UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒ |
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended December 31, 2017
OR
☐ |
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Transition Period From to
Commission File Number: 001-37845
MICROSOFT CORPORATION
(Exact name of registrant as specified in its charter)
Washington |
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91-1144442 |
(State or other jurisdiction of incorporation or organization) |
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(I.R.S. Employer Identification No.) |
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One Microsoft Way, Redmond, Washington |
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98052-6399 |
(Address of principal executive offices) |
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(Zip Code) |
(425) 882-8080
(Registrant’s telephone number, including area code)
None
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☒ |
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Accelerated filer ☐ |
Non-accelerated filer ☐ (Do not check if a smaller reporting company) |
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Smaller reporting company ☐ |
Emerging growth company ☐ |
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If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class |
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Outstanding as of January 26, 2018 |
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Common Stock, $0.00000625 par value per share |
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7,699,792,852 shares |
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FORM 10-Q
For the Quarter Ended December 31, 2017
INDEX
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Page |
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PART I. |
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Item 1. |
3 |
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a) |
Income Statements for the Three and Six Months Ended December 31, 2017 and 2016 |
3 |
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b) |
Comprehensive Income Statements for the Three and Six Months Ended December 31, 2017 and 2016 |
4 |
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c) |
5 |
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d) |
Cash Flows Statements for the Three and Six Months Ended December 31, 2017 and 2016 |
6 |
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e) |
Stockholders’ Equity Statements for the Three and Six Months Ended December 31, 2017 and 2016 |
7 |
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f) |
8 |
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g) |
39 |
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Item 2. |
Management’s Discussion and Analysis of Financial Condition and Results of Operations |
40 |
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Item 3. |
55 |
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Item 4. |
56 |
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PART II. |
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Item 1. |
57 |
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Item 1A. |
57 |
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Item 2. |
67 |
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Item 5. |
67 |
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Item 6. |
68 |
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69 |
2
PART I
Item 1
(In millions, except per share amounts) (Unaudited) |
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Three Months Ended |
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Six Months Ended |
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2017 |
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2016 |
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2017 |
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2016 |
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Revenue: |
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Product |
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$ |
17,926 |
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$ |
18,273 |
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$ |
32,224 |
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$ |
33,241 |
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Service and other |
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10,992 |
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7,553 |
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21,232 |
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14,513 |
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Total revenue |
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28,918 |
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25,826 |
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53,456 |
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47,754 |
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Cost of revenue: |
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Product |
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5,498 |
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5,378 |
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8,478 |
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8,959 |
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Service and other |
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5,566 |
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4,523 |
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10,864 |
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8,786 |
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Total cost of revenue |
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11,064 |
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9,901 |
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19,342 |
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17,745 |
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Gross margin |
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17,854 |
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15,925 |
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34,114 |
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30,009 |
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Research and development |
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3,504 |
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3,062 |
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7,078 |
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6,168 |
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Sales and marketing |
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4,562 |
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4,079 |
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8,374 |
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7,297 |
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General and administrative |
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1,109 |
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879 |
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2,275 |
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1,924 |
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Operating income |
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8,679 |
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7,905 |
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16,387 |
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14,620 |
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Other income, net |
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490 |
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117 |
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766 |
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229 |
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Income before income taxes |
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9,169 |
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8,022 |
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17,153 |
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14,849 |
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Provision for income taxes |
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15,471 |
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1,755 |
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16,879 |
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2,915 |
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Net income (loss) |
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$ |
(6,302 |
) |
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$ |
6,267 |
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$ |
274 |
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$ |
11,934 |
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Earnings (loss) per share: |
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Basic |
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$ |
(0.82 |
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$ |
0.81 |
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$ |
0.04 |
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$ |
1.54 |
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Diluted |
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$ |
(0.82 |
) |
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$ |
0.80 |
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$ |
0.04 |
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$ |
1.52 |
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Weighted average shares outstanding: |
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Basic |
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7,710 |
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7,755 |
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7,709 |
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7,772 |
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Diluted |
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7,710 |
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7,830 |
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7,799 |
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7,853 |
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Cash dividends declared per common share |
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$ |
0.42 |
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$ |
0.39 |
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$ |
0.84 |
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$ |
0.78 |
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Refer to accompanying notes.
