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 second quarter of fiscal year 2023 compared with the second quarter of fiscal year 2022 included:

• Microsoft Cloud revenue increased 22% to $27.1 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 decreased 2% and
        Microsoft 365 Consumer subscribers increased to 63.2 million.


  • LinkedIn revenue increased 10%.


     •  Dynamics products and cloud services revenue increased 13% driven by
        Dynamics 365 growth of 21%.

• Server products and cloud services revenue increased 20% driven by Azure

and other cloud services growth of 31%.

• Windows original equipment manufacturer licensing ("Windows OEM") revenue


        decreased 39%.


  • Windows Commercial products and cloud services revenue decreased 3%.


  • Xbox content and services revenue decreased 12%.

• Search and news advertising revenue excluding traffic acquisition costs


        increased 10%.


  • Devices revenue decreased 39%.


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                                     PART I
                                     Item 2



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 for the three and six months ended December
31, 2022.

On January 18, 2023, we announced decisions we made to align our cost structure
with our revenue and customer demand, prioritize our investments in strategic
areas, and consolidate office space. As a result, we recorded a $1.2 billion
charge in the second quarter of fiscal year 2023 ("Q2 charge"), which included
employee severance expenses of $800 million, impairment charges resulting from
changes to our hardware portfolio, and costs related to lease consolidation
activities. First, we are reducing our overall workforce by approximately 10,000
jobs through the third quarter of fiscal year 2023, which represents less than
5% of our total employee base. While we are eliminating roles in some areas, we
will continue to hire in key strategic areas. Second, we are allocating both our
capital and talent to areas of secular growth and long-term competitiveness,
while divesting in other areas. Third, we are consolidating our leases to create
higher density across our workspaces, which will also impact our financial
results through the remainder of fiscal year 2023, and we may make similar
decisions in future periods as we continue to evaluate our real estate needs.

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.


                                       32
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                                     Item 2

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 December 31, 2022 was an increase in operating income of
$945 million and net income of $768 million, or $0.10 per both basic and diluted
share. The effect of this change for the six months ended December 31, 2022 was
an increase in operating income of $2.0 billion and net income of $1.6 billion,
or $0.22 per both basic and diluted share. 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.

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




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                                     PART I
                                     Item 2


Productivity and Business Processes and Intelligent Cloud



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

Office Commercial products and cloud services revenue growth Revenue from Office Commercial products and


                                                               cloud 

services (Office 365 subscriptions, the


                                                               Office 365 

portion of Microsoft 365 Commercial

subscriptions, and Office licensed on-premises),


                                                               comprising 

Office, Exchange, SharePoint,


                                                               Microsoft 

Teams, Office 365 Security and


                                                               Compliance, 

and 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


                                       34
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                                     PART I
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                         SUMMARY RESULTS OF OPERATIONS

(In millions, except percentages and per share             Three Months Ended       Percentage                Six Months Ended       Percentage
amounts)                                                         December 31,           Change                    December 31,           Change


                                                        2022             2021                             2022            2021

Revenue                                          $    52,747      $    51,728               2%     $   102,869     $    97,045               6%
Gross margin                                          35,259           34,768               1%          69,929          66,439               5%
Operating income                                      20,399           22,247             (8)%          41,917          42,485             (1)%
Net income                                            16,425           18,765            (12)%          33,981          39,270            (13)%
Diluted earnings per share                              2.20             2.48            (11)%            4.54            5.19            (13)%

Adjusted gross margin (non-GAAP)                      35,411           34,768               2%          70,081          66,439               5%
Adjusted operating income (non-GAAP)                  21,570           22,247             (3)%          43,088          42,485               1%
Adjusted net income (non-GAAP)                        17,371           18,765             (7)%          34,927          35,979             (3)%
Adjusted diluted earnings per share (non-GAAP)          2.32             2.48             (6)%            4.67            4.76             (2)%




Adjusted gross margin, operating income, net income, and diluted earnings per
share ("EPS") are non-GAAP financial measures. Current year non-GAAP financial
measures exclude the impact of the Q2 charge, which includes employee severance
expenses, impairment charges resulting from changes to our hardware portfolio,
and costs related to lease consolidation activities. Prior year non-GAAP
financial measures exclude the net income tax benefit related to transfer of
intangible properties in the first quarter of fiscal year 2022. Refer to Note 11
- Income Taxes of the Notes to Financial Statements (Part I, Item 1 of this Form
10-Q) for further discussion. 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.

