Executive Vice President and Chief Financial Officer at Microsoft
Thank you, Satya, and good afternoon, everyone. Our first quarter revenue was $50.1 billion, up 11% and 16% in constant currency. Earnings per share was $2.35, increased 4% and 11% in constant currency when adjusted for the net tax benefit for the first quarter of fiscal year '22. Driven by strong execution in a dynamic environment, we delivered a solid start to our fiscal year, in line with our expectations even as we saw many of the macro trends from the end of the fourth quarter continued to weaken through Q1.
In our consumer business, PC market demand further deteriorated in September, which impacted our Windows OEM and Surface businesses. And reductions in customer advertising spend, which also weakened later in the quarter, impacted search and news advertising and LinkedIn Marketing Solutions.
As you heard from Satya, in our commercial business, we saw strong overall demand for our Microsoft cloud offerings with a growth of 31% in constant currency as well as share gains across many businesses. Commercial bookings declined 3% and increased 16% [Phonetic] in constant currency on a flat expiry base. Excluding the FX impact, growth was driven by strong renewal execution, and we continue to see growth in the number of large long-term Azure and Microsoft 365 contracts across all deal sizes. More than half of the $10 million plus Microsoft 365 bookings came from E5.
Commercial remaining performance obligation increased 31% and 34% in constant currency to $180 billion. Roughly 45% will be recognized in revenue in the next 12 months, up 23% year-over-year. The remaining portion, which we recognized beyond the next 12 months, increased 38% year-over-year, and our annuity mix increased one point year-over-year to 96%.
FX impacted Company results in line with expectations. With the stronger U.S. dollar, FX decreased total Company revenue by five points, and at the segment level, FX decreased productivity and business processes and intelligent cloud revenue growth by six points and more personal computing revenue growth by three points. Additionally, FX decreased COGS and operating expense growth by three points.
Microsoft Cloud gross margin percentage increased roughly two points year-over-year to 73%. Excluding the impact of the change in accounting estimate for useful lives, Microsoft cloud gross margin percentage decreased roughly one point driven by sales mix shift to Azure and lower Azure margin, primarily due to higher energy costs.
Company gross margin dollars increased 9% and 16% in constant currency, and gross margin percentage decreased slightly year-over-year to 69%. Excluding the impact of the latest change in accounting estimate, gross margin percentage decreased roughly three points, driven by sales mix shift to cloud, the lower Azure margin noted earlier and Nuance.
Operating expense increased 15% and 18% in constant currency, driven by investments in cloud engineering, LinkedIn, Nuance and commercial sales. At a total company level, headcount grew 22% year-over-year as we continued to invest in key areas just mentioned, as well as customer deployment. Headcount growth included roughly six points from the Nuance and Xandr acquisitions, which closed last Q3 and Q4, respectively.
Operating income increased 6% and 15% in constant currency, and operating margins decreased roughly two points year-over-year to 43%. Excluding the impact of the change in accounting estimate, operating margins declined roughly four points year-over-year driven by sales mix shift to cloud, unfavorable FX impact, Nuance, and the lower Azure margin noted earlier.
Now to our segment results. Revenue from Productivity and Business Processes was $16.5 billion and grew 9% and 15% in constant currency, ahead of expectations with better-than-expected results in office commercial and LinkedIn. Office commercial revenue grew 7% percent and 13% in constant currency.
Office 365 commercial revenue increased 11% and 17% in constant currency, slightly better than expected with the strong renewal execution noted earlier.
Growth was driven by installed base expansion across all workloads and customer segments, as well as higher ARPU from E5. Demand for security, compliance, and voice value in Microsoft 365 drove strong E5 momentum again this quarter.
Paid Office 365 commercial seats grew 14% year-over-year, driven by our small and medium business and frontline worker offerings although we saw continued impact of new deal moderation outside of E5.
