Item 1. Financial Statements

112K characters. Original on sec.gov · Markdown

Item 1. Financial Statements

(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, 2021

Changes in Fair Value Recorded in Other Comprehensive Income

Commercial paper	Level 2	$	4,316	$	0	$	0		$	4,316	$	1,331	$	2,985	$	0
Certificates of deposit	Level 2		3,615		0		0			3,615		2,920		695		0
U.S. government securities	Level 1		90,664		3,832		(111	)		94,385		1,500		92,885		0
U.S. agency securities	Level 2		807		2		0			809		0		809		0
Foreign government bonds	Level 2		6,213		9		(2	)		6,220		225		5,995		0
Mortgage- and asset-backed securities	Level 2		3,442		22		(6	)		3,458		0		3,458		0
Corporate notes and bonds	Level 2		8,443		249		(9	)		8,683		0		8,683		0
Corporate notes and bonds	Level 3		63		0		0			63		0		63		0
Municipal securities	Level 2		308		63		0			371		0		371		0
Municipal securities	Level 3		95		0		(7	)		88		0		88		0


Total debt investments		$	117,966	$	4,177	$	(135	)	$	122,008	$	5,976	$	116,032	$	0


Changes in Fair Value Recorded in Net Income

Equity investments	Level 1								$	1,582	$	976	$	0	$	606
Equity investments	Other									5,378		0		0		5,378


Total equity investments									$	6,960	$	976	$	0	$	5,984


Cash									$	7,272	$	7,272	$	0	$	0
Derivatives, net (a)										78		0		78		0


Total									$	136,318	$	14,224	$	116,110	$	5,984

(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 September 30, 2021 and June 30, 2021, equity investments without readily determinable fair values measured at cost with adjustments for observable changes in price or impairments were $3.5 billion and $3.3 billion, respectively.

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


September 30, 2021

U.S. government and agency securities	$	5,420	$	(98	)	$	604	$	(36	)	$	6,024	$	(134	)
Foreign government bonds		1,215		(3	)		8		(1	)		1,223		(4	)
Mortgage- and asset-backed securities		1,240		(5	)		140		(2	)		1,380		(7	)
Corporate notes and bonds		2,030		(12	)		43		(1	)		2,073		(13	)
Municipal securities		20		0			54		(7	)		74		(7	)


Total	$	9,925	$	(118	)	$	849	$	(47	)	$	10,774	$	(165	)

PART I

Item 1

	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, 2021

U.S. government and agency securities	$	5,294	$	(111	)	$	0	$	0		$	5,294	$	(111	)
Foreign government bonds		3,148		(1	)		5		(1	)		3,153		(2	)
Mortgage- and asset-backed securities		1,211		(5	)		87		(1	)		1,298		(6	)
Corporate notes and bonds		1,678		(8	)		34		(1	)		1,712		(9	)
Municipal securities		58		(7	)		1		0			59		(7	)


Total	$	11,389	$	(132	)	$	127	$	(3	)	$	11,516	$	(135	)

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


September 30, 2021

Due in one year or less	$	31,699	$	31,858
Due after one year through five years		60,679		63,102
Due after five years through 10 years		23,911		24,758
Due after 10 years		2,727		2,805


Total	$	119,016	$	122,523

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.

In the past, option and forward contracts were used to hedge a portion of forecasted international revenue and were designated as cash flow hedging instruments. Principal currencies hedged included the Euro, Japanese yen, British pound, Canadian dollar, and Australian dollar.

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.

PART I

Item 1

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 September 30, 2021, 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)	September 30, 2021		June 30, 2021


Designated as Hedging Instruments

Foreign exchange contracts purchased	$	635	$	635
Foreign exchange contracts sold		2,984		6,081
Interest rate contracts purchased		1,235		1,247

Not Designated as Hedging Instruments

Foreign exchange contracts purchased		8,527		14,223
Foreign exchange contracts sold		13,805		23,391
Other contracts purchased		3,042		2,456
Other contracts sold		719		763

PART I

Item 1

Fair Values of Derivative Instruments

The following table presents our derivative instruments:

	Derivative				Derivative		Derivative			Derivative
(In millions)	Assets				Liabilities		Assets			Liabilities


	September 30, 2021						June 30, 2021

Designated as Hedging Instruments

Foreign exchange contracts	$	49		$	(20	)	$	76		$	(8	)
Interest rate contracts		33			0			40			0

Not Designated as Hedging Instruments

Foreign exchange contracts		197			(155	)		227			(291	)
Other contracts		25			(73	)		56			(36	)


Gross amounts of derivatives		304			(248	)		399			(335	)
Gross amounts of derivatives offset in the balance sheet		(96	)		97			(141	)		142
Cash collateral received		0			(70	)		0			(42	)


Net amounts of derivatives	$	208		$	(221	)	$	258		$	(235	)


Reported as

Short-term investments	$	31		$	0		$	78		$	0
Other current assets		144			0			137			0
Other long-term assets		33			0			43			0
Other current liabilities		0			(141	)		0			(182	)
Other long-term liabilities		0			(80	)		0			(53	)


Total	$	208		$	(221	)	$	258		$	(235	)

Gross derivative assets and liabilities subject to legally enforceable master netting agreements for which we have elected to offset were $298 million and $245 million, respectively, as of September 30, 2021, and $395 million and $335 million, respectively, as of June 30, 2021.

