| | Research and development expenses increased $970 million or 9%, mainly due to increased investment in new products and services in our Devices engineering group, including NDS expenses, and increased investment in our Applications and Services engineering group. |
| | Sales and marketing expenses increased $535 million or 4%, primarily due to NDS expenses and increased investment in sales resources, offset in part by lower advertising costs. |
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SEGMENT RESULTS OF OPERATIONS
Devices and Consumer
| (In millions, except percentages) | 2015 | 2014 | 2013 | Percentage Change 2015 Versus 2014 |
Percentage Change 2014 Versus 2013 |
|||||||||||||||
| Revenue |
||||||||||||||||||||
| Licensing |
$ | 14,969 | $ | 19,528 | $ | 19,427 | (23)% | 1% | ||||||||||||
| Hardware: |
||||||||||||||||||||
| Computing and Gaming Hardware |
10,183 | 9,093 | 6,149 | 12% | 48% | |||||||||||||||
| Phone Hardware |
7,524 | 1,982 | 0 | * | * | |||||||||||||||
| Total Devices and Consumer Hardware |
17,707 | 11,075 | 6,149 | 60% | 80% | |||||||||||||||
| Other |
8,825 | 7,014 | 6,431 | 26% | 9% | |||||||||||||||
| Total Devices and Consumer revenue |
$ | 41,501 | $ | 37,617 | $ | 32,007 | 10% | 18% | ||||||||||||
| Gross Margin |
||||||||||||||||||||
| Licensing |
$ | 13,870 | $ | 17,439 | $ | 16,985 | (20)% | 3% | ||||||||||||
| Hardware: |
||||||||||||||||||||
| Computing and Gaming Hardware |
1,788 | 892 | 956 | 100% | (7)% | |||||||||||||||
| Phone Hardware |
701 | 54 | 0 | * | * | |||||||||||||||
| Total Devices and Consumer Hardware |
2,489 | 946 | 956 | 163% | (1)% | |||||||||||||||
| Other |
2,022 | 1,393 | 1,951 | 45% | (29)% | |||||||||||||||
| Total Devices and Consumer gross margin |
$ | 18,381 | $ | 19,778 | $ | 19,892 | (7)% | (1)% | ||||||||||||
| * | Not meaningful |
Fiscal year 2015 compared with fiscal year 2014
D&C revenue increased $3.9 billion or 10%, primarily due to a full year of Phone Hardware sales, as well as higher revenue from Surface, search advertising, and Xbox Live transactions, offset in part by a decrease in revenue from Windows OEM, licensing of Windows Phone operating system, and Office Consumer. Collectively, Office Consumer and Office 365 Consumer revenue declined 17%. D&C gross margin decreased $1.4 billion or 7%, reflecting higher cost of revenue, offset in part by higher revenue. D&C cost of revenue increased $5.3 billion or 30%, mainly due to a full year of Phone Hardware costs.
D&C Licensing
D&C Licensing revenue decreased $4.6 billion or 23%, mainly due to lower revenue from Windows OEM, Windows Phone licensing, and Office Consumer. Windows OEM revenue declined $1.9 billion or 15%, primarily due to declines of 15% in OEM Pro revenue and 16% in OEM non-Pro revenue. Windows OEM Pro revenue decreased, primarily due to benefits realized from the expiration of support for Windows XP in the prior year, and declines in the business PC market. Windows OEM non-Pro revenue declined, mainly due to an increased mix of opening price point devices sold, and declines in the consumer PC market. Revenue from licensing of Windows Phone operating system decreased $1.4 billion or 55%, primarily due to prior year revenue associated with our joint strategic initiatives with Nokia that terminated when we acquired NDS. Office Consumer revenue declined $946 million or 29%, reflecting the transition of customers to Office 365 Consumer, where revenue is recognized ratably, and declines in the Japan PC market, where Office is predominantly pre-installed on new PCs.
D&C Licensing gross margin decreased $3.6 billion or 20%, primarily due to the decline in revenue, offset in part by a $990 million or 47% decrease in cost of revenue. D&C Licensing cost of revenue decreased, mainly due to a $788 million decline in traffic acquisition costs, driven by prior year costs associated with our joint strategic initiatives with Nokia that terminated when we acquired NDS.
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Computing and Gaming Hardware
Computing and Gaming Hardware revenue increased $1.1 billion or 12%, primarily due to higher revenue from Surface, offset in part by lower revenue from Xbox Platform. Surface revenue increased 65% to $3.6 billion, primarily due to Surface Pro 3 units sold. Surface Pro 3 was released in June 2014. Xbox Platform revenue decreased $385 million or 6%, driven by lower prices of Xbox One consoles compared to the prior year, as well as a decrease in second- and third-party video games revenue. We sold 12.1 million Xbox consoles in fiscal year 2015 compared with 11.7 million consoles in fiscal year 2014.
Computing and Gaming Hardware gross margin increased $896 million or 100%, mainly due to higher revenue, offset in part by a $194 million or 2% increase in cost of revenue. Gross margin expansion was driven by Surface, which benefited from the mix shift to Surface Pro 3. Xbox Platform cost of revenue was comparable to the prior year.
Phone Hardware
Phone Hardware revenue increased $5.5 billion, as we sold 36.8 million Lumia phones and 126.8 million other non-Lumia phones in fiscal year 2015, compared with 5.8 million and 30.3 million sold, respectively, in fiscal year 2014 following the acquisition of NDS. We acquired NDS in the fourth quarter of fiscal year 2014.
Phone Hardware gross margin increased $647 million, primarily due to higher revenue, offset in part by higher cost of revenue. Phone Hardware cost of revenue increased $4.9 billion, and included $476 million of amortization of acquired intangible assets in fiscal year 2015.
We recorded goodwill and asset impairment charges of $7.5 billion related to our Phone Hardware business in the fourth quarter of fiscal year 2015. See further discussion under Impairment, Integration, and Restructuring Expenses below.
D&C Other
D&C Other revenue increased $1.8 billion or 26%, mainly due to higher revenue from search advertising, Xbox Live, first-party video games, including Minecraft, and Office 365 Consumer. D&C Other revenue included an unfavorable foreign currency impact of approximately 2%. Search advertising revenue increased $651 million or 22%, primarily driven by growth in Bing, due to higher revenue per search and search volume. Xbox Live and other store transaction revenue increased $531 million, driven by increased Xbox Live users and revenue per user. First-party video games revenue increased $367 million, mainly due to sales of Minecraft following the acquisition of Mojang in November 2014, and new Xbox titles released in the current year. Office 365 Consumer revenue increased $323 million, reflecting subscriber growth.
D&C Other gross margin increased $629 million or 45%, due to higher revenue, offset in part by a $1.2 billion or 21% increase in cost of revenue. D&C Other cost of revenue grew, mainly due to $372 million higher Xbox Live and other store transaction costs, a $279 million increase in search infrastructure costs, $267 million higher retail stores expenses, and $194 million higher first-party video games and Minecraft costs.
Fiscal year 2014 compared with fiscal year 2013
D&C revenue increased $5.6 billion or 18%, primarily due to higher revenue from Xbox Platform, Surface, and Windows Phone. Revenue also increased $2.0 billion due to the acquisition of NDS. D&C gross margin decreased slightly, reflecting higher cost of revenue, offset in part by higher revenue. Cost of revenue increased $5.7 billion or 47%, mainly due to Xbox Platform and Surface. Cost of revenue also increased $1.9 billion due to NDS.
D&C Licensing
D&C Licensing revenue increased $101 million or 1%, mainly due to increased Windows Phone revenue, offset in part by lower revenue from licenses of Windows and Office Consumer. Windows Phone revenue increased $822 million or 48%, mainly due to the recognition of $382 million revenue under our joint strategic initiatives with Nokia,
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which concluded in conjunction with the acquisition of NDS, as well as an increase in phone patent licensing revenue. Retail and non-OEM sales of Windows declined $274 million or 35%, mainly due to the launch of Windows 8 in the prior year. Windows OEM revenue declined $136 million or 1%, due to continued softness in the consumer PC market, offset in part by a 12% increase in OEM Pro revenue. Office Consumer revenue declined $249 million or 7%, reflecting the transition of customers to Office 365 Consumer as well as continued softness in the consumer PC market. The declines in Windows OEM and Office Consumer revenue were partially offset by benefits realized from ending our support for Windows XP in April 2014.
D&C Licensing gross margin increased $454 million or 3%, primarily due to a $353 million or 14% decrease in cost of revenue. D&C Licensing cost of revenue decreased, mainly due to a $411 million or 23% decline in traffic acquisition costs.
Computing and Gaming Hardware
Computing and Gaming Hardware revenue increased $2.9 billion or 48%, primarily due to higher revenue from the Xbox Platform and Surface. Xbox Platform revenue increased $1.7 billion or 34%, mainly due to sales of Xbox One, which was released in November 2013, offset in part by a decrease in sales of Xbox 360. We sold 11.7 million Xbox consoles during fiscal year 2014 compared with 9.8 million Xbox consoles during fiscal year 2013. Surface revenue increased $1.3 billion or 157%, mainly due to a higher number of devices and accessories sold.
Computing and Gaming Hardware gross margin decreased slightly, due to a $3.0 billion or 58% increase in cost of revenue, offset in part by higher revenue. Xbox Platform cost of revenue increased $2.1 billion or 72%, mainly due to higher volumes of consoles sold and higher costs associated with Xbox One. Surface cost of revenue increased $970 million or 51%, mainly due to a higher number of devices and accessories sold, offset in part by a charge for Surface RT inventory adjustments of approximately $900 million in fiscal year 2013.
Phone Hardware
Phone Hardware revenue was $2.0 billion in fiscal year 2014, reflecting sales of Lumia phones and other non-Lumia phones following the acquisition of NDS on April 25, 2014. Since the acquisition, we sold 5.8 million Lumia phones and 30.3 million other non-Lumia phones in fiscal year 2014.
Phone Hardware gross margin was $54 million in fiscal year 2014, reflecting revenue of $2.0 billion, offset in part by $1.9 billion cost of revenue, including amortization of acquired intangible assets and the impact of decisions to rationalize our device portfolio.
D&C Other
D&C Other revenue increased $583 million or 9%, mainly due to higher online advertising revenue and Office 365 Consumer revenue, offset in part by a $213 million decrease in first-party video games revenue, primarily due to the release of Halo 4 in the second quarter of fiscal year 2013. Online advertising revenue increased $497 million or 14%. Search advertising revenue increased 39%, primarily due to increased revenue per search resulting from ongoing improvements in advertising products, higher search volume, and the expiration of North American revenue per search guarantee payments to Yahoo! in the prior year, offset in part by a 25% reduction in display advertising revenue. Office 365 Consumer revenue grew $316 million, primarily reflecting subscriber growth. We ended fiscal year 2014 with over five million subscribers.
D&C Other gross margin decreased $558 million or 29%, due to a $1.1 billion or 25% increase in cost of revenue, offset in part by higher revenue. D&C Other cost of revenue grew, mainly due to a $541 million or 24% increase in online advertising cost of revenue, reflecting support of online infrastructure. Cost of revenue also increased $219 million or 15%, due to higher resale transactions costs.
