UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended March 31, 2016
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Transition Period From to
Commission File Number: 0-14278
MICROSOFT CORPORATION
(Exact name of registrant as specified in its charter)
Washington | 91-1144442 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) | |
One Microsoft Way, Redmond, Washington | 98052-6399 | |
(Address of principal executive offices) | (Zip Code) |
(425) 882-8080
(Registrants telephone number, including area code)
None
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer x |
Accelerated filer ¨ | |
Non-accelerated filer ¨ (Do not check if a smaller reporting company) |
Smaller reporting company ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
Class | Outstanding at April 15, 2016 | |||
Common Stock, $0.00000625 par value per share |
7,860,466,856 shares |
FORM 10-Q
For the Quarter Ended March 31, 2016
INDEX
2
PART I
Item 1
(In millions, except per share amounts) (Unaudited) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Revenue |
$ | 20,531 | $ | 21,729 | $ | 64,706 | $ | 71,400 | ||||||||
Cost of revenue |
7,722 | 7,161 | 24,801 | 25,570 | ||||||||||||
Gross margin |
12,809 | 14,568 | 39,905 | 45,830 | ||||||||||||
Research and development |
2,980 | 2,984 | 8,842 | 8,952 | ||||||||||||
Sales and marketing |
3,406 | 3,709 | 10,699 | 11,752 | ||||||||||||
General and administrative |
1,140 | 1,091 | 3,262 | 3,339 | ||||||||||||
Impairment, integration, and restructuring |
0 | 190 | 0 | 1,573 | ||||||||||||
Operating income |
5,283 | 6,594 | 17,102 | 20,214 | ||||||||||||
Other income (expense), net |
(247 | ) | (77 | ) | (698 | ) | 49 | |||||||||
Income before income taxes |
5,036 | 6,517 | 16,404 | 20,263 | ||||||||||||
Provision for income taxes |
1,280 | 1,532 | 2,728 | 4,875 | ||||||||||||
Net income |
$ | 3,756 | $ | 4,985 | $ | 13,676 | $ | 15,388 | ||||||||
Earnings per share: |
||||||||||||||||
Basic |
$ | 0.48 | $ | 0.61 | $ | 1.72 | $ | 1.87 | ||||||||
Diluted |
$ | 0.47 | $ | 0.61 | $ | 1.70 | $ | 1.86 | ||||||||
Weighted average shares outstanding: |
||||||||||||||||
Basic |
7,895 | 8,167 | 7,952 | 8,215 | ||||||||||||
Diluted |
7,985 | 8,237 | 8,041 | 8,293 | ||||||||||||
Cash dividends declared per common share |
$ | 0.36 | $ | 0.31 | $ | 1.08 | $ | 0.93 | ||||||||
See accompanying notes.
3
PART I
Item 1
COMPREHENSIVE INCOME STATEMENTS
(In millions) (Unaudited) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Net income |
$ | 3,756 | $ | 4,985 | $ | 13,676 | $ | 15,388 | ||||||||
Other comprehensive income (loss): |
||||||||||||||||
Net unrealized gains (losses) on derivatives (net of tax effects of $(30), $21, $(2), and $31) |
(285 | ) | 401 | (277 | ) | 967 | ||||||||||
Net unrealized gains (losses) on investments (net of tax effects of $186, $68, $(36), and $(158)) |
345 | 125 | (66 | ) | (295 | ) | ||||||||||
Translation adjustments and other (net of tax effects of $3, $(174), $(18), and $(432)) |
7 | (438 | ) | (339 | ) | (909 | ) | |||||||||
Other comprehensive income (loss) |
67 | 88 | (682 | ) | (237 | ) | ||||||||||
Comprehensive income |
$ | 3,823 | $ | 5,073 | $ | 12,994 | $ | 15,151 | ||||||||
See accompanying notes.
4
PART I
Item 1
(In millions) (Unaudited) | ||||||||
March 31, 2016 |
June 30, 2015 |
|||||||
Assets |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 7,170 | $ | 5,595 | ||||
Short-term investments (including securities loaned of $241 and $75) |
98,382 | 90,931 | ||||||
Total cash, cash equivalents, and short-term investments |
105,552 | 96,526 | ||||||
Accounts receivable, net of allowance for doubtful accounts of $361 and $335 |
12,247 | 17,908 | ||||||
Inventories |
2,450 | 2,902 | ||||||
Deferred income taxes |
1,574 | 1,915 | ||||||
Other |
6,598 | 5,461 | ||||||
Total current assets |
128,421 | 124,712 | ||||||
Property and equipment, net of accumulated depreciation of $18,885 and $17,606 |
16,831 | 14,731 | ||||||
Equity and other investments |
11,315 | 12,053 | ||||||
Goodwill |
17,948 | 16,939 | ||||||
Intangible assets, net |
4,459 | 4,835 | ||||||
Other long-term assets |
2,895 | 2,953 | ||||||
Total assets |
$ | 181,869 | $ | 176,223 | ||||
Liabilities and stockholders equity |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 6,759 | $ | 6,591 | ||||
Short-term debt |
5,498 | 4,985 | ||||||
Current portion of long-term debt |
0 | 2,499 | ||||||
Accrued compensation |
4,276 | 5,096 | ||||||
Income taxes |
685 | 606 | ||||||
Short-term unearned revenue |
20,876 | 23,223 | ||||||
Securities lending payable |
373 | 92 | ||||||
Other |
5,887 | 6,766 | ||||||
Total current liabilities |
44,354 | 49,858 | ||||||
Long-term debt |
40,896 | 27,808 | ||||||
Long-term unearned revenue |
5,017 | 2,095 | ||||||
Deferred income taxes |
2,674 | 2,835 | ||||||
Other long-term liabilities |
14,122 | 13,544 | ||||||
Total liabilities |
107,063 | 96,140 | ||||||
Commitments and contingencies |
||||||||
Stockholders equity: |
||||||||
Common stock and paid-in capitalshares authorized 24,000; outstanding 7,870 and 8,027 |
68,012 | 68,465 | ||||||
Retained earnings |
4,954 | 9,096 | ||||||
Accumulated other comprehensive income |
1,840 | 2,522 | ||||||
Total stockholders equity |
74,806 | 80,083 | ||||||
Total liabilities and stockholders equity |
$ | 181,869 | $ | 176,223 | ||||
See accompanying notes.
5
PART I
Item 1
(In millions) (Unaudited) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Operations |
||||||||||||||||
Net income |
$ | 3,756 | $ | 4,985 | $ | 13,676 | $ | 15,388 | ||||||||
Adjustments to reconcile net income to net cash from operations: |
||||||||||||||||
Depreciation, amortization, and other |
1,707 | 1,515 | 4,712 | 4,464 | ||||||||||||
Stock-based compensation expense |
672 | 641 | 2,004 | 1,920 | ||||||||||||
Net recognized losses (gains) on investments and derivatives |
65 | (55 | ) | 216 | (179 | ) | ||||||||||
Deferred income taxes |
351 | 253 | 177 | 868 | ||||||||||||
Deferral of unearned revenue |
13,073 | 10,163 | 36,066 | 28,385 | ||||||||||||
Recognition of unearned revenue |
(12,210 | ) | (11,209 | ) | (35,494 | ) | (33,347 | ) | ||||||||
Changes in operating assets and liabilities: |
||||||||||||||||
Accounts receivable |
2,288 | 3,655 | 5,546 | 6,904 | ||||||||||||
Inventories |
241 | (430 | ) | 408 | 157 | |||||||||||
Other current assets |
(420 | ) | (111 | ) | (1,914 | ) | (550 | ) | ||||||||
Other long-term assets |
7 | (108 | ) | 58 | 341 | |||||||||||
Accounts payable |
(129 | ) | (390 | ) | 105 | (912 | ) | |||||||||
Other current liabilities |
626 | 200 | (1,293 | ) | (1,952 | ) | ||||||||||
Other long-term liabilities |
340 | 492 | 594 | 1,332 | ||||||||||||
Net cash from operations |
10,367 | 9,601 | 24,861 | 22,819 | ||||||||||||
Financing |
||||||||||||||||
Proceeds from issuance (repayments) of short-term debt, maturities of 90 days or less, net |
2,622 | (6,575 | ) | 481 | 1,222 | |||||||||||
Proceeds from issuance of debt |
25 | 10,680 | 13,274 | 10,680 | ||||||||||||
Repayments of debt |
(900 | ) | 0 | (2,771 | ) | (1,500 | ) | |||||||||
Common stock issued |
159 | 146 | 495 | 483 | ||||||||||||
Common stock repurchased |
(3,857 | ) | (5,131 | ) | (12,292 | ) | (10,164 | ) | ||||||||
Common stock cash dividends paid |
(2,842 | ) | (2,532 | ) | (8,185 | ) | (7,386 | ) | ||||||||
Other |
(123 | ) | 316 | (366 | ) | 601 | ||||||||||
Net cash used in financing |
(4,916 | ) | (3,096 | ) | (9,364 | ) | (6,064 | ) | ||||||||
Investing |
||||||||||||||||
Additions to property and equipment |
(2,308 | ) | (1,391 | ) | (5,688 | ) | (4,163 | ) | ||||||||
Acquisition of companies, net of cash acquired, and purchases of intangible and other assets |
(559 | ) | (162 | ) | (1,330 | ) | (3,097 | ) | ||||||||
Purchases of investments |
(27,341 | ) | (30,218 | ) | (99,661 | ) | (73,470 | ) | ||||||||
Maturities of investments |
5,192 | 5,561 | 16,229 | 9,643 | ||||||||||||
Sales of investments |
19,599 | 21,063 | 76,292 | 53,616 | ||||||||||||
Securities lending payable |
(66 | ) | (334 | ) | 281 | (463 | ) | |||||||||
Net cash used in investing |
(5,483 | ) | (5,481 | ) | (13,877 | ) | (17,934 | ) | ||||||||
Effect of foreign exchange rates on cash and cash equivalents |
17 | (36 | ) | (45 | ) | (76 | ) | |||||||||
Net change in cash and cash equivalents |
(15 | ) | 988 | 1,575 | (1,255 | ) | ||||||||||
Cash and cash equivalents, beginning of period |
7,185 | 6,426 | 5,595 | 8,669 | ||||||||||||
Cash and cash equivalents, end of period |
$ | 7,170 | $ | 7,414 | $ | 7,170 | $ | 7,414 | ||||||||
See accompanying notes.
