per license. These results include roughly seven points of impact from the $210 million revenue deferral related to Windows 11 licenses sold to OEMs prior to general availability. The deferral was lower-than-expected OEMs prioritized upgraded eligible device bills early in the quarter. Windows commercial products and cloud services revenue grew 12% and 10% in constant currency driven by demand for Microsoft 365. Surface revenue declined 17% and 19% in constant currency on a strong prior-year comparable. Surge and news advertising revenue, XTech, increased 40% and 39% in constant currency in line with expectations benefiting from the advertising market noted earlier. And in gaming, revenue increased 16% at 14% in constant-currency ahead of expectations, better than expected console supply and continued strong demand. Resulted in Xbox hardware revenue growth of a 166% and 162% in constant currency. Xbox content services revenue increased 2%, and was relatively unchanged in constant currency against a strong prior-year comparable. Segment gross margin dollars increased 10% and 8% in constant currency. Gross margin percentage decreased roughly 1 point year-over-year, driven by sales mix shift to gaming hardware. Operating expenses increased 15% driven by the ZeniMax acquisition, as well as Windows 11 marketing. Operating income grew 7% and 5% in constant currency. Now, back to total Company results. Capital expenditures, including finance leases, were $7.4 billion in line with expectations. and cash paid for PP&E was $5.8 billion. Our capital investments, including both new datacenter regions and expansion in existing regions, continued to be based on significant customer demand and usage signals. Cash flow from operations was $24.5 billion, increasing 27% year-over-year, driven by strong Cloud billings and collections. Free cash flow was $18.7 billion up 30% year-over-year. This quarter, other income and expense was $286 million higher than anticipated, primarily driven by net gains on investments. As a reminder, we are required to recognize market-to-market gains or losses on our equity portfolio. Our non-GAAP effective tax rate was approximately 16%. And finally we've returned $10.9 billion to shareholders through share repurchases and dividends. Now, before we turn to our outlook, I'd like to provide a couple of reminders. First, the outlook we give, unless specifically noted otherwise, is on a U.S. dollar basis. Second, my remarks for the next quarter do not include the impact from the Nuance acquisition, which we now expect to close by the end of Q2 or early Q3. With that, let's move to our second quarter outlook. In our commercial business, our differentiated market position, compelling solution portfolio, and consistent execution should drive another strong quarter. Commercial bookings growth should again be healthy but impacted by modest growth in the Q2 XFree base and the normal quarterly volatility from large long-term Azure contracts previously discussed. Microsoft Cloud gross margin percentage decreased roughly two points year-over-year, excluding the impact of the change in accounting estimate previously discussed. Hugh gross margin percentage will increase roughly two points driven by continued improvement across our services despite revenue mix shift to Azure. Longer-term, we expect the Microsoft Cloud gross margin percentage to be impacted by revenue mix shift to Azure, increased usage of our Microsoft Cloud services, And ongoing strategic investments to support our customers success. And on a dollar basis, we expect capital expenditures to be roughly in line with the last quarter, as we continue to invest to support growing demand. Now to FX, based on current rates, we expect FX to increase revenue at the total Company and all individual segment levels by approximately one point and have no impact on total COGS or operating expense growth. Next, to segment guidance, in Productivity and Business Processes, we expect revenue between $15.7 and $15.95 billion. In office commercial, revenue growth will again be driven by Office 365 with healthy growth across customer segments and continued momentum in E5. In our on-premises business, we expect revenue to decline in the high teens consistent with the ongoing customer shift to the Cloud. In Office Consumer, we expect revenue to grow in the mid-teens with continued momentum in Microsoft 365 Consumer subscriptions. For LinkedIn, a strong job market and continued engagement on the platform should drive revenue growth in the mid 30% range and in dynamics we expect revenue growth similar to Q1. Driven by Strength and Dynamic 365 including continued momentum in Powerhouse For Intelligent Cloud, we expect revenue between $18.1 billion and $18.35 billion. Revenue will continue to be driven by Azure, which, as a reminder, can have quarterly variability, primarily from our per-user business and from revenue recognition depending on the mix of contracts. In Q2 we expect healthy drive based growth in our Azure consumption business consistent with recent trends. And per user business, while continuing to benefit from Microsoft 365 sweet momentum should see a moderation in growth rates given the size of we expect revenue growth in the mid-single digits driven by continued demand for hybrid solutions. In enterprise services, we expect revenue growth to be in the high single digits, In more personal computing, we expect revenue between $16.35 and $16.75 billion. Despite ongoing supply chain constraints, OEM revenue should grow low to mid-teens including 6 points of impact $10 million dollar Window 11referal that shifted revenue from Q1 to Q2. In Windows commercial products cloud services customer demand for Microsoft 365 and our advanced security solutions should drive low double digit growth. In Surface, we expect revenue to decline in single digits as we continue to work through supply chain uncertainty, particularly in our premium devices. In Search and News Advertising X Tech, we expect revenue growth in the low to mid 20s. If supply chain uncertainty reduces advertising budgets our results would be negatively impacted. And in gaming, on a high prior-year comparable, that included the launch of our new consoles and strength across Xbox content services, we expect revenue growth in a high single digits. Console sales will continue to be strong engagement on the Xbox platform in a holiday quarter that will include several AAA title. Now back to Company guidance. $17 to $17.2 billion and operating expense of $12.7 to $12.8 billion. In other income and expense, interest income and expense should offset each other. And finally, we expect our Q2 effective tax rate to be approximately 17%. In closing, we are off to a strong start in FY '22 with tremendous opportunity to drive sustained, long-term revenue growth. We remain focused on growing high value usage across our differentiated Microsoft Cloud offerings, and delivering exciting new consumer experiences with Windows 11, Surface and our Xbox gaming platform as we enter the holiday season. Our consistent approach to investing for these and other future opportunities, while continuing to deliver solid operating performance, will drive strong results throughout FY 22 and beyond. Now, Brett, let's go to Q&A.

