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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 March 31, 2019

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 every Interactive Data File required to be submitted 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 such files). Yes  No 

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

 

Large accelerated filer 

 

Accelerated filer 

Non-accelerated filer 

 

Smaller reporting company 

Emerging growth company 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

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 as of April 18, 2019

 

 

 

 

 

Common Stock, $0.00000625 par value per share

 

 

7,662,817,920 shares

 

 

 

 

 

 


 

MICROSOFT CORPORATION

FORM 10-Q

For the Quarter Ended March 31, 2019

INDEX

 

 

 

Page

PART I.

FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

 

 

 

a)

Income Statements for the Three and Nine Months Ended March 31, 2019 and 2018

3

 

 

 

 

 

 

 

b)

Comprehensive Income Statements for the Three and Nine Months Ended March 31, 2019 and 2018

4

 

 

 

 

 

 

 

c)

Balance Sheets as of March 31, 2019 and June 30, 2018

5

 

 

 

 

 

 

 

d)

Cash Flows Statements for the Three and Nine Months Ended March 31, 2019 and 2018

6

 

 

 

 

 

 

 

e)

Stockholders’ Equity Statements for the Three and Nine Months Ended March 31, 2019 and 2018

7

 

 

 

 

 

 

 

f)

Notes to Financial Statements

8

 

 

 

 

 

 

 

g)

Report of Independent Registered Public Accounting Firm

33

 

 

 

 

 

 

Item 2.

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

34

 

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

49

 

 

 

 

 

 

Item 4.

Controls and Procedures

49

 

 

 

 

 

PART II. 

OTHER INFORMATION

 

 

 

 

 

 

 

Item 1.

Legal Proceedings

50

 

 

 

 

 

 

Item 1A.

Risk Factors

50

 

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

62

 

 

 

 

 

 

Item 6.

Exhibits

63

 

 

 

 

 

SIGNATURE

64

 

 

 

2


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,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product

 

$

15,448

 

 

$

15,114

 

 

$

48,966

 

 

$

47,338

 

Service and other

 

 

15,123

 

 

 

11,705

 

 

 

43,160

 

 

 

32,937

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

 

30,571

 

 

 

26,819

 

 

 

92,126

 

 

 

80,275

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product

 

 

3,441

 

 

 

3,425

 

 

 

12,975

 

 

 

11,903

 

Service and other

 

 

6,729

 

 

 

5,844

 

 

 

19,523

 

 

 

16,708

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total cost of revenue

 

 

10,170

 

 

 

9,269

 

 

 

32,498

 

 

 

28,611

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross margin

 

 

20,401

 

 

 

17,550

 

 

 

59,628

 

 

 

51,664

 

Research and development

 

 

4,316

 

 

 

3,715

 

 

 

12,363

 

 

 

10,793

 

Sales and marketing

 

 

4,565

 

 

 

4,335

 

 

 

13,251

 

 

 

12,709

 

General and administrative

 

 

1,179

 

 

 

1,208

 

 

 

3,460

 

 

 

3,483

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

 

10,341

 

 

 

8,292

 

 

 

30,554

 

 

 

24,679

 

Other income, net

 

 

145

 

 

 

349

 

 

 

538

 

 

 

1,115

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

 

10,486

 

 

 

8,641

 

 

 

31,092

 

 

 

25,794

 

Provision for income taxes

 

 

1,677

 

 

 

1,217

 

 

 

5,039

 

 

 

18,096

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

8,809

 

 

$

7,424

 

 

$

26,053

 

 

$

7,698

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

1.15

 

 

$

0.96

 

 

$

3.39

 

 

$

1.00

 

Diluted

 

$

1.14

 

 

$

0.95

 

 

$

3.36

 

 

$

0.99

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

7,672

 

 

 

7,698

 

 

 

7,679

 

 

 

7,706

 

Diluted

 

 

7,744

 

 

 

7,794

 

 

 

7,759

 

 

 

7,798

 

 

 

 

 

 

 

 

 

 

 

 

Refer to accompanying notes.

 

 

3


PART I

Item 1

 

COMPREHENSIVE INCOME STATEMENTS

 

(In millions) (Unaudited)

 

Three Months Ended
March 31,

 

 

Nine Months Ended
March 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

2019

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

8,809

 

 

$

7,424

 

 

$

26,053

 

 

$

7,698

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net change related to derivatives

 

 

(33

)

 

 

7

 

 

 

(93

)

 

 

(106

)

Net change related to investments

 

 

714

 

 

 

(1,016

)

 

 

1,334

 

 

 

(2,182

)

Translation adjustments and other

 

 

67

 

 

 

255

 

 

 

(252

)

 

 

508

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss)

 

 

748

 

 

 

(754

)

 

 

989

 

 

 

(1,780

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

9,557

 

 

$

6,670

 

 

$

27,042

 

 

$

5,918

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Refer to accompanying notes. Refer to Note 16 – Accumulated Other Comprehensive Income (Loss) for further information.

 

 

4


PART I

Item 1

 

BALANCE SHEETS

 

(In millions) (Unaudited)

 

 

 

 

 

 

 

 

 

 

March 31,
2019

 

 

June 30,
2018

 

 

 

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

11,212

 

 

$

11,946

 

Short-term investments

 

 

120,406

 

 

 

121,822

 

 

 

 

 

 

 

 

 

 

 

 

 

Total cash, cash equivalents, and short-term investments

 

 

131,618

 

 

 

133,768

 

Accounts receivable, net of allowance for doubtful accounts of $336 and $377

 

 

19,269

 

 

 

26,481

 

Inventories

 

 

1,951

 

 

 

2,662

 

Other

 

 

7,049

 

 

 

6,751

 

 

 

 

 

 

 

 

 

 

 

 

 

Total current assets

 

 

159,887

 

 

 

169,662

 

Property and equipment, net of accumulated depreciation of $35,431 and $29,223

 

 

33,648

 

 

 

29,460

 

Operating lease right-of-use assets

 

 

7,121

 

 

 

6,686

 

Equity investments

 

 

2,403

 

 

 

1,862

 

Goodwill

 

 

41,861

 

 

 

35,683

 

Intangible assets, net

 

 

8,103

 

 

 

8,053

 

Other long-term assets

 

 

10,258

 

 

 

7,442

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

263,281

 

 

$

258,848

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

7,544

 

 

$

8,617

 

Current portion of long-term debt

 

 

6,515

 

 

 

3,998

 

Accrued compensation

 

 

5,764

 

 

 

6,103

 

Short-term income taxes

 

 

1,950

 

 

 

2,121

 

Short-term unearned revenue

 

 

24,251

 

 

 

28,905

 

Other

 

 

7,837

 

 

 

8,744

 

 

 

 

 

 

 

 

 

 

 

 

 

Total current liabilities

 

 

53,861

 

 

 

58,488

 

Long-term debt

 

 

66,585

 

 

 

72,242

 

Long-term income taxes

 

 

29,514

 

 

 

30,265

 

Long-term unearned revenue

 

 

3,884

 

 

 

3,815

 

Deferred income taxes

 

 

1,838

 

 

 

541

 

Operating lease liabilities

 

 

5,972

 

 

 

5,568

 

Other long-term liabilities

 

 

6,763

 

 

 

5,211

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities

 

 

168,417

 

 

 

176,130

 

 

 

 

 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

 

Common stock and paid-in capital – shares authorized 24,000; outstanding 7,666 and 7,677

 

 

77,791

 

 

 

71,223

 

Retained earnings

 

 

18,338

 

 

 

13,682

 

Accumulated other comprehensive loss

 

 

(1,265

)

 

 

(2,187

)

 

 

 

 

 

 

 

 

 

 

 

 

Total stockholders’ equity

 

 

94,864

 

 

 

82,718

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

263,281

 

 

$

258,848

 

 

 

 

 

 

 

 

 

 

 

Refer to accompanying notes.

 

5


PART I

Item 1

 

CASH FLOWS STATEMENTS

 

(In millions) (Unaudited)

 

Three Months Ended

March 31,

 

 

Nine Months Ended

March 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

2019

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

Operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

8,809

 

 

$

7,424

 

 

$

26,053

 

 

$

7,698

 

 

Adjustments to reconcile net income to net cash from operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation, amortization, and other

 

 

2,926

 

 

 

2,710

 

 

 

8,758

 

 

 

7,745

 

Stock-based compensation expense

 

 

1,172

 

 

 

969

 

 

 

3,462

 

 

 

2,928

 

Net recognized gains on investments and derivatives

 

 

(95

)

 

 

(438

)

 

 

(470

)

 

 

(1,645

)

Deferred income taxes

 

 

(320

)

 

 

(396

)

 

 

(740

)

 

 

(2,754

)

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts receivable

 

 

460

 

 

 

1,285

 

 

 

7,258

 

 

 

5,326

 

Inventories

 

 

12

 

 

 

(75

)

 

 

710

 

 

 

107

 

Other current assets

 

 

(14

)

 

 

(149

)

 

 

(864

)

 

 

(113

)

Other long-term assets

 

 

(517

)

 

 

(213

)

 

 

(969

)

 

 

(835

)

Accounts payable

 

 

(197

)

 

 

(393

)

 

 

(1,032

)

 

 

138

 

Unearned revenue

 

 

20

 

 

 

91

 

 

 

(4,543

)

 

 

(2,780

)

Income taxes

 

 

276

 

 

 

645

 

 

 

(879

)

 

 

17,280

 

Other current liabilities

 

 

649

 

 

 

546

 

 

 

(1,017

)

 

 

(975

)

Other long-term liabilities

 

 

339

 

 

 

145

 

 

 

350

 

 

 

346

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash from operations

 

 

13,520

 

 

 

12,151

 

 

 

36,077

 

 

 

32,466

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financing

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

0

 

 

 

(7,373

)

 

 

0

 

 

 

(7,324

)

Proceeds from issuance of debt

 

 

0

 

 

 

0

 

 

 

0

 

 

 

7,183

 

Repayments of debt

 

 

0

 

 

 

(4,883

)

 

 

(3,000

)

 

 

(9,379

)

Common stock issued

 

 

274

 

 

 

251

 

 

 

834

 

 

 

747

 

Common stock repurchased

 

 

(4,753

)

 

 

(3,781

)

 

 

(14,910

)

 

 

(8,359

)

Common stock cash dividends paid

 

 

(3,526

)

 

 

(3,232

)

 

 

(10,290

)

 

 

(9,473

)

Other, net

 

 

404

 

 

 

(640

)

 

 

(835

)

 

 

(946

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash used in financing

 

 

(7,601

)

 

 

(19,658

)

 

 

(28,201

)

 

 

(27,551

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investing

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Additions to property and equipment

 

 

(2,565

)

 

 

(2,934

)

 

 

(9,874

)

 

 

(7,652

)

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

 

 

(269

)

 

 

(248

)

 

 

(2,107

)

 

 

(454

)

Purchases of investments

 

 

(5,846

)

 

 

(26,885

)

 

 

(42,255

)

 

 

(105,000

)

Maturities of investments

 

 

5,893

 

 

 

7,674

 

 

 

14,889

 

 

 

19,252

 

Sales of investments

 

 

1,424

 

 

 

26,256

 

 

 

30,831

 

 

 

90,553

 

Securities lending payable

 

 

0

 

 

 

(19

)

 

 

0

 

 

 

(90

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash from (used in) investing

 

 

(1,363

)

 

 

3,844

 

 

 

(8,516

)

 

 

(3,391

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Effect of foreign exchange rates on cash and cash equivalents

 

 

18

 

 

 

25

 

 

 

(94

)

 

 

34

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net change in cash and cash equivalents

 

 

4,574

 

 

 

(3,638

)

 

 

(734

)

 

 

1,558

 

Cash and cash equivalents, beginning of period

 

 

6,638

 

 

 

12,859

 

 

 

11,946

 

 

 

7,663

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

11,212

 

 

$

9,221

 

 

$

11,212

 

 

$

9,221

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Refer to accompanying notes.

