UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended March 31, 2010
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Transition Period From to
Commission File Number: 0-14278
MICROSOFT CORPORATION
(Exact name of registrant as specified in its charter)
Washington | 91-1144442 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) | |
One Microsoft Way, Redmond, Washington | 98052-6399 | |
(Address of principal executive offices) | (Zip Code) |
(425) 882-8080
(Registrants telephone number, including area code)
None
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer x |
Accelerated filer ¨ | |
Non-accelerated filer ¨ (Do not check if a smaller reporting company) |
Smaller reporting company ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
Class | Outstanding at April 19, 2010 | |
Common Stock, $0.00000625 par value per share |
8,763,839,329 shares |
FORM 10-Q
For the Quarter Ended March 31, 2010
INDEX
PAGE | 2 |
PART I
Item 1
(In millions, except per share amounts) (Unaudited) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Revenue |
$ | 14,503 | $ | 13,648 | $ | 46,445 | $ | 45,338 | ||||||||
Operating expenses: |
||||||||||||||||
Cost of revenue |
2,755 | 2,814 | 9,225 | 9,569 | ||||||||||||
Research and development |
2,220 | 2,212 | 6,364 | 6,785 | ||||||||||||
Sales and marketing |
3,203 | 2,981 | 9,612 | 9,687 | ||||||||||||
General and administrative |
1,152 | 913 | 3,017 | 2,631 | ||||||||||||
Employee severance |
0 | 290 | 59 | 290 | ||||||||||||
Total operating expenses |
9,330 | 9,210 | 28,277 | 28,962 | ||||||||||||
Operating income |
5,173 | 4,438 | 18,168 | 16,376 | ||||||||||||
Other income (expense) |
168 | (388 | ) | 821 | (697 | ) | ||||||||||
Income before income taxes |
5,341 | 4,050 | 18,989 | 15,679 | ||||||||||||
Provision for income taxes |
1,335 | 1,073 | 4,747 | 4,155 | ||||||||||||
Net income |
$ | 4,006 | $ | 2,977 | $ | 14,242 | $ | 11,524 | ||||||||
Earnings per share: |
||||||||||||||||
Basic |
$ | 0.46 | $ | 0.33 | $ | 1.61 | $ | 1.29 | ||||||||
Diluted |
$ | 0.45 | $ | 0.33 | $ | 1.59 | $ | 1.28 | ||||||||
Weighted average shares outstanding: |
||||||||||||||||
Basic |
8,767 | 8,891 | 8,846 | 8,960 | ||||||||||||
Diluted |
8,876 | 8,904 | 8,955 | 9,008 | ||||||||||||
Cash dividends declared per common share |
$ | 0.13 | $ | 0.13 | $ | 0.39 | $ | 0.39 | ||||||||
See accompanying notes.
PAGE | 3 |
PART I
Item 1
(In millions) | March 31, | June 30, | ||||||
2010 |
|
2009 | (1) | |||||
(Unaudited) | ||||||||
Assets |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 8,155 | $ | 6,076 | ||||
Short-term investments (including securities loaned of $2,480 and $1,540) |
31,511 | 25,371 | ||||||
Total cash, cash equivalents, and short-term investments |
39,666 | 31,447 | ||||||
Accounts receivable, net of allowance for doubtful accounts of $381 and $451 |
9,137 | 11,192 | ||||||
Inventories |
501 | 717 | ||||||
Deferred income taxes |
2,222 | 2,213 | ||||||
Other |
2,992 | 3,711 | ||||||
Total current assets |
54,518 | 49,280 | ||||||
Property and equipment, net of accumulated depreciation of $8,393 and $7,547 |
7,372 | 7,535 | ||||||
Equity and other investments |
7,797 | 4,933 | ||||||
Goodwill |
12,463 | 12,503 | ||||||
Intangible assets, net |
1,282 | 1,759 | ||||||
Deferred income taxes |
0 | 279 | ||||||
Other long-term assets |
1,478 | 1,599 | ||||||
Total assets |
$ | 84,910 | $ | 77,888 | ||||
Liabilities and stockholders equity |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 3,279 | $ | 3,324 | ||||
Short-term debt |
2,249 | 2,000 | ||||||
Accrued compensation |
2,885 | 3,156 | ||||||
Income taxes |
901 | 725 | ||||||
Short-term unearned revenue |
11,171 | 13,003 | ||||||
Securities lending payable |
2,794 | 1,684 | ||||||
Other |
3,145 | 3,142 | ||||||
Total current liabilities |
26,424 | 27,034 | ||||||
Long-term debt |
3,746 | 3,746 | ||||||
Long-term unearned revenue |
1,089 | 1,281 | ||||||
Deferred income taxes |
828 | 0 | ||||||
Other long-term liabilities |
7,113 | 6,269 | ||||||
Commitments and contingencies |
||||||||
Stockholders equity: |
||||||||
Common stock and paid-in capitalshares authorized 24,000; outstanding 8,762 and 8,908 |
62,517 | 62,382 | ||||||
Retained deficit, including accumulated other comprehensive income of $1,453 and $969 |
(16,807 | ) | (22,824 | ) | ||||
Total stockholders equity |
45,710 | 39,558 | ||||||
Total liabilities and stockholders equity |
$ | 84,910 | $ | 77,888 | ||||
(1) | Derived from audited financial statements. |
See accompanying notes.
PAGE | 4 |
PART I
Item 1
(In millions) (Unaudited) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Operations |
||||||||||||||||
Net income |
$ | 4,006 | $ | 2,977 | $ | 14,242 | $ | 11,524 | ||||||||
Adjustments to reconcile net income to net cash from operations: |
||||||||||||||||
Depreciation, amortization, and other noncash items |
694 | 664 | 1,955 | 1,881 | ||||||||||||
Stock-based compensation |
481 | 432 | 1,409 | 1,292 | ||||||||||||
Net recognized losses (gains) on investments and derivatives |
(68 | ) | 507 | (322 | ) | 682 | ||||||||||
Excess tax benefits from stock-based compensation |
(14 | ) | (2 | ) | (38 | ) | (48 | ) | ||||||||
Deferred income taxes |
(241 | ) | (368 | ) | 263 | 462 | ||||||||||
Deferral of unearned revenue |
6,087 | 5,899 | 19,692 | 16,054 | ||||||||||||
Recognition of unearned revenue |
(6,395 | ) | (6,670 | ) | (21,758 | ) | (19,078 | ) | ||||||||
Changes in operating assets and liabilities: |
||||||||||||||||
Accounts receivable |
1,947 | 1,697 | 1,906 | 4,035 | ||||||||||||
Other current assets |
(284 | ) | 106 | 306 | 345 | |||||||||||
Other long-term assets |
(81 | ) | 26 | (143 | ) | (159 | ) | |||||||||
Other current liabilities |
897 | 114 | (57 | ) | (3,824 | ) | ||||||||||
Other long-term liabilities |
364 | 662 | 1,014 | 2,030 | ||||||||||||
Net cash from operations |
7,393 | 6,044 | 18,469 | 15,196 | ||||||||||||
Financing |
||||||||||||||||
Short-term borrowings (repayments), maturities of 90 days or less, net |
(349 | ) | (329 | ) | (446 | ) | 1,667 | |||||||||
Proceeds from issuance of debt, maturities longer than 90 days |
851 | 328 | 2,592 | 328 | ||||||||||||
Repayments of debt, maturities longer than 90 days |
(502 | ) | 0 | (1,898 | ) | 0 | ||||||||||
Common stock issued |
422 | 112 | 1,399 | 436 | ||||||||||||
Common stock repurchased |
(2,023 | ) | (18 | ) | (7,430 | ) | (9,331 | ) | ||||||||
Common stock cash dividends |
(1,139 | ) | (1,155 | ) | (3,448 | ) | (3,310 | ) | ||||||||
Excess tax benefits from stock-based compensation |
14 | 2 | 38 | 48 | ||||||||||||
Net cash used in financing |
(2,726 | ) | (1,060 | ) | (9,193 | ) | (10,162 | ) | ||||||||
Investing |
||||||||||||||||
Additions to property and equipment |
(408 | ) | (632 | ) | (1,219 | ) | (2,252 | ) | ||||||||
Acquisition of companies, net of cash acquired |
(143 | ) | 0 | (245 | ) | (827 | ) | |||||||||
Purchases of investments |
(11,217 | ) | (10,683 | ) | (25,994 | ) | (21,525 | ) | ||||||||
Maturities of investments |
1,054 | 915 | 6,448 | 1,669 | ||||||||||||
Sales of investments |
4,927 | 3,327 | 12,705 | 16,102 | ||||||||||||
Securities lending payable |
(117 | ) | 1,064 | 1,110 | (1,080 | ) | ||||||||||
Net cash used in investing |
(5,904 | ) | (6,009 | ) | (7,195 | ) | (7,913 | ) | ||||||||
Effect of exchange rates on cash and cash equivalents |
(30 | ) | (36 | ) | (2 | ) | (175 | ) | ||||||||
Net change in cash and cash equivalents |
(1,267 | ) | (1,061 | ) | 2,079 | (3,054 | ) | |||||||||
Cash and cash equivalents, beginning of period |
9,422 | 8,346 | 6,076 | 10,339 | ||||||||||||
Cash and cash equivalents, end of period |
$ | 8,155 | $ | 7,285 | $ | 8,155 | $ | 7,285 | ||||||||
See accompanying notes.
PAGE | 5 |
PART I
Item 1
STOCKHOLDERS EQUITY STATEMENTS
(In millions) (Unaudited) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Common stock and paid-in capital |
||||||||||||||||
Balance, beginning of period |
$ | 62,566 | $ | 61,392 | $ | 62,382 | $ | 62,849 | ||||||||
Common stock issued |
372 | 112 | 1,399 | 424 | ||||||||||||
Common stock repurchased |
(495 | ) | (18 | ) | (2,151 | ) | (2,589 | ) | ||||||||
Stock-based compensation |
481 | 432 | 1,409 | 1,292 | ||||||||||||
Stock-based compensation income tax deficiencies |
(410 | ) | (21 | ) | (524 | ) | (79 | ) | ||||||||
Other, net |
3 | (1 | ) | 2 | (1 | ) | ||||||||||
Balance, end of period |
62,517 | 61,896 | 62,517 | 61,896 | ||||||||||||
Retained deficit |
||||||||||||||||
Balance, beginning of period |
(18,283 | ) | (26,914 | ) | (22,824 | ) | (26,563 | ) | ||||||||
Net income |
4,006 | 2,977 | 14,242 | 11,524 | ||||||||||||
Other comprehensive income: |
||||||||||||||||
Net unrealized gains (losses) on derivatives |
103 | 36 | (258 | ) | 802 | |||||||||||
Net unrealized gains (losses) on investments |
124 | 67 | 777 | (845 | ) | |||||||||||
Translation adjustments and other |
(97 | ) | 38 | (36 | ) | (371 | ) | |||||||||
Comprehensive income |
4,136 | 3,118 | 14,725 | 11,110 | ||||||||||||
Common stock cash dividends |
(1,132 | ) | (1,157 | ) | (3,429 | ) | (3,461 | ) | ||||||||
Common stock repurchased |
(1,528 | ) | 0 | (5,279 | ) | (6,039 | ) | |||||||||
Balance, end of period |
(16,807 | ) | (24,953 | ) | (16,807 | ) | (24,953 | ) | ||||||||
Total stockholders equity |
$ | 45,710 | $ | 36,943 | $ | 45,710 | $ | 36,943 | ||||||||
See accompanying notes.
PAGE | 6 |
PART I
Item 1
(Unaudited)
NOTE 1 ACCOUNTING POLICIES
Basis of Presentation
In the opinion of management, the accompanying balance sheets and related interim statements of income, cash flows, and stockholders equity include all adjustments, consisting only of normal recurring items, necessary for their fair presentation in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP). Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Examples include: estimates of loss contingencies, product warranties, product life cycles, product returns, and stock-based compensation forfeiture rates; assumptions such as the elements comprising a software arrangement, including the distinction between upgrades/enhancements and new products; when technological feasibility is achieved for our products; the potential outcome of future tax consequences of events that have been recognized in our financial statements or tax returns; estimating the fair value and/or goodwill impairment for our reporting units; and determining when investment impairments are other-than-temporary. Actual results and outcomes may differ from managements estimates and assumptions.
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 2009 Form 10-K filed on July 30, 2009 with the U.S. Securities and Exchange Commission.
Principles of Consolidation
The financial statements include the accounts of Microsoft Corporation and its subsidiaries. Intercompany transactions and balances have been eliminated. Equity investments through which we exercise significant influence but do not exercise control and are not the primary beneficiary are accounted for using the equity method. Investments through which we are not able to exercise significant influence over the investee and which do not have readily determinable fair values are accounted for under the cost method.
