Certain statements in Management's Discussion and Analysis ("MD&A"), other than purely historical information, including estimates, projections, statements relating to our business plans, objectives, and expected operating results, and the assumptions upon which those statements are based, 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. These forward-looking statements generally are identified by the words "believe," "project," "expect," "anticipate," "estimate," "intend," "strategy," "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, which may cause actual results to differ materially from the forward-looking statements. A detailed discussion of risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included in the section titled "Risk Factors" (refer to Part II, Item 1A). We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise.

The following 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 financial statements and the accompanying notes to the financial statements ("Notes").

We generate revenue by developing, manufacturing, licensing, and supporting a wide range of software products and services for many different types of computing devices. Our software products and services include operating systems for personal computers, servers, and intelligent devices; server applications for distributed computing environments; information worker productivity applications; business solutions applications; high-performance computing applications; software development tools; and video games. We provide consulting and product support services, and we train and certify computer system integrators and developers. We also design and sell hardware including the Xbox 360 video game console, the Zune digital music and entertainment device, and peripherals. Online offerings and information are delivered through Live Search, Windows Live, Office Live, our MSN portals and channels, and the Microsoft Online Services platform, which includes offerings for businesses, such as Microsoft Dynamics CRM Online, Exchange Hosted Services, Exchange Online, and SharePoint Online. We enable the delivery of online advertising across our broad range of digital media properties and on Live Search through our proprietary adCenter® platform.

Our revenue historically has fluctuated quarterly and has generally been the highest in the second quarter of our fiscal year due to corporate calendar year-end spending trends in our major markets and holiday season spending by consumers. Our Entertainment and Devices Division is particularly seasonal as its products are aimed at the consumer market and are in highest demand during the holiday shopping season. Typically, the Entertainment and Devices Division has generated over 40% of its yearly segment revenues in our second fiscal quarter.

Summary



                                   Three Months Ended                       Nine Months Ended
(In millions, except per share         March 31,          Percentage            March 31,         Percentage
amounts and percentages)            2009         2008       Change           2009        2008       Change
Revenue                          $    13,648   $ 14,454           (6 )%   $   45,338   $ 44,583            2  %
Operating income                 $     4,438   $  4,290            3  %   $   16,376   $ 16,592           (1 )%
Diluted earnings per share       $      0.33   $   0.47          (30 )%   $     1.28   $   1.41           (9 )%

Three months ended March 31, 2009 compared with three months ended March 31, 2008

Revenue declined across most segments driven primarily by continued weakness in the global PC market and the recessionary economic environment. Revenue from Windows operating systems decreased reflecting PC market weakness, especially PCs sold to businesses, and a continued shift to lower priced netbook PCs. Revenue from the 2007 Microsoft Office system decreased reflecting PC market weakness, a shift to lower-priced products, and pricing promotions, while online advertising revenue decreased primarily reflecting decreased display advertising. These decreases were partially offset by increased SQL Server and Windows Server revenue reflecting continued strength in our annuity business. Foreign currency exchange rates did not have a significant impact on revenue.

Operating income increased primarily reflecting decreased general and administrative and sales and marketing expenses, partially offset by decreased revenue, increased cost of revenue, and employee severance of $290 million. General and administrative expenses decreased $1.4 billion or 61%, primarily due to decreased costs for legal settlements and legal contingencies, partially offset by increased headcount-related expenses. We incurred $57 million of legal charges during the three months and $90 million during the nine months ended March 31, 2009, as compared with $1.5 billion of legal charges during the three months and $1.8 billion during the nine months ended March 31, 2008. The fiscal year 2008 legal costs were primarily related to the European Commission fine of $1.4 billion (€899 million). Sales and marketing expenses decreased $293 million or 9%, primarily reflecting decreased corporate marketing and advertising campaigns and decreased professional consulting fees. Cost of revenue increased $300 million or 12%, primarily reflecting increased online costs (including traffic acquisition and people costs). Headcount-related expenses, excluding employee severance, increased 4%, reflecting a 9% increase in headcount during the past 12 months and an increase in salaries and benefits for existing headcount.

