Item 1. Financial Statements

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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, 2022

Changes in Fair Value Recorded in Other Comprehensive Income

Commercial paper	Level 2	$	2,500	$	0	$	0		$	2,500	$	2,498	$	2	$	0
Certificates of deposit	Level 2		2,071		0		0			2,071		2,032		39		0
U.S. government securities	Level 1		79,696		29		(2,178	)		77,547		9		77,538		0
U.S. agency securities	Level 2		419		0		(9	)		410		0		410		0
Foreign government bonds	Level 2		506		0		(24	)		482		0		482		0
Mortgage- and asset-backed securities	Level 2		727		1		(30	)		698		0		698		0
Corporate notes and bonds	Level 2		11,661		4		(554	)		11,111		0		11,111		0
Corporate notes and bonds	Level 3		67		0		0			67		0		67		0
Municipal securities	Level 2		368		19		(13	)		374		0		374		0
Municipal securities	Level 3		103		0		(6	)		97		0		97		0


Total debt investments		$	98,118	$	53	$	(2,814	)	$	95,357	$	4,539	$	90,818	$	0


Changes in Fair Value Recorded in Net Income

Equity investments	Level 1								$	1,590	$	1,134	$	0	$	456
Equity investments	Other									6,435		0		0		6,435


Total equity investments									$	8,025	$	1,134	$	0	$	6,891


Cash									$	8,258	$	8,258	$	0	$	0
Derivatives, net (a)										8		0		8		0


Total									$	111,648	$	13,931	$	90,826	$	6,891

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

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

Unrealized Losses on Debt Investments

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

	Less than 12 Months					12 Months or Greater								Total Unrealized Losses


(In millions)		Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Total Fair Value


September 30, 2022

U.S. government and agency securities	$	61,761	$	(3,411	)	$	4,233	$	(830	)	$	65,994	$	(4,241	)
Foreign government bonds		392		(22	)		64		(14	)		456		(36	)
Mortgage- and asset-backed securities		434		(27	)		130		(18	)		564		(45	)
Corporate notes and bonds		8,258		(554	)		2,178		(271	)		10,436		(825	)
Municipal securities		190		(22	)		74		(7	)		264		(29	)


Total	$	71,035	$	(4,036	)	$	6,679	$	(1,140	)	$	77,714	$	(5,176	)

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	Less than 12 Months					12 Months or Greater								Total Unrealized Losses


(In millions)		Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Total Fair Value


June 30, 2022

U.S. government and agency securities	$	59,092	$	(1,835	)	$	2,210	$	(352	)	$	61,302	$	(2,187	)
Foreign government bonds		418		(18	)		27		(6	)		445		(24	)
Mortgage- and asset-backed securities		510		(26	)		41		(4	)		551		(30	)
Corporate notes and bonds		9,443		(477	)		786		(77	)		10,229		(554	)
Municipal securities		178		(12	)		74		(7	)		252		(19	)


Total	$	69,641	$	(2,368	)	$	3,138	$	(446	)	$	72,779	$	(2,814	)

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

Debt Investment Maturities

(In millions)	Adjusted Cost Basis		Estimated Fair Value


September 30, 2022

Due in one year or less	$	35,526	$	35,416
Due after one year through five years		50,062		47,328
Due after five years through 10 years		17,070		14,925
Due after 10 years		1,355		1,191


Total	$	104,013	$	98,860

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 September 30, 2022, our long-term unsecured debt rating was AAA, and cash investments were in excess of $1.0 billion. As a result, no collateral was required to be posted.

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

(In millions)	September 30, 2022		June 30, 2022


Designated as Hedging Instruments

Foreign exchange contracts purchased	$	1,492	$	635
Interest rate contracts purchased		1,088		1,139

Not Designated as Hedging Instruments

Foreign exchange contracts purchased		6,933		10,322
Foreign exchange contracts sold		11,580		21,606
Other contracts purchased		2,568		2,773
Other contracts sold		848		544

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Fair Values of Derivative Instruments

The following table presents our derivative instruments:

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


	September 30, 2022						June 30, 2022

Designated as Hedging Instruments

Foreign exchange contracts	$	0		$	(127	)	$	0		$	(77	)
Interest rate contracts		2			0			3			0

Not Designated as Hedging Instruments

Foreign exchange contracts		406			(482	)		333			(362	)
Other contracts		36			(153	)		20			(112	)


Gross amounts of derivatives		444			(762	)		356			(551	)
Gross amounts of derivatives offset in the balance sheet		(158	)		163			(130	)		133
Cash collateral received		0			(67	)		0			(75	)


Net amounts of derivatives	$	286		$	(666	)	$	226		$	(493	)


Reported as

Short-term investments	$	18		$	0		$	8		$	0
Other current assets		271			0			218			0
Other long-term assets		(3	)		0			0			0
Other current liabilities		0			(396	)		0			(298	)
Other long-term liabilities		0			(270	)		0			(195	)


Total	$	286		$	(666	)	$	226		$	(493	)

Gross derivative assets and liabilities subject to legally enforceable master netting agreements for which we have elected to offset were $409 million and $759 million, respectively, as of September 30, 2022, and $343 million and $550 million, respectively, as of June 30, 2022.