3
PART I
Item 1
COMPREHENSIVE INCOME STATEMENTS
(In millions) (Unaudited) |
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Three Months Ended |
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Six Months Ended |
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2017 |
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2016 |
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2017 |
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2016 |
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Net income (loss) |
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$ |
(6,302 |
) |
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$ |
6,267 |
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$ |
274 |
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$ |
11,934 |
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Other comprehensive income (loss), net of tax: |
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Net change related to derivatives |
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(7 |
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280 |
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(113 |
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243 |
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Net change related to investments |
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(878 |
) |
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(994 |
) |
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(1,166 |
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(911 |
) |
Translation adjustments and other |
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(40 |
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(592 |
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253 |
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(474 |
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Other comprehensive loss |
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(925 |
) |
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(1,306 |
) |
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(1,026 |
) |
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(1,142 |
) |
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Comprehensive income (loss) |
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$ |
(7,227 |
) |
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$ |
4,961 |
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$ |
(752 |
) |
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$ |
10,792 |
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Refer to accompanying notes. Refer to Note 18 – Accumulated Other Comprehensive Income (Loss) for further information.
4
PART I
Item 1
(In millions) (Unaudited) |
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December 31, |
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June 30, |
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Assets |
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Current assets: |
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Cash and cash equivalents |
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$ |
12,859 |
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$ |
7,663 |
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Short-term investments (including securities loaned of $4,247 and $3,694) |
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129,921 |
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125,318 |
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Total cash, cash equivalents, and short-term investments |
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142,780 |
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132,981 |
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Accounts receivable, net of allowance for doubtful accounts of $337 and $345 |
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18,428 |
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22,431 |
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Inventories |
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2,003 |
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2,181 |
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Other |
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4,422 |
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5,103 |
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Total current assets |
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167,633 |
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162,696 |
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Property and equipment, net of accumulated depreciation of $26,849 and $24,179 |
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26,304 |
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23,734 |
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Operating lease right-of-use assets |
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6,749 |
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6,555 |
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Equity and other investments |
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3,961 |
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6,023 |
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Goodwill |
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35,355 |
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35,122 |
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Intangible assets, net |
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9,034 |
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10,106 |
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Other long-term assets |
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6,967 |
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6,076 |
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Total assets |
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$ |
256,003 |
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$ |
250,312 |
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Liabilities and stockholders’ equity |
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Current liabilities: |
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Accounts payable |
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$ |
7,850 |
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$ |
7,390 |
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Short-term debt |
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12,466 |
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|
9,072 |
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Current portion of long-term debt |
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3,446 |
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|
1,049 |
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Accrued compensation |
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4,427 |
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5,819 |
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Short-term income taxes |
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|
788 |
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|
718 |
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Short-term unearned revenue |
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21,309 |
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24,013 |
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Securities lending payable |
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26 |
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|
97 |
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Other |
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7,787 |
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7,587 |
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Total current liabilities |
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58,099 |
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|
55,745 |
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Long-term debt |
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|
73,348 |
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|
76,073 |
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Long-term income taxes |
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|
30,050 |
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|
13,485 |
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Long-term unearned revenue |
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|
2,500 |
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|
2,643 |
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Deferred income taxes |
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|
3,186 |
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5,734 |
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Operating lease liabilities |
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5,640 |
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|
5,372 |
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Other long-term liabilities |
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4,820 |
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|
3,549 |
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Total liabilities |
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177,643 |
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|
162,601 |
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Commitments and contingencies |
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Stockholders’ equity: |
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Common stock and paid-in capital – shares authorized 24,000; outstanding 7,705 and 7,708 |
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|
70,192 |
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|
69,315 |
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Retained earnings |
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|
8,567 |
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|
17,769 |
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Accumulated other comprehensive income (loss) |
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|
(399 |
) |
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|
627 |
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Total stockholders’ equity |
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78,360 |
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|
87,711 |
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Total liabilities and stockholders’ equity |
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$ |
256,003 |
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$ |
250,312 |
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Refer to accompanying notes.
