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Microsoft Corporation (NASDAQ:MSFT)
Q3 2018 Earnings Conference Call
April 26, 2018, 5:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to the Microsoft Fiscal Year 2018 Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press *0 on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mike Spencer, General Manager of Investor Relations. Thank you. You may begin.

Michael Spencer -- General Manager of Investor Relations

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

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 provide to 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 substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They're included as additional clarifying items to aid investors in further understanding the company's second quarter performance in addition to the impact that these items and events had 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 is performed, excluding the effect of foreign currency rate fluctuations. Where growth rates are 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 the 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.

Satya Nadella -- Chief Executive Officer

Thank you, Mike, and thanks to everyone on the phone for joining. It was another strong quarter, the result of picking the right secular trends, delivering differentiated innovation and focused execution that results in increased engagement and usage.

The intelligent cloud and the intelligent edge era is already upon us. It represents a tremendous opportunity. We took significant steps this quarter to put this at the forefront of everything we do, realigning our entire engineering organization to accelerate innovation and better serve the needs of customers and partners.

With that as the backdrop, I want to highlight key areas of innovation and growth across our customer solutions. Creating a modern workplace where people can do their best work requires the right culture and the right technology. Microsoft 365 helps every organization empower their employees with AI back tools that unlock creativity, increase teamwork, and fuel innovation, all the while ensuring compliance and protecting data from new cyber threats.

Microsoft is a clear leader in cloud security. Advanced AI reasons over hundreds of billions of signals each month to identify non-release automated action and help customers respond to cyber threats. Just last week, we announced new value for customers, Microsoft Secure, Attack Simulator, and Windows Defender ATP Automatic Detection and Remediation Capabilities as well as a new open API for the intelligence security graph.

We've also built compliance capability directly into our cloud services. Thousands of organizations are using the recently launched Compliance Manager with new information protection scanner and built-in classification capability to help prepare for GDPR. Our comprehensive approach and proactive protection are one reason Coca-Cola chose Microsoft Cloud for their digital transformation.

One year in, Teams has rapidly become the hub for teamwork. More than 200,000 organizations in 181 markets use Teams from Maersk to General Motors. Teams is now enabled for a broad spectrum of calling and meeting room devices. We're also building AI-powered services into teams. We've integrated Microsoft Stream, our enterprise video service, into Teams for transcription and time coding of recorded meetings, we've adding new facial recognition capabilities which will attribute remarks to specific meeting attendees, and we're adding new Cortana capability to make calls, join a meeting, or initiate three-way calling just using your voice. All this innovation is driving customer usage. Windows 10 continues to gain traction in the enterprise with Windows 10 commercial monthly active devices up 79% year-over-year. Office 365 commercial now has more than 135 million monthly active users, and Office 365 consumer subscribers increased to 30.6 million.

Now I'll turn to LinkedIn and business applications. From the start, we recognized the opportunity for LinkedIn and Microsoft to combine forces to create economic opportunity for every member of the global workforce and enable professionals to be more productive and successful. A little over one year in, we feel great about the value we are delivering for members, customers, and shareholders. Our integration model has enabled LinkedIn to accelerate growth while retaining its member-first ethos.

Results are ahead of expectations across all lines of business, with revenue growth of 37% year-over-year. We saw record levels of engagement again this quarter, with sessions growth of more than 30% year-over-year, driven by innovation across the platform. This increased engagement is driving strong demand for sponsored content in marketing solutions and record levels of job postings and job visitors again this quarter in talent solutions.

Shifting to business applications, Dynamics 365 is gaining traction as our third commercial cloud growth engine, up 65% this quarter. We unleashed a wave of AI innovation in dynamics with hundreds of new capabilities to transform sales and automate marketing with Office 365 embedded inside dynamics for productivity. Relationship analytics for sales and marketing leverage the Microsoft Graph and data from social networks to improve customer relationships, and predictive lead scoring helps sellers identify and focus on high quality leads.

We are investing in our business application platform capabilities across Power BI, PowerApps, Flow, and a common data model. Now customers can extend Dynamics 365 and Office 365 and quickly build applications using data from across the organization as well as third-party data with minimal custom code. The new "Power Platform" enables customers like Inter Cars, a leading European auto parts company, to go from paper to digitized workflows within days, versus months. With the rapid growth of Power BI, we are now the leader in business analytics in the cloud.

Now I'll turn to infrastructure and AI platforms. Our architectural advantage of a consistent stack from the cloud to the edge is resonating with customers, with Azure revenue growth of 93% this quarter. Recent CIO surveys affirm our leadership position in hybrid, developer productivity, trusted security and compliance, and new workloads such IoT and AI at the edge. We have made the right investment decisions and they are having an impact, increasing our overall share in an expanding market.

Our recent datacenter expansion, including the United Arab Emirates and Switzerland, brings our total number of regions to 50 -- more than any other cloud provider. And the additional availability zones provide the most comprehensive resiliency in the industry. We also continue to see strong customer demand for Azure Stack across industries, and it is unlocking new workload scenarios across hybrid and edge.

Industrial IoT is transforming the rules of manufacturing -- fueling cloud and edge innovation, accelerating the evolution of digital factories, and enhancing supply chain performance. Azure IoT and Azure Stack enable customers and partners to build industrial IoT solutions that run at the edge, so operators on the factory floor can manage devices and analyze data in real time. And HoloLens is quickly becoming an indispensable tool as we take digital twin technology to the next level. We are also innovating in silicon to help customers realize the promise of a connected world of devices and things. Our just-announced Azure Sphere is a first-of-its-kind, highly secure edge solution that combines chip design, an IoT operating system, and a cloud service to secure more than 9 billion microcontroller-powered devices entering the market each year.

And we are already seeing rapid customer adoption of IoT scenarios. Toyota Material Handling in Europe is using Azure as well as HoloLens to create a factory of the future. Using AI, drones learn complex processes to automate the flow of a factory, increasing supply chain and warehouse efficiency. And Microsoft and ABB are partnering to push the boundaries of smart manufacturing for industrial automation.