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

(In millions)	Level 1			Level 2		Level 3		Total


September 30, 2022

Derivative assets	$	0	$	427		$	17	$	444
Derivative liabilities		0		(762	)		0		(762	)

June 30, 2022

Derivative assets		1		349			6		356
Derivative liabilities		0		(551	)		0		(551	)

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

(In millions)


Three Months Ended September 30,		2022			2021

Designated as Fair Value Hedging Instruments

Foreign exchange contracts
Derivatives	$	0		$	3
Hedged items		0			(5	)
Excluded from effectiveness assessment		0			4

Interest rate contracts
Derivatives		(43	)		(3	)
Hedged items		43			7

Designated as Cash Flow Hedging Instruments

Foreign exchange contracts
Amount reclassified from accumulated other comprehensive income (loss)		(59	)		(15	)

Not Designated as Hedging Instruments

Foreign exchange contracts		240			177
Other contracts		2			(18	)

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

(In millions)


Three Months Ended September 30,	2022			2021

Designated as Cash Flow Hedging Instruments

Foreign exchange contracts
Included in effectiveness assessment	$	(40	)	$	(10	)

NOTE 6 — INVENTORIES

The components of inventories were as follows:

(In millions)


	September 30, 2022		June 30, 2022

Raw materials	$	1,143	$	1,144
Work in process		51		82
Finished goods		3,074		2,516


Total	$	4,268	$	3,742

NOTE 7 — BUSINESS COMBINATIONS

Nuance Communications, Inc.

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

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

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

(In millions)


Goodwill (a)	$	16,329
Intangible assets		4,365
Other assets		42
Other liabilities (b)		(1,973	)


Total	$	18,763

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

(b)	Includes $986 million of convertible senior notes issued by Nuance in 2015 and 2017, of which $985 million was redeemed as of September 30, 2022.

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

(In millions, except average life)	Amount


Customer-related	$	2,610	9 years
Technology-based		1,540	5 years
Marketing-related		215	4 years


Total	$	4,365	7 years

Activision Blizzard, Inc.

On January 18, 2022, we entered into a definitive agreement to acquire Activision Blizzard, Inc. (“Activision Blizzard”) for $95.00 per share in an all-cash transaction valued at $68.7 billion, inclusive of Activision Blizzard’s net cash. Activision Blizzard is a leader in game development and an interactive entertainment content publisher. The acquisition will accelerate the growth in our gaming business across mobile, PC, console, and cloud and will provide building blocks for the metaverse. The acquisition has been approved by Activision Blizzard’s shareholders, and we expect it to close in fiscal year 2023, 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, 2022		Acquisitions		Other			September 30, 2022


Productivity and Business Processes	$	24,811	$	11	$	(106	)	$	24,716
Intelligent Cloud		30,182		8		76			30,266
More Personal Computing		12,531		0		(54	)		12,477


Total	$	67,524	$	19	$	(84	)	$	67,459

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


	September 30, 2022							June 30, 2022

Technology-based	$	11,409	$	(7,253	)	$	4,156	$	11,277	$	(6,958	)	$	4,319
Customer-related		7,343		(3,407	)		3,936		7,342		(3,171	)		4,171
Marketing-related		4,941		(2,237	)		2,704		4,942		(2,143	)		2,799
Contract-based		21		(9	)		12		16		(7	)		9


Total	$	23,714	$	(12,906	)	$	10,808	$	23,577	$	(12,279	)	$	11,298

Intangible assets amortization expense was $633 million and $439 million for the three months ended September 30, 2022 and 2021, respectively.

The following table outlines the estimated future amortization expense related to intangible assets held as of September 30, 2022:

(In millions)


Year Ending June 30,

2023 (excluding the three months ended September 30, 2022)	$	2,033
2024		2,408
2025		1,666
2026		1,244
2027		826
Thereafter		2,631


Total	$	10,808

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NOTE 10 — DEBT

The components of debt were as follows:

(In millions, issuance by calendar year)							Effective Interest Rate			September 30, 2022			June 30, 2022


