Quarterly Report


 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

For the Quarterly Period Ended December 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: 001-37845

 

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   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   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 

 

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

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 January 20, 2017

 

 

 

 

 

Common Stock, $0.00000625 par value per share

 

 

7,727,529,820 shares

 

 

 

 

 

 


 

MICROSOFT CORPORATION

FORM 10-Q

For the Quarter Ended December 31, 2016

INDEX

 

 

 

Page

PART I.

FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

 

 

 

a)

Income Statements for the Three and Six Months Ended December 31, 2016 and 2015

3

 

 

 

 

 

 

 

b)

Comprehensive Income Statements for the Three and Six Months Ended December 31, 2016 and 2015

4

 

 

 

 

 

 

 

c)

Balance Sheets as of December 31, 2016 and June 30, 2016

5

 

 

 

 

 

 

 

d)

Cash Flows Statements for the Three and Six Months Ended December 31, 2016 and 2015

6

 

 

 

 

 

 

 

e)

Stockholders’ Equity Statements for the Three and Six Months Ended December 31, 2016 and 2015

7

 

 

 

 

 

 

 

f)

Notes to Financial Statements

8

 

 

 

 

 

 

 

g)

Report of Independent Registered Public Accounting Firm

34

 

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

35

 

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

50

 

 

 

 

 

 

Item 4.

Controls and Procedures

51

 

 

 

 

 

PART II. 

OTHER INFORMATION

 

 

 

 

 

 

 

Item 1.

Legal Proceedings

52

 

 

 

 

 

 

Item 1A.

Risk Factors

52

 

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

61

 

 

 

 

 

 

Item 6.

Exhibits

62

 

 

 

 

 

SIGNATURE

63

 

 

 

2


PART I

Item 1

PART I. FINANCI AL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

INCOME STATEMENTS

 

(In millions, except per share amounts) (Unaudited)

 

Three Months Ended
December 31,

 

 

Six Months Ended
December 31,

 

 

 

 

 

 

 

 

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

 

 

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product

 

$

  16,537

 

 

$

17,974

 

 

$

  30,030

 

 

$

  33,193

 

Service and other

 

 

7,553

 

 

 

5,822

 

 

 

14,513

 

 

 

10,982

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

 

  24,090

 

 

 

  23,796

 

 

 

44,543

 

 

 

44,175

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product

 

 

  5,378

 

 

 

  6,268

 

 

 

  8,959

 

 

 

  10,303

 

Service and other

 

 

4,523

 

 

 

3,604

 

 

 

8,786

 

 

 

6,776

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total cost of revenue

 

 

9,901

 

 

 

9,872

 

 

 

17,745

 

 

 

17,079

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross margin

 

 

14,189

 

 

 

13,924

 

 

 

26,798

 

 

 

27,096

 

Research and development

 

 

3,062

 

 

 

2,900

 

 

 

6,168

 

 

 

5,862

 

Sales and marketing

 

 

4,071

 

 

 

3,960

 

 

 

7,304

 

 

 

7,293

 

General and administrative

 

 

879

 

 

 

1,038

 

 

 

1,924

 

 

 

2,122

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

 

6,177

 

 

 

6,026

 

 

 

11,402

 

 

 

11,819

 

Other income (expense), net

 

 

186

 

 

 

(171

 

 

286

 

 

 

(451

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

 

6,363

 

 

 

5,855

 

 

 

11,688

 

 

 

11,368

 

Provision for income taxes

 

 

1,163

 

 

 

837

 

 

 

1,798

 

 

 

1,448

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

5,200

 

 

$

5,018

 

 

$

9,890

 

 

$

9,920

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.67

 

 

$

0.63

 

 

$

1.27

 

 

$

1.24

 

Diluted

 

$

0.66

 

 

$

0.62

 

 

$

1.26

 

 

$

1.23

 

 

 

 

 

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

7,755

 

 

 

7,964

 

 

 

7,772

 

 

 

7,980

 

Diluted

 

 

7,830

 

 

 

8,051

 

 

 

7,853

 

 

 

8,068

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared per common share

 

$

0.39

 

 

$

0.36

 

 

$

0.78

 

 

$

0.72

 

 

 

 

See accompanying notes.

