Microsoft (MSFT) 10-Q 2023 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended December 31, 2022

OR

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period From                  to

Commission File Number 001-37845

MICROSOFT CORPORATION

Washington	91-1144442
(STATE OF INCORPORATION)	(I.R.S. ID)

ONE MICROSOFT WAY, REDMOND, Washington 98052-6399

(425) 882-8080

www.microsoft.com/investor

Securities registered pursuant to Section 12(b) of the Act:
Title of each class	Trading Symbol	Name of exchange on which registered
Common stock, $0.00000625 par value per share	MSFT	Nasdaq
3.125% Notes due 2028	MSFT	Nasdaq
2.625% Notes due 2033	MSFT	Nasdaq

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer ☒	Accelerated Filer ☐
Non-accelerated Filer ☐	Smaller Reporting Company ☐
	Emerging Growth Company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class	Outstanding as of January 19, 2023
Common Stock, $0.00000625 par value per share		7,443,803,533 shares

MICROSOFT CORPORATION

FORM 10-Q

For the Quarter Ended December 31, 2022

INDEX

				Page
PART I.	FINANCIAL INFORMATION
	Item 1.	Financial Statements
		a)	Income Statements for the Three and Six Months Ended December 31, 2022 and 2021	3
		b)	Comprehensive Income Statements for the Three and Six Months Ended December 31, 2022 and 2021	4
		c)	Balance Sheets as of December 31, 2022 and June 30, 2022	5
		d)	Cash Flows Statements for the Three and Six Months Ended December 31, 2022 and 2021	6
		e)	Stockholders’ Equity Statements for the Three and Six Months Ended December 31, 2022 and 2021	7
		f)	Notes to Financial Statements	8
		g)	Report of Independent Registered Public Accounting Firm	30
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		31
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk		49
	Item 4.	Controls and Procedures		49
PART II.	OTHER INFORMATION
	Item 1.	Legal Proceedings		50
	Item 1A.	Risk Factors		50
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		65
	Item 6.	Exhibits		66
SIGNATURE				67

2

PART I

Item 1

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

INCOME STATEMENTS

(In millions, except per share amounts) (Unaudited)	Three Months Ended December 31,						Six Months Ended December 31,
	2022			2021			2022			2021
Revenue:
Product	$	16,517		$	20,779	$	32,258		$	37,410
Service and other		36,230			30,949		70,611			59,635
Total revenue		52,747			51,728		102,869			97,045
Cost of revenue:
Product		5,690			6,331		9,992			10,123
Service and other		11,798			10,629		22,948			20,483
Total cost of revenue		17,488			16,960		32,940			30,606
Gross margin		35,259			34,768		69,929			66,439
Research and development		6,844			5,758		13,472			11,357
Sales and marketing		5,679			5,379		10,805			9,926
General and administrative		2,337			1,384		3,735			2,671
Operating income		20,399			22,247		41,917			42,485
Other income (expense), net		(60	)		268		(6	)		554
Income before income taxes		20,339			22,515		41,911			43,039
Provision for income taxes		3,914			3,750		7,930			3,769
Net income	$	16,425		$	18,765	$	33,981		$	39,270
Earnings per share:
Basic	$	2.20		$	2.50	$	4.56		$	5.23
Diluted	$	2.20		$	2.48	$	4.54		$	5.19
Weighted average shares outstanding:
Basic		7,451			7,505		7,454			7,509
Diluted		7,473			7,555		7,479			7,561

Refer to accompanying notes.

3

PART I

Item 1

COMPREHENSIVE INCOME STATEMENTS

(In millions) (Unaudited)	Three Months Ended December 31,							Six Months Ended December 31,
	2022			2021				2022			2021
Net income	$	16,425		$	18,765		$	33,981		$	39,270
Other comprehensive income (loss), net of tax:
Net change related to derivatives		(32	)		0			(25	)		2
Net change related to investments		348			(743	)		(1,549	)		(1,165	)
Translation adjustments and other		570			(103	)		(205	)		(222	)
Other comprehensive income (loss)		886			(846	)		(1,779	)		(1,385	)
Comprehensive income	$	17,311		$	17,919		$	32,202		$	37,885

Refer to accompanying notes.

4

PART I

Item 1

BALANCE SHEETS

(In millions) (Unaudited)
	December 31, 2022			June 30, 2022
Assets
Current assets:
Cash and cash equivalents	$	15,646		$	13,931
Short-term investments		83,862			90,826
Total cash, cash equivalents, and short-term investments		99,508			104,757
Accounts receivable, net of allowance for doubtful accounts of $485 and $633		35,833			44,261
Inventories		2,980			3,742
Other current assets		19,502			16,924
Total current assets		157,823			169,684
Property and equipment, net of accumulated depreciation of $63,459 and $59,660		82,755			74,398
Operating lease right-of-use assets		13,624			13,148
Equity investments		7,097			6,891
Goodwill		67,905			67,524
Intangible assets, net		10,354			11,298
Other long-term assets		24,994			21,897
Total assets	$	364,552		$	364,840
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	15,354		$	19,000
Current portion of long-term debt		3,997			2,749
Accrued compensation		9,030			10,661
Short-term income taxes		3,553			4,067
Short-term unearned revenue		36,982			45,538
Other current liabilities		12,802			13,067
Total current liabilities		81,718			95,082
Long-term debt		44,119			47,032
Long-term income taxes		24,169			26,069
Long-term unearned revenue		2,644			2,870
Deferred income taxes		289			230
Operating lease liabilities		11,998			11,489
Other long-term liabilities		16,479			15,526
Total liabilities		181,416			198,298
Commitments and contingencies
Stockholders’ equity:
Common stock and paid-in capital – shares authorized 24,000; outstanding 7,447 and 7,464		90,225			86,939
Retained earnings		99,368			84,281
Accumulated other comprehensive loss		(6,457	)		(4,678	)
Total stockholders’ equity		183,136			166,542
Total liabilities and stockholders’ equity	$	364,552		$	364,840

Refer to accompanying notes.

5

PART I

Item 1

CASH FLOWS STATEMENTS

(In millions) (Unaudited)	Three Months Ended December 31,							Six Months Ended December 31,
	2022			2021				2022		2021
Operations
Net income	$	16,425		$	18,765		$	33,981		$	39,270
Adjustments to reconcile net income to net cash from operations:
Depreciation, amortization, and other		3,648			3,496			6,438			6,708
Stock-based compensation expense		2,538			1,897			4,730			3,599
Net recognized losses (gains) on investments and derivatives		214			(307	)		192			(671	)
Deferred income taxes		(1,305	)		183			(2,496	)		(5,787	)
Changes in operating assets and liabilities:
Accounts receivable		(3,164	)		(5,543	)		8,565			4,943
Inventories		1,305			394			762			(383	)
Other current assets		(392	)		830			(724	)		1,770
Other long-term assets		(65	)		(908	)		(731	)		(1,506	)
Accounts payable		(2,058	)		235			(3,625	)		(236	)
Unearned revenue		(5,186	)		(4,343	)		(8,508	)		(7,228	)
Income taxes		(2,863	)		(2,057	)		(2,453	)		596
Other current liabilities		1,819			1,745			(2,205	)		(2,398	)
Other long-term liabilities		257			93			445			343
Net cash from operations		11,173			14,480			34,371			39,020
Financing
Repayments of debt		(750	)		0			(1,750	)		(4,826	)
Common stock issued		243			291			818			903
Common stock repurchased		(5,459	)		(7,433	)		(11,032	)		(15,117	)
Common stock cash dividends paid		(5,066	)		(4,652	)		(9,687	)		(8,858	)
Other, net		(317	)		(192	)		(581	)		(364	)
Net cash used in financing		(11,349	)		(11,986	)		(22,232	)		(28,262	)
Investing
Additions to property and equipment		(6,274	)		(5,865	)		(12,557	)		(11,675	)
Acquisition of companies, net of cash acquired, and purchases of intangible and other assets		(679	)		(850	)		(1,028	)		(2,056	)
Purchases of investments		(11,599	)		(2,505	)		(16,612	)		(12,814	)
Maturities of investments		6,928			5,253			13,590			14,115
Sales of investments		4,775			2,895			7,486			8,525
Other, net		(301	)		(89	)		(1,161	)		(506	)
Net cash used in investing		(7,150	)		(1,161	)		(10,282	)		(4,411	)
Effect of foreign exchange rates on cash and cash equivalents		88			106			(142	)		33
Net change in cash and cash equivalents		(7,238	)		1,439			1,715			6,380
Cash and cash equivalents, beginning of period		22,884			19,165			13,931			14,224
Cash and cash equivalents, end of period	$	15,646		$	20,604		$	15,646		$	20,604

Refer to accompanying notes.

6

PART I

Item 1

STOCKHOLDERS’ EQUITY STATEMENTS

(In millions, except per share amounts) (Unaudited)	Three Months Ended December 31,							Six Months Ended December 31,
	2022			2021				2022			2021
Common stock and paid-in capital
Balance, beginning of period	$	88,535		$	83,751		$	86,939		$	83,111
Common stock issued		243			291			818			903
Common stock repurchased		(1,090	)		(1,411	)		(2,261	)		(3,088	)
Stock-based compensation expense		2,538			1,897			4,730			3,599
Other, net		(1	)		0			(1	)		3
Balance, end of period		90,225			84,528			90,225			84,528
Retained earnings
Balance, beginning of period		92,374			66,944			84,281			57,055
Net income		16,425			18,765			33,981			39,270
Common stock cash dividends		(5,059	)		(4,646	)		(10,123	)		(9,297	)
Common stock repurchased		(4,372	)		(6,018	)		(8,771	)		(11,983	)
Balance, end of period		99,368			75,045			99,368			75,045
Accumulated other comprehensive income (loss)
Balance, beginning of period		(7,343	)		1,283			(4,678	)		1,822
Other comprehensive income (loss)		886			(846	)		(1,779	)		(1,385	)
Balance, end of period		(6,457	)		437			(6,457	)		437
Total stockholders’ equity	$	183,136		$	160,010		$	183,136		$	160,010
Cash dividends declared per common share	$	0.68		$	0.62		$	1.36		$	1.24

Refer to accompanying notes.

7

PART I

Item 1

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 — ACCOUNTING POLICIES

Accounting Principles

Our unaudited interim consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). In the opinion of management, the unaudited interim consolidated financial statements reflect all adjustments of a normal recurring nature that are necessary for a fair presentation of the results for the interim periods presented. Interim results are not necessarily indicative of results for a full year. The information included in this Form 10-Q should be read in conjunction with information included in the Microsoft Corporation fiscal year 2022 Form 10-K filed with the U.S. Securities and Exchange Commission on July 28, 2022.