2009 issuance of $3.8 billion			2039			5.20%			5.24%	$	520		$	520
2010 issuance of $4.8 billion			2040			4.50%			4.57%		486			486
2011 issuance of $2.3 billion			2041			5.30%			5.36%		718			718
2012 issuance of $2.3 billion	2022	–	2042	2.13%	–	3.50%	2.24%	–	3.57%		1,204			1,204
2013 issuance of $5.2 billion	2023	–	2043	2.38%	–	4.88%	2.47%	–	4.92%		2,814			2,814
2013 issuance of €4.1 billion	2028	–	2033	2.63%	–	3.13%	2.69%	–	3.22%		2,251			2,404
2015 issuance of $23.8 billion	2025	–	2055	2.70%	–	4.75%	2.77%	–	4.78%		9,805			10,805
2016 issuance of $19.8 billion	2026	–	2056	2.40%	–	3.95%	2.46%	–	4.03%		9,430			9,430
2017 issuance of $17.0 billion	2027	–	2057	3.30%	–	4.50%	3.38%	–	4.53%		8,945			8,945
2020 issuance of $10.0 billion			2060			2.68%			2.68%		10,000			10,000
2021 issuance of $8.2 billion			2062			3.04%			3.04%		8,185			8,185


Total face value											54,358			55,511
Unamortized discount and issuance costs											(461	)		(471	)
Hedge fair value adjustments (a)											(111	)		(68	)
Premium on debt exchange											(5,164	)		(5,191	)


Total debt											48,622			49,781
Current portion of long-term debt											(3,248	)		(2,749	)


Long-term debt										$	45,374		$	47,032

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

As of September 30, 2022 and June 30, 2022, the estimated fair value of long-term debt, including the current portion, was $46.1 billion and $50.9 billion, respectively. The estimated fair values are based on Level 2 inputs.

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

The following table outlines maturities of our long-term debt, including the current portion, as of September 30, 2022:

(In millions)


Year Ending June 30,

2023 (excluding the three months ended September 30, 2022)	$	1,750
2024		5,250
2025		2,250
2026		3,000
2027		8,000
Thereafter		34,108


Total	$	54,358

NOTE 11 — INCOME TAXES

Effective Tax Rate

Our effective tax rate was 19% and 0% for the three months ended September 30, 2022 and 2021, respectively. The increase in our effective tax rate for the current quarter compared to the prior year was primarily due to a $3.3 billion net income tax benefit in the first quarter of fiscal year 2022 related to the transfer of intangible properties and a decrease in tax benefits relating to stock-based compensation.

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

Our effective tax rate was lower than the U.S. federal statutory rate for the three months ended September 30, 2022, primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations center in Ireland.

Uncertain Tax Positions

As of September 30, 2022 and June 30, 2022, unrecognized tax benefits and other income tax liabilities were $16.7 billion and $16.3 billion, respectively, and are included in long-term income taxes in our consolidated balance sheets.

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

As of September 30, 2022, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact in our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved key transfer pricing issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.

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

NOTE 12 — UNEARNED REVENUE

Unearned revenue by segment was as follows:

(In millions)


	September 30, 2022		June 30, 2022

Productivity and Business Processes	$	22,405	$	24,558
Intelligent Cloud		17,294		19,371
More Personal Computing		4,190		4,479


Total	$	43,889	$	48,408

Changes in unearned revenue were as follows:

(In millions)


Three Months Ended September 30, 2022

Balance, beginning of period	$	48,408
Deferral of revenue		23,577
Recognition of unearned revenue		(28,096	)


Balance, end of period	$	43,889

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Revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods, was $183 billion as of September 30, 2022, of which $180 billion is related to the commercial portion of revenue. We expect to recognize approximately 45% of this revenue over the next 12 months and the remainder thereafter.

NOTE 13 — LEASES

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

The components of lease expense were as follows:

(In millions)


Three Months Ended September 30,		2022		2021

Operating lease cost	$	662	$	588


Finance lease cost:
Amortization of right-of-use assets	$	189	$	226
Interest on lease liabilities		113		104


Total finance lease cost	$	302	$	330

Supplemental cash flow information related to leases was as follows:

(In millions)


Three Months Ended September 30,		2022		2021

Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	654	$	566
Operating cash flows from finance leases		113		104
Financing cash flows from finance leases		256		200

Right-of-use assets obtained in exchange for lease obligations:
Operating leases		1,189		1,171
Finance leases		611		1,389

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Supplemental balance sheet information related to leases was as follows:

(In millions, except lease term and discount rate)


	September 30, 2022			June 30, 2022

Operating Leases

Operating lease right-of-use assets	$	13,347		$	13,148


Other current liabilities	$	2,224		$	2,228
Operating lease liabilities		11,660			11,489


Total operating lease liabilities	$	13,884		$	13,717


Finance Leases

Property and equipment, at cost	$	17,322		$	17,388
Accumulated depreciation		(3,475	)		(3,285	)


Property and equipment, net	$	13,847		$	14,103


Other current liabilities	$	1,055		$	1,060
Other long-term liabilities		13,575			13,842


Total finance lease liabilities	$	14,630		$	14,902


Weighted Average Remaining Lease Term

Operating leases		8 years			8 years
Finance leases		11 years			12 years

Weighted Average Discount Rate

Operating leases		2.4%			2.1%
Finance leases		3.2%			3.1%

The following table outlines maturities of our lease liabilities as of September 30, 2022:

(In millions)


Year Ending June 30,	Operating Leases			Finance Leases

2023 (excluding the three months ended September 30, 2022)	$	1,913		$	1,107
2024		2,327			1,480
2025		2,060			1,796
2026		1,706			1,477
2027		1,409			1,482
Thereafter		5,960			10,028


Total lease payments		15,375			17,370
Less imputed interest		(1,491	)		(2,740	)


Total	$	13,884		$	14,630

As of September 30, 2022, we have additional operating and finance leases, primarily for datacenters, that have not yet commenced of $6.5 billion and $10.5 billion, respectively. These operating and finance leases will commence between fiscal year 2023 and fiscal year 2028 with lease terms of less than 1 year to 18 years.

