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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 December 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

 

 

Washington

 

91-1144442

(State of incorporation)

 

(I.R.S. ID)

 

ONE MICROSOFT WAY, REDMOND, washington 98052-6399

(425) 882-8080

www.microsoft.com/investor

 

 

 

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

 

 

 

 

 

 

 

Title of each class

 

Trading Symbol

 

Name of exchange on which registered

 

 

 

 

 

Common stock, $0.00000625 par value per share

 

MSFT

 

NASDAQ

2.125% Notes due 2021

 

MSFT

 

NASDAQ

3.125% Notes due 2028

 

MSFT

 

NASDAQ

2.625% Notes due 2033

 

MSFT

 

NASDAQ

 

 

 

 

 

Securities registered pursuant to Section 12(g) of the Act:

 

 

 

 

 

 

 

 

 

NONE

 

 

 

 

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  January 24, 2020

 

 

 

 

 

Common Stock, $0.00000625 par value per share

 

 

7,606,047,010 shares

 

 

 

 

 


 

MICROSOFT CORPORATION

FORM 10-Q

For the Quarter Ended December 31, 2019

INDEX

 

 

 

Page

PART I.

FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

 

 

 

a)

Income Statements for the Three and Six  Months Ended December 31, 2019 and 2018

3

 

 

 

 

 

 

 

b)

Comprehensive Income Statements for the Three and Six Months Ended December 31, 2019 and 2018

4

 

 

 

 

 

 

 

c)

Balance Sheets as of December 31, 2019 and June 30, 2019

5

 

 

 

 

 

 

 

d)

Cash Flows Statements for the Three and Six Months Ended December 31, 2019 and 2018

6

 

 

 

 

 

 

 

e)

Stockholders’ Equity Statements for the Three and Six Months Ended December 31, 2019 and 2018

7

 

 

 

 

 

 

 

f)

Notes to Financial Statements

8

 

 

 

 

 

 

 

g)

Report of Independent Registered Public Accounting Firm

30

 

 

 

 

 

 

Item 2.

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

31

 

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

46

 

 

 

 

 

 

Item 4.

Controls and Procedures

46

 

 

 

 

 

PART II. 

OTHER INFORMATION

 

 

 

 

 

 

 

Item 1.

Legal Proceedings

47

 

 

 

 

 

 

Item 1A.

Risk Factors

47

 

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

59

 

 

 

 

 

 

Item 6.

Exhibits

60

 

 

 

 

 

SIGNATURE

61

 

 

 

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
December 31,

 

 

Six Months Ended
December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product

 

$

18,255

 

 

$

16,219

 

 

$

34,023

 

 

$

33,518

 

Service and other

 

 

18,651

 

 

 

16,252

 

 

 

35,938

 

 

 

28,037

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

 

36,906

 

 

 

32,471

 

 

 

69,961

 

 

 

61,555

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product

 

 

4,966

 

 

 

5,885

 

 

 

8,271

 

 

 

9,534

 

Service and other

 

 

7,392

 

 

 

6,538

 

 

 

14,493

 

 

 

12,794

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total cost of revenue

 

 

12,358

 

 

 

12,423

 

 

 

22,764

 

 

 

22,328

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross margin

 

 

24,548

 

 

 

20,048

 

 

 

47,197

 

 

 

39,227

 

Research and development

 

 

4,603

 

 

 

4,070

 

 

 

9,168

 

 

 

8,047

 

Sales and marketing

 

 

4,933

 

 

 

4,588

 

 

 

9,270

 

 

 

8,686

 

General and administrative

 

 

1,121

 

 

 

1,132

 

 

 

2,182

 

 

 

2,281

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

 

13,891

 

 

 

10,258

 

 

 

26,577

 

 

 

20,213

 

Other income, net

 

 

194

 

 

 

127

 

 

 

194

 

 

 

393

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

 

14,085

 

 

 

10,385

 

 

 

26,771

 

 

 

20,606

 

Provision for income taxes

 

 

2,436

 

 

 

1,965

 

 

 

4,444

 

 

 

3,362

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

11,649

 

 

$

8,420

 

 

$

22,327

 

 

$

17,244

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

1.53

 

 

$

1.09

 

 

$

2.93

 

 

$

2.24

 

Diluted

 

$

1.51

 

 

$

1.08

 

 

$

2.90

 

 

$

2.22

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

7,621

 

 

 

7,692

 

 

 

7,628

 

 

 

7,683

 

Diluted

 

 

7,691

 

 

 

7,768

 

 

 

7,701

 

 

 

7,767

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Refer to accompanying notes.

3


PART I

Item 1

 

COMPREHENSIVE INCOME STATEMENTS

 

(In millions) (Unaudited)

 

Three Months Ended
December 31,

 

 

Six Months Ended
December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

11,649

 

 

$

8,420

 

 

$

22,327

 

 

$

17,244

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net change related to derivatives

 

 

(4

)

 

 

(15

)

 

 

(6

)

 

 

(60

)

Net change related to investments

 

 

(420

)

 

 

881

 

 

 

157

 

 

 

620

 

Translation adjustments and other

 

 

230

 

 

 

(264

)

 

 

(66

)

 

 

(319

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss)

 

 

(194

)

 

 

602

 

 

 

85

 

 

 

241

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

11,455

 

 

$

9,022

 

 

$

22,412

 

 

$

17,485

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Refer to accompanying notes.

4


PART I

Item 1

 

BALANCE SHEETS

 

(In millions) (Unaudited)

 

 

 

 

 

 

 

 

 

 

December 31,
2019

 

 

June 30,
2019

 

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

8,864

 

 

$

11,356

 

Short-term investments

 

 

125,389

 

 

 

122,463

 

 

 

 

 

 

 

 

 

 

 

 

 

Total cash, cash equivalents, and short-term investments

 

 

134,253

 

 

 

133,819

 

Accounts receivable, net of allowance for doubtful accounts of $384 and $411

 

 

23,525

 

 

 

29,524

 

Inventories

 

 

1,823

 

 

 

2,063

 

Other current assets

 

 

7,473

 

 

 

10,146

 

 

 

 

 

 

 

 

 

 

 

 

 

Total current assets

 

 

167,074

 

 

 

175,552

 

Property and equipment, net of accumulated depreciation of $39,597 and $35,330

 

 

40,522

 

 

 

36,477

 

Operating lease right-of-use assets

 

 

8,439

 

 

 

7,379

 

Equity investments

 

 

2,755

 

 

 

2,649

 

Goodwill

 

 

42,248

 

 

 

42,026

 

Intangible assets, net

 

 

7,126

 

 

 

7,750

 

Other long-term assets

 

 

14,630

 

 

 

14,723

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

282,794

 

 

$

286,556

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

8,811

 

 

$

9,382

 

Current portion of long-term debt

 

 

6,247

 

 

 

5,516

 

Accrued compensation

 

 

5,421

 

 

 

6,830

 

Short-term income taxes

 

 

2,687

 

 

 

5,665

 

Short-term unearned revenue

 

 

27,343

 

 

 

32,676

 

Other current liabilities

 

 

9,131

 

 

 

9,351

 

 

 

 

 

 

 

 

 

 

 

 

 

Total current liabilities

 

 

59,640

 

 

 

69,420

 

Long-term debt

 

 

63,361

 

 

 

66,662

 

Long-term income taxes

 

 

28,754

 

 

 

29,612

 

Long-term unearned revenue

 

 

3,878

 

 

 

4,530

 

Deferred income taxes

 

 

222

 

 

 

233

 

Operating lease liabilities

 

 

7,172

 

 

 

6,188

 

Other long-term liabilities

 

 

9,658

 

 

 

7,581

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities

 

 

172,685

 

 

 

184,226

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

 

Common stock and paid-in capital – shares authorized 24,000; outstanding 7,611 and 7,643

 

 

79,625

 

 

 

78,520

 

Retained earnings

 

 

30,739

 

 

 

24,150

 

Accumulated other comprehensive loss

 

 

(255

)

 

 

(340

)

 

 

 

 

 

 

 

 

 

 

 

 

Total stockholders’ equity

 

 

110,109

 

 

 

102,330

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

282,794

 

 

$

286,556

 

 

 

 

 

 

 

 

 

 

 

Refer to accompanying notes.

