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

Microsoft just released its second quarter financial results for 2023. The software maker earned $52.7 billion in revenue and $16.4 billion in net income during the second quarter. Revenues rose 2%, but net profit fell 12%. The results come just days after Microsoft announced 10,000 layoffs.

Microsoft previously predicted a tough quarter for Windows OEM revenue and hardware, and the results are clear about the state of the PC industry right now. PC shipments will fall 16% in 2022, according to Canalys analysis, and Gartner reported a nearly 29% year-over-year drop in the fourth quarter — the biggest quarterly drop in shipments 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 makers pay Microsoft to put Windows on machines, fell 39 percent in the second quarter. Microsoft says this was due to “continued weakness in the PC market and a similarly strong prior year.”

The Surface Pro 9 in laptop mode.

Surface Pro 9.
Photo: Amelia Holowaty Krales / The Verge

Gartner says total PC shipments in 2022 will be close to pre-pandemic levels, so the laptop buying boom is clearly over. “Because many consumers already have relatively new PCs purchased during the pandemic, unaffordability replaces any motivation to buy, causing demand for consumer PCs to fall to the lowest level in years,” says Mikako Kitagawa, principal analyst at Gartner.

“While the number of PCs shipped fell during the quarter, returning to pre-pandemic levels, the intensity of Windows usage continues to be higher than pre-pandemic, with time spent on the PC up nearly 10 percent,” says Microsoft CEO Satya Nadella. Call for earnings Today.

This deterioration in the PC market has also affected Microsoft’s device revenue, which now includes HoloLens and PC accessories beyond just Surface revenue. Device revenue also fell 39 percent in the second quarter, even though Microsoft launched the new Surface Pro 9, Surface Laptop 5 and Surface Studio 2 Plus devices just in time for the holidays.

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The personal computer market is not going to improve in the next quarter either. Microsoft CFO Amy Hood provided guidance for a mid-to-high 30 percent decline in Windows OEM revenue for the third quarter, alongside a mid-40 percent decline in device revenue.

Microsoft announced last week that it has changed its “hardware portfolio” amid layoffs. The software giant booked $1.2 billion of its second-quarter earnings related to those hardware changes, severance costs and “the cost of lease consolidation as we create higher density across our workspaces.”

After Congress rejected the military’s request to buy up to 6,900 headsets based on Microsoft’s HoloLens technology, job cuts hit the HoloLens division especially hard. Microsoft’s struggles with HoloLens have been well-documented over the past year after former HoloLens boss Alex Kipman left the company amid allegations of misconduct and Microsoft reportedly scrapped plans for HoloLens 3.

Microsoft's white Xbox Series S sits next to a large black Xbox Series X on a wooden coffee table in the living room

Xbox Series S and X consoles.
Photo by Tom Warren / The Verge

Elsewhere with Microsoft’s hardware efforts, the Xbox was also down this quarter. Xbox hardware revenue fell 13% alongside a 12% decline in Xbox content and services revenue. Microsoft says the decline in content and services revenue is related to a “comparatively strong prior year” that was “partially offset by growth in Xbox Game Pass subscriptions.” Overall, Microsoft’s gaming revenue fell 13% year over year.

The decline in Xbox hardware revenue was due to lower price and volume of consoles sold, which means Microsoft sold fewer Xbox Series S/X consoles over the holidays than at higher prices during the same period in 2022. Microsoft has dropped its Xbox line. S price for $249.99 for the holidays, hoping to drum up 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’s CEO of gaming, Phil Spencer, revealed in October that growth has stalled on the console side of the service.

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“We’re seeing incredible growth on PC … on consoles, I’ve seen the growth slow down, mostly because at some point you’ve reached everyone on consoles who wants to sign up,” Spencer said in an interview in October. Spencer also revealed that Xbox Game Pass will remain 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 subscribers, 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 plans to close in its 2023 fiscal year (end of June). The European Commission has launched what it calls an “in-depth investigation” into the Microsoft deal after Britain’s Competition and Markets Authority (CMA) flagged a closer look at the deal in September. The FTC is also suing Microsoft to block the acquisition after weeks of back-and-forth between Microsoft, Sony and regulators over competition concerns and the future of Sense of mission.

Hood also provided guidance on Microsoft’s gaming efforts for third-quarter revenue. Revenues from the games are expected to decrease in the next quarterly results “high single digits”, alongside a decrease in revenues from Xbo content and services “in low single digits”. Hood did not provide any guidance for Xbox hardware revenue in the third quarter.

Illustration of Microsoft 365 logos around a man

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

As always, it was Microsoft Office, cloud and server products that generated the revenue in the second quarter. Microsoft’s cloud revenue is heavily influencing this quarter’s earnings, with intelligent cloud revenue up 18% year-over-year. Revenue from server products and cloud services grew 20 percent, and Azure and other cloud services revenue grew 31 percent.

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“The next great wave of computing is born, as Microsoft’s cloud transforms the world’s most advanced artificial intelligence models into a new computing platform,” Nadella says 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 one day after Microsoft expanded its OpenAI partnership with an investment estimated at $10 billion. The long-term partnership will see Microsoft become OpenAI’s exclusive cloud partner, and Microsoft’s cloud services will power all OpenAI workloads across products, API services and research.

“Azure ML revenue alone has grown more than 100 percent for five consecutive quarters,” Nadella said on an earnings call today. Microsoft has not disclosed the full details of OpenAI, but rumors suggest that it may receive 75% of OpenAI’s profits until it secures a return on its investment and 49% of the company’s shares.

On the Office side of Microsoft’s earnings, Microsoft 365 consumer subscribers rose 12% this quarter, reaching a total of 63.2 million. Microsoft just launched a new $1.99 per month Microsoft 365 Basic subscription earlier this month, so expect to see that affect the number of subscribers in the next quarterly results. Microsoft has also pushed the Microsoft 365 brand above Microsoft Office, which will help with subscriber numbers and ads.

We haven’t heard much about Teams numbers in a few months, but Nadella shared an update today. Microsoft Teams passed 280 million monthly active users during this quarter, with Nadella saying that Microsoft “continues to take share in every category, from collaboration, to chat, to meetings, to conversations.”

Revenue from commercial office products and cloud services also grew by 7 percent, with Office 365 commercial revenue up 11 percent. Elsewhere, LinkedIn revenue was up 10% year over year, and search and news advertising revenue was up 10%.

Update, Jan. 24, 4:50 p.m. ET: Updated article with more information on Xbox revenue.
Update, Jan. 24, 4:50 p.m. ET: The article has been updated with comments from Microsoft CEO Satya Nadella and Microsoft CFO Amy Hood.

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