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, 2013
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 11, 2013 | |||
Common Stock, $0.00000625 par value per share |
8,351,106,590 shares |
MICROSOFT CORPORATION
FORM 10-Q
For the Quarter Ended March 31, 2013
2
PART I
Item 1
(In millions, except per share amounts) (Unaudited) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Revenue |
$ | 20,489 | $ | 17,407 | $ | 57,953 | $ | 55,664 | ||||||||
Cost of revenue |
4,787 | 3,952 | 14,647 | 13,367 | ||||||||||||
Gross profit |
15,702 | 13,455 | 43,306 | 42,297 | ||||||||||||
Operating expenses: |
||||||||||||||||
Research and development |
2,640 | 2,517 | 7,628 | 7,217 | ||||||||||||
Sales and marketing |
3,794 | 3,414 | 11,048 | 10,076 | ||||||||||||
General and administrative |
1,656 | 1,150 | 3,939 | 3,433 | ||||||||||||
Total operating expenses |
8,090 | 7,081 | 22,615 | 20,726 | ||||||||||||
Operating income |
7,612 | 6,374 | 20,691 | 21,571 | ||||||||||||
Other income (expense) |
(9 | ) | (11 | ) | 216 | 337 | ||||||||||
Income before income taxes |
7,603 | 6,363 | 20,907 | 21,908 | ||||||||||||
Provision for income taxes |
1,548 | 1,255 | 4,009 | 4,438 | ||||||||||||
Net income |
$ | 6,055 | $ | 5,108 | $ | 16,898 | $ | 17,470 | ||||||||
Earnings per share: |
||||||||||||||||
Basic |
$ | 0.72 | $ | 0.61 | $ | 2.02 | $ | 2.08 | ||||||||
Diluted |
$ | 0.72 | $ | 0.60 | $ | 1.99 | $ | 2.05 | ||||||||
Weighted average shares outstanding: |
||||||||||||||||
Basic |
8,364 | 8,401 | 8,385 | 8,398 | ||||||||||||
Diluted |
8,429 | 8,498 | 8,472 | 8,502 | ||||||||||||
Cash dividends declared per common share |
$ | 0.23 | $ | 0.20 | $ | 0.69 | $ | 0.60 | ||||||||
See accompanying notes.
3
PART I
Item 1
COMPREHENSIVE INCOME STATEMENTS
(In millions) (Unaudited) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Net income |
$ | 6,055 | $ | 5,108 | $ | 16,898 | $ | 17,470 | ||||||||
Other comprehensive income (loss): |
||||||||||||||||
Net unrealized gains (losses) on derivatives (net of tax effects of $19, $(24), $(10), and $103) |
35 | (44 | ) | (19 | ) | 192 | ||||||||||
Net unrealized gains (losses) on investments (net of tax effects of $150, $255, $401, and $(297)) |
278 | 474 | 744 | (551 | ) | |||||||||||
Translation adjustments and other (net of tax effects of $(61), $41, $31 and $(93)) |
(114 | ) | 76 | 58 | (172 | ) | ||||||||||
Other comprehensive income (loss) |
199 | 506 | 783 | (531 | ) | |||||||||||
Comprehensive income |
$ | 6,254 | $ | 5,614 | $ | 17,681 | $ | 16,939 | ||||||||
See accompanying notes.
4
PART I
Item 1
(In millions) (Unaudited) | ||||||||
March 31, 2013 |
June 30, 2012 |
|||||||
Assets |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 5,240 | $ | 6,938 | ||||
Short-term investments (including securities loaned of $493 and $785) |
69,243 | 56,102 | ||||||
Total cash, cash equivalents, and short-term investments |
74,483 | 63,040 | ||||||
Accounts receivable, net of allowance for doubtful accounts of $267 and $389 |
11,991 | 15,780 | ||||||
Inventories |
2,133 | 1,137 | ||||||
Deferred income taxes |
1,676 | 2,035 | ||||||
Other |
3,241 | 3,092 | ||||||
Total current assets |
93,524 | 85,084 | ||||||
Property and equipment, net of accumulated depreciation of $12,247 and $10,962 |
9,204 | 8,269 | ||||||
Equity and other investments |
11,193 | 9,776 | ||||||
Goodwill |
14,682 | 13,452 | ||||||
Intangible assets, net |
3,240 | 3,170 | ||||||
Other long-term assets |
2,262 | 1,520 | ||||||
Total assets |
$ | 134,105 | $ | 121,271 | ||||
Liabilities and stockholders equity |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 4,532 | $ | 4,175 | ||||
Current portion of long-term debt |
2,246 | 1,231 | ||||||
Accrued compensation |
3,474 | 3,875 | ||||||
Income taxes |
689 | 789 | ||||||
Short-term unearned revenue |
16,511 | 18,653 | ||||||
Securities lending payable |
564 | 814 | ||||||
Other |
3,913 | 3,151 | ||||||
Total current liabilities |
31,929 | 32,688 | ||||||
Long-term debt |
11,949 | 10,713 | ||||||
Long-term unearned revenue |
1,394 | 1,406 | ||||||
Deferred income taxes |
2,424 | 1,893 | ||||||
Other long-term liabilities |
9,721 | 8,208 | ||||||
Total liabilities |
57,417 | 54,908 | ||||||
Commitments and contingencies |
||||||||
Stockholders equity: |
||||||||
Common stock and paid-in capitalshares authorized 24,000; outstanding 8,349 and 8,381 |
66,826 | 65,797 | ||||||
Retained earnings (deficit) |
7,657 | (856 | ) | |||||
Accumulated other comprehensive income |
2,205 | 1,422 | ||||||
Total stockholders equity |
76,688 | 66,363 | ||||||
Total liabilities and stockholders equity |
$ | 134,105 | $ | 121,271 | ||||
See accompanying notes.
5
PART I
Item 1
(In millions) (Unaudited) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Operations |
||||||||||||||||
Net income |
$ | 6,055 | $ | 5,108 | $ | 16,898 | $ | 17,470 | ||||||||
Adjustments to reconcile net income to net cash from operations: |
||||||||||||||||
Depreciation, amortization, and other |
1,053 | 766 | 2,772 | 2,170 | ||||||||||||
Stock-based compensation expense |
599 | 591 | 1,805 | 1,724 | ||||||||||||
Net recognized losses (gains) on investments and derivatives |
(52 | ) | 68 | (19 | ) | (74 | ) | |||||||||
Excess tax benefits from stock-based compensation |
(6 | ) | (10 | ) | (192 | ) | (84 | ) | ||||||||
Deferred income taxes |
226 | (134 | ) | 404 | 282 | |||||||||||
Deferral of unearned revenue |
9,686 | 8,142 | 28,632 | 21,825 | ||||||||||||
Recognition of unearned revenue |
(11,599 | ) | (8,283 | ) | (30,852 | ) | (23,993 | ) | ||||||||
Changes in operating assets and liabilities: |
||||||||||||||||
Accounts receivable |
2,191 | 2,770 | 3,859 | 3,851 | ||||||||||||
Inventories |
(483 | ) | (50 | ) | (989 | ) | (79 | ) | ||||||||
Other current assets |
139 | 73 | (96 | ) | 938 | |||||||||||
Other long-term assets |
(13 | ) | 9 | (326 | ) | (36 | ) | |||||||||
Accounts payable |
(67 | ) | (114 | ) | 51 | (380 | ) | |||||||||
Other current liabilities |
1,238 | 492 | 119 | (107 | ) | |||||||||||
Other long-term liabilities |
699 | 166 | 864 | 442 | ||||||||||||
Net cash from operations |
9,666 | 9,594 | 22,930 | 23,949 | ||||||||||||
Financing |
||||||||||||||||
Proceeds from issuance of debt |
0 | 0 | 2,232 | 0 | ||||||||||||
Common stock issued |
203 | 1,091 | 765 | 1,635 | ||||||||||||
Common stock repurchased |
(1,028 | ) | (1,023 | ) | (4,318 | ) | (3,999 | ) | ||||||||
Common stock cash dividends paid |
(1,925 | ) | (1,683 | ) | (5,534 | ) | (4,707 | ) | ||||||||
Excess tax benefits from stock-based compensation |
6 | 10 | 192 | 84 | ||||||||||||
Other |
0 | 0 | (16 | ) | 0 | |||||||||||
Net cash used in financing |
(2,744 | ) | (1,605 | ) | (6,679 | ) | (6,987 | ) | ||||||||
Investing |
||||||||||||||||
Additions to property and equipment |
(930 | ) | (749 | ) | (2,463 | ) | (1,683 | ) | ||||||||
Acquisition of companies, net of cash acquired, and purchases of intangible and other assets |
(108 | ) | (84 | ) | (1,564 | ) | (9,586 | ) | ||||||||
Purchases of investments |
(18,160 | ) | (23,951 | ) | (48,372 | ) | (45,297 | ) | ||||||||
Maturities of investments |
1,265 | 4,236 | 4,513 | 13,122 | ||||||||||||
Sales of investments |
9,730 | 7,946 | 30,163 | 23,317 | ||||||||||||
Securities lending payable |
543 | 361 | (249 | ) | 3 | |||||||||||
Net cash used in investing |
(7,660 | ) | (12,241 | ) | (17,972 | ) | (20,124 | ) | ||||||||
Effect of exchange rates on cash and cash equivalents |
(39 | ) | 30 | 23 | (60 | ) | ||||||||||
Net change in cash and cash equivalents |
(777 | ) | (4,222 | ) | (1,698 | ) | (3,222 | ) | ||||||||
Cash and cash equivalents, beginning of period |
6,017 | 10,610 | 6,938 | 9,610 | ||||||||||||
Cash and cash equivalents, end of period |
$ | 5,240 | $ | 6,388 | $ | 5,240 | $ | 6,388 | ||||||||
See accompanying notes.
6
PART I
Item 1
STOCKHOLDERS EQUITY STATEMENTS
(In millions) (Unaudited) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Common stock and paid-in capital |
||||||||||||||||
Balance, beginning of period |
$ | 66,334 | $ | 63,902 | $ | 65,797 | $ | 63,415 | ||||||||
Common stock issued |
203 | 1,091 | 755 | 1,635 | ||||||||||||
Common stock repurchased |
(313 | ) | (262 | ) | (1,711 | ) | (1,426 | ) | ||||||||
Stock-based compensation expense |
599 | 591 | 1,805 | 1,724 | ||||||||||||
Stock-based compensation income tax benefits (deficiencies) |
2 | (50 | ) | 174 | (79 | ) | ||||||||||
Other, net |
1 | 1 | 6 | 4 | ||||||||||||
Balance, end of period |
66,826 | 65,273 | 66,826 | 65,273 | ||||||||||||
Retained earnings (deficit) |
||||||||||||||||
Balance, beginning of period |
4,236 | (607 | ) | (856 | ) | (8,195 | ) | |||||||||
Net income |
6,055 | 5,108 | 16,898 | 17,470 | ||||||||||||
Common stock cash dividends |
(1,919 | ) | (1,686 | ) | (5,778 | ) | (5,046 | ) | ||||||||
Common stock repurchased |
(715 | ) | (761 | ) | (2,607 | ) | (2,175 | ) | ||||||||
Balance, end of period |
7,657 | 2,054 | 7,657 | 2,054 | ||||||||||||
Accumulated other comprehensive income |
||||||||||||||||
Balance, beginning of period |
2,006 | 826 | 1,422 | 1,863 | ||||||||||||
Other comprehensive income (loss) |
199 | 506 | 783 | (531 | ) | |||||||||||
Balance, end of period |
2,205 | 1,332 | 2,205 | 1,332 | ||||||||||||
Total stockholders equity |
$ | 76,688 | $ | 68,659 | $ | 76,688 | $ | 68,659 | ||||||||
See accompanying notes.
7
PART I
Item 1
(Unaudited)
NOTE 1 ACCOUNTING POLICIES
Accounting Principles
In the opinion of management, the accompanying balance sheets and related interim statements of income, comprehensive 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). 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 2012 Form 10-K filed on July 26, 2012 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 over but do not control the investee and are not the primary beneficiary of the investees activities are accounted for using the equity method. Investments through which we are not able to exercise significant influence over the investee and which do not have readily determinable fair values are accounted for under the cost method.