Three Months Ended December 31, 2022 Compared with Three Months Ended December 31, 2021

Revenue increased $1.0 billion or 2% driven by growth in Intelligent Cloud and Productivity and Business Processes, offset in part by a decline in More Personal Computing. Intelligent Cloud revenue increased driven by Azure and other cloud services. Productivity and Business Processes revenue increased driven by Office 365 Commercial. More Personal Computing revenue decreased driven by declines in Windows, Devices, and Gaming.

Cost of revenue increased $528 million or 3% driven by growth in Microsoft Cloud, 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 $491 million or 1% 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 2 points
        driven by reductions in More Personal Computing and Intelligent Cloud,
        offset in part by sales mix shift.

• Microsoft Cloud gross margin percentage increased 2 points to 72%.

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 higher energy costs.

Operating expenses increased $2.3 billion or 19% driven by employee severance expenses, investments in cloud engineering, the Nuance acquisition, and LinkedIn.

Key changes in operating expenses were:

• Research and development expenses increased $1.1 billion or 19% driven by

investments in cloud engineering, impairment charges resulting from

changes to our hardware portfolio, and LinkedIn. Research and development

included a favorable foreign currency impact of 2%.




     •  Sales and marketing expenses increased $300 million or 6% driven by the
        Nuance acquisition and investments in commercial sales. Sales and
        marketing included a favorable foreign currency impact of 3%.


     •  General and administrative expenses increased $953 million or 69% driven
        by employee severance expenses. General and administrative included a
        favorable foreign currency impact of 2%.


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                                     Item 2

Operating income decreased $1.8 billion or 8% driven by a decline in More Personal Computing, offset in part by the change in accounting estimate.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 5%, 7%, and 8%, respectively. Cost of revenue and operating expenses both included a favorable foreign currency impact of 2%.

Current year gross margin, operating income, net income, and diluted EPS were negatively impacted by the Q2 charge, which resulted in decreases of $152 million, $1.2 billion, $946 million, and $0.12, respectively.

Six Months Ended December 31, 2022 Compared with Six Months Ended December 31, 2021



Revenue increased $5.8 billion or 6% driven by growth in Intelligent Cloud and
Productivity and Business Processes, offset in part by a decline in More
Personal Computing. 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 driven by declines in Windows, Devices, and Gaming, offset in part by
growth in Search and news advertising.

Cost of revenue increased $2.3 billion or 8% driven by growth in Microsoft Cloud, offset in part by the change in accounting estimate.



Gross margin increased $3.5 billion or 5% 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 2 points
        driven by reductions in More Personal Computing and Intelligent Cloud,
        offset in part by sales mix shift.

• Microsoft Cloud gross margin percentage increased 2 points to 72%.

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 higher energy costs.


Operating expenses increased $4.1 billion or 17% driven by investment in cloud
engineering, employee severance expenses, LinkedIn, the Nuance acquisition, and
commercial sales.

Key changes in operating expenses were:

• Research and development expenses increased $2.1 billion or 19% driven by


        investments in cloud engineering and LinkedIn.


     •  Sales and marketing expenses increased $879 million or 9% driven by
        investments in commercial sales and the Nuance acquisition. Sales and
        marketing included a favorable foreign currency impact of 4%.


     •  General and administrative expenses increased $1.1 billion or 40% driven
        by employee severance expenses. General and administrative included a
        favorable foreign currency impact of 3%.

Operating income decreased $568 million or 1% driven by a decline in More Personal Computing, offset in part by the change in accounting estimate and growth in Productivity and Business Processes and Intelligent Cloud.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 5%, 7%, and 8%, respectively. Cost of revenue and operating expenses included a favorable foreign currency impact of 2% and 3%, respectively.



Current year gross margin, operating income, net income, and diluted EPS were
negatively impacted by the Q2 charge, which resulted in decreases of $152
million, $1.2 billion, $946 million, and $0.13, respectively. 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 $0.43, respectively.