Principles of Consolidation

The consolidated financial statements include the accounts of Microsoft Corporation and its subsidiaries. Intercompany transactions and balances have been eliminated.

Estimates and Assumptions

Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Examples of estimates and assumptions include: for revenue recognition, determining the nature and timing of satisfaction of performance obligations, and determining the standalone selling price (“SSP”) of performance obligations, variable consideration, and other obligations such as product returns and refunds; loss contingencies; product warranties; the fair value of and/or potential impairment of goodwill and intangible assets for our reporting units; product life cycles; useful lives of our tangible and intangible assets; allowances for doubtful accounts; the market value of, and demand for, our inventory; stock-based compensation forfeiture rates; when technological feasibility is achieved for our products; the potential outcome of uncertain tax positions that have been recognized in our consolidated financial statements or tax returns; and determining the timing and amount of impairments for investments. Actual results and outcomes may differ from management’s estimates and assumptions due to risks and uncertainties.

In July 2022, we completed an assessment of the useful lives of our server and network equipment. Due to investments in software that increased efficiencies in how we operate our server and network equipment, as well as advances in technology, we determined we should increase the estimated useful lives of both server and network equipment from four years to six years. This change in accounting estimate was effective beginning fiscal year 2023. Based on the carrying amount of server and network equipment included in property and equipment, net as of June 30, 2022, the effect of this change in estimate for the three months ended December 31, 2022 was an increase in operating income of $945 million and net income of $768 million, or $0.10 per both basic and diluted share. The effect of this change for the six months ended December 31, 2022 was an increase in operating income of $2.0 billion and net income of $1.6 billion, or $0.22 per both basic and diluted share.

Financial Instruments

Investments

We consider all highly liquid interest-earning investments with a maturity of three months or less at the date of purchase to be cash equivalents. The fair values of these investments approximate their carrying values. In general, investments with original maturities of greater than three months and remaining maturities of less than one year are classified as short-term investments. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations.

8

PART I

Item 1

Debt investments are classified as available-for-sale and realized gains and losses are recorded using the specific identification method. Changes in fair value, excluding credit losses and impairments, are recorded in other comprehensive income. Fair value is calculated based on publicly available market information or other estimates determined by management. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the extent to which the fair value is less than cost. To determine credit losses, we employ a systematic methodology that considers available quantitative and qualitative evidence. In addition, we consider specific adverse conditions related to the financial health of, and business outlook for, the investee. If we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery, then a decline in fair value below cost is recorded as an impairment charge in other income (expense), net and a new cost basis in the investment is established. If market, industry, and/or investee conditions deteriorate, we may incur future impairments.

Equity investments with readily determinable fair values are measured at fair value. Equity investments without readily determinable fair values are measured using the equity method or measured at cost with adjustments for observable changes in price or impairments (referred to as the measurement alternative). We perform a qualitative assessment on a periodic basis and recognize an impairment if there are sufficient indicators that the fair value of the investment is less than carrying value. Changes in value are recorded in other income (expense), net.

Derivatives

Derivative instruments are recognized as either assets or liabilities and measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation.

For derivative instruments designated as fair value hedges, gains and losses are recognized in other income (expense), net with offsetting gains and losses on the hedged items. Gains and losses representing hedge components excluded from the assessment of effectiveness are recognized in other income (expense), net.

For derivative instruments designated as cash flow hedges, gains and losses are initially reported as a component of other comprehensive income and subsequently recognized in other income (expense), net with the corresponding hedged item. Gains and losses representing hedge components excluded from the assessment of effectiveness are recognized in other income (expense), net.

For derivative instruments that are not designated as hedges, gains and losses from changes in fair values are primarily recognized in other income (expense), net.

Fair Value Measurements

We account for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are:

• Level 1 – inputs are based upon unadjusted quoted prices for identical instruments in active markets. Our Level 1 investments include U.S. government securities, common and preferred stock, and mutual funds. Our Level 1 derivative assets and liabilities include those actively traded on exchanges.

• Level 2 – inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques (e.g. the Black-Scholes model) for which all significant inputs are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, credit spreads, foreign exchange rates, and forward and spot prices for currencies. Our Level 2 investments include commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. Our Level 2 derivative assets and liabilities include certain over-the-counter forward, option, and swap contracts.

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Item 1

• Level 3 – inputs are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques, including option pricing models and discounted cash flow models. Our Level 3 assets and liabilities include investments in corporate notes and bonds, municipal securities, and goodwill and intangible assets, when they are recorded at fair value due to an impairment charge. Unobservable inputs used in the models are significant to the fair values of the assets and liabilities.

We measure equity investments without readily determinable fair values on a nonrecurring basis. The fair values of these investments are determined based on valuation techniques using the best information available, and may include quoted market prices, market comparables, and discounted cash flow projections.

Our other current financial assets and current financial liabilities have fair values that approximate their carrying values.

Contract Balances and Other Receivables

As of December 31, 2022 and June 30, 2022, other receivables due from suppliers were $545 million and $1.0 billion, respectively, and are included in accounts receivable, net in our consolidated balance sheets.

As of both December 31, 2022 and June 30, 2022, long-term accounts receivable, net of allowance for doubtful accounts, was $4.2 billion and $3.8 billion, respectively, and is included in other long-term assets in our consolidated balance sheets.

We record financing receivables when we offer certain of our customers the option to acquire our software products and services offerings through a financing program in a limited number of countries. As of December 31, 2022 and June 30, 2022, our financing receivables, net were $3.1 billion and $4.1 billion, respectively, for short-term and long-term financing receivables, which are included in other current assets and other long-term assets in our consolidated balance sheets. We record an allowance to cover expected losses based on troubled accounts, historical experience, and other currently available evidence.

Employee Severance

On January 18, 2023, we announced a decision to reduce our overall workforce by approximately 10,000 jobs through the third quarter of fiscal year 2023. During the three months ended December 31, 2022, we recorded $800 million of employee severance expenses related to these job eliminations as part of an ongoing employee benefit plan. These employee severance expenses were included in general and administrative expenses in our consolidated income statements and allocated to our segments based on relative gross margin. Refer to Note 17 – Segment Information and Geographic Data for further information.

NOTE 2 — EARNINGS PER SHARE

Basic earnings per share (“EPS”) is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and stock awards.

10

PART I

Item 1

The components of basic and diluted EPS were as follows:

(In millions, except earnings per share)	Three Months Ended December 31,					Six Months Ended December 31,
	2022		2021			2022		2021
Net income available for common shareholders (A)	$	16,425	$	18,765	$	33,981	$	39,270
Weighted average outstanding shares of common stock (B)		7,451		7,505		7,454		7,509
Dilutive effect of stock-based awards		22		50		25		52
Common stock and common stock equivalents (C)		7,473		7,555		7,479		7,561
Earnings Per Share
Basic (A/B)	$	2.20	$	2.50	$	4.56	$	5.23
Diluted (A/C)	$	2.20	$	2.48	$	4.54	$	5.19

Anti-dilutive stock-based awards excluded from the calculations of diluted EPS were immaterial during the periods presented.

NOTE 3 — OTHER INCOME (EXPENSE), NET

The components of other income (expense), net were as follows:

(In millions)	Three Months Ended December 31,						Six Months Ended December 31,
	2022			2021			2022			2021
Interest and dividends income	$	700		$	503		$	1,341		$	1,023
Interest expense		(490	)		(525	)		(990	)		(1,064	)
Net recognized gains (losses) on investments		(15	)		300			(2	)		671
Net gains (losses) on derivatives		(199	)		7			(190	)		0
Net losses on foreign currency remeasurements		(18	)		(13	)		(96	)		(78	)
Other, net		(38	)		(4	)		(69	)		2
Total	$	(60	)	$	268		$	(6	)	$	554

Net Recognized Gains (Losses) on Investments

Net recognized gains (losses) on debt investments were as follows:

(In millions)		Three Months Ended December 31,						Six Months Ended December 31,
	2022			2021			2022			2021
Realized gains from sales of available-for-sale securities	$	27		$	12		$	30		$	31
Realized losses from sales of available-for-sale securities		(23	)		(6	)		(43	)		(13	)
Impairments and allowance for credit losses		5			(5	)		(13	)		(8	)
Total	$	9		$	1		$	(26	)	$	10

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PART I

Item 1

Net recognized gains (losses) on equity investments were as follows:

(In millions)	Three Months Ended December 31,					Six Months Ended December 31,
	2022			2021		2022			2021
Net realized gains (losses) on investments sold	$	(8	)	$	31	$	75		$	68
Net unrealized gains (losses) on investments still held		(7	)		268		(35	)		593
Impairments of investments		(9	)		0		(16	)		0
Total	$	(24	)	$	299	$	24		$	661

NOTE 4 — INVESTMENTS

Investment Components

The components of investments were as follows:

(In millions)	Fair Value Level	Adjusted Cost Basis		Unrealized Gains		Unrealized Losses			Recorded Basis		Cash  and Cash Equivalents		Short-term Investments		Equity Investments
December 31, 2022
Changes in Fair Value Recorded in Other Comprehensive Income
Commercial paper	Level 2	$	6,423	$	0	$	0		$	6,423	$	3,307	$	3,116	$	0
Certificates of deposit	Level 2		2,694		0		0			2,694		2,250		444		0
U.S. government securities	Level 1		67,941		0		(3,963	)		63,978		1,029		62,949		0
U.S. agency securities	Level 2		5,525		0		(6	)		5,519		674		4,845		0
Foreign government bonds	Level 2		491		1		(27	)		465		0		465		0
Mortgage- and asset-backed securities	Level 2		883		1		(43	)		841		0		841		0
Corporate notes and bonds	Level 2		11,310		8		(676	)		10,642		0		10,642		0
Corporate notes and bonds	Level 3		88		1		0			89		0		89		0
Municipal securities	Level 2		370		8		(17	)		361		0		361		0
Municipal securities	Level 3		104		0		(7	)		97		0		97		0
Total debt investments		$	95,829	$	19	$	(4,739	)	$	91,109	$	7,260	$	83,849	$	0
Changes in Fair Value Recorded in Net Income
Equity investments	Level 1								$	1,521	$	1,082	$	0	$	439
Equity investments	Other									6,658		0		0		6,658
Total equity investments									$	8,179	$	1,082	$	0	$	7,097
Cash									$	7,304	$	7,304	$	0	$	0
Derivatives, net (a)										13		0		13		0
Total									$	106,605	$	15,646	$	83,862	$	7,097