We are investing to make Azure the best cloud for enterprise data estates. In less than a year, Azure Cosmos DB, the first globally distributed and multi-model database, exceeded $100 million in annualized revenue. Azure Database for MySQL and PostgreSQL makes it even easier to bring open source powered applications to Azure, expanding our opportunity in this space. We are seeing rapid adoption of Azure Databricks for data preparation, advanced analytics, and machine learning scenarios.

We continue to innovate to democratize AI. More than one million developers have already used Cognitive Services to quickly and easily create AI applications, and we have more services than any other cloud provider. Our Azure Bot service has nearly 300,000 developers, up more than 150% year-over-year. Microsoft Translator brings AI-powered translation to developers where their data is, whether it's in the cloud or on an edge. And, just last month, we reached human parity in language translation, a new milestone, in addition to our previous human parity achievements in object recognition, speech recognition, and machine reading comprehension.

We are also gaining traction in Machine Learning tools adoption with tens of thousands of customers using Azure ML. Finally, we are innovating with new GPU and FPGA-based offerings to lead in AI infrastructure for both training and inference. I'm excited to share more about our cloud & AI innovation at our developer conference next month at Build.

Now to Gaming. We continue to pursue our expansive opportunity in gaming, from the way games are created and distributed to how they are played and viewed. We had one of the best quarters in Gaming, with strong revenue performance and record levels of engagement. Software and services revenue grew 24%, as we continued to attract, retain, and deepen user relationships across services like Xbox Live, Game Pass, and Mixer. Xbox Live monthly active users grew to 59 million, up 13%. Our new first party game, Sea of Thieves, drove gameplay across Windows 10 and Xbox One in addition to nearly 10 million hours of viewing on services like Mixer in its very first week.

Our results speak to the strength of our platform in services for both first-party and third-party experiences and we'll continue invest in our platform, enhancing our cloud services with new AI capabilities for developers to quickly build and monetize games across PC, console, and mobile. In closing, intelligent cloud and intelligent edge represents a tremendous opportunity for our customers. It comes with a responsibility to ensure trust in technology.

We are working to instill this trust in three key areas. The first is privacy. We recognize that privacy is a fundamental human right and we have consistently acted accordingly. Our success is grounded in our customers' success. We have been working toward the May 25th GDPR implementation date since 2016, with hundreds of engineers across the company working on end-to-end privacy architecture, and we'll ensure that all our products and services are GDPR compliant. For customers, we will provide robust tools backed by contractual commitments to help them comply with GDPR. In fact, for most customers, it will be more effective and less costly to host their data in Microsoft's GDPR-compliant cloud than to develop and maintain GDPR compliance tools themselves.

Second, cybersecurity: in response to escalating cyberattacks around the world, we are leading a bold initiative to defend and protect our customers. We recently led a coalition of 34 global technology and security companies in signing the Cybersecurity Tech Accord. The accord is an important first step by the industry to help create a safer and more secure online environment for everyone.

Finally, we recently established the AI and Ethics in Engineering and Research Committee at Microsoft to ensure we always advance AI in an ethical and responsible way to benefit our customers and the broader society. This includes new investments in technology to detect and address bias in AI systems. Microsoft stands for trust, and this will continue to be a differentiating focus for us moving forward.

With that, I'll hand it over to Amy to cover our financial results in more detail and share our outlook and I look forward to rejoining for your questions.

Amy Hood -- Executive Vice President and Chief Financial Officer

Thank you, Satya, and good afternoon, everyone. Our third quarter revenue was $26.8 billion, up 16% and 13% in constant currency, with better than expected performance across all segments. Gross margin increased 16% and 13% in constant currency. Operating income increased 23% and 20% in constant currency. Earnings per share was $0.95, increasing 36% and 31% in constant currency.

From a geographic perspective, we saw broad-based strength across markets of all sizes benefiting from the positive global corporate IT spend environment. Growth in cloud services increased our commercial annuity mix, up 2 points year-over-year to 89%. Along with healthy renewals, our sales teams and partners drove a higher volume of new business, leading to commercial bookings growth of 26% and 18% in constant currency. Commercial unearned came in slightly above our expectations due to FX, growing 20% and 17% in constant currency. Commercial cloud revenue was $6 billion, increasing 58% and 55% in constant currency, highlighted by healthy growth in the US, Western Europe, and the UK. We again improved commercial cloud gross margin, now at 57%, up 6 points, with improvement in each cloud service -- most notably, Azure.

We outperformed our expectations on company gross margin, finishing the quarter at 65%. We are up slightly year-over-year, with improvement in our productivity and business processes segment from Office 365 Commercial and LinkedIn, offset by a decline in our intelligent cloud segment driven by greater mix of Azure revenue. FX positively impacted revenue growth by 1 point more than expected, 3 points at the company and productivity and business processes level, and 2 points on both intelligent cloud and More Personal Computing. FX added 2 points of growth to COGS and operating expenses, 1 point more than expected. Operating expenses grew 10% and 8% in constant currency, as we continue to invest in commercial sales capacity, cloud engineering, and LinkedIn. Even with this accelerated pace of spend, we increased operating margin 2 points year-over-year, a direct result of our focused investments to drive top line growth.

Now to segment results. Revenue from productivity and business processes was approximately $9 billion, increasing 17% and 14% in constant currency, with better than expected results from Office 365 commercial and LinkedIn. Office Commercial revenue grew double-digits again this quarter, up 14% and 12% in constant currency, including a couple of points from a greater mix of contracts with higher in-period recognition. Office 365 commercial revenue grew 42% and 40% in constant currency, with continued installed-base growth and ARPU expansion, driven by customer migration to our premium workloads in E3 and E5. Office 365 commercial seats grew 28%, in line with the expected trend, given the increasing size of the installed base.

Office consumer revenue increased 12% and 9% in constant currency, driven by recurring subscription revenue and a growing overall installed base. Our dynamics business accelerated this quarter, growing 17% and 14% in constant currency, driven by Dynamics 365 growth of 65%, 62% in constant currency. LinkedIn revenue grew 37% and 33% in constant currency with more than $1.3 billion in revenue. We continued to see outperformance across all segments with record levels of engagement.