Estimates and Assumptions
Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Examples of estimates include: loss contingencies; product warranties; the fair value of, and/or potential goodwill impairment for, our reporting units; product life cycles; useful lives of our tangible and intangible assets; allowances for doubtful accounts; allowances for product returns; the market value of our inventory; and stock-based compensation forfeiture rates. Examples of assumptions include: the elements comprising a software arrangement, including the distinction between upgrades or enhancements and new products; when technological feasibility is achieved for our products; the potential outcome of future tax consequences of events that have been recognized in our financial statements or tax returns; and determining when investment impairments are other-than-temporary. Actual results and outcomes may differ from managements estimates and assumptions.
Recasting of Certain Prior Period Information
We have recast certain prior period amounts to conform to the current period presentation, including the reclassification of accumulated other comprehensive income (AOCI) from retained earnings to a separate component of stockholders equity, the reclassification of cost of revenue from operating expenses to a separate line and the addition of a gross profit line in the income statements, and the recasting of segment information for immaterial movements of business activities between segments and changes in cost allocations, with no impact on consolidated net income or cash flows.
Recent Accounting Guidance
Recently adopted accounting guidance
In September 2011, the Financial Accounting Standards Board (FASB) issued guidance on testing goodwill for impairment. The new guidance provides an entity the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity determines that this is the case, it is required to perform the currently prescribed two-step goodwill impairment test to identify potential goodwill impairment and measure the amount of goodwill impairment loss to be recognized for that reporting unit (if any). If an entity determines that the fair value of a reporting unit is greater than its carrying amount, the two-step goodwill impairment test is not required. We adopted this new guidance beginning July 1, 2012. Adoption of this new guidance did not have a material impact on our financial statements.
In June 2011, the FASB issued guidance on presentation of comprehensive income. The new guidance eliminated the option to report other comprehensive income (OCI) and its components in the statement of changes in stockholders equity. Instead, an entity is required to present either a continuous statement of net income and OCI or in two separate but consecutive statements. We adopted this new guidance beginning July 1, 2012. Adoption of this new guidance resulted only in changes to presentation of our financial statements.
8
PART I
Item 1
Recent accounting guidance not yet adopted
In December 2011, the FASB issued guidance enhancing disclosure requirements about the nature of an entitys right to offset and related arrangements associated with its financial instruments and derivative instruments. The new guidance requires the disclosure of the gross amounts subject to rights of set-off, amounts offset in accordance with the accounting standards followed, and the related net exposure. In January 2013, the FASB clarified that the scope of this guidance applies to derivatives, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset or subject to an enforceable master netting arrangement, or similar agreements. The new guidance will be effective for us beginning July 1, 2013. Other than requiring additional disclosures, we do not anticipate material impacts on our financial statements upon adoption.
In February 2013, the FASB issued guidance on disclosure requirements for items reclassified out of AOCI. This new guidance requires entities to present (either on the face of the income statement or in the notes) the effects on the line items of the income statement for amounts reclassified out of AOCI. The new guidance will be effective for us beginning July 1, 2013. Other than requiring additional disclosures, we do not anticipate material impacts on our financial statements upon adoption.
In March 2013, the FASB issued guidance on a parents accounting for the cumulative translation adjustment upon derecognition of a subsidiary or group of assets within a foreign entity. This new guidance requires that the parent release any related cumulative translation adjustment into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. The new guidance will be effective for us beginning July 1, 2014. We do not anticipate material impacts on our financial statements upon adoption.
NOTE 2 EARNINGS PER SHARE
Basic earnings per share (EPS) is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options, stock awards, and shared performance stock awards. The components of basic and diluted EPS are as follows:
(In millions, except earnings per share) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Net income available for common shareholders (A) |
$ | 6,055 | $ | 5,108 | $ | 16,898 | $ | 17,470 | ||||||||
Weighted average outstanding shares of common stock (B) |
8,364 | 8,401 | 8,385 | 8,398 | ||||||||||||
Dilutive effect of stock-based awards |
65 | 97 | 87 | 104 | ||||||||||||
Common stock and common stock equivalents (C) |
8,429 | 8,498 | 8,472 | 8,502 | ||||||||||||
Earnings Per Share |
||||||||||||||||
Basic (A/B) |
$ | 0.72 | $ | 0.61 | $ | 2.02 | $ | 2.08 | ||||||||
Diluted (A/C) |
$ | 0.72 | $ | 0.60 | $ | 1.99 | $ | 2.05 | ||||||||
Anti-dilutive stock-based awards excluded from the calculations of diluted EPS were immaterial during the periods presented.
In June 2010, we issued $1.25 billion of zero-coupon debt securities that are convertible into shares of our common stock. As of March 31, 2013, none of these securities were included in the calculation of diluted EPS as they would have been anti-dilutive. See Note 11 Debt for additional information.
9
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, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Dividends and interest income |
$ | 150 | $ | 180 | $ | 475 | $ | 573 | ||||||||
Interest expense |
(109 | ) | (95 | ) | (309 | ) | (284 | ) | ||||||||
Net recognized gains on investments |
57 | 34 | 85 | 352 | ||||||||||||
Net losses on derivatives |
(5 | ) | (102 | ) | (66 | ) | (278 | ) | ||||||||
Net losses on foreign currency remeasurements |
(22 | ) | (8 | ) | (58 | ) | (52 | ) | ||||||||
Other |
(80 | ) | (20 | ) | 89 | 26 | ||||||||||
Total |
$ | (9 | ) | $ | (11 | ) | $ | 216 | $ | 337 | ||||||
Following are details of net recognized gains (losses) on investments during the periods reported:
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Other-than-temporary impairments of investments |
$ | (22 | ) | $ | (82 | ) | $ | (152 | ) | $ | (234 | ) | ||||
Realized gains from sales of available-for-sale securities |
113 | 232 | 323 | 1,075 | ||||||||||||
Realized losses from sales of available-for-sale securities |
(34 | ) | (116 | ) | (86 | ) | (489 | ) | ||||||||
Total |
$ | 57 | $ | 34 | $ | 85 | $ | 352 | ||||||||
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 Equivalents |
Short-term Investments |
Equity and Other Investments |
|||||||||||||||||||||
March 31, 2013 | ||||||||||||||||||||||||||||
Cash |
$ | 2,271 | $ | 0 | $ | 0 | $ | 2,271 | $ | 2,271 | $ | 0 | $ | 0 | ||||||||||||||
Mutual funds |
1,064 | 0 | 0 | 1,064 | 1,064 | 0 | 0 | |||||||||||||||||||||
Commercial paper |
186 | 0 | 0 | 186 | 186 | 0 | 0 | |||||||||||||||||||||
Certificates of deposit |
933 | 0 | 0 | 933 | 550 | 383 | 0 | |||||||||||||||||||||
U.S. government and agency securities |
60,870 | 139 | (2 | ) | 61,007 | 69 | 60,938 | 0 | ||||||||||||||||||||
Foreign government bonds |
1,141 | 34 | (15 | ) | 1,160 | 0 | 1,160 | 0 | ||||||||||||||||||||
Mortgage-backed securities |
1,271 | 59 | (1 | ) | 1,329 | 0 | 1,329 | 0 | ||||||||||||||||||||
Corporate notes and bonds |
5,842 | 261 | (4 | ) | 6,099 | 1,100 | 4,999 | 0 | ||||||||||||||||||||
Municipal securities |
357 | 65 | 0 | 422 | 0 | 422 | 0 | |||||||||||||||||||||
Common and preferred stock |
7,063 | 3,033 | (190 | ) | 9,906 | 0 | 0 | 9,906 | ||||||||||||||||||||
Other investments |
1,299 | 0 | 0 | 1,299 | 0 | 12 | 1,287 | |||||||||||||||||||||
Total |
$ | 82,297 | $ | 3,591 | $ | (212 | ) | $ | 85,676 | $ | 5,240 | $ | 69,243 | $ | 11,193 | |||||||||||||
10
PART I
Item 1
(In millions) | Cost Basis | Unrealized Gains |
Unrealized Losses |
Recorded Basis |
Cash and Cash Equivalents |
Short-term Investments |
Equity and Other Investments |
|||||||||||||||||||||
June 30, 2012 | ||||||||||||||||||||||||||||
Cash |
$ | 2,019 | $ | 0 | $ | 0 | $ | 2,019 | $ | 2,019 | $ | 0 | $ | 0 | ||||||||||||||
Mutual funds |
820 | 0 | 0 | 820 | 820 | 0 | 0 | |||||||||||||||||||||
Commercial paper |
96 | 0 | 0 | 96 | 96 | 0 | 0 | |||||||||||||||||||||
Certificates of deposit |
744 | 0 | 0 | 744 | 342 | 402 | 0 | |||||||||||||||||||||
U.S. government and agency securities |
47,178 | 130 | (2 | ) | 47,306 | 561 | 46,745 | 0 | ||||||||||||||||||||
Foreign government bonds |
1,741 | 18 | (29 | ) | 1,730 | 575 | 1,155 | 0 | ||||||||||||||||||||
Mortgage-backed securities |
1,816 | 82 | (2 | ) | 1,896 | 0 | 1,896 | 0 | ||||||||||||||||||||
Corporate notes and bonds |
7,799 | 224 | (15 | ) | 8,008 | 2,525 | 5,483 | 0 | ||||||||||||||||||||
Municipal securities |
358 | 58 | 0 | 416 | 0 | 416 | 0 | |||||||||||||||||||||
Common and preferred stock |
6,965 | 2,204 | (436 | ) | 8,733 | 0 | 0 | 8,733 | ||||||||||||||||||||
Other investments |
1,048 | 0 | 0 | 1,048 | 0 | 5 | 1,043 | |||||||||||||||||||||
Total |
$ | 70,584 | $ | 2,716 | $ | (484 | ) | $ | 72,816 | $ | 6,938 | $ | 56,102 | $ | 9,776 | |||||||||||||
Unrealized Losses on Investments
Investments with continuous unrealized losses for less than 12 months and 12 months or greater and their related fair values were as follows:
Less than 12 Months |
12 Months or Greater |
Total Unrealized Losses |
||||||||||||||||||||||
(In millions) | Fair Value | Unrealized Losses |
Fair Value | Unrealized Losses |
Total Fair Value |
|||||||||||||||||||
March 31, 2013 | ||||||||||||||||||||||||
U.S. government and agency securities |
$ | 213 | $ | (2 | ) | $ | 0 | $ | 0 | $ | 213 | $ | (2 | ) | ||||||||||
Foreign government bonds |
151 | (2 | ) | 79 | (13 | ) | 230 | (15 | ) | |||||||||||||||
Mortgage-backed securities |
52 | 0 | 42 | (1 | ) | 94 | (1 | ) | ||||||||||||||||
Corporate notes and bonds |
364 | (1 | ) | 30 | (3 | ) | 394 | (4 | ) | |||||||||||||||
Common and preferred stock |
1,059 | (107 | ) | 426 | (83 | ) | 1,485 | (190 | ) | |||||||||||||||
Total |
$ | 1,839 | $ | (112 | ) | $ | 577 | $ | (100 | ) | $ | 2,416 | $ | (212 | ) | |||||||||
Less than 12 Months |
12 Months or Greater |
Total Unrealized Losses |
||||||||||||||||||||||
(In millions) | Fair Value | Unrealized Losses |
Fair Value | Unrealized Losses |
Total Fair Value |
|||||||||||||||||||
June 30, 2012 | ||||||||||||||||||||||||
U.S. government and agency securities |
$ | 44 | $ | (2 | ) | $ | 0 | $ | 0 | $ | 44 | $ | (2 | ) | ||||||||||
Foreign government bonds |
657 | (27 | ) | 12 | (2 | ) | 669 | (29 | ) | |||||||||||||||
Mortgage-backed securities |
53 | 0 | 48 | (2 | ) | 101 | (2 | ) | ||||||||||||||||
Corporate notes and bonds |
640 | (11 | ) | 70 | (4 | ) | 710 | (15 | ) | |||||||||||||||
Common and preferred stock |
2,135 | (329 | ) | 305 | (107 | ) | 2,440 | (436 | ) | |||||||||||||||
Total |
$ | 3,529 | $ | (369 | ) | $ | 435 | $ | (115 | ) | $ | 3,964 | $ | (484 | ) | |||||||||
Unrealized losses from fixed-income securities are primarily attributable to changes in interest rates. Unrealized losses from domestic and international equities are due to market price movements. Management does not believe any remaining unrealized losses represent other-than-temporary impairments based on our evaluation of available evidence as of March 31, 2013.