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(In millions)	Fair Value Level	Adjusted Cost Basis		Unrealized Gains		Unrealized Losses			Recorded Basis		Cash and Cash Equivalents		Short-term Investments		Equity Investments
June 30, 2022
Changes in Fair Value Recorded in Other Comprehensive Income
Commercial paper	Level 2	$	2,500	$	0	$	0		$	2,500	$	2,498	$	2	$	0
Certificates of deposit	Level 2		2,071		0		0			2,071		2,032		39		0
U.S. government securities	Level 1		79,696		29		(2,178	)		77,547		9		77,538		0
U.S. agency securities	Level 2		419		0		(9	)		410		0		410		0
Foreign government bonds	Level 2		506		0		(24	)		482		0		482		0
Mortgage- and asset-backed securities	Level 2		727		1		(30	)		698		0		698		0
Corporate notes and bonds	Level 2		11,661		4		(554	)		11,111		0		11,111		0
Corporate notes and bonds	Level 3		67		0		0			67		0		67		0
Municipal securities	Level 2		368		19		(13	)		374		0		374		0
Municipal securities	Level 3		103		0		(6	)		97		0		97		0
Total debt investments		$	98,118	$	53	$	(2,814	)	$	95,357	$	4,539	$	90,818	$	0
Changes in Fair Value Recorded in Net Income
Equity investments	Level 1								$	1,590	$	1,134	$	0	$	456
Equity investments	Other									6,435		0		0		6,435
Total equity investments									$	8,025	$	1,134	$	0	$	6,891
Cash									$	8,258	$	8,258	$	0	$	0
Derivatives, net (a)										8		0		8		0
Total									$	111,648	$	13,931	$	90,826	$	6,891

(a) Refer to Note 5 – Derivatives for further information on the fair value of our derivative instruments.

Equity investments presented as “Other” in the tables above include investments without readily determinable fair values measured using the equity method or measured at cost with adjustments for observable changes in price or impairments, and investments measured at fair value using net asset value as a practical expedient which are not categorized in the fair value hierarchy. As of both December 31, 2022 and June 30, 2022, equity investments without readily determinable fair values measured at cost with adjustments for observable changes in price or impairments were $3.8 billion.

Unrealized Losses on Debt Investments

Debt investments with continuous unrealized losses for less than 12 months and 12 months or greater and their related fair values were as follows:

	Less than 12 Months					12 Months or Greater								Total Unrealized Losses
(In millions)		Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Total Fair Value
December 31, 2022
U.S. government and agency securities	$	40,516	$	(2,586	)	$	8,890	$	(1,383	)	$	49,406	$	(3,969	)
Foreign government bonds		365		(14	)		94		(13	)		459		(27	)
Mortgage- and asset-backed securities		396		(22	)		148		(21	)		544		(43	)
Corporate notes and bonds		6,908		(337	)		3,204		(339	)		10,112		(676	)
Municipal securities		125		(5	)		149		(19	)		274		(24	)
Total	$	48,310	$	(2,964	)	$	12,485	$	(1,775	)	$	60,795	$	(4,739	)

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	Less than 12 Months					12 Months or Greater								Total Unrealized Losses
(In millions)		Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Total Fair Value
June 30, 2022
U.S. government and agency securities	$	59,092	$	(1,835	)	$	2,210	$	(352	)	$	61,302	$	(2,187	)
Foreign government bonds		418		(18	)		27		(6	)		445		(24	)
Mortgage- and asset-backed securities		510		(26	)		41		(4	)		551		(30	)
Corporate notes and bonds		9,443		(477	)		786		(77	)		10,229		(554	)
Municipal securities		178		(12	)		74		(7	)		252		(19	)
Total	$	69,641	$	(2,368	)	$	3,138	$	(446	)	$	72,779	$	(2,814	)

Unrealized losses from fixed-income securities are primarily attributable to changes in interest rates. Management does not believe any remaining unrealized losses represent impairments based on our evaluation of available evidence.

Debt Investment Maturities

(In millions)	Adjusted Cost Basis		Estimated Fair Value
December 31, 2022
Due in one year or less	$	28,885	$	28,758
Due after one year through five years		50,751		48,134
Due after five years through 10 years		14,845		13,012
Due after 10 years		1,348		1,205
Total	$	95,829	$	91,109

NOTE 5 — DERIVATIVES

We use derivative instruments to manage risks related to foreign currencies, interest rates, equity prices, and credit; to enhance investment returns; and to facilitate portfolio diversification. Our objectives for holding derivatives include reducing, eliminating, and efficiently managing the economic impact of these exposures as effectively as possible. Our derivative programs include strategies that both qualify and do not qualify for hedge accounting treatment.

Foreign Currencies

Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency hedge positions.

Foreign currency risks related to certain non-U.S. dollar-denominated investments are hedged using foreign exchange forward contracts that are designated as fair value hedging instruments. Foreign currency risks related to certain Euro-denominated debt are hedged using foreign exchange forward contracts that are designated as cash flow hedging instruments.

Certain options and forwards not designated as hedging instruments are also used to manage the variability in foreign exchange rates on certain balance sheet amounts and to manage other foreign currency exposures.

Interest Rate

Interest rate risks related to certain fixed-rate debt are hedged using interest rate swaps that are designated as fair value hedging instruments to effectively convert the fixed interest rates to floating interest rates.

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Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of our fixed-income portfolio to achieve economic returns that correlate to certain broad-based fixed-income indices using exchange-traded option and futures contracts and over-the-counter swap and option contracts. These contracts are not designated as hedging instruments and are included in “Other contracts” in the tables below.

Equity

Securities held in our equity investments portfolio are subject to market price risk. At times, we may hold options, futures, and swap contracts. These contracts are not designated as hedging instruments and are included in “Other contracts” in the tables below.

Credit

Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We use credit default swap contracts to manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. These contracts are not designated as hedging instruments and are included in “Other contracts” in the tables below.

Credit-Risk-Related Contingent Features

Certain of our counterparty agreements for derivative instruments contain provisions that require our issued and outstanding long-term unsecured debt to maintain an investment grade credit rating and require us to maintain minimum liquidity of $1.0 billion. To the extent we fail to meet these requirements, we will be required to post collateral, similar to the standard convention related to over-the-counter derivatives. As of December 31, 2022, our long-term unsecured debt rating was AAA, and cash investments were in excess of $1.0 billion. As a result, no collateral was required to be posted.

The following table presents the notional amounts of our outstanding derivative instruments measured in U.S. dollar equivalents:

(In millions)	December 31, 2022		June 30, 2022
Designated as Hedging Instruments
Foreign exchange contracts purchased	$	1,492	$	635
Interest rate contracts purchased		1,089		1,139
Not Designated as Hedging Instruments
Foreign exchange contracts purchased		7,042		10,322
Foreign exchange contracts sold		17,653		21,606
Other contracts purchased		4,803		2,773
Other contracts sold		1,023		544

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Fair Values of Derivative Instruments

The following table presents our derivative instruments:

	Derivative				Derivative		Derivative			Derivative
(In millions)	Assets				Liabilities		Assets			Liabilities
	December 31, 2022						June 30, 2022
Designated as Hedging Instruments
Foreign exchange contracts	$	13		$	(79	)	$	0		$	(77	)
Interest rate contracts		0			(3	)		3			0
Not Designated as Hedging Instruments
Foreign exchange contracts		195			(599	)		333			(362	)
Other contracts		41			(305	)		20			(112	)
Gross amounts of derivatives		249			(986	)		356			(551	)
Gross amounts of derivatives offset in the balance sheet		(203	)		206			(130	)		133
Cash collateral received		0			(12	)		0			(75	)
Net amounts of derivatives	$	46		$	(792	)	$	226		$	(493	)
Reported as
Short-term investments	$	13		$	0		$	8		$	0
Other current assets		27			0			218			0
Other long-term assets		6			0			0			0
Other current liabilities		0			(607	)		0			(298	)
Other long-term liabilities		0			(185	)		0			(195	)
Total	$	46		$	(792	)	$	226		$	(493	)

Gross derivative assets and liabilities subject to legally enforceable master netting agreements for which we have elected to offset were $239 million and $793 million, respectively, as of December 31, 2022, and $343 million and $550 million, respectively, as of June 30, 2022.

The following table presents the fair value of our derivatives instruments on a gross basis:

(In millions)	Level 1			Level 2		Level 3		Total
December 31, 2022
Derivative assets	$	0	$	241		$	8	$	249
Derivative liabilities		0		(986	)		0		(986	)
June 30, 2022
Derivative assets		1		349			6		356
Derivative liabilities		0		(551	)		0		(551	)

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Gains (losses) on derivative instruments recognized in other income (expense), net were as follows:

(In millions)		Three Months Ended December 31,						Six Months Ended December 31,
		2022			2021			2022			2021
Designated as Fair Value Hedging Instruments
Foreign exchange contracts
Derivatives	$	0		$	46		$	0		$	49
Hedged items		0			(45	)		0			(50	)
Excluded from effectiveness assessment		0			0			0			4
Interest rate contracts
Derivatives		5			(11	)		(38	)		(14	)
Hedged items		(8	)		15			35			22
Designated as Cash Flow Hedging Instruments
Foreign exchange contracts
Amount reclassified from accumulated other comprehensive income (loss)		103			(14	)		44			(29	)
Not Designated as Hedging Instruments
Foreign exchange contracts		(250	)		96			(10	)		273
Other contracts		(206	)		6			(204	)		(12	)

Losses, net of tax, on derivative instruments recognized in our consolidated comprehensive income statements were as follows:

(In millions)	Three Months Ended December 31,						Six Months Ended December 31,
	2022		2021				2022		2021
Designated as Cash Flow Hedging Instruments
Foreign exchange contracts
Included in effectiveness assessment	$	49	$	(11	)	$	9	$	(21	)

NOTE 6 — INVENTORIES

The components of inventories were as follows:

(In millions)
	December 31, 2022		June 30, 2022
Raw materials	$	1,060	$	1,144
Work in process		38		82
Finished goods		1,882		2,516
Total	$	2,980	$	3,742

NOTE 7 — BUSINESS COMBINATIONS

Nuance Communications, Inc.

On March 4, 2022, we completed our acquisition of Nuance Communications, Inc. (“Nuance”) for a total purchase price of $18.8 billion, consisting primarily of cash. Nuance is a cloud and artificial intelligence (“AI”) software provider with healthcare and enterprise AI experience, and the acquisition will build on our industry-specific cloud offerings. The financial results of Nuance have been included in our consolidated financial statements since the date of the acquisition. Nuance is reported as part of our Intelligent Cloud segment.

