Quarterly Report


Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-Q

 


 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2016

OR

 

¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period From                  to                

Commission File Number: 0-14278

 


MICROSOFT CORPORATION

(Exact name of registrant as specified in its charter)

 


 

Washington   91-1144442

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

One Microsoft Way, Redmond, Washington   98052-6399
(Address of principal executive offices)   (Zip Code)

(425) 882-8080

(Registrant’s telephone number, including area code)

None

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x  No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  x  No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  x

  

Accelerated filer  ¨

Non-accelerated filer  ¨ (Do not check if a smaller reporting company)

  

Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ¨  No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class    Outstanding at April 15, 2016  


Common Stock, $0.00000625 par value per share

     7,860,466,856 shares   

 



Table of Contents

MICROSOFT CORPORATION

FORM 10-Q

For the Quarter Ended March 31, 2016

INDEX

 

                 Page  

PART I.

  FINANCIAL INFORMATION        
    Item 1.   Financial Statements        
        a)    Income Statements for the Three and Nine Months Ended March 31, 2016 and 2015     3   
        b)    Comprehensive Income Statements for the Three and Nine Months Ended March 31, 2016 and 2015     4   
        c)    Balance Sheets as of March 31, 2016 and June 30, 2015     5   
        d)    Cash Flows Statements for the Three and Nine Months Ended March 31, 2016 and 2015     6   
        e)    Stockholders’ Equity Statements for the Three and Nine Months Ended March 31, 2016 and 2015     7   
        f)    Notes to Financial Statements     8   
        g)    Report of Independent Registered Public Accounting Firm     32   
    Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations     33   
    Item 3.   Quantitative and Qualitative Disclosures About Market Risk     50   
    Item 4.   Controls and Procedures     51   

PART II.  

  OTHER INFORMATION        
    Item 1.   Legal Proceedings     51   
    Item 1A.   Risk Factors     51   
    Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds     60   
    Item 6.   Exhibits     60   

SIGNATURE

    61   

 

2


Table of Contents

PART I

Item 1

 

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

INCOME STATEMENTS

 

(In millions, except per share amounts) (Unaudited)    Three Months Ended
March 31,
    Nine Months Ended
March 31,
 


     2016     2015     2016     2015  

Revenue

   $   20,531      $   21,729      $   64,706      $   71,400   

Cost of revenue

     7,722        7,161        24,801        25,570   


 


 


 


Gross margin

     12,809        14,568        39,905        45,830   

Research and development

     2,980        2,984        8,842        8,952   

Sales and marketing

     3,406        3,709        10,699        11,752   

General and administrative

     1,140        1,091        3,262        3,339   

Impairment, integration, and restructuring

     0        190        0        1,573   


 


 


 


Operating income

     5,283        6,594        17,102        20,214   

Other income (expense), net

     (247     (77     (698     49   


 


 


 


Income before income taxes

     5,036        6,517        16,404        20,263   

Provision for income taxes

     1,280        1,532        2,728        4,875   


 


 


 


Net income

   $ 3,756      $ 4,985      $ 13,676      $ 15,388   
    


 


 


 


Earnings per share:

                                

Basic

   $ 0.48      $ 0.61      $ 1.72      $ 1.87   

Diluted

   $ 0.47      $ 0.61      $ 1.70      $ 1.86   

Weighted average shares outstanding:

                                

Basic

     7,895        8,167        7,952        8,215   

Diluted

     7,985        8,237        8,041        8,293   

Cash dividends declared per common share

   $ 0.36      $ 0.31      $ 1.08      $ 0.93   


See accompanying notes.

 

3


Table of Contents

PART I

Item 1

 

COMPREHENSIVE INCOME STATEMENTS

 

(In millions) (Unaudited)    Three Months Ended
March 31,
    Nine Months Ended
March 31,
 


     2016     2015     2016     2015  

Net income

   $   3,756      $   4,985      $   13,676      $   15,388   
    


 


 


 


Other comprehensive income (loss):

                                

Net unrealized gains (losses) on derivatives (net of tax effects of $(30) , $21, $(2) , and $31)

     (285     401        (277     967   

Net unrealized gains (losses) on investments (net of tax effects of $186 , $68, $(36) , and $(158))

     345        125        (66     (295

Translation adjustments and other (net of tax effects of $3 , $(174), $(18) , and $(432))

     7        (438     (339     (909


 


 


 


Other comprehensive income (loss)

     67        88        (682     (237


 


 


 


Comprehensive income

   $ 3,823      $ 5,073      $ 12,994      $ 15,151   
    


 


 


 


See accompanying notes.

 

4


Table of Contents

PART I

Item 1

 

BALANCE SHEETS

 

(In millions) (Unaudited)             


    

March 31,

2016

    June 30,
2015
 

Assets

                

Current assets:

                

Cash and cash equivalents

   $ 7,170      $ 5,595   

Short-term investments (including securities loaned of $241 and $75)

     98,382        90,931   


 


Total cash, cash equivalents, and short-term investments

     105,552        96,526   

Accounts receivable, net of allowance for doubtful accounts of $361 and $335

     12,247        17,908   

Inventories

     2,450        2,902   

Deferred income taxes

     1,574        1,915   

Other

     6,598        5,461   


 


Total current assets

     128,421        124,712   

Property and equipment, net of accumulated depreciation of $18,885 and $17,606

     16,831        14,731   

Equity and other investments

     11,315        12,053   

Goodwill

     17,948        16,939   

Intangible assets, net

     4,459        4,835   

Other long-term assets

     2,895        2,953   


 


Total assets

   $   181,869      $   176,223   
    


 


Liabilities and stockholders’ equity

                

Current liabilities:

                

Accounts payable

   $ 6,759      $ 6,591   

Short-term debt

     5,498        4,985   

Current portion of long-term debt

     0        2,499   

Accrued compensation

     4,276        5,096   

Income taxes

     685        606   

Short-term unearned revenue

     20,876        23,223   

Securities lending payable

     373        92   

Other

     5,887        6,766   


 


Total current liabilities

     44,354        49,858   

Long-term debt

     40,896        27,808   

Long-term unearned revenue

     5,017        2,095   

Deferred income taxes

     2,674        2,835   

Other long-term liabilities

     14,122        13,544   


 


Total liabilities

     107,063        96,140   


 


Commitments and contingencies

                

Stockholders’ equity:

                

Common stock and paid-in capital—shares authorized 24,000; outstanding 7,870 and 8,027

     68,012        68,465   

Retained earnings

     4,954        9,096   

Accumulated other comprehensive income

     1,840        2,522   


 


Total stockholders’ equity

     74,806        80,083   


 


Total liabilities and stockholders’ equity

   $ 181,869      $ 176,223   
    


 


See accompanying notes.

 

5


Table of Contents

PART I

Item 1

 

CASH FLOWS STATEMENTS

 

(In millions) (Unaudited)   

Three Months Ended

March 31,

   

Nine Months Ended

March 31,

 


     2016     2015     2016     2015  

Operations

                                

Net income

   $ 3,756      $ 4,985      $ 13,676      $ 15,388   

Adjustments to reconcile net income to net cash from operations:

                                

Depreciation, amortization, and other

     1,707        1,515        4,712        4,464   

Stock-based compensation expense

     672        641        2,004        1,920   

Net recognized losses (gains) on investments and derivatives

     65        (55     216        (179

Deferred income taxes

     351        253        177        868   

Deferral of unearned revenue

     13,073        10,163        36,066        28,385   

Recognition of unearned revenue

       (12,210       (11,209       (35,494       (33,347

Changes in operating assets and liabilities:

                                

Accounts receivable

     2,288        3,655        5,546        6,904   

Inventories

     241        (430     408        157   

Other current assets

     (420     (111     (1,914     (550

Other long-term assets

     7        (108     58        341   

Accounts payable

     (129     (390     105        (912

Other current liabilities

     626        200        (1,293     (1,952

Other long-term liabilities

     340        492        594        1,332   


 


 


 


Net cash from operations

     10,367        9,601        24,861        22,819   


 


 


 


Financing

                                

Proceeds from issuance (repayments) of short-term debt, maturities of 90 days or less, net

     2,622        (6,575     481        1,222   

Proceeds from issuance of debt

     25        10,680        13,274        10,680   

Repayments of debt

     (900     0        (2,771     (1,500

Common stock issued

     159        146        495        483   

Common stock repurchased

     (3,857     (5,131     (12,292     (10,164

Common stock cash dividends paid

     (2,842     (2,532     (8,185     (7,386

Other

     (123     316        (366     601   


 


 


 


Net cash used in financing

     (4,916     (3,096     (9,364     (6,064


 


 


 


Investing

                                

Additions to property and equipment

     (2,308     (1,391     (5,688     (4,163

Acquisition of companies, net of cash acquired, and purchases of intangible and other assets

     (559     (162     (1,330     (3,097

Purchases of investments

     (27,341     (30,218     (99,661     (73,470

Maturities of investments

     5,192        5,561        16,229        9,643   

Sales of investments

     19,599        21,063        76,292        53,616   

Securities lending payable

     (66     (334     281        (463


 


 


 


Net cash used in investing

     (5,483     (5,481     (13,877     (17,934


 


 


 


Effect of foreign exchange rates on cash and cash equivalents

     17        (36     (45     (76


 


 


 


Net change in cash and cash equivalents

     (15     988        1,575        (1,255

Cash and cash equivalents, beginning of period

     7,185        6,426        5,595        8,669   


 


 


 


Cash and cash equivalents, end of period

   $ 7,170      $ 7,414      $ 7,170      $ 7,414   
    


 


 


 


See accompanying notes.