 

5


PART I

Item 1

 

CASH FLOWS STATEMENTS

 

(In millions) (Unaudited)

 

Three Months Ended

December 31,

 

 

 

Six Months Ended

December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

2019

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

Operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

11,649

 

 

$

8,420

 

 

$

22,327

 

 

$

17,244

 

Adjustments to reconcile net income to net cash from operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation, amortization, and other

 

 

3,203

 

 

 

2,995

 

 

 

6,174

 

 

 

5,832

 

Stock-based compensation expense

 

 

1,340

 

 

 

1,183

 

 

 

2,602

 

 

 

2,290

 

Net recognized gains on investments and derivatives

 

 

(203

)

 

 

(135

)

 

 

(192

)

 

 

(375

)

Deferred income taxes

 

 

(53

)

 

 

(173

)

 

 

(230

)

 

 

(420

)

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(4,203

)

 

 

(2,396

)

 

 

5,887

 

 

 

6,798

 

Inventories

 

 

799

 

 

 

1,654

 

 

 

238

 

 

 

698

 

Other current assets

 

 

165

 

 

 

(173

)

 

 

(273

)

 

 

(850

)

Other long-term assets

 

 

(517

)

 

 

(473

)

 

 

(850

)

 

 

(452

)

Accounts payable

 

 

(7

)

 

 

(440

)

 

 

(554

)

 

 

(835

)

Unearned revenue

 

 

(2,936

)

 

 

(2,122

)

 

 

(5,828

)

 

 

(4,563

)

Income taxes

 

 

(471

)

 

 

(64

)

 

 

(3,807

)

 

 

(1,155

)

Other current liabilities

 

 

1,489

 

 

 

656

 

 

 

(1,831

)

 

 

(1,666

)

Other long-term liabilities

 

 

425

 

 

 

(32

)

 

 

835

 

 

 

11

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash from operations

 

 

10,680

 

 

 

8,900

 

 

 

24,498

 

 

 

22,557

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financing

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Repayments of debt

 

 

(18

)

 

 

(3,000

)

 

 

(2,518

)

 

 

(3,000

)

Common stock issued

 

 

234

 

 

 

200

 

 

 

661

 

 

 

560

 

Common stock repurchased

 

 

(5,206

)

 

 

(6,413

)

 

 

(10,118

)

 

 

(10,157

)

Common stock cash dividends paid

 

 

(3,886

)

 

 

(3,544

)

 

 

(7,396

)

 

 

(6,764

)

Other, net

 

 

(39

)

 

 

(459

)

 

 

247

 

 

 

(1,239

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash used in financing

 

 

(8,915

)

 

 

(13,216

)

 

 

(19,124

)

 

 

(20,600

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investing

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Additions to property and equipment

 

 

(3,545

)

 

 

(3,707

)

 

 

(6,930

)

 

 

(7,309

)

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

 

 

(80

)

 

 

(1,593

)

 

 

(542

)

 

 

(1,838

)

Purchases of investments

 

 

(19,011

)

 

 

(16,858

)

 

 

(42,401

)

 

 

(36,409

)

Maturities of investments

 

 

11,230

 

 

 

3,782

 

 

 

30,312

 

 

 

8,996

 

Sales of investments

 

 

5,370

 

 

 

14,176

 

 

 

11,749

 

 

 

29,407

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash used in investing

 

 

(6,036

)

 

 

(4,200

)

 

 

(7,812

)

 

 

(7,153

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Effect of foreign exchange rates on cash and cash equivalents

 

 

18

 

 

 

17

 

 

 

(54

)

 

 

(112

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net change in cash and cash equivalents

 

 

(4,253

)

 

 

(8,499

)

 

 

(2,492

)

 

 

(5,308

)

Cash and cash equivalents, beginning of period

 

 

13,117

 

 

 

15,137

 

 

 

11,356

 

 

 

11,946

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

8,864

 

 

$

6,638

 

 

$

8,864

 

 

$

6,638

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Refer to accompanying notes.

 

6


PART I

Item 1

 

STOCKHOLDERS’ EQUITY STATEMENTS

 

(In millions) (Unaudited)

 

Three Months Ended

December 31,

 

 

 

Six Months Ended

December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock and paid-in capital

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

$

78,882

 

 

$

71,303

 

 

$

78,520

 

 

$

71,223

 

 

Common stock issued

 

 

234

 

 

 

5,887

 

 

 

661

 

 

 

6,247

 

 

Common stock repurchased

 

 

(831

)

 

 

(828

)

 

 

(2,157

)

 

 

(2,215

)

 

Stock-based compensation expense

 

 

1,340

 

 

 

1,183

 

 

 

2,602

 

 

 

2,290

 

 

Other, net

 

 

0

 

 

 

11

 

 

 

(1

)

 

 

11

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, end of period

 

 

79,625

 

 

 

77,556

 

 

 

79,625

 

 

 

77,556

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retained earnings

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

 

27,240

 

 

 

17,279

 

 

 

24,150

 

 

 

13,682

 

 

Net income

 

 

11,649

 

 

 

8,420

 

 

 

22,327

 

 

 

17,244

 

 

Common stock cash dividends

 

 

(3,875

)

 

 

(3,546

)

 

 

(7,762

)

 

 

(7,074

)

 

Common stock repurchased

 

 

(4,275

)

 

 

(5,568

)

 

 

(7,976

)

 

 

(7,944

)

 

Cumulative effect of accounting changes

 

 

0

 

 

 

0

 

 

 

0

 

 

 

677

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, end of period

 

 

30,739

 

 

 

16,585

 

 

 

30,739

 

 

 

16,585

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated other comprehensive income (loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

 

(61

)

 

 

(2,615

)

 

 

(340

)

 

 

(2,187

)

 

Other comprehensive income (loss)

 

 

(194

)

 

 

602

 

 

 

85

 

 

 

241

 

 

Cumulative effect of accounting changes

 

 

0

 

 

 

0

 

 

 

0

 

 

 

(67

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, end of period

 

 

(255

)

 

 

(2,013

)

 

 

(255

)

 

 

(2,013

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total stockholders’ equity

 

$

110,109

 

 

$

92,128

 

 

$

110,109

 

 

$

92,128

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared per common share

 

$

0.51

 

 

$

0.46

 

 

$

1.02

 

 

$

0.92

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 2019 Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”) on August 1, 2019.

 

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 uncertain tax positions that have been recognized in 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.

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. 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.

8


PART I

Item 1

 

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.

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. Gains and losses representing hedge components excluded from the assessment of effectiveness are recognized in other income (expense), net.

For derivative instruments designated as cash flow hedges, gains and losses are initially reported as a component of other comprehensive income and subsequently recognized in earnings with the corresponding hedged item. Gains and losses representing hedge components excluded from the assessment of effectiveness are recognized in earnings.

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.

 

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, municipal securities, 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.

9


PART I

Item 1

 

Contract Balances

As of December 31, 2019 and June 30, 2019, long-term accounts receivable, net of allowance for doubtful accounts, was $2.4 billion and $2.2 billion, respectively, and is included in other long-term assets in our consolidated balance sheets.

Recent Accounting Guidance

Recently Adopted Accounting Guidance

Financial Instruments – Targeted Improvements to Accounting for Hedging Activities

In August 2017, the Financial Accounting Standards Board (“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. We adopted the standard effective July 1, 2019. As we did not hold derivative instruments requiring an adjustment upon adoption, there was no impact in our consolidated financial statements. Adoption of the standard enhanced the presentation of the effects of our hedging instruments and the hedged items in our consolidated financial statements to increase the understandability of the results of our hedging strategies.

Recent Accounting Guidance Not Yet Adopted

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 adopted upon the effective date for us beginning July 1, 2020. 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 have evaluated the impact of this standard in our consolidated financial statements, including accounting policies, processes, and systems, and based on current market conditions, we do not expect the impact to be material upon adoption.

Accounting for Income Taxes

In December 2019, the FASB issued a new standard to simplify the accounting for income taxes. The guidance eliminates certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of deferred tax liabilities for outside basis differences related to changes in ownership of equity method investments and foreign subsidiaries. The guidance also simplifies aspects of accounting for franchise taxes and enacted changes in tax laws or rates, and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The standard will be effective for us beginning July 1, 2021, with early adoption permitted. We are currently evaluating the impact of this standard in 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.

10


PART I

Item 1

 

The components of basic and diluted EPS were as follows:

 

(In millions, except earnings per share)

 

Three Months Ended

December 31,

 

 

 

Six Months Ended

December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

2019

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income available for common shareholders (A)

 

$

11,649

 

 

$

8,420

 

 

$

22,327

 

 

$

17,244

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average outstanding shares of common stock (B)

 

 

7,621

 

 

 

7,692

 

 

 

7,628

 

 

 

7,683

 

Dilutive effect of stock-based awards

 

 

70

 

 

 

76

 

 

 

73

 

 

 

84

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock and common stock equivalents (C)

 

 

7,691

 

 

 

7,768

 

 

 

7,701

 

 

 

7,767

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings Per Share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic (A/B)

 

$

1.53

 

 

$

1.09

 

 

$

2.93

 

 

$

2.24

 

Diluted (A/C)

 

$

1.51

 

 

$

1.08

 

 

$

2.90

 

 

$

2.22

 

 

 

 

 

 

 

 

 

 

 

 

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
December 31,

 

 

Six Months Ended
December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

2019

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest and dividends income

 

$

688

 

 

$

704

 

 

$

1,412

 

 

$

1,385

 

Interest expense

 

 

(654

)

 

 

(672

)

 

 

(1,291

)

 

 

(1,346

)

Net recognized gains on investments

 

 

162

 

 

 

94

 

 

 

105

 

 

 

337

 

Net gains on derivatives

 

 

41

 

 

 

41

 

 

 

87

 

 

 

38

 

Net losses on foreign currency remeasurements

 

 

(24

)

 

 

(74

)

 

 

(82

)

 

 

(69

)

Other, net

 

 

(19

)

 

 

34

 

 

 

(37

)

 

 

48

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

194

 

 

$

127

 

 

$

194

 

 

$

393

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Recognized Gains (Losses) on Investments