 

 

3


PART I

Item 1

COMPREHENSIVE IN COME STATEMENTS

 

(In millions) (Unaudited)

 

Three Months Ended
December 31,

 

 

Six Months Ended
December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

 

 

 

 

 

Net income

 

$

  5,200

 

 

$

  5,018

 

 

$

  9,890

 

 

$

  9,920

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net unrealized gains (losses) on derivatives (net of tax effects of $0 , $5, $(2), and $28)

 

 

280

 

 

 

(49

)

 

 

243

 

 

 

8

 

Net unrealized gains (losses) on investments (net of tax effects of $(535), $86, $(491), and $(222))

 

 

(994

)

 

 

160

 

 

 

(911

)

 

 

(411

)

Translation adjustments and other (net of tax effects of $0 , $(9), $7 , and $(21))

 

 

(455

)

 

 

(76

)

 

 

(357

)

 

 

(346

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss)

 

 

(1,169

)

 

 

35

 

 

 

(1,025

)

 

 

(749

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

4,031

 

 

$

  5,053

 

 

$

  8,865

 

 

$

9,171

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes.

 

 

4


PART I

Item 1

BALANCE SHEETS

 

(In millions) (Unaudited)

 

 

 

 

 

 

 

 

 

 

December 31,
2016

 

 

June 30,
2016

 

 

 

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

8,468

 

 

$

6,510

 

Short-term investments (including securities loaned of $1,230 and $204)

 

 

114,313

 

 

 

106,730

 

 

 

 

 

 

 

 

 

 

 

 

 

Total cash, cash equivalents, and short-term investments

 

 

122,781

 

 

 

113,240

 

Accounts receivable, net of allowance for doubtful accounts of $340 and $426

 

 

14,343

 

 

 

18,277

 

Inventories

 

 

1,961

 

 

 

2,251

 

Other

 

 

5,864

 

 

 

5,892

 

 

 

 

 

 

 

 

 

 

 

 

 

Total current assets

 

 

144,949

 

 

 

139,660

 

Property and equipment, net of accumulated depreciation of $21,888 and $19,800

 

 

21,379

 

 

 

18,356

 

Equity and other investments

 

 

8,912

 

 

 

10,431

 

Goodwill

 

 

34,524

 

 

 

17,872

 

Intangible assets, net

 

 

11,001

 

 

 

3,733

 

Other long-term assets

 

 

3,845

 

 

 

3,416

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

  224,610

 

 

$

  193,468

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

6,580

 

 

$

6,898

 

Short-term debt

 

 

25,065

 

 

 

12,904

 

Current portion of long-term debt

 

 

599

 

 

 

0

 

Accrued compensation

 

 

3,982

 

 

 

5,264

 

Income taxes

 

 

508

 

 

 

580

 

Short-term unearned revenue

 

 

26,085

 

 

 

27,468

 

Securities lending payable

 

 

1,280

 

 

 

294

 

Other

 

 

6,688

 

 

 

5,949

 

 

 

 

 

 

 

 

 

 

 

 

 

Total current liabilities

 

 

70,787

 

 

 

59,357

 

Long-term debt

 

 

59,306

 

 

 

40,557

 

Long-term unearned revenue

 

 

8,595

 

 

 

6,441

 

Deferred income taxes

 

 

1,133

 

 

 

1,476

 

Other long-term liabilities

 

 

15,980

 

 

 

13,640

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities

 

 

155,801

 

 

 

121,471

 

 

 

 

 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

 

Common stock and paid-in capital—shares authorized 24,000; outstanding 7,730 and 7,808

 

 

68,177

 

 

 

68,178

 

Retained earnings

 

 

120

 

 

 

2,282

 

Accumulated other comprehensive income

 

 

512

 

 

 

1,537

 

 

 

 

 

 

 

 

 

 

 

 

 

Total stockholders’ equity

 

 

68,809

 

 

 

71,997

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

224,610

 

 

$

193,468

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes.