 

6


Table of Contents

PART I

Item 1

 

STOCKHOLDERS’ EQUITY STATEMENTS

 

(In millions) (Unaudited)   

Three Months Ended

March 31,

   

Nine Months Ended

March 31,

 


     2016     2015     2016     2015  

Common stock and paid-in capital

                                

Balance, beginning of period

   $ 67,977      $ 68,765      $ 68,465      $ 68,366   

Common stock issued

     159        146        495        483   

Common stock repurchased

     (853     (1,109     (3,010     (2,853

Stock-based compensation expense

     672        641        2,004        1,920   

Stock-based compensation income tax benefits

     0        30        0        555   

Other, net

     57        2        58        4   


 


 


 


Balance, end of period

     68,012        68,475        68,012        68,475   


 


 


 


Retained earnings

                                

Balance, beginning of period

     7,030        19,731        9,096        17,710   

Net income

     3,756        4,985        13,676        15,388   

Common stock cash dividends

     (2,822     (2,499     (8,530     (7,592

Common stock repurchased

     (3,010     (4,031     (9,288     (7,320


 


 


 


Balance, end of period

     4,954        18,186        4,954        18,186   


 


 


 


Accumulated other comprehensive income

                                

Balance, beginning of period

     1,773        3,383        2,522        3,708   

Other comprehensive income (loss)

     67        88        (682     (237


 


 


 


Balance, end of period

     1,840        3,471        1,840        3,471   


 


 


 


Total stockholders’ equity

   $   74,806      $   90,132      $   74,806      $   90,132   
    


 


 


 


See accompanying notes.

 

7


Table of Contents

PART I

Item 1

 

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 — ACCOUNTING POLICIES

Accounting Principles

We prepare our unaudited interim consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). In the opinion of management, the unaudited interim consolidated financial statements reflect all adjustments of a normal recurring nature that are necessary for a fair presentation of the results for the interim periods presented. Interim results are not necessarily indicative of results for a full year. The information included in this Form 10-Q should be read in conjunction with information included in the Microsoft Corporation 2015 Form 10-K and Form 8-K filed with the U.S. Securities and Exchange Commission on July 31, 2015 and October 27, 2015, respectively.

We have recast certain prior period amounts to conform to the current period presentation, with no impact on consolidated net income or cash flows.

Principles of Consolidation

The consolidated financial statements include the accounts of Microsoft Corporation and its subsidiaries. Intercompany transactions and balances have been eliminated. Equity investments through which we are able to exercise significant influence over but do not control the investee and are not the primary beneficiary of the investee’s activities are accounted for using the equity method. Investments through which we are not able to exercise significant influence over the investee and which do not have readily determinable fair values are accounted for under the cost method.

Recasting of Certain Prior Period Information

In June 2015, we announced a change in organizational structure as part of our transformation in the mobile-first, cloud-first world. During the first quarter of fiscal year 2016, the Company’s chief operating decision maker, who is also our Chief Executive Officer, requested changes in the information that he regularly reviews for purposes of allocating resources and assessing performance. As a result, beginning in fiscal year 2016, we report our financial performance based on our new segments described in Note 18 – Segment Information. We have recast certain prior period amounts to conform to the way we internally manage and monitor segment performance during fiscal year 2016. This change primarily impacted Note 9 – Goodwill, Note 14 – Unearned Revenue, and Note 18 – Segment Information, with no impact on consolidated net income or cash flows.

Estimates and Assumptions

Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Examples of estimates include: loss contingencies; product warranties; the fair value of, and/or potential impairment of goodwill and intangibles assets, for our reporting units; product life cycles; useful lives of our tangible and intangible assets; allowances for doubtful accounts; allowances for product returns; the market value of our inventory; and stock-based compensation forfeiture rates. Examples of assumptions include: the elements comprising a software arrangement, including the distinction between upgrades or enhancements and new products; when technological feasibility is achieved for our products; the potential outcome of future tax consequences of events that have been recognized in our consolidated financial statements or tax returns; and determining when investment impairments are other-than-temporary. Actual results and outcomes may differ from management’s estimates and assumptions.

Revenue Recognition for Windows 10 Licenses

Customers purchasing a Windows 10 license will receive unspecified updates and upgrades over the life of their Windows 10 device at no additional cost. As these updates and upgrades will not be sold on a stand-alone basis, we are unable to establish vendor-specific objective evidence of fair value. Accordingly, revenue from licenses of Windows 10 is recognized ratably over the estimated life of the related device, which ranges between two to four years.

 

8


Table of Contents

PART I

Item 1

 

Recent Accounting Guidance

Recently adopted accounting guidance

In March 2016, the Financial Accounting Standards Board (“FASB”) issued a new standard that changes the accounting for certain aspects of share-based payments to employees. The new guidance requires excess tax benefits and tax deficiencies to be recorded in the income statement when the awards vest or are settled. In addition, cash flows related to excess tax benefits will no longer be separately classified as a financing activity apart from other income tax cash flows. The standard also allows us to repurchase more of an employee’s shares for tax withholding purposes without triggering liability accounting, clarifies that all cash payments made on an employee’s behalf for withheld shares should be presented as a financing activity on our cash flows statement, and provides an accounting policy election to account for forfeitures as they occur. The new standard is effective for us beginning July 1, 2017, with early adoption permitted.

We elected to early adopt the new guidance in the third quarter of fiscal year 2016 which requires us to reflect any adjustments as of July 1, 2015, the beginning of the annual period that includes the interim period of adoption. The primary impact of adoption was the recognition of excess tax benefits in our provision for income taxes rather than paid-in capital for all periods in fiscal year 2016. Additional amendments to the accounting for income taxes and minimum statutory withholding tax requirements had no impact to retained earnings as of July 1, 2015, where the cumulative effect of these changes are required to be recorded. We have elected to continue to estimate forfeitures expected to occur to determine the amount of compensation cost to be recognized in each period.

We elected to apply the presentation requirements for cash flows related to excess tax benefits retrospectively to all periods presented which resulted in an increase to both net cash from operations and net cash used in financing of $31 million and $555 million for the three months and nine months ended March 31, 2015, respectively. The presentation requirements for cash flows related to employee taxes paid for withheld shares had no impact to any of the periods presented in our consolidated cash flows statements since such cash flows have historically been presented as a financing activity.

Adoption of the new standard resulted in the recognition of excess tax benefits in our provision for income taxes rather than paid-in capital of $74 million and $376 million for the three and nine months ended March 31, 2016, respectively, and impacted our previously reported quarterly results for fiscal year 2016 as follows:

 

(In millions, except earnings per share)   

Three Months Ended

September 30, 2015

   

Three Months Ended

December 31, 2015

 


     As
reported
    As
adjusted
    As
reported
    As
adjusted
 

Income statements:

                                

Provision for income taxes

   $ 893      $ 611      $ 857      $ 837   

Net income

   $ 4,620      $ 4,902      $ 4,998      $ 5,018   

Basic earnings per share

   $ 0.58      $ 0.61      $ 0.63      $ 0.63   

Diluted earnings per share

   $ 0.57      $ 0.61      $ 0.62      $ 0.62   

Diluted weighted average shares outstanding

     8,066        8,084        8,028        8,051   

Cash flows statements:

                                

Net cash from operations

   $ 8,594      $ 8,876      $   5,598      $   5,618   

Net cash used in financing

   $   (3,648   $   (3,930   $ (498   $ (518


 

(In millions)   

September 30,

2015

   

December 31,

2015

 


     As
reported
    As
adjusted
    As
reported
    As
adjusted
 

Balance sheets:

                                

Common stock and paid-in capital

   $   68,093      $   67,811      $   68,279      $   67,977   

Retained earnings

   $ 7,614      $ 7,896      $ 6,728      $ 7,030   


 

9


Table of Contents

PART I

Item 1

 

Recent accounting guidance not yet adopted

In May 2014, the FASB issued a new standard related to revenue recognition. Under the new standard, recognition of revenue occurs when a customer obtains control of promised goods or services in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The new standard will be effective for us beginning July 1, 2018, and adoption as of the original effective date of July 1, 2017 is permitted. We anticipate this standard will have a material impact on our consolidated financial statements, and we are currently evaluating its impact.