11
PART I
Item 1
At March 31, 2013 and June 30, 2012, the recorded bases of common and preferred stock and other investments that are restricted for more than one year or are not publicly traded were $380 million and $313 million, respectively. These investments are carried at cost and are reviewed quarterly for indicators of other-than-temporary impairment. It is not possible for us to reliably estimate the fair value of these investments.
Debt Investment Maturities
(In millions) | Cost Basis | Estimated Fair Value |
||||||
March 31, 2013 | ||||||||
Due in one year or less |
$ | 33,279 | $ | 33,331 | ||||
Due after one year through five years |
32,128 | 32,267 | ||||||
Due after five years through 10 years |
3,098 | 3,319 | ||||||
Due after 10 years |
2,095 | 2,219 | ||||||
Total |
$ | 70,600 | $ | 71,136 | ||||
NOTE 5 DERIVATIVES
We use derivative instruments to: manage risks related to foreign currencies, equity prices, interest rates, and credit; enhance investment returns; and 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, 2013 and June 30, 2012, the total notional amounts of these foreign exchange contracts sold were $4.5 billion and $6.7 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, 2013 and June 30, 2012, the total notional amounts of these foreign exchange contracts sold were $622 million and $1.3 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, 2013, the total notional amounts of these foreign exchange contracts purchased and sold were $3.8 billion and $4.4 billion, respectively. As of June 30, 2012, the total notional amounts of these foreign exchange contracts purchased and sold were $3.6 billion and $7.3 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, 2013, the total notional amounts of designated and non-designated equity contracts purchased and sold were both $1.1 billion. As of June 30, 2012, the total notional amounts of designated and non-designated equity contracts purchased and sold were $1.4 billion and $982 million, respectively.
12
PART I
Item 1
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, 2013, the total notional amounts of fixed-interest rate contracts purchased and sold were $1.4 billion and $1.6 billion, respectively. As of June 30, 2012, the total notional amounts of fixed-interest rate contracts purchased and sold were $3.2 billion and $1.9 billion, respectively.
In addition, we use To Be Announced forward purchase commitments of mortgage-backed assets to gain exposure to agency mortgage-backed securities. These meet the definition of a derivative instrument in cases where physical delivery of the assets is not taken at the earliest available delivery date. As of March 31, 2013 and June 30, 2012, the total notional derivative amounts of mortgage contracts purchased were $1.2 billion and $1.1 billion, respectively.
Credit
Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We use credit default swap contracts, not designated as hedging instruments, to manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. We use credit default swaps as they are a low-cost method of managing exposure to individual credit risks or groups of credit risks. As of March 31, 2013, the total notional amounts of credit contracts purchased and sold were $362 million and $466 million, respectively. As of June 30, 2012, the total notional amounts of credit contracts purchased and sold were $318 million and $456 million, respectively.
Commodity
We use broad-based commodity exposures to enhance portfolio returns and to facilitate portfolio diversification. We use swaps, futures, and option contracts, not designated as hedging instruments, to generate and manage exposures to broad-based commodity indices. We use derivatives on commodities as they can be low-cost alternatives to the purchase and storage of a variety of commodities, including, but not limited to, precious metals, energy, and grain. As of March 31, 2013, the total notional amounts of commodity contracts purchased and sold were $1.3 billion and $284 million, respectively. As of June 30, 2012, the total notional amounts of commodity contracts purchased and sold were $1.5 billion and $445 million, respectively.
Credit-Risk-Related Contingent Features
Certain of our counterparty agreements for derivative instruments contain provisions that require our issued and outstanding long-term unsecured debt to maintain an investment grade credit rating and require us to maintain minimum liquidity of $1.0 billion. To the extent we fail to meet these requirements, we will be required to post collateral, similar to the standard convention related to over-the-counter derivatives. As of March 31, 2013, our long-term unsecured debt rating was AAA, and cash investments were in excess of $1.0 billion. As a result, no collateral was required to be posted.
Fair Values of Derivative Instruments
Derivative instruments are recognized as either assets or liabilities and are measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation.
For derivative instruments designated as fair-value hedges, the gains (losses) are recognized in earnings in the periods of change together with the offsetting losses (gains) on the hedged items attributed to the risk being hedged. For options designated as fair-value hedges, changes in the time value are excluded from the assessment of hedge effectiveness and are recognized in earnings.
For derivative instruments designated as cash-flow hedges, the effective portion of the gains (losses) on the derivatives is initially reported as a component of OCI and is subsequently recognized in earnings when the hedged exposure is recognized in earnings. For options designated as cash-flow hedges, changes in the time value are excluded from the assessment of hedge effectiveness and are recognized in earnings. Gains (losses) on derivatives representing either hedge components excluded from the assessment of effectiveness or hedge ineffectiveness are recognized in earnings.
13
PART I
Item 1
For derivative instruments that are not designated as hedges, gains (losses) from changes in fair values are primarily recognized in other income (expense). Other than those derivatives entered into for investment purposes, such as commodity contracts, the gains (losses) are generally economically offset by unrealized gains (losses) in the underlying available-for-sale securities, which are recorded as a component of OCI until the securities are sold or other-than-temporarily impaired, at which time the amounts are reclassified from AOCI into other income (expense).
The following tables present the gross fair values of derivative instruments designated as hedging instruments (designated hedge derivatives) and not designated as hedging instruments (non-designated hedge derivatives). The fair values exclude the impact of netting derivative assets and liabilities when a legally enforceable master netting agreement exists and fair value adjustments related to our own credit risk and counterparty credit risk:
(In millions) | Foreign Exchange Contracts |
Equity Contracts |
Interest Rate Contracts |
Credit Contracts |
Commodity Contracts |
Total Derivatives |
||||||||||||||||||
March 31, 2013 | ||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||
Non-designated hedge derivatives: |
||||||||||||||||||||||||
Short-term investments |
$ | 18 | $ | 156 | $ | 7 | $ | 17 | $ | 3 | $ | 201 | ||||||||||||
Other current assets |
35 | 0 | 0 | 0 | 0 | 35 | ||||||||||||||||||
Total |
$ | 53 | $ | 156 | $ | 7 | $ | 17 | $ | 3 | $ | 236 | ||||||||||||
Designated hedge derivatives: |
||||||||||||||||||||||||
Short-term investments |
$ | 8 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 8 | ||||||||||||
Other current assets |
128 | 0 | 0 | 0 | 0 | 128 | ||||||||||||||||||
Total |
$ | 136 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 136 | ||||||||||||
Total assets |
$ | 189 | $ | 156 | $ | 7 | $ | 17 | $ | 3 | $ | 372 | ||||||||||||
Liabilities |
||||||||||||||||||||||||
Non-designated hedge derivatives: |
||||||||||||||||||||||||
Other current liabilities |
$ | (77 | ) | $ | (16 | ) | $ | (6 | ) | $ | (14 | ) | $ | 0 | $ | (113 | ) | |||||||
Designated hedge derivatives: |
||||||||||||||||||||||||
Other current liabilities |
$ | (2 | ) | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | (2 | ) | ||||||||||
Total liabilities |
$ | (79 | ) | $ | (16 | ) | $ | (6 | ) | $ | (14 | ) | $ | 0 | $ | (115 | ) | |||||||
(In millions) | Foreign Exchange Contracts |
Equity Contracts |
Interest Rate Contracts |
Credit Contracts |
Commodity Contracts |
Total Derivatives |
||||||||||||||||||
June 30, 2012 | ||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||
Non-designated hedge derivatives: |
||||||||||||||||||||||||
Short-term investments |
$ | 14 | $ | 162 | $ | 10 | $ | 26 | $ | 3 | $ | 215 | ||||||||||||
Other current assets |
85 | 0 | 0 | 0 | 0 | 85 | ||||||||||||||||||
Total |
$ | 99 | $ | 162 | $ | 10 | $ | 26 | $ | 3 | $ | 300 | ||||||||||||
Designated hedge derivatives: |
||||||||||||||||||||||||
Short-term investments |
$ | 6 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 6 | ||||||||||||
Other current assets |
177 | 0 | 0 | 0 | 0 | 177 | ||||||||||||||||||
Total |
$ | 183 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 183 | ||||||||||||
Total assets |
$ | 282 | $ | 162 | $ | 10 | $ | 26 | $ | 3 | $ | 483 | ||||||||||||
Liabilities |
||||||||||||||||||||||||
Non-designated hedge derivatives: |
||||||||||||||||||||||||
Other current liabilities |
$ | (84 | ) | $ | (19 | ) | $ | (17 | ) | $ | (21 | ) | $ | 0 | $ | (141 | ) | |||||||
Designated hedge derivatives: |
||||||||||||||||||||||||
Other current liabilities |
$ | (14 | ) | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | (14 | ) | ||||||||||
Total liabilities |
$ | (98 | ) | $ | (19 | ) | $ | (17 | ) | $ | (21 | ) | $ | 0 | $ | (155 | ) | |||||||
14
PART I
Item 1
See also Note 4 Investments and Note 6 Fair Value Measurements.
Fair-Value Hedge Gains (Losses)
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, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Foreign Exchange Contracts |
||||||||||||||||
Derivatives |
$ | 45 | $ | (12 | ) | $ | 68 | $ | 36 | |||||||
Hedged items |
(47 | ) | 11 | (68 | ) | (37 | ) | |||||||||
Total |
$ | (2 | ) | $ | (1 | ) | $ | 0 | $ | (1 | ) | |||||
Cash Flow Hedge Gains (Losses)
We recognized the following gains (losses) on foreign exchange contracts designated as cash flow hedges (our only cash flow hedges during the periods presented):
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Effective Portion |
||||||||||||||||
Gains (losses) recognized in OCI, net of tax effects of $36 and $(28) for the three months ended March 31, 2013 and 2012, and $31 and $74 for the nine months ended March 31, 2013 and 2012 |
$ | 66 | $ | (52 | ) | $ | 56 | $ | 138 | |||||||
Gains (losses) reclassified from AOCI into revenue |
$ | 47 | $ | (12 | ) | $ | 116 | $ | (82 | ) | ||||||
Amount Excluded from Effectiveness Assessment and Ineffective Portion |
||||||||||||||||
Losses recognized in other income (expense) |
$ | (27 | ) | $ | (107 | ) | $ | (134 | ) | $ | (172 | ) | ||||
We estimate that $108 million of net derivative gains included in AOCI at March 31, 2013 will be reclassified into earnings within the following 12 months. No significant amounts of gains (losses) were reclassified from AOCI into earnings as a result of forecasted transactions that failed to occur during the three and nine months ended March 31, 2013.
Non-Designated Derivative Gains (Losses)
Gains (losses) from changes in fair values of derivatives that are not designated as hedges are primarily recognized in other income (expense). 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 periods presented. Other than those derivatives entered into for investment purposes, such as commodity contracts, the gains (losses) below are generally economically offset by unrealized gains (losses) in the underlying available-for-sale securities.
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Foreign exchange contracts |
$ | (25 | ) | $ | (44 | ) | $ | (50 | ) | $ | (109 | ) | ||||
Equity contracts |
8 | 5 | 25 | (63 | ) | |||||||||||
Interest-rate contracts |
(1 | ) | 21 | 18 | 79 | |||||||||||
Credit contracts |
10 | (6 | ) | 1 | (13 | ) | ||||||||||
Commodity contracts |
(5 | ) | (1 | ) | 16 | (89 | ) | |||||||||
Total |
$ | (13 | ) | $ | (25 | ) | $ | 10 | $ | (195 | ) | |||||
15
PART I
Item 1
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. government securities, domestic and international equities, and actively traded mutual funds. Our Level 1 derivative assets and liabilities include those actively traded on exchanges. |
| Level 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, U.S. agency securities, certificates of deposit, and commercial paper. Our Level 2 derivative assets and liabilities primarily include certain over-the-counter option 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 and goodwill when it is recorded at fair value due to an impairment charge. We value the Level 3 corporate bonds using internally developed valuation models, inputs to which include interest rate curves, credit spreads, stock prices, and volatilities. 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. Unobservable inputs used in all of these models are significant to the fair values of the assets and liabilities. |
We measure certain assets, including our cost and equity method investments, at fair value on a nonrecurring basis when they are deemed to be other-than-temporarily impaired. The fair values of these investments are determined based on valuation techniques using the best information available, and may include quoted market prices, market comparables, and discounted cash flow projections. An impairment charge is recorded when the cost of the investment exceeds its fair value and this condition is determined to be other-than-temporary.
