Welcome to the fourth quarter fiscal year 2015 Microsoft Corporation earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded.

I'll now turn the conference over to Chris Suh, General Manager of Investor Relations. Chris, please proceed..

Thank you. Good afternoon and thank you for joining us today. On the call with me today are Satya Nadella, Chief Executive Officer; Amy Hood, Chief Financial Officer; Frank Brod, Chief Accounting Officer; and John Seethoff, Deputy General Counsel.

On our website, microsoft.com/investor, is our financial summary slide deck, which is intended to follow prepared remarks and provide the reconciliation of differences between GAAP and non-GAAP financial measures.

The non-GAAP measures exclude the impact of impairment, integration, and restructuring charges, and are included as additional clarifying items to aid investors in further understanding the company's fourth quarter and fiscal year performance and the impact of these items and events had on the financial results.

The non-GAAP financial measures provided above should not be considered a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. Unless otherwise specified, we will refer to non-GAAP metrics on the call.

All growth comparisons we make on the call today relate to the corresponding period of last year unless otherwise noted. For selected metrics on the call and in other earnings materials, we have provided growth rates in constant currency.

We present constant currency information to provide a framework for assessing how our underlying businesses performed excluding the effect of foreign currency rate fluctuation.

Additionally, any mention of operating expense refers to segment operating expenses as defined in the footnotes of our Form 10-K and includes research and development, sales and marketing, and general and administrative, but excludes the impact of impairment and integration and restructuring charges.

We will post the 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 until July 21, 2016. 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 uncertainty.

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..

Thank you, Chris. Good afternoon, everyone. Today, we will share the results of the final quarter of the year and our optimism for the year ahead. We delivered $22.2 billion in revenue this quarter and $93.6 billion total revenue for the fiscal year 2015, an increase of 8% year over year.

We pushed forward in our transformation by focusing our investment in areas where we have differentiation and significant opportunity for future growth in large addressable markets. We galvanized around our mission and ambitions. We aligned our structure to deliver better products at a more rapid pace. We focused our advertising business on search.

We focused our mapping efforts on higher-level experiences and development services. We restructured our phone portfolio so that we can operate more efficiently near term while driving reinvention long term. We invested more in new mobile applications like Wunderlist, Acompli, and Sunrise.

We also strengthened our enterprise cloud platform by acquiring Revolution Analytics, Datazen, and BlueStripe in this quarter alone. And we are at the threshold of the Windows 10 launch. I'm proud of these steps and I'm proud of the results we delivered in tandem.

In cloud alone, our annualized commercial cloud run rate surpassed $8 billion this quarter, and the revenue grew 88% year over year. We are on a strong trajectory towards our goal of $20 billion in fiscal year 2018. With that as the backdrop, I want to walk you through the progress we are making in each one of our three ambitions.

Let me start with reinventing productivity in business processes, including our efforts across Office 365 and Dynamics. We continue to see strong demand for Office 365 and Dynamics products. We now have more than 15 million Office 365 consumer subscribers, and customers are signing up at a pace of nearly 1 million per month.

In addition, we surpassed 150 million downloads of Office Mobile on iOS and Android and have introduced a new version of Office for the Mac. In the commercial space, the number of Office 365 users continues to climb, with seats growing 74% year over year.

Office 365 now is in four out of five Fortune 500 enterprises, and more than 55% of the installed base is on premium workloads. It is clear that we have success moving customers to the cloud, given half of all the enterprise agreement renewals were for Office 365 this quarter.

Small and medium businesses offer one of our best opportunities for new growth in the cloud. In fact, for more than a year now, we have seen 50,000 new SMB customers adopt Office 365 every month. Last week at our Worldwide Partner Conference, we announced our new Office 365 Premium SKU for business, E5.

Now our customers will get rich new voice functionality in Skype for Business with Cloud PBX and PSTN Conferencing, deep analytics with Delve analytics and Power BI Pro, and advanced security features such as lockbox and advanced threat protection. With E5, we have expanded our market opportunity for Office 365 by more than $50 billion.

This new E5 SKU and the launch of Office 2016 will drive one of the biggest new businesses for us. Let's now turn to CRM. This market alone is $20 billion-plus and has massive opportunity for reinvention.

Mainstreaming Dynamics into our engineering sales and marketing efforts gives us the ability to participate in this large and growing market in a more meaningful way. Last week we announced the acquisition of FieldOne, which helps strengthen our Dynamics CRM customer service offering.

This quarter, total paid seats for Dynamics CRM online increased 140% year over year, and we have more than 8 million paid Dynamics seats across CRM and ERP in total, up 25% year over year. This creates a great foundation for future growth in our Dynamics business.

Next, I want to share our progress in building the intelligent cloud platform with Azure. Again this quarter, we have seen proof that preference for our cloud staff services creates a flywheel of growth for our cloud platform services. In Azure, both revenue and compute usage increased by triple digits year over year.

We tripled our revenue from Azure premium services this quarter. In the enterprise mobility services, we now have 17,000 customers. Appeal for Visual Studio Tools has grown to include developers beyond our traditional base with some of the decisions we made to embrace open source with .Net and support across platform development.

Since November, we have seen more than 5 million downloads of Visual Studio Community, the fastest ever adoption of a Visual Studio product. Visual Studio Online continues to gain momentum, with over 3.1 million registered users.

Business intelligence and analytics is another large, rapidly growing market for us with an opportunity of more than $15 billion. We are focused on strengthening our offers in this space. Just last week we announced the availability of Cortana Analytics Suite, our fully-managed big data and advanced analytics solution.