In January 2016, the FASB issued a new standard to amend certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Most prominent among the amendments is the requirement for changes in the fair value of our equity investments, with certain exceptions, to be recognized through net income rather than other comprehensive income (“OCI”). The new standard will be effective for us beginning July 1, 2018. The application of the amendments will result in a cumulative-effect adjustment to our consolidated balance sheet as of the effective date. We are currently evaluating the impact of this standard on our consolidated financial statements.

In February 2016, the FASB issued a new standard related to leases to increase transparency and comparability among organizations by requiring the recognition of lease assets and lease liabilities on the balance sheet. Most prominent among the amendments is the recognition of assets and liabilities by lessees for those leases classified as operating leases under previous U.S. GAAP. Under the new standard, disclosures are required to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. The new standard will be effective for us beginning July 1, 2019, with early adoption permitted. We anticipate this standard will have a material impact on our consolidated balance sheets, and we are currently evaluating its impact.

NOTE 2 — EARNINGS PER SHARE

Basic earnings per share (“EPS”) is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and stock awards.

The components of basic and diluted EPS are as follows:

 

(In millions, except earnings per share)   

Three Months Ended

March 31,

   

Nine Months Ended

March 31,

 


     2016     2015     2016     2015  

Net income available for common shareholders (A)

   $   3,756      $   4,985      $   13,676      $   15,388   
    


 


 


 


Weighted average outstanding shares of common stock (B)

     7,895        8,167        7,952        8,215   

Dilutive effect of stock-based awards

     90        70        89        78   


 


 


 


Common stock and common stock equivalents (C)

     7,985        8,237        8,041        8,293   
    


 


 


 


Earnings Per Share

                                

Basic (A/B)

   $ 0.48      $ 0.61      $ 1.72      $ 1.87   

Diluted (A/C)

   $ 0.47      $ 0.61      $ 1.70      $ 1.86   


Anti-dilutive stock-based awards excluded from the calculations of diluted EPS were immaterial during the periods presented.

 

10


Table of Contents

PART I

Item 1

 

NOTE 3 — OTHER INCOME (EXPENSE), NET

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

 

(In millions)   

Three Months Ended

March 31,

   

Nine Months Ended

March 31,

 


     2016     2015     2016     2015  

Dividends and interest income

   $ 230      $ 160      $ 629      $ 568   

Interest expense

       (340       (211       (898       (534

Net recognized gains on investments

     85        169        193        565   

Net losses on derivatives

     (155     (114     (414     (386

Net gains (losses) on foreign currency remeasurements

     (18     (54     (52     107   

Other

     (49     (27     (156     (271


 


 


 


Total

   $ (247   $ (77   $ (698   $ 49   
    


 


 


 


Following are details of net recognized gains (losses) on investments during the periods reported:

 

(In millions)   

Three Months Ended

March 31,

   

Nine Months Ended

March 31,

 


     2016     2015     2016     2015  

Other-than-temporary impairments of investments

   $ (86   $ (95   $ (248   $ (130

Realized gains from sales of available-for-sale securities

     282          358        740        897   

Realized losses from sales of available-for-sale securities

       (111     (94       (299       (202


 


 


 


Total

   $ 85      $ 169      $ 193      $ 565   
    


 


 


 


NOTE 4 — INVESTMENTS

Investment Components

The components of investments, including associated derivatives, but excluding held-to-maturity investments, were as follows:

 

(In millions)    Cost Basis    

Unrealized

Gains

   

Unrealized

Losses

   

Recorded

Basis

   

Cash

and Cash

Equivalents

   

Short-term

Investments

   

Equity

and Other

Investments

 


March 31, 2016

                                                        

Cash

   $ 3,691      $ 0      $ 0      $ 3,691      $ 3,691      $ 0      $ 0   

Mutual funds

     1,111        0        0        1,111        1,111        0        0   

Commercial paper

     824        0        0        824        824        0        0   

Certificates of deposit

     1,324        0        0        1,324        1,178        146        0   

U.S. government and agency securities

     81,676        98        (23     81,751        138        81,613        0   

Foreign government bonds

     5,221        6        (28     5,199        228        4,971        0   

Mortgage- and asset-backed securities

     4,695        19        (4     4,710        0        4,710        0   

Corporate notes and bonds

     6,582        95        (64     6,613        0        6,613        0   

Municipal securities

     285        47        0        332        0        332        0   

Common and preferred stock

     6,075        4,912        (254     10,733        0        0        10,733   

Other investments

     554        0        0        554        0        (3     557   


 


 


 


 


 


 


Total

   $   112,038      $   5,177      $   (373   $   116,842      $   7,170      $   98,382      $   11,290   
    


 


 


 


 


 


 


 

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Table of Contents

PART I

Item 1

 

(In millions)    Cost Basis    

Unrealized

Gains

   

Unrealized

Losses

   

Recorded

Basis

   

Cash

and Cash

Equivalents

   

Short-term

Investments

   

Equity

and Other

Investments

 


June 30, 2015

                                                        

Cash

   $ 3,679      $ 0      $ 0      $ 3,679      $ 3,679      $ 0      $ 0   

Mutual funds

     1,100        0        0        1,100        1,100        0        0   

Commercial paper

     1        0        0        1        1        0        0   

Certificates of deposit

     906        0        0        906        776        130        0   

U.S. government and agency securities

     72,843        76        (30     72,889        39        72,850        0   

Foreign government bonds

     5,477        3        (24     5,456        0        5,456        0   

Mortgage- and asset-backed securities

     4,899        23        (6     4,916        0        4,916        0   

Corporate notes and bonds

     7,192        97        (37     7,252        0        7,252        0   

Municipal securities

     285        35        (1     319        0        319        0   

Common and preferred stock

     6,668        4,986        (215     11,439        0        0        11,439   

Other investments

     597        0        0        597        0        8        589   


 


 


 


 


 


 


Total

   $   103,647      $   5,220      $   (313   $   108,554      $   5,595      $   90,931      $   12,028   
    


 


 


 


 


 


 


As of March 31, 2016 and June 30, 2015, the recorded bases of common and preferred stock that are restricted for more than one year or are not publicly traded were $770 million and $561 million, respectively. These investments are carried at cost and are reviewed quarterly for indicators of other-than-temporary impairment. It is not practicable for us to reliably estimate the fair value of these investments.

We lend certain fixed-income and equity securities to increase investment returns. These transactions are accounted for as secured borrowings and the loaned securities continue to be carried as investments on our consolidated balance sheets. Cash and/or security interests are received as collateral for the loaned securities with the amount determined based upon the underlying security lent and the creditworthiness of the borrower. As of March 31, 2016, the collateral received under these agreements totaled $373 million which is primarily comprised of U.S. government and agency securities.

Unrealized Losses on Investments

Investments with continuous unrealized losses for less than 12 months and 12 months or greater and their related fair values were as follows:

 

     Less than 12 Months     12 Months or Greater          

Total

Unrealized

Losses

 
    


 


         
(In millions)    Fair Value     Unrealized
Losses
    Fair Value     Unrealized
Losses
    Total
Fair Value
   


March 31, 2016

                                                

U.S. government and agency securities

   $ 29,389      $ (12   $ 529      $ (11   $ 29,918      $ (23

Foreign government bonds

     4,231        (2     58        (26     4,289        (28

Mortgage- and asset-backed securities

     2,403        (4     136        0        2,539        (4

Corporate notes and bonds

     2,753        (34     467        (30     3,220        (64

Common and preferred stock

     991        (179     394        (75     1,385        (254


 


 


 


 


 


Total

   $   39,767      $   (231   $   1,584      $   (142   $   41,351      $   (373
    


 


 


 


 


 


 

12


Table of Contents

PART I

Item 1

 

     Less than 12 Months     12 Months or Greater          

Total

Unrealized

Losses

 
    


 


         
(In millions)    Fair Value     Unrealized
Losses
    Fair Value     Unrealized
Losses
    Total
Fair Value
   


June 30, 2015

                                                

U.S. government and agency securities

   $ 6,636      $ (9   $ 421      $ (21   $ 7,057      $ (30

Foreign government bonds

     4,611        (12     18        (12     4,629        (24

Mortgage- and asset-backed securities

     3,171        (5     28        (1     3,199        (6

Corporate notes and bonds

     2,946        (29     104        (8     3,050        (37

Municipal securities

     36        (1     0        0        36        (1

Common and preferred stock

     1,389        (180     148        (35     1,537        (215


 


 


 


 


 


Total

   $   18,789      $   (236   $   719      $   (77   $   19,508      $   (313
    


 


 


 


 


 


Unrealized losses from fixed-income securities are primarily attributable to changes in interest rates. Unrealized losses from domestic and international equities are due to market price movements. Management does not believe any remaining unrealized losses represent other-than-temporary impairments based on our evaluation of available evidence.