Recently Adopted Accounting Guidance
In January 2010, the Financial Accounting Standards Board (FASB) issued guidance to amend the disclosure requirements related to recurring and nonrecurring fair value measurements. The guidance requires new disclosures on the transfers of assets and liabilities between Level 1 (quoted prices in active market for identical assets or liabilities) and Level 2 (significant other observable inputs) of the fair value measurement hierarchy, including the reasons and the timing of the transfers. Additionally, the guidance requires a roll forward of activities on purchases, sales, issuance, and settlements of the assets and liabilities measured using significant unobservable inputs (Level 3 fair value measurements). The guidance became effective for us with the reporting period beginning January 1, 2010, except for the disclosure on the roll forward activities for Level 3 fair value measurements, which will become effective for us with the reporting period beginning July 1, 2011. Other than requiring additional disclosures, adoption of this new guidance did not have a material impact on our financial statements. See Note 6 Fair Value Measurements.
On July 1, 2009, we adopted guidance issued by the FASB on business combinations. The guidance retains the fundamental requirements that the acquisition method of accounting (previously referred to as the purchase method of accounting) be used for all business combinations, but requires a number of changes, including changes in the way assets and liabilities are recognized and measured as a result of business combinations. It also requires the capitalization of in-process research and development at fair value and requires the expensing of acquisition-related costs as incurred. We have applied this guidance to business combinations completed since July 1, 2009.
On July 1, 2009, we adopted guidance issued by the FASB that changes the accounting and reporting for non-controlling interests. Non-controlling interests are to be reported as a component of equity separate from the parents equity, and purchases or sales of equity interests that do not result in a change in control are to be accounted for as equity transactions. In addition, net income attributable to a non-controlling interest is to be included in net income and, upon a loss of control, the interest sold, as well as any interest retained, is to be recorded at fair value with any gain or loss recognized in net income. Adoption of the new guidance did not have a material impact on our financial statements.
PAGE | 7 |
PART I
Item 1
On July 1, 2009, we adopted guidance on fair value measurement for nonfinancial assets and liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Adoption of the new guidance did not have a material impact on our financial statements.
Recent Accounting Guidance Not Yet Adopted
In October 2009, the FASB issued guidance on revenue recognition that will become effective for us beginning July 1, 2010, with earlier adoption permitted. Under the new guidance on arrangements that include software elements, tangible products that have software components that are essential to the functionality of the tangible product will no longer be within the scope of the software revenue recognition guidance, and software-enabled products will now be subject to other relevant revenue recognition guidance. Additionally, the FASB issued guidance on revenue arrangements with multiple deliverables that are outside the scope of the software revenue recognition guidance. Under the new guidance, when vendor specific objective evidence or third party evidence for deliverables in an arrangement cannot be determined, a best estimate of the selling price is required to separate deliverables and allocate arrangement consideration using the relative selling price method. The new guidance includes new disclosure requirements on how the application of the relative selling price method affects the timing and amount of revenue recognition. We believe adoption of this new guidance will not have a material impact on our financial statements.
In June 2009, the FASB issued guidance on the consolidation of variable interest entities, which is effective for us beginning July 1, 2010. The new guidance requires revised evaluations of whether entities represent variable interest entities, ongoing assessments of control over such entities, and additional disclosures for variable interests. We believe adoption of this new guidance will not have a material impact on our financial statements.
NOTE 2 EARNINGS PER SHARE
Basic earnings per share is computed on the basis of the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed on the basis of 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, stock awards, and shared performance stock awards. The components of basic and diluted earnings per share are as follows:
(In millions, except earnings per share) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Net income available for common shareholders (A) |
$ | 4,006 | $ | 2,977 | $ | 14,242 | $ | 11,524 | ||||||||
Weighted average shares of common stock outstanding (B) |
8,767 | 8,891 | 8,846 | 8,960 | ||||||||||||
Dilutive effect of stock-based awards |
109 | 13 | 109 | 48 | ||||||||||||
Common stock and common stock equivalents (C) |
8,876 | 8,904 | 8,955 | 9,008 | ||||||||||||
Earnings per share: |
||||||||||||||||
Basic (A/B) |
$ | 0.46 | $ | 0.33 | $ | 1.61 | $ | 1.29 | ||||||||
Diluted (A/C) |
$ | 0.45 | $ | 0.33 | $ | 1.59 | $ | 1.28 | ||||||||
We excluded the following shares underlying stock-based awards from the calculations of diluted earnings per share because their inclusion would have been anti-dilutive:
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||
Shares excluded from calculations of diluted EPS |
41 | 518 | 49 | 352 | ||||||||
PAGE | 8 |
PART I
Item 1
NOTE 3 OTHER INCOME (EXPENSE)
The components of other income (expense) were as follows:
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Dividends and interest |
$ | 166 | $ | 164 | $ | 490 | $ | 546 | ||||||||
Net recognized gains (losses) on investments |
137 | (452 | ) | 299 | (53 | ) | ||||||||||
Net gains (losses) on derivatives |
(69 | ) | (55 | ) | 23 | (629 | ) | |||||||||
Net losses on foreign currency remeasurements |
(56 | ) | (26 | ) | (24 | ) | (555 | ) | ||||||||
Other |
(10 | ) | (19 | ) | 33 | (6 | ) | |||||||||
Total |
$ | 168 | $ | (388 | ) | $ | 821 | $ | (697 | ) | ||||||
Other-than-temporary impairments included in Net recognized gains (losses) on investments were $12 million and $36 million for the three months and nine months ended March 31, 2010, respectively, as compared with $420 million and $754 million during the three months and nine months ended March 31, 2009, respectively.
NOTE 4 INVESTMENTS
Investment Components
The components of investments, including associated derivatives, were as follows:
(In millions) | Cost Basis | Unrealized Gains |
Unrealized Losses |
Recorded Basis |
Cash and Cash |
Short-term Investments |
Equity and Other |
|||||||||||||||||||||
March 31, 2010 | ||||||||||||||||||||||||||||
Cash |
$ | 1,845 | $ | | $ | | $ | 1,845 | $ | 1,845 | $ | | $ | | ||||||||||||||
Mutual funds |
1,277 | | | 1,277 | 1,277 | | | |||||||||||||||||||||
Commercial paper |
1,603 | | | 1,603 | 1,429 | 174 | | |||||||||||||||||||||
Certificates of deposit |
2,884 | | | 2,884 | 2,649 | 235 | | |||||||||||||||||||||
U.S. government and agency securities |
19,902 | 88 | (11 | ) | 19,979 | 485 | 19,494 | | ||||||||||||||||||||
Foreign government bonds |
606 | 11 | (1 | ) | 616 | | 616 | | ||||||||||||||||||||
Mortgage-backed securities |
3,522 | 96 | (6 | ) | 3,612 | | 3,612 | | ||||||||||||||||||||
Corporate notes and bonds |
6,837 | 296 | (18 | ) | 7,115 | 350 | 6,765 | | ||||||||||||||||||||
Municipal securities |
734 | 4 | (3 | ) | 735 | 120 | 615 | | ||||||||||||||||||||
Common and preferred stock |
5,764 | 1,645 | (103 | ) | 7,306 | | | 7,306 | ||||||||||||||||||||
Other investments |
491 | | | 491 | | | 491 | |||||||||||||||||||||
Total |
$ | 45,465 | $ | 2,140 | $ | (142 | ) | $ | 47,463 | $ | 8,155 | $ | 31,511 | $ | 7,797 | |||||||||||||
PAGE | 9 |
PART I
Item 1
(In millions) | Cost Basis | Unrealized Gains |
Unrealized Losses |
Recorded Basis |
Cash and Cash |
Short-term Investments |
Equity and Other |
|||||||||||||||||||||
June 30, 2009 | ||||||||||||||||||||||||||||
Cash |
$ | 2,064 | $ | | $ | | $ | 2,064 | $ | 2,064 | $ | | $ | | ||||||||||||||
Mutual funds |
1,007 | | (25 | ) | 982 | 900 | 82 | | ||||||||||||||||||||
Commercial paper |
2,601 | | | 2,601 | 400 | 2,201 | | |||||||||||||||||||||
Certificates of deposit |
555 | | | 555 | 275 | 280 | | |||||||||||||||||||||
U.S. government and agency securities |
13,450 | 21 | (5 | ) | 13,466 | 2,369 | 11,097 | | ||||||||||||||||||||
Foreign government bonds |
3,450 | 71 | (4 | ) | 3,517 | | 3,517 | | ||||||||||||||||||||
Mortgage-backed securities |
3,353 | 81 | (16 | ) | 3,418 | | 3,418 | | ||||||||||||||||||||
Corporate notes and bonds |
4,361 | 287 | (52 | ) | 4,596 | | 4,596 | | ||||||||||||||||||||
Municipal securities |
255 | 2 | (1 | ) | 256 | 68 | 188 | | ||||||||||||||||||||
Common and preferred stock |
4,015 | 627 | (182 | ) | 4,460 | | | 4,460 | ||||||||||||||||||||
Other investments |
465 | | | 465 | | (8 | ) | 473 | ||||||||||||||||||||
Total |
$ | 35,576 | $ | 1,089 | $ | (285 | ) | $ | 36,380 | $ | 6,076 | $ | 25,371 | $ | 4,933 | |||||||||||||
Unrealized Losses on Investments
Investments with continuous unrealized losses for less than 12 months and 12 months or greater and their related fair values were as follows:
Less than 12 Months |
12 Months or Greater |
Total Unrealized |
|||||||||||||||||||||
(In millions) | Fair Value | Unrealized Losses |
Fair Value | Unrealized Losses |
Total Fair Value |
||||||||||||||||||
March 31, 2010 | |||||||||||||||||||||||
U.S. government and agency securities |
$ | 1,164 | $ | (11 | ) | $ | | $ | | $ | 1,164 | $ | (11 | ) | |||||||||
Foreign government bonds |
380 | (1 | ) | | | 380 | (1 | ) | |||||||||||||||
Mortgage-backed securities |
233 | (5 | ) | 19 | (1 | ) | 252 | (6 | ) | ||||||||||||||
Corporate notes and bonds |
1,044 | (10 | ) | 117 | (8 | ) | 1,161 | (18 | ) | ||||||||||||||
Municipal securities |
115 | (3 | ) | | | 115 | (3 | ) | |||||||||||||||
Common and preferred stock |
666 | (45 | ) | 229 | (58 | ) | 895 | (103 | ) | ||||||||||||||
Total |
$ | 3,602 | $ | (75 | ) | $ | 365 | $ | (67 | ) | $ | 3,967 | $ | (142 | ) | ||||||||
Less than 12 Months |
12 Months or Greater |
Total Unrealized |
||||||||||||||||||||||
(In millions) | Fair Value | Unrealized Losses |
Fair Value | Unrealized Losses |
Total Fair Value |
|||||||||||||||||||
June 30, 2009 | ||||||||||||||||||||||||
Mutual funds |
$ | 3 | $ | (1 | ) | $ | 77 | $ | (24 | ) | $ | 80 | $ | (25 | ) | |||||||||
U.S. government and agency securities |
4,033 | (5 | ) | | | 4,033 | (5 | ) | ||||||||||||||||
Foreign government bonds |
1,444 | (3 | ) | 669 | (1 | ) | 2,113 | (4 | ) | |||||||||||||||
Mortgage-backed securities |
503 | (16 | ) | | | 503 | (16 | ) | ||||||||||||||||
Corporate notes and bonds |
713 | (10 | ) | 504 | (42 | ) | 1,217 | (52 | ) | |||||||||||||||
Municipal securities |
16 | (1 | ) | | | 16 | (1 | ) | ||||||||||||||||
Common and preferred stock |
1,154 | (135 | ) | 120 | (47 | ) | 1,274 | (182 | ) | |||||||||||||||
Total |
$ | 7,866 | $ | (171 | ) | $ | 1,370 | $ | (114 | ) | $ | 9,236 | $ | (285 | ) | |||||||||
At March 31, 2010 and June 30, 2009, the recorded bases and estimated fair values of common and preferred stock and other investments that are restricted for more than one year or are not publicly traded were $215 million and $204 million, respectively. The estimated fair values are based on publicly available market information or other estimates determined by management. Unrealized losses on fixed-income securities are primarily attributable to changes in interest rates. Unrealized losses on domestic and international equities are due to market price
PAGE | 10 |
PART I
Item 1
movements. Management does not believe any remaining unrealized losses represent other-than-temporary impairments based on our evaluation of available evidence as of March 31, 2010.
Debt Investment Maturities
(In millions) | Cost Basis | Estimated Fair Value |
||||||
Due in one year or less |
$ | 10,986 | $ | 10,999 | ||||
Due after one year through five years |
19,079 | 19,365 | ||||||
Due after five years through 10 years |
2,016 | 2,082 | ||||||
Due after 10 years |
4,008 | 4,100 | ||||||
Total |
$ | 36,089 | $ | 36,546 | ||||
NOTE 5 DERIVATIVES
We use derivative instruments to manage risks related to foreign currencies, equity prices, interest rates, and credit; to enhance investment returns; and to facilitate portfolio diversification. Our objectives for holding derivatives include reducing, eliminating, and efficiently managing the economic impact of these exposures as effectively as possible. Our derivative programs include strategies that both qualify and do not qualify for hedge accounting treatment. All notional amounts presented below are measured in U.S. currency equivalents.