 

6


PART I

Item 1

 

STOCKHOLDERS’ EQUITY STATEMENTS

 

(In millions) (Unaudited)

 

Three Months Ended

March 31,

 

 

Nine Months Ended

March 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock and paid-in capital

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

$

77,556

 

 

$

70,192

 

 

$

71,223

 

 

$

69,315

 

Common stock issued

 

 

274

 

 

 

251

 

 

 

6,521

 

 

 

747

 

Common stock repurchased

 

 

(1,218

)

 

 

(995

)

 

 

(3,433

)

 

 

(2,572

)

Stock-based compensation expense

 

 

1,172

 

 

 

969

 

 

 

3,462

 

 

 

2,928

 

Other, net

 

 

7

 

 

 

1

 

 

 

18

 

 

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, end of period

 

 

77,791

 

 

 

70,418

 

 

 

77,791

 

 

 

70,418

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retained earnings

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

 

16,585

 

 

 

8,567

 

 

 

13,682

 

 

 

17,769

 

Net income

 

 

8,809

 

 

 

7,424

 

 

 

26,053

 

 

 

7,698

 

Common stock cash dividends

 

 

(3,518

)

 

 

(3,225

)

 

 

(10,592

)

 

 

(9,696

)

Common stock repurchased

 

 

(3,538

)

 

 

(2,792

)

 

 

(11,482

)

 

 

(5,797

)

Cumulative effect of accounting changes

 

 

0

 

 

 

0

 

 

 

677

 

 

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, end of period

 

 

18,338

 

 

 

9,974

 

 

 

18,338

 

 

 

9,974

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated other comprehensive income (loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

 

(2,013

)

 

 

(399

)

 

 

(2,187

)

 

 

627

 

Other comprehensive income (loss)

 

 

748

 

 

 

(754

)

 

 

989

 

 

 

(1,780

)

Cumulative effect of accounting changes

 

 

0

 

 

 

0

 

 

 

(67

)

 

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, end of period

 

 

(1,265

)

 

 

(1,153

)

 

 

(1,265

)

 

 

(1,153

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total stockholders’ equity

 

$

94,864

 

 

$

79,239

 

 

$

94,864

 

 

$

79,239

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared per common share

 

$

0.46

 

 

$

0.42

 

 

$

1.38

 

 

$

1.26

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Refer to accompanying notes.

 

 

7


PART I

Item 1

 

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 1 — ACCOUNTING POLICIES

Accounting Principles

Our unaudited interim consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (“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 fiscal year 2018 Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”) on August 3, 2018.

We have recast certain prior period amounts related to investments, derivatives, and fair value measurements to conform to the current period presentation based on our adoption of the new accounting standard for financial instruments. We have also recast prior period commercial cloud revenue to include the commercial portion of LinkedIn to provide a comparable view of our commercial cloud business performance. The commercial portion of LinkedIn includes LinkedIn Recruiter, Sales Navigator, premium business subscriptions, and other services for organizations. The recast of these prior period amounts had no impact on our consolidated financial statements.

Principles of Consolidation

The consolidated financial statements include the accounts of Microsoft Corporation and its subsidiaries. Intercompany transactions and balances have been eliminated.

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 and assumptions include: for revenue recognition, determining the nature and timing of satisfaction of performance obligations, and determining the standalone selling price of performance obligations, variable consideration, and other obligations such as product returns and refunds; 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; the market value of, and demand for, our inventory; stock-based compensation forfeiture rates; 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 the timing and amount of impairments for investments. Actual results and outcomes may differ from management’s estimates and assumptions.

Financial Instruments

Investments

We consider all highly liquid interest-earning investments with a maturity of three months or less at the date of purchase to be cash equivalents. The fair values of these investments approximate their carrying values. In general, investments with original maturities of greater than three months and remaining maturities of less than one year are classified as short-term investments. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations.

8


PART I

Item 1

 

Debt investments are classified as available-for-sale and realized gains and losses are recorded using the specific identification method. Changes in fair value, excluding other-than-temporary impairments, are recorded in other comprehensive income (“OCI”). Debt investments are impaired when a decline in fair value is judged to be other-than-temporary. Fair value is calculated based on publicly available market information or other estimates determined by management. We employ a systematic methodology on a quarterly basis that considers available quantitative and qualitative evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the duration and extent to which the fair value is less than cost. We also evaluate whether we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery. In addition, we consider specific adverse conditions related to the financial health of and business outlook for the investee, including industry and sector performance, changes in technology, and operational and financing cash flow factors. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded in other income (expense), net and a new cost basis in the investment is established.

Equity investments with readily determinable fair values are measured at fair value. Equity investments without readily determinable fair values are measured using the equity method, or measured at cost with adjustments for observable changes in price or impairments (referred to as the measurement alternative). We perform a qualitative assessment on a quarterly basis and recognize an impairment if there are sufficient indicators that the fair value of the investment is less than carrying value. Changes in value are recorded in other income (expense), net.

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. Cash received is recorded as an asset with a corresponding liability.

Derivatives

Derivative instruments are recognized as either assets or liabilities and 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, gains and losses are recognized in other income (expense), net with offsetting gains and losses on the hedged items. For options designated as fair value hedges, changes in the time value are excluded from the assessment of hedge effectiveness and recognized in other income (expense), net.

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

For derivative instruments that are not designated as hedges, gains and losses from changes in fair values are primarily recognized in other income (expense), net.

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 in active markets. Our Level 1 investments include U.S. government securities, common and preferred stock, and mutual funds. Our Level 1 derivative assets and liabilities include those actively traded on exchanges.

9


PART I

Item 1

 

 

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. Our Level 2 investments include commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. 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 assets and liabilities include investments in corporate notes and bonds, 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 equity investments without readily determinable fair values on a nonrecurring basis. 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.  

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

Contract Balances  

As of March 31, 2019 and June 30, 2018, long-term accounts receivable, net of allowance for doubtful accounts, were $2.0 billion and $1.8 billion, respectively, and are included in other long-term assets on our consolidated balance sheets.

Recent Accounting Guidance

Recently Adopted Accounting Guidance

Income Taxes – Intra-Entity Asset Transfers

In October 2016, the Financial Accounting Standards Board (“FASB”) issued new guidance requiring an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, rather than when the asset has been sold to an outside party. We adopted the guidance effective July 1, 2018. Adoption of the guidance was applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date. We recorded a net cumulative-effect adjustment that resulted in an increase in retained earnings of $557 million, which reversed the previous deferral of income tax consequences and recorded new deferred tax assets from intra-entity transfers involving assets other than inventory, partially offset by a U.S. deferred tax liability related to global intangible low-taxed income (“GILTI”). Adoption of the standard resulted in an increase in long-term deferred tax assets of $2.8 billion, an increase in long-term deferred tax liabilities of $2.1 billion, and a reduction in other current assets of $152 million. As a result of the Tax Cuts and Jobs Act (“TCJA”), we are continuing to evaluate the impact of this standard on our consolidated financial statements, including accounting policies, processes, and systems. Adoption of the standard had no impact to cash from or used in operating, financing, or investing on our consolidated cash flows statements.

Financial Instruments – Recognition, Measurement, Presentation, and Disclosure

In January 2016, the FASB issued a new standard related to certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Most prominent among the changes in the standard is the requirement for changes in the fair value of our equity investments, with certain exceptions, to be recognized through net income rather than OCI.

10


PART I

Item 1

 

We adopted the standard effective July 1, 2018. Adoption of the standard was applied using a modified retrospective approach through a cumulative-effect adjustment from accumulated other comprehensive income (“AOCI”) to retained earnings as of the effective date, and we elected to measure equity investments without readily determinable fair values at cost with adjustments for observable changes in price or impairments. The cumulative-effect adjustment included any previously held unrealized gains and losses held in AOCI related to our equity investments carried at fair value as well as the impact of recording the fair value of certain equity investments carried at cost. The impact on our consolidated balance sheets upon adoption was not material. Adoption of the standard had no impact to cash from or used in operating, financing, or investing on our consolidated cash flows statements.

Recent Accounting Guidance Not Yet Adopted

Financial Instruments – Targeted Improvements to Accounting for Hedging Activities

In August 2017, the FASB issued new guidance related to accounting for hedging activities. This guidance expands strategies that qualify for hedge accounting, changes how many hedging relationships are presented in the financial statements, and simplifies the application of hedge accounting in certain situations. The standard will be effective for us beginning July 1, 2019, with early adoption permitted for any interim or annual period before the effective date. Adoption of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date. We evaluated the impact of this standard on our consolidated financial statements, including accounting policies, processes, and systems, and do not expect the impact to be material upon adoption.

Financial Instruments – Credit Losses

In June 2016, the FASB issued a new standard to replace the incurred loss impairment methodology under current 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. We will be required to use a forward-looking expected credit loss model for accounts receivables, loans, and other financial instruments. 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 standard will be effective for us beginning July 1, 2020, with early adoption permitted beginning July 1, 2019. Adoption of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date to align our credit loss methodology with the new standard. We are currently evaluating the impact of this standard on our consolidated financial statements, including accounting policies, processes, and systems.

 

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 per share amounts)

 

Three Months Ended

March 31,

 

 

Nine Months Ended

March 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

2019

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income available for common shareholders (A)

 

$

8,809

 

 

$

7,424

 

 

$

26,053

 

 

$

7,698

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average outstanding shares of common stock (B)

 

 

7,672

 

 

 

7,698

 

 

 

7,679

 

 

 

7,706

 

Dilutive effect of stock-based awards

 

 

72

 

 

 

96

 

 

 

80

 

 

 

92

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock and common stock equivalents (C)

 

 

7,744

 

 

 

7,794

 

 

 

7,759

 

 

 

7,798

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings Per Share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic (A/B)

 

$

1.15

 

 

$

0.96

 

 

$

3.39

 

 

$

1.00

 

Diluted (A/C)

 

$

1.14

 

 

$

0.95

 

 

$

3.36

 

 

$

0.99

 

 

 

 

 

 

 

 

 

 

 

 

11


PART I

Item 1

 

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

 

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,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

2019

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest and dividends income

 

$

668

 

 

$

575

 

 

$

2,053

 

 

$

1,578

 

Interest expense

 

 

(671

)

 

 

(691

)

 

 

(2,017

)

 

 

(2,061

)

Net recognized gains on investments

 

 

44

 

 

 

510

 

 

 

381

 

 

 

1,851

 

Net gains (losses) on derivatives

 

 

51

 

 

 

(72

)

 

 

89

 

 

 

(206

)

Net gains (losses) on foreign currency remeasurements

 

 

37

 

 

 

20

 

 

 

(32

)

 

 

(49

)

Other, net

 

 

16

 

 

 

7

 

 

 

64

 

 

 

2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

145

 

 

$

349

 

 

$

538

 

 

$

1,115

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Recognized Gains (Losses) on Investments

Net recognized gains (losses) on debt investments were as follows:

 

(In millions)

 

Three Months Ended

March 31,

 

 

Nine Months Ended

March 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Realized gains from sales of available-for-sale securities

 

$

6

 

 

$

4

 

 

$

19

 

 

$

22

 

Realized losses from sales of available-for-sale securities

 

 

(10

)

 

 

(334

)

 

 

(100

)

 

 

(673

)

Other-than-temporary impairments of investments

 

 

0

 

 

 

(1

)

 

 

(7

)

 

 

(6

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

(4

)

 

$

(331

)

 

$

(88

)

 

$

(657

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net recognized gains (losses) on equity investments were as follows:

 

(In millions)

 

Three Months Ended

March 31,

 

 

Nine Months Ended

March 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net realized gains on investments sold

 

$

5

 

 

$

857

 

 

$

238

 

 

$

2,549

 

Net unrealized gains on investments still held

 

 

50

 

 

 

0

 

 

 

241

 

 

 

0

 

Impairments of investments

 

 

(7

)

 

 

(16

)

 

 

(10

)

 

 

(41

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

48

 

 

$

841

 

 

$

469

 

 

$

2,508

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

12


PART I

Item 1

 

NOTE 4  INVESTMENTS

Investment Components

The components of investments were as follows:

 

(In millions)

 

Fair Value Level

 

Cost Basis

 

Unrealized

Gains

 

Unrealized

Losses

 

Recorded Basis

 

Cash and Cash

Equivalents

 

Short-term

Investments

 

Equity

Investments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Changes in Fair Value Recorded in

Other Comprehensive Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial paper

 

Level 2

 

$

1,623

 

$

0

 

$

0

 

$

1,623

 

$

1,424

 

$

199

 

$

0

 

Certificates of deposit

 

Level 2

 

 

1,738

 

 

0

 

 

0

 

 

1,738

 

 

1,517

 

 

221

 

 

0

 

U.S. government securities

 

Level 1

 

 

105,168

 

 

836

 

 

(342

)

 

105,662

 

 

0

 

 

105,662

 

 

0

 

U.S. agency securities

 

Level 2

 

 

290

 

 

0

 

 

0

 

 

290

 

 

0

 

 

290

 

 

0

 

Foreign government bonds

 

Level 2

 

 

6,753

 

 

2

 

 

(10

)

 

6,745

 

 

4,002

 

 

2,743

 

 

0

 

Mortgage- and asset-backed securities

 

Level 2

 

 

3,427

 

 

5

 

 

(8

)

 

3,424

 

 

0

 

 

3,424

 

 

0

 

Corporate notes and bonds

 

Level 2

 

 

7,426

 

 

60

 

 

(19

)

 

7,467

 

 

0

 

 

7,467

 

 

0

 

Corporate notes and bonds

 

Level 3

 

 

15

 

 

0

 

 

0

 

 

15

 

 

0

 

 

15

 

 

0

 

Municipal securities

 

Level 2

 

 

263

 

 

41

 

 

(1

)

 

303

 

 

0

 

 

303

 

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total debt investments

 

 

 

$

126,703

 

$

944

 

$

(380

)

$

127,267

 

$

6,943

 

$

120,324

 

$

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity investments

 

Level 1

 

 

 

 

 

 

 

 

