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 December 31, 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 $3.6 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
December 31, 2021
U.S. government and agency securities		$	3,382			$	(40	)		$	2,206			$	(97	)		$	5,588			$	(137	)
Foreign government bonds			82				(2	)			13				(2	)			95				(4	)
Mortgage- and asset-backed securities			1,679				(12	)			191				(3	)			1,870				(15	)
Corporate notes and bonds			2,773				(31	)			250				(7	)			3,023				(38	)
Municipal securities			20				0				54				(7	)			74				(7	)
Total		$	7,936			$	(85	)		$	2,714			$	(116	)		$	10,650			$	(201	)

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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, 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
December 31, 2021
Due in one year or less		$	34,136			$	34,305
Due after one year through five years			56,690				58,435
Due after five years through 10 years			21,898				22,472
Due after 10 years			2,673				2,752
Total		$	115,397			$	117,964

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, 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)		December 31, 2021				June 30, 2021
Designated as Hedging Instruments
Foreign exchange contracts purchased		$	635			$	635
Foreign exchange contracts sold			0				6,081
Interest rate contracts purchased			1,224				1,247
Not Designated as Hedging Instruments
Foreign exchange contracts purchased			7,956				14,223
Foreign exchange contracts sold			18,931				23,391
Other contracts purchased			3,126				2,456
Other contracts sold			664				763

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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, 2021								June 30, 2021
Designated as Hedging Instruments
Foreign exchange contracts		$	0			$	(33	)		$	76			$	(8	)
Interest rate contracts			18				0				40				0
Not Designated as Hedging Instruments
Foreign exchange contracts			241				(187	)			227				(291	)
Other contracts			101				(18	)			56				(36	)
Gross amounts of derivatives			360				(238	)			399				(335	)
Gross amounts of derivatives offset in the balance sheet			(64	)			65				(141	)			142
Cash collateral received			0				(100	)			0				(42	)
Net amounts of derivatives		$	296			$	(273	)		$	258			$	(235	)
Reported as
Short-term investments		$	21			$	0			$	78			$	0
Other current assets			253				0				137				0
Other long-term assets			22				0				43				0
Other current liabilities			0				(160	)			0				(182	)
Other long-term liabilities			0				(113	)			0				(53	)
Total		$	296			$	(273	)		$	258			$	(235	)

Gross derivative assets and liabilities subject to legally enforceable master netting agreements for which we have elected to offset were $346 million and $238 million, respectively, as of December 31, 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
December 31, 2021
Derivative assets		$	0			$	347			$	13			$	360
Derivative liabilities			0				(238	)			0				(238	)
June 30, 2021
Derivative assets			0				396				3				399
Derivative liabilities			0				(335	)			0				(335	)

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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,
			2021				2020				2021				2020
Designated as Fair Value Hedging Instruments
Foreign exchange contracts
Derivatives		$	46			$	(124	)		$	49			$	(293	)
Hedged items			(45	)			125				(50	)			293
Excluded from effectiveness assessment			0				10				4				18
Interest rate contracts
Derivatives			(11	)			(9	)			(14	)			(9	)
Hedged items			15				12				22				16
Designated as Cash Flow Hedging Instruments
Foreign exchange contracts
Amount reclassified from accumulated other comprehensive income			(14	)			21				(29	)			41
Not Designated as Hedging Instruments
Foreign exchange contracts			96				139				273				197
Other contracts			6				3				(12	)			7

Gains (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,
		2021				2020					2021				2020
Designated as Cash Flow Hedging Instruments
Foreign exchange contracts
Included in effectiveness assessment		$	(11	)		$	25			$	(21	)		$	45

NOTE 6 — INVENTORIES

The components of inventories were as follows:

(In millions)
		December 31, 2021				June 30, 2021
Raw materials		$	944			$	1,190
Work in process			73				79
Finished goods			2,002				1,367
Total		$	3,019			$	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 $766 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.

