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 December 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 January 17, 2014 | |||
Common Stock, $0.00000625 par value per share |
8,300,723,725 shares |
FORM 10-Q
For the Quarter Ended December 31, 2013
INDEX
2
PART I
Item 1
(In millions, except per share amounts) (Unaudited) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Revenue |
$ | 24,519 | $ | 21,456 | $ | 43,048 | $ | 37,464 | ||||||||
Cost of revenue |
8,284 | 5,692 | 13,398 | 9,860 | ||||||||||||
Gross margin |
16,235 | 15,764 | 29,650 | 27,604 | ||||||||||||
Operating expenses: |
||||||||||||||||
Research and development |
2,748 | 2,528 | 5,515 | 4,988 | ||||||||||||
Sales and marketing |
4,283 | 4,309 | 7,587 | 7,254 | ||||||||||||
General and administrative |
1,235 | 1,156 | 2,245 | 2,283 | ||||||||||||
Total operating expenses |
8,266 | 7,993 | 15,347 | 14,525 | ||||||||||||
Operating income |
7,969 | 7,771 | 14,303 | 13,079 | ||||||||||||
Other income (expense) |
(91 | ) | (1 | ) | (17 | ) | 225 | |||||||||
Income before income taxes |
7,878 | 7,770 | 14,286 | 13,304 | ||||||||||||
Provision for income taxes |
1,320 | 1,393 | 2,484 | 2,461 | ||||||||||||
Net income |
$ | 6,558 | $ | 6,377 | $ | 11,802 | $ | 10,843 | ||||||||
Earnings per share: |
||||||||||||||||
Basic |
$ | 0.79 | $ | 0.76 | $ | 1.42 | $ | 1.29 | ||||||||
Diluted |
$ | 0.78 | $ | 0.76 | $ | 1.40 | $ | 1.28 | ||||||||
Weighted average shares outstanding: |
||||||||||||||||
Basic |
8,326 | 8,393 | 8,333 | 8,395 | ||||||||||||
Diluted |
8,395 | 8,444 | 8,423 | 8,480 | ||||||||||||
Cash dividends declared per common share |
$ | 0.28 | $ | 0.23 | $ | 0.56 | $ | 0.46 | ||||||||
See accompanying notes.
3
PART I
Item 1
COMPREHENSIVE INCOME STATEMENTS
(In millions) (Unaudited) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Net income |
$ | 6,558 | $ | 6,377 | $ | 11,802 | $ | 10,843 | ||||||||
Other comprehensive income (loss): |
||||||||||||||||
Net unrealized gains (losses) on derivatives (net of tax effects of $1, $(5), $(2), and $(29)) |
43 | (9 | ) | 17 | (54 | ) | ||||||||||
Net unrealized gains on investments (net of tax effects of $245, $103, $737, and $251) |
482 | 192 | 1,434 | 466 | ||||||||||||
Translation adjustments and other (net of tax effects of $11, $2, $44 and $92) |
21 | 3 | 83 | 172 | ||||||||||||
Other comprehensive income |
546 | 186 | 1,534 | 584 | ||||||||||||
Comprehensive income |
$ | 7,104 | $ | 6,563 | $ | 13,336 | $ | 11,427 | ||||||||
See accompanying notes.
4
PART I
Item 1
(In millions) (Unaudited) | ||||||||
December 31, 2013 |
June 30, 2013 |
|||||||
Assets |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 10,059 | $ | 3,804 | ||||
Short-term investments (including securities loaned of $685 and $579) |
73,885 | 73,218 | ||||||
Total cash, cash equivalents, and short-term investments |
83,944 | 77,022 | ||||||
Accounts receivable, net of allowance for doubtful accounts of $316 and $336 |
15,986 | 17,486 | ||||||
Inventories |
1,594 | 1,938 | ||||||
Deferred income taxes |
1,328 | 1,632 | ||||||
Other |
4,018 | 3,388 | ||||||
Total current assets |
106,870 | 101,466 | ||||||
Property and equipment, net of accumulated depreciation of $13,686 and $12,513 |
11,567 | 9,991 | ||||||
Equity and other investments |
14,607 | 10,844 | ||||||
Goodwill |
14,680 | 14,655 | ||||||
Intangible assets, net |
2,945 | 3,083 | ||||||
Other long-term assets |
2,874 | 2,392 | ||||||
Total assets |
$ | 153,543 | $ | 142,431 | ||||
Liabilities and stockholders equity |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 5,398 | $ | 4,828 | ||||
Short-term debt |
300 | 0 | ||||||
Current portion of long-term debt |
2,000 | 2,999 | ||||||
Accrued compensation |
3,169 | 4,117 | ||||||
Income taxes |
591 | 592 | ||||||
Short-term unearned revenue |
17,616 | 20,639 | ||||||
Securities lending payable |
748 | 645 | ||||||
Other |
3,920 | 3,597 | ||||||
Total current liabilities |
33,742 | 37,417 | ||||||
Long-term debt |
20,676 | 12,601 | ||||||
Long-term unearned revenue |
1,858 | 1,760 | ||||||
Deferred income taxes |
2,377 | 1,709 | ||||||
Other long-term liabilities |
9,790 | 10,000 | ||||||
Total liabilities |
68,443 | 63,487 | ||||||
Commitments and contingencies |
||||||||
Stockholders equity: |
||||||||
Common stock and paid-in capitalshares authorized 24,000; outstanding 8,300 and 8,328 |
67,476 | 67,306 | ||||||
Retained earnings |
14,347 | 9,895 | ||||||
Accumulated other comprehensive income |
3,277 | 1,743 | ||||||
Total stockholders equity |
85,100 | 78,944 | ||||||
Total liabilities and stockholders equity |
$ | 153,543 | $ | 142,431 | ||||
See accompanying notes.
5
PART I
Item 1
(In millions) (Unaudited) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Operations |
||||||||||||||||
Net income |
$ | 6,558 | $ | 6,377 | $ | 11,802 | $ | 10,843 | ||||||||
Adjustments to reconcile net income to net cash from operations: |
||||||||||||||||
Depreciation, amortization, and other |
1,261 | 1,009 | 2,215 | 1,719 | ||||||||||||
Stock-based compensation expense |
591 | 603 | 1,226 | 1,206 | ||||||||||||
Net recognized losses on investments and derivatives |
47 | 22 | 140 | 33 | ||||||||||||
Excess tax benefits from stock-based compensation |
(20 | ) | (9 | ) | (225 | ) | (186 | ) | ||||||||
Deferred income taxes |
(176 | ) | 140 | 228 | 178 | |||||||||||
Deferral of unearned revenue |
9,845 | 10,737 | 17,281 | 18,946 | ||||||||||||
Recognition of unearned revenue |
(10,578 | ) | (10,483 | ) | (20,255 | ) | (19,253 | ) | ||||||||
Changes in operating assets and liabilities: |
||||||||||||||||
Accounts receivable |
(4,875 | ) | (4,488 | ) | 1,742 | 1,668 | ||||||||||
Inventories |
1,029 | (33 | ) | 362 | (506 | ) | ||||||||||
Other current assets |
(95 | ) | 150 | (651 | ) | (235 | ) | |||||||||
Other long-term assets |
(315 | ) | (80 | ) | (396 | ) | (313 | ) | ||||||||
Accounts payable |
602 | 685 | 326 | 118 | ||||||||||||
Other current liabilities |
388 | 168 | (867 | ) | (1,119 | ) | ||||||||||
Other long-term liabilities |
151 | (18 | ) | (310 | ) | 165 | ||||||||||
Net cash from operations |
4,413 | 4,780 | 12,618 | 13,264 | ||||||||||||
Financing |
||||||||||||||||
Short-term debt repayments, maturities less than 90 days, net |
(712 | ) | 0 | 0 | 0 | |||||||||||
Proceeds from issuance of debt |
8,262 | 2,232 | 8,850 | 2,232 | ||||||||||||
Repayments of debt |
(588 | ) | 0 | (1,588 | ) | 0 | ||||||||||
Common stock issued |
117 | 145 | 320 | 562 | ||||||||||||
Common stock repurchased |
(2,113 | ) | (1,658 | ) | (4,301 | ) | (3,290 | ) | ||||||||
Common stock cash dividends paid |
(2,332 | ) | (1,933 | ) | (4,248 | ) | (3,609 | ) | ||||||||
Excess tax benefits from stock-based compensation |
20 | 9 | 225 | 186 | ||||||||||||
Other |
(39 | ) | (16 | ) | (39 | ) | (16 | ) | ||||||||
Net cash from (used in) financing |
2,615 | (1,221 | ) | (781 | ) | (3,935 | ) | |||||||||
Investing |
||||||||||||||||
Additions to property and equipment |
(1,732 | ) | (930 | ) | (2,963 | ) | (1,533 | ) | ||||||||
Acquisition of companies, net of cash acquired, and purchases of intangible and other assets |
(139 | ) | (311 | ) | (154 | ) | (1,456 | ) | ||||||||
Purchases of investments |
(13,126 | ) | (10,074 | ) | (27,894 | ) | (30,212 | ) | ||||||||
Maturities of investments |
1,451 | 1,989 | 1,798 | 3,248 | ||||||||||||
Sales of investments |
12,354 | 7,126 | 23,471 | 20,433 | ||||||||||||
Securities lending payable |
167 | (393 | ) | 103 | (792 | ) | ||||||||||
Net cash used in investing |
(1,025 | ) | (2,593 | ) | (5,639 | ) | (10,312 | ) | ||||||||
Effect of exchange rates on cash and cash equivalents |
33 | 15 | 57 | 62 | ||||||||||||
Net change in cash and cash equivalents |
6,036 | 981 | 6,255 | (921 | ) | |||||||||||
Cash and cash equivalents, beginning of period |
4,023 | 5,036 | 3,804 | 6,938 | ||||||||||||
Cash and cash equivalents, end of period |
$ | 10,059 | $ | 6,017 | $ | 10,059 | $ | 6,017 | ||||||||
See accompanying notes.