Foreign Currency
Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency hedge positions. Option and forward contracts are used to hedge a portion of forecasted international revenue for up to three years in the future and are designated as cash-flow hedging instruments. Principal currencies hedged include the euro, Japanese yen, British pound, and Canadian dollar. As of March 31, 2010 and June 30, 2009, the total notional amounts of these foreign exchange contracts sold were $10.6 billion and $7.2 billion, respectively. Foreign currency risks related to certain non-U.S. dollar denominated securities are hedged using foreign exchange forward contracts that are designated as fair-value hedging instruments. As of March 31, 2010 and June 30, 2009, the total notional amounts of these foreign exchange contracts sold were $586 million and $3.5 billion, respectively. Certain options and forwards not designated as hedging instruments are also used to manage the variability in exchange rates on accounts receivable, cash, and intercompany positions, and to manage other foreign currency exposures. As of March 31, 2010, the total notional amounts of these foreign exchange contracts purchased and sold were $3.5 billion and $3.5 billion, respectively. As of June 30, 2009, the total notional amounts of these foreign exchange contracts purchased and sold were $3.2 billion and $3.6 billion, respectively.
Equity
Securities held in our equity and other investments portfolio are subject to market price risk. Market price risk is managed relative to broad-based global and domestic equity indices using certain convertible preferred investments, options, futures, and swap contracts not designated as hedging instruments. From time to time, to hedge our price risk, we may use and designate equity derivatives as hedging instruments, including puts, calls, swaps, and forwards. As of March 31, 2010, the total notional amounts of designated and non-designated equity contracts purchased and sold were $1.0 billion and $535 million, respectively. As of June 30, 2009, the total notional amounts of designated and non-designated equity contracts purchased and sold were immaterial.
Interest Rate
Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of our fixed-income portfolio to achieve economic returns that correlate to certain broad-based fixed-income indices using exchange-traded option and futures contracts and over-the-counter swap and option contracts, none of which are designated as hedging instruments. As of March 31, 2010, the total notional amount of fixed-interest rate contracts purchased and sold were $2.8 billion and $2.1 billion, respectively. As of June 30, 2009, the total notional amounts of fixed-interest rate contracts purchased and sold were $2.7 billion and $456 million, respectively. In addition, we use To Be Announced forward purchase commitments of mortgage-backed assets to gain exposure to agency mortgage-backed securities. These meet the definition of a derivative instrument
PAGE | 11 |
PART I
Item 1
in cases where physical delivery of the assets is not taken at the earliest available delivery date. As of March 31, 2010, the total notional derivative amount of mortgage contracts purchased was immaterial. As of June 30, 2009, the total notional derivative amount of mortgage contracts purchased was $1.3 billion.
Credit
Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We use credit default swap contracts, not designated as hedging instruments, to manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. We use credit default swaps as they are a low cost method of managing exposure to individual credit risks or groups of credit risks. As of March 31, 2010 and June 30, 2009, the total notional amounts of credit contracts purchased and sold were immaterial.
Commodity
We use broad-based commodity exposures to enhance portfolio returns and to facilitate portfolio diversification. We use swap, futures and option contracts, not designated as hedging instruments, to generate and manage exposures to broad-based commodity indices. We use derivatives on commodities as they can be low-cost alternatives to the purchase and storage of a variety of commodities, including, but not limited to, precious metals, energy, and grain. As of March 31, 2010, the total notional amounts of commodity contracts purchased and sold were $1.0 billion and $335 million, respectively. As of June 30, 2009, the total notional amounts of commodity contracts purchased and sold were $543 million and $33 million, respectively.
Credit-Risk-Related Contingent Features
Certain of our counterparty agreements for derivative instruments contain provisions that require our issued and outstanding long-term unsecured debt to maintain an investment grade credit rating and require us to maintain a minimum liquidity of $1.0 billion. To the extent we fail to meet these requirements, we will be required to post collateral, similar to the standard convention related to over-the-counter derivatives. As of March 31, 2010, our long-term unsecured debt rating was AAA, and cash investments were in excess of $1.0 billion. As a result, no collateral is required to be posted.
Fair Values of Derivative Instruments
Following are the gross fair values of derivative instruments held at March 31, 2010 and June 30, 2009, excluding the impact of netting derivative assets and liabilities when a legally enforceable master netting agreement exists and fair value adjustments related to our own credit risk and counterparty credit risk:
(In millions) | Foreign Exchange Contracts |
Equity Contracts |
Interest Rate Contracts |
Credit Contracts |
Commodity Contracts |
Total Derivatives |
||||||||||||||||||
March 31, 2010 | ||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||
Derivatives not designated as hedging instruments: |
||||||||||||||||||||||||
Short-term investments |
$ | 14 | $ | 131 | $ | 8 | $ | 7 | $ | 7 | $ | 167 | ||||||||||||
Other current assets |
54 | | | | | 54 | ||||||||||||||||||
Total |
$ | 68 | $ | 131 | $ | 8 | $ | 7 | $ | 7 | $ | 221 | ||||||||||||
Derivatives designated as hedging instruments: |
||||||||||||||||||||||||
Short-term investments |
$ | 1 | $ | | $ | | $ | | $ | | $ | 1 | ||||||||||||
Other current assets |
421 | | | | | 421 | ||||||||||||||||||
Total |
$ | 422 | $ | | $ | | $ | | $ | | $ | 422 | ||||||||||||
Total assets |
$ | 490 | $ | 131 | $ | 8 | $ | 7 | $ | 7 | $ | 643 | ||||||||||||
PAGE | 12 |
PART I
Item 1
(In millions) | Foreign Exchange Contracts |
Equity Contracts |
Interest Rate Contracts |
Credit Contracts |
Commodity Contracts |
Total Derivatives |
||||||||||||||||||
Liabilities |
||||||||||||||||||||||||
Derivatives not designated as hedging instruments: |
||||||||||||||||||||||||
Other current liabilities |
$ | (67 | ) | $ | (9 | ) | $ | (6 | ) | $ | (42 | ) | $ | (12 | ) | $ | (136 | ) | ||||||
Derivatives designated as hedging instruments: |
||||||||||||||||||||||||
Other current liabilities |
$ | (93 | ) | $ | | $ | | $ | | $ | | $ | (93 | ) | ||||||||||
Total liabilities |
$ | (160 | ) | $ | (9 | ) | $ | (6 | ) | $ | (42 | ) | $ | (12 | ) | $ | (229 | ) | ||||||
(In millions) | Foreign Exchange Contracts |
Equity Contracts |
Interest Rate Contracts |
Credit Contracts |
Commodity Contracts |
Total Derivatives |
||||||||||||||||||
June 30, 2009 | ||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||
Derivatives not designated as hedging instruments: |
||||||||||||||||||||||||
Short-term investments |
$ | 9 | $ | 78 | $ | 44 | $ | 21 | $ | 2 | $ | 154 | ||||||||||||
Other current assets |
48 | | | | | 48 | ||||||||||||||||||
Total |
$ | 57 | $ | 78 | $ | 44 | $ | 21 | $ | 2 | $ | 202 | ||||||||||||
Derivatives designated as hedging instruments: |
||||||||||||||||||||||||
Short-term investments |
$ | 12 | $ | | $ | | $ | | $ | | $ | 12 | ||||||||||||
Other current assets |
417 | | | | | 417 | ||||||||||||||||||
Equity and other investments |
| 2 | | | | 2 | ||||||||||||||||||
Total |
$ | 429 | $ | 2 | $ | | $ | | $ | | $ | 431 | ||||||||||||
Total assets |
$ | 486 | $ | 80 | $ | 44 | $ | 21 | $ | 2 | $ | 633 | ||||||||||||
Liabilities |
||||||||||||||||||||||||
Derivatives not designated as hedging instruments: |
||||||||||||||||||||||||
Other current liabilities |
$ | (183 | ) | $ | (3 | ) | $ | (20 | ) | $ | (62 | ) | $ | (6 | ) | $ | (274 | ) | ||||||
Derivatives designated as hedging instruments: |
||||||||||||||||||||||||
Other current liabilities |
$ | (75 | ) | $ | | $ | | $ | | $ | | $ | (75 | ) | ||||||||||
Total liabilities |
$ | (258 | ) | $ | (3 | ) | $ | (20 | ) | $ | (62 | ) | $ | (6 | ) | $ | (349 | ) | ||||||
See also Note 4 Investments and Note 6 Fair Value Measurements.
Fair-Value Hedges
For a derivative instrument designated as a fair-value hedge, the gain (loss) is recognized in earnings in the period of change together with the offsetting loss or gain on the hedged item attributed to the risk being hedged. For options designated as fair-value hedges, changes in the time value are excluded from the assessment of hedge effectiveness and are recognized in earnings.
PAGE | 13 |
PART I
Item 1
We recognized in other income (expense) the following gains (losses) on contracts designated as fair value hedges and their related hedged items:
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Foreign exchange contracts |
||||||||||||||||
Derivatives |
$ | (2 | ) | $ | 195 | $ | (106 | ) | $ | 280 | ||||||
Hedged items |
4 | (190 | ) | 107 | (276 | ) | ||||||||||
Total |
$ | 2 | $ | 5 | $ | 1 | $ | 4 | ||||||||
Equity contracts |
||||||||||||||||
Derivatives |
$ | | $ | | $ | | $ | 191 | ||||||||
Hedged items |
| | | (211 | ) | |||||||||||
Total |
$ | | $ | | $ | | $ | (20 | ) | |||||||
Cash-Flow Hedges
For a derivative instrument designated as a cash-flow hedge, the effective portion of the derivatives gain (loss) is initially reported as a component of other comprehensive income (OCI) and is subsequently recognized in earnings when the hedged exposure is recognized in earnings. For options designated as cash-flow hedges, changes in the time value are excluded from the assessment of hedge effectiveness and are recognized in earnings. Gains (losses) on derivatives representing either hedge components excluded from the assessment of effectiveness or hedge ineffectiveness are recognized in earnings.
We recognized the following gains (losses) related to foreign exchange contracts designated as cash flow hedges (our only cash flow hedges during the period):
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Effective portion |
||||||||||||||||
Gain (loss) recognized in OCI, net of tax effect of $85 for the three months ended and $(26) for the nine months ended March 31, 2010, and $111 for the three months and $640 for the nine months ended March 31, 2009 |
$ | 159 | $ | 206 | $ | (48 | ) | $ | 1,188 | |||||||
Gain reclassified from accumulated OCI into revenue |
85 | 261 | 322 | 594 | ||||||||||||
Amount excluded from effectiveness assessment and ineffective portion |
||||||||||||||||
Loss recognized in other income (expense) |
(62 | ) | (100 | ) | (76 | ) | (294 | ) | ||||||||
We estimate that $197 million of net derivative gains included in OCI will be reclassified into earnings within the next 12 months. No significant amounts of gains (losses) were reclassified from OCI into earnings as a result of forecasted transactions that failed to occur during the three months and nine months ended March 31, 2010 and 2009.
Non-Designated Derivatives
Gains (losses) from changes in fair values of derivatives that are not designated as hedges are primarily recognized in other income (expense). These amounts are shown in the table below, with the exception of gains (losses) on derivatives presented in income statement line items other than other income (expense), which were immaterial for the three months and nine months ended March 31, 2010 and 2009. Other than those derivatives entered into for investment purposes, such as commodity contracts, the gains (losses) below are generally economically offset by unrealized gains (losses) in the underlying available-for-sale securities, which are recorded as a component of OCI until the securities are sold or other-than-temporarily impaired, at which time the amounts are moved from OCI into other income (expense).
