UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended December 31, 2014
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Transition Period From to
Commission File Number: 0-14278
MICROSOFT CORPORATION
(Exact name of registrant as specified in its charter)
Washington | 91-1144442 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) | |
One Microsoft Way, Redmond, Washington | 98052-6399 | |
(Address of principal executive offices) | (Zip Code) |
(425) 882-8080
(Registrants telephone number, including area code)
None
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer x |
Accelerated filer ¨ | |
Non-accelerated filer ¨ (Do not check if a smaller reporting company) |
Smaller reporting company ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
Class | Outstanding at January 22, 2015 | |||
Common Stock, $0.00000625 par value per share |
8,203,785,341 shares |
FORM 10-Q
For the Quarter Ended December 31, 2014
INDEX
2
PART I
Item 1
(In millions, except per share amounts) (Unaudited) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Revenue |
$ | 26,470 | $ | 24,519 | $ | 49,671 | $ | 43,048 | ||||||||
Cost of revenue |
10,136 | 8,322 | 18,409 | 13,467 | ||||||||||||
Gross margin |
16,334 | 16,197 | 31,262 | 29,581 | ||||||||||||
Research and development |
2,903 | 2,748 | 5,968 | 5,515 | ||||||||||||
Sales and marketing |
4,315 | 4,283 | 8,043 | 7,587 | ||||||||||||
General and administrative |
1,097 | 1,197 | 2,248 | 2,176 | ||||||||||||
Integration and restructuring |
243 | 0 | 1,383 | 0 | ||||||||||||
Operating income |
7,776 | 7,969 | 13,620 | 14,303 | ||||||||||||
Other income (expense), net |
74 | (91 | ) | 126 | (17 | ) | ||||||||||
Income before income taxes |
7,850 | 7,878 | 13,746 | 14,286 | ||||||||||||
Provision for income taxes |
1,987 | 1,320 | 3,343 | 2,484 | ||||||||||||
Net income |
$ | 5,863 | $ | 6,558 | $ | 10,403 | $ | 11,802 | ||||||||
Earnings per share: |
||||||||||||||||
Basic |
$ | 0.71 | $ | 0.79 | $ | 1.26 | $ | 1.42 | ||||||||
Diluted |
$ | 0.71 | $ | 0.78 | $ | 1.25 | $ | 1.40 | ||||||||
Weighted average shares outstanding: |
||||||||||||||||
Basic |
8,228 | 8,326 | 8,238 | 8,333 | ||||||||||||
Diluted |
8,297 | 8,395 | 8,321 | 8,423 | ||||||||||||
Cash dividends declared per common share |
$ | 0.31 | $ | 0.28 | $ | 0.62 | $ | 0.56 | ||||||||
See accompanying notes.
3
PART I
Item 1
COMPREHENSIVE INCOME STATEMENTS
(In millions) (Unaudited) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Net income |
$ | 5,863 | $ | 6,558 | $ | 10,403 | $ | 11,802 | ||||||||
Other comprehensive income (loss): |
||||||||||||||||
Net unrealized gains on derivatives (net of tax effects of $6, $1, $10, and $(2)) |
247 | 43 | 566 | 17 | ||||||||||||
Net unrealized gains (losses) on investments (net of tax effects of $(124), $245, $(226), and $737) |
(231 | ) | 482 | (420 | ) | 1,434 | ||||||||||
Translation adjustments and other (net of tax effects of $(211), $11, $(258), and $44) |
(390 | ) | 21 | (471 | ) | 83 | ||||||||||
Other comprehensive income (loss) |
(374 | ) | 546 | (325 | ) | 1,534 | ||||||||||
Comprehensive income |
$ | 5,489 | $ | 7,104 | $ | 10,078 | $ | 13,336 | ||||||||
See accompanying notes.
4
PART I
Item 1
(In millions) (Unaudited) | ||||||||
December 31, 2014 |
June 30, 2014 |
|||||||
Assets |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 6,426 | $ | 8,669 | ||||
Short-term investments (including securities loaned of $414 and $541) |
83,823 | 77,040 | ||||||
Total cash, cash equivalents, and short-term investments |
90,249 | 85,709 | ||||||
Accounts receivable, net of allowance for doubtful accounts of $288 and $301 |
16,186 | 19,544 | ||||||
Inventories |
2,053 | 2,660 | ||||||
Deferred income taxes |
1,701 | 1,941 | ||||||
Other |
6,173 | 4,392 | ||||||
Total current assets |
116,362 | 114,246 | ||||||
Property and equipment, net of accumulated depreciation of $16,192 and $14,793 |
13,607 | 13,011 | ||||||
Equity and other investments |
12,665 | 14,597 | ||||||
Goodwill |
21,855 | 20,127 | ||||||
Intangible assets, net |
7,299 | 6,981 | ||||||
Other long-term assets |
3,060 | 3,422 | ||||||
Total assets |
$ | 174,848 | $ | 172,384 | ||||
Liabilities and stockholders equity |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 6,932 | $ | 7,432 | ||||
Short-term debt |
8,299 | 2,000 | ||||||
Current portion of long-term debt |
1,749 | 0 | ||||||
Accrued compensation |
3,479 | 4,797 | ||||||
Income taxes |
711 | 782 | ||||||
Short-term unearned revenue |
19,192 | 23,150 | ||||||
Securities lending payable |
430 | 558 | ||||||
Other |
6,623 | 6,906 | ||||||
Total current liabilities |
47,415 | 45,625 | ||||||
Long-term debt |
18,260 | 20,645 | ||||||
Long-term unearned revenue |
2,051 | 2,008 | ||||||
Deferred income taxes |
2,820 | 2,728 | ||||||
Other long-term liabilities |
12,423 | 11,594 | ||||||
Total liabilities |
82,969 | 82,600 | ||||||
Commitments and contingencies |
||||||||
Stockholders equity: |
||||||||
Common stock and paid-in capitalshares authorized 24,000; outstanding 8,218 and 8,239 |
68,765 | 68,366 | ||||||
Retained earnings |
19,731 | 17,710 | ||||||
Accumulated other comprehensive income |
3,383 | 3,708 | ||||||
Total stockholders equity |
91,879 | 89,784 | ||||||
Total liabilities and stockholders equity |
$ | 174,848 | $ | 172,384 | ||||
See accompanying notes.
5
PART I
Item 1
(In millions) (Unaudited) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Operations |
||||||||||||||||
Net income |
$ | 5,863 | $ | 6,558 | $ | 10,403 | $ | 11,802 | ||||||||
Adjustments to reconcile net income to net cash from operations: |
||||||||||||||||
Depreciation, amortization, and other |
1,521 | 1,261 | 2,949 | 2,215 | ||||||||||||
Stock-based compensation expense |
633 | 591 | 1,279 | 1,226 | ||||||||||||
Net recognized losses (gains) on investments and derivatives |
(179 | ) | 47 | (124 | ) | 140 | ||||||||||
Excess tax benefits from stock-based compensation |
(22 | ) | (20 | ) | (524 | ) | (225 | ) | ||||||||
Deferred income taxes |
314 | (176 | ) | 615 | 228 | |||||||||||
Deferral of unearned revenue |
10,200 | 9,845 | 18,222 | 17,281 | ||||||||||||
Recognition of unearned revenue |
(11,495 | ) | (10,578 | ) | (22,138 | ) | (20,255 | ) | ||||||||
Changes in operating assets and liabilities: |
||||||||||||||||
Accounts receivable |
(3,378 | ) | (4,875 | ) | 3,249 | 1,742 | ||||||||||
Inventories |
1,070 | 1,029 | 587 | 362 | ||||||||||||
Other current assets |
(159 | ) | (95 | ) | (439 | ) | (651 | ) | ||||||||
Other long-term assets |
170 | (315 | ) | 449 | (396 | ) | ||||||||||
Accounts payable |
137 | 602 | (522 | ) | 326 | |||||||||||
Other current liabilities |
(986 | ) | 388 | (2,152 | ) | (867 | ) | |||||||||
Other long-term liabilities |
651 | 151 | 840 | (310 | ) | |||||||||||
Net cash from operations |
4,340 | 4,413 | 12,694 | 12,618 | ||||||||||||
Financing |
||||||||||||||||
Proceeds from issuance of short-term debt, maturities of 90 days or less, net |
4,798 | (712 | ) | 7,797 | 0 | |||||||||||
Proceeds from issuance of debt |
0 | 8,262 | 0 | 8,850 | ||||||||||||
Repayments of debt |
0 | (588 | ) | (1,500 | ) | (1,588 | ) | |||||||||
Common stock issued |
121 | 117 | 337 | 320 | ||||||||||||
Common stock repurchased |
(2,145 | ) | (2,113 | ) | (5,033 | ) | (4,301 | ) | ||||||||
Common stock cash dividends paid |
(2,547 | ) | (2,332 | ) | (4,854 | ) | (4,248 | ) | ||||||||
Excess tax benefits from stock-based compensation |
22 | 20 | 524 | 225 | ||||||||||||
Other |
285 | (39 | ) | 285 | (39 | ) | ||||||||||
Net cash from (used in) financing |
534 | 2,615 | (2,444 | ) | (781 | ) | ||||||||||
Investing |
||||||||||||||||
Additions to property and equipment |
(1,490 | ) | (1,732 | ) | (2,772 | ) | (2,963 | ) | ||||||||
Acquisition of companies, net of cash acquired, and purchases of intangible and other assets |
(2,794 | ) | (139 | ) | (2,935 | ) | (154 | ) | ||||||||
Purchases of investments |
(19,167 | ) | (13,126 | ) | (43,252 | ) | (27,894 | ) | ||||||||
Maturities of investments |
2,389 | 1,451 | 4,082 | 1,798 | ||||||||||||
Sales of investments |
16,108 | 12,354 | 32,553 | 23,471 | ||||||||||||
Securities lending payable |
238 | 167 | (129 | ) | 103 | |||||||||||
Net cash used in investing |
(4,716 | ) | (1,025 | ) | (12,453 | ) | (5,639 | ) | ||||||||
Effect of exchange rates on cash and cash equivalents |
(34 | ) | 33 | (40 | ) | 57 | ||||||||||
Net change in cash and cash equivalents |
124 | 6,036 | (2,243 | ) | 6,255 | |||||||||||
Cash and cash equivalents, beginning of period |
6,302 | 4,023 | 8,669 | 3,804 | ||||||||||||
Cash and cash equivalents, end of period |
$ | 6,426 | $ | 10,059 | $ | 6,426 | $ | 10,059 | ||||||||
See accompanying notes.