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The allocation of the purchase price to goodwill was completed as of December 31, 2021. The major classes of assets and liabilities to which we have allocated the purchase price were as follows:

(In millions)
Cash and cash equivalents			$	766
Goodwill				5,510
Intangible assets				1,968
Other assets				121
Other liabilities				(244	)
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			Weighted Average Life
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 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				December 31, 2021
Productivity and Business Processes		$	24,317			$	394			$	(30	)		$	24,681
Intelligent Cloud			13,256				584				97				13,937
More Personal Computing			12,138				224				(59	)			12,303
Total		$	49,711			$	1,202			$	8			$	50,921

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, 2021												June 30, 2021
Technology-based		$	9,988			$	(7,121	)		$	2,867			$	9,779			$	(7,007	)		$	2,772
Customer-related			5,005				(3,180	)			1,825				4,958				(2,859	)			2,099
Marketing-related			4,802				(2,043	)			2,759				4,792				(1,878	)			2,914
Contract-based			343				(332	)			11				446				(431	)			15
Total		$	20,138			$	(12,676	)		$	7,462			$	19,975			$	(12,175	)		$	7,800

Intangible assets amortization expense was $446 million and $885 million for the three and six months ended December 31, 2021, respectively, and $378 million and $761 million for the three and six months ended December 31, 2020, respectively.

The following table outlines the estimated future amortization expense related to intangible assets held as of December 31, 2021:

(In millions)
Year Ending June 30,
2022 (excluding the six months ended December 31, 2021)		$	895
2023			1,824
2024			1,515
2025			898
2026			554
Thereafter			1,776
Total		$	7,462

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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, 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%					2,615				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																				58,972				63,910
Unamortized discount and issuance costs																				(490	)			(511	)
Hedge fair value adjustments (b)																				18				40
Premium on debt exchange (a)																				(5,242	)			(5,293	)
Total debt																				53,258				58,146
Current portion of long-term debt																				(4,998	)			(8,072	)
Long-term debt																		$		48,260			$	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 December 31, 2021 and June 30, 2021, the estimated fair value of long-term debt, including the current portion, was $64.3 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 December 31, 2021:

(In millions)
Year Ending June 30,
2022 (excluding the six months ended December 31, 2021)		$	3,250
2023			2,750
2024			5,250
2025			2,250
2026			3,000
Thereafter			42,472
Total		$	58,972

PART I

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NOTE 11 — INCOME TAXES

Effective Tax Rate

Our effective tax rate was 17% and 16% for the three months ended December 31, 2021 and 2020, respectively, and 9% and 15% for the six months ended December 31, 2021 and 2020, respectively. The increase in our effective tax rate for the three months ended December 31, 2021 compared to the prior year was primarily due to changes in the mix of our income before income taxes between the U.S. and foreign countries and tax benefits from final Tax Cuts and Jobs Act regulations in fiscal year 2021, offset in part by an increase in tax benefits relating to stock-based compensation. The decrease in our effective tax rate for the six months ended December 31, 2021 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.

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 and six months ended December 31, 2021, 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, tax benefits relating to stock-based compensation, and for the six months ended December 31, 2021, the net income tax benefit related to the transfer of intangible properties.

Uncertain Tax Positions

As of December 31, 2021 and June 30, 2021, unrecognized tax benefits and other income tax liabilities were $16.3 billion and $15.9 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, 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)
		December 31, 2021				June 30, 2021
Productivity and Business Processes		$	18,494			$	22,120
Intelligent Cloud			14,549				17,710
More Personal Computing			3,726				4,311
Total		$	36,769			$	44,141

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Changes in unearned revenue were as follows:

(In millions)
Six Months Ended December 31, 2021
Balance, beginning of period		$	44,141
Deferral of revenue			44,389
Recognition of unearned revenue			(51,761	)
Balance, end of period		$	36,769

Revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods, was $152 billion as of December 31, 2021, of which $147 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 1 year to 20 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,
			2021				2020				2021				2020
Operating lease cost		$	469			$	503			$	1,057			$	1,001
Finance lease cost:
Amortization of right-of-use assets		$	264			$	249			$	490			$	455
Interest on lease liabilities			107				94				211				186
Total finance lease cost		$	371			$	343			$	701			$	641

Supplemental cash flow information related to leases was as follows:

(In millions)		Three Months Ended December 31,									Six Months Ended December 31,
			2021				2020				2021				2020
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases		$	441			$	482			$	1,007			$	973
Operating cash flows from finance leases			107				94				211				186
Financing cash flows from finance leases			222				153				422				289
Right-of-use assets obtained in exchange for lease obligations:
Operating leases			1,559				1,578				2,730				2,256
Finance leases			985				1,193				2,374				1,828

PART I

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Supplemental balance sheet information related to leases was as follows:

(In millions, except lease term and discount rate)
		December 31, 2021				June 30, 2021
Operating Leases
Operating lease right-of-use assets		$	12,354			$	11,088
Other current liabilities		$	2,126			$	1,962
Operating lease liabilities			10,774				9,629
Total operating lease liabilities		$	12,900			$	11,591
Finance Leases
Property and equipment, at cost		$	16,152			$	14,107
Accumulated depreciation			(2,795	)			(2,306	)
Property and equipment, net		$	13,357			$	11,801
Other current liabilities		$	944			$	791
Other long-term liabilities			13,251				11,750
Total finance lease liabilities		$	14,195			$	12,541
Weighted Average Remaining Lease Term
Operating leases			8 years				8 years
Finance leases			12 years				12 years
Weighted Average Discount Rate
Operating leases			2.0%				2.2%
Finance leases			3.2%				3.4%

The following table outlines maturities of our lease liabilities as of December 31, 2021:

(In millions)
Year Ending June 30,		Operating Leases				Finance Leases
2022 (excluding the six months ended December 31, 2021)		$	1,149			$	674
2023			2,206				1,360
2024			2,018				1,374
2025			1,751				1,702
2026			1,422				1,389
Thereafter			5,452				10,459
Total lease payments			13,998				16,958
Less imputed interest			(1,098	)			(2,763	)
Total		$	12,900			$	14,195

As of December 31, 2021, we have additional operating and finance leases, primarily for datacenters, that have not yet commenced of $5.8 billion and $6.5 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 64 patent infringement cases pending against Microsoft as of December 31, 2021, none of which are material individually or in aggregate.

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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.

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 claim submission process has been completed, and settlement funds will be distributed in accordance with the agreement.

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 June 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, 2021, we accrued aggregate legal liabilities of $352 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.

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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, 2021, $56.3 billion remained of this $60.0 billion share repurchase program.

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

(In millions)		Shares			Amount					Shares			Amount
Fiscal Year						2022								2021
First Quarter			21			$	6,200				25			$	5,270
Second Quarter			20				6,233				27				5,750
Total			41			$	12,433				52			$	11,020

All repurchases were made using cash resources. Shares repurchased during the second quarter of fiscal year 2022 were under the share repurchase programs approved on both September 18, 2019 and September 14, 2021. All other shares repurchased 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 $1.2 billion and $2.7 billion for the three and six months ended December 31, 2021, respectively, and $785 million and $2.3 billion for the three and six months ended December 31, 2020, respectively.

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			$	4,652
December 7, 2021			February 17, 2022					March 10, 2022					0.62				4,650
Total												$	1.24			$	9,302
Fiscal Year 2021
September 15, 2020			November 19, 2020					December 10, 2020				$	0.56			$	4,230
December 2, 2020			February 18, 2021					March 11, 2021					0.56				4,221
Total												$	1.12			$	8,451

The dividend declared on December 7, 2021 was included in other current liabilities as of December 31, 2021.

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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,
			2021				2020				2021				2020
Derivatives
Balance, beginning of period		$	(17	)		$	(34	)		$	(19	)		$	(38	)
Unrealized gains (losses), net of tax of $(3), $7**, $(6)**, and $12			(11	)			25				(21	)			45
Reclassification adjustments for (gains) losses included in other income (expense), net			14				(21	)			29				(41	)
Tax expense (benefit) included in provision for income taxes			(3	)			4				(6	)			8
Amounts reclassified from accumulated other comprehensive income (loss)			11				(17	)			23				(33	)
Net change related to derivatives, net of tax of $0, $3**, $0**, and $4			0				8				2				12
Balance, end of period		$	(17	)		$	(26	)		$	(17	)		$	(26	)
Investments
Balance, beginning of period		$	2,800			$	5,287			$	3,222			$	5,478
Unrealized losses, net of tax of $(197), $(128), $(307), and $(178)			(742	)			(477	)			(1,157	)			(665	)
Reclassification adjustments for gains included in other income (expense), net			(1	)			(19	)			(10	)			(36	)
Tax expense included in provision for income taxes			0				4				2				8
Amounts reclassified from accumulated other comprehensive income (loss)			(1	)			(15	)			(8	)			(28	)
Net change related to investments, net of tax of $(197), $(132), $(309), and $(186)			(743	)			(492	)			(1,165	)			(693	)
Cumulative effect of accounting changes			0				0				0				10
Balance, end of period		$	2,057			$	4,795			$	2,057			$	4,795
Translation Adjustments and Other
Balance, beginning of period		$	(1,500	)		$	(2,143	)		$	(1,381	)		$	(2,254	)
Translation adjustments and other, net of tax of $0, $0, $0, and $(9)			(103	)			741				(222	)			852
Balance, end of period		$	(1,603	)		$	(1,402	)		$	(1,603	)		$	(1,402	)
Accumulated other comprehensive income, end of period		$	437			$	3,367			$	437			$	3,367

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.