 

 

5


PART I

Item 1

CASH FLOWS STATEMENTS

 

(In millions) (Unaudited)

 

Three Months Ended

December 31,

 

 

Six Months Ended

December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

 

 

 

 

 

Operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

5,200

 

 

$

5,018

 

 

$

9,890

 

 

$

9,920

 

Adjustments to reconcile net income to net cash from operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation, amortization, and other

 

 

2,166

 

 

 

1,544

 

 

 

3,982

 

 

 

3,005

 

Stock-based compensation expense

 

 

767

 

 

 

658

 

 

 

1,470

 

 

 

1,332

 

Net recognized losses (gains) on investments and derivatives

 

 

(652

 

 

50

 

 

 

(963

 

 

151

 

Deferred income taxes

 

 

(587

)

 

 

(247

 

 

(572

)

 

 

(174

Deferral of unearned revenue

 

 

14,141

 

 

 

12,570

 

 

 

26,724

 

 

 

22,993

 

Recognition of unearned revenue

 

 

  (13,645

)

 

 

  (11,929

)

 

 

  (26,549

)

 

 

  (23,284

)

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(2,711

)

 

 

(3,118

 

 

4,463

 

 

 

3,258

 

Inventories

 

 

1,132

 

 

 

1,104

 

 

 

265

 

 

 

167

 

Other current assets

 

 

1,309

 

 

 

(932

)

 

 

343

 

 

 

(1,494

)

Other long-term assets

 

 

(243

 

 

56

 

 

 

(272

 

 

51

 

Accounts payable

 

 

99

 

 

 

369

 

 

 

(344

 

 

234

 

Other current liabilities

 

 

(1,529

 

 

105

 

 

 

(1,890

)

 

 

(1,919

)

Other long-term liabilities

 

 

846

 

 

 

370

 

 

 

1,295

 

 

 

254

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash from operations

 

 

6,293

 

 

 

5,618

 

 

 

17,842

 

 

 

14,494

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financing

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Repayments of short-term debt, maturities of 90 days or less, net

 

 

(3,755

)

 

 

(7,031

)

 

 

(7,145

)

 

 

(2,141

Proceeds from issuance of debt

 

 

17,069

 

 

 

13,128

 

 

 

42,046

 

 

 

13,249

 

Repayments of debt

 

 

(4,118

)

 

 

(121

 

 

(4,343

)

 

 

(1,871

)

Common stock issued

 

 

131

 

 

 

117

 

 

 

372

 

 

 

336

 

Common stock repurchased

 

 

(3,599

)

 

 

(3,678

)

 

 

(7,961

)

 

 

(8,435

)

Common stock cash dividends paid

 

 

(3,024

)

 

 

(2,868

)

 

 

(5,824

)

 

 

(5,343

)

Other

 

 

312

 

 

 

(65

 

 

200

 

 

 

(243

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash from (used in) financing

 

 

3,016

 

 

 

(518

)

 

 

17,345

 

 

 

(4,448

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investing

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Additions to property and equipment

 

 

(1,988

)

 

 

(2,024

)

 

 

(4,151

)

 

 

(3,380

)

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

 

 

(24,760

)

 

 

(381

)

 

 

(24,784

)

 

 

(771

)

Purchases of investments

 

 

(46,775

)

 

 

(34,750

)

 

 

(103,956

)

 

 

(72,320

)

Maturities of investments

 

 

8,715

 

 

 

5,351

 

 

 

17,374

 

 

 

11,037

 

Sales of investments

 

 

48,987

 

 

 

28,191

 

 

 

81,310

 

 

 

56,693

 

Securities lending payable

 

 

1,070

 

 

 

285

 

 

 

986

 

 

 

347

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash used in investing

 

 

(14,751

)

 

 

(3,328

)

 

 

(33,221

)

 

 

(8,394

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Effect of foreign exchange rates on cash and cash equivalents

 

 

(18

)

 

 

(18

)

 

 

(8

)

 

 

(62

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net change in cash and cash equivalents

 

 

(5,460

 

 

1,754

 

 

 

1,958

 

 

 

1,590

 

Cash and cash equivalents, beginning of period

 

 

13,928

 

 

 

5,431

 

 

 

6,510

 

 

 

5,595

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

8,468

 

 

$

7,185

 

 

$

8,468

 

 

$

7,185

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes.

 

 

6


PART I

Item 1

STOCKHOLDERS’ EQ UITY STATEMENTS

 

(In millions) (Unaudited)

 

Three Months Ended

December 31,

 

 

Six Months Ended

December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

 

 

 

 

 

Common stock and paid-in capital

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

$

67,747

 

 

$

67,811

 

 

$

68,178

 

 

$

68,465

 

Common stock issued

 

 

131

 

 

 

117

 

 

 

372

 

 

 

336

 

Common stock repurchased

 

 

(561

)

 

 

(609

)

 

 

(1,935

)

 

 

(2,157

)

Stock-based compensation expense

 

 

767

 

 

 

658

 

 

 

1,470

 

 

