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Dynamic quotes 
OFFON

MICROSOFT CORPORATION

(MSFT)
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MICROSOFT : form 10-K)

07/29/2021 | 04:33pm EDT

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

                                 OF OPERATIONS

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
consolidated financial statements and the accompanying Notes to Financial
Statements (Part II, Item 8 of this Form 10-K). This section generally discusses
the results of our operations for the year ended June 30, 2021 compared to the
year ended June 30, 2020. For a discussion of the year ended June 30, 2020
compared to the year ended June 30, 2019, please refer to Part II, Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in our Annual Report on Form 10-K for the year ended June 30, 2020.

                                    OVERVIEW

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

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

As the world continues to respond to COVID-19, we are working to do our part by
ensuring the safety of our employees, striving to protect the health and
well-being of the communities in which we operate, and providing technology and
resources to our customers to help them do their best work while remote.

Highlights from fiscal year 2021 compared with fiscal year 2020 included:

• Commercial cloud revenue increased 34% to $69.1 billion.

• Office Commercial products and cloud services revenue increased 13% driven

by Office 365 Commercial growth of 22%.

• Office Consumer products and cloud services revenue increased 10% and

        Microsoft 365 Consumer subscribers increased to 51.9 million.


  • LinkedIn revenue increased 27%.


     •  Dynamics products and cloud services revenue increased 25% driven by
        Dynamics 365 growth of 43%.

• Server products and cloud services revenue increased 27% driven by Azure

growth of 50%.

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

        increased slightly.


  • Windows Commercial products and cloud services revenue increased 14%.


  • Xbox content and services revenue increased 23%.

• Search advertising revenue, excluding traffic acquisition costs, increased

        13%.


  • Surface revenue increased 5%.


On March 9, 2021, we completed our acquisition of ZeniMax Media Inc.
("ZeniMax"), the parent company of Bethesda Softworks LLC, for a total purchase
price of $8.1 billion, consisting primarily of cash. The purchase price included
$768 million of cash and cash equivalents acquired. The financial results of
ZeniMax have been included in our consolidated financial statements since the
date of the acquisition. ZeniMax is reported as part of our More Personal
Computing segment. Refer to Note 8 - Business Combinations of the Notes to
Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.

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                                     Item 7



Industry Trends

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

Economic Conditions, Challenges, and Risks


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

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

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

Our international operations provide a significant portion of our total revenue
and expenses. Many of these revenue and expenses are denominated in currencies
other than the U.S. dollar. As a result, changes in foreign exchange rates may
significantly affect revenue and expenses. Weakening of the U.S. dollar relative
to certain foreign currencies increased reported revenue and did not have a
material impact on reported expenses from our international operations in fiscal
year 2021.

Refer to Risk Factors (Part I, Item 1A of this Form 10-K) for a discussion of these factors and other risks.

COVID-19


In fiscal year 2021, the COVID-19 pandemic continued to impact our business
operations and financial results. Cloud usage and demand benefited as customers
accelerate their digital transformation priorities. Our consumer businesses also
benefited from the remote environment, with continued demand for PCs and
productivity tools, as well as strong engagement across our Gaming platform. We
saw improvement in customer advertising spend and savings in operating expenses
related to COVID-19, but experienced weakness in transactional licensing. The
COVID-19 pandemic may continue to impact our business operations and financial
operating results, and there is uncertainty in the nature and degree of its
continued effects over time. Refer to Risk Factors (Part I, Item 1A of this Form
10-K) 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.

                                       40

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                                     Item 7


Change in Accounting Estimate


In July 2020, we completed an assessment of the useful lives of our server and
network equipment and determined we should increase the estimated useful life of
server equipment from three years to four years and increase the estimated
useful life of network equipment from two years to four years. This change in
accounting estimate was effective beginning fiscal year 2021. Based on the
carrying amount of server and network equipment included in property and
equipment, net as of June 30, 2020, the effect of this change in estimate for
fiscal year 2021 was an increase in operating income of $2.7 billion and net
income of $2.3 billion, or $0.30 per both basic and diluted share.