6
PART I
Item 1
STOCKHOLDERS EQUITY STATEMENTS
(In millions) (Unaudited) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Common stock and paid-in capital |
||||||||||||||||
Balance, beginning of period |
$ | 67,977 | $ | 68,765 | $ | 68,465 | $ | 68,366 | ||||||||
Common stock issued |
159 | 146 | 495 | 483 | ||||||||||||
Common stock repurchased |
(853 | ) | (1,109 | ) | (3,010 | ) | (2,853 | ) | ||||||||
Stock-based compensation expense |
672 | 641 | 2,004 | 1,920 | ||||||||||||
Stock-based compensation income tax benefits |
0 | 30 | 0 | 555 | ||||||||||||
Other, net |
57 | 2 | 58 | 4 | ||||||||||||
Balance, end of period |
68,012 | 68,475 | 68,012 | 68,475 | ||||||||||||
Retained earnings |
||||||||||||||||
Balance, beginning of period |
7,030 | 19,731 | 9,096 | 17,710 | ||||||||||||
Net income |
3,756 | 4,985 | 13,676 | 15,388 | ||||||||||||
Common stock cash dividends |
(2,822 | ) | (2,499 | ) | (8,530 | ) | (7,592 | ) | ||||||||
Common stock repurchased |
(3,010 | ) | (4,031 | ) | (9,288 | ) | (7,320 | ) | ||||||||
Balance, end of period |
4,954 | 18,186 | 4,954 | 18,186 | ||||||||||||
Accumulated other comprehensive income |
||||||||||||||||
Balance, beginning of period |
1,773 | 3,383 | 2,522 | 3,708 | ||||||||||||
Other comprehensive income (loss) |
67 | 88 | (682 | ) | (237 | ) | ||||||||||
Balance, end of period |
1,840 | 3,471 | 1,840 | 3,471 | ||||||||||||
Total stockholders equity |
$ | 74,806 | $ | 90,132 | $ | 74,806 | $ | 90,132 | ||||||||
See accompanying notes.
7
PART I
Item 1
(Unaudited)
NOTE 1 ACCOUNTING POLICIES
Accounting Principles
We prepare our unaudited interim consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP). In the opinion of management, the unaudited interim consolidated financial statements reflect all adjustments of a normal recurring nature that are necessary for a fair presentation of the results for the interim periods presented. Interim results are not necessarily indicative of results for a full year. The information included in this Form 10-Q should be read in conjunction with information included in the Microsoft Corporation 2015 Form 10-K and Form 8-K filed with the U.S. Securities and Exchange Commission on July 31, 2015 and October 27, 2015, respectively.
We have recast certain prior period amounts to conform to the current period presentation, with no impact on consolidated net income or cash flows.
Principles of Consolidation
The consolidated 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.
Recasting of Certain Prior Period Information
In June 2015, we announced a change in organizational structure as part of our transformation in the mobile-first, cloud-first world. During the first quarter of fiscal year 2016, the Companys chief operating decision maker, who is also our Chief Executive Officer, requested changes in the information that he regularly reviews for purposes of allocating resources and assessing performance. As a result, beginning in fiscal year 2016, we report our financial performance based on our new segments described in Note 18 Segment Information. We have recast certain prior period amounts to conform to the way we internally manage and monitor segment performance during fiscal year 2016. This change primarily impacted Note 9 Goodwill, Note 14 Unearned Revenue, and Note 18 Segment Information, with no impact on consolidated net income or cash flows.
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 impairment of goodwill and intangibles assets, 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 consolidated 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.
Revenue Recognition for Windows 10 Licenses
Customers purchasing a Windows 10 license will receive unspecified updates and upgrades over the life of their Windows 10 device at no additional cost. As these updates and upgrades will not be sold on a stand-alone basis, we are unable to establish vendor-specific objective evidence of fair value. Accordingly, revenue from licenses of Windows 10 is recognized ratably over the estimated life of the related device, which ranges between two to four years.
8
PART I
Item 1
Recent Accounting Guidance
Recently adopted accounting guidance
In March 2016, the Financial Accounting Standards Board (FASB) issued a new standard that changes the accounting for certain aspects of share-based payments to employees. The new guidance requires excess tax benefits and tax deficiencies to be recorded in the income statement when the awards vest or are settled. In addition, cash flows related to excess tax benefits will no longer be separately classified as a financing activity apart from other income tax cash flows. The standard also allows us to repurchase more of an employees shares for tax withholding purposes without triggering liability accounting, clarifies that all cash payments made on an employees behalf for withheld shares should be presented as a financing activity on our cash flows statement, and provides an accounting policy election to account for forfeitures as they occur. The new standard is effective for us beginning July 1, 2017, with early adoption permitted.
We elected to early adopt the new guidance in the third quarter of fiscal year 2016 which requires us to reflect any adjustments as of July 1, 2015, the beginning of the annual period that includes the interim period of adoption. The primary impact of adoption was the recognition of excess tax benefits in our provision for income taxes rather than paid-in capital for all periods in fiscal year 2016. Additional amendments to the accounting for income taxes and minimum statutory withholding tax requirements had no impact to retained earnings as of July 1, 2015, where the cumulative effect of these changes are required to be recorded. We have elected to continue to estimate forfeitures expected to occur to determine the amount of compensation cost to be recognized in each period.
We elected to apply the presentation requirements for cash flows related to excess tax benefits retrospectively to all periods presented which resulted in an increase to both net cash from operations and net cash used in financing of $31 million and $555 million for the three months and nine months ended March 31, 2015, respectively. The presentation requirements for cash flows related to employee taxes paid for withheld shares had no impact to any of the periods presented in our consolidated cash flows statements since such cash flows have historically been presented as a financing activity.
Adoption of the new standard resulted in the recognition of excess tax benefits in our provision for income taxes rather than paid-in capital of $74 million and $376 million for the three and nine months ended March 31, 2016, respectively, and impacted our previously reported quarterly results for fiscal year 2016 as follows:
(In millions, except earnings per share) | Three Months Ended September 30, 2015 |
Three Months Ended December 31, 2015 |
||||||||||||||
As reported |
As adjusted |
As reported |
As adjusted |
|||||||||||||
Income statements: |
||||||||||||||||
Provision for income taxes |
$ | 893 | $ | 611 | $ | 857 | $ | 837 | ||||||||
Net income |
$ | 4,620 | $ | 4,902 | $ | 4,998 | $ | 5,018 | ||||||||
Basic earnings per share |
$ | 0.58 | $ | 0.61 | $ | 0.63 | $ | 0.63 | ||||||||
Diluted earnings per share |
$ | 0.57 | $ | 0.61 | $ | 0.62 | $ | 0.62 | ||||||||
Diluted weighted average shares outstanding |
8,066 | 8,084 | 8,028 | 8,051 | ||||||||||||
Cash flows statements: |
||||||||||||||||
Net cash from operations |
$ | 8,594 | $ | 8,876 | $ | 5,598 | $ | 5,618 | ||||||||
Net cash used in financing |
$ | (3,648 | ) | $ | (3,930 | ) | $ | (498 | ) | $ | (518 | ) | ||||
(In millions) | September 30, 2015 |
December 31, 2015 |
||||||||||||||
As reported |
As adjusted |
As reported |
As adjusted |
|||||||||||||
Balance sheets: |
||||||||||||||||
Common stock and paid-in capital |
$ | 68,093 | $ | 67,811 | $ | 68,279 | $ | 67,977 | ||||||||
Retained earnings |
$ | 7,614 | $ | 7,896 | $ | 6,728 | $ | 7,030 | ||||||||
9
PART I
Item 1
Recent accounting guidance not yet adopted
In May 2014, the FASB issued a new standard related to revenue recognition. Under the new standard, recognition of revenue occurs when a customer obtains control of promised goods or services in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The new standard will be effective for us beginning July 1, 2018, and adoption as of the original effective date of July 1, 2017 is permitted. We anticipate this standard will have a material impact on our consolidated financial statements, and we are currently evaluating its impact.
In January 2016, the FASB issued a new standard to amend certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Most prominent among the amendments is the requirement for changes in the fair value of our equity investments, with certain exceptions, to be recognized through net income rather than other comprehensive income (OCI). The new standard will be effective for us beginning July 1, 2018. The application of the amendments will result in a cumulative-effect adjustment to our consolidated balance sheet as of the effective date. We are currently evaluating the impact of this standard on our consolidated financial statements.
In February 2016, the FASB issued a new standard related to leases to increase transparency and comparability among organizations by requiring the recognition of lease assets and lease liabilities on the balance sheet. Most prominent among the amendments is the recognition of assets and liabilities by lessees for those leases classified as operating leases under previous U.S. GAAP. Under the new standard, disclosures are required to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. The new standard will be effective for us beginning July 1, 2019, with early adoption permitted. We anticipate this standard will have a material impact on our consolidated balance sheets, and we are currently evaluating its impact.
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 March 31, |
Nine Months Ended March 31, |
||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Net income available for common shareholders (A) |
$ | 3,756 | $ | 4,985 | $ | 13,676 | $ | 15,388 | ||||||||
Weighted average outstanding shares of common stock (B) |
7,895 | 8,167 | 7,952 | 8,215 | ||||||||||||
Dilutive effect of stock-based awards |
90 | 70 | 89 | 78 | ||||||||||||
Common stock and common stock equivalents (C) |
7,985 | 8,237 | 8,041 | 8,293 | ||||||||||||
Earnings Per Share |
||||||||||||||||
Basic (A/B) |
$ | 0.48 | $ | 0.61 | $ | 1.72 | $ | 1.87 | ||||||||
Diluted (A/C) |
$ | 0.47 | $ | 0.61 | $ | 1.70 | $ | 1.86 | ||||||||
Anti-dilutive stock-based awards excluded from the calculations of diluted EPS were immaterial during the periods presented.