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The allocation of the purchase price to goodwill was completed as of December 31, 2022. The major classes of assets and liabilities to which we have allocated the purchase price were as follows:

(In millions)
Goodwill (a)	$	16,326
Intangible assets		4,365
Other assets		42
Other liabilities (b)		(1,972	)
Total	$	18,761

(a) Goodwill was assigned to our Intelligent Cloud segment and was primarily attributed to increased synergies that are expected to be achieved from the integration of Nuance. None of the goodwill is expected to be deductible for income tax purposes.

(b) Includes $986 million of convertible senior notes issued by Nuance in 2015 and 2017, substantially all of which have been redeemed.

Following are the details of the purchase price allocated to the intangible assets acquired:

(In millions, except average life)	Amount			Weighted Average Life
Customer-related	$	2,610	9 years
Technology-based		1,540	5 years
Marketing-related		215	4 years
Total	$	4,365	7 years

Activision Blizzard, Inc.

On January 18, 2022, we entered into a definitive agreement to acquire Activision Blizzard, Inc. (“Activision Blizzard”) for $95.00 per share in an all-cash transaction valued at $68.7 billion, inclusive of Activision Blizzard’s net cash. Activision Blizzard is a leader in game development and an interactive entertainment content publisher. The acquisition will accelerate the growth in our gaming business across mobile, PC, console, and cloud gaming. The acquisition has been approved by Activision Blizzard’s shareholders. We are continuing to engage with regulators reviewing the transaction and are working toward closing it in fiscal year 2023, subject to obtaining required regulatory approvals and satisfaction of other customary closing conditions.

NOTE 8 — GOODWILL

Changes in the carrying amount of goodwill were as follows:

(In millions)	June 30, 2022		Acquisitions		Other			December 31, 2022
Productivity and Business Processes	$	24,811	$	11	$	(15	)	$	24,807
Intelligent Cloud		30,182		183		87			30,452
More Personal Computing		12,531		0		115			12,646
Total	$	67,524	$	194	$	187		$	67,905

The measurement periods for the valuation of assets acquired and liabilities assumed end as soon as information on the facts and circumstances that existed as of the acquisition dates becomes available, but do not exceed 12 months. Adjustments in purchase price allocations may require a change in the amounts allocated to goodwill during the periods in which the adjustments are determined.

Any change in the goodwill amounts resulting from foreign currency translations and purchase accounting adjustments are presented as “Other” in the table above. Also included in “Other” are business dispositions and transfers between segments due to reorganizations, as applicable.

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NOTE 9 — INTANGIBLE ASSETS

The components of intangible assets, all of which are finite-lived, were as follows:

(In millions)	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
	December 31, 2022							June 30, 2022
Technology-based	$	11,093	$	(7,073	)	$	4,020	$	11,277	$	(6,958	)	$	4,319
Customer-related		7,352		(3,646	)		3,706		7,342		(3,171	)		4,171
Marketing-related		4,942		(2,324	)		2,618		4,942		(2,143	)		2,799
Contract-based		21		(11	)		10		16		(7	)		9
Total	$	23,408	$	(13,054	)	$	10,354	$	23,577	$	(12,279	)	$	11,298

Intangible assets amortization expense was $632 million and $1.3 billion for the three and six months ended December 31, 2022, respectively, and $446 million and $885 million for the three and six months ended December 31, 2021, respectively.

The following table outlines the estimated future amortization expense related to intangible assets held as of December 31, 2022:

(In millions)
Year Ending June 30,
2023 (excluding the six months ended December 31, 2022)	$	1,256
2024		2,377
2025		1,826
2026		1,309
2027		874
Thereafter		2,712
Total	$	10,354

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NOTE 10 — DEBT

The components of debt were as follows:

(In millions, issuance by calendar year)	Maturities (calendar year)				Stated Interest Rate				Effective Interest Rate			December 31, 2022			June 30, 2022
2009 issuance of $3.8 billion				2039				5.20%			5.24%	$	520		$	520
2010 issuance of $4.8 billion				2040				4.50%			4.57%		486			486
2011 issuance of $2.3 billion				2041				5.30%			5.36%		718			718
2012 issuance of $2.3 billion		2022	–	2042		2.13%	–	3.50%	2.24%	–	3.57%		454			1,204
2013 issuance of $5.2 billion		2023	–	2043		2.38%	–	4.88%	2.47%	–	4.92%		2,814			2,814
2013 issuance of €4.1 billion		2028	–	2033		2.63%	–	3.13%	2.69%	–	3.22%		2,455			2,404
2015 issuance of $23.8 billion		2025	–	2055		2.70%	–	4.75%	2.77%	–	4.78%		9,805			10,805
2016 issuance of $19.8 billion		2023	–	2056		2.00%	–	3.95%	2.10%	–	4.03%		9,430			9,430
2017 issuance of $17.0 billion		2024	–	2057		2.88%	–	4.50%	3.04%	–	4.53%		8,945			8,945
2020 issuance of $10.0 billion		2050	–	2060		2.53%	–	2.68%	2.53%	–	2.68%		10,000			10,000
2021 issuance of $8.2 billion		2052	–	2062		2.92%	–	3.04%	2.92%	–	3.04%		8,185			8,185
Total face value													53,812			55,511
Unamortized discount and issuance costs													(455	)		(471	)
Hedge fair value adjustments (a)													(103	)		(68	)
Premium on debt exchange													(5,138	)		(5,191	)
Total debt													48,116			49,781
Current portion of long-term debt													(3,997	)		(2,749	)
Long-term debt												$	44,119		$	47,032

 (a) Refer to Note 5 – Derivatives for further information on the interest rate swaps related to fixed-rate debt.

As of December 31, 2022 and June 30, 2022, the estimated fair value of long-term debt, including the current portion, was $46.4 billion and $50.9 billion, respectively. The estimated fair values are based on Level 2 inputs.

Debt in the table above is comprised of senior unsecured obligations and ranks equally with our other outstanding obligations. Interest is paid semi-annually, except for the Euro-denominated debt, which is paid annually.

The following table outlines maturities of our long-term debt, including the current portion, as of December 31, 2022:

(In millions)
Year Ending June 30,
2023 (excluding the six months ended December 31, 2022)	$	1,000
2024		5,250
2025		2,250
2026		3,000
2027		8,000
Thereafter		34,312
Total	$	53,812

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NOTE 11 — INCOME TAXES

Effective Tax Rate

Our effective tax rate was 19% and 17% for the three months ended December 31, 2022 and 2021, respectively, and 19% and 9% for the six months ended December 31, 2022 and 2021, respectively. The increase in our effective tax rate for the three months ended December 31, 2022 compared to the prior year was primarily due to a decrease in tax benefits relating to stock-based compensation. The increase in our effective tax rate for the six months ended December 31, 2022 compared to the prior year was primarily due to a $3.3 billion net income tax benefit in the first quarter of fiscal year 2022 related to the transfer of intangible properties and a decrease in tax benefits relating to stock-based compensation.

In the first quarter of fiscal year 2022, we transferred certain intangible properties from our Puerto Rico subsidiary to the U.S. The transfer of intangible properties resulted in a $3.3 billion net income tax benefit in the first quarter of fiscal year 2022, as the value of future U.S. tax deductions exceeded the current tax liability from the U.S. global intangible low-taxed income tax.

Our effective tax rate was lower than the U.S. federal statutory rate for the three and six months ended December 31, 2022, primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations center in Ireland.

Uncertain Tax Positions

As of December 31, 2022 and June 30, 2022, unrecognized tax benefits and other income tax liabilities were $17.1 billion and $16.3 billion, respectively, and are included in long-term income taxes in our consolidated balance sheets.

We settled a portion of the Internal Revenue Service (“IRS”) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. In the second quarter of fiscal year 2021, we settled an additional portion of the IRS audits for tax years 2004 to 2013 and made a payment of $1.7 billion, including tax and interest. We remain under audit for tax years 2004 to 2017.

As of December 31, 2022, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact in our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved key transfer pricing issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.

We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2022, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.

NOTE 12 — UNEARNED REVENUE

Unearned revenue by segment was as follows:

(In millions)
	December 31, 2022		June 30, 2022
Productivity and Business Processes	$	20,120	$	24,558
Intelligent Cloud		15,822		19,371
More Personal Computing		3,684		4,479
Total	$	39,626	$	48,408

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Changes in unearned revenue were as follows:

(In millions)
Six Months Ended December 31, 2022
Balance, beginning of period	$	48,408
Deferral of revenue		48,188
Recognition of unearned revenue		(56,970	)
Balance, end of period	$	39,626

Revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods, was $193 billion as of December 31, 2022, of which $189 billion is related to the commercial portion of revenue. We expect to recognize approximately 45% of this revenue over the next 12 months and the remainder thereafter.

NOTE 13 — LEASES

We have operating and finance leases for datacenters, corporate offices, research and development facilities, Microsoft Experience Centers, and certain equipment. Our leases have remaining lease terms of less than 1 year to 19 years, some of which include options to extend the leases for up to 5 years, and some of which include options to terminate the leases within 1 year.

The components of lease expense were as follows:

(In millions)	Three Months Ended December 31,				Six Months Ended  December 31,
		2022		2021		2022		2021
Operating lease cost	$	684	$	469	$	1,346	$	1,057
Finance lease cost:
Amortization of right-of-use assets	$	457	$	264	$	646	$	490
Interest on lease liabilities		119		107		232		211
Total finance lease cost	$	576	$	371	$	878	$	701

Supplemental cash flow information related to leases was as follows:

(In millions)	Three Months Ended December 31,				Six Months Ended December 31,
		2022		2021		2022		2021
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	645	$	441	$	1,299	$	1,007
Operating cash flows from finance leases		119		107		232		211
Financing cash flows from finance leases		262		222		518		422
Right-of-use assets obtained in exchange for lease obligations:
Operating leases		525		1,559		1,714		2,730
Finance leases		598		985		1,209		2,374

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Supplemental balance sheet information related to leases was as follows:

(In millions, except lease term and discount rate)
	December 31, 2022			June 30, 2022
Operating Leases
Operating lease right-of-use assets	$	13,624		$	13,148
Other current liabilities	$	2,287		$	2,228
Operating lease liabilities		11,998			11,489
Total operating lease liabilities	$	14,285		$	13,717
Finance Leases
Property and equipment, at cost	$	18,514		$	17,388
Accumulated depreciation		(3,920	)		(3,285	)
Property and equipment, net	$	14,594		$	14,103
Other current liabilities	$	1,105		$	1,060
Other long-term liabilities		14,479			13,842
Total finance lease liabilities	$	15,584		$	14,902
Weighted Average Remaining Lease Term
Operating leases		8 years			8 years
Finance leases		11 years			12 years
Weighted Average Discount Rate
Operating leases		2.5%			2.1%
Finance leases		3.2%			3.1%

The following table outlines maturities of our lease liabilities as of December 31, 2022:

(In millions)
Year Ending June 30,	Operating Leases			Finance Leases
2023 (excluding the six months ended December 31, 2022)	$	1,320		$	790
2024		2,498			1,598
2025		2,217			1,912
2026		1,847			1,595
2027		1,533			1,603
Thereafter		6,528			11,196
Total lease payments		15,943			18,694
Less imputed interest		(1,658	)		(3,110	)
Total	$	14,285		$	15,584

As of December 31, 2022, we have additional operating and finance leases, primarily for datacenters, that have not yet commenced of $6.3 billion and $19.7 billion, respectively. These operating and finance leases will commence between fiscal year 2023 and fiscal year 2028 with lease terms of less than 1 year to 18 years.