 

 

$

653

 

$

383

 

$

0

 

$

270

 

Equity investments

 

Other

 

 

 

 

 

 

 

 

 

 

 

2,133

 

 

0

 

 

0

 

 

2,133

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total equity investments

 

 

 

 

 

 

 

 

 

 

 

 

$

2,786

 

$

383

 

$

0

 

$

2,403

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash

 

 

 

 

 

 

 

 

 

 

 

 

$

3,886

 

$

3,886

 

$

0

 

$

0

 

Derivatives, net (a)

 

 

 

 

 

 

 

 

 

 

 

 

 

82

 

 

0

 

 

82

 

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

$

134,021

 

$

11,212

 

$

120,406

 

$

2,403

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

13


PART I

Item 1

 

(In millions)

 

Fair Value Level

 

Cost Basis

 

Unrealized

Gains

 

Unrealized

Losses

 

Recorded Basis

 

Cash and Cash

Equivalents

 

Short-term

Investments

 

Equity

Investments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Changes in Fair Value Recorded in

Other Comprehensive Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial paper

 

Level 2

 

$

2,513

 

$

0

 

$

0

 

$

2,513

 

$

2,215

 

$

298

 

$

0

 

Certificates of deposit

 

Level 2

 

 

2,058

 

 

0

 

 

0

 

 

2,058

 

 

1,865

 

 

193

 

 

0

 

U.S. government securities

 

Level 1

 

 

108,120

 

 

62

 

 

(1,167

)

 

107,015

 

 

2,280

 

 

104,735

 

 

0

 

U.S. agency securities

 

Level 2

 

 

1,742

 

 

0

 

 

0

 

 

1,742

 

 

1,398

 

 

344

 

 

0

 

Foreign government bonds

 

Level 1

 

 

22

 

 

0

 

 

0

 

 

22

 

 

0

 

 

22

 

 

0

 

Foreign government bonds

 

Level 2

 

 

5,063

 

 

1

 

 

(10

)

 

5,054

 

 

0

 

 

5,054

 

 

0

 

Mortgage- and asset-backed securities

 

Level 2

 

 

3,864

 

 

4

 

 

(13

)

 

3,855

 

 

0

 

 

3,855

 

 

0

 

Corporate notes and bonds

 

Level 2

 

 

6,929

 

 

21

 

 

(56

)

 

6,894

 

 

0

 

 

6,894

 

 

0

 

Corporate notes and bonds

 

Level 3

 

 

15

 

 

0

 

 

0

 

 

15

 

 

0

 

 

15

 

 

0

 

Municipal securities

 

Level 2

 

 

271

 

 

37

 

 

(1

)

 

307

 

 

0

 

 

307

 

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total debt investments

 

 

 

$

130,597

 

$

125

 

$

(1,247

)

$

129,475

 

$

7,758

 

$

121,717

 

$

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity investments

 

Level 1

 

 

 

 

 

 

 

 

 

 

$

533

 

$

246

 

$

0

 

$

287

 

Equity investments

 

Level 3

 

 

 

 

 

 

 

 

 

 

 

18

 

 

0

 

 

0

 

 

18

 

Equity investments

 

Other

 

 

 

 

 

 

 

 

 

 

 

1,558

 

 

0

 

 

1

 

 

1,557

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total equity investments

 

 

 

 

 

 

 

 

 

 

 

 

$

2,109

 

$

246

 

$

1

 

$

1,862

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash

 

 

 

 

 

 

 

 

 

 

 

 

$

3,942

 

$

3,942

 

$

0

 

$

0

 

Derivatives, net (a)

 

 

 

 

 

 

 

 

 

 

 

 

 

104

 

 

0

 

 

104

 

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

$

135,630

 

$

11,946

 

$

121,822

 

$

1,862

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(a)

Refer to Note 5 – Derivatives for further information on the fair value of our derivative instruments.

Equity investments presented as “Other” in the tables above include investments without readily determinable fair values measured using the equity method or measured at cost with adjustments for observable changes in price or impairments, and investments measured at fair value using net asset value as a practical expedient which are not categorized in the fair value hierarchy. As of March 31, 2019 and June 30, 2018, equity investments without readily determinable fair values measured at cost with adjustments for observable changes in price or impairments were $1.2 billion and $697 million, respectively.

As of March 31, 2019, we had no collateral received under agreements for loaned securities. As of June 30, 2018, collateral received under agreements for loaned securities was $1.8 billion and primarily comprised U.S. government and agency securities.

Unrealized Losses on Debt Investments

Debt 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, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agency securities

 

$

6,485

 

 

$

(23

)

 

$

54,161

 

 

$

(319

)

 

$

60,646

 

 

$

(342

)

Foreign government bonds

 

 

4,229

 

 

 

(2

)

 

 

88

 

 

 

(8

)

 

 

4,317

 

 

 

(10

)

Mortgage- and asset-backed securities

 

 

989

 

 

 

(3

)

 

 

561

 

 

 

(5

)

 

 

1,550

 

 

 

(8

)

Corporate notes and bonds

 

 

1,024

 

 

 

(6

)

 

 

1,151

 

 

 

(13

)

 

 

2,175

 

 

 

(19

)

Municipal securities

 

 

7

 

 

 

0

 

 

 

13

 

 

 

(1

)

 

 

20

 

 

 

(1

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

12,734

 

 

$

  (34

)

 

$

  55,974

 

 

$

  (346

)

 

$

 68,708

 

 

$

  (380

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

14


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, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agency securities

 

$

82,352

 

 

$

(1,064

)

 

$

4,459

 

 

$

(103

)

 

$

86,811

 

 

$

(1,167

)

Foreign government bonds

 

 

3,457

 

 

 

(7

)

 

 

13

 

 

 

(3

)

 

 

3,470

 

 

 

(10

)

Mortgage- and asset-backed securities

 

 

2,072

 

 

 

(9

)

 

 

96

 

 

 

(4

)

 

 

2,168

 

 

 

(13

)

Corporate notes and bonds

 

 

3,111

 

 

 

(43

)

 

 

301

 

 

 

(13

)

 

 

3,412

 

 

 

(56

)

Municipal securities

 

 

45

 

 

 

(1

)

 

 

0

 

 

 

0

 

 

 

45

 

 

 

(1

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

91,037

 

 

$

  (1,124

)

 

$

  4,869

 

 

$

  (123

)

 

$

 95,906

 

 

$

  (1,247

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized losses from fixed-income securities are primarily attributable to changes in interest rates. 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, 2019

 

 

 

 

 

 

 

 

 

 

 

Due in one year or less

 

$

48,902

 

 

$

48,729

 

Due after one year through five years

 

 

51,977

 

 

 

52,189

 

Due after five years through 10 years

 

 

24,920

 

 

 

25,428

 

Due after 10 years

 

 

904

 

 

 

921

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

  126,703

 

 

$

  127,267

 

 

 

 

 

 

 

 

 

 

 

 

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.

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 and are designated as cash flow hedging instruments. Principal currencies hedged include the euro, Japanese yen, British pound, Canadian dollar, and Australian dollar.

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.

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.

Equity

Securities held in our equity 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. In the past, to hedge our price risk, we also used and designated equity derivatives as hedging instruments, including puts, calls, swaps, and forwards.

15


PART I

Item 1

 

Other

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.

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.

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.

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, 2019, 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.

The following table presents the notional amounts of our outstanding derivative instruments measured in U.S. dollar equivalents:

 

(In millions)

 

March 31,

2019

 

 

June 30,

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts sold

 

$

7,937

 

 

$

11,101

 

 

 

 

 

 

 

 

 

 

Not Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts purchased

 

 

8,576

 

 

 

9,425

 

Foreign exchange contracts sold

 

 

10,166

 

 

 

13,374

 

Equity contracts purchased

 

 

50

 

 

 

49

 

Equity contracts sold

 

 

6

 

 

 

5

 

Other contracts purchased

 

 

1,330

 

 

 

878

 

Other contracts sold

 

 

426

 

 

 

472

 

 

 

 

 

 

 

 

 

 

 

16


PART I

Item 1

 

Fair Values of Derivative Instruments

The following table presents our derivative instruments:

 

 

 

 

Derivative

 

 

 

Derivative

 

 

Derivative

 

 

Derivative

 

(In millions)

 

Assets

 

 

 

Liabilities

 

 

Assets

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31,

2019

 

 

June 30,

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Changes in Fair Value Recorded in Other Comprehensive Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

$

58

 

 

$

0

 

 

$

174

 

 

$

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Changes in Fair Value Recorded in Net Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

 

85

 

 

 

(1

)

 

 

95

 

 

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Not Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

 

109

 

 

 

(114

)

 

 

256

 

 

 

(197

)

Equity contracts

 

 

5

 

 

 

(2

)

 

 

2

 

 

 

(7

)

Other contracts

 

 

16

 

 

 

(5

)

 

 

11

 

 

 

(3

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross amounts of derivatives

 

 

273

 

 

 

(122

)

 

 

538

 

 

 

(207

)

Gross amounts of derivatives offset in the balance sheet

 

 

(85

)

 

 

85

 

 

 

(152

)

 

 

153

 

Cash collateral received

 

 

 0

 

 

 

(49

)

 

 

0

 

 

 

(235

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net amounts of derivatives

 

$

188

 

 

$

(86

)

 

$

386

 

 

$

(289

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reported as

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Short-term investments

 

$

82

 

 

$

0

 

 

$

104

 

 

$

0

 

Other current assets

 

 

100

 

 

 

0

 

 

 

260

 

 

 

0

 

Other long-term assets

 

 

6

 

 

 

0

 

 

 

22

 

 

 

0

 

Other current liabilities

 

 

0

 

 

 

(67

)

 

 

0

 

 

 

(288

)

Other long-term liabilities

 

 

0

 

 

 

(19

)

 

 

0

 

 

 

(1

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

188

 

 

$

(86

)

 

$

386

 

 

$

(289

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross derivative assets and liabilities subject to legally enforceable master netting agreements for which we have elected to offset were $263 million and $122 million, respectively, as of March 31, 2019, and $533 million and $207 million, respectively, as of June 30, 2018.

The following table presents the fair value of our derivatives instruments on a gross basis:

 

(In millions)

 

Level 1

 

 

 

Level 2

 

 

Level 3

 

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative assets

 

$

0

 

 

$

270

 

 

$

3

 

 

$

273

 

Derivative liabilities

 

 

0

 

 

 

(122

)

 

 

0

 

 

 

(122

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative assets

 

 

1

 

 

 

535

 

 

 

2

 

 

 

538

 

Derivative liabilities

 

 

(1

)

 

 

(206

)

 

 

0

 

 

 

(207

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

17


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,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

Foreign Exchange Contracts

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives

 

$

129

 

 

$

(260

)

 

$

140

 

 

$

(224

)

Hedged items

 

 

(81

)

 

 

288

 

 

 

(19

)

 

 

298

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total amount of ineffectiveness

 

$

48

 

 

$

28

 

 

$

121

 

 

$

74

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity Contracts

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives

 

$

0

 

 

$

126

 

 

$

0

 

 

$

(181

)

Hedged items

 

 

0

 

 

 

(126

)

 

 

0

 

 

 

181

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total amount of ineffectiveness

 

$

0

 

 

$

0

 

 

$

0

 

 

$

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amount of equity contracts excluded from effectiveness assessment

 

$

0

 

  

$

0

 

 

$

0

 

 

$

60

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

Effective Portion

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gains recognized in other comprehensive income (loss), net of tax of $(1), $7, $1, and $8

 

$

31

 

 

$

14

 

 

$

145

 

 

$

29

 

Gains reclassified from accumulated other comprehensive income (loss) into revenue

 

 

66

 

 

 

8

 

 

 

246

 

 

 

138

 

 

 

 

 

 

 

 

 

 

 

 

Amount Excluded from Effectiveness Assessment and Ineffective Portion

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Losses recognized in other income (expense), net

 

 

(21

)

 

 

(62

)

 

 

(62

)

 

 

(226

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

We estimate that $81 million of net derivative gains included in AOCI as of March 31, 2019 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 for the three and nine months ended March 31, 2019.

Non-designated Derivative Gains (Losses)

We recognized in other income (expense), net the following gains (losses) on derivatives not designated as hedging instruments:

 

(In millions)

 

Three Months Ended

March 31,

 

 

Nine Months Ended

March 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

$

(87

)

 

$

(64

)

 

$

(196

)

 

$

(248

)

Equity contracts

 

 

2

 

 

 

(11

)

 

 

3

 

 

 

(89

)

Other contracts

 

 

20

 

 

 

(18

)

 

 

24

 

 

 

(9

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

(65

)

 

$

(93

)

 

$

(169

)

 

$

(346

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

18


PART I

Item 1

 

NOTE 6  INVENTORIES

The components of inventories were as follows:

 

(In millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31,

2019

 

 

June 30,

2018

 

 

 

 

Raw materials

 

$

450

 

 

$

655

 

Work in process

 

 

71

 

 

 

54

 

Finished goods

 

 

1,430

 

 

 

1,953

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

1,951

 

 

$

  2,662

 

 

 

 

 

 

 

 

 

 

 

NOTE 7 — BUSINESS COMBINATIONS

GitHub, Inc.