PAGE | 14 |
PART I
Item 1
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
|||||||||||||
2010 | 2009 | 2010 | 2009 | ||||||||||||
Foreign exchange contracts |
$ | 1 | $ | 11 | $ | 91 | $ | (139 | ) | ||||||
Equity contracts |
8 | (11 | ) | 24 | (160 | ) | |||||||||
Interest-rate contracts |
8 | 47 | 20 | (7 | ) | ||||||||||
Credit contracts |
7 | 9 | 18 | (26 | ) | ||||||||||
Commodity contracts |
(35 | ) | (8 | ) | 34 | (188 | ) | ||||||||
Total |
$ | (11 | ) | $ | 48 | $ | 187 | $ | (520 | ) | |||||
NOTE 6 FAIR VALUE MEASUREMENTS
We account for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are:
| Level 1inputs are based upon unadjusted quoted prices for identical instruments traded in active markets. Our Level 1 non-derivative investments primarily include U.S. treasuries and agency securities, domestic and international equities, and exchange-traded mutual funds. Our Level 1 derivative assets and liabilities include those traded on exchanges. |
| Level 2inputs 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, foreign exchange rates, and forward and spot prices for currencies and commodities. Our Level 2 non-derivative investments consist primarily of corporate notes and bonds, mortgage-backed securities, certain agency securities, certificates of deposit, and commercial paper. Our Level 2 derivative assets and liabilities primarily include certain over-the-counter option, futures, and swap contracts. |
| Level 3inputs are generally unobservable and typically reflect managements estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques, including option pricing models and discounted cash flow models. Our Level 3 non-derivative assets primarily comprise investments in certain corporate bonds. We value these corporate bonds using internally developed valuation models, inputs to which include interest rate curves, credit spreads, stock prices, and volatilities. Unobservable inputs used in these models are significant to the fair values of the investments. Our Level 3 derivative assets and liabilities primarily comprise derivatives for foreign equities. In certain cases, market-based observable inputs are not available and we use management judgment to develop assumptions to determine fair value for these derivatives. |
PAGE | 15 |
PART I
Item 1
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following tables present the fair values of our financial instruments that are measured at fair value on a recurring basis:
(In millions) |
Level 1 | Level 2 | Level 3 | |
Gross Fair Value |
|
Netting | (1) | |
Net Fair Value |
| |||||||||||||
March 31, 2010 | ||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||
Mutual funds |
$ | 1,277 | $ | | $ | | $ | 1,277 | $ | | $ | 1,277 | ||||||||||||
Commercial paper |
| 1,607 | | 1,607 | | 1,607 | ||||||||||||||||||
Certificates of deposit |
| 2,884 | | 2,884 | | 2,884 | ||||||||||||||||||
U.S. government and agency securities |
16,535 | 3,443 | | 19,978 | | 19,978 | ||||||||||||||||||
Foreign government bonds |
232 | 387 | | 619 | | 619 | ||||||||||||||||||
Mortgage-backed securities |
| 3,613 | | 3,613 | | 3,613 | ||||||||||||||||||
Corporate notes and bonds |
| 6,796 | 194 | 6,990 | | 6,990 | ||||||||||||||||||
Municipal securities |
| 735 | | 735 | | 735 | ||||||||||||||||||
Common and preferred stock |
7,043 | 43 | 5 | 7,091 | | 7,091 | ||||||||||||||||||
Derivatives |
14 | 623 | 6 | 643 | (183 | ) | 460 | |||||||||||||||||
Total |
$ | 25,101 | $ | 20,131 | $ | 205 | $ | 45,437 | $ | (183 | ) | $ | 45,254 | |||||||||||
Liabilities |
||||||||||||||||||||||||
Derivatives |
$ | 11 | $ | 218 | $ | | $ | 229 | $ | (182 | ) | $ | 47 | |||||||||||
(1) | This table includes the impact of netting derivative assets and derivative liabilities when a legally enforceable master netting agreement exists. These amounts also include fair value adjustments related to our own credit risk and counterparty credit risk. |
(In millions) |
Level 1 | Level 2 | Level 3 | |
Gross Fair Value |
|
Netting | (1 ) | |
Net Fair Value |
| |||||||||||||
June 30, 2009 | ||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||
Mutual funds |
$ | 982 | $ | | $ | | $ | 982 | $ | | $ | 982 | ||||||||||||
Commercial paper |
| 2,601 | | 2,601 | | 2,601 | ||||||||||||||||||
Certificates of deposit |
| 555 | | 555 | | 555 | ||||||||||||||||||
U.S. government and agency securities |
7,134 | 6,105 | | 13,239 | | 13,239 | ||||||||||||||||||
Foreign government bonds |
501 | 3,022 | | 3,523 | | 3,523 | ||||||||||||||||||
Mortgage-backed securities |
| 3,593 | | 3,593 | | 3,593 | ||||||||||||||||||
Corporate notes and bonds |
| 4,073 | 253 | 4,326 | | 4,326 | ||||||||||||||||||
Municipal securities |
| 256 | | 256 | | 256 | ||||||||||||||||||
Common and preferred stock |
4,218 | 28 | 5 | 4,251 | | 4,251 | ||||||||||||||||||
Derivatives |
5 | 623 | 5 | 633 | (235 | ) | 398 | |||||||||||||||||
Total |
$ | 12,840 | $ | 20,856 | $ | 263 | $ | 33,959 | $ | (235 | ) | $ | 33,724 | |||||||||||
Liabilities |
||||||||||||||||||||||||
Derivatives |
$ | 5 | $ | 344 | $ | | $ | 349 | $ | (231 | ) | $ | 118 | |||||||||||
(1) | This table includes the impact of netting derivative assets and derivative liabilities when a legally enforceable master netting agreement exists. These amounts also include fair value adjustments related to our own credit risk and counterparty credit risk. |
PAGE | 16 |
PART I
Item 1
The table below reconciles the total Net Fair Value of assets above to the balance sheet presentation in Note 4 for March 31, 2010 and June 30, 2009.
(In millions) | March 31, | June 30, | ||||||
2010 | 2009 | |||||||
Net fair value of assets measured at fair value on a recurring basis |
$ | 45,254 | $ | 33,724 | ||||
Cash |
1,845 | 2,064 | ||||||
Common and preferred stock measured at fair value on a nonrecurring basis |
215 | 204 | ||||||
Other investments measured at fair value on a nonrecurring basis |
491 | 465 | ||||||
Derivative assets classified as other current assets |
(475 | ) | (465 | ) | ||||
Derivative liabilities classified as other current assets |
148 | 231 | ||||||
Other |
(15 | ) | 157 | |||||
Recorded basis of investment components |
$ | 47,463 | $ | 36,380 | ||||
Changes in Financial Instruments Measured at Level 3 Fair Value on a Recurring Basis
The following tables present the changes during the three months and nine months ended March 31, 2010 and 2009 in our Level 3 financial instruments that are measured at fair value on a recurring basis. The majority of these instruments consist of investment securities classified as available-for-sale with changes in fair value included in other comprehensive income.
(In millions) | Corporate Notes and Bonds |
Common and Preferred Stock |
Derivative Assets |
Total | ||||||||||||
Three Months and Nine Months Ended March 31, 2010 | ||||||||||||||||
Balance as of June 30, 2009 |
$ | 253 | $ | 5 | $ | 5 | $ | 263 | ||||||||
Total realized and unrealized gains (losses): |
||||||||||||||||
Included in other income (expense) |
1 | | (2 | ) | (1 | ) | ||||||||||
Included in other comprehensive income |
(74 | ) | | | (74 | ) | ||||||||||
Balance as of September 30, 2009 |
$ | 180 | $ | 5 | $ | 3 | $ | 188 | ||||||||
Total realized and unrealized gains: |
||||||||||||||||
Included in other income (expense) |
1 | | 1 | 2 | ||||||||||||
Included in other comprehensive income |
11 | | | 11 | ||||||||||||
Balance as of December 31, 2009 |
$ | 192 | $ | 5 | $ | 4 | $ | 201 | ||||||||
Total realized and unrealized gains: |
||||||||||||||||
Included in other income (expense) |
2 | | 2 | 4 | ||||||||||||
Included in other comprehensive income |
| | | | ||||||||||||
Balance as of March 31, 2010 |
$ | 194 | $ | 5 | $ | 6 | $ | 205 | ||||||||
Change in unrealized gains included in other income (expense) for the three months ended March 31, 2010 related to assets held as of March 31, 2010 |
$ | 2 | $ | | $ | 2 | $ | 4 | ||||||||
Change in unrealized gains included in other income (expense) for the nine months ended March 31, 2010 related to assets held as of March 31, 2010 |
$ | 4 | $ | | $ | 1 | $ | 5 | ||||||||
PAGE | 17 |
PART I
Item 1
(In millions) | Corporate Notes and Bonds |
Common and Preferred Stock |
Derivative Assets |
Total | ||||||||||||
Three Months and Nine Months Ended March 31, 2009 | ||||||||||||||||
Balance as of June 30, 2008 |
$ | 138 | $ | 8 | $ | 71 | $ | 217 | ||||||||
Total realized and unrealized gains (losses): |
||||||||||||||||
Included in other income (expense) |
(9 | ) | (4 | ) | 48 | 35 | ||||||||||
Included in other comprehensive income |
(29 | ) | | | (29 | ) | ||||||||||
Purchases, issuances, and settlements |
| | (104 | ) | (104 | ) | ||||||||||
Transfers in and out of Level 3 |
11 | | | 11 | ||||||||||||
Balance as of September 30, 2008 |
$ | 111 | $ | 4 | $ | 15 | $ | 130 | ||||||||
Total realized and unrealized gains (losses): |
||||||||||||||||
Included in other income (expense) |
1 | (2 | ) | | (1 | ) | ||||||||||
Included in other comprehensive income |
10 | | | 10 | ||||||||||||
Purchases, issuances, and settlements |
| | (15 | ) | (15 | ) | ||||||||||
Transfers in and out of Level 3 |
(1 | ) | | | (1 | ) | ||||||||||
Balance as of December 31, 2008 |
$ | 121 | $ | 2 | $ | | $ | 123 | ||||||||
Total realized and unrealized gains (losses): |
||||||||||||||||
Included in other income (expense) |
1 | | | 1 | ||||||||||||
Included in other comprehensive income |
31 | | | 31 | ||||||||||||
Transfers in and out of Level 3 |
| (2 | ) | 2 | | |||||||||||
Balance as of March 31, 2009 |
$ | 153 | $ | | $ | 2 | $ | 155 | ||||||||
Change in unrealized gains included in other income (expense) for the three months ended March 31, 2009 related to assets held as of March 31, 2009 |
$ | 1 | $ | | $ | | $ | 1 | ||||||||
Change in unrealized gains (losses) included in other income (expense) for the nine months ended March 31, 2009 related to assets held as of March 31, 2009 |
$ | (8 | ) | $ | (5 | ) | $ | 1 | $ | (12 | ) | |||||
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
We measure certain assets, including our cost and equity method investments, at fair value on a nonrecurring basis when they are deemed to be other-than-temporarily impaired. The fair values of our investments are determined based on valuation techniques using the best information available, and may include quoted market prices, market comparables, and discounted cash flow projections.
An impairment charge is recorded when the cost of the investment exceeds its fair value and this condition is determined to be other-than-temporary. During the three months and nine months ended March 31, 2010, and during the three months ended March 31, 2009, we did not record any other-than-temporary impairments on those assets required to be measured at fair value on a non-recurring basis. The following table presents prior period balances for those assets required to be measured at fair value on a nonrecurring basis and the associated losses recognized during the nine months ended March 31, 2009:
(In millions) | March 31, 2009 |
Level 1 | Level 2 | Level 3 | Total Losses |
|||||||||||||||
Assets |
||||||||||||||||||||
Common and preferred stock |
$ | 164 | $ | | $ | | $ | 164 | $ | (85 | ) | |||||||||
Total |
$ | 164 | $ | | $ | | $ | 164 | $ | (85 | ) | |||||||||
PAGE | 18 |
PART I
Item 1
NOTE 7 INVENTORIES
The components of inventories were as follows:
(In millions) | March 31, | June 30, | ||||||||
2010 | 2009 | |||||||||
Raw materials |
$ | 120 | $ | 170 | ||||||
Work in process |
4 | 45 | ||||||||
Finished goods |
377 | 502 | ||||||||
Total |
$ | 501 | $ | 717 | ||||||
NOTE 8 BUSINESS COMBINATIONS
During the nine months ended March 31, 2010, we acquired five entities for total consideration of $267 million, substantially all of which was paid in cash. During this period, we also sold three entities for total consideration of $600 million, including Razorfish in the second quarter of fiscal year 2010. These entities have been included in or removed from our consolidated results of operations since their acquisition or sale dates, respectively. Pro forma results of operations have not been presented because the effects of these business combinations, individually and in the aggregate, were not material to our consolidated results of operations.
NOTE 9 GOODWILL
Following are details of the changes in our goodwill balances during the three months and nine months ended March 31, 2010:
(In millions) | Balance | Acquisitions | Purchase Accounting and Other |
Balance | ||||||||||||
December 31, 2009 |
March 31, 2010 |
|||||||||||||||
Windows & Windows Live Division |
$ | 77 | $ | | $ | | $ | 77 | ||||||||
Server and Tools |
1,119 | | | 1,119 | ||||||||||||
Online Services Division |
6,372 | | | 6,372 | ||||||||||||
Microsoft Business Division |
3,996 | 113 | (17 | ) | 4,092 | |||||||||||
Entertainment and Devices Division |
804 | | (1 | ) | 803 | |||||||||||
Total |
$ | 12,368 | $ | 113 | $ | (18 | ) | $ | 12,463 | |||||||
(In millions) | Balance | Acquisitions | Purchase and Other |
Balance | ||||||||||||
June 30, 2009 |
March 31, 2010 |
|||||||||||||||
Windows & Windows Live Division |
$ | 77 | $ | | $ | | $ | 77 | ||||||||
Server and Tools |
1,038 | 82 | (1 | ) | 1,119 | |||||||||||
Online Services Division |
6,657 | | (285 | ) | 6,372 | |||||||||||
Microsoft Business Division |
3,927 | 116 | 49 | 4,092 | ||||||||||||
Entertainment and Devices Division |
804 | | (1 | ) | 803 | |||||||||||
Total |
$ | 12,503 | $ | 198 | $ | (238 | ) | $ | 12,463 | |||||||
None of the amounts recorded as goodwill are expected to be deductible for tax purposes. The measurement period for purchase price allocations ends as soon as information on the facts and circumstances becomes available, but will not exceed 12 months. Adjustments in the purchase price allocation may require a recasting of the amounts allocated to goodwill retroactive to the period in which the acquisition occurred. Any change in the goodwill amounts
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resulting from foreign currency translations are presented as other in the table above. Also included within other is $286 million for the nine months ended March 31, 2010 of goodwill associated with business dispositions. See also Note 8 Business Combinations.