Reportable Segments


We report our financial performance based on the following segments:
Productivity and Business Processes, Intelligent Cloud, and More Personal
Computing. The segment amounts included in MD&A are presented on a basis
consistent with our internal management reporting. All differences between our
internal management reporting basis and accounting principles generally accepted
in the United States of America ("GAAP"), along with certain corporate-level and
other activity, are included in Corporate and Other.

Additional information on our reportable segments is contained in Note 19 - Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K).

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 II, Item 8 of this Form
10-K). Financial metrics are calculated based on GAAP results and growth
comparisons relate to the corresponding period of last fiscal year.

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

Commercial cloud revenue                      Revenue from our commercial cloud business,
                                              which includes Azure, Office 365 Commercial, the
                                              commercial portion of LinkedIn, Dynamics 365,
                                              and other commercial cloud properties

Commercial cloud gross margin percentage      Gross margin percentage for our commercial cloud
                                              business




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                                     Item 7


Productivity and Business Processes and Intelligent Cloud


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



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

                                                               cloud 

services (Office 365 subscriptions, the

                                                               Office 365 

portion of Microsoft 365 Commercial

subscriptions, and Office licensed on-premises),

                                                               comprising 

Office, Exchange, SharePoint,

                                                               Microsoft

Teams, Office 365 Security and

                                                               Compliance, 

and Skype for Business

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

                                                               services, 

including Microsoft 365 Consumer

subscriptions and Office licensed on-premises


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 (formerly

                                                               Office 365 

Consumer) subscribers at end of

                                                               period

Dynamics products and cloud services revenue growth            Revenue from 

Dynamics products and cloud

                                                               services, 

including Dynamics 365, comprising a

                                                               set of 

intelligent, cloud-based applications

                                                               across ERP, 

CRM, Customer Insights, Power Apps,

                                                               and Power 

Automate; and on-premises ERP and CRM

                                                               applications

LinkedIn revenue growth                                        Revenue from LinkedIn, including Talent
                                                               Solutions,

Marketing Solutions, Premium

Subscriptions, Sales Solutions, and Learning

                                                               Solutions

Server products and cloud services revenue growth              Revenue from 

Server products and cloud services,

                                                               including 

Azure; SQL Server, Windows Server,

                                                               Visual 

Studio, System Center, and related Client

                                                               Access Licenses ("CALs"); and GitHub


More Personal Computing

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



Windows OEM Pro revenue growth       Revenue from sales of Windows Pro licenses sold
                                     through the OEM channel, which primarily
                                     addresses demand in the commercial market

Windows OEM non-Pro revenue growth   Revenue from sales of Windows non-Pro licenses
                                     sold through the OEM channel, which primarily
                                     addresses demand in the consumer market



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                                     Item 7


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

                                                                cloud 

services, comprising volume licensing of

                                                                the Windows 

operating system, Windows cloud

                                                                services, 

and other Windows commercial offerings


Surface revenue                                                 Revenue 

from Surface devices and accessories


Xbox content and services revenue growth                        Revenue 

from Xbox content and services,

                                                                comprising 

digital transactions, Xbox Game Pass

                                                                and other subscriptions, video games,
                                                                third-party video game royalties, cloud
                                                                services, and advertising

Search advertising revenue, excluding TAC, growth               Revenue 

from search advertising excluding

                                                                traffic 

acquisition costs ("TAC") paid to Bing

                                                                Ads network publishers


                         SUMMARY RESULTS OF OPERATIONS



                                                                                        Percentage

(In millions, except percentages and per share amounts) 2021

 2020           Change


Revenue                                                   $ 168,088$ 143,015              18%
Gross margin                                                115,856        96,937              20%
Operating income                                             69,916        52,959              32%
Net income                                                   61,271        44,281              38%
Diluted earnings per share                                     8.05          5.76              40%

Adjusted net income (non-GAAP)                               60,651        44,281              37%
Adjusted diluted earnings per share (non-GAAP)                 7.97          5.76              38%





Adjusted net income and adjusted diluted earnings per share ("EPS") are non-GAAP
financial measures which exclude tax benefits related to an India Supreme Court
decision on withholding taxes in fiscal year 2021. Refer to the Non-GAAP
Financial Measures section below for a reconciliation of our financial results
reported in accordance with GAAP to non-GAAP financial results. See Note 12 -
Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form
10-K) for further discussion.