10
PART I
Item 1
NOTE 3 OTHER INCOME (EXPENSE), NET
The components of other income (expense), net were as follows:
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Dividends and interest income |
$ | 230 | $ | 160 | $ | 629 | $ | 568 | ||||||||
Interest expense |
(340 | ) | (211 | ) | (898 | ) | (534 | ) | ||||||||
Net recognized gains on investments |
85 | 169 | 193 | 565 | ||||||||||||
Net losses on derivatives |
(155 | ) | (114 | ) | (414 | ) | (386 | ) | ||||||||
Net gains (losses) on foreign currency remeasurements |
(18 | ) | (54 | ) | (52 | ) | 107 | |||||||||
Other |
(49 | ) | (27 | ) | (156 | ) | (271 | ) | ||||||||
Total |
$ | (247 | ) | $ | (77 | ) | $ | (698 | ) | $ | 49 | |||||
Following are details of net recognized gains (losses) on investments during the periods reported:
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Other-than-temporary impairments of investments |
$ | (86 | ) | $ | (95 | ) | $ | (248 | ) | $ | (130 | ) | ||||
Realized gains from sales of available-for-sale securities |
282 | 358 | 740 | 897 | ||||||||||||
Realized losses from sales of available-for-sale securities |
(111 | ) | (94 | ) | (299 | ) | (202 | ) | ||||||||
Total |
$ | 85 | $ | 169 | $ | 193 | $ | 565 | ||||||||
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 |
|||||||||||||||||||||
March 31, 2016 |
||||||||||||||||||||||||||||
Cash |
$ | 3,691 | $ | 0 | $ | 0 | $ | 3,691 | $ | 3,691 | $ | 0 | $ | 0 | ||||||||||||||
Mutual funds |
1,111 | 0 | 0 | 1,111 | 1,111 | 0 | 0 | |||||||||||||||||||||
Commercial paper |
824 | 0 | 0 | 824 | 824 | 0 | 0 | |||||||||||||||||||||
Certificates of deposit |
1,324 | 0 | 0 | 1,324 | 1,178 | 146 | 0 | |||||||||||||||||||||
U.S. government and agency securities |
81,676 | 98 | (23 | ) | 81,751 | 138 | 81,613 | 0 | ||||||||||||||||||||
Foreign government bonds |
5,221 | 6 | (28 | ) | 5,199 | 228 | 4,971 | 0 | ||||||||||||||||||||
Mortgage- and asset-backed securities |
4,695 | 19 | (4 | ) | 4,710 | 0 | 4,710 | 0 | ||||||||||||||||||||
Corporate notes and bonds |
6,582 | 95 | (64 | ) | 6,613 | 0 | 6,613 | 0 | ||||||||||||||||||||
Municipal securities |
285 | 47 | 0 | 332 | 0 | 332 | 0 | |||||||||||||||||||||
Common and preferred stock |
6,075 | 4,912 | (254 | ) | 10,733 | 0 | 0 | 10,733 | ||||||||||||||||||||
Other investments |
554 | 0 | 0 | 554 | 0 | (3 | ) | 557 | ||||||||||||||||||||
Total |
$ | 112,038 | $ | 5,177 | $ | (373 | ) | $ | 116,842 | $ | 7,170 | $ | 98,382 | $ | 11,290 | |||||||||||||
11
PART I
Item 1
(In millions) | Cost Basis | Unrealized Gains |
Unrealized Losses |
Recorded Basis |
Cash and Cash Equivalents |
Short-term Investments |
Equity and Other Investments |
|||||||||||||||||||||
June 30, 2015 |
||||||||||||||||||||||||||||
Cash |
$ | 3,679 | $ | 0 | $ | 0 | $ | 3,679 | $ | 3,679 | $ | 0 | $ | 0 | ||||||||||||||
Mutual funds |
1,100 | 0 | 0 | 1,100 | 1,100 | 0 | 0 | |||||||||||||||||||||
Commercial paper |
1 | 0 | 0 | 1 | 1 | 0 | 0 | |||||||||||||||||||||
Certificates of deposit |
906 | 0 | 0 | 906 | 776 | 130 | 0 | |||||||||||||||||||||
U.S. government and agency securities |
72,843 | 76 | (30 | ) | 72,889 | 39 | 72,850 | 0 | ||||||||||||||||||||
Foreign government bonds |
5,477 | 3 | (24 | ) | 5,456 | 0 | 5,456 | 0 | ||||||||||||||||||||
Mortgage- and asset-backed securities |
4,899 | 23 | (6 | ) | 4,916 | 0 | 4,916 | 0 | ||||||||||||||||||||
Corporate notes and bonds |
7,192 | 97 | (37 | ) | 7,252 | 0 | 7,252 | 0 | ||||||||||||||||||||
Municipal securities |
285 | 35 | (1 | ) | 319 | 0 | 319 | 0 | ||||||||||||||||||||
Common and preferred stock |
6,668 | 4,986 | (215 | ) | 11,439 | 0 | 0 | 11,439 | ||||||||||||||||||||
Other investments |
597 | 0 | 0 | 597 | 0 | 8 | 589 | |||||||||||||||||||||
Total |
$ | 103,647 | $ | 5,220 | $ | (313 | ) | $ | 108,554 | $ | 5,595 | $ | 90,931 | $ | 12,028 | |||||||||||||
As of March 31, 2016 and June 30, 2015, the recorded bases of common and preferred stock that are restricted for more than one year or are not publicly traded were $770 million and $561 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.
We lend certain fixed-income and equity securities to increase investment returns. These transactions are accounted for as secured borrowings and the loaned securities continue to be carried as investments on our consolidated balance sheets. Cash and/or security interests are received as collateral for the loaned securities with the amount determined based upon the underlying security lent and the creditworthiness of the borrower. As of March 31, 2016, the collateral received under these agreements totaled $373 million which is primarily comprised of U.S. government and agency securities.
Unrealized Losses on Investments
Investments with continuous unrealized losses for less than 12 months and 12 months or greater and their related fair values were as follows:
Less than 12 Months | 12 Months or Greater | Total Unrealized Losses |
||||||||||||||||||||||
(In millions) | Fair Value | Unrealized Losses |
Fair Value | Unrealized Losses |
Total Fair Value |
|||||||||||||||||||
March 31, 2016 |
||||||||||||||||||||||||
U.S. government and agency securities |
$ | 29,389 | $ | (12 | ) | $ | 529 | $ | (11 | ) | $ | 29,918 | $ | (23 | ) | |||||||||
Foreign government bonds |
4,231 | (2 | ) | 58 | (26 | ) | 4,289 | (28 | ) | |||||||||||||||
Mortgage- and asset-backed securities |
2,403 | (4 | ) | 136 | 0 | 2,539 | (4 | ) | ||||||||||||||||
Corporate notes and bonds |
2,753 | (34 | ) | 467 | (30 | ) | 3,220 | (64 | ) | |||||||||||||||
Common and preferred stock |
991 | (179 | ) | 394 | (75 | ) | 1,385 | (254 | ) | |||||||||||||||
Total |
$ | 39,767 | $ | (231 | ) | $ | 1,584 | $ | (142 | ) | $ | 41,351 | $ | (373 | ) | |||||||||
12
PART I
Item 1
Less than 12 Months | 12 Months or Greater | Total Unrealized Losses |
||||||||||||||||||||||
(In millions) | Fair Value | Unrealized Losses |
Fair Value | Unrealized Losses |
Total Fair Value |
|||||||||||||||||||
June 30, 2015 |
||||||||||||||||||||||||
U.S. government and agency securities |
$ | 6,636 | $ | (9 | ) | $ | 421 | $ | (21 | ) | $ | 7,057 | $ | (30 | ) | |||||||||
Foreign government bonds |
4,611 | (12 | ) | 18 | (12 | ) | 4,629 | (24 | ) | |||||||||||||||
Mortgage- and asset-backed securities |
3,171 | (5 | ) | 28 | (1 | ) | 3,199 | (6 | ) | |||||||||||||||
Corporate notes and bonds |
2,946 | (29 | ) | 104 | (8 | ) | 3,050 | (37 | ) | |||||||||||||||
Municipal securities |
36 | (1 | ) | 0 | 0 | 36 | (1 | ) | ||||||||||||||||
Common and preferred stock |
1,389 | (180 | ) | 148 | (35 | ) | 1,537 | (215 | ) | |||||||||||||||
Total |
$ | 18,789 | $ | (236 | ) | $ | 719 | $ | (77 | ) | $ | 19,508 | $ | (313 | ) | |||||||||
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.
Debt Investment Maturities
(In millions) | Cost Basis | Estimated Fair Value |
||||||
March 31, 2016 |
||||||||
Due in one year or less |
$ | 43,753 | $ | 43,745 | ||||
Due after one year through five years |
53,372 | 53,453 | ||||||
Due after five years through 10 years |
2,266 | 2,275 | ||||||
Due after 10 years |
1,216 | 1,280 | ||||||
Total |
$ | 100,607 | $ | 100,753 | ||||
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, Canadian dollar, and Australian dollar. As of March 31, 2016 and June 30, 2015, the total notional amounts of these foreign exchange contracts sold were $9.8 billion for both periods.
Foreign currency risks related to certain non-U.S. dollar denominated securities are hedged using foreign exchange forward contracts that are designated as fair-value hedging instruments. As of March 31, 2016 and June 30, 2015, the total notional amounts of these foreign exchange contracts sold were $5.0 billion and $5.3 billion, respectively.
Certain options and forwards not designated as hedging instruments are also used to manage the variability in foreign exchange rates on certain balance sheet amounts and to manage other foreign currency exposures. As of March 31, 2016, the total notional amounts of these foreign exchange contracts purchased and sold were $8.6 billion and $6.0 billion, respectively. As of June 30, 2015, the total notional amounts of these foreign exchange contracts purchased and sold were $9.7 billion and $11.0 billion, respectively.
13
PART I
Item 1
Equity
Securities held in our equity and other investments portfolio are subject to market price risk. Market price risk is managed relative to broad-based global and domestic equity indices using certain convertible preferred investments, options, futures, and swap contracts not designated as hedging instruments. From time to time, to hedge our price risk, we may use and designate equity derivatives as hedging instruments, including puts, calls, swaps, and forwards. As of March 31, 2016, the total notional amounts of equity contracts purchased and sold for managing market price risk were $1.4 billion and $2.1 billion, respectively, of which $697 million and $948 million, respectively, were designated as hedging instruments. As of June 30, 2015, the total notional amounts of equity contracts purchased and sold for managing market price risk were $2.2 billion and $2.6 billion, respectively, of which $1.1 billion and $1.4 billion, respectively, were designated as hedging instruments.
Interest Rate
Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of our fixed-income portfolio to achieve economic returns that correlate to certain broad-based fixed-income indices using exchange-traded option and futures contracts, and over-the-counter swap and option contracts, none of which are designated as hedging instruments. As of March 31, 2016, the total notional amounts of fixed-interest rate contracts purchased and sold were $356 million and $2.5 billion, respectively. As of June 30, 2015, the total notional amounts of fixed-interest rate contracts purchased and sold were $1.0 billion and $3.2 billion, respectively.
In addition, we use To Be Announced forward purchase commitments of mortgage-backed assets to gain exposure to agency mortgage-backed securities. These meet the definition of a derivative instrument in cases where physical delivery of the assets is not taken at the earliest available delivery date. As of March 31, 2016 and June 30, 2015, the total notional derivative amounts of mortgage contracts purchased were $534 million and $812 million, respectively.
Credit
Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We use credit default swap contracts, not designated as hedging instruments, to manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. We use credit default swaps as they are a low-cost method of managing exposure to individual credit risks or groups of credit risks. As of March 31, 2016, the total notional amounts of credit contracts purchased and sold were $468 million and $281 million, respectively. As of June 30, 2015, the total notional amounts of credit contracts purchased and sold were $618 million and $430 million, respectively.
Commodity
We use broad-based commodity exposures to enhance portfolio returns and to facilitate portfolio diversification. We use swaps, futures, and option contracts, not designated as hedging instruments, to generate and manage exposures to broad-based commodity indices. We use derivatives on commodities as they can be low-cost alternatives to the purchase and storage of a variety of commodities, including, but not limited to, precious metals, energy, and grain. As of March 31, 2016, the total notional amounts of commodity contracts purchased and sold were $613 million and $163 million, respectively. As of June 30, 2015, the total notional amounts of commodity contracts purchased and sold were $882 million and $316 million, respectively.
Credit-Risk-Related Contingent Features
Certain of our counterparty agreements for derivative instruments contain provisions that require our issued and outstanding long-term unsecured debt to maintain an investment grade credit rating and require us to maintain minimum liquidity of $1.0 billion. To the extent we fail to meet these requirements, we will be required to post collateral, similar to the standard convention related to over-the-counter derivatives. As of March 31, 2016, 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.
14
PART I
Item 1
Fair Values of Derivative Instruments
Derivative instruments are recognized as either assets or liabilities and are measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation.
For derivative instruments designated as fair value hedges, the gains (losses) are recognized in earnings in the periods of change together with the offsetting losses (gains) on the hedged items attributed to the risk being hedged. For options designated as fair value hedges, changes in the time value are excluded from the assessment of hedge effectiveness and are recognized in earnings.
For derivative instruments designated as cash-flow hedges, the effective portion of the gains (losses) on the derivatives is initially reported as a component of OCI and is subsequently recognized in earnings when the hedged exposure is recognized in earnings. For options designated as cash-flow hedges, changes in the time value are excluded from the assessment of hedge effectiveness and are recognized in earnings. Gains (losses) on derivatives representing either hedge components excluded from the assessment of effectiveness or hedge ineffectiveness are recognized in earnings.