6
PART I
Item 1
STOCKHOLDERS EQUITY STATEMENTS
(In millions) (Unaudited) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Common stock and paid-in capital |
||||||||||||||||
Balance, beginning of period |
$ | 68,362 | $ | 67,230 | $ | 68,366 | $ | 67,306 | ||||||||
Common stock issued |
121 | 117 | 337 | 320 | ||||||||||||
Common stock repurchased |
(376 | ) | (486 | ) | (1,744 | ) | (1,607 | ) | ||||||||
Stock-based compensation expense |
633 | 591 | 1,279 | 1,226 | ||||||||||||
Stock-based compensation income tax benefits |
23 | 21 | 525 | 226 | ||||||||||||
Other, net |
2 | 3 | 2 | 5 | ||||||||||||
Balance, end of period |
68,765 | 67,476 | 68,765 | 67,476 | ||||||||||||
Retained earnings |
||||||||||||||||
Balance, beginning of period |
18,051 | 11,680 | 17,710 | 9,895 | ||||||||||||
Net income |
5,863 | 6,558 | 10,403 | 11,802 | ||||||||||||
Common stock cash dividends |
(2,534 | ) | (2,319 | ) | (5,093 | ) | (4,656 | ) | ||||||||
Common stock repurchased |
(1,649 | ) | (1,572 | ) | (3,289 | ) | (2,694 | ) | ||||||||
Balance, end of period |
19,731 | 14,347 | 19,731 | 14,347 | ||||||||||||
Accumulated other comprehensive income |
||||||||||||||||
Balance, beginning of period |
3,757 | 2,731 | 3,708 | 1,743 | ||||||||||||
Other comprehensive income (loss) |
(374 | ) | 546 | (325 | ) | 1,534 | ||||||||||
Balance, end of period |
3,383 | 3,277 | 3,383 | 3,277 | ||||||||||||
Total stockholders equity |
$ | 91,879 | $ | 85,100 | $ | 91,879 | $ | 85,100 | ||||||||
See accompanying notes.
7
PART I
Item 1
(Unaudited)
NOTE 1 ACCOUNTING POLICIES
Accounting Principles
We prepared 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 2014 Form 10-K filed with the U.S. Securities and Exchange Commission on July 31, 2014.
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.
Estimates and Assumptions
Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Examples of estimates include: loss contingencies; product warranties; the fair value of, and/or potential goodwill impairment for, our reporting units; product life cycles; useful lives of our tangible and intangible assets; allowances for doubtful accounts; allowances for product returns; the market value of our inventory; and stock-based compensation forfeiture rates. Examples of assumptions include: the elements comprising a software arrangement, including the distinction between upgrades or enhancements and new products; when technological feasibility is achieved for our products; the potential outcome of future tax consequences of events that have been recognized in our 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.
Recent Accounting Guidance
Recent accounting guidance not yet adopted
In May 2014, as part of its ongoing efforts to assist in the convergence of U.S. GAAP and International Financial Reporting Standards, the Financial Accounting Standards Board 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, 2017, and early adoption is not permitted. We anticipate this standard will have a material impact on our consolidated financial statements, and we are currently evaluating its impact.
8
PART I
Item 1
NOTE 2 EARNINGS PER SHARE
Basic earnings per share (EPS) is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and stock awards.
The components of basic and diluted EPS are as follows:
(In millions, except earnings per share) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Net income available for common shareholders (A) |
$ | 5,863 | $ | 6,558 | $ | 10,403 | $ | 11,802 | ||||||||
Weighted average outstanding shares of common stock (B) |
8,228 | 8,326 | 8,238 | 8,333 | ||||||||||||
Dilutive effect of stock-based awards |
69 | 69 | 83 | 90 | ||||||||||||
Common stock and common stock equivalents (C) |
8,297 | 8,395 | 8,321 | 8,423 | ||||||||||||
Earnings Per Share | ||||||||||||||||
Basic (A/B) |
$ | 0.71 | $ | 0.79 | $ | 1.26 | $ | 1.42 | ||||||||
Diluted (A/C) |
$ | 0.71 | $ | 0.78 | $ | 1.25 | $ | 1.40 | ||||||||
Anti-dilutive stock-based awards excluded from the calculations of diluted EPS were immaterial during the periods presented.
NOTE 3 OTHER INCOME (EXPENSE)
The components of other income (expense) were as follows:
(In millions) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Dividends and interest income |
$ | 183 | $ | 219 | $ | 408 | $ | 398 | ||||||||
Interest expense |
(162 | ) | (135 | ) | (323 | ) | (253 | ) | ||||||||
Net recognized gains on investments |
317 | 70 | 396 | 63 | ||||||||||||
Net losses on derivatives |
(138 | ) | (117 | ) | (272 | ) | (203 | ) | ||||||||
Net gains (losses) on foreign currency remeasurements |
83 | (17 | ) | 161 | 9 | |||||||||||
Other |
(209 | ) | (111 | ) | (244 | ) | (31 | ) | ||||||||
Total |
$ | 74 | $ | (91 | ) | $ | 126 | $ | (17 | ) | ||||||
Following are details of net recognized gains on investments during the periods reported:
(In millions) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Other-than-temporary impairments of investments |
$ | (26 | ) | $ | (30 | ) | $ | (35 | ) | $ | (66 | ) | ||||
Realized gains from sales of available-for-sale securities |
421 | 144 | 539 | 258 | ||||||||||||
Realized losses from sales of available-for-sale securities |
(78 | ) | (44 | ) | (108 | ) | (129 | ) | ||||||||
Total |
$ | 317 | $ | 70 | $ | 396 | $ | 63 | ||||||||
9
PART I
Item 1
NOTE 4 INVESTMENTS
Investment Components
The components of investments, including associated derivatives but excluding held-to-maturity investments, were as follows:
(In millions) | Cost Basis | Unrealized Gains |
Unrealized Losses |
Recorded Basis |
Cash and Cash Equivalents |
Short-term Investments |
Equity and Other Investments |
|||||||||||||||||||||
December 31, 2014 | ||||||||||||||||||||||||||||
Cash |
$ | 4,468 | $ | 0 | $ | 0 | $ | 4,468 | $ | 4,468 | $ | 0 | $ | 0 | ||||||||||||||
Mutual funds |
651 | 0 | 0 | 651 | 651 | 0 | 0 | |||||||||||||||||||||
Commercial paper |
144 | 0 | 0 | 144 | 94 | 50 | 0 | |||||||||||||||||||||
Certificates of deposit |
1,248 | 0 | 0 | 1,248 | 1,006 | 242 | 0 | |||||||||||||||||||||
U.S. government and agency securities |
68,347 | 39 | (70 | ) | 68,316 | 201 | 68,115 | 0 | ||||||||||||||||||||
Foreign government bonds |
5,162 | 5 | (22 | ) | 5,145 | 0 | 5,145 | 0 | ||||||||||||||||||||
Mortgage- and asset-backed securities |
2,848 | 28 | (3 | ) | 2,873 | 0 | 2,873 | 0 | ||||||||||||||||||||
Corporate notes and bonds |
6,918 | 135 | (49 | ) | 7,004 | 6 | 6,998 | 0 | ||||||||||||||||||||
Municipal securities |
286 | 54 | 0 | 340 | 0 | 340 | 0 | |||||||||||||||||||||
Common and preferred stock |
6,865 | 4,982 | (283 | ) | 11,564 | 0 | 0 | 11,564 | ||||||||||||||||||||
Other investments |
810 | 0 | 0 | 810 | 0 | 60 | 750 | |||||||||||||||||||||
Total |
$ | 97,747 | $ | 5,243 | $ | (427 | ) | $ | 102,563 | $ | 6,426 | $ | 83,823 | $ | 12,314 | |||||||||||||
(In millions) | Cost Basis | Unrealized Gains |
Unrealized Losses |
Recorded Basis |
Cash and Cash Equivalents |
Short-term Investments |
Equity and Other Investments |
|||||||||||||||||||||
June 30, 2014 | ||||||||||||||||||||||||||||
Cash |
$ | 4,980 | $ | 0 | $ | 0 | $ | 4,980 | $ | 4,980 | $ | 0 | $ | 0 | ||||||||||||||
Mutual funds |
590 | 0 | 0 | 590 | 590 | 0 | 0 | |||||||||||||||||||||
Commercial paper |
189 | 0 | 0 | 189 | 89 | 100 | 0 | |||||||||||||||||||||
Certificates of deposit |
1,197 | 0 | 0 | 1,197 | 865 | 332 | 0 | |||||||||||||||||||||
U.S. government and agency securities |
66,952 | 103 | (29 | ) | 67,026 | 109 | 66,917 | 0 | ||||||||||||||||||||
Foreign government bonds |
3,328 | 17 | (10 | ) | 3,335 | 2,027 | 1,308 | 0 | ||||||||||||||||||||
Mortgage- and asset-backed securities |
1,048 | 31 | (2 | ) | 1,077 | 0 | 1,077 | 0 | ||||||||||||||||||||
Corporate notes and bonds |
6,788 | 190 | (9 | ) | 6,969 | 9 | 6,960 | 0 | ||||||||||||||||||||
Municipal securities |
287 | 45 | 0 | 332 | 0 | 332 | 0 | |||||||||||||||||||||
Common and preferred stock |
6,785 | 5,207 | (81 | ) | 11,911 | 0 | 0 | 11,911 | ||||||||||||||||||||
Other investments |
1,164 | 0 | 0 | 1,164 | 0 | 14 | 1,150 | |||||||||||||||||||||
Total |
$ | 93,308 | $ | 5,593 | $ | (131 | ) | $ | 98,770 | $ | 8,669 | $ | 77,040 | $ | 13,061 | |||||||||||||
In addition to the investments in the table above, we also own corporate notes that were purchased in connection with our agreement to lend $2.0 billion to the group that completed their acquisition of Dell on October 29, 2013. These corporate notes are classified as held-to-maturity investments and are included in equity and other investments on the balance sheet. The corporate notes are due October 31, 2023, and are measured at fair value on a non-recurring basis. As of December 31, 2014, the amortized cost, recorded basis, and estimated fair value of these corporate notes were $351 million, $351 million, and $429 million, respectively, while their associated gross unrealized holding gains were $78 million. As of June 30, 2014, the amortized cost, recorded basis, and estimated fair value of these corporate notes was $1.5 billion, $1.5 billion, and $1.7 billion, respectively, while their associated gross unrealized holding gains were $164 million.