Revenue increased $25.1 billion or 18% driven by growth across each of our segments. Intelligent Cloud revenue increased driven by Azure. Productivity and Business Processes revenue increased driven by Office 365 Commercial and LinkedIn. More Personal Computing revenue increased driven by Gaming.


Cost of revenue increased $6.2 billion or 13% driven by growth in commercial
cloud and Gaming, offset in part by a reduction in depreciation expense due to
the change in estimated useful lives of our server and network equipment.

Gross margin increased $18.9 billion or 20% driven by growth across each of our
segments and the change in estimated useful lives of our server and network
equipment. Gross margin percentage increased with the change in estimated useful
lives of our server and network equipment. Excluding this impact, gross margin
percentage decreased slightly driven by gross margin percentage reduction in
More Personal Computing. Commercial cloud gross margin percentage increased 4
points to 71% driven by gross margin percentage improvement in Azure and the
change in estimated useful lives of our server and network equipment, offset in
part by sales mix shift to Azure.

Operating expenses increased $2.0 billion or 4% driven by investments in cloud
engineering and commercial sales, offset in part by savings related to COVID-19
across each of our segments, prior year charges associated with the closing of
our Microsoft Store physical locations, and a reduction in bad debt expense.

Key changes in operating expenses were:

• Research and development expenses increased $1.4 billion or 8% driven by

investments in cloud engineering.

• Sales and marketing expenses increased $519 million or 3% driven by

investments in commercial sales, offset in part by a reduction in bad debt

expense. Sales and marketing included an unfavorable foreign currency

impact of 2%.

• General and administrative expenses were relatively unchanged, driven by

prior year charges associated with the closing of our Microsoft Store

        physical locations, offset in part by an increase in certain
        employee-related expenses and business taxes.


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                                     Item 7



Operating income increased $17.0 billion or 32% driven by growth across each of
our segments and the change in estimated useful lives of our server and network
equipment.

Current year net income and diluted EPS were positively impacted by the tax
benefit related to the India Supreme Court decision on withholding taxes, which
resulted in an increase to net income and diluted EPS of $620 million and $0.08,
respectively.

Revenue, gross margin, and operating income included a favorable foreign currency impact of 3%, 3%, and 4%, respectively.

                         SEGMENT RESULTS OF OPERATIONS



                                                                   Percentage

(In millions, except percentages) 2021 2020 Change



Revenue

Productivity and Business Processes   $  53,915$  46,398             16%
Intelligent Cloud                        60,080        48,366             24%
More Personal Computing                  54,093        48,251             12%


Total                                 $ 168,088$ 143,015             18%


Operating Income

Productivity and Business Processes   $  24,351$  18,724             30%
Intelligent Cloud                        26,126        18,324             43%
More Personal Computing                  19,439        15,911             22%


Total                                 $  69,916$  52,959             32%



Reportable Segments

Productivity and Business Processes

Revenue increased $7.5 billion or 16%.

• Office Commercial products and cloud services revenue increased $4.0

billion or 13%. Office 365 Commercial revenue grew 22% driven by seat

growth of 17% and higher revenue per user. Office Commercial products

revenue declined 23% driven by continued customer shift to cloud offerings

and transactional weakness.

• Office Consumer products and cloud services revenue increased $474 million

        or 10% driven by Microsoft 365 Consumer subscription revenue, on a strong
        prior year comparable that benefited from transactional strength in Japan.
        Microsoft 365 Consumer subscribers increased 22% to 51.9 million.

• LinkedIn revenue increased $2.2 billion or 27% driven by advertising

        demand in our Marketing Solutions business.


     •  Dynamics products and cloud services revenue increased 25% driven by
        Dynamics 365 growth of 43%.