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

(In millions)	Level 1				Level 2		Level 3		Total


September 30, 2021

Derivative assets	$	0		$	298		$	6	$	304
Derivative liabilities		(3	)		(245	)		0		(248	)

June 30, 2021

Derivative assets		0			396			3		399
Derivative liabilities		0			(335	)		0		(335	)

PART I

Item 1

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

(In millions)


Three Months Ended September 30,		2021			2020

Designated as Fair Value Hedging Instruments

Foreign exchange contracts
Derivatives	$	3		$	(169	)
Hedged items		(5	)		168
Excluded from effectiveness assessment		4			8

Interest rate contracts
Derivatives		(3	)		0
Hedged items		7			4

Designated as Cash Flow Hedging Instruments

Foreign exchange contracts
Amount reclassified from accumulated other comprehensive income		(15	)		20

Not Designated as Hedging Instruments

Foreign exchange contracts		177			58
Other contracts		(18	)		4

Gains (losses), net of tax, on derivative instruments recognized in our consolidated comprehensive income statements were as follows:

(In millions)


Three Months Ended September 30,	2021			2020

Designated as Cash Flow Hedging Instruments

Foreign exchange contracts
Included in effectiveness assessment	$	(10	)	$	20

NOTE 6 — INVENTORIES

The components of inventories were as follows:

(In millions)


	September 30, 2021		June 30, 2021

Raw materials	$	1,178	$	1,190
Work in process		74		79
Finished goods		2,159		1,367


Total	$	3,411	$	2,636

NOTE 7 — BUSINESS COMBINATIONS

ZeniMax Media Inc.

On March 9, 2021, we completed our acquisition of ZeniMax Media Inc. (“ZeniMax”), the parent company of Bethesda Softworks LLC (“Bethesda”), for a total purchase price of $8.1 billion, consisting primarily of cash. The purchase price included $768 million of cash and cash equivalents acquired. Bethesda is one of the largest, privately held game developers and publishers in the world, and brings a broad portfolio of games, technology, and talent to Xbox. The financial results of ZeniMax have been included in our consolidated financial statements since the date of the acquisition. ZeniMax is reported as part of our More Personal Computing segment.

The purchase price allocation as of the date of acquisition was based on a preliminary valuation and is subject to revision as more detailed analyses are completed and additional information about the fair value of assets acquired and liabilities assumed becomes available.

PART I

Item 1

The major classes of assets and liabilities to which we have preliminarily allocated the purchase price were as follows:

(In millions)


Cash and cash equivalents	$	768
Goodwill		5,469
Intangible assets		1,968
Other assets		139
Other liabilities		(223	)


Total	$	8,121

Goodwill was assigned to our More Personal Computing segment. The goodwill was primarily attributed to increased synergies that are expected to be achieved from the integration of ZeniMax. None of the goodwill is expected to be deductible for income tax purposes.

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

(In millions)	Amount


Technology-based	$	1,341	4 years
Marketing-related		627	11 years


Total	$	1,968	6 years

Nuance Communications, Inc.

On April 11, 2021, we entered into a definitive agreement to acquire Nuance Communications, Inc. (“Nuance”) for $56.00 per share in an all-cash transaction valued at $19.7 billion, inclusive of Nuance’s net debt. 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 acquisition has been approved by Nuance’s shareholders, and we expect it to close by the end of the second quarter or early in the third quarter of fiscal year 2022, subject to the satisfaction of certain regulatory approvals and other customary closing conditions.

NOTE 8 — GOODWILL

Changes in the carrying amount of goodwill were as follows:

(In millions)	June 30, 2021		Acquisitions		Other			September 30, 2021


Productivity and Business Processes	$	24,317	$	52	$	(16	)	$	24,353
Intelligent Cloud		13,256		584		7			13,847
More Personal Computing		12,138		172		(55	)		12,255


Total	$	49,711	$	808	$	(64	)	$	50,455

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.

PART I

Item 1

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


	September 30, 2021							June 30, 2021

Technology-based	$	10,207	$	(7,202	)	$	3,005	$	9,779	$	(7,007	)	$	2,772
Customer-related		4,960		(3,019	)		1,941		4,958		(2,859	)		2,099
Marketing-related		4,794		(1,959	)		2,835		4,792		(1,878	)		2,914
Contract-based		446		(433	)		13		446		(431	)		15


Total	$	20,407	$	(12,613	)	$	7,794	$	19,975	$	(12,175	)	$	7,800

Intangible assets amortization expense was $439 million and $383 million for the three months ended September 30, 2021 and 2020, respectively.

The following table outlines the estimated future amortization expense related to intangible assets held as of September 30, 2021:

(In millions)


Year Ending June 30,

2022 (excluding the three months ended September 30, 2021)	$	1,348
2023		1,821
2024		1,512
2025		898
2026		547
Thereafter		1,668


Total	$	7,794

PART I

Item 1

NOTE 10 — DEBT

The components of debt were as follows:

(In millions, issuance by calendar year)							Effective Interest Rate			September 30, 2021			June 30, 2021


2009 issuance of $3.8 billion (a)			2039			5.20%			5.24%	$	520		$	520
2010 issuance of $4.8 billion (a)			2040			4.50%			4.57%		486			486
2011 issuance of $2.3 billion (a)			2041			5.30%			5.36%		718			718
2012 issuance of $2.3 billion (a)	2022	–	2042	2.13%	–	3.50%	2.24%	–	3.57%		1,204			1,204
2013 issuance of $5.2 billion (a)	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%		2,665			4,803
2015 issuance of $23.8 billion (a)	2022	–	2055	2.38%	–	4.75%	2.47%	–	4.78%		12,305			12,305
2016 issuance of $19.8 billion (a)	2023	–	2056	2.00%	–	3.95%	2.10%	–	4.03%		9,430			12,180
2017 issuance of $17.0 billion (a)	2022	–	2057	2.40%	–	4.50%	2.52%	–	4.53%		10,695			10,695
2020 issuance of $10.0 billion (a)	2050	–	2060	2.53%	–	2.68%	2.53%	–	2.68%		10,000			10,000
2021 issuance of $8.2 billion (a)	2052	–	2062	2.92%	–	3.04%	2.92%	–	3.04%		8,185			8,185