For derivative instruments that are not designated as hedges, gains (losses) from changes in fair values are primarily recognized in other income (expense), net. Other than those derivatives entered into for investment purposes, such as commodity contracts, the gains (losses) are generally economically offset by unrealized gains (losses) in the underlying available-for-sale securities, which are recorded as a component of OCI until the securities are sold or other-than-temporarily impaired, at which time the amounts are reclassified from accumulated other comprehensive income (AOCI) into other income (expense), net.
15
PART I
Item 1
The following table presents 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:
March 31, 2016 | June 30, 2015 | |||||||||||||||||||||||||||||||||||||
Assets | Liabilities | Assets | Liabilities | |||||||||||||||||||||||||||||||||||
(In millions) | Short-term Investments |
Other Current Assets |
Equity and Other Investments |
Other Current Liabilities |
Short-term Investments |
Other Current Assets |
Equity and Other Investments |
Other Current Liabilities |
||||||||||||||||||||||||||||||
Non-designated Hedge Derivatives |
||||||||||||||||||||||||||||||||||||||
Foreign exchange contracts |
$ | 22 | $ | 248 | $ | 0 | $ | (177 | ) | $ | 17 | $ | 167 | $ | 0 | $ | (79 | ) | ||||||||||||||||||||
Equity contracts |
28 | 0 | 0 | (27 | ) | 148 | 0 | 0 | (18 | ) | ||||||||||||||||||||||||||||
Interest rate contracts |
7 | 0 | 0 | (19 | ) | 7 | 0 | 0 | (12 | ) | ||||||||||||||||||||||||||||
Credit contracts |
6 | 0 | 0 | (6 | ) | 16 | 0 | 0 | (9 | ) | ||||||||||||||||||||||||||||
Commodity contracts |
2 | 0 | 0 | (2 | ) | 0 | 0 | 0 | 0 | |||||||||||||||||||||||||||||
Total |
$ | 65 | $ | 248 | $ | 0 | $ | (231 | ) | $ | 188 | $ | 167 | $ | 0 | $ | (118 | ) | ||||||||||||||||||||
Designated Hedge Derivatives |
||||||||||||||||||||||||||||||||||||||
Foreign exchange contracts |
$ | 8 | $ | 358 | $ | 0 | $ | (112 | ) | $ | 56 | $ | 552 | $ | 0 | $ | (31 | ) | ||||||||||||||||||||
Equity contracts |
0 | 0 | 21 | (32 | ) | 0 | 0 | 25 | (69 | ) | ||||||||||||||||||||||||||||
Total |
$ | 8 | $ | 358 | $ | 21 | $ | (144 | ) | $ | 56 | $ | 552 | $ | 25 | $ | (100 | ) | ||||||||||||||||||||
Total gross amounts of derivatives |
$ | 73 | $ | 606 | $ | 21 | $ | (375 | ) | $ | 244 | $ | 719 | $ | 25 | $ | (218 | ) | ||||||||||||||||||||
Gross derivatives either offset or subject to an enforceable master netting agreement |
$ | 71 | $ | 606 | $ | 21 | $ | (375 | ) | $ | 126 | $ | 719 | $ | 25 | $ | (218 | ) | ||||||||||||||||||||
Gross amounts of derivatives offset in the balance sheet |
(98 | ) | (120 | ) | (25 | ) | 240 | (66 | ) | (71 | ) | (25 | ) | 161 | ||||||||||||||||||||||||
Net amounts presented in the balance sheet |
(27 | ) | 486 | (4 | ) | (135 | ) | 60 | 648 | 0 | (57 | ) | ||||||||||||||||||||||||||
Gross amounts of derivatives not offset in the balance sheet |
0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||||||||||||||
Cash collateral received |
0 | 0 | 0 | (261 | ) | 0 | 0 | 0 | (456 | ) | ||||||||||||||||||||||||||||
Net amount |
$ | (27 | ) | $ | 486 | $ | (4 | ) | $ | (396 | ) | $ | 60 | $ | 648 | $ | 0 | $ | (513 | ) | ||||||||||||||||||
See also Note 4 Investments and Note 6 Fair Value Measurements.
16
PART I
Item 1
Fair-Value Hedge Gains (Losses)
We recognized in other income (expense), net the following gains (losses) on contracts designated as fair-value hedges and their related hedged items:
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Foreign Exchange Contracts |
||||||||||||||||
Derivatives |
$ | (331 | ) | $ | 31 | $ | (364 | ) | $ | 653 | ||||||
Hedged items |
340 | (23 | ) | 390 | (647 | ) | ||||||||||
Total amount of ineffectiveness |
$ | 9 | $ | 8 | $ | 26 | $ | 6 | ||||||||
Equity Contracts |
||||||||||||||||
Derivatives |
$ | 15 | $ | (25 | ) | $ | (77 | ) | $ | (88 | ) | |||||
Hedged items |
(15 | ) | 25 | 77 | 88 | |||||||||||
Total amount of ineffectiveness |
$ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||
Amount of equity contracts excluded from effectiveness assessment |
$ | (12 | ) | $ | 5 | $ | (8 | ) | $ | (8 | ) | |||||
Cash Flow Hedge Gains (Losses)
We recognized the following gains (losses) on foreign exchange contracts designated as cash-flow hedges:
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Effective Portion |
||||||||||||||||
Gains (losses) recognized in OCI (net of tax effects of $(19), $25, $24, and $37) |
$ | (125 | ) | $ | 559 | $ | 158 | $ | 1,251 | |||||||
Gains reclassified from AOCI into revenue |
171 | 162 | 461 | 290 | ||||||||||||
Amount Excluded from Effectiveness Assessment and Ineffective Portion |
||||||||||||||||
Losses recognized in other income (expense), net |
(86 | ) | (120 | ) | (240 | ) | (262 | ) | ||||||||
We estimate that $290 million of net derivative gains included in AOCI at March 31, 2016 will be reclassified into earnings within the following 12 months. No significant amounts of gains (losses) were reclassified from AOCI into earnings as a result of forecasted transactions that failed to occur during the three and nine months ended March 31, 2016.
17
PART I
Item 1
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), net. 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), net, 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 and gains (losses) from foreign exchange rate changes on certain balance sheet amounts.
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Foreign exchange contracts |
$ | 188 | $ | (442 | ) | $ | 113 | $ | (647 | ) | ||||||
Equity contracts |
(19 | ) | (4 | ) | (15 | ) | (18 | ) | ||||||||
Interest-rate contracts |
(4 | ) | 3 | 4 | 21 | |||||||||||
Credit contracts |
1 | 2 | (2 | ) | (2 | ) | ||||||||||
Commodity contracts |
(9 | ) | (47 | ) | (145 | ) | (264 | ) | ||||||||
Total |
$ | 157 | $ | (488 | ) | $ | (45 | ) | $ | (910 | ) | |||||
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- and asset-backed securities, U.S. government and agency securities, and foreign government bonds. 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 common and preferred stock, and goodwill and intangible assets, when they are recorded at fair value due to an impairment charge. Unobservable inputs used in the models are significant to the fair values of the assets and liabilities. |
We measure 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.
18
PART I
Item 1
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following tables present the fair value of our financial instruments that are measured at fair value on a recurring basis:
(In millions) | Level 1 | Level 2 | Level 3 |
|
Gross Fair Value |
|
Netting | (a) | |
Net Fair Value |
| |||||||||||||
March 31, 2016 |
||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||
Mutual funds |
$ | 1,111 | $ | 0 | $ | 0 | $ | 1,111 | $ | 0 | $ | 1,111 | ||||||||||||
Commercial paper |
0 | 824 | 0 | 824 | 0 | 824 | ||||||||||||||||||
Certificates of deposit |
0 | 1,324 | 0 | 1,324 | 0 | 1,324 | ||||||||||||||||||
U.S. government and agency securities |
78,052 | 3,684 | 0 | 81,736 | 0 | 81,736 | ||||||||||||||||||
Foreign government bonds |
10 | 5,306 | 0 | 5,316 | 0 | 5,316 | ||||||||||||||||||
Mortgage- and asset-backed securities |
0 | 4,708 | 0 | 4,708 | 0 | 4,708 | ||||||||||||||||||
Corporate notes and bonds |
0 | 6,520 | 1 | 6,521 | 0 | 6,521 | ||||||||||||||||||
Municipal securities |
0 | 332 | 0 | 332 | 0 | 332 | ||||||||||||||||||
Common and preferred stock |
7,833 | 2,114 | 18 | 9,965 | 0 | 9,965 | ||||||||||||||||||
Derivatives |
1 | 699 | 0 | 700 | (243 | ) | 457 | |||||||||||||||||
Total |
$ | 87,007 | $ | 25,511 | $ | 19 | $ | 112,537 | $ | (243 | ) | $ | 112,294 | |||||||||||
Liabilities |
||||||||||||||||||||||||
Derivatives and other |
$ | 15 | $ | 360 | $ | 0 | $ | 375 | $ | (240 | ) | $ | 135 | |||||||||||
(In millions) | Level 1 | Level 2 | Level 3 |
|
Gross Fair Value |
|
Netting | (a) | |
Net Fair Value |
| |||||||||||||
June 30, 2015 |
||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||
Mutual funds |
$ | 1,100 | $ | 0 | $ | 0 | $ | 1,100 | $ | 0 | $ | 1,100 | ||||||||||||
Commercial paper |
0 | 1 | 0 | 1 | 0 | 1 | ||||||||||||||||||
Certificates of deposit |
0 | 906 | 0 | 906 | 0 | 906 | ||||||||||||||||||
U.S. government and agency securities |
71,930 | 955 | 0 | 72,885 | 0 | 72,885 | ||||||||||||||||||
Foreign government bonds |
131 | 5,299 | 0 | 5,430 | 0 | 5,430 | ||||||||||||||||||
Mortgage- and asset-backed securities |
0 | 4,917 | 0 | 4,917 | 0 | 4,917 | ||||||||||||||||||
Corporate notes and bonds |
0 | 7,108 | 1 | 7,109 | 0 | 7,109 | ||||||||||||||||||
Municipal securities |
0 | 319 | 0 | 319 | 0 | 319 | ||||||||||||||||||
Common and preferred stock |
8,585 | 2,277 | 14 | 10,876 | 0 | 10,876 | ||||||||||||||||||
Derivatives |
4 | 979 | 5 | 988 | (162 | ) | 826 | |||||||||||||||||
Total |
$ | 81,750 | $ | 22,761 | $ | 20 | $ | 104,531 | $ | (162 | ) | $ | 104,369 | |||||||||||
Liabilities |
||||||||||||||||||||||||
Derivatives and other |
$ | 5 | $ | 159 | $ | 54 | $ | 218 | $ | (161 | ) | $ | 57 | |||||||||||
(a) | These amounts represent the impact of netting derivative assets and derivative liabilities when a legally enforceable master netting agreement exists and fair value adjustments related to our own credit risk and counterparty credit risk. |
The changes in our Level 3 financial instruments that are measured at fair value on a recurring basis were immaterial during the periods presented.
19
PART I
Item 1
The following table reconciles the total Net Fair Value of assets above to our balance sheet presentation of these same assets in Note 4 Investments.