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NOTE 14 — CONTINGENCIES

U.S. Cell Phone Litigation

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

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

Other Contingencies

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

As of September 30, 2022, we accrued aggregate legal liabilities of $264 million. While we intend to defend these matters vigorously, adverse outcomes that we estimate could reach approximately $500 million in aggregate beyond recorded amounts are reasonably possible. Were unfavorable final outcomes to occur, there exists the possibility of a material adverse impact in our consolidated financial statements for the period in which the effects become reasonably estimable.

NOTE 15 — STOCKHOLDERS’ EQUITY

Share Repurchases

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

On September 14, 2021, our Board of Directors approved a share repurchase program authorizing up to $60.0 billion in share repurchases. This share repurchase program commenced in November 2021, following completion of the program approved on September 18, 2019, has no expiration date, and may be terminated at any time. As of September 30, 2022, $36.1 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)


Fiscal Year		2023			2022

First Quarter	17	$	4,600	21	$	6,200

PART I

Item 1

All repurchases were made using cash resources. Shares repurchased during the first quarter of fiscal year 2023 were under the share repurchase program approved on September 14, 2021. Shares repurchased during the first quarter of fiscal year 2022 were under the share repurchase program approved on September 18, 2019. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards of $973 million and $1.5 billion for the first quarter of fiscal years 2023 and 2022, respectively.

Dividends

Our Board of Directors declared the following dividends:

Declaration Date	Record Date	Payment Date		Dividend Per Share		Amount


Fiscal Year 2023						(In millions)

September 20, 2022	November 17, 2022	December 8, 2022	$	0.68	$	5,071

Fiscal Year 2022

September 14, 2021	November 18, 2021	December 9, 2021	$	0.62	$	4,652

The dividend declared on September 20, 2022 was included in other current liabilities as of September 30, 2022.

NOTE 16 — ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

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

(In millions)


Three Months Ended September 30,		2022			2021

Derivatives

Balance, beginning of period	$	(13	)	$	(19	)
Unrealized losses, net of tax of $(11) and $(3)		(40	)		(10	)

Reclassification adjustments for losses included in other income (expense), net		59			15
Tax benefit included in provision for income taxes		(12	)		(3	)


Amounts reclassified from accumulated other comprehensive income (loss)		47			12


Net change related to derivatives, net of tax of $1 and $0		7			2


Balance, end of period	$	(6	)	$	(17	)


Investments

Balance, beginning of period	$	(2,138	)	$	3,222
Unrealized losses, net of tax of $(510) and $(110)		(1,925	)		(415	)

Reclassification adjustments for (gains) losses included in other income (expense), net		35			(9	)
Tax expense (benefit) included in provision for income taxes		(7	)		2


Amounts reclassified from accumulated other comprehensive income (loss)		28			(7	)


Net change related to investments, net of tax of $(503) and $(112)		(1,897	)		(422	)


Balance, end of period	$	(4,035	)	$	2,800


Translation Adjustments and Other

Balance, beginning of period	$	(2,527	)	$	(1,381	)
Translation adjustments and other, net of tax of $0 and $0		(775	)		(119	)


Balance, end of period	$	(3,302	)	$	(1,500	)


Accumulated other comprehensive income (loss), end of period	$	(7,343	)	$	1,283

PART I

Item 1

NOTE 17 — SEGMENT INFORMATION AND GEOGRAPHIC DATA

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

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

Our reportable segments are described below.

Productivity and Business Processes

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

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

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

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

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

Intelligent Cloud

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

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

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

More Personal Computing

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

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

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

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

	•	Search and news advertising.

PART I

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

In addition, certain costs incurred at a corporate level that 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.

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

(In millions)


Three Months Ended September 30,	2022		2021

Revenue

Productivity and Business Processes	$	16,465	$	15,039
Intelligent Cloud		20,325		16,912
More Personal Computing		13,332		13,366


Total	$	50,122	$	45,317


Operating Income

Productivity and Business Processes	$	8,323	$	7,581
Intelligent Cloud		8,978		7,681
More Personal Computing		4,217		4,976


Total	$	21,518	$	20,238

No sales to an individual customer or country other than the United States accounted for more than 10% of revenue for the three months ended September 30, 2022 or 2021. Revenue, classified by the major geographic areas in which our customers were located, was as follows:

(In millions)


Three Months Ended September 30,	2022		2021

United States (a)	$	25,867	$	22,830
Other countries		24,255		22,487


Total	$	50,122	$	45,317

(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.