On October 25, 2018, we acquired GitHub, Inc. in a $7.5 billion stock transaction (inclusive of total cash payments of $1.3 billion in respect of vested GitHub equity awards and an indemnity escrow). The acquisition is expected to empower developers to achieve more at every stage of the development lifecycle, accelerate enterprise use of GitHub, and bring Microsoft’s developer tools and services to new audiences. The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition. GitHub is reported as part of our Intelligent Cloud segment.

The purchase price allocation as of the date of the acquisition was based on a preliminary valuation and is subject to revision as more detailed analyses are completed and additional information about the fair value of assets acquired and liabilities assumed becomes available.

The major classes of assets and liabilities to which we have preliminarily allocated the purchase price were as follows:

 

(In millions)

 

 

 

 

 

 

 

 

 

Cash, cash equivalents, and short-term investments

 

$

234

 

Goodwill 

 

 

5,494

 

Intangible assets

 

 

1,267

 

Other assets

 

 

143

 

Other liabilities

 

 

(214

)

 

 

 

 

 

 

 

 

 

 

Total

 

$

  6,924

 

 

 

 

 

 

 

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 our Intelligent Cloud segment.

Following are the details of the purchase price allocated to the intangible assets acquired:

 

(In millions)

 

Amount

 

 

Weighted

Average Life

  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer-related

 

$

648

 

 

 

8 years

 

Technology-based

 

 

447

 

 

 

5 years

 

Marketing-related

 

 

170

 

 

 

10 years

 

Contract-based

 

 

2

 

 

 

2 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

1,267

 

 

 

7 years

 

 

 

 

 

 

 

 

 

 

Transactions recognized separately from the preliminary purchase price allocation were approximately $600 million, primarily related to equity awards recognized as expense over the related service period.

19


PART I

Item 1

 

Other

For the nine months ended March 31, 2019, we completed 14 additional acquisitions for $1.3 billion, substantially all of which were paid in cash. These entities have been included in our consolidated results of operations since their respective acquisition dates.

 

NOTE 8 — GOODWILL

Changes in the carrying amount of goodwill were as follows:

 

(In millions)

 

June 30,

2018

 

 

Acquisitions

 

 

Other

 

 

March 31,

2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Productivity and Business Processes

 

$

23,823

 

 

$

342

 

 

$

(42

)

 

$

24,123

 

Intelligent Cloud

 

 

5,703

 

 

 

5,582

(a)

 

 

53

(a)

 

 

11,338

 

More Personal Computing

 

 

6,157

 

 

 

289

 

 

 

(46

)

 

 

6,400

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

  35,683

 

 

$

  6,213

 

 

$

  (35

)

 

$

  41,861

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(a)

Includes goodwill of $5.5 billion related to GitHub. See Note 7 – Business Combinations for further information.

 

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 change in the amounts allocated to goodwill during the periods in which the adjustments are determined.

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

 

 

NOTE 9  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,

2019

 

 

June 30,

2018

 

 

 

 

 

 

 

 

Technology-based

 

$

7,612

 

 

$

(5,574

)

 

$

2,038

 

 

$

7,220

 

 

$

(5,018

)

 

$

2,202

 

Customer-related

 

 

4,709

 

 

 

(1,635

)

 

 

3,074

 

 

 

4,031

 

 

 

(1,205

)

 

 

2,826

 

Marketing-related

 

 

4,181

 

 

 

(1,266

)

 

 

2,915

 

 

 

4,006

 

 

 

(1,071

)

 

 

2,935

 

Contract-based

 

 

575

 

 

 

(499

)

 

 

76

 

 

 

679

 

 

 

(589

)

 

 

90

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

  17,077

(a)

 

$

  (8,974

)

 

$

8,103

 

 

$

  15,936

 

 

$

  (7,883

)

 

$

 8,053

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(a)

Includes intangible assets of $1.3 billion related to GitHub. See Note 7 – Business Combinations for further information.  

Intangible assets amortization expense was $431 million and $560 million for the three months ended March 31, 2019 and 2018, respectively, and $1.5 billion and $1.7 billion for the nine months ended March 31, 2019 and 2018, respectively.

20


PART I

Item 1

 

The following table outlines the estimated future amortization expense related to intangible assets held as of March 31, 2019:

 

(In millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ending June 30,

 

 

 

 

 

 

2019 (excluding the nine months ended March 31, 2019)

 

$

436

 

2020

 

 

1,518

 

2021

 

 

1,297

 

2022

 

 

1,197

 

2023

 

 

1,018

 

Thereafter

 

 

2,637

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

8,103

 

 

 

 

 

 

 

NOTE 10  DEBT

Short-term Debt

As of March 31, 2019 and June 30, 2018, we had no commercial paper issued or outstanding. Effective August 31, 2018, we terminated our credit facilities, which served as back-up for our commercial paper program.

Long-term Debt

As of March 31, 2019, the total carrying value and estimated fair value of our long-term debt, including the current portion, were $73.1 billion and $77.0 billion, respectively. As of June 30, 2018, the total carrying value and estimated fair value of our long-term debt, including the current portion, were $76.2 billion and $77.5 billion, respectively. These estimated fair values are based on Level 2 inputs.

 

21


PART I

Item 1

 

The components of our long-term debt, including the current portion, and the associated interest rates were as follows:

 

(In millions, except interest rates)

 

Face Value

March 31,

2019

 

 

Face Value

June 30,

2018

 

 

Stated

Interest

Rate

 

 

Effective

Interest

Rate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Notes

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

November 3, 2018

 

$

0

 

 

$

1,750

 

 

 

1.300%

 

 

 

1.396%

 

December 6, 2018

 

 

0

 

 

 

1,250

 

 

 

1.625%

 

 

 

1.824%

 

June 1, 2019

 

 

1,000

 

 

 

1,000

 

 

 

4.200%

 

 

 

4.379%

 

August 8, 2019

 

 

2,500

 

 

 

2,500

 

 

 

1.100%

 

 

 

1.203%

 

November 1, 2019

 

 

18

 

 

 

18

 

 

 

0.500%

 

 

 

0.500%

 

February 6, 2020

 

 

1,500

 

 

 

1,500

 

 

 

1.850%

 

 

 

1.952%

 

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

 

 

2,250

 

 

 

2,250

 

 

 

2.000%

 

 

 

2.093%

 

February 8, 2021

 

 

500

 

 

 

500

 

 

 

4.000%

 

 

 

4.082%

 

August 8, 2021

 

 

2,750

 

 

 

2,750

 

 

 

1.550%

 

 

 

1.642%

 

December 6, 2021 (a)

 

 

1,965

 

 

 

2,044

 

 

 

2.125%

 

 

 

2.233%

 

February 6, 2022

 

 

1,750

 

 

 

1,750

 

 

 

2.400%

 

 

 

2.520%

 

February 12, 2022

 

 

1,500

 

 

 

1,500

 

 

 

2.375%

 

 

 

2.466%

 

November 3, 2022

 

 

1,000

 

 

 

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%

 

August 8, 2023

 

 

1,500

 

 

 

1,500

 

 

 

2.000%

 

 

 

2.101%

 

December 15, 2023

 

 

1,500

 

 

 

1,500

 

 

 

3.625%

 

 

 

3.726%

 

February 6, 2024

 

 

2,250

 

 

 

2,250

 

 

 

2.875%

 

 

 

3.041%

 

February 12, 2025

 

 

2,250

 

 

 

2,250

 

 

 

2.700%

 

 

 

2.772%

 

November 3, 2025

 

 

3,000

 

 

 

3,000

 

 

 

3.125%

 

 

 

3.176%

 

August 8, 2026

 

 

4,000

 

 

 

4,000

 

 

 

2.400%

 

 

 

 2.464%

 

February 6, 2027

 

 

4,000

 

 

 

4,000

 

 

 

3.300%

 

 

 

3.383%

 

December 6, 2028 (a)

 

 

1,965

 

 

 

2,044

 

 

 

3.125%

 

 

 

3.218%

 

May 2, 2033 (a)

 

 

618

 

 

 

642

 

 

 

2.625%

 

 

 

2.690%

 

February 12, 2035

 

 

1,500

 

 

 

1,500

 

 

 

3.500%

 

 

 

3.604%

 

November 3, 2035

 

 

1,000

 

 

 

1,000

 

 

 

4.200%

 

 

 

4.260%

 

August 8, 2036

 

 

2,250

 

 

 

2,250

 

 

 

3.450%

 

 

 

 3.510%

 

February 6, 2037

 

 

2,500

 

 

 

2,500

 

 

 

4.100%

 

 

 

4.152%

 

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

 

 

3,000

 

 

 

3,000

 

 

 

4.450%

 

 

 

4.492%

 

August 8, 2046

 

 

4,500

 

 

 

4,500

 

 

 

3.700%

 

 

 

3.743%

 

February 6, 2047

 

 

3,000

 

 

 

3,000

 

 

 

4.250%

 

 

 

4.287%

 

February 12, 2055

 

 

2,250

 

 

 

2,250

 

 

 

4.000%

 

 

 

4.063%

 

November 3, 2055

 

 

1,000

 

 

 

1,000

 

 

 

4.750%

 

 

 

4.782%

 

August 8, 2056

 

 

2,250

 

 

 

2,250

 

 

 

3.950%

 

 

 

 4.033%

 

February 6, 2057

 

 

2,000

 

 

 

2,000

 

 

 

4.500%

 

 

 

4.528%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

73,716

 

 

$

76,898

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(a)

Euro-denominated debt securities.

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, 2019 and June 30, 2018, the aggregate debt issuance costs and unamortized discount associated with our long-term debt, including the current portion, were $616 million and $658 million, respectively.

22


PART I

Item 1

 

NOTE 11  INCOME TAXES

Effective Tax Rate

Our effective tax rate was 16% and 14% for the three months ended March 31, 2019 and 2018, respectively, and 16% and 70% for the nine months ended March 31, 2019 and 2018, respectively. The increase in our effective tax rate for the three months ended March 31, 2019 compared to the prior year was primarily due to changes in the mix of our income before income taxes between the U.S. and foreign countries. The decrease in our effective tax rate for the nine months ended March 31, 2019 compared to the prior year was primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018.

Our effective tax rate for the three and nine months ended March 31, 2019 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, and tax benefits relating to stock-based compensation.

Tax Cuts and Jobs Act

On December 22, 2017, the TCJA was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business, such as imposing a one-time transition tax on deemed repatriation of deferred foreign income, reducing the U.S. federal statutory tax rate, and adopting a territorial tax system. In fiscal year 2018, the TCJA required us to incur a transition tax on deferred foreign income not previously subject to U.S. income tax at a rate of 15.5% for foreign cash and certain other net current assets, and 8% on the remaining income. The TCJA also reduced the U.S. federal statutory tax rate from 35% to 21% effective January 1, 2018. The TCJA included a provision to tax GILTI of foreign subsidiaries and a base erosion anti-abuse tax (“BEAT”) measure that taxes certain payments between a U.S. corporation and its foreign subsidiaries. The GILTI and BEAT provisions of the TCJA were effective for us beginning July 1, 2018.

The TCJA was effective in the second quarter of fiscal year 2018. We recorded a provisional net charge of $13.8 billion in the second quarter of fiscal year 2018, and $13.7 billion for the fiscal year ended June 30, 2018, related to the TCJA based on reasonable estimates for those tax effects. We adjusted our provisional net charge by recording additional tax expense of $157 million in the second quarter of fiscal year 2019 related to GILTI deferred taxes pursuant to SEC Staff Accounting Bulletin No. 118. As of March 31, 2019, the U.S. Treasury Department and the Internal Revenue Service (“IRS”) are still in the process of issuing various TCJA regulations. Accordingly, future adjustments to the financial statements may be necessary as regulations are issued and when we file our fiscal year 2018 tax returns with the IRS and foreign tax authorities in the current fiscal year.

We recorded an estimated charge of $17.8 billion in the second quarter of fiscal year 2018, and $17.9 billion in fiscal year 2018, related to the one-time transition tax on the deemed repatriation of deferred foreign income, which was included in the provision for income taxes on our consolidated income statements and income taxes on our consolidated balance sheets. To calculate the transition tax, we estimated our deferred foreign income for fiscal year 2018 because these tax returns are not complete or due. Taxable income for fiscal year 2018 will be known once the respective tax returns are completed and filed. In addition, U.S. and foreign audit settlements may significantly impact the estimated transition tax. The impact of the U.S. and foreign audits on the transition tax will be known as the audits are concluded.

In addition, we recorded an estimated benefit of $4.0 billion in the second quarter of fiscal year 2018, and $4.2 billion in fiscal year 2018, from the impact of changes in the tax rate, primarily on deferred tax assets and liabilities, which was included in provision for income taxes on our consolidated income statements and deferred income taxes and long-term income taxes on our consolidated balance sheets. We remeasured our deferred taxes to reflect the reduced rate that will apply when these deferred taxes are settled or realized in future periods. We adjusted our provisional charge by recording additional tax expense of $157 million in the second quarter of fiscal year 2019.