Operating income increased $5.6 billion or 30%.

• Gross margin increased $6.5 billion or 18% driven by growth in Office 365

Commercial and LinkedIn, and the change in estimated useful lives of our

server and network equipment. Gross margin percentage increased with the

change in estimated useful lives of our server and network equipment.

Excluding this impact, gross margin percentage decreased slightly driven

by a sales mix shift to cloud offerings, on a low prior year comparable

impacted by increased usage.

• Operating expenses increased $839 million or 5% driven by investments in

commercial sales, cloud engineering, and LinkedIn.

Revenue, gross margin, and operating income included a favorable foreign currency impact of 2%, 3%, and 4%, respectively.

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                                     Item 7



Intelligent Cloud

Revenue increased $11.7 billion or 24%.

• Server products and cloud services revenue increased $11.2 billion or 27%

driven by Azure. Azure revenue grew 50% due to growth in our

consumption-based services. Server products revenue increased 6% driven by

hybrid and premium solutions, on a strong prior year comparable that

benefited from demand related to SQL Server 2008 and Windows Server 2008

end of support.

• Enterprise Services revenue increased $534 million or 8% driven by growth

in Premier Support Services.

Operating income increased $7.8 billion or 43%.

• Gross margin increased $9.7 billion or 29% driven by growth in Azure and

the change in estimated useful lives of our server and network equipment.

        Gross margin percentage increased with the change in estimated useful
        lives of our server and network equipment. Excluding this impact, gross
        margin percentage was relatively unchanged driven by gross margin
        percentage improvement in Azure, offset in part by sales mix shift to
        Azure.

• Operating expenses increased $1.9 billion or 12% driven by investments in

Azure.

Revenue, gross margin, and operating income included a favorable foreign currency impact of 2%, 3%, and 4%, respectively.

More Personal Computing

Revenue increased $5.8 billion or 12%.

• Windows revenue increased $933 million or 4% driven by growth in Windows

Commercial. Windows Commercial products and cloud services revenue

increased 14% driven by demand for Microsoft 365. Windows OEM revenue

increased slightly driven by consumer PC demand, on a strong prior year

OEM Pro comparable that benefited from Windows 7 end of support. Windows

        OEM Pro revenue decreased 9% and Windows OEM non-Pro revenue grew 21%.


     •  Gaming revenue increased $3.8 billion or 33% driven by growth in Xbox

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

increased $2.3 billion or 23% driven by growth in third-party titles, Xbox

Game Pass subscriptions, and first-party titles. Xbox hardware revenue

        increased 92% driven by higher price of consoles sold due to the Xbox
        Series X|S launches.


     •  Search advertising revenue increased $788 million or 10%. Search
        advertising revenue excluding traffic acquisition costs increased 13%
        driven by higher revenue per search and search volume.


  • Surface revenue increased $302 million or 5%.


Operating income increased $3.5 billion or 22%.

• Gross margin increased $2.8 billion or 10% driven by growth in Windows,

        Gaming, and Search advertising. Gross margin percentage decreased driven
        by sales mix shift to Gaming hardware.

• Operating expenses decreased $752 million or 6% driven by prior year

charges associated with the closing of our Microsoft Store physical

locations and reductions in retail store expenses and marketing, offset in

part by investments in Gaming.

Gross margin and operating income included a favorable foreign currency impact of 2% and 3%, respectively.


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                                     Item 7



                               OPERATING EXPENSES

Research and Development



                                                                Percentage
(In millions, except percentages)       2021         2020           Change


Research and development            $ 20,716$ 19,269               8%
As a percent of revenue                  12%          13%           (1)ppt




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.

Research and development expenses increased $1.4 billion or 8% driven by investments in cloud engineering.

Sales and Marketing



                                                                Percentage
(In millions, except percentages)       2021         2020           Change


Sales and marketing
                                    $ 20,117$ 19,598               3%
As a percent of revenue                  12%          14%           (2)ppt





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

Sales and marketing expenses increased $519 million or 3% driven by investments
in commercial sales, offset in part by a reduction in bad debt expense. Sales
and marketing included an unfavorable foreign currency impact of 2%.