                                       36
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                                     PART I
                                     Item 2


                         SEGMENT RESULTS OF OPERATIONS

(In millions, except                Three Months Ended       Percentage           Six Months Ended       Percentage
percentages)                              December 31,           Change               December 31,           Change


                                     2022         2021                           2022         2021

Revenue

Productivity and Business                                                                 $
Processes                      $   17,002     $ 15,936               7%     $  33,467       30,975               8%
Intelligent Cloud                  21,508       18,262              18%        41,833       35,174              19%
More Personal Computing            14,237       17,530            (19)%        27,569       30,896            (11)%


Total                          $   52,747     $ 51,728               2%     $ 102,869     $ 97,045               6%


Operating Income

Productivity and Business                                                                 $
Processes                      $    8,175     $  7,688               6%     $  16,498       15,269               8%
Intelligent Cloud                   8,904        8,323               7%        17,882       16,004              12%
More Personal Computing             3,320        6,236            (47)%         7,537       11,212            (33)%


Total                          $   20,399     $ 22,247             (8)%     $  41,917     $ 42,485             (1)%





Reportable Segments

Three Months Ended December 31, 2022 Compared with Three Months Ended December 31, 2021

Productivity and Business Processes

Revenue increased $1.1 billion or 7%.

• Office Commercial products and cloud services revenue increased $627

million or 7%. Office 365 Commercial revenue grew 11% with seat growth of

12%, driven by small and medium business and frontline worker offerings,

as well as growth in revenue per user. Office Commercial products revenue

declined 30% driven by continued customer shift to cloud offerings.

• Office Consumer products and cloud services revenue decreased $39 million

or 2%. Microsoft 365 Consumer subscribers grew 12% to 63.2 million.

• LinkedIn revenue increased $345 million or 10% driven by Talent Solutions.




     •  Dynamics products and cloud services revenue increased 13% driven by
        Dynamics 365 growth of 21%.

Operating income increased $487 million or 6%.

• Gross margin increased $1.0 billion or 8% driven by growth in Office 365

Commercial. 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 $554 million or 12% driven by investment in

LinkedIn and employee severance expenses.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 6%, 8%, and 11%, respectively. Operating expenses included a favorable foreign currency impact of 2%.

Intelligent Cloud

Revenue increased $3.2 billion or 18%.

• Server products and cloud services revenue increased $3.2 billion or 20%

driven by Azure and other cloud services. Azure and other cloud services

revenue grew 31% driven by growth in our consumption-based services.

Server products revenue decreased 2%.




     •  Enterprise Services revenue increased $39 million or 2% driven by growth
        in Enterprise Support Services, offset by a decline in Microsoft
        Consulting Services.


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                                     PART I
                                     Item 2

Operating income increased $581 million or 7%.

• Gross margin increased $2.2 billion or 17% 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 higher energy costs.


     •  Operating expenses increased $1.6 billion or 34% driven by employee

severance expenses, investments in Azure, and the Nuance acquisition.

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 $3.3 billion or 19%.

• Windows revenue decreased $1.8 billion or 27% driven by a decrease in

Windows OEM. Windows OEM revenue decreased 39% on a strong prior year

comparable, driven by continued PC market weakness and 3 points of

negative impact from the prior year Windows 11 revenue deferral. Windows


        Commercial products and cloud services revenue decreased 3% driven by a
        decline in standalone product sales.

• Devices revenue decreased $927 million or 39% driven by continued PC


        market weakness and execution challenges on new product launches.

• Gaming revenue decreased $684 million or 13% driven by declines in Xbox

content and services and Xbox hardware. Xbox content and services revenue

decreased 12% on a strong prior year comparable impacted by first-party

game launches, driven by declines in first-party content and a lower rate


        of monetization in third-party content, offset in part by growth in Xbox
        Game Pass subscriptions. Xbox hardware revenue decreased 13% driven by
        lower price and volume of consoles sold.

• Search and news advertising revenue increased $159 million or 5%. Search

and news advertising revenue excluding traffic acquisition costs increased

10% driven by higher search volume and the Xandr acquisition, offset in

part by lower revenue per search.

Operating income decreased $2.9 billion or 47%.

• Gross margin decreased $2.7 billion or 29% driven by declines in Windows

and Devices. Gross margin percentage decreased driven by reductions in

Devices, including the impact of impairment charges resulting from changes

to our hardware portfolio, and sales mix shift to lower margin businesses.

• Operating expenses increased $198 million or 6% driven by employee


        severance expenses and investments in Search and news advertising, offset
        in part by a decline in Devices.