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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.

	•	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.

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

(In millions)		Three Months Ended December 31,								Six Months Ended December 31,
		2021				2020				2021				2020
Revenue
Productivity and Business Processes		$	15,936			$	13,353			$	30,975			$	25,672
Intelligent Cloud			18,327				14,601				35,291				27,587
More Personal Computing			17,465				15,122				30,779				26,971
Total		$	51,728			$	43,076			$	97,045			$	80,230
Operating Income
Productivity and Business Processes		$	7,688			$	6,181			$	15,269			$	11,887
Intelligent Cloud			8,197				6,492				15,759				11,914
More Personal Computing			6,362				5,224				11,457				9,972
Total		$	22,247			$	17,897			$	42,485			$	33,773

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, 2021 or 2020. 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,
		2021				2020				2021				2020
United States (a)		$	26,463			$	21,836			$	49,293			$	40,861
Other countries			25,265				21,240				47,752				39,369
Total		$	51,728			$	43,076			$	97,045			$	80,230

(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 December 31,								Six Months Ended December 31,
		2021				2020				2021				2020
Server products and cloud services		$	16,375			$	12,729			$	31,444			$	23,924
Office products and cloud services			11,251				9,881				22,059				19,159
Windows			6,600				5,514				12,276				10,665
Gaming			5,442				5,031				9,035				8,123
LinkedIn			3,531				2,577				6,667				4,783
Search and news advertising			3,064				2,386				5,720				4,329
Devices			2,285				2,120				3,646				3,740
Enterprise Services			1,823				1,695				3,614				3,332
Other			1,357				1,143				2,584				2,175
Total		$	51,728			$	43,076			$	97,045			$	80,230

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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 $22.1 billion and $42.8 billion for the three and six months ended December 31, 2021, respectively, and $16.7 billion and $31.9 billion for the three and six months ended December 31, 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.

NOTE 18 — SUBSEQUENT EVENT

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 and will provide building blocks for the metaverse. We expect this acquisition to close in fiscal year 2023, subject to approval by Activision Blizzard’s shareholders, the satisfaction of certain regulatory approvals, and other customary closing conditions.

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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, 2021, the related consolidated statements of income, comprehensive income, cash flows, and stockholders’ equity for the three-month and six-month periods ended December 31, 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

January 25, 2022

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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, 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 second quarter of fiscal year 2022 compared with the second quarter of fiscal year 2021 included:

	•	Microsoft Cloud (formerly commercial cloud) revenue increased 32% to $22.1 billion.

	•	Office Commercial products and cloud services revenue increased 14% driven by Office 365 Commercial growth of 19%.

	•	Office Consumer products and cloud services revenue increased 15% and Microsoft 365 Consumer subscribers grew to 56.4 million.

	•	LinkedIn revenue increased 37%.

	•	Dynamics products and cloud services revenue increased 29% driven by Dynamics 365 growth of 45%.

	•	Server products and cloud services revenue increased 29% driven by Azure and other cloud services growth of 46%.

	•	Windows original equipment manufacturer licensing (“Windows OEM”) revenue increased 25%.

	•	Windows Commercial products and cloud services revenue increased 13%.

	•	Xbox content and services revenue increased 10%.

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	•	Search and news advertising revenue excluding traffic acquisition costs increased 32%.

	•	Surface revenue increased 8%.

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. Fluctuations in the U.S. dollar relative to certain foreign currencies did not have a material impact on reported revenue or expenses from our international operations for the three or six months ended December 31, 2021.

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.