Office consumer revenue grew 7% percent and 11% in constant currency driven by continued momentum in Microsoft 365 subscriptions, which grew 13% percent to 61.3 million. Dynamics revenue grew 15% and 22% in constant currency driven by Dynamics 365, which grew 24% and 32% in constant currency.
LinkedIn revenue increased 17% percent and 21% in constant currency, ahead of expectations driven by better-than-expected growth in Talent Solutions partially offset by weakness in Marketing Solutions from the advertising trends noted earlier.
Segment gross margin dollars increased 11% and 18% in constant currency and gross margin percentage increased roughly one point year-over-year. Excluding the impact of the latest change in accounting estimate, gross margin percentage decreased slightly driven by sales mix shift to cloud offerings.
Operating expense increased 13% and 16% in constant currency, and operating income increased 10% and 19% in constant currency, including four points due to the latest change in accounting estimate.
Next, the Intelligent Cloud segment. Revenue was $20.3 billion, increasing 20% and 26% in constant currency, in line with expectations. Overall, server products and cloud services revenue increased 22% and 28% in constant currency. Azure and other cloud services revenue grew 35% and 42% in constant currency, about a point lower than expected driven by the continued moderation in Azure consumption growth, as we help customers optimize current workloads, while they prioritize new workloads.
In our per-user business, the enterprise mobility and security installed base grew 18% to over 232 million seats with continued impact from the new deal moderation noted earlier. In our on-premises server business, revenue was flat and increased 4% in constant currency, slightly ahead of expectations driven by hybrid demand including better-than-expected annuity purchasing ahead of the SQL Server 2022 launch.
Enterprise Services revenue grew 5% and 10% in constant currency, driven by Enterprise Support Services. Segment gross margin dollars increased 20% and 26% in constant currency and gross margin percentage decreased slightly.
Excluding the impact of the latest change in accounting estimate, gross margin percentage declined roughly three points driven by sales mix shift to Azure and higher energy costs impacting Azure margins.
Operating expenses increased 25% and 28% in constant currency, including roughly eight points of impact from Nuance, and operating income grew 17% and 25% in constant currency, with roughly nine points of favorable impact from the latest change in accounting estimate.
Now to more Personal Computing. Revenue decreased slightly year-over-year to $13.3 billion and grew 3% in constant currency, in line with expectations overall, but with OEM and Surface weakness offset by upside in gaming consoles. Windows OEM revenue decreased 15% year-over-year. Excluding the impact from the Windows 11 deferral last year, revenue declined 20% driven by PC market demand deterioration noted earlier. Devices revenue grew 2% and 8% in constant currency, in line with expectations, driven by the impact of a large Hollands deal, partially offset by low double-digit declines in consumer Surface sales.
Windows Commercial products and cloud services revenue grew 8% and 15% in constant currency, in line with expectations, driven by demand for Microsoft 365 E5 noted earlier. Search and news advertising revenue, ex TAC, increased 16% and 21% in constant currency, in line with expectations, benefiting from an increase in search volumes and roughly five points of impact from Xandr, even as we saw increased ad market headwinds during September. Edge browser gained share again this quarter.
And in gaming, revenue grew slightly and was up 4% in constant currency, ahead of expectations, driven by better-than-expected console sales. Xbox hardware revenue grew 13% and 19% in constant currency. Xbox content and services revenue declined 3% and increased 1% in constant currency, driven by declines in first-party content, as well as in third-party content, where we had lower engagement hours and higher monetization, partially offset by growth in Xbox Game Pass subscriptions.
Segment gross margin dollars declined 9% and 4% in constant currency, and gross margin percentage decreased roughly five points year-over-year, driven by sales mix shift to lower margin businesses.
Operating expenses increased 2% and 5% in constant currency, driven by the Xandr acquisition, and operating income decreased 15% and 9% in constant currency.
