MICROSOFT CORPORATION Note About Forward-Looking Statements
This report includes estimates, projections, statements relating to our business
plans, objectives, and expected operating results that are "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the
Securities Exchange Act of 1934. Forward-looking statements may appear
throughout this report, including the following sections: "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Risk Factors" (Part II, Item 1A of this Form 10-Q). These forward-looking
statements generally are identified by the words "believe," "project," "expect,"
"anticipate," "estimate," "intend," "strategy," "future," "opportunity," "plan,"
"may," "should," "will," "would," "will be," "will continue," "will likely
result," and similar expressions. Forward-looking statements are based on
current expectations and assumptions that are subject to risks and uncertainties
that may cause actual results to differ materially. We describe risks and
uncertainties that could cause actual results and events to differ materially in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Quantitative and Qualitative Disclosures about Market Risk" (Part
I, Item 3 of this Form 10-Q), and "Risk Factors". We undertake no obligation to
update or revise publicly any forward-looking statements, whether because of new
information, future events, or otherwise.
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations ("MD&A") is intended to help the reader understand the
results of operations and financial condition of Microsoft Corporation . MD&A is
provided as a supplement to, and should be read in conjunction with, our Annual
Report on Form 10-K for the year ended June 30, 2021 , and our financial
statements and the accompanying Notes to Financial Statements (Part I, Item 1 of
this Form 10-Q).
OVERVIEW
Microsoft is a technology company whose mission is to empower every person and
every organization on the planet to achieve more. We strive to create local
opportunity, growth, and impact in every country around the world. Our platforms
and tools help drive small business productivity, large business
competitiveness, and public-sector efficiency. They also support new startups,
improve educational and health outcomes, and empower human ingenuity.
We generate revenue by offering a wide range of cloud-based and other services
to people and businesses; licensing and supporting an array of software
products; designing, manufacturing, and selling devices; and delivering relevant
online advertising to a global audience. Our most significant expenses are
related to compensating employees; designing, manufacturing, marketing, and
selling our products and services; datacenter costs in support of our
cloud-based services; and income taxes.
As the world continues to respond to COVID-19, we are working to do our part by
ensuring the safety of our employees, striving to protect the health and
well-being of the communities in which we operate, and providing technology and
resources to our customers to help them do their best work while remote.
Highlights from the first quarter of fiscal year 2022 compared with the first quarter of fiscal year 2021 included:
•
billion.
• Office Commercial products and cloud services revenue increased 18% driven
by Office 365 Commercial growth of 23%.
• Office Consumer products and cloud services revenue increased 10% and
• LinkedIn revenue increased 42% driven by Marketing Solutions growth of 61%.
• Dynamics products and cloud services revenue increased 31% driven by
Dynamics 365 growth of 48%.
• Server products and cloud services revenue increased 35% driven by Azure
and other cloud services growth of 50%.
• Windows original equipment manufacturer licensing ("Windows OEM") revenue
increased 10%.
• Windows Commercial products and cloud services revenue increased 12%.
• Xbox content and services revenue increased 2%.
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• Search and news advertising revenue, excluding traffic acquisition costs,
increased 40%.
• Surface revenue decreased 17%.
Industry Trends
Our industry is dynamic and highly competitive, with frequent changes in both technologies and business models. Each industry shift is an opportunity to conceive new products, new technologies, or new ideas that can further transform the industry and our business. AtMicrosoft , we push the boundaries of what is possible through a broad range of research and development activities that seek to identify and address the changing demands of customers and users, industry trends, and competitive forces.
Economic Conditions, Challenges, and Risks
The markets for software, devices, and cloud-based services are dynamic and highly competitive. Our competitors are developing new software and devices, while also deploying competing cloud-based services for consumers and businesses. The devices and form factors customers prefer evolve rapidly, and influence how users access services in the cloud, and in some cases, the user's choice of which suite of cloud-based services to use. We must continue to evolve and adapt over an extended time in pace with this changing environment. The investments we are making in infrastructure and devices will continue to increase our operating costs and may decrease our operating margins. Our success is highly dependent on our ability to attract and retain qualified employees. We hire a mix of university and industry talent worldwide. We compete for talented individuals globally by offering an exceptional working environment, broad customer reach, scale in resources, the ability to grow one's career across many different products and businesses, and competitive compensation and benefits. Aggregate demand for our software, services, and devices is correlated to global macroeconomic and geopolitical factors, which remain dynamic. Our devices are primarily manufactured by third-party contract manufacturers, some of which contain certain components for which there are very few qualified suppliers. For these components, we have limited near-term flexibility to use other manufacturers if a current vendor becomes unavailable or is unable to meet our requirements. Extended disruptions at these suppliers could lead to a similar disruption in our ability to manufacture devices on time to meet consumer demand. Our international operations provide a significant portion of our total revenue and expenses. Many of these revenue and expenses are denominated in currencies other than theU.S. dollar. As a result, changes in foreign exchange rates may significantly affect revenue and expenses. Weakening of theU.S. dollar relative to certain foreign currencies increased reported revenue and did not have a material impact on reported expenses from our international operations in the first quarter of fiscal year 2022.