Our other current financial assets and our current financial liabilities have fair values that approximate their carrying values.
16
PART I
Item 1
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following tables present the fair value of our financial instruments that are measured at fair value on a recurring basis:
(In millions) |
Level 1 | Level 2 | Level 3 |
|
Gross Fair Value |
|
Netting | (a) | |
Net Fair Value |
| |||||||||||||
March 31, 2013 | ||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||
Mutual funds |
$ | 1,064 | $ | 0 | $ | 0 | $ | 1,064 | $ | 0 | $ | 1,064 | ||||||||||||
Commercial paper |
0 | 186 | 0 | 186 | 0 | 186 | ||||||||||||||||||
Certificates of deposit |
0 | 934 | 0 | 934 | 0 | 934 | ||||||||||||||||||
U.S. government and agency securities |
58,370 | 2,636 | 0 | 61,006 | 0 | 61,006 | ||||||||||||||||||
Foreign government bonds |
47 | 1,101 | 0 | 1,148 | 0 | 1,148 | ||||||||||||||||||
Mortgage-backed securities |
0 | 1,328 | 0 | 1,328 | 0 | 1,328 | ||||||||||||||||||
Corporate notes and bonds |
0 | 5,928 | 19 | 5,947 | 0 | 5,947 | ||||||||||||||||||
Municipal securities |
0 | 422 | 0 | 422 | 0 | 422 | ||||||||||||||||||
Common and preferred stock |
8,785 | 735 | 5 | 9,525 | 0 | 9,525 | ||||||||||||||||||
Derivatives |
10 | 362 | 0 | 372 | (93 | ) | 279 | |||||||||||||||||
Total |
$ | 68,276 | $ | 13,632 | $ | 24 | $ | 81,932 | $ | (93 | ) | $ | 81,839 | |||||||||||
Liabilities |
||||||||||||||||||||||||
Derivatives and other |
$ | 5 | $ | 110 | $ | 0 | $ | 115 | $ | (92 | ) | $ | 23 | |||||||||||
(In millions) |
Level 1 | Level 2 | Level 3 |
|
Gross Fair Value |
|
Netting | (a) | |
Net Fair Value |
| |||||||||||||
June 30, 2012 | ||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||
Mutual funds |
$ | 820 | $ | 0 | $ | 0 | $ | 820 | $ | 0 | $ | 820 | ||||||||||||
Commercial paper |
0 | 96 | 0 | 96 | 0 | 96 | ||||||||||||||||||
Certificates of deposit |
0 | 744 | 0 | 744 | 0 | 744 | ||||||||||||||||||
U.S. government and agency securities |
42,291 | 5,019 | 0 | 47,310 | 0 | 47,310 | ||||||||||||||||||
Foreign government bonds |
31 | 1,703 | 0 | 1,734 | 0 | 1,734 | ||||||||||||||||||
Mortgage-backed securities |
0 | 1,892 | 0 | 1,892 | 0 | 1,892 | ||||||||||||||||||
Corporate notes and bonds |
0 | 7,839 | 9 | 7,848 | 0 | 7,848 | ||||||||||||||||||
Municipal securities |
0 | 416 | 0 | 416 | 0 | 416 | ||||||||||||||||||
Common and preferred stock |
7,539 | 877 | 5 | 8,421 | 0 | 8,421 | ||||||||||||||||||
Derivatives |
16 | 467 | 0 | 483 | (141 | ) | 342 | |||||||||||||||||
Total |
$ | 50,697 | $ | 19,053 | $ | 14 | $ | 69,764 | $ | (141 | ) | $ | 69,623 | |||||||||||
Liabilities |
||||||||||||||||||||||||
Derivatives and other |
$ | 10 | $ | 145 | $ | 0 | $ | 155 | $ | (139 | ) | $ | 16 | |||||||||||
(a) | These amounts represent the impact of netting derivative assets and derivative liabilities when a legally enforceable master netting agreement exists and fair value adjustments related to our own credit risk and counterparty credit risk. |
The following table reconciles the total Net Fair Value of assets above to the balance sheet presentation of these same assets in Note 4 Investments.
17
PART I
Item 1
(In millions) | ||||||||
March 31, 2013 |
June 30, 2012 |
|||||||
Net fair value of assets measured at fair value on a recurring basis |
$ | 81,839 | $ | 69,623 | ||||
Cash |
2,271 | 2,019 | ||||||
Common and preferred stock measured at fair value on a nonrecurring basis |
380 | 313 | ||||||
Other investments measured at fair value on a nonrecurring basis |
1,287 | 1,043 | ||||||
Less derivative net assets classified as other current assets |
(105 | ) | (185 | ) | ||||
Other |
4 | 3 | ||||||
Recorded basis of investment components |
$ | 85,676 | $ | 72,816 | ||||
Changes in Financial Instruments Measured at Level 3 Fair Value on a Recurring Basis
The following tables present the changes during the periods presented 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 OCI.
(In millions) | Corporate Notes and Bonds |
Common and Preferred Stock |
Derivative Assets |
Total | ||||||||||||
Three and Nine Months Ended March 31, 2013 | ||||||||||||||||
Balance as of June 30, 2012 |
$ | 9 | $ | 5 | $ | 0 | $ | 14 | ||||||||
Realized and unrealized gains (losses): |
||||||||||||||||
Included in other income (expense) |
0 | 0 | 0 | 0 | ||||||||||||
Included in other comprehensive income (loss) |
0 | 0 | 0 | 0 | ||||||||||||
Purchases |
8 | 0 | 0 | 8 | ||||||||||||
Balance as of September 30, 2012 |
$ | 17 | $ | 5 | $ | 0 | $ | 22 | ||||||||
Realized and unrealized gains (losses): |
||||||||||||||||
Included in other income (expense) |
0 | 0 | 0 | 0 | ||||||||||||
Included in other comprehensive income |
1 | 0 | 0 | 1 | ||||||||||||
Balance as of December 31, 2012 |
$ | 18 | $ | 5 | $ | 0 | $ | 23 | ||||||||
Realized and unrealized gains (losses): |
||||||||||||||||
Included in other income (expense) |
0 | 0 | 0 | 0 | ||||||||||||
Included in other comprehensive income |
1 | 0 | 0 | 1 | ||||||||||||
Balance as of March 31, 2013 |
$ | 19 | $ | 5 | $ | 0 | $ | 24 | ||||||||
Change in unrealized gains (losses) included in other income (expense) for the three months ended March 31, 2013 related to assets held as of March 31, 2013 |
$ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||
Change in unrealized gains (losses) included in other income (expense) for the nine months ended March 31, 2013 related to assets held as of March 31, 2013 |
$ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||
18
PART I
Item 1
(In millions) | Corporate Notes and Bonds |
Common and Preferred Stock |
Derivative Assets |
Total | ||||||||||||
Three and Nine Months Ended March 31, 2012 | ||||||||||||||||
Balance as of June 30, 2011 |
$ | 58 | $ | 5 | $ | 20 | $ | 83 | ||||||||
Realized and unrealized gains (losses): |
||||||||||||||||
Included in other income (expense) |
0 | 0 | (2 | ) | (2 | ) | ||||||||||
Included in other comprehensive income |
(21 | ) | 0 | 0 | (21 | ) | ||||||||||
Balance as of September 30, 2011 |
$ | 37 | $ | 5 | $ | 18 | $ | 60 | ||||||||
Realized and unrealized gains (losses): |
||||||||||||||||
Included in other income (expense) |
0 | 0 | (3 | ) | (3 | ) | ||||||||||
Included in other comprehensive income |
0 | 0 | 0 | 0 | ||||||||||||
Conversions of Level 3 instruments to Level 1 instruments |
(28 | ) | 0 | (15 | ) | (43 | ) | |||||||||
Balance as of December 31, 2011 |
$ | 9 | $ | 5 | $ | 0 | $ | 14 | ||||||||
Realized and unrealized gains (losses): |
||||||||||||||||
Included in other income (expense) |
0 | 0 | 0 | 0 | ||||||||||||
Included in other comprehensive income |
0 | 0 | 0 | 0 | ||||||||||||
Balance as of March 31, 2012 |
$ | 9 | $ | 5 | $ | 0 | $ | 14 | ||||||||
Change in unrealized gains (losses) included in other income (expense) for the three months ended March 31, 2012 related to assets held as of March 31, 2012 |
$ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||
Change in unrealized gains (losses) included in other income (expense) for the nine months ended March 31, 2012 related to assets held as of March 31, 2012 |
$ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||
Financial Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
During the three and nine months ended March 31, 2013 and 2012, we did not record any material other-than-temporary impairments on financial assets required to be measured at fair value on a nonrecurring basis.
NOTE 7 INVENTORIES
The components of inventories were as follows:
(In millions) | ||||||||
March 31, 2013 |
June 30, 2012 |
|||||||
Raw materials |
$ | 802 | $ | 210 | ||||
Work in process |
11 | 96 | ||||||
Finished goods |
1,320 | 831 | ||||||
Total |
$ | 2,133 | $ | 1,137 | ||||
NOTE 8 BUSINESS COMBINATIONS
Yammer
On July 18, 2012, we acquired Yammer, Inc. (Yammer), a leading provider of enterprise social networks, for $1.1 billion in cash. Yammer will continue to develop its standalone service and will add an enterprise social networking service to Microsofts portfolio of complementary cloud-based services. The major classes of assets to which we allocated the purchase price were goodwill of $937 million and identifiable intangible assets of $178 million. We assigned the goodwill to the Microsoft Business Division. Yammer was consolidated into our results of operations starting on the acquisition date.
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Following are details of the purchase price allocated to the intangible assets acquired:
(In millions) | Weighted Average Life |
|||||||
Customer-related |
$ | 77 | 6 years | |||||
Technology-based |
67 | 4 years | ||||||
Marketing-related |
34 | 7 years | ||||||
Total |
$ | 178 | 5 years | |||||
Other
During the nine months ended March 31, 2013, we completed nine additional acquisitions for total consideration of $431 million, all of which was paid in cash. These entities have been included in our consolidated results of operations since their respective acquisition dates.
Pro forma results of operations have not been presented because the effects of the business combinations described in this Note, individually and in aggregate, were not material to our consolidated results of operations.
NOTE 9 GOODWILL
Changes in the carrying amount of goodwill were as follows:
(In millions) | Balance as of December 31, 2012 |
Acquisitions | Other | Balance as of March 31, 2013 |
||||||||||||
Windows Division |
$ | 89 | $ | 12 | $ | 0 | $ | 101 | ||||||||
Server and Tools |
1,355 | 1 | (2 | ) | 1,354 | |||||||||||
Online Services Division |
223 | 0 | 1 | 224 | ||||||||||||
Microsoft Business Division |
7,932 | 8 | (41 | ) | 7,899 | |||||||||||
Entertainment and Devices Division |
5,128 | 0 | (24 | ) | 5,104 | |||||||||||
Total |
$ | 14,727 | $ | 21 | $ | (66 | ) | $ | 14,682 | |||||||
(In millions) | Balance as of June 30, 2012 |
Acquisitions | Other | Balance as of March 31, 2013 |
||||||||||||
Windows Division |
$ | 89 | $ | 12 | $ | 0 | $ | 101 | ||||||||
Server and Tools |
1,144 | 212 | (2 | ) | 1,354 | |||||||||||
Online Services Division |
223 | 0 | 1 | 224 | ||||||||||||
Microsoft Business Division |
6,893 | 987 | 19 | 7,899 | ||||||||||||
Entertainment and Devices Division |
5,103 | 27 | (26 | ) | 5,104 | |||||||||||
Total |
$ | 13,452 | $ | 1,238 | $ | (8 | ) | $ | 14,682 | |||||||
The measurement periods for purchase price allocations end as soon as information on the facts and circumstances becomes available, but do not exceed 12 months. Adjustments in purchase price allocations may require a recasting of the amounts allocated to goodwill retroactive to the periods in which the acquisitions occurred.