Debt Investment Maturities

 

(In millions)    Cost Basis    

Estimated

Fair Value

 


March 31, 2016

                

Due in one year or less

   $ 43,753      $ 43,745   

Due after one year through five years

     53,372        53,453   

Due after five years through 10 years

     2,266        2,275   

Due after 10 years

     1,216        1,280   


 


Total

   $   100,607      $   100,753   
    


 


NOTE 5 — DERIVATIVES

We use derivative instruments to manage risks related to foreign currencies, equity prices, interest rates, and credit; to enhance investment returns; and to facilitate portfolio diversification. Our objectives for holding derivatives include reducing, eliminating, and efficiently managing the economic impact of these exposures as effectively as possible.

Our derivative programs include strategies that both qualify and do not qualify for hedge accounting treatment. All notional amounts presented below are measured in U.S. dollar equivalents.

Foreign Currency

Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency hedge positions. Option and forward contracts are used to hedge a portion of forecasted international revenue for up to three years in the future and are designated as cash-flow hedging instruments. Principal currencies hedged include the euro, Japanese yen, British pound, Canadian dollar, and Australian dollar. As of March 31, 2016 and June 30, 2015, the total notional amounts of these foreign exchange contracts sold were $9.8 billion for both periods.

Foreign currency risks related to certain non-U.S. dollar denominated securities are hedged using foreign exchange forward contracts that are designated as fair-value hedging instruments. As of March 31, 2016 and June 30, 2015, the total notional amounts of these foreign exchange contracts sold were $5.0 billion and $5.3 billion, respectively.

Certain options and forwards not designated as hedging instruments are also used to manage the variability in foreign exchange rates on certain balance sheet amounts and to manage other foreign currency exposures. As of March 31, 2016, the total notional amounts of these foreign exchange contracts purchased and sold were $8.6 billion and $6.0 billion, respectively. As of June 30, 2015, the total notional amounts of these foreign exchange contracts purchased and sold were $9.7 billion and $11.0 billion, respectively.

 

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PART I

Item 1

 

Equity

Securities held in our equity and other investments portfolio are subject to market price risk. Market price risk is managed relative to broad-based global and domestic equity indices using certain convertible preferred investments, options, futures, and swap contracts not designated as hedging instruments. From time to time, to hedge our price risk, we may use and designate equity derivatives as hedging instruments, including puts, calls, swaps, and forwards. As of March 31, 2016, the total notional amounts of equity contracts purchased and sold for managing market price risk were $1.4 billion and $2.1 billion, respectively, of which $697 million and $948 million, respectively, were designated as hedging instruments. As of June 30, 2015, the total notional amounts of equity contracts purchased and sold for managing market price risk were $2.2 billion and $2.6 billion, respectively, of which $1.1 billion and $1.4 billion, respectively, were designated as hedging instruments.

Interest Rate

Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of our fixed-income portfolio to achieve economic returns that correlate to certain broad-based fixed-income indices using exchange-traded option and futures contracts, and over-the-counter swap and option contracts, none of which are designated as hedging instruments. As of March 31, 2016, the total notional amounts of fixed-interest rate contracts purchased and sold were $356 million and $2.5 billion, respectively. As of June 30, 2015, the total notional amounts of fixed-interest rate contracts purchased and sold were $1.0 billion and $3.2 billion, respectively.

In addition, we use “To Be Announced” forward purchase commitments of mortgage-backed assets to gain exposure to agency mortgage-backed securities. These meet the definition of a derivative instrument in cases where physical delivery of the assets is not taken at the earliest available delivery date. As of March 31, 2016 and June 30, 2015, the total notional derivative amounts of mortgage contracts purchased were $534 million and $812 million, respectively.

Credit

Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We use credit default swap contracts, not designated as hedging instruments, to manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. We use credit default swaps as they are a low-cost method of managing exposure to individual credit risks or groups of credit risks. As of March 31, 2016, the total notional amounts of credit contracts purchased and sold were $468 million and $281 million, respectively. As of June 30, 2015, the total notional amounts of credit contracts purchased and sold were $618 million and $430 million, respectively.

Commodity

We use broad-based commodity exposures to enhance portfolio returns and to facilitate portfolio diversification. We use swaps, futures, and option contracts, not designated as hedging instruments, to generate and manage exposures to broad-based commodity indices. We use derivatives on commodities as they can be low-cost alternatives to the purchase and storage of a variety of commodities, including, but not limited to, precious metals, energy, and grain. As of March 31, 2016, the total notional amounts of commodity contracts purchased and sold were $613 million and $163 million, respectively. As of June 30, 2015, the total notional amounts of commodity contracts purchased and sold were $882 million and $316 million, respectively.

Credit-Risk-Related Contingent Features

Certain of our counterparty agreements for derivative instruments contain provisions that require our issued and outstanding long-term unsecured debt to maintain an investment grade credit rating and require us to maintain minimum liquidity of $1.0 billion. To the extent we fail to meet these requirements, we will be required to post collateral, similar to the standard convention related to over-the-counter derivatives. As of March 31, 2016, our long-term unsecured debt rating was AAA, and cash investments were in excess of $1.0 billion. As a result, no collateral was required to be posted.

 

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PART I

Item 1

 

Fair Values of Derivative Instruments

Derivative instruments are recognized as either assets or liabilities and are measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation.

For derivative instruments designated as fair value hedges, the gains (losses) are recognized in earnings in the periods of change together with the offsetting losses (gains) on the hedged items attributed to the risk being hedged. For options designated as fair value hedges, changes in the time value are excluded from the assessment of hedge effectiveness and are recognized in earnings.

For derivative instruments designated as cash-flow hedges, the effective portion of the gains (losses) on the derivatives is initially reported as a component of OCI and is subsequently recognized in earnings when the hedged exposure is recognized in earnings. For options designated as cash-flow hedges, changes in the time value are excluded from the assessment of hedge effectiveness and are recognized in earnings. Gains (losses) on derivatives representing either hedge components excluded from the assessment of effectiveness or hedge ineffectiveness are recognized in earnings.

For derivative instruments that are not designated as hedges, gains (losses) from changes in fair values are primarily recognized in other income (expense), net. Other than those derivatives entered into for investment purposes, such as commodity contracts, the gains (losses) are generally economically offset by unrealized gains (losses) in the underlying available-for-sale securities, which are recorded as a component of OCI until the securities are sold or other-than-temporarily impaired, at which time the amounts are reclassified from accumulated other comprehensive income (“AOCI”) into other income (expense), net.