Refer to Risk Factors (Part II, Item 1A of this Form 10-Q) for a discussion of these factors and other risks.
COVID-19
The COVID-19 pandemic continues to impact our business operations and financial results, although some of the effects have lessened over time. Our commercial and consumer businesses have benefited from demand for cloud and productivity tools, and we have experienced savings in operating expenses related to COVID-19. The COVID-19 pandemic may continue to impact our business operations and financial operating results, and there is uncertainty in the nature and degree of its continued effects over time. Refer to Risk Factors (Part II, Item 1A of this Form 10-Q) for a discussion of these factors and other risks.
Seasonality
Our revenue fluctuates quarterly and is generally higher in the second and fourth quarters of our fiscal year. Second quarter revenue is driven by corporate year-end spending trends in our major markets and holiday season spending by consumers, and fourth quarter revenue is driven by the volume of multi-year on-premises contracts executed during the period.
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Reportable Segments
We report our financial performance based on the following segments:
Productivity and Business Processes, Intelligent Cloud, and More Personal
Computing. The segment amounts included in MD&A are presented on a basis
consistent with our internal management reporting. All differences between our
internal management reporting basis and accounting principles generally accepted
in the United States of America ("GAAP"), along with certain corporate-level and
other activity, are included in Corporate and Other.
Additional information on our reportable segments is contained in Note 17 - Segment Information and Geographic Data of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q).
Metrics
We use metrics in assessing the performance of our business and to make informed decisions regarding the allocation of resources. We disclose metrics to enable investors to evaluate progress against our ambitions, provide transparency into performance trends, and reflect the continued evolution of our products and services. Our commercial and other business metrics are fundamentally connected based on how customers use our products and services. The metrics are disclosed in the MD&A or the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q). Financial metrics are calculated based on GAAP results and growth comparisons relate to the corresponding period of last fiscal year. In the first quarter of fiscal year 2022, we made updates to the presentation and method of calculation for certain metrics, most notably changes to incorporate all current and anticipated revenue streams within our Office Consumer and Server products and cloud services metrics and changes to align with how we manage our Windows OEM and Search and news advertising businesses. None of these changes had a material impact on previously reported amounts in our MD&A. Commercial
Our commercial business primarily consists of Server products and cloud services, Office Commercial, Windows Commercial, the commercial portion of LinkedIn, Enterprise Services, and Dynamics. Our commercial metrics allow management and investors to assess the overall health of our commercial business and include leading indicators of future performance.
Commercial remaining performance obligation Commercial portion of revenue allocated to
remaining performance obligations, which
includes unearned revenue and amounts that will
be invoiced and recognized as revenue in future
periods
Microsoft Cloud revenue Revenue from our commercial cloud business,
which includes Azure and other cloud services,
Office 365 Commercial, the commercial portion of
LinkedIn, Dynamics 365, and other commercial
cloud properties
Microsoft Cloud gross margin percentage Gross margin percentage for our commercial cloud
business
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Productivity and Business Processes and Intelligent Cloud
Metrics related to our Productivity and Business Processes and Intelligent Cloud segments assess the health of our core businesses within these segments. The metrics reflect our cloud and on-premises product strategies and trends.