6
PART I
Item 1
STOCKHOLDERS EQUITY STATEMENTS
(In millions) (Unaudited) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Common stock and paid-in capital |
||||||||||||||||
Balance, beginning of period |
$ | 67,230 | $ | 66,084 | $ | 67,306 | $ | 65,797 | ||||||||
Common stock issued |
117 | 145 | 320 | 552 | ||||||||||||
Common stock repurchased |
(486 | ) | (507 | ) | (1,607 | ) | (1,398 | ) | ||||||||
Stock-based compensation expense |
591 | 603 | 1,226 | 1,206 | ||||||||||||
Stock-based compensation income tax benefits |
21 | 5 | 226 | 172 | ||||||||||||
Other, net |
3 | 4 | 5 | 5 | ||||||||||||
Balance, end of period |
67,476 | 66,334 | 67,476 | 66,334 | ||||||||||||
Retained earnings (deficit) |
||||||||||||||||
Balance, beginning of period |
11,680 | 932 | 9,895 | (856 | ) | |||||||||||
Net income |
6,558 | 6,377 | 11,802 | 10,843 | ||||||||||||
Common stock cash dividends |
(2,319 | ) | (1,922 | ) | (4,656 | ) | (3,859 | ) | ||||||||
Common stock repurchased |
(1,572 | ) | (1,151 | ) | (2,694 | ) | (1,892 | ) | ||||||||
Balance, end of period |
14,347 | 4,236 | 14,347 | 4,236 | ||||||||||||
Accumulated other comprehensive income |
||||||||||||||||
Balance, beginning of period |
2,731 | 1,820 | 1,743 | 1,422 | ||||||||||||
Other comprehensive income |
546 | 186 | 1,534 | 584 | ||||||||||||
Balance, end of period |
3,277 | 2,006 | 3,277 | 2,006 | ||||||||||||
Total stockholders equity |
$ | 85,100 | $ | 72,576 | $ | 85,100 | $ | 72,576 | ||||||||
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 2013 Form 10-K and Form 8-K filed with the U.S. Securities and Exchange Commission on July 30, 2013 and November 26, 2013, respectively.
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 are able to 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
During the first quarter of fiscal year 2014, we changed our organizational structure as part of our transformation to a devices and services company. As a result of these changes, information that our chief operating decision maker regularly reviews for purposes of allocating resources and assessing performance changed. Therefore, beginning in fiscal year 2014, we are reporting our financial performance based on our new segments described in Note 16 Segment Information. We have recast certain prior period amounts to conform to the way we internally manage and monitor segment performance during fiscal year 2014. This change impacted Note 8 Goodwill, Note 12 Unearned Revenue, and Note 16 Segment Information, with no impact on consolidated net income or cash flows.
Recent Accounting Guidance
Recently adopted accounting guidance
In December 2011, the Financial Accounting Standards Board (FASB) issued guidance enhancing disclosure requirements about the nature of an entitys right to offset and related arrangements associated with its financial 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, repurchase agreements, and securities lending arrangements that are either offset or subject to an enforceable master netting arrangement, or similar agreements. We adopted this new guidance beginning July 1, 2013. Adoption of this new guidance resulted only in changes to the presentation of Note 5 Derivatives.
8
PART I
Item 1
In February 2013, the FASB issued guidance on disclosure requirements for items reclassified out of accumulated other comprehensive income (AOCI). This new guidance requires entities to present (either on the face of the income statement or in the notes to financial statements) the effects on the line items of the income statement for amounts reclassified out of AOCI. We adopted this new guidance beginning July 1, 2013. Adoption of this new guidance resulted only in changes to the presentation of Note 15 Accumulated Other Comprehensive Income.
Recent accounting guidance not yet adopted
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 and stock awards.
The components of basic and diluted EPS are as follows:
(In millions, except earnings per share) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Net income available for common shareholders (A) |
$ | 6,558 | $ | 6,377 | $ | 11,802 | $ | 10,843 | ||||||||
Weighted average outstanding shares of common stock (B) |
8,326 | 8,393 | 8,333 | 8,395 | ||||||||||||
Dilutive effect of stock-based awards |
69 | 51 | 90 | 85 | ||||||||||||
Common stock and common stock equivalents (C) |
8,395 | 8,444 | 8,423 | 8,480 | ||||||||||||
Earnings Per Share | ||||||||||||||||
Basic (A/B) |
$ | 0.79 | $ | 0.76 | $ | 1.42 | $ | 1.29 | ||||||||
Diluted (A/C) |
$ | 0.78 | $ | 0.76 | $ | 1.40 | $ | 1.28 | ||||||||
Anti-dilutive stock-based awards excluded from the calculations of diluted EPS were immaterial during the periods presented.
NOTE 3 OTHER INCOME (EXPENSE)
The components of other income (expense) were as follows:
(In millions) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Dividends and interest income |
$ | 219 | $ | 166 | $ | 398 | $ | 325 | ||||||||
Interest expense |
(135 | ) | (105 | ) | (253 | ) | (200 | ) | ||||||||
Net recognized gains on investments |
70 | 43 | 63 | 28 | ||||||||||||
Net losses on derivatives |
(117 | ) | (65 | ) | (203 | ) | (61 | ) | ||||||||
Net gains (losses) on foreign currency remeasurements |
(17 | ) | (7 | ) | 9 | (36 | ) | |||||||||
Other |
(111 | ) | (33 | ) | (31 | ) | 169 | |||||||||
Total |
$ | (91 | ) | $ | (1 | ) | $ | (17 | ) | $ | 225 | |||||
9
PART I
Item 1
Following are details of net recognized gains (losses) on investments during the periods reported:
(In millions) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Other-than-temporary impairments of investments |
$ | (30 | ) | $ | (40 | ) | $ | (66 | ) | $ | (130 | ) | ||||
Realized gains from sales of available-for-sale securities |
144 | 109 | 258 | 210 | ||||||||||||
Realized losses from sales of available-for-sale securities |
(44 | ) | (26 | ) | (129 | ) | (52 | ) | ||||||||
Total |
$ | 70 | $ | 43 | $ | 63 | $ | 28 | ||||||||
NOTE 4 INVESTMENTS
Investment Components
The components of investments, including associated derivatives but excluding held-to-maturity investments, were as follows:
(In millions) | Cost Basis | Unrealized Gains |
Unrealized Losses |
Recorded Basis |
Cash and Cash Equivalents |
Short-term Investments |
Equity and Other Investments |
|||||||||||||||||||||
December 31, 2013 | ||||||||||||||||||||||||||||
Cash |
$ | 2,747 | $ | 0 | $ | 0 | $ | 2,747 | $ | 2,747 | $ | 0 | $ | 0 | ||||||||||||||
Mutual funds |
766 | 0 | 0 | 766 | 766 | 0 | 0 | |||||||||||||||||||||
Commercial paper |
390 | 0 | 0 | 390 | 141 | 249 | 0 | |||||||||||||||||||||
Certificates of deposit |
979 | 0 | 0 | 979 | 771 | 208 | 0 | |||||||||||||||||||||
U.S. government and agency securities |
60,824 | 82 | (85 | ) | 60,821 | 452 | 60,369 | 0 | ||||||||||||||||||||
Foreign government bonds |
8,654 | 92 | (44 | ) | 8,702 | 5,169 | 3,533 | 0 | ||||||||||||||||||||
Mortgage-backed securities |
1,244 | 40 | (18 | ) | 1,266 | 0 | 1,266 | 0 | ||||||||||||||||||||
Corporate notes and bonds |
7,734 | 233 | (37 | ) | 7,930 | 13 | 7,917 | 0 | ||||||||||||||||||||
Municipal securities |
302 | 25 | (3 | ) | 324 | 0 | 324 | 0 | ||||||||||||||||||||
Common and preferred stock |
6,783 | 4,792 | (118 | ) | 11,457 | 0 | 0 | 11,457 | ||||||||||||||||||||
Other investments |
1,169 | 0 | 0 | 1,169 | 0 | 19 | 1,150 | |||||||||||||||||||||
Total |
$ | 91,592 | $ | 5,264 | $ | (305 | ) | $ | 96,551 | $ | 10,059 | $ | 73,885 | $ | 12,607 | |||||||||||||
(In millions) | Cost Basis | Unrealized Gains |
Unrealized Losses |
Recorded Basis |
Cash and Cash Equivalents |
Short-term Investments |
Equity and Other Investments |
|||||||||||||||||||||
June 30, 2013 | ||||||||||||||||||||||||||||
Cash |
$ | 1,967 | $ | 0 | $ | 0 | $ | 1,967 | $ | 1,967 | $ | 0 | $ | 0 | ||||||||||||||
Mutual funds |
868 | 0 | 0 | 868 | 868 | 0 | 0 | |||||||||||||||||||||
Commercial paper |
603 | 0 | 0 | 603 | 214 | 389 | 0 | |||||||||||||||||||||
Certificates of deposit |
994 | 0 | 0 | 994 | 609 | 385 | 0 | |||||||||||||||||||||
U.S. government and agency securities |
64,934 | 47 | (84 | ) | 64,897 | 146 | 64,751 | 0 | ||||||||||||||||||||
Foreign government bonds |
900 | 16 | (41 | ) | 875 | 0 | 875 | 0 | ||||||||||||||||||||
Mortgage-backed securities |
1,258 | 43 | (13 | ) | 1,288 | 0 | 1,288 | 0 | ||||||||||||||||||||
Corporate notes and bonds |
4,993 | 169 | (40 | ) | 5,122 | 0 | 5,122 | 0 | ||||||||||||||||||||
Municipal securities |
350 | 36 | (1 | ) | 385 | 0 | 385 | 0 | ||||||||||||||||||||
Common and preferred stock |
6,931 | 2,938 | (281 | ) | 9,588 | 0 | 0 | 9,588 | ||||||||||||||||||||
Other investments |
1,279 | 0 | 0 | 1,279 | 0 | 23 | 1,256 | |||||||||||||||||||||
Total |
$ | 85,077 | $ | 3,249 | $ | (460 | ) | $ | 87,866 | $ | 3,804 | $ | 73,218 | $ | 10,844 | |||||||||||||
10
PART I
Item 1
In addition to the investments in the table above, we also own certain corporate notes that were purchased in connection with our agreement to lend $2.0 billion to the group that completed their acquisition of Dell on October 29, 2013. These corporate notes are classified as held-to-maturity investments and are included in equity and other investments on the balance sheet. As of December 31, 2013, the amortized cost and recorded basis of these corporate notes was $2.0 billion, while their estimated fair value was $1.9 billion and associated gross unrecognized holding losses were $132 million.