We're not only building the tools but are also delivering the insights customers need to transform their businesses. Security is a key priority for our enterprise customers and another $30 billion market opportunity for us, and we are building capability to meet customers' need.

For example, we've made significant investments in security with Azure Key Vault, enabling customers to protect data in the cloud with secure key management and encryption customers can control. We have four new certifications for Azure, bringing our certification and at the station total to 22 globally, more than any other cloud platform today.

Our third bold ambition is to create more personal computing experiences with Windows and our devices. I am thrilled we are just days away from the start of Windows 10. It's the first step towards our goal of 1 billion Windows 10 active devices in the fiscal year 2018.

Our aspiration with Windows 10 is to move people from meeting to choosing to loving Windows. Based on feedback from more than 5 million people who have been using Windows 10, we believe people will love the familiarity of Windows 10 and the innovation. It's safe, secure, and always up to date.

Windows 10 is more personal and more productive with Cortana, Office, universal apps, and Continuum. And Windows 10 will deliver innovative new experiences like Inking on Microsoft Edge and gaming across Xbox and PCs, and also opens up entirely new device categories such as Hololens.

Windows 10 will deliver significant value to enterprise customers as well. Windows 10 provides advanced security capabilities with additional features for hardware-based security, mobile work and data protection. It also provides a single device management platform across all devices, from phones to laptops to Internet of Things devices.

And Windows 10 helps enterprises stay up to date with Windows Update for Business and Windows Store for Business. While the PC ecosystem has been under pressure recently, I do believe that Windows 10 will broaden our economic opportunity and return Windows to growth.

First, we have an OEM ecosystem that is creating exciting new hardware designs for Windows 10. In fact, our OEM partners have over 2,000 distinct devices or configurations already in testing for Windows 10 upgrades as well as hundreds of new hardware designs.

We are delighted that the first of these exciting new devices will start to be available on Windows 10 launch day, and by this holiday we will be selling the widest range of Windows hardware ever available. Second, we will generate new growth through gross margin on our own differentiated first-party premium device portfolio.

We will also significantly reduce our losses on the phone by operating more effectively and efficiently with a more focused portfolio. Third, we will grow monetization opportunities across the commercial and consumer space. In the enterprise, customers will continue to value our unparalleled management security, app dev, and servicing capability.

And for consumers, Windows 10 creates monetization opportunities with store, search, and gaming. We are confident that these are the right levers to revitalize Windows and restore growth. The progress we made this quarter and the forward-looking guidance that Amy will share shows the opportunity for renewed growth is real.

In hardware, both Surface and Xbox had an incredible Q4. We more than doubled Surface revenue to nearly $900 million this quarter, capping off a year in which it delivered more than $3.6 billion in revenue. Both consumers and enterprise customers love this device.

Surface is clearly a product where we have gotten the formula right, earned fans, and can apply this formula to other parts of the hardware portfolio. Gaming is an important scenario for Windows 10, and our success with Xbox this quarter gives us a strong starting position heading into launch.

Xbox Live users grew 22% this quarter and logged nearly 3.5 billion hours of gameplay. Our growing fan base is excited for the best games lineup in our history.

All of this comes together with Windows 10, when fans can connect with each other, stream all of their Xbox One games to Windows 10, and experience the best virtual reality platform given our partnership with Oculus Rift and Valve.

In search, Bing will now power both differentiated experiences on Windows 10 such as Cortana as well as search and search advertising across the AOL portfolio sites in addition to the partnership we already have with Yahoo!, Amazon, and Apple.

With advertising revenue growth of 21% year over year, Bing will transition to profitability in the coming fiscal year. It's been a strong year of progress. Above all else, I'm optimistic about our future. Our cloud services are accelerating fast, and Windows is positioned for renewed growth.

With that, I'll hand it over to Amy to talk about this quarter's results in more detail. I look forward to rejoining you after that for questions. Thank you..

Thanks and good afternoon, everyone. Our fourth quarter results demonstrate the strong progress that we've made as a company over the past year. Key strategic initiatives such as cloud, first-party hardware, and consumer services delivered significant growth as well as improved profitability.

Commercial customer renewals remained healthy with strong adoption of cloud services and a higher mix of annuity than we expected. And our disciplined approach to resource allocation has allowed us to increase investment in the growth initiatives Satya mentioned while reducing the company's operating expenses.

This allows us to better compete in markets with structural growth where we feel we have unique competitive advantages. With that said, I will start with an overview of our financial performance before moving into a more detailed discussion of the results.

This quarter we recorded an impairment charge related to our phone hardware business and incurred integration and restructuring expenses. Additionally, like most multinational companies, the strengthening of the U.S. dollar continues to have a significant impact on our reported results.

Accordingly, when applicable, I'll give results and growth rates adjusting for the impairment, integration, and restructuring expenses, but also in constant currency to help you better understand the underlying business fundamentals. Revenue was $22.2 billion, down 5% and down 2% in constant currency.

As a reminder, last year included $382 million of revenue that we recognized at the conclusion of our commercial agreement with Nokia. Significant gross margin improvement across commercial cloud, Surface, and our consumer services helped to mitigate the impact on gross margin from the decline in D&C licensing.

Total gross margin declined 7% and 3% in constant currency. Operating income declined 3% and 1% in constant currency. Earnings per share were $0.62, growth of 11% and growth of 8% in constant currency. Unearned revenue grew 1% to $25.3 billion and 7% in constant currency.