Office Commercial products and cloud services revenue growth Revenue from Office Commercial products and
cloud services (Office 365 subscriptions, the
Office 365
portion of
subscriptions, and Office licensed on-premises),
comprising Office, Exchange, SharePoint,
Microsoft
Teams, Office 365 Security and
Compliance,
and
Office Consumer products and cloud services revenue growth Revenue from Office Consumer products and cloud
services,
including
subscriptions, Office licensed on-premises, and
other Office services
Office 365 Commercial seat growth The number
of Office 365 Commercial seats at end
of period where seats are paid users covered by
an Office 365 Commercial subscription
Microsoft 365 Consumer subscribers The number
of
at end of period
Dynamics products and cloud services revenue growth Revenue from
Dynamics products and cloud
services, including Dynamics 365, comprising a
set of intelligent, cloud-based applications
across ERP, CRM, Customer Insights, Power Apps,
and Power Automate; and on-premises ERP and CRM
applications
LinkedIn revenue growth Revenue from LinkedIn, including Talent
Solutions,Marketing Solutions, Premium
Subscriptions, Sales Solutions, and Learning
Solutions
Server products and cloud services revenue growth Revenue from Server products and cloud services,
including Azure and other cloud services; SQL
Server, Windows Server, Visual Studio, System
Center, and related Client Access Licenses
("CALs"); and GitHub
More Personal Computing
Metrics related to our More Personal Computing segment assess the performance of
key lines of business within this segment. These metrics provide strategic
product insights which allow us to assess the performance across our commercial
and consumer businesses. As we have diversity of target audiences and sales
motions within the Windows business, we monitor metrics that are reflective of
those varying motions.
Windows OEM revenue growth Revenuefrom sales of Windows Pro and non-Pro
licenses sold through the OEM channel
Windows Commercial products and cloud services revenue growth Revenue from Windows Commercial products and
cloud services, comprising volume licensing of
the Windows operating system, Windows cloud
services, and other Windows commercial offerings
Surface revenue growth Revenue
from Surface devices and accessories
Xbox content and services revenue growth Revenue
from Xbox content and services,
comprising
digital transactions,
and other subscriptions, video games,
third-party video game royalties, cloud
services, and advertising
Search and news advertising revenue, excluding TAC, growth Revenue from search and news advertising
excluding traffic acquisition costs ("TAC") paid
to Bing Ads network publishers and news partners
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SUMMARY RESULTS OF OPERATIONS
Three Months Ended Percentage
(In millions, except percentages and per share amounts) September 30, Change
2021 2020
Revenue $ 45,317 $ 37,154 22%
Gross margin 31,671 26,152 21%
Operating income 20,238 15,876 27%
Net income 20,505 13,893 48%
Diluted earnings per share 2.71 1.82 49%
Adjusted net income (non-GAAP) 17,214 13,893 24%
Adjusted diluted earnings per share (non-GAAP) 2.27 1.82 25%
Adjusted net income and adjusted diluted earnings per share ("EPS") are non-GAAP
financial measures which exclude the net income tax benefit related to transfer
of intangible properties in fiscal year 2022. Refer to the Non-GAAP Financial
Measures section below for a reconciliation of our financial results reported in
accordance with GAAP to non-GAAP financial results. See Note 11 - Income Taxes
of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) for
further discussion.
Three Months Ended
Revenue increased$8.2 billion or 22% driven by growth across each of our segments. Intelligent Cloud revenue increased driven by Azure and other cloud services. Productivity and Business Processes revenue increased driven by Office 365 Commercial and LinkedIn. More Personal Computing revenue increased driven by Search and news advertising, Windows, and Gaming.
Cost of revenue increased
Gross margin increased
• Gross margin percentage decreased slightly. Excluding the impact of the
change in accounting estimate for the useful lives of our server and
network equipment, gross margin percentage increased 1 point, driven by
improvements in Productivity and Business Processes and Intelligent Cloud.
• Microsoft Cloud gross margin percentage decreased slightly to 71%.
Excluding the impact of the change in accounting estimate,
gross margin percentage increased 4 points, driven by improvement in Azure
and other cloud services, offset in part by sales mix shift to Azure and
other cloud services.
Operating expenses increased
Key changes in operating expenses were:
• Research and development expenses increased
investments in cloud engineering and Gaming.
• Sales and marketing expenses increased $316 million or 7% driven by
investments in commercial sales, Windows marketing, and LinkedIn.
• General and administrative expenses increased
by an increase in headcount.
Operating income increased
Current year net income and diluted EPS were positively impacted by the net tax benefit related to the transfer of intangible properties, which resulted in an increase to net income and diluted EPS of$3.3 billion and$0.44 , respectively.
Revenue, gross margin, and operating income included a favorable foreign currency impact of 2%, 2%, and 3%, respectively.