As of December 31, 2013 and June 30, 2013, the recorded bases of common and preferred stock that are restricted for more than one year or are not publicly traded were $450 million and $395 million, respectively. These investments are carried at cost and are reviewed quarterly for indicators of other-than-temporary impairment. It is not practicable for us to reliably estimate the fair value of these investments.
Unrealized Losses on Investments
Investments, excluding those held-to-maturity, with continuous unrealized losses for less than 12 months and 12 months or greater and their related fair values were as follows:
Less than 12 Months | 12 Months or Greater | Total Unrealized Losses |
||||||||||||||||||||||
(In millions) | Fair Value | Unrealized Losses |
Fair Value | Unrealized Losses |
Total Fair Value |
|||||||||||||||||||
December 31, 2013 | ||||||||||||||||||||||||
U.S. government and agency securities |
$ | 4,193 | $ | (85 | ) | $ | 0 | $ | 0 | $ | 4,193 | $ | (85 | ) | ||||||||||
Foreign government bonds |
741 | (32 | ) | 30 | (12 | ) | 771 | (44 | ) | |||||||||||||||
Mortgage-backed securities |
430 | (14 | ) | 66 | (4 | ) | 496 | (18 | ) | |||||||||||||||
Corporate notes and bonds |
1,494 | (36 | ) | 18 | (1 | ) | 1,512 | (37 | ) | |||||||||||||||
Municipal securities |
42 | (3 | ) | 0 | 0 | 42 | (3 | ) | ||||||||||||||||
Common and preferred stock |
590 | (72 | ) | 273 | (46 | ) | 863 | (118 | ) | |||||||||||||||
Total |
$ | 7,490 | $ | (242 | ) | $ | 387 | $ | (63 | ) | $ | 7,877 | $ | (305 | ) | |||||||||
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, 2013 | ||||||||||||||||||||||||
U.S. government and agency securities |
$ | 2,208 | $ | (84 | ) | $ | 0 | $ | 0 | $ | 2,208 | $ | (84 | ) | ||||||||||
Foreign government bonds |
589 | (18 | ) | 69 | (23 | ) | 658 | (41 | ) | |||||||||||||||
Mortgage-backed securities |
357 | (12 | ) | 39 | (1 | ) | 396 | (13 | ) | |||||||||||||||
Corporate notes and bonds |
1,142 | (38 | ) | 27 | (2 | ) | 1,169 | (40 | ) | |||||||||||||||
Municipal securities |
44 | (1 | ) | 0 | 0 | 44 | (1 | ) | ||||||||||||||||
Common and preferred stock |
1,166 | (168 | ) | 409 | (113 | ) | 1,575 | (281 | ) | |||||||||||||||
Total |
$ | 5,506 | $ | (321 | ) | $ | 544 | $ | (139 | ) | $ | 6,050 | $ | (460 | ) | |||||||||
As of December 31, 2013, the fair value of our held-to-maturity investments that have been in an unrecognized loss position for less than 12 months was $1.9 billion. The associated unrealized loss was $132 million. As of December 31, 2013, we did not hold any held-to-maturity investments that have been in an unrecognized loss position for 12 months or greater.
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 December 31, 2013.
11
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Debt Investment Maturities
(In millions) | Cost Basis | Estimated Fair Value |
||||||
December 31, 2013 | ||||||||
Due in one year or less |
$ | 29,401 | $ | 29,480 | ||||
Due after one year through five years |
44,372 | 44,505 | ||||||
Due after five years through 10 years |
4,633 | 4,670 | ||||||
Due after 10 years |
1,721 | 1,757 | ||||||
Total (a) |
$ | 80,127 | $ | 80,412 | ||||
(a) | Excludes held-to-maturity investments due October 31, 2023 with a cost basis and estimated fair value at December 31, 2013 of $2.0 billion and $1.9 billion, respectively. |
NOTE 5 DERIVATIVES
We use derivative instruments to manage risks related to foreign currencies, equity prices, interest rates, and credit; to enhance investment returns; and to facilitate portfolio diversification. Our objectives for holding derivatives include reducing, eliminating, and efficiently managing the economic impact of these exposures as effectively as possible. Our derivative programs include strategies that both qualify and do not qualify for hedge accounting treatment. All notional amounts presented below are measured in U.S. dollar 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 December 31, 2013 and June 30, 2013, the total notional amounts of these foreign exchange contracts sold were $4.3 billion and $5.1 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 December 31, 2013 and June 30, 2013, the total notional amounts of these foreign exchange contracts sold were $1.8 billion and $407 million, 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 December 31, 2013, the total notional amounts of these foreign exchange contracts purchased and sold were $4.6 billion and $6.9 billion, respectively. As of June 30, 2013, the total notional amounts of these foreign exchange contracts purchased and sold were $5.0 billion and $7.9 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 December 31, 2013, the total notional amounts of equity contracts purchased and sold for managing market price risk were $1.6 billion and $1.6 billion, respectively, of which $362 million and $420 million, respectively, were designated as hedging instruments. As of June 30, 2013, the total notional amounts of equity contracts purchased and sold for managing market price risk were $898 million and $1.0 billion, respectively, none of which were designated as hedging instruments.
In connection with our agreement to purchase substantially all of the Devices & Services business of Nokia Corporation (Nokia), on September 23, 2013, we provided to Nokia 1.5 billion ($2.0 billion) of financing in the form of convertible notes, which we have recorded as short-term investments. See further discussion in Note 13 Contingencies. The total notional amount of derivatives related to the Nokia convertible notes was $2.1 billion as of December 31, 2013. See Note 6 Fair Value Measurements for additional details.
12
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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 December 31, 2013, the total notional amounts of fixed-interest rate contracts purchased and sold were $3.0 billion and $776 million, respectively. As of June 30, 2013, the total notional amounts of fixed-interest rate contracts purchased and sold were $1.1 billion and $809 million, respectively.
In addition, we use To Be Announced forward purchase commitments of mortgage-backed assets to gain exposure to agency mortgage-backed securities. These meet the definition of a derivative instrument in cases where physical delivery of the assets is not taken at the earliest available delivery date. As of December 31, 2013 and June 30, 2013, the total notional derivative amounts of mortgage contracts purchased were $1.0 billion and $1.2 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 December 31, 2013, the total notional amounts of credit contracts purchased and sold were $506 million and $470 million, respectively. As of June 30, 2013, the total notional amounts of credit contracts purchased and sold were $377 million and $501 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 December 31, 2013, the total notional amounts of commodity contracts purchased and sold were $1.3 billion and $338 million, respectively. As of June 30, 2013, the total notional amounts of commodity contracts purchased and sold were $1.2 billion and $249 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 December 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 other comprehensive income (OCI) and is subsequently recognized in earnings when the hedged exposure is recognized in earnings. For options designated as cash-flow
13
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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.
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 moved from OCI into other income (expense).