Operator:

Absolutely, If you would like to ask a question, . A confirmation tone will indicate that your line is in the question queue. You may if you'd like to remove your question from the queue, for participants using a speaker equipment, it may be necessary to pick up your handset before . Our first question comes from Keith Weiss, with Morgan Stanley. Please proceed with your question.

Satya Nadella:

and a great question. Because we will always, as you know Keith, architected Azure for the distributed computing fabric to remain distributed. In other words, when we talked about hybrid computing even five years ago, the idea was always that, we will always have a Cloud and then we will have a distributed Cloud infrastructure for application deployment. So when we think about Cloud Plus Edge, we even put even the multi-cloud control playing in there, right? So whether it is, what's happening with the 5G and how naturally compute will go to where data is getting generated with low latency access to a factory floor, to a hospital, to cities where you want to play XCloud gaming, that's one phenomena. The other is just literally treating every Cloud, whether it's the on-premise data center. It's the other public cloud, and our public cloud, and being able to use Azure Arc in its control plane to ease the deployment across all clouds. That's another thing that we're seeing. So when I think about what is going to be key in such a distributed world is having that full suite of applications infrastructure, right? All the way from the management and security control plane, something like Azure Active Directory managing the security principles and Identities or and to the management control planes like Azure Arc and so we feel well-positioned for it. And I think that the multi-cloud, multi-edge world is really how we build Azure in the first place. And I think we're still very early in all of that playing out, but we feel well-positioned.

Brett Iversen:

Thanks Keith. Operator, next question, please.

Brent Thill:

Amy, commercial bookings up 14% is impressive, but its slowdown from last call was 25 against the more difficult comp. I think you had mentioned some color around Azure and the size and duration. Can you just maybe anything else you would call out there and realize -- realize it's come off a tough comps.

Brent Thill:

Thank you.

Operator:

Our next question is coming from Karl Keirstead with UBS. Please proceed with your question.