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NOTE 14 — CONTINGENCIES

U.S. Cell Phone Litigation

Microsoft Mobile Oy, a subsidiary of Microsoft, along with other handset manufacturers and network operators, is a defendant in 46 lawsuits, including 45 lawsuits filed in the Superior Court for the District of Columbia by individual plaintiffs who allege that radio emissions from cellular handsets caused their brain tumors and other adverse health effects. We assumed responsibility for these claims in our agreement to acquire Nokia’s Devices and Services business and have been substituted for the Nokia defendants. Nine of these cases were filed in 2002 and are consolidated for certain pre-trial proceedings; the remaining cases are stayed. In a separate 2009 decision, the Court of Appeals for the District of Columbia held that adverse health effect claims arising from the use of cellular handsets that operate within the U.S. Federal Communications Commission radio frequency emission guidelines (“FCC Guidelines”) are pre-empted by federal law. The plaintiffs allege that their handsets either operated outside the FCC Guidelines or were manufactured before the FCC Guidelines went into effect. The lawsuits also allege an industry-wide conspiracy to manipulate the science and testing around emission guidelines.

In 2013, the defendants in the consolidated cases moved to exclude the plaintiffs’ expert evidence of general causation on the basis of flawed scientific methodologies. In 2014, the trial court granted in part and denied in part the defendants’ motion to exclude the plaintiffs’ general causation experts. The defendants filed an interlocutory appeal to the District of Columbia Court of Appeals challenging the standard for evaluating expert scientific evidence. In October 2016, the Court of Appeals issued its decision adopting the standard advocated by the defendants and remanding the cases to the trial court for further proceedings under that standard. The plaintiffs have filed supplemental expert evidence, portions of which were stricken by the court. A hearing on general causation took place in September of 2022.

Other Contingencies

We also are subject to a variety of other claims and suits that arise from time to time in the ordinary course of our business. Although management currently believes that resolving claims against us, individually or in aggregate, will not have a material adverse impact in our consolidated financial statements, these matters are subject to inherent uncertainties and management’s view of these matters may change in the future.

As of December 31, 2022, we accrued aggregate legal liabilities of $181 million. While we intend to defend these matters vigorously, adverse outcomes that we estimate could reach approximately $500 million in aggregate beyond recorded amounts are reasonably possible. Were unfavorable final outcomes to occur, there exists the possibility of a material adverse impact in our consolidated financial statements for the period in which the effects become reasonably estimable.

NOTE 15 — STOCKHOLDERS’ EQUITY

Share Repurchases

On September 18, 2019, our Board of Directors approved a share repurchase program authorizing up to $40.0 billion in share repurchases. This share repurchase program commenced in February 2020 and was completed in November 2021.

On September 14, 2021, our Board of Directors approved a share repurchase program authorizing up to $60.0 billion in share repurchases. This share repurchase program commenced in November 2021, following completion of the program approved on September 18, 2019, has no expiration date, and may be terminated at any time. As of December 31, 2022, $31.5 billion remained of this $60.0 billion share repurchase program.

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We repurchased the following shares of common stock under the share repurchase programs:

(In millions)	Shares		Amount			Shares		Amount
Fiscal Year				2023					2022
First Quarter		17		$	4,600		21		$	6,200
Second Quarter		20			4,600		20			6,233
Total		37		$	9,200		41		$	12,433

All repurchases were made using cash resources. Shares repurchased during fiscal year 2023 were under the share repurchase program approved on September 14, 2021. Shares repurchased during the second quarter of fiscal year 2022 were under the share repurchase programs approved on both September 14, 2021 and September 18, 2019. Shares repurchased during the first quarter of fiscal year 2022 were under the share repurchase program approved on September 18, 2019. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards of $859 million and $1.8 billion for the three and six months ended December 31, 2022, respectively, and $1.2 billion and $2.7 billion for the three and six months ended December 31, 2021, respectively.

Dividends

Our Board of Directors declared the following dividends:

Declaration Date	Record Date	Payment Date		Dividend Per Share		Amount
Fiscal Year 2023						(In millions)
September 20, 2022	November 17, 2022	December 8, 2022	$	0.68	$	5,066
November 29, 2022	February 16, 2023	March 9, 2023		0.68		5,064
Total			$	1.36	$	10,130
Fiscal Year 2022
September 14, 2021	November 18, 2021	December 9, 2021	$	0.62	$	4,652
December 7, 2021	February 17, 2022	March 10, 2022		0.62		4,645
Total			$	1.24	$	9,297

The dividend declared on November 29, 2022 was included in other current liabilities as of December 31, 2022.

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NOTE 16 — ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following table summarizes the changes in accumulated other comprehensive income (loss) by component:

(In millions)	Three Months Ended December 31,							Six Months Ended December 31,
		2022			2021			2022			2021
Derivatives
Balance, beginning of period	$	(6	)	$	(17	)	$	(13	)	$	(19	)
Unrealized gains (losses), net of tax of $13, $(3), $2, and $(6)		49			(11	)		9			(21	)
Reclassification adjustments for (gains) losses included in other income (expense), net		(103	)		14			(44	)		29
Tax expense (benefit) included in provision for income taxes		22			(3	)		10			(6	)
Amounts reclassified from accumulated other comprehensive income (loss)		(81	)		11			(34	)		23
Net change related to derivatives, net of tax of $(9), $0, $(8), and $0		(32	)		0			(25	)		2
Balance, end of period	$	(38	)	$	(17	)	$	(38	)	$	(17	)
Investments
Balance, beginning of period	$	(4,035	)	$	2,800		$	(2,138	)	$	3,222
Unrealized gains (losses), net of tax of $89, $(197), $(421), and $(307)		340			(742	)		(1,585	)		(1,157	)
Reclassification adjustments for (gains) losses included in other income (expense), net		10			(1	)		45			(10	)
Tax expense (benefit) included in provision for income taxes		(2	)		0			(9	)		2
Amounts reclassified from accumulated other comprehensive income (loss)		8			(1	)		36			(8	)
Net change related to investments, net of tax of $91, $(197), $(412), and $(309)		348			(743	)		(1,549	)		(1,165	)
Balance, end of period	$	(3,687	)	$	2,057		$	(3,687	)	$	2,057
Translation Adjustments and Other
Balance, beginning of period	$	(3,302	)	$	(1,500	)	$	(2,527	)	$	(1,381	)
Translation adjustments and other, net of tax of $0, $0, $0, and $0		570			(103	)		(205	)		(222	)
Balance, end of period	$	(2,732	)	$	(1,603	)	$	(2,732	)	$	(1,603	)
Accumulated other comprehensive income (loss), end of period	$	(6,457	)	$	437		$	(6,457	)	$	437

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NOTE 17 — SEGMENT INFORMATION AND GEOGRAPHIC DATA

In its operation of the business, management, including our chief operating decision maker, who is also our Chief Executive Officer, reviews certain financial information, including segmented internal profit and loss statements prepared on a basis not consistent with GAAP. During the periods presented, we reported our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing.

We have recast certain prior period amounts to conform to the way we internally manage and monitor our business.

Our reportable segments are described below.

Productivity and Business Processes

Our Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises:

• Office Commercial (Office 365 subscriptions, the Office 365 portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises), comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Microsoft Viva.

• Office Consumer, including Microsoft 365 Consumer subscriptions, Office licensed on-premises, and other Office services.

• LinkedIn, including Talent Solutions, Marketing Solutions, Premium Subscriptions, and Sales Solutions.

• Dynamics business solutions, including Dynamics 365, comprising a set of intelligent, cloud-based applications across ERP, CRM, Customer Insights, Power Apps, and Power Automate; and on-premises ERP and CRM applications.

Intelligent Cloud

Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business and developers. This segment primarily comprises:

• Server products and cloud services, including Azure and other cloud services; SQL Server, Windows Server, Visual Studio, System Center, and related Client Access Licenses (“CALs”); and Nuance and GitHub.

• Enterprise Services, including Enterprise Support Services, Microsoft Consulting Services, and Nuance professional services.

More Personal Computing

Our More Personal Computing segment consists of products and services that put customers at the center of the experience with our technology. This segment primarily comprises:

• Windows, including Windows original equipment manufacturer (“OEM”) licensing and other non-volume licensing of the Windows operating system; Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings; patent licensing; and Windows Internet of Things.

• Devices, including Surface, HoloLens, and PC accessories.

• Gaming, including Xbox hardware and Xbox content and services, comprising first- and third-party content (including games and in-game content), Xbox Game Pass and other subscriptions, Xbox Cloud Gaming, third-party disc royalties, advertising, and other cloud services.

• Search and news advertising.

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Revenue and costs are generally directly attributed to our segments. However, due to the integrated structure of our business, certain revenue recognized and costs incurred by one segment may benefit other segments. Revenue from certain contracts is allocated among the segments based on the relative value of the underlying products and services, which can include allocation based on actual prices charged, prices when sold separately, or estimated costs plus a profit margin. Cost of revenue is allocated in certain cases based on a relative revenue methodology. Operating expenses that are allocated primarily include those relating to marketing of products and services from which multiple segments benefit and are generally allocated based on relative gross margin.

In addition, certain costs incurred at a corporate level that benefit our segments are allocated to them. These allocated costs include legal, including settlements and fines, information technology, human resources, finance, excise taxes, field selling, shared facilities services, customer service and support, and severance. Each allocation is measured differently based on the specific facts and circumstances of the costs being allocated and is generally based on relative gross margin or relative headcount.