In January 2009, we announced and implemented a resource management program to reduce discretionary operating expenses, employee headcount, and capital expenditures. As part of this program, we will eliminate up to 5,000 positions in research and development, marketing, sales, finance, legal, human resources, and information technology by June 30, 2010. During the three months ended March 31, 2009, we recorded employee severance charges of $290 million for the expected reduction in headcount. We reduced employee headcount by approximately 1,100 employees during the quarter.

Diluted earnings per share declined because other income (expense) was lower and the provision for income taxes grew, partially offset by share repurchases during the past 12 months. Other income (expense) decreased reflecting increased net recognized losses on investments due to higher other-than-temporary impairments and losses on investment sales. Provision for income taxes increased reflecting the fiscal year 2008 resolution of tax positions relating to our agreement with the Internal Revenue Service of the 2000-2003 examination.

Nine months ended March 31, 2009 compared with nine months ended March 31, 2008

Revenue grew primarily because of increased SQL Server and Windows Server revenue and increased licensing of the 2007 Microsoft Office system, partially offset by decreased revenue from

Windows operating systems as a result of PC market weakness and a continued shift to lower priced netbook PCs. Foreign currency exchange rates accounted for a $705 million or two percentage point increase in revenue.

Operating income decreased primarily reflecting increased headcount-related expenses and cost of revenue, partially offset by decreased general and administrative expenses and increased revenue. Headcount-related expenses, excluding employee severance, increased 13%, reflecting a 9% increase in headcount during the past 12 months and an increase in salaries and benefits for existing headcount. Cost of revenue increased $837 million or 10%, primarily reflecting increased online costs (including traffic acquisition, people, and data center and equipment costs) and increased costs associated with the growth in our consulting services. General and administrative expenses decreased $1.5 billion or 36%, primarily due to decreased costs for legal settlements and legal contingencies, partially offset by increased headcount-related expenses.

Diluted earnings per share declined primarily reflecting decreased other income (expense), partially offset by share repurchases during the past 12 months. Other income (expense) decreased reflecting increased net losses on derivatives and foreign currency remeasurements.

Outlook

Demand for our software, services, hardware, and online offerings are correlated with global macroeconomic factors. In the fourth quarter of fiscal year 2009, we expect the trends seen in the third quarter to continue, including weakness in the PC and server hardware markets and in our non-annuity business. We will continue to focus on executing in the areas we can control by continuing to provide high value products at the lowest total cost of ownership while managing our expenses. We intend to reduce discretionary operating expenses, employee headcount, and capital expenditures. As part of the resource management program announced in January 2009, in addition to the reductions in the third quarter of fiscal year 2009, we will reduce employee headcount by approximately 3,400 employees by June 30, 2010, and will eliminate merit increases for employees in fiscal year 2010.

SEGMENT PRODUCT REVENUE/OPERATING INCOME (LOSS)

Revenue and operating income (loss) amounts in this section are presented on a basis consistent with accounting principles generally accepted in the United States of America ("U.S. GAAP") and include certain reconciling items attributable to each of the segments. Segment information appearing in Note 17 - Segment Information (Part I, Item 1) is presented on a basis consistent with our current internal management reporting, in accordance with Statement of Financial Accounting Standards ("SFAS") No. 131, Disclosures about Segments of an Enterprise and Related Information. Certain corporate-level activity has been excluded from segment operating results and is analyzed separately. Prior period amounts have been recast to conform to the way we internally managed and monitored performance at the segment level during the current period.