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SEGMENT RESULTS OF OPERATIONS
Three Months Ended Percentage
(In millions, except percentages) September 30, Change
2021 2020
Revenue
Productivity and Business Processes $ 15,039 $ 12,319 22%
Intelligent Cloud 16,964 12,986 31%
More Personal Computing 13,314 11,849 12%
Total $ 45,317 $ 37,154 22%
Operating Income
Productivity and Business Processes $ 7,581 $ 5,706 33%
Intelligent Cloud 7,562 5,422 39%
More Personal Computing 5,095 4,748 7%
Total $ 20,238 $ 15,876 27%
Reportable Segments
Three Months Ended
Productivity and Business Processes
Revenue increased
• Office Commercial products and cloud services revenue increased $1.4
billion or 18%. Office 365 Commercial revenue grew 23% driven by seat
growth, up 17% with continued momentum in small and medium business andfrontline worker offerings, and higher revenue per user. Office Commercial
products revenue declined 13% driven by continued customer shift to cloud
offerings, on a low prior year comparable impacted by a slowdown in
transactional licensing.
• Office Consumer products and cloud services revenue increased
or 10% driven by Microsoft 365 Consumer subscription revenue, on a strong
prior year comparable. Microsoft 365 Consumer subscribers increased 19% to
54.1 million.
• LinkedIn revenue increased
demand in our Marketing Solutions business and an improving job market in
our Talent Solutions business.
• Dynamics products and cloud services revenue increased 31% driven by
Dynamics 365 growth of 48%.
Operating income increased
• Gross margin increased
Commercial and LinkedIn. Gross margin percentage increased slightly.
Excluding the impact of the change in accounting estimate, gross margin
percentage increased 2 points, driven by improvement across all cloud
services.
• Operating expenses increased
cloud engineering and LinkedIn.
Revenue, gross margin, and operating income included a favorable foreign currency impact of 2%, 2%, and 4%, respectively.
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Intelligent Cloud
Revenue increased
• Server products and cloud services revenue increased
driven by Azure and other cloud services. Azure and other cloud services
revenue grew 50% driven by growth in our consumption-based services.
Server products revenue increased 14% driven by hybrid solutions,
including Windows Server and SQL Server running in multi-cloud
environments, with an increase in multi-year agreements that carry higherin-quarter revenue recognition, on a low prior year comparable impacted by
a slowdown in transactional licensing.
• Enterprise Services revenue increased
in
Operating income increased
• Gross margin increased
other cloud services. Gross margin percentage decreased. Excluding the
impact of the change in accounting estimate, gross margin percentage
increased 2 points, driven by gross margin percentage improvement in Azure
and other cloud services, offset in part by sales mix shift to Azure and
other cloud services.
• Operating expenses increased
Azure and other cloud services.
Revenue, gross margin, and operating income each included a favorable foreign currency impact of 2%.
More Personal Computing
Revenue increased
• Windows revenue increased
OEM and Windows Commercial. Windows OEM revenue increased 10%, including 7
points of negative impact from the Windows 11 revenue deferral, driven by
growth in the PC market, particularly in commercial with higher revenue
per license. Windows Commercial products and cloud services revenue
increased 12% driven by demand for Microsoft 365.
• Search and news advertising revenue increased
and news advertising revenue excluding traffic acquisition costs increased
40% driven by higher revenue per search, on a low prior year comparable.
• Gaming revenue increased
hardware. Xbox hardware revenue increased 166% driven by higher volume and
price of consoles sold due to continued demand for Xbox Series X|S, on a
low prior year comparable impacted by a slowdown in volume of consoles
sold ahead of Xbox Series X|S launches. Xbox content and services revenue
increased 2% driven by growth in
first-party titles, offset in part by a decline in third-party titles, on
a strong prior year comparable that benefitted from stay-at-home
scenarios.
• Surface revenue decreased
comparable.
Operating income increased
• Gross margin increased
Search and news advertising. Gross margin percentage decreased driven by
sales mix shift to Gaming hardware.
• Operating expenses increased
Gaming as well as Windows marketing.
Gross margin and operating income both included a favorable foreign currency impact of 2%.
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OPERATING EXPENSES
Research and Development
Three Months Ended Percentage
(In millions, except percentages) September 30, Change
2021 2020
Research and development $ 5,599 $ 4,926 14%
As a percent of revenue 12% 13% (1)ppt
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.