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Commercial
| (In millions, except percentages) | 2015 | 2014 | 2013 | Percentage Change 2015 Versus 2014 |
Percentage Change 2014 Versus 2013 |
|||||||||||||||
| Revenue |
||||||||||||||||||||
| Licensing |
$ | 41,039 | $ | 42,085 | $ | 39,778 | (2)% | 6% | ||||||||||||
| Other |
10,836 | 7,546 | 5,661 | 44% | 33% | |||||||||||||||
| Total Commercial revenue |
$ | 51,875 | $ | 49,631 | $ | 45,439 | 5% | 9% | ||||||||||||
| Gross Margin |
||||||||||||||||||||
| Licensing |
$ | 37,830 | $ | 38,615 | $ | 36,280 | (2)% | 6% | ||||||||||||
| Other |
4,199 | 1,855 | 922 | 126% | 101% | |||||||||||||||
| Total Commercial gross margin |
$ | 42,029 | $ | 40,470 | $ | 37,202 | 4% | 9% | ||||||||||||
Fiscal year 2015 compared with fiscal year 2014
Commercial revenue increased $2.2 billion or 5%, mainly due to growth in revenue from our Commercial Cloud and server products, offset in part by a decline in Office Commercial. Commercial revenue included an unfavorable foreign currency impact of approximately 2%. Our server products and services grew 9%. Our Office Commercial products and services declined 1%. Commercial gross margin increased $1.6 billion or 4%.
Commercial Licensing
Commercial Licensing revenue decreased $1.0 billion or 2%, primarily due to a decline in revenue from Office Commercial, offset in part by increased revenue from our server products. Commercial Licensing revenue included an unfavorable foreign currency impact of approximately 2%. Office Commercial revenue declined $2.5 billion or 13%, due to lower transactional license volume, reflecting a decline in the business PC market following Windows XP end of support in the prior year, customers transitioning to Office 365 Commercial, and declines in Japan. Our server products revenue grew $1.1 billion or 7%, primarily driven by higher premium mix of Microsoft SQL Server, Windows Server, and System Center.
Commercial Licensing gross margin decreased $785 million or 2%, in line with revenue.
Commercial Other
Commercial Other revenue increased $3.3 billion or 44%, primarily due to higher Commercial Cloud revenue. Commercial Other revenue included an unfavorable foreign currency impact of approximately 3%. Commercial Cloud revenue grew $3.0 billion or 106%, mainly due to subscriber growth and higher premium mix of Office 365 Commercial, as well as continued revenue growth from Microsoft Azure.
Commercial Other gross margin increased $2.3 billion or 126%, due to higher revenue, offset in part by a $946 million or 17% increase in cost of revenue. The increase in Commercial Other cost of revenue was mainly due to higher datacenter and other online infrastructure expenses, reflecting increased datacenter capacity to serve our growing Commercial Cloud.
Fiscal year 2014 compared with fiscal year 2013
Commercial revenue increased $4.2 billion or 9%, mainly due to growth in revenue from our on-premises licensing businesses and Commercial Cloud. Collectively, Office Commercial and Office 365 Commercial revenue grew 7%. Collectively, our server products revenue, including Microsoft Azure, grew 13%. Commercial gross margin increased $3.3 billion or 9%, in line with revenue.
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Commercial Licensing
Commercial Licensing revenue increased $2.3 billion or 6%, primarily due to increased revenue from our server products, as well as higher revenue from Windows Commercial and Office Commercial. Our server products revenue grew $1.7 billion or 11%, driven primarily by increased sales of Microsoft SQL Server. Windows Commercial revenue grew $334 million or 10%, mainly due to increased renewal rates and transactional purchases driven by Windows XP end of support. Office Commercial revenue grew $219 million or 1%, and was impacted by customers transitioning to Office 365 Commercial.
Commercial Licensing gross margin increased $2.3 billion or 6%, in line with revenue growth.
Commercial Other
Commercial Other revenue increased $1.9 billion or 33%, due to higher Commercial Cloud revenue and Enterprise Services revenue. Commercial Cloud revenue grew $1.5 billion or 116%, mainly due to higher revenue from Office 365 Commercial. Enterprise Services revenue grew $380 million or 9%, mainly due to growth in Premier Support Services.
Commercial Other gross margin increased $933 million or 101%, due to higher revenue, offset in part by a $952 million or 20% increase in cost of revenue. The increase in cost of revenue was mainly due to higher datacenter expenses, reflecting support of our growing Commercial Cloud.
Corporate and Other
| (In millions, except percentages) | 2015 | 2014 | 2013 | Percentage Change 2015 Versus 2014 |
Percentage Change 2014 Versus 2013 |
|||||||||||||||
| Revenue |
$ | 204 | $ | (415 | ) | $ | 403 | 149% | (203)% | |||||||||||
| Gross margin |
$ | 132 | $ | (493 | ) | $ | 370 | 127% | (233)% | |||||||||||
Corporate and Other revenue comprises certain revenue deferrals, including those related to product and service upgrade offers and pre-sales of new products to OEMs prior to general availability.
Fiscal year 2015 compared with fiscal year 2014
Corporate and Other revenue increased $619 million, primarily due to the timing of revenue deferrals compared to the prior year. During fiscal year 2015, we recognized a net $303 million of previously deferred revenue related to Bundled Offerings. During fiscal year 2014, we deferred a net $349 million of revenue related to Bundled Offerings.
Corporate and Other gross margin increased $625 million, primarily due to increased revenue.
Fiscal year 2014 compared with fiscal year 2013
Corporate and Other revenue decreased $818 million, primarily due to the timing of revenue deferrals. During fiscal year 2014, we deferred a net $349 million of revenue related to Bundled Offerings. During fiscal year 2013, we recognized $540 million of previously deferred revenue related to the Windows Upgrade Offer. The revenue was recognized upon expiration of the offer.
Corporate and Other gross margin decreased $863 million, mainly due to decreased revenue.
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OPERATING EXPENSES
Research and Development
| (In millions, except percentages) | 2015 | 2014 | 2013 | Percentage Change 2015 Versus 2014 |
Percentage Change 2014 Versus 2013 |
|||||||||||||||
| Research and development |
$ | 12,046 | $ | 11,381 | $ | 10,411 | 6% | 9% | ||||||||||||
| As a percent of revenue |
13% | 13% | 13% | 0ppt | 0ppt | |||||||||||||||
Research and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code.
Fiscal year 2015 compared with fiscal year 2014
Research and development expenses increased $665 million or 6%, mainly due to increased investment in new products and services, including $739 million higher NDS expenses, offset in part by reduced headcount-related expenses.
Fiscal year 2014 compared with fiscal year 2013
Research and development expenses increased $970 million or 9%, mainly due to increased investment in new products and services in our Devices engineering group, including $275 million of NDS expenses, and increased investment in our Applications and Services engineering group.
Sales and Marketing
| (In millions, except percentages) | 2015 | 2014 | 2013 | Percentage Change 2015 Versus 2014 |
Percentage Change 2014 Versus 2013 |
|||||||||||||||
| Sales and marketing |
$ | 15,713 | $ | 15,811 | $ | 15,276 | (1)% | 4% | ||||||||||||
| As a percent of revenue |
17% | 18% | 20% | (1)ppt | (2)ppt | |||||||||||||||
Sales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel and the costs of advertising, promotions, trade shows, seminars, and other programs.
Fiscal year 2015 compared with fiscal year 2014
Sales and marketing expenses decreased $98 million or 1%, primarily due to a decline in advertising and marketing programs costs and a reduction in headcount-related expenses, offset in part by an increase in NDS expenses. Sales and marketing expenses included a favorable foreign currency impact of approximately 4%.
Fiscal year 2014 compared with fiscal year 2013
Sales and marketing expenses increased $535 million or 4%, primarily due to NDS expenses and increased investment in sales resources, offset in part by lower advertising costs. NDS sales and marketing expenses were $394 million during fiscal year 2014. Average headcount, excluding NDS, grew 4%. Advertising costs, excluding NDS, declined $403 million or 15%, primarily due to Windows 8 and Surface costs in the prior year.
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General and Administrative
| (In millions, except percentages) | 2015 | 2014 | 2013 | Percentage Change 2015 Versus 2014 |
Percentage Change 2014 Versus 2013 |
|||||||||||||||
| General and administrative |
$ | 4,611 | $ | 4,677 | $ | 5,013 | (1)% | (7)% | ||||||||||||
| As a percent of revenue |
5% | 5% | 6% | 0ppt | (1)ppt | |||||||||||||||
General and administrative expenses include payroll, employee benefits, stock-based compensation expense, severance expense, and other headcount-related expenses associated with finance, legal, facilities, certain human resources and other administrative personnel, certain taxes, and legal and other administrative fees.
Fiscal year 2015 compared with fiscal year 2014
General and administrative expenses were comparable to the prior year.
Fiscal year 2014 compared with fiscal year 2013
General and administrative expenses decreased $336 million or 7%, mainly due to the European Commission fine in the prior year, offset in part by higher business taxes, higher costs for internal use software capitalized in the prior year, and NDS expenses. NDS general and administrative expenses were $77 million during fiscal year 2014.
IMPAIRMENT, INTEGRATION, AND RESTRUCTURING EXPENSES
Impairment, integration, and restructuring expenses include costs associated with the impairment of goodwill and intangible assets related to our Phone Hardware business, employee severance expenses and costs associated with the consolidation of facilities and manufacturing operations related to restructuring activities, and systems consolidation and other business integration expenses associated with our acquisition of NDS.
Fiscal year 2015 compared with fiscal year 2014
Impairment, integration, and restructuring expenses were $10.0 billion for fiscal year 2015, compared to $127 million for fiscal year 2014. The increase was mainly due to impairment charges of $7.5 billion related to our Phone Hardware business in the fourth quarter of fiscal year 2015. Our annual goodwill impairment test as of May 1, 2015 indicated that the carrying value of Phone Hardware goodwill exceeded its estimated fair value. Accordingly, we recorded a goodwill impairment charge of $5.1 billion, reducing Phone Hardwares goodwill from $5.4 billion to $116 million, net of foreign currency remeasurements, as well as an impairment charge of $2.2 billion related to the write-down of Phone Hardware intangible assets. Restructuring charges were $2.1 billion, including employee severance expenses and the write-down of certain assets in connection with our restructuring activities. Integration expenses increased $308 million, due to a full-year of integration activities in fiscal year 2015 associated with the acquisition of NDS.
Fiscal year 2014 compared with fiscal year 2013
Impairment, integration, and restructuring expenses were $127 million for fiscal year 2014, reflecting integration expenses associated with the acquisition of NDS. No impairment, integration, and restructuring expenses were recorded in fiscal year 2013.
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OTHER INCOME (EXPENSE), NET
The components of other income (expense), net were as follows:
| (In millions) | ||||||||||||
| Year Ended June 30, | 2015 | 2014 | 2013 | |||||||||
| Dividends and interest income |
$ | 766 | $ | 883 | $ | 677 | ||||||
| Interest expense |
(781 | ) | (597 | ) | (429 | ) | ||||||
| Net recognized gains on investments |
716 | 437 | 116 | |||||||||
| Net losses on derivatives |
(423 | ) | (328 | ) | (196 | ) | ||||||
| Net gains (losses) on foreign currency remeasurements |
335 | (165 | ) | (74 | ) | |||||||
| Other |
(267 | ) | (169 | ) | 194 | |||||||
| Total |
$ | 346 | $ | 61 | $ | 288 | ||||||
We use derivative instruments to: manage risks related to foreign currencies, equity prices, interest rates, and credit; enhance investment returns; and facilitate portfolio diversification. Gains and losses from changes in fair values of derivatives that are not designated as hedges are primarily recognized in other income (expense), net. Other than those derivatives entered into for investment purposes, such as commodity contracts, the gains (losses) are generally economically offset by unrealized gains (losses) in the underlying available-for-sale securities and gains (losses) on certain balance sheet amounts from foreign exchange rate changes.