Total face value											59,022			63,910
Unamortized discount and issuance costs											(499	)		(511	)
Hedge fair value adjustments (b)											33			40
Premium on debt exchange (a)											(5,268	)		(5,293	)


Total debt											53,288			58,146
Current portion of long-term debt											(3,249	)		(8,072	)


Long-term debt										$	50,039		$	50,074

(a)	In March 2021 and June 2020, we exchanged a portion of our existing debt at a premium for cash and new debt with longer maturities. The premiums are amortized over the terms of the new debt.

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

As of September 30, 2021 and June 30, 2021, the estimated fair value of long-term debt, including the current portion, was $64.2 billion and $70.0 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 September 30, 2021:

(In millions)


Year Ending June 30,

2022 (excluding the three months ended September 30, 2021)	$	3,250
2023		2,750
2024		5,250
2025		2,250
2026		3,000
Thereafter		42,522


Total	$	59,022

NOTE 11 — INCOME TAXES

Effective Tax Rate

Our effective tax rate was 0% and 14% for the three months ended September 30, 2021 and 2020, respectively. The decrease in our effective tax rate for the current quarter 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.

PART I

Item 1

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 exceeds 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 months ended September 30, 2021, primarily due to the net income tax benefit related to the transfer of intangible properties, 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, and tax benefits relating to stock-based compensation.

Uncertain Tax Positions

As of both September 30, 2021 and June 30, 2021, unrecognized tax benefits and other income tax liabilities were $15.9 billion 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 September 30, 2021, 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 2021, 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)


	September 30, 2021		June 30, 2021

Productivity and Business Processes	$	20,565	$	22,120
Intelligent Cloud		16,117		17,710
More Personal Computing		4,333		4,311


Total	$	41,015	$	44,141

Changes in unearned revenue were as follows:

(In millions)


Three Months Ended September 30, 2021

Balance, beginning of period	$	44,141
Deferral of revenue		21,970
Recognition of unearned revenue		(25,096	)


Balance, end of period	$	41,015

PART I

Item 1

Revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods, was $142 billion as of September 30, 2021, of which $137 billion is related to the commercial portion of revenue. We expect to recognize approximately 50% 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 1 year to 15 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 September 30,		2021		2020

Operating lease cost	$	588	$	498


Finance lease cost:
Amortization of right-of-use assets	$	226	$	206
Interest on lease liabilities		104		92


Total finance lease cost	$	330	$	298

Supplemental cash flow information related to leases was as follows:

(In millions)


Three Months Ended September 30,		2021		2020

Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	566	$	491
Operating cash flows from finance leases		104		92
Financing cash flows from finance leases		200		136

Right-of-use assets obtained in exchange for lease obligations:
Operating leases		1,171		678
Finance leases		1,389		635

PART I

Item 1

Supplemental balance sheet information related to leases was as follows:

(In millions, except lease term and discount rate)


	September 30, 2021			June 30, 2021

Operating Leases

Operating lease right-of-use assets	$	11,575		$	11,088


Other current liabilities	$	2,049		$	1,962
Operating lease liabilities		10,050			9,629


Total operating lease liabilities	$	12,099		$	11,591


Finance Leases

Property and equipment, at cost	$	15,285		$	14,107
Accumulated depreciation		(2,531	)		(2,306	)


Property and equipment, net	$	12,754		$	11,801


Other current liabilities	$	882		$	791
Other long-term liabilities		12,666			11,750


Total finance lease liabilities	$	13,548		$	12,541


Weighted Average Remaining Lease Term

Operating leases		8 years			8 years
Finance leases		10 years			12 years

Weighted Average Discount Rate

Operating leases		2.1%			2.2%
Finance leases		3.3%			3.4%

The following table outlines maturities of our lease liabilities as of September 30, 2021:

(In millions)


Year Ending June 30,	Operating Leases			Finance Leases

2022 (excluding the three months ended September 30, 2021)	$	1,667		$	962
2023		2,072			1,295
2024		1,871			1,312
2025		1,588			1,638
2026		1,256			1,324
Thereafter		4,647			9,743


Total lease payments		13,101			16,274
Less imputed interest		(1,002	)		(2,726	)


Total	$	12,099		$	13,548

As of September 30, 2021, we have additional operating and finance leases, primarily for datacenters, that have not yet commenced of $5.1 billion and $5.9 billion, respectively. These operating and finance leases will commence between fiscal year 2022 and fiscal year 2026 with lease terms of 1 year to 15 years.

NOTE 14 — CONTINGENCIES

Patent and Intellectual Property Claims

There were 65 patent infringement cases pending against Microsoft as of September 30, 2021, none of which are material individually or in aggregate.

PART I

Item 1

Antitrust, Unfair Competition, and Overcharge Class Actions

Antitrust and unfair competition class action lawsuits were filed against us in British Columbia, Ontario, and Quebec, Canada. All three have been certified on behalf of Canadian indirect purchasers who acquired licenses for Microsoft operating system software and/or productivity application software between 1998 and 2010.