10
PART I
Item 1
As of December 31, 2014 and June 30, 2014, the recorded bases of common and preferred stock that are restricted for more than one year or are not publicly traded were $550 million and $520 million, respectively. These investments are carried at cost and are reviewed quarterly for indicators of other-than-temporary impairment. It is not practicable for us to reliably estimate the fair value of these investments.
Unrealized Losses on Investments
Investments with continuous unrealized losses for less than 12 months and 12 months or greater and their related fair values were as follows:
Less than 12 Months | 12 Months or Greater | Total Unrealized Losses |
||||||||||||||||||||||
(In millions) | Fair Value | Unrealized Losses |
Fair Value | Unrealized Losses |
Total Fair Value |
|||||||||||||||||||
December 31, 2014 | ||||||||||||||||||||||||
U.S. government and agency securities |
$ | 29,604 | $ | (37 | ) | $ | 563 | $ | (33 | ) | $ | 30,167 | $ | (70 | ) | |||||||||
Foreign government bonds |
3,724 | (10 | ) | 28 | (12 | ) | 3,752 | (22 | ) | |||||||||||||||
Mortgage- and asset-backed securities |
1,529 | (2 | ) | 27 | (1 | ) | 1,556 | (3 | ) | |||||||||||||||
Corporate notes and bonds |
2,717 | (41 | ) | 243 | (8 | ) | 2,960 | (49 | ) | |||||||||||||||
Common and preferred stock |
1,319 | (234 | ) | 146 | (49 | ) | 1,465 | (283 | ) | |||||||||||||||
Total |
$ | 38,893 | $ | (324 | ) | $ | 1,007 | $ | (103 | ) | $ | 39,900 | $ | (427 | ) | |||||||||
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, 2014 | ||||||||||||||||||||||||
U.S. government and agency securities |
$ | 4,161 | $ | (29 | ) | $ | 850 | $ | 0 | $ | 5,011 | $ | (29 | ) | ||||||||||
Foreign government bonds |
566 | (4 | ) | 21 | (6 | ) | 587 | (10 | ) | |||||||||||||||
Mortgage- and asset-backed securities |
120 | 0 | 61 | (2 | ) | 181 | (2 | ) | ||||||||||||||||
Corporate notes and bonds |
1,154 | (8 | ) | 34 | (1 | ) | 1,188 | (9 | ) | |||||||||||||||
Common and preferred stock |
463 | (48 | ) | 257 | (33 | ) | 720 | (81 | ) | |||||||||||||||
Total |
$ | 6,464 | $ | (89 | ) | $ | 1,223 | $ | (42 | ) | $ | 7,687 | $ | (131 | ) | |||||||||
Unrealized losses from fixed-income securities are primarily attributable to changes in interest rates. Unrealized losses from domestic and international equities are due to market price movements. Management does not believe any remaining unrealized losses represent other-than-temporary impairments based on our evaluation of available evidence as of December 31, 2014.
Debt Investment Maturities
(In millions) | Cost Basis | Estimated Fair Value |
||||||
December 31, 2014 | ||||||||
Due in one year or less |
$ | 29,985 | $ | 29,998 | ||||
Due after one year through five years |
50,792 | 50,822 | ||||||
Due after five years through 10 years |
2,719 | 2,710 | ||||||
Due after 10 years |
1,457 | 1,540 | ||||||
Total |
$ | 84,953 | $ | 85,070 | ||||
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NOTE 5 DERIVATIVES
We use derivative instruments to manage risks related to foreign currencies, equity prices, interest rates, and credit; to enhance investment returns; and to facilitate portfolio diversification. Our objectives for holding derivatives include reducing, eliminating, and efficiently managing the economic impact of these exposures as effectively as possible.
Our derivative programs include strategies that both qualify and do not qualify for hedge accounting treatment. All notional amounts presented below are measured in U.S. dollar equivalents.
Foreign Currency
Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency hedge positions. Option and forward contracts are used to hedge a portion of forecasted international revenue for up to three years in the future and are designated as cash-flow hedging instruments. Principal currencies hedged include the euro, Japanese yen, British pound, and Canadian dollar. As of December 31, 2014 and June 30, 2014, the total notional amounts of these foreign exchange contracts sold were $7.5 billion and $4.9 billion, respectively.
Foreign currency risks related to certain non-U.S. dollar denominated securities are hedged using foreign exchange forward contracts that are designated as fair-value hedging instruments. As of December 31, 2014 and June 30, 2014, the total notional amounts of these foreign exchange contracts sold were $5.0 billion and $3.1 billion, respectively.
Certain options and forwards not designated as hedging instruments are also used to manage the variability in exchange rates on accounts receivable, cash, and intercompany positions, and to manage other foreign currency exposures. As of December 31, 2014, the total notional amounts of these foreign exchange contracts purchased and sold were $9.5 billion and $9.2 billion, respectively. As of June 30, 2014, the total notional amounts of these foreign exchange contracts purchased and sold were $6.2 billion and $8.5 billion, respectively.
Equity
Securities held in our equity and other investments portfolio are subject to market price risk. Market price risk is managed relative to broad-based global and domestic equity indices using certain convertible preferred investments, options, futures, and swap contracts not designated as hedging instruments. From time to time, to hedge our price risk, we may use and designate equity derivatives as hedging instruments, including puts, calls, swaps, and forwards. As of December 31, 2014, the total notional amounts of equity contracts purchased and sold for managing market price risk were $1.5 billion and $1.9 billion, respectively, of which $483 million and $550 million, respectively, were designated as hedging instruments. As of June 30, 2014, the total notional amounts of equity contracts purchased and sold for managing market price risk were $1.9 billion and $1.9 billion, respectively, of which $362 million and $420 million, 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 December 31, 2014, the total notional amounts of fixed-interest rate contracts purchased and sold were $3.0 billion and $2.8 billion, respectively. As of June 30, 2014, the total notional amounts of fixed-interest rate contracts purchased and sold were $1.7 billion and $936 million, respectively.
In addition, we use To Be Announced forward purchase commitments of mortgage-backed assets to gain exposure to agency mortgage-backed securities. These meet the definition of a derivative instrument in cases where physical delivery of the assets is not taken at the earliest available delivery date. As of December 31, 2014 and June 30, 2014, the total notional derivative amounts of mortgage contracts purchased were $953 million and $1.1 billion, respectively.
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Credit
Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We use credit default swap contracts, not designated as hedging instruments, to manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. We use credit default swaps as they are a low-cost method of managing exposure to individual credit risks or groups of credit risks. As of December 31, 2014, the total notional amounts of credit contracts purchased and sold were $828 million and $492 million, respectively. As of June 30, 2014, the total notional amounts of credit contracts purchased and sold were $550 million and $440 million, respectively.
Commodity
We use broad-based commodity exposures to enhance portfolio returns and to facilitate portfolio diversification. We use swaps, futures, and option contracts, not designated as hedging instruments, to generate and manage exposures to broad-based commodity indices. We use derivatives on commodities as they can be low-cost alternatives to the purchase and storage of a variety of commodities, including, but not limited to, precious metals, energy, and grain. As of December 31, 2014, the total notional amounts of commodity contracts purchased and sold were $1.1 billion and $338 million, respectively. As of June 30, 2014, the total notional amounts of commodity contracts purchased and sold were $1.4 billion and $408 million, respectively.
Credit-Risk-Related Contingent Features
Certain of our counterparty agreements for derivative instruments contain provisions that require our issued and outstanding long-term unsecured debt to maintain an investment grade credit rating and require us to maintain minimum liquidity of $1.0 billion. To the extent we fail to meet these requirements, we will be required to post collateral, similar to the standard convention related to over-the-counter derivatives. As of December 31, 2014, our long-term unsecured debt rating was AAA, and cash investments were in excess of $1.0 billion. As a result, no collateral was required to be posted.
Fair Values of Derivative Instruments
Derivative instruments are recognized as either assets or liabilities and are measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation.
For derivative instruments designated as fair-value hedges, the gains (losses) are recognized in earnings in the periods of change together with the offsetting losses (gains) on the hedged items attributed to the risk being hedged. For options designated as fair-value hedges, changes in the time value are excluded from the assessment of hedge effectiveness and are recognized in earnings.
For derivative instruments designated as cash-flow hedges, the effective portion of the gains (losses) on the derivatives is initially reported as a component of other comprehensive income (OCI) and is subsequently recognized in earnings when the hedged exposure is recognized in earnings. For options designated as cash-flow hedges, changes in the time value are excluded from the assessment of hedge effectiveness and are recognized in earnings. Gains (losses) on derivatives representing either hedge components excluded from the assessment of effectiveness or hedge ineffectiveness are recognized in earnings.
For derivative instruments that are not designated as hedges, gains (losses) from changes in fair values are primarily recognized in other income (expense). Other than those derivatives entered into for investment purposes, such as commodity contracts, the gains (losses) are generally economically offset by unrealized gains (losses) in the underlying available-for-sale securities, which are recorded as a component of OCI until the securities are sold or other-than-temporarily impaired, at which time the amounts are reclassified from accumulated other comprehensive income (AOCI) into other income (expense).