Client



                                      Three Months Ended                     Nine Months Ended
                                           March 31,          Percentage         March 31,          Percentage
(In millions, except percentages)      2009         2008        Change        2009        2008        Change
Revenue                             $    3,404    $   4,033        (16)%   $   11,604   $  12,506         (7)%
Operating income                    $    2,514    $   3,115        (19)%   $    8,689   $   9,855        (12)%

Client offerings consist of premium and standard edition Windows operating systems. Premium editions are those that include additional functionality and are sold at a price above our standard editions. Premium editions include Windows Vista Business, Windows Vista Home Premium, Windows

Vista Ultimate, Windows Vista Enterprise, Windows XP Professional, Windows XP Media Center Edition, and Windows XP Tablet PC Edition. Standard editions include Windows Vista Home Basic and Windows XP Home. Client revenue growth is directly impacted by growth of PC purchases from OEMs that pre-install versions of Windows operating systems because the OEM channel accounts for over 80% of total Client revenue. The differences between unit growth rates and revenue growth rates from year to year are affected primarily by changes in the mix of OEM Windows premium edition operating systems licensed as a percentage of total OEM Windows operating systems licensed ("OEM premium mix"). Additional differences in growth rates result from the impact from lower cost netbook PCs, which are sold with a lower cost version of Windows, changes in geographic mix, and changes in the channel mix of products sold by large, multi-national OEMs versus those sold by local and regional system builders.

Three months ended March 31, 2009 compared with three months ended March 31, 2008

Client revenue decreased primarily as a result of PC market weakness, especially PCs sold to businesses, and a continued shift to netbook PCs. OEM revenue decreased $637 million or 19%, while OEM license units decreased 6%. The decline in OEM revenue reflects a 14 percentage point decrease in the OEM premium mix to 62%, primarily driven by growth of licenses related to sales of netbook PCs, a decline in premium editions sold to business customers, and changes in geographic mix. Based on our estimates, total worldwide PC shipments from all sources declined approximately 7% to 9%, driven by decreased demand in emerging and mature markets.

Client operating income decreased primarily reflecting decreased revenue and increased research and development expenses, partially offset by decreased sales and marketing expenses. Research and development expenses increased $45 million or 17%, primarily driven by increased headcount-related expenses. Sales and marketing expenses decreased $52 million or 13%, primarily reflecting decreased corporate marketing activities and decreased headcount-related costs associated with our corporate sales force.

Nine months ended March 31, 2009 compared with nine months ended March 31, 2008

Client revenue decreased primarily as a result of PC market weakness and a continued shift to netbook PCs. OEM revenue decreased $1.1 billion or 11% while OEM license units remained flat. The decline in OEM revenue reflects a nine percentage point decrease in the OEM premium mix to 66%, primarily driven by growth of licenses related to sales of netbook PCs, a decline in premium editions sold to business customers, and changes in geographic mix. Revenue from commercial and retail licensing of Windows operating systems increased $246 million or 13%. Based on our estimates, total worldwide PC shipments from all sources grew approximately 1% to 3%, driven by increased demand in emerging markets.

Client operating income decreased primarily reflecting decreased revenue and increased sales and marketing and research and development expenses. Sales and marketing expenses increased $149 million or 14%, primarily reflecting increased advertising and marketing campaigns. Research and development expenses increased $126 million or 16% as a result of increased headcount-related expenses.

Server and Tools

Server and Tools licenses products, applications, tools, content, and services that are designed to make information technology professionals and developers more productive and efficient. Server and Tools offerings consist of server software licenses and client access licenses ("CAL") for Windows Server, Microsoft SQL Server, and other server products. We also offer developer tools, training, certification, Microsoft Press, Premier and Professional product support services, and Microsoft Consulting Services. Server products can be run on-site, in a hosted environment, or in a Web-based environment. We use multiple channels for licensing, including pre-installed OEM versions, licenses through partners, and licenses directly to end customers. We sell licenses both as one-time licenses and as multi-year volume licenses.