(In millions) | ||||||||
March 31, 2016 |
June 30, 2015 |
|||||||
Net fair value of assets measured at fair value on a recurring basis |
$ | 112,294 | $ | 104,369 | ||||
Cash |
3,691 | 3,679 | ||||||
Common and preferred stock measured at fair value on a nonrecurring basis |
770 | 561 | ||||||
Other investments measured at fair value on a nonrecurring basis |
557 | 589 | ||||||
Less derivative net assets classified as other current assets |
(486 | ) | (648 | ) | ||||
Other |
16 | 4 | ||||||
Recorded basis of investment components |
$ | 116,842 | $ | 108,554 | ||||
Financial Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
During the three and nine months ended March 31, 2016 and 2015, we did not record any material other-than-temporary impairments on financial assets required to be measured at fair value on a nonrecurring basis.
NOTE 7 INVENTORIES
The components of inventories were as follows:
(In millions) | ||||||||
March 31, 2016 |
June 30, 2015 |
|||||||
Raw materials |
$ | 636 | $ | 1,100 | ||||
Work in process |
122 | 202 | ||||||
Finished goods |
1,692 | 1,600 | ||||||
Total |
$ | 2,450 | $ | 2,902 | ||||
NOTE 8 BUSINESS COMBINATIONS
Mojang Synergies AB
On November 6, 2014, we acquired Mojang Synergies AB (Mojang), the Swedish video game developer of the Minecraft gaming franchise, for $2.5 billion in cash, net of cash acquired. The addition of Minecraft and its community enhances our gaming portfolio across Windows, Xbox, and other ecosystems besides our own. The significant classes of assets and liabilities to which we allocated the purchase price were goodwill of $1.8 billion and identifiable intangible assets of $928 million, primarily marketing-related (trade names). The goodwill recognized in connection with the acquisition is primarily attributable to anticipated synergies from future growth, and is not expected to be deductible for tax purposes. We assigned the goodwill to More Personal Computing under our current segment structure. Identifiable intangible assets were assigned a total weighted-average amortization period of 6.3 years. Mojang has been included in our consolidated results of operations since the acquisition date.
Other
During the nine months ended March 31, 2016, we completed 14 acquisitions for total cash consideration of $1.3 billion. These entities have been included in our consolidated results of operations since their respective acquisition dates.
Pro forma results of operations have not been presented because the effects of these business combinations, individually and in aggregate, were not material to our consolidated results of operations.
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NOTE 9 GOODWILL
Changes in the carrying amount of goodwill were as follows:
(In millions) | June 30, 2015 |
Acquisitions |
Other | March 31, 2016 |
||||||||||||||||
Productivity and Business Processes |
$ | 6,309 | $ | 444 | $ | (61 | ) | $ | 6,692 | |||||||||||
Intelligent Cloud |
4,917 | 537 | 15 | 5,469 | ||||||||||||||||
More Personal Computing |
5,713 | 91 | (17 | ) | 5,787 | |||||||||||||||
Total goodwill |
$ | 16,939 | $ | 1,072 | $ | (63 | ) | $ | 17,948 | |||||||||||
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 purchase accounting adjustments are presented as Other in the above table. Also included in Other are business dispositions and transfers between business segments due to reorganizations, as applicable.
As discussed in Note 18 Segment Information, during the first quarter of fiscal year 2016 the Companys chief operating decision maker requested changes in the information that he regularly reviews for purposes of allocating resources and assessing performance. 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.
NOTE 10 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 |
||||||||||||||||||||||||||
March 31, 2016 |
June 30, 2015 |
|||||||||||||||||||||||||||||||
Technology-based (a) |
$ | 6,169 | $ | (3,532 | ) | $ | 2,637 | $ | 5,926 | $ | (3,149 | ) | $ | 2,777 | ||||||||||||||||||
Marketing-related |
1,936 | (631 | ) | 1,305 | 1,942 | (508 | ) | 1,434 | ||||||||||||||||||||||||
Contract-based |
1,177 | (757 | ) | 420 | 1,192 | (710 | ) | 482 | ||||||||||||||||||||||||
Customer-related |
469 | (372 | ) | 97 | 492 | (350 | ) | 142 | ||||||||||||||||||||||||
Total |
$ | 9,751 | $ | (5,292 | ) | $ | 4,459 | $ | 9,552 | $ | (4,717 | ) | $ | 4,835 | ||||||||||||||||||
(a) | Technology-based intangible assets included $128 million and $116 million as of March 31, 2016 and June 30, 2015, respectively, of net carrying amount of software to be sold, leased, or otherwise marketed. |
Intangible assets amortization expense was $249 million and $740 million for the three and nine months ended March 31, 2016, respectively, and $361 million and $1.1 billion for the three and nine months ended March 31, 2015, respectively. Amortization of capitalized software was $18 million and $55 million for the three and nine months ended March 31, 2016, respectively, and $13 million and $68 million for the three and nine months ended March 31, 2015, respectively.
In the third quarter of fiscal year 2016, we corrected our intangible assets in the table above for a $585 million misstatement between gross carrying amount and accumulated amortization as of June 30, 2015. We do not consider this correction to be material, and there was no impact to our consolidated financial statements.
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The following table outlines the estimated future amortization expense related to intangible assets held as of March 31, 2016:
(In millions) | ||||
Year Ending June 30, |
||||
2016 (excluding the nine months ended March 31, 2016) |
$ | 247 | ||
2017 |
861 | |||
2018 |
753 | |||
2019 |
602 | |||
2020 |
522 | |||
Thereafter |
1,474 | |||
Total |
$ | 4,459 | ||
NOTE 11 DEBT
Short-term Debt
As of March 31, 2016, we had $5.5 billion of commercial paper issued and outstanding, with a weighted-average interest rate of 0.36% and maturities ranging from 26 days to 91 days. As of June 30, 2015, we had $5.0 billion of commercial paper issued and outstanding, with a weighted-average interest rate of 0.11% and maturities ranging from 8 days to 63 days. The estimated fair value of this commercial paper approximates its carrying value.
We currently have two $5.0 billion credit facilities that expire on November 1, 2016 and November 14, 2018, respectively. These credit facilities serve as a back-up for our commercial paper program. As of March 31, 2016, we were in compliance with the only financial covenant in both credit agreements, 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 agreements. No amounts were drawn against these credit facilities during any of the periods presented.
Long-term Debt
As of March 31, 2016, the total carrying value and estimated fair value of our long-term debt were $40.9 billion and $43.5 billion, respectively. This is compared to a carrying value and estimated fair value of our long-term debt, including the current portion, of $30.3 billion and $30.5 billion, respectively, as of June 30, 2015. These estimated fair values are based on Level 2 inputs.
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The components of our long-term debt, including the current portion, and the associated interest rates were as follows as of March 31, 2016 and June 30, 2015:
Due Date | Face Value March 31, 2016 |
Face Value June 30, 2015 |
Stated Interest Rate |
Effective Interest Rate |
||||||||||||||||
(In millions) | ||||||||||||||||||||
Notes |
||||||||||||||||||||
September 25, 2015 |
$ | * | $ | 1,750 | 1.625% | 1.795% | ||||||||||||||
February 8, 2016 |
* | 750 | 2.500% | 2.642% | ||||||||||||||||
November 15, 2017 |
600 | 600 | 0.875% | 1.084% | ||||||||||||||||
May 1, 2018 |
450 | 450 | 1.000% | 1.106% | ||||||||||||||||
November 3, 2018 (a) |
1,750 | * | 1.300% | 1.396% | ||||||||||||||||
December 6, 2018 |
1,250 | 1,250 | 1.625% | 1.824% | ||||||||||||||||
June 1, 2019 |
1,000 | 1,000 | 4.200% | 4.379% | ||||||||||||||||
February 12, 2020 |
1,500 | 1,500 | 1.850% | 1.935% | ||||||||||||||||
October 1, 2020 |
1,000 | 1,000 | 3.000% | 3.137% | ||||||||||||||||
November 3, 2020 (a) |
2,250 | * | 2.000% | 2.093% | ||||||||||||||||
February 8, 2021 |
500 | 500 | 4.000% | 4.082% | ||||||||||||||||
December 6, 2021 (b) |
1,994 | 1,950 | 2.125% | 2.233% | ||||||||||||||||
February 12, 2022 |
1,500 | 1,500 | 2.375% | 2.466% | ||||||||||||||||
November 3, 2022 (a) |
1,000 | * | 2.650% | 2.717% | ||||||||||||||||
November 15, 2022 |
750 | 750 | 2.125% | 2.239% | ||||||||||||||||
May 1, 2023 |
1,000 | 1,000 | 2.375% | 2.465% | ||||||||||||||||
December 15, 2023 |
1,500 | 1,500 | 3.625% | 3.726% | ||||||||||||||||
February 12, 2025 |
2,250 | 2,250 | 2.700% | 2.772% | ||||||||||||||||
November 3, 2025 (a) |
3,000 | * | 3.125% | 3.176% | ||||||||||||||||
December 6, 2028 (b) |
1,994 | 1,950 | 3.125% | 3.218% | ||||||||||||||||
May 2, 2033 (b) |
627 | 613 | 2.625% | 2.690% | ||||||||||||||||
February 12, 2035 |
1,500 | 1,500 | 3.500% | 3.604% | ||||||||||||||||
November 3, 2035 (a) |
1,000 | * | 4.200% | 4.260% | ||||||||||||||||
June 1, 2039 |
750 | 750 | 5.200% | 5.240% | ||||||||||||||||
October 1, 2040 |
1,000 | 1,000 | 4.500% | 4.567% | ||||||||||||||||
February 8, 2041 |
1,000 | 1,000 | 5.300% | 5.361% | ||||||||||||||||
November 15, 2042 |
900 | 900 | 3.500% | 3.571% | ||||||||||||||||
May 1, 2043 |
500 | 500 | 3.750% | 3.829% | ||||||||||||||||
December 15, 2043 |
500 | 500 | 4.875% | 4.918% | ||||||||||||||||
February 12, 2045 |
1,750 | 1,750 | 3.750% | 3.800% | ||||||||||||||||
November 3, 2045 (a) |
3,000 | * | 4.450% | 4.492% | ||||||||||||||||
February 12, 2055 |
2,250 | 2,250 | 4.000% | 4.063% | ||||||||||||||||
November 3, 2055 (a) |
1,000 | * | 4.750% | 4.782% | ||||||||||||||||
Total |
$ | 41,065 | $ | 30,463 | ||||||||||||||||
(a) | In November 2015, we issued $13.0 billion of debt securities. |
(b) | Euro-denominated 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 March 31, 2016 and June 30, 2015, the aggregate unamortized discount for our long-term debt, including the current portion, was $169 million and $156 million, respectively.
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NOTE 12 INCOME TAXES
Our effective tax rate for the three months ended March 31, 2016 and 2015 was 25% and 24%, respectively, and 17% and 24% for the nine months ended March 31, 2016 and 2015, 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.
The change in the current quarter and year-to-date effective tax rate compared to prior year was primarily due to changes in the mix of our income before income taxes between the U.S. and foreign countries, offset by a benefit from the adoption of the new accounting guidance relating to stock-based compensation. The prior year-to-date effective tax rate also included an expense relating to Internal Revenue Service (IRS) audit adjustments and adjustments to prior years liabilities for intercompany transfer pricing that increased taxable income in more highly-taxed jurisdictions.