The following tables present the 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:
December 31, 2013 | June 30, 2013 | |||||||||||||||||||||||||||||||||||||||
Assets | Liabilities | Assets | Liabilities | |||||||||||||||||||||||||||||||||||||
(In millions) | Short-term |
Other Current |
Equity and Other Investments |
Other Current Liabilities |
Other Long-term Liabilities |
Short-term |
Other Current Assets |
Other Current Liabilities |
||||||||||||||||||||||||||||||||
Non-designated Hedge Derivatives | ||||||||||||||||||||||||||||||||||||||||
Foreign exchange contracts |
$ | 33 | $ | 81 | $ | 0 | $ | (67 | ) | $ | 0 | $ | 41 | $ | 87 | $ | (63 | ) | ||||||||||||||||||||||
Equity contracts |
166 | 0 | 0 | (17 | ) | 0 | 157 | 0 | (9 | ) | ||||||||||||||||||||||||||||||
Interest rate contracts |
19 | 0 | 0 | (10 | ) | 0 | 18 | 0 | (45 | ) | ||||||||||||||||||||||||||||||
Credit contracts |
25 | 0 | 0 | (17 | ) | 0 | 19 | 0 | (17 | ) | ||||||||||||||||||||||||||||||
Commodity contracts |
4 | 0 | 0 | (1 | ) | 0 | 3 | 0 | (1 | ) | ||||||||||||||||||||||||||||||
Total |
$ | 247 | $ | 81 | $ | 0 | $ | (112 | ) | $ | 0 | $ | 238 | $ | 87 | $ | (135 | ) | ||||||||||||||||||||||
Designated Hedge Derivatives | ||||||||||||||||||||||||||||||||||||||||
Foreign exchange contracts |
$ | 86 | $ | 90 | $ | 0 | $ | (1 | ) | $ | 0 | $ | 9 | $ | 167 | $ | 0 | |||||||||||||||||||||||
Equity contracts |
0 | 0 | 35 | (45 | ) | (26 | ) | 0 | 0 | 0 | ||||||||||||||||||||||||||||||
Total |
$ | 86 | $ | 90 | $ | 35 | $ | (46 | ) | $ | (26 | ) | $ | 9 | $ | 167 | $ | 0 | ||||||||||||||||||||||
Total gross amounts of derivatives |
$ | 333 | $ | 171 | $ | 35 | $ | (158 | ) | $ | (26 | ) | $ | 247 | $ | 254 | $ | (135 | ) | |||||||||||||||||||||
Gross derivatives either offset or subject to an enforceable master netting agreement |
$ | 187 | $ | 171 | $ | 35 | $ | (151 | ) | $ | (26 | ) | $ | 105 | $ | 254 | $ | (97 | ) | |||||||||||||||||||||
Gross amounts offset in the balance sheet |
(63 | ) | (52 | ) | (35 | ) | 136 | 14 | (72 | ) | (9 | ) | 80 | |||||||||||||||||||||||||||
Net amounts presented in the balance sheet |
$ | 124 | $ | 119 | $ | 0 | $ | (15 | ) | $ | (12 | ) | $ | 33 | $ | 245 | $ | (17 | ) | |||||||||||||||||||||
Gross amounts not offset in the balance sheet |
0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||||||||||||||||
Net amount |
$ | 124 | $ | 119 | $ | 0 | $ | (15 | ) | $ | (12 | ) | $ | 33 | $ | 245 | $ | (17 | ) | |||||||||||||||||||||
See also Note 4 Investments and Note 6 Fair Value Measurements.
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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 December 31, |
Six Months Ended December 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Foreign Exchange Contracts |
||||||||||||||||
Derivatives |
$ | 73 | $ | 35 | $ | 59 | $ | 23 | ||||||||
Hedged items |
(74 | ) | (35 | ) | (61 | ) | (21 | ) | ||||||||
Total amount of ineffectiveness |
$ | (1 | ) | $ | 0 | $ | (2 | ) | $ | 2 | ||||||
Equity Contracts |
||||||||||||||||
Derivatives |
$ | (10 | ) | $ | 0 | $ | (10 | ) | $ | 0 | ||||||
Hedged items |
10 | 0 | 10 | 0 | ||||||||||||
Total amount of ineffectiveness |
$ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||
Amount of equity contracts excluded from effectiveness assessment |
$ | (26 | ) | $ | 0 | $ | (26 | ) | $ | 0 | ||||||
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 December 31, |
Six Months Ended December 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Effective Portion |
||||||||||||||||
Gains (losses) recognized in OCI (net of tax effects of $2, $7, $0 and $(5)) |
$ | 67 | $ | 13 | $ | 59 | $ | (10 | ) | |||||||
Gains reclassified from AOCI into revenue |
25 | 34 | 44 | 69 | ||||||||||||
Amount Excluded from Effectiveness Assessment and Ineffective Portion |
||||||||||||||||
Losses recognized in other income (expense) |
(40 | ) | (36 | ) | (120 | ) | (107 | ) | ||||||||
We estimate that $82 million of net derivative gains included in OCI at December 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 six months ended December 31, 2013.
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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 December 31, |
Six Months Ended December 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Foreign exchange contracts |
$ | 60 | $ | (12 | ) | $ | 74 | $ | (25 | ) | ||||||
Equity contracts |
(41 | ) | 15 | (46 | ) | 17 | ||||||||||
Interest-rate contracts |
(13 | ) | 1 | 0 | 19 | |||||||||||
Credit contracts |
4 | (2 | ) | 3 | (9 | ) | ||||||||||
Commodity contracts |
0 | (45 | ) | 11 | 21 | |||||||||||
Total |
$ | 10 | $ | (43 | ) | $ | 42 | $ | 23 | |||||||
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, credit spreads, 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, common and preferred stock, mortgage-backed securities, U.S. agency securities, foreign government bonds, 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, volatilities, and probability-weighted scenarios. 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
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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 | (a) |
|
Gross Fair Value |
|
Netting | (b) | |
Net Fair Value |
| ||||||||||||
December 31, 2013 | ||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||
Mutual funds |
$ | 766 | $ | 0 | $ | 0 | $ | 766 | $ | 0 | $ | 766 | ||||||||||||
Commercial paper |
0 | 390 | 0 | 390 | 0 | 390 | ||||||||||||||||||
Certificates of deposit |
0 | 979 | 0 | 979 | 0 | 979 | ||||||||||||||||||
U.S. government and agency securities |
58,963 | 1,858 | 0 | 60,821 | 0 | 60,821 | ||||||||||||||||||
Foreign government bonds |
354 | 8,261 | 0 | 8,615 | 0 | 8,615 | ||||||||||||||||||
Mortgage-backed securities |
0 | 1,267 | 0 | 1,267 | 0 | 1,267 | ||||||||||||||||||
Corporate notes and bonds |
0 | 5,662 | 2,066 | 7,728 | 0 | 7,728 | ||||||||||||||||||
Municipal securities |
0 | 324 | 0 | 324 | 0 | 324 | ||||||||||||||||||
Common and preferred stock |
9,544 | 1,487 | 12 | 11,043 | 0 | 11,043 | ||||||||||||||||||
Derivatives |
13 | 480 | 46 | 539 | (150 | ) | 389 | |||||||||||||||||
Total |
$ | 69,640 | $ | 20,708 | $ | 2,124 | $ | 92,472 | $ | (150 | ) | $ | 92,322 | |||||||||||
Liabilities |
||||||||||||||||||||||||
Derivatives and other |
$ | 14 | $ | 99 | $ | 71 | $ | 184 | $ | (150 | ) | $ | 34 | |||||||||||
(In millions) |
Level 1 | Level 2 | Level 3 |
|
Gross Fair Value |
|
Netting | (b) | |
Net Fair Value |
| |||||||||||||
June 30, 2013 | ||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||
Mutual funds |
$ | 868 | $ | 0 | $ | 0 | $ | 868 | $ | 0 | $ | 868 | ||||||||||||
Commercial paper |
0 | 603 | 0 | 603 | 0 | 603 | ||||||||||||||||||
Certificates of deposit |
0 | 994 | 0 | 994 | 0 | 994 | ||||||||||||||||||
U.S. government and agency securities |
62,237 | 2,664 | 0 | 64,901 | 0 | 64,901 | ||||||||||||||||||
Foreign government bonds |
9 | 851 | 0 | 860 | 0 | 860 | ||||||||||||||||||
Mortgage-backed securities |
0 | 1,311 | 0 | 1,311 | 0 | 1,311 | ||||||||||||||||||
Corporate notes and bonds |
0 | 4,915 | 19 | 4,934 | 0 | 4,934 | ||||||||||||||||||
Municipal securities |
0 | 385 | 0 | 385 | 0 | 385 | ||||||||||||||||||
Common and preferred stock |
8,470 | 717 | 5 | 9,192 | 0 | 9,192 | ||||||||||||||||||
Derivatives |
12 | 489 | 0 | 501 | (81 | ) | 420 | |||||||||||||||||
Total |
$ | 71,596 | $ | 12,929 | $ | 24 | $ | 84,549 | $ | (81 | ) | $ | 84,468 | |||||||||||
Liabilities |
||||||||||||||||||||||||
Derivatives and other |
$ | 14 | $ | 121 | $ | 0 | $ | 135 | $ | (80 | ) | $ | 55 | |||||||||||
(a) | Level 3 assets at December 31, 2013 primarily comprised 1.5 billion principal amount of Nokia convertible notes. The valuation of these notes considers the probability of closing our purchase of Nokias Devices & Services business as well as an analysis of market comparable transactions and management assumptions. The probability-weighted scenarios are considered significant unobservable inputs used in the fair value measurement of both the convertible notes and the embedded derivative. Significant changes in these probabilities in isolation would significantly alter the fair value measurement for both the notes and the embedded derivative. |
17
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(b) | 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.