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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

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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 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

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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
			2021				2020								2021				2020
Revenue		$	51,728			$	43,076				20%			$	97,045			$	80,230				21%
Gross margin			34,768				28,882				20%				66,439				55,034				21%
Operating income			22,247				17,897				24%				42,485				33,773				26%
Net income			18,765				15,463				21%				39,270				29,356				34%
Diluted earnings per share			2.48				2.03				22%				5.19				3.85				35%
Adjusted net income (non-GAAP)			18,765				15,463				21%				35,979				29,356				23%
Adjusted diluted earnings per share (non-GAAP)			2.48				2.03				22%				4.76				3.85				24%

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 the first quarter of 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 December 31, 2021 Compared with Three Months Ended December 31, 2020

Revenue increased $8.7 billion or 20% 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 Windows and Search and news advertising.

Cost of revenue increased $2.8 billion or 19% driven by growth in Microsoft Cloud.

Gross margin increased $5.9 billion or 20% driven by growth across each of our segments.

	•	Gross margin percentage was relatively unchanged. Excluding the impact of the change in accounting estimate for the useful lives of our server and network equipment, gross margin percentage increased 2 points driven by improvements in More Personal Computing and Productivity and Business Processes.

	•	Microsoft Cloud gross margin percentage decreased slightly to 70%. Excluding the impact of the change in accounting estimate, Microsoft Cloud gross margin percentage increased 3 points driven by improvement across our cloud services, offset in part by sales mix shift to Azure and other cloud services.

Operating expenses increased $1.5 billion or 14% driven by investments in cloud engineering, Gaming, LinkedIn, and commercial sales.

Key changes in operating expenses were:

	•	Research and development expenses increased $859 million or 18% driven by investments in cloud engineering and Gaming.

	•	Sales and marketing expenses increased $432 million or 9% driven by investments in commercial sales and LinkedIn.

	•	General and administrative expenses increased $245 million or 22% primarily driven by an increase in headcount.

Operating income increased $4.4 billion or 24% driven by growth across each of our segments.

PART I

Item 2

Six Months Ended December 31, 2021 Compared with Six Months Ended December 31, 2020

Revenue increased $16.8 billion or 21% 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 Windows, Search and news advertising, and Gaming.

Cost of revenue increased $5.4 billion or 21% driven by growth in Microsoft Cloud and Gaming.

Gross margin increased $11.4 billion or 21% driven by growth across each of our segments.

	•	Gross margin percentage was relatively unchanged. Excluding the impact of the change in accounting estimate, gross margin percentage increased 2 points driven by improvements across each of our segments.

	•	Microsoft Cloud gross margin percentage decreased slightly to 70%. Excluding the impact of the change in accounting estimate, Microsoft Cloud gross margin percentage increased 3 points driven by improvement across our cloud services offset in part by sales mix shift to Azure and other cloud services.

Operating expenses increased $2.7 billion or 13% driven by investments in cloud engineering, Gaming, commercial sales, and LinkedIn.

Key changes in operating expenses were:

	•	Research and development expenses increased $1.5 billion or 16% driven by investments in cloud engineering and Gaming.

	•	Sales and marketing expenses increased $748 million or 8% driven by investments in commercial sales, LinkedIn, and Windows marketing.

	•	General and administrative expenses increased $413 million or 18% primarily driven by an increase in headcount.

Operating income increased $8.7 billion or 26%, including a favorable foreign currency impact of 2%, 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 $0.43, respectively.

SEGMENT RESULTS OF OPERATIONS

(In millions, except percentages)		Three Months Ended December 31,								Percentage Change				Six Months Ended December 31,								Percentage Change
		2021				2020									2021				2020
Revenue
Productivity and Business Processes		$	15,936			$	13,353				19%			$	30,975			$	25,672				21%
Intelligent Cloud			18,327				14,601				26%				35,291				27,587				28%
More Personal Computing			17,465				15,122				15%				30,779				26,971				14%
Total		$	51,728			$	43,076				20%			$	97,045			$	80,230				21%
Operating Income
Productivity and Business Processes		$	7,688			$	6,181				24%			$	15,269			$	11,887				28%
Intelligent Cloud			8,197				6,492				26%				15,759				11,914				32%
More Personal Computing			6,362				5,224				22%				11,457				9,972				15%
Total		$	22,247			$	17,897				24%			$	42,485			$	33,773				26%

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Item 2

Reportable Segments

Three Months Ended December 31, 2021 Compared with Three Months Ended December 31, 2020

Productivity and Business Processes

Revenue increased $2.6 billion or 19%.