Amy Hood:

Thanks, Karl. I want to start by saying and repeating something that Tatia, I think was careful to include in his remarks. And it is the central nature of the PC to relay the nature of both hybrid work and fundamentally about getting jobs done. And I think the central role it's played we've talked about, I think, now for a number of quarters, and I think the reality of that continues to exist. I think the come more real for people as we talk about what hybrid is going to look like and continue to learn what hybrid is going to look like. And to that end your PCs, the market grew this quarter, and it was constrained by supply. I believe Q2 will also be a strong demand quarter that is constrained by supply. But even with that, we see a growing market. And in particularly, in both Q1 and Q2, we see a strong demand in the commercial segment. I think that ties directly back to some of Satya 's comments about the central nature of the device. Then of course, we do get some benefit, Karl, because revenue per license is higher in commercial than it is in the broad market. Those things together, which is a growing market, strong Windows performance within that market, in commercial in particular, And then, the resulting higher revenue per license results, and I think a very strong position in Q1 and Q2.

Amy Hood:

Thank you.

Operator:

Thank your next question is coming from the line of Mark Moerdler with Bernstein Research, please proceed with your question.

Satya Nadella:

Maybe I'll just start and then Amy, you can add to it. In an inflationary environment, the first place any business should go to is how to really ensure that they're able to get productivity gains. And even dealing with constraints, for example, if You have supply chain constraints, one of the things you want to do is run your factories at the efficient frontier, that means things like digital twins, simulation, are the ones where you are going to make sure that every production run has the least amount of wastage. I think any which way you look, whether it's in the knowledge work, first-line work, whether it's actually digital twins and simulation, All of those things are going to be the best way for any Company to deal with inflationary pressures, so that they can, in fact, have the best productivity and that -- thereby the best ability to be able to meet aggregate demand out there. That's why we're very, very excited about making sure our software products are available to our business customers all around to be able to manage through this inflationary environment and I'll let Amy add to that.

Mark Moerdler:

Thank you. That's extremely helpful. I appreciate and congrats again.

Operator:

Our next question is coming from the line of Kash Rangan with Goldman Sachs, please proceed with your question.

Satya Nadella:

Thanks Kash for the question. So on the labor market, maybe I'll start Amy, you can add to this. The first place where we're very, very focused on is to making sure that, with LinkedIn, we're doing everything to help everyone find their best economic opportunity and when Ryan Roslansky was the CEO of LinkedIn, talks about the great reshuffle. I think along with the hybrid work change, there is a real question everybody is asking. Not only where and how they work, but why they work. And so to be able to make sure that we can help them find the opportunity that they are looking for is, I think, the most critical work that we can be doing. The second side to this, though, is also to per take the productivity of the people, whether they are on the front lines, and the first-line workers, or the knowledge workers, or even software developers, and making sure that they have the best tools, whether it's the GitHub harness and Visual Studio code for people who are developers or whether it is Power Apps or whether it is the Office 365, and then Microsoft 365 tooling to help them be most productive. That's I think the thing that we're very, very focused on because key to dealing with labor shortages is productivity gains. And that Plus the work we're doing in LinkedIn is where we're focused on. So with that, Amy, I will hand it over to you.

Kash Rangan:

Brilliant. Thank you so much.

Operator:

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

Satya Nadella:

Maybe I can talk a bit to sort of what we are seeing, take the most, I would say, the classic model of lift shift in modernized motions, which is I think at the core of hybrid Cloud, that's still in -- still early innings. Every day I wake up to talk to customers who are planning out that motion and making sure that that able to modernize their entire application portfolio in various ways. So that's obviously still very, very strong. The interesting thing for us, even in that context, is even in the height of our success in declined server era, we really would never a Tier-1 Company that is not who we are. In the sense that you take all the SAP workloads that are running on Azure, which I talked about, or other Tier-1 workloads that are migrating, whether it's HPC or transactional database workloads. So that's the other thing which is happening is real production workloads moving over. And then on the data estate, that's the place where perhaps we're seeing significant traction, and I referenced that in some of my remarks all the way from what's happening with, say, operational data stores like Cosmos DB, with Synapse linked to Synapse or Power BI to Synapse or in fact, Dynamics 365 data wars to Synapse. There's tons and tons of coming together of the data estate, with for example, regulatory requirements now that you need to have real governance on data. That's where Azure Purview becomes, again, a pretty big driver of that data gravity to the Cloud from a governance perspective. The other side of this is what's happening with Dev Tools. When you start having your CI/CD to your Cloud, then modern new applications and the agility with which you bill. So with GitHub, VS code becoming essentially default for any modern dev shop in the enterprise or otherwise, that’s he other thing that we see. But perhaps more than anything else, the interesting circuit for us is what happens with Teams. With Teams, you suddenly now have a new platform in which applications get hosted, whether it's developed by the enterprise or by third-party. And I referenced that in my remarks, and those applications in many cases get built on our Cloud, use things like Azure DB, use things like Power Platform. and so the reinforcing and compounding side of Teams to Power Apps to Dynamics to Azure is probably one of the most unique things we're seeing in terms of new applications getting built. And then the Cloud Plus Edge, which I referenced in the answer to the first question, which is in a multi-Cloud, multi edge world, you still need a control plane that manages all that complexity and that's where something like Azure Arc and GitHub become the two standards. You develop in one place, you deploy in one place, and then you propagate to every Cloud that you want to deploy in.

Raimo Lenschow:

Thank you. Very clear. Congrats.

Operator:

Our next question comes from Brad Reback with Stifel. Please proceed with your question.

Satya Nadella:

I mean, I will point to Amy's guide for the next quarter as far as we are looking at is the demand across the entire stack is pretty robust and obviously what happens in the labor market, whether it's in the tech labor market or any other labor market, will ultimately be something that we would all be subject to. But the thing at least about the software businesses are in order to deal with a lot of other constraints, whether they are labor shortages or supply shortages, deploying digital tech is one way to really overcome them. So that's what we see clearly, I think in the tech sector today there is more structural demand than perhaps supply all around. But we like that position because at some level we just want to make sure that we have the most competitive products out there, and as long as we continue to do so, I think we'll be fine.

Brad Reback:

That's great. Thank you.

Operator:

Thank you. Our final question comes from Brad Sills with Bank of America. Please proceed with your question.

Satya Nadella:

Thank you for the question. Absolutely, we think of the Microsoft Cloud, which includes Azure, it includes Dynamics 365, it includes Microsoft 365, it includes things like Power Platform, it includes even GitHub and VS Code. That's why we keep stressing the full modern tech stack that makes up Microsoft Cloud. And then with the Industry Cloud, we add value on top of that, which is specific, whether it's in retail, whether it's manufacturing, obviously in healthcare, and our pending Nuance acquisition really in add further to that. Obviously, we're very focused on, first of all, not any just one piece, which we -- each one of those has to be competitive on their own, it's the coming together of the Microsoft Cloud and in the Industry Cloud, adds further value on top of it. So yes, I think ultimately our competitiveness comes because of all of those layers integrated and delivering that time-to-value for our customers while maintaining openness in each layer and competitiveness in each layer

Brett Iversen:

Thanks, Brad. That wraps up the Q&A portion of today's call. Thank you for joining us today and we look forward to speaking with all of you soon.

Amy Hood:

Thank you.

Brett Iversen:

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; Alice Jolla, Chief Accounting Officer; and Keith Dolliver, Deputy General Counsel. 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 and provides a reconciliation of differences between GAAP and non-GAAP financial measures. Unless otherwise specified, we will refer to the non-GAAP metrics on the call. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the Company’s fourth quarter performance in addition to the impact these items and events have on the financial results. All growth comparisons we make on the call today relate to the corresponding period of last year, unless otherwise noted. We’ll 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 the growth rates are the same in constant currency, we’ll refer to growth rate only. We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today’s call is being webcast live and recorded. If 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 replay the call and view the transcript on the Microsoft Investor Relations website. During this call, we will make 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. Actual results could materially differ because of factors discussed in today’s earnings press release, in 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 the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that, I’ll turn the call over to Satya.