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

 

(In millions)

 

Three Months Ended
December 31,

 

 

Six Months Ended
December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

2019

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Realized gains from sales of available-for-sale securities

 

$

14

 

 

$

6

 

 

$

21

 

 

$

13

 

Realized losses from sales of available-for-sale securities

 

 

(6

)

 

 

(5

)

 

 

(10

)

 

 

(90

)

Other-than-temporary impairments of investments

 

 

(1

)

 

 

(7

)

 

 

(5

)

 

 

(7

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

7

 

 

$

(6

)

 

$

6

 

 

$

(84

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

(In millions)

 

Three Months Ended

December 31,

 

Six Months Ended

December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net realized gains on investments sold

 

$

53

 

 

$

30

 

 

$

75

 

 

$

233

 

Net unrealized gains on investments still held

 

 

111

 

 

 

73

 

 

 

55

 

 

 

191

 

Impairments of investments

 

 

(9

)

 

 

(3

)

 

 

(31

)

 

 

(3

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

155

 

 

$

100

 

 

$

99

 

 

$

421

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

11


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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Changes in Fair Value Recorded in Other Comprehensive Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial paper

 

Level 2

 

 

$

3,966

 

 

$

0

 

 

$

0

 

 

$

3,966

 

 

$

1,742

 

 

$

2,224

 

 

$

0

 

Certificates of deposit

 

Level 2

 

 

 

2,591

 

 

 

0

 

 

 

0

 

 

 

2,591

 

 

 

1,548

 

 

 

1,043

 

 

 

0

 

U.S. government securities

 

Level 1

 

 

 

102,567

 

 

 

1,995

 

 

 

(105

)

 

 

104,457

 

 

 

0

 

 

 

104,457

 

 

 

0

 

U.S. agency securities

 

Level 2

 

 

 

399

 

 

 

0

 

 

 

0

 

 

 

399

 

 

 

0

 

 

 

399

 

 

 

0

 

Foreign government bonds

 

Level 2

 

 

 

6,605

 

 

 

5

 

 

 

(10

)

 

 

6,600

 

 

 

680

 

 

 

5,920

 

 

 

0

 

Mortgage- and asset-backed securities

 

Level 2

 

 

 

3,862

 

 

 

12

 

 

 

(2

)

 

 

3,872

 

 

 

0

 

 

 

3,872

 

 

 

0

 

Corporate notes and bonds

 

Level 2

 

 

 

6,900

 

 

 

130

 

 

 

(7

)

 

 

7,023

 

 

 

0

 

 

 

7,023

 

 

 

0

 

Corporate notes and bonds

 

Level 3

 

 

 

13

 

 

 

0

 

 

 

0

 

 

 

13

 

 

 

0

 

 

 

13

 

 

 

0

 

Municipal securities

 

Level 2

 

 

 

289

 

 

 

49

 

 

 

0

 

 

 

338

 

 

 

0

 

 

 

338

 

 

 

0

 

Municipal securities

 

Level 3

 

 

 

78

 

 

 

0

 

 

 

0

 

 

 

78

 

 

 

0

 

 

 

78

 

 

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total debt investments

 

 

 

 

$

127,270

 

 

$

2,191

 

 

$

(124

)

 

$

129,337

 

 

$

3,970

 

 

$

125,367

 

 

$

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Changes in Fair Value Recorded in Net Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity investments

 

Level 1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

1,074

 

 

$

618

 

 

$

0

 

 

$

456

 

Equity investments

 

Other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2,299

 

 

 

0

 

 

 

0

 

 

 

2,299

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total equity investments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

3,373

 

 

$

618

 

 

$

0

 

 

$

2,755

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

4,276

 

 

$

4,276

 

 

$

0

 

 

$

0

 

Derivatives, net (a)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

22

 

 

 

0

 

 

 

22

 

 

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

137,008

 

 

$

8,864

 

 

$

125,389

 

 

$

2,755

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

12


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, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Changes in Fair Value Recorded in Other Comprehensive Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial paper

 

Level 2

 

 

$

2,211

 

 

$

0

 

 

$

0

 

 

$

2,211

 

 

$

1,773

 

 

$

438

 

 

$

0

 

Certificates of deposit

 

Level 2

 

 

 

2,018

 

 

 

0

 

 

 

0

 

 

 

2,018

 

 

 

1,430

 

 

 

588

 

 

 

0

 

U.S. government securities

 

Level 1

 

 

 

104,925

 

 

 

1,854

 

 

 

(104

)

 

 

106,675

 

 

 

769

 

 

 

105,906

 

 

 

0

 

U.S. agency securities

 

Level 2

 

 

 

988

 

 

 

0

 

 

 

0

 

 

 

988

 

 

 

698

 

 

 

290

 

 

 

0

 

Foreign government bonds

 

Level 2

 

 

 

6,350

 

 

 

4

 

 

 

(8

)

 

 

6,346

 

 

 

2,506

 

 

 

3,840

 

 

 

0

 

Mortgage- and asset-backed securities

 

Level 2

 

 

 

3,554

 

 

 

10

 

 

 

(3

)

 

 

3,561

 

 

 

0

 

 

 

3,561

 

 

 

0

 

Corporate notes and bonds

 

Level 2

 

 

 

7,437

 

 

 

111

 

 

 

(7

)

 

 

7,541

 

 

 

0

 

 

 

7,541

 

 

 

0

 

Corporate notes and bonds

 

Level 3

 

 

 

15

 

 

 

0

 

 

 

0

 

 

 

15

 

 

 

0

 

 

 

15

 

 

 

0

 

Municipal securities

 

Level 2

 

 

 

242

 

 

 

48

 

 

 

0

 

 

 

290

 

 

 

0

 

 

 

290

 

 

 

0

 

Municipal securities

 

Level 3

 

 

 

7

 

 

 

0

 

 

 

0

 

 

 

7

 

 

 

0

 

 

 

7

 

 

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total debt investments

 

 

 

 

$

127,747

 

 

$

2,027

 

 

$

(122

)

 

$

129,652

 

 

$

7,176

 

 

$

122,476

 

 

$

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Changes in Fair Value Recorded in Net Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity investments

 

Level 1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

973

 

 

$

409

 

 

$

0

 

 

$

564

 

Equity investments

 

Other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2,085

 

 

 

0

 

 

 

0

 

 

 

2,085

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total equity investments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

3,058

 

 

$

409

 

 

$

0

 

 

$

2,649

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

3,771

 

 

$

3,771

 

 

$

0

 

 

$

0

 

Derivatives, net (a)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(13

)

 

 

0

 

 

 

(13

)

 

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

136,468

 

 

$

11,356

 

 

$

122,463

 

 

$

2,649

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(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 December 31, 2019 and June 30, 2019, equity investments without readily determinable fair values measured at cost with adjustments for observable changes in price or impairments were $1.3 billion and $1.2 billion, respectively.

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agency securities

 

$

7,650

 

 

$

(97

)

 

$

9,121

 

 

$

(8

)

 

$

16,771

 

 

$

(105

)

Foreign government bonds

 

 

2,545

 

 

 

(3

)

 

 

11

 

 

 

(7

)

 

 

2,556

 

 

 

(10

)

Mortgage- and asset-backed securities

 

 

684

 

 

 

(1

)

 

 

408

 

 

 

(1

)

 

 

1,092

 

 

 

(2

)

Corporate notes and bonds

 

 

220

 

 

 

(3

)

 

 

137

 

 

 

(4

)

 

 

357

 

 

 

(7

)

Municipal securities

 

 

0

 

 

 

0

 

 

 

1

 

 

 

0

 

 

 

1

 

 

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

11,099

 

 

$

(104

)

 

$

9,678

 

 

$

(20

)

 

$

20,777

 

 

$

(124

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

13


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, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agency securities

 

$

1,491

 

 

$

(1

)

 

$

39,158

 

 

$

(103

)

 

$

40,649

 

 

$

(104

)

Foreign government bonds

 

 

25

 

 

 

0

 

 

 

77

 

 

 

(8

)

 

 

102

 

 

 

(8

)

Mortgage- and asset-backed securities

 

 

664

 

 

 

(1

)

 

 

378

 

 

 

(2

)

 

 

1,042

 

 

 

(3

)

Corporate notes and bonds

 

 

498

 

 

 

(3

)

 

 

376

 

 

 

(4

)

 

 

874

 

 

 

(7

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

2,678

 

 

$

(5

)

 

$

39,989

 

 

$

(117

)

 

$

42,667

 

 

$

(122

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

Due in one year or less

 

$

40,357

 

 

$

40,381

 

Due after one year through five years

 

 

48,195

 

 

 

49,166

 

Due after five years through 10 years

 

 

37,123

 

 

 

38,138

 

Due after 10 years

 

 

1,595

 

 

 

1,652

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

127,270

 

 

$

129,337

 

 

 

 

 

 

 

 

 

 

 

NOTE 5 — DERIVATIVES

We use derivative instruments to manage risks related to foreign currencies, interest rates, equity prices, 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.

Foreign currency risks related to certain non-U.S. dollar-denominated investments are hedged using foreign exchange forward contracts that are designated as fair value hedging instruments. Foreign currency risks related to certain Euro-denominated debt are hedged using foreign exchange forward contracts that are designated as cash flow hedging instruments.