	•	Office Commercial products and cloud services revenue increased $1.1 billion or 14%. Office 365 Commercial revenue grew 19% driven by seat growth of 16%, with continued momentum in small and medium business and frontline worker offerings, and growth in revenue per user. Office Commercial products revenue declined 17% 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 $220 million or 15% driven by Microsoft 365 Consumer subscription revenue. Microsoft 365 Consumer subscribers grew 19% to 56.4 million.

	•	LinkedIn revenue increased $954 million or 37% 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 29% driven by Dynamics 365 growth of 45%.

Operating income increased $1.5 billion or 24%.

	•	Gross margin increased $2.0 billion or 20% driven by growth in Office 365 Commercial and LinkedIn. Gross margin percentage was relatively unchanged. 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 $531 million or 13% driven by investments in cloud engineering and LinkedIn.

Intelligent Cloud

Revenue increased $3.7 billion or 26%.

	•	Server products and cloud services revenue increased $3.6 billion or 29% driven by Azure and other cloud services. Azure and other cloud services revenue grew 46% driven by growth in our consumption-based services. Server products revenue increased 6% driven by hybrid solutions, including Windows Server and SQL Server running in multi-cloud environments.

	•	Enterprise Services revenue increased $128 million or 8% driven by growth in Enterprise Support Services and Microsoft Consulting Services.

Operating income increased $1.7 billion or 26%.

	•	Gross margin increased $2.3 billion or 21% 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 slightly 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 $569 million or 14% driven by investments in Azure and other cloud services.

More Personal Computing

Revenue increased $2.3 billion or 15%.

	•	Windows revenue increased $1.1 billion or 20% driven by growth in Windows OEM and Windows Commercial. Windows OEM revenue increased 25%, including 6 points of positive impact from the Windows 11 revenue deferral, driven by continued growth in the PC market, particularly in commercial which has higher revenue per license. Windows Commercial products and cloud services revenue increased 13% driven by demand for Microsoft 365.

	•	Search and news advertising revenue increased $678 million or 28%. Search and news advertising revenue excluding traffic acquisition costs increased 32% driven by higher revenue per search.

PART I

Item 2

| | • | Gaming revenue increased $411 million or 8% on a strong prior year comparable that benefited from Xbox Series X|S launches and stay-at-home scenarios, driven by growth in Xbox content and services. Xbox content and services revenue increased 10% driven by growth in first-party titles and Xbox Game Pass subscriptions, offset in part by a decline in third-party titles. Xbox hardware revenue increased 4% due to continued demand for Xbox Series X|S. | | --- | --- | --- | --- | --- |

	•	Surface revenue increased $162 million or 8% driven by Surface Laptop.

Operating income increased $1.1 billion or 22%.

	•	Gross margin increased $1.6 billion or 20% driven by growth in Windows and Search and news advertising. Gross margin percentage increased driven by sales mix shift to higher margin businesses and improvement in Search and news advertising.

	•	Operating expenses increased $436 million or 17% driven by investments in Gaming, Search and news advertising, and Windows marketing.

Six Months Ended December 31, 2021 Compared with Six Months Ended December 31, 2020

Productivity and Business Processes

Revenue increased $5.3 billion or 21%.

	•	Office Commercial products and cloud services revenue increased $2.5 billion or 16%. Office 365 Commercial revenue grew 21% driven by seat growth of 16%, with continued momentum in small and medium business and frontline worker offerings, and growth in revenue per user. Office Commercial products revenue declined 15% 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 $355 million or 13% driven by Microsoft 365 Consumer subscription revenue.

	•	LinkedIn revenue increased $1.9 billion or 39% 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 30% driven by Dynamics 365 growth of 46%.

Operating income increased $3.4 billion or 28%, including a favorable foreign currency impact of 2%.

	•	Gross margin increased $4.2 billion or 21% driven by growth in Office 365 Commercial and LinkedIn. Gross margin percentage was relatively unchanged. 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 $821 million or 10% driven by investments in cloud engineering and LinkedIn.

Intelligent Cloud

Revenue increased $7.7 billion or 28%.

	•	Server products and cloud services revenue increased $7.5 billion or 31% driven by Azure and other cloud services. Azure and other cloud services revenue grew 48% driven by growth in our consumption-based services. Server products revenue increased 10% driven by hybrid solutions, including Windows Server and SQL Server running in multi-cloud environments, on a low prior year comparable impacted by a slowdown in transactional licensing.