 

1,332

 

Other, net

 

 

93

 

 

 

0

 

 

 

92

 

 

 

1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, end of period

 

 

68,177

 

 

 

67,977

 

 

 

68,177

 

 

 

67,977

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retained earnings

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

 

944

 

 

 

7,896

 

 

 

2,282

 

 

 

9,096

 

Net income

 

 

5,200

 

 

 

5,018

 

 

 

9,890

 

 

 

9,920

 

Common stock cash dividends

 

 

(3,003

)

 

 

(2,846

)

 

 

(6,028

)

 

 

(5,708

)

Common stock repurchased

 

 

(3,021

)

 

 

(3,038

)

 

 

(6,024

)

 

 

(6,278

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, end of period

 

 

120

 

 

 

7,030

 

 

 

120

 

 

 

7,030

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

 

1,681

 

 

 

1,738

 

 

 

1,537

 

 

 

2,522

 

Other comprehensive income (loss)

 

 

(1,169

 

 

35

 

 

 

(1,025

)

 

 

(749

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, end of period

 

 

512

 

 

 

1,773

 

 

 

512

 

 

 

1,773

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total stockholders’ equity

 

$

  68,809

 

 

$

  76,780

 

 

$

  68,809

 

 

$

  76,780

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes.

 

 

7


PART I

Item 1

NOTES TO FINANCI AL STATEMENTS

(Unaudited)

 

NOTE 1   ACCOUNTING POLICIES

Accounting Principles

We prepare our unaudited interim consolidated financial statements in accordance 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 2016 Form 10-K filed with the U.S. Securities and Exchange Commission on July 28, 2016.

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.

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 intangible 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 and volume of demand for 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 on 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.

Product Revenue and Service and Other Revenue

Product revenue includes sales from operating systems; cross-device productivity applications; server applications; business solution applications; desktop and server management tools; software development tools; video games; hardware such as PCs, tablets, gaming and entertainment consoles, phones, other intelligent devices, and related accessories; and training and certification of computer system integrators and developers.

Service and other revenue includes sales from cloud-based solutions that provide customers with software, services, platforms, and content such as Office 365, Microsoft Azure (“Azure”), Microsoft Dynamics 365 (“Dynamics 365”), and Xbox Live; solution support; and consulting services. Service and other revenue also includes sales from online advertising and LinkedIn.

Recent Accounting Guidance Not Yet Adopted

Financial Instruments – Credit Losses

In June 2016, the Financial Accounting Standards Board (“FASB”) issued a new standard to replace the incurred loss impairment methodology in current U.S. GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. For trade and other receivables, loans, and other financial instruments, we will be required to use a forward-looking expected

8


PART I

Item 1

loss model rather than the incurred loss model for recognizing credit losses w hich reflects losses that are probable. Credit losses relating to available-for-sale debt securities will also be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. The new standard wil l be effective for us beginning July 1, 2020, with early adoption permitted beginning July 1, 2019. Application of the amendments is through a cumulative-effect adjustment to retained earnings as of the effective date. We are currently evaluating the impac t of this standard on our consolidated financial statements.

Leases

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. We will be required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach.

The new standard will be effective for us beginning July 1, 2019, with early adoption permitted. We currently anticipate early adoption of the new standard effective July 1, 2017 in conjunction with our adoption of the new revenue standard. Our ability to early adopt is dependent on system readiness, including software procured from third-party providers, and the completion of our analysis of information necessary to restate prior period financial statements. We remain on schedule and have implemented specific system functionality to enable the accounting transition.

We anticipate this standard will have a material impact on our consolidated balance sheets. However, we do not believe adoption will have a material impact on our consolidated income statements. Due to the recent acquisition of LinkedIn Corporation (“LinkedIn”), we are still assessing the qualitative and quantitative impacts of the leases assumed on our consolidated balance sheets. While we are continuing to assess all potential impacts of the standard, we currently believe the most significant impact relates to our accounting for office space, retail space, and datacenter operating leases. We expect our accounting for capital leases related to office space and datacenters will remain substantially unchanged under the new standard.

Financial Instruments – Recognition, Measurement, Presentation, and Disclosure

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 sheets as of the effective date. We are currently evaluating the impact of this standard on our consolidated financial statements.

Revenue from Contracts with Customers

In May 2014, the FASB issued a new standard related to revenue recognition. Under the new standard, revenue is recognized when a customer obtains control of promised goods or services and is recognized 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 FASB recently issued several amendments to the standard, including clarifications on disclosure of prior-period performance obligations and remaining performance obligations.