Any change in the goodwill amounts resulting from foreign currency translations are presented as other in the above table. Also included within other are business dispositions and transfers between business segments due to reorganizations, as applicable.
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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 |
Gross Carrying Amount |
Accumulated Amortization |
Net Carrying Amount |
||||||||||||||||||
|
March 31, 2013 |
|
|
June 30, 2012 |
| |||||||||||||||||||
Technology-based (a) |
$ | 4,052 | $ | (2,294 | ) | $ | 1,758 | $ | 3,550 | $ | (1,899 | ) | $ | 1,651 | ||||||||||
Marketing-related |
1,363 | (203 | ) | 1,160 | 1,325 | (136 | ) | 1,189 | ||||||||||||||||
Contract-based |
823 | (683 | ) | 140 | 824 | (644 | ) | 180 | ||||||||||||||||
Customer-related |
497 | (315 | ) | 182 | 408 | (258 | ) | 150 | ||||||||||||||||
Total |
$ | 6,735 | $ | (3,495 | ) | $ | 3,240 | $ | 6,107 | $ | (2,937 | ) | $ | 3,170 | ||||||||||
(a) | Technology-based intangible assets included $265 million and $177 million as of March 31, 2013 and June 30, 2012, respectively, of net carrying amount of software to be sold, leased, or otherwise marketed. |
Intangible assets amortization expense was $187 million and $563 million for the three and nine months ended March 31, 2013, respectively, as compared with $142 million and $406 million for the three and nine months ended March 31, 2012, respectively. Amortization of capitalized software was $52 million and $153 million for the three and nine months ended March 31, 2013, respectively, and $28 million and $85 million for the three and nine months ended March 31, 2012, respectively.
The following table outlines the estimated future amortization expense related to intangible assets held at March 31, 2013:
(In millions) | ||||
Year Ending June 30, | ||||
2013 (excluding the nine months ended March 31, 2013) |
$ | 170 | ||
2014 |
613 | |||
2015 |
473 | |||
2016 |
389 | |||
2017 |
277 | |||
Thereafter |
1,318 | |||
Total |
$ | 3,240 | ||
NOTE 11 DEBT
As of March 31, 2013, the total carrying value and estimated fair value of our long-term debt, including the current portion, were $14.2 billion and $15.0 billion, respectively. This is compared to a carrying value and estimated fair value of $11.9 billion and $13.2 billion, respectively, as of June 30, 2012. These estimated fair values are based on Level 2 inputs.
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The components of our long-term debt, including the current portion, and the associated interest rates were as follows as of March 31, 2013 and June 30, 2012:
Due Date | Face Value March 31, |
Face Value June 30, |
Stated Rate |
Effective Rate |
||||||||||||
(In millions) | ||||||||||||||||
Notes | ||||||||||||||||
September 27, 2013 |
$ | 1,000 | $ | 1,000 | 0.875% | 1.000% | ||||||||||
June 1, 2014 |
2,000 | 2,000 | 2.950% | 3.049% | ||||||||||||
September 25, 2015 |
1,750 | 1,750 | 1.625% | 1.795% | ||||||||||||
February 8, 2016 |
750 | 750 | 2.500% | 2.642% | ||||||||||||
November 15, 2017 (a) |
600 | * | 0.875% | 1.084% | ||||||||||||
June 1, 2019 |
1,000 | 1,000 | 4.200% | 4.379% | ||||||||||||
October 1, 2020 |
1,000 | 1,000 | 3.000% | 3.137% | ||||||||||||
February 8, 2021 |
500 | 500 | 4.000% | 4.082% | ||||||||||||
November 15, 2022 (a) |
750 | * | 2.125% | 2.239% | ||||||||||||
June 1, 2039 |
750 | 750 | 5.200% | 5.240% | ||||||||||||
October 1, 2040 |
1,000 | 1,000 | 4.500% | 4.567% | ||||||||||||
February 8, 2041 |
1,000 | 1,000 | 5.300% | 5.361% | ||||||||||||
November 15, 2042 (a) |
900 | * | 3.500% | 3.571% | ||||||||||||
Total |
13,000 | 10,750 | ||||||||||||||
Convertible Debt | ||||||||||||||||
June 15, 2013 |
1,250 | 1,250 | 0.000% | 1.849% | ||||||||||||
Total |
$ | 14,250 | $ | 12,000 | ||||||||||||
(a) | In November 2012, we issued $2.25 billion of debt securities. The notes are senior unsecured obligations and rank equally with our other unsecured and unsubordinated debt outstanding. |
* | Not applicable. |
Interest on the notes is paid semi-annually. As of March 31, 2013 and June 30, 2012, the aggregate unamortized discount for our long-term debt, including the current portion, was $55 million and $56 million, respectively.
Notes
The Notes are senior unsecured obligations and rank equally with our other unsecured and unsubordinated debt outstanding.
Convertible Debt
In June 2010, we issued $1.25 billion of zero coupon convertible unsecured debt due on June 15, 2013 in a private placement offering. Proceeds from the offering were $1.24 billion, net of fees and expenses, which were capitalized. Initially, each $1,000 principal amount of notes was convertible into 29.94 shares of Microsoft common stock at a conversion price of $33.40 per share. The conversion ratio is adjusted periodically for dividends in excess of the initial dividend threshold as defined in the debt agreement. As of March 31, 2013, the net carrying amount of our convertible debt was $1.25 billion and the unamortized discount was $4 million.
The notes are convertible at any time. If converted, we will pay cash up to the aggregate principal amount of the notes and pay or deliver cash, shares of our common stock, or a combination of cash and shares of our common stock, at our election.
Because the convertible debt may be wholly or partially settled in cash, we are required to separately account for the liability and equity components of the notes in a manner that reflects our nonconvertible debt borrowing rate when interest costs are recognized in subsequent periods. The net proceeds of $1.24 billion were allocated between debt for $1.18 billion and stockholders equity for $58 million with the portion in stockholders equity representing the fair value of the option to convert the debt.
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In connection with issuance of the notes, we entered into capped call transactions with certain option counterparties who are initial purchasers of the notes or their affiliates. The capped call transactions are expected to reduce potential dilution of earnings per share upon conversion of the notes. Under the capped call transactions, we purchased from the option counterparties capped call options that in the aggregate relate to the total number of shares of our common stock underlying the notes, with a strike price equal to the conversion price of the notes and with an initial cap price equal to $37.16, which is adjusted periodically to mirror any adjustments to the conversion price. The purchased capped calls were valued at $40 million and recorded in stockholders equity.
NOTE 12 INCOME TAXES
Our effective tax rate was approximately 20% for both the three months ended March 31, 2013 and 2012, and 19% and 20% for the nine months ended March 31, 2013 and 2012, respectively. Our effective tax rate was lower than the U.S. federal statutory rate primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico, which have lower income tax rates.
Tax contingencies and other tax liabilities were $9.1 billion and $7.6 billion as of March 31, 2013 and June 30, 2012, respectively, and are included in other long-term liabilities. This increase primarily relates to transfer pricing developments in certain foreign tax jurisdictions. While we settled a portion of the I.R.S. audit for tax years 2004 to 2006 during the third quarter of fiscal year 2011, we remain under audit for those years. In February 2012, the I.R.S. withdrew its 2011 Revenue Agents Report and reopened the audit phase of the examination. As of March 31, 2013, the primary unresolved issue relates to transfer pricing which could have a significant impact on our financial statements if not resolved favorably. We do not believe it is reasonably possible that the total amount of unrecognized tax benefits will significantly increase or decrease within the next 12 months because we do not believe the remaining open issues will be resolved within the next 12 months. We also continue to be subject to examination by the I.R.S. for tax years 2007 to 2012.
We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2012, some of which are currently under audit by local tax authorities. The resolutions of these audits are not expected to be material to our financial statements.
NOTE 13 UNEARNED REVENUE
The components of unearned revenue were as follows:
(In millions) | ||||||||
|
March 31, 2013 |
|
|
June 30, 2012 |
| |||
Volume licensing programs |
$ | 14,205 | $ | 16,717 | ||||
Other (a) |
3,700 | 3,342 | ||||||
Total |
$ | 17,905 | $ | 20,059 | ||||
(a) | Other as of March 31, 2013 includes a net $784 million of unearned revenue associated with sales of the previous version of the Microsoft Office system with a guarantee to be upgraded to the new Office at minimal or no cost (the Office Upgrade Offer). |
Other as of June 30, 2012 includes $540 million of unearned revenue associated with sales of Windows 7 with an option to upgrade to Windows 8 Pro at a discounted price (the Windows Upgrade Offer).
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Unearned revenue by segment was as follows:
(In millions) | ||||||||
|
March 31, 2013 |
|
|
June 30, 2012 |
| |||
Windows Division |
$ | 1,593 | $ | 2,444 | ||||
Server and Tools |
6,496 | 7,445 | ||||||
Microsoft Business Division |
8,404 | 9,015 | ||||||
Other segments |
1,412 | 1,155 | ||||||
Total |
$ | 17,905 | $ | 20,059 | ||||
NOTE 14 CONTINGENCIES
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 between 1999 and 2005. We obtained dismissals or reached settlements of all claims made in the United States.
All settlements in the United 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 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 $1.9 billion and $2.0 billion. At March 31, 2013, we have recorded a liability related to these claims of approximately $500 million, which reflects our estimated exposure of $1.9 billion less payments made to date of approximately $1.4 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. In April 2011, the British Columbia Court of Appeal reversed the class certification ruling and dismissed the case, holding that indirect purchasers do not have a claim. The plaintiffs have filed an appeal to the Canadian Supreme Court, which was heard in the fall of 2012. The other two actions have been stayed.
Other Antitrust Litigation and Claims
In November 2004, Novell, Inc. (Novell) filed a complaint in U.S. District Court for the District of Utah (later transferred to federal court in Maryland), 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. In June 2005, the trial court granted our motion to dismiss four of Novells six claims. In March 2010, the trial court granted summary judgment in favor of Microsoft as to all remaining claims. The court of appeals reversed that ruling as to one claim. Trial of that claim took place from October to December 2011 and resulted in a mistrial because the jury was unable to reach a verdict. In July 2012, the trial court granted Microsofts motion for judgment as a matter of law. Novell has appealed this decision to the U.S. Court of Appeals for the Tenth Circuit.
Government Competition Law Matters
In December 2009, the European Commission adopted a decision that rendered legally binding commitments offered by Microsoft to address the Commissions concerns about the inclusion of Web browsing software in Windows. Among other things, Microsoft committed to display a Browser Choice Screen on Windows-based PCs in Europe where Internet Explorer is set as the default browser. Due to a technical error, we failed to deliver the requisite software to enable that display to PCs that came preinstalled with a version of Windows 7 called Windows 7
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Service Pack 1. We did deliver the requisite software to PCs running the original version of Windows 7 and earlier editions of Windows. Following notification by the Commission of reports that some PCs were not receiving the update, we promptly fixed the error and advised the Commission of what we had discovered. PCs that come preinstalled with Windows 7 Service Pack 1 are now receiving the Browser Choice Screen software, as intended. After conducting an investigation and issuing a Statement of Objections in October 2012, the Commission concluded that Microsoft failed to comply with the 2009 commitments and imposed a fine of 561 million (approximately $733 million) on March 6, 2013. We will not appeal the fine. The amount was included in other current liabilities as of March 31, 2013.
Patent and Intellectual Property Claims
Motorola Litigation
In October 2010, Microsoft filed patent infringement complaints against Motorola Mobility (Motorola) with the International Trade Commission (ITC) and in U.S. District Court in Seattle for infringement of nine Microsoft patents by Motorolas Android devices. Since then, Microsoft and Motorola have filed additional claims against each other in the ITC, in federal district courts in Seattle, Wisconsin, Florida, and California, and in courts in Germany and the United Kingdom. In April 2012, following complaints by Microsoft and Apple, the European Unions competition office opened two antitrust investigations against Motorola to determine whether it has abused certain of its standard essential patents to distort competition in breach of European Union antitrust rules. In June 2012, we received a request for information from the U.S. Federal Trade Commission (FTC) apparently related to an FTC investigation into whether Motorolas conduct violates U.S. law. The nature of the claims asserted and status of individual matters are summarized below.