Three Months Ended
Research and development expenses increased
Sales and Marketing
Three Months Ended Percentage
(In millions, except percentages) September 30, Change
2021 2020
Sales and marketing $ 4,547 $ 4,231 7%
As a percent of revenue 10% 11% (1)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.
Three Months Ended
Sales and marketing expenses increased
General and Administrative
Three Months Ended Percentage
(In millions, except percentages) September 30, Change
2021 2020
General and administrative $ 1,287 $ 1,119 15%
As a percent of revenue 3% 3% 0ppt
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.
Three Months Ended
General and administrative expenses increased
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OTHER INCOME (EXPENSE), NET
The components of other income (expense), net were as follows:
(In millions) Three Months Ended September 30, 2021 2020 Interest and dividends income$ 520 $ 570 Interest expense (539 ) (589 ) Net recognized gains on investments 371 125 Net gains (losses) on derivatives (7 ) 3 Net gains (losses) on foreign currency remeasurements (65 ) 139 Other, net 6 0 Total$ 286 $ 248
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 hedging instruments are primarily recognized in other income (expense), net.
Three Months Ended
Interest and dividends income decreased due to lower portfolio balances.
Interest expense decreased due to a decrease in outstanding long-term debt due
to debt maturities. Net recognized gains on investments increased due to higher
gains on equity securities.
INCOME TAXES
Effective Tax Rate
Our effective tax rate was 0% and 14% for the three months ended September 30,
2021 and 2020, respectively. The decrease in our effective tax rate for the
current quarter compared to the prior year was primarily due to a $3.3 billion
net income tax benefit in the first quarter of fiscal year 2022 related to the
transfer of intangible properties.
In the first quarter of fiscal year 2022, we transferred certain intangible
properties from our Puerto Rico subsidiary to the U.S. The transfer of
intangible properties resulted in a $3.3 billion net income tax benefit in the
first quarter of fiscal year 2022, as the value of future U.S. tax deductions
exceeds the current tax liability from the U.S. global intangible low-taxed
income tax.
Our effective tax rate was lower than the U.S. federal statutory rate for the
three months ended September 30, 2021 , primarily due to the net income tax
benefit related to the transfer of intangible properties, earnings taxed at
lower rates in foreign jurisdictions resulting from producing and distributing
our products and services through our foreign regional operations center in
Ireland , and tax benefits relating to stock-based compensation.
Uncertain Tax Positions
We settled a portion of the Internal Revenue Service ("IRS") audit for tax years
2004 to 2006 in fiscal year 2011. In February 2012 , the IRS withdrew its 2011
Revenue Agents Report related to unresolved issues for tax years 2004 to 2006
and reopened the audit phase of the examination. We also settled a portion of
the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of
the IRS audit for tax years 2010 to 2013 in fiscal year 2018. In the second
quarter of fiscal year 2021, we settled an additional portion of the IRS audits
for tax years 2004 to 2013 and made a payment of $1.7 billion , including tax and
interest. We remain under audit for tax years 2004 to 2017.
As of September 30, 2021 , the primary unresolved issues for the IRS audits
relate to transfer pricing, which could have a material impact in our
consolidated financial statements when the matters are resolved. We believe our
allowances for income tax contingencies are adequate. We have not received a
proposed assessment for the unresolved key transfer pricing 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.
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We are subject to income tax in many jurisdictions outside the U.S. Our
operations in certain jurisdictions remain subject to examination for tax years
1996 to 2021, some of which are currently under audit by local tax authorities.
The resolution of each of these audits is not expected to be material to our
consolidated financial statements.
NON-GAAP FINANCIAL MEASURES
Adjusted net income and adjusted diluted EPS are non-GAAP financial measures
which exclude the net tax benefit related to the transfer of intangible
properties in fiscal year 2022. We believe these non-GAAP measures aid investors
by providing additional insight into our operational performance and help
clarify trends affecting our business. For comparability of reporting,
management considers non-GAAP measures in conjunction with GAAP financial
results in evaluating business performance. These non-GAAP financial measures
presented should not be considered a substitute for, or superior to, the
measures of financial performance prepared in accordance with GAAP.