The trial of the British Columbia action commenced in May 2016. Following a mediation, the parties agreed to a global settlement of all three Canadian actions and submitted the proposed settlement agreement to the courts in all three jurisdictions for approval. The final settlement and form of notice were approved by the courts in British Columbia, Ontario, and Quebec, and the claims period that commenced on November 23, 2020 has closed. The claims review deadline is January 21, 2022.

Other Antitrust Litigation and Claims

China State Administration for Market Regulation Investigation

In 2014, Microsoft was informed that China’s State Agency for Market Regulation (“SAMR”) (formerly State Administration for Industry and Commerce) had begun a formal investigation relating to China’s Anti-Monopoly Law, and the SAMR conducted onsite inspections of Microsoft offices in Beijing, Shanghai, Guangzhou, and Chengdu. In 2019, the SAMR presented preliminary views as to certain possible violations of China’s Anti-Monopoly Law.

Product-Related Litigation

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 the defendants have moved to strike. In August 2018, the trial court issued an order striking portions of the plaintiffs’ expert reports. A hearing on general causation is scheduled for January and February 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 September 30, 2021, we accrued aggregate legal liabilities of $333 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.

PART I

Item 1

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, has no expiration date, and may be terminated at any time. As of September 30, 2021, $2.5 billion remained of this $40.0 billion share repurchase program.

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 will commence following completion of the program approved on September 18, 2019, has no expiration date, and may be terminated at any time.

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

(In millions)


Fiscal Year		2022			2021

First Quarter	21	$	6,200	25	$	5,270

The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards of $1.5 billion for the first quarter of both fiscal years 2022 and 2021, respectively. All repurchases were made using cash resources.

Dividends

Our Board of Directors declared the following dividends:

Declaration Date	Record Date	Payment Date		Dividend Per Share		Amount


Fiscal Year 2022						(In millions)

September 14, 2021	November 18, 2021	December 9, 2021	$	0.62	$	4,656

Fiscal Year 2021

September 15, 2020	November 19, 2020	December 10, 2020	$	0.56	$	4,230

The dividend declared on September 14, 2021 was included in other current liabilities as of September 30, 2021.

PART I

Item 1

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 September 30,		2021			2020

Derivatives

Balance, beginning of period	$	(19	)	$	(38	)
Unrealized gains (losses), net of tax of $(3) and $5		(10	)		20

Reclassification adjustments for (gains) losses included in other income (expense), net		15			(20	)
Tax expense (benefit) included in provision for income taxes		(3	)		4


Amounts reclassified from accumulated other comprehensive income		12			(16	)


Net change related to derivatives, net of tax of $0 and $1		2			4


Balance, end of period	$	(17	)	$	(34	)


Investments

Balance, beginning of period	$	3,222		$	5,478
Unrealized losses, net of tax of $(110) and $(50)		(415	)		(188	)

Reclassification adjustments for gains included in other income (expense), net		(9	)		(17	)
Tax expense included in provision for income taxes		2			4


Amounts reclassified from accumulated other comprehensive income		(7	)		(13	)


Net change related to investments, net of tax of $(112) and $(54)		(422	)		(201	)
Cumulative effect of accounting changes		0			10


Balance, end of period	$	2,800		$	5,287


Translation Adjustments and Other

Balance, beginning of period	$	(1,381	)	$	(2,254	)
Translation adjustments and other, net of tax of $0 and $(9)		(119	)		111


Balance, end of period	$	(1,500	)	$	(2,143	)


Accumulated other comprehensive income, end of period	$	1,283		$	3,110

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.

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 Skype for Business.

PART I

Item 1

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

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

	•	Enterprise Services, including Enterprise Support Services and Microsoft Consulting 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 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 and PC accessories.

	•	Gaming, including Xbox hardware and Xbox content and services, comprising digital transactions, Xbox Game Pass and other subscriptions, video games, third-party video game royalties, cloud services, and advertising.

	•	Search and news advertising.

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 are identifiable and 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, and customer service and support. Each allocation is measured differently based on the specific facts and circumstances of the costs being allocated. Certain corporate-level activity is not allocated to our segments.

PART I

Item 1

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

(In millions)


Three Months Ended September 30,	2021		2020

Revenue

Productivity and Business Processes	$	15,039	$	12,319
Intelligent Cloud		16,964		12,986
More Personal Computing		13,314		11,849


Total	$	45,317	$	37,154


Operating Income

Productivity and Business Processes	$	7,581	$	5,706
Intelligent Cloud		7,562		5,422
More Personal Computing		5,095		4,748


Total	$	20,238	$	15,876

No sales to an individual customer or country other than the United States accounted for more than 10% of revenue for the three months ended September 30, 2021 or 2020. Revenue, classified by the major geographic areas in which our customers were located, was as follows:

(In millions)


Three Months Ended September 30,	2021		2020

United States (a)	$	22,830	$	19,025
Other countries		22,487		18,129


Total	$	45,317	$	37,154

(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.

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

(In millions)


Three Months Ended September 30,	2021		2020

Server products and cloud services	$	15,069	$	11,195
Office products and cloud services		10,808		9,278
Windows		5,676		5,151
Gaming		3,593		3,092
LinkedIn		3,136		2,206
Search and news advertising		2,656		1,943
Enterprise Services		1,791		1,637
Devices		1,361		1,620
Other		1,227		1,032


Total	$	45,317	$	37,154

PART I

Item 1

We have recast certain previously reported amounts in the table above to conform to the way we internally manage and monitor our business.