 

15


Table of Contents

PART I

Item 1

 

The following table presents the fair values of derivative instruments designated as hedging instruments (“designated hedge derivatives”) and not designated as hedging instruments (“non-designated hedge derivatives”). The fair values exclude the impact of netting derivative assets and liabilities when a legally enforceable master netting agreement exists and fair value adjustments related to our own credit risk and counterparty credit risk:

 

         March 31, 2016            June 30, 2015  
        


          


         Assets     Liabilities            Assets     Liabilities  
        


 


          


 


(In millions)        Short-term
Investments
    Other
Current
Assets
    Equity and
Other
Investments
    Other
Current
Liabilities
           Short-term
Investments
    Other
Current
Assets
    Equity and
Other
Investments
    Other
Current
Liabilities
 


Non-designated Hedge Derivatives

                                                                             

Foreign exchange contracts

       $ 22      $ 248      $ 0      $ (177             $ 17      $ 167      $ 0      $ (79

Equity contracts

         28        0        0        (27              148        0        0        (18

Interest rate contracts

         7        0        0        (19              7        0        0        (12

Credit contracts

         6        0        0        (6              16        0        0        (9

Commodity contracts

         2        0        0        (2              0        0        0        0   


 


 


 


          


 


 


 


Total

       $ 65      $ 248      $ 0      $ (231            $ 188      $ 167      $ 0      $ (118
        


 


 


 


          


 


 


 


Designated Hedge Derivatives

                                                                             

Foreign exchange contracts

       $ 8      $ 358      $ 0      $ (112            $ 56      $ 552      $ 0      $ (31

Equity contracts

         0        0        21        (32              0        0        25        (69


 


 


 


          


 


 


 


Total

       $ 8      $ 358      $ 21      $ (144            $ 56      $ 552      $ 25      $ (100


 


 


 


          


 


 


 


Total gross amounts of derivatives

       $ 73      $ 606      $ 21      $ (375            $   244      $   719      $ 25      $ (218
        


 


 


 


          


 


 


 


Gross derivatives either offset or subject to an enforceable master netting agreement

       $ 71      $ 606      $ 21      $ (375            $ 126      $ 719      $ 25      $   (218

Gross amounts of derivatives offset in the balance sheet

         (98       (120       (25     240                 (66     (71       (25     161   


 


 


 


          


 


 


 


Net amounts presented in the balance sheet

         (27     486        (4     (135              60        648        0        (57

Gross amounts of derivatives not offset in the balance sheet

         0        0        0        0                 0        0        0        0   

Cash collateral received

         0        0        0        (261              0        0        0        (456


 


 


 


          


 


 


 


Net amount

       $   (27   $ 486      $ (4   $   (396            $ 60      $ 648      $ 0      $ (513
        


 


 


 


          


 


 


 


See also Note 4 – Investments and Note 6 – Fair Value Measurements.

 

16


Table of Contents

PART I

Item 1

 

Fair-Value Hedge Gains (Losses)

We recognized in other income (expense), net the following gains (losses) on contracts designated as fair-value hedges and their related hedged items:

 

(In millions)   

Three Months Ended

March 31,

   

Nine Months Ended

March 31,

 


     2016     2015     2016     2015  

Foreign Exchange Contracts

                                

Derivatives

   $   (331   $ 31      $   (364   $ 653   

Hedged items

     340        (23     390          (647


 


 


 


Total amount of ineffectiveness

   $ 9      $ 8      $ 26      $ 6   
    


 


 


 


Equity Contracts

                                

Derivatives

   $ 15      $   (25   $ (77   $ (88

Hedged items

     (15     25        77        88   


 


 


 


Total amount of ineffectiveness

   $ 0      $ 0      $ 0      $ 0   
    


 


 


 


Amount of equity contracts excluded from effectiveness assessment

   $ (12   $ 5      $ (8   $ (8


Cash Flow Hedge Gains (Losses)

We recognized the following gains (losses) on foreign exchange contracts designated as cash-flow hedges:

 

(In millions)   

Three Months Ended

March 31,

   

Nine Months Ended

March 31,

 


     2016     2015     2016     2015  

Effective Portion

                                

Gains (losses) recognized in OCI (net of tax effects of $(19) , $25, $24, and $37)

   $   (125   $ 559      $ 158      $   1,251   

Gains reclassified from AOCI into revenue

     171        162        461        290   

Amount Excluded from Effectiveness Assessment and Ineffective Portion

                                

Losses recognized in other income (expense), net

     (86       (120       (240     (262


We estimate that $290 million of net derivative gains included in AOCI at March 31, 2016 will be reclassified into earnings within the following 12 months. No significant amounts of gains (losses) were reclassified from AOCI into earnings as a result of forecasted transactions that failed to occur during the three and nine months ended March 31, 2016.

 

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Table of Contents

PART I

Item 1

 

Non-Designated Derivative Gains (Losses)

Gains (losses) from changes in fair values of derivatives that are not designated as hedges are primarily recognized in other income (expense), net. These amounts are shown in the table below, with the exception of gains (losses) on derivatives presented in income statement line items other than other income (expense), net, which were immaterial for the periods presented. Other than those derivatives entered into for investment purposes, such as commodity contracts, the gains (losses) below are generally economically offset by unrealized gains (losses) in the underlying available-for-sale securities and gains (losses) from foreign exchange rate changes on certain balance sheet amounts.

 

(In millions)   

Three Months Ended

March 31,

   

Nine Months Ended

March 31,

 


     2016     2015     2016     2015  

Foreign exchange contracts

   $   188      $ (442   $ 113      $   (647

Equity contracts

     (19     (4     (15     (18

Interest-rate contracts

     (4     3        4        21   

Credit contracts

     1        2        (2     (2

Commodity contracts

     (9     (47       (145     (264


 


 


 


Total

   $ 157      $   (488   $ (45   $ (910
    


 


 


 


NOTE 6 — FAIR VALUE MEASUREMENTS

We account for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are:

 

   

Level 1 —inputs are based upon unadjusted quoted prices for identical instruments traded in active markets. Our Level 1 non-derivative investments primarily include U.S. government securities, domestic and international equities, and actively traded mutual funds. Our Level 1 derivative assets and liabilities include those actively traded on exchanges.

 

   

Level 2 —inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques (e.g. the Black-Scholes model) for which all significant inputs are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, credit spreads, foreign exchange rates, and forward and spot prices for currencies and commodities. Our Level 2 non-derivative investments consist primarily of corporate notes and bonds, common and preferred stock, mortgage- and asset-backed securities, U.S. government and agency securities, and foreign government bonds. Our Level 2 derivative assets and liabilities primarily include certain over-the-counter option and swap contracts.

 

   

Level 3 —inputs are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques, including option pricing models and discounted cash flow models. Our Level 3 non-derivative assets primarily comprise investments in common and preferred stock, and goodwill and intangible assets, when they are recorded at fair value due to an impairment charge. Unobservable inputs used in the models are significant to the fair values of the assets and liabilities.

We measure certain assets, including our cost and equity method investments, at fair value on a nonrecurring basis when they are deemed to be other-than-temporarily impaired. The fair values of these investments are determined based on valuation techniques using the best information available, and may include quoted market prices, market comparables, and discounted cash flow projections. An impairment charge is recorded when the cost of the investment exceeds its fair value and this condition is determined to be other-than-temporary.

Our other current financial assets and our current financial liabilities have fair values that approximate their carrying values.

 

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Table of Contents

PART I

Item 1

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following tables present the fair value of our financial instruments that are measured at fair value on a recurring basis:

 

(In millions)      Level 1        Level 2        Level 3       

 

Gross Fair

Value

  

  

    Netting (a)      
 
Net Fair
Value
  
  


March 31, 2016

                                                

Assets

                                                

Mutual funds

   $ 1,111      $ 0      $ 0      $ 1,111      $ 0      $ 1,111   

Commercial paper

     0        824        0        824        0        824   

Certificates of deposit

     0        1,324        0        1,324        0        1,324   

U.S. government and agency securities

     78,052        3,684        0        81,736        0        81,736   

Foreign government bonds

     10        5,306        0        5,316        0        5,316   

Mortgage- and asset-backed securities

     0        4,708        0        4,708        0        4,708   

Corporate notes and bonds

     0        6,520        1        6,521        0        6,521   

Municipal securities

     0        332        0        332        0        332   

Common and preferred stock

     7,833        2,114        18        9,965        0        9,965   

Derivatives

     1        699        0        700        (243     457   


 


 


 


 


 


Total

   $   87,007      $   25,511      $   19      $   112,537      $   (243   $   112,294   
    


 


 


 


 


 


Liabilities

                                                

Derivatives and other

   $ 15      $ 360      $ 0      $ 375      $ (240   $ 135   


 

(In millions)      Level 1        Level 2        Level 3       

 

Gross Fair

Value

  

  

    Netting (a)      
 
Net Fair
Value
  
  


June 30, 2015

                                                

Assets

                                                

Mutual funds

   $ 1,100      $ 0      $ 0      $ 1,100      $ 0      $ 1,100   

Commercial paper

     0        1        0        1        0        1   

Certificates of deposit

     0        906        0        906        0        906   

U.S. government and agency securities

     71,930        955        0        72,885        0        72,885   

Foreign government bonds

     131        5,299        0        5,430        0        5,430   

Mortgage- and asset-backed securities

     0        4,917        0        4,917        0        4,917   

Corporate notes and bonds

     0        7,108        1        7,109        0        7,109   

Municipal securities

     0        319        0        319        0        319   

Common and preferred stock

     8,585        2,277        14        10,876        0        10,876   

Derivatives

     4        979        5        988        (162     826   


 


 


 


 


 


Total

   $   81,750      $   22,761      $   20      $   104,531      $   (162   $   104,369   
    


 


 


 


 


 


Liabilities

                                                

Derivatives and other

   $ 5      $ 159      $ 54      $ 218      $ (161   $ 57   


 

(a)

These amounts represent the impact of netting derivative assets and derivative liabilities when a legally enforceable master netting agreement exists and fair value adjustments related to our own credit risk and counterparty credit risk.