13
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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:
December 31, 2014 | June 30, 2014 | |||||||||||||||||||||||||||||||||||||
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 |
|
$ | 104 | $ | 238 | $ | 0 | $ | (302 | ) | $ | 10 | $ | 39 | $ | 0 | $ | (97 | ) | |||||||||||||||||||
Equity contracts |
151 | 0 | 0 | (34 | ) | 177 | 0 | 0 | (21 | ) | ||||||||||||||||||||||||||||
Interest rate contracts |
12 | 0 | 0 | (25 | ) | 17 | 0 | 0 | (12 | ) | ||||||||||||||||||||||||||||
Credit contracts |
24 | 0 | 0 | (13 | ) | 24 | 0 | 0 | (13 | ) | ||||||||||||||||||||||||||||
Commodity contracts |
0 | 0 | 0 | 0 | 15 | 0 | 0 | (1 | ) | |||||||||||||||||||||||||||||
Total |
$ | 291 | $ | 238 | $ | 0 | $ | (374 | ) | $ | 243 | $ | 39 | $ | 0 | $ | (144 | ) | ||||||||||||||||||||
Designated Hedge Derivatives | ||||||||||||||||||||||||||||||||||||||
Foreign exchange contracts |
$ | 193 | $ | 590 | $ | 0 | $ | 0 | $ | 1 | $ | 70 | $ | 0 | $ | (15 | ) | |||||||||||||||||||||
Equity contracts |
0 | 0 | 48 | (134 | ) | 0 | 0 | 7 | (125 | ) | ||||||||||||||||||||||||||||
Total |
$ | 193 | $ | 590 | $ | 48 | $ | (134 | ) | $ | 1 | $ | 70 | $ | 7 | $ | (140 | ) | ||||||||||||||||||||
Total gross amounts of derivatives |
$ | 484 | $ | 828 | $ | 48 | $ | (508 | ) | $ | 244 | $ | 109 | $ | 7 | $ | (284 | ) | ||||||||||||||||||||
Gross derivatives either offset or subject to an enforceable master netting agreement |
$ | 365 | $ | 828 | $ | 48 | $ | (508 | ) | $ | 99 | $ | 109 | $ | 7 | $ | (284 | ) | ||||||||||||||||||||
Gross amounts of derivatives offset in the balance sheet |
(99 | ) | (271 | ) | (48 | ) | 418 | (77 | ) | (71 | ) | (7 | ) | 155 | ||||||||||||||||||||||||
Net amounts presented in the balance sheet |
266 | 557 | 0 | (90 | ) | 22 | 38 | 0 | (129 | ) | ||||||||||||||||||||||||||||
Gross amounts of derivatives not offset in the balance sheet |
0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||||||||||||||
Cash collateral received |
0 | 0 | 0 | (285 | ) | 0 | 0 | 0 | 0 | |||||||||||||||||||||||||||||
Net amount |
$ | 266 | $ | 557 | $ | 0 | $ | (375 | ) | $ | 22 | $ | 38 | $ | 0 | $ | (129 | ) | ||||||||||||||||||||
See also Note 4 Investments and Note 6 Fair Value Measurements.
14
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Fair-Value Hedge Gains (Losses)
We recognized in other income (expense) the following gains (losses) on contracts designated as fair-value hedges and their related hedged items:
(In millions) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Foreign Exchange Contracts |
||||||||||||||||
Derivatives |
$ | 381 | $ | 73 | $ | 622 | $ | 59 | ||||||||
Hedged items |
(382 | ) | (74 | ) | (624 | ) | (61 | ) | ||||||||
Total amount of ineffectiveness |
$ | (1 | ) | $ | (1 | ) | $ | (2 | ) | $ | (2 | ) | ||||
Equity Contracts |
||||||||||||||||
Derivatives |
$ | 18 | $ | (10 | ) | $ | (63 | ) | $ | (10 | ) | |||||
Hedged items |
(18 | ) | 10 | 63 | 10 | |||||||||||
Total amount of ineffectiveness |
$ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||
Amount of equity contracts excluded from effectiveness assessment |
$ | (9 | ) | $ | (26 | ) | $ | (13 | ) | $ | (26 | ) | ||||
Cash Flow Hedge Gains (Losses)
We recognized the following gains (losses) on foreign exchange contracts designated as cash flow hedges (our only cash flow hedges during the periods presented):
(In millions) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Effective Portion |
||||||||||||||||
Gains recognized in OCI (net of tax effects of $8, $2, $12, and $0) |
$ | 357 | $ | 67 | $ | 692 | $ | 59 | ||||||||
Gains reclassified from AOCI into revenue |
112 | 25 | 128 | 44 | ||||||||||||
Amount Excluded from Effectiveness Assessment and Ineffective Portion |
||||||||||||||||
Losses recognized in other income (expense) |
(74 | ) | (40 | ) | (142 | ) | (120 | ) | ||||||||
We estimate that $478 million of net derivative gains included in AOCI at December 31, 2014 will be reclassified into earnings within the following 12 months. No significant amounts of gains (losses) were reclassified from AOCI into earnings as a result of forecasted transactions that failed to occur during the three and six months ended December 31, 2014.
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Non-Designated Derivative Gains (Losses)
Gains (losses) from changes in fair values of derivatives that are not designated as hedges are primarily recognized in other income (expense). These amounts are shown in the table below, with the exception of gains (losses) on derivatives presented in income statement line items other than other income (expense), which were immaterial for the periods presented. Other than those derivatives entered into for investment purposes, such as commodity contracts, the gains (losses) below are generally economically offset by unrealized gains (losses) in the underlying available-for-sale securities.
(In millions) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Foreign exchange contracts |
$ | 28 | $ | 60 | $ | (205 | ) | $ | 74 | |||||||
Equity contracts |
(24 | ) | (41 | ) | (14 | ) | (46 | ) | ||||||||
Interest-rate contracts |
24 | (13 | ) | 18 | 0 | |||||||||||
Credit contracts |
1 | 4 | (4 | ) | 3 | |||||||||||
Commodity contracts |
(106 | ) | 0 | (217 | ) | 11 | ||||||||||
Total |
$ | (77 | ) | $ | 10 | $ | (422 | ) | $ | 42 | ||||||
NOTE 6 FAIR VALUE MEASUREMENTS
We account for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are:
| Level 1inputs are based upon unadjusted quoted prices for identical instruments traded in active markets. Our Level 1 non-derivative investments primarily include U.S. government securities, domestic and international equities, and actively traded mutual funds. Our Level 1 derivative assets and liabilities include those actively traded on exchanges. |
| Level 2inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques (e.g. the Black-Scholes model) for which all significant inputs are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, credit spreads, foreign exchange rates, and forward and spot prices for currencies and commodities. Our Level 2 non-derivative investments consist primarily of corporate notes and bonds, common and preferred stock, mortgage-backed and asset-backed securities, certificates of deposit, 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 when it is 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.
16
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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 |
| |||||||||||||
December 31, 2014 | ||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||
Mutual funds |
$ | 651 | $ | 0 | $ | 0 | $ | 651 | $ | 0 | $ | 651 | ||||||||||||
Commercial paper |
0 | 144 | 0 | 144 | 0 | 144 | ||||||||||||||||||
Certificates of deposit |
0 | 1,248 | 0 | 1,248 | 0 | 1,248 | ||||||||||||||||||
U.S. government and agency securities |
67,714 | 604 | 0 | 68,318 | 0 | 68,318 | ||||||||||||||||||
Foreign government bonds |
131 | 4,816 | 0 | 4,947 | 0 | 4,947 | ||||||||||||||||||
Mortgage- and asset-backed securities |
0 | 2,870 | 0 | 2,870 | 0 | 2,870 | ||||||||||||||||||
Corporate notes and bonds |
0 | 6,877 | 0 | 6,877 | 0 | 6,877 | ||||||||||||||||||
Municipal securities |
0 | 340 | 0 | 340 | 0 | 340 | ||||||||||||||||||
Common and preferred stock |
8,915 | 2,084 | 14 | 11,013 | 0 | 11,013 | ||||||||||||||||||
Derivatives |
4 | 1,308 | 48 | 1,360 | (418 | ) | 942 | |||||||||||||||||
Total |
$ | 77,415 | $ | 20,291 | $ | 62 | $ | 97,768 | $ | (418 | ) | $ | 97,350 | |||||||||||
Liabilities |
||||||||||||||||||||||||
Derivatives and other |
$ | 17 | $ | 357 | $ | 134 | $ | 508 | $ | (418 | ) | $ | 90 | |||||||||||
(In millions) |
Level 1 | Level 2 | Level 3 |
|
Gross Fair Value |
|
Netting | (a) | |
Net Fair Value |
| |||||||||||||
June 30, 2014 | ||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||
Mutual funds |
$ | 590 | $ | 0 | $ | 0 | $ | 590 | $ | 0 | $ | 590 | ||||||||||||
Commercial paper |
0 | 189 | 0 | 189 | 0 | 189 | ||||||||||||||||||
Certificates of deposit |
0 | 1,197 | 0 | 1,197 | 0 | 1,197 | ||||||||||||||||||
U.S. government and agency securities |
66,288 | 745 | 0 | 67,033 | 0 | 67,033 | ||||||||||||||||||
Foreign government bonds |
139 | 3,210 | 0 | 3,349 | 0 | 3,349 | ||||||||||||||||||
Mortgage- and asset-backed securities |
0 | 1,073 | 0 | 1,073 | 0 | 1,073 | ||||||||||||||||||
Corporate notes and bonds |
0 | 6,805 | 0 | 6,805 | 0 | 6,805 | ||||||||||||||||||
Municipal securities |
0 | 332 | 0 | 332 | 0 | 332 | ||||||||||||||||||
Common and preferred stock |
9,552 | 1,825 | 14 | 11,391 | 0 | 11,391 | ||||||||||||||||||
Derivatives |
5 | 348 | 7 | 360 | (155 | ) | 205 | |||||||||||||||||
Total |
$ | 76,574 | $ | 15,724 | $ | 21 | $ | 92,319 | $ | (155 | ) | $ | 92,164 | |||||||||||
Liabilities |
||||||||||||||||||||||||
Derivatives and other |
$ | 5 | $ | 153 | $ | 126 | $ | 284 | $ | (155 | ) | $ | 129 | |||||||||||
(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.
17
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The following table reconciles the total Net Fair Value of assets above to the balance sheet presentation of these same assets in Note 4 Investments.
(In millions) | ||||||||
December 31, 2014 |
June 30, 2014 |
|||||||
Net fair value of assets measured at fair value on a recurring basis |
$ | 97,350 | $ | 92,164 | ||||
Cash |
4,468 | 4,980 | ||||||
Common and preferred stock measured at fair value on a nonrecurring basis |
550 | 520 | ||||||
Other investments measured at fair value on a nonrecurring basis |
750 | 1,150 | ||||||
Less derivative net assets classified as other current assets |
(557 | ) | (38 | ) | ||||
Other |
2 | (6 | ) | |||||
Recorded basis of investment components |
$ | 102,563 | $ | 98,770 | ||||
Financial Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
During the three and six months ended December 31, 2014 and 2013, we did not record any material other-than-temporary impairments on financial assets required to be measured at fair value on a nonrecurring basis.