In the past, option and forward contracts were used to hedge a portion of forecasted international revenue and were designated as cash flow hedging instruments. Principal currencies hedged included the Euro, Japanese yen, British pound, Canadian dollar, and Australian dollar.

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. 

Interest Rate

Interest rate risks related to certain fixed-rate debt are hedged using interest rate swaps that are designated as fair value hedging instruments to effectively convert the fixed interest rates to floating interest rates.

14


PART I

Item 1

 

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. These contracts are not designated as hedging instruments and are included in “Other contracts” in the tables below.

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. These contracts are not designated as hedging instruments and are included in “Other contracts” in the tables below.

Credit

Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We use credit default swap contracts to manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. These contracts are not designated as hedging instruments and are included in “Other contracts” in the tables below.

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 December 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)

 

December 31,

2019

 

 

June 30,

2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts purchased

 

$

438

 

 

$

0

 

Foreign exchange contracts sold

 

 

6,440

 

 

 

6,034

 

Interest rate contracts purchased

 

 

1,187

 

 

 

0

 

 

 

 

 

 

 

 

 

 

Not Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts purchased

 

 

11,460

 

 

 

14,889

 

Foreign exchange contracts sold

 

 

11,738

 

 

 

15,614

 

Other contracts purchased

 

 

1,715

 

 

 

2,007

 

Other contracts sold

 

 

463

 

 

 

456

 

 

 

 

 

 

 

 

 

 

 

15


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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,

2019

 

 

June 30,

2019

 

Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

$

33

 

 

$

(24

)

 

$

0

 

 

$

(93

)

Interest rate contracts

 

 

0

 

 

 

(11

)

 

 

0

 

 

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Not Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

 

165

 

 

 

(148

)

 

 

204

 

 

 

(172

)

Other contracts

 

 

33

 

 

 

(4

)

 

 

46

 

 

 

(7

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross amounts of derivatives

 

 

231

 

 

 

(187

)

 

 

250

 

 

 

(272

)

Gross amounts of derivatives offset in the balance sheet

 

 

(85

)

 

 

86

 

 

 

(113

)

 

 

114

 

Cash collateral received

 

 

 0

 

 

 

(93

)

 

 

 0

 

 

 

(78

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net amounts of derivatives

 

$

146

 

 

$

(194

)

 

$

137

 

 

$

(236

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reported as

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Short-term investments

 

$

22

 

 

$

0

 

 

$

(13

)

 

$

0

 

Other current assets

 

 

133

 

 

 

0

 

 

 

146

 

 

 

0

 

Other long-term assets

 

 

(9

)

 

 

0

 

 

 

4

 

 

 

0

 

Other current liabilities

 

 

0

 

 

 

(150

)

 

 

0

 

 

 

(221

)

Other long-term liabilities

 

 

0

 

 

 

(44

)

 

 

0

 

 

 

(15

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

146

 

 

$

(194

)

 

$

137

 

 

$

(236

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross derivative assets and liabilities subject to legally enforceable master netting agreements for which we have elected to offset were $227 million and $187 million, respectively, as of December 31, 2019, and $247 million and $272 million, respectively, as of June 30, 2019.  

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

 

(In millions)

 

Level 1

 

 

 

Level 2

 

 

Level 3

 

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative assets

 

$

1

 

 

$

227

 

 

$

3

 

 

$

231

 

Derivative liabilities

 

 

0

 

 

 

(187

)

 

 

0

 

 

 

(187

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative assets

 

 

0

 

 

 

247

 

 

 

3

 

 

 

250

 

Derivative liabilities

 

 

0

 

 

 

(272

)

 

 

0

 

 

 

(272

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

16


PART I

Item 1

 

Gains (losses) on derivative instruments recognized in our consolidated income statements were as follows:

 

 

 

Three Months Ended

December 31,

 

 

Six Months Ended

December 31,

 

 

 

2019

 

 

2018

 

 

2019

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(In millions)

 

Revenue

 

 

Other
Income

(Expense),
Net

 

 

Revenue

 

 

Other
Income

(Expense),
Net

 

 

Revenue

 

 

Other

Income

(Expense),

Net

 

 

Revenue

 

 

Other

Income

(Expense),

Net

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Designated as Fair Value Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives

 

$

0

 

 

$

23

 

 

$

0

 

 

$

(184

)

 

$

0

 

 

$

53

 

 

$

0

 

 

$

(62

)

Hedged items

 

 

0

 

 

 

(26

)

 

 

0

 

 

 

184

 

 

 

0

 

 

 

(59

)

 

 

0

 

 

 

62

 

Excluded from effectiveness assessment

 

 

0

 

 

 

42

 

 

 

0

 

 

 

45

 

 

 

0

 

 

 

83

 

 

 

0

 

 

 

73

 

Interest rate contracts

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives

 

 

0

 

 

 

(14

)

 

 

0

 

 

 

0

 

 

 

0

 

 

 

(13

)

 

 

0

 

 

 

0

 

Hedged items

 

 

0

 

 

 

13

 

 

 

0

 

 

 

0

 

 

 

0

 

 

 

12

 

 

 

0

 

 

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Designated as Cash Flow Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amount reclassified from accumulated other comprehensive income

 

 

0

 

 

 

8

 

 

 

88

 

 

 

0

 

 

 

0

 

 

 

3

 

 

 

180

 

 

 

0

 

Excluded from effectiveness assessment

 

 

0

 

 

 

0

 

 

 

0

 

 

 

(14

)

 

 

0

 

 

 

0

 

 

 

0

 

 

 

(41

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Not Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

 

0

 

 

 

52

 

 

 

0

 

 

 

(79

)

 

 

0

 

 

 

(119

)

 

 

0

 

 

 

(109

)

Other contracts

 

 

0

 

 

 

1

 

 

 

0

 

 

 

8

 

 

 

0

 

 

 

2

 

 

 

0

 

 

 

5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gains (losses), net of tax, on derivative instruments recognized in our consolidated comprehensive income statements were as follows:

 

(In millions)

 

Three Months Ended

December 31,

 

 

Six Months Ended

December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Designated as Cash Flow Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Included in effectiveness assessment

 

$

2

 

 

$

70

 

 

$

(4

)

 

$

114

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NOTE 6 — INVENTORIES

The components of inventories were as follows:

 

(In millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,

2019

 

 

June 30,

2019

 

 

 

 

Raw materials

 

$

409

 

 

$

399

 

Work in process

 

 

49

 

 

 

53

 

Finished goods

 

 

1,365

 

 

 

1,611

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

1,823

 

 

$

2,063

 

 

 

 

 

 

 

 

 

 

 

17


PART I

Item 1

 

NOTE 7 — GOODWILL

Changes in the carrying amount of goodwill were as follows:

 

(In millions)

 

June 30,

2019

 

 

Acquisitions

 

 

Other

 

 

December 31,

2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Productivity and Business Processes

 

$

24,277

 

 

$

7

 

 

$

(18

)

 

$

24,266

 

Intelligent Cloud

 

 

11,351

 

 

 

118

 

 

 

19

 

 

 

11,488

 

More Personal Computing

 

 

6,398

 

 

 

96

 

 

 

0

 

 

 

6,494

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

42,026

 

 

$

221

 

 

$

1

 

 

$

42,248

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 8  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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,

2019

 

 

June 30,

2019

 

 

 

 

 

 

 

 

Technology-based

 

$

7,821

 

 

$

(6,097

)

 

$

1,724

 

 

$

7,691

 

 

$

(5,771

)

 

$

1,920

 

Customer-related

 

 

4,673

 

 

 

(2,030

)

 

 

2,643

 

 

 

4,709

 

 

 

(1,785

)

 

 

2,924

 

Marketing-related

 

 

4,157

 

 

 

(1,453

)

 

 

2,704

 

 

 

4,165

 

 

 

(1,327

)

 

 

2,838

 

Contract-based

 

 

475

 

 

 

(420

)

 

 

55

 

 

 

574

 

 

 

(506

)

 

 

68

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

  17,126

 

 

$

  (10,000

)

 

$

7,126

 

 

$

  17,139

 

 

$

  (9,389

)

 

$

7,750

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Intangible assets amortization expense was $411 million and $845 million for the three and six months ended December 31, 2019, respectively, and $530 million and $1.1 billion for the three and six months ended December 31, 2018, respectively.

