The operator welcomes listeners to the Microsoft Fiscal Year 2024 Second Quarter Earnings Conference Call and reminds them that the call is being recorded. The host, Brett Iversen, introduces the participants and directs listeners to the Microsoft Investor Relations website for the earnings press release and financial summary. He also mentions that the acquisition of Activision Blizzard will impact the More Personal Computing segment and provides information on how it will be reported. Non-GAAP financial measures will also be discussed on the call.

In addition to discussing the company's second-quarter performance, the call will also provide growth comparisons and rates in constant currency, and will be available for replay on the Microsoft Investor Relations website. The call will also include forward-looking statements and cautionary notes about potential risks and uncertainties. Satya Nadella will be leading the call, highlighting the record quarter driven by the success of Microsoft Cloud, which generated over $33 billion in revenue, a 24% increase from the previous year.

Microsoft has successfully integrated AI across their tech stack and has gained new customers as a result. Azure, their AI platform, has seen significant growth and now has 53,000 customers, with a third being new in the past year. They offer a diverse selection of AI accelerators and have partnerships with companies like Cohere, Meta, and Mistral. They have also developed popular SLMs that can run on laptops and mobile devices, with major companies like Anker, Ashley, AT&T, EY, and Thomson Reuters already using them. Azure OpenAI Service has also seen an increase in usage, with over half of the Fortune 500 companies using it, including Walmart, which shared how they are using it to streamline their operations and improve customer experience.

Customers are increasingly choosing Azure for their cloud migrations, with larger and more strategic deals being made. The Microsoft Intelligent Data Platform integrates AI across the entire data stack, with Cosmos DB being a popular choice for AI-powered apps. KPMG has used Cosmos DB and Azure OpenAI service to increase productivity. Azure AI search is also being used by OpenAI for retrieval augmented generation. Microsoft Fabric, a unified SaaS solution, has seen a 46% increase in data stored in its multi-cloud data lake. GitHub, with its popular AI developer tool GitHub Copilot, has seen over 40% revenue growth.

GitHub Copilot has seen significant growth in paid subscribers and usage by organizations, with plans to make it more ubiquitous and introduce new AI-powered security features. Microsoft is also a leader in low-code no-code development, with over 230,000 organizations using AI capabilities in Power Platform. Copilot Studio allows for customization and is already being used by over 10,000 organizations. Dynamics 365 is also gaining traction as organizations use AI-powered apps to transform various functions. Copilot is also being integrated into third-party systems, with success in sales and customer service interactions.

Microsoft's AI solution, DAX Copilot, has been integrated with popular apps like Salesforce and ServiceNow. It is tailored for specific industries such as healthcare and retail, with successful implementations at companies like Lifespan and Canadian Tire Corporation. The use of AI in the workplace has shown a 70% improvement in productivity and early adopters of Copilot for Microsoft 365 have seen a 29% increase in speed for tasks. The ecosystem for Copilot is expanding with the development of plug-ins by ISVs and customers. Microsoft Teams has also seen record usage, with many enterprise customers also purchasing additional features like Phone and Rooms. Overall, Microsoft 365 is experiencing growth due to these innovations.

The article discusses the success of Microsoft's Office 365 with over 400 million paid seats and the adoption of E5 by major organizations. It also mentions the integration of AI into Windows PCs, with built-in neural processing units and the introduction of Copilot and the Copilot key. The company is also transforming how Windows is experienced and managed with Azure Virtual Desktop and Windows 365. The recent security attacks have highlighted the need for increased cybersecurity, leading Microsoft to prioritize security across all products and infrastructure. They continue to innovate in their security portfolio to help customers adopt a Zero Trust security architecture.

Microsoft's unified security operations platform, which includes SIM Microsoft Sentinel, XDR Microsoft Defender, and Copilot for security, has helped early access customers like Cmax, Dow, LTI Mindtree, and McAfee increase their SecOps team's productivity. This quarter, Copilot was extended to Entra, Intune, and Purview, and over 1 million customers, including 700,000 who use four or more of their security products, have been helped. LinkedIn has over 1 billion members and is seeing strong global membership growth, with members adding 680 million skills in the last 12 months. AI-powered features are transforming the LinkedIn member experience, and the hiring business has taken share for six consecutive quarters. AI is also transforming the search and browser experience, with 5 billion images created and 5 billion chats conducted to-date. Copilot has been introduced as a standalone destination and app on iOS and Android.

In the past two weeks, Microsoft has introduced Copilot Pro and reached record numbers of monthly active users in Xbox, PC, and mobile gaming. With the recent acquisition of Activision Blizzard King, they have added millions of gamers to their ecosystem. The company is focused on providing players with more ways to experience their favorite games through cloud gaming and is excited about their upcoming line-up of games. Revenue for the quarter was $62 billion, up 18% and 16% in constant currency, with operating income and earnings per share also showing strong growth. Microsoft attributes this success to strong execution by their sales teams and partners.