Tax contingencies and other income tax liabilities were $12.7 billion and $12.1 billion as of March 31, 2016 and June 30, 2015, respectively, and are included in other long-term liabilities. This increase relates primarily to current period quarterly growth relating to intercompany transfer pricing adjustments, offset by a partial settlement of the IRS audit for tax years 2007 to 2009 in the first quarter of fiscal year 2016. While we settled a portion of the IRS audit for tax years 2004 to 2006 during the third quarter of fiscal year 2011, and settled a portion of the IRS audit for tax years 2007 to 2009 during the first quarter of fiscal year 2016, we remain under audit for those years. In February 2012, the IRS withdrew its 2011 Revenue Agents Report for tax years 2004 to 2006 and reopened the audit phase of the examination. As of March 31, 2016, the primary unresolved issue relates to transfer pricing, which could have a significant impact on our consolidated financial statements if not resolved favorably. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months. We also continue to be subject to examination by the IRS for tax years 2010 to 2016.
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 2016, some of which are currently under audit by local tax authorities. The resolutions of these audits are not expected to be material to our consolidated financial statements.
NOTE 13 RESTRUCTURING CHARGES
Phone Hardware Integration
In July 2014, we announced a restructuring plan to simplify our organization and align the purchase of Nokia Corporations (Nokia) Devices and Services business (NDS) with our companys overall strategy (the Phone Hardware Integration Plan). Pursuant to the Phone Hardware Integration Plan, we eliminated approximately 19,000 positions in fiscal year 2015, including approximately 13,000 professional and factory positions related to the NDS business. The actions associated with the Phone Hardware Integration Plan were completed as of June 30, 2015.
In connection with the Phone Hardware Integration Plan, we incurred restructuring charges of $98 million and $1.3 billion during the three and nine months ended March 31, 2015, respectively, including severance expenses and other reorganization costs, primarily associated with our facilities consolidation. Total restructuring charges incurred under the Phone Hardware Integration Plan were $1.3 billion, all of which were recognized in fiscal year 2015.
Phone Hardware Restructuring
In June 2015, management approved a plan to restructure our phone business to better focus and align resources (the Phone Hardware Restructuring Plan), under which we will eliminate up to 7,800 positions in fiscal year 2016. The actions associated with the Phone Hardware Restructuring Plan are expected to be completed as of June 30, 2016.
To date, we have incurred restructuring charges of $780 million under the Phone Hardware Restructuring Plan, including severance expenses and other reorganization costs.
Restructuring charges associated with these plans were included in impairment, integration, and restructuring expenses in our consolidated income statement, and reflected in Corporate and Other in our table of operating income (loss) by segment in Note 18 Segment Information.
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Changes in the restructuring liability were as follows:
(In millions) |
Severance |
|
Asset Impairments and Other |
(a) |
Total | |||||||
Restructuring liability as of June 30, 2015 |
$ | 588 | $ | 249 | $ | 837 | ||||||
Restructuring charges |
0 | 0 | 0 | |||||||||
Cash paid |
(400 | ) | (92 | ) | (492 | ) | ||||||
Other |
(23 | ) | 0 | (23 | ) | |||||||
Restructuring liability as of March 31, 2016 |
$ | 165 | $ | 157 | $ | 322 | ||||||
(a) | Asset Impairments and Other primarily reflects activities associated with the consolidation of our facilities and manufacturing operations, including asset write-downs as well as contract termination costs. |
NOTE 14 UNEARNED REVENUE
Unearned revenue by segment was as follows:
(In millions) | ||||||||
March 31, 2016 |
June 30, 2015 |
|||||||
Productivity and Business Processes |
$ | 9,635 | $ | 11,643 | ||||
Intelligent Cloud |
8,658 | 10,346 | ||||||
More Personal Computing |
2,848 | 3,246 | ||||||
Corporate and Other |
4,752 | 83 | ||||||
Total |
$ | 25,893 | $ | 25,318 | ||||
Revenue from Windows 10 is primarily recognized upfront in the More Personal Computing segment, and the deferral and subsequent recognition of revenue is reflected in Corporate and Other in the table above. As of March 31, 2016, we deferred a net $4.6 billion in revenue related to Windows 10.
NOTE 15 CONTINGENCIES
Patent and Intellectual Property Claims
IPCom patent litigation
IPCom GmbH & Co. (IPCom) is a German company that holds a large portfolio of mobile technology-related patents spanning about 170 patent families and addressing a broad range of cellular technologies. IPCom has asserted 19 of these patents in litigation against Nokia and many of the leading cell phone companies and operators. In November 2014, Microsoft and IPCom entered into a standstill agreement staying all of the pending litigation against Microsoft to permit the parties to pursue settlement discussions.
InterDigital patent litigation
InterDigital Technology Corporation and InterDigital Communications Corporation (collectively, IDT) filed four patent infringement cases against Nokia in the International Trade Commission (ITC) and in U.S. District Court for the District of Delaware between 2007 and 2013. We have been added to these cases as a defendant. IDT has cases pending against other defendants based on the same patents because most of the patents at issue allegedly relate to 3G and 4G wireless communications standards essential functionality. The cases involving us include three ITC investigations where IDT sought an order excluding importation of 3G and 4G phones into the U.S. and one active case in U.S. District Court in Delaware seeking an injunction and damages. Each of the ITC matters has been resolved in our favor. In September 2015, in an inter partes review the United States Patent Trial and Appeal Board issued a final written decision that deemed unpatentable all asserted claims of the patent remaining at issue in the Delaware case. IDT has appealed this decision to the U.S. Court of Appeals for the Federal Circuit. The Delaware case has been stayed pending final completion of the inter partes review (including appeals and any subsequent proceedings in the Patent Office). We filed an antitrust complaint against IDT in the District of Delaware in August 2015 asserting violations of Section 2 of the Sherman Act, alleging the unlawful exploitation of standard essential patents. IDT filed a motion to dismiss, which remains pending.
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Item 1
European copyright levies
We assumed from Nokia all potential liability due to Nokias alleged failure to pay private copying levies in various European countries based upon sale of memory cards and mobile phones that incorporate blank memory. The levies are based upon a 2001 European Union (EU) Directive establishing a right for end users to make copies of copyrighted works for personal or private use, but also allowing the collection of levies based upon sales of blank media or recording devices to compensate copyright holders for private copying. Various collecting societies in EU countries initiated litigation against Nokia, stating that Nokia must pay levies not only based upon sales of blank memory cards, but also phones that include blank memory for data storage on the phones, regardless of actual usage of that memory. The most significant cases against Nokia are pending in Germany and Austria, due to both the high volume of sales and high levy amounts sought in these countries. In December 2015, the industry group BITKOM, of which we are a member, reached a settlement with the German collecting society for all claims from 2008 forward, leaving litigation only for the period 2004-2007 pending in Germany. In addition, the industry is engaged in settlement negotiations with the Austrian collecting society. We have also settled copyright levies litigation in Spain and France.
Other patent and intellectual property claims
In addition to these cases, there are approximately 55 other patent infringement cases pending against Microsoft.
Antitrust and Unfair Competition Claims
Three antitrust and unfair competition class action lawsuits were filed against us in British Columbia, Ontario, and Quebec, Canada on behalf of various classes of direct and indirect purchasers of our PC operating system and certain other software products between 1999 and 2005.
In 2010, the court in the British Columbia case certified it as a class action. After the British Columbia Court of Appeal dismissed the case, in 2013 the Canadian Supreme Court reversed the appellate court and reinstated part of the British Columbia case, which is now scheduled for trial beginning in 2016. The other two cases are inactive.
China State Administration for Industry and Commerce investigation
In 2014, Microsoft was informed that Chinas State Administration for Industry and Commerce (SAIC) had begun a formal investigation relating to Chinas Anti-Monopoly Law, and the SAIC conducted onsite inspections of Microsoft offices in Beijing, Shanghai, Guangzhou, and Chengdu. SAIC has stated the investigation relates to compatibility, bundle sales, file verification issues related to Windows and Office software, and potentially other issues.
Product-Related Litigation
U.S. cell phone litigation
Nokia, along with other handset manufacturers and network operators, is a defendant in 19 lawsuits filed in the Superior Court for the District of Columbia by individual plaintiffs who allege that radio emissions from cellular handsets caused their brain tumors and other adverse health effects. We assumed responsibility for these claims as part of the NDS acquisition and have been substituted for the Nokia defendants. Nine of these cases were filed in 2002 and are consolidated for certain pre-trial proceedings; the remaining 10 cases are stayed. In a separate 2009 decision, the Court of Appeals for the District of Columbia held that adverse health effect claims arising from the use of cellular handsets that operate within the U.S. Federal Communications Commission radio frequency emission guidelines (FCC Guidelines) are pre-empted by federal law. The plaintiffs allege that their handsets either operated outside the FCC Guidelines or were manufactured before the FCC Guidelines went into effect. The lawsuits also allege an industry-wide conspiracy to manipulate the science and testing around emission guidelines.
In 2013, defendants in the consolidated cases moved to exclude plaintiffs expert evidence of general causation on the basis of flawed scientific methodologies. In 2014, the court granted in part defendants motion to exclude plaintiffs general causation experts. The plaintiffs filed an interlocutory appeal challenging the standard for evaluating expert scientific evidence, which the District of Columbia Court of Appeals agreed to hear en banc. Trial court proceedings are stayed pending resolution of the appeal.
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Canadian cell phone class action
Nokia, along with other handset manufacturers and network operators, is a defendant in a 2013 class action lawsuit filed in the Supreme Court of British Columbia by a purported class of Canadians who have used cellular phones for at least 1,600 hours, including a subclass of users with brain tumors. Microsoft was served with the complaint in June 2014 and has been substituted for the Nokia defendants. The litigation is not yet active as several defendants remain to be served.
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 consolidated financial statements, these matters are subject to inherent uncertainties and managements view of these matters may change in the future.
As of March 31, 2016, we accrued aggregate legal liabilities of $520 million in other current liabilities and $10 million in other long-term liabilities. While we intend to defend these matters vigorously, adverse outcomes that we estimate could reach approximately $1.6 billion in aggregate beyond recorded amounts are reasonably possible. Were unfavorable final outcomes to occur, there exists the possibility of a material adverse impact on our consolidated financial statements for the period in which the effects become reasonably estimable.
NOTE 16 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 March 31, |
Nine Months Ended March 31, |
||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Shares of common stock repurchased |
69 | 116 | 224 | 202 | ||||||||||||
Value of common stock repurchased |
$ | 3,600 | $ | 5,000 | $ | 11,200 | $ | 9,000 | ||||||||
The above table excludes shares repurchased to settle statutory employee tax withholding related to the vesting of stock awards. On September 16, 2013, our Board of Directors approved a share repurchase program authorizing up to $40.0 billion in share repurchases. 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 March 31, 2016, $10.7 billion remained of our $40.0 billion share repurchase program. All repurchases were made using cash resources.