Commercial unearned was better than expected, as we saw a higher mix of annuity in the quarter. From a geographic perspective, the majority of markets performed in line with our expectations. The notable exception was Brazil, where inflation and macroeconomic volatility weighed on our performance.

Overall, macro conditions remain a challenge in some large opportunity markets like China, Russia, Japan, and Brazil. There was slightly less impact from currency than our expectation. With that backdrop, I'll move to a detailed discussion of our results. Q4 last year effectively marked the end of the XP refresh cycle.

It impacted our Windows OEM and non-annuity volume licensing as well as our Office non-annuity volume licensing results. During that time, OEM revenue exceeded that of the underlying PC market, driven by a higher attach of Pro, particularly within the developed markets. This quarter Pro declined by roughly 21%.

And similar to last quarter, we saw Pro attach remain at pre-XP levels, even with the underlying softness in the business PC market. The annuity portion of Windows licensing grew again on a constant currency basis, with non- annuity revenue declining due to XP.

Windows non-Pro revenue declined 27%, as OEMs tightly managed PC inventory ahead of the Windows 10 launch, particularly in developed markets. In our view, this is a healthy state for the channel as we head into a transformational launch that starts next week. Consumer Office 365 had another strong quarter of net subscriber growth.

Overall, consumer Office revenue results reflected the decline in the underlying driver of that business, developed market consumer PC sales. Within D&C licensing, the transition to Office 365 accounted for 13 points, and the impact of Japan's PC market accounted for another 19 points.

We had another impressive quarter in search, with revenue growth of 21% and 25% in constant currency, driven by increases in both volume and revenue per search. As Satya said, revenue from Surface more than doubled this quarter, with continued strength of Surface Pro 3 and the launch of Surface 3.

Enterprise sales accelerated this quarter, and sales of Surface 3 were particularly strong to educational customers. Our differentiated products as well as improved discipline and execution helped to improve gross margins by $450 million this quarter and $1.3 billion in fiscal 2015.

Within Xbox, strong growth in consoles, online transactions, and first-party games helped to drive revenue growth of 27%. This progress as well as the excitement we generated at E3 with Xbox exclusive gaming content and backwards compatibility demonstrates the building momentum that exists within the Xbox ecosystem.

In phones, we sold 8.4 million Lumias, which is an increase over last year's full-quarter sales. ASPs, however, have continued to decline. Gross margin declined this quarter, driven by lower per unit margins on Lumia devices as well as reduced volumes in non-Lumia phones.

As announced on July 8, we are changing our approach in this business and are focused on delivering differentiated experiences for our targeted customer segments while improving our operating results. Moving to our commercial results, total revenue across our two segments grew slightly in USD and 4% in constant currency.

Our contracted-not-billed balance, which is a key indicator of customer commitment, reached an all-time high of over $24.5 billion, and it reached this level even with the significant appreciation in the U.S. dollar.

Constant currency bookings were flat to the prior year, though as a reminder, last year commercial bookings grew 23% on the strength of a large renewal base as well as the end of XP, discussed earlier. Our Office commercial business continues to transition to Office 365.

We again grew the installed seat base for Office, Exchange, SharePoint, and Skype for Business. Office 365 allows us to have a deeper ongoing relationship with all of our customers, which in turn provides us with the opportunity to expand and grow our business over time.

Because of this transition as well as weakness in Japan and the impact of XP, Office commercial products and services grew 1% in constant currency, quite similar to Q3. Dynamics revenue grew 15% on a constant currency basis, driven by the strong CRM results Satya talked about and our ERP business, which saw 35% growth in customers this quarter.

Server products and services grew 4% and 9% in constant currency, continuing to outperform our peers in the enterprise software sector. SQL Server share growth continued, as customers value its high performance and lower cost of ownership.

Revenue and licenses of Windows Server grew against the backdrop of a declining server hardware market; and in the public cloud space, yet another quarter of significant Azure usage growth. Additionally, we significantly grew the gross margin percentage in our commercial other segment, increasing 13 points to over 43%.

Moving to operating expenses, which declined 9% or 4% in constant currency, our continued disciplined approach has allowed us to incrementally fund strategic initiatives without having to increase our expense base. Other income was favorable to our expectations, driven by gains on foreign currency and sales of investments.

Our non-GAAP effective tax rate was 24% and was at the high end of our guided range, due in part to strong performance in our computing and gaming hardware segment in the U.S. We returned $6.7 billion to shareholders this quarter, nearly double the amount from last year.

With that overview of the current quarter, let me turn to our outlook, starting with a few overall comments. As has been communicated over the past couple of months, the accounting for Windows 10 will change. We will be deferring a portion of Windows 10 revenue, primarily OEM, and recognizing it over time, generally two to four years.

As shared previously, the initial deferral and the subsequent recognition of those deferrals will be netted in Corporate and Other in our segment reporting. Most importantly, underlying billings and cash flow won't change.

Therefore, our commentary in this and subsequent earnings calls, including our guidance, will focus on results prior to the net deferral impact, which we believe is the best reflection of business health. With that background, let me share some thoughts on fiscal 2016. The strengthening of the U.S.

dollar will continue to have a significant impact on results over the course of FY 2016, assuming rates across our largest currencies, the euro, Japanese yen, and the British pound, stay in line with current rates, and that the geographic mix of revenue stays as forecasted.