Amy Hood:

Thank you, Satya, and good afternoon, everyone. This quarter, revenue was $46.2 billion, up 21% and 17% in constant currency. Earnings per share was $2.17, increasing 49% and 42% in constant currency. In our largest quarter of the year, focused execution by our sales and partner teams, along with broad-based strength across geographical markets and customer segments drove another very strong quarter of top and bottom line growth. In our commercial business, healthy demand for our differentiated hybrid and cloud offering as well as increased long-term commitment to our platform drove significant growth in the number of $10 million-plus Azure and Microsoft 365 contracts. Customer reliance on the Microsoft Cloud drove sequential increases in usage across Teams, Power Platform and our Advanced Security and identity offerings, which are empowering organizations to shift to hybrid work and modernize business processes. And in LinkedIn Talent Solutions business, an improving job market drove strength in annual contracts and job postings. In our on-premises business, strong annuity performance across Officer, Server and Windows also benefited from a greater mix of contracts with higher in-period revenue recognition under ASC 606. In our Consumer business, Windows OEM and Surface were impacted by the ongoing constraints in the supply chain. Search and LinkedIn benefited from an improved advertising market. And in gaming, we again saw strong engagement across our platform, while demand for Xbox Series X and S consoles continued to exceed supply. As a reminder, Q4 was the first full quarter impacted by COVID-19 a year ago across revenue and operating expense. This quarter, even with a declining exploration base, commercial bookings grew 30% and 25% in constant currency, significantly ahead of expectations, driven by strong execution across our core annuity sales motions and an increase in the number of larger long-term Azure contracts. As a result, commercial remaining performance obligation increased 32% and 31% in constant currency to $141 billion. Roughly 45% will be recognized in revenue in the next 12 months, up 25% year-over-year. The remaining portion, which will be recognized beyond the next 12 months, increased 38% year-over-year, highlighting the growing long-term commitment to our Microsoft Cloud. And our annuity mix increased 1 point year-over-year to 95%. Commercial cloud revenue, also better than expected, was $19.5 billion as growth accelerated to 36% and 31% in constant currency. Commercial cloud gross margin percentage expanded 4 points year-over-year to 70%, with roughly 1 point from the change in accounting estimate for the useful life of server and network equipment assets. Excluding this impact, commercial cloud gross margin percentage increased despite revenue mix shift to Azure, driven by improvement across all our cloud services on a prior year comparable impacted by strategic investments we made to support significant customer engagement and usage in remote work scenarios, including free trials, flexible financing options and capacity for cloud infrastructure usage. With the weaker U.S. dollar, FX increased growth by approximately 4 points, about 1 point more favorable than anticipated. FX increased COGS growth by approximately 1 point and operating expense growth by approximately 2 points, both in line with expectations. Gross margin dollars increased 25% and 20% in constant currency. Gross margin percentage was 70%, up 2 points year-over-year, with roughly 1 point of favorable impact from the change in accounting estimate. Excluding this impact, Company gross margin percentage increased despite sales mix shift to the cloud, driven by commercial cloud gross margin percentage improvement noted earlier. Operating expense grew 6% and 4% in constant currency, in line with expectations on a prior year comparable that included roughly 4 points of impact from the realignment of our retail storage strategy and 2 points of impact from an increase in bad debt expense. Overall, Company headcount grew again this quarter, up 12% year-over-year as we continue to invest across key areas like cloud engineering, sales and customer deployment. Operating income increased 42% and 35% in constant currency, and operating margins expanded 6 points year-over-year to 41%, including roughly 2 points of impact from the retail stores charge and increase in bad debt expense in the prior year and nearly 1 point of favorable impact from the change in accounting estimate. Now, to our segment results. Revenue from Productivity and Business Processes was $14.7 billion and grew 25% and 21% in constant currency with better-than-expected performance across all businesses. Office Commercial revenue grew 20% and 15% in constant currency. Office 365 Commercial revenue grew 25% and 20% in constant currency, again driven by installed base expansion across all workloads and customer segments, as well as higher ARPU. Paid Office 365 Commercial seats increased 17% year-over-year, with continued recovery driving acceleration in our small and medium business and frontline worker offerings. Demand for Microsoft 365, particularly for security, compliance and voice drove strong E5 momentum again this quarter. E5 now accounts for 8% of our Office 365 Commercial installed base. And on a low prior year comparable impacted by a slowdown in transactional purchasing, Office Commercial licensing was ahead of expectations, down 8% and 11% in constant currency, also benefiting from higher in-period