5
PART I
Item 1
(In millions) (Unaudited) |
|
Three Months Ended December 31, |
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Six Months Ended December 31, |
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2017 |
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2016 |
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2017 |
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2016 |
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Operations |
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Net income (loss) |
|
$ |
(6,302 |
) |
|
$ |
6,267 |
|
|
$ |
274 |
|
|
$ |
11,934 |
|
Adjustments to reconcile net income (loss) to net cash from operations: |
|
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|
|
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|
|
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|
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Depreciation, amortization, and other |
|
|
2,536 |
|
|
|
2,166 |
|
|
|
5,035 |
|
|
|
3,982 |
|
Stock-based compensation expense |
|
|
986 |
|
|
|
767 |
|
|
|
1,959 |
|
|
|
1,470 |
|
Net recognized gains on investments and derivatives |
|
|
(684 |
) |
|
|
(652 |
) |
|
|
(1,207 |
) |
|
|
(963 |
) |
Deferred income taxes |
|
|
(2,305 |
) |
|
|
5 |
|
|
|
(2,358 |
) |
|
|
545 |
|
Changes in operating assets and liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable |
|
|
(3,908 |
) |
|
|
(2,789 |
) |
|
|
4,041 |
|
|
|
4,398 |
|
Inventories |
|
|
1,205 |
|
|
|
1,132 |
|
|
|
182 |
|
|
|
265 |
|
Other current assets |
|
|
354 |
|
|
|
1,300 |
|
|
|
36 |
|
|
|
335 |
|
Other long-term assets |
|
|
(344 |
) |
|
|
(200 |
) |
|
|
(622 |
) |
|
|
(293 |
) |
Accounts payable |
|
|
938 |
|
|
|
99 |
|
|
|
531 |
|
|
|
(344 |
) |
Unearned revenue |
|
|
(1,065 |
) |
|
|
(1,077 |
) |
|
|
(2,871 |
) |
|
|
(2,884 |
) |
Income taxes |
|
|
15,974 |
|
|
|
843 |
|
|
|
16,635 |
|
|
|
1,407 |
|
Other current liabilities |
|
|
643 |
|
|
|
(1,267 |
) |
|
|
(1,521 |
) |
|
|
(1,727 |
) |
Other long-term liabilities |
|
|
(153 |
) |
|
|
(301 |
) |
|
|
201 |
|
|
|
(283 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash from operations |
|
|
7,875 |
|
|
|
6,293 |
|
|
|
20,315 |
|
|
|
17,842 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financing |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from issuance (repayments) of short-term debt, maturities of 90 days or less, net |
|
|
3,759 |
|
|
|
(3,755 |
) |
|
|
49 |
|
|
|
(7,145 |
) |
Proceeds from issuance of debt |
|
|
3,229 |
|
|
|
17,069 |
|
|
|
7,183 |
|
|
|
42,046 |
|
Repayments of debt |
|
|
(3,327 |
) |
|
|
(4,118 |
) |
|
|
(4,496 |
) |
|
|
(4,343 |
) |
Common stock issued |
|
|
189 |
|
|
|
131 |
|
|
|
496 |
|
|
|
372 |
|
Common stock repurchased |
|
|
(2,008 |
) |
|
|
(3,599 |
) |
|
|
(4,578 |
) |
|
|
(7,961 |
) |
Common stock cash dividends paid |
|
|
(3,238 |
) |
|
|
(3,024 |
) |
|
|
(6,241 |
) |
|
|
(5,824 |
) |
Other, net |
|
|
(156 |
) |
|
|
312 |
|
|
|
(306 |
) |
|
|
200 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash from (used in) financing |
|
|
(1,552 |
) |
|
|
3,016 |
|
|
|
(7,893 |
) |
|
|
17,345 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investing |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additions to property and equipment |
|
|
(2,586 |
) |
|
|
(1,988 |
) |
|
|
(4,718 |
) |
|
|
(4,151 |
) |
Acquisition of companies, net of cash acquired, and purchases of intangible and other assets |
|
|
(27 |
) |
|
|
(24,760 |
) |
|
|
(206 |
) |
|
|
(24,784 |
) |
Purchases of investments |
|
|
(45,154 |
) |
|
|
(46,775 |
) |
|
|
(78,115 |
) |
|
|
(103,956 |
) |
Maturities of investments |
|
|
6,352 |
|
|
|
8,715 |
|
|
|
11,578 |
|
|
|
17,374 |
|
Sales of investments |
|
|
41,261 |
|
|
|
48,987 |
|
|
|
64,297 |
|
|
|
81,310 |
|
Securities lending payable |
|
|
(177 |
) |
|
|
1,070 |
|
|
|
(71 |
) |
|
|
986 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing |
|
|
(331 |
) |
|
|
(14,751 |
) |
|
|
(7,235 |
) |
|
|
(33,221 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of foreign exchange rates on cash and cash equivalents |
|
|
(17 |
) |
|
|
(18 |
) |
|
|
9 |
|
|
|
(8 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash equivalents |
|
|
5,975 |
|
|
|
(5,460 |
) |
|
|
5,196 |
|
|
|
1,958 |
|
Cash and cash equivalents, beginning of period |
|
|
6,884 |
|
|
|
13,928 |
|
|
|
7,663 |
|
|
|
6,510 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of period |
|
$ |
12,859 |
|
|
$ |
8,468 |
|
|
$ |
12,859 |
|
|
$ |
8,468 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Refer to accompanying notes.