Fiscal year 2015 compared with fiscal year 2014
Dividends and interest income decreased due to lower yields on fixed income securities, offset in part by higher portfolio balances. Interest expense increased due to higher outstanding long-term debt. Net recognized gains on investments increased primarily due to higher gains on sales of equity securities, offset in part by higher other-than-temporary impairments. Other-than-temporary impairments were $183 million in fiscal year 2015, compared with $106 million in fiscal year 2014. Net losses on derivatives increased due to losses on commodity contracts in the current period as compared to gains in the prior period, offset in part by lower losses on currency and equity contracts. For fiscal year 2015, other reflects recognized losses from certain joint ventures and divestitures.
Fiscal year 2014 compared with fiscal year 2013
Dividends and interest income increased due to higher portfolio balances. Interest expense increased due to higher outstanding long-term debt. Net recognized gains on investments increased primarily due to higher gains on sales of equity securities and lower other-than-temporary impairments. Other-than-temporary impairments were $106 million in fiscal year 2014, compared with $208 million in fiscal year 2013. Net losses on derivatives increased due to higher losses on foreign exchange contracts, losses on equity derivatives as compared to gains in the prior period, offset in part by gains on commodity and interest rate derivatives as compared to losses in the prior period. For fiscal year 2014, other reflects recognized losses from certain joint ventures, offset in part by a recognized gain on a divestiture. For fiscal year 2013, other reflects recognized gains on divestitures, including the gain recognized upon the divestiture of our 50% share in the MSNBC joint venture.
INCOME TAXES
Fiscal year 2015 compared with fiscal year 2014
Our effective tax rate for fiscal years 2015 and 2014 was approximately 34% and 21%, respectively. The fiscal year 2015 effective rate increased by 13%, primarily due to goodwill and asset impairments and restructuring charges recorded in fiscal year 2015, most of which did not generate a tax benefit. Our effective tax rate was lower than the U.S. federal statutory rate primarily due to foreign earnings taxed at lower rates resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico. In fiscal year 2015, this reduction was mostly offset by losses in foreign jurisdictions for which we may not realize a tax benefit, primarily as a result of impairment and restructuring charges.
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Changes in the mix of income before income taxes between the U.S. and foreign countries also impacted our effective tax rates and resulted primarily from changes in the geographic distribution of and changes in consumer demand for our products and services. We supply our Windows PC operating system to customers through our U.S. regional operating center, while we supply the Microsoft Office system and our server products and tools to customers through our foreign regional operations centers. In fiscal years 2015 and 2014, our U.S. income before income taxes was $7.4 billion and $7.1 billion, respectively, and comprised 40% and 26%, respectively, of our income before income taxes. In fiscal years 2015 and 2014, our foreign income before income taxes was $11.1 billion and $20.7 billion, respectively, and comprised 60% and 74%, respectively, of our income before income taxes.
Tax contingencies and other income tax liabilities were $12.1 billion and $10.4 billion as of June 30, 2015 and 2014, respectively, and are included in other long-term liabilities. This increase relates primarily to adjustments to prior years liabilities for intercompany transfer pricing and adjustments related to our IRS audits. While we settled a portion of the I.R.S. audit for tax years 2004 to 2006 during the third quarter of fiscal year 2011, we remain under audit for those years. In February 2012, the I.R.S. withdrew its 2011 Revenue Agents Report and reopened the audit phase of the examination. As of June 30, 2015, the primary unresolved issue relates to transfer pricing, which could have a significant impact on our consolidated financial statements if not resolved favorably. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months. We also continue to be subject to examination by the I.R.S. for tax years 2007 to 2015.
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 2015, some of which are currently under audit by local tax authorities. The resolutions of these audits are not expected to be material to our consolidated financial statements.
Fiscal year 2014 compared with fiscal year 2013
Our effective tax rate for fiscal years 2014 and 2013 was approximately 21% and 19%, 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.
Our fiscal year 2014 effective rate increased by 2% from fiscal year 2013 mainly due to adjustments of $458 million to prior years liabilities for intercompany transfer pricing that increased taxable income in more highly taxed jurisdictions, as well as losses incurred by NDS and changes in the geographic mix of our business. This was offset in part by favorable transfer pricing developments in certain foreign tax jurisdictions, primarily Denmark.
Changes in the mix of income before income taxes between the U.S. and foreign countries also impacted our effective tax rates and resulted primarily from changes in the geographic distribution of and changes in consumer demand for our products and services. We supply our Windows PC operating system to customers through our U.S. regional operating center, while we supply the Microsoft Office system and our server products and tools to customers through our foreign regional operations centers. Windows PC operating system revenue decreased $655 million in fiscal year 2014, while Microsoft Office system and server products and tools revenue increased $1.3 billion and $1.6 billion, respectively, during this same period. In fiscal years 2014 and 2013, our U.S. income before income taxes was $7.1 billion and $6.7 billion, respectively, and comprised 26% and 25%, respectively, of our income before income taxes. In fiscal years 2014 and 2013, the foreign income before income taxes was $20.7 billion and $20.4 billion, respectively, and comprised 74% and 75%, respectively, of our income before income taxes.
FINANCIAL CONDITION
Cash, Cash Equivalents, and Investments
Cash, cash equivalents, and short-term investments totaled $96.5 billion as of June 30, 2015, compared with $85.7 billion as of June 30, 2014. Equity and other investments were $12.1 billion as of June 30, 2015, compared with $14.6 billion as of June 30, 2014. Our short-term investments are primarily to facilitate liquidity and for capital
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preservation. They consist predominantly of highly liquid investment-grade fixed-income securities, diversified among industries and individual issuers. The investments are predominantly U.S. dollar-denominated securities, but also include foreign currency-denominated securities in order to diversify risk. Our fixed-income investments are exposed to interest rate risk and credit risk. The credit risk and average maturity of our fixed-income portfolio are managed to achieve economic returns that correlate to certain fixed-income indices. The settlement risk related to these investments is insignificant given that the short-term investments held are primarily highly liquid investment-grade fixed-income securities.
Of the cash, cash equivalents, and short-term investments at June 30, 2015, $94.4 billion was held by our foreign subsidiaries and would be subject to material repatriation tax effects. The amount of cash, cash equivalents, and short-term investments held by foreign subsidiaries subject to other restrictions on the free flow of funds (primarily currency and other local regulatory) was $2.1 billion. As of June 30, 2015, approximately 79% of the cash equivalents and short-term investments held by our foreign subsidiaries were invested in U.S. government and agency securities, approximately 5% were invested in corporate notes and bonds of U.S. companies, and approximately 5% were invested in U.S. mortgage- and asset-backed securities, all of which are denominated in U.S. dollars.
Securities lending
We lend certain fixed-income and equity securities to increase investment returns. The loaned securities continue to be carried as investments on our balance sheet. Cash and/or security interests are received as collateral for the loaned securities with the amount determined based upon the underlying security lent and the creditworthiness of the borrower. Cash received is recorded as an asset with a corresponding liability. Our securities lending payable balance was $92 million as of June 30, 2015. Our average and maximum securities lending payable balances for the fiscal year were $287 million and $750 million, respectively. Intra-year variances in the amount of securities loaned are mainly due to fluctuations in the demand for the securities.
Valuation
In general, and where applicable, we use quoted prices in active markets for identical assets or liabilities to determine the fair value of our financial instruments. This pricing methodology applies to our Level 1 investments, such as exchange-traded mutual funds, domestic and international equities, and U.S. government securities. If quoted prices in active markets for identical assets or liabilities are not available to determine fair value, then we use quoted prices for similar assets and liabilities or inputs other than the quoted prices that are observable either directly or indirectly. This pricing methodology applies to our Level 2 investments such as corporate notes and bonds, common and preferred stock, foreign government bonds, mortgage- and asset-backed securities, U.S. government and agency securities, and certificates of deposit. Level 3 investments are valued using internally developed models with unobservable inputs. Assets and liabilities measured at fair value on a recurring basis using unobservable inputs are an immaterial portion of our portfolio.
A majority of our investments are priced by pricing vendors and are generally Level 1 or Level 2 investments as these vendors either provide a quoted market price in an active market or use observable inputs for their pricing without applying significant adjustments. Broker pricing is used mainly when a quoted price is not available, the investment is not priced by our pricing vendors, or when a broker price is more reflective of fair values in the market in which the investment trades. Our broker-priced investments are generally classified as Level 2 investments because the broker prices these investments based on similar assets without applying significant adjustments. In addition, all of our broker-priced investments have a sufficient level of trading volume to demonstrate that the fair values used are appropriate for these investments. Our fair value processes include controls that are designed to ensure appropriate fair values are recorded. These controls include model validation, review of key model inputs, analysis of period-over-period fluctuations, and independent recalculation of prices where appropriate.
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Cash Flows
Fiscal year 2015 compared with fiscal year 2014
Cash flows from operations decreased $3.2 billion during the fiscal year to $29.1 billion, mainly due to an increase in materials and production costs in support of sales growth as well as payments related to restructuring charges and other changes in working capital, offset in part by increases in cash received from customers. Cash used in financing increased $686 million to $9.1 billion, mainly due to a $7.1 billion increase in cash used for common stock repurchases, offset in part by a $6.7 billion increase in proceeds from issuances of debt, net of repayments. Cash used in investing increased $4.2 billion to $23.0 billion, mainly due to a $5.5 billion increase in cash used for net investment purchases, sales, and maturities, partially offset by a $2.2 billion decrease in cash used for acquisitions of companies and purchases of intangible and other assets.
Fiscal year 2014 compared with fiscal year 2013
Cash flows from operations increased $3.4 billion during fiscal year 2014 to $32.2 billion, mainly due to increases in cash received from customers. Cash used in financing increased $246 million to $8.4 billion, mainly due to a $2.0 billion increase in cash used for common stock repurchases, a $1.4 billion increase in dividends paid, and a $324 million decrease in proceeds from the issuance of common stock, offset in part by a $3.4 billion increase in proceeds from issuances of debt, net of repayments. Cash used in investing decreased $5.0 billion to $18.8 billion, mainly due to a $10.5 billion decrease in cash used for net investment purchases, sales, and maturities, offset in part by a $4.4 billion increase in cash used for acquisition of companies and purchases of intangible and other assets, and a $1.2 billion increase in capital expenditures for property and equipment.
Debt
We issued debt to take advantage of favorable pricing and liquidity in the debt markets, reflecting our credit rating and the low interest rate environment. The proceeds of these issuances were or will be used for general corporate purposes, which may include, among other things, funding for working capital, capital expenditures, repurchases of capital stock, acquisitions, and repayment of existing debt. See Note 12 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K for further discussion.
Unearned Revenue
Unearned revenue at June 30, 2015 was comprised mainly of unearned revenue from volume licensing programs. Unearned revenue from volume licensing programs represents customer billings for multi-year licensing arrangements paid for either at inception of the agreement or annually at the beginning of each coverage period and accounted for as subscriptions with revenue recognized ratably over the coverage period. Unearned revenue at June 30, 2015 also included payments for: post-delivery support and consulting services to be performed in the future; Xbox Live subscriptions and prepaid points; Microsoft Dynamics business solutions products; Office 365 subscriptions; Skype prepaid credits and subscriptions; Bundled Offerings; and other offerings for which we have been paid in advance and earn the revenue when we provide the service or software, or otherwise meet the revenue recognition criteria.
The following table outlines the expected future recognition of unearned revenue as of June 30, 2015:
| (In millions) | ||||
| Three Months Ending, |
||||
| September 30, 2015 |
$ | 8,889 | ||
| December 31, 2015 |
7,172 | |||
| March 31, 2016 |
4,848 | |||
| June 30, 2016 |
2,314 | |||
| Thereafter |
2,095 | |||
| Total |
$ | 25,318 | ||
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Share Repurchases
On September 16, 2013, our Board of Directors approved a share repurchase program authorizing up to $40.0 billion in share repurchases. The share repurchase program became effective on October 1, 2013, has no expiration date, and may be suspended or discontinued at any time without notice. While the program has no expiration date, we intend to complete it by December 31, 2016. As of June 30, 2015, $21.9 billion remained of our $40.0 billion share repurchase program.