revenue recognition noted earlier. In Office Consumer, revenue grew 18% and 15% in constant currency, driven by continued momentum in Microsoft 365 subscriptions, which grew to 51.9 million, up 22% year-over-year. Dynamics revenue grew 33% and 26% in constant currency, better than expected. Dynamics 365 revenue growth was 49%, and 42% in constant currency, with strong momentum in Power Apps and Power Automate, reflecting growing demand for our modern solutions to build apps and automate workflows. Dynamics 365 now accounts for over 70% of total Dynamics revenue. LinkedIn revenue increased 46% and 42% in constant currency, ahead of expectations against the comparable impacted by the advertising and job markets of a year ago. Segment gross margin dollars increased 33% and 27% in constant currency, and gross margin percentage was up 5 points year-over-year, primarily driven by improvement in our cloud services against a low prior year comparable impacted mostly by increased usage. The change in accounting estimate drove roughly 1 point of favorable impact. Operating expense increased 8% and 6% in constant currency, and operating income increased 62% and 53% in constant currency, including 4 points due to the change in accounting estimate. Next, the Intelligent Cloud segment. Revenue was $17.4 billion, increasing 30% and 26% in constant currency. We exceeded expectations across our consumption and per-user Azure businesses as well as in our on-premises server products business. Overall, server products and cloud services revenue increased 34% and 29% in constant currency. Azure revenue grew 51% and 45% in constant currency, driven by strong performance across our core and premium consumption-based services. In our per user business, the enterprise mobility and security installed base increased 29% to over 190 million seats. Our on-premise server business increased 16% and 12% in constant currency, driven by strong annuity performance and benefiting roughly 4 points from the higher in-period revenue recognition noted earlier, particularly in some of our largest deals in the quarter. Enterprise Services revenue grew 12% and 9% in constant currency, driven by growth in premier support services and Microsoft consulting services. Segment gross margin dollars increased 32% and 27% in constant currency. Gross margin percentage increased 1 point year-over-year with roughly 1 point of favorable impact from the change in accounting estimate. Operating expense increased 14% and 12% in constant currency, and operating income grew 46% and 39% in constant currency, including 3 points due to the change in accounting estimate. Now to More Personal Computing. Revenue was $14.1 billion, increasing 9% and 6% in constant currency, with better-than-expected performance in Windows Commercial, gaming and search offsetting OEM and Surface weakness from supply chain constraints. OEM revenue declined 3% and Surface declined 20% and 23% in constant currency as both were impacted by the significant supply chain constraints noted earlier in a good demand environment. Windows Commercial products and cloud services revenue grew 20% and 14% in constant currency, driven by demand for Microsoft 365, with some benefit from the higher in-period revenue recognition, noted earlier. Search revenue ex TAC increased 53% and 49% in constant currency, benefiting from the improved advertising market. And in gaming, revenue increased 11% and 7% in constant currency. Xbox hardware revenue grew 172% and 163% in constant currency, driven by demand for our new consoles. Xbox content and services revenue declined 4% and 7% in constant currency against a high prior year comparable. Segment gross margin dollars increased 8% and 4% in constant currency. Gross margin percentage decreased roughly 1 point year-over-year, driven by sales mix shift to gaming hardware. Operating expense decreased 6% and 7% in constant currency, including approximately 13 points of impact from the retail stores charge in the prior year. And operating income grew 19% and 13% in constant currency. Now, back to our total Company results. Capital expenditures, including finance leases, were $7.3 billion, in line with expectations, driven by ongoing investment to support growing global demand and usage of our cloud services. Cash paid for PP&E was $6.5 billion. Cash flow from operations was $22.7 billion, increasing 22% year-over-year, driven by strong cloud billings and collections. Free cash flow was $16.3 billion, up 17%, reflecting higher capital expenditures in support of our growing cloud business. For FY21, we generated over $76 billion in operating cash flow, up 26% year-over-year, and over $56 billion in free cash flow, up 24% year-over-year. This quarter, other income and expense was $310 million, higher than anticipated, primarily driven by net gains on investments. As a reminder, we are required to recognize mark-to-market gains or losses on our equity portfolio. Our effective tax rate was approximately 15%. And finally, we returned $10.4 billion to shareholders through share repurchases and dividends, bringing our total cash returned to shareholders to over $39 billion for the full fiscal year. Now, before we turn to our outlook, I’d like to provide a few reminders for next fiscal year. Revenue growth rates across all segments will reflect the impact from COVID-19 a year ago, though the impacts do shift as we move through the year. Also, our FY21 operating income and margin benefited from two factors that will be headwinds in FY22