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Dividends
Our Board of Directors declared the following dividends:
Declaration Date | Dividend Per Share |
Record Date | Total Amount | Payment Date | ||||||||||||
(in millions) | ||||||||||||||||
Fiscal Year 2016 |
||||||||||||||||
September 15, 2015 |
$ | 0.36 | November 19, 2015 | $ | 2,868 | December 10, 2015 | ||||||||||
December 2, 2015 |
$ | 0.36 | February 18, 2016 | $ | 2,842 | March 10, 2016 | ||||||||||
March 15, 2016 |
$ | 0.36 | May 19, 2016 | $ | 2,833 | June 9, 2016 | ||||||||||
Declaration Date | Dividend Per Share |
Record Date | Total Amount | Payment Date | ||||||||||||
(in millions) | ||||||||||||||||
Fiscal Year 2015 |
||||||||||||||||
September 16, 2014 |
$ | 0.31 | November 20, 2014 | $ | 2,547 | December 11, 2014 | ||||||||||
December 3, 2014 |
$ | 0.31 | February 19, 2015 | $ | 2,532 | March 12, 2015 | ||||||||||
March 10, 2015 |
$ | 0.31 | May 21, 2015 | $ | 2,515 | June 11, 2015 | ||||||||||
The dividend declared on March 15, 2016 was included in other current liabilities as of March 31, 2016.
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NOTE 17 ACCUMULATED OTHER COMPREHENSIVE INCOME
The following table summarizes the changes in accumulated other comprehensive income by component:
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Derivatives |
||||||||||||||||
Accumulated other comprehensive income balance, beginning of period |
$ | 598 | $ | 597 | $ | 590 | $ | 31 | ||||||||
Unrealized gains (losses), net of tax effects of $(19), $25, $24, and $37 |
(125 | ) | 559 | 158 | 1,251 | |||||||||||
Reclassification adjustments for gains included in revenue |
(171 | ) | (162 | ) | (461 | ) | (290 | ) | ||||||||
Tax expense included in provision for income taxes |
11 | 4 | 26 | 6 | ||||||||||||
Amounts reclassified from accumulated other comprehensive income |
(160 | ) | (158 | ) | (435 | ) | (284 | ) | ||||||||
Net current period other comprehensive income (loss) |
(285 | ) | 401 | (277 | ) | 967 | ||||||||||
Accumulated other comprehensive income balance, end of period |
$ | 313 | $ | 998 | $ | 313 | $ | 998 | ||||||||
Investments |
||||||||||||||||
Accumulated other comprehensive income balance, beginning of period |
$ | 2,758 | $ | 3,111 | $ | 3,169 | $ | 3,531 | ||||||||
Unrealized gains, net of tax effects of $217, $133, $34, and $47 |
402 | 245 | 64 | 83 | ||||||||||||
Reclassification adjustments for gains included in other income (expense), net |
(88 | ) | (185 | ) | (200 | ) | (583 | ) | ||||||||
Tax expense included in provision for income taxes |
31 | 65 | 70 | 205 | ||||||||||||
Amounts reclassified from accumulated other comprehensive income |
(57 | ) | (120 | ) | (130 | ) | (378 | ) | ||||||||
Net current period other comprehensive income (loss) |
345 | 125 | (66 | ) | (295 | ) | ||||||||||
Accumulated other comprehensive income balance, end of period |
$ | 3,103 | $ | 3,236 | $ | 3,103 | $ | 3,236 | ||||||||
Translation adjustments and other |
||||||||||||||||
Accumulated other comprehensive income (loss) balance, beginning of period |
$ | (1,583 | ) | $ | (325 | ) | $ | (1,237 | ) | $ | 146 | |||||
Translation adjustments and other, net of tax effects of $3, $(174), $(18), and $(432) |
7 | (438 | ) | (339 | ) | (909 | ) | |||||||||
Accumulated other comprehensive loss balance, end of period |
$ | (1,576 | ) | $ | (763 | ) | $ | (1,576 | ) | $ | (763 | ) | ||||
Accumulated other comprehensive income, end of period |
$ | 1,840 | $ | 3,471 | $ | 1,840 | $ | 3,471 | ||||||||
NOTE 18 SEGMENT INFORMATION
In its operation of the business, management, including our chief operating decision maker, reviews certain financial information, including segmented internal profit and loss statements prepared on a basis not consistent with U.S. GAAP.
In June 2015, we announced a change in organizational structure as part of our transformation in the mobile-first, cloud-first world. During the first quarter of fiscal year 2016, the Companys chief operating decision maker requested changes in the information that he regularly reviews for purposes of allocating resources and assessing performance. As a result, beginning in fiscal year 2016, we report our financial performance based on our new segments, Productivity and Business Processes, Intelligent Cloud, and More Personal Computing, and analyze operating income as the measure of segment profitability. We have recast certain prior period amounts to conform to the way we internally manage and monitor segment performance.
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Our reportable segments are described below.
Productivity and Business Processes
Our Productivity and Business Processes segment consists of products and cloud services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises:
| Office Commercial, including volume licensing and subscriptions to Office 365 Commercial for products and cloud services such as Microsoft Office, Exchange, SharePoint, and Skype for Business, and related Client Access Licenses (CALs). |
| Office Consumer, including Office sold through retail or through an Office 365 Consumer subscription, and Office Consumer Services, including Outlook.com, OneDrive, and consumer Skype services. |
| Microsoft Dynamics business solutions, including Dynamics ERP products, Dynamics CRM on-premises, and Dynamics CRM Online (Microsoft Dynamics). |
Intelligent Cloud
Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business. This segment primarily comprises:
| Server products and cloud services, including Windows Server, Microsoft SQL Server, Visual Studio, System Center, and related CALs, as well as Microsoft Azure. |
| Enterprise Services, including Premier Support Services and Microsoft Consulting Services. |
More Personal Computing
Our More Personal Computing segment consists of products and services geared towards harmonizing the interests of end users, developers, and information technology professionals across screens of all sizes. This segment primarily comprises:
| Windows, including Windows original equipment manufacturer licensing (Windows OEM) and other non-volume licensing of the Windows operating system, volume licensing of the Windows operating system, patent licensing, Windows Embedded, MSN display advertising, and Windows Phone licensing. |
| Devices, including phones, Surface, and Microsoft PC accessories. |
| Gaming, including Xbox hardware; Xbox Live, comprising transactions, subscriptions, and advertising; video games; and third-party video game royalties. |
| Search advertising. |
Revenue and costs are generally directly attributed to our segments. However, due to the integrated structure of our business, certain revenue recognized and costs incurred by one segment may benefit other segments. Revenue on certain contracts is allocated among the segments based on the relative value of the underlying products and services, which can include allocation based on actual prices charged, prices when sold separately, or estimated costs plus a profit margin. Cost of revenue is allocated in certain cases based on a relative revenue methodology. Operating expenses that are allocated primarily include those relating to marketing of products and services from which multiple segments benefit, and are generally allocated based on relative gross margin.
In addition, certain costs incurred at a corporate level that are identifiable and that benefit our segments are allocated to them. These allocated costs include costs of: legal, including settlements and fines; information technology; human resources; finance; excise taxes; field selling; shared facilities services; and customer service and support. Each allocation is measured differently based on the specific facts and circumstances of the costs being allocated. Certain corporate-level activity is not allocated to our segments, including impairment, integration, and restructuring expenses.
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Segment revenue and operating income (loss) were as follows during the periods presented:
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Revenue |
||||||||||||||||
Productivity and Business Processes |
$ | 6,522 | $ | 6,457 | $ | 19,518 | $ | 19,769 | ||||||||
Intelligent Cloud |
6,096 | 5,903 | 18,331 | 17,419 | ||||||||||||
More Personal Computing |
9,458 | 9,369 | 31,563 | 33,917 | ||||||||||||
Corporate and Other |
(1,545 | ) | 0 | (4,706 | ) | 295 | ||||||||||
Total revenue |
$ | 20,531 | $ | 21,729 | $ | 64,706 | $ | 71,400 | ||||||||
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Operating income (loss) |
||||||||||||||||
Productivity and Business Processes |
$ | 2,994 | $ | 3,204 | $ | 9,461 | $ | 10,192 | ||||||||
Intelligent Cloud |
2,188 | 2,533 | 7,168 | 7,238 | ||||||||||||
More Personal Computing |
1,645 | 1,049 | 5,178 | 4,063 | ||||||||||||
Corporate and Other |
(1,544 | ) | (192 | ) | (4,705 | ) | (1,279 | ) | ||||||||
Total operating income |
$ | 5,283 | $ | 6,594 | $ | 17,102 | $ | 20,214 | ||||||||
Corporate and Other operating income (loss) includes adjustments to conform our internal accounting policies to U.S. GAAP, and impairment, integration, and restructuring expenses. Significant internal accounting policies that differ from U.S. GAAP relate to revenue recognition.
Corporate and Other operating income (loss) activity was as follows during the periods presented:
(In millions) | Three Months Ended March 31, |
Nine Months Ended March 31, |
||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Revenue reconciling amounts and other (a) |
$ | (1,544 | ) | $ | (2 | ) | $ | (4,705 | ) | $ | 294 | |||||
Impairment, integration, and restructuring expenses |
0 | (190 | ) | 0 | (1,573 | ) | ||||||||||
Total Corporate and Other |
$ | (1,544 | ) | $ | (192 | ) | $ | (4,705 | ) | $ | (1,279 | ) | ||||
(a) | Revenue reconciling amounts and other for the three months ended March 31, 2016 primarily consisted of a net $1.6 billion of revenue deferrals related to sales of Windows 10. |
Revenue reconciling amounts and other for the nine months ended March 31, 2016 primarily consisted of a net $4.6 billion of revenue deferrals related to sales of Windows 10. Revenue reconciling amounts and other for the nine months ended March 31, 2015 included the net recognition of $296 million of previously deferred revenue related to bundled products and services. |
Assets are not allocated to segments for internal reporting presentations. A portion of amortization and depreciation is included with various other costs in an overhead allocation to each segment, and it is impracticable for us to separately identify the amount of amortization and depreciation by segment that is included in the measure of segment profit or loss.
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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 Company) as of March 31, 2016, and the related consolidated statements of income, comprehensive income, cash flows, and stockholders equity for the three-month and nine-month periods ended March 31, 2016 and 2015. These interim financial statements are the responsibility of the Companys 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 the Company as of June 30, 2015, 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 31, 2015 (October 26, 2015 as to the effects of the retrospective adjustments in Note 1, 10, 15, and 22) 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, 2015 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
/S/ DELOITTE & TOUCHE LLP
Seattle, Washington
April 21, 2016
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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Note About Forward-Looking Statements
This report includes estimates, projections, statements relating to our business plans, objectives, and expected operating results that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may appear throughout this report, including the following sections: 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 that may cause actual results to differ materially. We describe risks and uncertainties that could cause actual results and events to differ materially in Risk Factors (Part II, Item 1A of this Form 10-Q), Quantitative and Qualitative Disclosures about Market Risk (Part I, Item 3 of this Form 10-Q), and Managements Discussion and Analysis (Part I, Item 2 of this Form 10-Q). We undertake no obligation to update or revise publicly any forward-looking statements, whether because of new information, future events, or otherwise.
OVERVIEW
The following Managements Discussion and Analysis (MD&A) is intended to help the reader understand the results of operations and financial condition of Microsoft Corporation. MD&A is provided as a supplement to, and should be read in conjunction with, our Annual Report on Form 10-K for the year ended June 30, 2015, our Form 8-K filed on October 27, 2015, and our consolidated financial statements and the accompanying Notes to Financial Statements in this Form 10-Q.
Microsoft is a technology leader focused on building best-in-class platforms and productivity services for a mobile-first, cloud-first world. We strive to empower every person and every organization on the planet to achieve more. We develop and market software, services, and devices that deliver new opportunities, greater convenience, and enhanced value to peoples lives.
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, manufacturing, 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, datacenter costs in support of our cloud-based services, and income taxes.