6
PART I
Item 1
STOCKHOLDERS’ EQUITY STATEMENTS
(In millions) (Unaudited) |
|
Three Months Ended December 31, |
|
|
Six Months Ended December 31, |
|
||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||
|
|
2017 |
|
|
2016 |
|
|
2017 |
|
|
2016 |
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||||
Common stock and paid-in capital |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, beginning of period |
|
$ |
69,419 |
|
|
$ |
67,747 |
|
|
$ |
69,315 |
|
|
$ |
68,178 |
|
Common stock issued |
|
|
189 |
|
|
|
131 |
|
|
|
496 |
|
|
|
372 |
|
Common stock repurchased |
|
|
(402 |
) |
|
|
(561 |
) |
|
|
(1,577 |
) |
|
|
(1,935 |
) |
Stock-based compensation expense |
|
|
986 |
|
|
|
767 |
|
|
|
1,959 |
|
|
|
1,470 |
|
Other, net |
|
|
0 |
|
|
|
93 |
|
|
|
(1 |
) |
|
|
92 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, end of period |
|
|
70,192 |
|
|
|
68,177 |
|
|
|
70,192 |
|
|
|
68,177 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retained earnings |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, beginning of period |
|
|
19,702 |
|
|
|
12,757 |
|
|
|
17,769 |
|
|
|
13,118 |
|
Net income (loss) |
|
|
(6,302 |
) |
|
|
6,267 |
|
|
|
274 |
|
|
|
11,934 |
|
Common stock cash dividends |
|
|
(3,232 |
) |
|
|
(3,003 |
) |
|
|
(6,471 |
) |
|
|
(6,028 |
) |
Common stock repurchased |
|
|
(1,601 |
) |
|
|
(3,021 |
) |
|
|
(3,005 |
) |
|
|
(6,024 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, end of period |
|
|
8,567 |
|
|
|
13,000 |
|
|
|
8,567 |
|
|
|
13,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated other comprehensive income (loss) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, beginning of period |
|
|
526 |
|
|
|
1,958 |
|
|
|
627 |
|
|
|
1,794 |
|
Other comprehensive loss |
|
|
(925 |
) |
|
|
(1,306 |
) |
|
|
(1,026 |
) |
|
|
(1,142 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, end of period |
|
|
(399 |
) |
|
|
652 |
|
|
|
(399 |
) |
|
|
652 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stockholders’ equity |
|
$ |
78,360 |
|
|
$ |
81,829 |
|
|
$ |
78,360 |
|
|
$ |
81,829 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Refer to accompanying notes.
7
PART I
Item 1
(Unaudited)
NOTE 1 — ACCOUNTING POLICIES
Accounting Principles
Our unaudited interim consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). In the opinion of management, the unaudited interim consolidated financial statements reflect all adjustments of a normal recurring nature that are necessary for a fair presentation of the results for the interim periods presented. Interim results are not necessarily indicative of results for a full year. The information included in this Form 10-Q should be read in conjunction with information included in the Microsoft Corporation 2017 Form 10-K filed with the U.S. Securities and Exchange Commission on August 2, 2017.