PART I

Item 1

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

(In millions)


Three Months Ended September 30,	2022		2021

Server products and cloud services	$	18,388	$	15,070
Office products and cloud services		11,548		10,808
Windows		5,313		5,674
LinkedIn		3,663		3,136
Gaming		3,610		3,593
Search and news advertising		2,928		2,656
Enterprise Services		1,876		1,791
Devices		1,448		1,414
Other		1,348		1,175


Total	$	50,122	$	45,317

Our Microsoft Cloud revenue, which includes Azure and other cloud services, Office 365 Commercial, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties, was $25.7 billion and $20.7 billion for the three months ended September 30, 2022 and 2021, respectively. These amounts are primarily included in Server products and cloud services, Office products and cloud services, and LinkedIn in the table above.

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

PART I

Item 1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and the Board of Directors of Microsoft Corporation

Results of Review of Interim Financial Information

We have reviewed the accompanying consolidated balance sheet of Microsoft Corporation and subsidiaries (the "Company") as of September 30, 2022, the related consolidated statements of income, comprehensive income, cash flows, and stockholders’ equity for the three-month periods ended September 30, 2022 and 2021, and the related notes (collectively referred to as the “interim financial information”). Based on our reviews, we are not aware of any material modifications that should be made to the accompanying interim financial information for it to be in conformity with accounting principles generally accepted in the United States of America.

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

Basis for Review Results

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

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

/S/ DELOITTE & TOUCHE LLP

Seattle, Washington

October 25, 2022

PART I

Item 2

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

Note About Forward-Looking Statements

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

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

OVERVIEW

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

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

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

	•	Microsoft Cloud revenue increased 24% to $25.7 billion.

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

	•	Office Consumer products and cloud services revenue increased 7% and Microsoft 365 Consumer subscribers increased to 61.3 million.

	•	LinkedIn revenue increased 17%.

	•	Dynamics products and cloud services revenue increased 15% driven by Dynamics 365 growth of 24%.

	•	Server products and cloud services revenue increased 22% driven by Azure and other cloud services growth of 35%.

	•	Windows original equipment manufacturer licensing (“Windows OEM”) revenue decreased 15%.

	•	Windows Commercial products and cloud services revenue increased 8%.

	•	Xbox content and services revenue decreased 3%.

	•	Search and news advertising revenue excluding traffic acquisition costs increased 16%.

	•	Devices revenue increased 2%.

PART I

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Industry Trends

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

Economic Conditions, Challenges, and Risks

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

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

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

Our international operations provide a significant portion of our total revenue and expenses. Many of these revenue and expenses are denominated in currencies other than the U.S. dollar. As a result, changes in foreign exchange rates may significantly affect revenue and expenses. Fluctuations in the U.S. dollar relative to certain foreign currencies reduced reported revenue and expenses from our international operations in the first quarter of fiscal year 2023. 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.

Change in Accounting Estimate

In July 2022, we completed an assessment of the useful lives of our server and network equipment. Due to investments in software that increased efficiencies in how we operate our server and network equipment, as well as advances in technology, we determined we should increase the estimated useful lives of both server and network equipment from four years to six years. This change in accounting estimate was effective beginning fiscal year 2023. Based on the carrying amount of server and network equipment included in property and equipment, net as of June 30, 2022, the effect of this change in estimate for the three months ended September 30, 2022, was an increase in operating income of $1.1 billion and net income of $859 million, or $0.12 and $0.11 per basic and diluted share, respectively. It is estimated this change will increase our fiscal year 2023 annual operating income by $3.7 billion.

Reportable Segments

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

PART I

Item 2

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

Metrics

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

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

Commercial

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

Commercial remaining performance obligation		Commercial portion of revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods

Microsoft Cloud revenue		Revenue from Azure and other cloud services, Office 365 Commercial, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties

Microsoft Cloud gross margin percentage		Gross margin percentage for our Microsoft Cloud business

PART I

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Productivity and Business Processes and Intelligent Cloud

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

Office Commercial products and cloud services revenue growth		Revenue from Office Commercial products and cloud services (Office 365 subscriptions, the Office 365 portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises), comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Microsoft Viva

Office Consumer products and cloud services revenue growth		Revenue from Office Consumer products and cloud services, including Microsoft 365 Consumer subscriptions, Office licensed on-premises, and other Office services

Office 365 Commercial seat growth		The number of Office 365 Commercial seats at end of period where seats are paid users covered by an Office 365 Commercial subscription

Microsoft 365 Consumer subscribers		The number of Microsoft 365 Consumer subscribers at end of period