International Trade Commission
The hearing in Microsofts ITC case against Motorola took place in August 2011 on seven of the nine patents originally asserted in the complaint. In December 2011, the administrative law judge (ALJ) issued an initial determination that Motorola infringed one Microsoft patent, and recommended that the ITC issue a limited exclusion order against Motorola prohibiting importation of infringing Motorola Android devices. In May 2012, the ITC issued the limited exclusion order recommended by the ALJ, which became effective on July 18, 2012. Microsoft has appealed certain aspects of the ITC ruling adverse to Microsoft and Motorola has appealed the ITC exclusion order.
In November 2010, Motorola filed an action against Microsoft in the ITC alleging infringement of five Motorola patents by Xbox consoles and accessories and seeking an exclusion order to prohibit importation of the allegedly infringing Xbox products into the U.S. In April 2012, the ALJ found that Xbox products infringe four of the five patents asserted by Motorola. The ALJ recommended that the ITC issue a limited exclusion order and a cease and desist order. Both Microsoft and Motorola sought ITC review of the ALJs findings. In June 2012, Microsoft filed a motion to terminate the investigation as to certain patents based on facts arising as the result of Googles acquisition of Motorola. The ITC determined that it would review the ALJs initial determination in its entirety and remanded the matter to the ALJ (1) to apply certain ITC case precedent, (2) to rule on Microsofts June 2012 motion to terminate, and (3) set a new target date for completion of the investigation. The ALJ held a hearing in December 2012 and has set a target date for a final ITC ruling in July 2013. At Motorolas request, the ITC has terminated its investigation as to four Motorola patents, leaving only one Motorola patent at issue before the ITC. In March 2013, the ALJ ruled that there has been no violation as to this last Motorola patent. Motorola is expected to seek ITC review of the ALJs determination. If the ITC rejects the ALJs ruling and issues an exclusion order or cease and desist order, it will be subject to Presidential review for up to 60 days, during which Microsoft may be able to import Xbox products subject to posting a bond. If an order is issued and survives Presidential review, Microsoft may be able to mitigate the orders impact by altering Xbox products to avoid Motorolas infringement claims.
U.S. District Court
The Seattle District Court case filed in October 2010 by Microsoft as a companion to Microsofts ITC case against Motorola has been stayed pending the outcome of Microsofts ITC case.
In November 2010, Microsoft sued Motorola for breach of contract in U.S. District Court in Seattle, alleging that Motorola breached its commitments to standards-setting organizations to license to Microsoft certain patents on reasonable and non-discriminatory (RAND) terms and conditions. Motorola has declared these patents essential to the implementation of the H.264 video standard and the 802.11 Wi-Fi standard. In suits described below, Motorola or
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a Motorola affiliate subsequently sued Microsoft on those patents in U.S. District Courts, in the ITC, and in Germany. In February 2012, the Seattle District Court granted a partial summary judgment in favor of Microsoft ruling that (1) Motorola entered into binding contractual commitments with standards organizations committing to license its declared-essential patents on RAND terms and conditions; and (2) Microsoft is a third-party beneficiary of those commitments. The court rejected Motorolas argument that Microsoft had repudiated its right to a RAND license, and ruled a trial is needed to determine whether Motorola is in breach of its obligation to enter into a patent license with Microsoft and, if so, the amount of the RAND royalty. In April 2012, the court issued a temporary restraining order preventing Motorola from taking steps to enforce an injunction in Germany relating to the H.264 video patents. In May 2012, the court converted that order into a preliminary injunction. Motorola appealed the courts injunction orders to the Court of Appeals for the Ninth Circuit, which affirmed the orders in September 2012. The Seattle District Court held a trial in November 2012 to determine the RAND royalty for Motorolas H.264 and 802.11 patents. In December 2012, the Seattle District Court ruled that Motorola could not obtain injunctive relief in connection with any of its claims for infringement of its H.264 and 802.11 patents. Trial of Microsofts breach of contract claim is set for August 26, 2013.
Cases filed by Motorola in Wisconsin, California, and Florida, with the exception of one currently stayed case in Wisconsin (a companion case to Motorolas ITC action), have been transferred to the U.S District Court in Seattle. Motorola and Microsoft both seek damages as well as injunctive relief. No trial dates have been set in any of the transferred cases, and the court has stayed these cases on agreement of the parties.
| In the transferred cases, Motorola asserts 15 patents are infringed by many Microsoft products including Windows Mobile 6.5 and Windows Phone 7, Windows Marketplace, Silverlight, Windows Vista and Windows 7, Exchange Server 2003 and later, Exchange ActiveSync, Windows Live Messenger, Lync Server 2010, Outlook 2010, Office 365, SQL Server, Internet Explorer 9, Xbox, and Kinect. |
| In the Motorola action originally filed in California, Motorola asserts that Microsoft violated antitrust laws in connection with Microsofts assertion of patents against Motorola that Microsoft has agreed to license to certain qualifying entities on RAND terms and conditions. |
| In counterclaims in the patent actions brought by Motorola, Microsoft asserts 14 patents are infringed by Motorola Android devices and certain Motorola digital video recorders. |
Germany
In July 2011, Motorola filed patent infringement actions in Germany against Microsoft and several Microsoft subsidiaries.
| Two of the patents are asserted by Motorola to be essential to implementation of the H.264 video standard, and Motorola alleges that H.264 capable products including Xbox 360, Windows 7, Media Player, and Internet Explorer infringe those patents. Motorola seeks damages and an injunction. In May 2012, the court issued an injunction relating to all H.264 capable Microsoft products in Germany. However, due to orders in the separate litigation pending in Seattle, Washington described above, Motorola is enjoined from taking steps to enforce the German injunction. Damages would be determined in later proceedings. Microsoft has appealed the rulings of the first instance court. |
| Motorola asserts one of the patents covers certain syncing functionality in the ActiveSync protocol employed by Windows Phone 7, Outlook Mobile, Hotmail Mobile, Exchange Online, Exchange Server, and Hotmail Server. Motorola seeks damages and an injunction. If the court rules in favor of Motorola, an injunction could be issued immediately relating to these products employing the ActiveSync protocol in Germany, which Motorola could then take steps to enforce. We expect the court to issue a ruling in April 2013. If Motorola prevails, damages would be determined in later proceedings. |
| Should injunction orders be issued and enforced by Motorola, Microsoft may be able to mitigate the adverse impact by altering its products to avoid Motorolas infringement claims. |
In lawsuits Microsoft filed in Germany in September, October, and December 2011 and in April 2012, Microsoft asserts Motorola Android devices infringe Microsoft patents. Microsoft seeks damages and an injunction. In May, July, and September 2012, courts in Germany issued injunctions on three patents against Motorola Android devices and in May and July ruled against Microsoft on two patents. Microsoft is taking steps to enforce the injunctions. Damages will be determined in later proceedings. Each party has appealed or is expected to appeal the rulings against it.
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United Kingdom
In December 2011, Microsoft filed an action against Motorola in the High Court of Justice, Chancery Division, Patents Court, in London, England, seeking to revoke the UK part of the European patent asserted by Motorola in Germany against the ActiveSync protocol. In February 2012, Motorola counterclaimed alleging infringement of the patent and seeking damages and an injunction. A trial took place in December 2012, and the court ruled that Motorolas patent is invalid and revoked. The court also ruled that the patent, even if valid, would be licensed under the grant-back clause in Googles ActiveSync license. Motorola has appealed.
Other Patent and Intellectual Property Claims
In addition to these cases, there are approximately 65 other patent infringement cases pending against Microsoft.
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, 2013, we had accrued aggregate liabilities of $419 million in other current liabilities and $176 million in other long-term liabilities for all of our legal matters that were contingencies as of that date. While we intend to defend these matters vigorously, adverse outcomes that we estimate could reach approximately $450 million in aggregate beyond recorded amounts are reasonably possible. Were unfavorable final outcomes to occur, there exists the possibility of a material adverse impact on our financial statements for the period in which the effects become reasonably estimable.
NOTE 15 STOCKHOLDERS EQUITY
Share Repurchases
We repurchased the following shares of common stock through our repurchase program, during the periods presented:
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Shares of common stock repurchased |
36 | 31 | 127 | 109 | ||||||||||||
Value of common stock repurchased |
$ | 1,000 | $ | 1,000 | $ | 3,607 | $ | 3,000 | ||||||||
Excluded from this table are shares repurchased to settle statutory employee tax withholding related to the vesting of stock awards. We repurchased all shares with cash resources. As of March 31, 2013, approximately $4.6 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.
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Dividends
Our Board of Directors declared the following dividends during the periods presented:
Declaration Date | Dividend Per Share |
Record Date | Total Amount | Payment Date | ||||||||||||
(in millions) | ||||||||||||||||
Fiscal Year 2013 | ||||||||||||||||
September 18, 2012 |
$ | 0.23 | November 15, 2012 | $ | 1,933 | December 13, 2012 | ||||||||||
November 28, 2012 |
$ | 0.23 | February 21, 2013 | $ | 1,925 | March 14, 2013 | ||||||||||
March 11, 2013 |
$ | 0.23 | May 16, 2013 | $ | 1,920 | June 13, 2013 | ||||||||||
Fiscal Year 2012 | ||||||||||||||||
September 20, 2011 |
$ | 0.20 | November 17, 2011 | $ | 1,683 | December 8, 2011 | ||||||||||
December 14, 2011 |
$ | 0.20 | February 16, 2012 | $ | 1,683 | March 8, 2012 | ||||||||||
March 13, 2012 |
$ | 0.20 | May 17, 2012 | $ | 1,678 | June 14, 2012 | ||||||||||
The estimate of the amount to be paid as a result of the March 11, 2013 declaration was included in other current liabilities as of March 31, 2013.
NOTE 16 SEGMENT INFORMATION
In its operation of the business, management, including our chief operating decision maker, the companys Chief Executive Officer, reviews certain financial information, including segmented internal profit and loss statements prepared on a basis not consistent with U.S. GAAP. The segment information within this note is reported on that basis. Our five segments are Windows Division, Server and Tools, Online Services Division, Microsoft Business Division, and Entertainment and Devices Division. During the three months ended December 31, 2012, we changed the name of our Windows & Windows Live Division to Windows Division.
Due to the integrated structure of our business, certain revenue earned and costs incurred by one segment may benefit other segments. Revenue on certain contracts may be allocated among the segments based on the relative value of the underlying products and services. 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. Allocated costs may include those relating to development and marketing of products and services from which multiple segments benefit, or those costs relating to services performed by one segment on behalf of other segments. Each allocation is measured differently based on the specific facts and circumstances of the costs being allocated.
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.
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, reflecting immaterial movements of business activities between segments and changes in cost allocations.
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PART I
Item 1
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, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Revenue |
||||||||||||||||
Windows Division |
$ | 4,614 | $ | 4,614 | $ | 14,268 | $ | 14,166 | ||||||||
Server and Tools |
5,043 | 4,534 | 14,789 | 13,491 | ||||||||||||
Online Services Division |
851 | 725 | 2,457 | 2,181 | ||||||||||||
Microsoft Business Division |
6,130 | 5,838 | 18,304 | 17,752 | ||||||||||||
Entertainment and Devices Division |
2,145 | 1,612 | 8,233 | 7,819 | ||||||||||||
Unallocated and other |
1,706 | 84 | (98 | ) | 255 | |||||||||||
Consolidated |
$ | 20,489 | $ | 17,407 | $ | 57,953 | $ | 55,664 | ||||||||
Operating income (loss) |
||||||||||||||||
Windows Division |
$ | 2,369 | $ | 2,960 | $ | 7,849 | $ | 9,054 | ||||||||
Server and Tools |
1,981 | 1,692 | 5,855 | 5,214 | ||||||||||||
Online Services Division |
(263 | ) | (476 | ) | (904 | ) | (1,445 | ) | ||||||||
Microsoft Business Division |
3,911 | 3,792 | 12,112 | 11,667 | ||||||||||||
Entertainment and Devices Division |
(6 | ) | (232 | ) | 944 | 642 | ||||||||||
Reconciling amounts |
(380 | ) | (1,362 | ) | (5,165 | ) | (3,561 | ) | ||||||||
Consolidated |
$ | 7,612 | $ | 6,374 | $ | 20,691 | $ | 21,571 | ||||||||
Reconciling amounts in the tables above and below include adjustments to conform our internal accounting policies to 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 depreciation.