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

 

(In millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ending June 30,

 

 

 

 

 

 

2020 (excluding the six months ended December 31, 2019)

 

$

687

 

2021

 

 

1,346

 

2022

 

 

1,246

 

2023

 

 

1,088

 

2024

 

 

757

 

Thereafter

 

 

2,002

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

7,126

 

 

 

 

 

 

 

18


PART I

Item 1

 

NOTE 9  DEBT

The components of debt were as follows:

 

(In millions, issuance by calendar year)

 

Maturities

(calendar year)

 

Stated Interest

Rate

 

 

Effective Interest

Rate

 

 

December 31,

2019

 

 

June 30,

2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2009 issuance of $3.8 billion

 

 

 

 

2039

 

 

 

 

5.20%

 

 

 

 

5.24%

 

 

$

750

 

 

$

750

 

2010 issuance of $4.8 billion

 

 

2020

2040

 

 

3.00%

4.50%

 

 

3.14%

4.57%

 

 

 

2,000

 

 

 

2,000

 

2011 issuance of $2.3 billion

 

 

2021

2041

 

 

4.00%

5.30%

 

 

4.08%

5.36%

 

 

 

1,500

 

 

 

1,500

 

2012 issuance of $2.3 billion

 

 

2022

2042

 

 

2.13%

3.50%

 

 

2.24%

3.57%

 

 

 

1,650

 

 

 

1,650

 

2013 issuance of $5.2 billion

 

 

2023

2043

 

 

2.38%

4.88%

 

 

2.47%

4.92%

 

 

 

3,500

 

 

 

3,500

 

2013 issuance of €4.1 billion

 

 

2021

2033

 

 

2.13%

3.13%

 

 

2.23%

3.22%

 

 

 

4,546

 

 

 

4,613

 

2014 issuance

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

0

 

 

 

18

 

2015 issuance of $23.8 billion

 

 

2020

2055

 

 

1.85%

4.75%

 

 

1.93%

4.78%

 

 

 

22,000

 

 

 

22,000

 

2016 issuance of $19.8 billion

 

 

2021

2056

 

 

1.55%

3.95%

 

 

1.64%

4.03%

 

 

 

17,250

 

 

 

19,750

 

2017 issuance of $17.0 billion

 

 

2020

2057

 

 

1.85%

4.50%

 

 

1.95%

4.53%

 

 

 

17,000

 

 

 

17,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total face value

 

 

 

 

 

 

 

 

 

 

 

 

70,196

 

 

 

72,781

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unamortized discount and issuance costs

 

 

 

 

 

 

 

 

 

 

 

 

(577

)

 

 

(603

)

Hedge fair value adjustments (a)

 

 

 

 

 

 

 

 

 

 

 

 

(11

)

 

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total debt

 

 

 

 

 

 

 

 

 

 

 

 

69,608

 

 

 

72,178

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current portion of long-term debt

 

 

 

 

 

 

 

 

 

 

 

 

(6,247

)

 

 

(5,516

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Long-term debt

 

 

 

 

 

 

 

 

 

 

 

$

63,361

 

 

$

66,662

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 (a)

Refer to Note 5 – Derivatives for further information on the interest rate swaps related to fixed-rate debt.

As of December 31, 2019 and June 30, 2019, the estimated fair value of long-term debt, including the current portion, was $78.0 billion and $78.9 billion, respectively. The estimated fair values are based on Level 2 inputs.

Debt in the table above is comprised of senior unsecured obligations and ranks equally with our other outstanding obligations. Interest is paid semi-annually, except for the Euro-denominated debt, which is paid annually.

The following table outlines maturities of our long-term debt for each of the next five years and thereafter as of December 31, 2019:

 

(In millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ending June 30,

 

 

 

 

 

 

 

 

 

2020 (excluding the six months ended December 31, 2019)

 

$

3,000

 

2021

 

 

3,750

 

2022

 

 

7,964

 

2023

 

 

2,750

 

2024

 

 

5,250

 

Thereafter

 

 

47,482

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

70,196

 

 

 

 

 

 

 

19


PART I

Item 1

 

NOTE 10 — INCOME TAXES

Tax Cuts and Jobs Act

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 related to the enactment of the TCJA in fiscal year 2018 and adjusted the provisional net charge by recording additional tax expense of $157 million in the second quarter of fiscal year 2019 pursuant to SEC Staff Accounting Bulletin No. 118.

Effective Tax Rate

Our effective tax rate was 17% and 19% for the three months ended December 31, 2019 and 2018, respectively, and 17% and 16% for the six months ended December 31, 2019 and 2018, respectively. The decrease in our effective tax rate for the three months ended December 31, 2019 compared to the prior year was primarily due to the adjustment of the provisional net charge related to the TCJA in the second quarter of fiscal year 2019. The increase in our effective tax rate for the six months ended December 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, offset in part by the adjustment of the provisional net charge related to the TCJA.

Our effective tax rate was lower than the U.S. federal statutory rate for the three and six months ended December 31, 2019, primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland and Puerto Rico, and tax benefits relating to stock-based compensation.

Uncertain Tax Positions

As of December 31, 2019 and June 30, 2019, unrecognized tax benefits and other income tax liabilities were $16.0 billion and $15.3 billion, respectively, and are included in long-term income taxes in our consolidated balance sheets.

We settled a portion of the Internal Revenue Service (“IRS”) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. We remain under audit for tax years 2004 to 2013. We expect the IRS to begin an examination of tax years 2014 to 2017 within the next 12 months.

As of December 31, 2019, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact in our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved 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 2019, 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.

20


PART I

Item 1

 

NOTE 11 — UNEARNED REVENUE

Unearned revenue by segment was as follows:

 

(In millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,
2019

 

 

June 30,
2019

 

 

 

 

Productivity and Business Processes

 

$

14,266

 

 

$

16,831

 

Intelligent Cloud

 

 

13,766

 

 

 

16,988

 

More Personal Computing

 

 

3,189

 

 

 

3,387

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

31,221

 

 

$

37,206

 

 

 

 

 

 

 

 

 

 

 

Changes in unearned revenue were as follows:

 

(In millions)

 

 

 

 

 

 

 

Six Months Ended December 31, 2019

 

 

 

Balance, beginning of period

 

$

37,206

 

Deferral of revenue

 

 

31,108

 

Recognition of unearned revenue

 

 

(37,093

)

 

 

 

 

 

 

 

Balance, end of period

 

$

31,221

 

 

 

 

 

 

 

Revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods, was $93 billion as of December 31, 2019, of which $90 billion is related to the commercial portion of revenue. We expect to recognize approximately 50% of this 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 remaining performance obligations that will be recognized beyond the next 12 months.

 

 

NOTE 12  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
December 31,

 

 

Six Months Ended
December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating lease cost

 

$

478

 

 

$

413

 

 

$

943

 

 

$

823

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Finance lease cost:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amortization of right-of-use assets

 

$

163

 

 

$

84

 

 

$

288

 

 

$

162

 

Interest on lease liabilities

 

 

84

 

 

 

59

 

 

 

162

 

 

 

114

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total finance lease cost

 

$

247

 

 

$

143

 

 

$

450

 

 

$

276

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

21


PART I

Item 1

 

Supplemental cash flow information related to leases was as follows:

 

(In millions)

 

Three Months Ended
December 31,

 

 

Six Months Ended
December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating cash flows from operating leases

 

$

479

 

 

$

407

��

 

$

932

 

 

$

804

 

Operating cash flows from finance leases

 

 

84

 

 

 

59

 

 

 

162

 

 

 

114

 

Financing cash flows from finance leases

 

 

104

 

 

 

54

 

 

 

183

 

 

 

101

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating leases

 

 

948

 

 

 

472

 

 

 

1,931

 

 

 

968

 

Finance leases

 

 

863

 

 

 

645

 

 

 

2,352

 

 

 

1,064

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Supplemental balance sheet information related to leases was as follows:

 

(In millions, except lease term and discount rate)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,
2019

 

 

June 30,
2019

 

 

 

 

Operating Leases

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating lease right-of-use assets

 

$

8,439

 

 

$

7,379

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other current liabilities

 

$

1,616

 

 

$

1,515

 

Operating lease liabilities

 

 

7,172

 

 

 

6,188

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total operating lease liabilities

 

$

8,788

 

 

$

7,703

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Finance Leases

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property and equipment, at cost

 

$

9,403

 

 

$

7,041

 

Accumulated depreciation

 

 

(1,062

)

 

 

(774

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property and equipment, net

 

$

8,341

 

 

$

6,267

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other current liabilities

 

$

464

 

 

$

317

 

Other long-term liabilities

 

 

8,287

 

 

 

6,257

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total finance lease liabilities

 

$

8,751

 

 

$

6,574

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted Average Remaining Lease Term

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating leases

 

 

7 years

 

 

 

7 years

 

Finance leases

 

 

13 years

 

 

 

13 years

 

 

 

 

 

 

 

 

 

 

Weighted Average Discount Rate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating leases

 

 

2.8%

 

 

 

3.0%

 

Finance leases

 

 

4.1%

 

 

 

4.6%

 

 

 

 

 

 

 

 

 

 

 

22


PART I

Item 1

 

Maturities of lease liabilities were as follows:

 

(In millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ending June 30,

 

Operating Leases

 

 

Finance Leases

 

 

 

 

2020 (excluding the six months ended December 31, 2019)

 

$

966

 

 

$

393

 

2021

 

 

1,705

 

 

 

804

 

2022

 

 

1,507

 

 

 

819

 

2023

 

 

1,306

 

 

 

827

 

2024

 

 

1,084

 

 

 

838

 

Thereafter

 

 

3,394

 

 

 

7,619

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total lease payments

 

 

9,962

 

 

 

11,300

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less imputed interest

 

 

(1,174

)

 

 

(2,549

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

8,788

 

 

$

8,751

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2019, we have additional operating and finance leases, primarily for datacenters, that have not yet commenced of $2.4 billion and $4.2 billion, respectively. These operating and finance leases will commence between fiscal year 2020 and fiscal year 2022 with lease terms of 1 year to 16 years.