In connection with the disposal of Razorfish, we performed an interim impairment analysis of our Online Services Division goodwill balance during the first quarter of fiscal year 2010. No impairment of goodwill was identified.
NOTE 10 INTANGIBLE ASSETS
The components of intangible assets, all of which are finite-lived, were as follows:
(In millions) | Gross Carrying Amount |
Accumulated Amortization |
Net Carrying Amount |
Gross Carrying Amount |
Accumulated Amortization |
Net Carrying Amount |
||||||||||||||||||
|
March 31, 2010 |
|
|
June 30, 2009 |
| |||||||||||||||||||
Contract-based |
$ | 1,081 | $ | (905 | ) | $ | 176 | $ | 1,087 | $ | (855 | ) | $ | 232 | ||||||||||
Technology-based |
2,284 | (1,410 | ) | 874 | 2,033 | (1,090 | ) | 943 | ||||||||||||||||
Marketing-related |
117 | (85 | ) | 32 | 188 | (97 | ) | 91 | ||||||||||||||||
Customer-related |
458 | (258 | ) | 200 | 732 | (239 | ) | 493 | ||||||||||||||||
Total |
$ | 3,940 | $ | (2,658 | ) | $ | 1,282 | $ | 4,040 | $ | (2,281 | ) | $ | 1,759 | ||||||||||
We generally amortize acquired intangibles on a straight-line basis over their estimated weighted average lives. Intangible assets amortization expense was $198 million for the three months and $516 million for the nine months ended March 31, 2010 as compared with $156 million for the three months and $441 million for the nine months ended March 31, 2009. The following table outlines the estimated future amortization expense related to intangible assets held at March 31, 2010:
(In millions) | |||
Year Ending June 30, | |||
2010 (excluding the nine months ended March 31, 2010) |
$ | 132 | |
2011 |
498 | ||
2012 |
381 | ||
2013 |
242 | ||
2014 and thereafter |
29 | ||
Total |
$ | 1,282 | |
NOTE 11 DEBT
In September 2008, our Board of Directors authorized debt financings of up to $6.0 billion. Our initial commercial paper program provided for the issuance and sale of up to $2.0 billion. Following the issuance of our long-term debt in May 2009, we increased the commercial paper program and issued an additional $250 million of commercial paper during the nine months ended March 31, 2010. As of March 31, 2010, we had $2.25 billion of commercial paper and $3.75 billion of long-term debt issued and outstanding.
Short-term Debt
As of March 31, 2010, our $2.25 billion of commercial paper issued and outstanding had a weighted average interest rate, including issuance costs, of 0.17% and maturities of 35 to 216 days. The estimated fair value of this commercial paper approximates its carrying value.
In November 2009, we replaced our $2.0 billion and $1.0 billion credit facilities with a $2.25 billion 364-day credit facility, which expires on November 5, 2010. This facility serves as a back-up for our commercial paper program. As of March 31, 2010, we were in compliance with the financial covenant in the credit facility, which requires a coverage ratio be maintained of at least three times earnings before interest, taxes, depreciation, and amortization to interest expense. No amounts were drawn against the credit facilities during the nine months ended March 31, 2010.
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Long-term Debt
As of March 31, 2010, we had issued and outstanding $3.75 billion of debt securities as follows: $2.0 billion aggregate principal amount of 2.95% notes due 2014, $1.0 billion aggregate principal amount of 4.20% notes due 2019, and $750 million aggregate principal amount of 5.20% notes due 2039 (collectively the Notes). Interest on the Notes is payable semi-annually on June 1 and December 1 of each year to holders of record on the preceding May 15 and November 15. The Notes are senior unsecured obligations and rank equally with our other unsecured and unsubordinated debt outstanding.
As of March 31, 2010, the total carrying value and estimated fair value of our long-term debt were $3.75 billion and $3.79 billion, respectively. The estimated fair value is based on quoted prices for our publicly-traded debt as of March 31, 2010.
NOTE 12 INCOME TAXES
Our effective tax rate was 25% for both the three months and nine months ended March 31, 2010, as compared with 27% for both the three months and nine months ended March 31, 2009. The fiscal year 2010 rate reflects a higher mix of foreign earnings taxed at lower rates.
Tax contingencies and other tax liabilities were $6.5 billion as of March 31, 2010 and $5.5 billion as of June 30, 2009, and were included in other long-term liabilities.
NOTE 13 UNEARNED REVENUE
The components of unearned revenue were as follows:
(In millions) | March 31, | June 30, | |||||||
2010 | 2009 | ||||||||
Volume licensing programs |
$ | 9,576 | $ | 11,350 | |||||
Undelivered elements |
764 | 1,083 | |||||||
Other |
1,920 | 1,851 | |||||||
Total |
$ | 12,260 | $ | 14,284 | |||||
Unearned revenue by segment was as follows:
(In millions) | March 31, | June 30, | |||||||
2010 | 2009 | ||||||||
Windows & Windows Live Division |
$ | 1,498 | $ | 2,345 | |||||
Server and Tools |
4,242 | 4,732 | |||||||
Microsoft Business Division |
5,657 | 6,508 | |||||||
Other segments |
863 | 699 | |||||||
Total |
$ | 12,260 | $ | 14,284 | |||||
NOTE 14 COMMITMENTS AND GUARANTEES
Yahoo! Commercial Agreement
On December 4, 2009, we entered into a definitive agreement with Yahoo! Inc. (Yahoo) whereby Microsoft will provide the exclusive algorithmic and paid search platform for Yahoo websites. The transaction received clearance, without restrictions, from both the U.S. Department of Justice and the European Commission during the third fiscal quarter of 2010. The term of the agreement is 10 years subject to termination provisions after five years based on performance.
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Microsoft provided Yahoo country level revenue per search guarantees for a period of 18 months after migration. These guarantees are calculated, paid, and trued-up in three six-month periods starting at transition date, and are intended to insure Yahoo against any persistent drop in search yield from pre-migration levels. This is a rate guarantee not a guarantee of search volume. No amount has been recorded for the revenue per search guarantees as we do not believe that such liability, if any, is probable at this time.
Microsoft also agreed to reimburse Yahoo for certain transition expenses incurred both before and after the effective date of the agreement.
Finally, Microsoft also agreed to reimburse Yahoo for certain costs of running algorithmic and paid search services prior to migration to Microsofts platform.
Product Warranty
We provide for the estimated costs of fulfilling our obligations under hardware and software warranties at the time the related revenue is recognized. For hardware warranties, we estimate the costs based on historical and projected product failure rates, historical and projected repair costs, and knowledge of specific product failures (if any). The specific hardware warranty terms and conditions vary depending upon the product sold and country in which we do business, but generally include parts and labor over a period generally ranging from 90 days to three years. For software warranties, we estimate the costs to provide bug fixes, such as security patches, over the estimated life of the software. We regularly re-evaluate our estimates to assess the adequacy of the recorded warranty liabilities and adjust the amounts as necessary.
Our aggregate product warranty liabilities, which are included in other current liabilities and other long-term liabilities on our balance sheets, changed during the three months and nine months ended March 31, 2010 as follows:
(In millions) | Three Months Ended |
Nine Months Ended |
||||||||||
2010 | 2010 | |||||||||||
Balance, beginning of period |
$ | 308 | $ | 342 | ||||||||
Accrual for warranties issued |
27 | 121 | ||||||||||
Adjustments to pre-existing warranties |
| (2 | ) | |||||||||
Settlements of warranty claims |
(77 | ) | (203 | ) | ||||||||
Balance, end of period |
$ | 258 | $ | 258 | ||||||||
NOTE 15 CONTINGENCIES
Government Competition Law Matters
In March 2004, the European Commission issued a competition law decision that, among other things, ordered us to license certain Windows server protocol technology to our competitors. In March 2007, the European Commission issued a statement of objections claiming that the pricing terms we proposed for licensing the technology as required by the March 2004 decision were not reasonable. Following additional steps we took to address these concerns, the Commission announced on October 22, 2007 that we were in compliance with the March 2004 decision and that no further penalty should accrue after that date. On February 27, 2008, the Commission issued a fine of $1.4 billion (899 million) relating to the period prior to October 22, 2007. In May 2008, we filed an application with the European Court of First Instance to annul the February 2008 fine. We paid the $1.4 billion (899 million) fine in June 2008, pending the outcome of the appeal.
In January 2008, the Commission opened a competition law investigation that relates primarily to interoperability with respect to our Microsoft Office family of products. This investigation resulted from complaints filed with the Commission by a trade association of Microsofts competitors. Microsoft has made a number of proposals to address the Commissions competition law concerns in this area. The Commission announced on December 16, 2009 that it welcomed these proposals and that it will take them into account in assessing this matter.
We are also subject to a Consent Decree and Final Judgment (Final Judgments) that resolved lawsuits brought by the U.S. Department of Justice, 18 states, and the District of Columbia in two separate actions. The Final Judgments imposed various constraints on our Windows operating system businesses. The Final Judgments are scheduled to expire in May 2011.
In other ongoing investigations, various foreign governments and several state attorneys general have requested information from us concerning competition, privacy, and security issues.
Antitrust, Unfair Competition, and Overcharge Class Actions
A large number of antitrust and unfair competition class action lawsuits were filed against us in various state, federal, and Canadian courts on behalf of various classes of direct and indirect purchasers of our PC operating system and certain other software products. We obtained dismissals of damages claims of indirect purchasers under federal law and in 15 states. Courts refused to certify classes in two additional states. We have reached agreements to settle all claims that have been made to date in 19 states and the District of Columbia.
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The settlements in all states have received final court approval. Under the settlements, generally class members can obtain vouchers that entitle them to be reimbursed for purchases of a wide variety of platform-neutral computer hardware and software. The total value of vouchers that we may issue varies by state. We will make available to certain schools a percentage of those vouchers that are not issued or claimed (one-half to two-thirds depending on the state). The total value of vouchers we ultimately issue will depend on the number of class members who make claims and are issued vouchers. The maximum value of vouchers to be issued is approximately $2.7 billion. The actual costs of these settlements will be less than that maximum amount, depending on the number of class members and schools that are issued and redeem vouchers. We estimate the total cost to resolve all of the state overcharge class action cases will range between $1.8 billion and $2.0 billion. At March 31, 2010, we have recorded a liability related to these claims of approximately $675 million, which reflects our estimated exposure of $1.8 billion less payments made to date of approximately $1.2 billion mostly for vouchers, legal fees, and administrative expenses.
The three cases pending in British Columbia, Ontario, and Quebec, Canada have not been settled. In March 2010, the court in the British Columbia case certified it as a class action. We have appealed this ruling. The other two actions have been stayed.
Other Antitrust Litigation and Claims
In November 2004, Novell, Inc. filed a complaint in U.S. District Court for the District of Utah, asserting antitrust and unfair competition claims against us related to Novells ownership of WordPerfect and other productivity applications during the period between June 1994 and March 1996. This case was transferred to the District of Maryland. In June 2005, the trial court granted our motion to dismiss four of six claims of the complaint. Both parties appealed, and in October 2007, the court of appeals affirmed the decision of the trial court and remanded the case to the trial court for further proceedings. On March 30, 2010, the trial court granted summary judgment in favor of Microsoft. Novell has indicated it will appeal.
Patent and Intellectual Property Claims
In 2003, we filed an action in U.S. District Court in California seeking a declaratory judgment that we do not infringe certain Alcatel-Lucent patents (although this action began before the merger of Alcatel and Lucent in 2006, for simplicity we refer to the post-merger entity of Alcatel-Lucent). In April 2008, a jury returned a verdict in Alcatel-Lucents favor in a trial on a consolidated group of one video and three user interface patents. The jury concluded that we had infringed two user interface patents and awarded $367 million in damages. In June 2008, the trial judge increased the amount of damages to $512 million to include $145 million of interest. We appealed that award to the Federal Circuit. In December 2008, we entered into a settlement agreement resolving all other litigation pending between Microsoft and Alcatel-Lucent, leaving approximately $500 million remaining in dispute. In September 2009, the United States Court of Appeals for the Federal Circuit affirmed the liability award but vacated the verdict and remanded the case to the trial court for a re-trial of the damages ruling, indicating the damages previously awarded were too high. Trial on the remanded damages claim has been set for the first week of December 2010.