In our non-annuity businesses, the impact is immediate as the revenue is recognized in quarter. In our annuity business, revenue is deferred and the impact is delayed as we earn the revenue off the balance sheet.

In total, we expect FX will negatively impact total revenue growth by five points in each quarter of H1, with seven points of negative impact in our commercial segments. H1 would be the peak of the FX headwinds.

And in H2, we expect FX to have three points of negative impact in total and roughly four points of negative impact on our commercial revenue. With Windows 10, we expect momentum to build throughout the year, as we and our partners bring new devices, applications, and services to market.

We expect this to benefit our business results in the second half of the fiscal year. With the strength in Xbox and Xbox Live along with the launch of Halo 5 in October, Xbox will continue to grow both fans and profitability.

With the recently announced changes in phone, there will be significant revenue declines year over year in the phone segment each quarter. With the proactive measures we've taken to reduce our cost structure, overall losses will also decline for the fiscal year.

We would expect the majority of that improvement in the second half of the year once the restructuring efforts are materially complete. Bing will be profitable in FY 2016. And assuming the macro environment is stable, we expect that our commercial momentum will continue, highlighted by growth in our commercial cloud.

We remain on track to achieve our $20 billion commercial cloud ambition in fiscal 2018. We now expect operating expenses to be $32.1 billion to $32.4 billion, which is lower than the guidance we provided in April.

The lower guidance reflects the savings from our restructuring of the phone business as well as important investments to drive top line growth as we support Windows 10, our first-party hardware efforts, as well as sales head count to accelerate our leadership position in the commercial cloud.

We expect our full-year tax rate to be 24% plus or minus one point, excluding the net impact from the Windows 10 deferral. Now to Q1, starting with Devices and Consumer. In licensing we expect revenue to be $3.4 billion to $3.6 billion. This range reflects Windows revenue roughly in line with the PC market.

Within Consumer Office, we expect to transition to Office 365 subscriptions to continue. In computing and gaming hardware, we expect revenues to be $2.0 billion to $2.1 billion. As a reminder, we launched Surface Pro 3 in late June last year, with launch benefits extending into Q1.

As far as hardware, we expect revenue to be approximately $900 million, reflecting our change in approach. We expect gross margin in phone to improve sequentially in Q1. In devices and consumer other, we expect revenue to be $2.2 billion to $2.3 billion, with continued growth in Bing, Consumer Office 365, and Xbox Live transactions.

And in commercial, as I discussed previously, we expect a significant FX headwind this quarter. Our constant currency growth is expected to be about 7% in Q1, which assumes we continue to take share in key markets and build momentum in the new areas we have entered. With the negative impact of FX, we expect revenue to be roughly flat.

On commercial licensing, we expect revenue of $9.1 billion to $9.2 billion, with a continued shift to annuity; and in commercial other, with the significant growth in our cloud revenue of $3.1 billion to $3.2 billion. We expect COGS to be $7.0 billion $7.2 billion, with the variability being driven by the hardware segment.

We expect operating expenses to be $7.6 billion to $7.7 billion. As a reminder, other income and expense includes dividend and interest income offset by interest expense and the net cost of hedging. Given the current FX environment, we expect our net cost of hedging to increase and other income and expense to be negative $200 million.

Excluding the Windows 10 deferral and the impact of foreign currency, we expect the sequential decline in unearned to be slightly better than historic seasonality, driven by the growing mix of annuity revenue. In closing, I'm proud of the tremendous amount of progress that our company has made over the past year.

We've improved how we operate in virtually every sense. These changes have allowed us to aggressively invest in areas that will drive future growth for the company. I'm looking forward for a better position to capitalize on the significant opportunities ahead of us. With that, let me turn it back over to Chris for the Q&A..

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

Thank you. Our first question comes from Phil Winslow from Credit Suisse. Philip Alan Winslow - Credit Suisse Securities (USA) LLC (Broker) Thanks, guys, and congrats on a great quarter. I just wanted to double-click on Office 365.

You guys showed another huge quarter of growth in terms of your consumer seat count, and I think it was 86% growth on the commercial other side for Office 365. I'm wondering if you could just drill into both the consumer and then enterprise side, just the trends you're seeing there.

And obviously the guidance you all just provided, it looks like you expect those trends to continue in Q1, so any color there would be great..

Yes, I'll take that. Overall, we are very excited about the growth we are seeing in Office 365. On the consumer side, as you noted, we are growing 1 million subs a month, and that's fantastic growth for us.

The consumer value, especially now that we have even all the endpoints covered with Office, the definition of Office and where all it's present is also changed, and that all accrues to consumers being willing to have a subscription relationship with us.

On the enterprise side, the growth remains very exciting for us, and the growth comes in multiple forms. It comes in the form of just the EAs renewing more to Office 365. It also comes in the form of some of the more comprehensive suites, the E3 and the new E5. That's the commitment we are seeing. And we also see small businesses.

I talked about the 50,000 businesses, small and medium-sized businesses each month signing up for Office 365. That's pretty unprecedented. Having been in the server business all my life, I've never seen a lot of the small business customers adopt some of the rich capabilities like it's possible now, and that's great growth as well.

And that cloud revenue number that is the 88% is all up cloud revenues inclusive of Office 365, EMS, and Azure. And it's good to see that kind of growth at that kind of scale now with $8 billion..

One thing I would add, Phil, to that is an important dynamic that we're seeing in Office 365. As we are having this momentum build, in fact we talked about some of the new customers we're adding, and the way we see that is the install base growing. And we were able to see that this quarter across all the core workloads in Office.