(In millions) | ||||||||
December 31, 2013 |
June 30, 2013 |
|||||||
Net fair value of assets measured at fair value on a recurring basis |
$ | 92,322 | $ | 84,468 | ||||
Cash |
2,747 | 1,967 | ||||||
Common and preferred stock measured at fair value on a nonrecurring basis |
450 | 395 | ||||||
Other investments measured at fair value on a nonrecurring basis |
1,150 | 1,256 | ||||||
Less derivative net assets classified as other current assets |
(119 | ) | (213 | ) | ||||
Other |
1 | (7 | ) | |||||
Recorded basis of investment components (a) |
$ | 96,551 | $ | 87,866 | ||||
(a) | Excludes held-to-maturity investments recorded at amortized cost and measured at fair value on a nonrecurring basis. |
Financial Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
During the three and six months ended December 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) | ||||||||
December 31, 2013 |
June 30, 2013 |
|||||||
Raw materials |
$ | 389 | $ | 328 | ||||
Work in process |
80 | 201 | ||||||
Finished goods |
1,125 | 1,409 | ||||||
Total |
$ | 1,594 | $ | 1,938 | ||||
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NOTE 8 GOODWILL
Changes in the carrying amount of goodwill were as follows:
(In millions) | September 30, 2013 |
Acquisitions |
Other | December 31, 2013 |
||||||||||||||||||||||
Devices and Consumer |
Licensing | $ | 867 | $ | 0 | $ | 1 | $ | 868 | |||||||||||||||||
Hardware |
1,680 | 0 | 8 | 1,688 | ||||||||||||||||||||||
Other |
738 | 0 | 0 | 738 | ||||||||||||||||||||||
Total Devices and Consumer |
$ | 3,285 | $ | 0 | $ | 9 | $ | 3,294 | ||||||||||||||||||
Commercial |
Licensing | $ | 10,071 | $ | 2 | $ | (13 | ) | $ | 10,060 | ||||||||||||||||
Other |
1,311 | 15 | 0 | 1,326 | ||||||||||||||||||||||
Total Commercial |
$ | 11,382 | $ | 17 | $ | (13 | ) | 11,386 | ||||||||||||||||||
Total goodwill |
$ | 14,667 | $ | 17 | $ | (4 | ) | $ | 14,680 | |||||||||||||||||
(In millions) | June 30, 2013 |
Acquisitions |
Other | December 31, 2013 |
||||||||||||||||||||||
Devices and Consumer |
Licensing | $ | 866 | $ | 0 | $ | 2 | $ | 868 | |||||||||||||||||
Hardware |
1,689 | 0 | (1 | ) | 1,688 | |||||||||||||||||||||
Other |
738 | 0 | 0 | 738 | ||||||||||||||||||||||
Total Devices and Consumer |
$ | 3,293 | $ | 0 | $ | 1 | $ | 3,294 | ||||||||||||||||||
Commercial |
Licensing | $ | 10,051 | $ | 2 | $ | 7 | $ | 10,060 | |||||||||||||||||
Other |
1,311 | 15 | 0 | 1,326 | ||||||||||||||||||||||
Total Commercial |
$ | 11,362 | $ | 17 | $ | 7 | 11,386 | |||||||||||||||||||
Total goodwill |
$ | 14,655 | $ | 17 | $ | 8 | $ | 14,680 | ||||||||||||||||||
The measurement periods for the valuation of assets acquired and liabilities assumed end as soon as information on the facts and circumstances that existed as of the acquisition dates becomes available, but do not exceed 12 months. Adjustments in purchase price allocations may require a 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 and business dispositions are presented as Other in the table above.
As discussed in Note 16 Segment Information, during the first quarter of fiscal year 2014, we changed our organizational structure as part of our transformation to a devices and services company. This resulted in a change in our operating segments and reporting units. We allocated goodwill to our new reporting units using a relative fair value approach. In addition, we completed an assessment of any potential goodwill impairment for all reporting units immediately prior to the reallocation and determined that no impairment existed.
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NOTE 9 INTANGIBLE ASSETS
The components of intangible assets, all of which are finite-lived, were as follows:
(In millions) | Gross Carrying Amount |
Accumulated |
Net Carrying |
Gross Carrying Amount |
Accumulated |
Net Carrying Amount |
||||||||||||||||||||||||||
December 31, 2013 |
June 30, 2013 |
|||||||||||||||||||||||||||||||
Technology-based (a) |
$ | 3,880 | $ | (2,288 | ) | $ | 1,592 | $ | 3,760 | $ | (2,110 | ) | $ | 1,650 | ||||||||||||||||||
Marketing-related |
1,348 | (256 | ) | 1,092 | 1,348 | (211 | ) | 1,137 | ||||||||||||||||||||||||
Contract-based |
798 | (675 | ) | 123 | 823 | (688 | ) | 135 | ||||||||||||||||||||||||
Customer-related |
373 | (235 | ) | 138 | 380 | (219 | ) | 161 | ||||||||||||||||||||||||
Total |
$ | 6,399 | $ | (3,454 | ) | $ | 2,945 | $ | 6,311 | $ | (3,228 | ) | $ | 3,083 | ||||||||||||||||||
(a) | Technology-based intangible assets included $165 million and $218 million as of December 31, 2013 and June 30, 2013, respectively, of net carrying amount of software to be sold, leased, or otherwise marketed. |
Intangible assets amortization expense was $166 million and $328 million for the three and six months ended December 31, 2013, respectively, and $198 million and $376 million for the three and six months ended December 31, 2012, respectively. Amortization of capitalized software was $50 million and $96 million for the three and six months ended December 31, 2013, respectively, and $61 million and $101 million for the three and six months ended December 31, 2012, respectively.
The following table outlines the estimated future amortization expense related to intangible assets held at December 31, 2013:
(In millions) | ||||
Year Ending June 30, | ||||
2014 (excluding the six months ended December 31, 2013) |
$ | 338 | ||
2015 |
500 | |||
2016 |
410 | |||
2017 |
297 | |||
2018 |
259 | |||
Thereafter |
1,141 | |||
Total |
$ | 2,945 | ||
NOTE 10 DEBT
As of December 31, 2013, we had $23.0 billion of issued and outstanding debt, comprising $300 million of commercial paper and $22.7 billion of long-term debt, including the current portion.
Short-term Debt
As of December 31, 2013, we had $300 million of commercial paper issued and outstanding, with a weighted-average interest rate of 0.11% and maturities of 91 days. The estimated fair value of this commercial paper approximates its carrying value.
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In November 2013, we amended our existing credit agreement to increase our credit facility from $1.3 billion to $5.0 billion and extend the expiration date to November 14, 2018. This facility serves as a back-up for our commercial paper program. As of December 31, 2013, we were in compliance with the only financial covenant in the credit agreement, which requires us to maintain a coverage ratio of at least three times earnings before interest, taxes, depreciation, and amortization to interest expense, as defined in the credit agreement. No amounts were drawn against the credit facility during any of the periods presented.
Long-term Debt
As of December 31, 2013, the total carrying value and estimated fair value of our long-term debt, including the current portion, were $22.7 billion and $22.6 billion, respectively. This is compared to a carrying value and estimated fair value of $15.6 billion and $15.8 billion, respectively, as of June 30, 2013. These estimated fair values are based on Level 2 inputs.
The components of our long-term debt, including the current portion, and the associated interest rates were as follows as of December 31, 2013 and June 30, 2013:
Due Date | Face Value December 31, |
Face Value June 30, |
Stated Rate |
Effective Rate |
||||||||||||||||
(In millions) | ||||||||||||||||||||
Notes |
||||||||||||||||||||
September 27, 2013 |
$ | * | $ | 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 |
600 | 600 | 0.875% | 1.084% | ||||||||||||||||
May 1, 2018 |
450 | 450 | 1.000% | 1.106% | ||||||||||||||||
December 6, 2018 (a) |
1,250 | * | 1.625% | 1.824% | ||||||||||||||||
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% | ||||||||||||||||
December 6, 2021 (b) |
2,412 | * | 2.125% | 2.233% | ||||||||||||||||
November 15, 2022 |
750 | 750 | 2.125% | 2.239% | ||||||||||||||||
May 1, 2023 |
1,000 | 1,000 | 2.375% | 2.465% | ||||||||||||||||
December 15, 2023 (a) |
1,500 | * | 3.625% | 3.726% | ||||||||||||||||
December 6, 2028 (b) |
2,412 | * | 3.125% | 3.218% | ||||||||||||||||
May 2, 2033 (c) |
757 | 715 | 2.625% | 2.690% | ||||||||||||||||
June 1, 2039 |
750 | 750 | 5.200% | 5.240% | ||||||||||||||||
October 1, 2040 |
1,000 | 1,000 | 4.500% | 4.567% | ||||||||||||||||
February 8, 2041 |
1,000 | 1,000 | 5.300% | 5.361% | ||||||||||||||||
November 15, 2042 |
900 | 900 | 3.500% | 3.571% | ||||||||||||||||
May 1, 2043 |
500 | 500 | 3.750% | 3.829% | ||||||||||||||||
December 15, 2043 (a) |
500 | * | 4.875% | 4.918% | ||||||||||||||||
Total |
$ | 22,781 | $ | 15,665 | ||||||||||||||||
(a) | In December 2013, we issued $3.3 billion of debt securities. |
(b) | In December 2013, we issued 3.5 billion of debt securities. |
(c) | In April 2013, we issued 550 million of debt securities. |
* | Not applicable. |
The notes in the table above are senior unsecured obligations and rank equally with our other senior unsecured debt outstanding. Interest on these notes is paid semi-annually, except for the euro-denominated debt securities on which interest is paid annually. As of December 31, 2013 and June 30, 2013, the aggregate unamortized discount for our long-term debt, including the current portion, was $105 million and $65 million, respectively.