In October 2003, Uniloc USA Inc., a subsidiary of a Singapore-based security technology company, filed a patent infringement suit in U.S. District Court in Rhode Island, claiming that product activation technology in Windows XP and certain other Microsoft programs violated a Uniloc patent. After we obtained a favorable summary judgment that we did not infringe any of the claims of this patent, the court of appeals vacated the trial court decision and remanded the case for trial. In April 2009, the jury returned a $388 million verdict against us, including a finding of willful infringement. In September 2009, the district court judge overturned the jury verdict, ruling that the evidence did not support the jurys finding that Microsoft infringed the patent. Uniloc has appealed.
In March 2007, i4i Limited Partnership sued Microsoft in U.S. District Court in Texas claiming that certain custom XML technology in Word 2003 and 2007 infringed i4is patent. In May 2009, a jury returned a verdict against us, finding damages of $200 million and that we willfully infringed the patent. In August 2009, the court denied our post-trial motions and awarded enhanced damages of $40 million and prejudgment interest of $37 million. The court also issued a permanent injunction prohibiting additional distribution of the allegedly infringing technology. We appealed and the appellate court stayed the injunction pending our appeal. On December 22, 2009, the court of appeals rejected our appeal and affirmed the trial courts judgment and injunction, except that the court of appeals modified the effective date of the injunction to January 11, 2010. On April 1, 2010, the court of appeals denied our request for a rehearing. We are considering whether to appeal further.
In 2007, VirnetX Inc. brought suit in U.S. District Court in Texas claiming that various Microsoft products including Windows client and server operating systems software and communications software infringe two patents related to
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technology for securely communicating over the Internet. This case was tried to a jury in March 2010. The jury returned a verdict that Microsoft willfully infringed both patents, and found damages of approximately $106 million. VirnetX is also seeking injunctive relief, and has indicated that it may also seek a future royalty if injunctive relief is denied. VirnetX will also likely ask the Court to enhance damages based on the jurys finding of willful infringement. In post-trial proceedings, Microsoft will ask the court to overturn the jury verdict. We will also argue that injunctive relief and enhanced damages are not proper. On March 17, 2010, VirnetX filed a new lawsuit in the Eastern District of Texas alleging that additional Microsoft products and services including Windows 7 and Windows Server 2008 R2 infringe the same two patents.
There are over 50 other patent infringement cases pending against Microsoft, 10 of which are set for trial in fiscal year 2010.
Other
We also are subject to a variety of other claims and suits that arise from time to time in the ordinary course of our business. Although management currently believes that resolving claims against us, individually or in aggregate, will not have a material adverse impact on our financial statements, these matters are subject to inherent uncertainties and managements view of these matters may change in the future.
As of March 31, 2010, we had accrued aggregate liabilities of approximately $1.1 billion in other current liabilities and approximately $295 million in other long-term liabilities for all of the contingent matters described in this note. While we intend to vigorously defend these matters, there exists the possibility of adverse outcomes that we estimate could be up to $1.1 billion in aggregate beyond recorded amounts. Were unfavorable final outcomes to occur, there exists the possibility of a material adverse impact on our financial statements for the period in which the effects become reasonably estimable.
NOTE 16 EMPLOYEE SEVERANCE
In January 2009, we announced and implemented a resource management program to reduce discretionary operating expenses, employee headcount, and capital expenditures. As part of this program, we announced the elimination of 5,000 positions in research and development, marketing, sales, finance, legal, human resources, and information technology by June 30, 2010. As of September 30, 2009, we had reduced our overall number of positions by approximately 5,000 and headcount by approximately 4,600.
In November 2009, we identified an additional 800 positions for elimination based on our efforts to manage our expenses. Severance expense of approximately $52 million associated with these additional eliminations was reflected in our second fiscal quarter financial statements. We have now completed this program and reduced our overall headcount by approximately 5,300. The balance of the costs are associated with severance packages primarily for international employees that have yet to be paid out due to specific country policies and regulations.
The changes in our employee severance liabilities related to our resource management efforts during the three months and nine months ended March 31, 2010 were as follows:
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||
2010 | 2010 | |||||||||||
Balance, beginning of period |
$ | 31 | $ | 127 | ||||||||
Additional accruals |
| 52 | ||||||||||
Adjustments |
| 7 | ||||||||||
Cash payments |
(19 | ) | (174 | ) | ||||||||
Balance, end of period |
$ | 12 | $ | 12 | ||||||||
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NOTE 17 STOCKHOLDERS EQUITY
Share Repurchases
We repurchased the following shares of common stock during the periods presented:
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Shares of common stock repurchased |
67 | | 250 | 318 | ||||||||||||
Value of common stock repurchased |
$ | 2,000 | $ | | $ | 7,028 | $ | 8,200 | ||||||||
We repurchased all shares with cash resources. As of March 31, 2010, approximately $27.5 billion remained of our $40.0 billion repurchase program that we announced on September 22, 2008. The repurchase program expires September 30, 2013 but may be suspended or discontinued at any time without notice.
Dividends
Our Board of Directors declared the following dividends during the periods presented:
Declaration Date | Per Share Dividend |
Record Date | Total Amount | Payment Date | |||||||||
(in millions) | |||||||||||||
Fiscal year 2010 |
|||||||||||||
September 18, 2009 |
$ | 0.13 | November 19, 2009 | $ | 1,152 | December 10, 2009 | |||||||
December 9, 2009 |
$ | 0.13 | February 18, 2010 | $ | 1,139 | March 11, 2010 | |||||||
March 8, 2010 |
$ | 0.13 | May 20, 2010 | $ | 1,139 | June 10, 2010 | |||||||
Fiscal year 2009 |
|||||||||||||
September 19, 2008 |
$ | 0.13 | November 20, 2008 | $ | 1,157 | December 11, 2008 | |||||||
December 10, 2008 |
$ | 0.13 | February 19, 2009 | $ | 1,155 | March 12, 2009 | |||||||
March 9, 2009 |
$ | 0.13 | May 21, 2009 | $ | 1,158 | June 18, 2009 | |||||||
The estimate of the amount to be paid as a result of the March 8, 2010 declaration was included in other current liabilities as of March 31, 2010.
NOTE 18 SEGMENT INFORMATION
In its operation of the business, management reviews certain financial information, including segmented internal profit and loss statements prepared on a basis not consistent with U.S. GAAP. Our five segments are: Windows & Windows Live Division; Server and Tools; Online Services Division; Microsoft Business Division; and Entertainment and Devices Division. We have recast certain prior period amounts within this note to conform to the way we internally managed and monitored segment performance during the current fiscal year, including moving Windows Live from Online Services Division to Windows & Windows Live Division, Mobile Services from Online Services Division to Entertainment and Devices Division, and Razorfish from Online Services Division to Corporate. Razorfish was disposed of during the second quarter of fiscal year 2010.
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Segment revenue and operating income (loss) were as follows during the periods presented:
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Revenue |
||||||||||||||||
Windows & Windows Live Division |
$ | 4,273 | $ | 3,354 | $ | 13,328 | $ | 11,393 | ||||||||
Server and Tools |
3,578 | 3,501 | 10,862 | 10,714 | ||||||||||||
Online Services Division |
566 | 506 | 1,632 | 1,613 | ||||||||||||
Microsoft Business Division |
4,551 | 4,504 | 13,706 | 14,315 | ||||||||||||
Entertainment and Devices Division |
1,670 | 1,629 | 6,499 | 6,778 | ||||||||||||
Unallocated and other |
(135 | ) | 154 | 418 | 525 | |||||||||||
Consolidated |
$ | 14,503 | $ | 13,648 | $ | 46,445 | $ | 45,338 | ||||||||
Operating income (loss) |
||||||||||||||||
Windows & Windows Live Division |
$ | 2,872 | $ | 2,141 | $ | 9,192 | $ | 7,546 | ||||||||
Server and Tools |
1,119 | 1,181 | 3,647 | 3,476 | ||||||||||||
Online Services Division |
(738 | ) | (434 | ) | (1,707 | ) | (1,140 | ) | ||||||||
Microsoft Business Division |
2,825 | 2,716 | 8,575 | 8,815 | ||||||||||||
Entertainment and Devices Division |
138 | (67 | ) | 791 | 170 | |||||||||||
Reconciling amounts |
(1,043 | ) | (1,099 | ) | (2,330 | ) | (2,491 | ) | ||||||||
Consolidated |
$ | 5,173 | $ | 4,438 | $ | 18,168 | $ | 16,376 | ||||||||
Due to the integrated structure of our business, certain costs incurred by one segment may benefit other segments. The costs that are identifiable are allocated to the segments that benefit to incent cross-collaboration among our segments so that one segment is not solely burdened by the cost of a mutually beneficial activity. Each allocation is measured differently based on the specific facts and circumstances of the costs being allocated. These cost allocations were not material in any period presented.
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: field selling; employee benefits; 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 other corporate-level activity is not allocated to our segments, including costs of: broad-based sales and marketing; product support services; human resources; legal; finance; information technology; corporate development and procurement activities; research and development; legal settlements and contingencies; and employee severance.
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 and 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.
Reconciling amounts include adjustments to conform with U.S. GAAP and corporate-level activity not specifically attributed to a segment. Significant internal accounting policies that differ from U.S. GAAP relate to revenue recognition, income statement classification, and accelerated depreciation and amortization of stock-based awards. For the three months and nine months ended March 31, 2010, reconciling amounts include the deferral of revenue related to sales of the 2007 Microsoft Office system with a guarantee to be upgraded to the 2010 Microsoft Office system at minimal or no cost.
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Significant reconciling items were as follows:
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Corporate-level activity (1) |
$ | (1,217 | ) | $ | (1,363 | ) | $ | (3,375 | ) | $ | (3,414 | ) | ||||
Stock-based compensation |
139 | 189 | 368 | 563 | ||||||||||||
Revenue reconciling amounts |
(174 | ) | 89 | 254 | 396 | |||||||||||
Other |
209 | (14 | ) | 423 | (36 | ) | ||||||||||
Total |
$ | (1,043 | ) | $ | (1,099 | ) | $ | (2,330 | ) | $ | (2,491 | ) | ||||
(1) | Corporate-level activity excludes stock-based compensation and revenue reconciling amounts presented separately in those line items. |
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Microsoft Corporation
Redmond, Washington
We have reviewed the accompanying consolidated balance sheet of Microsoft Corporation and subsidiaries as of March 31, 2010, and the related consolidated statements of income, stockholders equity, and cash flows for the three-month and nine-month periods ended March 31, 2010 and 2009. These interim financial statements are the responsibility of the Corporations management.
We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 Public Company Accounting Oversight Board (United States), 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.
Based on our reviews, we are not aware of any material modifications that should be made to such consolidated interim financial statements for them 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), the consolidated balance sheet of Microsoft Corporation and subsidiaries as of June 30, 2009, and the related consolidated statements of income, stockholders equity, and cash flows for the year then ended (not presented herein); and in our report dated July 29, 2009 we expressed an unqualified opinion on those consolidated financial statements (which report includes an explanatory paragraph regarding the adoption of new accounting standards). In our opinion, the information set forth in the accompanying consolidated balance sheet as of June 30, 2009 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
/s/ DELOITTE & TOUCHE LLP |
Seattle, Washington |
April 22, 2010
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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Note About Forward-Looking Statements
Certain statements in Managements Discussion and Analysis (MD&A), other than purely historical information, including estimates, projections, statements relating to our business plans, objectives, and expected operating results, and the assumptions upon which those statements are based, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements generally are identified by the words believe, project, expect, anticipate, estimate, intend, strategy, plan, may, should, will, would, will be, will continue, will likely result, and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties, which may cause actual results to differ materially from the forward-looking statements. A detailed discussion of risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included in the section titled Risk Factors (refer to Part II, Item 1A). We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise.
OVERVIEW
Managements discussion and analysis is intended to help the reader understand the results of operations and financial condition of Microsoft Corporation. The following discussion should be read in conjunction with our Annual Report on Form 10-K for the year ended June 30, 2009 and the Consolidated Financial Statements and accompanying notes (Notes) included in this Form 10-Q.
We generate revenue by developing, manufacturing, licensing, and supporting a wide range of software products and services for many different types of computing devices. Our software products and services include operating systems for personal computers, servers, and intelligent devices; server applications for distributed computing environments; information worker productivity applications; business solutions applications; high-performance computing applications; software development tools; and video games. We provide consulting and product and solution support services, and we train and certify computer system integrators and developers. We also design and sell hardware, including the Xbox 360 video game console, the Zune digital music and entertainment device, and peripherals. Online offerings and information are delivered to consumers through Bing, Windows Live, Office Live, Xbox LIVE, our MSN portals and channels, and to businesses through Microsoft Online Services offerings, such as Microsoft Dynamics CRM Online, Exchange Online, Windows Azure, and SharePoint Online. We enable the delivery of online advertising across our broad range of digital media properties and on Bing through our proprietary adCenter platform.