	•	Enterprise Services revenue increased $282 million or 8% driven by growth in Microsoft Consulting Services and Enterprise Support Services.

PART I

Item 2

Operating income increased $3.8 billion or 32%.

	•	Gross margin increased $4.9 billion or 25% 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 1 point 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 $1.1 billion or 13% driven by investments in Azure and other cloud services.

More Personal Computing

Revenue increased $3.8 billion or 14%.

	•	Windows revenue increased $1.6 billion or 15% driven by growth in Windows OEM and Windows Commercial. Windows OEM revenue increased 18% driven by continued growth in the PC market, particularly in commercial which has higher revenue per license. Windows Commercial products and cloud services revenue increased 13% driven by demand for Microsoft 365.

	•	Search and news advertising revenue increased $1.4 billion or 32%. Search and news advertising revenue excluding traffic acquisition costs increased 36% driven by higher revenue per search, on a low prior year comparable.

| | • | Gaming revenue increased $912 million or 11% on a strong prior year comparable that benefited from Xbox Series X|S launches and stay-at-home scenarios, driven by growth in Xbox hardware and Xbox content and services. Xbox hardware revenue increased 28% driven by higher volume of consoles sold due to continued demand for Xbox Series X|S. Xbox content and services revenue increased 6% driven by growth in first-party titles and Xbox Game Pass subscriptions, offset in part by a decline in third-party titles. | | --- | --- | --- | --- | --- |

	•	Surface revenue decreased $105 million or 3% on a strong prior year comparable.

Operating income increased $1.5 billion or 15%.

	•	Gross margin increased $2.3 billion or 15% driven by growth in Windows and Search and news advertising. Gross margin percentage increased slightly driven by sales mix shift to higher margin businesses and improvement in Search and news advertising.

	•	Operating expenses increased $807 million or 16% driven by investments in Gaming, Windows marketing, and Search and news advertising.

OPERATING EXPENSES

Research and Development

(In millions, except percentages)		Three Months Ended December 31,								Percentage Change				Six Months Ended December 31,								Percentage Change
		2021				2020									2021				2020
Research and development		$	5,758			$	4,899				18%			$	11,357			$	9,825				16%
As a percent of revenue			11%				11%				0ppt				12%				12%				0ppt

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, 2021 Compared with Three Months Ended December 31, 2020

Research and development expenses increased $859 million or 18% driven by investments in cloud engineering and Gaming.

PART I

Item 2

Six Months Ended December 31, 2021 Compared with Six Months Ended December 31, 2020

Research and development expenses increased $1.5 billion or 16% driven by investments in cloud engineering and Gaming.

Sales and Marketing

(In millions, except percentages)		Three Months Ended December 31,								Percentage Change				Six Months Ended December 31,								Percentage Change
		2021				2020									2021				2020
Sales and marketing		$	5,379			$	4,947				9%			$	9,926			$	9,178				8%
As a percent of revenue			10%				11%				(1)ppt				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 December 31, 2021 Compared with Three Months Ended December 31, 2020

Sales and marketing expenses increased $432 million or 9% driven by investments in commercial sales and LinkedIn.

Six Months Ended December 31, 2021 Compared with Six Months Ended December 31, 2020

Sales and marketing expenses increased $748 million or 8% driven by investments in commercial sales, LinkedIn, and Windows marketing.

General and Administrative

(In millions, except percentages)		Three Months Ended December 31,								Percentage Change				Six Months Ended December 31,								Percentage Change
		2021				2020									2021				2020
General and administrative		$	1,384			$	1,139				22%			$	2,671			$	2,258				18%
As a percent of revenue			3%				3%				0ppt				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 December 31, 2021 Compared with Three Months Ended December 31, 2020

General and administrative expenses increased $245 million or 22% primarily driven by an increase in headcount.

Six Months Ended December 31, 2021 Compared with Six Months Ended December 31, 2020

General and administrative expenses increased $413 million or 18% primarily driven by an increase in headcount.