And when you think about why that's so critical long term, it's our ability to sell some of the workloads Satya actually referenced that will be in E5 when it launches. They have the capability of upgrading on a more consistent basis using more of these premium services.

So when you can both add to your install base and add overall market opportunity, we do feel good about our line of sight in that business for our long-term goals. Philip Alan Winslow - Credit Suisse Securities (USA) LLC (Broker) Great. Thanks, guys, and congrats again..

Okay, thank you, Phil. We'll take the next question now, please..

Our next question comes from Brent Thill from UBS..

Good afternoon. Satya, the server business continues a steady outperformance and, as Amy pointed out, better growth than your peers. I guess a couple questions as it relates to the Windows 2003 retirement and any impact you're seeing there. And then secondarily, if you could, just comment on some of the new product launches.

It seems like there's a stack of new solutions that are coming on the server side that look pretty exciting. Your partners are excited about it. If you could highlight what you see as the most interesting from your perspective over the next several quarters. Thank you..

Overall, I'd start even with the bold view that my server business is not a legacy business. We fundamentally think about servers as the extension of the cloud. I even describe it architecturally as the edge of our cloud. Every server, for example, has things like disaster recovery, backup, and tier-ing with the cloud.

And so we will continue to push that differentiation because I think that view architecturally and the delivery of it is what makes us pretty unique. And you see it in the numbers. Our servers even this quarter grew 9%.

And compared to the industry peers, we're obviously gaining share with Windows Server, on SQL Server, and pretty much all of our management and security products as well.

And going forward, we have a fantastic lineup of servers, not just the infrastructure, but even SharePoint, Exchange, Lync Server continues to have significant on-premise deployment. So as our cloud continues to grow, obviously, we are getting where there is more capability in the cloud. We're incenting customers and our partners to move to the cloud.

But at the same time, we are going to have a great server wave. I'm excited about our SQL product. I think it goes into the first preview next – in fact, tomorrow.

And that product I think is a pretty revolutionary product because for the first time you can take a single table in a database and you would tier it with the cloud, and that kind of capability only we can provide, and that's something that I'm looking forward to..

And, Brent, to your specific question on Windows Server 2003, we did have a good quarter, as we talked about, in Windows Server. But in general, that business, unlike the quiet upgrades that we see, just because so much of the business is already on annuity, you don't see that type of incremental impact in an in-quarter release.

That isn't to say there isn't ample opportunity for us to make sure we upgrade customers to the higher-value product and more secure and more manageable offerings we have in the server business..

Thanks, Brent. Operator, we'll take the next question, please..

Our next question comes from Mark Moerdler from Bernstein Research..

Thank you, nice quarter. I want to drill in, in terms of the move to the cloud. This quarter the year-over-year server product and services revenue growth was slower than it was in the past quarters.

How much of that is because you're seeing now some revenue shift to Azure, or is it not yet seeing any revenue shift going? And then I have a follow-up question..

Why don't I take that one, and we'll see what Mark's follow-up is? At 9% growth and continuing to take share, I feel like our performance in this continues to be a positive outlier to the peer group. And for me, that type of performance in double digits for the year, I still feel quite good about.

In general, what's interesting I think is you're getting to the crux of it is do we have incremental workloads that are unique to the cloud. We continue to see that. The very best example, frankly, as Satya mentioned in his comments, which is our EMS performance, Enterprise Mobility Suite offerings.

It's taking something that's very unique, builds off of our core in the server business, and allows us to both grow and add new perspective there. So I don't think of it as reflecting a bigger shift than we've seen in particular this quarter.

Also, if you'll remember, a year ago we had a very big base of expirations in Q4 and had very strong performance a year ago. So I don't look at it as a direct trend line..

The only thing I'll add is when I look at the total growth of Azure, the growth that's coming now from some of the premium services, these are businesses that we actually did not ever participate on premise at all. Even EMS, when I think about our management, our management was just about Windows management.

But we now have management data protection and identity systems that cross all devices in the enterprise, including the Internet of Things, and that makes it pretty exciting. And that growth is great to see.

Same thing on server management, we have a new suite called the Operations Management Suite, which also spans all the cloud units as well as on-premise units. Cortana Analytics, we never participated in any of the advanced analytics workloads at all in spite of all the success we had in the database business.

So I'm excited about built new workloads that in many cases are born in the cloud workloads where we are expanding our market opportunity and continuing to outperform our peers and grab share when it comes to on-premise..

That's very helpful. Switching gears a bit, on Windows, obviously you're seeing some amount of delay due to Windows 10 on the OEM side.

Can you give maybe a little more higher color in terms of how you're thinking about that, how big a delay is it, how much we could see that starting to be replaced next quarter and beyond?.

I'll take that and, Amy, you can add to it. The way the Windows ecosystem works is there are phases to it.

And in fact, if anything, this release of Windows 10, just the way we have built it with the Insider program, everything is of course speeding up because in some sense we've taken a very different approach with this Windows-as-a-service even when it comes to OEM relations and how they're able to co-create the products with us.

But that said, there are three distinct phases. The first phase is what I will describe as the upgrade phase. That's what starts in a week's time, and that is a more retail execution and upgrade. Then come the fall, you will see the devices from all the OEMs going into the holiday quarter.

And then the enterprise upgrades; in fact, we have a release of enterprise features, which I mentioned in my script, which will ship in that timeframe. And I expect piloting to start and deployments to start in the second half of the fiscal year. So that's how I would think about the OEM as well as enterprise adoption.