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NOTE 11 INCOME TAXES
Our effective tax rates were approximately 17% and 18% for the three months ended December 31, 2013 and 2012, respectively, and 17% and 18% for the six months ended December 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.
Tax contingencies and other tax liabilities were $9.2 billion and $9.4 billion as of December 31, 2013 and June 30, 2013, respectively, and were included in other long-term liabilities. While we settled a portion of the U.S. Internal Revenue Service (I.R.S.) audit for tax years 2004 to 2006 during the third quarter of fiscal year 2011, we remain under audit for these years. In February 2012, the I.R.S. withdrew its 2011 Revenue Agents Report and reopened the audit phase of the examination. As of December 31, 2013, the primary unresolved issue was related to transfer pricing, which could have a significant impact on our financial statements if not resolved favorably. We believe our allowances for tax contingencies are appropriate. 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, as 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 12 UNEARNED REVENUE
Unearned revenue by segment was as follows, with segments with significant balances shown separately:
(In millions) | ||||||||
December 31, 2013 |
June 30, 2013 |
|||||||
Commercial Licensing |
$ | 15,592 | $ | 18,460 | ||||
Commercial Other |
2,173 | 2,272 | ||||||
Rest of the segments |
1,709 | 1,667 | ||||||
Total |
$ | 19,474 | $ | 22,399 | ||||
NOTE 13 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. Under the settlements, generally class members can obtain vouchers that entitle them to be reimbursed for purchases of a wide variety of platform-neutral computer hardware and software. The total value of vouchers that we may issue varies by state. We will make available to certain schools a percentage of those vouchers that are not issued or claimed (one-half to two-thirds depending on the state). The total value of vouchers we ultimately issue will depend on the number of class members who make claims and are issued vouchers. We estimate the total remaining cost of the settlements is approximately $400 million, all of which had been accrued as of December 31, 2013.
Three similar 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 appealed the decision to the Canadian Supreme Court. In October 2013, the Supreme Court reversed and reinstated part of the British Columbia case, which is now proceeding. The other two actions were inactive pending action by the Supreme Court on the British Columbia case.
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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. After the trial court dismissed or granted summary judgment on a number of Novells claims, trial of the one remaining claim took place from October to December 2011, and resulted in a mistrial. In July 2012, the trial court granted Microsofts motion for judgment as a matter of law. Novell appealed this decision to the U.S. Court of Appeals for the Tenth Circuit, which affirmed the trial courts decision in September 2013. The Court of Appeals denied Novells request for rehearing and en banc review.
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. The nature of the claims asserted and status of individual matters are summarized below.
International Trade Commission
In May 2012, the ITC issued a limited exclusion order against Motorola on one Microsoft patent, which became effective on July 18, 2012. Microsoft appealed certain aspects of the ITC rulings adverse to Microsoft, and Motorola has appealed the ITC exclusion order, to the Court of Appeals for the Federal Circuit. In October 2013, the Court of Appeals ruled in Microsofts favor on one additional patent (since expired) and, in December 2013, affirmed the ITCs exclusion order.
In July 2013, Microsoft filed an action in U.S. District Court in Washington, D.C. seeking an order to compel enforcement of the ITCs May 2012 import ban against infringing Motorola products by the Bureau of Customs and Border Protection (CBP), after learning that CBP had failed to fully enforce the 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. At Motorolas request, the ITC terminated its investigation as to four Motorola patents, leaving only one Motorola patent at issue. In March 2013, the administrative law judge (ALJ) ruled that there has been no violation of the remaining Motorola patent. Motorola sought ITC review of the ALJs determination, which the ITC denied in May 2013. Motorola has appealed the ITCs decision to the U.S. Court of Appeals for the Federal Circuit.
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 the Motorola ITC case described above and in suits described below, Motorola or 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. After trial, the Seattle District Court set per unit royalties for Motorolas H.264 and 802.11 patents, which resulted in an immaterial Microsoft liability. In September 2013, following trial of Microsofts breach of contract claim, a jury awarded $14.5 million in damages to Microsoft. Motorola has appealed.
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.
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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 patents (one now expired) 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. 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. Microsoft has appealed the rulings of the first instance court. |
| Motorola asserts that one patent covers certain syncing functionality in the ActiveSync protocol employed by Windows Phone 7, Outlook Mobile, Hotmail Mobile, Exchange Online, Exchange Server, and Hotmail Server. In April 2013, the court stayed the case pending the outcome of parallel proceedings in which Microsoft is seeking to invalidate the patent. In November 2013, the Federal Patent Court invalidated the patent in relevant part. Motorola has appealed. |
| Microsoft may be able to mitigate the adverse impact of any injunction issued and enforced by altering its products to avoid Motorolas infringement claims. |
| Any damages would be determined in separate proceedings. |
In lawsuits Microsoft filed in Germany in 2011 and 2012, Microsoft asserts Motorola Android devices infringe Microsoft patents and is seeking damages and injunctions. In 2012, regional courts in Germany issued injunctions on three of the patents Microsoft asserts. Motorola has appealed each of these cases. One judgment has been affirmed on appeal (and Motorola has further appealed), and the other two appeals are still pending. In actions filed separately by Motorola to invalidate these patents, the Federal Patent court in November and December 2013 held invalid two of the patents on which Microsoft had obtained injunctions. Microsoft has appealed. One of Microsofts cases seeking an injunction is still pending in the first instance court. For the cases in which Microsoft obtained injunctions, if Motorola were to prevail following all appeals, Motorola could have a claim against Microsoft for damages caused by an erroneously granted injunction.
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 appealed and the appeals court affirmed the lower courts ruling in Microsofts favor in November 2013.
Other patent and intellectual property claims
In addition to these cases, there are approximately 70 other patent infringement cases pending against Microsoft.
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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 December 31, 2013, we had accrued aggregate liabilities of $397 million in other current liabilities and $115 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 $600 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.
Other Commitments
On September 2, 2013, we announced that we entered into a definitive agreement to acquire substantially all of Nokias Devices & Services business, license Nokias patents, and license and use Nokias mapping services (the Agreement). Under the terms of the Agreement, we agreed to pay 3.79 billion (approximately $5.0 billion) to purchase substantially all of Nokias Devices & Services business, and 1.65 billion (approximately $2.2 billion) to license Nokias patents, for a total transaction price of 5.44 billion (approximately $7.2 billion) in cash. We intend to draw upon our overseas cash resources to fund the acquisition. In connection with the Agreement, on September 23, 2013, we provided Nokia 1.5 billion ($2.0 billion) of financing in the form of convertible notes, which are included in short-term investments on our balance sheet. Nokia will repay these notes from the proceeds of the acquisition upon closing. Nokias shareholders approved the Agreement on November 19, 2013. We expect the acquisition will close in the first calendar quarter of 2014, subject to regulatory approvals and other closing conditions.
NOTE 14 STOCKHOLDERS EQUITY
Share Repurchases
We repurchased the following shares of common stock through our share repurchase program, during the periods presented:
(In millions) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Shares of common stock repurchased |
53 | 58 | 100 | 91 | ||||||||||||
Value of common stock repurchased |
$ | 2,000 | $ | 1,607 | $ | 3,500 | $ | 2,607 | ||||||||
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. On September 16, 2013, our Board of Directors approved a $40.0 billion share repurchase program, which replaced the share repurchase program that expired September 30, 2013. The share repurchase program became effective on October 1, 2013, has no expiration date, and may be suspended or discontinued at any time without notice. As of December 31, 2013, approximately $38.0 billion remained of our $40.0 billion share repurchase program.
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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 2014 |
||||||||||||||||
September 16, 2013 |
$ | 0.28 | November 21, 2013 | $ | 2,332 | December 12, 2013 | ||||||||||
November 19, 2013 |
$ | 0.28 | February 20, 2014 | $ | 2,324 | March 13, 2014 | ||||||||||
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 | ||||||||||
The estimate of the amount to be paid as a result of the November 19, 2013 declaration was included in other current liabilities as of December 31, 2013.
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NOTE 15 ACCUMULATED OTHER COMPREHENSIVE INCOME
The following table summarizes the changes in accumulated other comprehensive income by component:
(In millions) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Derivatives |
||||||||||||||||
Accumulated other comprehensive income balance, beginning of period |
$ | 40 | $ | 47 | $ | 66 | $ | 92 | ||||||||
Unrealized gains (losses), net of tax effects of $2, $7, $0, and $(4) |
67 | 13 | 59 | (10 | ) | |||||||||||
Reclassification adjustments for gains included in revenue |
(25 | ) | (34 | ) | (44 | ) | (69 | ) | ||||||||
Tax expense included in provision for income taxes |
1 | 12 | 2 | 25 | ||||||||||||
Amounts reclassified from accumulated other comprehensive income |
(24 | ) | (22 | ) | (42 | ) | (44 | ) | ||||||||
Net current period other comprehensive income (loss) |
43 | (9 | ) | 17 | (54 | ) | ||||||||||
Accumulated other comprehensive income balance, end of period |
$ | 83 | $ | 38 | $ | 83 | $ | 38 | ||||||||
Investments |
||||||||||||||||
Accumulated other comprehensive income balance, beginning of period |
$ | 2,746 | $ | 1,705 | $ | 1,794 | $ | 1,431 | ||||||||
Unrealized gains, net of tax effects of $270, $118, $760, and $261 |
527 | 220 | 1,474 | 484 | ||||||||||||
Reclassification adjustments for gains included in other income (expense) |
(70 | ) | (43 | ) | (63 | ) | (28 | ) | ||||||||
Tax expense included in provision for income taxes |
25 | 15 | 23 | 10 | ||||||||||||
Amounts reclassified from accumulated other comprehensive income |
(45 | ) | (28 | ) | (40 | ) | (18 | ) | ||||||||
Net current period other comprehensive income |
482 | 192 | 1,434 | 466 | ||||||||||||
Accumulated other comprehensive income balance, end of period |
$ | 3,228 | $ | 1,897 | $ | 3,228 | $ | 1,897 | ||||||||
Translation adjustments and other |
||||||||||||||||
Accumulated other comprehensive income (loss) balance, beginning of period |
$ | (55 | ) | $ | 68 | $ | (117 | ) | $ | (101 | ) | |||||
Translation adjustments and other, net of tax effects of $11, $2, $44, and $92 |
21 | 3 | 83 | 172 | ||||||||||||
Accumulated other comprehensive income (loss) balance, end of period |
$ | (34 | ) | $ | 71 | $ | (34 | ) | $ | 71 | ||||||
Accumulated other comprehensive income, end of period |
$ | 3,277 | $ | 2,006 | $ | 3,277 | $ | 2,006 | ||||||||
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.