Three months ended March 31, 2009 compared with three months ended March 31, 2008

Server and Tools revenue increased reflecting growth in product and services revenue. Server and server application revenue (including CAL) and developer tools revenue increased $191 million or 7%, primarily driven by growth in SQL Server, CAL Suites, and System Center revenue. This growth reflects recognition of deferred revenue from previously signed agreements and continued adoption of Windows Platform applications through SQL Server 2008, which was released in the first quarter of fiscal year 2009, CAL Suites, and System Center products. Consulting and Premier and Professional product support services revenue increased $38 million or 6%, primarily due to revenue from annuity support agreements. Foreign currency exchange rates did not have a significant impact on revenue during the quarter.

Server and Tools operating income increased primarily due to growth in high-margin product revenue and a slight decline in operating expenses. Operating expenses decreased $35 million or 2%, primarily driven by a decrease in corporate marketing activities and headcount-related expenses associated with our corporate sales force.

Nine months ended March 31, 2009 compared with nine months ended March 31, 2008

Server and Tools revenue increased reflecting growth in product and services revenue and included a favorable impact from foreign currency exchange rates of $223 million or two percentage points. Server and server application revenue (including CAL) and developer tools revenue increased $981 million or 13%, primarily driven by growth in SQL Server, Windows Server, and CAL Suites revenue. This growth reflects recognition of deferred revenue from previously signed agreements and continued adoption of Windows Platform and applications through SQL Server 2008, Windows Server 2008, and CAL Suites. Consulting and Premier and Professional product support services revenue increased $254 million or 13%, primarily due to revenue from annuity support agreements.

Server and Tools operating income increased primarily due to growth in high-margin product revenue, partially offset by increased cost of revenue and research and development expenses. Cost of revenue increased $176 million or 10%, reflecting the growth in consulting, support, and online services. Research and development expenses increased $175 million or 13%, primarily driven by increased headcount-related expenses.

Online Services Business



                                        Three Months Ended                          Nine Months Ended
                                            March 31,              Percentage           March 31,             Percentage
(In millions, except percentages)     2009             2008          Change        2009           2008          Change
Revenue                             $     721       $      843          (14)%   $    2,357     $    2,377           (1)%
Operating loss                      $    (575 )     $     (226 )       (154)%   $   (1,521 )   $     (737 )       (106)%

Online Services Business ("OSB") consists of an online advertising platform with offerings for both publishers and advertisers, personal communications services, such as email and instant messaging, online information offerings, such as Live Search, and the MSN portals and channels around the world. We earn revenue primarily from online advertising, including search, display, and advertiser and publisher tools. Revenue is also generated through subscriptions and transactions generated from online paid services, digital marketing and advertising agency services, and from MSN narrowband Internet access subscribers. During the first quarter of fiscal year 2008, we completed our acquisition of aQuantive, Inc. ("aQuantive"), a digital marketing business. aQuantive was consolidated into our results of operations starting August 10, 2007, the acquisition date. Amounts during the nine months ended March 31, 2009 included nine months of aQuantive results whereas amounts during the nine months ended March 31, 2008 included aQuantive results only from the acquisition date through the end of the period.

Three months ended March 31, 2009 compared with three months ended March 31, 2008

OSB revenue decreased as a result of decreased online advertising, access, and other OSB revenue and included an unfavorable impact from foreign currency exchange rates of $16 million or two percentage points. Online advertising revenue decreased $98 million or 16%, to $521 million, primarily reflecting a decrease in display advertising. Access revenue decreased $17 million or 28%, to $43 million, reflecting continued migration of subscribers to broadband or other competitively-priced service providers.

OSB operating loss increased due to increased cost of revenue and decreased revenue. Cost of revenue increased $223 million or 48%, primarily driven by increased traffic acquisition costs and data center and equipment costs.

Nine months ended March 31, 2009 compared with nine months ended March 31, 2008

OSB revenue decreased primarily as a result of decreased access revenue, partially offset by increased online advertising revenue. Access revenue decreased $56 million or 28%, to $141 million, reflecting continued migration of subscribers to broadband or other competitively-priced service providers. Online advertising revenue increased $13 million or 1%, to $1.7 billion.