So my bullishness for Windows 10 is more in the second half of the fiscal year, and of course it will build. It will build starting in a week's time in retail and in the upgrades, but I see this in three phases..

And to your specific question, Mark, before every launch we tend to have a tightening in the channel as they prepare and run reasonably lean. This is a healthy state. It's within the range of normal. So I don't think of it as a delay in the way you're talking about it. It is pretty standard in fact, as Satya talked about, in terms of the dynamic.

And he mentioned we are feeling I think a lot of excitement from the ecosystem about what's possible with some of the new devices that will come. And so I don't really think of it in that way. I think about it as an encouragement that they want to fill the channel as quickly as they can over the coming quarters with new machines..

Thank you, I appreciate it..

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

Our next question comes from Keith Weiss from Morgan Stanley..

Excellent, nice quarter, guys, and thank you for taking the question. I wanted to drill into the new strategy around the phone business a little bit. The revenue expectation for Q1 I think was below our expectations and I think a point below what the Street was looking for.

Can you give us a sense of how you see that business trending over a longer period of time? Because there is a significant restructuring going on and I think – I would think a lot of guys have a good view in their head of what your expectation is for this business on a revenue run rate basis? Or what do you expect to be selling this year on a going forward basis is right now?.

Let me start and then, Amy, you can add to this. The big shift that we are making when it comes to phones is to not think about phones in isolation. That's perhaps the biggest shift because I think about Windows 10 in its entirety, the Windows ecosystem in its entirety.

We clearly are going to have premium first-party portfolio, and you've seen some of the numbers, some of the progress we have made in Surface. I feel that we have a formula there that I would like to apply more broadly in terms of growing, just delivering innovation, growing our own economic return for it, stimulating demand, creating categories.

All of that is what I want to do broadly. And it applies to phones, it applies to Surface hardware, it applies to Hololens, and that's how I view it.

I believe our participation in the phone segment by itself with Windows phones and Lumia phones being there is important, and that's why we picked the three areas where we have differentiation and we want to focus on it. We're going to have great flagship phones for Windows 10.

That's actually a segment we don't today have good devices, and we hope to change that with Windows 10. We have in fact good traction in the business segment. This is business customers who are actually buying phone devices, which is basically a radio with essentially a smartphone to be able to deploy their line-of-business applications.

That's where we have pretty unparalleled value, which is we have Visual Studio Online and some of the tools I talked about, so you can generate these apps at a low cost of ownership, manage them, secure them, and deploy them to our phone endpoints, and then of course, management and security. So that's a place where we want to continue to focus.

And in the value smartphones, that's the place where I want us to be much more efficient. We clearly have some value to add there because of the uniqueness of Office and Skype and our services. But at the same time, I think we want to be smart about how many of these phones do we want to generate, how many, which price points we want to participate.

That's where you will see the most significant operational changes from how we operated last year to the coming year..

And so, Keith, the way that I think about it and I tried to outline it in my comments is that the significant revenue declines quarter over quarter through the year are a reflection of the focused approach we're going to take in phone. It's an approach that we've executed in other hardware segments that I feel is a proven model for us.

Our profitability will also improve. More of that comes in the second half of the year structurally as we complete some of the restructuring efforts and those costs come out of our operating expense run rate.

But I think that's probably the way to more appropriately think about over time you expect to see gross margin improvement and operating profit improvement as opposed to focusing on the revenue line..

Got it. And if I could sneak one more in just on the security side of the business, I think a lot of guys have thought traditionally about security as something that Microsoft does to make their platform more secure, and it does provide more confidence in users using your platforms and your tools.

On a going-forward basis, is there more of an opportunity for you guys to sell security as more of a standalone opportunity? It's something that's in very high demand today with those looking for more secure solutions.

Is that something that could potentially be more of a standalone opportunity for Microsoft on a go-forward basis?.

In fact, we are adding significant value in security. It's much better for us, for example, to add capabilities. There are no (46:55) 365 in security, and that's all in, for example, this new suite that we have just announced called E5, the secure lock box.

That's actually a pretty – a very cool set of features that allow both regulators and businesses to have, for example, audit ability and control over their movement in the cloud. Similarly Azure, where we launched a whole set of security offers around how people can encrypt and manage keys. So those are all security features.

We bought a company in Colorado that's essentially a firewall on all your identity management. So when we talk about enterprise management suite growth, a lot of it is just obviously is management growth, but it's also security and data protection growth.

So the approach we're taking is we are essentially creating, to your point, security value around our products, which allows us to participate in essentially a security market that we never did in the ways that we are. So it's more than just launching one point security product.

It's much more broadly participating in the security market, and you have seen some of that in the inorganic moves and the suites we have created..

Excellent. Thank you, guys..

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

Our next question comes from Walter Pritchard from Citi..

Hi. Amy, just for you on the annuity, it looks like annuity was about 82% of the commercial revenue for the last two quarters. How high do you think that goes? It sounds like you do expect that to continue to go up, although it probably never gets to 100%..

I do think over the long term you're right. That is how I think about it. And frankly, inherent in the conversation around moving to the cloud with the aggressive targets we've given, that is implied, to your point. And so I think 100% is not the logical answer.

There will always be somebody who chooses to purchase on a one-time basis, or there's a logic to it. But I do think over time, we do expect that to trend in that general direction..

And then, Satya, you mentioned CRM in your comments, your prepared comments, which we haven't really heard you talk that much about as an area of interest in the past. I'm wondering.