NOTE 7 INVENTORIES
The components of inventories were as follows:
(In millions) | ||||||||
December 31, 2014 |
June 30, 2014 |
|||||||
Raw materials |
$ | 681 | $ | 944 | ||||
Work in process |
260 | 266 | ||||||
Finished goods |
1,112 | 1,450 | ||||||
Total |
$ | 2,053 | $ | 2,660 | ||||
NOTE 8 BUSINESS COMBINATIONS
Nokias Devices and Services Business
On April 25, 2014, we acquired substantially all of Nokia Corporations (Nokia) Devices and Services business (NDS) for a total purchase price of $9.4 billion, including cash acquired of $1.5 billion (the Acquisition). The purchase price consisted primarily of cash of $7.1 billion and Nokias repurchase of convertible notes of $2.1 billion, which was a non-cash transaction. The Acquisition is expected to accelerate the growth of our Devices and Consumer (D&C) business through faster innovation, synergies, and unified branding and marketing.
The purchase price allocation as of December 31, 2014 and June 30, 2014, was based on a preliminary valuation and is subject to revision as more detailed analyses are completed and additional information about the fair value of assets acquired and liabilities assumed become available. The allocation of purchase price to goodwill was revised as of December 31, 2014. Goodwill was reduced by $29 million, due to revisions that decreased the acquisition date fair value of other current assets by $14 million, other long-term assets by $7 million, long-term liabilities by $27 million, and the purchase price by $23 million. The adjustments did not have a material effect on our current or prior period consolidated financial statements.
18
PART I
Item 1
The major classes of assets and liabilities to which we have preliminarily allocated the purchase price were as follows:
(In millions) | ||||
Cash |
$ | 1,503 | ||
Accounts receivable (a) |
754 | |||
Inventories |
544 | |||
Other current assets |
946 | |||
Property and equipment |
981 | |||
Intangible assets |
4,509 | |||
Goodwill (b) |
5,429 | |||
Other |
242 | |||
Current liabilities |
(4,576 | ) | ||
Long-term liabilities |
(890 | ) | ||
Total purchase price |
$ | 9,442 | ||
(a) | Gross accounts receivable is $901 million, of which $147 million is expected to be uncollectible. |
(b) | Goodwill was assigned to our Phone Hardware segment. The goodwill was primarily attributed to increased synergies that are expected to be achieved from the integration of NDS. |
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 and devices outside our own. Our purchase price allocation is preliminary and subject to revision as more detailed analyses are completed and additional information about fair value of assets and liabilities becomes available, including additional information relating to tax matters and finalization of our valuation of identified intangible assets.
The significant classes of assets and liabilities to which we preliminarily allocated the purchase price were goodwill of $1.8 billion and identifiable intangible assets of $916 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 our D&C Other segment. Identifiable intangible assets were assigned a total weighted-average amortization period of 6.4 years. Mojang has been included in our consolidated results of operations since the acquisition date.
Other
During the six months ended December 31, 2014, we completed seven additional acquisitions for total cash consideration of $422 million. These entities have been included in our consolidated results of operations since their respective acquisition dates.
Pro forma results of operations for Mojang and our other acquisitions during the current period have not been presented because the effects of these business combinations, individually and in aggregate, were not material to our consolidated results of operations.
19
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Item 1
NOTE 9 GOODWILL
Changes in the carrying amount of goodwill were as follows:
(In millions) | June 30, 2014 |
Acquisitions | Other | December 31, 2014 |
||||||||||||||||||||||
Devices and Consumer |
Licensing | $ | 868 | $ | 4 | $ | 0 | $ | 872 | |||||||||||||||||
Hardware: |
||||||||||||||||||||||||||
Computing and Gaming Hardware |
1,698 | 0 | (38 | ) | 1,660 | |||||||||||||||||||||
Phone Hardware |
5,354 | 0 | (90 | ) | 5,264 | |||||||||||||||||||||
Total Devices and Consumer Hardware |
7,052 | 0 | (128 | ) | 6,924 | |||||||||||||||||||||
Other |
738 | 1,772 | (101 | ) | 2,409 | |||||||||||||||||||||
Total Devices and Consumer |
8,658 | 1,776 | (229 | ) | 10,205 | |||||||||||||||||||||
Commercial |
Licensing | 10,058 | 0 | (137 | ) | 9,921 | ||||||||||||||||||||
Other |
1,411 | 323 | (5 | ) | 1,729 | |||||||||||||||||||||
Total Commercial |
11,469 | 323 | (142 | ) | 11,650 | |||||||||||||||||||||
Total goodwill |
$ | 20,127 | $ | 2,099 | $ | (371 | ) | $ | 21,855 | |||||||||||||||||
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.
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 Amount |
||||||||||||||||||||||||||
December 31, 2014 |
June 30, 2014 |
|||||||||||||||||||||||||||||||
Technology-based (a) |
$ | 6,911 | $ | (3,028 | ) | $ | 3,883 | $ | 6,440 | $ | (2,615 | ) | $ | 3,825 | ||||||||||||||||||
Marketing-related |
2,028 | (435 | ) | 1,593 | 1,518 | (324 | ) | 1,194 | ||||||||||||||||||||||||
Contract-based |
2,265 | (797 | ) | 1,468 | 2,266 | (716 | ) | 1,550 | ||||||||||||||||||||||||
Customer-related |
775 | (420 | ) | 355 | 732 | (320 | ) | 412 | ||||||||||||||||||||||||
Total |
$ | 11,979 | $ | (4,680 | ) | $ | 7,299 | $ | 10,956 | $ | (3,975 | ) | $ | 6,981 | ||||||||||||||||||
(a) | Technology-based intangible assets included $43 million and $98 million as of December 31, 2014 and June 30, 2014, respectively, of net carrying amount of software to be sold, leased, or otherwise marketed. |
Intangible assets amortization expense was $329 million and $701 million for the three and six months ended December 31, 2014, respectively, and $166 million and $328 million for the three and six months ended December 31, 2013, respectively. Amortization of capitalized software was $15 million and $55 million for the three and six months ended December 31, 2014, respectively, and $50 million and $96 million for the three and six months ended December 31, 2013, respectively.
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The following table outlines the estimated future amortization expense related to intangible assets held at December 31, 2014:
(In millions) | ||||
Year Ending June 30, | ||||
2015 (excluding the six months ended December 31, 2014) |
$ | 683 | ||
2016 |
1,233 | |||
2017 |
978 | |||
2018 |
843 | |||
2019 |
759 | |||
Thereafter |
2,803 | |||
Total |
$ | 7,299 | ||
NOTE 11 DEBT
As of December 31, 2014, we had $28.3 billion of issued and outstanding debt, comprising $8.3 billion of short-term debt and $20.0 billion of long-term debt, including the current portion. As of June 30, 2014, we had $22.6 billion of issued and outstanding debt, comprising $2.0 billion of short-term debt and $20.6 billion of long-term debt.
Short-term Debt
As of December 31, 2014, we had $8.3 billion of commercial paper issued and outstanding, with a weighted-average interest rate of 0.11% and maturities ranging from 16 to 89 days. As of June 30, 2014, we had $2.0 billion of commercial paper issued and outstanding, with a weighted-average interest rate of 0.12% and maturities ranging from 86 to 91 days. The estimated fair value of this commercial paper approximates its carrying value.
In addition to the $5.0 billion credit facility that expires on November 14, 2018, we entered into another $5.0 billion credit facility in November 2014 that expires on November 4, 2015. These credit facilities serve as a back-up for our commercial paper program. As of December 31, 2014, 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 December 31, 2014, the total carrying value and estimated fair value of our long-term debt, including the current portion, were $20.0 billion and $21.6 billion, respectively. This is compared to a carrying value and estimated fair value of our long-term debt of $20.6 billion and $21.5 billion, respectively, as of June 30, 2014. 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 December 31, 2014 and June 30, 2014:
Due Date | Face Value December 31, |
Face Value June 30, |
Stated Rate |
Effective Rate |
||||||||||||||||
(In millions) | ||||||||||||||||||||
Notes |
||||||||||||||||||||
September 25, 2015 |
$ | 1,750 | $ | 1,750 | 1.625% | 1.795% | ||||||||||||||
February 8, 2016 |
750 | 750 | 2.500% | 2.642% | ||||||||||||||||
November 15, 2017 |
600 | 600 | 0.875% | 1.084% | ||||||||||||||||
May 1, 2018 |
450 | 450 | 1.000% | 1.106% | ||||||||||||||||
December 6, 2018 |
1,250 | 1,250 | 1.625% | 1.824% | ||||||||||||||||
June 1, 2019 |
1,000 | 1,000 | 4.200% | 4.379% | ||||||||||||||||
October 1, 2020 |
1,000 | 1,000 | 3.000% | 3.137% | ||||||||||||||||
February 8, 2021 |
500 | 500 | 4.000% | 4.082% | ||||||||||||||||
December 6, 2021 (a) |
2,119 | 2,396 | 2.125% | 2.233% | ||||||||||||||||
November 15, 2022 |
750 | 750 | 2.125% | 2.239% | ||||||||||||||||
May 1, 2023 |
1,000 | 1,000 | 2.375% | 2.465% | ||||||||||||||||
December 15, 2023 |
1,500 | 1,500 | 3.625% | 3.726% | ||||||||||||||||
December 6, 2028 (a) |
2,119 | 2,396 | 3.125% | 3.218% | ||||||||||||||||
May 2, 2033 (b) |
666 | 753 | 2.625% | 2.690% | ||||||||||||||||
June 1, 2039 |
750 | 750 | 5.200% | 5.240% | ||||||||||||||||
October 1, 2040 |
1,000 | 1,000 | 4.500% | 4.567% | ||||||||||||||||
February 8, 2041 |
1,000 | 1,000 | 5.300% | 5.361% | ||||||||||||||||
November 15, 2042 |
900 | 900 | 3.500% | 3.571% | ||||||||||||||||
May 1, 2043 |
500 | 500 | 3.750% | 3.829% | ||||||||||||||||
December 15, 2043 |
500 | 500 | 4.875% | 4.918% | ||||||||||||||||
Total |
$ | 20,104 | $ | 20,745 | ||||||||||||||||
(a) | In December 2013, we issued 3.5 billion of debt securities. |
(b) | In April 2013, we issued 550 million of debt securities. |
The notes in the table above are senior unsecured obligations and rank equally with our other senior unsecured debt outstanding. Interest on these notes is paid semi-annually, except for the euro-denominated debt securities on which interest is paid annually. As of December 31, 2014 and June 30, 2014, the aggregate unamortized discount for our long-term debt, including the current portion, was $95 million and $100 million, respectively.
NOTE 12 INCOME TAXES
Our effective tax rate for the three months ended December 31, 2014 and 2013 was 25% and 17%, respectively, and 24% and 17% for the six months ended December 31, 2014 and 2013, respectively. Our effective tax rate was lower than the U.S. federal statutory rate primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico.