Segment gross margin dollars increased 18% and 15% in constant currency. Gross margin percentage increased with margin improvements in Office 365 commercial and LinkedIn, offsetting the increased mix of cloud revenue. Operating expenses grew 14% and 12% in constant currency as we continued to strategically invest in LinkedIn, commercial sales capacity, and cloud engineering. Operating income increased 23% and 19% in constant currency.

The intelligent cloud segment delivered $7.9 billion of revenue, increasing 17% and 15% in constant currency, exceeding expectations due to our on-premises server business. Server products and cloud services revenue grew 20% and 17% in constant currency to $6.3 billion driven by continued strong Azure revenue growth of 93%, 89% in constant currency, on a significant revenue base. Our on-premises server business grew 3% and 1% in constant currency driven by customer demand for hybrid solutions as well as increasing virtualization needs, resulting in uptake of premium versions.

Enterprise Services revenue increased 8% and 5% in constant currency, with growth in Premium Support Services and Microsoft Consulting Services, more than offsetting the continued decline in custom support agreements for Windows Server 2003. Segment gross margin dollars grew 16% and 14% in constant currency, and gross margin percentage declined with the growing mix of Azure IaaS and PaaS revenue mostly offset by another quarter of material improvement in Azure gross margin. Operating expenses increased 9% and 7% in constant currency, driven by our continued investment in sales capacity and cloud engineering. Operating income increased 24%, up 21% in constant currency.

Now to the results of More Personal Computing. Revenue from this segment was $9.9 billion, up 13% and 11% in constant currency, with significantly better than expected results in gaming, Windows Commercial and Surface. Windows OEM revenue increased 4% this quarter. OEM Pro revenue grew 11%, in line with a strong commercial PC market. We continued to see healthy enterprise demand for Windows 10, benefiting our OEM partners. OEM non-pro revenue declined this quarter by 8%, below the consumer PC market, driven by a higher mix of lower-priced licenses and continued pressure in the entry-level price category. Inventory levels were within the normal range.

Windows commercial products and cloud services increased 21% and 17% in constant currency from strong double-digit billings as well as a higher mix of in quarter recognition from multi-year agreements. The fundamentals of the business remained healthy, with installed base growth and adoption of our security solutions. As a reminder, under Accounting Standard 606, the Windows Commercial growth rate will have significant variability quarter to quarter due to its relatively high mix of on-premises licensing revenue. Search revenue ex-TAC grew 16% and 14% in constant currency with higher revenue per search and search volume driven by Bing performance in the US and international markets.

Surface revenue grew 32% and 27% in constant currency, with better than expected performance from Surface Book, as we continued to transition to the latest products in our portfolio and against a prior year comparable impacted by product end of lifecycle dynamics. Gaming revenue increased 18% and 16% in constant currency, due to Xbox software and services revenue growth of 24% and 21% in constant currency. Momentum in digital distribution as well as record levels of engagement driven by a third-party title contributed to better than expected software and services revenue. We grew Xbox Live monthly active users by 13% to 59 million, with user expansion across Xbox One, Windows 10, and mobile platforms.

Segment gross margin dollars increased 13% and 11% in constant currency in line with revenue growth. Segment gross margin percentage was relatively flat year-on-year. Operating expenses increased 5% and 3% in constant currency, from investments in engineering across gaming, search, and AI. Operating income grew 24% and 20% in constant currency.

Now back to total company results. In line with our expectations, we increased capital expenditures on a sequential basis, with $3.5 billion invested to support current and future growth of our cloud offerings. Cash paid for plant, property, and equipment was $2.9 billion. Cash flow from operations was up 14%, driven by collections from strong billings growth. Free cash flow of $9.2 billion grew at a slower rate, 3%, due to an increase in cash used for property, plant, and equipment. Other income and expenses was approximately $350 million from net recognized gains on investments and income from dividends and interest, partially offset by interest expense. Our effective tax rate came in at 14% due to a benefit from an R&D tax credit.

We returned $6.3 billion to shareholders through dividends and share repurchases, increasing total shareholder return by 37%. We nearly doubled our year-over-year buyback amount, accelerating our pace from the prior quarter, and now have roughly $30 billion remaining of our current $40 billion share repurchase authorization.

Now let's turn to next quarter's outlook. First on FX, assuming current rates remain stable, we expect FX to increase revenue growth by 3 points, COGS by 1 point, and operating expenses by 1 point. Second, we again expect strong performance from our commercial business with solid execution in our largest quarter of the year. We expect commercial unearned revenue to be up 38 to 39% sequentially. Third, on CapEx, we expect sequential growth in capital expenditures on an accrual dollar basis as we continue to see strong demand signals globally. Finally, we expect commercial cloud gross margin to be roughly flat to Q3, representing another quarter of material year-over-year improvement even with increasing Azure revenue mix.

Now to the segments: In productivity and business processes, we expect revenue between $9.55 and $9.75 billion. We expect Office Commercial growth rates to normalize as we do not expect the same level of in-quarter recognition on multi-year contracts as we saw in Q3. Dynamics should see another quarter of double-digit revenue growth, driven by Dynamics 365 and LinkedIn revenue growth should remain high.

In intelligent cloud, we expect revenue between $8.95 and $9.15 billion with another quarter of server products and cloud services revenue growth in the high-teens as our hybrid cloud leadership continues to be a differentiator for customers. We expect the total Azure revenue growth rate to reflect a balance of our continued strength in our infrastructure, data, and application services and a moderating rate of growth in our per-user based services like EMS. In More Personal Computing, we expect $10.3 to $10.6 billion. Across both OEM Pro and Non-Pro, we anticipate trends in Q3 to continue into Q4.

In our devices business, we expect Surface revenue growth in the high teens as we continue to transition to the latest products in our portfolio. Search ex-TAC should see another mid-teens revenue growth quarter as it has the entire year. In gaming, we expect a higher revenue growth rate than Q3 as we continue to benefit from third party game title performance and user engagement on our platform. We expect COGS between $9.6 and $9.8 billion, including 1 point of growth from FX.