Dynamics products and cloud services revenue growth		Revenue from Dynamics products and cloud services, including Dynamics 365, comprising a set of intelligent, cloud-based applications across ERP, CRM, Customer Insights, Power Apps, and Power Automate; and on-premises ERP and CRM applications

LinkedIn revenue growth		Revenue from LinkedIn, including Talent Solutions, Marketing Solutions, Premium Subscriptions, and Sales Solutions

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

More Personal Computing

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

Windows OEM revenue growth		Revenue from sales of Windows Pro and non-Pro licenses sold through the OEM channel

Windows Commercial products and cloud services revenue growth		Revenue from Windows Commercial products and cloud services, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings

Devices revenue growth		Revenue from Devices, including Surface, HoloLens, and PC accessories

Xbox content and services revenue growth		Revenue from Xbox content and services, comprising first- and third-party content (including games and in-game content), Xbox Game Pass and other subscriptions, Xbox Cloud Gaming, third-party disc royalties, advertising, and other cloud services

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

PART I

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SUMMARY RESULTS OF OPERATIONS

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


		2022		2021

Revenue	$	50,122	$	45,317	11%
Gross margin		34,670		31,671	9%
Operating income		21,518		20,238	6%
Net income		17,556		20,505	(14)%
Diluted earnings per share		2.35		2.71	(13)%

Adjusted net income (non-GAAP)		17,556		17,214	2%
Adjusted diluted earnings per share (non-GAAP)		2.35		2.27	4%

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. Refer to Note 11 – Income Taxes of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) for further discussion.

Three Months Ended September 30, 2022 Compared with Three Months Ended September 30, 2021

Revenue increased $4.8 billion or 11% driven by growth in Intelligent Cloud and Productivity and Business Processes. Intelligent Cloud revenue increased driven by Azure and other cloud services. Productivity and Business Processes revenue increased driven by Office 365 Commercial and LinkedIn. More Personal Computing revenue decreased slightly primarily driven by a decline in Windows, offset in part by growth in Search and news advertising.

Cost of revenue increased $1.8 billion or 13% driven by growth in Microsoft Cloud and Gaming, offset in part by a reduction in depreciation expense due to the change in accounting estimate for the useful lives of our server and network equipment.

Gross margin increased $3.0 billion or 9% driven by growth in Intelligent Cloud and Productivity and Business Processes and the change in accounting estimate, offset in part by a decline in More Personal Computing.

	•	Gross margin percentage decreased slightly. Excluding the impact of the change in accounting estimate, gross margin percentage decreased 3 points driven by reductions in More Personal Computing and Intelligent Cloud.

	•	Microsoft Cloud gross margin percentage increased 2 points to 73%. Excluding the impact of the change in accounting estimate, Microsoft Cloud gross margin percentage decreased 1 point driven by sales mix shift to Azure and other cloud services and lower margins in Azure and other cloud services, primarily due to higher energy costs.

Operating expenses increased $1.7 billion or 15% driven by investments in cloud engineering, LinkedIn, Nuance, and commercial sales.

Key changes in operating expenses were:

	•	Research and development expenses increased $1.0 billion or 18% driven by investments in cloud engineering and LinkedIn. Research and development included a favorable foreign currency impact of 2%.

	•	Sales and marketing expenses increased $579 million or 13% driven by investments in commercial sales, Nuance, and LinkedIn. Sales and marketing included a favorable foreign currency impact of 4%.

	•	General and administrative expenses increased $111 million or 9% driven by investments in corporate functions. General and administrative included a favorable foreign currency impact of 3%.

Operating income increased $1.3 billion or 6% driven by growth in Intelligent Cloud and Productivity and Business Processes and the change in accounting estimate, offset in part by a decline in More Personal Computing.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 5%, 7%, and 9%, respectively. Cost of revenue and operating expenses both included a favorable foreign currency impact of 3%.

PART I

Item 2

Prior year net income and diluted EPS were positively impacted by the net tax benefit related to the transfer of intangible properties, which resulted in an increase to net income and diluted EPS of $3.3 billion and $0.44, respectively.

SEGMENT RESULTS OF OPERATIONS

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


	2022		2021

Revenue

Productivity and Business Processes	$	16,465	$	15,039	9%
Intelligent Cloud		20,325		16,912	20%
More Personal Computing		13,332		13,366	0%


Total	$	50,122	$	45,317	11%


Operating Income

Productivity and Business Processes	$	8,323	$	7,581	10%
Intelligent Cloud		8,978		7,681	17%
More Personal Computing		4,217		4,976	(15)%


Total	$	21,518	$	20,238	6%

Reportable Segments

Three Months Ended September 30, 2022 Compared with Three Months Ended September 30, 2021

Productivity and Business Processes

Revenue increased $1.4 billion or 9%.

	•	Office Commercial products and cloud services revenue increased $633 million or 7%. Office 365 Commercial revenue grew 11% with seat growth of 14%, driven by small and medium business and frontline worker offerings, as well as growth in revenue per user. Office Commercial products revenue declined 28% driven by continued customer shift to cloud offerings.