 

 

NOTE 13 — CONTINGENCIES

Patent and Intellectual Property Claims

There were 50 patent infringement cases pending against Microsoft as of December 31, 2019, none of which are material individually or in aggregate.

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 once the court approves the form of notice to the class.

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.

23


PART I

Item 1

 

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 scheduled for June 2020.

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. In December 2019, the U.S. Court of Appeals for the Ninth Circuit affirmed the denial of class certification.

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 in 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 December 31, 2019, we accrued aggregate legal liabilities of $319 million. While we intend to defend these matters vigorously, adverse outcomes that we estimate could reach approximately $900 million in aggregate beyond recorded amounts are reasonably possible. Were unfavorable final outcomes to occur, there exists the possibility of a material adverse impact in our consolidated financial statements for the period in which the effects become reasonably estimable.

24


PART I

Item 1

 

NOTE 14  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 December 31, 2019, $2.8 billion remained of this $40.0 billion share repurchase program.

On September 18, 2019, our Board of Directors approved a share repurchase program authorizing up to $40.0 billion in share repurchases. This share repurchase program will commence following completion of the program approved on September 20, 2016, has no expiration date, and may be terminated at any time.

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

 

(In millions)

 

Shares

 

Amount

 

 

Shares

 

Amount

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fiscal Year

 

 

 

 

2020

 

 

 

 

 

2019

 

 

 

 

 

 

First Quarter

 

 

29

 

 

$

4,000

 

 

 

24

 

 

$

2,600

 

Second Quarter

 

 

32

 

 

 

4,600

 

 

 

57

 

 

 

6,100

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

61

 

 

$

8,600

 

 

 

81

 

 

$

8,700

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The shares repurchased were under the share repurchase program approved on September 20, 2016. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards of $551 million and $1.5 billion for the three and six months ended December 31, 2019, respectively, and $313 million and $1.5 billion for the three and six months ended December 31, 2018, respectively. All repurchases were made using cash resources.

Dividends

Our Board of Directors declared the following dividends:

 

Declaration Date

 

Record Date

 

Payment Date

 

 

Dividend

Per Share

 

 

Amount

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fiscal Year 2020

 

 

 

 

 

 

 

 

 

(In millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

September 18, 2019

 

November 21, 2019

 

December 12, 2019

 

 

$

0.51

 

 

$

3,886

 

December 4, 2019

 

February 20, 2020

 

March 12, 2020

 

 

 

0.51

 

 

 

3,881

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

$

1.02

 

 

$

7,767

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fiscal Year 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

$

0.92

 

 

$

7,070

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The dividend declared on December 4, 2019 was included in other current liabilities as of December 31, 2019.

25


PART I

Item 1

 

NOTE 15 — ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

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

 

(In millions)

 

Three Months Ended
December 31,

 

Six Months Ended

December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

$

(2

)

 

$

128

 

 

$

0

 

 

$

173

 

Unrealized gains (losses), net of tax of $1, $3, $(1), and $2

 

 

2

 

 

 

71

 

 

 

(4

)

 

 

115

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reclassification adjustments for gains included in earnings

 

 

(8

)

 

 

(88

)

 

 

(3

)

 

 

(180

)

Tax expense included in provision for income taxes

 

 

2

 

 

 

2

 

 

 

1

 

 

 

5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts reclassified from accumulated other comprehensive income (loss)

 

 

(6

)

 

 

(86

)

 

 

(2

)

 

 

(175

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net change related to derivatives, net of tax of $(1), $1, $(2), and $(3)

 

 

(4

)

 

 

(15

)

 

 

(6

)

 

 

(60

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, end of period

 

$

(6

)

 

$

113

 

 

$

(6

)

 

$

113

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

$

2,065

 

 

$

(1,178

)

 

$

1,488

 

 

$

(850

)

Unrealized gains (losses), net of tax of $(111), $234, $45, and $148

 

 

(414

)

 

 

879

 

 

 

162

 

 

 

556

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

(7

)

 

 

2

 

 

 

(6

)

 

 

80

 

Tax expense (benefit) included in provision for income taxes

 

 

1

 

 

 

0

 

 

 

1

 

 

 

(16

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts reclassified from accumulated other comprehensive income (loss)

 

 

(6

)

 

 

2

 

 

 

(5

)

 

 

64

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net change related to investments, net of tax of $(112), $234, $44, and $164

 

 

(420

)

 

 

881

 

 

 

157

 

 

 

620

 

Cumulative effect of accounting changes

 

 

0

 

 

 

0

 

 

 

0

 

 

 

(67

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, end of period

 

$

1,645

 

 

$

(297

)

 

$

1,645

 

 

$

(297

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Translation Adjustments and Other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

$

(2,124

)

 

$

(1,565

)

 

$

(1,828

)

 

$

(1,510

)

Translation adjustments and other, net of tax of $0, $(1), $(8), and $(1)

 

 

230

 

 

 

(264

)

 

 

(66

)

 

 

(319

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, end of period

 

$

(1,894

)

 

$

(1,829

)

 

$

(1,894

)

 

$

(1,829

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated other comprehensive loss, end of period

 

$

(255

)

 

$

(2,013

)

 

$

(255

)

 

$

(2,013

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

26


PART I

Item 1

 

NOTE 16  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.

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

 

Office Consumer, including Office 365 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.

 

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

Intelligent Cloud

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

 

Server products and cloud services, including Microsoft Azure; Microsoft SQL Server, Windows Server, Visual Studio, System Center, and related CALs; 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 that put customers at the center of the experience with our technology. 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 and PC accessories.

 

Gaming, including Xbox hardware and Xbox content and services, comprising Xbox Live transactions, subscriptions, cloud services, 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.

27


PART I

Item 1

 

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.

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

 

(In millions)

 

Three Months Ended
December 31,

 

 

Six Months Ended
December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Productivity and Business Processes

 

$

11,826

 

 

$

10,100

 

 

$

22,903

 

 

$

19,871

 

Intelligent Cloud

 

 

11,869

 

 

 

9,378

 

 

 

22,714

 

 

 

17,945

 

More Personal Computing

 

 

13,211

 

 

 

12,993

 

 

 

24,344

 

 

 

23,739

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

36,906

 

 

$

32,471

 

 

$

69,961

 

 

$

61,555

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Productivity and Business Processes

 

$

5,182

 

 

$

4,015

 

 

$

9,964

 

 

$

7,896

 

Intelligent Cloud

 

 

     4,531

 

 

 

3,279

 

 

 

8,420

 

 

 

6,210

 

More Personal Computing

 

 

4,178

 

 

 

2,964

 

 

 

8,193

 

 

 

6,107

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

13,891

 

 

$

10,258

 

 

$

26,577

 

 

$

20,213

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

No sales to an individual customer or country other than the United States accounted for more than 10% of revenue for the three or six months ended December 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
December 31,

 

 

Six Months Ended
December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

United States (a)

 

$

19,149

 

 

$

16,787

 

 

$

36,419

 

 

$

31,527

 

Other countries

 

 

17,757

 

 

 

15,684

 

 

 

33,542

 

 

 

30,028

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

36,906

 

 

$

32,471

 

 

$

69,961

 

 

$

61,555

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(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
December 31,

 

 

Six Months Ended
December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

Server products and cloud services

 

$

10,119

 

 

$

7,791

 

 

$

19,311

 

 

$

14,849

 

Office products and cloud services

 

 

8,983

 

 

 

7,747

 

 

 

17,449

 

 

 

15,369

 

Windows

 

 

5,593

 

 

 

4,758

 

 

 

10,946

 

 

 

9,659

 

Gaming

 

 

3,327

 

 

 

4,232

 

 

 

5,869

 

 

 

6,970

 

Search advertising

 

 

2,163

 

 

 

1,976

 

 

 

4,154

 

 

 

3,764

 

LinkedIn

 

 

2,102

 

 

 

1,693

 

 

 

4,011

 

 

 

3,223

 

Devices

 

 

2,048

 

 

 

1,948

 

 

 

3,250

 

 

 

3,209

 

Enterprise Services

 

 

1,612

 

 

 

1,521

 

 

 

3,157

 

 

 

2,971

 

Other

 

 

959

 

 

 

805

 

 

 

1,814

 

 

 

1,541

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

36,906

 

 

$

32,471

 

 

$

69,961

 

 

$

61,555

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

28


PART I

Item 1

 

Our commercial cloud revenue, which includes Office 365 Commercial, Azure, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties, was $12.5 billion and $24.1 billion for the three and six months ended December 31, 2019, respectively, and $9.0 billion and $17.5 billion for the three and six months ended December 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.

 

29


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 December 31, 2019, the related consolidated statements of income, comprehensive income, cash flows, and stockholders’ equity for the three-month and six-month periods ended December 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, 2019, 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 1, 2019, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of June 30, 2019, 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

January 29, 2020

 

 

 

30


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, 2019, 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 offering a wide range of cloud-based and other services to people and businesses; licensing and supporting an array of software products; designing, manufacturing, and selling devices; and delivering relevant online advertising to a global audience. Our most significant expenses are related to compensating employees; designing, manufacturing, marketing, and selling our products and services; datacenter costs in support of our cloud-based services; and income taxes.