Tax contingencies and other tax liabilities were $11.3 billion and $10.4 billion as of December 31, 2014 and June 30, 2014, respectively, and are included in other long-term liabilities. This increase relates primarily to current period quarterly growth relating to intercompany transfer pricing adjustments. While we settled a portion of the Internal Revenue Service (I.R.S.) audit for tax years 2004 to 2006 during the third quarter of fiscal year 2011, we remain under audit for those years. In February 2012, the I.R.S. withdrew its 2011 Revenue Agents Report and reopened the audit phase of the examination. As of December 31, 2014, the primary unresolved issue relates to transfer pricing which could have a significant adverse impact on our consolidated financial statements if it is 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 income tax contingencies for these issues within the next 12 months. We also continue to be subject to examination by the I.R.S. for tax years 2007 to 2014.
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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 2014, some of which are currently under audit by local tax authorities. Resolution of these audits are not expected to be material to our consolidated financial statements.
NOTE 13 RESTRUCTURING CHARGES
In July 2014, we announced a restructuring plan to simplify our organization and align NDS with our companys overall strategy (the Restructuring Plan). Pursuant to the Restructuring Plan, we will eliminate up to 18,000 positions in the current fiscal year, including approximately 12,500 professional and factory positions related to the NDS business. The actions associated with the Restructuring Plan are expected to be completed by June 30, 2015.
We incurred restructuring charges of $132 million and $1.2 billion during the three and six months ended December 31, 2014, respectively, including severance expenses and other reorganization costs, primarily associated with our facilities consolidation. As of December 31, 2014, we have notified approximately 17,500 employees of their job elimination, entered into mutually agreed separations, or commenced required consultation processes, and recognized substantially all anticipated severance charges for the 18,000 positions in the Restructuring Plan. We also wrote down the carrying value of certain assets and recognized a restructuring charge relating to the write downs of $56 million and $309 million during the three and six months ended December 31, 2014, respectively. Restructuring charges were included in integration and restructuring expenses in our consolidated income statement, and reflected in Corporate and Other in our table of operating income (loss) by segment group in Note 18 Segment Information.
During the remainder of fiscal year 2015, we expect to incur additional pre-tax restructuring charges of approximately $200 million, primarily related to asset write-downs and lease termination costs.
Changes in the restructuring liability were as follows:
(In millions) |
Severance |
|
Asset Impairments and Other |
(a) |
Total | |||||||
Restructuring liability as of June 30, 2014 |
$ | 0 | $ | 0 | $ | 0 | ||||||
Restructuring charges |
739 | 441 | 1,180 | |||||||||
Cash paid |
(521 | ) | (56 | ) | (577 | ) | ||||||
Other |
(15 | ) | (313 | ) | (328 | ) | ||||||
Restructuring liability as of December 31, 2014 |
$ | 203 | $ | 72 | $ | 275 | ||||||
(a) | Asset Impairments and Other primarily reflects activities associated with the consolidation of our facilities and manufacturing operations, including asset write-downs of $309 million in the six months ended December 31, 2014, as well as contract termination costs. |
NOTE 14 UNEARNED REVENUE
Unearned revenue by segment was as follows, with segments with significant balances shown separately:
(In millions) | ||||||||
December 31, 2014 |
June 30, 2014 |
|||||||
Commercial Licensing |
$ | 15,776 | $ | 19,099 | ||||
Commercial Other |
3,486 | 3,934 | ||||||
Rest of the segments |
1,981 | 2,125 | ||||||
Total |
$ | 21,243 | $ | 25,158 | ||||
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NOTE 15 CONTINGENCIES
Antitrust, Unfair Competition, and Overcharge Class Actions
A large number of antitrust and unfair competition class action lawsuits were filed against us in various state, federal, and Canadian courts on behalf of various classes of direct and indirect purchasers of our PC operating system and certain other software products between 1999 and 2005.
We obtained dismissals or reached settlements of all claims made in the United States. Under the settlements, generally class members can obtain vouchers that entitle them to be reimbursed for purchases of a wide variety of platform-neutral computer hardware and software. The total value of vouchers that we may issue varies by state. We will make available to certain schools a percentage of those vouchers that are not issued or claimed (one-half to two-thirds depending on the state). The total value of vouchers we ultimately issue will depend on the number of class members who make claims and are issued vouchers. We estimate the total remaining cost of the settlements is approximately $300 million, all of which had been accrued as of December 31, 2014.
Three similar cases pending in British Columbia, Ontario, and Quebec, Canada have not been settled. In March 2010, the court in the British Columbia case certified it as a class action. After the British Columbia Court of Appeal dismissed the case, in October 2013 the Canadian Supreme Court reversed the appellate court and reinstated part of the British Columbia case, which is now scheduled for trial in September 2015. The other two cases were inactive pending action by the Supreme Court on the British Columbia case.
Other Antitrust Litigation and Claims
GO Computer litigation
In June 2005, GO Computer Inc. and co-founder Jerry Kaplan filed a complaint in California state court asserting antitrust claims under the Cartwright Act related to the business of the former GO Corporation in the early 1990s and its successor in interest, Lucent Corporation in the early 2000s. All claims prior to June 2001 have been dismissed with prejudice as barred by the statute of limitations. After a mini-trial on standing issues, the case is now moving forward with discovery, and a trial is set for September 2015.
China State Administration for Industry and Commerce investigation
On July 28, 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, and file verification issues related to Windows and Office software.
Patent and Intellectual Property Claims
Motorola litigation
In October 2010, Microsoft filed patent infringement complaints against Motorola Mobility (Motorola) with the International Trade Commission (ITC) and in U.S. District Court in Seattle for infringement of nine Microsoft patents by Motorolas Android devices. Since then, Microsoft and Motorola have filed additional claims against each other with the ITC, in federal district courts in Seattle, Wisconsin, Florida, and California, and in courts in Germany and the United Kingdom. The nature of the claims asserted and status of individual matters are summarized below.
International Trade Commission
In May 2012, the ITC issued a limited exclusion order against Motorola on one Microsoft patent, which became effective in July 2012 and was affirmed on appeal in December 2013. In July 2013, Microsoft filed an action in U.S. District Court in Washington, D.C. seeking an order to compel enforcement of the ITCs May 2012 import ban against infringing Motorola products by the Bureau of Customs and Border Protection (CBP), after learning that CBP had failed to fully enforce the order.
In November 2010, Motorola filed an action against Microsoft with the ITC alleging infringement of five Motorola patents by Xbox consoles and accessories and seeking an exclusion order to prohibit importation of the allegedly infringing Xbox products. At Motorolas request, the ITC terminated its investigation of four Motorola patents. In March 2013, the ITC affirmed there was no violation of the remaining Motorola patent. Motorola appealed the ITCs decision to the U.S. Court of Appeals for the Federal Circuit.
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U.S. District Court
The Seattle District Court case filed in October 2010 by Microsoft as a companion to Microsofts ITC case against Motorola was stayed pending the outcome of the ITC case.
In November 2010, Microsoft sued Motorola for breach of contract in U.S. District Court in Seattle, alleging that Motorola breached its commitments to standards-setting organizations to license to Microsoft certain patents on reasonable and non-discriminatory (RAND) terms and conditions. Motorola has declared these patents essential to the implementation of the H.264 video standard and the 802.11 Wi-Fi standard. In the Motorola ITC case described above and in suits described below, Motorola or a Motorola affiliate subsequently sued Microsoft on those patents in U.S. District Courts, in the ITC, and in Germany. In February 2012, the Seattle District Court granted a partial summary judgment in favor of Microsoft ruling that (1) Motorola had committed to standards organizations to license its declared-essential patents on RAND terms and conditions; and (2) Microsoft is a third-party beneficiary of those commitments. After trial, the Seattle District Court set per unit royalties for Motorolas H.264 and 802.11 patents, which resulted in an immaterial Microsoft liability. In September 2013, following trial of Microsofts breach of contract claim, a jury awarded $14.5 million in damages to Microsoft. Motorola appealed.
Cases filed by Motorola in Wisconsin, California, and Florida, with the exception of one case in Wisconsin initially stayed and later dismissed without prejudice (a companion case to Motorolas ITC action), have been transferred to the U.S District Court in Seattle. Motorola and Microsoft both seek damages as well as injunctive relief. The court has stayed these cases in Seattle on agreement of the parties.
| In the transferred cases, Motorola asserts 15 patents are infringed by a range of Microsoft products including mobile and PC operating system, productivity, server, communication, browser and gaming products. |
| In the Motorola action originally filed in California, Motorola asserts Microsoft violated antitrust laws in connection with Microsofts assertion of patents against Motorola that Microsoft agreed to license to certain qualifying entities on RAND terms and conditions. |
| In counterclaims, Microsoft asserts 14 patents are infringed by Motorola Android devices and certain Motorola digital video recorders. |
Germany
In July 2011, Motorola filed patent infringement actions in Germany against Microsoft and several Microsoft subsidiaries.
| Motorola asserts two patents (both now expired) are essential to implementation of the H.264 video standard, and Motorola alleges that H.264 capable products including Xbox 360, Windows 7, Media Player, and Internet Explorer infringe those patents. In May 2012, the court issued an injunction relating to all H.264 capable Microsoft products in Germany, which Microsoft appealed. Orders in the litigation pending in Seattle, Washington described above enjoin Motorola from enforcing the German injunction. |
| Motorola asserts that one patent covers certain syncing functionality in the ActiveSync protocol employed by Windows Phone 7, Outlook Mobile, Hotmail Mobile, Exchange Online, Exchange Server, and Hotmail Server. In April 2013, the court stayed the case pending the outcome of parallel proceedings in which Microsoft is seeking to invalidate the patent. In November 2013, the Federal Patent Court invalidated the originally issued patent claims, but ruled that certain new amended claims were patentable. Both Motorola and Microsoft appealed. In June 2014, the court reopened infringement proceedings, which are currently stayed. |
| Microsoft may be able to mitigate the adverse impact of any injunction by altering its products to avoid Motorolas infringement claims. |
| Any damages would be determined in separate proceedings. |
In lawsuits Microsoft filed in Germany in 2011 and 2012, Microsoft asserts that Motorola Android devices infringe Microsoft patents and is seeking damages and injunctions. In 2012, regional courts in Germany issued injunctions on three of the Microsoft patents, which Motorola appealed. One judgment has been affirmed on appeal (and Motorola
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has further appealed), and the other two appeals are pending (in one of these two cases the asserted patent has expired). An additional infringement proceeding is still pending in the court of first instance. In actions filed separately by Motorola to invalidate these patents, the Federal Patent Court in 2013 and 2014 held the Microsoft patents invalid, and Microsoft appealed. For the cases in which Microsoft obtained injunctions, if Motorola were to prevail following all appeals, Motorola could have a claim against Microsoft for damages caused by an erroneously granted injunction.