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 for which we are able to exercise significant influence over but do not control the investee and are not the primary beneficiary of the investee’s activities are accounted for using the equity method. Investments for 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 and assumptions include: for revenue recognition, determining the nature and timing of satisfaction of performance obligations, and determining the standalone selling price (“SSP”) of performance obligations, variable consideration, and other obligations such as product returns and refunds; loss contingencies; product warranties; the fair value of and/or potential impairment of goodwill and intangible assets for our reporting units; product life cycles; useful lives of our tangible and intangible assets; allowances for doubtful accounts; the market value of, and demand for, our inventory; stock-based compensation forfeiture rates; when technological feasibility is achieved for our products; the potential outcome of future tax consequences of events that have been recognized on our consolidated financial statements or tax returns; and determining when investment impairments are other-than-temporary. Actual results and outcomes may differ from management’s estimates and assumptions.
Revenue
Product Revenue and Service and Other Revenue
Product revenue includes sales from operating systems; cross-device productivity applications; server applications; business solution applications; desktop and server management tools; software development tools; video games; and hardware such as PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories.
Service and other revenue includes sales from cloud-based solutions that provide customers with software, services, platforms, and content such as Microsoft Office 365, Microsoft Azure, Microsoft Dynamics 365, and Xbox Live; solution support; and consulting services. Service and other revenue also includes sales from online advertising and LinkedIn.
Revenue Recognition
Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We enter into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities.
8
PART I
Item 1
Nature of Products and Services
Licenses for on-premises software provide the customer with a right to use the software as it exists when made available to the customer. Customers may purchase perpetual licenses or subscribe to licenses, which provide customers with the same functionality and differ mainly in the duration over which the customer benefits from the software. Revenue from distinct on-premises licenses is recognized upfront at the point in time when the software is made available to the customer. In cases where we allocate revenue to software updates, primarily because the updates are provided at no additional charge, revenue is recognized as the updates are provided, which is generally ratably over the estimated life of the related device or license.
Certain volume licensing programs, including Enterprise Agreements, include on-premises licenses combined with Software Assurance (“SA”). SA conveys rights to new software and upgrades released over the contract period and provides support, tools, and training to help customers deploy and use products more efficiently. On-premises licenses are considered distinct performance obligations when sold with SA. Revenue allocated to SA is generally recognized ratably over the contract period as customers simultaneously consume and receive benefits, given that SA comprises distinct performance obligations that are satisfied over time.
Cloud services, which allow customers to use hosted software over the contract period without taking possession of the software, are provided on either a subscription or consumption basis. Revenue related to cloud services provided on a subscription basis is recognized ratably over the contract period. Revenue related to cloud services provided on a consumption basis, such as the amount of storage used in a period, is recognized based on the customer utilization of such resources. When cloud services require a significant level of integration and interdependency with software and the individual components are not considered distinct, all revenue is recognized over the period in which the cloud services are provided.
Revenue from search advertising is recognized when the advertisement appears in the search results or when the action necessary to earn the revenue has been completed. Revenue from consulting services is recognized as services are provided.
Our hardware is generally highly dependent on, and interrelated with, the underlying operating system and cannot function without the operating system. In these cases, the hardware and software license are accounted for as a single performance obligation and revenue is recognized at the point in time when ownership is transferred to resellers or directly to end customers through retail stores and online marketplaces.
Refer to Note 19 – Segment Information and Geographic Data for further information, including revenue by significant product and service offering.
Significant Judgments
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 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.
9
PART I
Item 1
Our products are generally sold with a right of return and we may provide other credits or incentives, which are accounted for as variable consideration when estimating the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period as additional information becomes available.
Contract Balances
Timing of revenue recognition may differ from the timing of invoicing to customers. We record a receivable when revenue is recognized prior to invoicing, or unearned revenue when revenue is recognized subsequent to invoicing. For multi-year agreements, we generally invoice customers annually at the beginning of each annual coverage period. We record a receivable related to revenue recognized for multi-year on-premises licenses as we have an unconditional right to invoice and receive payment in the future related to those licenses.
The opening balance of current and long-term accounts receivable, net of allowance for doubtful accounts, was $22.3 billion as of July 1, 2016.