Segment revenue and operating income were as follows during the periods presented:

(In millions)	Three Months Ended December 31,				Six Months Ended December 31,
	2022		2021		2022		2021
Revenue
Productivity and Business Processes	$	17,002	$	15,936	$	33,467	$	30,975
Intelligent Cloud		21,508		18,262		41,833		35,174
More Personal Computing		14,237		17,530		27,569		30,896
Total	$	52,747	$	51,728	$	102,869	$	97,045
Operating Income
Productivity and Business Processes	$	8,175	$	7,688	$	16,498	$	15,269
Intelligent Cloud		8,904		8,323		17,882		16,004
More Personal Computing		3,320		6,236		7,537		11,212
Total	$	20,399	$	22,247	$	41,917	$	42,485

No sales to an individual customer or country other than the United States accounted for more than 10% of revenue for the three or six months ended December 31, 2022 or 2021. Revenue, classified by the major geographic areas in which our customers were located, was as follows:

(In millions)	Three Months Ended December 31,				Six Months Ended December 31,
	2022		2021		2022		2021
United States (a)	$	26,976	$	26,463	$	52,843	$	49,293
Other countries		25,771		25,265		50,026		47,752
Total	$	52,747	$	51,728	$	102,869	$	97,045

(a) Includes billings to OEMs and certain multinational organizations because of the nature of these businesses and the impracticability of determining the geographic source of the revenue.

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Revenue, classified by significant product and service offerings, was as follows:

(In millions)	Three Months Ended December 31,						Six Months Ended December 31,
	2022		2021		2022			2021
Server products and cloud services	$	19,594	$	16,382	$	37,982		$	31,452
Office products and cloud services		11,837		11,251		23,385			22,059
Windows		4,808		6,594		10,121			12,268
Gaming		4,758		5,442		8,368			9,035
LinkedIn		3,876		3,531		7,539			6,667
Search and news advertising		3,223		3,064		6,151			5,720
Enterprise Services		1,862		1,823		3,738			3,614
Devices		1,430		2,357		2,878			3,771
Other		1,359		1,284		2,707			2,459
Total	$	52,747	$	51,728	$	102,869		$	97,045

Our Microsoft Cloud revenue, which includes Azure and other cloud services, Office 365 Commercial, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties, was $27.1 billion and $52.8 billion for the three and six months ended December 31, 2022, respectively, and $22.2 billion and $42.9 billion for the three and six months ended December 31, 2021, respectively. These amounts are primarily included in Server products and cloud services, Office products and cloud services, and LinkedIn in the table above.

Assets are not allocated to segments for internal reporting presentations. A portion of amortization and depreciation is included with various other costs in an overhead allocation to each segment. It is impracticable for us to separately identify the amount of amortization and depreciation by segment that is included in the measure of segment profit or loss.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and the Board of Directors of Microsoft Corporation

Results of Review of Interim Financial Information

We have reviewed the accompanying consolidated balance sheet of Microsoft Corporation and subsidiaries (the "Company") as of December 31, 2022, the related consolidated statements of income, comprehensive income, cash flows, and stockholders’ equity for the three-month and six-month periods ended December 31, 2022 and 2021, and the related notes (collectively referred to as the “interim financial information”). Based on our reviews, we are not aware of any material modifications that should be made to the accompanying interim financial information for it to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheet of the Company as of June 30, 2022, and the related consolidated statements of income, comprehensive income, cash flows, and stockholders' equity for the year then ended (not presented herein); and in our report dated July 28, 2022, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of June 30, 2022, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

Basis for Review Results

This interim financial information is the responsibility of the Company's management. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our reviews in accordance with standards of the PCAOB. A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the PCAOB, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

/S/ DELOITTE & TOUCHE LLP

Seattle, Washington

January 24, 2023

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Note About Forward-Looking Statements

This report includes estimates, projections, statements relating to our business plans, objectives, and expected operating results that are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may appear throughout this report, including the following sections: “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” (Part II, Item 1A of this Form 10-Q). These forward-looking statements generally are identified by the words “believe,” “project,” “expect,” “anticipate,” “estimate,” “intend,” “strategy,” “future,” “opportunity,” “plan,” “may,” “should,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties that may cause actual results to differ materially. We describe risks and uncertainties that could cause actual results and events to differ materially in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Quantitative and Qualitative Disclosures about Market Risk” (Part I, Item 3 of this Form 10-Q), and “Risk Factors”. We undertake no obligation to update or revise publicly any forward-looking statements, whether because of new information, future events, or otherwise.

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand the results of operations and financial condition of Microsoft Corporation. MD&A is provided as a supplement to, and should be read in conjunction with, our Annual Report on Form 10-K for the year ended June 30, 2022, and our financial statements and the accompanying Notes to Financial Statements (Part I, Item 1 of this Form 10-Q).

OVERVIEW

Microsoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platforms and tools help drive small business productivity, large business competitiveness, and public-sector efficiency. We are creating the platforms and tools that deliver better, faster, and more effective solutions to support new startups, improve educational and health outcomes, and empower human ingenuity.

We generate revenue by offering a wide range of cloud-based and other services to people and businesses; licensing and supporting an array of software products; designing, manufacturing, and selling devices; and delivering relevant online advertising to a global audience. Our most significant expenses are related to compensating employees; designing, manufacturing, marketing, and selling our products and services; datacenter costs in support of our cloud-based services; and income taxes.

Highlights from the second quarter of fiscal year 2023 compared with the second quarter of fiscal year 2022 included:

• Microsoft Cloud revenue increased 22% to $27.1 billion.

• Office Commercial products and cloud services revenue increased 7% driven by Office 365 Commercial growth of 11%.

• Office Consumer products and cloud services revenue decreased 2% and Microsoft 365 Consumer subscribers increased to 63.2 million.

• LinkedIn revenue increased 10%.

• Dynamics products and cloud services revenue increased 13% driven by Dynamics 365 growth of 21%.

• Server products and cloud services revenue increased 20% driven by Azure and other cloud services growth of 31%.

• Windows original equipment manufacturer licensing (“Windows OEM”) revenue decreased 39%.

• Windows Commercial products and cloud services revenue decreased 3%.

• Xbox content and services revenue decreased 12%.

• Search and news advertising revenue excluding traffic acquisition costs increased 10%.

• Devices revenue decreased 39%.

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Industry Trends

Our industry is dynamic and highly competitive, with frequent changes in both technologies and business models. Each industry shift is an opportunity to conceive new products, new technologies, or new ideas that can further transform the industry and our business. At Microsoft, we push the boundaries of what is possible through a broad range of research and development activities that seek to identify and address the changing demands of customers and users, industry trends, and competitive forces.

Economic Conditions, Challenges, and Risks

The markets for software, devices, and cloud-based services are dynamic and highly competitive. Our competitors are developing new software and devices, while also deploying competing cloud-based services for consumers and businesses. The devices and form factors customers prefer evolve rapidly, and influence how users access services in the cloud, and in some cases, the user’s choice of which suite of cloud-based services to use. We must continue to evolve and adapt over an extended time in pace with this changing environment. The investments we are making in infrastructure and devices will continue to increase our operating costs and may decrease our operating margins.

Our success is highly dependent on our ability to attract and retain qualified employees. We hire a mix of university and industry talent worldwide. We compete for talented individuals globally by offering an exceptional working environment, broad customer reach, scale in resources, the ability to grow one’s career across many different products and businesses, and competitive compensation and benefits. Aggregate demand for our software, services, and devices is correlated to global macroeconomic and geopolitical factors, which remain dynamic.

Our devices are primarily manufactured by third-party contract manufacturers, some of which contain certain components for which there are very few qualified suppliers. For these components, we have limited near-term flexibility to use other manufacturers if a current vendor becomes unavailable or is unable to meet our requirements. Extended disruptions at these suppliers and/or manufacturers could lead to a similar disruption in our ability to manufacture devices on time to meet consumer demand.

Our international operations provide a significant portion of our total revenue and expenses. Many of these revenue and expenses are denominated in currencies other than the U.S. dollar. As a result, changes in foreign exchange rates may significantly affect revenue and expenses. Fluctuations in the U.S. dollar relative to certain foreign currencies reduced reported revenue and expenses from our international operations for the three and six months ended December 31, 2022.

On January 18, 2023, we announced decisions we made to align our cost structure with our revenue and customer demand, prioritize our investments in strategic areas, and consolidate office space. As a result, we recorded a $1.2 billion charge in the second quarter of fiscal year 2023 (“Q2 charge”), which included employee severance expenses of $800 million, impairment charges resulting from changes to our hardware portfolio, and costs related to lease consolidation activities. First, we are reducing our overall workforce by approximately 10,000 jobs through the third quarter of fiscal year 2023, which represents less than 5% of our total employee base. While we are eliminating roles in some areas, we will continue to hire in key strategic areas. Second, we are allocating both our capital and talent to areas of secular growth and long-term competitiveness, while divesting in other areas. Third, we are consolidating our leases to create higher density across our workspaces, which will also impact our financial results through the remainder of fiscal year 2023, and we may make similar decisions in future periods as we continue to evaluate our real estate needs.

Refer to Risk Factors (Part II, Item 1A of this Form 10-Q) for a discussion of these factors and other risks.

Seasonality

Our revenue fluctuates quarterly and is generally higher in the second and fourth quarters of our fiscal year. Second quarter revenue is driven by corporate year-end spending trends in our major markets and holiday season spending by consumers, and fourth quarter revenue is driven by the volume of multi-year on-premises contracts executed during the period.

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Change in Accounting Estimate

In July 2022, we completed an assessment of the useful lives of our server and network equipment. Due to investments in software that increased efficiencies in how we operate our server and network equipment, as well as advances in technology, we determined we should increase the estimated useful lives of both server and network equipment from four years to six years. This change in accounting estimate was effective beginning fiscal year 2023. Based on the carrying amount of server and network equipment included in property and equipment, net as of June 30, 2022, the effect of this change in estimate for the three months ended December 31, 2022 was an increase in operating income of $945 million and net income of $768 million, or $0.10 per both basic and diluted share. The effect of this change for the six months ended December 31, 2022 was an increase in operating income of $2.0 billion and net income of $1.6 billion, or $0.22 per both basic and diluted share. It is estimated this change will increase our fiscal year 2023 annual operating income by $3.7 billion.

Reportable Segments

We report our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. The segment amounts included in MD&A are presented on a basis consistent with our internal management reporting. We have recast certain prior period amounts to conform to the way we internally manage and monitor our business.