Our Microsoft Cloud (formerly commercial 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 $20.7 billion and $15.2 billion for the three months ended September 30, 2021 and 2020, 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.

PART I

Item 1

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 September 30, 2021, the related consolidated statements of income, comprehensive income, cash flows, and stockholders’ equity for the three-month periods ended September 30, 2021 and 2020, 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, 2021, 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 29, 2021, 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, 2021, 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

October 26, 2021

PART I

Item 2

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, 2021, 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. They also 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.

As the world continues to respond to COVID-19, we are working to do our part by ensuring the safety of our employees, striving to protect the health and well-being of the communities in which we operate, and providing technology and resources to our customers to help them do their best work while remote.

Highlights from the first quarter of fiscal year 2022 compared with the first quarter of fiscal year 2021 included:

	•	Microsoft Cloud (formerly commercial cloud) revenue increased 36% to $20.7 billion.

	•	Office Commercial products and cloud services revenue increased 18% driven by Office 365 Commercial growth of 23%.

	•	Office Consumer products and cloud services revenue increased 10% and Microsoft 365 Consumer subscribers increased to 54.1 million.

	•	LinkedIn revenue increased 42% driven by Marketing Solutions growth of 61%.

	•	Dynamics products and cloud services revenue increased 31% driven by Dynamics 365 growth of 48%.

	•	Server products and cloud services revenue increased 35% driven by Azure and other cloud services growth of 50%.

	•	Windows original equipment manufacturer licensing (“Windows OEM”) revenue increased 10%.

	•	Windows Commercial products and cloud services revenue increased 12%.

	•	Xbox content and services revenue increased 2%.

PART I

Item 2

	•	Search and news advertising revenue, excluding traffic acquisition costs, increased 40%.

	•	Surface revenue decreased 17%.

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 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. Weakening of the U.S. dollar relative to certain foreign currencies increased reported revenue and did not have a material impact on reported expenses from our international operations in the first quarter of fiscal year 2022.

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

COVID-19

The COVID-19 pandemic continues to impact our business operations and financial results, although some of the effects have lessened over time. Our commercial and consumer businesses have benefited from demand for cloud and productivity tools, and we have experienced savings in operating expenses related to COVID-19. The COVID-19 pandemic may continue to impact our business operations and financial operating results, and there is uncertainty in the nature and degree of its continued effects over time. 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.

PART I

Item 2

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. All differences between our internal management reporting basis and accounting principles generally accepted in the United States of America (“GAAP”), along with certain corporate-level and other activity, are included in Corporate and Other.

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 GAAP results and growth comparisons relate to the corresponding period of last fiscal year.

In the first quarter of fiscal year 2022, we made updates to the presentation and method of calculation for certain metrics, most notably changes to incorporate all current and anticipated revenue streams within our Office Consumer and Server products and cloud services metrics and changes to align with how we manage our Windows OEM and Search and news advertising businesses. None of these changes had a material impact on previously reported amounts in our MD&A.

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 our commercial cloud business, which includes 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 commercial cloud business

PART I

Item 2

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 Skype for Business

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, Sales Solutions, and Learning 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 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

Surface revenue growth		Revenue from Surface devices and accessories

Xbox content and services revenue growth		Revenue from Xbox content and services, comprising digital transactions, Xbox Game Pass and other subscriptions, video games, third-party video game royalties, cloud services, and advertising

Search and news advertising revenue, excluding TAC, growth		Revenue from search and news advertising excluding traffic acquisition costs (“TAC”) paid to Bing Ads network publishers and news partners

PART I

Item 2

SUMMARY RESULTS OF OPERATIONS

(In millions, except percentages and per share amounts)		Three Months Ended September 30,


		2021		2020

Revenue	$	45,317	$	37,154	22%
Gross margin		31,671		26,152	21%
Operating income		20,238		15,876	27%
Net income		20,505		13,893	48%
Diluted earnings per share		2.71		1.82	49%
Adjusted net income (non-GAAP)		17,214		13,893	24%
Adjusted diluted earnings per share (non-GAAP)		2.27		1.82	25%

Adjusted net income and adjusted diluted earnings per share (“EPS”) are non-GAAP financial measures which exclude the net income tax benefit related to transfer of intangible properties in fiscal year 2022. 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. See Note 11 – Income Taxes of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) for further discussion.

Three Months Ended September 30, 2021 Compared with Three Months Ended September 30, 2020

Revenue increased $8.2 billion or 22% driven by growth across each of our segments. 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 increased driven by Search and news advertising, Windows, and Gaming.

Cost of revenue increased $2.6 billion or 24% driven by growth in Microsoft Cloud and Gaming.

Gross margin increased $5.5 billion or 21% driven by growth across each of our segments.

	•	Gross margin percentage decreased slightly. Excluding the impact of the change in accounting estimate for the useful lives of our server and network equipment, gross margin percentage increased 1 point, driven by improvements in Productivity and Business Processes and Intelligent Cloud.

	•	Microsoft Cloud gross margin percentage decreased slightly to 71%. Excluding the impact of the change in accounting estimate, Microsoft Cloud gross margin percentage increased 4 points, driven by improvement in Azure and other cloud services, offset in part by sales mix shift to Azure and other cloud services.

Operating expenses increased $1.2 billion or 11% driven by investments in cloud engineering, Gaming, and commercial sales.

Key changes in operating expenses were:

	•	Research and development expenses increased $673 million or 14% driven by investments in cloud engineering and Gaming.