The TCJA subjects a U.S. corporation to tax on its GILTI. Under GAAP, we can make an accounting policy election to either treat taxes due on the GILTI inclusion as a current period expense or factor such amounts into our measurement of deferred taxes. We elected the deferred method, under which we recorded the corresponding deferred tax assets and liabilities on our consolidated balance sheets.

23


PART I

Item 1

 

Uncertain Tax Positions

While we settled a portion of the IRS audit for tax years 2004 to 2006 in the third quarter of fiscal year 2011, a portion of the IRS audit for tax years 2007 to 2009 in the first quarter of fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in the second quarter of fiscal year 2018, we remain under audit for those years. We continue to be subject to examination by the IRS for tax years 2014 to 2017. 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, 2019, the primary unresolved issues for this and other open IRS audits are related to transfer pricing. While we believe our allowances for income tax contingencies related to the unresolved issues are adequate, the final resolution of these issues, if unfavorable, could have a material impact on our consolidated financial statements. 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 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 2018, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.

While we believe our allowances for all income tax contingencies are adequate, the final resolution of these issues, if unfavorable, could have a material impact on our consolidated financial statements. Income tax contingencies and other income tax liabilities were $15.7 billion and $15.1 billion as of March 31, 2019 and June 30, 2018, respectively, and are included in long-term income taxes on our consolidated balance sheets. This increase was primarily due to current period intercompany transactions and interest accruals.

NOTE 12 — UNEARNED REVENUE

Unearned revenue by segment was as follows:

 

(In millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31,
2019

 

 

June 30,
2018

 

 

 

 

Productivity and Business Processes

 

$

12,679

 

 

$

14,864

 

Intelligent Cloud

 

 

12,531

 

 

 

14,706

 

More Personal Computing

 

 

2,925

 

 

 

3,150

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

28,135

 

 

$

32,720

 

 

 

 

 

 

 

 

 

 

 

Changes in unearned revenue were as follows:

 

(In millions)

 

 

 

 

 

 

 

Nine Months Ended March 31, 2019

 

 

 

Balance, beginning of period

 

$

32,720

 

Deferral of revenue

 

 

48,957

 

Recognition of unearned revenue

 

 

(53,542

)

 

 

 

 

 

 

 

Balance, end of period

 

$

28,135

 

 

 

 

 

 

 

Revenue allocated to remaining performance obligations represents contracted revenue that has not yet been recognized (“contracted not recognized revenue”), which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods. Contracted not recognized revenue was $75 billion as of March 31, 2019, of which we expect to recognize approximately 55% of the revenue over the next 12 months and the remainder thereafter. Many customers are committing to our products and services for longer contract terms, which is increasing the percentage of contracted revenue that will be recognized beyond the next 12 months.

 

 

24


PART I

Item 1

 

NOTE 13  LEASES

We have operating and finance leases for datacenters, corporate offices, research and development facilities, retail stores, and certain equipment. Our leases have remaining lease terms of 1 year to 20 years, some of which include options to extend the leases for up to 5 years, and some of which include options to terminate the leases within 1 year.

The components of lease expense were as follows:

 

(In millions)

 

Three Months Ended

March 31,

 

 

Nine Months Ended

 March 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating lease cost

 

$

431

 

 

$

395

 

 

$

1,254

 

 

$

1,182

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Finance lease cost:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amortization of right-of-use assets

 

$

100

 

 

$

70

 

 

$

262

 

 

$

175

 

Interest on lease liabilities

 

 

65

 

 

 

47

 

 

 

179

 

 

 

121

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total finance lease cost

 

$

165

 

 

$

117

 

 

$

441

 

 

$

296

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Supplemental cash flow information related to leases was as follows:

 

(In millions)

 

Three Months Ended

March 31,

 

 

Nine Months Ended

March 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash paid for amounts included in the measurement of lease liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating cash flows from operating leases

 

$

425

 

 

$

388

 

 

$

1,229

 

 

$

1,132

 

Operating cash flows from finance leases

 

 

65

 

 

 

46

 

 

 

179

 

 

 

121

 

Financing cash flows from finance leases

 

 

66

 

 

 

37

 

 

 

167

 

 

 

93

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Right-of-use assets obtained in exchange for lease obligations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating leases

 

 

730

 

 

 

570

 

 

 

1,698

 

 

 

1,269

 

Finance leases

 

 

658

 

 

 

412

 

 

 

1,722

 

 

 

1,790

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

25


PART I

Item 1

 

Supplemental balance sheet information related to leases was as follows:

 

(In millions, except lease term and discount rate)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31,
2019

 

 

June 30,
2018

 

 

 

 

Operating Leases

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating lease right-of-use assets

 

$

7,121

 

 

$

6,686

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other current liabilities

 

$

1,461

 

 

$

1,399

 

Operating lease liabilities

 

 

5,972

 

 

 

5,568

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total operating lease liabilities

 

$

7,433

 

 

$

6,967

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Finance Leases

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property and equipment, at cost

 

$

6,222

 

 

$

4,543

 

Accumulated depreciation

 

 

(666

)

 

 

(404

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property and equipment, net

 

$

5,556

 

 

$

4,139

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other current liabilities

 

$

282

 

 

$

176

 

Other long-term liabilities

 

 

5,528

 

 

 

4,125

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total finance lease liabilities

 

$

5,810

 

 

$

4,301

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted Average Remaining Lease Term

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating leases

 

 

7 years

 

 

 

7 years

 

Finance leases

 

 

13 years

 

 

 

13 years

 

 

 

 

 

 

 

 

 

 

Weighted Average Discount Rate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating leases

 

 

2.9%

 

 

 

2.7%

 

Finance leases

 

 

4.9%

 

 

 

5.2%

 

 

 

 

 

 

 

 

 

 

 

Maturities of lease liabilities were as follows:

 

(In millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ending June 30,

 

Operating

Leases

 

 

Finance

Leases

 

 

 

 

2019 (excluding the nine months ended March 31, 2019)

 

$

422

 

 

$

138

 

2020

 

 

1,586

 

 

 

534

 

2021

 

 

1,335

 

 

 

543

 

2022

 

 

1,135

 

 

 

552

 

2023

 

 

942

 

 

 

556

 

Thereafter

 

 

2,904

 

 

 

5,552

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total lease payments

 

 

8,324

 

 

 

7,875

 

Less imputed interest

 

 

(891

)

 

 

(2,065

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

7,433

 

 

$

5,810

 

 

 

 

 

 

 

 

 

 

 

As of March 31, 2019, we have additional operating and finance leases, primarily for datacenters, that have not yet commenced of $1.9 billion and $6.4 billion, respectively. These operating and finance leases will commence between fiscal year 2019 and fiscal year 2022 with lease terms of 1 year to 15 years.

 

 

NOTE 14 — CONTINGENCIES

Patent and Intellectual Property Claims

There were 35 patent infringement cases pending against Microsoft as of March 31, 2019, none of which are material individually or in aggregate.

26


PART I

Item 1

 

Antitrust, Unfair Competition, and Overcharge Class Actions

Antitrust and unfair competition class action lawsuits were filed against us in British Columbia, Ontario, and Quebec, Canada. All three have been certified on behalf of Canadian indirect purchasers who acquired licenses for Microsoft operating system software and/or productivity application software between 1998 and 2010.

The trial of the British Columbia action commenced in May 2016. Following a mediation, the parties agreed to a global settlement of all three Canadian actions, and submitted the proposed settlement agreement to the courts in all three jurisdictions for approval. The final settlement has been approved by the courts in British Columbia, Ontario, and Quebec, and the claims administration process will commence.

Other Antitrust Litigation and Claims

China State Administration for Industry and Commerce Investigation

In 2014, Microsoft was informed that China’s State Agency for Market Regulation (“SAMR”) (formerly State Administration for Industry and Commerce) had begun a formal investigation relating to China’s Anti-Monopoly Law, and the SAMR conducted onsite inspections of Microsoft offices in Beijing, Shanghai, Guangzhou, and Chengdu. The SAMR has presented its preliminary views as to certain possible violations of China's Anti-Monopoly Law, and discussions are expected to continue.

Product-Related Litigation

U.S. Cell Phone Litigation

Microsoft Mobile Oy, a subsidiary of Microsoft, along with other handset manufacturers and network operators, is a defendant in 40 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 in our agreement to acquire Nokia’s Devices and Services business 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 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, the defendants in the consolidated cases moved to exclude the plaintiffs’ expert evidence of general causation on the basis of flawed scientific methodologies. In 2014, the trial court granted in part and denied in part the defendants’ motion to exclude the plaintiffs’ general causation experts. The defendants filed an interlocutory appeal to the District of Columbia Court of Appeals challenging the standard for evaluating expert scientific evidence. In October 2016, the Court of Appeals issued its decision adopting the standard advocated by the defendants and remanding the cases to the trial court for further proceedings under that standard. The plaintiffs have filed supplemental expert evidence, portions of which the defendants have moved to strike. In August 2018, the trial court issued an order striking portions of the plaintiffs’ expert reports. A hearing is expected to be scheduled in the second half of calendar year 2019.

Canadian Cell Phone Class Action

Microsoft Mobile Oy, 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, alleging adverse health effects from cellular phone use. Microsoft was served with the complaint in June 2014 and has been substituted for the Nokia defendants. The lawsuit was dismissed without prejudice on March 7, 2019.

27


PART I

Item 1

 

Employment-Related Litigation

Moussouris v. Microsoft

Current and former female Microsoft employees in certain engineering and information technology roles brought this class action in federal court in Seattle in 2015, alleging systemic gender discrimination in pay and promotions. The plaintiffs moved to certify the class in October 2017. Microsoft filed an opposition in January 2018, attaching an expert report showing no statistically significant disparity in pay and promotions between similarly situated men and women. In June 2018, the court denied the plaintiffs’ motion for class certification. Plaintiffs sought an interlocutory appeal to the U.S. Court of Appeals for the Ninth Circuit, which was granted in September 2018. Oral arguments are expected to be scheduled in early calendar year 2020.

Other Contingencies

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, 2019, we accrued aggregate legal liabilities of $253 million. While we intend to defend these matters vigorously, adverse outcomes that we estimate could reach approximately $1.0 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 15  STOCKHOLDERS’ EQUITY

Share Repurchases

On September 20, 2016, our Board of Directors approved a share repurchase program authorizing up to $40.0 billion in share repurchases. This share repurchase program commenced on December 22, 2016, has no expiration date, and may be suspended or discontinued at any time without notice. As of March 31, 2019, $15.6 billion remained of this $40.0 billion share repurchase program.

We repurchased the following shares of common stock under the share repurchase program:

 

(In millions)

 

Shares

 

Amount

 

 

Shares

 

Amount

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fiscal Year

 

 

 

 

2019

 

 

 

 

 

2018

 

 

 

 

 

 

First Quarter

 

 

24

 

 

$

2,600

 

 

 

22

 

 

$

1,600

 

Second Quarter

 

 

57

 

 

 

6,100

 

 

 

22

 

 

 

1,800

 

Third Quarter

 

 

36

 

 

 

3,899

 

 

 

34

 

 

 

3,100

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

117

 

 

$

12,599

 

 

 

78

 

 

$

6,500

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards. All repurchases were made using cash resources.

28


PART I

Item 1

 

Dividends

Our Board of Directors declared the following dividends:

 

Declaration Date

 

Record Date

 

Payment Date

 

 

Dividend

Per Share

 

 

Amount

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fiscal Year 2019

 

 

 

 

 

 

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

September 18, 2018

 

November 15, 2018

 

December 13, 2018

 

 

$

0.46

 

 

$

3,544

 

November 28, 2018

 

February 21, 2019

 

March 14, 2019

 

 

 

0.46

 

 

 

3,526

 

March 11, 2019

 

May 16, 2019

 

June 13, 2019

 

 

 

0.46

 

 

 

3,526

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

$

1.38

 

 

$

10,596

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fiscal Year 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 19, 2017

 

November 16, 2017

 

December 14, 2017

 

 

$

0.42

 

 

$

3,238

 

November 29, 2017

 

February 15, 2018

 

March 8, 2018

 

 

 

0.42

 

 

 

3,232

 

March 12, 2018

 

May 17, 2018

 

June 14, 2018

 

 

 

0.42

 

 

 

3,226

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

$

1.26

 

 

$

9,696

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The dividend declared on March 11, 2019 was included in other current liabilities as of March 31, 2019.