Our revenue historically has fluctuated quarterly and has generally been the highest in the second quarter of our fiscal year due to corporate calendar year-end spending trends in our major markets and holiday season spending by consumers. Our Entertainment and Devices Division is particularly seasonal as its products are aimed at the consumer market and are in highest demand during the holiday shopping season. Typically, the Entertainment and Devices Division has generated approximately 40% of its yearly segment revenues in our second fiscal quarter. In addition, quarterly revenues may be impacted by the deferral of revenue. See the discussions below regarding the deferral of revenue related to sales of the 2007 Microsoft Office system with a guarantee to be upgraded to the 2010 Microsoft Office system at minimal or no cost (the Office 2010 Deferral) and sales of Windows Vista with a guarantee to be upgraded to Windows 7 at minimal or no cost and of Windows 7 to retailers before general availability (the Windows 7 Deferral).
All growth and percentage comparisons refer to the three months and nine months ended March 31, 2010, as compared with the three months and nine months ended March 31, 2009, unless otherwise noted.
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Summary
(In millions, except per share amounts and percentages) | Three Months Ended March 31, |
Percentage Change |
Nine Months Ended March 31, |
Percentage Change | |||||||||||||||||
2010 | 2009 | 2010 | 2009 | ||||||||||||||||||
Revenue |
$ | 14,503 | $ | 13,648 | 6% | $ | 46,445 | $ | 45,338 | 2% | |||||||||||
Operating income |
$ | 5,173 | $ | 4,438 | 17% | $ | 18,168 | $ | 16,376 | 11% | |||||||||||
Diluted earnings per share |
$ | 0.45 | $ | 0.33 | 36% | $ | 1.59 | $ | 1.28 | 24% | |||||||||||
Three months ended March 31, 2010 compared with three months ended March 31, 2009
Revenue increased mainly due to strong sales of Windows 7 and PC market improvement, offset in part by the deferral of $305 million of revenue for the Office 2010 Deferral. Operating income increased reflecting increased revenue offset by an overall modest increase in operating expenses.
| General and administrative expenses increased $239 million or 26%, primarily due to increased legal charges and transition expenses associated with the inception of the Yahoo! Commercial Agreement, offset in part by a reduction in headcount-related expenses. |
| Sales and marketing expenses increased $222 million or 7%, primarily reflecting increased advertising and marketing of Windows 7 and increased sales force expenses related to Windows 7. |
| Cost of revenue decreased $59 million or 2%, primarily reflecting decreased Xbox 360 console costs and cost controls, offset in part by increased online costs, mainly traffic acquisition costs. |
Diluted earnings per share increased primarily reflecting increased net income and share repurchases during the past 12 months. We repurchased 250 million shares during the 12 months ended March 31, 2010.
Nine months ended March 31, 2010 compared with nine months ended March 31, 2009
Revenue increased mainly due to strong sales of Windows 7 and PC market improvement, offset in part by the deferral of $305 million of revenue for the Office 2010 Deferral. Operating income increased reflecting increased revenue and decreased expenses in nearly all operating expense categories.
| Research and development expenses decreased $421 million or 6%, primarily reflecting a decrease in third-party development and programming costs and the capitalization of certain software development costs. |
| General and administrative expenses increased $386 million or 15%, primarily due to increased legal charges and transition expenses associated with the inception of the Yahoo! Commercial Agreement, offset in part by a reduction in headcount-related expenses. |
| Cost of revenue decreased $344 million or 4%, primarily reflecting decreased Xbox 360 console costs and cost controls, offset in part by increased online costs, mainly traffic acquisition costs. |
Diluted earnings per share increased primarily reflecting increased net income and share repurchases during the past 12 months. We repurchased 250 million shares during the 12 months ended March 31, 2010.
Demand for our software, services, hardware, and online offerings has a strong correlation to global macroeconomic factors. While we see the potential for improvement in calendar year 2010, the timing is uncertain. In the meantime, we are positive about our relative market position and our product delivery plans. In addition, we remain focused on executing in the areas we can control by continuing to provide high value products at the lowest total cost of ownership while managing our expenses.
SEGMENT PRODUCT REVENUE/OPERATING INCOME (LOSS)
The revenue and operating income (loss) amounts in this section are presented on a basis consistent with accounting principles generally accepted in the United States of America (U.S. GAAP) and include certain reconciling items attributable to each of the segments. Segment information appearing in Note 18 Segment Information of the Notes to Financial Statements (Part I, Item I) is presented on a basis consistent with our current internal management reporting. Certain corporate-level activity has been excluded from segment operating results and is analyzed separately. We have recast certain prior period amounts within this section to conform to the way we internally managed and monitored segment performance during fiscal year 2010, including moving Windows Live
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from Online Services Division to Windows & Windows Live Division, Mobile Services from Online Services Division to Entertainment and Devices Division, and Razorfish from Online Services Division to Corporate. Razorfish was disposed of in the second quarter of fiscal year 2010.
Windows & Windows Live Division
(In millions, except percentages) | Three Months Ended March 31, |
Percentage Change |
Nine Months Ended March 31, |
Percentage Change | |||||||||||||||||
2010 | 2009 | 2010 | 2009 | ||||||||||||||||||
Revenue |
$ | 4,415 | $ | 3,448 | 28% | $ | 13,943 | $ | 11,805 | 18% | |||||||||||
Operating income |
$ | 3,061 | $ | 2,273 | 35% | $ | 9,914 | $ | 8,053 | 23% | |||||||||||
Windows & Windows Live (Windows) Division offerings consist of premium and standard edition Windows operating systems and online software and services through Windows Live. Premium Windows operating systems are those that include additional functionality and are sold at a price above our standard editions. Premium editions include Windows 7 Home Premium, Windows 7 Professional, Windows 7 Ultimate, Windows 7 Enterprise, Windows Vista Business, Windows Vista Home Premium, Windows Vista Ultimate, and Windows Vista Enterprise. Standard editions include Windows 7 Starter, Windows 7 Home Basic, Windows Vista Home Basic, and Windows XP Home. Windows Live primarily generates revenue from online advertising.
Windows Division revenue growth is directly impacted by growth of PC purchases from original equipment manufacturers (OEMs) that pre-install versions of Windows operating systems because the OEM channel accounts for approximately 80% of total Windows Division revenue. The remaining approximately 20% of Windows Division revenue (other revenue) is generated by commercial and retail sales of Windows and online advertising from Windows Live.
Three months ended March 31, 2010 compared with three months ended March 31, 2009
Windows Division revenue increased due to strong sales of Windows 7 and PC market improvement. We estimate total worldwide PC shipments from all sources grew approximately 25% to 27%. OEM revenue increased $781 million or 29%, while OEM license units increased 30%. The OEM revenue increase was primarily driven by PC market growth and higher Windows attach rates across consumer and business segments, partially offset by PC market strength in emerging markets versus developed markets. Other revenue increased $186 million or 26% driven primarily by strong Windows 7 retail sales.
Windows Division operating income increased as a result of increased revenue, offset in part by increased operating expenses. Sales and marketing expenses increased $105 million or 23% reflecting increased advertising and marketing of Windows 7 and increased sales force expenses related to Windows 7. Cost of revenue increased $91 million or 27%, primarily driven by increased traffic acquisition costs and royalties. These increases were offset in part by a $20 million or 6% reduction in research and development expenses, primarily driven by third-party development and programming costs.
Nine months ended March 31, 2010 compared with nine months ended March 31, 2009
Windows Division revenue increased primarily as a result of strong sales of Windows 7 and PC market improvement. We estimate total worldwide PC shipments from all sources grew approximately 13% to 15%. OEM revenue increased $1.5 billion or 16%. Excluding the recognition of $273 million of revenue associated with the Windows 7 Deferral, OEM revenue increased $1.2 billion or 13%, while OEM license units increased 19%. The OEM revenue increase was primarily driven by PC market growth, higher Windows attach rates across consumer and business segments and the restoration of normal OEM inventory levels, offset in part by PC market changes, including stronger growth of emerging markets versus developed markets and of consumer PCs versus business PCs. Other revenue increased $649 million or 27% driven primarily by strong Windows 7 retail sales.
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Windows Division operating income increased as a result of increased revenue, offset in part by increased operating expenses. Cost of revenue increased $213 million or 22%, primarily driven by increased traffic acquisition costs, royalties, and other product costs. Sales and marketing expenses increased $179 million or 11% reflecting increased advertising and marketing of Windows 7. These operating expense increases were offset in part by a $96 million or 10% decrease in research and development expenses, which resulted primarily from capitalization of certain software development costs and completion of Windows 7 product development.
Server and Tools
(In millions, except percentages) | Three Months Ended March 31, |
Percentage Change |
Nine Months Ended March 31, |
Percentage Change | |||||||||||||||||
2010 | 2009 | 2010 | 2009 | ||||||||||||||||||
Revenue |
$ | 3,575 | $ | 3,491 | 2% | $ | 10,854 | $ | 10,663 | 2% | |||||||||||
Operating income |
$ | 1,255 | $ | 1,224 | 3% | $ | 3,945 | $ | 3,597 | 10% | |||||||||||
Server and Tools licenses products, applications, tools, content, and Enterprise Services that are designed to make information technology professionals and developers more productive and efficient. Server and Tools product offerings consist of server software licenses and client access licenses (CAL) for Windows Server, Microsoft SQL Server, Windows Azure and other server products. We also offer developer tools, training and certification. Enterprise Services comprise Premier product support services and Microsoft Consulting Services. Server product offerings can be run on-site, in a partner-hosted environment, or in a Microsoft-hosted environment. We use multiple sales channels, including pre-installed OEM versions, sales through partners and sales directly to end customers. Approximately 50% of Server and Tools revenue comes from annuity volume licensing agreements, approximately 30% is purchased through transactional volume licensing programs, fully packaged product and licenses sold to OEMs, and the remainder comes from Enterprise Services.
Three months ended March 31, 2010 compared with three months ended March 31, 2009
Server and Tools revenue increased reflecting growth in product revenue and Enterprise Services revenue. Product revenue increased $50 million or 2%, driven primarily by growth in Windows Server and Enterprise CAL Suites revenue, reflecting continued adoption of Windows platform applications, offset in part by a decline in developer tools revenue. Enterprise Services revenue grew $34 million or 5%, primarily due to growth in Premier product support services, offset in part by decreased consulting services.
Server and Tools revenue for the three months ended March 31, 2010 included a favorable foreign currency exchange impact of $55 million.
Server and Tools operating income increased primarily due to revenue growth, offset in part by increased research and development and sales and marketing expenses. Research and development expenses increased $23 million or 4%, primarily driven by increased hosting and localization costs. Sales and marketing expenses increased $19 million or 2%, primarily due to increased corporate marketing expenses.
Nine months ended March 31, 2010 compared with nine months ended March 31, 2009
Server and Tools revenue increased mainly reflecting growth in product revenue. Product revenue increased $189 million or 2%, driven primarily by growth in Enterprise CAL Suites, System Center and SQL Server revenue, reflecting increased revenue from annuity volume licensing agreements and continued adoption of Windows platform applications, offset in part by a decline in developer tools revenue. Enterprise Services revenue was relatively flat, with growth in Premier product support services nearly offset by decreased consulting services.
Server and Tools operating income increased due to revenue growth and reduced operating expenses. Sales and marketing expenses decreased $60 million or 2%, primarily due to a decrease in headcount-related expenses and corporate marketing expenses. Cost of revenue decreased $47 million or 2%, reflecting a decline in demand for consulting services, offset in part by increased online costs. Research and development expenses decreased $25 million or 2%, primarily driven by reduced third-party development and programming costs and headcount-related expenses, offset in part by increased lab and hosting costs. General and administrative expenses decreased $25 million or 9%, due to decreased headcount-related expenses.
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Online Services Division
(In millions, except percentages) | Three Months Ended March 31, |
Percentage Change |
Nine Months Ended March 31, |
Percentage Change | |||||||||||||||||
2010 | 2009 | 2010 | 2009 | ||||||||||||||||||
Revenue |
$ | 566 | $ | 507 | 12 % | $ | 1,634 | $ | 1,620 | 1 % | |||||||||||
Operating loss |
$ | (713 | ) | $ | (411 | ) | (73)% | $ | (1,659 | ) | $ | (1,067 | ) | (55)% | |||||||
Online Services Division (OSD) consists of an online advertising platform with offerings for both publishers and advertisers, online information offerings, such as Bing, and the MSN portals and channels around the world. We earn revenue primarily from online advertising, including search, display, and advertiser and publisher tools. Revenue is also generated through subscriptions and transactions generated from online paid services and from MSN narrowband Internet access subscribers (Access).
Yahoo! Commercial Agreement
On December 4, 2009, we entered into a definitive agreement with Yahoo! Inc. (Yahoo) whereby Microsoft will provide the exclusive algorithmic and paid search platform for Yahoo websites. We believe this agreement will allow us over time to improve the effectiveness and increase the value of our search offering through greater scale in search queries and an expanded and more competitive search and advertising marketplace. See Note 14 Commitments and Guarantees in the Notes to Financial Statements (Part I, Item I) for additional information about the agreement.