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

Six Months Ended December 31, 2022 Compared with Six Months Ended December 31, 2021

Productivity and Business Processes

Revenue increased $2.5 billion or 8%.

• Office Commercial products and cloud services revenue increased $1.3

billion or 7%. Office 365 Commercial revenue grew 11% with seat growth of

12%, driven by small and medium business and frontline worker offerings,

as well as growth in revenue per user. Office Commercial products revenue

declined 29% driven by continued customer shift to cloud offerings.

• Office Consumer products and cloud services revenue increased $66 million


        or 2% with continued growth in Microsoft 365 Consumer subscription
        revenue.

• LinkedIn revenue increased $872 million or 13% driven by Talent Solutions.




     •  Dynamics products and cloud services revenue increased 14% driven by
        Dynamics 365 growth of 23%.


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                                     PART I
                                     Item 2


Operating income increased $1.2 billion or 8%.

• Gross margin increased $2.4 billion or 10% driven by growth in Office 365

Commercial and LinkedIn. 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 $1.1 billion or 12% driven by investments in

LinkedIn and cloud engineering, as well as employee severance expenses.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 6%, 7%, and 10%, respectively. Operating expenses included a favorable foreign currency impact of 3%.

Intelligent Cloud

Revenue increased $6.7 billion or 19%.

• Server products and cloud services revenue increased $6.5 billion or 21%

driven by Azure and other cloud services. Azure and other cloud services

revenue grew 33% driven by growth in our consumption-based services.

Server products revenue decreased 1%.

• Enterprise Services revenue increased $124 million or 3% driven by growth

in Enterprise Support Services, offset in part by a decline in Microsoft

Consulting Services.

Operating income increased $1.9 billion or 12%.

• Gross margin increased $4.5 billion or 18% 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 higher energy costs.

• Operating expenses increased $2.7 billion or 30% driven by investments in

Azure, the Nuance acquisition, and employee severance expenses.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 6%, 7%, and 8%, respectively. Operating expenses included a favorable foreign currency impact of 3%.

More Personal Computing

Revenue decreased $3.3 billion 11%.

• Windows revenue decreased $2.1 billion or 18% driven by a decrease in

Windows OEM. Windows OEM revenue decreased 28% driven by continued PC

market weakness. Windows Commercial products and cloud services revenue


        increased 2% driven by demand for Microsoft 365, offset in part by a
        decline in standalone product sales.


     •  Devices revenue decreased $893 million or 24% driven by continued PC
        market weakness and execution challenges on new product launches.

• Gaming revenue decreased $667 million or 7% driven by declines in Xbox

content and services and Xbox hardware. Xbox content and services revenue

decreased 8% driven by declines in first-party content and in third-party

content, with lower rate of monetization and engagement hours, offset in

part by growth in Xbox Game Pass subscriptions. Xbox hardware revenue

decreased 5% driven by lower price of consoles sold.

• Search and news advertising revenue increased $431 million or 8%. Search

and news advertising revenue excluding traffic acquisition costs increased

13% driven by higher search volume and the Xandr acquisition, offset in

part by lower revenue per search.

Operating income decreased $3.7 billion or 33%.

• Gross margin decreased $3.4 billion or 20% driven by declines in Windows,

Devices, and Gaming. Gross margin percentage decreased driven by

reductions in Devices, including the impact of impairment charges

resulting from changes to our hardware portfolio, and sales mix shift to

lower margin businesses.

• Operating expenses increased $269 million or 4% driven by investment in


        Search and news advertising and employee severance expenses, offset in
        part by a decline in Devices.


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                                     PART I
                                     Item 2

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



                               OPERATING EXPENSES

Research and Development

                                          Three Months Ended      Percentage              Six Months Ended      Percentage
(In millions, except percentages)               December 31,          Change                  December 31,          Change


                                          2022          2021                             2022         2021

Research and development            $    6,844      $  5,758             19%     $     13,472     $ 11,357             19%
As a percent of revenue                    13%           11%            2ppt              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 December 31, 2022 Compared with Three Months Ended December 31, 2021

Research and development expenses increased $1.1 billion or 19% driven by investments in cloud engineering, impairment charges resulting from changes to our hardware portfolio, and LinkedIn. Research and development included a favorable foreign currency impact of 2%.

Six Months Ended December 31, 2022 Compared with Six Months Ended December 31, 2021

Research and development expenses increased $2.1 billion or 19% driven by investments in cloud engineering and LinkedIn.