Now back to total company results. Capital expenditures, including finance leases were $6.6 billion, and cash paid for PP&E was $6.3 billion. Our data center investments continue to be based on strong customer demand and usage signals.
Cash flow from operations was $23.2 billion, down 5% year-over-year, driven by strong cloud billings and collections, which were more than offset by a tax payment related to the transfer of intangible property completed in Q1 of FY '22.
Free cash flow was $16.9 billion, down 10% year-over-year. Excluding the impact of this tax payment, cash flow from operations grew 2%, and free cash flow was relatively unchanged year-over-year.
This quarter, other income and expense was $54 million, driven by interest income, which was mostly offset by interest expense and net losses on foreign currency remeasurement.
Our effective tax rate was approximately 19%. And finally, we returned $9.7 billion to shareholders through share repurchases and dividends.
Now, moving to our Q2 outlook, which unless specifically noted otherwise, is on a U.S. dollar basis. My commentary, for both the full year and next quarter, does not include any impact from Activision, which we still expect to close by the end of the fiscal year.
First, FX. With the stronger U.S. dollar and based on current rates, we now expect FX to decrease total revenue growth by approximately five points and to decrease total COGS and operating expense growth by approximately three points. Within the segments, we anticipate roughly seven points of negative FX impact on revenue growth in Productivity and Business Processes, six points in Intelligent Cloud and three points in more Personal Computing.
Our outlook has many of the trends we saw at the end of Q1, continue into Q2. In our consumer business, materially weaker PC demand from September will continue, and impact both Windows OEM and Surface device results even as the Windows installed base and usage grows, as you heard from Satya. Additionally, customers focusing their [Phonetic] advertising spend will impact LinkedIn and Search and News advertising revenue.
In our commercial business, demand for our differentiated hybrid and cloud offerings, together with consistent execution, should drive healthy growth across the Microsoft Cloud.
In commercial bookings, continued strong execution across core annuity sales motions and commitments to our platform should drive solid growth on a moderately growing expiry base against a strong prior year comparable, which included a significant volume of large long-term Azure contracts. As a reminder, the growing mix of larger long-term Azure contracts, which are more unpredictable in their timing, always drives increased quarterly volatility in our bookings growth rate.
Microsoft Cloud gross margin percentage should be up roughly one point year-over-year, driven by the latest accounting estimate change noted earlier. Excluding that impact, Q2 gross margin percentage will decrease roughly two points driven by lower Azure margin, primarily due to higher energy cost, revenue mix shift to Azure and the impact from Nuance.
In capital expenditures, we expect a sequential increase on a dollar basis with normal quarterly spend variability in the timing of our cloud infrastructure build-out.
Next to segment guidance. In Productivity and Business Processes, we expect revenue to grow between 11% and 13% in constant currency or USD16.6 billion to USD16.9 billion. In Office Commercial, revenue growth will again be driven by Office 365, with seat growth across customer segments and ARPU growth from E5. We expect Office 365 revenue growth to be similar to last quarter on a constant currency basis.
In our on-premises business, we expect revenue to decline in the low to mid 30s [Phonetic]. In Office Consumer, we expect revenue to decline low to mid-single digits, as Microsoft 365 subscription growth will be more than offset by unfavorable FX impact.
For LinkedIn, we expect continued strong engagement on the platform, although results will be impacted by a slowdown in advertising spend and hiring, resulting in mid to high single-digit revenue growth or low to mid-teens growth in constant currency.
And in Dynamics, we expect revenue growth in the low double-digits or the low 20s [Phonetic] in constant currency, driven by continued share gains in Dynamics 365.
For Intelligent Cloud, we expect revenue to grow between 22% and 24% in constant currency or USD21.25 billion to USD21.55 billion. Revenue will continue to be driven by Azure, which, as a reminder, can have quarterly variability primarily from our per-user business and from in-period recognition depending on the mix of contracts. We expect Azure revenue growth to be sequentially lower by roughly five points on a constant currency basis.