The changes in our Level 3 financial instruments that are measured at fair value on a recurring basis were immaterial during the periods presented.

 

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The following table reconciles the total “Net Fair Value” of assets above to our balance sheet presentation of these same assets in Note 4 – Investments.

 

(In millions)             


March 31,

2016

   

June 30,

2015

 

Net fair value of assets measured at fair value on a recurring basis

   $ 112,294      $ 104,369   

Cash

     3,691        3,679   

Common and preferred stock measured at fair value on a nonrecurring basis

     770        561   

Other investments measured at fair value on a nonrecurring basis

     557        589   

Less derivative net assets classified as other current assets

     (486     (648

Other

     16        4   


 


Recorded basis of investment components

   $   116,842      $   108,554   
    


 


Financial Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

During the three and nine months ended March 31, 2016 and 2015, we did not record any material other-than-temporary impairments on financial assets required to be measured at fair value on a nonrecurring basis.

NOTE 7 — INVENTORIES

The components of inventories were as follows:

 

(In millions)             


March 31,

2016

   

June 30,

2015

 

Raw materials

   $ 636      $ 1,100   

Work in process

     122        202   

Finished goods

     1,692        1,600   


 


Total

   $   2,450      $   2,902   
    


 


NOTE 8 — BUSINESS COMBINATIONS

Mojang Synergies AB

On November 6, 2014, we acquired Mojang Synergies AB (“Mojang”), the Swedish video game developer of the Minecraft gaming franchise, for $2.5 billion in cash, net of cash acquired. The addition of Minecraft and its community enhances our gaming portfolio across Windows, Xbox, and other ecosystems besides our own. The significant classes of assets and liabilities to which we allocated the purchase price were goodwill of $1.8 billion and identifiable intangible assets of $928 million, primarily marketing-related (trade names). The goodwill recognized in connection with the acquisition is primarily attributable to anticipated synergies from future growth, and is not expected to be deductible for tax purposes. We assigned the goodwill to More Personal Computing under our current segment structure. Identifiable intangible assets were assigned a total weighted-average amortization period of 6.3 years. Mojang has been included in our consolidated results of operations since the acquisition date.

Other

During the nine months ended March 31, 2016, we completed 14 acquisitions for total cash consideration of $1.3 billion. These entities have been included in our consolidated results of operations since their respective acquisition dates.

Pro forma results of operations have not been presented because the effects of these business combinations, individually and in aggregate, were not material to our consolidated results of operations.

 

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NOTE 9 — GOODWILL

Changes in the carrying amount of goodwill were as follows:

 

(In millions)   

June 30,

2015

   

Acquisitions

    Other     March 31,
2016
 


Productivity and Business Processes

   $ 6,309                $ 444      $ (61   $ 6,692   

Intelligent Cloud

     4,917                 537        15        5,469   

More Personal Computing

     5,713                 91        (17     5,787   


          


 


 


Total goodwill

   $   16,939               $   1,072      $   (63   $   17,948   
    


          


 


 


The measurement periods for the valuation of assets acquired and liabilities assumed end as soon as information on the facts and circumstances that existed as of the acquisition dates becomes available, but do not exceed 12 months. Adjustments in purchase price allocations may require a recasting of the amounts allocated to goodwill retroactive to the periods in which the acquisitions occurred.

Any change in the goodwill amounts resulting from foreign currency translations and purchase accounting adjustments are presented as “Other” in the above table. Also included in “Other” are business dispositions and transfers between business segments due to reorganizations, as applicable.

As discussed in Note 18 – Segment Information, during the first quarter of fiscal year 2016 the Company’s chief operating decision maker requested changes in the information that he regularly reviews for purposes of allocating resources and assessing performance. This resulted in a change in our operating segments and reporting units. We allocated goodwill to our new reporting units using a relative fair value approach. In addition, we completed an assessment of any potential goodwill impairment for all reporting units immediately prior to the reallocation and determined that no impairment existed.

NOTE 10 — INTANGIBLE ASSETS

The components of intangible assets, all of which are finite-lived, were as follows:

 

(In millions)    Gross
Carrying
Amount
   

Accumulated
Amortization

   

Net

Carrying
Amount

    Gross
Carrying
Amount
   

Accumulated
Amortization

   

Net

Carrying
Amount

 


    

March 31,

2016

   

June 30,

2015

 

Technology-based  (a)

   $ 6,169              $ (3,532   $ 2,637      $ 5,926              $ (3,149   $ 2,777   

Marketing-related

     1,936                 (631     1,305        1,942                 (508     1,434   

Contract-based

     1,177                 (757     420        1,192                 (710     482   

Customer-related

     469                 (372     97        492                 (350     142   


          


 


 


          


 


Total

   $   9,751               $   (5,292   $   4,459      $   9,552               $   (4,717   $   4,835   
    


          


 


 


          


 


 

(a)

Technology-based intangible assets included $128 million and $116 million as of March 31, 2016 and June 30, 2015, respectively, of net carrying amount of software to be sold, leased, or otherwise marketed.

Intangible assets amortization expense was $249 million and $740 million for the three and nine months ended March 31, 2016, respectively, and $361 million and $1.1 billion for the three and nine months ended March 31, 2015, respectively. Amortization of capitalized software was $18 million and $55 million for the three and nine months ended March 31, 2016, respectively, and $13 million and $68 million for the three and nine months ended March 31, 2015, respectively.

In the third quarter of fiscal year 2016, we corrected our intangible assets in the table above for a $585 million misstatement between gross carrying amount and accumulated amortization as of June 30, 2015. We do not consider this correction to be material, and there was no impact to our consolidated financial statements.

 

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The following table outlines the estimated future amortization expense related to intangible assets held as of March 31, 2016:

 

(In millions)       


Year Ending June 30,

        

2016 (excluding the nine months ended March 31, 2016)

   $ 247   

2017

     861   

2018

     753   

2019

     602   

2020

     522   

Thereafter

     1,474   


Total

   $   4,459   
    


NOTE 11 — DEBT

Short-term Debt

As of March 31, 2016, we had $5.5 billion of commercial paper issued and outstanding, with a weighted-average interest rate of 0.36% and maturities ranging from 26 days to 91 days. As of June 30, 2015, we had $5.0 billion of commercial paper issued and outstanding, with a weighted-average interest rate of 0.11% and maturities ranging from 8 days to 63 days. The estimated fair value of this commercial paper approximates its carrying value.

We currently have two $5.0 billion credit facilities that expire on November 1, 2016 and November 14, 2018, respectively. These credit facilities serve as a back-up for our commercial paper program. As of March 31, 2016, we were in compliance with the only financial covenant in both credit agreements, which requires us to maintain a coverage ratio of at least three times earnings before interest, taxes, depreciation, and amortization to interest expense, as defined in the credit agreements. No amounts were drawn against these credit facilities during any of the periods presented.

Long-term Debt

As of March 31, 2016, the total carrying value and estimated fair value of our long-term debt were $40.9 billion and $43.5 billion, respectively. This is compared to a carrying value and estimated fair value of our long-term debt, including the current portion, of $30.3 billion and $30.5 billion, respectively, as of June 30, 2015. These estimated fair values are based on Level 2 inputs.