Significant reconciling items were as follows:
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Corporate-level activity (a) |
$ | (2,010 | ) | $ | (1,380 | ) | $ | (4,923 | ) | $ | (3,640 | ) | ||||
Revenue reconciling amounts (b) |
1,641 | 8 | (286 | ) | 60 | |||||||||||
Other |
(11 | ) | 10 | 44 | 19 | |||||||||||
Total |
$ | (380 | ) | $ | (1,362 | ) | $ | (5,165 | ) | $ | (3,561 | ) | ||||
(a) | Corporate-level activity excludes revenue reconciling amounts presented separately in that line item. |
(b) | Revenue reconciling amounts for the three months ended March 31, 2013 includes the recognition of: $1.1 billion of previously deferred revenue related to the Windows Upgrade Offer; $380 million of previously deferred revenue related to the sales of video games with the right to receive specified software upgrades/enhancements; $101 million of previously deferred revenue related to pre-sales of the new Office to original equipment manufacturers and retailers before general availability; and a net $92 million of previously deferred revenue related to the Office Upgrade Offer. |
Revenue reconciling amounts for the nine months ended March 31, 2013 includes a net $784 million of revenue deferred related to the Office Upgrade Offer and the recognition of $540 million of previously deferred revenue related to the Windows Upgrade Offer.
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.
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PART I
Item 1
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 (the Corporation) as of March 31, 2013, and the related consolidated statements of income, comprehensive income, cash flows, and stockholders equity for the three-month and nine-month periods ended March 31, 2013 and 2012. 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, 2012, and the related consolidated statements of income, cash flows, and stockholders equity for the year then ended (not presented herein); and in our report dated July 26, 2012 we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of June 30, 2012 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 18, 2013
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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 this report, 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. Forward-looking statements may appear throughout this report, including without limitation, the following sections: Managements Discussion and Analysis, and Risk Factors. These forward-looking statements generally are identified by the words believe, project, expect, anticipate, estimate, intend, strategy, future, opportunity, plan, may, should, will, would, will be, will continue, will likely result, and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties 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 (Part II, Item 1A of this Form 10-Q). We undertake no obligation to update or revise publicly any forward-looking statements, whether because of new information, future events, or otherwise.
OVERVIEW
The following managements discussion and analysis (MD&A) is intended to help the reader understand the results of operations and financial condition of Microsoft Corporation. MD&A is provided as a supplement to, and should be read in conjunction with, our Annual Report on Form 10-K for the year ended June 30, 2012 and our financial statements and accompanying Notes to Financial Statements in this Form 10-Q.
Microsoft is a technology leader focused on helping people and businesses throughout the world realize their full potential. We create technology that transforms the way people work, play, and communicate across a wide range of computing devices.
We generate revenue by developing, licensing, and supporting a wide range of software products, by offering an array of services, including cloud-based services to consumers and businesses, by designing and selling hardware that integrates with our cloud-based services, and by delivering relevant online advertising to a global audience. Our most significant expenses are related to compensating employees, designing, manufacturing, marketing, and selling our products and services, and income taxes.
Industry Trends
Our industry is dynamic and highly competitive, with frequent changes in both technologies and business models. Each industry shift is an opportunity to conceive new products, new technologies, or new ideas that can further transform the industry and our business. At Microsoft, we push the boundaries of what is possible through a broad range of research and development activities that seek to anticipate the changing demands of customers, industry trends, and competitive forces.
Key Opportunities and Investments
We invest research and development resources in new products and services in the areas where we see significant opportunities to drive future growth. As we look forward, the capabilities and accessibility of PCs, tablets, phones, televisions, and other devices powered by rich software platforms and applications continue to grow. With this trend, we believe the full potential of software will be seen and felt in how people use these devices and the associated services at work and in their personal lives.
Devices with end-user services
We work with an ecosystem of partners to deliver a broad spectrum of Windows devices. In some cases, we build our own devices, as we have chosen to do with Xbox and Surface. In all our work with partners and on our own devices, we focus on delivering seamless services and experiences across devices. As consumer services and hardware advance, we expect they will continue to better complement one another, connecting the devices people use daily to unique communications, productivity, and entertainment services from Microsoft and our partners and developers around the world.
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Windows 8 reflects this shift. Launched in October 2012 on a variety of state-of-the-art hardware, Windows 8 is built to take advantage of our consumer cloud services. Windows 8 is made for both personal and professional use and unites the light, thin, and convenient aspects of a tablet with the power of a PC. For example, Xbox Music, Video, Games, and SmartGlass applications make it possible to select and experience entertainment across a range of devices by simplifying and increasing the accessibility of those experiences. SkyDrive, our cloud storage solution, connects content across all of a users devices. Bings search technologies in Windows 8 are designed to help users get more done. Skype has a new Windows 8 application and connects directly to the new Office.
The new Office is designed for Windows 8 and takes advantage of new mobile form factors with touch and pen capabilities. It unlocks new experiences for reading, note taking, meetings, and communications and brings social experiences directly into productivity and collaboration scenarios. The combination of a Windows 8 tablet with OneNote and SkyDrive will transform how to take notes, annotate documents, and share information.
Services for the enterprise
Today, businesses face important opportunities and challenges. Enterprise IT departments are asked to deploy technology that drives business strategy forward. They decide what solutions will make employees more productive, collaborative, and satisfied. They work to unlock business insights from a world of data. At the same time, they must manage and secure corporate information that employees access across a growing number of personal and corporate devices.
To address these opportunities, businesses look to our world-class business applications like Microsoft Dynamics, Office, Exchange, SharePoint, Lync, and our business intelligence solutions. They rely on our technology to manage employee corporate identity and to protect their corporate data. And, increasingly, businesses of all sizes are looking to Microsoft to realize the benefits of the cloud.
Helping businesses move to the cloud is one of our largest opportunities. Cloud-based solutions provide customers with software, services, and content over the Internet by way of shared computing resources located in centralized data centers. The shift to the cloud is driven by three important economies of scale: larger data centers can deploy computational resources at significantly lower cost per unit than smaller ones; larger data centers can coordinate and aggregate diverse customer, geographic, and application demand patterns improving the utilization of computing, storage, and network resources; and multi-tenancy lowers application maintenance labor costs for large public clouds. Because of the improved economics, the cloud offers unique levels of elasticity and agility that enable new solutions and applications. For businesses of all sizes, the cloud creates the opportunity to focus on innovation while leaving non-differentiating activities to reliable and cost-effective providers.
Unique to Microsoft, we continue to design and deliver cloud solutions that allow our customers to use both the cloud and their on-premise assets however best suits their own needs. For example, a company can choose to deploy Office or Microsoft Dynamics on premises, as a cloud service, or a combination of both. With Windows Server 2012, Windows Azure, and System Center infrastructure, businesses can deploy applications in their own datacenter, a partners datacenter, or in Microsofts datacenter with common security, management, and administration across all environments, with the flexibility and scale they desire. Our business customers tell us these hybrid capabilities are critical to harnessing the power of the cloud so they can reach new levels of efficiency and tap new areas of growth.
Our future opportunity
There are several distinct areas of technology that we are focused on driving forward. Our goal is to lead the industry in these areas over the long-term, which we expect will translate to sustained growth well into the future. We are investing significant resources in:
| Developing new form factors that have increasingly natural ways to use them, including touch, gesture, and speech. |
| Making technology more intuitive and able to act on our behalf, instead of at our command, with machine learning. |
| Building and running cloud services in ways that unleash new experiences and opportunities for businesses and individuals. |
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| Firmly establishing our Windows platform across the PC, tablet, phone, server, and cloud to drive a thriving ecosystem of developers, unify the cross-device user experience, and increase agility when bringing new advances to market. |
| Delivering new scenarios with improvements in how people learn, work, play, and interact with one another. |
We believe the breadth of our devices and services portfolio, our large, global partner and customer base, and the growing Windows ecosystem position us to be a leader in these areas.
Economic Conditions, Challenges, and Risks
As discussed above, our industry is dynamic and highly competitive. We must anticipate changes in technology and business models. Our model for growth is based on our ability to initiate and embrace disruptive technology trends, to enter new markets, both in terms of geographies and product areas, and to drive broad adoption of the products and services we develop and market.
We prioritize our investments among the highest long-term growth opportunities. These investments require significant resources and are multi-year in nature. The products and services we bring to market may be developed internally, brought to market as part of a partnership or alliance, or through acquisition.
Our success is highly dependent on our ability to attract and retain qualified employees. We hire a mix of university and industry talent worldwide. Microsoft competes for talented individuals worldwide by offering broad customer reach, scale in resources, and competitive compensation.
Demand for our software, services, and hardware has a strong correlation to global macroeconomic factors. The current macroeconomic factors remain dynamic. See a discussion of these factors and other risks under Risk Factors (Part II, Item 1A. of this Form 10-Q).
Seasonality
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 revenue in our second fiscal quarter.
Unearned Revenue
Quarterly and annual revenue may be impacted by the deferral of revenue. See the discussions below regarding revenue deferred on: sales of Windows 7 with an option to upgrade to Windows 8 Pro at a discounted price (the Windows Upgrade Offer); sales of the previous version of the Microsoft Office system with a guarantee to be upgraded to the new Office at minimal or no cost (the Office Upgrade Offer) and pre-sales of the new Office to OEMs and retailers before general availability (Office Pre-Sales) (collectively, the Office Deferral); and on sales of video games with the right to receive specified software upgrades/enhancements (the Video Game Deferral).
RESULTS OF OPERATIONS
Summary
(In millions, except percentages and per share amounts) | Three Months Ended March 31, |
Percentage Change |
Nine Months Ended March 31, |
Percentage Change |
||||||||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||||||||||
Revenue |
$ | 20,489 | $ | 17,407 | 18% | $ | 57,953 | $ | 55,664 | 4% | ||||||||||||||
Operating income |
$ | 7,612 | $ | 6,374 | 19% | $ | 20,691 | $ | 21,571 | (4)% | ||||||||||||||
Diluted earnings per share |
$ | 0.72 | $ | 0.60 | 20% | $ | 1.99 | $ | 2.05 | (3)% | ||||||||||||||
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Three months ended March 31, 2013 compared with three months ended March 31, 2012
Revenue increased, primarily due to revenue from new products and services, including Windows 8, Surface, and the new Office, offset in part by the impact on revenue of a decline in the x86 PC market, as well as due to higher revenue from Server and Tools and Entertainment and Devices products and services. During the three months ended March 31, 2013, we recognized a net $1.1 billion of revenue related to the Windows Upgrade Offer, $380 million of revenue related to the Video Game Deferral, and a net $193 million of revenue related to the Office Deferral.
Operating income increased, reflecting revenue growth, offset in part by higher cost of revenue and operating expenses. Key changes in cost of revenue and operating expenses were:
| Cost of revenue increased $835 million or 21%, primarily reflecting product costs associated with Surface and Windows 8, increased royalties on Xbox LIVE content and video games, and higher headcount-related expenses, offset in part by lower traffic acquisition costs. |
| General and administrative expenses increased $506 million or 44%, due to higher legal charges. |
| Sales and marketing expenses increased $380 million or 11%, primarily reflecting advertising of Windows 8 and Surface. |
Nine months ended March 31, 2013 compared with nine months ended March 31, 2012
Revenue increased, primarily due to higher revenue from Server and Tools and Entertainment and Devices products and services as well as revenue from new products and services, including Windows 8, Surface, and the new Office, offset in part by the impact on revenue of a decline in the x86 PC market. During the nine months ended March 31, 2013, we recognized a net $540 million of revenue related to the Windows Upgrade Offer and deferred a net $784 million of revenue related to the Office Upgrade Offer.