During the first quarter of fiscal year 2014, we changed our organizational structure as part of our transformation to a devices and services company. As a result of these changes, information that our chief operating decision maker regularly reviews for purposes of allocating resources and assessing performance changed. Therefore, beginning in fiscal year 2014, we are reporting our financial performance based on our new segments; Devices and Consumer (D&C) Licensing, D&C Hardware, D&C Other, Commercial Licensing, and Commercial Other. We have recast certain prior period amounts to conform to the way we internally manage and monitor segment performance during fiscal year 2014. Our reportable segments are described below.
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Devices and Consumer
Our D&C segments develop, market, and support products and services designed to entertain and connect people, increase personal productivity, help people simplify tasks and make more informed decisions online, and help advertisers connect with audiences. Our D&C segments are:
| D&C Licensing, comprising: Windows, including all original equipment manufacturer (OEM) licensing (Windows OEM) and other non-volume licensing and academic volume licensing of the Windows operating system and related software (collectively, Consumer Windows); non-volume licensing of Microsoft Office, comprising the core Office product set, for consumers (Consumer Office); Windows Phone, including related patent licensing; and certain other patent licensing revenue; |
| D&C Hardware, comprising: Xbox gaming and entertainment consoles and accessories, second-party and third-party video game royalties, and Xbox LIVE subscriptions (Xbox Platform); Surface; and Microsoft PC accessories; and |
| D&C Other, comprising: Resale, including Windows Store, Xbox LIVE transactions, and Windows Phone Store; search advertising; display advertising; Subscription, comprising Office 365 Home Premium; Studios, comprising first-party video games; our retail stores; and certain other consumer products and services not included in the categories above. |
Commercial
Our Commercial segments develop, market, and support software and services designed to increase individual, team, and organizational productivity and efficiency, including simplifying everyday tasks through seamless operations across the users hardware and software. Our Commercial segments are:
| Commercial Licensing, comprising: server products, including Windows Server, Microsoft SQL Server, Visual Studio, and System Center; Windows Embedded; volume licensing of the Windows operating system, excluding academic (Commercial Windows); Microsoft Office for business, including Office, Exchange, SharePoint, and Lync (Commercial Office); Client Access Licenses, which provide access rights to certain server products (CAL); Microsoft Dynamics business solutions, excluding Dynamics CRM Online; and Skype; and |
| Commercial Other, comprising: Enterprise Services, including Premier Support Services and Microsoft Consulting Services; Cloud Services, comprising Office 365, excluding Office 365 Home Premium (Commercial Office 365), other Microsoft Office online offerings, Dynamics CRM Online, and Windows Azure; and certain other commercial products and online services not included in the categories above. |
Revenue and cost of revenue are generally directly attributed to our segments. Certain revenue contracts are allocated among the segments based on the relative value of the underlying products and services. Cost of revenue is directly charged to the D&C Hardware segment. For the remaining segments, cost of revenue is directly charged in most cases and allocated in certain cases, generally using a relative revenue methodology.
We do not allocate operating expenses to our segments. Rather, we allocate them to our two segment groups, D&C and Commercial. Due to the integrated structure of our business, allocations of expenses are made in certain cases to incent cross-collaboration among our segment groups so that a segment group is not solely burdened by the cost of a mutually beneficial activity as we seek to deliver seamless experiences across devices, whether on premise or in the cloud.
Operating expenses are attributed to our segment groups as follows:
| Sales and marketing expenses are primarily recorded directly to each segment group based on identified customer segment. |
| Research and development expenses are primarily shared across the segment groups based on relative gross margin but are mapped directly in certain cases where the value of the expense only accrues to that segment group. |
| General and administrative expenses are primarily allocated based on relative gross margin. |
Certain corporate-level activity is not allocated to our segment groups, including costs of: legal, including expenses, settlements, and fines; information technology; human resources; corporate finance; and excise taxes.
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Segment revenue and gross margin were as follows during the periods presented:
(In millions) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||||
Revenue |
| |||||||||||||||||
Devices and Consumer |
Licensing | $ | 5,384 | $ | 5,703 | $ | 9,727 | $ | 10,381 | |||||||||
Hardware |
4,729 | 2,808 | 6,214 | 3,892 | ||||||||||||||
Other |
1,793 | 1,999 | 3,428 | 3,399 | ||||||||||||||
Total Devices and Consumer |
$ | 11,906 | $ | 10,510 | $ | 19,369 | $ | 17,672 | ||||||||||
Commercial |
Licensing | $ | 10,888 | $ | 10,135 | $ | 20,482 | $ | 19,080 | |||||||||
Other |
1,780 | 1,389 | 3,383 | 2,637 | ||||||||||||||
Total Commercial |
$ | 12,668 | $ | 11,524 | $ | 23,865 | $ | 21,717 | ||||||||||
Corporate and Other |
(55 | ) | (578 | ) | (186 | ) | (1,925 | ) | ||||||||||
Total revenue |
$ | 24,519 | $ | 21,456 | $ | 43,048 | $ | 37,464 | ||||||||||
Gross Margin |
||||||||||||||||||
Devices and Consumer |
Licensing | $ | 4,978 | $ | 5,131 | $ | 8,903 | $ | 9,234 | |||||||||
Hardware |
411 | 762 | 617 | 1,210 | ||||||||||||||
Other |
431 | 886 | 783 | 1,248 | ||||||||||||||
Total Devices and Consumer |
$ | 5,820 | $ | 6,779 | $ | 10,303 | $ | 11,692 | ||||||||||
Commercial |
Licensing | $ | 10,077 | $ | 9,326 | $ | 18,878 | $ | 17,509 | |||||||||
Other |
415 | 216 | 690 | 321 | ||||||||||||||
Total Commercial |
$ | 10,492 | $ | 9,542 | $ | 19,568 | $ | 17,830 | ||||||||||
Corporate and Other |
(77 | ) | (557 | ) | (221 | ) | (1,918 | ) | ||||||||||
Total gross margin |
$ | 16,235 | $ | 15,764 | $ | 29,650 | $ | 27,604 | ||||||||||
Following is operating expenses by segment group. As discussed above, we do not allocate operating expenses below cost of revenue to our segments.
(In millions) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Devices and Consumer |
$ | 3,178 | $ | 3,227 | $ | 5,466 | $ | 5,289 | ||||||||
Commercial |
4,189 | 3,846 | 8,211 | 7,481 | ||||||||||||
Corporate and Other |
899 | 920 | 1,670 | 1,755 | ||||||||||||
Total operating expenses |
$ | 8,266 | $ | 7,993 | $ | 15,347 | $ | 14,525 | ||||||||
Following is operating income (loss) by segment group.
(In millions) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Devices and Consumer |
$ | 2,642 | $ | 3,552 | $ | 4,837 | $ | 6,403 | ||||||||
Commercial |
6,303 | 5,696 | 11,357 | 10,349 | ||||||||||||
Corporate and Other |
(976 | ) | (1,477 | ) | (1,891 | ) | (3,673 | ) | ||||||||
Total operating income |
$ | 7,969 | $ | 7,771 | $ | 14,303 | $ | 13,079 | ||||||||
29
PART I
Item 1
Corporate and Other operating loss includes 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 generally relate to revenue recognition, income statement classification, and depreciation.
Corporate and Other activity was as follows:
(In millions) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Corporate (a) |
$ | (892 | ) | $ | (886 | ) | $ | (1,667 | ) | $ | (1,684 | ) | ||||
Other (adjustments to U.S. GAAP): |
||||||||||||||||
Revenue reconciling amounts (b) |
(55 | ) | (578 | ) | (186 | ) | (1,925 | ) | ||||||||
Cost of revenue reconciling amounts |
(22 | ) | 21 | (35 | ) | 7 | ||||||||||
Operating expenses reconciling amounts |
(7 | ) | (34 | ) | (3 | ) | (71 | ) | ||||||||
Total Corporate and Other |
$ | (976 | ) | $ | (1,477 | ) | $ | (1,891 | ) | $ | (3,673 | ) | ||||
(a) | Corporate is presented on the basis of our internal accounting policies and excludes the adjustments to U.S. GAAP that are presented separately in those line items. |
(b) | Revenue reconciling amounts for the three months ended December 31, 2013 included $150 million of revenue deferrals related to sales of certain devices bundled with other products and services (Bundled Offerings), offset in part by the recognition of $105 million of previously deferred revenue related to pre-sales of Windows 8.1 to OEMs and retailers before general availability (Windows 8.1 Pre-Sales). |
Revenue reconciling amounts for the three months ended December 31, 2012 included: the recognition of $783 million of previously deferred revenue related to pre-sales of Windows 8 to OEMs and retailers before general availability (Windows 8 Pre-Sales); a net $161 million of revenue deferred related to sales of Windows 7 with an option to upgrade to Windows 8 Pro at a discounted price (the Windows Upgrade Offer); $689 million of revenue deferred related to 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 a net $99 million of revenue deferred related to pre-sales of the new Office to OEMs and retailers before general availability (Office Pre-Sales)(collectively, the Office Deferral); and $380 million of revenue deferred related to sales of video games with the right to receive specified software upgrades/enhancements (the Video Game Deferral).