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Item 2

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,
		2021				2020					2021				2020
Interest and dividends income		$	503			$	545			$	1,023			$	1,115
Interest expense			(525	)			(571	)			(1,064	)			(1,160	)
Net recognized gains on investments			300				359				671				484
Net gains (losses) on derivatives			7				(5	)			0				(2	)
Net gains (losses) on foreign currency remeasurements			(13	)			42				(78	)			181
Other, net			(4	)			70				2				70
Total		$	268			$	440			$	554			$	688

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 December 31, 2021 Compared with Three Months Ended December 31, 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 decreased due to lower gains on equity securities.

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

Our effective tax rate was 17% and 16% for the three months ended December 31, 2021 and 2020, respectively, and 9% and 15% for the six months ended December 31, 2021 and 2020, respectively. The increase in our effective tax rate for the three months ended December 31, 2021 compared to the prior year was primarily due to changes in the mix of our income before income taxes between the U.S. and foreign countries and tax benefits from final Tax Cuts and Jobs Act (“TCJA”) regulations in fiscal year 2021, offset in part by an increase in tax benefits relating to stock-based compensation. The decrease in our effective tax rate for the six months ended December 31, 2021 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.

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 and six months ended December 31, 2021, 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, tax benefits relating to stock-based compensation, and for the six months ended December 31, 2021, the net income tax benefit related to the transfer of intangible properties.

PART I

Item 2

Uncertain Tax Positions

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, 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.

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 the first quarter of 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 and per share amounts)			Three Months Ended December 31,								Percentage Change				Six Months Ended December 31,								Percentage Change
			2021				2020								2021				2020
Net income		$	18,765			$	15,463				21%			$	39,270			$	29,356				34%
Net income tax benefit related to transfer of intangible properties			0				0				*				(3,291	)			0				*
Adjusted net income (non-GAAP)		$	18,765			$	15,463				21%			$	35,979			$	29,356				23%
Diluted earnings per share		$	2.48			$	2.03				22%			$	5.19			$	3.85				35%
Net income tax benefit related to transfer of intangible properties			0				0				*				(0.43	)			0				*
Adjusted diluted earnings per share (non-GAAP)		$	2.48			$	2.03				22%			$	4.76			$	3.85				24%

*	Not meaningful.

PART I

Item 2

FINANCIAL CONDITION

Cash, Cash Equivalents, and Investments

Cash, cash equivalents, and short-term investments totaled $125.4 billion and $130.3 billion as of December 31, 2021 and June 30, 2021, respectively. Equity investments were $7.0 billion and $6.0 billion as of December 31, 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.

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

Cash from operations increased $7.2 billion to $39.0 billion for the six months ended December 31, 2021, mainly due to an increase in cash received from customers, offset in part by an increase in cash paid to employees and suppliers. Cash used in financing increased $4.3 billion to $28.3 billion for the six months ended December 31, 2021, mainly due to a $1.8 billion increase in common stock repurchases and a $1.6 billion increase in repayments of debt. Cash used in investing decreased $2.6 billion to $4.4 billion for the six months ended December 31, 2021, mainly due to a $5.1 billion increase in cash from net investment purchases, sales, and maturities and a $1.3 billion decrease in other investing to facilitate the purchase of components, offset in part by a $2.6 billion increase in additions to property and equipment and a $1.2 billion increase in cash used for acquisitions of companies, net of cash acquired, and purchases of intangible and other assets.

PART I

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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 December 31, 2021:

(In millions)
Three Months Ending
March 31, 2022		$	16,736
June 30, 2022			10,252
September 30, 2022			4,546
December 31, 2022			2,467
Thereafter			2,768
Total		$	36,769

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.

Share Repurchases

For the six months ended December 31, 2021 and 2020, we repurchased 41 million shares and 52 million shares of our common stock for $12.4 billion and $11.0 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.

PART I

Item 2

Other Planned Uses of Capital

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. We expect this acquisition to close in fiscal year 2023, subject to approval by Activision Blizzard’s shareholders, the satisfaction of certain regulatory approvals, and other customary closing conditions.

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 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 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 six months ended December 31, 2021. The remaining transition tax of $12.0 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.

APPLICATION OF CRITICAL ACCOUNTING POLICIES

Our consolidated financial statements and accompanying notes are prepared in accordance with GAAP. Preparing consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by management’s application of accounting policies, as well as uncertainty in the current economic environment due to COVID-19. Critical accounting policies for us include revenue recognition, impairment of investment securities, goodwill, research and development costs, legal and other contingencies, income taxes, and inventories.

Revenue Recognition

Our contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided.

PART I