General and Administrative



                                                              Percentage
(In millions, except percentages)      2021        2020           Change


General and administrative          $ 5,107$ 5,111               0%
As a percent of revenue                  3%          4%           (1)ppt





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

General and administrative expenses were relatively unchanged, driven by prior
year charges associated with the closing of our Microsoft Store physical
locations, offset in part by an increase in certain employee-related expenses
and business taxes.

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                                     Item 7



                          OTHER INCOME (EXPENSE), NET

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



(In millions)


Year Ended June 30,                                         2021         2020

Interest and dividends income                           $  2,131     $  

2,680

Interest expense                                          (2,346 )     (2,591 )
Net recognized gains on investments                        1,232           

32

Net gains on derivatives                                      17          

187

Net gains (losses) on foreign currency remeasurements         54         (191 )
Other, net                                                    98          (40 )


Total                                                   $  1,186$     77

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.

Interest and dividends income decreased due to lower yields on fixed-income securities. Interest expense decreased due to a decrease in outstanding long-term debt due to debt maturities. Net recognized gains on investments increased due to higher gains on equity securities. Net gains on derivatives decreased due to lower gains on foreign currency contracts.

                                  INCOME TAXES

Effective Tax Rate


Our effective tax rate for fiscal years 2021 and 2020 was 14% and 17%,
respectively. The decrease in our effective tax rate was primarily due to tax
benefits from a decision by the India Supreme Court on withholding taxes in the
case of Engineering Analysis Centre of Excellence Private Limited vs The
Commissioner of Income Tax, an agreement between the U.S. and India tax
authorities related to transfer pricing, final Tax Cuts and Jobs Act ("TCJA")
regulations, and an increase in tax benefits relating to stock-based
compensation.

We have historically paid India withholding taxes on software sales through
distributor withholding and tax audit assessments in India. In March 2021, the
India Supreme Court ruled favorably for companies in 86 separate appeals, some
dating back to 2012, holding that software sales are not subject to India
withholding taxes. Although we were not a party to the appeals, our software
sales in India were determined to be not subject to withholding taxes.
Therefore, we recorded a net income tax benefit of $620 million in the third
quarter of fiscal year 2021 to reflect the results of the India Supreme Court
decision impacting fiscal year 1996 through fiscal year 2016.

Our effective tax rate was lower than the U.S. federal statutory rate, 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 centers in Ireland and Puerto Rico, tax benefits relating to
stock-based compensation, and tax benefits from the India Supreme Court decision
on withholding taxes.

The mix of income before income taxes between the U.S. and foreign countries
impacted our effective tax rate as a result of the geographic distribution of,
and customer demand for, our products and services. In fiscal year 2021, our
U.S. income before income taxes was $35.0 billion and our foreign income before
income taxes was $36.1 billion. In fiscal year 2020, our U.S. income before
income taxes was $24.1 billion and our foreign income before income taxes was
$28.9 billion.

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.

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                                     Item 7



As of June 30, 2021, the primary unresolved issues for the IRS audits relate to
transfer pricing, which could have a material impact in our consolidated
financial statements when the matters are resolved. We believe our allowances
for income tax contingencies are adequate. We have not received a proposed
assessment for the unresolved key transfer pricing issues and do not expect a
final resolution of these issues in the next 12 months. Based on the information
currently available, we do not anticipate a significant increase or decrease to
our tax contingencies for these issues within the next 12 months.

We are subject to income tax in many jurisdictions outside the U.S. Our
operations in certain jurisdictions remain subject to examination for tax years
1996 to 2020, some of which are currently under audit by local tax authorities.
The resolution of each of these audits is not expected to be material to our
consolidated financial statements.