The guidance permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the cumulative catch-up transition method). We currently anticipate adopting the standard using the full retrospective method to restate each prior reporting period presented.

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 currently anticipate early adoption of the new standard effective July 1, 2017. While our ability to early adopt using the full retrospective method is dependent on system readiness, including software procured from third-party providers, and the completion of our analysis of information necessary to restate prior

9


PART I

Item 1

period financial statements , we remain on schedule and have implemented key system functionality to enable restated financial information. Our progress includes nearing completion of retrospectively adjusted financial information for fiscal year 2016.

We anticipate this standard will have a material impact on our consolidated financial statements, and continue to make progress in assessing all potential impacts of the standard, including any impacts from recently issued amendments. We have reached conclusions on all key accounting assessments related to the new standard. However, we are still assessing impacts from guidance issued by the FASB Transition Resource Group as part of their November 2016 meeting. We will continue to monitor and assess the impact of changes to the standard and interpretations as they become available. We have also started our assessment to determine the revenue recognition impact of our recent acquisition of LinkedIn. The most significant impact of the standard relates to our accounting for software license revenue. Specifically, under the new standard we expect to recognize Windows 10 revenue predominantly at the time of billing rather than ratably over the life of the related device. We expect to recognize license revenue at the time of contract execution rather than over the subscription period from certain multi-year commercial software subscriptions that include both software licenses and Software Assurance. Due to the complexity of certain of our commercial license subscription contracts, the actual revenue recognition treatment required under the standard will be dependent on contract-specific terms, and may vary in some instances from recognition at the time of billing. We expect revenue recognition related to our hardware, cloud offerings including Office 365, and professional services to remain substantially unchanged.

We continue to believe that the net change in Windows 10 revenue from period to period is indicative of the net change in revenue we expect from the adoption of the new standard.

 

 

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 were as follows:

 

(In millions, except earnings per share)

 

Three Months Ended

December 31,

 

 

Six Months Ended

December 31,

 

  

 

  

 

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income available for common shareholders (A)

 

$

  5,200

 

 

$

  5,018

 

 

$

  9,890

 

 

$

  9,920

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average outstanding shares of common stock (B)

 

 

7,755

 

 

 

7,964

 

 

 

7,772

 

 

 

7,980

 

Dilutive effect of stock-based awards

 

 

75

 

 

 

87

 

 

 

81

 

 

 

88

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock and common stock equivalents (C)

 

 

7,830

 

 

 

8,051

 

 

 

7,853

 

 

 

8,068

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings Per Share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic (A/B)

 

$

0.67

 

 

$

0.63

 

 

$

1.27

 

 

$

1.24

 

Diluted (A/C)

 

$

0.66

 

 

$

0.62

 

 

$

1.26

 

 

$

1.23

 

 

 

 

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

 

 

10


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

December 31,

 

 

Six Months Ended

December 31,

 

  

 

 

 

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

 

 

 

 

 

Dividends and interest income

 

$

311

 

 

$

200

 

 

$

604

 

 

$

399

 

Interest expense

 

 

  (521

)

 

 

  (309

)

 

 

  (958

)

 

 

  (558

)

Net recognized gains on investments

 

 

698

 

 

 

106

 

 

 

1,103

 

 

 

108

 

Net losses on derivatives

 

 

(46

)

 

 

(156

)

 

 

(140

)

 

 

(259

)

Net gains (losses) on foreign currency remeasurements

 

 

(82

)

 

 

2

 

 

 

(134

)

 

 

(34

)

Other

 

 

(174

)

 

 

(14

)

 

 

(189

)

 

 

(107

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

186

 

 

$

(171

)

 

$

286

 

 

$

(451

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

(In millions)

 

Three Months Ended

December 31,

 

 

Six Months Ended

December 31,

 

  

 

 

 

 

 

 

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

 

 

 

 

 

Other-than-temporary impairments of investments

 

$

(21

)

 

$

(127

)

 

$

(39

)

 

$

(162

)

Realized gains from sales of available-for-sale securities

 

 

  851

 

 

 

  351

 

 

 

1,334

 

 

 

458

 

Realized losses from sales of available-for-sale securities

 

 

(132

)

 

 

(118

)

 

 

  (192

)

 

 

  (188

)