 

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The components of our long-term debt, including the current portion, and the associated interest rates were as follows as of March 31, 2016 and June 30, 2015:

 

Due Date   

Face Value

March 31,

2016

   

Face Value

June 30,

2015

   

Stated

Interest

Rate

    

Effective

Interest

Rate

 


            (In millions)               

Notes

                                          

September 25, 2015

             $ *      $ 1,750        1.625%         1.795%   

February 8, 2016

              *        750        2.500%         2.642%   

November 15, 2017

              600        600        0.875%         1.084%   

May 1, 2018

              450        450        1.000%         1.106%   

November 3, 2018 (a)

              1,750        *        1.300%         1.396%   

December 6, 2018

              1,250        1,250        1.625%         1.824%   

June 1, 2019

              1,000        1,000        4.200%         4.379%   

February 12, 2020

              1,500        1,500        1.850%         1.935%   

October 1, 2020

              1,000        1,000        3.000%         3.137%   

November 3, 2020 (a)

              2,250        *        2.000%         2.093%   

February 8, 2021

              500        500        4.000%         4.082%   

December 6, 2021 (b)

              1,994        1,950        2.125%         2.233%   

February 12, 2022

              1,500        1,500        2.375%         2.466%   

November 3, 2022 (a)

              1,000        *        2.650%         2.717%   

November 15, 2022

              750        750        2.125%         2.239%   

May 1, 2023

              1,000        1,000        2.375%         2.465%   

December 15, 2023

              1,500        1,500        3.625%         3.726%   

February 12, 2025

              2,250        2,250        2.700%         2.772%   

November 3, 2025 (a)

              3,000        *        3.125%         3.176%   

December 6, 2028 (b)

              1,994        1,950        3.125%         3.218%   

May 2, 2033  (b)

              627        613        2.625%         2.690%   

February 12, 2035

              1,500        1,500        3.500%         3.604%   

November 3, 2035 (a)

              1,000        *        4.200%         4.260%   

June 1, 2039

              750        750        5.200%         5.240%   

October 1, 2040

              1,000        1,000        4.500%         4.567%   

February 8, 2041

              1,000        1,000        5.300%         5.361%   

November 15, 2042

              900        900        3.500%         3.571%   

May 1, 2043

              500        500        3.750%         3.829%   

December 15, 2043

              500        500        4.875%         4.918%   

February 12, 2045

              1,750        1,750        3.750%         3.800%   

November 3, 2045 (a)

              3,000        *        4.450%         4.492%   

February 12, 2055

              2,250        2,250        4.000%         4.063%   

November 3, 2055 (a)

              1,000        *        4.750%         4.782%   


                

Total

            $   41,065      $   30,463                    
             


 


                

 

(a)

In November 2015, we issued $13.0 billion of debt securities.

 

(b)

Euro-denominated debt securities.

 

*

Not applicable

The notes in the table above are senior unsecured obligations and rank equally with our other senior unsecured debt outstanding. Interest on these notes is paid semi-annually, except for the euro-denominated debt securities on which interest is paid annually. As of March 31, 2016 and June 30, 2015, the aggregate unamortized discount for our long-term debt, including the current portion, was $169 million and $156 million, respectively.

 

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NOTE 12 — INCOME TAXES

Our effective tax rate for the three months ended March 31, 2016 and 2015 was 25% and 24%, respectively, and 17% and 24% for the nine months ended March 31, 2016 and 2015, respectively. 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, Singapore, and Puerto Rico.

The change in the current quarter and year-to-date effective tax rate compared to prior year was primarily due to changes in the mix of our income before income taxes between the U.S. and foreign countries, offset by a benefit from the adoption of the new accounting guidance relating to stock-based compensation. The prior year-to-date effective tax rate also included an expense relating to Internal Revenue Service (“IRS”) audit adjustments and adjustments to prior years’ liabilities for intercompany transfer pricing that increased taxable income in more highly-taxed jurisdictions.

Tax contingencies and other income tax liabilities were $12.7 billion and $12.1 billion as of March 31, 2016 and June 30, 2015, respectively, and are included in other long-term liabilities. This increase relates primarily to current period quarterly growth relating to intercompany transfer pricing adjustments, offset by a partial settlement of the IRS audit for tax years 2007 to 2009 in the first quarter of fiscal year 2016. While we settled a portion of the IRS audit for tax years 2004 to 2006 during the third quarter of fiscal year 2011, and settled a portion of the IRS audit for tax years 2007 to 2009 during the first quarter of fiscal year 2016, we remain under audit for those years. In February 2012, the IRS withdrew its 2011 Revenue Agents Report for tax years 2004 to 2006 and reopened the audit phase of the examination. As of March 31, 2016, the primary unresolved issue relates to transfer pricing, which could have a significant impact on our consolidated financial statements if not resolved favorably. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved 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 also continue to be subject to examination by the IRS for tax years 2010 to 2016.

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 2016, some of which are currently under audit by local tax authorities. The resolutions of these audits are not expected to be material to our consolidated financial statements.

NOTE 13 — RESTRUCTURING CHARGES

Phone Hardware Integration

In July 2014, we announced a restructuring plan to simplify our organization and align the purchase of Nokia Corporation’s (“Nokia”) Devices and Services business (“NDS”) with our company’s overall strategy (the “Phone Hardware Integration Plan”). Pursuant to the Phone Hardware Integration Plan, we eliminated approximately 19,000 positions in fiscal year 2015, including approximately 13,000 professional and factory positions related to the NDS business. The actions associated with the Phone Hardware Integration Plan were completed as of June 30, 2015.

In connection with the Phone Hardware Integration Plan, we incurred restructuring charges of $98 million and $1.3 billion during the three and nine months ended March 31, 2015, respectively, including severance expenses and other reorganization costs, primarily associated with our facilities consolidation. Total restructuring charges incurred under the Phone Hardware Integration Plan were $1.3 billion, all of which were recognized in fiscal year 2015.

Phone Hardware Restructuring

In June 2015, management approved a plan to restructure our phone business to better focus and align resources (the “Phone Hardware Restructuring Plan”), under which we will eliminate up to 7,800 positions in fiscal year 2016. The actions associated with the Phone Hardware Restructuring Plan are expected to be completed as of June 30, 2016.

To date, we have incurred restructuring charges of $780 million under the Phone Hardware Restructuring Plan, including severance expenses and other reorganization costs.

Restructuring charges associated with these plans were included in impairment, integration, and restructuring expenses in our consolidated income statement, and reflected in Corporate and Other in our table of operating income (loss) by segment in Note 18 – Segment Information.

 

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Changes in the restructuring liability were as follows:

 

(In millions)

     Severance       

 

 

Asset

Impairments

and  Other

  

  

(a)  

    Total   


Restructuring liability as of June 30, 2015

   $ 588      $   249      $ 837   

Restructuring charges

     0        0        0   

Cash paid

       (400     (92       (492

Other

     (23     0        (23


 


 


Restructuring liability as of March 31, 2016

   $ 165      $ 157      $ 322   
    


 


 


 

(a)

“Asset Impairments and Other” primarily reflects activities associated with the consolidation of our facilities and manufacturing operations, including asset write-downs as well as contract termination costs.

NOTE 14 — UNEARNED REVENUE

Unearned revenue by segment was as follows:

 

(In millions)             


    

March 31,

2016

   

June 30,

2015

 

Productivity and Business Processes

   $ 9,635      $ 11,643   

Intelligent Cloud

     8,658        10,346   

More Personal Computing

     2,848        3,246   

Corporate and Other

     4,752        83   


 


Total

   $   25,893      $   25,318   
    


 


Revenue from Windows 10 is primarily recognized upfront in the More Personal Computing segment, and the deferral and subsequent recognition of revenue is reflected in Corporate and Other in the table above. As of March 31, 2016, we deferred a net $4.6 billion in revenue related to Windows 10.

NOTE 15 — CONTINGENCIES

Patent and Intellectual Property Claims

IPCom patent litigation

IPCom GmbH & Co. (“IPCom”) is a German company that holds a large portfolio of mobile technology-related patents spanning about 170 patent families and addressing a broad range of cellular technologies. IPCom has asserted 19 of these patents in litigation against Nokia and many of the leading cell phone companies and operators. In November 2014, Microsoft and IPCom entered into a standstill agreement staying all of the pending litigation against Microsoft to permit the parties to pursue settlement discussions.

InterDigital patent litigation

InterDigital Technology Corporation and InterDigital Communications Corporation (collectively, “IDT”) filed four patent infringement cases against Nokia in the International Trade Commission (“ITC”) and in U.S. District Court for the District of Delaware between 2007 and 2013. We have been added to these cases as a defendant. IDT has cases pending against other defendants based on the same patents because most of the patents at issue allegedly relate to 3G and 4G wireless communications standards essential functionality. The cases involving us include three ITC investigations where IDT sought an order excluding importation of 3G and 4G phones into the U.S. and one active case in U.S. District Court in Delaware seeking an injunction and damages. Each of the ITC matters has been resolved in our favor. In September 2015, in an inter partes review the United States Patent Trial and Appeal Board issued a final written decision that deemed unpatentable all asserted claims of the patent remaining at issue in the Delaware case. IDT has appealed this decision to the U.S. Court of Appeals for the Federal Circuit. The Delaware case has been stayed pending final completion of the inter partes review (including appeals and any subsequent proceedings in the Patent Office). We filed an antitrust complaint against IDT in the District of Delaware in August 2015 asserting violations of Section 2 of the Sherman Act, alleging the unlawful exploitation of standard essential patents. IDT filed a motion to dismiss, which remains pending.