                          NON-GAAP FINANCIAL MEASURES

Adjusted net income and adjusted diluted EPS are non-GAAP financial measures
which exclude the tax benefits related to the India Supreme Court decision on
withholding taxes in fiscal year 2021. We believe these non-GAAP measures aid
investors by providing additional insight into our operational performance and
help clarify trends affecting our business. For comparability of reporting,
management considers non-GAAP measures in conjunction with GAAP financial
results in evaluating business performance. These non-GAAP financial measures
presented should not be considered a substitute for, or superior to, the
measures of financial performance prepared in accordance with GAAP.

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




(In millions, except percentages and per                                          Percentage
share amounts)                                        2021            2020            Change


Net income                                     $    61,271$    44,281               38%
Net income tax benefit related to India
Supreme Court decision on withholding taxes           (620 )             0                 *


Adjusted net income (non-GAAP)                 $    60,651$    44,281               37%


Diluted earnings per share                     $      8.05$      5.76               40%
Net income tax benefit related to India
Supreme Court decision on withholding taxes          (0.08 )             0                 *


Adjusted diluted earnings per share
(non-GAAP)                                     $      7.97$      5.76               38%





* Not meaningful.


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                                     Item 7



                              FINANCIAL CONDITION

Cash, Cash Equivalents, and Investments


Cash, cash equivalents, and short-term investments totaled $130.3 billion and
$136.5 billion as of June 30, 2021 and 2020. Equity investments were $6.0
billion and $3.0 billion as of June 30, 2021 and 2020, respectively. Our
short-term investments are primarily intended to facilitate liquidity and
capital preservation. They consist predominantly of highly liquid
investment-grade fixed-income securities, diversified among industries and
individual issuers. The investments are predominantly U.S. dollar-denominated
securities, but also include foreign currency-denominated securities to
diversify risk. Our fixed-income investments are exposed to interest rate risk
and credit risk. The credit risk and average maturity of our fixed-income
portfolio are managed to achieve economic returns that correlate to certain
fixed-income indices. The settlement risk related to these investments is
insignificant given that the short-term investments held are primarily highly
liquid investment-grade fixed-income securities.

Valuation


In general, and where applicable, we use quoted prices in active markets for
identical assets or liabilities to determine the fair value of our financial
instruments. This pricing methodology applies to our Level 1 investments, such
as U.S. government securities, common and preferred stock, and mutual funds. If
quoted prices in active markets for identical assets or liabilities are not
available to determine fair value, then we use quoted prices for similar assets
and liabilities or inputs other than the quoted prices that are observable
either directly or indirectly. This pricing methodology applies to our Level 2
investments, such as commercial paper, certificates of deposit, U.S. agency
securities, foreign government bonds, mortgage- and asset-backed securities,
corporate notes and bonds, and municipal securities. Level 3 investments are
valued using internally-developed models with unobservable inputs. Assets and
liabilities measured at fair value on a recurring basis using unobservable
inputs are an immaterial portion of our portfolio.

A majority of our investments are priced by pricing vendors and are generally
Level 1 or Level 2 investments as these vendors either provide a quoted market
price in an active market or use observable inputs for their pricing without
applying significant adjustments. Broker pricing is used mainly when a quoted
price is not available, the investment is not priced by our pricing vendors, or
when a broker price is more reflective of fair values in the market in which the
investment trades. Our broker-priced investments are generally classified as
Level 2 investments because the broker prices these investments based on similar
assets without applying significant adjustments. In addition, all our
broker-priced investments have a sufficient level of trading volume to
demonstrate that the fair values used are appropriate for these investments. Our
fair value processes include controls that are designed to ensure appropriate
fair values are recorded. These controls include model validation, review of key
model inputs, analysis of period-over-period fluctuations, and independent
recalculation of prices where appropriate.

Cash Flows


Cash from operations increased $16.1 billion to $76.7 billion for fiscal year
2021, mainly due to an increase in cash received from customers, offset in part
by an increase in cash paid to suppliers and employees. Cash used in financing
increased $2.5 billion to $48.5 billion for fiscal year 2021, mainly due to a
$4.4 billion increase in common stock repurchases and a $1.4 billion increase in
dividends paid, offset in part by a $1.8 billion decrease in repayments of debt
and a $1.7 billion decrease in cash premium paid on debt exchange. Cash used in
investing increased $15.4 billion to $27.6 billion for fiscal year 2021, mainly
due to a $6.4 billion increase in cash used for acquisitions of companies, net
of cash acquired, and purchases of intangible and other assets, a $5.2 billion
increase in additions to property and equipment, and a $4.1 billion decrease in
cash from net investment purchases, sales, and maturities.