Sales and Marketing



                                          Three Months Ended      Percentage              Six Months Ended      Percentage
(In millions, except percentages)               December 31,          Change                  December 31,          Change


                                          2022          2021                              2022        2021

Sales and marketing                 $    5,679      $  5,379              6%     $      10,805     $ 9,926              9%

As a percent of revenue                    11%           10%            1ppt               11%         10%            1ppt




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

Three Months Ended December 31, 2022 Compared with Three Months Ended December 31, 2021



Sales and marketing expenses increased $300 million or 6% driven by the Nuance
acquisition and investments in commercial sales. Sales and marketing included a
favorable foreign currency impact of 3%.

Six Months Ended December 31, 2022 Compared with Six Months Ended December 31, 2021



Sales and marketing expenses increased $879 million or 9% driven by investments
in commercial sales and the Nuance acquisition. Sales and marketing included a
favorable foreign currency impact of 4%.

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                                     PART I
                                     Item 2


General and Administrative

                                          Three Months Ended      Percentage              Six Months Ended      Percentage
(In millions, except percentages)               December 31,          Change                  December 31,          Change


                                          2022          2021                              2022        2021

General and administrative          $    2,337      $  1,384             69%     $       3,735     $ 2,671             40%
As a percent of revenue                     4%            3%            1ppt                4%          3%            1ppt




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

Three Months Ended December 31, 2022 Compared with Three Months Ended December 31, 2021

General and administrative expenses increased $953 million or 69% driven by employee severance expenses. General and administrative included a favorable foreign currency impact of 2%.

Six Months Ended December 31, 2022 Compared with Six Months Ended December 31, 2021

General and administrative expenses increased $1.1 billion or 40% driven by employee severance expenses. General and administrative included a favorable foreign currency impact of 3%.


                          OTHER INCOME (EXPENSE), NET

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



                                                         Three Months Ended             Six Months Ended
(In millions)                                                  December 31,                 December 31,


                                                      2022             2021           2022          2021

Interest and dividends income                   $      700       $      503     $    1,341     $   1,023
Interest expense                                      (490 )           (525 )         (990 )      (1,064 )
Net recognized gains (losses) on investments           (15 )            300             (2 )         671
Net gains (losses) on derivatives                     (199 )              7           (190 )           0
Net losses on foreign currency remeasurements          (18 )            (13 )          (96 )         (78 )
Other, net                                             (38 )             (4 )          (69 )           2


Total                                           $      (60 )     $      268     $       (6 )   $     554

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

Three Months Ended December 31, 2022 Compared with Three Months Ended December 31, 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 losses on
investments increased due to losses on equity securities in the current period
compared to gains in the prior period. Net losses on derivatives increased due
to losses on a forward purchase agreement for shares of the London Stock
Exchange Group.

Six Months Ended December 31, 2022 Compared with Six Months Ended December 31, 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 losses on
investments increased due to losses on fixed income securities in the current
period compared to gains in the prior period, and lower gains on equity
securities in the current period. Net losses on derivatives increased due to
losses on a forward purchase agreement for shares of the London Stock Exchange
Group.

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                                     PART I
                                     Item 2


                                  INCOME TAXES

Effective Tax Rate

Our effective tax rate was 19% and 17% for the three months ended December 31,
2022 and 2021, respectively, and 19% and 9% for the six months ended December
31, 2022 and 2021, respectively. The increase in our effective tax rate for the
three months ended December 31, 2022 compared to the prior year was primarily
due to a decrease in tax benefits relating to stock-based compensation. The
increase in our effective tax rate for the six months ended December 31, 2022
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.

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 and six months ended December 31, 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



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

As of December 31, 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.

                          NON-GAAP FINANCIAL MEASURES

Adjusted gross margin, operating income, net income, and diluted EPS are
non-GAAP financial measures. Current year non-GAAP financial measures exclude
the impact of the Q2 charge, which includes employee severance expenses,
impairment charges resulting from changes to our hardware portfolio, and costs
related to lease consolidation activities. Prior year non-GAAP financial
measures exclude the net income tax benefit related to 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.