During fiscal year 2015, we repurchased 295 million shares of Microsoft common stock for $13.2 billion under the share repurchase program approved by our Board of Directors on September 16, 2013. During fiscal year 2014, we repurchased 175 million shares for $6.4 billion; 128 million shares were repurchased for $4.9 billion under the share repurchase program approved by our Board of Directors on September 16, 2013, and 47 million shares were repurchased for $1.5 billion under the share repurchase program that was announced on September 22, 2008 and expired September 30, 2013. During fiscal year 2013, we repurchased 158 million shares for $4.6 billion, under the share repurchase program announced on September 22, 2008. All repurchases were made using cash resources.
Dividends
See Note 19 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.
Off-Balance Sheet Arrangements
We provide indemnifications of varying scope and size to certain customers against claims of intellectual property infringement made by third parties arising from the use of our products and certain other matters. In evaluating estimated losses on these indemnifications, we consider factors such as the degree of probability of an unfavorable outcome and our ability to make a reasonable estimate of the amount of loss. These obligations did not have a material impact on our consolidated financial statements during the periods presented.
Contractual Obligations
The following table summarizes the payments due by fiscal year for our outstanding contractual obligations as of June 30, 2015:
| (In millions) | 2016 | 2017-2018 | 2019-2020 | Thereafter | Total | |||||||||||||||
| Long-term debt: (a) |
||||||||||||||||||||
| Principal payments |
$ | 2,500 | $ | 1,050 | $ | 3,750 | $ | 23,163 | $ | 30,463 | ||||||||||
| Interest payments |
855 | 1,641 | 1,552 | 11,412 | 15,460 | |||||||||||||||
| Construction commitments (b) |
681 | 0 | 0 | 0 | 681 | |||||||||||||||
| Operating leases (c) |
863 | 1,538 | 1,135 | 1,617 | 5,153 | |||||||||||||||
| Purchase commitments (d) |
13,018 | 989 | 164 | 261 | 14,432 | |||||||||||||||
| Other long-term liabilities (e) |
0 | 237 | 75 | 639 | 951 | |||||||||||||||
| Total contractual obligations |
$ | 17,917 | $ | 5,455 | $ | 6,676 | $ | 37,092 | $ | 67,140 | ||||||||||
| (a) | See Note 12 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). |
| (b) | These amounts represent commitments for the construction of buildings, building improvements, and leasehold improvements. |
| (c) | These amounts represent undiscounted future minimum rental commitments under noncancellable facilities leases. |
| (d) | These amounts represent purchase commitments, including all open purchase orders and all contracts that are take-or-pay contracts that are not presented as construction commitments above. |
| (e) | We have excluded long-term tax contingencies, other tax liabilities, deferred income taxes, and long-term pension liabilities of $15.2 billion from the amounts presented. We have also excluded unearned revenue and non-cash items. |
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Other Planned Uses of Capital
We will continue to invest in sales, marketing, product support infrastructure, and existing and advanced areas of technology, as well as continue making acquisitions that align with our business strategy. Additions to property and equipment will continue, including new facilities, data centers, and computer systems for research and development, sales and marketing, support, and administrative staff. We expect capital expenditures to increase in coming years in support of our productivity and platform strategy. We have operating leases for most U.S. and international sales and support offices and certain equipment. We have not engaged in any related party transactions or arrangements with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of capital resources.
Liquidity
We earn a significant amount of our operating income outside the U.S., which is deemed to be permanently reinvested in foreign jurisdictions. As a result, as discussed above under Cash, Cash Equivalents, and Investments, the majority of our cash, cash equivalents, and short-term investments are held by foreign subsidiaries. We currently do not intend nor foresee a need to repatriate these funds. We expect existing domestic cash, cash equivalents, short-term investments, cash flows from operations, and access to capital markets to continue to be sufficient to fund our domestic operating activities and cash commitments for investing and financing activities, such as regular quarterly dividends, debt maturities, and material capital expenditures, for at least the next 12 months and thereafter for the foreseeable future. In addition, we expect existing foreign cash, cash equivalents, short-term investments, and cash flows from operations to continue to be sufficient to fund our foreign operating activities and cash commitments for investing activities, such as material capital expenditures, for at least the next 12 months and thereafter for the foreseeable future.
Should we require more capital in the U.S. than is generated by our operations domestically, for example to fund significant discretionary activities, such as business acquisitions and share repurchases, we could elect to repatriate future earnings from foreign jurisdictions or raise capital in the U.S. through debt or equity issuances. These alternatives could result in higher effective tax rates, increased interest expense, or dilution of our earnings. We have borrowed funds domestically and continue to believe we have the ability to do so at reasonable interest rates.
RECENT ACCOUNTING GUIDANCE
See Note 1 Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements and accompanying notes are prepared in accordance with U.S. GAAP. Preparing consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by managements application of accounting policies. Critical accounting policies for us include revenue recognition, impairment of investment securities, goodwill, research and development costs, contingencies, income taxes, and inventories.
Revenue Recognition
Revenue recognition for multiple-element arrangements requires judgment to determine if multiple elements exist, whether elements can be accounted for as separate units of accounting, and if so, the fair value for each of the elements.
Judgment is also required to assess whether future releases of certain software represent new products or upgrades and enhancements to existing products. Certain volume licensing arrangements include a perpetual license for current products combined with rights to receive unspecified future versions of software products and are accounted for as subscriptions, with billings recorded as unearned revenue and recognized as revenue ratably over the coverage period.
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Software updates are evaluated on a case-by-case basis to determine whether they meet the definition of an upgrade, which may require revenue to be deferred and recognized when the upgrade is delivered. If it is determined that implied post-contract customer support (PCS) is being provided, revenue from the arrangement is deferred and recognized over the implied PCS term. If updates are determined to not meet the definition of an upgrade, revenue is generally recognized as products are shipped or made available.
Microsoft enters into arrangements that can include various combinations of software, services, and hardware. Where elements are delivered over different periods of time, and when allowed under U.S. GAAP, revenue is allocated to the respective elements based on their relative selling prices at the inception of the arrangement, and revenue is recognized as each element is delivered. We use a hierarchy to determine the fair value to be used for allocating revenue to elements: (i) vendor-specific objective evidence of fair value (VSOE), (ii) third-party evidence, and (iii) best estimate of selling price (ESP). For software elements, we follow the industry specific software guidance which only allows for the use of VSOE in establishing fair value. Generally, VSOE is the price charged when the deliverable is sold separately or the price established by management for a product that is not yet sold if it is probable that the price will not change before introduction into the marketplace. ESPs are established as best estimates of what the selling prices would be if the deliverables were sold regularly on a stand-alone basis. Our process for determining ESPs requires judgment and considers multiple factors that may vary over time depending upon the unique facts and circumstances related to each deliverable.
In January 2015, we announced Windows 10 will be free to all qualified existing users of Windows 7 and Windows 8.1. This offer differs from historical offers preceding the launch of new versions of Windows as it is being made available for free to existing users in addition to new customers after the offer announcement. We evaluated the nature and accounting treatment of the Windows 10 offer and determined that it represents a marketing and promotional activity, in part because the offer is being made available for free to existing users. As this is a marketing and promotional activity, revenue recognition of new sales of Windows 8 will continue to be recognized as delivered.
Impairment of Investment Securities
We review investments quarterly for indicators of other-than-temporary impairment. This determination requires significant judgment. In making this judgment, we employ a systematic methodology quarterly that considers available quantitative and qualitative evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, the duration and extent to which the fair value is less than cost, and for equity securities, our intent and ability to hold, or plans to sell, the investment. For fixed-income securities, we also evaluate whether we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery. We also consider specific adverse conditions related to the financial health of and business outlook for the investee, including industry and sector performance, changes in technology, and operational and financing cash flow factors. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded to other income (expense), net and a new cost basis in the investment is established. If market, industry, and/or investee conditions deteriorate, we may incur future impairments.
Goodwill
We allocate goodwill to reporting units based on the reporting unit expected to benefit from the business combination. We evaluate our reporting units on an annual basis and, if necessary, reassign goodwill using a relative fair value allocation approach. Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit.
Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. The fair value of each reporting unit is estimated primarily through the use of a
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discounted cash flow methodology. This analysis requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the useful life over which cash flows will occur, and determination of our weighted average cost of capital.
The estimates used to calculate the fair value of a reporting unit change from year to year based on operating results, market conditions, and other factors. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for each reporting unit.
Based on the results of our annual goodwill impairment testing as of May 1, 2015, we determined that goodwill associated with our Phone Hardware reporting unit was impaired, resulting in a material charge to earnings in the fourth quarter of fiscal year 2015. As of June 30, 2015, none of our reporting units were considered to be at risk of impairment.
Research and Development Costs
Costs incurred internally in researching and developing a computer software product are charged to expense until technological feasibility has been established for the product. Once technological feasibility is established, all software costs are capitalized until the product is available for general release to customers. Judgment is required in determining when technological feasibility of a product is established. We have determined that technological feasibility for our software products is reached after all high-risk development issues have been resolved through coding and testing. Generally, this occurs shortly before the products are released to manufacturing. The amortization of these costs is included in cost of revenue over the estimated life of the products.
Legal and Other Contingencies
The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. An estimated loss from a loss contingency such as a legal proceeding or claim is accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. In determining whether a loss should be accrued we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our consolidated financial statements.
Income Taxes
The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entitys financial statements or tax returns. We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Accounting literature also provides guidance on derecognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and income tax disclosures. Judgment is required in assessing the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our consolidated financial statements.
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Inventories
Inventories are stated at average cost, subject to the lower of cost or market. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. These reviews include analysis of demand forecasts, product life cycle status, product development plans, current sales levels, pricing strategy, and component cost trends. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue. The determination of market value and the estimated volume of demand used in the lower of cost or market analysis require significant judgment.
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STATEMENT OF MANAGEMENTS RESPONSIBILITY FOR FINANCIAL STATEMENTS
Management is responsible for the preparation of the consolidated financial statements and related information that are presented in this report. The consolidated financial statements, which include amounts based on managements estimates and judgments, have been prepared in conformity with accounting principles generally accepted in the United States of America.
The Company designs and maintains accounting and internal control systems to provide reasonable assurance at reasonable cost that assets are safeguarded against loss from unauthorized use or disposition, and that the financial records are reliable for preparing consolidated financial statements and maintaining accountability for assets. These systems are augmented by written policies, an organizational structure providing division of responsibilities, careful selection and training of qualified personnel, and a program of internal audits.
The Company engaged Deloitte & Touche LLP, an independent registered public accounting firm, to audit and render an opinion on the consolidated financial statements and internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States).
The Board of Directors, through its Audit Committee, consisting solely of independent directors of the Company, meets periodically with management, internal auditors, and our independent registered public accounting firm to ensure that each is meeting its responsibilities and to discuss matters concerning internal controls and financial reporting. Deloitte & Touche LLP and the internal auditors each have full and free access to the Audit Committee.
| Satya Nadella |
| Chief Executive Officer |
| Amy E. Hood |
| Executive Vice President and Chief Financial Officer |
| Frank H. Brod |
| Corporate Vice President, Finance and Administration; Chief Accounting Officer |
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
RISKS
We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, equity prices, and commodity prices. A portion of these risks is hedged, but they may impact our consolidated financial statements.
Foreign Currency
Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily and use hedges where practicable to offset the risks and maximize the economic effectiveness of our foreign currency positions. Principal currencies hedged include the euro, Japanese yen, British pound, Canadian dollar, and Australian dollar.