We expect operating expenses of $9.8 to $9.9 billion with 1 point of growth from FX. This would place us slightly above the high end of our prior range for full year operating expense growth due to the impact from FX and incremental revenue-driven expenses that support our continued strong top line growth. In Q4, we expect other income and expense to be approximately $350 million as we continue to take gains in our equities portfolio and earn dividend and interest income, as we have in prior quarters. We expect our effective tax rate in Q4 to be approximately 16%, with some volatility in the final quarter of our fiscal year.

Finally, I want to offer a few early thoughts on FY '19. Assuming the macro environment remains consistent, many of the key drivers of our business should remain intact. Revenue growth will continue to be driven by the transition to cloud services. Within our commercial business, strong execution and our differentiated hybrid position should drive continued high-teens growth in our server products and cloud services revenue KPI. Office 365, Dynamics 365, and LinkedIn should also continue to drive double-digit revenue growth in our productivity and business processes segment.

The gross margin percentage of every commercial cloud service will continue to improve with more improvement in Azure IAAS and PAAS consumption-based services and less improvement in our per-user SAAS services. While we expect continued improvement in the overall commercial cloud gross margin, the revenue mix shift to Azure will moderate the rate of improvement relative to FY '18.

We'll continue to grow our investment in capital expenditures to meet the growing demand for our cloud services. With the business results we've delivered and the tremendous opportunities we see ahead, we will continue to see growth in operating expenses in the key areas we have discussed, including LinkedIn. We expect other income and expenses to be slightly negative in FY '19, as we do not expect to have any significant equity gains. And lastly, we continue to expect the full year FY '19 effective tax rate to be slightly below the new US corporate rate of 21%, with variability across the quarters due to the mix of cloud versus license revenue and the timing of equity vest.

And with that, Mike, let's go to Q&A.

Questions and Answers:

Michael Spencer -- General Manager of Investor Relations

Thanks, Amy. We'll now move over to Q&A. Operator, can you please repeat your instructions?

Operator

Ladies and gentlemen, at this time, we will be conducting the question-and-answer session. If you would like to ask a question, please press *1 on your telephone keypad. A confirmation will indicate that your line is in question queue. You may press *2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the * keys.

Our first question is coming from the line of Heather Bellini with Goldman Sachs. Please proceed with your question.

Heather Bellini -- Goldman Sachs -- Managing Director

Great. Thank you, Satya and Amy. You guys are seeing a really nice acceleration in intelligent cloud gross profit growth and, with 15 straight quarters now of triple-digits premium services growth in Azure, I know you mentioned some comments directionally about the growth margin ramp, but how do we think about the pace of the ramp in gross margin expansion from here for Azure, in particular, as you approach what we estimate to be roughly an $8 million business in annualized revenue? And I guess the other thing that would be helpful is, when you think of the COGS of commercial cloud, could you give us a rough ballpark of what percentage of COGS comes from CapEx depreciation? Thank you.

Satya Nadella -- Chief Executive Officer

So, maybe I'll start and then I'll have you, Amy, go into the numbers. One of the things, Heather, that's happening is there is growth in Azure across each of the layers -- and I think I've said this before -- sometimes when you have new workloads and you have new customers on-board, they start with, in some sense, the IASS and the data more at a block storage and then scale to higher layer services like our Cosmos DB or even some of our compute higher level services like an AI. So, that, I think, will continue because we're still in the early innings of the cloud transition. We're investing aggressively, whether it's on the field side or on the CapEx side, to attract more customers and more workloads per customer so they will have that same profile, which is lower-margin services first, higher-margin services over time. That's just inside of Azure and, of course, you combine that with the rest.

One of the things that I think should be fairly clear is the high correlation between our services in Office 365 as well as Dynamics 365 around data, in particular, in Azure so that's why we think of this as one-cloud play but that should give you a feel to how customers are looking at it.

Amy Hood -- Executive Vice President and Chief Financial Officer

And I think, to your specific questions-- there were a couple in there, Heather -- the portion of our commercial cloud gross margins that come from depreciation, it's best to think of it as roughly half and, actually, it's been going up as we begin to get scale through these services over time, actually. Some of the fixed costs, frankly, even in COGS, tends to come down as a percentage over time so that should help you roughly to think about how much appreciation is at that number.

Now, if you think about the dynamics that we've been going through in the intelligent cloud segment, in particular, the way I tend to think about that is you've seen over 20% growth this quarter in that server and product services KPI, 17% on a constant currency basis, and our confidence, you should continue to see that, as I said, into Q4 and then into FY '19 as well. I tend to think about that as we'll have significant revenue growth in that segment, we'll have significant gross margin dollar growth in that segment and you'll actually continue to see operating margin dollar growth as significant in that segment even as we reinvest into it, given the topline signal.

If you think about gross margins, in particular, what you'll see is Azure continuing to be a growing percentage of the total revenue growth so, even with significant improvement, again, in what Satya was talking about, some of the lower IASS and PAAS services within Azure. On the gross margin side, you'll see some gross margin percentage pressure in that segment through '19 but with significant dollar growth.

Heather Bellini -- Goldman Sachs -- Managing Director

Great, thank you.

Michael Spencer -- General Manager of Investor Relations

Thanks, Heather. We'll take the next question now, please.

Operator

Thank you, the next question is coming from the line of Mark Moerdler with Alliance Bernstein. Please proceed with your question.

Mark Moerdler -- Alliance Bernstein -- Managing Director, SVP and Senior Research Analyst

Thank you very much and congrats on the quarter. CapEx increased significantly this quarter, $2.9 billion you said in cash on property and equipment. We know that you billed out, you significantly invested in the data center footprint ahead of demand, but that you don't build out the equipment, itself, that far in advance. Is there a large corporate or government requirement or it the acceleration in the data centers that ended up that causing that lift or is there something else driving it? And, as a follow-up, how should we think about that for the next couple quarters? Thanks.