Microsoft's commercial business saw strong demand for cloud offerings and AI services, leading to better-than-expected growth and large long-term contracts for Azure. The Microsoft 365 suite contributed to increased ARPU for office commercial business, while standalone products outside the suite saw moderate growth. Commercial bookings exceeded expectations and increased by 17% in constant currency. The strength in long-term Azure contracts and strong sales execution drove results. The remaining performance obligation for commercial business also saw significant increases. In the consumer business, the PC and advertising markets were in line with expectations, while the gaming console market was slightly smaller. The net impact of Activision, which was recently acquired, contributed 4 points to revenue growth but had a 2 point negative impact on adjusted operating income and a negative $0.5 impact on earnings per share. This includes costs related to purchase accounting, integration, and transaction-related expenses.

In the second quarter, Microsoft's FX was in line with expectations for total company revenue, segment-level revenue, COGS, and operating expenses. Microsoft Cloud revenue exceeded expectations and grew by 24% in constant currency. The gross margin percentage for Microsoft Cloud remained relatively unchanged, but excluding an accounting estimate change, it increased by 1 point due to improvements in Azure and Office 365. Company gross margin dollars and percentage also increased year-over-year, with a 2 point increase excluding the impact of the accounting estimate change and costs from the Activision acquisition. Operating expenses increased by 3%, with 11 points from the Activision acquisition and 7 points from a favorable impact in the prior year. The company's headcount decreased by 2% compared to the previous year, and operating margins increased by 5 points, or 6 points excluding the accounting estimate change, due to higher gross margin, favorable impact from the prior year, and cost control.

In the second quarter, Revenue from Productivity and Business Processes exceeded expectations, primarily due to strong results from LinkedIn. Office commercial revenue and Office 365 commercial revenue also saw significant growth, driven by healthy renewal execution and increased ARPU. However, Office commercial licensing declined due to a shift towards cloud offerings. Office Consumer revenue also saw growth, driven by subscriptions to Microsoft 365. LinkedIn revenue also exceeded expectations, with growth across all businesses. Dynamics revenue also saw strong growth, driven by Dynamics 365, but bookings were impacted by weaker new business. Segment gross margin and operating expenses both saw increases.

In the second quarter, Microsoft's operating income increased by 26% and 24% in constant currency, driven by strong performance in the Intelligent Cloud segment. Revenue for this segment grew 20% and 19% in constant currency, with significant growth in server products and cloud services, particularly in Azure and other cloud services. The Enterprise Mobility and Security installed base also saw strong growth. In the Personal Computing segment, revenue increased by 19% and 18% in constant currency, including a 15-point impact from the Activision acquisition. Overall, operating expenses decreased and operating income grew by 40% and 37% in constant currency.

In the second quarter, Windows OEM revenue increased 11%, driven by strong performance in consumer markets. Windows Commercial products and cloud services revenue were below expectations due to revenue recognition issues. Devices revenue decreased 9%, but was ahead of expectations in the commercial segment. Search and news advertising revenue increased 8%, in line with expectations. Gaming revenue increased 49%, with a significant impact from the Activision acquisition. Xbox content and services revenue increased 61%, while Xbox hardware revenue grew 3%. Segment gross margin dollars increased 34%, and operating expenses increased 38% due to the Activision acquisition. Operating income increased 29%. Capital expenditures were lower than expected due to a contract delay.

In the third quarter, Microsoft's cash paid-for PP&E was $9.7 billion, primarily for investments in data centers to support cloud demand and AI infrastructure. Cash flow from operations was $18.9 billion, up 69%, while free cash flow was $9.1 billion, up 86% due to timing of property and equipment payments. Other income and expense was negative $506 million, and the effective tax rate was 18%. $8.4 billion was returned to shareholders through dividends and share repurchases. In the third quarter, FX is expected to have minimal impact on revenue and expenses. Commercial bookings are expected to see healthy growth, and Microsoft Cloud gross margin percentage is expected to decrease slightly. Capital expenditures are expected to increase due to investments in cloud and AI infrastructure.

The company expects strong revenue growth in both Productivity and Business Processes and Intelligent Cloud segments. Office 365 and Azure are expected to be the main drivers of this growth, with Microsoft 365 and AI contributing as well. However, there may be some variability in revenue due to contract mix and in-period recognition. The company also expects growth in LinkedIn and Dynamics, as well as continued demand for on-premise server licenses in multi-cloud environments.