Operator:

[Operator Instructions] Our first question is coming from the line of Keith Weiss with Morgan Stanley.

Satya Nadella:

Thanks so much, Keith, for the question. I mean, the way we see the results today reflect that, but more importantly, on a secular basis, as I think about -- I always go back to that number, which is 5% of the world GDP is tech spend, it’s projected to double. I think that doubling will happen in a more accelerated pace. And we feel well-positioned because of the innovation across the stack. Because if you think about it, what’s going to happen is every business, whether you’re a retailer or a manufacturer, in the service sector, public sector or private sector, digital adoption is the way you’re going to be both, resilient as well as transform the core business processes. And the strength we have is that entirety of the Microsoft Cloud stack, right? So, it’s not just about infrastructure or any application, it’s the entirety of what we do. And so, I think it is durable. Quarter-to-quarter, depending on what happened during the pandemic, depending on the segments that were impacted, for example, the consumer segments that were impacted are coming back and then they’ll normalize. Whereas in our case, we do, in fact, one of the things I love about sort of our exposure is both, it’s a worldwide exposure and it has got the right balance between the consumer segments and the enterprise business-to-business segment. So, it’s a very durable long-term growth prospect that we have tough competition, we need to keep innovating, which is what we’ll stay focused on.

Operator:

Our next question comes from the line of Mark Moerdler with Bernstein Research.

Amy Hood:

Thanks, Mark, for the question. Let me cover your first one, which is the seasonality in the Azure business. In some ways, Mark, some of that seasonality frankly was because Azure has two fundamental components. It’s got a consumption model as well as a per-user model. The per-user model, which as you well know is far more aligned to our end-of-year and can be more aligned to our end-of-year rhythms. It also can have more quarterly volatility in terms of accounting, in terms of revenue recognition, the same topic we often talk about when it comes to Microsoft 365 in terms of more in-quarter recognition. What you’ve seen is that did historically represent a larger component of Azure, so added volatility to Q4. As we’ve seen our consumption businesses grow and grow consistently, thus far becoming a larger percentage of Azure, you do have more stability, Mark. And so, you start seeing less of that volatility that we’ve historically seen from Q3 to Q4. We still have some of it, as we talked about, but I think it’s an interesting observation and it’s a very good question. In terms of your comment on cloud revenue and OpEx, yes, I do believe that’s durable. We get a lot of focus. We’ll continue to invest. There’s lots of opportunity there, but the market certainly warrants it.

Brent Thill:

Amy, a lot of questions on margins, I’m curious if you think there is the ceiling in the near term on margins, or do you feel that you’ve got an elevated flight level, if you will, and we shouldn’t have to be worrying about that level of margins? Can you just give us any more color as it relates to how you’re thinking about that? Thank you.

Operator:

Our next question comes from the line of Karl Keirstead with UBS.

Amy Hood:

Thanks, Karl. I think, in general, you’ve got the right trajectory. And I do think it’s both things. You’ve heard me say, it’s both some of our core as well as premium SKUs. We’ve seen some nice execution. And I think Satya mentioned some of these differentiated places in the Azure stack, where I think we also can see some growth. Data services is a very good point where I feel like we’ve made a lot of progress, have a real differentiation, have seen some acceleration in the past couple of quarters.