Interest Rate
Our fixed-income portfolio is diversified across credit sectors and maturities, consisting primarily of investment-grade securities. The credit risk and average maturity of the fixed-income portfolio is managed to achieve economic returns that correlate to certain global and domestic fixed-income indices. In addition, we use To Be Announced forward purchase commitments of mortgage-backed assets to gain exposure to agency mortgage-backed securities.
Equity
Our equity portfolio consists of global, developed, and emerging market securities that are subject to market price risk. We manage the securities relative to certain global and domestic indices and expect their economic risk and return to correlate with these indices.
Commodity
We use broad-based commodity exposures to enhance portfolio returns and facilitate portfolio diversification. Our investment portfolio has exposure to a variety of commodities, including precious metals, energy, and grain. We manage these exposures relative to global commodity indices and expect their economic risk and return to correlate with these indices.
VALUE-AT-RISK
We use a value-at-risk (VaR) model to estimate and quantify our market risks. VaR is the expected loss, for a given confidence level, in the fair value of our portfolio due to adverse market movements over a defined time horizon. The VaR model is not intended to represent actual losses in fair value, including determinations of other-than-temporary losses in fair value in accordance with U.S. GAAP, but is used as a risk estimation and management tool. The distribution of the potential changes in total market value of all holdings is computed based on the historical volatilities and correlations among foreign exchange rates, interest rates, equity prices, and commodity prices, assuming normal market conditions.
The VaR is calculated as the total loss that will not be exceeded at the 97.5 percentile confidence level or, alternatively stated, the losses could exceed the VaR in 25 out of 1,000 cases. Several risk factors are not captured in the model, including liquidity risk, operational risk, and legal risk.
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The following table sets forth the one-day VaR for substantially all of our positions as of June 30, 2015 and 2014 and for the year ended June 30, 2015:
| (In millions) | ||||||||||||||||||||
| June 30, 2015 |
June 30, 2014 |
Year Ended June 30, 2015 |
||||||||||||||||||
| Risk Categories | Average | High | Low | |||||||||||||||||
| Foreign currency |
$ | 120 | $ | 179 | $ | 162 | $ | 200 | $ | 107 | ||||||||||
| Interest rate |
$ | 51 | $ | 73 | $ | 57 | $ | 74 | $ | 48 | ||||||||||
| Equity |
$ | 149 | $ | 176 | $ | 161 | $ | 178 | $ | 146 | ||||||||||
| Commodity |
$ | 13 | $ | 17 | $ | 16 | $ | 20 | $ | 11 | ||||||||||
Total one-day VaR for the combined risk categories was $237 million at June 30, 2015 and $333 million at June 30, 2014. The total VaR is 29% less at June 30, 2015, and 25% less at June 30, 2014, than the sum of the separate risk categories in the table above due to the diversification benefit of the combination of risks.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INCOME STATEMENTS
| (In millions, except per share amounts) | ||||||||||||
| Year Ended June 30, | 2015 | 2014 | 2013 | |||||||||
| Revenue |
$ | 93,580 | $ | 86,833 | $ | 77,849 | ||||||
| Cost of revenue |
33,038 | 27,078 | 20,385 | |||||||||
| Gross margin |
60,542 | 59,755 | 57,464 | |||||||||
| Research and development |
12,046 | 11,381 | 10,411 | |||||||||
| Sales and marketing |
15,713 | 15,811 | 15,276 | |||||||||
| General and administrative |
4,611 | 4,677 | 5,013 | |||||||||
| Impairment, integration, and restructuring |
10,011 | 127 | 0 | |||||||||
| Operating income |
18,161 | 27,759 | 26,764 | |||||||||
| Other income, net |
346 | 61 | 288 | |||||||||
| Income before income taxes |
18,507 | 27,820 | 27,052 | |||||||||
| Provision for income taxes |
6,314 | 5,746 | 5,189 | |||||||||
| Net income |
$ | 12,193 | $ | 22,074 | $ | 21,863 | ||||||
| Earnings per share: |
||||||||||||
| Basic |
$ | 1.49 | $ | 2.66 | $ | 2.61 | ||||||
| Diluted |
$ | 1.48 | $ | 2.63 | $ | 2.58 | ||||||
| Weighted average shares outstanding: |
||||||||||||
| Basic |
8,177 | 8,299 | 8,375 | |||||||||
| Diluted |
8,254 | 8,399 | 8,470 | |||||||||
| Cash dividends declared per common share |
$ | 1.24 | $ | 1.12 | $ | 0.92 | ||||||
See accompanying notes.
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COMPREHENSIVE INCOME STATEMENTS
| (In millions) | ||||||||||||
| Year Ended June 30, | 2015 | 2014 | 2013 | |||||||||
| Net income |
$ | 12,193 | $ | 22,074 | $ | 21,863 | ||||||
| Other comprehensive income (loss): |
||||||||||||
| Net unrealized gains (losses) on derivatives (net of tax effects of $20, $(4), and $(14)) |
559 | (35 | ) | (26 | ) | |||||||
| Net unrealized gains (losses) on investments (net of tax effects of $(197), $936, and $195) |
(362 | ) | 1,737 | 363 | ||||||||
| Translation adjustments and other (net of tax effects of $16, $12, and $(8)) |
(1,383 | ) | 263 | (16 | ) | |||||||
| Other comprehensive income (loss) |
(1,186 | ) | 1,965 | 321 | ||||||||
| Comprehensive income |
$ | 11,007 | $ | 24,039 | $ | 22,184 | ||||||
See accompanying notes.
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| (In millions) | ||||||||
| June 30, | 2015 | 2014 | ||||||
| Assets |
||||||||
| Current assets: |
||||||||
| Cash and cash equivalents |
$ | 5,595 | $ | 8,669 | ||||
| Short-term investments (including securities loaned of $75 and $541) |
90,931 | 77,040 | ||||||
| Total cash, cash equivalents, and short-term investments |
96,526 | 85,709 | ||||||
| Accounts receivable, net of allowance for doubtful accounts of $335 and $301 |
17,908 | 19,544 | ||||||
| Inventories |
2,902 | 2,660 | ||||||
| Deferred income taxes |
1,915 | 1,941 | ||||||
| Other |
5,461 | 4,392 | ||||||
| Total current assets |
124,712 | 114,246 | ||||||
| Property and equipment, net of accumulated depreciation of $17,606 and $14,793 |
14,731 | 13,011 | ||||||
| Equity and other investments |
12,053 | 14,597 | ||||||
| Goodwill |
16,939 | 20,127 | ||||||
| Intangible assets, net |
4,835 | 6,981 | ||||||
| Other long-term assets |
2,953 | 3,422 | ||||||
| Total assets |
$ | 176,223 | $ | 172,384 | ||||
| Liabilities and stockholders equity |
||||||||
| Current liabilities: |
||||||||
| Accounts payable |
$ | 6,591 | $ | 7,432 | ||||
| Short-term debt |
4,985 | 2,000 | ||||||
| Current portion of long-term debt |
2,499 | 0 | ||||||
| Accrued compensation |
5,096 | 4,797 | ||||||
| Income taxes |
606 | 782 | ||||||
| Short-term unearned revenue |
23,223 | 23,150 | ||||||
| Securities lending payable |
92 | 558 | ||||||
| Other |
6,766 | 6,906 | ||||||
| Total current liabilities |
49,858 | 45,625 | ||||||
| Long-term debt |
27,808 | 20,645 | ||||||
| Long-term unearned revenue |
2,095 | 2,008 | ||||||
| Deferred income taxes |
2,835 | 2,728 | ||||||
| Other long-term liabilities |
13,544 | 11,594 | ||||||
| Total liabilities |
96,140 | 82,600 | ||||||
| Commitments and contingencies |
||||||||
| Stockholders equity: |
||||||||
| Common stock and paid-in capital shares authorized 24,000; outstanding 8,027 and 8,239 |
68,465 | 68,366 | ||||||
| Retained earnings |
9,096 | 17,710 | ||||||
| Accumulated other comprehensive income |
2,522 | 3,708 | ||||||
| Total stockholders equity |
80,083 | 89,784 | ||||||
| Total liabilities and stockholders equity |
$ | 176,223 | $ | 172,384 | ||||
See accompanying notes.
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| (In millions) | ||||||||||||
| Year Ended June 30, | 2015 | 2014 | 2013 | |||||||||
| Operations |
||||||||||||
| Net income |
$ | 12,193 | $ | 22,074 | $ | 21,863 | ||||||
| Adjustments to reconcile net income to net cash from operations: |
||||||||||||
| Goodwill and asset impairments |
7,498 | 0 | 0 | |||||||||
| Depreciation, amortization, and other |
5,957 | 5,212 | 3,755 | |||||||||
| Stock-based compensation expense |
2,574 | 2,446 | 2,406 | |||||||||
| Net recognized losses (gains) on investments and derivatives |
(443 | ) | (109 | ) | 80 | |||||||
| Excess tax benefits from stock-based compensation |
(588 | ) | (271 | ) | (209 | ) | ||||||
| Deferred income taxes |
224 | (331 | ) | (19 | ) | |||||||
| Deferral of unearned revenue |
45,072 | 44,325 | 44,253 | |||||||||
| Recognition of unearned revenue |
(44,920 | ) | (41,739 | ) | (41,921 | ) | ||||||
| Changes in operating assets and liabilities: |
||||||||||||
| Accounts receivable |
1,456 | (1,120 | ) | (1,807 | ) | |||||||
| Inventories |
(272 | ) | (161 | ) | (802 | ) | ||||||
| Other current assets |
62 | (29 | ) | (129 | ) | |||||||
| Other long-term assets |
346 | (628 | ) | (478 | ) | |||||||
| Accounts payable |
(1,054 | ) | 473 | 537 | ||||||||
| Other current liabilities |
(624 | ) | 1,075 | 146 | ||||||||
| Other long-term liabilities |
1,599 | 1,014 | 1,158 | |||||||||
| Net cash from operations |
29,080 | 32,231 | 28,833 | |||||||||
| Financing |
||||||||||||
| Proceeds from issuance of short-term debt, maturities of 90 days or less, net |
4,481 | 500 | 0 | |||||||||
| Proceeds from issuance of debt |
10,680 | 10,350 | 4,883 | |||||||||
| Repayments of debt |
(1,500 | ) | (3,888 | ) | (1,346 | ) | ||||||
| Common stock issued |
634 | 607 | 931 | |||||||||
| Common stock repurchased |
(14,443 | ) | (7,316 | ) | (5,360 | ) | ||||||
| Common stock cash dividends paid |
(9,882 | ) | (8,879 | ) | (7,455 | ) | ||||||
| Excess tax benefits from stock-based compensation |
588 | 271 | 209 | |||||||||
| Other |
362 | (39 | ) | (10 | ) | |||||||
| Net cash used in financing |
(9,080 | ) | (8,394 | ) | (8,148 | ) | ||||||
| Investing |
||||||||||||
| Additions to property and equipment |
(5,944 | ) | (5,485 | ) | (4,257 | ) | ||||||
| Acquisition of companies, net of cash acquired, and purchases of intangible and other assets |
(3,723 | ) | (5,937 | ) | (1,584 | ) | ||||||
| Purchases of investments |
(98,729 | ) | (72,690 | ) | (75,396 | ) | ||||||
| Maturities of investments |
15,013 | 5,272 | 5,130 | |||||||||
| Sales of investments |
70,848 | 60,094 | 52,464 | |||||||||
| Securities lending payable |
(466 | ) | (87 | ) | (168 | ) | ||||||
| Net cash used in investing |
(23,001 | ) | (18,833 | ) | (23,811 | ) | ||||||
| Effect of exchange rates on cash and cash equivalents |
(73 | ) | (139 | ) | (8 | ) | ||||||
| Net change in cash and cash equivalents |
(3,074 | ) | 4,865 | (3,134 | ) | |||||||
| Cash and cash equivalents, beginning of period |
8,669 | 3,804 | 6,938 | |||||||||
| Cash and cash equivalents, end of period |
$ | 5,595 | $ | 8,669 | $ | 3,804 | ||||||
See accompanying notes.