 

29


PART I

Item 1

 

NOTE 16 — ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

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

 

(In millions)

 

Three Months Ended

March 31,

 

 

Nine Months Ended

March 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

$

113

 

 

$

21

 

 

$

173

 

 

$

134

 

Unrealized gains, net of tax of $0, $7, $2, and $8

 

 

31

 

 

 

15

 

 

 

146

 

 

 

30

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reclassification adjustments for gains included in revenue

 

 

(66

)

 

 

(8

)

 

 

(246

)

 

 

(138

)

Tax expense included in provision for income taxes

 

 

2

 

 

 

0

 

 

 

7

 

 

 

2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts reclassified from accumulated other comprehensive income (loss)

 

 

(64

)

 

 

(8

)

 

 

(239

)

 

 

(136

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net change related to derivatives, net of tax of $(2), $7, $(5), and $6

 

 

(33

)

 

 

7

 

 

 

(93

)

 

 

(106

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, end of period

 

$

80

 

 

$

28

 

 

$

80

 

 

$

28

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

$

(297

)

 

$

659

 

 

$

(850

)

 

$

1,825

 

Unrealized gains (losses), net of tax of $189, $(186), $337, and $(347)

 

 

711

 

 

 

(644

)

 

 

1,267

 

 

 

(961

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

4

 

 

 

(517

)

 

 

84

 

 

 

(1,823

)

Tax expense (benefit) included in provision for income taxes

 

 

(1

)

 

 

145

 

 

 

(17

)

 

 

602

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts reclassified from accumulated other comprehensive income (loss)

 

 

3

 

 

 

(372

)

 

 

67

 

 

 

(1,221

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net change related to investments, net of tax of $190, $(331), $354, and $(949)

 

 

714

 

 

 

(1,016

)

 

 

1,334

 

 

 

(2,182

)

Cumulative effect of accounting changes

 

 

0

 

 

 

0

 

 

 

(67

)

 

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, end of period

 

$

417

 

 

$

(357

)

 

$

417

 

 

$

(357

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Translation Adjustments and Other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

$

(1,829

)

 

$

(1,079

)

 

$

(1,510

)

 

$

(1,332

)

Translation adjustments and other, net of tax of $1, $0, $0, and $(1)

 

 

67

 

 

 

255

 

 

 

(252

)

 

 

508

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, end of period

 

$

(1,762

)

 

$

(824

)

 

$

(1,762

)

 

$

(824

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated other comprehensive loss, end of period

 

$

(1,265

)

 

$

(1,153

)

 

$

(1,265

)

 

$

(1,153

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NOTE 17  SEGMENT INFORMATION AND GEOGRAPHIC DATA

In its operation of the business, management, including our chief operating decision maker, who is also our Chief Executive Officer, reviews certain financial information, including segmented internal profit and loss statements prepared on a basis not consistent with GAAP. During the periods presented, we reported our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing.

30


PART I

Item 1

 

Our reportable segments are described below.

Productivity and Business Processes

Our Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises:

 

Office Commercial, including Microsoft Office 365 Commercial subscriptions and Office licensed on-premises, comprising Office, Exchange, SharePoint, Skype for Business, and Microsoft Teams, and related Client Access Licenses (“CALs”).

 

Office Consumer, including Office 365 Consumer subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive.

 

LinkedIn, including Talent Solutions, Marketing Solutions, and Premium Subscriptions.

 

Microsoft Dynamics business solutions, including Dynamics ERP on-premises, Dynamics CRM on-premises, and Dynamics 365, a set of cloud-based applications across ERP and CRM.

Intelligent Cloud

Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business. This segment primarily comprises:

 

Server products and cloud services, including Microsoft SQL Server, Windows Server, Visual Studio, System Center, and related CALs, Microsoft Azure, and GitHub.

 

Enterprise Services, including Premier Support Services and Microsoft Consulting Services.

More Personal Computing

Our More Personal Computing segment consists of products and services geared towards harmonizing the interests of end users, developers, and IT professionals across all devices. This segment primarily comprises:

 

Windows, including Windows original equipment manufacturer (“OEM”) licensing and other non-volume licensing of the Windows operating system; Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings; patent licensing; Windows Internet of Things (“IoT”); and MSN advertising.

 

Devices, including Microsoft Surface, PC accessories, and other intelligent devices.

 

Gaming, including Xbox hardware and Xbox software and services, comprising Xbox Live transactions, subscriptions, and advertising (“Xbox Live”), video games, and third-party video game royalties.

 

Search.

Revenue and costs are generally directly attributed to our segments. However, due to the integrated structure of our business, certain revenue recognized and costs incurred by one segment may benefit other segments. Revenue from certain contracts is allocated among the segments based on the relative value of the underlying products and services, which can include allocation based on actual prices charged, prices when sold separately, or estimated costs plus a profit margin. Cost of revenue is allocated in certain cases based on a relative revenue methodology. Operating expenses that are allocated primarily include those relating to marketing of products and services from which multiple segments benefit and are generally allocated based on relative gross margin.

In addition, certain costs incurred at a corporate level that are identifiable and that benefit our segments are allocated to them. These allocated costs include costs of: legal, including settlements and fines; information technology; human resources; finance; excise taxes; field selling; shared facilities services; and customer service and support. Each allocation is measured differently based on the specific facts and circumstances of the costs being allocated. Certain corporate-level activity is not allocated to our segments, including impairment and restructuring expenses.

31


PART I

Item 1

 

Segment revenue and operating income were as follows during the periods presented:

 

(In millions)

 

Three Months Ended

March 31,

 

Nine Months Ended

 March 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

2019

 

 

 

2018

 

  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

Productivity and Business Processes

 

$

10,242

 

 

$

9,006

 

 

$

30,113

 

 

$

26,197

 

Intelligent Cloud

 

 

9,649

 

 

 

7,896

 

 

 

27,594

 

 

 

22,613

 

More Personal Computing

 

 

10,680

 

 

 

9,917

 

 

 

34,419

 

 

 

31,465

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

30,571

 

 

$

26,819

 

 

$

92,126

 

 

$

80,275

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Productivity and Business Processes

 

$

3,979

 

 

$

3,115

 

 

$

11,875

 

 

$

9,458

 

Intelligent Cloud

 

 

3,208

 

 

 

2,654

 

 

 

9,418

 

 

 

7,623

 

More Personal Computing

 

 

3,154

 

 

 

2,523

 

 

 

9,261

 

 

 

7,598

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

10,341

 

 

$

8,292

 

 

$

30,554

 

 

$

24,679

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

No sales to an individual customer or country other than the United States accounted for more than 10% of revenue for the three or nine months ended March 31, 2019 or 2018. Revenue, classified by the major geographic areas in which our customers were located, was as follows:

 

(In millions)

 

Three Months Ended

March 31,

 

 

Nine Months Ended

March 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

United States (a)

 

$

15,372

 

 

$

13,457

 

 

$

46,899

 

 

$

41,094

 

Other countries

 

 

15,199

 

 

 

13,362

 

 

 

45,227

 

 

 

39,181

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

30,571

 

 

$

26,819

 

 

$

92,126

 

 

$

80,275

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(a)

Includes billings to OEMs and certain multinational organizations because of the nature of these businesses and the impracticability of determining the geographic source of the revenue.

Revenue from external customers, classified by significant product and service offerings, was as follows:

 

(In millions)

 

Three Months Ended

March 31,

 

 

Nine Months Ended

March 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

Office products and cloud services

 

$

7,889

 

 

$

7,088

 

 

$

23,258

 

 

$

20,739

 

Server products and cloud services

 

 

8,053

 

 

 

6,343

 

 

 

22,902

 

 

 

18,139

 

Windows

 

 

4,944

 

 

 

4,612

 

 

 

14,603

 

 

 

14,094

 

Gaming

 

 

2,363

 

 

 

2,251

 

 

 

9,333

 

 

 

8,067

 

Search advertising

 

 

1,911

 

 

 

1,784

 

 

 

5,675

 

 

 

5,243

 

LinkedIn

 

 

1,696

 

 

 

1,335

 

 

 

4,919

 

 

 

3,795

 

Devices

 

 

1,423

 

 

 

1,219

 

 

 

4,632

 

 

 

3,851

 

Enterprise Services

 

 

1,542

 

 

 

1,489

 

 

 

4,513

 

 

 

4,295

 

Other

 

 

750

 

 

 

698

 

 

 

2,291

 

 

 

2,052

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

30,571

 

 

$

26,819

 

 

$

92,126

 

 

$

80,275

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Our commercial cloud revenue, which includes Office 365 Commercial, Azure, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties, was $9.6 billion and $27.1 billion for the three and nine months ended March 31, 2019, respectively, and $6.8 billion and $18.7 billion for the three and nine months ended March 31, 2018, respectively. These amounts are primarily included in Office products and cloud services, Server products and cloud services, and LinkedIn in the table above.

Assets are not allocated to segments for internal reporting presentations. A portion of amortization and depreciation is included with various other costs in an overhead allocation to each segment; it is impracticable for us to separately identify the amount of amortization and depreciation by segment that is included in the measure of segment profit or loss.

 

 

32


PART I

Item 1

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and the Board of Directors of Microsoft Corporation

Results of Review of Interim Financial Information

We have reviewed the accompanying consolidated balance sheet of Microsoft Corporation and subsidiaries (the "Company") as of March 31, 2019, the related consolidated statements of income, comprehensive income, cash flows, and stockholders’ equity for the three-month and nine-month periods ended March 31, 2019 and 2018, and the related notes (collectively referred to as the “interim financial information”).  Based on our reviews, we are not aware of any material modifications that should be made to the accompanying interim financial information for it to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheet of the Company as of June 30, 2018, and the related consolidated statements of income, comprehensive income, cash flows, and stockholders’ equity for the year then ended (not presented herein); and in our report dated August 3, 2018, we expressed an unqualified opinion on those consolidated financial statements and included an explanatory paragraph regarding a change in accounting principles. In our opinion, the information set forth in the accompanying consolidated balance sheet as of June 30, 2018, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

Basis for Review Results

This interim financial information is the responsibility of the Company's management.  We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the PCAOB and the Securities and Exchange Commission.

We conducted our reviews in accordance with standards of the PCAOB. A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the PCAOB, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

/S/ DELOITTE & TOUCHE LLP

Seattle, Washington

April 24, 2019

 

 

 

33


PART I

Item 2

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Note About Forward-Looking Statements

This report includes estimates, projections, statements relating to our business plans, objectives, and expected operating results that are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may appear throughout this report, including the following sections: “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” (Part II, Item 1A of this Form 10-Q). These forward-looking statements generally are identified by the words “believe,” “project,” “expect,” “anticipate,” “estimate,” “intend,” “strategy,” “future,” “opportunity,” “plan,” “may,” “should,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties that may cause actual results to differ materially. We describe risks and uncertainties that could cause actual results and events to differ materially in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Quantitative and Qualitative Disclosures about Market Risk” (Part I, Item 3 of this Form 10-Q), and “Risk Factors”. We undertake no obligation to update or revise publicly any forward-looking statements, whether because of new information, future events, or otherwise.

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand the results of operations and financial condition of Microsoft Corporation. MD&A is provided as a supplement to, and should be read in conjunction with, our Annual Report on Form 10-K for the year ended June 30, 2018, and our financial statements and the accompanying Notes to Financial Statements (Part I, Item 1 of this Form 10-Q).

OVERVIEW

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

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

Highlights from the third quarter of fiscal year 2019 compared with the third quarter of fiscal year 2018 included:

 

Commercial cloud revenue, which includes Microsoft Office 365 Commercial, Microsoft Azure, the commercial portion of LinkedIn, Microsoft Dynamics 365, and other commercial cloud properties, increased 41% to $9.6 billion.

 

Office Commercial revenue increased 12%, driven by Office 365 Commercial growth of 30%.

 

Office Consumer revenue increased 8% and Office 365 Consumer subscribers increased to 34.2 million.

 

LinkedIn revenue increased 27%, with record levels of engagement highlighted by LinkedIn sessions growth of 24%.

 

Dynamics revenue increased 13%, driven by Dynamics 365 growth of 43%.  

 

Server products and cloud services revenue, including GitHub, increased 27%, driven by Azure growth of 73%.  

 

Enterprise Services revenue increased 4%.

 

Windows original equipment manufacturer licensing (“Windows OEM”) revenue increased 9%.

 

Windows Commercial revenue increased 18%.

 

Microsoft Surface revenue increased 21%.

 

Gaming revenue increased 5%, driven by Xbox software and services growth of 12%.

34


PART I

Item 2

 

 

Search advertising revenue, excluding traffic acquisition costs, increased 12%.

We have recast certain prior period commercial cloud metrics to include the commercial portion of LinkedIn to provide a comparable view of our commercial cloud business performance. The commercial portion of LinkedIn includes LinkedIn Recruiter, Sales Navigator, premium business subscriptions, and other services for organizations.

On October 25, 2018, we acquired GitHub, Inc. in a $7.5 billion stock transaction (inclusive of total cash payments of $1.3 billion in respect of vested GitHub equity awards and an indemnity escrow). The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition. GitHub is reported as part of our Intelligent Cloud segment. Refer to Note 7 – Business Combinations of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) for further discussion.