	•	Sales and marketing expenses increased $316 million or 7% driven by investments in commercial sales, Windows marketing, and LinkedIn.

	•	General and administrative expenses increased $168 million or 15%, driven by an increase in headcount.

Operating income increased $4.4 billion or 27% driven by growth across each of our segments.

Current 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 $0.44, respectively.

Revenue, gross margin, and operating income included a favorable foreign currency impact of 2%, 2%, and 3%, respectively.

PART I

Item 2

SEGMENT RESULTS OF OPERATIONS

(In millions, except percentages)	Three Months Ended September 30,


	2021		2020

Revenue

Productivity and Business Processes	$	15,039	$	12,319	22%
Intelligent Cloud		16,964		12,986	31%
More Personal Computing		13,314		11,849	12%


Total	$	45,317	$	37,154	22%


Operating Income

Productivity and Business Processes	$	7,581	$	5,706	33%
Intelligent Cloud		7,562		5,422	39%
More Personal Computing		5,095		4,748	7%


Total	$	20,238	$	15,876	27%

Reportable Segments

Three Months Ended September 30, 2021 Compared with Three Months Ended September 30, 2020

Productivity and Business Processes

Revenue increased $2.7 billion or 22%.

	•	Office Commercial products and cloud services revenue increased $1.4 billion or 18%. Office 365 Commercial revenue grew 23% driven by seat growth, up 17% with continued momentum in small and medium business and frontline worker offerings, and higher revenue per user. Office Commercial products revenue declined 13% driven by continued customer shift to cloud offerings, on a low prior year comparable impacted by a slowdown in transactional licensing.

	•	Office Consumer products and cloud services revenue increased $135 million or 10% driven by Microsoft 365 Consumer subscription revenue, on a strong prior year comparable. Microsoft 365 Consumer subscribers increased 19% to 54.1 million.

	•	LinkedIn revenue increased $930 million or 42% driven by advertising demand in our Marketing Solutions business and an improving job market in our Talent Solutions business.

	•	Dynamics products and cloud services revenue increased 31% driven by Dynamics 365 growth of 48%.

Operating income increased $1.9 billion or 33%.

	•	Gross margin increased $2.2 billion or 22% driven by growth in Office 365 Commercial and LinkedIn. Gross margin percentage increased slightly. Excluding the impact of the change in accounting estimate, gross margin percentage increased 2 points, driven by improvement across all cloud services.

	•	Operating expenses increased $290 million or 7% driven by investments in cloud engineering and LinkedIn.

Revenue, gross margin, and operating income included a favorable foreign currency impact of 2%, 2%, and 4%, respectively.

PART I

Item 2

Intelligent Cloud

Revenue increased $4.0 billion or 31%.

	•	Server products and cloud services revenue increased $3.9 billion or 35% driven by Azure and other cloud services. Azure and other cloud services revenue grew 50% driven by growth in our consumption-based services. Server products revenue increased 14% driven by hybrid solutions, including Windows Server and SQL Server running in multi-cloud environments, with an increase in multi-year agreements that carry higher in-quarter revenue recognition, on a low prior year comparable impacted by a slowdown in transactional licensing.

	•	Enterprise Services revenue increased $154 million or 9% driven by growth in Microsoft Consulting Services and Enterprise Support Services.

Operating income increased $2.1 billion or 39%.

	•	Gross margin increased $2.6 billion or 28% driven by growth in Azure and other cloud services. Gross margin percentage decreased. Excluding the impact of the change in accounting estimate, gross margin percentage increased 2 points, driven by gross margin percentage improvement in Azure and other cloud services, offset in part by sales mix shift to Azure and other cloud services.

	•	Operating expenses increased $496 million or 13% driven by investments in Azure and other cloud services.

Revenue, gross margin, and operating income each included a favorable foreign currency impact of 2%.

More Personal Computing

Revenue increased $1.5 billion or 12%.

	•	Windows revenue increased $525 million or 10% driven by growth in Windows OEM and Windows Commercial. Windows OEM revenue increased 10%, including 7 points of negative impact from the Windows 11 revenue deferral, driven by growth in the PC market, particularly in commercial with higher revenue per license. Windows Commercial products and cloud services revenue increased 12% driven by demand for Microsoft 365.

	•	Search and news advertising revenue increased $713 million or 37%. Search and news advertising revenue excluding traffic acquisition costs increased 40% driven by higher revenue per search, on a low prior year comparable.

| | • | Gaming revenue increased $501 million or 16% driven by growth in Xbox hardware. Xbox hardware revenue increased 166% driven by higher volume and price of consoles sold due to continued demand for Xbox Series X|S, on a low prior year comparable impacted by a slowdown in volume of consoles sold ahead of Xbox Series X|S launches. Xbox content and services revenue increased 2% driven by growth in Xbox Game Pass subscriptions and first-party titles, offset in part by a decline in third-party titles, on a strong prior year comparable that benefitted from stay-at-home scenarios. | | --- | --- | --- | --- | --- |

	•	Surface revenue decreased $267 million or 17% on a strong prior year comparable.

Operating income increased $347 million or 7%.

	•	Gross margin increased $718 million or 10% driven by growth in Windows and Search and news advertising. Gross margin percentage decreased driven by sales mix shift to Gaming hardware.

	•	Operating expenses increased $371 million or 15% driven by investments in Gaming as well as Windows marketing.

Gross margin and operating income both included a favorable foreign currency impact of 2%.