Amy Hood -- Executive Vice President and Chief Financial Officer

Thanks, Mark. I actually didn't think of it as a significant change in trajectory from what we expected. A year ago, Q3 was actually a little low so, on a year-over-year basis, I think it pops a little bit, Mark, when on, really, a sequential basis, I actually don't think, to me, it looks out of sorts, especially with the type of demand we're seeing, not just for Azure but across all of the cloud components. Those growth rates really, at 58% on that total cloud number, it's pretty good demand signal on a global basis. So, I hear you on a year-over-year basis, but Q3 was a little funny a year ago on that front.

Satya Nadella -- Chief Executive Officer

And we continue to really monitor the actual equipment, and that supply chain, and what have you and, if anything, there's a lot of automation and demand-sensing capability we have there.

Amy Hood -- Executive Vice President and Chief Financial Officer

Yeah. And I would say, Mark, while I appreciate your point that it takes -- and we do build data centers in advance -- the majority of the cost, obviously, in any data center is in the equipment inside and so, while... This really is -- the majority of the spend -- is servers.

Mark Moerdler -- Alliance Bernstein -- Managing Director, SVP and Senior Research Analyst

Perfect. Thank you.

Michael Spencer -- General Manager of Investor Relations

Thanks, Mark. Operator, can we please move to the next question?

Operator

The next question is coming from the line of Keith Weiss with Alliance Bernstein. Please proceed with your question. Please proceed with your question.

Keith Weiss -- Morgan Stanley -- Equity Analyst

Excellent. Thank you, guys, for taking the question and really nice quarter across the board -- there's really not much to pick on in this quarter. One of the highlights, from my perspective, is definitely LinkedIn and what seems to be an acceleration in revenue growth in LinkedIn. So, two-parter, here: one, where are we in terms of that acquisition? Is this still just LinkedIn operating better than an independent company or are we starting to see some of the synergies? Because, specifically, revenue synergies come to bear from, maybe, broader distribution channel that they get from maybe Microsoft or that product integration. So, have synergies started to kick in, No. 1, and No. 2, given where we are in terms of the M&A process on LinkedIn, what's the appetite for further large M&A for Microsoft on a going forward basis?

Satya Nadella -- Chief Executive Officer

Thanks, Keith, for the question. Let me start and then, Amy, you can add to this. First of all, it is very important for us to ensure that we did everything to enable LinkedIn to keep their product and cultural ethos of putting members-first and innovating on their behalf -- that was Priority 1, 2, and 3 -- and that's what you see in their sessions growth, engagement growth, their quality member growth. And, obviously, that all translates into the revenue growth, as well, across all of the marketing solutions, talent solutions, and fill solutions.

We also, during that one year, have done integrations. I see it everyday in my Outlook Mobile, I see it in Sales Navigator in Dynamics, and with Windows 10, and so you will see us continue to do these integrations that add value, again, to both the Microsoft 365 and Dynamics users as well as LinkedIn members. And, clearly, that's increasing engagement as well and that, obviously, translates into revenue growth of those business solutions we mentioned. So, yes, revenue synergies are showing up, but mostly because product synergies are showing up and that's because of the product ethos of LinkedIn around member-first is what we maintain throughout this integration.

Amy Hood -- Executive Vice President and Chief Financial Officer

And I would also add, Keith, the LinkedIn team has really done a tremendous job so let me also say, after a year of working with them closely, my appreciation and, frankly, a lot of inspiration that I think you've seen in our own product development has been their focus on users, and how important it is, and how focused they are on it. In some of the products, I would urge people to look at the Outlook Mobile experience and how really meaningful the experience is for the user and the member. And I think, sometimes, it's harder for us to measure exactly what a revenue synergy means, but I look at this and I say, at a 37% growth rate plus some of the integrations we've seen and the growth in usage and users of things like Outlook Mobile, I believe that we're probably a little bit on the front end of the revenue synergies you'll see in product over time.

When it comes to our appetite for M&A, I think it has remained unchanged, which is, when things meet our criteria and when we feel like it's in core areas for us where markets are expanding, where the companies have a unique asset, I think that our ability to both execute on those and see them both execute on their own and execute inside Microsoft, I actually feel quite good that we don't worry about our ability to do them, but I wouldn't say that's new this quarter.

Satya Nadella -- Chief Executive Officer

Yeah, and I think, just to add on that, which is whether it's Minecraft, or LinkedIn, or many other acquisitions we have done as part of Azure, I think the key thing that we are very, very focused on is how do we make this culturally accretive, management times accretive, as well as revenue and that's where we're building good muscle and we'll continue on that.

Keith Weiss -- Morgan Stanley -- Equity Analyst

Excellent. Thank you very much, guys.

Michael Spencer -- General Manager of Investor Relations

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

Operator

Thank you, the next question is coming from the line of Karl Keirstead with Deutsche Bank. Please proceed with your question.

Karl Keirstead -- Deutsche Bank -- Managing Director, Software Equity Research

Thanks. And, just to start, Satya, congrats on getting Microsoft to over 10% organic growth. That's a big achievement for a company at your scale and it looks like you're expecting the same for the June quarter so congrats.

So, I guess my question is, in the spirit of this, to Amy, on the overall gross margin trade-off as you look into Fiscal '19, Amy, when I go back to the Analyst Day you had almost a year ago, I left thinking that your messaging was really that you were going to press on revenue growth and not on big margin leverage. So, I'm just wondering, as we look into Fiscal '19, is it correct to assume that that's a similar framework with the focus on topline growth and not to expect much in the way of overall improvement in gross margins? Thank you.

Amy Hood -- Executive Vice President and Chief Financial Officer

Thanks, Karl. Yes, I think that's a fair interpretation of my commentary, both last year and this, which really speaks to consistency. I do believe that the market which we are operating, the set of assets we've picked, the team we've built, the investments we've made in our sales force, even, to some extent, the acquisitions we've done, these are all showing up a topline revenue growth for us. You see it this quarter, you see it, frankly, in the guide, and I think your interpretation that our focus on being a growth company even at our scale is certainly the right interpretation.