On December 22, 2017, the Tax Cuts and Jobs Act (“TCJA”) was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business. We recorded a provisional net charge of $13.8 billion in the second quarter of fiscal year 2018, and $13.7 billion in fiscal year 2018, related to the TCJA. We adjusted our provisional net charge by recording additional tax expense of $157 million in the second quarter of fiscal year 2019. Refer to Note 11 – Income Taxes of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) for further discussion.

Industry Trends

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

Economic Conditions, Challenges, and Risks

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

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

Our international operations provide a significant portion of our total revenue and expenses. Many of these revenue and expenses are denominated in currencies other than the U.S. dollar. As a result, changes in foreign exchange rates may significantly affect revenue and expenses. Strengthening of foreign currencies relative to the U.S. dollar throughout fiscal year 2018 positively impacted reported revenue and increased reported expenses from our international operations. Strengthening of the U.S. dollar relative to certain foreign currencies did not significantly impact reported revenue or expenses from our international operations in the first and second quarters of fiscal year 2019, and reduced reported revenue and expenses from our international operations in the third quarter of fiscal year 2019.

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

Seasonality

Our revenue fluctuates quarterly and is generally higher in the second and fourth quarters of our fiscal year. Second quarter revenue is driven by corporate year-end spending trends in our major markets and holiday season spending by consumers, and fourth quarter revenue is driven by the volume of multi-year on-premises contracts executed during the period.

35


PART I

Item 2

 

Reportable Segments

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

Additional information on our reportable segments is contained in Note 17 – Segment Information and Geographic Data of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q).

SUMMARY RESULTS OF OPERATIONS

 

(In millions, except percentages and per share amounts)

 

 

Three Months Ended

March 31,

 

 

Percentage

Change

 

 

Nine Months Ended

March 31,

 

 

Percentage

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

30,571

 

 

$

26,819

 

 

 

14%

 

 

$

92,126

 

 

$

80,275

 

 

 

15%

 

Gross margin

 

 

20,401

 

 

 

17,550

 

 

 

16%

 

 

 

59,628

 

 

 

51,664

 

 

 

15%

 

Operating income

 

 

10,341

 

 

 

8,292

 

 

 

25%

 

 

 

30,554

 

 

 

24,679

 

 

 

24%

 

Net income

 

 

8,809

 

 

 

7,424

 

 

 

19%

 

 

 

26,053

 

 

 

7,698

 

 

 

*

 

Diluted earnings per share

 

 

1.14

 

 

 

0.95

 

 

 

20%

 

 

 

3.36

 

 

 

0.99

 

 

 

*

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP net income

 

 

8,809

 

 

 

7,424

 

 

 

19%

 

 

 

26,210

 

 

 

21,498

 

 

 

22%

 

Non-GAAP diluted earnings per share

 

 

1.14

 

 

 

0.95

 

 

 

20%

 

 

 

3.38

 

 

 

2.76

 

 

 

22%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

*

Not meaningful.

Non-GAAP net income and diluted earnings per share (“EPS”) exclude the net charge related to the TCJA. Refer to the Non-GAAP Financial Measures section below for a reconciliation of our financial results reported in accordance with GAAP to non-GAAP financial results.

Three Months Ended March 31, 2019 Compared with Three Months Ended March 31, 2018

Revenue increased $3.8 billion or 14%, driven by growth across each of our segments. Intelligent Cloud revenue increased, driven by server products and cloud services. Productivity and Business Processes revenue increased, driven by Office and LinkedIn. More Personal Computing revenue increased, driven by Windows and Surface.

Gross margin increased $2.9 billion or 16%, driven by growth across each of our segments. Gross margin percentage increased, driven by gross margin percentage improvement in More Personal Computing and Productivity and Business Processes, and favorable segment sales mix. Gross margin included a 5 percentage point improvement in commercial cloud, primarily from Azure.

Operating income increased $2.0 billion or 25%, driven by growth across each of our segments.

Key changes in expenses were:

 

Cost of revenue increased $901 million or 10%, driven by growth in commercial cloud and Surface.

 

Research and development expenses increased $601 million or 16%, driven by investments in cloud engineering, Gaming, GitHub, and LinkedIn.

 

Sales and marketing expenses increased $230 million or 5%, driven by investments in LinkedIn, GitHub, and commercial sales capacity.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 2%. Sales and marketing expenses included a favorable foreign currency impact of 2%.

Nine Months Ended March 31, 2019 Compared with Nine Months Ended March 31, 2018

Revenue increased $11.9 billion or 15%, driven by growth across each of our segments. Intelligent Cloud revenue increased, driven by server products and cloud services. Productivity and Business Processes revenue increased, driven by Office and LinkedIn. More Personal Computing revenue increased, driven by Gaming and Surface.

36


PART I

Item 2

 

Gross margin increased $8.0 billion or 15%, driven by growth across each of our segments. Gross margin percentage increased slightly, due to favorable segment sales mix and gross margin percentage improvement in Intelligent Cloud, offset in part by a gross margin percentage decline in Productivity and Business Processes. Gross margin included a 4 percentage point improvement in commercial cloud, primarily from Azure.

Operating income increased $5.9 billion or 24%, driven by growth across each of our segments.

Key changes in expenses were:

 

Cost of revenue increased $3.9 billion or 14%, driven by growth in commercial cloud, Surface, and Gaming.

 

Research and development expenses increased $1.6 billion or 15%, driven by investments in cloud engineering, LinkedIn, and Gaming.

 

Sales and marketing expenses increased $542 million or 4%, driven by investments in commercial sales capacity, LinkedIn, and GitHub, offset in part by a decrease in marketing. Sales and marketing expenses included a favorable foreign currency impact of 2%.

Current year net income and diluted EPS were negatively impacted by the net charge related to TCJA, which resulted in a decrease to net income and diluted EPS of $157 million and $0.02, respectively. Prior year net income and diluted EPS were negatively impacted by the net charge related to TCJA, which resulted in a decrease to net income and diluted EPS of $13.8 billion and $1.77, respectively.

SEGMENT RESULTS OF OPERATIONS

 

(In millions, except percentages)

 

Three Months Ended

March 31,

 

 

Percentage

Change

 

 

Nine Months Ended

March 31,

 

 

Percentage

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Productivity and Business Processes

 

$

10,242

 

 

$

9,006

 

 

 

14%

 

 

$

30,113

 

 

$

26,197

 

 

 

15%

 

Intelligent Cloud

 

 

9,649

 

 

 

7,896

 

 

 

22%

 

 

 

27,594

 

 

 

22,613

 

 

 

22%

 

More Personal Computing

 

 

10,680

 

 

 

9,917

 

 

 

8%

 

 

 

34,419

 

 

 

31,465

 

 

 

9%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

30,571

 

 

$

26,819

 

 

 

14%

 

 

$

92,126

 

 

$

80,275

 

 

 

15%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Productivity and Business Processes

 

$

3,979

 

 

$

3,115

 

 

 

28%

 

 

$

11,875

 

 

$

9,458

 

 

 

26%

 

Intelligent Cloud

 

 

3,208

 

 

 

2,654

 

 

 

21%

 

 

 

9,418

 

 

 

7,623

 

 

 

24%

 

More Personal Computing

 

 

3,154

 

 

 

2,523

 

 

 

25%

 

 

 

9,261

 

 

 

7,598

 

 

 

22%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

10,341

 

 

$

8,292

 

 

 

25%

 

 

$

30,554

 

 

$

24,679

 

 

 

24%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reportable Segments

Three Months Ended March 31, 2019 Compared with Three Months Ended March 31, 2018

Productivity and Business Processes

Revenue increased $1.2 billion or 14%.

 

Office Commercial revenue increased $737 million or 12%, driven by Office 365 Commercial, due to growth in subscribers and average revenue per user, offset in part by lower revenue from products licensed on-premises, reflecting a continued shift to Office 365 Commercial.

 

Office Consumer revenue increased $76 million or 8%, driven by Office 365 Consumer, due to growth in subscribers, and transactional strength in Japan.

 

LinkedIn revenue increased $361 million or 27%, driven by growth across each line of business.

 

Dynamics revenue increased 13%, driven by Dynamics 365 growth.

37


PART I

Item 2

 

Operating income increased $864 million or 28%.

 

Gross margin increased $1.0 billion or 15% driven by growth in Office Commercial and LinkedIn. Gross margin percentage increased slightly, due to gross margin percentage improvement in LinkedIn and Office 365 Commercial, offset in part by an increased mix of cloud offerings.

 

Operating expenses increased $162 million or 4%, driven by investments in LinkedIn and cloud engineering, offset in part by a decrease in Office advertising.  

Gross margin and operating income included an unfavorable foreign currency impact of 2%. Operating expenses included a favorable foreign currency impact of 2%.

Intelligent Cloud

Revenue increased $1.8 billion or 22%.

 

Server products and cloud services revenue, including GitHub, increased $1.7 billion or 27%, driven by Azure. Azure revenue growth was 73%, due to higher infrastructure-as-a-service and platform-as-a-service consumption-based and per user-based services. Server products revenue increased 7%, due to continued demand for premium versions and hybrid solutions, and GitHub.

 

Enterprise Services revenue increased $53 million or 4%, driven by growth in Premier Support Services.

Operating income increased $554 million or 21%.

 

Gross margin increased $1.2 billion or 21%, driven by growth in server products and cloud services revenue and cloud services scale and efficiencies. Gross margin percentage decreased slightly, due to an increased mix of cloud offerings, offset in part by gross margin percentage improvement in Azure.

 

Operating expenses increased $598 million or 22%, driven by investments in cloud and artificial intelligence (“AI”) engineering, GitHub, and commercial sales capacity.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 2%.

More Personal Computing

Revenue increased $763 million or 8%.

 

Windows revenue increased $332 million or 7%, driven by growth in Windows OEM and Windows Commercial, offset in part by a decrease in patent licensing. Windows OEM revenue increased 9%. Windows OEM Pro revenue increased 15%, driven by improved chip supply that met both unfulfilled second quarter and better than expected third quarter commercial PC demand. Windows OEM non-Pro revenue declined 1%, ahead of the consumer PC market, driven by improved chip supply for premium devices that met both unfulfilled second quarter and third quarter demand. Windows Commercial revenue increased 18%, driven by an increased mix of multi-year agreements that carry higher in-quarter revenue recognition.

 

Surface revenue increased $235 million or 21%, with strong growth across commercial and consumer.

 

Search advertising revenue increased $127 million or 7%. Search advertising revenue, excluding traffic acquisition costs, increased 12%, driven by growth in Bing, due to higher revenue per search.

 

Gaming revenue increased $112 million or 5%, driven by Xbox software and services growth of 12%, primarily due to third-party title strength and subscriptions growth, offset in part by a decline in Xbox hardware of 33% primarily due to a decrease in volume of consoles sold.

Operating income increased $631 million or 25%, including an unfavorable foreign currency impact of 3%.

 

Gross margin increased $673 million or 13%, driven by growth in Windows, Gaming, and Search. Gross margin percentage increased, due to a sales mix shift to higher gross margin businesses in Gaming and Windows. Gross margin included an unfavorable foreign currency impact of 2%.

 

Operating expenses increased $42 million or 1%, driven by an increase in Surface advertising.

38


PART I

Item 2

 

Nine Months Ended March 31, 2019 Compared with Nine Months Ended March 31, 2018

Productivity and Business Processes

Revenue increased $3.9 billion or 15%.

 

Office Commercial revenue increased $2.3 billion or 13%, driven by Office 365 Commercial, due to growth in subscribers and average revenue per user, offset in part by lower revenue from products licensed on-premises, reflecting a continued shift to Office 365 Commercial.

 

Office Consumer revenue increased $229 million or 8%, driven by Office 365 Consumer, due to growth in subscribers.

 

LinkedIn revenue increased $1.1 billion or 30%, driven by growth across each line of business.

 

Dynamics revenue increased 16%, driven by Dynamics 365 growth.

Operating income increased $2.4 billion or 26%.

 

Gross margin increased $2.9 billion or 15%, driven by growth in Office Commercial and LinkedIn. Gross margin percentage decreased slightly, due to an increased mix of cloud offerings, offset in part by gross margin percentage improvement in LinkedIn and Office 365 Commercial.  

 

Operating expenses increased $492 million or 5%, driven by investments in LinkedIn and cloud engineering, offset in part by a decrease in marketing.  

Intelligent Cloud

Revenue increased $5.0 billion or 22%.

 

Server products and cloud services revenue, including GitHub, increased $4.8 billion or 26%, driven by Azure. Azure revenue growth was 75%, due to higher infrastructure-as-a-service and platform-as-a-service consumption-based and per user-based services. Server products revenue increased 7%, due to continued demand for premium versions and hybrid solutions.

 

Enterprise Services revenue increased $218 million or 5%, driven by growth in Premier Support Services and Microsoft Consulting Services.

Operating income increased $1.8 billion or 24%.

 

Gross margin increased $3.5 billion or 23%, driven by growth in server products and cloud services revenue and cloud services scale and efficiencies. Gross margin percentage increased slightly, due to gross margin percentage improvement in Azure, offset in part by an increased mix of cloud offerings.