Highlights from the second quarter of fiscal year 2020 compared with the second quarter of fiscal year 2019 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 39% to $12.5 billion.

 

Office Commercial revenue increased 16%, driven by Office 365 Commercial growth of 27%.

 

Office Consumer revenue increased 19%, and Office 365 Consumer subscribers increased to 37.2 million.

 

LinkedIn revenue increased 24%.

 

Dynamics revenue increased 12%, driven by Dynamics 365 growth of 42%.

 

Server products and cloud services revenue increased 30%, driven by Azure growth of 62%.

 

Enterprise Services revenue increased 6%.

 

Windows original equipment manufacturer licensing (“Windows OEM”) revenue increased 18%.

 

Windows Commercial revenue increased 25%.

 

Search advertising revenue, excluding traffic acquisition costs, increased 6%.

 

Microsoft Surface revenue increased 6%.

 

Xbox content and services revenue decreased 11%.

31


PART I

Item 2

 

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 the U.S. dollar relative to certain foreign currencies reduced reported revenue and expenses from our international operations in the first and second quarter of fiscal year 2020.

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.

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 16 – Segment Information and Geographic Data of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q).

32


PART I

Item 2

 

SUMMARY RESULTS OF OPERATIONS

 

(In millions, except percentages and per share amounts)

 

 

Three Months Ended

December 31,

 

 

Percentage

Change

 

 

Six Months Ended
December 31,

 

 

Percentage
Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

36,906

 

 

$

32,471

 

 

 

14%

 

 

$

69,961

 

 

$

61,555

 

 

 

14%

 

Gross margin

 

 

     24,548

 

 

 

20,048

 

 

 

22%

 

 

 

47,197

 

 

 

39,227

 

 

 

20%

 

Operating income

 

 

13,891

 

 

 

10,258

 

 

 

35%

 

 

 

26,577

 

 

 

20,213

 

 

 

31%

 

Net income

 

 

11,649

 

 

 

     8,420

 

 

 

38%

 

 

 

22,327

 

 

 

17,244

 

 

 

29%

 

Diluted earnings per share

 

 

1.51

 

 

 

1.08

 

 

 

40%

 

 

 

2.90

 

 

 

2.22

 

 

 

31%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP net income

 

 

11,649

 

 

 

8,577

 

 

 

36%

 

 

 

22,327

 

 

 

17,401

 

 

 

28%

 

Non-GAAP diluted earnings per share

 

 

1.51

 

 

 

1.10

 

 

 

37%

 

 

 

2.90

 

 

 

2.24

 

 

 

29%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP net income and diluted earnings per share (“EPS”) exclude the net charge related to the Tax Cuts and Jobs Act (“TCJA”) of $157 million in the second quarter of fiscal year 2019. 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.

The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition on October 25, 2018.

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

Revenue increased $4.4 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, offset in part by a decrease in Gaming.

Gross margin increased $4.5 billion or 22%, driven by growth across each of our segments. Gross margin percentage increased, driven by sales mix shift to higher margin businesses. Gross margin included a 5-point improvement in commercial cloud, primarily from Azure.

Operating income increased $3.6 billion or 35%, driven by growth across each of our segments.

Key changes in expenses were:

 

Cost of revenue decreased $65 million or 1%, driven by a decline in Gaming, offset in part by growth in commercial cloud.

 

Research and development expenses increased $533 million or 13%, driven by investments in cloud engineering, LinkedIn, and Gaming.

 

Sales and marketing expenses increased $345 million or 8%, driven by investments in LinkedIn and commercial sales.

 

General and administrative expenses decreased $11 million or 1%.

Gross margin and operating income included an unfavorable foreign currency impact of 3% and 4%, respectively.

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

Six Months Ended December 31, 2019 Compared with Six Months Ended December 31, 2018

Revenue increased $8.4 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, offset in part by a decrease in Gaming.

33


PART I

Item 2

 

Gross margin increased $8.0 billion or 20%, driven by growth across each of our segments. Gross margin percentage increased, driven by sales mix shift to higher margin businesses. Gross margin included a 5-point improvement in commercial cloud, primarily from Azure.

Operating income increased $6.4 billion or 31%, driven by growth across each of our segments.

Key changes in expenses were:

 

Cost of revenue increased $436 million or 2%, driven by growth in commercial cloud, offset in part by a decline in Gaming.

 

Research and development expenses increased $1.1 billion or 14%, driven by investments in cloud engineering, LinkedIn, Gaming, and GitHub.

 

Sales and marketing expenses increased $584 million or 7%, driven by investments in LinkedIn and commercial sales.

 

General and administrative expenses decreased $99 million or 4%.

Gross margin and operating income included an unfavorable foreign currency impact of 3% and 5%, respectively.

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

SEGMENT RESULTS OF OPERATIONS

 

(In millions, except percentages)

 

Three Months Ended

December 31,

 

 

Percentage

Change

 

 

Six Months Ended
December 31,

 

 

Percentage
Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Productivity and Business Processes

 

$

11,826

 

 

$

10,100

 

 

 

17%

 

 

$

22,903

 

 

$

19,871

 

 

 

15%

 

Intelligent Cloud

 

 

11,869

 

 

 

9,378

 

 

 

27%

 

 

 

22,714

 

 

 

17,945

 

 

 

27%

 

More Personal Computing

 

 

13,211

 

 

 

12,993

 

 

 

2%

 

 

 

24,344

 

 

 

23,739

 

 

 

3%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

36,906

 

 

$

32,471

 

 

 

14%

 

 

$

69,961

 

 

$

61,555

 

 

 

14%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Productivity and Business Processes

 

$

5,182

 

 

$

4,015

 

 

 

29%

 

 

$

9,964

 

 

$

7,896

 

 

 

26%

 

Intelligent Cloud

 

 

4,531

 

 

 

3,279

 

 

 

38%

 

 

 

8,420

 

 

 

6,210

 

 

 

36%

 

More Personal Computing

 

 

4,178

 

 

 

2,964

 

 

 

41%

 

 

 

8,193

 

 

 

6,107

 

 

 

34%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

13,891

 

 

$

10,258

 

 

 

35%

 

 

$

26,577

 

 

$

20,213

 

 

 

31%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reportable Segments

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

Productivity and Business Processes

Revenue increased $1.7 billion or 17%.

 

Office Commercial revenue increased $1.1 billion or 16%, driven by Office 365 Commercial growth of 27%, due to growth in seats and revenue per user.

 

Office Consumer revenue increased $190 million or 19%, driven by Office 365 recurring subscription revenue and transactional strength in Japan, as well as a benefit from a low prior year comparable.

 

LinkedIn revenue increased $409 million or 24%, driven by continued strength across all businesses.

 

Dynamics revenue increased 12%, driven by Dynamics 365 growth of 42%.

34


PART I

Item 2

 

Operating income increased $1.2 billion or 29%.

 

Gross margin increased $1.6 billion or 21%, driven by growth in Office 365 Commercial and LinkedIn. Gross margin percentage increased, due to gross margin percentage improvement in Office 365 Commercial and LinkedIn, offset in part by an increased mix of cloud offerings.

 

Operating expenses increased $442 million or 12%, driven by investments in LinkedIn and cloud engineering.  

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 2%, 2%, and 4%, respectively.

Intelligent Cloud

Revenue increased $2.5 billion or 27%.

 

Server products and cloud services revenue increased $2.3 billion or 30%, driven by Azure. Azure revenue grew 62%, due to higher infrastructure-as-a-service and platform-as-a-service consumption-based services and per user-based services. Server products revenue increased 10%, due to hybrid and premium solutions, as well as demand related to Windows Server 2008 end of support.

 

Enterprise Services revenue increased $91 million or 6%, driven by growth in Premier Support Services.

Operating income increased $1.3 billion or 38%.

 

Gross margin increased $1.8 billion or 28%, driven by growth in server products and cloud services revenue and cloud services scale and efficiencies. Gross margin percentage increased, due to gross margin percentage improvement in Azure, offset in part by an increased mix of cloud offerings.

 

Operating expenses increased $575 million or 18%, driven by investments in Azure.

Gross margin and operating income included an unfavorable foreign currency impact of 3% and 4%, respectively.

More Personal Computing

Revenue increased $218 million or 2%.

 

Windows revenue increased $835 million or 18%, driven by growth in Windows OEM and Windows Commercial. Windows OEM revenue increased 18%, ahead of PC market growth that was impacted in the prior year by chip supply constraints. Windows OEM Pro revenue grew 26%, driven by continued momentum in advance of Windows 7 end of support and healthy Windows 10 demand, in addition to the benefit from the low prior year comparable. Windows OEM non-Pro revenue grew 4%, driven by the benefit from the low prior year comparable and the timing of license purchases, offset in part by continued pressure in the entry-level category. Windows Commercial revenue increased 25%, primarily driven by an increase in Microsoft 365 agreements, which carry higher in-quarter revenue recognition.

 

Search advertising revenue increased $187 million or 9%. Search advertising revenue, excluding traffic acquisition costs, increased 6%, driven by higher revenue per search.

 

Surface revenue increased $116 million or 6%, driven by commercial growth.