OSB operating loss increased due to increased cost of revenue and research and development expenses. Cost of revenue increased $543 million or 41%, primarily driven by increased traffic acquisition costs, data center and equipment costs, people costs, and agency expenses. Research and development expenses increased $146 million or 17%, primarily due to increased headcount-related expenses.

Microsoft Business Division



                                      Three Months Ended                    Nine Months Ended
                                          March 31,          Percentage         March 31,         Percentage
(In millions, except percentages)      2009         2008       Change        2009        2008       Change
Revenue                             $    4,505    $  4,731         (5)%   $   14,330   $ 13,663           5%
Operating income                    $    2,877    $  3,127         (8)%   $    9,325   $  9,010           3%

Microsoft Business Division ("MBD") offerings consist of the Microsoft Office system and Microsoft Dynamics business solutions. Microsoft Office system products are designed to increase personal, team, and organization productivity through a range of programs, services, and software solutions. Growth of revenue from the Microsoft Office system offerings, which generate over 90% of MBD revenue, depends on our ability to add value to the core Office product set and to continue to expand

our product offerings in other information worker areas such as enterprise content management, collaboration, unified communications, and business intelligence. Microsoft Dynamics products provide business solutions for financial management, customer relationship management, supply chain management, and analytics applications for small and mid-size businesses, large organizations, and divisions of global enterprises. We evaluate our results based upon the nature of the end user in two primary parts: business revenue, which includes Microsoft Office system revenue generated through volume licensing agreements and Microsoft Dynamics revenue; and consumer revenue, which includes revenue from retail packaged product sales and OEM revenue.

Three months ended March 31, 2009 compared with three months ended March 31, 2008

MBD revenue declined reflecting decreased consumer revenue, partially offset by increased business revenue, and included a favorable impact from foreign currency exchange rates of $73 million or two percentage points. Consumer revenue decreased $299 million or 30%, primarily as a result of PC market weakness, a shift to lower-priced products, and pricing promotions on the 2007 Microsoft Office system. Business revenue increased $73 million or 2%, primarily reflecting growth in volume licensing agreement revenue and included an 8% decrease in Microsoft Dynamics customer billings. The growth in volume licensing agreement revenue primarily reflects recognition of deferred revenue from previously signed agreements.

MBD operating income decreased reflecting decreased revenue and increased cost of revenue, partially offset by decreased sales and marketing expenses. Cost of revenue increased $38 million or 16%, primarily driven by expenses associated with Fast Search & Transfer ASA ("FAST") which we acquired in April 2008. Sales and marketing expenses decreased $61 million or 6%, primarily driven by a decrease in corporate marketing activities and headcount-related costs associated with our corporate sales force.

Nine months ended March 31, 2009 compared with nine months ended March 31, 2008

MBD revenue increased reflecting increased business revenue, partially offset by a decrease in consumer revenue, and included a favorable impact from foreign currency exchange rates of $453 million or three percentage points. Business revenue increased $894 million or 8%, primarily reflecting growth in volume licensing agreement revenue and included a 4% decrease in Microsoft Dynamics customer billings. The growth in volume licensing agreement revenue primarily reflects the recognition of deferred revenue from previously signed agreements. Consumer revenue decreased $227 million or 8%, primarily as a result of decreased licensing of the 2007 Microsoft Office system through our OEM channel.

MBD operating income increased reflecting increased revenue, partially offset by increased cost of revenue and research and development expenses. Cost of revenue increased $147 million or 21%, primarily driven by FAST. Research and development expenses increased $140 million or 13%, primarily driven by an increase in headcount-related expenses associated with FAST.

Entertainment and Devices Division



                                      Three Months Ended                     Nine Months Ended
                                           March 31,          Percentage         March 31,         Percentage
(In millions, except percentages)      2009          2008       Change        2009        2008       Change
. . .