Karl Keirstead -- Deutsche Bank -- Managing Director, Software Equity Research

Okay. Thanks for that.

Michael Spencer -- General Manager of Investor Relations

Thanks, Karl. Let's please move to the next question.

Operator

Thank you, the next question is coming from the line of Walter Pritchard with Citi. Please proceed with your question.

Walter Pritchard -- Citi -- Managing Director, Global Software Analyst

Hi, thank you. I'm wondering if -- a combination of Amy and Satya -- you talked about the forward view of Azure growth and how we should think about the drivers of that as we go into '19 -- new customers, existing consumption, premium services -- and I think we're growing at eye-popping rates right now -- we saw that with Office 365 in the early days. How should we expect this start to level out over time as it inevitably will as we look to next year?

Satya Nadella -- Chief Executive Officer

Yeah, and I'll start qualitatively. And it's true that we are, at this point, at scale on Azure and with very, very high growth rates but, as I said, I think the key things that we think about is differentiation of Azure at each level because that's what's super important for us as we compete in this marketplace and, more importantly, double down on areas of differentiation we have. So, the first thing is, on the infrastructure side, itself, with the combination of the edge and the cloud, I believe between Azure Stack and Azure as well as inclusive of our servers, we have the best cloud platform for what is going to be hybrid computing and will continue to push on that so you'll see growth which has gotten a different margin profile.

The layer above that is the place which we are very excited about -- we've seen lots of consecutive quarters of growth in our higher-level services, but we're now seeing some good scale. I, for the first time, talked about Cosmos DB. This was actually a database just launched last year. I've been around databases for a long time -- I've never seen a product that's gotten to this kind of scale this quickly. And so, we are very bullish about what can happen in the higher-level services and will continue to build on that piece.

But, as I said, one of the key things is, architecturally, the way we build Azure, the way we build Office 365, the way we build our gaming cloud, and the way we build even dynamics are all pretty much one architecture and you see that even in the way customers use it. So, overall, to your specific question on Azure, the growth will moderate as the numbers become big -- and they've already become very big -- but, that said, we see plenty of opportunity for total gross margin growth in terms of dollars just because of the number of markets that we participate in. Which we, by the way, never participated in the old server world.

Amy Hood -- Executive Vice President and Chief Financial Officer

And, Walter, I think the way you see that show up is really -- in my conversation at that point on team, to Satya's point -- really, we talked about that server product in KPI being high teens through FY '19. We're really confident in double-digit growth in that PBP segment with the components of Office 365, and Dynamics 365, and LinkedIn. So, if you think about that as the primary components of our commercial cloud, overall, we're certainly saying that it's a big business growing very fast -- at $6 billion not counting LinkedIn at 58% growth, it certainly speaks to having a big base and a big growth number.

On Azure, you're right -- it will moderate through next year, but because of the scale at which it's operating, that's why you still see that server KPI remain at that high level even as the base grows. And so, you will see, also, some different dynamics within that Azure revenue number. Satya mentioned the layers of Azure. If you think about the IAAS and PAAS numbers, I would expect to be on the higher end of growth rates and some of the services that are more per-user like EMS within the Azure frame, you would expect that growth to moderate somewhat more quickly just because it's per-seat business. You will actually, over time, see us be able to be able to continue to add ARPU and growth in those segments. Think of it almost like an office business. Internally, we call that component part of our Microsoft 365 value -- that's how we sell it externally, even -- and so, hopefully, that helps give a little context to the number as well as our overall ability to continue to grow the hybrid cloud opportunity high teens.

Walter Pritchard -- Citi -- Managing Director, Global Software Analyst

Thank you.

Michael Spencer -- General Manager of Investor Relations

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

Operator

Thank you. The next question is coming from the line of Phil Winslow with Wells Fargo. Please proceed with your question.

Phillip Winslow -- Wells Fargo -- Managing Director

Thanks, guys, for taking my question and congrats on a great quarter. Satya, you touched on the synergies that you're seeing between your applications businesses and LinkedIn helping the two out. I was wondering if you could talk just high-level and strategically about applications and enterprise applications and Azure and how you see the synergy potentially coming out between those, especially when you think about Azure AI ML services? The question is how important -- how critical -- are applications like the growth that we're seeing in dynamics, etc.?

Satya Nadella -- Chief Executive Officer

Yeah, one of the things that I talked about in my remarks this time was this power platform. One of the areas of, in fact, real breakout growth and differentiation as being in Power BI, Power Apps, and Flow, for the first time, in fact, in our own Microsoft history, we have an extensibility model that is the same for Office 365 and Dynamics 365. This has been a dream of mine for, I don't know, for 15 years, probably. And we're finally here and we are executing super well, but the interesting thing is it's not just even for our own SAAS applications -- it is the extensibility model for every SAAS application out there, including a common data model. So, I think that that's where the synergies lie because AI starts with having a data state that can really bring data from all of your applications -- siloes, in some sense -- together so that you can start building the analytical power that you can then visualize and put in the hands of people using Power BI or run an AI model that does some prediction that you can deploy in your system, whether it's forecasting, sales lead scoring, what have you.

So, that work flow, we have every layer of it -- we have the best deployment tools and development tools in Azure, we have this common data model, on top of this we have the best BI visualization technology. So, that's what you're seeing increasingly as the synergy but, most importantly, architecture benefit for customers because, by having in currents around these layers is where you may feel like you're making some great best-of-breed choices in individual layers, but you'll bear that expense in your overall agility as well as your overall management of your data and that's where I think we'll be very well differentiate.

Phillip Winslow -- Wells Fargo -- Managing Director

Great. Thanks, guys.

Michael Spencer -- General Manager of Investor Relations

Thank you. Let's move to the next question, please.

Operator

We'll move onto the next question which is coming from the line of Brad Reback with Stifel. Please proceed with your question.