 

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European copyright levies

We assumed from Nokia all potential liability due to Nokia’s alleged failure to pay “private copying levies” in various European countries based upon sale of memory cards and mobile phones that incorporate blank memory. The levies are based upon a 2001 European Union (“EU”) Directive establishing a right for end users to make copies of copyrighted works for personal or private use, but also allowing the collection of levies based upon sales of blank media or recording devices to compensate copyright holders for private copying. Various collecting societies in EU countries initiated litigation against Nokia, stating that Nokia must pay levies not only based upon sales of blank memory cards, but also phones that include blank memory for data storage on the phones, regardless of actual usage of that memory. The most significant cases against Nokia are pending in Germany and Austria, due to both the high volume of sales and high levy amounts sought in these countries. In December 2015, the industry group BITKOM, of which we are a member, reached a settlement with the German collecting society for all claims from 2008 forward, leaving litigation only for the period 2004-2007 pending in Germany. In addition, the industry is engaged in settlement negotiations with the Austrian collecting society. We have also settled copyright levies litigation in Spain and France.

Other patent and intellectual property claims

In addition to these cases, there are approximately 55 other patent infringement cases pending against Microsoft.

Antitrust and Unfair Competition Claims

Three antitrust and unfair competition class action lawsuits were filed against us in British Columbia, Ontario, and Quebec, Canada on behalf of various classes of direct and indirect purchasers of our PC operating system and certain other software products between 1999 and 2005.

In 2010, the court in the British Columbia case certified it as a class action. After the British Columbia Court of Appeal dismissed the case, in 2013 the Canadian Supreme Court reversed the appellate court and reinstated part of the British Columbia case, which is now scheduled for trial beginning in 2016. The other two cases are inactive.

China State Administration for Industry and Commerce investigation

In 2014, Microsoft was informed that China’s State Administration for Industry and Commerce (“SAIC”) had begun a formal investigation relating to China’s Anti-Monopoly Law, and the SAIC conducted onsite inspections of Microsoft offices in Beijing, Shanghai, Guangzhou, and Chengdu. SAIC has stated the investigation relates to compatibility, bundle sales, file verification issues related to Windows and Office software, and potentially other issues.

Product-Related Litigation

U.S. cell phone litigation

Nokia, along with other handset manufacturers and network operators, is a defendant in 19 lawsuits filed in the Superior Court for the District of Columbia by individual plaintiffs who allege that radio emissions from cellular handsets caused their brain tumors and other adverse health effects. We assumed responsibility for these claims as part of the NDS acquisition and have been substituted for the Nokia defendants. Nine of these cases were filed in 2002 and are consolidated for certain pre-trial proceedings; the remaining 10 cases are stayed. In a separate 2009 decision, the Court of Appeals for the District of Columbia held that adverse health effect claims arising from the use of cellular handsets that operate within the U.S. Federal Communications Commission radio frequency emission guidelines (“FCC Guidelines”) are pre-empted by federal law. The plaintiffs allege that their handsets either operated outside the FCC Guidelines or were manufactured before the FCC Guidelines went into effect. The lawsuits also allege an industry-wide conspiracy to manipulate the science and testing around emission guidelines.

In 2013, defendants in the consolidated cases moved to exclude plaintiffs’ expert evidence of general causation on the basis of flawed scientific methodologies. In 2014, the court granted in part defendants’ motion to exclude plaintiffs’ general causation experts. The plaintiffs filed an interlocutory appeal challenging the standard for evaluating expert scientific evidence, which the District of Columbia Court of Appeals agreed to hear en banc . Trial court proceedings are stayed pending resolution of the appeal.

 

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Item 1

 

Canadian cell phone class action

Nokia, along with other handset manufacturers and network operators, is a defendant in a 2013 class action lawsuit filed in the Supreme Court of British Columbia by a purported class of Canadians who have used cellular phones for at least 1,600 hours, including a subclass of users with brain tumors. Microsoft was served with the complaint in June 2014 and has been substituted for the Nokia defendants. The litigation is not yet active as several defendants remain to be served.

Other

We also are subject to a variety of other claims and suits that arise from time to time in the ordinary course of our business. Although management currently believes that resolving claims against us, individually or in aggregate, will not have a material adverse impact on our consolidated financial statements, these matters are subject to inherent uncertainties and management’s view of these matters may change in the future.

As of March 31, 2016, we accrued aggregate legal liabilities of $520 million in other current liabilities and $10 million in other long-term liabilities. While we intend to defend these matters vigorously, adverse outcomes that we estimate could reach approximately $1.6 billion in aggregate beyond recorded amounts are reasonably possible. Were unfavorable final outcomes to occur, there exists the possibility of a material adverse impact on our consolidated financial statements for the period in which the effects become reasonably estimable.

NOTE 16 — STOCKHOLDERS’ EQUITY

Share Repurchases

We repurchased the following shares of common stock through our share repurchase program during the periods presented:

 

(In millions)   

Three Months Ended

March 31,

   

Nine Months Ended

March 31,

 


       2016        2015        2016        2015   

Shares of common stock repurchased

     69        116        224        202   

Value of common stock repurchased

   $   3,600      $   5,000      $   11,200      $   9,000   


The above table excludes shares repurchased to settle statutory employee tax withholding related to the vesting of stock awards. On September 16, 2013, our Board of Directors approved a share repurchase program authorizing up to $40.0 billion in share repurchases. The share repurchase program became effective on October 1, 2013, has no expiration date, and may be suspended or discontinued at any time without notice. As of March 31, 2016, $10.7 billion remained of our $40.0 billion share repurchase program. All repurchases were made using cash resources.

 

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Item 1

 

Dividends

Our Board of Directors declared the following dividends:

 

Declaration Date   

Dividend

Per Share

    Record Date      Total Amount     Payment Date  


                  (in millions)        

Fiscal Year 2016

                                 

September 15, 2015

   $ 0.36        November 19, 2015       $ 2,868        December 10, 2015   

December 2, 2015

   $ 0.36        February 18, 2016       $ 2,842        March 10, 2016   

March 15, 2016

   $   0.36        May 19, 2016       $   2,833        June 9, 2016   


Declaration Date   

Dividend

Per Share

    Record Date      Total Amount     Payment Date  


                  (in millions)        

Fiscal Year 2015

                                 

September 16, 2014

   $ 0.31        November 20, 2014       $ 2,547        December 11, 2014   

December 3, 2014

   $ 0.31        February 19, 2015       $ 2,532        March 12, 2015   

March 10, 2015

   $ 0.31        May 21, 2015       $ 2,515        June 11, 2015   


The dividend declared on March 15, 2016 was included in other current liabilities as of March 31, 2016.

 

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Item 1

 

NOTE 17 — ACCUMULATED OTHER COMPREHENSIVE INCOME

The following table summarizes the changes in accumulated other comprehensive income by component:

 

(In millions)   

Three Months Ended

March 31,

   

Nine Months Ended

March 31,

 


     2016     2015     2016     2015  

Derivatives

                                

Accumulated other comprehensive income balance, beginning of period

   $ 598      $ 597      $ 590      $ 31   

Unrealized gains (losses), net of tax effects of $(19) , $25, $24 , and $37

     (125     559        158        1,251   

Reclassification adjustments for gains included in revenue

     (171     (162     (461     (290

Tax expense included in provision for income taxes

     11        4        26        6   


 


 


 


Amounts reclassified from accumulated other comprehensive income

     (160     (158     (435     (284


 


 


 


Net current period other comprehensive income (loss)

     (285     401        (277     967   


 


 


 


Accumulated other comprehensive income balance, end of period

   $ 313      $ 998      $ 313      $ 998   


 


 


 


Investments

                                

Accumulated other comprehensive income balance, beginning of period

   $ 2,758      $ 3,111      $ 3,169      $ 3,531   

Unrealized gains, net of tax effects of $217 , $133, $34 , and $47

     402        245        64        83   

Reclassification adjustments for gains included in other income (expense), net

     (88     (185     (200     (583

Tax expense included in provision for income taxes

     31        65        70        205   


 


 


 


Amounts reclassified from accumulated other comprehensive income

     (57     (120     (130     (378


 


 


 


Net current period other comprehensive income (loss)

     345        125        (66     (295


 


 


 


Accumulated other comprehensive income balance, end of period

   $ 3,103      $ 3,236      $ 3,103      $ 3,236   


 


 


 


Translation adjustments and other

                                

Accumulated other comprehensive income (loss) balance, beginning of period

   $ (1,583   $ (325   $ (1,237   $ 146   

Translation adjustments and other, net of tax effects of $3 , $(174), $(18) , and $(432)

     7        (438     (339     (909


 


 


 


Accumulated other comprehensive loss balance, end of period

   $   (1,576   $ (763