The following table reconciles our financial results reported in accordance with GAAP to non-GAAP financial results:
Three Months Ended Percentage
(In millions, except percentages) September 30, Change
2021 2020
Net income $ 20,505 $ 13,893 48%
Net income tax benefit related to transfer of
intangible properties (3,291 ) 0 *
Adjusted net income (non-GAAP) $ 17,214 $ 13,893 24%
Diluted earnings per share $ 2.71 $ 1.82 49%
Net income tax benefit related to transfer of
intangible properties (0.44 ) 0 *
Adjusted diluted earnings per share (non-GAAP)
25%
* Not meaningful.
FINANCIAL CONDITION
Cash, Cash Equivalents, and Investments
Cash, cash equivalents, and short-term investments totaled$130.6 billion and$130.3 billion as ofSeptember 30, 2021 andJune 30, 2021 . Equity investments were$6.4 billion and$6.0 billion as ofSeptember 30, 2021 andJune 30, 2021 , respectively. Our short-term investments are primarily intended to facilitate liquidity and capital preservation. They consist predominantly of highly liquid investment-grade fixed-income securities, diversified among industries and individual issuers. The investments are predominantlyU.S. dollar-denominated securities, but also include foreign currency-denominated securities 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.
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 asU.S. government securities, common and preferred stock, and mutual funds. 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 commercial paper, certificates of deposit,U.S. agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. 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. 40 --------------------------------------------------------------------------------
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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 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.
Cash Flows
Three Months Ended
Cash from operations increased$5.2 billion to$24.5 billion for the three months endedSeptember 30, 2021 , mainly due to an increase in cash received from customers, offset in part by an increase in cash paid to employees. Cash used in financing increased$6.0 billion to$16.3 billion for the three months endedSeptember 30, 2021 , mainly due to a$4.8 billion increase in repayments of debt and a$941 million increase in common stock repurchases. Cash used in investing decreased$2.1 billion to$3.3 billion for the three months endedSeptember 30, 2021 , mainly due to a$2.1 billion increase in cash from net investment purchases, sales, and maturities and a$1.7 billion decrease in other investing to facilitate the purchase of components, offset in part by a$903 million increase in additions to property and equipment and a$725 million increase in cash used for acquisitions of companies, net of cash acquired, and purchases of intangible and other assets.
Debt
We issue 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. InMarch 2021 andJune 2020 , we exchanged a portion of our existing debt at a premium for cash and new debt with longer maturities to take advantage of favorable financing rates in the debt markets, reflecting our credit rating and the low interest rate environment. Refer to Note 10 - Debt of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) for further discussion. Unearned Revenue Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include Software Assurance ("SA") and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments for other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service.
The following table outlines the expected future recognition of unearned revenue
as of
(In millions) Three Months EndingDecember 31, 2021 $ 17,504 March 31, 2022 12,044 June 30, 2022 7,103 September 30, 2022 1,814 Thereafter 2,550 Total$ 41,015
If our customers choose to license cloud-based versions of our products and services rather than licensing transaction-based products and services, the associated revenue will shift from being recognized at the time of the transaction to being recognized over the subscription period or upon consumption, as applicable.
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Share Repurchases
For the three months ended September 30, 2021 and 2020, we repurchased 21
million shares and 25 million shares of our common stock for $6.2 billion and
$5.3 billion , respectively, through our share repurchase programs. All
repurchases were made using cash resources. Refer to Note 15 - Stockholders'
Equity of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q)
for further discussion.
Dividends
Refer to Note 15 - Stockholders' Equity of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) 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. Additionally, we have agreed to cover damages resulting from breaches of certain security and privacy commitments in our cloud business. In evaluating estimated losses on these obligations, 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 in our consolidated financial statements during the periods presented.
Other Planned Uses of Capital
OnApril 11, 2021 , we entered into a definitive agreement to acquire Nuance Communications, Inc. ("Nuance") for$56.00 per share in an all-cash transaction valued at$19.7 billion , inclusive of Nuance's net debt. The acquisition has been approved by Nuance's shareholders, and we expect it to close by the end of the second quarter or early in the third quarter of fiscal year 2022, subject to the satisfaction of certain regulatory approvals and other customary closing conditions. 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, datacenters, and computer systems for research and development, sales and marketing, support, and administrative staff. We expect capital expenditures to increase in coming years to support growth in our cloud offerings. We have operating and finance leases for datacenters, corporate offices, research and development facilities,Microsoft Experience Centers, 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
As a result of the Tax Cuts and Jobs Act ("TCJA"), we are required to pay a
one-time transition tax on deferred foreign income not previously subject to
U.S. income tax. Under the TCJA, the transition tax is payable in interest-free
installments over eight years, with 8% due in each of the first five years, 15%
in year six, 20% in year seven, and 25% in year eight. We have paid transition
tax of $6.2 billion , which included $1.5 billion during the three months ended
September 30, 2021 . The remaining transition tax of $12.1 billion is payable
over the next four years with a final payment in fiscal year 2026.
