Microsoft Q2 2023: Windows, devices, and Xbox down as cloud holds strong

Microsoft has just posted the second quarter of its 2023 fiscal financial results. The software maker made $52.7 billion in revenue and a net income of $16.4 billion during Q2. Revenue is up 2 percent, but net income has dropped by 12 percent. The results come just days after Microsoft announced 10,000 layoffs.

Microsoft previously forecast a tough quarter for Windows OEM revenue and hardware, and the results are clear on the state of the PC industry right now. PC shipments fell by 16 percent in 2022, according to analysis by Canalys, and Gartner reported a nearly 29 percent year-over-year drop in Q4 — the largest quarterly shipment decline since it began tracking the PC market in the mid-1990s. Microsoft’s Windows-related revenue has been hit hard as a result.

Windows OEM revenue, the price PC manufacturers pay Microsoft to put Windows on machines, fell by a massive 39 percent in Q2. Microsoft says this was driven by “continued PC market weakness and a strong prior year comparable.”

Surface Pro 9.
Photo by Amelia Holowaty Krales / WM Leader

Gartner says the total amount of PC shipments in 2022 was close to pre-pandemic levels, so it’s clear the boom of laptop purchases is well and truly over. “Since many consumers already have relatively new PCs that were purchased during the pandemic, a lack of affordability is superseding any motivation to buy, causing consumer PC demand to drop to its lowest level in years,” says Mikako Kitagawa, director analyst at Gartner.

“While the number of PCs shipped declined during the quarter, returning to pre-pandemic levels, usage intensity of Windows continues to be higher than pre-pandemic, with time spent per PC up nearly 10 percent,” says Microsoft CEO Satya Nadella in an earnings call today.

This deterioration in the PC market has also had an impact on Microsoft’s devices revenues, which now include HoloLens and PC accessories beyond just Surface revenue. Devices revenue has also dropped a massive 39 percent in Q2, despite Microsoft launching the new Surface Pro 9, Surface Laptop 5, and Surface Studio 2 Plus devices just ahead of the holidays.

The PC market isn’t going to improve next quarter, either. Microsoft CFO Amy Hood provided guidance of mid to high 30 percent declines in Windows OEM revenue for Q3, alongside mid 40 percent declines for devices revenue.

Microsoft announced last week that it has changed its “hardware portfolio” amid layoffs. The software giant is writing down $1.2 billion in its Q2 earnings related to these hardware changes, severance costs, and “the cost of lease consolidation as we create higher density across our workspaces.”

After Congress denied the Army’s request to buy up to 6,900 headsets based on Microsoft’s HoloLens technology, job cuts have hit the HoloLens division particularly hard. Microsoft’s struggles with HoloLens have been well documented over the past year after former HoloLens boss Alex Kipman departed the company following misconduct allegations and Microsoft reportedly scrapped plans for a HoloLens 3.

Microsoft’s white Xbox Series S sits alongside a bigger and black Xbox Series X on a wooden coffee table in a living room

Xbox Series S and X consoles.
Photo by Tom Warren / WM Leader

Elsewhere with Microsoft’s hardware efforts, Xbox is also down this quarter. Xbox hardware revenue has decreased by 13 percent alongside a 12 percent dip in Xbox content and services revenue. Microsoft says this was content and services revenue decrease was related to “a strong prior year comparable” that was “partially offset by growth in Xbox Game Pass subscriptions.” Overall, Microsoft’s gaming revenue declined 13 percent year over year.

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The Xbox hardware revenue decrease was “driven by lower price and volume of consoles sold,” which means Microsoft sold less Xbox Series S / X consoles over the holidays than it did at higher prices in the same period in 2022. Microsoft dropped its Xbox Series S price to $249.99 for the holidays, hoping to stoke interest in its Xbox Game Pass console.

This time last year, Microsoft said Xbox Game Pass had grown to 25 million subscribers, but the company hasn’t provided an update since then, and there’s no mention of new numbers today. That could be because Microsoft Gaming CEO Phil Spencer revealed in October that growth has stalled on the console side of the service.

“We’re seeing incredible growth on PC … On console, I’ve seen growth slow down, mainly because at some point you’ve reached everybody on console that wants to subscribe,” said Spencer in an interview in October. Spencer also revealed that Xbox Game Pass will stay at around 10–15 percent of Microsoft’s Xbox content and services revenue and that the service is profitable.

“We saw new highs for [Xbox] Game Pass subscriptions, game streaming hours, and monthly active devices,” says Nadella. “And monthly active users surpassed a record 120 million during the quarter.”

Microsoft continues to face pushback from regulators over its planned $68.7 billion acquisition of Activision Blizzard, which it intends to close in its fiscal 2023 year (end of June). The European Commission has opened what it calls an “in-depth investigation” into Microsoft’s deal after the UK’s Competition and Markets Authority (CMA) signaled a closer look at the deal in September. The FTC is also suing Microsoft to block the purchase after weeks of back and forth between Microsoft, Sony, and regulators over competition concerns and the future of Call of Duty.

Hood also provided guidance on Microsoft’s gaming efforts for Q3 revenues. Gaming revenue is expected to decline in “high single digits” next quarterly results, alongside Xbox content and services revenue declining “in low single digits.” Hood didn’t provide any guidance for Xbox hardware revenues in Q3.

Illustration of Microsoft 365 logos around a man

Microsoft just launched a new Microsoft 365 Basic subscription.
Image: Microsoft

As always, it was Microsoft Office, cloud, and server products that drove revenue in Q2. Microsoft’s cloud revenue is a big influence on this quarter’s earnings, with overall intelligent cloud revenue up 18 precent year over year. Server products and cloud services revenues grew by 20 percent, and Azure and other cloud services revenue grew by 31 percent.

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“The next major wave of computing is being born, as the Microsoft Cloud turns the world’s most advanced AI models into a new computing platform,” says Nadella in an earnings statement. “We are committed to helping our customers use our platforms and tools to do more with less today and innovate for the future in the new era of AI.”

Nadella’s comments come just a day after Microsoft extended its OpenAI partnership with an investment believed to be valued at $10 billion. The long-term partnership will see Microsoft become the exclusive cloud partner for OpenAI, and Microsoft’s cloud services will power all OpenAI workloads across products, API services, and research.

“Azure ML revenue alone has increased more than 100 percent for five quarters in a row,” said Nadella on an earnings call today. Microsoft didn’t disclose full OpenAI details, but rumors suggest it may receive 75 percent of OpenAI’s profits until it secures its investment return and a 49 percent stake in the company.

Over on the Office side of Microsoft’s earnings, Microsoft 365 consumer subscriptions are up by 12 percent this quarter, reaching 63.2 million in total. Microsoft has just launched a new $1.99-a-month Microsoft 365 Basic subscription earlier this month, so expect to see that impact the number of subscribers in the next quarterly results. Microsoft has also been pushing the Microsoft 365 brand over Microsoft Office, which will help with subscription numbers and awareness.

We haven’t heard much about Teams numbers for some months now, but Nadella shared an update today. Microsoft Teams has passed 280 million monthly active users during this quarter, with Nadella saying Microsoft “continues to take share across every category, from collaboration, to chat, to meetings, to calling.”

Office commercial products and cloud services revenue also grew by 7 percent, with Office 365 commercial revenue up 11 percent. Elsewhere, LinkedIn revenue is up 10 percent year over year, and search and news advertising revenues are up 10 percent.

Update, January 24th 4:50PM ET: Article updated with more Xbox revenue information.
Update, January 24th 4:50PM ET: Article updated with comments from Microsoft CEO Satya Nadella and Microsoft CFO Amy Hood.

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