Operating income decreased, reflecting increased cost of revenue and operating expenses, offset in part by revenue growth. Key changes in cost of revenue and operating expenses were:
| Cost of revenue increased $1.3 billion or 10%, primarily reflecting increased product costs associated with Surface and Windows 8, higher headcount-related expenses, payments made to Nokia related to joint strategic initiatives, and royalties on Xbox LIVE content, offset in part by decreased costs associated with lower sales of Xbox 360 consoles. |
| Sales and marketing expenses increased $972 million or 10%, primarily reflecting advertising of Windows 8 and Surface. |
| General and administrative expenses increased $506 million or 15%, due to higher legal charges. |
| Research and development expenses increased $411 million or 6%, due mainly to higher headcount-related expenses, primarily related to the Entertainment and Devices Division. |
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 U.S. (U.S. GAAP) and include certain reconciling items attributable to each of the segments. Segment information appearing in Note 16 Segment Information of the Notes to Financial Statements (Part I, Item I of this Form 10-Q) 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 MD&A to conform to the way we internally managed and monitored segment performance during the current fiscal year.
Windows Division
(In millions, except percentages) | Three Months Ended March 31, |
Percentage Change |
Nine Months Ended March 31, |
Percentage Change |
||||||||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||||||||||
Revenue |
$ | 5,703 | $ | 4,633 | 23% | $ | 14,828 | $ | 14,248 | 4% | ||||||||||||||
Operating income |
$ | 3,459 | $ | 2,979 | 16% | $ | 8,405 | $ | 9,133 | (8)% | ||||||||||||||
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Windows Division develops and markets PC operating systems, related software, and online services, and PC hardware products. This collection of software, hardware, and services is designed to simplify everyday tasks through seamless operations across the users hardware and software. Windows Division offerings consist of the Windows operating system, software, and services, Surface, and Microsoft PC hardware products. The general availability of Surface RT and Windows 8 started on October 26, 2012. The general availability of Surface Pro started on February 9, 2013.
Excluding the impact of the Windows Deferral, approximately 65% of total Windows Division revenue comes from Windows operating system software purchased by OEMs, which they pre-install on equipment they sell. The remaining Windows Division revenue is generated by commercial and retail sales of Windows, Surface, PC hardware products, and online advertising.
Three months ended March 31, 2013 compared with three months ended March 31, 2012
Windows Division revenue increased, due mainly to the recognition of $1.1 billion of revenue related to the Windows Upgrade Offer. Revenue from Surface and increased commercial sales of Windows was offset by the impact on revenue of a decline in the x86 PC market. OEM revenue grew 17%, reflecting the revenue related to the Windows Upgrade Offer, offset in part by the impact on revenue of a decline in the x86 PC market.
Windows Division operating income increased, primarily due to revenue growth, offset in part by higher cost of revenue and sales and marketing expenses. Cost of revenue increased $306 million or 65%, reflecting product costs associated with Surface and Windows 8. Sales and marketing expenses increased $291 million or 43%, reflecting advertising costs associated with Windows 8 and Surface.
Nine months ended March 31, 2013 compared with nine months ended March 31, 2012
Windows Division revenue increased, due mainly to the recognition of $540 million of revenue related to the Windows Upgrade Offer. Revenue from Surface, increased commercial sales of Windows, and Windows 8 upgrades, were largely offset by the impact on revenue of a decline in the x86 PC market. OEM revenue decreased 4%, reflecting the impact on revenue of a decline in the x86 PC market and continued higher relative growth in emerging markets, where average selling prices are lower than developed markets, offset in part by the revenue related to the Windows Upgrade Offer.
Windows Division operating income decreased, primarily due to higher sales and marketing expenses and cost of revenue, offset in part by revenue growth. Sales and marketing expenses increased $659 million or 30%, reflecting advertising costs associated with Windows 8 and Surface. Cost of revenue increased $598 million or 41%, reflecting product costs associated with Surface and Windows 8.
Server and Tools
(In millions, except percentages) | Three Months Ended March 31, |
Percentage Change |
Nine Months Ended March 31, |
Percentage Change |
||||||||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||||||||||
Revenue |
$ | 5,039 | $ | 4,531 | 11% | $ | 14,779 | $ | 13,484 | 10% | ||||||||||||||
Operating income |
$ | 1,979 | $ | 1,686 | 17% | $ | 5,839 | $ | 5,195 | 12% | ||||||||||||||
Server and Tools develops and markets technology and related services that enable information technology professionals and their systems to be more productive and efficient. Server and Tools product and service offerings include Windows Server, Microsoft SQL Server, Windows Azure, Visual Studio, System Center products, Windows Embedded device platforms, and Enterprise Services. Enterprise Services comprise Premier product support services and Microsoft Consulting Services. We also offer developer tools, training, and certification. Approximately 80% of Server and Tools revenue comes from product revenue, including purchases through volume licensing programs, licenses sold to OEMs, and retail packaged product, while the remainder comes from Enterprise Services.
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Three months ended March 31, 2013 compared with three months ended March 31, 2012
Server and Tools revenue increased in both product sales and Enterprise Services. Product revenue increased $396 million or 11%, driven primarily by growth in SQL Server, System Center, and Windows Server. Enterprise Services revenue grew $112 million or 11%, due to growth in both Premier product support and consulting services.
Server and Tools operating income increased, primarily due to revenue growth, offset in part by higher cost of revenue and sales and marketing expenses. Cost of revenue increased $151 million or 15%, primarily reflecting higher headcount-related and datacenter expenses. Sales and marketing expenses grew $47 million or 4%, reflecting increased fees paid to third-party enterprise software advisors and corporate sales and marketing activities.
Nine months ended March 31, 2013 compared with nine months ended March 31, 2012
Server and Tools revenue increased in both product sales and Enterprise Services. Product revenue increased $957 million or 9%, driven primarily by growth in SQL Server, System Center, and Windows Server. Enterprise Services revenue grew $338 million or 12%, due to growth in both Premier product support and consulting services.
Server and Tools operating income increased, primarily due to revenue growth, offset in part by higher cost of revenue and sales and marketing expenses. Cost of revenue increased $424 million or 15%, primarily reflecting higher headcount-related and datacenter expenses. Sales and marketing expenses grew $171 million or 5%, reflecting increased fees paid to third-party enterprise software advisors and corporate sales and marketing activities.
Online Services Division
(In millions, except percentages) | Three Months Ended March 31, |
Percentage Change |
Nine Months Ended March 31, |
Percentage Change |
||||||||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||||||||||
Revenue |
$ | 832 | $ | 707 | 18% | $ | 2,397 | $ | 2,132 | 12% | ||||||||||||||
Operating loss |
$ | (262 | ) | $ | (480 | ) | 45% | $ | (909 | ) | $ | (1,453 | ) | 37% | ||||||||||
Online Services Division (OSD) develops and markets information and content designed to help people simplify tasks and make more informed decisions online, and to help advertisers connect with audiences. OSD offerings include Bing, Bing Ads, MSN, and advertiser tools. Bing and MSN generate revenue through the sale of search and display advertising, accounting for nearly all of OSDs annual revenue.
Three months ended March 31, 2013 compared with three months ended March 31, 2012
Online advertising revenue grew $143 million or 22% to $784 million, reflecting continued growth in search advertising revenue, offset in part by decreased display advertising revenue. Search revenue grew, primarily due to increased revenue per search. According to third-party sources, Bing organic U.S. market share for the month of March 2013 was approximately 17%, and grew 160 basis points year over year. Bing-powered U.S. market share, including Yahoo! Inc. (Yahoo!) properties, was approximately 26% for the month of March 2013, which grew 20 basis points year over year.
OSDs operating loss was reduced by higher revenue and lower cost of revenue and sales and marketing expenses. Cost of revenue decreased $65 million, driven by lower traffic acquisition costs. Sales and marketing expenses decreased $31 million or 15%, due mainly to decreased advertising and corporate sales and marketing activities.
Nine months ended March 31, 2013 compared with nine months ended March 31, 2012
Online advertising revenue grew $336 million or 17% to $2.3 billion, reflecting continued growth in search advertising revenue, offset in part by decreased display advertising revenue. Search revenue grew, primarily due to increased revenue per search.
OSDs operating loss was reduced by higher revenue and lower cost of revenue and sales and marketing expenses. Cost of revenue decreased $228 million, driven by lower traffic acquisition costs and Yahoo! reimbursement costs. Sales and marketing expenses decreased $103 million or 18%, due mainly to decreased advertising and corporate sales and marketing activities.
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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 |
||||||||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||||||||||
Revenue |
$ | 6,319 | $ | 5,842 | 8% | $ | 17,511 | $ | 17,787 | (2)% | ||||||||||||||
Operating income |
$ | 4,104 | $ | 3,797 | 8% | $ | 11,321 | $ | 11,704 | (3)% | ||||||||||||||
Microsoft Business Division (MBD) develops and markets software and online services designed to increase personal, team, and organization productivity. MBD offerings include the Microsoft Office system (comprising mainly Office, SharePoint, Exchange, Lync, and Office 365), which generates over 90% of MBD revenue, and Microsoft Dynamics business solutions. We evaluate MBD 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, 2013 compared with three months ended March 31, 2012
MBD revenue increased, due to overall increased sales of the Microsoft Office system, as well as the recognition of $101 million of revenue related to Office Pre-Sales and a net $92 million of revenue related to the Office Upgrade Offer. Business revenue increased $477 million or 10%, reflecting growth in multi-year volume licensing revenue and a 13% increase in Microsoft Dynamics revenue. Consumer revenue was flat, reflecting the recognition of revenue related to the Office Deferral, offset in part by the impact on revenue of a decline in the x86 PC market.
MBD revenue for the three months ended March 31, 2013 included an unfavorable foreign currency impact of $114 million.
MBD operating income increased, due mainly to revenue growth, offset in part by higher sales and marketing expenses. Sales and marketing expenses increased $126 million or 13%, primarily due to increased advertising, fees paid to third-party software advisors, and cross-platform marketing activities.
Nine months ended March 31, 2013 compared with nine months ended March 31, 2012
MBD revenue decreased, due to the deferral of a net $784 million of revenue related to the Office Upgrade Offer, offset in part by overall increased sales of the Microsoft Office system. Business revenue increased $816 million or 6%, reflecting growth in multi-year volume licensing revenue and an 11% increase in Microsoft Dynamics revenue. Consumer revenue decreased $1.1 billion or 32%, driven by the deferral of revenue related to the Office Upgrade Offer and the impact on revenue of a decline in the x86 PC market.
MBD revenue for the nine months ended March 31, 2013 included an unfavorable foreign currency impact of $336 million.
MBD operating income decreased, due mainly to lower revenue and higher sales and marketing expenses, offset in part by lower research and development expenses. Sales and marketing expenses increased $98 million or 3%, primarily due to higher fees paid to third-party software advisors and increased advertising. Research and development expenses decreased $76 million or 5%, primarily due to the capitalization of certain Microsoft Office system software development costs, offset in part by increased headcount-related expenses.
Entertainment and Devices Division
(In millions, except percentages) | Three Months Ended March 31, |
Percentage Change |
Nine Months Ended March 31, |
Percentage Change |
||||||||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||||||||||
Revenue |
$ | 2,531 | $ | 1,618 | 56% | $ | 8,250 | $ | 7,818 | 6% | ||||||||||||||
Operating income (loss) |
$ | 342 | $ | (228 | ) | * | $ | 958 | $ | 632 | 52% | |||||||||||||
* | Not meaningful |
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Entertainment and Devices Division (EDD) develops and markets products and services designed to entertain and connect people. EDD offerings include the Xbox 360 entertainment platform (which includes the Xbox 360 gaming and entertainment console, Kinect for Xbox 360, Xbox 360 video games, Xbox LIVE, and Xbox 360 accessories), Mediaroom (our Internet protocol television software), Skype, and Windows Phone, including related patent licensing revenue. We acquired Skype on October 13, 2011, and its results of operations from that date are reflected in our results discussed below.
Three months ended March 31, 2013 compared with three months ended March 31, 2012
EDD revenue increased, primarily due to higher Xbox 360 platform and Windows Phone revenue. Xbox 360 platform revenue increased $641 million or 55%, primarily due to the recognition of $380 million of revenue related to the Video Game Deferral and higher Xbox LIVE revenue. Windows Phone revenue increased $259 million, including patent licensing revenue and increased sales of Windows Phone licenses.
EDD operating income increased, primarily due to revenue growth, offset in part by higher cost of revenue and research and development expenses. Cost of revenue increased $275 million or 23%, due mainly to increased royalties on Xbox LIVE content and video games. Researc