Three months ended March 31, 2010 compared with three months ended March 31, 2009
OSD revenue increased primarily as a result of increased online advertising revenue, offset in part by decreased Access revenue. Online advertising revenue increased $81 million or 19%, to $502 million, reflecting an increase in search and display advertising revenue, offset in part by decreased advertiser and publisher tools revenue. Access revenue decreased $14 million or 33%, reflecting continued migration of subscribers to broadband or other competitively-priced service providers.
OSD revenue for the three months ended March 31, 2010 included a favorable foreign currency exchange impact of $13 million.
OSD operating loss increased due to increased operating expenses, offset in part by increased revenue. General and administrative expenses increased $154 million due mainly to transition expenses associated with the inception of the Yahoo! Commercial Agreement. Research and development expenses increased $74 million or 33%, primarily due to increased headcount-related expenses and reimbursement to Yahoo for certain of their costs incurred prior to migration to the Microsoft platform. Sales and marketing expenses increased $69 million or 30% due to increased marketing activities. Cost of revenue increased $64 million or 15%, primarily driven by higher online traffic acquisition costs.
Nine months ended March 31, 2010 compared with nine months ended March 31, 2009
OSD revenue was nearly flat, reflecting increased online advertising revenue, offset in part by decreased Access revenue. Online advertising revenue increased $68 million or 5%, to $1.4 billion, reflecting an increase in search and display advertising revenue, offset in part by decreased advertiser and publisher tools revenue. Access revenue decreased $43 million or 31%, reflecting continued migration of subscribers to broadband or other competitively-priced service providers.
OSD operating loss increased due to increased operating expenses, offset in part by increased revenue. Cost of revenue increased $408 million or 38%, primarily driven by higher online traffic acquisition costs. General and administrative expenses increased $140 million due mainly to the transition expenses associated with the inception of the Yahoo! Commercial Agreement. Sales and marketing expenses increased $72 million or 10% due to increased marketing activities. Research and development expenses decreased $14 million or 2%, primarily due to decreased third-party development and programming costs, offset in part by increased headcount-related expenses and reimbursement to Yahoo for certain of their costs incurred prior to migration to the Microsoft platform.
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Microsoft Business Division
(In millions, except percentages) | Three Months Ended March 31, |
Percentage Change |
Nine Months Ended March 31, |
Percentage Change | ||||||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||||||||
Revenue |
$ | 4,243 | $ | 4,508 | (6)% | $ | 13,392 | $ | 14,343 | (7)% | ||||||||||||
Operating income |
$ | 2,622 | $ | 2,756 | (5)% | $ | 8,492 | $ | 8,958 | (5)% | ||||||||||||
Microsoft Business Division (MBD) offerings consist of the Microsoft Office system and Microsoft Dynamics business solutions. Microsoft Office system products are designed to increase personal, team, and organization productivity through a range of programs, services, and software solutions. Microsoft Office system offerings generate over 90% of MBD revenue. Microsoft Dynamics products provide business solutions for financial management, customer relationship management, supply chain management, and analytics applications for small and mid-size businesses, large organizations, and divisions of global enterprises. We evaluate our results based upon the nature of the end user in two primary parts: business revenue, which includes Microsoft Office system revenue generated through volume licensing agreements and Microsoft Dynamics revenue; and consumer revenue, which includes revenue from retail packaged product sales and OEM revenue.
Three months ended March 31, 2010 compared with three months ended March 31, 2009
MBD revenue decreased primarily as a result of the deferral of $305 million of revenue for the Office 2010 Deferral. Business revenue decreased $37 million or 1%, primarily reflecting a decline in licensing the 2007 Microsoft Office system to transactional business customers, offset in part by a 3% increase in Microsoft Dynamics revenue. Consumer revenue decreased $228 million or 32%. Including the revenue associated with the Office 2010 Deferral, consumer revenue increased $77 million or 11% due mainly to growth in the PC market.
MBD revenue for the three months ended March 31, 2010 included a favorable foreign currency exchange impact of $69 million.
MBD operating income decreased due mainly to decreased revenue, offset in part by decreased operating expenses. Sales and marketing expenses decreased $71 million or 7%, primarily driven by a decrease in corporate marketing activities. Research and development expenses decreased $70 million or 17%, primarily as a result of capitalization of certain Microsoft Office system software development costs. General and administrative expenses decreased $22 million or 28% primarily due to expenses in the prior year associated with the acquisition of FAST Search & Transfer ASA (FAST), which we acquired in April 2008. These decreases were offset in part by a $32 million or 12% increase in cost of revenue, primarily driven by increased traffic acquisition costs and increased costs of providing services.
Nine months ended March 31, 2010 compared with nine months ended March 31, 2009
MBD revenue decreased primarily as a result of the deferral of $305 million of revenue for the Office 2010 Deferral. Business revenue decreased $428 million or 4%, primarily reflecting a decline in licensing the 2007 Microsoft Office system to transactional business customers and a 1% decrease in Microsoft Dynamics revenue, offset in part by growth in multi-year volume licensing agreement revenue. The growth in multi-year volume licensing agreement revenue primarily reflects recognition of deferred revenue from previously signed agreements. Consumer revenue decreased $523 million or 20%. Including the revenue associated with the Office 2010 Deferral, consumer revenue decreased $218 million or 8%, primarily as a result of pricing promotions in the first half of fiscal year 2009 that drove increased licensing in that period, a shift to lower-priced products, and a decline in licensing the 2007 Microsoft Office system.
MBD operating income decreased due mainly to decreased revenue, offset in part by decreased operating expenses. Sales and marketing expenses decreased $333 million or 11%, primarily driven by a decrease in corporate marketing activities. Research and development expenses decreased $165 million or 13%, primarily as a result of capitalization of certain Microsoft Office system software development costs and lower headcount-related expenses. General and administrative expenses decreased $50 million or 22% primarily due to expenses in the prior year associated with the acquisition of FAST. These decreases were offset in part by a $63 million or 8% increase in cost of revenue, primarily driven by increased traffic acquisition costs and increased costs of providing services.
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Entertainment and Devices Division
(In millions, except percentages) | Three Months Ended March 31, |
Percentage Change |
Nine Months Ended March 31, |
Percentage Change | |||||||||||||||||
2010 | 2009 | 2010 | 2009 | ||||||||||||||||||
Revenue |
$ | 1,665 | $ | 1,629 | 2% | $ | 6,458 | $ | 6,778 | (5)% | |||||||||||
Operating income (loss) |
$ | 165 | $ | (41 | ) | * | $ | 851 | $ | 249 | 242 % | ||||||||||
* | Not meaningful |
Entertainment and Devices Division (EDD) offerings include the Xbox 360 platform (which includes the Microsoft Xbox 360 video game console system, Xbox 360 video games, Xbox LIVE, and Xbox 360 accessories), the Zune digital music and entertainment platform (including Zune HD, which was released in September 2009), PC software games, online games and services, Mediaroom (our Internet protocol television software), the Microsoft Surface computing platform, Windows Mobile and embedded device platforms, and other devices. EDD leads the development efforts for our line of consumer software and hardware products including application software for Apples Macintosh computers and Microsoft PC hardware products, and is responsible for all retail sales and marketing for Microsoft Office and Windows operating systems.
Three months ended March 31, 2010 compared with three months ended March 31, 2009
EDD revenue increased primarily reflecting an increase in Xbox LIVE revenue and non-gaming revenue, offset in part by decreased revenue from Xbox 360 video games and decreased Xbox 360 consoles sold. Non-gaming revenue increased $77 million or 14%, primarily reflecting increased sales of Windows embedded device platforms and PC hardware products. The decreased revenue from Xbox 360 video games was due primarily to the launch of Halo Wars in the third quarter of the prior year. We shipped 1.5 million Xbox 360 consoles during the third quarter of fiscal year 2010, compared with 1.7 million Xbox 360 consoles during the third quarter of fiscal year 2009.
EDD revenue for the three months ended March 31, 2010 included a favorable foreign currency exchange impact of $62 million.
EDD operating income increased due mainly to a $199 million or 22% decrease in cost of revenue resulting primarily from lower Xbox 360 console costs, offset in part by increased online costs resulting from increased Xbox LIVE activity. Research and development expenses increased $31 million or 7%, primarily reflecting increased headcount-related expenses, partially offset by decreased third-party development and programming costs.
Nine months ended March 31, 2010 compared with nine months ended March 31, 2009
EDD revenue decreased reflecting decreases in Xbox 360 platform and PC game revenue, as well as decreased revenue from the non-gaming portion of the business. Xbox 360 platform and PC game revenue decreased $240 million or 5% due mainly to decreased Xbox 360 consoles sold, decreased revenue per console, and decreased revenue from Xbox 360 video games, offset in part by increased Xbox LIVE revenue. We shipped 8.8 million Xbox 360 consoles during the first nine months of fiscal year 2010, compared with 10 million Xbox 360 consoles during the first nine months of fiscal year 2009. The decreased revenue per console resulted from price reductions during the past 12 months. The decreased revenue from Xbox 360 video games was due primarily to the release of three significant games in the prior year compared to two significant games in the current year. Non-gaming revenue decreased $80 million or 4%, primarily reflecting decreased sales of Window Mobile device platforms and Zune digital music and entertainment devices.
EDD operating income increased due to reduced operating expenses, offset in part by decreased revenue. Cost of revenue decreased $779 million or 19%, primarily due to lower Xbox 360 console costs, offset in part by increased online costs resulting from increased Xbox LIVE activity. Research and development expenses decreased $82 million or 6%, primarily reflecting decreased third-party development and programming costs. Sales and marketing expenses decreased by $60 million or 6%, primarily due to decreased marketing for the Xbox 360 platform.
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Corporate-Level Activity
(In millions, except percentages) | Three Months Ended March 31, |
Percentage Change |
Nine Months Ended March 31, |
Percentage Change | |||||||||||||||||
2010 | 2009 | 2010 | 2009 | ||||||||||||||||||
Corporate-level activity |
$ | (1,217 | ) | $ | (1,363 | ) | 11% | $ | (3,375 | ) | $ | (3,414 | ) | 1% | |||||||
Certain corporate-level activity is not allocated to our segments, including costs of: broad-based sales and marketing; product support services; human resources; legal; finance; information technology; corporate development and procurement activities; research and development; legal settlements and contingencies; and employee severance. Corporate-level expenses decreased due mainly to employee severance charges of $290 million incurred in the third quarter of the prior year and cost controls, and for the nine months ended March 31, 2010, due also to decreased partner payments. These decreases in expenses were offset in part by an increase in legal charges and costs associated with broad-based sales and marketing activities. Legal charges were approximately $187 million and $436 million during the three and nine months ended March 31, 2010, respectively. This is compared to legal charges of $57 million and $90 million for the three and nine months ended March 31, 2009, respectively.
OPERATING EXPENSES
Cost of Revenue
(In millions, except percentages) | Three Months Ended March 31, |
Percentage Change |
Nine Months Ended March 31, |
Percentage Change | |||||||||||||||||
2010 | 2009 | 2010 | 2009 | ||||||||||||||||||
Cost of revenue |
$ | 2,755 | $ | 2,814 | (2)% | $ | 9,225 | $ | 9,569 | (4)% | |||||||||||
As a percent of revenue |
19 | % | 21 | % | (2)ppt | 20 | % | 21 | % | (1)ppt | |||||||||||
Cost of revenue includes manufacturing and distribution costs for products sold and programs licensed, operating costs related to product support service centers and product distribution centers, costs incurred to drive traffic to our websites and/or acquire online advertising space (traffic acquisition costs), costs incurred to support and maintain Internet-based products and services, warranty costs, inventory valuation adjustments, costs associated with the delivery of consulting services, and the amortization of capitalized research and development costs associated with software products that have reached technological feasibility. Cost of revenue decreased reflecting decreased Xbox 360 console costs and cost controls, offset in part by increased online costs, mainly traffic acquisition costs.
Research and Development
(In millions, except percentages) | Three Months Ended March 31, |
Percentage Change |
Nine Months Ended March 31, |
Percentage Change | |||||||||||||||||
2010 | 2009 | 2010 | 2009 | ||||||||||||||||||
Research and development |
$ | 2,220 | $ | 2,212 | % | $ | 6,364 | $ | 6,785 | (6)% | |||||||||||
As a percent of revenue |
15 | % | 16 | % | (1)ppt | 14 | % | 15 | % | (1)ppt | |||||||||||
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, the amortization of purchased software code and services content, and in-process research and development. The decrease in research and development expenses was primarily driven by a decrease in third-party development and programming costs and the capitalization of certain software development costs, offset in part for the three months ended March 31, 2010 by a 4% increase in headcount-related expenses.
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Sales and Marketing
(In millions, except percentages) | Three Months Ended March 31, |
Percentage Change |
Nine Months Ended March 31, |
Percentage Change | |||||||||||||||||
2010 | 2009 | 2010 | 2009 | ||||||||||||||||||
Sales and marketing |
$ | 3,203 | $ | 2,981 | 7% | $ | 9,612 | $ | 9,687 | (1)% | |||||||||||