What changed in your view, or how do you look to bring that into it sounds like more the core productivity scenario that you deliver?.

Overall, business process collaborations, communications, these category boundaries are things that I believe are going to change. I've always felt that in some sense, most of the time we even automate business processes, but we spend really getting our business done in our communication and collaboration tools.

And this impedance is something that I've always dreamt of how do we go forward. And CRM has taken our own Dynamics product, has taken some pretty unique approaches. And quite frankly, I was the one who opened up our communications and collaborations for other CRM vendors.

One of the things that I'm very explicit about is we will have an open platform for other business process applications because it's a very fragmented market the world over, especially if you add SMB. And so we want to be having a platform play as well as our own business applications play, and both of them should be high-growth for us.

And in the last year, we just added more focus and we put more selling capacity around it, more marketing capacity, and now for the mainstream that's across Microsoft because I'm a big believer in this because I think we have something unique to add.

As opposed to driving our own top line/bottom line growth, I think we can bring real innovation, and that's what is exciting to see. And it's not just CRM. I'm actually excited about our ERP business. Some of the numbers that Amy talked about is growth in the seats.

And when I think about data as the new currency, we have lots of managed seats and a lot of data which all will move to the cloud. And so things like Power BI and Cortana Analytics can help customers transform.

So in fact, that's one of the reasons why we have been very optimistic about some of our new data capabilities because we have the attach capability go out even in the install base of Dynamics..

And, Walter, just quickly, this is one of the areas that we have invested in actually leading into this past fiscal year, FY 2015. And the results have actually been better than we anticipated when we first made the investment. So I think we both feel very good about the momentum that's built through the year..

Great, thank you..

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

Our next question comes from Karl Keirstead from Deutsche Bank..

Hi, thanks, a question for Amy on the cost control front. It looks like you once again came in below your OpEx guide, but I think the COGS number came a little bit above what you had guided to three months ago, and I'm just wondering if you could talk through that. Obviously, it affects everybody's gross margin calculations.

Was it the hardware mix shift? Was it the challenges with the phone business? Perhaps a little color there might help us. Thank you..

Sure, Karl. Because of the performance in Xbox and in Surface, you're right, it is a hardware mix shift a bit. We outperformed significantly in both those products in Q4, and that took us a little bit outside the COGS range but not as much as our revenue outperformed. So actually, margins structurally were better than I thought they would be.

And so I actually feel quite good with that outperformance and our ability to see that outperformance fall to the bottom line through stronger executional gross margin percentage, particularly in that segment..

Okay, good. That's helpful, thank you..

Thanks, Karl, next question, please..

Our next question comes from Raimo Lenschow from Barclays..

Thanks for taking my question. I wanted to go back to Azure. You obviously have strong momentum there. Can you talk a little bit about the use cases you see from the enterprise and SMB customers? Is this very much a test and development situation, or are you thinking of broader adoption there as defined by obviously Office 365, et cetera? Thank you..

At this point, I would say it's pretty broad even use cases for even enterprise customers. There's definitely dev/test happening. There is production IaaS infrastructure-as-a-service deployment given some of the new high-performance SKUs and storage options that we have.

And we've seen significant adoption of SQL, so this is Azure DB, machine learning-as-a-service. One of the things that we realize is as every company out there becomes a software company, beyond even our traditional reach through IT, everyone has a digital office inside the company.

They are, in fact, doing things in advanced analytics and using machine learning, and that's a place where we have some very unique capabilities. So that's another place where we're seeing wide adoption.

We are seeing adoption in the building of new front ends, back ends for new front ends, so essentially using Azure as the cloud back end for their mobile apps across Android, iOS, and Windows as well as their web. That's another use case that's high growth for us. And of course, Cortana Analytics; this is the big data side of it.

This is happening in IT. It's happening, as I said, in digital offices within each one of the customers. So we have a pretty broad spectrum of use cases. And some of the customers have talked about it in their recent set of conferences, from our Partner Conference to our Ignite Conference.

We have been in fact showcasing; even our ad campaign showcases some of these use cases..

Perfect, thank you..

Thanks, Raimo, next question, please..

Our next question comes from Heather Bellini from Goldman Sachs..

Great, thank you. I just had two questions, pretty quick ones. Just to follow up on Azure, I was wondering if you could share with us what you're seeing in the mix between IaaS and PaaS and how you've seen that shift evolve over the last few quarters.

And then secondly, just to follow up I think on Walter's question, yes, you've definitely been focusing on the customer relationship management opportunity and the financials market more.

But given the big SaaS incumbent already competing in that area, can you share with us? Do you think you have the assets you need internally to execute against your long-term goals?.

Sure. On the IaaS with the SaaS, it's an interesting question. I've not looked at it in isolation, because what happens is at least the use cases, what starts off as IaaS suddenly will start using Azure AD for identity management, will use a little bit of our media services, for example, just doing content and encoding. So there's a mix always.

So there's nothing pure PaaS, nothing pure IaaS. That's the trend I see, but it's a split that we should go take a look at and then offline maybe even talk about it. But overall, we see significant amount of IaaS in the last year, because that's probably the place where we had more of a weakness which we have now overcome.

And so we're seeing significant growth of IaaS in the enterprise. But the place where we continue to have significant differentiation is in some of these managed services and PaaS. And that I think is the mix on it. And then on the Dynamics side, I absolutely believe we have a huge opportunity.