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STOCKHOLDERS EQUITY STATEMENTS
| (In millions) | ||||||||||||
| Year Ended June 30, | 2015 | 2014 | 2013 | |||||||||
| Common stock and paid-in capital |
||||||||||||
| Balance, beginning of period |
$ | 68,366 | $ | 67,306 | $ | 65,797 | ||||||
| Common stock issued |
634 | 607 | 920 | |||||||||
| Common stock repurchased |
(3,700 | ) | (2,328 | ) | (2,014 | ) | ||||||
| Stock-based compensation expense |
2,574 | 2,446 | 2,406 | |||||||||
| Stock-based compensation income tax benefits |
588 | 272 | 190 | |||||||||
| Other, net |
3 | 63 | 7 | |||||||||
| Balance, end of period |
68,465 | 68,366 | 67,306 | |||||||||
| Retained earnings |
||||||||||||
| Balance, beginning of period |
17,710 | 9,895 | (856 | ) | ||||||||
| Net income |
12,193 | 22,074 | 21,863 | |||||||||
| Common stock cash dividends |
(10,063 | ) | (9,271 | ) | (7,694 | ) | ||||||
| Common stock repurchased |
(10,744 | ) | (4,988 | ) | (3,418 | ) | ||||||
| Balance, end of period |
9,096 | 17,710 | 9,895 | |||||||||
| Accumulated other comprehensive income |
||||||||||||
| Balance, beginning of period |
3,708 | 1,743 | 1,422 | |||||||||
| Other comprehensive income (loss) |
(1,186 | ) | 1,965 | 321 | ||||||||
| Balance, end of period |
2,522 | 3,708 | 1,743 | |||||||||
| Total stockholders equity |
$ | 80,083 | $ | 89,784 | $ | 78,944 | ||||||
See accompanying notes.
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NOTE 1 ACCOUNTING POLICIES
Accounting Principles
The consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP).
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 impairment of goodwill and intangibles assets, for our reporting units; product life cycles; useful lives of our tangible and intangible assets; allowances for doubtful accounts; allowances for product returns; the market value of our inventory; and stock-based compensation forfeiture rates. Examples of assumptions include: the elements comprising a software arrangement, including the distinction between upgrades or enhancements and new products; when technological feasibility is achieved for our products; the potential outcome of future tax consequences of events that have been recognized in our consolidated financial statements or tax returns; and determining when investment impairments are other-than-temporary. Actual results and outcomes may differ from managements estimates and assumptions.
Foreign Currencies
Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Revenue and expenses are translated at average rates of exchange prevailing during the year. Translation adjustments resulting from this process are recorded to other comprehensive income (OCI).
Revenue Recognition
Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectability is probable. Revenue generally is recognized net of allowances for returns and any taxes collected from customers and subsequently remitted to governmental authorities.
Revenue recognition for multiple-element arrangements requires judgment to determine if multiple elements exist, whether elements can be accounted for as separate units of accounting, and if so, the fair value for each of the elements.
Microsoft enters into arrangements that can include various combinations of software, services, and hardware. Where elements are delivered over different periods of time, and when allowed under U.S. GAAP, revenue is allocated to the respective elements based on their relative selling prices at the inception of the arrangement, and revenue is recognized as each element is delivered. We use a hierarchy to determine the fair value to be used for allocating revenue to elements: (i) vendor-specific objective evidence of fair value (VSOE), (ii) third-party evidence,
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and (iii) best estimate of selling price (ESP). For software elements, we follow the industry specific software guidance which only allows for the use of VSOE in establishing fair value. Generally, VSOE is the price charged when the deliverable is sold separately or the price established by management for a product that is not yet sold if it is probable that the price will not change before introduction into the marketplace. ESPs are established as best estimates of what the selling prices would be if the deliverables were sold regularly on a stand-alone basis. Our process for determining ESPs requires judgment and considers multiple factors that may vary over time depending upon the unique facts and circumstances related to each deliverable.
Revenue for retail packaged products, products licensed to original equipment manufacturers (OEMs), and perpetual licenses under certain volume licensing programs generally is recognized as products are shipped or made available.
Technology guarantee programs are accounted for as multiple-element arrangements as customers receive free or significantly discounted rights to use upcoming new versions of a software product if they license existing versions of the product during the eligibility period. Revenue is allocated between the existing product and the new product, and revenue allocated to the new product is deferred until that version is delivered. The revenue allocation is based on the VSOE of fair value of the products. The VSOE of fair value for upcoming new products are based on the price determined by management having the relevant authority when the element is not yet sold separately, but is expected to be sold in the near future at the price set by management.
Software updates that will be provided free of charge are evaluated on a case-by-case basis to determine whether they meet the definition of an upgrade and create a multiple-element arrangement, which may require revenue to be deferred and recognized when the upgrade is delivered, or if it is determined that implied post-contract customer support (PCS) is being provided, the arrangement is accounted for as a multiple-element arrangement and all revenue from the arrangement is deferred and recognized over the implied PCS term when the VSOE of fair value does not exist. If updates are determined to not meet the definition of an upgrade, revenue is generally recognized as products are shipped or made available.
Certain volume licensing arrangements include a perpetual license for current products combined with rights to receive unspecified future versions of software products, which we have determined are additional software products and are therefore accounted for as subscriptions, with billings recorded as unearned revenue and recognized as revenue ratably over the coverage period. Arrangements that include term-based licenses for current products with the right to use unspecified future versions of the software during the coverage period, are also accounted for as subscriptions, with revenue recognized ratably over the coverage period.
Revenue from cloud-based services arrangements that allow for the use of a hosted software product or service over a contractually determined period of time without taking possession of software are accounted for as subscriptions with billings recorded as unearned revenue and recognized as revenue ratably over the coverage period beginning on the date the service is made available to customers. Revenue from cloud-based services arrangements that are provided on a consumption basis (for example, the amount of storage used in a particular period) is recognized commensurate with the customer utilization of such resources.
Some volume licensing arrangements include time-based subscriptions for cloud-based services and software offerings that are accounted for as subscriptions. These arrangements are considered multiple-element arrangements. However, because all elements are accounted for as subscriptions and have the same coverage period and delivery pattern, they have the same revenue recognition timing.
Revenue related to phones, Surface devices, Xbox consoles, games published by us, and other hardware components is generally recognized when ownership is transferred to the resellers or to end customers when selling directly through Microsoft retail stores and online marketplaces. A portion of revenue may be deferred when these products are combined with software elements, and/or services. Revenue related to licensing for games published by third parties for use on the Xbox consoles is recognized when games are manufactured by the game publishers.
Display advertising revenue is recognized as advertisements are displayed. Search advertising revenue is recognized when the ad appears in the search results or when the action necessary to earn the revenue has been
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completed. Consulting services revenue is recognized as services are rendered, generally based on the negotiated hourly rate in the consulting arrangement and the number of hours worked during the period. Consulting revenue for fixed-price services arrangements is recognized as services are provided. Revenue from prepaid points redeemable for the purchase of software or services is recognized upon redemption of the points and delivery of the software or services.
Cost of Revenue
Cost of revenue includes: manufacturing and distribution costs for products sold and programs licensed; operating costs related to product support service centers and product distribution centers; costs incurred to include software on PCs sold by OEMs, to drive traffic to our websites, and to acquire online advertising space; costs incurred to support and maintain Internet-based products and services, including datacenter costs and royalties; warranty costs; inventory valuation adjustments; costs associated with the delivery of consulting services; and the amortization of capitalized software development costs. Capitalized software development costs are amortized over the estimated lives of the products.
Product Warranty
We provide for the estimated costs of fulfilling our obligations under hardware and software warranties at the time the related revenue is recognized. For hardware warranties, we estimate the costs based on historical and projected product failure rates, historical and projected repair costs, and knowledge of specific product failures (if any). The specific hardware warranty terms and conditions vary depending upon the product sold and the country in which we do business, but generally include parts and labor over a period generally ranging from 90 days to three years. For software warranties, we estimate the costs to provide bug fixes, such as security patches, over the estimated life of the software. We regularly reevaluate our estimates to assess the adequacy of the recorded warranty liabilities and adjust the amounts as necessary.
Research and Development
Research and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Such costs related to software development are included in research and development expense until the point that technological feasibility is reached, which for our software products, is generally shortly before the products are released to manufacturing. Once technological feasibility is reached, such costs are capitalized and amortized to cost of revenue over the estimated lives of the products.
Sales and Marketing
Sales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Advertising costs are expensed as incurred. Advertising expense was $1.9 billion, $2.3 billion, and $2.6 billion in fiscal years 2015, 2014, and 2013, respectively.
Stock-Based Compensation
We measure stock-based compensation cost at the grant date based on the fair value of the award and recognize it as expense, net of estimated forfeitures, over the vesting or service period, as applicable, of the stock award (generally four to five years) using the straight-line method.
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Employee Stock Purchase Plan
Shares of our common stock may be purchased by employees at three-month intervals at 90% of the fair market value of the stock on the last day of each three-month period. Compensation expense for the employee stock purchase plan is measured as the discount the employee is entitled to upon purchase and is recognized in the period of purchase.
Income Taxes
Income tax expense includes U.S. and international income taxes, the provision for U.S. taxes on undistributed earnings of international subsidiaries not deemed to be permanently invested, and interest and penalties on uncertain tax positions. Certain income and expenses are not reported in tax returns and financial statements in the same year. The tax effect of such temporary differences is reported as deferred income taxes. Deferred tax assets are reported net of a valuation allowance when it is more likely than not that a tax benefit will not be realized. The deferred income taxes are classified as current or long-term based on the classification of the related asset or liability.
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 1 inputs 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 2 inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques (e.g. the Black-Scholes model) for which all significant inputs are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, credit spreads, foreign exchange rates, and forward and spot prices for currencies and commodities. Our Level 2 non-derivative investments consist primarily of corporate notes and bonds, common and preferred stock, mortgage- and asset-backed securities, U.S. government and agency securities, and foreign government bonds. Our Level 2 derivative assets and liabilities primarily include certain over-the-counter option and swap contracts. |
| | Level 3 inputs 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. Our Level 3 derivative assets and liabilities primarily include equity derivatives. |
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.
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Financial Instruments
We consider all highly liquid interest-earning investments with a maturity of three months or less at the date of purchase to be cash equivalents. The fair values of these investments approximate their carrying values. In general, investments with original maturities of greater than three months and remaining maturities of less than one year are classified as short-term investments. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. All cash equivalents and short-term investments are classified as available-for-sale and realized gains and losses are recorded using the specific identification method. Changes in market value, excluding other-than-temporary impairments, are reflected in OCI.
Equity and other investments classified as long-term include both debt and equity instruments. With the exception of certain corporate notes that are classified as held-to-maturity, debt and publicly-traded equity securities are classified as available-for-sale and realized gains and losses are recorded using the specific identification method. Changes in the market value of available-for-sale securities, excluding other-than-temporary impairments, are reflected in OCI. Held-to-maturity investments are recorded and held at amortized cost. Common and preferred stock and other investments that are restricted for more than one year or are not publicly traded are recorded at cost or using the equity method.
We lend certain fixed-income and equity securities to increase investment returns. The loaned securities continue to be carried as investments on our balance sheet. Cash and/or security interests are received as collateral for the loaned securities with the amount determined based upon the underlying security lent and the creditworthiness of the borrower. Cash received is recorded as an asset with a corresponding liability.