	•	Office Consumer products and cloud services revenue increased $105 million or 7% driven by Microsoft 365 Consumer subscription revenue. Microsoft 365 Consumer subscribers grew 13% to 61.3 million.

	•	LinkedIn revenue increased $527 million or 17% driven by Talent Solutions.

	•	Dynamics products and cloud services revenue increased 15% driven by Dynamics 365 growth of 24%.

Operating income increased $742 million or 10%.

	•	Gross margin increased $1.3 billion or 11% driven by growth in Office 365 Commercial and LinkedIn, as well as the change in accounting estimate. Gross margin percentage increased. Excluding the impact of the change in accounting estimate, gross margin percentage decreased slightly driven by sales mix shift to cloud offerings.

	•	Operating expenses increased $568 million or 13% driven by investments in LinkedIn and cloud engineering.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 6%, 7%, and 9%, respectively. Operating expenses included a favorable foreign currency impact of 3%.

Intelligent Cloud

Revenue increased $3.4 billion or 20%.

	•	Server products and cloud services revenue increased $3.3 billion or 22% driven by Azure and other cloud services. Azure and other cloud services revenue grew 35% driven by growth in our consumption-based services. Server products revenue was relatively unchanged.

	•	Enterprise Services revenue increased $85 million or 5% driven by growth in Enterprise Support Services.

PART I

Item 2

Operating income increased $1.3 billion or 17%.

	•	Gross margin increased $2.4 billion or 20% driven by growth in Azure and other cloud services and the change in accounting estimate. Gross margin percentage decreased slightly. Excluding the impact of the change in accounting estimate, gross margin percentage decreased 3 points driven by sales mix shift to Azure and other cloud services and lower margins in Azure and other cloud services, primarily due to higher energy costs.

	•	Operating expenses increased $1.1 billion or 25% driven by investments in Azure and Nuance.

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

More Personal Computing

Revenue decreased slightly.

	•	Windows revenue decreased $361 million or 6% driven by a decrease in Windows OEM, offset in part by growth in Windows Commercial. Windows OEM revenue decreased 15% driven by continued deterioration in the PC market, offset in part by 5 points of positive impact from the prior year Windows 11 revenue deferral. Windows Commercial products and cloud services revenue increased 8% driven by demand for Microsoft 365.

	•	Search and news advertising revenue increased $272 million or 10%. Search and news advertising revenue excluding traffic acquisition costs increased 16% driven by higher search volume and Xandr.

	•	Devices revenue increased $34 million or 2%.

	•	Gaming revenue increased slightly driven by growth in Xbox hardware, offset in part by a decline in Xbox content and services. Xbox hardware revenue increased 13% driven by higher volume and price of consoles sold. Xbox content and services revenue decreased 3% driven by declines in first-party content and in third-party content, with lower engagement hours and higher rate of monetization, offset in part by growth in Xbox Game Pass subscriptions.

Operating income decreased $759 million or 15%.

	•	Gross margin decreased $688 million or 9% driven by declines in Windows and Gaming. Gross margin percentage decreased driven by sales mix shift to lower margin businesses.

	•	Operating expenses increased $71 million or 2% primarily driven by investments in Search and news advertising.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 3%, 5%, and 6%, respectively. Operating expenses included a favorable foreign currency impact of 3%.

OPERATING EXPENSES

Research and Development

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


	2022		2021

Research and development	$	6,628	$	5,599	18%
As a percent of revenue		13%		12%	1ppt

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

Three Months Ended September 30, 2022 Compared with Three Months Ended September 30, 2021

Research and development expenses increased $1.0 billion or 18% driven by investments in cloud engineering and LinkedIn. Research and development included a favorable foreign currency impact of 2%.

PART I

Item 2

Sales and Marketing

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


	2022		2021

Sales and marketing	$	5,126	$	4,547	13%
As a percent of revenue		10%		10%	0ppt

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

Three Months Ended September 30, 2022 Compared with Three Months Ended September 30, 2021

Sales and marketing expenses increased $579 million or 13% driven by investments in commercial sales, Nuance, and LinkedIn. Sales and marketing included a favorable foreign currency impact of 4%.

General and Administrative

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


	2022		2021

General and administrative	$	1,398	$	1,287	9%
As a percent of revenue		3%		3%	0ppt

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

Three Months Ended September 30, 2022 Compared with Three Months Ended September 30, 2021

General and administrative expenses increased $111 million or 9% driven by investments in corporate functions. General and administrative included a favorable foreign currency impact of 3%.

PART I

Item 2

OTHER INCOME (EXPENSE), NET

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

(In millions)


Three Months Ended September 30,	2022			2021

Interest and dividends income	$	641		$	520
Interest expense		(500	)		(539	)
Net recognized gains on investments		13			371
Net gains (losses) on derivatives		9			(7	)
Net losses on foreign currency remeasurements		(78	)		(65	)
Other, net		(31	)		6


Total	$	54		$	286

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

Three Months Ended September 30, 2022 Compared with Three Months Ended September 30, 2021

Interest and dividends income increased due to higher yields, offset in part by 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 primarily due to lower gains on equity securities.