As of December 31, 2017 and June 30, 2017, long-term accounts receivable, net of allowance for doubtful accounts, were $1.6 billion and $1.7 billion, respectively, and are included in other long-term assets on our consolidated balance sheets.
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) |
|
|||
|
|
|||
|
|
|||
Six Months Ended December 31, 2017 |
|
|||
|
|
|||
Balance, beginning of period |
|
$ |
361 |
|
Charged to costs and other |
|
|
45 |
|
Write-offs |
|
|
(53 |
) |
|
|
|||
|
|
|
|
|
Balance, end of period |
|
$ |
353 |
|
|
|
|
|
|
|
|
|
|
|
Reported as of December 31, 2017 |
|
|||
|
|
|||
Accounts receivable, net of allowance for doubtful accounts |
|
$ |
337 |
|
Other long-term assets |
|
|
16 |
|
|
|
|||
|
|
|
|
|
Total |
|
$ |
353 |
|
|
|
|
|
|
Unearned revenue is comprised mainly of unearned revenue related to volume licensing programs, which may include 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 consulting services to be performed in the future; LinkedIn subscriptions; Office 365 subscriptions; Xbox Live subscriptions; Dynamics business solutions; Windows 10 post-delivery support; Skype prepaid credits and subscriptions; and other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service.
Refer to Note 14 – Unearned Revenue for further information, including unearned revenue by segment and changes in unearned revenue during the period.
Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 to 60 days. In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined our contracts generally do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period, and multi-year on-premises licenses that are invoiced annually with revenue recognized upfront.
10
PART I
Item 1
Assets Recognized from Costs to Obtain a Contract with a Customer
We recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year. We have determined that certain sales incentive programs meet the requirements to be capitalized. Total capitalized costs to obtain a contract were immaterial during the periods presented and are included in other current and long-term assets on our consolidated balance sheets.
We apply a practical expedient to expense costs as incurred for costs to obtain a contract with a customer when the amortization period would have been one year or less. These costs include our internal sales force compensation program and certain partner sales incentive programs as we have determined annual compensation is commensurate with annual sales activities.
Leases
We determine if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (“ROU”) assets, other current liabilities, and operating lease liabilities on our consolidated balance sheets. Finance leases are included in property and equipment, other current liabilities, and other long-term liabilities on our consolidated balance sheets.
ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term.
We have lease agreements with lease and non-lease components, which are generally accounted for separately. For certain equipment leases, such as vehicles, we account for the lease and non-lease components as a single lease component. Additionally, for certain equipment leases, we apply a portfolio approach to effectively account for the operating lease ROU assets and liabilities.
Recent Tax Legislation
On December 22, 2017, the Tax Cuts and Jobs Act (“TCJA”) was enacted into law, which significantly changes existing U.S. tax law and includes numerous provisions that affect our business. Refer to Note 12 – Income Taxes for further discussion.
As a result of the TCJA, we have recast certain prior period income tax liabilities on our consolidated balance sheets to conform to the current period presentation. Previously reported balances were impacted as follows:
(In millions) |
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As Previously Reported |
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As Adjusted |
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As Previously Reported |
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As Adjusted |
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Balance Sheets |
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June 30, 2017 |
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September 30, 2017 |
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|
|
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|
|
|
|
|
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|
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Long-term income taxes |
|
$ |
0 |
|
|
$ |
13,485 |
|
|
$ |
0 |
|
|
$ |
13,944 |
|
Other long-term liabilities |
|
|
17,034 |
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|
|
3,549 |
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|
|
18,173 |
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|
|
4,229 |
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These adjustments had no impact on our consolidated income statements or net cash from or used in operating, financing, or investing on our consolidated cash flows statements.
Recent Accounting Guidance
Recently Adopted Accounting Guidance
Leases
In February 2016, the Financial Accounting Standards Board (“FASB”) issued a new standard related to leases to increase transparency and comparability among organizations by requiring the recognition of ROU assets and lease liabilities on the balance sheet. Most prominent among the changes in the standard is the recognition of ROU assets
11
PART I
Item 1
and lease liabilities by lessees for those leases classified as operating leases. Under the standard, disclosures are required to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. We are also required to recognize and measure leases existing at, or entered into after, the beginning of the earliest comparative period presented using a modified retrospective approach, with certain practical expedients available.