Investments are considered to be impaired when a decline in fair value is judged to be other-than-temporary. Fair value is calculated based on publicly available market information or other estimates determined by management. We employ a systematic methodology on a quarterly basis that considers available quantitative and qualitative evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, the duration and extent to which the fair value is less than cost, and for equity securities, our intent and ability to hold, or plans to sell, the investment. For fixed-income securities, we also evaluate whether we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery. We also consider specific adverse conditions related to the financial health of and business outlook for the investee, including industry and sector performance, changes in technology, and operational and financing cash flow factors. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded to other income (expense), net and a new cost basis in the investment is established.
Derivative instruments are recognized as either assets or liabilities and are measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation.
For derivative instruments designated as fair value hedges, the gains (losses) are recognized in earnings in the periods of change together with the offsetting losses (gains) on the hedged items attributed to the risk being hedged. For options designated as fair value hedges, changes in the time value are excluded from the assessment of hedge effectiveness and are recognized in earnings.
For derivative instruments designated as cash-flow hedges, the effective portion of the gains (losses) on the derivatives is initially reported as a component of OCI and is subsequently recognized in earnings when the hedged exposure is recognized in earnings. For options designated as cash-flow hedges, changes in the time value are excluded from the assessment of hedge effectiveness and are recognized in earnings. Gains (losses) on derivatives representing either hedge components excluded from the assessment of effectiveness or hedge ineffectiveness are recognized in earnings.
For derivative instruments that are not designated as hedges, gains (losses) from changes in fair values are primarily recognized in other income (expense), net. Other than those derivatives entered into for investment
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purposes, such as commodity contracts, the gains (losses) are generally economically offset by unrealized gains (losses) in the underlying available-for-sale securities, which are recorded as a component of OCI until the securities are sold or other-than-temporarily impaired, at which time the amounts are reclassified from accumulated other comprehensive income (AOCI) into other income (expense), net.
Allowance for Doubtful Accounts
The allowance for doubtful accounts reflects our best estimate of probable losses inherent in the accounts receivable balance. We determine the allowance based on known troubled accounts, historical experience, and other currently available evidence. Activity in the allowance for doubtful accounts was as follows:
| (In millions) | ||||||||||||
| Year Ended June 30, | 2015 | 2014 | 2013 | |||||||||
| Balance, beginning of period |
$ | 301 | $ | 336 | $ | 389 | ||||||
| Charged to costs and other |
77 | 16 | 4 | |||||||||
| Write-offs |
(43 | ) | (51 | ) | (57 | ) | ||||||
| Balance, end of period |
$ | 335 | $ | 301 | $ | 336 | ||||||
Inventories
Inventories are stated at average cost, subject to the lower of cost or market. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue. The determination of market value and the estimated volume of demand used in the lower of cost or market analysis require significant judgment.
Property and Equipment
Property and equipment is stated at cost and depreciated using the straight-line method over the shorter of the estimated useful life of the asset or the lease term. The estimated useful lives of our property and equipment are generally as follows: computer software developed or acquired for internal use, three to seven years; computer equipment, two to three years; buildings and improvements, five to 15 years; leasehold improvements, three to 20 years; and furniture and equipment, one to 10 years. Land is not depreciated.
Goodwill
Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value.
Intangible Assets
All of our intangible assets are subject to amortization and are amortized using the straight-line method over their estimated period of benefit, ranging from one to 15 years. We evaluate the recoverability of intangible assets periodically by taking into account events or circumstances that may warrant revised estimates of useful lives or that indicate the asset may be impaired.
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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 (FASB) issued a new standard related to revenue recognition. Under the new standard, recognition of revenue occurs when a customer obtains control of promised goods or services in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The new standard will be effective for us beginning July 1, 2018, and adoption as of the original effective date of July 1, 2017 is permitted. We anticipate this standard will have a material impact on our consolidated financial statements, and we are currently evaluating its impact.
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 were as follows:
| (In millions, except earnings per share) | ||||||||||||
| Year Ended June 30, | 2015 | 2014 | 2013 | |||||||||
| Net income available for common shareholders (A) |
$ | 12,193 | $ | 22,074 | $ | 21,863 | ||||||
| Weighted average outstanding shares of common stock (B) |
8,177 | 8,299 | 8,375 | |||||||||
| Dilutive effect of stock-based awards |
77 | 100 | 95 | |||||||||
| Common stock and common stock equivalents (C) |
8,254 | 8,399 | 8,470 | |||||||||
| Earnings Per Share |
||||||||||||
| Basic (A/B) |
$ | 1.49 | $ | 2.66 | $ | 2.61 | ||||||
| Diluted (A/C) |
$ | 1.48 | $ | 2.63 | $ | 2.58 | ||||||
Anti-dilutive stock-based awards excluded from the calculations of diluted EPS were immaterial during the periods presented.
NOTE 3 OTHER INCOME (EXPENSE), NET
The components of other income (expense), net were as follows:
| (In millions) | ||||||||||||
| Year Ended June 30, | 2015 | 2014 | 2013 | |||||||||
| Dividends and interest income |
$ | 766 | $ | 883 | $ | 677 | ||||||
| Interest expense |
(781 | ) | (597 | ) | (429 | ) | ||||||
| Net recognized gains on investments |
716 | 437 | 116 | |||||||||
| Net losses on derivatives |
(423 | ) | (328 | ) | (196 | ) | ||||||
| Net gains (losses) on foreign currency remeasurements |
335 | (165 | ) | (74 | ) | |||||||
| Other |
(267 | ) | (169 | ) | 194 | |||||||
| Total |
$ | 346 | $ | 61 | $ | 288 | ||||||
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Following are details of net recognized gains on investments during the periods reported:
| (In millions) | ||||||||||||
| Year Ended June 30, | 2015 | 2014 | 2013 | |||||||||
| Other-than-temporary impairments of investments |
$ | (183 | ) | $ | (106 | ) | $ | (208 | ) | |||
| Realized gains from sales of available-for-sale securities |
1,176 | 776 | 489 | |||||||||
| Realized losses from sales of available-for-sale securities |
(277 | ) | (233 | ) | (165 | ) | ||||||
| Total |
$ | 716 | $ | 437 | $ | 116 | ||||||
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 |
|||||||||||||||||||||
| June 30, 2015 |
||||||||||||||||||||||||||||
| Cash |
$ | 3,679 | $ | 0 | $ | 0 | $ | 3,679 | $ | 3,679 | $ | 0 | $ | 0 | ||||||||||||||
| Mutual funds |
1,100 | 0 | 0 | 1,100 | 1,100 | 0 | 0 | |||||||||||||||||||||
| Commercial paper |
1 | 0 | 0 | 1 | 1 | 0 | 0 | |||||||||||||||||||||
| Certificates of deposit |
906 | 0 | 0 | 906 | 776 | 130 | 0 | |||||||||||||||||||||
| U.S. government and agency securities |
72,843 | 76 | (30 | ) | 72,889 | 39 | 72,850 | 0 | ||||||||||||||||||||
| Foreign government bonds |
5,477 | 3 | (24 | ) | 5,456 | 0 | 5,456 | 0 | ||||||||||||||||||||
| Mortgage- and asset-backed securities |
4,899 | 23 | (6 | ) | 4,916 | 0 | 4,916 | 0 | ||||||||||||||||||||
| Corporate notes and bonds |
7,192 | 97 | (37 | ) | 7,252 | 0 | 7,252 | 0 | ||||||||||||||||||||
| Municipal securities |
285 | 35 | (1 | ) | 319 | 0 | 319 | 0 | ||||||||||||||||||||
| Common and preferred stock |
6,668 | 4,986 | (215 | ) | 11,439 | 0 | 0 | 11,439 | ||||||||||||||||||||
| Other investments |
597 | 0 | 0 | 597 | 0 | 8 | 589 | |||||||||||||||||||||
| Total |
$ | 103,647 | $ | 5,220 | $ | (313 | ) | $ | 108,554 | $ | 5,595 | $ | 90,931 | $ | 12,028 | |||||||||||||
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| (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 |
991 | 30 | (2 | ) | 1,019 | 0 | 1,019 | 0 | ||||||||||||||||||||
| Corporate notes and bonds |
6,845 | 191 | (9 | ) | 7,027 | 9 | 7,018 | 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 are classified as held-to-maturity investments, which are included in equity and other investments on the balance sheet. These corporate notes are due October 31, 2023 and are measured at fair value on a nonrecurring basis. As of June 30, 2015, the amortized cost and recorded basis of these corporate notes were both $25 million with an estimated fair value that approximates the carrying value. 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.
As of June 30, 2015 and 2014, the recorded bases of common and preferred stock that are restricted for more than one year or are not publicly traded were $561 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.
We lend certain fixed-income and equity securities to increase investment returns. These transactions are accounted for as secured borrowings and the loaned securities continue to be carried as investments on our balance sheet. Cash and/or security interests are received as collateral for the loaned securities with the amount determined based upon the underlying security lent and the creditworthiness of the borrower. As of June 30, 2015, collateral received under these agreements totaled $92 million which is comprised of $79 million of certificates of deposit and $13 million of U.S. government and agency securities. The contractual maturities of these agreements are primarily on a continuous and overnight basis.
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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 |
|||||||||||||||||||
| June 30, 2015 |
||||||||||||||||||||||||
| U.S. government and agency securities |
$ | 6,636 | $ | (9 | ) | $ | 421 | $ | (21 | ) | $ | 7,057 | $ | (30 | ) | |||||||||
| Foreign government bonds |
4,611 | (12 | ) | 18 | (12 | ) | 4,629 | (24 | ) | |||||||||||||||
| Mortgage- and asset-backed securities |
3,171 | $ | (5 | ) | 28 | (1 | ) | 3,199 | (6 | ) | ||||||||||||||
| Corporate notes and bonds |
2,946 | (29 | ) | 104 | (8 | ) | 3,050 | (37 | ) | |||||||||||||||
| Municipal securities |
36 | (1 | ) | 0 | 0 | 36 | (1 | ) | ||||||||||||||||
| Common and preferred stock |
1,389 | (180 | ) | 148 | (35 | ) | 1,537 | (215 | ) | |||||||||||||||
| Total |
$ | 18,789 | $ | (236 | ) | $ | 719 | $ | (77 | ) | $ | 19,508 | $ | (313 | ) | |||||||||
| 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 June 30, 2015.
Debt Investment Maturities
| (In millions) | Cost Basis | Estimated Fair Value |
||||||
| June 30, 2015 |
||||||||
| Due in one year or less |
$ | 53,616 | $ | 53,645 | ||||
| Due after one year through five years |
33,260 | 33,336 | ||||||
| Due after five years through 10 years |
3,180 | 3,161 | ||||||
| Due after 10 years |
1,547 | 1,597 | ||||||
| Total |
$ | 91,603 | $ | 91,739 | ||||
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.
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Foreign Currency
Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency hedge positions. Option and forward contracts are used to hedge a portion of forecasted international revenue for up to three years in the future and are designated as cash flow hedging instruments. Principal currencies hedged include the euro, Japanese yen, British pound, Canadian dollar, and Australian dollar. As of June 30, 2015 and June 30, 2014, the total notional amounts of these foreign exchange contracts sold were $9.8 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 June 30, 2015 and June 30, 2014, the total notional amounts of these foreign exchange contracts sold were $5.3 billion and $3.1 billion, respectively.