INCOME TAXES

Effective Tax Rate

Uncertain Tax Positions

PART I

Item 2

NON-GAAP FINANCIAL MEASURES

Adjusted net income and adjusted diluted EPS are non-GAAP financial measures which exclude the net tax benefit related to the transfer of intangible properties in 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)		Three Months Ended September 30,				Percentage Change


		2022		2021

Net income	$	17,556	$	20,505		(14)%
Net income tax benefit related to transfer of intangible properties		0		(3,291	)	*


Adjusted net income (non-GAAP)	$	17,556	$	17,214		2%


Diluted earnings per share	$	2.35	$	2.71		(13)%
Net income tax benefit related to transfer of intangible properties		0		(0.44	)	*


Adjusted diluted earnings per share (non-GAAP)	$	2.35	$	2.27		4%

*	Not meaningful.

LIQUIDITY AND CAPITAL RESOURCES

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 Tax Cuts and Jobs Act (“TCJA”), for at least the next 12 months and thereafter for the foreseeable future.

Cash, Cash Equivalents, and Investments

Cash, cash equivalents, and short-term investments totaled $107.3 billion and $104.8 billion as of September 30, 2022 and June 30, 2022, respectively. Equity investments were $6.8 billion and $6.9 billion as of September 30, 2022 and June 30, 2022, 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.

PART I

Item 2

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 decreased $1.3 billion to $23.2 billion for the three months ended September 30, 2022, mainly due to an increase in cash paid to suppliers and employees and cash used to pay income taxes, offset in part by an increase in cash received from customers. Cash used in financing decreased $5.4 billion to $10.9 billion for the three months ended September 30, 2022, mainly due to a $3.8 billion decrease in repayments of debt and a $2.1 billion decrease in common stock repurchases. Cash used in investing decreased $118 million to $3.1 billion for the three months ended September 30, 2022, due to an $857 million decrease in cash used for acquisitions of companies, net of cash acquired, and purchases of intangible and other assets, and a $177 million increase in cash from net investment purchases, sales, and maturities, offset in part by a $473 million increase in additions to property and equipment and a $443 million increase in other investing to facilitate the purchase of components.

Debt Proceeds

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. 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.

PART I

Item 2

The following table outlines the expected future recognition of unearned revenue as of September 30, 2022:

(In millions)


Three Months Ending

December 31, 2022	$	18,766
March 31, 2023		13,080
June 30, 2023		7,631
September 30, 2023		1,863
Thereafter		2,549


Total	$	43,889

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. Refer to Note 12 – Unearned Revenue of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) for further discussion.

Material Cash Requirements and Other Obligations

Income Taxes

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 $7.7 billion, which included $1.5 billion during the three months ended September 30, 2022. The remaining transition tax of $10.5 billion is payable over the next three years, with $2.5 billion payable within 12 months.

Provisions enacted in the TCJA related to the capitalization for tax purposes of research and experimental expenditures became effective on July 1, 2022. These provisions require us to capitalize research and experimental expenditures and amortize them on the U.S. tax return over five or fifteen years, depending on where research is conducted. The final foreign tax credit regulations, also effective on July 1, 2022, introduced significant changes to foreign tax credit calculations in the U.S. tax return. While these provisions are not expected to have a material impact on our fiscal year 2023 effective tax rate on a net basis, our cash paid for taxes would increase unless these provisions are postponed or modified through legislative processes.

Share Repurchases

For the three months ended September 30, 2022 and 2021, we repurchased 17 million shares and 21 million shares of our common stock for $4.6 billion and $6.2 billion, respectively, through our share repurchase programs. All repurchases were made using cash resources. As of September 30, 2022, $36.1 billion remained of our $60 billion share repurchase program. 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

For the three months ended September 30, 2022 and 2021, our Board of Directors declared quarterly dividends of $0.68 per share and $0.62 per share, respectively. We intend to continue returning capital to shareholders in the form of dividends, subject to declaration by our Board of Directors. Refer to Note 15 – Stockholders’ Equity of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) for further discussion.

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. The acquisition has been approved by Activision Blizzard’s shareholders, and we expect it to close in fiscal year 2023, subject to the satisfaction of certain regulatory approvals and other customary closing conditions.

PART I

Item 2

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.

CRITICAL ACCOUNTING ESTIMATES

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. Critical accounting estimates are those estimates that involve a significant level of estimation uncertainty and could have a material impact on our financial condition or results of operations. We have critical accounting estimates in the areas of 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.

Judgment is required to determine the stand-alone selling price (“SSP") for each distinct performance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services.

In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP.

Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers.

Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented.

PART I

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