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 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 is seeking 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.
European copyright levies
We have 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. We are litigating against certain collecting societies on the basis that the levy schemes exceed what the EU Directive and European Court of Justice decisions permit.
Other patent and intellectual property claims
In addition to these cases, there are approximately 100 other patent infringement cases pending against Microsoft.
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 have 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 September 2013, defendants in the consolidated cases moved to exclude plaintiffs expert evidence of general causation on the basis of flawed scientific methodologies. The motion was heard in December 2013 and January 2014. In March 2014, defendants filed a separate motion to preclude plaintiffs general causation testimony on the
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ground that it is pre-empted by federal law because the experts challenge the safety of all cellular handsets, including those that comply with the FCC Guidelines. In August 2014, the court granted in part defendants motion to exclude plaintiffs general causation experts. The court granted an order permitting an interlocutory appeal of its decision in October 2014. In December 2014, the District of Columbia Court of Appeals agreed to hear en banc defendants interlocutory appeal challenging the standard for evaluating expert scientific evidence. The appeal is scheduled for argument in May 2015. Trial court proceedings are stayed pending resolution of the appeal.
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 December 31, 2014, we had accrued aggregate liabilities of $691 million in other current liabilities and $35 million in other long-term liabilities for all of our legal matters that were contingencies as of that date. While we intend to defend these matters vigorously, adverse outcomes that we estimate could reach approximately $1.9 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 December 31, |
Six Months Ended December 31, |
||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Shares of common stock repurchased |
43 | 53 | 86 | 100 | ||||||||||||
Value of common stock repurchased |
$ | 2,000 | $ | 2,000 | $ | 4,000 | $ | 3,500 | ||||||||
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 plan authorizing up to $40.0 billion in share repurchases. The share repurchase program became effective October 1, 2013, has no expiration date, and may be suspended or discontinued at any time without notice. As of December 31, 2014, $31.1 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 during the periods presented:
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 | $ | 2,548 | March 12, 2015 | ||||||||||
Fiscal Year 2014 |
||||||||||||||||
September 16, 2013 |
$ | 0.28 | November 21, 2013 | $ | 2,332 | December 12, 2013 | ||||||||||
November 19, 2013 |
$ | 0.28 | February 20, 2014 | $ | 2,322 | March 13, 2014 | ||||||||||
The dividend declared on December 3, 2014 was included in other current liabilities as of December 31, 2014.
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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 December 31, |
Six Months Ended December 31, |
||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Derivatives |
||||||||||||||||
Accumulated other comprehensive income balance, beginning of period |
$ | 350 | $ | 40 | $ | 31 | $ | 66 | ||||||||
Unrealized gains, net of tax effects of $8, $2, $12, and $0 |
357 | 67 | 692 | 59 | ||||||||||||
Reclassification adjustments for gains included in revenue |
(112 | ) | (25 | ) | (128 | ) | (44 | ) | ||||||||
Tax expense included in provision for income taxes |
2 | 1 | 2 | 2 | ||||||||||||
Amounts reclassified from accumulated other comprehensive income |
(110 | ) | (24 | ) | (126 | ) | (42 | ) | ||||||||
Net current period other comprehensive income |
247 | 43 | 566 | 17 | ||||||||||||
Accumulated other comprehensive income balance, end of period |
$ | 597 | $ | 83 | $ | 597 | $ | 83 | ||||||||
Investments |
||||||||||||||||
Accumulated other comprehensive income balance, beginning of period |
$ | 3,342 | $ | 2,746 | $ | 3,531 | $ | 1,794 | ||||||||
Unrealized gains (losses), net of tax effects of $(12), $270, $(86), and $760 |
(24 | ) | 527 | (162 | ) | 1,474 | ||||||||||
Reclassification adjustments for gains included in other income (expense) |
(319 | ) | (70 | ) | (398 | ) | (63 | ) | ||||||||
Tax expense included in provision for income taxes |
112 | 25 | 140 | 23 | ||||||||||||
Amounts reclassified from accumulated other comprehensive income |
(207 | ) | (45 | ) | (258 | ) | (40 | ) | ||||||||
Net current period other comprehensive income (loss) |
(231 | ) | 482 | (420 | ) | 1,434 | ||||||||||
Accumulated other comprehensive income balance, end of period |
$ | 3,111 | $ | 3,228 | $ | 3,111 | $ | 3,228 | ||||||||
Translation adjustments and other |
||||||||||||||||
Accumulated other comprehensive income (loss) balance, beginning of period |
$ | 65 | $ | (55 | ) | $ | 146 | $ | (117 | ) | ||||||
Translation adjustments and other, net of tax effects of $(211), $11, $(258), and $44 |
(390 | ) | 21 | (471 | ) | 83 | ||||||||||
Accumulated other comprehensive loss balance, end of period |
$ | (325 | ) | $ | (34 | ) | $ | (325 | ) | $ | (34 | ) | ||||
Accumulated other comprehensive income, end of period |
$ | 3,383 | $ | 3,277 | $ | 3,383 | $ | 3,277 | ||||||||
NOTE 18 SEGMENT INFORMATION
In its operation of the business, management, including our chief operating decision maker, the companys Chief Executive Officer, reviews certain financial information, including segmented internal profit and loss statements prepared on a basis not consistent with U.S. GAAP. The segment information in this note is reported on that basis. During the periods presented, we reported our financial performance based on the following segments; D&C Licensing, Computing and Gaming Hardware, Phone Hardware, D&C Other, Commercial Licensing, and Commercial Other.
On April 25, 2014, we acquired substantially all of NDS. See Note 8 Business Combinations for additional details. NDS has been included in our consolidated results of operations since the acquisition date. We report the financial performance of the acquired business in our Phone Hardware segment. Prior to the acquisition of NDS, financial results associated with our joint strategic initiatives with Nokia were reflected in our D&C Licensing segment. The contractual relationship with Nokia related to those initiatives ended in conjunction with the acquisition.
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Our reportable segments are described below.
Devices and Consumer
Our D&C segments develop, manufacture, market, and support products and services designed to entertain and connect people, increase personal productivity, help people simplify tasks and make more informed decisions online, and help advertisers connect with audiences. Our D&C segments are:
| D&C Licensing, comprising: Windows, including all original equipment manufacturer (OEM) licensing (Windows OEM) and other non-volume licensing and academic volume licensing of the Windows operating system and related software; non-volume licensing of Microsoft Office, comprising the core Office product set, for consumers (Office Consumer); Windows Phone operating system, including related patent licensing; and certain other patent licensing revenue; |
| Computing and Gaming Hardware, comprising: Xbox gaming and entertainment consoles and accessories, second-party and third-party video game royalties, and Xbox Live subscriptions (Xbox Platform); Surface devices and accessories (Surface); and Microsoft PC accessories; |
| Phone Hardware, comprising: Lumia phones and other non-Lumia phones, beginning with our acquisition of NDS; and |
| D&C Other, comprising: Resale, including Windows Store, Xbox Live transactions, and Windows Phone Store; search advertising; display advertising; Office 365 Consumer, comprising Office 365 Home and Office 365 Personal; Studios, comprising first-party video games; Mojang; non-Microsoft products sold in our retail stores; and certain other consumer products and services not included in the categories above. |
Commercial
Our Commercial segments develop, market, and support software and services designed to increase individual, team, and organizational productivity and efficiency, including simplifying everyday tasks through seamless operations across the users hardware and software. Our Commercial segments are:
| Commercial Licensing, comprising: server products, including Windows Server, Microsoft SQL Server, Visual Studio, System Center, and related Client Access Licenses (CALs); Windows Embedded; volume licensing of the Windows operating system, excluding academic (Windows Commercial); Microsoft Office for business, including Office, Exchange, SharePoint, Lync, and related CALs (Office Commercial); Microsoft Dynamics business solutions, excluding Dynamics CRM Online; and Skype; and |
| Commercial Other, comprising: Enterprise Services, including Premier Support Services and Microsoft Consulting Services; Commercial Cloud, comprising Office 365 Commercial, other Microsoft Office online offerings, Dynamics CRM Online, and Microsoft Azure; and certain other commercial products and online services not included in the categories above. |
Revenue and cost of revenue are generally directly attributed to our segments. Certain revenue contracts are allocated among the segments based on the relative value of the underlying products and services, which can include allocation based on actual prices charged, prices when sold separately, or estimated costs plus a profit margin. Cost of revenue is directly charged to our hardware segments. For the remaining segments, cost of revenue is directly charged in most cases and allocated in certain cases, generally using a relative revenue methodology.
We do not allocate operating expenses to our segments. Rather, we allocate them to our two segment groups, Devices and Consumer and Commercial. Due to the integrated structure of our business, allocations of expenses are made in certain cases to incent cross-collaboration among our segment groups so that a segment group is not solely burdened by the cost of a mutually beneficial activity as we seek to deliver seamless experiences across devices, whether on-premises or in the cloud.
Operating expenses are attributed to our segment groups as follows:
| Sales and marketing expenses are primarily recorded directly to each segment group based on identified customer segment. |
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| Research and development expenses are primarily shared across the segment groups based on relative gross margin but are mapped directly in certain cases where the value of the expense only accrues to that segment group. |
| General and administrative expenses are primarily allocated based on relative gross margin. |
Certain corporate-level activity is not allocated to our segment groups, including costs of: legal, including expenses, settlements, and fines; information technology; human resources; finance; excise taxes; and integration and restructuring expenses.