Having worked in business applications for a long time, first of all, the market is very fragmented. I think people like to talk about leaders, and there are clearly leaders when you go to the very top of the enterprise customers and segments.

But the way the market splits into verticals and into horizontals and then the platform affects it, there's plenty of opportunity. For sure, you've got to be one of the players. It will be three players, four players, whatever, but in every technology paradigm, you want to be one of them. We already have a $2 billion-plus Dynamics business.

I talked about the total number of seats. And now we have this triple-digit CRM online growth. So I feel that we are in a good position. And I feel that things – we'll look at and even some of the inorganic means to keep growing it. In fact, the field service acquisition I talked about in my script is an example of that.

So that's my bullishness on our business process prospects..

Thank you very much..

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

Our next question comes from Ross MacMillan from RBC Capital Markets..

Thanks for taking my question. First on OpEx, the guidance, Amy, is impressive. I presume that fully accommodates the restructuring announced two weeks ago. And then last year, you said core Microsoft ex-NBS would be down slightly in OpEx. I wondered if you could provide a similar comment for fiscal 2016 for core Microsoft ex-phone..

Sure. Look, I talked a little bit about it, but let me go into a bit of detail on that. I think the first half of your question was does the $32.1 billion to $32.4 billion full-year OpEx guide reflect the timing of the implementation of our restructuring, and it certainly does.

And so what you can then see, relating to the second half your question, is that we are taking some of those savings and investing them back into the business in some of these key growth areas we've seen. I outlined three on the call. The third one I probably could have expanded more on. The first one is Windows 10.

The second is the first-party hardware, where we just had such terrific performance again this Q4. And then finally, the third bucket was about accelerating our commercial cloud lead. And I do feel like in that area, we could invest in Office 365 some of the new E5 capabilities and look forward to adding sales capacity to take advantage of that.

We'll also add sales capacity across some of the other opportunities we've seen broadly. And so I look and see that as an opportunity to accelerate top line growth..

And one thing I would just add because a lot of folks even ask about our business process and business applications, I want to build a long-term profitable business. In other words, one of the keys in business apps is you can always get into the trap of overspending in sales and marketing and not having long-term leverage at all.

One of the things I feel very good about our position is how do you really build a long-term profitable business; that's front and center to me.

So we will not overspend there in sales and marketing because we do believe the products – in fact, there is a different way to sell even business process applications because of the cloud, and that's something that we want to take advantage of..

And I had have one quick follow-up, if I could. That's helpful. At Analyst Day you did talk about – I think it was 8% unit growth in the Office ecosystem over the last three years. And it sounds like you continued to see nice unit growth in Office.

How should we think about that going forward? Are you fully expecting to continue to see unit growth? And then also just a clarification, I think your customer lifetime value was based on existing SKUs. So as you introduce E5 and others, does that open up the potential for even higher customer lifetime value? Thanks..

Great. I do think the work we showed at the analyst meeting on the importance of increasing the install base across Office and Exchange, that it did occur again this quarter. So I feel good that we're staying on the trajectory that we showed in the projections. I do continue to expect that to happen, as we shared back that last week in April.

On the second half of your question, I tend to think you're right. Generically, each of the examples was quite different. There were people that were upgrading from X to Y. There were people that were just simply moving to the cloud.

But one of the things that the cloud, to your point, makes fundamentally possible is the opportunity for us to quickly iterate the opportunity's billed value and deploy it more quickly to customers. Generally, I do think that they will pay us for that, to your specific question.

I also think the importance of it is that it tends to also come with higher margin. So our improvement and continued improvement in our commercial cloud gross margin portfolio, I think this is a key criteria of that. So I associate it, yes, with lifetime value, and I also associate it with our ability to move our gross margin percentage up..

That's great, thank you..

Thanks, Ross. We have time for one last question, please..

Thank you. Our last question comes from Daniel Ives with FBR Capital..

Thanks, just one last one just on M&A. Maybe you could just talk through the change in the strategy.

Obviously, given what's happened with the Nokia write-down, the security acquisition going to Pivotal-Cisco year, how you're thinking about M&A in the scheme of everything, especially as you guys have been pretty tight on cost controls and everything else. Thanks..

Overall, again, the way I look at it is, first of all I'm most focused on obviously our organic growth. And in there, Amy alluded to this. We've made significant changes in how we've allocated our own organic dollars, both in R&D as well as in sales and marketing.

And we'll continue to do that because I think there are significant new opportunities for us to go after, and that will require us to reallocate aggressively, and that to me is core. But beyond that, we will look at inorganic means.

When I look at all the acquisitions that we have made over the course of last year and our OpEx guidance for next year shows how disciplined we are in bringing new talent in, be it in R&D, be it in sales and marketing. So we are not afraid to bring in new capability, but then also questioning what is the allocation we have.

Of course, we have done smaller acquisitions, but they add up. They're pretty significant when you add up all the things that we have done in the Office 365 space, all of the things that we have done in the Azure space. So we'll continue to do that.

And if anything comes up in M&A which allows us to pursue our strategic vision that we will need to even allocate more to on an OpEx basis, post-acquisition we will look at that. So I won't shy away from it because what's important to us is growth in areas where we have something unique to contribute and long-term profitability..

Thank you..

That wraps up the Q&A portion of today's earnings call. We look forward to seeing many of you in the coming months at various investor conferences. For those unable to attend in person, these events will generally be webcast, and you can follow our comments at the Microsoft.com/investor website.

Please contact us if you need any additional details, and thank you for joining us today..

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