Brad Reback -- Stifel, Nicolaus, & Co. -- Senior Analyst

Great, thanks very much. Maybe, Amy, quick question: the Windows OEM Pro business has been extraordinarily strong the last few quarters. Can you maybe give us a sense of how penetrated you guys are in the Windows 10 corporate upgrade cycle and the sustainability of that growth? Thanks.

Amy Hood -- Executive Vice President and Chief Financial Officer

Thanks, Brad. Let me first, I wouldn't say penetration's the word for this -- let me talk about this in two or even a couple of components. Because, when you think about Windows 10, what we've seen over the past couple of years is, you're right, a very strong enterprise deployment cycle and real pull for that product inside enterprises because of the security value prop of the product, itself.

When you see that deployment, for security reasons, an externality of that is people often choose to upgrade machines in that process. We've seen good demand inside commercial entities for and when they make those upgrades to buy Windows PCs and, often, Surface devices in that choice. I think it's benefited our OEM partners and us. The portfolio of devices that are available are incredibly compelling -- I think our partners have done a terrific job on that as well. The overall economy is certainly also quite good and the installed base had actually gotten older and so I think what you're starting to see is a process whereby there's a great product, there's a good macro environment, and you've got customers who really want to move to a modern infrastructure. A modern infrastructure has to both be secure at its very core and that can result, as you're seeing, that confluence of events, in a very strong PC market with very strong Pro performance. And, certainly, the guide for Q4 continues to imply all those factors.

Brad Reback -- Stifel, Nicolaus, & Co. -- Senior Analyst

Great. Thanks very much.

Michael Spencer -- General Manager of Investor Relations

Thanks, Brad. We'll take the next question now, please.

Operator

Thank you. Our next question is coming from the line of Michael Nemeroff with Credit Suisse. Please proceed with your question.

Michael Nemeroff -- Credit Suisse -- Director, Software Research

Thanks for taking my question. Satya or Amy, can you help us understand the large revenue outperformance and guide for continued strong growth in gaming? And, Amy, could you please give us a sense of the margin profile of the areas of gaming that exceeded expectations? And if you could also comment on the strength in the MPC margin in the context of the gaming margin, as well, that would be helpful. Thanks very much.

Satya Nadella -- Chief Executive Officer

Yeah, I can start and then...

Amy Hood -- Executive Vice President and Chief Financial Officer

Why don't you start?

Satya Nadella -- Chief Executive Officer

Because, even on gaming, we're very much like how we talk about some of our commercial segments -- we've gotten a strategy which really helps us articulate both the growth opportunity as well as our investments across all the various layers. So, first is the console, itself, is the highest engagement console out in the marketplace. So, any time a new game, whether it's first party or third-party releases, the fact that Xbox is where the best engagement is driven benefits us. So, as a platform owner, that's a great growth area for us. But we don't stop there because now we have, whether it's Xbox live, whether it's Game Pass, or Mixer, these are all additional opportunities to really serve the gamer as they play more games or watch games on different platforms so that's the other big opportunity.

But the last one, which I think is new and is something which is already paying its dividends on the Azure growth side, is we've taken all the knowledge of what it means to build any one of these first party titles of ours and building it as a pass service in Azure for game developers and the PlayFab acquisition speaks directly that. So, those are all the various levels we have in gaming and you'll see it in the MPC segment and you'll see it, as I said, increasingly over time even in Azure.

Amy Hood -- Executive Vice President and Chief Financial Officer

And I think, Michael, if you don't mind, I'm going to expand your question a little bit because I don't think the increase in the MPC guide is simply gaming so let me talk a bit about the components and which ones I think are a bit more sustainable and which ones may have a temporal nature to them. The performance in Q3 and the guidance for Q4 shows, actually, strong performance in a number of places that we expect to continue. OEM Pro is a terrific example for the reasons I just gave in Brad's question. Windows Commercial, which is really the business inside the enterprise of selling much of the security value on a far more annuity-like basis, we've seen strong double-digit billings growth there and we expect that to continue into Q4 as well. The next piece, I would say, is a part of that uplift in Q4 is our Surface device -- the reception to Surface Book 2 as well as Surface Pro with LTE has been quite good and you see us reflect that again in Q4 even as the comp gets a little more difficult than it was in Q3 for us when you saw a very large growth rate, we're still expecting high teens there.

Then you get to that gaming component and, specifically what Satya was talking about, Xbox software and services component is where I would expect to see the impact of the continuation of Q3. Part of that, I want to be very clear, is consistent, even going back a few quarters. That has been a double-digit grower. It will be a double-digit grower. There'll be some volatility in the number like anything else. And third party hit games will move it higher as they did this quarter and we're expecting in Q4, but there's also a really strong base to that business that is the result of what Satya is talking about in terms of having a vibrant platform with fans that believe in it and come to it with all the value that's been added.

Michael Nemeroff -- Credit Suisse -- Director, Software Research

That's very helpful. Thank you very much.

Amy Hood -- Executive Vice President and Chief Financial Officer

Does that help? Okay, great. Thanks.

Michael Spencer -- General Manager of Investor Relations

Thanks, Michael. We'll move to the next question, please.

Operator

Thank you, the next question is coming from the line of Ross MacMillan with RBC Capital Markets. Please proceed with your question.

Ross MacMillan -- RBC Capital Markets -- Equity Research Analyst

Thanks so much. Hopefully, the line's clearer this time. So, Satya and Amy, I wanted to ask about server products which is striking growth given the comp. And, Amy, you talked about expected strength into Fiscal Q4 and all of that, I guess, is a testament to the strength of the good hybrid leadership you have. The two questions, though, were really, is that strength in several products broad-based across Windows servers, SQL server, System Center, etc. or is there any sort of bias in the mix, if you will, in terms of what's driving that strength?

And then, Satya, you mentioned Cosmos DB and that was a striking number to me as well. And I was just curious, do you think -- now you have the multi-model database and market -- that can help you pick market share within the data management database space? Thanks.

Satya Nadella -- Chief Executive Officer

Yeah, I'll take the second one. I think that, yes, Cosmos DB's pretty unique capability in combination with everything else we do in both the data layer, the AI later, and the infrastructure layer, I think we have a tremendous opportunity because, as I said, this AI era is mostly first a data era and that's where I think the opportunity lies.