Debt


We issue debt to take advantage of favorable pricing and liquidity in the debt
markets, reflecting our credit rating and the low interest rate environment. The
proceeds of these issuances were or will be used for general corporate purposes,
which may include, among other things, funding for working capital, capital
expenditures, repurchases of capital stock, acquisitions, and repayment of
existing debt. In March 2021 and June 2020, we exchanged a portion of our
existing debt at a premium for cash and new debt with longer maturities to take
advantage of favorable financing rates in the debt markets, reflecting our
credit rating and the low interest rate environment. Refer to Note 11 - Debt of
the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for
further discussion.

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                                     Item 7



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. Refer to Note 1 - Accounting Policies of the Notes to
Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.

The following table outlines the expected future recognition of unearned revenue
as of June 30, 2021:



(In millions)


Three Months Ending

September 30, 2021$ 15,922
December 31, 2021       12,646
March 31, 2022           8,786
June 30, 2022            4,171
Thereafter               2,616


Total                 $ 44,141

If our customers choose to license cloud-based versions of our products and services rather than licensing transaction-based products and services, the associated revenue will shift from being recognized at the time of the transaction to being recognized over the subscription period or upon consumption, as applicable.

Share Repurchases


During fiscal years 2021 and 2020, we repurchased 101 million shares and 126
million shares of our common stock for $23.0 billion and $19.7 billion,
respectively, through our share repurchase programs. All repurchases were made
using cash resources. Refer to Note 16 - Stockholders' Equity of the Notes to
Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.

Dividends

Refer to Note 16 - Stockholders' Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.

Off-Balance Sheet Arrangements


We provide indemnifications of varying scope and size to certain customers
against claims of intellectual property infringement made by third parties
arising from the use of our products and certain other matters. Additionally, we
have agreed to cover damages resulting from breaches of certain security and
privacy commitments in our cloud business. In evaluating estimated losses on
these obligations, we consider factors such as the degree of probability of an
unfavorable outcome and our ability to make a reasonable estimate of the amount
of loss. These obligations did not have a material impact in our consolidated
financial statements during the periods presented.

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                                     Item 7



Contractual Obligations

The following table summarizes the payments due by fiscal year for our outstanding contractual obligations as of June 30, 2021:



(In millions)                          2022       2023-2024       2025-2026       Thereafter         Total


Long-term debt: (a)
Principal payments                $   8,075$     8,000$     5,250$     42,585$  63,910
Interest payments                     1,628           2,847           2,438           17,320        24,233
Construction commitments (b)          8,927             529               0                0         9,456
Operating leases, including           2,801           4,956           3,469            6,747        17,973
imputed interest (c)
Finance leases, including             1,341           3,256           3,774           14,096        22,467
imputed interest (c)
Transition tax (d)                    1,427           4,105           8,030                0        13,562
Purchase commitments (e)             29,129           1,708             446              270        31,553
Other long-term liabilities (f)           0             365              68              263           696


Total                             $  53,328$    25,766$    23,475$     81,281$ 183,850

(a) Refer to Note 11 - Debt of the Notes to Financial Statements (Part II, Item 8

of this Form 10-K).

(b) Refer to Note 7 - Property and Equipment of the Notes to Financial Statements

(Part II, Item 8 of this Form 10-K).

(c) Refer to Note 14 - Leases of the Notes to Financial Statements (Part II, Item

8 of this Form 10-K).

(d) Refer to Note 12 - Income Taxes of the Notes to Financial Statements (Part

II, Item 8 of this Form 10-K).

(e) Amounts represent purchase commitments, including open purchase orders and

take-or-pay contracts that are not presented as construction commitments

above.