PART I

Item 2

OPERATING EXPENSES

Research and Development

(In millions, except percentages)	Three Months Ended September 30,


	2021		2020

Research and development	$	5,599	$	4,926	14%
As a percent of revenue		12%		13%	(1)ppt

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 September 30, 2021 Compared with Three Months Ended September 30, 2020

Research and development expenses increased $673 million or 14% driven by investments in cloud engineering and Gaming.

Sales and Marketing

(In millions, except percentages)	Three Months Ended September 30,


	2021		2020

Sales and marketing	$	4,547	$	4,231	7%
As a percent of revenue		10%		11%	(1)ppt

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 September 30, 2021 Compared with Three Months Ended September 30, 2020

Sales and marketing expenses increased $316 million or 7% driven by investments in commercial sales, Windows marketing, and LinkedIn.

General and Administrative

(In millions, except percentages)	Three Months Ended September 30,


	2021		2020

General and administrative	$	1,287	$	1,119	15%
As a percent of revenue		3%		3%	0ppt

General and administrative expenses include payroll, employee benefits, stock-based compensation expense, severance expense, and other headcount-related expenses associated with finance, legal, facilities, certain human resources and other administrative personnel, certain taxes, and legal and other administrative fees.

Three Months Ended September 30, 2021 Compared with Three Months Ended September 30, 2020

General and administrative expenses increased $168 million or 15% driven by an increase in headcount.

PART I

Item 2

OTHER INCOME (EXPENSE), NET

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

(In millions)


Three Months Ended September 30,	2021			2020

Interest and dividends income	$	520		$	570
Interest expense		(539	)		(589	)
Net recognized gains on investments		371			125
Net gains (losses) on derivatives		(7	)		3
Net gains (losses) on foreign currency remeasurements		(65	)		139
Other, net		6			0


Total	$	286		$	248

We use derivative instruments to manage risks related to foreign currencies, equity prices, interest rates, and credit; enhance investment returns; and facilitate portfolio diversification. Gains and losses from changes in fair values of derivatives that are not designated as hedging instruments are primarily recognized in other income (expense), net.

Three Months Ended September 30, 2021 Compared with Three Months Ended September 30, 2020

Interest and dividends income decreased due to lower portfolio balances. Interest expense decreased due to a decrease in outstanding long-term debt due to debt maturities. Net recognized gains on investments increased due to higher gains on equity securities.

INCOME TAXES

Effective Tax Rate

Uncertain Tax Positions

PART I

Item 2

NON-GAAP FINANCIAL MEASURES

Adjusted net income and adjusted diluted EPS are non-GAAP financial measures which exclude the net tax benefit related to the transfer of intangible properties in fiscal year 2022. We believe these non-GAAP measures aid investors by providing additional insight into our operational performance and help clarify trends affecting our business. For comparability of reporting, management considers non-GAAP measures in conjunction with GAAP financial results in evaluating business performance. These non-GAAP financial measures presented should not be considered a substitute for, or superior to, the measures of financial performance prepared in accordance with GAAP.

The following table reconciles our financial results reported in accordance with GAAP to non-GAAP financial results:

(In millions, except percentages)		Three Months Ended September 30,				Percentage Change


		2021			2020

Net income	$	20,505		$	13,893	48%
Net income tax benefit related to transfer of intangible properties		(3,291	)		0	*


Adjusted net income (non-GAAP)	$	17,214		$	13,893	24%


Diluted earnings per share	$	2.71		$	1.82	49%
Net income tax benefit related to transfer of intangible properties		(0.44	)		0	*


Adjusted diluted earnings per share (non-GAAP)	$	2.27		$	1.82	25%

*	Not meaningful.

FINANCIAL CONDITION

Cash, Cash Equivalents, and Investments

Cash, cash equivalents, and short-term investments totaled $130.6 billion and $130.3 billion as of September 30, 2021 and June 30, 2021. Equity investments were $6.4 billion and $6.0 billion as of September 30, 2021 and June 30, 2021, respectively. Our short-term investments are primarily intended to facilitate liquidity and capital preservation. They consist predominantly of highly liquid investment-grade fixed-income securities, diversified among industries and individual issuers. The investments are predominantly U.S. dollar-denominated securities, but also include foreign currency-denominated securities to diversify risk. Our fixed-income investments are exposed to interest rate risk and credit risk. The credit risk and average maturity of our fixed-income portfolio are managed to achieve economic returns that correlate to certain fixed-income indices. The settlement risk related to these investments is insignificant given that the short-term investments held are primarily highly liquid investment-grade fixed-income securities.

Valuation

In general, and where applicable, we use quoted prices in active markets for identical assets or liabilities to determine the fair value of our financial instruments. This pricing methodology applies to our Level 1 investments, such as U.S. government securities, common and preferred stock, and mutual funds. If quoted prices in active markets for identical assets or liabilities are not available to determine fair value, then we use quoted prices for similar assets and liabilities or inputs other than the quoted prices that are observable either directly or indirectly. This pricing methodology applies to our Level 2 investments, such as commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. Level 3 investments are valued using internally-developed models with unobservable inputs. Assets and liabilities measured at fair value on a recurring basis using unobservable inputs are an immaterial portion of our portfolio.