But, to your previous question, even there, there are multiple trends here and Amy referenced it in her remarks which is, for example, virtualization still continues to be a growth driver of server products. The other growth driver of server products is cybersecurity and the security value in our servers. So, that's one. The fact that we now have SQL and, for example, when you think about SQL, itself, it's a hybrid product. You can pair SQL databases with the cloud, SQL is an AI product because we are the one database that actually allows you to write Python and R in situas, store procedures right in your database. So, for example, when we talk about data and AI close to data -- because computation will always go where data is -- and a lot of data shows up in relational databases and we have a growth driver there as well.

And then there is the hybrid choices, where somebody's building a smart factor -- they're now looking and saying, "What does the server deploy in the factory to manage the millions of sensors that are there across the factory and that's where Azure Stack shows up. So, multiple drivers of what is, essentially, the server and cloud numbering combinations.

Amy Hood -- Executive Vice President and Chief Financial Officer

And, to your point on the on-prem component, even with comparable doing well, let me break Satya's comment into two drivers that have been, actually, more sustaining and it's across both Windows, in particular, but also SQL, which are obviously the largest products within our server portfolio. The first, exactly, with hybrid demand. We have something Azure Hybrid Benefits. What it does is really provide confidence to our committed customers buying on-prem servers that their transition to a hybrid -- to cloud over a period of their agreement -- is really about their choices, their timelines, and their confidence. And so, with that right, it lets them easily transition between Windows or SQL to those same benefits in Azure with a small uplift in price. I think that has actually been a core component.

The second one is the virtualization drive or data center modernization, another one, do move the premium mix up a bit. So, that's, if you wanted to break it down into two more sustaining things, those are the types of things we're seeing in that number.

Michael Spencer -- General Manager of Investor Relations

Great, thanks. And this will be our last question.

Operator

Thank you, our final question is coming from the line of Kash Rangan with Bank of America Merrill Lynch. Please proceed with your question.

Kash Rangan -- Bank of America Merrill Lynch -- Managing Director

Last question will be the longest one -- really, really long. Thank you guys, for getting me in. Question for you, Satya, as you meet with CEOs of large companies, this is a recurring theme that we've been hearing from other software company CEOs, the theme of visualization. Can you help us understand, especially given that Microsoft's growth rate is accelerating, whereas the GDP growth rate...? So, obviously, tech's expanding or IT's expanding as percentage of GDP or average company revenue is going higher, so can you help us, given your perspective which is pretty unique, help us understand what is the baseline of IT that we've been operating in? And, when it comes to digital business transformation, what are the Phase 1, Phase 2, Phase 3 initiatives like, and where are companies likely to spend more, and what kinds of products and services that are new and upcoming -- or maybe you sell them today -- that comprise that incremental swing factor over the baseline of what IT is today versus where we're likely to go with the digitization of business processes? Thank you.

Satya Nadella -- Chief Executive Officer

Yeah, I think, when we talk to customers and CEOs, what have you, we talk about four digital transformational outcomes. In fact, everything that we do across our solutionaries are all ingredients to helping our customers achieve digital transformation objectives on, for example, how do they engage their customers? When I talked about Cosmos DB growth, Cosmos DB happens to be one of the best database products to be able to catch the signals that you want around your customers from a variety of different sources? That's one example of it.

The second piece is, of course, around empowering your employees. One of the things that has increasingly become No. 1 priority for every CEO is to make sure that the right tools, the right products are in front of their own employees so that they can do their very best work and collaborate -- so Teams growth is a great example of how companies are modernizing their workforce with things like Microsoft 365.

The third one is operational efficiency. When we see the Dynamics 365 growth or Azure IoT growth, that's taking every IoT project, it ends up as a few service projects so that's a classic way somebody says, "Let me say something, predict something, and then actually fix using field service," so that's a transformational outcome. We are very well-positioned.

And, lastly, people are changing their business models. You take somebody like Nalco water. You could say they're a water company but now they're a pure water service company. In other words, they put sensors that allow them to actually deliver a very differentiated business model to their customers. And so that's the transformational outcomes we see and we feel, at Microsoft, we are well-positioned, both with the technology, but also with our frontline sales capability, service capability and partner capacity to best address the digital transformation needs.

Kash Rangan -- Bank of America Merrill Lynch -- Managing Director

Wonderful. It seems like CRM, HCM, ERP, IoT teams are the prominent teams that are going to be driving your growth. Okay. Thank you very much. Very useful and insightful.

Michael Spencer -- General Manager of Investor Relations

Thanks, Kash. That wraps up the Q&A portion of today's earnings call. Thank you for joining us and we look forward to speaking with all of you soon. You can find additional details at the Microsoft Investor Relations website.

Amy Hood -- Executive Vice President and Chief Financial Officer

Thanks, everyone.

Satya Nadella -- Chief Executive Officer

Thank you, everyone.

Operator

Ladies and gentlemen, this does conclude teleconference. Again, we thank you for your participation and you may disconnect your lines at this time.

Duration: 70 minutes

Call participants:

Michael Spencer -- General Manager of Investor Relations

Satya Nadella -- Chief Executive Officer

Amy Hood -- Executive Vice President and Chief Financial Officer

Heather Bellini -- Goldman Sachs -- Managing Director

Mark Moerdler -- Alliance Bernstein -- Managing Director, SVP and Senior Research Analyst

Keith Weiss -- Morgan Stanley -- Equity Analyst

Karl Keirstead -- Deutsche Bank -- Managing Director, Software Equity Research

Walter Pritchard -- Citi -- Managing Director, Global Software Analyst

Brad Reback -- Stifel, Nicolaus, & Co. -- Senior Analyst

Michael Nemeroff -- Credit Suisse -- Director, Software Research

Ross MacMillan -- RBC Capital Markets -- Equity Research Analyst

Kash Rangan -- Bank of America Merrill Lynch -- Managing Director

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