Additional information on our reportable segments is contained in Note 17 – Segment Information and Geographic Data of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q).

Metrics

We use metrics in assessing the performance of our business and to make informed decisions regarding the allocation of resources. We disclose metrics to enable investors to evaluate progress against our ambitions, provide transparency into performance trends, and reflect the continued evolution of our products and services. Our commercial and other business metrics are fundamentally connected based on how customers use our products and services. The metrics are disclosed in the MD&A or the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q). Financial metrics are calculated based on financial results prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), and growth comparisons relate to the corresponding period of last fiscal year.

In the first quarter of fiscal year 2023, we made updates to the presentation and method of calculation for certain metrics, most notably expanding our Surface metric into a broader Devices metric to incorporate additional revenue streams, along with other minor changes to align with how we manage our businesses.

Commercial

Our commercial business primarily consists of Server products and cloud services, Office Commercial, Windows Commercial, the commercial portion of LinkedIn, Enterprise Services, and Dynamics. Our commercial metrics allow management and investors to assess the overall health of our commercial business and include leading indicators of future performance.

Commercial remaining performance obligation	Commercial portion of revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods
Microsoft Cloud revenue	Revenue from Azure and other cloud services, Office 365 Commercial, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties
Microsoft Cloud gross margin percentage	Gross margin percentage for our Microsoft Cloud business

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Productivity and Business Processes and Intelligent Cloud

Metrics related to our Productivity and Business Processes and Intelligent Cloud segments assess the health of our core businesses within these segments. The metrics reflect our cloud and on-premises product strategies and trends.

Office Commercial products and cloud services revenue growth	Revenue from Office Commercial products and cloud services (Office 365 subscriptions, the Office 365 portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises), comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Microsoft Viva
Office Consumer products and cloud services revenue growth	Revenue from Office Consumer products and cloud services, including Microsoft 365 Consumer subscriptions, Office licensed on-premises, and other Office services
Office 365 Commercial seat growth	The number of Office 365 Commercial seats at end of period where seats are paid users covered by an Office 365 Commercial subscription
Microsoft 365 Consumer subscribers	The number of Microsoft 365 Consumer subscribers at end of period
Dynamics products and cloud services revenue growth	Revenue from Dynamics products and cloud services, including Dynamics 365, comprising a set of intelligent, cloud-based applications across ERP, CRM, Customer Insights, Power Apps, and Power Automate; and on-premises ERP and CRM applications
LinkedIn revenue growth	Revenue from LinkedIn, including Talent Solutions, Marketing Solutions, Premium Subscriptions, and Sales Solutions
Server products and cloud services revenue growth	Revenue from Server products and cloud services, including Azure and other cloud services; SQL Server, Windows Server, Visual Studio, System Center, and related Client Access Licenses (“CALs”); and Nuance and GitHub

More Personal Computing

Metrics related to our More Personal Computing segment assess the performance of key lines of business within this segment. These metrics provide strategic product insights which allow us to assess the performance across our commercial and consumer businesses. As we have diversity of target audiences and sales motions within the Windows business, we monitor metrics that are reflective of those varying motions.

Windows OEM revenue growth	Revenue from sales of Windows Pro and non-Pro licenses sold through the OEM channel
Windows Commercial products and cloud services revenue growth	Revenue from Windows Commercial products and cloud services, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings
Devices revenue growth	Revenue from Devices, including Surface, HoloLens, and PC accessories
Xbox content and services revenue growth	Revenue from Xbox content and services, comprising first- and third-party content (including games and in-game content), Xbox Game Pass and other subscriptions, Xbox Cloud Gaming, third-party disc royalties, advertising, and other cloud services
Search and news advertising revenue (ex TAC) growth	Revenue from search and news advertising excluding traffic acquisition costs (“TAC”) paid to Bing Ads network publishers and news partners

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SUMMARY RESULTS OF OPERATIONS

(In millions, except percentages and per share amounts)		Three Months Ended December 31,			Percentage Change		Six Months Ended December 31,				Percentage Change
		2022		2021				2022		2021
Revenue	$	52,747	$	51,728		2%	$	102,869	$	97,045		6%
Gross margin		35,259		34,768		1%		69,929		66,439		5%
Operating income		20,399		22,247		(8)%		41,917		42,485		(1)%
Net income		16,425		18,765		(12)%		33,981		39,270		(13)%
Diluted earnings per share		2.20		2.48		(11)%		4.54		5.19		(13)%
Adjusted gross margin (non-GAAP)		35,411		34,768		2%		70,081		66,439		5%
Adjusted operating income (non-GAAP)		21,570		22,247		(3)%		43,088		42,485		1%
Adjusted net income (non-GAAP)		17,371		18,765		(7)%		34,927		35,979		(3)%
Adjusted diluted earnings per share (non-GAAP)		2.32		2.48		(6)%		4.67		4.76		(2)%

Adjusted gross margin, operating income, net income, and diluted earnings per share (“EPS”) are non-GAAP financial measures. Current year non-GAAP financial measures exclude the impact of the Q2 charge, which includes employee severance expenses, impairment charges resulting from changes to our hardware portfolio, and costs related to lease consolidation activities. Prior year non-GAAP financial measures exclude the net income tax benefit related to transfer of intangible properties in the first quarter of fiscal year 2022. Refer to Note 11 – Income Taxes of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) for further discussion. Refer to the Non-GAAP Financial Measures section below for a reconciliation of our financial results reported in accordance with GAAP to non-GAAP financial results.

Three Months Ended December 31, 2022 Compared with Three Months Ended December 31, 2021

Revenue increased $1.0 billion or 2% driven by growth in Intelligent Cloud and Productivity and Business Processes, offset in part by a decline in More Personal Computing. Intelligent Cloud revenue increased driven by Azure and other cloud services. Productivity and Business Processes revenue increased driven by Office 365 Commercial. More Personal Computing revenue decreased driven by declines in Windows, Devices, and Gaming.

Cost of revenue increased $528 million or 3% driven by growth in Microsoft Cloud, offset in part by a reduction in depreciation expense due to the change in accounting estimate for the useful lives of our server and network equipment.

Gross margin increased $491 million or 1% driven by growth in Intelligent Cloud and Productivity and Business Processes and the change in accounting estimate, offset in part by a decline in More Personal Computing.

• Gross margin percentage decreased slightly. Excluding the impact of the change in accounting estimate, gross margin percentage decreased 2 points driven by reductions in More Personal Computing and Intelligent Cloud, offset in part by sales mix shift.

• Microsoft Cloud gross margin percentage increased 2 points to 72%. Excluding the impact of the change in accounting estimate, Microsoft Cloud gross margin percentage decreased 1 point driven by sales mix shift to Azure and other cloud services and higher energy costs.

Operating expenses increased $2.3 billion or 19% driven by employee severance expenses, investments in cloud engineering, the Nuance acquisition, and LinkedIn.

Key changes in operating expenses were:

• Research and development expenses increased $1.1 billion or 19% driven by investments in cloud engineering, impairment charges resulting from changes to our hardware portfolio, and LinkedIn. Research and development included a favorable foreign currency impact of 2%.

• Sales and marketing expenses increased $300 million or 6% driven by the Nuance acquisition and investments in commercial sales. Sales and marketing included a favorable foreign currency impact of 3%.

• General and administrative expenses increased $953 million or 69% driven by employee severance expenses. General and administrative included a favorable foreign currency impact of 2%.

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Operating income decreased $1.8 billion or 8% driven by a decline in More Personal Computing, offset in part by the change in accounting estimate.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 5%, 7%, and 8%, respectively. Cost of revenue and operating expenses both included a favorable foreign currency impact of 2%.

Current year gross margin, operating income, net income, and diluted EPS were negatively impacted by the Q2 charge, which resulted in decreases of $152 million, $1.2 billion, $946 million, and $0.12, respectively.

Six Months Ended December 31, 2022 Compared with Six Months Ended December 31, 2021

Revenue increased $5.8 billion or 6% driven by growth in Intelligent Cloud and Productivity and Business Processes, offset in part by a decline in More Personal Computing. Intelligent Cloud revenue increased driven by Azure and other cloud services. Productivity and Business Processes revenue increased driven by Office 365 Commercial and LinkedIn. More Personal Computing revenue decreased driven by declines in Windows, Devices, and Gaming, offset in part by growth in Search and news advertising.

Cost of revenue increased $2.3 billion or 8% driven by growth in Microsoft Cloud, offset in part by the change in accounting estimate.

Gross margin increased $3.5 billion or 5% driven by growth in Intelligent Cloud and Productivity and Business Processes and the change in accounting estimate, offset in part by a decline in More Personal Computing.

• Gross margin percentage decreased slightly. Excluding the impact of the change in accounting estimate, gross margin percentage decreased 2 points driven by reductions in More Personal Computing and Intelligent Cloud, offset in part by sales mix shift.

• Microsoft Cloud gross margin percentage increased 2 points to 72%. Excluding the impact of the change in accounting estimate, Microsoft Cloud gross margin percentage decreased 1 point driven by sales mix shift to Azure and other cloud services and higher energy costs.

Operating expenses increased $4.1 billion or 17% driven by investment in cloud engineering, employee severance expenses, LinkedIn, the Nuance acquisition, and commercial sales.

Key changes in operating expenses were:

• Research and development expenses increased $2.1 billion or 19% driven by investments in cloud engineering and LinkedIn.

• Sales and marketing expenses increased $879 million or 9% driven by investments in commercial sales and the Nuance acquisition. Sales and marketing included a favorable foreign currency impact of 4%.

• General and administrative expenses increased $1.1 billion or 40% driven by employee severance expenses. General and administrative included a favorable foreign currency impact of 3%.

Operating income decreased $568 million or 1% driven by a decline in More Personal Computing, offset in part by the change in accounting estimate and growth in Productivity and Business Processes and Intelligent Cloud.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 5%, 7%, and 8%, respectively. Cost of revenue and operating expenses included a favorable foreign currency impact of 2% and 3%, respectively.

Current year gross margin, operating income, net income, and diluted EPS were negatively impacted by the Q2 charge, which resulted in decreases of $152 million, $1.2 billion, $946 million, and $0.13, respectively. Prior year net income and diluted EPS were positively impacted by the net tax benefit related to the transfer of intangible properties, which resulted in an increase to net income and diluted EPS of $3.3 billion and $0.43, respectively.