Microsoft expects a decline in enterprise and partner services revenue, with a 10% decrease in enterprise support services and flat growth in Windows OEM revenue. Windows Commercial products and cloud services are expected to see mid-teens growth, while Devices revenue will decline. Search and news advertising revenue is expected to grow in the mid-to-high single-digits, driven by volume strength. In gaming, revenue is expected to grow in the low 40s, including a net impact from the Activision acquisition. COGS is projected to be between $18.6 billion to $18.8 billion, with operating expenses of $15.8 billion to $15.9 billion. Other income and expenses are expected to be roughly negative $600 million.

The company is required to recognize gains or losses on equity investments, which may cause quarterly volatility. The effective tax rate for Q3 is expected to be in line with the full-year rate of approximately 18%. Foreign exchange is expected to have a minimal impact on revenue growth for the full year. The company expects Activision to have a positive impact on operating income for the full fiscal year. The company is focused on scaling cloud and AI investments while also driving efficiencies and managing costs. Operating margins are expected to increase year-over-year, excluding the impact of the Activision acquisition and a change in useful lives from the previous year. The company is committed to executing its strategy and leading the AI platform wave. Q&A will now begin.

The questioner congratulates the company on their strong quarter and asks about the growth of Azure AI revenue. They want to know how the revenue will be affected by the stabilization of optimization and the shift from training to inferencing. Satya Nadella explains that most of the revenue currently comes from inferencing and Amy Hood will provide more technical details. He also mentions that the new workload in AI includes the Frontier model and other models.

The paragraph discusses the life cycle of AI workloads, which involves building, optimizing, and continuously improving them. The traditional optimization cycle has ended, and now there is a constant cycle of building and optimizing both AI and traditional workloads. The contribution of AI is significant and is starting to be applied at scale, particularly in inferencing workloads, which can lead to productivity gains and revenue growth.

The company is seeing a significant margin improvement due to investments in AI, which is a key focus for the company across all teams. This has been made possible by building consistency in the tech stack and shifting to an AI-first position. Additionally, there has been work done to improve the gross margin of products such as Office 365 and Azure core.

Satya Nadella discusses the significant impact that generative AI will have on the tech stack, including changes to the core compute architecture, power density, data center design, and memory architecture. He also mentions how this will affect every workload, with the data layer evolving to be specifically built for AI.

The speaker discusses the success of Microsoft's Fabric technology, which separates storage from the compute layer. They also mention the changing landscape of tools, such as Copilot's integration with GPT. The speaker believes that being in the cloud has been helpful in building AI, but AI is now redefining what the cloud looks like. The next question asks about the progress in standing up infrastructure to meet the demand for AI, to which the speaker responds that they feel good about their progress and have been scaling up through increased capital expenses.

The early market feedback on Microsoft 365 copilot is positive, with adoption trends surpassing those of previous suites like E3 or E5. The demand and deployment signals are faster than anything else, and usage is becoming a daily habit for users. This adoption is reminiscent of the early days of PC adoption.

In the business world, there is a trend towards companies adopting standard practices, similar to how personal computers became standard after being adopted by early adopters. This is reflected in the data, as summarization, drafting, and chat are the most used features. Summarization allows for easier understanding of meetings, emails, and documents, while drafting helps with starting new projects. Chat is also a powerful tool, as it allows for natural language queries to access important company information. These changes in work artifacts and workflows are similar to the impact that personal computers had on forecasting.

The company is seeing a 6 point AI services tailwind, with the strongest activity being in people adopting it for inferencing at the API level. There is also growth in GitHub Copilot and a growing number of third parties using it for training.

The speaker discusses the factors driving growth in Azure, including inferencing workloads, OpenAI, and small batch training. They also mention the convergence of seat growth and ARPU in Commercial Office 365, and how seat growth primarily comes from small and medium-sized businesses and frontline workers. They explain that while seat growth may slow down, ARPU can still increase through adding new seats and upgrading to higher tiers.

The speaker discusses the potential for growth in GitHub Copilot revenue, which will not be reflected in seat growth. They believe that Copilot, E3, and E5 transitions will contribute to ARPU growth, while seat growth will come from small businesses, frontline workers, and new industries. They do not see these as related lines, but rather unique independent motions. The speaker also expresses enthusiasm for Copilot and the potential for AI to drive productivity for developers, and mentions the move from 2.5 to 3 of GPT as a key factor in this.

The speaker discusses the growing importance of GitHub Copilot in the software development industry, comparing it to the essential use of spell check in Word. They also mention the potential for other "copilot" tools in various areas of business, such as sales and security, to provide productivity and cost-saving benefits. This could lead to a new phase of knowledge work and frontline work, ultimately increasing the value of Microsoft's products and services.

The speaker discusses the impact of GitHub Copilot on the tools business and how it is now seen as contributing to a company's operating expenses for development activity. They also mention the importance of productivity for a dev team. The Q&A portion of the earnings call then ends.

This summary was generated with AI and may contain some inaccuracies.