In July 2015, we announced a restructuring of our phone business, including the creation of the Windows and Devices Group. This reinforces our strategy to create a vibrant Windows ecosystem with a single set of experiences across our first-party device family and original equipment manufacturer (OEM) offerings. Part of this strategy involves focusing our phone devices on a narrower range of customer categories and differentiating through the combination of hardware and software we are uniquely positioned to offer. Our change in strategy for the phone business is expected to result in a reduction in units sold and associated expenses.
Highlights from the third quarter of fiscal year 2016 included:
| Our commercial cloud, which primarily comprises Office 365 Commercial, Microsoft Azure, and Dynamics CRM Online, reached an annualized run rate* exceeding $10.0 billion. |
| Office 365 Consumer subscribers increased to 22.2 million. |
| Dynamics CRM Online seat additions more than doubled year-over-year. |
| Microsoft Azure revenue grew 110%, with usage of Azure compute and Azure SQL database more than doubling year-over-year. Enterprise Mobility customers more than doubled year-over-year to 27,000, and the installed base nearly quadrupled year-over-year. |
| Windows 10 is now active on more than 270 million devices around the world. |
| Xbox Live monthly active users grew 26% year-over-year to 46 million. |
* | Annualized run rate was calculated by multiplying March 2016 revenue by twelve months. |
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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.
Economic Conditions, Challenges, and Risks
The market for software, devices, and cloud-based services is dynamic and highly competitive. Our competitors are developing new software and devices, while also deploying competing cloud-based services for consumers and businesses. The devices and form factors customers prefer evolve rapidly, and influence how users access services in the cloud, and in some cases, the users choice of which suite of cloud-based services to use. We must continue to evolve and adapt over an extended time in pace with this changing environment. The investments we are making in devices and infrastructure will continue to increase our operating costs and may decrease our operating margins.
Our success is highly dependent on our ability to attract and retain qualified employees. We hire a mix of university and industry talent worldwide. Microsoft competes for talented individuals globally by offering an exceptional working environment, broad customer reach, scale in resources, the ability to grow ones career across many different products and businesses, and competitive compensation and benefits. Aggregate demand for our software, services, and devices is correlated to global macroeconomic and geopolitical factors, which remain dynamic.
Our international operations provide a significant portion of our total revenue and expenses. Many of these revenue and expenses are denominated in currencies other than the U.S. dollar. As a result, changes in foreign exchange rates may significantly affect revenue and expenses. The strengthening of the U.S. dollar relative to certain foreign currencies throughout fiscal year 2015, and continuing into fiscal year 2016, negatively impacted reported revenue and reduced reported expenses from our international operations in the current period as compared to the prior year.
See a discussion of these factors and other risks under Risk Factors (Part II, Item 1A of this Form 10-Q).
Seasonality
Our revenue historically has fluctuated quarterly and has generally been highest in the second quarter of our fiscal year due to corporate calendar year-end spending trends in our major markets and holiday season spending by consumers.
Unearned Revenue
Quarterly and annual revenue is impacted by the deferral of revenue, primarily including:
| Revenue deferred on Windows 10 licenses to reflect ratable recognition over the life of the device. |
| Revenue deferred on bundled products and services (Bundled Offerings). |
If our customers choose 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 18 Segment Information of the Notes to Financial Statements is also presented on this basis. All differences between our internal management reporting basis and accounting principles generally accepted in the United States (U.S. GAAP), along with certain corporate-level and other activity, are included in Corporate and Other.
In June 2015, we announced a change in organizational structure as part of our transformation in the mobile-first, cloud-first world. During the first quarter of fiscal year 2016, the Companys chief operating decision maker, who is also our Chief Executive Officer, requested changes in the information that he regularly reviews for purposes of allocating resources and assessing performance. As a result, beginning in fiscal year 2016, we report our financial
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performance based on our new segments, Productivity and Business Processes, Intelligent Cloud, and More Personal Computing, and analyze operating income as the measure of segment profitability. We have recast certain previously reported amounts to conform to the way we internally manage and monitor segment performance.
Our reportable segments are described below.
Productivity and Business Processes
Our Productivity and Business Processes segment consists of products and cloud services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises:
| Office Commercial, including volume licensing and subscriptions to Office 365 Commercial for products and cloud services such as Microsoft Office, Exchange, SharePoint, and Skype for Business, and related Client Access Licenses (CALs). |
| Office Consumer, including Office sold through retail or through an Office 365 Consumer subscription, and Office Consumer Services, including Outlook.com, OneDrive, and consumer Skype services. |
| Microsoft Dynamics business solutions, including Dynamics ERP products, Dynamics CRM on-premises, and Dynamics CRM Online (Microsoft Dynamics). |
Intelligent Cloud
Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business. This segment primarily comprises:
| Server products and cloud services, including Windows Server, Microsoft SQL Server, Visual Studio, System Center, and related CALs, as well as Microsoft Azure. |
| Enterprise Services, including Premier Support Services and Microsoft Consulting Services. |
More Personal Computing
Our More Personal Computing segment consists of products and services geared towards harmonizing the interests of end users, developers, and information technology professionals across screens of all sizes. This segment primarily comprises:
| Windows, including Windows OEM licensing (Windows OEM) and other non-volume licensing of the Windows operating system, volume licensing of the Windows operating system, patent licensing, Windows Embedded, MSN display advertising, and Windows Phone licensing. |
| Devices, including phones, Surface, and Microsoft PC accessories. |
| Gaming, including Xbox hardware; Xbox Live, comprising transactions, subscriptions, and advertising; video games; and third-party video game royalties. |
| Search advertising. |
SUMMARY RESULTS OF OPERATIONS
(In millions, except percentages and per share amounts) | Three Months Ended March 31, |
Percentage Change |
Nine Months Ended March 31, |
Percentage Change |
||||||||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||||||||||
Revenue |
$ | 20,531 | $ | 21,729 | (6)% | $ | 64,706 | $ | 71,400 | (9)% | ||||||||||||||
Gross margin |
$ | 12,809 | $ | 14,568 | (12)% | $ | 39,905 | $ | 45,830 | (13)% | ||||||||||||||
Operating income |
$ | 5,283 | $ | 6,594 | (20)% | $ | 17,102 | $ | 20,214 | (15)% | ||||||||||||||
Diluted earnings per share |
$ | 0.47 | $ | 0.61 | (23)% | $ | 1.70 | $ | 1.86 | (9)% | ||||||||||||||
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Three months ended March 31, 2016 compared with three months ended March 31, 2015
Revenue decreased $1.2 billion or 6%, primarily due to the impact of a net revenue deferral related to Windows 10 of $1.6 billion and an unfavorable foreign currency impact of approximately $838 million or 4%, offset in part by revenue growth in each of our reportable segments. Windows 10 revenue is primarily recognized upfront in the More Personal Computing segment, and the deferral and subsequent recognition of revenue is reflected in Corporate and Other. Intelligent Cloud revenue increased, primarily due to higher Enterprise Services revenue, as well as higher revenue from server products and cloud services, including Microsoft Azure. More Personal Computing revenue increased, primarily due to revenue growth in search advertising and Gaming, offset in part by lower revenue from Windows and Devices. Productivity and Business Processes revenue increased, driven by higher revenue from Office and Microsoft Dynamics.
Operating income decreased $1.3 billion or 20%, primarily due to lower gross margin, offset in part by a reduction in operating expenses, and impairment, integration, and restructuring expenses in the prior year. Gross margin decreased $1.8 billion or 12%, driven by the decline in revenue as discussed above, and included an unfavorable foreign currency impact of approximately $749 million or 5%. Productivity and Business Processes and Intelligent Cloud gross margin decreased, offset in part by higher gross margin from More Personal Computing.
Key changes in expenses were:
| Cost of revenue increased $561 million or 8%, mainly due to growth in our commercial cloud and search advertising, offset in part by lower phone sales, driven by the previously announced change in strategy for the phone business. |
| Operating expenses decreased $258 million or 3%, primarily due to a decline in sales and marketing expenses, driven by a reduction in phone expenses. |
| Impairment, integration, and restructuring expenses were $190 million in the prior year, comprised mainly of restructuring charges associated with our July 2014 restructuring plan to simplify our organization and align the purchase of Nokia Corporations Devices and Services business (NDS) with our overall strategy (Phone Hardware Integration Plan). |
Diluted earnings per share (EPS) was $0.47 for the three months ended March 31, 2016. Current year diluted EPS was negatively impacted by net revenue deferrals, primarily related to Windows 10, which resulted in a decrease to diluted EPS of $0.15, and was favorably impacted by the adoption of new accounting guidance related to stock-based compensation, which resulted in an increase to diluted EPS of $0.01. Diluted EPS was $0.61 for the three months ended March 31, 2015. Prior year diluted EPS was negatively impacted by impairment, integration, and restructuring expenses, which resulted in a decrease to diluted EPS of $0.01.
Nine months ended March 31, 2016 compared with nine months ended March 31, 2015
Revenue decreased $6.7 billion or 9%, primarily due to the impact of a net revenue deferral related to Windows 10 of $4.6 billion and an unfavorable foreign currency impact of approximately $3.2 billion or 4%. More Personal Computing revenue decreased, primarily due to lower revenue from Devices and Windows, offset in part by revenue growth in search advertising and Gaming. Productivity and Business Processes revenue decreased, driven by an unfavorable foreign currency impact. Intelligent Cloud revenue increased, primarily due to higher revenue from server products and cloud services, including Microsoft Azure, and Enterprise Services revenue.
Operating income decreased $3.1 billion or 15%, primarily due to lower gross margin, offset in part by prior year impairment, integration, and restructuring expenses and a reduction in operating expenses in the current year. Gross margin decreased $5.9 billion or 13%, driven by the decline in revenue as discussed above, and included an unfavorable foreign currency impact of approximately $2.8 billion or 6%. Productivity and Business Processes and More Personal Computing gross margin decreased, offset in part by higher gross margin from Intelligent Cloud.
Key changes in expenses were:
| Cost of revenue decreased $769 million or 3%, mainly due to lower phone sales, driven by the previously announced change in strategy for the phone business, offset in part by growth in our commercial cloud and search advertising. |
| Impairment, integration, and restructuring expenses were $1.6 billion in the prior year, comprised mainly of restructuring charges associated with our Phone Hardware Integration Plan. |
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| Operating expenses decreased $1.2 billion or 5%, primarily due to a decline in sales and marketing expenses, driven by a reduction in phone expenses and a favorable foreign currency impact of approximately 4%. |
Diluted EPS was $1.70 for the nine months ended March 31, 2016. Current year diluted EPS was negatively impacted by net revenue deferrals, primarily related to Windows 10, which resulted in a decrease to diluted EPS of $0.40, and was favorably impacted by the adoption of new accounting guidance related to stock-based compensation, which resulted in an increase to diluted EPS of $0.05. Diluted EPS was $1.86 for the nine months ended March 31, 2015. Prior year diluted EPS was negatively impacted by impairment, integration, and restructuring expenses, and favorably impacted by the recognition of previously deferred net revenue related to Bundled Offerings, which resulted in a net decrease to diluted EPS of $0.13.
SEGMENT RESULTS OF OPERATIONS
(In millions, except percentages) | Three Months Ended March 31, |
Percentage Change |
Nine Months Ended March 31, |
Percentage Change |
||||||||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||||||||||
Revenue |