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SEGMENT RESULTS OF OPERATIONS

(In millions, except percentages)	Three Months Ended December 31,				Percentage Change		Six Months Ended December 31,				Percentage Change
	2022		2021					2022		2021
Revenue
Productivity and Business Processes	$	17,002	$	15,936		7%	$	33,467	$	30,975		8%
Intelligent Cloud		21,508		18,262		18%		41,833		35,174		19%
More Personal Computing		14,237		17,530		(19)%		27,569		30,896		(11)%
Total	$	52,747	$	51,728		2%	$	102,869	$	97,045		6%
Operating Income
Productivity and Business Processes	$	8,175	$	7,688		6%	$	16,498	$	15,269		8%
Intelligent Cloud		8,904		8,323		7%		17,882		16,004		12%
More Personal Computing		3,320		6,236		(47)%		7,537		11,212		(33)%
Total	$	20,399	$	22,247		(8)%	$	41,917	$	42,485		(1)%

Reportable Segments

Three Months Ended December 31, 2022 Compared with Three Months Ended December 31, 2021

Productivity and Business Processes

Revenue increased $1.1 billion or 7%.

• Office Commercial products and cloud services revenue increased $627 million or 7%. Office 365 Commercial revenue grew 11% with seat growth of 12%, driven by small and medium business and frontline worker offerings, as well as growth in revenue per user. Office Commercial products revenue declined 30% driven by continued customer shift to cloud offerings.

• Office Consumer products and cloud services revenue decreased $39 million or 2%. Microsoft 365 Consumer subscribers grew 12% to 63.2 million.

• LinkedIn revenue increased $345 million or 10% driven by Talent Solutions.

• Dynamics products and cloud services revenue increased 13% driven by Dynamics 365 growth of 21%.

Operating income increased $487 million or 6%.

• Gross margin increased $1.0 billion or 8% driven by growth in Office 365 Commercial. Gross margin percentage increased. Excluding the impact of the change in accounting estimate, gross margin percentage decreased slightly driven by sales mix shift to cloud offerings.

• Operating expenses increased $554 million or 12% driven by investment in LinkedIn and employee severance expenses.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 6%, 8%, and 11%, respectively. Operating expenses included a favorable foreign currency impact of 2%.

Intelligent Cloud

Revenue increased $3.2 billion or 18%.

• Server products and cloud services revenue increased $3.2 billion or 20% driven by Azure and other cloud services. Azure and other cloud services revenue grew 31% driven by growth in our consumption-based services. Server products revenue decreased 2%.

• Enterprise Services revenue increased $39 million or 2% driven by growth in Enterprise Support Services, offset by a decline in Microsoft Consulting Services.

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Operating income increased $581 million or 7%.

• Gross margin increased $2.2 billion or 17% driven by growth in Azure and other cloud services and the change in accounting estimate. Gross margin percentage decreased slightly. Excluding the impact of the change in accounting estimate, gross margin percentage decreased 3 points driven by sales mix shift to Azure and other cloud services and higher energy costs.

• Operating expenses increased $1.6 billion or 34% driven by employee severance expenses, investments in Azure, and the Nuance acquisition.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 6%, 6%, and 8%, respectively. Operating expenses included a favorable foreign currency impact of 3%.

More Personal Computing

Revenue decreased $3.3 billion or 19%.

• Windows revenue decreased $1.8 billion or 27% driven by a decrease in Windows OEM. Windows OEM revenue decreased 39% on a strong prior year comparable, driven by continued PC market weakness and 3 points of negative impact from the prior year Windows 11 revenue deferral. Windows Commercial products and cloud services revenue decreased 3% driven by a decline in standalone product sales.

• Devices revenue decreased $927 million or 39% driven by continued PC market weakness and execution challenges on new product launches.

• Gaming revenue decreased $684 million or 13% driven by declines in Xbox content and services and Xbox hardware. Xbox content and services revenue decreased 12% on a strong prior year comparable impacted by first-party game launches, driven by declines in first-party content and a lower rate of monetization in third-party content, offset in part by growth in Xbox Game Pass subscriptions. Xbox hardware revenue decreased 13% driven by lower price and volume of consoles sold.

• Search and news advertising revenue increased $159 million or 5%. Search and news advertising revenue excluding traffic acquisition costs increased 10% driven by higher search volume and the Xandr acquisition, offset in part by lower revenue per search.

Operating income decreased $2.9 billion or 47%.

• Gross margin decreased $2.7 billion or 29% driven by declines in Windows and Devices. Gross margin percentage decreased driven by reductions in Devices, including the impact of impairment charges resulting from changes to our hardware portfolio, and sales mix shift to lower margin businesses.

• Operating expenses increased $198 million or 6% driven by employee severance expenses and investments in Search and news advertising, offset in part by a decline in Devices.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 3%, 5%, and 7%, respectively. Operating expenses included a favorable foreign currency impact of 3%.

Six Months Ended December 31, 2022 Compared with Six Months Ended December 31, 2021

Productivity and Business Processes

Revenue increased $2.5 billion or 8%.

• Office Commercial products and cloud services revenue increased $1.3 billion or 7%. Office 365 Commercial revenue grew 11% with seat growth of 12%, driven by small and medium business and frontline worker offerings, as well as growth in revenue per user. Office Commercial products revenue declined 29% driven by continued customer shift to cloud offerings.

• Office Consumer products and cloud services revenue increased $66 million or 2% with continued growth in Microsoft 365 Consumer subscription revenue.

• LinkedIn revenue increased $872 million or 13% driven by Talent Solutions.

• Dynamics products and cloud services revenue increased 14% driven by Dynamics 365 growth of 23%.

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Operating income increased $1.2 billion or 8%.

• Gross margin increased $2.4 billion or 10% driven by growth in Office 365 Commercial and LinkedIn. Gross margin percentage increased. Excluding the impact of the change in accounting estimate, gross margin percentage decreased slightly driven by sales mix shift to cloud offerings.

• Operating expenses increased $1.1 billion or 12% driven by investments in LinkedIn and cloud engineering, as well as employee severance expenses.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 6%, 7%, and 10%, respectively. Operating expenses included a favorable foreign currency impact of 3%.

Intelligent Cloud

Revenue increased $6.7 billion or 19%.

• Server products and cloud services revenue increased $6.5 billion or 21% driven by Azure and other cloud services. Azure and other cloud services revenue grew 33% driven by growth in our consumption-based services. Server products revenue decreased 1%.

• Enterprise Services revenue increased $124 million or 3% driven by growth in Enterprise Support Services, offset in part by a decline in Microsoft Consulting Services.

Operating income increased $1.9 billion or 12%.

• Gross margin increased $4.5 billion or 18% driven by growth in Azure and other cloud services and the change in accounting estimate. Gross margin percentage decreased slightly. Excluding the impact of the change in accounting estimate, gross margin percentage decreased 3 points driven by sales mix shift to Azure and other cloud services and higher energy costs.

• Operating expenses increased $2.7 billion or 30% driven by investments in Azure, the Nuance acquisition, and employee severance expenses.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 6%, 7%, and 8%, respectively. Operating expenses included a favorable foreign currency impact of 3%.

More Personal Computing

Revenue decreased $3.3 billion 11%.

• Windows revenue decreased $2.1 billion or 18% driven by a decrease in Windows OEM. Windows OEM revenue decreased 28% driven by continued PC market weakness. Windows Commercial products and cloud services revenue increased 2% driven by demand for Microsoft 365, offset in part by a decline in standalone product sales.

• Devices revenue decreased $893 million or 24% driven by continued PC market weakness and execution challenges on new product launches.

• Gaming revenue decreased $667 million or 7% driven by declines in Xbox content and services and Xbox hardware. Xbox content and services revenue decreased 8% driven by declines in first-party content and in third-party content, with lower rate of monetization and engagement hours, offset in part by growth in Xbox Game Pass subscriptions. Xbox hardware revenue decreased 5% driven by lower price of consoles sold.

• Search and news advertising revenue increased $431 million or 8%. Search and news advertising revenue excluding traffic acquisition costs increased 13% driven by higher search volume and the Xandr acquisition, offset in part by lower revenue per search.

Operating income decreased $3.7 billion or 33%.

• Gross margin decreased $3.4 billion or 20% driven by declines in Windows, Devices, and Gaming. Gross margin percentage decreased driven by reductions in Devices, including the impact of impairment charges resulting from changes to our hardware portfolio, and sales mix shift to lower margin businesses.

• Operating expenses increased $269 million or 4% driven by investment in Search and news advertising and employee severance expenses, offset in part by a decline in Devices.

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Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 3%, 5%, and 7%, respectively. Operating expenses included a favorable foreign currency impact of 3%.

OPERATING EXPENSES

Research and Development

(In millions, except percentages)	Three Months Ended December 31,				Percentage Change		Six Months Ended December 31,					Percentage Change
	2022		2021					2022			2021
Research and development	$	6,844	$	5,758		19%	$		13,472	$	11,357		19%
As a percent of revenue		13%		11%		2ppt		13%			12%		1ppt

Research and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content.

Three Months Ended December 31, 2022 Compared with Three Months Ended December 31, 2021

Research and development expenses increased $1.1 billion or 19% driven by investments in cloud engineering, impairment charges resulting from changes to our hardware portfolio, and LinkedIn. Research and development included a favorable foreign currency impact of 2%.

Six Months Ended December 31, 2022 Compared with Six Months Ended December 31, 2021

Research and development expenses increased $2.1 billion or 19% driven by investments in cloud engineering and LinkedIn.

Sales and Marketing

(In millions, except percentages)	Three Months Ended December 31,				Percentage Change		Six Months Ended December 31,					Percentage Change
	2022		2021					2022			2021
Sales and marketing	$	5,679	$	5,379		6%	$		10,805	$	9,926		9%
As a percent of revenue		11%		10%		1ppt		11%			10%		1ppt

Sales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs.

Three Months Ended December 31, 2022 Compared with Three Months Ended December 31, 2021

Sales and marketing expenses increased $300 million or 6% driven by the Nuance acquisition and investments in commercial sales. Sales and marketing included a favorable foreign currency impact of 3%.

Six Months Ended December 31, 2022 Compared with Six Months Ended December 31, 2021

Sales and marketing expenses increased $879 million or 9% driven by investments in commercial sales and the Nuance acquisition. Sales and marketing included a favorable foreign currency impact of 4%.

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General and Administrative

(In millions, except percentages)	Three Months Ended December 31,				Percentage Change		Six Months Ended December 31,					Percentage Change
	2022		2021					2022			2021
General and administrative	$	2,337	$	1,384		69%	$		3,735	$	2,671		40%
As a percent of revenue		4%		3%		1ppt		4%			3%