PART I

Item 2

A majority of our investments are priced by pricing vendors and are generally Level 1 or Level 2 investments as these vendors either provide a quoted market price in an active market or use observable inputs for their pricing without applying significant adjustments. Broker pricing is used mainly when a quoted price is not available, the investment is not priced by our pricing vendors, or when a broker price is more reflective of fair values in the market in which the investment trades. Our broker-priced investments are generally classified as Level 2 investments because the broker prices these investments based on similar assets without applying significant adjustments. In addition, all our broker-priced investments have a sufficient level of trading volume to demonstrate that the fair values used are appropriate for these investments. Our fair value processes include controls that are designed to ensure appropriate fair values are recorded. These controls include model validation, review of key model inputs, analysis of period-over-period fluctuations, and independent recalculation of prices where appropriate.

Cash Flows

Three Months Ended September 30, 2021 Compared with Three Months Ended September 30, 2020

Cash from operations increased $5.2 billion to $24.5 billion for the three months ended September 30, 2021, mainly due to an increase in cash received from customers, offset in part by an increase in cash paid to employees. Cash used in financing increased $6.0 billion to $16.3 billion for the three months ended September 30, 2021, mainly due to a $4.8 billion increase in repayments of debt and a $941 million increase in common stock repurchases. Cash used in investing decreased $2.1 billion to $3.3 billion for the three months ended September 30, 2021, mainly due to a $2.1 billion increase in cash from net investment purchases, sales, and maturities and a $1.7 billion decrease in other investing to facilitate the purchase of components, offset in part by a $903 million increase in additions to property and equipment and a $725 million increase in cash used for acquisitions of companies, net of cash acquired, and purchases of intangible and other assets.

Debt

We issue debt to take advantage of favorable pricing and liquidity in the debt markets, reflecting our credit rating and the low interest rate environment. The proceeds of these issuances were or will be used for general corporate purposes, which may include, among other things, funding for working capital, capital expenditures, repurchases of capital stock, acquisitions, and repayment of existing debt. In March 2021 and June 2020, we exchanged a portion of our existing debt at a premium for cash and new debt with longer maturities to take advantage of favorable financing rates in the debt markets, reflecting our credit rating and the low interest rate environment. Refer to Note 10 – Debt of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) for further discussion.

Unearned Revenue

Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include Software Assurance (“SA”) and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments for other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service.

The following table outlines the expected future recognition of unearned revenue as of September 30, 2021:

(In millions)


Three Months Ending

December 31, 2021	$	17,504
March 31, 2022		12,044
June 30, 2022		7,103
September 30, 2022		1,814
Thereafter		2,550


Total	$	41,015

If our customers choose to license cloud-based versions of our products and services rather than licensing transaction-based products and services, the associated revenue will shift from being recognized at the time of the transaction to being recognized over the subscription period or upon consumption, as applicable.

PART I

Item 2

Share Repurchases

For the three months ended September 30, 2021 and 2020, we repurchased 21 million shares and 25 million shares of our common stock for $6.2 billion and $5.3 billion, respectively, through our share repurchase programs. All repurchases were made using cash resources. Refer to Note 15 – Stockholders’ Equity of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) for further discussion.

Dividends

Refer to Note 15 – Stockholders’ Equity of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) for further discussion.

Off-Balance Sheet Arrangements

We provide indemnifications of varying scope and size to certain customers against claims of intellectual property infringement made by third parties arising from the use of our products and certain other matters. Additionally, we have agreed to cover damages resulting from breaches of certain security and privacy commitments in our cloud business. In evaluating estimated losses on these obligations, we consider factors such as the degree of probability of an unfavorable outcome and our ability to make a reasonable estimate of the amount of loss. These obligations did not have a material impact in our consolidated financial statements during the periods presented.

Other Planned Uses of Capital

On April 11, 2021, we entered into a definitive agreement to acquire Nuance Communications, Inc. (“Nuance”) for $56.00 per share in an all-cash transaction valued at $19.7 billion, inclusive of Nuance’s net debt. The acquisition has been approved by Nuance’s shareholders, and we expect it to close by the end of the second quarter or early in the third quarter of fiscal year 2022, subject to the satisfaction of certain regulatory approvals and other customary closing conditions.

We will continue to invest in sales, marketing, product support infrastructure, and existing and advanced areas of technology, as well as continue making acquisitions that align with our business strategy. Additions to property and equipment will continue, including new facilities, datacenters, and computer systems for research and development, sales and marketing, support, and administrative staff. We expect capital expenditures to increase in coming years to support growth in our cloud offerings. We have operating and finance leases for datacenters, corporate offices, research and development facilities, Microsoft Experience Centers, and certain equipment. We have not engaged in any related party transactions or arrangements with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of capital resources.

Liquidity

As a result of the Tax Cuts and Jobs Act (“TCJA”), we are required to pay a one-time transition tax on deferred foreign income not previously subject to U.S. income tax. Under the TCJA, the transition tax is payable in interest-free installments over eight years, with 8% due in each of the first five years, 15% in year six, 20% in year seven, and 25% in year eight. We have paid transition tax of $6.2 billion, which included $1.5 billion during the three months ended September 30, 2021. The remaining transition tax of $12.1 billion is payable over the next four years with a final payment in fiscal year 2026.

We expect existing cash, cash equivalents, short-term investments, cash flows from operations, and access to capital markets to continue to be sufficient to fund our operating activities and cash commitments for investing and financing activities, such as dividends, share repurchases, debt maturities, material capital expenditures, and the transition tax related to the TCJA, for at least the next 12 months and thereafter for the foreseeable future.

RECENT ACCOUNTING GUIDANCE

Refer to Note 1 – Accounting Policies of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) for further discussion.

PART I

Previous: Cover and table of contents · Next: Item 2. APPLICATION OF CRITICAL ACCOUNTING POLICIES