We elected to early adopt the standard effective July 1, 2017 concurrent with our adoption of the new standard related to revenue recognition. We elected the available practical expedients and implemented internal controls and key system functionality to enable the preparation of financial information on adoption.
The standard had a material impact on our consolidated balance sheets, but did not have an impact on our consolidated income statements. The most significant impact was the recognition of ROU assets and lease liabilities for operating leases, while our accounting for finance leases remained substantially unchanged. Adoption of the standard required us to restate certain previously reported results, including the recognition of additional ROU assets and lease liabilities for operating leases. Refer to Impacts to Previously Reported Results below for the impact of adoption of the standard on our consolidated financial statements.
Revenue from Contracts with Customers
In May 2014, the FASB issued a new standard related to revenue recognition. Under the standard, revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the consideration 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.
We elected to early adopt the standard effective July 1, 2017, using the full retrospective method, which required us to restate each prior reporting period presented. We implemented internal controls and key system functionality to enable the preparation of financial information on adoption.
The most significant impact of the standard relates to our accounting for software license revenue. Specifically, for Windows 10, we recognize revenue predominantly at the time of billing and delivery rather than ratably over the life of the related device. For certain multi-year commercial software subscriptions that include both distinct software licenses and SA, we recognize license revenue at the time of contract execution rather than over the subscription period. Due to the complexity of certain of our commercial license subscription contracts, the actual revenue recognition treatment required under the standard depends on contract-specific terms and in some instances may vary from recognition at the time of billing. Revenue recognition related to our hardware, cloud offerings (such as Office 365), LinkedIn, and professional services remains substantially unchanged.
Adoption of the standard using the full retrospective method required us to restate certain previously reported results, including the recognition of additional revenue and an increase in the provision for income taxes, primarily due to the net change in Windows 10 revenue recognition. In addition, adoption of the standard resulted in an increase in accounts receivable and other current and long-term assets, driven by unbilled receivables from upfront recognition of revenue for certain multi-year commercial software subscriptions that include both distinct software licenses and SA; a reduction of unearned revenue, driven by the upfront recognition of license revenue from Windows 10 and certain multi-year commercial software subscriptions; and an increase in deferred income taxes, driven by the upfront recognition of revenue. Refer to Impacts to Previously Reported Results below for the impact of adoption of the standard on our consolidated financial statements.
12
PART I
Item 1
Impacts to Previously Reported Results
Adoption of the standards related to revenue recognition and leases impacted our previously reported results as follows:
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As Previously Reported |
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New Revenue Standard Adjustment |
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As Restated |
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Income Statements |
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Three Months Ended December 31, 2016 |
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Revenue |
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$ |
24,090 |
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$ |
1,736 |
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$ |
25,826 |
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Provision for income taxes |
|
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1,163 |
|
|
|
592 |
|
|
|
1,755 |
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Net income |
|
|
5,200 |
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|
|
1,067 |
|
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|
6,267 |
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Diluted earnings per share |
|
|
0.66 |
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|
|
0.14 |
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0.80 |
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Six Months Ended December 31, 2016 |
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Revenue |
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$ |
44,543 |
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$ |
3,211 |
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$ |
47,754 |
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Provision for income taxes |
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1,798 |
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1,117 |
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2,915 |
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Net income |
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9,890 |
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2,044 |
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11,934 |
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Diluted earnings per share |
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1.26 |
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0.26 |
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1.52 |
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(In millions) |
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As Previously Reported |
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New Revenue Standard Adjustment |
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New Lease Standard Adjustment |
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As Restated |
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Balance Sheets |
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June 30, 2017 |
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Accounts receivable, net of allowance for doubtful accounts |
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$ |
19,792 |
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$ |
2,639 |
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$ |
0 |
|
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$ |
22,431 |
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Operating lease right-of-use assets |
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0 |
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0 |
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6,555 |
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6,555 |
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Other current and long-term assets |
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11,147 |
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32 |
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0 |
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11,179 |
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Unearned revenue |
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44,479 |
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(17,823 |
) |
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0 |
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26,656 |
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Deferred income taxes |
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|
531 |
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5,203 |
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0 |
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5,734 |
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Operating lease liabilities |
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0 |
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0 |
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5,372 |
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5,372 |
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Other current and long-term liabilities |
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23,464 |
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(26 |
) |
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1,183 |
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24,621 |
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Stockholders' equity |
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72,394 |
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15,317 |
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0 |
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87,711 |
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Adoption of the standards related to revenue recognition and leases had no impact to cash from or used in operating, financing, or investing on our consolidated cash flows statements.