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                                     PART I
                                     Item 2

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



(In millions, except percentages and per share            Three Months Ended     Percentage             Six Months Ended     Percentage
amounts)                                                        December 31,         Change                 December 31,         Change


                                                        2022            2021                         2022           2021

Gross margin                                     $    35,259    $     34,768             1%   $    69,929    $    66,439             5%
Severance, hardware-related impairment, and
lease consolidation costs                                152               0              *           152              0              *


Adjusted gross margin (non-GAAP)                 $    35,411    $     34,768             2%   $    70,081    $    66,439             5%


Operating income                                 $    20,399    $     22,247           (8)%   $    41,917    $    42,485           (1)%
Severance, hardware-related impairment, and
lease consolidation costs                              1,171               0              *         1,171              0              *


Adjusted operating income (non-GAAP)             $    21,570    $     22,247           (3)%   $    43,088    $    42,485             1%


Net income                                       $    16,425    $    

18,765 (12)% $ 33,981 $ 39,270 (13)% Severance, hardware-related impairment, and lease consolidation costs

                                946               0              *           946              0              *
Net income tax benefit related to transfer of
intangible properties                                      0               0              *             0         (3,291 )            *


Adjusted net income (non-GAAP)                   $    17,371    $     18,765           (7)%   $    34,927    $    35,979           (3)%


Diluted earnings per share                       $      2.20    $       

2.48 (11)% $ 4.54 $ 5.19 (13)% Severance, hardware-related impairment, and lease consolidation costs

                               0.12               0              *          0.13              0              *
Net income tax benefit related to transfer of
intangible properties                                      0               0              *             0          (0.43 )            *


Adjusted diluted earnings per share (non-GAAP)   $      2.32    $       2.48           (6)%   $      4.67    $      4.76           (2)%





* 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 $99.5 billion and
$104.8 billion as of December 31, 2022 and June 30, 2022, respectively. Equity
investments were $7.1 billion and $6.9 billion as of December 31, 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.

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                                     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 $4.7 billion to $34.4 billion for the six months
ended December 31, 2022, mainly due to an increase in cash paid to employees and
suppliers and cash used to pay income taxes, offset in part by an increase in
cash received from customers. Cash used in financing decreased $6.0 billion to
$22.2 billion for the six months ended December 31, 2022, mainly due to a $4.1
billion decrease in common stock repurchases and a $3.1 billion decrease in
repayments of debt. Cash used in investing increased $5.9 billion to $10.3
billion for the six months ended December 31, 2022, due to a $5.4 billion
decrease in cash from net investment purchases, sales, and maturities, an $882
million increase in additions to property and equipment, and a $655 million
increase in other investing to facilitate the purchase of components, offset in
part by a $1.0 billion decrease in cash used for acquisitions of companies, net
of cash acquired, and purchases of intangible and other assets.

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.

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                                     PART I
                                     Item 2

The following table outlines the expected future recognition of unearned revenue as of December 31, 2022:



(In millions)


Three Months Ending

March 31, 2023        $ 18,324
June 30, 2023           11,215
September 30, 2023       4,888
December 31, 2023        2,555
Thereafter               2,644


Total                 $ 39,626

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 six months ended December 31, 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 six months ended December 31, 2022 and 2021, we repurchased 37 million
shares and 41 million shares of our common stock for $9.2 billion and $12.4
billion, respectively, through our share repurchase programs. All repurchases
were made using cash resources. As of December 31, 2022, $31.5 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 six months ended December 31, 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. We are continuing to engage with regulators reviewing the
transaction and are working toward closing it in fiscal year 2023, subject to
obtaining required regulatory approvals and satisfaction of other customary
closing conditions.

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                                     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.

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                                     PART I
                                     Item 2

Impairment of Investment Securities



We review debt investments quarterly for credit losses and impairment. If the
cost of an investment exceeds its fair value, we evaluate, among other factors,
general market conditions, credit quality of debt instrument issuers, and the
extent to which the fair value is less than cost. This determination requires
significant judgment. In making this judgment, we employ a systematic
methodology that considers available quantitative and qualitative evidence in
evaluating potential impairment of our investments. In addition, we consider
specific adverse conditions related to the financial health of, and business
outlook for, the investee. If we have plans to sell the security or it is more
likely than not that we will be required to sell the security before recovery,
then a decline in fair value below cost is recorded as an impairment charge in
other income (expense), net and a new cost basis in the investment is
established. If market, industry, and/or investee conditions deteriorate, we may
incur future impairments.