Revenue reconciling amounts for the six months ended December 31, 2013 included $150 million of revenue deferrals related to Bundled Offerings.
Revenue reconciling amounts for the six months ended December 31, 2012 includes: $977 million of revenue deferred related to the Office Deferral; a net $545 million of revenue deferred related to the Windows Upgrade Offer; and $380 million of revenue deferred related to the Video Game Deferral.
Assets are not allocated to segments for internal reporting presentations. A portion of amortization and depreciation is charged to the respective segment. It is impracticable for us to separately identify the amount of amortization and depreciation by segment that is included in the measure of segment profit or loss.
30
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 December 31, 2013, and the related consolidated statements of income, comprehensive income, cash flows, and stockholders equity for the three-month and six-month periods ended December 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, 2013, and the related consolidated statements of income, comprehensive income, cash flows, and stockholders equity for the year then ended (not presented herein); and in our report dated July 30, 2013 (November 26, 2013 as to the effects of the retrospective adjustments described in Notes 1, 5, 10, 14, 19 and 21) 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, 2013 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
January 23, 2014
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PART I
Item 2
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 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. We describe risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements in Risk Factors (Part II, Item 1A of this Form 10-Q), Quantitative and Qualitative Disclosures about Market Risk (Part I, Item 3), and Managements Discussion and Analysis (Part I, Item 2). 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, 2013, our Form 8-K filed on November 26, 2013, 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 devices that integrate 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 identify and address the changing demands of customers, industry trends, and competitive forces.
Key Opportunities and Investments
Based on our assessment of key technology trends and our broad focus on long-term research and development of new products and services, we see significant opportunities to generate future growth.
We invest research and development resources in new products and services in these areas. 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.
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PART I
Item 2
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. Xbox One was released on November 22, 2013. Surface RT and Surface Pro were released October 26, 2012 and February 9, 2013, respectively, and Surface 2 and Surface Pro 2 were released October 22, 2013.
In all of 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.
Windows 8 reflects this shift. Launched in October 2012, Windows 8 was designed to unite the light, thin, and convenient aspects of a tablet with the power of a PC. The Windows 8 operating system includes the Windows Store, which offers a large and growing number of applications from Microsoft and partners for both business and consumer customers. The general availability of Windows 8.1, which enables new hardware and furthers the integration with other Microsoft services, started on October 17, 2013.
Going forward, our strategy will focus on creating a family of devices and services for individuals and businesses that empower people around the globe at home, at work, and on the go, for the activities they value most. This strategy will require investment in datacenters and other infrastructure to support our devices and services, and will bring continued competition with Apple, Google, and other well-established and emerging competitors. We believe our history of powering devices such as Windows PCs and Xbox, as well as our experience delivering high-value experiences through Office and other applications, will position us for future success.
Services for the enterprise
Today, businesses face important opportunities and challenges. Enterprises are asked to deploy technology that drives business strategy forward. They decide what solutions will make employees more productive, collaborative, and satisfied, or connect with customers in new and compelling ways. 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 Office, Exchange, SharePoint, Lync, Yammer, Microsoft Dynamics, 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.
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 premise, 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. These hybrid capabilities allow customers to fully harness the power of the cloud so they can achieve greater levels of efficiency and tap new areas of growth.
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PART I
Item 2
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. |
| Applying machine learning to make technology more intuitive and able to act on our behalf, instead of at our command. |
| Building and running cloud-based services in ways that unleash new experiences and opportunities for businesses and individuals. |
| Establishing our Windows platform across the PC, tablet, phone, server, and additional devices, as well as 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 high-value experiences 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
The market for software, devices, and cloud-based services is dynamic and highly competitive. Some of our traditional businesses such as the Windows operating system are in a period of transition. Our competitors are developing new devices and deploy competing cloud-based services for consumers and businesses. The devices and form factors customers prefer evolve rapidly, and influence how users access services in the cloud and in some cases the users choice of which suite of cloud-based services to use. The Windows ecosystem must continue to evolve and adapt over an extended time in pace with this changing environment. To support our strategy of offering a family of devices and services designed to empower our customers for the activities they value most, we announced a change in our organizational structure in July 2013. Through this realignment, our goal is to become more nimble, collaborative, communicative, motivated, and decisive. Even if we achieve these benefits, the investments we are making in devices and infrastructure to support our cloud-based services will increase our operating costs and may decrease our operating margins.
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, 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.
Aggregate demand for our software, services, and hardware is correlated to global macroeconomic factors, which remain dynamic. See a discussion of these factors and other risks under Risk Factors (Part II, Item 1A of this Form 10-Q).
Unearned Revenue
Quarterly and annual revenue may be impacted by the deferral of revenue. See the discussions within Corporate and Other below regarding:
| revenue deferred on certain devices bundled with other products and services (Bundled Offerings); |
| revenue deferred on pre-sales of Windows 8.1 to original equipment manufacturers (OEMs) and retailers before general availability (Windows 8.1 Pre-Sales); |
| revenue deferred on sales of Windows 7 with an option to upgrade to Windows 8 Pro at a discounted price (the Windows Upgrade Offer) and pre-sales of Windows 8 to OEMs and retailers before general availability (collectively, the Windows Deferral); |
34
PART I
Item 2
| revenue deferred on 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 (collectively, the Office Deferral); and |
| revenue deferred on sales of video games with the right to receive specified software upgrades/enhancements (the Video Game Deferral). |
If our customers elect to license cloud-based versions of our products and services rather than licensing transaction-based products and services, the associated revenue will shift from being recognized at the time of the transaction to being recognized over the subscription period or upon consumption, as applicable.
Reportable Segments
The segment amounts included in MD&A are presented on a basis consistent with our internal management reporting. Segment information appearing in Note 16 Segment Information in the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) is also presented on this basis. All differences between our internal management reporting basis and accounting principles generally accepted in the U.S. (U.S. GAAP), along with certain corporate-level and other activity, are included in Corporate and Other. Operating expenses are not allocated to our segments.
During the first quarter of fiscal year 2014, we changed our organizational structure as part of our transformation to a devices and services company. As a result of these changes, information that our chief operating decision maker regularly reviews for purposes of allocating resources and assessing performance changed. Therefore, we have recast certain prior period amounts to conform to the way we internally manage and monitor segment performance during fiscal year 2014. Our reportable segments are described below.
Devices and Consumer (D&C)
Our D&C segments develop, market, and support products and services designed to entertain and connect people, increase personal productivity, help people simplify tasks and make more informed decisions online, and help advertisers connect with audiences. Our D&C segments are:
| D&C Licensing, comprising: Windows, including all OEM licensing (Windows OEM) and other non-volume licensing and academic volume licensing of the Windows operating system and related software (collectively, Consumer Windows); non-volume licensing of Microsoft Office, comprising the core Office product set, for consumers (Consumer Office); Windows Phone, including related patent licensing; and certain other patent licensing revenue; |
| D&C Hardware, comprising: Xbox gaming and entertainment consoles and accessories, second-party and third-party video game royalties, and Xbox LIVE subscriptions (Xbox Platform); Surface; and Microsoft PC accessories; and |
| D&C Other, comprising: Resale, including Windows Store, Xbox LIVE transactions, and Windows Phone Store; search advertising; display advertising; Subscription, comprising Office 365 Home Premium; Studios, comprising first-party video games; our retail stores; and certain other consumer products and services not included in the categories above. |
Commercial
Our Commercial segments develop, market, and support software and services designed to increase individual, team, and organizational productivity and efficiency, including simplifying everyday tasks through seamless operations across the users hardware and software. Our Commercial segments are:
| Commercial Licensing, comprising: server products, including Windows Server, Microsoft SQL Server, Visual Studio, and System Center; Windows Embedded; volume licensing of the Windows operating system, excluding academic (Commercial Windows); Microsoft Office for business, including Office, Exchange, SharePoint, and Lync (Commercial Office); Client Access Licenses, which provide access rights to certain server products (CAL); Microsoft Dynamics business solutions, excluding Dynamics CRM Online; and Skype; and |
| Commercial Other, comprising: Enterprise Services, including Premier Support Services and Microsoft Consulting Services; Cloud Services, comprising Office 365, excluding Office 365 Home Premium (Commercial Office 365), other Microsoft Office online offerings, Dynamics CRM Online, and Windows Azure; and certain other commercial products and online services not included in the categories above. |
35
PART I
Item 2
SUMMARY RESULTS OF OPERATIONS
Summary
(In millions, except percentages and per share amounts) | Three Months Ended December 31, |
Percentage Change |
Six Months Ended December 31, |
P |