Recent Accounting Guidance Not Yet Adopted
Financial Instruments – Targeted Improvements to Accounting for Hedging Activities
In August 2017, the FASB issued new guidance related to accounting for hedging activities. This guidance expands strategies that qualify for hedge accounting, changes how many hedging relationships are presented in the financial statements, and simplifies the application of hedge accounting in certain situations. The standard will be effective for us beginning July 1, 2019, with early adoption permitted for any interim or annual period before the effective date. Adoption of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date. We are currently evaluating the impact of this standard on our consolidated financial statements, including accounting policies, processes, and systems.
Accounting for Income Taxes – Intra-Entity Asset Transfers
In October 2016, the FASB issued new guidance requiring an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, rather than when the asset has been sold to an outside party. This guidance is effective for us beginning July 1, 2018, with early adoption permitted beginning July 1, 2017. We plan to adopt the guidance effective July 1, 2018. Adoption of the guidance will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date. A cumulative-effect adjustment will capture the write-off of income tax consequences deferred
13
PART I
Item 1
from past intra-entity transfers involving assets other than inventory and new deferred tax assets for amounts not recognized under current GAAP. As a result of the TCJA, we are currently re-evaluating the impact of this standard on our consolidated financial statements, including accounting policies, processes, and systems.
Financial Instruments – Credit Losses
In June 2016, the FASB issued a new standard to replace the incurred loss impairment methodology under current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. We will be required to use a forward-looking expected credit loss model for accounts receivables, loans, and other financial instruments. Credit losses relating to available-for-sale debt securities will also be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. The standard will be effective for us beginning July 1, 2020, with early adoption permitted beginning July 1, 2019. Adoption of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date to align our credit loss methodology with the new standard. We are currently evaluating the impact of this standard on our consolidated financial statements, including accounting policies, processes, and systems.
Financial Instruments – Recognition, Measurement, Presentation, and Disclosure
In January 2016, the FASB issued a new standard related to certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Most prominent among the changes in the standard is the requirement for changes in the fair value of our equity investments, with certain exceptions, to be recognized through net income rather than other comprehensive income (“OCI”). Under the standard, equity investments that do not have a readily determinable fair value are eligible for the measurement alternative. Using the measurement alternative, investments without readily determinable fair values will be valued at cost, with adjustments to fair value for changes in price or impairments reflected through net income.
The standard will be effective for us beginning July 1, 2018. Adoption of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment from accumulated other comprehensive income (“AOCI”) to retained earnings as of the effective date. A cumulative-effect adjustment will capture any previously held unrealized gains and losses held in AOCI related to our equity investments carried at fair value as well as the impact of recording the fair value of certain equity investments carried at cost. The remaining implementation matters include establishing processes and controls around equity securities without readily determinable fair values and evaluating the impact of the standard to our accounting policies and disclosures. We expect to elect the measurement alternative for equity investments that do not have readily determinable fair values.
The impact on our consolidated balance sheets upon adoption will depend on the unrealized gains and losses held in AOCI related to our equity investments on the date of adoption, and on any impact the new guidance may have on our equity investments carried at cost. See Note 4 – Investments for our current investment balances. The impact of the standard going forward on our consolidated income statement will be dependent on our equity investment holdings, with adjustments to fair value reflected through net income. Adoption of the standard is expected to have no impact to cash from or used in operating, financing or investing on our consolidated cash flows statements.
14
PART I
Item 1
NOTE 2 — EARNINGS PER SHARE
Basic earnings per share (“EPS”) is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and stock awards.
The components of basic and diluted EPS were as follows:
(In millions, except per share amounts) |
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Three Months Ended December 31, |
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Six Months Ended December 31, |
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2017 |
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