 

Operating expenses increased $1.7 billion or 22%, driven by investments in cloud and AI engineering, GitHub, and commercial sales capacity.

More Personal Computing

Revenue increased $3.0 billion or 9%.

 

Windows revenue increased $509 million or 4%, driven by growth in Windows Commercial and Windows OEM, offset in part by a decline in patent licensing. Windows Commercial revenue increased 15%, driven by an increased mix of multi-year agreements that carry higher in-quarter revenue recognition. Windows OEM revenue increased 2%. Windows OEM Pro revenue grew 7%, ahead of the commercial PC market. Windows OEM non-Pro revenue declined 6%, in line with the consumer PC market.

 

Gaming revenue increased $1.3 billion or 16%, driven by Xbox software and services growth of 26%, primarily due to third-party title strength, offset in part by a decline in Xbox hardware of 8%.

 

Surface revenue increased $903 million or 26%, with strong growth across consumer and commercial.

 

Search advertising revenue increased $432 million or 8%. Search advertising revenue, excluding traffic acquisition costs, increased 14%, driven by growth in Bing, due to higher revenue per search and search volume.

39


PART I

Item 2

 

Operating income increased $1.7 billion or 22%.

 

Gross margin increased $1.5 billion or 9%, driven by growth in Windows, Gaming, and Search. Gross margin percentage was relatively unchanged, due to sales mix shift to higher gross margin businesses in Gaming, offset by a sales mix shift to our lower gross margin Surface business.

 

Operating expenses decreased $120 million or 1%, driven by a decline in Windows marketing.

OPERATING EXPENSES

Research and Development

 

(In millions, except percentages)

 

Three Months Ended

March 31,

 

 

Percentage

Change

 

 

Nine Months Ended

March 31,

 

 

Percentage

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

$

4,316

 

 

$

3,715

 

 

 

16%

 

 

$

12,363

 

 

$

10,793

 

 

 

15%

 

As a percent of revenue

 

 

14%

 

 

 

14%

 

 

 

0ppt

 

 

 

13%

 

 

 

13%

 

 

 

0ppt

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content.

Three Months Ended March 31, 2019 Compared with Three Months Ended March 31, 2018

Research and development expenses increased $601 million or 16%, driven by investments in cloud engineering, Gaming, GitHub, and LinkedIn.

Nine Months Ended March 31, 2019 Compared with Nine Months Ended March 31, 2018

Research and development expenses increased $1.6 billion or 15%, driven by investments in cloud engineering, LinkedIn, and Gaming.

Sales and Marketing

 

(In millions, except percentages)

 

Three Months Ended

March 31,

 

 

Percentage

Change

 

 

Nine Months Ended

March 31,

 

 

Percentage

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales and marketing

 

$

4,565

 

 

$

4,335

 

 

 

5%

 

 

$

13,251

 

 

$

12,709

 

 

 

4%

 

As a percent of revenue

 

 

15%

 

 

 

16%

 

 

 

(1)ppt

 

 

 

14%

 

 

 

16%

 

 

 

(2)ppt

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

Three Months Ended March 31, 2019 Compared with Three Months Ended March 31, 2018

Sales and marketing expenses increased $230 million or 5%, driven by investments in LinkedIn, GitHub, and commercial sales capacity. Expenses included a favorable foreign currency impact of 2%.

Nine Months Ended March 31, 2019 Compared with Nine Months Ended March 31, 2018

Sales and marketing expenses increased $542 million or 4%, driven by investments in commercial sales capacity, LinkedIn, and GitHub, offset in part by a decrease in marketing. Expenses included a favorable foreign currency impact of 2%.

40


PART I

Item 2

 

General and Administrative

 

(In millions, except percentages)

 

Three Months Ended

March 31,

 

 

Percentage

Change

 

 

Nine Months Ended

March 31,

 

 

Percentage

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

General and administrative

 

$

1,179

 

 

$

1,208

 

 

 

(2)%

 

 

$

3,460

 

 

$

3,483

 

 

 

(1)%

 

As a percent of revenue

 

 

4%

 

 

 

5%

 

 

 

(1)ppt

 

 

 

4%

 

 

 

4%

 

 

 

0ppt

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

Three Months Ended March 31, 2019 Compared with Three Months Ended March 31, 2018

General and administrative expenses decreased slightly.

Nine Months Ended March 31, 2019 Compared with Nine Months Ended March 31, 2018

General and administrative expenses decreased slightly.

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,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

2019

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest and dividends income

 

$

668

 

 

$

575

 

 

$

2,053

 

 

$

1,578

 

Interest expense

 

 

(671

)

 

 

(691

)

 

 

  (2,017

)

 

 

  (2,061

)

Net recognized gains on investments

 

 

44

 

 

 

510

 

 

 

381

 

 

 

1,851

 

Net gains (losses) on derivatives

 

 

51

 

 

 

(72

)

 

 

89

 

 

 

(206

)

Net gains (losses) on foreign currency remeasurements

 

 

37

 

 

 

20

 

 

 

(32

)

 

 

(49

)

Other, net

 

 

16

 

 

 

7

 

 

 

64

 

 

 

2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

145

 

 

$

349

 

 

$

538

 

 

$

1,115

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

Three Months Ended March 31, 2019 Compared with Three Months Ended March 31, 2018

Interest and dividends income increased primarily due to higher yields on fixed-income securities. Interest expense decreased primarily driven by a decrease in outstanding long-term debt due to debt maturities, offset in part by higher finance lease expense. Net recognized gains on investments decreased primarily due to lower gains on sales of equity investments. Net gains on derivatives includes gains on foreign exchange derivatives in the current period as compared to losses in the prior period.

Nine Months Ended March 31, 2019 Compared with Nine Months Ended March 31, 2018

Interest and dividends income increased primarily due to higher yields on fixed-income securities. Interest expense decreased primarily driven by a decrease in outstanding long-term debt due to debt maturities, offset in part by higher finance lease expense. Net recognized gains on investments decreased primarily due to lower gains on sales of equity investments. Net gains on derivatives includes gains on foreign exchange, interest-rate and equity derivatives in the current period as compared to losses in the prior period.

41


PART I

Item 2

 

INCOME TAXES

Effective Tax Rate

Our effective tax rate was 16% and 14% for the three months ended March 31, 2019 and 2018, respectively, and 16% and 70% for the nine months ended March 31, 2019 and 2018, respectively. The increase in our effective tax rate for the three months ended March 31, 2019 compared to the prior year was primarily due to changes in the mix of our income before income taxes between the U.S. and foreign countries. The decrease in our effective tax rate for the nine months ended March 31, 2019 compared to the prior year was primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018.

Our effective tax rate for the three and nine months ended March 31, 2019 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, and tax benefits relating to stock-based compensation.

Tax Cuts and Jobs Act

On December 22, 2017, the TCJA was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business, such as imposing a one-time transition tax on deemed repatriation of deferred foreign income, reducing the U.S. federal statutory tax rate, and adopting a territorial tax system. In fiscal year 2018, the TCJA required us to incur a transition tax on deferred foreign income not previously subject to U.S. income tax at a rate of 15.5% for foreign cash and certain other net current assets, and 8% on the remaining income. The TCJA also reduced the U.S. federal statutory tax rate from 35% to 21% effective January 1, 2018. The TCJA included a provision to tax global intangible low-taxed income (“GILTI”) of foreign subsidiaries and a base erosion anti-abuse tax (“BEAT”) measure that taxes certain payments between a U.S. corporation and its foreign subsidiaries. The GILTI and BEAT provisions of the TCJA were effective for us beginning July 1, 2018.

The TCJA was effective in the second quarter of fiscal year 2018. We recorded a provisional net charge of $13.8 billion in the second quarter of fiscal year 2018, and $13.7 billion for the fiscal year ended June 30, 2018, related to the TCJA based on reasonable estimates for those tax effects. We adjusted our provisional net charge by recording additional tax expense of $157 million in the second quarter of fiscal year 2019 related to GILTI deferred taxes pursuant to SEC Staff Accounting Bulletin No. 118. Refer to Note 11 – Income Taxes of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) for further discussion.

Uncertain Tax Positions

While we settled a portion of the Internal Revenue Service (“IRS”) audit for tax years 2004 to 2006 in the third quarter of fiscal year 2011, a portion of the IRS audit for tax years 2007 to 2009 in the first quarter of fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in the second quarter of fiscal year 2018, we remain under audit for those years. We continue to be subject to examination by the IRS for tax years 2014 to 2017. 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, 2019, the primary unresolved issues for this and other open IRS audits are related to transfer pricing. While we believe our allowances for income tax contingencies related to the unresolved issues are adequate, the final resolution of these issues, if unfavorable, could have a material impact on our consolidated financial statements. 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 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 2018, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.

42


PART I

Item 2

 

NON-GAAP FINANCIAL MEASURES

Non-GAAP net income and diluted earnings per share are non-GAAP financial measures which exclude the net charge related to the TCJA. We believe these non-GAAP measures aid investors by providing additional insight into our operational performance and help clarify trends affecting our business. For comparability of reporting, management considers non-GAAP measures in conjunction with GAAP financial results in evaluating business performance. These non-GAAP financial measures presented should not be considered a substitute for, or superior to, the measures of financial performance prepared in accordance with GAAP.

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

 

(In millions, except percentages and per share amounts)

 

Three Months Ended

March 31,

 

Percentage

Change

 

Nine Months Ended

March 31,

 

Percentage

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

 

 

2019

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

8,809

 

$

7,424

 

 

19%

 

$

26,053

 

$

7,698

 

 

*

 

Net charge related to the TCJA

 

 

0

 

 

0

 

 

*

 

 

157

 

 

13,800

 

 

*

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP net income

 

$

8,809

 

$

7,424

 

 

19%

 

$

26,210

 

$

21,498

 

 

22%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share

 

$

1.14

 

$

0.95

 

 

20%

 

$

3.36

 

$

0.99

 

 

*

 

Net charge related to the TCJA

 

 

0

 

 

0

 

 

*

 

 

0.02

 

 

1.77

 

 

*

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP diluted earnings per share

 

$

1.14

 

$

0.95

 

 

20%

 

$

3.38

 

$

2.76

 

 

22%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

*

Not meaningful.

FINANCIAL CONDITION

Cash, Cash Equivalents, and Investments

Cash, cash equivalents, and short-term investments totaled $131.6 billion and $133.8 billion as of March 31, 2019 and June 30, 2018, respectively. Equity investments were $2.4 billion and $1.9 billion as of March 31, 2019 and June 30, 2018, respectively. Our short-term investments are primarily intended to facilitate liquidity and capital preservation. They consist predominantly of highly liquid investment-grade fixed-income securities, diversified among industries and individual issuers. The investments are predominantly U.S. dollar-denominated securities, but also include foreign currency-denominated securities to diversify risk. Our fixed-income investments are exposed to interest rate risk and credit risk. The credit risk and average maturity of our fixed-income portfolio are managed to achieve economic returns that correlate to certain fixed-income indices. The settlement risk related to these investments is insignificant given that the short-term investments held are primarily highly liquid investment-grade fixed-income securities.

Valuation

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

43


PART I

Item 2

 

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

Cash Flows

Cash from operations increased $3.6 billion to $36.1 billion for the nine months ended March 31, 2019, mainly due to an increase in cash received from customers, offset in part by an increase in cash paid for income taxes and an increase in cash paid to suppliers and employees. Cash used in financing increased $650 million to $28.2 billion for the nine months ended March 31, 2019, mainly due to a $6.6 billion increase in common stock repurchases and an $817 million increase in dividends paid, offset in part by a $6.5 billion decrease in repayments of debt, net of proceeds. Cash used in investing increased $5.1 billion to $8.5 billion for the nine months ended March 31, 2019, mainly due to a $2.2 billion increase in additions to property and equipment, a $1.7 billion increase in cash used for acquisitions of companies, net of cash acquired, and purchases of intangible and other assets, and a $1.3 billion decrease in net investment purchases, sales, and maturities.

Debt

We issue debt to take advantage of favorable pricing and liquidity in the debt markets, reflecting our credit rating and the low interest rate environment. The proceeds of these issuances were or will be used for general corporate purposes, which may include, among other things, funding for working capital, capital expenditures, repurchases of capital stock, acquisitions, and repayment of existing debt. Refer to Note 10 – Debt of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) for further discussion.

Unearned Revenue

Unearned revenue comprises mainly unearned revenue related to volume licensing programs and includes Software Assurance (“SA”) and cloud services. Unearned revenue is generally billed upfront at the beginning of each annual coverage period for multi-year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments for other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service.

The following table outlines the expected future recognition of unearned revenue as of March 31, 2019:

 

(In millions)

 

 

 

 

 

 

 

 

Three Months Ending

 

 

 

 

 

 

June 30, 2019

 

$

11,158

 

September 30, 2019

 

 

6,329

 

December 31, 2019

 

 

4,707

 

March 31, 2020

 

 

2,057

 

Thereafter

 

 

3,884

 

 

 

 

 

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