Azure revenue will continue to be driven by strong growth in consumption with some impact from the Q1 trends noted earlier. And our per-user business should continue to benefit from Microsoft 365 suite momentum, though we expect moderation in growth rate given the size of the installed base.
In our on-premises server business, we expect revenue to decline low single-digits, as demand for our hybrid solutions, including strong annuity purchasing from the SQL Server 2022 launch, will be more than offset by unfavorable FX impact. And in Enterprise Services, we expect revenue growth to be in the low single-digits, driven by enterprise support.
In More Personal Computing, we expect revenue of USD14.5 billion to USD14.9 billion. In Windows OEM, we expect revenue to decline in the high 30s [Phonetic]. Excluding the impact from the Windows 11 revenue deferral last year, revenue would decline mid 30s [Phonetic], reflecting both PC market demand and a strong prior year comparable, particularly in the Commercial segment.
In devices, revenue should decline approximately 30%, again, roughly in line with the PC market. In Windows commercial products and cloud services, customer demand for Microsoft 365 and our advanced security solutions should drive growth in the mid single-digits or low double-digits in constant currency.
Search and news advertising, ex TAC, should grow in the low to mid-teens, roughly six points faster than overall search and news advertising revenue, driven by growing first-party revenue and the inclusion of Xandr.
And in gaming, we expect revenue to decline in the low to mid-teens against a strong prior year comparable. That included several first-party title launches, partially offset by growth in Xbox Game Pass subscribers. We expect Xbox content and services revenue to decline in the low to mid-teens.
Now back to company guidance. We expect COGS to grow between 6% and 7% in constant currency or to be between USD17.4 billion and USD17.6 billion, and operating expense to grow between 17% and 18% in constant currency, or to be between USD14.3 billion and USD14.4 billion. As we continue to focus our investment in key growth areas, total headcount growth sequentially should be minimal.
Other income and expense should be roughly $100 million, as interest income is expected to more than offset interest expense. Further FX and equity movements through Q2 are not reflected in this number.
And as a reminder, we are required to recognize mark-to-market gains or losses on our equity portfolio, which can increase quarterly volatility. And we expect our Q2 effective tax rate to be between 19% and 20%.
And finally, as a reminder, for Q2 cash flow, we expect to make a $2.4 billion cash tax payment related to the capitalization of R&D provision enacted in the 2017 TCJA and effective as of July 1st, 2022.
Now some thoughts on the full fiscal year. First, FX. Based on current rates, we now expect a roughly five point headwind to full year revenue growth. And FX should decrease COGS and operating expense growth by approximately three points.
At the total company level, we continue to expect double-digit revenue and operating income growth on a constant currency basis. Revenue will be driven by around 20% constant currency growth in our commercial business, driven by strong demand for our Microsoft Cloud offerings. That growth will be partially offset by the increased declines we now see in the PC market.
With the high margins in our Windows OEM business and the cyclical nature of the PC market, we take a long-term approach to investing in our core strategic growth areas and maintain these investment levels regardless of PC market conditions. Therefore, with our first quarter results and lower expected OEM revenue for the remainder of the year as well as over $800 million of greater than expected energy cost, we now expect operating margins in U.S. dollars to be down roughly a point year-over-year. On a constant currency basis, excluding the incremental impact of the lower Windows OEM revenue and the favorable impact of the latest accounting change, we continue to expect FY '23 operating margins to be roughly flat year-over-year.
In closing, in this environment, it is more critical than ever to continue to invest in our strategic growth markets such as Cloud, Security, Teams, Dynamics 365 and LinkedIn, where we have opportunities to continue to gain share, as we provide problem solving innovations to our customers. And while we continue to help our customers do more with less, we will do the same internally. And you should expect to see our operating expense growth moderate materially through the year, while we focus on growing productivity of the significant headcount investments we've made over the last year.
With that, let's go to Q&A. Brett?