We expect existing cash, cash equivalents, short-term investments, cash flows
from operations, and access to capital markets to continue to be sufficient to
fund our operating activities and cash commitments for investing and financing
activities, such as dividends, share repurchases, debt maturities, material
capital expenditures, and the transition tax related to the TCJA, for at least
the next 12 months and thereafter for the foreseeable future.
RECENT ACCOUNTING GUIDANCERefer to Note 1 - Accounting Policies of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) for further discussion.
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APPLICATION OF CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements and accompanying notes are prepared in
accordance with 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 management's application of accounting policies, as well as
uncertainty in the current economic environment due to COVID-19. Critical
accounting policies for us include revenue recognition, impairment of investment
securities, goodwill, research and development costs, legal and other
contingencies, income taxes, and inventories.
Revenue Recognition
Our contracts with customers often include promises to transfer multiple
products and services to a customer. Determining whether products and services
are considered distinct performance obligations that should be accounted for
separately versus together may require significant judgment. When a cloud-based
service includes both on-premises software licenses and cloud services, judgment
is required to determine whether the software license is considered distinct and
accounted for separately, or not distinct and accounted for together with the
cloud service and recognized over time. Certain cloud services, primarily Office
365, depend on a significant level of integration, interdependency, and
interrelation between the desktop applications and cloud services, and are
accounted for together as one performance obligation. Revenue from Office 365 is
recognized ratably over the period in which the cloud services are provided.
Judgment is required to determine the stand-alone selling price ("SSP") for each
distinct performance obligation. We use a single amount to estimate SSP for
items that are not sold separately, including on-premises licenses sold with SA
or software updates provided at no additional charge. We use a range of amounts
to estimate SSP when we sell each of the products and services separately and
need to determine whether there is a discount to be allocated based on the
relative SSP of the various products and services.
In instances where SSP is not directly observable, such as when we do not sell
the product or service separately, we determine the SSP using information that
may include market conditions and other observable inputs. We typically have
more than one SSP for individual products and services due to the stratification
of those products and services by customers and circumstances. In these
instances, we may use information such as the size of the customer and
geographic region in determining the SSP.
Due to the various benefits from and the nature of our SA program, judgment is
required to assess the pattern of delivery, including the exercise pattern of
certain benefits across our portfolio of customers.
Our products are generally sold with a right of return, we may provide other
credits or incentives, and in certain instances we estimate customer usage of
our products and services, which are accounted for as variable consideration
when determining the amount of revenue to recognize. Returns and credits are
estimated at contract inception and updated at the end of each reporting period
if additional information becomes available. Changes to our estimated variable
consideration were not material for the periods presented.
Impairment of
We review debt investments quarterly for credit losses and impairment. If the
cost of an investment exceeds its fair value, we evaluate, among other factors,
general market conditions, credit quality of debt instrument issuers, and the
extent to which the fair value is less than cost. This determination requires
significant judgment. In making this judgment, we employ a systematic
methodology that considers available quantitative and qualitative evidence in
evaluating potential impairment of our investments. In addition, we consider
specific adverse conditions related to the financial health of, and business
outlook for, the investee. If 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,
then a decline in fair value below cost is recorded as an impairment charge in
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.
Equity investments without readily determinable fair values are written down to
fair value if a qualitative assessment indicates that the investment is impaired
and the fair value of the investment is less than carrying value. We perform a
qualitative assessment on a periodic basis. We are required to estimate the fair
value of the investment to determine the amount of the impairment loss. Once an
investment is determined to be impaired, an impairment charge is recorded in
other income (expense), net.
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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 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.
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, 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 production. 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 entity's 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 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 net
realizable value. Cost includes materials, labor, and manufacturing overhead
related to the purchase and production of inventories. Net realizable value is
the estimated selling price less estimated costs of completion, disposal, and
transportation. 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.
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Item 3, 4© Edgar Online, source