Equity investments without readily determinable fair values are written down to
fair value if a qualitative assessment indicates that the investment is impaired
and the fair value of the investment is less than carrying value. We perform a
qualitative assessment on a periodic basis. We are required to estimate the fair
value of the investment to determine the amount of the impairment loss. Once an
investment is determined to be impaired, an impairment charge is recorded in
other income (expense), net.

Goodwill

We allocate goodwill to reporting units based on the reporting unit expected to
benefit from the business combination. We evaluate our reporting units on an
annual basis and, if necessary, reassign goodwill using a relative fair value
allocation approach. Goodwill is tested for impairment at the reporting unit
level (operating segment or one level below an operating segment) on an annual
basis (May 1 for us) and between annual tests if an event occurs or
circumstances change that would more likely than not reduce the fair value of a
reporting unit below its carrying value. These events or circumstances could
include a significant change in the business climate, legal factors, operating
performance indicators, competition, or sale or disposition of a significant
portion of a reporting unit.

Application of the goodwill impairment test requires judgment, including the
identification of reporting units, assignment of assets and liabilities to
reporting units, assignment of goodwill to reporting units, and determination of
the fair value of each reporting unit. The fair value of each reporting unit is
estimated primarily through the use of a discounted cash flow methodology. This
analysis requires significant judgments, including estimation of future cash
flows, which is dependent on internal forecasts, estimation of the long-term
rate of growth for our business, estimation of the useful life over which cash
flows will occur, and determination of our weighted average cost of capital.

The estimates used to calculate the fair value of a reporting unit change from
year to year based on operating results, market conditions, and other factors.
Changes in these estimates and assumptions could materially affect the
determination of fair value and goodwill impairment for each reporting unit.

Research and Development Costs



Costs incurred internally in researching and developing a computer software
product are charged to expense until technological feasibility has been
established for the product. Once technological feasibility is established,
software costs are capitalized until the product is available for general
release to customers. Judgment is required in determining when technological
feasibility of a product is established. We have determined that technological
feasibility for our software products is reached after all high-risk development
issues have been resolved through coding and testing. Generally, this occurs
shortly before the products are released to production. The amortization of
these costs is included in cost of revenue over the estimated life of the
products.

Legal and Other Contingencies



The outcomes of legal proceedings and claims brought against us are subject to
significant uncertainty. An estimated loss from a loss contingency such as a
legal proceeding or claim is accrued by a charge to income if it is probable
that an asset has been impaired or a liability has been incurred and the amount
of the loss can be reasonably estimated. In determining whether a loss should be
accrued we evaluate, among other factors, the degree of probability of an
unfavorable outcome and the ability to make a reasonable estimate of the amount
of loss. Changes in these factors could materially impact our consolidated
financial statements.

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                                     PART I
                                     Item 2


Income Taxes

The objectives of accounting for income taxes are to recognize the amount of
taxes payable or refundable for the current year, and deferred tax liabilities
and assets for the future tax consequences of events that have been recognized
in an entity's financial statements or tax returns. We recognize the tax benefit
from an uncertain tax position only if it is more likely than not that the tax
position will be sustained on examination by the taxing authorities, based on
the technical merits of the position. The tax benefits recognized in the
financial statements from such a position are measured based on the largest
benefit that has a greater than 50% likelihood of being realized upon ultimate
settlement. Accounting literature also provides guidance on derecognition of
income tax assets and liabilities, classification of deferred income tax assets
and liabilities, accounting for interest and penalties associated with tax
positions, and income tax disclosures. Judgment is required in assessing the
future tax consequences of events that have been recognized in our consolidated
financial statements or tax returns. Variations in the actual outcome of these
future tax consequences could materially impact our consolidated financial
statements.

Inventories



Inventories are stated at average cost, subject to the lower of cost or net
realizable value. Cost includes materials, labor, and manufacturing overhead
related to the purchase and production of inventories. Net realizable value is
the estimated selling price less estimated costs of completion, disposal, and
transportation. We regularly review inventory quantities on hand, future
purchase commitments with our suppliers, and the estimated utility of our
inventory. These reviews include analysis of demand forecasts, product life
cycle status, product development plans, current sales levels, pricing strategy,
and component cost trends. If our review indicates a reduction in utility below
carrying value, we reduce our inventory to a new cost basis through a charge to
cost of revenue.



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                                     PART I
                                   Item 3, 4

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