Certain options and forwards not designated as hedging instruments are also used to manage the variability in foreign exchange rates on certain balance sheet amounts and to manage other foreign currency exposures. As of June 30, 2015, the total notional amounts of these foreign exchange contracts purchased and sold were $9.7 billion and $11.0 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 June 30, 2015, the total notional amounts of equity contracts purchased and sold for managing market price risk were $2.2 billion and $2.6 billion, respectively, of which $1.1 billion and $1.4 billion, respectively, were designated as hedging instruments. 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 June 30, 2015, the total notional amounts of fixed-interest rate contracts purchased and sold were $1.0 billion and $3.2 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 June 30, 2015 and 2014, the total notional derivative amounts of mortgage contracts purchased were $812 million and $1.1 billion, respectively.
Credit
Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We use credit default swap contracts, not designated as hedging instruments, to manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. We use credit default swaps as they are a low-cost method of managing exposure to individual credit risks or groups of credit risks. As of June 30, 2015, the total notional amounts of credit contracts purchased and sold were $618 million and $430 million, respectively. As of June 30, 2014, the total notional amounts of credit contracts purchased and sold were $550 million and $440 million, respectively.
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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 June 30, 2015, the total notional amounts of commodity contracts purchased and sold were $882 million and $316 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 June 30, 2015, 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.
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Fair Values of Derivative Instruments
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:
| June 30, 2015 |
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 |
$ | 17 | $ | 167 | $ | 0 | $ | (79 | ) | $ | 10 | $ | 39 | $ | 0 | $ | (97 | ) | ||||||||||||||
| Equity contracts |
148 | 0 | 0 | (18 | ) | 177 | 0 | 0 | (21 | ) | ||||||||||||||||||||||
| Interest rate contracts |
7 | 0 | 0 | (12 | ) | 17 | 0 | 0 | (12 | ) | ||||||||||||||||||||||
| Credit contracts |
16 | 0 | 0 | (9 | ) | 24 | 0 | 0 | (13 | ) | ||||||||||||||||||||||
| Commodity contracts |
0 | 0 | 0 | 0 | 15 | 0 | 0 | (1 | ) | |||||||||||||||||||||||
| Total |
$ | 188 | $ | 167 | $ | 0 | $ | (118 | ) | $ | 243 | $ | 39 | $ | 0 | $ | (144 | ) | ||||||||||||||
| Designated Hedge Derivatives |
||||||||||||||||||||||||||||||||
| Foreign exchange contracts |
$ | 56 | $ | 552 | $ | 0 | $ | (31 | ) | $ | 1 | $ | 70 | $ | 0 | $ | (15 | ) | ||||||||||||||
| Equity contracts |
0 | 0 | 25 | (69 | ) | 0 | 0 | 7 | (125 | ) | ||||||||||||||||||||||
| Total |
$ | 56 | $ | 552 | $ | 25 | $ | (100 | ) | $ | 1 | $ | 70 | $ | 7 | $ | (140 | ) | ||||||||||||||
| Total gross amounts of derivatives |
$ | 244 | $ | 719 | $ | 25 | $ | (218 | ) | $ | 244 | $ | 109 | $ | 7 | $ | (284 | ) | ||||||||||||||
| Gross derivatives either offset or subject to an enforceable master netting agreement |
$ | 126 | $ | 719 | $ | 25 | $ | (218 | ) | $ | 99 | $ | 109 | $ | 7 | $ | (284 | ) | ||||||||||||||
| Gross amounts of derivatives offset in the balance sheet |
(66 | ) | (71 | ) | (25 | ) | 161 | (77 | ) | (71 | ) | (7 | ) | 155 | ||||||||||||||||||
| Net amounts presented in the balance sheet |
60 | 648 | 0 | (57 | ) | 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 | (456 | ) | 0 | 0 | 0 | 0 | |||||||||||||||||||||||
| Net amount |
$ | 60 | $ | 648 | $ | 0 | $ | (513 | ) | $ | 22 | $ | 38 | $ | 0 | $ | (129 | ) | ||||||||||||||
See also Note 4 Investments and Note 6 Fair Value Measurements.
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Fair Value Hedge Gains (Losses)
We recognized in other income (expense), net the following gains (losses) on contracts designated as fair value hedges and their related hedged items:
| (In millions) | ||||||||||||
| Year Ended June 30, | 2015 | 2014 | 2013 | |||||||||
| Foreign Exchange Contracts |
||||||||||||
| Derivatives |
$ | 741 | $ | (14 | ) | $ | 70 | |||||
| Hedged items |
$ | (725 | ) | 6 | (69 | ) | ||||||
| Total amount of ineffectiveness |
$ | 16 | $ | (8 | ) | $ | 1 | |||||
| Equity Contracts |
||||||||||||
| Derivatives |
$ | (107 | ) | $ | (110 | ) | $ | 0 | ||||
| Hedged items |
107 | 110 | 0 | |||||||||
| Total amount of ineffectiveness |
$ | 0 | $ | 0 | $ | 0 | ||||||
| Amount of equity contracts excluded from effectiveness assessment |
$ | 0 | $ | (9 | ) | $ | 0 | |||||
Cash Flow Hedge Gains (Losses)
We recognized the following gains (losses) on foreign exchange contracts designated as cash flow hedges (our only cash flow hedges during the periods presented):
| (In millions) | ||||||||||||
| Year Ended June 30, | 2015 | 2014 | 2013 | |||||||||
| Effective Portion |
||||||||||||
| Gains recognized in OCI (net of tax effects of $35, $2 and $54) |
$ | 1,152 | $ | 63 | $ | 101 | ||||||
| Gains reclassified from AOCI into revenue |
$ | 608 | $ | 104 | $ | 195 | ||||||
| Amount Excluded from Effectiveness Assessment and Ineffective Portion |
||||||||||||
| Losses recognized in other income (expense), net |
$ | (346 | ) | $ | (239 | ) | $ | (168 | ) | |||
We estimate that $492 million of net derivative gains included in AOCI at June 30, 2015 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 fiscal year 2015.
Non-Designated Derivative Gains (Losses)
Gains (losses) from changes in fair values of derivatives that are not designated as hedges are primarily recognized in other income (expense), net. These amounts are shown in the table below, with the exception of gains (losses) on derivatives presented in income statement line items other than other income (expense), net, which were immaterial for the periods presented. Other than those derivatives entered into for investment purposes, such as commodity contracts, the gains (losses) below are generally economically offset by unrealized gains (losses) in the underlying available-for-sale securities and gains (losses) from foreign exchange rate changes on certain balance sheet amounts.
| (In millions) | ||||||||||||
| Year Ended June 30, | 2015 | 2014 | 2013 | |||||||||
| Foreign exchange contracts |
$ | (483 | ) | $ | (78 | ) | $ | 18 | ||||
| Equity contracts |
(19 | ) | (64 | ) | 16 | |||||||
| Interest-rate contracts |
23 | 24 | (11 | ) | ||||||||
| Credit contracts |
(1 | ) | 13 | (3 | ) | |||||||
| Commodity contracts |
(223 | ) | 71 | (42 | ) | |||||||
| Total |
$ | (703 | ) | $ | (34 | ) | $ | (22 | ) | |||
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NOTE 6 FAIR VALUE MEASUREMENTS
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 |
||||||||||||||||||
| June 30, 2015 | ||||||||||||||||||||||||
| Assets |
||||||||||||||||||||||||
| Mutual funds |
$ | 1,100 | $ | 0 | $ | 0 | $ | 1,100 | $ | 0 | $ | 1,100 | ||||||||||||
| Commercial paper |
0 | 1 | 0 | 1 | 0 | 1 | ||||||||||||||||||
| Certificates of deposit |
0 | 906 | 0 | 906 | 0 | 906 | ||||||||||||||||||
| U.S. government and agency securities |
71,930 | 955 | 0 | 72,885 | 0 | 72,885 | ||||||||||||||||||
| Foreign government bonds |
131 | 5,299 | 0 | 5,430 | 0 | 5,430 | ||||||||||||||||||
| Mortgage- and asset-backed securities |
0 | 4,917 | 0 | 4,917 | 0 | 4,917 | ||||||||||||||||||
| Corporate notes and bonds |
0 | 7,108 | 1 | 7,109 | 0 | 7,109 | ||||||||||||||||||
| Municipal securities |
0 | 319 | 0 | 319 | 0 | 319 | ||||||||||||||||||
| Common and preferred stock |
8,585 | 2,277 | 14 | 10,876 | 0 | 10,876 | ||||||||||||||||||
| Derivatives |
4 | 979 | 5 | 988 | (162 | ) | 826 | |||||||||||||||||
| Total |
$ | 81,750 | $ | 22,761 | $ | 20 | $ | 104,531 | $ | (162 | ) | $ | 104,369 | |||||||||||
| Liabilities |
||||||||||||||||||||||||
| Derivatives and other |
$ | 5 | $ | 159 | $ | 54 | $ | 218 | $ | (161 | ) | $ | 57 | |||||||||||
| (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 | 1,015 | 0 | 1,015 | 0 | 1,015 | ||||||||||||||||||
| Corporate notes and bonds |
0 | 6,863 | 0 | 6,863 | 0 | 6,863 | ||||||||||||||||||
| 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.
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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) | ||||||||
| June 30, | 2015 | 2014 | ||||||
| Net fair value of assets measured at fair value on a recurring basis |
$ | 104,369 | $ | 92,164 | ||||
| Cash |
3,679 | 4,980 | ||||||
| Common and preferred stock measured at fair value on a nonrecurring basis |
561 | 520 | ||||||
| Other investments measured at fair value on a nonrecurring basis |
589 | 1,150 | ||||||
| Less derivative net assets classified as other current assets |
(648 | ) | (38 | ) | ||||
| Other |
4 | (6 | ) | |||||
| Recorded basis of investment components |
$ | 108,554 | $ | 98,770 | ||||
Financial Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
During fiscal year 2015 and 2014, 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) | ||||||||
| June 30, | 2015 | 2014 | ||||||
| Raw materials |
$ | 1,100 | $ | 944 | ||||
| Work in process |
202 | 266 | ||||||
| Finished goods |
1,600 | 1,450 | ||||||
| Total |
$ | 2,902 | $ | 2,660 | ||||
NOTE 8 PROPERTY AND EQUIPMENT
The components of property and equipment were as follows:
| (In millions) | ||||||||
| June 30, | 2015 | 2014 | ||||||
| Land |
$ | 769 | $ | 541 | ||||
| Buildings and improvements |
10,800 | 8,867 | ||||||
| Leasehold improvements |
3,577 | 3,560 | ||||||
| Computer equipment and software |
13,612 | 11,430 | ||||||
| Furniture and equipment |
3,579 | 3,406 | ||||||
| Total, at cost |
32,337 | 27,804 | ||||||
| Accumulated depreciation |
(17,606 | ) | (14,793 | ) | ||||
| Total, net |
$ | 14,731 | $ | 13,011 | ||||
During fiscal years 2015, 2014, and 2013, depreciation expense was $4.1 billion, $3.4 billion, and $2.6 billion, respectively.
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NOTE 9 BUSINESS COMBINATIONS
Mojang Synergies AB
On November 6, 2014, we acquired Mojang Synergies AB (Mojang), the Swedish video game developer of the Minecraft gaming franchise, for $2.5 billion in cash, net of cash acquired. The addition of Minecraft and its community enhances our gaming portfolio across Windows, Xbox, and other ecosystems besides our own. 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 $928 million, primarily marketing-related (trade names). The goodwill recognized in connection with the acquisition is primarily attributable to anticipated synergies from future growth, and is not expected to be deductible for tax purposes. We assigned the goodwill to our Devices and Consumer (D&C) Other segment. Identifiable intangible assets were assigned a total weighted-average amortization period of 6.3 years. Mojang has been included in our consolidated results of operations since the acquisition date.
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, and liabilities assumed of $0.2 billion. The Acquisition was expected to accelerate the growth of our D&C business through faster innovation, synergies, and unified branding and marketing.