Segment revenue and gross margin were as follows during the periods presented:
(In millions) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||||
Revenue |
| |||||||||||||||||
Devices and Consumer |
Licensing | $ | 4,167 | $ | 5,544 | $ | 8,260 | $ | 10,028 | |||||||||
Hardware: |
||||||||||||||||||
Computing and Gaming Hardware |
3,997 | 4,470 | 6,450 | 5,879 | ||||||||||||||
Phone Hardware |
2,284 | 0 | 4,893 | 0 | ||||||||||||||
Total Devices and Consumer Hardware |
6,281 | 4,470 | 11,343 | 5,879 | ||||||||||||||
Other | 2,436 | 1,874 | 4,245 | 3,428 | ||||||||||||||
Total Devices and Consumer |
12,884 | 11,888 | 23,848 | 19,335 | ||||||||||||||
Commercial |
Licensing | 10,679 | 10,906 | 20,552 | 20,517 | |||||||||||||
Other |
2,593 | 1,780 | 5,000 | 3,382 | ||||||||||||||
Total Commercial |
13,272 | 12,686 | 25,552 | 23,899 | ||||||||||||||
Corporate and Other |
314 | (55 | ) | 271 | (186 | ) | ||||||||||||
Total revenue |
$ | 26,470 | $ | 24,519 | $ | 49,671 | $ | 43,048 | ||||||||||
Gross Margin |
||||||||||||||||||
Devices and Consumer |
Licensing | $ | 3,876 | $ | 4,981 | $ | 7,694 | $ | 8,901 | |||||||||
Hardware: |
||||||||||||||||||
Computing and Gaming Hardware |
460 | 411 | 939 | 616 | ||||||||||||||
Phone Hardware |
331 | 0 | 809 | 0 | ||||||||||||||
Total Devices and Consumer Hardware |
791 | 411 | 1,748 | 616 | ||||||||||||||
Other |
550 | 387 | 862 | 711 | ||||||||||||||
Total Devices and Consumer |
5,217 | 5,779 | 10,304 | 10,228 | ||||||||||||||
Commercial |
Licensing | 9,926 | 10,080 | 19,026 | 18,885 | |||||||||||||
Other |
900 | 415 | 1,705 | 689 | ||||||||||||||
Total Commercial |
10,826 | 10,495 | 20,731 | 19,574 | ||||||||||||||
Corporate and Other |
291 | (77 | ) | 227 | (221 | ) | ||||||||||||
Total gross margin |
$ | 16,334 | $ | 16,197 | $ | 31,262 | $ | 29,581 | ||||||||||
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Following is operating expenses by segment group. As discussed above, we do not allocate operating expenses to our segments.
(In millions) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Devices and Consumer |
$ | 3,324 | $ | 3,178 | $ | 6,383 | $ | 5,466 | ||||||||
Commercial |
4,300 | 4,189 | 8,333 | 8,211 | ||||||||||||
Corporate and Other |
691 | 861 | 1,543 | 1,601 | ||||||||||||
Total segment operating expenses |
8,315 | 8,228 | 16,259 | 15,278 | ||||||||||||
Integration and restructuring |
243 | 0 | 1,383 | 0 | ||||||||||||
Total operating expenses |
$ | 8,558 | $ | 8,228 | $ | 17,642 | $ | 15,278 | ||||||||
Following is operating income (loss) by segment group.
(In millions) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Devices and Consumer |
$ | 1,893 | $ | 2,601 | $ | 3,921 | $ | 4,762 | ||||||||
Commercial |
6,526 | 6,306 | 12,398 | 11,363 | ||||||||||||
Corporate and Other |
(643 | ) | (938 | ) | (2,699 | ) | (1,822 | ) | ||||||||
Total operating income |
$ | 7,776 | $ | 7,969 | $ | 13,620 | $ | 14,303 | ||||||||
Corporate and Other operating income includes adjustments to conform our internal accounting policies to U.S. GAAP and corporate-level activity not specifically attributed to a segment. Significant internal accounting policies that differ from U.S. GAAP relate to revenue recognition, income statement classification, and depreciation.
Corporate and Other activity was as follows:
(In millions) | Three Months Ended December 31, |
Six Months Ended December 31, |
||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Corporate (a)(b) |
$ | (889 | ) | $ | (854 | ) | $ | (2,823 | ) | $ | (1,599 | ) | ||||
Other (adjustments to U.S. GAAP): |
||||||||||||||||
Revenue reconciling amounts (c) |
314 | (55 | ) | 271 | (186 | ) | ||||||||||
Cost of revenue reconciling amounts |
(23 | ) | (22 | ) | (44 | ) | (35 | ) | ||||||||
Operating expenses reconciling amounts |
(45 | ) | (7 | ) | (103 | ) | (2 | ) | ||||||||
Total Corporate and Other |
$ | (643 | ) | $ | (938 | ) | $ | (2,699 | ) | $ | (1,822 | ) | ||||
(a) | Corporate is presented on the basis of our internal accounting policies and excludes the adjustments to U.S. GAAP that are presented separately in those line items. |
(b) | Corporate for the three and six months ended December 31, 2014 included integration and restructuring expenses of $243 million and $1.4 billion, respectively. |
(c) | Revenue reconciling amounts for the three months ended December 31, 2014 included the recognition of $326 million of previously deferred net revenue related to sales of bundled products and services (Bundled Offerings). Revenue reconciling amounts for the three months ended December 31, 2013 included $135 million of net revenue deferrals related to Bundled Offerings, offset in part by the recognition of $105 million of previously deferred revenue related to the pre-sales of Windows 8.1 to OEMs and retailers before general availability. |
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Revenue reconciling amounts for the six months ended December 31, 2014 included the recognition of $297 million of previously deferred net revenue related to Bundled Offerings. Revenue reconciling amounts for the six months ended December 31, 2013 included $140 million of net revenue deferrals related to Bundled Offerings.
Assets are not allocated to segments for internal reporting presentations. A portion of amortization and depreciation is charged to the respective segment. It is impracticable for us to separately identify the amount of amortization and depreciation by segment that is included in the measure of segment profit or loss.
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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 December 31, 2014, and the related consolidated statements of income, comprehensive income, cash flows, and stockholders equity for the three-month and six-month periods ended December 31, 2014 and 2013. 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, 2014, 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, 2014 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, 2014 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
/S/ DELOITTE & TOUCHE LLP
Seattle, Washington
January 26, 2015
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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, 2014, and our consolidated financial statements and the accompanying Notes to Financial Statements in this Form 10-Q.
Microsoft is a technology leader focused on being the productivity and platform company for the mobile-first and cloud-first world. We strive to reinvent productivity to empower people and organizations to do more and achieve more. We create technology that transforms the way people work, play, and communicate across a wide range of computing devices.
We generate revenue by developing, licensing, and supporting a wide range of software products, by offering an array of services, including cloud-based services, to consumers and businesses, by designing, 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.
Industry Trends
Our industry is dynamic and highly competitive, with frequent changes in both technologies and business models. Each industry shift is an opportunity to conceive new products, new technologies, or new ideas that can further transform the industry and our business. At Microsoft, we push the boundaries of what is possible through a broad range of research and development activities that seek to identify and address the changing demands of customers, industry trends, and competitive forces.
Key Opportunities and Investments
We see significant opportunities for growth by investing research and development resources in the following areas:
| Digital work and life experiences. |
| Our cloud operating system. |
| Our devices operating system and hardware. |
With investments in these areas, we work to fulfill the evolving needs of our customers in a mobile-first and cloud-first world. We view mobility broadly not just by devices, but by experiences. Today, people move just as quickly into new contexts as to new locations. Mobility goes beyond devices users carry with them as they move from place to place, to encompass the rich collection of data, applications, and services that accompany them as they move from setting to setting in their lives. Many of our customers are dual users, employing technology for work or school and also in their personal lives.
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Digital work and life experiences
We believe we can significantly enhance the digital lives of our customers using our broad portfolio of communication, productivity, and information services. We work to deliver digital work and life experiences that are reinvented for the mobile-first and cloud-first world. Productivity will be the first and foremost objective, to enable people to meet and collaborate more easily, and to effectively express ideas in new ways. We will design applications as dual-use with the intelligence to partition data between work and life while respecting each persons privacy choices. The foundation for these efforts will rest on advancing our leading productivity, collaboration, and business process tools including Skype, OneDrive, OneNote, Outlook, Word, Excel, PowerPoint, Bing, and Dynamics.
We see opportunity in combining these services in new ways that are more contextual and personal, while ensuring people, rather than their devices, remain at the center of the digital experience. We will offer our services across ecosystems and devices outside our own. As people move from device to device, so will their content and the richness of their services. We strive to engineer applications so users can find, try, and buy them in friction-free ways.
Cloud operating system
Today, businesses face important opportunities and challenges. Enterprises are asked to deploy technology that advances business strategy. They decide what solutions will make employees more productive, collaborative, and satisfied, or connect with customers in new and compelling ways. They work to unlock business insights from a world of data. They rely on our technology to manage employee corporate identity, and to manage and secure corporate information accessed and stored across a growing number of devices. To achieve these objectives, increasingly businesses look to leverage the benefits of the cloud. Helping businesses move to the cloud is one of our largest opportunities, and we believe we work from a position of strength.
The shift to the cloud is driven by three important economies of scale: larger datacenters can deploy computational resources at significantly lower cost per unit than smaller ones; larger datacenters can coordinate and aggregate diverse customer, geographic, and application demand patterns improving the utilization of computing, storage, and network resources; and multi-tenancy lowers application maintenance labor costs for large public clouds. The cloud creates the opportunity for businesses to focus on innovation while leaving non-differentiating activities to reliable and cost-effective providers.
With Azure, we are one of very few cloud vendors that run at a scale that meets the needs of businesses of all sizes and complexities. We believe the combination of Azure and Windows Server makes us the only company with a public, private, and hybrid cloud platform that can power modern business. We are working to enhance the return on information technology (IT) investment by enabling enterprises to combine their existing datacenters and our public cloud into a single cohesive infrastructure. Businesses can deploy applications in their own datacenter, a partners datacenter, or in our datacenters with common security, management, and administration across all environments, with the flexibility and scale they desire.
Our cloud enables richer employee experiences. We enable organizations to securely adopt software-as-a-service applications (both our own and third-party) and integrate them with their existing security and management infrastructure. We will continue to innovate with higher level services including identity and directory services, rich data storage and analytics services, machine learning services, media services, web and mobile backend services, and developer productivity services. To foster a rich developer ecosystem, our digital work and life experiences will also be extensible, enabling customers and partners to further customize and enhance our solutions, achieving even more value. Our strategy requires continuing investment in datacenters and other infrastructure to support our devices and services.
Devices operating system and hardware
With our Windows devices operating system and hardware, we strive to set the standard for productivity experiences. We aim to deliver the richest and most consistent user experience for digital work and life scenarios on screens of all sizes from phones, tablets, and laptops to TVs and large, multi-touch displays. We are investing to make Windows the most secure, manageable, a