 

Gaming revenue decreased $905 million or 21%. Xbox hardware revenue decreased 43%, primarily due to a decrease in volume and price of consoles sold. Xbox content and services revenue decreased $295 million or 11%, against a high prior year comparable primarily from a third-party title, offset in part by growth in subscriptions.

Operating income increased $1.2 billion or 41%.

 

Gross margin increased $1.1 billion or 18%, driven by growth in Windows and Surface. Gross margin percentage increased, due to sales mix shift to higher margin businesses.

 

Operating expenses decreased $150 million or 5%, driven by the redeployment of engineering resources, offset in part by investments in Gaming, primarily in first-party content.

Gross margin and operating income included an unfavorable foreign currency impact of 2% and 4%, respectively.

35


PART I

Item 2

 

Six Months Ended December 31, 2019 Compared with Six Months Ended December 31, 2018

Productivity and Business Processes

Revenue increased $3.0 billion or 15%.

 

Office Commercial revenue increased $1.9 billion or 14%, driven by Office 365 Commercial growth of 26%, due to growth in seats and revenue per user.

 

Office Consumer revenue increased $241 million or 12%, driven by Office 365 recurring subscription revenue and transactional strength in Japan.

 

LinkedIn revenue increased $788 million or 24%, driven by continued strength across all businesses.

 

Dynamics revenue increased 13%, driven by Dynamics 365 growth of 41%.

Operating income increased $2.1 billion or 26%.

 

Gross margin increased $2.8 billion or 19%, driven by growth in Office 365 Commercial and LinkedIn. Gross margin percentage increased, 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 $729 million or 10%, driven by investments in LinkedIn and cloud engineering.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 2%, 2%, and 4%, respectively.

Intelligent Cloud

Revenue increased $4.8 billion or 27%.

 

Server products and cloud services revenue increased $4.5 billion or 30%, driven by Azure. Azure revenue grew 61%, due to higher infrastructure-as-a-service and platform-as-a-service consumption-based services and per user-based services. Server products revenue increased 11%, due to hybrid and premium solutions, demand related to Microsoft SQL Server 2008 and Windows Server 2008 end-of-support, and GitHub.

 

Enterprise Services revenue increased $186 million or 6%, driven by growth in Premier Support Services.

Operating income increased $2.2 billion or 36%.

 

Gross margin increased $3.4 billion or 28%, 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 $1.2 billion or 20%, driven by investments in Azure, as well as GitHub.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 2%, 2%, and 4%, respectively.

More Personal Computing

Revenue increased $605 million or 3%.

 

Windows revenue increased $1.3 billion or 13%, driven by growth in Windows OEM and Windows Commercial. Windows OEM revenue increased 13%, ahead of PC market growth that was impacted in the prior year by chip supply constraints. Windows OEM Pro revenue grew 22%, driven by continued momentum in advance of Windows 7 end of support and healthy Windows 10 demand, in addition to the benefit from the low prior year comparable. Windows OEM non-Pro revenue declined 1%, driven by continued pressure in the entry-level category, offset in part by the benefit from the low prior year comparable. Windows Commercial revenue increased 26%, driven by an increase in Microsoft 365 agreements, which carry higher in-quarter revenue recognition.

 

Search advertising revenue increased $390 million or 10%. Search advertising revenue, excluding traffic acquisition costs, increased 8%, driven by higher revenue per search.

36


PART I

Item 2

 

 

Surface revenue increased $72 million or 2%, driven by commercial growth, offset in part by a decline in consumer.

 

Gaming revenue decreased $1.1 billion or 16%, driven by a decrease in Xbox hardware of 40%, primarily due to a decrease in volume and price of consoles sold. Xbox content and services revenue decreased $302 million or 6%, against a high prior year comparable primarily from a third-party title, offset in part by growth in subscriptions.

Operating income increased $2.1 billion or 34%.

 

Gross margin increased $1.8 billion or 15%, driven by growth in Windows. Gross margin percentage increased, due to sales mix shift to higher margin businesses.

 

Operating expenses decreased $334 million or 6%, driven by the redeployment of engineering resources.

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

OPERATING EXPENSES

Research and Development

 

(In millions, except percentages)

 

Three Months Ended

December 31,

 

 

Percentage

Change

 

 

Six Months Ended
December 31,

 

 

Percentage
Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

$

4,603

 

 

$

4,070

 

 

 

13%

 

 

$

9,168

 

 

$

8,047

 

 

 

14%

 

As a percent of revenue

 

 

12%

 

 

 

13%

 

 

 

(1)ppt

 

 

 

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

Research and development expenses increased $533 million or 13%, driven by investments in cloud engineering,  LinkedIn, and Gaming.

Six Months Ended December 31, 2019 Compared with Six Months Ended December 31, 2018

Research and development expenses increased $1.1 billion or 14%, driven by investments in cloud engineering, LinkedIn, Gaming, and GitHub.

Sales and Marketing

 

(In millions, except percentages)

 

Three Months Ended

December 31,

 

 

Percentage

Change

 

 

Six Months Ended
December 31,

 

 

Percentage
Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

 

 

 

2019

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales and marketing

 

$

4,933

 

 

$

4,588

 

 

 

8%

 

 

$

9,270

 

 

$

8,686

 

 

 

7%

 

As a percent of revenue

 

 

13%

 

 

 

14%

 

 

 

(1)ppt

 

 

 

13%

 

 

 

14%

 

 

 

(1)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 December 31, 2019 Compared with Three Months Ended December 31, 2018

Sales and marketing expenses increased $345 million or 8%, driven by investments in LinkedIn and commercial sales.

37


PART I

Item 2

 

Six Months Ended December 31, 2019 Compared with Six Months Ended December 31, 2018

Sales and marketing expenses increased $584 million or 7%, driven by investments in LinkedIn and commercial sales.

General and Administrative

 

(In millions, except percentages)

 

Three Months Ended

December 31,

 

 

Percentage

Change

 

 

Six Months Ended

December 31,

 

 

Percentage

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

 

 

 

2019

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

General and administrative

 

$

1,121

 

 

$

1,132

 

 

 

(1)%

 

 

$

2,182

 

 

$

2,281

 

 

 

(4)%

 

As a percent of revenue

 

 

3%

 

 

 

3%

 

 

 

0ppt

 

 

 

3%

 

 

 

4%

 

 

 

(1)ppt

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

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

General and administrative expenses decreased $11 million or 1%.

Six Months Ended December 31, 2019 Compared with Six Months Ended December 31, 2018

General and administrative expenses decreased $99 million or 4%.

OTHER INCOME (EXPENSE), NET

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

 

(In millions)

 

Three Months Ended

December 31,

 

 

Six Months Ended

December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

2018

 

 

2019

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest and dividends income

 

$

688

 

 

$

704

 

 

$

1,412

 

 

$

1,385

 

Interest expense

 

 

(654

)

 

 

(672

)

 

 

(1,291

)

 

 

(1,346

)

Net recognized gains on investments

 

 

162

 

 

 

94

 

 

 

105

 

 

 

337

 

Net gains on derivatives

 

 

41

 

 

 

41

 

 

 

87

 

 

 

38

 

Net losses on foreign currency remeasurements

 

 

(24

)

 

 

(74

)

 

 

(82

)

 

 

(69

)

Other, net

 

 

(19

)

 

 

34

 

 

 

(37

)

 

 

48

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

194

 

 

$

127

 

 

$

194

 

 

$

393

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

Interest and dividends income decreased due to lower yields on fixed-income securities. Interest expense decreased due to capitalization of interest expense and a decrease in outstanding long-term debt due to debt maturities, offset in part by higher finance lease expense. Net recognized gains on investments increased due to higher gains on equity investments.

38


PART I

Item 2

 

Six Months Ended December 31, 2019 Compared with Six Months Ended December 31, 2018

Interest and dividends income increased due to higher average portfolio balances on fixed-income securities. Interest expense decreased due to capitalization of interest expense and 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 due to lower gains on equity investments. Net gains on derivatives increased due to higher gains on foreign exchange derivatives.

INCOME TAXES

Effective Tax Rate

Our effective tax rate was 17% and 19% for the three months ended December 31, 2019 and 2018, respectively, and 17% and 16% for the six months ended December 31, 2019 and 2018, respectively. The decrease in our effective tax rate for the three months ended December 31, 2019 compared to the prior year was primarily due to the adjustment of the provisional net charge related to the TCJA in the second quarter of fiscal year 2019. The increase in our effective tax rate for the six months ended December 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, offset in part by the adjustment of the provisional net charge related to the TCJA.

Our effective tax rate was lower than the U.S. federal statutory rate for the three and six months ended December 31, 2019, primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland and Puerto Rico, and tax benefits relating to stock-based compensation.

Uncertain Tax Positions

We settled a portion of the Internal Revenue Service (“IRS”) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. We remain under audit for tax years 2004 to 2013. We expect the IRS to begin an examination of tax years 2014 to 2017 within the next 12 months.

As of December 31, 2019, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact in our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved 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 2019, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.

NON-GAAP FINANCIAL MEASURES

Non-GAAP net income and diluted earnings per share are non-GAAP financial measures which exclude a 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.

39


PART I

Item 2

 

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)