(f) We have excluded long-term tax contingencies, other tax liabilities, and

deferred income taxes of $14.6 billion from the amounts presented as the

timing of these obligations is uncertain. We have also excluded unearned

revenue and non-cash items.

Other Planned Uses of Capital


On April 11, 2021, we entered into a definitive agreement to acquire Nuance
Communications, Inc. ("Nuance") for $56.00 per share in an all-cash transaction
valued at $19.7 billion, inclusive of Nuance's net debt. The acquisition has
been approved by Nuance's shareholders, and we expect it to close by the end of
calendar year 2021, subject to the satisfaction of certain regulatory approvals
and other customary closing conditions.

We will continue to invest in sales, marketing, product support infrastructure,
and existing and advanced areas of technology, as well as continue making
acquisitions that align with our business strategy. Additions to property and
equipment will continue, including new facilities, datacenters, and computer
systems for research and development, sales and marketing, support, and
administrative staff. We expect capital expenditures to increase in coming years
to support growth in our cloud offerings. We have operating and finance leases
for datacenters, corporate offices, research and development facilities,
Microsoft Experience Centers, and certain equipment. We have not engaged in any
related party transactions or arrangements with unconsolidated entities or other
persons that are reasonably likely to materially affect liquidity or the
availability of capital resources.

Liquidity


As a result of the TCJA, we are required to pay a one-time transition tax on
deferred foreign income not previously subject to U.S. income tax. Under the
TCJA, the transition tax is payable in interest-free installments over eight
years, with 8% due in each of the first five years, 15% in year six, 20% in year
seven, and 25% in year eight. We have paid transition tax of $4.7 billion, which
included $1.5 billion for fiscal year 2021. The remaining transition tax of
$13.6 billion is payable over the next five years with a final payment in fiscal
year 2026.

We expect existing cash, cash equivalents, short-term investments, cash flows
from operations, and access to capital markets to continue to be sufficient to
fund our operating activities and cash commitments for investing and financing
activities, such as dividends, share repurchases, debt maturities, material
capital expenditures, and the transition tax related to the TCJA, for at least
the next 12 months and thereafter for the foreseeable future.

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                                     Item 7



                           RECENT ACCOUNTING GUIDANCE

Refer to Note 1 - Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.

                  APPLICATION OF CRITICAL ACCOUNTING POLICIES

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

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.

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                                     Item 7



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.

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.

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                                     Item 7


The TCJA significantly changes existing U.S. tax law and includes numerous provisions that affect our business. Refer to Note 12 - Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.


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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                                     Item 7


STATEMENT OF MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS

Management is responsible for the preparation of the consolidated financial statements and related information that are presented in this report. The consolidated financial statements, which include amounts based on management's estimates and judgments, have been prepared in conformity with accounting principles generally accepted in the United States of America.


The Company designs and maintains accounting and internal control systems to
provide reasonable assurance at reasonable cost that assets are safeguarded
against loss from unauthorized use or disposition, and that the financial
records are reliable for preparing consolidated financial statements and
maintaining accountability for assets. These systems are augmented by written
policies, an organizational structure providing division of responsibilities,
careful selection and training of qualified personnel, and a program of internal
audits.

The Company engaged Deloitte & Touche LLP, an independent registered public
accounting firm, to audit and render an opinion on the consolidated financial
statements and internal control over financial reporting in accordance with the
standards of the Public Company Accounting Oversight Board (United States).

The Board of Directors, through its Audit Committee, consisting solely of independent directors of the Company, meets periodically with management, internal auditors, and our independent registered public accounting firm to ensure that each is meeting its responsibilities and to discuss matters concerning internal controls and financial reporting. Deloitte & Touche LLP and the internal auditors each have full and free access to the Audit Committee.




Satya Nadella
Chief Executive Officer

Amy E. Hood
Executive Vice President and Chief Financial Officer

Alice L. Jolla
Corporate Vice President and Chief Accounting Officer




                                       55
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                                    PART II

                                    Item 7A

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